-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F+oLCCKyoPvQ4zB2+uNFtowa459V87ZViXhbM9C9B5tPPsQIf8EHWuhI2dpmNaef 9JCTxJVAhWvZ58EESbrOaQ== 0001068800-05-000415.txt : 20050614 0001068800-05-000415.hdr.sgml : 20050613 20050614172358 ACCESSION NUMBER: 0001068800-05-000415 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050614 DATE AS OF CHANGE: 20050614 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KV PHARMACEUTICAL CO /DE/ CENTRAL INDEX KEY: 0000057055 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 430618919 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09601 FILM NUMBER: 05895641 BUSINESS ADDRESS: STREET 1: 2503 S HANLEY RD CITY: ST LOUIS STATE: MO ZIP: 63144 BUSINESS PHONE: 3146456600 MAIL ADDRESS: STREET 1: 2503 S HANLEY RD CITY: ST LOUIS STATE: MO ZIP: 63144 10-K 1 kv10k.txt - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2005 Commission file number 1-9601 K-V PHARMACEUTICAL COMPANY (Exact name of registrant as specified in its charter) 2503 South Hanley Road St. Louis, Missouri 63144 (314) 645-6600 DELAWARE 43-0618919 (State of Incorporation) (IRS Employer Identification No.) Securities Registered Pursuant to Section 12(b) of the Act: Class A Common Stock, par value $.01 per share New York Stock Exchange Class B Common Stock, par value $.01 per share New York Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act: 7% Cumulative Convertible Preferred, par value $.01 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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. [X] Yes [ ] No 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No --- --- The aggregate market value of the shares of Class A and Class B Common Stock held by nonaffiliates of the registrant as of September 30, 2004, the last business day of the registrant's most recently completed second fiscal quarter, was $502,350,165 and $144,631,685, respectively. As of June 9, 2005, the registrant had outstanding 35,962,654 and 13,322,699 shares of Class A and Class B Common Stock, respectively, exclusive of treasury shares. DOCUMENTS INCORPORATED BY REFERENCE Part III: Portions of the definitive proxy statement of the registrant (to be filed pursuant to Regulation 14A for registrant's 2005 Annual Meeting of Shareholders, which involves the election of directors), are incorporated by reference into Items 10, 11, 12, 13 and 14 to the extent stated in such items. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Form 10-K, including the documents that we incorporate herein by reference, contains various forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995 ("PSLRA"), which may be based on or include assumptions, concerning our operations, future results and prospects. Such statements may be identified by the use of words like "plans," "expect," "aim," "believe," "projects," "anticipate," "commit," "intend," "estimate," "will," "should," "could," and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including without limitation, statements about our strategy for growth, product development, regulatory approvals, market position, expenditures and financial results, are forward-looking statements. All forward-looking statements are based on current expectations and are subject to risk and uncertainties. In connection with the "safe harbor" provisions, we provide the following cautionary statements identifying important economic, political and technology factors which, among others, could cause the actual results or events to differ materially from those set forth or implied by the forward-looking statements and related assumptions. Such factors include (but are not limited to) the following: (1) changes in the current and future business environment, including interest rates and capital and consumer spending; (2) the difficulty of predicting FDA approvals, including the timing, and that any period of exclusivity may not be realized; (3) acceptance and demand for new pharmaceutical products; (4) the impact of competitive products and pricing; (5) new product development and launch, including but limited to the possibility that any product launch may be delayed or that product acceptance may be less than anticipated; (6) reliance on key strategic alliances; (7) the availability of raw materials; (8) the regulatory environment; (9) fluctuations in operating results; (10) the difficulty of predicting international regulatory approval, including the timing; (11) the difficulty of predicting the pattern of inventory movements by our customers; (12) the impact of competitive response to our sales, marketing and strategic efforts; (13) risks that we may not ultimately prevail in our litigation; and (14) the risks detailed from time to time in our filings with the Securities and Exchange Commission. This discussion is by no means exhaustive, but is designed to highlight important factors that may impact the Company's outlook. Because the factors referred to above, as well as the statements included under the captions "Narrative Description of Business," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Form 10-K, could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and, unless applicable law requires to the contrary, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise, when they will arise and/or their effects. In addition, we cannot assess the impact of each factor on our business or financial condition or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. 2 ITEM 1. BUSINESS -------- (a) GENERAL DEVELOPMENT OF BUSINESS ------------------------------- Unless the context otherwise indicates, when we use the words "we," "our," "us," "our company" or "KV" we are referring to K-V Pharmaceutical Company and its wholly-owned subsidiaries, including Ther-Rx Corporation, ETHEX Corporation and Particle Dynamics, Inc. We were incorporated under the laws of Delaware in 1971 as a successor to a business originally founded in 1942. Victor M. Hermelin, our Chairman and founder, invented and obtained initial patents for early controlled release and enteric coating which became part of our core business and a platform for future drug delivery emphasis. We develop advanced drug delivery technologies which enhance the effectiveness of new therapeutic agents, existing pharmaceutical products and prescription nutritional products. We have developed and patented a wide variety of drug delivery and formulation technologies which are primarily focused in four principal areas: SITE RELEASE(R) bioadhesives; tastemasking; oral controlled release; and oral quick dissolving tablets. We incorporate these technologies in the products we market to control and improve the absorption and utilization of active pharmaceutical compounds. In 1990, we established a generic marketing capability through a wholly-owned subsidiary, ETHEX Corporation ("ETHEX"), which we believe makes us one of the only drug delivery research and development companies that also markets "technologically distinguished" generic products. In 1999, we established a wholly-owned subsidiary, Ther-Rx Corporation ("Ther-Rx"), to market branded pharmaceuticals directly to physician specialists. Our wholly-owned subsidiary, Particle Dynamics, Inc. ("PDI"), was acquired in 1972. Through PDI, we develop and market specialty value-added raw materials, including drugs, directly compressible and microencapsulated products, and other products used in the pharmaceutical, nutritional, food, personal care and other markets. (b) SIGNIFICANT BUSINESS DEVELOPMENTS --------------------------------- In September 2004, we made a settlement payment in the amount of $16.5 million to resolve all previously pending claims between us and Healthpoint, Ltd. without the admission of any liability. The settlement was fully reserved by us in September 2002 and therefore had no impact on our earnings in fiscal 2005. In December 2004, we increased our available credit facilities to $140.0 million. The revised credit facilities provide for an increase from $40.0 million to $80.0 million in our revolving line of credit along with an increase from $25.0 million to $60.0 million in the supplemental credit line that is available for financing acquisitions. These credit facilities expire in October 2006 and December 2005, respectively. In January 2005, Ther-Rx introduced its second New Drug Application, or NDA, approved product, Clindesse(TM), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), our vaginal antifungal cream product, Clindesse(TM) incorporates our proprietary VagiSite(R) bioadhesive drug delivery technology. During fiscal 2005, we entered into two separate licensing agreements for the right to market both Gynazole-1(R) and Clindesse(TM) in Spain, Portugal, Andorra, and Mexico. These arrangements expanded Gynazole-1's future international presence beyond the over 50 markets in Europe, Latin America, the Middle East, Asia, Indonesia, the People's Republic of China, Australia and New Zealand covered in other previously signed licensing agreements. Also, during fiscal 2005, we received our second regulatory approval to market Gynazole-1(R) into an international market. 3 In April 2005, the Company completed the purchase of a 260,000 square foot building in the St. Louis metropolitan area for $11.8 million. The property had been leased by the Company since April 2000 and will continue to function as the Company's main distribution facility. The purchase price was paid with cash on hand. In May 2005, we entered into a long-term product development and marketing license agreement with Strides Arcolab, Ltd, (Strides) an Indian generic pharmaceutical developer and manufacturer, for exclusive marketing rights in the United States and Canada for 10 new generic drugs. Under the agreement, Strides will be responsible for developing, submitting for regulatory approval and manufacturing the 10 products and we will be responsible for exclusively marketing the products in the territories covered by the agreement. Under a separate agreement, we invested $11.3 million in Strides' redeemable preferred stock. In May 2005, the Company and FemmePharma, Inc. (FemmePharma) mutually agreed to terminate the license agreement we entered into with them in April 2002. As part of this transaction, we acquired all of the common stock of FemmePharma for $25.0 million after certain assets of the entity had been distributed to FemmePharma's other shareholders. Included in our acquisition of FemmePharma are the worldwide marketing rights to an endometriosis product that has successfully completed Phase II clinical trials. This product was originally part of the licensing arrangement with FemmePharma that provided us, among other things, marketing rights for the product principally in the United States. In accordance with the new agreement, we are assuming responsibility for conducting the Phase III clinical study, have acquired worldwide licensing rights of the endometriosis product, are no longer responsible for milestone payments and royalties specified in the original licensing agreement, and have secured exclusive worldwide rights for use of the FemmePharma technology for vaginal anti-infective products. We believe the Phase III clinical study for the endometriosis product will begin during fiscal 2006. In connection with this transaction, we expect to incur a charge of approximately $30.0 million in the first quarter of fiscal 2006, which includes the write-off of the $25.0 million payment plus preferred stock investments previously made, and which principally relates to in-process research and development. (c) INDUSTRY SEGMENTS ----------------- We operate principally in three industry segments, consisting of branded products marketing, specialty generics marketing and specialty raw materials marketing. Revenues are derived primarily from directly marketing our own technologically distinguished generic/non-branded and brand-name products. Revenues may also be received in the form of licensing revenues and/or royalty payments based upon a percentage of the licensee's sales of the product, in addition to manufacturing revenues, when marketing rights to products using our advanced drug delivery technologies are licensed. See Note 20 to our consolidated financial statements. (d) NARRATIVE DESCRIPTION OF BUSINESS --------------------------------- OVERVIEW We are a fully integrated specialty pharmaceutical company that develops, acquires, manufactures and markets technologically distinguished branded and generic/non-branded prescription pharmaceutical products. We have a broad range of dosage form capabilities including tablets, capsules, creams, liquids and ointments. We conduct our branded pharmaceutical operations through Ther-Rx and our generic/non-branded pharmaceutical operations through ETHEX. Through PDI, we also develop, manufacture and market technologically advanced, value-added raw material products for the pharmaceutical, nutritional, personal care, food and other markets. We have a broad portfolio of drug delivery technologies which we leverage to create technologically distinguished brand name and specialty generic/non-branded products. We have developed and patented 15 drug delivery and formulation technologies primarily in four principal areas: SITE RELEASE(R) bioadhesives, oral controlled release, tastemasking, and oral quick dissolving tablets. We incorporate these technologies in the products we market to control and improve the absorption and utilization of active pharmaceutical compounds. 4 These technologies provide a number of benefits, including reduced frequency of administration, reduced side effects, improved drug efficacy, enhanced patient compliance and improved taste. We have a long history of developing drug delivery technologies. In the 1950's, we received what we believe to be the first patents for sustained release delivery systems which enhance the convenience and effectiveness of pharmaceutical products. In our early years, we used our technologies to develop products for other drug marketers. Our technologies have been used in several well known products including Actifed(R) 12-hour, Sudafed(R) SA, Centrum Jr.(R) and Kaopectate(R) Chewable. Since the 1990's, we have chosen to focus our drug development expertise on internally developed products for our branded and generic/non-branded pharmaceutical businesses. For example, since its inception in March 1999, our Ther-Rx business has successfully launched seven internally developed branded pharmaceutical products, all of which incorporate our drug delivery technologies. We have also introduced technology-improved versions for three of the branded products acquired by us. Furthermore, most of the internally developed generic/non-branded products marketed by our ETHEX business incorporate one or more of our drug delivery technologies. Our drug delivery technology allows us to differentiate our products in the marketplace, both in the branded and generic/non-branded pharmaceutical areas. We believe that this differentiation provides substantial competitive advantages for our products, allowing us to establish a strong record of growth and profitability and a leadership position in certain segments of our industry. From 1998 to 2005, we have grown net revenues and net income at compounded annual growth rates of 17.6% and 17.1%, respectively. Ther-Rx has grown substantially since its inception in March 1999 and continues to gain market share in its women's healthcare family of products. Also, by focusing on the development and marketing of technology-distinguished, multisource drugs, over half of the more than 140 specialty generic/non-branded products sold by our ETHEX subsidiary are market leaders in the multisource-brand market. THER-RX -- OUR BRAND NAME PHARMACEUTICAL BUSINESS We established Ther-Rx in 1999 to market brand name pharmaceutical products which incorporate our proprietary technologies. Since its inception, Ther-Rx has introduced over 10 products into two principal therapeutic categories - women's health and oral hematinics - where physician specialists can be reached using a highly focused sales force. By targeting physician specialists, we believe Ther-Rx can compete successfully without the need for a sales force as large as pharmaceutical companies with less specialized product lines. Ther-Rx's net revenues grew from $82.9 million in fiscal 2004 to $90.1 million in fiscal 2005 and represented 29.7% of our fiscal 2005 total net revenues. We established our women's healthcare franchise through the August 1999 acquisition of PreCare(R), a prescription prenatal vitamin, from UCB Pharma, Inc. Since the acquisition, Ther-Rx has reformulated the original product using proprietary technologies, and subsequently has launched five internally developed products as extensions to the PreCare(R) product line. Building upon the PreCare(R) acquisition, we have developed a line of proprietary products which makes Ther-Rx the leading provider of branded prescription prenatal vitamins in the United States. The first of our internally developed, patented line extensions to PreCare(R) was PreCare(R) Chewables, the world's first prescription chewable prenatal vitamin. PreCare(R) Chewables addressed a longstanding challenge to improve pregnant women's compliance with prenatal vitamin regimens by alleviating the difficulty that patients experience in swallowing large prenatal pills. Ther-Rx's second internally developed product, PremesisRx(TM), is an innovative prenatal prescription product that incorporates our controlled release Vitamin B(6). This product is designed for use in conjunction with a physician-supervised program to reduce pregnancy-related nausea and vomiting, which is experienced by 50% to 90% of women who become pregnant. The third product, PreCare(R) Conceive(TM), is the first product designed as a prescription nutrional pre-conception supplement. The fourth 5 product, PrimaCare(R), is the first prescription prenatal/postnatal nutritional supplement with essential fatty acids specially designed to help provide nutritional support for women during pregnancy, postpartum recovery and throughout the childbearing years. The fifth product, PrimaCare(R) ONE, was launched in fiscal 2005 as a proprietary line extension to PrimaCare(R) and is the first prenatal product to contain essential fatty acids in a one-dose-per-day dosage form. All of the products in the PreCare(R) product line have been formulated to contain 1 mg. of folic acid, which has been shown to reduce the incidence of fetal neural tube defects by at least 50%. In June 2000, Ther-Rx launched its first NDA approved product, Gynazole-1(R), the only one-dose prescription cream treatment for vaginal yeast infections. Gynazole-1(R) incorporates our patented drug delivery technology, VagiSite(R), the only clinically proven and Federal Food and Drug Administration, or FDA, approved controlled release bioadhesive system. Since its launch, the product has gained a 31.5% market share in the U.S. prescription vaginal antifungal cream market. In addition, we have entered into licensing agreements for the right to market Gynazole-1(R) in over 50 markets in Europe, Latin America, the Middle East, Asia, Indonesia, the People's Republic of China, Australia, New Zealand and Mexico. We also received, during fiscal 2005, our second regulatory approval to market Gynazole-1(R) into an international market. In January 2005, Ther-Rx introduced its second NDA approved product, Clindesse(TM), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM) incorporates our proprietary VagiSite(R) bioadhesive drug delivery technology. Since its launch, Clindesse(TM) has garnered 13.1% of the intravaginal bacterial vaginosis market in the United States. We have also entered into licensing agreements for the right to market Clindesse(TM) in Spain, Portugal, Andorra, Brazil and Mexico. We established our hematinic product line by acquiring two leading hematinic brands, Chromagen(R) and Niferex(R), in March 2003. We re-launched technology-improved versions of these products mid-way through fiscal 2004. In fiscal 2005, the reformulated hematinic brands have generated 64.8% growth in new prescription volume compared to new prescription volume in the prior year. Ther-Rx's cardiovascular product line consists of Micro-K(R), an extended-release potassium supplement used to replenish electrolytes, primarily in patients who are on medication which depletes the levels of potassium in the body. We acquired Micro-K(R) in March 1999 from the pharmaceutical division of Wyeth. Based on the addition of new products and our expectation of continued growth in our branded business, Ther-Rx expanded its branded sales force by 80 specialty sales representatives and sales management personnel in fiscal 2004 and Ther-Rx added an additional 30 specialty sales representatives late in fiscal 2005. Ther-Rx's sales force focuses on physician specialists who are identified through available market research as frequent prescribers of our prescription products. Ther-Rx also has a corporate sales and marketing management team dedicated to planning and managing Ther-Rx's sales and marketing efforts. ETHEX -- OUR TECHNOLOGICALLY DISTINGUISHED GENERIC/NON-BRANDED DRUG BUSINESS We established ETHEX, currently our largest business segment, in 1990 to utilize our portfolio of drug delivery systems to develop and market hard-to-copy generic/non-branded pharmaceuticals. We believe many of our ETHEX products enjoy higher gross margins than other generic pharmaceutical companies due to our approach of selecting products that benefit from our proprietary drug delivery systems and our specialty manufacturing capabilities. These advantages can act as barriers to entry which may limit competition and reduce the rate of price erosion typically experienced in the generic market. ETHEX's net revenues were $191.9 million for fiscal 2005, which represented 63.2% of our total net revenues. We have incorporated our proprietary drug delivery technology in many of our generic/non-branded pharmaceutical products. For example, we have included METER RELEASE(R), one of our proprietary controlled 6 release technologies, into the only generic equivalent to Norpace(R) CR, an antiarrhythmic that is taken twice daily. Further, we have used our KV/24(R) once daily technology in the generic equivalent to IMDUR(R), a cardiovascular drug that is taken once per day. In addition, utilizing our specialty manufacturing expertise and a sublingual delivery system, we produced and marketed the first non-branded alternative to Nitrostat(R) sublingual, an anti-angina product which historically has been difficult to manufacture. To capitalize on ETHEX's unique product capabilities, we continue to expand our ETHEX product portfolio. Over the past two years, we have introduced more than 20 new generic/non-branded products and have a number of products currently in development to be marketed by ETHEX. Since January 1, 2004, we have received six new Abbreviated New Drug Application, or ANDA, approvals. We also anticipate receipt of ANDA approvals for Diltiazem and Levothyroxine, among other products, in fiscal 2006. In addition to our internal marketing efforts, we have licensed the exclusive rights to co-develop and market more than 15 products with other drug delivery companies. These products are generic equivalents to brand name products with aggregate annual sales totaling over $4 billion and, subject to completion of development and regulatory approvals, are expected to be launched at various times beginning in fiscal 2006 and continuing through fiscal 2008. In fiscal 2005, we began marketing the 50mg/200mg strength of Carbidopa-Levodopa, the generic equivalent to Sinemet(R), under a co-development licensing agreement with another drug delivery company. By focusing our efforts on the development and marketing of technology-distinguished, multisource drugs, over half of the more than 140 specialty generic/non-branded products sold by our ETHEX subsidiary are leaders in their respective multisource-brand markets. ETHEX primarily focuses on the therapeutic categories of cardiovascular, women's health, pain management and respiratory, leveraging our expertise in developing and manufacturing products in these areas. In addition, we pursue opportunities outside of these categories where we also may differentiate our products based upon our proprietary drug delivery systems and our specialty manufacturing expertise. CARDIOVASCULAR. ETHEX currently markets over 40 products in its cardiovascular line, including products to treat angina, arrhythmia and hypertension, as well as for potassium supplementation. The cardiovascular line accounted for 44.6% of ETHEX's net revenues in fiscal 2005. PAIN MANAGEMENT. ETHEX currently markets over 20 products in its pain management line. Included in this line are several controlled substance drugs, such as morphine, hydromorphone and oxycodone. The pain management line accounted for 18.6% of ETHEX's net revenues in fiscal 2005. RESPIRATORY. ETHEX currently markets over 30 products in its respiratory line, which consists primarily of cough/cold products. ETHEX is the leading provider on a unit basis of prescription cough/cold products in the United States today. The cough/cold line accounted for 15.2% of ETHEX's net revenues in fiscal 2005. WOMEN'S HEALTH CARE. ETHEX currently markets over 20 products in its women's healthcare line, all of which are prescription prenatal vitamins. Based on the number of units sold, ETHEX is the leading provider of prescription prenatal vitamins in the United States. The women's healthcare line accounted for 10.5% of ETHEX's net revenues in fiscal 2005. OTHER THERAPEUTICS. In addition to our core therapeutic lines, ETHEX markets over 30 products in the gastrointestinal, dermatological, anti-anxiety, digestive enzyme and dental categories. ETHEX has a dedicated sales and marketing team, which includes an outside sales team of regional managers and national account managers and an inside sales team. The outside sales force calls on wholesalers and distributors 7 and national drugstore chains, as well as hospitals, nursing homes, independent pharmacies and mail order firms. The inside sales force calls on independent pharmacies to create pull-through at the wholesale level. PDI - OUR VALUE-ADDED RAW MATERIAL BUSINESS PDI develops and markets specialty raw material products for the pharmaceutical, nutritional, food and personal care industries. Its products include value-added active drug molecules, vitamins, minerals and other raw material ingredients that provide benefits such as improved taste, altered or controlled release profiles, enhanced product stability or more efficient and other manufacturing process advantages. PDI is also a significant supplier of value-added raw material for our Ther-Rx and ETHEX businesses. Net revenues for PDI were $18.3 million in fiscal 2005, which represented 6.0% of our total net revenues. PDI currently offers three distinct lines of specialty raw material products: o DESCOTE(R) is a family of microencapsulated tastemasked vitamins and minerals for use in chewable nutritional products, quick dissolve dosage forms, foods, children's vitamins and other products. o DESTAB(TM) is a family of direct compression products that enables pharmaceutical manufacturers to produce tablets and caplets more efficiently and economically. o MicroMask(TM) is a family of products designed to alleviate problems associated with swallowing tablets. This is accomplished by offering superior tasting, chewable or quick dissolving dosage forms of medication. BUSINESS STRATEGY Our goal is to enhance our position as a leading fully integrated specialty pharmaceutical company that utilizes its expanding drug delivery expertise to bring technologically distinguished brand name and generic/non-branded products to market. Our strategies incorporate the following key elements: INTERNALLY DEVELOP BRAND NAME PRODUCTS. We apply our existing drug delivery technologies, research and development and manufacturing expertise to introduce new products which can expand our existing franchises. In January 2005, Ther-Rx introduced its second NDA approved product, Clindesse(TM), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM) incorporates our proprietary VagiSite(R) bioadhesive drug delivery technology. We plan to continue to use our research and development, manufacturing and marketing expertise to create unique brand name products within our core therapeutic areas and we currently have a number of new products in clinical development. CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek acquisition opportunities for both Ther-Rx and ETHEX. Ther-Rx continually looks for platform acquisition opportunities similar to PreCare(R) around which we can build franchises. We believe that consolidation among large pharmaceutical companies, coupled with cost-containment pressures, has increased the level of sales necessary for an individual product to justify active marketing and promotion. This has led large pharmaceutical companies to focus their marketing efforts on drugs with higher volume sales, newer or novel drugs which have the potential for high volume sales and products which fit within core therapeutic or marketing priorities. As a result, major pharmaceutical companies increasingly have sought to divest small or non-strategic product lines, which can be profitable for specialty pharmaceutical companies like us. In making acquisitions, we apply several important criteria in our decision-making process. We pursue products with the following attributes: o products which we believe have relevance for treatment of significant clinical needs; 8 o promotionally sensitive maintenance drugs which require continual use over a long period of time, as opposed to more limited use products for acute indications; o products which are predominantly prescribed by physician specialists, which can be cost-effectively marketed by our focused sales force; and o products which we believe have potential for technological enhancements and line extensions based upon our drug delivery technologies. FOCUS SALES EFFORTS ON HIGH VALUE NICHE MARKETS. We focus our Ther-Rx sales efforts on niche markets where we believe we can target a relatively narrow physician audience. Because our products are sold to specialty physician groups that tend to be relatively concentrated, we believe that we can address these markets cost effectively with a focused sales force. Based on the addition of new products and our expectation of continued growth in our branded business, Ther-Rx expanded its branded sales force by 80 specialty sales representatives and sales management personnel in fiscal 2004 and Ther-Rx added an additional 30 specialty sales representatives late in fiscal 2005. We plan to continue to build our sales force as necessary to accommodate current and future expansions of our product lines. PURSUE ATTRACTIVE GROWTH OPPORTUNITIES WITHIN THE GENERIC INDUSTRY. We plan to continue introducing generic and non-branded alternatives to select drugs whose patents have expired, particularly when we can add value through our drug delivery technologies. Such generic or off-patent pharmaceutical products are generally sold at significantly lower prices than the branded product. Accordingly, generic pharmaceuticals provide a cost-efficient alternative to users of branded products. We believe the health care industry will continue to support growth in the generic pharmaceutical market and that industry trends favor generic product expansion into the managed care, long-term care and government contract markets. We further believe that we are uniquely positioned to capitalize on this growing market given our large base of proprietary drug delivery technologies and our proven ability to lead the therapeutic categories we enter. ADVANCE EXISTING AND DEVELOP NEW DRUG DELIVERY TECHNOLOGIES. We believe our drug delivery platform of 15 distinguished technologies has unique breadth and depth. These technologies have enabled us to create innovative products, including Gynazole-1(R) and Clindesse(TM), which incorporate VagiSite(TM), our proprietary bioadhesive controlled release system. In addition, our tastemasking and controlled release systems are incorporated into our prenatal vitamins, providing them with differentiated benefits over other products on the market. We plan to continue to develop our drug delivery technologies and have various technologies currently under development, such as: TransCell(R) for oral esophageal delivery of bioactive peptides and proteins that are normally degraded by stomach enzymes or first-pass liver effects; PulmoSite(TM) which applies bioadhesive and controlled release characteristics to drug agents that are inhaled for either local action in the lung or for systemic absorption; and Ocusite(TM) for the delivery of active agents by a bioadhesive topical application to the eye. OUR PROPRIETARY DRUG DELIVERY TECHNOLOGIES We believe we are a leader in the development of proprietary drug delivery systems and formulation technologies which enhance the effectiveness of new therapeutic agents, existing pharmaceutical products and nutritional supplements. We have used many of these technologies to successfully commercialize technologically distinguished branded and generic/non-branded products. Additionally, we continue to invest our resources in the development of new technologies. The following describes our principal drug delivery technologies. SITE RELEASE(R) TECHNOLOGIES. SITE RELEASE(R) is our largest family of technologies and includes eight systems designed specifically for oral, topical or interorificial use. These systems rely on controlled bioadhesive properties to optimize the delivery of drugs to either wet mucosal tissue or the skin and are the subject of issued 9 patents and pending patent applications. Of the technologies developed, products using the VagiSite(TM) and DermaSite(TM) technologies have been successfully commercialized. Our fully developed technologies include the following: o VagiSite(TM) is a controlled release bioadhesive delivery system that incorporates advanced polyphasic principles to create a bioemulsion system delivering therapeutic agents to the vagina. We have outlicensed VagiSite(TM) for sale in international markets for the treatment of vaginal infections. VagiSite(TM) technology is used in Gynazole-1(R), a one-dose prescription cream treatment for vaginal yeast infections and Clindesse(TM), a one-dose prescription cream treatment for bacterial vaginosis. o DermaSite(TM) is a semi-solid SITE RELEASE(R) configuration for topical applications to the skin. The bioadhesive and controlled release properties of the delivery platform have made possible the development of products requiring a significantly reduced frequency of application. DermaSite(TM) technology is used in Dermarin-L(TM), a topical antifungal product being marketed by the leading over-the-counter pharmaceutical company in Japan, Taisho Pharmaceutical, Ltd. o OraSite(R) is a controlled release mucoadhesive delivery system administered orally in a solid or liquid form. A drug formulated with the OraSite(R) technology may be formulated as a liquid or as a lozenge in which the dosage form liquefies upon insertion and adheres to the mucosal surface of the mouth, throat and esophagus. OraSite(R) possesses characteristics particularly advantageous to therapeutic categories such as oral hygiene, sore throat and periodontal and upper gastrointestinal tract disorders. o OraSert(TM) is a solid dosage-form application system specifically designed for localized delivery of active agents to the oral tissues. The product is formulated as a "cough drop" type tablet, which immediately liquefies upon placement in the mouth and bioadheres to mucosal tissue in the mouth, throat and esophagus. OraSert(TM) possesses characteristics particularly advantageous to therapeutic applications such as periodontal disease, respiratory conditions, pharyngeal conditions and upper gastrointestinal tract disorders. o BioSert(TM) is a bioadhesive delivery system in a solid insert formulation for vaginal or rectal administration, similar in appearance to a vaginal or rectal suppository, which can be used for both local and systemic delivery of drugs. The BioSert(TM) dosage form liquefies and bioadheres to vaginal or rectal tissues, which is of particular benefit when a patient can no longer tolerate orally administered medications. We are currently developing several drug products that utilize the BioSert(TM) technology, including non-steroidal anti-inflammatory drugs, or NSAIDs, and antifungals for a local effect and opioids for a systemic effect. In addition, the following SITE RELEASE(R) technologies are currently under development: o Trans-Cell(R) is a novel bioadhesive, controlled release delivery system that may permit oral delivery of bioactive peptides and proteins that are normally degraded by stomach enzymes or first-pass liver effects. This technology was specifically designed to provide an oral delivery alternative to biotechnology and other compounds that currently are delivered as injections or infused. o OcuSite(TM) is a liquid, microemulsion delivery system intended for topical applications in the eye. The microemulsion formulation lends optical clarity to the application and is particularly well suited for ophthalmic use. The bioadhesive and controlled release properties of this delivery system allow for reduced dosing regimentation. o PulmoSite(TM) applies bioadhesive and controlled release characteristics to drug agents that are to be inhaled for either local action to the lung or for systemic absorption. 10 ORAL CONTROLLED RELEASE TECHNOLOGIES. The technological preeminence of our advanced drug delivery systems was established in the development of our three oral controlled release technologies, all of which have been commercialized. Our systems can be individually designed to achieve the desired release profile for a given drug. The release profile is dependent on many parameters, such as drug solubility, protein binding and site of absorption. Some of the products utilizing our oral controlled release systems in the market include Isosorbide-5-Mononitrate (an AB rated generic equivalent to IMDUR(R)) and Disopyramide Phosphate (an AB rated generic equivalent of Norpace(R) CR). Our patented technologies include the following: o KV/24(R) is a multi-particulate drug delivery system that encapsulates one or more drug compounds into spherical particles which release the active drug or drugs systemically over an 18- to 24-hour period, permitting the development of once-a-day drug formulations. We believe that our KV/24(R) oral dosing system is the only commercialized 24-hour oral controlled release system that is successfully able to incorporate more than one active compound. o METER RELEASE(R) is a polymer-based drug delivery system that offers different release characteristics than KV/24(R) and is used for products that require drug release rates of between eight and 12 hours. We have developed METER RELEASE(R) systems in tablet, capsule and caplet form that have been commercialized in ETHEX products in the cardiovascular, gastrointestinal and upper respiratory product categories. o MICRO RELEASE(R) is a microparticulate formulation that encapsulates therapeutic agents, employing smaller particles than KV/24(R) and METER RELEASE(R). This system is used to extend the release of drugs in the body where precise release profiles are less important. MICRO RELEASE(R) has been commercialized in prescription products marketed by ETHEX and Ther-Rx as well as over-the-counter nutritional products. TASTEMASKING TECHNOLOGIES. Our tastemasking technologies improve the taste of unpleasant drugs. Our three patented tastemasking systems can be applied to liquids, chewables or dry powders. We first introduced tastemasking technologies in 1991 and have utilized them in a number of Ther-Rx and ETHEX products, including PreCare(R) Chewables and most of the liquid products that are sold in ETHEX's cough/cold line. Our patented technologies include the following: o LIQUETTE(R) is a tastemasking system that incorporates unpleasant tasting drugs into a hydrophilic and lipophilic polymer matrix to suppress the taste of a drug. This technology is used for mildly to moderately distasteful drugs where low manufacturing costs are particularly important. o FlavorTech(R) is a liquid formulation technology designed to reduce the objectionable taste of a wide variety of therapeutic products. FlavorTech(R) technology has been used in cough/cold syrup products sold by ETHEX and has special application to other products, such as antibiotic, geriatric and pediatric pharmaceuticals. o MicroMask(TM) is a tastemasking technology that incorporates a dry powder, microparticulate approach to reducing objectionable tastes by sequestering the unpleasant drug agent in a specialized matrix. This formulation technique has the effect of "shielding" the drug from the taste receptors without interfering with the dissolution and ultimate absorption of the agent within the gastrointestinal tract. MicroMask(TM) is a more potent tastemasking technology than LIQUETTE(R) and has been used in connection with two Ther-Rx products. QUICK DISSOLVING TECHNOLOGY. Our quick dissolving oral tablet technology provides the ability to tastemask, yet dissolves in the mouth in a matter of seconds. Most other quick-dissolving technologies offer either quickness at the expense of poor tastemasking or excellent tastemasking at the expense of quickness. While still under development, this system allows for a drug to be quickly dissolved in the mouth, and can be combined with tastemasking capabilities that offer a unique dosage form for the most bitter tasting drug compounds. We have been issued patents and have patents pending for this system with the U.S. Patent and Trademark Office, or PTO. 11 SALES AND MARKETING Ther-Rx has a national sales and marketing infrastructure which includes approximately 240 sales representatives dedicated to promoting and marketing our branded pharmaceutical products to targeted physician specialists. Based on the addition of new products and our expectation of continued growth in our branded business, Ther-Rx expanded its branded sales force by 80 specialty sales representatives and sales management personnel in fiscal 2004 and added an additional 30 specialty sales representatives late in fiscal 2005. Ther-Rx's sales force focuses on physician specialists who are identified through available market research as frequent prescribers of our prescription products. Ther-Rx also has a corporate sales and marketing management team dedicated to planning and managing Ther-Rx's sales and marketing efforts. We attempt to increase sales of our branded pharmaceutical products through physician sales calls and promotional efforts, including sampling, advertising and direct mail. For acquired branded products, we generally increase the level of physician sales calls and promotion relative to the previous owner. For example, with the PreCare(R) prenatal sales efforts, we increased the level of physician sales calls and sampling to the highest prescribers of prenatal vitamins. We also have enhanced our PreCare(R) brand franchise by launching five more line extensions to address unmet needs, including the launch of PreCare(R) Chewables, Premesis Rx(TM), PreCare(R) Conceive(TM), PrimaCare(R) and PrimaCare(R) ONE. The PreCare(R) product line enables us to deliver a full range of nutritional products for physicians to prescribe to women in their childbearing years. In addition, we added to our women's health care family of products in June 2000 with the introduction of our first NDA approved product, Gynazole-1(R), the only one-dose prescription cream treatment for vaginal yeast infections. In fiscal 2004, we further expanded our branded product offerings when we launched technology improved versions of the Chromagen(R) and Niferex(R) oral hematinic product lines that were acquired at the end of fiscal 2003. In January 2005, we introduced our second NDA approved product, Clindesse(TM), the first approved single-dose therapy for bacterial vaginosis. By offering multiple products to the same group of physician specialists, we are able to maximize the effectiveness of our experienced sales force. ETHEX has an experienced sales and marketing team, which includes an outside sales team, regional account managers, national account managers and an inside sales team. The outside sales force calls on wholesalers, distributors and national drugstore chains, as well as hospitals, nursing homes, mail order firms and independent pharmacies. The inside sales team calls on independent pharmacies to create pull-through at the wholesale level. We believe that industry trends favor generic product expansion into the managed care, long-term care and government contract markets. Further, we believe that our competitively priced, technology-distinguished generic/non-branded products can fulfill the increasing need of these markets to contain costs and improve patient compliance. Accordingly, we intend to continue to devote significant marketing resources to the penetration of those markets. Particle Dynamics has a specialized technical sales group that calls on the leading companies in the pharmaceutical, nutritional, personal care, food and other markets in the United States. During fiscal 2005, our three largest customers accounted for 27%, 16% and 12% of gross revenues. These customers were McKesson Drug Company, Cardinal Health and Amerisource Corporation, respectively. In fiscal 2004 and 2003, these customers accounted for gross revenues of 25%, 16% and 13% and 23%, 14% and 18%, respectively. Although we sell internationally, we do not have material operations or sales in foreign countries and our sales are not subject to significant geographic concentration. 12 RESEARCH AND DEVELOPMENT We have long recognized that development of successful new products is critical to achieving our goal of sustainable growth over the long term. As such, our investment in research and development, which increased at a compounded annual growth rate of 26.2% over the past four fiscal years, reflects our continued commitment to develop new products and/or technologies through our internal development programs, and with our external strategic partners. Our research and development activities include the development of new and next generation drug delivery technologies, the formulation of brand name proprietary products and the development of technologically distinguished generic/non-branded versions of previously approved brand name pharmaceutical products. In fiscal 2005, 2004 and 2003, total research and development expenses were $23.5 million, $20.7 million and $19.1 million, respectively. In January 2005, Ther-Rx introduced its second NDA approved product, Clindesse(TM), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(TM) incorporates our proprietary VagiSite(R) bioadhesive drug delivery technology. Ther-Rx currently has a number of products in its research and development pipeline at various stages of development. We believe we have the technological expertise required to develop unique products to meet currently unmet needs in the area of women's health, as well as other therapeutic areas. To capitalize on ETHEX's unique product capabilities, we continue to expand our ETHEX product portfolio. Over the past two fiscal years, we have introduced more than 20 new generic/non-branded products and have a number of products currently in development to be marketed by ETHEX. Our development process typically consists of formulation, development and laboratory testing, and where required (1) preliminary bioequivalency studies of pilot batches of the manufactured product, (2) full scale bioequivalency studies using commercial quantities of the manufactured product and (3) submission of an ANDA to the FDA. We believe that, unlike many generic drug companies, we have the technical expertise required to develop generic substitutes for hard-to-copy branded pharmaceutical products. Since January 1, 2004, we have received six new ANDA approvals. We also anticipate receipt of ANDA approvals for Diltiazem and Levathyroxine, among other products, in fiscal 2006. In addition to our internal marketing efforts, we have licensed the exclusive rights to co-develop and market more than 15 products with other drug delivery companies. These products are generic equivalents to brand name products with aggregate annual sales totaling over $4 billion and, subject to completion of development and regulatory approvals, are expected to be launched at various times beginning in fiscal 2006 and continuing through fiscal 2008. In fiscal 2005, we began marketing the 50mg/200mg strength of Carbidopa-Levodopa, the generic equivalent to Sinemet(R), under a co-development licensing agreement with another drug delivery company. PDI currently has a number of products in its research and development pipeline at various stages of development. PDI applies its technologies to a diverse number of active and inactive chemicals for more efficient processing of materials to achieve benefits such as prolonged action of release, tastemasking, making materials more site specific and other benefits. Typically, the finished products into which the specialty raw materials are incorporated do not require FDA approval. We continually apply our scientific and development expertise to refine and enhance our existing drug delivery systems and formulation technologies and to create new technologies that may be used in our drug development programs. Certain of these technologies currently under development include advanced oral controlled release systems, quick dissolving oral delivery systems (with and without tastemasking characteristics) and transesophageal and intrapulmonary delivery technologies. 13 PATENTS AND OTHER PROPRIETARY RIGHTS We actively seek, when appropriate and available, protection for our products and proprietary information by means of U.S. and foreign patents, trademarks, trade secrets, copyrights, and contractual arrangements. Patent protection in the pharmaceutical field, however, can involve complex legal and factual issues. Moreover, broad patent protection for new formulations or new methods of use of existing chemical entities is sometimes difficult to obtain, primarily because the active ingredient and many of the formulation techniques have been known for some time. Consequently, some patents claiming new formulations or new methods of use for old drugs may not provide meaningful protection against competition. Nevertheless, we intend to seek patent protection when appropriate and available and otherwise to rely on regulatory-related exclusivity and trade secrets to protect certain of our products, technologies and other scientific information. There can be no assurance, however, that any steps taken to protect such proprietary information will be effective. Our policy is to file patent applications in appropriate situations to protect and preserve, for our own use, technology, inventions and improvements that we consider important to the development of our business. We currently hold domestic and foreign issued patents the last of which expires in fiscal 2022 relating to our controlled release, site-specific, quick dissolve and tastemasking technologies. We have been granted 33 U.S. patents and have 22 U.S. patent applications pending. In addition, we have 11 foreign issued patents and a total of 100 patent applications pending primarily in Canada, Europe, Australia, Japan, South America, Mexico and South Korea (see "We depend on our patents and other proprietary rights" under "Risk Factors" for additional information). We currently own more than 100 U.S. and foreign trademark registrations and have also applied for trademark protection for the names of our proprietary controlled-release, tastemasking, site-specific and quick dissolve technologies. We intend to continue to trademark new technology and product names as they are developed. To protect our trademark, domain name, and related rights, we generally rely on trademark and unfair competition laws, which are subject to change. Some, but not all, of our trademarks are registered in the jurisdictions where they are used. Some of our other trademarks are the subject of pending applications in the jurisdictions where they are used or intended to be used and others are not. MANUFACTURING AND FACILITIES We believe that our administrative, research, manufacturing and distribution facilities are an important factor in achieving our long-term growth objectives. All facilities at March 31, 2005, aggregating approximately 1.1 million square feet, are located in the St. Louis, Missouri area. We own approximately 600,000 square feet, with the balance under various leases at pre-determined annual rates under agreements expiring from fiscal 2006 through fiscal 2012, subject in most cases to renewal at our option. We manufacture drug products in liquid, semi-solid, tablet, capsule and caplet forms for distribution by Ther-Rx, ETHEX and our corporate licensees and value-added specialty raw materials for distribution by Particle Dynamics. We believe that all of our facilities are in material compliance with applicable regulatory requirements. We seek to maintain inventories at sufficient levels to support current production and sales levels. During fiscal 2005, we encountered no serious shortage of any particular raw materials, except that in the fourth quarter of fiscal 2005, we experienced a supply disruption of a key ingredient for our PrimaCare(R) ONE product. This interruption in production was temporary and has since been resolved. Although there can be no assurance that 14 raw material supply will not adversely affect our future operations, we do not believe that additional shortages will occur in the foreseeable future. COMPETITION Competition in the development and marketing of pharmaceutical products is intense and characterized by extensive research efforts and rapid technological progress. Many companies, including those with financial and marketing resources and development capabilities substantially greater than our own, are engaged in developing, marketing and selling products that compete with those that we offer. Our branded pharmaceutical products may also be subject to competition from alternate therapies during the period of patent protection and thereafter from generic equivalents. In addition, our generic/non-branded pharmaceutical products may be subject to competition from pharmaceutical companies engaged in the development of alternatives to the generic/non-branded products we offer or of which we undertake development. Our competitors may develop generic products before we do or may have pricing advantages over our products. In our specialty pharmaceutical businesses, we compete primarily on the basis of product efficacy, breadth of product line and price. We believe that our patents, proprietary trade secrets, technological expertise, product development and manufacturing capabilities will enable us to maintain a leadership position in the field of advanced drug delivery technologies and to continue to develop products to compete effectively in the marketplace. In addition, we compete with pharmaceutical companies that acquire branded product lines from other pharmaceutical companies. These competitors may have substantially greater financial and marketing resources than we do. Accordingly, our competitors may succeed in product line acquisitions that we seek to acquire. We also compete with drug delivery companies engaged in the development of alternative drug delivery systems. We are aware of a number of companies currently seeking to develop new non-invasive drug delivery systems, including oral delivery and transmucosal systems. Many of these companies may have greater research and development capabilities, experience, manufacturing, marketing, financial and managerial resources than we do. Accordingly, our competitors may succeed in developing competing technologies, obtaining FDA approval for products or gaining market acceptance more rapidly than we do. GOVERNMENT REGULATION All pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally the FDA, and, to a lesser extent, by state, local and foreign governments. The Federal Food, Drug and Cosmetic Act, or FDCA, and other federal statutes and regulations govern or influence, among other things, the development, testing, manufacture, safety, labeling, storage, recordkeeping, approval, advertising, promotion, sale and distribution of pharmaceutical products. Pharmaceutical manufacturers are also subject to certain record keeping and reporting requirements, establishment registration and product listing, and FDA inspections. With respect to any non-biological "new drug" product with active ingredients not previously approved by the FDA, a prospective manufacturer must submit a full NDA, including complete reports of preclinical, clinical and other studies to prove the product's safety and efficacy. A full NDA may also need to be submitted for a drug product with a previously approved active ingredient if, among other things, the drug will be used to treat an indication for which the drug was not previously approved, or if the abbreviated procedure discussed below is otherwise not available. A manufacturer intending to conduct clinical trials in humans for a new drug may be required first to submit a Notice of Claimed Investigational Exception for a New Drug, or IND, to the FDA containing information relating to preclinical and clinical studies. INDs and full NDAs may be required to be filed to obtain approval of certain of our products, including those that do not qualify for abbreviated application procedures. The full NDA process, including clinical development and testing, is expensive and time consuming. The Drug Price Competition and Patent Restoration Act of 1984, known as the Hatch-Waxman Act, established ANDA procedures for obtaining FDA approval for generic versions of many non-biological drugs for which 15 patent or marketing exclusivity rights have expired and which are bioequivalent to previously approved drugs. "Bioequivalence" for this purpose, with certain exceptions, generally means that the proposed generic formulation is absorbed by the body at the same rate and extent as a previously approved "reference drug." Approval to manufacture these drugs is obtained by filing abbreviated applications, such as ANDAs. As a substitute for clinical studies, the FDA requires data indicating the ANDA drug formulation is bio-equivalent to a previously approved reference drug among other requirements. The same abbreviated application procedures apply to antibiotic drug products that are bio-equivalent to previously approved antibiotics, except that products containing certain older antibiotic ingredients are not subject to the special patent or marketing exclusivity protections afforded by the Hatch-Waxman Act to other drug products. The advantage of the ANDA approval mechanism, compared to an NDA, is that an ANDA applicant is not required to conduct preclinical and clinical studies to demonstrate that the product is safe and effective for its intended use and may rely, instead, on studies demonstrating bio-equivalence to a previously approved reference drug. In addition to establishing ANDA approval mechanisms, the Hatch-Waxman Act fosters pharmaceutical innovation through such incentives as non-patent exclusivity and patent restoration. The Act provides two distinct exclusivity provisions that either preclude the submission or delay the approval of an ANDA. A five-year exclusivity period is provided for new chemical compounds, and a three-year marketing exclusivity period is provided for changes to previously approved drugs which are based on new clinical investigations essential to the approval. The three-year marketing exclusivity period may be applicable to the approval of a novel drug delivery system. The marketing exclusivity provisions apply equally to patented and non-patented drug products, but do not apply to products containing antibiotic ingredients first submitted for approval on or before November 20, 1997. These provisions do not delay or otherwise affect the approvability of full NDAs even when effective ANDA approvals are not available. For drugs covered by patents, patent extension may be provided for up to five years as compensation for reduction of the effective life of the patent resulting from time spent in conducting clinical trials and in FDA review of a drug application. There has been substantial litigation in the biomedical, biotechnology and pharmaceutical industries with respect to the manufacture, use and sale of new products that are alleged to infringe outstanding patent rights. One or more patents cover most of the proprietary products for which we are developing generic versions. When we file an ANDA for such drug products, we will, in most cases, be required to certify to the FDA that any patent which has been listed with the FDA as covering the product is invalid or will not be infringed by our sale of our product. Alternatively, we could certify that we would not market our proposed product until the applicable patent expires. A patent holder may challenge a notice of noninfringement or invalidity by filing suit for patent infringement, which would, in most cases, prevent FDA approval until the suit is resolved or until at least 30 months has elapsed (or until the patent expires, whichever is earlier). Should any entity commence a lawsuit with respect to any alleged patent infringement by us, the uncertainties inherent in patent litigation would make the outcome of such litigation difficult to predict. In addition to marketing drugs which are subject to FDA review and approval, we market certain drug products in the United States without FDA approval under certain "grandfather" clauses and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the FDCA. A determination as to whether a particular product does or does not require FDA pre-market review and approval can involve consideration of numerous complex and imprecise factors. If a determination is made by the FDA that any product marketed without approval requires such approval, the FDA may institute enforcement actions, including product seizure, or an action seeking an injunction against further marketing and may or may not allow sufficient time to obtain the necessary approvals before it seeks to curtail further marketing. For example, in October 2002, the FDA sent warning letters to us and other manufacturers and distributors of unapproved prescription drug products containing the expectorant guaifenesin as a single entity in a solid oral extended-release dosage form. Citing the recent approval of one such product, the FDA warning letters asserted that the marketing of all such products without NDA or ANDA approval should stop. The FDA subsequently agreed to allow continued manufacture through May 2003 and sale through November 2003 of the products, and we complied with those deadlines. We are not in a position to predict whether or when the FDA might choose to raise similar objections 16 to the marketing without NDA or ANDA approval of another category or categories of drug products represented in our product lines. In the event such objections are raised, we could be required or could decide to cease distribution of additional products until pre-market approval is obtained. In addition, we may not be able to obtain any particular approval that may be required or such approval may not be obtained on a timely basis. In addition to obtaining pre-market approval for certain of our products, we are required to maintain all facilities in compliance with the FDA's current Good Manufacturing Practice, or cGMP, requirements. In addition to compliance with cGMP each pharmaceutical manufacturer's facilities must be registered with the FDA. Manufacturers must also be registered with the U.S. Drug Enforcement Administration or DEA, and similar state and local regulatory authorities if they handle controlled substances, and with the EPA and similar state and local regulatory authorities if they generate toxic or dangerous wastes, and must comply with other applicable DEA and EPA requirements. Noncompliance with applicable requirements can result in fines, recall or seizure of products, total or partial suspension of production and distribution, refusal of the government to enter into supply contracts or to approve NDA's, ANDA's or other applications and criminal prosecution. The FDA also has the authority to revoke for-cause drug approvals previously granted. The Prescription Drug Marketing Act, or PDMA, which amended various sections of the FDCA, requires, among other things, state licensing of wholesale distributors of prescription drugs under federal guidelines that include minimum standards for storage, handling and record keeping. All of our facilities are registered with the State of Missouri, where they are located, as required by Federal and Missouri law. The PDMA also imposes detailed requirements on the distribution of prescription drug samples such as those distributed by the Ther-Rx sales force. The PDMA sets forth substantial civil and criminal penalties for violations of these and other provisions. Many states also require registration of out-of-state drug manufacturers and distributors who sell products in their states, and may also impose additional requirements or restrictions on out-of-state firms. These requirements vary widely from state-to-state and are subject to change with little or no direct notice to potentially affected firms. We believe that we are currently in compliance in all material respects with applicable state requirements. However, in the event that we are found to have failed to comply with applicable state requirements, we may be subject to sanctions, including monetary penalties, and potential restrictions on our sales or other activities within particular states. For international markets, a pharmaceutical company is subject to regulatory requirements, inspections and product approvals substantially the same as those in the United States. In connection with any future marketing, distribution and license agreements that we may enter into, our licensees may accept or assume responsibility for such foreign regulatory approvals. The time and cost required to obtain these international market approvals may be greater or lesser than those required for FDA approval. Product development and approval within this regulatory framework take a number of years, involve the expenditure of substantial resources and is uncertain. Many drug products ultimately do not reach the market because they are not found to be safe or effective or cannot meet the FDA's other regulatory requirements. In addition, the current regulatory framework may change and additional regulatory or approval requirements may arise at any stage of our product development that may affect approval, delay the submission or review of an application or require additional expenditures by us. We may not be able to obtain necessary regulatory clearances or approvals on a timely basis, if at all, for any of our products under development, and delays in receipt or failure to receive such clearances or approvals, the loss of previously received clearances or approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on our business. EMPLOYEES As of March 31, 2005, we employed a total of 1,072 employees. We are party to a collective bargaining agreement covering 119 employees that will expire December 31, 2009. We believe that our relations with our employees are good. 17 ENVIRONMENT We do not expect that compliance with Federal, state or local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment will have a material effect on our capital expenditures, earnings or competitive position. AVAILABLE INFORMATION We make available, free of charge through our Internet website (http://www.kvpharmaceutical.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file these reports with, or furnish them to, the Securities and Exchange Commission, or SEC. Also, copies of our Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter, Nominating and Corporate Governance Committee Charter, Code of Ethics for Senior Executives and Standard of Business Ethics for all Directors and employees are available on our Internet website, and available in print to any stockholder who requests it. In addition, the SEC maintains an Internet website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. RISK FACTORS We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of these risks and others are discussed elsewhere in this report. Additional risks presently unknown to us or that we currently consider immaterial or unlikely to occur could also impair our operations. These and other risks could materially and adversely affect our business, financial condition, operating results or cash flows. RISKS RELATED TO OUR BUSINESS OUR FUTURE GROWTH IS LARGELY DEPENDENT UPON OUR ABILITY TO DEVELOP NEW PRODUCTS. We need to continue to develop and commercialize new brand name products and generic products utilizing our proprietary drug delivery systems to maintain the growth of Ther-Rx, ETHEX and Particle Dynamics. To do this we will need to identify, develop and commercialize technologically enhanced branded products and identify, develop and commercialize drugs that are off-patent and that can be produced and sold by us as generic products using our drug delivery technologies. If we are unable to identify, develop and commercialize new products, we may need to obtain licenses to additional rights to branded or generic products, assuming they would be available for licensing, which could decrease our profitability. We cannot assure you that we will be successful in pursuing this strategy. IF WE ARE UNABLE TO COMMERCIALIZE PRODUCTS UNDER DEVELOPMENT, OUR FUTURE OPERATING RESULTS MAY SUFFER. Certain products we are developing will require significant additional development and investment, including preclinical and clinical testing, where required, prior to their commercialization. We expect that many of these products will not be commercially available for several years, if at all. We cannot assure you that such products or future products will be successfully developed, prove to be safe and effective in clinical trials (if required), meet applicable regulatory standards, or be capable of being manufactured in commercial quantities at reasonable cost. 18 OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL. We intend to continue to acquire pharmaceutical products, novel drug delivery technologies and/or companies that fit into our research, manufacturing, distribution or sales and marketing operations or that could provide us with additional products, technologies or sales and marketing capabilities. We may not be able to successfully identify, evaluate and acquire any such products, technologies or companies or, if acquired, we may not be able to successfully integrate such acquisitions into our business. We compete with many specialty pharmaceutical companies for products and product line acquisitions. These competitors may have substantially greater financial and managerial resources than we have. WE DEPEND ON OUR PATENTS AND OTHER PROPRIETARY RIGHTS AND CANNOT BE CERTAIN OF THEIR CONFIDENTIALITY AND PROTECTION. Our success depends, in large part, on our ability to protect our current and future technologies and products, to defend our intellectual property rights and to avoid infringing on the proprietary rights of others. We have been issued numerous patents in the United States and in certain foreign countries, which cover certain of our technologies, and have filed, and expect to continue to file, patent applications seeking to protect newly developed technologies and products. The pharmaceutical field is crowded and a substantial number of patents have been issued. In addition, the patent position of pharmaceutical companies can be highly uncertain and frequently involves complex legal and factual questions. As a result, the breadth of claims allowed in patents relating to pharmaceutical applications or their validity and enforceability cannot be predicted. Patents are examined for patentability at patent offices against bodies of prior art which by their nature may be incomplete and imperfectly categorized. Therefore, even presuming that the examiner has been able to identify and cite the best prior art available to him during the examination process, any patent issued to us could later be found by a court or a patent office during post issuance proceedings to be invalid in view of newly-discovered prior art or already considered prior art or other legal reasons. Furthermore, there are categories of "secret" prior art unavailable to any examiner, such as the prior inventive activities of others, which could form the basis for invalidating any patent. In addition, there are other reasons why a patent may be found to be invalid, such as an offer for sale or public use of the patented invention in the United States more than one year before the filing date of the patent application. Moreover, a patent may be deemed unenforceable if, for example, the inventor or the inventor's agents failed to disclose prior art to the PTO that they knew was material to patentability. The coverage claimed in a patent application can be significantly reduced before a patent is issued, either in the United States or abroad. Consequently, there can be no assurance that any of our pending or future patent applications will result in the issuance of patents. Patents issued to us may be subjected to further proceedings limiting their scope and may not provide significant proprietary protection or competitive advantage. Our patents also may be challenged, circumvented, invalidated or deemed unenforceable. Patent applications in the United States filed prior to November 29, 2000 are currently maintained in secrecy until and unless patents issue, and patent applications in certain other countries generally are not published until more than 18 months after they are first filed (which generally is the case in the United States for applications filed on or after November 29, 2000). In addition, publication of discoveries in scientific or patent literature often lags behind actual discoveries. As a result, we cannot be certain that we or our licensors will be entitled to any rights in purported inventions claimed in pending or future patent applications or that we or our licensors were the first to file patent applications on such inventions. Furthermore, patents already issued to us or our pending applications may become subject to dispute, and any dispute could be resolved against us. For example, we may become involved in re-examination, reissue or interference proceedings in the PTO, or opposition proceedings in a foreign country. The result of these proceedings can be the invalidation or substantial narrowing of our patent claims. We also could be subject to court proceedings that could find our patents invalid or unenforceable or could substantially narrow the scope of our patent claims. In addition, statutory differences in patentable subject matter may limit the protection we can obtain on some of our inventions outside of the United States. For example, methods of treating humans are not patentable in many countries outside of the United States. 19 These and other issues may prevent us from obtaining patent protection outside of the United States. Furthermore, once patented in foreign countries, the inventions may be subjected to mandatory working requirements and/or subject to compulsory licensing regulations. We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation that we seek to protect, in part by confidentiality agreements with licensees, suppliers, employees and consultants. These agreements may be breached by the other parties to these agreements. We may not have adequate remedies for any breach. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of our confidentiality agreements and there can be no assurance that any such disputes would be resolved in our favor. Furthermore, our trade secrets and proprietary technology may become known or be independently developed by our competitors, or patents may not be issued with respect to products or methods arising from our research, and we may not be able to maintain the confidentiality of information relating to those products or methods. Furthermore, certain unpatented technology may be subject to intervening rights. WE DEPEND ON OUR TRADEMARKS AND RELATED RIGHTS. To protect our trademarks and goodwill associated therewith, domain name, and related rights, we generally rely on federal and state trademark and unfair competition laws, which are subject to change. Some, but not all, of our trademarks are registered in the jurisdictions where they are used. Some of our other trademarks are the subject of pending applications in the jurisdictions where they are used or intended to be used, and others are not. It is possible that third parties may own or could acquire rights in trademarks or domain names in the United States or abroad that are confusingly similar to or otherwise compete unfairly with our marks and domain names, or that our use of trademarks or domain names may infringe or otherwise violate the intellectual property rights of third parties. The use of similar marks or domain names by third parties could decrease the value of our trademarks or domain names and hurt our business, for which there may be no adequate remedy. THIRD PARTIES MAY CLAIM THAT WE INFRINGE ON THEIR PROPRIETARY RIGHTS, OR SEEK TO CIRCUMVENT OURS. We may be required to defend against charges of infringement of patents, trademarks or other proprietary rights of third parties. This defense could require us to incur substantial expense and to divert significant effort of our technical and management personnel, and could result in our loss of rights to develop or make certain products or require us to pay monetary damages or royalties to license proprietary rights from third parties. If a dispute is settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Furthermore, we cannot be certain that the necessary licenses would be available to us on acceptable terms, if at all. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing, using, selling and/or importing in to the United States certain of our products. Litigation also may be necessary to enforce our patents against others or to protect our know-how or trade secrets. That litigation could result in substantial expense or put our proprietary rights at risk of loss, and we cannot assure you that any litigation will be resolved in our favor. There currently are two patent infringement lawsuits pending against us. Although we do not believe they will have a material adverse effect on our future financial condition or results of operations, we cannot assure you of that. WE MAY BE UNABLE TO MANAGE OUR GROWTH. Over the past ten years, our businesses and product offerings have grown substantially. This growth and expansion has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. To manage our growth, we must continue to (1) expand our operational, customer support and financial control systems and (2) hire, train and retain qualified personnel. We cannot assure you that 20 we will be able to adequately manage our growth. If we are unable to manage our growth effectively, our business, results of operations and financial condition could be materially adversely affected. WE MAY NOT OBTAIN REGULATORY APPROVAL FOR OUR NEW PRODUCTS ON A TIMELY BASIS, OR AT ALL. Many of our new products will require FDA approval. FDA approval typically involves lengthy, detailed and costly laboratory and clinical testing procedures, as well as the FDA's review and approval of the information submitted. We cannot assure you that the products we develop will be determined to be safe and effective in these testing procedures, or that they will be approved by the FDA. The FDA also has the authority to revoke for-cause drug approvals previously granted. WE MAY BE ADVERSELY AFFECTED BY THE CONTINUING CONSOLIDATION OF OUR DISTRIBUTION NETWORK AND THE CONCENTRATION OF OUR CUSTOMER BASE. Our principal customers are wholesale drug distributors, major retail drug store chains, independent pharmacies and mail order firms. These customers comprise a significant part of the distribution network for pharmaceutical products in the United States. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers. For the fiscal year ended March 31, 2005, our three largest customers accounted for 27%, 16% and 12% of our gross sales. The loss of any of these customers could materially and adversely affect our results of operations or financial condition. THE REGULATORY STATUS OF CERTAIN OF OUR GENERIC PRODUCTS MAY MAKE THEM SUBJECT TO INCREASED COMPETITION. Many of our products are manufactured and marketed without FDA approval. For example, our prenatal products, which contain folic acid, are sold as prescription multiple vitamin supplements. These types of prenatal vitamins are typically regulated by the FDA as prescription drugs, but are not covered by an NDA or ANDA. As a result, competitors may more easily and rapidly introduce products competitive with our prenatal and other products that have a similar regulatory status. One of the key motivations for challenging patents is the reward of a 180-day period of market exclusivity. Under the Hatch-Waxman Act, the developer of a generic version of a product which is the first to have its ANDA accepted for filing by the FDA, and whose filing includes a certification that the patent is invalid, unenforceable and/or not infringed (a so-called "Paragraph IV certification"), may be eligible to receive a 180-day period of generic market exclusivity. This period of market exclusivity provides the patent challenger with the opportunity to earn a risk-adjusted return on legal and development costs associated with bringing a product to market. In cases such as these where suit is filed by the manufacturer of the branded product, final FDA approval of an ANDA generally requires a favorable disposition of the suit, either by judgment that the patents at issue are invalid and/or not infringed or by settlement. There can be no assurance that we will ultimately prevail in these litigations, that we will receive final FDA approval of our ANDAs, or that any expectation of a period of generic exclusivity for certain of these products will actually be realized when and if resolution of the litigations and receipt of final approvals from the FDA occur. Since enactment of the Hatch-Waxman Act in 1984, the interpretation and implementation of the statutory provisions relating to the 180-day period of generic market exclusively have been the subject of controversy, court decisions, formal changes to FDA regulations and guidelines, and other changes in FDA interpretation. In addition, on December 8, 2003, significant changes were enacted in the statutory provisions themselves, some of which were retroactive and others of which apply only prospectively or to situations where the first ANDA filing with a Paragraph IV certification occurs after the date of enactment. These interpretations and changes, over time, 21 have had significant affects on the ability of sponsors of particular generic drug products to qualify for or utilize fully the 180-day generic marketing exclusivity period. These interpretations and changes have, in turn, affected the ability of sponsors of corresponding innovator drugs to market their branded products without any generic competition and the ability of sponsors of other generic versions of the same products to market their products in competition with the first generic applicant. Because application of these provisions, and any changes in them or in the applicable interpretations of them, depends almost entirely on the specific facts of the particular NDA and ANDA filings at issue, many of which are not in our control, we cannot predict whether any changes would, on balance, have a positive or negative effect on our business as a whole, although particular changes may have predictable, and potentially significant positive or negative affects on particular pipeline products. In addition, continuing uncertainty over the interpretation and implementation of the original Hatch-Waxman provisions, as well as the December 8, 2003 statutory revisions, is likely to continue to impair our ability to predict the likely exclusivity that we may be granted, or blocked by, based on the outcome of particular patent challenges in which we are involved. WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS, FOR WHICH WE MAY BE INADEQUATELY INSURED. Manufacturing, selling and testing pharmaceutical products involve a risk of product liability. Even unsuccessful product liability claims could require us to spend money on litigation, divert management's time, damage our reputation and impair the marketability of our products. A successful product liability claim outside of or in excess of our insurance coverage could require us to pay substantial sums and adversely affect our results of operations and financial condition. We previously distributed several pharmaceutical products that contained phenylpropanolamine, or PPA, and that were discontinued in 2000 and 2001. We are presently named a defendant in a product liability lawsuit in federal court in Mississippi involving PPA. The suit originated out of a case, Virginia Madison, et al. v. Bayer Corporation, et al. The original suit was filed in December 2002, but was not served on us until February 2003. The case was originally filed in the Circuit Court of Hinds County, Mississippi, and was removed to the Federal District Court for the Southern District of Mississippi by then co-defendant Bayer Corporation. The case has been transferred to a Judicial Panel on Multi-District Litigation for PPA claims sitting in the Western District of Washington. The claims against us have been segregated into a lawsuit brought by Johnny Fulcher individually and on behalf of the wrongful death beneficiaries of Linda Fulcher, deceased, against the Company. It alleges bodily injury, wrongful death, economic injury, punitive damages, loss of consortium and/or loss of services from the use of our distributed pharmaceuticals containing PPA that have since been discontinued and/or reformulated to exclude PPA. In May 2004, the case was dismissed with prejudice by the Federal District Court for the Western District of Washington for a failure to timely file an individual complaint as required by certain court orders. The plaintiff filed a request for reconsideration which was opposed and subsequently denied by the Court in June 2004. In July 2004, the plaintiff filed a notice of appeal of the dismissal. We have opposed this appeal. We intend to vigorously defend our interests; however, we cannot give any assurance we will prevail. We have also been advised that one of our former distributor customers is being sued in Florida state court in a case captioned Darrian Kelly v. K-Mart et. al. for personal injury allegedly caused by ingestion of K-Mart diet caplets that are alleged to have been manufactured by us and to contain PPA. The distributor has tendered defense of the case to us and has asserted a right to indemnification for any financial judgment it must pay. We previously notified our product liability insurer of this claim in 1999, and we have demanded that the insurer assume our defense. The insurer has stated that it has retained counsel to secure additional factual information and will defer its coverage decision until that information is received. We intend to vigorously defend our interests; however, we cannot give any assurance that we will not be impleaded into the action, or that, if we are impleaded, that we would prevail. Our product liability coverage for PPA claims expired for claims made after June 15, 2002. Although we renewed our product liability coverage for coverage after June 15, 2002, that policy excludes future PPA claims in accordance with the standard industry exclusion. Consequently, as of June 15, 2002, we will provide for legal 22 defense costs and indemnity payments involving PPA claims on a going forward basis as incurred, including the Mississippi lawsuit that was filed after June 15, 2002. Moreover, we may not be able to obtain product liability insurance in the future for PPA claims with adequate coverage limits at commercially reasonable prices for subsequent periods. From time to time in the future, we may be subject to further litigation resulting from products containing PPA that we formerly distributed. We intend to vigorously defend our interests; however, we cannot give any assurances we will prevail. WE DEPEND ON LICENSES FROM OTHERS, AND ANY LOSS OF THESE LICENSES COULD HARM OUR BUSINESS, MARKET SHARE AND PROFITABILITY. We have acquired the rights to manufacture, use and/or market certain products. We also expect to continue to obtain licenses for other products and technologies in the future. Our license agreements generally require us to develop the markets for the licensed products. If we do not develop these markets, the licensors may be entitled to terminate these license agreements. We cannot be certain that we will fulfill all of our obligations under any particular license agreement for any variety of reasons, including insufficient resources to adequately develop and market a product, lack of market development despite our efforts and lack of product acceptance. Our failure to fulfill our obligations could result in the loss of our rights under a license agreement. Certain products we have the right to license are at certain stages of clinical tests and FDA approval. Failure of any licensed product to receive regulatory approval could result in the loss of our rights under its license agreement. OUR POLICIES REGARDING RETURNS, ALLOWANCES AND CHARGEBACKS, AND MARKETING PROGRAMS ADOPTED BY WHOLESALERS, MAY REDUCE OUR REVENUES IN FUTURE FISCAL PERIODS. Based on industry practice, generic product manufacturers, including us, have liberal return policies and have been willing to give customers post-sale inventory allowances. Under these arrangements, from time to time, we give our customers credits on our generic products that our customers hold in inventory after we have decreased the market prices of the same generic products. Therefore, if additional competitors enter the marketplace and significantly lower the prices of any of their competing products, we would likely reduce the price of our comparable products. As a result, we would be obligated to provide significant credits to our customers who are then holding inventories of such products, which could reduce sales revenue and gross margin for the period the credit is provided. Like our competitors, we also give credits for chargebacks to wholesale customers that have contracts with us for their sales to hospitals, group purchasing organizations, pharmacies or other retail customers. A chargeback is the difference between the price the wholesale customer pays and the price that the wholesale customer's end-customer pays for a product. Although we establish reserves based on our prior experience and our best estimates of the impact that these policies may have in subsequent periods, we cannot ensure that our reserves are adequate or that actual product returns, allowances and chargebacks will not exceed our estimates. INVESTIGATIONS OF THE CALCULATION OF AVERAGE WHOLESALE PRICES MAY ADVERSELY AFFECT OUR BUSINESS. Many government and third-party payors, including Medicare, Medicaid, health maintenance organizations, or HMOs, and managed care organizations, or MCOs, reimburse doctors and others for the purchase of certain prescription drugs based on a drug's average wholesale price, or AWP. In the past several years, state and federal government agencies have conducted ongoing investigations of manufacturers' reporting practices with respect to AWP, in which they have suggested that reporting of inflated AWP's have led to excessive payments for prescription drugs. Determination of AWP is complex and third party payors may disagree with our calculations. 23 KV and/or ETHEX have been named as defendants in certain multi-defendant cases alleging that the defendants reported improper or fraudulent pharmaceutical pricing information, i.e., AWP and/or Wholesale Acquisition Cost, or WAC, information, which caused the governmental plaintiffs to incur excessive costs for pharmaceutical products under the Medicaid program. Cases of this type have been filed against KV and/or ETHEX and other pharmaceutical manufacturer defendants by the State of Massachusetts, the State of Alabama, New York City, and approximately 25 counties in New York State (less than ten of which have been formally served on KV or ETHEX). The New York City case and all but one of the New York County cases have been transferred (or will be the subject of a notice of related action in order to effectuate transfer) to the Federal District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation (MDL No. 1456). Each of these actions is in the early stages, and fact discovery has not yet begun in any of the cases other than the Alabama case, where the State's first discovery request has been filed. We intend to vigorously defend our interests in the actions described above; however, we cannot give any assurance we will prevail. We believe that various other governmental entities have commenced investigations into the generic and branded pharmaceutical industry at large regarding pricing and price reporting practices. Although we believe our pricing and reporting practices have complied in all material respects with our legal obligations, we cannot give any assurance that we would prevail if legal actions are instituted by these governmental entities. RISING INSURANCE COSTS COULD NEGATIVELY IMPACT PROFITABILITY. The cost of insurance, including workers' compensation, product liability and general liability insurance, has risen significantly in the past few years and is expected to continue to increase. In response, we may increase deductibles and/or decrease certain coverages to mitigate these costs. These increases, and our increased risk due to increased deductibles and reduced coverages, could have a negative impact on our results of operations, financial condition and cash flows. INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. As a result of our issuance of 2.5% Contingent Convertible Subordinated Notes, or the Notes, in May 2003, our indebtedness increased by $200.0 million. In addition, we increased our available credit facilities in December 2004 to $140.0 million. The revised credit facilities provide for an increase from $40.0 million to $80.0 million in our revolving line of credit along with an increase from $25.0 million to $60.0 million in the supplemental credit line that is available for financing acquisitions. These credit facilities expire in October 2006 and December 2005, respectively. At March 31, 2005, we had no cash borrowings under either credit facility. Our level of indebtedness may have several important effects on our future operations, including: o we will be required to use a portion of our cash flow from operations for the payment of any principal or interest due on our outstanding indebtedness; o our outstanding indebtedness and leverage will increase the impact of negative changes in general economic and industry conditions, as well as competitive pressures; and o the level of our outstanding debt and the impact it has on our ability to meet debt covenants associated with our revolving line of credit arrangement may affect our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes. General economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which are beyond our control, may affect our future performance. As a result, our business might not continue to generate cash flow at or above current levels. If we cannot generate sufficient cash flow from operations in the future to service our debt, we may, among other things: o seek additional financing in the debt or equity markets; 24 o refinance or restructure all or a portion of our indebtedness; o sell selected assets; o reduce or delay planned capital expenditures; or o reduce or delay planned research and development expenditures. These measures might not be sufficient to enable us to service our debt. In addition, any financing, refinancing or sale of assets might not be available on economically favorable terms. Holders of the Notes may require us to offer to repurchase their Notes for cash upon the occurrence of a change in control or on May 16, 2008, 2013, 2018, 2023 and 2028. The source of funds for any repurchase required as a result of any such events will be our available cash or cash generated from operating activities or other sources, including borrowings, sales of assets, sales of equity or funds provided by a new controlling entity. The use of available cash to fund the repurchase of the Notes may impair our ability to obtain additional financing in the future. WE MAY HAVE FUTURE CAPITAL NEEDS AND FUTURE ISSUANCES OF EQUITY SECURITIES WILL RESULT IN DILUTION. We anticipate that funds generated internally, together with funds available under our credit facility, and the proceeds received from our Notes offering completed in May 2003, will be sufficient to implement our business plan for the foreseeable future, subject to additional needs as may arise if acquisition opportunities become available. We also may need additional capital if unexpected events occur or opportunities arise. Additional capital might be raised through the public or private sale of debt or equity securities. If we sell equity securities, holders of our common stock could experience dilution. Furthermore, those securities could have rights, preferences and privileges more favorable than those of the Class A or Class B common stock. We cannot assure you that additional funding will be available, or available on terms favorable to us. If the funding is not available, we may not be able to fund our expansion, take advantage of acquisition opportunities or respond to competitive pressures. WE MAY INCUR CHARGES FOR INTANGIBLE ASSET IMPAIRMENT. When we acquire the rights to manufacture and sell a product, we record the aggregate purchase price, along with the value of the product related liabilities we assume, as intangible assets. We use the assistance of valuation experts to help us allocate the purchase price to the fair value of the various intangible assets we have acquired. Then, we must estimate the economic useful life of each of these intangible assets in order to amortize their cost as an expense in our consolidated statement of income over the estimated economic useful life of the related asset. The factors that drive the actual economic useful life of a pharmaceutical product are inherently uncertain, and include patent protection, physician loyalty and prescribing patterns, competition by products prescribed for similar indications, future introductions of competing products not yet FDA approved, the impact of promotional efforts and many other issues. We use all of these factors in initially estimating the economic useful lives of our products, and we also continuously monitor these factors for indications of appropriate revisions. In assessing the recoverability of our intangible assets, we must make assumptions regarding estimated undiscounted future cash flows and other factors. If the estimated undiscounted future cash flows do not exceed the carrying value of the intangible assets we must determine the fair value of the intangible assets. If the fair value of the intangible assets is less than its carrying value, an impairment loss will be recognized in an amount equal to the difference. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. We review intangible assets for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If we determine that an intangible asset is impaired, a non-cash impairment charge would be recognized. 25 As circumstances after an acquisition can change, the value of intangible assets may not be realized by us. If we determine that an impairment has occurred, we would be required to write-off the impaired portion of the unamortized intangible assets, which could have a material adverse effect on our results of operations in the period in which the write-off occurs. For example, we expect to report a non-cash charge of approximately $30.0 million in the first quarter of fiscal 2006 reflecting primarily a write-off of in-process research and development costs in connection with our acquisition of FemmePharma and all of the worldwide marketing rights to an endometriosis product that has successfully completed Phase II clinical trials and was originally part of a licensing arrangement with FemmePharma. In addition, in the event of a sale of any of our assets, we cannot be certain that our recorded value of such intangible assets would be recovered. RISKS RELATED TO OUR INDUSTRY LEGISLATIVE PROPOSALS, REIMBURSEMENT POLICIES OF THIRD PARTIES, COST CONTAINMENT MEASURES AND HEALTH CARE REFORM COULD AFFECT THE MARKETING, PRICING AND DEMAND FOR OUR PRODUCTS. Various legislative proposals, including proposals relating to prescription drug benefits, could materially impact the pricing and sale of our products. Further, reimbursement policies of third parties may affect the marketing of our products. Our ability to market our products will depend in part on reimbursement levels for the cost of the products and related treatment established by health care providers, including government authorities, private health insurers and other organizations, such as HMOs and MCOs. Insurance companies, HMOs, MCOs, Medicaid and Medicare administrators and others are increasingly challenging the pricing of pharmaceutical products and reviewing their reimbursement practices. In addition, the following factors could significantly influence the purchase of pharmaceutical products, which could result in lower prices and a reduced demand for our products: o the trend toward managed health care in the United States; o the growth of organizations such as HMOs and MCOs; o legislative proposals to reform health care and government insurance programs; and o price controls and non-reimbursement of new and highly priced medicines for which the economic therapeutic rationales are not established. These cost-containment measures and health care reform proposals could affect our ability to sell our products. The reimbursement status of a newly approved pharmaceutical product may be uncertain. Reimbursement policies may not include some of our products. Even if reimbursement policies of third parties grant reimbursement status for a product, we cannot be sure that these reimbursement policies will remain in effect. Limits on reimbursement could reduce the demand for our products. The unavailability or inadequacy of third party reimbursement for our products could reduce or possibly eliminate demand for our products. We are unable to predict whether governmental authorities will enact additional legislation or regulation which will affect third party coverage and reimbursement that reduces demand for our products. Our ability to market generic pharmaceutical products successfully depends, in part, on the acceptance of the products by independent third parties, including pharmacies, government formularies and other retailers, as well as patients. We manufacture a number of prescription drugs which are used by patients who have severe health conditions. Although the brand-name products generally have been marketed safely for many years prior to our introduction of a generic/non-branded alternative, there is a possibility that one of these products could produce a side effect which could result in an adverse effect on our ability to achieve acceptance by managed care providers, 26 pharmacies and other retailers, customers and patients. If these independent third parties do not accept our products, it could have a material adverse effect on our financial condition and results of operations. EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A SIGNIFICANT IMPACT ON OUR BUSINESS, ESPECIALLY OUR PRODUCT DEVELOPMENT, MANUFACTURING AND DISTRIBUTION CAPABILITIES. All pharmaceutical companies, including us, are subject to extensive, complex, costly and evolving regulation by the federal government, principally the FDA and, to a lesser extent, the DEA and state government agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacturing, packing, labeling, storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products. Failure to comply with applicable FDA or other regulatory requirements may result in criminal prosecution, civil penalties, injunctions, recall or seizure of products and total or partial suspension of production, as well as other regulatory actions against our products and us. We market certain drug products in the United States without FDA approval under certain "grandfather" clauses and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the Federal Food, Drug and Cosmetic Act, or the FDCA. A determination as to whether a particular product does or does not require FDA pre-market review and approval can involve consideration of numerous complex and imprecise factors. If a determination is made by the FDA that any product marketed without approval requires such approval, the FDA may institute enforcement actions, including product seizure, or an action seeking an injunction against further marketing and may or may not allow sufficient time to obtain the necessary approvals before it seeks to curtail further marketing. For example, in October 2002, FDA sent warning letters to us and other manufacturers and distributors of unapproved prescription drug products containing the expectorant guaifenesin as a single entity in a solid oral extended-release dosage form. Citing the recent approval of one such product, the FDA warning letters asserted that the marketing of all such products without NDA or ANDA approval should stop. The FDA subsequently agreed to allow continued manufacture through May 2003 and sale through November 2003 of the products, and we complied with those deadlines. We are not in a position to predict whether or when the FDA might choose to raise similar objections to the marketing without NDA or ANDA approval of another category or categories of drug products represented in our product lines. In the event such objections are raised, we could be required or could decide to cease distribution of additional products until pre-market approval is obtained. In addition, we may not be able to obtain any particular approval that may be required or such approvals may not be obtained on a timely basis. In addition to compliance with current Good Manufacturing Practice, or cGMP, requirements, drug manufacturers must register each manufacturing facility with the FDA. Manufacturers and distributors of prescription drug products are also required to be registered in the states where they are located and in certain states that require registration by out-of-state manufacturers and distributors. Manufacturers also must be registered with the Drug Enforcement Administration, or DEA, and similar applicable state and local regulatory authorities if they handle controlled substances, and with the Environmental Protection Agency, or EPA, and similar state and local regulatory authorities if they generate toxic or dangerous wastes, and must also comply with other applicable DEA and EPA requirements. We believe that we are currently in material compliance with cGMP and are registered with the appropriate state and federal agencies. Non-compliance with applicable cGMP requirements or other rules and regulations of these agencies can result in fines, recall or seizure of products, total or partial suspension of production and/or distribution, refusal of government agencies to grant pre-market approval or other product applications and criminal prosecution. Despite our ongoing efforts, cGMP requirements and other regulatory requirements, and related enforcement priorities and policies may evolve over time and we may not be able to remain continuously in material compliance with all of these requirements. From time to time, governmental agencies have conducted investigations of pharmaceutical companies relating to the distribution and sale of drug products to government purchasers or subject to government or third party reimbursement. We believe that we have marketed our products in compliance with applicable laws and 27 regulations. However, standards sought to be applied in the course of governmental investigations can be complex and may not be consistent with standards previously applied to our industry generally or previously understood by us to be applicable to our activities. The process for obtaining governmental approval to manufacture and market pharmaceutical products is rigorous, time-consuming and costly, and we cannot predict the extent to which we may be affected by legislative and regulatory developments. We are dependent on receiving FDA and other governmental or third-party approvals prior to manufacturing, marketing and shipping many of our products. Consequently, there is always the chance that we will not obtain FDA or other necessary approvals, or that the rate, timing and cost of such approvals, will adversely affect our product introduction plans or results of operations. In many instances we carry inventories of products in anticipation of launch, and if such products are not subsequently launched, we may be required to write-off the related inventory. OUR INDUSTRY IS HIGHLY COMPETITIVE. Numerous pharmaceutical companies are involved or are becoming involved in the development and commercialization of products incorporating advanced drug delivery systems. Our business is highly competitive, and we believe that competition will continue to increase in the future. Many pharmaceutical companies have invested, and are continuing to invest, significant resources in the development of proprietary drug delivery systems. In addition, several companies have been formed to develop specific advanced drug delivery systems. Many of these pharmaceutical and other companies who may develop drug delivery systems have greater financial, research and development and other resources than we do, as well as more experience in commercializing pharmaceutical and drug delivery products. Those companies may develop products using their drug delivery systems more rapidly than we do or develop drug delivery systems that are more effective than ours and thus may represent significant potential competitors. Our branded pharmaceutical business is subject to competition from larger companies with greater financial resources that can support larger sales forces. The ability of a sales force to compete is affected by the number of physician calls it can make, which is directly related to its size, the brand name recognition it has in the marketplace and its advertising and promotional efforts. We are not as well established in our branded product sales initiative as larger pharmaceutical companies and could be adversely affected by competition from companies with larger, more established sales forces and higher advertising and promotional expenditures. Our generic pharmaceutical business is also subject to competitive pressures from a number of companies, some of which have greater financial resources and broader product lines. To the extent that we succeed in being first to market with a generic/non-branded version of a significant product, our sales and profitability can be substantially increased in the period following the introduction of such product and prior to additional competitors' introduction of an equivalent product. Competition is generally on price, which can have an adverse effect on profitability as falling prices erode margins. In addition, the continuing consolidation of the customer base (wholesale distributors and retail drug chains) and the impact of managed care organizations will increase competition as suppliers compete for fewer customers. Consolidation of competitors will increase competitive pressures as larger suppliers are able to offer a broader product line. Further, companies continually seek new ways to defeat generic competition, such as filing applications for new patents to cover drugs whose original patent protection is about to expire, developing and marketing other dosage forms including patented controlled-release products or developing and marketing as over-the-counter products those branded products which are about to lose exclusivity and face generic competition. In addition to litigation over patent rights, pharmaceutical companies are often the subject of objections by competing manufacturers over the qualities of their branded or generic products and/or their promotional activities. For example, marketers of branded products have challenged the marketing of certain of our non-branded products that do not require FDA approval and are not rated for therapeutic equivalence. 28 Currently, the Company and ETHEX are named as defendants in ongoing litigation with Solvay Pharmaceuticals, Inc. regarding Solvay's allegations that ETHEX's comparative promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20 products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted in false advertising and misleading statements under various Federal and state laws, and constituted unfair and deceptive trade practices. Discovery is active and the case is required to be ready for trial by February 1, 2006. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. Competitors' objections also may be pursued in complaints before governmental agencies or courts. These objections can be very expensive to pursue or to defend, and the outcome of agency or court review of the issues raised is impossible to predict. In these proceedings, companies can be subjected to restrictions on their activities or to liability for alleged damages despite their belief that their products and procedures are in full compliance with appropriate standards. In addition, companies that pursue what they believe are legitimate complaints about competing manufacturers and/or their products may nevertheless be unable to obtain any relief. OUR INDUSTRY EXPERIENCES RAPID TECHNOLOGICAL CHANGE. The drug delivery industry is a rapidly evolving field. A number of companies, including major pharmaceutical companies, are developing and marketing advanced delivery systems for the controlled delivery of drugs. Products currently on the market or under development by competitors may deliver the same drugs, or other drugs to treat the same indications, as many of the products we market or are developing. The first pharmaceutical branded or generic/non-branded product to reach the market in a therapeutic area often obtains and maintains significant market share relative to later entrants to the market. Our products also compete with drugs marketed not only in similar delivery systems but also in traditional dosage forms. New drugs, new therapeutic approaches or future developments in alternative drug delivery technologies may provide advantages over the drug delivery systems and products that we are marketing, have developed or are developing. Changes in drug delivery technology may require substantial investments by companies to maintain their competitive position and may provide opportunities for new competitors to enter the industry. Developments by others could render our drug delivery products or other technologies uncompetitive or obsolete. If others develop drugs which are cheaper or more effective or which are first to market, sales or prices of our products could decline. RISKS RELATED TO OUR COMMON STOCK MANAGEMENT STOCKHOLDERS CONTROL OUR COMPANY. At March 31, 2005, our directors and executive officers beneficially own approximately 13% of our Class A Common Stock and approximately 60% of our Class B Common Stock. As a result, these persons control approximately 53% of the combined voting power represented by our outstanding securities. These persons will retain effective voting control of our company and are expected to continue to have the ability to effectively determine the outcome of any matter being voted on by our stockholders, including the election of directors and any merger, sale of assets or other change in control of our company. THE MARKET PRICE OF OUR STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE. The market prices of securities of companies engaged in pharmaceutical development and marketing activities historically have been highly volatile. In addition, any or all of the following may have a significant impact on the market price of our common stock: announcements by us or our competitors of technological innovations or new commercial products; delays in the development or approval of products; developments or disputes concerning patent or other proprietary rights; publicity regarding actual or potential medical results relating to products marketed by us or products under development; regulatory developments in both the United States and foreign countries; publicity regarding actual or potential acquisitions; public concern as to the safety of drug 29 technologies or products; financial results which are different from securities analysts' forecasts; and economic and other external factors, as well as period-to-period fluctuations in our financial results. FUTURE SALES OF COMMON STOCK COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR CLASS A OR CLASS B COMMON STOCK. As of March 31, 2005, an aggregate of 2,707,207 shares of our Class A common stock and 395,591 shares of our Class B common stock were issuable upon exercise of outstanding stock options under our stock option plans, and an additional 988,473 shares of our Class A common stock and 1,214,399 shares of Class B common stock were reserved for the issuance of additional options and shares under these plans. In addition, as of March 31, 2005, 8.7 million shares of Class A common stock were reserved for issuance upon conversion of $200.0 million principal amount of convertible notes, and 337,500 shares of our Class A common stock were reserved for issuance upon conversion of our outstanding 7% cumulative convertible preferred stock. Future sales of our common stock and instruments convertible or exchangeable into our common stock and transactions involving equity derivatives relating to our common stock, or the perception that such sales or transactions could occur, could adversely affect the market price of our common stock. This could, in turn, have an adverse effect on the trading price of the Notes resulting from, among other things, a delay in the ability of holders to convert their Notes into our Class A common stock. OUR CHARTER PROVISIONS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER EFFECTS. Our Amended Certificate of Incorporation authorizes the issuance of common stock in two classes, Class A common stock and Class B common stock. Each share of Class A common stock entitles the holder to one-twentieth of one vote on all matters to be voted upon by stockholders, while each share of Class B common stock entitles the holder to one full vote on each matter considered by the stockholders. In addition, our directors have the authority to issue additional shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The existence of two classes of common stock with different voting rights and the ability of our directors to issue additional shares of preferred stock could make it more difficult for a third party to acquire a majority of our voting stock. Other provisions of our Amended Certificate of Incorporation and Bylaws, such as a classified board of directors, also may have the effect of discouraging, delaying or preventing a merger, tender offer or proxy contest, which could have an adverse effect on the market price of our Class A common stock. In addition, certain provisions of Delaware law applicable to our company could also delay or make more difficult a merger, tender offer or proxy contest involving our company, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. Our senior management is entitled to certain payments upon a change in control. All of our stock option plans provide for the acceleration of vesting in the event of a change in control of our company. 30 ITEM 2. PROPERTIES ---------- Our corporate headquarters is located at 2503 South Hanley Road in St. Louis County, Missouri, and contains approximately 40,000 square feet of floor space. We have a lease on the building for a period of ten years expiring December 31, 2006, with one five-year option to renew and a successive three-year renewal option. The building is leased from an affiliated partnership of an officer and director of the Company. In addition, we lease or own the facilities shown in the following table. All of these facilities are located in the St. Louis metropolitan area.
SQUARE LEASE RENEWAL FOOTAGE USAGE EXPIRES OPTIONS ----------------------------------------------------------------------------------------- 31,630 PDI Office/Mfg./Whse. 11/30/07 5 Years(1) 10,000 PDI/KV Lab/Whse. 11/30/05 None 15,000 KV/Ther-Rx Office 02/28/08 2 Years(3) 23,000 KV Office/R&D/Mfg. 12/31/06 5 Years(2) 122,350 KV Office/Whse./Lab Owned N/A 90,000 KV Mfg. Oper. Owned N/A 87,020 Under renovation(5) Owned N/A 302,940 Under renovation(6) Owned N/A 260,160 ETHEX/Ther-Rx/PDI Distribution(7) 04/30/12 5 Years(2) 40,000 KV Warehouse 11/30/05 1 Year(4) 128,960 ETHEX/PDI Office/Whse. 06/14/11 5 Years(2) ------- (1) One five-year option. (2) Two five-year options. (3) Two two-year options. (4) Two one-year options. (5) This facility is currently being renovated to provide an additional research lab facility. (6) This facility is currently being renovated into office space for ETHEX, Ther-Rx and certain KV administrative functions and production space for additional operations. We financed the purchase of this facility with a term loan secured by the facility. (7) On April 14, 2005, the Company completed the purchase of this building for $11.8 million. The property had been leased by the Company since April 2000 and will continue to function as the Company's main distribution facility. The purchase price of the building was paid with cash on hand.
Properties used in our operations are considered suitable for the purposes for which they are used and are believed to be adequate to meet our Company's needs for the reasonably foreseeable future. However, we will consider leasing or purchasing additional facilities from time to time, when attractive facilities become available, to accommodate the consolidation of certain operations and to meet future expansion plans. ITEM 3. LEGAL PROCEEDINGS ----------------- The Company and ETHEX are named as defendants in a case brought by CIMA LABS, Inc. and Schwarz Pharma, Inc. and styled CIMA LABS, Inc. et. al. v. KV Pharmaceutical Company et. al. filed in Federal District Court in Minnesota. It is alleged that the Company and ETHEX infringed on a CIMA patent in connection with the manufacture and sale of Hyoscyamine Sulfate Orally Dissolvable Tablets, 0.125 mg. The court has denied the plaintiffs' motion for a preliminary injunction, which allows ETHEX to continue marketing the product during the pendancy of the subject lawsuit. The Company has filed several motions for summary judgment requesting that the Court rule that the relevant patent is unenforceable, invalid or not infringed. These motions have been denied and the issues will be considered at trial. CIMA and Schwarz filed a summary judgment motion seeking the Court to rule that the patent is valid in the face of some prior art references cited by the Company as providing support for its invalidity defense. The Court granted the motion; however, the issue of invalidity based on prior art 31 that was not the subject of the motion will be tried. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. The Company and ETHEX are named as defendants in a case brought by Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals, Inc. v. ETHEX Corporation, filed in Federal District Court in Minnesota. In general, Solvay alleges that ETHEX's comparative promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20 products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted in false advertising and misleading statements under various federal and state laws, and constituted unfair and deceptive trade practices. Discovery is active and the case is required to be trial ready by February 1, 2006. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. KV previously distributed several pharmaceutical products that contained phenylpropanolamine, or PPA, and that were discontinued in 2000 and 2001. The Company is presently named a defendant in a product liability lawsuit in federal court in Mississippi involving PPA. The suit originated out of a case, Virginia Madison, et al. v. Bayer Corporation, et al. The original suit was filed in December 2002, but was not served on KV until February 2003. The case was originally filed in the Circuit Court of Hinds County, Mississippi, and was removed to the Federal District Court for the Southern District of Mississippi by then co-defendant Bayer Corporation. The case has been transferred to a Judicial Panel on Multi-District Litigation for PPA claims sitting in the Western District of Washington. The claims against the Company have been segregated into a lawsuit brought by Johnny Fulcher individually and on behalf of the wrongful death beneficiaries of Linda Fulcher, deceased, against the Company. It alleges bodily injury, wrongful death, economic injury, punitive damages, loss of consortium and/or loss of services from the use of the Company's distributed pharmaceuticals containing PPA that have since been discontinued and/or reformulated to exclude PPA. In May 2004, the case was dismissed with prejudice by the Federal District Court for the Western District of Washington for a failure to timely file an individual complaint as required by certain court orders. The plaintiff filed a request for reconsideration which was opposed and subsequently denied by the Court in June 2004. In July 2004, the plaintiff filed a notice of appeal of the dismissal. The Company has opposed this appeal. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. The Company has also been advised that one of its former distributor customers is being sued in Florida state court in a case captioned Darrian Kelly v. K-Mart et. al. for personal injury allegedly caused by ingestion of K-Mart diet caplets that are alleged to have been manufactured by the Company and to contain PPA. The distributor has tendered defense of the case to the Company and has asserted a right to indemnification for any financial judgment it must pay. The Company previously notified its product liability insurer of this claim in 1999, and the Company has demanded that the insurer assume the Company's defense. The insurer has stated that it has retained counsel to secure additional factual information and will defer its coverage decision until that information is received. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will not be impleaded into the action, or that, if it is impleaded, that it would prevail. KV's product liability coverage for PPA claims expired for claims made after June 15, 2002. Although the Company renewed its product liability coverage for coverage after June 15, 2002, that policy excludes future PPA claims in accordance with the standard industry exclusion. Consequently, as of June 15, 2002, the Company will provide for legal defense costs and indemnity payments involving PPA claims on a going forward basis as incurred, including the Mississippi lawsuit that was filed after June 15, 2002. Moreover, the Company may not be able to obtain product liability insurance in the future for PPA claims with adequate coverage limits at commercially reasonable prices for subsequent periods. From time to time in the future, KV may be subject to further litigation resulting from products containing PPA that it formerly distributed. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. After the Company filed ANDAs with the FDA seeking permission to market a generic version of the 50 mg, 100 mg, and 200 mg strengths of Toprol(R) XL in extended release capsule form, AstraZeneca filed lawsuits against KV for patent infringement under the provisions of the Hatch-Waxman Act. In the Company's Paragraph IV certification, KV contended that its proposed generic versions do not infringe AstraZeneca's patents. Pursuant to 32 the Hatch-Waxman Act, the filing date of the suit against the Company instituted an automatic stay of FDA approval of the Company's ANDA until the earlier of a judgment of non-infringement or invalidity, or 30 months from the date the application was filed. The Company has filed a motion for summary judgment with the Federal District Court in Missouri alleging, among other things, that AstraZeneca's patent is invalid. There is no trial setting. The Company intends to vigorously defend its interests; however, it cannot give any assurances it will prevail. The Company and/or ETHEX have been named as defendants in certain multi-defendant cases alleging that the defendants reported improper or fraudulent pharmaceutical pricing information, i.e., AWP and/or Wholesale Acquisition Cost, or WAC, information, which caused the governmental plaintiffs to incur excessive costs for pharmaceutical products under the Medicaid program. Cases of this type have been filed against the Company and/or ETHEX and other pharmaceutical manufacturer defendants by the State of Massachusetts, the State of Alabama, New York City, and approximately 25 counties in New York State (less than ten of which have been formally served on the Company or ETHEX). The New York City case and all but one of the New York County cases have been transferred (or will be the subject of a notice of related action in order to effectuate transfer) to the Federal District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation (MDL No. 1456). Each of these actions is in the early stages, and fact discovery has not yet begun in any of the cases other than the Alabama case, where the State's first discovery request has been filed. The Company intends to vigorously defend its interests in the actions described above; however, it cannot give any assurance it will prevail. The Company believes that various other governmental entities have commenced investigations into the generic and branded pharmaceutical industry at large regarding pricing and price reporting practices. Although the Company believes its pricing and reporting practices have complied in all material respects with its legal obligations, it cannot give any assurances that it would prevail if legal actions are instituted by these governmental entities. On May 20, 2005 the Company was notified by the SEC that a non-public formal investigation was initiated that appears to relate to the Form 8-K disclosures the Company made on July 13, 2004. The Company is cooperating fully and believes the matter will be satisfactorily resolved. From time to time, the Company is involved in various other legal proceedings in the ordinary course of its business. These legal proceedings include various patent infringement actions brought by potential competitors with respect to products the Company proposes to market and for which it has submitted ANDA filings and provided notice of certification required under the provisions of the Act. While it is not feasible to predict the ultimate outcome of such other proceedings, the Company believes that the ultimate outcome of such other proceedings will not have a material adverse effect on its results of operations or financial position. There are uncertainties and risks associated with all litigation and there can be no assurance that the Company will prevail in any particular litigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- No matters were submitted to a vote of security holders during the fourth quarter of the Company's fiscal year ended March 31, 2005. 33 ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------ The following is a list of current executive officers of our Company, their ages, their positions with our Company and their principal occupations for at least the past five years.
NAME AGE POSITION HELD AND PAST EXPERIENCE - ---------------------------------------------------------------------------------------------------------------------------------- Marc S. Hermelin 63 Vice Chairman of the Board of the Company since 1974; Chief Executive Officer from 1975 to February 1994 and since December 1994; Director and Vice President of Particle Dynamics, Inc. since 1974.(1) Alan G. Johnson 70 Director, Senior Vice President-Strategic Planning and Corporate Growth since September 1999 and Secretary of the Company; Chairman of Johnson Research & Capital, Inc., an investment banking and institutional research firm from January to September 1999; Member of the law firm Gallop, Johnson & Neuman, L.C. 1976 to 1998; Director of Siboney Corporation. Gerald R. Mitchell 65 Vice President and Chief Financial Officer since 1981. Richard H. Chibnall 49 Vice President, Finance since February 2000. Michael S. Anderson 56 Chief Executive Officer, Ther-Rx Corporation since February 2000. Jerald J. Wenker 43 President, Ther-Rx Corporation since June 2004; Vice President, Licensing and New Business Development, Abbot Corporation from January 2002 to April 2004; Vice President and General Manager, Anti-Infective Franchise Abbot Corporation from April 2000 to January 2002. Philip J. Vogt 48 President, ETHEX Corporation since February 2000. Ray F. Chiostri 71 Chairman and Chief Executive Officer, Particle Dynamics, Inc. since 1999. Paul T. Brady 42 President, Particle Dynamics, Inc. since 2003; Senior Vice President and General Manager, International Specialty Products Corporation from June 2002 to January 2003; Senior Vice President, Commercial Director, North and South America International Specialty Products from 2000 to 2002. Eric D. Moyermann 47 President, Pharmaceutical Manufacturing since February 2000. Executive officers of the Company serve at the pleasure of the Board of Directors. - ---------- (1) Marc S. Hermelin is the son of Victor M. Hermelin, Chairman of the Board of Directors of the Company since 1971 and father of David S. Hermelin, a member of the Board of Directors since 2004.
34 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS a) PRINCIPAL MARKET ---------------- Our Class A common stock and Class B common stock are traded on the New York Stock Exchange under the symbols KV.A and KV.B, respectively. b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK --------------------------------------------- The number of holders of record of Class A and Class B Common Stock as of June 9, 2005 was 786 and 389, respectively (not separately counting shareholders whose shares are held in "nominee" or "street" names, which are estimated to represent approximately 5,000 additional Class A common stock and Class B common stock shareholders combined). c) STOCK PRICE AND DIVIDEND INFORMATION ------------------------------------ The high and low closing sales prices of our Class A and Class B common stock during each quarter of fiscal 2005 and 2004, as reported on the New York Stock Exchange and as adjusted for the 3 for 2 stock split effective on September 8, 2003 were as follows:
CLASS A COMMON STOCK -------------------- FISCAL 2005 FISCAL 2004 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- -------------------- --------------------- First...................... $26.24 $22.25 $20.29 $12.61 Second..................... 23.11 15.31 23.49 17.91 Third...................... 22.14 18.18 27.67 22.22 Fourth..................... 23.20 19.78 27.51 22.10 CLASS B COMMON STOCK -------------------- FISCAL 2005 FISCAL 2004 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- -------------------- --------------------- First...................... $29.60 $25.00 $20.39 $12.63 Second..................... 25.05 16.35 23.53 18.09 Third...................... 22.77 18.65 27.77 22.31 Fourth..................... 23.49 20.42 29.40 22.60
Since 1980, we have not declared or paid any cash dividends on our common stock and we do not plan to do so in the foreseeable future. No dividends may be paid on Class A common stock or Class B common stock unless all dividends on the Cumulative Convertible Preferred Stock have been declared and paid. Dividends must be paid on Class A common stock when, and if, we declare and distribute dividends on the Class B common stock. Dividends of $70,000 were paid in fiscal 2005 and 2004 on 40,000 shares of outstanding Cumulative Convertible Preferred Stock. Also, $366,000, or $9.14 per share, of undeclared and unaccrued cumulative preferred dividends were paid on May 12, 2003. There were no undeclared and unaccrued cumulative preferred dividends at March 31, 2005. 35 Also, under the terms of our credit agreement, we may not pay cash dividends in excess of 25% of the prior fiscal year's consolidated net income. For the foreseeable future, we plan to use cash generated from operations for general corporate purposes, including funding potential acquisitions, research and development and working capital. Our board of directors reviews our dividend policy periodically. Any payment of dividends in the future will depend upon our earnings, capital requirements, financial condition and other factors considered relevant by our board of directors. See also Item 12 for information relating to the Company's equity compensation plans.
- ---------------------------------------------------------------------------------------------------------------------- Issuer Purchases of Equity Securities - ---------------------------------------------------------------------------------------------------------------------- Period Total number of Average price paid Total number of Maximum number (or shares purchased per share shares purchased approximate dollar (a) as part of publicly value) of shares (or announced plans or units) that may yet programs be purchased under the plans or programs - ---------------------------------------------------------------------------------------------------------------------- 1/1/05 - 1/31/05 188 $21.75 -- -- - ---------------------------------------------------------------------------------------------------------------------- 2/1/05 - 2/28/05 104 $20.22 -- -- - ---------------------------------------------------------------------------------------------------------------------- 3/1/05 - 3/31/05 64 $21.85 -- -- - ---------------------------------------------------------------------------------------------------------------------- Total 356 $21.32 -- -- - ---------------------------------------------------------------------------------------------------------------------- (a) Shares were purchased from employees upon their termination pursuant to the terms of the Company's stock option plan.
36 ITEM 6. SELECTED FINANCIAL DATA ----------------------- (in thousands, except per share data)
MARCH 31, -------------------------------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Total assets $558,317 $528,438 $352,668 $195,192 $151,417 Long-term debt 209,767 210,741 10,106 4,387 5,080 Shareholders' equity 292,702 257,749 260,616 158,792 125,942 INCOME STATEMENT DATA: YEARS ENDED MARCH 31, -------------------------------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- Net revenues $303,493 $283,941 $244,996 $204,105 $177,767 % Increase from prior period 6.9% 15.9% 20.0% 14.8% 24.5% Operating income(a)(b)(c) $ 52,412 $ 73,771 $ 42,929 $ 49,294 $ 37,972 Net income(a)(b)(c) 33,269 45,848 28,110 31,464 23,625 Net income per common share-diluted(d) (e) $ 0.63 $ 0.84 $ 0.55 $ 0.65 $ 0.49 Preferred stock dividends $ 70 $ 436 $ 70 $ 70 $ 420 - --------------------------- (a) Operating income in fiscal 2005 included a $0.6 million net payment received by us in accordance with a legal settlement and additional income of $0.8 million for the reversal of a portion of the Healthpoint litigation reserve that remained after payment of the $16.5 million settlement amount and related litigation costs (see Note 11 in the accompanying Notes to Consolidated Financial Statements). The impact of these items, net of applicable income taxes, was to increase net income by $1.0 million and diluted earnings per share by $.02 in fiscal 2005. (b) Operating income in fiscal 2004 included a $3.5 million net payment received by us in accordance with a legal settlement (see Note 13 in the accompanying Notes to Consolidated Financial Statements) and an additional reserve of $1.8 million for attorney's fees associated with a lawsuit. The impact of these items, net of applicable income taxes, was to increase net income by $1.1 million and diluted earnings per share by $.02 in fiscal 2004. (c) Operating income in fiscal 2003 included a reserve of $16.5 million for potential damages associated with the Healthpoint litigation. The impact of the litigation reserve, net of applicable income taxes, was to reduce net income by $10.4 million and diluted earnings per share by $.20 in fiscal 2003. (d) Previously reported amounts give effect to the three-for-two stock splits effected in the form of a 50% stock dividend that occurred on September 29, 2003 and September 7, 2000. (e) Amounts for fiscal year 2004 have been restated to report shares issuable upon conversion of contingent convertible notes, which were issued in May 2003, pursuant to Emerging Issues Task Force (EITF) Issue No. 04-08, the Effect of Contingently Convertible Debt on Diluted Earnings per Share.
37 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, -------------------------------------------------------------- AND LIQUIDITY AND CAPITAL RESOURCES ----------------------------------- Except for the historical information contained herein, the following discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. These risks, uncertainties and other factors are discussed throughout this report and specifically under the captions "Cautionary Statement Regarding Forward-Looking Information" and "Risk Factors." In addition, the following discussion and analysis of the financial condition and results of operations should be read in conjunction with "Selected Financial Data" and our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. BACKGROUND We are a fully integrated specialty pharmaceutical company that develops, acquires, manufactures and markets technologically- distinguished branded and generic/non-branded prescription pharmaceutical products. We have a broad range of dosage form capabilities, including tablets, capsules, creams, liquids and ointments. We conduct our branded pharmaceutical operations through Ther-Rx Corporation and our generic/non-branded pharmaceutical operations through ETHEX Corporation, which focuses principally on technologically-distinguished generic products. Through Particle Dynamics, Inc., we develop, manufacture and market technologically advanced, value-added raw material products for the pharmaceutical, nutritional, personal care, food and other markets. We have a broad portfolio of drug delivery technologies which we leverage to create technologically-distinguished brand name and specialty generic products. We have developed and patented 15 drug delivery and formulation technologies primarily in four principal areas: SITE RELEASE(R) bioadhesives, oral controlled release, tastemasking and oral quick dissolving tablets. We incorporate these technologies in the products we market to control and improve the absorption and utilization of active pharmaceutical compounds. These technologies provide a number of benefits, including reduced frequency of administration, reduced side effects, improved drug efficacy, enhanced patient compliance and improved taste. Our drug delivery technologies allow us to differentiate our products in the marketplace, both in the branded and generic pharmaceutical areas. We believe that this differentiation provides substantial competitive advantages for our products, allowing us to establish a strong record of growth and profitability and a leadership position in certain segments of our industry. RESULTS OF OPERATIONS In fiscal 2005, net revenues increased 6.9% as we experienced sales growth compared to fiscal 2004 in all three of our operating segments: branded products, specialty generics and specialty materials. Our sales growth in fiscal 2005 was constrained by slower than anticipated ANDA approvals by the FDA on two brand equivalent products that we expected to introduce in the fourth quarter of fiscal 2005 and delays in the timing of other certain approvals during the year. We expect these approvals will be received in the second half of fiscal 2006. Sales of our branded segment also were negatively impacted in the fourth quarter by a shortage of raw material for one of our products. The $10.3 million increase in gross profit was more than offset by an increase in operating expenses of $31.7 million. The increase in operating expenses was primarily due to: greater personnel expenses associated with an increase in management personnel and expansion of the branded sales force, an increase in branded marketing expense primarily related to the approval and introduction of the Company's second NDA product - Clindesse(TM), increases in professional fees and legal expenses, and an increase in research and development expense. As a result, net income decreased $12.6 million, or 27.4%, to $33.3 million compared to fiscal 2004. 38 FISCAL 2005 COMPARED TO FISCAL 2004 NET REVENUES BY SEGMENT ----------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % -------- -------- ------- ----- Branded products $ 90,085 $ 82,868 $ 7,217 8.7% as % of net revenues 29.7% 29.2% Specialty generics 191,870 181,455 10,415 5.7% as % of net revenues 63.2% 63.9% Specialty materials 18,345 16,550 1,795 10.8% as % of net revenues 6.0% 5.8% Other 3,193 3,068 125 4.1% ======== ======== ======= Total net revenues $303,493 $283,941 $19,552 6.9% The increase in branded product sales was due primarily to the introduction of Clindesse(TM) in the fourth quarter of fiscal 2005, continued growth of Gynazole-1(R) and increased sales of our two hematinic brands. The introduction of Clindesse(TM), a single-dose prescription cream therapy indicated to treat bacterial vaginosis, contributed $4.2 million of incremental sales during the fourth quarter of fiscal 2005. Since its launch in January 2005, Clindesse(TM) has garnered 13.1% of the intravaginal bacterial vaginosis market in the United States. Sales of Gynazole-1, our vaginal antifungal cream product, increased $2.7 million, or 14.4%, to $21.3 million during fiscal 2005 as our share of the prescription vaginal antifungal cream market increased to 31.5% at the end of fiscal 2005, from 26.9% at the end of the prior year. Sales from our two hematinic product lines, Chromagen(R) and Niferex(R), increased 22.6% to $25.4 million during fiscal 2005 as both product lines experienced significant growth in new prescriptions filled. During the year, new prescription growth for Chromagen(R) and Niferex(R) was 74.7% and 52.7%, respectively, compared to the prior year. Also included in branded product sales is the PreCare(R) product line which contributed $31.7 million of sales during fiscal 2005. Although sales of our PreCare(R) product line declined 2.7% during the year, the PreCare(R) family of products continued to be the leading branded line of prescription prenatal nutritional supplements in the United States. The $0.9 million decrease in sales of our PreCare(R) product line was partially the result of a temporary fourth quarter supply disruption of PrimaCare(R) ONE, our proprietary line extension to PrimaCare(R), that was launched in the second quarter. Prior to the occurrence of this supply issue, which has since been resolved, PrimaCare(R) ONE generated $4.1 million of incremental sales in fiscal 2005. The increase in branded product sales for fiscal 2005 was partially offset by a $2.2 million decline in sales of our Micro-K(R) product line. The growth in specialty generic sales resulted from $15.9 million of incremental sales volume from new product introductions, principally in our lower margin cough/cold product line, coupled with $8.8 million of increased sales volume from existing products in our cardiovascular and pain management product lines. These increases were offset in part by product price erosion of $14.3 million principally in the second half of the fiscal year, that resulted from pricing pressures on certain products in the cardiovascular, pain management and cough/cold product lines. Although specialty generic sales increased in fiscal 2005, we experienced a $9.0 million, or 18.2%, decline in sales for the three months ended March 31, 2005. This decrease resulted from a significant decline in cardiovascular products sales due in part to the absence of trade shows that occurred in the fourth quarter of the prior year and resulted in an unfavorable mix in product categories in the fourth quarter of fiscal 2005. The anticipated approval of Diltiazem and another product in the fourth quarter of fiscal 2005, would have more than offset the above decrease, had the approvals been received. We now expect them to be launched in the second half of fiscal 2006. 39 The increase in specialty material product sales was primarily due to renewed focus on expanding the specialty materials business, the addition of a new major customer in fiscal 2005 that resulted in $1.3 million of incremental sales and an increased emphasis on international markets that provided additional sales of $1.0 million in fiscal 2005. GROSS PROFIT BY SEGMENT ----------------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2005 2004 $ % -------- -------- ------- ------- Branded products $ 78,844 $ 72,008 $ 6,836 9.5% as % of net revenues 87.5% 86.9% Specialty generics 113,084 110,180 2,904 2.6% as % of net revenues 58.9% 60.7% Specialty materials 6,394 4,789 1,605 33.5% as % of net revenues 34.9% 28.9% Other (2,511) (1,463) (1,048) (71.6)% ======== ======== ======= Total gross profit $195,811 $185,514 $10,297 5.6% as % of total net revenues 64.5% 65.3% The increase in gross profit was primarily attributable to the sales growth experienced by all three of our segments: branded products, specialty generics and specialty materials. The lower gross profit percentage on a consolidated basis primarily reflected the impact of price erosion on certain specialty generic products beginning in the second quarter and extending through the balance of fiscal 2005, offset in part by certain selective price increases taken near the end of the third quarter. The gross profit percentage decline experienced by the specialty generics segment was offset in part by a shift in the mix of branded product sales toward higher margin products with the introduction of Clindesse(TM) in the fourth quarter coupled with improved pricing and lower raw material costs at our specialty materials business. RESEARCH AND DEVELOPMENT ------------------------ YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % ------- ------- ------ ----- Research and development $23,538 $20,651 $2,887 14.0% as % of net revenues 7.8% 7.3% The increase in research and development expense primarily resulted from increased spending on bioequivalency studies for products in our internal development pipeline and higher personnel expenses related to the growth of our research and development staff. In May 2005, we announced an agreement with FemmePharma to terminate the license agreement we entered into with them in April 2002. As part of this transaction, we acquired FemmePharma for $25.0 million after the assets of the entity had been distributed to FemmePharma's other shareholders. Included in our acquisition of FemmePharma are all of the worldwide marketing rights to an endometriosis product that has successfully completed Phase II clinical trials and was originally part of the licensing arrangement with FemmePharma. In connection with this transaction, we expect to incur an in-process 40 research and development charge of approximately $30.0 million in the first quarter of fiscal 2006, which includes the write-off of the $25.0 million payment plus preferred stock investments previously made. SELLING AND ADMINISTRATIVE -------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % -------- ------- ------- ----- Selling and administrative $116,638 $88,333 $28,305 32.0% as % of net revenues 38.4% 31.1% The increase in selling and administrative expense was due primarily to: greater personnel expenses resulting from an increase in management personnel ($4.3 million) and expansion of the branded sales force ($5.1 million including approximately $1.1 million for sales representatives added during the fourth quarter of fiscal 2005); a $2.2 million increase in branded marketing and promotions expense commensurate with the growth of the segment; a $2.9 million increase in rent, depreciation, insurance and utilities expense associated with expansion of our office facilities over the past two years; a $1.7 million increase in professional fees associated primarily with implementation of the internal control provisions of the Sarbanes-Oxley Act of 2002; a $1.2 million increase in legal expense; and $3.0 million of costs incurred in the fourth quarter to support the launch of Clindesse(TM). The increase in legal expense was due to an increase in litigation activity, which included various patent infringement actions brought by potential competitors with respect to products we propose to market and for which we have submitted ANDA filings and provided notice of certification required under the provisions of the Hatch-Waxman Act. AMORTIZATION OF INTANGIBLE ASSETS --------------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % ------ ------ ---- ---- Amortization of intangible assets $4,653 $4,459 $194 4.4% as % of net revenues 1.5% 1.6% The increase in amortization of intangible assets was due primarily to the amortization of license costs incurred under a co-development arrangement in fiscal 2005. 41 LITIGATION ---------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % -------- -------- ----- ------- Litigation $(1,430) $(1,700) $270 (15.9)% The $1.4 million of income reflected in "Litigation" consists of a $0.6 million net payment received by us in accordance with a favorable legal settlement of vitamin antitrust litigation and $0.8 million related to the reversal of excess reserves related to the Healthpoint litigation (see Note 11 in the accompanying Notes to Consolidated Financial Statements). In the second quarter of the prior year, we received $3.5 million for settlement with a branded company of our claim that the branded company interfered with our right to a timely introduction of a generic product in a previous fiscal year. The impact of this payment was offset in part by an additional litigation reserve of $1.8 million related to attorneys' fees awarded in the Healthpoint matter, which subsequently was settled. OPERATING INCOME ---------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2005 2004 $ % ------- ------- -------- ------- Operating income $52,412 $73,771 $(21,359) (29.0)% The decrease in operating income resulted primarily from a $28.3 million, or 32.0%, increase in selling and administrative expense coupled with a $2.9 million increase in research and development expense, offset in part by a $10.3 million increase in gross profit. INTEREST EXPENSE ---------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % ------ ------ ------ ------ Interest expense $5,432 $5,865 $(433) (7.4)% The decrease in interest expense was primarily due to an increase in the level of capitalized interest recorded on capital projects that we have in process. 42 INTEREST AND OTHER INCOME ------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2005 2004 $ % ------ ------ ---- ----- Interest and other income $3,048 $2,092 $956 45.7% The increase in interest and other income was primarily due to an increase in the weighted average interest rate earned on short-term investments, offset in part by a decline in the average balance of short-term investments. PROVISION FOR INCOME TAXES -------------------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2005 2004 $ % ------- ------- -------- ------ Provision for income taxes $16,759 $24,150 $(7,391) (30.6)% effective tax rate 33.5% 34.5% The decrease in the provision for income taxes resulted from a corresponding decrease in income before taxes coupled with a decline in the effective tax rate. The decline in the effective tax rate primarily resulted from the implementation of various tax planning initiatives, as well as the generation of income tax credits at both the Federal and state levels. NET INCOME AND DILUTED EARNINGS PER SHARE ----------------------------------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2005 2004 $ % ------- ------- --------- ------- Net income $33,269 $45,848 $(12,579) (27.4)% Diluted earnings per share 0.63 0.84 (0.21) (25.0)% The decrease in net income resulted primarily from a $28.3 million, or 32.0%, increase in selling and administrative expense coupled with a $2.9 million increase in research and development expense, offset in part by a $10.3 million increase in gross profit. 43 FISCAL 2004 COMPARED TO FISCAL 2003 NET REVENUES BY SEGMENT ----------------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2004 2003 $ % -------- -------- ------- ------- Branded products $ 82,868 $ 43,677 $ 39,191 89.7% as % of net revenues 29.2% 17.8% Specialty generics 181,455 179,724 1,731 1.0% as % of net revenues 63.9% 73.4% Specialty materials 16,550 17,395 (845) (4.9)% as % of net revenues 5.8% 7.1% Other 3,068 4,200 (1,132) (27.0)% ======== ======== ======== Total net revenues $283,941 $244,996 $ 38,945 15.9% The increase in branded product sales was due primarily to continued growth of our women's healthcare family of products and the sales impact of products acquired by us on March 31, 2003. The increase was also impacted by a March 1, 2004 price increase instituted by Ther-Rx on all of its products. In anticipation of the scheduled price increase, customers made larger than normal purchases, which the Company limits to a 30-day supply and is consistent with prior price increase policies. This forward purchasing approximated $7.4 million during the fourth quarter. Sales from the women's healthcare product group increased $17.9 million, or 53.6%, in fiscal 2004. Included in the women's healthcare family of products is the PreCare(R) product line which contributed $11.8 million of incremental sales in fiscal 2004. This increase was attributable to increased sales volume associated with higher market shares for PrimaCare(R), our prescription prenatal/postnatal multivitamin and mineral supplement with essential fatty acids, and the PreCare(R) prenatal vitamin. The PreCare(R) family of products continues to be the leading branded line of prescription prenatal nutritional supplements in the United States as market share for the product line grew to 37.6% at the end of fiscal 2004 compared to 31.0% at the end of fiscal 2003. Sales of Gynazole-1(R), our vaginal antifungal cream product, increased $6.1 million, or 48.8%, during fiscal 2004 as our share of the prescription vaginal antifungal cream market increased to 26.9% at the end of fiscal 2004, from 18.1% at the end of the prior year. The increase in sales from our women's healthcare family of products was supplemented by $22.6 million of sales during fiscal 2004 from our two hematinic product lines, Chromagen(R) and Niferex(R), and the StrongStart(R) prenatal vitamin product line that we acquired at the end of fiscal 2003. Introduction of technology-improved versions of the hematinic products in the second quarter of fiscal 2004, generated 69% growth in new prescription volume. The increase in branded product sales for fiscal 2004 was partially offset by a $1.2 million decline in sales of the Micro-K(R) product line. The minimal growth in specialty generic sales resulted from $8.8 million of incremental sales volume from new product introductions, primarily in the cough/cold, cardiovascular and prenatal vitamin product lines, offset by a $7.3 million decline in sales volume from existing products primarily in our cough/cold product line. During fiscal 2004, we introduced 16 new products, including the February 2004 ANDA approval for four strengths of Benazepril Hydrochloride tablets (generic equivalent to Lotensin(R)). The decline in sales of existing cough/cold products was due primarily to an FDA order which required us and all manufacturers of unapproved single-ingredient, extended-release guaifenesin products to discontinue distribution of these products after November 2003. The FDA ruling affected five of our guaifenesin products that were first introduced when ANDA approval was not required. Also, we experienced slower than anticipated ANDA approvals by the FDA on a number of brand equivalent products that we expected to introduce in fiscal 2004. The decrease in specialty material product sales was primarily due to a slowdown in a major customer's business in the vitamin supplement market. The decrease in other revenue resulted from a smaller contract manufacturing customer base due to continued de-emphasis of this lower margin operation in our business strategy. 44 GROSS PROFIT BY SEGMENT ----------------------- YEARS ENDED MARCH 31, ------------------------------------------ CHANGE ------------------ ($ IN THOUSANDS): 2004 2003 $ % -------- -------- ------- -------- Branded products $ 72,008 $ 38,460 $33,548 87.2% as % of net revenues 86.9% 88.1% Specialty generics 110,180 106,854 3,326 3.1% as % of net revenues 60.7% 59.5% Specialty materials 4,789 5,720 (931) (16.3)% as % of net revenues 28.9% 32.9% Other (1,463) (565) (898) (158.9)% ======== ======== ======= Total gross profit $185,514 $150,469 $35,045 23.3% as % of total net revenues 65.3% 61.4% The increase in consolidated gross profit was primarily attributable to the sales growth experienced by the branded products and specialty generics segments, offset in part by a sales decline in the specialty materials segment. The increased gross profit percentage on a consolidated basis reflected a favorable shift in the mix of product sales toward higher margin branded products, which comprised a larger percentage of net revenues. The gross profit percentage decrease experienced by the branded products segment was due to the acquired hematinic products, which have a slightly lower gross margin than other products in the branded line. While the gross profit percentage in specialty generics increased for the fiscal year, the segment experienced a decline in gross profit as a percent of net revenues during the fourth quarter due to more competitive pricing and higher costs associated with a new product launch. Gross profit as a percent of net revenues also declined in the specialty raw materials segment during the fourth quarter as a result of unfavorable costs variances associated with lower production volume. RESEARCH AND DEVELOPMENT ------------------------ YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------- ------- ------ ---- Research and development $20,651 $19,135 $1,516 7.9% as % of net revenues 7.3% 7.8% The increase in research and development expense resulted from higher costs associated with the continued expansion of clinical testing for our product development efforts and increased personnel expenses related to the growth of our research and development staff. The increase in research and development expense was below management's expectation of greater spending due to rescheduling the timing of certain clinical studies. SELLING AND ADMINISTRATIVE -------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------- ------- ------- ----- Selling and administrative $88,333 $69,584 $18,749 26.9% as % of net revenues 31.1% 28.4% 45 The increase in selling and administrative expense was due primarily to greater personnel expenses resulting from an increase in management personnel ($1.7 million) and expansion of the branded sales force ($4.9 million), an increase in rent, depreciation and utilities associated with recently added facilities ($2.5 million), and an increase in branded marketing expense ($3.7 million) commensurate with the growth of the segment and to support the launch and on-going promotion of technology-improved versions of the Chromagen(R) and Niferex(R) products we acquired at the end of fiscal 2003. We also experienced a $4.3 million increase in legal expense due to an increase in litigation activity coupled with the appeal of the Healthpoint litigation, Paragraph IV litigation and other matters. AMORTIZATION OF INTANGIBLE ASSETS --------------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------ ------ ------- ----- Amortization of intangible assets $4,459 $2,321 $2,138 92.1% as % of net revenues 1.6% 0.9% The increase in amortization of intangible assets was due primarily to the amortization of trademarks acquired in the two product acquisitions completed on March 31, 2003. LITIGATION ---------- YEARS ENDED MARCH 31, ------------------------------------------ CHANGE ------------------ ($ IN THOUSANDS): 2004 2003 $ % -------- ------- --------- -------- Litigation $(1,700) $16,500 $(18,200) (110.3)% In September 2002, we recorded a litigation reserve of $16.5 million for potential damages associated with the adverse decision made by a federal court in Texas to uphold a jury verdict in a lawsuit against ETHEX. During fiscal 2004, we recorded an additional litigation reserve of $1.8 million related to this matter for attorney's fees awarded to the plaintiffs by the court. The impact of this reserve was more than offset by a $3.5 million net payment, received by us during fiscal 2004, for a settlement with a branded company of our claim that the branded company interfered with our right to a timely introduction of a generic product in a previous fiscal year. OPERATING INCOME ---------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------- ------- ------- ----- Operating income $73,771 $42,929 $30,842 71.8% The increase in operating income resulted primarily from a $35.0 million, or 23.3%, increase in gross profit in fiscal 2004, offset in part by a $4.2 million increase in fiscal 2004 operating expenses. The $18.7 million increase in our fiscal 2004 selling and administrative expenses was primarily offset by the impact on fiscal 2003 operating 46 expenses of a $16.5 million litigation reserve established by us for potential damages associated with a lawsuit that was settled in fiscal 2005. INTEREST EXPENSE ---------------- YEARS ENDED MARCH 31, ----------------------------------------- CHANGE ----------------- ($ IN THOUSANDS): 2004 2003 $ % ------ ---- ------ -------- Interest expense $5,865 $325 $5,540 1,704.6% The increase in interest expense resulted primarily from the interest expense accrued on the $200.0 million of Convertible Subordinated Notes issued May 16, 2003. INTEREST AND OTHER INCOME ------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------ ---- ------ ------ Interest and other income $2,092 $977 $1,115 114.1% The increase in interest and other income was due to the investment of $144.2 million of net proceeds from the May 2003 Convertible Subordinated Notes offering in short-term, highly liquid investments combined with the impact of an $82.3 million increase in short-term investments during fiscal 2003 from the proceeds of a secondary offering during that year. PROVISION FOR INCOME TAXES -------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------- ------- ------ ----- Provision for income taxes $24,150 $15,471 $8,679 56.1% effective tax rate 34.5% 35.5% The increase in the provision for income taxes resulted from a corresponding increase in income before taxes. The decline in the effective tax rate primarily resulted from the implementation of various tax planning initiatives, as well as the generation of income tax credits at both the Federal and state levels. 47 NET INCOME AND DILUTED EARNINGS PER SHARE ----------------------------------------- YEARS ENDED MARCH 31, --------------------------------------- CHANGE --------------- ($ IN THOUSANDS): 2004 2003 $ % ------- ------- ------- ----- Net income $45,848 $28,110 $17,738 63.1% Diluted earnings per share 0.84 0.55 0.29 52.7% The increase in net income resulted primarily from a $38.9 million, or $15.9%, increase in our fiscal 2004 net revenues coupled with the impact on fiscal 2003 net income of a $16.5 million litigation reserve established by us in September 2002 for potential damages associated with a lawsuit that was settled in fiscal 2005. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Cash and cash equivalents and working capital were $159.8 million and $302.5 million, respectively, at March 31, 2005, compared to $191.6 million and $306.6 million, respectively, at March 31, 2004. Internally generated funds from product sales was the primary source of operating capital used in the funding of our businesses in fiscal 2005. Net cash flow from operating activities was $49.0 million in fiscal 2005 compared to $34.0 in fiscal 2004. Cash flow from operations was favorably impacted by net income adjusted for non-cash items and an increase in accounts payable related to the timing of payments, offset in part by the $18.3 million payment attributable to settlement of the Healthpoint litigation. In September 2004, we made a settlement payment in the amount of $16.5 million to resolve all previously pending claims between us and Healthpoint, Ltd. without the admission of any liability. The settlement was fully reserved by us in September 2002 and therefore had no impact on our earnings in fiscal 2005. The $0.8 million of income reflected in "Litigation" for the year ended March 31, 2005 represents a reversal of the portion of the Healthpoint litigation reserve that remained after payment of the settlement amount and related litigation costs. Net cash flow used in investing activities primarily consisted of capital expenditures of $63.6 million in fiscal 2005 compared to $21.8 million for the prior year. Capital expenditures in fiscal 2005 were primarily for building renovation projects and for purchasing machinery and equipment to upgrade and expand our pharmaceutical manufacturing and distribution capabilities. Other investing activities in fiscal 2005 included $10.6 million in purchases of marketable securities that are classified as available for sale. In the prior year, we made cash payments of $14.3 million in April 2003 to complete the acquisition of the Niferex(R) product line and $4.0 million in January 2004 to FemmePharma, Inc. to complete the licensing of certain trademark rights and to increase our equity investment in the company. Our debt balance was $210.7 million at March 31, 2005 compared to $218.7 million at March 31, 2004. In May 2003, we issued $200.0 million principal amount of Convertible Subordinated Notes that are convertible, under certain circumstances, into shares of our Class A common stock at an initial conversion price of $23.01 per share. The Convertible Subordinated Notes bear interest at a rate of 2.50% and mature on May 16, 2033. We are also obligated to pay contingent interest at a rate equal to 0.5% per annum during any six-month period commencing May 16, 2006, if the average trading price of the Notes per $1,000 principal amount for the five-trading day period ending on the third trading day immediately preceding the first day of the applicable six-month period equals $1,200 or more. We may redeem some or all of the Convertible Subordinated Notes at any time on or after May 21, 2006, at a redemption price, payable in cash, of 100% of the principal amount of the Convertible Subordinated Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date of redemption. Holders may require us to repurchase all or a portion of their Convertible Subordinated Notes on May 16, 2008, 2013, 2018, 2023 and 2028, or upon a change in control, as defined in the indenture governing the Convertible Subordinated Notes, at 100% of the principal amount of the Convertible Subordinated Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date of repurchase, payable in cash. The Convertible Subordinated Notes are subordinate to all of our existing and future senior obligations. On March 31, 48 2005, we repaid the second of two $7.0 million promissory notes entered into in conjunction with the Altana acquisition agreement (see Note 3 in the accompanying Notes to Consolidated Financial Statements). In December 2004, we increased our available credit facilities to $140.0 million. The revised agreement provided for an increase from $40.0 million to $80.0 million in our revolving line of credit along with an increase from $25.0 million to $60.0 million in the supplemental credit line that is available for financing acquisitions. These credit facilities expire in October 2006 and December 2005, respectively. The revolving and supplemental credit lines are unsecured and interest is charged at the lower of the prime rate or the one-month LIBOR rate plus 175 basis points. At March 31, 2005, we had $3.9 million in open letters of credit issued under the revolving credit line and no cash borrowings under either credit facility. The revised agreement contains substantially identical financial and other covenants, representations, warranties, conditions and default provisions as the replaced facility. The financial covenants impose minimum levels of earnings before interest, taxes, depreciation and amortization, a maximum funded debt ratio, a limit on capital expenditures and dividend payments, a minimum fixed charge coverage ratio and a maximum senior leverage ratio. As of March 31, 2005, we were in compliance with all of our covenants. The following table summarizes our contractual obligations (in thousands):
LESS THAN MORE THAN TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS ----- ------ --------- --------- ------- OBLIGATIONS AT MARCH 31, 2005 ----------------------------- Long-term debt obligations $210,740 $ 973 $3,853 $5,914 $200,000 Operating lease obligations 5,257 1,598 1,949 1,086 624 Other long-term obligations 4,477 - - - 4,477 --------------------------------------------------------------- Total contractual cash obligations(a) $220,474 $2,571 $5,802 $7,000 $205,101 --------------------------------------------------------------- (a) The Company has licensed the exclusive rights to co-develop and market various generic equivalent products with other drug delivery companies. These collaboration agreements require the Company to make up-front and ongoing payments as development milestones are attained. If all milestones remaining under these agreements were reached, payments by the Company could total up to $15,455.
We believe our cash and cash equivalents balance, cash flows from operations and funds available under our credit facilities, will be adequate to fund operating activities for the presently foreseeable future, including the payment of short-term and long-term debt obligations, capital improvements, research and development expenditures, product development activities and expansion of marketing capabilities for the branded pharmaceutical business. In addition, we continue to examine opportunities to expand our business through the acquisition of or investment in companies, technologies, product rights, research and development and other investments that are compatible with our existing businesses. We intend to use our available cash to help in funding any acquisitions or investments. As such, cash has been invested in short-term, highly liquid instruments. We also may use funds available under our credit facility, or financing sources that subsequently become available, including the future issuances of additional debt or equity securities, to fund these acquisitions or investments. If we were to fund one or more such acquisitions or investments, our capital resources, financial condition and results of operations could be materially impacted in future periods. INFLATION Inflation may apply upward pressure on the cost of goods and services used by us in the future. However, we believe that the net effect of inflation on our operations during the past three years has been minimal. In addition, changes in the mix of products sold and the effect of competition has made a comparison of changes in selling prices less meaningful relative to changes in the overall rate of inflation over the past three fiscal years. 49 CRITICAL ACCOUNTING ESTIMATES Our consolidated financial statements are presented on the basis of U.S. generally accepted accounting principles. Our significant accounting policies are described in Note 2 in the accompanying notes to consolidated financial statements. Certain of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management. As a result, these policies are subject to an inherent degree of uncertainty. In applying these policies, we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. We base our estimates and judgments on historical experience, the terms of existing contracts, observance of trends in the industry, information that is obtained from customers and outside sources, and on various other assumptions that are believed to be reasonable and appropriate under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although we believe that our estimates and assumptions are reasonable, actual results may differ significantly from our estimates. Changes in estimates and assumptions based upon actual results may have a material impact on our results of operations and/or financial condition. Our critical accounting estimates are described below. REVENUE AND PROVISION FOR SALES RETURNS AND ALLOWANCES. Revenue is ------------------------------------------------------ generally realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectibility is reasonably assured. Accordingly, we record revenue from product sales when title and risk of ownership have been transferred to the customer, which is typically upon shipment to the customer. We also enter into long-term agreements under which we assign marketing rights for the products we have developed to pharmaceutical marketers. Royalties under these arrangements are earned based on the sale of products. When we sell our products, we reduce the amount of revenue we recognize from such sales by an estimate of future product returns and sales allowances. Sales allowances include cash discounts, rebates, chargebacks, and other similar expected future payments relating to products sold in the current period. Factors that are considered in our estimates of future product returns and sales allowances include historical payment experience in relationship to revenues, estimated customer inventory levels, and current contract prices and terms with both direct and indirect customers. If actual future payments for product returns and sales allowances exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted. The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. We establish contract prices for indirect customers who are supplied by our wholesale customers. A chargeback represents the difference between our invoice price to the wholesaler and the indirect customer's contract price, which is lower. We credit the wholesaler for purchases by indirect customers at the lower price. Accordingly, we record these chargebacks at the time we recognize revenue in connection with our sales to wholesalers. Provisions for estimating chargebacks are calculated primarily using historical chargeback experience, actual contract pricing and estimated wholesaler inventory levels. We continually monitor our assumptions, giving consideration to estimated wholesaler inventory levels and current pricing trends, and make adjustments to these estimates when we believe that the actual chargeback amounts payable in the future will differ from our original estimates. INVENTORY VALUATION. Inventories consist of finished goods held for ------------------- distribution, raw materials and work in process. Our inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out basis. In evaluating whether inventory is to be stated at the lower of cost or market, we consider such factors as the amount of inventory on hand and in the distribution channel, estimated time required to sell existing inventory, remaining shelf life and current and expected market conditions, including levels of competition. We establish reserves, when necessary, for slow-moving and obsolete inventories based upon our historical experience and management's assessment of current product demand. INTANGIBLE ASSETS AND GOODWILL. Our intangible assets consist of ------------------------------ product rights, license agreements and trademarks resulting from product acquisitions and legal fees and similar costs relating to the development of 50 patents and trademarks. Intangible assets that are acquired are stated at cost, less accumulated amortization, and are amortized on a straight-line basis over their estimated useful lives. Upon approval, costs associated with the development of patents and trademarks are amortized on a straight-line basis over estimated useful lives ranging from five to 17 years. We determine amortization periods for intangible assets that are acquired based on our assessment of various factors impacting estimated useful lives and cash flows of the acquired products. Such factors include the product's position in its life cycle, the existence or absence of like products in the market, various other competitive and regulatory issues, and contractual terms. Significant changes to any of these factors may result in a reduction in the intangible asset's useful life and an acceleration of related amortization expense. We assess the impairment of intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include the following: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant negative industry or economic trends. When we determine that the carrying value of an intangible asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, we first perform an assessment of the asset's recoverability. Recoverability is determined by comparing the carrying amount of an intangible asset against an estimate of the undiscounted future cash flows expected to result from its use and eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the intangible asset, an impairment loss is recognized based on the excess of the carrying amount over the estimated fair value of the intangible asset. CONTINGENCIES. The Company is involved in various legal ------------- proceedings, some of which involve claims for substantial amounts. An estimate is made to accrue for a loss contingency relating to any of these legal proceedings if it is probable that a liability was incurred as of the date of the financial statements and the amount of loss can be reasonably estimated. Because of the subjective nature inherent in assessing the outcome of litigation and because of the potential that an adverse outcome in legal proceedings could have a material impact on our financial position or results of operations, such estimates are considered to be critical accounting estimates. After review, it was determined at March 31, 2005 that for each of the various legal proceedings in which we are involved, the conditions mentioned above were not met. We will continue to evaluate all legal matters as additional information becomes available. RECENTLY ISSUED ACCOUNTING STANDARDS In March 2004, the EITF completed its discussion of and provided consensus guidance on Issue No. 03-06, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share. The consensus interpreted the definition of a "participating security," required the use of the two-class method in the calculation and disclosure of basic earnings per share for companies with participating securities or more than one class of common stock, and provided guidance on the allocation of earnings and losses for purposes of calculating basic earnings per share. Since the Company has two classes of common stock, this consensus has been applied in the calculation of basic earnings per share for all periods presented. There was no impact on diluted earnings per share as reported. In April 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position No. 129-1 (FSP 129-1), Disclosure Requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, Relating to Contingently Convertible Securities. This FSP requires the disclosure provisions of Statement 129 to apply to all existing and newly created contingently convertible securities and to their potentially dilutive effects on earnings per share. The adoption of the disclosure provisions of FSP 129-1 did not have a material impact on the Company's financial condition or results of operations. In September 2004, the EITF reached a consensus that contingently convertible debt instruments should be included in diluted earnings per share computations (if dilutive) regardless of whether the market price trigger (or 51 other contingent feature) has been met. Additionally, the EITF stated that prior period earnings per share amounts presented for comparative purposes should be restated to conform to this consensus, which is effective for reporting periods ending after December 15, 2004. The consensus adopted by the EITF required the addition of approximately 8.7 million shares associated with the conversion of the Company's $200.0 million principal amount Convertible Subordinated Notes to the number of shares outstanding for the calculation of diluted earnings per share for all reported periods since the issuance of the Notes. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an Amendment to ARB No. 43, Chapter 4 which requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) costs be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently determining the impact, if any, the adoption of this statement will have on its financial condition and results of operations. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS 123) and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retrospective adoption options. Under the modified retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the modified retrospective method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are evaluating the requirements of SFAS 123R. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123. In April 2005, the Securities and Exchange Commission announced an amendment to Regulation S-X to amend the date for compliance with SFAS 123R. The amendment requires each registrant that is not a small business issuer to adopt SFAS 123R in the first fiscal year commencing after June 15, 2005. As a result, we are required to adopt SFAS 123R beginning April 1, 2006. Adoption of SFAS 123R will have an impact on our consolidated financial statements, as we will be required to expense the fair value of our employee stock option grants rather than disclose the pro forma impact on our consolidated net income within the footnotes to our consolidated financial statements, as is our current practice. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- Our exposure to market risk is limited to fluctuating interest rates associated with variable rate indebtedness that is subject to interest rate changes. Advances to us under our credit facilities bear interest at a rate that varies consistent with increases or decreases in the publicly announced prime rate and/or the LIBOR rate with respect to LIBOR-related loans, if any. A material increase in such rates could significantly increase borrowing expenses. We did not have any cash borrowings under our credit facilities at March 31, 2005. In May 2003, we issued $200.0 million principal amount of Convertible Subordinated Notes. The interest rate on the Convertible Subordinated Notes is fixed at 2.50% per annum and not subject to market interest rate changes. Beginning May 16, 2006, we will become obligated to pay contingent interest at a rate equal to 0.5% per annum during any six-month period, if the average trading price of the Convertible Subordinated Notes per $1,000 principal amount for the five-trading day period ending on the third trading day immediately preceding the first day of the applicable six-month period equals $1,200 or more. 52 In April 2003, we entered into an $8.8 million term loan secured by a building under a floating rate loan with a bank. We also entered into an interest rate swap agreement with the same bank, which fixed the interest rate of the building mortgage at 5.31% for the term of the loan. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- 53 Report of Independent Registered Public Accounting Firm ------------------------------------------------------- The Board of Directors and Shareholders K-V Pharmaceutical Company: We have audited the accompanying consolidated balance sheet of K-V Pharmaceutical Company and subsidiaries as of March 31, 2005, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year ended March 31, 2005. In connection with our audit of the consolidated financial statements, we have also audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K-V Pharmaceutical Company and subsidiaries as of March 31, 2005, and the results of their operations and their cash flows for the year ended March 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule for the year ended March 31, 2005, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 2 to the consolidated financial statements, during fiscal 2005, the Company adopted the provisions of Emerging Issues Task Force (EITF) Issue No. 03-6 Participating Securities and the Two-Class Method under FASB Statement No. 128 and EITF Issue No. 04-8 The Effect of Contingently Convertible Instruments on Diluted Earnings per Share. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of internal control over financial reporting of K-V Pharmaceutical Company as of March 31, 2005, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 14, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP St. Louis, Missouri June 14, 2005 54 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Stockholders and Board of Directors of K-V Pharmaceutical Company We have audited the accompanying consolidated balance sheets of K-V Pharmaceutical Company and Subsidiaries as of March 31, 2004 and the related consolidated statements of income, shareholders' equity and cash flows for each of the two years in the period ended March 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K-V Pharmaceutical Company and Subsidiaries at March 31, 2004, and the results of its operations and its cash flows for each of the two years in the period ended March 31, 2004, in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman, LLP Chicago, Illinois June 4, 2004 55 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
MARCH 31, --------------------- 2005 2004 ---- ---- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents............................................................ $159,825 $191,581 Marketable securities................................................................ 45,694 35,330 Receivables, less allowance for doubtful accounts of $461 and $402 in 2005 and 2004, respectively.................................................... 62,361 65,872 Inventories, net..................................................................... 53,945 50,697 Prepaid and other assets............................................................. 9,530 6,591 Deferred tax asset................................................................... 5,827 8,037 -------- -------- Total Current Assets.............................................................. 337,182 358,108 Property and equipment, less accumulated depreciation................................ 131,624 75,777 Intangible assets and goodwill, net.................................................. 76,430 80,809 Other assets......................................................................... 13,081 13,744 -------- -------- TOTAL ASSETS......................................................................... $558,317 $528,438 ======== ======== LIABILITIES ----------- CURRENT LIABILITIES: Accounts payable..................................................................... $ 18,011 $ 12,650 Accrued liabilities.................................................................. 15,733 30,917 Current maturities of long-term debt................................................. 973 7,909 -------- -------- Total Current Liabilities......................................................... 34,717 51,476 Long-term debt....................................................................... 209,767 210,741 Other long-term liabilities.......................................................... 4,477 3,122 Deferred tax liability............................................................... 16,654 5,350 -------- -------- TOTAL LIABILITIES.................................................................... 265,615 270,689 -------- -------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY -------------------- 7% cumulative convertible Preferred Stock, $.01 par value; $25.00 stated and liquidation value; 840,000 shares authorized; issued and outstanding -- 40,000 shares at both 2005 and 2004 (convertible into Class A shares at a ratio of 8.4375 to one)...................................................... -- -- Class A and Class B Common Stock, $.01 par value;150,000,000 and 75,000,000 shares authorized, respectively; Class A - issued 39,059,428 and 36,080,583 at March 31, 2005 and 2004, respectively........................................................ 391 362 Class B - issued 13,422,101 and 16,148,739 at March 31, 2005 and 2004, respectively (convertible into Class A shares on a one-for-one basis)... 134 162 Additional paid-in capital........................................................... 128,182 123,828 Retained earnings.................................................................... 217,779 184,580 Accumulated other comprehensive loss................................................. (133) -- Less: Treasury stock, 3,111,003 shares of Class A and 92,902 shares of Class B Common Stock in 2005, and 3,035,948 shares of Class A and 80,142 shares of Class B Common Stock in 2004, at cost..................................................... (53,651) (51,183) -------- -------- TOTAL SHAREHOLDERS' EQUITY........................................................... 292,702 257,749 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $558,317 $528,438 ======== ======== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
56 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share data)
YEARS ENDED MARCH 31, ----------------------------------- 2005 2004 2003 -------- -------- ------- Net revenues........................................................... $303,493 $283,941 $244,996 Cost of sales.......................................................... 107,682 98,427 94,527 -------- -------- -------- Gross profit........................................................... 195,811 185,514 150,469 -------- -------- -------- Operating expenses: Research and development............................................ 23,538 20,651 19,135 Selling and administrative.......................................... 116,638 88,333 69,584 Amortization of intangible assets................................... 4,653 4,459 2,321 Litigation.......................................................... (1,430) (1,700) 16,500 -------- -------- -------- Total operating expenses............................................... 143,399 111,743 107,540 -------- -------- -------- Operating income....................................................... 52,412 73,771 42,929 -------- -------- -------- Other expense (income): Interest expense.................................................... 5,432 5,865 325 Interest and other income........................................... (3,048) (2,092) (977) -------- -------- -------- Total other expense (income), net...................................... 2,384 3,773 (652) -------- -------- --------- Income before income taxes............................................. 50,028 69,998 43,581 Provision for income taxes............................................. 16,759 24,150 15,471 -------- -------- -------- Net income............................................................. $ 33,269 $ 45,848 $ 28,110 ======== ======== ======== Earnings per common share: Basic - Class A common.............................................. $ 0.71 $ 0.98 $ 0.59 Basic - Class B common.............................................. 0.59 0.82 0.50 Diluted............................................................. $ 0.63 $ 0.84 $ 0.55 ======== ======== ======= Weighted Average Shares Outstanding: Basic - Class A common.............................................. 34,228 33,046 33,997 Basic - Class B common.............................................. 15,005 15,941 15,803 Diluted............................................................. 59,468 58,708 51,561 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
57 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands)
YEARS ENDED MARCH 31, --------------------------------- 2005 2004 2003 ------- ------- ------- Net income............................................................. $33,269 $45,848 $28,110 Other comprehensive income (loss): Unrealized loss on available for sale securities.................... (201) -- -- Less related taxes.................................................. 68 -- -- ------- ------- ------- Total unrealized loss on available for sale securities, net...... (133) -- -- ------- ------- ------- Total comprehensive income............................................. $33,136 $45,848 $28,110 ======= ======= ======= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
58 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2005, 2004 AND 2003 ---------------------------------------------------------------------------- CLASS A CLASS B ADDITIONAL PREFERRED COMMON COMMON PAID IN TREASURY RETAINED STOCK STOCK STOCK CAPITAL STOCK EARNINGS ----- ----- ----- ------- ----- -------- (Dollars in thousands) BALANCE AT MARCH 31, 2002........................ $ -- $201 $108 $ 47,231 $ (49) $111,301 Net income....................................... -- -- -- -- -- 28,110 Dividends paid on preferred stock................ -- -- -- -- -- (70) Conversion of 175,000 Class B shares to Class A shares...................... -- 2 (2) -- -- -- Issuance of 3,285,000 Class A shares............. -- 33 -- 72,347 -- -- Sale of 40,461 Class A shares to employee profit sharing plan........................... -- -- -- 884 21 -- Stock Options exercised - 49,563 shares of Class A less 9,502 shares repurchased and 40,717 shares of Class B less 112 shares repurchased................................... -- -- -- 499 -- -- ---------------------------------------------------------------------------- BALANCE AT MARCH 31, 2003........................ -- 236 106 120,961 (28) 139,341 Net income....................................... -- -- -- -- -- 45,848 Dividends paid on preferred stock................ -- -- -- -- -- (436) Conversion of 117,187 Class B shares to Class A shares................................ -- 1 (1) -- -- -- Issuance of 27,992 Class A shares under product development agreement........... -- -- -- 505 -- -- Purchase of common stock for treasury............ -- -- -- -- (51,155) -- Three-for-two stock dividend..................... -- 120 53 -- -- (173) Stock Options exercised - 552,617 shares of Class A less 91,538 shares repurchased and 413,419 shares of Class B less 15,625 shares repurchased................................... -- 5 4 2,362 -- -- ---------------------------------------------------------------------------- BALANCE AT MARCH 31, 2004........................ -- 362 162 123,828 (51,183) 184,580 Net income....................................... -- -- -- -- -- 33,269 Dividends paid on preferred stock................ -- -- -- -- -- (70) Conversion of 2,783,537 Class B shares to Class A shares................................ -- 28 (28) -- -- -- Issuance of 14,679 Class A shares under product development agreement......................... -- -- -- 237 -- -- Purchase of common stock for treasury............ -- -- -- -- (2,468) -- Stock Options exercised - 180,629 shares of Class A and 56,899 shares of Class B.......... -- 1 -- 4,117 -- -- Unrealized loss on marketable securities available for sale, net of related taxes of $68........................................ -- -- -- -- -- -- ---------------------------------------------------------------------------- BALANCE AT MARCH 31, 2005........................ $ $391 $134 $128,182 $(53,651) $217,779 ============================================================================ ------------------------------- ACCUMULATED OTHER TOTAL COMPREHENSIVE SHAREHOLDERS' LOSS, NET EQUITY --------- ------ BALANCE AT MARCH 31, 2002........................ $ -- $158,792 Net income....................................... -- 28,110 Dividends paid on preferred stock................ -- (70) Conversion of 175,000 Class B shares to Class A shares...................... -- -- Issuance of 3,285,000 Class A shares............. -- 72,380 Sale of 40,461 Class A shares to employee profit sharing plan........................... -- 905 Stock Options exercised - 49,563 shares of Class A less 9,502 shares repurchased and 40,717 shares of Class B less 112 shares repurchased................................... -- 499 ------------------------------- BALANCE AT MARCH 31, 2003........................ -- 260,616 Net income....................................... -- 45,848 Dividends paid on preferred stock................ -- (436) Conversion of 117,187 Class B shares to Class A shares................................ -- -- Issuance of 27,992 Class A shares under product development agreement........... -- 505 Purchase of common stock for treasury............ -- (51,155) Three-for-two stock dividend..................... -- -- Stock Options exercised - 552,617 shares of Class A less 91,538 shares repurchased and 413,419 shares of Class B less 15,625 shares repurchased................................... -- 2,371 ------------------------------- BALANCE AT MARCH 31, 2004........................ -- 257,749 Net income....................................... -- 33,269 Dividends paid on preferred stock................ -- (70) Conversion of 2,783,537 Class B shares to Class A shares................................ -- -- Issuance of 14,679 Class A shares under product development agreement......................... -- 237 Purchase of common stock for treasury............ -- (2,468) Stock Options exercised - 180,629 shares of Class A and 56,899 shares of Class B.......... -- 4,118 Unrealized loss on marketable securities available for sale, net of related taxes of $68........................................ (133) (133) ------------------------------- BALANCE AT MARCH 31, 2005........................ $(133) $292,702 =============================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
59 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
YEARS ENDED MARCH 31, --------------------------------------- 2005 2004 2003 -------- -------- -------- Operating Activities: Net income............................................................. $ 33,269 $ 45,848 $ 28,110 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and other non-cash charges............... 13,904 12,663 7,773 Deferred income tax provision (benefit)............................. 13,582 8,691 (8,091) Deferred compensation............................................... 1,355 209 196 Litigation.......................................................... (843) 1,825 16,500 Changes in operating assets and liabilities: Decrease (increase) in receivables, net............................. 3,511 (8,487) (3,167) Increase in inventories............................................. (3,248) (9,977) (5,623) (Increase) decrease in prepaid and other assets..................... (3,520) (6,294) 496 (Decrease) increase in accounts payable and accrued................. liabilities...................................................... (8,980) (10,471) 7,127 -------- -------- -------- Net cash provided by operating activities.............................. 49,030 34,007 43,321 -------- -------- -------- Investing Activities: Purchase of property and equipment.................................. (63,622) (21,792) (16,113) Purchase of marketable securities................................... (10,565) (278) (35,052) Purchase of stock and intangible assets............................. - (4,000) (3,000) Product acquisition................................................. - (14,300) (13,000) -------- -------- -------- Net cash used in investing activities.................................. (74,187) (40,370) (67,165) -------- -------- -------- Financing Activities: Principal payments on long-term debt................................ (8,179) (8,237) (743) Dividends paid on preferred stock................................... (70) (436) (70) Proceeds from issuance of convertible notes......................... - 194,165 - Purchase of common stock for treasury............................... (2,468) (51,155) - Proceeds from issuance of common stock.............................. - - 72,380 Sale of common stock to employee profit sharing plan................ - - 905 Exercise of common stock options.................................... 4,118 2,371 499 -------- -------- -------- Net cash (used in) provided by financing activities.................... (6,599) 136,708 72,971 -------- -------- -------- (Decrease) increase in cash and cash equivalents....................... (31,756) 130,345 49,127 Cash and cash equivalents: Beginning of year................................................... 191,581 61,236 12,109 -------- -------- -------- End of year......................................................... $159,825 $191,581 $ 61,236 ======== ======== ======== Non-cash investing and financing activities: Term loan to finance building purchase.............................. $ - $ 8,800 $ - Term loans refinanced............................................... - - 1,738 Issuance of common stock under product development agreement........................................................ 237 505 - Payments due on product acquisitions................................ - - 15,983 Portion of product acquisition financed by promissory notes......... - - 13,234 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) 1. DESCRIPTION OF BUSINESS ----------------------- K-V Pharmaceutical Company and its subsidiaries ("KV" or the "Company") are primarily engaged in the development, acquisition, manufacture, marketing and sale of technologically distinguished branded and generic/non-branded prescription pharmaceutical products. The Company was incorporated in 1971 and has become a leader in the development of advanced drug delivery and formulation technologies that are designed to enhance therapeutic benefits of existing drug forms. Through internal product development and synergistic acquisitions of products, KV has grown into a fully integrated specialty pharmaceutical company. The Company also develops, manufactures and markets technologically advanced, value-added raw material products for the pharmaceutical, nutritional, food and personal care industries. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ BASIS OF PRESENTATION --------------------- The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. The consolidated financial statements include the accounts of KV and its wholly-owned subsidiaries. All material inter-company accounts and transactions have been eliminated in consolidation. Certain reclassifications, none of which affected net income or retained earnings, have been made to prior year amounts to conform to the current year presentation. USE OF ESTIMATES ---------------- The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results in subsequent periods may differ from the estimates and assumptions used in the preparation of the accompanying consolidated financial statements. The most significant estimates made by management include the determination of sales allowances, valuation of inventory balances, the determination of useful lives for intangible assets, and the evaluation of intangible assets and goodwill for impairment. Management periodically evaluates estimates used in the preparation of the consolidated financial statements and makes changes on a prospective basis when adjustments are necessary. CASH EQUIVALENTS ---------------- Cash equivalents consist of interest-bearing deposits that can be redeemed on demand and investments that have original maturities of three months or less. MARKETABLE SECURITIES --------------------- The Company's marketable securities consist of mutual funds comprised of U.S. government investments and auction rate securities. The Company classifies its marketable securities as available-for-sale securities with net unrealized gains or losses recorded as a separate component of stockholders' equity, net of any related tax effect. Auction rate securities generally have long-term stated maturities of 20 to 30 years. However, these 61 securities have certain economic characteristics of short-term investments due to a rate-setting mechanism and the ability to liquidate them through a Dutch auction process that occurs on pre-determined intervals of less than 90 days. The Company had previously classified its auction rate securities as cash and cash equivalents. In fiscal 2005, the Company reclassified $10,000 of auction rate securities from cash and cash equivalents to marketable securities because the underlying instrument has a maturity date in August 2030. Prior periods have been reclassified to provide consistent presentation. INVENTORIES ----------- Inventories consist of finished goods held for distribution, raw materials and work in process. Inventories are stated at the lower of cost or market, with the cost determined on the first-in, first-out (FIFO) basis. Reserves for obsolete, excess or slow moving inventory are established by management based on evaluation of inventory levels, forecasted demand, and market conditions. PROPERTY AND EQUIPMENT ---------------------- Property and equipment are stated at cost, less accumulated depreciation. Major renewals and improvements are capitalized, while routine maintenance and repairs are expensed as incurred. At the time properties are retired from service, the cost and accumulated depreciation are removed from the respective accounts and the related gains or losses are reflected in earnings. The Company capitalizes interest on qualified construction projects. Depreciation expense is computed over the estimated useful lives of the related assets using the straight-line method. The estimated useful lives are principally 10 years for land improvements, 10 to 40 years for buildings and improvements, 3 to 15 years for machinery and equipment, and 3 to 10 years for office furniture and equipment. Leasehold improvements are amortized on a straight-line basis over the shorter of the respective lease terms or the estimated useful life of the assets. The Company assesses property and equipment for impairment whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. INTANGIBLE ASSETS AND GOODWILL ------------------------------ Intangible assets consist of product rights, license agreements and trademarks resulting from product acquisitions and legal fees and similar costs relating to the development of patents and trademarks. Intangible assets that are acquired are stated at cost, less accumulated amortization, and are amortized on a straight-line basis over estimated useful lives of 20 years. Costs associated with the development of patents and trademarks are amortized on a straight-line basis over estimated useful lives ranging from 5 to 17 years. The Company evaluates its intangible assets for impairment whenever events or changes in circumstances indicate that an intangible asset's carrying amount may not be recoverable. Recoverability is determined by comparing the carrying amount of an intangible asset against an estimate of the undiscounted future cash flows expected to result from its use and eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the intangible asset, an impairment loss is recognized based on the excess of the carrying amount over the estimated fair value of the intangible asset. Goodwill relates to the 1972 acquisition of the Company's specialty materials segment and is recorded net of accumulated amortization through March 31, 2002. In accordance with the Company's adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, on April 1, 2002, amortization of goodwill was discontinued. Instead, goodwill is subject to at least an annual assessment of impairment on a fair value basis. If the Company determines through the assessment process that goodwill 62 has been impaired, the Company will record the impairment charge in its results of operations. The Company's test for goodwill impairment in fiscal 2005 determined there was no goodwill impairment. OTHER ASSETS ------------ Non-marketable equity investments for which the Company does not have the ability to exercise significant influence over operating and financial policies (generally less than 20% ownership) are accounted for using the cost method. Such investments are included in "Other assets" in the accompanying consolidated balance sheets and relate to the Company's $5,000 investment in the preferred stock of FemmePharma, Inc. (see Note 3). This investment is periodically reviewed for other-than-temporary declines in fair value. Other than temporary declines in fair value are identified by evaluating market conditions, the entity's ability to achieve forecast and regulatory submission guidelines, as well as the entity's overall financial condition. REVENUE RECOGNITION ------------------- Revenue is generally realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and the customer's payment ability has been reasonably assured. Accordingly, the Company records revenue from product sales when title and risk of ownership have been transferred to the customer, which is typically upon shipment to the customer. The Company also enters into long-term agreements under which it assigns marketing rights for the products it has developed to pharmaceutical marketers. Royalties under these arrangements are earned based on the sale of products. Concurrently with the recognition of revenue, the Company records estimated sales provisions for product returns, sales rebates, payment discounts, chargebacks, and other sales allowances. Sales provisions are established based upon consideration of a variety of factors, including but not limited to, historical relationship to revenues, historical payment and return experience, estimated customer inventory levels, customer rebate arrangements, and current contract sales terms with wholesale and indirect customers. The following briefly describes the nature of each provision and how such provisions are estimated. o Payment discounts are reductions to invoiced amounts offered to customers for payment within a specified period and are estimated utilizing historical customer payment experience. o Sales rebates are offered to certain customers to promote customer loyalty and encourage greater product sales. These rebate programs provide that, upon the attainment of pre-established volumes or the attainment of revenue milestones for a specified period, the customer receives credit against purchases. Other promotional programs are incentive programs periodically offered to customers. Due to the nature of these programs, the Company is able to estimate provisions for rebates and other promotional programs based on the specific terms in each agreement. o Consistent with common industry practices, the Company has agreed to terms with its customers to allow them to return product that is within a certain period of the expiration date. Upon recognition of revenue from product sales to customers, the Company provides for an estimate of product to be returned. This estimate is determined by applying a historical relationship of customer returns to amounts invoiced. o Generally, the Company provides credits to customers for decreases that are made to selling prices for the value of inventory that is owned by customers at the date of the price reduction. The Company has not contractually agreed to provide price adjustment credits to its customers; instead, the Company issues price adjustment credits at its discretion. Price 63 adjustment credits are estimated at the time the price reduction occurs. The amount is calculated based on an estimate of customer inventory levels. o KV has arrangements with certain parties establishing prices for the Company's products for which the parties independently select a wholesaler from which to purchase. Such parties are referred to as indirect customers. A chargeback represents the difference between the Company's invoice price to the wholesaler and the indirect customer's contract price, which is lower. Provisions for estimated chargebacks are calculated primarily using historical chargeback experience, actual contract pricing and estimated wholesaler inventory levels. Actual product returns, chargebacks and other sales allowances incurred are, however, dependent upon future events and may be different than the Company's estimates. The Company continually monitors the factors that influence sales allowance estimates and makes adjustments to these provisions when management believes that actual product returns, chargebacks and other sales allowances may differ from established allowances. Accruals for sales provisions are presented in the consolidated financial statements as reductions to net revenues and accounts receivable. Sales provisions totaled $133,475, $103,262 and $98,929 for the years ended March 31, 2005, 2004 and 2003, respectively. The reserve balances related to the sales provisions totaled $21,056 and $20,648 at March 31, 2005 and 2004, respectively, and are included in "Receivables, less allowance for doubtful accounts" in the accompanying consolidated balance sheets. CONCENTRATION OF CREDIT RISK ---------------------------- The Company extends credit on an uncollateralized basis primarily to wholesale drug distributors and retail pharmacy chains throughout the United States. As a result, the Company is required to estimate the level of receivables which ultimately will not be paid. The Company calculates this estimate based on prior experience supplemented by a customer specific review when it is deemed necessary. On a periodic basis, the Company performs evaluations of the financial condition of all customers to further limit its credit risk exposure. Actual losses from uncollectible accounts have historically been insignificant. The Company's three largest customers accounted for approximately 23%, 18% and 16%, and 31%, 16% and 11% of gross receivables at March 31, 2005 and 2004, respectively. For the year ended March 31, 2005, KV's three largest customers accounted for 27%, 16% and 12% of gross revenues. During the years ended March 31, 2004 and 2003, the Company's three largest customers accounted for gross revenues of 25%, 16% and 13% and 23%, 18% and 14%, respectively. The Company maintains cash balances at certain financial institutions that are greater than the FDIC insurable limit. SHIPPING AND HANDLING COSTS --------------------------- The Company classifies shipping and handling costs in cost of sales. The Company does not derive revenue from shipping. 64 RESEARCH AND DEVELOPMENT ------------------------ Research and development costs, including licensing fees for early stage development products, are expensed in the period incurred. The Company has licensed the exclusive rights to co-develop and market various products with other drug delivery companies. These collaborative agreements usually require the Company to pay up-front fees and ongoing milestone payments. When the Company makes an up-front or milestone payment, management evaluates the stage of the related product to determine the appropriate accounting treatment. If the product is considered to be beyond the early development stage but has not yet been approved by regulatory authorities, the Company will evaluate the facts and circumstances of each case to determine if a portion or all of the payment has future economic benefit and should be capitalized. Payments made to third parties subsequent to regulatory approval are capitalized with that cost generally amortized over the shorter of the patented life of the product or the term of the licensing agreement. The Company accrues estimated costs associated with clinical studies performed by contract research organizations based on the total of costs incurred through the balance sheet date. The Company monitors the progress of the trials and their related activities to the extent possible, and adjusts the accruals accordingly. These accrued costs are recorded as a component of research and development expense. ADVERTISING ----------- Costs associated with advertising are expensed in the period in which the advertising is used and these costs are included in selling and administrative expense. Advertising expenses totaled $10,885, $7,264 and $5,662 for the years ended March 31, 2005, 2004 and 2003, respectively. Advertising expense includes the cost of product samples given to physicians for marketing to their patients. LITIGATION ---------- The Company is subject to litigation in the ordinary course of business and to certain other contingencies (see Note 11). Legal fees and other expenses related to litigation and contingencies are recorded as incurred. The Company, in consultation with its legal counsel, also assesses the need to record a liability for litigation and contingencies on a case-by-case basis. Accruals are recorded when the Company determines that a loss related to a matter is both probable and reasonably estimable. DEFERRED FINANCING COSTS ------------------------ Deferred financing costs of $5,835 were incurred in connection with the issuance of the 2.5% Contingent Convertible Notes due 2033. These costs are being amortized into interest expense on a straight-line basis over the five-year period that ends on the first date the debt can be put by the holders to the Company. Accumulated amortization totaled $2,143 and $979 at March 31, 2005 and 2004, respectively. Deferred financing costs, net of accumulated amortization, are included in "Other Assets" in the accompanying consolidated balance sheet. EARNINGS PER SHARE ------------------ Basic earnings per share is calculated by dividing net income available to common shareholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average common shares and common share equivalents outstanding during the periods presented assuming the conversion of preferred shares and the exercise of all in-the-money stock options based on the treasury stock method. Common share equivalents 65 have been excluded from the computation of diluted earnings per share where their inclusion would be anti-dilutive. In June 2004, the Company adopted the guidance in Emerging Issues Task Force (EITF) Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128. The pronouncement required the use of the two-class method in the calculation and disclosure of basic earnings per share and provided guidance on the allocation of earnings and losses for purposes of calculating basic earnings per share. Accordingly, all periods presented have been retroactively adjusted to give effect to such guidance. For purposes of calculating basic earnings per share, undistributed earnings are allocated to each class of common stock based on the contractual participation rights of each class of security. Holders of Class A common stock are entitled to receive dividends per share equal to 120% of the dividends per share paid on the Class B common stock. In December 2004, the Company adopted the guidance in EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share. The EITF consensus required that the impact of contingently convertible debt instruments be included in diluted earnings per share computations (if dilutive) regardless of whether the market price trigger (or other contingent feature) had been met. Additionally, the EITF stated that prior period earnings per share amounts presented for comparative purposes should be restated to conform to this consensus. INCOME TAXES ------------ Income taxes are accounted for under the asset and liability method where deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. 66 STOCK-BASED COMPENSATION ------------------------ The Company grants stock options for a fixed number of shares to employees with an exercise price greater than or equal to the fair value of the shares at the date of grant. As permissible under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, the Company elected to continue to account for stock option grants to employees in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. APB 25 requires that compensation cost related to fixed stock option plans be recognized only to the extent that the fair value of the shares at the grant date exceeds the exercise price. Accordingly, no compensation expense is recognized for stock option awards granted to employees with exercise prices at or above fair value. Had the Company determined compensation expense using the fair value method prescribed by SFAS 123, the Company's net income and earnings per share would have been as follows:
YEARS ENDED MARCH 31, --------------------------------- 2005 2004 2003 ---- ---- ---- Net income, as reported........................ $33,269 $45,848 $28,110 Stock based employee compensation expense, net of related tax effects................... (640) (695) (815) ------- ------- ------- Pro forma net income........................... $32,629 $45,153 $27,295 ======= ======= ======= Earnings per share: Basic Class A common - as reported.......... $ 0.71 $ 0.98 $ 0.59 Basic Class A common - pro forma............ 0.70 0.97 0.58 Basic Class B common - as reported.......... 0.59 0.82 0.50 Basic Class B common - pro forma............ 0.58 0.80 0.48 Diluted - as reported....................... 0.63 0.84 0.55 Diluted - pro forma......................... 0.62 0.83 0.53
The weighted average fair value of the options has been estimated on the date of grant using the following weighted average assumptions for grants issued during the years ended March 31, 2005, 2004 and 2003, respectively: no dividend yield; expected volatility of 36%, 43% and 45% for Class A common stock; expected volatility of 33%, 39% and 45% for Class B common stock; risk-free interest rate of 3.65%, 3.00% and 2.40% per annum; and expected option terms ranging from 3 to 10 years for all three periods. Weighted averages are used because of varying assumed exercise dates. COMPREHENSIVE INCOME -------------------- Comprehensive income includes all changes in equity during a period except those that resulted from investments by or distributions to the Company's shareholders. Other comprehensive income refers to revenues, expenses, gains and losses that, under generally accepted accounting principles, are included in comprehensive income, but excluded from net income as these amounts are recorded directly as an adjustment to shareholders' equity. For the Company, other comprehensive income (loss) is comprised of the net changes in unrealized gains and losses on available-for-sale securities, net of applicable income taxes. FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------- The fair values of the Company's cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate their carrying values due to the relatively short maturity of these items. The carrying 67 amount of all long-term financial obligations approximates their fair value because their terms are similar to those which can be obtained for similar financial instruments in the current marketplace. The Company's $5,000 investment in the preferred stock of FemmePharma, Inc. had a fair value of $19,200 and $11,840 at March 31, 2005 and 2004, respectively, based on an annual independent valuation analysis. Based on quoted market rates, the Company's $200,000 principal amount of Convertible Subordinated Notes had a fair value of $217,620 and $247,940 at March 31, 2005 and 2004, respectively. DERIVATIVE FINANCIAL INSTRUMENTS -------------------------------- In April 2003, the Company entered into an interest rate swap agreement with a major financial institution to hedge variable interest rate exposure related to a term loan with the same financial institution. Under the agreement, the Company fixed the interest rate of the debt at 5.31% per annum for the term of the loan. The swap is settled monthly and is recorded at each reporting date on the Company's consolidated balance sheet at fair value. Since the swap has not been designated as a hedge, any unrealized gains and losses are recognized in earnings. The Company's derivative financial instruments also consist of embedded derivatives related to the 2.5% Convertible Subordinated Notes due 2033. These embedded derivatives include certain conversion features and a contingent interest feature. Although the conversion features represent embedded derivative financial instruments, based on the de minimis value of these features at the time of issuance and at March 31, 2005, no value has been assigned to these embedded derivatives. The contingent interest feature provides unique tax treatment under the Internal Revenue Service's contingent debt regulations. In essence, interest accrues, for tax purposes, on the basis of the instrument's comparable yield (the yield at which the issuer would issue a fixed rate instrument with similar terms). NEW ACCOUNTING PRONOUNCEMENTS ----------------------------- In March 2004, the EITF completed its discussion of and provided consensus guidance on Issue No. 03-06, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share. The consensus interpreted the definition of a "participating security," required the use of the two-class method in the calculation and disclosure of basic earnings per share for companies with participating securities or more than one class of common stock, and provided guidance on the allocation of earnings and losses for purposes of calculating basic earnings per share. Since the Company has two classes of common stock, this consensus has been applied in the calculation of basic earnings per share for all periods presented. There was no impact on diluted earnings per share as reported. In April 2004, the FASB issued FASB Staff Position No. 129-1 (FSP 129-1), Disclosure Requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, Relating to Contingently Convertible Securities. This FSP requires the disclosure provisions of Statement 129 to apply to all existing and newly created contingently convertible securities and to their potentially dilutive effects on earnings per share. The adoption of the disclosure provisions of FSP 129-1 did not have a material impact on the Company's financial condition or results of operations. In September 2004, the EITF reached a consensus that contingently convertible debt instruments should be included in diluted earnings per share computations (if dilutive) regardless of whether the market price trigger (or other contingent feature) has been met. Additionally, the EITF stated that prior period earnings per share amounts presented for comparative purposes should be restated to conform to this consensus, which is effective for reporting periods ending after December 15, 2004. The consensus adopted by the EITF required 68 the addition of approximately 8.7 million shares associated with the conversion of the Company's $200,000 principal amount Convertible Subordinated Notes to the number of shares outstanding for the calculation of diluted earnings per share for all reported periods since the issuance of the Notes. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an Amendment to ARB No. 43, Chapter 4 which requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) costs be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company is currently determining the impact, if any, the adoption of this statement will have on its financial condition and results of operations. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retrospective adoption options. Under the modified retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the modified retrospective method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R. The Company has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123. In April 2005, the Securities and Exchange Commission announced an amendment to Regulation S-X to amend the date for compliance with SFAS 123R. The amendment requires each registrant that is not a small business issuer to adopt SFAS 123R in the first fiscal year commencing after June 15, 2005. As a result, the Company is required to adopt SFAS 123R beginning April 1, 2006. Adoption of SFAS 123R will have an impact on the Company's consolidated financial statements, as it will be required to expense the fair value of its employee stock option grants rather than disclose the pro forma impact on its consolidated net income within the footnotes to the Company's consolidated financial statements, as is its current practice. 69 3. ACQUISITIONS AND LICENSE AGREEMENT ---------------------------------- On March 31, 2003, the Company acquired from Schwarz Pharma (Schwarz) the product rights and trademarks to the Niferex(R) line of hematinic products for $14,300, plus expenses. The acquisition was financed with cash on hand. The purchase price was allocated to the trademark rights acquired and is being amortized over an estimated life of 20 years. On March 31, 2003, the Company acquired from a subsidiary of Altana Pharma AG (Altana) the world-wide product rights and trademarks to the Chromagen(R) line of hematinic products and the StrongStart(R) line of prenatal vitamin products for $27,000, plus expenses. The purchase price was allocated to the trademark rights acquired and is being amortized over an estimated life of 20 years. On April 18, 2002, the Company entered into an agreement with FemmePharma, Inc. (FemmePharma) whereby the Company was granted an exclusive license to manufacture and sell in North America and certain foreign markets intravaginal products and certain vaginal anti-infective products under development (the "License Agreement"). The initial product covered by the License Agreement was intended for use in the treatment of endometriosis using FemmePharma's patented PARDEL(TM) technology. In consideration for the rights and licenses received, the Company paid $2,000 for use of the PARDEL(TM) trademark (see Note 21). Under a separate agreement, the Company invested $2,000 in FemmePharma's convertible preferred stock in fiscal 2003 and made an additional $3,000 convertible preferred stock investment in January 2004 upon the completion of Phase II studies on the initial product covered by the License Agreement. The $5,000 investment has been accounted for using the cost method and is included in "Other assets" in the accompanying consolidated balance sheets (see Note 21). 4. MARKETABLE SECURITIES --------------------- The carrying amount of available-for-sale securities and their approximate fair values at March 31, 2005 and 2004 were as follows.
MARCH 31, 2005 -------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Auction rate securities......... $10,000 $ - $ - $10,000 Equity securities............... 35,895 - (201) 35,694 ------- ----- ----- ------- Total....................... $45,895 $ - $(201) $45,694 ======= ===== ===== ======= MARCH 31, 2004 -------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Auction rate securities......... $10,000 $ - $ - $10,000 Equity securities............... 25,330 - - 25,330 ------- ----- ----- ------- Total....................... $35,330 $ - $ - $35,330 ======= ===== ===== =======
70 The Company's marketable securities are classified as available-for-sale and are recorded at fair value based on quoted market prices using the specific identification method. These investments are classified as current as the Company has the ability to use them for current operating and investing purposes. There were no realized gains or losses for the years ended March 31, 2005, 2004 and 2003. At March 31, 2005, the Company has determined that its unrealized losses are temporary based on the de minimis amount of losses compared to cost and the duration of the losses being less than 12 months. The Company expects that all losses will be recovered, and intends to hold these marketable securities to recovery. If market conditions deteriorate, we may incur future impairments. Included in the Company's marketable securities at March 31, 2005 and 2004 are $10,000 of auction rate securities. Auction rate securities are investments with an underlying component of long-term debt or an equity instrument. These auction rate securities trade or mature on a shorter term than the underlying instrument based on an auction bid that resets the interest rate of the security. The auction or reset dates occur at intervals that are typically less than three months providing high liquidity to otherwise longer term investments. The Company had previously classified its auction rate securities as cash and cash equivalents. In fiscal 2005, the Company reclassified auction rate securities from cash and cash equivalents to marketable securities because the underlying instrument has a maturity date of August 2030. Prior periods have been reclassified to provide consistent presentation. 5. INVENTORIES ----------- Inventories as of March 31, consist of:
2005 2004 ---- ---- Finished goods..................... $30,521 $30,432 Work-in-process.................... 5,773 4,736 Raw materials...................... 17,651 15,529 ------- ------- $53,945 $50,697 ======= =======
6. PROPERTY AND EQUIPMENT ---------------------- Property and equipment as of March 31, consist of:
2005 2004 ---- ---- Land and improvements............... $ 2,030 $ 2,083 Building and building improvements.. 19,984 17,767 Machinery and equipment............. 41,399 43,442 Office furniture and equipment...... 14,871 15,051 Leasehold improvements.............. 9,985 11,338 Construction-in-progress............ 74,394 24,529 -------- -------- 162,663 114,210 Less accumulated depreciation....... (31,039) (38,433) -------- --------- Net property and equipment....... $131,624 $ 75,777 ======== ========
Capital additions to property and equipment were $63,622, $30,592 and $16,113 for the years ended March 31, 2005, 2004 and 2003, respectively. Depreciation of property and equipment was $7,775, $6,718 and $5,434 for the years ended March 31, 2005, 2004 and 2003, respectively. Property and equipment projects classified as construction-in- progress at March 31, 2005 are projected to be completed during the next 12 months at an estimated cost of $14,775. 71 During the years ended March 31, 2005 and 2004, the Company recorded capitalized interest on qualifying construction projects of $1,511 and $577, respectively. In fiscal 2003, the Company did not record any capitalized interest. 7. INTANGIBLE ASSETS AND GOODWILL ------------------------------ Intangible assets and goodwill as of March 31, consist of:
2005 2004 ------------------------------ ----------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION ------ ------------ ------ ------------ Product rights - Micro-K(R)..... $36,140 $(10,904) $36,140 $ (9,099) Product rights - PreCare(R)..... 8,433 (2,389) 8,433 (1,968) Trademarks acquired: Niferex(R)................... 14,834 (1,484) 14,834 (742) Chromagen(R)/StrongStart(R).. 27,642 (2,764) 27,642 (1,382) License agreements.............. 4,168 (120) 3,825 - Trademarks and patents.......... 2,814 (497) 2,980 (411) ------- -------- ------- -------- Total intangible assets..... 94,031 (18,158) 93,854 (13,602) Goodwill........................ 557 - 557 - ------- -------- ------- -------- $94,588 $(18,158) $94,411 $(13,602) ======= ======== ======= ========
As of March 31, 2005, the Company's intangible assets have a weighted average useful life of approximately 19 years. Amortization of intangible assets was $4,653, $4,459 and $2,321 for the years ended March 31, 2005, 2004 and 2003, respectively. Assuming no additions, disposals or adjustments are made to the carrying values and/or useful lives of the intangible assets, annual amortization expense on product rights, trademarks acquired and other intangible assets is estimated to be approximately $4,730 in each of the five succeeding fiscal years. 8. OTHER ASSETS ------------ Other assets as of March 31, consist of:
2005 2004 ---- ---- Cash surrender value of life insurance......... $ 2,822 $ 2,531 Preferred stock in FemmePharma................. 5,000 5,000 Deferred financing costs, net.................. 3,852 4,993 Deposits....................................... 1,407 1,220 ------- ------- $13,081 $13,744 ======= =======
72 9. ACCRUED LIABILITIES ------------------- Accrued liabilities as of March 31, consist of:
2005 2004 ---- ---- Salaries, wages, incentives and benefits....... $10,383 $ 6,160 Income taxes - current......................... - 2,409 Promotion expenses............................. 131 635 Litigation reserve............................. - 18,325 Other.......................................... 5,219 3,388 ------- ------- $15,733 $30,917 ======= =======
10. LONG-TERM DEBT -------------- Long-term debt as of March 31, consists of:
2005 2004 ---- ---- Industrial revenue bonds....................... $ - $ 205 Notes payable.................................. - 6,731 Building mortgages............................. 10,740 11,714 Convertible notes.............................. 200,000 200,000 -------- -------- 210,740 218,650 Less current portion........................... (973) (7,909) -------- -------- $209,767 $210,741 ======== ========
In December 2004, the Company increased its available credit facilities to $140,000. The revised agreement provides for an increase from $40,000 to $80,000 in the Company's revolving line of credit along with an increase from $25,000 to $60,000 in the supplemental credit line that is available for financing acquisitions. These credit facilities expire in October 2006 and December 2005, respectively. The revolving and supplemental credit lines are unsecured and interest is charged at the lower of the prime rate or the one-month LIBOR rate plus 175 basis points (4.61% at March 31, 2005). At March 31, 2005, the Company had no cash borrowings outstanding under either credit facility and $3,856 in open letters of credit issued under the credit facilities. The revised agreement contains substantially identical financial and other covenants, representations, warranties, conditions and default provisions as the replaced facility. The financial covenants impose minimum levels of earnings before interest, taxes, depreciation and amortization, a maximum funded debt ratio, a limit on capital expenditures and dividend payments, a minimum fixed charge coverage ratio and a maximum senior leverage ratio. As of March 31, 2005, the Company was in compliance with the covenants. The industrial revenue bonds, which paid interest at 7.35% per annum, matured serially through 2005 and were collateralized by certain property and equipment, as well as through a letter of credit, which was only accessible in case of default on the bonds. The bonds were paid in full in fiscal 2005. In April 2003, the Company financed the purchase of an $8.8 million building with a term loan secured by the property under a floating rate loan with a bank. The remaining principal balance plus any unpaid interest is due in April 2008. The Company also entered into an interest rate swap agreement with the same bank, which fixed the interest rate of the building mortgage at 5.31% for the term of the loan. At March 31, 2005, the Company's other two outstanding building mortgages bear interest at 7.57% and 6.27% and the remaining principal balances plus any unpaid interest are due in December 2006 and December 2007, respectively. 73 Notes payable related to a $7,000 unsecured promissory note that was entered into in conjunction with the Altana acquisition agreement (see Note 3) and was repaid on March 31, 2005. This note, which was non-interest bearing, was discounted using an imputed interest rate of 4.08%, which approximated the Company's borrowing rate for similar debt instruments at the time of the borrowing. The original discount on this note of $538 was amortized to interest expense over the two year term of the note. A second $7,000 unsecured promissory note entered into with Altana was repaid on March 31, 2004. On May 16, 2003, the Company issued $200,000 principal amount of Convertible Subordinated Notes (the "Notes") that are convertible, under certain circumstances, into shares of Class A common stock at an initial conversion price of $23.01 per share. The Notes, which are due May 16, 2033, bear interest that is payable on May 16 and November 16 of each year at a rate of 2.50% per annum. The Company also is obligated to pay contingent interest at a rate equal to 0.5% per annum during any six-month period from May 16 to November 15 and from November 16 to May 15, with the initial six-month period commencing May 16, 2006, if the average trading price of the Notes per $1,000 principal amount for the five trading day period ending on the third trading day immediately preceding the first day of the applicable six-month period equals $1,200 or more. As this contingent interest feature is based on the underlying trading price of the Notes, the contingent interest meets the criteria of and qualifies as an embedded derivative. At the time of issuance and at March 31, 2005, management determined that the fair value of this contingent interest embedded derivative was de minimis and, accordingly, no value has been assigned to this embedded derivative. The Company may redeem some or all of the Notes at any time on or after May 21, 2006, at a redemption price, payable in cash, of 100% of the principal amount of the Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders may require the Company to repurchase all or a portion of their Notes on May 16, 2008, 2013, 2018, 2023 and 2028 or upon a change in control, as defined in the indenture governing the Notes, at a purchase price, payable in cash, of 100% of the principal amount of the Notes, plus accrued and unpaid interest, including contingent interest, if any. The Notes are subordinate to all of our existing and future senior obligations. The net proceeds to the Company were approximately $194.2 million, after deducting underwriting discounts, commissions and offering expenses. The Notes are convertible, at the holders' option, into shares of the Company's Class A common stock prior to the maturity date under the following circumstances: o during any quarter commencing after June 30, 2003, if the closing sale price of the Company's Class A common stock over a specified number of trading days during the previous quarter is more than 120% of the conversion price of the Notes on the last trading day of the previous quarter. The Notes are initially convertible at a conversion price of $23.01 per share, which is equal to a conversion rate of approximately 43.4594 shares per $1,000 principal amount of Notes; o if the Company has called the Notes for redemption; o during the five trading day period immediately following any nine consecutive day trading period in which the trading price of the Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of our Class A common stock on that day multiplied by the number of shares of our Class A common stock issuable upon conversion of $1,000 principal amount of the Notes; or o upon the occurrence of specified corporate transactions. The Company has reserved 8,691,880 shares of Class A common stock for issuance in the event the Notes are converted into the Company's common shares. 74 The Notes, which are unsecured, do not contain any restrictions on the payment of dividends, the incurrence of additional indebtedness or the repurchase of the Company's securities, and do not contain any financial covenants. The aggregate maturities of long-term debt as of March 31, 2005 are as follows: Due in one year............... $ 973 Due in two years.............. 2,179 Due in three years............ 1,674 Due in four years............. 5,914 Due in five years............. - Thereafter.................... 200,000 -------- $210,740 ======== The Company paid interest, net of capitalized interest, of $4,156 during the year ended March 31, 2005. For the years ended March 31, 2004 and 2003, the Company paid interest of $3,215 and $389, respectively. 11. COMMITMENTS AND CONTINGENCIES ----------------------------- LEASES The Company leases manufacturing, office and warehouse facilities, equipment and automobiles under operating leases expiring through fiscal 2013. Total rent expense for the years ended March 31, 2005, 2004 and 2003 was $5,734, $5,246 and $4,785, respectively. Future minimum lease commitments under non-cancelable leases are as follows: 2006.......................... $1,598 2007.......................... 1,167 2008.......................... 782 2009.......................... 551 2010.......................... 535 Later years................... 624 A building leased by the Company on March 31, 2005 was purchased on April 14, 2005 (see Note 21). The future minimum lease payments under this lease were only included above through the date of the purchase. Payments that would have been due under this lease were $1,324 per year through April 2008 and $1,454 per year through April 2012. CONTINGENCIES The Company is currently subject to legal proceedings and claims that have arisen in the ordinary course of business. While the Company is not presently able to determine the potential liability, if any, related to such matters, the Company believes none of the matters it currently faces, individually or in the aggregate, will have a material adverse effect on its financial position or operations except for the specific cases described in "Litigation" below. The Company has licensed the exclusive rights to co-develop and market various generic equivalent products with other drug delivery companies. These collaboration agreements require the Company to make up-front and ongoing payments as development milestones are attained. If all milestones remaining under these agreements were reached, payments by the Company could total up to $15,455. 75 LITIGATION ETHEX Corporation (ETHEX), a subsidiary of the Company, was a defendant in a lawsuit styled Healthpoint, Ltd. v. ETHEX Corporation, filed in federal court in San Antonio, Texas. The Company and ETHEX were also named as defendants in a second lawsuit brought by Healthpoint and others styled Healthpoint Ltd. v. ETHEX Corporation, filed in federal court in San Antonio, Texas. In September 2004, the Company made a settlement payment in the amount of $16,500 to resolve all previously pending claims between KV and Healthpoint without the admission of any liability. The settlement was fully reserved by the Company in September 2002 and therefore had no impact on KV's earnings for the year ended March 31, 2005. The $1,430 of income reflected in "Litigation" on the Company's consolidated income statement for the year ended March 31, 2005 represents a $587 net payment received by us in accordance with a settlement of vitamin antitrust litigation and $843 related to the reversal of the portion of the Healthpoint litigation reserve that remained after payment of the settlement amount and related litigation costs. The Company and ETHEX are named as defendants in a case brought by CIMA LABS, Inc. and Schwarz Pharma, Inc. and styled CIMA LABS, Inc. et. al. v. KV Pharmaceutical Company et. al. filed in Federal District Court in Minnesota. It is alleged that the Company and ETHEX infringed on a CIMA patent in connection with the manufacture and sale of Hyoscyamine Sulfate Orally Dissolvable Tablets, 0.125 mg. The court has denied the plaintiffs' motion for a preliminary injunction, which allows ETHEX to continue marketing the product during the pendancy of the subject lawsuit. The Company has filed several motions for summary judgment requesting that the Court rule that the relevant patent is unenforceable, invalid or not infringed. These motions have been denied and the issues will be considered at trial. CIMA and Schwarz filed a summary judgment motion seeking the court to rule that the patent is valid in the face of some prior art references cited by the Company as providing support for its invalidity defense. The Court granted the motion; however, the issue of invalidity based on prior art that was not the subject of the motion will be tried. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. The Company and ETHEX are named as defendants in a case brought by Solvay Pharmaceuticals, Inc. and styled Solvay Pharmaceuticals, Inc. v. ETHEX Corporation, filed in Federal District Court in Minnesota. In general, Solvay alleges that ETHEX's comparative promotion of its Pangestyme(TM) CN 10 and Pangestyme(TM) CN 20 products to Solvay's Creon(R) 10 and Creon(R) 20 products resulted in false advertising and misleading statements under various federal and state laws, and constituted unfair and deceptive trade practices. Discovery is active and the case is required to be trial ready by February 1, 2006. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. KV previously distributed several pharmaceutical products that contained phenylpropanolamine, or PPA, and that were discontinued in 2000 and 2001. The Company is presently named a defendant in a product liability lawsuit in federal court in Mississippi involving PPA. The suit originated out of a case, Virginia Madison, et al. v. Bayer Corporation, et al. The original suit was filed in December 2002, but was not served on KV until February 2003. The case was originally filed in the Circuit Court of Hinds County, Mississippi, and was removed to the Federal District Court for the Southern District of Mississippi by then co-defendant Bayer Corporation. The case has been transferred to a Judicial Panel on Multi-District Litigation for PPA claims sitting in the Western District of Washington. The claims against the Company have been segregated into a lawsuit brought by Johnny Fulcher individually and on behalf of the wrongful death beneficiaries of Linda Fulcher, deceased, against the Company. It alleges bodily injury, wrongful death, economic injury, punitive damages, loss of consortium and/or loss of services from the use of the Company's distributed pharmaceuticals containing PPA that have since been discontinued and/or reformulated to exclude PPA. In May 2004, the case was dismissed with prejudice by the Federal District Court for the Western District of Washington for a failure to timely file an individual complaint 76 as required by certain court orders. The plaintiff filed a request for reconsideration which was opposed and subsequently denied by the Court in June 2004. In July 2004, the plaintiff filed a notice of appeal of the dismissal. The Company has opposed this appeal. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. The Company has also been advised that one of its former distributor customers is being sued in Florida state court in a case captioned Darrian Kelly v. K-Mart et. al. for personal injury allegedly caused by ingestion of K-Mart diet caplets that are alleged to have been manufactured by the Company and to contain PPA. The distributor has tendered defense of the case to the Company and has asserted a right to indemnification for any financial judgment it must pay. The Company previously notified its product liability insurer of this claim in 1999, and the Company has demanded that the insurer assume the Company's defense. The insurer has stated that it has retained counsel to secure additional factual information and will defer its coverage decision until that information is received. The Company intends to vigorously defend its interests; however, it cannot give any assurance that is will not be impleaded into the action, or that, if it is impleaded, that it would prevail. KV's product liability coverage for PPA claims expired for claims made after June 15, 2002. Although the Company renewed its product liability coverage for coverage after June 15, 2002, that policy excludes future PPA claims in accordance with the standard industry exclusion. Consequently, as of June 15, 2002, the Company will provide for legal defense costs and indemnity payments involving PPA claims on a going forward basis as incurred, including the Mississippi lawsuit that was filed after June 15, 2002. Moreover, the Company may not be able to obtain product liability insurance in the future for PPA claims with adequate coverage limits at commercially reasonable prices for subsequent periods. From time to time in the future, KV may be subject to further litigation resulting from products containing PPA that it formerly distributed. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. After the Company filed ANDAs with the FDA seeking permission to market a generic version of the 50 mg, 100 mg, and 200 mg strengths of Toprol(R) XL in extended release capsule form, AstraZeneca filed lawsuits against KV for patent infringement under the provisions of the Hatch-Waxman Act. In the Company's Paragraph IV certification, KV contended that its proposed generic versions do not infringe AstraZeneca's patents. Pursuant to the Hatch-Waxman Act, the filing date of the suit against the Company instituted an automatic stay of FDA approval of the Company's ANDA until the earlier of a judgment, or 30 months from the date of the suit. The Company has filed a motion for summary judgment with the Federal District Court in Missouri alleging, among other things, that AstraZeneca's patent is invalid. There is no trial setting. The Company intends to vigorously defend its interests; however, it cannot give any assurance it will prevail. The Company and/or ETHEX have been named as defendants in certain multi-defendant cases alleging that the defendants reported improper or fraudulent pharmaceutical pricing information, i.e., Average Wholesale Price, or AWP, and/or Wholesale Acquisition Cost, or WAC, information, which caused the governmental plaintiffs to incur excessive costs for pharmaceutical products under the Medicaid program. Cases of this type have been filed against the Company and/or ETHEX and other pharmaceutical manufacturer defendants by the State of Massachusetts, the State of Alabama, New York City, and approximately 25 counties in New York State (less than ten of which have been formally served on the Company or ETHEX). The New York City case and all but one of the New York County cases have been transferred (or will be the subject of a notice of related action in order to effectuate transfer) to the Federal District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation (MDL No. 1456). Each of these actions is in the early stages, and fact discovery has not yet begun in any of the cases other than the Alabama case, where the State's first discovery request has been filed. The Company intends to vigorously defend its interests in the actions described above; however, it cannot give any assurance it will prevail. The Company believes that various other governmental entities have commenced investigations into the generic and branded pharmaceutical industry at large regarding pricing and price reporting practices. Although the 77 Company believes its pricing and reporting practices have complied in all material respects with its legal obligations, it cannot give any assurance that it would prevail if legal actions are instituted by these governmental entities. On May 20, 2005, the Company was notified by the SEC that a non-public formal investigation was initiated that appears to relate to the Form 8-K disclosures the Company made on July 13, 2004. The Company is cooperating fully and believes the matter will be satisfactorily resolved. From time to time, the Company is involved in various other legal proceedings in the ordinary course of its business. These legal proceedings include various patent infringement actions brought by potential competitors with respect to products the Company proposes to market and for which it has submitted ANDA filings and provided notice of certification required under the provisions of the Act. While it is not feasible to predict the ultimate outcome of such other proceedings, the Company believes that the ultimate outcome of such other proceedings will not have a material adverse effect on its results of operations or financial position. There are uncertainties and risks associated with all litigation and there can be no assurance that the Company will prevail in any particular litigation. 12. EMPLOYMENT AGREEMENTS --------------------- The Company has employment agreements with certain officers and key employees which extend for one to five years. These agreements provide for base levels of compensation and, in certain instances, also provide for incentive bonuses and separation benefits. Also, the agreement with the Chief Executive Officer (CEO) contains provisions for partial salary continuation under certain conditions, contingent upon noncompete restrictions and providing consulting services to the Company as specified in the agreement. In addition, the CEO is entitled to receive retirement compensation paid in the form of a single annuity equal to 30% of the CEO's final average compensation payable each year beginning at retirement and continuing for the longer of 10 years or the life of the CEO. In accordance with this agreement, the Company recognized retirement expense of $1,355, $209 and $196 for the years ended March 31, 2005, 2004 and 2003, respectively. In fiscal 2005, the Company actuarily updated the appropriateness of the liability. 13. GAIN FROM LEGAL SETTLEMENT -------------------------- In September 2003, the Company received a payment from a branded pharmaceutical company in the amount of $4,000. The payment received by the Company was made in response to the Company's claim that the branded company violated federal antitrust laws and interfered with the Company's right to a timely introduction of a generic pharmaceutical product in a previous fiscal year. The payment was reflected by the Company in the "Litigation" line item of operating income and was recorded net of approximately $500 of attorney-related fees. 14. INCOME TAXES ------------ The income tax provisions for the years ended March 31, 2005, 2004 and 2003 were based on estimated Federal and state taxable income using the applicable statutory rates. The current and deferred Federal and state income tax provisions for the years ended March 31, 2005, 2004 and 2003 are as follows:
2005 2004 2003 ---- ---- ---- PROVISION Current Federal............................... $ 2,982 $14,184 $21,524 State................................. 195 1,275 2,038 ------- ------- ------- 3,177 15,459 23,562 ------- ------- ------- Deferred Federal............................... 12,473 7,792 (7,207) State................................. 1,109 899 (884) ------- ------- ------- 13,582 8,691 (8,091) ------- ------- ------- $16,759 $24,150 $15,471 ======= ======= =======
78 The reasons for the differences between the provision for income taxes and the expected Federal income taxes at the statutory rate are as follows:
2005 2004 2003 ---- ---- ---- Expected income tax expense................. $17,510 $24,499 $15,253 State income taxes, less Federal income tax benefit............... 847 1,413 750 Business credits............................ (1,080) (1,240) (370) Other ...................................... (518) (522) (162) ------- ------- ------- $16,759 $24,150 $15,471 ======= ======= =======
As of March 31, 2005 and 2004, the tax effect of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts are as follows:
2005 2004 ------------------------- ------------------------ CURRENT NON-CURRENT CURRENT NON-CURRENT ------- ----------- ------- ----------- Fixed asset basis differences........ $ - $ (6,658) $ - $(4,870) Reserves for inventory and receivables....................... 5,510 - 5,313 - Vacation pay reserve................. 249 - 460 - Deferred compensation................ - 1,620 - 1,164 Amortization......................... - (2,121) - (1,644) Litigation reserve................... - - 6,704 - Convertible notes interest........... - (9,495) (4,566) - Other................................ 68 - 126 - ------ -------- ------- ------- Net deferred tax asset (liability) $5,827 $(16,654) $ 8,037 $(5,350) ====== ======== ======= =======
The Company paid income taxes of $8,769, $22,201, and $22,088 during the years ended March 31, 2005, 2004 and 2003, respectively. Included in "Prepaid and other assets" at March 31, 2005 in the accompanying consolidated balance sheet was income tax refunds receivable of $2,518. 15. EMPLOYEE BENEFITS ----------------- STOCK OPTION PLAN AND AGREEMENTS On August 30, 2002, the Company's shareholders approved KV's 2001 Incentive Stock Option Plan (the "2001 Plan"), which allows for the issuance of up to 3,000,000 shares of common stock. Prior to the approval of the 2001 Plan, the Company operated under the 1991 Incentive Stock Option Plan, as amended, which still allows for the issuance of up to 750,000 shares of common stock. Under the Company's stock option plans, options to acquire shares of common stock have been made available for grant to certain employees. Each option granted has an exercise price of not less than 100% of the market value of the common stock on the date of grant. The contractual life of each option is generally 10 years. The exercisability of the grants varies according to the individual options granted. In addition to these plans, the Company has issued stock options periodically to executives with employment agreements and to non-employee directors. At March 31, 2005, options to purchase 34,875 shares of stock were outstanding pursuant to employment agreements and grants to non-employee directors. 79 The following summary shows the transactions for the years ended March 31, 2005, 2004 and 2003 under option arrangements:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------- ------------------- AVERAGE AVERAGE NO. OF PRICE PER NO. OF PRICE PER SHARES SHARE SHARES SHARE ------ ----- ------ ----- Balance, March 31, 2002........... 3,198,579 $ 8.12 1,435,756 $ 7.41 Options granted................... 700,538 12.35 - - Options becoming exercisable...... - - 566,455 9.21 Options exercised................. (135,420) 5.26 (135,420) 5.26 Options canceled.................. (260,664) 11.67 (75,952) 10.97 --------- --------- Balance March 31, 2003............ 3,503,033 8.81 1,790,839 8.00 Options granted................... 677,313 19.56 - - Options becoming exercisable...... - - 541,924 12.17 Options exercised................. (966,036) 7.80 (966,036) 7.80 Options canceled.................. (437,502) 11.72 (132,869) 10.37 --------- --------- Balance March 31, 2004............ 2,776,808 11.33 1,233,858 9.71 Options granted................... 676,250 22.19 - - Options becoming exercisable...... - - 431,164 14.42 Options exercised................. (220,743) 6.44 (220,743) 6.44 Options canceled.................. (129,517) 16.30 (34,285) 13.35 --------- --------- Balance March 31, 2005............ 3,102,798 $13.84 1,409,994 $11.58 ========= =========
The weighted average fair value of options granted at market price was $3.29, $3.42, and $2.18 per share for the years ended March 31, 2005, 2004 and 2003, respectively. The weighted average fair value of options granted with an exercise price exceeding market price on the date of grant was $2.94, $1.97, and $0.14 per share for the years ended March 31, 2005, 2004 and 2003, respectively. The following table summarizes information about stock options outstanding at March 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------------------- ----------------------------- RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED EXERCISE OUTSTANDING LIFE AVERAGE EXERCISABLE AVERAGE PRICES AT 3/31/05 REMAINING EXERCISE PRICE AT 3/31/05 EXERCISE PRICE ------ ---------- --------- -------------- ---------- -------------- $ 0.82 - $ 5.00 365,186 1 Years $ 3.14 306,717 $ 3.06 $ 5.01 - $10.00 614,120 5 Years $ 7.37 308,035 $ 7.23 $10.01 - $15.00 795,534 6 Years $12.04 379,562 $12.07 $15.01 - $20.00 614,938 7 Years $17.79 252,405 $18.24 $20.01 - $27.50 713,020 8 Years $23.48 163,275 $24.32
PROFIT SHARING PLAN The Company has a qualified trustee profit sharing plan (the "Plan") covering substantially all non-union employees. The Company's annual contribution to the Plan, as determined by the Board of Directors, is discretionary and was $300, $400, and $375 for the years ended March 31, 2005, 2004 and 2003, respectively. The Plan includes features as described under Section 401(k) of the Internal Revenue Code. 80 The Company's contributions to the 401(k) investment funds are 50% of the first 7% of the salary contributed by each participant. Contributions of $1,547, $1,286, and $1,185 were made to the 401(k) investment funds during the years ended March 31, 2005, 2004 and 2003, respectively. Contributions are also made to multi-employer defined benefit plans administered by labor unions for certain union employees. Amounts charged to pension expense and contributed to these plans were $200, $202, and $231 for the years ended March 31, 2005, 2004 and 2003, respectively. HEALTH AND MEDICAL INSURANCE PLAN The Company contributes to health and medical insurance programs for its non-union and union employees. For non-union employees, the Company self-insures the first $150,000 of each employee's covered medical claims. Included in accrued liabilities in the consolidated balance sheets as of March 31, 2005 and 2004 were $20 and $450 of accrued health insurance reserves, respectively, for claims incurred but not reported. In fiscal 2005, the Company established a Voluntary Employees' Beneficiary Association for its non-union employees to fund payments made by the Company for covered medical claims. As a result of initially funding this plan, the Company's liability for claims incurred but not reported was reduced by $680. For union employees, the Company participates in a fully funded insurance plan sponsored by the union. Total health and medical insurance expense for the two plans was $9,431, $7,331, and $6,636 for the years ended March 31, 2005, 2004 and 2003, respectively. 16. RELATED PARTY TRANSACTIONS -------------------------- The Company currently leases certain real property from an affiliated partnership of an officer and director of the Company. Lease payments made for this property for the years ended March 31, 2005, 2004 and 2003 totaled $277, $271, and $269, respectively. 17. EQUITY TRANSACTIONS ------------------- As of March 31, 2005 and 2004, the Company had 40,000 shares of 7% Cumulative Convertible Preferred Stock (par value $.01 per share) outstanding at a stated value of $25 per share. The preferred stock is non-voting with dividends payable quarterly. The preferred stock is redeemable by the Company at its stated value. Each share of preferred stock is convertible into Class A common stock at a conversion price of $2.96 per share. The preferred stock has a liquidation preference of $25 per share plus all accrued but unpaid dividends prior to any liquidation distributions to holders of Class A or Class B common stock. No dividends may be paid on Class A or Class B common stock unless all dividends on the Cumulative Convertible Preferred Stock have been declared and paid. There were no undeclared and unaccrued cumulative preferred dividends at March 31, 2005 and 2004. Also, under the terms of its credit agreement, the Company may not pay cash dividends in excess of 25% of the prior fiscal year's consolidated net income. The Company has reserved 750,000 shares of Class A common stock for issuance under KV's 2002 Consultants Plan. These shares may be issued from time to time in consideration for consulting and other services provided to the Company by independent consultants. Since inception of this plan, the Company has issued 47,732 Class A shares as payment for certain milestones under product development agreements. Holders of Class A common stock are entitled to receive dividends per share equal to 120% of the dividends per share paid on the Class B common stock and have one-twentieth vote per share in the election of directors and on other matters. 81 Under the terms of the Company's current loan agreement (see Note 10), the Company has limitations on paying dividends, except in stock, on its Class A and Class B common stock. Payment of dividends may also be restricted under Delaware Corporation law. On September 8, 2003, the Company's Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend of its common stock to shareholders of record on September 18, 2003, payable on September 29, 2003. Common stock was credited and retained earnings was charged for the aggregate par value of the shares issued. The stated par value of each share was not changed from $0.01. All per share data in this report has been restated to reflect the aforementioned three-for-two stock split in the form of a 50% stock dividend. In May 2003, the Company used $50,000 of the net proceeds from the Convertible Subordinated Notes issuance (see Note 10) to fund the repurchase of 2,000,000 shares of the Company's Class A common stock. 82 18. EARNINGS PER SHARE ------------------ The following table sets forth the computation of basic and diluted earnings per share:
2005 2004 2003 ---- ---- ---- Undistributed earnings: Net income ....................................... $33,269 $45,848 $28,110 Less - preferred stock dividends.................. (70) (436) (70) ------- ------- ------- Undistributed earnings - basic EPS................ 33,199 45,412 28,040 Add - preferred stock dividends................... 70 436 70 Add - interest expense on convertible notes, net of tax.............................. 4,099 3,507 - ------- ------- ------- Net income - diluted EPS.......................... $37,368 $49,355 $28,110 ======= ======= ======= Allocation of undistributed earnings: Class A common stock.............................. $24,316 $32,391 $20,211 Class B common stock.............................. 8,883 13,021 7,829 ------- ------- ------- Total allocated earnings - basic EPS........... $33,199 $45,412 $28,040 ======= ======= ======= Weighted average shares outstanding - basic: Class A common stock.............................. 34,228 33,046 33,997 Class B common stock.............................. 15,005 15,941 15,803 ------- ------- ------- Total weighted average shares outstanding - basic......................... 49,233 48,987 49,800 ------- ------- ------- Effect of dilutive securities: Employee stock options............................ 1,205 1,760 1,423 Convertible preferred stock....................... 338 338 338 Convertible notes................................. 8,692 7,623 - ------- ------- ------- Dilutive potential common shares............... 10,235 9,721 1,761 ------- ------- ------- Total weighted average shares outstanding - diluted....................... 59,468 58,708 51,561 ======= ======= ======= Basic earnings per share: Class A common stock.............................. $ 0.71 $ 0.98 $ 0.59 Class B common stock.............................. 0.59 0.82 0.50 Diluted earnings per share(1)........................ 0.63 0.84 0.55 ======= ======= ======= - ----------------- (1) Excluded from the computation of diluted earnings per share are outstanding stock options whose exercise prices are greater than the average market price of the common shares for the period reported. For the years ended March 31, 2005, 2004 and 2003, options to purchase 712,770, 206,771 and 405,735 Class A and Class B common shares, respectively, were excluded from the computation.
83 19. QUARTERLY FINANCIAL RESULTS (UNAUDITED) ---------------------------------------
1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER YEAR ------- ------- ------- ------- ---- YEAR ENDED MARCH 31, 2005 - ------------------------- Net sales.................................. $66,087 $79,322 $86,857 $71,227 $303,493 Gross profit............................... 42,353 52,466 56,922 44,070 195,811 Pretax income (loss)....................... 11,543 19,591 20,062 (1,168) 50,028 Net income (loss).......................... 7,561 12,676 13,552 (520) 33,269 Basic earnings per share: Class A common stock.................... 0.16 0.27 0.29 (0.01) 0.71 Class B common stock.................... 0.14 0.23 0.24 (0.01) 0.59 Diluted earnings per share................. 0.14 0.23 0.25 (0.01) 0.63 YEAR ENDED MARCH 31, 2004 - ------------------------- Net sales.................................. $59,379 $71,019 $69,598 $83,945 $283,941 Gross profit............................... 38,389 46,879 46,837 53,409 185,514 Pretax income.............................. 13,291 18,978 17,874 19,855 69,998 Net income................................. 8,573 12,241 11,529 13,505 45,848 Basic earnings per share: Class A common stock.................... 0.17 0.27 0.25 0.29 0.98 Class B common stock.................... 0.14 0.22 0.21 0.24 0.82 Diluted earnings per share................. 0.16 0.22 0.21 0.24 0.84
84 20. SEGMENT REPORTING ----------------- The reportable operating segments of the Company are branded products, specialty generics and specialty materials. The Company has aggregated its branded product lines in a single segment because of similarities in regulatory environment, manufacturing processes, methods of distribution and types of customer. This segment includes patent-protected products and certain trademarked off-patent products that the Company sells and markets as brand pharmaceutical products. The specialty generics business segment includes off-patent pharmaceutical products that are therapeutically equivalent to proprietary products. The Company sells its brand and generic products primarily to pharmaceutical wholesalers, drug distributors and chain drug stores. The specialty materials segment is distinguished as a single segment because of differences in products, marketing and regulatory approval when compared to the other segments. Accounting policies of the segments are the same as the Company's consolidated accounting policies. Segment profits are measured based on income before taxes and are determined based on each segment's direct revenues and expenses. The majority of research and development expense, corporate general and administrative expenses, amortization and interest expense, as well as interest and other income, are not allocated to segments, but included in the "all other" classification. Identifiable assets for the three reportable operating segments primarily include receivables, inventory, and property and equipment. For the "all other" classification, identifiable assets consist of cash and cash equivalents, corporate property and equipment, intangible and other assets and all income tax related assets. The following represents information for the Company's reportable operating segments for fiscal 2005, 2004 and 2003.
FISCAL YEAR ENDED BRANDED SPECIALTY SPECIALTY ALL MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED --------- -------- -------- --------- ----- ------------ ------------ - -------------------------------------------------------------------------------------------------------------------------------- NET REVENUES 2005 $90,085 $191,870 $18,345 $ 3,193 $ - $303,493 2004 82,868 181,455 16,550 3,068 - 283,941 2003 43,677 179,724 17,395 4,200 - 244,996 - -------------------------------------------------------------------------------------------------------------------------------- SEGMENT PROFIT (LOSS) 2005 24,037 102,937 3,043 (79,989) - 50,028 2004 31,661 101,163 1,365 (64,191) - 69,998 2003 8,361 97,339 1,692 (63,811) - 43,581 - -------------------------------------------------------------------------------------------------------------------------------- IDENTIFIABLE ASSETS 2005 25,015 66,834 8,001 459,625 (1,158) 558,317 2004 24,585 70,581 8,343 426,087 (1,158) 528,438 2003 7,819 69,303 8,797 267,907 (1,158) 352,668 - -------------------------------------------------------------------------------------------------------------------------------- PROPERTY AND EQUIPMENT ADDITIONS 2005 2,463 - 318 60,841 - 63,622 2004 420 1,685 71 28,416 - 30,592 2003 634 116 143 15,220 - 16,113 - -------------------------------------------------------------------------------------------------------------------------------- DEPRECIATION AND AMORTIZATION 2005 217 235 140 13,312 - 13,904 2004 332 123 141 12,067 - 12,663 2003 260 55 164 7,294 - 7,773 - --------------------------------------------------------------------------------------------------------------------------------
Consolidated revenues are principally derived from customers in North America and substantially all property and equipment is located in St. Louis, Missouri. 85 21. SUBSEQUENT EVENTS ----------------- On April 14, 2005, the Company completed the purchase of a 260,000 square foot building for $11,800. The property had been leased by the Company since April 2000 and will continue to function as the Company's main distribution facility. The purchase of the building was financed with cash on hand. In May 2005, the Company and FemmePharma mutually agreed to terminate the license agreement they entered into in April 2002 (see Note 3). As part of this transaction, the Company acquired all of the common stock of FemmePharma for $25,000 after certain assets of the entity had been distributed to FemmePharma's other shareholders. Included in the Company's acquisition of FemmePharma are the worldwide marketing rights to an endometriosis product that has successfully completed Phase II clinical trials. This product was originally part of the licensing arrangement with FemmePharma that provided the Company, among other things, marketing rights for the product principally in the United States. In accordance with the new agreement, the Company is assuming responsibility for conducting the Phase III clinical study; has acquired worldwide licensing rights of the endometriosis product; is no longer responsible for milestone payments and royalties specified in the original licensing agreement; and has secured exclusive worldwide rights for use of the FemmePharma technology for vaginal anti-infective products. The Company believes the Phase III clinical study for the endometriosis product will begin during fiscal 2006. In connection with this transaction, the Company expects to incur a charge of approximately $30,000 in the first quarter of fiscal 2006, which includes the write-off of the $25,000 payment plus preferred stock investments previously made, and which principally relates to in-process research and development. In May 2005, the Company entered into a long-term product development and marketing license agreement with Strides Arcolab, Ltd, (Strides) an Indian generic pharmaceutical developer and manufacturer, for exclusive marketing rights in the United States and Canada for 10 new generic drugs. Under the agreement, Strides will be responsible for developing, submitting for regulatory approval and manufacturing the 10 products and the Company will be responsible for exclusively marketing the products in the territories covered by the agreement. Under a separate agreement, the Company invested $11,300 in Strides' redeemable preferred stock. 86 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- On August 17, 2004, the Company engaged KPMG LLP as its independent auditor. KMPG LLP replaced BDO Seidman LLP after their resignation which was reported in an 8-K filed July 13, 2004. There have been no disagreements with accountants on accounting or financial disclosure matters. ITEM 9A. CONTROLS AND PROCEDURES ----------------------- EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports 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 the Company's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures. Based on the foregoing, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is 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. The 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 the 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. 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 performed an assessment of the effectiveness of the Company's internal control over financial reporting as of March 31, 2005. Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. As a result of this assessment and based on the criteria set forth in the COSO framework, management has concluded that, as of March 31, 2005, the Company's internal control over financial reporting was effective. 87 Management's assessment of the effectiveness of the Company's internal control over financial reporting as of March 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report appearing herein. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There have been no changes in the Company's internal control over financial reporting, during the fiscal quarter ended March 31, 2005, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Report of Independent Registered Public Accounting Firm ------------------------------------------------------- The Board of Directors and Shareholders K-V Pharmaceutical Company: We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that K-V Pharmaceutical Company maintained effective internal control over financial reporting as of March 31, 2005, based on the 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 maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. 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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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. 88 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. In our opinion, management's assessment that K-V Pharmaceutical Company maintained effective internal control over financial reporting as of March 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control--Integrated Framework issued by COSO. Also, in our opinion, K-V Pharmaceutical Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of K-V Pharmaceutical Company and subsidiaries as of March 31, 2005, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year ended March 31, 2005, and our report dated June 14, 2005 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP St. Louis, Missouri June 14, 2005 89 ITEM 9B. OTHER INFORMATION ----------------- DEPARTURE OF DIRECTORS OR PRINCIPAL OFFICERS; ELECTION OF DIRECTORS; APPOINTMENT OF PRINCIPAL OFFICERS. On June 13, 2005, K-V Pharmaceutical Company (the "Registrant") designated Richard H. Chibnall, age 49, as its principal accounting officer. Mr. Chibnall has served as the Registrant's Vice President, Finance since February 2000 and will continue to serve in such position in addition to his duties as principal accounting officer. Gerald R. Mitchell, the Registrant's Vice President and Chief Financial Officer, formerly acted as both principal financial officer and principal accounting officer and will continue to serve as the Registrant's principal financial officer. Mr. Chibnall is employed by the Registrant pursuant to an employment agreement, dated December 22, 1995, as amended February 1, 2000, and April 1, 2005. Under the employment agreement, Mr. Chibnall is entitled to an annual base salary of $220,000, which may be increased from year to year, and certain separation benefits. Mr. Chibnall is also entitled to participate in any fringe benefits normally provided to employees of the Registrant at comparable employment levels. The employment agreement automatically renews for successive one-year periods until terminated under the terms of the agreement. Under the employment agreement, if Mr. Chibnall's employment is involuntarily terminated without cause by the Registrant (other than within two years after a change of control of the Registrant), Mr. Chibnall will be entitled to severance pay equal to one-half of his then current salary. He would also receive continuation of any health and welfare benefits for a period of 6 months following the involuntary termination. In addition, all stock options held by Mr. Chibnall would immediately vest and become exercisable. Except in the case of Mr. Chibnall's death or disability, if Mr. Chibnall's employment is involuntarily terminated with or without cause within two years after the occurrence of a change of control (as defined in the employment agreement), Mr. Chibnall is entitled to severance pay equal to one and one-half times the sum of his annual salary and 18 months' worth of bonus. Mr. Chibnall also would continue to receive health and welfare benefits for a period of 18 months after such a termination. All stock options held by Mr. Chibnall would immediately vest and become exercisable. The employment agreement also contains restrictive covenants preventing Mr. Chibnall from competing against the Registrant or soliciting customers or employees of the Registrant for a period of 24 months after termination of his employment. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------- The information contained under the caption "INFORMATION CONCERNING NOMINEES AND DIRECTORS CONTINUING IN OFFICE" in the Company's definitive proxy statement to be filed pursuant to 90 Regulation 14(a) for its 2005 Annual Meeting of Shareholders, which involves the election of directors, is incorporated herein by this reference. Also see Item 4(a) of Part I hereof. ITEM 11. EXECUTIVE COMPENSATION ---------------------- The information contained under the captions "EXECUTIVE COMPENSATION" and "INFORMATION AS TO STOCK OPTIONS" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(a) for its 2005 Annual Meeting of Shareholders is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------- The information contained under the captions "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS" and "SECURITY OWNERSHIP OF MANAGEMENT" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(a) for its 2005 Annual Meeting of Shareholders is incorporated herein by this reference. EQUITY COMPENSATION PLAN INFORMATION The following information regarding compensation plans of the Company is furnished as of March 31, 2005, the end of the Company's most recently completed fiscal year. EQUITY COMPENSATION PLAN INFORMATION REGARDING CLASS A COMMON STOCK - --------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) ------------------- ---------------------------- ------------------------ PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders(1) 2,700,457 $14.12 988,473 Equity compensation plans not approved by security holders(2) 6,750 $3.22 N/A --------- Total 2,707,207 $14.10 ========= (1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 15 of Notes to Consolidated Financial Statements. (2) Consists of options granted to non-employee members of the Board of Directors.
91 EQUITY COMPENSATION PLAN INFORMATION REGARDING CLASS B COMMON STOCK - --------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) ------------------- ---------------------------- ------------------------ PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders(1) 367,466 $13.08 1,214,399 Equity compensation plans not approved by security holders(2) 28,125 $4.82 N/A ------ Total 395,591 $12.49 ======= (1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 15 of Notes to Consolidated Financial Statements. (2) Consists of options granted to non-employee members of the Board of Directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------- The information contained under the caption "TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(a) for its 2005 Annual Meeting of Shareholders is incorporated herein by this reference. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES -------------------------------------- The information contained under the caption "FEES PAID TO INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(a) for its 2005 Annual Meeting of Shareholders is incorporated herein by this reference. 92 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES --------------------------------------- (a) 1. Financial Statements: Page The following consolidated financial statements of the Company are included in Part II, Item 8: Report of Independent Registered Public Accounting Firm......... 54 Report of Independent Registered Public Accounting Firm......... 55 Consolidated Balance Sheets as of March 31, 2005 and 2004....... 56 Consolidated Statements of Income for the Years Ended March 31, 2005, 2004 and 2003............................................. 57 Consolidated Statements of Comprehensive Income for the Years Ended March 31, 2005, 2004 and 2003............................. 58 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 2005, 2004 and 2003............................. 59 Consolidated Statements of Cash Flows for the Years Ended March 31, 2005, 2004 and 2003................................... 60 Notes to Financial Statements................................... 61-86 Controls and Procedures......................................... 87 Evaluation of Disclosure Controls and Procedures................ 87 Management's Report on Internal Control over Financial Reporting....................................................... 87 Changes in Internal Control over Financial Reporting............ 88 Report of Independent Registered Public Accounting Firm......... 88 2. Financial Statement Schedules: Report of Independent Registered Public Accounting Firm regarding Financial Statement Schedule.......................... 94 Schedule II - Valuation and Qualifying Accounts................. 95 (b) Exhibits. See Exhibit Index on pages 97 through 104 of this Report. Management contracts and compensatory plans are designated on the Exhibit Index. (c) Financial Statement Schedules. 93 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Stockholders and Board of Directors of K-V Pharmaceutical Company The audits referred to in our report dated June 4, 2004, relating to the consolidated financial statements of K-V Pharmaceutical Company, which are included in Item 8 of this Form 10-K, included the audits of the accompanying financial statement schedule for the years ended March 31, 2004 and 2003. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based upon our audits. In our opinion, the 2004 and 2003 financial statement schedule presents fairly, in all material respects, the information set forth therein. /s/ BDO SEIDMAN, LLP Chicago, Illinois June 4, 2004 94 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS BALANCE AT CHARGED TO AMOUNTS BALANCE BEGINNING COSTS AND CHARGED TO AT END OF YEAR EXPENSES RESERVES OF YEAR ------- -------- -------- ------- (in thousands) Year Ended March 31, 2003: Allowance for doubtful accounts............ $ 403 $ (81) $ (100) $ 422 Reserves for sales allowances.............. 18,958 98,929 88,229 29,658 Inventory obsolescence..................... 1,108 2,053 2,158 1,003 ------- -------- -------- ------- $20,469 $100,901 $ 90,287 $31,083 ======= ======== ======== ======= Year Ended March 31, 2004: Allowance for doubtful accounts............ $ 422 $ (20) $ - $ 402 Reserves for sales allowances.............. 29,658 103,262 112,272 20,648 Inventory obsolescence..................... 1,003 2,442 2,443 1,002 ------- -------- -------- ------- $31,083 $105,684 $114,715 $22,052 ======= ======== ======== ======= Year Ended March 31, 2005: Allowance for doubtful accounts............ $ 402 $ 235 $ 176 $ 461 Reserves for sales allowances.............. 20,648 133,475 133,067 21,056 Inventory obsolescence..................... 1,002 3,182 2,891 1,293 ------- -------- -------- ------- $22,052 $136,892 $136,134 $22,810 ======= ======== ======== =======
Financial statements of K-V Pharmaceutical Company (separately) are omitted because KV is primarily an operating company and its subsidiaries included in the financial statements are wholly-owned and are not materially indebted to any person other than through the ordinary course of business. 95 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. K-V PHARMACEUTICAL COMPANY Date: June 14, 2005 By /s/ Marc S. Hermelin ------- ----------------------------------- Vice Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: June 14, 2005 By /s/ Gerald R. Mitchell ------- ----------------------------------- Vice President and Chief Financial Officer (Principal Financial Officer) Date: June 14, 2005 By /s/ Richard H. Chibnall ------- ----------------------------------- Vice President, Finance (Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on the dates indicated by the following persons on behalf of the Company and in their capacities as members of the Board of Directors of the Company: Date: June 14, 2005 By /s/ Marc S. Hermelin ----------------------------------- Marc S. Hermelin Date: June 14, 2005 By /s/ Victor M. Hermelin ----------------------------------- Victor M. Hermelin Date: June 14, 2005 By /s/ Norman D. Schellenger ----------------------------------- Norman D. Schellenger Date: June 14, 2005 By /s/ Alan G. Johnson ----------------------------------- Alan G. Johnson Date: June 14, 2005 By /s/ Kevin S. Carlie ----------------------------------- Kevin S. Carlie Date: June 14, 2005 By /s/ David A. Van Vliet ----------------------------------- David Van Vliet Date: June 14, 2005 By /s/ Jean M. Bellin ----------------------------------- Jean M. Bellin Date: June 14, 2005 By /s/ Terry B. Hatfield ----------------------------------- Terry B. Hatfield Date: June 14, 2005 By /s/ David S. Hermelin ----------------------------------- David S. Hermelin 96 EXHIBIT INDEX Exhibit No. Description ----------- ----------- 3(a) The Company's Certificate of Incorporation, which was filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended March 31, 1981, is incorporated herein by this reference. 3(b) Certificate of Amendment to Certificate of Incorporation of the Company, effective March 7, 1983, which was filed as Exhibit 3(c) to the Company's Annual Report on Form 10-K for the year ended March 31, 1983, is incorporated herein by this reference. 3(c) Certificate of Amendment to Certificate of Incorporation of the Company, effective June 9, 1987, which was filed as Exhibit 3(d) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988, is incorporated herein by this reference. 3(d) Certificate of Amendment to Certificate of Incorporation of the Company, effective September 24, 1987, which was filed as Exhibit 3(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988, is incorporated herein by this reference. 3(e) Certificate of Amendment to Certificate of Incorporation of the Company, effective July 17, 1986, which was filed as Exhibit 3(e) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 3(f) Certificate of Amendment to Certificate of Incorporation of the Company, effective December 23, 1991, which was filed as Exhibit 3(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 3(g) Certificate of Amendment to Certificate of Incorporation of the Company, effective September 3, 1998, which was filed as Exhibit 4(g) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-87402), filed May 1, 2002, is incorporated herein by this reference. 3(h) Bylaws of the Company, as amended through November 18, 1982, which was filed as Exhibit 3(e) to the Company's Annual Report on Form 10-K for the year ended March 31, 1993, is incorporated herein by this reference. 3(i) Amendment to Bylaws of the Company, effective July 2, 1984, which was filed as Exhibit 4(i) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-87402), filed May 1, 2002, is incorporated herein by this reference. 3(j) Amendment to Bylaws of the Company, effective December 4, 1986, which was filed as Exhibit 4(j) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-87402), filed May 1, 2002, is incorporated herein by this reference. 3(k) Amendment to Bylaws of the Company effective March 17, 1992, which was filed as Exhibit 4(k) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-87402), filed May 1, 2002, is incorporated herein by this reference. 3(l) Amendment to Bylaws of the Company effective November 18, 1992, which was filed as Exhibit 4(l) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-87402), filed May 1, 2002, is incorporated herein by this reference. 97 3(m) Amendment to Bylaws of the Company, effective December 30, 1993, which was filed as Exhibit 3(h) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 3(n) Amendment to Bylaws of the Company, effective September 24, 2002, which was filed as Exhibit 4(n) to the Company's Registration Statement on Form S-3 (Registration Statement No. 333-106294), filed June 19, 2003, is incorporated herein by this reference. 4(a) Certificate of Designation of Rights and Preferences of 7% Cumulative Convertible preferred stock of the Company, effective June 9, 1987, and related Certificate of Correction, dated June 17, 1987, which was filed as Exhibit 4(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1987, is incorporated herein by this reference. 4(b) Loan Agreement dated June 18, 1997 between the Company and its subsidiaries and LaSalle National Bank ("LaSalle"), which was filed as Exhibit 4(i) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 4(c) Revolving Note, dated June 18, 1997, by the Company and its subsidiaries in favor of LaSalle, which was filed as Exhibit 4(j) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 4(d) Term Note, dated June 24, 1997, by the Company and its subsidiaries in favor of LaSalle, which was filed as Exhibit 4(k) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 4(e) Reimbursement Agreement dated as of October 16, 1997, between the Company and LaSalle, which was filed as Exhibit 4(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1998, is incorporated herein by this reference. 4(f) Deed of Trust and Security Agreement dated as of October 16, 1997, between the Company and LaSalle, which was filed as Exhibit 4(g) to the Company's Annual Report on Form 10-K for the year ended March 31, 1998, is incorporated herein by this reference. 4(g) First Amendment, dated as of October 28, 1998, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(h) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999, is incorporated herein by this reference. 4(h) Second Amendment, dated as of March 11, 1999, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(i) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999, is incorporated herein by this reference. 4(i) Third Amendment, dated June 22, 1999, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(j) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated herein by this reference. 98 4(j) Fourth Amendment, dated December 17, 1999, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(k) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated herein by this reference. 4(k) Fifth Amendment, dated December 21, 2001, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(l) to the Company's Annual Report on Form 10-K for the year ended March 31, 2002, is incorporated herein by this reference. 4(l) Sixth Amendment, dated December 20, 2002, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(m) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 4(m) Seventh Amendment, dated April 28, 2003, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(n) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 4(n) Indenture dated as of May 16, 2003, by and between the Company and Deutsche Bank Trust Company Americas, filed on May 21, 2003, as Exhibit 4.1 to the Company's Current Report on Form 8-K, is incorporated herein by this reference. 4(o) Registration Rights Agreement dated as of May 16, 2003, by and between the Company and Deutsche Bank Securities, Inc., as representative of the several Purchasers, filed on May 21, 2003 as Exhibit 4.2 to the Company's Current Report on Form 8-K, is incorporated herein by this reference. 4(p) Eighth Amendment, dated June 30, 2003, to loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(q) to the Company's Annual Report on Form 10-K for the year ended March 31, 2004, is incorporated herein by this reference. 4(q) Ninth Amendment, dated December 19, 2003, to Loan Agreement between the Company and its subsidiaries and LaSalle, which was filed as Exhibit 4(r) to the Company's Annual Report on Form 10-K for the year ended March 31, 2004, is incorporated herein by this reference. 4(r) Tenth Amendment, dated December 20, 2004, to Loan Agreement between the Company and its subsidiaries and LaSalle, filed on January 18, 2005, as Exhibit 10.1 to the Company's Current Report on Form 8-K, is incorporated herein by this reference. 4(s) Amended and Restated Loan Agreement, dated December 31, 2004, among the Company and its subsidiaries, LaSalle National Bank Association and Citibank, F.S.B., filed on January 18, 2005, as Exhibit 10.2 to the Company's Current Report on Form 8-K, is incorporated herein by this reference. 10(a)* First Amendment to and Restatement of the KV Pharmaceutical 1981 Employee Incentive Stock Option Plan, dated March 9, 1987 (the "Restated 1981 Option Plan"), which was filed as Exhibit 10(t) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988, is incorporated herein by this reference. 10(b)* Second Amendment to the Restated 1981 Option Plan, dated June 12, 1987, which was filed as Exhibit 10(u) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988, is incorporated herein by this reference. 10(c)* Revised Form of Stock Option Agreement, effective June 12, 1987, for the Restated 1981 Option Plan, which was filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988, is incorporated herein by this reference. 99 10(d)* Consulting Agreement between the Company and Victor M. Hermelin, Chairman of the Board, dated October 30, 1978, as amended October 30, 1982, and Employment Agreement dated February 20, 1974, referred to therein (which was filed as Exhibit 10(m) to the Company's Annual Report on Form 10-K for the year ended March 31, 1983) and subsequent Amendments dated as of August 12, 1986, which was filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1987, and dated as of September 15, 1987 (which was filed as Exhibit 10(s) to the Company's Annual Report on Form 10-K for the year ended March 31, 1988), and dated October 25, 1988 (which was filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K for the year ended March 31, 1989), and dated October 30, 1989 (which was filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K for the year ended March 31, 1990), and dated October 30, 1990 (which was filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K for the year ended March 31, 1991), and dated as of October 30, 1991 (which was filed as Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended March 31, 1992), are incorporated herein by this reference. 10(e)* Restated and Amended Employment Agreement between the Company and Gerald R. Mitchell, Vice President, Finance, dated as of March 31, 1994, is incorporated herein by this reference. 10(f)* Employment Agreement between the Company and Raymond F. Chiostri, Corporate Vice-President and President-Pharmaceutical Division, which was filed as Exhibit 10(l) to the Company's Annual Report on Form 10-K for the year ended March 31, 1992, is incorporated herein by this reference. 10(g) Lease of the Company's facility at 2503 South Hanley Road, St. Louis, Missouri, and amendment thereto, between the Company as Lessee and Marc S. Hermelin as Lessor, which was filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K for the year ended March 31, 1983, is incorporated herein by this reference. 10(h) Amendment to the Lease for the facility located at 2503 South Hanley Road, St. Louis, Missouri, between the Company as Lessee and Marc S. Hermelin as Lessor, which was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended March 31, 1992, is incorporated herein by this reference. 10(i)* KV Pharmaceutical Company Fourth Restated Profit Sharing Plan and Trust Agreement dated September 18, 1990, which was filed as Exhibit 4.1 to the Company's Registration Statement on Form S-8 No. 33-36400, is incorporated herein by this reference. 10(j)* First Amendment to the KV Pharmaceutical Company Fourth Restated Profit Sharing Plan and Trust dated September 18, 1990, is incorporated herein by this reference. 10(k)* Employment Agreement between the Company and Marc S. Hermelin, Vice-Chairman, dated November 15, 1993, which was filed as Exhibit 10(u) to the Company's Annual Report on Form 10-K for the year ended March 31, 1994, is incorporated herein by this reference. 100 10(l)* Second Amendment dated as of June 1, 1995, to Employment Agreement between the Company and Marc S. Hermelin, which was filed as Exhibit 10(x) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996, is incorporated herein by this reference. 10(m)* Stock Option Agreement dated as of January 22, 1996, granting stock options to MAC & Co., which was filed as Exhibit 10(z) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 10(n)* Third Amendment dated as of November 22, 1995, to Employment Agreement between the Company and Marc S. Hermelin, which was filed as Exhibit 10(aa) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 10(o)* Stock Option Agreement dated as of November 22, 1995, granting a stock option to Victor M. Hermelin, which was filed as Exhibit 10(bb) to the Company's Annual Report on Form 10-K for the year ended March 31, 1996, is incorporated herein by this reference. 10(p)* Stock Option Agreement dated as of November 6, 1996, granting a stock option to Alan G. Johnson, which was filed as Exhibit 10(s) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(q)* Fourth Amendment to and Restatement, dated as of January 2, 1997, of the KV Pharmaceutical Company 1991 Incentive Stock Option Plan, which was filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 10(r)* Agreement between the Company and Marc S. Hermelin, Vice Chairman, dated December 16, 1996, with supplemental letter attached, which was filed as Exhibit 10(z) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 10(s) Amendment to Lease dated February 17, 1997, for the facility located at 2503 South Hanley Road, St. Louis, Missouri, between the Company as Lessee and Marc S. Hermelin as Lessor, which was filed as Exhibit 10(aa) to the Company's Annual Report on Form 10-K for the year ended March 31, 1997, is incorporated herein by this reference. 10(t)* Stock Option Agreement dated as of January 3, 1997, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(bb) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999, is incorporated herein by this reference. 10(u)* Stock Option Agreement dated as of May 15, 1997, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(cc) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999, is incorporated herein by this reference. 101 10(v)* Amendment, dated as of October 30, 1998, to Employment Agreement between the Company and Marc S. Hermelin, which was filed as Exhibit 10(ee) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999, is incorporated herein by this reference. 10(w) Exclusive License Agreement, dated as of April 1, 1999 between Victor M. Hermelin as licenser and the Company as licensee, which was filed as Exhibit 10(ff) to the Company's Annual Report on Form 10-K for the year ended March 31, 1999 is incorporated herein by this reference. 10(x)* Stock Option Agreement dated as of March 31, 1999, granting a stock option to Victor M. Hermelin, which was filed as Exhibit 10(aa) to the Company's Annual Report on Form 10-K for the year ended March 31, 2001, is incorporated by this reference. 10(y)* Stock Option Agreement dated as of March 31, 1999, granting a stock option to Norman D. Schellenger, which was filed as Exhibit 10(cc) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(z)* Stock Option Agreement dated as of April 1, 1999, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(gg) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated by this reference. 10(aa)* Stock Option Agreement dated as of August 16, 1999, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10 (hh) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated by this reference. 10(bb)* Stock Option Agreement dated as of October 13, 1999, granting a stock option to Alan G. Johnson, which was filed as Exhibit 10(ff) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(cc)* Stock Option Agreement dated as of October 13, 1999, granting a stock option to Alan G. Johnson, which was filed as Exhibit 10(gg) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(dd)* Stock Option Agreement dated as of October 13, 1999, granting a stock option to Alan G. Johnson, which was filed as Exhibit 10(hh) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(ee)* Stock Option Agreement dated as of October 13, 1999, granting a stock option to Alan G. Johnson, which was filed as Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(ff)* Amendment, dated December 2, 1999, to Employment Agreement between the Company and Marc S. Hermelin, Vice-Chairman, which was filed as Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated by this reference. 10(gg)* Employment Agreement between the Company and Alan G. Johnson, Senior Vice-President, Strategic Planning and Corporate Growth, dated September 27, 1999, which was filed as Exhibit 10(jj) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated by this reference. 102 10(hh)* Consulting Agreement, dated as of May 1, 1999, between the Company and Victor M. Hermelin, Chairman, which was filed as Exhibit 10(kk) to the Company's Annual Report on Form 10-K for the year ended March 31, 2000, is incorporated by this reference. 10(ii)* Stock Option Agreement dated as of June 1, 2000, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(gg) to the Company's Annual Report on Form 10-K for the year ended March 31, 2001, is incorporated by this reference. 10(jj)* Stock Option Agreement dated as of June 1, 2000, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(hh) to the Company's Annual Report on Form 10-K for the year ended March 31, 2001, is incorporated by this reference. 10(kk)* Stock Option Agreement dated as of April 9, 2001, granting a stock option to Kevin S. Carlie, which was filed as Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the year ended March 31, 2002, is incorporated herein by this reference. 10(ll)* Stock Option Agreement dated as of April 9, 2001, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(jj) to the Company's Annual Report on Form 10-K for the year ended March 31, 2002, is incorporated herein by this reference. 10(mm)* Stock Option Agreement dated as of April 9, 2001, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(kk) to the Company's Annual Report on Form 10-K for the year ended March 31, 2002, is incorporated herein by this reference. 10(nn)* Stock Option Agreement dated as of July 26, 2002, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(rr) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(oo)* Stock Option Agreement dated as of October 21, 2002, granting a stock option to John P. Isakson, which was filed as Exhibit 10(ss) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(pp) License Agreement by and between the Company and FemmePharma, Inc., dated as of April 18, 2002, which was filed as Exhibit 10(tt) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(qq) Stock Purchase Agreement by and between the Company and FemmePharma, Inc., dated as of April 18, 2002, which was filed as Exhibit 10(uu) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(rr) Product Acquisition Agreement by and between the Company and Schwarz Pharma dated as of March 31, 2003, which was filed as Exhibit 10(vv) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(ss) Product Acquisition Agreement by and between the Company and Altana Inc. dated as of March 31, 2003, which was filed as Exhibit 10(ww) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 10(tt)* Stock Option Agreement dated as of October 21, 2002, granting a stock option to John P. Isakson, which was filed as Exhibit 10(xx) to the Company's Annual Report on Form 10-K for the year ended March 31, 2003, is incorporated herein by this reference. 103 10 (uu)* Stock Option Agreement dated as of May 30, 2003, granting a stock option to Marc S. Hermelin, which was filed as Exhibit 10(yy) to the Company's Annual Report on Form 10-K for the year ended March 31, 2004, is incorporated herein by this reference. 10(vv)* Amendment, dated November 5, 2004, to Employment Agreement between the Company and Marc S. Hermelin, Vice-Chairman, which was filed as Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, is incorporated herein by this reference. 10(ww) Agreement and Plan of Merger by and among K-V Pharmaceutical Company, Kestrel-Falcon Acquisition Corporation, FP1096, Inc., and FemmePharma Holding Company, Inc., dated as of May 4, 2005, filed herewith. 21 List of Subsidiaries, filed herewith. 23.1 Consent of KPMG LLP, filed herewith. 23.2 Consent of BDO Seidman, LLP, filed herewith. 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, is filed herewith. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, is filed herewith. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. *Management contract or compensation plan. 104 EX-10.(ZZ) 2 ex10pzz.txt Exhibit 10(zz) EXECUTION COPY -------------- AGREEMENT AND PLAN OF MERGER BY AND AMONG K-V PHARMACEUTICAL COMPANY, KESTREL-FALCON ACQUISITION CORPORATION, FP1096, INC., AND FEMMEPHARMA HOLDING COMPANY, INC. DATED AS OF MAY 4, 2005 TABLE OF CONTENTS
Page ---- ARTICLE I DEFINITIONS.................................................................................................1 ARTICLE II THE MERGER................................................................................................14 2.1 THE MERGER.........................................................................................14 2.2 EFFECTIVE TIME.....................................................................................14 2.3 EFFECT OF THE MERGER...............................................................................14 2.4 ARTICLES OF INCORPORATION AND BYLAWS...............................................................14 2.5 DIRECTORS AND OFFICERS.............................................................................15 2.6 EFFECT OF MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT CORPORATIONS..............................15 2.7 DISSENTING SHARES..................................................................................17 2.8 SURRENDER OF CERTIFICATES..........................................................................17 2.9 NO FURTHER OWNERSHIP RIGHTS IN FP1096 CAPITAL STOCK................................................19 2.10 LOST, STOLEN OR DESTROYED CERTIFICATES.............................................................19 2.11 CLOSING DATE DELIVERIES OF FP1096 AND FEMMEPHARMA..................................................19 2.12 CLOSING DATE DELIVERIES OF K-V.....................................................................20 2.13 TAKING OF NECESSARY ACTION; FURTHER ACTION.........................................................21 ARTICLE III REPRESENTATIONS AND WARRANTIES OF FP1096 AND FEMMEPHARMA.................................................21 3.1 ORGANIZATION.......................................................................................21 3.2 FP1096 CAPITAL STRUCTURE...........................................................................21 3.3 SUBSIDIARIES.......................................................................................23 3.4 AUTHORITY..........................................................................................23 3.5 NO CONFLICT........................................................................................23 3.6 CONSENTS...........................................................................................23 3.7 REGULATORY MATTERS.................................................................................24 3.8 FP1096 FINANCIAL STATEMENTS........................................................................25 3.9 NO UNDISCLOSED LIABILITIES.........................................................................26 3.10 NO CHANGES.........................................................................................26 3.11 TAX MATTERS........................................................................................27 3.12 RESTRICTIONS ON BUSINESS ACTIVITIES................................................................28 3.13 TITLE TO PROPERTIES; ABSENCE OF LIENS AND ENCUMBRANCES; SUFFICIENCY OF ASSETS......................29 3.14 INTELLECTUAL PROPERTY..............................................................................30 3.15 AGREEMENTS, CONTRACTS AND COMMITMENTS..............................................................32 3.16 INTERESTED PARTY TRANSACTIONS......................................................................32 3.17 GOVERNMENTAL AUTHORIZATION.........................................................................32 3.18 LITIGATION.........................................................................................32 3.19 MINUTE BOOKS.......................................................................................33 3.20 ENVIRONMENTAL MATTERS..............................................................................33 3.21 BROKERS' AND FINDERS' FEES.........................................................................34 3.22 EMPLOYEE BENEFIT PLANS AND COMPENSATION............................................................34 3.23 INSURANCE..........................................................................................35 -i- TABLE OF CONTENTS (CONTINUED) PAGE ---- 3.24 COMPLIANCE WITH LAWS...............................................................................36 3.25 WARRANTIES; INDEMNITIES............................................................................36 3.26 COPIES OF MATERIALS................................................................................36 3.27 FULL DISCLOSURE....................................................................................36 3.28 INFORMATION STATEMENT..............................................................................36 3.29 OWNERSHIP OF FP1096 CAPITAL STOCK..................................................................37 3.30 ABSENCE OF CLAIMS BY THE SHAREHOLDERS..............................................................37 ARTICLE IV REPRESENTATIONS AND WARRANTIES OF K-V AND K-V SUB.........................................................37 4.1 ORGANIZATION, STANDING AND POWER...................................................................37 4.2 AUTHORITY..........................................................................................37 4.3 CONSENTS...........................................................................................38 4.4 CAPITAL RESOURCES..................................................................................38 4.5 BROKER'S AND FINDERS' FEES.........................................................................38 4.6 NO CONFLICTS.......................................................................................38 4.7 INTERIM OPERATIONS OF K-V SUB......................................................................38 ARTICLE V ADDITIONAL AGREEMENTS......................................................................................38 5.1 CONFIDENTIALITY....................................................................................38 5.2 EXPENSES...........................................................................................40 5.3 FIRPTA COMPLIANCE..................................................................................40 5.4 ADDITIONAL DOCUMENTS AND FURTHER ASSURANCES........................................................40 5.5 RETAINED EMPLOYMENT LIABILITIES....................................................................40 5.6 ADDITIONAL INFORMATION.............................................................................41 5.7 NON-COMMERCIALIZATION..............................................................................41 5.8 TAX MATTERS........................................................................................41 ARTICLE VI CONDITIONS TO THE MERGER..................................................................................43 6.1 CONDITIONS TO OBLIGATIONS OF EACH PARTY TO EFFECT THE MERGER.......................................43 6.2 CONDITIONS TO THE OBLIGATIONS OF K-V AND K-V SUB...................................................43 6.3 CONDITIONS TO OBLIGATIONS OF FP1096, FEMMEPHARMA AND THE SHAREHOLDERS..............................46 ARTICLE VII SURVIVAL; INDEMNIFICATION................................................................................47 7.1 SURVIVAL OF REPRESENTATIONS AND WARRANTIES.........................................................47 7.2 INDEMNIFICATION....................................................................................48 7.3 PROCEDURE..........................................................................................49 7.4 LIMITATION ON INDEMNIFICATION; ESCROW..............................................................50 7.5 EXCLUSIVE REMEDY...................................................................................52 7.6 ESCROW AND ESCROW RELEASE AMOUNT...................................................................52 7.7 SELLER REPRESENTATIVE..............................................................................52 ARTICLE VIII GENERAL PROVISIONS......................................................................................53 8.1 TERMINATION........................................................................................53 8.2 EFFECT OF TERMINATION..............................................................................53 8.3 NOTICES............................................................................................53 -ii- TABLE OF CONTENTS (CONTINUED) PAGE ---- 8.4 INTERPRETATION.....................................................................................54 8.5 COUNTERPARTS.......................................................................................55 8.6 AMENDMENT..........................................................................................55 8.7 ENTIRE AGREEMENT; ASSIGNMENT.......................................................................55 8.8 SEVERABILITY.......................................................................................55 8.9 OTHER REMEDIES.....................................................................................55 8.10 GOVERNING LAW; VENUE...............................................................................55 8.11 RULES OF CONSTRUCTION..............................................................................56 8.12 WAIVER OF JURY TRIAL...............................................................................56
-iii- INDEX OF EXHIBITS EXHIBIT DESCRIPTION - ------- ----------- Exhibit A Asset Contribution Agreement Exhibit B Form of Escrow Agreement Exhibit C Form of License Agreement Exhibit D Form of Release Agreement Exhibit E Retained Contracts Exhibit F List of Shareholders Exhibit G Form of Transition Agreement Exhibit H1 Form of Merger Certificate Exhibit H2 Form of Certificate of Merger of Domestic Corporation into Foreign Corporation Exhibit I Letter of Transmittal Exhibit J Closing Instructions Exhibit K Form(s) of Proprietary Information, Confidentiality and Assignment Agreement SCHEDULES - --------- THIS AGREEMENT AND PLAN OF MERGER (this "Agreement") is made and --------- entered into as of May 4, 2005 by and among K-V Pharmaceutical Company, a Delaware corporation ("K-V"), Kestrel-Falcon Acquisition Corporation, a --- Delaware corporation and a wholly-owned subsidiary of K-V Pharmaceutical ("K-V Sub"), FP1096, Inc., a Pennsylvania corporation ("FP1096"), and ------- ------ FemmePharma Holding Company, Inc., a Delaware corporation and a wholly-owned subsidiary of FP1096 ("FemmePharma"). ----------- RECITALS A. K-V and FP1096 believe it is in the best interests of each company and its respective shareholders that K-V acquire FP1096 through the statutory merger of K-V Sub with and into FP1096 (the "Merger"). ------ B. Immediately prior to the Merger, FP1096 will have executed and delivered the Asset Contribution Agreement (as defined in Article I) and the License Agreement (as defined in Article I) as a condition to K-V to consummate the transactions pursuant to this Agreement. C. Immediately prior to the Merger, FP1096 will have consummated the Spin Off (as defined in Article I) as a condition to FP1096 to consummate the transactions pursuant to this Agreement. Therefore, in consideration of the premises and mutual covenants and conditions set forth herein and intending to be legally bound, the parties hereto hereby agree as follows: ARTICLE I DEFINITIONS ----------- The terms defined in this Article I, whenever used in this Agreement, including without limitation in the exhibits and schedules hereto and the disclosure letters delivered in connection herewith, unless otherwise specified, shall have the following meanings: "Accounts Receivable" means, in the ordinary course of business: ------------------- (i) all trade accounts receivable and other rights to payment from customers of FP1096 and the full benefit of all security for such accounts or rights to payment, (ii) all other accounts or notes receivable of FP1096, and the full benefit of all security for such accounts or notes, and (iii) any claim, remedy or other right related to any of the foregoing. "Affiliate" means with respect to any Person, any other Person that --------- directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such first Person. The term "control" of such first Person (including the terms "controlling," "controlled by" and "under common control with" such first Person) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such first Person, whether through the ownership of voting securities, by contract, or otherwise. "Agreement" has the meaning given to it in the first paragraph of --------- this Agreement. "Anti-infective Product" means any local regional, topical or ---------------------- intravaginally administered product that is delivered to the pelvic region used for the treatment of candidiasis, bacterial vaginosis or trichomoniasis, whether such conditions are described by such terms or any other terminology. "Appraisal" has the meaning given to it in Section 6.2(u) of this --------- Agreement. "Asset Contribution Agreement" means the Asset Contribution ---------------------------- Agreement dated as of the date hereof by and between FP1096 and FemmePharma in substantially the form of EXHIBIT A. "Audit" has the meaning given to it in Section 5.8(c). ----- "Balance Sheet Date" has the meaning given to it in Section 3.8(a). ------------------ "Books and Records" of any Person means all files, documents, ----------------- correspondence, instruments, papers, books and records relating to the business, operations, condition, financial or other results of operations, and assets of such Person, including without limitation, financial statements and information; employment and personnel records, including employee medical surveillance records; tax returns; budgets, business plans, projections, prospects, opportunities and strategies; reliability and cost data; pricing lists, formulas and guidelines; ledgers, journals, deeds, title policies, minute books, stock certificates and books, stock transfer ledgers and legal matters; customer lists; advertising and promotions; computer files and programs; retrieval programs; operating data and plans; environmental studies and plans; and all employee rosters and other employee related documents and copies of all personnel records required by Law to be retained. "Business Day" means each day that is not a Saturday, Sunday or ------------ holiday on which banking institutions located in New York, New York are authorized or obligated by Law to close. "Business Facility" means any real property that is or at any time ----------------- has been owned, operated, occupied, controlled or leased by either FP1096 or FemmePharma in connection with the operation of its business. "Cap" has the meaning given to it in Section 7.4. --- "Charter Documents" has the meaning given to it in Section 3.1. ----------------- "Claim" has the meaning given to it in Section 7.3(b). ----- "Claim Notice" has the meaning given to it in Section 7.3(b). ------------ "Clinical Trials" means, with respect to a product, any and all --------------- animal, non-human, and non-clinical trials and human clinical trials performed by or under authority of FP1096 or its Affiliate prior to the Closing Date, and the foreign equivalents of such trials, performed prior to or following the filing of a Marketing Authorization Application for purposes of obtaining approval therefore, including phase I, phase II and phase III clinical trials in the United States as -2- defined under the FFDCA and their foreign equivalents, and any clinical studies performed after such approval is obtained. "Closing" has the meaning given to it in Section 2.2. ------- "Closing Date" has the meaning given to it in Section 2.2. ------------ "Closing Instructions" has the meaning given to it in Section -------------------- 2.8(g). "Closing Payments" has the meaning given to it in Section 2.8(g). ---------------- "COBRA" means the Consolidated Omnibus Budget Reconciliation Act of ----- 1985, as amended. "Code" means the Internal Revenue Code of 1986, as amended. ---- "Confidential Information" has the meaning given to it in Section ------------------------ 5.1(c). "Conflict" has the meaning given to it in Section 3.5. -------- "Consideration Per Share" means $6.0990 per share, subject to the ----------------------- last paragraph of Section 2.6(a). "Contract" means any agreement, joint venture agreement, -------- partnership agreement, assignment, lease, sublease or other occupancy agreement, license, sublicense, settlement agreement, consent decree, stipulation, promissory note, evidence of indebtedness, loan agreement, credit agreement or document, indenture, security agreement, insurance policy, purchase order, or other contract, arrangement, understanding or conduct giving rise to any binding commitment, whether written or oral, including any amendments, supplements or modifications thereto. "Copyrights" has the meaning given to it in the definition of ---------- Intellectual Property Rights. "Current Balance Sheet" has the meaning given to it in Section --------------------- 3.8(a). "Damage" means any loss, damage, deficiency, cost, expense or other ------ Liability, including attorneys' fees and expenses of investigation and defense and all other amounts paid in investigation, defense or settlement of any of the foregoing, in each case whether or not arising out of third-party claims. Damage shall not include a reduction in amount or limitation on the use of FP1096's net operating loss carryforward to offset income attributable to any taxable period (or portion thereof) beginning after the Closing Date. "Danazol" has the meaning given to it in The Merck Index, 13th ------- Edition (2001). "Danazol Product" has the meaning given to it under the definition --------------- of K-V Product. "Data" means, with respect to a K-V Product developed by or on ---- behalf of FP1096, all data, analyses, opinions, results, reports, clinical Development tests and results, and other information, in FP1096's possession or control and generated or used in or for or material to the -3- Development of a K-V Product developed by or on behalf of FP1096, including such data and information with respect to a K-V Product developed by or on behalf of FP1096 that relates to: (i) any screening, optimization, and in vitro and in vivo testing and studies, (ii) the pharmacological properties, including pharmacokinetic, toxicological and metabolic properties or composition of the K-V Product or any of its components, (iii) protocols and methods for Development, and protocol and process changes and amendments, (iv) safety data and information, adverse effects, adverse reactions and events, clinical databases, case report forms, and patient records, and (v) all other data and information included in any Marketing Authorization Application, other Regulatory Documentation, or otherwise provided or made available to, or received from, any Regulatory Authority, or developed or obtained in order to meet the requirements of any applicable Laws or to seek Regulatory Approval with respect to a K-V Product as developed by or on behalf of FP1096. "Development," and with correlative meaning "Develop," means, with ----------- ------- respect to a product, all formulation development, process development, stability studies, Manufacturing development, production of clinical product batches, validation studies, qualification, quality assurance/quality control testing, regulatory affairs (including meetings with and other communications to and from Regulatory Authorities), and other development and preparation for the Manufacture, supply and commercialization of or for the product in any and all countries, including all activities for pre-clinical testing and studies, the evaluation of toxicological, pharmacological, metabolic or other clinical aspects of the product, Clinical Trials and activities otherwise related to the submission of Marketing Authorization Applications and seeking Regulatory Approvals. "Dissenting Share Payments" has the meaning given to it in Section ------------------------- 2.7(c). "Dissenting Shares" has the meaning given to it in Section 2.7(a). ----------------- "DOL" means the United States Department of Labor. --- "Effective Time" has the meaning given to it in Section 2.2. -------------- "Employee" means any current or former employee, consultant or -------- director of FP1096 or any ERISA Affiliate. "Employee Agreement" means each management, employment, severance, ------------------ consulting, relocation, repatriation, expatriation, visa, work permit or other agreement, or contract (including, without limitation, any offer letter or any agreement providing for acceleration of FP1096 Options, or any other agreement providing for compensation or benefits) between FP1096 or any ERISA Affiliate and any Employee. "Employment Liabilities" means any and all claims, debts, ---------------------- commitments, obligations or other Liabilities whether fixed, contingent or absolute, matured or unmatured, liquidated or unliquidated, accrued or unaccrued, known or unknown, whenever or however arising, including all costs and expenses relating thereto, and including those debts, obligations and other Liabilities arising under Law, rule, regulation, permits, actions or proceedings before any Governmental Entity, order or consent decree or any award of any arbitrator of any kind relating to any FP1096 Employee Plan, International Employee Plan, or otherwise to an Employee. -4- "Environmental Laws" means all applicable rules, regulations, ------------------ orders, treaties, statutes, and codes and other Laws promulgated by any Governmental Entity which prohibit, regulate or control any Hazardous Material or any Hazardous Material Activity, including, without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, the Resource Recovery and Conservation Act of 1976, the Federal Water Pollution Control Act, the Clean Air Act, the Hazardous Materials Transportation Act, the Occupational Safety and Health Act, the Clean Water Act, comparable laws, rules, regulations, ordinances, orders, treaties, statutes, and codes of other Governmental Entities, the regulations promulgated to any of the foregoing, and all amendments and modifications of any of the foregoing. "Environmental Permit" means any approval, permit, license, -------------------- clearance or consent required to be obtained from any private person or any Governmental Entity with respect to a Hazardous Materials Activity which is or was conducted by FP1096 or FemmePharma. "ERISA" means the Employee Retirement Income Security Act of 1974, ----- as amended. "ERISA Affiliate" means any other Person that is or has been under --------------- common control with FP1096 or a subsidiary of FP1096 within the meaning of Section 414(b), (c), (m) or (o) of the Code, and the regulations issued thereunder. "Escrow Agent" means U.S. Bank National Association. ------------ "Escrow Agreement" means the Escrow Agreement by and among K-V, ---------------- FP1096, FemmePharma, the Seller Representative and the Escrow Agent in substantially the form attached hereto as EXHIBIT B. "Escrow Amount" means $1,750,000 and any interest thereon received ------------- by the Escrow Agent from time to time following the investment thereof. "Escrow Amount Per Share" means $0.4339 per share, being the ----------------------- quotient obtained by dividing (i) $1,750,000 by (ii) the Total Outstanding Shares, less the Excluded Shares, measured on an as-converted to FP1096 Common Stock basis as of the Effective Time. "Escrow Fund" means the Escrow Amount deposited by K-V with the ----------- Escrow Agent under the terms of this Agreement and the Escrow Agreement, which shall be subject to increase and decrease over time, as provided under the Escrow Agreement. "Excluded Shares" means the 87,412.5 shares of FP1096 Series C --------------- Preferred Stock held by K-V as of the date hereof, as the same may be adjusted for stock splits, stock dividends, stock combinations and the like, or as converted into FP1096 Common Stock. "Final Return" has the meaning given to it in Section 5.8(a). ------------ "FP1096" has the meaning given to it in the first paragraph of this ------ Agreement. "FP1096 Authorizations" has the meaning given to it in Section --------------------- 3.17. -5- "FP1096 Business" means (i) the K-V Products developed by or on --------------- behalf of FP1096, (ii) all Development, Clinical Trials, Manufacture, marketing, distribution, sale, use and other commercialization and exploitation of the K-V Products developed by or on behalf of FP1096, and (iii) all Data and Regulatory Documentation for the K-V Products developed by or on behalf of FP1096; each in any and all countries and only to the extent conducted by or on behalf of FP1096 and any of its Affiliates prior to the Closing. "FP1096 Capital Stock" means FP1096 Common Stock, FP1096 Preferred -------------------- Stock and any other shares of capital stock, if any, of FP1096, taken together. "FP1096 Closing Balance Sheet" has the meaning given to it in ---------------------------- Section 3.9. "FP1096 Common Shareholder" means a holder of FP1096 Common Stock, ------------------------- each of whom is listed on Section 3.2(a)(1) of the FP1096 Disclosure Letter. "FP1096 Common Stock" means shares of common stock, no par value, ------------------- of FP1096. "FP1096 Disclosure Letter" means the letter entitled FP1096 ------------------------ Disclosure Letter to be delivered by FP1096 and FemmePharma to K-V concurrently with the execution and delivery of this Agreement, addressing certain matters specifically called for by this Agreement. "FP1096 Employee Plan" means any plan, program, policy, practice, -------------------- contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation, retirement benefits, performance awards, stock or stock-related awards, including the Plans, fringe benefits or other employee benefits or remuneration of any kind, whether written, unwritten or otherwise, funded or unfunded, including without limitation, each "employee benefit plan," within the meaning of Section 3(3) of ERISA which is or has been maintained, contributed to, or required to be contributed to, by FP1096 or any ERISA Affiliate for the benefit of any Employee, or with respect to which FP1096 or any ERISA Affiliate has or may have any liability or obligation. "FP1096 Financial Statements" has the meaning given to it in --------------------------- Section 3.8(a). "FP1096 Options" means all issued and outstanding options, -------------- including commitments to grant options, to purchase or otherwise acquire FP1096 Capital Stock, whether or not vested, held by any Person, each of which FP1096 Options and the Persons in whose name the same are recorded are listed on Section 3.2(b) of the FP1096 Disclosure Letter. "FP1096 Preferred Shareholder" means a holder of FP1096 Preferred ---------------------------- Stock, each of whom is listed on Section 3.2(a)(1) of the FP1096 Disclosure Letter. "FP1096 Preferred Stock" means FP1096 Series A Preferred Stock, ---------------------- FP1096 Series B Preferred Stock, FP1096 Series C Preferred Stock and FP1096 Series D Preferred Stock, taken together. "FP1096 Series A Preferred Shareholder" means a holder of FP1096 ------------------------------------- Series A Preferred Stock, each of whom is listed in the FP1096 Disclosure Letter. -6- "FP1096 Series A Preferred Stock" means the Series A Preferred ------------------------------- Stock, no par value, of FP1096. "FP1096 Series B Preferred Shareholder" means a holder of FP1096 ------------------------------------- Series B Preferred Stock, each of whom is listed in the FP1096 Disclosure Letter. "FP1096 Series B Preferred Stock" means the Series B Preferred ------------------------------- Stock, no par value, of FP1096. "FP1096 Series C Preferred Shareholder" means a holder of FP1096 ------------------------------------- Series C Preferred Stock, each of whom is listed in the FP1096 Disclosure Letter. "FP1096 Series C Preferred Stock" means the Series C Preferred ------------------------------- Stock, no par value, of FP1096. "FP1096 Series D Preferred Shareholder" means a holder of FP1096 ------------------------------------- Series D Preferred Stock, each of whom is listed in the FP1096 Disclosure Letter. "FP1096 Series D Preferred Stock" means the Series D Preferred ------------------------------- Stock, no par value, of FP1096. "FP1096 Stock Certificates" has the meaning given to it in Section ------------------------- 2.8(c). "FP1096 Warrants" means all issued and outstanding warrants or --------------- other rights, including commitments to grant warrants or other rights, but excluding FP1096 Options, to purchase or otherwise acquire FP1096 Capital Stock, whether or not vested, held by any Person, each of which FP1096 Warrants and the Persons in whose name the same are recorded are listed on Section 3.2(b) of the FP1096 Disclosure Letter. "FemmePharma" has the meaning given to it in the first paragraph of ----------- this Agreement. "FemmePharma Affiliate" means, with respect to FemmePharma, any --------------------- other entity that, directly or indirectly, controls, or is controlled by, or is under common control with, FemmePharma. The term "control" (including the terms "controlling," "controlled by" and "under common control with") means the possession of the power to direct or cause the direction of the management and policies of such entity. "FemmePharma Technology" has the meaning given to it in the License ---------------------- Agreement. "FDA" means the United States Food and Drug Administration and any --- successor agency or authority thereto. "FFDCA" means the United States Federal Food, Drug and Cosmetic Act ----- and rules and regulations thereunder and any successor thereto. "FICA" has the meaning given to it in Section 3.11(a)(ii). ---- "FIRPTA Compliance Certificate" has the meaning given to it in ------ Section 5.3. -7- "FUTA" has the meaning given to it in Section 3.11(a)(ii). ---- "GAAP" means United States generally accepted accounting principles ---- consistently applied. "Governmental Entity" means any court, administrative agency or ------------------- commission or other federal, state, county, local, foreign or other governmental authority, instrumentality, agency or commission. "Hazardous Material" means any material, chemical, substance or ------------------ waste that has been designated by any Governmental Entity to be radioactive, toxic, hazardous or otherwise a danger to health, reproduction or the environment or the disposal, treatment, transfer, storage or manufacture of which is regulated in any manner by a Governmental Entity. "Hazardous Materials Activity" means the transportation, transfer, ---------------------------- recycling, storage, use, treatment, manufacture, removal, remediation, release or threat of release, exposure of others to, sale, or distribution of any Hazardous Material or any product containing a Hazardous Material. "IND" means an Investigational New Drug submission under the FFDCA. --- "Indemnified Party" has the meaning given to it in Section 7.2(b). ----------------- "Indemnifying Party" has the meaning given to it in Section 7.2(b). ------------------ "Initial Danazol Product" means the intravaginally administered ----------------------- Danazol product that has been Developed by or on behalf of FP1096, including but not limited to as described in IND 51,223 (and any amendments thereto) as filed with the FDA prior to the Closing Date. "Intellectual Property Rights" means any and all of the following ---------------------------- and all statutory and common law rights throughout the world in, arising out of, or associated therewith: (i) patents and patent applications in the world, including but not limited to any and all equivalents, provisional applications, non-provisional applications, continuations, continuations-in-part, divisionals, reissues, reexaminations, substitutions, international applications, national phase applications, regional phase applications, registrations, confirmations, renewals, petty patent applications, and utility model applications, that may be filed in the United States and every foreign country, and the patents, extensions (including, without limitation, patent term extensions and supplementary protection certificates), counterparts or derivations thereof, both foreign and domestic (collectively, "Patents"), (ii) all inventions (whether ------- patentable or not), invention disclosures, improvements, data, all trade secrets, confidential information, proprietary information, know how and technology (collectively, "Trade Secrets"), (iii) all copyrights, copyright ------------- registrations and applications, including moral rights, and all other grants for the protection of industrial designs and any registrations and applications therefor (collectively, "Copyrights"), and (iv) any similar, ---------- corresponding or equivalent rights to any of the foregoing or other intellectual property or proprietary rights anywhere in the world. "International Employee Plan" means each FP1096 Employee Plan or --------------------------- Employee Agreement that has been adopted or maintained by FP1096 or any ERISA Affiliate, whether -8- formally or informally or with respect to which FP1096 or any ERISA Affiliate will or may have any liability with respect to Employees who perform services outside the United States. "IRS" means the United States Internal Revenue Service. --- "K-V" has the meaning given to it in the first paragraph of this --- Agreement. "K-V Material Adverse Effect" has the meaning given to it in --------------------------- Section 4.1. "K-V Product" means any: (i) local regional or intravaginally ----------- administered product containing Danazol, or any analogue, salt, ester, prodrug, isomer, derivative or metabolite of Danazol, that is delivered directly to the vagina, cervix, uterus, ovaries or fallopian tubes (a "Danazol Product"), including, without limitation, the Initial Danazol --------------- Product, or (ii) Anti-infective Product. "K-V Sub" has the meaning given to it in the first paragraph of ------- this Agreement. "Knowledge," "Know" or "Known" means, with respect to FP1096, --------- ---- ----- FemmePharma, the Shareholders and/or their Affiliates, the actual knowledge (after review of this Agreement and the Schedules hereto) of Gerianne M. DiPiano, Michael A. DiPiano, Jr., Peter Mays and Jessica Donahue. "Law" means all laws, statutes, ordinances, regulations and other --- pronouncements having the effect of law of the United States, or any other country or territory, or domestic or foreign state, prefecture, province, commonwealth, city, county, municipality, territory, protectorate, possession, court, tribunal, agency, government, department, commission, arbitrator, board, bureau or instrumentality thereof. "Lease Agreements" has the meaning given to it in Section 3.13(a). ---------------- "Leased Real Property" has the meaning given to it in Section -------------------- 3.13(b). "Letter of Transmittal" has the meaning given to it in Section --------------------- 2.8(c). "Liability" means any liability, obligation, responsibility, --------- indebtedness, expense, claim, deficiency, Lien, or guaranty of any type, whether known or unknown, whether asserted or unasserted, whether absolute or contingent, whether accrued or unaccrued, whether liquidated or unliquidated, whether incurred or consequential, whether matured or unmatured, whether due or to become due and whether or not required to be reflected in financial statements prepared in accordance with GAAP, including any liability for Taxes. "License Agreement" means the License Agreement by and between ----------------- FemmePharma and FP1096 in substantially the form attached hereto as EXHIBIT C. "Lien" means any mortgage, pledge, lien, statutory or other, ---- security interest, charge, claim, encumbrance, restriction on transfer, restriction on conveyance, assignment, license, exclusivity, right of refusal, right of offer, conditional sale, obligation to assign, or other title retention device or arrangement, including, without limitation, a capital lease, of any kind or any -9- nature whatsoever, or restriction on the creation of any of the foregoing, whether relating to any property or right or the income or profits therefrom. "Manufacture," and with correlative meaning "Manufacturing," means, ----------- ------------- with respect to a product, making the product and related activities, including synthesis, formulation, filling, processing, testing, finishing, packaging, labeling, storing, warehousing, quality control, quality assurance, releasing, handling, shipping and all other activities undertaken or required to be undertaken in order to manufacture and supply the product. "Marketing Authorization Application" means, with respect to a ----------------------------------- product and any jurisdiction, a pre-marketing application (including and comparable to an IND) and a marketing authorization application (including and comparable to an NDA in the United States), including all supporting documentation and data submitted for such application to be accepted for review or approval, filed with the requisite Regulatory Authority of such jurisdiction, and requesting approval for marketing and/or commercialization of the product, including, if applicable, approval of pricing or reimbursement. "Merger" has the meaning given to it in the Recital A at the ------ beginning of this Agreement. "Merger Certificate" has the meaning given to it in Section 2.2. ------------------ "Merger Consideration" means an amount equal to $25,000,000. -------------------- "Multiemployer Plan" means any Pension Plan which is a ------------------ "multiemployer plan," as defined in Section 3(37) of ERISA. "NDA" means a New Drug Application filed with the FDA seeking --- permission to market the applicable product in interstate commerce in the United States which meets the requirements of the FFDCA. "Non-Commercialization Period" means, on a country by country ---------------------------- basis, the period commencing on the Closing Date and terminating on the later to occur of (x) or (y), where: (x) is the date that is ten (10) years after the Regulatory Approval has been obtained in the country that is necessary to market, sell, and commercialize the first K-V Product in such country (including, if applicable, approval of pricing and reimbursement), and (y) is the first to occur of (i) the date of the last expiration or invalidation of all of the Patent Rights in the particular country or (ii) the date when K-V (or its sublicensees or assignees) ceases development or commercialization of any K-V Product in such country. "Order" means any ruling, judgment, order, decree or ordinance of a ----- Governmental Entity. "Patent Rights" has the meaning given to it in the License ------------- Agreement. "Patents" has the meaning given to it in the definition of ------- Intellectual Property Rights. "PBGC" means the United States Pension Benefit Guaranty ---- Corporation. -10- "PCB" means Polychlorinated Biphenyls as defined in 40 CFR 761.3, --- (Polychlorinated Biphenyls (PCBs) Manufacturing, Processing, Distribution in Commerce and Use Prohibitions). "Pennsylvania Law" means the Corporations Code of the Consolidated ---------------- Statutes of the Commonwealth of Pennsylvania. "Pension Plan" means each FP1096 Employee Plan that is an "employee ------------ pension benefit plan," within the meaning of Section 3(2) of ERISA. "Permitted Liens" means such of the following as to which no --------------- enforcement, collection, execution, levy or foreclosure proceeding has been commenced: (i) Liens for Taxes, assessments and governmental charges or levies not yet due and payable, (ii) Liens imposed by Law, such as materialmen's, mechanics', carriers', workmen's and repairmen's liens and other similar Liens arising in the ordinary course of business securing obligations that: (A) are not overdue for a period of more than 30 days and (B) are not in excess of $5,000 in the case of a single property or $10,000 in the aggregate at any time, and (iii) pledges or deposits to secure obligations under workers' compensation laws or to secure public or statutory obligations. "Person" means an individual, a partnership, whether general or ------ limited, a corporation, a limited liability company, a business trust, an association, a joint stock company, a trust, a joint venture, an unincorporated organization or other business enterprise or entity, or a Governmental Entity, or any department, agency or political subdivision thereof. The term "Person" as used solely for purposes of the definition of an "Affiliate" of such Person includes, in addition to such Person, all of the following Persons: (i) any relative or spouse of such Person, or any relative of such spouse, any one of whom has the same home as such Person; (ii) any trust or estate in which such Person or any of the Persons specified in clause (i) collectively own ten percent or more of the total beneficial interest or of which any of such Persons serve as trustee, executor or in any similar capacity; and (iii) any corporation or other organization (other than FP1096 or FemmePharma) in which such Person or any of the Persons specified in clause (i) are the beneficial owners collectively of ten percent or more of any class of equity securities or ten percent or more of the equity interest. "Plans" means FP1096's 2002 Stock Option Plan. ----- "Proceeding" has the meaning given to it in Section 8.10. ---------- "Proprietary Information Agreements" has the meaning given to it in ---------------------------------- Section 3.14(h). "PTO" means the United States Patent and Trademark Office. --- "Purchaser Indemnified Parties" has the meaning given to it in ----------------------------- Section 7.2(a). "Purchaser Indemnifying Party" has the meaning given to it in ---------------------------- Section 7.2(a). "Regulatory Approval" means, with respect to a particular ------------------- pharmaceutical product and jurisdiction, all approvals and authorizations by the applicable Regulatory Authorities in such jurisdiction which are required for the Development, Manufacture, use, import, export, -11- marketing, promotion, pricing, offer for sale, sale and distribution of the product in such jurisdiction, including by way of example, approval by the FDA of an NDA. "Regulatory Authority" means, in respect of a jurisdiction, any -------------------- agency, department, bureau or other Governmental Entity with authority over the Development, Manufacture, use, marketing or sale (including approval of NDAs and other Marketing Authorization Applications) with respect to any product in the jurisdiction, including the FDA. "Regulatory Documentation" means, with respect to a pharmaceutical ------------------------ product, all filings submitted to, or written communications to or received from any and all Regulatory Authorities relating to the product, and all supporting documents, including any INDs (or any equivalent submissions in other countries), Marketing Authorization Applications (including NDAs), drug master files, investigator's brochures, correspondence to and from Regulatory Authorities, notes, memoranda and minutes from teleconferences and meetings with Regulatory Authorities, registrations and licenses, regulatory drug lists, advertising and promotion documents submitted to Regulatory Authorities, product labeling, adverse event files, complaint files, patient consent forms and Manufacturing records. "Related Agreements" means the Asset Contribution Agreement (and ------------------ ancillary agreements expressly referenced therein), the Escrow Agreement, the Release Agreement, the Transition Agreement and the Merger Certificates. "Release Agreement" means the Release Agreement by and among K-V, ----------------- FP1096, FemmePharma and Kestrel-Falcon Acquisition Corporation, in substantially the form attached hereto as EXHIBIT D. "Requisite Shareholder Vote" has the meaning given to it in Section -------------------------- 3.4. "Retained Assets" has the meaning given to it in the Asset --------------- Contribution Agreement. "Retained Contracts" means the Contracts listed on EXHIBIT E. ------------------ "Retained Employment Liabilities" has the meaning given to it in ------------------------------- Section 5.5. "Returns" has the meaning given to it in Section 3.11(a)(i). ------- "SEC" means the United States Securities and Exchange Commission. --- "Seller Indemnified Party" has the meaning given to it in Section ------------------------ 7.2(b). "Seller Indemnifying Party" has the meaning given to it in Section ------------------------- 7.2(b). "Seller Representative" has the meaning given to it in the Escrow --------------------- Agreement. "Shareholder" means each holder of FP1096 Capital Stock, FP1096 ----------- Options and FP1096 Warrants immediately prior to the Effective Time, excluding K-V, which Shareholders are listed on EXHIBIT F. -12- "Spin Off" means the distribution by FP1096 to all of its -------- Shareholders other than K-V of all of the issued and outstanding capital stock of FemmePharma prior to the consummation of the Merger. "Surviving Corporation" has the meaning given to it in Section 2.1. --------------------- "Tax" or, collectively, "Taxes" means: (i) any and all federal, --- ----- state, local and foreign taxes, assessments and other governmental charges, duties, impositions and Liabilities, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, value added, ad valorem, transfer, franchise, withholding, payroll, recapture, employment, excise and property taxes, as well as public imposts, fees and social security charges (including but not limited to health, unemployment and pension insurance), together with all interest, penalties and additions imposed with respect to such amounts, (ii) any liability for the payment of any amounts of the type described in clause (i) of this definition as a result of being a member of an affiliated, consolidated, combined or unitary group for any period, and (iii) any liability for the payment of any amounts of the type described in clause (i) or (ii) of this definition as a result of any express or implied obligation to indemnify any other Person or as a result of any obligation under any agreement or arrangement with any other Person with respect to such amounts and including any liability for taxes of a predecessor entity. "Technology" means public and nonpublic technical or other ---------- information, Trade Secrets, know-how, research, processes, formulations, concepts, ideas, preclinical, clinical, pharmacological or other Data and testing results, all experimental or test methods, laboratory notebooks, results, assays, descriptions, all scientific plans, depictions, inventions, processes, Manufacturing methods, physical and analytical safety, testing and quality control data and results, customer lists, marketing information, sales information, and any other written, printed or electronically stored information and materials and any and all other technology, of any nature whatsoever. "Third Party Consents" has the meaning given to it in Section -------------------- 6.2(b). "Third Party Expenses" has the meaning given to it in Section 5.2. -------------------- "Threshold" has the meaning given to it in Section 7.4. --------- "Total Outstanding Shares" means the FP1096 Capital Stock issued ------------------------ and outstanding immediately prior to the Effective Time, including all FP1096 Options and FP1096 Warrants on an as-exercised basis. "Trade Secrets" has the meaning given to it in the definition of ------------- Intellectual Property Rights. "Transferred Assets" has the meaning given to it in the Asset ------------------ Contribution Agreement. "Transferred Liabilities" has the meaning given to it in the Asset ----------------------- Contribution Agreement. -13- "Transition Agreement" means the Transition Agreement by and among -------------------- K-V, FP1096 and Surviving Corporation, in substantially the form attached hereto as EXHIBIT G. ARTICLE II THE MERGER 2.1 THE MERGER. At the Effective Time and subject to and upon the terms and conditions of this Agreement and the applicable provisions of Pennsylvania Law, K-V Sub shall be merged with and into FP1096, the separate corporate existence of K-V Sub shall cease, and FP1096 shall continue as the surviving corporation and as a wholly-owned subsidiary of K-V. The surviving corporation after the Merger is sometimes referred to herein as the "Surviving Corporation." --------------------- 2.2 EFFECTIVE TIME. The closing of the Merger (the "Closing") will ------- take place at 2:00 p.m., New York City time, at the offices of Wilson Sonsini Goodrich & Rosati, Professional Corporation, 12 East 49th Street, 30th Floor, New York, New York, on the later of April 29, 2005 and the first Business Day following the fulfillment of the conditions set forth in Sections 6.2(x), 6.2(b), and 6.3(e), or at such other time or place or on such other date as may be agreed upon in writing by the parties hereto. The date upon which the Closing actually occurs shall be referred to herein as the "Closing Date." On the Closing Date, the parties hereto shall cause the ------------ Merger to be consummated by (i) filing the Articles of Merger in substantially the form attached hereto as EXHIBIT H1 (the "Merger ------ Certificate") or like instrument with the Secretary of the Commonwealth of - ----------- Pennsylvania, in accordance with the relevant provisions of Pennsylvania Law and (ii) filing the Certificate of Merger of Domestic Corporation into Foreign Corporation, in substantially the form attached hereto as EXHIBIT H2 (the "Delaware Certificate of Merger") or like instrument with the Secretary ------------------------------ of the State of Delaware, in accordance with the relevant provisions of the Delaware General Corporation Law (the time of acceptance by the Secretary of the Commonwealth of Pennsylvania of the filing of the Merger Certificate, or such later time and date as may be mutually agreed and set forth in the Merger Certificate, being referred to herein as the "Effective Time"). -------------- 2.3 EFFECT OF THE MERGER. At the Effective Time, the effect of the Merger shall be as provided in the applicable provisions of Pennsylvania Law. 2.4 ARTICLES OF INCORPORATION AND BYLAWS. (a) The articles of incorporation of the Surviving Corporation, as in effect immediately prior to the Effective Time, shall be amended and restated in their entirety to be identical to the articles of incorporation of K-V Sub, as in effect immediately prior to the Effective Time, with such amendments as may be required in accordance with Pennsylvania Law, until thereafter amended in accordance with Pennsylvania Law and as provided in such articles of incorporation. (b) The bylaws of K-V Sub, as in effect immediately prior to the Effective Time, shall be the bylaws of the Surviving Corporation at the Effective Time, until thereafter -14- amended in accordance with Pennsylvania Law and as provided in the articles of incorporation of the Surviving Corporation and such bylaws. 2.5 DIRECTORS AND OFFICERS. (a) DIRECTORS OF FP1096. The directors of K-V Sub immediately prior to the Effective Time shall be the directors of the Surviving Corporation immediately after the Effective Time, each to hold the office of a director of the Surviving Corporation in accordance with the provisions of Pennsylvania Law and the articles of incorporation and bylaws of the Surviving Corporation until their successors are duly elected and qualified. (b) OFFICERS OF FP1096. The officers of K-V Sub immediately prior to the Effective Time shall be the officers of the Surviving Corporation immediately after the Effective Time, each to hold office in accordance with the provisions of the bylaws of the Surviving Corporation. 2.6 EFFECT OF MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT CORPORATIONS. (a) EFFECT ON CAPITAL STOCK OF FP1096. At the Effective Time, by virtue of the Merger and without any further action on the part of K-V Sub, FP1096 or the Shareholders: (i) each share of FP1096 Capital Stock issued and outstanding immediately prior to the Effective Time (other than (x) Dissenting Shares and (y) Excluded Shares), upon the terms and subject to the conditions set forth in this Section 2.6, will be cancelled and extinguished and be converted automatically into the right to receive, upon surrender of the certificate representing such shares of FP1096 Capital Stock in the manner provided in Section 2.8, an amount of cash, without interest, equal to the product of (A) the number of shares of FP1096 Common Stock into which such share of FP1096 Capital Stock is convertible as of the Effective Time (which, in the case of a share of FP1096 Common Stock, shall be one (1)) multiplied by (B) the Consideration Per Share less the Escrow Amount Per Share. (ii) each Excluded Share issued and outstanding immediately prior to the Effective Time will be cancelled and extinguished and be converted automatically into the right to receive, upon surrender of the certificate representing such Excluded Share in the manner provided in Section 2.8, one validly issued, fully paid and nonassessable share of Preferred Stock of the Surviving Corporation. (iii) each share of treasury stock of FP1096 will be cancelled and extinguished. For purposes of clarity, in no event shall the Excluded Shares receive any payment; nor shall K-V be obligated under this Section 2.6 to pay to the holders of FP1096 Capital Stock, FP1096 Options or FP1096 Warrants and any other holder of securities or rights of any kind exercisable for, exchangeable for or convertible into FP1096 Capital Stock an aggregate amount in excess of the Merger Consideration less the Escrow Amount, and, if necessary, the Consideration Per Share shall be adjusted accordingly to effectuate the intent of this paragraph. -15- (b) TERMINATION OF FP1096 OPTIONS AND WARRANTS. (i) K-V shall not assume any FP1096 Options or FP1096 Warrants. FP1096 shall cause the termination, effective immediately prior to the Effective Time, of all outstanding FP1096 Options and FP1096 Warrants, in each case whether or not vested, that then remain unexercised so that no FP1096 Options or FP1096 Warrants remain outstanding immediately prior to the Effective Time. In connection with such termination, holders of FP1096 Options and FP1096 Warrants shall receive, in respect of each share of capital stock subject thereto, an amount equal to the sum of (i) the Consideration Per Share, less (ii) the Escrow Amount Per Share, less (iii) the applicable exercise price theretofore not otherwise paid. Thereafter, the holders of FP1096 Options and FP1096 Warrants shall, as of the Effective Time, cease to have any further right or entitlement to acquire any FP1096 Capital Stock or any shares of capital stock of K-V or the Surviving Corporation under the terminated FP1096 Options or FP1096 Warrants. (ii) FP1096 shall cause the termination, effective immediately prior to the Effective Time, of all Plans. (iii) FP1096 shall obtain all consents and take all action necessary to cause the termination or exercise of all FP1096 Options and FP1096 Warrants as provided under subparagraph (i) above. FP1096 shall take all other actions necessary or appropriate so that, as of the Effective Time and as a result of the Merger: (A) no options, warrants or other rights to acquire any FP1096 Capital Stock or any securities, debt or other rights convertible into or exchangeable or exercisable for FP1096 Capital Stock are outstanding, (B) no Person holding FP1096 Capital Stock, FP1096 Options or FP1096 Warrants shall, on and after the Closing, have any right, title or interest in or to FP1096 or the Surviving Corporation or any securities of FP1096 or the Surviving Corporation, other than, in the case of the holders of FP1096 Capital Stock, FP1096 Options and FP1096 Warrants, the right to payments of cash in the manner described in this Agreement, and (C) no Person holding FP1096 Capital Stock, FP1096 Options or FP1096 Warrants shall by virtue of any such securities have any right to acquire any securities of K-V. (c) WITHHOLDING TAXES. Notwithstanding any other provision in this Agreement, K-V, FP1096, K-V Sub, and FemmePharma (and its subsidiaries) shall have the right to deduct and withhold Taxes from any payments to be made hereunder if such withholding is required by Law and to request any necessary Tax forms, including Form W-9 or the appropriate series of Form W-8, as applicable, or any similar information, from the recipients of payments hereunder. To the extent that amounts are so withheld, such withheld amounts shall be treated for all purposes of this Agreement as having been delivered and paid to the recipient of the payment in respect of which such deduction and withholding was made. (d) CAPITAL STOCK OF K-V SUB. Each share of Common Stock of K-V Sub issued and outstanding immediately prior to the Effective Time shall be converted into and exchanged for one validly issued, fully paid and nonassessable share of Common Stock of the Surviving Corporation. Each stock certificate of K-V Sub evidencing ownership of any such shares shall continue to evidence ownership of such shares of capital stock of the Surviving Corporation. -16- 2.7 DISSENTING SHARES. (a) Notwithstanding any other provisions of this Agreement to the contrary, any shares of FP1096 Capital Stock, other than Excluded Shares, held by a holder who (notwithstanding that such holder may have previously approved this Agreement, the Related Agreements, the License Agreement and the transactions contemplated hereby and thereby) has exercised and perfected appraisal rights for such shares in accordance with Pennsylvania Law and who, as of the Effective Time, has not effectively withdrawn or lost such holder's appraisal rights (collectively, the "Dissenting Shares") shall not be converted into or represent a right to ----------------- receive the applicable consideration for FP1096 Capital Stock set forth in Section 2.6, but the holder thereof shall only be entitled to such rights as are provided by Pennsylvania Law. (b) Notwithstanding the provisions of Section 2.7(a), if any holder of Dissenting Shares shall effectively withdraw or lose, through failure to perfect or otherwise, such holder's appraisal rights under Pennsylvania Law, then, as of the occurrence of such event, such holder's shares shall automatically be converted into and represent only the right to receive the consideration for FP1096 Capital Stock, as applicable, set forth in Section 2.6 hereof, without interest thereon, upon surrender of the certificate representing such shares. (c) FP1096 shall give K-V: (i) prompt notice of any written demand for appraisal received by FP1096 pursuant to the applicable provisions of Pennsylvania Law, and (ii) the opportunity to participate in all negotiations and proceedings with respect to such demands. FP1096 shall not, except with the prior written consent of K-V, make any payment with respect to any such demands or offer to settle or settle any such demands. Notwithstanding the foregoing, to the extent that K-V or FP1096: (i) is required to make any payment or payments in respect of any Dissenting Shares in excess of the consideration that otherwise would have been payable in respect of such shares in accordance with this Agreement or (ii) reasonably incurs any other costs or expenses, (including specifically, but without limitation, reasonable attorneys' fees, costs and expenses in connection with any action or proceeding) in respect of any Dissenting Shares (excluding payments for such shares) (together "Dissenting Share Payments"), ------------------------- K-V shall be entitled to recover under the terms of Article VII the amount of such Dissenting Share Payments without regard to the Threshold. 2.8 SURRENDER OF CERTIFICATES. (a) [INTENTIONALLY OMITTED.] (b) K-V TO PROVIDE CASH; DEPOSIT OF ESCROW AMOUNT. Except as provided in subsection (g) below, at the Effective Time, K-V shall make available for exchange in accordance with this Article II the cash payable at the Effective Time pursuant to Section 2.6 hereof in exchange for outstanding shares of FP1096 Capital Stock, and shall deposit the Escrow Amount with the Escrow Agent, to be held, invested and disbursed in accordance with the terms of the Escrow Agreement. Such funds shall be treated in accordance with the Escrow Agreement. (c) EXCHANGE PROCEDURES. Except as provided in subsection (g) below, on the Closing Date, K-V shall provide a letter of transmittal in the form of EXHIBIT I hereto (the -17- "Letter of Transmittal") to each Shareholder at the address set forth --------------------- opposite each such Shareholder's name in Section 3.2(a)(1) of the FP1096 Disclosure Letter. In the Letter of Transmittal, the Shareholders will be instructed to surrender the certificates representing their shares of FP1096 Capital Stock (the "FP1096 Stock Certificates") for cancellation together ------------------------- with a duly completed and validly executed Letter of Transmittal. Upon surrender of a FP1096 Stock Certificate for cancellation to K-V, together with the Letter of Transmittal, duly completed and validly executed in accordance with the instructions thereto, subject to the terms of Section 2.8(d), the holder of such FP1096 Stock Certificate shall be entitled to receive in exchange therefor the cash amounts to which such holder is entitled pursuant to Section 2.6, and the FP1096 Stock Certificate so surrendered shall be cancelled. Until so surrendered, each FP1096 Stock Certificate outstanding after the Effective Time will be deemed, for all corporate purposes thereafter, to evidence only the right to receive the cash amounts payable in exchange for shares of FP1096 Capital Stock, without interest, into which such shares of FP1096 Capital Stock shall have been so converted. No portion of the Merger Consideration will be paid to the holder of any unsurrendered FP1096 Stock Certificate with respect to shares of FP1096 Common Stock formerly represented thereby until the holder of record of such FP1096 Stock Certificate shall surrender such FP1096 Stock Certificate pursuant hereto. (d) TRANSFERS OF OWNERSHIP. If any cash amounts are to be disbursed pursuant to Section 2.6 to a Person other than the Person whose name is reflected on the FP1096 Stock Certificate surrendered in exchange therefor, it will be a condition of the issuance or delivery thereof that the certificate so surrendered will be properly endorsed and otherwise in proper form for transfer and that the Person requesting such exchange will have paid to K-V any transfer or other Taxes required by reason of the disbursement of cash amounts to a Person other than the registered holder of the certificate surrendered, or established to the satisfaction of K-V that such Tax has been paid or is not payable. (e) RETURN OF CASH CONSIDERATION. At any time following the last day of the sixth (6th) month following the Effective Time, K-V shall be entitled to all cash amounts, and any and all interest thereon or other income or proceeds thereof, not disbursed to the holders of FP1096 Stock Certificates pursuant to Section 2.8(c), and thereafter the holders of FP1096 Stock Certificates shall be entitled to look only to K-V (subject to the terms of Section 2.8(f)) only as general creditors thereof with respect to any and all cash amounts that may be payable to such holders of FP1096 Stock Certificates pursuant to Section 2.6 upon the due surrender of such FP1096 Stock Certificates in the manner provided in Section 2.8(c). (f) NO LIABILITY. Notwithstanding anything to the contrary in this Section 2.8, neither the Surviving Corporation nor any party hereto shall be liable to a holder of shares of FP1096 Capital Stock for any amount paid to a public official pursuant to any applicable abandoned property, escheat or similar Law. (g) CLOSING PAYMENTS. Notwithstanding any provision in this section or Section 2.12 to the contrary, K-V shall pay directly to the Shareholders (other than with respect to Excluded Shares) the cash payable under Section 2.6 for whom executed payment and delivery instructions in the form of EXHIBIT J hereto (the "Closing Instructions"), a Letter of -------------------- Transmittal, and their FP1096 Stock Certificate (FP1096 Option or FP1096 Warrant, as applicable) shall have been delivered by FemmePharma at the Closing; such payment to be made -18- at the Effective Time by wire transfer of immediately available funds to each such Shareholder pursuant to the wire transfer instructions in the applicable Closing Instructions. Such payments to Shareholders shall be referred to as the "Closing Payments." ---------------- 2.9 NO FURTHER OWNERSHIP RIGHTS IN FP1096 CAPITAL STOCK. The cash amounts paid in respect of the surrender for exchange of shares of FP1096 Capital Stock in accordance with the terms hereof shall be deemed to be full satisfaction of all rights pertaining to such shares of FP1096 Capital Stock, and there shall be no further registration of transfers on the records of the Surviving Corporation of shares of FP1096 Capital Stock which were outstanding immediately prior to the Effective Time. If, after the Effective Time, FP1096 Stock Certificates are presented to the Surviving Corporation for any reason, they shall be canceled and exchanged as provided in this Article II. 2.10 LOST, STOLEN OR DESTROYED CERTIFICATES. In the event any FP1096 Stock Certificates shall have been lost, stolen or destroyed, K-V shall issue in exchange for such lost, stolen or destroyed certificates, upon the making of an affidavit of that fact by the holder thereof, such amount, if any, as may be required pursuant to Section 2.6; provided, -------- however, that K-V may, in its discretion and as a condition precedent to the - ------- issuance thereof, require the Shareholder who is the owner of such lost, stolen or destroyed certificates to: (i) deliver a bond in such amount as it may reasonably direct and/or (ii) provide an indemnification agreement in a form and substance reasonably acceptable to K-V against any claim that may be made against K-V or the Surviving Corporation with respect to the certificates alleged to have been lost, stolen or destroyed. 2.11 CLOSING DATE DELIVERIES OF FP1096 AND FEMMEPHARMA. At the Closing, FP1096 or FemmePharma, as applicable, shall deliver to K-V: (a) all Third Party Consents; (b) a written resignation from each of the officers, directors and employees of FP1096 effective as of the Effective Time; -19- (c) a certificate of the Chief Executive Officer of FP1096 as provided for in Section 6.2; (d) a certificate of the Chief Executive Officer of FemmePharma as provided for in Section 6.2; (e) a certificate of the Secretary of FP1096 as provided for in Section 6.2; (f) a certificate of the Secretary of FemmePharma as provided for in Section 6.2; (g) a certificate of good standing for FP1096 from the Secretary of State of the Commonwealth of Pennsylvania to be dated within a reasonable period prior to Closing with respect to FP1096; (h) a copy of the FIRPTA Compliance Certificate, validly executed by a duly authorized officer of FP1096; (i) all Books and Records and Data included in the Retained Assets; (j) the Appraisal; (k) a complete, accurate and legible copy of each of the Retained Contracts (including all amendments and supplements thereto); (l) all FP1096 Options and FP1096 Warrants and evidence of the cancellation thereof to the extent the same are not exercised at or prior to the Effective Time; and (m) final, original copies of the Escrow Agreement, the License Agreement, the Release Agreement and the Transition Agreement duly executed by FP1096, FemmePharma, the Escrow Agent and the Seller Representative, as applicable. 2.12 CLOSING DATE DELIVERIES OF K-V. At the Closing: (i) K-V shall pay by wire transfer of immediately available funds, as set forth in the Closing Instructions: (A) to the Shareholders identified on the Closing Instructions the amounts payable to the holders of shares of FP1096 Capital Stock pursuant to Section 2.6(a), (B) to the Escrow Agent the Escrow Amount (C) to FemmePharma Global Healthcare, Inc. $400,225 for the costs and expenses incurred by FP1096 and FemmePharma in connection with the transactions contemplated by this Agreement and (D) to FemmePharma Global Healthcare, Inc. $473,621 for employee tax withholding on compensation realized by employees and former employees on the exercise of any options prior to Closing, and (ii) K-V shall deliver to FP1096 and FemmePharma: (a) a certificate of a Vice President of K-V as provided for in Section 6.3; and (b) final, original copies of the Escrow Agreement, the License Agreement, the Release Agreement and the Transition Agreement executed by K-V and K-V Sub, as applicable. -20- 2.13 TAKING OF NECESSARY ACTION; FURTHER ACTION. If at any time after the Effective Time, any further action is necessary or desirable to carry out the purposes of this Agreement and to vest the Surviving Corporation with full right, title and possession to all Retained Assets, rights, privileges, powers and franchises of FP1096, K-V, K-V Sub and the Surviving Corporation and the officers and directors of FP1096, K-V, K-V Sub and the Surviving Corporation are fully authorized in the name of their respective corporations or otherwise to take, and may take, any and all such lawful and necessary actions. ARTICLE III REPRESENTATIONS AND WARRANTIES OF FP1096 AND FEMMEPHARMA FP1096 and FemmePharma, jointly and severally, hereby represent and warrant to K-V and K-V Sub as of the Effective Time as follows: 3.1 ORGANIZATION. FP1096 is a corporation duly organized, validly existing and in good standing under the laws of the Commonwealth of Pennsylvania. FemmePharma is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Each of FP1096 and FemmePharma has the corporate power to own, operate or lease its properties and to carry on its business as currently conducted. Each of FP1096 and FemmePharma is duly authorized and qualified to conduct business and in good standing as a foreign corporation in each jurisdiction in which it conducts business, except where a failure to be so qualified or in good standing would not have a material adverse effect on the business, assets or financial condition of FP1096. Each of FP1096 and FemmePharma has delivered to K-V a true, correct and complete copy of its articles or certificate of incorporation, as the case may be, and bylaws, each as amended to date and in full force and effect on the date hereof (collectively, the "Charter ------- Documents"). Section 3.1 of the FP1096 Disclosure Letter lists the directors - --------- and officers of each of FP1096 and FemmePharma as of the date hereof. The operations now being conducted by each of FP1096 and FemmePharma are not now and have never been conducted by FP1096 and FemmePharma, respectively, under any other name, except "Meridian Pharmaceuticals, Inc." and "FemmePharma, Inc." Section 3.1 of the FP1096 Disclosure Letter lists every state or foreign jurisdiction in which each of FP1096 and FemmePharma has employees, assets or facilities or otherwise carries on business. 3.2 FP1096 CAPITAL STRUCTURE. (a) The authorized capital stock of FP1096 consists of 19,000,000 shares of Common Stock, of which 2,249,792 shares are issued and outstanding, 2,000,000 shares of Preferred Stock, of which 713,500 shares have been designated Series A Preferred Stock, 713,375 shares of which are issued and outstanding, 713,500 shares have been designated Series B Preferred Stock, all of which are issued and outstanding, 130,000 shares have been designated Series C Preferred Stock, 87,412.5 shares of which are issued and outstanding, and 300,000 shares have been designated Series D Preferred Stock, 132,736 shares of which are issued and outstanding. As of the date hereof, the capitalization of FP1096 is as set forth in Section 3.2(a)(1) of the FP1096 Disclosure Letter, which capitalization schedule shows for the shares of FP1096 Preferred Stock that number of shares of FP1096 Common Stock into which such shares of FP1096 Preferred Stock are convertible as of the Effective Time. FP1096 Capital -21- Stock is held by the persons with the domicile addresses and in the amounts set forth in Section 3.2(a)(1) of the FP1096 Disclosure Letter. All outstanding shares of FP1096 Capital Stock are duly authorized, validly issued, fully paid and non-assessable and not subject to preemptive rights created by statute, the Charter Documents of FP1096, or any Contract to which FP1096 is a party or by which it is bound, and have been issued in compliance with federal and state securities laws. All outstanding shares of FP1096 Capital Stock, FP1096 Options and FP1096 Warrants have been issued and, in the case of shares that were outstanding and repurchased by FP1096 or any Shareholder of FP1096, repurchased, in compliance with all applicable Laws, including federal and state securities laws. FP1096 has not, and will not have, suffered or incurred any Liability relating to or arising out of the issuance or repurchase of any FP1096 Capital Stock or options or warrants to purchase FP1096 Capital Stock, or out of any agreements or arrangements relating thereto (including any amendment of the terms of any such agreement or arrangement). There are no declared or accrued but unpaid dividends with respect to any shares of FP1096 Capital Stock. FP1096 has no other capital stock authorized, issued or outstanding. There are no shares of FP1096 Capital Stock that are unvested or subject to a repurchase option, risk of forfeiture or other condition under any applicable stock restriction agreement or other agreement with FP1096. (b) Except for the Plans, or as noted in the FP1096 Disclosure Letter, FP1096 has never adopted, sponsored or maintained any stock option plan or any other plan or agreement providing for equity compensation to any Person. FP1096 has reserved 475,000 shares of FP1096 Common Stock for issuance to employees and directors of, and consultants to, FP1096 upon the issuance of stock or the exercise of options granted under the Plans or any other plan, agreement or arrangement (whether written or oral, formal or informal), of which (i) 375,199 shares are issuable as of the date hereof upon the exercise of outstanding, unexercised options, and (ii) 1,215,000 shares have been issued upon the exercise of options previously granted and remain outstanding as of the date hereof. Except for FP1096 Options and FP1096 Warrants scheduled in the FP1096 Disclosure Letter (which schedule shows for each FP1096 Option and FP1096 Warrant the date of grant, the exercise price, whether each such FP1096 Option is an "incentive stock option" within the meaning of Section 422 of the Code, and the vesting schedule for such FP1096 Option and FP1096 Warrant, including the extent vested to date and whether the vesting will be accelerated by the transactions contemplated by this Agreement), all of which are to be exercised or cancelled at or prior to the Effective Time, there are no options, warrants, calls, rights, convertible securities, commitments or agreements of any character, written or oral, to which FP1096 is a party or by which FP1096 is bound obligating FP1096 to issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered, sold, repurchased or redeemed, any shares of FP1096 Capital Stock or obligating FP1096 to grant, extend, accelerate the vesting of, change the price of, or otherwise amend or enter into any such option, warrant, call, right, commitment or agreement. There are no outstanding or authorized stock appreciation, phantom stock, profit participation or other similar rights with respect to FP1096. Except as contemplated hereby, there are no voting trusts, proxies or other agreements or understandings with respect to the voting stock of FP1096. There are no agreements to which FP1096 is a party relating to the registration, sale or transfer (including agreements relating to rights of first refusal, co-sale rights or "drag-along" rights) of any FP1096 Capital Stock. As a result of the Merger, K-V will be the sole record and beneficial holder of all issued and outstanding FP1096 Capital Stock and all rights to acquire or receive any shares of FP1096 Capital Stock, whether or not such shares of FP1096 Capital Stock are outstanding. -22- (c) The allocation of the Merger Consideration set forth in Section 2.6(a) is consistent with the articles of incorporation of FP1096 immediately prior to the Effective Time. 3.3 SUBSIDIARIES. Other than FemmePharma, FP1096 has had no subsidiaries. At the Effective Time, FP1096 will have no subsidiaries. 3.4 AUTHORITY. Each of FP1096 and FemmePharma has all requisite power and authority to enter into this Agreement, the License Agreement and any Related Agreements to which it is a party and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement, the License Agreement and any Related Agreements to which each of FP1096 and FemmePharma is a party and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of FP1096 and FemmePharma, as applicable, and no further action is required on the part of FP1096 or FemmePharma to authorize the Agreement, the License Agreement and any Related Agreements to which it is a party and the transactions contemplated hereby and thereby. This Agreement, the License Agreement, the Related Agreements, the Merger and the Spin Off have been approved by the Board of Directors of FP1096. This Agreement, the License Agreement, each of the Related Agreements, the Merger and the Spin Off shall have been approved prior to Closing by a majority of the holders of FP1096 Capital Stock (the "Requisite Shareholder Vote"). The Spin Off has been approved by the Board -------------------------- of Directors of FemmePharma. This Agreement, the License Agreement and each of the Related Agreements to which each of FP1096 and FemmePharma is a party has been duly executed and delivered by FP1096 and FemmePharma, as applicable, and assuming the due authorization, execution and delivery by the other parties hereto and thereto, constitute the valid and binding obligations of FP1096 and FemmePharma, as applicable, enforceable against it in accordance with their respective terms, except as such enforceability may be subject to the laws of general application relating to bankruptcy, insolvency, and the relief of debtors and rules of Law governing specific performance, injunctive relief or other equitable remedies. 3.5 NO CONFLICT. The execution and delivery by FP1096 and FemmePharma, as applicable, of this Agreement, the License Agreement and any Related Agreement to which it is a party, and the consummation of the transactions contemplated hereby and thereby, will not: (i) conflict with or result in any violation of or default under, with or without notice or lapse of time, or both, or give rise to a right of termination, cancellation, modification or acceleration of any obligation or loss of any benefit under (any such event, a "Conflict") (A) any provision of the Charter Documents, -------- (B) any Contract to which FP1096 or FemmePharma is a party or by which either of them is bound, or (C) any Law or Order applicable to FP1096, FemmePharma or any of their properties whether tangible or intangible or assets, or (ii) result in the imposition of any Lien (other than a Permitted Lien). 3.6 CONSENTS. Except as set forth on Section 3.6 of the FP1096 Disclosure Letter, no consent, notice, waiver, approval, order or authorization of, or registration, declaration or filing with any Person is required by, or with respect to, FP1096 or FemmePharma in connection with the execution and delivery of this Agreement, the License Agreement and any Related Agreement to which FP1096 or FemmePharma is a party or the consummation of the transactions contemplated hereby and thereby, except for the filing of the Merger Certificate or like instrument with the Secretary of the Commonwealth of Pennsylvania. -23- 3.7 REGULATORY MATTERS. (a) To the extent that they have conducted or been responsible for such activities, whether directly or indirectly (including through any third party other than K-V), FP1096, FemmePharma and their Affiliates have performed all human Clinical Trials with the Initial Danazol Product in accordance with all applicable Laws and all filings with, and approvals, licenses and authorizations by, Regulatory Authorities, including Marketing Authorization Applications and Regulatory Approvals. Except as set forth in Section 3.7 of the FP1096 Disclosure Letter, to the extent that they have conducted or been responsible for such activities, whether directly or indirectly (including through any third party other than K-V), FP1096, FemmePharma and their Affiliates have performed all Development and Manufacturing, use and disposition of the Initial Danazol Product in accordance with all applicable Laws, including applicable good manufacturing practices, good laboratory practices and other regulations, and all filings with, and approvals, licenses and authorizations by, Regulatory Authorities, including Marketing Authorization Applications, and Regulatory Approvals. No Initial Danazol Product has been marketed or commercially distributed by FP1096, FemmePharma or their Affiliates. All Regulatory Authorities with which FP1096 has had any filing, correspondence or other communications concerning the Initial Danazol Product are listed in Section 3.7(a) of the FP1096 Disclosure Letter, including a brief description of the nature of each related item of Regulatory Documentation in its possession or control. FP1096 has not had any filing, correspondence or other communications with Regulatory Authorities concerning any K-V Products other than the Initial Danazol Product. As of the Closing Date, FP1096, FemmePharma and their Affiliates have delivered to K-V all Regulatory Documentation in its possession or control related to the Initial Danazol Product. (b) None of FP1096, FemmePharma and their Affiliates have (i) made an untrue statement of a material fact, (ii) failed to disclose a material fact, or (iii) submitted inaccurate or misleading Regulatory Documentation to any Regulatory Authority with respect to the Initial Danazol Product or any component of the Initial Danazol Product. (c) The FP1096 Disclosure Letter sets forth a list of all Marketing Authorization Applications and Regulatory Approvals sought or received and Clinical Trials that are being or have been conducted prior to the Closing Date by FP1096, FemmePharma and their Affiliates, for the Initial Danazol Product. As of the Closing Date, FP1096 is the exclusive sponsor of all such Clinical Trials and owns all right, title and interest in and to all such Marketing Authorization Applications, Regulatory Approvals, and other Regulatory Documentation. As of the Closing Date, there have been no Marketing Authorization Applications and Regulatory Approvals sought or received or Clinical Trials that are being or have been conducted prior to the Closing Date by FP1096, FemmePharma and their Affiliates, for K-V Products other than the Initial Danazol Product. FP1096 shall give K-V notice and copies (if applicable) of all future correspondence, notices and other communications received from the FDA or other Regulatory Authorities relating to the Initial Danazol Product and, unless requested by K-V in writing, will no longer communicate with the FDA or such other Regulatory Authorities with respect to the Initial Danazol Product. (d) As of the Closing Date, FP1096 has given the FDA (and any applicable Regulatory Authorities outside the United States) written notice of the change of control of the -24- Marketing Authorization Applications for the Initial Danazol Product, authorizing FP1096, K-V and its Affiliates to communicate with the FDA and such Regulatory Authorities with respect to all matters related thereto. As of the Closing Date, FP1096 has given written notice (to the extent necessary) to all Regulatory Authorities of the transfer to FemmePharma of all human Clinical Trials and any Marketing Authorization Applications for all products other than the K-V Products and has transferred to FemmePharma all Clinical Trials and any Marketing Authorization Applications and all Liabilities associated with such other products under all applicable Laws. (e) The FP1096 Disclosure Letter lists all significant event(s) and circumstances that, to FP1096's Knowledge, will have a material adverse effect on achieving Regulatory Approval for the Initial Danazol Product, including, but not limited to, adverse drug experiences, clinical holds or suspensions, and governmental inquiries, competitive products, and materials, supply and use factors. Without limiting the foregoing, FemmePharma has disclosed to K-V prior to the date hereof in writing all failures, and allegations by any Regulatory Authority of failure of FP1096, FemmePharma or their Affiliates to comply with the provisions of applicable Laws in any manner which affects or could affect the Manufacture, Development, marketing or other commercialization of the Initial Danazol Product, the performance by FP1096 or FemmePharma of its obligations under this Agreement, or the use and other exploitation of the Retained Assets or performance of the FP1096 Business by or under authority of Surviving Corporation and K-V, or otherwise expose Surviving Corporation to Liability that, to FP1096's Knowledge, will have a material adverse effect on achieving Regulatory Approval for the Initial Danazol Product. (f) Other than with respect to the Initial Danazol Product, FP1096 has not (i) sponsored or conducted any Clinical Trials, nor commenced any Development or Manufacturing activities relating to any K-V Product or (ii) sought or received any Regulatory Approvals relating to any K-V Product developed by or on behalf of FP1096. 3.8 FP1096 FINANCIAL STATEMENTS. (a) The FP1096 Disclosure Letter sets forth FP1096's (i) audited balance sheet as of December 31, 2003, and the related statements of operations, cash flows and stockholders' equity for the twelve (12) month period then ended, (ii) FP1096's unaudited balance sheet as of December 31, 2004, (the "Balance Sheet Date") and the related statements of operations ------------------ and cash flows for the twelve (12) month period then ended (the "Current ------- Balance Sheet") and (iii) the unaudited FP1096 Closing Balance Sheet (the - ------------- financial statements in clauses (i),(ii) and (iii) jointly, the "FP1096 ------ Financial Statements"). - -------------------- (b) The FP1096 Financial Statements (i) have been prepared in accordance with GAAP consistently applied on a consistent basis throughout the periods indicated and consistent with each other and (ii) present fairly in all material respects FP1096's financial condition, operating results and cash flows as of the dates and during the periods indicated therein, subject in the case of the Current Balance Sheet and the FP1096 Closing Balance Sheet to the omission of footnote information and to normal year-end adjustments, which are not material in amount or significance in any individual case or in the aggregate. -25- 3.9 NO UNDISCLOSED LIABILITIES. FP1096 has no Liability that has not been reflected in the unaudited balance sheet (the "FP1096 Closing -------------- Balance Sheet") dated as of the date of this Agreement and set forth in the - ------------- FP1096 Disclosure Letter or as otherwise listed in Section 3.9 of the FP1096 Disclosure Letter. 3.10 NO CHANGES. Since the Balance Sheet Date: (a) except as provided in the Asset Contribution Agreement or with respect to the Spin Off, FP1096 has carried on activities affecting the FP1096 Business in the ordinary course of business, consistent with past practices. (b) there have not been any amendments or changes to the Charter Documents; (c) there has not been any employment dispute, including but not limited to, claims or matters raised by any individuals or any workers' representative organization, bargaining unit or union regarding labor trouble or claim of wrongful discharge or other unlawful employment or labor practice or action with respect to FP1096; (d) there has not been any change in any material election in respect of Taxes, adoption or change in any accounting method in respect of Taxes, agreement or settlement of any claim or assessment in respect of Taxes, or extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes; (e) there has not been any revaluation by FP1096 of any of its assets, whether tangible or intangible, including without limitation, writing down the value of inventory or writing off notes or Accounts Receivable; (f) there has not been any split, combination or reclassification in respect of any shares of FP1096 Capital Stock, or any issuance or authorization of any issuance of any other securities in respect of, in lieu of or in substitution for shares of FP1096 Capital Stock; (g) FP1096 has not amended the terms of any outstanding loan agreement, guaranteed any indebtedness, issued or sold any debt securities or guaranteed any debt securities of others; (h) FP1096 has not created or permitted the creation of a Lien, other than a Permitted Lien; (i) no Retained Asset has been damaged or destroyed; (j) there has not been any commencement or settlement of any lawsuit by FP1096, the commencement, settlement, notice or, to the Knowledge of FP1096, FemmePharma or the Shareholders, threat of any lawsuit or proceeding or other investigation against FP1096 or its affairs, or any reasonable basis for any of the foregoing; (k) Except as set forth in the FP1096 Disclosure Letter, there has not been any issuance or sale, or contract or agreement to issue or sell, by FP1096 of any shares of FP1096 -26- Capital Stock or securities convertible into, or exercisable or exchangeable for, shares of FP1096 Capital Stock, or any securities, warrants, options or rights to purchase any of the foregoing; (l) there has not been any event or condition of any character that has had or is reasonably likely to have a material adverse effect on the FP1096 Business; and (m) there has not been any agreement by FP1096, or any Person on behalf of FP1096, to do any of the things described in the preceding clauses (a) through (k) of this Section 3.10. 3.11 TAX MATTERS. (a) TAX RETURNS AND AUDITS. (i) Each of FP1096 and FemmePharma has: (a) prepared and timely filed all required federal, state, local and foreign returns, estimates, information statements and reports ("Returns") relating ------- to any and all Taxes concerning or attributable to FP1096 or FemmePharma, and such Returns are true and correct and have been completed in accordance with applicable Law and (b) timely paid all Taxes it is required to pay. (ii) Each of FP1096 and FemmePharma has timely paid or withheld with respect to its Employees and other third parties, all federal, state and foreign income taxes and social security charges and similar fees, Federal Insurance Contribution Act ("FICA"), Federal Unemployment Tax Act ("FUTA") and other Taxes required to be paid or withheld, and has timely paid over any such Taxes withheld to the appropriate authorities. (iii) FP1096 has not been delinquent in the payment of any Tax, nor is there any Tax deficiency outstanding, assessed or proposed against FP1096 or FemmePharma, nor has FP1096 or FemmePharma executed any waiver of any statute of limitations on or extending the period for the assessment or collection of any Tax. (iv) No audit or other examination of any Return of FP1096 is presently in progress, nor has FP1096 been notified of any request for such an audit or other examination. No adjustment relating to any Return filed by FP1096 has been proposed formally or, to the Knowledge of FP1096, informally by any Tax authority to FP1096 or any representative thereof. No claim has ever been made by an authority in a jurisdiction where FP1096 does not file Returns that FP1096 is or may be subject to taxation by that jurisdiction. (v) As of the Balance Sheet Date, FP1096 had no liabilities for unpaid Taxes which had not been accrued or reserved on the Current Balance Sheet, whether asserted or unasserted, contingent or otherwise, and neither FP1096 nor FemmePharma has incurred any liability for Taxes since the date of the Balance Sheet Date other than in the ordinary course of business. (vi) FP1096 has provided K-V or its legal counsel copies of all Returns for FP1096 filed for the last three (3) calendar years. -27- (vii) There are (and immediately following the Effective Time there will be) no Liens on the assets of FP1096 relating or attributable to Taxes. FP1096 has no Knowledge of any basis for the assertion of any claim relating or attributable to Taxes which, if adversely determined, would result in any Lien on the assets of FP1096 or FemmePharma. (viii) FP1096 has not: (A) been a member of an affiliated group (within the meaning of Code Section 1504(a)) filing a consolidated federal income Tax Return (other than a group the common parent of which was FP1096), (B) been a party to any Tax sharing, indemnification, allocation or similar agreement, (C) any liability for the Taxes of any Person under Treasury Regulation Section 1.1502-6 (or any similar provision of Law), as a transferee or successor, by contract, agreement or otherwise or (D) been a party to any joint venture, partnership or other arrangement that could be treated as a partnership for Tax purposes. (ix) FP1096 is not, nor has been at any time, a "United States Real Property Holding Corporation" within the meaning of Section 897(c)(2) of the Code. (x) FP1096 has not constituted either a "distributing corporation" or a "controlled corporation" in a distribution of stock intended to qualify for tax-free treatment under Section 355 of the Code. (xi) Any and all amounts realized by FP1096 in connection with the Spin Off will be fully offset by FP1096's current year expenses and available net operating loss carryforwards, and FP1096 will not be liable for any Taxes in connection with the Spin Off. (xii) FP1096 has not engaged in a reportable transaction under Treas. Reg. Section 1.6011-4(b) or in a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction, as set forth in Treas. Reg. Section 1.6011-4(b)(2). (xiii) FP1096 is and has at all times been resident for Tax purposes in its place of incorporation or formation and is not and has not at any time been treated as resident in any other jurisdiction for any Tax purpose (including any arrangement for the avoidance of double taxation). FP1096 is not subject to Tax in any jurisdiction other than its place of incorporation or formation by virtue of having a permanent establishment or other place of business or by virtue of having a source of income in that jurisdiction. FP1096 is not liable for any tax as the agent of any other person, business or enterprise and does not constitute a permanent establishment or other place of business of any other person, business or enterprise for any Tax purpose. (xiv) FP1096 will not be required to include any income or gain or exclude any deduction or loss in Tax periods (or portions thereof) that begin on or after the Closing as a result of (A) any change in method of accounting under Section 481(a) of the Code, (B) a closing agreement as defined under Section 7121 of the Code, (C) an installment sale or open transaction disposition, or (D) prepaid amount. 3.12 RESTRICTIONS ON BUSINESS ACTIVITIES. Except as set forth in the FP1096 Disclosure Letter, there is no Contract, non-competition or otherwise, commitment or Order to which -28- FP1096 is a party or otherwise binding upon FP1096 which has the effect of prohibiting or impairing the FP1096 Business, the conduct of the FP1096 Business by FP1096, or otherwise limiting the freedom of FP1096 to engage in any line of business or to compete with any Person, including without limitation any Contract containing any non-compete, right of refusal, right of offer, right of negotiation, exclusivity, obligation to assign, or other material restriction on the operation or scope of its businesses, or the use or exploitation of any Intellectual Property Right or Technology, including without limitation in the case of each of the foregoing with respect to the FP1096 Business or the Retained Assets. Without limiting the generality of the foregoing, FP1096 has not entered into any Contract under which FP1096 is restricted from selling, licensing, Manufacturing, Developing, importing, exporting, using or otherwise distributing, exploiting or disposing of any of FP1096's Technology, Patent Rights or products or from providing services to customers or potential customers or any class of customers, in any geographic area, during any period of time or in any segment of the market. 3.13 TITLE TO PROPERTIES; ABSENCE OF LIENS AND ENCUMBRANCES; SUFFICIENCY OF ASSETS. (a) FP1096 does not own nor has it ever owned any real property. Each Contract pursuant to which real property is currently leased, subleased or licensed by or from FP1096 or otherwise used or occupied by FP1096 (the "Lease Agreements") constitutes Transferred Assets and/or ---------------- Transferred Liabilities and does not constitute Retained Assets or Retained Contracts. FP1096 has not received any notice of a default, alleged failure to perform, or any offset or counterclaim with respect to any such Lease Agreement which has not been fully remedied and withdrawn. (b) Neither the operation of FP1096 or the FP1096 Business in the Leased Real Property nor, to the Knowledge of FP1096 or FemmePharma, such Leased Real Property, including the improvements thereon, has violated in any material respect any applicable building code, zoning requirement or statute relating to such property or operations thereon, and any such non-violation is not dependent on so-called non-conforming use exceptions. (c) FP1096 has sole and exclusive ownership, free and clear of any Liens, of all Retained Assets, and no Person other than FP1096 possesses any claims or rights with respect to the Retained Assets. (d) The Retained Assets comprise all of the assets, properties and rights of every type and description (other than Intellectual Property Rights or Technology), used in, related to, arising out of, or reasonably necessary for the FP1096 Business as has been conducted by FP1096 prior to the Closing Date. (e) The Transferred Assets and Retained Assets constitute all of the properties, interests, titles, estates, remedies, powers, claims, causes of action, Regulatory Documentation, Intellectual Property Rights, Technology, other privileges and rights, and other assets of every nature, kind and description, tangible and intangible, including goodwill, whether real, personal or mixed, whether accrued, contingent or otherwise, wherever located, of FP1096 as of the date hereof. Other than the Transferred Liabilities and Retained Contracts, as of the date hereof FP1096 has no Liabilities of any sort, whether known or unknown, fixed or contingent, accrued or not accrued, suspected or not suspected. -29- 3.14 INTELLECTUAL PROPERTY. (a) Section 3.14(a) of the FP1096 Disclosure Letter lists, under separate headings: (i) all Patent Rights and (ii) any proceedings or actions before any court, tribunal (including the PTO or equivalent authority anywhere in the world, such as oppositions, interferences, reexaminations, reissues, nullity actions and the like) related to any Patent Rights to which FP1096, FemmePharma or their Affiliates is a party (and identifies the applicable party). To FP1096's Knowledge, each of the Patent Rights is valid, enforceable and subsisting and FP1096, FemmePharma and their Affiliates Know of no acts, omissions, information, material facts or circumstances, including any information or fact that would constitute prior art, that would render any claim of any Patent Right invalid or unenforceable. To FP1096's Knowledge, all necessary registration, maintenance and renewal fees in connection with the Patent Rights have been paid and all necessary documents and certificates in connection therewith have been filed with the relevant patent authorities in the United States and foreign jurisdictions, as the case may be, for the purposes of maintaining the Patent Rights. (b) Except as set forth in Section 3.14(a) of the FP1096 Disclosure Letter, to FP1096's Knowledge, no licenses, authorizations, consents or notices are required from or to any third party (including Governmental Entities) to permit or authorize K-V, Surviving Corporation and their Affiliates to fully assign, license, transfer and otherwise exploit the Retained Assets. (c) As of the Closing Date, the Retained Assets and FP1096's rights and licenses under the License Agreement constitute all of the Intellectual Property Rights and Technology that at any time have been owned or controlled by any of FP1096, FemmePharma and their Affiliates related to the Initial Danazol Product or reasonably necessary for the FP1096 Business. (d) Other than the Retained Contracts, none of FP1096, FemmePharma or their Affiliates is, or was prior to the Closing Date, a party to any Contract involving the Initial Danazol Product or the Anti-infective Product, including without limitation any Contracts under which any rights or licenses have been obtained, acquired or granted with respect to such products developed by or on behalf of FP1096 (e.g., Contracts in which any marketing or distribution rights or options, or any exclusive rights, rights of refusal or offer, rights of negotiation, or the like, have been granted involving the Initial Danazol Product or the Anti-infective Product and Contracts involving contract research organizations, scientific advisory boards, study centers, consulting agreements or other Development or Manufacturing services related to the Initial Danazol Product or the Anti-infective Product that resulted in a grant of rights to such Persons. (e) FP1096, FemmePharma or their Affiliates have not transferred whole or partial ownership of, granted any license of or right to use, or otherwise transferred any right, title or interest with respect to any Patent Rights or FemmePharma Technology, nor has FP1096 taken any action nor granted any right that would breach or be breached by the rights and licenses granted to FP1096 in the License Agreement. No third party has any right, title or interest in or to any Patent Rights made by or under authority of FP1096, FemmePharma or their Affiliates. -30- (f) The operation of the business of FP1096, as has been and is now being conducted as of immediately prior to the Spin Off, including the design, development, use, and manufacture and sale of the Initial Danazol Product (and to the Knowledge of FP1096, any other K-V Products), has not and does not infringe or misappropriate, and in the case of the FP1096 Business when conducted by K-V and/or Surviving Corporation immediately following the Closing in the same manner as FP1096 as of immediately prior to the Spin Off, will not infringe or misappropriate, the Intellectual Property Rights of any Person, and neither FP1096, FemmePharma or their Affiliates has received any written notice from any Person, or has Knowledge of, any actual or threatened claim or assertion to the contrary or of any facts or alleged facts which are likely to serve as the basis for any such claim or assertion. Without limiting the foregoing, FP1096 and FemmePharma have disclosed to K-V prior to the Closing Date the date, author, recipient and subject matter of all patentability, validity, infringement and noninfringement opinions obtained by or Known to FP1096 or FemmePharma, related to the K-V Products or any Patent Rights or FemmePharma Technology or third party Patents and provided a copy of each of them to K-V. (g) To the Knowledge of FP1096, FemmePharma and its Affiliates, no Person has infringed or misappropriated or is infringing or misappropriating any Patent Rights or FemmePharma Technology. (h) FP1096, FemmePharma and their Affiliates have taken all commercially reasonable steps that are required or necessary to protect their rights in their confidential information and Trade Secrets or the confidential information and Trade Secrets of others that they have received. FP1096, FemmePharma and their Affiliates have, and enforce, a policy requiring each employee and, to the extent applicable each consultant and contractor, to execute proprietary information, confidentiality and assignment agreements ("Proprietary Information Agreements") substantially ---------------------------------- in FP1096's standard forms (in the forms set forth on EXHIBIT K), and all current and former employees, consultants and contractors of FP1096, FemmePharma and their Affiliates (each of whom is listed in Section 3.14(h) of the FP1096 Disclosure Letter) have executed such an agreement in substantially FP1096's standard form. FP1096, FemmePharma and their Affiliates have not delivered, and will not deliver, to K-V, Surviving Corporation or their Affiliates any confidential or proprietary information or Trade Secrets of any third party without disclosing to K-V, in writing in advance of such disclosure, the source thereof and FP1096's, FemmePharma's or their Affiliates' right to make such disclosure, as the case may be. (i) No government funding, facilities or resources, or facilities or resources of a university, college, other educational institution or research center, or funding from third parties, was used in the FP1096 Business, and, to FP1096's Knowledge, no Governmental Entity, university, college, other educational institution or research center has any rights thereto. To FP1096's Knowledge, no current or former employee, consultant or independent contractor of FP1096 who was involved in, or who contributed to, the creation or development of any Retained Assets, K-V Products or Patent Rights or FemmePharma Technology, has performed services for the government, a university, college or other educational institution, or a research center, during a period of time during which such employee, consultant or independent contractor was at the same time performing services for FP1096, FemmePharma, or their Affiliates. -31- 3.15 AGREEMENTS, CONTRACTS AND COMMITMENTS. (a) Except for the Retained Contracts, all other Contracts shall be, and have been, transferred by FP1096 to FemmePharma prior to the Closing Date. Other than the Retained Contracts, FP1096 and Surviving Corporation shall have no Liability under or as a result of any Contract, and FP1096 has no Knowledge of any event that would give rise to any such Liability with the lapse of time, giving of notice or both. Each Retained Contract is in full force and effect, and to the Knowledge of FP1096, no party obligated to FP1096 thereunder is in default pursuant to any such Retained Contract. (b) The FP1096 Disclosure Letter sets forth all necessary consents and notices to, parties to any Contracts as are required thereunder in connection with the Merger, including to authorize the transfer of all Contracts, other than the Retained Contracts, from FP1096 to FemmePharma or for any Retained Contract to remain in full force and effect without limitation, modification or alteration after the Effective Time so as to preserve all rights of, and benefits to, FP1096 under such Retained Contracts from and after the Effective Time. Following the Effective Time, the Surviving Corporation will be permitted to exercise all of its rights under the Retained Contracts in accordance with the terms and conditions thereof. 3.16 INTERESTED PARTY TRANSACTIONS. No officer, director or Shareholder of FP1096 or its Affiliates, nor any ancestor, sibling, descendant or spouse of any of such persons, has: (i) any material interest in any entity which furnished or sold, or furnishes or sells, services, products, Technology or Intellectual Property Rights that FP1096 also furnishes or sells, or proposes to furnish or sell, or (ii) a material beneficial interest in any entity that purchases from or sells or furnishes to FP1096 any goods or services, or (iii) any material beneficial interest in any Retained Contract. No Shareholder has any loans outstanding from FP1096 or its Affiliates. 3.17 GOVERNMENTAL AUTHORIZATION. Each governmental consent, license, permit, grant or other authorization which is or was obtained by or on behalf of FP1096 in connection with its Manufacture or Development of K-V Products, including all Regulatory Approvals (collectively, "FP1096 ------ Authorizations"), has been issued or granted to FP1096. Section 3.17 of the - -------------- FP1096 Disclosure Letter lists all FP1096 Authorizations. The FP1096 Authorizations are in full force and effect and constitute all consents, licenses, permits, grants and other authorizations obtained or required as of the Closing Date in connection with the Manufacture and Development by or on behalf of FP1096 of K-V Products. 3.18 LITIGATION. There is no action, suit, claim or proceeding of any nature pending or, to the Knowledge of FP1096, threatened against FP1096, its properties (tangible or intangible, including any products and all Technology and Intellectual Property Rights) or any of its officers or directors, nor to the Knowledge of FP1096 is there any reasonable basis therefor. There is no investigation or other proceeding pending or, to the Knowledge of FP1096, threatened against FP1096, any of its properties (tangible or intangible, including the K-V Products and all Technology and Intellectual Property Rights) or any of its officers or directors by or before any Governmental Entity, nor to the Knowledge of FP1096 is there any reasonable basis therefor. No Governmental Entity has at any time challenged or questioned the legal right of FP1096 to conduct its operations as presently or previously conducted or as presently contemplated to be conducted. The FP1096 Disclosure Letter contains a list of all actions, suits and proceedings in -32- which FP1096 has been involved. The FP1096 Disclosure Letter lists all notices, allegations, claims, demands and papers concerning or alleging wrongful death or personal injury from the use of any Product or Technology owned or used by FP1096, or concerning any related lawsuit or similar proceeding relating thereto. 3.19 MINUTE BOOKS. The minutes of FP1096 and FemmePharma provided to counsel for K-V contain complete (except to the extent reasonably redacted) and accurate records of all actions taken, and summaries, in all material respects, of all meetings held, by the shareholders, the Board of Directors of each of FP1096 (and any committees thereof) and FemmePharma since the time of incorporation of FP1096 and FemmePharma, as applicable. 3.20 ENVIRONMENTAL MATTERS. (a) CONDITION OF PROPERTY. As of the Closing, except in compliance with Environmental Laws and in a manner that could not reasonably be expected to subject FP1096 to Liability, no Hazardous Materials are present on any Business Facility currently operated, occupied, controlled or leased by FP1096, or were present on any other Business Facility at the time it ceased to be operated, occupied, controlled or leased by FP1096. There are no underground storage tanks, asbestos which is friable or likely to become friable or PCBs present on any Business Facility currently owned, operated, occupied, controlled or leased by FP1096, or as a consequence of the acts of FP1096 or its agents. (b) HAZARDOUS MATERIALS ACTIVITIES. FP1096 has conducted all Hazardous Materials Activities in compliance in all material respects with all applicable Environmental Laws. The Hazardous Materials Activities of FP1096 prior to the Closing have not resulted in the exposure of any person to a Hazardous Material in a manner which has caused or could reasonably be expected to cause an adverse health effect to any such person. (c) PERMITS. FP1096 holds all Environmental Permits necessary for the conduct of its business as currently being conducted and as currently contemplated to be conducted. All such Environmental Permits are valid and in full force and effect. FP1096 has complied in all material respects with all covenants and conditions of any Environmental Permit which is or has been in force with respect to its Hazardous Materials Activities. No circumstances exist which could cause any Environmental Permit to be revoked, modified or rendered non-renewable upon payment of the permit fee. All Environmental Permits and all other consents and clearances required by any Environmental Law or any agreement to which FP1096 is bound as a condition to the performance and enforcement of this Agreement have been obtained or will be obtained prior to the Closing at no cost to K-V. (d) ENVIRONMENTAL LITIGATION. No action, proceeding, revocation proceeding, amendment procedure, writ, injunction or claim is pending, or to the best Knowledge of FP1096, threatened, concerning or relating to any Environmental Permit, Hazardous Materials Activity or any Business Facility. (e) ENVIRONMENTAL LIABILITIES. FP1096 does not Know of any fact or circumstance, which could result in any Environmental Liabilities which could reasonably be expected to result in material liability to the business or financial status of FP1096. FP1096 has -33- not entered into any agreement that may require it to guarantee, reimburse, pledge, defend, hold harmless or indemnify any other party with respect to liabilities arising out of Environmental Laws or Hazardous Materials Activities. (f) REPORTS AND RECORDS. FP1096 and FemmePharma have delivered to K-V or made available for inspection by K-V and its agents, representatives and employees all records in FP1096 and FemmePharma's possession concerning their Hazardous Materials Activities and all environmental audits and environmental assessments of any Business Facility conducted at the request of, or otherwise in the possession of, FP1096 or FemmePharma. FP1096 and FemmePharma have complied with all environmental disclosure obligations imposed by applicable law with respect to the transactions contemplated by this Agreement. 3.21 BROKERS' AND FINDERS' FEES. FP1096 has not incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders' fees or agents' commissions, fees related to investment banking or similar advisory services or any similar charges in connection with the Agreement or any transaction contemplated hereby. 3.22 EMPLOYEE BENEFIT PLANS AND COMPENSATION. (a) SCHEDULE. Each FP1096 Employee Plan, each Employee Agreement, each Employment Liability and all other Liabilities related to the foregoing constitute Transferred Assets and/or Transferred Liabilities and do not constitute Retained Assets or Retained Contracts. (b) EMPLOYEE PLAN COMPLIANCE. FP1096 has performed, in all material respects, all obligations required to be performed by it under each FP1096 Employee Plan, and each FP1096 Employee Plan has been established and maintained in material compliance with its terms and in material compliance with all applicable laws, statutes, orders, rules and regulations, including but not limited to ERISA or the Code. No "prohibited transaction," within the meaning of Section 4975 of the Code or Sections 406 and 407 of ERISA, and not otherwise exempt under Section 408 of ERISA, has occurred with respect to any FP1096 Employee Plan. There are no actions, suits or claims pending or, to the Knowledge of FP1096, FemmePharma or the Shareholders, threatened or reasonably anticipated (other than routine claims for benefits) against any FP1096 Employee Plan or against the assets of any FP1096 Employee Plan. There are no audits, inquiries or proceedings pending or to the Knowledge of FP1096, FemmePharma or the Shareholders or any ERISA Affiliates, threatened by the IRS, DOL or any other Governmental Entity with respect to any FP1096 Employee Plan. Neither FP1096 nor any ERISA Affiliate is subject to any penalty or tax with respect to any FP1096 Employee Plan under Section 502(i) of ERISA or Sections 4975 through 4980 of the Code. FP1096 has timely made all contributions and other payments required by and due under the terms of each FP1096 Employee Plan. (c) NO PENSION PLANS. Neither FP1096 nor any ERISA Affiliate has ever maintained, established, sponsored, participated in, or contributed to any Pension Plans subject to Title IV of ERISA. At no time has FP1096 or any ERISA Affiliate contributed to or been obligated to contribute to any Multiemployer Plan. Neither FP1096 nor any ERISA Affiliate has -34- at any time ever maintained, established, sponsored, participated in or contributed to any multiple employer plan or to any plan described in Section 413 of the Code. (d) NO SELF-INSURED PLANS. Neither FP1096 nor any ERISA Affiliate has ever maintained, established sponsored, participated in or contributed to any self-insured plan that provides benefits to employees (including, without limitation, any such plan pursuant to which a stop-loss policy or contract applies). (e) NO POST-EMPLOYMENT OBLIGATIONS. No FP1096 Employee Plan or Employee Agreement provides, or reflects or represents any liability to provide, retiree life insurance, retiree health or other retiree employee welfare benefits to any Person for any reason, except as may be required by COBRA or other applicable statute, and FP1096 has never represented, promised or contracted (whether in oral or written form) to any Employee (either individually or to Employees as a group) or any other Person that such Employee(s) or other Person would be provided with retiree life insurance, retiree health or other retiree employee welfare benefits. (f) EMPLOYMENT MATTERS. FP1096 is in material compliance with all applicable foreign, federal, state and local laws, rules and regulations respecting employment, employment practices, terms and conditions of employment, employee safety and wages and hours. There are no actions, suits, claims, labor disputes or grievances pending or threatened or reasonably anticipated relating to any labor matters involving any Employee, including, without limitation, charges of unfair labor practices. FP1096 is not presently, nor has it been in the past, a party to, or bound by, any collective bargaining agreement or union contract with respect to Employees and no collective bargaining agreement is being negotiated by FP1096. (g) NO INTERFERENCE OR CONFLICT. Neither the execution nor delivery of this Agreement, the License Agreement or the Related Agreements, nor the carrying on of FP1096's, FemmePharma's and their Affiliates' business, as presently conducted or proposed to be conducted, nor any activity of such officers, directors, Employees or consultants in connection with the carrying on of FP1096's, FemmePharma's and their Affiliates' business as presently conducted or currently proposed to be conducted will, to the Knowledge of FP1096, FemmePharma and the Shareholders, conflict with or result in a breach of the terms, conditions, or provisions of, or constitute a default under, any contract or agreement under which any of such officers, directors, Employees or consultants is now bound. (h) INTERNATIONAL EMPLOYEE PLAN. Neither FP1096 nor any ERISA Affiliate currently has, nor has it ever had, the obligation to maintain, establish, sponsor, participate in, be bound by or contribute to any International Employee Plan. 3.23 INSURANCE. The FP1096 Disclosure Letter lists all insurance policies and fidelity bonds covering the assets, business, equipment, properties, operations, employees, officers and directors of FP1096, including the type of coverage, the carrier, the amount of coverage, the term and the annual premiums of such policies. There is no claim pending under any of such policies or bonds as to which coverage has been questioned, denied or disputed or that FP1096 has a reason to believe will be denied or disputed by the underwriters of such policies or bonds. In addition, there is no pending claim of which its total value (inclusive of defense expenses) will -35- exceed the policy limits. All premiums due and payable under all such policies and bonds have been paid, (or if installment payments are due, will be paid if incurred prior to the Closing Date) and FP1096 is otherwise in material compliance with the terms of such policies and bonds (or other policies and bonds providing substantially similar insurance coverage). Such policies and bonds (or other policies and bonds providing substantially similar coverage) have been in effect since the incorporation of FP1096 and remain in full force and effect. FP1096 has no Knowledge or reasonable belief of threatened termination of, or premium increase with respect to, any of such policies. FP1096 has never maintained, established, sponsored, participated in or contributed to any self-insurance plan. 3.24 COMPLIANCE WITH LAWS. FP1096 has complied with, is not in violation of, and has not received any notices of violation with respect to, any Law. Notwithstanding the foregoing, regulatory matters are exclusively addressed in Section 3.7. 3.25 WARRANTIES; INDEMNITIES. Except as set forth in Section 3.25 of the FP1096 Disclosure Letter and warranties implied by law, FP1096 has not given any warranties or indemnities relating to products or technology sold or services rendered by FP1096. 3.26 COPIES OF MATERIALS. Prior to the Closing Date, K-V has been provided copies of, and access to, all regulatory materials, Regulatory Documentation and Data filed by or under authority of FP1096 with Regulatory Authorities and the supporting Data therefor relevant to the K-V Products, as required to support the Development, Manufacture and Regulatory Approval of the K-V Products, as has been developed by or on behalf of FP1096, and FP1096 has at all relevant times, and Surviving Corporation has as of the Closing Date, the right to disclose such subject matter to K-V and any other Person. 3.27 FULL DISCLOSURE. To the Knowledge of FP1096, neither this Agreement, the License Agreement or the Related Agreements, including all exhibits, schedules and certificates thereto furnished by FP1096 or FemmePharma, contains, or will contain at the Effective Time, any untrue statement of a material fact, or omits or will omit at the Effective Time to state any material fact necessary in order to make the statements contained herein or therein, in the light of the circumstances under which made, not misleading. 3.28 INFORMATION STATEMENT. The information furnished on or in any document mailed, delivered or otherwise furnished to Shareholders by FP1096 in connection with the solicitation of their consent to this Agreement, the License Agreement, the Related Agreements and the transactions contemplated hereby and thereby: (a) did not contain, at or prior to the Effective Time, any untrue statement of a material fact, (b) complied in all respects with the Charter Documents, Pennsylvania Law and all other applicable Law, (c) specified the approval by the Shareholders of the appointment of the Seller Representative, (d) included a description of the Merger, this Agreement, the License Agreement, the Related Agreements and the transactions contemplated hereby and thereby, (e) included a statement that appraisal rights are available for FP1096 Capital Stock pursuant to Pennsylvania Law in accordance with the terms thereof, (f) were submitted to and approved by K-V prior to their distribution and (g) included the recommendation of the Board of Directors of FP1096 in favor of the Merger, this Agreement, the License Agreement, the Related Agreements and the transactions contemplated hereby and -36- thereby, and the conclusion of FP1096's Board of Directors that the terms and conditions of the Merger are fair and reasonable to the Shareholders. 3.29 OWNERSHIP OF FP1096 CAPITAL STOCK. Each Shareholder is the sole record and beneficial owner of FP1096 Capital Stock designated as being owned by such Shareholder opposite such Shareholder's name in the FP1096 Disclosure Letter. Such FP1096 Capital Stock is not subject to any Liens or to any rights of first refusal of any kind, and such Shareholder has not granted any rights to purchase such FP1096 Capital Stock to any other Person. Such FP1096 Capital Stock constitutes all of the FP1096 Capital Stock owned, beneficially or of record, by such Shareholder, and such Shareholder has no other options, warrants or other rights to acquire FP1096 Capital Stock. At the Effective Time, in exchange for the consideration paid pursuant to Article II, K-V will receive good title to such FP1096 Capital Stock, subject to no Liens retained, granted or permitted by such Shareholder or FP1096. 3.30 ABSENCE OF CLAIMS BY THE SHAREHOLDERS. None of the Shareholders have any claim against FP1096, whether present or future, contingent or unconditional, fixed or variable, under any contract or on any other basis whatsoever, whether in equity or at law. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF K-V AND K-V SUB Each of K-V and K-V Sub jointly and severally hereby represents and warrants to FP1096 as follows: 4.1 ORGANIZATION, STANDING AND POWER. K-V is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. K-V Sub is a corporation duly organized, validly existing and in good standing under the laws of Pennsylvania. Each of K-V and K-V Sub has the corporate power to own its properties and to carry on its business as now being conducted and is duly qualified or licensed to do business and is in good standing in each jurisdiction in which the failure to be so qualified or licensed would have a material adverse effect on the business, assets, including intangible assets, condition, financial or otherwise, results of operation or capitalization of K-V, taken as a whole (a "K-V --- Material Adverse Effect"); provided, however, that in no event shall any - ----------------------- ----------------- occurrence relating to the industry in which K-V operates as a whole, other than that which affects K-V disproportionately, be considered a K-V Material Adverse Effect. 4.2 AUTHORITY. Each of K-V and K-V Sub has all requisite corporate power and authority to enter into this Agreement, the License Agreement and any Related Agreements to which it is a party and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement, the License Agreement and any Related Agreements to which it is a party and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of K-V and K-V Sub. This Agreement, the License Agreement and any Related Agreements to which K-V and K-V Sub are parties have been duly executed and delivered by K-V and K-V Sub and constitute the -37- valid and binding obligations of K-V and K-V Sub, enforceable against each of K-V and K-V Sub in accordance with their terms, except as such enforceability may be limited by principles of public policy and subject to the laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of Law governing specific performance, injunctive relief or other equitable remedies. 4.3 CONSENTS. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity, is required by or with respect to K-V or K-V Sub in connection with the execution and delivery of this Agreement, the License Agreement and any Related Agreements to which K-V or K-V Sub is a party or the consummation of the transactions contemplated hereby and thereby, except for (i) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable securities laws, (ii) such consents, waivers, approvals, orders, authorizations, registrations, declarations and filings which, if not obtained or made, would not have a K-V Material Adverse Effect, and (iii) the filing of the Merger Certificate or like instrument with the Secretary of the Commonwealth of Pennsylvania. 4.4 CAPITAL RESOURCES. K-V has sufficient capital resources to pay the Merger Consideration. 4.5 BROKER'S AND FINDERS' FEES. Neither K-V nor K-V Sub has incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders' fees or agents' commissions or any similar charges in connection with this Agreement or any transaction contemplated hereby. 4.6 NO CONFLICTS. The execution and delivery of this Agreement, the License Agreement and any Related Agreement to which K-V or K-V Sub is a party do not, and the consummation of the transactions contemplated hereby and thereby will not, conflict with or result in any conflict with: (i) any provision of the articles or certificate of incorporation or bylaws of K-V or K-V Sub, as amended, (ii) any mortgage, indenture, lease, contract or other agreement or instrument, permit, concession, franchise or license to which K-V or any of its respective properties or assets are subject, or (iii) any Law or Order applicable to K-V or K-V Sub or their respective properties or assets, except in each case where such conflict will not have a K-V Material Adverse Effect. 4.7 INTERIM OPERATIONS OF K-V SUB. K-V Sub was formed solely for the purpose of engaging in the transactions contemplated by this Agreement and has engaged in no business activities other than as contemplated by this Agreement. ARTICLE V ADDITIONAL AGREEMENTS 5.1 CONFIDENTIALITY. (a) The terms, conditions, subject matter and transactions contemplated by this Agreement, including, if applicable, the termination of this Agreement and the reasons therefor, shall be considered "Confidential Information" (as further defined in paragraph (d) -38- below) that each party will maintain as confidential. Notwithstanding anything herein to the contrary, each of the parties hereto has the right to disclose the terms and conditions of this Agreement, without the prior written consent of the other party hereto: (i) in confidence to its directors, officers, employees, accountants, legal counsel, agents, advisors, lenders, investors and on a need-to-know basis to others under conditions which reasonably ensure the confidentiality thereof; (ii) as required by any court or other governmental body, or by the New York Stock Exchange; (iii) as otherwise required by Law; (iv) in confidence, in connection with the enforcement of this Agreement or rights under this Agreement; or (v) as required in connection with any government or regulatory filings, including without limitation filings with the SEC. In addition, (i) FemmePharma may issue a press release generally announcing the transaction contemplated hereby provided it obtains the prior written consent of K-V to such press release, which consent shall not be unreasonably withheld, and (ii) K-V may issue a press release generally announcing the transaction contemplated hereby with or without such consent. (b) FP1096 recognizes that by reason of FP1096's ownership of the Transferred Assets and the Transferred Liabilities prior to the Closing, FP1096 may acquire FemmePharma Confidential Information. Accordingly, FP1096 and K-V covenant and agree that, following the Closing, FP1096 and K-V shall treat such FemmePharma Holding Company Confidential Information in the same manner that it treats its own valuable confidential information and shall not disclose such FemmePharma Confidential Information on terms differently than it treats its own confidential information, except to the extent: (i) such information becomes generally known to the public through no fault of FP1096 or K-V, (ii) FP1096 or K-V; is advised in writing by counsel that disclosure is required by Law or the order of any Governmental Entity, or (iii) FP1096 or K-V reasonably believes that such disclosure is required in connection with the defense of a lawsuit; provided, that prior to disclosing any information pursuant to clause (i), (ii) or (iii) above, FP1096 and K-V shall give prior written notice thereof to FemmePharma and provide FemmePharma with the opportunity to contest such disclosure and to seek confidential treatment thereof, and shall reasonably cooperate with such efforts of FemmePharma. "FemmePharma Holding Company Confidential Information" means written information identified as "FemmePharma Holding Company Confidential Information" that has not been disclosed to the public and that does not relate to the FP1096 Business or the Retained Assets. (c) FemmePharma recognizes that by reason of FP1096's ownership of the FP1096 Business and the Retained Assets prior to the Closing, FemmePharma has acquired Confidential Information related to FP1096, the FP1096 Business and the Retained Assets, the use or disclosure of which after the Closing could cause FP1096 or its Affiliates substantial loss and damages that could not be readily calculated and for which no remedy at law would be adequate. Accordingly, FemmePharma covenants and agrees that, following the Closing, it shall treat such Confidential Information in the same manner that it treats its own valuable confidential information, and shall not use or disclose such Confidential Information, except as expressly authorized in this Agreement and except to the extent: (i) such information becomes generally known to the public through no fault of FemmePharma, (ii) FemmePharma is advised in writing by counsel that disclosure is required by Law or the order of any Governmental Entity, or (iii) FemmePharma reasonably believes that such disclosure is required in connection with the defense of a lawsuit; provided, that prior to disclosing any information pursuant to clause (i), (ii) or (iii) above, FemmePharma shall give prior written notice thereof to K-V and provide K-V -39- with the opportunity to contest such disclosure and to seek confidential treatment thereof, and shall reasonably cooperate with such efforts of K-V. FemmePharma also covenants and agrees that following the Closing Date it shall monitor compliance under and enforce the terms of its Proprietary Information Agreements as reasonably necessary to prevent the misuse or disclosure of such Confidential Information. (d) In addition to the provisions of Section 5.3(a), the term "Confidential Information" means information that has not been disclosed to the public with respect to the present or future business, operations, services, products or Technology relating to the FP1096 Business and the Retained Assets, including confidential and proprietary information and trade secrets of third parties learned in confidence pursuant to a written confidentiality agreement. Notwithstanding anything to the contrary, all Confidential Information within the FP1096 Business and the Retained Assets (which, as set forth in the Asset Contribution Agreement, is all information (including Data) "to the extent related to the K-V Products and the FP1096 Business") shall be deemed to be the Confidential Information of K-V and Surviving Corporation under this Agreement, and not the Confidential Information of FemmePharma or its Affiliates, for purposes of this Agreement, the License Agreement and the Related Agreements, including Section 5.3(a). For the avoidance of doubt, the parties acknowledge and agree that, as set forth in the Asset Contribution Agreement, all information (including Data) of FP1096 to the extent not related to the K-V Products or the FP1096 Business is included in the Transferred Assets now owned by FemmePharma and is not Confidential Information. 5.2 EXPENSES. Whether or not the Merger is consummated, all fees and expenses incurred in connection with the Merger including, without limitation, all legal, financial advisory, consulting and all other fees and expenses of third parties and severance/termination fees and expenses incurred by a party in connection with the negotiation and effectuation of the terms and conditions of this Agreement and the transactions contemplated hereby ("Third Party Expenses"), shall be the obligation of the respective -------------------- party incurring such fees and expenses; provided, however, that all Third ----------------- Party Expenses of FP1096 incurred prior to the Effective Time, including the cost of the Appraisal, shall be either paid by FP1096 prior to such time or be borne by FemmePharma. 5.3 FIRPTA COMPLIANCE. On the Closing Date, FP1096 shall deliver to K-V a properly executed statement (a "FIRPTA Compliance Certificate") in a ----------------------------- form reasonably acceptable to K-V for purposes of satisfying K-V's obligations under Treasury Regulation Section 1.1445-2(c)(3). 5.4 ADDITIONAL DOCUMENTS AND FURTHER ASSURANCES. Each party hereto, at the request of another party hereto, shall execute and deliver such other instruments and do and perform such other acts and things as may be necessary or desirable for effecting completely the consummation of the Merger and the transactions contemplated hereby. 5.5 RETAINED EMPLOYMENT LIABILITIES. From and after the Closing Date, FemmePharma shall assume, and be solely responsible for: (i) all Employment Liabilities whether incurred before, on or after the Closing Date, and (ii) providing continuation coverage under COBRA to those individuals who are M&A qualified beneficiaries of FP1096 (as defined -40- in Treasury Regulation Section 54.4980B-9, Q&A-4(a)) with respect to the transactions contemplated by this Agreement (collectively, the "Retained -------- Employment Liabilities"). - ---------------------- 5.6 ADDITIONAL INFORMATION. FemmePharma shall promptly supply K-V and K-V Sub with any information, statements and certificates that may be required in order to effectuate filings, notices, petitions or statements required by any Governmental Entity in connection with the Merger and the transactions contemplated hereby, including, without limitation, any filings required under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, or any rules and regulations of the SEC or the New York Stock Exchange. FemmePharma shall give K-V notice and copies (if applicable) of all future correspondence, notices and other communications received from the FDA or other Regulatory Authorities relating to the Initial Danazol Product and, unless requested by K-V in writing, will no longer communicate with the FDA or such other Regulatory Authorities with respect to the Initial Danazol Product. 5.7 NON-COMMERCIALIZATION. (a) FemmePharma agrees that, on a country by country basis in any country in the world, neither FemmePharma, nor Gerianne M. DiPiano ("DiPiano"), nor any FemmePharma Affiliate (but not including any bona fide ------- third party that acquires all or substantially all of FemmePharma's assets or equity interests) shall directly or indirectly (for example, through licensees or in collaboration with third parties) commercialize any K-V Product during the Non-Commercialization Period. (b) The parties agree that the relevant public policy aspects of the non-commercialization covenant set forth in this Section 5.7 have been discussed, and that every effort has been made to limit the restrictions placed upon FemmePharma, DiPiano or any FemmePharma Affiliate to those that are reasonable and necessary to protect the legitimate interests of K-V and the Surviving Corporation. The restrictions contained in this Section 5.7 are necessary for the protection of the business and goodwill of K-V and the Surviving Corporation and are considered by FemmePharma and DiPiano to be reasonable for such purposes. FemmePharma and DiPiano acknowledge that the non-commercialization covenant set forth in this Section 5.7 will not prevent FemmePharma or DiPiano from operating as successful businesses, earning a livelihood and/or supporting themselves during the relevant time periods. (c) If any restriction set forth in this Section 5.7 is found by any court of competent jurisdiction to be unenforceable because it extends for too long a period of time or over too great a range of activities or geographic area, it shall be interpreted to extend over the maximum period of time, range of activities or geographic areas as to which it may be enforceable. 5.8 TAX MATTERS. (a) FINAL RETURNS. Subject to Section 5.8(d) below, FemmePharma shall timely prepare or cause to be prepared any Returns to be filed by FP1096 or FemmePharma for a period that (i) ends on or before Closing or (ii) begins before Closing and ends after Closing (each a "Final Return"), whenever due. All Final Returns shall be prepared consistently with (i) -41- FP1096's past practice (except to the extent FemmePharma and FP1096 mutually agree that deviations from past practices are required by applicable law), (ii) the financial statements attached in the FP1096 Disclosure Letter hereto, and (ii) the asset valuation set forth in an appraisal of FemmePharma obtained by FP1096 prior to the date hereof. FemmePharma shall deliver a draft of each Final Return to FP1096 for its review and comments at least twenty (20) business days prior to the due date (including applicable extensions) thereof, along with written notice of the due date (including applicable extensions)of the Return. FemmePharma shall consider in good faith any comments provided, or changes suggested, by FP1096 relating to any such Final Return to the extent the comments or changes are provided to FemmePharma at least ten (10) business days prior to the due date (including applicable extensions) of the Final Return, and will use its reasonable efforts to revise the Final Return to incorporate such changes or suggestions, to the extent they either do not materially adversely affect FemmePharma or are consistent with the second sentence of this Section 5.8(a). FP1096 shall timely file the Final Returns for FP1096 prepared in accordance with this Section 5.8(a). FemmePharma shall be responsible for and shall pay (or shall reimburse FP1096 if it is required by law to pay) all Taxes attributable to the taxable period or portion thereof ending on or prior to the Closing Date (the "Pre-Closing Tax Period"), with property and similar taxes allocated to the Pre-Closing Tax Period on a per diem basis. For the avoidance of doubt, the Transferred Liabilities (as defined in the Asset Contribution Agreement) shall be attributable to the Pre-Closing Tax Period. FemmePharma shall be responsible for the timely preparation, filing and delivery of all forms W-2 and 1099 with respect to employees and contractors of FP1096 for the Pre-Closing Tax Period, and will provide FP1096 with copies of such forms within ten (10) days after the filing with the Internal Revenue Service. FemmePharma shall be responsible for the withholding of the appropriate taxes on compensation realized by employees and former employees on the exercise of any options prior to Closing, and will timely pay such amounts to the appropriate tax authorities. (b) COOPERATION. FP1096 and its Affiliates shall cooperate fully with FemmePharma in the preparation of the Final Returns and any Audits (as defined below), including allowing FemmePharma and its representatives access to the books and records of the FP1096, and the employees of FP1096 or K-V and it affiliates as reasonably needed. (c) AUDITS. If FP1096 or an Affiliate receives a notice of a an intention of a Tax authority to audit FP1096 for periods (or a portion of period ) that began before Closing, FP1096 shall notify FemmePharma within five (5) business days of the receipt of the notice. For this purpose, an audit includes any request by a Tax authority or other Governmental Entity for information with respect to Taxes or Returns, and any related administrative or judicial proceedings (an "Audit"). FemmePharma ----- shall have the right to control any Audit and any related administrative or judicial proceedings that relate solely to any taxable period that ends on or prior to the Closing Date. FP1096 may reasonably participate in such proceedings at its own expense. FP1096 shall have the right to control any Audit of FP1096 and any related administrative or judicial proceedings that relate to any taxable period that begins before the Closing Date and ends after the Closing Date or that begins after the Closing Date. FemmePharma may reasonably participate in such proceedings at its own expense if the resolution of such proceedings would give rise to an indemnification obligation on the part of the Shareholders or FemmePharma. FP1096 may not settle, compromise or conclude any Audits that include a period that begins before Closing without the prior written consent of -42- FemmePharma, which shall not be unreasonably withheld, conditioned or delayed. To the extent this Section 5.8(c) is inconsistent with Section 7.3(b), this Section shall control any claims for indemnification with respect to Taxes. (d) AMENDED RETURNS. FP1096 shall not file any amended Returns for periods beginning prior to the Closing Date, without the prior written consent of FemmePharma which consent shall not be unreasonably withheld, conditioned or delayed. (e) NET OPERATING LOSSES. Notwithstanding any other provision of this Agreement to the contrary, FemmePharma and FP1096 make no representations as to the amount or the availability of FP1096's net operating loss carryforward to offset any income of attributable to any taxable period or portion thereof beginning after the Closing Date. For the avoidance of doubt, the preceding sentence is not intended to limit FP1096's representation set forth in Section 3.11(a)(xi) of this Agreement, FP1096 will take no action after Closing that would limit the ability of FP1096 to claim the net operating loss as a deduction on a Final Return, or any amended Final Return, or in an audit of a Final Return. Without limiting the foregoing sentence, K-V shall not make an election pursuant to Section 338 of the Code with respect to the Merger. ARTICLE VI CONDITIONS TO THE MERGER 6.1 CONDITIONS TO OBLIGATIONS OF EACH PARTY TO EFFECT THE MERGER. The respective obligations of FP1096, K-V and K-V Sub to effect the Merger shall be subject to the satisfaction, at or prior to the Effective Time, of the condition that no Governmental Entity shall have enacted, issued, promulgated, enforced or entered any statute, rule, regulation, executive order, decree, injunction or other order, whether temporary, preliminary or permanent, which is in effect and which has the effect of making the Merger illegal or otherwise prohibiting consummation of the Merger. 6.2 CONDITIONS TO THE OBLIGATIONS OF K-V AND K-V SUB. The obligations of K-V and K-V Sub to consummate and effect this Agreement and the transactions contemplated hereby shall be subject to the satisfaction at or prior to the Effective Time of each of the following conditions, any of which may be waived, in writing, by K-V and K-V Sub: (a) REPRESENTATIONS, WARRANTIES AND COVENANTS. (i) The representations and warranties made in this Agreement by FP1096, FemmePharma and the Shareholders shall be true, correct and complete as of the date hereof and as of the Closing Date, except for those representations and warranties that refer to facts existing at a specific date, which shall be true, correct and complete as of such date, and (ii) FP1096, FemmePharma and the Shareholders shall have performed or complied in all respects with all obligations and covenants required by this Agreement to be performed or complied with by FP1096, FemmePharma and the Shareholders, as the case may be, at or prior to the Closing. -43- (b) THIRD PARTY CONSENTS. FP1096 shall have obtained and delivered to K-V all consents, waivers and approvals listed on Schedule 6.2(b) (the "Third Party Consents"), which Third Party Consents shall be in -------------------- a form reasonably acceptable to K-V. (c) TERMINATION OF AGREEMENTS. FP1096 shall have terminated each of those agreements listed on Schedule 6.2(c) to this Agreement and each such agreement shall be of no further force or effect. (d) RELEASE OF LIENS. K-V shall have received from FP1096 a duly and validly executed copy of all agreements, instruments, certificates and other documents, in form and substance reasonably satisfactory to K-V, that are necessary or appropriate to evidence the release of all Liens set forth in Schedule 6.2(d) to this Agreement. (e) RESIGNATION OF OFFICERS AND DIRECTORS. K-V shall have received a written resignation from each of the officers and directors of FP1096 effective as of the Effective Time. (f) APPRAISAL RIGHTS. No Shareholder shall continue to have a right to exercise appraisal, dissenters' or similar rights under applicable Law with respect to their FP1096 Capital Stock by virtue of the Merger. (g) CERTIFICATE OF FP1096. K-V shall have received a certificate, validly executed by the Chief Executive Officer of FP1096 for and on FP1096's behalf, to the effect that, as of the Closing: (i) all representations and warranties made by FP1096 in this Agreement (other than the representations and warranties of FP1096 as of a specified date, which were true and correct as of such date) were true and correct on the date they were made and are true and correct on and as of the Closing Date as though such representations and warranties were made on and as of such time; (ii) all covenants and obligations under this Agreement to be performed or complied with by FP1096 on or before the Closing have been performed or complied with; and (iii) the conditions to the obligations of K-V and K-V Sub set forth in this Section 6.2 have been satisfied in full (unless otherwise waived in accordance with the terms hereof). (h) CERTIFICATE OF FEMMEPHARMA. K-V shall have received a certificate, validly executed by the Chief Executive Officer of FemmePharma for and on FemmePharma's behalf, to the effect that, as of the Closing: (i) all representations and warranties made by FemmePharma in this Agreement (other than the representations and warranties of FemmePharma as of a specified date, which were true and correct as of such date) were true and correct on the date they were made and are true and correct on and as of the Closing Date as though such representations and warranties were made on and as of such time; -44- (ii) all covenants and obligations under this Agreement to be performed or complied with by FemmePharma on or before the Closing have been performed or complied with; and (iii) the conditions to the obligations of K-V and K-V Sub set forth in this Section 6.2 have been satisfied in full (unless otherwise waived in accordance with the terms hereof). (i) CERTIFICATE OF SECRETARY OF FP1096. K-V shall have received a certificate, validly executed by the Secretary of FP1096, certifying as to: (i) the continuing effectiveness of the Charter Documents of FP1096, and (ii) the valid adoption of resolutions of the Board of Directors of FP1096 (whereby the Merger and the transactions contemplated hereunder, under the License Agreement and under the Related Agreements were approved by the Board of Directors) and (iii) that the shareholders of FP1096 constituting the Requisite Shareholder Vote have approved this Agreement and the consummation of the transactions contemplated hereby. (j) CERTIFICATE OF SECRETARY OF FEMMEPHARMA. K-V shall have received a certificate, validly executed by the Secretary of FemmePharma, certifying as to: (i) the continuing effectiveness of the Charter Documents of FemmePharma, and (ii) the valid adoption of resolutions of the Board of Directors of FemmePharma (whereby the transactions contemplated hereunder, under the License Agreement and under the Related Agreements, as applicable to FemmePharma, were approved by its Board of Directors) and (iii) that the sole stockholder of FemmePharma immediately prior to the Spin Off has approved this Agreement, the License Agreement and the Related Agreements and the consummation of the transactions contemplated hereby and thereby. (k) CERTIFICATES OF GOOD STANDING. K-V shall have received a certificate of good standing regarding FP1096 from the Secretary of State of the Commonwealth of Pennsylvania, and a good standing certificate from each jurisdiction in which FP1096 is qualified to do business, each of which is dated within a reasonable period prior to Closing. (l) FIRPTA CERTIFICATE. K-V shall have received a copy of the FIRPTA Compliance Certificate, validly executed by a duly authorized officer of FP1096. (m) EMPLOYEES. On the Closing Date, FP1096 shall have no employees. (n) EXERCISE OR TERMINATION OF FP1096 OPTIONS AND FP1096 WARRANTS. K-V shall have received evidence reasonably satisfactory to it that all outstanding FP1096 Options and FP1096 Warrants have been exercised in full or terminated immediately prior to the Effective Time. (o) ASSET CONTRIBUTION AGREEMENT. The assignment and transfer from FP1096 to FemmePharma of all of the Transferred Assets and the assumption by FemmePharma of all of the Transferred Liabilities of FP1096 shall have occurred immediately prior to the Effective Time in accordance with the terms of the Asset Contribution Agreement. (p) SPIN OFF. The Spin Off shall have been completed to the satisfaction of K-V. Without limiting the foregoing, FP1096 shall have issued as a dividend to each of its -45- shareholders other than K-V, which exclusion of K-V may be accomplished through the waiver of receipt by K-V of such dividend or some other method that complies with all applicable Laws, all of the issued and outstanding capital stock of FemmePharma in a manner that does not result in the imposition of any Tax on K-V. (q) LICENSE AGREEMENT. The License Agreement shall have been executed and shall be in full force and effect, and FemmePharma shall not be in breach of any provision thereof. (r) RELEASE AGREEMENT. The Release Agreement shall have been executed and shall be in full force and effect, and FemmePharma shall not be in breach of any provision thereof. (s) TRANSITION AGREEMENT. The Transition Agreement shall have been executed and shall be in full force and effect, and FemmePharma shall not be in breach of any provision thereof. (t) ESCROW AGREEMENT. The Escrow Agreement shall have been executed and shall be in full force and effect, and FemmePharma shall not be in breach of any provision thereof. (u) APPRAISAL. FP1096, at its expense, shall have: (i) hired an independent appraiser of recognized standing mutually agreeable to K-V and FP1096 to perform an appraisal of the value of FemmePharma's business, including the Transferred Assets and Transferred Liabilities (the "Appraisal"), and (ii) delivered the Appraisal to FP1096. The Appraisal --------- shall have resulted in an appraised value of the FemmePharma business, including the value of the Transferred Assets and Transferred Liabilities, of no greater than $4,000,000. FP1096 and FemmePharma shall report the Spin Off for all Tax purposes consistent with the Appraisal. (v) DELIVERY OBLIGATIONS. FP1096 and FemmePharma shall have fulfilled all of their delivery obligations set forth in Section 2.11 hereof. (w) NO GOVERNMENTAL OR OTHER ORDER. No court order or regulation shall have been enacted, promulgated, issued or entered against K-V or FP1096 that prohibits consummation of the Merger and the other terminations contemplated by this Agreement. (x) SHAREHOLDER APPROVAL. The Shareholders of FP1096 shall have duly approved and adopted the Merger, this Agreement and the transactions contemplated hereby in accordance with the provisions of applicable Law and FP1096's articles of incorporation and bylaws. 6.3 CONDITIONS TO OBLIGATIONS OF FP1096, FEMMEPHARMA AND THE SHAREHOLDERS. The obligations of FP1096, FemmePharma and each of the Shareholders to consummate and effect this Agreement and the transactions contemplated hereby shall be subject to the satisfaction at or prior to the Effective Time of each of the following conditions, any of which may be waived, in writing, exclusively by FP1096: -46- (a) REPRESENTATIONS, WARRANTIES AND COVENANTS. (i) The representations and warranties of K-V and K-V Sub made in this Agreement shall be true, correct and complete as of the date hereof and as of the Closing Date, as though made on such date, except for those representations and warranties that refer to facts existing at a specific date, which shall be true, correct and complete as of such date, and (ii) K-V and K-V Sub shall have performed or complied with all obligations and covenants required by this Agreement to be performed or complied with by K-V and K-V Sub, as the case may be, at or prior to the Closing. (b) CERTIFICATE OF K-V. FP1096 shall have received a certificate, validly executed on behalf of K-V by a Vice President for and on its behalf to the effect that, as of the Closing: (i) all representations and warranties made by K-V and K-V Sub in this Agreement (other than the representations and warranties of K-V and K-V Sub as of a specified date, which were true and correct as of such date) were true and correct on the date they were made and are true and correct on and as of the Closing Date as though such representations and warranties were made on and as of such time; and (ii) all covenants and obligations under this Agreement to be performed by K-V and K-V Sub on or before the Closing have been so performed. (c) DELIVERY OBLIGATIONS. K-V shall have fulfilled all of its delivery obligations set forth in Section 2.12 hereof. (d) NO GOVERNMENTAL OR OTHER ORDER. No court order or regulation shall have been enacted, promulgated, issued or entered against K-V or FP1096 prohibits consummation of the Merger and the other terminations contemplated by this Agreement. (e) SHAREHOLDER APPROVAL. FP1096's shareholders shall have duly approved and adopted the Merger, this Agreement and the transactions contemplated hereby in accordance with the provisions of applicable Law and FP1096's articles of incorporation and bylaws. ARTICLE VII SURVIVAL; INDEMNIFICATION 7.1 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All of the representations and warranties of FP1096 and FemmePharma contained in this Agreement, in the License Agreement, in any Related Agreement or in any document, certificate or other instrument required to be delivered hereunder or thereunder, shall survive the Closing Date and remain in full force and effect as follows: (a) until the date that is thirty (30) days after the end date of the longest applicable statute of limitations, including extensions thereof, with respect to representations and warranties made in Section 3.11 (Tax Matters), and (b) until the date that is two (2) years following the Closing Date, with respect to all other representations and warranties provided, however, that if a Claim Notice is given prior to the applicable - ----------------- termination date, then -47- any representation or warranty that is related to such Claim Notice that would otherwise terminate in accordance with clause (a) or (b) of this Section 7.1 will continue to survive indefinitely only with respect to such Claim until the Claim is finally resolved. The representations and warranties of K-V and K-V Sub contained in this Agreement, or in any certificate or other instrument delivered pursuant to this Agreement, shall terminate two (2) years following the Closing Date. 7.2 INDEMNIFICATION. (a) INDEMNIFICATION BY FEMMEPHARMA. Subject to the terms and conditions of this Article VII, FemmePharma (the "Purchaser Indemnifying ---------------------- Party") agrees to indemnify, defend, save and hold harmless K-V and the - ----- Surviving Corporation and their respective officers, directors, agents and assigns (the "Purchaser Indemnified Parties"), against all Damages incurred ----------------------------- in connection with, arising out of, resulting from or incident to: (i) any breach or inaccuracy of a representation or warranty of FP1096 or FemmePharma contained in this Agreement or the Contribution Agreement or in any certificate delivered pursuant hereto or thereto; (ii) any breach or any failure to fulfill, perform or comply with any covenant or agreement made by FP1096 or FemmePharma in this Agreement or the Contribution Agreement or any schedule, exhibit, document, certificate or other instrument delivered pursuant hereto or thereto; provided, however, that with respect to FP1096 only, this clause ----------------- (ii) shall apply only to such breaches and failures to fulfill, perform or comply that occur on or prior to the Closing Date, and such breaches and failures on the part of FP1096 occurring on or prior to the Closing Date shall be part of and included in the Transferred Liabilities; (iii) the Transferred Assets or the Transferred Liabilities, including the failure to obtain consents and waivers to transfer the same; and (iv) the amount of any Dissenting Share Payments. For purposes of clarity, notwithstanding anything to the contrary contained herein, from and after the Closing Date, FemmePharma and the Shareholders shall have no right of contribution or any other right to receive payment or indemnification from FP1096 with respect to any Damage claimed by an Indemnified Party. Payments by a Purchaser Indemnified Party of amounts for which such Purchaser Indemnified Party is indemnified hereunder shall not be a condition precedent to recovery. (b) INDEMNIFICATION BY K-V. Subject to the terms and conditions of this Article VII, K-V (the "Seller Indemnifying Party") agrees ------------------------- to indemnify, defend, save and hold harmless FemmePharma and its officers, directors, agents and assigns (the "Seller Indemnified Party"), against all ------------------------ Damages incurred in connection with, arising out of, resulting from or incident to: (i) any breach or inaccuracy of a representation or warranty of K-V contained in this Agreement or in any certificate delivered pursuant hereto; and -48- (ii) any breach or any failure to fulfill, perform or comply with any covenant or agreement made by K-V in this Agreement, or any schedule, exhibit, document, certificate or other instrument delivered pursuant hereto or thereto. For purposes of this Article VII, (i) each of the Purchaser Indemnifying Party and the Seller Indemnifying Party may be referred to from time to time, as appropriate, as an "Indemnifying Party" or the ------------------ "Indemnifying Parties" and (ii) each of the Purchaser Indemnified Parties -------------------- and the Seller Indemnified Party may be referred to from time to time, as appropriate, as an "Indemnified Party" or the "Indemnified Parties." ----------------- ------------------- 7.3 PROCEDURE. (a) The Indemnified Parties shall cooperate in all reasonable respects with the Indemnifying Parties in the investigation, trial and defense of any lawsuit or action related to a third party Claim and any appeal arising therefrom; provided, however, that the Indemnified ----------------- Parties may at their own cost, participate in negotiations, arbitrations and the investigation, trial and defense of any such lawsuit or action and any appeal arising therefrom. The parties shall cooperate with each other in any notifications to insurers. Notwithstanding anything to the contrary contained herein, an Indemnified Party shall have the right to make a Claim directly against an Indemnifying Party, and seek indemnification directly from such Indemnifying Party under this Article VII for Damages arising out of, attributable to, or resulting from any inaccuracy in or breach of any of the representations, warranties, covenants or agreements of the Indemnifying Party. The Indemnified Party shall be entitled to seek satisfaction of its Claim against the Indemnifying Party in a court of law. (b) If a claim for Damages (a "Claim") is to be made by an ----- Indemnified Party against an Indemnifying Party, the Indemnified Party shall give written notice (a "Claim Notice") to the Indemnifying Party as soon as ------------ reasonably practicable after the Indemnified Party obtains actual knowledge of any fact, condition or event which is reasonably likely to give rise to Damages for which indemnification may be sought under this Article VII. If any lawsuit or enforcement action is filed against an Indemnified Party, written notice thereof shall be given to the Indemnifying Party as promptly as practicable (and in any event within thirty (30) calendar days after the service of the citation or summons). Notwithstanding the foregoing, the failure of the Indemnified Party to give timely notice hereunder for any purpose shall not affect the Indemnified Party's rights to indemnification hereunder, except to the extent that the Indemnifying Party has been damaged by such failure. After such notice, except as provided in the remainder of this paragraph (b), if the Indemnifying Party shall acknowledge in writing to the Indemnified Party that the Indemnifying Party shall be obligated under the terms of the indemnity hereunder in connection with, or otherwise elects to defend, such lawsuit or action, then the Indemnifying Party shall be entitled, at its own election and cost, risk and expense: (i) to take control of the defense and investigation of such lawsuit or action, (ii) to employ and engage attorneys of its own choice to handle and defend the same unless the named parties to such action or proceeding, including any impleaded parties, include both an Indemnifying Party and an Indemnified Party and the Indemnified Party has been advised by counsel that there may be one or more legal defenses available to such Indemnified Party that are different from or additional to those available to the Indemnifying Party or advised that there is a conflict or potential conflict of interest of such counsel, in which event the affected Indemnified Party shall -49- be entitled, at its own cost, risk and expense, to separate counsel of its own choosing and (iii) to compromise or settle such lawsuit or action, which compromise or settlement shall be made only with the prior written consent of the Indemnified Party(ies), such consent not to be unreasonably withheld or delayed; provided, however, that the Indemnifying Parties shall be ----------------- entitled, without consent, to compromise or settle any Claim solely for money damages provided that: (x) such amounts are available under the Escrow Fund pursuant to the Escrow Agreement and (y) the Indemnified Parties are unconditionally released from any further liability with respect to such Claim. (c) If the Indemnifying Party fails to assume the defense of a lawsuit or action within fifteen (15) calendar days after receipt of the Claim Notice, the Indemnified Party against which such lawsuit or action has been asserted will (upon delivering notice to such effect to the Indemnifying Party) have the right to undertake the defense, compromise or settlement of such lawsuit or action on behalf of and for the account and risk of the Indemnifying Party, and the Indemnifying Party shall, upon request of the Indemnified Party, promptly pay to such Indemnified Party, in accordance with the terms of this Article VII, the amount of any Damages resulting from such lawsuit or action, including the amount of Damages incurred by the Indemnified Party in the defense, compromise or settlement thereof, including without limitation attorneys' fees; provided, however, ----------------- that such lawsuit or action shall not be compromised or settled without the written consent of the Indemnifying Party, which consent shall not be unreasonably withheld or delayed. In the event the Indemnified Party assumes the defense of the lawsuit or action, the Indemnified Party will keep the Indemnifying Party informed of the progress of any such defense, compromise or settlement. Subject to the provisions of this Section 7.3 and Section 7.4, the Indemnifying Party shall be liable for any settlement of any action effected pursuant to and in accordance with this Article VII and for any final judgment, subject to any right of appeal, and the Indemnifying Party agrees to indemnify and hold harmless the Indemnified Party from and against any Damages by reason of such settlement or judgment. 7.4 LIMITATION ON INDEMNIFICATION; ESCROW. (a) The indemnification obligations under this Agreement shall be limited to claims for Damages made on or prior to the last date of survival thereof referred to in Section 7.1. The indemnification obligations with respect to any breach of any covenant or agreement pursuant to Section 7.2, shall survive indefinitely with respect to Claims made pursuant to the terms of this Agreement, subject to the provisions of this Section 7.4. (b) Subject to the terms and conditions of this Agreement, the Indemnifying Party shall not be liable for Damages incurred by any Indemnified Party pursuant to Section 7.2 unless and until the aggregate amount of Damages relating to such Claims for which the Indemnified Parties, in the aggregate, are seeking indemnification under Section 7.2 exceeds $150,000 (the "Threshold); provided, however, that in the event the --------- ----------------- aggregate amount of Damages for which the Indemnified Party is seeking indemnification pursuant to Section 7.2 exceeds the Threshold, such party may recover the full amount of such Damages up to, and not in excess of, $1,750,000 (the "Cap"); provided, however, that the Cap shall not apply to --- Claims by the Purchaser Indemnified Party relating to or arising from the Transferred Liabilities, and the Purchaser Indemnified Party may recover the full amount of Damages relating to any such Claim. Notwithstanding the foregoing, nothing contained herein shall limit the amount of -50- recovery or constitute a waiver by any Indemnifying Party or a limitation of any of the rights or remedies of an Indemnified Party arising as a result of FemmePharma's fraud. (c) The Indemnified Parties shall have the right to make a Claim hereunder prior to the time at which the Threshold that is applicable to such Claim has been surpassed for the purposes of asserting such claim within the relevant survival period of the applicable indemnification obligation. Any such Claim made within such period shall, to the extent such Threshold ultimately is met, survive until its final resolution. (d) The Purchaser Indemnified Parties further agree that if for any reason the amount of the Escrow Fund under the Escrow Agreement is insufficient to cover the indemnification claims of the Purchaser Indemnified Parties, the Purchaser Indemnified Parties shall have no recourse whatsoever to any Shareholders for any of such Damages; provided, however, that this provision shall not constitute a waiver by the Purchaser Indemnified Parties or a limitation or restriction of any of the rights or remedies of the Purchaser Indemnified Parties arising as a result of any action, claim or lawsuit based on fraud of a Shareholder. (e) K-V and the Surviving Corporation acknowledge that they are not relying upon any financial forecasts or projections from FP1096 or FemmePharma in connection with the consummation of the transactions contemplated by this Agreement. (f) Each Indemnified Party shall use reasonable commercial efforts to mitigate its losses upon and after having actual knowledge of any event giving rise to an indemnification claim. (g) Any claim for Damages shall be net of any third party payments, tax benefits actually recognized (including tax benefits associated with reclassification of an expense deduction which changes the timing of such deduction) and insurance proceeds actually received by the Indemnified Party. Each Indemnified Party shall be obligated in any claim for indemnification hereunder to make a claim under any applicable insurance policy maintained by it. (h) Notwithstanding any other provision of this Agreement, FemmePharma shall not be considered to be in breach of any of its representations or warranties under this Agreement if and to the extent any such representation or warranty is rendered inaccurate as a result of, and FemmePharma shall not be obligated to provide indemnification with respect to any Taxes or other Damages arising from, either: (i) the breach by K-V of any agreements contained in Section 5.8; or (ii) any transactions taken by or with respect to FP1096 or any of its Subsidiaries on the Closing Date after the Effective Time, other than transactions that are (A) taken in the ordinary course of business and (B) properly allocable to tax periods of FP1096 and its Subsidiaries ending on the Closing Date. (i) Amounts payable in respect of the indemnification obligations under Sections 7.2 hereof shall be treated by the parties as adjustments to the Merger Consideration to the extent not prohibited by law. -51- 7.5 EXCLUSIVE REMEDY. Indemnification pursuant to this Article VII, including claims under the Escrow Agreement, is the sole remedy of the Indemnified Parties for claims arising out of this Agreement or the Contribution Agreement. Notwithstanding any provision in this Agreement to the contrary, in no event shall the Shareholders have any liability under this Agreement except indirectly and only to the extent of such Shareholder's respective interest in the Escrow Fund. 7.6 ESCROW AND ESCROW RELEASE AMOUNT. The parties and the Shareholders hereby agree that any indemnification claims made by Purchaser Indemnified Parties against Purchaser Indemnifying Parties hereunder, to the extent properly made and not disputed hereunder, shall be paid first from the Escrow Fund (notwithstanding that the Purchaser Indemnifying Party was not the only Persons on whose behalf funds were contributed to the Escrow Fund) until the Escrow Fund is exhausted in its entirety or has been released in its entirety in accordance with the terms of the Escrow Agreement, and thereafter, to the extent any amount remains unpaid under Section 8.1(a), shall be paid by FemmePharma; provided, however, that the foregoing clause shall not apply to claims made by Purchaser Indemnified Parties against FemmePharma relating to or arising from the Transferred Liabilities. With respect to any such claim payable from the Escrow Fund, following compliance with the procedures set forth in this Article VII, K-V shall promptly, and in any event not later than ten (10) business days thereafter, give notice to the Escrow Agent of such claim, as provided in the Escrow Agreement. Neither the exercise of nor the failure to exercise such right to give notice of a claim in accordance with the Escrow Agreement will limit any Purchaser Indemnified Party in any manner in the enforcement of any remedies that may be available to it hereunder unless FemmePharma is materially prejudiced by such failure. 7.7 SELLER REPRESENTATIVE. (a) By virtue of the approval of the Merger and this Agreement by the requisite vote of the Shareholders, each of the Shareholders shall be deemed to have agreed to appoint Michael A. DiPiano, Jr. as its agent and attorney-in-fact, as the "Seller Representative" for and on behalf of each of the Shareholders, to give and receive notices and communications, to authorize payment to any Purchaser Indemnified Party pursuant to the terms of this Article VII and the Escrow Agreement, to object to such payments, to agree to, negotiate, enter into settlements and compromises of, and comply with orders of courts with respect to such claims, to negotiate, investigate and resolve all matters relating to this Article VII or the Escrow Agreement, to assert, negotiate, enter into settlements and compromises of, and comply with orders of courts with respect to, any other claim by any Purchaser Indemnified Party against any Shareholder or by any such Shareholder against any Purchaser Indemnified Party or any dispute between any Purchaser Indemnified Party and any such Shareholder, in each case relating to this Agreement, the License Agreement or the Related Agreements or the transactions contemplated hereby or thereby, and to take all other actions that are either: (i) necessary or appropriate in the judgment of the Seller Representative for the accomplishment of the foregoing or (ii) specifically mandated by the terms of this Agreement. No bond shall be required of the Seller Representative, and the Seller Representative shall not receive any compensation for its services. Notices or communications to or from the Seller Representative shall constitute notice to or from the Shareholders. -52- (b) The Seller Representative shall not be liable for any act done or omitted to be done hereunder as Seller Representative while acting in good faith and in the exercise of reasonable judgment. A decision, act, consent or instruction of the Seller Representative, including but not limited to an amendment, extension or waiver of this Agreement, shall constitute a decision of the Shareholders, individually and collectively, and shall be final, binding and conclusive upon the Shareholders; and K-V may rely upon any such decision, act, consent or instruction of the Seller Representative as being the decision, act, consent or instruction of the Shareholders. K-V is hereby relieved from any liability to any Person for any acts done by it in accordance with any such decision, act, consent or instruction of the Seller Representative. ARTICLE VIII GENERAL PROVISIONS 8.1 TERMINATION. This Agreement may be terminated by written notice of termination only as follows: (a) by mutual consent of K-V and FP1096; (b) by either K-V or FP1096 if the Closing has not occurred on or before May 4, 2005, unless the reason that the Closing has not occurred shall be the failure of the party seeking to terminate this Agreement to fulfill its obligations hereunder; or (c) by either K-V or FP1096 if there has been a material misrepresentation or material breach on the part of the other party in the representations, warranties, covenants or agreements contained herein which is not cured within ten business days after such other party has been notified of the intent to terminate this Agreement pursuant to this Section 8.1. Each party expressly (x) acknowledges and agrees that termination of this Agreement pursuant to this Section 8.1 is its exclusive remedy if the events specified in Sections 8.1(a) or (c) shall occur, (y) waives and releases any other rights or remedies it may have in connection with any such events specified in Sections 8.1(a) or (c), at law, in equity, under this Agreement or otherwise, and (z) acknowledges and agrees that in the event of any such termination no party shall have any liability or obligation with respect to any loss, liability or expense (including without limitation reasonable attorneys' fees and expenses) of any other party hereto. 8.2 EFFECT OF TERMINATION. In the event of the termination hereof as expressly permitted under Section 8.1, this Agreement shall forthwith become void and have no effect, and there shall be no liability in respect of this Agreement on the part of any of K-V, FP1096 or their respective officers, directors, or shareholders. In the event of termination hereunder without Closing, each party hereto shall return promptly to the other parties hereto all documents, work papers and other material of the other party furnished or made available to such parties or their representatives or agents, and all copies thereof, and agrees that no information received by any such party or such party's representatives or agents shall be revealed by such party or such party's representatives or agents to any third party or used for the advantage of such party or any other person. 8.3 NOTICES. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by commercial messenger or courier service, or mailed by registered or certified mail (return receipt requested) or sent via facsimile (with acknowledgment of transmission) to the parties at the following addresses (or at such other -53- address for a party as shall be specified by like notice); provided, --------- however, that notices sent by mail will not be deemed given until received: - ------- (a) if to K-V or K-V Sub, to: K-V Pharmaceutical Company 2503 South Hanley Road St. Louis, MO 63144 Attention: Alan Johnson, Senior Vice President, Strategic Planning and Corporate Growth Facsimile No.: (314) 645-4705 with a copy to: K-V Pharmaceutical Company 2503 South Hanley Road St. Louis, MO 63144 Attention: Marc S. Hermelin, Vice Chairman of the Board and Chief Executive Officer Facsimile No.: (314) 645-4705 and to: Wilson Sonsini Goodrich & Rosati Professional Corporation 12 E. 49th Street, 30th Floor New York, NY 10017 Attention: Len Jacoby, Esq. Facsimile No.: (212) 999-5899 (b) if to FP1096 or the Seller Representative, to: FP1096 37 West Avenue, Second Floor Wayne, PA 19087 Attention: Chief Executive Officer Facsimile No.: (610) 995-0825 with a copy to: Morgan, Lewis & Bockius LLP 1701 Market Street Philadelphia, PA 19103 Attention: Manya S. Deehr Facsimile No.: (215) 963-5001 8.4 INTERPRETATION. The words "include," "includes" and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." The table -54- of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 8.5 COUNTERPARTS. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. 8.6 AMENDMENT. This Agreement may be amended by the parties hereto at any time by execution of an instrument in writing. 8.7 ENTIRE AGREEMENT; ASSIGNMENT. This Agreement, the License Agreement, the Related Agreements, the Exhibits hereto, the FP1096 Disclosure Letter and the documents and instruments and other agreements among the parties hereto referenced herein: (i) constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings both written and oral, among the parties with respect to the subject matter hereof, (ii) are not intended to confer upon any other Person any rights or remedies hereunder, and (iii) shall not be assigned by operation of law or otherwise, except that K-V may without consent delegate its obligations hereunder to its Affiliates as long as K-V remains ultimately liable for all of K-V's obligations hereunder and may assign and otherwise transfer its rights and obligations hereunder, in whole or in part, including without limitation its rights under Section 5.7. 8.8 SEVERABILITY. In the event that any provision of this Agreement or the application thereof, becomes or is declared by a court of competent jurisdiction to be illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision to other persons or circumstances will be interpreted so as reasonably to effect the intent of the parties hereto. The parties further agree to replace such void or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the extent possible, the economic, business and other purposes of such void or unenforceable provision. 8.9 OTHER REMEDIES. Any and all remedies herein expressly conferred upon a party will be deemed cumulative with and not exclusive of any other remedy conferred hereby, or by law or equity upon such party, and the exercise by a party of any one remedy will not preclude the exercise of any other remedy. 8.10 GOVERNING LAW; VENUE. This Agreement and all rights and obligations hereunder, including matters of construction, validity and performance, shall be governed by and construed under the laws of the State of Delaware, without giving effect to conflict of law principles which would cause the laws of any other jurisdiction to be applicable hereto, except for the corporate acts of the Merger and Spin Off which shall be governed by and construed under the laws of the Commonwealth of Pennsylvania. With respect to any suit, action or proceeding relating to this Agreement (each a "Proceeding"), each of the parties hereto: (i) irrevocably agrees and ---------- consents to the exclusive jurisdiction and venue of the United States District Court for the District of Delaware, in connection with any matter based upon or arising out of this Agreement or the matters contemplated herein, (ii) agrees that process may be served -55- upon it in any manner authorized by the laws of the State of Delaware, and (iii) waives and covenants not to assert or plead any objection which it may have at any time to the laying of venue in any Proceeding brought in any such court, waives any claim that such Proceeding has been brought in an inconvenient forum and further waives the right to object, with respect to such Proceeding, that such court does not have jurisdiction over such party. 8.11 RULES OF CONSTRUCTION. The parties hereto agree that they have been represented by counsel during the negotiation and execution of this Agreement and, therefor, waive the application of any Law or rule of construction providing that ambiguities in an agreement or other document will be construed against the party drafting such agreement or document. 8.12 WAIVER OF JURY TRIAL. EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT, OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE ACTIONS OF ANY PARTY HERETO IN NEGOTIATION, ADMINISTRATION, PERFORMANCE OR ENFORCEMENT HEREOF. [remainder of page intentionally left blank] -56- IN WITNESS WHEREOF, K-V, K-V Sub, FP1096 and FemmePharma have caused this Agreement to be signed, all as of the date first written above. K-V PHARMACEUTICAL COMPANY By: --------------------------------------- Name: Alan G. Johnson Title: Senior Vice President KESTREL-FALCON ACQUISITION CORPORATION By: --------------------------------------- Name: Alan G. Johnson Title: President, Secretary and Treasurer FP1096, INC. By: --------------------------------------- Name: Gerianne M. Tringali DiPiano Title: President FEMMEPHARMA HOLDING COMPANY, INC. By: --------------------------------------- Name: Gerianne M. Tringali DiPiano Title: President SIGNATURE PAGE TO AGREEMENT AND PLAN OF MERGER EX-21 3 ex21.txt Exhibit 21 LIST OF SUBSIDIARIES ETHEX Corporation, a Missouri corporation Ther-Rx Corporation, a Missouri corporation Particle Dynamics, Inc., a New York corporation DrugTech Corporation, a Delaware corporation EX-23.1 4 ex23p1.txt Exhibit 23.1 Consent of Independent Registered Public Accounting Firm -------------------------------------------------------- The Board of Directors and Shareholders K-V Pharmaceutical Company: We consent to the incorporation by reference in the registration statements (Nos. 33-46400, 33-44927, 333-48252 and 333-85516) on Form S-8 and registration statements (Nos. 333-87402 and 333-106294) on Form S-3 of our reports dated June 14, 2005, with respect to the consolidated balance sheet of K-V Pharmaceutical Company and subsidiaries as of March 31, 2005, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for the year ended March 31, 2005, and the related financial statement schedule for the year ended March 31, 2005, management's assessment of the effectiveness of internal control over financial reporting as of March 31, 2005, and the effectiveness of internal control over financial reporting as of March 31, 2005, which reports appear in the March 31, 2005 annual report on Form 10-K of K-V Pharmaceutical Company. As discussed in Note 2 to the consolidated financial statements, during fiscal 2005, the Company adopted the provisions of Emerging Issues Task Force (EITF) Issue No. 03-6 Participating Securities and the Two-Class Method under FASB Statement No. 128 and EITF Issue No. 04-8 The Effect of Contingently Convertible Instruments on Diluted Earnings per Share. /s/ KPMG LLP St. Louis, Missouri June 14, 2005 EX-23.2 5 ex23p2.txt EXHIBIT 23.2 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM K-V Pharmaceutical Company St. Louis, Missouri We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File Numbers 2-56793, 2-76173, 33-46400, 33-44927, 333-00199, 333-48252 and 333-85516) and Registration Statement on Form S-3 (File Number 333-87402 and 333-106294) of our reports dated June 4, 2004, relating to the consolidated financial statements and schedule of K-V Pharmaceutical Company appearing in the Company's Annual Report on Form 10-K as of and for the year ended March 31, 2004. /s/ BDO Seidman, LLP Chicago, Illinois June 13, 2005 EX-31.1 6 ex31p1.txt EXHIBIT 31.1 ------------ CERTIFICATIONS I, Marc S. Hermelin, Vice Chairman of the Board and Chief Executive Officer, certify that: 1. I have reviewed this Annual Report on Form 10-K of K-V Pharmaceutical Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 14, 2005 /s/ MARC S. HERMELIN ----------------------------------------- Marc S. Hermelin Vice Chairman and Chief Executive Officer (Principal Executive Officer) EX-31.2 7 ex31p2.txt EXHIBIT 31.2 ------------ CERTIFICATIONS I, Gerald R. Mitchell, Vice President and Chief Financial Officer, certify that: 1. I have reviewed this Annual Report on Form 10-K of K-V Pharmaceutical Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 14, 2005 /s/ GERALD R. MITCHELL ------------------------------------------ Gerald R. Mitchell Vice President and Chief Financial Officer (Principal Financial Officer) EX-32.1 8 ex32p1.txt EXHIBIT 32.1 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of K-V Pharmaceutical Company (the "Company") on Form 10-K for the fiscal year ended March 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Marc S. Hermelin, Vice Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Marc S. Hermelin ----------------------------------------- Marc S. Hermelin Vice Chairman and Chief Executive Officer Date: June 14, 2005 (Principal Executive Officer) EX-32.2 9 ex32p2.txt EXHIBIT 32.2 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of K-V Pharmaceutical Company (the "Company") on Form 10-K for the fiscal year ended March 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gerald R. Mitchell, Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Gerald R. Mitchell ------------------------------------------ Gerald R. Mitchell Vice President and Chief Financial Officer Date: June 14, 2005 (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----