-----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, NU0XbCX78F8Wi293MA5pX2yUFwh9TTAOAYIopgJWHkx8pGW+lvsZALdSWUmvEvn4 OxyQq9EA5QK4+BZKTBr8Kg== 0001068800-06-000493.txt : 20060614 0001068800-06-000493.hdr.sgml : 20060614 20060614080059 ACCESSION NUMBER: 0001068800-06-000493 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060614 DATE AS OF CHANGE: 20060614 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: 06903622 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, 2006 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 is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ X ] No [ ] 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. Yes [ X ] 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act). Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [ X ] The aggregate market value of the shares of Class A and Class B Common Stock held by non-affiliates of the registrant as of September 30, 2005, the last business day of the registrant's most recently completed second fiscal quarter, was $548,161,941 and $89,557,184, respectively. As of June 8, 2006, the registrant had outstanding 36,974,977 and 12,524,759 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 2006 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, and 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, regulatory and technological 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 whether any period of exclusivity will 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 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; (14) risks that we may see increased spending as we continue to ramp up our branded business; and (15) 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 May 2005, we entered into a long-term product development and marketing license agreement with Strides Arcolab Limited ("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 is responsible for developing, submitting for regulatory approval and manufacturing the 10 products and we are 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 between them entered into 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. Under a separate agreement, we had previously invested $5.0 million in FemmePharma's convertible preferred stock. Included in the 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 acquired worldwide licensing rights of the endometriosis product, are no longer responsible for milestone payments and royalties specified in the original licensing agreement, and secured exclusive worldwide rights for use of the FemmePharma technology for vaginal anti-infective products. During the fiscal year ended March 31, 2006, the Company recorded expense of $30.4 million in connection with the FemmePharma acquisition that consisted of $29.6 million for acquired in-process research and development and $0.9 million in direct expenses related to the transaction. The acquired in-process research and development charge represented the estimated fair value of the endometriosis product being 3 developed that, at the time of the acquisition, had no alternative future use and for which technological feasibility had not been established. In December 2005, we entered into a financing arrangement with St. Louis County, Missouri related to expansion of our operations in St. Louis County. In total, up to $135.5 million of industrial revenue bonds may be issued to us by St. Louis County relative to capital improvements made through December 31, 2009. This agreement provides that 50% of the real and personal property taxes on up to $135.5 million of capital improvements will be abated for a period of 10 years subsequent to the property being placed in service. The industrial revenue bonds are issued by St. Louis County to us upon our payment of qualifying costs of capital improvements and transfer of such improvements to St. Louis County, which are then leased by us for a period ending December 1, 2019, unless earlier terminated. We have the option at any time to discontinue the arrangement and regain full title to the abated property. The industrial revenue bonds bear interest at 4.25% per annum and are payable as to principal and interest concurrently with payments due under the terms of the lease. Industrial revenue bonds totaling $73.0 million were outstanding at March 31, 2006. We have classified the leased assets as property and equipment and have established a capital lease obligation equal to the outstanding principal balance of the industrial revenue bonds. Lease payments may be made by tendering an equivalent portion of the industrial revenue bonds. As the capital lease payments to St. Louis County may be satisfied by tendering industrial revenue bonds (which is our intention), the capital lease obligation, industrial revenue bonds and related interest expense and interest income, respectively, have been offset for presentation purposes in the Consolidated Financial Statements. In March 2006, we entered into a $43.0 million mortgage loan agreement with one of our primary lenders, in part, to refinance $9.9 million of existing mortgages. The $32.8 million of net proceeds we received from the new mortgage loan will be used for working capital and general corporate purposes. The new mortgage loan bears interest at a rate of 5.91% and matures on April 1, 2021. In fiscal 2006, we expanded our branded prescription nutritional franchise when Ther-Rx introduced Encora(TM), a twice-daily prescription nutritional supplement designed to meet the key nutritional and preventative health needs of women past their childbearing years. Ther-Rx also introduced two new branded hematinic products, Niferex(R) Gold and Repliva 21/7(TM) in fiscal 2006. In February 2006, we entered into an exclusive arrangement with Gedeon Richter, Ltd., a European pharmaceutical company, to market a broad group of generic drug products to the U.S. marketplace. The products will serve the cardiovascular, diabetic and central nervous system markets. Subject to FDA approval and patent expirations, we expect to introduce these products to the U.S. market over the next several years through 2017. During fiscal 2006, we entered into two additional licensing arrangements - one to market both Gynazole-1(R) and Clindesse(TM) in five Scandanavian countries, the other to market Clindesse(TM) in 18 Eastern European countries. These arrangements expanded Gynazole-1(R)'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. We have previously entered into licensing agreements for the right to market Clindesse(TM) in Spain, Portugal, Andorra, Brazil and Mexico. During fiscal 2006, we also received regulatory approvals to market Gynazole-1(R) in 15 Eastern European countries and our first regulatory approval in an Asian market. In fiscal 2006, we received a favorable court ruling in a Paragraph IV patent infringement action filed against us by AstraZeneca based on our ANDA submissions to market generic formulations of Toprol-XL(R). We believe we were the first company to file with the FDA for generic approval of the 100mg and 200mg dosage strengths, a position that may, upon approval, afford us the opportunity for a six-month exclusivity period for marketing these generic versions. The total branded dollar volume of Toprol-XL(R) in 2005 was $1.3 billion, of which the 100mg and 200mg strengths represented nearly half. 4 On June 9, 2006, we replaced our $140.0 million credit line by entering into a new credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320.0 million. The new credit agreement also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50.0 million. The new credit facility is unsecured unless we, under certain specified circumstances, utilize the facility to redeem part or all of our outstanding Convertible Subordinated Notes. Interest is charged under the facility at the lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis points depending on the ratio of senior debt to EBITDA. The new credit agreement contains financial covenants that impose limits on dividend payments, require minimum equity, a maximum senior leverage ratio and minimum fixed charge coverage ratio. The new credit facility has a five-year term expiring in June 2011. (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 21 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. 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 11 internally developed branded pharmaceutical products, all of which incorporate our drug delivery technologies. We have also introduced several technology-improved versions of the four product franchises 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. For the past five years, we have grown net revenues at a compounded annual growth rate of 15.6%. Ther-Rx has grown substantially since its inception in March 1999 and continues to gain market share in its women's healthcare and hematinic family of products. Also, by focusing on the development and marketing of technology-distinguished, multisource drugs, ETHEX has been able to identify and bring to market niche products that leverage our portfolio of drug delivery technologies in a way that produces relatively high gross margin generics/non branded products. 5 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 11 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 $90.1 million in fiscal 2005 to $145.4 million in fiscal 2006 and represented 39.6% of our fiscal 2006 total net revenues. 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 fiscal 1999 from the pharmaceutical division of Wyeth. Sales of Micro-K(R) increased 28.2% to $8.3 million in fiscal 2006. 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 B6. 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 nutritional pre-conception supplement. The fourth 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. The PrimaCare(R) franchise has grown to be the number one branded prenatal prescription vitamin in the U.S. As a result of this, sales of our branded prescription prenatal vitamins increased 56.0% in fiscal 2006 to $50.4 million. 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(TM), the only clinically proven and Federal Food and Drug Administration, or FDA, approved controlled release bioadhesive system. 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, Mexico and Scandanavia. We also received, during fiscal 2006, regulatory approval to market Gynazole-1(R) into 15 Eastern European markets and our first regulatory approval in an Asian market. 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 2006, we introduced two new hematinic products - Niferex(R) Gold and Repliva 21/7(TM). As 6 a result of new prescription growth and the introduction of the two new products, sales of our hematinic product line grew to $36.8 million in fiscal 2006, a 44.8% increase over fiscal 2005. 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(TM) bioadhesive drug delivery technology. Since its launch, Clindesse(TM) has gained 19.7% of the intravaginal bacterial vaginosis market in the United States and generated $22.0 million of sales for its first full year in the market. We have also entered into licensing agreements for the right to market Clindesse(TM) in Spain, Portugal, Andorra, Brazil, Mexico, five Scandanavian markets, and 18 Eastern European countries. In fiscal 2006, we expanded our prescription nutritional franchise when Ther-Rx introduced Encora(TM), a twice-daily prescription nutritional supplement designed to meet the key nutritional and preventative health needs of women past their childbearing years. Based on the addition of new products and our expectation of continued growth in our branded business, Ther-Rx has expanded its branded sales force to approximately 285 specialty sales representatives and sales management personnel. 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 $203.8 million for fiscal 2006, which represented 55.4% 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 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. In fiscal 2006, we launched a new InveAmp(TM) line extension to our pain management business. InveAmp(TM), a unique one unit dose ampoule, was designed to make dispensing of schedule II solutions more effective. Over the past two years, we have introduced a number of new generic/non-branded products and currently have more than 50 new product opportunities in our generic/non-branded products pipeline. Although specialty generic sales resulting from new product introductions were limited during fiscal 2006, we did receive ANDA approval for Prednisolone Sodium Phosphate Liquid 15 mg (base)/5 mL in June 2005 and late in the 2006 fiscal year ANDA approvals for five strengths of Oxycodone Hydrochloride tablets, three strengths of Hydromorphone Hydrochloride tablets and the 30 mg strength of Morphine Sulfate. We also anticipate ANDA approvals for Diltiazem, Levothyroxine and Metoprolol, among other products, in fiscal 2007. In addition to our internal marketing efforts, we have entered into a long-term product development and marketing license agreement with Strides, an Indian generic pharmaceutical developer and manufacturer, for 7 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 February 2006, we entered into an exclusive arrangement with Gedeon Richter, Ltd., a European pharmaceutical company, to market a broad group of generic drug products to the U.S. marketplace. The products will serve the cardiovascular, diabetic and central nervous system markets. Subject to FDA approval and patent expirations, we expect to introduce these products to the U.S. market over the next several years through 2017. Also, late in fiscal 2006, we received a favorable court ruling in a Paragraph IV patent infringement action filed against us by AstraZeneca based on our ANDA submissions to market generic formulations of Toprol-XL(R). We believe we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, a position that may, upon approval, afford us the opportunity for a six month exclusivity period for marketing these generic versions. The total branded dollar volume of Toprol-XL(R) in 2005 was $1.3 billion, of which the 100 mg and 200 mg strengths represented nearly half. 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 45 products in its cardiovascular line, including products to treat angina, arrhythmia and hypertension, as well as for potassium supplementation. The cardiovascular line accounted for 41.9% of ETHEX's net revenues in fiscal 2006. 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. Pain management products accounted for 18.4% of ETHEX's net revenues in fiscal 2006. RESPIRATORY. ETHEX currently markets over 35 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 17.7% of ETHEX's net revenues in fiscal 2006. WOMEN'S HEALTH CARE. ETHEX currently markets over 20 products in its women's healthcare line, all of which are prescription prenatal vitamins. The women's healthcare line accounted for 8.3% of ETHEX's net revenues in fiscal 2006. OTHER THERAPEUTICS. In addition to our core therapeutic lines, ETHEX markets over 40 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 and national drugstore chains, as well as hospitals, nursing homes, independent pharmacies and mail order firms. The inside sales force makes calls to independent pharmacies to create pull-through at the wholesale level. 8 PDI - OUR VALUE-ADDED RAW MATERIAL BUSINESS PDI develops and markets specialty raw material products for the pharmaceutical, nutritional, food, personal care and other 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 materials for the development and manufacture of both existing and new products at our Ther-Rx and ETHEX businesses. Net revenues for PDI were $17.0 million in fiscal 2006, which represented 4.6% 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 brand name products which can expand our existing franchises. During the second quarter of fiscal 2006, Ther-Rx introduced Encora(TM), a new prescription nutritional supplement product, and two new hematinic products, Niferex(R) Gold and Repliva 21/7(TM). 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; 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 that have strong patent protection or can be protected; 9 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 has expanded its branded sales force to approximately 285 specialty sales representatives and sales management personnel. 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 where we can use 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 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: 10 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. 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. ORAL CONTROLLED RELEASE TECHNOLOGIES. The technological leadership 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 11 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. SALES AND MARKETING Ther-Rx has a national sales and marketing infrastructure which includes approximately 285 sales representatives and sales management personnel dedicated to promoting and marketing our branded pharmaceutical products to 12 targeted physician specialists. The Ther-Rx sales force focuses on physician specialists who are identified through available market research as frequent prescribers of products in our therapeutic categories. 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. And in fiscal 2006, we introduced Encora(TM), a new prescription nutritional supplement product, and two new hematinic products, Niferex(R) Gold and Repliva 21/7(TM). By offering multiple products to the same group of physician specialists, we believe 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. PDI 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 2006, our three largest customers accounted for 27%, 16% and 13% of gross revenues. These customers were McKesson Drug Company, Cardinal Health and Amerisource Corporation, respectively. In fiscal 2005 and 2004, these customers accounted for gross revenues of 27%, 16% and 12% and 25%, 16% and 13%, 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. 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 28.2% 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. 13 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 2006, 2005 and 2004, total research and development expenses were $28.9 million, $23.5 million and $20.7 million, respectively. In January 2005, we introduced our 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(TM) bioadhesive drug delivery technology. In fiscal 2006, we introduced Encora(TM), a new prescription nutritional supplement product, and two new hematinic products, Niferex(R) Gold and Repliva 21/7(TM). 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. As part of the May 2005 acquisition of FemmePharma, we assumed development responsibility and secured full worldwide marketing rights to an endometriosis product that had successfully completed Phase II clinical trials. We believe that this transaction allows us to best monitor the drug's continued development to ultimately capitalize on an attractive opportunity in this therapeutic area. The Phase III clinical studies began during the latter part of fiscal 2006. In connection with the FemmePharma acquisition, the Company recorded expense of $30.4 million that consisted of $29.6 million for acquired in-process research and development and $0.9 million in direct expenses related to the transaction. 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 a number of new generic/non-branded products and currently have a large portfolio of opportunities in our generic/non-branded products pipeline. 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. We received ANDA approval for Prednisolone Sodium Phosphate Liquid 15 mg (base)/5 mL in June 2005 and late in the 2006 fiscal year ANDA approvals for five strengths of Oxycodone Hydrochloride tablets, three strengths of Hydromorphone Hydrochloride tablets and the 30 mg. strength of Morphine Sulfate. We anticipate receiving ANDA approvals for Diltiazem, Levothyroxine and Metoprolol, among other products, in fiscal 2007. In addition to our internal marketing efforts, we have entered into a long-term product development and marketing license agreement with 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. In February 2006, we entered into an exclusive arrangement with Gedeon Richter, Ltd., a European pharmaceutical company, to market a broad group of generic drug products to the U.S. marketplace. The products will serve the cardiovascular, diabetic and central nervous system markets. Subject to FDA approval and patent expirations, we expect to introduce these products to the U.S. market over the next several years through 2017. Also, late in fiscal 2006, we received a favorable court ruling in a Paragraph IV patent infringement action filed against us by AstraZeneca based on our ANDA submissions to market generic formulations of Toprol-XL(R). We believe we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, a position that may, upon approval, afford us the opportunity for a six-month exclusivity period for 14 marketing these generic versions. The total branded dollar volume of Toprol-XL(R) in 2005 was $1.3 billion, of which the 100 mg and 200 mg strengths represented nearly half. 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, manufacturing efficiencies, taste-masking, 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. 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 compounds 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 continue 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 35 U.S. patents and have 50 U.S. patent applications pending. In addition, we have 26 foreign issued patents and a total of 131 patent applications pending primarily in Canada, Europe, Australia, Japan, South America, Mexico and South Korea (see Item 1A "Risk Factors - We depend on our patents and other proprietary rights" for additional information). We currently own more than 150 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, 2006, aggregating approximately 1.2 million square feet, are located in the St. Louis, Missouri area. We own facilities with approximately 1.0 million square feet, with the balance under various leases at pre-determined annual rates under agreements expiring from 15 fiscal 2007 through fiscal 2008, subject in most cases to renewal at our option. The purchase option on a 129,000 square foot building leased by us on March 31, 2006 was exercised by us in accordance with the lease agreement and is scheduled to be acquired for $4.9 million in June 2006. 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 PDI. 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 2006, we encountered no serious shortage of any particular raw materials. Although there can be no assurance that raw material supply will not adversely affect our future operations, we do not believe that any 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 for product acquisitions with 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 16 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, time consuming and is subject to inherent uncertainties. 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 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 either invalid or will not be infringed by the 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 non-infringement or invalidity by filing suit, which would in most cases, prevent FDA approval until the suit is resolved or at least 30 months have elapsed (unless 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 17 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. 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 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 NDAs, ANDAs 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. 18 EMPLOYEES As of March 31, 2006, we employed a total of 1,145 employees. We are party to a collective bargaining agreement covering 120 employees that will expire December 31, 2009. We believe that our relations with our employees are good. 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 amended, 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 them. The information posted on our website is not incorporated into this annual report. 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. ITEM 1A. 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 our business. 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. 19 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. 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 20 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. 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 21 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 and operational and financial resources. To manage our growth, we must continue to (1) expand our operational, sales, customer support and financial control systems and (2) hire, train and retain qualified personnel. We cannot assure you that 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, 2006, our three largest customers, which are wholesale distributors, accounted for 27%, 16% and 13% 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 22 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, 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, have had significant effects 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 effects 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 amendments, 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. COMMERCIALIZATION OF A GENERIC PRODUCT PRIOR TO THE FINAL RESOLUTION OF PATENT INFRINGEMENT LITIGATION COULD EXPOSE US TO SIGNIFICANT DAMAGES IF THE OUTCOME OF SUCH LITIGATION IS UNFAVORABLE AND COULD IMPAIR OUR REPUTATION. We could invest a significant amount of time and expense in the development of our generic products only to be subject to significant additional delay and changes in the economic prospects for our products. If we receive FDA approval for our pending ANDAs, particularly our generic version of Toprol-XL(R), we may consider commercializing the product prior to the final resolution of any related patent infringement litigation. The risk involved in marketing a product prior to the final resolution of the litigation may be substantial because the remedies available to the patent holder could include, among other things, damages measured by the profits lost by such patent holder and not by the profits earned by us. Patent holders may also recover damages caused by the erosion of prices for its patented drug as a result of the introduction of our generic drug in the marketplace. Further, in the case of a willful infringement, which requires a complex analysis of the totality of the circumstances, such damages may be trebled. However, in order to realize the economic benefits of some of our products, we may decide to risk an amount that may exceed the profit we anticipate making on our product. There are a number of factors we would need to consider in order to decide whether to launch our product prior to final resolution, including, (i) outside legal advice, (ii) the status of a pending lawsuit, (iii) interim court decisions, (iv) status and timing of the trial, (v) legal decisions affecting other competitors for the same product, (vi) market factors, (vii) liability sharing agreements, (viii) internal capacity issues, (ix) expiration dates of patents, (x) strength of lower court decisions and (xi) potential triggering or forfeiture of exclusivity. An adverse determination in the litigation relating to a product we launch at risk could have a material adverse effect on our business and consolidated financial statements. 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 23 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 District 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 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. 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 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 assurance 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. 24 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 when the credits are accrued. 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 allowances based on our prior experience and our best estimates of the impact that these policies may have in subsequent periods, we cannot assure you that our allowancess 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. 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, the State of Mississippi, New York City, and approximately 40 counties in New York State. The New York City case and all New York County cases have been transferred to the Federal District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation. One of the counties, Erie County, challenged the transfer and the Erie County Case has been remanded to state court. Each of these actions is in the early stages, with fact discovery at beginning phases in the Alabama, Massachusetts and Mississippi cases, but has not yet commenced in the New York City/Counties or the Erie County case. 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. 25 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. OUR GROSS PROFIT MAY FLUCTUATE FROM PERIOD TO PERIOD DEPENDING UPON OUR PRODUCT SALES MIX, OUR PRODUCT PRICING, AND OUR COSTS TO MANUFACTURE OR PURCHASE PRODUCTS. Our future results of operations, financial condition and cash flows will depend to a significant extent upon our branded and generic/non-branded product sales mix. Our sales of branded products create higher gross margins than our sales of generic/non-branded products. As a result, our sales mix (the proportion of total sales between branded products and generic/non-branded products) will significantly impact our gross profit from period to period. During fiscal 2006, sales of our branded products and generic/non-branded products accounted for 39.6% and 55.4%, respectively, of our net revenues. During that same period, branded products and generic/non-branded products contributed 52.7% and 45.9%, respectively, to our consolidated gross profits. Factors that may cause our sales mix to vary include: o the amount of new product introductions; o marketing exclusivity, if any, which may be obtained on certain products; o the level of competition in the marketplace for certain products; o the availability of raw materials and finished products from our suppliers; o the scope and outcome of governmental regulatory action that may involve us; and o periodic dependence on a small number of products for a significant portion of net revenue or income. The profitability of our product sales is also dependent upon the prices we are able to charge for our products, the costs to purchase products from third parties, and our ability to manufacture our products in a cost effective manner. INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. At March 31, 2006, we had $243.0 million of outstanding debt, consisting of $200.0 million of 2.5% Contingent Convertible Subordinated Notes (the "Notes") and a $43.0 million mortgage loan entered into in March 2006. We also have credit agreements with two banks that provide revolving lines of credit for borrowing up to $140.0 million. The credit agreements provide for $80.0 million in revolving lines of credit along with supplemental credit lines of $60.0 million that are available for financing acquisitions. These credit facilities expire in October 2006 and June 2006, respectively. At March 31, 2006, 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. 26 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; 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 or at all. We may also consider issuing additional debt or equity securities in the future to fund potential acquisitions or investments, to refinance existing debt, or for general corporate purposes. If a material acquisition or investment is completed, our operating results and financial condition could change materially in future periods. However, no assurance can be given that additional funds will be available on satisfactory terms, or at all, to fund such activities. 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 that 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 accessible 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 27 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. As circumstances after an acquisition can change, the value of intangible assets may not be realized by us. If we determine that 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. 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. THERE ARE INHERENT UNCERTAINTIES INVOLVED IN THE ESTIMATES, JUDGMENTS AND ASSUMPTIONS USED IN THE PREPARATION OF OUR FINANCIAL STATEMENTS, AND ANY CHANGES IN THOSE ESTIMATES, JUDGMENTS AND ASSUMPTIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. The consolidated and condensed consolidated financial statements that we file with the SEC are prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of financial statements in accordance with U.S. GAAP involves making estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. The most significant estimates we are required to make under U.S. GAAP include, but are not limited to, those related to revenue recognition, sales allowances, inventories and cost of goods sold, determining the useful life or impairment of goodwill and other long-lived assets, litigation outcomes and related liabilities, income taxes and self-insurance programs. We periodically evaluate estimates used in the preparation of the consolidated financial statements for reasonableness, including estimates provided by third parties. Appropriate adjustments to the estimates will be made prospectively, as necessary, based on such periodic evaluations. We base our estimates on, among other things, currently available information, market conditions, historical experience and various assumptions, which together form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although we believe that our assumptions are reasonable under the circumstances, estimates would differ if different assumptions were utilized and these estimates may prove in the future to have been inaccurate. OUR INTERNAL CONTROLS MAY NOT BE SUFFICIENT TO ENSURE TIMELY AND RELIABLE FINANCIAL INFORMATION. As reported under Item 9A of this Form 10-K, our management completed its assessment of the effectiveness of our internal control over financial reporting as of March 31, 2006, and based on that assessment concluded that we maintained effective internal control over financial reporting as of March 31, 2006. Our independent registered public accounting firm, KPMG LLP, has issued an attestation report on management's assessment that expresses unqualified opinions on management's assessment and on the effectiveness of our internal control over financial reporting. However, our operations continue to place stress on our internal controls, and there can be no assurance that our control procedures will continue to be adequate. The effectiveness of our controls and procedures may be limited by a variety of risks, including, among other things, faulty human judgment, simple errors, omissions and mistakes, collusion of two or more people or inappropriate override of procedures. If we fail to have effective internal controls and procedures for financial reporting in place, we may be unable to provide timely, accurate and reliable financial information. 28 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, 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 29 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 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. 30 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. Currently, KV 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 has concluded. The case is expected to be tried in calendar 2006, but no trial date has been set. We intend to vigorously defend our interests; however, we cannot give any assurance we 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 31 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 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 technologies or products; financial results which are different from securities analysts' forecasts; economic and other external factors; and 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, 2006, an aggregate of 3,162,307 shares of our Class A common stock and 356,849 shares of our Class B common stock were issuable upon exercise of outstanding stock options under our stock option plans, and an additional 611,494 shares of our Class A common stock and 1,879,500 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, 2006, 8,691,880 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. MANAGEMENT STOCKHOLDERS CONTROL OUR COMPANY. At March 31, 2006, our directors and executive officers beneficially own approximately 13% of our Class A Common Stock and approximately 62% of our Class B Common Stock. As a result, these persons control approximately 55% 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 32 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. 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" (as defined in the statute) for a period of three years unless certain conditions are met. In addition, our senior management is entitled to certain payments upon a change in control and all of our stock option plans provide for the acceleration of vesting in the event of a change in control of our company. ITEM 1B. UNRESOLVED STAFF COMMENTS ------------------------- None. 33 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 ----------------------------------------------------------------------------------------------------- 30,150 PDI Mfg./Whse. 11/30/07 5 Years(1) 10,000 PDI/KV Lab/Whse. 11/30/06 None 15,000 KV/PDI Office 02/29/08 2 Years(3) 23,000 KV Office/R&D/Mfg. 12/31/06 5 Years(2) 44,100 KV Warehouse 11/30/06 1 Year(4) 128,960 KV Office/Mfg(7) 06/14/11 N/A 121,500 KV Office/Whse./Lab(8) Owned N/A 87,250 KV Mfg. Owned N/A 86,800 KV Lab(5) Owned N/A 302,940 KV Mfg/Whse/ETHEX/Ther-Rx Office(6)(8) Owned N/A 260,160 ETHEX/Ther-Rx/PDI Distribution(8) Owned N/A 96,360 KV Warehouse Owned N/A ---------------------------------------- (1) One five-year option. (2) Two five-year options. (3) Two two-year options. (4) One one-year option. (5) This facility was renovated into an additional research lab facility. (6) This facility was renovated into office space for ETHEX, Ther-Rx and certain KV administrative functions and production space for additional operations. (7) The purchase option on this building, which was leased by the Company on March 31, 2006, was exercised by the Company in accordance with the lease agreement and is scheduled to be acquired for $4.9 million in June 2006. (8) In March 2006, we entered into a $43.0 million mortgage loan agreement with one of our primary lenders secured, in part, by this property. This loan bears interest at a rate of 5.91% and matures on April 1, 2021.
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 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 information set forth under Note 12 - Commitments and Contingencies - to the Consolidated Financial Statements included in Item 8 of this report is incorporated in this Item 3 by reference. 34 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, 2006. 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 64 Vice Chairman of the Board of the Company since 1974; Vice Chairman and Chief Executive Officer since 1975. Gerald R. Mitchell 67 Director since March 2006, Vice President and Chief Financial Officer since 1981. Richard H. Chibnall 50 Vice President, Finance since February 2000. Michael S. Anderson 57 Vice President, Industry Presence and Development since March 2006; Chief Executive Officer, Ther-Rx Corporation from February 2000 to February 2006. Jerald J. Wenker 44 President, Ther-Rx Corporation since June 2004; Vice President, Licensing and New Business Development, Abbott Corporation from January 2002 to April 2004; Vice President and General Manager, Anti-Infective Franchise Abbott Corporation from April 2000 to January 2002. Patricia K. McCullough 54 Chief Executive Officer, ETHEX Corporation since January 30, 2006; Group Vice President, Business Development and Strategic Planning, Taro Pharmaceuticals from September 2003 to January 2006; Senior Vice President, Account Development, Cardinal Health from June 2000 to July 2003. Philip J. Vogt 49 President, ETHEX Corporation since February 2000. Raymond F. Chiostri 72 Chairman and Chief Executive Officer of Particle Dynamics, Inc. since 1999. Paul T. Brady 43 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 48 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.
35 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 8, 2006 was 811 and 364, 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 2006 and 2005, as reported on the New York Stock Exchange were as follows: CLASS A COMMON STOCK --------------------
FISCAL 2006 FISCAL 2005 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- ---------------------- ----------------------- First...................... $24.37 $16.75 $26.24 $22.25 Second..................... 18.27 15.53 23.11 15.31 Third...................... 21.50 16.79 22.14 18.18 Fourth..................... 24.22 20.60 23.20 19.78 CLASS B COMMON STOCK -------------------- FISCAL 2006 FISCAL 2005 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- ---------------------- ----------------------- First...................... $24.72 $16.79 $29.60 $25.00 Second..................... 18.24 15.53 25.05 16.35 Third...................... 21.57 16.83 22.77 18.65 Fourth..................... 24.13 21.27 23.49 20.42
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 2006 and 2005 on 40,000 shares of outstanding Cumulative Convertible Preferred Stock. There were no undeclared and unaccrued cumulative preferred dividends at March 31, 2006. 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 36 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 Note 16 of Notes to Consolidated Financial Statements for information relating to our equity compensation plans. - ---------------------------------------------------------------------------------------------------------------------- Issuer Purchases of Equity Securities - ----------------------------------------------------------------------------------------------------------------------
Period Total number of Average price paid Total number of Maximum number of shares purchased per share shares purchased as shares (or units) (a) part of publicly that may yet be announced plans or purchased under the programs plans or programs - ---------------------------------------------------------------------------------------------------------------------- 1/1/06 - 1/31/06 4,541 $21.88 - - - ---------------------------------------------------------------------------------------------------------------------- 2/1/06 - 2/28/06 600 $22.64 - - - ---------------------------------------------------------------------------------------------------------------------- 3/1/06 - 3/31/06 - - - - - ---------------------------------------------------------------------------------------------------------------------- Total 5,141 $21.97 - - - ---------------------------------------------------------------------------------------------------------------------- (a) Shares were purchased from employees upon their termination pursuant to the terms of the Company's stock option plan.
37 EQUITY COMPENSATION PLAN INFORMATION The following information regarding compensation plans of the Company is furnished as of March 31, 2006, 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 FUTURE ISSUANCE UNDER NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING (EXCLUDING SECURITIES OUTSTANDING OPTIONS, OPTIONS, WARRANTS REFLECTED IN WARRANTS AND RIGHTS AND RIGHTS COLUMN (a)) ------------------------- ------------------------ ------------------------- PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders(1) 3,155,557 $15.83 611,494 Equity compensation plans not approved by security holders(2) 6,750 $3.22 N/A --------- Total 3,162,307 $15.80 ========= (1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 16 of Notes to Consolidated Financial Statements. (2) Consists of options granted to non-employee members of the Board of Directors.
38 EQUITY COMPENSATION PLAN INFORMATION REGARDING CLASS B COMMON STOCK - ----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES REMAINING AVAILABLE FOR FUTURE ISSUANCE UNDER NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING (EXCLUDING SECURITIES OUTSTANDING OPTIONS, OPTIONS, WARRANTS REFLECTED IN WARRANTS AND RIGHTS AND RIGHTS COLUMN (a)) ------------------------- ------------------------ ------------------------- PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders(1) 328,724 $14.38 1,879,500 Equity compensation plans not approved by security holders(2) 28,125 $4.82 N/A ------- Total 356,849 $13.63 ======= (1) Consists of the Company's 2001 Incentive Stock Option Plan. See Note 16 of Notes to Consolidated Financial Statements. (2) Consists of options granted to non-employee members of the Board of Directors.
39 ITEM 6. SELECTED FINANCIAL DATA ----------------------- (in thousands, except per share data)
MARCH 31, -------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Total assets $618,013 $558,317 $528,438 $352,668 $195,192 Long-term debt 241,319 209,767 210,741 10,106 4,387 Shareholders' equity 309,275 292,702 257,749 260,616 158,792 INCOME STATEMENT DATA: YEARS ENDED MARCH 31, -------------------------------------------------------------------- 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- Net revenues $367,618 $303,493 $283,941 $244,996 $204,105 % Increase from prior year 21.1% 6.9% 15.9% 20.0% 14.8% Operating income(a)(b)(c)(d) $ 39,218 $ 52,412 $ 73,771 $ 42,929 $ 49,294 Net income(a)(b)(c)(d) 15,787 33,269 45,848 28,110 31,464 Net income per common share-diluted(e) (f) $ 0.31 $ 0.63 $ 0.84 $ 0.55 $ 0.65 Preferred stock dividends $ 70 $ 70 $ 436 $ 70 $ 70 (a) Operating income in fiscal 2006 included an expense of $30.4 million recognized in connection with the FemmePharma acquisition that consisted of $29.6 million for acquired in-process research and development and $0.9 million for direct expenses related to the transaction (see Note 3 in the accompanying Notes to Consolidated Financial Statements). The impact of this item, which was determined by the Company to not be deductible for tax purposes, was to reduce our diluted earnings per share for fiscal 2006 by $0.60. (b) 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. 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 $0.02 in fiscal 2005. (c) Operating income in fiscal 2004 included a $3.5 million net payment received by us in accordance with a legal settlement and an additional reserve of $1.8 million for attorneys' 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 $0.02 in fiscal 2004. (d) Operating income in fiscal 2003 included a provision 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 $0.20 in fiscal 2003. (e) Previously reported amounts give effect to the three-for-two stock split effected in the form of a 50% stock dividend that occurred on September 29, 2003. (f) Amounts for fiscal 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.
40 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 the 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/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. RESULTS OF OPERATIONS During fiscal 2006, we recorded expense of $30.4 million in connection with the FemmePharma acquisition (see Note 3 to Consolidated Financial Statements) that consisted of $29.6 million for acquired in-process research and development and $0.9 million for direct expenses related to the transaction. The valuation of acquired in-process research and development represented the estimated fair value of the worldwide marketing rights to an endometriosis product we acquired as part of the FemmePharma acquisition that, at the time of the acquisition, had no alternative future use and for which technological feasibility had not been clinically proven. The FemmePharma acquisition expense of $30.4 million reduced our fiscal 2006 diluted earnings per share by $0.60 to $0.31 per diluted share and reduced our fiscal 2006 net income to $15.8 million. Net revenues for fiscal 2006 increased $64.1 million, or 21.1%, from fiscal 2005 as we reported sales growth of 61.4% and 5.4% in our branded products and specialty generics segments, respectively. The resulting $47.9 million increase in gross profit was offset in part by a $30.7 million increase in operating expenses before taking into account the $30.4 million of expense associated with the FemmePharma acquisition. This increase in operating expenses was primarily due to increases in personnel costs, branded marketing and promotions expense, legal and professional expenses, and research and development expense. 41 FISCAL 2006 COMPARED TO FISCAL 2005 NET REVENUES BY SEGMENT -----------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Branded products $ 145,435 $ 90,085 $ 55,350 61.4% as % of net revenues 39.6% 29.7% Specialty generics 203,833 193,402 10,431 5.4% as % of net revenues 55.4% 63.7% Specialty materials 16,988 18,345 (1,357) (7.4)% as % of net revenues 4.6% 6.0% Other 1,362 1,661 (299) (18.0)% ---------- ---------- ---------- Total net revenues $ 367,618 $ 303,493 $ 64,125 21.1%
The growth in branded product sales was due primarily to increased sales of our two anti-infective brands, Clindesse(TM) and Gynazole-1(R), and continued sales growth from our hematinic and prescription prenatal product lines. Clindesse(TM), a single-dose prescription cream therapy indicated to treat bacterial vaginosis, contributed $22.0 million of sales during fiscal 2006. Since its launch in January 2005, Clindesse(TM) has gained 19.7% of the intravaginal bacterial vaginosis market. Sales of Gynazole-1(R), our vaginal antifungal cream product, increased $3.9 million, or 18.3%, to $25.2 million during fiscal 2006. This increase was due primarily to higher pricing as our prescription volume declined 3.6% in fiscal 2006. Sales of our hematinic products in fiscal 2006 increased $11.4 million, or 44.8%, to $36.8 million. The growth in hematinic sales resulted from a 13.8% increase in prescription volume during fiscal 2006, higher pricing and $3.3 million of incremental sales associated with the introduction of two new products, Niferex(R) Gold and Repliva 21/7(TM). Also included in branded product sales was our PreCare(R) product line which continued as the leading branded line of prescription prenatal nutritional supplements in the United States. Sales from our PreCare(R) product line increased $18.1 million, or 56.0%, to $50.4 million in fiscal 2006. This increase was primarily due to sales growth experienced by PrimaCare(R) ONE, our proprietary line extension to PrimaCare(R), as its share of the branded prenatal nutritional supplement market increased to 17.5% at the end of fiscal 2006. The increase in PreCare(R) product sales was also impacted by a temporary fourth quarter supply disruption of PrimaCare(R) ONE in the prior year. The increase in branded product sales was further supplemented by the introduction of Encora(TM), a new prescription nutritional supplement with essential fatty acids, which contributed $1.8 million of incremental revenue during fiscal 2006 and a $1.8 million increase in sales of our Micro-K(R) product line. The increase in specialty generic sales resulted from $16.0 million of increased sales volume from existing products in our cough/cold, pain management and digestive enzyme product lines coupled with $1.5 million of incremental sales volume from new product introductions primarily in our pain management product line. These increases were offset in part by product price erosion of $7.1 million that resulted from pricing pressures on certain products. Although specialty generic sales resulting from new product introductions were limited during fiscal 2006, we did receive late in the fiscal year ANDA approval for five strengths of Oxycodone Hydrochloride tablets and three strengths of Hydromorphone Hydrochloride tablets. Also, late in fiscal 2006, we received a favorable court ruling in a Paragraph IV patent infringement action filed against us by AstraZeneca based on our ANDA submissions to market generic formulations of Toprol-XL(R). We believe we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, a position that may, upon approval, afford us the opportunity for a six-month exclusivity period for marketing these generic versions. The 42 total branded dollar volume of Toprol-XL(R) in 2005 was $1.3 billion, of which the 100 mg and 200 mg strengths represented nearly half. The decrease in specialty material product sales was primarily due to reduced sales on a product that is used by a customer in a chewable vitamin that the customer was in the process of reformulating, coupled with increased competition on our calcium carbonate products. GROSS PROFIT BY SEGMENT -----------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Branded products $ 128,516 $ 78,844 $ 49,672 63.0% as % of net revenues 88.4% 87.5% Specialty generics 111,982 114,616 (2,634) (2.3)% as % of net revenues 54.9% 59.3% Specialty materials 4,732 6,394 (1,662) (26.0)% as % of net revenues 27.9% 34.9% Other (1,506) (4,043) 2,537 62.8% ---------- ---------- ---------- Total gross profit $ 243,724 $ 195,811 $ 47,913 24.5% as % of total net revenues 66.3% 64.5%
The increase in gross profit was primarily due to the significant sales growth experienced by our branded products segment. The higher gross profit percentage on a consolidated basis reflected the impact of our higher margin branded products comprising a larger percentage of net revenues. This effect was offset in part by lower margins in the specialty generics segment due primarily to the impact of price erosion on certain products in the cardiovascular and pain management product lines coupled with a shift in the mix of sales toward lower margin products, particularly in the cough/cold category. The gross profit percentage decrease experienced by specialty materials primarily resulted from higher production costs associated with lower volume and an unfavorable mix of products sold. RESEARCH AND DEVELOPMENT ------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Research and development $ 28,886 $ 23,538 $ 5,348 22.7% as % of net revenues 7.9% 7.8%
The increase in research and development expense was due to increased spending on bioequivalency studies as we continued active development of various branded and generic/non-brand products in our internal and external pipelines and increased personnel expenses related to the growth of our research and development staff. We anticipate that research and development costs for fiscal 2007 will continue to increase based on our growing product development pipeline, the expected cost of the Phase III clinical study on the endometriosis product acquired in the first quarter of fiscal 2006 and other branded and generic opportunities. 43 PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT ---------------------------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Purchased in-process research and development $ 30,441 $ - $ 30,441 NM
During fiscal 2006, we recorded expense of $30.4 million in connection with the FemmePharma acquisition that consisted of $29.6 million for acquired in-process research and development and $0.9 million in direct expenses related to the transaction. The valuation of acquired in-process research and development represents the estimated fair value of the worldwide marketing rights to an endometriosis product we acquired as part of the FemmePharma acquisition that, at the time of the acquisition, had no alternative future use and for which technological feasibility had not been established. The FemmePharma acquisition expense of $30.4 million reduced our diluted earnings per share for the year ended March 31, 2006 by $0.60. SELLING AND ADMINISTRATIVE --------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Selling and administrative $ 140,395 $ 116,638 $ 23,757 20.4% as % of net revenues 38.2% 38.4%
The increase in selling and administrative expense was primarily due to: o $9.8 million increase in personnel costs associated with expansion of the branded sales force in fiscal 2005 and 2006 and increases in management and other personnel to support the overall growth of the business; o $7.3 million increase in branded marketing and promotions expense for promotion of our existing brands, to further promote the launch of Clindesse(TM) and to support the introduction in fiscal 2006 of a new prescription nutritional supplement product and two new hematinic products; and o $6.4 million increase in legal and professional expense commensurate with an increase in litigation activity and evaluation of potential acquisition opportunities. The increase in litigation activity included ongoing costs associated with certain patent infringement actions brought against us on products we market or propose to market. 44 AMORTIZATION OF INTANGIBLE ASSETS ---------------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Amortization of intangible assets $ 4,784 $ 4,653 $ 131 2.8% as % of net revenues 1.3% 1.5%
The increase in amortization of intangible assets was due primarily to a full year's amortization in fiscal 2006 of license costs incurred for a product launched in fiscal 2005 under a co-development arrangement, an increase in amortization of patent and trademark costs, and amortization of the purchase price allocated to the non-compete agreement obtained in the FemmePharma acquisition. LITIGATION ----------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Litigation $ - $ (1,430) $ 1,430 NM
The $1.4 million of income reflected in "Litigation" for fiscal 2005 consisted of a $0.6 million net payment received by us in accordance with a favorable legal settlement of vitamin antitrust litigation and $0.8 million associated with the reversal of excess reserves that resulted from settlement of the Healthpoint litigation in fiscal 2005. OPERATING INCOME ----------------
YEARS ENDED MARCH 31, ----------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Operating income $ 39,218 $ 52,412 $ (13,194) (25.2)%
The decrease in operating income resulted from the $30.4 million in-process research and development charge recorded in connection with the FemmePharma acquisition. 45 INTEREST EXPENSE ----------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Interest expense $ 6,045 $ 5,432 $ 613 11.3%
The increase in interest expense was primarily due to the completion of a number of capital projects during fiscal 2006 and the related reduced level of capitalized interest thereon. INTEREST AND OTHER INCOME -------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Interest and other income $ 5,737 $ 3,048 $ 2,689 88.2%
The increase in interest and other income was primarily due to an increase in interest income on short-term investments and dividends earned on redeemable preferred stock. The increase in interest income resulted from a full year's effect of investing excess cash into short-term investments with higher yielding interest rates. The higher weighted average interest rate earned on short-term investments was offset in part by a decline in the average balance of invested cash. PROVISION FOR INCOME TAXES --------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Provision for income taxes $ 23,123 $ 16,759 $ 6,364 38.0% effective tax rate 59.4% 33.5%
The increase in the effective tax rate was attributable to the non-deductibility for tax purposes of the $30.4 million of expense we recorded for the FemmePharma acquisition. For fiscal 2006, the provision for income taxes was based on an effective tax rate of 33.3 % which was applied to a pre-tax income amount that excluded the FemmePharma acquisition expense of $30.4 million. NET INCOME AND DILUTED EARNINGS PER SHARE -----------------------------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2006 2005 $ % ---------- ---------- ---------- ------- Net income $ 15,787 $ 33,269 $ (17,482) (52.6)% Diluted earnings per share 0.31 0.63 (0.32) (50.8)%
46 The decrease in net income resulted from the $30.4 million in-process research and development charge, or $0.60 per share, we recorded in connection with the FemmePharma acquisition. FISCAL 2005 COMPARED TO FISCAL 2004 NET REVENUES BY SEGMENT -----------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ---------------------- ($ IN THOUSANDS): 2005 2004 $ % ---------- ---------- ---------- ------- Branded products $ 90,085 $ 82,868 $ 7,217 8.7% as % of net revenues 29.7% 29.2% Specialty generics 193,402 182,825 10,577 5.8% as % of net revenues 63.7% 64.4% Specialty materials 18,345 16,550 1,795 10.8% as % of net revenues 6.0% 5.8% Other 1,661 1,698 (37) (2.2)% ----------- ------------- ----------- 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. Sales of Gynazole-1(R), 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. 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 was 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 $9.0 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 an $8.6 million, or 17.6%, 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 approval been received. 47 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 114,616 111,550 3,066 2.7% as % of net revenues 59.3% 61.0% Specialty materials 6,394 4,789 1,605 33.5% as % of net revenues 34.9% 28.9% Other (4,043) (2,833) (1,210) (42.7)% ----------- ------------ ----------- 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 implemented 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%
48 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. 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 and other personnel ($4.3 million) and expansion of the branded sales force ($5.1 million including approximately $1.1 million for sales representatives 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 due to the investment of hiring additional management and field personnel to provide additional resources for future planned product launches; 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 for a product launched under a co-development arrangement in fiscal 2005. 49 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" in fiscal 2005 consisted 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. In the second quarter of fiscal 2004, 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 had in process. 50 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. 51 LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Cash and cash equivalents and working capital were $100.7 million and $311.2 million, respectively, at March 31, 2006, compared to $159.8 million and $302.5 million, respectively, at March 31, 2005. The increase in working capital resulted primarily from a $16.8 million increase in inventories related primarily to new specialty generic products we expect to launch in fiscal 2007, offset in part by a $7.6 million decrease in receivables associated primarily with a $5.2 million increase in the reserve for chargebacks and a $1.7 million increase in the reserve for Medicaid rebates. The increase in the reserve for chargebacks at March 31, 2006 was primarily due to our specialty generics segment experiencing continued price erosion during fiscal 2006 coupled with higher customer inventory levels of our specialty generic products at the end of the year. The impact of increased utilization of our branded products by state Medicaid programs during the past two years resulted in a larger reserve for Medicaid rebates at March 31, 2006. The primary source of operating cash flow used in the funding of our businesses continues to be internally generated funds from product sales. Net cash flow from operating activities was $64.6 million in fiscal 2006 compared to $49.0 in fiscal 2005. This increase resulted primarily from the operating cash flows for fiscal 2005 including an $18.3 million reduction in accrued liabilities attributable to settlement of the Healthpoint litigation which was resolved during fiscal 2005. Net cash used in investing activities included capital expenditures of $58.3 million in fiscal 2006 compared to $63.6 million for the prior year. 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 continues to function as the Company's main distribution facility. The purchase price was paid with cash. The remaining capital expenditures during fiscal 2006 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 2006 consisted of $61.2 million in purchases of short-term marketable securities that were classified as available for sale. In addition, in May 2005, the Company and FemmePharma mutually agreed to terminate the license agreement we entered into with them in April 2002 (see Note 3 to Consolidated Financial Statements). As part of this transaction, we acquired all of the common stock of FemmePharma for a $25.0 million cash payment. In connection with this transaction, we acquired the worldwide marketing rights to an endometriosis product that we are now developing. Also, in May 2005, we entered into a long-term product development and marketing license agreement with Strides, an Indian generic pharmaceutical developer and manufacturer, for exclusive marketing rights in the United States and Canada for 10 new generic drugs. Under a separate agreement, the Company invested $11.3 million in Strides redeemable preferred stock (see Note 3 to Consolidated Financial Statements). Our debt balance was $243.0 million at March 31, 2006 compared to $210.7 million at March 31, 2005 (see Note 10 to Consolidated Financial Statements). In March 2006, we entered into a $43.0 million mortgage loan agreement with one of our primary lenders, in part, to refinance $9.9 million of existing mortgages. The $32.8 million of net proceeds we received from the new mortgage loan will be used for working capital and general corporate purposes. The new mortgage loan bears interest at a rate of 5.91% and matures on April 1, 2021. 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 52 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. At March 31, 2006, we had credit agreements with two banks that provided revolving lines of credit for borrowing up to $140.0 million. The credit agreements provided for $80.0 million in revolving lines of credit along with supplemental credit lines of $60.0 million that were available for financing acquisitions. These credit facilities were to expire in October 2006 and June 2006, respectively. The revolving and supplemental credit lines were unsecured and interest was charged at the lower of the prime rate or the one-month LIBOR rate plus 175 basis points. At March 31, 2006, we had $3.9 million in an open letter of credit issued under the revolving credit line and no cash borrowings under either credit facility. The credit agreements contained financial covenants that imposed 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, 2006, we were in compliance with all of our covenants. On June 9, 2006, we replaced our $140.0 million credit line by entering into a new credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320.0 million. The new credit agreement also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50.0 million. The new credit facility is unsecured unless we, under certain specified circumstances, utilize the facility to redeem part or all of our outstanding Convertible Subordinated Notes. Interest is charged under the facility at the lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis points depending on the ratio of senior debt to EBITDA. The new credit agreement contains financial covenants that impose limits on dividend payments, require minimum equity, a maximum senior leverage ratio and minimum fixed charge coverage ratio. The new credit facility has a five-year term expiring in June 2011. In December 2005, we entered into a financing arrangement with St. Louis County, Missouri related to expansion of our operations in St. Louis County (see Note 11 to Consolidated Financial Statements). Up to $135.5 million of industrial revenue bonds may be issued to us by St. Louis County relative to capital improvements made through December 31, 2009. This agreement provides that 50% of the real and personal property taxes on up to $135.5 million of capital improvements will be abated for a period of 10 years subsequent to the property being placed in service. Industrial revenue bonds totaling $73.0 million were outstanding at March 31, 2006. The industrial revenue bonds are issued by St. Louis County to us upon our payment of qualifying costs of capital improvements, which are then leased by us for a period ending December 1, 2019, unless earlier terminated. We have the option at any time to discontinue the arrangement and regain full title to the abated property. The industrial revenue bonds bear interest at 4.25% per annum and are payable as to principal and interest concurrently with payments due under the terms of the lease. We have classified the leased assets as property and equipment and have established a capital lease obligation equal to the outstanding principal balance of the industrial revenue bonds. Lease payments may be made by tendering an equivalent portion of the industrial revenue bonds. As the capital lease payments to St. Louis County may be satisfied by tendering industrial revenue bonds (which is our intention), the capital lease obligation, industrial revenue bonds and related interest expense and interest income, respectively, have been offset for presentation purposes in the Consolidated Financial Statements. 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, 2006 ----------------------------- Long-term debt obligations(a) $ 243,000 $ 1,681 $ 3,998 $ 4,497 $ 232,824 Operating lease obligations(b) 1,693 1,186 502 5 - Other long-term obligations 5,442 - - - 5,442 ------------------------------------------------------------------ Total contractual cash obligations(c) $ 250,135 $ 2,867 $ 4,500 $ 4,502 $ 238,266 ------------------------------------------------------------------ (a) Holders of the $200.0 million aggregate principal amount of Convertible Subordinated Notes may require the Company to repurchase them for an amount equal to the unpaid principal amount in May 2008. (b) The purchase option on a 129,000 square foot building leased by us on March 31, 2006 was exercised by us in accordance with the lease agreement and is scheduled to be acquired for $4.9 million in June 2006. (c) 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 $42,138.
53 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 facilities, 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. 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 the 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 RECOGNITION AND PROVISIONS FOR ESTIMATED REDUCTIONS TO -------------------------------------------------------------- GROSS REVENUES. Revenue is generally realized or realizable and --------------- earned when persuasive evidence of an arrangement exists, the seller's price to the buyer is fixed or determinable, the customer's payment ability has been reasonably assured and title and risk of ownership have been transferred to the customer, which is typically upon shipment to the customer. Simultaneously with the recognition of revenue, we reduce the amount of gross revenues by recording estimated sales provisions for chargebacks, sales rebates, sales returns, cash discounts and other allowances, and Medicaid rebates. These 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 and actual customer inventory levels, customer rebate arrangements, and current contract sales terms with wholesale and indirect customers. 54 From time to time, we provide incentives to our wholesale customers, such as trade show allowances or stocking allowances that they in turn use to accelerate distribution to their end customers. We believe that such incentives are normal and customary in the industry. Sales allowances are accrued and revenue is recognized as sales are made pursuant to the terms of the allowances offered to the customer. Due to the nature of these allowances, we are able to accurately calculate the required provisions for the allowances based on the specific terms in each agreement. Additionally, customers will normally purchase additional product ahead of regular demand to take advantage of the temporarily lower cost resulting from the sales allowances. This practice has been customary in the industry and we believe would be part of a customer's ordinary course of business inventory level. We reserve the right, with our major wholesale customers, to limit the amount of these forward buys. Sales made as a result of allowances offered on our specialty generics product line in conjunction with trade shows sponsored by our major wholesale customers and for other promotional programs accounted for 11.8% and 15.2% of total gross revenues for fiscal 2006 and fiscal 2005, respectively. In addition, we understand that certain of our wholesale customers have anticipated the timing of price increases and have made, and may continue to make, business decisions to buy additional product in anticipation of future price increases. This practice has been customary in the industry and we believe would be part of a customer's ordinary course of business inventory level. We evaluate inventory levels at our wholesale customers, which accounted for approximately 59% of our unit sales in fiscal 2006, through an internal analysis that considers, among other things, wholesaler purchases, wholesaler contract sales, available end consumer prescription information and inventory data received from our three largest wholesale customers. We believe that our evaluation of wholesaler inventory levels allows us to make reasonable estimates of our reserve balances. Further, our products are typically sold with adequate shelf life to permit sufficient time for our wholesaler customers to sell our products in their inventory through to the end consumer. The following table reflects the fiscal 2006 activity for each reserve that serves to reduce our receivables balance:
Current Provision Current Provision Actual Returns Related to Sales Related to Sales or Credits (in thousands) Beginning Made in the Made in in the Ending Balance Current Period Prior Periods Current Period Balance --------- ----------------- ----------------- -------------- ------- YEAR ENDED MARCH 31, 2006 Accounts Receivable Reserves: Chargebacks $ 9,409 $ 97,605 $ - $ (92,393) $14,621 Sales Rebates 1,246 14,158 - (13,142) 2,262 Sales Returns 2,286 14,212 - (14,325) 2,173 Cash Discounts and Other Allowances 3,880 17,362 - (16,925) 4,317 Medicaid Rebates 4,235 11,031 - (9,322) 5,944 ------- --------- ----- ---------- ------- TOTAL $21,056 $154,368 $ - $(146,107) $29,317 ======= ========= ===== ========== =======
55 The increase in the reserve for chargebacks at March 31, 2006 was primarily due to our specialty generics segment experiencing price erosion during fiscal 2006 coupled with higher customer inventory levels of our specialty generic products at the end of the year. The reserve for sales returns at March 31, 2006 was relatively consistent with the prior year-end balance as improvement in the rate of product returns at our specialty generics segment was offset by an increase in the product return rate at our branded business. The impact of increased utilization of our branded products by state Medicaid programs during the past two years resulted in a larger reserve for Medicaid rebates at March 31, 2006. The increase in reserves for sales rebates and cash discounts and other allowances at March 31, 2006 was primarily due to greater fourth quarter sales in fiscal 2006 compared to the prior year's fourth quarter. The following table reflects the fiscal 2005 activity for each reserve that serves to reduce our receivables balance:
Current Provision Current Provision Actual Returns Related to Sales Related to Sales or Credits (in thousands) Beginning Made in the Made in in the Ending Balance Current Period Prior Periods Current Period Balance --------- ----------------- ----------------- -------------- ------- YEAR ENDED MARCH 31, 2005 Accounts Receivable Reserves: Chargebacks $ 7,475 $ 81,871 $ - $ (79,937) $ 9,409 Sales Rebates 1,815 17,479 - (18,048) 1,246 Sales Returns 4,035 10,505 - (12,254) 2,286 Cash Discounts and Other Allowances 4,261 14,361 - (14,742) 3,880 Medicaid Rebates 3,062 9,048 211 (8,086) 4,235 ------- -------- ---- --------- ------- TOTAL $20,648 $133,264 $211 $(133,067) $21,056 ======= ======== ==== ========= =======
The fiscal 2005 reserve for chargebacks increased primarily due to continued price erosion in the specialty generics segment of our business, which was reflected in an increase in the current provision from 14.2% of sales in fiscal 2004 to 18.7% of sales in fiscal 2005. A reduction in the rate of product returns experienced during fiscal 2005 to 2.4% of sales from 2.8% of sales in fiscal 2004 resulted in the lower reserve for sales returns. Increased utilization of products in our branded products segment by state Medicaid programs during fiscal 2005 resulted in the increase in the reserve for Medicaid rebates, which was reflected in an increase in the related provision from 1.9% of sales in fiscal 2004 to 2.1% of sales in fiscal 2005. Reserves for sales rebates and cash discounts and other allowances declined primarily due to lower fourth quarter sales, in both the retail chain and wholesale distribution channels, compared to the prior year's fourth quarter. The reserves for sales rebates and cash discounts and other allowances require a lower degree of subjectivity, are less complex in nature and are more readily ascertainable due to specific contract terms, rates and consistent historical performance. The reserves for chargebacks, sales returns and Medicaid rebates, however, are more complex and require management to make more subjective judgments. These reserves and their respective provisions are discussed in further detail below. Chargebacks - We market and sell products directly to wholesalers, ----------- distributors, warehousing pharmacy chains, mail order pharmacies and other direct purchasing groups. We also market products indirectly to independent pharmacies, non-warehousing chains, managed care organizations, and group purchasing organizations, collectively referred to as "indirect customers." We enter into agreements with some indirect customers to establish contract pricing for certain products. These indirect customers then independently select a wholesaler from which to purchase the products at these contracted prices. Alternatively, we may pre-authorize wholesalers to offer specified contract pricing to other indirect customers. Under either arrangement, we provide credit to the wholesaler for any difference between the contracted price with the indirect customer and the wholesaler's invoice price. This credit is called a chargeback. 56 Chargeback transactions are almost exclusively related to our specialty generics business segment. During fiscal 2006 and 2005, the chargeback provision reduced the gross sales of our specialty generics segment by $97.0 million and $80.6 million, respectively. These amounts accounted for 99.4% and 98.5% of the total chargeback provisions recorded in fiscal 2006 and 2005, respectively. The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. The primary factors we consider in developing and evaluating the reserve for chargebacks include: |X| The amount of inventory in the wholesale distribution channel. We receive actual inventory information from our three major wholesale customers and estimate the inventory position of the remaining wholesalers based on historical buying patterns. During fiscal 2006, unit sales to our three major wholesale customers accounted for 78% of our total unit sales to all wholesalers, and the aggregate inventory position of the three major wholesalers at March 31, 2006 was approximately equivalent to our last eight weeks of shipments during the fiscal year. We currently use the last six weeks of our shipments as an estimate of the inventory held by the remaining wholesalers where we do not receive actual inventory data, as our experience and buying patterns indicate that our smaller wholesale customers carry less inventory than our large wholesale customers. As of March 31, 2006, each week of inventory for those remaining wholesalers represented approximately $0.2 million, or 1.6%, of the reported reserve for chargebacks. |X| The percentage of sales to our wholesale customers that will result in chargebacks. Using our automated chargeback system we track, at the product level, the percentage of sales units shipped to our wholesale customers that eventually result in chargebacks to us. The percentage for each product, which is based on actual historical experience, is applied to the respective inventory units in the wholesale distribution channel. As of March 31, 2006, the aggregate weighted average percentage of sales to wholesalers assumed to result in chargebacks was approximately 95%, with each 1% representing approximately $0.2 million, or 1.1%, of the reported reserve for chargebacks. |X| Contract pricing and the resulting chargeback per unit. The chargeback provision is based on the difference between our invoice price to the wholesaler (referred to as wholesale acquisition cost, or "WAC") and the contract price negotiated with either our indirect customer or with the wholesaler for sales by the wholesaler to the indirect customers. We calculate the price difference, or chargeback per unit, for each product and for each major wholesale customer using historical weighted average pricing, based on actual chargeback experience. Use of weighted average pricing over time compensates for changes in the mix of indirect customers and products from period to period. As of March 31, 2006, a 5% shift in the calculated chargeback per unit in the same direction across all products and customers would result in a $0.7 million, or 5.0%, impact on the reported reserve for chargebacks. Shelf-Stock Adjustments - These adjustments represent credits ----------------------- issued to our wholesale customers that result from a decrease in our WAC. Decreases in our invoice prices are discretionary decisions we make to reflect market conditions. These credits are customary in the industry and are intended to reduce a wholesale customer's inventory cost to better reflect current market prices. Generally, we provide credits to customers at the time the price reduction occurs based on the inventory that is owned by them on the effective date of the price reduction. Since a reduction in WAC reduces the chargeback per unit, or the difference between WAC and the contract price, shelf-stock adjustments are typically included as part of the reserve for chargebacks because the price reduction credits act essentially as accelerated chargebacks. Although we have contractually agreed to provide price adjustment credits to our major wholesale customers at the time they occur, the impact of any such price reductions not included in the reserve for chargebacks is immaterial to the amount of revenue recognized in any given period. Sales Returns - Consistent with industry practice, we maintain a ------------- returns policy that allows our direct and indirect customers to return product six months prior to expiration and within one year after expiration. This policy is applicable to both our branded and specialty generics business segments. Upon recognition of revenue from 57 product sales to customers, we provide for an estimate of product to be returned. This estimate is determined by applying a historical relationship of customer returns to gross sales. We evaluate the reserve for sales returns by calculating historical return rates using data from the last 12 months on a product specific basis and by class of trade (wholesale versus retail chain). The calculated percentages are applied against estimates of inventory in the distribution channel on a product specific basis. To determine the inventory levels in the wholesale distribution channel, we utilize actual inventory information from our major wholesale customers and estimate the inventory positions of the remaining wholesalers based on historical buying patterns. For inventory held by our non-wholesale customers, we use the last two months of sales to the direct buying chains and the indirect buying retailers as an estimate. A 10% change in the product specific historical return rates used in the reserve analysis would have changed the reserve balance at March 31, 2006 by approximately $0.1 million, or 5.7%, of the reported reserve for sales returns. A 10% change in the amount of estimated inventory in the distribution channel would have changed the reserve balance at March 31, 2006 by approximately $0.1 million, or 6.9%, of the reported reserve for sales returns. Medicaid Rebates - Established in 1990, the Medicaid Drug Rebate ---------------- Program requires a drug manufacturer to provide to each state a rebate every calendar quarter for covered outpatient drugs dispensed to Medicaid patients. Medicaid rebates apply to both our branded and specialty generic segments. Individual states invoice us for Medicaid rebates on a quarterly basis using statutorily determined rates for generic (11%) and branded (15%) products, which are applied to the Average Manufacturer's Price, or "AMP", for a particular product to arrive at a Unit Rebate Amount, or "URA". The amount owed is based on the number of units dispensed by the pharmacy to Medicaid patients extended by the URA. The reserve for Medicaid rebates is based on expected payments, which are driven by patient usage and estimated inventory in the distribution channel. We estimate patient usage by calculating a payment rate as a percentage of net sales lagged six months, which is then applied to an estimate of customer inventory. We currently use the last two months of our shipments to wholesalers and direct buying chains as an estimate of inventory in the wholesale and chain channels and an additional month of wholesale sales as an estimate of inventory held by the indirect buying retailer. A 10% change in the amount of customer inventory subject to Medicaid rebates would have changed the reserve at March 31, 2006 by $0.6 million, or 9.8% of the reported reserve for Medicaid rebates. Similarly, a 10% change in estimated patient usage would have changed the reserve by $0.6 million, or 9.8% of the reported reserve for Medicaid rebates. 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 should 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. Our intangible assets principally 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 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 58 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. We are 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, 2006 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 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. We are currently determining the impact, if any, the adoption of this statement will have on our 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 supersedes 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. 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 adopted SFAS 123R beginning April 1, 2006 using the modified prospective method. Adoption of SFAS 123R will have a significant impact on the Company's consolidated financial statements, as it will be required to expense the fair value of 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. Based on the unvested stock option grants at March 31, 2006, the Company estimates that the adoption of SFAS 123R will 59 reduce consolidated net income for fiscal 2007 between $0.05 and $0.06 per diluted share. This estimate is based, in part, on a projection of our common stock prices and other valuation assumptions related to potential fiscal 2007 stock option grants which are subject to various uncertainties, including our future share-based compensation strategy, stock price volatility, estimated forfeiture rate and employee stock option exercise behavior. Changes in any of the Company's assumptions could cause future expenses to vary significantly from the Company's current estimates. In March 2005, the SEC issued SEC Staff Accounting Bulletin No. 107 ("SAB 107") which describes the SEC staff's position on the application of SFAS 123R. SAB 107 contains interpretive and certain transitional guidance relating to the interaction between SFAS 123R and certain SEC rules and regulations including the SEC's views regarding the valuation of share-based payment arrangements including assumptions related to expected volatility and expected term, first time adoption of SFAS 123R in an interim period, the modification of certain terms of employee share options prior to the adoption of SFAS 123R and disclosures within Management's Discussion and Analysis subsequent to the adoption of SFAS 123R. We are currently evaluating SAB 107 and its guidance and will be adopting it as part of our adoption of SFAS 123R beginning April 1, 2006. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"), which replaces Accounting Principles Board ("APB") Opinion No. 20, "Accounting Changes" ("APB 20") and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements" ("SFAS 3"). SFAS 154 applies to all voluntary changes in accounting principle and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 also requires retrospective application to prior period financial statements involving changes in accounting principle unless it is impracticable to determine either the period-specific or cumulative effect of the change. This statement also requires that a change in the method of depreciation, amortization or depletion of long-lived assets be accounted for as a change in accounting estimate that is accounted for prospectively. SFAS 154 also retains many provisions of APB 20 including those related to reporting a change in accounting estimate, a change in the reporting entity and a correction of an error and also carries forward provisions of SFAS 3 governing the reporting of accounting changes in interim financial statements. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We believe that the adoption of SFAS 154 will not have a material effect on our Consolidated Financial Statements. 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, 2006. 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. 60 In March 2006, we entered into a $43.0 million mortgage loan secured by three of our buildings that matures in April 2021. The interest rate on this loan is fixed at 5.91% per annum and not subject to market interest rate changes. 61 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- Report of Independent Registered Public Accounting Firm ------------------------------------------------------- The Board of Directors and Shareholders K-V Pharmaceutical Company: We have audited the accompanying consolidated balance sheets of K-V Pharmaceutical Company and subsidiaries as of March 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the years then ended. In connection with our audits 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 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 as of March 31, 2006 and 2005, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, 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 EITF 03-6 Participating Securities and the Two-Class Method under SFAS No. 128 and EITF 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, 2006, 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, 2006 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, 2006 62 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Stockholders and Board of Directors K-V Pharmaceutical Company We have audited the accompanying consolidated statements of income, shareholders' equity and cash flows of K-V Pharmaceutical Company and Subsidiaries for the year 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 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 results of operations and cash flows of K-V Pharmaceutical Company and Subsidiaries for the year 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 63 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
MARCH 31, --------------------------- 2006 2005 ---- ---- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents............................................................ $ 100,706 $ 159,825 Marketable securities................................................................ 106,763 45,694 Receivables, less allowance for doubtful accounts of $397 and $461 in 2006 and 2005, respectively.................................................... 54,746 62,361 Inventories, net..................................................................... 70,778 53,945 Prepaid and other assets............................................................. 6,963 9,530 Deferred tax asset................................................................... 8,034 5,827 ----------- ----------- Total Current Assets.............................................................. 347,990 337,182 Property and equipment, less accumulated depreciation................................ 178,042 131,624 Intangible assets and goodwill, net.................................................. 72,955 76,430 Other assets......................................................................... 19,026 13,081 ----------- ----------- TOTAL ASSETS......................................................................... $ 618,013 $ 558,317 =========== =========== LIABILITIES ----------- CURRENT LIABILITIES: Accounts payable..................................................................... $ 17,975 $ 18,011 Accrued liabilities.................................................................. 17,100 15,733 Current maturities of long-term debt................................................. 1,681 973 ----------- ----------- Total Current Liabilities......................................................... 36,756 34,717 Long-term debt....................................................................... 241,319 209,767 Other long-term liabilities.......................................................... 5,442 4,477 Deferred tax liability............................................................... 25,221 16,654 ----------- ----------- TOTAL LIABILITIES.................................................................... 308,738 265,615 ----------- ----------- 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 March 31, 2006 and 2005 (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 39,984,919 and 39,059,428 at March 31, 2006 and 2005, respectively........................................................ 400 391 Class B - issued 12,695,561 and 13,422,101 at March 31, 2006 and 2005, respectively (convertible into Class A shares on a one-for-one basis)... 127 134 Additional paid-in capital........................................................... 129,367 128,182 Retained earnings.................................................................... 233,496 217,779 Accumulated other comprehensive loss................................................. (211) (133) Less: Treasury stock, 3,123,975 shares of Class A and 92,902 shares of Class B Common Stock at March 31, 2006, and 3,111,003 shares of Class A and 92,902 shares of Class B Common Stock at March 31, 2005, at cost................................ (53,904) (53,651) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY........................................................... 309,275 292,702 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 618,013 $ 558,317 =========== =========== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
64 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
YEARS ENDED MARCH 31, ----------------------------------------------- 2006 2005 2004 ------------ ----------- ------------ Net revenues........................................................... $ 367,618 $ 303,493 $ 283,941 Cost of sales.......................................................... 123,894 107,682 98,427 ------------ ----------- ------------ Gross profit........................................................... 243,724 195,811 185,514 ------------ ----------- ------------ Operating expenses: Research and development............................................ 28,886 23,538 20,651 Purchased in-process research and development and transaction costs............................... 30,441 -- -- Selling and administrative.......................................... 140,395 116,638 88,333 Amortization of intangible assets................................... 4,784 4,653 4,459 Litigation.......................................................... -- (1,430) (1,700) ------------ ----------- ------------ Total operating expenses............................................... 204,506 143,399 111,743 ------------ ----------- ------------ Operating income....................................................... 39,218 52,412 73,771 ------------ ----------- ------------ Other expense (income): Interest expense.................................................... 6,045 5,432 5,865 Interest and other income........................................... (5,737) (3,048) (2,092) ------------ ----------- ------------ Total other expense, net.............................................. 308 2,384 3,773 ------------ ----------- ------------ Income before income taxes............................................. 38,910 50,028 69,998 Provision for income taxes............................................. 23,123 16,759 24,150 ------------ ----------- ------------ Net income............................................................. $ 15,787 $ 33,269 $ 45,848 ============ =========== ============ Earnings per common share: Basic - Class A common.............................................. $ 0.33 $ 0.71 $ 0.98 Basic - Class B common.............................................. 0.28 0.59 0.82 Diluted............................................................. $ 0.31 $ 0.63 $ 0.84 ============ =========== ============ Weighted Average Shares Outstanding: Basic - Class A common.............................................. 36,277 34,228 33,046 Basic - Class B common.............................................. 13,065 15,005 15,941 Diluted............................................................. 50,729 59,468 58,708 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
65 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands)
YEARS ENDED MARCH 31, ----------------------------------------------- 2006 2005 2004 ------------ ----------- ------------ Net income............................................................. $ 15,787 $ 33,269 $ 45,848 Other comprehensive income (loss): Unrealized loss on available for sale securities.................... (118) (201) -- Less related taxes.................................................. 40 68 -- ------------ ----------- ------------ Total unrealized loss on available for sale securities, net...... (78) (133) -- ------------ ----------- ------------ Total comprehensive income............................................. $ 15,709 $ 33,136 $ 45,848 ============ =========== ============ SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
66 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2006, 2005 AND 2004 ----------------------------------------------------- CLASS A CLASS B ADDITIONAL PREFERRED COMMON COMMON PAID-IN STOCK STOCK STOCK CAPITAL ----- ----- ----- ------- (Dollars in thousands) BALANCE AT MARCH 31, 2003................................ $ -- $ 236 $ 106 $120,961 Net income............................................... -- -- -- -- Dividends paid on preferred stock........................ -- -- -- -- 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.................... -- -- -- -- Three-for-two stock dividend............................. -- 120 53 -- 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 Net income............................................... -- -- -- -- Dividends paid on preferred stock........................ -- -- -- -- 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.................... -- -- -- -- 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 Net income............................................... -- -- -- -- Dividends paid on preferred stock........................ -- -- -- -- Conversion of 736,778 Class B shares to Class A shares -- 7 (7) -- Purchase of common stock for treasury.................... -- -- -- -- Stock options exercised - 188,713 shares of Class A and 10,238 shares of Class B.......................... -- 2 -- 1,185 Unrealized loss on marketable securities available for sale, net of related taxes of $40................. -- -- -- -- ----------------------------------------------------- BALANCE AT MARCH 31, 2006................................ $ -- $ 400 $ 127 $129,367 ================================================================================================================= YEARS ENDED MARCH 31, 2006, 2005 AND 2004 ----------------------------------------------------------------- ACCUMULATED OTHER TOTAL TREASURY RETAINED COMPREHENSIVE SHAREHOLDERS' STOCK EARNINGS LOSS EQUITY ----- -------- ---- ------ (Dollars in thousands) BALANCE AT MARCH 31, 2003................................ $ (28) $139,341 $ -- $260,616 Net income............................................... -- 45,848 -- 45,848 Dividends paid on preferred stock........................ -- (436) -- (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) -- -- (51,155) Three-for-two stock dividend............................. -- (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................ -- -- -- 2,371 ----------------------------------------------------------------- BALANCE AT MARCH 31, 2004................................ (51,183) 184,580 -- 257,749 Net income............................................... -- 33,269 -- 33,269 Dividends paid on preferred stock........................ -- (70) -- (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) -- -- (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................................ (53,651) 217,779 (133) 292,702 Net income............................................... -- 15,787 -- 15,787 Dividends paid on preferred stock........................ -- (70) -- (70) Conversion of 736,778 Class B shares to Class A shares -- -- -- -- Purchase of common stock for treasury.................... (253) -- -- (253) Stock options exercised - 188,713 shares of Class A and 10,238 shares of Class B.......................... -- -- -- 1,187 Unrealized loss on marketable securities available for sale, net of related taxes of $40................. -- -- (78) (78) ----------------------------------------------------------------- BALANCE AT MARCH 31, 2006................................ $(53,904) $233,496 $(211) $309,275 ============================================================================================================================= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
67 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
YEARS ENDED MARCH 31, ----------------------------------------------- 2006 2005 2004 ------------- ------------ ----------- Operating Activities: Net income............................................................. $ 15,787 $ 33,269 $ 45,848 Adjustments to reconcile net income to net cash provided by operating activities: Acquired in-process research and development........................ 29,570 -- -- Depreciation, amortization and other non-cash charges............... 18,002 13,904 12,663 Deferred income tax provision....................................... 6,707 13,582 8,691 Deferred compensation............................................... 965 1,355 209 Litigation.......................................................... -- (843) 1,825 Changes in operating assets and liabilities: Decrease (increase) in receivables, net............................. 7,615 3,511 (8,487) Increase in inventories............................................. (16,833) (3,248) (9,977) Decrease (increase) in prepaid and other assets..................... 1,372 (3,520) (6,294) Increase (decrease) in accounts payable and accrued................. liabilities...................................................... 1,424 (8,980) (10,471) ------------- ------------ ----------- Net cash provided by operating activities.............................. 64,609 49,030 34,007 ------------- ------------ ----------- Investing Activities: Purchase of property and equipment.................................. (58,334) (63,622) (21,792) Purchase of marketable securities................................... (61,187) (10,565) (278) Purchase of stock and intangible assets............................. (11,300) -- (4,000) Product acquisition................................................. (25,643) -- (14,300) ------------- ------------ ----------- Net cash used in investing activities.................................. (156,464) (74,187) (40,370) ------------- ------------ ----------- Financing Activities: Principal payments on long-term debt................................ (892) (8,179) (8,237) Proceeds from borrowing of long-term debt........................... 32,764 -- -- Dividends paid on preferred stock................................... (70) (70) (436) Proceeds from issuance of convertible notes......................... -- -- 194,165 Purchase of common stock for treasury............................... (253) (2,468) (51,155) Exercise of common stock options.................................... 1,187 4,118 2,371 ------------- ------------ ----------- Net cash provided by (used in) financing activities................... 32,736 (6,599) 136,708 ------------- ------------ ----------- (Decrease) increase in cash and cash equivalents....................... (59,119) (31,756) 130,345 Cash and cash equivalents: Beginning of year................................................... 159,825 191,581 61,236 ------------- ------------ ----------- End of year......................................................... $ 100,706 $ 159,825 $ 191,581 ============= ============ =========== Non-cash investing and financing activities: Term loan to finance building purchase.............................. $ -- $ -- $ 8,800 Term loans refinanced............................................... 9,859 -- -- Issuance of common stock under product development agreement........................................................ -- 237 505 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
68 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 shareholders' equity, net of any related tax effect. Auction rate securities generally have long-term stated maturities of 20 to 30 years. However, these 69 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. 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 has been impaired, the Company will record the impairment charge in its results of operations. The Company's test for goodwill impairment in fiscal 2006 determined there was no goodwill impairment. 70 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 $11,052 investment in the preferred stock of Strides Arcolab Limited (see Note 3). This investment is periodically reviewed for other-than-temporary declines in fair value. An other than temporary decline in fair value is 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 and actual 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. |X| Payment discounts are reductions to invoiced amounts offered to customers for payment within a specified period and are estimated utilizing historical customer payment experience. |X| 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. |X| 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. |X| The Company markets and sells products directly to wholesalers, distributors, warehousing pharmacy chains, mail order pharmacies and other direct purchasing groups. The Company also markets products indirectly to independent pharmacies, non-warehousing chains, managed care organizations, and group purchasing organizations, collectively referred to as "indirect customers." The Company enters into agreements with some indirect customers to establish contract pricing for certain products. These indirect customers then independently select a wholesaler from which to purchase the products at these contracted 71 prices. Alternatively, the Company may pre-authorize wholesalers to offer specified contract pricing to other indirect customers. Under either arrangement, the Company provides credit to the wholesaler for any difference between the contracted price with the indirect customer and the wholesaler's invoice price. This credit is called a chargeback. Provisions for estimated chargebacks are calculated primarily using historical chargeback experience, actual contract pricing and estimated and actual wholesaler inventory levels. |X| Generally, the Company provides credits to wholesale customers for decreases that are made to selling prices for the value of inventory that is owned by these customers at the date of the price reduction. These credits are customary in the industry and are intended to reduce a wholesale customer's inventory cost to better reflect current market prices. Since a reduction in the wholesaler's invoice price reduces the chargeback per unit, price reduction credits are typically included as part of the reserve for chargebacks because they act essentially as accelerated chargebacks. Although the Company contractually agreed to provide price adjustment credits to its major wholesale customers at the time they occur, the impact of any such price reductions not included in the reserve for chargebacks is immaterial to the amount of revenue recognized in any given period. Actual product returns, chargebacks and other sales allowances incurred are 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 $154,368, $133,475 and $103,262 for the years ended March 31, 2006, 2005 and 2004, respectively. The reserve balances related to the sales provisions totaled $29,317 and $21,056 at March 31, 2006 and 2005, 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 31%, 19% and 14%, and 23%, 18% and 16% of gross receivables at March 31, 2006 and 2005, respectively. For the year ended March 31, 2006, KV's three largest customers accounted for 27%, 16% and 13% of gross revenues. For the years ended March 31, 2005 and 2004, the Company's three largest customers accounted for gross revenues of 27%, 16% and 12% and 25%, 16% and 13%, 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. 72 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 $18,366, $10,885 and $7,264 for the years ended March 31, 2006, 2005 and 2004, 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 12). 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% Convertible Subordinated 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 $3,307 and $2,143 at March 31, 2006 and 2005, respectively. Deferred financing costs, net of accumulated amortization, are included in "Other Assets" in the accompanying consolidated balance sheets. 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 73 Convertible Subordinated Notes and the exercise of all in-the-money stock options based on the treasury stock method. Common share equivalents 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. 03-06, "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 04-08, "The Effect of Contingently Convertible Debt 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. 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 intrinsic value of the options 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 the market price at date of grant. The table that follows illustrates the effect on net income and earnings per share if the Company had determined stock-based compensation using the fair value method prescribed by SFAS 123. Certain revisions have been made to the expense amounts reported under the pro-forma disclosure provisions of SFAS 123 for fiscal 2005 and 2004. These revisions were not material and did not impact the consolidated financial statements. The table that follows reflects the Company's revised pro-forma results. 74
YEARS ENDED MARCH 31, ------------------------------------------ 2006 2005 2004 ---- ---- ---- Net income, as reported........................ $15,787 $33,269 $45,848 Stock-based employee compensation expense, net of related tax effects................... (2,433) (2,463) (1,726) ------- ------- ------- Pro forma net income........................... $13,354 $30,806 $44,122 ======= ======= ======= Earnings per share: Basic Class A common - as reported.......... $ 0.33 $ 0.71 $ 0.98 Basic Class A common - pro forma............ 0.28 0.66 0.94 Basic Class B common - as reported.......... 0.28 0.59 0.82 Basic Class B common - pro forma............ 0.23 0.55 0.79 Diluted - as reported....................... 0.31 0.63 0.84 Diluted - pro forma......................... 0.26 0.59 0.81
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, 2006, 2005 and 2004, respectively: no dividend yield; expected volatility of 46%, 50% and 52% for Class A common stock; expected volatility of 44%, 47% and 50% for Class B common stock; risk-free interest rate of 4.21%, 3.65% and 3.00% 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. Except for the Convertible Subordinated Notes discussed below, the carrying 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 $11,052 investment in the preferred stock of Strides Arcolab Limited had a fair value of $11,251 at March 31, 2006 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 $214,860 and $217,620 at March 31, 2006 and 2005, respectively. DERIVATIVE FINANCIAL INSTRUMENTS -------------------------------- The Company's derivative financial instruments 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 75 instruments, based on the de minimis value of these features at the time of issuance and at March 31, 2006, 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 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 supersedes 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. 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 adopted SFAS 123R beginning April 1, 2006 using the modified prospective method. Adoption of SFAS 123R will have a significant impact on the Company's consolidated financial statements, as it will be required to expense the fair value of 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. In March 2005, the SEC issued SEC Staff Accounting Bulletin No. 107 ("SAB 107") which describes the SEC staff position on the application of SFAS 123R. SAB 107 contains interpretive and certain transitional guidance relating to the interaction between SFAS 123R and certain SEC rules and regulations including the SEC's views regarding the valuation of share-based payment arrangements including assumptions related to expected volatility and expected term, first time adoption of SFAS 123R in an interim period, the modification of certain terms of employee share options prior to the adoption of SFAS 123R and disclosures within Management's Discussion and Analysis subsequent to the adoption of SFAS 123R. The Company is currently evaluating SAB 107 and its guidance and will be adopting it as part of the adoption of SFAS 123R beginning April 1, 2006. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"), which replaces Accounting Principles Board ("APB") Opinion No. 20, "Accounting Changes" ("APB 20") 76 and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements" ("SFAS 3"). SFAS 154 applies to all voluntary changes in accounting principle and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 also requires retrospective application to prior period financial statements involving changes in accounting principle unless it is impracticable to determine either the period-specific or cumulative effect of the change. This statement also requires that a change in the method of depreciation, amortization or depletion of long-lived assets be accounted for as a change in accounting estimate that is accounted for prospectively. SFAS 154 also retains many provisions of APB 20 including those related to reporting a change in accounting estimate, a change in the reporting entity and a correction of an error and also carries forward provisions of SFAS 3 governing the reporting of accounting changes in interim financial statements. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company believes that the adoption of SFAS 154 will not have a material effect on its Consolidated Financial Statements. 3. ACQUISITIONS AND LICENSE AGREEMENT ---------------------------------- In May 2005, the Company and FemmePharma, Inc. ("FemmePharma") mutually agreed to terminate the license agreement between them entered into in April 2002. 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. Under a separate agreement, the Company had previously invested $5,000 in FemmePharma's convertible preferred stock. 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 acquired worldwide licensing rights of the endometriosis product, no longer is responsible for milestone payments and royalties specified in the original licensing agreement, and secured exclusive worldwide rights for use of the FemmePharma technology for vaginal anti-infective products. For the year ended March 31, 2006, the Company recorded expense of $30,441 in connection with the FemmePharma acquisition that consisted of $29,570 for acquired in-process research and development and $871 in direct expenses related to the transaction. The acquired in-process research and development charge represented the estimated fair value of the endometriosis product being developed that, at the time of the acquisition, had no alternative future use and for which technological feasibility had not been established. The FemmePharma acquisition expense was determined by the Company to not be deductible for tax purposes. The Company also allocated $375 of the purchase price for a non-compete agreement and $300 of the purchase price for the royalty-free worldwide license to use FemmePharma's technology for vaginal anti-infective products acquired in the transaction. In May 2005, the Company entered into a long-term product development and marketing license agreement with Strides Arcolab Limited ("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. This investment is denominated in the Indian rupee and is subject to foreign currency transaction gains or losses resulting from exchange rate changes. As a result of a change in the exchange rate, the carrying value of this investment was $11,052 at March 31, 2006. This investment has been accounted for using the cost method and is included in "Other assets" in the accompanying consolidated balance sheet at March 31, 2006. 77 4. MARKETABLE SECURITIES --------------------- The carrying amount of available-for-sale securities and their approximate fair values at March 31, 2006 and 2005 were as follows.
MARCH 31, 2006 ---------------------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Auction rate securities......... $ 70,000 $ - $ - $ 70,000 Equity securities............... 37,082 - (319) 36,763 ---------- ---------- ----------- ---------- Total....................... $ 107,082 $ - $ (319) $ 106,763 ========== ========== =========== ========== 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 ========== ========== =========== ==========
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 assets 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, 2006, 2005 and 2004. At March 31, 2006, 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 24 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, 2006 and 2005 are $70,000 and $10,000, respectively 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. 5. INVENTORIES ----------- Inventories as of March 31, consist of:
2006 2005 ---- ---- Finished goods..................... $ 28,977 $ 30,521 Work-in-process.................... 7,969 5,773 Raw materials...................... 33,832 17,651 --------- --------- $ 70,778 $ 53,945 ========= =========
78 6. PROPERTY AND EQUIPMENT ---------------------- Property and equipment as of March 31, consist of:
2006 2005 ---- ---- Land and improvements................................. $ 5,763 $ 2,030 Building and building improvements.................... 101,135 19,984 Machinery and equipment............................... 57,021 41,399 Office furniture and equipment........................ 24,573 14,871 Leasehold improvements................................ 21,044 9,985 Construction-in-progress.............................. 10,265 74,394 ---------- ---------- 219,801 162,663 Less accumulated depreciation......................... (41,759) (31,039) ---------- ---------- Net property and equipment......................... $ 178,042 $ 131,624 ========== ==========
Capital additions to property and equipment were $58,334, $63,622 and $30,592 for the years ended March 31, 2006, 2005 and 2004, respectively. Depreciation of property and equipment was $11,916, $7,775 and $6,718 for the years ended March 31, 2006, 2005 and 2004, respectively. Property and equipment projects classified as construction-in-progress at March 31, 2006 are projected to be completed during the next 12 months at an estimated cost of $5,301. During the years ended March 31, 2006, 2005 and 2004, the Company recorded capitalized interest on qualifying construction projects of $940, $1,511 and $577, respectively. 7. INTANGIBLE ASSETS AND GOODWILL ------------------------------ Intangible assets and goodwill as of March 31, consist of:
2006 2005 ---------------------------------- -------------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION ------ ------------ ------ ------------ Product rights - Micro-K(R)....... $ 36,140 $ (12,708) $ 36,140 $(10,904) Product rights - PreCare(R)....... 8,433 (2,811) 8,433 (2,389) Trademarks acquired: Niferex(R)..................... 14,834 (2,225) 14,834 (1,484) Chromagen(R)/StrongStart(R).... 27,642 (4,147) 27,642 (2,764) License agreements................ 4,400 (300) 4,168 (120) Covenant not to compete........... 375 (34) - - Trademarks and patents............ 3,403 (604) 2,814 (497) ---------- --------- --------- -------- Total intangible assets....... 95,227 (22,829) 94,031 (18,158) Goodwill.......................... 557 - 557 - ---------- --------- --------- -------- $ 95,784 $ (22,829) $ 94,588 $(18,158) ========== ========= ========= ========
As of March 31, 2006, the Company's intangible assets have a weighted average useful life of approximately 19 years. Amortization of intangible assets was $4,784, $4,653 and $4,459 for the years ended March 31, 2006, 2005 and 2004, respectively. Assuming no additions, disposals or adjustments are made to the carrying values and/or useful lives of the 79 intangible assets, annual amortization expense on product rights, trademarks acquired and other intangible assets is estimated to be approximately $4,788 in each of the five succeeding fiscal years. 8. OTHER ASSETS ------------ Other assets as of March 31, consist of:
2006 2005 ---- ---- Cash surrender value of life insurance............... $ 3,416 $ 2,822 Preferred stock investments.......................... 11,052 5,000 Accrued dividends on preferred stock ................ 509 - Deferred financing costs, net........................ 2,879 3,852 Deposits............................................. 1,170 1,407 --------- --------- $ 19,026 $ 13,081 ========= =========
9. ACCRUED LIABILITIES ------------------- Accrued liabilities as of March 31, consist of:
2006 2005 ---- ---- Salaries, wages, incentives and benefits....... $ 11,312 $ 10,383 Income taxes - current......................... 584 -- Promotion expenses............................. 344 131 Accrued interest payable....................... 1,875 1,875 Other.......................................... 2,985 3,344 --------- --------- $ 17,100 $ 15,733 ========= =========
10. LONG-TERM DEBT -------------- Long-term debt as of March 31, consists of:
2006 2005 ---- ---- Building mortgages............................. $ 43,000 $ 10,740 Convertible notes.............................. 200,000 200,000 --------- --------- 243,000 210,740 Less current portion........................... (1,681) (973) --------- --------- $ 241,319 $ 209,767 ========= =========
As of March 31, 2006, the Company has credit agreements with two banks that provide revolving lines of credit for borrowing up to $140,000. The credit agreements provide for $80,000 in revolving lines of credit along with supplemental credit lines of $60,000 that are available for financing acquisitions. These credit facilities expire in October 2006 and June 2006, 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, 2006, the Company had $3,900 in an open letter of credit issued under the revolving credit line and no cash borrowings under either credit facility. The credit agreements contain financial covenants that 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. 80 In March 2006, the Company entered into a $43,000 mortgage loan agreement with one of its primary lenders, in part, to refinance $9,859 of existing mortgages. The $32,764 of net proceeds the Company received from the new mortgage loan will be used for working capital and general corporate purposes. The new mortgage loan, which is secured by three of the Company's buildings, bears interest at a rate of 5.91% and matures on April 1, 2021. 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, 2006, 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 $194,200, 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. 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. 81 The aggregate maturities of long-term debt as of March 31, 2006 are as follows: Due in one year............... $ 1,681 Due in two years.............. 1,940 Due in three years............ 2,058 Due in four years............. 2,182 Due in five years............. 2,315 Thereafter.................... 232,824 --------- $ 243,000 ========= The Company paid interest, net of capitalized interest, of $4,692 and $4,156 during the years ended March 31, 2006 and 2005, respectively. For the year ended March 31, 2004, the Company paid interest of $3,215. 11. TAXABLE INDUSTRIAL REVENUE BONDS -------------------------------- In December 2005, the Company entered into a financing arrangement with St. Louis County, Missouri related to expansion of its operations in St. Louis County. Up to $135,500 of industrial revenue bonds may be issued to the Company by St. Louis County relative to capital improvements made through December 31, 2009. This agreement provides that 50% of the real and personal property taxes on up to $135,500 of capital improvements will be abated for a period of 10 years subsequent to the property being placed in service. Industrial revenue bonds totaling $73,000 were outstanding at March 31, 2006. The industrial revenue bonds are issued by St. Louis County to the Company upon its payment of qualifying costs of capital improvements, which are then leased by the Company for a period ending December 1, 2019, unless earlier terminated. The Company has the option at any time to discontinue the arrangement and regain full title to the abated property. The industrial revenue bonds bear interest at 4.25% per annum and are payable as to principal and interest concurrently with payments due under the terms of the lease. The Company has classified the leased assets as property and equipment and has established a capital lease obligation equal to the outstanding principal balance of the industrial revenue bonds. Lease payments may be made by tendering an equivalent portion of the industrial revenue bonds. As the capital lease payments to St. Louis County may be satisfied by tendering industrial revenue bonds (which is the Company's intention), the capital lease obligation, industrial revenue bonds and related interest expense and interest income, respectively, have been offset for presentation purposes in the Consolidated Financial Statements. 12. 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, 2006, 2005 and 2004 was $3,819, $5,734 and $5,246, respectively. Future minimum lease commitments under non-cancelable leases are as follows: 2007.......................... $ 1,186 2008.......................... 430 2009.......................... 72 2010.......................... 5 A purchase option on a building leased by the Company on March 31, 2006 was exercised by the Company in accordance with the lease agreement and is scheduled to be acquired for $4,900 in June 2006. The future 82 minimum lease payments under this lease were only included above through the date of the scheduled purchase. Payments that would have been due under this lease were $535 per year through June 2011. 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 $42,138. LITIGATION 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 entered a stay pending the outcome of the Patent and Trademark Offices' reexamination of the patent in suit. ETHEX will continue to market the product during the stay. The Company intends to vigorously defend its interests when the stay is lifted; 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 has concluded. The Case is expected to be tried in 2006, but no trial date has been set. 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 District 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. 83 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 Madison/Fulcher 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 25 mg, 50 mg, 100 mg, and 200 mg strengths of Toprol-XL(R) 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 filed motions for summary judgment with the Federal District Court in Missouri alleging, among other things, that AstraZeneca's patent is invalid and unenforceable. These motions have been granted. AstraZeneca has appealed. 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, the State of Mississippi, New York City, and approximately 40 counties in New York State. The New York City case and all New York County cases have been transferred 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). One of the counties, Erie County, challenged the transfer and the Erie County Case has been remanded to state court. Each of these actions is in the early stages, with fact discovery at beginning phases in the Alabama, Massachusetts and Mississippi cases, but has not yet commenced in the New York City/Counties or the Erie County case. 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 assurance that it would prevail if legal actions are instituted by these governmental entities. 84 The Company and ETHEX are named as defendants in a case brought by the Estate of Bertie Helen Dye and styled Hope Campbell and Charles Lee Dye, Co-administrators of the Estate of Bertie Helen Dye filed in Federal District court in Virginia. It is alleged that the Company and ETHEX caused Ms. Dye's death in connection with their manufacture and sale of Ethezyme 830, a topical wound debridement ointment. The claims are for negligence, breach of warranty, fraud and punitive damages. Discovery has begun and the trial is set for October 16, 2006. The Company intends to vigorously defend its interests; however; it cannot give any assurance it will prevail. The Company and ETHEX are named as co-defendants in a suit in the U.S. District Court for the Southern District of Florida filed by the personal representative of the estate of Joyce Hoyle and her children in connection with Ms. Hoyle's death in 2003, allegedly from oxycodone toxicity styled Thomas Hoyle v. Purdue Pharma et al. The suit alleges that between June 2001 and May 2003 Ms. Hoyle was prescribed and took three different opiate pain medications manufactured and sold by the defendants, including one product, oxycodone, that was manufactured by the Company and marketed by ETHEX, and that such medications were promoted without sufficient warnings about the side effect of addiction. The causes of action are strict liability for an inherently dangerous product, negligence, breach of express and implied warranty and breach of implied warranty of fitness for a particular purpose. The discovery process has not yet begun, and the court has set the trial to commence on July 16, 2007. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. 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 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. 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. 13. 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 $965, $1,355 and $209 for the years ended March 31, 2006, 2005 and 2004, respectively. 14. 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. 85 15. INCOME TAXES ------------ The income tax provisions for the years ended March 31, 2006, 2005 and 2004 are 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, 2006, 2005 and 2004 are as follows:
2006 2005 2004 ---- ---- ---- PROVISION Current Federal............................... $ 15,034 $ 2,982 $ 14,184 State................................. 1,382 195 1,275 --------- -------- --------- 16,416 3,177 15,459 --------- -------- --------- Deferred Federal............................... 6,320 12,473 7,792 State................................. 387 1,109 899 --------- -------- --------- 6,707 13,582 8,691 --------- -------- --------- $ 23,123 $ 16,759 $ 24,150 ========= ======== =========
The reasons for the differences between the provision for income taxes and the expected Federal income taxes at the statutory rate are as follows:
2006 2005 2004 ---- ---- ---- Expected income tax expense................. $ 13,618 $ 17,510 $ 24,499 Purchased in-process research and development.......................... 10,654 - - State income taxes, less Federal income tax benefit............... 1,150 847 1,413 Business credits............................ (831) (1,080) (1,240) Other ...................................... (1,468) (518) (522) --------- -------- --------- $ 23,123 $ 16,759 $ 24,150 ========= ======== =========
As of March 31, 2006 and 2005, the tax effect of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts are as follows:
2006 2005 -------------------------- -------------------------- CURRENT NON-CURRENT CURRENT NON-CURRENT ------- ----------- ------- ----------- Fixed asset basis differences........ $ - $ (8,701) $ - $ (6,658) Reserves for inventory and receivables....................... 7,547 - 5,510 - Vacation pay reserve................. 378 - 249 - Deferred compensation................ - 1,973 - 1,620 Amortization......................... - (2,652) - (2,121) Convertible notes interest........... - (15,699) - (9,495) Other................................ 109 (142) 68 - ------- --------- ------- --------- Net deferred tax asset (liability) $ 8,034 $ (25,221) $ 5,827 $ (16,654) ======= ========= ======= =========
The Company paid income taxes of $15,482, $8,769, and $22,201 during the years ended March 31, 2006, 2005 and 2004, respectively. 86 Included in "Prepaid and other assets" at March 31, 2005 in the accompanying consolidated balance sheet was income tax refunds receivable of $2,518. 16. 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 4,500,000 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 1,125,000 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, 2006, options to purchase 34,875 shares of stock were outstanding pursuant to employment agreements and grants to non-employee directors. The following summary shows the transactions for the years ended March 31, 2006, 2005 and 2004 under option arrangements:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------- ------------------- AVERAGE AVERAGE NO. OF PRICE PER NO. OF PRICE PER SHARES SHARE SHARES SHARE ------ ----- ------ ----- 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 Options granted................... 964,706 18.80 - - Options becoming exercisable...... - - 416,898 13.75 Options exercised................. (198,730) 5.28 (198,730) 5.28 Options canceled.................. (349,618) 14.74 (143,513) 13.09 --------- --------- Balance March 31, 2006............ 3,519,156 $15.55 1,484,649 $12.82 ========= =========
The weighted average fair value of options granted at market price on the date of grant was $6.25, $7.26, and $7.34 per share for the years ended March 31, 2006, 2005 and 2004, respectively. The weighted average fair value of options granted with an exercise price exceeding market price on the date of grant was $5.84 and $4.15 per share for the years ended March 31, 2005 and 2004, respectively. During the year ended March 31, 2006, there were no options granted with an exercise price exceeding market price on the date of grant. 87 The following table summarizes information about stock options outstanding at March 31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------------ ----------------------------------- RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED EXERCISE OUTSTANDING LIFE AVERAGE EXERCISABLE AVERAGE PRICES AT 3/31/06 REMAINING EXERCISE PRICE AT 3/31/06 EXERCISE PRICE ------ ---------- --------- -------------- ---------- -------------- $ 0.82 - $ 5.00 239,735 1 Year $ 3.26 236,518 $ 3.22 $ 5.01 - $ 9.00 514,174 3 Years $ 7.09 289,307 $ 7.12 $ 9.01 - $14.00 617,764 4 Years $11.61 364,576 $11.83 $14.01 - $20.00 1,204,963 8 Years $17.18 351,319 $17.77 $20.01 - $27.50 942,520 8 Years $23.63 242,929 $24.05
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 $400, $300 and $400 for the years ended March 31, 2006, 2005 and 2004, respectively. The Plan includes features as described under Section 401(k) of the Internal Revenue Code. 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 $1,877, $1,547 and $1,286 were made to the 401(k) investment funds during the years ended March 31, 2006, 2005 and 2004, 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 $180, $200 and $202 for the years ended March 31, 2006, 2005 and 2004, 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, 2006 and 2005 were $292 and $20 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 funding this plan, the Company's liability for claims incurred but not reported was reduced by $850 and $680 at March 31, 2006 and 2005, respectively. 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 $9,662, $9,431, and $7,331 for the years ended March 31, 2006, 2005 and 2004, respectively. 17. 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, 2006, 2005 and 2004 totaled $284, $277, and $271, respectively. 88 18. EQUITY TRANSACTIONS ------------------- As of March 31, 2006 and 2005, 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, 2006 and 2005. 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. 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. 89 19. EARNINGS PER SHARE ------------------ The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
2006 2005 2004 ---- ---- ---- Undistributed earnings: Net income ....................................... $ 15,787 $ 33,269 $ 45,848 Less - preferred stock dividends.................. (70) (70) (436) --------- -------- --------- Undistributed earnings - basic EPS................ 15,717 33,199 45,412 Add - preferred stock dividends................... 70 70 436 Add - interest expense on convertible notes, net of tax.............................. - 4,099 3,507 --------- -------- --------- Net income - diluted EPS.......................... $ 15,787 $ 37,368 $ 49,355 ========= ======== ========= Allocation of undistributed earnings: Class A common stock.............................. $ 12,089 $ 24,316 $ 32,391 Class B common stock.............................. 3,628 8,883 13,021 --------- -------- --------- Total allocated earnings - basic EPS........... $ 15,717 $ 33,199 $ 45,412 ========= ======== ========= Weighted average shares outstanding - basic: Class A common stock.............................. 36,277 34,228 33,046 Class B common stock.............................. 13,065 15,005 15,941 --------- -------- --------- Total weighted average shares outstanding - basic......................... 49,342 49,233 48,987 --------- -------- --------- Effect of dilutive securities: Employee stock options............................ 1,049 1,205 1,760 Convertible preferred stock....................... 338 338 338 Convertible notes................................. - 8,692 7,623 --------- -------- --------- Dilutive potential common shares............... 1,387 10,235 9,721 --------- -------- --------- Total weighted average shares outstanding - diluted....................... 50,729 59,468 58,708 ========= ======== ========= Basic earnings per share: Class A common stock.............................. $ 0.33 $ 0.71 $ 0.98 Class B common stock.............................. 0.28 0.59 0.82 Diluted earnings per share(1) (2).................... 0.31 0.63 0.84 ========= ======== ========= - ----------------------- (1) Excluded from the computation of diluted earnings per share were outstanding stock options whose exercise prices were greater than the average market price of the common shares for the period reported. For the years ended March 31, 2006, 2005 and 2004, excluded from the computation were options to purchase 942, 713 and 207 of Class A and Class B common shares, respectively. (2) For the year ended March 31, 2006, $200,000 principal amount of Convertible Subordinated Notes convertible into 8,692 shares of Class A common stock were excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive.
90 20. QUARTERLY FINANCIAL RESULTS (UNAUDITED) ---------------------------------------
1ST 2ND 3RD 4TH QUARTER QUARTER QUARTER QUARTER YEAR ------- ------- ------- ------- ---- YEAR ENDED MARCH 31, 2006 - ------------------------- Net revenues............................... $ 85,475 $96,321 $98,392 $87,430 $367,618 Gross profit............................... 59,273 62,277 64,651 57,523 243,724 Pretax income (loss)....................... (17,664) 17,316 20,923 18,335 38,910 Net income (loss).......................... (21,944) 11,515 14,414 11,802 15,787 Basic earnings (loss) per share: Class A common stock.................... (0.45) 0.24 0.31 0.25 0.33 Class B common stock.................... (0.45) 0.20 0.25 0.21 0.28 Diluted earnings (loss) per share.......... (0.45) 0.21 0.26 0.21 0.31 YEAR ENDED MARCH 31, 2005 - ------------------------- Net revenues............................... $ 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 (loss) 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 (loss) per share.......... 0.14 0.23 0.25 (0.01) 0.63
91 21. 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 2006, 2005 and 2004.
FISCAL YEAR ENDED BRANDED SPECIALTY SPECIALTY ALL MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED --------- -------- -------- --------- ----- ------------ ------------ ------------------------------------------------------------------------------------------------------------------------ NET REVENUES 2006 $145,435 $203,833 $16,988 $ 1,362 $ - $367,618 2005 90,085 193,402 18,345 1,661 - 303,493 2004 82,868 182,825 16,550 1,698 - 283,941 ----------------------------------------------------------------------------------------------------------------------- SEGMENT PROFIT (LOSS) 2006 58,648 100,806 1,082 (121,626) - 38,910 2005 24,307 104,469 3,043 (81,521) - 50,028 2004 31,661 102,533 1,365 (65,561) - 69,998 ----------------------------------------------------------------------------------------------------------------------- IDENTIFIABLE ASSETS 2006 23,891 63,431 7,353 524,496 (1,158) 618,013 2005 25,015 67,209 8,001 459,250 (1,158) 558,317 2004 24,585 70,966 8,343 425,702 (1,158) 528,438 ----------------------------------------------------------------------------------------------------------------------- PROPERTY AND EQUIPMENT ADDITIONS 2006 540 1,097 269 56,428 - 58,334 2005 2,463 - 318 60,841 - 63,622 2004 420 1,685 71 28,416 - 30,592 ----------------------------------------------------------------------------------------------------------------------- DEPRECIATION AND AMORTIZATION 2006 587 317 173 16,925 - 18,002 2005 217 235 140 13,312 - 13,904 2004 332 123 141 12,067 - 12,663 -----------------------------------------------------------------------------------------------------------------------
Consolidated revenues are principally derived from customers in North America and substantially all property and equipment is located in St. Louis, Missouri. 92 22. SUBSEQUENT EVENT ---------------- On June 9, 2006, the Company replaced its $140,000 credit line by entering into a new credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320,000. The new credit agreement also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50,000. The new credit facility is unsecured unless the Company, under certain specified circumstances, utilizes the facility to redeem part or all of its outstanding Convertible Subordinated Notes. Interest is charged under the facility at the lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis points depending on the ratio of senior debt to EBITDA. The new credit agreement contains financial covenants that impose limits on dividend payments, require minimum equity, a maximum senior leverage ratio and minimum fixed charge coverage ratio. The new credit facility has a five-year term expiring in June 2011. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- 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, 2006. 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 93 this assessment and based on the criteria set forth in the COSO framework, management has concluded that, as of March 31, 2006, the Company's internal control over financial reporting was effective. Management's assessment of the effectiveness of the Company's internal control over financial reporting as of March 31, 2006 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, 2006, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 94 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, 2006, 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. 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, 2006, 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, 2006, 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 sheets of K-V Pharmaceutical Company and subsidiaries as of March 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the years then ended, and our report dated June 14, 2006 expressed an unqualified opinion on those consolidated financial statements. /S/ KPMG LLP St. Louis, Missouri June 14, 2006 95 ITEM 9B. OTHER INFORMATION ----------------- ETHEX Corporation and Patricia McCullough entered into an Employment and Confidential Information Agreement dated as of January 30, 2006. Under the terms of the agreement, Ms. McCullough will serve as ETHEX's Chief Executive Officer. Ms. McCullough will receive a base annual salary of $285,000 and relocation and fringe benefits normally provided to other employees in comparable positions, subject to normal compensation review. Ms. McCullough will be eligible for an incentive bonus and will be granted options to purchase 50,000 shares of KV Class A common stock. The term of the agreement is through April 1, 2007, subject to successive automatic renewals of one year unless earlier terminated. Either party may terminate the agreement upon 120 days advance written notice to the other, provided ETHEX may terminate the agreement at any time for what it believes to be cause. For the 36 month period following termination of the agreement, Ms. McCullough will be subject to certain non-competition and non-solicitation covenants. Ms. McCullough also agrees to maintain the confidentiality of all confidential information of ETHEX and its affiliates. Effective February 20, 2006, the Company and Michael Anderson entered into an amendment to Mr. Anderson's Employment and Confidential Information Agreement. Under the amendment, Mr. Anderson's title is changed to Corporate Vice President, Industry Presence and Development, and his base salary is changed to $332,000. The term of the agreement is extended until March 31, 2011, subject to successive automatic renewals of one year unless earlier terminated. The amendment also permits Mr. Anderson to terminate the agreement upon six months notice due to health problems confirmed by a physician. Ther-Rx Corporation and Jerald J. Wenker entered into an Employment and Confidential Information Agreement dated as of April 8, 2004. Under the terms of the agreement, Mr. Wenker will serve as Ther-Rx's President. Mr. Wenker will receive a base annual salary of $350,000 and relocation and fringe benefits normally provided to other employees in comparable positions, subject to normal compensation review. Mr. Wenker will be eligible for an incentive bonus and will be granted options to purchase shares of KV Class A common stock. The term of the agreement is through March 31, 2005, subject to successive automatic renewals of one year unless earlier terminated. Mr. Wenker may terminate the agreement upon 120 days advance written notice to the Ther-Rx. Ther-Rx may terminate the agreement upon 30 days advance written notice to the Mr. Wenker, provided Ther-Rx may terminate the agreement at any time for what it believes to be cause. For the 36 month period following termination of the agreement, Mr. Wenker will be subject to certain non-competition and non-solicitation covenants. Mr. Wenker also agrees to maintain the confidentiality of all confidential information of Ther-Rx and its affiliates. On June 9, 2006, the Company replaced its $140 million credit line by entering into a credit agreement with LaSalle Bank National Association, Citibank, F.S.B and the other lenders thereto. This new credit agreement with ten banks provides the Company with a revolving line of credit for borrowing up to $320 million. The new credit agreement also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50 million. The credit facility is unsecured unless the Company, under certain specified circumstances, utilizes the facility to redeem part or all of its outstanding Convertible Subordinated Notes. Interest is charged under the facility at the lower of the prime rate or one-month LIBOR plus 62.5 to 150 basis points depending on the ratio of the Company's senior debt to EBITDA. The new credit agreement contains financial covenants that impose limits on dividend payments, require minimum equity, a maximum senior leverage ratio and minimum fixed charge coverage ratio. The new credit facility has a five-year term expiring in June 2011. 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 Regulation 14(a) for its 2006 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 2006 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 2006 Annual Meeting of Shareholders is incorporated herein by this reference. 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 2006 Annual Meeting of Shareholders is incorporated herein by this reference. 96 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 2006 Annual Meeting of Shareholders is incorporated herein by this reference. 97 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.......... 62 Report of Independent Registered Public Accounting Firm.......... 63 Consolidated Balance Sheets as of March 31, 2006 and 2005........ 64 Consolidated Statements of Income for the Years Ended March 31, 2006, 2005 and 2004.............................................. 65 Consolidated Statements of Comprehensive Income for the Years Ended March 31, 2006, 2005 and 2004.............................. 66 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 2006, 2005 and 2004.............................. 67 Consolidated Statements of Cash Flows for the Years Ended March 31, 2006, 2005 and 2004.................................... 68 Notes to Financial Statements.................................... 69-93 Controls and Procedures.......................................... 93 Evaluation of Disclosure Controls and Procedures................. 93 Management's Report on Internal Control over Financial Reporting........................................................ 93-94 Changes in Internal Control over Financial Reporting............. 94 Report of Independent Registered Public Accounting Firm.......... 95 2. Financial Statement Schedules: Report of Independent Registered Public Accounting Firm regarding Financial Statement Schedule..................................... 100 Schedule II - Valuation and Qualifying Accounts.................. 101 98 (b) Exhibits. See Exhibit Index on pages 104 through 108 of this Report. Management contracts and compensatory plans are designated on the Exhibit Index. (c) Financial Statement Schedules. 99 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Stockholders and Board of Directors K-V Pharmaceutical Company The audit 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 audit of the accompanying financial statement schedule for the year ended March 31, 2004. 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 audit. In our opinion, the 2004 financial statement schedule presents fairly, in all material respects, the information set forth therein. /s/ BDO SEIDMAN, LLP Chicago, Illinois June 4, 2004 100 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, 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 ========= ========= ========= ======== Year Ended March 31, 2006: Allowance for doubtful accounts............ $ 461 $ (49) $ 15 $ 397 Reserves for sales allowances.............. 21,056 154,368 146,107 29,317 Inventory obsolescence..................... 1,293 4,215 3,808 1,700 --------- --------- --------- -------- $ 22,810 $ 158,534 $ 149,930 $ 31,414 ========= ========= ========= ========
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. 101 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, 2006 By /s/ Marc S. Hermelin ----------------- ------------------------------------ Vice Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: June 14, 2006 By /s/ Gerald R. Mitchell ----------------- ------------------------------------ Vice President and Chief Financial Officer (Principal Financial Officer) Date: June 14, 2006 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, 2006 By /s/ Marc S. Hermelin ----------------- ----------------------------------- Marc S. Hermelin Date: June 14, 2006 By /s/ Victor M. Hermelin ----------------- ----------------------------------- Victor M. Hermelin Date: June 14, 2006 By /s/ Norman D. Schellenger ----------------- ----------------------------------- Norman D. Schellenger Date: June 14, 2006 By /s/ Gerald R. Mitchell ----------------- ----------------------------------- Gerald R. Mitchell Date: June 14, 2006 By /s/ Kevin S. Carlie ----------------- ----------------------------------- Kevin S. Carlie Date: June 14, 2006 By /s/ David A. Van Vliet ----------------- ----------------------------------- David A. Van Vliet Date: June 14, 2006 By /s/ Jean M. Bellin ----------------- ----------------------------------- Jean M. Bellin 102 Date: June 14, 2006 By /s/ Terry B. Hatfield ----------------- ----------------------------------- Terry B. Hatfield Date: June 14, 2006 By /s/ David S. Hermelin ----------------- ----------------------------------- David S. Hermelin 103 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. 104 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. 3(o) Amendment to Bylaws of the Company, effective June 28, 2004, which increased the size of the board of directors from seven to ten, filed herewith. 3(p) Amendment to Bylaws of the Company, effective September 9, 2004, which decreased the size of the board of directors from ten to nine, filed herewith. 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) 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(c) 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(d) Amended and Restated Loan Agreement, dated December 31, 2004 between 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. 4(e) Promissory Note, dated March 23, 2006 between MECW, LLC and LaSalle National Bank Association, filed on March 29, 2006, as exhibit 99 to the Company's Current Report on Form 8-K, is incorporated herein by this reference. 4(f) Second Amendment to Amended and Restated Loan Agreement, dated March 20, 2006 between the Company and its subsidiaries, LaSalle National Bank Association and Citibank, F.S.B., filed herewith. 4(g) Credit Agreement, dated as of June 9, 2006, among the Company and its subsidiaries, LaSalle Bank National Association, Citibank, F.S.B. and the other lenders thereto, filed herewith. 10(a)* 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(b)* 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(c) 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. 105 10(d) 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(e)* 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(f)* 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(g)* 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(h)* 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(i) 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(j)* 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(k) 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(l)* 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(n)* 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(o)* 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(p)* 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. 106 10(q) 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(r) 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(s) 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(t) 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(u) 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(v)* 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(w) 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, which was filed as Exhibit 10(ww) to the Company's Annual Report on Form 10-K for the year ended March 31, 2005, is incorporated herein by this reference. 10(x)* K-V Pharmaceutical 2001 Incentive Stock Option Plan, which was filed as Exibit 10.1 to the Company's Current report on Form 8-K filed November 22, 2005, is incorporated by this reference. 10(y)* Form of 2001 Incentive Stock Option Plan Award Agreement for Employees, which was filed as Exhibit 10.2 to the Company's Current Report on Form 8-K filed November 22, 2005, is incorporated by this reference. 10(z)* Form of 2001 Incentive Stock Option Plan Award Agreement for Directors, which was filed as Exhibit 10.3 to the Company's Current Report on Form 8-K filed November 22, 2005, is incorporated by this reference. 10(aa)* Employment Agreement between ETHEX and Patricia McCullough, Chief Executive Officer of ETHEX, dated January 30, 2006, filed herewith. 10(bb)* Employment Agreement between the Company and Michael S. Anderson, Corporate Vice President, Industry Presence and Development, dated May 23, 1994, and amendments thereto, filed herewith. 10(cc)* Employment Agreement between Ther-Rx and Jerald J. Wenker, President of Ther-Rx, dated April 8, 2004, 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. 107 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. 108 EX-3.(O) 2 ex3o.txt Exhibit 3(o) AMENDMENT TO BYLAWS OF K-V PHARMACEUTICAL COMPANY As directed by the unanimously adopted resolution of the Board of Directors of K-V Pharmaceutical Company duly adopted on June 28, 2004, the Bylaws of the Company were amended, effective June 28, 2004, by amending the first sentence of Article III, Section 1 thereof to read as follows in its entirety: "The number of directors which shall constitute the whole board shall be ten." EX-3.(P) 3 ex3p.txt Exhibit 3(p) AMENDMENT TO BYLAWS OF K-V PHARMACEUTICAL COMPANY As directed by the unanimously adopted resolution of the Board of Directors of K-V Pharmaceutical Company duly adopted on June 28, 2004, the Bylaws of the Company were amended, effective September 9, 2004 (the date of the Annual Meeting of Shareholders held on such date), by amending the first sentence of Article III, Section 1 thereof to read as follows in its entirety: "The number of directors which shall constitute the whole board shall be nine." EX-4.(G) 4 ex4g.txt Exhibit 4(g) CREDIT AGREEMENT DATED AS OF JUNE 9, 2006 AMONG K-V PHARMACEUTICAL COMPANY, PARTICLE DYNAMICS, INC. ETHEX CORPORATION AND THER-RX CORPORATION, AS THE LOAN PARTIES, THE VARIOUS FINANCIAL INSTITUTIONS PARTY HERETO, AS LENDERS, LASALLE BANK NATIONAL ASSOCIATION, AS ADMINISTRATIVE AGENT, CITIBANK, F.S.B., AS SYNDICATION AGENT, AND EACH OF LASALLE BANK NATIONAL ASSOCIATION, AND CITIBANK, N.A., AS JOINT LEAD ARRANGERS AND BOOK RUNNERS SECTION 1 DEFINITIONS................................................................................1 1.1 Definitions....................................................................................1 1.2 Other Interpretive Provisions.................................................................15 SECTION 2 COMMITMENTS OF THE LENDERS; BORROWING, CONVERSION AND LETTER OF CREDIT PROCEDURES.........16 2.1 Commitments...................................................................................16 2.2 Loan Procedures...............................................................................16 2.3 Letter of Credit Procedures...................................................................19 2.4 Commitments Several...........................................................................22 2.5 Certain Conditions............................................................................22 2.6 Increases in Revolving Commitment.............................................................22 SECTION 3 EVIDENCING OF LOANS.......................................................................23 3.1 Notes.........................................................................................23 3.2 Recordkeeping.................................................................................23 SECTION 4 INTEREST..................................................................................23 4.1 Interest Rates................................................................................23 4.2 Interest Payment Dates........................................................................24 4.3 Setting and Notice of LIBOR Rates.............................................................24 4.4 Computation of Interest.......................................................................24 SECTION 5 FEES......................................................................................24 5.1 Non-Use Fee...................................................................................24 5.2 Letter of Credit Fees.........................................................................24 5.3 Administrative Fees...........................................................................25 SECTION 6 REDUCTION OR TERMINATION OF THE REVOLVING COMMITMENT; PREPAYMENTS.........................25 6.1 Reduction or Termination of the Revolving Commitment..........................................25 6.2 Prepayments...................................................................................25 6.3 Manner of Prepayments.........................................................................26 6.4 Repayments....................................................................................26 SECTION 7 MAKING AND PRORATION OF PAYMENTS; SETOFF; TAXES...........................................26 7.1 Making of Payments............................................................................26 7.2 Application of Certain Payments...............................................................26 7.3 Due Date Extension............................................................................27 7.4 Setoff........................................................................................27 7.5 Proration of Payments.........................................................................27 7.6 Taxes.........................................................................................27 SECTION 8 INCREASED COSTS; SPECIAL PROVISIONS FOR LIBOR LOANS.......................................29 8.1 Increased Costs...............................................................................29 8.2 Basis for Determining Interest Rate Inadequate or Unfair......................................30 i 8.3 Changes in Law Rendering LIBOR Loans Unlawful.................................................30 8.4 Funding Losses................................................................................31 8.5 Right of Lenders to Fund through Other Offices................................................31 8.6 Discretion of Lenders as to Manner of Funding.................................................31 8.7 Mitigation of Circumstances; Replacement of Lenders...........................................31 8.8 Conclusiveness of Statements; Survival of Provisions..........................................32 SECTION 9 REPRESENTATIONS AND WARRANTIES............................................................32 9.1 Organization..................................................................................32 9.2 Authorization; No Conflict....................................................................32 9.3 Validity and Binding Nature...................................................................33 9.4 Financial Condition...........................................................................33 9.5 No Material Adverse Change....................................................................33 9.6 Litigation and Contingent Liabilities.........................................................33 9.7 Ownership of Properties; Liens................................................................33 9.8 Equity Ownership; Subsidiaries................................................................33 9.9 Pension Plans.................................................................................33 9.10 Investment Company Act........................................................................34 9.11 Reserved......................................................................................34 9.12 Regulation U..................................................................................34 9.13 Taxes.........................................................................................34 9.14 Solvency, etc.................................................................................35 9.15 Environmental Matters.........................................................................35 9.16 Insurance.....................................................................................35 9.17 Real Property.................................................................................36 9.18 Information...................................................................................36 9.19 Intellectual Property.........................................................................36 9.20 Reserved......................................................................................36 9.21 Labor Matters.................................................................................36 9.22 No Default....................................................................................36 SECTION 10 AFFIRMATIVE COVENANTS.....................................................................36 10.1 Reports, Certificates and Other Information...................................................37 10.2 Books, Records and Inspections................................................................38 10.3 Maintenance of Property; Insurance............................................................39 10.4 Compliance with Laws; Payment of Taxes and Liabilities........................................39 10.5 Maintenance of Existence, etc.................................................................40 10.6 Use of Proceeds...............................................................................40 10.7 Employee Benefit Plans........................................................................40 10.8 Environmental Matters.........................................................................40 10.9 Further Assurances............................................................................41 10.10 Reserved......................................................................................41 10.11 Springing Lien................................................................................41 10.12 Syndication...................................................................................42 SECTION 11 NEGATIVE COVENANTS........................................................................42 11.1 Debt..........................................................................................42 ii 11.2 Liens.........................................................................................43 11.3 Reserved......................................................................................43 11.4 Restricted Payments...........................................................................43 11.5 Mergers, Consolidations, Sales................................................................44 11.6 Modification of Organizational Documents......................................................45 11.7 Transactions with Affiliates..................................................................45 11.8 Reserved......................................................................................45 11.9 Inconsistent Agreements.......................................................................45 11.10 Business Activities; Issuance of Equity.......................................................46 11.11 Investments...................................................................................46 11.12 Restriction of Amendments to Certain Documents................................................46 11.13 Fiscal Year...................................................................................47 11.14 Financial Covenants...........................................................................47 SECTION 12 EFFECTIVENESS; CONDITIONS OF LENDING, ETC.................................................47 12.1 Initial Credit Extension......................................................................47 12.2 Conditions....................................................................................48 SECTION 13 EVENTS OF DEFAULT AND THEIR EFFECT........................................................49 13.1 Events of Default.............................................................................49 13.2 Effect of Event of Default....................................................................50 SECTION 14 THE AGENT[S]..............................................................................51 14.1 Appointment and Authorization.................................................................51 14.2 Issuing Lender................................................................................51 14.3 Delegation of Duties..........................................................................52 14.4 Exculpation of Administrative Agent...........................................................52 14.5 Reliance by Administrative Agent..............................................................52 14.6 Notice of Default.............................................................................53 14.7 Credit Decision...............................................................................53 14.8 Indemnification...............................................................................53 14.9 Administrative Agent in Individual Capacity...................................................54 14.10 Successor Administrative Agent................................................................54 14.11 Administrative Agent May File Proofs of Claim.................................................55 14.12 Other Agents; Arrangers and Managers..........................................................55 SECTION 15 GENERAL...................................................................................56 15.1 Waiver; Amendments............................................................................56 15.2 Confirmations.................................................................................56 15.3 Notices.......................................................................................56 15.4 Computations..................................................................................57 15.5 Costs, Expenses and Taxes.....................................................................57 15.6 Assignments; Participations...................................................................57 15.7 Register......................................................................................59 15.8 GOVERNING LAW.................................................................................59 15.9 Confidentiality...............................................................................59 15.10 Severability..................................................................................60 iii 15.11 Nature of Remedies............................................................................60 15.12 Entire Agreement..............................................................................60 15.13 Counterparts..................................................................................60 15.14 Successors and Assigns........................................................................60 15.15 Captions......................................................................................61 15.16 Customer Identification - USA Patriot Act Notice..............................................61 15.17 INDEMNIFICATION BY THE LOAN PARTIES...........................................................61 15.18 Nonliability of Lenders.......................................................................62 15.19 FORUM SELECTION AND CONSENT TO JURISDICTION...................................................62 15.20 WAIVER OF JURY TRIAL..........................................................................63 15.21 Reimbursement Among the Loan Parties..........................................................63 15.22 Joint and Several Liability...................................................................63
ANNEXES ANNEX A Lenders and Pro Rata Shares ANNEX B Addresses for Notices SCHEDULES SCHEDULE 9.6 Litigation and Contingent Liabilities SCHEDULE 9.8 Subsidiaries SCHEDULE 9.16 Insurance SCHEDULE 9.17 Real Property SCHEDULE 9.21 Labor Matters SCHEDULE 11.1 Existing Debt SCHEDULE 11.2 Existing Liens SCHEDULE 11.7 Transactions with Affiliates SCHEDULE 11.11 Investments SCHEDULE 12.1 Debt to be Repaid EXHIBITS EXHIBIT A Form of Revolving Note (Section 3.1) EXHIBIT B Form of Compliance Certificate (Section 10.1.3) EXHIBIT C Form of Assignment Agreement EXHIBIT D Form of Notice of Borrowing (Section 2.2.2) EXHIBIT E Form of Notice of Conversion/Continuation (Section 2.2.3) iv CREDIT AGREEMENT ---------------- THIS CREDIT AGREEMENT dated as of June 9, 2006 (this "Agreement") --------- is entered into among K-V PHARMACEUTICAL COMPANY, a Delaware corporation, PARTICLE DYNAMICS, INC., a New York corporation, ETHEX CORPORATION, a Missouri corporation and THER-Rx CORPORATION, a Missouri corporation (collectively, the "Loan Parties"), the financial institutions that are or ------------ may from time to time become parties hereto (together with their respective successors and assigns, the "Lenders"), LASALLE BANK NATIONAL ASSOCIATION, ------- a national banking association (in its individual capacity, "LaSalle"), as ------- administrative agent for the Lenders, CITIBANK, F.S.B. (in its individual capacity, "Citibank"), as syndication agent (in such capacity, the "Syndication Agent") and each of LASALLE and CITIBANK, N.A., a national ----------------- banking association, as joint lead arrangers and bookrunners (collectively, the "Arrangers"). The Lenders have agreed to make available to the Loan Parties a revolving credit facility (which includes letters of credit) upon the terms and conditions set forth herein. In consideration of the mutual agreements herein contained, the parties hereto agree as follows: SECTION 1 DEFINITIONS. 1.1 Definitions. When used herein the following terms shall have ----------- the following meanings: Account Debtor is defined in the UCC. -------------- Account or Accounts is defined in the UCC. ------------------- Acquisition means any single transaction or series of related ----------- transactions for the purpose of or resulting, directly or indirectly, in (a) the acquisition of any individual product or product line utilized in any Loan Party's business, (b) the acquisition of all or substantially all of the assets of a Person, or of all or substantially all of any business or division of a Person, (c) the acquisition of in excess of 50% of the Capital Securities of any Person, or otherwise causing any Person to become a Subsidiary, or (d) a merger or consolidation or any other combination with another Person (other than a Person that is already a Subsidiary). Administrative Agent means LaSalle in its capacity as -------------------- administrative agent for the Lenders hereunder and any successor thereto in such capacity. Affected Loan - see Section 8.3. ------------- ----------- Affiliate of any Person means (a) any other Person which, directly --------- or indirectly, controls or is controlled by or is under common control with such Person and (b) with respect to any Lender, any entity administered or managed by such Lender or an Affiliate or investment advisor thereof and which is engaged in making, purchasing, holding or otherwise investing in commercial loans. A Person shall be deemed to be "controlled by" any other Person if such Person possesses, directly or indirectly, power to vote 5% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managers or power to direct or cause the direction of the management and policies of such Person whether by contract or otherwise. Unless expressly stated otherwise herein, neither the Administrative Agent nor any Lender shall be deemed an Affiliate of any Loan Party. Agreement - see the Preamble. --------- -------- Applicable Margin means, for any day, the rate per annum set forth ----------------- below opposite the level (the "Level") then in effect, it being understood ----- that the Applicable Margin for (i) LIBOR Loans shall be the percentage set forth under the column "LIBOR Margin", (ii) Base Rate Loans shall be the percentage set forth under the column "Base Rate Margin", (iii) the Non-Use Fee Rate shall be the percentage set forth under the column "Non-Use Fee Rate" and (iv) the L/C Fee shall be the percentage set forth under the column "L/C Fee Rate":
- ---------------------------------------------------------------------------------------------------------------------- SENIOR DEBT LIBOR BASE RATE NON-USE L/C FEE LEVEL TO EBITDA RATIO MARGIN MARGIN FEE RATE RATE - ----- --------------- ------ ------ -------- ---- - ---------------------------------------------------------------------------------------------------------------------- I Greater than or equal to 2.75:1 1.50% 0% 0.250% 1.50% but less than 3.0:1 - ---------------------------------------------------------------------------------------------------------------------- II Greater than or equal to 2.25:1 1.25% 0% 0.225% 1.25% but less than 2.75:1 - ---------------------------------------------------------------------------------------------------------------------- III Greater than or equal to 1.75:1 1.00% 0% 0.200% 1.00% but less than 2.25:1 - ---------------------------------------------------------------------------------------------------------------------- IV Greater than or equal to 1.25:1 0.750% 0% 0.150% 0.750% but less than 1.75:1 - ---------------------------------------------------------------------------------------------------------------------- V Less than 1.25:1 0.625% 0% 0.125% 0.625% - ----------------------------------------------------------------------------------------------------------------------
The LIBOR Margin, the Base Rate Margin, the Non-Use Fee Rate and the L/C Fee Rate shall be adjusted, to the extent applicable, on the fifth (5th) Business Day after the Loan Parties provide or are required to provide the annual and quarterly financial statements and other information pursuant to Sections 10.1.1 or 10.1.2, as applicable, and the related Compliance --------------- ------ Certificate, pursuant to Section 10.1.3. Notwithstanding anything contained -------------- in this paragraph to the contrary, (a) if the Loan Parties fail to deliver the financial statements and Compliance Certificate in accordance with the provisions of Sections 10.1.1, 10.1.2 and 10.1.3, the LIBOR Margin, the Base --------------- ------ ------ Rate Margin, the Non-Use Fee Rate and the L/C Fee Rate shall be based upon Level I above beginning on the date such financial statements and Compliance Certificate were required to be delivered until the fifth (5th) Business Day after such financial statements and Compliance Certificate are actually delivered, whereupon the Applicable Margin shall be determined by the then current Level; (b) no reduction to any Applicable Margin shall become 2 effective at any time when an Event of Default or Unmatured Event of Default has occurred and is continuing; and (c) the initial Applicable Margin on the Closing Date shall be based on Level V until the date on which the financial statements and Compliance Certificate are required to be delivered for the Fiscal Year ending March 31, 2006. Assignee - see Section 15.6.1. -------- -------------- Assignment Agreement - see Section 15.6.1. -------------------- -------------- Attorney Costs means, with respect to any Person, all reasonable -------------- fees and out-of-pocket charges of any outside counsel to such Person, all reasonable disbursements of such counsel and all court costs and similar legal expenses. Bank Product Agreements means those certain cash management service ----------------------- agreements entered into from time to time between any Loan Party and a Lender or its Affiliates in connection with any of the Bank Products. Bank Product Obligations means all obligations, liabilities, ------------------------ contingent reimbursement obligations, fees, and expenses owing by the Loan Parties to any Lender or its Affiliates pursuant to or evidenced by the Bank Product Agreements and irrespective of whether for the payment of money, whether direct or indirect, absolute or contingent, due or to become due, now existing or hereafter arising, and including all such amounts that a Loan Party is obligated to reimburse to the Administrative Agent or any Lender as a result of the Administrative Agent or such Lender purchasing participations or executing indemnities or reimbursement obligations with respect to the Bank Products provided to the Loan Parties pursuant to the Bank Product Agreements. Bank Products means any service or facility extended to any Loan ------------- Party by any Lender or its Affiliates including: (a) credit cards, (b) credit card processing services, (c) debit cards, (d) purchase cards, (e) ACH transactions, (f) cash management, including controlled disbursement, accounts or services, or (g) Hedging Agreements. Base Rate means at any time the greater of (a) the Federal Funds --------- Rate plus 0.5% and (b) the Prime Rate. Base Rate Loan means any Loan which bears interest at or by -------------- reference to the Base Rate. Base Rate Margin - see the definition of Applicable Margin. ---------------- BSA - see Section 10.4. --- ------------ Business Day means any day on which LaSalle is open for commercial ------------ banking business in Chicago, Illinois and, in the case of a Business Day which relates to a LIBOR Loan, on which dealings are carried on in the London interbank eurodollar market. Capital Expenditures means all expenditures which, in accordance -------------------- with GAAP, would be required to be capitalized and shown on the consolidated balance sheet of the Loan Parties, including expenditures in respect of Capital Leases, but excluding expenditures made in connection with the replacement, substitution or restoration of assets to the extent financed 3 (a) from insurance proceeds (or other similar recoveries) paid on account of the loss of or damage to the assets being replaced or restored or (b) with awards of compensation arising from the taking by eminent domain or condemnation of the assets being replaced. Capital Lease means, with respect to any Person, any lease of (or ------------- other agreement conveying the right to use) any real or personal property by such Person that, in conformity with GAAP, is accounted for as a capital lease on the balance sheet of such Person. Capital Securities means, with respect to any Person, all shares, ------------------ interests, participations or other equivalents (however designated, whether voting or non-voting) of such Person's capital, whether now outstanding or issued or acquired after the Closing Date, including common shares, preferred shares, membership interests in a limited liability company, limited or general partnership interests in a partnership, interests in a Trust, interests in other unincorporated organizations or any other equivalent of such ownership interest. Cash Collateralize means to deliver cash collateral to the ------------------ Administrative Agent, to be held as cash collateral for outstanding Letters of Credit, pursuant to documentation satisfactory to the Administrative Agent. Derivatives of such term have corresponding meanings. Cash Equivalent Investment means, at any time, (a) any evidence of -------------------------- Debt, maturing not more than one year after such time, issued or guaranteed by the United States Government or any agency thereof, (b) commercial paper, maturing not more than one year from the date of issue, or corporate demand notes, in each case (unless issued by a Lender or its holding company) rated at least A-l by Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. or P-l by Moody's Investors Service, Inc., (c) any certificate of deposit, time deposit or banker's acceptance, maturing not more than one year after such time, or any overnight Federal Funds transaction that is issued or sold by any Lender or its holding company (or by a commercial banking institution that is a member of the Federal Reserve System and has a combined capital and surplus and undivided profits of not less than $500,000,000), (d) any repurchase agreement entered into with any Lender (or commercial banking institution of the nature referred to in clause (c)) which (i) is secured by a fully perfected security interest in any obligation of the type described in any of clauses (a) through (c) above and (ii) has a market value at the time such repurchase agreement is entered into of not less than 100% of the repurchase obligation of such Lender (or other commercial banking institution) thereunder and (e) money market accounts or mutual funds which invest exclusively in assets satisfying the foregoing requirements, (f) securities issued through major broker-dealers on behalf of their public and corporate financial clients that reset interest rates at 7, 28 or 35 day intervals and are traded in what is commonly known as the "Auction Rate Securities Market"; and (g) other short term liquid investments approved in writing by the Administrative Agent. Change of Control means, with respect to any Person, an event or ----------------- series of events by which: (a) any "person" or "group" as such terms are used in Sections -------- 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the - ----- ----- "Exchange Act"), becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except that a person or group shall be deemed to have "beneficial ownership" of all securities that such person or group has the right to acquire (such right, an "option right"), whether such right is exercisable 4 immediately or only after the passage of time), directly or indirectly, of 30% or more of the equity securities of the Company entitled to vote for members of the board of directors or equivalent governing body of the Company on a fully diluted basis (and, taking into account all such securities that such person or group has the right to acquire pursuant to any option right); or (b) during any period of 24 consecutive months, a majority of the members of the board of directors or other equivalent governing body of such Person cease to be composed of individuals: (i) who were members of that board or equivalent governing body on the first day of such period, (ii) whose election or nomination to that board or equivalent governing body was approved or recommended by individuals referred to in clause (i) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body or (iii) whose election or nomination to that board or other equivalent governing body was approved or recommended by individuals referred to in clauses (i) and (ii) above constituting at the time of such election or nomination at least a majority of that board or equivalent governing body (excluding, in the case of both clause (ii) and clause (iii), any individual whose initial nomination for, or assumption of office as, a member of that board or equivalent governing body occurs solely as a result of an actual or threatened solicitation of proxies or consents for the election of such director by any person or group other than (x) Marc S. Hermelin and all relatives and trusts of which Marc S. Hermelin or a relative is a trust or beneficiary and (y) a solicitation for the election of one or more directors by or on behalf of the board of directors); or (d) the Loan Parties shall cease to, directly or indirectly, own and control 100% of each class of the outstanding Capital Securities of each of its Subsidiaries. Citibank - see the Preamble. -------- -------- Closing Date - see Section 12.1. ------------ ------------ Code means the Internal Revenue Code of 1986. ---- Commitment means, as to any Lender, such Lender's commitment to ---------- make Loans, and to issue or participate in Letters of Credit, under this Agreement. The initial amount of each Lender's commitment to make Loans is set forth on Annex A. ------- Company means K-V Pharmaceutical Company, a Delaware corporation. ------- Compliance Certificate means a Compliance Certificate in ---------------------- substantially the form of Exhibit B. --------- Computation Period means each period of four consecutive Fiscal ------------------ Quarters ending on the last day of a Fiscal Quarter. Consolidated Net Income means, with respect to the Company and its ----------------------- Subsidiaries for any period, the net income (or loss) of the Company and its Subsidiaries for such period, excluding (i) any gains or losses from the sale of assets, (ii) any extraordinary gains or losses and any gains or losses from discontinued operations, and (iii) any expenses associated with any in-process research and development acquired in connection with any Acquisition which are required to be expensed under GAAP. 5 Contingent Liability means, with respect to any Person, each -------------------- obligation and liability of such Person and all such obligations and liabilities of such Person incurred pursuant to any agreement, undertaking or arrangement by which such Person: (a) guarantees, endorses or otherwise becomes or is contingently liable upon (by direct or indirect agreement, contingent or otherwise, to provide funds for payment, to supply funds to, or otherwise to invest in, a debtor, or otherwise to assure a creditor against loss) the indebtedness, dividend, obligation or other liability of any other Person in any manner (other than by endorsement of instruments in the course of collection), including any indebtedness, dividend or other obligation which may be issued or incurred at some future time; (b) guarantees the payment of dividends or other distributions upon the Capital Securities of any other Person; (c) undertakes or agrees (whether contingently or otherwise): (i) to purchase, repurchase, or otherwise acquire any indebtedness, obligation or liability of any other Person or any property or assets constituting security therefor, (ii) to advance or provide funds for the payment or discharge of any indebtedness, obligation or liability of any other Person (whether in the form of loans, advances, stock purchases, capital contributions or otherwise), or to maintain solvency, assets, level of income, working capital or other financial condition of any other Person, or (iii) to make payment to any other Person other than for value received; (d) agrees to lease property or to purchase securities, property or services from such other Person with the purpose or intent of assuring the owner of such indebtedness or obligation of the ability of such other Person to make payment of the indebtedness or ------- obligation; (e) to induce the issuance of, or in connection with the issuance of, any letter of credit for the benefit of such other Person; or (f) undertakes or agrees otherwise to assure a creditor against loss. The amount of any Contingent Liability shall (subject to any limitation set forth herein) be deemed to be the outstanding principal amount (or maximum permitted principal amount, if larger) of the indebtedness, obligation or other liability guaranteed or supported thereby. Controlled Group means all members of a controlled group of ---------------- corporations, all members of a controlled group of trades or businesses (whether or not incorporated) under common control and all members of an affiliated service group which, together with the Loan Parties or any of their Subsidiaries, are treated as a single employer under Section 414 of the Code or Section 4001 of ERISA. Convertible Notes means those certain 2.5% Contingent Convertible ----------------- Subordinated Notes due 2033 payable by the Company to the holders thereof. Debt of any Person means, without duplication, (a) all indebtedness ---- of such Person, (b) all borrowed money of such Person, whether or not evidenced by bonds, debentures, notes or similar instruments, (c) all obligations of such Person as lessee under Capital Leases which have been or should be recorded as liabilities on a balance sheet of such Person in accordance with GAAP, (d) all obligations of such Person to pay the deferred purchase price of property or services (excluding trade accounts payable in the ordinary course of business), (e) all indebtedness secured by a Lien on the property of such Person, whether or not such indebtedness shall have been assumed by such Person; provided that if such Person has not assumed or -------- otherwise become liable for such indebtedness, such indebtedness shall be measured at the fair market value of such property securing such indebtedness at the time of determination, (f) all obligations, contingent or otherwise, with respect to the face amount of all letters of credit (whether or not drawn), bankers' acceptances and similar obligations issued for the account of such Person (including the Letters of Credit), (g) all Hedging Obligations of such Person, (h) all 6 Contingent Liabilities of such Person, (i) all Debt of any partnership of which such Person is a general partner and (j) any Capital Securities or other equity instrument, whether or not mandatorily redeemable, that under GAAP is characterized as debt, whether pursuant to financial accounting standards board issuance No. 150 or otherwise. Debt to be Repaid means Debt listed on Schedule 12.1. ----------------- ------------- Dollar and the sign "$" mean lawful money of the United States of ------ - America. EBITDA means, with respect to any fiscal period of the Company, ------ Company's and its Subsidiaries' aggregate (a) Consolidated Net Income for such period, plus (b) the aggregate amounts deducted in determining such Consolidated Net Income in respect of (i) Interest Expense, (ii) income taxes, (iii) depreciation and (iv) amortization, each determined on a consolidated basis and in accordance with GAAP consistently applied. In the event any Loan Party consummates an Acquisition (whether via stock purchase, asset purchase, merger or otherwise) (the Person or assets so acquired being referred to herein as the "Acquired Company"), EBITDA of the Company for the fiscal period during which such Acquisition occurred and all other relevant "trailing" measuring periods shall be calculated to include the EBITDA of the Acquired Company on a pro-forma basis, for the relevant measuring periods as if such Acquired Company was a Loan Party hereunder at all such times, to the extent the results of operations of such acquired asset are not reflected in the Company's financial statements. Environmental Claims means all claims, however asserted, by any -------------------- governmental, regulatory or judicial authority or other Person alleging potential liability or responsibility for violation of any Environmental Law, or for release or injury to the environment. Environmental Laws means all present or future federal, state or ------------------ local laws, statutes, common law duties, rules, regulations, ordinances and codes, together with all administrative or judicial orders, consent agreements, directed duties, requests, licenses, authorizations and permits of, and agreements with, any governmental authority, in each case relating to any matter arising out of or relating to public health and safety, or pollution or protection of the environment or workplace, including any of the foregoing relating to the presence, use, production, generation, handling, transport, treatment, storage, disposal, distribution, discharge, emission, release, threatened release, control or cleanup of any Hazardous Substance. ERISA means the Employee Retirement Income Security Act of 1974. ----- Event of Default means any of the events described in Section 13.1. ---------------- ------------ Excluded Taxes means taxes based upon, or measured by, the Lender's -------------- or Administrative Agent's (or a branch of the Lender's or Administrative Agent's) overall net income, overall net receipts, or overall net profits (including franchise taxes imposed in lieu of such taxes), but only to the extent such taxes are imposed by a taxing authority (a) in a jurisdiction in which such Lender or Administrative Agent is organized, (b) in a jurisdiction which the Lender's or Administrative Agent's principal office is located, or (c) in a jurisdiction in which such Lender's or Administrative Agent's lending office (or branch) in respect of which payments under this Agreement are made is located. 7 Federal Funds Rate means, for any day, a fluctuating interest rate ------------------ equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by the Administrative Agent. The Administrative Agent's determination of such rate shall be binding and conclusive absent manifest error. Fee Letter means the Fee letter dated as of May 8, 2006 between the ---------- Company and the Arrangers. Fiscal Quarter means a fiscal quarter of a Fiscal Year. -------------- Fiscal Year means the fiscal year of the Company and its ----------- Subsidiaries, which period shall be the 12-month period ending on the Company's Fiscal Year End of each year. References to a Fiscal Year with a number corresponding to any calendar year (e.g., "Fiscal Year 2005") refer to the Fiscal Year ending on the Company's Fiscal Year End of such calendar year. Fixed Charge Coverage Ratio means, for any Computation Period, the --------------------------- ratio of (a) the total for such period of EBITDA to (b) the sum for such -- period of (i) cash Interest Expense plus (ii) required payments of principal ---- of Funded Debt. FRB means the Board of Governors of the Federal Reserve System or --- any successor thereto. Funded Debt means, as to any Person, all Debt of such Person that ----------- matures more than one year from the date of its creation (or is renewable or extendible, at the option of such Person, to a date more than one year from such date). GAAP means generally accepted accounting principles set forth from ---- time to time in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board (or agencies with similar functions of comparable stature and authority within the U.S. accounting profession) and the Securities and Exchange Commission, which are applicable to the circumstances as of the date of determination. Group - see Section 2.2.1. ----- ------------- Hazardous Substances means (a) any petroleum or petroleum products, -------------------- radioactive materials, asbestos in any form that is or could become friable, urea formaldehyde foam insulation, dielectric fluid containing levels of polychlorinated biphenyls, radon gas and mold; (b) any chemicals, materials, pollutant or substances defined as or included in the definition of "hazardous substances", "hazardous waste", "hazardous materials", "extremely hazardous substances", "restricted hazardous waste", "toxic substances", "toxic pollutants", "contaminants", "pollutants" or words of similar import, under any applicable Environmental Law; and (c) any other chemical, material or substance, the exposure to, or release of which is 8 prohibited, limited or regulated by any governmental authority or for which any duty or standard of care is imposed pursuant to, any Environmental Law. Hedging Agreement means any interest rate, currency or commodity ----------------- swap agreement, cap agreement or collar agreement, and any other agreement or arrangement designed to protect a Person against fluctuations in interest rates, currency exchange rates or commodity prices. Hedging Obligation means, with respect to any Person, any liability ------------------ of such Person under any Hedging Agreement. Indemnified Liabilities - see Section 15.16. ----------------------- ------------- Interest Expense means for any period the consolidated interest ---------------- expense of the Company and its Subsidiaries for such period (including all imputed interest on Capital Leases). Interest Period means, as to any LIBOR Loan, the period commencing --------------- on the date such Loan is borrowed or continued as, or converted into, a LIBOR Loan and ending on the date one, two, three or six months thereafter as selected by the Company pursuant to Section 2.2.2 or 2.2.3, as the case ------------- ----- may be; provided that: -------- (a) if any Interest Period would otherwise end on a day that is not a Business Day, such Interest Period shall be extended to the following Business Day unless the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the preceding Business Day; (b) any Interest Period that begins on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period shall end on the last Business Day of the calendar month at the end of such Interest Period; and (c) the Loan Parties may not select any Interest Period for a Revolving Loan which would extend beyond the scheduled Termination Date. Investment means, with respect to any Person, any investment in ---------- another Person, whether by acquisition of any debt or Capital Security, by making any loan or advance, by becoming obligated with respect to a Contingent Liability in respect of obligations of such other Person (other than travel and similar advances to employees in the ordinary course of business) or by making an Acquisition. Issuing Lender means LaSalle or Citibank, in their capacity as the -------------- issuer of Letters of Credit hereunder, or any Affiliate of LaSalle or Citibank that may from time to time issue Letters of Credit, and their successors and assigns in such capacity. LaSalle - see the Preamble. ------- -------- L/C Application means, with respect to any request for the issuance --------------- of a Letter of Credit, a letter of credit application in the form being used by the Issuing Lender at the time of such request for the type of letter of credit requested. 9 L/C Fee Rate - see the definition of Applicable Margin. ------------ Lender - see the Preamble. References to the "Lenders" shall ------ -------- include the Issuing Lender; for purposes of clarification only, to the extent that LaSalle (or any successor Issuing Lender) may have any rights or obligations in addition to those of the other Lenders due to its status as Issuing Lender, its status as such will be specifically referenced. In addition to the foregoing, the term "Lender" shall include Affiliates of a Lender providing a Bank Product. Lender Party - see Section 15.17. ------------ ------------- Letter of Credit - see Section 2.1.2. ---------------- ------------- LIBOR Loan means any Loan which bears interest at a rate determined ---------- by reference to the LIBOR Rate. LIBOR Margin - see the definition of Applicable Margin. ------------ LIBOR Office means with respect to any Lender the office or offices ------------ of such Lender which shall be making or maintaining the LIBOR Loans of such Lender hereunder. A LIBOR Office of any Lender may be, at the option of such Lender, either a domestic or foreign office. LIBOR Rate means a rate of interest equal to (a) the per annum rate ---------- of interest at which United States dollar deposits in an amount comparable to the amount of the relevant LIBOR Loan and for a period equal to the relevant Interest Period are offered in the London Interbank Eurodollar market at 11:00 A.M. (London time) two (2) Business Days prior to the commencement of such Interest Period (or three (3) Business Days prior to the commencement of such Interest Period if banks in London, England were not open and dealing in offshore United States dollars on such second preceding Business Day), as displayed in the Bloomberg Financial Markets system (or other authoritative source selected by the Administrative Agent in its sole discretion) or, if the Bloomberg Financial Markets system or another authoritative source is not available, as the LIBOR Rate is otherwise determined by the Administrative Agent in its sole and absolute discretion, divided by (b) a number determined by subtracting from 1.00 the then stated maximum reserve percentage for determining reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency funding or liabilities as defined in Regulation D (or any successor category of liabilities under Regulation D), such rate to remain fixed for such Interest Period. The Administrative Agent's determination of the LIBOR Rate shall be conclusive, absent manifest error. Lien means, with respect to any Person, any interest granted by ---- such Person in any real or personal property, asset or other right owned or being purchased or acquired by such Person (including an interest in respect of a Capital Lease) which secures payment or performance of any obligation and shall include any mortgage, lien, encumbrance, title retention lien, charge or other security interest of any kind, whether arising by contract, as a matter of law, by judicial process or otherwise. Loan Documents means this Agreement, the Notes, the Letters of -------------- Credit, the Master Letter of Credit Agreement, the L/C Applications, the Fee Letter 10 and all documents, instruments and agreements delivered in connection with the foregoing. Loan Party - see the Preamble. ---------- -------- Loan or Loans means, as the context may require, Revolving Loans, ------------- and/or Swing Line Loans. Margin Stock means any "margin stock" as defined in Regulation U. ------------ Master Letter of Credit Agreement means, at any time, with respect --------------------------------- to the issuance of Letters of Credit, a master letter of credit agreement or reimbursement agreement in the form, if any, being used by the Issuing Lender at such time. Material Adverse Effect means (a) a material adverse change in, or ----------------------- a material adverse effect upon, the financial condition, operations, assets, business or properties of the Loan Parties taken as a whole, (b) a material impairment of the ability of any Loan Party to perform any of the Obligations under any Loan Document or (c) a material adverse effect upon the legality, validity, binding effect or enforceability against any Loan Party of any Loan Document. Mortgage means a mortgage, deed of trust, leasehold mortgage or -------- similar instrument granting the Administrative Agent a Lien on real property of any Loan Party. Multiemployer Pension Plan means a multiemployer plan, as defined -------------------------- in Section 4001(a)(3) of ERISA, to which the any Loan Party or any other member of the Controlled Group may have any liability. Net Worth means, as of any date, the sum of the capital stock and --------- additional paid-in capital plus retained earnings (or minus accumulated deficit) calculated in conformity with GAAP, excluding the impact of any expenses associated with in-process research and development acquired in connection with any Acquisition which are required to be expensed under GAAP. Non-U.S. Participant - see Section 7.6(d). -------------------- -------------- Non-Use Fee Rate - see the definition of Applicable Margin. ---------------- Note means a promissory note substantially in the form of Exhibit A. ---- --------- Notice of Borrowing - see Section 2.2.2. ------------------- ------------- Notice of Conversion/Continuation - see Section 2.2.3. --------------------------------- ------------- Obligations means all obligations (monetary (including ----------- post-petition interest, allowed or not) or otherwise) of any Loan Party under this Agreement and any other Loan Document including Attorney Costs and any reimbursement obligations of each Loan Party in respect of Letters of Credit and surety bonds, all Hedging Obligations permitted hereunder which are owed to any Lender or Administrative Agent, and all Bank Products Obligations, all in each case 11 howsoever created, arising or evidenced, whether direct or indirect, absolute or contingent, now or hereafter existing, or due or to become due. OFAC - see Section 10.4. ---- ------------ Operating Lease means any lease of (or other agreement conveying --------------- the right to use) any real or personal property by any Loan Party, as lessee, other than any Capital Lease. PBGC means the Pension Benefit Guaranty Corporation and any entity ---- succeeding to any or all of its functions under ERISA. Participant - see Section 15.6.2. ----------- -------------- Pension Plan means a "pension plan", as such term is defined in ------------ Section 3(2) of ERISA, which is subject to Title IV of ERISA or the minimum - ------------ funding standards of ERISA (other than a Multiemployer Pension Plan), and as to which any Loan Party or any member of the Controlled Group may have any liability, including any liability by reason of having been a substantial employer within the meaning of Section 4063 of ERISA at any time during the preceding five years, or by reason of being deemed to be a contributing sponsor under Section 4069 of ERISA. Permitted Lien means a Lien expressly permitted hereunder pursuant -------------- to Section 11.2. ------------ Person means any natural person, corporation, partnership, trust, ------ limited liability company, association, governmental authority or unit, or any other entity, whether acting in an individual, fiduciary or other capacity. Prime Rate means, for any day, the rate of interest in effect for ---------- such day as publicly announced from time to time by the Administrative Agent as its prime rate (whether or not such rate is actually charged by the Administrative Agent), which is not intended to be the Administrative Agent's lowest or most favorable rate of interest at any one time. Any change in the Prime Rate announced by the Administrative Agent shall take effect at the opening of business on the day specified in the public announcement of such change; provided that the Administrative Agent shall -------- not be obligated to give notice of any change in the Prime Rate. Pro Rata Share means: -------------- (d) with respect to a Lender's obligation to make Revolving Loans, participate in Letters of Credit, reimburse the Issuing Lender, and receive payments of principal, interest, fees, costs, and expenses with respect thereto, (x) prior to the Revolving Commitment being terminated or reduced to zero, the percentage obtained by dividing (i) such Lender's Revolving Commitment, by (ii) the aggregate Revolving Commitment of all Lenders and (y) from and after the time the Revolving Commitment has been terminated or reduced to zero, the percentage obtained by dividing (i) the aggregate unpaid principal amount of such Lender's Revolving Outstandings (after settlement and repayment of all Swing Line Loans by the Lenders) by (ii) the aggregate unpaid principal amount of all Revolving Outstandings; and 12 (e) with respect to all other matters as to a particular Lender, the percentage obtained by dividing (i) such Lender's Revolving Commitment, by (ii) the aggregate amount of Revolving Commitment of all Lenders; provided that in the event the -------- Commitments have been terminated or reduced to zero, Pro Rata Share shall be the percentage obtained by dividing (A) the principal amount of such Lender's Revolving Outstandings (after settlement and repayment of all Swing Line Loans by the Lenders) by (B) the principal amount of all outstanding Revolving Outstandings. Refunded Swing Line Loan - see Section 2.2.4(c). ------------------------ ---------------- Regulation D means Regulation D of the FRB. ------------ Regulation U means Regulation U of the FRB. ------------ Replacement Lender - see Section 8.7(b). ------------------ -------------- Reportable Event means a reportable event as defined in Section ---------------- 4043 of ERISA and the regulations issued thereunder as to which the PBGC has not waived the notification requirement of Section 4043(a), or the failure of a Pension Plan to meet the minimum funding standards of Section 412 of the Code (without regard to whether the Pension Plan is a plan described in Section 4021(a)(2) of ERISA) or under Section 302 of ERISA. Required Lenders means, at any time, Lenders whose Pro Rata Shares ---------------- exceed 50% as determined pursuant to clause (b) of the definition of "Pro Rata Share"; provided, however, that if any time there are only two Lenders, Required Lenders shall mean both Lenders. Revolving Commitment means $320,000,000, as reduced from time to -------------------- time pursuant to Section 6.1. ----------- Revolving Loan - see Section 2.1.1. -------------- ------------- Revolving Loan Availability means the Revolving Commitment less --------------------------- ---- Revolving Outstandings. Revolving Outstandings means, at any time, the sum of (a) the ---------------------- aggregate principal amount of all outstanding Revolving Loans, plus (b) the ---- Stated Amount of all Letters of Credit. SEC means the Securities and Exchange Commission or any other --- governmental authority succeeding to any of the principal functions thereof. Senior Debt means all Debt of the Loan Parties and their ----------- Subsidiaries other than Subordinated Debt. Senior Debt to EBITDA Ratio means, as of the last day of any Fiscal --------------------------- Quarter, the ratio of (a) Senior Debt as of such day to (b) EBITDA for the Computation Period ending on such day. Senior Officer means, with respect to any Loan Party, any of the -------------- chief executive officer, the chief financial officer, the chief operating officer or the treasurer of such Loan Party. 13 Stated Amount means, with respect to any Letter of Credit at any ------------- date of determination, (a) the maximum aggregate amount available for drawing thereunder under any and all circumstances plus (b) the aggregate amount of all unreimbursed payments and disbursements under such Letter of Credit. Subordinated Debt means the Convertible Notes, as such notes are in ----------------- effect on the date hereof, which are subordinated in right of payment to the Obligations pursuant to the terms of the trust indenture governing the terms of the Convertible Notes in effect on the date hereof. Subsidiary means, with respect to any Person, a corporation, ---------- partnership, limited liability company or other entity of which such Person owns, directly or indirectly, such number of outstanding Capital Securities as have more than 50% of the ordinary voting power for the election of directors or other managers of such corporation, partnership, limited liability company or other entity. Unless the context otherwise requires, each reference to Subsidiaries herein shall be a reference to Subsidiaries of the Loan Parties. Swing Line Availability means the lesser of (a) the Swing Line ----------------------- Commitment Amount and (b) Revolving Loan Availability. Swing Line Commitment Amount means $25,000,000, as reduced from ---------------------------- time to time pursuant to Section 6.1, which commitment constitutes a ----------- subfacility of the Revolving Commitment of the Swing Line Lender. Swing Line Lender means LaSalle. ----------------- ------- Swing Line Loan - see Section 2.2.4. --------------- ------------- Taxes means any and all present and future taxes, duties, levies, ----- imposts, deductions, assessments, charges or withholdings, and any and all liabilities (including interest and penalties and other additions to taxes) with respect to the foregoing, but excluding Excluded Taxes. Termination Date means the earlier to occur of (a) June 9, 2011 or ---------------- (b) such other date on which the Commitments terminate pursuant to Section 6 --------- or Section 13. ---------- Termination Event means, with respect to a Pension Plan that is ----------------- subject to Title IV of ERISA, (a) a Reportable Event, (b) the withdrawal of any Loan Party or any other member of the Controlled Group from such Pension Plan during a plan year in which such Loan Party or any other member of the Controlled Group was a "substantial employer" as defined in Section 4001(a)(2) of ERISA or was deemed such under Section 4068(f) of ERISA, (c) the termination of such Pension Plan, the filing of a notice of intent to terminate the Pension Plan or the treatment of an amendment of such Pension Plan as a termination under Section 4041 of ERISA, (d) the institution by the PBGC of proceedings to terminate such Pension Plan or (e) any event or condition that might constitute grounds under Section 4042 of ERISA for the termination of, or appointment of a trustee to administer, such Pension Plan. Total Plan Liability means, at any time, the present value of all -------------------- vested and unvested accrued benefits under all Pension Plans, determined as of the then most recent valuation date for each Pension Plan, using PBGC actuarial assumptions for single employer plan terminations. 14 Type - see Section 2.2.1. ---- ------------- UCC means the Uniform Commercial Code as in effect on the date --- hereof and from time to time in the State of Illinois, provided that if by reason of mandatory provisions of law, the perfection or the effect of perfection or non-perfection of the security interests in any collateral or the availability of any remedy hereunder is governed by the Uniform Commercial Code as in effect on or after the date hereof in any other jurisdiction, "UCC" means the Uniform Commercial Code as in effect in such other jurisdiction for purposes of the provisions hereof relating to such perfection or effect of perfection or non-perfection or availability of such remedy. Unfunded Liability means the amount (if any) by which the present ------------------ value of all vested and unvested accrued benefits under all Pension Plans exceeds the fair market value of all assets allocable to those benefits, all determined as of the then most recent valuation date for each Pension Plan, using PBGC actuarial assumptions for single employer plan terminations. Unmatured Event of Default means any event that, if it continues -------------------------- uncured, will, with lapse of time or notice or both, constitute an Event of Default. Withholding Certificate - see Section 7.6(d). ----------------------- -------------- Wholly-Owned Subsidiary means, as to any Person, a Subsidiary all ----------------------- of the Capital Securities of which (except directors' qualifying Capital Securities) are at the time directly or indirectly owned by such Person and/or another Wholly-Owned Subsidiary of such Person. 1.2 Other Interpretive Provisions. (a) The meanings of defined ----------------------------- terms are equally applicable to the singular and plural forms of the defined terms. (b) Section, Annex, Schedule and Exhibit references are to this Agreement unless otherwise specified. (c) The term "including" is not limiting and means "including without limitation." (d) In the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including"; the words "to" and "until" each mean "to but excluding", and the word "through" means "to and including." (e) Unless otherwise expressly provided herein, (i) references to agreements (including this Agreement and the other Loan Documents) and other contractual instruments shall be deemed to include all subsequent amendments, restatements, supplements and other modifications thereto, but only to the extent such amendments, restatements, supplements and other modifications are not prohibited by the terms of any Loan Document, and (ii) references to any statute or regulation shall be construed as including all statutory and regulatory provisions amending, replacing, supplementing or interpreting such statute or regulation. (f) This Agreement and the other Loan Documents may use several different limitations, tests or measurements to regulate the same or similar matters. All such limitations, tests and measurements are cumulative and each shall be performed in accordance with its terms. 15 (g) This Agreement and the other Loan Documents are the result of negotiations among and have been reviewed by counsel to the Administrative Agent, the Loan Parties, the Lenders and the other parties thereto and are the products of all parties. Accordingly, they shall not be construed against the Administrative Agent or the Lenders merely because of the Administrative Agent's or Lenders' involvement in their preparation. SECTION 2 COMMITMENTS OF THE LENDERS; BORROWING, CONVERSION AND LETTER OF CREDIT PROCEDURES. 2.1 Commitments. On and subject to the terms and conditions of this ----------- Agreement, each of the Lenders, severally and for itself alone, agrees to make loans to, and to issue or participate in letters of credit for the account of, the Loan Parties as follows: 2.1.1 Revolving Loan Commitment. Each Lender with a Revolving Loan ------------------------- Commitment agrees to make loans on a revolving basis ("Revolving Loans") --------------- from time to time until the Termination Date in such Lender's Pro Rata Share of such aggregate amounts as the Loan Parties may request from all Lenders; provided that the Revolving Outstandings will not at any time exceed the - -------- Revolving Commitment (less the amount of any Swing Line Loans outstanding at such time). 2.1.2 L/C Commitment. Subject to Section 2.3.1, the Issuing Lender -------------- ------------- agrees to issue letters of credit, in each case containing such terms and conditions as are permitted by this Agreement and are reasonably satisfactory to the Issuing Lender (each, a "Letter of Credit"), at the ---------------- request of and for the account of the Loan Parties from time to time before the scheduled Termination Date and, as more fully set forth in Section ------- 2.3.2, each Lender agrees to purchase a participation in each such Letter of - ----- Credit; provided that (a) the aggregate Stated Amount of all Letters of -------- Credit shall not at any time exceed $160,000,000 and (b) the Revolving Outstandings shall not at any time exceed the Revolving Commitment (less the amount of any Swing Line Loans outstanding at such time). 2.2 Loan Procedures. --------------- 2.2.1 Various Types of Loans. Each Revolving Loan shall be divided ---------------------- into tranches which are, either a Base Rate Loan or a LIBOR Loan (each a "type" of Loan), as the Company shall specify in the related notice of ---- borrowing or conversion pursuant to Section 2.2.2 or 2.2.3. LIBOR Loans ------------- ----- having the same Interest Period which expire on the same day are sometimes called a "Group" or collectively "Groups". Base Rate Loans and LIBOR Loans ----- ------ may be outstanding at the same time, provided that not more than twenty-five -------- (25) different Groups of LIBOR Loans shall be outstanding at any one time. All borrowings, conversions and repayments of Revolving Loans shall be effected so that each Lender will have a ratable share (according to its Pro Rata Share) of all types and Groups of Loans. 2.2.2 Borrowing Procedures. The Loan Parties shall give written -------------------- notice (each such written notice, a "Notice of Borrowing") substantially in ------------------- the form of Exhibit D or telephonic notice (followed immediately by a Notice --------- of Borrowing) to the Administrative Agent of each proposed borrowing not later than (a) in the case of a Base Rate borrowing, 11:00 A.M., Chicago 16 time, on the proposed date of such borrowing, and (b) in the case of a LIBOR borrowing, 11:00 A.M., Chicago time, at least three Business Days prior to the proposed date of such borrowing. Each such notice shall be effective upon receipt by the Administrative Agent, shall be irrevocable, and shall specify the date, amount and type of borrowing and, in the case of a LIBOR borrowing, the initial Interest Period therefor. Promptly upon receipt of such notice, the Administrative Agent shall advise each Lender thereof. Not later than 1:00 P.M., Chicago time, on the date of a proposed borrowing, each Lender shall provide the Administrative Agent at the office specified by the Administrative Agent with immediately available funds covering such Lender's Pro Rata Share of such borrowing and, so long as the Administrative Agent has not received written notice that the conditions precedent set forth in Section 11 with respect to such borrowing have not been satisfied, ---------- the Administrative Agent shall pay over the funds received by the Administrative Agent to the Loan Parties on the requested borrowing date. Each borrowing shall be on a Business Day. Each Base Rate borrowing shall be in an aggregate amount of at least $500,000 and an integral multiple of $100,000, and each LIBOR borrowing shall be in an aggregate amount of at least $1,000,000 and an integral multiple of at least $100,000. 2.2.3 Conversion and Continuation Procedures. (a) Subject to -------------------------------------- Section 2.2.1, the Loan Parties may, upon irrevocable written notice to the - ------------- Administrative Agent in accordance with clause (b) below: ---------- (A) elect, as of any Business Day, to convert any Loans (or any part thereof in an aggregate amount not less than $1,000,000 a higher integral multiple of $100,000) into Loans of the other type; or (B) elect, as of the last day of the applicable Interest Period, to continue any LIBOR Loans having Interest Periods expiring on such day (or any part thereof in an aggregate amount not less than $1,000,000 or a higher integral multiple of $100,000) for a new Interest Period; provided that after giving effect to any prepayment, conversion or - -------- continuation, the aggregate principal amount of each Group of LIBOR Loans shall be at least $1,000,000 and an integral multiple of $100,000. (b) The Loan Parties shall give written notice (each such written notice, a "Notice of Conversion/Continuation") substantially in the form of --------------------------------- Exhibit E or telephonic notice (followed immediately by a Notice of - --------- Conversion/Continuation) to the Administrative Agent of each proposed conversion or continuation not later than (i) in the case of conversion into Base Rate Loans, 11:00 A.M., Chicago time, on the proposed date of such conversion and (ii) in the case of conversion into or continuation of LIBOR Loans, 11:00 A.M., Chicago time, at least three Business Days prior to the proposed date of such conversion or continuation, specifying in each case: (A) the proposed date of conversion or continuation; (B) the aggregate amount of Loans to be converted or continued; (C) the type of Loans resulting from the proposed conversion or continuation; and 17 (D) in the case of conversion into, or continuation of, LIBOR Loans, the duration of the requested Interest Period therefor. (c) If upon the expiration of any Interest Period applicable to LIBOR Loans, the Loan Parties have failed to select timely a new Interest Period to be applicable to such LIBOR Loans, the Loan Parties shall be deemed to have elected to convert such LIBOR Loans into Base Rate Loans effective on the last day of such Interest Period. (d) The Administrative Agent will promptly notify each Lender of its receipt of a notice of conversion or continuation pursuant to this Section 2.2.3 or, if no timely notice is provided by the Loan Parties, of - ------------- the details of any automatic conversion. (e) Any conversion of a LIBOR Loan on a day other than the last day of an Interest Period therefor shall be subject to Section 8.4. ----------- 2.2.4 Swing Line Facility. ------------------- (a) The Administrative Agent shall notify the Swing Line Lender upon the Administrative Agent's receipt of any Notice of Borrowing. Subject to the terms and conditions hereof, the Swing Line Lender may, in its sole discretion, make available from time to time until the Termination Date advances (each, a "Swing Line Loan") in accordance with any such notice, --------------- notwithstanding that after making a requested Swing Line Loan, the sum of the Swing Line Lender's Pro Rata Share of the Revolving Outstanding and all outstanding Swing Line Loans, may exceed the Swing Line Lender's Pro Rata Share of the Revolving Commitment. The provisions of this Section 2.2.4 ------------- shall not relieve Lenders of their obligations to make Revolving Loans under Section 2.1.1; provided that if the Swing Line Lender makes a Swing Line - ------------- -------- Loan pursuant to any such notice, such Swing Line Loan shall be in lieu of any Revolving Loan that otherwise may be made by the Lenders pursuant to such notice. The aggregate amount of Swing Line Loans outstanding shall not exceed at any time Swing Line Availability. Until the Termination Date, the Loan Parties may from time to time borrow, repay and reborrow under this Section 2.2.4. Each Swing Line Loan shall be made pursuant to a Notice of - ------------- Borrowing delivered by the Loan Parties to the Administrative Agent in accordance with Section 2.2.2. Any such notice must be given no later than ------------- 2:00 P.M., Chicago time, on the Business Day of the proposed Swing Line Loan. Unless the Swing Line Lender has received at least one Business Day's prior written notice from the Required Lenders instructing it not to make a Swing Line Loan, the Swing Line Lender shall, notwithstanding the failure of any condition precedent set forth in Section 12.2, be entitled to fund that ------------ Swing Line Loan, and to have such Lender make Revolving Loans in accordance with Section 2.2.4(c) or purchase participating interests in accordance with ---------------- Section 2.2.4(d). Notwithstanding any other provision of this Agreement or - ---------------- the other Loan Documents, each Swing Line Loan shall constitute a Base Rate Loan. The Loan Parties shall repay the aggregate outstanding principal amount of each Swing Line Loan upon demand therefor by the Administrative Agent. (b) The entire unpaid balance of each Swing Line Loan and all other noncontingent Obligations shall be immediately due and payable in full in immediately available funds on the Termination Date if not sooner paid in full. 18 (c) The Swing Line Lender, at any time and from time to time no less frequently than once weekly, shall on behalf of the Loan Parties (and the Loan Parties hereby irrevocably authorize the Swing Line Lender to so act on its behalf) request each Lender with a Revolving Commitment (including the Swing Line Lender) to make a Revolving Loan to the Loan Parties (which shall be a Base Rate Loan) in an amount equal to that Lender's Pro Rata Share of the principal amount of all Swing Line Loans (the "Refunded Swing Line Loan") outstanding on the date such notice is given. ------------------------ Unless any of the events described in Section 13.1.4 has occurred (in which -------------- event the procedures of Section 2.2.4(d) shall apply) and regardless of ---------------- whether the conditions precedent set forth in this Agreement to the making of a Revolving Loan are then satisfied, each Lender shall disburse directly to the Administrative Agent, its Pro Rata Share on behalf of the Swing Line Lender, prior to 2:00 P.M., Chicago time, in immediately available funds on the date that notice is given (provided that such notice is given by 12:00 -------- p.m., Chicago time, on such date). The proceeds of those Revolving Loans shall be immediately paid to the Swing Line Lender and applied to repay the Refunded Swing Line Loan. (d) If, prior to refunding a Swing Line Loan with a Revolving Loan pursuant to Section 2.2.4(c), one of the events described in Section 13.1.4 ---------------- ------------- has occurred, then, subject to the provisions of Section 2.2.4(e) below, ---------------- each Lender shall, on the date such Revolving Loan was to have been made for the benefit of the Loan Parties, purchase from the Swing Line Lender an undivided participation interest in the Swing Line Loan in an amount equal to its Pro Rata Share of such Swing Line Loan. Upon request, each Lender shall promptly transfer to the Swing Line Lender, in immediately available funds, the amount of its participation interest. (e) Each Lender's obligation to make Revolving Loans in accordance with Section 2.2.4(c) and to purchase participation interests in accordance ---------------- with Section 2.2.4(d) shall be absolute and unconditional and shall not be ---------------- affected by any circumstance, including (i) any setoff, counterclaim, recoupment, defense or other right that such Lender may have against the Swing Line Lender, any Loan Party or any other Person for any reason whatsoever; (ii) the occurrence or continuance of any Unmatured Event of Default or Event of Default; (iii) any inability of any Loan Party to satisfy the conditions precedent to borrowing set forth in this Agreement at any time or (iv) any other circumstance, happening or event whatsoever, whether or not similar to any of the foregoing. If and to the extent any Lender shall not have made such amount available to the Administrative Agent or the Swing Line Lender, as applicable, by 2:00 P.M., Chicago time, the amount required pursuant to Sections 2.2.4(c) or 2.2.4(d), as the case may ----------------- -------- be, on the Business Day on which such Lender receives notice from the Administrative Agent of such payment or disbursement (it being understood that any such notice received after noon, Chicago time, on any Business Day shall be deemed to have been received on the next following Business Day), such Lender agrees to pay interest on such amount to the Administrative Agent for the Swing Line Lender's account forthwith on demand, for each day from the date such amount was to have been delivered to the Administrative Agent to the date such amount is paid, at a rate per annum equal to (a) for the first three days after demand, the Federal Funds Rate from time to time in effect and (b) thereafter, the Base Rate from time to time in effect. 19 2.3 Letter of Credit Procedures. --------------------------- 2.3.1 L/C Applications. The Loan Parties shall execute and deliver ---------------- to the Issuing Lender the Master Letter of Credit Agreement from time to time in effect. The Loan Parties shall give notice to the Administrative Agent and the Issuing Lender of the proposed issuance of each Letter of Credit on a Business Day which is at least three Business Days (or such lesser number of days as the Administrative Agent and the Issuing Lender shall agree in any particular instance in their sole discretion) prior to the proposed date of issuance of such Letter of Credit. Each such notice shall be accompanied by an L/C Application, duly executed by the Loan Parties and in all respects satisfactory to the Administrative Agent and the Issuing Lender, together with such other documentation as the Administrative Agent or the Issuing Lender may request in support thereof, it being understood that each L/C Application shall specify, among other things, the date on which the proposed Letter of Credit is to be issued, the expiration date of such Letter of Credit (which shall not be later than the scheduled Termination Date (unless such Letter of Credit is Cash Collateralized)) and whether such Letter of Credit is to be transferable in whole or in part. Any Letter of Credit outstanding after the scheduled Termination Date which is Cash Collateralized for the benefit of the Issuing Lender shall be the sole responsibility of the Issuing Lender. So long as the Issuing Lender has not received written notice that the conditions precedent set forth in Section ------- 12 with respect to the issuance of such Letter of Credit have not been - -- satisfied, the Issuing Lender shall issue such Letter of Credit on the requested issuance date. The Issuing Lender shall promptly advise the Administrative Agent of the issuance of each Letter of Credit and of any amendment thereto, extension thereof or event or circumstance changing the amount available for drawing thereunder. In the event of any inconsistency between the terms of the Master Letter of Credit Agreement, any L/C Application and the terms of this Agreement, the terms of this Agreement shall control. 2.3.2 Participations in Letters of Credit. Concurrently with the ----------------------------------- issuance of each Letter of Credit, the Issuing Lender shall be deemed to have sold and transferred to each Lender with a Revolving Loan Commitment, and each such Lender shall be deemed irrevocably and unconditionally to have purchased and received from the Issuing Lender, without recourse or warranty, an undivided interest and participation, to the extent of such Lender's Pro Rata Share, in such Letter of Credit and the Loan Parties' reimbursement obligations with respect thereto. If the Loan Parties do not pay any reimbursement obligation when due, the Loan Parties shall be deemed to have immediately requested that the Lenders make a Revolving Loan which is a Base Rate Loan in a principal amount equal to such reimbursement obligations. The Administrative Agent shall promptly notify such Lenders of such deemed request and, without the necessity of compliance with the requirements of Section 2.2.2, Section 12.2 or otherwise such Lender shall ------------- ------------ make available to the Administrative Agent its Pro Rata Share of such Loan. The proceeds of such Loan shall be paid over by the Administrative Agent to the Issuing Lender for the account of the Loan Parties in satisfaction of such reimbursement obligations. For the purposes of this Agreement, the unparticipated portion of each Letter of Credit shall be deemed to be the Issuing Lender's "participation" therein. The Issuing Lender hereby agrees, upon request of the Administrative Agent or any Lender, to deliver to the Administrative Agent or such Lender a list of all outstanding Letters of Credit issued by the Issuing Lender, together with such information related thereto as the Administrative Agent or such Lender may reasonably request. 20 2.3.3 Reimbursement Obligations. (a) The Loan Parties hereby ------------------------- unconditionally and irrevocably agree to reimburse the Issuing Lender for each payment or disbursement made by the Issuing Lender under any Letter of Credit honoring any demand for payment made by the beneficiary thereunder, in each case on the date that such payment or disbursement is made. Any amount not reimbursed on the date of such payment or disbursement shall bear interest from the date of such payment or disbursement to the date that the Issuing Lender is reimbursed by the Loan Parties therefor, payable on demand, at a rate per annum equal to the Base Rate from time to time in effect plus the Base Rate Margin from time to time in effect plus, beginning on the third Business Day after receipt of notice from the Issuing Lender of such payment or disbursement, 2%. The Issuing Lender shall notify the Loan Parties and the Administrative Agent whenever any demand for payment is made under any Letter of Credit by the beneficiary thereunder; provided that the failure of the Issuing Lender to so notify the Loan Parties or the Administrative Agent shall not affect the rights of the Issuing Lender or the Lenders in any manner whatsoever. (b) The Loan Parties' reimbursement obligations hereunder shall be irrevocable and unconditional under all circumstances, including (a) any lack of validity or enforceability of any Letter of Credit, this Agreement or any other Loan Document, (b) the existence of any claim, set-off, defense or other right which any Loan Party may have at any time against a beneficiary named in a Letter of Credit, any transferee of any Letter of Credit (or any Person for whom any such transferee may be acting), the Administrative Agent, the Issuing Lender, any Lender or any other Person, whether in connection with any Letter of Credit, this Agreement, any other Loan Document, the transactions contemplated herein or any unrelated transactions (including any underlying transaction between any Loan Party and the beneficiary named in any Letter of Credit), (c) the validity, sufficiency or genuineness of any document which the Issuing Lender has determined complies on its face with the terms of the applicable Letter of Credit, even if such document should later prove to have been forged, fraudulent, invalid or insufficient in any respect or any statement therein shall have been untrue or inaccurate in any respect, or (d) the surrender or impairment of any security for the performance or observance of any of the terms hereof. Without limiting the foregoing, no action or omission whatsoever by the Administrative Agent or any Lender (excluding any Lender in its capacity as the Issuing Lender) under or in connection with any Letter of Credit or any related matters shall result in any liability of the Administrative Agent or any Lender to any Loan Party, or relieve any Loan Party of any of its obligations hereunder to any such Person. 2.3.4 Funding by Lenders to Issuing Lender. If the Issuing Lender ------------------------------------ makes any payment or disbursement under any Letter of Credit and (a) the Loan Parties have not reimbursed the Issuing Lender in full for such payment or disbursement by 1:00 P.M., Chicago time, on the date of such payment or disbursement, (b) a Revolving Loan may not be made in accordance with Section 2.3.2 or (c) any reimbursement received by the Issuing Lender from - ------------- the Loan Parties is or must be returned or rescinded upon or during any bankruptcy or reorganization of the Loan Parties or otherwise, each other Lender with a Revolving Loan Commitment shall be obligated to pay to the Administrative Agent for the account of the Issuing Lender, in full or partial payment of the purchase price of its participation in such Letter of Credit, its Pro Rata Share of such payment or disbursement (but no such payment shall diminish the obligations of the Loan Parties under Section ------- 2.3.3), and, upon notice from the Issuing Lender, the Administrative Agent - ----- shall promptly notify each other Lender thereof. Each other Lender 21 irrevocably and unconditionally agrees to so pay to the Administrative Agent in immediately available funds for the Issuing Lender's account the amount of such other Lender's Pro Rata Share of such payment or disbursement. If and to the extent any Lender shall not have made such amount available to the Administrative Agent by 2:00 P.M., Chicago time, on the Business Day on which such Lender receives notice from the Administrative Agent of such payment or disbursement (it being understood that any such notice received after noon, Chicago time, on any Business Day shall be deemed to have been received on the next following Business Day), such Lender agrees to pay interest on such amount to the Administrative Agent for the Issuing Lender's account forthwith on demand, for each day from the date such amount was to have been delivered to the Administrative Agent to the date such amount is paid, at a rate per annum equal to (a) for the first three days after demand, the Federal Funds Rate from time to time in effect and (b) thereafter, the Base Rate from time to time in effect. Any Lender's failure to make available to the Administrative Agent its Pro Rata Share of any such payment or disbursement shall not relieve any other Lender of its obligation hereunder to make available to the Administrative Agent such other Lender's Pro Rata Share of such payment, but no Lender shall be responsible for the failure of any other Lender to make available to the Administrative Agent such other Lender's Pro Rata Share of any such payment or disbursement. 2.4 Commitments Several. The failure of any Lender to make a ------------------- requested Loan on any date shall not relieve any other Lender of its obligation (if any) to make a Loan on such date, but no Lender shall be responsible for the failure of any other Lender to make any Loan to be made by such other Lender. 2.5 Certain Conditions. Except as otherwise provided in Sections ------------------ -------- 2.2.4 and 2.3.4 of this Agreement, no Lender shall have an obligation to - ----- ----- make any Loan, or to permit the continuation of or any conversion into any LIBOR Loan, and the Issuing Lender shall not have any obligation to issue any Letter of Credit, if an Event of Default or Unmatured Event of Default exists. 2.6 Increases in Revolving Commitment. The Company may, at its --------------------------------- option at any time and from time to time on or before the Termination Date, seek to increase the aggregate amount of the Revolving Commitment by up to an aggregate amount not exceeding Fifty Million Dollars ($50,000,000) (resulting in maximum Revolving Commitment of Three Hundred Seventy Million Dollars ($370,000,000)) upon written notice to the Administrative Agent, which notice shall specify the amount of any such incremental increase (which shall not be less than Ten Million Dollars ($10,000,000)) and shall be delivered at a time when no Event of Default or Unmatured Event of Default has occurred and is continuing. The Administrative Agent, subject to the consent of the Company, which shall not be unreasonably withheld or delayed, may allocate, as it determines in Administrative Agent's sole discretion, the incremental increase in the Revolving Commitment on either a ratable basis to the Lenders (which may be declined by any Lender in its sole discretion) or on a non pro-rata basis to one or more Lenders (which may be declined by any Lender in its sole discretion) and/or to other banks or entities reasonably acceptable to the Administrative Agent and the Company which have expressed a desire to accept the increase in its Revolving Commitment. The Administrative Agent will then notify each existing and potentially new Lender of such revised allocations of the aggregate amount of the Revolving Commitment, including the desired increase. No increase in the aggregate amount of the Revolving Commitment shall become effective until each of the existing or new Lenders 22 extending such incremental increase in its Revolving Commitment and the Company shall have delivered to the Administrative Agent one or more documents, notes, opinions, and other agreements in form reasonably satisfactory to the Administrative Agent pursuant to which any such existing Lender states, inter alia, the amount of its Revolving Commitment increase, any such new Lender states its Revolving Commitment amount and agrees to assume and accept the obligations and rights of a Lender hereunder, the Company accepts such new Revolving Commitments, and Company certifies that no Event of Default or Unmatured Event of Default has occurred and is continuing. After giving effect to such increase in the aggregate amount of the Revolving Commitment, all Loans and all such other credit exposure shall be held ratably by the Lenders in proportion to their respective Revolving Commitments, as revised to accommodate the increase in the Revolving Commitment. Upon any increase in the aggregate amount of the Revolving Commitment pursuant to this Section, the Company shall pay Administrative Agent for the ratable benefit of only the Lenders (including any new Lender) whose Revolving Commitments are increased an upfront fee in an amount equal to what is mutually agreed to among the Company, the Lenders whose Revolving Commitments are increased and the Administrative Agent. Upon any such increase, Annex A shall be deemed to be amended to reflect such increase and ------- the Administrative Agent shall promptly deliver a copy of the revised Annex ----- A to each Lender and the Company. - - SECTION 3 EVIDENCING OF LOANS. 3.1 Notes. The Loans of each Lender shall be evidenced by a Note, ----- with appropriate insertions, payable to the order of such Lender in a face principal amount equal to the sum of such Lender's Revolving Loan Commitment. 3.2 Recordkeeping. The Administrative Agent, on behalf of each ------------- Lender, shall record in its records, the date and amount of each Loan made by each Lender, each repayment or conversion thereof and, in the case of each LIBOR Loan, the dates on which each Interest Period for such Loan shall begin and end. The aggregate unpaid principal amount so recorded shall be rebuttably presumptive evidence of the principal amount of the Loans owing and unpaid. The failure to so record any such amount or any error in so recording any such amount shall not, however, limit or otherwise affect the Obligations of the Loan Parties hereunder or under any Note to repay the principal amount of the Loans hereunder, together with all interest accruing thereon. SECTION 4 INTEREST. 4.1 Interest Rates. The Loan Parties, jointly and severally, -------------- promise to pay interest on the unpaid principal amount of each Loan for the period commencing on the date of such Loan until such Loan is paid in full as follows: (a) at all times while such Loan is a Base Rate Loan, at a rate per annum equal to the sum of the Base Rate from time to time in effect plus the Base Rate Margin from time to time in effect; and 23 (b) at all times while such Loan is a LIBOR Loan, at a rate per annum equal to the sum of the LIBOR Rate applicable to each Interest Period for such Loan plus the LIBOR Margin from time to time in effect; provided that at any time an Event of Default exists, unless the Required - -------- Lenders otherwise consent, the interest rate applicable to each Loan shall be increased by 2% (and, in the case of Obligations not bearing interest, such Obligations shall bear interest at the Base Rate applicable to Revolving Loans plus 2%), provided further that such increase may thereafter -------- ------- be rescinded by the Required Lenders, notwithstanding Section 15.1. ------------ Notwithstanding the foregoing, upon the occurrence of an Event of Default under Sections 13.1.1 or 13.1.4, such increase shall occur automatically. --------------- ------ 4.2 Interest Payment Dates. Accrued interest on each Base Rate Loan ---------------------- shall be payable in arrears on the last day of each calendar quarter and at maturity. Accrued interest on each LIBOR Loan shall be payable on the last day of each Interest Period relating to such Loan (and, in the case of a LIBOR Loan with an Interest Period in excess of three months, on the three-month anniversary of the first day of such Interest Period), upon a prepayment of such Loan, and at maturity. After maturity, and at any time an Event of Default exists, accrued interest on all Loans shall be payable on demand. 4.3 Setting and Notice of LIBOR Rates. The applicable LIBOR Rate --------------------------------- for each Interest Period shall be determined by the Administrative Agent, and notice thereof shall be given by the Administrative Agent promptly to the Loan Parties and each Lender. Each determination of the applicable LIBOR Rate by the Administrative Agent shall be conclusive and binding upon the parties hereto, in the absence of demonstrable error. The Administrative Agent shall, upon written request of the Loan Parties or any Lender, deliver to the Loan Parties or such Lender a statement showing the computations used by the Administrative Agent in determining any applicable LIBOR Rate hereunder. 4.4 Computation of Interest. Interest shall be computed for the ----------------------- actual number of days elapsed on the basis of a year of 360 days. The applicable interest rate for each Base Rate Loan shall change simultaneously with each change in the Base Rate. SECTION 5 FEES. 5.1 Non-Use Fee. The Loan Parties agree to pay to the ----------- Administrative Agent for the account of each Lender a non-use fee, for the period from the Closing Date to the Termination Date, at the Non-Use Fee Rate in effect from time to time of such Lender's Pro Rata Share (as adjusted from time to time) of the unused amount of the Revolving Commitment. For purposes of calculating usage under this Section, the Revolving Commitment shall be deemed used to the extent of Revolving Outstandings (without giving effect to any outstanding Swing Loans). Such non-use fee shall be payable in arrears on the last day of each calendar quarter and on the Termination Date for any period then ending for which such non-use fee shall not have previously been paid. The non-use fee shall be computed for the actual number of days elapsed on the basis of a year of 360 days. 24 5.2 Letter of Credit Fees. (a) The Loan Parties agree to pay to the --------------------- Administrative Agent for the account of each Lender a letter of credit fee for each Letter of Credit equal to the L/C Fee Rate in effect from time to time of such Lender's Pro Rata Share (as adjusted from time to time) of the undrawn amount of such Letter of Credit (computed for the actual number of days elapsed on the basis of a year of 360 days); provided that, unless the -------- Required Lenders otherwise consent, the rate applicable to each Letter of Credit shall be increased by 2% at any time that an Event of Default exists. Such letter of credit fee shall be payable on the first day of each calendar quarter, in advance, and on the Termination Date (or such later date on which such Letter of Credit expires or is terminated) for the period from the date of the issuance of each Letter of Credit (or the last day on which the letter of credit fee was paid with respect thereto) to the date such payment is due or, if earlier, the date on which such Letter of Credit expired or was terminated. (b) In addition, with respect to each Letter of Credit, the Loan Parties agree to pay to the Issuing Lender, for its own account, (i) such fees and expenses as the Issuing Lender customarily requires in connection with the issuance, negotiation, processing and/or administration of letters of credit in similar situations and (ii) a letter of credit fronting fee in the amount and at the times agreed to by the Loan Parties and the Issuing Lender. 5.3 Administrative Fees. The Loan Parties agree to pay to the ------------------- Administrative Agent and the Arrangers such fees as are mutually agreed to from time to time by the Loan Parties and such parties including the fees set forth in the Fee Letter. SECTION 6 REDUCTION OR TERMINATION OF THE REVOLVING COMMITMENT; PREPAYMENTS. 6.1 Reduction or Termination of the Revolving Commitment. ---------------------------------------------------- 6.1.1 Voluntary Reduction or Termination of the Revolving --------------------------------------------------- Commitment. The Loan Parties may from time to time on at least five Business - ---------- Days' prior written notice received by the Administrative Agent (which shall promptly advise each Lender thereof) permanently reduce the Revolving Commitment to an amount not less than the Revolving Outstandings plus the ---- outstanding amount of all Swing Line Loans. Any such reduction shall be in an amount not less than $10,000,000 or a higher integral multiple of $5,000,000. Concurrently with any reduction of the Revolving Commitment to zero, the Loan Parties shall pay all interest on the Revolving Loans, all non-use fees and all letter of credit fees and shall Cash Collateralize in full all obligations arising with respect to the Letters of Credit. 6.1.2 All Reductions of the Revolving Commitment. All reductions of ------------------------------------------ the Revolving Commitment shall reduce the Commitments ratably among the Lenders according to their respective Pro Rata Shares. 6.2 Prepayments. ----------- 6.2.1 Voluntary Prepayments. The Loan Parties may from time to time --------------------- prepay the Loans in whole or in part; provided that the Loan Parties shall give the Administrative Agent (which shall promptly advise each Lender) notice thereof not later than 11:00 A.M., Chicago time, on the day of such prepayment (which shall be a Business Day), specifying the Loans to be 25 prepaid and the date and amount of prepayment. Any such partial prepayment shall be in an amount equal to $5,000,000 or a higher integral multiple of $1,000,000. (a) If on any day the Revolving Outstandings plus the outstanding amount of the Swing Line Loan exceeds the Revolving Commitment, the Loan Parties shall immediately prepay Revolving Loans and/or Cash Collateralize the outstanding Letters of Credit, or do a combination of the foregoing, in an amount sufficient to eliminate such excess. (b) If on any day on which the Revolving Commitment is reduced the Revolving Outstandings plus the outstanding amount of the Swing Line Loan ---- exceeds the Revolving Commitment, the Loan Parties shall immediately prepay Revolving Loans or Cash Collateralize the outstanding Letters of Credit, or do a combination of the foregoing, in an amount sufficient to eliminate such excess. 6.3 Manner of Prepayments. Each voluntary partial prepayment shall be --------------------- in a principal amount of $5,000,000 or a higher integral multiple of $1,000,000. Any partial prepayment of a Group of LIBOR Loans shall be subject to the proviso to Section 2.2.3(a). Any prepayment of a LIBOR Loan ---------------- on a day other than the last day of an Interest Period therefor shall include interest on the principal amount being repaid and shall be subject to Section 8.4. Except as otherwise provided by this Agreement, all ----------- principal payments in respect of the Loans (other than the Swing Line Loans) shall be applied first, to repay outstanding Base Rate Loans and then to repay outstanding LIBOR Rate Loans in direct order of Interest Period maturities. 6.4 Repayments. The Revolving Loans of each Lender shall be paid in ---------- full and the Revolving Commitment shall terminate on the Termination Date. SECTION 7 MAKING AND PRORATION OF PAYMENTS; SETOFF; TAXES. 7.1 Making of Payments. All payments of principal or interest on ------------------ the Notes, and of all fees, shall be made by the Loan Parties to the Administrative Agent in immediately available funds at the office specified by the Administrative Agent not later than noon, Chicago time, on the date due; and funds received after that hour shall be deemed to have been received by the Administrative Agent on the following Business Day. The Administrative Agent shall promptly remit to each Lender its share of all such payments received in collected funds by the Administrative Agent for the account of such Lender. All payments under Section 8.1 shall be made by ----------- the Loan Parties directly to the Lender entitled thereto without setoff, counterclaim or other defense. 7.2 Application of Certain Payments. So long as no Unmatured Event ------------------------------- of Default or Event of Default has occurred and is continuing, (a) payments matching specific scheduled payments then due shall be applied to those scheduled payments and (b) voluntary and mandatory prepayments shall be applied as set forth in Sections 6.2 and 6.3. After the occurrence and ------------ --- during the continuance of an Unmatured Event of Default or Event of Default, all amounts collected or received by the Administrative Agent or any Lender shall be applied as follows: first, to all fees, costs, indemnities, liabilities, obligations and expenses incurred by or owing to Administrative Agent with respect to this Agreement and the other Loan Documents; second, to all fees, costs, indemnities, liabilities, obligations and expenses incurred by or owing to any Lender with respect to this Agreement and the other Loan Documents; third, to pay accrued and unpaid interest on Swing Line Loans; fourth, to accrued and unpaid interest on the Loans (other than Swing Line Loans) (including any interest which, but for the provisions of Title 11 of the United States Bankruptcy Code, would have accrued on such amounts); fifth, to the principal amount of all outstanding Swing Line Loans; sixth, to the principal amount of the Loans outstanding (other than Swing Line Loans); seventh to provide cash collateral, to the extent required; and eighth to all other Obligations. Any balance remaining shall be delivered to the Loan Parties or to whoever may be lawfully entitled to receive such balance or as a court of competent jurisdiction may direct. In carrying out the foregoing, (x) amounts received shall be applied in the numerical order provided until exhausted prior to the application to the next succeeding category and (y) each of the Persons entitled to receive a payment in any particular category shall receive an amount equal to its pro rata share of amounts available to be applied pursuant thereto for such category. 26 Concurrently with each remittance to any Lender of its share of any such payment, the Administrative Agent shall advise such Lender as to the application of such payment. 7.3 Due Date Extension. If any payment of principal or interest ------------------ with respect to any of the Loans, or of any fees, falls due on a day which is not a Business Day, then such due date shall be extended to the immediately following Business Day (unless, in the case of a LIBOR Loan, such immediately following Business Day is the first Business Day of a calendar month, in which case such due date shall be the immediately preceding Business Day) and, in the case of principal, additional interest shall accrue and be payable for the period of any such extension. 7.4 Setoff. Each Loan Party, for itself and each other Loan Party, ------ agrees that the Administrative Agent and each Lender have all rights of set-off and bankers' lien provided by applicable law, and in addition thereto, each Loan Party, for itself and each other Loan Party, agrees that at any time any Event of Default exists, the Administrative Agent and each Lender may apply to the payment of any Obligations of the Loan Parties, whether or not then due, any and all balances, credits, deposits, accounts or moneys of any Loan Party then or thereafter with the Administrative Agent or such Lender. 7.5 Proration of Payments. If any Lender shall obtain any payment --------------------- or other recovery (whether voluntary, involuntary, by application of offset or otherwise, on account of (a) principal of or interest on any Loan, but excluding (i) any payment pursuant to Section 8.7 or 15.6 and (ii) payments ----------- ---- of interest on any Affected Loan) or (b) its participation in any Letter of Credit) in excess of its applicable Pro Rata Share of payments and other recoveries obtained by all Lenders on account of principal of and interest on the Loans (or such participation) then held by them, then such Lender shall purchase from the other Lenders such participations in the Loans (or sub-participations in Letters of Credit) held by them as shall be necessary to cause such purchasing Lender to share the excess payment or other recovery ratably with each of them; provided that if all or any portion of -------- the excess payment or other recovery is thereafter recovered from such purchasing Lender, the purchase shall be rescinded and the purchase price restored to the extent of such recovery. 7.6 Taxes. ----- (a) All payments made by the Loan Parties hereunder or under any Loan Documents shall be made without setoff, counterclaim, or other defense. To the extent permitted by applicable law, all payments hereunder or under the Loan Documents (including any payment of principal, interest, or fees) to, or for the benefit, of any person shall be made by the Loan Parties free and clear of and without deduction or withholding for, or account of, any Taxes now or hereinafter imposed by any taxing authority. (b) If the Loan Parties make any payment hereunder or under any Loan Document in respect of which it is required by applicable law to deduct or withhold any Taxes, the Loan Parties shall increase the payment hereunder or under any such Loan Document such that after the reduction for the amount of Taxes withheld (and any taxes withheld or imposed with respect to the additional payments required under this Section 7.6(b)), the amount paid to -------------- the Lenders or the Administrative Agent equals the amount that was payable hereunder or under any such Loan Document without regard to this Section ------- 7.6(b). To the extent the Loan Parties withhold any - ------ 27 Taxes on payments hereunder or under any Loan Document, the Loan Parties shall pay the full amount deducted to the relevant taxing authority within the time allowed for payment under applicable law and shall deliver to the Administrative Agent within 30 days after it has made payment to such authority a receipt issued by such authority (or other evidence satisfactory to the Administrative Agent) evidencing the payment of all amounts so required to be deducted or withheld from such payment. (c) If any Lender or the Administrative Agent is required by law to make any payments of any Taxes on or in relation to any amounts received or receivable hereunder or under any other Loan Document, or any Tax is assessed against a Lender or the Administrative Agent with respect to amounts received or receivable hereunder or under any other Loan Document, the Loan Parties will, jointly and severally, indemnify such person against (i) such Tax (and any reasonable counsel fees and expenses associated with such Tax) and (ii) any taxes imposed as a result of the receipt of the payment under this Section 7.6(c). A certificate prepared in good faith as -------------- to the amount of such payment by such Lender or the Administrative Agent shall, absent manifest error, be final, conclusive, and binding on all parties. (d) (i) To the extent permitted by applicable law, each Lender that is not a United States person within the meaning of Code Section 7701(a)(30) (a "Non-U.S. Participant") shall deliver to the Loan Parties and the -------------------- Administrative Agent on or prior to the Closing Date (or in the case of a Lender that is an Assignee, on the date of such assignment to such Lender) two accurate and complete original signed copies of IRS Form W-8BEN, W-8ECI, or W-8IMY (or any successor or other applicable form prescribed by the IRS) certifying to such Lender's entitlement to a complete exemption from, or a reduced rate in, United States withholding tax on interest payments to be made hereunder or any Loan. If a Lender that is a Non-U.S. Participant is claiming a complete exemption from withholding on interest pursuant to Code Sections 871(h) or 881(c), the Lender shall deliver (along with two accurate and complete original signed copies of IRS Form W-8BEN) a certificate in form and substance reasonably acceptable to Administrative Agent (any such certificate, a "Withholding Certificate"). In addition, each Lender that is ----------------------- a Non-U.S. Participant agrees that from time to time after the Closing Date, (or in the case of a Lender that is an Assignee, after the date of the assignment to such Lender), when a lapse in time (or change in circumstances occurs) renders the prior certificates hereunder obsolete or inaccurate in any material respect, such Lender shall, to the extent permitted under applicable law, deliver to the Loan Parties and the Administrative Agent two new and accurate and complete original signed copies of an IRS Form W-8BEN, W-8ECI, or W-8IMY (or any successor or other applicable forms prescribed by the IRS), and if applicable, a new Withholding Certificate, to confirm or establish the entitlement of such Lender or the Administrative Agent to an exemption from, or reduction in, United States withholding tax on interest payments to be made hereunder or any Loan. (ii) Each Lender that is not a Non-U.S. Participant (other than any such Lender which is taxed as a corporation for U.S. federal income tax purposes) shall provide two properly completed and duly executed originals of IRS Form W-9 (or any successor or other applicable form) to the Loan Parties and the Administrative Agent certifying that such Lender is exempt from United States backup withholding tax. To the extent that a form provided pursuant to this Section 7.6(d)(ii) is rendered obsolete or ------------------ inaccurate in any material respect as result of change in circumstances with respect to the status of a Lender, such Lender shall, to the extent 28 permitted by applicable law, deliver to the Loan Parties and the Administrative Agent revised forms necessary to confirm or establish the entitlement to such Lender's or Agent's exemption from United States backup withholding tax. (iii) The Loan Parties shall not be required to pay additional amounts to a Lender, or indemnify any Lender, under this Section ------- 7.6 to the extent that such obligations would not have arisen but for the - --- failure of such Lender to comply with Section 7.6(d). -------------- (iv) Each Lender agrees to indemnify the Administrative Agent and hold the Administrative Agent harmless for the full amount of any and all present or future Taxes and related liabilities (including penalties, interest, additions to tax and expenses, and any Taxes imposed by any jurisdiction on amounts payable to the Administrative Agent under this Section 7.6) which are imposed on or with respect to principal, interest or - ----------- fees payable to such Lender hereunder and which are not paid by the Loan Parties pursuant to this Section 7.6, whether or not such Taxes or related ----------- liabilities were correctly or legally asserted. This indemnification shall be made within 30 days from the date the Administrative Agent makes written demand therefor. SECTION 8 INCREASED COSTS; SPECIAL PROVISIONS FOR LIBOR LOANS. 8.1 Increased Costs. (a) If, after the date hereof, the adoption --------------- of, or any change in, any applicable law, rule or regulation, or any change in the interpretation or administration of any applicable law, rule or regulation by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Lender with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency: (i) shall impose, modify or deem applicable any reserve (including any reserve imposed by the FRB, but excluding any reserve included in the determination of the LIBOR Rate pursuant to Section 4), special deposit or similar requirement --------- against assets of, deposits with or for the account of, or credit extended by any Lender; or (ii) shall impose on any Lender any other condition affecting its LIBOR Loans, its Note or its obligation to make LIBOR Loans; and the result of anything described in clauses (i) and (ii) above is to increase the cost to (or to impose a cost on) such Lender (or any LIBOR Office of such Lender) of making or maintaining any LIBOR Loan, or to reduce the amount of any sum received or receivable by such Lender (or its LIBOR Office) under this Agreement or under its Note with respect thereto, then upon demand by such Lender (which demand shall be accompanied by a statement setting forth the basis for such demand and a calculation of the amount thereof in reasonable detail, a copy of which shall be furnished to the Administrative Agent), the Loan Parties shall pay directly to such Lender such additional amount as will compensate such Lender for such increased cost or such reduction, so long as such amounts have accrued on or after the day which is 180 days prior to the date on which such Lender first made demand therefor. (b) If any Lender shall reasonably determine that any change in, or the adoption or phase-in of, any applicable law, rule or regulation regarding capital adequacy, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or the compliance by any Lender or any Person controlling such Lender with any request or directive regarding 29 capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Lender's or such controlling Person's capital as a consequence of such Lender's obligations hereunder or under any Letter of Credit to a level below that which such Lender or such controlling Person could have achieved but for such change, adoption, phase-in or compliance (taking into consideration such Lender's or such controlling Person's policies with respect to capital adequacy) by an amount deemed by such Lender or such controlling Person to be material, then from time to time, upon demand by such Lender (which demand shall be accompanied by a statement setting forth the basis for such demand and a calculation of the amount thereof in reasonable detail, a copy of which shall be furnished to the Administrative Agent), the Loan Parties shall pay to such Lender such additional amount as will compensate such Lender or such controlling Person for such reduction so long as such amounts have accrued on or after the day which is 180 days prior to the date on which such Lender first made demand therefor. 8.2 Basis for Determining Interest Rate Inadequate or Unfair. If: -------------------------------------------------------- (a) the Administrative Agent reasonably determines (which determination shall be binding and conclusive on the Loan Parties) that by reason of circumstances affecting the interbank LIBOR market adequate and reasonable means do not exist for ascertaining the applicable LIBOR Rate; or (b) the Required Lenders advise the Administrative Agent that the LIBOR Rate as determined by the Administrative Agent will not adequately and fairly reflect the cost to such Lenders of maintaining or funding LIBOR Loans for such Interest Period (taking into account any amount to which such Lenders may be entitled under Section 8.1) or that the making or funding of ----------- LIBOR Loans has become impracticable as a result of an event occurring after the date of this Agreement which in the opinion of such Lenders materially affects such Loans; then the Administrative Agent shall promptly notify the other parties - ---- thereof and, so long as such circumstances shall continue, (i) no Lender shall be under any obligation to make or convert any Base Rate Loans into LIBOR Loans and (ii) on the last day of the current Interest Period for each LIBOR Loan, such Loan shall, unless then repaid in full, automatically convert to a Base Rate Loan. 8.3 Changes in Law Rendering LIBOR Loans Unlawful. If any change --------------------------------------------- in, or the adoption of any new, law or regulation, or any change in the interpretation of any applicable law or regulation by any governmental or other regulatory body charged with the administration thereof, should make it (or in the good faith judgment of any Lender cause a substantial question as to whether it is) unlawful for any Lender to make, maintain or fund LIBOR Loans, then such Lender shall promptly notify each of the other parties hereto and, so long as such circumstances shall continue, (a) such Lender shall have no obligation to make or convert any Base Rate Loan into a LIBOR Loan (but shall make Base Rate Loans concurrently with the making of or conversion of Base Rate Loans into LIBOR Loans by the Lenders which are not so affected, in each case in an amount equal to the amount of LIBOR Loans which would be made or converted into by such Lender at such time in the absence of such circumstances) and (b) on the last day of the current Interest Period for each LIBOR Loan of such Lender (or, in any event, on such earlier date as may be required by the relevant law, regulation or interpretation), such LIBOR 30 Loan shall, unless then repaid in full, automatically convert to a Base Rate Loan. Each Base Rate Loan made by a Lender which, but for the circumstances described in the foregoing sentence, would be a LIBOR Loan (an "Affected -------- Loan") shall remain outstanding for the period corresponding to the Group of - ---- LIBOR Loans of which such Affected Loan would be a part absent such circumstances. 8.4 Funding Losses. The Loan Parties hereby agree that upon demand -------------- by any Lender (which demand shall be accompanied by a statement setting forth the basis for the amount being claimed, a copy of which shall be furnished to the Administrative Agent), the Loan Parties will, jointly and severally, indemnify such Lender against any net loss or expense which such Lender may sustain or incur (including any net loss or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund or maintain any LIBOR Loan), as reasonably determined by such Lender, as a result of (a) any payment, prepayment or conversion of any LIBOR Loan of such Lender on a date other than the last day of an Interest Period for such Loan (including any conversion pursuant to Section 8.3) or (b) any failure of the Loan Parties to borrow, convert or ----------- continue any Loan on a date specified therefor in a notice of borrowing, conversion or continuation pursuant to this Agreement. For this purpose, all notices to the Administrative Agent pursuant to this Agreement shall be deemed to be irrevocable. 8.5 Right of Lenders to Fund through Other Offices. Each Lender ---------------------------------------------- may, if it so elects, fulfill its commitment as to any LIBOR Loan by causing a foreign branch or Affiliate of such Lender to make such Loan; provided -------- that in such event for the purposes of this Agreement such Loan shall be deemed to have been made by such Lender and the obligation of the Loan Parties to repay such Loan shall nevertheless be to such Lender and shall be deemed held by it, to the extent of such Loan, for the account of such branch or Affiliate. 8.6 Discretion of Lenders as to Manner of Funding. Notwithstanding --------------------------------------------- any provision of this Agreement to the contrary, each Lender shall be entitled to fund and maintain its funding of all or any part of its Loans in any manner it sees fit, it being understood, however, that for the purposes of this Agreement all determinations hereunder shall be made as if such Lender had actually funded and maintained each LIBOR Loan during each Interest Period for such Loan through the purchase of deposits having a maturity corresponding to such Interest Period and bearing an interest rate equal to the LIBOR Rate for such Interest Period. 8.7 Mitigation of Circumstances; Replacement of Lenders. (a) Each --------------------------------------------------- Lender shall promptly notify the Loan Parties and the Administrative Agent of any event of which it has knowledge which will result in, and will use reasonable commercial efforts available to it (and not, in such Lender's sole judgment, otherwise disadvantageous to such Lender) to mitigate or avoid, (i) any obligation by the Loan Parties to pay any amount pursuant to Sections 7.6 or 8.1 or (ii) the occurrence of any circumstances described in - ------------ --- Sections 8.2 or 8.3 (and, if any Lender has given notice of any such event - ------------ --- described in clause (i) or (ii) above and thereafter such event ceases to exist, such Lender shall promptly so notify the Loan Parties and the Administrative Agent). Without limiting the foregoing, each Lender will designate a different funding office if such designation will avoid (or reduce the cost to the Loan Parties of) any event described in clause (i) or (ii) above and such designation will not, in such Lender's sole judgment, be otherwise disadvantageous to such Lender. 31 (b) If the Loan Parties become obligated to pay additional amounts to any Lender pursuant to Sections 7.6 or 8.1, or any Lender gives notice of ------------ --- the occurrence of any circumstances described in Sections 8.2 or 8.3, the ------------ --- Loan Parties may designate another bank which is acceptable to the Administrative Agent and the Issuing Lender in their reasonable discretion (such other bank being called a "Replacement Lender") to purchase the Loans ------------------ of such Lender and such Lender's rights hereunder, without recourse to or warranty by, or expense to, such Lender, for a purchase price equal to the outstanding principal amount of the Loans payable to such Lender plus any accrued but unpaid interest on such Loans and all accrued but unpaid fees owed to such Lender and any other amounts payable to such Lender under this Agreement, and to assume all the obligations of such Lender hereunder, and, upon such purchase and assumption (pursuant to an Assignment Agreement), such Lender shall no longer be a party hereto or have any rights hereunder (other than rights with respect to indemnities and similar rights applicable to such Lender prior to the date of such purchase and assumption) and shall be relieved from all obligations to the Loan Parties hereunder, and the Replacement Lender shall succeed to the rights and obligations of such Lender hereunder. 8.8 Conclusiveness of Statements; Survival of Provisions. ---------------------------------------------------- Determinations and statements of any Lender pursuant to Sections 8.1, 8.2, ------------ --- 8.3 or 8.4 shall be conclusive absent demonstrable error. Lenders may use - --- --- reasonable averaging and attribution methods in determining compensation under Sections 8.1 and 8.4, and the provisions of such Sections shall ------------ --- survive repayment of the Obligations, cancellation of any Notes, expiration or termination of the Letters of Credit and termination of this Agreement. SECTION 9 REPRESENTATIONS AND WARRANTIES. To induce the Administrative Agent and the Lenders to enter into this Agreement and to induce the Lenders to make Loans and issue and participate in Letters of Credit hereunder, each Loan Party represents and warrants to the Administrative Agent and the Lenders that: 9.1 Organization. Each Loan Party is validly existing and in good ------------ standing under the laws of its jurisdiction of organization and each Loan Party is duly qualified to do business in each jurisdiction where, because of the nature of its activities or properties, such qualification is required, except for such jurisdictions where the failure to so qualify would not have a Material Adverse Effect. 9.2 Authorization; No Conflict. Each Loan Party is duly authorized -------------------------- to execute and deliver each Loan Document to which it is a party, each Loan Party is duly authorized to borrow monies hereunder and each Loan Party is duly authorized to perform its Obligations under each Loan Document to which it is a party. The execution, delivery and performance by each Loan Party of each Loan Document to which it is a party, and the borrowings by each Loan Party hereunder, do not and will not (a) require any consent or approval of any governmental agency or authority (other than any consent or approval which has been obtained and is in full force and effect), (b) conflict with (i) any provision of law, (ii) the charter, by-laws or other organizational documents of any Loan Party or (iii) any agreement, indenture, instrument or other document, or any judgment, order or decree, which is binding upon any Loan Party or any of their respective properties or (c) require, or result in, the creation or imposition of any Lien on any asset of any Loan Party. 32 9.3 Validity and Binding Nature. Each of this Agreement and each --------------------------- other Loan Document to which any Loan Party is a party is the legal, valid and binding obligation of such Person, enforceable against such Person in accordance with its terms, subject to bankruptcy, insolvency and similar laws affecting the enforceability of creditors' rights generally and to general principles of equity. 9.4 Financial Condition. The audited consolidated financial ------------------- statements of the Company and its Subsidiaries as at March 31, 2005, and the unaudited consolidated financial statements of the Company and the Subsidiaries as at December 31, 2005, copies of each of which have been delivered to each Lender, were prepared in accordance with GAAP (subject, in the case of such unaudited statements, to the absence of footnotes and to normal year-end adjustments) and present fairly the consolidated financial condition of the Company and its Subsidiaries as at such dates and the results of their operations for the periods then ended. 9.5 No Material Adverse Change. Since March 31, 2005, there has -------------------------- been no material adverse change in the financial condition, operations, assets, business, properties or prospects of the Loan Parties taken as a whole. 9.6 Litigation and Contingent Liabilities. No litigation (including ------------------------------------- derivative actions), arbitration proceeding or governmental investigation or proceeding is pending or, to any Loan Party's knowledge, threatened against any Loan Party which is reasonably likely to have a Material Adverse Effect, except as set forth in Schedule 9.6. Other than any liability incident to ------------ such litigation or proceedings, no Loan Party has any material contingent liabilities not listed on Schedule 9.6 or permitted by Section 11.1. ------------ ------------ 9.7 Ownership of Properties; Liens. Each Loan Party owns good and, ------------------------------ in the case of real property, marketable title to all of its properties and assets, real and personal, tangible and intangible, of any nature whatsoever (including patents, trademarks, trade names, service marks and copyrights), free and clear of all Liens, charges and claims (including infringement claims with respect to patents, trademarks, service marks, copyrights and the like) except as permitted by Section 11.2. ------------ 9.8 Equity Ownership; Subsidiaries. All issued and outstanding ------------------------------ Capital Securities of each Loan Party and each Subsidiary thereof are duly authorized and validly issued, fully paid, non-assessable, and free and clear of all Liens other than those in favor of the Administrative Agent, and such securities were issued in compliance with all applicable state and federal laws concerning the issuance of securities. Schedule 9.8 sets forth ------------ the authorized Capital Securities of each Loan Party and each Subsidiary thereof as of the Closing Date. All of the issued and outstanding Capital Securities of each Wholly-Owned Subsidiary is, directly or indirectly, owned by the Company. As of the Closing Date, except as set forth on Schedule 9.8, ------------ there are no pre-emptive or other outstanding rights, options, warrants, conversion rights or other similar agreements or understandings for the purchase or acquisition of any Capital Securities of any Loan Party or any Subsidiary thereof. 9.9 Pension Plans. (a) The Unfunded Liability of all Pension Plans ------------- does not in the aggregate exceed twenty percent of the Total Plan Liability for all such Pension Plans. Each Pension Plan complies in all material respects with all applicable requirements of law and 33 regulations. No contribution failure under Section 412 of the Code, Section 302 of ERISA or the terms of any Pension Plan has occurred with respect to any Pension Plan, sufficient to give rise to a Lien under Section 302(f) of ERISA, or otherwise to have a Material Adverse Effect. There are no pending or, to the knowledge of Loan Parties, threatened, claims, actions, investigations or lawsuits against any Pension Plan, any fiduciary of any Pension Plan, or any Loan Party or any other member of the Controlled Group with respect to a Pension Plan or a Multiemployer Pension Plan which could reasonably be expected to have a Material Adverse Effect. Neither the Loan Parties nor any other member of the Controlled Group has engaged in any prohibited transaction (as defined in Section 4975 of the Code or Section 406 of ERISA) in connection with any Pension Plan or Multiemployer Pension Plan which would subject that Person to any material liability. Within the past five years, neither the Loan Parties nor any other member of the Controlled Group has engaged in a transaction which resulted in a Pension Plan with an Unfunded Liability being transferred out of the Controlled Group, which could reasonably be expected to have a Material Adverse Effect. No Termination Event has occurred or is reasonably expected to occur with respect to any Pension Plan, which could reasonably be expected to have a Material Adverse Effect. (b) All contributions (if any) have been made to any Multiemployer Pension Plan that are required to be made by the Loan Parties or any other member of the Controlled Group under the terms of the plan or of any collective bargaining agreement or by applicable law; neither the Loan Parties nor any other member of the Controlled Group has withdrawn or partially withdrawn from any Multiemployer Pension Plan, incurred any withdrawal liability with respect to any such plan or received notice of any claim or demand for withdrawal liability or partial withdrawal liability from any such plan, and no condition has occurred which, if continued, could result in a withdrawal or partial withdrawal from any such plan; and neither the Loan Parties nor any other member of the Controlled Group has received any notice that any Multiemployer Pension Plan is in reorganization, that increased contributions may be required to avoid a reduction in plan benefits or the imposition of any excise tax, that any such plan is or has been funded at a rate less than that required under Section 412 of the Code, that any such plan is or may be terminated, or that any such plan is or may become insolvent. 9.10 Investment Company Act. No Loan Party is an "investment ---------------------- company" or a company "controlled" by an "investment company" or a "subsidiary" of an "investment company," within the meaning of the Investment Company Act of 1940. 9.11 Reserved. -------- 9.12 Regulation U. No Loan Party is engaged principally, or as one ------------ of its important activities, in the business of extending credit for the purpose of purchasing or carrying Margin Stock. 9.13 Taxes. Each Loan Party has timely filed all tax returns and ----- reports required by law to have been filed by it and has paid all taxes and governmental charges due and payable with respect to such return, except any such taxes or charges which are being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP shall have been set aside on its books. The Loan Parties have made adequate reserves on their books and records in accordance with GAAP for all taxes that have accrued but which are 34 not yet due and payable. No Loan Party has participated in any transaction that relates to a year of the taxpayer (which is still open under the applicable statute of limitations) which is a "reportable transaction" within the meaning of Treasury Regulation Section 1.6011-4(b)(2) (irrespective of the date when the transaction was entered into). 9.14 Solvency, etc. On the Closing Date, and immediately prior to ------------- and after giving effect to the issuance of each Letter of Credit and each borrowing hereunder and the use of the proceeds thereof, with respect to each Loan Party, individually, (a) the fair value of its assets is greater than the amount of its liabilities (including disputed, contingent and unliquidated liabilities) as such value is established and liabilities evaluated in accordance with GAAP, (b) the present fair saleable value of its assets is not less than the amount that will be required to pay the probable liability on its debts as they become absolute and matured, (c) it is able to realize upon its assets and pay its debts and other liabilities (including disputed, contingent and unliquidated liabilities) as they mature in the normal course of business, (d) it does not intend to, and does not believe that it will, incur debts or liabilities beyond its ability to pay as such debts and liabilities mature and (e) it is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which its property would constitute unreasonably small capital. 9.15 Environmental Matters. The on-going operations of each Loan --------------------- Party comply in all respects with all Environmental Laws, except such non-compliance which could not (if enforced in accordance with applicable law) reasonably be expected to result, either individually or in the aggregate, in a Material Adverse Effect. Each Loan Party has obtained, and maintained in good standing, all licenses, permits, authorizations, registrations and other approvals required under any Environmental Law and required for their respective ordinary course operations, and for their reasonably anticipated future operations, and each Loan Party is in compliance with all terms and conditions thereof, except where the failure to do so could not reasonably be expected to result in material liability to any Loan Party and could not reasonably be expected to result, either individually or in the aggregate, in a Material Adverse Effect. No Loan Party or any of its properties or operations is subject to, or reasonably anticipates the issuance of, any written order from or agreement with any Federal, state or local governmental authority, nor subject to any judicial or docketed administrative or other proceeding, respecting any Environmental Law, Environmental Claim or Hazardous Substance. There are no Hazardous Substances or other conditions or circumstances existing with respect to any property, arising from operations prior to the Closing Date, or relating to any waste disposal, of any Loan Party that would reasonably be expected to result, either individually or in the aggregate, in a Material Adverse Effect. No Loan Party has any underground storage tanks that are not properly registered or permitted under applicable Environmental Laws or that at any time have released, leaked, disposed of or otherwise discharged Hazardous Substances. 9.16 Insurance. Set forth on Schedule 9.16 is a complete and --------- ------------- accurate summary of the property and casualty insurance program of the Loan Parties as of the Closing Date (including the names of all insurers, policy numbers, expiration dates, amounts and types of coverage, annual premiums, exclusions, deductibles, self-insured retention, and a description in reasonable detail of any self-insurance program, retrospective rating plan, fronting arrangement or other risk assumption arrangement involving any Loan Party). Each Loan Party and its properties are insured with financially sound and reputable insurance companies which are not Affiliates of the Loan Parties, in such amounts, with such deductibles and covering such risks as are customarily 35 carried by companies engaged in similar businesses and owning similar properties in localities where such Loan Parties operate. 9.17 Real Property. Set forth on Schedule 9.17 is a complete and ------------- ------------- accurate list, as of the Closing Date, of the address of all real property owned or leased by any Loan Party, together with, in the case of leased property, the name and mailing address of the lessor of such property. 9.18 Information. All information heretofore or contemporaneously ----------- herewith furnished in writing by any Loan Party to the Administrative Agent or any Lender for purposes of or in connection with this Agreement and the transactions contemplated hereby is, and all written information hereafter furnished by or on behalf of any Loan Party to the Administrative Agent or any Lender pursuant hereto or in connection herewith will be, true and accurate in every material respect on the date as of which such information is dated or certified, and none of such information is or will be incomplete by omitting to state any material fact necessary to make such information not misleading in light of the circumstances under which made (it being recognized by the Administrative Agent and the Lenders that any projections and forecasts provided by the Loan Parties are based on good faith estimates and assumptions believed by the Loan Parties to be reasonable as of the date of the applicable projections or assumptions and that actual results during the period or periods covered by any such projections and forecasts may differ from projected or forecasted results). 9.19 Intellectual Property. Each Loan Party owns and possesses or --------------------- has a license or other right to use all patents, patent rights, trademarks, trademark rights, trade names, trade name rights, service marks, service mark rights and copyrights as are necessary for the conduct of the businesses of the Loan Parties, without any infringement upon rights of others which could reasonably be expected to have a Material Adverse Effect. 9.20 Reserved. -------- 9.21 Labor Matters. Except as set forth on Schedule 9.21, no Loan ------------- ------------- Party is subject to any labor or collective bargaining agreement. There are no existing or threatened strikes, lockouts or other labor disputes involving any Loan Party that singly or in the aggregate could reasonably be expected to have a Material Adverse Effect. Hours worked by and payment made to employees of the Loan Parties are not in violation of the Fair Labor Standards Act or any other applicable law, rule or regulation dealing with such matters. 9.22 No Default. No Event of Default or Unmatured Event of Default ---------- exists or would result from the incurrence by any Loan Party of any Debt hereunder or under any other Loan Document. SECTION 10 AFFIRMATIVE COVENANTS. Until the expiration or termination of the Commitments and thereafter until all Obligations hereunder and under the other Loan Documents are paid in full and all Letters of Credit have been terminated, each Loan Party agrees that, unless at any time the Required Lenders shall otherwise expressly consent in writing, it will: 36 10.1 Reports, Certificates and Other Information. Furnish to the ------------------------------------------- Administrative Agent and each Lender: 10.1.1 Annual Report. Promptly when available and in any event ------------- within 90 days after the close of each Fiscal Year: a copy of the annual audit report of the Company and its Subsidiaries for such Fiscal Year, including therein consolidated balance sheets and statements of earnings and cash flows of the Company and its Subsidiaries as at the end of such Fiscal Year, certified without adverse reference to going concern value and without material qualification by independent auditors of recognized standing selected by the Company and reasonably acceptable to the Administrative Agent. 10.1.2 Interim Reports. Promptly when available and in any event --------------- within 45 days after the end of each of the first three Fiscal Quarters of each Fiscal Year, consolidated balance sheet of the Company and its Subsidiaries as of the end of each of the first three Fiscal Quarters of each Fiscal Year, together with consolidated statements of earnings and cash flows for such Fiscal Quarter and for the period beginning with the first day of such Fiscal Year and ending on the last day of such Fiscal Quarter, together with a comparison with the corresponding period of the previous Fiscal Year, certified by a Senior Officer of the Company. 10.1.3 Compliance Certificates. Contemporaneously with the ----------------------- furnishing of a copy of each annual audit report pursuant to Section 10.1.1 -------------- and each set of quarterly statements pursuant to Section 10.1.2, a duly -------------- completed compliance certificate in the form of Exhibit B, with appropriate --------- insertions, dated the date of such annual report or such quarterly statements and signed by a Senior Officer of the Company, containing a computation of each of the financial ratios and restrictions set forth in Section 11.14 and to the effect that such officer has not become aware of - ------------- any Event of Default or Unmatured Event of Default that has occurred and is continuing or, if there is any such event, describing it and the steps, if any, being taken to cure it. 10.1.4 Reports to the SEC and to Shareholders. Promptly upon the -------------------------------------- filing or sending thereof, copies of all regular, periodic or special reports of any Loan Party filed with the SEC; copies of all registration statements of any Loan Party filed with the SEC (other than on Form S-8); and copies of all proxy statements or other communications made to security holders generally. 10.1.5 Notice of Default, Litigation and ERISA Matters. Promptly ----------------------------------------------- upon becoming aware of any of the following, written notice describing the same and the steps being taken by each Loan Party or the Subsidiary affected thereby with respect thereto: (a) the occurrence of an Event of Default or an Unmatured Event of Default; (b) any litigation, arbitration or governmental investigation or proceeding not previously disclosed by the Loan Parties to the Lenders which has been instituted or, to the knowledge of the Loan Parties, is threatened against any Loan Party or to which any of the properties of any thereof is subject which is likely to have a Material Adverse Effect; (c) the institution of any steps by any member of the Controlled Group or any other Person to terminate any Pension Plan, or the failure of any member of the 37 Controlled Group to make a required contribution to any Pension Plan (if such failure is sufficient to give rise to a Lien under Section 302(f) of ERISA) or to any Multiemployer Pension Plan, or the taking of any action with respect to a Pension Plan which could result in the requirement that the Loan Parties furnish a bond or other security to the PBGC or such Pension Plan, or the occurrence of any event with respect to any Pension Plan or Multiemployer Pension Plan which could result in the incurrence by any member of the Controlled Group of any material liability, fine or penalty (including any claim or demand for withdrawal liability or partial withdrawal from any Multiemployer Pension Plan), or any material increase in the contingent liability of any Loan Party with respect to any post-retirement welfare benefit plan or other employee benefit plan of any Loan Party or another member of the Controlled Group, or any notice that any Multiemployer Pension Plan is in reorganization, that increased contributions may be required to avoid a reduction in plan benefits or the imposition of an excise tax, that any such plan is or has been funded at a rate less than that required under Section 412 of the Code, that any such plan is or may be terminated, or that any such plan is or may become insolvent; (d) any cancellation or material reduction in any insurance maintained by any Loan Party; (e) any violation of any Environmental Law or the assertion of any Environmental Claim or (ii) the enactment or effectiveness of any law, rule or regulation which is reasonably likely to have a Material Adverse Effect; or (f) the receipt by any Loan Party of any "Notice of Inspectional Observations" from the U.S. Food and Drug Administration (the "FDA") on Form 483 or successor form setting forth any deficiencies noted in any inspection conducted by the FDA of any Loan Party which is reasonably likely to have a Material Adverse Effect. 10.1.6 Other Information. Promptly from time to time, such other ----------------- information concerning the Loan Parties as any Lender or the Administrative Agent may reasonably request. 10.2 Books, Records and Inspections. Keep, and cause each other ------------------------------ Loan Party to keep, its books and records in accordance with sound business practices sufficient to allow the preparation of financial statements in accordance with GAAP; permit, and cause each other Loan Party to permit, the Administrative Agent and Citibank or any representative thereof to inspect the properties and operations of the Loan Parties; and permit, and cause each other Loan Party to permit, at any reasonable time and with reasonable notice (or at any time without notice if an Event of Default exists), the Administrative Agent and Citibank or any representative thereof to visit any or all of its offices, to discuss its financial matters with its officers and, following an Event of Default, its independent auditors (and the Loan Parties hereby authorize such independent auditors to discuss such financial matters with the Administrative Agent and Citibank or any representative thereof), and to examine (and, at the expense of the Loan Parties, photocopy extracts from) any of its books or other records; and permit, and cause each other Loan Party to permit, the Administrative Agent and Citibank and its representatives to inspect the Inventory and other tangible assets of the Loan Parties, to perform appraisals of the equipment of the Loan Parties, and to inspect, audit, check and make copies of and extracts from the books, records, computer data, computer programs, journals, orders, receipts, correspondence and other data relating to the assets of each Loan Party. All such inspections or audits by the Administrative Agent and Citibank shall be at the Loan Parties' expense, provided that so long as no Event of Default or Unmatured Event of Default exists, the Loan Parties shall not be required to reimburse the Administrative Agent or Citibank for inspections or audits more frequently than twice each Fiscal Year in the aggregate. 38 10.3 Maintenance of Property; Insurance. (a) Keep, and cause each ---------------------------------- other Loan Party to keep, all property useful and necessary in the business of the Loan Parties in good working order and condition, ordinary wear and tear excepted. (b) Maintain, and cause each other Loan Party to maintain, with responsible insurance companies, such insurance coverage as may be required by any law or governmental regulation or court decree or order applicable to it and such other insurance, to such extent and against such hazards and liabilities, as is customarily maintained by companies similarly situated, but which shall insure against all risks and liabilities of the type identified on Schedule 9.16 and shall have insured amounts no less than, and ------------- deductibles no higher than, those set forth on such schedule; and, upon request of the Administrative Agent or any Lender, furnish to the Administrative Agent or such Lender a certificate setting forth in reasonable detail the nature and extent of all insurance maintained by the Loan Parties. (c) UNLESS THE LOAN PARTIES PROVIDE THE ADMINISTRATIVE AGENT WITH EVIDENCE OF THE INSURANCE COVERAGE REQUIRED BY THIS AGREEMENT, THE ADMINISTRATIVE AGENT MAY, FOLLOWING NOTICE TO THE COMPANY, PURCHASE INSURANCE AT THE LOAN PARTIES' EXPENSE. THIS INSURANCE MAY, BUT NEED NOT, PROTECT ANY LOAN PARTY'S INTERESTS. THE COVERAGE THAT THE ADMINISTRATIVE AGENT PURCHASES MAY NOT PAY ANY CLAIM THAT IS MADE AGAINST ANY LOAN PARTY. THE LOAN PARTIES MAY LATER CANCEL ANY INSURANCE PURCHASED BY THE ADMINISTRATIVE AGENT, BUT ONLY AFTER PROVIDING THE ADMINISTRATIVE AGENT WITH EVIDENCE THAT THE LOAN PARTIES HAVE OBTAINED INSURANCE AS REQUIRED BY THIS AGREEMENT. IF THE ADMINISTRATIVE AGENT PURCHASES INSURANCE FOR THE LOAN PARTIES, THE LOAN PARTIES WILL BE RESPONSIBLE FOR THE COSTS OF THAT INSURANCE, INCLUDING INTEREST AND ANY OTHER CHARGES THAT MAY BE IMPOSED WITH THE PLACEMENT OF THE INSURANCE, UNTIL THE EFFECTIVE DATE OF THE CANCELLATION OR EXPIRATION OF THE INSURANCE. THE COSTS OF THE INSURANCE MAY BE ADDED TO THE PRINCIPAL AMOUNT OF THE LOANS OWING HEREUNDER. THE COSTS OF THE INSURANCE MAY BE MORE THAN THE COST OF THE INSURANCE THE LOAN PARTIES MAY BE ABLE TO OBTAIN ON THEIR OWN. 10.4 Compliance with Laws; Payment of Taxes and Liabilities. (a) ------------------------------------------------------ Comply, and cause each other Loan Party to comply, in all material respects with all applicable laws, rules, regulations, decrees, orders, judgments, licenses and permits, except where failure to comply could not reasonably be expected to have a Material Adverse Effect; (b) without limiting clause (a) above, ensure, and cause each other Loan Party to ensure, that no person who owns a controlling interest in or otherwise controls a Loan Party is or shall be (i) listed on the Specially Designated Nationals and Blocked Person List maintained by the Office of Foreign Assets Control ("OFAC"), Department ---- of the Treasury, and/or any other similar lists maintained by OFAC pursuant to any authorizing statute, Executive Order or regulation or (ii) a person designated under Section 1(b), (c) or (d) of Executive Order No. 13224 ------------ --- --- (September 23, 2001), any related enabling legislation or any other similar Executive Orders, (c) without limiting clause (a) above, comply, and cause each other Loan Party to comply, with all applicable Bank 39 Secrecy Act ("BSA") and anti-money laundering laws and regulations and (d) --- pay, and cause each other Loan Party to pay, prior to delinquency, all taxes and other governmental charges against it or any collateral, as well as claims of any kind which, if unpaid, could become a Lien on any of its property; provided that the foregoing shall not require any Loan Party to -------- pay any such tax or charge so long as it shall contest the validity thereof in good faith by appropriate proceedings and shall set aside on its books adequate reserves with respect thereto in accordance with GAAP and, in the case of a claim which could become a Lien on any collateral, such contest proceedings shall stay the foreclosure of such Lien or the sale of any portion of the collateral to satisfy such claim. 10.5 Maintenance of Existence, etc. Maintain and preserve, and ----------------------------- (subject to Section 11.5) cause each other Loan Party to maintain and ------------ preserve, (a) its existence and good standing in the jurisdiction of its organization and (b) its qualification to do business and good standing in each jurisdiction where the nature of its business makes such qualification necessary (other than such jurisdictions in which the failure to be qualified or in good standing could not reasonably be expected to have a Material Adverse Effect). 10.6 Use of Proceeds. Use the proceeds of the Loans, and the --------------- Letters of Credit, solely for working capital purposes, for Acquisitions permitted by Section 11.5, for Capital Expenditures and for other general ------------ business purposes; and not use or permit any proceeds of any Loan to be used, either directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of "purchasing or carrying" any Margin Stock. 10.7 Employee Benefit Plans. ---------------------- (a) Maintain, and cause each other member of the Controlled Group to maintain, each Pension Plan in substantial compliance with all applicable requirements of law and regulations. (b) Make, and cause each other member of the Controlled Group to make, on a timely basis, all required contributions to any Multiemployer Pension Plan. (c) Not, and not permit any other member of the Controlled Group to (i) seek a waiver of the minimum funding standards of ERISA, (ii) terminate or withdraw from any Pension Plan or Multiemployer Pension Plan or (iii) take any other action with respect to any Pension Plan that would reasonably be expected to entitle the PBGC to terminate, impose liability in respect of, or cause a trustee to be appointed to administer, any Pension Plan, unless the actions or events described in clauses (i), (ii) and (iii) individually or in the aggregate would not have a Material Adverse Effect. 10.8 Environmental Matters. If any release or threatened release or --------------------- other disposal of Hazardous Substances shall occur or shall have occurred on any real property or any other assets of any Loan Party, the Loan Parties shall, or shall cause the applicable Loan Party to, cause the prompt containment and removal of such Hazardous Substances and the remediation of such real property or other assets as necessary to comply with all Environmental Laws and to preserve the value of such real property or other assets. Without limiting the generality of the foregoing, the Loan Parties shall, and shall cause each other Loan Party to, comply with any Federal or state judicial or administrative order requiring the performance at any real property of any Loan Party 40 of activities in response to the release or threatened release of a Hazardous Substance. To the extent that the transportation of Hazardous Substances is permitted by this Agreement, the Loan Parties shall, and shall cause its Subsidiaries to, dispose of such Hazardous Substances, or of any other wastes, only at licensed disposal facilities operating in compliance with Environmental Laws. 10.9 Further Assurances. Take, and cause each other Loan Party to ------------------ take, such actions as are necessary or as the Administrative Agent or the Required Lenders may reasonably request from time to time to ensure that the Obligations of each Loan Party under the Loan Documents are guaranteed by each active domestic Subsidiary (including, upon the acquisition or creation thereof, any Subsidiary acquired or created after the Closing Date), in each case as the Administrative Agent may determine, including the execution and delivery of guaranties and other documents, and the filing or recording of any of the foregoing. 10.10 Reserved. -------- 10.11 Springing Lien. Upon the occurrence of a Springing Lien -------------- Event, take, and cause each other Loan Party to take, such actions as are necessary or as the Administrative Agent or the Required Lenders request to ensure that the Obligations of each Loan Party under the Loan Documents are secured by a first priority security interest in all Accounts, inventory and intangible assets (subject to certain exceptions concerning intangible assets in Administrative Agent's discretion) (the "Pledged Assets") of the Loan Parties and each of their active Subsidiaries (including, upon the acquisition or creation thereof, any Subsidiary acquired or created after the Closing Date), other than MECW, LLC, a Delaware limited liability company, in each case as the Administrative Agent may determine, including (a) the execution and delivery of guaranties, security agreements, pledge agreements, financing statements and other documents, and the filing or recording of any of the foregoing and (b) the delivery of certificated securities and other Collateral with respect to which perfection is obtained by possession. For purposes herein, a "Springing Lien Event" will take effect in the event that both (i) the amount of Convertible Notes repaid minus increases in Net Worth from the date of the Closing Date rounded up to the nearest million (for purposes below, the "Net Recapitalization Amount") totals or exceeds $25,000,000; and (ii) the amount of Revolving Outstandings totals or exceeds $25,000,000. In the event both preceding conditions are met, a "Springing Lien Event" will be deemed to have occurred. Notwithstanding the foregoing, the Administrative Agent's claim against the Pledged Assets will be limited to an amount equal to 120% of the "Collateral Coverage Amount," which is defined as the lesser of (x) the Net Recapitalization Amount and (y) Revolving Outstandings, at any point in time. The Collateral Coverage Amount will be tested on an annual basis. To the extent the Administrative Agent determines, following such annual test, that the Collateral Coverage Amount has been reduced to zero, the Administrative Agent shall release its lien on the assets of the Company and its Subsidiaries. 10.12 Syndication. Enter into such modifications to the Loan ----------- Documents as the Administrative Agent may reasonably request as necessary for the initial syndication of the Loans and the Commitments and, in the event such initial syndication shall prove to be impracticable in the Administrative Agent's reasonable determination, such modifications (including adjustments to the Base Rate Margin and/or LIBOR Margin) as the Administrative Agent may reasonably request as necessary to make the syndication of the Loans and the Commitments reasonably practicable. 41 SECTION 11 NEGATIVE COVENANTS Until the expiration or termination of the Commitments and thereafter until all Obligations hereunder and under the other Loan Documents are paid in full and all Letters of Credit have been terminated, each Loan Party agrees that, unless at any time the Required Lenders shall otherwise expressly consent in writing, it will: 11.1 Debt. Not, and not permit any other Loan Party to, create, ---- incur, assume or suffer to exist any Debt, except: (a) Obligations under this Agreement and the other Loan Documents; (b) Debt secured by Liens permitted by Section 11.2(c), --------------- and extensions, renewals and refinancings thereof; provided that -------- the aggregate amount of all such Debt at any time outstanding shall not exceed $1,750,000 (excluding any Debt permitted under Section ------- 11.1(f) below); ------- (c) Debt of the Loan Parties to any domestic Wholly-Owned Subsidiary or Debt of any domestic Wholly-Owned Subsidiary to the Loan Parties or another domestic Wholly-Owned Subsidiary; provided, -------- the obligations under any note evidencing such Debt shall be subordinated to the Obligations of the Loan Parties hereunder in a manner reasonably satisfactory to the Administrative Agent to the extent such Wholly-Owned Subsidiary is not a Loan Party hereunder; (d) the Convertible Notes; (e) Hedging Obligations approved by Administrative Agent and incurred in favor of a Lender or an Affiliate thereof for bona fide hedging purposes and not for speculation; (f) $50,000,000 for commercial mortgages (including all existing mortgage financing in existence on the Closing Date) and any extension, renewal or refinancing thereof so long as the principal amount thereof is not increased; (g) the Debt to be Repaid (so long as such Debt is repaid on the Closing Date with the proceeds of the initial Loans hereunder); and (h) Contingent Liabilities arising with respect to customary indemnification obligations in favor of sellers in connection with Acquisitions permitted under Section 11.5 and ------------ purchasers in connection with dispositions permitted under Section ------- 11.5. ---- 11.2 Liens. Not, and not permit any other Loan Party to, create or ----- permit to exist any Lien on any of its real or personal properties, assets or rights of whatsoever nature (whether now owned or hereafter acquired), except: 42 (a) Liens for taxes or other governmental charges not at the time delinquent or thereafter payable without penalty or being contested in good faith by appropriate proceedings and, in each case, for which it maintains adequate reserves; (b) Liens arising in the ordinary course of business (such as (i) Liens of carriers, warehousemen, mechanics and materialmen and other similar Liens imposed by law and (ii) Liens in the form of deposits or pledges incurred in connection with worker's compensation, unemployment compensation and other types of social security (excluding Liens arising under ERISA) or in connection with surety bonds, bids, performance bonds and similar obligations) for sums not overdue or being contested in good faith by appropriate proceedings and not involving any advances or borrowed money or the deferred purchase price of property or services and, in each case, for which it maintains adequate reserves; (c) subject to the limitation set forth in Section ------- 11.1(b), (i) Liens arising in connection with Capital Leases (and ------- attaching only to the property being leased), (ii) Liens existing on property at the time of the acquisition thereof by any Loan Party (and not created in contemplation of such acquisition) and (iii) Liens that constitute purchase money security interests on any property securing debt incurred for the purpose of financing all or any part of the cost of acquiring such property, provided that any such Lien attaches to such property within 20 days of the acquisition thereof and attaches solely to the property so acquired; (d) attachments, appeal bonds, judgments and other similar Liens, for sums not exceeding $500,000 arising in connection with court proceedings, provided the execution or other enforcement of such Liens is effectively stayed and the claims secured thereby are being actively contested in good faith and by appropriate proceedings; and (e) easements, rights of way, restrictions, minor defects or irregularities in title and other similar Liens not interfering in any material respect with the ordinary conduct of the business of any Loan Party. 11.3 Reserved. -------- 11.4 Restricted Payments. Not, and not permit any other Loan Party ------------------- to, (a) make any distribution to any holders of its Capital Securities, (b) purchase or redeem any of its Capital Securities, (c) pay any management fees or similar fees to any of its equityholders or any Affiliate thereof (provided, however, that the foregoing shall not prevent any Loan Party from paying management or similar fees to another Loan Party), (d) make any redemption, prepayment, defeasance, repurchase or any other payment in respect of any Subordinated Debt or (e) set aside funds for any of the foregoing. Notwithstanding the foregoing, (i) any Subsidiary may pay dividends or make other distributions to the Company; (ii) the Loan Parties may make regularly scheduled payments of interest in respect of Subordinated Debt to the extent permitted under the subordination provisions thereof; and (iii) so long as no Event of Default or Unmatured Event of Default exists or would result therefrom, the Company may (A) pay dividends or make distributions up to an amount not to exceed twenty-five percent (25%) of the Company's prior Fiscal Year's Consolidated Net Income, determined in accordance with GAAP, in any one Fiscal 43 Year; (B) purchase or redeem its Capital Securities and (C) redeem any portion of the Contingent Notes to the extent the requirements of Section ------- 10.11, as applicable, are also satisfied. - ----- 11.5 Mergers, Consolidations, Sales. Not, and not permit any other ------------------------------ Loan Party to, be a party to any merger or consolidation, or purchase or otherwise acquire all or substantially all of the assets or any Capital Securities of any class of, or any partnership or joint venture interest in, any other Person, except for (i) any such merger, consolidation, sale, transfer, conveyance, lease or assignment of or by any Loan Party into another Loan Party; (ii) any such purchase or other acquisition by the Loan Parties of the assets or Capital Securities of any Wholly-Owned Subsidiary; and (iii) any Acquisition by the Company or any domestic Wholly-Owned Subsidiary where: (A) the business or division acquired are for use, or the Person acquired is engaged, in the businesses engaged in by the Loan Parties on the Closing Date; (B) immediately before and after giving effect to such Acquisition, no Event of Default or Unmatured Event of Default shall exist; (C) the aggregate consideration to be paid by the Loan Parties (including any Debt assumed or issued in connection therewith, the amount thereof to be calculated in accordance with GAAP) in connection with such Acquisition (or any series of related Acquisitions) is less than $75,000,000; (D) immediately after giving effect to such Acquisition, the Loan Parties are in pro forma compliance with all the financial ratios and restrictions set forth in Section 11.14; ------------- (E) in the case of the Acquisition of any Person, the board of directors or similar governing body of such Person has approved such Acquisition; (F) reasonably prior to such Acquisition, the Administrative Agent shall have received complete executed or conformed copies of each material document, instrument and agreement to be executed in connection with such Acquisition together with all lien search reports and lien release letters and other documents as the Administrative Agent may require to evidence the termination of Liens on the assets or business to be acquired; (G) not less than ten Business Days prior to such Acquisition, the Administrative Agent shall have received an acquisition summary with respect to the Person and/or business or division to be acquired, such summary to include a reasonably detailed description thereof (including financial information) and operating results (including financial statements for the most recent 12 month period for which they are available and as otherwise available), the terms and conditions, including economic terms, of the proposed Acquisition, and the Loan Parties' calculation of pro forma EBITDA relating thereto; (H) the Administrative Agent and Required Lenders shall have approved the Loan Parties' computation of pro forma EBITDA; (I) consents have been obtained in favor of the Administrative Agent and the Lenders to the collateral assignment of rights and indemnities under the related acquisition 44 documents and opinions of counsel for the Loan Parties and (if delivered to the Loan Party) the selling party in favor of the Administrative Agent and the Lenders have been delivered; (J) the provisions of Section 10.9 have been satisfied; ------------ (K) simultaneously with the closing of such Acquisition, the target company (if such Acquisition is structured as a purchase of equity) or the Loan Party (if such Acquisition is structured as a purchase of assets or a merger and a Loan Party is the surviving entity) executes and delivers to Administrative Agent an unlimited Guaranty of the Obligations, or at the option of Administrative Agent in Administrative Agent's absolute discretion, a joinder agreement satisfactory to Administrative Agent in which such target company or surviving company, and their respective Subsidiaries becomes a borrower under this Agreement and assumes primary, joint and several liability for the Obligations; and (L) if the Acquisition is structured as a merger, the Company is the surviving entity or, in the alternative, the survivor of such merger is a Wholly-Owned Subsidiary of the Company. 11.6 Modification of Organizational Documents. Not permit the ---------------------------------------- charter, by-laws or other organizational documents of any Loan Party to be amended or modified in any way which could reasonably be expected to materially adversely affect the interests of the Lenders; not change, or allow any Loan Party to change, its state of formation or its organizational form. 11.7 Transactions with Affiliates. Except as set forth on Schedule ---------------------------- -------- 11.7, not, and not permit any other Loan Party to, enter into, or cause, - ---- suffer or permit to exist any transaction, arrangement or contract with any of its other Affiliates (other than the Loan Parties) which is on terms which are less favorable than are obtainable from any Person which is not one of its Affiliates. 11.8 Reserved. -------- 11.9 Inconsistent Agreements. Not, and not permit any other Loan ----------------------- Party to, enter into any agreement containing any provision which would (a) be violated or breached by any borrowing by the Loan Parties hereunder or by the performance by any Loan Party of any of its Obligations hereunder or under any other Loan Document, (b) prohibit any Loan Party from granting to the Administrative Agent and the Lenders, a Lien on any of its assets or (c) create or permit to exist or become effective any encumbrance or restriction on the ability of any Subsidiary to (i) pay dividends or make other distributions to the Company or any other Subsidiary, or pay any Debt owed to the Company or any other Subsidiary, (ii) make loans or advances to any Loan Party or (iii) transfer any of its assets or properties to any Loan Party, other than (A) customary restrictions and conditions contained in agreements relating to the sale of all or a substantial part of the assets of any Subsidiary pending such sale, provided that such restrictions and -------- conditions apply only to the Subsidiary to be sold and such sale is permitted hereunder (B) restrictions or conditions imposed by any agreement relating to purchase money Debt, Capital Leases and other secured Debt permitted by this Agreement if such restrictions or conditions apply only to the property or assets securing such Debt and (C) customary provisions in leases and other contracts restricting the assignment thereof. 45 11.10 Business Activities; Issuance of Equity. Not, and not permit --------------------------------------- any other Loan Party to, engage in any line of business other than the businesses engaged in on the date hereof and businesses reasonably related thereto. Not, and not permit any Loan Party other than the Company to, issue any Capital Securities other than (a) any issuance of shares of such Loan Party's common Capital Securities pursuant to any employee or director option program, benefit plan or compensation program or (b) any issuance by a Subsidiary to the Company or another Subsidiary in accordance with Section ------- 11.4. - ---- 11.11 Investments. Not, and not permit any other Loan Party to, ----------- make or permit to exist any Investment in any other Person, except the following: (a) contributions by the Loan Parties to the capital of any Wholly-Owned Subsidiary, or by any Subsidiary to the capital of any other domestic Wholly-Owned Subsidiary, so long as the recipient of any such capital contribution has guaranteed the Obligations, in each case in accordance with Section 10.9; ------------ (b) Investments constituting Debt permitted by Section ------- 11.1; ---- (c) Contingent Liabilities constituting Debt permitted by Section 11.1 or Liens permitted by Section 11.2; ------------ ------------ (d) Cash Equivalent Investments; (e) Investments in securities of Account Debtors received pursuant to any plan of reorganization or similar arrangement upon the bankruptcy or insolvency of such account debtors; (f) Investments to consummate Acquisitions permitted by Section 11.5; ------------ (g) Investments listed on Schedule 11.11 as of the Closing -------------- Date; and (h) so long as no Event of Default or Unmatured Event of Default exists or would result therefrom, other cash Investments in public or private companies provided the aggregate consideration paid by the Loan Parties in connection with any single Investment (or any series of related Investments) does not exceed $75,000,000 in the aggregate. provided that (x) any Investment which when made complies with the - -------- requirements of the definition of the term "Cash Equivalent Investment" may -------------------------- continue to be held notwithstanding that such Investment if made thereafter would not comply with such requirements; (y) no Investment otherwise permitted by clause (b), (c), or (f) shall be permitted to be made if, immediately before or after giving effect thereto, any Event of Default or Unmatured Event of Default exists. 11.12 Restriction of Amendments to Certain Documents. Not amend or ---------------------------------------------- otherwise modify, or waive any rights under, any provision governing the subordination terms of any Subordinated Debt without the consent of the Required Lenders. 46 11.13 Fiscal Year. Not change its Fiscal Year. ----------- 11.14 Financial Covenants. ------------------- 11.14.1 Fixed Charge Coverage Ratio. Not permit the Fixed Charge --------------------------- Coverage Ratio for any Computation Period to be less than 2.0:1.0, measured on a quarterly basis. 11.14.2 Senior Debt to EBITDA Ratio. Not permit the Senior Debt to --------------------------- EBITDA Ratio as of the last day of any Computation Period to exceed 3.0:1.0, measured on a quarterly basis. 11.14.3 Net Worth. Maintain Net Worth of at least $262,883,750 at --------- all times measured as of the last day of each calendar quarter. SECTION 12 EFFECTIVENESS; CONDITIONS OF LENDING, ETC. The obligation of each Lender to make its Loans and of the Issuing Lender to issue Letters of Credit is subject to the following conditions precedent: 12.1 Initial Credit Extension. The obligation of the Lenders to ------------------------ make the initial Loans and the obligation of the Issuing Lender to issue its initial Letter of Credit (whichever first occurs) is, in addition to the conditions precedent specified in Section 12.2, subject to the conditions ------------ precedent that (a) all Debt to be Repaid has been (or concurrently with the initial borrowing will be) paid in full, and that all agreements and instruments governing the Debt to be Repaid and that all Liens securing such Debt to be Repaid have been (or concurrently with the initial borrowing will be) terminated and (b) the Administrative Agent shall have received all of the following, each duly executed and dated the Closing Date (or such earlier date as shall be satisfactory to the Administrative Agent), in form and substance satisfactory to the Administrative Agent (and the date on which all such conditions precedent have been satisfied or waived in writing by the Administrative Agent and the Lenders is called the "Closing Date"): 12.1.1 Notes. A Note for each Lender. ----- 12.1.2 Authorization Documents. For each Loan Party, such Person's ----------------------- (a) charter (or similar formation document), certified by the appropriate governmental authority; (b) good standing certificates in its state of incorporation (or formation) and in each other state requested by the Administrative Agent; (c) bylaws (or similar governing document); (d) resolutions of its board of directors (or similar governing body) approving and authorizing such Person's execution, delivery and performance of the Loan Documents to which it is party and the transactions contemplated thereby; and (e) signature and incumbency certificates of its officers executing any of the Loan Documents (it being understood that the Administrative Agent and each Lender may conclusively rely on each such certificate until formally advised by a like certificate of any changes therein), all certified by its secretary or an assistant secretary (or similar officer) as being in full force and effect without modification. 12.1.3 Consents, etc. Certified copies of all documents evidencing ------------- any necessary corporate or partnership action, consents and governmental approvals (if any) required for the 47 execution, delivery and performance by the Loan Parties of the documents referred to in this Section 12. ---------- 12.1.4 Letter of Direction. A letter of direction containing funds ------------------- flow information with respect to the proceeds of the Loans on the Closing Date. 12.1.5 Opinions of Counsel. Opinions of counsel for each Loan ------------------- Party, including local counsel reasonably requested by the Administrative Agent. 12.1.6 Insurance. Evidence of the existence of insurance required --------- to be maintained pursuant to Section 10.3(b). --------------- 12.1.7 Payment of Fees. Evidence of payment by the Loan Parties of --------------- all accrued and unpaid fees, costs and expenses to the extent then due and payable on the Closing Date, together with all Attorney Costs of the Administrative Agent to the extent invoiced prior to the Closing Date, plus such additional amounts of Attorney Costs as shall constitute the Administrative Agent's reasonable estimate of Attorney Costs incurred or to be incurred by the Administrative Agent through the closing proceedings (provided that such estimate shall not thereafter preclude final settling of -------- accounts between the Loan Parties and the Administrative Agent). 12.1.8 Solvency Certificate. A Solvency Certificate executed by a -------------------- Senior Officer of the Loan Parties. 12.1.9 Environmental Reports. Environmental site assessment reports --------------------- requested by the Administrative Agent. 12.1.10 Search Results; Lien Terminations. Certified copies of --------------------------------- Uniform Commercial Code search reports dated a date reasonably near to the Closing Date, listing all effective financing statements which name any Loan Party (under their present names and any previous names) as debtors, together with (a) copies of such financing statements, (b) payoff letters evidencing repayment in full of all Debt to be Repaid, the termination of all agreements relating thereto and the release of all Liens granted in connection therewith, with Uniform Commercial Code or other appropriate termination statements and documents effective to evidence the foregoing (other than Liens permitted by Section 11.2) and (c) such other Uniform ------------ Commercial Code termination statements as the Administrative Agent may reasonably request. 12.1.11 Other. Such other documents as the Administrative Agent or ----- any Lender may reasonably request. 12.2 Conditions. The obligation (a) of each Lender to make each ---------- Loan and (b) of the Issuing Lender to issue each Letter of Credit is subject to the following further conditions precedent that: 12.2.1 Compliance with Warranties, No Default, etc. Both before and ------------------------------------------- after giving effect to any borrowing and the issuance of any Letter of Credit, the following statements shall be true and correct: 48 (a) the representations and warranties of each Loan Party set forth in this Agreement and the other Loan Documents shall be true and correct in all respects with the same effect as if then made (except to the extent stated to relate to a specific earlier date, in which case such representations and warranties shall be true and correct as of such earlier date); and (b) no Event of Default or Unmatured Event of Default shall have then occurred and be continuing. 12.2.2 Confirmatory Certificate. If requested by the Administrative ------------------------ Agent or any Lender, the Administrative Agent shall have received (in sufficient counterparts to provide one to each Lender) a certificate dated the date of such requested Loan or Letter of Credit and signed by a duly authorized representative of each Loan Party to the matters set out in Section 12.2.1 (it being understood that each request by the Loan Parties - -------------- for the making of a Loan or the issuance of a Letter of Credit shall be deemed to constitute a representation and warranty by each Loan Party that the conditions precedent set forth in Section 12.2.1 will be satisfied at -------------- the time of the making of such Loan or the issuance of such Letter of Credit), together with such other documents as the Administrative Agent or any Lender may reasonably request in support thereof. SECTION 13 EVENTS OF DEFAULT AND THEIR EFFECT. 13.1 Events of Default. Each of the following shall constitute an ----------------- Event of Default under this Agreement: 13.1.1 Non-Payment of the Loans, etc. Default in the payment when ----------------------------- due of the principal of any Loan; or default, and continuance thereof for five days, in the payment when due of any interest, fee, reimbursement obligation with respect to any Letter of Credit or other amount payable by any Loan Party hereunder or under any other Loan Document. 13.1.2 Non-Payment of Other Debt. Any default shall occur under the ------------------------- terms applicable to any Debt of any Loan Party in an aggregate amount (for all such Debt so affected and including undrawn committed or available amounts and amounts owing to all creditors under any combined or syndicated credit arrangement) exceeding $1,750,000 and such default shall (a) consist of the failure to pay such Debt when due, whether by acceleration or otherwise, or (b) accelerate the maturity of such Debt or permit the holder or holders thereof, or any trustee or agent for such holder or holders, to cause such Debt to become due and payable (or require any Loan Party to purchase or redeem such Debt or post cash collateral in respect thereof) prior to its expressed maturity. 13.1.3 Reserved. -------- 13.1.4 Bankruptcy, Insolvency, etc. Any Loan Party becomes --------------------------- insolvent or generally fails to pay, or admits in writing its inability or refusal to pay, debts as they become due; or any Loan Party applies for, consents to, or acquiesces in the appointment of a trustee, receiver or other custodian for such Loan Party or any property thereof, or makes a general assignment for the benefit of creditors; or, in the absence of such application, consent or acquiescence, a trustee, receiver or other custodian is appointed for any Loan Party or for a substantial part of the property of any thereof and is not discharged within 60 days; or any bankruptcy, reorganization, 49 debt arrangement, or other case or proceeding under any bankruptcy or insolvency law, or any dissolution or liquidation proceeding, is commenced in respect of any Loan Party, and if such case or proceeding is not commenced by such Loan Party, it is consented to or acquiesced in by such Loan Party, or remains for 60 days undismissed; or any Loan Party takes any action to authorize, or in furtherance of, any of the foregoing. 13.1.5 Non-Compliance with Loan Documents. (a) Failure by any Loan ---------------------------------- Party to comply with or to perform any covenant set forth in Sections -------- 10.1.5, 10.3(b) or 10.5 or Section 11; or (b) failure by any Loan Party to - ------ ------- ---- ---------- comply with or to perform any other provision of this Agreement or any other Loan Document (and not constituting an Event of Default under any other provision of this Section 13) and continuance of such failure described in ---------- this clause (b) for 30 days. 13.1.6 Representations; Warranties. Any representation or warranty --------------------------- made by any Loan Party herein or any other Loan Document is breached or is false or misleading in any material respect, or any schedule, certificate, financial statement, report, notice or other writing furnished by any Loan Party to the Administrative Agent or any Lender in connection herewith is false or misleading in any material respect on the date as of which the facts therein set forth are stated or certified. 13.1.7 Pension Plans. (a) Any Person institutes steps to terminate ------------- a Pension Plan if as a result of such termination any Loan Party or any member of the Controlled Group could be required to make a contribution to such Pension Plan, or could incur a liability or obligation to such Pension Plan, in excess of $1,000,000; (b) a contribution failure occurs with respect to any Pension Plan sufficient to give rise to a Lien under Section 302(f) of ERISA; (c) the Unfunded Liability exceeds twenty percent of the Total Plan Liability, or (d) there shall occur any withdrawal or partial withdrawal from a Multiemployer Pension Plan and the withdrawal liability (without unaccrued interest) to Multiemployer Pension Plans as a result of such withdrawal (including any outstanding withdrawal liability that any Loan Party or any member of the Controlled Group have incurred on the date of such withdrawal) exceeds $1,000,000. 13.1.8 Judgments. Final judgments which exceed an aggregate of --------- $1,000,000 shall be rendered against any Loan Party and shall not have been paid, discharged or vacated or had execution thereof stayed pending appeal within 30 days after entry or filing of such judgments. 13.1.9 Invalidity of Subordination Provisions, etc. Any ------------------------------------------- subordination provision in any document or instrument governing Subordinated Debt, or any subordination provision in any guaranty by any Subsidiary of any Subordinated Debt, shall cease to be in full force and effect or shall be amended without the prior written consent of the Administrative Agent, or any Loan Party or any other Person (including the holder of any applicable Subordinated Debt) shall contest in any manner the validity, binding nature or enforceability of any such provision. 13.1.10 Change of Control. A Change of Control shall occur. ----------------- 13.2 Effect of Event of Default. If any Event of Default described -------------------------- in Section 13.1.4 shall occur in respect of any Loan Party, the Commitments -------------- shall immediately terminate and the Loans and all other Obligations hereunder shall become immediately due and payable and the 50 Loan Parties shall become immediately obligated to Cash Collateralize all Letters of Credit, all without presentment, demand, protest or notice of any kind; and, if any other Event of Default shall occur and be continuing, the Administrative Agent may (and, upon the written request of the Required Lenders shall) declare the Commitments to be terminated in whole or in part and/or declare all or any part of the Loans and all other Obligations hereunder to be due and payable and/or demand that the Loan Parties immediately Cash Collateralize all or any Letters of Credit, whereupon the Commitments shall immediately terminate (or be reduced, as applicable) and/or the Loans and other Obligations hereunder shall become immediately due and payable (in whole or in part, as applicable) and/or the Loan Parties shall immediately become obligated to Cash Collateralize the Letters of Credit (all or any, as applicable), all without presentment, demand, protest or notice of any kind. The Administrative Agent shall promptly advise the Loan Parties of any such declaration, but failure to do so shall not impair the effect of such declaration. Any cash collateral delivered hereunder shall be held by the Administrative Agent (without liability for interest thereon) and applied to the Obligations arising in connection with any drawing under a Letter of Credit. After the expiration or termination of all Letters of Credit, such cash collateral shall be applied by the Administrative Agent to any remaining Obligations hereunder and any excess shall be delivered to the Loan Parties or as a court of competent jurisdiction may elect. SECTION 14 THE AGENT[S]. 14.1 Appointment and Authorization. Each Lender hereby irrevocably ----------------------------- (subject to Section 14.10) appoints, designates and authorizes the ------------- Administrative Agent to take such action on its behalf under the provisions of this Agreement and each other Loan Document and to exercise such powers and perform such duties as are expressly delegated to it by the terms of this Agreement or any other Loan Document, together with such powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary contained elsewhere in this Agreement or in any other Loan Document, the Administrative Agent shall not have any duty or responsibility except those expressly set forth herein, nor shall the Administrative Agent have or be deemed to have any fiduciary relationship with any Lender or participant, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into this Agreement or any other Loan Document or otherwise exist against the Administrative Agent. Without limiting the generality of the foregoing sentence, the use of the term "agent" herein and in other Loan Documents with reference to the Administrative Agent is not intended to connote any fiduciary or other implied (or express) obligations arising under agency doctrine of any applicable law. Instead, such term is used merely as a matter of market custom, and is intended to create or reflect only an administrative relationship between independent contracting parties. 14.2 Issuing Lender. The Issuing Lender shall act on behalf of the -------------- Lenders (according to their Pro Rata Shares) with respect to any Letters of Credit issued by it and the documents associated therewith. The Issuing Lender shall have all of the benefits and immunities (a) provided to the Administrative Agent in this Section 14 with respect to any acts taken or ---------- omissions suffered by the Issuing Lender in connection with Letters of Credit issued by it or proposed to be issued by it and the applications and agreements for letters of credit pertaining to such Letters of Credit as fully as if the term "Administrative Agent", as used in this Section 14, ---------- included the Issuing Lender with respect to such acts or omissions and (b) as additionally provided in this Agreement with respect to the Issuing Lender. 51 14.3 Delegation of Duties. The Administrative Agent may execute any -------------------- of its duties under this Agreement or any other Loan Document by or through agents, employees or attorneys-in-fact and shall be entitled to advice of counsel and other consultants or experts concerning all matters pertaining to such duties. The Administrative Agent shall not be responsible for the negligence or misconduct of any agent or attorney-in-fact that it selects in the absence of gross negligence or willful misconduct. 14.4 Exculpation of Administrative Agent. None of the ----------------------------------- Administrative Agent nor any of its directors, officers, employees or agents shall (a) be liable for any action taken or omitted to be taken by any of them under or in connection with this Agreement or any other Loan Document or the transactions contemplated hereby (except to the extent resulting from its own gross negligence or willful misconduct in connection with its duties expressly set forth herein as determined by a final, nonappealable judgment by a court of competent jurisdiction), or (b) be responsible in any manner to any Lender or participant for any recital, statement, representation or warranty made by any Loan Party or Affiliate of the Loan Parties, or any officer thereof, contained in this Agreement or in any other Loan Document, or in any certificate, report, statement or other document referred to or provided for in, or received by the Administrative Agent under or in connection with, this Agreement or any other Loan Document, or the validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or any other Loan Document (or the creation, perfection or priority of any Lien or security interest therein), or for any failure of the Loan Parties or any other party to any Loan Document to perform its Obligations hereunder or thereunder. The Administrative Agent shall not be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any other Loan Document, or to inspect the properties, books or records of the Loan Parties or any of the Loan Parties' Subsidiaries or Affiliates. 14.5 Reliance by Administrative Agent. The Administrative Agent -------------------------------- shall be entitled to rely, and shall be fully protected in relying, upon any writing, communication, signature, resolution, representation, notice, consent, certificate, electronic mail message, affidavit, letter, telegram, facsimile, telex or telephone message, statement or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons, and upon advice and statements of legal counsel (including counsel to the Loan Parties), independent accountants and other experts selected by the Administrative Agent. The Administrative Agent shall be fully justified in failing or refusing to take any action under this Agreement or any other Loan Document unless it shall first receive such advice or concurrence of the Required Lenders as it deems appropriate and, if it so requests, confirmation from the Lenders of their obligation to indemnify the Administrative Agent against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Administrative Agent shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement or any other Loan Document in accordance with a request or consent of the Required Lenders and such request and any action taken or failure to act pursuant thereto shall be binding upon each Lender. For purposes of determining compliance with the conditions specified in Section 12, each Lender that has signed this Agreement shall be deemed to - ---------- have consented to, approved or accepted or to be satisfied with, each document or other matter required thereunder to be consented to or approved by or acceptable or satisfactory 52 to a Lender unless the Administrative Agent shall have received written notice from such Lender prior to the proposed Closing Date specifying its objection thereto. 14.6 Notice of Default. The Administrative Agent shall not be ----------------- deemed to have knowledge or notice of the occurrence of any Event of Default or Unmatured Event of Default except with respect to defaults in the payment of principal, interest and fees required to be paid to the Administrative Agent for the account of the Lenders, unless the Administrative Agent shall have received written notice from a Lender or the Loan Parties referring to this Agreement, describing such Event of Default or Unmatured Event of Default and stating that such notice is a "notice of default". The Administrative Agent will notify the Lenders of its receipt of any such notice. The Administrative Agent shall take such action with respect to such Event of Default or Unmatured Event of Default as may be requested by the Required Lenders in accordance with Section 13; provided that unless and ---------- -------- until the Administrative Agent has received any such request, the Administrative Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Event of Default or Unmatured Event of Default as it shall deem advisable or in the best interest of the Lenders. 14.7 Credit Decision. Each Lender acknowledges that the --------------- Administrative Agent has not made any representation or warranty to it, and that no act by the Administrative Agent hereafter taken, including any consent and acceptance of any assignment or review of the affairs of the Loan Parties, shall be deemed to constitute any representation or warranty by the Administrative Agent to any Lender as to any matter, including whether the Administrative Agent has disclosed material information in its possession. Each Lender represents to the Administrative Agent that it has, independently and without reliance upon the Administrative Agent and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, prospects, operations, property, financial and other condition and creditworthiness of the Loan Parties, and made its own decision to enter into this Agreement and to extend credit to the Loan Parties hereunder. Each Lender also represents that it will, independently and without reliance upon the Administrative Agent and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, appraisals and decisions in taking or not taking action under this Agreement and the other Loan Documents, and to make such investigations as it deems necessary to inform itself as to the business, prospects, operations, property, financial and other condition and creditworthiness of the Loan Parties. Except for notices, reports and other documents expressly herein required to be furnished to the Lenders by the Administrative Agent, the Administrative Agent shall not have any duty or responsibility to provide any Lender with any credit or other information concerning the business, prospects, operations, property, financial or other condition or creditworthiness of the Loan Parties which may come into the possession of the Administrative Agent. 14.8 Indemnification. Whether or not the transactions contemplated --------------- hereby are consummated, each Lender shall indemnify upon demand the Administrative Agent and its directors, officers, employees and agents (to the extent not reimbursed by or on behalf of the Loan Parties and without limiting the obligation of the Loan Parties to do so), according to its applicable Pro Rata Share, from and against any and all Indemnified Liabilities (as hereinafter defined); provided that no Lender shall be -------- liable for any payment to any such Person of any portion of the Indemnified Liabilities to the extent determined by a final, nonappealable 53 judgment by a court of competent jurisdiction to have resulted from the applicable Person's own gross negligence or willful misconduct. No action taken in accordance with the directions of the Required Lenders shall be deemed to constitute gross negligence or willful misconduct for purposes of this Section. Without limitation of the foregoing, each Lender shall reimburse the Administrative Agent upon demand for its ratable share of any costs or out-of-pocket expenses (including Attorney Costs and Taxes) incurred by the Administrative Agent in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of rights or responsibilities under, this Agreement, any other Loan Document, or any document contemplated by or referred to herein, to the extent that the Administrative Agent is not reimbursed for such expenses by or on behalf of the Loan Parties. The undertaking in this Section shall survive repayment of the Loans, cancellation of the Notes, expiration or termination of the Letters of Credit, any foreclosure under, or modification, release or discharge of, any or all of the Loan Documents, termination of this Agreement and the resignation or replacement of the Administrative Agent. 14.9 Administrative Agent in Individual Capacity. LaSalle and its ------------------------------------------- Affiliates may make loans to, issue letters of credit for the account of, accept deposits from, acquire equity interests in and generally engage in any kind of banking, trust, financial advisory, underwriting or other business with the Loan Parties and Affiliates as though LaSalle were not the Administrative Agent hereunder and without notice to or consent of any Lender. Each Lender acknowledges that, pursuant to such activities, LaSalle or its Affiliates may receive information regarding the Loan Parties or its Affiliates (including information that may be subject to confidentiality obligations in favor of the Loan Parties or such Affiliate) and acknowledge that the Administrative Agent shall be under no obligation to provide such information to them. With respect to their Loans (if any), LaSalle and its Affiliates shall have the same rights and powers under this Agreement as any other Lender and may exercise the same as though LaSalle were not the Administrative Agent, and the terms "Lender" and "Lenders" include LaSalle and its Affiliates, to the extent applicable, in their individual capacities. 14.10 Successor Administrative Agent. The Administrative Agent may ------------------------------ resign as Administrative Agent upon 30 days' notice to the Lenders. If the Administrative Agent resigns under this Agreement, the Required Lenders shall, with (so long as no Event of Default exists) the consent of the Loan Parties (which shall not be unreasonably withheld or delayed), appoint from among the Lenders a successor agent for the Lenders. If no successor agent is appointed prior to the effective date of the resignation of the Administrative Agent, the Administrative Agent may appoint, after consulting with the Lenders and the Loan Parties, a successor agent from among the Lenders. Upon the acceptance of its appointment as successor agent hereunder, such successor agent shall succeed to all the rights, powers and duties of the retiring Administrative Agent and the term "Administrative Agent" shall mean such successor agent, and the retiring Administrative Agent's appointment, powers and duties as Administrative Agent shall be terminated. After any retiring Administrative Agent's resignation hereunder as Administrative Agent, the provisions of this Section 14 and Sections 15.5 ---------- ------------- and 15.16 shall inure to its benefit as to any actions taken or omitted to ----- be taken by it while it was Administrative Agent under this Agreement. If no successor agent has accepted appointment as Administrative Agent by the date which is 30 days following a retiring Administrative Agent's notice of resignation, the retiring Administrative Agent's resignation shall nevertheless thereupon become 54 effective and the Lenders shall perform all of the duties of the Administrative Agent hereunder until such time, if any, as the Required Lenders appoint a successor agent as provided for above. 14.11 Administrative Agent May File Proofs of Claim. In case of the --------------------------------------------- pendency of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to any Loan Party, the Administrative Agent (irrespective of whether the principal of any Loan shall then be due and payable as herein expressed or by declaration or otherwise and irrespective of whether the Administrative Agent shall have made any demand on the Loan Parties) shall be entitled and empowered, by intervention in such proceeding or otherwise: (a) to file and prove a claim for the whole amount of the principal and interest owing and unpaid in respect of the Loans, and all other Obligations that are owing and unpaid and to file such other documents as may be necessary or advisable in order to have the claims of the Lenders and the Administrative Agent (including any claim for the reasonable compensation, expenses, disbursements and advances of the Lenders and the Administrative Agent and their respective agents and counsel and all other amounts due the Lenders and the Administrative Agent under Sections 5, 15.5 ---------- ---- and 15.17) allowed in such judicial proceedings; and ----- (b) to collect and receive any monies or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or other similar official in any such judicial proceeding is hereby authorized by each Lender to make such payments to the Administrative Agent and, in the event that the Administrative Agent shall consent to the making of such payments directly to the Lenders, to pay to the Administrative Agent any amount due for the reasonable compensation, expenses, disbursements and advances of the Administrative Agent and its agents and counsel, and any other amounts due the Administrative Agent under Sections 5, 15.5 and 15.17. ---------- ---- ----- Nothing contained herein shall be deemed to authorize the Administrative Agent to authorize or consent to or accept or adopt on behalf of any Lender any plan of reorganization, arrangement, adjustment or composition affecting the Obligations or the rights of any Lender or to authorize the Administrative Agent to vote in respect of the claim of any Lender in any such proceeding. 14.12 Other Agents; Arrangers and Managers. None of the Lenders or ------------------------------------ other Persons identified on the facing page or signature pages of this Agreement as a "syndication agent," "documentation agent," "co-agent," "book manager," "lead manager," "arranger," "lead arranger" or "co-arranger", if any, shall have any right, power, obligation, liability, responsibility or duty under this Agreement other than, in the case of such Lenders, those applicable to all Lenders as such. Without limiting the foregoing, none of the Lenders or other Persons so identified shall have or be deemed to have any fiduciary relationship with any Lender. Each Lender acknowledges that it has not relied, and will not rely, on any of the Lenders or other Persons so identified in deciding to enter into this Agreement or in taking or not taking action hereunder. 55 SECTION 15 GENERAL. 15.1 Waiver; Amendments. No delay on the part of the Administrative ------------------ Agent or any Lender in the exercise of any right, power or remedy shall operate as a waiver thereof, nor shall any single or partial exercise by any of them of any right, power or remedy preclude other or further exercise thereof, or the exercise of any other right, power or remedy. No amendment, modification or waiver of, or consent with respect to, any provision of this Agreement or the other Loan Documents shall in any event be effective unless the same shall be in writing and acknowledged by Lenders having an aggregate Pro Rata Shares of not less than the aggregate Pro Rata Shares expressly designated herein with respect thereto or, in the absence of such designation as to any provision of this Agreement, by the Required Lenders, and then any such amendment, modification, waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No amendment, modification, waiver or consent shall (a) extend or increase the Commitment of any Lender without the written consent of such Lender, (b) extend the date scheduled for payment of any principal (excluding mandatory prepayments) of or interest on the Loans or any fees payable hereunder without the written consent of each Lender directly affected thereby, (c) reduce the principal amount of any Loan, the rate of interest thereon or any fees payable hereunder, without the consent of each Lender directly affected thereby (except for periodic adjustments of interest rates and fees resulting from a change in the Applicable Margin as provided for in this Agreement); or (d) release any party from its obligations under any Guaranty, release any substantial part of any collateral, if any, change the definition of Required Lenders, any provision of this Section 15.1 or reduce the aggregate Pro Rata Share required to ------------ effect an amendment, modification, waiver or consent, without, in each case, the written consent of all Lenders. No provision of Section 14 or other ---------- provision of this Agreement affecting the Administrative Agent in its capacity as such shall be amended, modified or waived without the consent of the Administrative Agent. No provision of this Agreement relating to the rights or duties of the Issuing Lender in its capacity as such shall be amended, modified or waived without the consent of the Issuing Lender. No provision of this Agreement relating to the rights or duties of the Swing Line Lender in its capacity as such shall be amended, modified or waived without the consent of the Swing Line Lender. 15.2 Confirmations. The Loan Parties and each holder of a Note ------------- agree from time to time, upon written request received by it from the other, to confirm to the other in writing (with a copy of each such confirmation to the Administrative Agent) the aggregate unpaid principal amount of the Loans then outstanding under such Note. 15.3 Notices. Except as otherwise provided in Sections 2.2.2 and ------- -------------- 2.2.3, all notices hereunder shall be in writing (including facsimile - ----- transmission) and shall be sent to the applicable party at its address shown on Annex B or at such other address as such party may, by written notice ------- received by the other parties, have designated as its address for such purpose. Notices sent by facsimile transmission shall be deemed to have been given when sent; notices sent by mail shall be deemed to have been given three Business Days after the date when sent by registered or certified mail, postage prepaid; and notices sent by hand delivery or overnight courier service shall be deemed to have been given when received. For purposes of Sections 2.2.2 and 2.2.3, the Administrative Agent shall be -------------- ----- entitled to rely on telephonic instructions from any person that the Administrative Agent in good faith believes is an authorized officer or employee of the Loan Parties, and the Loan Parties shall hold the 56 Administrative Agent and each other Lender harmless from any loss, cost or expense resulting from any such reliance. 15.4 Computations. Where the character or amount of any asset or ------------ liability or item of income or expense is required to be determined, or any consolidation or other accounting computation is required to be made, for the purpose of this Agreement, such determination or calculation shall, to the extent applicable and except as otherwise specified in this Agreement, be made in accordance with GAAP, consistently applied; provided that if the Loan Parties notify the Administrative Agent that the Loan Parties wish to amend any covenant in Sections 10 or 11.14 (or any related definition) to ----------- ----- eliminate or to take into account the effect of any change in GAAP on the operation of such covenant (or if the Administrative Agent notifies the Loan Parties that the Required Lenders wish to amend Sections 10 or 11.14 (or any ----------- ----- related definition) for such purpose), then the Loan Parties' compliance with such covenant shall be determined on the basis of GAAP in effect immediately before the relevant change in GAAP became effective, until either such notice is withdrawn or such covenant (or related definition) is amended in a manner satisfactory to the Loan Parties and the Required Lenders. 15.5 Costs, Expenses and Taxes. The Loan Parties agree to pay on ------------------------- demand all reasonable out-of-pocket costs and expenses of the Administrative Agent and each Arranger (including Attorney Costs and any Taxes) in connection with the preparation, execution, syndication, delivery and administration (including the costs of Intralinks (or other similar service), if applicable) of this Agreement, the other Loan Documents and all other documents provided for herein or delivered or to be delivered hereunder or in connection herewith (including any amendment, supplement or waiver to any Loan Document), whether or not the transactions contemplated hereby or thereby shall be consummated, and all reasonable out-of-pocket costs and expenses (including Attorney Costs and any Taxes) incurred by the Administrative Agent and each Lender after an Event of Default in connection with the collection of the Obligations or the enforcement of this Agreement the other Loan Documents or any such other documents or during any workout, restructuring or negotiations in respect thereof. In addition, the Loan Parties agree to pay, and to save the Administrative Agent and the Lenders harmless from all liability for, any fees of the Loan Parties' auditors in connection with any reasonable exercise by the Administrative Agent and the Lenders of their rights pursuant to Section 10.2. All Obligations provided ------------ for in this Section 15.5 shall survive repayment of the Loans, cancellation ------------ of the Notes, expiration or termination of the Letters of Credit and termination of this Agreement. 15.6 Assignments; Participations. --------------------------- 15.6.1 Assignments. (a) Any Lender may at any time assign to one or ----------- more Persons (any such Person, an "Assignee") all or any portion of such Lender's Loans and Commitments, with the prior written consent of the Administrative Agent, the Issuing Lender (for an assignment of the Revolving Loans and the Revolving Commitment) and, so long as no Event of Default exists, the Loan Parties (which consents shall not be unreasonably withheld or delayed and shall not be required for an assignment by a Lender to a Lender or an Affiliate of a Lender). Except as the Administrative Agent may otherwise agree, any such assignment shall be in a minimum aggregate amount equal to $5,000,000 or, if less, the remaining Commitment and Loans held by the assigning Lender. The Loan Parties and the Administrative Agent shall be entitled to 57 continue to deal solely and directly with such Lender in connection with the interests so assigned to an Assignee until the Administrative Agent shall have received and accepted an effective assignment agreement in substantially the form of Exhibit C hereto (an "Assignment Agreement") --------- executed, delivered and fully completed by the applicable parties thereto and a processing fee of $3,500. No assignment may be made to any Person if at the time of such assignment the Loan Parties would be obligated to pay any greater amount under Sections 7.6 or 8 to the Assignee than the Loan ------------ - Parties are then obligated to pay to the assigning Lender under such Sections (and if any assignment is made in violation of the foregoing, the Loan Parties will not be required to pay such greater amounts). Any attempted assignment not made in accordance with this Section 15.6.1 shall -------------- be treated as the sale of a participation under Section 15.6.2. The Loan -------------- Parties shall be deemed to have granted their consent to any assignment requiring its consent hereunder unless the Loan Parties have expressly objected to such assignment within three Business Days after notice thereof. (b) From and after the date on which the conditions described above have been met, (i) such Assignee shall be deemed automatically to have become a party hereto and, to the extent that rights and obligations hereunder have been assigned to such Assignee pursuant to such Assignment Agreement, shall have the rights and obligations of a Lender hereunder and (ii) the assigning Lender, to the extent that rights and obligations hereunder have been assigned by it pursuant to such Assignment Agreement, shall be released from its rights (other than its indemnification rights) and obligations hereunder. Upon the request of the Assignee (and, as applicable, the assigning Lender) pursuant to an effective Assignment Agreement, the Loan Parties shall execute and deliver to the Administrative Agent for delivery to the Assignee (and, as applicable, the assigning Lender) a Note in the principal amount of the Assignee's Pro Rata Share of the Revolving Commitment (and, as applicable, a Note in the principal amount of the Pro Rata Share of the Revolving Commitment retained by the assigning Lender). Each such Note shall be dated the effective date of such assignment. Upon receipt by the assigning Lender of such Note, the assigning Lender shall return to the Loan Parties any prior Note held by it. (c) Any Lender may at any time pledge or assign a security interest in all or any portion of its rights under this Agreement to secure obligations of such Lender, including any pledge or assignment to secure obligations to a Federal Reserve Bank, and this Section shall not apply to any such pledge or assignment of a security interest; provided that no such -------- pledge or assignment of a security interest shall release a Lender from any of its obligations hereunder or substitute any such pledgee or assignee for such Lender as a party hereto. 15.6.2 Participations. Any Lender may at any time sell to one or -------------- more Persons participating interests in its Loans, Commitments or other interests hereunder (any such Person, a "Participant"). In the event of a ----------- sale by a Lender of a participating interest to a Participant, (a) such Lender's obligations hereunder shall remain unchanged for all purposes, (b) the Loan Parties and the Administrative Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations hereunder and (c) all amounts payable by the Loan Parties shall be determined as if such Lender had not sold such participation and shall be paid directly to such Lender. No Participant shall have any direct or indirect voting rights hereunder except with respect to any event described in Section 15.1 expressly requiring the unanimous vote of all Lenders or, as ------------ applicable, all affected Lenders. Each Lender agrees to incorporate the requirements of the preceding sentence into each participation agreement which 58 such Lender enters into with any Participant. The Loan Parties agree that if amounts outstanding under this Agreement are due and payable (as a result of acceleration or otherwise), each Participant shall be deemed to have the right of set-off in respect of its participating interest in amounts owing under this Agreement and with respect to any Letter of Credit to the same extent as if the amount of its participating interest were owing directly to it as a Lender under this Agreement; provided that such right of set-off -------- shall be subject to the obligation of each Participant to share with the Lenders, and the Lenders agree to share with each Participant, as provided in Section 7.5. The Loan Parties also agree that each Participant shall be ----------- entitled to the benefits of Section 7.6 or 8 as if it were a Lender ----------- - (provided that on the date of the participation no Participant shall be entitled to any greater compensation pursuant to Section 7.6 or 8 than would ----------- - have been paid to the participating Lender on such date if no participation had been sold and that each Participant complies with Section 7.6(d) as if -------------- it were an Assignee). 15.7 Register. The Administrative Agent shall maintain a copy of -------- each Assignment Agreement delivered and accepted by it and register (the "Register") for the recordation of names and addresses of the Lenders and the Commitment of each Lender from time to time and whether such Lender is the original Lender or the Assignee. No assignment shall be effective unless and until the Assignment Agreement is accepted and registered in the Register. All records of transfer of a Lender's interest in the Register shall be conclusive, absent manifest error, as to the ownership of the interests in the Loans. The Administrative Agent shall not incur any liability of any kind with respect to any Lender with respect to the maintenance of the Register. 15.8 GOVERNING LAW. THIS AGREEMENT AND EACH NOTE SHALL BE A ------------- CONTRACT MADE UNDER AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF ILLINOIS APPLICABLE TO CONTRACTS MADE AND TO BE PERFORMED ENTIRELY WITHIN SUCH STATE, WITHOUT REGARD TO CONFLICT OF LAWS PRINCIPLES. 15.9 Confidentiality. As required by federal law and the --------------- Administrative Agent's policies and practices, the Administrative Agent may need to obtain, verify, and record certain customer identification information and documentation in connection with opening or maintaining accounts, or establishing or continuing to provide services. The Administrative Agent and each Lender agree to use commercially reasonable efforts (equivalent to the efforts the Administrative Agent or such Lender applies to maintain the confidentiality of its own confidential information) to maintain as confidential all information provided to them by any Loan Party and designated as confidential, except that the Administrative Agent and each Lender may disclose such information (a) to Persons employed or engaged by the Administrative Agent or such Lender in evaluating, approving, structuring or administering the Loans and the Commitments; (b) to any assignee or participant or potential assignee or participant that has agreed to comply with the covenant contained in this Section 15.9 (and any such ------------ assignee or participant or potential assignee or participant may disclose such information to Persons employed or engaged by them as described in clause (a) above); (c) as required or requested by any federal or state regulatory authority or examiner, or any insurance industry association, or as reasonably believed by the Administrative Agent or such Lender to be compelled by any court decree, subpoena or legal or administrative order or process; (d) as, on the advice of the Administrative Agent's or such Lender's counsel, is required by law; (e) in connection with the 59 exercise of any right or remedy under the Loan Documents or in connection with any litigation to which the Administrative Agent or such Lender is a party; (f) to any nationally recognized rating agency that requires access to information about a Lender's investment portfolio in connection with ratings issued with respect to such Lender; (g) to any Affiliate of the Administrative Agent, the Issuing Lender or any other Lender who may provide Bank Products to the Loan Parties; or (h) that ceases to be confidential through no fault of the Administrative Agent or any Lender. Notwithstanding the foregoing, the Loan Parties consent to the publication by the Administrative Agent or any Lender of a tombstone or similar advertising material relating to the financing transactions contemplated by this Agreement, and the Administrative Agent reserves the right to provide to industry trade organizations information necessary and customary for inclusion in league table measurements. 15.10 Severability. Whenever possible each provision of this ------------ Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement. All obligations of the Loan Parties and rights of the Administrative Agent and the Lenders expressed herein or in any other Loan Document shall be in addition to and not in limitation of those provided by applicable law. 15.11 Nature of Remedies. All Obligations of the Loan Parties and ------------------ rights of the Administrative Agent and the Lenders expressed herein or in any other Loan Document shall be in addition to and not in limitation of those provided by applicable law. No failure to exercise and no delay in exercising, on the part of the Administrative Agent or any Lender, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. 15.12 Entire Agreement. This Agreement, together with the other ---------------- Loan Documents, embodies the entire agreement and understanding among the parties hereto and supersedes all prior or contemporaneous agreements and understandings of such Persons, verbal or written, relating to the subject matter hereof and thereof (except as relates to the fees described in Section 5.3) and any prior arrangements made with respect to the payment by - ----------- the Loan Parties of (or any indemnification for) any fees, costs or expenses payable to or incurred (or to be incurred) by or on behalf of the Administrative Agent or the Lenders. 15.13 Counterparts. This Agreement may be executed in any number of ------------ counterparts and by the different parties hereto on separate counterparts and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same Agreement. Receipt of an executed signature page to this Agreement by facsimile or other electronic transmission shall constitute effective delivery thereof. Electronic records of executed Loan Documents maintained by the Lenders shall deemed to be originals. 15.14 Successors and Assigns. This Agreement shall be binding upon ---------------------- each Loan Party, the Lenders and the Administrative Agent and their respective successors and assigns, and shall inure to the benefit of the Loan Parties, the Lenders and the Administrative Agent and the successors and assigns of the Lenders and the Administrative Agent. No other Person shall be a 60 direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any of the other Loan Documents. No Loan Party may assign or transfer any of its rights or Obligations under this Agreement without the prior written consent of the Administrative Agent and each Lender. 15.15 Captions. Section captions used in this Agreement are for -------- convenience only and shall not affect the construction of this Agreement. 15.16 Customer Identification - USA Patriot Act Notice. Each Lender ------------------------------------------------ and LaSalle (for itself and not on behalf of any other party) hereby notifies the Loan Parties that, pursuant to the requirements of the USA Patriot Act, Title III of Pub. L. 107-56, signed into law October 26, 2001 (the "Act"), it is required to obtain, verify and record information that identifies the Loan Parties, which information includes the name and address of the Loan Parties and other information that will allow such Lender or LaSalle, as applicable, to identify the Loan Parties in accordance with the Act. 15.17 INDEMNIFICATION BY THE LOAN PARTIES. IN CONSIDERATION OF THE ----------------------------------- EXECUTION AND DELIVERY OF THIS AGREEMENT BY THE ADMINISTRATIVE AGENT AND THE LENDERS AND THE AGREEMENT TO EXTEND THE COMMITMENTS PROVIDED HEREUNDER, EACH LOAN PARTY HEREBY AGREES TO INDEMNIFY, EXONERATE AND HOLD THE ADMINISTRATIVE AGENT, EACH LENDER AND EACH OF THE OFFICERS, DIRECTORS, EMPLOYEES, AFFILIATES AND AGENTS OF THE ADMINISTRATIVE AGENT AND EACH LENDER (EACH A "LENDER PARTY") FREE AND HARMLESS FROM AND AGAINST ANY AND ALL ACTIONS, CAUSES OF ACTION, SUITS, LOSSES, LIABILITIES, DAMAGES AND EXPENSES, INCLUDING ATTORNEY COSTS (COLLECTIVELY, THE "INDEMNIFIED LIABILITIES"), INCURRED BY THE LENDER PARTIES OR ANY OF THEM AS A RESULT OF, OR ARISING OUT OF, OR RELATING TO (A) ANY TENDER OFFER, MERGER, PURCHASE OF CAPITAL SECURITIES, PURCHASE OF ASSETS OR OTHER SIMILAR TRANSACTION FINANCED OR PROPOSED TO BE FINANCED IN WHOLE OR IN PART, DIRECTLY OR INDIRECTLY, WITH THE PROCEEDS OF ANY OF THE LOANS, (B) THE USE, HANDLING, RELEASE, EMISSION, DISCHARGE, TRANSPORTATION, STORAGE, TREATMENT OR DISPOSAL OF ANY HAZARDOUS SUBSTANCE AT ANY PROPERTY OWNED OR LEASED BY ANY LOAN PARTY, (C) ANY VIOLATION OF ANY ENVIRONMENTAL LAWS WITH RESPECT TO CONDITIONS AT ANY PROPERTY OWNED OR LEASED BY ANY LOAN PARTY OR THE OPERATIONS CONDUCTED THEREON, (D) THE INVESTIGATION, CLEANUP OR REMEDIATION OF OFFSITE LOCATIONS AT WHICH ANY LOAN PARTY OR THEIR RESPECTIVE PREDECESSORS ARE ALLEGED TO HAVE DIRECTLY OR INDIRECTLY DISPOSED OF HAZARDOUS SUBSTANCES OR (E) THE EXECUTION, DELIVERY, PERFORMANCE OR ENFORCEMENT OF THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT BY ANY OF THE LENDER PARTIES, EXCEPT FOR ANY SUCH INDEMNIFIED LIABILITIES ARISING ON ACCOUNT OF THE APPLICABLE LENDER PARTY'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT AS DETERMINED BY A FINAL, NONAPPEALABLE JUDGMENT BY A COURT OF COMPETENT 61 JURISDICTION. IF AND TO THE EXTENT THAT THE FOREGOING UNDERTAKING MAY BE UNENFORCEABLE FOR ANY REASON, THE LOAN PARTIES HEREBY AGREE TO MAKE THE MAXIMUM CONTRIBUTION TO THE PAYMENT AND SATISFACTION OF EACH OF THE INDEMNIFIED LIABILITIES WHICH IS PERMISSIBLE UNDER APPLICABLE LAW. ALL OBLIGATIONS PROVIDED FOR IN THIS SECTION 15.17 SHALL SURVIVE REPAYMENT OF ------------- THE LOANS, CANCELLATION OF THE NOTES, EXPIRATION OR TERMINATION OF THE LETTERS OF CREDIT AND TERMINATION OF THIS AGREEMENT. 15.18 Nonliability of Lenders. The relationship between the Loan ----------------------- Parties on the one hand and the Lenders and the Administrative Agent on the other hand shall be solely that of borrower and lender. Neither the Administrative Agent nor any Lender has any fiduciary relationship with or duty to any Loan Party arising out of or in connection with this Agreement or any of the other Loan Documents, and the relationship between the Loan Parties, on the one hand, and the Administrative Agent and the Lenders, on the other hand, in connection herewith or therewith is solely that of debtor and creditor. Neither the Administrative Agent nor any Lender undertakes any responsibility to any Loan Party to review or inform any Loan Party of any matter in connection with any phase of any Loan Party's business or operations. Each Loan Party agrees, on behalf of itself and each other Loan Party, that neither the Administrative Agent nor any Lender shall have liability to any Loan Party (whether sounding in tort, contract or otherwise) for losses suffered by any Loan Party in connection with, arising out of, or in any way related to the transactions contemplated and the relationship established by the Loan Documents, or any act, omission or event occurring in connection therewith, unless it is determined in a final non-appealable judgment by a court of competent jurisdiction that such losses resulted from the gross negligence or willful misconduct of the party from which recovery is sought. NO LENDER PARTY SHALL BE LIABLE FOR ANY DAMAGES ARISING FROM THE USE BY OTHERS OF ANY INFORMATION OR OTHER MATERIALS OBTAINED THROUGH INTRALINKS OR OTHER SIMILAR INFORMATION TRANSMISSION SYSTEMS IN CONNECTION WITH THIS AGREEMENT, NOR SHALL ANY LENDER PARTY HAVE ANY LIABILITY WITH RESPECT TO, AND EACH LOAN PARTY ON BEHALF OF ITSELF AND EACH OTHER LOAN PARTY, HEREBY WAIVES, RELEASES AND AGREES NOT TO SUE FOR ANY SPECIAL, PUNITIVE, EXEMPLARY, INDIRECT OR CONSEQUENTIAL DAMAGES RELATING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT OR ARISING OUT OF ITS ACTIVITIES IN CONNECTION HEREWITH OR THEREWITH (WHETHER BEFORE OR AFTER THE CLOSING DATE). Each Loan Party acknowledges that it has been advised by counsel in the negotiation, execution and delivery of this Agreement and the other Loan Documents to which it is a party. No joint venture is created hereby or by the other Loan Documents or otherwise exists by virtue of the transactions contemplated hereby among the Lenders or among the Loan Parties and the Lenders. 15.19 FORUM SELECTION AND CONSENT TO JURISDICTION. ANY LITIGATION ------------------------------------------- BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, SHALL BE BROUGHT AND MAINTAINED EXCLUSIVELY IN THE COURTS OF THE STATE OF ILLINOIS OR IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS; PROVIDED THAT NOTHING IN THIS -------- 62 AGREEMENT SHALL BE DEEMED OR OPERATE TO PRECLUDE THE ADMINISTRATIVE AGENT FROM BRINGING SUIT OR TAKING OTHER LEGAL ACTION IN ANY OTHER JURISDICTION. EACH LOAN PARTY HEREBY EXPRESSLY AND IRREVOCABLY SUBMITS TO THE JURISDICTION OF THE COURTS OF THE STATE OF ILLINOIS AND OF THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS FOR THE PURPOSE OF ANY SUCH LITIGATION AS SET FORTH ABOVE. EACH LOAN PARTY FURTHER IRREVOCABLY CONSENTS TO THE SERVICE OF PROCESS BY REGISTERED MAIL, POSTAGE PREPAID, OR BY PERSONAL SERVICE WITHIN OR WITHOUT THE STATE OF ILLINOIS. EACH LOAN PARTY HEREBY EXPRESSLY AND IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUCH LITIGATION BROUGHT IN ANY SUCH COURT REFERRED TO ABOVE AND ANY CLAIM THAT ANY SUCH LITIGATION HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. 15.20 WAIVER OF JURY TRIAL. EACH LOAN PARTY, THE ADMINISTRATIVE -------------------- AGENT AND EACH LENDER HEREBY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS UNDER THIS AGREEMENT, ANY NOTE, ANY OTHER LOAN DOCUMENT AND ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR THEREWITH OR ARISING FROM ANY LENDING RELATIONSHIP EXISTING IN CONNECTION WITH ANY OF THE FOREGOING, AND AGREES THAT ANY SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY. 15.21 Reimbursement Among the Loan Parties. To the extent that any ------------------------------------ Loan Party shall be required to pay a portion of the Obligations, which shall exceed the amount of loans, advances or other extensions of credit received by any such Loan Party and all interest, costs, fees and expenses attributable to such loans, advances or other extensions of credit, then such Loan Party shall be reimbursed by the other Loan Parties for the amount of such excess pro rata, based on their respective receipt of such loans, advances and extensions of credit. This Section 15.21 is intended only to ------------- define the relative rights of the Loan Parties among the Loan Parties and nothing set forth in this Section 15.21 is intended to or shall impair the ------------- obligations of Loan Parties, jointly and severally, to pay the Obligations to the Lenders as and when the same shall become due and payable in accordance with the terms hereof. 15.22 Joint and Several Liability. Except as specifically set forth --------------------------- herein, the liability of each Loan Party for the Obligations in respect of the Loans under this Agreement and the Loan Documents in general shall be joint and several, and each reference herein to the Loan Parties shall be deemed to refer to each such Loan Party. In furtherance and not in limitation of each Lender's rights and remedies hereunder or at law, Administrative Agent, on behalf of Lenders, may proceed under this Agreement and the other Loan Documents against any one or more of the Loan Parties in its absolute and sole discretion for any of the Obligations or any other liability or obligation of the Loan Parties arising hereunder. [signature pages follow] 63 (SIGNATURE PAGE TO CREDIT AGREEMENT) The parties hereto have caused this Credit Agreement to be duly executed and delivered by their duly authorized officers as of the date first set forth above. K-V PHARMACEUTICAL COMPANY By: ---------------------------------------- Title: ------------------------------------- PARTICLE DYNAMICS, INC. By: ---------------------------------------- Title: ------------------------------------- ETHEX CORPORATION By: ---------------------------------------- Title: ------------------------------------- THER-Rx CORPORATION By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) LASALLE BANK NATIONAL ASSOCIATION, as Administrative Agent, Issuing Lender, Arranger and a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) CITIBANK, F.S.B., as Syndication Agent, Issuing Lender and a Lender By: ---------------------------------------- Title: ------------------------------------- CITIBANK, N.A., as Arranger By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) WACHOVIA BANK, NATIONAL ASSOCIATION, as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) U.S. BANK NATIONAL ASSOCIATION, as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) JP MORGAN CHASE BANK, N.A., as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) NATIONAL CITY BANK OF THE MIDWEST, as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) BANK OF AMERICA, N.A., as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) SUNTRUST BANK, as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) FIFTH THIRD BANK, a Michigan banking corporation, as a Lender By: ---------------------------------------- Title: ------------------------------------- (SIGNATURE PAGE TO CREDIT AGREEMENT (CONTINUED)) UMB BANK, N.A., as a Lender By: ---------------------------------------- Title: ------------------------------------- EX-10.(AA) 5 ex10aa.txt Exhibit 10(aa) [ETHEX logo] EMPLOYMENT AND CONFIDENTIAL INFORMATION AGREEMENT This Agreement ("Agreement") is entered into on JANUARY 30, 2006 between ---------------- PATRICIA McCULLOUGH ("Employee") and ETHEX CORPORATION ("ETHEX"), a wholly - ------------------- owned subsidiary of KV PHARMACEUTICAL COMPANY ("KV"), a Delaware corporation ("Employer"). In consideration of Employee's employment or continued employment by Employer and other valuable consideration, the receipt and sufficiency of which are acknowledged, Employee agrees as follows: 1. AFFILIATES. ETHEX and/or KV have or may in the future have one or more parents, subsidiaries and/or affiliated companies (collectively referred to in the remainder of this Agreement along with ETHEX and KV as the "Companies"). From time to time, Employer and the Companies may exchange or use facilities, technology and/or Confidential Information (as that term is defined in Paragraph 6 below) of the other. The covenants in this Agreement are for the benefit and protection of the Employer and the Companies. 2. NATURE OF EMPLOYMENT. Employee is hereby employed by Employer in the position of CHIEF EXECUTIVE OFFICER. Employee acknowledges and agrees that ----------------------- his/her job title and/or responsibilities may change from time to time. Employee further agrees that, at all times, (s)he shall devote his/her full time and best efforts to performing all duties reasonably assigned by Employer. 3. COMPENSATION. As compensation for Employee's services to Employer, Employee will receive a base salary at the rate of TWO HUNDRED EIGHTY FIVE ----------------------- THOUSAND dollars per year ($285,000.00), payable at such intervals as - -------- ---------- Employer pays its other employees at comparable employment levels. Employee will be entitled to participate in the fringe benefits normally provided to other employees at comparable employment levels. Employee's compensation will be subject to Employer's normal compensation review. 4. TERM. The initial term of this Agreement shall begin on JANUARY 30, 2006, ---------------- and continue until APRIL 1, 2007, unless terminated sooner in accordance ------------- with this Agreement. If not terminated sooner, this Agreement will automatically renew for successive one (1) year periods unless and until either party terminates this Agreement. Termination of this Agreement by either party, for any reason, will in no manner affect the covenants contained in Sections 6-11 of this Agreement. 5. TERMINATION. A. Employee may terminate this Agreement, for any reason, with ONE --- HUNDRED TWENTY (120) calendar days advance written notice. Employer may elect - -------------------- to have the Employee cease work at any time during the notice period for any reason, including without limitation, the reasons set forth in Paragraph 5C below. In such event, Employer's obligation to provide Employee with compensation and benefits will end when Employee ceases to work. Employer's exercise of this option will not be construed as a termination by Employer. B. Employer may terminate this Agreement for any reason by giving the Employee ONE HUNDRED TWENTY (120) calendar days advance written notice. ------------------------ Employer may, in its sole discretion, either permit Employee to work during the notice period, or pay Employee in lieu of having Employee continue to work. If Employer exercises this right and option, it shall pay Employee, on Employer's regularly scheduled paydays and in accordance with Employer's regular pay practices, either: (A) Employee's regular weekly compensation for the notice period or (B) one-half (1/2) of Employee's regular weekly compensation for a period of twice the notice period. Employer reserves the right to cease the payment(s) described above if, in Employer's reasonable determination, Employee breaches this Agreement during the period of such payments. If Employer elects to pay Employee in lieu of Employee continuing to work, Employer will pay Employee's regular wages for the notice period, less whatever compensation Employee receives from other full-time employment during the notice period. Notwithstanding the foregoing, Employer may terminate this Agreement without prior written notice to Employee or any continuing compensation obligations if, in Employer's reasonable determination, Employee has breached this Agreement or Employee has engaged in dishonesty, disloyalty, failure to perform his/her duties to Employer or any act which may be harmful to the reputation of Employer and/or the Companies. C. Employee agrees to faithfully, diligently, and to the best of her/his ability, experience and talents, perform all of the duties required prior to notice if Employee continues to work during the notice period. In all situations, Employee will comply with the terms of this Agreement and will engage in honest, faithful and loyal conduct during the notice period. 6. CONFIDENTIAL INFORMATION. In the course of performing his/her responsibilities, as well as through training pertaining to the business of the Companies, Emp1oyee has or may come into possession of technical, financial, sales and/or other business information pertaining to Employer and/or the Companies which is not published or readily available to the public, and from which the Employer and/or the Companies may derive economic value, actual or potential, including, but not limited to, trade secrets, techniques, designs, formulae, methods, processes, devices, machinery, equipment, inventions, research and development projects, programs, plans and data, clinical projects and data, plans for future developments, marketing concepts and plans, pricing information, licensing agreements, and lists of or other information pertaining to and/or received from Employer, employees of the Companies, customers and/or suppliers (collectively referred to as "Confidential Information"). Employee acknowledges that the Confidential Information is important to and greatly affects the success of the Employer and the Companies in a competitive marketplace. Employee further agrees that while employed by Employer or any of the Companies, and at all times thereafter, regardless of how, when and why that employment ends, Employee will hold in the strictest confidence, and will not directly or indirectly disclose, duplicate and/or use for himself/herself or any other person or entity any Confidential Information without the prior written consent of an officer of Employer, or unless required to do so in order to perform his/her responsibilities while employed by Employer. 7. PUBLICATION. It is expressly agreed between Employee and the Companies that Employee will hold in confidence and not make use of any Confidential Information at any time except as required in the course and performance of the Employee's employment with Employer or as otherwise agreed to in writing by the Corporate Communications Officer of Employer. Employee agrees not to publish or cause or permit to be published or otherwise disclose any article, oral presentation or material related to Employer and/or the Companies, including without limitation the Employer's and/or the Companies' Confidential Information and information related to any products or proposed products, without obtaining the prior written consent of the Corporate Communications Officer. 8. NO OTHER CONTRACT. Except as listed below, Employee warrants that (s)he is not bound by the terms of any other agreement, oral or written, which would limit or preclude him/her from disclosing to Employer and/or the Companies any idea, invention, discovery or other information pertaining or related to Employee's responsibilities. Employee agrees to promptly provide Employer with a copy of any and all agreements listed below, and other agreements which may prohibit or restrict his/her employment with Employer. Employee further agrees not to disclose to Employer or the Companies, or to seek to induce Employer or the Companies to use any confidential information, material or trade secrets belonging to any other person or entity._____________________________________________________________________ ____________________________________________________________________________ ____________________________________________________________________________ 9. RIGHT TO WORK PRODUCT. Any and all designs, inventions, discoveries, improvements, specifications, technical data, reports, business plans and other embodiments of Employee's work conceived, made, discovered and/or produced by Employee during the period of his/her employment by Employer, either solely or jointly with others and in the course of performing his/her duties for Employer, which are based, in whole or part, upon Confidential Information, the resources, supplies, facilities or business, technical or financial information of Employer and/or the Companies, or which relate to the business, the research or the anticipated research and development of Employer and/or the Companies (collectively referred to herein as "Work Product"), will be the sole property of Employer and available to Employer at all times. Employee agrees to promptly disclose and assign and hereby assigns to Employer, without royalty or other additional consideration, any and all of Employee's proprietary rights to any and all Work Product. Employee further agrees that during his/her employment by Employer and after that employment ends, regardless of how, when and why, (s)he will, upon Employer's request: (A) execute any and all applications for copyright and/or patent of Work Product which may be prepared for his/her signature, (B) assign to Employer and/or the Companies any and all such applications, copyrights and patents relating to Work Product, and (C) assist Employer and/or the Companies, as Employer and/or the Companies deem necessary, in its application, defense and enforcement of any copyright or patent relating to Work Product. Employer will pay all expenses of preparing, filing, prosecuting and defending any such application and of obtaining such copyrights and patents. In the event Employer does not employ Employee at the time any request for such assistance is made by Employer, Employer will pay Employee a reasonable amount for Employee's time and will schedule any needed assistance so as not to interfere with Employee's then current employment and obligations. 10. RETURN OF PROPERTY. Upon the termination of Employee's employment with Employer, regardless of how, when and why that employment ends, Employee will immediately deliver to Employer all property of Employer and all property of the Companies, including, without limitation, all Company equipment, records, documents, and computer disks (including all copies). If Employee fails to return to Employer all property of Employer and the Companies, Employee authorizes Employer to deduct from his/her final paycheck such amount to cover the loss, to the extent permitted by applicable law. Nothing contained herein shall limit Employer's right to recover the full value of such property from Employee in any proceeding. 11. RESTRICTIVE COVENANTS. A. The parties agree that at the time this Agreement was entered, the business of Employer was the marketing and sale of generic and/or lower-cost prescription pharmaceutical products that compete with branded products (hereafter "the business of Employer"). Employee agrees that during the thirty-six (36) consecutive months immediately following termination of Employee's employment with Employer, regardless of how, when or why that employment ends, Employee will not in any manner or in any capacity, directly or indirectly, for himself/herself or any other person or entity, actually or attempt to do any of the following: 1. Perform any of the same or similar responsibilities as Employee performed for Employer on behalf of a competitor that engages in the business of Employer. 2. Solicit, contact, divert, interfere with or take away any customer of Employer and/or the Companies that has conducted business or negotiations with Employer or the Companies during the twenty-four (24) months immediately preceding termination of employment. 3. Interfere with any of the suppliers of Employer and/or the Companies, including, without limitation, reducing in any material way the willingness or capability of any supplier to continue supplying Employer and/or the Companies with their present or contemplated requirements. 4. Solicit or interfere with the Employer's and/or the Companies' relationship with any of their employees or agents, or provide the names of any of Employer's and/or the Companies' employees or agents, to any third party. 5. Acquire any interest in any business that markets or sells any product or product line that is competitive with any product or product line Employer sold during the twenty-four (24) months immediately preceding termination of employment, except as permitted in Section 12 below. B. Employee further agrees that (s)he will not engage in any of the activities listed above while employed by Employer. C. Employee acknowledges and agrees that his/her experience, knowledge and capabilities are such that (s)he can obtain employment in unrelated pharmaceutical, chemical, nutritional, food, industrial, household, confectionery or other businesses, and that the enforcement of this paragraph 11 by way of injunction would not prevent Employee from earning a livelihood. Employee further agrees that if (s)he has any question(s) regarding the scope of activities restricted by this Section 11, (s)he will, to avoid confusion or misunderstanding, submit the question(s) in writing to the Director, Human Resources of the Employer for a written response. Employee additionally agrees to promptly inform and keep the Employer advised of the identity of his/her employer (including any unit or division to which Employee is assigned), his/her work location, and his/her title and work responsibilities during the period covered by this Section 11. D. Employee agrees to fully disclose the terms of this Agreement to any person or entity by which or with whom (s)he may hereafter become employed or to which (s)he may hereafter render services, and agrees that Employer may, if desired, send a copy of this Agreement, or otherwise make the provisions hereof known, to any such entity. E. In the event of a breach by Employee of any of the terms of Section 11, the period of time the obligations hereunder apply will be automatically extended for a period of time equal to the length of time Employee is in breach. 12. INVESTMENT SECURITIES. Nothing in this Agreement will limit the right of Employee, as an investor, to hold or acquire the stock or other investment securities of any business entity that is registered on a national securities exchange or regularly traded on a generally recognized over-the-counter market, so long as Employee's interest in any such business entity does not exceed five percent (5%) of its ownership. 13. MATERIAL BREACH. Any breach of this Agreement by the Employee will be a material breach. 14. EMPLOYEE CONSENT. In order to preserve their rights under this Agreement, Employer and/or the Companies may advise any third party with whom Employee may consider, establish or contract an employment, consulting or service relationship of the existence of this Agreement and of its terms. Employee agrees that Employer and the Companies will have no liability for so acting. 15. CONTROLLING LAW. This Agreement will be governed and construed in accordance with the laws of the State of Missouri and the rights and duties of the parties pursuant to this Agreement or by operation of law by reason of any matter relating to this Agreement, will be governed by the laws of the State of Missouri, without regard to conflicts of laws principles. The parties agree that any controversy arising with respect to this agreement will fall under the exclusive jurisdiction of the Circuit Court of the County of St. Louis, Missouri, and each party hereby consents to the jurisdiction and venue of that court. 16. REMEDIES. Employee agrees that the promises in this Agreement are reasonable and necessary to protect the legitimate business interests of Employer and the Companies, and that any violation by Employee of any of the promises in this Agreement would result in great damage and irreparable injury to Employer and/or the Companies. Employee further agrees that if Employee were to violate the covenants in Section 11 of this Agreement, the unauthorized disclosure of Confidential Information would be inevitable and result in great damage and irreparable harm. Employee agrees that in the event of a breach of this Agreement, the Employer and/or the Companies have the right to seek any and all legal and/or equitable remedies available for any breach of this Agreement, including, but not limited to, enforcement by injunction including ex parte temporary restraining order relief, in view of such irreparable harm. Employee agrees that enforcement by way of Injunction would not prevent Employee from making a living as described in Paragraph 11C. Employer is entitled to its attorneys' fees, costs, and any related expenses incurred in the enforcement of this Agreement in the event of any breach by Employee. 17. SEVERABILITY. In the event any provision in this Agreement is deemed unenforceable, in whole or in part, it will not invalidate either the balance of the provisions or the remaining provisions of this Agreement. In addition, the parties have attempted to limit Employee's right to compete only to the extent necessary to protect Employer from unfair competition. Consequently, the parties further agree that if any restrictive covenant in this Agreement is deemed unenforceable, in whole or in part, because overly broad in geographic scope, activity or time duration, that provision shall be automatically modified so as to be enforceable to the maximum extent reasonable. 18. ASSIGNMENT. This Agreement is not assignable by Employee, and will be binding upon Employee and Employee's heirs, executors and legal and/or personal representatives. This Agreement is assignable by Employer, and will inure to the benefit of Employer, its successors and assigns. If Employee subsequently accepts employment with one of the Companies, this Agreement will be automatically assigned to the employing Company without additional covenant or notice to Employee. In the event of this or any other assignment, sale, merger, or other change in the ownership or structure of Employer, the resulting entity will step into the place of the Employer under this Agreement without additional covenant or notice to Employee. If the Agreement is assigned, the term "Employer" will mean the then-employing Company and the term "Companies" will mean the then-employing Company's parents, subsidiaries and affiliates. 19. NONWAIVER. Failure of Employer and/or the Companies to exercise any of its/their rights in the event Employee breaches any of the promises in this Agreement shall not be construed as a waiver of such a breach or prevent Employer and/or the Companies from later enforcing strict compliance with the promises in this Agreement. 20. MODIFICATION. This Agreement contains the parties' complete agreement, and supersedes any other agreement, oral or written, pertaining to the subject matter of this Agreement. This Agreement may be altered, amended or revoked at any time only by a writing signed by both parties. 21. ACKNOWLEDGMENT. Employee agrees that (s)he fully understands his/her right to discuss all aspects of this Agreement with the legal or personal advisors of his/her choice, and warrants that, to the extent (s)he desired, (s)he has done so, (s)he has carefully read and fully understands all of the provisions of this Agreement, and (s)he has voluntarily entered into this Agreement. IN WITNESS WHEREOF, Employee and Employer have executed this Agreement on the day and year first written above. EMPLOYEE EMPLOYER /s/ Patricia K. McCullough By /s/ Gerald R. Mitchell - ---------------------------------- --------------------------------------- Title ----------------------------------- EX-10.(BB) 6 ex10bb.txt Exhibit 10(bb) [KV logo] K-V PHARMACEUTICAL COMPANY EMPLOYMENT AND CONFIDENTIAL INFORMATION AGREEMENT This Agreement ("Agreement") is entered into on May 23, 1994, between ------ -- Michael S. Anderson ("Employee") and K-V PHARMACEUTICAL COMPANY, a Delaware - ------------------- corporation ("KV"). In consideration of Employee's employment or continued employment by KV and other valuable consideration, the receipt and sufficiency of which are acknowledged, Employee agrees as follows: 1. AFFILIATES. KV has or may in the future have one or more subsidiaries and/or affiliated companies (collectively referred to in the remainder of this Agreement as the "Companies"). From time to time, KV and the Companies may exchange or use facilities, technology and/or Confidential Information (as that term is defined below) of the other. The covenants in this Agreement are for the benefit and protection of KV and the Companies. 2. NATURE OF EMPLOYMENT. Employee is hereby employed by KV in the position of President. ETHEX. Employee acknowledges and agrees that his/her --------- ------ job title and/or responsibilities may change from time to time. Employee further agrees that, at all times, (s)he shall devote his/her full time and best efforts to performing all duties reasonably assigned by KV. 3. COMPENSATION. As compensation for Employee's services to KV, Employee shall receive a base salary at the rate of One Hundred Seventy ------------------- Thousand Dollars ($170,000.00**) per year, payable at such intervals as - ---------------- ---------- KV pays its other employees. In addition, Employee shall be entitled to participate in the fringe benefits normally provided to other KV employees at comparable employment levels. Employee's compensation shall be subject to KV's normal compensation review. 4. TERM. The initial term of this Agreement shall begin on May 23, 1994, ------ -- and continue until March 31, 1995, unless terminated sooner in -------- -- accordance with paragraph 5 of this Agreement. If not terminated sooner under paragraph 5 hereof, this Agreement shall automatically renew for successive one (1) year periods unless and until either party terminates this Agreement pursuant to the provisions of paragraph 5. Termination of this Agreement by either party, for any reason, shall in no manner affect the covenants contained in paragraphs 6-11 of this Agreement. 5. TERMINATION. Either party may terminate this Agreement, for any reason, by giving the other party thirty (30) calendar day's advance written notice. KV may, at its sole discretion, elect to pay Employee in lieu of having Employee continue to work during the notice period. If KV exercises this right and option, it shall pay Employee, on KV's regularly scheduled paydays and in accordance with KV's regular pay practices, either: (A) Employee's regular wages for a period of thirty (30) calendar days or (B) one-half (1/2) of Employee's regular wages for a period of sixty (60) calendar days. KV reserves the right to cease the payment(s) described above if, in KV's reasonable determination, Employee breaches this Agreement during the period of such payments. Notwithstanding the foregoing, KV may terminate this Agreement without prior written notice to Employee or any continuing compensation obligations if, in KV's reasonable determination, Employee has breached this Agreement or Employee's continued employment is detrimental to KV's best interests. By way of example, but not limitation, Employee's continued employment will be deemed detrimental to KV's best interests if Employee has engaged in dishonesty, disloyalty, failure to perform his/her duties to KV or any act which may be harmful to the reputation of KV and/or the Companies. 6. CONFIDENTIAL INFORMATION. In the course of performing his/her responsibilities as an employee of KV, Employee has or may come into possession of technical, financial or business information pertaining to KV and/or the Companies which is not published or readily available to the public, including, but not limited to, trade secrets, techniques, designs, formulae, methods, processes, devices, machinery, equipment, inventions, research and development projects, programs, plans and data, clinical projects and data, plans for future developments, marketing concepts and plans, pricing information, licensing agreements, and lists of or other information pertaining to and/or received from employees, customers and/or suppliers ("Confidential Information"). Employee acknowledges that the Confidential Information is important to and greatly affects the success of KV and the Companies in a competitive, worldwide marketplace. Employee further agrees that while employed by KV and at all times thereafter, regardless of how, when and why that employment ends, Employee shall hold in the strictest confidence, and shall not disclose, duplicate and/or use for himself/herself or any other person or entity any Confidential Information without: (A) the prior written consent of an officer of KV, or (B) unless required to do so in order to perform his/her responsibilities while employed by KV. 7. PUBLICATION. Employee agrees not to publish or cause or permit to be published any article, oral presentation or material related to KV and/or the Companies, including any information related to any products or proposed products, without obtaining the prior written consent of an officer of KV. 8. NO OTHER CONTRACT. Except as listed below, Employee warrants that (s)he is not bound by the terms of any other agreement, oral or written, which would limit or preclude him/her from disclosing to KV and/or the Companies any idea, invention, discovery or other information pertaining or related to Employee's responsibilities as an employee of KV. Employee agrees to promptly provide KV with a copy of any and all agreements listed below. Employee further agrees not to disclose to KV or the Companies, or to seek to induce KV or the Companies to use any confidential information, material or trade secrets belonging to any other person or entity.__________ ___________________________________________________________________________ ___________________________________________________________________________. 9. RIGHT TO WORK PRODUCT. Any and all designs, inventions, discoveries, improvements, specifications, technical data, reports, business plans and other embodiments of Employee's work conceived, made, discovered and/or produced by Employee during the period of his/her employment by KV, either solely or jointly with others: (A) in the course of performing his/her duties for KV, (B) which are based, in whole or part, upon Confidential Information, the resources, supplies, facilities or business, technical or financial information of KV and/or the Companies, or (C) which relate to the business or the anticipated research and development of KV, the Companies or both ("Work Product"), shall be the sole property of KV and available to KV at all times. Employee agrees to promptly disclose and assign and hereby assigns to KV, without royalty or other additional consideration, any and all of Employee's proprietary rights to any and all Work Product. Employee further agrees that during his/her employment by KV and after that employment ends, regardless of how, when and why, (s)he shall, upon KV's request: (A) execute any and all applications for copyright and/or patent of Work Product which may be prepared for his/her signature, (B) assign to KV any and all such applications, copyrights and patents relating thereto, and (C) assist KV, as KV deems necessary, in order for KV to apply for, defend or enforce any copyright or patent. KV shall pay all expenses of preparing, filing and prosecuting any such application and of obtaining such copyrights and patents. In the event Employee is not employed by KV at the time any request for assistance is made by KV, KV shall pay Employee a reasonable payment for Employee's time and shall schedule any needed assistance so as to not to interfere with Employee's then current employment and obligations. 10. RETURN OF PROPERTY. Upon the termination of Employee's employment with KV, regardless of how, when and why that employment ends, Employee shall immediately deliver to KV all property of KV and all property of the Companies, including, but not limited to, all records and documents (including all copies) containing or relating to Confidential Information. 11. RESTRICTIVE COVENANTS. The parties acknowledge and agree that at the time this Agreement was entered, the business of KV and the Companies included, but was not limited to, the contract or private label manufacture for other marketers or distributors of pharmaceutical preparations or specialty chemicals, and the research, development, manufacture, sale and distribution of drug delivery products and technology. Employee agrees that during the thirty-six (36) consecutive months immediately following termination of Employee's employment with KV, regardless of how, when or why that employment ends, Employee shall not in any manner or in any capacity, directly or indirectly, for himself/herself or any other person or entity, actually or attempt: (A) to perform any of the same or similar responsibilities as Employee performed for KV under this Agreement, on behalf of or for any business that engages in the same or similar business as: (i) KV anywhere KV has conducted business, or (ii) the Companies anywhere the Companies have conducted business during the twenty-four (24) months immediately preceding termination of employment; or (B) to interfere with or take away: (i) any customer of KV that has conducted business with KV, or (ii) any customer of the Companies that has conducted business with the Companies during the twenty-four (24) months immediately preceding termination of employment; or (C) to interfere with any of the suppliers of KV and/or the Companies, including, without limitation, reducing in any material way the willingness or capability of any supplier to continue supplying KV with its and/or the Companies with their present or contemplated requirements; or (D) to solicit or interfere with the relationship between KV and any of its employees or agents, and/or the Companies and any of their employees or agents; or (E) to acquire any interest in any business that engages in the same or similar business as: (i) KV anywhere KV has conducted business, or (ii) the Companies anywhere the Companies have conducted business during the twenty-four (24) months immediately preceding termination of employment. Employee further agrees that (s)he shall not engage in any of the activities listed above while (s)he is employed by KV. Employee acknowledges and agrees that his/her experience, knowledge and capabilities are such that (s)he can obtain employment in unrelated pharmaceutical, chemical, food, industrial, household, confectionery or other businesses, and that the enforcement of this paragraph 11 by way of injunction would not prevent Employee from earning a livelihood. Employee further agrees that if (s)he has any question(s) regarding the scope of activities restricted by this paragraph 11, (s)he shall, to avoid confusion or misunderstanding, submit the question(s) in writing to an officer of KV for a written response by KV. Employee additionally agrees to keep KV advised of the identity of his/her employer and his/her work location during the period covered by this paragraph 11. 12. INVESTMENT SECURITIES. Anything to the contrary notwithstanding, nothing in this Agreement shall limit the right of Employee as an investor to hold or to acquire the stock or other investment securities of any business entity that is registered on a national securities exchange or regularly traded on a generally recognized over-the-counter market, so long as Employee's interest of any such business entity does not exceed five percent (5%) of the ownership of that business entity. 13. MATERIAL BREACH. Any breach of this Agreement shall be a material breach of this Agreement. 14. EMPLOYEE CONSENT. In order to preserve the rights under this Agreement of KV and the Companies, KV and/or the Companies may advise any third party with whom Employee may consider, establish or contract a relationship of the existence of this Agreement and of its terms. KV and the Companies shall have no liability for so acting. 15. CONTROLLING LAW. This Agreement shall be construed in accordance with the laws of the State of Missouri. The parties agree that any controversy arising with respect to this Agreement shall fall under the exclusive jurisdiction of the Circuit Court of the County of St. Louis, Missouri, and each party hereby consents to the jurisdiction of that court. 16. REMEDIES. Employee agrees that the promises in this Agreement are reasonable and necessary to protect the legitimate business interests of KV and the Companies, that any violation by Employee of any of the promises in this Agreement would result in great damage and irreparable injury to KV and/or the Companies, and that KV and/or the Companies have the right to any and all legal and/or equitable remedies available for breach of this Agreement. Employee further agrees that enforcement by KV and/or the Companies of the promises contained in this Agreement by way of injunction would not prevent Employee from making a living. 17. SEVERABILITY. In the event any whole or partial provision in this Agreement is deemed unenforceable, it shall not invalidate the remaining whole or partial provisions of this Agreement. In addition, the parties have attempted to limit Employee's right to compete only to the extent necessary to protect KV from unfair competition. Consequently, the parties further agree that if any whole or partial restrictive covenant in this Agreement is deemed unenforceable because overly broad in geographic scope, activity or time duration, that provision shall be automatically modified so as to be enforceable to the maximum extent reasonable. 18. ASSIGNMENT. This Agreement is not assignable by Employee, and shall be binding upon Employee and Employee's heirs, executors and legal and/or personal representatives. This Agreement is assignable by KV, and shall inure to the benefit of KV, its successors and assigns. 19. NONWAIVER. Failure of KV and/or the Companies to exercise any of its/their rights in the event Employee breaches any of the promises in this Agreement shall not be construed as a waiver of such a breach or prevent KV and/or the Companies from later enforcing strict compliance with the promises in this Agreement. 20. MODIFICATION. This Agreement contains the parties' complete agreement, and supersedes any other agreement, oral or written, pertaining to the subject matter of this Agreement. This Agreement may be altered, amended or revoked at any time only by a writing signed by both parties. 21. ACKNOWLEDGMENT. Employee agrees that: (A) (s)he fully understands his/her right to discuss all aspects of this Agreement with legal or personal advisors of his/her choice, (B) to the extent (s)he desired, (s)he has done so, (C) (s)he has carefully read and fully understands all of the provisions of this Agreement, and (D) (s)he has voluntarily entered into this Agreement. IN WITNESS WHEREOF, Employee and KV have executed this Agreement on the day and year first written above. EMPLOYEE COMPANY /s/ Michael S. Anderson By /s/ Gerald R. Mitchell - ---------------------------------- --------------------------------------- Title VP - Finance ------------------------------------ KV Pharmaceutical Company KV PHARMACEUTICAL COMPANY AMENDMENT TO EMPLOYMENT AGREEMENT THIS AMENDMENT ("Amendment") is entered into effective February 16, ----------- 2000, between MICHAEL S. ANDERSON ("Employee") and KV PHARMACEUTICAL COMPANY, a Delaware corporation ("KV"). WHEREAS KV and Employee have entered into that certain KV Pharmaceutical Company Employment and Confidential Information Agreement dated May 23, 1994 (the "Employment Agreement") and a subsequent amendment dated May 5, 1997; WHEREAS KV and Employee desire to make certain changes and additions to Employment Agreement and to modify and supercede the Amendment dated May 5, 1997 as provided herein; NOW THEREFORE, in consideration of Employee's employment or continued employment by KV and other valuable consideration, the receipt and sufficiency of which are acknowledged, KV and Employee agrees as follows: 1. Paragraph 2 of the Employment Agreement regarding "Nature of Employment" is hereby amended to specify the position of President and Chief Executive Officer of Ther-Rx Corporation. 2. Paragraph 3 of the Employment Agreement regarding "Compensation" is hereby amended to specify a base salary of Two Hundred Sixty Five Thousand Dollars ($265,000) effective February 16, 2000. 3. Paragraph 4 of the Employment Agreement regarding "Term" is hereby amended in its entirety to read as follows: 4. TERM. This Agreement shall be effective as of the date first set forth above and continue until March 31, 2006, unless terminated sooner in accordance with Paragraph 5 of this Agreement. If not terminated sooner under Paragraph 5 hereof, this Agreement shall automatically renew for successive twelve (12) month periods unless and until either party terminates this Agreement pursuant to the provisions of Paragraph 5. Termination of this Agreement by either party, for any reason, shall in no matter affect the covenants contained in Paragraphs 6-11 of this Agreement. 4. Paragraph 5 of the Employment Agreement regarding "Termination" is hereby amended in its entirety to read as follows: 1 of 7 5. TERMINATION. (A) VOLUNTARY. Employee may terminate this Agreement at the end of the initial term or, after completion of the initial term, at the end of each successive term, for any reason, by notifying KV in writing three (3) calendar months' prior to the end of the term. Such advance written notice shall be directed to KV's Vice President, Human Resources. In the event of such voluntary termination, Employee agrees to remain on the job for the balance of the term and for three (3) additional months after the end of the term and at all times faithfully, industriously and to the best of his ability, experience and talents, perform all of the duties that have been required of him prior to Employee's notice of termination, all to the reasonable satisfaction of KV. Employee agrees that he will remain actively at work, as described above and will continue to be compensated at his normal rate, during the entire six (6) month notice period unless he is released from all responsibilities prior to the end of the notice period by the Board of Directors or the Chief Executive Officer of KV, in which case, his compensation shall be discontinued. Because of the nature of the position and the business, Employee agrees that if he should fail to fully comply with the notice required by this subsection, and if he should fail to fully comply with the requirement to remain on the job and faithfully and to the best of his ability perform all of his duties, KV will incur damages as a direct result and that the amount of said damages will be difficult to ascertain. Accordingly, specific performance will be required unless KV releases Employee from these obligations. If Employee decided to terminate his employment with KV, Employee shall disclose Employee's decision to terminate to the Vice President, Human Resources of KV and shall not disclose such information to any other party (except for a subsequent employer of Employee which has agreed to keep such information confidential until KV has announced Employee's termination) until such time as the Vice President, Human Resources of KV determines how and when to announce Employee's termination. (B) INVOLUNTARY. In the event of involuntary termination by KV, except termination for cause, KV shall provide Employee with severance pay of no less than one-half of the Employee's annual base salary, then in effect under Paragraph 3 of this Agreement, less usual withholdings. This severance package shall be paid in twelve (12) equal monthly installments, each payment to be made on the last day of each of the twelve (12) calendar months following the last day worked. In addition, KV shall provide Employee, at KV's expense, with medical, disability and life insurance coverage and all other insurance coverage of the same or similar types, and in the same or similar amounts as KV is providing to Employee immediately prior to the last day worked. This continuation of insurance coverage shall cease the earlier of twelve (12) months after the last date worked or at such time as Employee obtains other full-time, non-temporary employment which provides comparable coverage. In addition, as of the last date worked, unless Employee is involuntarily terminated for cause, all stock options shall become immediately exercisable and shall remain exercisable until the earlier of six (6) months following the last date worked or at such time as Employee obtains other full-time, non-temporary employment. 2 of 7 In consideration of the severance pay provided under this paragraph, in the event of the cancellation, termination or expiration of the Employment Agreement for any reason, Employee agrees to provide reasonable and necessary services to assist KV in transition of responsibilities and ongoing continuity of his job function unless KV does not request such services. KV may terminate this Agreement for cause and in such event Employee shall not be entitled to any severance pay. The term "for cause" as used herein shall mean (i) commission of a dishonest or criminal act in respect of Employee's employment or conviction of a felony, or (ii) breach of trust or gross negligence, or (iii) willful refusal to perform duties imposed by this Agreement which are legal and not improper, or (iv) Employee's violation of Paragraph 6, 8, 9 or 10 of this Agreement, or (v) the continuing neglect or failure of Employee to perform the duties reasonably assigned to Employee by KV and after notice from KV of such neglect or failure, Employee's failure to cure such neglect or failure. Any termination of this agreement by KV shall be effective only upon providing Employee with written notice and advising Employee as to whether his termination is for cause. Employee acknowledges that the duties and obligations of Paragraphs 7, 9, 10, 11 and 12 shall survive the termination of his employment. 6. The following new Sections 22 and 23 are hereby added to the end of the Employment Agreement: 22. CHANGE OF CONTROL (A) DEFINITION. For purposes of this Agreement, a "Change of Control" of KV shall mean the occurrence of any one of the following events: (i) any "person," as such term is used in Section 13(d) of the Securities Exchange Act of 1934, becomes a "beneficial owner," as such term is used in Rule 13d-3 promulgated under that Act, of twenty percent (20%) or more of the voting stock of KV; (ii) the majority of the Board consists of individuals other than Incumbent Directors, which term means the members of the Board on the date of this Agreement; provided that any person becoming a director subsequent to such date whose election or nomination for election was supported by two-thirds (2/3) of the directors who then comprised the Incumbent Directors shall be considered to be an Incumbent Director; (iii) KV adopts any plan of liquidation providing for the distribution of all or substantially all of its assets; 3 of 7 (iv) all or substantially all of the assets or business of KV is disposed of pursuant to a merger, consolidation or other transaction (unless the shareholders of KV immediately prior to such merger, consolidation or other transaction beneficially own, directly or indirectly, in substantially the same proportion as they owned the voting stock of the company, all of the voting stock or other ownership interests of the entity or entities, if any, that succeed to the business of KV); or (v) KV combines with another company and is the surviving corporation but, immediately after the combination, the shareholders of KV, immediately prior to the combination hold, direct or indirectly, fifty percent (50%) or less of the voting stock of the combined company (there being excluded from the number of shares held by such shareholders, but not from the voting stock of the combined company, any shares received by affiliates of such other company in exchange for stock of such other company). (B) TERMINATION AFTER CHANGE IN CONTROL. In the event of a Change of Control of KV, if (i) immediately preceding such Change of Control, Employee was providing services under Paragraph 2 or 5, and (ii) Employee's employment in such capacity terminates within a two-year period following such Change of Control ("Termination"), involuntarily, with or without cause, for any reason whatsoever, except for the death or disability of Employee, Employee shall be entitled to the benefits provided in Paragraph 22(C). For purposes of this Paragraph 22, "Date of Termination" shall mean the date on which a Notice of Termination is given, unless the parties agree to another date, and "Notice of Termination" shall mean a written notice communicated by either party to the other party which indicates that Employee's employment with KV is being terminated. (C) PAYMENTS ON TERMINATION AFTER CHANGE IN CONTROL. (i) Employee's annual base salary through the Date of Termination at the rate in effect on the date Notice of Termination is given, including vacation pay, allowances and other compensation and benefits, and (ii) the amount, if any, of any bonus for the past fiscal year (and pro rata for any portion of the then current fiscal year through the Date of Termination) which has not been awarded or paid under any bonus plans in which Employee is entitled to participate at the time of the Change of Control or under other bonus plans at least as beneficial to Employee. In addition, KV shall continue in full force and effect for the benefit of Employee through the Date of Termination all stock ownership, purchase or option plans, employee benefit or compensation plans, and insurance or disability plans in effect immediately preceding the Change of Control or plans substantially similar thereto. 4 of 7 (ii) In lieu of any further payments or benefits to be paid or otherwise provided under Paragraph 5 (excluding any stock option or restricted stock grants, and any deferred compensation benefits for any period subsequent to the Date of Termination), KV shall pay as severance pay ("Severance Pay") to Employee a lump sum payment equal to the sum of: (a) one and one-half (1 1/2) times the greater of: (x) Employee's base salary immediately prior to the Date of Termination, or (y) Employee's base salary in effect immediately prior to the date on which the Change of Control occurred, and (b) Employee's bonus, which would be payable in respect of the eighteen (18) month period beginning on the Date of Termination as if Employee had continued his position assuming an annual bonus equal to the average of the three (3) complete bonus years immediately preceding the Date of Termination. Such Severance Pay shall be subject to all applicable federal and state income taxes. The portion of the Severance Pay based upon Employee's base salary shall be paid on or before the fifth (5th) day following the Date of Termination, and the portion of the Severance Pay based upon any bonus plan shall be paid to Employee as and when payable under the terms of the applicable plan had Employee's employment continued. Employee, by written notice to KV at any time prior to a Change of Control of KV or the Date of Termination, may elect, in his sole discretion, to receive said Severance Pay interest-free at a future time, but in no event any later than eighteen (18) months after the Date of Termination. (iii) To the extent not otherwise provided for under the terms of any of KV's stock option agreements, all stock options granted by KV or any predecessor of KV to Employee shall vest and be exercisable or transferable as of the Date of Termination, and shall remain fully exercisable for ninety (90) days following the Date of Termination. (iv) With respect to welfare benefits (health, life, dental, AD&D), KV shall maintain in full force and effect, for the continued benefit of Employee and members of Employee's family, for a period of twenty four (24) months after the Date of Termination; all employee benefit plans and programs, which KV otherwise provides for its employees. (D) APPLICATION OF SECTION 280G AND SECTION 4999. If it shall be determined that any payment or distribution by KV to or for the benefit of Employee (whether paid or payable or distributable pursuant to the terms of this Paragraph 22), would be considered tO be a parachute payment as defined in Section 280G of the Internal Revenue Code such that it would be subject to the payment by Employee of the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, or any interest and penalties is alleged to be due from Employee with respect to such excise tax (such excise tax, together with any interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then Employee's Severance Pay shall be limited, as determined by Employer in its discretion, so as to avoid any Excise Tax. 5 of 7 (23) NOTICE. Any notice given by either party hereunder shall be in writing and shall be personally delivered or shall be mailed, Express, certified or registered mail, or sent by a generally recognized next business day courier, postage or other charges prepaid, as follows: To KV: KV Pharmaceutical Company 2503 South Hanley Road St. Louis, Missouri 63144 Attention: Vice President, Human Resources To Employee: At his address as set forth on the payroll records of KV, or to such other address as may have been furnished to the other party by written notice. Notice shall be deemed given on the date personally delivered, or if sent by Express Mail or next business day courier on the business day following the date sent, or if otherwise mailed, two (2) calendar days after the date postmarked. 6 of 7 IN WITNESS WHEREOF, Employee and KV have executed this Amendment on the day and year first written above. "EMPLOYEE" /s/ Michael S. Anderson ----------------------------------------- MICHAEL S. ANDERSON "KV" KV PHARMACEUTICAL COMPANY By: /s/ Marc S. Hermelin -------------------------------------- MARC S. HERMELIN CHIEF EXECUTIVE OFFICER Witness: /s/ Sarah Weltscheff ---------------------------- Date: February 16, 2000 ---------------------------- 7 of 7 KV PHARMACEUTICAL COMPANY AMENDMENT TO EMPLOYMENT AGREEMENT THIS AMENDMENT ("Amendment") is entered into effective February 20, 2006, between MICHAEL S. ANDERSON ("Employee") and KV PHARMACEUTICAL COMPANY, a Delaware corporation ("KV"). WHEREAS KV and Employee have entered into that certain KV Pharmaceutical Company Employment and Confidential Information Agreement dated May 23, 1994 (the "Employment Agreement"), and Amendments dated May 5, 1997 and February 16, 2000; WHEREAS KV and Employee desire to make certain changes and additions to Employment Agreement as provided herein; NOW THEREFORE, in consideration of Employee's employment or continued employment by KV and other valuable consideration, the receipt and sufficiency of which are acknowledged, KV and Employee agrees as follows: 1. Paragraph 2 of the Employment Agreement regarding "Nature of Employment" is hereby amended to specify the position of Corporate Vice President, Industry Presence and Development, KV Pharmaceutical Company. 2. Paragraph 3 of the Employment Agreement regarding "Compensation" is hereby amended to specify a base salary of Three Hundred Thirty Two Thousand Dollars ($332,000) effective February 20, 2006, through March 31, 2007. 3. Paragraph 4 of the Employment Agreement regarding "Term" is hereby amended in its entirety to read as follows: 4. TERM. This Agreement shall be effective as of the date first set forth above and continue until March 31, 2011, unless terminated sooner in accordance with Paragraph 5 of this Agreement. If not terminated sooner under Paragraph 5 hereof, this Agreement shall automatically renew for successive twelve (12) month periods unless and until either party terminates this Agreement pursuant to the provisions of Paragraph 5. Termination of this Agreement by either party, for any reason, shall in no manner affect the covenants contained in Paragraphs 6-11 of this Agreement. 4. Paragraph 5 of the Employment Agreement regarding "Termination" is hereby amended to include the following provision: In the event Employee experiences health problems, as confirmed by a physician mutually agreed upon by KV and Employee, that requires his retirement from a business career, Employee may terminate this Agreement by giving six (6) months notice, unless Employee is disabled and unable to carry out the duties of his position, in which case, Employee may terminate his employment by giving less than six (6) months notice. Page 1 of 2 The paragraphs of the Employment Agreement which have not been amended by this Amendment shall remain in full force and effect. IN WITNESS WHEREOF, Employee and KV have executed this Amendment on the day and year first written above. "EMPLOYEE" /s/ Michael S. Anderson ----------------------------------------- MICHAEL S. ANDERSON "KV" KV PHARMACEUTICAL COMPANY By: /s/ Gerald R. Mitchell -------------------------------------- GERALD R. MITCHELL VP & CFO Witness: /s/ Sarah Weltscheff ---------------------------- Date: March 27, 2006 ---------------------------- Page 2 of 2 EX-10.(CC) 7 ex10cc.txt Exhibit 10(cc) [THER-RX logo] EMPLOYMENT AND CONFIDENTIAL INFORMATION AGREEMENT This Agreement ("Agreement") is entered into on APRIL 8, 2004 between ------------- JERALD J. WENKER ("Employee") and THER-RX CORPORATION ("Ther-Rx"), a wholly - ---------------- owned subsidiary of KV PHARMACEUTICAL COMPANY ("KV"), a Delaware corporation ("Employer"). In consideration of Employee's employment or continued employment by Employer and other valuable consideration, the receipt and sufficiency of which are acknowledged, Employee agrees as follows: 1. AFFILIATES. Ther-Rx and/or KV have or may in the future have one or more parents, subsidiaries and/or affiliated companies (collectively referred to in the remainder of this Agreement along with Ther-Rx and KV as the "Companies"). From time to time, Employer and the Companies may exchange or use facilities, technology and/or Confidential Information (as that term is defined in Paragraph 6 below) of the other. The covenants in this Agreement are for the benefit and protection of the Employer and the Companies. 2. NATURE OF EMPLOYMENT. Employee is hereby employed by Employer in the position of PRESIDENT. Employee acknowledges and agrees that his/her job --------- title and/or responsibilities may change from time to time. Employee further agrees that, at all times, (s)he shall devote his/her full time and best efforts to performing all duties reasonably assigned by Employer. 3. COMPENSATION. As compensation for Employee's services to Employer, Employee will receive a base salary at the rate of THREE HUNDRED FIFTY ------------------- THOUSAND dollars per year ($350,000.00), payable at such intervals as - -------- ---------- Employer pays its other employees at comparable employment levels. Employee will be entitled to participate in the fringe benefits normally provided to other employees at comparable employment levels. Employee's compensation will be subject to Employer's normal compensation review for employees in this job classification. 4. TERM. The initial term of this Agreement shall begin on APRIL 8, 2004, ------------- and continue until MARCH 31, 2005, unless terminated sooner in accordance -------------- with this Agreement. If not terminated sooner, this Agreement will automatically renew for successive one (1) year periods unless and until either party terminates this Agreement. Termination of this Agreement by either party, for any reason, will in no manner affect the covenants contained in Sections 6-11 of this Agreement. 5. TERMINATION. A. Employee may terminate this Agreement, for any reason, with ONE --- HUNDRED TWENTY (120) calendar days advance written notice. Employer may - -------------- --- elect to have the Employee cease work at any time during the notice period for any reason, including without limitation, the reasons set forth in Paragraph 5C below. In such event, Employer's obligation to provide Employee with compensation and benefits will end when Employee ceases to work. Employer's exercise of this option will not be construed as a termination by Employer. B. Employer may terminate this Agreement for any reason by giving the Employee THIRTY (30) calendar days advance written notice. Employer may, in ------ -- its sole discretion, either permit Employee to work during the notice period, or pay Employee in lieu of having Employee continue to work. If Employer exercises this right and option, it shall pay Employee, on Employer's regularly scheduled paydays and in accordance with Employer's regular pay practices, either: (A) Employee's regular weekly compensation for the notice period or (B) one-half (1/2) of Employee's regular weekly compensation for a period of twice the notice period. Employer reserves the right to cease the payment(s) described above if, in Employer's reasonable determination, Employee breaches this Agreement during the period of such payments. If Employer elects to pay Employee in lieu of Employee continuing to work, Employer will pay Employee's regular wages for the notice period, less whatever compensation Employee receives from other full-time employment during the notice period. Notwithstanding the foregoing, Employer may terminate this Agreement without prior written notice to Employee or any continuing compensation obligations if, in Employer's reasonable determination, Employee has breached this Agreement or Employee has engaged in dishonesty, disloyalty, failure to perform his/her duties to Employer or any act which may be harmful to the reputation of Employer and/or the Companies. C. Employee agrees to faithfully, diligently, and to the best of her/his ability, experience and talents, perform all of the duties required prior to notice if Employee continues to work during the notice period. In all situations, Employee will comply with the terms of this Agreement and will engage in honest, faithful and loyal conduct during the notice period. 6. CONFIDENTIAL INFORMATION. In the course of performing his/her responsibilities, as well as through training pertaining to the business of the Companies, Employee has or may come into possession of technical, financial, sales and/or other business information pertaining to Employer and/or the Companies which is not published or readily available to the public, and from which the Employer and/or the Companies may derive economic value, actual or potential, including, but not limited to, trade secrets, techniques, designs, formulae, methods, processes, devices, machinery, equipment, inventions, research and development projects, programs, plans and data, clinical projects and data, plans for future developments, marketing concepts and plans, pricing information, licensing agreements, and lists of or other information pertaining to and/or received from Employer, employees of the Companies, customers and/or suppliers (collectively referred to as "Confidential Information"). Employee acknowledges that the Confidential Information is important to and greatly affects the success of the Employer and the Companies in a competitive marketplace. Employee further agrees that while employed by Employer or any of the Companies, and at all times thereafter, regardless of how, when and why that employment ends, Employee will hold in the strictest confidence, and will not directly or indirectly disclose, duplicate and/or use for himself/herself or any other person or entity any Confidential Information without the prior written consent of an officer of Employer, or unless required to do so in order to perform his/her responsibilities while employed by Employer. 7. PUBLICATION. It is expressly agreed between Employee and the Companies that Employee will hold in confidence and not make use of any Confidential Information at any time except as required in the course and performance of the Employee's employment with Employer or as otherwise agreed to in writing by the Corporate Communications Officer of Employer. Employee agrees not to publish or cause or permit to be published or otherwise disclose any article, oral presentation or material related to Employer and/or the Companies, including without limitation the Employer's and/or the Companies' Confidential Information and information related to any products or proposed products, without obtaining the prior written consent of the Corporate Communications Officer. 8. NO OTHER CONTRACT. Except as listed below, Employee warrants that (s)he is not bound by the terms of any other agreement, oral or written, which would limit or preclude him/her from disclosing to Employer and/or the Companies any idea, invention, discovery or other information pertaining or related to Employee's responsibilities. Employee agrees to promptly provide Employer with a copy of any and all agreements listed below and other agreements which may prohibit or restrict his/her employment with Employer. Employee further agrees not to disclose to Employer or the Companies, or to seek to induce Employer or the Companies to use any confidential information, material or trade secrets belonging to any other person or entity. ____________________________________________________________________ ____________________________________________________________________________ ____________________________________________________________________________ 9. RIGHT TO WORK PRODUCT. Any and all designs, inventions, discoveries, improvements, specifications, technical data, reports, business plans and other embodiments of Employee's work conceived, made, discovered and/or produced by Employee during the period of his/her employment by Employer, either solely or jointly with others and in the course of performing his/her duties for Employer, which are based, in whole or part, upon Confidential Information, the resources, supplies, facilities or business, technical or financial information of Employer and/or the Companies, or which relate to the business, the research or the anticipated research and development of Employer and/or the Companies (collectively referred to herein as "Work Product"), will be the sole property of Employer and available to Employer at all times. Employee agrees to promptly disclose and assign and hereby assigns to Employer, without royalty or other additional consideration, any and all of Employee's proprietary rights to any and all Work Product. Employee further agrees that during his/her employment by Employer and after that employment ends, regardless of how, when and why, (s)he will, upon Employer's request: (A) execute any and all applications for copyright and/or patent of Work Product which may be prepared for his/her signature, (B) assign to Employer and/or the Companies any and all such applications, copyrights and patents relating to Work Product, and (C) assist Employer and/or the Companies, as Employer and/or the Companies deem necessary, in its application, defense and enforcement of any copyright or patent relating to Work Product. Employer will pay all expenses of preparing, filing, prosecuting and defending any such application and of obtaining such copyrights and patents. In the event Employer does not employ Employee at the time any request for such assistance is made by Employer, Employer will pay Employee a reasonable amount for Employee's time and will schedule any needed assistance so as not to interfere with Employee's then current employment and obligations. 10. RETURN OF PROPERTY. Upon the termination of Employee's employment with Employer, regardless of how, when and why that employment ends, Employee will immediately deliver to Employer all property of Employer and all property of the Companies, including, without limitation, all Company equipment, records, documents and computer disks (including all copies). If Employee fails to return to Employer all property of Employer and the Companies, Employee authorizes Employer to deduct from his/her final paycheck such amount to cover the loss, to the extent permitted by applicable law. Nothing contained herein shall limit Employer's right to recover the full value of such property from Employee in any proceeding. 11. RESTRICTIVE COVENANTS. A. The parties agree that at the time this Agreement was entered, the business of Employer was the marketing and sale of brand name prescription pharmaceutical products (hereafter "the business of Employer"). Employee agrees that during the thirty-six (36) consecutive months immediately following termination of Employee's employment with Employer, regardless of how, when or why that employment ends, Employee will not in any manner or in any capacity, directly or indirectly, for himself/herself or any other person or entity, actually or attempt to do any of the following: 1. To sell or market, manage or direct the sale or marketing, or indirectly or directly assist any other person in the sale or marketing of the same or similar brand name products as Employee marketed or sold for Employer under this Agreement, on behalf of or for any business that markets or sells any product or product line which is competitive with any product or product line Employer has sold during the most recent twenty-four (24) month period anywhere Employer conducted business. 2. Solicit, contact, divert, interfere with or take away any customer of Employer and/or the Companies that has conducted business or negotiations with Employer or the Companies during the twenty-four (24) months immediately preceding termination of employment. 3. Interfere with any of the suppliers of Employer and/or the Companies, including, without limitation, reducing in any material way the willingness or capability of any supplier to continue supplying Employer and/or the Companies with their present or contemplated requirements. 4. Solicit or interfere with the Employer's and/or the Companies' relationship with any of their employees or agents, or provide the names of any of Employer's and/or the Companies' employees or agents, to any third party. 5. Acquire any interest in any business that markets or sells any product or product line that is competitive with any product or product line Employer sold during the twenty-four (24) months immediately preceding termination of employment, except as permitted in Section 12 below. B. Employee further agrees that (s)he will not engage in any of the activities listed above while employed by Employer. C. Employee acknowledges and agrees that his/her experience, knowledge and capabilities are such that (s)he can obtain employment in unrelated pharmaceutical, chemical, nutritional, food, industrial, household, confectionery or other businesses, and that the enforcement of this paragraph 11 by way of injunction would not prevent Employee from earning a livelihood. Employee further agrees that if (s)he has any question(s) regarding the scope of activities restricted by this Section 11, (s)he will, to avoid confusion or misunderstanding, submit the question(s) in writing to the Director, Human Resources of the Employer for a written response. Employee additionally agrees to promptly inform and keep the Employer advised of the identity of his/her employer (including any unit or division to which Employee is assigned), his/her work location, and his/her title and work responsibilities during the period covered by this Section 11. D. Employee agrees to fully disclose the terms of this Agreement to any person or entity by which or with whom (s)he may hereafter become employed or to which (s)he may hereafter render services, and agrees that Employer may, if desired, send a copy of this Agreement, or otherwise make the provisions hereof known, to any such entity. E. In the event of a breach by Employee of any of the terms of Section 11, the period of time the obligations hereunder apply will be automatically extended for a period of time equal to the length of time Employee is in breach. 12. INVESTMENT SECURITIES. Nothing in this Agreement will limit the right of Employee, as an investor, to hold or acquire the stock or other investment securities of any business entity that is registered on a national securities exchange or regularly traded on a generally recognized over-the-counter market, so long as Employee's interest in any such business entity does not exceed five percent (5%) of its ownership. 13. MATERIAL BREACH. Any breach of this Agreement by the Employee will be a material breach. 14. EMPLOYEE CONSENT. In order to preserve their rights under this Agreement, Employer and/or the Companies may advise any third party with whom Employee may consider, establish or contract an employment, consulting or service relationship of the existence of this Agreement and of its terms. Employee agrees that Employer and the Companies will have no liability for so acting. 15. CONTROLLING LAW. This Agreement will be governed and construed in accordance with the laws of the State of Missouri and the rights and duties of the parties pursuant to this Agreement or by operation of law by reason of any matter relating to this Agreement, will be governed by the laws of the State of Missouri, without regard to conflicts of laws principles. The parties agree that any controversy arising with respect to this Agreement will fall under the exclusive jurisdiction of the Circuit Court of the County of St. Louis, Missouri, and each party hereby consents to the jurisdiction and venue of that court. 16. REMEDIES. Employee agrees that the promises in this Agreement are reasonable and necessary to protect the legitimate business interests of Employer and the Companies, and that any violation by Employee of any of the promises in this Agreement would result in great damage and irreparable injury to Employer and/or the Companies. Employee further agrees that if Employee were to violate the covenants in Section 11 of this Agreement, the unauthorized disclosure of Confidential Information would be inevitable and result in great damage and irreparable harm. Employee agrees that in the event of a breach of this Agreement, the Employer and/or the Companies have the right to seek any and all legal and/or equitable remedies available for any breach of this Agreement, including, but not limited to, enforcement by injunction including ex parte temporary restraining order relief, in view of such irreparable harm. Employee agrees that enforcement by way of Injunction would not prevent Employee from making a living as described in Paragraph 11C. Employer is entitled to its attorneys' fees, costs, and any related expenses incurred in the enforcement of this Agreement in the event of any breach by Employee. 17. SEVERABILITY. In the event any provision in this Agreement is deemed unenforceable, in whole or in part, it will not invalidate either the balance of the provisions or the remaining provisions of this Agreement. In addition, the parties have attempted to limit Employee's right to compete only to the extent necessary to protect Employer from unfair competition. Consequently, the parties further agree that if any restrictive covenant in this Agreement is deemed unenforceable, in whole or in part, because overly broad in geographic scope, activity or time duration, that provision shall be automatically modified so as to be enforceable to the maximum extent reasonable. 18. ASSIGNMENT. This Agreement is not assignable by Employee, and will be binding upon Employee and Employee's heirs, executors and legal and/or personal representatives. This Agreement is assignable by Employer, and will inure to the benefit of Employer, its successors and assigns. If Employee subsequently accepts employment with one of the Companies, this Agreement will be automatically assigned to the employing Company without additional covenant or notice to Employee. In the event of this or any other assignment, sale, merger, or other change in the ownership or structure of Employer, the resulting entity will step into the place of the Employer under this Agreement without additional covenant or notice to Employee. If the Agreement is assigned, the term "Employer" will mean the then-employing Company and the term "Companies" will mean the then-employing Company's parents, subsidiaries and affiliates. 19. NONWAIVER. Failure of Employer and/or the Companies to exercise any of its/their rights in the event Employee breaches any of the promises in this Agreement shall not be construed as a waiver of such a breach or prevent Employer and/or the Companies from later enforcing strict compliance with the promises in this Agreement. 20. MODIFICATION. This Agreement contains the parties' complete agreement, and supersedes any other agreement, oral or written, pertaining to the subject matter of this Agreement. This Agreement may be altered, amended or revoked at any time only by a writing signed by both parties. 21. ACKNOWLEDGMENT. Employee agrees that (s)he fully understands his/her right to discuss all aspects of this Agreement with the legal or personal advisors of his/her choice, and warrants that, to the extent (s)he desired, (s)he has done so, (s)he has carefully read and fully understands all of the provisions of this Agreement, and (s)he has voluntarily entered into this Agreement. IN WITNESS WHEREOF, Employee and Employer have executed this Agreement on the day and year first written above. EMPLOYEE EMPLOYER /s/ Jerald J. Wenker /s/ Gerald R. Mitchell - ---------------------------------- --------------------------------------- Title ---------------------------------- EX-21 8 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 FP1096, Inc., a Pennsylvania corporation KV Pharmaceutical Company Limited (England and Wales) DrugTech, sarl (Switzerland) EX-23.1 9 ex23p1.txt Exhibit 23.1 Consent of Independent Registered Public Accounting Firm -------------------------------------------------------- The Board of Directors K-V Pharmaceutical Company: We consent to the incorporation by reference in the registration statements (Nos. 2-56793, 2-76173, 33-46400, 33-44927, 333-00199, 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, 2006, with respect to the consolidated balance sheets of K-V Pharmaceutical Company and subsidiaries as of March 31, 2006 and 2005, the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the years then ended, and the related financial statement schedule for the years ended March 31, 2006 and 2005, management's assessment of the effectiveness of internal control over financial reporting as of March 31, 2006 and the effectiveness of internal control over financial reporting as of March 31, 2006, which reports appear in the March 31, 2006 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, 2006 EX-23.2 10 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 for the year ended March 31, 2004. /s/ BDO Seidman, LLP Chicago, Illinois June 13, 2006 EX-31.1 11 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, 2006 ---------------- /s/ MARC S. HERMELIN ----------------------------------------- Marc S. Hermelin Vice Chairman and Chief Executive Officer (Principal Executive Officer) EX-31.2 12 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, 2006 ------------------- /s/ GERALD R. MITCHELL ------------------------------------------ Gerald R. Mitchell Vice President and Chief Financial Officer (Principal Financial Officer) EX-32.1 13 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, 2006, 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. Date: June 14, 2006 /s/ Marc S. Hermelin ---------------------- ----------------------------------------- Marc S. Hermelin Vice Chairman and Chief Executive Officer (Principal Executive Officer) EX-32.2 14 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, 2006, 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. Date: June 14, 2006 /s/ Gerald R. Mitchell ---------------------- ------------------------------------------ Gerald R. Mitchell Vice President and Chief Financial Officer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----