-----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, NYrPiSvw0k3yTZRWHn+qd8CnaAUvT+LDDZ+xeBNu6SH8isLjvWutgmQ46nUDoYqd ZUZJ7SKy8dT7UgFY/rbpEA== 0001068800-08-000269.txt : 20080626 0001068800-08-000269.hdr.sgml : 20080626 20080625174006 ACCESSION NUMBER: 0001068800-08-000269 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20080331 FILED AS OF DATE: 20080626 DATE AS OF CHANGE: 20080625 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: 08917448 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 [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2008 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________ COMMISSION FILE NUMBER 1-9601 - -------------------------------------------------------------------------------- K-V PHARMACEUTICAL COMPANY (Exact name of registrant as specified in its charter) DELAWARE 43-0618919 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2503 SOUTH HANLEY ROAD, ST. LOUIS, MISSOURI 63144 (Address of principal executive offices, including ZIP code) Registrant's telephone number, including area code: (314) 645-6600 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 [ ] No [X] Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] 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, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ ] 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 28, 2007, the last business day of the registrant's most recently completed second fiscal quarter, was $887,560,274 and $37,278,549, respectively. As of June 6, 2008, the registrant had outstanding 37,755,099 and 12,256,159 shares of Class A Common Stock and Class B Common Stock, respectively. Documents incorporated by reference: Portions of the Company's Definitive Proxy Statement for its 2008 Annual Meeting of Shareholders are incorporated by reference in Part III of this Annual Report on Form 10-K. 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 U.S. 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," "expects," "aims," "believes," "projects," "anticipates," "commits," "intends," "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, product launches, regulatory approvals, governmental and regulatory actions and proceedings, market position, market share increases, acquisitions, revenues, expenditures and other 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, competitive, political, regulatory and technological factors which, among others, could cause 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 timing, and that any period of exclusivity may not be realized; (3) acceptance and demand for new pharmaceutical products; (4) the impact of competitive products and pricing, including as a result of so-called authorized-generic drugs; (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 and/or products manufactured for us under contract manufacturing arrangements with third parties; (8) the regulatory environment, including regulatory agency and judicial actions and changes in applicable law or regulations; (9) fluctuations in operating results; (10) the difficulty of predicting international regulatory approval, including 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) actions by the Securities and Exchange Commission and the Internal Revenue Service with respect to our stock option grants and accounting practices; (15) the impact of credit market disruptions on the fair value of auction rate securities that we acquired as short-term investments and have now become illiquid; (16) whether any recalled products will have any material financial impact or result in litigation, agency actions or material damages; and (17) the risks detailed from time to time in our filings with the Securities and Exchange Commission. This discussion is not 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 future 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 Founder and Chairman Emeritus, invented and obtained initial patents for early controlled release and enteric coating which became part of our core business in the 1950's to 1970's and a platform for later drug delivery emphasis in the 1980's to the present. Today, 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 developed and patented a wide variety of drug delivery and formulation technologies which are primarily focused in four principal areas: SITE RELEASE(R); 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, non-branded 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 its own "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. Today, we believe we are a leading, vertically integrated specialty pharmaceutical marketer. 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 2007, we acquired the U.S. marketing rights to Evamist(TM), a new estrogen replacement therapy product delivered with a patented metered-dose transdermal spray system, from VIVUS, Inc. Under the terms of the asset purchase agreement, we paid $10.0 million in cash at closing and agreed to make an additional cash payment of $141.5 million upon final approval of the product by the U.S. Food and Drug Administration ("FDA"). The agreement also provides for two future payments upon achievement of certain net sales milestones. If Evamist(TM) achieves $100.0 million of net sales in a fiscal year, a one-time payment of $10.0 million will be made, and if net sales levels reach $200.0 million in a fiscal year, a one-time payment of up to $20.0 million will be made. Because the product had not obtained FDA approval when the initial payment was made at closing, we recorded the $10.0 million payment made during the first quarter of fiscal 2008 as in-process research and development expense. In July 2007, FDA approval for Evamist(TM) was received and a payment of $141.5 million was made to VIVUS, Inc. The preliminary purchase price allocation, which is subject to change based on the final fair value assessment, resulted in estimated identifiable intangible assets of $52.4 million to product rights; $15.2 million to trademark rights; $66.4 million to rights under a sublicense agreement; and, $7.5 million to a covenant not to compete. This product was purchased using $91.5 million in cash and $50 million of our revolving line of credit. Upon FDA approval in July 2007, we began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years. In May 2007, we received FDA approval to market the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R) (marketed by AstraZeneca). 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 these generic formulations. Since we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, we were accorded the opportunity for a 180-day exclusivity period for marketing these two dosage strengths. The 180-day exclusivity period has allowed us to realize higher margins on these products compared to our other generic/non-branded products. We 3 began shipping these two products in July 2007, and along with the 25 mg strength approved in March 2008, they generated net revenues in fiscal 2008 of $120.0 million. We received FDA approval to market the 25 mg and 50 mg strengths of metoprolol succinate extended-release tablets in March 2008 and May 2008, respectively. As a result of the recent 50 mg approval, KV now offers the complete line of all four dosage strengths of metoprolol succinate extended-release tablets - 200 mg, 100 mg, 50 mg and 25 mg. As of March 31, 2008, KV had a 69.1% and 72.5% share of the generic market place according to IMS Inc. for the 200 mg and 100 mg strengths, respectively. In July 2007, we entered into an additional licensing arrangement to market Clindesse(R) in the People's Republic of China. We have previously entered into licensing arrangements for the right to market Clindesse(R) in Spain, Portugal, Andorra, Brazil, Mexico, five Scandinavian markets and 18 Eastern European countries. In January 2008, we entered into a definitive asset purchase agreement with CYTYC Prenatal Products and Hologic, Inc. ("CYTYC") to acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate). The New Drug Application ("NDA") for Gestiva(TM) is currently before the FDA, pending approval for use in the prevention of preterm birth in certain categories of pregnant women. The proposed indication is for women with a history of at least one spontaneous preterm delivery (i.e., less than 37 weeks), who are pregnant with a single fetus. Under the terms of the asset purchase agreement, we agreed to pay $82.0 million for Gestiva(TM), $7.5 million of which was paid at closing. Because the product had not obtained FDA approval when the initial payment was made at closing, we recorded the $7.5 million payment as in-process research and development expense in the fourth quarter of fiscal 2008. The remainder of the purchase price is payable on the completion of two milestones: (1) $2.0 million on the earlier to occur of CYTYC's receipt of acknowledgement from the FDA that their response to the FDA's October 20, 2006 "approvable" letter is sufficient for the FDA to proceed with their review of the NDA or the receipt of FDA's approval of the Gestiva(TM) NDA and (2) $72.5 million on FDA approval of a Gestiva(TM) NDA, transfer of all rights in the NDA to us and receipt by us of defined launch quantities of finished Gestiva(TM) suitable for commercial sale. (c) INDUSTRY SEGMENTS ----------------- We operate principally in three industry segments, consisting of branded products marketing, specialty generics marketing and specialty raw materials marketing. We derive revenues primarily from directly marketing our own technologically distinguished brand-name and generic/non-branded products and products marketed under joint development agreement with other companies. 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 of the Notes to the Consolidated Financial Statements. (d) NARRATIVE DESCRIPTION OF BUSINESS --------------------------------- OVERVIEW We are a fully integrated specialty pharmaceutical company that develops, manufactures, acquires 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 developed a diverse portfolio of drug delivery technologies which we leverage to create technologically distinguished brand name and specialty generic/non-branded products. We have patented 15 drug delivery and formulation technologies primarily in four principal areas: SITE RELEASE(R), 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 4 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 1999, Ther-Rx 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 ETHEX incorporate one or more of our drug delivery technologies. Our drug delivery technologies play a vital role in our ability to offer improved and differentiated products in our branded products portfolio and allow us to develop hard to replicate products that are marketed through our generic/non-branded products business. We believe that this differentiation provides substantial competitive advantages for our products, which has allowed us to establish a strong record of growth and profitability and a leadership position in certain segments of our industry. As a result, we have grown consolidated net revenues at a compounded annual growth rate of 19.4% over the five fiscal years in the period ended March 31, 2008 marking the Company's 13th consecutive year of record revenues. Ther-Rx has grown substantially since its inception in 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 generic/non-branded products. 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 $188.7 million in fiscal 2007 to $214.9 million in fiscal 2008 and represented 35.7% of our fiscal 2008 total net revenues. We established our women's healthcare franchise through our 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 six 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. Ther-Rx's second internally developed product, PremesisRx(R), 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 Conceive(R), 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 ONE(R), was launched in fiscal 2005 as a 5 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. During June 2008, a third party company introduced a product purporting to be a substitute for PrimaCare ONE(R), and we are currently engaged in litigation with this company with respect to patent and trademark infringement and other claims. See Note 12 of the Notes to Consolidated Financial Statements. The PrimaCare(R) franchise has grown to be the number one branded prenatal prescription vitamin in the U.S. Our sixth product line extension, PreCare Premier(R), provides a wide range of vitamins and minerals, plus a stool softener, in a small, easy-to-swallow, once-daily caplet. Sales of our branded prescription prenatal vitamins increased 13.7% in fiscal 2008 to $82.5 million. In fiscal 2006, we expanded our prescription nutritional franchise when Ther-Rx introduced Encora(R), a twice-daily prescription nutritional supplement designed to meet the key nutritional and preventative health needs of women past their childbearing years. Sales of Encora(R) increased 45.0% in fiscal 2008 to $4.5 million. In 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), which we believe is the only clinically proven and FDA approved controlled release bioadhesive system. Sales of Gynazole-1(R) were $24.0 million in fiscal 2008. We have also 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 Scandinavia. In January 2005, Ther-Rx introduced its second NDA approved product, Clindesse(R), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(R) incorporates our proprietary VagiSite(TM) bioadhesive drug delivery technology. Since its launch, Clindesse(R) has gained 28.0% of the intravaginal bacterial vaginosis market in the United States. Clindesse(R) generated a 27.4% increase in sales to $40.5 million in fiscal 2008. We have also entered into licensing agreements for the right to market Clindesse(R) in Spain, Portugal, Andorra, Brazil, Mexico, five Scandinavian markets, 18 Eastern European countries and the People's Republic of China. We established our hematinic product line by acquiring two leading hematinic brands, Chromagen(R) and Niferex(R), in 2003. We re-launched technology-improved versions of these products mid-way through fiscal 2004. In fiscal 2006, we introduced two new hematinic products -- Repliva 21/7(R) and Niferex Gold(R). We believe Repliva 21/7(R) is a product offering that represents a revolutionary advancement in iron therapy. Repliva 21/7(R) has been uniquely formulated to promote maximum red blood cell regeneration while minimizing uncomfortable side effects that patients have typically endured with traditional iron supplements. With Repliva 21/7(R) becoming the number one branded oral iron product in the United States and Ther-Rx being the number one provider of branded prescription oral iron supplements in the United States, sales of our hematinic product line grew to $53.8 million in fiscal 2008, an 11.6% increase over fiscal 2007. In May 2007, we acquired from VIVUS, Inc. the U.S. marketing rights to Evamist(TM), a unique transdermal estrogen therapy delivering a low dose of estradiol in a once-daily spray. Under terms of the asset purchase agreement, we paid $10.0 million in cash at closing and made an additional cash payment of $141.5 million upon final approval of the product by the FDA in July 2007. Evamist(TM) is indicated for the treatment of moderate-to-severe vasomotor symptoms due to menopause and targets the estrogen replacement market where physicians and patients are seeking an effective and safe, low-dose estrogen product. We believe Evamist(TM) will significantly augment the women's health offerings of our branded segment as we leverage the promotion of this product through our expanded branded sales force. We began shipping this product at the end of fiscal 2008. In January 2008, we entered into a definitive asset purchase agreement with CYTYC to acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate). Under the terms of the asset purchase agreement, we agreed to pay $82.0 million for Gestiva(TM), $7.5 million of which was paid at closing. The NDA for Gestiva(TM) is currently before the FDA, pending approval for use in the prevention of preterm birth in certain categories of pregnant women. The proposed indication is for women with a history of at least one spontaneous preterm delivery (i.e., less than 37 weeks), who are pregnant with a single fetus. The FDA issued an "approvable" letter for Gestiva(TM) in October 2006, and a final approval is anticipated in fiscal 2009. The FDA has granted an Orphan Drug Designation for Gestiva(TM). The acquisition of Gestiva(TM) is intended to allow Ther- 6 Rx to capitalize on the already strong relationships built over the past seven years between Ther-Rx's 330-member sales force and Obstetrician/Gynecologists. To capitalize on Ther-Rx's success in marketing women's health products, we continue to look for opportunities to expand our Ther-Rx product portfolio. 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 are now testing an alternative formula in a Phase II study to determine which alternative to take into Phase III clinicals. The Company expects to start Phase III clinicals in fiscal 2010. Based on the addition and development of new products and our expectation of continued growth in our branded business, Ther-Rx has expanded its branded sales force to approximately 330 specialty sales representatives. 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 differentiate our products and reduce the rate of price erosion typically experienced in the generic market. ETHEX's net revenues increased 56.1% to $367.9 million for fiscal 2008, which represented 61.1% of our total net revenues. In May 2007, we received FDA approval to market the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R) (marketed by AstraZeneca). 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 these generic formulations. Since we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, we were accorded the opportunity for a 180-day exclusivity period for marketing these two dosage strengths. The 180-day exclusivity period has allowed us to realize higher margins on these products compared to our other generic/non-branded products. We began shipping these two products in July 2007 and along with the 25 mg approved and launched in March 2008 generated net revenues in fiscal 2008 of $120.0 million. We have used our proprietary drug delivery technologies in many of our generic/non-branded pharmaceutical products. For example, we have used METER RELEASE(R), one of our proprietary controlled release technologies, in a variety of products including the only generic equivalent to Norpace(R) CR, an antiarrhythmic that is taken twice daily. Further, we have used KV/24(TM) once daily technology in the generic equivalent to IMDUR(R), a cardiovascular drug that is taken once per day, among others. To capitalize on ETHEX's unique product capabilities, we continue to expand our ETHEX product portfolio. In fiscal 2006, we launched a new InveAmp(R) line extension to our pain management business. InveAmp(R), a unique one unit dose ampoule, was designed to make dispensing of narcotic pain relievers more effective. In fiscal 2007, we received ANDA approval for six strengths of diltiazem hydrochloride extended-release capsules. As noted above, in fiscal 2008, we received FDA approval to market the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R). We also received in fiscal 2008 ANDA approval for ondansetron 4 mg and 8 mg orally disintegrating tablets, the 100 mg and 200 mg strengths of morphine sulfate extended-release tablets, the generic equivalent of MS Contin(R), and the 100 mg and 200 mg strengths of benzonatate USP capsules, the generic equivalent to Tessalon(R). In addition, we received FDA approval to market the 25 mg and 50 mg strengths of metoprolol succinate extended-release tablets in March 2008 and May 2008, respectively. As a result of the recent 50 mg approval, KV now offers the complete line of all four dosage strengths of metoprolol succinate extended-release tablets - 200 mg, 100 mg, 50 mg and 25 mg. 7 In addition to our internal product development efforts, we have entered into several long-term product development and marketing license agreements with various generic pharmaceutical developers and manufacturers. Under most of these arrangements, the other parties are responsible for developing, submitting for regulatory approval and manufacturing the products and we are responsible for exclusively marketing these products in the territories covered by the in-licensing agreements. We expect certain products under these agreements to be filed and/or approved beginning in fiscal 2009. With the majority of our internal generic/non-branded product development efforts primarily focused on building our pipeline with products that use one or more of our 15 drug delivery technologies, we believe these development agreements with existing parties will further provide an opportunity to grow our generic/non-branded business. These new product sources have increased the scope of our generic/non-branded product pipeline to more than 50 product opportunities. The Company seeks to pursue an approach of developing generic products that are more difficult to develop or manufacture and that will therefore have significant barriers to entry by other generic companies, such as metoprolol succinate extended-release tablets. The Company has a rich generic pipeline. In fiscal year 2008, between the Company's own internal development activities and its external development partners, the Company filed 16 ANDAs and received 5 generic product approvals from the FDA. In fiscal year 2009, the Company anticipates that, between its external development partners and its own internal development activities, it will file approximately 16 generic ANDA filings and receive six product approvals from the FDA. On February 14, 2006, the Company announced it had entered into an agreement with Gedeon Richter under which the Company had acquired exclusive rights to market a group of generic products in the United States. However, due to changes in the generic drug marketplace, the Company and Gedeon Richter have agreed the current portfolio of products covered by the agreement, which has now been terminated, no longer represent market opportunities that are worth pursuing. The two companies remain committed partners in other endeavors and are keeping options open to explore other more meaningful joint opportunities. 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 70 products in its cardiovascular line, including products to treat angina, arrhythmia and hypertension, as well as for potassium supplementation. The cardiovascular line accounted for $237.2 million, or 64.5%, of ETHEX's net revenues in fiscal 2008. PAIN MANAGEMENT. ETHEX currently markets over 30 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 $45.7 million, or 12.4%, of ETHEX's net revenues in fiscal 2008. RESPIRATORY. During most of fiscal 2008, ETHEX marketed approximately 30 products in its respiratory line, which consisted primarily of cough/cold products. The cough/cold line accounted for $38.5 million, or 10.5% of ETHEX's net revenues in fiscal 2008. In March 2008, representatives of the Missouri Department of Health and Senior Services and the FDA notified us of a hold on our inventory of certain unapproved products. Previously, we had received notices that required us to cease the manufacture and sale of unapproved products containing timed-release guaifenesin. As a result of these notices, we are currently marketing one cough/cold product. We will discontinue manufacturing and marketing all unapproved cough/cold products subject to the hold. See Part I, Item 1A "Risk Factors" for additional information. The regulatory status of certain of our generic products may make them subject to increased competition or to regulatory decisions that may require market withdrawal of one or more of our unapproved products. 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 $14.1 million, or 3.8%, of ETHEX's net revenues in fiscal 2008. 8 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. These categories accounted for $32.2 million, or 8.8%, of ETHEX's net revenues in fiscal 2008. 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, 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 demand at the wholesale level. 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 Ther-Rx and ETHEX. Net revenues for PDI were $18.0 million in fiscal 2008, up 3.3% over net revenues of $17.4 for fiscal 2007, which represented 3.0% of our total net revenues. 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. 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, possibly, new therapeutic areas. We believe we have in place a strong pipeline of potential new products. CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek acquisition opportunities for both Ther-Rx and ETHEX. In May 2007, we completed the acquisition of the U.S. marketing rights to Evamist(TM), a new low-dose estrogen transdermal spray, from VIVUS, Inc. The NDA for this product was approved by the FDA in July 2007 and we began shipping Evamist(TM) during the fourth quarter of fiscal 2008. In January 2008, we entered into a definitive purchase agreement that gives us full U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate) upon approval of the pending Gestiva(TM) NDA by FDA. Gestiva(TM) is seeking an indication for use in the prevention of preterm birth in certain categories of pregnant women. The FDA issued an "approvable" letter for Gestiva(TM) in October 2006, and a final approval is anticipated in late 2008. The FDA has granted an Orphan Drug Designation for Gestiva(TM). Ther-Rx is also continually looking for platform acquisition opportunities similar to PreCare(R) around which it 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 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; 9 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; o products which are predominantly prescribed by physician specialists, which can be cost-effectively marketed by a 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 specialist 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 and development of new products and our expectation of continued growth in our branded business, Ther-Rx has expanded its branded sales force to approximately 330 specialty sales representatives. We plan to continue to build our sales force over time 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. 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. Almost two-thirds of ETHEX'S generic/non-branded products use the Company's proprietary drug delivery technologies, and approximately 80% rank either first or second in their respective generic categories by volume. In May 2007, we received FDA approval to market the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R) (marketed by AstraZeneca). 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 these generic formulations. Since we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, we were accorded the opportunity for a 180-day exclusivity period for marketing these two dosage strengths. The 180-day exclusivity period has allowed us to realize higher margins on these products compared to our other generic/non-branded products. We began shipping these two products in July 2007 and with the approval and launch in March 2008 of the 25 mg strength they generated net revenues in fiscal 2008 of $120.0 million. We received FDA approval to market the 25 mg and 50 mg strengths of metoprolol succinate extended-release tablets in March 2008 and May 2008, respectively. As a result of the recent 50 mg approval, KV now offers the complete line of all four dosage strengths of metoprolol succinate extended-release tablets - 200 mg, 100 mg, 50 mg and 25 mg. 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(R), 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 are actively advancing our existing portfolio of drug delivery technologies and developing or acquiring exciting new technologies with substantial growth potential. In May 2007, we completed the acquisition of the U.S. marketing rights to Evamist(TM), a new low-dose estrogen transdermal spray, from VIVUS, Inc. The product was formulated with a patented metered-dose transdermal spray system which is designed to provide an easy, once-daily dose of estrodial via the skin. Evamist(TM) is the first transdermal spray estrogen replacement therapy 10 product approved for use in the U.S. The NDA for this product was approved by the FDA in July 2007 and we began shipping Evamist(TM) during the fourth quarter of fiscal 2008. 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 or acquisition 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. 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 diltiazem extended-release capsules (an AB rated generic equivalent to Tiazac(R)) and metoprolol succinate extended-release tablets (an AB rated generic equivalent to Toprol-XL(R)). 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. ORAL 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. Our unique quick dissolving tablet can be taken without water. Its durability avoids the need for special packaging and it supports the incorporation of our tastemasking technologies. Our oral dissolving tablet technology is commercialized in our hyoscyamine sulfate orally disintegrating tablets, as well as the ondansetron orally disintegrating tablets approved by the FDA in fiscal 2008. SALES AND MARKETING Ther-Rx has a national sales and marketing infrastructure which includes approximately 330 sales representatives dedicated to promoting and marketing our branded pharmaceutical products to 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. 11 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 six additional line extensions to address unmet needs, including the launch of PreCare(R) Chewables, Premesis Rx(R), PreCare Conceive(R), PrimaCare(R), PrimaCare ONE(R) and PreCare Premier(R). 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(R), the first approved single-dose therapy for bacterial vaginosis. In fiscal 2006, we introduced Encora(R), a new prescription nutritional supplement product, and two new hematinic products, Repliva 21/7(R) and Niferex Gold(R). In May 2007, we completed the acquisition of the U.S. marketing rights to Evamist(TM), a new low-dose estrogen transdermal spray, from VIVUS, Inc. The NDA for this product was approved by the FDA in July 2007 and we began shipping Evamist(TM) during March 2008. 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 primarily calls on independent pharmacies to create demand 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. During fiscal 2008, our three largest customers accounted for 24.6%, 23.9% and 9.8% of gross revenues. These customers were Cardinal Health, McKesson Drug Company and Amerisource Corporation, respectively. In fiscal 2007 and 2006, these customers accounted for gross revenues of 21.1%, 25.7% and 14.4%, and 15.7%, 26.9% and 12.7%, 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 19.5% over the past five fiscal years, reflects our continued commitment to develop new products and/or technologies through our internal development programs, and with our external strategic partners. Our research and development activities include the development of new and next generation drug delivery technologies, the formulation of brand name proprietary products and the development of technologically distinguished generic/non-branded versions of previously approved brand name pharmaceutical products. In fiscal 2008, 2007 and 2006, total research and development expenses were $46.6 million, $31.5 million and $28.9 million, respectively, excluding acquired in-process research and development. 12 All applications for FDA approval must contain information relating to product formulation, raw material suppliers, stability, manufacturing processes, packaging, labeling and quality control. Information to support the bioequivalence of generic drug products or the safety and effectiveness of new drug products for their intended use is also required to be submitted. There are generally two types of applications used for obtaining FDA approval of new products: o New Drug Application ("NDA"). An NDA is filed when approval is sought to market a drug with active ingredients that have not been previously approved by the FDA. NDAs are filed for newly developed brand products and, in certain instances, for a new dosage form, a new delivery system or a new indication for previously approved drugs. o Abbreviated New Drug Application ("ANDA"). An ANDA is filed when approval is sought to market a generic equivalent of a drug product previously approved under an NDA and listed in the FDA's "Orange Book" or for a new dosage strength or a new delivery system for a drug previously approved under an ANDA. One requirement for FDA approval of NDAs and ANDAs is that our manufacturing procedures and operations conform to FDA requirements and guidelines, generally referred to as current Good Manufacturing Practices ("cGMP"). The requirements for FDA approval encompass all aspects of the production process, including validation and recordkeeping, and involve changing and evolving standards. BRANDED PRODUCT DEVELOPMENT. The process required by the FDA before a pharmaceutical product, with active ingredients that have not been previously approved, may be marketed in the United States generally involves the following: o laboratory and preclinical tests; o submission of an Investigational New Drug ("IND") application, which must become effective before clinical studies may begin; o adequate and well-controlled human clinical studies to establish the safety and efficacy of the proposed product for its intended use; o submission of an NDA containing the results of the preclinical tests and clinical studies establishing the safety and efficacy of the proposed product for its intended use, as well as extensive data addressing matters such as manufacturing and quality assurance; o scale-up to commercial manufacturing; and o FDA approval of an NDA. Preclinical tests include laboratory evaluation of the product, its chemistry, formulation and stability, as well as toxicology and pharmacology studies to help define the pharmacological profile of the drug and assess the potential safety and efficacy of the product. The results of these studies are submitted to the FDA as part of the IND. They must demonstrate that the product delivers sufficient quantities of the drug to the bloodstream or intended site of action to produce the desired therapeutic results before human clinical trials may begin. These studies must also provide the appropriate supportive safety information necessary for the FDA to determine whether the clinical studies proposed to be conducted under the IND can safely proceed. The IND automatically becomes effective 30 days after receipt by the FDA unless the FDA, during that 30-day period, raises concerns or questions about the conduct of the proposed trials as outlined in the IND. In such cases, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials may begin. In addition, an independent institutional review board must review and approve any clinical study prior to initiation. Human clinical studies are typically conducted in three sequential phases, which may overlap: o Phase I: The drug is initially introduced into a relatively small number of healthy human subjects or patients and is tested for safety, dosage tolerance, mechanism of action, absorption, metabolism, distribution and excretion. 13 o Phase II: Studies are performed with a limited patient population to identify possible adverse effects and safety risks, to assess the efficacy of the product for specific targeted diseases or conditions, and to determine dosage tolerance and optimal dosage. o Phase III: When Phase II evaluations demonstrate that a dosage range of the product is effective and has an acceptable safety profile, Phase III trials are undertaken to evaluate further dosage and clinical efficacy and to test further for safety in an expanded patient population at geographically dispersed clinical study sites. The results of the product development, preclinical studies and clinical studies are then submitted to the FDA as part of the NDA. The NDA drug development and approval process could take from three to more than 10 years. In fiscal 2005, we introduced our second NDA approved product, Clindesse(R), the first approved single-dose therapy for bacterial vaginosis. Similar to Gynazole-1(R), Clindesse(R) incorporates our proprietary VagiSite(TM) bioadhesive drug delivery technology. In fiscal 2006, we introduced Encora(R), a new prescription nutritional supplement product, and two new hematinic products, Niferex Gold(R) and Repliva 21/7(R). 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 are now testing an alternative formula in a Phase II study to determine which alternative to take into Phase III clinicals. The Company expects to start Phase III clinicals in fiscal 2010. In May 2007, we acquired from VIVUS, Inc. the U.S. marketing rights to Evamist(TM), a unique transdermal estrogen therapy delivering a low dose of estradiol in a once-daily spray. Under terms of the asset purchase agreement, we paid $10.0 million in cash at closing and made an additional cash payment of $141.5 million upon final approval of the product by the FDA in July 2007. Evamist(TM) is indicated for the treatment of moderate-to-severe vasomotor symptoms due to menopause and targets the estrogen replacement market where physicians and patients are seeking an effective and safe, low-dose estrogen product. We began shipping this product at the end of fiscal 2008. In January 2008, we entered into a definitive asset purchase agreement with CYTYC to acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate). Under the terms of the asset purchase agreement, we agreed to pay $82.0 million for Gestiva(TM), $7.5 million of which was paid at closing. The NDA for Gestiva(TM) is currently before the FDA, pending approval for use in the prevention of preterm birth in certain categories of pregnant women. The proposed indication is for women with a history of at least one spontaneous preterm delivery (i.e., less than 37 weeks), who are pregnant with a single fetus. The FDA issued an "approvable" letter for Gestiva(TM) in October 2006, and a final approval is anticipated in fiscal 2009. The FDA has granted an Orphan Drug Designation for Gestiva(TM). GENERIC/NON-BRANDED PRODUCT DEVELOPMENT. FDA approval of an ANDA is required before marketing a generic equivalent of a drug approved under an NDA in the United States or for a previously unapproved dosage strength or delivery system for a drug approved under an ANDA. The ANDA development process is generally less time consuming and complex than the NDA development process. It typically does not require new preclinical and clinical studies because it relies on the studies establishing safety and efficacy conducted for the drug previously approved through the NDA process. The ANDA process, however, does require one or more bioequivalency studies to show that the ANDA drug is bioequivalent to the previously approved drug. Bioequivalence compares the bioavailability of one drug product with that of another formulation containing the same active ingredient. When established, bioequivalence confirms that the rate of absorption and levels of concentration in the bloodstream of a formulation of the previously approved drug and the generic drug are equivalent. Bioavailability indicates the rate and extent of absorption and levels of concentration of a drug product in the bloodstream needed to produce the same therapeutic effect. 14 Supplemental ANDAs are required for approval of various types of changes to an approved application, and these supplements may be under review for six months or more. In addition, certain types of changes may be approved only once new bioequivalence studies are conducted or other requirements are satisfied. PATENTS AND OTHER PROPRIETARY RIGHTS When appropriate and available, we actively seek 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 2023 relating to our controlled-release, site-specific, quick dissolve and taste-masking technologies. We have been granted 42 U.S. patents and have 37 U.S. patent applications pending. In addition, we have 71 foreign issued patents and a total of 204 patent applications pending primarily in Canada, Europe, Australia, Japan, South America, Mexico and South Korea (see Part I, Item 1A "Risk Factors for additional information). We depend on our patents and other proprietary rights and cannot be certain of their confidentiality and protection. We currently own more than 224 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 research, manufacturing, distribution and administrative facilities are an important factor in achieving our long-term growth objectives. All facilities at March 31, 2008, aggregating approximately 1.3 million square feet, are located in the St. Louis, Missouri metropolitan area. We own facilities with approximately 1.1 million square feet, with the balance under various leases at pre-determined annual rates under agreements expiring from fiscal 2009 through fiscal 2021, subject in most cases to renewal at our option. We manufacture drug products in liquid, cream, 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 2008, 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. 15 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. Many of these competitors 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. (See "-Research and Development"). 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. 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 16 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. We are involved in various lawsuits resulting from ANDA filings. See Note 12 of the Notes to Consolidated Financial Statements. In addition to marketing drugs which are subject to FDA review and approval, we market certain drug products in the U.S. without FDA approval under certain "grandfather" clauses and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the FDCA. A determination as to whether a particular product does or does not require FDA pre-market review and approval can involve consideration of numerous complex and imprecise factors. If a determination is made by the FDA that any product marketed without approval requires such approval, the FDA may institute enforcement actions, including product seizure, or action seeking an injunction or hold 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 objections to the marketing without NDA or ANDA approval of a 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 affected 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 this regard, in June 2006, May 2007 and September 2007, the FDA issued Notices to the pharmaceutical industry stating that manufacture of all unapproved drug products containing carbinoxamine, carbinoxamine labeled for children under two, timed-released guaifenesin, hydrocodone labeled for children under six and all other unapproved products containing hydrocodone, respectively, cease by September 6, 2006, July 9, 2006, August 26, 2007, October 31, 2007, and December 31, 2007, respectively. These Notices affect the continued manufacture and sale of ETHEX's Hydro-Tussin(TM) CBX Syrup, Tri-Vent(TM) HC Liquid, Guaifenex(R) DM ER Tablets, Guaifenex(R) PSE 60 ER Tablets, PhenaVent(TM) D Capsules, Guaifenex(R) PSE 80 ER Tablets, Pseudovent(TM) DM Tablets, Histinex(R) PV Syrup, Hydrocodone Bitartrate & Guaifenesin Liquid, Hydro-Tussin(TM) HC Syrup, Histinex(R) HC Syrup and Hydro-Tussin(TM) Syrup. In March 2008, representatives of the Missouri Department of Health and Senior Services, accompanied by representatives of the FDA, notified us of a hold on our inventory of certain unapproved drug products, restricting our ability to remove or dispose of those inventories without permission. The hold relates to a misinterpretation about the intended scope of recent FDA notices setting limits on the marketing of unapproved guaifenesin products. In response to notices issued by the FDA in 2002 and 2003 with respect to single-entity timed-release guaifenesin products, and a further notice issued in 2007 with respect to combination timed-released guaifenesin products, we timely discontinued a number of our guaifenesin products and believed that, by doing so, had complied with those notices. The recent action to place a hold on certain of our products indicates that additional guaifenesin products should also have been discontinued. In addition, the FDA expanded the hold to include other products that did not contain guaifenesin but were being marketed without FDA approval under certain "grandfather clauses" and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the FDCA. FDA policies permit the agency to initiate broad action against the marketing of additional categories of our unapproved products, if the FDA deems approval necessary, even if the agency has not instituted similar actions against the marketing of such products by other 17 parties. Pursuant to discussions with the Missouri Department of Health and Senior Services and with the FDA, the affected Morphine and Oxycodone products have been released from the hold. We will discontinue manufacturing and marketing all of the other unapproved products subject to the hold. The FDA has not proposed, nor do we expect them to propose, that the products subject to the hold be recalled from the distribution channel. We have written-off the value of the products subject to the hold in our inventory as of March 31, 2008. We also evaluated the active pharmaceutical ingredients and excipients used in the manufacture of the hold products and determined that they should also be written-off since we will be discontinuing further manufacturing and many of them cannot be returned or sold to other manufacturers. The write-off included in the results of operations for the fourth quarter of fiscal 2008 totaled $5.5 million. In October 2007, the FDA issued a Notice extending the period during which the FDA will exercise its enforcement discretion not to challenge continued marketing and distribution of pancreatic enzyme products, such as ETHEX's Pangestyme(TM) product. Under the extension, FDA will continue to exercise its enforcement discretion with respect to unapproved pancreatic enzyme products that have an active Investigational New Drug Application ("IND") on active status on or before April 28, 2008 and have submitted an NDA on or before April 28, 2009. We have timely filed an IND for such products. 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, 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, if 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 U.S. 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 less 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 are 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 18 receipt or failure to receive such clearances or approvals, the loss of previously received clearances or approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on our business. EMPLOYEES As of March 31, 2008, we employed a total of 1,590 employees. We were a party to a collective bargaining agreement with the Teamsters Union covering 133 employees that would have expired on December 31, 2009. However, in January 2008, the employee members of the union voted to decertify their union representation. The decertification became effective in February 2008. 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. 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 Standards of Business Ethics for all Directors and employees are available on our Internet website, and available in print to any shareholder 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 registrants 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 THE MATTERS RELATING TO THE INVESTIGATION BY THE SPECIAL COMMITTEE OF THE BOARD OF DIRECTORS AND THE RESTATEMENT IN PRIOR PERIODS OF THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS MAY RESULT IN ADDITIONAL LITIGATION AND GOVERNMENT ENFORCEMENT ACTIONS. In October 2006, the Board of Directors formed a Special Committee of independent directors to conduct an investigation, with the assistance of independent legal counsel and forensic accounting experts, of our past stock option grant practices over the period January 1, 1995 through October 31, 2006. The investigation concluded that no employee, officer or director of the Company engaged in any intentional wrongdoing or was aware that the Company's policies and procedures for granting and accounting for stock options were materially noncompliant with GAAP. The investigation also concluded that there was no intentional violation of law or accounting rules with respect to the Company's historical stock option grant practices. The Special Committee concluded, and based on its internal review, management agreed, that incorrect measurement dates were used for financial accounting purposes for stock option grants made in certain prior periods. Therefore, we recorded 19 additional non-cash stock-based compensation expense, and related tax effects, with regard to certain past stock option grants, and we restated certain previously filed financial statements included in our Form 10-K for fiscal 2007. The independent investigation and management's internal review and related activities required us to incur substantial expenses for legal, accounting, tax and other professional services, diverted some of our management's attention from the Company's business, and could have a material adverse effect on our business, financial condition, results of operations and cash flows. While we believe we have made appropriate judgments in determining the correct measurement dates for our stock option grants, based upon the Special Committee's findings and in consultation with outside experts and our independent registered public accounting firm, the SEC may disagree with the manner in which we have accounted for and reported the financial impact in our consolidated financial statements. Accordingly, there is a risk we may have to further restate our prior financial statements, amend prior filings with the SEC, or take other actions not currently contemplated by us. Our past stock option grant practices and the restatement of prior financial statements have exposed the Company to risks associated with litigation, regulatory proceedings and government enforcement actions. As described in Note 12 of the Notes to the Consolidated Financial Statements, "Commitments and Contingencies," derivative lawsuits were filed in state and federal courts against certain current and former directors and executive officers pertaining to allegations relating to stock option grants. The parties recently agreed to settle these derivative lawsuits, subject to court approval. Also, the Company was notified by the SEC in December 2007 that it had issued a formal order of investigation with respect to the Company's stock option plans, grants, exercises and accounting practices. If the Company is subject to adverse findings in litigation, regulatory proceedings or government enforcement actions, we could be required to pay damages or penalties or have other remedies imposed, all of which could have a material adverse effect on our financial condition, results of operations or cash flows. The resolution of these matters could continue to be time-consuming, expensive, and a distraction to some of our management from the conduct of the Company's business. WE HAVE A MATERIAL WEAKNESS IN INTERNAL CONTROL OVER FINANCIAL REPORTING AND CANNOT ASSURE YOU THAT ADDITIONAL MATERIAL WEAKNESSES WILL NOT BE IDENTIFIED IN THE FUTURE. IF WE FAIL TO MAINTAIN AN EFFECTIVE SYSTEM OF INTERNAL CONTROLS OR DISCOVER MATERIAL WEAKNESSES IN OUR INTERNAL CONTROL OVER FINANCIAL REPORTING, WE MAY NOT BE ABLE TO REPORT OUR FINANCIAL RESULTS ACCURATELY OR TIMELY OR DETECT FRAUD, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to attest to, and report on, the effectiveness of our internal control over financial reporting. Management concluded that there was a material weakness, as defined in the Public Company Accounting Oversight Board's Auditing Standard No. 5, in our internal control over financial reporting as of March 31, 2008. Management is implementing steps to remediate this material weakness, however, we cannot assure you that such remediation will be effective. Management also concluded there were material weaknesses, as defined in the Public Company Accounting Oversight Board's Auditing Standard No. 2, in our internal control over financial reporting as of March 31, 2007. Management implemented steps to remediate these material weaknesses as of March 31, 2008. See the discussion included in Part I, Item 9A of this report for additional information regarding our internal control over financial reporting. Our internal control over financial reporting may not prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's 20 objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. As a result, significant deficiencies or material weaknesses in our internal control over financial reporting may be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated there under. If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements that could require a restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price. OUR FUTURE GROWTH WILL LARGELY DEPEND 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 may not be successful in pursuing this strategy. IF WE ARE UNABLE TO COMMERCIALIZE PRODUCTS UNDER DEVELOPMENT OR THAT WE ACQUIRE, OUR FUTURE OPERATING RESULTS MAY SUFFER. Certain products we develop or acquire 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 or at all. OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL. We intend to continue to pursue our efforts 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 and other types of pharmaceutical companies for products and product line acquisitions. Many of these competitors 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 U.S. 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 21 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 U.S. 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 U.S. or abroad. Consequently, our pending or future patent applications may not 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. For example, a third party company has recently filed a declaratory judgment complaint in federal court challenging patents pertaining to Ther-Rx's PrimaCare ONE(R). See 12 of the Notes to Consolidated Financial Statements. Patent applications in the U.S. 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 U.S. for applications filed on or after November 29, 2000). In addition, publication of discoveries in scientific or patent literature often lags behind actual discoveries. As a result, we cannot be certain that we or our licensors will be entitled to any rights in purported inventions claimed in pending or future patent applications or that we or our licensors were the first to file patent applications on such inventions. Furthermore, patents already issued to us or our pending applications may become subject to dispute, and any dispute could be resolved against us. For example, we may become involved in re-examination, reissue or interference proceedings in the PTO, or opposition proceedings in a foreign country. The result of these proceedings can be the invalidation or substantial narrowing of our patent claims. We also could be subject to court proceedings that could find our patents invalid or unenforceable or could substantially narrow the scope of our patent claims. In addition, statutory differences in patentable subject matter may limit the protection we can obtain on some of our inventions outside of the U.S. For example, methods of treating humans are not patentable in many countries outside of the U.S. These and other issues may prevent us from obtaining patent protection outside of the U.S. 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. 22 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 U.S. 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. We are involved in defending various patent lawsuits resulting from ANDA filings by ETHEX or an effort by a third party company to invalidate certain of our patents. See Note 12 of the Notes to Consolidated Financial Statements. 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 U.S. 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 five patent infringement lawsuits pending against us and one declaratory judgment lawsuit by a third party seeking to invalidate certain of our patents. They could have a material adverse effect on our future business, financial condition, results of operations or cash flows. 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 posed, and is expected to continue to pose, significant challenges for our management, 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. If we are unable to manage our growth effectively, our business, financial condition, results of operations or cash flows could be materially adversely affected. OUR DEPENDENCE ON KEY EXECUTIVES AND SCIENTISTS COULD IMPACT THE DEVELOPMENT AND MANAGEMENT OF OUR BUSINESS. We are highly dependent upon our ability to attract and retain qualified scientific, technical and managerial personnel. There is intense competition for qualified personnel in the pharmaceutical and biotechnology industries, and we cannot be sure that we will be able to continue to attract and retain qualified personnel necessary for the development and management of our business. Although we do not believe the loss of one individual would materially harm our business, our business might be harmed by the loss of services of multiple existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner. Much of the know-how we have developed resides in our scientific and technical personnel and is not readily transferable to other personnel. While we have employment agreements with our key executives, we do not ordinarily enter into employment agreements with our other scientific, technical and managerial employees. 23 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 U.S. 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, 2008, our three largest customers, which are wholesale distributors, accounted for 24.6%, 23.9% and 9.8% of our gross sales, respectively. The loss of any of these customers could materially and adversely affect our business, financial condition, results of operations or cash flows. THE REGULATORY STATUS OF CERTAIN OF OUR GENERIC PRODUCTS MAY MAKE THEM SUBJECT TO INCREASED COMPETITION OR TO REGULATORY DECISIONS TO REQUIRE MARKET WITHDRAWAL OF ONE OR MORE OF OUR UNAPPROVED PRODUCTS. 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. For example, during June 2008, a third party company introduced a product purporting to be substitutable for our PrimaCare ONE(R), for which no FDA approval is required. We are currently in litigation with this company with respect to patent and trademark infringement and other claims. See Note 12 of the Notes to Consolidated Financial Statements. In other cases, we sell unapproved products that may become subject to FDA orders to the pharmaceutical industry to remove one or more types of such products from the marketplace. During the past year, such FDA orders have required manufacturers and distributors of certain unapproved products containing guaifenesin and hydrocodone to cease manufacture or distribution, including certain ETHEX products. In the future, FDA may issue similar orders affecting other of our products. In addition, in the event that FDA concludes that we have failed to comply with a notice setting deadlines for discontinuation of the manufacture and sale of unapproved products, or decides to take enforcement action against us on other grounds, such as for alleged violations of current good manufacturing practice requirements or for failure to obtain product approvals that FDA deems to be necessary, FDA policies permit the agency to initiate broad action against the marketing of additional categories of our unapproved drug products, even if the agency has not instituted similar actions against the marketing of such products by other parties. In March 2008, representatives of the Missouri Department of Health and Senior Services, accompanied by representatives of the FDA, notified us of a hold on our inventory of certain unapproved drug products restricting our ability to remove or dispose of those inventories without permission. The hold relates to a misinterpretation about the intended scope of recent FDA notices setting limits on the marketing of unapproved guaifenesin products. In response to notices issued by the FDA in 2002 and 2003 with respect to single-entity timed-release guaifenesin products, and a further notice issued in 2007 with respect to combination timed-released guaifenesin products, we timely discontinued a number of our guaifenesin products and believed that, by doing so, had complied with those notices. The recent action to place a hold on certain of our products indicates that additional guaifenesin products should also have been discontinued. In addition, the FDA expanded the hold to include other products that did not contain guaifenesin but were being marketed without FDA approval under certain "grandfather clauses" and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the FDCA. FDA policies permit the agency to initiate broad action against the marketing of additional categories of our unapproved products, if the FDA deems approval necessary, even if the agency has not instituted similar actions against the marketing of such products by other parties. Pursuant to discussions with the Missouri Department of Health and Senior Services and with the FDA, the affected Morphine and Oxycodone products have been released from the hold. We will discontinue 24 manufacturing and marketing all of the other unapproved products subject to the hold with the exception of most of our Hyoscyamine products. Discussions are continuing with respect to those products. The FDA has not proposed, nor do we expect them to propose, that the products subject to the hold be recalled from the distribution channel. We have written-off the value of the products subject to the hold in our inventory as of March 31, 2008. We also evaluated the active pharmaceutical ingredients and excipients used in the manufacture of the hold products and determined that they should also be written-off since we will be discontinuing further manufacturing and many of them cannot be returned or sold to other manufacturers. The write-off included in the results of operations for the fourth quarter of fiscal 2008 totaled $5.5 million. 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. We may not ultimately prevail in these litigations, we may not receive final FDA approval of our ANDAs, and we may not achieve our expectation of a period of generic exclusivity for certain of these products 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 exclusivity has been the subject of controversy, court decisions, changes to FDA regulations and guidelines, and other changes in FDA interpretation. In addition, in 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 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, 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 25 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 (1) outside legal advice, (2) the status of a pending lawsuit, (3) interim court decisions, (4) status and timing of a trial, (5) legal decisions affecting other competitors for the same product, (6) market factors, (7) liability sharing agreements, (8) internal capacity issues, (9) expiration dates of patents, (10) strength of lower court decisions and (11) 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, financial condition, results of operations or cash flows. WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS, FOR WHICH WE MAY BE INADEQUATELY INSURED. Manufacturing, selling and testing pharmaceutical products involve a risk of product liability. Even unsuccessful product liability claims could require us to spend money on litigation, divert management's time, damage our reputation and impair the marketability of our products. A successful product liability claim outside of or in excess of our insurance coverage could require us to pay substantial sums and adversely affect our business, financial condition, results of operations or cash flows. We have 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 phenylpropanolamine, or 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 again in 2004, and we demanded that the insurer assume our defense. The insurer has stated that it has retained counsel to secure additional factual information and will defer its coverage decision until that information is received. We intend to vigorously defend our interests, however, we may be impleaded into the action, and, if we are impleaded, we may not 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. 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 may not 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 through license agreements. We also expect to continue to obtain licenses for other products and technologies in the future. Our license agreements generally require us to develop the markets for the licensed products. If we do not develop these markets, the licensors may be entitled to terminate these license agreements. We cannot be certain that we will fulfill all of our obligations under any particular license agreement for any variety of reasons, including insufficient resources to adequately develop and market a product, lack of market development despite our efforts and lack of product acceptance. Our failure to fulfill our obligations could result in the loss of our rights under a license agreement. Certain products we have the right to license are at certain stages of clinical tests and FDA approval. Failure of any licensed product to receive regulatory approval could result in the loss of our rights under its license agreement. 26 WE EXPEND A SIGNIFICANT AMOUNT OF RESOURCES ON RESEARCH AND DEVELOPMENT EFFORTS THAT MAY NOT LEAD TO SUCCESSFUL PRODUCT INTRODUCTIONS. We conduct research and development primarily to enable us to manufacture and market FDA-approved pharmaceuticals in accordance with FDA regulations. Typically, research costs related to the development of innovative compounds and the filing of NDAs are significantly greater than those expenses associated with ANDA filings. As such, our investment in research and development, which increased at a compounded annual growth rate of 19.5% over the five fiscal year period ended March 31, 2008, reflects our ongoing commitment to develop new products and/or technologies through our internal development programs, and with our external strategic partners. Because of the inherent risk associated with research and development efforts in our industry, particularly with respect to new drugs, our research and development expenditures may not result in the successful introduction of FDA approved new pharmaceutical products. Also, after we submit an ANDA, the FDA may request that we conduct additional studies and as a result, we may be unable to reasonably determine the total research and development costs to develop a particular product. Finally, we cannot be certain that any investment made in developing products will be recovered, even if we are successful in commercialization. To the extent that we expend significant resources on research and development efforts and are not able, ultimately, to introduce successful new products as a result of those efforts, our business, financial condition, results of operations or cash flows may be materially adversely affected. ANY SIGNIFICANT INTERRUPTION IN THE SUPPLY OF RAW MATERIALS OR FINISHED PRODUCT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. We typically purchase the active pharmaceutical ingredient (i.e., the chemical compounds that produce the desired therapeutic effect in our products) and other materials and supplies that we use in our manufacturing operations, as well as certain finished products (including Evamist(TM) and, once approved, Gestiva(TM)), from many different domestic and foreign suppliers. Additionally, we maintain safety stocks in our raw materials inventory, and in certain cases where we have listed only one supplier in our applications with the FDA, have received FDA approval to use alternative suppliers should the need arise. However, there is no guarantee that we will always have timely and sufficient access to a critical raw material or finished product. A prolonged interruption in the supply of a single-sourced raw material, including the active ingredient, or finished product could cause our business, financial condition, results of operations or cash flows to be materially adversely affected. In addition, our manufacturing capabilities could be impacted by quality deficiencies in the products which our suppliers provide, which could have a material adverse effect on our business. We utilize controlled substances in certain of our current products and products in development and therefore must meet the requirements of the Controlled Substances Act of 1970 and the related regulations administered by the DEA. These regulations relate to the manufacture, shipment, storage, sale and use of controlled substances. The DEA limits the availability of the active ingredients used in certain of our current products and products in development and, as a result, our procurement quota of these active ingredients may not be sufficient to meet commercial demand or complete clinical trials. We must annually apply to the DEA for procurement quota in order to obtain these substances. Any delay or refusal by the DEA in establishing our procurement quota for controlled substances could delay or stop our clinical trials or product launches, or could cause trade inventory disruptions for those products that have already been launched, which could have a material adverse effect on our business, financial condition, results of operations or cash flows. 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 27 comparable products. As a result, we could 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, our allowances may not be adequate or our actual product returns, allowances and chargebacks may 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 asserted that reporting of inflated AWP's have led to excessive payments for prescription drugs. 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 States of Massachusetts, Alabama, Mississippi, Utah and Iowa, New York City, and approximately 45 counties in New York State. The State of Mississippi effectively voluntarily dismissed the Company and ETHEX without prejudice in October 2006, by virtue of the State's filing an Amended Complaint on such date that does not name either the Company or ETHEX as a defendant. In the remaining cases, only ETHEX is a named defendant. In August 2007, ETHEX settled the Massachusetts lawsuit for $0.6 million in cash and agreed to supply $0.2 million in free pharmaceutical products over the next two years and received a general release with no admission of liability. The New York City case and all New York county cases (other than the Erie, Oswego and Schenectady County cases) have been transferred to the U.S. District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation (MDL No. 1456). The cases pertaining to the State of Alabama, Erie County, Oswego County, and Schenectady County were removed to federal court by a co-defendant in October 2006, but all of these cases have since been remanded to the state courts in which they originally were filed. Each of these actions is in the early stages, with fact discovery commencing or ongoing. In October 2007, ETHEX was served with a complaint naming ETHEX and nine other pharmaceutical companies as defendants in a pricing suit filed in state court in Utah by the State of Utah. The State of Utah filed an amended complaint in November 2007. This suit has been removed to federal court, where the State of Utah is seeking a remand to the state courts. A decision is pending before the court. The time to file an answer or other response in the Utah suit has not yet run. In October 2007, the State of Iowa filed a complaint naming ETHEX and 77 other pharmaceutical companies as defendants in a pricing suit in federal court in the State of Iowa. ETHEX and the other defendants have moved to dismiss the Iowa complaint. The Company intends to vigorously defend its interests in the actions described above; however, we may not prevail in one or more of such cases and the outcome may have a material adverse effect on our future business, financial condition, results of operations or cash flows. 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 may not prevail if legal actions are instituted by these governmental entities. 28 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 business, financial condition, results of operations or cash flows. OUR REVENUES, GROSS PROFIT AND OPERATING RESULTS 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 (the proportion of total sales between branded products and generic/non-branded products). Our sales of branded products generate higher gross margins than our sales of generic/non-branded products. In addition, the introduction of new generic products at any given time can involve significant initial quantities being purchased by our wholesaler customers, as they supply initial quantities to pharmacies and purchase product for their own wholesaler inventories. As a result, our sales mix will significantly impact our gross profit from period to period. During fiscal 2008, sales of our branded products and generic/non-branded products accounted for 35.7% and 61.1%, respectively, of our net revenues. During that year, branded products and generic/non-branded products contributed gross margins of 89.7% and 63.1%, respectively, to our consolidated gross profit margin of 69.0% in fiscal 2008. Factors that may cause our sales mix to vary include: o the amount and timing of new product introductions; o marketing exclusivity on products, if any, which may be obtained; 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 buying patterns of our three largest wholesaler customers; o the scope and outcome of governmental regulatory action that may involve us; o periodic dependence on a relatively small number of products for a significant portion of net revenue or income; and o legal actions brought by our competitors. 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. If our revenues and gross profit decline or do not grow as anticipated, we may not be able to correspondingly reduce our operating expenses. INCREASED INDEBTEDNESS MAY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. At March 31, 2008, we had $269.5 million of outstanding debt, consisting of $200.0 million principal amount of Contingent Convertible Subordinated Notes due 2033 (the "Notes"), the remaining principal balance of a $43.0 million mortgage loan entered into in March 2006, and $30.0 million of borrowings outstanding under our credit facility. We have a credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320.0 million. This credit facility also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50.0 million. The credit agreement is unsecured unless we, under certain specified circumstances, utilize the facility to redeem part or all of our outstanding Notes. The credit facility has a five-year term expiring in June 2011. 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 increases in interest rates; and 29 o the level of our outstanding debt and the impact it has on our ability to meet debt covenants associated with our revolving line of credit arrangement may affect our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes. General economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which are beyond our control, may affect our future performance. As a result, our business might not continue to generate cash flow at or above current levels. If we cannot generate sufficient cash flow from operations in the future to service our debt, we may, among other things: o seek additional financing in the debt or equity markets; 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, and/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, additional funds may not 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. Even though no holders required us to repurchase all or a portion of their Notes on May 16, 2008, we classified the Notes as a current liability as of March 31, 2008 due to the right the holders had to require us to repurchase the Notes on May 16, 2008. Since the holders did not elect to cause us to repurchase any of the Notes, the Notes will be reclassified as long-term liabilities beginning with our consolidated balance sheet as of June 30, 2008. 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 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. We may raise additional capital 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. Additional funding may not be accessible or available to us on favorable terms or at all. 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 BE ADVERSELY IMPACTED BY ECONOMIC FACTORS BEYOND OUR CONTROL AND MAY INCUR IMPAIRMENT CHARGES TO OUR INVESTMENT PORTFOLIO. We have funds invested in auction rate securities ("ARS"). Consistent with our investment policy guidelines, the ARS held by us are AAA rated securities with long-term nominal maturities secured by student loans which are guaranteed by the U.S. Government. The interest rates on these securities are reset through an auction process at pre-determined intervals, up to 35 days. There may be liquidity issues which arise in the credit and capital 30 markets and the ARS held by us may experience failed auctions as the amount of securities submitted for sale may exceed the amount of purchase orders. As a result, we may not be able to liquidate some or all of our ARS prior to their maturities at prices approximating their face amounts. During the fourth quarter of fiscal 2008, disruption in the credit and capital markets adversely affected the auction market for the type of securities we own and the ARS held by us experienced failed auctions as the amount of securities submitted for sale exceeded the amount of purchase orders. If uncertainties in these credit and capital markets continue or these markets deteriorate further we may incur other-than-temporary impairments to our investments in ARS, which could negatively affect our financial condition, cash flow and reported earnings. (See Note 4 of the Notes to Consolidated Financial Statements for further discussion of the Company's investment in ARS.) We believe that as of March 31, 2008, based on our current cash, cash equivalents and marketable securities balances of $126.9 million (exclusive of auction rate securities) and our current borrowing capacity of $290.0 million under our credit facility, the current lack of liquidity in the auction rate market will not have a material impact on our ability to fund our operations or interfere with our external growth plans, although, we cannot assure you that this will continue to be the case. 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 statements of income over the estimated economic useful life of the related asset. The factors that affect 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 and the impact of promotional efforts, among many others. We consider all of these factors in initially estimating the economic useful lives of our products, and we also continuously monitor these factors for indications of decline in carrying value. 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. Because circumstances after an acquisition can change, the value of intangible assets we record 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 might not recover our recorded value of associated intangible assets. 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 CONDITION AND RESULTS OF OPERATIONS. The consolidated financial statements that we file with the SEC are prepared in accordance with GAAP. The preparation of financial statements in accordance with 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 GAAP include, but are not limited to, those related to revenue recognition and reductions to gross revenues, inventory valuation, intangible 31 assets, stock-based compensation, income taxes and loss contingencies related to legal proceedings. 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. 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 health maintenance organizations ("HMO's") and managed care organizations ("MCO's"). Insurance companies, HMOs, MCOs, Medicaid and Medicare administrators and others regularly challenge the pricing of pharmaceutical products and review 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 U.S.; 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 or of unapproved products may be uncertain. Reimbursement policies may not include some of our products or government agencies or third parties may assert that certain of our products are not eligible for Medicaid, Medicare or other reimbursement and were not so eligible in the past, possibly resulting in demands for damages or refunds. 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 business, financial condition, results of operations or cash flows. 32 EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A SIGNIFICANT IMPACT ON OUR INDUSTRY AND 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 or holds, recall or seizure of products and total or partial suspension of production, as well as other regulatory actions against our products and us. 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 Company received a subpoena from the Office of Inspector General of the Department of Health and Human Services, seeking documents with respect to two of ETHEX's nitroglycerin products. Both are unapproved products, that is, they have not received FDA approval. (FDA approval is not necessarily required for all drugs to be sold in the marketplace, such as pre-1938 "grandfathered" products or certain drugs reviewed under the so-called DESI process. The Company believes that its two products come within these exceptions.) The subpoena states that it is in connection with an investigation into potential false claims under Title 42 of the U.S. Code, and appears to pertain to whether these products are eligible for reimbursement under federal health care programs, such as Medicaid and VA programs. On June 6, 2008, ETHEX initiated a voluntary recall of a single lot of morphine sulfate 60 mg extended release tablets due to a report that a tablet with as much as double the appropriate thickness was identified and therefore the possibility that other oversized tablets could have been commercially released in the affected lot. On June 13, 2008, the recall was expanded to include additional specific lots of morphine sulfate 60 mg extended release tablets and specific lots of morphine sulfate 30 mg extended release tablets. We accrued a liability of $0.9 million in the fourth quarter of fiscal 2008 for the anticipated cost of the recall. No oversized tablets have been identified in any additional distributed lots of these products and based on our investigation, there are likely to be few, if any, oversized tablets in the recall lots. In addition, under ordinary pharmacy dispensing procedures, any significantly oversized tablets would likely be identified at the time of dispensing. However, the decision to recall the additional lots has been taken as a responsible precaution because of the possibility that there may be oversized tablets in the recalled lots. 33 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. 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: developments regarding litigation and actual or potential investigations regarding our former stock option grant practices, our reporting of prices used by government agencies or third parties in setting reimbursement rates, the introduction by other companies of generic or competing products, or the eligibility of our products for Medicaid, Medicare or other reimbursement; announcements by us or our competitors of technological innovations or new commercial products; delays in the development or approval of products; regulatory withdrawals of our products from the market; 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 U.S. 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, 2008, an aggregate of 3,697,049 shares of our Class A Common Stock and 236,415 shares of our Class B Common Stock were issuable upon exercise of outstanding stock options under our stock option plans, and an additional 96,405 shares of our Class A Common Stock and 1,212,500 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, 2008, 8,691,880 shares of Class A Common Stock were reserved for issuance upon conversion of $200.0 million principal amount of Notes, and 337,500 shares of our Class A Common Stock were reserved for issuance upon conversion of our outstanding 7% Cumulative Convertible Preferred Stock. Future sales of our common stock and instruments convertible or exchangeable into our common stock and transactions involving equity derivatives relating to our common stock, or the perception that such sales or transactions could occur, could adversely affect the market price of our common stock. This could, in turn, have an adverse effect on the trading price of the Notes resulting from, among other things, a delay in the ability of holders to convert their Notes into our Class A Common Stock. MANAGEMENT SHAREHOLDERS CONTROL OUR COMPANY. At March 31, 2008, our directors and executive officers beneficially own approximately 16.4% of our Class A Common Stock and approximately 89.3% of our Class B Common Stock. As a result, these persons control approximately 57.3% of the combined voting power represented by our outstanding securities. These persons will retain effective voting control of our Company and are expected to continue to have the ability to effectively determine the outcome of any matter being voted on by our shareholders, including the election of directors and any merger, sale of assets or other change in control of our Company. 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 34 one-twentieth of one vote on all matters to be voted upon by shareholders, while each share of Class B Common Stock entitles the holder to one full vote on each matter considered by the shareholders. 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 shareholders. 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 shareholder" (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. 35 ITEM 2. PROPERTIES ---------- Our corporate headquarters is located at 2503 South Hanley Road in St. Louis County, Missouri, and contains approximately 35,000 square feet of floor space. We have a lease on the building for a period of five years expiring December 31, 2011, with one 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, Missouri metropolitan area.
SQUARE LEASE RENEWAL FOOTAGE USAGE EXPIRES OPTIONS -------------------------------------------------------------------------------------------------------------- Leased Facilities 30,150 PDI Mfg./Whse. 11/30/12 5 Years(1) 10,000 PDI/KV Lab/Whse. 11/30/08 None 15,000 KV/PDI Office 02/29/10 2 Years 23,000 KV Office/R&D/Mfg. 12/31/11 5 Years(1) 41,316 KV Warehouse 11/30/16 None 33,860 Pharmaceutical Division Offices 05/01/13 5 Years ------ 153,326 Owned Facilities 126,168 KV Office/Mfg 121,472 KV Office/Whse./Lab(2) 87,250 KV Mfg. 88,850 KV Lab 302,940 KV Mfg/Whse/ETHEX/Ther-Rx Office (2) 259,990 ETHEX/Ther-Rx/PDI Distribution(2) 96,360 KV Warehouse ------ 1,083,030 ---------------------------------------- (1) Two five-year options. (2) In March 2006, we entered into a $43.0 million mortgage loan agreement with one of our primary lenders secured, in part, by these properties. 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 - of the Notes to Consolidated Financial Statements included in Part I, Item 8 of this report is incorporated in this Item 3 by reference. 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, 2008. 36 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 - ---------------------------------------------------------------------------------------------------------------------------------- Michael S. Anderson 59 Corporate Vice President, Industry Presence and Development since February 2006; Chief Executive Officer, Ther-Rx Corporation from February 2000 to February 2006. Gregory S. Bentley 58 Senior Vice President and General Counsel since April 2006; Executive Vice President, General Counsel and Corporate Compliance Officer, AAI Pharma, Inc. from 1999 to April 2006. Rita E. Bleser 52 President, Pharmaceutical Manufacturing Division since April 2007; Vice President, Technology, Tyco Healthcare from September 2001 to April 2007. Paul T. Brady 45 Corporate Vice President, Business Development Administration, KV Pharmaceutical since 2007; 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. Richard H. Chibnall 52 Vice President, Finance and Chief Accounting Officer since June 2005; Vice President, Finance from February 2000 to June 2005. Raymond F. Chiostri 74 Corporate Vice President, KV Pharmaceutical since September 2006; Chairman and Chief Executive Officer of Particle Dynamics, Inc. from 1999 to September 2006. Gregory J. Divis, Jr. 41 President, Ther-Rx Corporation since July 2007; Vice President, Business Development and Life Cycle Management, Sanofi-aventis U.S. from February 2006 to July 2007; Vice President Sales, Respiratory East, Sanofi-aventis U.S. from June 2004 to February 2006; Executive Director, Sales and Marketing National Accounts, Reliant Pharmaceuticals from December 2003 to June 2004; Vice President and Country Manager United Kingdom and Ireland, Schering-Plough from May 2002 to December 2003; Vice President, Field Operations Oncology-Biotech Division, Schering-Plough from October 2000 to April 2002. Marc S. Hermelin(1) 66 Chairman of the Board and Chief Executive Officer since August 2006; Vice Chairman and Chief Executive Officer from 1975 to August 2006; Vice Chairman of the Board from 1974 to 1975. Ronald J. Kanterman 53 Vice President, Chief Financial Officer, Treasurer and Assistant Secretary since March 2008; Vice President, Strategic Financial Management, Treasurer, and Assistant Secretary from March 2006 to February 2008; Vice President, Treasury from January 2004 to March 2006; Partner, Brown Smith Wallace, LLP from 1993 to January 2004; Partner, Arthur Andersen & Co., from 1987 to 1993. Patricia K. McCullough 56 Chief Executive Officer, ETHEX Corporation since January 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. David A. Van Vliet 53 Chief Administration Officer since September 2006; Director from August 2004 to September 2006; President and Chief Operating Officer of Angelica Corporation from June 2005 to September 2006; President and Chief Executive Officer of Growing Family, Inc. from 1998 to June 2005. Executive officers of the Company serve at the pleasure of the Board of Directors. - ------------------------------- (1) Marc S. Hermelin is the father of David S. Hermelin, Vice President, Corporate Strategy & Operation Analysis, a member of the Board of Directors since 2004.
37 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS ---------------------------------------------------------------------- AND ISSUER PURCHASES OF EQUITY SECURITIES ----------------------------------------- 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 March 31, 2008, was 893 and 313, respectively (not separately counting shareholders whose shares are held in "nominee" or "street" names, which are estimated to represent approximately 5,000 additional holders of Class A Common Stock and Class B Common Stock 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 2008 and 2007, as reported on the New York Stock Exchange were as follows:
CLASS A COMMON STOCK -------------------- FISCAL 2008 FISCAL 2007 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- ---------------------- ----------------------- First...................... $28.35 $24.58 $24.31 $17.50 Second..................... 28.80 26.09 23.94 16.90 Third...................... 31.34 27.16 24.91 21.74 Fourth..................... 28.20 24.71 26.28 22.83 CLASS B COMMON STOCK -------------------- FISCAL 2008 FISCAL 2007 ----------- ----------- QUARTER HIGH LOW HIGH LOW ------- ---------------------- ----------------------- First...................... $28.40 $24.61 $24.27 $17.48 Second..................... 28.90 25.96 23.92 16.92 Third...................... 31.25 27.30 24.86 21.78 Fourth..................... 28.09 24.63 26.21 22.71
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 each of fiscal 2008 and 2007 on 40,000 shares of outstanding Cumulative Convertible Preferred Stock. There were no undeclared and unaccrued cumulative preferred dividends at March 31, 2008. 38 Also, under the terms of our credit agreement, we may not pay cash dividends in excess of 25% of the prior fiscal year's consolidated net income. For the foreseeable future, we plan to use cash generated from operations for general corporate purposes, including funding potential acquisitions, research and development and working capital. Our board of directors reviews our dividend policy periodically. Any payment of dividends in the future will depend upon our earnings, capital requirements, financial condition and other factors considered relevant by our board of directors. See also Note 16 of the Notes to Consolidated Financial Statements for information relating to our equity compensation plans. - ---------------------------------------------------------------------------------------------------------------------- ISSUER PURCHASES OF EQUITY SECURITIES - ---------------------------------------------------------------------------------------------------------------------
PERIOD TOTAL NUMBER OF WEIGHTED TOTAL NUMBER OF MAXIMUM NUMBER OF SHARES PURCHASED AVERAGE PRICE PAID SHARES PURCHASED AS SHARES (OR UNITS) (a) PER SHARE PART OF PUBLICLY THAT MAY YET BE ANNOUNCED PLANS OR PURCHASED UNDER THE PROGRAMS PLANS OR PROGRAMS - ------------------------- ---------------------- ----------------------- ---------------------- ---------------------- 1/1/08 - 1/31/08 104 $27.61 - - - --------------------------------------------------------------------------------------------------------------------- 2/1/08 - 2/29/08 37 $27.51 - - - --------------------------------------------------------------------------------------------------------------------- 3/1/08 - 3/31/08 1,247 $25.46 - - - --------------------------------------------------------------------------------------------------------------------- Total 1,388 $25.67 - - - --------------------------------------------------------------------------------------------------------------------- (a) Shares were purchased from employees upon their termination pursuant to the terms of the Company's Stock Option Plan.
39 EQUITY COMPENSATION PLAN INFORMATION The following information regarding compensation plans of the Company is furnished as of March 31, 2008, the end of the Company's most recently completed fiscal year. EQUITY COMPENSATION PLAN INFORMATION REGARDING CLASS A COMMON STOCK - ----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) ------------------- ---------------------------- ------------------------ PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders (1) 3,697,049 $19.09 96,405 Equity compensation plans not approved by security holders -- -- -- --------- ------ ------ Total 3,697,049 $19.09 96,405 ========= ====== - ------------------------------- (1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans. See Note 16 of the Notes to Consolidated Financial Statements. EQUITY COMPENSATION PLAN INFORMATION REGARDING CLASS B COMMON STOCK - ---------------------------------------------------------------------------------------------------------------------- NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES TO BE FUTURE ISSUANCE UNDER ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING (EXCLUDING SECURITIES WARRANTS AND RIGHTS OPTIONS, WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)) ------------------- ---------------------------- ------------------------ PLAN CATEGORY (a) (b) (c) Equity compensation plans approved by security holders (1) 236,415 $14.85 1,212,500 Equity compensation plans not approved by security holders -- -- -- ------- ------ --------- Total 236,415 $14.85 1,212,500 ======= ========= - ------------------------------- (1) Consists of the Company's 1991 and 2001 Incentive Stock Option Plans. See Note 16 of the Notes to Consolidated Financial Statements.
40 STOCK PRICE PERFORMANCE GRAPH Set forth below is a line-graph presentation comparing cumulative shareholder returns for the last five fiscal years on an indexed basis with the NYSE Composite Index and the S&P Pharmaceuticals Index, a nationally recognized industry standard index. The graph assumes the investment of $100 in Company Class A Common Stock and $100 in Class B Common Stock, the NYSE Composite Index, and the S&P Pharmaceuticals Index on March 31, 2003, and reinvestment of all dividends. The Company's stock performance may not continue into the future with the same or similar trends depicted in the graph below. [COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN GRAPH] YEARS ENDED MARCH 31, ---------------------
2004 2005 2006 2007 2008 ---- ---- ---- ---- ---- K-V PHARMACEUTICAL COMPANY 210.92 200.13 201.57 202.83 203.75 NYSE COMPOSITE 142.52 158.13 185.71 213.48 207.39 S&P PHARMACEUTICALS 105.12 100.38 101.53 113.21 104.33
41 ITEM 6. SELECTED FINANCIAL DATA ----------------------- The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and the notes thereto in Part II, Item 8 and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this report. The selected consolidated financial data presented below under the captions "BALANCE SHEET DATA" and "INCOME STATEMENT DATA" as of and for each of the years in the five-year period ended March 31, 2008 is derived, with respect to the years ended March 31, 2008, 2007 and 2006, from our audited consolidated financial statements, and, with respect to the years ended March 31, 2005 and 2004, from the selected financial data of the Company included in our Form 10-K for the year ended March 31, 2007. The consolidated financial statements as of March 31, 2008 and 2007, and for each of the years in the three-year period ended March 31, 2008, which have been audited by KPMG LLP, our independent registered public accounting firm, are included in Part II, Item 8 of this report. BALANCE SHEET DATA
(in thousands) MARCH 31, ------------------------------------------------------------------------------- 2008 2007 2006 2005 2004 -------- -------- -------- -------- -------- Cash, cash equivalents and marketable securities $126,893 $240,386 $207,469 $205,519 $226,911 Working capital 88,764 372,291 304,958 296,240 301,604 Property and equipment, net 196,200 186,900 178,042 131,624 75,777 Total assets 869,027 707,783 619,313 558,952 527,679 Current liabilities 280,655 59,179 44,332 41,577 55,745 Long-term debt 67,432 239,451 241,319 209,767 210,741 Shareholders' equity 459,282 364,827 302,999 286,477 252,721
INCOME STATEMENT DATA
(in thousands, except per share data) YEARS ENDED MARCH 31, -------------------------------------------------------------------------------- 2008 2007 2006 2005 2004 --------- --------- --------- --------- --------- Net revenues $ 601,896 $ 443,627 $ 367,640 $ 304,656 $ 282,994 Operating income (a)(b) 130,370 88,156 36,157 51,684 70,600 Net income (a)(b) 88,354 58,090 11,416 31,217 41,700 Earnings per share: Diluted - Class A common $ 1.57 $ 1.05 $ 0.23 $ 0.60 $ 0.78 Diluted - Class B common 1.35 0.91 0.20 0.52 0.68 Shares used in per share calculation: Diluted - Class A common 59,144 58,953 49,997 58,633 57,792 Diluted - Class B common 12,281 12,489 13,113 15,072 16,175 Preferred stock dividends $ 70 $ 70 $ 70 $ 70 $ 436 - ---------------------- (a) Operating income in fiscal 2008 included purchased in-process research and development expenses of $10.0 million and $7.5 million recorded in connection with the Evamist(TM) and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes to the Consolidated Financial Statements). The impact of these items was to decrease net income on an after-tax basis by $11.7 million in fiscal 2008. (b) 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 of the Notes to Consolidated Financial Statements). The impact of this item, which is not deductible for tax purposes, was to decrease net income by $30.4 million in fiscal 2006.
42 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- 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, manufactures, acquires 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 diverse 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), 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 Net revenues for fiscal 2008 increased $158.3 million, or 35.7%, as we experienced sales growth of 56.1% in our specialty generics/non-branded products segment. The increase in specialty generic net revenues resulted primarily from the launch in July 2007 of the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, which along with the 25 mg approved and launched in March 2008, generated net revenues of $120.0 million in fiscal 2008. The resulting $119.0 million increase in gross profit was offset in part by a $76.8 million increase in operating expenses. The increase in operating expenses was primarily due to increases in personnel costs, branded marketing and promotions expense, legal fees, research and development expense, and amortization of intangibles. Operating expenses for fiscal 2008 also included purchased in-process research and development expenses of $10.0 million and $7.5 million recorded in connection with the Evamist(TM) and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes to the Consolidated Financial Statements). As a result, net income for fiscal 2008 increased $30.3 million, or 52.1%, to $88.4 million. 43 FISCAL 2008 COMPARED TO FISCAL 2007 NET REVENUES BY SEGMENT -----------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE ------------------- ($ IN THOUSANDS): 2008 2007 $ % ------------- ------------ ---------- ----- Branded products $ 214,863 $ 188,681 $ 26,182 13.9% as % of net revenues 35.7% 42.5% Specialty generics/non-branded 367,862 235,594 132,268 56.1% as % of net revenues 61.1% 53.1% Specialty materials 18,020 17,436 584 3.3% as % of net revenues 3.0% 3.9% Other 1,151 1,916 (765) (39.9)% ------------- ------------ ---------- Total net revenues $ 601,896 $ 443,627 $ 158,269 35.7%
The increase in branded product sales was due primarily to continued sales growth of our anti-infective brand, Clindesse(R), coupled with increased sales from our prescription prenatal and hematinic product lines. Sales of Clindesse(R) increased 27.4% to $40.5 million during fiscal 2008 due to an increase in prescription volume of 27.4% coupled with the impact of price increases over the past year. Sales from our PreCare(R) product line increased 13.7% to $82.5 million during fiscal 2008. This increase was primarily due to sales growth experienced by PrimaCare ONE(R) and PreCare Premier(R), coupled with product line price increases. Specifically sales of PrimaCare ONE(R) increased $13.3 million, or 30.3%, to $57.0 million in fiscal 2008. This increase reflected the impact of price increases over the past 12 months coupled with continued market share gains as PrimaCare ONE(R)'s share of the prescription prenatal vitamin market improved to 27.2% at the end of the fiscal 2008, up from 23.1% at the end of fiscal 2007. During June 2008, a third party company has introduced a product that purports to be substitutable for PrimaCare ONE(R), and we are currently in litigation with this company with respect to patent and trademark infringement and other claims. See Note 12 of the Notes to Consolidated Financial Statements. Sales of our hematinic products increased 11.6% to $53.8 million in fiscal 2008, which primarily reflected sales growth of our newest hematinic product, Repliva 21/7(R). Sales of Gynazole-1(R), our vaginal antifungal cream product, declined 2.7% to $24.0 million during fiscal 2008. The fluctuation in Gynazole-1(R) sales reflected the impact of a decline in market share, offset in part by price increases that occurred in the first and fourth quarters of fiscal 2008. Branded product sales were also impacted by the introduction of Evamist(TM) at the end of fiscal 2008. Evamist(TM), a unique transdermal estrogen therapy that delivers a low dose of estradiol in a once-daily spray, was acquired in May 2007 and received FDA approval in July 2007. We began shipping this new product at the end of March 2008 and generated fiscal 2008 sales of $2.0 million. We believe Evamist(TM) will significantly augment the women's health offerings of our branded segment as we leverage the promotion of this product through our expanded branded sales force. The growth in specialty generic/non-branded sales resulted primarily from the launch in July 2007 of the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R) (marketed by AstraZeneca). 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 these generic formulations. Since we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, we were accorded the opportunity for a 180-day exclusivity period for marketing these two dosage strengths. We began shipping these two products in July 2007 and they generated net revenues of $119.1 million during fiscal 2008. We received FDA approval to market the 25 mg strength of metoprolol succinate extended-release tablets in March 2008 and began shipping this product at that time. Sales of this product totaled $0.9 million in fiscal 2008. In addition, we received FDA approval to market the 50 mg strength of metoprolol succinate extended-release tablets in May 2008. As a result of the recent 50 mg approval, we now offer the complete line of all four dosage strengths of metoprolol succinate extended-release tablets - 200 mg, 100 mg, 50 44 mg and 25 mg - and as of March 2008, we had a 69.1% and 72.5% share of the generic market according to IMS Inc. for the 200 mg and 100 mg strengths, respectively. Our specialty generic sales for the year were also favorably impacted by sales of six strengths of Diltiazem HCI ER Capsules (AB rated to Tiazac(R)) which we launched in September 2006. These products generated net revenues of $22.1 million in fiscal 2008, an increase of $10.5 million over the prior year amount. GROSS PROFIT BY SEGMENT -----------------------
YEARS ENDED MARCH 31, --------------------------------------------------- CHANGE -------------------- ($ IN THOUSANDS): 2008 2007 $ % ------------ ----------- ---------- ------ Branded products $ 192,666 $ 167,864 $ 24,802 14.8% as % of net revenues 89.7% 89.0% Specialty generics/non-branded 232,182 138,272 93,910 67.9% as % of net revenues 63.1% 58.7% Specialty materials 7,173 6,005 1,168 19.5% as % of net revenues 39.8% 34.4% Other (16,680) (15,777) (903) (5.7)% ------------- ----------- ---------- Total gross profit $ 415,341 $ 296,364 $ 118,977 40.1% as % of total net revenues 69.0% 66.8%
The increase in gross profit was primarily due to the sales growth experienced by our specialty generics and branded products segments. The increase in specialty generic sales resulted primarily from the launch in July 2007 of the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, which along with the 25 mg approved and launched in March 2008, generated net revenues of $120.0 million in fiscal 2008. Since we were the first company to file with the FDA for generic approval of the 100 mg and 200 mg dosage strengths, we were accorded the opportunity for a 180-day exclusivity period for marketing these two dosage strengths. The gross profit percentages at our specialty generic/non-branded segment and on a consolidated basis increased over the prior year because the 180-day exclusivity period allowed us to offer the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets at relatively higher margins than our other generic/non-branded products. Impacting the "Other" category are contract manufacturing revenues, pricing and production variances, and changes to inventory reserves associated with production. Any inventory reserve changes associated with finished goods are reflected in the applicable segment. During fiscal 2008, the provision for obsolete inventory increased to $18.8 million compared to $12.0 million in fiscal 2007. The increase in the provision for obsolete inventory was primarily due to the impact of the FDA hold on certain unapproved specialty generic products that occurred in March 2008. We included in the reserve for obsolete inventory $5.5 million for all of the unapproved specialty generic products subject to the FDA hold, including the raw materials used to manufacture the products and work-in-process inventories that we had on hand at March 31, 2008. RESEARCH AND DEVELOPMENT ------------------------
YEARS ENDED MARCH 31, --------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS): 2008 2007 $ % ----------- ----------- ---------- ---- Research and development $ 46,634 $ 31,462 $ 15,172 48.2% as % of net revenues 7.7% 7.1%
45 The increase in research and development expense was primarily due to a growing product development pipeline, 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. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT ---------------------------------------------
YEARS ENDED MARCH 31, ----------------------------------------------------- CHANGE -------------------- ($ IN THOUSANDS): 2008 2007 $ % ----------- ----------- ----------- ----- Purchased in-process research and development $ 17,500 $ - $ 17,500 NM
In May 2007, we acquired from VIVUS, Inc the U.S. marketing rights to Evamist(TM), a new estrogen replacement therapy product delivered with a patented metered-dose transdermal spray system (see Note 3 of the Notes to Consolidated Financial Statements). Under terms of the agreement, we paid $10.0 million in cash at closing and made additional cash payments of $141.5 million in July 2007 when final approval of the product was received from the FDA. Since the product had not yet obtained FDA approval when the initial payment was made at closing, we recorded a $10.0 million purchased in-process research and development charge in fiscal 2008. In January 2008, we entered into a definitive asset purchase agreement with CYTYC to acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate). The NDA for Gestiva(TM) is currently before the FDA, pending approval for use in the prevention of preterm birth in certain categories of pregnant women. Under the terms of the asset purchase agreement, we agreed to pay $82.0 million for Gestiva(TM), $7.5 million of which was paid at closing. Because the product had not obtained FDA approval when the initial payment was made, we recorded the $7.5 million payment as in-process research and development expense in fiscal 2008. SELLING AND ADMINISTRATIVE --------------------------
YEARS ENDED MARCH 31, ----------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2008 2007 $ % --------- --------- -------- ---- Selling and administrative $ 208,206 $ 171,936 $ 36,270 21.1% as % of net revenues 34.6% 38.8%
The increase in selling and administrative expenses was primarily due to: o $13.9 million increase in personnel costs due to increases in management, sales and other personnel; o $8.3 million increase in branded marketing and promotions expense; o $2.3 million increase in travel and auto leasing costs at our branded products segment; o $4.0 million increase in legal and professional expense commensurate with an increase in litigation activity; and o $4.5 million increase in costs associated with redistribution fees paid to major wholesalers and chains. Redistribution fees are fees paid to large customers for single point shipping services which allow manufacturers to ship to a single location rather than to multiple customer warehouse locations. 46 AMORTIZATION AND IMPAIRMENT OF INTANGIBLE ASSETS ------------------------------------------------
YEARS ENDED MARCH 31, -------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2008 2007 $ % ---------- ----------- ------- ----- Amortization and impairment of intangible assets $ 12,631 $ 4,810 $ 7,821 162.6% as % of net revenues 2.1% 1.1%
The increase in the amortization of intangible assets of $6.7 million was primarily due to the purchase of Evamist(TM) in May 2007 and the impact of intangible assets that we recorded thereon (see Note 3 of the Notes to Consolidated Financial Statements). Under terms of the purchase agreement, we made two cash payments: $10.0 million was paid in May 2007 and expensed as in-process research and development and $141.5 million was paid in July 2007 when final approval of the product was received from the FDA. The preliminary purchase price allocation, which is subject to change based on the final fair value assessment, resulted in estimated identifiable intangible assets of $52.4 million to product rights; $15.2 million to trademark rights; $66.4 million to rights under a sublicense agreement; and, $7.5 million to a covenant not to compete. Upon FDA approval in July 2007, we began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years. During the year ended March 31, 2008, we recognized an impairment charge of $1.1 million for the intangible asset related to a product right acquired under an external development agreement. Price erosion on the product eliminated the economics of marketing the product. The entire balance of the intangible asset was written-off as the product is no longer expected to generate positive future cash flows. OPERATING INCOME ----------------
YEARS ENDED MARCH 31, ------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS): 2008 2007 $ % --------- -------- --------- ---- Operating income $ 130,370 $ 88,156 $ 42,214 47.9%
The improvement in operating income was primarily due to sales of the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets. We began shipping these two products in July 2007 and they generated net revenues of $119.1 million during the year. The related increase in gross profit of $119.0 million was offset in part by a $76.8 million increase in operating expenses, which included purchased in-process research and development expenses of $10.0 million and $7.5 million recorded in connection with the Evamist(TM) and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes to the Consolidated Financial Statements). Excluding the effect of the $17.5 million of purchased in-process research and development expense, operating income for fiscal 2008 would have increased $59.7 million, or 67.7%. INTEREST EXPENSE ----------------
YEARS ENDED MARCH 31, --------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2008 2007 $ % --------- ------- ------- ---- Interest expense $ 10,353 $ 8,985 $ 1,368 15.2%
The increase in interest expense was primarily the result of interest incurred on the $50.0 million of borrowings made under our credit facility in August 2007. The advance against our credit facility was used, along with cash on hand, to fund the $141.5 million payment for the purchase of Evamist(TM) (see Note 3 of the Notes to 47 Consolidated Financial Statements). We repaid $20.0 million of the borrowing against our credit facility in November 2007. INTEREST AND OTHER INCOME -------------------------
YEARS ENDED MARCH 31, ------------------------------------------------ CHANGE ---------------- ($ IN THOUSANDS): 2008 2007 $ % ---------- ------- ------- ---- Interest and other income $ 11,646 $ 9,901 $ 1,745 17.6%
The increase in interest and other income resulted primarily from an increase in the weighted average interest rate earned on short-term investments. The increase in the weighted average interest rate resulted principally from a restructuring of the investment portfolio in the prior year from short-term tax-exempt securities to short-term taxable securities. PROVISION FOR INCOME TAXES --------------------------
YEARS ENDED MARCH 31, ------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS EXCEPT PER SHARE DATA): 2008 2007 $ % --------- --------- --------- ---- Provision for income taxes $ 43,309 $ 32,958 $ 10,351 31.4% effective tax rate 32.9% 37.0%
The lower effective tax rate in fiscal 2008 resulted primarily from the reversal of certain tax liabilities associated with tax positions from previous years that were determined to no longer be necessary as the relevant statute of limitations had expired. The effective tax rates for both the current and prior periods were favorably impacted by the domestic manufacturer's deduction and the use of business credits. (See Note 15 of the Notes to Consolidated Financial Statements). The fiscal 2007 tax rate was adversely affected by the recording of additional liabilities associated with tax positions claimed on filed tax returns. NET INCOME AND DILUTED EARNINGS PER SHARE -----------------------------------------
YEARS ENDED MARCH 31, ------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS EXCEPT PER SHARE DATA): 2008 2007 $ % -------- -------- --------- ---- Net income $ 88,354 $ 58,090 $ 30,264 52.1% Diluted earnings per Class A share 1.57 1.05 0.52 49.5% Diluted earnings per Class B share 1.35 0.91 0.44 48.4%
The improvement in net income per share was primarily due to sales of the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets. We began shipping these two products in July 2007 and along with the approval and launch of the 25 mg in March 2008, they generated net revenues of $120.0 million during the year. The increase in gross profit of $119.0 million was offset in part by a $76.8 million increase in operating expenses, which included purchased in-process research and development expenses of $10.0 million and $7.5 million recorded in connection with the Evamist(TM) and Gestiva(TM) acquisitions, respectively (see Note 3 of the Notes to the Consolidated Financial Statements). Excluding the effect of the purchased in-process research and development expense, net income for fiscal 2008 would have increased $42.0 million, or 72.3%. 48 FISCAL 2007 COMPARED TO FISCAL 2006 NET REVENUES BY SEGMENT -----------------------
YEARS ENDED MARCH 31, --------------------------------------------------- CHANGE ------------------- ($ IN THOUSANDS): 2007 2006 $ % ------------ ------------ ---------- ---- Branded products $ 188,681 $ 145,503 $ 43,178 29.7% as % of net revenues 42.5% 39.6% Specialty generics/non-branded 235,594 203,787 31,807 15.6% as % of net revenues 53.1% 55.4% Specialty materials 17,436 16,988 448 2.6% as % of net revenues 3.9% 4.6% Other 1,916 1,362 554 40.7% ------------- ------------ ---------- Total net revenues $ 443,627 $ 367,640 $ 75,987 20.7%
The increase in branded product sales was due primarily to continued sales growth from our prescription prenatal and hematinic product lines coupled with increased sales of our anti-infective brand, Clindesse(R). Sales from our PreCare(R) product line increased 44.1% to $72.5 million during fiscal 2007. This increase was primarily due to sales growth experienced by PrimaCare ONE(R), the introduction of PreCare Premier(R) and product line price increases that occurred over the past 12 months. Sales of PrimaCare ONE(R) in fiscal 2007 increased $22.3 million, or 104.2%, due primarily to market share gains over the past two years. Specifically, PrimaCare ONE(R) experienced an increase in prescription volume of 101.9% during fiscal 2007. Sales from our hematinic products increased 31.0% to $48.2 million in fiscal 2007. These increases primarily reflected $8.3 million of incremental sales of Repliva 21/7(R), a new hematinic product introduced in the second quarter of fiscal 2006, coupled with increased sales from our Niferex(R) products. Clindesse(R), a single-dose prescription cream therapy indicated to treat bacterial vaginosis, experienced sales growth of 44.6% to $31.8 million during fiscal 2007 as our share of the prescription intravaginal bacterial vaginosis market increased to 26.4% at the end of fiscal 2007. Sales of Clindesse(R) in fiscal 2007 also reflected the impact of a price increase in September 2006. The growth in specialty generic/non-branded sales resulted primarily from increases experienced by our cardiovascular, cough/cold and pain management product lines. The cardiovascular product line contributed sales growth of $16.0 million, or 18.7%, in fiscal 2007 due to $11.5 million of incremental sales volume from new products with the remaining increase attributable to higher prices. The reported new products consisted of six strengths of diltiazem HCI ER Capsules (AB rated to Tiazac(R)) that were approved by the FDA in September 2006. In fiscal 2007, our cough/cold product line reported sales growth of $8.1 million, or 23.5%, as sales volume grew $5.0 million and price increases generated increased sales of $3.1 million. Sales from the pain management product line in fiscal 2007 increased $9.1 million, or 24.2%, due to incremental sales from three product approvals received late in fiscal 2006 and increased prices on the other pain management products. The increase in specialty material product sales was primarily due to the impact of price increases on certain products. 49 GROSS PROFIT BY SEGMENT -----------------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE -------------------- ($ IN THOUSANDS): 2007 2006 $ % ------------ ----------- ---------- ------ Branded products $ 167,864 $ 128,572 $ 39,292 30.6% as % of net revenues 89.0% 88.4% Specialty generics/non-branded 138,272 111,907 26,365 23.6% as % of net revenues 58.7% 54.9% Specialty materials 6,005 4,732 1,273 26.9% as % of net revenues 34.4% 27.9% Other (15,777) (1,506) (14,271) (947.6)% ------------ ----------- ---------- Total gross profit $ 296,364 $ 243,705 $ 52,659 21.6% as % of total net revenues 66.8% 66.3%
The increase in gross profit was principally due to the sales growth experienced by our branded products and specialty generic/non-branded segments. The higher specialty generic gross profit percentage in fiscal 2007 was primarily attributable to sales of new cardiovascular products coupled with the impact of price increases on certain cardiovascular, cough/cold and pain management products. Impacting the Other category are contract manufacturing revenues, pricing and production variances, and changes to inventory reserves associated with production. Any inventory reserve changes associated with finished goods are reflected in the applicable segment. The fluctuation in the Other category was primarily due to the impact of higher production costs during the first six months of the fiscal year that resulted from lower-than-expected production volume, coupled with an increase in provisions for obsolete inventory on certain existing products in various stages of production. Also, during the last three quarters of fiscal 2007, we recorded provisions associated with certain new products where production occurred prior to receiving FDA approval and the upcoming expiration dates made them unsalable. The provision for obsolete inventory for fiscal 2007 and 2006 was $12.0 million and $4.2 million, respectively. RESEARCH AND DEVELOPMENT ------------------------
YEARS ENDED MARCH 31, --------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS): 2007 2006 $ % ------------ ------------ ---------- --- Research and development $ 31,462 $ 28,886 $ 2,576 8.9% as % of net revenues 7.1% 7.9%
The increase in research and development expense was due to increased spending on bioequivalence studies as we continued active development of various brand and non-brand/generic products in our internal and external pipelines, coupled with an increase in research and development personnel. PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT ---------------------------------------------
YEARS ENDED MARCH 31, --------------------------------------------------- CHANGE ------------------- ($ IN THOUSANDS): 2007 2006 $ % ------------ ------------ ---------- ---- Purchased in-process research and development $ - $ 30,441 $ (30,441) NM
50 During fiscal 2006, we recorded expense of $30.4 million in connection with the FemmePharma acquisition (see Note 3 of the Notes to the Consolidated Financial Statements) "Acquisitions and License Agreement" that consisted of $29.6 million for acquired in-process research and development and $0.9 million in direct expenses related to the transaction. The valuation of acquired in-process research and development represents the estimated fair value of the worldwide marketing rights to an endometriosis product we acquired as part of the FemmePharma acquisition that, at the time of the acquisition, had no alternative future use and for which technological feasibility had not been established. SELLING AND ADMINISTRATIVE --------------------------
YEARS ENDED MARCH 31, -------------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS): 2007 2006 $ % --------- --------- --------- ---- Selling and administrative $ 171,936 $ 143,437 $ 28,499 20.0% as % of net revenues 38.8% 39.0%
The increase in selling and administrative expense was primarily due to: o $14.8 million increase in personnel costs due to increases in management and other personnel; o $3.4 million increase in branded marketing and promotions expense and o $2.2 million increase in expense resulting from facility expansion. The increase in personnel costs included $3.1 million of incremental stock-based compensation expense resulting from the adoption of SFAS 123R, "Share-Based Payment," and an increase in accrued payroll taxes, interest and penalties associated with the disqualification of certain stock options. We adopted SFAS 123R using the modified prospective method and, as a result, did not retroactively adjust results from prior periods. Prior to the adoption of SFAS 123R, we accounted for stock-based compensation using the intrinsic value method prescribed in APB 25. AMORTIZATION OF INTANGIBLE ASSETS ---------------------------------
YEARS ENDED MARCH 31, ------------------------------------------ CHANGE -------------- ($ IN THOUSANDS): 2007 2006 $ % ------- ------- ----- --- Amortization of intangible assets $ 4,810 $ 4,784 $ 26 0.5% as % of net revenues 1.1% 1.3%
The increase in amortization of intangible assets was due primarily to an increase in amortization of patent and trademark costs. OPERATING INCOME ----------------
YEARS ENDED MARCH 31, ---------------------------------------------------- CHANGE -------------------- ($ IN THOUSANDS): 2007 2006 $ % -------- -------- --------- ----- Operating income $ 88,156 $ 36,157 $ 51,999 143.8%
51 The improvement in operating income was partially due to the $30.4 million of expense we recorded during fiscal 2006 in connection with the FemmePharma acquisition. Excluding the effect of this $30.4 million of expense, operating income for fiscal 2007 would have increased $21.6 million, or 32.4%. INTEREST EXPENSE ----------------
YEARS ENDED MARCH 31, ----------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2007 2006 $ % ------- ------- ------- ---- Interest expense $ 8,985 $ 6,045 $ 2,940 48.6%
The increase in interest expense resulted from interest incurred on the $43.0 million mortgage loan we entered into in March 2006 coupled with the completion of a number of sizable capital projects during fiscal 2006 and the related reduced level of capitalized interest recorded on those projects. INTEREST AND OTHER INCOME -------------------------
YEARS ENDED MARCH 31, ----------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2007 2006 $ % ------- ------- ------- ---- Interest and other income $ 9,901 $ 5,737 $ 4,164 72.6%
The increase in interest and other income resulted primarily from an increase in the average balance of invested cash coupled with an increase in the weighted average interest rate earned on short-term investments. The increase in the weighted average interest rate was due to higher short-term market interest rates. PROVISION FOR INCOME TAXES --------------------------
YEARS ENDED MARCH 31, ------------------------------------------------- CHANGE ---------------- ($ IN THOUSANDS): 2007 2006 $ % -------- -------- ------- ---- Provision for income taxes $ 32,958 $ 24,433 $ 8,525 34.9% effective tax rate 37.0% 68.2%
The higher effective tax rate for fiscal 2006 was attributable to the determination that $30.4 million of expense we recorded for the FemmePharma acquisition was not deductible for tax purposes. The effective tax rate would have been 36.9% for that year when applied to a pre-tax income amount that excluded the FemmePharma acquisition expense of $30.4 million. The effective tax rates in both fiscal 2007 and 2006 were adversely affected by the recording of additional liabilities associated with tax positions claimed on filed tax returns for those years. 52 NET INCOME AND DILUTED EARNINGS PER SHARE -----------------------------------------
YEARS ENDED MARCH 31, ----------------------------------------------- CHANGE ------------------ ($ IN THOUSANDS): 2007 2006 $ % -------- -------- --------- ----- Net income $ 58,090 $ 11,416 $ 46,674 408.9% Diluted earnings per Class A share 1.05 0.23 0.82 356.5% Diluted earnings per Class B share 0.91 0.20 0.71 355.0%
The improvement in net income per share was partially due to the $30.4 million of expense we recorded during fiscal 2006 in connection with the FemmePharma acquisition. Net income was also favorably impacted by a $52.7 million increase in gross profit, offset in part by a $31.1 million increase in operating expenses before taking into account the $30.4 million of expense associated with the prior year acquisition of FemmePharma. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company reports cash and cash equivalents and working capital of $86.3 million and $88.8 million, respectively, at March 31, 2008, compared to $82.6 million and $372.3 million, respectively, at March 31, 2007. The decrease in working capital resulted primarily from the $200.0 million principal amount of Convertible Subordinated Notes (the "Notes") that we classified as a current liability at March 31, 2008 due to the holders having the right to require us to repurchase all or a portion of their Notes on May 16, 2008. Working capital was also reduced in fiscal 2008 by the reclassification of $81.5 million of auction rate securities from current assets to non-current assets (see Note 4 of the Notes to Consolidated Financial Statements). The primary source of operating cash flow used in the funding of our businesses continues to be internally generated funds from product sales. Our net cash flow from operating activities of $122.4 million in fiscal 2008 resulted primarily from net income adjusted for non-cash items. Net cash flow used in investing activities included capital expenditures of $23.7 million in fiscal 2008 compared to $25.1 million for the prior year. Investing activities in fiscal 2008 also consisted of two cash payments made under the Evamist(TM) purchase agreement: $10.0 million was paid in May 2007 and expensed as in-process research and development and $141.5 million was paid in July 2007 when final approval of the product was received from the FDA. The preliminary purchase price allocation, which is subject to change based on the final fair value assessment, resulted in estimated identifiable intangible assets of $52.4 million to product rights; $15.2 million to trademark rights; $66.4 million to rights under a sublicense agreement; and $7.5 million to a covenant not to compete. Upon FDA approval in July 2007, we began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years. In addition, other investing activities in fiscal 2008 included a $7.5 million payment we made when we acquired the U.S. and worldwide rights to Gestiva(TM) in January 2008. Because the product had not obtained FDA approval when the initial payment was made at closing, we recorded the $7.5 million as in-process research and development expense. The remainder of the purchase price is payable on the completion of two milestones: (1) $2.0 million on the earlier to occur of the seller's receipt of acknowledgement from the FDA that their response to the FDA's October 20, 2006 "approvable" letter is sufficient for the FDA to proceed with their review of the NDA or the receipt of FDA's approval of the Gestiva(TM) NDA and (2) $72.5 million on FDA approval of a Gestiva(TM) NDA, transfer of all rights in the NDA to us and receipt by us of defined launch quantities of finished Gestiva(TM) suitable for commercial sale. We expect approval of the Gestiva(TM) NDA in fiscal 2009. Finally, other investing activities for 2008 included $125.4 million and $158.8 million of purchases and sales, respectively, of investment securities classified as available for sale. At March 31, 2008, we had invested $83.9 million in principal amount of auction rate securities ("ARS"). Our investments in ARS represent interests in securities that have student loans as collateral that are guaranteed by the U.S. Government. Accordingly, ARS that are backed by student loans are viewed as having low default risk and very low risk of downgrade. The interest rates on these securities are reset through an auction process that resets the applicable interest rate at pre-determined intervals, up to 35 days. The auctions have historically provided a liquid market for these securities. The ARS investments held by us all had AAA credit ratings at the time of purchase and at the end of our fiscal 2008 year end. With the liquidity issues experienced in global credit 53 and capital markets, the ARS held by us at March 31, 2008 experienced failed auctions beginning in February 2008 as the amount of securities submitted for sale exceeded the amount of purchase orders. Given the failed auctions, our ARS will continue to be illiquid until there is a successful auction for them. We cannot predict how long the current imbalance in the auction rate market will continue. The estimated fair value of our ARS holdings at March 31, 2008 was $81.5 million, which reflected a $2.4 million difference from the principal amount of $83.9 million. The estimated fair value of the ARS was based on a discounted cash flow model that considered, among other factors, the time to work out the market disruption in the traditional trading mechanism, the stream of cash flows (coupons) earned until maturity, the prevailing risk free yield curve, credit spreads applicable to a portfolio of student loans with various tenures and ratings and an illiquidity premium. These factors were used in a Monte Carlo simulation based methodology to derive the estimated fair value of the ARS. Although the ARS continue to pay interest according to their stated terms, we recorded during the fourth quarter of fiscal 2008 an unrealized loss of $1.6 million, net of tax, as a reduction to shareholders' equity in accumulated other comprehensive loss, reflecting adjustments to the ARS holdings that we have concluded have a temporary decline in value. ARS have historically been classified as short-term marketable securities in our consolidated balance sheet. Given the failed auctions, we have reclassified the $81.5 million of ARS as of March 31, 2008 from current assets to non-current assets (see Note 4 to the Notes to Consolidated Financial Statements). We believe that as of March 31, 2008, based on our current cash, cash equivalents and marketable securities balances of $126.9 million and our current borrowing capacity under our credit facility of $290.0 million, the current lack of liquidity in the auction rate market will not have a material impact on our ability to fund our operations or interfere with our external growth plans, although we cannot assure you that this will continue to be the case. Our debt balance, including current maturities, was $269.5 million at March 31, 2008 compared to $241.3 million at March 31, 2007. In August 2007, we borrowed $50.0 million under our credit facility, the proceeds of which were used in the funding of the Evamist(TM) purchase. We repaid $20.0 million of the borrowing under our credit facility in November 2007. In May 2003, we issued $200.0 million principal amount of 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 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. In November 2007, the average trading price of the Notes reached the threshold for the five-day trading period that results in the payment of contingent interest and beginning November 16, 2007 the Notes began to bear interest at a rate of 3.00% per annum. We 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) to the date of redemption. Holders may require us 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 100% of the principal amount of the Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date of repurchase, payable in cash. Even though no holders required us to repurchase all or a portion of their Notes on May 16, 2008, we classified the Notes as a current liability as of March 31, 2008 due to the right the holders had to require us to repurchase the Notes on May 16, 2008. Since the holders did not elect to cause us to repurchase any of the Notes, the Notes will be reclassified as long-term beginning with our consolidated balance sheet as of June 30, 2008. The Notes are subordinate to all of our existing and future senior obligations. We have a credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320.0 million. The credit agreement also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50.0 million. This credit facility is unsecured unless we, under certain specified circumstances, utilize the facility to redeem part or all of our outstanding 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 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 credit facility has a five-year term expiring in June 2011. As of March 31, 2008, we were in 54 compliance with all of our financial covenants. At March 31, 2008, we had $0.9 million in open letters of credit issued under the revolving credit line and $30.0 million of cash borrowings outstanding under the facility. 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 of the Notes 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 ten years subsequent to the property being placed in service. Industrial revenue bonds totaling $120.4 million were outstanding at March 31, 2008. 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 5 TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS YEARS ----- ------ --------- --------- ----- OBLIGATIONS AT MARCH 31, 2008 ----------------------------- Long-term debt obligations(1) $ 269,452 $ 202,020 $ 4,420 $ 34,976 $ 28,036 Operating lease obligations 8,147 2,183 2,909 2,116 939 Other long-term obligations(2) 8,551 - - - 8,551 --------- ----------- -------- --------- --------- Total contractual cash obligations(3)(4) $ 286,150 $ 204,203 $ 7,329 $ 37,092 $ 37,526 ========= =========== ======== ========= ========= ------------------ (1) Holders of the $200.0 million aggregate principal amount of Notes had the right to require the Company to repurchase them for an amount equal to the unpaid principal amount in May 2008. No bonds were tendered to the Company under the holders put right. (2) Represents the accrual of retirement compensation the Company is obligated to pay its CEO beginning at retirement for the longer of ten years or the life of the CEO. (3) Excluded from the contractual obligations table is the liability for unrecognized tax benefits totaling $11.7 million. This liability for unrecognized tax benefits has been excluded because we cannot make a reliable estimate of the period in which the unrecognized tax benefits will be realized. (4) 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 $31.0 million as of March 31, 2008. Also, under terms of the Evamist(TM) asset purchase agreement, it provides for two future payments upon achievement of certain net sales milestones. If Evamist(TM) achieves $100.0 million of net sales in a fiscal year, a one-time payment of $10.0 million will be made, and if net sales levels reach $200.0 million in a fiscal year, a one-time payment of up to $20.0 million will be made. In addition, under terms of the Gestiva(TM) asset purchase agreement, the remainder of the purchase price is payable on the completion of two milestones: (1) $2.0 million on the earlier to occur of the seller's receipt of acknowledgement from the FDA that their response to the FDA's October 20, 2006 "approvable" letter is sufficient for the FDA to proceed with their review of the NDA or the receipt of FDA's approval of the Gestiva(TM) NDA and (2) $72.5 million on FDA approval of a Gestiva(TM) NDA, transfer of all rights in the NDA to us and receipt by us of defined launch quantities of finished Gestiva(TM) suitable for commercial sale.
On February 14, 2006, the Company announced it had entered into an agreement with Gedeon Richter under which the Company had acquired exclusive rights to market a group of generic products in the U.S. However, due to changes in the generic drug marketplace, the Company and Gedeon Richter have agreed the current portfolio of products covered by the agreement, which has now been terminated, no longer represent market opportunities that are worth pursuing. The two companies remain committed partners in other endeavors and are keeping options open to explore other more meaningful joint opportunities. 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 generally has been invested in short-term, highly liquid instruments, however, certain of our investments in auction-rate securities have become illiquid, as described 55 above. 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. GOVERNMENT REGULATION In March 2008, representatives of the Missouri Department of Health and Senior Services, accompanied by representatives of the FDA, notified us of a hold on our inventory of certain unapproved drug products, restricting our ability to remove or dispose of those inventories without permission. The hold relates to a misinterpretation about the intended scope of recent FDA notices setting limits on the marketing of unapproved guaifenesin products. In response to notices issued by the FDA in 2002 and 2003 with respect to single-entity timed-release guaifenesin products, and a further notice issued in 2007 with respect to combination timed-released guaifenesin products, we timely discontinued a number of our guaifenesin products and believed that, by doing so, had complied with those notices. The recent action to place a hold on certain of our products indicates that additional guaifenesin products should also have been discontinued. In addition, the FDA expanded the hold to include other products that did not contain guaifenesin but were being marketed by us without FDA approval under certain "grandfather clauses" and statutory and regulatory exceptions to the pre-market approval requirement for "new drugs" under the FDCA. FDA policies permit the agency to initiate broad action against the marketing of additional categories of our unapproved products, if the FDA deems approval necessary, even if the agency has not instituted similar actions against the marketing of such products by other parties. Pursuant to discussions with the Missouri Department of Health and Senior Services and with the FDA, the affected Morphine and Oxycodone products have been released from the hold. We will discontinue manufacturing and marketing substantially all unapproved products subject to the hold. The FDA has not proposed, nor do we expect them to propose, that the products subject to the hold be recalled from the distribution channel. As such, we have written-off the value of the products subject to the hold in our inventory as of March 31, 2008. We also evaluated the active pharmaceutical ingredients and excipients used in the manufacture of the hold products and determined that they should also be written-off since we will be discontinuing further manufacturing and many of them cannot be returned or sold to other manufacturers. The write-off included in the results of operations for the fourth quarter of fiscal 2008 totaled $5.5 million. During most of fiscal 2008, we marketed approximately 30 products in our generic/non-branded respiratory line, which consisted primarily of cough/cold products. The cough/cold line accounted for $38.5 million, or 10.5%, of our specialty generic net revenues in fiscal 2008. As a result of the FDA hold discussed above, we are currently marketing one generic cough/cold product with four strengths that has been approved by the FDA. Since its launch in December 2007, this approved product generated sales of $0.9 million during fiscal 2008. On June 6, 2008, ETHEX initiated a voluntary recall of a single lot of morphine sulfate 60 mg extended release tablets due to a report that a tablet with as much as double the appropriate thickness was identified and therefore the possibility that other oversized tablets could have been commercially released in the affected lot. On June 13, 2008, the recall was expanded to include additional specific lots of morphine sulfate 60 mg extended release tablets and specific lots of morphine sulfate 30 mg extended release tablets. We accrued a liability of $0.9 million in the fourth quarter of fiscal 2008 for the anticipated cost of the recall. No oversized tablets have been identified in any additional distributed lot of these products and based on our investigation, there are likely to be few, if any, oversized tablets in the recall lots. In addition, under ordinary pharmacy dispensing procedures, any significantly oversized tablets would likely be identified at the time of dispensing. However, the decision to recall the additional lots has been taken as a responsible precaution because of the possibility that there may be oversized tablets in the recalled lots. 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 effects of competition have 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 GAAP. Our significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements. Certain of our accounting policies are particularly important to the presentation of our financial condition and results of operations and require the application of significant judgment by our management. As a result, amounts determined under 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 56 industry, information that is obtained from customers and outside sources, and on various other assumptions that we believe 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. 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 among other factors, 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. 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 these incentives are normal and customary in the industry. Sales allowances are accrued and revenue is recognized as sales are made in accordance with 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 non-branded/generics product line in conjunction with trade shows sponsored by our major wholesale customers and for other promotional programs accounted for 10.4% and 11.6% of total gross revenues for fiscal 2008 and fiscal 2007, 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 60% of our unit sales in fiscal 2008, 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. 57 The following table reflects the fiscal 2008 activity for each accounts receivable reserve:
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, 2008 Accounts Receivable Reserves: Chargebacks $ 13,005 $ 145,005 $ - $ (140,410) $ 17,600 Sales rebates 5,386 36,582 - (29,384) 12,584 Sales returns 2,873 15,733 - (14,311) 4,295 Cash discounts and other allowances 3,511 26,674 - (24,518) 5,667 Medicaid rebates 6,506 10,433 - (10,439) 6,500 -------- --------- ------------ ---------- -------- Total $ 31,281 $ 234,427 $ - $ (219,062) $ 46,646 ======== ========= ============ ========== ========
The increase in the reserve for chargebacks at March 31, 2008 was primarily due to chargeback reserves established on the 100 mg and 200 mg strengths of metoprolol succinate extended-release tablets, the generic version of Toprol-XL(R) (marketed by AstraZeneca). We began shipping these two products in July 2007, and along with the approval and launch of the 25 mg in March 2007, they generated net revenues of $120.0 million in fiscal 2008. The increases in the reserves for sales rebates and cash discounts and other allowances at March 31, 2008 were also primarily due to the impact of sales associated with the two strengths of metoprolol succinate extended-release tablets. We received FDA approval to market the 25 mg strength of metoprolol succinate extended-release tablets in March 2008 and began shipping this product at that time. Sales of this product near year-end and wholesaler inventory levels of such at March 31, 2008 increased the reserves for chargebacks and sales rebates as well. The increase in the reserve for sales returns resulted primarily from the discontinuance of certain cardiovascular products late in fiscal 2008 coupled with higher returns of two pain management products in fiscal 2008. The following table reflects the fiscal 2007 activity for each accounts receivable reserve:
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, 2007 Accounts Receivable Reserves: Chargebacks $ 14,312 $ 94,716 $ - $ (96,023) $ 13,005 Sales rebates 2,214 17,155 - (13,983) 5,386 Sales returns 2,127 12,591 - (11,845) 2,873 Cash discounts and other allowances 4,226 17,541 - (18,256) 3,511 Medicaid rebates 5,818 6,819 - (6,131) 6,506 -------- --------- --------- ---------- -------- Total $ 28,697 $ 148,822 $ - $ (146,238) $ 31,281 ======== ========= ========= ========== ========
The decrease in the reserve for chargebacks at March 31, 2007 was primarily due to a decline in customer inventory levels of our specialty generic/non-branded products at the end of the year. The higher reserve for sales rebates at March 31, 2007 resulted from increased reserves on rebates associated with branded product sales to managed care organizations that began late in the fiscal 2006 year and ongoing sales promotions on new specialty generic/non-branded products introduced in fiscal 2007. The increase in the reserve for sales returns at March 31, 2007 was primarily due to an increase in branded product sales coupled with reserves established on certain new specialty generic/non-branded products where inventory with short shelf lives was sold. 58 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. Chargeback transactions are almost exclusively related to our specialty generics/non-branded business segment. During fiscal 2008 and 2007, the chargeback provision reduced the gross sales of our specialty generics segment by $142.9 million and $93.9 million, respectively. These amounts accounted for 98.8% and 99.2% of the total chargeback provisions recorded in fiscal 2008 and 2007, 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: o 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 wholesaler customers based on historical buying patterns. During fiscal 2008, unit sales to our three major wholesale customers accounted for 82% of our total unit sales to all wholesalers, and the aggregate inventory position of the three major wholesalers at March 31, 2008 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 wholesale customers for which we do not receive actual inventory data, as our experience and customer buying patterns indicate that our smaller wholesale customers carry less inventory than our large wholesale customers. As of March 31, 2008, each week of inventory for those remaining wholesalers represented approximately $0.2 million, or 1.2%, of the reported reserve for chargebacks. o 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, 2008, 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 1.0%, of the reported reserve for chargebacks. o 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, 2008, a 5% shift in the calculated chargeback per unit in the same direction across all products and customers would result in a $0.8 million, or 4.5%, impact on the reported reserve for chargebacks. 59 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. As a result of WAC decreases to certain specialty generic/non-branded products, we paid shelf-stock adjustments of $7.6 million to our wholesale customers during fiscal 2008. 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 generic/non-branded business segments. Upon recognition of revenue from 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, 2008 by approximately $0.2 million, or 5.6%, 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, 2008 by approximately $0.3 million, or 8.1%, 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 non-branded/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 affected 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, 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, 2008 by $0.5 million, or 8.3% of the reported reserve for Medicaid rebates. Similarly, a 10% change in estimated patient usage would have changed the reserve by $0.5 million, or 8.3% 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. 60 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, which range from nine to 20 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 the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include: (1) significant underperformance relative to expected historical or projected future operating results; (2) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and (3) significant negative industry or economic trends. When we determine that the carrying value of an intangible asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, we first perform an assessment of the asset's recoverability. Recoverability is determined by comparing the carrying amount of an intangible asset against an estimate of the undiscounted future cash flows expected to result from its use and eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the intangible asset, an impairment loss is recognized based on the excess of the carrying amount over the estimated fair value of the intangible asset. STOCK-BASED COMPENSATION Effective April 1, 2006, we adopted SFAS ------------------------ 123R, which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based compensation awards made to employees and directors over the vesting period of the awards. We adopted SFAS 123R using the modified prospective method and, as a result, did not retroactively adjust results from prior periods. Under the modified prospective method, stock-based compensation was recognized (1) for the unvested portion of previously issued awards that were outstanding at the initial date of adoption based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and (2) for any awards granted on or subsequent to the effective date of SFAS 123R based on the grant date fair value estimated in accordance with the provisions of that statement. Determining the fair value of share-based awards at the grant date requires judgment to identify the appropriate valuation model and estimate the assumptions, including the expected term of the stock options and expected stock-price volatility, to be used in the calculation. Judgment is also required in estimating the percentage of share-based awards that are expected to be forfeited. We estimated the fair value of stock options granted using the Black-Scholes option-pricing model with assumptions based primarily on historical data. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. INCOME TAXES Our deferred tax assets and liabilities are determined ------------ based on temporary differences between the financial reporting and tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets. If all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. Similarly, if we subsequently realize deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in a positive adjustment to earnings in the period such determination is made. Management regularly reevaluates the Company's tax positions taken on filed tax returns using information about recent tax court decisions and legislative activities. Many factors are considered in making these evaluations, including past history, recent interpretations of tax law, and the specific facts and circumstances of each matter. Because tax regulations are subject to interpretation and tax litigation is inherently uncertain, these evaluations 61 can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. The recorded tax liabilities are based on estimates and assumptions that have been deemed reasonable by management. However, if our estimates are not representative of actual outcomes, recorded tax liabilities could be materially impacted. Our accounting for income taxes was affected by the adoption of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109," on April 1, 2007. See Note 15 of the Notes to Consolidated Financial Statements. 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 we determine 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 future outcome of litigation and because of the potential that an adverse outcome in legal proceedings could have a material impact on our financial condition or results of operations, such estimates are considered to be critical accounting estimates. After review, it was determined at March 31, 2008 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 September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability, provides a framework for measuring fair value under GAAP and expands disclosure requirements about fair value measurements. SFAS 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We plan to adopt SFAS 157 at the beginning of fiscal 2009 and are evaluating the impact, if any, the adoption of SFAS 157 will have on our financial condition and results of operations. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), which permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Companies are not allowed to adopt SFAS 159 on a retrospective basis unless they choose early adoption. We plan to adopt SFAS 159 at the beginning of fiscal 2009 and are evaluating the impact, if any, the adoption of SFAS 159 will have on our financial condition and results of operations. In March 2007, the FASB ratified the consensus reached by the EITF in Issue No. 06-10, "Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements" ("Issue 06-10"). Issue 06-10 requires companies with collateral assignment split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods to recognize a liability for future benefits based on the substantive agreement with the employee. Recognition should be in accordance with FASB Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," or APB Opinion No. 12, "Omnibus Opinion - 1967," depending on whether a substantive plan is deemed to exist. Companies are permitted to recognize the effects of applying the consensus through either (1) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets as of the beginning of the year of adoption or (2) a change in accounting principle through retrospective application to all prior periods. Issue 06-10 is effective for fiscal years beginning after December 15, 2007, with early adoption permitted. We plan to adopt Issue 06-10 at the beginning of fiscal 2009 and are evaluating the impact of the adoption of Issue 06-10 on our financial condition and results of operations. In June 2007, the FASB ratified the consensus reached by the EITF on Issue No. 07-3, Accounting for Advance Payments for Goods or Services Received for Use in Future Research and Development Activities ("Issue 07-3"), 62 which is effective for fiscal years beginning after December 15, 2007 and is applied prospectively for new contracts entered into on or after the effective date. Issue 07-3 addresses nonrefundable advance payments for goods or services for use in future research and development activities. Issue 07-3 will require that these payments that will be used or rendered for future research and development activities be deferred and capitalized and recognized as an expense as the related goods are delivered or the related services are performed. If an entity does not expect the goods to be delivered or the services to be rendered the capitalized advance payments should be expensed. We plan to adopt Issue 07-3 at the beginning of fiscal 2009 and are evaluating the impact of the adoption of this issue on our financial condition and results of operations. In September 2007, the EITF reached a consensus on Issue No. 07-1 ("Issue 07-1"), "Accounting for Collaborative Arrangements." The scope of Issue 07-1 is limited to collaborative arrangements where no separate legal entity exists and in which the parties are active participants and are exposed to significant risks and rewards that depend on the success of the activity. The EITF concluded that revenue transactions with third parties and associated costs incurred should be reported in the appropriate line item in each company's financial statements pursuant to the guidance in Issue 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The EITF also concluded that the equity method of accounting under Accounting Principles Board Opinion 18, "The Equity Method of Accounting for Investments in Common Stock," should not be applied to arrangements that are not conducted through a separate legal entity. The EITF also concluded that the income statement classification of payments made between the parties in an arrangement should be based on a consideration of the following factors: the nature and terms of the arrangement; the nature of the entities' operations; and whether the partners' payments are within the scope of existing GAAP. To the extent such costs are not within the scope of other authoritative accounting literature, the income statement characterization for the payments should be based on an analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. The provisions of Issue 07-1 are effective for fiscal years beginning on or after December 15, 2008, and companies will be required to apply the provisions through retrospective application. We plan to adopt Issue 07-1 at the beginning of fiscal 2010 and are evaluating the impact of the adoption of Issue 07-1 on our financial condition and results of operations. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"), which replaces SFAS 141 but retains the fundamental concept of purchase method of accounting in a business combination and improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this goal, the new standard requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction and any non-controlling interest at the acquisition date at their fair value as of that date. This statement requires measuring a non-controlling interest in the acquiree at fair value which will result in recognizing the goodwill attributable to the non-controlling interest in addition to that attributable to the acquirer. This statement also requires the recognition of assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition fair values. SFAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and earlier adoption is prohibited. We plan to adopt SFAS 141(R) at the beginning of fiscal 2010 and are evaluating the impact of SFAS 141(R) on our financial condition and results of operations. In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements" ("SFAS 160"), an amendment of ARB No. 51, which will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary by requiring all entities to report non-controlling (minority) interests in subsidiaries in the same way as equity in the consolidated financial statements. In addition, SFAS 160 eliminates the diversity that currently exists in accounting for transactions between an entity and non-controlling interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We plan to adopt SFAS 160 at the beginning of fiscal 2010 and are evaluating the impact of SFAS 160 on our financial condition and results of operations. In May 2008, the FASB issued FASB Staff Position No. APB 14-a, "Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement)." Under the new rules for convertible debt instruments that may be settled entirely or partially in cash upon conversion, an entity 63 should separately account for the liability and equity components of the instrument in a manner that reflects the issuer's economic interest cost. The effect of the proposed new rules for the debentures is that the equity component would be included in the paid-in-capital section of shareholders' equity on an entity's consolidated balance sheet and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of convertible debt. The FSP will be effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. Early adoption is not permitted. We are currently evaluating the proposed new rules and the impact on our financial condition and results of operations. 64 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. We currently have investments in taxable auction rate securities. The rates on these securities reset at pre-determined intervals up to 35 days. As of March 31, 2008, we had invested $83.9 million principal amount in auction rate securities consisting of high quality (AAA rated) bonds secured by student loans which are guaranteed by the U. S. Government. The maturity of these securities is greater than 10 years. During the fourth quarter of fiscal 2008, certain developments in the capital and credit markets adversely affected the market for auction rate securities, which has resulted in a loss of liquidity for these investments. We have evaluated these securities to determine if other-than-temporary impairment of the carrying value of the securities has occurred due to the loss of liquidity. At March 31, 2008, the fair value of auction rate securities was $81.5 million and the resultant difference of $2.4 million was recorded in accumulated other comprehensive loss as the unrealized losses were considered to be temporary (see Note 4 of the Notes to Consolidated Financial Statements). We believe that as of March 31, 2008, based on our cash, cash equivalents and short-term marketable securities balances of $126.9 million, excluding auction rate securities, and our current borrowing capacity of $290.0 million under our credit facility, the current lack of liquidity in the auction rate market will not have a material impact on our ability to fund our operations or interfere with our external growth plans, although we cannot assure you that this will continue to be the case. The favorable impact on our pre-tax income as a result of a 25, 50 or 100 basis point (where 100 basis points equals 1%) increase in short-term interest rates would be approximately $0.5 million, $1.1 million or $2.2 million annually based on our average cash, cash equivalents and short-term marketable investment balances during the fiscal year ended March 31, 2008. Advances to us under our credit facility 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. At March 31, 2008, we had $30.0 million of borrowings outstanding under our credit facility. The unfavorable impact on our pre-tax income as a result of a 25, 50 or 100 basis point (where 100 basis points equals 1%) increase in short-term interest rates would be approximately $0.1 million, $0.2 million or $0.3 million annually based on the $30.0 million of borrowings that were outstanding under our line of credit at March 31, 2008. In May 2003, we issued $200.0 million principal amount of Convertible Subordinated Notes. The interest rate on the Notes is fixed at 2.50% and therefore not subject to interest rate changes. Beginning May 16, 2006, we became 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 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. In November 2007, the average trading price of the Notes reached the threshold for the five-day trading period that results in the payment of contingent interest and beginning November 16, 2007 the Notes began to bear interest at a rate of 3.00% per annum. Holders may require us 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 100% of the principal amount of the Notes, plus accrued and unpaid interest (including contingent interest, if any) to the date of repurchase, payable in cash. Even though no holders required us to repurchase all or a portion of their Notes on May 16, 2008, we have classified the Notes as a current liability as of March 31, 2008 due to the right the holders had to require us to repurchase the Notes on May 16, 2008. Since the holders did not elect to cause us to repurchase any of the Notes, the Notes will be reclassified as long-term liabilities beginning with our consolidated balance sheet as of June 30, 2008. 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. 65 ITEM 8. 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 (the Company) as of March 31, 2008 and 2007, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three-year period ended March 31, 2008. In connection with our audits of the consolidated financial statements, we also have 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, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2008, 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, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (Revised 2004), "Share-Based Payment", effective April 1, 2006. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), K-V Pharmaceutical Company's internal control over financial reporting as of March 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 25, 2008 expressed an adverse opinion on the effectiveness of the Company's internal control over financial reporting. St. Louis, Missouri June 25, 2008 66 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)
MARCH 31, --------------------------- 2008 2007 ----------- ----------- ASSETS ------ CURRENT ASSETS: Cash and cash equivalents............................................................ $ 86,345 $ 82,574 Marketable securities................................................................ 40,548 157,812 Receivables, less allowance for doubtful accounts of $867 and $716 in 2008 and 2007, respectively.................................................... 107,070 78,634 Inventories, net..................................................................... 94,980 91,515 Prepaid and other assets............................................................. 7,792 6,571 Income taxes receivable.............................................................. 9,872 -- Deferred tax asset................................................................... 22,812 14,364 ----------- ----------- Total Current Assets.............................................................. 369,419 431,470 Property and equipment, less accumulated depreciation................................ 196,200 186,900 Investment securities................................................................ 81,516 -- Intangible assets and goodwill, net.................................................. 198,784 69,010 Other assets......................................................................... 23,108 20,403 ----------- ----------- TOTAL ASSETS......................................................................... $ 869,027 $ 707,783 =========== =========== LIABILITIES ----------- CURRENT LIABILITIES: Accounts payable..................................................................... $ 32,119 $ 18,506 Accrued liabilities.................................................................. 46,516 33,218 Income taxes payable................................................................. -- 5,558 Current maturities of long-term debt................................................. 202,020 1,897 ----------- ----------- Total Current Liabilities......................................................... 280,655 59,179 Long-term debt....................................................................... 67,432 239,451 Other long-term liabilities.......................................................... 22,359 6,319 Deferred tax liability............................................................... 39,299 38,007 ----------- ----------- TOTAL LIABILITIES.................................................................... 409,745 342,956 ----------- ----------- 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, 2008 and 2007 (convertible into Class A shares on a 8.4375 to one basis)................... -- -- Class A and Class B Common Stock, $.01 par value;150,000,000 and 75,000,000 shares authorized, respectively; Class A - issued 40,764,603 and 40,316,426 at March 31, 2008 and 2007, respectively........................................................ 407 403 Class B - issued 12,170,172 and 12,393,982 at March 31, 2008 and 2007, respectively (convertible into Class A shares on a one-for-one basis)... 122 124 Additional paid-in capital........................................................... 158,742 150,818 Retained earnings.................................................................... 357,714 269,430 Accumulated other comprehensive (loss) income........................................ (1,543) 33 Less: Treasury stock, 3,289,324 shares of Class A and 92,902 shares of Class B Common Stock at March 31, 2008, and 3,237,023 shares of Class A and 92,902 shares of Class B Common Stock at March 31, 2007, at cost................................ (56,160) (55,981) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY........................................................... 459,282 364,827 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................................... $ 869,027 $ 707,783 =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 67 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
YEARS ENDED MARCH 31, ----------------------------------------------------- 2008 2007 2006 --------- --------- --------- Net revenues....................................................... $ 601,896 $ 443,627 $ 367,640 Cost of sales...................................................... 186,555 147,263 123,935 --------- --------- --------- Gross profit....................................................... 415,341 296,364 243,705 --------- --------- --------- Operating expenses: Research and development....................................... 46,634 31,462 28,886 Purchased in-process research and development and transaction costs.......................... 17,500 -- 30,441 Selling and administrative..................................... 208,206 171,936 143,437 Amortization and impairment of intangible assets............... 12,631 4,810 4,784 --------- --------- --------- Total operating expenses........................................... 284,971 208,208 207,548 --------- --------- --------- Operating income................................................... 130,370 88,156 36,157 --------- --------- --------- Other expense (income): Interest expense............................................... 10,353 8,985 6,045 Interest and other income...................................... (11,646) (9,901) (5,737) --------- --------- --------- Total other expense (income), net.................................. (1,293) (916) 308 --------- --------- --------- Income before income taxes and cumulative effect of change in accounting principle.............................. 131,663 89,072 35,849 Provision for income taxes......................................... 43,309 32,958 24,433 --------- --------- --------- Income before cumulative effect of change in accounting principle........................................ 88,354 56,114 11,416 Cumulative effect of change in accounting principle (net of $670 in taxes)............................... -- 1,976 -- --------- --------- --------- Net income......................................................... $ 88,354 $ 58,090 $ 11,416 ========= ========= ========= (CONTINUED) 68 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME - (CONTINUED) (In thousands, except per share data) YEARS ENDED MARCH 31, ------------------------------------------------------- 2008 2007 2006 ----------- ----------- ----------- Earnings per share before cumulative effect of change in accounting principle: Basic - Class A common.............................. $ 1.87 $ 1.19 $ 0.24 Basic - Class B common.............................. 1.55 0.99 0.20 Diluted - Class A common............................ 1.57 1.02 0.23 Diluted - Class B common............................ 1.35 0.88 0.20 Per share effect of cumulative effect of change in accounting principle: Basic - Class A common.............................. $ - $ 0.04 $ - Basic - Class B common.............................. - 0.04 - Diluted - Class A common............................ - 0.03 - Diluted - Class B common............................ - 0.03 - Earnings per share: Basic - Class A common.............................. $ 1.87 $ 1.23 $ 0.24 Basic - Class B common.............................. 1.55 1.03 0.20 Diluted - Class A common............................ 1.57 1.05 0.23 Diluted - Class B common............................ 1.35 0.91 0.20 Shares used in per share calculation: Basic - Class A common.............................. 37,150 36,813 35,842 Basic - Class B common.............................. 12,198 12,390 12,918 Diluted - Class A common............................ 59,144 58,953 49,997 Diluted - Class B common............................ 12,281 12,489 13,113 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
69 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands)
YEARS ENDED MARCH 31, ----------------------------------------------- 2008 2007 2006 ----------- ---------- ------------ Net income............................................................. $ 88,354 $ 58,090 $ 11,416 Unrealized gain (loss) on available for sale securities: Unrealized holding gain (loss) during the period.................... (2,424) 100 (118) Reclassification of losses included in net income................... -- 270 -- Tax impact related to other comprehensive income (loss)............. 848 (126) 40 ----------- ---------- ------------ Total other comprehensive income (loss).......................... (1,576) 244 (78) ----------- ---------- ------------ Total comprehensive income............................................. $ 86,778 $ 58,334 $ 11,338 =========== ========== ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 70 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED MARCH 31, 2008, 2007 AND 2006 ------------------------------------------------------------------------------------------- ACCUMULATED TOTAL CLASS A CLASS B ADDITIONAL OTHER SHARE- PREFERRED COMMON COMMON PAID-IN TREASURY RETAINED COMPREHENSIVE HOLDERS' STOCK STOCK STOCK CAPITAL STOCK EARNINGS INCOME (LOSS) EQUITY ----- ----- ----- ------- ----- -------- ------------- ------ (Dollars in thousands) BALANCE AT MARCH 31, 2005............... $ -- $ 386 $ 133 $ 139,678 $ (53,651) $ 200,064 $ (133) $ 286,477 Net income.............................. -- -- -- -- -- 11,416 -- 11,416 Dividends paid on preferred stock....... -- -- -- -- -- (70) -- (70) Conversion of 736,778 Class B shares to Class A shares.............. -- 7 (7) -- -- -- -- -- Stock-based compensation................ -- -- -- 927 -- -- -- 927 Purchase of common stock for treasury.............................. -- -- -- -- (253) -- -- (253) Stock options exercised - 353,355 shares of Class A and 127,519 shares of Class B..................... -- 4 1 3,138 -- -- -- 3,143 Excess income tax benefits from stock option exercises................ -- -- -- 1,437 -- -- -- 1,437 Other comprehensive loss................ -- -- -- -- -- -- (78) (78) ----------------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2006............... -- 397 127 145,180 (53,904) 211,410 (211) 302,999 Net income.............................. -- -- -- -- -- 58,090 -- 58,090 Dividends paid on preferred stock....... -- -- -- -- -- (70) -- (70) Conversion of 441,341 Class B shares to Class A shares.............. -- 4 (4) -- -- -- -- -- Stock-based compensation................ -- -- -- 3,984 -- -- -- 3,984 Purchase of common stock for treasury.............................. -- -- -- -- (2,077) -- -- (2,077) Stock options exercised - 166,169 shares of Class A and 193,899 shares of Class B..................... -- 2 1 3,617 -- -- -- 3,620 Excess income tax benefits from stock option exercises................ -- -- -- 683 -- -- -- 683 Cumulative effect of change in accounting principle.................. -- -- -- (2,646) -- -- -- (2,646) Other comprehensive income.............. -- -- -- -- -- -- 244 244 ----------------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2007............... -- 403 124 150,818 (55,981) 269,430 33 364,827 Net income.............................. -- -- -- -- -- 88,354 -- 88,354 Dividends paid on preferred stock....... -- -- -- -- -- (70) -- (70) Conversion of 234,528 Class B shares to Class A shares.............. -- 2 (2) -- -- -- -- -- Stock-based compensation................ -- -- -- 5,205 -- -- -- 5,205 Purchase of common stock for treasury.............................. -- -- -- -- (179) -- -- (179) Stock options exercised - 174,813 shares of Class A and 9,427 shares of Class B........................... -- 2 -- 1,343 -- -- -- 1,345 Excess income tax benefits from stock option exercises............... -- -- -- 1,376 -- -- -- 1,376 Reimbursement payment received from CEO - 45,531 shares of Class A Common Stock................. -- -- -- -- -- -- -- -- Other comprehensive loss .............. -- -- -- -- -- -- (1,576) (1,576) ----------------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2008.............. $ -- $ 407 $ 122 $ 158,742 $ (56,160) $ 357,714 $ (1,543) $ 459,282 =========================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 71 K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
YEARS ENDED MARCH 31, ----------------------------------------------- 2008 2007 2006 ------------ ---------- ---------- Operating Activities: Net income............................................................. $ 88,354 $ 58,090 $ 11,416 Adjustments to reconcile net income to net cash provided by operating activities: Acquired in-process research and development........................ 17,500 -- 29,570 Cumulative effect of change in accounting principle................. -- (1,976) -- Depreciation and amortization ..................................... 31,120 22,388 18,002 Deferred income tax (benefit) provision............................. (6,308) 7,698 6,062 Deferred compensation............................................... 2,232 877 965 Stock-based compensation............................................ 5,205 3,984 927 Excess tax benefits associated with stock options................... (1,376) (683) -- Other............................................................... 1,440 270 -- Changes in operating assets and liabilities: Decrease (increase) in receivables, net............................. (28,436) (25,063) 7,593 Increase in inventories............................................. (3,465) (20,349) (16,792) Increase in prepaid and other assets................................ (6,443) (2,771) (1,185) (Decrease) increase in income taxes payable......................... (1,622) 2,413 3,659 Increase in accounts payable and accrued liabilities...................................................... 24,157 12,257 4,392 ------------ ---------- ---------- Net cash provided by operating activities.............................. 122,358 57,135 64,609 ------------ ---------- ---------- Investing Activities: Purchase of property and equipment.................................. (23,656) (25,066) (58,334) Purchase of marketable securities................................... (125,426) (178,949) (61,187) Sale of marketable securities....................................... 158,750 128,000 -- Purchase of preferred stock......................................... -- (400) (11,300) Product acquisitions................................................ (159,000) -- (25,643) ------------ ---------- ---------- Net cash used in investing activities.................................. (149,332) (76,415) (156,464) ------------ ---------- ---------- Financing Activities: Principal payments on long-term debt................................ (1,896) (1,652) (892) Proceeds from borrowing of long-term debt........................... -- -- 32,764 Proceeds from borrowing on line of credit........................... 50,000 -- -- Repayment of borrowing on line of credit............................ (20,000) -- -- Dividends paid on preferred stock................................... (70) (70) (70) Purchase of common stock for treasury............................... (179) (2,077) (253) Excess tax benefits associated with stock options................... 1,376 683 -- Cash deposits received for stock options............................ 1,514 4,264 1,187 ------------ ---------- ---------- Net cash provided by financing activities............................. 30,745 1,148 32,736 ------------ ---------- ---------- Increased (decrease) in cash and cash equivalents..................... 3,771 (18,132) (59,119) Cash and cash equivalents: Beginning of year................................................... 82,574 100,706 159,825 ------------ ---------- ---------- End of year......................................................... $ 86,345 $ 82,574 $ 100,706 ============ ========== ========== Non-cash investing and financing activities: Term loans refinanced............................................... $ -- $ -- $ 9,859 Stock options exercised (at expiration of two-year forfeiture period).......................................... 1,345 3,620 3,143
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data) 1. DESCRIPTION OF BUSINESS ----------------------- K-V Pharmaceutical Company and its subsidiaries ("KV" or the "Company") are primarily engaged in the development, manufacture, acquisition, 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 ("GAAP"). 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. USE OF ESTIMATES ---------------- The preparation of financial statements in conformity with GAAP 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 revenue recognition and reductions to gross revenues, inventory valuation, intangible assets, stock-based compensation, income taxes, and loss contingencies related to legal proceedings. 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. INVESTMENT SECURITIES --------------------- The Company's investment securities consist of mutual funds comprised of U.S. government guaranteed investments and auction rate securities. The Company classifies its investment securities as available-for-sale 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 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, up to 35 days. The Company reclassified these securities to non-current investment securities at March 31, 2008 to reflect the current lack of liquidity in these investments (see Note 4). 73 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 ranging from nine to 20 years. 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. The Company evaluates its intangible assets for impairment at least annually or 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. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," 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 2008 determined there was no goodwill impairment. OTHER ASSETS ------------ Non-marketable equity investments for which the Company does not have the ability to exercise significant influence over operating and financial policies (generally less than 20% ownership) are accounted for using the cost method. Such investments are included in "Other assets" in the accompanying consolidated balance sheets and relate primarily to the Company's $12,284 investment at March 31, 2008 in the preferred stock of Strides Arcolab Limited. 74 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. The Company also enters into long-term agreements under which it assigns marketing rights for 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. o Payment discounts are reductions to invoiced amounts offered to customers for payment within a specified period and are estimated utilizing historical customer payment experience. o Sales rebates are offered to certain customers to promote customer loyalty and encourage greater product sales. These rebate programs provide that, upon the attainment of pre-established volumes or the attainment of revenue milestones for a specified period, the customer receives credit against purchases. Other promotional programs are incentive programs periodically offered to customers. Due to the nature of these programs, the Company is able to estimate provisions for rebates and other promotional programs based on the specific terms in each agreement. o Consistent with common industry practices, the Company has agreed to terms with its customers to allow them to return product that is within a certain period of the expiration date. Upon recognition of revenue from product sales to customers, the Company provides for an estimate of product to be returned. This estimate is determined by applying a historical relationship of customer returns to amounts invoiced. o 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 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. o 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 75 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. o 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. The provision for Medicaid rebates is based upon historical experience of claims submitted by the various states. The Company also monitors Medicaid legislative changes to determine what impact such legislation may have on the provision for Medicaid rebates. 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 $234,427, $148,822 and $154,662 for the years ended March 31, 2008, 2007 and 2006, respectively. The reserve balances related to the sales provisions totaled $46,646 and $31,281 at March 31, 2008 and 2007, 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 U.S. 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 31.0%, 28.6% and 9.0%, and 33.7%, 19.7% and 15.1% of gross receivables at March 31, 2008 and 2007, respectively. For the year ended March 31, 2008, KV's three largest customers accounted for 24.6%, 23.9% and 9.8% of gross revenues. For the years ended March 31, 2007 and 2006, the Company's three largest customers accounted for gross revenues of 21.1%, 25.7% and 14.4% and 15.7%, 26.9% and 12.7%, 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. 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 76 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 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 $27,545, $21,932 and $18,366 for the years ended March 31, 2008, 2007 and 2006, 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 convertible debt (see Note 10). 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 $5,635 and $4,471 at March 31, 2008 and 2007, respectively. Deferred financing costs, net of accumulated amortization, are included in "Other Assets" in the accompanying consolidated balance sheets. EARNINGS PER SHARE ------------------ The Company has two classes of common stock: Class A Common Stock and Class B Common Stock that is convertible into Class A Common Stock. With respect to dividend rights, holders of Class A Common Stock are entitled to receive cash dividends per share equal to 120% of the dividends per share paid on the Class B Common Stock. 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. The Company presents diluted earnings per share for Class B Common Stock for all periods using the two-class method which does not assume the conversion of Class B Common Stock into Class A Common Stock. The Company presents diluted earnings per share for Class A Common Stock using the if-converted method which assumes the conversion of Class B Common Stock into Class A Common Stock, if dilutive. Basic earnings per share is computed using the weighted average number of common shares outstanding during the period except that it does not include unvested common shares subject to repurchase. Diluted earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options, unvested common shares subject to repurchase, 77 convertible preferred stock and the Notes. The dilutive effects of outstanding stock options and unvested common shares subject to repurchase are reflected in diluted earnings per share by application of the treasury stock method. Convertible preferred stock and the Notes are reflected on an if-converted basis. The computation of diluted earnings per share for Class A Common Stock assumes the conversion of the Class B Common Stock, while the diluted earnings per share for Class B Common Stock does not assume the conversion of those shares. 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 amount of existing assets and liabilities and the respective tax basis. 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. The Company evaluates the realizability of its deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include the Company's forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company's effective tax rate on future earnings. The Company accounts for uncertain tax positions in accordance with FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -- an Interpretation of FASB Statement No. 109" ("FIN 48"), which was issued in July 2006. This interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense. STOCK-BASED COMPENSATION ------------------------ Effective April 1, 2006, the Company adopted SFAS No. 123 (revised 2004), "Share-Based Payment ("SFAS 123R"), which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based compensation awards made to employees and directors over the vesting period of the awards. The Company adopted SFAS 123R using the modified prospective method and, as a result, did not retroactively adjust results from prior periods. Under the modified prospective method, stock-based compensation expense was recognized (1) for the unvested portion of previously issued awards that were outstanding at the initial date of adoption based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 "Accounting for Stock-Based Compensation" and (2) for any awards granted or modified on or subsequent to the effective date of SFAS 123R based on the grant date fair value estimated in accordance with the provisions of this statement. Prior to the adoption of SFAS 123R, the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"). The Company also applied the disclosure provisions of SFAS 123, as amended by SFAS 148, as if the fair value-based method had been applied in measuring compensation expense. Under APB 25, compensation cost for stock options was recognized based on the excess, if any, of the quoted market price of the stock at the grant date of the award or other measurement date over the amount an employee must pay to acquire the stock. 78 The following table provides the pro forma effects on net income and earnings per share for fiscal 2006 as if the fair value recognition provisions of SFAS 123 had been applied to options granted under the Company's employee compensation plans:
YEAR ENDED MARCH 31, 2006 ------------------- Net income $ 11,416 Add: Stock-based compensation expense included in net income, net of tax 641 Deduct: Stock-based compensation using the fair value based method for all awards (2,669) ------------------- Pro forma net income $ 9,388 =================== Earnings per share: Basic - Class A common $ 0.24 Basic - Class B common 0.20 Diluted - Class A common 0.23 Diluted - Class B common 0.20 Earnings per share - pro forma: Basic - Class A common $ 0.20 Basic - Class B common 0.17 Diluted - Class A common 0.19 Diluted - Class B common 0.16
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. FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------- The Company's financial instruments consist primarily of cash and cash equivalents, marketable securities, receivables, investments, trade accounts payable, the convertible debt, embedded derivatives related to the issuance of the convertible debt, a mortgage loan agreement, and borrowings under the Company's line of credit. The carrying amounts of cash and cash equivalents, receivables and trade accounts payable are representative of their respective fair values due to their relatively short maturities. The fair values of marketable securities are based on quoted market prices. The Company estimates the fair value of its fixed rate long-term obligations based on quoted market rates of interest and maturity schedules for similar issues. The carrying value of these obligations approximates their fair value. The Company's investment in the preferred stock of Strides Arcolab Limited of $14,311, including accrued but unpaid dividends, had a fair value of $14,600 at March 31, 2008 based on a valuation analysis. Based on quoted market rates, the Company's convertible debt had a fair value of $228,360 and $229,240 at March 31, 2008 and 2007, respectively. The carrying amount of the mortgage loan agreement and the outstanding balance of the line of credit approximate their fair values because their terms are similar to those which can be obtained for similar financial instruments in the current marketplace. 79 DERIVATIVE FINANCIAL INSTRUMENTS -------------------------------- The Company's derivative financial instruments consist of embedded derivatives related to the convertible debt. These embedded derivatives include certain conversion features and a contingent interest feature. Although the conversion features represent embedded derivative financial instruments, based on the de minimis value of these features at the time of issuance and at March 31, 2008, 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 September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS 157 clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability, provides a framework for measuring fair value under GAAP and expands disclosure requirements about fair value measurements. SFAS 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company plans to adopt SFAS 157 at the beginning of fiscal 2009 and is evaluating the impact, if any, the adoption of SFAS 157 will have on its financial condition and results of operations. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), which permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Companies are not allowed to adopt SFAS 159 on a retrospective basis unless they choose early adoption. The Company plans to adopt SFAS 159 at the beginning of fiscal 2009 and is evaluating the impact, if any, the adoption of SFAS 159 will have on its financial condition and results of operations. In March 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force ("EITF") in Issue No. 06-10, "Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements" ("Issue 06-10"). Issue 06-10 requires companies with collateral assignment split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods to recognize a liability for future benefits based on the substantive agreement with the employee. Recognition should be in accordance with FASB Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," or APB Opinion No. 12, "Omnibus Opinion - 1967," depending on whether a substantive plan is deemed to exist. Companies are permitted to recognize the effects of applying the consensus through either (1) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets as of the beginning of the year of adoption or (2) a change in accounting principle through retrospective application to all prior periods. Issue 06-10 is effective for fiscal years beginning after December 15, 2007, with early adoption permitted. The Company plans to adopt Issue 06-10 at the beginning of fiscal 2009 and is evaluating the impact of the adoption of Issue 06-10 on its financial condition and results of operations. In June 2007, the FASB ratified the consensus reached by the EITF on Issue No. 07-3, Accounting for Advance Payments for Goods or Services Received for Use in Future Research and Development Activities ("Issue 07-3"), which is effective for fiscal years beginning after December 15, 2007 and is applied prospectively for new contracts entered into on or after the effective date. Issue 07-3 addresses nonrefundable advance payments for goods or services for use in future research and development activities. Issue 07-3 will require that these payments that will be used or rendered for future research and development activities be deferred and capitalized and recognized as an expense as the related goods are delivered or the 80 related services are performed. If an entity does not expect the goods to be delivered or the services to be rendered, the capitalized advance payments should be expensed. The Company plans to adopt Issue 07-3 at the beginning of fiscal 2009 and is evaluating the impact of the adoption of this issue on its financial condition and results of operations. In September 2007, the EITF reached a consensus on Issue No. 07-1 ("Issue 07-1"), "Accounting for Collaborative Arrangements." The scope of Issue 07-1 is limited to collaborative arrangements where no separate legal entity exists and in which the parties are active participants and are exposed to significant risks and rewards that depend on the success of the activity. The EITF concluded that revenue transactions with third parties and associated costs incurred should be reported in the appropriate line item in each company's financial statements pursuant to the guidance in Issue 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." The EITF also concluded that the equity method of accounting under Accounting Principles Board Opinion 18, "The Equity Method of Accounting for Investments in Common Stock," should not be applied to arrangements that are not conducted through a separate legal entity. The EITF also concluded that the income statement classification of payments made between the parties in an arrangement should be based on a consideration of the following factors: the nature and terms of the arrangement; the nature of the entities' operations; and whether the partners' payments are within the scope of existing GAAP. To the extent such costs are not within the scope of other authoritative accounting literature, the income statement characterization for the payments should be based on an analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. The provisions of Issue 07-1 are effective for fiscal years beginning on or after December 15, 2008, and companies will be required to apply the provisions through retrospective application. The Company plans to adopt Issue 07-1 at the beginning of fiscal 2010 and is evaluating the impact of the adoption of Issue 07-1 on its financial condition and results of operations. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)") which replaces SFAS 141 but retains the fundamental concept of purchase method of accounting in a business combination and improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this goal, the new standard requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction and any non-controlling interest at the acquisition date at their fair value as of that date. This statement requires measuring a non-controlling interest in the acquiree at fair value which will result in recognizing the goodwill attributable to the non-controlling interest in addition to that attributable to the acquirer. This statement also requires the recognition of assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition date fair values. SFAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and earlier adoption is prohibited. The Company plans to adopt SFAS 141(R) at the beginning of fiscal 2010 and is evaluating the impact of SFAS 141(R) on its financial condition and results of operations. In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements" ("SFAS 160") an amendment of ARB No. 51, which will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary by requiring all entities to report non-controlling (minority) interests in subsidiaries in the same way as equity in the consolidated financial statements. In addition, SFAS 160 eliminates the diversity that currently exists in accounting for transactions between an entity and non-controlling interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company plans to adopt SFAS 160 at the beginning of fiscal 2010 and is evaluating the impact of SFAS 160 on its financial condition and results of operations. In May 2008, the FASB issued FASB Staff Position No. APB 14-a, "Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement)." Under the new rules for convertible debt instruments that may be settled entirely or partially in cash upon conversion, an 81 entity should separately account for the liability and equity components of the instrument in a manner that reflects the issuer's economic interest cost. The effect of the proposed new rules for the debentures is that the equity component would be included in the paid-in-capital section of shareholders' equity on an entity's consolidated balance sheet and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of convertible debt. The FSP will be effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. Early adoption is not permitted. The Company is currently evaluating the proposed new rules and the impact on its financial condition and results of operations. 3. ACQUISITIONS AND LICENSE AGREEMENT ---------------------------------- In January 2008, we entered into a definitive asset purchase agreement with CYTYC Prenatal Products and Hologic, Inc. ("CYTYC") to acquire the U.S. and worldwide rights to Gestiva(TM) (17-alpha hydroxyprogesterone caproate). The New Drug Application ("NDA") for Gestiva(TM) is currently before the FDA, pending approval for use in the prevention of preterm birth in certain categories of pregnant women. The proposed indication is for women with a history of at least one spontaneous preterm delivery (i.e., less than 37 weeks), who are pregnant with a single fetus. Under the terms of the asset purchase agreement, the Company agreed to pay $82,000 for Gestiva(TM), $7,500 of which was paid at closing. For the year ended March 31, 2008, the Company recorded the $7,500 payment as in-process research and development expense because the product had not obtained FDA approval when the initial payment was made. The remainder of the purchase price is payable on the completion of two milestones: (1) $2,000 on the earlier to occur of CYTYC's receipt of acknowledgement from the FDA that their response to the FDA's October 20, 2006 "approvable" letter is sufficient for the FDA to proceed with their review of the NDA or the receipt of FDA's approval of the Gestiva(TM) NDA and (2) $72,500 on FDA approval of a Gestiva(TM) NDA, transfer of all rights in the NDA to the Company and receipt by the Company of defined launch quantities of finished Gestiva(TM) suitable for commercial sale. In May 2007, the Company acquired the U.S. marketing rights to Evamist(TM), a new estrogen replacement therapy product delivered with a patented metered-dose transdermal spray system, from VIVUS, Inc. Under terms of the Asset Purchase Agreement, the Company paid $10,000 in cash at closing and agreed to make an additional cash payment of $141,500 upon final approval of the product by the U.S. Food and Drug Administration ("FDA"). The agreement also provides for two future payments upon achievement of certain net sales milestones. If Evamist(TM) achieves $100,000 of net sales in a fiscal year, a one-time payment of $10,000 will be made, and if net sales levels reach $200,000 in a fiscal year, a one-time payment of $20,000 will be made. For the year ended March 31, 2008, the Company recorded the $10,000 payment made at closing as in-process research and development expense because the product had not obtained FDA approval when the initial payment was made. In July 2007, FDA approval for Evamist(TM) was received and the payment of $141,500 was made to VIVUS, Inc. The preliminary purchase price allocation, which is subject to change based on the final fair value assessment, resulted in estimated identifiable intangible assets of $52,446 to product rights; $15,166 to trademark rights; $66,417 to rights under a sublicense agreement; and, $7,471 to a covenant not to compete. Upon FDA approval in July 2007, the Company began amortizing the product rights, trademark rights and rights under the sublicense agreement over 15 years and the covenant not to compete over nine years. 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 separate agreements, 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 was originally part of the licensing arrangement with FemmePharma that provided the Company, among other things, marketing rights for the product principally in the U.S. In accordance with the new agreement, the Company acquired worldwide licensing rights of the endometriosis product, no longer was 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 82 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. 4. INVESTMENT SECURITIES --------------------- The carrying amount of available-for-sale securities and their approximate fair values at March 31, 2008 and 2007 were as follows.
MARCH 31, 2008 ---------------------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Short-term marketable securities..... $ 40,538 $ 10 $ - $ 40,548 Non-current auction rate securities........................ 83,900 - (2,384) 81,516 ---------- ---------- ---------- ---------- Total............................ $ 124,438 $ 10 $ (2,384) $ 122,064 ========== ========== ========== ========== MARCH 31, 2007 ---------------------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Short-term marketable securities..... $ 38,612 $ 50 $ - $ 38,662 Short-term auction rate securities........................ 119,150 - - 119,150 ---------- ---------- ---------- ---------- Total............................ $ 157,762 $ 50 $ - $ 157,812 ========== ========== ========== ==========
The Company accounts for its investment securities in accordance with SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," and classifies them as "available for sale." The Company's marketable securities at March 31, 2008 are recorded at fair value based on quoted market prices using the specific identification method and consisted of mutual funds comprised of U.S. government investments. These marketable securities are classified as current assets as the Company has the ability to use them for current operating and investing purposes. For the year ended March 31, 2007, a realized loss of $270 was recognized when the Company determined that its unrealized loss on marketable securities had become other-than-temporary as the duration of the losses had surpassed 24 months and the Company no longer intended to hold these securities to recovery. There were no realized gains or losses for the years ended March 31, 2008 and 2006. At March 31, 2008 and 2007, the Company also had $83,900 and $119,150 of principal invested in auction rate securities ("ARS"). These securities all have a maturity in excess of 10 years. The Company's investments in ARS primarily represent interests in collateralized debt obligations supported by pools of student loans, the principal of which is guaranteed by the U.S. Government. ARS backed by student loans are viewed as having low default risk and therefore very low risk of credit downgrade. The ARS held by the Company are AAA rated securities with long-term nominal maturities for which the interest rates are reset through a dutch auction at pre-determined intervals, up to 35 days. The auctions historically have provided a liquid market for these securities. With the liquidity issues experienced in global credit and capital markets, the ARS held by the Company at March 31, 2008 have experienced multiple failed auctions beginning in February 2008 as the amount of securities 83 submitted for sale has exceeded the amount of purchase orders. Given the failed auctions, the Company's ARS are illiquid until a successful auction for them occurs. The estimated fair value of the Company's ARS holdings at March 31, 2008 was $81,516, which reflects a $2,384 difference from the principal value of $83,900. Although the ARS continue to pay interest according to their stated terms, the Company has recorded an unrealized loss of $1,550, net of tax, as a reduction to shareholders' equity in accumulated other comprehensive loss, reflecting adjustments to the ARS holdings that the Company has concluded have a temporary decline in value. The ARS are valued based on a discounted cash flow model that considers, among other factors, the time to work out the market disruption in the traditional trading mechanism, the stream of cash flows (coupons) earned until maturity, the prevailing risk free yield curve, credit spreads applicable to a portfolio of student loans with various tenures and ratings and an illiquidity premium. These factors were used in a Monte Carlo simulation based methodology to derive the estimated fair value of the ARS. At March 31, 2007, ARS are classified as current assets and included in the line item "Marketable securities." Given the failed auctions, the Company's ARS are illiquid until there is a successful auction for them. Accordingly, the $81,516 of ARS have been reclassified at March 31, 2008 from current assets to non-current assets and are included in the line item "Investment securities." 5. INVENTORIES ----------- Inventories as of March 31, consist of:
2008 2007 ---- ---- Finished goods..................... $ 27,654 $ 35,420 Work-in-process.................... 15,925 13,294 Raw materials...................... 51,401 42,801 --------- --------- $ 94,980 $ 91,515 ========= =========
6. PROPERTY AND EQUIPMENT ---------------------- Property and equipment as of March 31, consist of:
2008 2007 ---- ---- Land and improvements................................. $ 6,253 $ 6,253 Buildings and building improvements................... 109,128 108,631 Machinery and equipment............................... 86,490 73,461 Office furniture and equipment........................ 32,417 27,819 Leasehold improvements................................ 21,057 21,057 Construction-in-progress.............................. 14,870 5,865 ---------- ---------- 270,215 243,086 Less accumulated depreciation......................... (74,015) (56,186) ---------- ---------- Net property and equipment......................... $ 196,200 $ 86,900 ========== ==========
Capital additions to property and equipment were $23,656, $25,066 and $58,334 for the years ended March 31, 2008, 2007 and 2006, respectively. Depreciation of property and equipment was $18,317, $16,208 and $11,916 for the years ended March 31, 2008, 2007 and 2006, respectively. Property and equipment projects classified as construction-in-progress at March 31, 2008 are projected to be completed during the next 12 months at an estimated cost of $4,595. During the year ended March 31, 2006, the Company recorded capitalized interest on qualifying construction projects of $940. In fiscal 2008 and 2007, the Company did not record any capitalized interest. 84 7. INTANGIBLE ASSETS AND GOODWILL ------------------------------ Intangible assets and goodwill as of March 31, consist of:
2008 2007 --------------------------------- --------------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION ------ ------------ ------ ------------ Product rights acquired: Micro-K(R).......................... $ 36,140 $ (16,318) $ 36,140 $ (14,513) PreCare(R).......................... 8,433 (3,654) 8,433 (3,233) Evamist(TM).......................... 52,446 (2,378) -- -- Trademarks acquired: Niferex(R).......................... 14,834 (3,709) 14,834 (2,967) Chromagen(R)/StrongStart(R)........... 27,642 (6,910) 27,642 (5,528) Evamist(TM).......................... 15,166 (688) -- -- License agreements: Evamist(TM).......................... 66,417 (3,011) -- -- Other............................. 2,300 -- 4,400 (480) Covenants not to compete: Evamist(TM).......................... 7,471 (565) -- -- Other............................. 375 (109) 375 (72) Trademarks and patents............... 5,317 (972) 4,196 (774) ---------- ---------- ---------- ---------- Total intangible assets..... 236,541 (38,314) 96,020 (27,567) Goodwill........................ 557 - 557 - ---------- ---------- ---------- ---------- $ 237,098 $ (38,314) $ 96,577 $ (27,567) ========== ========== ========== ==========
As of March 31, 2008, the Company's intangible assets have a weighted average useful life of approximately 16 years. Amortization of intangible assets was $11,491, $4,810 and $4,784 for the years ended March 31, 2008, 2007 and 2006, respectively. During the year ended March 31, 2008, the Company recognized an impairment charge of $1,140 for the intangible asset related to a product right acquired under an external development agreement. Price erosion on the product eliminated the economics of marketing the product. The entire balance of the intangible asset was written-off as the product is no longer expected to generate positive future cash flows. The impairment loss is included in "Amortization and impairment of intangible assets" in the Consolidated Statement of Income and is included under the All Other segment in Note 21. Assuming no other additions, disposals or adjustments are made to the carrying values and/or useful lives of the intangible assets, annual amortization expense on product rights, trademarks acquired and other intangible assets is estimated to be approximately $14,500 in each of the five succeeding fiscal years. 85 8. OTHER ASSETS ------------ Other assets as of March 31, consist of:
2008 2007 ---- ---- Cash surrender value of life insurance............... $ 4,300 $ 3,874 Preferred stock investments.......................... 12,684 11,806 Accrued dividends on preferred stock ................ 2,027 1,198 Deferred financing costs, net........................ 859 2,159 Deposits............................................. 3,238 1,366 ---------- ---------- $ 23,108 $ 20,403 ========== ==========
9. ACCRUED LIABILITIES ------------------- Accrued liabilities as of March 31, consist of:
2008 2007 ---- ---- Salaries, wages, incentives and benefits....... $ 30,314 $ 20,669 Accrued interest payable....................... 2,721 2,192 Professional fees.............................. 4,837 5,921 Promotion expenses............................. 4,984 369 Stock option deposits.......................... 2,729 2,560 Other.......................................... 931 1,507 --------- ---------- $ 46,516 $ 33,218 ========= ==========
10. LONG-TERM DEBT -------------- Long-term debt as of March 31, consists of:
2008 2007 ---- ---- Building mortgages............................. $ 39,452 $ 41,348 Line of credit................................. 30,000 -- Convertible notes.............................. 200,000 200,000 ----------- ----------- 269,452 241,348 Less current portion........................... (202,020) (1,897) ----------- ----------- $ 67,432 $ 239,451 =========== ===========
In June 2006, the Company entered into a credit agreement with ten banks that provides for a revolving line of credit for borrowing up to $320,000. This credit facility also includes a provision for increasing the revolving commitment, at the lenders' sole discretion, by up to an additional $50,000. The credit agreement is unsecured unless the Company, under certain specified circumstances, utilizes the facility to redeem part or all of its outstanding Notes. Interest is charged under the credit facility at the lower of the prime rate or LIBOR plus 62.5 to 150 basis points depending on the ratio of senior debt to EBITDA. The credit facility has a five-year term expiring in June 2011. The 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. At March 31, 2008, the Company had $942 in open letters of credit issued under the revolving credit line and $30,000 of cash borrowings outstanding under the facility. 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 86 mortgage loan was used for working capital and general corporate purposes. The 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. In May 2003, the Company issued $200,000 principal amount of 2.5% Contingent Convertible Subordinated Notes due 2033 (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. In November 2007, the average trading price of the Notes reached the threshold for the five-day trading period that resulted in the payment of contingent interest and beginning November 16, 2007 the Notes began to bear interest at a rate of 3.00% per annum. 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. Even though no holders required the Company to repurchase all or a portion of their Notes on May 16, 2008, the Company classified the Notes as a current liability as of March 31, 2008 due to the right the holders had to require the Company to repurchase the Notes on May 16, 2008. Since the holders did not elect to cause us to repurchase any of the Notes, the Notes will be reclassified as long-term beginning with our consolidated balance sheet as of June 30, 2008. The Notes are subordinate to all of our existing and future senior obligations. 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. The contingent interest feature of the Notes meets the criteria of and qualifies as an embedded derivative. Although this feature represents an embedded derivative financial instrument, based on its de minimis value at the time of issuance and at March 31, 2008, no value has been assigned to this embedded derivative. 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. 87 The aggregate maturities of long-term debt as of March 31, 2008 are as follows: Due in one year............... $ 202,020 Due in two years.............. 2,144 Due in three years............ 2,276 Due in four years............. 32,411 Due in five years............. 2,565 Thereafter.................... 28,036 ---------- $ 269,452 ========== The Company paid interest of $8,648 and $7,316 for the years ended March 31, 2008 and 2007, respectively. For the year ended March 31, 2006, the Company paid interest, net of capitalized interest, of $4,692. 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 ten years subsequent to the property being placed in service. Industrial revenue bonds totaling $120,407 were outstanding at March 31, 2008. 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 2021. Total rent expense for the years ended March 31, 2008, 2007 and 2006 was $4,536, $4,132 and $3,819, respectively. Future minimum lease commitments under non-cancelable operating leases are as follows: 2009.......................... $ 2,183 2010.......................... 1,531 2011.......................... 1,378 2012.......................... 1,255 2013.......................... 861 Thereafter.................... 939 88 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 condition 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 $31,000. LITIGATION The Company and its subsidiaries Drugtech Corporation and Ther-Rx Corporation were named as defendants in a declaratory judgment case filed in the U.S. District Court for the District of Delaware by Lannett Company, Inc. ("Lannett") on June 6, 2008 and styled Lannett Company Inc. v. KV Pharmaceuticals et. al. Lannett has subsequently amended its complaint. The action seeks a declaratory judgment of patent invalidity, patent non-infringement, and patent unenforceability for inequitable conduct with respect to five patents owned by, and two patents licensed to, the Company or its subsidiaries and pertaining to the PrimaCare ONE(R) product marketed by Ther-Rx Corporation; unfair competition; deceptive trade practices; and antitrust violations. No specific amount of damages was stated in the complaint or amended complaint. We have not yet been served with either the complaint or the amended complaint. However, on June 17 2008, the Company filed a counterclaim against Lannett in that action asserting patent infringement; federal and common law trademark infringement, false advertising, and unfair competition; federal false designation of origin, false description and false representation; and common law misappropriation. The Company has requested a temporary restraining order and preliminary injunction against Lannett's continued sale of its product and continued infringement of the Company's trademarks and patents, unfair competition or misappropriation, and to require Lannett to recall all of its shipped product. A briefing schedule has been set by the court on the Company's motion and a hearing has been scheduled before the court on the Company's motion on June 25, 2008. No discovery has yet commenced nor a trial date been set. The Company is named as a defendant in a patent infringement case filed in the U.S. District Court for the District of Delaware by UCB, Inc. and Celltech Manufacturing CA, Inc. (collectively, "UCB") on April 21, 2008 and styled UCB, Inc. et al. v. KV Pharmaceutical Company. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 40 mg, 50 mg and 60 mg strengths of Metadate CD(R) methylphenidate hydrochloride extended-release capsules, UCB filed this lawsuit under a patent owned by Celltech. In a Paragraph IV certification accompanying the ANDA, KV contended that its proposed 40mg generic formulation would not infringe Celltech's patent. Because the patent was not listed in the Orange Book for the 50mg and 60mg dosages, a Paragraph I certification was filed with respect to them. Pursuant to the Hatch-Waxman Act, the filing of the suit against the Company instituted an automatic stay of FDA approval of the Company's ANDA with respect to the 40 mg strength of this product until the earlier of a judgment in the Company's favor, or 30 months from the date of suit. Inasmuch as the Celltech patent was not listed in the Orange Book with respect to the 50 mg and 60 mg strengths, it is the Company's belief that the automatic stay does not apply to the Company's 50 mg and 60 mg strengths of this product. UCB may, however, seek to keep these strengths tied up in the litigation. The Company has filed an answer, asserted certain affirmative defenses (including that Plaintiffs are estopped to assert infringement of the 50 mg and 60 mg dosages due to their not listing the Celltech patent in the Orange Book for these dosages), and has asserted a counterclaim in which it seeks a declaratory judgment of invalidity and non-infringement of the claims in the Celltech patent, and an award of attorneys fees and costs. The case has recently commenced and no trial date has yet been set. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. 89 The Company is named as a defendant in a patent infringement case filed in the U.S. District Court for the District of New Jersey by Janssen, L.P., Janssen Pharmaceutica N.V. and Ortho-McNeil Neurologics, Inc. (collectively, "Janssen") on December 14, 2007 and styled Janssen, L.P. et al. v. KV Pharmaceutical Company. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 8 mg and 16 mg strengths of Razadyne(R) ER (formerly Reminyl(R)) galantamine hydrobromide extended-release capsules, Janssen filed this lawsuit for patent infringement under a patent owned by Janssen. In the Company's Paragraph IV certification, KV contended that its proposed generic versions do not infringe Janssen's patent. Pursuant to the Hatch-Waxman Act, the filing date of the suit against the Company instituted an automatic stay of FDA approval of the Company's ANDA until the earlier of a judgment, or 30 months from the date of the suit. The Company has filed an answer and counterclaim for declaratory judgment of non-infringement and patent invalidity. Discovery is on-going, but no trial date has yet been set. Following the Company's filing of an ANDA pertaining to a generic version of the 24 mg strength of Razadyne(R) ER (formerly Reminyl(R)) galantamine hydrobromide extended-release capsules and the Company's giving of notice of this filing to Janssen, Janssen has filed in June 2008 a second complaint in the same federal court, naming the Company as a defendant in a related patent infringement case under the same Janssen patent with respect to such 24 mg generic version. The time to answer the new complaint has not yet run. The Company anticipates that both cases will be coordinated before the court. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. The Company is named as a defendant in a patent infringement case filed in the U.S. District Court for the District of New Jersey by Celgene Corporation ("Celgene") and Novartis Pharmaceuticals Corporation and Novartis Pharma AG (collectively, "Novartis") on October 4, 2007 and styled Celgene Corporation et al. v. KV Pharmaceutical Company. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 10 mg, 20 mg, 30 mg, and 40 mg strengths of Ritalin LA(R) methylphenidate hydrochloride extended-release capsules, Celgene and Novartis filed this lawsuit for patent infringement under the provisions of the Hatch-Waxman Act with respect to two patents owned by Celgene and licensed to Novartis. In the Company's Paragraph IV certification, KV contended that its proposed generic versions do not infringe Celgene's patents. Pursuant to the Hatch-Waxman Act, the filing date of the suit against the Company instituted an automatic stay of FDA approval of the Company's ANDA until the earlier of a judgment, or 30 months from the date of the suit. The Company has been served with this complaint and has filed its answer and a counterclaim in the case, seeking a declaratory judgment of non-infringement, patent invalidity, and inequitable conduct in obtaining the patents. The case is just commencing and no trial date has yet been set. Celgene has moved to disqualify the Company's counsel in the case, asserting a conflict of interest despite its signing of an advance waiver with such counsel, and this motion is pending before the court. Should this motion be granted, the Company will need to retain new counsel. The Company does not believe that this would materially delay the progress of the lawsuit. The Company has filed a motion for sanctions against plaintiffs pursuant to Rule 11 of the Federal Rules of Civil Procedure for bringing an action without proper basis and is seeking an order dismissing the patent infringement complaint filed by plaintiffs, and awarding the Company its costs and attorneys' fees. Celgene has asked the court to dismiss the Company's Rule 11 motion, and the matter is pending before the court. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. The Company is named as a defendant in a patent infringement case brought by Purdue Pharma L.P., The P.F. Laboratories, Inc., and Purdue Pharmaceuticals L.P. ("Purdue") on January 17, 2007 against it and an unrelated third party and styled Purdue Pharma L.P. et al. v. KV Pharmaceutical Company et al. filed in the U.S. District Court for the District of Delaware. After the Company filed an ANDA with the FDA seeking permission to market a generic version of the 10 mg, 20 mg, 40 mg, and 80 mg strengths of OxyContin(R) in extended-release tablet form, Purdue filed a lawsuit against KV for patent infringement under the provisions of the Hatch-Waxman Act with respect to three Purdue patents. In the Company's Paragraph IV certification, KV contended that Purdue's patents are invalid, unenforceable, or will not be infringed by KV's proposed generic versions. On February 12, 2007, a second patent infringement lawsuit was filed in the same court against the Company by Purdue, asserting patent infringement under the same three patents with respect to the Company's filing of an amendment to its ANDA with FDA to sell a generic equivalent of Purdue's OxyContin(R), 30 mg and 60 mg strengths, products. On June 6, 2007, a third patent infringement lawsuit was filed against the Company by Purdue in the U.S. District Court for the Southern District of New York, asserting patent infringement under the 90 same three patents with respect to the Company's filing of an amendment to its ANDA with FDA to sell a generic equivalent of Purdue's OxyContin(R), 15 mg strength, product. The two lawsuits filed in federal court in Delaware have been transferred to the federal court in New York for multi-district litigation purposes together with an additional lawsuit by Purdue against another unrelated company, also in federal court in New York. Purdue currently has similar lawsuits pending against additional unrelated companies in federal court in New York. The Company filed answers and counterclaims against Purdue in all three lawsuits, asserting various defenses to Purdue's claims; seeking declaratory relief of the invalidity, unenforceability and non-infringement of the Purdue patents; and asserting counterclaims against Purdue for violations of federal antitrust law, including Sherman Act Section 1 and Section 2 for monopolization, attempt to monopolize, and conspiracy to monopolize with respect to the U.S. market for controlled-release oxycodone, and agreements in unreasonable restraint of competition, and for intentional interference with valid business expectancy. Purdue has filed replies to the Company's counterclaims. 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 court initially stayed all proceedings pending determining whether Purdue committed inequitable conduct in its dealings with the U.S. Patent and Trademark Office with respect to the issuance of its patents, which would render such patents unenforceable, and the court's subsequent decision on the issue. On January 7, 2008, the court issued its decision finding that Purdue had not committed inequitable conduct with respect to the patents in suit. The Company, among others, has asked the court to lift the stay so that the remainder of the case may resume but the stay has not yet been lifted. Discovery in the suit has not yet commenced but is expected to commence shortly after the stay is lifted on the case. No trial date has yet been set. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. 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 U.S. District Court for the District of Minnesota. CIMA 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 U.S. Patent and Trademark Office's reexamination of a patent at issue in the suit. The Patent and Trademark Office has, to date, issued a final office action rejecting all existing and proposed new claims by CIMA with respect to this patent. CIMA has certain rights of appeal of this rejection of its claims and has exercised those rights. The product involved in this lawsuit is currently subject to a hold on the Company's inventory of certain unapproved products notified to the Company in March 2008 by representatives of the Missouri Department of Health and Senior Services and the FDA. In the event that such hold is lifted, ETHEX intends to resume marketing the product during the stay in the lawsuit with CIMA. The Company intends to vigorously defend its interests when or if the stay is lifted; however, it cannot give any assurance it will prevail or that the stay will be lifted. The Company and ETHEX are named as defendants in a case brought by Axcan ScandiPharm Inc. and styled Axcan ScandiPharm Inc. v. ETHEX Corporation et. al., filed in U.S. District Court in Minnesota on June 1, 2007. In general, Axcan alleges that ETHEX's comparative promotion of its Pangestyme(TM) UL12 and Pangestyme(TM) UL18 products to Axcan's Ultrase(R) MT12 and Ultrase(R) MT18 products resulted in false advertising and misleading statements under various federal and state laws, and constituted unfair and deceptive trade practices. The Company filed a motion for judgment on the pleadings in its favor on several grounds. The motion has been granted in part and denied in part by the court on October 19, 2007, with the court applying the statute of limitations to cut off Axcan's claims concerning conduct prior to June 2001, determining that it was too early to determine whether laches or res judicata barred the suit, and rejecting the remaining bases for dismissal. Discovery has since commenced and a trial date has been set for January 2010. Plaintiffs have recently filed a motion to amend their complaint to seek declaratory judgments that Axcan does not have "unclean hands" nor violated any antitrust or unfair competition laws. This motion is pending before the court. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. The Company has 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 91 caplets that are alleged to have been manufactured by the Company and to contain phenylpropanolamine, or 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 again in 2004, 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. 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 in the event of such future litigation; however, it cannot give any assurance it will prevail. The Company was named as a defendant in a case filed in U.S. District Court in Missouri by AstraZeneca AB, Aktiebolaget Hassle and AstraZeneca LP (collectively, "AstraZeneca") and styled AstraZeneca AB et. al. v. KV Pharmaceutical Company. 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 District Court in Missouri alleging, among other things, that AstraZeneca's patent is invalid and unenforceable. These motions were granted and AstraZeneca appealed. On July 23, 2007, the Court of Appeals for the Federal Circuit affirmed the decision of the District Court below with respect to the invalidity of AstraZeneca's patent but reversed and remanded with respect to inequitable conduct by AstraZeneca. AstraZeneca filed for rehearing by the Federal Circuit, which was denied and the time has now run with respect to any petition for certiorari to the United States Supreme Court. As a result, the Company no longer faces the prospect of any liability to AstraZeneca in connection with this lawsuit. KV continued to proceed with its counterclaim against AstraZeneca for inequitable conduct in obtaining the patents that have been ruled invalid, in order to recover the Company's defense costs, including legal fees. In May 2008, the Company entered into a settlement agreement with AstraZeneca and settled its remaining counterclaims against AstraZeneca in exchange for a payment of $2,700. 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 States of Massachusetts, Alabama, Mississippi, Utah and Iowa, New York City, and approximately 45 counties in New York State. The State of Mississippi effectively voluntarily dismissed the Company and ETHEX without prejudice on October 5, 2006 by virtue of the State's filing an Amended Complaint on such date that does not name either the Company or ETHEX as a defendant. In the remaining cases, only ETHEX is a named defendant. On August 13, 2007, ETHEX settled the Massachusetts lawsuit for $575 in cash and pharmaceutical products valued at $150, both of which are to be paid or delivered over the next two years, and received a general release; no admission of liability was made. The New York City case and all New York county cases (other than the Erie, Oswego and Schenectady County cases) have been transferred to the U.S. District Court for the District of Massachusetts for coordinated or consolidated pretrial proceedings under the Average Wholesale Price Multidistrict Litigation (MDL No. 1456). The cases pertaining to the State of Alabama, Erie County, Oswego 92 County, and Schenectady County were removed to federal court by a co-defendant in October 2006, but all of these cases have since been remanded to the state courts in which they originally were filed. A motion is pending in New York state court to coordinate the Oswego, Erie and Schenectady Counties cases. Each of these actions is in the early stages, with fact discovery commencing or ongoing in the Alabama case and the federal cases involving New York City and 42 New York counties. On October 24, 2007, ETHEX was served with a complaint filed in Utah state court by the State of Utah naming it and nine other pharmaceutical companies as defendants in a pricing suit. On November 19, 2007, the State of Utah filed an amended complaint. The Utah suit has been removed to federal court and a motion has been filed to transfer the case to the MDL litigation for pretrial coordination. The State is seeking to remand the case to state court, and the decision is pending before the court. The time for ETHEX to answer or respond to the Utah complaint has not yet run. On October 9, 2007, the State of Iowa filed a complaint in federal court in Iowa naming ETHEX and 77 other pharmaceutical companies as defendants in a pricing suit. ETHEX and the other defendants have filed a motion to dismiss the Iowa complaint. 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. The Company and ETHEX were 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 alleged 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 were 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 had not yet begun, and the court had set the trial to commence in July 2007. The plaintiff and the Company agreed, however, to a tolling agreement, under which the plaintiff dismissed the case without prejudice in return for the Company's agreement to toll the statute of limitations in the event the plaintiff refiled its case in the future. The case was dismissed without prejudice. On January 18, 2008, the Company and ETHEX were served with a new complaint, substantially similar to the earlier law suit. KV and ETHEX have filed an answer to the new complaint, as well as a motion to dismiss the lawsuit based on expiration of the statute of limitations. This motion is pending before the court, with a hearing scheduled by the court on July 7, 2008. A trial date has been set for November 2008. The Company intends to vigorously defend its interests; however, it cannot give any assurance that it will prevail. On September 15, 2006, a shareholder derivative suit, captioned Fuhrman v. Hermelin et al., was filed in state court in St. Louis, Missouri against the Company, as nominal defendant, and seven present or former officers and directors, alleging that defendants had breached their fiduciary duties and engaged in unjust enrichment in connection with the granting, dating, expensing and accounting treatment of past grants of stock options between 1995 and 2002 to six current or former directors or officers. Relief sought included damages, disgorgement of backdated stock options and their proceeds, attorneys' fees, and equitable relief. On February 26, 2007, the Fuhrman lawsuit was dismissed without prejudice by the plaintiff in state court, and a lawsuit, captioned Krasick v. Hermelin et al., was filed in the U.S. District Court for the Eastern District of Missouri by the same law firms as in the Fuhrman lawsuit, with a different plaintiff. The Krasick lawsuit was also a shareholder derivative suit filed against the Company, as nominal defendant, and 19 present or former officers and directors. The complaint asserted within its fiduciary duties claims allegations that the officers and/or directors of KV improperly (including through collusion and aiding and abetting) backdated stock option grants in violation of shareholder-approved plans, improperly recorded and accounted for the allegedly backdated options in violation of GAAP, improperly took tax deductions under the Internal Revenue Code, disseminated and filed false financials and false SEC filings in violation of federal securities laws and rules thereunder, and engaged in insider trading and 93 misappropriation of information. Relief sought included damages, a demand for accounting and recovery of the benefits allegedly improperly received, rescission of the allegedly backdated stock options and disgorgement of their proceeds, and reasonable attorney's fees, in addition to equitable relief, including an injunction to require the Company to change certain of its corporate governance and internal control procedures. On May 11, 2007, the Company learned of the filing of another lawsuit, captioned Gradwell v. Hermelin et al., also in the U.S. District Court for the Eastern District of Missouri. The complaint was brought by the same law firms that brought the Krasick litigation and was substantively the same as in the Krasick litigation, other than being brought on behalf of a different plaintiff and eliminating one individual defendant from the suit. On July 18, 2007, the Krasick and Gradwell suits were refiled as a consolidated action in U.S. District Court for the Eastern District of Missouri, styled In re K-V Pharmaceutical Company Derivative Litigation, which was substantively the same as the Krasick and Gradwell suits. The Company moved to terminate the litigation based on a determination by members of a Special Committee of the Board of Directors that continuation of the litigation was not in the best interest of KV and its shareholders. All individual officer and director defendants joined in that motion. Plaintiffs filed a motion for rule to show cause why the defendants' motion to terminate the lawsuit should not be stricken and dismissed. On February 15, 2008, the court stayed proceedings in the case until April 9, 2008, to permit mediation pursuant to the parties' stipulation. Mediation occurred on April 2, 2008. On May 23, 2008, all remaining parties to the litigation filed a proposed settlement with the court which, if approved by the court, would resolve all claims asserted in the Action. The proposed settlement provides for a payment of fees and expenses to plaintiffs' counsel not to exceed $1,650, which amount is expected to be covered by insurance. The proposed settlement received preliminary approval by the court on June 3, 2008. Notice of the terms of the settlement has been mailed to all shareholders of record as of May 23, 2008 and a final fairness hearing has been scheduled by the court to be conducted on August 26, 2008. In the course of the Special Committee's investigation, by letter dated December 18, 2006, the Company was notified by the SEC staff that it had commenced an investigation with respect to the Company's stock option plans, grants, exercises, and accounting treatment. The Company has cooperated with the SEC staff in its investigation and, among other things, has provided them with copies of the Special Committee's report and all documents collected by the Special Committee in the course of its review. In December 2007, the SEC staff, pursuant to a formal order of investigation, issued subpoenas for additional documents and testimony by certain employees. The production of additional documents called for by the subpoena and the testimony of the employees was completed in May 2008. The Company has received a subpoena from the Office of Inspector General of the Department of Health and Human Services, seeking documents with respect to two of ETHEX's nitroglycerin products. Both are unapproved products, that is, they have not received FDA approval. (FDA approval is not necessarily required for all drugs to be sold in the marketplace, such as pre-1938 "grandfathered" products or certain drugs reviewed under the so-called DESI process. The Company believes that its two products come within these exceptions.) The subpoena states that it is in connection with an investigation into potential false claims under Title 42 of the U.S. Code, and appears to pertain to whether these products are eligible for reimbursement under federal health care programs, such as Medicaid and VA programs. Resolution of any of the matters discussed above could have a material adverse effect on the Company's results of operations or financial condition. 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 the ultimate outcome of such other proceedings will not have a material adverse effect on its results of operations or financial condition. There are uncertainties and risks associated with all litigation and there can be no assurance the Company will prevail in any particular litigation. 94 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 non-compete 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 ten years or the life of the CEO. In accordance with this agreement, the Company recognized retirement expense of $2,232, $877 and $965 for the years ended March 31, 2008, 2007 and 2006, respectively. 14. GAIN FROM LEGAL SETTLEMENT -------------------------- In January 2007, the Company received a $3,600 payment from an insurance company in accordance with a settlement agreement entered into with the insurance company for insurance coverage associated with the Healthpoint litigation. The payment was reflected by the Company in the "Selling and Administrative" expense line item of operating income for the year ended March 31, 2007 and was recorded net of approximately $1,192 of attorney-related fees. 15. INCOME TAXES ------------ The income tax provisions for the years ended March 31, 2008, 2007 and 2006, are based on estimated federal and state taxable income using the applicable statutory rates. The current and deferred federal and state income tax provisions, excluding income taxes related to the cumulative effect of a change in accounting, for the years ended March 31, 2008, 2007 and 2006 are as follows:
2008 2007 2006 ---- ---- ---- PROVISION Current: Federal............................... $ 44,280 $ 23,434 $ 17,035 State................................. 3,414 1,918 1,552 -------- -------- -------- 47,694 25,352 18,587 -------- -------- -------- Deferred: Federal............................... (4,073) 7,042 5,521 State................................. (312) 564 325 -------- -------- -------- (4,385) 7,606 5,846 -------- -------- -------- $ 43,309 $ 32,958 $ 24,433 ======== ======== ========
The reasons for the differences between the provision for income taxes and the expected federal income taxes at the U.S. statutory rate are as follows:
2008 2007 2006 ---- ---- ---- Expected income tax expense................. $ 46,082 $ 31,175 $ 12,547 Purchased in-process research and development.......................... -- -- 10,654 State income taxes, net of federal income tax benefit............... 2,016 1,613 1,218 Business credits............................ (1,213) (945) (831) Domestic manufacturer deduction............. (2,829) (707) (512) Adjustment to unrecognized tax benefits..... (2,464) 1,910 1,712 Other ...................................... 1,717 (88) (355) --------- -------- --------- Provision for income tax expense............ $ 43,309 $ 32,958 $ 24,433 ========= ======== =========
95 As of March 31, 2008 and 2007, the tax effect of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts are as follows:
2008 2007 -------------------------------- --------------------------------- CURRENT NON-CURRENT CURRENT NON-CURRENT ------- ----------- ------- ----------- Fixed asset basis differences........ $ -- $ (16,996) $ -- $ (14,121) Reserves for inventory and receivables....................... 14,728 -- 10,307 -- Accrued compensation................. 1,612 -- -- -- Deferred compensation................ -- 3,138 -- 2,320 Amortization......................... -- 2,120 -- (3,440) Convertible notes interest........... -- (30,305) -- (22,766) Stock-based compensation............. 2,592 -- 1,525 -- Payroll taxes........................ 3,227 -- 2,196 -- Other................................ 653 2,744 336 -- --------- ---------- --------- ---------- Net deferred tax asset (liability) $ 22,812 $ (39,299) $ 14,364 $ (38,007) ========= ========== ========= ==========
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the timing of deferred tax liability reversals and projected future taxable income. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the temporary differences are deductible, management believes it more likely than not the Company will realize the benefits of these deductible differences. An income tax benefit has resulted from the determination that certain non-qualified stock options for which stock-based compensation expense was recorded will create an income tax deduction. This tax benefit has resulted in an increase to the Company's deferred tax assets for stock options prior to the occurrence of a taxable event or the forfeiture of the related options. Upon the occurrence of a taxable event or forfeiture of the underlying options, the corresponding deferred tax asset is reversed and the excess or deficiency in the deferred tax asset is recorded to paid-in capital in the period in which the taxable event or forfeiture occurs. The Company paid income taxes of $49,862, $22,134, and $15,482 during the years ended March 31, 2008, 2007 and 2006, respectively. The Company adopted FIN 48 effective April 1, 2007. The adoption of FIN 48 was not material to the Company's consolidated financial position, however, certain reclassifications of various income tax related balance sheet amounts were required. Upon adoption of FIN 48, the Company had $12,980 of gross unrecognized tax benefits, of which $12,980 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. 96 A reconciliation of the unrecognized tax benefits at the beginning and end of the period is as follows: Balance of unrecognized tax benefits at April 1, 2007 $ 12,980 Increase/(decrease) in unrecognized tax benefits resulting from tax positions taken during current period 1,347 Increase/(decrease) in unrecognized tax benefits resulting from tax positions taken in prior periods 0 Reduction to unrecognized tax benefits as a result of a settlement with taxing authorities 0 Reduction to unrecognized tax benefits as a result of the lapse of the applicable statute of limitations (2,670) -------- Balance of unrecognized tax benefits at March 31, 2008 $ 11,657 ========
The Company recognizes interest and penalties associated with uncertain tax positions as a component of income tax expense. At April 1, 2007, the Company had accrued $1,950 for interest and penalties. Through March 31, 2008, the Company accrued an additional $1,450 of interest and penalties and released $1,248 of interest and penalties as a result of the expiration of the statute of limitations. As of March 31, 2008, the accrual for interest and penalties was $2,152. It is anticipated the Company will recognize approximately $1,100 of unrecognized tax benefits within the next 12 months. This recognition is as a result of the expected expiration of the relevant statute of limitations. The Company is subject to taxation in the U.S. and various states and is subject to examination by those authorities. The Company's federal statute of limitations has expired for fiscal years prior to 2005 and the relevant state statutes vary. The Company currently is being audited by the IRS for its March 31, 2006 and 2007 tax years. The IRS is also currently auditing the employment tax returns of the Company for calendar years 2004, 2005, 2006 and 2007. Various information requests with respect to the periods under audit have been received and responded to. The Company expects the IRS to issue additional information requests. The Company does not have any state examinations in progress at this time. Management regularly reevaluates the Company's tax positions taken on filed tax returns using information about recent court decisions and legislative activities. Many factors are considered in making these evaluations, including past history, recent interpretations of tax law, and the specific facts and circumstances of each matter. Because tax law and regulations are subject to interpretation and tax litigation is inherently uncertain, these evaluations can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. The recorded tax liabilities are based on estimates and assumptions that have been deemed reasonable by management. However, if the Company's estimates are not representative of actual outcomes, recorded tax liabilities could be materially impacted. The Company determined that certain options previously classified as ISO grants were determined to have been granted with an exercise price below the fair market value of the Company's stock on the revised measurement dates. Under Internal Revenue Code Section 422, ISOs may not be granted with an exercise price less than the fair market value on the date of grant, and therefore these grants would not likely qualify for ISO tax treatment. The disqualification of ISO classification exposes the Company and the affected employees to payroll related withholding taxes once the underlying shares are released from the post exercise two-year forfeiture period and the substantial risk of forfeiture has lapsed, which creates a taxable event. The Company and the affected employees may also be subject to interest and penalties for failing to properly withhold taxes and report the taxable event on their respective tax returns. The Company is currently reviewing the potential disqualification of ISO grants and the related withholding tax implications with the IRS in an effort to reach agreement on the 97 resulting tax liability. The Company recorded liabilities related to this matter of $9,765 as of March 31, 2008 in accrued liabilities on the consolidated balance sheet. 16. STOCK-BASED COMPENSATION ------------------------ In August 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 shares of common stock. Under the Company's stock option plan, 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 ten years and the options vest at the rate of 10% per year from the date of grant. The Company estimates the fair value of stock options granted using the Black-Scholes option pricing model (the "Option Model"). The Option Model requires the use of subjective and complex assumptions, including the option's expected term and the estimated future price volatility of the underlying stock, which determine the fair value of the share-based awards. The Company's estimate of expected term was determined based on the average period of time that options granted are expected to be outstanding considering current vesting schedules and the historical exercise patterns of existing option plans and the two-year forfeiture period. The expected volatility assumption used in the Option Model is based on historical volatility over a period commensurate with the expected term of the related options. The risk-free interest rate used in the Option Model is based on the yield of U.S. Treasuries with a maturity closest to the expected term of the Company's stock options. The Company's stock option agreements include a post-exercise service condition which provides that exercised options are to be held by the Company for a two-year period during which time the shares can not be sold by the employee. If the employee terminates employment voluntarily or involuntarily (other than by retirement, death or disability) during the two-year period, the stock option agreements provide the Company with the option of repurchasing the shares at the lower of the exercise price or the fair market value of the stock on the date of termination. This repurchase option is considered a forfeiture provision and the two-year period is included in determining the requisite service period over which stock-based compensation expense is recognized. The requisite service period initially is equal to the expected term (as discussed above) and is revised when an option exercise occurs. If stock options expire unexercised or an employee terminates employment after options become exercisable, no compensation expense associated with the exercisable, but unexercised, options is reversed. In those instances where an employee terminates employment before options become exercisable or the Company repurchases the shares during the two-year forfeiture period, compensation expense for these options is reversed as a forfeiture. When an employee exercises stock options, the exercise proceeds received by the Company are recorded as a deposit and classified as a current liability for the two-year forfeiture period. The shares issuable upon exercise of these options are accounted for as issued when the two-year forfeiture period lapses. Until the two-year forfeiture requirement is met, the underlying shares are not considered outstanding and not included in calculating basic earnings per share. In accordance with the provisions of SFAS 123R, share-based compensation expense recognized during a period is based on the value of the portion of share-based awards that are expected to vest with employees. Accordingly, the recognition of share-based compensation expense beginning April 1, 2006 has been reduced for estimated future forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant with adjustments recorded in subsequent period compensation expense if actual forfeitures differ from those estimates. Prior to adoption, the Company accounted for forfeitures as they occurred for the disclosure of pro forma information presented in the Notes to Consolidated Financial Statements for prior periods. Upon adoption of SFAS 123R on April 1, 2006, the Company recognized the cumulative effect of a change in accounting principle to reflect the effect of estimated forfeitures related to outstanding awards that are not expected to vest as of the adoption date. For the year ended March 31, 2007, the cumulative adjustment increased net income by $1,976, net of tax, and increased diluted earnings per share for Class A and Class B shares by $0.03 and $0.03, respectively. 98 The Company recognized, in accordance with SFAS 123R, stock-based compensation expense of $5,205 and $3,984, respectively, and related tax benefits of $1,250 and $1,134, respectively, for the years ended March 31, 2008 and 2007. Stock-based compensation expense of $927 and a related tax benefit of $286 were recognized in the year ended March 31, 2006. There was no stock-based employee compensation cost capitalized as of March 31, 2008 or 2007. Cash received as deposits for option exercises was $1,514, $4,264, and $1,187 and the actual tax benefit realized for the tax deductions from option exercises (at expiration of two-year forfeiture period) was $1,522, $934, and $1,709 for 2008, 2007 and 2006, respectively. The following weighted average assumptions were used for stock options granted during the years ended March 31, 2008, 2007 and 2006:
YEARS ENDED MARCH 31, --------------------------------------- 2008 2007 2006 ---- ---- ---- Dividend yield........................... None None None Expected volatility...................... 42% 45% 48% Risk-free interest rate.................. 4.53% 4.93% 4.91% Expected term............................ 9.0 years 8.9 years 8.8 years Weighted average fair value per share at grant date................... $ 15.40 $ 12.98 $ 12.74
A summary of the changes in the Company's stock option plan for the years ended March 31, 2008, 2007 and 2006 consisted of the following:
WEIGHTED AVERAGE ----------------------------- REMAINING AGGREGATE EXERCISE EXPECTED INTRINSIC SHARES PRICE TERM VALUE ------ ----- ---- ----- Balance, March 31, 2005............... 3,853 $ 12.53 Options granted....................... 955 18.99 Options exercised..................... (481) 5.80 $ 8,519 Options canceled...................... (401) 14.59 ------ Balance, March 31, 2006............... 3,926 14.71 Options granted....................... 555 21.64 Options exercised..................... (360) 8.80 5,631 Options canceled...................... (455) 16.62 ------ Balance, March 31, 2007............... 3,666 16.11 Options granted....................... 944 27.02 Options exercised..................... (184) 5.19 3,644 Options canceled...................... (493) 19.28 ------ Balance, March 31, 2008............... 3,933 $ 18.84 5.8 $24,114 ====== Expected to vest at March 31, 2008................... 3,048 $ 18.84 5.8 $18,688 Options exercisable at March 31, 2008 (excluding shares in the two-year forfeiture period)............... 1,197 $ 16.64 5.1 $10,210
As of March 31, 2008, the Company had $42,137 of total unrecognized compensation expense, related to stock option grants, which will be recognized over the remaining weighted average period of 5.0 years. 99 17. EMPLOYEE BENEFITS ----------------- 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 $500, $500 and $400 for the years ended March 31, 2008, 2007 and 2006, 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 $2,477, $2,227 and $1,877 were made to the 401(k) investment funds for the years ended March 31, 2008, 2007 and 2006, respectively. PENSION PLANS Contributions are made to a multi-employer defined benefit plan administered by Teamsters Negotiated Pension Plan for certain union employees. In the event of a withdrawal from the multi-employer pension plan, the Company would incur an obligation to the plan for the portion of the unfunded benefit obligation applicable to its employees covered by the plan. Amounts charged to pension expense and contributed to this plan were $170, $197 and $180 for the years ended March 31, 2008, 2007 and 2006, respectively. In January 2008,133 employees represented by the Teamsters Union voted to decertify union representation effective February 7, 2008. As a result of the decertification, the Company recorded in fiscal 2008 a withdrawal liability of $923 for the portion of the unfunded benefit obligation associated with the multi-employer pension plan administered by the union applicable to its employees covered by the plan. 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. In fiscal 2005, the Company established a Voluntary Employees' Beneficiary Association ("VEBA") 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 $797 and $935 at March 31, 2008 and 2007, respectively. For union employees, the Company participated in a fully funded insurance plan sponsored by the union. The Company's participation in the union plan ended as a result of the decertification of union representation effective February 7, 2008. Total health and medical insurance expense for the two plans was $13,731, $12,029 and $9,662 for the years ended March 31, 2008, 2007 and 2006, respectively. 18. RELATED PARTY TRANSACTIONS -------------------------- The Company currently leases certain real property from an affiliated partnership of the Chairman and CEO of the Company. Lease payments made for this property for the years ended March 31, 2008, 2007 and 2006 totaled $303, $296, and $284, respectively. 19. EQUITY TRANSACTIONS ------------------- As of March 31, 2008 and 2007, 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. 100 There were no undeclared and accrued cumulative preferred dividends at March 31, 2008 and 2007. 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. In accordance with the Special Committee's investigation of the Company's stock option grant practices, a remediation plan was developed by the Committee that recommended reimbursement of $1,401 by the Company's CEO. The recommended reimbursement was made by the CEO in November 2007 by delivery to the Company of 45,531 shares of Class A Common Stock. 101 20. EARNINGS PER SHARE ------------------ The following table sets forth the computation of basic and diluted earnings per share:
2008 2007 2006 CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B -------- -------- -------- -------- ------- ------- Basic earnings per share: Numerator: Allocation of undistributed earnings before cumulative effect of change in accounting principle $ 69,317 $ 18,967 $ 43,768 $ 12,276 $ 8,725 $ 2,621 Allocation of cumulative effect of change in accounting principle - - 1,543 433 - - -------- -------- -------- -------- -------- ------- Allocation of undistributed earnings $ 69,317 $ 18,967 $ 45,311 $ 12,709 $ 8,725 $ 2,621 ======== ======== ======== ======== ======== ======= Denominator: Weighted average shares outstanding 37,582 12,299 37,180 12,455 36,277 13,065 Less - weighted average unvested common shares subject to repurchase (432) (101) (367) (65) (435) (147) -------- -------- -------- -------- -------- ------- Number of shares used in per share computations 37,150 12,198 36,813 12,390 35,842 12,918 ======== ======== ======== ======== ======== ======= Basic earnings per share before cumulative effect of change in accounting principle $ 1.87 $ 1.55 $ 1.19 $ 0.99 $ 0.24 $ 0.20 Per share effect of cumulative effect of change in accounting principle - - 0.04 0.04 - - -------- -------- -------- -------- -------- ------- Basic earnings per share $ 1.87 $ 1.55 $ 1.23 $ 1.03 $ 0.24 $ 0.20 ======== ======== ======== ======== ======== ======= Diluted earnings per share: Numerator: Allocation of undistributed earnings for basic computation before cumulative effect of change in accounting principle $ 69,317 $ 18,967 $ 43,768 $ 12,276 $ 8,725 $ 2,621 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 18,967 - 12,276 - 2,621 - Reallocation of undistributed earnings to Class B shares - (2,344) - (1,297) - (12) Add - preferred stock dividends 70 - 70 - 70 - Add - interest expense convertible notes 4,388 - 3,883 - - - -------- -------- -------- -------- -------- ------- Allocation of undistributed earnings for diluted computation before cumulative effect of change in accounting principle 92,742 16,623 59,997 10,979 11,416 2,609 Allocation of cumulative effect of change in accounting principle - - 1,976 362 - - -------- -------- -------- -------- -------- ------- Allocation of undistributed earnings $ 92,742 $ 16,623 $ 61,973 $ 11,341 $ 11,416 $ 2,609 ======== ======== ======== ======== ======== ======= (CONTINUED) 102 ----------------------------------------------------------------------------- 2008 2007 2006 ------------------------ ------------------------ ----------------------- CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B ----------- ----------- ----------- ----------- ----------- ---------- Diluted earnings per share (continued): Denominator: Number of shares used in basic computation 37,150 12,198 36,813 12,390 35,842 12,918 Weighted average effect of dilutive securities: Conversion of Class B to Class A shares 12,198 - 12,390 - 12,918 - Employee stock options 766 83 720 99 899 195 Convertible preferred stock 338 - 338 - 338 - Convertible notes 8,692 - 8,692 - - - --------- --------- --------- --------- --------- --------- Number of shares used in per share computations 59,144 12,281 58,953 12,489 49,997 13,113 ========= ========= ========= ========= ========= ========= Diluted earnings per share before cumulative effect of change in accounting principle $ 1.57 $ 1.35 $ 1.02 $ 0.88 $ 0.23 $ 0.20 Per share effect of cumulative effect of change in accounting principle - - 0.03 0.03 - - --------- --------- --------- --------- --------- --------- Diluted earnings per share (1) (2) $ 1.57 $ 1.35 $ 1.05 $ 0.91 $ 0.23 $ 0.20 ========== ========= ========= ========= ========= ========= - --------------------------- (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, 2008, 2007 and 2006, excluded from the computation were options to purchase 649, 216 and 291 of Class A and Class B common shares, respectively. (2) For the year ended March 31, 2006, the $200,000 principal amount of 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.
21. SEGMENT REPORTING ----------------- The reportable operating segments of the Company are branded products, specialty generic/non-branded and specialty materials. The branded products segment includes patent-protected products and certain trademarked off-patent products that the Company sells and markets as brand pharmaceutical products. The specialty generics segment includes off-patent pharmaceutical products that are therapeutically equivalent to proprietary products. The Company sells its branded and generic/non-branded 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. 103 The following represents information for the Company's reportable operating segments for fiscal 2008, 2007 and 2006.
YEAR ENDED BRANDED SPECIALTY SPECIALTY ALL MARCH 31, PRODUCTS GENERICS MATERIALS OTHER ELIMINATIONS CONSOLIDATED --------- -------- -------- --------- ----- ------------ ------------ ------------------------------------------------------------------------------------------------------------------------------ NET REVENUES 2008 $214,863 $367,862 $18,020 $1,151 $ - $601,896 2007 188,681 235,594 17,436 1,916 - 443,627 2006 145,503 203,787 16,988 1,362 - 367,640 ------------------------------------------------------------------------------------------------------------------------------ SEGMENT PROFIT (LOSS) 2008 95,143 218,111 5,900 (187,491) - 131,663 2007 87,346 125,596 2,799 (126,669) - 89,072 2006 58,704 100,731 1,082 (124,668) - 35,849 ------------------------------------------------------------------------------------------------------------------------------ IDENTIFIABLE ASSETS 2008 39,955 99,567 7,990 722,673 (1,158) 869,027 2007 32,995 84,581 8,410 582,955 (1,158) 707,783 2006 23,582 62,953 7,353 526,583 (1,158) 619,313 ------------------------------------------------------------------------------------------------------------------------------ PROPERTY AND EQUIPMENT ADDITIONS 2008 257 - 119 23,280 - 23,656 2007 96 - 108 24,862 - 25,066 2006 540 1,097 269 56,428 - 58,334 ------------------------------------------------------------------------------------------------------------------------------ DEPRECIATION AND AMORTIZATION 2008 753 319 177 29,871 - 31,120 2007 709 338 163 21,178 - 22,388 2006 587 317 173 16,925 - 18,002 ------------------------------------------------------------------------------------------------------------------------------
Consolidated revenues are principally derived from customers in North America and substantially all property and equipment is located in the St. Louis, Missouri metropolitan area. 22. QUARTERLY FINANCIAL RESULTS (UNAUDITED) ---------------------------------------
1ST 2ND 3RD 4TH FULL QUARTER QUARTER QUARTER QUARTER YEAR -------------------------------------------------------------------- YEAR ENDED MARCH 31, 2008 - ------------------------- Net revenues $ 114,358 $172,925 $161,623 $ 152,990 $601,896 Gross profit 74,788 127,793 111,627 101,133 415,341 Income before income taxes 9,917 62,002 46,093 13,651 131,663 Net income 6,200 40,223 32,612 9,319 88,354 Earnings per share: Basic - Class A common 0.13 0.85 0.69 0.20 1.87 Basic - Class B common 0.11 0.71 0.57 0.16 1.55 Diluted - Class A common 0.12 0.70 0.57 0.18 1.57 Diluted - Class B common 0.10 0.60 0.49 0.15 1.35 104 1ST 2ND 3RD 4TH FULL QUARTER QUARTER QUARTER QUARTER YEAR --------------------------------------------------------------------- YEAR ENDED MARCH 31, 2007 - ------------------------- Net revenues........................................ $ 96,200 $108,983 $ 117,949 $120,495 $443,627 Gross profit........................................ 62,738 70,104 79,510 84,012 296,364 Income before income taxes and cumulative effect of change in accounting principle....... 13,335 19,655 28,048 28,034 89,072 Income before cumulative effect of change in accounting principle........................ 8,122 12,085 18,462 17,445 56,114 Cumulative effect of change in accounting principle...................................... 1,976 - - - 1,976 Net income.......................................... 10,098 12,085 18,462 17,445 58,090 Earnings per share before effect of change in accounting principle: Basic - Class A common....................... $0.17 $0.26 $0.39 $0.37 $1.19 Basic - Class B common....................... 0.14 0.21 0.33 0.31 0.99 Diluted - Class A common..................... 0.15 0.22 0.33 0.31 1.02 Diluted - Class B common..................... 0.13 0.19 0.29 0.27 0.88 Per share effect of cumulative effect of change in accounting principle: Basic - Class A common....................... 0.04 - - - 0.04 Basic - Class B common....................... 0.04 - - - 0.04 Diluted - Class A common..................... 0.04 - - - 0.03 Diluted - Class B common..................... 0.03 - - - 0.03 Earnings per share: Basic - Class A common....................... 0.21 0.26 0.39 0.37 1.23 Basic - Class B common....................... 0.18 0.21 0.33 0.31 1.03 Diluted - Class A common..................... 0.19 0.22 0.33 0.31 1.05 Diluted - Class B common..................... 0.16 0.19 0.29 0.27 0.91
105 Report of Independent Registered Public Accounting Firm - ------------------------------------------------------- The Board of Directors and Shareholders K-V Pharmaceutical Company: We have audited K-V Pharmaceutical Company's (the Company) internal control over financial reporting as of March 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting, appearing under Item 9A(a). Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness has been identified and included in management's assessment that states the Company had inadequate policies and procedures over the accounting for customer rebates. 106 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, 2008 and 2007, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three-year period ended March 31, 2008. This material weakness was considered in determining the nature, timing and extent of audit tests applied in our audit of the March 31, 2008 consolidated financial statements, and this report does not affect our report dated June 25, 2008, which expressed an unqualified opinion on those consolidated financial statements. In our opinion, because of the effect of the aforementioned material weakness on the achievement of the objectives of the control criteria, K-V Pharmaceutical Company has not maintained effective internal control over financial reporting as of March 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by COSO. St. Louis, Missouri June 25, 2008 107 ITEM 9A. CONTROLS AND PROCEDURES ----------------------- (a) MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2008. In making this assessment, our management used the criteria established in Internal Control -- Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel, 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 and 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 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. Exchange Act Rule 12b-2 defines a material weakness as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. Based on our evaluation of internal control over financial reporting as of March 31, 2008, management has determined that the following material weakness existed in our internal control over financial reporting. The design of the Company's policies and procedures did not adequately address the financial reporting risks associated with customer rebate agreements. Specifically, the Company's policies and procedures were inadequate to ensure that the necessary information for new or modified rebate agreements was captured and communicated to those responsible for evaluating the accounting implications. This deficiency resulted in a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. As a result of the material weakness described above, management has concluded that the Company did not maintain effective internal control over financial reporting as of March 31, 2008 based on the criteria established in COSO's Internal Control - Integrated Framework. KPMG LLP, our independent registered public accounting firm, who audited the consolidated financial statements of the Company included in this annual report has issued an adverse opinion on the effectiveness of 108 our internal control over financial reporting as of March 31, 2008. This report appears on page 66 of this annual report. (b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There were changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. These changes consisted of controls we implemented to remediate the material weaknesses identified in our annual report on the effectiveness of internal control over financial reporting as of March 31, 2007, which related to the Company's accounting for stock-based compensation, income taxes and revenue recognition: Stock-Based Compensation - The design of the Company's policies and procedures did not adequately address the financial reporting risks associated with stock options. Specifically, these deficiencies in the design of the Company's controls resulted in a more than remote likelihood of a material misstatement in the Company's financial statements in each of the following areas: o Determining measurement dates, o Determining forfeiture provisions, o Determining the tax treatment of stock option awards. Additionally, the Company's policies and procedures to ensure that the necessary information was captured and communicated to those responsible for stock option accounting were inadequate, and the Company's finance and accounting personnel involved in the stock option granting and administration process were inadequately trained. Income Taxes - The design of the Company's policies and procedures did not adequately address the financial reporting risks associated with uncertain tax positions. Additionally, the Company's policies and procedures to ensure that the necessary information was captured and communicated to those responsible for accounting for uncertain tax positions were inadequate. Revenue Recognition - The design of the Company's policies and procedures did not adequately address the financial reporting risks associated with customer shipping terms. During the quarter ended March 31, 2008, we implemented changes to internal control over financial reporting to complete remediation of the material weaknesses described above as follows: Stock-Based Compensation o Expanded the General Counsel's role to include oversight of the process of documenting stock option grants in order to assure that grants are properly awarded under the approved plan document and proper grant dates are associated with awards. o Engaged an outside professional services firm to advise us on improving the design of the internal controls over our stock option processes and controls over the preparation and review of stock-based compensation information in the Company's financial reports. o Established an Employee Compensation Reporting Committee comprised of senior tax, legal, human resource, and accounting/finance personnel, to assure that grants are properly awarded under the plan document, proper grant dates are assigned for measurement purposes, the reasonableness of key assumptions used in the valuation of stock options are reviewed for appropriateness and any modifications to the standard terms of outstanding awards are reviewed for appropriate accounting treatment. o Established a procedure whereby senior financial management reviews employment agreements, employment offers, and other employee agreements to ensure proper accounting based upon the terms and conditions of such agreements. 109 o Training and education to ensure that all relevant personnel involved in the administration of and accounting for stock option grants, including tax personnel, understand the terms of the Company's stock option plans and the relevant accounting guidance under U.S. generally accepted accounting principles. o Established quarterly testing by the Company's Internal Audit Department of controls relating to stock option activity and the accuracy of the model used in valuing the Company's stock options. Income Taxes o Established quarterly meetings between the tax department, operating division executives and other management personnel to facilitate communication of relevant business issues impacting accounting for income taxes, and; o Implemented procedures that require the documentation of tax liabilities and facilitate an effective review of the recognition and measurement of tax liabilities. Revenue Recognition o Implemented a procedure to verify actual customer receipt dates of shipments made during the last several days of a period end for the FOB destination customers. o Implemented a policy requiring that shipping terms for all customers are properly documented and reviewed by finance/accounting personnel to verify the appropriate timing of revenue recognition. (c) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such terms are defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of March 31, 2008, the end of the period covered by this Annual Report on Form 10-K. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in the Company's reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As a result of the material weakness in our internal control over financial reporting described above, our management, including our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2008. Notwithstanding the material weakness described above, our management have concluded that our consolidated financial statements for the periods covered by and included in this Annual Report on Form 10-K are fairly stated in all material respects in accordance with U.S. generally accepted accounting principles for each of the periods presented herein. (d) REMEDIATION ACTIVITIES Subsequent to March 31, 2008, we are taking several steps to remediate the material weakness related to revenue recognition described in (a) above by designing policies and procedures that require that all new or modified customer agreements are reviewed by accounting personnel with relevant GAAP knowledge to determine the appropriate accounting treatment. ITEM 9B. OTHER INFORMATION ----------------- The Board of Directors of the Company has called the 2008 Annual Meeting of Stockholders (the "Annual Meeting") for Friday, September 5, 2008, at 9:00 A.M., Central Daylight Savings Time, at The St. Louis Club (Lewis and Clark Room, 16th Floor), 7701 Forsyth Boulevard, Clayton, Missouri 63105. Proposals of stockholders and nominations for directors intended to be presented at the Annual Meeting must be received by the Company's Assistant Secretary no later than July 1, 2008 in order to be considered for inclusion 110 in the Company's proxy statement and proxy card for that meeting. Upon receipt of any such proposal, the Company will determine whether or not to include such proposal in the proxy statement and proxy in accordance with regulations governing the solicitation of proxies. Stockholder proposals and nominations for directors that do not appear in the proxy statement may be considered at the Annual Meeting only if written notice of the proposal is received by the Company's Assistant Secretary no later than July 1, 2008. Such notice must include a description of the proposed business and the reasons therefor. The Board of Directors or the presiding officer at the Annual Meeting may reject any proposal that is not made in accordance with these procedures or that is not a proper subject for stockholder action in accordance with applicable law. These requirements are separate from the procedural requirements a stockholder must meet to have a proposal included in the Company's proxy statement. All proposals should be addressed to the Assistant Secretary, K-V Pharmaceutical Company, 2503 South Hanley Road, St. Louis, MO 63144. 111 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 2008 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 2008 Annual Meeting of Shareholders is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND ------------------------------------------------------------------ RELATED STOCKHOLDER MATTERS --------------------------- 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 2008 Annual Meeting of Shareholders is incorporated herein by this reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR ----------------------------------------------------------- INDEPENDENCE ------------ The information contained under the caption "COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION; TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(A) for its 2008 Annual Meeting of Shareholders is incorporated herein by this reference. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES -------------------------------------- The information contained under the caption "FEES BILLED BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM" in the Company's definitive proxy statement to be filed pursuant to Regulation 14(A) for its 2008 Annual Meeting of Shareholders is incorporated herein by this reference. 112 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 of this report: Report of Independent Registered Public Accounting Firm........................ 66 Consolidated Balance Sheets as of March 31, 2008 and 2007...................... 67 Consolidated Statements of Income for the Years Ended March 31, 2008, 2007 and 2006............................................................ 68-69 Consolidated Statements of Comprehensive Income for the Years Ended March 31, 2008, 2007 and 2006............................................ 70 Consolidated Statements of Shareholders' Equity for the Years Ended March 31, 2008, 2007 and 2006............................................ 71 Consolidated Statements of Cash Flows for the Years Ended March 31, 2008, 2007 and 2006.................................................. 72 Notes to Consolidated Financial Statements..................................... 73-105 2. Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts................................ 115
(b) Exhibits. See Exhibit Index on pages 116 through 121 of this Report. Management contracts and compensatory plans are designated on the Exhibit Index. 113 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 25, 2008 By /s/ Marc S. Hermelin ---------------- --------------------------------------------- Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: June 25, 2008 By /s/ Ronald J. Kanterman ---------------- ----------------------------------------- Vice President and Chief Financial Officer (Principal Financial Officer) Date: June 25, 2008 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 25, 2008 By /s/ Marc S. Hermelin ------------- ----------------------------------------- Marc S. Hermelin Date: June 25, 2008 By /s/ Norman D. Schellenger ------------- ----------------------------------------- Norman D. Schellenger Date: June 25, 2008 By /s/ Kevin S. Carlie ------------- ----------------------------------------- Kevin S. Carlie Date: June 25, 2008 By /s/ Jonathon E. Killmer ------------- ----------------------------------------- Jonathon E. Killmer Date: June 25, 2008 By /s/ Jean M. Bellin ------------- ----------------------------------------- Jean M. Bellin Date: June 25, 2008 By /s/ Terry B. Hatfield ------------- ----------------------------------------- Terry B. Hatfield Date: June 25, 2008 By /s/ David S. Hermelin ------------- ----------------------------------------- David S. Hermelin Date: June 25, 2008 By /s/ Ronald J. Kanterman ------------- ----------------------------------------- Ronald J. Kanterman 114 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, 2006: Allowance for doubtful accounts............ $ 461 $ (49) $ 15 $ 397 Reserves for sales allowances.............. 20,142 154,662 146,107 28,697 Inventory obsolescence..................... 1,293 4,215 3,808 1,700 ------------- ------------- ------------- -------------- $ 21,896 $ 158,828 $ 149,930 $ 30,794 ============= ============= ============= ============== Year Ended March 31, 2007: Allowance for doubtful accounts............ $ 397 $ 320 $ 1 $ 716 Reserves for sales allowances.............. 28,697 148,822 146,238 31,281 Inventory obsolescence..................... 1,700 11,979 4,650 9,029 ------------- ------------- ------------- -------------- $ 30,794 $ 161,121 $ 150,889 $ 41,026 ============= ============= ============= ============== Year Ended March 31, 2008: Allowance for doubtful accounts............ $ 716 $ 168 $ 17 $ 867 Reserves for sales allowances.............. 31,281 234,427 219,062 46,646 Inventory obsolescence..................... 9,029 18,849 12,411 15,467 ------------- ------------- ------------- -------------- $ 41,026 $ 253,444 $ 231,490 $ 62,980 ============= ============= ============= ==============
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. 115 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. 116 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 was filed as Exhibit 3(o) to the Company's Annual Report on Form 10-K for the year ended March 31, 2006, is incorporated herein by this reference. 3(p) Amendment to Bylaws of the Company, effective June 28, 2004, which was filed as Exhibit 3(p) to the Company's Annual Report on Form 10-K for the year ended March 31, 2006, is incorporated herein by this reference. 3(q) Amendment to Bylaws of the Company, effective November 30, 2007, which was filed as Exhibit 99 to the Company's Current Report on Form 8-K, filed December 31, 2007, is incorporated herein by this reference. 3(r) Amendment to Bylaws of the Company, effective March 26, 2008, which was filed as Exhibit 3.1 to the Company's current Report on Form 8-K, filed March 28, 2008, is incorporated herein by this reference. 4(a) Certificate of Designation of Rights and Preferences of 7% Cumulative Convertible preferred stock of the Company, effective June 9, 1987, and related Certificate of Correction, dated June 17, 1987, which was filed as Exhibit 4(f) to the Company's Annual Report on Form 10-K for the year ended March 31, 1987, is incorporated herein by this reference. 4(b) 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(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(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, which was filed as Exhibit 4(g) to the Company's Annual Report on Form 10-K for the year ended March 31, 2006, 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. 117 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, 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, 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. 10(q) 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. 118 10(r)* Amendment, dated November 5, 2004, to Employment Agreement between the Company and Marc S. Hermelin, 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(s)* K-V Pharmaceutical 2001 Incentive Stock Option Plan, which was filed as Exhibit 10.1 to the Company's Current report on Form 8-K filed November 22, 2005, is incorporated by this reference. 10(t)* 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(u)* 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(v)* Employment Agreement between ETHEX and Patricia McCullough, Chief Executive Officer of ETHEX, dated January 30, 2006, which was filed as Exhibit 10(aa) to the Company's Annual Report on Form 10-K for the year ended March 31, 2006, is incorporated herein by this reference. 10(w)* Employment Agreement between the Company and Michael S. Anderson, Corporate Vice President, Industry Presence and Development, dated May 23, 1994, and amendments thereto, which was filed as Exhibit 10(bb) to the Company's Annual Report on Form 10-K for the year ended March 31, 2006, is incorporated herein by this reference. 10(x)* Employment Agreement between the Company and Ronald J. Kanterman, Vice President, Treasurer dated January 26, 2004, which was filed as Exhibit 10(x) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(y)* Employment Agreement between the Company and Gregory S. Bentley, Senior Vice President and General Counsel, dated April 24, 2006, which was filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(z)* Employment Agreement between the Company and David A. Van Vliet, Chief Administration Officer, dated September 29, 2006, which was filed as Exhibit 10(z) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(aa)* Employment Agreement between the Company and Rita E. Bleser, President, Pharmaceutical Division, dated April 30, 2007, which was filed as Exhibit 10(aa) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(bb)* Employment Agreement between Ther-Rx and Gregory J. Divis, Jr., President, Ther-Rx Corporation, dated July 20, 2007, which was filed as Exhibit 10(bb) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(cc)* Employment Agreement by and between the Company and Richard H. Chibnall, Vice President, Finance and Chief Accounting Officer, dated December 22, 1995, as amended by amendment dated April 1, 2005, is incorporated herein by this reference. 10(dd)* Employment Agreement by and between Particle Dynamics, Inc. and Paul T. Brady, President, Particle Dynamics, Inc., dated May 5, 2005, which was filed as Exhibit 10(dd) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference, 10(ee)* Employment Agreement between the Company and David S. Hermelin, Vice President, Corporate Strategy and Operations Analysis, dated April 8, 1998, as amended by amendment dated August 16, 119 2004, which was filed as Exhibit 10(ee) to the Company's Annual Report on Form 10-K for the year ended March 31, 2007, is incorporated herein by this reference. 10(ff)* Amendment to Employment Agreement between the Company and Ronald J. Kanterman, Vice President and Chief Financial Officer, dated March 23, 2008, filed herewith. 10(gg)* Consulting agreement, dated March 23, 2008, between the Company and Gerald R. Mitchell, filed herewith. 10(hh)** Asset Purchase Agreement by and between the Company and VIVUS, Inc., dated as of March 30, 2007, which was filed as Exhibit 10.1 to The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, is incorporated herein by this reference. 10(ii) Asset Purchase Agreement by and among the Company, CYTYC Prenatal Products, Corp. and Hologic, Inc., dated as of January 16, 2008, filed herewith. 120 21 List of Subsidiaries, filed herewith. 23.1 Consent of KPMG 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, 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, filed herewith. 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. *Management contract or compensation plan. ** Confidential portions of this exhibit have been redacted and filed separately with the Commission pursuant to a confidential treatment request in accordance with Rule 24b-2 of the Securities Exchange Act of 1934, as amended. 121 APPENDIX Page 41 of the 10-K contains a Comparison of 5 Year Cumulative Total Return Graph. The information displayed in the graph is presented in a tabular format immediately following the graph. EX-10.GG 2 ex10gg.txt Exhibit 10(gg) CONSULTING AND CONFIDENTIALITY AGREEMENT ---------------------------------------- This Agreement is entered into as of the 23rd day of March, 2008, to become effective on March 23, 2008 ("Effective Date") by and between KV Pharmaceutical Company, on behalf of itself and its wholly-owned subsidiaries (hereinafter collectively referred to as "KV"), 2503 South Hanley Road, St. Louis, Missouri 63144-2307, and Gerald R. Mitchell ("Mr. Mitchell" or "Consultant"), **********[home address]***********. Whereas, KV possesses information relating to its business which is regarded as confidential and proprietary, as hereinafter more fully defined in Paragraph 7 of this Agreement ("Confidential Information"); Whereas, Mr. Mitchell has worked for KV as an employee pursuant to Employment and Confidential Information Agreements initially entered into on July 24, 1981 and subsequently restated and amended on March 31, 1994 (collectively referred to as the "Employment Agreement"); Whereas, Mr. Mitchell desires to retire, thereby ending his employment relationship with KV and Mr. Mitchell and KV desire to terminate the Employment Agreement except as otherwise provided herein, and to enter into an agreement whereby Mr. Mitchell will serve as an independent consultant to KV, providing advice, information and other assistance on various projects for KV; Therefore, KV and Consultant agree as follows: 1. TERM OF AGREEMENT; TERMINATION. The initial term of this Agreement will be for a period of 24 months, beginning on the Effective Date ("Initial Term"), and thereafter will automatically renew and continue in effect for successive twelve (12) month periods, unless otherwise terminated in accordance with the terms hereof. Either KV or Mr. Mitchell may terminate this Agreement at any time and for any reason by providing 60 day's written notice to the other. 2. DESCRIPTION OF SERVICES. Beginning on the Effective Date, Consultant will provide to KV such consulting services as may be requested from time to time by KV (the "Services"). 3. PERFORMANCE OF SERVICES. Consultant and KV will meet as required to discuss/advise on areas of KV business. Consultant agrees to use diligent efforts to respond to and complete projects and/or advise on matters on a timely basis. For up to 80 hours a month, Consultant agrees to make himself available to provide the Services to KV whenever KV, in its sole discretion, considers it necessary for him to perform the assignments. In rendering the Services, Consultant will strictly comply with all laws and regulations and all pharmaceutical industry standards applicable to the activities undertaken by Consultant in connection with this Agreement. Consultant acknowledges that in the context of the provision of Services hereunder, Consultant may be provided material non-public information, attorney-client privileged material or other information or documents, the unauthorized disclosure or use of which may constitute a violation of applicable law or this Agreement. 4. OFFICE FACILITIES, EQUIPMENT, TOOLS, MATERIALS AND SUPPLIES. (a) Consultant will maintain his own office facilities, equipment, computers, materials and supplies at his home. If required in order to perform consulting assignments, consultant will hire an outside consultant recommended by KV's business Technology Department to provide technical support needed and will submit their bills for reimbursement by KV. (b) At such times as Consultant is working in KV's St. Louis offices, Consultant will have the use of KV's equipment, tools, materials and supplies as and to the extent necessary to perform the Services. (c) Consultant may use KV's offices and communications equipment as and when necessary to interact with KV's employees and others in the performance of the Services. 5. COMPENSATION FOR SERVICES. (a) Compensation. Consultant will keep complete and accurate ------------ records of all work performed and time spent hereunder and will submit to KV monthly itemized invoices at the end of each month for all work performed during such previous month period. During the first year of the Initial Term, KV will pay $115.00 an hour for a guaranteed minimum of 80 hours a month of service per month. Travel will not be calculated as hours worked. (b) Reimbursement for Expenses. KV will reimburse Consultant for -------------------------- economy travel and related expenses agreed to in advance by KV and incurred by Consultant in connection with rendering the Services; provided, however, that KV will not be responsible for and Consultant will bear the normal operating expenses of operating Consultant's home office (except to the limited extent provided in Section 4(a) above). Consultant will render an itemized invoice, accompanied by appropriate supporting documentation, to KV for reimbursable expenses incurred during any calendar month, and KV will make payment of each such properly rendered invoice within 30 days of the date of receipt thereof. 6. WORK PRODUCT. All right, title and interest in and to any and all documents, information, ideas, designs, inventions, materials, discoveries, improvements, specifications, technical data, reports, business plans and other embodiments of Consultant's work: (a) conceived, made, discovered and/or produced by Consultant in connection with Consultant's performance of the Services, whether alone or jointly with others, (b) which are based, in whole or part, upon Confidential Information, the resources, supplies, facilities or business, technical or financial information of KV, or (c) which relate to the business, the products or the research and development of KV ("Work Product"), will be solely owned by KV and available to KV at all times. Consultant agrees to promptly disclose and to assign, transfer and deliver, and hereby transfers, assigns and conveys, to KV, without royalty or other additional consideration, any and all right, title and interest of Consultant in and to any and all Work Product, free and clear of all liens, charges, encumbrances, residual interests or rights of any kind of Consultant or any other parties, including, but not limited to, all patent rights, copyrights, moral rights, trade secrets and other intellectual property rights. 2 7. CONFIDENTIALITY. During the course of rendering the Services to KV under this Agreement, Consultant may come into contact with information regarding KV's capabilities, existing and prospective products, product concepts, research and development, technologies, materials, formulations, sales, customers, suppliers, prices, costs, business plans, competitive positioning, strategies and other information regarding the business and proposed business of KV ("Confidential Information"). Consultant agrees that during the term of this Agreement and indefinitely thereafter, Consultant will hold all Confidential Information in confidence, and will not disclose Confidential Information to any third party or use Confidential Information for any purpose other than in connection with the rendering of the Services to KV under this Agreement. 8. OWNERSHIP OF COMPANY RECORDS. All documents, agreements, records, notebooks, patent filings, memos, correspondence and information, including all copies thereof, containing or related to KV Projects and/or Confidential Information relating to the business of KV, whether prepared by KV, Consultant or others ("Company Records") whether presently existing or hereafter prepared, are and will continue to be the property of KV. Upon the termination of this Agreement for any reason, or otherwise upon the written request of KV at any time, Consultant will return all Confidential Information and Company Records to KV. 9. INDEPENDENT CONTRACTOR. It is understood by the parties that Consultant is an independent contractor with respect to, and not an employee or agent of, KV. During the term of this Agreement: (a) No Authority to Bind the Company. Consultant will have no -------------------------------- authority to enter into contracts or agreements or otherwise to make any commitment on behalf of KV unless specifically agreed to and authorized in writing by CEO of KV Pharmaceutical or by a designated authorized representative. (b) Payroll Taxes. Neither state or federal income tax, nor ------------- payroll tax of any kind, will be withheld or paid by KV on behalf of Consultant. As an independent contractor, Consultant will be solely responsible for such taxes. (c) KV is not Responsible for Workers' Compensation Insurance. No --------------------------------------------------------- Workers' Compensation insurance will be obtained or paid for by KV on account of Consultant. As an independent contractor, Consultant will be solely responsible for obtaining any necessary workers' compensation insurance. (d) Ineligibility for Benefits. As an independent contractor, -------------------------- Consultant will not be eligible for any benefits provided by KV to its employees. 10. COVENANTS AND WARRANTIES. Consultant covenants and agrees that it will not at any time provide any consulting services to or enter into any agreements or other arrangements with any party that conflict with the Services to be provided to KV by Consultant hereunder. Consultant warrants that Consultant is not bound by any agreement with any current or former employer or other party that would in any manner prevent or limit its performance of this Agreement. Consultant further warrants that neither the Services performed hereunder nor any materials produced hereunder will infringe or otherwise violate the legal rights of any third party. 3 11. EMPLOYMENT AND CONFIDENTIAL INFORMATION AGREEMENT. This Consulting Agreement replaces and supersedes all other agreements concerning Consultant's relationship with KV, provided, however, that the terms of Paragraphs 5, 6 and 7 of the Employment Agreement dated March 31, 1994 and Paragraphs 2, 4, 5, 6 and 7 of the Confidentiality Agreement dated March 31, 1994 will remain in full force and effect and will not be affected by this Agreement. 12. NOTICES. All notices required or permitted under this Agreement will be in writing and will be deemed delivered when delivered in person, deposited in the United States mail, postage prepaid, or sent by generally recognized next business day delivery service (such as Federal Express), addressed as set forth in the first paragraph of this Agreement. A party's address may changed by it from time to time by providing written notice to the other in the manner set forth above. 13. ASSIGNMENT. Neither this Agreement nor the rights or obligations of Consultant hereunder will be assigned, transferred or subcontracted, by operation of law or otherwise, without KV's prior written consent. 14. ENTIRE AGREEMENT. This Agreement contains the entire agreement of the parties and there are no other promises or conditions between them in any other agreement, whether oral or written, except as provided in Paragraph 11. This Agreement supersedes any prior written or oral agreements between the parties, except as provided in Paragraph 11, and may not be amended except in writing signed by them. The provisions of Paragraphs 6, 7 and 8, and the covenants and warranties provided in Paragraph 10 will survive the expiration or termination of this Agreement. 15. SEVERABILITY. If any provision of this Agreement, under any set of circumstances, whether or not foreseeable by the parties, is hereafter held to be invalid, illegal or unenforceable in its present form and scope in any jurisdiction or proceeding, the remaining provisions of this Agreement will continue to be given full force and effect, without regard to the invalid, illegal or unenforceable provision in such jurisdiction or proceeding, and will be liberally construed in order to carry out the intentions of the parties hereto as nearly as may be possible, and such holding will not affect the validity, legality or enforceability of this Agreement in its entirety in any other jurisdiction or proceeding. Furthermore, if any of the provisions of this Agreement are held to be unenforceable in any jurisdiction or proceeding because of their duration or scope, the parties agree that the court, arbitration panel or other authority making such determination will have the power, and is hereby directed, to reduce or alter the duration and/or scope of such provision so that, in its reduced form, the provision is enforceable and effective as nearly as possible for the purposes expressed in this Agreement; provided, however, that the determination and amendment hereof by any such court, panel or authority will be limited to the jurisdiction thereof and will not affect the validity, legality, enforceability or application of this Agreement in its existing form and scope in any other jurisdiction or proceeding. To the extent permitted by applicable law, KV and Consultant hereby waive any provision of law that would render any provision hereof prohibited or unenforceable in any respect. 16. MODIFICATION OF AGREEMENT. No waiver or modification of this Agreement or of any covenant, condition or limitation herein contained shall be valid unless in writing and duly 4 executed by the party to be charged therewith, and no evidence of any waiver or modification shall be offered or received in evidence in any proceeding, arbitration or litigation between the parties hereto arising out of or affecting this Agreement, or the rights or obligations of the parties hereunder, unless such waiver or modification is in writing, duly executed as aforesaid, and the parties further agree that the provisions of this Paragraph 16 may not be waived except as herein set forth. Without limiting the generality of the foregoing, any failure by KV to exercise or otherwise act with respect to any of its rights hereunder in the event of a breach of any of the terms or conditions hereof by Consultant shall in no way be construed as a waiver of such breach, nor prevent KV from thereafter enforcing strict compliance with any and all of the terms and conditions hereof. 17. VIOLATION, BREACH OR EVASION OF AGREEMENT. Employee acknowledges and agrees that any violation, breach or evasion of any of the terms of this Agreement by Consultant will result in immediate and irreparable injury to KV and KV shall have the right to seek recourse therefrom by injunction and/or specific performance as well as through all other legal or equitable remedies to which KV may otherwise be entitled. 18. DEFINITION. For purposes of Paragraphs 5, 6 and 7 hereof, references to KV shall, except where the context of a particular reference clearly indicates otherwise, include all companies controlling, controlled by or under common control with KV. 19. WAIVER. The failure of either party to enforce any provision of this Agreement will not be construed as a waiver or limitation of that party's rights to subsequently enforce and compel strict compliance of the same provision and each and every other provision of this Agreement. 20. GOVERNING LAW. This Agreement will be governed by and construed under the laws of the State of Missouri, notwithstanding the application of any conflict of law principles which would otherwise make the laws of any other jurisdiction applicable hereto. The interpretation of and any disputes arising out of this Agreement will be subject to the exclusive jurisdiction of and venue in the federal and state courts of the State of Missouri and both parties hereby consent to such exclusive jurisdiction and venue. In witness whereof, the parties have duly executed this Agreement as of the date first set forth above. Dated: March 23, 2008 ------------------ KV Pharmaceutical Company Gerald R. Mitchell By: /s/ Gregory S. Bentley By: /s/ Gerald R. Mitchell ------------------------------- --------------------------------- Gregory S. Bentley SVP and General Counsel 5 EX-10.FF 3 ex10pff.txt Exhibit 10(ff) KV PHARMACEUTICAL COMPANY AMENDMENT TO EMPLOYMENT AGREEMENT THIS AMENDMENT ("Amendment") is entered into effective March 23, --------- 2008, between RONALD J. KANTERMAN ("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 January 26, 2004 (the "Employment Agreement"); 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 Chief Financial --------------- Officer. - ------- 2. Paragraph 3 of the Employment Agreement regarding "Compensation" is hereby amended to specify a base salary of Three Hundred Thirty Thousand ----------------------------- Dollars ($330,000) effective March 23, 2008. - ------------------ 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, 2013, 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: 5. TERMINATION. (A) VOLUNTARY. Employee may terminate this Agreement at the end of the initial term for any reason, by notifying KV in writing three (3) calendar months prior to the end of the initial term. After completion of the initial term, Employee may terminate this Agreement by providing 120 calendar days notice to KV. In either such events written notice shall be directed to KV's Vice President, Staffing. In the event of such voluntary termination at the end of the initial term, Employee agrees to remain on the job 1 of 4 for the balance of the term and for three (3) additional months after the end of the initial 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, unless he is released from all responsibilities prior to the end of the notice period, by 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. In the event Employee terminates this Agreement upon 120 days calendar notice after completion of the initial term, KV, in its sole discretion, shall determine whether Employee shall continue to be employed during the notice period. If KV, in its sole discretion, determines Employee's services are not required during the notice, no salary continuation shall be provided during any part of the 120 day notice period not worked by Employee. If Employee decides to terminate his employment with KV, Employee shall disclose Employee's decision to terminate to the Vice President, Staffing of KV and shall not disclose such information to any other party (except for a subsequent employer of Employee who has agreed to keep such information confidential until KV has announced Employee's termination) until such time as the Vice President, Staffing 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 six (6) equal monthly installments, each payment to be made on the last day of each of the six (6) 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 six (6) 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, those stock options which are vested and exercisable by Employee 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 4 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 or benefits set forth in Paragraph 5(B). 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. In the event Employee is involuntarily terminated by KV for reasons other than for cause, employee will receive the severance pay and benefits set forth in Paragraph 5(B) unless employee is determined by KV, in its sole discretion, to have engaged in conduct harmful to KV after his termination, in which case KV's obligation to provide the aforesaid severance pay and benefits shall cease. In addition, KV's decision to discontinue Employee's services following Employee's notice of voluntary termination under paragraph 5(A), above, shall not be considered an involuntary termination and shall not trigger any severance pay obligations. Any payments or benefits made or provided pursuant to this Agreement are subject to Executive's: (i) compliance with the provisions of the KV Pharmaceutical Company Employment and Confidential Information Agreement dated January 26, 2004; (ii) delivery to the Company of an executed full and complete Release, on a form then acceptable to the Company, with such terms as needed under then applicable law to give full effect to its intent and purpose; notwithstanding the due date of any post-employment payments, any amounts due under this Agreement shall not be due until after the expiration of any revocation period applicable to the Release; and (iii) delivery to the Company of a resignation from all offices, directorships and fiduciary positions with the Company, its affiliates and employee benefit plans. 3 of 4 6. The following new Sections 22 and 23 are hereby added to the end of the Employment Agreement: (22) 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, Staffing 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. (23) Continuation of Other Provisions of Employment Agreement. 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/ Ronald J. Kanterman ----------------------------------------- RONALD J. KANTERMAN "KV" KV PHARMACEUTICAL COMPANY By: /s/ Gregory S. Bentley -------------------------------------- GREGORY S. BENTLEY Senior Vice President, General Counsel Witness: /s/ Shelly A. Smugala -------------------------- Date: ---------------------------- 4 of 4 EX-10.II 4 ex10pii.txt EXHIBIT 10(ii) EXECUTION COPY ============================================================================== ASSET PURCHASE AGREEMENT BY AND AMONG K-V PHARMACEUTICAL COMPANY, CYTYC PRENATAL PRODUCTS, CORP. AND HOLOGIC, INC. DATED AS OF JANUARY 16, 2008 ============================================================================== TABLE OF CONTENTS
Page ARTICLE I. DEFINITIONS............................................................................................1 Section 1.1 Defined Terms..........................................................................1 Section 1.2 Construction of Certain Terms and Phrases.............................................12 ARTICLE II. PURCHASE AND SALE OF ASSETS..........................................................................13 Section 2.1 Grant of Exclusive License............................................................13 Section 2.2 Purchase, Sale and Transfer of Assets.................................................13 Section 2.3 Excluded Assets.......................................................................14 Section 2.4 Retention of Copies...................................................................14 Section 2.5 Assignability and Consents............................................................14 ARTICLE III. ASSUMPTION OF LIABILITIES...........................................................................15 Section 3.1 Assumption of Liabilities.............................................................15 ARTICLE IV. PURCHASE PRICE, PAYMENT, REIMBURSEMENT OF EXPENSES AND TRANSFER......................................17 Section 4.1 Initial Payment of Purchase Price.....................................................17 Section 4.2 Additional Payments, Reimbursement of Expenses and Transfer of Assets.................17 Section 4.3 Allocation of Purchase Price..........................................................18 Section 4.4 Sales, Use and Other Taxes............................................................19 Section 4.5 Tax Withholding.......................................................................19 Section 4.6 Risk of Loss..........................................................................19 Section 4.7 Subsidiaries..........................................................................19 ARTICLE V. CLOSING AND TRANSFER DATE.............................................................................19 Section 5.1 Time and Place of Closing.............................................................19 Section 5.2 Deliveries at Closing.................................................................20 Section 5.3 Time and Place of Transfer Date.......................................................20 Section 5.4 Transfer Date Deliveries..............................................................20 ARTICLE VI. REPRESENTATIONS AND WARRANTIES OF THE SELLER.........................................................21 Section 6.1 Organization, Etc.....................................................................22 Section 6.2 Authority of the Seller...............................................................22 Section 6.3 Consents and Approvals................................................................22 Section 6.4 Non-Contravention.....................................................................23 Section 6.5 Contracts.............................................................................23 i Section 6.6 Intellectual Property Rights..........................................................23 Section 6.7 Litigation............................................................................26 Section 6.8 Permits; Compliance with Law..........................................................26 Section 6.9 Gestiva Inventory.....................................................................27 Section 6.10 Suppliers.............................................................................28 Section 6.11 Absence of Certain Changes or Events..................................................28 Section 6.12 Title to Assets; Sufficiency of Assets................................................29 Section 6.13 Disclosure............................................................................29 Section 6.14 Taxes.................................................................................30 Section 6.15 Competing Business....................................................................31 Section 6.16 Unlawful Payments.....................................................................31 Section 6.17 Brokers...............................................................................31 ARTICLE VII. REPRESENTATIONS AND WARRANTIES OF THE ACQUIROR......................................................31 Section 7.1 Corporate Organization................................................................32 Section 7.2 Authority of the Acquiror.............................................................32 Section 7.3 Non-Contravention.....................................................................32 Section 7.4 Litigation............................................................................32 Section 7.5 Brokers...............................................................................33 ARTICLE VIII. COVENANTS OF THE PARTIES...........................................................................33 Section 8.1 Operation of the Gestiva Business.....................................................33 Section 8.2 Reasonable Efforts....................................................................35 Section 8.3 Access; Confidentiality...............................................................37 Section 8.4 Public Announcements; Confidentiality.................................................39 Section 8.5 Regulatory Matters....................................................................39 Section 8.6 Covenant Not to Compete...............................................................41 Section 8.7 Further Assurances....................................................................43 Section 8.8 No Solicitation.......................................................................43 Section 8.9 Insurance.............................................................................43 Section 8.10 Tax Matters...........................................................................44 Section 8.11 Employee Matters......................................................................46 ARTICLE IX. CONDITIONS TO THE OBLIGATIONS OF THE PARTIES FOR THE CLOSING.........................................46 Section 9.1 Seller's Conditions to Closing........................................................46 Section 9.2 Acquiror's Obligations to Closing.....................................................46 ARTICLE X. CONDITIONS TO THE OBLIGATIONS OF THE PARTIES FOR THE TRANSFER DATE....................................47 Section 10.1 Seller's Obligations for the Transfer Date............................................47 Section 10.2 Acquiror's Obligations for the Transfer Date..........................................48 ARTICLE XI. INDEMNIFICATION......................................................................................49 ii Section 11.1 Survival of Representations, Warranties, Covenants, Etc...............................49 Section 11.2 Indemnification.......................................................................49 Section 11.3 Limitations...........................................................................53 Section 11.4 Conflict with other Provisions........................................................54 ARTICLE XII. TERMINATION.........................................................................................54 Section 12.1 Methods of Termination................................................................54 Section 12.2 Procedure upon Termination............................................................55 Section 12.3 Termination Fee.......................................................................56 ARTICLE XIII. MISCELLANEOUS......................................................................................56 Section 13.1 Notices...............................................................................56 Section 13.2 Entire Agreement......................................................................57 Section 13.3 Waiver................................................................................57 Section 13.4 Amendment.............................................................................58 Section 13.5 Third Party Beneficiaries.............................................................58 Section 13.6 Assignment; Binding Effect............................................................58 Section 13.7 Headings..............................................................................58 Section 13.8 Severability..........................................................................58 Section 13.9 Governing Law.........................................................................58 Section 13.10 Expenses..............................................................................59 Section 13.11 Counterparts..........................................................................59 Section 13.12 Remedies..............................................................................59 Exhibit A-Form of Assumption and Assignment Agreement Exhibit B-Form of Bill of Sale Exhibit C-Form of Trademark Assignment Agreement Exhibit D-Form of FDA Transfer Letters Exhibit E-Form of License Agreement
iii ASSET PURCHASE AGREEMENT This Asset Purchase Agreement (this "AGREEMENT") is made and entered into as of January 16, 2008, by and among K-V Pharmaceutical Company, a Delaware corporation (the "ACQUIROR"), Cytyc Prenatal Products Corp., a Delaware corporation (the "SELLER") and solely for purposes of Section 8.6 and ----------- ARTICLE XI, Hologic, Inc., a Delaware corporation ("PARENT"). - ---------- RECITALS WHEREAS, Seller is engaged in researching, manufacturing, developing, marketing, and selling Gestiva; WHEREAS, on the Closing Date (as defined herein), Seller will, by the terms of this Agreement, conditionally sell the Purchased Assets (as defined herein) to Acquiror and grant to Acquiror an exclusive license to use the Gestiva Intellectual Property (as defined herein) during the period between the Closing Date and the Transfer Date (as defined herein). WHEREAS, on the Transfer Date, Seller will, by the terms of this Agreement, transfer to Acquiror all of the Purchased Assets; and WHEREAS, Acquiror has agreed to assume the Assumed Liabilities on the Transfer Date on the terms and subject to the conditions set forth herein. AGREEMENT NOW, THEREFORE, in consideration of the premises, covenants, representations and warranties contained herein, and other good and valuable consideration, the adequacy and receipt of which are hereby acknowledged, the parties hereto, intending to be legally bound, agree as follows: ARTICLE I. DEFINITIONS Section 1.1 Defined Terms. As used in this Agreement, the ------------- following defined terms shall have the meanings specified below: "ACCOUNTANTS" has the meaning set forth in Section 8.10(h). --------------- "AAA" has the meaning set forth in Section 11.2(f)(ii). ------------------- "ACQUIROR" has the meaning set forth in the preamble to this Agreement. "ACQUIROR MATERIAL ADVERSE EFFECT" means any Effect that, individually or in the aggregate, has had or would be reasonably expected to have a material adverse effect on (i) the Acquiror's ability to consummate the transactions contemplated hereby in accordance with the terms and conditions hereof or (ii) on the business, assets (including intangible assets), results of operations, liabilities (contingent or otherwise) or conditions (financial or otherwise) of the Acquiror. "ACTION OR PROCEEDING" means any action, suit, claim, proceeding, arbitration, dispute, Order, inquiry, hearing, assessment with respect to fines or penalties or litigation (whether civil, criminal, administrative or investigative) commenced, brought, conducted or heard by or before, or otherwise involving, any Governmental or Regulatory Authority. "ADDITIONAL PURCHASE PRICE AMOUNT" has the meaning set forth in Section 4.2(b). -------------- "AFFILIATE" means, with respect to any Person, any other Person which Controls, is Controlled by or is under common Control with such Person. "AGREEMENT" has the meaning set forth in the preamble hereto. "API" means the 17 alpha-hydroxyprogesterone caproate active pharmaceutical ingredient. "APPLICABLE PERIOD" has the meaning set forth in Section ------- 8.6(a). - ------ "ASSIGNMENT AND ASSUMPTION AGREEMENT" means the Assignment and Assumption Agreement substantially in the form attached hereto as Exhibit A. --------- "ASSUMED CONTRACTS" means the Gestiva Contracts set forth on Schedule 1.1(a) and any Contracts entered into by Seller or its Affiliates - --------------- from the date hereof to the Transfer Date in accordance with Section 8.1(b)(iv) ------------------ to the extent relating solely to Gestiva or the Purchased Assets. "ASSUMED LIABILITIES" has the meaning set forth in Section ------- 3.1(a). - ------ "BILL OF SALE" means the Bill of Sale conveying the Purchased Assets from the Seller to the Acquiror as of the Transfer Date, substantially in the form attached hereto as Exhibit B. --------- "BUSINESS DAY" means a day other than Saturday, Sunday or any day on which commercial banks located in New York are authorized or obligated by Law to close. "CHARTER DOCUMENTS" has the meaning set forth in Section 6.1. ----------- "CLOSING" has the meaning set forth in Section 5.1. ----------- "CLOSING DATE" has the meaning set forth in Section 5.1. ----------- "CODE" means the Internal Revenue Code of 1986, as amended. "COMPETING PRODUCT" has the meaning set forth in Section ------- 8.6(a). - ------ "COMPLETE RESPONSE" has the meaning set forth in Section ------- 4.2(a). - ------ 2 "CONFIDENTIALITY AGREEMENT" means the Confidentiality Agreement, dated as October 30, 2007, by and between Parent and Acquiror. "CONTRACTS" means any and all written or legally binding oral commitments, contracts, purchase orders, sales orders, leases, subleases, licenses, easements, commitments, arrangements, undertakings, evidence of indebtedness, security or pledge agreements or other agreements. "CONTROL" means: (a) ownership (directly or indirectly) of at least fifty percent (50%) of the shares or stock entitled to vote for the election of directors in the case of a company or corporation; or (b) the ability otherwise to direct and control (whether directly or indirectly through one or more intermediaries) the actions of a Person. "DAMAGES" has the meaning set forth in Section 11.2(a). --------------- "DEFAULT" means (i) a breach, default or violation, (ii) the occurrence of an event that with or without the passage of time or the giving of notice, or both, would constitute a breach, default or violation or cause an Encumbrance to arise or (iii) with respect to any Contract, the occurrence of an event that with or without the passage of time or the giving of Notice, or both, would constitute a change of control or give rise to a right of termination, modification, renegotiation, acceleration, cancellation, or a right to receive Damages or a payment of penalties. "DESIGNATED ACQUIROR SUBSIDIARY" shall have the meaning set forth in Section 4.7. ----------- "EFFECT" means any state of facts, change, development, event, occurrence, effect or condition. "ENCUMBRANCE" means any claim, mortgage, pledge, assessment, security interest, option, deed of trust, lease, lien, levy, license, restriction on transferability, defect in title, charge or other encumbrance of any kind, whether voluntarily incurred or arising by operation of Law or any conditional sale or title retention agreement or other agreement to give any of the foregoing in the future. "ENVIRONMENTAL LAWS" means any federal, state, local or non-U.S. Law and any judicial or administrative interpretation thereof, including any judicial or administrative order, consent decree, judgment, stipulation, injunction, permit, authorization, policy, opinion, or agency requirement, in each case having the force and effect of Law, relating to the pollution, protection, investigation or restoration of the environment or health and safety as affected by the environment or natural resources, including those relating to the use, handling, presence, transportation, treatment, storage, disposal, release, threatened release or discharge of Hazardous Materials or noise, odor, wetlands, pollution or contamination. 3 "ERISA AFFILIATE" means any entity which is (or at any relevant time was) a member of a "controlled group of corporations" with, under "common control" with, or a member of an "affiliated service group" with, Seller, as defined in Section 414(b), (c), (m) or (o) of the Code, or under "common control" with Seller, within the meaning of Section 4001(b)(1) of ERISA. "EXCLUDED ASSETS" has the meaning set forth in Section 2.3. ----------- "EXCLUDED LIABILITIES" has the meaning set forth in Section ------- 3.1(b). - ------ "EXCLUDED TAX LIABILITY" has the meaning set forth in Section 3.1(b)(iii). - ------------------- "FDA" means the United States Food and Drug Administration or any successor thereto. "FDA ACT" means the U.S. Food, Drug and Cosmetic Act of 1938, as it may be superseded or amended from time to time. "FDA TRANSFER LETTERS" has the meaning set forth in Section ------- 8.2(e). - ------ "GESTIVA" means the pharmaceutical product containing the API described in NDA #21-945. "GESTIVA BOOKS AND RECORDS" means all books, records, files, documents, data, information and correspondence related to the Gestiva Business which are owned by the Parent, the Seller or their Subsidiaries, including, without limitation, all records with respect to supply sources; all pre-clinical, clinical and process data and reports relating to research or development of products or of any materials used in the research, development, use, testing, manufacture, marketing or sale of products, including all raw data relating to clinical trials of products, all case report forms relating thereto and all statistical programs developed (or modified in a manner material to the use or function thereof) to analyze clinical data; all market research data, market intelligence reports and statistical programs (if any) used for marketing and sales research; promotional, advertising and marketing materials, sales forecasting models, medical education materials, sales training materials, web site content and advertising and display materials; all records, including vendor and supplier lists, manufacturing records, sampling records, standard operating procedures and batch records, related to the manufacturing process; all data contained in laboratory notebooks relating to products or relating to their biological, physiological, mechanical or formula properties; all adverse experience reports and files related thereto (including source documentation) and all periodic adverse experience reports and all data contained in electronic data bases relating to periodic adverse experience reports; all analytical and quality control data; all written correspondence with the FDA; and written records relating to the regulatory filings with the FDA or its foreign counterparts, including, but not limited to, the Gestiva FDA Submission. Notwithstanding the foregoing, the Gestiva Books and Records shall exclude any books, records, files, documents, data, information and correspondence relating to human resources or employees of the Parent, the Seller and their Subsidiaries and in the case of any books, records, files, documents, data, information and correspondence also relating to the other businesses or assets of the Parent, the Seller and their Subsidiaries, the Seller shall have the right to exclude or redact the same with respect to such other businesses and assets. 4 "GESTIVA BUSINESS" means the research, development, regulatory approval, manufacture, distribution, marketing, sale and promotion of Gestiva, and to the extent applicable, Gestiva Product Improvements in each case as conducted by the Parent, the Seller and their Subsidiaries. "GESTIVA CONTRACTS" means all (i) Contracts pursuant to which Seller or its Affiliates purchases any materials from any third party for use in connection with the development, testing or manufacture of Gestiva, all of which Contracts in effect on the date hereof are set forth on Schedule -------- 1.1(a), (ii) Contracts relating to any pre-clinical or clinical trial - ------ involving Gestiva, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), (iii) Contracts constituting material transfer --------------- agreements involving the transfer of Gestiva, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), (iv) Contracts relating --------------- to the marketing of Gestiva or educational matters relating to Gestiva, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), --------------- (v) Contracts relating to the supply or manufacture of Gestiva or Gestiva Product Improvements, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), (vi) Contracts constituting confidentiality --------------- agreements involving Gestiva or Gestiva Intellectual Property, including non-compete or non-solicitation agreements with employees, independent contractors or agents of Seller with third parties, (vii) Contracts involving any royalty, licensing, partnering or similar arrangement involving Gestiva or Gestiva Intellectual Property, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), (viii) Contracts pursuant to which --------------- any services are provided to Seller or its Affiliates with respect to Gestiva, including consultation agreements, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a), and (ix) Contracts pursuant to --------------- which any third party collaborates with Seller or its Affiliates in the performance of research or development of Gestiva, all of which Contracts in effect on the date hereof are set forth on Schedule 1.1(a). --------------- "GESTIVA COPYRIGHTS" means all copyrightable works and copyrights, and any registrations, applications, and renewals in connection therewith worldwide, if any, including moral rights, website content, and other rights of authorship and exploitation in each case as set forth on Schedule 1.1(b) of the Seller Disclosure Schedule. - --------------- "GESTIVA FDA SUBMISSIONS" means, collectively, the Gestiva Pre-IND and Gestiva NDA. "GESTIVA GOVERNMENTAL PERMITS" means all authorizations, licenses, permits, certificates, approvals, exemptions, consents, confirmations, orders, registrations, product registrations, concessions, franchises, waivers and clearances of a Governmental or Regulatory Authority (including all authorizations under the FDA Act, the Public Health Services Act, the Controlled Substances Act and the regulations of the FDA and the United States Drug Enforcement Agency promulgated thereunder) necessary for the Seller to carry on the Gestiva Business as it is being conducted as of the date hereof. "GESTIVA INTELLECTUAL PROPERTY" means (i) the Gestiva Copyrights, (ii) the Gestiva Patent Rights, (iii) the Gestiva Know-How, (iv) the Gestiva Trademarks, (v) the rights to exclude others from appropriating any of the foregoing, including the rights to sue for and remedies against past, present and future infringements of any or all of the foregoing and rights of priority 5 and protection of interests therein and (vi) any other proprietary, intellectual property and other rights relating to any or all of the foregoing anywhere in the world. "GESTIVA PRE-IND" means the Pre-IND #68,108, as filed as of the date hereof of this Agreement, and all documents, data, analyses, files related thereto, in each case as may be updated in accordance with this Agreement. "GESTIVA INVENTORY" means all inventories of Gestiva in existence as of the Transfer Date, together with all bulk active pharmaceutical ingredient, all other raw materials, components, parts, work in process and packaging materials owned by the Parent, the Seller or any of their Subsidiaries as of the Transfer Date for use in the operation of the Gestiva Business. For clarity, Gestiva Inventory shall exclude raw materials, components, parts, work in process and packaging materials not specific to Gestiva. "GESTIVA KNOW-HOW" means any and all Gestiva Manufacturing Know-How and other Know-How that is currently owned or used under license by the Parent, the Seller or any of their Subsidiaries related to Gestiva or the Gestiva Product Improvements as of the Transfer Date. For the sake of clarity, none of the foregoing information shall be included in Gestiva Know-How to the extent that such information is covered by any claim of any Gestiva Patent Rights. "GESTIVA MANUFACTURING KNOW-HOW" means any Know-How or other information relating to the manufacture of Gestiva or Gestiva Product Improvements owned or used under license by the Parent, the Seller or their Subsidiaries, including without limitation the identity, amounts and assurance quality of ingredients, the manufacturing processes and controls, specifications, technology, inventions, assays, quality control and testing procedures, Know-How and trade secrets used, held for use, or intended to be used in or necessary to manufacture, formulate, test and package Gestiva for use, sale, marketing and distribution as of the Transfer Date. For sake of clarity, none of the foregoing information shall be included in the Gestiva Manufacturing Know-How to the extent that such information is covered by any claim of any Gestiva Patent Rights. "GESTIVA NDA" means NDA # 21-945 as filed as of the date of this Agreement, and all documents, data, analyses, and files related thereto, in each case as may be updated in accordance with this Agreement. "GESTIVA NDA APPROVAL" means approval of the Gestiva NDA by the FDA allowing for the initiation of marketing and sale of Gestiva in the United States for the prevention of preterm delivery in woman with a history of a prior preterm delivery or any other similar treatment. "GESTIVA NDA APPROVAL DATE" means the date upon which the FDA issues to the Seller written notice of the Gestiva NDA Approval. "GESTIVA PATENT RIGHTS" means those Patent Rights owned or used under license by the Parent, the Seller or their Subsidiaries listed on Schedule 1.1(c), together with all registrations, applications and renewals - --------------- thereof, and any other Patent Rights that are owned or used under license by the Parent, the Seller or any of their Subsidiaries and that would be 6 infringed by the manufacture, sale, offer to sell or importation of Gestiva or any Gestiva Product Improvement. "GESTIVA PRODUCT IMPROVEMENT" means (to the extent applicable) any: (i) line extension of Gestiva, (ii) new indication of Gestiva, (iii) composition of matter or article of manufacture consisting essentially of 17 alpha-hydroxyprogesterone caproate, (iv) pharmaceutical combination containing 17 alpha-hydroxyprogesterone caproate and another active ingredient, (v) new formulations comprising of 17 alpha-hydroxyprogesterone caproate and/or (vi) compositions of matter or articles of manufacture constituting any of the foregoing or components thereof. "GESTIVA PRODUCT REGISTRATIONS" means (i) the exemptions, approvals or registrations which have been received by the Parent, the Seller or any of their Subsidiaries as of the date of this Agreement, or which are received by the Parent, the Seller or any of their Subsidiaries after the date of this Agreement but before the Transfer Date, for the manufacturing, testing, investigation, sale, use, distribution and/or marketing of Gestiva or a Gestiva Product Improvement (including any NDAs or INDs) and (ii) all dossiers, reports, data and other written materials filed as part of or referenced in any applications for such approvals or registrations, or maintained by the Parent, the Seller or any of their Subsidiaries and relating to such approvals or registrations. "GESTIVA TRADEMARKS" means all trademarks, trade names, product names, trade dress, service marks, logos and slogans set forth on Schedule 1.1(d), in each case, whether registered or unregistered, including - --------------- all common law rights, registrations and applications for registrations for any of the foregoing, and all internet domain names, and all registrations, applications and renewals thereof and the goodwill associated therewith. "GOVERNMENTAL OR REGULATORY AUTHORITY" means any court, tribunal, arbitrator, authority, agency, commission, department, ministry, official or other instrumentality of the United States or other country, or any supra-national organization, or any foreign or domestic, state, county, city or other political subdivision. "HAZARDOUS MATERIALS" means (i) any petroleum, petroleum products, byproducts or breakdown products, radioactive materials, asbestos-containing materials or polychlorinated biphenyls or (ii) any chemical, material or other substance defined or regulated as toxic or hazardous or as a pollutant or contaminant or waste under any Environmental Law. "HSR ACT" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, together with any rules or regulations promulgated thereunder. "IND" means (i) an Investigational New Drug Application, as defined in the FDA Act and the regulations promulgated thereunder, which is required to be filed with the FDA before beginning clinical testing of a product in human subjects, or any successor application or procedure, (ii) all supplements and amendments that may be filed with respect to the foregoing and (iii) all international equivalents of the foregoing. "INDEMNIFICATION CLAIM NOTICE" has the meaning set forth in Section 11.2(c). - --------------- 7 "INDEMNIFIED PARTY" has the meaning set forth in Section ------- 11.2(c). - ------- "INDEMNITEES" has the meaning set forth in Section 11.2(c). --------------- "INITIAL GESTIVA INVENTORY" means the release and shipment of no fewer than 15,000 5-milliliter vials of finished Gestiva suitable for commercial sale by the Acquiror. "INITIAL PURCHASE PRICE AMOUNT" has the meaning set forth in Section 4.1. - ----------- "JOINT INTEGRATION COMMITTEE" means a committee of representatives comprised of two (2) members selected by the Acquiror from its senior executives and two (2) members selected by the Seller from its senior executives; each having responsibility at the respective party for the development of Gestiva. Each party will give the other written notification concerning its executives nominated to serve on the Joint Integration Committee. Either party may replace either of its members on the Joint Integration Committee with an equivalent senior executive by providing written notice of the change to the other party. "KNOW-HOW" means any proprietary or nonproprietary information directly related to the manufacture, preparation, development (both research and clinical), or commercialization of a product, including, without limitation, product specifications, processes, product designs, plans, trade secrets (including, without limitation, user information, customer and supplier lists, and related information, business and marketing plans, any other financial, marketing and business data), ideas, concepts, inventions, formulae, chemical, pharmacological, toxicological, pharmaceutical, physical, analytical, stability, safety, quality assurance, quality control and clinical information, technical information, research information, and all other confidential or proprietary technical and business information, whether or not embodied in any documentation or other tangible materials, but in no event shall the definition of "Know-How" include information properly in the public domain. "KNOWLEDGE" with respect to (i) the Seller means the actual knowledge of Robb Hesley, Catherine Williams, Mary Eckstein, Lynn Jones, Tom Umbel, Howard Doran, Tony Kingsley and Mark Casey (whose positions and operational responsibilities are listed on Schedule 1.1(e) hereto), following --------------- reasonable inquiry and (ii) the Acquiror means the knowledge of the officers, directors or senior managers, following reasonable inquiry. "LAW" means any federal, state, local or foreign law, statute, code or ordinance, or any rule or regulation promulgated by any Governmental or Regulatory Authority. "LIABILITY" means any direct or indirect liability, obligation, claim, deficiency, guarantee or commitment of any kind or nature (whether known or unknown, asserted or unasserted, absolute or contingent, accrued or unaccrued, liquidated or unliquidated, or due or to become due), including any liability for Taxes. "LIABILITY CAP" means $750,000 until the Seller receives payment of the NDA Milestone Payment pursuant to Section 4.2(a), if ever, and -------------- thereafter shall be $950,000, until the Seller receives payment of the Additional Purchase Price Amount pursuant to Section 4.2(b), if ever, and -------------- thereafter shall be $8,200,000. 8 "LIABILITY THRESHOLD" has the meaning set forth in Section ------- 11.3(a). - ------- "LICENSE AGREEMENT" has the meaning set forth in Section ------- 2.1. - --- "NDA" means (i) a New Drug Application for any product, as appropriate, requesting permission to place a drug on the market in accordance with 21 C.F.R. Part 314, and all supplements or amendments filed pursuant to the requirements of the FDA, including all documents, data and other information concerning a product which are reasonably necessary for FDA approval to market a product in the United States and (ii) all international equivalents of the foregoing. "NDA MILESTONE PAYMENT" has the meaning set forth in Section ------- 4.2(a). - ------ "NON-ASSIGNABLE ASSET" has the meaning set forth in Section ------- 2.5(a). - ------ "NO-SHOP PERIOD" has the meaning set forth in Section 8.8. ----------- NOTICE" with respect to a party means notice actually received by an officer, director or senior manager of the Seller, in the case of the Seller, or of the Acquiror, in the case of the Acquiror, in each case with responsibility in the relevant area, or delivered in accordance with the terms of the document, Law or Order pursuant to which such notice was given. "OBJECTION NOTICE" has the meaning set forth in Section ------- 11.2(f)(i). - ---------- "ORDER" means any writ, judgment, decree, injunction or similar order, including consent orders, of any Governmental or Regulatory Authority (in each such case whether preliminary or final). "ORDINARY COURSE OF BUSINESS" means an action or activity that is consistent in nature, scope and magnitude with the past practices of the Seller and its Affiliates with respect to the Gestiva Business. "PARENT" has the meaning set forth in the preamble to this Agreement. "PATENT RIGHTS" means any invention disclosure, patent application (including any provisionals, divisionals, continuations, continuations-in-part (to the extent claiming subject matter invented on or before the Transfer Date) and substitutions thereof), patents issuing from or granted upon such invention disclosure or patent application (including patents of addition (to the extent claiming subject matter invented on or before the Transfer Date) and substitutions thereof), reissues, extensions, reexaminations, renewal applications, supplemental patent certificates or any confirmation patent or registration patent) and all foreign counterparts of any of the foregoing. "PERMITTED ENCUMBRANCES" means with respect to the Seller: (i) statutory liens of landlords, liens of carriers, warehousepersons, mechanics and material persons or similar liens incurred or arising in the ordinary course of business, none of which materially detracts from the value or materially impairs the use of the asset or property subject thereto, or materially impairs the operations of the Parent, the Seller or any of their Subsidiaries, (ii) liens incurred or deposits 9 made in connection with workers' compensation, unemployment insurance and other similar types of social security programs or to secure the performance of tenders, statutory obligations, surety and appeal bonds, bids, leases, government contracts, performance and return of money bonds and similar obligations, in each case in the ordinary course of business, consistent with past practice, (iii) encumbrances which do not interfere with the ordinary conduct of business of the Seller and do not materially detract from the value of the underlying asset, (iv) liens for Taxes, assessments and governmental charges not yet due and payable and (v) non-exclusive end-user licenses entered in the ordinary course of business. "PERSON" means any natural person, corporation, general partnership, limited partnership, limited liability company, proprietorship, joint venture, other business organization, trust, entity, union, association or Governmental or Regulatory Authority. "PERSONNEL" has the meaning set forth in Section 6.6(l). -------------- "POST-TRANSFER TAX PERIOD" means any Tax Period beginning after the Transfer Date and the portion of any Straddle Period beginning after the Transfer Date. "PRE-TRANSFER TAX PERIOD" means any Tax Period ending on or before the Transfer Date and the portion of any Straddle Period ending on the Transfer Date. "PURCHASE PRICE" has the meaning set forth in Section 4.2(b). -------------- "PURCHASED ASSETS" has the meaning set forth in Section 2.2. ----------- "REGISTERED GESTIVA INTELLECTUAL PROPERTY" means all Gestiva Intellectual Property that has been registered, filed, certified or otherwise perfected or recorded with or by any Governmental or Regulatory Authority, including all Gestiva Patent Rights. "REIMBURSABLE EXPENSES" means any (i) all out-of-pocket expenses incurred by the Parent, the Seller or their Subsidiaries, between January 1, 2008 and the Transfer Date, in conducting the Gestiva Business in the Ordinary Course of Business, including in seeking to obtain and obtaining the Gestiva NDA Approval as required pursuant to Section 8.5 hereof, in ----------- accordance with the budget set forth on Schedule 1.1(f) or as approved by the --------------- Joint Integration Committee or otherwise incurred in accordance with Section ------- 8.1(b)(i), other than any expenses, including salary and benefits, related to - --------- the continued employment of any employee of the Parent, the Seller or their Subsidiaries, (ii) all out-of-pocket expenses incurred by the Parent, the Seller or their Subsidiaries, between January 1, 2008 and the Transfer Date, under the Assumed Contracts pursuant to the terms in effect on the date hereof or otherwise entered into or amended as permitted by Section 8.1(b)(iv), (iii) all out-of-pocket expenses incurred by the Parent, the Seller or their Subsidiaries in the Ordinary Course of Business in respect of the Gestiva Governmental Permits that are Purchased Assets to the extent relating to the operation or conduct of the Gestiva Business during the period beginning on January 1, 2008 and ending on the Transfer Date, and (iv) the expenses set forth on Schedule 1.1(g), in each of the cases of clauses (i)-(iv) without --------------- duplication of expenses. "RELATED AGREEMENTS" means the (i) Trademark Assignment Agreement, Bill of Sale, Assignment and Assumption Agreement and duly executed and attested assignments of 10 transfer, or such other instruments of conveyance as may be required by Law, sufficient to permit the proper recordation of transfer of title ownership in all Registered Gestiva Intellectual Property owned by the Seller from the Parent, the Seller or their Subsidiaries to Acquiror in accordance with this Agreement, (ii) the Transition Services Agreement and (iii) the License Agreement. "RESTRICTED TERRITORY" shall mean world-wide. "RETAINED DOCUMENTS" shall have the meaning set forth in Section 2.4. - ----------- "SELLER" has the meaning set forth in the preamble to this Agreement. "SELLER DISCLOSURE SCHEDULE" has the meaning set forth in the preamble to ARTICLE VI. ---------- "SELLER GOVERNMENTAL CONSENTS" has the meaning set forth in Section 6.3(a). - -------------- "SELLER MATERIAL ADVERSE EFFECT" means any Effect that, individually or in the aggregate, (i) has had or would reasonably be expected to have a material adverse effect on the Purchased Assets taken as a whole or (ii) could reasonably be expected to materially impair or delay the ability of the Seller to perform its obligation hereunder; provided, however, that none of the following shall be deemed in themselves, either alone or in combinations, to constitute, and none of the following shall be taken into account in determining whether there has been, or will be, a Seller Material Adverse Effect: (A) any Effect relating to general economic conditions in the United States or foreign economies in any locations where the Seller and its Affiliates have material operations relating to the Gestiva Business except to the extent such Effect disproportionately affects the Seller and its Affiliates, (B) any Effect attributable to conditions that generally affect the industries in which the Seller and its Affiliates participate relating to the Gestiva Business except to the extent such Effect disproportionately affects the Seller and its Affiliates, taken as a whole and (C) any Effect that results from actions taken by the Seller as required by this Agreement or at the written direction of the Acquiror. "SELLER THIRD PARTY CONSENTS" has the meaning set forth in Section 6.3(b). - -------------- "STRADDLE PERIOD" means any Tax period beginning on or before the date hereof and ending after the Transfer Date. "SUBSIDIARY" of a Person means any entity Controlled by that Person. "SURVIVAL PERIOD" shall have the meaning set forth in Section 11.1. - ------------ "TAXES" means all of the following in connection with the operations of the Gestiva Business or the transactions contemplated hereby: (i) any net income, alternative or add-on minimum, gross income, gross receipts, sales, use, value added, ad valorem, transfer, franchise, profits, license, excise, severance, stamp, occupation, payroll, employment, withholding, social security, unemployment, disability, registration, premium, property, environmental, windfall profits, capital stock, customs duty, or other tax, governmental fee or other like assessment imposed by any governmental, regulatory or administrative entity or 11 agency responsible for the imposition of any such tax (domestic or foreign) including any interest, penalty or addition thereon, whether disputed or not, (ii) any Liability for the payment of any amounts of the type described in (i) as a result of being a member of any affiliated, consolidated, combined, unitary or other group for any Tax Period and (iii) any Liability for the payment of any amounts of the type described in (i) or (ii) as a result of any express or implied obligation to indemnify any other Person. "TAX PERIOD" means any period prescribed by any Governmental or Regulatory Authority for which a Tax Return is required to be filed or a Tax is required to be paid or measured. "TAX RETURN" means any return, declaration, report, claim for refund, or information return or statement relating to Taxes, including any schedule or attachment thereto, and including any amendment thereof. "TERMINATION DATE" has the meaning set forth in Section ------- 12.1(b). - ------- "THIRD PARTY CLAIM" has the meaning set forth in Section ------- 11.2(d). - ------- "TRADEMARK ASSIGNMENT AGREEMENT" means the Trademark Assignment Agreement to be dated as of the Transfer Date by and between the Acquiror and Seller, substantially in the form attached hereto as Exhibit C. --------- "TRANSFER DATE" shall have the meaning set forth in Section ------- 5.3. - --- "TRANSFER TAXES" has the meaning set forth in Section 4.4. ----------- "TRANSITION SERVICES AGREEMENT" means the Transition Services Agreement, by and between the Acquiror and the Seller, in a form to be mutually agreed upon by the Acquiror and the Seller. "TREASURY REGULATIONS" means the Treasury regulations promulgated under the Code. Section 1.2 Construction of Certain Terms and Phrases. ----------------------------------------- Unless the context of this Agreement otherwise requires: (i) words of any gender include each other gender, (ii) words using the singular or plural number also include the plural or singular number, respectively, (iii) the terms "hereof," "herein," "hereby" and derivative or similar words refer to this entire Agreement, (iv) the terms "Article" or "Section" refer to the specified Article or Section of this Agreement, (v) the term "or" has, except where otherwise indicated, the inclusive meaning represented by the phrase "and/or" and (vi) the term "including" means "including without limitation." Whenever this Agreement refers to a number of days, such number shall refer to calendar days unless Business Days are specified. 12 ARTICLE II. PURCHASE AND SALE OF ASSETS Section 2.1 Grant of Exclusive License. Subject to the terms -------------------------- and conditions set forth in this Agreement, Seller grants to Acquiror an exclusive paid-up, royalty-free, worldwide license to use Gestiva Intellectual Property during the period beginning on the Closing Date and ending on the earlier to occur of (i) the date this Agreement is terminated pursuant to Section 12.1 and (ii) the Transfer Date, pursuant to the terms and conditions - ------------ of the License Agreement attached hereto as Exhibit E (the "License --------- ------- Agreement"). Notwithstanding the foregoing, the Seller shall retain all rights - --------- to use the Gestiva Intellectual Property to the extent necessary to enable the Seller to perform its obligations under this Agreement. Section 2.2 Purchase, Sale and Transfer of Assets. Upon the ------------------------------------- terms and subject to the conditions set forth in this Agreement, on the Closing Date, Seller shall, or cause its Affiliates to, conditionally sell, convey and assign to the Acquiror, and the Acquiror shall conditionally purchase and acquire from Seller and its Affiliates, all of Seller's and its Affiliates' right, title and interest in and to all of the following assets, free and clear of all Encumbrances (collectively, the "PURCHASED ASSETS"), provided, however, that notwithstanding the foregoing, the conditions to the conditional sale, conveyance and assignment of the Purchased Assets shall only be satisfied and the Purchased Assets shall only be transferred and delivered by the Seller or its Affiliates to the Acquiror upon the Transfer Date (as defined herein): (a) the Assumed Contracts; (b) all Gestiva Books and Records; (c) all Gestiva Inventory, excluding such Gestiva Inventory Acquiror elects to exclude as designated by Acquiror in writing prior to the Closing Date; (d) all Gestiva Intellectual Property; (e) all Gestiva Product Registrations, excluding the Gestiva FDA Submissions; (f) all Gestiva Product Improvements; (g) all Gestiva Governmental Permits, to the extent legally transferable, excluding the Gestiva FDA Submissions; (h) the Gestiva FDA Submissions (unless earlier transferred pursuant to Section 8.5); ----------- (i) any other assets owned by the Seller or its Affiliates related to the research (including all pre-clinical and clinical studies), development, manufacture, formulation, use, distribution, marketing, sale and promotion of Gestiva and/or Gestiva Product Improvements, including but not limited to, any equipment and tangible property related thereto; 13 (j) all customer and supplier relationships, goodwill and other intangible assets associated with the Gestiva Business; (k) all claims, causes of action or rights to collect, including for past, present or future infringement, misappropriation or violation of Gestiva Intellectual Property rights; (l) all rights related to or arising out of or under any express or implied warranties from suppliers relating to the Gestiva Business; and (m) all rights, claims and credits (including all guarantees, warranties, indemnities and similar rights and all refunds, credits and claims for refunds or credits relating to Taxes incurred during the Post-Transfer Tax Period), in favor of Seller or any of its Affiliates or any of their respective employees to the extent relating to any Purchased Asset or any Assumed Liability. Section 2.3 Excluded Assets. Notwithstanding anything to the --------------- contrary contained in this Agreement, from and after each of the Closing Date and the Transfer Date, the Seller and its Affiliates shall retain all of their respective rights, title and interest in their assets and properties other than the Purchased Assets (the "EXCLUDED ASSETS"). Section 2.4 Retention of Copies. From and after the Transfer ------------------- Date, the Seller may retain, at its expense, one archival copy of all documents or materials conveyed hereunder which do not contain or otherwise consist of, in whole or in part, the Assumed Contracts or the Gestiva Books and Records (the "RETAINED DOCUMENTS"); provided that access to such Retained Documents shall be restricted to the Seller's legal counsel and such employees of the Seller who have a "need to know" such information for conducting the operations of Seller and its Affiliates following the Transfer Date; provided, further, that no such operations shall include, directly or indirectly, the Gestiva Business or otherwise conflict with or result in a breach of Section 8.6 hereof. In addition, from and after the Transfer Date, the Seller may retain, at its expense, one archival copy of all Assumed Contracts and the Gestiva Books and Records, in each case, which the Seller in good faith determines it is reasonably likely to need access to in connection with performing its rights and obligations under this Agreement. Access to such Assumed Contracts and Gestiva Books and Records shall be restricted to the Seller's legal counsel and such employees of the Seller who have a "need to know" such information in connection therewith and from and after the Transfer Date and shall be kept strictly confidential by Seller and its Affiliates and not used for any other purpose. Upon final performance of its rights and obligations hereunder, Seller shall destroy or deliver any such copies of such Assumed Contracts and Gestiva Books and Records to Acquiror. Section 2.5 Assignability and Consents. -------------------------- (a) Notwithstanding anything to the contrary contained in this Agreement, if the sale, conveyance, assignment, transfer or delivery or attempted sale, conveyance, assignment, transfer or delivery to the Acquiror of any Purchased Asset is (i) prohibited by any applicable Law or (ii) would require any authorizations, approvals, consents or waivers from a Person other than Seller or any Affiliate of Seller and such authorizations, approvals, consents or waivers shall not have 14 been obtained prior to the Transfer Date (each, a "NON-ASSIGNABLE ASSET"), in either case, the transactions contemplated on the Transfer Date shall proceed (subject to the parties rights under ARTICLE X), but the Transfer Date shall --------- not constitute the sale, conveyance, assignment, transfer or delivery of such Non-Assignable Asset, and this Agreement shall not constitute a sale, conveyance, assignment, transfer or delivery of such Non-Assignable Asset unless and until such authorization, approval, consent or waiver is obtained. After the Transfer Date, the Seller shall continue to use commercially reasonable efforts to obtain any Seller Third Party Consent, and the Seller shall cooperate with the Acquiror in any such commercially reasonable arrangement, including performance by the Seller as agent if commercially reasonable to the Seller, and, in such case, the Acquiror shall be liable to the Seller in a fashion equivalent to what the Acquiror's Liabilities would be under the Non-Assignable Asset if it were assigned. The Seller shall promptly pay over to the Acquiror the net amount (after expenses and taxes) of all payments received by it in respect of all Non-Assignable Assets. (b) Once authorization, approval or waiver of or consent for the sale, conveyance, assignment, transfer or delivery of any such Non-Assignable Asset not sold, conveyed, assigned, transferred or delivered at the Closing is obtained, the Seller shall convey, assign, transfer and deliver such Non-Assignable Asset to the Acquiror at no additional cost to the Acquiror. Notwithstanding anything to the contrary contained in this Agreement, the Acquiror shall not assume any Liabilities with respect to a Non-Assignable Asset until it has been assigned to the Acquiror. ARTICLE III. ASSUMPTION OF LIABILITIES Section 3.1 Assumption of Liabilities. ------------------------- (a) Upon the terms and subject to the conditions set forth in this Agreement, as of the Transfer Date, the Acquiror agrees to assume, satisfy, perform, pay and discharge each of the following Liabilities (the "ASSUMED LIABILITIES"): (i) all Liabilities of the Parent, the Seller or any of their Subsidiaries under the Assumed Contracts (in the case of an Assumed Contract requiring third party consent to assignment, where such consent has been obtained), but only to the extent such Liabilities arise from and after the Transfer Date; and (ii) all Liabilities with respect to the Gestiva Governmental Permits that are Purchased Assets to the extent relating to the operation or conduct of the Gestiva Business by or on behalf of the Acquiror from and after the Transfer Date, excluding the Gestiva NDA (subject to Section 8.5). - ------------ (b) Notwithstanding anything contained in this Agreement to the contrary, from and after the Closing Date and the Transfer Date, the Seller shall retain all of the following Liabilities ("EXCLUDED LIABILITIES"): 15 (i) any Liability incurred by the Seller in accordance with Section 8.5 in obtaining the Gestiva NDA Approval (subject to the ----------- reimbursement right set forth in Section 4.2(c)); -------------- (ii) all accounts payable and other similar Liabilities of the Seller and its Subsidiaries; (iii) any Liability for (A) Taxes of Seller, (B) all other Taxes relating to the Gestiva Business or the Purchased Assets attributable to any Pre-Transfer Tax Period and (C) Taxes of any other Person for which Seller is liable pursuant to any Agreement, by Law or otherwise ("EXCLUDED TAX LIABILITY"); (iv) all Liabilities of the Parent, the Seller and their Subsidiaries arising out of any product liability, intellectual property infringement, breach of warranty or similar claim for injury to person or property or any other claim related to the Purchased Assets or Gestiva arising prior to the Transfer Date (including all proceedings relating to any such Liabilities); (v) all Liabilities of the Parent, the Seller and their Subsidiaries arising out of government seizures, field corrections, withdrawals or recalls of Gestiva manufactured, transferred or sold prior to the Transfer Date, which are claimed prior to, on or after the Transfer Date; (vi) all Liabilities of the Parent, the Seller and their Subsidiaries with respect to any litigation or other claims related to Gestiva or the Purchased Assets to the extent arising from any event, circumstance or condition occurring or alleged to have occurred prior to the Transfer Date; (vii) any Liability of the Seller related to any product or service of the Seller or any of its Affiliates, other than Gestiva (subject to Section 3.1(a)); - -------------- (viii) any Liability or obligation of the Parent, the Seller or any of their Subsidiaries (A) arising out of any actual or alleged breach by the Parent, the Seller or any of their Subsidiaries of, or nonperformance by the Parent, the Seller or any of their Subsidiaries under, any Assumed Contract prior to the Transfer Date or (B) accruing under any Assumed Contract prior to the Transfer Date, including any accrued patent and other intellectual property license fees and liabilities; (ix) any Liability of the Seller to the extent arising out of (A) any suit, action or proceeding pending or, to the Knowledge of the Seller, threatened as of the Transfer Date, with respect to claims which arise from facts, events or circumstances occurring prior to the Transfer Date, or (B) any actual or alleged violation by the Seller or any of its Affiliates of any Law applicable to the Seller or any of its Affiliates; (x) any Liability of the Parent, the Seller or their Subsidiaries that relates to any Excluded Asset; (xi) any Liability of the Parent, the Seller or any of their Subsidiaries or ERISA Affiliates under or relating to (A) any employee benefit plan, or relating to wages, 16 bonuses, payroll, vacation, sick leave, workers' compensation, unemployment benefits, pension benefits, employee stock option or profit-sharing plans, health care plans or benefits, phantom stock, deferred compensation or other similar plan or arrangement, or any other employee plans or benefits of any kind, in each case, which the Parent, the Seller or any of their Subsidiaries or ERISA Affiliates has entered into, maintains or administers or has maintained or administered, to which the Parent, the Seller or any of their Subsidiaries or ERISA Affiliates contributes or has contributed or is or has been required to contribute, or under or with respect to which the Parent, the Seller or any of their ERISA Affiliates has or may have any Liability and (B) any actual or alleged violation by the Parent, the Seller or any of their Affiliates of any equal employment or employment discrimination laws; (xii) any Liability under Environmental Laws arising out of or relating to the operation or conduct of the business of the Parent, the Seller or their Subsidiaries or the use or ownership of the Purchased Assets, in each case, before the Transfer Date; (xiii) any Liability of the Seller to any of its Affiliates; and (xiv) any other Liability of Seller or any of its Subsidiaries or Affiliates that is not specifically listed as an Assumed Liability under Section 3.1(a) (including any Liability to the extent -------------- resulting from the ownership, use, operation or maintenance of the Purchased Assets by or on behalf of Seller prior to the Transfer Date, or the operation or conduct of the business of the Parent, the Seller or their Subsidiaries, by or on behalf of the Seller prior to the Transfer Date). ARTICLE IV. PURCHASE PRICE, PAYMENT, REIMBURSEMENT OF EXPENSES AND TRANSFER Section 4.1 Initial Payment of Purchase Price. As --------------------------------- consideration for the agreements of the parties hereunder, at the Closing, the Acquiror shall pay to Seller an aggregate amount equal to the sum of $7,500,000 (the "INITIAL PURCHASE PRICE AMOUNT"). The Initial Purchase Price Amount shall be payable in cash by wire transfer of immediately available funds to an account designated by Seller to Acquiror in writing at least two (2) Business Days prior to Closing. Section 4.2 Additional Payments, Reimbursement of Expenses ---------------------------------------------- and Transfer of Assets. ---------------------- (a) Upon the earlier to occur of (i) the Seller's receipt of written communication from the FDA acknowledging the FDA's receipt of a "Complete Response" from Seller relating to the FDA's October 20, 2006 Approvable Letter and that such response contains all necessary elements required by the FDA to proceed with their review of such "Complete Response" (the "COMPLETE RESPONSE"), or (ii) receipt of the Gestiva NDA Approval, Acquiror shall pay to Seller, within five (5) Business Days thereafter, $2,000,000 in cash (the "NDA MILESTONE PAYMENT"). 17 (b) Subject to the terms and conditions of this Agreement (including the conditions to the Transfer Date set forth in Article X), on the --------- Transfer Date, the Acquiror shall pay to the Seller the sum of $72,500,000 in accordance with Section 5.4(b) (such amount being the "ADDITIONAL PURCHASE -------------- PRICE AMOUNT" and together with the Initial Purchase Price Amount, the "PURCHASE PRICE"), the NDA Milestone Payment (if not yet paid pursuant to Section 4.2(a)) and any Reimbursable Expenses not yet reimbursed to the Seller - -------------- pursuant to the terms of this Agreement in accordance with Section 5.4(b). For -------------- avoidance of doubt, the Transfer Date shall not occur and the Additional Purchase Price Amount shall not be payable by the Acquiror prior to the occurrence of each of the following conditions (which are in addition to the conditions set forth in Article X): (i) the Gestiva NDA Approval Date, (ii) --------- the transfer by the Seller to the Acquiror of the Gestiva FDA Submissions and all rights associated therewith pursuant to Section 8.5, (iii) the transfer of ----------- the Gestiva Books and Records to the offices of Brown Rudnick Berlack Israels LLP, at One Financial Center, Boston Massachusetts 02111, at least five (5) days prior to the Transfer Date, provided however, such transfer shall not limit the rights of Acquiror set forth in Section 8.3(a) and (iv) the receipt -------------- by the Acquiror of the Initial Gestiva Inventory. (c) The Acquiror shall reimburse the Seller for any Reimbursable Expenses as may be submitted by the Seller on a monthly basis, such reimbursement to be made within ten (10) Business Days of the Acquiror's receipt of evidence documenting the Seller's incurrence of such Reimbursable Expenses, which documentation shall include an itemization of such expenses in reasonable detail and specificity. (d) All payments paid to the Seller pursuant to this Section 4.2, ----------- shall be by wire transfer of immediately available funds to an account designated by the Seller at least two (2) Business Days prior to the date on which such payment is required to be paid. Section 4.3 Allocation of Purchase Price. The Purchase Price ---------------------------- shall be allocated among the Purchased Assets in accordance with Section 1060 of the Code and the Treasury Regulations promulgated thereunder, and the Acquiror and the Seller agree to (a) be bound by the allocation, (b) act in accordance with the allocation in the preparation of financial statements and filing of all Tax Returns (including, without limitation, filing Internal Revenue Service Form 8594 with their United States federal income Tax Return for the taxable year that includes the Transfer Date) and in the course of any Tax audit, Tax review or Tax litigation relating thereto, and (c) take no position and cause their Affiliates to take no position inconsistent with the allocation for income Tax purposes, including United States federal and state income Tax and foreign income Tax, unless otherwise required pursuant to a "determination" within the meaning of Section 1313(a) of the Code. The Acquiror shall after consultation with the Seller initially determine and send written Notice to the Seller of the allocation of the Purchase Price within thirty (30) days after the Transfer Date. The Seller will be deemed to have accepted such allocation unless it provides written Notice of disagreement to the Acquiror within twenty (20) Business Days after the receipt of the Acquiror's Notice of allocation. If the Seller provides such Notice of disagreement to the Acquiror, then the parties shall proceed in good faith to determine the allocation in dispute. If, within ten (10) days after the Acquiror receives the Seller's Notice of disagreement, the parties have not reached agreement, then the Accountants shall be engaged to determine the final allocation in dispute. Not later than thirty (30) days prior to the filing of their respective Internal Revenue Service Forms 8594 relating to this transaction, each party shall deliver to the other party a copy of its Internal Revenue Service Form 8594. 18 Section 4.4 Sales, Use and Other Taxes. All transfer, -------------------------- documentary, sales, use, valued-added, gross receipts, stamp, registration or other similar transfer taxes incurred in connection with the transfer and sale of the Purchased Assets as contemplated by the terms of this Agreement, including all recording or filing fees, notarial fees and other similar costs of Closing or similar costs arising on the Transfer Date, that may be imposed, payable, collectible or incurred ("TRANSFER TAXES") shall be timely paid by the Seller. The Seller will, at its own expense, file all necessary Tax Returns and other documentation with respect to any such Transfer Taxes and shall file such Tax Returns within the time prescribed by applicable law, and the Acquiror will join in the execution of any such Tax Returns and other documentation. The Seller shall provide the Acquiror with evidence satisfactory to Acquiror that such transfer Taxes have been timely paid by the Seller. Section 4.5 Tax Withholding. Acquiror shall be entitled to --------------- deduct and withhold from the consideration otherwise payable pursuant to this Agreement to Seller such amounts as Acquiror is required to deduct and withhold under the Code, any Tax Law or any other Law with respect to the making of such payment. To the extent that amounts are so withheld by Acquiror, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the Seller in respect of whom such deduction and withholding was made by Acquiror. Section 4.6 Risk of Loss. Until the Transfer Date, the ------------ Seller shall bear the risk of any loss or damage to the Purchased Assets from fire, casualty or any other occurrence. Following the Transfer Date, Acquiror shall bear the risk of any loss or damage to the Purchased Assets from fire, casualty or any other occurrence. Section 4.7 Subsidiaries. Acquiror shall, upon ten (10) ------------ Business Days prior written notice to Seller, have the right to designate one or more of its wholly-owned direct or indirect Subsidiaries (each, a "DESIGNATED ACQUIROR SUBSIDIARY") to purchase all or any of the Purchased Assets or assume all or any of the Assumed Liabilities so long as Acquiror shall remain liable for all of its liabilities and obligations hereunder and under the Related Agreements; provided, however, that Acquiror shall not be permitted to make such a designation if such designation would, or would reasonably be expected to, (i) result in any material costs, or any material liabilities, to the Seller or its Subsidiaries, (ii) materially delay or prevent the consummation of the transactions contemplated hereby, (iii) materially adversely affect the obtaining of consents and approvals in connection with the transactions contemplated hereby (or require that material consents and approvals be resolicited) or (iv) otherwise cause the conditions to the Transfer Date set forth in ARTICLE X hereof to not be satisfied. --------- ARTICLE V. CLOSING AND TRANSFER DATE Section 5.1 Time and Place of Closing. Unless this Agreement ------------------------- is earlier terminated pursuant to ARTICLE XII, the closing (the "CLOSING") of ----------- the transactions contemplated by this Agreement to be consummated on the Closing shall take place as promptly as practicable, but in no event later than five (5) Business Days following satisfaction or waiver 19 of the conditions set forth in ARTICLE IX, at 9:00 a.m., Pacific Standard ---------- time, at the offices of Latham & Watkins LLP, 650 Town Center Drive 20th Floor, Costa Mesa, California 92626, unless another time or place shall be agreed to by the parties (the "CLOSING DATE"). Section 5.2 Deliveries at Closing. --------------------- (a) Closing Deliveries by the Seller. At the Closing, the Seller -------------------------------- shall deliver or cause to be delivered to the Acquiror: (i) all forms, certificates and other documents referred to in Section 8.10(d); --------------- (ii) an original of the License Agreement, executed by the Seller; and (iii) the certificates and other matters described in ARTICLE IX. - ---------- (b) Closing Deliveries by the Acquiror. At the Closing, the ---------------------------------- Acquiror will deliver or cause to be delivered to the Seller: (i) the Initial Purchase Price Amount in immediately available funds by wire transfer to an account or accounts that shall have been designated by the Seller not less than two (2) Business Days prior to the Closing Date; and (ii) the certificates and other matters described in ARTICLE IX. - ---------- Section 5.3 Time and Place of Transfer Date. Unless this ------------------------------- Agreement is earlier terminated pursuant to ARTICLE XII, the transfer and sale ----------- of the Purchased Assets and Assumed Liabilities shall take place as promptly as practicable, but in no event later than five (5) Business Days following the satisfaction or waiver of the conditions set forth in Articles X, at 9:00 ---------- a.m., Pacific Standard time, at the offices of Latham & Watkins LLP, 650 Town Center Drive 20th Floor, Costa Mesa, California 92626, unless another time or place shall be agreed to by the parties (the "TRANSFER DATE"). Section 5.4 Transfer Date Deliveries ------------------------ (a) Transfer Date Deliveries by the Seller. On the Transfer -------------------------------------- Date, the Seller shall deliver to the Acquiror: (i) an unredacted, fully executed copy of each of the Assumed Contracts; (ii) written evidence (including duly executed UCC-3 forms, as applicable) that all Encumbrances related to the Purchased Assets, if any, have been released; (iii) written evidence of the receipt of all Seller Governmental Consents set forth on Section 6.3(a) of the Seller Disclosure -------------- Schedule and Seller Third Party Consents set forth on Section 6.3(b) of the -------------- Seller Disclosure Schedule; (iv) an original of each Related Agreement (excluding the License Agreement and, if previously executed pursuant to Section 8.5(b), the -------------- Transition Services Agreement) 20 executed by the Seller and copies of all documents required to be delivered by the Seller pursuant thereto; (v) written evidence (including duly executed UCC-3 forms, as applicable) that all Encumbrances related to the Purchased Assets, if any, have been released; (vi) the Gestiva Books and Records; (vii) the FDA Transfer Letters, unless previously delivered pursuant to Section 8.5(b); -------------- (viii) the certificates and other matters described in ARTICLE X; and - --------- (ix) such other instruments or documents, in form and substance reasonably acceptable to the Seller and the Acquiror, as may be necessary to effect the Acquiror's assumption of the Assumed Liabilities and the Assumed Contracts. (b) Transfer Date Deliveries by the Acquiror. On the Transfer ---------------------------------------- Date, the Acquiror shall deliver to the Seller (i) an original of each of the Related Agreements (excluding the License Agreement and, if previously executed pursuant to Section 8.5(b), the Transition Services Agreement) executed by the Acquiror, - -------------- and copies of all documents required to be delivered by the Acquiror pursuant thereto; (ii) the certificates and other matters described in ARTICLE X; - --------- (iii) such other instruments or documents, in form and substance reasonably acceptable to the Seller and the Acquiror, as may be necessary to effect the Acquiror's assumption of the Assumed Liabilities and the Assumed Contracts; and (iv) the Additional Purchase Price Amount, the NDA Milestone Payment (if not yet paid pursuant to Section 4.2(a)) and any -------------- Reimbursable Expenses owed to the Seller pursuant to the terms of this Agreement in immediately available funds by wire transfer to an account or accounts that shall have been designated by the Seller to the Acquiror not less than two (2) Business Days prior to the Transfer Date. (c) Further Deliveries of the Seller. At or promptly following -------------------------------- the Transfer Date, but in no event later than ten (10) days thereafter, the Seller shall deliver or cause to be delivered to Acquiror any other Purchased Asset which was not delivered to Acquiror on the Transfer Date. ARTICLE VI. REPRESENTATIONS AND WARRANTIES OF THE SELLER 21 Subject to the such exceptions as are disclosed in the disclosure schedule supplied by the Seller to the Acquiror dated as of the date hereof (the "SELLER DISCLOSURE SCHEDULE"), which Seller Disclosure Schedule identifies the Section (or, if applicable, subsection) to which such exception relates (provided, however, that such disclosure shall also apply to particular matters represented or warranted in other Sections and subsections to the extent that it is readily apparent from the text of such disclosure), the Seller represents and warrants to the Acquiror as follows: Section 6.1 Organization, Etc. The Seller is duly ------------------ incorporated, validly existing and in good standing under the laws of Delaware and has all requisite power and authority to own its assets, including the Purchased Assets. The Seller is duly authorized to conduct its business and is in good standing in each jurisdiction where such qualification is required to own the Purchased Assets or conduct its business as it is now being conducted, except where the failure to be so qualified or in good standing would not be reasonably expected to have a Seller Material Adverse Effect. The certificate of incorporation, bylaws or other similar governing instruments and organizational documents (the "CHARTER DOCUMENTS") of the Seller that have been delivered to the Acquiror on or prior to the date hereof are effective under applicable Laws and are current, correct and complete. Section 6.2 Authority of the Seller. The Seller has all ----------------------- necessary corporate power and authority and has taken all corporate actions necessary to enter into this Agreement, to execute and deliver the Related Agreements to which it is or will be a party and carry out the transactions contemplated hereby and by the Related Agreements to which it is or will be a party. The board of directors of the Seller has taken all action required by Law and the Charter Documents of the Seller to duly authorize (i) the execution and delivery of this Agreement and the Related Agreements to which it is or will be a party and (ii) the consummation of the transactions contemplated hereby and by the Related Agreements to which it is or will be a party. No other corporate proceedings on the part of the Seller are necessary to authorize this Agreement and Related Agreements and the transactions contemplated hereby and thereby. This Agreement has been duly and validly executed and delivered by the Seller and, when executed and delivered by the Acquiror, will constitute a legal, valid and binding obligation of the Seller, enforceable against it in accordance with its terms. When executed and delivered by the Seller, each Related Agreement will constitute a legal, valid and binding obligation of the Seller enforceable against it in accordance with its terms. Notwithstanding the matters set forth in this Section 6.2, the ----------- enforceability of this Agreement and the Related Agreements may be limited by principles of public policy, the rules of law governing specific performance, injunctive relief or other equitable remedies, and by bankruptcy, insolvency, reorganization or similar laws affecting creditors' rights generally. Section 6.3 Consents and Approvals. ---------------------- (a) Schedule 6.3(a) of the Seller Disclosure Schedule sets forth --------------- a complete and accurate list (the "SELLER GOVERNMENTAL CONSENTS") of all consents, waivers, approvals, Orders, permits or authorizations of, or registrations, notifications, declarations, payments or filings with, any Governmental or Regulatory Authority that are required by or with respect to the Seller in connection with the execution and delivery of this Agreement and the Related Agreements by the Seller or the performance of its obligations thereunder. 22 (b) Schedule 6.3(b) of the Seller Disclosure Schedule sets forth --------------- a complete and accurate list (the "SELLER THIRD PARTY CONSENTS") of all material consents, waivers, approvals, or authorizations of, or notices to, any third party (other than a Governmental or Regulatory Authority) that are required by or with respect to the Seller in connection with the execution and delivery of this Agreement and the Related Agreements by the Seller or the performance of its obligations hereunder and thereunder. Section 6.4 Non-Contravention. The execution and delivery by ----------------- the Seller of this Agreement and the Related Agreements does not, and the performance by Seller of its obligations under this Agreement and the Related Agreements and the consummation of the transactions contemplated hereby and thereby will not: (a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of the Seller; (b) assuming the receipt of all consents, waivers, approvals, Orders, permits or authorizations of Governmental and Regulatory Authorities, and the termination or expiration of any waiting periods thereunder (set forth in Schedule 6.4(b) of the Seller Disclosure Schedule) required to be obtained --------------- by the Seller and the making of all registrations, notifications, declarations or filings with Governmental and Regulatory Authorities, and the termination or expiration of any waiting periods thereunder (set forth in Schedule 6.4(b) --------------- of the Seller Disclosure Schedule) required to be made by or with respect to the Seller, conflict with or result in a violation or breach of any term or provision of any Law applicable to the Seller, the Gestiva Business or the Purchased Assets; or (c) conflict with or result in (i) a Default under, (ii) the loss of any benefit under or (iii) the creation of any Encumbrance on any of the Purchased Assets (including any Assumed Contract). Section 6.5 Contracts. The Assumed Contracts are valid, --------- binding and in full force and effect. Except as set forth on Schedule 6.5(a) --------------- of the Seller Disclosure Schedule, the Seller and, to the Knowledge of the Seller, any other party thereunder, has performed all obligations required to be performed by such party under the Assumed Contracts and is not (with or without the lapse of time or the giving of notice, or both) in material breach or default under any Assumed Contract and, to the Knowledge of the Seller, no other party to any Assumed Contract is (with or without the lapse of time or the giving of notice, or both) in material breach or default thereunder. The Seller has not received any notice of the intention of any party to terminate any Assumed Contract. Complete and correct copies of all written Assumed Contracts and amendments thereto have been made available to Acquiror, and summaries of any oral Assumed Contracts have been provided to the Acquiror. No Contracts other than the Assumed Contracts and the rights of Seller under the Related Agreements are used, held for use, or intended to be use in or necessary to the conduct of the Gestiva Business. Section 6.6 Intellectual Property Rights. ---------------------------- (a) The Gestiva Intellectual Property set forth in Schedule 6.6(a) --------------- of the Seller Disclosure Schedule constitutes all of the Gestiva Copyrights, Gestiva Patent Rights and Gestiva 23 Trademarks. As of the Closing Date and Transfer Date, the Seller has or its Subsidiaries have a valid and enforceable right to use or will be the sole and exclusive owners of all of the Gestiva Intellectual Property set forth on Schedule 6.6(a) of the Seller Disclosure Schedule. - --------------- (b) To the Knowledge of the Seller, the operation of the Gestiva Business, as has been and is now being conducted, does not presently infringe or constitute a misappropriation of any registered or unregistered patents, trademarks, copyrights, trade secrets or other proprietary rights of any Person and neither the Parent, the Seller, nor any of their Subsidiaries thereof, has received any written notice from any Person, or has Knowledge of, any actual or threatened claim or assertion to the contrary or of any facts or alleged facts which are likely to serve as the basis for any such claim or assertion. (c) With respect to all Gestiva Intellectual Property that consists of Registered Gestiva Intellectual Property or is subject to an application for copyright registration, mask work registration, or trademark or service mark registration, Schedule 6.6(c) sets forth a list of all --------------- jurisdictions in which such Registered Gestiva Intellectual Property is issued or registered, and all patent, registration and/or application numbers. Any registration, maintenance and renewal fees due in connection with the Gestiva Intellectual Property set forth in Schedule 6.6(c) have been paid in a timely --------------- manner and all necessary documents and certificates in connection with such Gestiva Intellectual Property have, for the purposes of maintaining such Gestiva Intellectual Property, been filed in a timely manner with the relevant Governmental or Regulatory Authorities. (d) To the Knowledge of the Seller, the Gestiva Intellectual Property set forth on Schedule 6.6(a) of the Seller Disclosure Schedule is --------------- free and clear of all Encumbrances other than Permitted Encumbrances and no Person other than the Parent, the Seller or their Subsidiaries, including any current or former employee or consultant of the Parent, the Seller or their Subsidiaries, has any proprietary, commercial or other interest in any of the Gestiva Intellectual Property. There are no existing agreements, options, commitments, or rights with, of or to any Person to acquire or obtain any rights to, any of the Gestiva Intellectual Property set forth on Schedule 6.6(a) --------------- of the Seller Disclosure Schedule. (e) To the Knowledge of the Seller, the Seller or its Affiliates have the unrestricted right to assign, transfer and/or grant to the Acquiror all rights in the Gestiva Intellectual Property that are being assigned, transferred and/or granted to the Acquiror under this Agreement and the Related Agreements, in each case free of any rights or claims of any Person and without payment of any royalties, license fees or other amounts to any Person. To the Knowledge of the Seller, the consummation of this Agreement and the other transactions contemplated hereby does not and will not infringe or misappropriate any Gestiva Intellectual Property or any intellectual property of any other Person. (f) To the Knowledge of the Seller, there is no unauthorized use, violation, misappropriation or infringement of any of the Gestiva Intellectual Property by any Person. (g) There are no Actions or Proceedings (including any inventorship challenges) pending or, to the Knowledge of the Seller, threatened, with respect to any of the Gestiva Intellectual Property nor have any such Actions or Proceedings been brought during the past 24 three (3) years. (h) Solely as it relates to Gestiva or a Gestiva Product Improvement, the Seller has not entered into any Contract (i) granting any Person the right to bring infringement actions with respect to, or otherwise to enforce rights with respect to, any of the Gestiva Intellectual Property, or (ii) expressly agreeing to indemnify any Person against any charge of infringement of any of the Gestiva Intellectual Property. (i) The Seller has not entered into any Contract granting any Person the right to control the prosecution of any of the Gestiva Patent Rights. (j) None of the Gestiva Trademarks are or have been the subject of any opposition, cancellation, abandonment or similar proceeding, and neither the Parent, the Seller, nor any of their Subsidiaries, has received any written notice from any Person, or has Knowledge, of any actual or threatened claim or assertion to the contrary, or of any facts or alleged facts which are likely to serve as a basis for any such claim or assertion. (k) Except for the License Agreement or as set forth on Schedule -------- 6.6(k) of the Seller Disclosure Schedule, the Seller has not granted any - ------ licenses under or to any of the Gestiva Intellectual Property or entered into any distribution or marketing arrangements with respect to any Gestiva Intellectual Property or Gestiva. The Seller has not granted any licenses under or to any of the Gestiva Intellectual Property or entered into any distribution or marketing arrangements with respect to any Gestiva Intellectual Property or Gestiva. (l) All Gestiva Know-How that would otherwise constitute a trade secret has been the subject of reasonable measures to maintain its secrecy. All former and current employees, independent contractors, members of management and key personnel of the Parent, the Seller or their Subsidiaries with access to such trade secrets or similar confidential information, including all former and current employees, agents, consultants and independent contractors who have contributed to or participated in the conception and development of material Gestiva Intellectual Property (collectively, "PERSONNEL"), have executed and delivered to Seller a proprietary information agreement restricting such person's right to disclose or use for unauthorized purposes such trade secrets or information. All such former and current Personnel (i) who are or were employees of Seller have executed a written "work-for-hire" agreement with Seller that, in accordance with all applicable Laws, has accorded the Seller full, effective, exclusive and original ownership of all Gestiva Intellectual Property rights therein and thereby arising and (ii) who were or are not employees of Seller have executed appropriate instruments of assignment in favor of Seller as assignee that have conveyed to Seller full, effective and exclusive ownership of all Gestiva Intellectual Property rights therein and thereby arising. No former or current Personnel have any claim against Seller in connection with such person's involvement in the conception and development of any Gestiva Intellectual Property except for such claims that, individually or in the aggregate, do not have, have not had and could not reasonably be expected to have a Seller Material Adverse Effect, and no such claim has been asserted or is threatened in writing, or to Seller's Knowledge, orally. (m) No licensing fees, royalties, profit participations, or other payments are due or payable by the Parent, the Seller or any of their Subsidiaries in connection with Gestiva 25 Intellectual Property, other than maintenance fees. Section 6.7 Litigation. Schedule 6.7 of the Seller ---------- ------------ Disclosure Schedule sets forth a list as of the date hereof of each pending or, to the Knowledge of the Seller, threatened suit, claim, action, proceeding or investigation, arising out of the conduct of the Gestiva Business or against or affecting any Purchased Assets or Assumed Liability. Except as set forth in Schedule 6.7 of the Seller Disclosure Schedule, none of the suits, ------------ claims, actions, proceedings or investigations listed in Schedule 6.7 of the ------------ Seller Disclosure Schedule as to which there is at least a reasonable possibility of adverse determination would have, if so determined, individually or in the aggregate, a Seller Material Adverse Effect. Except as set forth in Schedule 6.7 of the Seller Disclosure Schedule, neither the ------------ Seller nor any of its Affiliates are a party or subject to or in Default under any Order applicable to the conduct of the Gestiva Business, any Purchased Assets or any Assumed Liability, and there are no outstanding Orders of any Governmental or Regulatory Authority that apply to the Purchased Assets that restricts the manufacture, use or sale of Gestiva, the ownership, disposition or use of the Purchased Assets by the Seller or the conduct of the Gestiva Business by the Seller, in each case, in any material respect. Section 6.8 Permits; Compliance with Law. ---------------------------- (a) Schedule 6.8 of the Seller Disclosure Schedule sets forth a ------------ true and complete list of all Gestiva Governmental Permits. The Seller is in possession of all Gestiva Governmental Permits and all Gestiva Governmental Permits are valid and in full force and effect. (b) The Gestiva Business has been and is currently conducted by the Seller and its Subsidiaries in material compliance with all Gestiva Governmental Permits and applicable Law by which the Gestiva Business, Gestiva or any Purchased Asset is bound. (c) No Governmental or Regulatory Authority has notified the Seller or any of its Subsidiaries in writing that the Gestiva Business or the Purchased Assets were or are in material violation of any Law or Required Permit or the subject of any investigation in any jurisdiction where the Gestiva Business is conducted. (d) No Governmental or Regulatory Authority has notified the Parent, the Seller or any of their Subsidiaries of any facts or circumstances which would lead to any suspension, loss of or material modification to any Required Permit or refusal by a Governmental or Regulatory Authority to renew or accept for filing any Required Permit on terms less advantageous, individually or in the aggregate, to the Parent, the Seller and their Subsidiaries than the terms of those Gestiva Governmental Permits currently in force. (e) (i) All applications, submissions, information, claims, reports and statistics, and other data derived therefrom, utilized as the basis for or submitted in connection with any and all requests for a Required Permit of the FDA or other Governmental or Regulatory Authority relating to the Purchased Assets, when submitted to the FDA or other Governmental or Regulatory Authority were true, complete and correct in all material respects as of the date of submission and any legally necessary or required updates, changes, corrections or modifications to such applications, submissions, information, claims, reports or statistics have been submitted to FDA and other Governmental or Regulatory Authority. 26 (ii) To the Knowledge of the Seller or its Affiliates, all pre-clinical and clinical trials conducted by the Parent, the Seller or any of their Subsidiaries with regard to Gestiva or the Purchased Assets have been conducted in material compliance with experimental protocols, procedures and controls pursuant to accepted professional scientific standards and all applicable Laws promulgated by the FDA relating thereto, including without limitation the FDA Act and its applicable implementing regulations at 21 C.F.R. Parts 50, 54, 56 and 312, as amended. (iii) There are no investigations, audits, actions or other proceedings of a Governmental or Regulatory Authority pending with respect to a violation by the Parent, the Seller or any of their Subsidiaries of the FDA Act or other applicable Law that would reasonably be expected to result in administrative, civil or criminal liability, and, to the Knowledge of the Seller, there are no facts or circumstances existing that would reasonably be expected to serve as a basis for such an investigation, audit, action or other proceeding, in each case with respect to Gestiva, the Purchased Assets, the Assumed Liabilities or the Gestiva Business. (iv) No Governmental or Regulatory Authority has commenced or threatened in writing to initiate any action to withdraw the Gestiva Product Registrations or request the recall of Gestiva, or commenced or threatened to initiate any action to enjoin production of Gestiva at any facility, nor have the Parent, the Seller or any of their Subsidiaries received any notice to such effect and, there are no grounds for such action. (v) To the Knowledge of the Seller, none of the officers of the Seller, have been disqualified or debarred by the FDA for any purpose, or have been charged with or convicted under United States federal Law for conduct relating to the development or approval or otherwise relating to the regulation of any drug product under the Generic Drug Enforcement Act of 1992, the FDA Act or any other similar Law or have made an untrue statement of a material fact to any Governmental or Regulatory Authority with respect to Gestiva (whether in any submission to such Governmental or Regulatory Authority or otherwise), or failed to disclose a material fact required to be disclosed to any Governmental or Regulatory Authority with respect to Gestiva. Neither the Seller nor any of its Subsidiaries are the subject of any pending or threatened investigation in respect of the Seller of any of its Subsidiaries or its products, by the FDA pursuant to its "Fraud, Untrue Statements of Material Facts, Bribery, and Illegal Gratuities" Final Policy set forth in 56 Fed. Reg. 46191 (September 10, 1991) and any amendments thereto. (f) None of Parent, Seller or any of their Subsidiaries are, directly or indirectly, engaged in the research, review or development, at any stage, of any product which contains the API, including any and all dosage forms, modifications, prototypes, formulas, or strengths of the API. In addition, none of Parent, Seller nor any of their Subsidiaries is, directly or indirectly, engaged in the research, review or development of any product which is intended to treat the Gestiva indication. Section 6.9 Gestiva Inventory. All of the Gestiva Inventory ----------------- (i) will be as of the Transfer Date, free of any material defect or deficiency and (ii) was produced or manufactured in accordance with the specifications for Gestiva as set forth in the applicable Gestiva Product Registrations and in compliance with applicable Law. The Seller at Closing, and upon delivery 27 of the Gestiva Inventory on the Transfer Date, as applicable, will have good and marketable title to the Gestiva Inventory free and clear of any Encumbrances. As of immediately prior to the Transfer Date, none of the Gestiva Inventory has been sold commercially and all prior human uses thereof have been subject to appropriate exemptions. Section 6.10 Suppliers. All of the suppliers to the Gestiva ---------- Business since January 1, 2006 and all Contracts with any such supplier currently in effect are set forth on Schedule 6.10 and Schedule 1.1(a). None ------------- --------------- of such suppliers has given the Parent, the Seller or any of their Subsidiaries notice terminating, canceling or threatening to terminate or cancel any Contract or relationship with the Parent, the Seller or any of their Subsidiaries relating to the Gestiva Business. To the Knowledge of the Seller, such suppliers are manufacturing and otherwise operating in compliance with applicable FDA requirements with respect to the products and materials supplied to Seller. Section 6.11 Absence of Certain Changes or Events. ------------------------------------ (a) Except as set forth on Schedule 6.11(a) of the Seller ---------------- Disclosure Schedule, since December 31, 2006, there has not been a Seller Material Adverse Effect. (b) Except as set forth in Schedule 6.11(b) of the Seller ---------------- Disclosure Schedule, since April 2, 2007 to the date of this Agreement, and to the Knowledge of the Seller during the period between December 31, 2006 and April 1, 2007, the Seller has conducted and did conduct the Gestiva Business in the Ordinary Course of Business, and the Seller has not, with respect to the Gestiva Business or any of the Purchased Assets: (i) subjected any of the Purchased Assets to any Encumbrances other than Permitted Encumbrances (subject to Section 6.12(a)); --------------- (ii) sold, transferred, leased, subleased, licensed, sublicensed or otherwise disposed of, to any third party, any Purchased Assets or assets used in or necessary for the conduct of the Gestiva Business; (iii) entered into any Assumed Contract or accelerated, cancelled, modified or terminated any Assumed Contract except in connection with any renewal thereof in the Ordinary Course of Business; (iv) surrendered, revoked or otherwise terminated any Gestiva Governmental Permits, except in connection with any renewal or reissuance thereof; (v) incurred Assumed Liabilities, other than in the Ordinary Course of Business; (vi) waived, released or assigned any rights, which rights, but for such waiver, release or assignment, would have been classified as Purchased Assets, other than in the Ordinary Course of Business; 28 (vii) experienced any damage, destruction or casualty loss (whether or not covered by insurance) with respect to any Purchased Asset other than as a result of ordinary wear and tear, where applicable; (viii) delayed or postponed the payment of any Assumed Liability; or (ix) with respect to the Purchased Assets or the Gestiva Business, made any election or change to any election in respect to Taxes, adopted or changed any accounting method in respect to Taxes, entered into any Tax allocation agreement, Tax sharing agreement, Tax indemnity agreement or settled or compromised on any claim, notice, audit report or assessment in respect of Taxes, consented to any extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes, changed any annual Tax accounting period, filed any amended Tax Return, or surrendered any right to claim a Tax refund; or (x) agreed, whether in writing or otherwise, to do any of the foregoing, except as expressly contemplated by this Agreement. Section 6.12 Title to Assets; Sufficiency of Assets. -------------------------------------- (a) Except as set forth on Schedule 6.12(a) of the Seller ---------------- Disclosure Schedule, as of the Closing Date, the Seller has and, at the Transfer Date the Seller will deliver to Acquiror, good and valid title to or, in the case of licensed assets, a valid and binding license to the Purchased Assets free and clear of all Encumbrances (except that as of the Closing Date the Purchased Assets may have been subject to any Permitted Encumbrances). Except as set forth on Schedule 6.12(a) of the Seller Disclosure Schedule, no ---------------- Subsidiary or other Affiliate of the Seller owns, beneficially or of record, or has any rights, title or interest in, to or under any Purchased Asset, and there are no employees of any Subsidiary of the Seller employed in the Gestiva Business or who perform tasks that are necessary for the operation of the Gestiva Business. (b) The Purchased Assets (together with the rights of the Acquiror and its Affiliates under the Related Agreements) constitute all of the assets, Contracts, Gestiva Governmental Permits , rights and services required for the continued operation of the Gestiva Business by the Acquiror as conducted by the Seller during the past twelve (12) months. (c) Each item of equipment which is a Purchased Asset is in good operating condition for the purposes for which it is currently being used, subject to ordinary wear and tear and is free from any material defect. (d) During the twelve (12) calendar month period prior to the date hereof, the Seller has not experienced any out-of-stock or back-order situation with respect to the Gestiva Business. Section 6.13 Disclosure. The Seller has made available and ---------- disclosed to Acquiror all material information in the possession of the Seller concerning the safety, efficacy, side effects or toxicity of Gestiva (in animals or humans), derived from any pre-clinical or clinical use, studies, investigations or tests of Gestiva (in animals or humans) conducted by 29 Seller in all indications for Gestiva that has been submitted to the FDA or studied by the Seller, whether or not determined to be attributed to Gestiva. Section 6.14 Taxes. As of the date hereof and as of the ----- Transfer Date: (a) To the extent that such action relates to the Purchased Assets or the Gestiva Business, (i) the Seller has, and its Affiliates have, duly and timely filed (or caused to be filed) with the appropriate taxing authorities all Tax Returns required to be filed through the date hereof, and (ii) all such Tax Returns filed are complete and accurate in all material respects. All Taxes owed by the Seller in respect of the Gestiva Business (whether or not shown on any Tax Return) have been paid. Neither the Seller nor any of its Affiliates are currently the beneficiary of any extension of time within which to file any Tax Return with respect to the Purchased Assets or the Gestiva Business. (b) There are no liens for Taxes (other than for current Taxes not yet due and payable) on any of the Purchased Assets. (c) No deficiencies for Taxes have been claimed, proposed or assessed by any taxing or other Governmental Authority against the Seller or its Subsidiaries with respect to the Purchased Assets or the Gestiva Business, and there are no pending or, to the Knowledge of the Seller, threatened audits, investigations, disputes or claims or other actions for or relating to any Liability for Taxes with respect to the Purchased Assets or the Gestiva Business, and there are no matters under discussion with any Governmental or Regulatory Authorities, or known to the Parent, the Seller or their Subsidiaries, with respect to Taxes that are likely to result in an additional Liability for Taxes with respect to the Purchased Assets or the Gestiva Business. The Seller has delivered or made available to Acquiror complete and accurate copies of all examination reports and statements of deficiencies assessed against or agreed to by the Parent, the Seller or their Subsidiaries since December 31, 2003 with respect to the Purchased Assets or the Gestiva Business. With respect to the Purchased Assets or the Gestiva Business, neither the Parent, the Seller nor any of their Subsidiaries have waived any statute of limitations in respect of Taxes or agreed to any extension of time with respect to a Tax assessment or deficiency. (d) There are no Tax-sharing agreements or similar arrangements (including indemnity arrangements) with respect to or involving the Purchased Assets or the Gestiva Business, and after the Transfer Date, the Purchased Assets and the Gestiva Business shall not be bound by any such Tax-sharing agreements or similar arrangements or have any Liability thereunder for amounts due in respect of periods prior to the Transfer Date. (e) The Parent, the Seller and their Subsidiaries have withheld and paid, and will withhold and pay prior to the Transfer Date, all Taxes concerning the Gestiva Business required to have been withheld and paid in connection with amounts paid or owing to any employee, independent contractor, creditor, stockholder or other third party. (f) Neither the Parent, the Seller nor any of their Subsidiaries (i) has consented at any time under former Section 341(f)(1) of the Code to have the provisions of former Section 341(f)(2) of the Code apply to any disposition of the Purchased Assets; (ii) has acquired or owns Purchased Assets that directly or indirectly secure any debt, the interest on which is tax exempt 30 under Section 103(a) of the Code; or (iii) has made any of the foregoing elections or is required to apply any of the foregoing rules under any comparable foreign, state or local Tax Law. (g) The Seller is not a "foreign person" as defined in Section 1445(f)(3) of the Code. The transactions contemplated herein are not subject to the tax withholding provisions of Section 3406 of the Code or of Subchapter A of Chapter 3 of the Code or of any other provision of law. (h) None of the Purchased Assets is "tax-exempt use property" within the meaning of Section 168(h) of the Code. (i) None of the Purchased Assets is property that is required to be treated as being owned by any other Person pursuant to the so-called safe harbor lease provisions of former Section 168(f)(8) of the Code or any comparable provision of state law. Section 6.15 Competing Business. None of the Parent, the ------------------ Seller, nor any of their Subsidiaries, are (i) with the exception of Gestiva, developing or considering engaging in the development of a pharmaceutical product for the prevention of preterm birth or (ii) in discussion with a potential acquisition target or a potential acquirer of the Parent, the Seller or any of their Subsidiaries that is, to the knowledge of the Seller, developing or considering engaging in the development of a pharmaceutical product for the prevention of preterm birth. Section 6.16 Unlawful Payments. None of the Parent, the ----------------- Seller, nor any of their Subsidiaries, or to the Knowledge of the Seller, any officer, director, employee, agent, Affiliate, representative of the Parent, the Seller or any of their Subsidiaries has made, directly or indirectly, any bribe or kickback, illegal political contribution, payment from corporate funds which was incorrectly recorded on the books and records of the Parent, the Seller or any of their Subsidiaries, unlawful payment from corporate funds to governmental or municipal officials in their individual capacities for the purpose of affecting their action or the actions of the jurisdiction which they represent to obtain favorable treatment in securing business or licenses or to obtain special concessions of any kind whatsoever, or illegal payment from corporate funds to obtain or retain any business. Section 6.17 Brokers. The Acquiror has no, and will have no, ------- obligation to pay any brokers (including real estate brokers), finders, investment bankers, financial advisors or similar fees in connection with this Agreement or the transactions contemplated hereby by reason of any action taken by or on behalf of the Parent, the Seller or any of their Subsidiaries. ARTICLE VII. REPRESENTATIONS AND WARRANTIES OF THE ACQUIROR Subject to the such exceptions as are disclosed in the disclosure schedule supplied by the Acquiror to the Seller dated as of the date hereof (the "ACQUIROR DISCLOSURE SCHEDULE"), which Acquiror Disclosure Schedule identifies the Section (or, if applicable, subsection) to which such exception relates (provided, however, that such disclosure shall also apply to particular matters represented or warranted in other Sections and subsections to the extent that it is readily apparent from the text of such disclosure), the Acquiror represents and warrants to the Seller as follows: 31 Section 7.1 Corporate Organization. The Acquiror is duly ---------------------- incorporated, validly existing and, where applicable, in good standing under the laws of Delaware and has all requisite power and authority to own its assets and carry on its business as currently conducted by it. The Acquiror is duly authorized to conduct its business and is in good standing in each jurisdiction where such qualification is required, except where the failure to be so qualified or in good standing would not be reasonably expected to have an Acquiror Material Adverse Effect. The Charter Documents of the Acquiror are effective under the applicable Laws and are current, correct and complete. Section 7.2 Authority of the Acquiror. The Acquiror has all ------------------------- necessary power and authority and has taken all corporate actions necessary to enter into this Agreement and to carry out the transactions contemplated hereby. The board of directors of the Acquiror has taken all action required by Law and its Charter Documents to authorize the execution and delivery by the Acquiror of this Agreement and the Related Agreements to which the Acquiror is or will be a party and the consummation of the transactions contemplated hereby and thereby. This Agreement has been duly and validly executed and delivered by the Acquiror and, when executed and delivered by the Seller, will constitute a legal, valid and binding obligation of the Acquiror enforceable against it in accordance with its terms. When executed and delivered by the Acquiror, each Related Agreement to which the Acquiror is or will be a party will constitute a legal, valid and binding obligation of the Acquiror enforceable against it in accordance with its terms. Notwithstanding the matters set forth in this Section 7.2, the enforceability of this ----------- Agreement and the Related Agreements may be limited by principles of public policy and the rules of law governing specific performance, injunctive relief, other equitable remedies, or bankruptcy, insolvency, reorganization or similar laws affecting creditors' rights generally. Section 7.3 Non-Contravention. The execution and delivery by ----------------- the Acquiror of this Agreement and each of the Related Agreements does not, and the performance by it of its obligations under this Agreement and each of the Related Agreements and the consummation of the transactions contemplated hereby and thereby will not: (a) conflict with or result in a violation or breach of any of the terms, conditions or provisions of the Charter Documents of the Acquiror; (b) assuming the receipt of all consents, waivers, approvals, Orders or authorizations of Governmental and Regulatory Authorities required to be obtained by the Acquiror and the making of all registrations, declarations or filings with Governmental and Regulatory Authorities required to be made by the Acquiror, conflict with or result in a violation or breach of any term or provision of any Law applicable to the Acquiror; or (c) conflict with or result in a Default under any Contract to which the Acquiror is a party or by which the Acquiror or any of its assets is bound. Section 7.4 Litigation. There are no Actions or Proceedings ---------- pending, or to the Knowledge of the Acquiror, threatened, against Acquiror in connection with (i) this Agreement or any Related Agreement or (ii) the transactions contemplated by this Agreement. The Acquiror is not subject to any Order that could reasonably be expected to result in an Acquiror Material Adverse Effect. 32 Section 7.5 Brokers. The Seller has no, and will have no, ------- obligation to pay any brokers, finders, investment bankers, financial advisors or similar fees in connection with this Agreement or the transactions contemplated hereby by reason of any action taken by or on behalf of the Acquiror or any of its Affiliates. ARTICLE VIII. COVENANTS OF THE PARTIES Section 8.1 Operation of the Gestiva Business. --------------------------------- (a) Between the date of this Agreement and the Transfer Date, except as expressly permitted by this Agreement, or as otherwise directed in writing by the Acquiror, the Seller shall conduct the Gestiva Business only in the Ordinary Course of Business in substantially the same manner as previously conducted (including with respect to research and development efforts, manufacturing and capital expenditures) (it being acknowledged that after the Closing Date the Acquiror will be solely responsible for, and the Seller will reasonably cooperate with the Acquiror in, conducting all marketing and promotional activities with respect to the Gestiva Business prior to the Transfer Date; provided, that neither the Seller nor Parent, nor any of their respective Subsidiaries, shall be obligated to provide the Acquiror access to any employee for such purposes other than Robb Hesley), and use its commercially reasonable efforts to keep intact the Purchased Assets, and preserve the relationships of the Seller with customers, suppliers, licensors, licensees, distributors, regulatory authorities and other Persons, in each case, who are material to the Gestiva Business. Without limiting the generality of the foregoing, from the date of this Agreement to the Transfer Date, the Seller shall: (i) use its commercially reasonable efforts to keep available the services of the current employees and consultants in the Gestiva Business; (ii) confer with the Acquiror, where reasonably practicable, prior to implementing material operational decisions relating to the Gestiva Business; (iii) keep in full force and effect, without amendment (except in connection with any renewal thereof in the Ordinary Course of Business), all material rights relating to the Purchased Assets and the Gestiva Business; (iv) comply in all material respects with all requirements of Law and contractual obligations, in each case applicable to the Purchased Assets and operation of the Gestiva Business; (v) maintain all Gestiva Books and Records; (vi) maintain the Purchased Assets in good operating order and condition, reasonable wear and tear excepted; 33 (vii) not waive, release or assign any rights, which rights, but for such waiver, release or assignment, would have been classified as Purchased Assets; (viii) not fail to maintain its existing insurance coverage to the extent relating to the Gestiva Business in all material respects in effect as of the date hereof; and (ix) upon any damage, destruction or loss of any material Purchased Asset, apply any and all insurance proceeds received with respect thereto to the prompt repair, replacement and restoration thereof to the condition of such Purchased Asset before such event or, if required, to such other (better) condition as may be required by applicable Law. (b) Without limiting the generality of the lead-in paragraph of Section 8.1(a), and except as set forth in Schedule 8.1(b) of the Seller - -------------- --------------- Disclosure Schedule or as otherwise expressly permitted by the terms of this Agreement, from the date of this Agreement to the Transfer Date, without the prior written consent of the Acquiror (which shall not be unreasonably withheld), the Seller shall not: (i) Without the prior approval of the Joint Integration Committee, (A) incur or obligate itself to incur any liability in excess of $25,000 unless such liability is set forth on the budget set forth as Schedule -------- 1.1(g) hereto, which budget may be amended from time to time upon the mutual - ------ written consent of the parties hereto or (B) make any non-monetary decision that could reasonably be expected to result in a significant economic adverse impact on the Gestiva Business following the Closing Date; (ii) subject any Purchased Assets to any Encumbrances other than a Permitted Encumbrance; (iii) sell, transfer, lease, sublease, license or otherwise dispose of or grant any option or rights in, to or under any Purchased Assets; (iv) enter into any Contract that would have been required to be set forth on Schedule 1.1(a) of the Seller Disclosure Schedule if such --------------- Contract had existed as of the date hereof, or terminate, extend or amend any Assumed Contract set forth in Schedule 1.1(a) of the Seller Disclosure --------------- Schedule; (v) abandon or terminate any clinical trials relating to Gestiva (other than for safety concerns or in accordance with the terms of existing agreements with respect to such clinical trials) or terminate, withhold or delay the Seller's support of clinical trials sponsored by clinical investigators with respect to Gestiva; (vi) commence, sponsor or commit to participate in any clinical trials or investigator sponsored trials with respect to Gestiva or provide any clinical grants with respect to Gestiva; (vii) abandon any patents or patent filings or any litigation seeking to enforce the Seller's interest in any Gestiva Intellectual Property used, or contemplated to be used, in the conduct of the Gestiva Business; 34 (viii) take any action that would, or that could reasonably be expected to, result in any of the conditions to the purchase and sale of the Purchased Assets set forth in ARTICLE X not being satisfied; --------- (ix) to the extent that doing so would relate to the Purchased Assets or the Gestiva Business, make any election or change to any election in respect to Taxes, adopt or change any accounting method in respect to Taxes, enter into any Tax allocation agreement, Tax sharing agreement, Tax indemnity agreement or closing agreement, settle or compromise on any claim, notice, audit report or assessment in respect of Taxes, consent to any extension or waiver of the limitation period applicable to any claim or assessment in respect of Taxes, change any annual Tax accounting period, file any amended Tax Return, or surrender any right to claim a Tax refund; or (x) agree, whether in writing or otherwise, to do any of the foregoing set forth in clauses (i) through (ix) above. Section 8.2 Reasonable Efforts. ------------------ (a) Subject to Section 8.2(b), and following the date hereof, -------------- each of the parties hereto shall use its commercially reasonable efforts to take, or cause to be taken, all action, or to do, or cause to be done, all things necessary, proper or advisable under applicable Laws to consummate and make effective the transactions contemplated by this Agreement and the Related Agreements and to cause the conditions to the obligations of the other party hereto to consummate the transactions contemplated hereby to be satisfied at the Closing and as of the Transfer Date as provided herein, including obtaining all consents and approvals of all Persons and Governmental or Regulatory Authorities and removing any injunctions or other Encumbrances on the Purchased Assets, impairments or delays the obtaining or removal of which are necessary, proper or advisable to the consummation of the transactions contemplated by this Agreement and the Related Agreements. The parties hereto shall cooperate with each other in connection with the taking of all actions referenced in the preceding sentence, including providing (i) such reasonable assistance as the other party may request in connection with its preparation of any required filings or submissions and (ii) copies of all such filings and submissions to the non-filing party and its advisors prior to filing or submission and, if requested, to accept all reasonable additions, deletions or changes suggested in connection therewith. The Seller and the Acquiror shall have the right to review in advance, and, to the extent practicable, each shall consult the other on, all the information relating to the Seller or the Acquiror, as the case may be, that appears in any filing made with, or written materials submitted to, any third party and/or any Governmental Entity in connection with the transactions contemplated by this Agreement (including any filing contemplated by this Section 8.2(a)). The Seller and the Acquiror may, -------------- as each deems reasonably advisable and necessary, designate any competitively sensitive information provided to the other under this section as "outside counsel only." Such information shall be given only to outside counsel of the recipient. In addition, the Seller and the Acquiror may redact any information from such documents shared with the other party or its counsel that is not pertinent to the subject matter of the filing or submission or pertaining to the transactions contemplated by this Agreement. (b) The Acquiror and the Seller shall each: (i) promptly take all actions necessary to 35 make the filing required of such party or any of its Affiliates under the HSR Act within five (5) Business Days after the date hereof, (ii) comply at the earliest practicable date with any request for additional information or documentary material received by such party or any of its Affiliates from the Federal Trade Commission or the Antitrust Division of the Department of Justice pursuant to the HSR Act and (iii) cooperate with the other party in connection with any filing under the HSR Act and in connection with resolving any investigation or other inquiry concerning the transactions contemplated under this Agreement commenced by either the Federal Trade Commission or the Antitrust Division of the Department of Justice or state attorneys general. Each of the Seller, on one hand, and the Acquiror, on the other hand, shall be responsible for its own legal fees for preparing its portion of the HSR Act filings. For the avoidance of doubt, the Acquiror and the Seller shall share equally any required filing fees under the HSR Act. (c) In furtherance and not in limitation of the other covenants of the parties contained herein, each party shall use commercially reasonable efforts to resolve such objections, if any, as may be asserted with respect to the consummation of the transactions contemplated hereby under any antitrust Law. If any administrative, judicial or legislative Action or Proceeding is instituted (or threatened to be instituted) challenging the sale and purchase of any of the Purchased Assets or any other transaction as violative of any antitrust Law, each party shall cooperate and use commercially reasonable efforts to contest and resist any such Action or Proceeding, and to have vacated, lifted, reversed or overturned any decree, judgment, injunction or other Order that is in effect and that restricts, prevents or prohibits consummation at the Closing of the sale and purchase of the Purchased Assets or any other transaction contemplated under this Agreement; provided, however, that nothing in this Agreement shall require the Acquiror or its Subsidiaries to commit to any divestitures, licenses or hold separate or similar arrangements with respect to its assets, the Purchased Assets or the Assumed Liabilities or otherwise agree to any limitation on conduct of business arrangements (including the Gestiva Business), whether as a condition to obtaining any approval from a Governmental and Regulatory Authority or any other Person for any other reason. (d) Each party shall promptly inform the other parties of any material communication received by such party from the Federal Trade Commission or the Antitrust Division of the Department of Justice regarding any of the transactions contemplated under this Agreement. Each party shall advise the other party promptly of any understandings, undertakings or agreements that such party proposes to make or enter into with the Federal Trade Commission or the Antitrust Division of the Department of Justice in connection with the transactions contemplated under this Agreement. (e) The Seller shall, (i) to the extent practicable include the Acquiror in any substantive discussions with the FDA regarding any Gestiva Product Registration, (ii) if reasonably requested by the Acquiror, upon reasonable notice, attend meetings or conference calls involving the Acquiror or one of its Subsidiaries and the FDA related to any of the foregoing and (iii) cooperate with Acquiror by submitting the FDA transfer letters, substantially in the form of Exhibit D hereto (the "FDA TRANSFER LETTERS") to --------- the FDA on the Transfer Date or sooner pursuant to the provision set forth in Section 8.5(b), in order to have the FDA transfer all Gestiva Product - -------------- Registrations to one of Acquiror's Subsidiaries or to Acquiror at such time as requested by the Acquiror. Notwithstanding the foregoing, without the prior written approval of 36 the Seller, which shall not be unreasonably withheld, the Acquiror shall not directly initiate correspondence with or meet with the FDA regarding Gestiva, the Gestiva Product Registration or any matter relating to the Gestiva Business. (f) Notwithstanding anything in this Agreement to the contrary, the Acquiror shall not be required to expend money, commence any litigation or offer or grant any accommodation (financial or otherwise) to any third party in connection with obtaining any consent, substitution, approval or amendment required to be obtained by the Seller in order to assign or transfer any Purchased Asset to the Acquiror. In the event any such consent, substitution, approval or amendment is not obtained prior to the Transfer Date, the Seller shall continue to use commercially reasonable best efforts to obtain such consent, waiver or approval after the Transfer Date. Section 8.3 Access; Confidentiality. ----------------------- (a) From the date hereof until the Transfer Date, the Seller shall permit the Acquiror and its representatives to have reasonable access, during regular business hours and upon reasonable advance notice, to all the personnel, properties, Contracts relating to Gestiva, the Purchased Assets or the Assumed Liabilities, Tax Returns, the Gestiva Books and Records, the Assumed Liabilities or the Gestiva Business, and the Seller shall furnish promptly to the Acquiror such information in the Seller's possession concerning the Purchased Assets, the Assumed Liabilities or the Gestiva Business as the Acquiror may reasonably request; provided, however, that any such access shall be conducted in a manner as not to unreasonably interfere with the operation of the Gestiva Business. The Seller shall instruct its respective employees, counsel and financial advisors to provide reasonable cooperation to the Acquiror in its investigation of the Gestiva Business. (b) From and after the Closing, the Seller shall implement procedures to keep confidential, and cause its officers, directors, employees, representatives, agents and advisors to keep confidential, all information relating to the Purchased Assets, Assumed Liabilities and Gestiva Business, except as required by Law and except for information which was in the public domain or was publicly known prior to the Closing or which becomes generally available to the public after the Closing Date other than as a result of a disclosure by the Seller or its officers, directors, employees, representatives, agents and advisors. The Seller shall not disseminate any such information other than to those employees of the Seller who have a business need to access such information (i) in connection with the preparation of the Seller's accounting records, (ii) in connection with the preparation of any Tax Returns or with any Tax audits or (iii) in connection with any suit, claim, action, proceeding or investigation relating to the Purchased Assets, the Assumed Liabilities or the Gestiva Business. The Seller shall not use or cause or permit its officers, directors, employees, representatives and advisors to use any such information after the Closing for any purpose whatsoever, other than in implementation of this Agreement. Effective upon Closing, upon written request of the Acquiror, from time to time, the Seller shall (at the Acquiror's sole cost and expense) use reasonable efforts to enforce the Seller's rights with respect to the use and maintenance of confidential information relating to the Gestiva Business under all confidentiality agreements between the Seller and any other third party. The Seller shall not waive or release its rights under such confidentiality agreements with respect to the use and maintenance of such confidential information with respect to the Gestiva Business. 37 (c) Between the date hereof and the Transfer Date, information disclosed to the Acquiror pursuant to this Agreement (including in the Seller Disclosure Schedule) shall be held as Confidential Information (as defined in the Confidentiality Agreement) and shall be subject to the Confidentiality Agreement. (d) Following the Transfer Date, for so long as such information is retained by the Seller (which shall be for a period of at least five (5) years), the Seller shall permit the Acquiror and its authorized representatives to have reasonable access and duplicating rights during normal business hours, upon reasonable prior notice, to the Seller and its books, records and personnel solely to the extent relating to the Purchased Assets, the Assumed Liabilities or the Gestiva Business, to the extent such access may reasonably be required: (i) in connection with the preparation of the Acquiror's accounting records or with any audits thereof, (ii) in connection with any suit, claim, action, proceeding or investigation relating to the Purchased Assets, the Assumed Liabilities or the Gestiva Business or (iii) in connection with any required regulatory filing relating to the Purchased Assets, the Assumed Liabilities or the Gestiva Business; provided that the Acquiror shall reimburse the Seller promptly for all reasonable and necessary out-of-pocket costs and expenses incurred by the Seller in connection with any such request. Notwithstanding the foregoing, the Seller need not disclose to the Acquiror any information: (i) relating to pricing or other matters that are highly sensitive if (I) providing such portions of documents or information, in the good faith opinion of the Seller's counsel, would reasonably be expected to result in a violation of antitrust laws and (II) the Seller designates such information as "outside counsel and retained experts only" and discloses such information to Acquiror's outside counsel and retained experts; or (ii) which the Seller is prohibited from disclosing by applicable Law. If any material is withheld by the Seller pursuant to the immediately preceding sentence, the Seller shall inform the Acquiror as to the general nature of what is being withheld. The Seller may redact such portions of such books and records that do not relate to the Purchased Assets, the Assumed Liabilities or the Gestiva Business. (e) Following the Transfer Date, for so long as such information is retained by Acquiror (which shall be for a period of at least five (5) years), the Acquiror shall permit the Seller and its authorized representatives to have reasonable access and duplicating rights during normal business hours, upon reasonable prior notice, to the Acquiror and the Gestiva Books and Records and the employees of the Acquiror or its Subsidiaries, to the extent that such access may reasonably be required: (i) in connection with the preparation of the Seller's accounting records or with any audits thereof, (ii) in connection with any suit, claim, action, proceeding or investigation with an adverse third party relating to the Purchased Assets, the Assumed Liabilities or the Gestiva Business or (iii) in connection with any required regulatory filing relating to the Purchased Assets the Assumed Liabilities or the Gestiva Business; provided that the Seller shall reimburse the Acquiror promptly for all reasonable and necessary out-of-pocket costs and expenses incurred by the Acquiror in connection with any such request. Notwithstanding the foregoing, the Acquiror need not disclose to the Seller any information: (A) relating to pricing or other matters that are highly sensitive if (I) providing such portions of documents or information, in the opinion of the Acquiror's counsel, might reasonably result in a violation of antitrust laws and (II) the Acquiror designates such information as "outside counsel and retained experts only" and discloses such information to the Seller's outside counsel and retained experts or (B) which the Acquiror is prohibited from disclosing by applicable Law. If any material is withheld by the Acquiror pursuant to the immediately preceding sentence, the 38 Acquiror shall inform the Seller as to the general nature of what is being withheld. The Acquiror may redact such portions of such Gestiva Books and Records that do not relate to the Purchased Assets, the Assumed Liabilities or the Gestiva Business. Section 8.4 Public Announcements; Confidentiality. Except as ------------------------------------- otherwise required by applicable Law or applicable stock exchange requirements, prior to the Transfer Date, neither the Acquiror nor the Seller shall, and each of them shall cause their respective Affiliates, representatives and agents not to, issue or cause the publication of any press release or public announcement with respect to the transactions contemplated by this Agreement without the express prior written approval of the other party, which approval shall not be unreasonably withheld or delayed; provided, that after the Seller or the Acquiror has issued a press release announcing the execution of this Agreement (the "INITIAL PRESS RELEASE") each of the Seller and the Acquiror may make any public statement in response to questions by the press, analysts, investors or those attending industry conferences or financial analyst calls, or issue press releases, so long as any such public statement or press release is not inconsistent with prior public disclosures, press releases or public statements approved by the other party pursuant to this Section 8.4 and which do not reveal non-public information about the ----------- other party. The parties acknowledge that the Acquiror intends to disclose certain financial projections regarding Gestiva with its Initial Press Release. Section 8.5 Regulatory Matters. ------------------ (a) Until the Gestiva NDA Approval Date, the Seller shall control the prosecution of the Gestiva NDA before the FDA as described in this Section 8.5. Unless and until the Acquiror notifies the Seller otherwise in - ----------- accordance with Section 8.5(b), the Seller shall use its commercially -------------- reasonable efforts, at its expense, subject to the reimbursement provisions of Section 4.2(c), to obtain Gestiva NDA Approval as soon as practicable. In - -------------- connection therewith, the Seller shall continue to be the party of record with respect to the Gestiva NDA and, following the Closing, shall keep the Acquiror fully informed with respect to the prosecution of the Gestiva NDA and (i) promptly provide to the Acquiror or its designee any material written correspondence from the FDA with respect thereto and (ii) no later than two (2) Business Days prior to the submission thereof provide to the Acquiror or its designee any proposed written correspondence to the FDA with respect thereto, including copies of any and all underlying data to accompany any such correspondence. Following the Closing, the Seller shall consider in good faith any comments of the Acquiror or its designee with respect to such correspondence and including any reasonable comments proposed by the Acquiror provided, however, that the Seller shall have the right to determine the final form of any such correspondence, provided such determination is made in good faith. Following the Closing, the Seller shall also notify the Acquiror of any pre-scheduled meetings during which the Seller reasonably expects to discuss matters material to the Gestiva NDA (including any pre-scheduled telephonic discussions during which the Seller reasonably expects to discuss matters material to the Gestiva NDA) with the FDA, and the Acquiror or its designee shall have the right to participate in such meetings and any internal pre-meetings with respect thereto. Following the Closing until the Gestiva NDA Approval Date, the Seller shall use any and all Purchased Assets solely and to the extent necessary for carrying out the Seller's right hereunder to prosecute the Gestiva NDA and obtain the Gestiva NDA Approval. Without limiting any other obligation of the Acquiror under this Agreement, the Acquiror shall cooperate with the Seller in the Seller's efforts to obtain Gestiva 39 NDA Approval, including providing to the Seller all relevant data, information and material reasonably requested by the Seller which the Seller shall not disclose to any third Person or use except solely and to the extent necessary for prosecuting the Gestiva NDA and obtaining the Gestiva NDA Approval. (b) Prior to Gestiva NDA Approval, upon the mutual consent of the Seller and the Acquiror following discussion between the parties, the Seller shall promptly assign to the Acquiror the Gestiva NDA and all related files, which assignment shall be effected by the Seller submitting the FDA Transfer Letters to the FDA. The Seller shall cooperate with Acquiror in obtaining the assignment and shall take all actions reasonably requested by Acquiror necessary, proper or advisable to effectuate the assignment. Thereafter, the Acquiror shall (i) be the party of record with respect to the Gestiva NDA and (ii) use commercially reasonable efforts, at its expense, to obtain Gestiva NDA Approval as soon as practicable. In connection therewith, the Acquiror shall keep the Seller reasonably informed with respect to the prosecution of the Gestiva NDA and consider in good faith the Seller's comments with respect thereto and include any reasonable comments proposed by the Seller. Without limiting any other obligation of the Seller under this Agreement, the Seller shall cooperate with the Acquiror in the Acquiror's efforts to obtain the Gestiva NDA Approval, including providing to the Acquiror all relevant data, information and material reasonably requested by the Acquiror which the Acquiror shall not disclose to any third Person or use except solely and to the extent necessary for prosecuting the Gestiva NDA and obtaining the Gestiva NDA Approval. The Seller agrees and acknowledges that, following the Closing, the Acquiror shall have the right to use any and all materials of Seller, whether or not such materials are Purchased Assets, solely and to the extent necessary for carrying out the Acquiror's right hereunder to prosecute the Gestiva NDA and obtain the Gestiva NDA Approval if the Seller and Acquiror consent to the assignment of the Gestiva FDA Submissions as provided in this Section 8.5(b). In the event that the parties -------------- transfer the Gestiva NDA to the Acquiror pursuant to this Section 8.5(b), the -------------- parties shall concurrently execute and deliver the Transition Services Agreement. (c) Unless previously assigned to the Acquiror pursuant to Section 8.5(b), on the Transfer Date, the Seller shall transfer and assign to - -------------- the Acquiror (A) the Gestiva FDA Submissions (including all associated rights) together with (B) all files related thereto. Thereafter, the Acquiror shall have all rights and responsibilities with respect to such Gestiva FDA Submissions. The foregoing transfer and assignment shall be effected by the Seller submitting the FDA Transfer Letters to the FDA. (d) From and after the transfer by the Seller to the Acquiror of each Gestiva Product Registration held by the Seller or any of its Subsidiaries pursuant to the terms hereof, except as required by applicable Law, the Acquiror shall be solely responsible and liable for (i) taking all actions, paying all fees and conducting all communication with the appropriate Governmental or Regulatory Authority required by Law in respect of such Gestiva Product Registration, including preparing and filing all reports (including adverse drug experience reports) and responding to and answering all questions and complaints requested by the appropriate Governmental or Regulatory Authority, (ii) taking all actions and conducting all communication with third parties in respect of Gestiva manufactured, tested, used or distributed pursuant to such Gestiva Product Registration (whether manufactured, tested, used or distributed before or after transfer of such Gestiva Product Registration), including responding to all complaints in respect thereof, 40 including complaints related to tampering or contamination, and (iii) investigating all complaints and adverse drug experiences in respect of Gestiva manufactured, tested, used or distributed pursuant to such Gestiva Product Registration (whether manufactured, tested, used or distributed before or after transfer of such Gestiva Product Registration, as set forth in Section 8.5(e) below). It is understood and agreed that Seller shall be responsible for all foregoing obligations listed in this Section 8.5(d) prior to the transfer of the Gestiva Product Registrations and shall use commercially reasonable efforts to timely and appropriately fulfill such obligations. (e) From and after the transfer of the Gestiva FDA Submissions, the Acquiror shall be responsible for the investigation, analysis and reporting to the FDA of any adverse experience report or complaint in connection with the Product received by either the Acquiror or the Seller from any source (including any patient, health care professional or other customer of the Gestiva Business), regardless of whether the Product involved in any such adverse experience report or complaint was manufactured, tested, used or distributed by the Seller or Acquiror. The Seller shall use its commercially reasonable efforts to report to the Acquiror any adverse experience report or complaint received by the Seller relating to the Product after the Closing within four (4) business days and in no event later than four (4) Business Days, after receipt of such adverse experience report or complaint by the Seller. The Seller shall reasonably cooperate with the Acquiror in connection with the investigation and analysis of all adverse experience reports or complaints that relate to the period before the date of the assignment of the Gestiva FDA Submissions. It is understood and agreed that the Seller shall be responsible for all foregoing obligations listed in this Section 8.5(e) prior -------------- to the transfer of the Gestiva FDA Submissions and shall use commercially reasonable efforts to timely and appropriately fulfill such obligations. Section 8.6 Covenant Not to Compete. ----------------------- (a) The Parent and Seller understand that Acquiror shall be entitled to protect and preserve the going concern value of the Gestiva Business following the Closing to the extent permitted by Law and that the Acquiror would not have entered into this Agreement absent the provisions of this Section 8.6 and, therefore, for the period from the date hereof until ----------- seven (7) years following the Closing Date with respect to a 17-P Competing Product and ten (10) years following the Closing Date with respect to a Preterm Delivery Competing Product (the "APPLICABLE PERIOD"), neither the Parent nor Seller, nor any of their Subsidiaries, nor their respective successors or assigns, nor, any of its or their respective Affiliates (which term, for purposes of this Section 8.6, shall not be deemed to include ----------- stockholders of Parent in such capacity), shall directly or indirectly, engage, license or assist another to engage in the research, marketing, manufacturing, distribution or sale of any Competing Product anywhere in the Restricted Territory. As used herein, a "17-P COMPETING PRODUCT" means any product that contains 17 alpha-hydroxyprogesterone caproate or any other form of progesterone; a "PRETERM DELIVERY COMPETING PRODUCT" means any product that contains 17 alpha-hydroxyprogesterone caproate, or any other form of progesterone, and that is marketed, promoted, or sold for the prevention of preterm delivery and a "COMPETING PRODUCT" means any 17-P Competing Product and any Preterm Delivery Competing Product. (b) If a court determines that the foregoing restrictions are too broad or otherwise unreasonable under applicable Law, including with respect to time or space, the court is hereby requested and authorized by the parties to revise the foregoing restriction to include the 41 maximum restrictions allowable under applicable Law. Each of the parties acknowledges, however, that this Section 8.6 has been negotiated by the ----------- parties and that the Restricted Territory and the Applicable Period are reasonable in light of the circumstances pertaining to the parties. (c) Notwithstanding any other provision of this Agreement, it is understood and agreed that the remedy of indemnity payments pursuant to ARTICLE XI and other remedies at law would be inadequate in the case of any - ---------- breach of the covenants contained in Section 8.6, and, accordingly, the ----------- Acquiror shall be entitled to equitable relief, including the remedy of specific performance, with respect to any breach or attempted breach of such covenants. (d) Notwithstanding the foregoing, if the Parent or the Seller or any of their Subsidiaries signs a definitive agreement with respect to a merger or acquisition pursuant to which the Parent or the Seller or any of their Subsidiaries would acquire rights (other than residual financial rights) in a Competing Product at any time during the Applicable Period relating to such Competing Product, then the Parent or the Seller or their Affiliates or Subsidiaries, as applicable, shall have six (6) months from the closing of such definitive agreement to divest itself of such rights in the Competing Product and, during such six (6) month period, the manufacture, developing, marketing, distributing, and/or sale of such Competing Product shall not be in violation of this Section 8.6. In the case of divestiture under the preceding ----------- sentence, such divestiture can occur by either (x) an outright sale of all rights in the Competing Product to a third party or (y) an out-license to an unaffiliated third party of the right to make, have made, use, sell, offer for sale and import such Competing Product; provided, however, that the Parent and the Seller and their Subsidiaries may only retain residual financial rights to such Competing Product and must not exercise or have the ability to exercise any role or influence in any manner over the performance of any clinical trials with respect to such Competing Product, or the sale, offering for sale or other promotion of such Competing Product. The Parent or Seller shall provide Acquiror with reasonable advance notice of any such sale contemplated by this Section 8.6(d) and an opportunity to bid on the divested asset. (e) If solely due to the fault of the Acquiror, the parties have not given effect to the Transfer Date within five (5) Business Days following the satisfaction or waiver of the conditions set forth in Article X, and the --------- Seller has demonstrated to the reasonable satisfaction of the Acquiror that it is fully prepared to consummate the transactions and matters to be consummated on the Transfer Date, including (i) transferring to the Acquiror the Gestiva FDA Submissions and all rights associated therewith pursuant to Section 8.5, ----------- (ii) executing and delivering the Related Agreements and other documents and materials to be delivered on the Transfer Date, and (iii) delivering to the Acquiror the Initial Gestiva Inventory, the provisions of this Section 8.6 ----------- shall cease to apply until such time as the Acquiror has made the deliveries required by Section 5.4(b), including the Additional Purchase Price Amount. -------------- (f) For the avoidance of doubt, if any Person acquires Control of the Parent, whether by stock purchase, merger, consolidation or other business combination, the provision of this Section 8.6 shall not apply to ----------- such acquiror or its Affiliates if such Competing Product is researched, marketed, manufactured, distributed or sold without, directly or indirectly, the assistance of, the resources of, the employees of, or assets of Parent, the Seller and their Subsidiaries in existence immediately prior to such acquisition; provided, however, notwithstanding this Section 8.6(f), the restrictions set forth in this Section 8.6 shall continue to ----------- 42 apply to the Parent, the Seller and their Subsidiaries following such transaction. Section 8.7 Further Assurances. ------------------ (a) On and after the Transfer Date, the Seller shall from time to time, at the reasonable request of the Acquiror, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, such further conveyances, notices and assumptions and such other instruments, and take such other actions as the Acquiror may reasonably request, in order to more effectively consummate the transactions contemplated hereby and to transfer fully to the Acquiror good and marketable title to the Purchased Assets and all of the titles, rights, interests, remedies, powers and privileges intended to be conveyed under this Agreement and the Related Agreements (including assistance in the collection or reduction to possession of any of the Purchased Assets). (b) On and after the Transfer Date, the Acquiror shall from time to time, at the reasonable request of the Seller, take such actions as the Seller may reasonably request, in order to more effectively consummate the transactions contemplated hereby, including the Acquiror's assumption of the Assumed Liabilities and to conduct the Gestiva Business as contemplated by this Agreement and the Related Agreements. Section 8.8 No Solicitation. From the date of this Agreement --------------- until the earlier to occur of (i) the Transfer Date or (ii) the termination of this Agreement in accordance with ARTICLE XII (the "NO-SHOP PERIOD"), the ----------- Seller shall not, nor shall it permit any of its Subsidiaries to, nor shall it authorize or permit any of its directors, officers or employees or any investment banker, financial advisor, attorney, accountant or other representative retained by it or any of its Subsidiaries to, directly or indirectly, (I) solicit, initiate or encourage any Other Bid (as defined below), (II) enter into any agreement with respect to any Other Bid or (III) participate in any discussions or negotiations regarding, or furnish to any person any information with respect to, or take any other action to facilitate any inquiries or the making of any proposal that constitutes, or may reasonably be expected to lead to, any Other Bid. In the event that the Seller (or any of its Subsidiaries) receives any Other Bid, the Seller shall promptly advise the Acquiror of such proposal. As used in this Section 8.8, "OTHER BID" means any proposal for a sale, spin-off or other disposition or similar transaction involving the Gestiva Business or any of the Purchased Assets, other than the transactions contemplated by this Agreement. For the avoidance of doubt, "OTHER BID" shall not mean any proposal relating to any merger, consolidation, business combination or similar transaction involving twenty five percent (25%) or more of the total outstanding voting equity securities of the Parent. Section 8.9 Insurance. In the event that prior to the --------- Transfer Date any Purchased Asset suffers any damage, destruction or other loss as a result of a casualty event, the Seller shall, after the Transfer Date, (i) promptly pay to the Acquiror all insurance proceeds received by the Seller with respect to such damage, destruction or other loss, less any proceeds applied to the physical restoration of such asset, and (ii) assign to the Acquiror all rights of the Seller against third parties (other than against its insurance carriers) with respect to any causes of action, whether or not litigation has commenced as of the Transfer Date, in connection with such damage, destruction or other loss; provided, however, that the proceeds of such insurance shall be subject to (and recovery thereon shall be reduced by the amount of) any applicable 43 deductibles and co-payment provisions or any payment or reimbursement obligations of the Seller in respect thereof. Section 8.10 Tax Matters. ----------- (a) Books & Records; Cooperation. The Acquiror, on one hand, and ---------------------------- the Seller, on the other hand, agree to furnish or cause to be furnished to the other, upon request, as promptly as practicable, such information and assistance relating to the Purchased Assets or the Gestiva Business, including, without limitation, access to books and records, as is reasonably necessary for the filing of all Tax Returns by the Acquiror or the Seller, the making of any election relating to Taxes, the preparation for any audit by any taxing authority, and the prosecution or defense of any claim, suit or proceeding relating to any Taxes. The Seller shall retain all books and records with respect to Taxes pertaining to the Purchased Assets or the Gestiva Business, for a period of at least six (6) years following the Transfer Date. At the end of such period, the Seller shall provide the Acquiror with at least ten (10) days prior written notice before transferring, destroying or discarding any such books and records, during which period the Acquiror can elect to take possession, at its own expense, of such books and records. The Acquiror, on one hand, and the Seller, on the other hand, shall cooperate fully with the other in the conduct of any audit, litigation or other proceeding relating to Taxes involving the Purchased Assets or the Gestiva Business. The Acquiror, on one hand, and the Seller, on the other hand, further agree, upon request, to use their commercially reasonable efforts prior to the Transfer Date, and for a period of three (3) years following the Transfer Date, to obtain any certificate or other document from any governmental authority or any other Person as may be necessary to mitigate, reduce or eliminate any Tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby). Any information obtained pursuant to this Section 8.10(a) shall be kept strictly --------------- confidential, except as may be otherwise necessary in connection with the filing of Tax Returns, claims for a Tax refund or in conducting any audit, examination or other proceeding in respect of Taxes. (b) Allocation of Taxes. Except as otherwise provided in Section ------------------- ------- 4.4 hereof relating to Transfer Taxes, the Seller shall be responsible for and - --- shall promptly pay when due all Taxes levied with respect to the Purchased Assets or the Gestiva Business attributable to the Pre-Transfer Tax Period. All Taxes levied with respect to the Purchased Assets or the Gestiva Business for the Straddle Period shall be apportioned between the Pre-Transfer Tax Period and the Post-Transfer Tax Period, as follows: (i) in the case of any Taxes other than Taxes based upon or related to income or receipts, the portion allocable to the Pre-Transfer Tax Period shall be deemed to be the amount of such Tax for the entire Straddle Period multiplied by a fraction the numerator of which is the number of days in the Tax period ending on the Transfer Date and the denominator of which is the number of days in the entire Straddle Period, and (ii) in the case of any Tax based upon or related to income or receipts, the portion allocable to the Pre-Transfer Tax Period shall be deemed equal to the amount which would be payable if the relevant Straddle Period ended on the Transfer Date. 44 Upon receipt of any bill for such Taxes relating to the Purchased Assets or the Gestiva Business, the Acquiror, on one hand, and the Seller, on the other hand, shall present a statement to the other setting forth the amount of reimbursement to which each is entitled under this Section 8.10 together with ------------ such supporting evidence as is reasonably necessary to calculate the proration amount. The proration amount shall be paid by the party owing it to the other within ten (10) days after delivery of such statement. In the event that the Acquiror or the Seller shall make any payment for which it is entitled to reimbursement under this Section 8.10, the applicable party shall make such ------------ reimbursement promptly but in no event later than ten (10) days after the presentation of a statement setting forth the amount of reimbursement to which the presenting party is entitled along with such supporting evidence as is reasonably necessary to calculate the amount of reimbursement. (c) Notices. The Seller shall promptly notify the Acquiror in ------- writing upon its receipt of notice of any pending or threatened federal, state, local or foreign Tax audits or assessments relating to the income, properties or operations of Seller that reasonably may be expected to relate to the Purchased Assets or the Gestiva Business. (d) At the Closing and on the Transfer Date (prior to payment of the Additional Purchase Price), the Seller shall deliver to the Acquiror a duly executed and acknowledged Internal Revenue Service Form W-9 and a duly executed and acknowledged non-foreign status FIRTPA certificate prepared pursuant to Treasury Regulation Section 1.1445-2(b)(2) in a form satisfactory to the Acquiror. (e) Any payments made to any Indemnified Party pursuant to this Agreement shall constitute an adjustment of the consideration paid for the Purchased Assets for Tax purposes and shall be treated as such by the Acquiror and the Seller on their Tax Returns to the extent permitted by Law. (f) At the Closing and on the Transfer Date (prior to payment of the Additional Purchase Price), the Seller shall deliver to the Acquiror a duly executed bulk sales and/or Tax clearance certificate or certificates as required by applicable Law or as reasonably requested by Acquiror. (g) Except as otherwise provided in this Agreement, each Party (or their respective Affiliates) shall be responsible for and shall pay all Taxes payable on any payments made to such Party by the other Party (or their respective Affiliates). (h) Any dispute, controversy, or claim between Seller, on the one hand, and Acquiror, on the other hand, arising out of or relating to the provisions of this Agreement that relates to Taxes that cannot be resolved by negotiations between Seller and Acquiror shall be submitted to a mutually agreed-upon independent public accounting firm (the "ACCOUNTANTS") for resolution. The Accountants shall control the proceedings related to the dispute resolution and may request such evidence and information as it deems necessary. The resolution reached by the Accountants shall be binding on the Seller and Acquiror and their respective affiliates. The expenses of the Accountants shall be borne equally by Seller, on the one hand, and Acquiror, on the other hand. 45 Section 8.11 Employee Matters. Notwithstanding the ---------------- provisions of the Confidentiality Agreement or any existing Gestiva Contracts, between the date of this Agreement and the Transfer Date, Acquiror shall have the right, after consultation with and the prior approval of the Seller (which approval shall not be unreasonably withheld), to contact the employees and consultants of Seller currently performing services for the Gestiva Business or whose work primarily relates to the Gestiva Business (each, a "Business Employee"), and to discuss the possible employment or consultancy of such employees by the Acquiror from and after the Transfer Date. ARTICLE IX. CONDITIONS TO THE OBLIGATIONS OF THE PARTIES FOR THE CLOSING Section 9.1 Seller's Conditions to Closing. The obligation ------------------------------ of the Seller to effect the Closing is subject to the satisfaction (or waiver by the Seller), at or before the Closing, of each of the following conditions: (a) The representations and warranties of the Acquiror contained in ARTICLE VII of this Agreement shall be true and correct in all material ----------- respects (without giving effect to any "materiality", "material adverse effect" or "Acquiror Material Adverse Effect" qualifiers set forth therein) at and as of the Closing Date as if made at and as of such time (except to the extent expressly made as of an earlier date, in which case, as of such earlier date) and the Acquiror shall have performed in all material respects all agreements and covenants required by this Agreement or any Related Agreements to be performed by it prior to or on the Closing Date. The Seller shall have received a certificate as to satisfaction of the conditions set forth in this Section 9.1(a) dated as of the Closing Date and executed by a duly authorized - -------------- officer of the Acquiror. (b) No Orders prohibiting the transactions contemplated hereby shall have been instituted and not settled or otherwise terminated. No Law shall have been enacted, entered, promulgated or enforced by any Governmental or Regulatory Authority that is in effect and has the effect of making the purchase and sale of the Purchased Assets illegal or otherwise prohibiting the consummation of such purchase and sale. The waiting period (including any extensions thereof) applicable to the consummation of the transactions contemplated by this Agreement required pursuant to the HSR Act shall have expired or been terminated. (c) The Acquiror shall have delivered or caused to be delivered to the Seller each of the documents, materials and funds as specified in Section 5.2(b). - -------------- (d) No Acquiror Material Adverse Effect shall have occurred. Section 9.2 Acquiror's Obligations to Closing. The --------------------------------- obligation of the Acquiror to effect the Closing is subject to the satisfaction (or waiver by the Acquiror), at or before the Closing, of each of the following conditions: (a) The representations and warranties of the Seller contained in ARTICLE VI of this Agreement shall be true and correct in all material ---------- respects (without giving effect to any "materiality", "material adverse effect" or "Seller Material Adverse Effect" qualifiers set forth 46 therein) at and as of the Closing Date as if made at and as of such time (except to the extent expressly made as of an earlier date, in which case, as of such earlier date) and the Seller shall have performed in all material respects all agreements and covenants required by this Agreement or any Related Agreements to be performed by it prior to or on the Closing Date. The Acquiror shall have received a certificate as to satisfaction of the conditions set forth in this Section 9.2(a) dated as of the Closing Date and -------------- executed by a duly authorized officer of the Seller. (b) No Orders prohibiting the transactions contemplated hereby shall have been instituted and not settled or otherwise terminated. No Law shall have been enacted, entered, promulgated or enforced by any Governmental or Regulatory Authority that is in effect and has the effect of making the purchase and sale of the Purchased Assets illegal or otherwise prohibiting the consummation of such purchase and sale. The waiting period (including any extensions thereof) applicable to the consummation of the transactions contemplated by this Agreement required pursuant to the HSR Act shall have expired or been terminated. (c) No Seller Material Adverse Effect shall have occurred. (d) The Seller shall have delivered or caused to be delivered to the Acquiror each of the documents and materials specified in Section 5.2(a). -------------- (e) There shall not be pending any action, litigation or proceeding by any Governmental or Regulatory Authority seeking to (i) prohibit or restrain the transactions contemplated by this Agreement or (ii) seeking to impose or confirm limitations on the ability of Acquiror or any of its Subsidiaries to effectively exercise full rights of ownership of the Gestiva Business or the Purchased Assets after the Closing. ARTICLE X. CONDITIONS TO THE OBLIGATIONS OF THE PARTIES FOR THE TRANSFER DATE Section 10.1 Seller's Obligations for the Transfer Date. The ------------------------------------------ obligation of the Seller to effect the transactions contemplated on the Transfer Date is subject to the satisfaction (or waiver by the Seller), at or before the Transfer Date, of each of the following conditions: (a) The representations and warranties of the Acquiror contained in ARTICLE VII of this Agreement shall be true and correct in all respects ----------- (without giving effect to any "materiality", "material adverse effect" or "Acquiror Material Adverse Effect" qualifiers set forth therein) at and as of the Transfer Date as if made at and as of such time (except to the extent expressly made as of an earlier date, in which case, as of such earlier date), except where the failure of such representations and warranties to be true and correct (without giving effect to any "materiality", "material adverse effect" or "Acquiror Material Adverse Effect" qualifiers set forth therein) would not, individually or in the aggregate, result in an Acquiror Material Adverse Effect, and the Acquiror shall have performed in all material respects all agreements and covenants required by this Agreement or any Related Agreements to be performed by it prior to or on the Transfer Date. The Seller shall have received a certificate as to satisfaction of the conditions set forth in this Section 10.1(a) dated as of the Transfer Date and executed by a duly - --------------- 47 authorized officer of the Acquiror. (b) No Orders prohibiting the transactions contemplated hereby shall have been instituted and not settled or otherwise terminated. No Law shall have been enacted, entered, promulgated or enforced by any Governmental or Regulatory Authority that is in effect and has the effect of making the purchase and sale of the Purchased Assets illegal or otherwise prohibiting the consummation of such purchase and sale. (c) The Acquiror shall have delivered or caused to be delivered to the Seller each of the documents, materials and funds specified in Section ------- 5.4(b). - ------ (d) The Gestiva NDA Approval shall have occurred. Section 10.2 Acquiror's Obligations for the Transfer Date. -------------------------------------------- The obligation of the Acquiror to effect the transactions contemplated on the Transfer Date is subject to the satisfaction (or waiver by the Acquiror), at or before the Transfer Date, of each of the following conditions: (a) The representations and warranties of the Seller contained in ARTICLE VI of this Agreement shall be true and correct in all respects ---------- (without giving effect to any "materiality", "material adverse effect" or "Seller Material Adverse Effect" qualifiers set forth therein) at and as of the Transfer Date as if made at and as of such time (except to the extent expressly made as of an earlier date, in which case, as of such earlier date), except where the failure of such representations and warranties to be true and correct (without giving effect to any "materiality", "material adverse effect" or "Seller Material Adverse Effect" qualifiers set forth therein) would not, individually or in the aggregate, result in a Seller Material Adverse Effect, and the Seller shall have performed in all material respects all agreements and covenants required by this Agreement or any Related Agreements to be performed by it prior to or on the Transfer Date. The Acquiror shall have received a certificate as to satisfaction of the conditions set forth in this Section 10.2(a) dated as of the Transfer Date and executed by a duly - --------------- authorized officer of the Seller. (b) No Orders prohibiting the transactions contemplated hereby shall have been instituted and not settled or otherwise terminated. No Law shall have been enacted, entered, promulgated or enforced by any Governmental or Regulatory Authority that is in effect and has the effect of making the purchase and sale of the Purchased Assets illegal or otherwise prohibiting the consummation of such purchase and sale. (c) All Seller Governmental Consents set forth on Section 6.3 of ----------- the Seller Disclosure Schedule shall have been obtained or made. (d) The Acquiror shall have received all Seller Third Party Consents and all Gestiva Governmental Permits necessary to effect the transactions contemplated by this Agreement and the Related Agreements (which shall include the consents and permits set forth on Section 6.3(b) and Section -------------- ------- 6.8 of the Seller Disclosure Schedule, excluding the Gestiva FDA Submissions). - --- (e) There shall not be pending any action, litigation or proceeding by any Governmental or Regulatory Authority seeking to (i) prohibit or restrain the transactions 48 contemplated by this Agreement or (ii) seeking to impose or confirm limitations on the ability of Acquiror or any of its Subsidiaries to effectively exercise full rights of ownership of the Gestiva Business or the Purchased Assets after the Transfer Date. (f) The Acquiror shall have received the Initial Gestiva Inventory. (g) The Seller shall have delivered or caused to be delivered to the Acquiror each of the documents and materials specified in Section 5.4(a). -------------- (h) The Gestiva NDA Approval shall have occurred. ARTICLE XI. INDEMNIFICATION Section 11.1 Survival of Representations, Warranties, ---------------------------------------- Covenants, Etc. The representations and warranties of the parties contained in - --------------- ARTICLE VI and ARTICLE VII hereof and in the Related Agreements (if any) shall - ---------- ----------- survive the Closing until twenty-one (21) months after the Closing Date; provided, however, that the representations and warranties of the Seller in Section 6.2, Section 6.12 and Section 6.14 hereof shall survive the Closing - ----------- ------------ ------------ until sixty (60) days following the expiration of the applicable statute of limitations (with extensions) with respect to the matters addressed in such sections. The period of time a representation or warranty survives the Closing pursuant to the preceding sentence shall be the "SURVIVAL PERIOD" with respect to such representation or warranty. The covenants and agreements of the parties hereto contained herein shall survive in accordance with their respective terms. So long as an Indemnified Party gives an Indemnification Claim Notice for such claim on or before the expiration of the applicable Survival Period, such Indemnified Party shall be entitled to pursue its rights to indemnification under Section 11.2(a) or Section 11.2(b) hereof, as --------------- --------------- applicable. In the event notice of any claim for indemnification under Section ------- 11.2(a) or Section 11.2(b) hereof shall have been given within the applicable - ------- --------------- Survival Period and such claim has not been finally resolved by the expiration of such Survival Period, the representations and warranties that are the subject of such claim shall survive the end of the Survival Period of such representations or warranties until such claim is finally resolved, but such representations and warranties shall only survive with respect to such asserted claim. Section 11.2 Indemnification. --------------- (a) By the Seller. Subject to Section 11.1 and Section 11.3, ------------- ------------ ------------ from and after the Closing, the Seller shall indemnify, reimburse, defend and hold harmless the Acquiror, its Affiliates and their respective officers, directors, employees, agents, successors and assigns from and against any and all costs, losses, Liabilities, damages, fines, penalties, interest, judgments, lawsuits, deficiencies, claims, expenses (including reasonable fees and disbursements of attorneys and other professionals, including third party consultants) (collectively, "DAMAGES") incurred in connection with, arising out of, resulting from or incident to (i) any breach of, or inaccuracy in, any representation or warranty of the Seller set forth in this Agreement, any Related Agreement or any certificate of the Seller delivered to Acquiror at the Closing or the Transfer Date, (ii) the failure to perform any covenant or agreement of the Seller set forth in the 49 Agreement or in any of the Related Agreements, (iii) any Excluded Asset, (iv) any Excluded Liability (including, but not limited to, any Excluded Tax Liability); and (v) the fraud or willful misconduct of the Seller. (b) By the Acquiror. Subject to Section 11.1 and Section 11.3, --------------- ------------ ------------ from and after the Closing, the Acquiror shall indemnify, defend and hold harmless the Seller, its Affiliates and their respective officers, directors, employees, agents, successors and assigns from and against any and all Damages incurred in connection with, arising out of, resulting from or incident to (i) any breach or inaccuracy in any representation or warranty of the Acquiror set forth in this Agreement, any Related Agreement or any certificate of the Acquiror delivered to the Seller at Closing or the Transfer Date, (ii) the failure to perform any covenant or agreement of the Acquiror set forth in this Agreement or in any of the Related Agreements, (iii) any Assumed Liabilities; and (iv) the fraud or willful misconduct of the Acquiror. (c) Procedure for Claims. The Indemnified Party shall give the -------------------- indemnifying party prompt written notice (an "INDEMNIFICATION CLAIM NOTICE") of any Damages or discovery of fact upon which such Indemnified Party intends to base a request for indemnification under Section 11.2(a) or Section --------------- ------- 11.2(b). Failure to give any such Indemnification Claim Notice shall not - ------- constitute a waiver of any right to indemnification or reduce in any way the indemnification available hereunder, except to the extent the indemnifying party demonstrates that such failure to notify has materially prejudiced the indemnifying party. Each Indemnification Claim Notice must contain a description of the claim and the nature and amount of such Damages (to the extent that the nature and amount of such Damages are known at such time). The Indemnified Party shall furnish promptly to the indemnifying party copies of all papers and official documents received in respect of any Damages. All indemnification claims in respect of a party, its Affiliates or their respective directors, officers, employees and agents (collectively, the "INDEMNITEES" and each an "INDEMNITEE") shall be made solely by such party to this Agreement (the "INDEMNIFIED PARTY"). (d) Third Party Claims. The obligations of an indemnifying party ------------------ under this Section 11.2(d) with respect to Damages arising from claims of any --------------- third party that are subject to indemnification as provided for Section 11.2(a) --------------- or Section 11.2(b) (a "THIRD PARTY CLAIM") shall be governed by and be --------------- contingent upon the following additional terms and conditions: (i) Subject to Section 11.2(d)(iii) and Section -------------------- ------- 11.2(d)(iv), at its option, the indemnifying party may assume the defense of - ----------- any Third Party Claim by giving written Notice to the Indemnified Party within ten (10) days after the indemnifying party's receipt of an Indemnification Claim Notice, provided, however, that prior to assuming control of the defense of such Third Party Claim the indemnifying party shall agree that the indemnifying party shall be obligated to indemnify the Indemnified Party and hold the Indemnified Party harmless from and against any and all Damages caused by or arising out of any settlement of such Third Party Claim or any judgment in connection with such Third Party Claim when and only if it is finally determined that such Indemnified Party is entitled to indemnification pursuant to Section 11.2. Upon assuming the defense of a Third Party Claim, ------------ the indemnifying party may appoint as lead counsel in the defense of the Third Party Claim any legal counsel selected by the indemnifying party; provided, however, that such counsel is reasonably acceptable to the Indemnified Party, provided, further, that in the event that (i) a conflict of interest arises between the indemnifying 50 party and the Indemnified Party such that such legal counsel cannot represent both the indemnifying party and the Indemnified Party or (ii) the Indemnitee has been advised in writing by counsel that there may be one or more legal defenses available to the Indemnitee that are different from or in addition to that of the indemnifying party, the Indemnified Party may retain its own legal counsel at the expense of the indemnifying party and the indemnifying party and its counsel shall cooperate with the Indemnified Party and its counsel, as may be reasonably requested. Except as set forth above, should the indemnifying party assume the defense of a Third Party Claim, the indemnifying party shall not be liable to the Indemnified Party or any other Indemnitee for any legal expenses subsequently incurred by such Indemnified Party or other Indemnitee in connection with the analysis, defense or settlement of the Third Party Claim. (ii) Without limiting Section 11.2(d)(i), any Indemnitee ------------------ shall be entitled to participate in, but not control, the defense of such Third Party Claim and to employ counsel of its choice for such purpose; provided, however, that such employment shall be at the Indemnitee's sole cost and expense, except as described in Section 11.2(d)(i), unless (A) the ------------------ employment thereof has been specifically authorized by the indemnifying party in writing, or (B) the indemnifying party has failed to assume the defense and employ counsel in accordance with Section 11.2(d)(i) (in which case the ------------------ Indemnified Party shall control the defense). (iii) With respect to any Damages relating solely to the payment of money damages in connection with a Third Party Claim and that will not result in the Indemnitee's or the Indemnified Party's becoming subject to injunctive or other relief or otherwise adversely affect the business or reputation of the Indemnitee in any manner, and as to which the indemnifying party shall have acknowledged in writing the obligation to indemnify the Indemnitee hereunder, the indemnifying party shall have the sole right to consent to the entry of any judgment, enter into any settlement or otherwise dispose of such Damages, on such terms as the indemnifying party, in its sole discretion, shall deem appropriate, provided that, as a result of or in connection with any such settlement each Indemnitee or Indemnified Party shall receive a full release with respect to such claim and such settlement would not otherwise adversely affect the business or reputation of the Indemnitee. The indemnifying party shall not be liable for any settlement or other disposition of Damages by an Indemnitee or Indemnified Party that is reached without the written consent of the indemnifying party, which consent shall not be unreasonably withheld. If the indemnifying party chooses to defend or prosecute any Third Party Claim, no Indemnitee or Indemnified Party shall admit any liability with respect to, or settle, compromise or discharge, any Third Party Claim without the prior written consent of the indemnifying party, which consent shall not be unreasonably withheld. (iv) Notwithstanding the foregoing, the indemnifying party shall not be entitled to assume the defense of any Third Party Claim (and shall be liable for the reasonable fees and expenses of counsel incurred by the Indemnified Party in defending such Third Party Claim) if the Third Party Claim seeks an order, injunction or other equitable relief or relief for other than money damages against the Indemnified Party that the Indemnified Party reasonably determines cannot be separated from any related claim for money damages. If such equitable relief or other relief portion of the Third Party Claim can be so separated from that for money damages, the indemnifying party shall be entitled to assume the defense of the portion relating to money damages, subject to the provisions of this Section 11.2(d). --------------- 51 (v) Regardless of whether the indemnifying party chooses to defend or prosecute any Third Party Claim, the Indemnified Party and the indemnifying party shall, and shall cause each other Indemnitee or Affiliate of the indemnifying party, as applicable, to, cooperate in the defense or prosecution thereof and shall furnish such records, information and testimony, provide such witnesses and attend such conferences, discovery proceedings, hearings, trials and appeals as may be reasonably requested in connection therewith. Such cooperation shall include access during normal business hours afforded to the indemnifying party or Indemnified Party, as applicable, to, and reasonable retention by each such Person of, records and information that are reasonably relevant to such Third Party Claim, and making each such Person and other employees and agents available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder, and the indemnifying party shall reimburse each such Person for all its reasonable out-of-pocket expenses in connection therewith. (e) Other Claims. In the event any Indemnified Party has a claim ------------ against any indemnifying party under Section 11.2(a) or Section 11.2(b) that --------------- --------------- does not involve a Third Party Claim being asserted against or sought to be collected from such Indemnified Party, the Indemnified Party shall deliver an Indemnification Claim Notice regarding such claim with reasonable promptness to the indemnifying party. The failure by any Indemnified Party so to notify the indemnifying party shall not relieve the indemnifying party from any liability that it may have to such Indemnified Party under Section 11.2(a) or --------------- Section 11.2(b), except to the extent that the indemnifying party demonstrates - --------------- that such failure to notify has materially prejudiced the indemnifying party. If the indemnifying party does not notify the Indemnified Party within twenty (20) Business Days following its receipt of such notice that the indemnifying party disputes its liability to the Indemnified Party under Section 11.2(a) or --------------- Section 11.2(b), such claim specified by the Indemnified Party in such notice - --------------- shall be conclusively deemed a Liability of the indemnifying party under Section 11.2(a) or Section 11.2(b) and the indemnifying party shall pay the - --------------- --------------- amount of such Liability to the Indemnified Party on demand or, in the case of any notice in which the amount of the claim (or any portion thereof) is estimated, on such later date when the amount of such claim (or such portion thereof) becomes finally determined. (f) Resolution of Conflicts and Claims. ---------------------------------- (i) If the indemnifying party objects in writing to any claim for indemnification made by an Indemnified Party in any Indemnification Claim Notice (an "OBJECTION NOTICE"), the indemnifying party and the Indemnified Party shall attempt in good faith to agree upon the rights of the respective parties with respect to each of such claims and shall provide information to the other party (as reasonably requested) related to the issues set forth in the Objection Notice. If the indemnifying party and the Indemnified Party should so agree, a memorandum setting forth such agreement shall be prepared and signed by both parties. (ii) If no such agreement is reached after good faith negotiation, either the indemnifying party or the Indemnified Party may demand mediation of the dispute, unless the amount of the damage or loss is at issue in a pending action or proceeding involving a Third Party Claim, in which event mediation shall not be commenced until such amount is ascertained or both parties agree to mediation. In any such mediation, indemnifying party and the Indemnified Party agree to employ a mediator from the American Arbitration Association (the 52 "AAA") to assist them in reaching resolution of such dispute according to the Commercial Mediation Rules of the AAA. The mediator shall be a corporate attorney mutually selected by the Acquiror and Seller. The fees and expenses of the mediator shall be shared equally by indemnifying party and the Indemnified Party. If, after mediation efforts, the indemnifying party and the Indemnified Party should agree as to all or a portion of a claim, a memorandum setting forth such agreement shall be prepared and signed by both parties. If after reasonable efforts, and over a period of sixty (60) calendar days, the parties are unable to reach agreement on such dispute utilizing the mediator, the parties shall be permitted to proceed with any other remedy available to such party. (g) Effect of Investigation or Knowledge. Any claim by the ------------------------------------ Acquiror or its Affiliates or any of their respective directors, officers, employees or agents for indemnification shall not be adversely affected by any investigation by or opportunity to investigate afforded to the Acquiror, nor shall such a claim be adversely affected by the Acquiror's Knowledge on or before the Transfer Date of any breach of the type specified in this Section ------- 11.2 or of any state of facts that may give rise to such a breach. The waiver - ---- of any condition based on the accuracy of any representation or warranty, or on the performance of or compliance with any covenant or obligation, will not adversely affect the right to indemnification, payment of Damages or other remedy based on such representations, warranties, covenants or obligations. (h) Interpretation. For purposes of Section 11.2(a) and Section -------------- --------------- ------- 11.2(b), in determining whether a breach of a representation, warranty, - ------- covenant or agreement has occurred, all materiality qualifiers in such representation, warranty, covenant or agreement (i.e. "material," "material adverse effect," "Seller Material Adverse Effect," "Acquiror Material Adverse Effect" or similar phrase), if any, shall be disregarded for purposes of making such determination and shall be determined as if such representation, warranty, covenant or agreement were made without such materiality qualification and (ii) Damages incurred or suffered by an Indemnified Party arising out of any breach of any representation, warranty, covenant or agreement shall be determined without deduction on account of any materiality, Seller Material Adverse Effect or Acquiror Material Adverse Effect qualification contained in any representation, warranty, covenant or agreement giving rise to the claim for indemnification hereunder. Section 11.3 Limitations. ----------- (a) Except for representations, warranties and covenants relating to Taxes or any Damages arising from or related to the Excluded Tax Liabilities or fraud, in no event shall the Seller or the Acquiror be liable for any Damages pursuant to Section 11.2(a) or Section 11.2(b), as applicable, --------------- --------------- unless and until the aggregate amount of all such Damages exceeds $150,000 (the "LIABILITY THRESHOLD"), in which case the Seller or the Acquiror, as applicable, shall be liable for all such Damages in excess of the Liability Threshold, and then not for any Damages in excess of the Liability Cap for all claims made under such Section 11.2(a) or Section 11.2(b), as applicable, in --------------- --------------- the aggregate; provided, however, that for purposes of claims made by the Acquiror under Section 11.2(a)(iii), Section 11.2(a)(iv) or Section 11.2(a)(v), -------------------- ----------------------------------------- the Seller shall be liable for all Damages suffered by the Acquiror without regard to the Liability Threshold or Liability Cap; provided, further, that for purposes of claims made by the Seller under Section 11.2(b)(iii) or -------------------- Section 11.2(b)(iv) or for claims made by the Seller relating to the - ------------------- Acquiror's breach of its payment obligations in Section 4.1 or Section 4.2, ----------- ----------- the Acquiror shall be liable for all 53 Damages suffered by the Seller without regard to the Liability Threshold or Liability Cap. (b) The amount of any Damages recoverable by a party under Section 11.2 shall be reduced by: (i) the amount of any insurance proceeds - ------------ actually paid to the Indemnified Party or Indemnitee, as applicable, relating to such claim (net cost of recovery) and (ii) any recoveries actually received by the Indemnified Party from third parties pursuant to indemnification or otherwise with respect thereto (net of cost of recovery). (c) Following the Closing, the indemnification expressly provided in this Article XI (except for indemnification claims arising out of ---------- the fraud or willful misconduct of either party) shall be the sole and exclusive remedy for any breach of representation or warranty by the parties hereto under this Agreement or any Related Agreement, except to the extent such indemnification is held by a court of competent jurisdiction to be ineffective or unenforceable. (d) NOTWITHSTANDING ANYTHING HEREIN TO THE CONTRARY, THE INDEMNIFICATION OBLIGATIONS OF THE PARTIES HERETO SHALL NOT EXTEND TO CONSEQUENTIAL OR PUNITIVE DAMAGES. Section 11.4 Conflict with other Provisions. To the extent ------------------------------ that any provision in this ARTICLE XI conflicts with any provision of this ---------- Agreement relating to Taxes (including, but not limited to, the provisions of Section 8.10(b)), the other provisions of this Agreement relating to Taxes, - --------------- and not the provisions of this ARTICLE XI, shall govern. ---------- ARTICLE XII. TERMINATION Section 12.1 Methods of Termination. This Agreement may be ---------------------- terminated: (a) at any time prior to the Transfer Date, by mutual written agreement of the Seller and the Acquiror; (b) at any time by either the Seller or the Acquiror, if the Closing shall not have occurred by March 31, 2008 or if the Transfer Date has not occurred by the second (2nd) anniversary of the Closing Date (the relevant date being referred to herein as the "TERMINATION DATE"); provided, however, that the right to terminate the Agreement pursuant to this Section 12.1(b) --------------- shall not be available to a party if such party's failure to perform in all material respects any of their obligations under this Agreement or any Related Agreement results in the failure of the Closing to occur by such time; (c) at any time prior to the Transfer Date by either the Seller or the Acquiror, if there shall be in effect any Law that prohibits the Closing or the consummation of the transactions contemplated at the Transfer Date or if such transactions would violate any non-appealable Order, issued by a competent Governmental Entity, that permanently restrains, enjoins or prohibits the consummation of the transactions contemplated by this Agreement; 54 (d) at any time prior to the Closing Date by either the Seller or the Acquiror (as the non-breaching party), if the other party has breached any material representation, warranty, covenant or agreement hereunder, such breach causes any condition to Closing hereunder as set forth in ARTICLE IX to ---------- not be satisfied, such breach has not been waived by the non-breaching party, and the breach has not been cured within a period of thirty (30) days following the terminating party's written notice of such breach and the breaching party is diligently proceeding to cure such breach during such period, unless such breach is not capable of cure, in which event the non-breaching party may terminate immediately; (e) at any time prior to the Transfer Date by either the Seller or the Acquiror (as the non-breaching party), if the other party has breached any material representation, warranty, covenant or agreement hereunder, such breach causes any condition to the transfer of the Purchased Assets and Assumed Liabilities on the Transfer Date set forth in ARTICLE X to not be --------- satisfied, such breach has not been waived by the non-breaching party, and the breach has not been cured within a period of thirty (30) days following the terminating party's written notice of such breach and the breaching party is diligently proceeding to cure such breach during such period, unless such breach is not capable of cure, in which event the non-breaching party may terminate immediately; (f) at any time prior to the Transfer Date by Acquiror, if there shall has been any materially adverse changes to the FDA requirements necessary for Seller to submit a Complete Response amendment filing pursuant to the Manual of Policies and Procedures 6020.4, or any successor manual of policies and procedures; (g) at any time prior to the Closing Date by the Acquiror, if a Seller Material Adverse Effect shall have occurred since the date of this Agreement; (h) at any time prior to the Transfer Date by the Acquiror, if the FDA requires (i) any additional clinical studies to be conducted prior to the Gestiva NDA Approval Date for the approval of Gestiva or (ii) any additional studies to be conducted following the Gestiva NDA Approval Date which shall be materially more expensive or time consuming than the studies set forth on Schedule 12.1(h), such schedule to be mutually agreed upon by the ---------------- parties in good faith prior to the Closing Date; or (i) at any time prior to the Transfer Date by the Acquiror, if the FDA (i) revokes or rejects Gestiva's orphan drug exclusivity, (ii) reinstates approval of a previously approved product containing the API or (iii) approves an ANDA or NDA which relies, in whole or in part, upon a previously approved product containing the API as the reference drug. Section 12.2 Procedure upon Termination. In the event of -------------------------- termination of this Agreement under Section 12.1, written Notice thereof shall ------------ forthwith be given to the other party, and the transactions contemplated by this Agreement shall be terminated and abandoned, without further action by the parties hereto. If this Agreement is terminated as provided herein: (a) each party, if requested, will redeliver all documents, work papers and other material received from of the other party and its Affiliates relating to the transactions contemplated hereby, whether so obtained before or after the execution hereof, to the party 55 furnishing the same; and (b) no party hereto and none of their respective directors, officers, stockholders or Affiliates shall have any further liability or obligation to any other party to this Agreement, other than Section 12.2, and ------------ ARTICLE XIII; provided, however, that nothing in this Section 12.2(b) shall - ------------ --------------- prejudice any rights, claims, or causes of action that may have accrued hereunder or with respect hereto prior to the date of such termination, including for breach of this Agreement (whether based upon the termination or otherwise). Section 12.3 Termination Fee. In the event of termination of --------------- this Agreement by the Acquiror pursuant to Section 12.1(d) or Section 12.1(e), --------------- --------------- the Seller shall pay to the Acquiror an amount equal to the Initial Purchase Price Amount and the NDA Milestone Payment, to the extent such payments were previously made by the Acquiror, and shall pay an additional amount to the Acquiror equal to all Reimbursable Expenses paid by the Acquiror to the Seller hereunder. All payments under this Section 12.3 will be made within five (5) ------------ Business Days from the termination of this Agreement. ARTICLE XIII. MISCELLANEOUS Section 13.1 Notices. All Notices, requests and other ------- communications hereunder must be in writing and will be deemed to have been duly given only if delivered personally against written receipt or by facsimile transmission with answer back confirmation or mailed (postage prepaid by certified or registered mail, return receipt requested) or by nationally recognized overnight courier that maintains records of delivery to the parties at the following addresses or facsimile numbers: If to the Acquiror to: K-V Pharmaceutical Company 2503 S. Hanley Road St. Louis, Missouri 63144 Facsimile: (314) 645-4705 Attention: Vice President, Business Development General Counsel With copies to: Latham & Watkins LLP 650 Town Center Drive. 20th Floor Costa Mesa, California 92626 Facsimile: (714) 755-8290 Attention: Charles K. Ruck, Esq. Kevin B. Espinola, Esq. If to the Seller to: 56 Hologic, Inc. 35 Crosby Drive Bedford, Massachusetts 01730-1401 Facsimile: (781) 280-0669 Attention: Mark Casey With copies to: Brown Rudnick Berlack Israels LLP One Financial Center Boston, Massachusetts 02111 Facsimile: (617) 856-8201 Attention: Philip J. Flink, Esq. All such Notices, requests and other communications will (i) if delivered personally to the address as provided in this Section 13.1, be deemed given ------------ upon receipt, (ii) if delivered by facsimile to the facsimile number as provided in this Section 13.1, be deemed given upon receipt by the sender of ------------ the answer back confirmation and (ii) if delivered by mail in the manner described above or by overnight courier to the address as provided in this Section 13.1, be deemed given upon receipt (in each case regardless of whether - ------------ such Notice, request or other communication is received by any other Person to whom a copy of such Notice, request or other communication is to be delivered pursuant to this Section 13.1). Any party from time to time may change its ------------ address, facsimile number or other information for the purpose of Notices to that party by giving Notice specifying such change to the other party hereto in accordance with the terms of this Section 13.1. ------------ Section 13.2 Entire Agreement. This Agreement (and all ---------------- Exhibits and Schedules attached hereto and all other documents delivered in connection herewith) supersedes all prior discussions and agreements, both oral and written, among the parties with respect to the subject matter hereof and contains the sole and entire agreement among the parties hereto with respect to the subject matter hereof. Further, the parties agree and acknowledge that the Confidentiality Agreement shall remain in effect until, but shall terminate effective as of, the Transfer Date. Section 13.3 Waiver. Any term or condition of this Agreement ------ may be waived at any time by the party that is entitled to the benefit thereof, but no such waiver shall be effective unless set forth in a written instrument duly executed by or on behalf of the party waiving such term or condition. No waiver by any party hereto of any term or condition of this Agreement, in any one or more instances, shall be deemed to be or construed as a waiver of the same or any other term or condition of this Agreement on any future occasion. All remedies, either under this Agreement or by Law or otherwise afforded, will be cumulative and not in the alternative. 57 Section 13.4 Amendment. This Agreement may be amended, --------- supplemented or modified only by a written instrument mutually agreed upon and duly executed by each party hereto. Section 13.5 Third Party Beneficiaries. The terms and ------------------------- provisions of this Agreement are intended solely for the benefit of each party hereto and their respective successors or permitted assigns and it is not the intention of the parties to confer third party beneficiary rights upon any other Person, except as achieved through the indemnification clause set forth in Section 11.2. ------------ Section 13.6 Assignment; Binding Effect. Neither this -------------------------- Agreement nor any rights, interests or obligations hereunder shall be transferred, assigned or delegated by any party hereto without the prior written consent of the other party hereto and any attempt to make any such transfer assignment or delegation without such consent shall be null and void; provided, however, that (i) without the consent of the Acquiror, the Seller may (in whole or in part) transfer, assign and delegate its rights, interests and obligations to one or more of its Affiliates or to one or more banks or other lenders providing financing to the Seller or its Affiliates from time to time, (ii) without the consent of the Seller, the Acquiror may (in whole or in part) transfer, assign and delegate its rights, interests and obligations to any Affiliate of the Acquiror (including pursuant to Section 4.7 hereof), and ----------- (iii) without the consent of the Seller, the Acquiror may transfer and assign its rights to indemnity, in whole or in part, to any purchaser of all or substantially all of the Gestiva Business; provided, further, this Agreement is binding upon, inures to the benefit of and is enforceable by the parties hereto and their respective successors and permitted assigns and no transfer, assignment or delegation shall limit, affect or discharge the assignor's obligations hereunder. In addition, notwithstanding the foregoing, either party hereto may assign this Agreement, without the prior written consent of the other party hereto, to a Person that succeeds to all or substantially all of such party's business or assets related to this Agreement, whether by sale, merger, operation of law or otherwise, provided that such assignee or transferee agrees in writing to be bound by the terms and conditions of this Agreement. Section 13.7 Headings. The headings used in this Agreement -------- have been inserted for convenience of reference only and do not define or limit the provisions hereof. Section 13.8 Severability. If any provision of this ------------ Agreement is held to be illegal, invalid or unenforceable under any present or future law, and if the rights or obligations of any party hereto under this Agreement will not be materially and adversely affected thereby, (i) such provision will be fully severable, (ii) this Agreement will be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part hereof, (iii) the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid or unenforceable provision or by its severance herefrom, and (iv) in lieu of such illegal, invalid or unenforceable provision, there will be added automatically as a part of this Agreement a legal, valid and enforceable provision as similar to the terms of such illegal, invalid or unenforceable provision as may be possible and reasonably acceptable to the parties herein. Section 13.9 Governing Law. THIS AGREEMENT SHALL BE GOVERNED ------------- BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF 58 DELAWARE APPLICABLE TO CONTRACTS EXECUTED AND PERFORMED IN SUCH STATE, WITHOUT GIVING EFFECT TO CONFLICTS OF LAWS PRINCIPLES. ALL DISPUTES UNDER, OR PERTAINING TO, THIS AGREEMENT SHALL BE RESOLVED EXCLUSIVELY IN THE STATE OR FEDERAL COURTS OF THE STATE OF MISSOURI. Section 13.10 Expenses. Except as otherwise provided in this -------- Agreement, each party hereto shall pay its own expenses and costs incidental to the preparation of this Agreement and to the consummation of the transactions contemplated hereby. Section 13.11 Counterparts. This Agreement may be executed ------------ in any number of counterparts and by facsimile, each of which will be deemed an original, but all of which together will constitute one and the same instrument. A facsimile copy shall be a sufficient proof of signature, without it being necessary to produce the original copy. Section 13.12 Remedies. Except as otherwise provided in -------- Section 11.3(c), any and all remedies herein expressly conferred upon a party shall be deemed cumulative with and not exclusive of any other remedy conferred hereby, or by law or equity upon such party, and the exercise by a party of any one remedy shall not preclude the exercise of any other remedy. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement, this being in addition to any other remedy to which the parties are entitled at law or in equity. [SIGNATURES ON FOLLOWING PAGE] 59 IN WITNESS WHEREOF, this Agreement has been executed by the parties hereto all as of the date first above written. ACQUIROR: K-V PHARMACEUTICAL COMPANY, a Delaware corporation By: /s/ Thomas J. Brya ---------------------------------------- Name: Thomas J. Brya -------------------------------------- Title: VP, Commercial Growth and Strategies ------------------------------------- SELLER: CYTYC PRENATAL PRODUCTS, CORP., a Delaware corporation By: /s/ Glenn P. Muir ---------------------------------------- Name: Glenn P. Muir -------------------------------------- Title: Executive Vice President ------------------------------------- PARENT (SOLELY FOR PURPOSES OF SECTION 8.6 AND ARTICLE XI): HOLOGIC, INC., a Delaware corporation By: /s/ Thomas J. Umbel ---------------------------------------- Name: Thomas J. Umbel -------------------------------------- Title: Sr. VP Bus. Dev. ------------------------------------- 60 EX-21 5 ex21.txt Exhibit 21 List of Subsidiaries ETHEX Corporation Ther-Rx Corporation Particle Dynamics, Inc. Drugtech Corporation FP1096, Inc. Drugtech SARL (Switzerland) KV Pharmaceutical Company Limited (UK) EX-31.1 6 ex31p1.txt EXHIBIT 31.1 ------------ CERTIFICATIONS I, Marc S. Hermelin, 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 25, 2008 -------------------- /s/ MARC S. HERMELIN --------------------------------------- Marc S. Hermelin Chairman and Chief Executive Officer (Principal Executive Officer) EX-31.2 7 ex31p2.txt EXHIBIT 31.2 ------------ CERTIFICATIONS I, Ronald J. Kanterman, 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 25, 2008 --------------------- /s/ RONALD J. KANTERMAN ------------------------------------------- Ronald J. Kanterman Vice President and Chief Financial Officer (Principal Financial Officer) EX-32.1 8 ex32p1.txt EXHIBIT 32.1 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of K-V Pharmaceutical Company (the "Company") on Form 10-K for the fiscal year ended March 31, 2008, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Marc S. Hermelin, 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 25, 2008 -------------------- /s/ Marc S. Hermelin --------------------------------------- Marc S. Hermelin Chairman and Chief Executive Officer (Principal Executive Officer) EX-32.2 9 ex32p2.txt EXHIBIT 32.2 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of K-V Pharmaceutical Company (the "Company") on Form 10-K for the fiscal year ended March 31, 2008, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Ronald J. Kanterman, 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 25, 2008 /s/ Ronald J. Kanterman -------------------- ------------------------------------------- Ronald J. Kanterman Vice President and Chief Financial Officer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----