KV PHARMACEUTICAL CO /DE/ - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2002

Commission file number 1-9601

K-V Pharmaceutical Company
2503 South Hanley Road
St. Louis, MO 63144
(314) 645-6600

Incorporated in Delaware IRS Employer identification No. 43-0618919

Securities Registered Pursuant to Section 12(b) of the Act:

Class A Common Stock par value $.01 per share New York Stock Exchange
Class B Common Stock par value $.01 per share New York Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:
7% Cumulative Convertible Preferred, par value $.01 per share

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X]

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. [ ]

The aggregate market value of the 15,946,635 shares of Class A and 5,107,068
shares of Class B Common Stock held by nonaffiliates of the Registrant as of May
29, 2002, was $501,521,671 and $165,469,003, respectively. As of May 29,
2002, the Registrant had outstanding 20,130,733 and 10,658,222 shares of Class A
and Class B Common Stock, respectively, exclusive of treasury shares.

DOCUMENTS INCORPORATED BY REFERENCE

Part III: Portions of the definitive proxy statement of the Registrant (to be
filed pursuant to Regulation 14A for Registrant's 2002 Annual Meeting of
Shareholders, which involves the election of directors), are incorporated by
reference into Items 10, 11, 12 and 13 to the extent stated in such items.

_______________________________________________________________________________

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This Form 10-K, including the documents that we incorporate herein by reference,
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Any statements about our expectations, beliefs,
plans, objectives, assumptions or future events or performance are not
historical facts and may be forward-looking. These statements are often, but not
always, made through the use of words or phrases such as "anticipate,"
"estimate," "plans," "projects," "continuing," "ongoing," "expects," "management
believes," "we believe," "we intend" and similar words or phrases. Accordingly,
these statements involve estimates, assumptions and uncertainties that could
cause actual results to differ materially from those expressed in them. Any
forward-looking statements are qualified in their entirety by reference to the
factors discussed throughout this Form 10-K.

Factors that could cause actual results to differ materially from the
forward-looking statements include, but are not limited to, the following: (1)
the degree to which we are successful in developing new products and
commercializing products under development; (2) the degree to which we are
successful in acquiring new pharmaceutical products, drug delivery technologies
and/or companies that offer these properties; (3) the difficulty of predicting
FDA approvals; (4) acceptance and demand for new pharmaceutical products; (5)
the impact of competitive products and pricing; (6) the availability of raw
materials; (7) the regulatory environment; (8) fluctuations in operating
results; (9) the difficulty of predicting the pattern of inventory movements by
our customers; (10) the impact of competitive response to our efforts to
leverage our brand power with product innovation, promotional programs, and new
advertising; (11) the risks detailed from time to time in our filings with the
Securities and Exchange Commission; (12) the availability of third-party
reimbursement for our products; and (13) our dependence on sales to a limited
number of large pharmacy chains and wholesale drug distributors for a large
portion of our total net sales.

Because the factors referred to above, as well as the statements included under
the caption "Narrative Description of Business," "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and elsewhere in
this Form 10-K, could cause actual results or outcomes to differ materially from
those expressed in any forward-looking statements made by us or on our behalf,
you should not place undue reliance on any forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which it is made
and, unless applicable law requires to the contrary, we undertake no obligation
to update any forward-looking statement to reflect events or circumstances after
the date on which the statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time, and it is not
possible for us to predict which factors will arise, when they will arise and/or
their effects. In addition, we cannot assess the impact of each factor on our
business or financial condition or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.

ITEM 1. DESCRIPTION OF BUSINESS

(a) GENERAL DEVELOPMENT OF BUSINESS

Generally, when we use the words "we," "our," "us" or "our company"
we are referring to K-V Pharmaceutical Company and its wholly-owned
subsidiaries, including Ther-Rx Corporation, ETHEX Corporation and
Particle Dynamics, Inc.

We were incorporated under the laws of Delaware in 1971 as a
successor to a business originally founded in 1942. Victor M.
Hermelin, our Chairman and founder, invented and obtained initial
patents for early controlled release and enteric coating which became
part of our core business and a platform for future drug delivery
emphasis.

We are a leader in the development of advanced drug delivery
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) bioadhesives; tastemasking;
controlled release; and 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 1991, we established a generic marketing capability through a
wholly-owned subsidiary, ETHEX Corporation ("ETHEX"), which makes it
one of the only drug delivery research and development companies that
also markets "technologically distinguished" generic products.

In 1999, we established a wholly-owned subsidiary, Ther-Rx
Corporation ("Ther-Rx"), to market branded pharmaceuticals directly
to physician specialists.

Our wholly-owned subsidiary, Particle Dynamics, Inc. ("PDI"), was
acquired in 1972. Through PDI, we develop and market specialty value
added raw materials, including drugs, directly compressible and
microencapsulated products, and other products used in the
pharmaceutical, nutritional, food, personal care and other markets.

(Hereinafter, KV, ETHEX, PDI and Ther-Rx are sometimes referred to
collectively as "We," "KV" or the "Company").

(b) INDUSTRY SEGMENTS

We operate principally in four industry segments, consisting of
branded products marketing, specialty generics marketing, specialty
raw materials marketing and manufacturing, and pharmaceutical
manufacturing. Our discussion of the Company's business and operating
results is focused primarily on the marketing segments. Revenues are
derived primarily from directly marketing our own technologically
distinguished generic and brand-name products. Revenues may also be
received in the form of licensing revenues and/or royalty payments
based upon a percentage of the licensee's sales of the product, in
addition to manufacturing revenues, when marketing rights to products
using our advanced drug delivery technologies are licensed (see Note
18 to our consolidated financial statements).

(c) NARRATIVE DESCRIPTION OF BUSINESS

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OVERVIEW

We are a fully integrated specialty pharmaceutical company that develops,
acquires, manufactures and markets technologically distinguished branded and
generic prescription pharmaceutical products. We have a broad range of internal
dosage form capabilities including tablets, capsules, creams, liquids and
ointments. We conduct our branded pharmaceutical operations through Ther-Rx
Corporation. Ther-Rx currently markets products focused on the women's health
and cardiovascular therapeutic areas. We conduct our generic pharmaceutical
operations through ETHEX Corporation, which focuses principally on
technologically distinguished generic products in multiple therapeutic
categories, with a particular emphasis on the cardiovascular, women's health,
pain management and respiratory areas. Through Particle Dynamics, Inc., we also
develop, manufacture and market technologically advanced, value-added raw
material products for the pharmaceutical, nutritional, personal care, food and
other markets.

We have a broad portfolio of drug delivery technologies which we leverage
to create technologically distinguished brand name and specialty generic
products. We have developed and patented 14 drug delivery and formulation
technologies primarily in four principal areas: SITE RELEASE(R) bioadhesives,
oral controlled release, tastemasking, and quick dissolving tablets. We
incorporate these technologies in the products we market to control and improve
the absorption and utilization of active pharmaceutical compounds. These
technologies provide a number of benefits, including reduced frequency of
administration, reduced side effects, improved drug efficacy, enhanced patient
compliance and improved taste.

We have a long history of developing drug delivery technologies. In the
1950's, we received what we believe to be the first patents for sustained
release delivery systems which enhance the convenience and effectiveness of
pharmaceutical products. In our earlier 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. More recently, we have chosen to focus our
drug development expertise on internally developed products for our branded and
generic pharmaceutical businesses. For example, since its inception in March
1999, our Ther-Rx business has launched five internally developed branded
pharmaceutical products, all of which incorporate our drug delivery
technologies. In addition, most of the internally developed generic products
marketed by our ETHEX business incorporate one or more of our drug delivery
technologies.

Our drug delivery technology has allowed us to differentiate our products
in the marketplace, both in the branded and generic pharmaceutical arenas. We
believe that this differentiation provides substantial competitive advantages
for our products, allowing us to establish a record of growth and profitability
and a leadership position in certain segments of our industry. Over the past
five years, we have grown net revenues and net income at compounded annual
growth rates of 20.2% and 29.2%, respectively.

THER-RX -- OUR BRAND NAME PHARMACEUTICAL BUSINESS

We established our Ther-Rx business in 1999 to market brand name
pharmaceutical products which incorporate our proprietary technologies. We
currently focus on the areas of women's health and cardiovascular therapeutic
categories. Since its inception, Ther-Rx has introduced seven products, two of
which were acquired and five of which were developed internally using our
proprietary technologies. As we evaluate product development and acquisition
opportunities, we may expand our therapeutic focus. Ther-Rx generated $40.4
million of net sales during fiscal 2002, which represented 19.8% of our net
revenues.

We established our women's health care franchise through the August 1999
acquisition of PreCare(R), a prescription prenatal vitamin, from UCB Pharma,
Inc. Since the acquisition, Ther-Rx reformulated the original product
incorporating our controlled release technology and proprietary ingredients, and
subsequently has launched four 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.

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The first of our internally developed, patented line extensions to
PreCare(R) was PreCare(R) Chewables, the world's first prescription chewable
prenatal vitamin. PreCare(R) Chewables address a longstanding challenge to
improve pregnant women's compliance with prenatal vitamin regimens by
alleviating the difficulty that patients experience in swallowing large prenatal
pills. Ther-Rx's second internally developed product, PremesisRx(TM), is an
innovative prenatal prescription product that incorporates our controlled
release Vitamin B(6). This product is designed for use in conjunction with a
physician-supervised program to reduce pregnancy-related nausea and vomiting,
which is experienced by 50% to 90% of women. The third product, PreCare(R)
Conceive(TM), is the first single nutritional pre-conception supplement designed
for use by both men and women. The fourth product, PrimaCare(TM), 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. All of the
products in the PreCare(R) product line have been formulated to contain 1 mg. of
folic acid, which has been shown to reduce the incidence of fetal neural tube
defects by at least 50%.

In June 2000, Ther-Rx launched its first new drug application, or NDA,
approved product, Gynazole-1(R), the only one-dose prescription cream treatment
for vaginal yeast infections. Gynazole-1(R) incorporates our patented drug
delivery technology, VagiSite(R), the only clinically proven and Federal Food
and Drug Administration, or FDA, approved controlled release bioadhesive system.
Since its launch, the product has gained a 13% market share in the U.S.
prescription vaginal antifungal cream market. In addition, we have entered into
four licensing agreements for the right to market Gynazole-1(R) in 49 countries
outside of the United States. We expect to continue to license marketing rights
for Gynazole-1(R) in additional international markets.

Ther-Rx's cardiovascular product line consists of Micro-K(R), an
extended-release potassium supplement used to replenish the electrolytes,
primarily in patients who are on medication which depletes the levels of
potassium in the body. We acquired Micro-K(R) in March 1999 from the
pharmaceutical division of Wyeth.

Ther-Rx has approximately 150 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 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 pharmaceuticals. By focusing on difficult to produce niche
generic products, we often experience limited competition for our products. As a
result, many of our generic products enjoy high gross margins.

We have incorporated our proprietary drug delivery technology in many of
our generic pharmaceutical products. For example, we have included METER
RELEASE(R), one of our proprietary controlled release technologies, into the
only generic equivalent to Norpace(R) CR, an antiarrhythmic that is taken twice
daily. Further, we have used our KV/24(R) once daily technology in the generic
equivalent to IMDUR(R), a cardiovascular drug that is taken once per day. In
addition, utilizing our specialty manufacturing expertise and a sublingual
delivery system, we produced and marketed the first non-branded alternative to
Nitrostat(R) sublingual, an anti-angina product which historically has been
difficult to manufacture.

To capitalize on ETHEX's unique generic product capabilities, we continue
to expand our generic product portfolio. Over the past two years, we have
introduced more than 20 new generic products and have a number of generic
products currently in development. In the first six months of calendar year
2002, we have received five new abbreviated new drug application, or ANDA,
approvals and have several currently pending.

ETHEX's current product line consists of more than 80 products, of which
approximately 58% are identified by IMS as the leading products in their
respective generic categories. ETHEX's net sales were $141.0 million for fiscal
2002, which represented 69.1% of our net revenues. ETHEX primarily focuses on
the therapeutic categories of cardiovascular, women's health, pain management
and respiratory, leveraging

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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 technology
and our specialty manufacturing expertise.

CARDIOVASCULAR. ETHEX currently markets 17 products in its cardiovascular
line, including products to treat angina, arrhythmia and hypertension, as well
as for potassium supplementation. In addition to the generic versions of
IMDUR(R) and Norpace CR(R), we recently received approvals to market the generic
equivalents to Cardura(R) and Rythmol(R). The cardiovascular line accounted for
approximately 45% of ETHEX's net revenues in fiscal 2002.

WOMEN'S HEALTH CARE. ETHEX currently markets 18 products in its women's
health care line, all of which are prescription prenatal vitamins. Based on the
number of units sold, ETHEX is the leading provider of prescription prenatal
vitamins in the United States. The women's health care line accounted for
approximately 16% of ETHEX's net revenues in fiscal 2002.

PAIN MANAGEMENT. ETHEX currently markets 13 products in its pain
management line. Included in this line are several controlled substance drugs,
such as morphine and hydromorphone, as well as oxycodone capsules, which are
currently the only alternative to OxyIR(R) capsules. The pain management line
accounted for approximately 11% of ETHEX's net revenues in fiscal 2002.

RESPIRATORY. ETHEX currently markets over 20 products in its respiratory
line, which consists primarily of cough/cold products. ETHEX is the leading
provider on a unit basis of prescription cough/ cold products in the United
States today. The cough/cold line accounted for approximately 16% of ETHEX's net
revenues in fiscal 2002.

OTHER THERAPEUTICS. In addition to our core therapeutic lines, ETHEX
markets over 20 products in the gastrointestinal, dermatological,
anti-inflammatory, digestive enzyme and general nutritional categories. These
categories accounted for approximately 12% of ETHEX's net revenues in fiscal
2002.

ETHEX has a dedicated sales and marketing team, which includes an outside
sales team of regional managers and national account managers and an inside
sales team. The outside sales force calls on wholesalers and distributors and
national drugstore chains, as well as hospitals, nursing homes, independent
pharmacies and mail order firms. The inside sales force calls on independent
pharmacies to create pull-through at the wholesale level.

PARTICLE DYNAMICS, INC. -- OUR VALUE-ADDED RAW MATERIAL BUSINESS

Particle Dynamics develops and markets specialty raw material product lines
for the pharmaceutical, nutritional, food and personal care industries. Its
products include value-added active drug molecules, vitamins, minerals and other
raw material ingredients that provide benefits such as improved taste, altered
or controlled release profiles, enhanced product stability or more efficient and
other manufacturing process advantages and benefits. Particle Dynamics is also a
significant supplier of value-added raw material for our Ther-Rx and ETHEX
businesses. Net sales for Particle Dynamics were $19.6 million in fiscal 2002,
which represented 9.6% of our net revenues. Particle Dynamics currently offers
three distinct lines of specialty raw material products:

- DESCOTE(R) is a family of microencapsulated tastemasked vitamins and
minerals for use in chewable nutritional products, quick dissolve dosage
forms, foods, children's vitamins and other products. This technology is
incorporated in Centrum(R) and Centrum Jr.(R) vitamins and
Flintstones(R), Bugs Bunny(R) and One a Day(R) vitamins.

- DESTAB(TM) is a family of direct compression products that enables
pharmaceutical manufacturers to produce tablets and caplets more
efficiently and economically. This technology is incorporated in
Di-gel(R), Maalox(R) Quick Dissolve, Tylenol PM(R) and Mylanta(R)
gelcaps, Centrum(R) and Centrum Jr.(R) vitamins and Flintstones(R), Bugs
Bunny(R) and One a Day(R) vitamins.

- MicroMask(TM) is a family of products designed to alleviate problems
associated with swallowing tablets. This is accomplished by offering
superior tasting, chewable or quick dissolving dosage forms

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of medication. This technology is incorporated in Triaminic(R) Soft Chew and
Children's Sudafed(R). In addition, we use MicroMask(TM) technology in
PreCare(R) Prenatal caplet, PreCare(R) Chewables and PreCare(R) Conceive(TM),
all of which are marketed by Ther-Rx.

STRATEGIES

Our goal is to enhance our position as a leading specialty pharmaceutical
company that utilizes its expanding drug delivery expertise to bring
technologically distinguished brand name and generic products to market. Our
strategies incorporate the following key elements:

INTERNALLY DEVELOP BRAND NAME PRODUCTS. We apply our existing drug
delivery technologies, research and development and manufacturing expertise to
introduce new products which can expand our existing franchises. Since the
acquisition and reformulation of PreCare(R), we have successfully introduced
four internally developed brand name products, including PreCare(R) Chewables,
PremesisRx(TM), PreCare(R) Conceive(TM) and PrimaCare(TM). These products
incorporate our proprietary oral extended release and tastemasking technologies.
In June 2000, Ther-Rx launched its first NDA approved product, Gynazole-1(R),
the only one-dose prescription cream treatment for vaginal yeast infections. 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. We currently have a number of products in clinical
development, including product candidates in Phase III clinical trials.

CAPITALIZE ON ACQUISITION OPPORTUNITIES. We actively seek acquisition
opportunities for both Ther-Rx and ETHEX. Ther-Rx continually looks for platform
acquisition opportunities similar to PreCare(R) around which we can build
franchises. We believe that consolidation among large pharmaceutical companies,
coupled with cost-containment pressures, has increased the level of sales
necessary for an individual product to justify active marketing and promotion.
This has led large pharmaceutical companies to focus their marketing efforts on
drugs with higher volume sales, newer or novel drugs which have the potential
for high volume sales and products which fit within core therapeutic or
marketing priorities. As a result, major pharmaceutical companies increasingly
have sought to divest small or non-strategic product lines, which can be
profitable for specialty pharmaceutical companies like us.

In making acquisitions, we apply several important criteria in our decision
making process. We pursue products with the following attributes:

- products which we believe have relevance for treatment of significant
clinical needs;

- promotionally sensitive maintenance drugs which require continual use
over a long period of time, as opposed to more limited use products for
acute indications;

- products which are predominantly prescribed by physician specialists,
which can be cost effectively marketed by our focused sales force; and

- products which we believe have potential for technological enhancements
and line extensions based upon our drug delivery technologies.

FOCUS SALES EFFORTS ON HIGH VALUE NICHE MARKETS. We focus our Ther-Rx
sales efforts on niche markets where we believe we can target a relatively
narrow physician audience. Because our products are sold to specialty physician
groups that tend to be relatively concentrated, we believe that we can address
these markets cost effectively with a focused sales force. Currently, we have
approximately 150 sales representatives who call on gynecologists and
obstetricians. We plan to continue to build our sales force as necessary to
accommodate future expansion of our product line.

PURSUE ATTRACTIVE GROWTH OPPORTUNITIES WITHIN THE GENERIC INDUSTRY. We
intend to continue to introduce generic counterparts to drugs whose patents have
expired. When patents no longer protect a branded product, opportunities exist
for ETHEX to introduce generic counterparts to branded products. Such generic or
off-patent pharmaceutical products are generally sold at significantly lower
prices than the branded product. Accordingly, off-patent pharmaceuticals provide
a cost-efficient alternative to users of branded products. We believe the health
care industry will continue to support growth in the generic

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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 our competitively priced, technologically distinguished
generic products can help contain costs and improve patient compliance.

ADVANCE EXISTING AND DEVELOP NEW DRUG DELIVERY TECHNOLOGIES. We believe
our drug delivery platform of 14 distinguished technologies has unique breadth
and depth. These technologies have enabled us to create innovative products,
including Gynazole-1(R), the only one-dose vaginal antifungal prescription cream
treatment for yeast infections, incorporating VagiSite(TM), our proprietary
bioadhesive controlled release system. In addition, our tastemasking and
controlled release systems are incorporated into our prenatal vitamins,
providing them with differentiated benefits over other products on the market.
We plan to continue to develop our drug delivery technologies and have
identified various technologies with substantial growth potential, such as
TransCell(TM), a novel bioadhesive, controlled release delivery system that may
permit oral delivery of bioactive peptides and proteins that are normally
degraded by stomach enzymes or first-pass liver effects.

OUR PROPRIETARY DRUG DELIVERY TECHNOLOGIES

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 products. Additionally, we continue to invest
our resources in the development of new technologies. The following describes
our principal drug delivery technologies.

SITE RELEASE(R) TECHNOLOGIES. SITE RELEASE(R) is our largest family of
technologies and includes eight systems designed specifically for oral, topical
or interorificial use. These systems rely on controlled bioadhesive properties
to optimize the delivery of drugs to either wet mucosal tissue or the skin and
are the subject of issued patents and pending patent applications. Of the
technologies developed, products using the VagiSite(TM) and DermaSite(TM)
technologies have been successfully commercialized. Our fully developed
technologies include the following:

- VagiSite(TM) is a controlled release bioadhesive delivery system that
incorporates advanced polyphasic principles to create a bioemulsion
system delivering therapeutic agents to the vagina. We have outlicensed
VagiSite(TM) for sale in international markets for the treatment of
vaginal infections. VagiSite(TM) technology is used in Gynazole-1(R), a
one-dose prescription cream treatment for vaginal yeast infections.

- DermaSite(TM) is a semi-solid SITE RELEASE(R) configuration for topical
applications to the skin. The bioadhesive and controlled release
properties of the delivery platform have made possible the development of
products requiring a significantly reduced frequency of application.
DermaSite(TM) technology is used in Dermarin-L(TM), a topical antifungal
product being marketed by the leading over-the-counter company in Japan,
Taisho Pharmaceutical, Ltd.

- OraSite(R) is a controlled release mucoadhesive delivery system
administered orally in a solid or liquid form. A drug formulated with the
OraSite(R) technology may be formulated as a liquid or as a lozenge in
which the dosage form liquifies upon insertion and adheres to the mucosal
surface of the mouth, throat and esophagus. OraSite(R) possesses
characteristics particularly advantageous to therapeutic categories such
as oral hygiene, sore throat and periodontal and upper gastointestinal
tract disorders.

- OraSert(TM) is a solid dosage-form application system specifically
designed for localized delivery of active agents to the oral tissues. The
product is formulated as a "cough drop" type tablet, which immediately
liquifies upon placement in the mouth and bioadheres to mucosal tissue in
the mouth, throat and esophagus. OraSert(TM) possesses characteristics
particularly advantageous to therapeutic applications such as periodontal
disease, respiratory conditions, pharyngeal conditions and upper
gastrointestinal tract disorders.

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- BioSert(TM) is a bioadhesive delivery system in a solid insert
formulation for vaginal or rectal administration, similar in appearance
to a vaginal or rectal suppository, which can be used for both local and
systemic delivery of drugs. The BioSert(TM) dosage form liquifies and
bioadheres to vaginal or rectal tissues, which is of particular benefit
when a patient can no longer tolerate orally administered medications. We
are currently developing several drug products that utilize the
BioSert(TM) technology, including non-steroidal anti-inflammatory drugs,
or NSAIDs, and antifungals for a local effect and opioids for a systemic
effect.

In addition, the following SITE RELEASE(R) technologies are currently under
development:

- TransCell(TM) is a novel bioadhesive, controlled release delivery system
that may permit oral delivery of bioactive peptides and proteins that are
normally degraded by stomach enzymes or first-pass liver effects. The
TransCell(TM) technology was specifically designed to provide an oral
delivery alternative to biotechnology and other compounds that currently
are delivered as injections or infused. In "proof of principle" and
"proof of concept" studies conducted during fiscal 2002, the
TransCell(TM) delivery system demonstrated the successful oral delivery
of the hormone calcitonin, a drug used in the treatment and prevention of
osteoporosis and to normalize calcium levels in renal dialysis patients.

- OcuSite(TM) is a liquid, microemulsion delivery system intended for
topical applications in the eye. The microemulsion formulation lends
optical clarity to the application and is ideal for ophthalmic use. The
bioadhesive and controlled release properties of this delivery system
allow for reduced dosing regimentation.

- PulmoSite(TM) applies bioadhesive and controlled release characteristics
to drug agents that are to be inhaled for either local action to the lung
or for systemic absorption.

ORAL CONTROLLED RELEASE TECHNOLOGIES. The technological preeminence of our
advanced drug delivery systems was established in the development of our three
oral controlled release technologies, all of which have been commercialized. Our
systems can be individually designed to achieve the desired release profile for
a given drug. The release profile is dependent on many parameters, such as drug
solubility, protein binding and site of absorption. Some of the products
utilizing our oral controlled release systems in the market include
Isosorbide-5-Mononitrate (an AB rated generic equivalent to IMDUR(R)) and
Disopyramide Phosphate (an AB rated generic equivalent of Norpace(R) CR). Our
patented technologies include the following:

- KV/24(R) is a multi-particulate drug delivery system that encapsulates
one or more drug compounds into spherical particles which release the
active drug or drugs systemically over an 18- to 24-hour period,
permitting the development of once-a-day drug formulations. We believe
that our KV/24(R) oral dosing system is the only commercialized 24-hour
oral controlled release system that is successfully able to incorporate
more than one active compound.

- METER RELEASE(R) is a polymer-based drug delivery system that offers
different release characteristics than KV/24(R) and is used for products
that require drug release rates of between eight and 12 hours. We have
developed METER RELEASE(R) systems in tablet, capsule and caplet form
that have been commercialized in ETHEX products in the cardiovascular,
gastrointestinal and upper respiratory product categories.

- MICRO RELEASE(R) is a microparticulate formulation that encapsulates
therapeutic agents, employing smaller particles than KV/24(R) and METER
RELEASE(R). This system is used to extend the release of drugs in the
body where precise release profiles are less important.

MICRO RELEASE(R) has been commercialized in prescription products
marketed by ETHEX and Ther-Rx as well as over-the-counter nutritional
products.

TASTEMASKING TECHNOLOGIES. Our tastemasking technologies improve the taste
of unpleasant drugs. Our three patented tastemasking systems can be applied to
liquids, chewables or dry powders. We first introduced tastemasking technologies
in 1991 and have utilized them in a number of Ther-Rx and

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ETHEX products, including PreCare(R) Chewables and most of the liquid products
that are sold in ETHEX's cough/cold line. Our patented technologies include the
following:

- LIQUETTE(R) is a tastemasking system that incorporates unpleasant tasting
drugs into a hydrophilic and lipophilic polymer matrix to suppress the
taste of a drug. This technology is used for mildly to moderately
distasteful drugs where low manufacturing costs are particularly
important.

- FlavorTech(R) is a liquid formulation technology designed to reduce the
objectionable taste of a wide variety of therapeutic products.
FlavorTech(R) technology has been used in cough/cold syrup products sold
by ETHEX and has special application to other products, such as
antibiotic, geriatric and pediatric pharmaceuticals.

- MicroMask(TM) is a tastemasking technology that incorporates a dry
powder, microparticulate approach to reducing objectionable tastes by
sequestering the unpleasant drug agent in a specialized matrix. This
formulation technique has the effect of "shielding" the drug from the
taste receptors without interfering with the dissolution and ultimate
absorption of the agent within the gastrointestinal tract. MicroMask(TM)
is a more potent tastemasking technology than LIQUETTE(R) and has been
used in connection with two Ther-Rx products.

QUICK DISSOLVING TECHNOLOGY. Our OraQuick(TM) system is a quick-dissolving
tablet technology that provides the ability to tastemask, yet dissolves in the
mouth in a matter of seconds. Most other quick-dissolving technologies offer
either quickness at the expense of poor tastemasking or excellent tastemasking
at the expense of quickness. While still under development, this system allows
for a drug to be quickly dissolved in the mouth, and can be combined with
tastemasking capabilities that offer a unique dosage form for the most bitter
tasting drug compounds. We have been issued patents and have patents pending for
this system with the PTO.

SALES AND MARKETING

Ther-Rx has a national sales and marketing infrastructure which includes
approximately 150 sales representatives dedicated to promoting and marketing our
branded pharmaceutical products to targeted physician specialists. By targeting
physician specialists, we believe we can compete successfully without the need
to build a larger sales force. We also have a national sales management team, as
well as a sales team dedicated to managed care and trade accounts and an inside
sales team.

We seek to increase the 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 four more line extensions to address unmet needs,
including the launch of PreCare(R) Chewables, Premesis Rx(TM), PreCare(R)
Conceive(TM) and PrimaCare(TM). 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 yeast infections. By offering multiple products to the same group of
physician specialists, we are able to maximize the effectiveness of our
experienced sale force.

ETHEX has an experienced sales and marketing team, which includes an
outside sales team, regional account managers, national account managers and an
inside sales team. The outside sales force calls on wholesalers, distributors
and national drugstore chains, as well as hospitals, nursing homes, mail order
firms and independent pharmacies. The inside sales team calls on independent
pharmacies to create pull-through at the wholesale level.

We believe that industry trends favor generic product expansion into the
managed care, long-term care and government contract markets. Further, we
believe that our competitively priced, technologically distinguished generic
products can fulfill the increasing need of these markets to contain costs and
improve
8

patient compliance. Accordingly, we intend to continue to devote significant
marketing resources to the penetration of such markets.

Particle Dynamics has a specialized technical sales group that calls on the
leading companies in the pharmaceutical, nutritional, personal care, food and
other markets in the United States.

During fiscal 2002 and 2001, the Company's three largest customers
accounted for 20%, 19% and 13%, and 23%, 20% and 14%, respectively, of gross
revenues. These customers were McKesson Drug Company, Cardinal Health and
Amerisource Corporation, respectively. In fiscal 2000, the Company's two largest
customers, McKesson Drug Company and Cardinal Health accounted for 18% and 12%,
respectively, of the Company's gross revenue.

Although we sell internationally, we do not have material operations or
sales in foreign countries and our sales are not subject to unusual geographic
concentration.

RESEARCH AND DEVELOPMENT

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 versions of previously approved brand name pharmaceutical products. In
fiscal 2000, 2001 and 2002, total research and development expenses were $8.0
million, $9.3 million, and $10.7 million, respectively.

Ther-Rx currently has a number of products in its research and development
pipeline at various stages of development, including product candidates in Phase
III clinical trials. 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.

ETHEX currently has more than 30 products in its research and development
pipeline at various stages of development and exploration. Our development
process consists of formulation, development and laboratory testing, and where
required (1) preliminary bioequivalency studies of pilot batches of the
manufactured product, (2) full scale bioequivalency studies using commercial
quantities of the manufactured product and (3) submission of an ANDA, to the
FDA. We believe that, unlike many generic drug companies, we have the technical
expertise required to develop generic substitutes to the hard-to-copy branded
pharmaceutical products.

Since January 1, 2002, ETHEX has received five ANDA approvals from the FDA.
The five products approved include generic equivalents to Rythmol(R), Buspar(R),
Lortab(R) Elixir, K-Dur(R) and Prelone(R).

In addition to our internal marketing efforts, we have licensed the
exclusive rights to co-develop and market nine products with other drug delivery
companies. These products will be generic equivalents to brand name products
with aggregate annual sales totaling approximately $2.5 billion and are expected
to be launched at various times beginning in fiscal 2005.

Particle Dynamics currently has more than 20 products in its research and
development pipeline at various stages of development. Particle Dynamics applies
its technologies to a diverse number of active and inactive chemicals for more
efficient processing of materials to achieve benefits such as prolonged action
of release, tastemasking, making materials more site specific and other
benefits. Typically, the finished products into which the specialty raw
materials are incorporated do not require FDA approval. We expect to market a
number of new specialty raw material products in fiscal 2003.

We continually apply our scientific and development expertise to refine and
enhance our existing drug delivery systems and formulation technologies and to
create new technologies that may be used in our drug development programs.
Certain of these technologies currently under development include advanced oral
controlled release systems, quick dissolving oral delivery systems (with and
without tastemasking characteristics) and transesophageal and intrapulmonary
delivery technologies.

PATENTS AND OTHER PROPRIETARY RIGHTS

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 2018 relating
to our controlled release, site-specific, quick dissolve and tastemasking
technologies. We have been granted 28 U.S. patents and have 17 U.S. patent
applications pending. In addition, we have 36 foreign issued

9

patents and a total of 64 patent applications pending primarily in Canada,
Europe, Australia, Japan and South Korea.

Our success will also depend to a significant extent on our ability to
obtain and enforce patents, maintain trade secret protection and operate without
infringing on the proprietary rights of third parties. The pharmaceutical
industry 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 enforceability cannot be predicted. To the extent we
endeavor to protect our inventions outside the United States, statutory
differences in patentable subject matter may limit the protection we can obtain.
For example, methods of treating humans are not patentable in some countries
outside of the United States. These and other issues may prevent us from
obtaining patent protection outside of the United States. 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. Furthermore, there are categories of "secret" prior art unavailable to any
examiner, such as the prior inventive activities of others, which could form the
basis for invalidating any patent. In addition, there are other reasons why a
patent may be found to be invalid, such as an offer for sale or public use of
the patented invention in the United States more than one year before the filing
date of the patent application. Moreover, a patent may be deemed unenforceable
if, for example, the inventor or the inventor's agents failed to disclose prior
art to the U.S. Patent and Trademark Office, or PTO, that they knew was material
to patentability.

The coverage claimed in a patent application can be significantly reduced
before a patent is issued, either in the United States or abroad. Consequently,
there can be no assurance that any of our pending or future patent applications
will result in the issuance of patents. Patents issued to us may be subjected to
further proceedings limiting their scope and may not provide significant
proprietary protection or competitive advantage. Our patents also may be
challenged, circumvented, invalidated or deemed unenforceable. In addition,
because patent applications in the United States filed prior to November 29,
2000 are currently maintained in secrecy until and unless patents issue, and
patent applications in certain other countries generally are not published until
more than 18 months after they are first filed (which generally is the case in
the United States for applications filed on or after November 29, 2000), and
because publication of discoveries in scientific or patent literature often lags
behind actual discoveries, we cannot be certain that we or any licensor was the
first creator of inventions covered by pending patent applications or that we or
licensors will be entitled to any rights in purported inventions claimed in
pending or future patent applications or that we or our licensors were the first
to file patent applications on such inventions. Furthermore, patents already
issued to us or our pending applications may become subject to dispute, and any
dispute could be resolved against us. For example, we may become involved in re-
examination, reissue or interference proceedings in the PTO, or opposition
proceedings in a foreign country. The result of these proceedings can be the
invalidation or substantial narrowing of our patent claims. We also could be
subject to court proceedings that could find our patents invalid or
unenforceable or could substantially narrow the scope of our patent claims. In
addition, statutory differences in patentable subject matter may limit the
protection we can obtain on some of our inventions outside of the United States.
For example, methods of treating humans are not patentable in many countries
outside of the United States. These and other issues may prevent us from
obtaining patent protection outside of the United States.

We also rely upon trade secrets, unpatented proprietary know-how and
continuing technological innovation to develop and maintain our competitive
position. We enter into confidentiality agreements with each of our employees
and consultants upon the commencement of an employment or consulting
relationship. These agreements generally provide that all inventions, ideas,
discoveries, improvements and copyrightable material made or conceived by the
individual arising out of the employment or consulting relationship and all
confidential information developed or made known to the individual during the
term of

10

the relationship is our exclusive property. We cannot assure the enforceability
of these agreements or that they will not be breached. We also cannot be certain
that we will 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. Further, others may
acquire or independently develop similar technology, or if patents are not
issued with respect to products arising from research, we may not be able to
maintain information pertinent to such research as proprietary technology or
trade secrets.

We currently own more than 45 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.

It is possible that third parties may own or could acquire rights in
trademarks or domain names in the United States or abroad that are confusingly
similar to or otherwise compete unfairly with our marks and domain names, or
that our use of trademarks or domain names may infringe or otherwise violate the
intellectual property rights of third parties. The use of similar marks or
domain names by third parties could decrease the value of our trademarks or
domain names and hurt our business, for which there may be no adequate remedy.

We may be required to defend against charges of infringement of patent or
other proprietary rights of third parties. Such 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. Although patent and other intellectual
property disputes in the pharmaceutical product area have often been 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 and selling certain of our products.
Litigation may also be necessary to enforce our patents against others or to
protect our trademarks, know-how or trade secrets. Such litigation could result
in substantial expense and there cannot be assurance that any litigation will be
resolved in our favor.

MANUFACTURING AND FACILITIES

We believe that our administrative, research, manufacturing and
distribution facilities are an important factor in achieving our long-term
growth objectives. All facilities, aggregating approximately 835,000 square
feet, are located in the St. Louis, Missouri area. We own approximately 299,000
square feet, with the balance under various leases at pre-determined annual
rates under agreements expiring from 2002 through 2012, subject in most cases to
renewal at our option. We believe the facilities are suitable for the purposes
for which they are used and adequate to meet our needs for at least the next
three years.

We manufacture drug products in liquid, semi-solid, tablet, capsule and
caplet forms for distribution by Ther-Rx, ETHEX and its corporate licensees and
value-added specialty raw materials for distribution by Particle Dynamics. We
believe that all of our facilities comply with applicable regulatory
requirements.

We seek to maintain inventories at sufficient levels to support current
production and sales levels. During fiscal 2002, we encountered no serious
shortage of any particular raw materials and have no indication that significant
shortages will occur in the foreseeable future.

11

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 pharmaceutical products may
be subject to competition from pharmaceutical companies engaged in the
development of alternatives to the generic 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 position us to maintain a leadership position in the
field of advanced drug delivery technologies and to continue to develop products
to compete effectively in the marketplace.

In addition, we compete with other pharmaceutical companies that acquire
branded product lines from other pharmaceutical companies. These competitors may
have substantially greater financial and managerial resources than we do.
Accordingly, our competitors may succeed in product line acquisitions that we
seek to acquire.

We also compete with drug delivery companies engaged in the development of
alternative drug delivery systems. We are aware of a number of companies
currently seeking to develop new non-invasive drug delivery systems, including
oral delivery and transmucosal systems. Many of these companies may have greater
research and development capabilities, experience, manufacturing, marketing,
financial and managerial resources than we do. Accordingly, our competitors may
succeed in developing competing technologies, obtaining FDA approval for
products or gaining market acceptance more rapidly than we do.

GOVERNMENT REGULATION

All pharmaceutical manufacturers are subject to extensive regulation by the
federal government, principally the FDA, and, to a lesser extent, by state,
local and foreign governments. The Federal Food, Drug and Cosmetic Act, or FDCA,
and other federal statutes and regulations govern or influence, among other
things, the development, testing, manufacture, safety, labeling, storage,
recordkeeping, approval, advertising, promotion, sale and distribution of
pharmaceutical products. Pharmaceutical manufacturers are also subject to
certain record keeping and reporting requirements, establishment registration
and product listing, and FDA inspections.

With respect to any non-biological "new drug" product with active
ingredients not previously approved by the FDA, a prospective manufacturer must
submit a full NDA, including complete reports of preclinical, clinical and other
studies to prove the product's safety and efficacy. A full NDA may also need to
be submitted for a drug product with a previously approved active ingredient if,
among other things, the drug will be used to treat an indication for which the
drug was not previously approved, or if the abbreviated procedure discussed
below is otherwise not available. A manufacturer intending to conduct clinical
trials in humans for a new drug may be required first to submit a Notice of
Claimed Investigational Exception for a New Drug, or IND, to the FDA containing
information relating to preclinical and clinical studies. INDs and full NDAs may
be required to be filed to obtain approval of certain of our products, including
those that do not qualify for abbreviated application procedures. The full NDA
process, including clinical development and testing, is expensive and time
consuming.

The Drug Price Competition and Patent Restoration Act of 1984, known as the
Waxman-Hatch Act, established ANDA procedures for obtaining FDA approval for
generic versions of many non-biological drugs for which patent or marketing
exclusivity rights have expired and which are bioequivalent to previously
approved drugs. "Bioequivalence" for this purpose, with certain exceptions,
generally means that the proposed generic formulation is absorbed by the body at
the same rate and extent as a previously approved "reference drug." Approval to
manufacture these drugs is obtained by filing abbreviated

12

applications, such as ANDAs. As a substitute for clinical studies, the FDA
requires data indicating the ANDA drug formulation is bio-equivalent to a
previously approved reference drug among other requirements. Analogous
abbreviated application procedures apply to antibiotic drug products that are
bio-equivalent to previously approved antibiotics. The advantage of the ANDA
approval mechanism, compared to an NDA, is that an ANDA applicant is not
required to conduct preclinical and clinical studies to demonstrate that the
product is safe and effective for its intended use and may rely, instead, on
studies demonstrating bio-equivalence to a previously approved reference drug.

In addition to establishing ANDA approval mechanisms, the Waxman-Hatch 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. These provisions do
not delay or otherwise affect the approvability of full NDAs even when effective
ANDA approvals are not available. For drugs covered by patents, patent extension
may be provided for up to five years as compensation for reduction of the
effective life of the patent resulting from time spent in conducting clinical
trials and in FDA review of a drug application.

There has been substantial litigation in the biomedical, biotechnology and
pharmaceutical industries with respect to the manufacture, use and sale of new
products that are the subject of conflicting patent rights. One or more patents
cover most of the proprietary products for which we are developing generic
versions. When we file an ANDA for such drug products, we will, in most cases,
be required to certify to the FDA that any patent which has been listed with the
FDA as covering the product is invalid or will not be infringed by our sale of
our product. Alternatively, we could certify that we would not market our
proposed product until the applicable patent expires. A patent holder may
challenge a notice of noninfringement or invalidity by filing suit for patent
infringement, which would prevent FDA approval until the suit is resolved or
until at least 30 months has elapsed (or until the patent expires, whichever is
earlier). Should any entity commence a lawsuit with respect to any alleged
patent infringement by us, the uncertainties inherent in patent litigation would
make the outcome of such litigation difficult to predict.

In addition to marketing drugs which are subject to FDA review and
approval, we market products under (a) certain "grandfather" clauses of the FDCA
that exempt certain categories of drugs from some or all pre-market approval
requirements, and (b) additional statutory and regulatory exceptions from pre-
market approval requirements that apply to certain drug products that fall
outside of the legal definition of a "new drug." A determination as to whether a
particular product does or does not require pre-market NDA or ANDA approval can
involve numerous complex considerations. The FDA has published a Compliance
Policy Guide that recognizes the marketing of certain categories of drug
products without an approved NDA or ANDA as long as those products are not
significantly different in formulation than products marketed before November
13, 1984. With respect to these products, any enforcement action initiated by
the FDA would typically affect all similarly situated products at the same time
and in a similar manner. If a product is significantly different from all
products marketed before November 13, 1984 or falls outside of the scope of the
Compliance Guide or raises significant new questions of safety or effectiveness,
however, the FDA could make a determination whether or not the new drug
provisions are applicable to it without first implementing the procedures called
for by the policy guide and could single out the product for immediate
regulatory action, including seizure or injunction against further marketing. We
list all of our marketed drug products, as required, with the FDA. We believe
that each of our generic products which has been marketed without FDA approval
qualifies for deferral of regulatory action under the Compliance Policy Guide or
under other agency policies. The FDA has initiated no regulatory or judicial
proceeding to prevent the marketing of any of these products. However, if a
determination is made by the FDA that a particular drug requires an approved NDA
or ANDA, we may be required to cease distribution of the product until such
approval is obtained.

13

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 Drug Enforcement Agency,
or DEA, and similar state and local regulatory authorities if they handle
controlled substances, and with the EPA and similar state and local regulatory
authorities if they generate toxic or dangerous wastes. Noncompliance with
applicable requirements can result in fines, recall or seizure of products,
total or partial suspension of production and distribution, refusal of the
government to enter into supply contracts or to approve NDA's, ANDA's or other
applications and criminal prosecution. The FDA also has the authority to revoke
for cause drug approvals previously granted.

The Prescription Drug Marketing Act, or PDMA, which amended various
sections of the FDCA, requires, among other things, state licensing of wholesale
distributors of prescription drugs under federal guidelines that include minimum
standards for storage, handling and record keeping. It also imposes detailed
requirements on the distribution of prescription drug samples 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.

For international markets, a pharmaceutical company is subject to
regulatory requirements, inspections and product approvals substantially the
same as those in the United States. In connection with any future marketing,
distribution and license agreements that we may enter, our licensees may accept
or assume responsibility for such foreign regulatory approvals. The time and
cost required to obtain these international market approvals may be greater or
lesser than those required for FDA approval.

Product development and approval within this regulatory framework take a
number of years, involve the expenditure of substantial resources and is
uncertain. Many drug products ultimately do not reach the market because they
are not found to be safe or effective or cannot meet the FDA's other regulatory
requirements. In addition, the current regulatory framework may change and
additional regulation may arise at any stage of our product development that may
affect approval, delay the submission or review of an application or require
additional expenditures by us. We may not be able to obtain necessary regulatory
clearances or approvals on a timely basis, if at all, for any of our products
under development, and delays in receipt or failure to receive such clearances
or approvals, the loss of previously received clearances or approvals, or
failure to comply with existing or future regulatory requirements could have a
material adverse effect on our business.

EMPLOYEES

As of March 31, 2002, we employed a total of 860 employees. We are party to
a collective bargaining agreement covering 149 employees that will expire
December 31, 2004. We believe that our relations with our employees are good.

14

ENVIRONMENT

The Company does not expect that compliance with Federal, state or local
provisions regulating the discharge of materials into the environment or
otherwise relating to the protecting of the environment will have a material
effect on its capital expenditures, earnings or competitive position.

15

ITEM 2. PROPERTIES

Our corporate headquarters is located at 2503 South Hanley Road in
St. Louis County, Missouri, and contains approximately 25,000 square
feet of floor space. We have a lease on the building for a period of
ten years expiring December 31, 2006, with one five-year option to
renew.

In addition, we lease or own the facilities shown in the following
table:

- ----------
(1) Three five-year options.

(2) Two five-year options.

Properties used in our operations are considered suitable for the
purposes for which they are used and are believed to be adequate to
meet our Company's needs for the reasonably foreseeable future.
However, we will consider leasing or purchasing additional facilities
from time to time, when attractive facilities become available, to
accommodate the consolidation of certain operations and to meet
future expansion plans.

ITEM 3. LEGAL PROCEEDINGS

ETHEX is a defendant in a lawsuit styled Healthpoint, Ltd. v. ETHEX Corporation,
pending in federal court in the Western District of Texas, San Antonio Division.
The suit was filed by Healthpoint, Ltd., or Healthpoint, on August 3, 2000 and
later was joined by companies affiliated with Healthpoint. In general, the
plaintiffs allege that ETHEX's promotion of its Ethezyme(TM) product as an
alternative to Healthpoint's Accuzyme(R) product resulted in false advertising
and misleading statements under various federal and state laws, and constituted
unfair competition and misappropriation of trade secrets. On September 28, 2001,
the jury returned verdicts, in the form of special interrogatories, against
ETHEX on certain false advertising, unfair competition, and misappropriation
claims. The jury awarded compensatory and punitive damages totaling $16.5
million. In addition, Healthpoint has asked the court to enter judgment in
accordance with the jury's verdict with respect to compensatory and punitive
damages. Healthpoint has also asked the court to award $10 million in enhanced
damages ($2.7 million more than the jury recommended), and attorneys fees which
are believed to be in excess of $1 million. We and our counsel believe that the
jury's recommended award is excessive and is not sufficiently supported by the
facts or the law. We intend to vigorously appeal any adverse judgment the court
may enter. In the event an adverse decision against us occurs, appropriate
provision for liability, if any, would be provided for in our financial
statements at the time of the court's ruling. We have filed motions asking the
court to overrule the jury's verdicts or, in the alternative, grant a new trial.
However, we can offer no assurances that we will prevail or that the jury's
verdicts will be reduced or set aside. If we do not prevail and are ordered by
the court to pay damages in accordance with the jury's verdicts or the higher
amount sought by Healthpoint, our profitability would be impaired and our
liquidity reduced.

We previously manufactured two low volume pharmaceutical products that
contained phenylpropanolame, or PPA, and that were discontinued in 2000 and
2001, respectively. We have been named one of several defendants in two product
liability lawsuits in federal court in Nevada and Kentucky, respectively,
involving PPA. These two lawsuits have been transferred to the nationwide,
multi-district litigation for PPA claims now pending in the U.S. District Court
for the Western District of Washington. Each lawsuit alleges bodily injury,
wrongful death, economic injury, punitive damages, loss of consortium and/or
loss of services from the use of our manufactured, marketed and/or distributed
pharmaceuticals containing PPA that have since been discontinued and/or
reformulated to exclude PPA. Discovery in these cases is ongoing. We believe
that we have substantial defenses to these claims, though the ultimate outcome
of these cases and the potential material affect on us cannot be determined.

We are being defended and indemnified in these two PPA lawsuits by our
primary commercial general liability insurer subject to aggregate
products-completed operations policy limits in the amount of $10 million and
subject to a reservation of rights. Our product liability-completed operations
coverage was obtained on a claims made basis and provides coverage for
judgments, settlements and defense costs arising from product liability claims.
However, such insurance may not be adequate to remove the risk from some or all
product liability claims, including PPA claims, and is subject to the
limitations described in the terms of the policies. Furthermore, in accordance
with a standard industry exclusion, our product liability coverage for PPA
claims will expire on June 15, 2002. We are currently in the process of
reviewing our product liability insurances and expect to be able to obtain new
coverage soon, however, we may not be able to obtain product liability insurance
in the future for PPA claims or other product liability claims with adequate
coverage limits at commercially reasonable prices. Consequently, as of June 16,
2002, we may have to provide for legal defense costs and indemnity payments
involving PPA claims and/or other product liability claims on a going forward
basis. From time to time in the future, we may be subject to further litigation
resulting from products containing PPA that we formerly manufactured and sold
and we intend to vigorously defend any claims that may be raised in the current
and future litigations.

From time to time, we become involved in various legal matters in addition to
the above described matters, that we consider to be in the ordinary course of

17

business. While we are not presently able to determine the potential liability,
if any, related to such matters, we believe none of such matters, individually
or in the aggregate, will have a material adverse effect on our financial
position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No such matters were submitted during the fourth quarter of the
Company's fiscal year ended March 31, 2002.

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.

The term of office for each executive officer of the Company expires
at the next annual meeting of the Board of Directors or at such time
as his successor has been elected and qualified.

- ----------

(1) Victor M. Hermelin is the father of Marc S. Hermelin.

18

PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS

a) PRINCIPAL MARKET

Our Class A Common Stock and Class B Common Stock are traded on the
New York Stock Exchange under the symbols KV.A and KV.B,
respectively.

b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK

The number of holders of record of Class A and Class B Common Stock
as of June 6, 2002 was 693 and 478, respectively (not separately
counting shareholders whose shares are held in "nominee" or "street"
names, which are estimated to represent approximately 6,000 of Class
A and of Class B additional shareholders combined).

c) STOCK PRICE AND DIVIDEND INFORMATION

The high and low closing sales prices of our Class A and Class B
Common Stock, as reported on the New York Stock Exchange, during each
quarter of fiscal 2002 and 2001 were as follows:

CLASS A COMMON STOCK

CLASS B COMMON STOCK

All per share data reflects the three-for-two stock split effected in
the form of a 50% stock dividend that occurred on September 7, 2000.

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. Undeclared and unaccrued cumulative preferred
dividends were approximately $2.2 million, or $9.14 per share, at
March 31, 2000 and 2001 and $366,000, or $9.14 per share, at March
31, 2002. Also, under the terms of our credit agreement, we may not
pay cash dividends in excess of 25% of the prior year's consolidated
net income. Dividends of $70,000 and $420,000 were paid in fiscal
2002 and 2001, respectively, on 40,000 and 240,000 shares of
Cumulative Convertible Preferred Stock, respectively. 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.

19

ITEM 6. SELECTED FINANCIAL DATA

(a) Certain reclassifications to prior years' financial information have
been made to conform to the fiscal 2002 presentation. These
reclassifications include amounts associated with tradeshow allowances
and administrative cost rebates paid to resellers which were previously
classified as selling and administrative expenses that have been
reclassified as a reduction of net revenues.

(b) Net income in fiscal 2000 and 1999 includes non-recurring gains
associated with $7.0 million and $13.3 million in arbitration awards,
respectively. The awards net of applicable income taxes and expenses
(see Note 16 of Notes to Consolidated Financial Statements) were as
follows:

(c) Previously reported amounts give effect to the three-for-two stock
splits effected in the form of a 50% stock dividend that occurred on
September 7, 2000 and April 17, 1998.

20

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, AND
LIQUIDITY AND CAPITAL RESOURCES

Except for the historical information contained herein, the following
discussion contains forward-looking statements that are subject to known and
unknown risks, uncertainties, and other factors that may cause our actual
results to differ materially from those expressed or implied by such
forward-looking statements. These risks, uncertainties and other factors are
discussed throughout this report and specifically under the caption "Cautionary
Statement Regarding Forward-Looking Information." In addition, the following
discussion and analysis of the financial condition and results of operations
should be read in conjunction with "Selected Financial Data" and our
consolidated financial statements and notes thereto appearing elsewhere in this
Form 10-K.

BACKGROUND

We develop, acquire, manufacture and market technologically distinguished
branded and generic prescription pharmaceutical products. We also enter into
licensing agreements with pharmaceutical marketing companies to develop and
commercialize additional brand name products. Until the mid-1990's, we derived
most of our revenues from our manufacturing and licensing activities. Today, we
derive most of our revenues from our product sales. While we expect to continue
to enter into new licensing agreements, we emphasize the development or
acquisition and marketing of technologically distinguished prescription
products, whether branded or generic, through our Ther-Rx and ETHEX business
lines, as well as specialty raw materials through Particle Dynamics.

In 1990, we established our ETHEX business to market and distribute
technologically distinguished generic and non-branded alternative drugs that use
our proprietary technologies. Net revenues from ETHEX have increased from $13.5
million in fiscal 1994 to $141.0 million in fiscal 2002.

We launched our Ther-Rx business in 1999 to market branded pharmaceutical
products. We acquired and introduced our first two of seven Ther-Rx branded
products, Micro-K(R) and PreCare(R), in March and August 1999, respectively.
Ther-Rx has also introduced four internally developed product line extensions to
PreCare(R) since October 1999, including PrimaCare(TM), 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. In June 2000, we
launched our first NDA approved product, Gynazole-1(R), a one-dose prescription
cream treatment for vaginal yeast infections. Net revenues from Ther-Rx have
increased from $1.8 million in fiscal 1999 to $40.4 million in fiscal 2002.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our significant accounting policies are described in Note 2 to our
consolidated financial statements. These financial statements have been prepared
in accordance with U.S. generally accepted accounting principles. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent liabilities. On an on-going
basis, we evaluate our estimates, including those related to the allowance for
doubtful accounts receivable, allowance for inventories, sales allowances and
useful life or impairment of other intangibles. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis of
judgments regarding the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

REVENUE RECOGNITION AND SALES ALLOWANCES. We recognize revenue at the time
product is shipped to customers. We establish sales provisions for estimated
chargebacks, discounts, rebates, returns, pricing adjustments and other sales
allowances concurrently with the recognition of revenue. The sales provisions

22

are established based upon consideration of a variety of factors, including but
not limited to, actual return and historical experience by product type, the
number and timing of competitive products approved for sale, the expected market
for the product, estimated customer inventory levels by product, price declines
and current and projected economic conditions and levels of competition. Actual
product returns, chargebacks and other sales allowances incurred are, however,
dependent upon future events. We continually monitor the factors that influence
sales allowance estimates and make adjustments to these provisions when
management believes that actual product returns, chargebacks and other sales
allowances may differ from established allowances.

ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE. We maintain an allowance for
doubtful accounts receivable for estimated losses resulting from the inability
of customers to make required payments. We extend credit on an uncollateralized
basis primarily to wholesale drug distributors and retail pharmacy chains
throughout the United States. Management specifically analyzes accounts
receivable, historical bad debts, customer concentrations, customer
credit-worthiness, percentage of accounts receivable by aging category and
changes in customer payment terms when evaluating the adequacy of the allowance
for doubtful accounts. We also perform ongoing credit evaluations of our
customers. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. Historically, our actual losses from uncollectible
accounts have been insignificant.

ALLOWANCE FOR INVENTORIES. Our inventories are stated at the lower of cost
or market, with cost determined on the first-in, first-out basis. In evaluating
whether inventory is stated at the lower of cost or market, management considers
such factors as the amount of inventory on hand and in the distribution channel,
estimated time required to sell such inventory, remaining shelf life and current
and expected market conditions, including levels of competition. As appropriate,
we make provisions to reduce inventories to their net realizable value.

OTHER INTANGIBLE ASSETS. Other intangible assets consist of brand product
rights purchased from other pharmaceutical companies, all of which are being
amortized over 20-year periods. The amortization periods for product rights are
based on our assessment of various factors impacting estimated useful lives and
cash flows of the acquired products. These factors include the product's
position in its life cycle, competitive positioning, the existence or absence of
like products in the market and various competitive and technical issues. Other
intangible assets also consist of patents and trademarks, which are being
amortized over periods ranging from five to 17 years. As of March 31, 2002, the
net carrying amount of other intangibles was $40.7 million. Amortization is
calculated using the straight-line method over the estimated useful life.
Intangible assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In accordance with Statement of Financial Accounting Standards, or
SFAS, No. 142, Goodwill and Other Intangible Assets, we are in the process of
reassessing the useful lives of our intangible assets, determining which
intangible assets, if any, have indefinite lives and evaluating the extent of
impairment, if any, of indefinite-lived intangible assets that may need to be
recorded (see "-- Recently Issued Accounting Standards" below for a discussion
on SFAS 142). We do not expect that the adoption of SFAS 142 will have a
material effect on our financial condition or results of operations.

23

RESULTS OF OPERATIONS

In the following table, we have summarized our historical results of
operations as a percentage of net revenues. You should read this information in
conjunction with our consolidated financial statements and related notes.

FISCAL 2002 COMPARED TO FISCAL 2001

REVENUES. Net revenues increased $26.3 million, or 14.8%, to $204.1
million in fiscal 2002 compared to $177.8 million in fiscal 2001. The increase
in net revenues was due to increased sales of branded products, specialty
generics and specialty materials.

Branded product sales increased $15.2 million, or 60.4%, to $40.4 million
in fiscal 2002 compared to $25.2 million in fiscal 2001. Branded product sales
comprised 19.8% of net revenues in fiscal 2002 compared to 14.2% of net revenues
in fiscal 2001. The increase in branded product sales was due to increased sales
volume among all product categories. Sales from the women's health care family
of products increased $11.3 million, or 69.2%, in fiscal 2002. Included in
women's health care is the PreCare(R) family of prenatal products, which
contributed $9.1 million of incremental sales in fiscal 2002 due to
volume-related increases in market share. During the fourth quarter of fiscal
2002, Ther-Rx introduced PrimaCare(TM), a prescription prenatal/postnatal
multivitamin and mineral supplement with essential fatty acids. We also market
Gynazole-1(R), a vaginal antifungal product introduced in the first quarter of
fiscal 2001. Due to its continued growth in market share, Gynazole-1(R) sales
increased $2.2 million, or 38.1%, in fiscal 2002. Sales from the cardiovascular
disease product line increased $4.0 million, or 47.8%, in fiscal 2002 as
customer inventories returned to normal levels.

Specialty generic product sales increased $8.9 million, or 6.7%, to $141.0
million in fiscal 2002 compared to $132.2 million in fiscal 2001. Specialty
generic product sales comprised 69.1% of net revenues in fiscal 2002 compared to
74.3% of net revenues in fiscal 2001. The increase in specialty generic sales
was primarily due to a $17.8 million increase in the sales volume of existing
products coupled with

24

$10.8 million of incremental sales from new products. The cardiovascular product
line, which comprised 45.4% of specialty generic sales, accounted for $7.2
million of the total sales growth. We introduced 14 new products in fiscal 2002.
The volume growth experienced by specialty generics was partially offset by
$19.7 million of product price erosion that resulted from normal and expected
competitive pricing pressures on certain products.

Specialty raw material product sales increased $2.5 million, or 14.4%, to
$19.6 million in fiscal 2002 compared to $17.1 million in fiscal 2001. Specialty
raw material product sales comprised 9.6% of net revenues in both fiscal 2002
and fiscal 2001. The increase in specialty raw material product sales was
primarily due to sales of new products and increased sales of existing products.

GROSS PROFIT. Gross profit increased $16.6 million, or 15.5%, to $123.7
million in fiscal 2002 compared to $107.1 million in fiscal 2001. The increase
in gross profit was primarily attributable to the increased level of product
sales. Gross profit as a percentage of net revenues increased slightly to 60.6%
in fiscal 2002 compared to 60.3% in fiscal 2001. The higher gross profit
percentage in fiscal 2002 resulted primarily from a shift in the mix of product
sales toward higher margin branded products comprising a larger percentage of
net revenues and favorable cost variances associated with increased production.
The positive impact of these two factors was partially offset by the price
erosion in certain specialty generic products discussed above.

OPERATING EXPENSES. Research and development expense increased $1.4
million, or 15.4%, to $10.7 million in fiscal 2002 compared to $9.3 million in
fiscal 2001. The increase in research and development expense was primarily due
to higher costs associated with clinical testing connected to our internal
product development efforts and higher personnel expenses related to expansion
of our research and development staff. Research and development expense as a
percentage of net revenues was flat at 5.2% in fiscal 2002 compared to fiscal
2001. In April 2002, we announced that we had received favorable results from
screening studies on a number of products utilizing one of our newest drug
delivery technologies. Because of the significant revenue and profit potential
of these products, we plan to increase our research and development expenditures
by approximately 75% to 80% in fiscal 2003 over fiscal 2002 levels.

Selling and administrative expense increased $3.8 million, or 6.7%, to
$61.3 million in fiscal 2002 compared to $57.5 million in fiscal 2001. The
increase in selling and administrative expense was due primarily to an increase
in personnel costs associated with administration and branded marketing. Selling
and administrative expense as a percentage of net revenues decreased to 30.0% in
fiscal 2002 compared to 32.4% in fiscal 2001.

OTHER EXPENSE (INCOME). Interest expense decreased $0.7 million, or 67.4%,
to $0.4 million in fiscal 2002 compared to $1.1 million in fiscal 2001. The
decrease in interest expense was due to a corresponding reduction in debt.

NET INCOME. As a result of the factors discussed above, net income
improved by $7.8 million, or 33.2%, to $31.5 million in fiscal 2002 compared to
$23.6 million in fiscal 2001.

FISCAL 2001 COMPARED TO FISCAL 2000

REVENUES. Net revenues increased $35.0 million, or 24.5%, to $177.8
million in fiscal 2001 compared to $142.7 million in fiscal 2000. The increase
in net revenues was due primarily to higher sales of specialty generic and
branded products.

Branded product sales increased $1.7 million, or 7.4%, to $25.2 million in
fiscal 2001 compared to $23.5 million in fiscal 2000. The increase in sales was
due to the introduction of Gynazole-1(R), a vaginal antifungal product, at the
end of the first quarter of the fiscal year and higher sales of existing women's
health care products. The introduction of Gynazole-1(R) contributed $6.0 million
of incremental sales in fiscal 2001 due to increases in market share. Since its
June 2000 launch, the product has captured 13.0% of total prescriptions written
for vaginal antifungal creams. Existing women's health care products increased
$5.3 million, or 101%, in fiscal 2001, due primarily to higher volume associated
with increased market share of the PreCare(R) brand prenatal vitamin line.
Including Gynazole-1(R), total sales of women's health

25

care products increased 216% in fiscal 2001. These increases were partially
offset by lower sales of the Micro-K(R) cardiovascular potassium supplement.
Micro-K(R) sales were down $9.6 million in fiscal 2001 compared to fiscal 2000
as a result of speculative customer buying during the latter half of the prior
year in anticipation of a year-end price increase.

Specialty generic product sales increased $34.0 million, or 34.7%, to
$132.2 million in fiscal 2001 compared to $98.1 million in fiscal 2000. The
increase was due to incremental volume from new products introduced in fiscal
2001 ($18.1 million), a full year of sales of products introduced in fiscal 2000
($2.2 million), net volume increases across the existing product line ($8.2
million), and increased pricing ($5.5 million), primarily on cardiovascular
products. We introduced 10 new products in fiscal 2001. The increase in volume
of the existing products was attributable to higher generic substitution rates,
increased sales associated with trade shows and price increase buy-ins.

Specialty raw material product sales were practically flat at $17.1 million
in fiscal 2001 compared to fiscal 2000 due to a soft market in the general
industry.

Contract services and other revenues declined $0.7 million, or 16.5%, to
$3.3 million in fiscal 2001 compared to $4.0 million in fiscal 2000. The
decrease in contract services and licensing revenues was primarily due to lower
contract manufacturing volume, reflecting a smaller customer base as we
purposefully have de-emphasized lower margin contract manufacturing in our
business strategy.

GROSS PROFIT. Gross profit increased $27.8 million, or 35.1%, to $107.1
million in fiscal 2001 compared to $79.3 million in fiscal 2000. The increase in
gross profit was primarily attributable to the increased level of product sales.
Gross profit as a percentage of net revenues increased to 60.3% in fiscal 2001
compared to 55.5% in fiscal 2000. The higher gross profit percentage in fiscal
2001 was due primarily to favorable changes in product mix, lower costs within
the specialty generic line, and higher pricing in the branded and generic line.
Lower costs in specialty generics were due to favorable cost variances from
increased volume and lower prices for material and ingredients. Of the 4.8
percentage point net increase, changes in product mix accounted for 2.4%, higher
pricing accounted for 1.7% and lower costs accounted for 0.7% of the
improvement.

OPERATING EXPENSES. Research and development expense increased $1.2
million, or 15.4%, to $9.3 million in fiscal 2001 compared to $8.0 million in
fiscal 2000. The increase in research and development expense was primarily due
to payments made in connection with product co-development agreements and
expansion of the research and development staff. Research and development
expense as a percentage of net revenues decreased to 5.2% in fiscal 2001
compared to 5.6% in fiscal 2000.

Selling and administrative expense increased $22.7 million, or 65.4%, to
$57.5 million in fiscal 2001 compared to $34.7 million in fiscal 2000. The
increase was due primarily to higher corporate administrative expenses,
incremental marketing expenses in support of the specialty generics product line
and continued investment in expanding the sales force for the branded products
marketing division. Selling and administrative expense as a percentage of net
revenues increased to 32.4% in fiscal 2001 compared to 24.3% in fiscal 2000.
Corporate administrative expense was higher due to increases in payroll-related
expenses of $2.7 million associated with expanding our management and
administrative infrastructure to keep pace with our continued growth, higher
professional fees of $2.1 million for various legal and consulting services and
increased lease expense of $1.0 million from the acquisition of a leased
facility for future expansion of our distribution operations and administrative
offices. Marketing and selling expense associated with branded products
increased $14.7 million in fiscal 2001, due primarily to expenses associated
with the increase in the branded sales force and increased sampling costs in
connection with the introduction of Gynazole-1(R) in fiscal 2001.

Amortization expense was primarily attributable to the product acquisitions
of Micro-K(R) and Pre-Care(R). These product acquisitions are being amortized on
a straight-line basis over 20 years and there was no change compared to the
prior year.

26

OTHER INCOME (EXPENSE). Interest expense decreased $0.9 million, or 44.5%,
to $1.1 million in fiscal 2001 compared to $2.0 million in fiscal 2000. The
decrease in interest expense was due to lower long-term debt outstanding on our
line of credit.

Other income decreased $6.7 million in fiscal 2001 due primarily to a
non-recurring gain related to an arbitration award of $6.1 million received in
fiscal 2000 and a decrease in interest income of $0.6 million. See Note 16 to
our consolidated financial statements.

NET INCOME. As a result of the factors described above, net income
decreased $0.7 million, or 2.8%, to $23.6 million in fiscal 2001 compared to
$24.3 million in fiscal 2000. Excluding the effect of the non-recurring gain,
net income increased $3.2 million, or 15.6%, to $23.6 million in fiscal 2001
compared to $20.4 in fiscal 2000.

LIQUIDITY AND CAPITAL RESOURCES

Our cash and cash equivalents and working capital were $12.1 million and
$81.4 million, respectively, at March 31, 2002, compared to $4.1 million and
$50.9 million, respectively, at March 31, 2001. The increasing level of net
income associated with higher product sales continues to be the primary source
of operating capital which we utilize to fund our businesses. The net cash flow
from operating activities was $15.9 million in fiscal 2002 compared to $17.1
million in fiscal 2001. The 6.9% decline in operating cash flow resulted from an
increase in receivables, offset partially by higher net income and increased
accounts payable and accrued liabilities. The increase in receivables was
primarily due to certain delayed customer payments, which were collected
subsequent to year-end, and the timing of wholesaler purchases within the fourth
quarter of fiscal 2002. Subsequent to year end, through May 31, 2002, we have
collected approximately $46.0 million of the March 31, 2002 accounts receivable
balance outstanding. The increase in accounts payable reflected increased trade
payables, which resulted from the timing of various material purchases, while
the increase in accrued liabilities was attributable to a higher current tax
liability.

Capital expenditures of $8.5 million in fiscal 2002 were funded by net cash
flows from operating activities. Our investment in capital assets was primarily
for purchasing machinery and equipment to upgrade and expand our pharmaceutical
manufacturing and distribution capabilities. We believe we have adequate
resources to fund the estimated cost of $3.1 million to complete
construction-in-progress at March 31, 2002.

Long-term debt decreased to $5.1 million at March 31, 2002 compared to $5.8
million at March 31, 2001. The decrease resulted from principal payments made
during fiscal 2002. In December 2001, we refinanced a $2.5 million building
mortgage that was due in June 2002. The building mortgage bears interest at
7.57% and is due in December 2006.

During December 2001, we increased our revolving credit agreement with
LaSalle National Bank to $60.0 million. The revised agreement provides for the
continuation of our $40.0 million revolving line of credit along with a
supplemental credit line of $20.0 million for financing acquisitions. The
revolving credit lines are unsecured. At March 31, 2002, we had no borrowings
outstanding under either credit facility and $3.6 million in open letters of
credit issued under the revolving credit line.

The following table summarizes our contractual obligations at March 31,
2002 (in thousands):

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

27

development expenditures, product development activities and expansion of
marketing capabilities for the branded pharmaceutical business. However, 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
business. We intend to use our available cash to help in funding any
acquisitions or investments. Cash has been invested in short-term, highly liquid
instruments. We may also use funds available under our credit facilities, or
financing sources that subsequently become available, including the future
issuances of additional debt or equity securities, to fund these acquisitions or
investments. If we were to fund one or more such acquisitions or investments,
our capital resources, financial condition and results of operations could be
materially impacted in future periods.

INFLATION

Although at reduced levels in recent years, inflation continues to apply
upward pressure on the cost of goods and services used by us. However, we
believe that the net effect of inflation on our operations has been minimal
during the past three years. In addition, changes in the mix of products sold
and the effect of competition has made a comparison of changes in selling prices
less meaningful relative to changes in the overall rate of inflation over the
past three years.

RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board, or FASB, issued
SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible
Assets. SFAS 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interest method of accounting for business
combinations initiated after June 30, 2001. SFAS 141 also requires that we
recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, that upon
adoption of SFAS 142, we reclassify the carrying amounts of certain intangible
assets into or out of goodwill based on certain criteria in SFAS 141.

SFAS 142 addresses accounting for intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) at acquisition. The statement also addresses accounting
for goodwill and other intangible assets after they have been initially
recognized in the financial statements. Intangible assets that have indefinite
useful lives and goodwill will no longer be amortized, but instead must be
tested at least annually for impairment using fair values. Intangible assets
that have finite useful lives will continue to be amortized over their estimated
useful lives. The provisions of SFAS 142 are effective for fiscal years
beginning after December 15, 2001.

Our previous business combinations were accounted for using the purchase
method. As of March 31, 2002, the net carrying amount of goodwill and other
intangible assets was $0.6 million and $40.7 million, respectively. In
accordance with the adoption of SFAS 142, amortization of goodwill ceased
effective April 1, 2002. Amortization of goodwill during the year ended March
31, 2002 was $55,000.

At this time, we are reassessing the useful lives of previously recognized
intangible assets, determining which intangible assets, if any, have indefinite
lives and evaluating the extent of impairment, if any, of goodwill and
indefinite-lived intangible assets that may need to be recorded. Amortization of
other intangible assets was $2.3 million during the year ended March 31, 2002.
We do not expect that the adoption of SFAS 142 will have a material effect on
our financial condition or results of operations.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002. We do not believe the adoption of this
statement will have a material impact on our results of operations or financial
position.

28

In August 2001, the FASB issued SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. It supersedes
SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, and certain provisions of APB Opinion No. 30,
Reporting the Effects of Disposal of a Segment of a Business and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions, for the disposal of
a segment of a business. SFAS 144 establishes a single accounting model, based
on the framework established in SFAS 121, for long-lived assets to be disposed
of by sale and resolves other implementation issues related to SFAS 121. This
statement is effective for fiscal years beginning after December 15, 2001. Based
on our current operations, we do not expect the adoption of SFAS 144 to have a
material impact on our results of operations or financial position.

In November 2001, the Emerging Issues Task Force issued EITF 01-09,
"Accounting for Consideration Given by a Vendor to a Customer or a Reseller of
the Vendor's Products." EITF 01-09 codified and reconciled the task force's
consensuses on prior issues and identified other issues related to various
aspects of the accounting for consideration given by a vendor to a customer or a
reseller of the vendor's products. EITF 01-09 requires certain items we
previously had reported as selling expenses to be reclassified as reductions of
revenues in the income statement. EITF 01-09 is effective for reporting periods
beginning after December 15, 2001 and we adopted it for the fourth quarter of
our fiscal year ended March 31, 2002. In connection with the adoption and to
conform to current period presentation, we reclassified certain prior period
items which had been included in selling and administrative expenses to reduce
net revenues. However, the reclassification did not affect reported net income
or net sales growth rates.

ITEM 7A. QUANTITIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

29

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Stockholders and Board of Directors
of K-V Pharmaceutical Company

We have audited the consolidated balance sheets of K-V Pharmaceutical Company as
of March 31, 2002 and 2001 and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 at March 31, 2002 and 2001, and the results of its operations and its
cash flows for each of the three years in the period ended March 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.

/s/ BDO SEIDMAN, LLP

Chicago, Illinois
May 24, 2002

30

K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See Accompanying Notes to Consolidated Financial Statements
31

K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

See Accompanying Notes to Consolidated Financial Statements
32

K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See Accompanying Notes to Consolidated Financial Statements
33

K-V PHARMACEUTICAL COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See Accompanying Notes to Consolidated Financial Statements
34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

1. DESCRIPTION OF BUSINESS

K-V Pharmaceutical Company ("KV" or the "Company") is a fully integrated
pharmaceutical company that develops, manufactures, markets and sells
technologically distinguished branded and generic prescription pharmaceutical
products. The Company was incorporated in 1971 and is a leader in the
development of advanced drug delivery and formulation technologies that are
designed to enhance therapeutic benefits of existing drug forms. KV 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

Principles of Consolidation

The consolidated financial statements include the accounts of KV and its
wholly-owned subsidiaries. All material intercompany accounts and transactions
have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results in subsequent periods may differ from the
estimates and assumptions used in the preparation of the accompanying
consolidated financial statements.

The most significant estimates made by management include the allowance for
doubtful accounts receivable, inventory reserves, sales allowances, the useful
lives of intangible assets, and the cash flows used in evaluating long-lived
assets for impairment. Management periodically evaluates estimates used in the
preparation of the consolidated financial statements and makes changes on a
prospective basis when adjustments are necessary.

Cash Equivalents

Cash equivalents consist of highly liquid investments with original
maturities of three months or less at the date of purchase. At March 31, 2001
and 2002, cash equivalents totaled $3,682 and $10,350, respectively.

Inventories

Inventories are stated at the lower of cost or market, with the cost
determined on the first-in, first-out (FIFO) basis.

Property and Equipment

Property and equipment are stated at cost. Depreciation 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.

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Intangibles and Other Assets

Product rights associated with the Micro-K(R) and PreCare(R) product
acquisitions are stated at cost, less accumulated amortization, and are
amortized on a straight-line basis over 20 years. Goodwill resulting from the
acquisition of the Company's Particle Dynamics, Inc. ("PDI") subsidiary is
amortized on a straight-line basis over 40 years. All other intangible assets
and deferred charges are being amortized on a straight-line basis over periods
varying from 5 to 17 years.

Long-Lived Assets

The Company periodically evaluates whether events or changes in
circumstances have occurred that may indicate that the remaining net book value
of a long-lived asset may not be recoverable. Recoverability is determined by
comparing the carrying amount of an 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 asset, an impairment loss is recognized based on
the excess of the carrying amount over the estimated fair value of the asset.
Any impairment amount is charged to operations.

Revenue Recognition

Revenue is recognized at the time product is shipped to customers. Net
revenues consist of gross sales to customers less provisions for expected
customer returns, rebates, discounts, chargebacks, and other sales allowances.
Sales provisions totaled $47,415, $85,881 and $98,592 for the years ended March
31, 2000, 2001 and 2002, respectively. The reserve balances related to the sales
provisions totaled $26,631 and $18,958 at March 31, 2001 and 2002, respectively,
and are included in "Receivables, less allowance for doubtful accounts" in the
accompanying consolidated balance sheets.

Sales provisions for estimated chargebacks, discounts, rebates, returns,
pricing adjustments and other sales allowances are established by the Company
concurrently with the recognition of revenue. The sales provisions are
established based upon consideration of a variety of factors, including but not
limited to, actual return and historical experience by product type, the number
and timing of competitive products approved for sale, the expected market for
the product, estimated customer inventory levels by product, price declines and
current and projected economic conditions and levels of competition. Actual
product returns, chargebacks and other sales allowances incurred are, however,
dependent upon future events. 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.

The Company also enters into long-term agreements under which it assigns
marketing rights for the products it has developed to pharmaceutical marketers.
Royalties are earned based on the sale of products. Other non-refundable
payments specified in the agreements such as milestone payments and research and
development reimbursements, are recognized as income when the results or
objectives stipulated in the agreements have been achieved.

Concentration of Credit Risk

The Company extends credit on an uncollateralized basis primarily to
wholesale drug distributors and retail pharmacy chains throughout the United
States. The Company's three largest customers accounted for approximately 24%,
19% and 15%, and 29%, 25% and 12% of gross receivables at March 31, 2001 and
2002, respectively. The Company performs ongoing credit evaluations of its
customers and maintains an allowance for potential uncollectible accounts.
Historically, actual losses from uncollectible accounts have been insignificant.

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For the year ended March 31, 2000, the Company's two largest customers
accounted for 18% and 12% of gross sales. For the years ended March 31, 2001 and
2002, the Company's three largest customers accounted for 23%, 20% and 14%, and
20%, 19% and 13%, respectively, of gross sales.

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 costs funded by third parties,
are expensed in the period incurred. Payments received from third parties for
research and development are offset against expenses when the parties are
billed.

Earnings Per Share

Basic earnings per share is calculated by dividing net income available to
common shareholders for the period by the weighted average number of common
shares outstanding during the period. Diluted earnings per share is based on the
treasury stock method and is computed by dividing net income by the weighted
average common shares and common share equivalents outstanding during the
periods presented assuming the conversion of preferred shares and the exercise
of all in-the-money stock options. Common share equivalents have been excluded
from the computation of diluted earnings per share where their inclusion would
be anti-dilutive.

Income Taxes

Income taxes are accounted for under the asset and liability method where
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
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.

Stock-Based Compensation

The Company grants stock options for a fixed number of shares to employees
with an exercise price greater than or equal to the fair value of the shares at
the date of grant. As permissible under Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, the Company
elected to continue to account for stock option grants to employees in
accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees and related interpretations. APB 25 requires that
compensation cost related to fixed stock option plans be recognized only to the
extent that the fair value of the shares at the grant date exceeds the exercise
price. Accordingly, no compensation expense is recognized for stock option
awards granted to employees at or above fair value. In accordance with SFAS 123,
the Company provides disclosure of pro forma net income and earnings per share
as if the fair value based method of accounting under SFAS 123 had been applied
(see Note 12).

Fair Value of Financial Instruments

The fair values of the Company's cash and cash equivalents, receivables,
accounts payable and accrued liabilities approximate their carrying values due
to the relatively short maturity of these items. The
37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

carrying amount of all long-term financial instruments approximates their fair
value because their terms are similar to those which can be obtained for similar
financial instruments in the current marketplace.

New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible
Assets. SFAS 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interest method of accounting for business
combinations initiated after June 30, 2001. SFAS 141 also requires that the
Company recognize acquired intangible assets apart from goodwill if the acquired
intangible assets meet certain criteria. SFAS 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, that upon
adoption of SFAS 142, the Company reclassify the carrying amounts of certain
intangible assets into or out of goodwill based on certain criteria in SFAS 141.

SFAS 142 addresses accounting for intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) at acquisition. The statement also addresses accounting
for goodwill and other intangible assets after they have been initially
recognized in the financial statements. Intangible assets that have indefinite
useful lives and goodwill will no longer be amortized, but instead must be
tested at least annually for impairment using fair values. Intangible assets
that have finite useful lives will continue to be amortized over their estimated
useful lives. The provisions of SFAS 142 are effective for fiscal years
beginning after December 15, 2001.

The Company's previous business combinations were accounted for using the
purchase method. As of March 31, 2002, the net carrying amount of goodwill and
other intangible assets was $556 and $40,736, respectively. In accordance with
the adoption of SFAS 142, amortization of goodwill will cease effective April 1,
2002. Amortization of goodwill during the year ended March 31, 2002 was $55. At
this time, the Company is reassessing the useful lives of previously recognized
intangible assets, determining which intangible assets, if any, have indefinite
lives and evaluating the extent of impairment, if any, of goodwill and
indefinite-lived intangible assets that may need to be recorded. Amortization of
other intangible assets was $2,298 during the year ended March 31, 2002.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002. Management does not believe the adoption of
this statement will have a material impact on its results of operations or
financial position.

In August 2001, the FASB issued SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. It supersedes
SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, and certain provisions of APB Opinion No. 30,
Reporting the Effects of Disposal of a Segment of a Business and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions, for the disposal of
a segment of a business. SFAS 144 establishes a single accounting model, based
on the framework established in SFAS 121, for long-lived assets to be disposed
of by sale and resolves other implementation issues related to SFAS 121. This
statement is effective for fiscal years beginning after December 15, 2001. Based
on the Company's current operations, management does not expect the adoption of
SFAS 144 to have a material impact on its results of operations or financial
position.

Reclassification

Certain reclassifications to prior years' financial information have been
made to conform to the fiscal 2002 presentation. These reclassifications
included amounts associated with tradeshow allowances and
38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

administrative cost rebates paid to resellers which were previously classified
as selling and administrative expense that have been reclassified as a reduction
of net revenues.

3. ACQUISITIONS

On August 2, 1999, the Company acquired the world-wide rights and trademark
for the prescription prenatal product, PreCare(R), from UCB Pharma for $8,433.
The purchase price was funded by a $3,000 cash payment, a $933 note and $4,500
in Class A common stock. The product right intangible asset related to the
acquisition is being amortized on a straight-line basis over 20 years. The pro
forma results related to the PreCare(R) product are not material to the
consolidated financial statements for comparative purposes.

4. INVENTORIES

Inventories as of March 31, consist of:

5. COMPREHENSIVE INCOME

Changes in accumulated comprehensive income, net for the year ended March
31, 2000 are as follows:

The Company had no other comprehensive income for the years ended March 31,
2001 and 2002.

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. PROPERTY AND EQUIPMENT

Property and equipment as of March 31, consist of:

Purchases of property and equipment were $15,380, $8,057 and $8,484 for
fiscal 2000, 2001 and 2002, respectively. Depreciation and amortization of
property and equipment was $2,173, $3,383 and $4,107 for fiscal 2000, 2001 and
2002, respectively.

7. INTANGIBLE AND OTHER ASSETS

Intangibles and other assets as of March 31, consist of:

Amortization of product rights and all other deferred charges was $2,252,
$2,315 and $2,316 for fiscal 2000, 2001 and 2002, respectively. Amortization of
goodwill was $55 for fiscal 2000, 2001 and 2002.

8. ACCRUED LIABILITIES

Accrued liabilities as of March 31, consist of:

40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. LONG-TERM DEBT

Long-term debt as of March 31, consists of:

As of March 31, 2002, the Company has a revolving credit agreement with
LaSalle National Bank (LaSalle) that provides for a revolving line of credit for
borrowing up to $60,000. During December 2001, the Company revised the previous
revolving credit agreement with LaSalle to provide for the continuation of the
Company's $40,000 revolving line of credit along with a supplemental credit line
of $20,000 for financing acquisitions. These credit facilities expire in October
2004 and December 2002, respectively. The revolving credit lines are unsecured
and interest is charged at the lower of the prime rate or the one-month LIBOR
rate plus 150 basis points. At March 31, 2002, the Company had $3,609 in open
letters of credit issued under the credit facilities. The credit agreement
includes covenants that impose minimum levels of earnings before interest,
taxes, depreciation and amortization, a maximum funded debt ratio, and a limit
on capital expenditures and dividend payments. As of March 31, 2002, the Company
was in compliance with all of its covenants.

The industrial revenue bonds, which bear interest at 7.35% per annum,
mature serially through 2005 and are collateralized by certain property and
equipment, as well as through a letter of credit, which may only be accessed in
case of default on the bonds. The bonds do not allow the holder to require the
Company to redeem the bonds.

In December 2001, the Company refinanced $2,500 of a building mortgage that
was due in June 2002. At March 31, 2002, the building mortgages bear interest at
7.57% and 7.95% and require monthly principal payments of $19 and $13 plus
interest through November 2006 and February 2004, respectively. The remaining
principal balances plus any unpaid interest are due on December 20, 2006 and
March 11, 2004, respectively.

The aggregate maturities of long-term debt as of March 31, 2002 are as
follows:

The Company paid interest of $1,954, $1,329 and $417 during the years ended
March 31, 2000, 2001 and 2002, respectively.

10. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases manufacturing, office and warehouse facilities,
equipment and automobiles under operating leases expiring through 2012. Total
rent expense for the years ended March 31, 2000, 2001 and 2002 was $2,185,
$4,319 and $4,441, respectively.

41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Future minimum lease commitments under non-cancelable leases are as
follows:

Contingencies

The Company currently carries product liability coverage of $10 million per
occurrence and $10 million in the aggregate on a "claims made" basis. There is
no assurance that its present insurance will cover any potential claims that may
be asserted in the future.

The Company is subject to legal proceedings and claims that arise 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, individually or in the aggregate, will have a
material adverse effect on its financial position or operations.

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 one officer contains
provisions for partial salary continuation under certain conditions, contingent
upon noncompete restrictions and providing consulting services to the Company as
specified in the agreement. The Company expensed $257, $174 and $183, under this
agreement in March 31, 2000, 2001 and 2002, respectively.

Litigation

KV, along with ETHEX Corporation, a wholly-owned subsidiary of the Company,
are defendants in a lawsuit styled, Healthpoint, Ltd. V. ETHEX Corporation. On
September 28, 2001, the jury returned verdicts, in the form of answers to
special interrogatories, against ETHEX on certain false advertising, unfair
competition and misappropriation claims and awarded damages aggregating $16,500.
The court will enter a judgment after consideration of the post-trial motions.
The court's judgment may then be appealed. The Company and its counsel believe
that the jury's recommended award is excessive and is not sufficiently supported
by the facts or the law. The court may or may not accept the jury's verdicts.
The Company intends to vigorously appeal any adverse judgment that the court may
enter. The Company and its legal counsel are not presently able to predict the
outcome of the matter and cannot reasonably estimate the Company's ultimate
liability, if any. Accordingly, the Company has not recorded any contingent
liability in its consolidated financial statements related to this matter.

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. INCOME TAXES

The fiscal 2000, 2001, and 2002 provisions were based on estimated Federal
and state taxable income using the applicable statutory rates. The current and
deferred Federal and state income tax provisions for fiscal years 2000, 2001 and
2002 are as follows:

The reasons for the differences between the provision for income taxes and
the expected Federal income taxes at the statutory rate are as follows:

As of March 31, 2001 and 2002, the tax effect of temporary differences
between the tax basis of assets and liabilities and their financial reporting
amounts are as follows:

The Company paid income taxes of $19,754, $11,971 and $15,578 during the
years ended March 31, 2000, 2001 and 2002, respectively.

12. EMPLOYEE BENEFITS

Stock Option Plan and Agreements

During fiscal 2002, the Board of Directors adopted the Company's 2001
Incentive Stock Option Plan (the 2001 Plan), which allows for the issuance of up
to 3,750,000 shares of common stock. Prior to the approval of the 2001 Plan, the
Company operated under the 1991 Incentive Stock Option Plan, as
43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

amended, which allowed for the issuance of up to 4,500,000 shares of common
stock. Under the Company's stock option plans, options to acquire shares of
common stock have been made available for grant to certain employees. Each
option granted has an exercise price of not less than 100% of the market value
of the common stock on the date of grant. The contractual life of each option is
generally 10 years. The exercisability of the grants varies according to the
individual options granted. In addition to the Stock Option Plan, the Company
issues stock options periodically related to employment agreements with its
executives and to non-employee directors. At March 31, 2002, options to purchase
334,350 shares of stock were outstanding pursuant to employment agreements and
grants to non-employee directors.

The following summary shows the transactions for the fiscal years 2000,
2001 and 2002 under option arrangements:

The weighted-average fair value of options granted at market price was
$3.11, $4.18 and $5.45 per share in 2000, 2001 and 2002, respectively. The
weighted-average fair value of options granted with an exercise price exceeding
market price on the date of grant was $0.73, $1.83 and $0.45 per share in 2000,
2001 and 2002, respectively.

The following table summarizes information about stock options outstanding
at March 31, 2002:

SFAS No. 123 requires the Company to provide pro forma information
regarding net income and earnings per share as if compensation cost for the
Company's stock option plan had been determined in

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

accordance with the fair value of each stock option at the grant date using the
Black-Scholes option-pricing model.

The weighted average fair value of the options has been estimated on the
date of grant using the following weighted average assumptions for grants in
fiscal 2000, 2001 and 2002, respectively: no dividend yield; expected volatility
of 66%, 56% and 56%; risk-free interest rate of 6.47%, 6.50% and 6.00% per
annum; and expected option terms ranging from 3 to 10 years for all three years.
Weighted averages are used because of varying assumed exercise dates.

Under the accounting provisions of SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts
indicated below:

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 $175, $300 and $350 for fiscal 2000, 2001 and 2002,
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 $586,
$907 and $1,028 were made to the 401(k) investment funds in fiscal 2000, 2001
and 2002, respectively.

Contributions are also made to multi-employer defined benefit plans
administered by labor unions for certain union employees. Amounts charged to
pension expense and contributed to these plans were $119, $161 and $165 in
fiscal 2000, 2001 and 2002, respectively.

Health and Medical Insurance Plan

The Company contributes to health and medical insurance programs for its
non-union and union employees. For non-union employees, the Company self-insures
the first $100,000 of each employee's covered medical claims. Included in
accrued liabilities in the consolidated balance sheets as of March 31, 2001 and
2002 were $300 and $400 of accrued health insurance reserves, respectively, for
claims incurred but not reported. For union employees, the Company participates
in a fully funded insurance plan sponsored by the union. Total health and
medical insurance expense for the two plans was $2,714, $4,088, and $5,255 in
fiscal 2000, 2001 and 2002, respectively.

13. RELATED PARTY TRANSACTIONS

The Company currently leases certain real property from an affiliated
partnership of an officer and director of the Company. Lease payments made for
this property during the years ended March 31, 2000, 2001 and 2002 totaled $246,
$246 and $263, respectively.

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. EQUITY TRANSACTIONS

On June 29, 2001, 200,000 shares of 7% Cumulative Convertible Preferred
Stock were converted, at a conversion rate of 5.625-to-one, into 1,125,000
shares of Class A common stock. As of March 31, 2001 and 2002, the Company had
240,000 and 40,000 shares, respectively, 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 at its stated value. Each share of preferred stock
is convertible into Class A Common Stock at a conversion price of $4.45 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. Undeclared and unaccrued cumulative
preferred dividends were $2,194, or $9.14 per share and $366, or $9.14 per
share, at March 31, 2001 and 2002, respectively. 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.

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 9), the
Company has limitations on paying dividends, except in stock, on its Class A and
Class B common stock. Payment of dividends may also be restricted under Delaware
Corporation law.

On August 18, 2000, the Company's Board of Directors declared a
three-for-two stock split in the form of a 50% stock dividend of its common
stock to shareholders of record on August 28, 2000, payable on September 7,
2000. Common Stock was credited and retained earnings was charged for the
aggregate par value of the shares issued. The stated par value of each share was
not changed from $.01.

All per share data in this report has been restated to reflect the
aforementioned three-for-two stock split in the form of a 50% stock dividend.

15. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per share:

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- ---------------
(1) The two-class method for Class A and Class B common stock is not presented
because the earnings per share are equivalent to the if converted method
since dividends were not declared or paid and each class of common stock has
equal ownership of the Company.

(2) Employee stock options to purchase 107,250, 5,750 and 27,550 shares of Class
A common stock at March 31, 2000, 2001 and 2002, respectively, are not
presented because these options are anti-dilutive. The exercise prices of
these options exceeded the average market prices of the shares under option
in each respective period.

16. NONRECURRING GAIN

Under a contract that the Company has with a supplier, issues arose with
respect to the timing of supply of a product and the supplier's failure to
pursue another product. The terms of the contract provided for binding private
arbitration between the parties which resulted in the Company receiving notice
of an award in December 1998 of $13,253. The Arbitration Panel subsequently
directed the parties to have further discussions including possible replacement
products. Payment of the award was deferred pending the outcome of these
discussions. Subsequent attempts to obtain replacement products were
unsuccessful and the Company was paid the arbitration in June 1999. In January
2000, the Company received an additional award of $6,973 covering all open
monetary issues related to the contract. The $6,973 award, net of applicable
income taxes and expenses, represents $.13 per common share on a diluted basis
for the year ended March 31, 2000, and is reflected in the fiscal 2000
consolidated statement of income as other income.

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

17. QUARTERLY FINANCIAL RESULTS (UNAUDITED)

- ---------------
Note:

(a) All earnings per share amounts have been restated to reflect a three-for-two
stock split in the form of a 50% stock dividend, declared by the Board of
Directors on August 18, 2000 and distributed September 7, 2000 to
shareholders of record as of August 28, 2000.

18. SEGMENT REPORTING

The reportable operating segments of the Company are branded products,
specialty generics, specialty materials and contract services. The operating
segments are distinguished by differences in products, marketing and regulatory
approval. 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 four 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, intangibles and other assets and all income
tax related assets. Accounting policies of the segments are the same as the
Company's consolidated accounting policies.

48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following represents information for the Company's reportable operating
segments for fiscal 2000, 2001 and 2002

Consolidated revenues are principally derived from customers in North
America and all property and equipment is located in St. Louis, Missouri.

49

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not Applicable.

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 2002 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 2002
Annual Meeting of Shareholders is incorporated herein by this
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information contained under the caption "SECURITY OWNERSHIP OF
PRINCIPAL HOLDERS AND MANAGEMENT" in the Company's definitive proxy
statement to be filed pursuant to Regulation 14(a) for its 2002
Annual Meeting of Shareholders is incorporated herein by this
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information contained under the caption "TRANSACTIONS WITH
ISSUER" in its definitive proxy statement to be filed pursuant to
Regulation 14(a) for its 2002 Annual Meeting of Shareholders is
incorporated herein by this reference.

50

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1. Financial Statements: Page
-------------------- ----

The following consolidated financial statements of the Company
are included in Part II, Item 8:

Report of Independent Certified Public Accountants 30

Consolidated Balance Sheets as of March 31, 2002 and 2001 31

Consolidated Statements of Income for the Years Ended March 31, 32
2002, 2001 and 2000

Consolidated Statements of Shareholders' Equity for the Years 33
Ended March 31, 2002, 2001 and 2000

Consolidated Statements of Cash Flows for the Years Ended 34
March 31, 2002, 2001 and 2000

Notes to Financial Statements 35

2. Financial Statement Schedules:
-----------------------------

Report of Independent Certified Public Accountants regarding 51
Financial Statement Schedule

Schedule II - Valuation and Qualifying Accounts 52

3. Exhibits:
--------

See Exhibit Index on pages 52 through 56 of this Report.
Management contracts and compensatory plans are designated
on the Exhibit Index.

(b) A report on Form 8-K was filed by the Company on April 1, 2002 for
a Regulation FD disclosure.

51

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Stockholders and Board of Directors
K-V Pharmaceutical Company

The audits referred to in our report dated May 24, 2002 relating to the
consolidated financial statements of K-V Pharmaceutical Company, which are
included in Item 8 of this Form 10-K, included the audit of the accompanying
financial statement schedule. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based upon our audits. In our
opinion such financial statement schedule presents fairly, in all material
respects, the information set forth therein.

/s/ BDO SEIDMAN, LLP

Chicago, Illinois
May 24, 2002

52

2. Financial Statement Schedules:

SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS

Financial Statements of KV 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.

53
4

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.

KV PHARMACEUTICAL COMPANY

Date: June 7, 2002 By /s/ Marc S. Hermelin
------------------------------
Vice Chairman of the Board
(Principal Executive Officer)

Date: June 7, 2002 By /s/ Gerald R. Mitchell
------------------------------
Vice President, Treasurer and
Chief Financial Officer
(Principal Financial and
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 7, 2002 By /s/ Marc S. Hermelin
------------------------------
Marc S. Hermelin

Date: June 7, 2002 By /s/ Victor M. Hermelin
------------------------------
Victor M. Hermelin

Date: June 7, 2002 By /s/ Garnet E. Peck
------------------------------
Garnet E. Peck, Ph.D.

Date: June 7, 2002 By /s/ Norman D. Schellenger
------------------------------
Norman D. Schellenger

Date: June 7, 2002 By /s/ Alan G. Johnson
------------------------------
Alan G. Johnson

Date: June 7, 2002 By /s/ Kevin S. Carlie
------------------------------
Kevin S. Carlie

54

* Management contract or compensation plan.

57

* Management contract or compensation plan.

58

* Management contract or compensation plan.

59