VALEANT PHARMACEUTICALS INTERNATIONAL - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

The number of outstanding shares of the registrant’s Common Stock, $0.01 par value, as of November 1, 2004 was 84,124,669.

The accompanying notes are an integral part of these consolidated condensed financial statements.

The consolidated condensed financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared on the basis of accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The results of operations presented herein are not necessarily indicative of the results to be expected for a full year. Although the Company believes that all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the interim periods presented are included and that the disclosures are adequate to make the information presented not misleading, these consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Organization: Valeant Pharmaceuticals International (“Valeant”) and its subsidiaries (collectively, the “Company”) is a global, research-based, specialty pharmaceutical company that discovers, develops, manufactures, and markets a broad range of pharmaceutical products. In addition, the Company generates royalty revenues from the sale of ribavirin by Schering-Plough Ltd. (“Schering-Plough”) and F. Hoffman-LaRoche (“Roche”).

Principles of Consolidation: The accompanying consolidated condensed financial statements include the accounts of Valeant, its wholly owned subsidiaries and all of its majority-owned subsidiaries. Minority interest in results of operations of consolidated subsidiaries represents the minority stockholders’ share of the income or loss of these consolidated subsidiaries. All significant intercompany account balances and transactions have been eliminated.

Marketable Securities: The Company invests in investment grade securities and classifies these securities as available-for-sale as they typically have maturities of one year or less and are highly liquid. As of September 30, 2004, the fair market value of these securities approximates cost. Included in marketable securities is restricted cash of $9,362,000 related to collateral on an interest rate swap and foreign currency hedges as of September 30, 2004.

Impairment of Property, Plant and Equipment: The Company, from time to time as circumstances warrant, evaluates the carrying value of property, plant and equipment. In evaluating property, plant and equipment, the Company determines whether there has been impairment by comparing the anticipated undiscounted future cash flows expected to be generated by the property, plant and equipment with its carrying value. If the undiscounted cash flows is less than the carrying value, the amount of the impairment, if any, will be determined by comparing the carrying value of the property, plant and equipment with its fair value. Fair value is generally based on a discounted cash flows analysis, independent appraisals or preliminary offers from prospective buyers. In the second quarter of 2004, the Company recorded an impairment charge of $18,000,000 on certain of its manufacturing sites. See Note 4.

Acquired In-Process Research and Development: In the nine months ended September 30, 2004, the Company incurred an expense of $11,770,000 associated with acquired in-process research and development (“IPR&D”) related to the acquisition of Amarin Pharmaceuticals, Inc. (“Amarin”) and all of its U.S. product rights. The amount expensed as IPR&D represents an estimate of the fair value of purchased in-process technology for Zelapar® that, as of the acquisition date, had not yet reached technological feasibility and had no alternative future use. The data used to determine fair value requires significant judgment. The estimated fair value was based on the use of a discounted cash flow model (based on an estimate of future sales and an average gross margin of 66%). The estimated after-tax cash flows (using a tax rate of 40%) were

then discounted to a present value using a discount rate of 20%, reflecting the Company’s estimated risk adjusted after tax weighted average cost of capital for its industry. The Company estimated that the Zelapar studies would be completed in 2004 and, if successful, revenue for Zelapar would commence in 2005. The Company expects to incur approximately $4,800,000 in research and development expenditures on Zelapar. See Note 2 for discussion of the acquisition of Amarin.

The major risks and uncertainties associated with the timely and successful completion of the development of Zelapar consists of the ability to confirm the safety and efficacy of the technology based on the data from clinical trials and obtaining necessary regulatory approvals. In addition, no assurance can be given that the underlying assumptions used to forecast the cash flows or the timely and successful completion of such projects will materialize, as estimated. For these reasons, among others, actual results may vary significantly from the estimated results.

Derivative Financial Instruments: The Company’s accounting policies for derivative instruments are based on whether they meet the Company’s criteria for designation as hedging transactions, either as cash flow or fair value hedges. The Company’s derivative instruments are recorded at fair value and are included in other current assets, other assets, accrued liabilities or debt. Depending on the nature of the hedge, changes in the fair value of the hedged item are either offset against the change in the fair value of the hedged item through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings.

Comprehensive Income: The Company has adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 130, Reporting Comprehensive Income. Accumulated other comprehensive loss consists of accumulated foreign currency translation adjustments, unrealized losses on marketable equity securities, minimum pension liability and changes in the fair value of derivative financial instruments.

Per Share Information: Basic earnings per share are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding. In computing diluted earnings per share, the weighted-average number of common shares outstanding is adjusted to reflect the effect of potentially dilutive securities including options, warrants, and convertible debt or preferred stock; income available to common stockholders is adjusted to reflect any changes in income or loss that would result from the issuance of the dilutive common shares.

In 2004, the Company’s Board of Directors declared a first, second and third quarter cash dividend of $0.0775 per share, which were paid on April 28, July 28 and October 27, 2004, respectively. While the Company has historically paid quarterly cash dividends, there can be no assurance that it will continue to do so.

Stock-Based Compensation: The Company has adopted the disclosure-only provision of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. Compensation cost for stock-based compensation issued to employees has been measured using the intrinsic value method provided by Accounting Principles Board Opinion No. 25. Accordingly, no compensation cost has been recognized for options granted under the Company’s 2003 Equity Incentive Plan (the “Incentive Plan”), as all options granted under the Incentive Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for the Incentive Plan been determined based on the fair value at the grant date for awards in the three and nine months ended September 30, 2004 and 2003

consistent with the provisions of SFAS No. 123, the Company’s net loss and loss per share would have been the unaudited pro forma amounts indicated below (in thousands, except per share data):

New Accounting Pronouncements: In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This Issue establishes impairment models for determining whether to record impairment losses associated with investments in certain equity and debt securities. In September 2004, the FASB issued FSP EITF 03-1-1, which defers the effective date of a substantial portion of EITF 03-1 until such time as the FASB issues further implementation guidance, which is expected in the fourth quarter of 2004. Adoption of this pronouncement is not expected to have an impact on the Company’s consolidated condensed financial statements.

In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. SAB 104 did not have a significant impact on the Company’s consolidated condensed financial statements.

Reclassifications: Certain prior year items have been reclassified to conform to the current year presentation, with no effect on previously reported net income or stockholders’ equity.

Amarin Pharmaceuticals, Inc.: On February 25, 2004, the Company acquired from Amarin Corporation, plc (“Amarin plc”) its U.S.-based subsidiary (“Amarin”) and all of its U.S. product rights (the “Amarin Acquisition”). Under the terms of the transaction, the Company acquired the rights to Amarin’s product portfolio, which includes Permax® and a primary care portfolio with a broad range of indications. The Company also acquired in the transaction the rights to Zelapar, a late-stage candidate for the treatment of Parkinson’s disease. Amarin has received an approvable letter from the Food and Drug Administration (“FDA”) for Zelapar, subject to the completion of two safety studies which are now completed. The

Company anticipates filing the final results of these studies with the FDA before the end of 2004. The Company paid $38,000,000 in cash at the closing for the Amarin acquisition.

Subsequent to the Amarin Acquisition, the Company became aware of a significant amount of dated Amarin products in wholesaler channels. Under the terms of the original purchase agreement, Amarin plc was responsible for any excess inventory at wholesalers that existed at the date of acquisition. On September 27, 2004, the Company and Amarin plc entered into an amended purchase agreement (the “Amended Purchase Agreement”), which also revised certain milestone payments. Under the terms of the Amended Purchase Agreement, the Company will no longer pay up to $8,000,000 in milestone payments, but will pay an additional $2,000,000 on or before November 30, 2004, which the Company expensed as research and development in the third quarter of 2004 related to Amarin plc’s commitment to fund a portion of the Zelapar studies. The Company remains obligated to make the $10,000,000 milestone payment to the developer of Zelapar upon the attainment of specified sales thresholds. All other terms of the original purchase agreement remain substantially unchanged.

The Amarin Acquisition has been accounted for using the purchase method of accounting, and Amarin’s results of operations have been included in the Company’s consolidated condensed financial statements from the date of acquisition. Allocation of the purchase price for the Amarin Acquisition is based on estimates of the fair value of the assets acquired and liabilities assumed at the date of acquisition. Estimates for the purchase price allocation may change as subsequent information becomes available. Pro forma results are not presented as the acquisition did not materially affect the Company’s results of operations.

The components of the purchase price allocation for the Amarin Acquisition is as follows (in thousands):

Tasmar®: On April 22, 2004, the Company acquired the worldwide rights, excluding the European Union, to Tasmar® (tolcapone) from Roche. Tasmar is indicated for the treatment of Parkinson’s disease. Under the terms of the agreement, the Company paid $13,500,000 in cash, plus future additional royalty amounts. On September 13, 2004, the Company acquired the European Union rights to Tasmar from Roche for $11,400,000 in cash, plus future royalties. The Company accounted for the acquisition of Tasmar as product rights.

In the second half of 2002, the Company made a strategic decision to divest its Russian Pharmaceuticals segment, biomedicals segment, Photonics business, raw materials businesses and manufacturing facilities in Central Europe and Circe unit. During 2003, the Company disposed of its Russian Pharmaceuticals segment, biomedicals segment, Photonics business and Circe unit. In July 2004, the Company disposed of one of the raw materials business and manufacturing facility in Central Europe for net cash proceeds of $3,611,000. The Company recorded a net loss on disposal of discontinued operations of $1,522,000 related to the sale of this business in the third quarter of 2004. The Company is actively marketing for sale the remaining raw materials business and manufacturing facility in Central Europe and is working toward disposing of these assets.

Summarized selected financial information for discontinued operations for the three and nine months ended September 30, 2004 and 2003 is as follows (in thousands):

The assets and liabilities of discontinued operations are stated separately as of September 30, 2004 and December 31, 2003 on the accompanying consolidated condensed balance sheets. The major assets and liabilities categories are as follows (in thousands):

Environmental contamination has been identified in the soil under a facility built by the Company which housed operations of its discontinued Biomedicals division and is currently vacant. Remediation of the site will

likely involve excavation and disposal of the waste at appropriately licensed sites some distance from the facility. Environmental reserves have been provided for remediation and related costs that the Company can reasonably estimate. Remediation costs are applied against these environmental reserves as they are incurred. In July 2004, preliminary supplemental site characterization information was received. As a result of this information, the Company recorded an additional environmental charge of $16,000,000, which is included in loss from discontinued operations for the nine months ended September 30, 2004. As assessments and remediation progress, these liabilities will be reviewed and adjusted to reflect additional information that becomes available. Total environmental reserves for this site were $21,689,000 and $5,033,000 as of September 30, 2004 and December 31, 2003, respectively, and are included in the liabilities of discontinued operations. Although the Company believes that its reserves are adequate, there can be no assurance that the amount of expenditures and other expenses, which will be required relating to remediation actions and compliance with applicable environmental laws will not exceed the amounts reflected in reserves or will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows. Any possible loss that may be incurred in excess of amounts provided for as of September 30, 2004 cannot be reasonably estimated.

During the third quarter of 2003, the Company approved restructuring plans to establish a global manufacturing and supply chain network of five manufacturing sites, which will result in the closing of ten of the Company’s manufacturing sites (the “Manufacturing Restructuring Plan”). The Manufacturing Restructuring Plan includes a refocus of the Company’s international operations to improve profitability and achieve greater operating efficiencies. The Company has made significant progress towards its plans of disposing of certain manufacturing sites and is currently actively marketing the sites to prospective buyers. The sites were tested for impairment, resulting in impairment of asset value on three of the sites. Accordingly, the Company wrote these sites down to their fair value and recorded an impairment charge of $18,000,000 in the second quarter of 2004. In addition to the impairment charge, the Company recorded $2,116,000 in restructuring and impairment charges related to severance for the nine months ended September 30, 2004. These restructuring charges are recorded as a component of costs and expenses in the consolidated condensed statement of income. The Company will continue to depreciate the remaining sites until the facility closures are complete. The Company intends to dispose of these ten manufacturing plants by selling each to a buyer who we believe will continue to operate the plant, including the assumption of employee obligations. However, the Company may not locate a buyer for each such manufacturing plant, which would require the Company to close certain of these manufacturing plants and incur additional severance charges.

On May 14 and July 21, 2004, the Company repurchased $326,001,000 in aggregate principal amount of its 6 1/2% Convertible Subordinated Notes due 2008. In connection with these repurchases, the Company recorded a loss on early extinguishment of debt of $13,994,000 and $19,892,000 for the three and nine months ended September 30, 2004, respectively.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

For the three and nine months ended September 30, 2004, options to purchase 2,423,000 and 2,693,000 weighted average shares of common stock, respectively, were not included in the computation of earnings per share because the Company incurred a loss and the effect would have been anti-dilutive.

For the three and nine months ended September 30, 2004, options to purchase 2,526,000 and 2,485,000 weighted average shares of common stock, respectively, were also not included in the computation of earnings per share because the options exercise prices were greater than the average market price of the Company’s common stock and, therefore, the effect would have been anti-dilutive.

Goodwill and intangible assets: As of September 30, 2004 and December 31, 2003, goodwill and intangible assets were as follows (in thousands):

Goodwill increased $1,735,000 and $3,672,000 for the three and nine months ended September 30, 2004, respectively, primarily due to the Amarin Acquisition.

Amortization expenses for the three and nine months ended September 30, 2004 were $14,094,000 and $41,514,000, respectively, of which $9,587,000 and $27,253,000 were related to amortization of acquired product rights, respectively. Estimated amortization expenses for the years ending December 31, 2004, 2005, 2006, 2007 and 2008 were $55,000,000, $53,000,000, $53,000,000, $51,000,000 and $45,000,000, respectively.

The Company’s effective tax rate for the nine months ended September 30, 2004 was affected by pre-tax losses resulting from restructuring and impairment charges $20,116,000 and a European work force reduction charge of $4,510,000, for which the Company recorded a minimal tax benefit of $1,138,000 (5%). This minimal tax benefit reflects uncertainty of the realization of tax benefits in some of the jurisdictions in which these charges were incurred. Additionally, in the nine months ended September 30, 2004, the Company recorded a tax provision of $1,828,000 related to the settlement of a tax dispute with Puerto Rico relating to tax years 1998 and 1999.

The Company’s U.S. tax returns for the period from 1997 to 2001 are currently being reviewed by the Internal Revenue Service. While the Company believes the review will not result in the returns being found to contain any substantive and material deficiencies, there can be no assurance that the Internal Revenue Service’s findings will not have a material adverse effect on the Company’s reported effective tax rate.

In 1999, the Company restructured its operations by contributing the stock of several non-United States subsidiaries to a wholly owned Dutch company. At the time of the restructuring, the Company wished to avail itself of the non-recognition provisions of the Internal Revenue Code to avoid generating taxable income on the inter-company transfer. One of the requirements under the non-recognition provisions was to file Gain Recognition Agreements with the Company’s timely filed 1999 U.S. Corporate Income Tax Return. The Company has recently discovered that although it was clearly the intent of the Company to file the Gain Recognition Agreements and it has operated as if such filings had been submitted, former management inadvertently omitted the Gain Recognition Agreements from its filing. In accordance with Treasury guidelines, a formal request has been made to the Internal Revenue Service to rule that reasonable cause existed for the failure to provide these agreements. While management is still evaluating the underlying values of the stock contributed, if the requested relief were to be denied and the matter could not otherwise be resolved favorably with the Internal Revenue Service, management believes the resulting cash tax obligation would likely offset a substantial portion of the Company’s accumulated tax loss carryforwards and the impact to net income in the period such obligation became probable would be material.

Ribapharm Tender Offer Litigation: In June 2003, seven purported class actions were filed against the Company, Ribapharm and certain directors and officers of Ribapharm in the Delaware Court of Chancery. Six of these complaints were consolidated under the caption In re Ribapharm Inc. Shareholders Litigation, Consol. C.A. No. 20337 and the seventh suit is proceeding in coordination with the consolidated case in which the plaintiffs allege, among other things, that the Company breached its fiduciary duties as a controlling stockholder of Ribapharm in connection with its tender offer for the shares of Ribapharm it did not already own. On August 4, 2003, the Company and the plaintiffs reached an agreement in principle to settle these lawsuits for a nominal amount and, after settlement papers are prepared, will present that settlement to the Court of Chancery for its approval.

In June 2003, a purported class action on behalf of certain stockholders of Ribapharm was filed against the Company in the Delaware Court of Chancery seeking a declaration that the shareholders rights plan is valid and enforceable. The Company and the plaintiffs reached an agreement in principle to settle this lawsuit which will be completed in combination with the settlement In re Ribapharm Inc. Shareholders Litigation, Consol. C.A. No. 20337.

In June 2003, a purported class action was filed in the Superior Court of Orange County, California, against the Company, Ribapharm and certain of Ribapharm’s officers and directors asserting the same claims, on behalf of the same class of plaintiffs and against the same defendants as in the seven lawsuits filed in Delaware that are described above. The settlement of the Delaware tender offer litigation has been designed to

release the claims brought in this lawsuit, although the decision as to the effect of that release will be subject to the discretion of the California court.

The Delaware court has scheduled a hearing for December 2, 2004 to consider the fairness of the settlement of the Delaware actions. If the settlement is approved, the Delaware cases will be dismissed with prejudice. The Company and the other defendants in the California action will then ask the California court to dismiss the California action based on the release approved by the Delaware court.

In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.

Section 10b-5 Litigation: Since July 25, 2002, multiple class actions have been filed against the Company and some of its current and former executive officers alleging that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, by issuing false and misleading financial results to the market during different class periods ranging from May 3, 2001 to July 10, 2002, thereby artificially inflating the price of the Company’s stock. The lawsuits generally claim that the Company issued false and misleading statements regarding the Company’s earnings prospects and sales figures (based upon “channel stuffing” allegations), its operations in Russia, the marketing of Efudex, and the earnings and sales of its Photonics division. The plaintiffs generally seek to recover compensatory damages, including interest.

All the actions have been consolidated to the Central District of California. On June 24, 2004, the Court dismissed the Second Amended Complaint. The plaintiffs have filed a notice of appeal to the United States Court of Appeals for the Ninth Circuit seeking review of the dismissal of the complaint.

Valuepoint Bondholders’ Litigation: On May 9, 2003, a bondholder filed a class action lawsuit in Orange County Superior Court against the Company and some of its current and former directors and former executive officers. The lawsuit alleges that the defendants violated Sections 11 and 15 of the Securities Act of 1933 by making false and misleading statements in connection with an offering of 6 1/2% Convertible Subordinated Notes due 2008 in November 2001, thereby artificially inflating the market price of the Notes. The plaintiffs generally seek to recover compensatory damages, including interest.

On June 24, 2004, the Court granted the motion to strike and permitted plaintiffs to amend the complaint to comply with certain notice requirements. The Court also held that plaintiffs must, but did not, provide particular facts in the complaint to show that the defendants violated the securities law. Ultimately, the Court dismissed most of the claims but granted the plaintiffs until September 4, 2004 to file an amended complaint. The Court denied the defendants’ motion to dismiss with respect to one claim involving the impairment of the Company’s Russian assets.

The Company and plaintiffs have agreed to extend the time for plaintiffs to file another complaint pending preliminary approval of an agreement in principle among the parties to settle the matter for approximately $3,200,000. If plaintiffs ultimately file another complaint, the Company expects to file an additional motion to dismiss. In that case, the Company also expects further motion practice and limited discovery regarding the surviving Russian assets impairment claim.

Derivative Actions: The Company is a nominal defendant in a shareholder derivative lawsuit pending in state court in Orange County, California, styled James Herrig, IRA v. Milan Panic et al. This lawsuit, which was filed on June 6, 2002, purports to assert derivative claims on behalf of the Company against certain current and/or former officers and directors of the Company. The lawsuit asserts claims for breach of fiduciary duties, abuse of control, gross mismanagement and waste of corporate assets. The plaintiff seeks, among other

things, damages and a constructive trust over cash bonuses paid to the officer and director defendants in connection with the Ribapharm offering (the “Ribapharm Bonuses”).

On October 1, 2002, several former and current directors of the Company, as individuals, as well as the Company, as a nominal defendant, were named as defendants in a second shareholder’s derivative complaint filed in the Delaware Court of Chancery, styled Paul Gerstley v. Norman Barker, Jr. et al. The original complaint in the Delaware action purported to state causes of action for violation of Delaware General Corporation Law Section 144, breach of fiduciary duties and waste of corporate assets in connection with the defendants’ management of the Company. The allegations in the Delaware action were similar to those contained in the derivative lawsuit filed in Orange County, California, but included additional claims asserting that the defendants breached their fiduciary duties by disseminating materially misleading and inaccurate information.

The Company established a Special Litigation Committee to evaluate the plaintiffs’ claims in both derivative actions. The Special Litigation Committee concluded that it would not be in the best interest of the Company’s shareholders to pursue many of the claims in these two lawsuits, but decided to pursue, through litigation or settlement, claims arising from the April 2002 decision of the Board to approve the payment of approximately $50,000,000 in bonuses to various members of the Board and management arising from the initial public offering of Ribapharm. The Court granted the Company’s motion to stay the California proceedings in favor of the similar Delaware proceedings. On June 27, 2003, the Company filed a motion in the Delaware derivative action to (a) realign itself as plaintiff in the Delaware proceedings, (b) pursue the primary derivative claims relating to the Ribapharm Bonuses, (c) seek dismissal of the secondary derivative claims, and (d) settle certain claims with respect to certain of the defendants. The Court granted the Company’s motion for realignment on October 27, 2003; additional aspects of the Company’s motion are still pending. The Company filed an amended complaint in the Delaware action on September 17, 2003. Three defendants have entered into settlement agreements, as amended, whereby they forfeit their 2003 annual stipend and all of their restricted stock units in exchange for a release from further liability in the lawsuit. The settlement will not be effective unless approved by the Delaware Court of Chancery. The remaining parties to the Delaware proceedings have agreed to court-sponsored mediation, and discovery in the case is proceeding.

Patents: Various parties are opposing the Company’s ribavirin patents in actions before the European Patent Office, and the Company is responding to these oppositions. Regardless of the outcome of these oppositions, the Company believes the combination therapies marketed by Schering-Plough and Roche will continue to benefit from a period of data and marketing protection in the major markets of the European Union until 2009 for Schering and 2012 for Roche.

Yugoslavia: In March 1999, arbitration was initiated in the following matters before the International Chamber of Commerce International Court of Arbitration: (a) State Health Fund of Serbia v. ICN Pharmaceuticals, Inc., Case No. 10 373/AMW/BDW, and (b) ICN Pharmaceuticals, Inc. v. Federal Republic of Yugoslavia and Republic of Serbia, Case No. 10 439/BWD. At issue in these matters are the parties’ respective ownership interests in ICN Yugoslavia, a joint venture formed by the parties’ predecessors-in-interest in 1990. In these proceedings, the Company asserted claims against the Federal Republic of Yugoslavia (“FRY”) and the Republic of Serbia (“ROS”) and counterclaims against the State Health Fund of Serbia (“Health Fund”) for, inter alia, unlawful seizure of the Company’s majority interest in the joint venture and failure to pay obligations to the joint venture in excess of $176,000,000. The Company seeks damages in excess of $277,000,000. The Health Fund has asserted claims against the Company for breach of the joint venture agreement based on the Company’s alleged failure to contribute intangible assets, and the Company’s alleged mismanagement of the joint venture. The Health Fund seeks damages in excess of $270,000,000. The arbitral tribunal dismissed the FRY from these proceedings for lack of jurisdiction. The final arbitral hearings in this matter were held March 29 and March 30, 2004, and the Company is awaiting the decision of the arbitral tribunal.

Circe: The former shareholders (the “Circe Shareholders”) of Circe Biomedical, Inc. (“Circe”) filed in July 2003 a demand for arbitration claiming indemnification from the Company for approximately $10,000,000 of purported financial losses, based on provisions of an agreement entered into at the time the Company acquired Circe. The Circe Shareholders claim to have suffered such losses as a result of the Company’s alleged breach of its obligations to register for resale the Company shares issued to the Circe Shareholders as part of the purchase price for the Circe acquisition. In order to avoid costly and protracted arbitration proceedings, and without admitting any of the allegations made by the Circe Shareholders, the Company settled the matter by agreeing to pay the Circe Shareholders $4,500,000.

Argentina Antitrust Matter: In July 2004, the Company was advised that the Argentine Antitrust Agency had issued a notice unfavorable to the Company in a proceeding against its Argentine subsidiary. The proceeding involves allegations that the subsidiary in Argentina abused a dominant market position in 1999 by increasing its price on Mestinon in Argentina and not supplying the market for approximately two months. The subsidiary filed documents with the agency offering an explanation justifying its actions, but the agency has now rejected the explanation. The Company is considering its response. Argentinean law permits a fine to be levied of up to $5,000,000 plus 20% of profits realized due to the alleged wrongful conduct. Counsel in the matter advises that the size of the transactions alleged to have violated the law will unlikely draw the maximum penalty.

Permax Product Liability Cases: In February 2004, the Company purchased the shares of Amarin Pharmaceuticals Inc. A case captioned Debra Ann Blackstone v. Amarin Pharmaceuticals, Inc., Amarin International Company, Eli Lilly & Company, Health Net, Inc., Blue Shield of California, Inc., Walgreen Co., Gaye Swenn, R.Ph., and John Lowhon, R.Ph. Case No. 017 201332 03 has been filed in the District Court of Tarrant County, Texas alleging that use of Permax, a drug for the treatment of Parkinson’s Disease marketed and sold by Amarin, caused valvular heart disease. The plaintiff generally seeks compensatory damages. The Company has also received from time to time other claims alleging that the use of Permax caused congestive heart failure and other coronary-related damage. Eli Lilly, holder of the right granted by the FDA to market and sell Permax in the United States, though such right was licensed to Amarin and the source of the manufactured product, has also been named in the suits. Under an agreement between the Company and Eli Lilly, Eli Lilly will bear a portion of the liability associated with these claims. Product liability insurance exists with respect to these claims. Although it is expected that the insurance proceeds will be sufficient to cover existing claims against the Company, there can be no assurance that defending against any future similar claims and any resulting settlements or judgments will not, individually or in the aggregate, have a material adverse affect on the Company’s consolidated financial position, results of operation or liquidity.

Other: The Company is a party to other pending lawsuits or subject to a number of threatened lawsuits. While the ultimate outcome of pending and threatened lawsuits or pending violations cannot be predicted with certainty, and an unfavorable outcome could have a negative impact on the Company, at this time in the opinion of management, the ultimate resolution of these matters will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

The Company’s four reportable pharmaceutical segments are comprised of its pharmaceutical operations in North America, Latin America, Europe and Asia, Africa and Australia. In addition, the Company has a research and development division. The segment reporting has been reclassified to conform to discontinued operations presentation for all periods presented. See Note 3 for discussion of discontinued operations.

The following table sets forth the amounts of segment revenues and operating income of the Company for the three and nine months ended September 30, 2004 and 2003 (in thousands):


(1)	Restructuring charges and IPR&D are not included in the applicable segments as management excludes these items in assessing the financial performance of these segments, primarily due to their non-operational nature. For the nine months ended September 30, 2004, restructuring charges of $18,750,000 and $1,366,000 were incurred in the Europe and Latin America pharmaceutical segments, respectively.

The following table sets forth the segment total assets of the Company as of September 30, 2004 and December 31, 2003 (in thousands):

The following table summarizes the Company’s ten largest products and seven global brands by therapeutic class based on sales for the three and nine months ended September 30, 2004 and 2003 (in thousands):

Phantom Stock: For the nine months ended September 30, 2004, pursuant to the Company’s approved director compensation plan, the Company granted its non-employee directors 49,990 shares of phantom stock with a fair market value of approximately $935,000. Each share of phantom stock vests on May 25, 2005, but pursuant to elections made by the directors, the phantom stock is not exchangeable for shares of the Company’s common stock until one year after the director ceases to serve as a member of the Company’s Board.

Stockholder Rights Plan: On October 5, 2004, the Company amended its Stockholders Rights Plan. The amendment to the Stockholder Rights Plan changes certain provisions in the Stockholder Rights Plan including extending the expiration date to November 1, 2009 and increasing the exercise price of the Rights to $100 per right, subject to adjustment. Additionally, in connection with the amendment, the Company increased the number of shares designated as Series A Participating Preferred Stock from 1,000,000 shares to 2,000,000 shares.

In its discussion of the material changes in the Company’s financial condition and results of operations between the reporting periods in the consolidated condensed financial statements, management has sought to identify and, in some cases, quantify, the factors that contributed to such material changes. However, quantifying these factors may involve the presentation of numerical measures that exclude amounts that are included in the most directly comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (“GAAP”). Management uses this information to assess material changes in the Company’s financial condition and results of operations and is providing it to enable investors and potential investors to understand these assessments. In each instance, such information is presented immediately following (and in connection with an explanation of) the most directly comparable financial measure calculated in accordance with GAAP, and includes other material information necessary to reconcile the information with the comparable GAAP financial measure.

The Company is a global research-based specialty pharmaceutical company that discovers, develops, manufactures and markets a broad range of pharmaceutical products, but focuses its greatest resources and attention principally on nine global brands (seven of which are currency marketed) in the therapeutic areas of neurology, dermatology and infectious disease. The Company focuses its research and development capability to commercialize products worldwide. The Company expects to leverage this position now and in the future with its existing products and those expected to be added through commercialization of the Company’s internal pipeline and through acquisitions.

The Company revenues are derived from product sales and royalty revenues. Product sales accounted for approximately 87% and 73% of the Company’s total revenues from continuing operations for the nine months ended September 30, 2004 and 2003, respectively, and increased $58,102,000 (16%) over the comparable periods. The increase in product sales was due to approximate changes in the following categories: a 7% increase in volume, a 6% increase due to changes in selling prices and a 3% favorable impact from foreign exchange rate fluctuations. The Company also receives royalties from the sale of ribavirin, which it licensed to Schering-Plough and Roche in oral form for the treatment of hepatitis C. Royalty revenues decreased $73,311,000 (54%) and accounted for 13% of the Company’s total revenues from continuing operations for the nine months ended September 30, 2004 as compared to 27% for the same period in 2003. The decline in royalty revenues, and the decreasing contribution of royalties to the Company’s revenues, had been expected with the entrance of generic ribavirin in the U.S.

Future growth of the Company is expected to be driven primarily by growth of its existing products, the commercialization of new products and business development. The Company’s global brands accounted for 24% and 21% of its product sales for the nine months ended September 30, 2004 and 2003, respectively. The Company’s global brands increased $8,110,000 (28%) and $24,675,000 (32%) in the three and nine months ended September 30, 2004, respectively, compared to the similar periods in 2003. The Company has experienced generic challenges and other competition to its products, as well as pricing challenges through government imposed price controls and reductions, and expects these challenges to continue in 2004 and beyond.

The Company has undergone significant changes in its leadership, strategic direction and operations in the past two years. In an effort to drive change, the Company’s stockholders elected new directors at its annual meetings in 2001 and 2002, resulting in a new board composition and the appointment of a new senior management team. A three part plan was initiated to restructure the Company, transform the business and grow through innovation. The Company has made significant progress in the execution of this plan with the completion of its restructuring phase, which included its divestiture program, the restructuring of the management team, the implementation of strong governance protocols and the strengthening of the Company’s research and development capability. The Company is moving rapidly through the transformation phase with the development of a growth strategy leveraging its current products, further reducing costs, rationalizing its supply chain and employing other measures to obtain significant efficiencies. The Company is

In order to drive specialty pharmaceuticals sales growth, the Company focuses its business on the following specific markets, therapeutic areas and brands:


	Focus on 10 Key Geographic Regions. The Company has four pharmaceutical segments comprising its pharmaceutical operations in North America, Latin America, Europe and Asia, Africa and Australia. Within these four pharmaceutical segments, the Company focuses on 10 key geographic regions: the United States, Canada, Mexico, United Kingdom, France, Italy, Poland, Germany, Spain and China. In particular, as the Company pursues acquisition opportunities and product line extensions, it plans to focus on North America, the largest pharmaceutical market worldwide and thus its biggest growth opportunity.

	Focus on Three Core Therapeutic Classes. The Company focuses on infectious disease, neurology and dermatology. The Company believes that these three therapeutic classes are positioned for further growth, and that it is possible for a mid-sized company to attain a leadership position within these categories.

	Focus on Nine Global Brands. The Company currently focuses on nine global brands, seven of which are currently being marketed. Two of these brands, Viramidine and remofovir, are currently in clinical development. All of these nine global brands are within the Company’s three targeted core therapeutic classes. The Company believes that these brands have the potential for global penetration and growth rates above the industry average of 5 to 10 percent per year. The Company is actively pursuing life cycle management strategies for all of its global brands and selectively for its other brands.

Under the Company’s global manufacturing strategy announced in October 2003, the Company plans to reduce the number of manufacturing facilities from 15 to five by 2006, in order to increase capacity utilization and improve efficiencies. In conjunction with the rationalization of the Company’s manufacturing facilities, it has undertaken a major process improvement initiative, affecting all phases of its operations, from raw material and supply logistics, to manufacturing, warehousing and distribution. In addition, procurement efforts have been centralized to realize economies of scale.

In the nine months ended September 30, 2004, the Company has made significant progress towards its plans of disposing of certain of the manufacturing sites and recorded a pre-tax restructuring and impairment charge of $20,116,000 primarily for impairment of these sites.

The Company seeks to discover, develop and commercialize innovative products for the treatment of significant unmet medical needs, principally in the areas of infectious diseases and cancer. The Company intends to combine its scientific expertise with advanced drug screening techniques in order to discover and develop new antiviral candidates from its nucleoside analog and non-nucleoside libraries. Except as otherwise required by the terms of its November 2000 agreement with Schering-Plough, the Company generally intends to retain control of its product candidates in its major markets in order to obtain the maximum value from its research efforts.

In addition to the Company’s in-house development efforts, the Company plans to selectively license or acquire product candidates, technologies and businesses from third parties which complement its existing business and provide for effective life cycle management of key products. The Company believes that its drug development expertise may allow it to recognize licensing opportunities and to capitalize on research initially conducted and funded by others.

In 2004, the Company acquired from Amarin Corporation, plc its U.S.-based subsidiary, Amarin Pharmaceuticals, Inc. (“Amarin”), and all of its U.S. product rights, which includes Permax® and a primary care portfolio with a broad range of indications for consideration of $40,000,000. The Company also acquired in the transaction the rights to Zelapar®, a late-stage candidate for the treatment of Parkinson’s disease. Amarin has received an approvable letter from the FDA for Zelapar, subject to the completion of two safety studies, which are now completed and the Company anticipates filing the final results of these studies with the FDA before the end of 2004. See Note 2 to notes to consolidated condensed financial statements for a discussion of this acquisition.

In April 2004, the Company acquired the worldwide rights, excluding the European Union, to Tasmar® (tolcapone), an indication for the treatment of Parkinson’s disease, from Roche for $13,500,000 in cash, plus future royalty payments. In September 2004, the Company acquired the European Union rights to Tasmar from Roche for $11,400,000 in cash, plus future royalties.

The Company’s four reportable pharmaceutical segments are comprised of its pharmaceuticals operations in North America, Latin America, Europe and Asia, Africa and Australia. In addition, the Company has a research and development division. Certain financial information for the Company’s business segments is set forth below. This discussion of the Company’s results of operations should be read in conjunction with the consolidated condensed financial statements of the Company included elsewhere in this quarterly report. For additional financial information by business segment, see Note 10 of notes to consolidated condensed financial statements included elsewhere in this quarterly report.

The following tables compare 2004 and 2003 revenues by reportable segments and operating expenses for the three and nine months ended September 30, 2004 and 2003 (in thousands, except percentages):

Pharmaceutical Revenues: Pharmaceutical product sales increased $19,809,000 (15%) and $58,102,000 (16%) for the three and nine months ended September 30, 2004, respectively, over the same periods in 2003. The increases were led by continued improvements in sales of the Company’s global brands, which contributed $8,110,000 and $24,675,000 to the increase in product sales for the three and nine months ended September 30, 2004, respectively. In addition, favorable foreign currency exchange rates contributed $3,800,000 and $11,556,000 on a net basis to the increase in overall product sales for the three and nine months ended September 30, 2004, respectively, primarily due to the increase in the value of the Euro over the U.S. dollar.

In the North America Pharmaceuticals segment, revenues for the three months ended September 30, 2004 and 2003 were $36,613,000 and $29,403,000, respectively, an increase of $7,210,000 (25%). The increase reflects higher sales of Efudex of $5,212,000 primarily related to the launch of a 40 gram product and sales of products related to the Amarin and Tasmar acquisitions of $3,902,000. Revenues for the nine months ended September 30, 2004 and 2003 were $99,500,000 and $70,837,000, respectively, an increase of $28,663,000 (40%). The increase reflects sales of products related to the Tasmar and Amarin acquisitions of $8,372,000. Additionally, the change in comparison from 2004 to 2003 revenues partially reflects depressed 2003 sales due to the inventory reduction program at the Company’s wholesalers in 2003, which was completed in April 2003.

In the Latin America Pharmaceuticals segment, revenues for the three and nine months ended September 30, 2004 were $38,514,000 and $104,158,000, respectively, compared to $34,746,000 and $94,802,000 for the same periods in 2003, resulting in increases of $3,768,000 (11%) and $9,356,000 (10%), respectively. The increases were primarily due to price increases to wholesalers in the region of $6,206,000 and $13,712,000 for the three and nine months ended September 30, 2004, respectively, partially offset by

In the Europe Pharmaceuticals segment, revenues for the three and nine months ended September 30, 2004 were $61,472,000 and $184,671,000, respectively, compared to $54,512,000 and $169,396,000 for the same periods in 2003, resulting in increases of $6,960,000 (13%) and $15,275,000 (9%), respectively. The increase in the value of currencies in the region as compared to the U.S. dollar contributed $5,079,000 and $12,399,000 to the increase in revenues in the region for the three and nine months ended September 30, 2004, respectively. The remaining increase is attributable to sales of the Company’s global products in the region.

In the Asia, Africa and Australia (“AAA”) Pharmaceuticals segment, revenues for the three and nine months ended September 30, 2004 were $14,500,000 and $42,729,000, respectively, compared to $12,629,000 and $37,921,000 for the same periods in 2003, resulting in increases of $1,871,000 (15%) and $4,808,000 (13%), respectively. The increases were primarily due to higher sales of Reptilase® ($1,306,000) in the quarter and Nyal ($2,442,000) in the nine months ended September 30, 2004. In addition, increases in the value of currencies in the region as compared to the U.S. dollar contributed $615,000 and $2,011,000 to the increase in revenues for the three and nine months ended September 30, 2004, respectively.

Royalties: Royalty revenues represent amounts earned under the license and supply agreements with Schering-Plough and Roche. Under a license and supply agreement, Schering-Plough licensed all oral forms of ribavirin for the treatment of chronic hepatitis C. Roche pays royalty fees to the Company under a license agreement on sale of Roche’s version of ribavirin, Copegus, for use in combination with interferon alfa or pegylated interferon alfa.

Royalties from Schering-Plough and Roche for the three and nine months ended September 30, 2004 were $15,333,000 and $63,444,000, respectively, compared to $36,217,000 and $136,755,000 for the same periods in 2003, reflecting decreases of $20,884,000 (58%) and $73,311,000 (54%), respectively. The decrease in royalties include the effects of the launch of generic ribavirin in the United States and increasing competition between Schering-Plough and Roche. Approval of a generic form of oral ribavirin by the U.S. Food and Drug Administration (“FDA”) in the U.S. was announced on April 7, 2004. Competition from generic pharmaceutical companies has had and is expected to continue to have a material negative impact on the Company’s royalty revenue. With respect to Schering-Plough, effective royalty rates increase in tiers based on increased sales levels in the United States. As a result of reduced sales, the likelihood of achieving the maximum effective royalty rate in the U.S. is diminished. With respect to Roche, under the license agreement, the introduction of generics in any market eliminates the obligation of Roche to pay royalties for sales in that market. Upon the entry of generics into the United States on April 17, 2004, Roche ceased paying royalties on sales in the U.S. Schering-Plough announced its launch of a generic version of ribavirin. Under the license and supply agreement, Schering-Plough is obligated to pay the Company royalties for sales of their generic ribavirin.

Gross Profit Margin: Gross profit margin on product sales remained relatively consistent at 67% for the third quarter of 2004, compared to 68% for the same period in 2003. Gross profit margin on product sales for the nine months ended September 30, 2004 was 67% compared to 65% in 2003. The increase in year-to-date gross profit margin is primarily due to an increase in sales from North America and higher efficiencies in the Company’s global manufacturing and supply chain operations, which were partially offset by an increase in costs related to the manufacturing rationalization plan.

Selling Expenses: Selling expenses were $45,046,000 and $146,363,000 for the three and nine months ended September 30, 2004, respectively, compared to $39,179,000 and $119,847,000 for the same periods in 2003, resulting in increases of $5,867,000 (15%) and $26,516,000 (22%), respectively. As a percent of product sales, selling expenses were 30% and 34% for the three and nine months ended September 30, 2004, respectively, compared to 30% and 32% for the same periods in 2003. Included in selling expenses for the nine months ended September 30, 2004 were severance charges of $3,351,000 related to a sales force reduction in Europe. The increase in selling expenses reflects the Company’s increased promotional efforts primarily in Europe, North America and Latin America and includes costs related to new product launches and unified promotional materials and campaigns for the Company’s global products.

General and Administrative Expenses: General and administrative expenses were $24,962,000 and $73,686,000 for the three and nine months ended September 30, 2004, respectively, compared to $27,834,000 and $84,760,000 for the same periods in 2003, resulting in decreases of $2,872,000 (10%) and $11,074,000 (13%), respectively. As a percent of product sales, general and administrative expenses were 17% for both the three and nine months ended September 30, 2004 compared to 21% and 23% for the same periods in 2003, respectively. Included in general and administrative expenses for the nine months ended September 30, 2004 were severance charges of $1,159,000 related to workforce reductions in Spain. The decrease in general and administrative expenses were primarily due to reduced legal fees. While steps continue to be taken to more effectively manage legal costs, legal fees can vary from period to period based on the level of activity surrounding outstanding legal challenges.

Research and Development: Research and development expenses were $25,045,000 and $64,429,000 for the three and nine months ended September 30, 2004, respectively, compared to $10,752,000 and $29,701,000 for the same periods in 2003, resulting in increases of $14,293,000 (133%) and $34,728,000 (117%), respectively. The increase in research and development expenses were primarily attributable to the acceleration of clinical trials for Viramidine and remofovir and costs associated with the completion of safety studies for Zelapar. The Company completed enrollment of one of two Phase 3 studies being conducted for Viramidine, and is continuing to enroll patients in the second Phase 3 study for Viramidine and Phase 2 study for remofovir. It is expected that research and development expenses will increase in 2005 compared to 2004 as progress continues with the clinical trials of Viramidine and remofovir.

Acquired In-Process Research and Development: In the nine months ended September 30, 2004, the Company incurred an expense of $11,770,000 associated with IPR&D related to the Amarin Acquisition that occurred in February 2004. In the three and nine months ended September 30, 2003, the Company incurred an expense of $117,609,000 associated with IPR&D related to the acquisition of Ribapharm. The amount expensed as IPR&D represents the Company’s estimate of the fair value of purchased in-process technology for projects that, as of the acquisition date, had not yet reached technological feasibility and had no alternative future use.

Restructuring and impairment charges: In the nine months ended September 30, 2004, the Company incurred an expense of $20,116,000 related to the manufacturing and rationalization plan. The Company has made significant progress towards its plans of disposing of the manufacturing sites in the third quarter of 2004 and is currently actively marketing the sites to prospective buyers. The sites were tested for impairment in the second quarter of 2004, resulting in impairment of asset value on three of the sites. Accordingly, the Company wrote these sites down to their fair value and recorded an impairment charge of $18,000,000 for the nine months ended September 30, 2004. In addition to the impairment charge, the Company recorded $2,116,000 related to severance for the nine months ended September 30, 2004.

Amortization: Amortization expense was $14,094,000 and $41,514,000 for the three and nine months ended September 30, 2004, respectively, compared to $9,921,000 and $25,805,000 for the same periods in 2003, reflecting increases of $4,173,000 (42%) and $15,709,000 (61%), respectively. The increase was primarily related to amortization of intangibles related to the acquisition of Ribapharm of $2,572,000 and $12,326,000 for the three and nine months ended September 30, 2004, respectively. The remaining increase in 2004 relates to amortization of intangibles acquired with the Amarin and Tasmar acquisitions.

Other Income, Net, Including Translation and Exchange: Other income, net, including translation and exchange was a loss of $515,000 and $2,193,000 for the three and nine months ended September 30, 2004, respectively, compared to income of $2,208,000 and $496,000 for the same periods in 2003. In the third quarter of 2004, translation losses principally consisted of translation and exchange losses in North America of $666,000, partially offset by translation and exchange gains in Latin America of $113,000. In the nine months ended September 30, 2004, translation losses principally consisted of translation and exchange losses in Europe of $3,471,000, which included losses resulting from the sale of certain long-term investments prior management had made, partially offset by translation and exchange gains in Latin America of $998,000. The Company’s translation and exchange losses are primarily related to U.S. dollar denominated assets and liabilities at its foreign currency denominated subsidiaries.

Loss on Early Extinguishment of Debt: Loss on early extinguishment of debt for the three and nine months ended September 30, 2004 was $13,994,000 and $19,892,000, respectively, related to the repurchase of $326,001,000 aggregate principal amount of the Company’s 6 1/2% Convertible Subordinated Notes due 2008.

Interest Expense and Income: Interest expense increased $2,230,000 and $15,468,000 during the three and nine months ended September 30, 2004, respectively, compared to the same periods in 2003. The increase was due to the issuance of $480,000,000 aggregate principal amount of 3.0% and 4.0% Convertible Subordinated Notes and $300,000,000 aggregate principal amount of 7.0% Senior Notes in the fourth quarter of 2003. The Company repurchased and redeemed all of its 6 1/2% Convertible Subordinated Notes due 2008 in July 2004, which is expected to lower interest expense. Interest income increased $1,400,000 and $5,473,000 during the three and nine months ended September 30, 2004, respectively, compared to the same periods in 2003, due primarily to higher cash balances during those periods.

Income Taxes: As a result of the Company’s loss from continuing operations for the three and nine months ended September 30, 2004, its effective tax rates were a benefit of 39% and 20%, respectively, compared to its effective tax rates of a provision of 15% and 203% for the three and nine months ended September 30, 2003, respectively. The Company’s effective tax rate for the nine months ended September 30, 2004 was affected by pre-tax losses resulting from restructuring and impairment charges ($20,116,000) and in Europe a work force reduction ($4,685,000), for which the Company recorded a minimal tax benefit of $1,138,000 (5%). This minimal tax benefit reflects the uncertainty of the realization of tax benefits in some of the jurisdictions in which these charges were incurred. Additionally, the Company recorded a tax provision of $1,828,000 related to the settlement of a tax dispute with Puerto Rico in the nine months ended September 30, 2004. Excluding the effect of these items, the year-to-date 2004 effective tax rate would have been 37%. The Company’s effective tax rates for 2003 were affected by pre-tax losses resulting from the write-off of acquired IPR&D expenses in connection with the Ribapharm acquisition, which was not deductible for tax purposes. Excluding the effect of the acquired IPR&D write-off, the 2003 effective tax rates would have been 38% for the three and nine months ended September 30, 2003.

Income (Loss) from Discontinued Operations, Net of Taxes: Income (loss) from discontinued operations were losses of $7,365,000 and $24,392,000 for the three and nine months ended September 30, 2004, respectively, compared to income of $16,110,000 and $13,992,000 for the same periods in 2003. The loss in the quarter and year-to-date of 2004 relates to losses from the Company’s raw materials businesses and manufacturing capability in Central Europe and a loss on disposal of $1,522,000 related to the sale of the business in the Czech Republic. The Company expects to sell the remaining business in Central Europe prior to the end of the year. The loss in the nine months ended September 30, 2004 included environmental charges of $16,000,000 ($10,080,000 net of taxes) related to a former operating site of the Company’s Biomedicals division, which the Company retained the liability for when it sold this business. In September 2003, the Company sold the remaining assets of its Biomedicals segment for cash proceeds of $58,000,000 and recorded a net gain on disposal of $23,288,000, net of taxes of $15,526,000. The income in 2003 includes a net gain on disposal of discontinued operations of $6,478,000 and income from discontinued operations of $7,514,000.

Cash and marketable securities totaled $471,910,000 at September 30, 2004 compared to $873,981,000 at December 31, 2003. Working capital was $568,902,000 at September 30, 2004 compared to $980,401,000 at December 31, 2003. The decrease in working capital of $411,499,000 was primarily attributable to payments on long-term debt and notes payable of $342,028,000, the use of cash in the acquisition of Amarin, Tasmar and various other product rights of $76,139,000, partially offset by cash generated from operations of $21,897,000.

Cash provided by operating activities is expected to be the Company’s primary recurring source of funds in 2004. During the nine months ended September 30, 2004, cash provided by operating activities totaled $21,897,000 compared to $171,132,000 for the same period in 2003. Cash flow from operating activities for the nine months ended September 30, 2004 was negatively impacted by a decrease in royalty revenues and

increased spending in research and development activities. The Company expects to see the effect of lower royalty revenues and increased research and development for the remainder of the year and in 2005 and 2006.

Cash used in investing activities was $166,213,000 for the nine months ended September 30, 2004 compared to $97,570,000 for the same period in 2003. In 2004, cash used in investing activities consisted of payments for the acquisition of Amarin, Tasmar and various other product rights of $76,139,000, net change in marketable equity securities of $91,119,000 and capital expenditures of $14,294,000, partially offset by proceeds from sale of assets of $11,405,000 primarily related to the sale of investments. In 2003, net cash used in investing activities consisted of payments for the acquisition of license rights, product lines and businesses of $192,923,000 related to the Ribapharm acquisition and capital expenditures of $9,241,000 partially offset by investing activities in discontinued operations of $104,276,000 primarily related to net proceeds from the sale of the Russian Pharmaceuticals segment and the Biomedicals Dosimetry business.

Cash used in financing activities was $349,509,000 for the nine months ended September 30, 2004, including payments on long-term debt and notes payable of $342,028,000, principally for the repurchase of the remaining portion of the 6 1/2% Convertible Subordinated Notes due 2008, and cash dividends paid on common stock of $19,388,000, partially offset by proceeds received from the issuance of stock of $11,907,000. In 2003, cash used in financing activities was $26,277,000 for the nine months ended September 30, 2003, including dividends paid on common stock of $19,501,000 and payments on long-term debt and notes payable of $6,797,000.

In January 2004, the Company entered into an interest rate swap agreement with respect to $150,000,000 principal amount of the Company’s 7.0% Senior Notes. The interest rate on the swap is variable at LIBOR plus 2.41%. The effect of this transaction is to initially lower the Company’s effective interest rate by exchanging fixed rate payments for floating rate payments. On a prospective basis, the effective rate will float and correlate to the variable interest earned on the Company’s cash held. The Company continues to expect to retain minimum cash levels of between $100,000,000 and $150,000,000.

The Company has collateral requirements on an interest rate swap agreement and foreign currency hedges. The amount of collateral varies monthly depending on the fair value of the underlying swap contracts. As of September 30, 2004, the Company has collateral of $9,632,000 included in marketable securities related to these instruments.

Management believes that the Company’s existing cash and cash equivalents and funds generated from operations will be sufficient to meet its operating requirements at least through September 30, 2005, to fund anticipated acquisitions, capital expenditures and its research and development program. While the Company has no current intent to issue additional debt or equity securities, it may also seek additional debt financing or issue additional equity securities to finance future acquisitions or for other purposes. The Company funds its cash requirements primarily from cash provided by its operating activities. The Company’s sources of liquidity are its cash and cash equivalent balances and its cash flow from operations.

While the Company has historically paid quarterly cash dividends and has declared a dividend of $0.0775 per share for the third quarter, there can be no assurance that it will continue to do so in the future.

The Company currently has no product liability insurance for a majority of its products in the United States. In connection with the Amarin acquisition, the Company acquired product liability insurance for Permax, which coverage it expects to maintain, as a result of this product being subject to settled and pending product liability litigation. While, to date, no material adverse claim for personal injury resulting from allegedly defective products has been successfully maintained against it, a substantial claim, if successful, could have a material adverse effect on the Company’s liquidity and financial performance. The Company maintains clinical trial insurance in major markets in which it conducts clinical trials.

The Company expects its research and development expenses to increase in the future, of which a large percentage will be to support the continuing product development programs for Viramidine and remofovir.

For Viramidine, the Company is continuing its Phase 2 study in 180 patients with hepatitis C. This study began in 2003 and has continued into 2004. The study included an interim analysis performed on the first 160 patients who received at least 12 weeks of therapy. In the second half of 2003, protocols for two Phase 3 Viramidine studies were developed. The Company decided to initiate the Phase 3 studies of Viramidine prior to the completion of the Phase 2 clinical trials. Each of the two Phase 3 studies will be conducted on a global basis, and each study will consist of approximately 100 investigative sites and approximately 1,000 enrolled patients. The studies will compare Viramidine and ribavirin, each in conjunction with a pegylated interferon. The first of the two global studies, known as VISER 1, began enrollment in the fourth quarter of 2003 and completed enrollment in August 2004. The second study, known as VISER 2, began enrollment in the second quarter of 2004. The Company’s external research and development expenses for Viramidine were approximately $7,735,000 and $20,996,000 for the three and nine months ended September 30, 2004, respectively, and $39,858,000 from inception through September 30, 2004.

For remofovir, the Company has completed two Phase 1 clinical trials in a total of 47 healthy volunteers. Remofovir is currently being evaluated in a third Phase 1 study, which is designed as a 28 day, randomized, placebo-controlled, double-blind, dose-escalation clinical trial in up to 40 patients with hepatitis B in the United States. The treatment phase of this study was completed and the results are expected in late 2004. Further, a fourth Phase 1 multiple dose study in Taiwan completed treatment in May 2004. A 48-week dose-ranging Phase 2 study in Asia and the US has started enrolling in July 2004. The Company’s external research and development expenses for remofovir were approximately $1,777,000 and $5,283,000 for the three and nine months ended September 30, 2004, respectively, and $18,405,000 (including a milestone payment of $2,100,000) from inception through September 30, 2004.

Approximately 80% and 77% of the Company’s revenues from continuing operations, which includes royalties, for the nine months ended September 30, 2004 and 2003, respectively, were generated from operations or earned outside the United States. All of the Company’s foreign operations are subject to risks inherent in conducting business abroad, including possible nationalization or expropriation, price and currency exchange controls, fluctuations in the relative values of currencies, political instability and restrictive governmental actions. Changes in the relative values of currencies occur from time to time and may, in some instances, materially affect the Company’s results of operations. The effect of these risks remains difficult to predict.

The consolidated condensed financial statements appearing elsewhere in this quarterly report have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, the Company evaluates its estimates, including those related to product returns, collectibility of receivables, inventories, intangible assets, income taxes and contingencies and litigation. The actual results could differ materially from those estimates.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated condensed financial statements.

The Company recognizes revenues from product sales when title and risk of ownership transfers to the customer. Revenues are recorded net of provisions for rebates, discounts and returns, which are established at the time of sale. Allowances for future returns of products sold to the Company’s direct and indirect

customers, who include wholesalers, retail pharmacies and hospitals, are calculated as a percent of sales based on historical return percentages taking into account additional available information on competitive products and contract changes. The Company uses third-party data to estimate the level of product inventories, expiration dating, and product demand at the Company’s major wholesalers. Based upon this information, adjustments are made to the accrual if deemed necessary. Actual results could be materially different from the Company’s estimates, resulting in future adjustments to revenue. For the nine months ended September 30, 2004, returns received were less than 2% of product sales. For the nine months ended September 30, 2004 and 2003, the provision for sales returns was less than 3% of product sales. The Company conducts a review of the current methodology and assesses the adequacy of the allowance for returns on a quarterly basis, adjusting for changes in assumptions, historical results and business practices, as necessary.

The Company may offer sales incentives primarily in international markets, where typically no right of return exists except for goods damaged in transit, product recalls or for replacement of existing products due to packaging or labeling changes. In the U.S. market, the Company’s current practice is to offer sales incentives primarily in connection with launches of new products or changes of existing products where demand has not yet been established. The Company monitors and restricts sales in the U.S. market in order to limit wholesaler purchases in excess of their ordinary-course-of-business inventory levels. However, specific events such as the case of sales incentives described above or seasonal demand (e.g. antivirals during an outbreak) may justify purchases by the wholesalers in excess of their ordinary course of business. The Company’s revenue recognition policy on these types of purchases and on incentives in international markets is consistent with the policies described in the revenue recognition critical accounting policy.

The Company operates in numerous countries where its income tax returns are subject to audit. Internal and external tax professionals are employed to minimize tax audit adjustments where possible. The Company considers the expected outcome of these audits in the calculation of its tax provision.

The Company assesses whether its is more likely than not that it will realize the tax benefits associated with its deferred tax assets and establishes a valuation allowance for assets that are not expected to result in a realized tax benefit. A significant amount of judgment is used in this process, including preparation of forecasts of future taxable income and evaluation of tax planning initiatives. If the Company revises these forecasts or determines that certain planning events will not occur, an adjustment to the valuation allowance will be made to tax expense in the period such determination is made. The Company’s U.S. tax returns for the period from 1997 to 2001 are currently being reviewed by the Internal Revenue Service. While the Company believes the review will not result in the returns being found to contain any substantive and material deficiencies, there can be no assurance that the Internal Revenue Service’s findings will not have a material adverse effect on the Company’s reported effective tax rate and after-tax cash flows.

The Company is currently reviewing the impact of The American Jobs Creation Act, primarily as it relates to its potential opportunity to repatriate cash to the United States at a low effective tax rate. The Company expects to complete the evaluation and develop an appropriate plan of action during the fourth quarter of 2004.

The Company evaluates the carrying value of property, plant and equipment in accordance with guidelines. In evaluating property, plant and equipment, the Company determines whether there has been impairment by comparing the anticipated undiscounted future cash flows expected to be generated by the property, plant and equipment with its carrying value. If the undiscounted cash flows is less than the carrying value, the amount of the impairment, if any, will be determined by comparing the carrying value of the property, plant and equipment with its fair value. Fair value is generally based on a discounted cash flows analysis, independent appraisals or preliminary offers from prospective buyers.

The Company periodically reviews intangible assets for impairment using an undiscounted net cash flows approach. The Company determines whether there has been impairment by comparing the anticipated undiscounted future operating income of the product line with its carrying value. If the undiscounted operating income is less than the carrying value, the amount of the impairment, if any, will be determined by comparing the value of each intangible asset with its fair value. Fair value is generally based on a discounted cash flows analysis.

The Company uses a discounted cash flow model to value intangible assets acquired and for the assessment of impairment. The discounted cash flow model requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The Company evaluated the businesses included in discontinued operations by comparing the carrying value of each intangible asset to their fair value, as determined using discounted cash flows analysis, appraisals, and purchase offers.

The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about our businesses and their prospects, or changes in market conditions, could result in an impairment charge.

The purchase price for the Amarin Acquisition was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. Such a valuation requires significant estimates and assumptions, including but not limited to: determining the timing and expected costs to complete the in-process projects; projecting regulatory approvals; estimating future cash flows from product sales resulting from completed products and in-process projects; and developing appropriate discount rates and probability rates by project. The Company believes the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions. However, these assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Additionally, estimates for the purchase price allocation may change as subsequent information becomes available.

The Company values in-process research and development (“IPR&D”) acquired in a business combination based on an approach consistent with the AICPA Practice Aid, Assets Acquired in Business Combinations to be Used in Research and Development Activities: A Focus in Software, Electronic Devices and Pharmaceutical Industries. The amount expensed as acquired IPR&D represents an estimate of the fair value of purchased in-process technology for Zelapar that, as of the acquisition date, had not yet reached technological feasibility and had no alternative future use. The data used to determine fair value requires significant judgment. The estimated fair value was based on the Company’s use of a discounted cash flow model (based on an estimate of future sales and an average gross profit margin of 66%). The estimated after-tax cash flows (using a tax rate of 40%) were then discounted to a present value using a discount rate of 20%.

The Company estimated that the Zelapar studies would be completed in 2004 and, if successful, revenue for Zelapar will commence in 2005. See Note 2 of notes to consolidated condensed financial statements for discussion of the Amarin Acquisition.

The major risks and uncertainties associated with the timely and successful completion of these projects include the uncertainty of the Company’s ability to confirm the safety and efficacy of the technology based on the data from clinical trials and of obtaining necessary regulatory approvals. In addition, no assurance can be given that the underlying assumptions the Company used to forecast the cash flows or the timely and successful completion of these projects will materialize as estimated. For these reasons, among others, actual results may vary significantly from the estimated results.

The Company is exposed to contingencies in the ordinary course of business, such as legal proceedings and business-related claims, which range from product and environmental liabilities to tax matters. In accordance with SFAS No. 5, Accounting for Contingencies, we record accruals for such contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. The estimates are refined each accounting period, as additional information is known. See Note 3 and Note 9 of notes to consolidated condensed financial statements for a discussion of contingencies.

The Company’s business and financial results are affected by fluctuations in world financial markets. The Company evaluates its exposure to such risks on an ongoing basis, and seeks ways to manage these risks to an acceptable level, based on management’s judgment of the appropriate trade-off between risk, opportunity and cost. The Company does not hold any significant amount of market risk sensitive instruments whose value is subject to market price risk. The Company’s significant foreign currency exposure relates to the Euro, the Mexican Peso, the Polish Zloty, the Swiss Franc and the Canadian Dollar. The Company seeks to manage its foreign currency exposure by maintaining the majority of cash balances at foreign subsidiaries in U.S. dollars and through operational means by managing local currency revenues in relation to local currency costs. The Company is currently taking steps to mitigate the impact of foreign currency on the income statement, which include hedging its foreign currency exposure. In March and June 2004, the Company entered into foreign currency hedge transactions to reduce its exposure to variability in the Euro.

In the normal course of business, the Company also faces risks that are either non-financial or non-quantifiable. Such risks principally include country risk, credit risk and legal risk and are not discussed or quantified in the following analysis. At September 30, 2004, the fair value of the Company’s financial instruments were as follows (in thousands):

The Company currently does not hold financial instruments for trading or speculative purposes. The financial assets of the Company are not subject to significant interest rate risk due to their short duration. At September 30, 2004, the Company had $13,134,000 of foreign denominated variable rate debt that would subject it to both interest rate and currency risks. In January 2004, the Company entered into an interest rate swap agreement with respect to $150,000,000 principal amount of the Company’s 7.0% Senior Notes. A 100 basis-point increase in interest rates affecting the Company’s financial instruments would not have had a material effect on the Company’s third quarter 2004 pretax earnings. In addition, the Company has $780,000,000 of fixed rate debt as of September 30, 2004, that require U.S. dollar repayment. To the extent that the Company requires, as a source of debt repayment, earnings and cash flow from some of its units located in foreign countries, the Company is subject to risk of changes in the value of certain currencies relative to the U.S. dollar. However, the increase of a 100 basis-points in interest rates would have reduced the fair value of the Company’s remaining fixed-rate debt instruments by approximately $48,000,000 as of September 30, 2004.

The Company estimated the sensitivity of the fair value of its derivative foreign exchange contracts to a hypothetical 10% strengthening and 10% weakening of the spot exchange rates for the U.S. dollar against the Euro at September 30, 2004. The analysis showed that a 10% strengthening of the U.S. dollar would have resulted in a gain from a fair value change of $3,806,000 and a 10% weakening of the U.S. dollar would have resulted in a loss from a fair value change of $8,684,000 in these instruments. Losses and gains on the underlying transactions being hedged would have largely offset any gains and losses on the fair value of derivative contracts. These offsetting gains and losses are not reflected in the above analysis.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of September 30, 2004, the Company conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based upon the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.

There has been no change in the Company’s internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer, that occurred during the three months ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Except for the historical information contained herein, the matters addressed in this quarterly report on Form 10-Q constitute “forward-looking statements.” Forward-looking statements may be identified by the use of the words “anticipates,” “expects,” “intends,” “plans,” and variations or similar expressions. These forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below and elsewhere in this quarterly report on Form 10-Q, which could cause actual results to differ materially from those anticipated by the Company’s management. In addition, the information set forth in the Company’s Form 10-K for the fiscal year ended December 31, 2003, describes certain additional risks and uncertainties that could cause actual results to vary materially from the future results covered in such forward-looking statements. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which speak only as of the date of this report. The Company undertakes no obligation to update any of these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes.

The short and long-term success of the Company is subject to a variety of risks and uncertainties, many of which are beyond the Company’s control. Stockholders and prospective stockholders of the Company should consider carefully the following risk factors, in addition to other information contained in this report and in the Company’s annual report on Form 10-K. The Company’s actual results could differ materially from these anticipated in this report as a result of various factors, including those set forth below.


	•	The future growth of the Company’s business depends on the development and approval of new products, including Viramidine. The process of developing new drugs has an inherent risk of failure. Although certain of the Company’s research compounds show promise at their current stages of development, the Company may fail to commercialize them for various reasons. For example, they may turn out to be ineffective or unsafe in clinical or pre-clinical testing; their patent protection may become compromised; other therapies may prove safer or more effective; or the prevalence of the disease for which they are being developed may decrease. The Company’s inability to successfully develop its products due to these or other factors could have a material adverse effect on future revenues.

	•	The Company can protect its products from generic substitution by third parties only to the extent that its technologies are covered by valid and enforceable patents, are effectively maintained as trade secrets or are protected by data exclusivity. However, the Company’s presently pending or future patent applications may not issue as patents. Any patent issued may be challenged, invalidated, held unenforceable or circumvented. Furthermore, the Company’s patents may not be sufficiently broad to prevent third parties’ competing products. The expiration of patent protection for ribavirin has resulted in significant competition from generic substitutes and declining royalty revenues.

	•	Trade secret protection is less effective than patent protection because competitors may discover our technology or develop parallel technology.

	•	The scope of protection afforded by a patent can be highly uncertain. A pending claim or a result unfavorable to the Company in a patent dispute may preclude development or commercialization of products or impact sales of existing products, and result in payment of monetary damages.

	•	Obtaining drug approval in the United States and other countries is costly and time consuming. Uncertainties and delays inherent in the process can preclude or delay development and commercialization of the Company’s products.

	•	The Company’s current business plan includes expansion through acquisitions, in addition to the development of new products. If the Company is unable to successfully execute on its expansion plans to find attractive acquisition candidates at appropriate prices, and to integrate successfully any acquired companies or products, the expected growth of the Company’s business will be impeded.

	•	The Company and its competitors are always striving to develop products that are more effective, safer, more easily tolerated or less costly. If the Company’s competitors succeed in developing better


		alternatives to the Company’s current products before it does, the Company will lose sales and revenues to their alternative products. If vaccines are introduced to prevent the diseases treated by the Company’s products, the Company’s potential sales and revenues will decrease.

	•	The pharmaceutical industry is subject to substantial government regulation, including the approval of new pharmaceutical products, labeling, advertising and, in most countries, pricing, as well as inspection and approval of manufacturing facilities. The costs of complying with these regulations is high, and failure to comply could result in fines or interruption in our business.

	•	The Company sells products in many countries that are susceptible to significant foreign currency risk. The Company generally sells products in these countries for U.S. dollars. While this eliminates the Company’s direct currency risk, it increases the Company’s credit risk because if a local currency is devalued significantly, it becomes more expensive for customers in that market to purchase the Company’s products in U.S. dollars. The Company entered into foreign currency hedge transactions to reduce its exposure to variability in the Euro. The Company continues to evaluate the possibility of entering into additional hedge arrangements which would result in additional expenditures.

	•	A significant part of the Company’s revenue is derived from products manufactured by third parties. The Company relies on their quality level, compliance with the FDA regulations and continuity of supply. Any failure by them in these areas could disrupt the Company’s product supply and negatively impact its revenues.

	•	The Company’s flexibility in maximizing commercialization opportunities for its compounds may be limited by its obligations to Schering-Plough. In November 2000, the Company entered into an agreement that provides Schering-Plough with an option to acquire the rights to up to three of its products that they designate at an early stage of product development and a right for first/last refusal to license various compounds the Company may develop and elect to license to others. Viramidine was not subject to the option of Schering-Plough, but it would be subject to their right of first/last refusal if the Company elected to license it to a third party. The interest of potential collaborators in obtaining rights to the Company’s compounds or the terms of any agreement it ultimately enters into for these rights may be hindered by its agreement with Schering-Plough.

	•	To purchase the Company’s products, many patients rely on reimbursement by third party payors such as insurance companies, HMOs and government agencies. These third party payors are increasingly attempting to contain costs by limiting both coverage and the level of reimbursement of new drug products. The reimbursement levels established by third party payors in the future may not be sufficient for the Company to realize an appropriate return on its investment in product development.

	•	Some of the Company’s development programs are based on the library of nucleoside compounds it has developed. It is not practicable to create backups for the Company’s nucleoside library, and accordingly it is at risk of loss in earthquakes, fire and other natural disasters.

	•	All drugs have potential harmful side effects and can expose drug manufacturers and distributors to liability. The Company generally does not maintain product liability insurance. As a result, in the event one or more of the Company’s products is found to have harmed an individual or individuals, it may be responsible for paying all or substantially all damages awarded. Any event causing product liability while the Company lacks insurance coverage could have a material negative impact on its financial position and results of operations.

	•	Subject to the terms of the Company’s debt agreements, the Company may incur additional indebtedness from time to time to finance working capital needs, acquisitions, capital expenditures or for other purposes. There can be no assurance that financing will continue to be available on terms acceptable to the Company or at all. The absence of such financing will reduce the Company’s ability to respond to changing business and economic conditions, to fund scheduled investments and capital expenditures, to make future acquisitions and to absorb negative operating results.


	•	The Company is involved in several legal proceedings, including those described in Note 9 to notes to consolidated condensed financial statements.

	•	Dependence on key personnel leaves the Company vulnerable to a negative impact if they leave. The Company’s continued success will depend, to a significant extent, upon the efforts and abilities of the key members of management. The loss of their services could have a negative impact on the Company.

	•	The Company’s research and development activities involve the controlled use of potentially harmful biological materials as wells as hazardous materials, chemicals and various radioactive compounds. The Company cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, the Company could be held liable for damages that result. Any liability could exceed the Company’s resources.

	•	The Company’s stockholder rights plan, provisions of its certificate of incorporation and provisions of the Delaware General Corporation Law could provide its board of directors with the ability to deter hostile takeovers or delay, deter or prevent a change in control of the Company, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.

	•	The Company is authorized to issue, without stockholder approval, 10,000,000 shares of preferred stock, 200,000,000 shares of common stock and securities convertible into either shares of common stock or preferred stock. If the Company issues additional equity securities, the price of its securities may be materially and adversely affected. The board of directors can also use issuances of preferred or common stock to deter a hostile takeover or change in control of the Company.

	•	The Company is subject to a Consent Order with the Securities and Exchange Commission, which permanently enjoins the Company from violating securities laws and regulations. The Consent Order also precludes protection for forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The existence of the permanent injunction under the Consent Order, and the lack of protection under the Safe Harbor may limit the Company’s ability to defend against future allegations.

	•	The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 (‘Sarbanes-Oxley‘) requires the Company to provide an assessment of the effectiveness of internal control over financial reporting beginning with the Company’s Annual Report on Form 10-K for the fiscal year ending December 31, 2004. While the Company has not completed its review of the effectiveness of its internal control over financial reporting, as of the date of this quarterly report on From 10-Q, no items have been identified that would be considered material deficiencies requiring reporting under Section 404 of Sarbanes-Oxley. Nonetheless, the Company’s review of its internal controls, or the tests conducted by the Company’s auditors, may uncover unexpected material weaknesses. If the Company or its auditors discover a material weakness, corrective action may be time consuming, costly and further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements and harm its stock price. Until the Company completes its review and all necessary remedial action, and secures the written attestation of the Company’s auditors that its internal controls are adequate, the Company will not be able to file its Annual Report on Form 10-K for fiscal year 2004 as required by the Securities Exchange Act of 1934. If the Company’s Form 10-K is delayed, its stock price could fall. If the delay is protracted, the Company could be subject to a variety of administrative sanctions, including the delisting of its common stock from the NYSE and the inability of registered broker-dealers to make a market in the Company’s common stock, which would further reduce its stock price.

See Note 9 of notes to consolidated condensed financial statements in Item 1 of Part I of this quarterly report, which is incorporated herein by reference.


(1)	Represents shares of the Company’s common stock which would have been issuable upon conversion of the Company’s 6 1/2% Convertible Subordinated Notes due 2008.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this quarterly report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.


	VALEANT PHARMACEUTICALS INTERNATIONAL
	Registrant

	/s/ ROBERT W. O’LEARY
	Robert W. O’Leary
	Chairman of the Board and Chief Executive Officer


	/s/ BARY G. BAILEY
	Bary G. Bailey
	Executive Vice President and Chief Financial Officer (principal financial and accounting officer)


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended September 30, 2004

or

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

		For the transition period from to


Delaware		33-0628076
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

3300 Hyland Avenue Costa Mesa, California (Address of principal executive offices)		92626 (Zip Code)


		Page
		Number

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Condensed Balance Sheets as of September 30, 2004 and December 31, 2003		2
	Consolidated Condensed Statements of Income for the three months and nine months ended September 30, 2004 and 2003		3
	Consolidated Condensed Statements of Comprehensive Income for the three months and nine months ended September 30, 2004 and 2003		4
	Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 2004 and 2003		5
	Notes to Consolidated Condensed Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		34
Item 4.	Controls and Procedures		35

PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		39
Item 6.	Exhibits		39
SIGNATURES			40
EXHIBIT 15.1
EXHIBIT 15.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


			September 30,			December 31,
			2004			2003

			(Unaudited)
ASSETS
Current Assets:
	Cash and cash equivalents		$	373,062		$	866,431
	Marketable securities			98,848			7,550
	Accounts receivable, net			145,327			162,402
	Inventories, net			102,075			91,906
	Prepaid expenses and other current assets			13,989			13,863

		Total current assets		733,301			1,142,152
Property, plant and equipment, net				217,583			241,016
Deferred tax assets, net				106,069			68,601
Intangible assets, net				463,507			435,029
Other assets				44,592			62,145

		Total non-current assets		831,751			806,791
Assets of discontinued operations				30,239			27,994

			$	1,595,291		$	1,976,937


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
	Trade payables		$	36,305		$	36,073
	Accrued liabilities			109,961			109,373
	Notes payable and current portion of long-term debt			774			1,343
	Income taxes payable			17,359			14,962

		Total current liabilities		164,399			161,751
Long-term debt, less current portion				792,692			1,119,802
Deferred income taxes and other liabilities				74,708			70,292

		Total non-current liabilities		867,400			1,190,094
Liabilities of discontinued operations				35,979			19,731

Commitments and contingencies
Stockholders’ Equity:
	Common stock, $0.01 par value; 200,000 shares authorized; 84,118 (September 30, 2004) and 83,185 (December 31, 2003) shares outstanding (after deducting shares in treasury of 1,068 as of September 30, 2004 and December 31, 2003)			841			832
	Additional capital			987,672			976,773
	Accumulated deficit			(428,664	)		(338,384	)
	Accumulated other comprehensive loss			(32,336	)		(33,860	)

		Total stockholders’ equity		527,513			605,361

			$	1,595,291		$	1,976,937



			Three Months Ended						Nine Months Ended
			September 30,						September 30,

			2004			2003			2004			2003

Revenues:
	Product sales		$	151,099		$	131,290		$	431,058		$	372,956
	Royalties			15,333			36,217			63,444			136,755

		Total revenues		166,432			167,507			494,502			509,711

Costs and expenses:
	Cost of goods sold (excluding amortization)			49,264			41,637			141,914			130,197
	Selling expenses			45,046			39,179			146,363			119,847
	General and administrative expenses			24,962			27,834			73,686			84,760
	Research and development costs			25,045			10,752			64,429			29,701
	Acquired in-process research and development			—			117,609			11,770			117,609
	Restructuring charges			(69	)		—			20,116			—
	Amortization expense			14,094			9,921			41,514			25,805

		Total costs and expenses		158,342			246,932			499,792			507,919

		Income (loss) from operations		8,090			(79,425	)		(5,290	)		1,792
Other income (loss), net, including translation and exchange				(515	)		2,208			(2,193	)		496
Loss on early extinguishment of debt				(13,994	)		—			(19,892	)		—
Interest income				2,353			953			8,539			3,066
Interest expense				(10,101	)		(7,871	)		(39,360	)		(23,892	)

Loss from continuing operations before income taxes and minority interest				(14,167	)		(84,135	)		(58,196	)		(18,538	)
Provision (benefit) for income taxes				(5,550	)		12,720			(11,831	)		37,647
Minority interest, net				(81	)		1,656			8			11,667

	Loss from continuing operations			(8,536	)		(98,511	)		(46,373	)		(67,852	)
	Income (loss) from discontinued operations			(7,365	)		16,110			(24,392	)		13,992

	Net loss		$	(15,901	)	$	(82,401	)	$	(70,765	)	$	(53,860	)

Basic and diluted income (loss) per share:
	Loss from continuing operations		$	(0.10	)	$	(1.18	)	$	(0.55	)	$	(0.81	)
	Discontinued operations			(0.09	)		0.19			(0.29	)		0.17

	Basic and diluted net income (loss) per share		$	(0.19	)	$	(0.99	)	$	(0.84	)	$	(0.64	)

Basic and diluted shares used in per share computation				84,055			83,067			83,795			83,759

Dividends paid per share of common stock			$	0.08		$	0.08		$	0.23		$	0.23

Dividends declared per share of common stock			$	0.08		$	0.08		$	0.23		$	0.23


1.	Organization and Summary of Significant Accounting Policies


Purchase price:
	Cash paid	$	38,000
	Amount payable		2,000
	Transaction costs		2,811
	Less: Cash acquired		(601	)

		$	42,210

Allocation:
	Current assets	$	2,642
	Prepaid research and development		2,000
	Property, plant, and equipment		205
	Acquired intangible assets		37,113
	Goodwill		3,350
	Acquired IPR&D		11,770
	Other liabilities assumed		(14,870	)

		$	42,210



			September 30, 2004					December 31, 2003

			Gross		Accumulated			Gross		Accumulated
			Amount		Amortization			Amount		Amortization

Intangible assets:
	Product rights		$	563,925	$	(163,576	)	$	520,025	$	(158,743	)
	License agreement			67,376		(21,172	)		67,376		(6,911	)
	Goodwill			16,954		—			13,282		—

		Total	$	648,255	$	(184,748	)	$	600,683	$	(165,654	)



			Total Assets

			September 30,		December 31,
			2004		2003

Pharmaceuticals
	North America		$	441,814	$	400,265
	Latin America			131,216		105,333
	Europe			335,829		350,142
	Asia, Africa, Australia			55,717		25,631

		Total pharmaceuticals		964,576		881,371
Corporate				393,380		853,718
Research and development division				207,096		213,854
Discontinued operations				30,239		27,994

Total			$	1,595,291	$	1,976,937


(T)		— Indicates ten largest product

(G)		— Indicates global brand


Item 2.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*


	Development of New Products Via Internal Research and Development Activities



			Three Months Ended
			September 30,
									Increase/			Percent
			2004			2003			(Decrease)			Change

Revenues
Pharmaceuticals
	North America		$	36,613		$	29,403		$	7,210			25	%
	Latin America			38,514			34,746			3,768			11
	Europe			61,472			54,512			6,960			13
	Asia, Africa, Australia			14,500			12,629			1,871			15

		Total pharmaceuticals		151,099			131,290			19,809			15
Royalties				15,333			36,217			(20,884	)		(58	)

Total revenues				166,432			167,507			(1,075	)		(1	)
Costs and Expenses
Cost of goods sold (excluding amortization)				49,264			41,637			7,627			18
Selling expenses				45,046			39,179			5,867			15
General and administrative expenses				24,962			27,834			(2,872	)		(10	)
Research and development costs				25,045			10,752			14,293			133
Acquired IPR&D				—			117,609			(117,609	)		—
Restructuring charges				(69	)		—			(69	)		—
Amortization expense				14,094			9,921			4,173			42

	Operating income (loss)		$	8,090		$	(79,425	)	$	87,515			—

Gross profit on product sales (excluding amortization)			$	101,835		$	89,653		$	12,182			14

Gross profit margin on product sales				67	%		68	%


	*Purchase Price Allocation Including Acquired In-Process Research and Development*


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*


Item 1.	*Financial Statements*


2.	Acquisitions


3.	Discontinued Operations


7.	Detail of Certain Accounts



			Assets (Liabilities)
	Notional/
	Contract		Carrying
Description	Amount		Value			Fair Value

Forward contracts	$	60,807	$	(1,815	)	$	(1,815	)
Interest rate swaps		150,000		(224	)		(224	)
Outstanding debt		780,000		(780,000	)		(810,000	)


Item 2.	*Unregistered Sales of Equity Securities and Use of Proceeds*


							Approximate
					Total Number of		Dollar Value of
	Total				Units Purchased as		Units that May
	Number		Average		Part of Publicly		Yet Be Purchased
	of Units		Price Paid		Announced Plans		Under the Plans
Period	Purchased		per Unit		or Programs		or Programs

July 1 — 30, 2004(1)		236,599	$	103.714		236,599	$	—
August 1 — 31, 2004		—		—		—		—
September 1 — 30, 2004		—		—		—		—

Total		236,599	$	103.714		236,599	$


15.1		Review Report of Independent Registered Public Accounting Firm.
15.2		Awareness Letter of Independent Registered Public Accounting Firm.
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer and Chief Financial Officer of Periodic Financial Reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. § 1350.


Exhibit

	15	.1	Review Report of Independent Registered Public Accounting Firm.
	15	.2	Awareness Letter of Independent Registered Public Accounting Firm.
	31	.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.
	32	.1	Certification of Chief Executive Officer and Chief Financial Officer of Periodic Financial Reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. § 1350.