UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number 1-11397

 

 

Valeant Pharmaceuticals International

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(949) 461-6000

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant on June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter based on the closing price of the common stock on the New York Stock Exchange on such date, was approximately $2,117,574,000.

 

The number of outstanding shares of the registrant’s common stock as of February 18, 2010 was 78,021,855.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information contained in Valeant Pharmaceuticals International’s definitive proxy statement for the 2010 annual meeting of stockholders is incorporated by reference into Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

 

In addition to current and historical information, this Annual Report on Form 10-K contains forward-looking statements. These statements relate to, but are not limited to, our future operations, future alliance revenue, prospects, potential products, developments and business strategies. Words such as “expects,” “anticipates,” “intends,” “plans,” “should,” “could,” “would,” “may,” “will,” “believes,” “estimates,” “potential,” or “continue” or similar language identify forward-looking statements.

 

Forward-looking statements involve known and unknown risks and uncertainties. Our actual results may differ materially from those contemplated by the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and sections in other documents filed with the Securities and Exchange Commission (“SEC”), under similar captions. You should consider these in evaluating our prospects and future financial performance. These forward-looking statements are made as of the date of this report. We disclaim any obligation to update or alter these forward-looking statements in this report or the other documents in which they are found, whether as a result of new information, future events or otherwise, or any obligation to explain the reasons why actual results may differ.

 

Acanya, Ancobon, Atralin, Bedoyecta, Bisocard, CeraVe, Cesamet, Cloderm, Diastat, Diastat AcuDial, Dermaveen, Dr. Renaud, Dr. LeWinn’s, Efudex/Efudix, Infergen, Kinerase, Librax, Librium, Mestinon, Migranal, MVE, M.V.I., Nyal, Opana, Permax, Quarzan, Syncumar and Sinupret are trademarks or registered trademarks of Valeant Pharmaceuticals International or its related companies or are used under license. This annual report also contains trademarks or trade names of other companies and those trademarks and trade names are the property of their respective owners.

 

 

Unless the context indicates otherwise, when we refer to “we,” “us,” “our,” “Valeant” or the “Company” in this Annual Report on Form 10-K, we are referring to Valeant Pharmaceuticals International, a Delaware corporation, and its subsidiaries on a consolidated basis.

 

Introduction

 

We are a multinational specialty pharmaceutical company that develops, manufactures and markets a broad range of pharmaceutical products. Our specialty pharmaceutical and OTC products are marketed under brand names and are sold in the United States, Canada, Australia and New Zealand, where we focus most of our efforts on the dermatology and neurology therapeutic classes. We also have branded generic and OTC operations in Europe and Latin America which focus on pharmaceutical products that are bioequivalent to original products and are marketed under company brand names.

 

Business Strategy

 

Our strategy is to focus the business on core geographies and therapeutic classes, maximize pipeline assets through strategic partnerships with other pharmaceutical companies and deploy cash with an appropriate mix of selective acquisitions, share buybacks and debt repurchases. We believe this strategy will allow us to improve both our growth rates and profitability.

 

Our leveraged research and development (“R&D”) model is a key element to our business strategy. It allows us to progress development programs to drive future commercial growth, while minimizing our R&D expense. This is achieved in 4 ways: (1) we structure partnerships and collaborations so that our partner partially funds development work, e.g., collaboration on retigabine with Glaxo Group Limited (“GSK”), a wholly-owned subsidiary of GlaxoSmithKline plc, (2) we bring products already developed for other markets to our territories, e.g., our joint venture relationship in Canada with Meda AB (“Meda”), an international specialty pharmaceutical company located in Stockholm, Sweden, (3) we acquire dossiers and registrations for branded generic products, which

require limited and low risk manufacturing start-up and development activities and (4) we have a dermatology service business that works with external customers as well as progressing our internal development programs. This service business model allows higher utilization and infrastructure cost absorption.

 

In March 2008, we announced a company-wide restructuring effort, designed to streamline our business, align our infrastructure to the scale of our operations, maximize our pipeline assets and deploy our cash assets to maximize shareholder value, while highlighting key opportunities for growth. Specifically, we reduced our focus to two therapeutic classes — dermatology and neurology, and to five geographic areas — U.S., Canada, Australia/New Zealand, Mexico/Brazil and Central Europe, and we adjusted our business infrastructure to support our strategy.

 

In 2008, we divested or discontinued certain non-strategic products and regional operations that did not meet our growth and profitability expectations. In January 2008, we sold our rights in Infergen to Three Rivers Pharmaceuticals, LLC. In March 2008, we sold certain assets in Asia to Invida Pharmaceutical Holdings Pte. Ltd. that included certain of our subsidiaries, branch offices and commercial rights in Singapore, the Philippines, Thailand, Indonesia, Vietnam, Korea, China, Hong Kong, Malaysia and Macau. This transaction also included the sale of certain product rights in Japan. In June 2008, we sold our subsidiaries in Argentina and Uruguay. In September 2008, we sold our business operations located in Western and Eastern Europe, Middle East and Africa (the “WEEMEA business”) to Meda. As a result of these dispositions, the results of operations of Infergen and of the WEEMEA business have been classified as discontinued operations in our consolidated financial statements for all periods presented in this report.

 

Acquisitions

 

In December 2009, we acquired Laboratoire Dr. Renaud, a privately-held cosmeceutical company located in Canada that specializes in topical formulations, and a related U.S. company (together “Dr. Renaud”), for aggregate cash consideration of $21.5 million. As a result of the acquisition, we gained access to a dermatology sales and marketing infrastructure in Canada and entered into a lease for a dermatological manufacturing facility.

 

In October 2009, we acquired Private Formula Holdings International Pty Limited (“PFI”), a privately-held company located in Australia that is engaged in product development, sales and marketing of premium skincare products primarily in Australia, for aggregate cash consideration of $71.1 million and the issuance of 162,500 restricted shares of our common stock valued at approximately $3.4 million. The purchase price includes a working capital adjustment of $0.9 million, which was paid in 2010. The acquisition of PFI gives us access to two leading brands in the Australian and New Zealand prestige skincare and nail treatment market and access to PFI’s established pharmacy and department store distribution network.

 

In July 2009, we acquired Tecnofarma S.A. de C.V. (“Tecnofarma”), a privately-held company located in Mexico, for a purchase price of approximately one times sales, plus the assumption of debt of approximately $13.0 million. Tecnofarma produces generic pharmaceuticals for sale primarily to the government and private label markets. The acquisition of Tecnofarma included the acquisition of manufacturing facilities, which will allow us to reduce our dependence upon third party manufacturers in Latin America.

 

In May 2009, we acquired intellectual property, trademarks and inventory related to certain dermatology products approved for sale in Australia and New Zealand, for cash of approximately $7.3 million, including transaction costs.

 

In April 2009, we acquired EMO-FARM sp. z o.o. (“Emo-Farm”), a privately-held Polish company that specializes in gel-based over-the-counter and cosmetic products, for aggregate cash consideration of $28.6 million. The acquisition of Emo-Farm expanded our base in Poland into topical products and included the acquisition of a topical manufacturing facility.

 

In December 2008, we acquired Dow Pharmaceutical Sciences, Inc. (“Dow”), a privately-held dermatology company that specializes in the development of topical products on a proprietary basis, as well as for pharmaceutical and biotechnology companies. We acquired Dow for an agreed price of $285.0 million, subject to certain closing adjustments, plus transaction costs. Contingent consideration of up to $235.0 million for future milestones related to certain pipeline products still in development was included in the merger agreement. In 2009, we paid

$115.0 million to the former Dow common stockholders in order to settle all current and future income and milestone obligations that we had to these stockholders under the merger agreement. Specifically, in exchange for this payment, we received (i) rights to all future profit share payments to Dow under Dow’s 2008 agreement with Mylan Pharmaceuticals Inc. (“Mylan”) related to sales of 1% clindamycin and 5% benzoyl peroxide gel (“IDP-111”), for which 90% was required to be paid to the former Dow common stockholders under the original merger agreement, and (ii) a release by these former Dow common stockholders of their right to receive up to $235.0 million in milestone payments upon a successful commercialization of Dow pipeline products currently under development.

 

In November 2008, we acquired DermaTech Pty Ltd (“DermaTech”), an Australian specialty pharmaceutical company focused on dermatology products marketed in Australia, for aggregate cash consideration of $15.5 million, including transaction costs and working capital adjustments.

 

In October 2008, we acquired Coria Laboratories Ltd. (“Coria”), a privately-held specialty pharmaceutical company focused on dermatology products in the United States, for aggregate cash consideration of $96.9 million, including transaction costs and working capital adjustments. As a result of the acquisition, we acquired an assembled sales force and a suite of dermatology products which enhanced our existing product base.

 

For information regarding these acquisitions, see Note 3 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

Segment Information

 

Our current product portfolio comprises approximately 380 products, with approximately 2,000 stock keeping units, with no individual product comprising 10% or more of our consolidated revenues in 2009. Our products are sold through three segments comprising Specialty Pharmaceuticals, Branded Generics — Europe and Branded Generics — Latin America. Additionally, within our Specialty Pharmaceuticals segment, we generate alliance revenue and service revenue from the licensing of dermatological products and from contract services in the areas of dermatology and topical medication. We also generate further alliance revenue, including royalties from the sale of ribavirin by Schering-Plough Ltd. (“Schering-Plough”).

 

Specialty Pharmaceuticals

 

The Specialty Pharmaceuticals segment generates product revenues from pharmaceutical and OTC products primarily from the United States, Canada, Australia and New Zealand. Within the Specialty Pharmaceutical segment, we have a broad range of pharmaceutical products including dermatology, neurology and prescription products in other therapeutic areas. These pharmaceutical products are marketed and sold primarily through wholesalers and to a lesser extent through retail and direct-to-physician channels.

 

Dermatology Products — Efudex/Efudix is indicated for the treatment of multiple actinic or solar keratoses and superficial basal cell carcinoma. It is sold as a cream and ointment under the Efudex/Efudix brand name and as generic fluorouracil 5%. Acanya gel is a fixed-combination clindamycin (1.2%)/benzoyl peroxide (2.5%) aqueous gel approved by the U.S. Food and Drug Administration (“FDA”) for the treatment of acne vulgaris in patients 12 years and older. Studied in patients with moderate and severe acne, Acanya is a once-daily formulation that offers high efficacy with a favorable tolerability profile because patients experience less dryness and skin irritation. Acanya was launched in March 2009. Atralin gel is an aqueous gel containing tretinoin (0.05%) approved for acne vulgaris in patients 10 years and older and is optimized for follicular skin penetration. Atralin has been demonstrated to reduce acne lesions as early as one month after the start of treatment and contains ingredients (hyaluronic acid, collagen and glycerin) known to moisturize and hydrate the skin. Combined sales of these products in the Specialty Pharmaceutical segment total approximately 18%, 20% and 19% of Specialty Pharmaceutical product sales for the years ended December 31, 2009, 2008 and 2007, respectively.

 

OTC Products — CeraVe is a range of over-the-counter products with essential ceramides and other skin-nourishing and skin-moisturizing ingredients (humectants and emollients) combined with a unique, patented Multivesicular Emulsion (MVE) delivery technology that, together, work to rebuild and repair the skin barrier. CeraVe formulations incorporate ceramides, cholesterol and fatty acids, all of which are essential for skin barrier

repair and are used as adjunct therapy in the management of various skin conditions. Kinerase is a range of over-the-counter and prescription cosmetic products that help skin look smoother, younger and healthier. Kinerase contains the synthetic plant growth factor N6-furfuryladenine which has been shown to slow the changes that naturally occur in the cell aging process in plants and in skin cells. Nyal is an Australian range of over-the-counter products covering an extensive range of tablets, liquids and nasal sprays to treat cough, cold, flu, sinus and hayfever symptoms. We also sell topical OTC products under the tradenames Dermaveen and Dr. LeWinn’s in Australia and Dr. Renaud in Canada. The Dr. LeWinn’s and Dr. Renaud products were acquired in 2009. Combined sales of these products in the Specialty Pharmaceutical segment total approximately 14%, 12% and 11% of Specialty Pharmaceutical product sales for the years ended December 31, 2009, 2008 and 2007, respectively.

 

Neurology / Other Products — Diastat/Diastat Acudial are gel formulations of diazepam administered rectally for the management of selected, refractory patients with epilepsy, who require intermittent use of diazepam to control bouts of increased seizure activity. Diastat and Diastat AcuDial are the only products approved by the FDA for treatment of such conditions outside of hospital situations. Cesamet is a synthetic cannabinoid sold in Canada. It is indicated for the management of severe nausea and vomiting associated with cancer chemotherapy. Mestinon is an orally active cholinesterase inhibitor used in the treatment of myasthenia gravis, a chronic neuromuscular, autoimmune disorder that causes varying degrees of fatigable weakness involving the voluntary muscles of the body. Migranal is a nasal spray formulation of dihydroergotamine indicated for the treatment of acute migraine headaches. Librax is a combination within a single capsule formulation of the antianxiety action of Librium (chlordiazepoxide) and the anticholinergic/spasmolytic effects of Quarzan (clidinium). It is used as adjunctive therapy in the treatment of peptic ulcer and in the treatment of irritable bowel syndrome (irritable colon, spastic colon, mucous colitis) and acute enterocolitis. Combined sales of these products in the Specialty Pharmaceutical segment total approximately 39%, 39% and 36% of Specialty Pharmaceutical product sales for the years ended December 31, 2009, 2008 and 2007, respectively.

 

Specialty Pharmaceutical Service and Alliance Revenue — We generate alliance revenue and service revenue from the licensing of dermatological products and from contract services in the areas of dermatology and topical medication. Alliance revenue within our Specialty Pharmaceuticals segment currently includes profit sharing payments from the sale of a 1% clindamycin and 5% benzoyl peroxide gel product (“IDP-111”) by Mylan, royalty payments on net sales of Cesamet in the U.S. through license agreements entered into with Meda in September 2009 and royalties from patent-protected formulations developed by Dow and licensed to third parties. In addition, we will receive future royalties on net sales of two dermatology products in Europe pursuant to license agreements entered into with Meda. Contract services are primarily focused on contract research for external development and clinical research in areas such as formulations development, in vitro drug penetration studies, analytical sciences and consulting in the areas of labeling and regulatory affairs. We also generate revenues associated with the Collaboration Agreement with GSK (as defined below).

 

Branded Generics — Europe

 

The Branded Generics — Europe segment generates revenues from branded generic pharmaceutical products primarily in Poland, Hungary, the Czech Republic and Slovakia. The Polish market represents approximately 77%, 74% and 74% of product sales in this segment for the years ended December 31, 2009, 2008 and 2007, respectively. Our Branded Generics — Europe segment develops, manufactures and markets products that are the therapeutic equivalent to their brand name counterparts, which are developed when patents or other regulatory exclusivity no longer protect an originator’s brand product. Our branded generics strategy is to develop a commercialization strategy to differentiate these products through innovative marketing tactics. Our products in this region are sold under the ICN Polfa brand name and we market our portfolio of generic branded products to doctors and pharmacists through approximately 300 sales professionals.

 

Our branded generics cover a broad range of treatments including antibiotics, antifungal medications and diabetic therapies among many others. Our largest product in this market is Bisocard, a Beta-blocker that is indicated to treat hypertension and angina pectoris. Syncumar is a courmarin that is used as an anti-coagulant for the treatment and prevention of thromboembolic diseases. Sinupret is an herbal supplement that is claimed to be beneficial for supporting healthy sinus and respiratory function. It is commonly used for the treatment of allergies, coughs, colds and sinus infections.

Branded Generics — Latin America

 

The Branded Generics — Latin America segment generates revenues from branded generic pharmaceutical products and OTC products in Mexico, Brazil and exports out of Mexico to other Latin American markets. The Mexico domestic market represents approximately 78%, 77% and 79% of product sales in this segment for the years ended December 31, 2009, 2008 and 2007, respectively. Our branded generic and generic products are developed when patents or other regulatory exclusivity no longer protect an originator’s brand product. Our branded generic products are primarily marketed to physicians and pharmacies through approximately 300 sales professionals under the Grossman brand. Our generic portfolio is primarily sold through the Government Health Care System, which awards its business through a tender process.

 

Our portfolio covers a broad range of therapeutic classes including antibacterials, vitamin deficiency and dermatology. Our largest product in this market is Bedoyecta, a brand of vitamin B complex (B1, B6 and B12 vitamins) products. Bedoyecta products act as energy improvement agents for fatigue related to age or chronic diseases, and as nervous system maintenance agents to treat neurotic pain and neuropathy. Bedoyecta is sold in an injectable form as well as in a tablet form in Mexico and has strong brand recognition in Mexico. Our second largest product, M.V.I., multi- vitamin infusion, is a hospital dietary supplement used in treating trauma and burns.

 

For detailed information regarding the revenues, operating profits and identifiable assets attributable to our operating segments, see Note 18 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

Alliance Revenue (Ribavirin Royalties only)

 

Royalties are derived from sales of ribavirin, a nucleoside analog that we discovered. In 1995, Schering-Plough licensed from us all oral forms of ribavirin for the treatment of chronic hepatitis C. For further discussion of this licensing arrangement, see Note 19 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K. We also licensed ribavirin to Roche in 2003. Roche discontinued royalty payments to us in June 2007 when the European Patent Office revoked a ribavirin patent which would have provided protection through 2017.

 

Ribavirin royalty revenues were $46.7 million, $59.4 million and $67.2 million for the years ended December 31, 2009, 2008 and 2007, respectively, and accounted for 6%, 9% and 10% of our total revenues in 2009, 2008 and 2007, respectively. Royalty revenues in 2009, 2008 and 2007 were substantially lower than those in prior years. This decrease was expected and relates to: 1) Roche’s discontinuation of royalty payments to us in June 2007; 2) Schering-Plough’s market share losses in ribavirin sales; 3) reduced Schering-Plough sales in Japan from a peak in 2005 and 4) discontinuation of royalty payments from Schering-Plough in European countries after the ten-year anniversary of the launch of the product, which varied by European country and started in May 1999.

 

We expect ribavirin royalties to continue to decline in 2010 predominantly due to discontinued Schering-Plough royalty payments for European countries. We expect that royalties from Schering-Plough in Japan will continue after 2010.

 

Collaboration Agreement

 

In October 2008, we closed the worldwide License and Collaboration Agreement (“the Collaboration Agreement”) with Glaxo Group Limited (“GSK”), a wholly-owned subsidiary of GlaxoSmithKline plc, to develop and commercialize retigabine, a first-in-class neuronal potassium channel opener for the treatment of adult epilepsy patients with refractory partial onset seizures, and its backup compounds. We received $125.0 million in upfront fees from GSK upon the closing.

 

We agreed to share equally with GSK the development and pre-commercialization expenses of retigabine in the United States, Australia, New Zealand, Canada and Puerto Rico (the “Collaboration Territory”) and GSK will develop and commercialize retigabine in the rest of the world. Our share of such expenses in the Collaboration Territory is limited to $100.0 million, provided that GSK will be entitled to credit our share of any such expenses in excess of such amount against future payments owed to us under the Collaboration Agreement. The difference between the upfront payment of $125.0 million and our expected development and pre-commercialization expenses under the Collaboration Agreement is being recognized as alliance revenue over the period prior to the launch of a

retigabine product (the “Pre-Launch Period”). We recognize alliance revenue during the Pre-Launch Period as we complete our performance obligations using the proportional performance model, which requires us to determine and measure the completion of our expected development and pre-commercialization costs during the Pre-Launch Period, in addition to our participation in the joint steering committee.

 

GSK has the right to terminate the Collaboration Agreement at any time prior to the receipt of the approval by the FDA of a new drug application (“NDA”) for a retigabine product, which right may be irrevocably waived at any time by GSK. The period of time prior to such termination or waiver is referred to as the “Review Period”. If GSK terminates the Collaboration Agreement prior to December 31, 2010, we would be required to refund to GSK a portion of the upfront fee. In February 2009, the Collaboration Agreement was amended to, among other matters, reduce the maximum amount of the upfront fee that we would be required to refund to GSK to $40.0 million through December 31, 2009, with additional ratable reductions in the amount of the required refund during 2010 until reaching zero at December 31, 2010.

 

During the years ended December 31, 2009 and 2008, the combined research and development expenses and pre-commercialization expenses incurred under the Collaboration Agreement by us and GSK were $65.3 million and $13.1 million, respectively. We recorded a charge of $1.2 million and a credit of $4.1 million in the years ended December 31, 2009 and 2008, respectively, against our share of the expenses to equalize our expenses with GSK, pursuant to the terms of the Collaboration Agreement. See Note 4 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for additional information

 

Our rights to retigabine are subject to an Asset Purchase Agreement between Meda Pharma GmbH & Co. KG (“Meda Pharma”) and Xcel Pharmaceuticals, Inc.(“Xcel”), which was acquired by us in 2005 (the “Meda Pharma Agreement”). Under the Meda Pharma Agreement, we are required to make certain milestone and royalty payments to Meda Pharma. Within the Collaboration Territory, any royalties to Meda Pharma will be shared by us and GSK. In the rest of the world, we will be responsible for the payment of these royalties to Meda Pharma from the royalty payments we receive from GSK.

 

Research and Development

 

Our research and development organization focuses on the development of products through clinical trials. We currently have a number of compounds in clinical development: retigabine, taribavirin, IDP-107, IDP-108, IDP-113 and IDP-115. Our research and development expenses for the years ended December 31, 2009, 2008 and 2007 were $44.0 million, $87.0 million and $98.0 million, respectively.

 

As of December 31, 2009, approximately 150 employees were involved in our research and development efforts.

 

Products in Development

 

Retigabine

 

Subject to the terms of the Collaboration Agreement with GSK, we are developing retigabine as an adjunctive treatment for partial-onset seizures in patients with epilepsy. Retigabine stabilizes hyper-excited neurons primarily by opening neuronal potassium channels. On October 30, 2009, the NDA was filed for retigabine for the treatment of refractory partial onset seizures. The FDA accepted the NDA for review on December 29, 2009 and established a Prescription Drug User Fee Act (“PDUFA”) date of August 30, 2010. In addition, the European Medicines Evaluation Agency (“EMEA”) confirmed on November 17, 2009 that the Marketing Authorization Application (“MAA”) was successfully validated, thus enabling the MAA review to commence. Retigabine has been in development by us since our acquisition of Xcel in 2005.

 

In September 2009, a Phase I clinical study was initiated for three additional retigabine modified release technologies, the purpose of which is to identify a lead modified release formulation that will be advanced in further research intended to support a product with either a once or twice daily dosing regimen for epilepsy patients.

As discussed in more detail in the subsection “Collaboration Agreement” above, in October 2008, we closed the worldwide Collaboration Agreement with GSK to develop and commercialize retigabine and its backup compounds and received $125.0 million in upfront fees from GSK upon the closing.

 

External research and development expenses for retigabine were $25.7 million ($31.2 million total research and development expenses) and $49.9 million prior to the credit from the GSK Collaboration Agreement in 2009 and 2008, respectively.

 

Taribavirin

 

Taribavirin (formerly referred to as viramidine) is a nucleoside (guanosine) analog that is converted into ribavirin by adenosine deaminase in the liver and intestine. Taribavirin was in development in oral form for the treatment of hepatitis C.

 

During 2009, we ceased any further independent development work on taribavirin and we are seeking potential partners for the taribavirin program. External research and development expenses for taribavirin were $2.3 million and $8.5 million in 2009 and 2008, respectively.

 

Dermatology Products

 

A number of dermatology product candidates in development were acquired as part of the acquisition of Dow in December 2008. These include, but are not limited to:

 

IDP-107 is an oral treatment for moderate to severe acne vulgaris. Acne is a disorder of the pilosebaceous unit characterized by the presence of inflammatory (pimples) and non-inflammatory (whiteheads and blackheads) lesions, predominately on the face. Acne vulgaris is a common skin disorder that affects about 85% of people at some point in their lives.

 

IDP-108, a novel triazole compound, is an antifungal targeted to treat onychomycosis, a fungal infection of the fingernails and toenails primarily in older adults. The mechanism of antifungal activity appears similar to other antifungal triazoles, i.e. ergosterol synthesis inhibition. IDP-108 is a non-lacquer formulation designed for topical delivery into the nail.

 

IDP-113 has the same active pharmaceutical ingredient as IDP-108. IDP-113 is a topical therapy for the treatment of tinea capitis, which is a fungal infection of the scalp characterized by redness, scaling and bald patches, particularly in children. There are currently no approved topical treatments for this scalp condition.

 

IDP-115 combines an established anti-rosacea active ingredient with sunscreen agents to provide sun protection in the same topical treatment for rosacea patients. Rosacea is a common condition treated by dermatologists and characterized by multiple signs and symptoms including papules, pustules and erythema, most commonly on the central area of the face.

 

Licenses and Patents (Proprietary Rights)

 

Data and Patent Exclusivity

 

We rely on a combination of regulatory and patent rights to protect the value of our investment in the development of our products.

 

A patent is the grant of a property right which allows its holder to exclude others from, among other things, selling the subject invention in, or importing such invention into, the jurisdiction that granted the patent. In both the United States and the European Union, patents expire 20 years from the date of application.

 

In the United States, the Hatch-Waxman Act provides nonpatent regulatory exclusivity for five years from the date of the first FDA approval of a new drug compound in an NDA. The FDA is prohibited during those five years from approving a generic, or ANDA, that references the NDA. Protection under the Hatch-Waxman Act will not prevent the filing or approval of another full NDA. However, the NDA applicant would be required to conduct its own pre-clinical, adequate and well-controlled clinical trials to independently demonstrate safety and effectiveness.

A similar data exclusivity scheme exists in the European Union, whereby only the pioneer drug company can use data obtained at the pioneer’s expense for up to eight years from the date of the first approval of a drug by the EMEA and no generic drug can be marketed for ten years from the approval of the innovator product. Under both the United States and the European Union data exclusivity programs, products without patent protection can be marketed by others so long as they repeat the clinical trials necessary to show safety and efficacy.

 

Exclusivity Rights with Respect to Retigabine and Taribavirin

 

We own a United States composition of matter patent (which will expire in 2013) directed to retigabine without regard to crystalline form. We anticipate that this patent will be extended to 2018 upon approval of retigabine pursuant to the patent term restoration provisions of the Hatch-Waxman Act. We also own two United States patents (both of which will expire in 2018) that are directed to specific crystalline forms of retigabine. In addition, we own a number of United States patents and pending applications, with expiration dates ranging from 2016 to 2023, directed to the use of retigabine to treat a variety of disease indications. We also own several patents and pending applications in foreign countries with expiration dates ranging from 2012 to 2024.

 

We own a United States patent (which will expire in 2018) directed to a method of treating a viral infection using a genus of compounds that includes taribavirin. We also own a United States patent (which will expire in 2020) that specifically claims the use of taribavirin to treat hepatitis C infection. If taribavirin receives regulatory approval, these patents may be eligible for patent term extensions. We are also pursuing patent rights for taribavirin in certain foreign countries where we believe it may be strategically important for the development or commercialization of the product.

 

Upon regulatory approval, we expect to obtain five years of data exclusivity in the United States and eight years in Europe for retigabine and taribavirin.

 

Exclusivity with Respect to Ribavirin

 

Royalty payments from Schering-Plough do not depend on the existence of a patent. We expect ribavirin royalties to continue to decline significantly in 2010 in that royalty payments from Schering-Plough will continue for European sales only until the ten-year anniversary of the launch of the product, which varied by European country and started in May 1999. Royalties from Schering-Plough in Japan will continue after 2010.

 

Generic ribavirin was launched in the United States in the first half of 2004. Under our agreement with Roche, upon the entry of generics into the United States, Roche ceased paying royalties on sales in the United States. Roche discontinued paying royalties to us for ribavirin sales in Europe in June 2007 when the Opposition Division of the European Patent Office revoked a patent covering ribavirin.

 

Government Regulations

 

Government authorities in the United States, at the federal, state and local level, and in other countries extensively regulate, among other things, the research, development, testing, approval, manufacturing, labeling, post-approval monitoring and reporting, packaging, promotion, storage, advertising, distribution, marketing and export and import of pharmaceutical products. The process of obtaining regulatory approvals and the subsequent compliance with appropriate federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources. FDA approval must be obtained in the United States, EMEA approval must be obtained for countries that are part of the European Union and approval must be obtained from comparable agencies in other countries prior to marketing or manufacturing new pharmaceutical products for use by humans.

 

Manufacturers of drug products are required to comply with manufacturing regulations, including current good manufacturing regulations enforced by the FDA and similar regulations enforced by regulatory agencies outside the United States. In addition, we are subject to price control restrictions on our pharmaceutical products in many countries in which we operate.

 

We are also subject to extensive health care marketing and fraud and abuse regulation by the federal and state governments, such as the federal False Claims Act, and similar regulations in foreign countries in which we may conduct our business. The federal False Claims Act imposes civil and criminal liability on individuals or entities

who submit (or cause the submission of) false or fraudulent claims for payment to the government. If our operations are found to be in violation of any of these laws, regulations, rules or policies or any other law or governmental regulation, or if interpretations of the foregoing change, we may be subject to civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations.

 

Environmental Regulation

 

We are subject to national, state and local environmental laws and regulations, including those governing the handling and disposal of hazardous wastes, wastewater, solid waste and other environmental matters. Our development and manufacturing activities involve the controlled use of hazardous materials.

 

Marketing and Customers

 

Our four major geographic markets are: the United States, Poland, Mexico and Canada. During the year ended December 31, 2009, we derived approximately 78% of our revenues from these markets. U.S. sales represented 42%, 37% and 37% of our total consolidated product net sales in 2009, 2008 and 2007, respectively. Poland accounted for 15%, 19% and 15% of our total consolidated product net sales in 2009, 2008 and 2007, respectively, while Mexico accounted for 17%, 18% and 20%, respectively. Sales to McKesson Corporation and its affiliates in the United States, Canada and Mexico for the years ended December 31, 2009, 2008 and 2007 were 21%, 24% and 24%, respectively, of our total consolidated product net sales. Sales to Cardinal Healthcare in the United States for the years ended December 31, 2009, 2008 and 2007 were 14%, 17% and 12%, respectively, of our total consolidated product net sales. No other country, or single customer, generated over 10% of our total product net sales.

 

We currently promote our pharmaceutical products to physicians, hospitals, pharmacies and wholesalers through our own sales force and sell through wholesalers. In some limited markets, we additionally sell directly to physicians, hospitals and large drug store chains and we sell through distributors in countries where we do not have our own sales staff. As part of our marketing program for pharmaceuticals, we use direct mailings, advertise in trade and medical periodicals, exhibit products at medical conventions and sponsor medical education symposia.

 

In October 2008, we signed an agreement with GSK, for the promotion of Diastat and Diastat AcuDial. Under the terms of the agreement, GSK had exclusive rights to promote Diastat and Diastat AcuDial to U.S. physicians in 2009. The agreement was not extended at expiration on December 31, 2009. We recorded the sales of Diastat and Diastat AcuDial and were responsible for ongoing brand development during the term of the agreement.

 

Competition

 

Competitive Landscape for Products and Products in Development

 

Our competitors include specialty and large pharmaceutical companies, biotechnology companies, OTC companies, academic and other research and development institutions and generic manufacturers, both in the United States and abroad. The dermatology competitive landscape is highly fragmented, with a large number of mid size and smaller companies competing in both the prescription sector and the OTC and cosmeceutical sectors. Our competitors are pursuing the development of pharmaceuticals and OTC products that target the same diseases and conditions that we are targeting in neurology, infectious disease and dermatology.

 

We sell a broad range of products, and competitive factors vary by product line and geographic area in which the products are sold.

 

Retigabine

 

Our competitors are developing products and product candidates that would compete with retigabine. The success of any of our competitors’ products or product candidates could adversely affect our expected revenues for retigabine, if approved.

Generic Competition

 

We also face increased competition from manufacturers of generic pharmaceutical products when patents covering certain of our currently marketed products expire or are successfully challenged. Generic versions are generally significantly less expensive than branded versions, and, where available, may be required in preference to the branded version under third-party reimbursement programs, or substituted by pharmacies. If competitors introduce new products, delivery systems or processes with therapeutic or cost advantages, our products can be subject to progressive price reductions or decreased volume of sales, or both. Most new products that we introduce must compete with other products already on the market or products that are later developed by competitors. Manufacturers of generic pharmaceuticals typically invest far less in research and development than research-based pharmaceutical companies and therefore can price their products significantly lower than branded products. Accordingly, when a branded product loses its market exclusivity, it normally faces intense price competition from generic forms of the product. To successfully compete for business with managed care and pharmacy benefits management organizations, we must often demonstrate that our products offer not only medical benefits but also cost advantages as compared with other forms of care.

 

We currently have one significant product, Cesamet, which does not currently have generic competition and which is not protected by patent or regulatory exclusivity. In mid 2008, the first generic competitor to Efudex, which is not protected by patent or regulatory exclusivity, was launched.

 

On October 12, 2007, we settled a patent infringement lawsuit with Kali Laboratories, Inc. regarding Kali’s submission of an ANDA with the FDA seeking approval for a generic version of Diastat (a diazepam rectal gel). Under the terms of this settlement, we agreed that Valeant would allow Barr Laboratories (now Teva Pharmaceuticals), with whom Kali has a marketing agreement, to introduce a generic version of Diastat and Diastat AcuDial on or after September 1, 2010, or earlier under certain circumstances.

 

Manufacturing

 

We currently operate ten manufacturing plants. All of our manufacturing facilities that require certification from the FDA or foreign agencies have obtained such approval.

 

We also subcontract the manufacturing of certain of our products, including products manufactured under the rights acquired from other pharmaceutical companies. Generally, acquired products continue to be produced for a specific period of time by the selling company. During that time, we integrate the products into our own manufacturing facilities or initiate toll manufacturing agreements with third parties.

 

We estimate that products representing approximately 60% of our product sales are produced by third party manufacturers under toll manufacturing arrangements.

 

The principal raw materials used by us for our various products are purchased in the open market. Most of these materials are available from several sources.

 

Employees

 

As of December 31, 2009, we had approximately 3,100 employees. These employees include approximately 1,350 in production, 1,100 in sales and marketing, 150 in research and development, 100 in service related positions and 400 in general and administrative positions. Collective bargaining exists for some employees in a number of markets. We currently consider our relations with our employees to be good and have not experienced any work stoppages, slowdowns or other serious labor problems that have materially impeded our business operations.

 

Product Liability Insurance

 

We have product liability insurance to cover damages resulting from the use of our products. We have in place clinical trial insurance in the major markets where we conduct clinical trials.

Foreign Operations

 

Approximately 57%, 66% and 65% of our revenues from continuing operations, which includes royalties, for the years ended December 31, 2009, 2008 and 2007, respectively, were generated from operations or otherwise earned outside the United States. All of our foreign operations are subject to risks inherent in conducting business abroad, including price and currency exchange controls, fluctuations in the relative values of currencies, political instability and restrictive governmental actions including possible nationalization or expropriation. Changes in the relative values of currencies may materially affect our results of operations. For a discussion of these risks, see Item 1A, Risk Factors in this Annual Report on Form 10-K.

 

Available Information

 

Our Internet address is www.valeant.com. We post links on our website to the following filings as soon as reasonably practicable after they are electronically filed or furnished to the SEC: annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendment to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Act of 1934. All such filings are available through our website free of charge. The information on our Internet website is not incorporated by reference into this Annual Report on Form 10-K or our other securities filings and is not a part of such filings.

 

Our filings may also be read and copied at the SEC’s Public Reference Room at 100 F. Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC.

 

 

You should consider carefully the following risk factors, together with all of the other information included or incorporated in this Annual Report on Form 10-K. Each of these risk factors, either alone or taken together, could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our securities. There may be additional risks that we do not presently know of or that we currently believe are immaterial which could also impair our business and financial position.

 

We operate in an extremely competitive industry. If competitors develop more effective or less costly drugs for our target indications, our business could be seriously harmed.

 

Many of our competitors, particularly large pharmaceutical companies, have substantially greater financial, technical and human resources than we do. Many of our competitors spend significantly more on research and development related activities than we do. Others may succeed in developing products that are more effective than those currently marketed or proposed for development by us. Progress by other researchers in areas similar to those being explored by us may result in further competitive challenges. In addition, academic institutions, government agencies and other public and private organizations conducting research may seek patent protection with respect to potentially competitive products. They may also establish exclusive collaborative or licensing relationships with our competitors.

 

Our business, financial condition and results of operations are subject to risks arising from the international scope of our operations.

 

We conduct a significant portion of our business outside the United States. Approximately 57% and 66% of our revenues from continuing operations were generated outside the United States during the years ended December 31, 2009 and 2008, respectively. We sell our pharmaceutical products in many countries around the world. All of our 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.

If retigabine and other product candidates in development do not become approved and commercially successful products, our ability to generate future growth in revenue and earnings will be adversely affected.

 

We focus our development activities on areas in which we have particular strengths. The outcome of any development program is highly uncertain. Products in clinical trials may fail to yield a commercial product, or a product may be approved by the FDA yet not be a commercial success. Success in preclinical and early stage clinical trials may not necessarily translate into success in large-scale clinical trials.

 

In addition, we or a partner will need to obtain and maintain regulatory approval in order to market retigabine and other product candidates. Even if they appear promising in large-scale Phase III clinical trials, regulatory approval may not be achieved. The results of clinical trials are susceptible to varying interpretations that may delay, limit or prevent approval or result in the need for post-marketing studies. In addition, changes in regulatory policy for product approval during the period of product development and FDA review of a new application may cause delays or rejection. Even if we receive regulatory approval, this approval may include limitations on the indications for which we can market a product or onerous risk management programs, thereby reducing the size of the market that we would be able to address or our product may not be chosen by physicians for use by their patients. There is no guarantee that we will be able to satisfy the needed regulatory requirements, and we may not be able to generate significant revenue, if any, from retigabine and other product candidates.

 

Obtaining necessary government approvals is time consuming and not assured.

 

FDA approval must be obtained in the United States and approval must be obtained from comparable agencies in other countries prior to marketing or manufacturing new pharmaceutical products for use by humans. Obtaining FDA approval for new products and manufacturing processes can take a number of years and involves the expenditure of substantial resources. Numerous requirements must be satisfied, including preliminary testing programs on animals and subsequent clinical testing programs on humans, to establish product safety and efficacy. No assurance can be given that we will obtain approval in the United States, or any other country, of any application we may submit for the commercial sale of a new or existing drug or compound. Nor can any assurance be given that if such approval is secured, the approved labeling will not have significant labeling limitations, or that those drugs or compounds will be commercially successful.

 

Furthermore, changes in existing regulations or adoption of new regulations could prevent or delay us from obtaining future regulatory approvals or jeopardize existing approvals, which could significantly increase our costs associated with obtaining approvals and negatively impact our market position.

 

If we, our partners or licensees cannot successfully develop and/or commercialize our products, our growth rate would be negatively impacted.

 

Our future growth rate will depend, in part, upon our ability or the ability of our partners or licensees to develop or obtain and commercialize new products and new formulations of, or indications for, current products. We are engaged in programs involving compounds which we may develop and/or commercialize ourselves, or with a partner or by a licensee. We may also participate in the development and/or commercialization of our partners’ product candidates. Commercializing products is time consuming, expensive and unpredictable. There can be no assurance that we will be able to, either by ourselves or in collaboration with our partners or through our licensees, successfully develop or commercialize new products, complete clinical trials, obtain regulatory approvals, or gain market acceptance for such products. Our existing arrangements with our partners and licensees contain, and future arrangements are likely to contain, various provisions, such as repayment upon termination rights, that, if exercised, could have a negative impact on efforts to commercialize the applicable products, or on our company in general. It may be necessary for us to enter into other arrangements with other pharmaceutical companies in order to market effectively any new products or new indications for existing products. There can be no assurance that we will be successful in entering into such arrangements on terms favorable to us or at all.

 

Any future revenue we may obtain under our worldwide license and collaboration agreement with GSK is subject to the risks and uncertainties described above.

Due to the large portion of our business conducted outside the United States, we have significant foreign currency risk.

 

We sell products in many countries that are susceptible to significant foreign currency risk. In some of these markets we sell products for U.S. Dollars. While this eliminates our direct currency risk in such markets, it increases our risk that we could lose market share to competitors because if a local currency is devalued significantly, it becomes more expensive for customers in that market to purchase our products in U.S. Dollars. The international scope of our operations may also lead to volatile financial results and difficulties in managing our operations.

 

We may be unable to identify, acquire and integrate acquisition targets successfully.

 

Part of our business strategy includes acquiring and integrating complementary businesses, products, technologies or other assets, and forming strategic alliances, joint ventures and other business combinations, to help drive future growth. Acquisitions or similar arrangements may be complex, time consuming and expensive. They may fail to further our business strategy as anticipated, expose us to increased competition or challenges with respect to our products or geographic markets, and expose our to additional liabilities associated with acquired business, product, technology or other asset or arrangement. Any one of these challenges or risks could impair our ability to realize any benefit from our acquisition or arrangement after we have expended resources on them.

 

In addition, our acquisitions strategy may require us to use a significant portion of our available cash, obtain additional debt or contingent liabilities that may increase leverage, or issue additional equity that may dilute ownership of our stockholders. We may not be able to finance acquisitions on terms satisfactory to us.

 

Finally, we may not consummate some negotiations for acquisitions or arrangements. Negotiations for acquisitions or arrangements that are not ultimately consummated could result in significant diversion of management time, as well as substantial out-of-pocket costs. Our competitors may have greater resources than us and therefore be better able to complete acquisitions or may cause the ultimate price we pay for acquisitions to increase.

 

We cannot forecast the number, timing or size of future acquisitions or arrangements, or the effect that any such transactions might have on our operating or financial results. Any such acquisition or arrangement could disrupt our business and negatively impact our operating results and financial condition. Our failure to implement successfully our acquisition strategy would limit our potential growth and could have a material adverse effect on our business.

 

If we or our third-party manufacturers are unable to manufacture our products or the manufacturing process is interrupted due to failure to comply with regulations or for other reasons, the manufacture of our products could be interrupted.

 

We manufacture and have contracted with third parties to manufacture some of our drug products, including products under the rights acquired from other pharmaceutical companies. Manufacturers are required to adhere to current good manufacturing (“cGMP”) regulations enforced by the FDA or similar regulations required by regulatory agencies in other countries. Compliance with the FDA’s cGMP requirements applies to both drug products seeking regulatory approval and to approved drug products. Our manufacturing facilities and those of our contract manufacturers must be inspected and found to be in full compliance with cGMP or similar standards before approval for marketing.

 

Our dependence upon others to manufacture our products may adversely affect our profit margins and our ability to develop and obtain approval for our products on a timely and competitive basis, if at all. Our failure or that of our contract manufacturers to comply with cGMP regulations or similar regulations outside of the United States can result in enforcement action by the FDA or its foreign counterparts, including, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to renew marketing applications and criminal prosecution. In addition, delays or difficulties by us or with our contract manufacturers in producing, packaging, or distributing our products could adversely affect the sales of our current products or introduction of other products.

 

In addition to regulatory compliance risks, our contract manufacturers in the United States and in other countries are subject to a wide range of business risks, such as seizure of assets by governmental authorities, natural disasters, and domestic and international economic conditions. Were we or any of our contract manufacturers not

able to manufacture our products because of regulatory, business or any other reasons, the manufacture of our products would be interrupted. This could have a negative impact on our sales, financial condition and competitive position.

 

Adverse U.S. and international economic and market conditions may adversely affect our product sales and business.

 

Current U.S. and international economic and market conditions are uncertain. Our revenues and operating results may be affected by uncertain or changing economic and market conditions, including the challenges faced in the credit markets and financial services industry. If domestic and global economic and market conditions remain uncertain or persist or deteriorate further, we may experience material impacts on our business, operating results and financial condition. Adverse economic conditions impacting our customers, including among others, increased taxation, higher unemployment, lower customer confidence in the economy, higher customer debt levels, lower availability of customer credit, higher interest rates and hardships relating to declines in the stock markets, could cause purchases of our products to decline, which could adversely affect our revenues and operating results.

 

Moreover, our projected revenues and operating results are based on assumptions concerning certain levels of customer spending. Any failure to attain our projected revenues and operating results as a result of adverse economic or market conditions estimated by us, our investors or the securities analysts that follow our common stock, could have a material adverse effect on our business and result in a decline in the price of our common stock.

 

Adverse economic and market conditions could also negatively impact our business by negatively impacting the parties with whom we do business, including among others, our business partners (including our customers as well as our alliance partners from whom we receive royalties and milestone payments), our manufacturers and our suppliers.

 

If our products cause, or are alleged to cause, serious or widespread personal injury, we may have to withdraw those products from the market and/or incur significant costs, including payment of substantial sums in damages.

 

Even in well designed clinical trials, the potential of a drug to cause serious or widespread personal injury may not be apparent. In addition, the existence of a correlation between use of a drug and serious or widespread personal injury may not be apparent until it has been in widespread use for some period of time. Particularly when a drug is used to treat a disease or condition which is complex and the patients are taking multiple medications, such correlations may indicate, but do not necessarily indicate, that the drug has caused the injury; nevertheless we may decide to, or regulatory authorities may require that we, withdraw the drug from the market and/or we may incur significant costs, including the potential of paying substantial damages. Withdrawals of products from the market and/or incurring significant costs, including the requirement to pay substantial damages in personal injury cases, would materially affect our business and results of operation.

 

Legislative or regulatory reform of the healthcare system may affect our ability to sell our products profitably.

 

In both the United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the healthcare system in ways that could impact our ability to sell our products profitably. In recent years, new legislation has been proposed in the United States at the federal and state levels that would effect major changes in the healthcare system, either nationally or at the state level. Recently, President Obama and members of Congress have proposed significant reforms. On November 7, 2009, the House of Representatives passed and, on December 24, 2009, the Senate passed health care reform legislation that would require most individuals to have health insurance, establish new regulations on health plans, create insurance pooling mechanisms and a government health insurance option to compete with private plans and other expanded public health measures. This legislation would also reduce Medicare spending on services provided by hospitals and other providers.

 

Given that legislation has not yet been enacted, it is still not possible to determine what, if any impact this legislation may have on the pharmaceutical industry and our business. Further federal and state proposals are likely.

However, an expansion in government’s role in the U.S. healthcare industry may lower reimbursements for our products, reduce medical procedure volumes and adversely affect our business, possibly materially. In addition, the potential for adoption of these proposals affects or will affect our ability to raise capital, obtain additional collaborators and market our products. We expect to experience pricing pressures in connection with the sale of our products due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals. Our results of operations could be adversely affected by future health care reforms.

 

Products representing a significant amount of our revenue are not protected by patent or data exclusivity rights.

 

A majority of the products we sell have no meaningful exclusivity protection via patent or data exclusivity rights. These products represent a significant amount of our revenues. Without exclusivity protection, competitors face fewer barriers in introducing competing products. The introduction of competing products could adversely affect our results of operations and financial condition.

 

Many of our key processes, opportunities and expenses are a function of existing national and/or local government regulation. Significant changes in regulations could have a material adverse impact on our business.

 

The process by which pharmaceutical products are approved is lengthy and highly regulated. Our multi-year clinical trials programs are planned and executed to conform to these regulations, and once begun, can be difficult and expensive to change should the regulations regarding approval of pharmaceutical products significantly change.

 

Failures to comply with the applicable legal requirements at any time during the product development process, approval process or after approval may result in administrative or judicial sanctions. These sanctions could include the FDA’s imposition of a hold on clinical trials, refusal to approve pending applications, withdrawal of an approval, warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties or criminal prosecution. Any agency or judicial enforcement action could have a material adverse effect on us. In addition, newly discovered or developed safety or effectiveness data may require changes to a product’s approved labeling, including the addition of new warnings, precautions and contraindications.

 

Manufacturers of drug products are required to comply with manufacturing regulations, including current good manufacturing regulations enforced by the FDA and similar regulations enforced by regulatory agencies outside the United States. In addition, we are subject to price control restrictions on our pharmaceutical products in many countries in which we operate. We are also subject to extensive health care marketing and fraud and abuse regulation by the federal and state governments and foreign countries in which we may conduct our business. If our operations are found to be in violation of any of these laws, regulations, rules or policies or any other law or governmental regulation, or if interpretations of the foregoing change, we may be subject to civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations.

 

In addition, we depend on patent law and data exclusivity to keep generic products from reaching the market in our evaluations of the development of our products. In assessing whether we will invest in any development program, or license a product from a third party, we assess the likelihood of patent and/or data exclusivity under the laws and regulations then in effect. If those schemes significantly change in a large market, or across many smaller markets, our ability to protect our investment may be adversely affected.

 

Appropriate tax planning requires that we consider the current and prevailing national and local tax laws and regulations, as well as international tax treaties and arrangements that we enter into with various government authorities. Changes in national/local tax regulations or changes in political situations may limit or eliminate the effects of our tax planning and could result in unanticipated tax expenses.

We are involved in various legal proceedings that could adversely affect us.

 

We are involved in several legal proceedings, including those described in Note 21 of notes to the consolidated financial statements. Defending against claims and any unfavorable legal decisions, settlements or orders could have a material adverse effect on us.

 

We are subject to “fraud and abuse” and similar laws and regulations, and a failure to comply with such regulations or prevail in any litigation related to noncompliance could harm our business.

 

Pharmaceutical and biotechnology companies have faced lawsuits and investigations pertaining to violations of health care “fraud and abuse” laws, such as the federal False Claims Act, the federal Anti-kickback Statute, the Foreign Corrupt Practices Act and other state and federal laws and regulations. Increasingly, states require pharmaceutical companies to have comprehensive compliance programs and to disclose certain payments made to healthcare providers or funds spent on marketing and promotion of drug products. If we are in violation of any of these requirements or any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of significant fines or other sanctions.

 

We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws.

 

The U.S. Foreign Corrupt Practices Act, or FCPA, and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these anti-bribery laws.

 

We operate in many parts of the world that have experienced governmental corruption to some degree and in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices or may require us to interact with doctors and hospitals, some of which may be state controlled, in a manner that is different than in the United States. Despite our training and compliance program, we cannot assure you that our internal control policies and procedures always will protect us from reckless or criminal acts committed by our employees or agents. Violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our financial condition, results of operations and cash flows.

 

We may be involved in infringement actions which are uncertain, costly and time-consuming and could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

In order to protect or enforce patent rights, we may initiate litigation against third parties, and we may also become subject to infringement claims by third parties. The outcomes of infringement action are uncertain and infringement actions are costly and divert technical and management personnel from their normal responsibilities. The cost of such actions as well as the ultimate outcome of such actions could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

The existence of a patent will not necessarily protect us from competition. Competitors may successfully challenge our patents, produce similar drugs that do not infringe our patents or produce drugs in countries that do not respect our patents.

 

Existing and future audits by, or other disputes with, taxing authorities may not be resolved in our favor.

 

Our income tax returns are subject to audit in various jurisdictions. Existing and future audits by, or other disputes with, tax authorities may not be resolved in our favor and could have an adverse effect on our reported effective tax rate and after-tax cash flows.

 

We are subject to a consent order with the SEC.

 

We are subject to a consent order with the SEC, which permanently enjoins us 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 with respect to forward-looking statements we

made prior to November 28, 2005. The existence of the permanent injunction under the consent order, and the lack of protection under the safe harbor with respect to forward-looking statements we made prior to November 28, 2005 may limit our ability to defend against future allegations.

 

The current SEC investigation could adversely affect our business and the trading price of our securities.

 

The SEC is conducting an investigation regarding events and circumstances surrounding trading in our common stock and the public release of data from our first pivotal Phase III trial for taribavirin in March 2006. In addition, the SEC requested information regarding our restatement of certain historical financial statements announced in March 2008, data regarding our stock option grants since January 1, 2000 and information about our pursuit in the Delaware Chancery Court of the return of certain bonuses paid to Milan Panic, a former chairman and chief executive officer, and others. In September 2006, our board of directors established the Special Committee to review our historical stock option practices and related accounting. The Special Committee concluded its investigation in January 2007. We have briefed the SEC with the results of the Special Committee’s investigation. We have cooperated fully and will continue to cooperate with the SEC on its investigation. We cannot predict the outcome of the investigation. In the event that the investigation leads to SEC action against any current or former officer or director, our business (including our ability to complete financing transactions) and the trading price of our securities may be adversely impacted. In addition, if the SEC investigation continues for a prolonged period of time, it may have an adverse impact on our business or the trading price of our securities regardless of the ultimate outcome of the investigation. In addition, the SEC inquiry has resulted in the incurrence of significant legal expenses and the diversion of management’s attention from our business, and this may continue, or increase, until the investigation is concluded.

 

The matters relating to the Special Committee’s review of our historical stock option granting practices and the restatement of our consolidated financial statements have resulted in increased litigation and regulatory proceedings against us and could have a material adverse effect on us.

 

In September 2006, our board of directors appointed a Special Committee, which consisted solely of independent directors, to conduct a review of our historical stock option granting practices and related accounting during the period from 1982 through July 2006. The Special Committee identified a number of occasions on which the exercise prices for stock options granted to certain of our directors, officers and employees were set using closing prices of our common stock with dates different than the actual approval dates, resulting in additional compensation charges.

 

To correct these and other accounting errors, we amended our Annual Report on Form 10-K for the year ended December 31, 2005 and our quarterly reports on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006 to restate the consolidated financial statements contained in those reports.

 

Our historical stock option granting practices and the restatement of our prior financial statements have exposed us to greater risks associated with litigation and regulatory proceedings. We were named as nominal defendant in three shareholder derivative lawsuits which asserted claims related to our historic stock option practices. To date, these shareholder derivative lawsuits have been dismissed. In addition, the SEC has opened a formal SEC inquiry into our historical stock option grant practices. We cannot assure you that this current litigation, the SEC inquiry or any future litigation or regulatory action will result in the same conclusions reached by the Special Committee. The conduct and resolution of these matters will be time consuming, expensive and distracting from the conduct of our business. Furthermore, if we are subject to adverse findings in any of these matters, we could be required to pay damages or penalties or have other remedies imposed upon us which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

If we identify a material weakness in our internal control over financial reporting in future periods, our stock price could be adversely affected and our ability to prepare complete and accurate financial statements in a timely manner could be adversely affected.

 

We identified a material weakness in our internal control over financial reporting as of December 31, 2007. The material weakness, which arose primarily as a result of our lack of a sufficient complement of personnel in our

foreign locations and monitoring controls at the corporate level, is further described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2007. Because of the foregoing, we concluded that certain financial statements, earnings press releases and similar communications should no longer be relied upon and that certain of our financial statements would need to be restated. We also concluded that our disclosure controls and procedures were not effective as of December 31, 2007. As more fully described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2008, in 2008 we took steps to remediate this material weakness and to improve our disclosure controls and procedures.

 

If we fail to maintain our disclosure controls and procedures at the reasonable assurance level, our financial statements and related disclosure could contain material misstatements, the preparation and filing of our financial statements and related filings could be delayed, and substantial costs and resources may be required to remediate any weaknesses or deficiencies or to improve our disclosure controls and procedures. If we cannot produce reliable and timely financial statements, investors could lose confidence in our reported financial information, the market price of our stock could decline significantly or we may be unable to obtain financing on acceptable terms, and our business and financial condition could be harmed.

 

 

None.

 

 

Our major facilities are in the following locations:

 

 

In our opinion, facilities occupied by us are more than adequate for present requirements, and our current equipment is considered to be in good condition and suitable for the purposes for which they are used.

 

 

See Note 21 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

 

No matters were submitted for a vote of our stockholders during the fourth quarter of the year ended December 31, 2009.

 

 

Price Range of Common Stock

 

Our common stock is traded on the New York Stock Exchange (symbol: VRX). As of February 18, 2010 there were 4,352 holders of record of our common stock.

 

The following table sets forth, for the periods indicated the high and low sales prices of our common stock on the New York Stock Exchange — Composite Transactions reporting system.

 

 

Performance Graph

 

The following graph compares the cumulative total return on our common stock with the cumulative return on the Standard and Poor’s Mid Cap 400 Index (“S&P Mid Cap 400 Index”) and a 10-Stock Custom Composite Index (the “Custom Composite Index”) for the five years ended December 31, 2009. The Custom Composite Index consists of Allergan, Inc.; Biovail Corporation; Cephalon, Inc.; Forest Laboratories, Inc.; Gilead Sciences, Inc.; King Pharmaceuticals, Inc.; Medicis Pharmaceutical Corporation; Mylan Inc.; Shire Pharmaceuticals Group plc and Watson Pharmaceuticals, Inc.

 

 

Based on reinvestment of $100 beginning on December 31, 2004

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The information required under this section is set forth in our definitive proxy statement to be filed in connection with our 2010 annual meeting of stockholders and is incorporated by reference.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

In October 2008, our board of directors authorized us to repurchase up to $200.0 million of our outstanding common stock or convertible subordinated notes in a 24-month period ending October 2010, unless earlier terminated or completed. In May 2009, our board of directors increased the authorization to $500.0 million, over a period ending in May 2011. Under the program, purchases may be made from time to time on the open market, in privately negotiated transactions, pursuant to tender offers or otherwise, including pursuant to one or more trading plans, at times and in amounts as we see appropriate. The number of securities to be purchased and the timing of such purchases are subject to various factors, which may include the price of our common stock, general market conditions, corporate and regulatory requirements and alternate investment opportunities. The securities repurchase program may be modified or discontinued at any time.

 

During the year ended December 31, 2009, we purchased $173.5 million aggregate principal amount of our 3.0% Convertible Subordinated Notes (the “3.0% Notes”) and 4.0% Convertible Subordinated Notes (the “4.0% Notes”) for $178.3 million consisting of cash consideration aggregating $171.1 million and warrants (the “Warrants”) to purchase 1,769,265 shares of our common stock (the “Warrant Shares”) at an exercise price of $31.61 per share. The Warrants were issued to certain former holders of 3.0% Notes in August 2009 as part of an exchange transaction, which was made without registration under the Securities Act of 1933, as amended (the “Securities Act”) in reliance on Section 3(a)(9) thereof. The estimated fair value of the Warrants using the Black-Scholes pricing model was $7.2 million. The Warrants are fully vested, are exercisable on a cashless basis only and expire on August 16, 2010. The number of Warrant Shares and the per share exercise price are subject to adjustment upon stock splits and combinations, certain dividends and distributions, rights offerings, tender offers and consolidations, mergers and sales or conveyances of all or substantially all of our assets made or effected by us. In total, we have purchased $206.1 million aggregate principal amount of our 3.0% Notes and 4.0% Notes at a purchase price of $207.3 million as of December 31, 2009, including cash and warrants. During the year ended December 31, 2009, we purchased 6,949,932 shares of our common stock for a total of $202.4 million. As of December 31, 2009, we have repurchased an aggregate 7,248,893 shares of our common stock for $208.5 million under this program.

 

Set forth below is the information regarding shares repurchased under the securities repurchase program during the fourth quarter of the year ended December 31, 2009:

 

 

Dividend Policy

 

We did not declare and did not pay dividends in 2009 or 2008. While our board of directors reviews our dividend policy from time to time, we currently intend to retain any earnings for future growth and, therefore, do not expect to pay any cash dividends in the foreseeable future.

 

The selected statement of operations and balance sheet data shown below were derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2009, 2008 and 2007 and the consolidated balance sheet data as of December 31, 2009 and 2008 have been derived from our audited financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended December 31, 2006 and 2005 and the consolidated balance sheet data as of December 31, 2007, 2006 and 2005 have been derived from audited consolidated financial statements which are not included in this Annual Report on Form 10-K. You should read this selected financial data together with our consolidated financial statements and related notes, as well as the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

 

Notes to Selected Financial Data:

 

 

Pharmaceutical Products

 

Product sales from our pharmaceutical segments accounted for 86% of our total revenues from continuing operations for the year ended December 31, 2009, compared to 90% for the year ended December 31, 2008. Product sales increased by $117.6 million for the year ended December 31, 2009, as compared to the year ended December 31, 2008. The increase in pharmaceutical product sales for the year ended December 31, 2009 was due to a 25% increase in volume and a 7% increase in price, offset by a 12% reduction due to currency fluctuations.

 

Our current product portfolio comprises approximately 380 products, with approximately 2,000 stock keeping units. We market our products through a marketing and sales force consisting of approximately 1,100 employees. Our future growth is expected to be driven primarily by the commercialization of new products, growth of our existing products, and business development.

 

We have experienced generic challenges and other competition to our products, as well as pricing challenges, and expect these challenges to continue in 2010 and beyond.

 

Results of Operations

 

Our products are sold through three operating segments comprising Specialty Pharmaceuticals, Branded Generics — Europe and Branded Generics — Latin America. Certain financial information for our business segments is set forth below. This discussion of our results of operations should be read in conjunction with the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. For additional financial information by business segment, see Note 18 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

Year Ended December 31, 2009 Compared to 2008

 

Computations of percentage change period over period are based upon our results, as rounded and presented herein.

 

Product Sales Revenues:  In our Specialty Pharmaceuticals segment, revenues from product sales for the year ended December 31, 2009 increased $100.2 million (33%) to $403.9 million from $303.7 million in 2008. The increase in Specialty Pharmaceuticals sales for the year ended December 31, 2009 was driven by net growth of $61.9 million in existing products, predominantly Diastat, Acanya, Librax, Cesamet, Migranal and Ancobon, as well as from sales of products acquired in late 2008 as part of the Coria and DermaTech acquisitions, which contributed incremental revenues of $34.7 million and $9.0 million, respectively. Product sales revenue in 2009 also include $5.7 million attributable to our 2009 acquisitions of PFI and Dr. Renaud. These increases were partially offset by a reduction of $5.8 million due to the sale of business operations in Argentina, Uruguay and Asia in 2008 and $5.3 million due to depreciation of the Canadian Dollar and Australian Dollar relative to the U.S. Dollar.

 

In our Branded Generics — Europe segment, revenues for the year ended December 31, 2009 decreased $1.1 million (1%) to $151.7 million from $152.8 million in 2008. The depreciation of foreign currencies, particularly the Polish Zloty, relative to the U.S. Dollar resulted in decreases of $39.8 million in product sales. This reduction was largely offset by a net increase across most of our existing products of $31.2 million and $7.5 million from the April 2009 acquisition of Emo-Farm.

 

In our Branded Generics — Latin America segment, revenues for the year ended December 31, 2009 increased $18.6 million (14%) to $155.2 million from $136.6 million in 2008. Product sales from the existing business grew by a net $34.8 million across substantially all products primarily from the improvement of trading relationships with the major wholesalers in Mexico. Revenues attributable to the July 2009 acquisition of Tecnofarma contributed $12.1 million in 2009. These increases were partially offset by a decrease of $28.3 million due to the depreciation of foreign currencies, particularly the Mexican Peso, relative to the U.S. Dollar in 2009.

 

Specialty Pharmaceuticals Service and Alliance Revenue:  Service and alliance revenue in the Specialty Pharmaceuticals segment for the year ended December 31, 2009 consists of (in thousands):

 

 

Beginning in January 2009, we receive revenue from contract research services performed by Dow in the areas of dermatology and topical medication. The services are primarily focused on contract research for external development and clinical research in areas such as formulations development, in vitro drug penetration studies, analytical sciences and consulting in the areas of labeling and regulatory affairs.

 

Beginning in January 2009, we receive royalties from patent protected formulations developed by Dow and licensed to third parties. These royalties were $11.2 million in 2009. Beginning in the third quarter of 2009, we receive profit sharing payments equal to a majority portion of the net profits on the sale of 1% clindamycin and 5% benzoyl peroxide gel by Mylan, which totaled $18.1 million in 2009. In 2009, we received $6.8 million in initial fees pursuant to licensing agreements for various products.

 

We also earned $14.5 million under the GSK Collaboration Agreement (as defined below) in 2009 compared to $4.4 million in 2008.

 

Alliance Revenue (Ribavirin Royalties only):  Ribavirin royalty revenue was $46.7 million for the year ended December 31, 2009 compared to $59.4 million in 2008, a decrease of $12.7 million (21%). We expect ribavirin royalties to continue to decline in 2010 as royalty payments from Schering-Plough will continue for European sales

only until the ten-year anniversary of the launch of the product, which varied by European country and started in May 1999. We expect that royalties from Schering-Plough in Japan will continue after 2010.

 

Gross Profit Margin:  Gross profit margin on product sales, net of pharmaceutical product amortization, was 64% for the years ended December 31, 2009 and 2008. Product amortization expense was $60.6 million in 2009 compared to $43.8 million in 2008. The increase in product amortization expense is primarily attributable to products acquired within the Specialty Pharmaceuticals segment in the U.S. in late 2008.

 

Gross profit margin on product sales (excluding pharmaceutical product amortization) was 73% for the year ended December 31, 2009 compared to 72% in 2008. The gross profit margin in the Specialty Pharmaceuticals segment was relatively flat in 2009 compared to 2008, reflecting a 1% increase. The gross profit margin in the Branded Generics — Europe segment decreased to 55% in 2009 compared to 62% in 2008, primarily due to mix of products, including low margin revenue from distribution contracts and lower margin OTC sales attributable to the April 2009 Emo-Farm acquisition. The gross profit margin in the Branded Generics — Latin America segment increased to 70% in 2009 compared to 66% in 2008. This increase was primarily due to the negative impact of inventory reserve provisions of $12.7 million in 2008, offset in part by lower margin sales attributable to the July 2009 Tecnofarma acquisition.

 

The following table sets forth a summary of gross profit by segment, both excluding and including amortization (discussed below), for the three years ended December 31, 2009, 2008 and 2007 (dollar amounts in thousands):

 

 

NM — Not meaningful

Gross profit margin on service revenue was 20% for the year ended December 31, 2009.

 

Selling, General and Administrative Expenses:  Selling, general and administrative (“SG&A”) expenses were $255.8 million in the year ended December 31, 2009 compared to $278.0 million in 2008, a decrease of $22.2 million (8%). As a percent of product sales and service revenue, SG&A expenses were 35% for the year ended December 31, 2009 and 47% in 2008. The decrease in SG&A expense primarily reflects the effects of our restructuring initiatives as well as the favorable impact of foreign currency exchange rates. These decreases were offset in part by expenses attributable to our 2009 business acquisitions; a full year of expense related to our 2008 business acquisitions, all of which occurred in the fourth quarter; and a $9.2 million increase in stock-based compensation expense.

 

Research and Development:  Research and development (“R&D”) expenses were $44.0 million in the year ended December 31, 2009 compared to $87.0 million in 2008, a decrease of $43.0 million (49%). The decrease in R&D expenses was largely due to $31.0 million of expense offsets attributable to the GSK Collaboration Agreement, compared to $10.2 million of offsets in 2008. R&D expenses also decreased $6.2 million due to cessation of further independent development work on taribavirin.

 

Special Charges and Credits Including Acquired In-Process Research and Development:  In the fourth quarter of 2009, we recorded litigation settlement charges of $4.4 million, primarily related to the settlement of the Spear Pharmaceuticals, Inc. matter. See Note 21 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information.

 

In June 2009, we entered into an exclusive license agreement with Endo Pharmaceuticals Inc. that grants us an exclusive license to develop and commercialize Opana and Opana ER in Canada, Australia and New Zealand (the “Opana Territory”). Regulatory approval must be received prior to any sale of the licensed products. We recorded a $1.8 million charge related to the initial license fee in the second quarter of 2009. In 2009, we acquired rights to other products in Mexico that are not currently approved for sale, for an aggregate price of $0.2 million, which was recorded as a charge in 2009.

 

In 2008 we incurred IPR&D expense of $185.8 million related to the acquisition of Dow and $0.5 million related to the acquisition of Coria for IPR&D assets acquired that we determined were not yet complete and had no future uses in their current state. Under the revised accounting standard for business combinations effective January 1, 2009, acquired IPR&D is recorded as an intangible asset at its fair value at the acquisition date. As a result of adopting this revised standard, we did not record any IPR&D expense in 2009.

 

Amortization:  Amortization expense was $70.6 million in the year ended December 31, 2009 compared to $50.0 million in 2008, an increase of $20.6 million (41%). Amortization increased by $33.0 million in 2009 related to the intangible assets obtained in our acquisitions of Dow and Coria, comprised of $17.0 million related to Acanya, which we launched in the first quarter of 2009, and $16.0 million related to other acquired intangible assets. This increase was partially offset by the declining amortization of the rights to the ribavirin royalty intangible, which was amortized using an accelerated method and was fully amortized in the third quarter of 2008. Amortization expense in 2009 and 2008 includes intangible asset impairment charges of a $0.5 million and $1.6 million, respectively.

 

Restructuring, Asset Impairments, Dispositions and Acquisition-related Costs:  In 2009 and 2008 we incurred $10.1 million and $21.3 million, respectively, in restructuring, asset impairments, dispositions and acquisition-related costs, including $6.5 million of acquisition-related costs.

 

Our restructuring charges include severance costs, contract cancellation costs, the abandonment of capitalized assets, the impairment of manufacturing facilities and other associated costs, including legal and professional fees. We have accounted for statutory and contractual severance obligations when they are estimable and probable. For one-time severance arrangements, the benefits are detailed in an approved severance plan, which is specific as to number of employees, position, location and timing. In addition, the benefits are communicated in specific detail to affected employees and it is unlikely that the plan will change when the costs are recorded. If service requirements exceed a minimum retention period, the costs are spread over the service period; otherwise they are recognized when they are communicated to the employees. Contract cancellation costs are recorded at fair value when the contract is terminated. Other associated costs, such as legal and professional fees, have been expensed as incurred.

2008 Restructuring

 

In October 2007, our board of directors initiated a strategic review of our business direction, geographic operations, product portfolio, growth opportunities and acquisition strategy. In March 2008, we completed this strategic review and announced a strategic plan designed to streamline our business, align our infrastructure to the scale of our operations, maximize our pipeline assets and deploy our cash assets to maximize shareholder value. The strategic plan included a restructuring program (the “2008 Restructuring”), which reduced our geographic footprint and product focus by restructuring our business in order to focus on the pharmaceutical markets in our core geographies of the United States, Canada and Australia and on the branded generics markets in Europe (Poland, Hungary, the Czech Republic and Slovakia) and Latin America (Mexico and Brazil). The 2008 Restructuring plan included actions to divest our operations in markets outside of these core geographic areas through sales of subsidiaries or assets and other strategic alternatives.

 

In March 2008, we closed the sale to Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”) of certain assets in Asia that included certain of our subsidiaries, branch offices and commercial rights in Singapore, the Philippines, Thailand, Indonesia, Vietnam, Taiwan, Korea, China, Hong Kong, Malaysia and Macau. This transaction also included the sale of certain product rights in Japan. During the year ended December 31, 2008, we received proceeds of $37.9 million and recorded a gain of $34.5 million, net of charges for closing costs, in this transaction. During the first quarter of 2009, we received substantially all of the remaining additional proceeds of $3.4 million from the sale in accordance with net asset settlement provisions of the sale.

 

In June 2008, we sold our subsidiaries in Argentina and Uruguay and recorded a loss on the sale of $2.7 million, in addition to a $7.9 million impairment charge recorded in the first quarter of 2008 related to the anticipated sale.

 

In December 2008, as part of our efforts to align our infrastructure to the scale of our operations, we exercised our option to terminate the lease of our Aliso Viejo, California corporate headquarters as of December 2011 and, as a result, recorded a restructuring charge of $3.8 million for the year ended December 31, 2008. The charge consisted of a lease termination penalty of $3.2 million, which will be payable in October 2011, and $0.6 million for certain fixed assets.

 

The net restructuring, asset impairments and dispositions charge of $3.5 million in the year ended December 31, 2009 included $2.2 million of employee severance costs for a total of 38 affected employees who were part of the selling, general and administrative and research and development workforce in the United States. The charge also included $1.3 million of contract cancellation costs and other cash costs. The net restructuring, asset impairments and dispositions charge of $21.3 million in the year ended December 31, 2008 included $19.2 million of employee severance costs for a total of 389 affected employees who were part of the supply, selling, general and administrative and research and development workforce in the United States, Mexico, Brazil and the Czech Republic. The charges also included $10.4 million for professional service fees related to the strategic review of our business, $7.7 million of contract cancellation costs and $0.3 million of other cash costs. Additional amounts incurred included a stock compensation charge for the accelerated vesting of the stock options of our former chief executive officer of $4.8 million, impairment charges relating to the sale of our subsidiaries in Argentina and Uruguay and certain fixed assets in Mexico of $10.8 million, and the loss of $2.6 million in the sale of our subsidiaries in Argentina and Uruguay, offset in part by the gain of $34.5 million in the transaction with Invida.

The following table summarizes the restructuring costs recorded in the years ended December 31, 2009, 2008 and 2007 (in thousands):

 

 

2006 Restructuring

 

In April 2006, we announced a restructuring program (the “2006 Restructuring”) which was primarily focused on our research and development and manufacturing operations. The objective of the 2006 Restructuring program as it related to research and development activities was to focus our efforts and expenditures on retigabine and taribavirin, our two late-stage projects in development. The 2006 Restructuring was designed to rationalize our investments in research and development efforts in line with our financial resources. In December 2006, we sold our HIV and cancer development programs and certain discovery and pre-clinical assets to Ardea Biosciences, Inc. (“Ardea”), with an option for us to reacquire rights to commercialize the HIV program outside of the United States and Canada upon Ardea’s completion of Phase IIb trials. In March 2007, we sold our former headquarters building in Costa Mesa, California, where our former research laboratories were located, for net proceeds of $36.8 million.

 

The objective of the 2006 Restructuring as it related to manufacturing was to further rationalize our manufacturing operations to reflect the regional nature of our existing products and further reduce our excess capacity after considering the delay in the development of taribavirin. The impairment charges included the charges related to estimated future losses expected upon the disposition of specific assets related to our manufacturing operations in Switzerland and Puerto Rico. We completed the 2006 Restructuring in June 2007 with the sale of our former manufacturing facilities in Humacao, Puerto Rico and Basel, Switzerland to Legacy Pharmaceuticals International.

The following table summarizes the restructuring costs recorded in the year ended December 31, 2007 and cumulatively (in thousands):

 

 

Aggregate restructuring charges for the 2008 and 2006 restructuring programs, by reportable segment, were as follows (in thousands):

 

 

Reconciliation of Cash Restructuring Payments with Restructuring Accrual

 

Cash-related charges in the above tables relate to severance payments and other costs which have been either paid with cash expenditures or have been accrued and will be paid with cash in future quarters. As of December 31, 2008, the restructuring accrual for the 2006 Restructuring was $0.6 million and related to ongoing contractual payments to Legacy Pharmaceuticals International relating to the sale of our former site in Puerto Rico. These payment obligations ended in June 2009.

 

As of December 31, 2009, the restructuring accrual for the 2008 Restructuring was $6.4 million and relates primarily to severance and lease termination penalty costs expected to be paid primarily during 2010, except for the lease termination penalty which will be paid in 2011. A summary of accruals and expenditures of restructuring costs which will be paid in cash is as follows (in thousands):

 

The 2008 restructuring initiatives were substantially completed by the end of the third quarter of 2009. We expect to continue to recognize costs through 2011 related primarily to the accretion of lease termination penalty costs.

 

In 2009, we incurred $6.5 million of costs related to business acquisitions. These costs include transaction costs such as broker fees, legal, accounting and other costs directly related to our 2009 acquisitions and integration and other costs including contract cancellation costs, severance for employees of acquired businesses and obligations to employees established by the former Dow shareholders. In 2008, under the prior guidance for accounting for business acquisitions, transaction costs were included in the purchase price of the related business.

 

Other Income/Expense, Net, Including Translation and Exchange:  Other income (expense), net including translation and exchange was expense of $1.5 million for the year ended December 31, 2009 compared to income of $2.1 million in 2008. The expense in 2009 related primarily to the weakening of the U.S. Dollar relative to the British Pound, the Swiss Franc and the Euro resulting in translation and exchange losses on foreign currency denominated liabilities in our U.S. Dollar denominated subsidiaries and losses related to our joint venture with Meda AB in Canada. In 2008, the amount represents primarily the effects of translation gains in Europe.

 

Gain/Loss on Early Extinguishment of Debt:  In 2009, we repurchased an aggregate of $173.5 million principal amount of the 3.0% Notes and 4.0% Notes at a purchase price of $178.3 million, consisting of cash consideration aggregating $171.1 million and warrants to purchase 1,769,265 shares of our common stock at an exercise price of $31.61 per share, with an estimated fair value of $7.2 million. For additional information, see Note 10 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K. The carrying amount, net of unamortized debt issuance costs, of the 3.0% Notes and 4.0% Notes purchased was $162.6 million and the estimated fair value of the 3.0% Notes and 4.0% Notes exclusive of the conversion feature was $155.4 million. The difference between the carrying amount and the estimated fair value was recognized as a gain of $7.2 million upon early extinguishment of debt.

 

Loss on early extinguishment of debt of $13.0 million in 2008 includes a loss of $14.9 million as a result of the July 2008 redemption of our 7.0% Senior Notes, partially offset by a $1.9 million gain as a result of the repurchase of $32.6 million aggregate principal amount of our 3.0% Notes.

 

Interest Expense and Income:  Interest income decreased $12.8 million during the year ended December 31, 2009 compared to 2008. The decrease was due to lower cash balances resulting from our acquisitions, the purchase of our $300.0 million 7.0% Senior Notes, the purchase of a portion of our 3.0% Notes and 4.0% Notes, repurchases of our common stock and lower average interest rates on invested cash. Interest expense decreased $1.8 million during the year ended December 31, 2009 compared to 2008, due primarily to redemption of our $300.0 million 7.0% Senior Notes in July 2008 and the purchase of a portion of our 3.0% and 4.0% Notes, offset in part by interest expense on our $365.0 million Senior Notes issued in June 2009.

 

Income Taxes:  In 2009, we recorded a tax benefit of $58.3 million compared to tax expense in 2008 of $34.7 million. The 2009 tax benefit amount is primarily related to the benefit upon release of $102.5 million of the valuation allowance previously recorded against our net deferred tax assets, which were primarily comprised of net operating losses and credits in the U.S. In the fourth quarter of 2009, we concluded that it was more likely than not that we would be able to realize the benefits of the majority of our deferred tax assets. In making this decision, we considered several factors, including but not limited to, future taxable income from the scheduling of deferred tax liabilities and forecasted book and taxable income over the next several years. In general, we have been profitable for U.S. tax return purposes over the last two years and our 2009 taxable income exceeded the allowed current year net operating loss limitation. Due to the successful integration of recent U.S. acquisitions we believe that our current and expected future profitability supports the realization of our deferred tax assets.

 

In 2008, we recorded a valuation allowance against the deferred tax assets associated with the U.S. tax benefits we will receive as income tax loss carryforwards and credits are offset against U.S. tax liability in future years. As of December 31, 2009 the valuation allowance against deferred tax assets totaled $4.4 million compared to $123.8 million as of December 31, 2008. The valuation allowance also had the effect of deferring certain amounts that would normally impact the effective tax rate. See Note 11 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information.

The 2008 tax provision amount is the result of no tax benefits being recorded for the acquired IPR&D charge, the U.S. operating losses and credits. Additionally, as a result of utilizing a portion of our net operating loss carryforward in 2008, we released a portion of our valuation allowance against additional capital resulting in an increased income tax provision.

 

In February 2010, President Obama’s administration proposed significant changes to the U.S. international tax laws, including changes that would limit U.S. deductions for interest expenses related to un-repatriated foreign-source income and modify the U.S. foreign tax credit rules. We cannot determine whether these proposals will be enacted into law or what, if any, changes may be made to such proposals prior to their being enacted into law. We are currently unable to predict whether any such new legislation, if and when it becomes effective, could have a significant adverse impact to our effective tax rate.

 

Income/Loss from Discontinued Operations:  Income from discontinued operations was $6.1 million in 2009 compared to $166.5 million in 2008. The discontinued operations amounts in 2009 relate primarily to the reversal of a contingent liability accrued in 2008 upon sale of our Infergen operations, which did not meet the conditions for payment upon expiration of the payment criteria as of December 31, 2009. The discontinued operations amounts in 2008 relate primarily to our WEEMEA business and Infergen operations that were sold in 2008. In 2008, the loss from discontinued operations before income taxes of the WEEMEA business and Infergen operations was $1.8 million and $11.4 million, respectively. The income in 2008 includes the gain on sale of the WEEMEA business of $158.9 million.

 

Year Ended December 31, 2008 Compared to 2007

 

Product Sales Revenues:  Total consolidated revenues decreased $32.6 million for the year ended December 31, 2008 compared to 2007. Total product sales decreased $9.9 million (2%) to $593.2 million in 2008 from $603.1 million in 2007. Product sales in 2008 included a 3% favorable impact from foreign exchange rate fluctuations, offset by a 4% reduction in volume and a 1% aggregate decrease in price. The decline in volume is primarily a result of the divestment of operations in Asia, Argentina and Uruguay, which resulted in aggregate revenue decreases of $24.5 million in 2008 compared to 2007. This decline was partially offset by revenues of $8.2 million in 2008 attributable to our Coria acquisition. The decrease in sales is also attributable to the sales decline in Mexico, offset by sales increases in Poland and Canada.

 

In our Specialty Pharmaceuticals segment, revenues for the year ended December 31, 2008 decreased $23.0 million (7%) to $303.7 million from $326.7 million in 2007. The decrease in Specialty Pharmaceuticals sales for the year ended December 31, 2008 was due to a 9% decrease in volume, partially offset by a 2% increase in price. This decrease reflects the divestment of operations in Asia, Argentina and Uruguay, which resulted in aggregate revenue decreases of $24.5 million in 2008 compared to 2007, partially offset by revenues of $8.2 million attributable to our Coria acquisition. The decrease in volume is also attributable to a decrease in sales of Diastat, Kinerase and Efudex in the United States.

 

In our Branded Generics — Europe segment, revenues for the year ended December 31, 2008 increased $27.7 million (22%) to $152.8 million from $125.1 million in 2007. Branded Generics - Europe sales in 2008 were impacted by a 14% positive contribution from currency fluctuations and a 12% increase in volume, offset by a 4% aggregate reduction in prices. The increase in the value of currencies in the region relative to the U.S. Dollar contributed $17.9 million to revenues in the segment in 2008. The increase in volume includes a full year of sales in 2008 from products launched during 2007, resulting in a sales increase of $3.9 million.

 

In our Branded Generics — Latin America segment, revenues for the year ended December 31, 2008 decreased $14.7 million (10%) to $136.6 million from $151.3 million in 2007. Branded Generics - Latin America sales in 2008 reflected a 5% decrease in price, a 4% reduction in volume and a 1% reduction from foreign currency. The decline in volume in 2008 is due in part to a planned reduction of shipments to wholesaler customers in Mexico to reduce the amount of product in the wholesale channel.

 

Alliance Revenue:  Alliance revenue in the year ended December 31, 2008 included $4.4 million attributable to the GSK Collaboration Agreement. Alliance revenue in 2007 included a licensing payment of $19.2 million

which we received from Schering-Plough as a payment for the license to pradefovir. In 2007, we announced an agreement with Schering-Plough and Metabasis which returned all pradefovir rights to Metabasis.

 

Ribavirin royalties for the year ended December 31, 2008 were $59.4 million compared to $67.2 million for 2007, a decrease of $7.8 million (12%). Ribavirin royalty revenues decreased due to Schering-Plough’s global market share losses in ribavirin sales and Roche’s discontinuation of royalty payments to us in June 2007.

 

Gross Profit Margin:  Gross profit margin, excluding amortization, as a percentage of product sales decreased to 72% for the year ended December 31, 2008 compared to 74% in 2007. Gross profit margin in 2008 was negatively impacted by increases in reserves for returns, in addition to inventory provisions and write offs in Mexico, the United States and Europe resulting primarily from decisions to cease promotion of or discontinue certain products, decisions to discontinue certain manufacturing transfers, and product quality failures.

 

Selling, General and Administrative Expenses:  SG&A expenses were $278.0 million for the year ended December 31, 2008 compared to $292.0 million for 2007, a decrease of $14.0 million (5%). As a percent of product sales, SG&A expenses were 47% for the year ended December 31, 2008 and 48% in 2007. The decrease in SG&A expense primarily reflects the effects of our restructuring initiatives, including a $10.1 million reduction due to the divestment of our businesses in Asia, Argentina and Uruguay, in addition to a reduction in stock-based compensation expense of $4.5 million in 2008. The savings from our restructuring initiatives were offset in part by the recognition of an other-than temporary impairment of $4.8 million in an investment in a publicly traded investment fund, a $3.4 million reversal of a tax benefit in Mexico and $3.5 million of expenses related to our expansion into additional markets in Central Europe.

 

Research and Development:  R&D expenses were $87.0 million for the year ended December 31, 2008 compared to $98.0 million for 2007, a reduction of $11.0 million (11%). The decrease in R&D expenses was primarily due to $10.2 million of expense offsets attributable to the GSK Collaboration Agreement (as defined below), which was effective in October 2008.

 

Special Charges and Credits Including Acquired In-Process Research and Development:  Acquired IPR&D expense represents the estimate of the fair value of in-process technology for projects that, as of the acquisition date, had not yet reached technological feasibility and had no alternative future use. In 2008 we incurred IPR&D expense of $185.8 million related to the acquisition of Dow and $0.5 million related to the acquisition of Coria for IPR&D assets acquired that we determined were not yet complete and had no future uses in their current state. The major risks and uncertainties associated with the timely and successful completion of the acquired IPR&D assets consist of the ability to confirm the safety and efficacy of the product based upon the data from clinical trials and obtaining the necessary approval from the FDA.

 

The IPR&D assets of Dow are comprised of the following items; IDP-107 for the treatment of acne, IDP-108 for fungal infections and IDP-115 for rosacea, which were valued at $107.3 million, $49.0 million and $29.5 million, respectively. All of these IPR&D assets had not yet received approval from the FDA as of the acquisition date.

 

The estimated fair value of the IPR&D assets was determined based upon the use of a discounted cash flow model for each asset. The estimated after-tax cash flows were probability weighted to take into account the stage of completion and the risks surrounding the successful development and commercialization of each asset. The cash flows for each asset were then discounted to a present value using a discount rate of 15%. Material net cash inflows were estimated to begin in 2013 for IDP-107, IDP-108 and IDP-115. Gross margins and expense levels were estimated to be consistent with Dow’s historical results. Solely for the purpose of estimating the fair value of these assets, we assumed we would incur future research and development costs of $26.6 million, $29.6 million and $20.1 million to complete IDP-107, IDP-108 and IDP-115, respectively.

 

Amortization:  Amortization expense was $50.0 million for the year ended December 31, 2008 compared to $56.0 million for 2007, a decrease of $6.0 million (11%). The decrease is the result of the declining amortization of the rights to the ribavirin royalty intangible, which was amortized using an accelerated method and was fully amortized in the third quarter of 2008. Amortization expense in 2008 includes a $1.6 million intangible asset impairment charge related to a product sold in the United States.

Restructuring Charges and Asset Impairments:  In 2008 and 2007, we incurred $21.3 million and $27.7 million, respectively, in restructuring charges relating primarily to severance charges, contract cancellations and asset impairments. See above for a detailed discussion of the charges in each year.

 

Other Income/Expense, Net, Including Translation and Exchange:  Other income, net, including translation and exchange was income of $2.1 million for the year ended December 31, 2008 compared to income of $1.7 million for 2007. In 2008, the amount represents primarily the effects of translation gains in Europe. In 2007, the amounts represent primarily the effects of translation gains and losses in Europe and Latin America. Translation and exchange gains are primarily related to U.S. Dollar denominated assets and liabilities at our foreign currency denominated subsidiaries.

 

Gain/Loss on Early Extinguishment of Debt:  Loss on early extinguishment of debt in the year ended December 31, 2008 includes a loss of $14.9 million as a result of the July 2008 redemption of our 7.0% Senior Notes and includes redemption premium of $10.5 million, unamortized loan costs of $2.9 million and an interest rate swap agreement termination fee of $1.5 million. This loss was partially offset by a $1.9 million gain as a result of the November 2008 repurchase of $32.6 million aggregate principal amount of our 3.0% Notes for an aggregate purchase price of $29.0 million. The carrying amount, net of unamortized debt issuance costs, of the 3.0% Notes purchased was $30.1 million and the estimated fair value exclusive of the conversion feature was $28.2 million. The difference between the carrying amount and the estimated fair value was recognized as a gain of $1.9 million upon early extinguishment of debt.

 

Interest Expense and Income:  Interest income decreased $0.5 million during the year ended December 31, 2008 compared to 2007. Interest expense was $45.4 million and $56.9 million for the years ended December 31, 2008 and 2007, respectively, and decreased $11.5 million during the year ended December 31, 2008 compared to 2007. The decrease was due primarily to lower interest expense resulting from the July 2008 redemption of the 7.0% Senior Notes, and to a lesser extent to the November 2008 purchase of a portion of the 3.0% Notes.

 

Income Taxes:  In 2008 and 2007, we recorded tax expense of $34.7 million and $13.5 million, respectively. The 2008 tax provision amount is the result of no tax benefits being recorded for the acquired IPR&D charge, the U.S. operating losses and credits. Additionally, as a result of utilizing a portion of our net operating loss carryforward in 2008, we released a portion of our valuation allowance against additional capital resulting in an increased income tax provision. The 2007 tax provision amount related primarily to the fact that no tax benefits were recorded for the U.S. operating losses and credits.

 

In 2008 and 2007, we recorded valuation allowances against the deferred tax assets associated with the U.S. tax benefits we will receive as income tax loss carryforwards and credits are offset against U.S. tax liability in future years. As of December 31, 2008 the valuation allowance against deferred tax assets totaled $123.8 million compared to $126.2 million as of December 31, 2007. The valuation allowance also had the effect of deferring certain amounts that would normally impact the effective tax rate. See Note 11 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information.

 

Income/Loss from Discontinued Operations:  Income from discontinued operations was $166.5 million in 2008 compared to a loss of $26.8 million in 2007. The discontinued operations amounts in 2008 and 2007 relate primarily to our WEEMEA business and Infergen operations that were sold in 2008. In 2008, the loss from discontinued operations before income taxes of the WEEMEA business and Infergen operations was $1.8 million and $11.4 million, respectively. The income in 2008 includes the gain on sale of the WEEMEA business of $158.9 million. In 2007, the $31.5 million loss before income taxes from our Infergen operations was partially offset by income before income taxes of $17.1 million related to the WEEMEA business.

Sources and Uses of Cash

 

Cash and cash equivalents and marketable securities totaled $81.9 million at December 31, 2009 compared to $218.8 million at December 31, 2008. The decrease of $136.9 million primarily resulted from the following:

 

Uses of Cash:

 

 

Sources of Cash:

 

 

Working capital was $125.1 million at December 31, 2009, compared to $175.5 million at December 31, 2008. The decrease in working capital of $50.4 million primarily resulted from the decrease in cash and cash equivalents and marketable securities and an increase in notes payable and current portion of long-term debt, offset, in part, by an increase in net current deferred tax assets, inventory, accounts receivable and a decrease in accrued liabilities.

 

Cash provided by operating activities in continuing operations is expected to be our primary source of funds for operations in 2010. During the year ended December 31, 2009, cash provided by operating activities in continuing operations totaled $186.3 million, compared to $200.7 million in 2008. The cash provided by operating activities in continuing operations for 2009 was primarily a result of net income adjusted for non-cash charges, offset by the reduction in other liabilities. The cash provided by operating activities in continuing operations for 2008 included receipt from GSK of $125.0 million in upfront fees pursuant to the Collaboration Agreement (as defined below).

 

Cash used in investing activities in continuing operations was $337.5 million for the year ended December 31, 2009, compared to cash used in investing activities in continuing operations of $277.2 million in 2008. In 2009, cash used in investing activities consisted primarily of $162.4 million paid for liabilities for the acquisition of Dow, $151.5 million, net of cash acquired, paid for the acquisitions of PFI, Tecnofarma, Emo-Farm and Dr. Renaud and capital expenditures of $20.0 million. In 2008, cash used in investing activities in continuing operations consisted primarily of the acquisition of businesses and product rights of $355.3 million, the purchase of investments of $155.7 million, and capital expenditures of $16.6 million, offset in part by proceeds from investments of $200.8 million and proceeds from the sale of businesses of $48.6 million. Cash provided by investing activities in discontinued operations in 2008 of $447.1 million consisted primarily of the net proceeds of $379.3 million from the sale of the WEEMEA business to Meda and $70.8 million of cash proceeds received as the initial payment in the sale of our Infergen operations to Three Rivers Pharmaceuticals, LLC.

 

Cash provided by financing activities in continuing operations was $29.9 million in the year ended December 31, 2009, and primarily consisted of the net proceeds of $346.0 million for the issuance of the Senior Notes, proceeds from

stock option exercises and employee stock purchases of $40.4 million, offset in part by the purchase of treasury stock for $202.4 million and payments on long-term debt and notes payable of $151.7 million. Cash used in financing activities in continuing operations in 2008 was $468.8 million and primarily consisted of payments on long-term debt and notes payable of $323.8 million and purchase of treasury stock of $206.5 million, offset in part by proceeds from stock option exercises and employee stock purchases of $49.1 million and excess tax deductions from stock options exercised of $12.3 million.

 

Liquidity and Capital Resources

 

Historically, our primary sources of liquidity have been our cash flow from operations and issuances of long-term debt securities. In 2009, cash generated from operations was sufficient to meet our operating requirements. We believe that cash generated from operations, along with our existing cash, will be sufficient to meet our operating requirements at least through December 31, 2010, to fund capital expenditures and our clinical development program. We do not have any short-term debt maturities, other than the $48.9 million principal amount of our 3.0% Notes maturing in August 2010. Our cash on hand is sufficient to cover this short-term debt maturity. However, since part of our business strategy is to expand through strategic acquisitions, we may seek additional debt financing or issue additional equity securities or sell assets to finance future acquisitions or for other purposes.

 

If GSK terminates the Collaboration Agreement prior to December 31, 2010, we would be required to refund to GSK up to $40.0 million of the upfront fee through December 31, 2009; however, the refundable portion will be reduced ratably throughout 2010 until it reaches zero at December 31, 2010.

 

In October 2009, we paid $115.0 million to the former Dow common stockholders in order to settle all current and future income milestone obligations that we had to these stockholders under the December 2008 Dow merger agreement. Specifically, in exchange for this payment, we received rights to all future profit share payments to Dow under Dow’s 2008 agreement with Mylan related to sales of IDP-111 and a release by the former Dow stockholders of their right to receive up to $235.0 million in milestone payments upon successful development and commercialization of certain Dow pipeline products. We further agreed to terminate the indemnification obligations of the former Dow common stockholders and to release the $35.0 million escrow account.

 

We did not declare and did not pay dividends in 2009 or 2008.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of December 31, 2009, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

 

 

We have no material commitments for purchases of property, plant and equipment.

 

In addition to the commitments in the table above, we are required under the terms of various license agreements to make contingent milestone payments aggregating $19.9 million. These payments are not included in the table above as the likelihood and timing of payments, if any, are uncertain. The table above also excludes an

$8.0 million milestone payable to Meda Pharma upon acceptance of the filing of the NDA for retigabine included in current liabilities at December 31, 2009.

 

Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2009, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $13.1 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 11 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for a discussion of income taxes.

 

Off-Balance Sheet Arrangements

 

We do not use special purpose entities or other off-balance sheet financing techniques except for operating leases disclosed in the table contained in the “Contractual Obligations” section above. Our 3.0% Notes and 4.0% Notes include conversion features that are considered as off-balance sheet arrangements under SEC requirements. For further discussion of the 3.0% and 4.0% Notes, please refer to Note 10 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

Foreign Operations

 

Approximately 57%, 66% and 65% of our revenues from continuing operations, which includes royalties, for the years ended December 31, 2009, 2008 and 2007, respectively, were generated from operations or otherwise earned outside the United States. All of our foreign operations are subject to risks inherent in conducting business abroad, including price and currency exchange controls, fluctuations in the relative values of currencies, political instability and restrictive governmental actions including possible nationalization or expropriation. Changes in the relative values of currencies may materially affect our results of operations. For a discussion of these risks, see Item 1A, Risk Factors in this Annual Report on Form 10-K.

 

Inflation and Changing Prices

 

We experience the effects of inflation through increases in the costs of labor, services and raw materials. We are subject to price control restriction on our pharmaceutical products in the majority of countries in which we operate. While we attempt to raise selling prices in anticipation of inflation, we operate in some markets which have price controls that may limit our ability to raise prices in a timely fashion.

 

Recent Accounting Pronouncements

 

Information regarding recent accounting pronouncements is contained in Note 1 to consolidated financial statements in Item 8 of this Annual Report on Form 10-K

 

Critical Accounting Estimates

 

The consolidated financial statements appearing elsewhere in this document have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these statements requires us 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 ongoing basis, we evaluate our estimates, including those related to product returns, rebates, collectability of receivables, inventories, intangible assets, income taxes and contingencies and litigation. The actual results could differ materially from those estimates.

 

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

 

Revenue Recognition

 

We recognize 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 estimated and recorded at the time of sale. Allowances for future returns of products sold to our 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. Sales revenue in certain countries is recognized on a consignment basis.

 

Our product sales are subject to a variety of deductions, primarily representing rebates and discounts to government agencies, wholesalers and managed care organizations. These deductions represent estimates of the related obligations and, as such, judgment is required when estimating the impact of these sales deductions on revenues for a reporting period.

 

In the United States we record provisions for Medicaid, Medicare and contract rebates based upon our actual experience ratio of rebates paid and actual prescriptions written during prior quarters. We apply the experience ratio to the respective period’s sales to determine the rebate accrual and related expense. This experience ratio is evaluated regularly and adjusted if necessary to ensure that the historical trends are as current as practicable. We adjust the ratio to better match our current experience or our expected future experience, as appropriate. In developing this ratio, we consider current contract terms, such as changes in formulary status and discount rates. If our ratio is not indicative of future experience, our results could be materially affected.

 

Outside of the United States, the majority of our rebates are contractual or legislatively mandated and our estimates are based on actual invoiced sales within each period; both of these elements help to reduce the risk of variations in the estimation process. Some European countries base their rebates on the government’s unbudgeted pharmaceutical spending and we use an estimated allocation factor against our actual invoiced sales to project the expected level of reimbursement. We obtain third party information that helps us to monitor the adequacy of these accruals. If our estimates are not indicative of actual unbudgeted spending, our results could be materially affected.

 

The sensitivity of our estimates can vary by program, type of customer and geographic location. However, estimates associated with U.S. Medicaid and contract rebates are most at-risk for material adjustment because of the extensive time delay between the recording of the accrual and its ultimate settlement. This interval can range up to one year. Because of this time lag, in any given quarter, our adjustments to actual can incorporate revisions of several prior quarters. Significant changes in estimate related to prior periods are discussed following the table below.

 

We record sales incentives as a reduction of revenues at the time the related revenues are recorded or when the incentive is offered, whichever is later. We estimate the cost of our sales incentives based on our historical experience with similar incentives programs.

 

We use third-party data to estimate the level of product inventories, expiration dating and product demand at our major wholesalers. Actual results could be materially different from our estimates, resulting in future adjustments to revenue. We conduct a review of the current methodology and assess the adequacy of the allowance for returns on a quarterly basis, adjusting for changes in assumptions, historical results and business practices, as necessary.

The following table summarizes deductions from gross sales and related accruals for the three years ended December 31, 2009, 2008 and 2007:

 

 

Sales return accruals are recorded based on historical experience, estimated customer inventory levels and forecasted sales patterns. Rebates include various managed care sales rebate and other incentive programs, the largest of which relates to Medicaid and Medicare. Discounts include cash discounts that are provided to customers that pay within a specific period and volume discounts. The provision for cash discounts is estimated based upon invoice billings, utilizing historical customer payment experience. Chargebacks represent amounts payable in the future to a wholesaler for the difference between the invoice prices paid to us by our wholesale customers for a particular product and the negotiated contract price that the wholesalers’ customer pays for that product. Our chargeback provision and related reserve varies with changes in product mix, changes in customer pricing and changes to estimated wholesaler inventories. Inventory Management Agreement (“IMA”) Fees are deductions from gross sales, recorded pursuant to agreements with certain of our wholesale customers.

 

We estimate product returns at the time of sale based on historical patterns and rates of return of our products. This estimation methodology relies upon a historical model to calculate sales return accruals, with a comparison to historical experience, including the historical rate of actual returns. These comparisons are reviewed quarterly, with adjustments made when trends are identified. A more detailed review of our returns model is undertaken on an annual basis.

 

As part of our review of our returns reserve in the third quarter of 2008, we recognized that recent experience of actual product returns in the United States was higher than had previously been estimated under our methodology for certain products. As a result of this review of our returns reserve, we adjusted our reserve for product returns. This adjustment resulted in an increase of $7.3 million in 2008 resulting most notably from returns of Diastat and Migranal.

Diastat in 2005 experienced two changes in product characteristics which included longer dating (average shelf life at the time of sale approximately doubled) along with the replacement of four fixed dosage products with two variable dosage products. As a result, we reduced our estimated rates of future product returns for prospective sales. In 2008, we began to experience actual returns on these products which were higher than estimated using our methodology resulting in a revision of the previous estimate of returns reserves. In addition, Migranal has been sold in two new trade sizes since its acquisition in 2005 with the returns estimate for these launches utilizing the returns experience of the previous trade sizes. In 2008, the more recent trade size product experienced a higher level of returns than estimated using our methodology which resulted in an adjustment in the returns reserve.

 

As part of our review of our returns reserve in the third quarter of 2007, we recognized that we had experienced higher actual product returns in the United States and certain other countries than had been previously estimated. As a result of this review of our returns reserve, we adjusted our reserve for product returns. This adjustment resulted in an increase of $2.8 million in our returns reserve in the third quarter of 2007, resulting most notably from returns of Permax and Cesamet in the United States. Approximately $0.4 million of this amount relates to our discontinued operations in Western Europe.

 

We earn ribavirin royalties as a result of sales of products by Schering-Plough. Ribavirin royalties are earned at the time the products subject to the royalty are sold by the third party and are reduced by an estimate for discounts and rebates that will be paid in subsequent periods for those products sold during the current period. We rely on a limited amount of financial information provided by Schering-Plough to estimate the amounts due to us under the royalty agreements.

 

Sales Incentives

 

In the U.S. market, our 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. We monitor and restrict sales in the U.S. market in order to limit wholesaler purchases in excess of their ordinary-course-of-business inventory levels. We operate IMAs with major wholesalers in the United States. However, specific events such as the case of sales incentives described above or seasonal demand (e.g. antivirals during an outbreak) may justify larger purchases by wholesalers. We may offer sales incentives primarily in international markets, where typically no right of return exists except for goods damaged in transit, product recalls or replacement of existing products due to packaging or labeling changes. Our revenue recognition policy on these types of purchases and on incentives in international markets is consistent with the policies described above.

 

Collaboration Agreement

 

In October 2008, we closed the Collaboration Agreement with GSK to develop and commercialize retigabine, a first-in-class neuronal potassium channel opener for treatment of adult epilepsy patients with refractory partial onset seizures and its backup compounds. Pursuant to the terms of the Collaboration Agreement, we granted co-development rights and worldwide commercialization rights to GSK.

 

We agreed to share equally with GSK the development and pre-commercialization expenses of retigabine in the United States, Australia, New Zealand, Canada and Puerto Rico (the “Collaboration Territory”). Our share of such expenses in the Collaboration Territory is limited to $100.0 million, provided that GSK will be entitled to credit our share of any such expenses in excess of such amount against future payments owed to us under the Collaboration Agreement. Following the launch of a retigabine product, we will share equally in the profits of retigabine in the Collaboration Territory. In addition, we granted GSK an exclusive license to develop and commercialize retigabine in countries outside of the Collaboration Territory and certain backup compounds to retigabine worldwide. GSK will be responsible for all expenses outside of the Collaboration Territory and will solely fund the development of any backup compound. We will receive up to a 20% royalty on net sales of retigabine outside of the Collaboration Territory. In addition, if backup compounds are developed and commercialized by GSK, GSK will pay us royalties of up to 20% of net sales of products based upon such backup compounds.

 

Pursuant to the Collaboration Agreement, GSK paid us $125.0 million in upfront fees in October 2008. GSK has the right to terminate the Collaboration Agreement at any time prior to the receipt of the approval by the FDA of a NDA for a retigabine product, which right may be irrevocably waived at any time by GSK. The period of time prior to such termination or waiver is referred to as the “Review Period”. If GSK terminates the Collaboration Agreement prior to

December 31, 2010, we would be required to refund to GSK a portion of the upfront fee. In February 2009, the Collaboration Agreement was amended to, among other matters, reduce the maximum amount that we would be required to refund to GSK to $40.0 million through December 31, 2009, with additional ratable reductions during 2010 until reaching zero at December 31, 2010. Unless otherwise terminated, the Collaboration Agreement will continue on a country-by-country basis until GSK has no remaining payment obligations with respect to such country.

 

Under terms of the Collaboration Agreement, GSK has agreed to pay us up to an additional $545.0 million based upon the achievement of certain regulatory, commercialization and sales milestones and the development of additional indications for retigabine. GSK has also agreed to pay us up to an additional $150.0 million if certain regulatory and commercialization milestones are achieved for backup compounds to retigabine.

 

The Collaboration Agreement contains multiple elements and requires evaluation pursuant to ASC 605-25. The Collaboration Agreement includes a provision for us to participate on a joint steering committee. We evaluated the facts and circumstances of the Collaboration Agreement to determine whether our participation is protective of our interests or if it constitutes a deliverable to be included in our evaluation of the arrangement under ASC 605-25. We concluded the participation in the joint steering committee is a deliverable until certain regulatory approval is obtained. In addition, we determined that completion of our development and pre-commercialization efforts during the time prior to the launch of a retigabine product (the “Pre-Launch Period”) is also a deliverable under the Collaboration Agreement. As a result, we recognize alliance revenue during the Pre-Launch Period as we complete our performance obligations using the proportional performance model, which requires us to determine and measure the completion of our expected development and pre-commercialization costs, in addition to our participation in the joint steering committee. We will also record a credit to our development and pre-commercialization costs from the upfront payment based upon our proportional performance against our expected development and pre-commercialization costs during the Pre-Launch Period. The determination of such credit to our development and pre-commercialization costs is limited to the amount that is no longer potentially refundable to GSK should they elect to terminate the Collaboration Agreement. The difference between the upfront payment of $125.0 million and our expected development and pre-commercialization costs is being recognized as alliance revenue based upon the proportional performance model during the Pre-Launch Period. Determination of our expected development and pre-commercialization costs and measurement of our completion of those costs requires the use of management’s judgment. Significant factors considered in our evaluation of our expected development and pre-commercialization costs include, but are not limited to, our experience, along with GSK’s experience, in completing clinical trials and costs of completing similar development and commercialization programs. We expect to complete our research and development and pre-commercialization obligations in effect during the Pre-Launch Period by the first quarter of 2011.

 

Impairment of Property, Plant and Equipment

 

We evaluate the carrying value of property, plant and equipment when conditions indicate a potential impairment. We determine 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 are less than the carrying value, the amount of the asset impairment, if any, is then 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.

 

Valuation of Intangible Assets

 

We periodically review intangible assets for impairment using an undiscounted net cash flows approach. We determine whether there has been impairment by comparing the anticipated undiscounted future operating cash flows of the products associated with the intangible asset with its carrying value. If the undiscounted operating cash flows are less than the carrying value, the amount of the asset 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.

 

We use 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 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. Some of the more significant estimates and assumptions inherent in the intangible asset impairment estimation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory factors.

 

We recorded an impairment charge of $0.5 million, which is included in amortization expense for the year ended December 31, 2009. Certain patents, with a carrying value of $29.9 million at December 31, 2009, owned by Dow and licensed to Galderma are being challenged by a third party, Tolmar, Inc. If the challenge is successful, the intangible asset associated with these patents could be impaired in the future. See Note 21 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

 

Valuation of Goodwill

 

We evaluate the recoverability of goodwill at least annually and also in the event of an impairment indicator. The evaluation is based on a two-step impairment test. The first step compares the fair value of the reporting unit with its carrying amount including goodwill. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. Fair value is computed based on estimated future cash flows discounted at a rate that approximates our cost of capital. Such estimates are subject to change, and we may be required to recognize impairment losses in the future. Our analysis of recoverability of goodwill performed in the fourth quarter of 2009 did not result in an impairment charge.

 

Purchase Price Allocation Including Acquired In-Process Research and Development

 

The purchase prices for the Dr. Renaud, PFI, Tecnofarma, Emo-Farm, Dow, DermaTech and Coria acquisitions were 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. We believe 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.

 

We value 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 amounts expensed as acquired IPR&D in 2008 represents an 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. The data used to determine fair value requires significant judgment. The estimated fair values were based on our use of a discounted cash flow model. For each project, the estimated after-tax cash flows were probability weighted to take account of the stage of completion and the risks surrounding the successful development and commercialization. The assumed tax rates are our estimate of the effective tax rates that will apply to the expected cash flows. These cash flows were then discounted to a present value using discount rates between 14% and 22%. The discount rates represent our weighted-average cost of capital for each of the acquisitions. See Note 3 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for a discussion of acquisitions.

 

The major risks and uncertainties associated with the timely and successful completion of these projects include the uncertainty of our ability to confirm the safety and efficacy of product candidates based on the data from clinical trials and of obtaining necessary regulatory approvals. In addition, no assurance can be given that the underlying assumptions we 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.

Contingencies

 

We are 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. 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 21 of notes to consolidated financial statements in Item 8 of this Annual Report on Form 10-K for a discussion of contingencies.

 

Income Taxes

 

Our income tax returns are subject to audit in various jurisdictions. Existing and future audits by, or other disputes with, tax authorities may not be resolved favorably for us and could have a material adverse effect on our reported effective tax rate and after-tax cash flows. We record liabilities for uncertain tax positions, which involves significant management judgment. New laws and new interpretations of laws and rulings by tax authorities may affect the liability for uncertain tax positions. Due to the subjectivity and complex nature of the underlying issues, actual payments or assessments may differ from our estimates. To the extent that our estimates differ from amounts eventually assessed and paid our income and cash flows can be materially and adversely affected.

 

We assess whether it is more likely than not that we will realize the tax benefits associated with our deferred tax assets and establish 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 we revise these forecasts or determine 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.

 

 

Our business and financial results are affected by fluctuations in world financial markets. We evaluate our exposure to such risks on an ongoing basis, and seek ways to manage these risks to an acceptable level, based on management’s judgment of the appropriate trade-off between risk, opportunity and cost. We do not hold any significant amount of market risk sensitive instruments whose value is subject to market price risk. Our significant foreign currency exposure relates to the Polish Zloty, the Mexican Peso, the Australian Dollar and the Canadian Dollar. During 2009 and 2008, we entered into various forward currency contracts to a) reduce our exposure to forecasted Japanese Yen denominated royalty revenue, b) hedge our net investment in our Polish and Brazilian subsidiaries, c) reduce our exposure to various currencies as a result of repetitive short-term intercompany investments and obligations. In the aggregate, an unrealized gain of $0.2 million was recorded in the financial statements at December 31, 2009. In the normal course of business, we also face 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 December 31, 2009 and 2008, the fair value of our derivatives was (in thousands):

 

 

We currently do not hold financial instruments for trading or speculative purposes. Our financial assets are not subject to significant interest rate risk due to their short duration. A 100 basis-point increase in interest rates affecting our financial instruments would not have had a material effect on our 2009 pretax earnings. In addition, we had $638.8 million principal amount of fixed rate debt as of December 31, 2009 that requires U.S. Dollar repayment. To the extent that we require, as a source of debt repayment, earnings and cash flow from some of our units located in foreign countries, we are subject to risk of changes in the value of certain currencies relative to the U.S. Dollar.

 

 

Quarterly Financial Data

 

Following is a summary of quarterly financial data for the years ended December 31, 2009 and 2008 (in thousands, except per share data):