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

 

 

 

 

Form 10-Q

 

 

Commission file number: 1-11397

 

 

 

 

Valeant Pharmaceuticals International

(Exact name of registrant as specified in its charter)

 

(949) 461-6000

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant is 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):

 

 

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 number of outstanding shares of the registrant’s Common Stock, $0.01 par value, as of August 6, 2008 was 88,066,534.

 

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

INDEX

 

 

 

VALEANT PHARMACEUTICALS INTERNATIONAL

CONSOLIDATED CONDENSED BALANCE SHEETS
As of June 30, 2008 and December 31, 2007
(In thousands, except par value data)

 

 

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

VALEANT PHARMACEUTICALS INTERNATIONAL

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 2008 and 2007
(Unaudited, in thousands, except per share data)

 

 

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

VALEANT PHARMACEUTICALS INTERNATIONAL

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the three and six months ended June 30, 2008 and 2007
(Unaudited, in thousands)

 

 

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

VALEANT PHARMACEUTICALS INTERNATIONAL

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2008 and 2007
(Unaudited, in thousands)

 

 

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

VALEANT PHARMACEUTICALS INTERNATIONAL

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

 

In the consolidated condensed financial statements included herein, “we,” “us,” “our,” “Valeant” and the “Company” refer to Valeant Pharmaceuticals International and its subsidiaries. The condensed consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared on the basis of accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The results of operations presented herein are not necessarily indicative of the results to be expected for a full year. Although we believe that all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the interim periods presented are included and that the disclosures are adequate to make the information presented not misleading, these consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2007. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

 

 

Organization:  We are a multinational pharmaceutical company that develops, manufactures and markets a broad range of pharmaceutical products. Additionally, we generate royalty revenues from the sale of ribavirin by Schering-Plough Ltd. (“Schering-Plough”).

 

Principles of Consolidation:  The accompanying consolidated condensed financial statements include the accounts of Valeant Pharmaceuticals International, its wholly owned subsidiaries and its majority-owned subsidiary in Poland. All significant intercompany account balances and transactions have been eliminated.

 

Marketable Securities:  Marketable securities include short-term commercial paper and government agency securities which, at the time of purchase, have maturities of greater than three months. Marketable securities are generally categorized as held-to-maturity and are thus carried at amortized cost, because we have both the intent and the ability to hold these investments until they mature. As of June 30, 2008 and December 31, 2007, the fair value of our marketable securities approximated cost.

 

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

 

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

 

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

 

Stock-Based Compensation Expense:  We have adopted SFAS No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

under our Employee Stock Purchase Plan based on estimated fair values. In order to estimate the fair value of stock options, we use the Black-Scholes option valuation model, which was developed for use in estimating the fair value of publicly traded options which have no vesting restrictions and are fully transferable. Option valuation models require the input of subjective assumptions which can vary over time.

 

Assets Held for Sale:  We have classified certain assets as assets held for sale in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS 144”). At December 31, 2007, assets held for sale included the assets related to our Infergen operations and the assets included in the sale of certain business subsidiaries and assets in Asia to Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”). We sold the assets related to our Infergen operations to Three Rivers Pharmaceuticals, LLC on January 14, 2008. We completed the transaction with Invida on March 3, 2008. At March 31, 2008, assets held for sale included the assets related to our subsidiaries in Argentina and Uruguay. We sold these subsidiaries on June 5, 2008.

 

Discontinued Operations:  The results of the Infergen operations and the related financial position have been reflected as discontinued operations in the consolidated financial statements in accordance with SFAS 144 and EITF 03-13, Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations. The consolidated financial statements have been reclassified to conform to discontinued operations presentation for all historical periods presented. More details on discontinued operations are available in Note 5.

 

Use of Estimates:  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. Actual results could differ materially from those estimates.

 

Out of Period Adjustments:  In the second quarter of 2008 we recorded adjustments related to stock compensation expense and foreign taxes that affected costs of goods sold, selling expenses, research and development expenses and general and administrative expenses and that in the aggregate increased income from continuing operations before income taxes by approximately $916,000, comprising an increase of $1,988,000 related to 2007 and 2006 and a decrease of $1,072,000 related to the first quarter of 2008. These corrections were a reversal of stock compensation expense to adjust our historical estimated forfeiture rate for actual forfeitures which occurred in 2006, 2007 and the first quarter of 2008 and a foreign tax error recorded in 2007 and the first quarter of 2008. Correcting the stock compensation error increased income from continuing operations before income taxes by $3,870,000 and correcting the foreign tax error decreased income from continuing operations before income taxes by $2,954,000. Because these errors, both individually and in the aggregate, were not material to any of the prior years’ financial statements, and the impact of correcting these errors is not expected to be material to the full year 2008 financial statements, we recorded the correction of these errors in the second quarter of 2008 financial statements.

 

Recent Accounting Pronouncements:

 

SFAS No. 157.  In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements but does not change the requirements to apply fair value in existing accounting standards. Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. The standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability. SFAS 157 became effective for Valeant as of January 1, 2008. In February 2008, the FASB issued FASB Staff Positions (“FSP”) 157-1 and 157-2. FSP 157-1 amends SFAS 157 to exclude SFAS No. 13, Accounting for Leases, (“SFAS 13”) and its related interpretive accounting pronouncements that address leasing transactions, while FSP 157-2 delays the effective date of the application of SFAS 157 to fiscal years beginning after

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

November 15, 2008 for all nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. For more details about our implementation of SFAS 157, see Note 3.

 

SFAS No. 159.  In February 2007 the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS 159”) which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 does not eliminate any disclosure requirements included in other accounting standards. SFAS 159 permitted us to choose to measure many financial instruments and certain other items at fair value and established presentation and disclosure requirements. SFAS 159 became effective for Valeant as of January 1, 2008. The implementation of SFAS 159 did not have a material effect on our financial statements as we did not elect the fair value option for any new financial instruments or other assets and liabilities.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141(R) also provides guidance for recognizing and measuring goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Among other requirements, SFAS 141(R) expands the definition of a business combination, requires acquisitions to be accounted for at fair value, and requires transaction costs and restructuring charges to be expensed. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. When implemented, SFAS 141(R) will require that any reduction to a valuation allowance established in purchase accounting will be accounted for as a reduction to income tax expense, rather than a reduction of goodwill.

 

In December 2007, the FASB ratified the consensus reached by the EITF in EITF Issue No. 07-1, Accounting for Collaborative Arrangements (“EITF 07-1”). EITF 07-1 defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-1 also establishes the appropriate income statement presentation and classification for joint operating activities and payments between participants, as well as the sufficiency of the disclosures related to these arrangements. EITF 07-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Retrospective application to all prior periods presented is required for all collaborative arrangements existing as of the effective date. We do not expect the adoption of EITF 07-1 to have a material impact on our accounting for any existing collaborative arrangements in our consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities, including (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS 133, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This standard becomes effective for Valeant on January 1, 2009. Earlier adoption of SFAS 161 and, separately, comparative disclosures for earlier periods at initial adoption are encouraged. We are currently assessing the impact that SFAS 161 may have on our financial statements.

 

In April 2008, the FASB issued FASB Statement of Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets, (“SFAS 142”) in order to improve the

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R). FSP FAS 142-3 becomes effective for Valeant on January 1, 2009. We are currently assessing the impact that FSP FAS 142-3 may have on our financial statements.

 

In May 2008, the FASB issued FASB Statement of Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), (“FSP APB 14-1”). FSP APB 14-1 requires the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The guidance in FSP APB 14-1 will be applied retrospectively to all periods presented. The implementation of FSP APB 14-1 will materially increase our reported interest expense.

 

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used (order of authority) in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. We do not expect the adoption of SFAS 162 to have a material impact on our financial statements.

 

 

Our restructuring charges include severance costs, contract cancellation costs, the abandonment of capitalized assets such as software systems, the impairment of manufacturing and research facilities, and other associated costs, including legal and professional costs. We have accounted for statutory and contractual severance obligations when they are estimable and probable, pursuant to SFAS No. 112, Employers’ Accounting for Postemployment Benefits. For one-time severance arrangements, we have applied the methodology defined in SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). Pursuant to these requirements, these benefits are detailed in an approved severance plan, which is specific as to number, 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 in accordance with SFAS 146. We have followed the requirements of SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS 144”), in recognizing the abandonment of capitalized assets such as software and the impairment of manufacturing and research facilities. For a further description of the accounting for impairment of long-lived assets under SFAS 144, see Note 1, Organization and Summary of Significant Accounting Policies. Other associated costs, such as legal and professional fees, have been expensed as incurred, pursuant to SFAS 146.

 

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. As announced on March 27, 2008, we have completed this strategic review and announced a strategic plan which includes a restructuring program (the “2008 Restructuring”). The 2008 Restructuring is expected to reduce 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, Mexico, Canada, Brazil and Australia. We are pursuing plans to divest our operations in markets outside of these core geographic areas through sales of subsidiaries or assets or other strategic alternatives, to seek partners for taribavirin and retigabine and to make selective acquisitions.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

In December 2007, we signed an agreement with Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”) to sell to Invida certain Valeant subsidiaries and product rights in Asia in a transaction 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 certain product rights in Japan. We closed this transaction on March 3, 2008. The assets sold to Invida were classified as “held for sale” as of December 31, 2007 in accordance with SFAS 144. During the three months ended March 31, 2008, we received initial proceeds of $37,855,000 and recorded a gain of $36,922,000 in this transaction. During the three months ended June 30, 2008 we recorded $257,000 of additional closing costs and $760,000 of net asset adjustments resulting in a reduced gain of $35,905,000 on the transaction. We expect to receive additional proceeds in 2008 of approximately $4,825,000 subject to net asset settlement provisions in the agreement.

 

As of March 31, 2008, we classified our subsidiaries in Argentina and Uruguay as “held for sale” in accordance with SFAS 144. In the three months ended March 31, 2008, we recorded an impairment charge of $7,852,000 related to this anticipated sale. We sold these subsidiaries on June 5, 2008 and recorded a loss on the sale of $2,926,000.

 

The net restructuring, asset impairments and dispositions charge of $17,583,000 in the three months ended June 30, 2008 included the $257,000 of additional closing costs and $760,000 of net asset adjustments recorded as reductions of the gain originally recorded in the three months ended March 31, 2008 in the Invida transaction, $6,497,000 of severance charges for a total of 134 affected employees, professional service fees and other cash costs of $6,649,000, a $494,000 impairment charge related to certain fixed assets in Mexico and the $2,926,000 loss on the sale of our subsidiaries in Argentina and Uruguay. The net restructuring, asset impairments and dispositions charge of $4,919,000 in the six months ended June 30, 2008 included $13,239,000 of employee severance costs for a total of 151 affected employees who were part of the supply, selling, general and administrative and research and development workforce in the United States, Mexico, Brazil and Europe, professional service fees and other cash costs of $11,535,000, a stock compensation charge for the accelerated vesting of the stock options of our former chief executive officer of $4,778,000, impairment charges relating to the sale of our subsidiaries in Argentina and Uruguay and certain fixed assets in Mexico of $8,346,000, and the loss of $2,926,000 in the sale of our subsidiaries in Argentina and Uruguay, offset in part by the gain of $35,905,000 in the transaction with Invida.

 

The $17,583,000 restructuring charges for the three months ended June 30, 2008 represent charges of $21,790,000 and $733,000 in the Corporate division and the EMEA segment, respectively, offset by the gain of $4,940,000 in the International segment. The $4,919,000 restructuring charges for the six months ended June 30, 2008 represent charges of $26,017,000 and $2,213,000 in the Corporate division and the International segment, respectively, offset in part by gains of $11,807,000 and $11,504,000 in the North America and EMEA segments, respectively. The gains relate to the ownership of assets sold in the transaction with Invida.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes the restructuring costs recorded in the three and six months ended June 30, 2008 (in thousands):

 

 

In the three and six months ended June 30, 2008, we recorded inventory obsolescence charges of $15,029,000 and $22,351,000, resulting primarily from decisions to cease promotion or discontinue certain products, discontinue certain manufacturing transfers, and product quality failures. These inventory obsolescence charges were recorded in costs of goods sold, in accordance with EITF 96-9, Classification of Inventory Markdowns and Other Costs Associated with a Restructuring.

 

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 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 restructuring program 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 2b 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 $36,758,000.

 

In the three and six months ended June 30, 2007, we recorded charges of $6,337,000 and $13,575,000 related to the 2006 Restructuring, respectively. Severance charges recorded in the three and six months ended June 30, 2007 for employees whose positions were eliminated in the restructuring totaled $1,350,000 and $5,130,000, respectively.

 

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.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

The following table summarizes the restructuring costs recorded in the three and six months ended June 30, 2007 (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. The $3,432,000 restructuring accrual for the 2006 Restructuring, accrued as of June 30, 2008, relates to ongoing contractual payments to Legacy Pharmaceuticals International relating to the sale of our former sites in Basel, Switzerland and Puerto Rico. These payment obligations last until June 30, 2009. The $12,513,000 restructuring accrual for the 2008 Restructuring, accrued as of June 30, 2008, relates to severance, professional service fees and other obligations and is expected to be paid primarily during the remainder of 2008. A summary of accruals and expenditures of restructuring costs which will be paid in cash is as follows (in thousands):

 

 

 

We adopted SFAS 157 as of January 1, 2008, with the exception of the application of the statement to nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis including those measured at fair value in goodwill impairment testing, indefinite-lived intangible assets measured at fair value for impairment testing and those initially measured at fair value in a business combination. We are currently assessing the impact SFAS 157 will have on such nonfinancial assets and liabilities.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows.

 

Level 1 — Quoted market prices in active markets for identical assets or liabilities.

 

Level 2 — Inputs, other than quoted prices in active markets, that are observable, either directly or indirectly.

 

Level 3 — Unobservable inputs that are not corroborated by market data.

 

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of June 30, 2008 (in thousands):

 

 

Available for sale securities are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy. Derivative contracts used as hedges are valued based on observable inputs such as changes in interest rates and currency fluctuations and are classified within Level 2 of the valuation hierarchy.

 

For a derivative instrument in an asset position, we analyze the credit standing of the counterparty and factor it into the fair value measurement. SFAS 157 states that the fair value measurement of a liability must reflect the nonperformance risk of the reporting entity. Therefore, the impact of our creditworthiness has also been factored into the fair value measurement of the derivative instruments in a liability position.

 

 

In the three months ended June 30, 2008, we acquired product rights in Poland and Germany for $1,050,000 in cash and $405,000 in other consideration. In the six months ended June 30, 2008, we acquired product rights in Poland and Germany for $1,554,000 in cash and $812,000 in other consideration.

 

In the six months ended June 30, 2007, we acquired product rights in the United States, Europe, and Argentina for aggregate consideration of $39,510,000. In the six months ended June 30, 2007, (i) in the United States we acquired a paid-up license to Kinetin and Zeatin, the active ingredients of Kinerase, for cash consideration of $21,000,000 and other consideration of $4,170,000; (ii) in Europe we acquired the rights to Nabilone, the product we currently market as Cesamet in Canada and in the U.S., for $13,396,000; and (iii) we acquired the rights to certain products in Poland and Argentina for $944,000.

 

 

In September 2007, we decided to divest our Infergen product rights. The results of the Infergen operations and the related financial position have been reflected as discontinued operations in the consolidated financial statements in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS 144”). The consolidated financial statements have been reclassified to conform to discontinued operations presentation for all historical periods presented.

 

We sold these Infergen rights to Three Rivers Pharmaceuticals, LLC on January 14, 2008. We received $70,800,000 as the initial payment for our Infergen product rights, with additional payments due of up to $20,500,000. We recorded a net gain in this transaction of $27,536,000 after deducting the carrying value of the net assets sold from the proceeds received.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

In the three and six months ended June 30, 2008 and 2007, the results from discontinued operations primarily related to Infergen and the release of an environmental reserve in our discontinued biomedicals business. The $682,000 credit to general and administrative expense in the three and six months ended June 30, 2008 relates to an insurance recovery for damaged Infergen inventory. The loss on disposal of discontinued operations in 2007 primarily related to a legal judgment with respect to the discontinued biomedical business.

 

Summarized selected financial information for discontinued operations for the three and six months ended June 30, 2008 and 2007, respectively, is as follows (in thousands):

 

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

The assets and liabilities of discontinued operations are stated separately as of June 30, 2008 and December 31, 2007 on the accompanying consolidated condensed balance sheets. The major assets and liabilities categories are as follows (in thousands):

 

 

The assets held for sale and assets of discontinued operations as of December 31, 2007 had a total value of $66,247,000, which included the assets of discontinued operations of $60,449,000 detailed above and other assets held for sale, which consisted of the assets sold to Invida on March 3, 2008. The liabilities held for sale and liabilities of discontinued operations as of December 31, 2007 had a total value of $4,194,000, which included the liabilities of discontinued operations of $1,897,000 detailed above and other liabilities held for sale, which consisted of the liabilities sold to Invida on March 3, 2008.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

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

 

 

For the three months and six months ended June 30, 2008, options to purchase 829,000 and 652,000 weighted average shares of common stock, respectively, were not included in the computation of earnings per share because we incurred a loss and the effect would have been anti-dilutive. For the three months ended June 30, 2008 and 2007, options to purchase 7,590,000 and 9,202,000 weighted average shares of common stock, respectively, were also not included in the computation of earnings per share because the option exercise prices were greater than the average market price of our common stock and, therefore, the effect would have been anti-dilutive. For the six months ended June 30, 2008 and 2007, options to purchase 8,553,000 and 9,269,000 weighted average shares of common stock, respectively, were also not included in the computation of earnings per share because the option exercise prices were greater than the average market price of our common stock and, therefore, the effect would have been anti-dilutive.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

The following tables present the details of certain amounts included in the consolidated balance sheet at June 30, 2008 and December 31, 2007 (in thousands):

 

 

The increase in other receivables includes receivables of $7,000,000 and $4,825,000 related to the transactions with Three Rivers Pharmaceuticals, LLC and Invida, respectively.

 

Other assets totaled $42,223,000 as of June 30, 2008, an increase of $6,880,000 from $35,343,000, reported as of December 31, 2007. This increase primarily related to the $11,222,000 note receivable from Three Rivers Pharmaceuticals, LLC, offset in part by a reduction of $1,550,000 in the value of an investment in a publicly traded investment fund and a reduction of $1,262,000 in deferred loan costs. In the three months ended June 30, 2008, we recognized an other-than-temporary impairment loss of $3,233,000 in an investment in a publicly traded investment fund.

 

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Intangible assets:  As of June 30, 2008 and December 31, 2007, intangible assets were as follows (in thousands, except life data):

 

 

Estimated future amortization expenses are as follows (in thousands):

 

 

Amortization expense for the three and six months ended June 30, 2008 was $18,112,000 and $36,178,000, respectively, of which $15,749,000 and $31,451,000, respectively, related to amortization of acquired product rights.

 

 

We incur losses in the United States, where our research and development activities are conducted and our corporate offices are located. We anticipate that we will realize the tax benefits associated with these losses by offsetting such losses against future taxable income resulting from products in our development pipeline, further growth in U.S. product sales, dividends paid by our foreign subsidiaries, the sale of our foreign subsidiaries or assets, and other measures. However, at this time there is insufficient objective evidence of the timing and amounts of such future U.S. taxable income to assure realization of the tax benefits, and valuation allowances have been established to reserve these benefits.

 

During the three months ended June 30, 2008, the company reversed its position that all unremitted earnings of its foreign subsidiaries would be indefinitely reinvested and is now required to provide U.S. tax on these earnings. As of June 30, 2008, a deferred tax liability of $97,075,000 was established to provide tax on these earnings which includes $12,693,000 of withholding tax that will be due upon repatriation. Setting up the deferred tax liability has allowed the company to benefit its 2008 U.S. losses and release $67,256,000 of its U.S. valuation allowance which includes the recognition of $19,876,000 of U.S. uncertain tax benefits which were settled as of June 30, 2008. The release of valuation allowance also includes $12,328,000 and $7,209,000 in benefits that were credited to additional

 

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

paid-in capital and goodwill, respectively. As of June 30, 2008, there is insufficient objective evidence as to the timing and amount of future US taxable income to allow for the release of the remaining U.S. valuation allowance which is primarily offsetting future benefits of foreign tax credits. The valuation allowance was recorded because it is more likely than not that such benefits could not be utilized. Ultimate realization of these tax benefits is dependent upon generating sufficient taxable income in the U.S. Based on Valeant’s historic losses, the Company could not demonstrate that it would utilize these tax benefits with sufficient objective evidence.

 

Our effective tax rate for the six months ended June 30, 2008 was affected by deferred taxes provided on unrepatriated foreign earnings, net of the benefit of releasing a portion of the U.S. valuation allowance, pre-tax losses resulting from the sale of our Argentina subsidiaries of $9,602,000 for which we do not expect to realize income tax benefits, and pre-tax income resulting from restructuring associated with the sale of assets in Asia of $8,962,000 which we do not expect to be subject to tax in certain jurisdictions. A provision for income taxes of $46,850,000 was recorded for the three months ended June 30, 2008, comprising the following amounts:

 

 

Due to ownership changes in the stock of the company, the benefit of U.S. losses are subject to a yearly limitation. However, the limitation is sufficient to allow for utilization of all losses through the reversal of taxable temporary differences.

 

During the quarter ended March 31, 2008, we recorded a net pre-tax gain from discontinued operations from the sale of our Infergen product line in the U.S. This gain was considered in determining the amount of income tax benefit to be allocated to current year losses from continuing operations in the U.S. As a result, we recorded income tax expense of $6,498,000 in discontinued operations for the six months ended June 30, 2008 and this same amount will be recorded as an income tax benefit in continuing operations for the full year 2008. Of this amount, $4,345,000 was included in the provision for income taxes in continuing operations for the six months ended June 30, 2008 based on an allocation of the full year impact to the six months ended June 30, 2008.

 

At June 30, 2008 we had $100,235,000 of unrecognized tax benefits (FIN 48), of which $5,793,000 would reduce our effective tax rate, if recognized. Of the total unrecognized tax benefits, $24,256,000 was recorded as an offset against a valuation allowance. To the extent such portion of unrecognized tax benefits is recognized at a time when a valuation allowance no longer exists, the recognition would affect our tax rate. Based on current discussions with the IRS, we believe it is reasonably possible that $40,649,000 of unrecognized tax benefits will be reversed within the next twelve months.

 

Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense. As of June 30, 2008, we had recorded $7,241,000 for interest and $2,184,000 for penalties. We accrued an additional $102,000 of interest during the quarter ended June 30, 2008.

 

We are currently under audit by the IRS for the 2005 and 2006 tax years. We are appealing adjustments that were proposed during the audit of the 2002 through 2004 tax years in the U.S. In the second quarter of 2007, the IRS examination of the U.S. income tax returns for the years ended December 31, 1997 through 2001 was resolved. All years prior to 1997 are closed under the statute of limitations in the U.S. Our significant subsidiaries are open to tax examinations for years ending in 2001 and later.

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

In June 2007, our board of directors authorized a stock repurchase program. This program authorized us to repurchase up to $200 million of our outstanding common stock in a 24-month period. In June 2008, our board of directors increased the authorization to $300 million, over the original 24-month period. Under the program, purchases may be made from time to time on the open market, in privately negotiated transactions, and in amounts as we see appropriate. The number of shares 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 requirements, and alternate investment opportunities. The share repurchase program may be modified or discontinued at any time. In the three months ended June 30, 2008, we purchased 411,989 shares, for a total amount of $6,819,000. In total, we have used $106,377,000 to repurchase 6,902,679 shares as of June 30, 2008.

 

We apply SFAS 123(R), Share-Based Payment which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, based on estimated fair values. We estimate the fair value of employee stock options on the date of grant using the Black-Scholes model. The determination of the fair value of share-based payments on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables.

 

The variables used in our share-based compensation expense calculations include our estimation of the forfeiture rate related to share-based payments. In 2006, 2007 and continuing into 2008, we experienced significant turnover at both the executive and management levels, which affected our actual forfeiture rate. We increased the estimated forfeiture rate in the three months ended December 31, 2007 from 5% to 35%. As described in Note 1, during the second quarter of 2008, we recorded a correction to adjust our historical estimated forfeiture rate for actual forfeitures which took place in 2006, 2007 and the first quarter of 2008. The correction recorded in the second quarter resulted in a $3,870,000 decrease in stock compensation expense comprising a $778,000 reduction in cost of goods sold, a $1,068,000 reduction in selling expenses, a $1,231,000 reduction in research and development expenses and a $793,000 reduction in general and administrative expenses.

 

Also during the second quarter of 2008, we recognized a change in estimate related to our estimated forfeiture rate for share-based payments of $3,048,000 for forfeitures which occurred in the three months ended June 30, 2008. This change in estimate related to forfeitures which occurred in the three months ended June 30, 2008 comprised a $214,000 reduction in cost of goods sold, an $802,000 reduction in selling expenses, a $53,000 reduction in research and development expenses and a $1,979,000 reduction in general and administrative expenses.

 

A summary of stock compensation expense for our stock incentive plans is presented below (in thousands):

 

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Future stock compensation expense for restricted stock units and stock option incentive awards outstanding at June 30, 2008 is as follows (in thousands):

 

 

 

We are involved in several legal proceedings, including the following matters (Valeant was formerly known as ICN Pharmaceuticals, Inc.):

 

Securities Class Actions:

 

SEC Investigation:  We are the subject of a Formal Order of Investigation with respect to events and circumstances surrounding trading in our common stock, the public release of data from our first pivotal Phase III trial for taribavirin, statements made in connection with the public release of data and matters regarding our stock option grants since January 1, 2000 and our restatement of certain historical financial statements announced in March 2008. In September 2006, our board of directors established a Special Committee to review our historical stock option practices and related accounting, and informed the SEC of these efforts. We have cooperated fully and will continue to cooperate with the SEC in its investigation. We cannot predict the outcome of the investigation.

 

Derivative Actions Related to Stock Options:  We are a nominal defendant in two shareholder derivative lawsuits pending in state court in Orange County, California, styled (i) Michael Pronko v. Timothy C. Tyson et al., and (ii) Kenneth Lawson v. Timothy C. Tyson et al. These lawsuits, which were filed on October 27, 2006 and November 16, 2006, respectively, purport to assert derivative claims on our behalf against certain of our current and/or former officers and directors. The lawsuits assert claims for breach of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment, and violations of the California Corporations Code related to the purported backdating of employee stock options. The plaintiffs seek, among other things, damages, an accounting, the rescission of stock options, and a constructive trust over amounts acquired by the defendants who have exercised Valeant stock options. On January 16, 2007, the court issued an order consolidating the two cases before Judge Ronald L. Bauer. On February 6, 2007, the court issued a further order abating the Lawson action due to a procedural defect while the Pronko action proceeds to conclusion. On July 10, 2008, the parties in the Pronko action reached an agreement in principle to settle the plaintiff’s claims. The agreement, which is intended to resolve the claims raised in the Pronko and Lawson actions, requires us to adopt certain corporate governance reforms aimed at improving our process for granting stock options. It also provides for an award of fees to counsel for the plaintiffs of $1,300,000, which amount is covered by insurance and remains subject to court approval.

 

We are also a nominal defendant in a shareholder derivative action pending in the Court of Chancery of the state of Delaware, styled Sherwood v. Tyson, et. al., filed on March 20, 2007. This complaint also purports to assert derivative claims on the Company’s behalf for breach of fiduciary duties, gross mismanagement and waste, constructive fraud and unjust enrichment related to the alleged backdating of employee stock options. The plaintiff seeks, among other things, damages, an accounting, disgorgement, rescission and/or repricing of stock options, and imposition of a constructive trust for the benefit of the Company on amounts by which the defendants were unjustly enriched. The plaintiff has agreed to a stay pending resolution of the Pronko action in California.

 

Argentina Antitrust Matter:  In July 2004, we were advised that the Argentine Antitrust Agency had issued a notice unfavorable to us in a proceeding against our Argentine subsidiary. The proceeding involves allegations that the subsidiary in Argentina abused a dominant market position in 1999 by increasing its price on Mestinon in Argentina and not supplying the market for approximately two months. The subsidiary filed documents with the

 

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

agency offering an explanation justifying its actions, but the agency has now rejected the explanation. The agency is collecting evidence prior to issuing a new decision. Argentinean law permits a fine to be levied of up to $5,000,000 plus 20% of profits realized due to the alleged wrongful conduct. Based upon the size of the transactions alleged to have violated the law, we do not expect this matter to draw the maximum penalty. On June 5, 2008, we sold our Argentine subsidiary. The former Argentine subsidiary, as transferred to the buyer, retains any liability associated with this claim.

 

Permax Product Liability Cases:  On February 8, 2007, we were served a complaint in a case captioned Kathleen M. O’Connor v. Eli Lilly & Company, Valeant Pharmaceuticals International, Amarin Corporation plc, Amarin Pharmaceuticals, Inc., Elan Pharmaceuticals, Inc., and Athena Neurosciences, Inc., Case No. 07 L 47 in the Circuit Court of the 17th Judicial Circuit, Winnebago County, Illinois. This case, which has been removed to federal court in the Northern District of Illinois, alleges that the use of Permax for restless leg syndrome caused the plaintiff to have valvular heart disease, and as a result, she suffered damages, including extensive pain and suffering, emotional distress and mental anguish. On August 6, 2008, the court granted Valeant’s motion for summary judgment on all claims, finding that plaintiff did not use Permax after February 25, 2004, when Valeant acquired the right to market and sell Permax in the United States. We expect Valeant to be dismissed with prejudice shortly. However, Valeant’s acquired subsidiary Amarin Pharmaceuticals Inc. remains a defendant in this case. On April 23, 2008, we were served a complaint in a case captioned Barbara M. Shows v. Eli Lilly and Company, Elan Corporation, PLC, Amarin Corporation, PLC, and Valeant Pharmaceuticals International, Case No. 2008-24P in the Circuit Court of Jefferson Davis County, Mississippi. We are in the process of defending this matter. Eli Lilly, holder of the right granted by the FDA to market and sell Permax in the United States, which right was licensed to Amarin and the source of the manufactured product, has also been named in the suits. Under an agreement between Valeant and Eli Lilly, Eli Lilly will bear a portion of the liability, if any, associated with these claims. Product liability insurance exists with respect to these claims. Although it is expected that the insurance proceeds will be sufficient to cover any material liability which might arise from these claims, there can be no assurance that defending against any future similar claims and any resulting settlements or judgments will not, individually or in the aggregate, have a material adverse effect on our consolidated financial position, results of operation or liquidity.

 

Alfa Wasserman:  On December 29, 2005, Alfa Wassermann (“Alfa”) filed suit against our Spanish subsidiary in the Commercial Court of Barcelona, Spain, alleging that our Calcitonina Hubber Nasal 200 UI Monodosis product infringes Alfa’s European patent EP 363.876 (ES 2.053.905) and demanded that we cease selling our product in the Spanish market and pay damages for lost profits caused by competition in the amount of approximately 9 million Euros. We filed a successful counter-claim; however, Alfa filed an appeal. The Court of Appeals held a hearing in February 2008 and on July 14, 2008 ruled that we infringed Alfa’s patent. Pursuant to the ruling, we would be required to: (i) cease manufacturing and selling certain Calcitonina products, (ii) withdraw such products from the market, (iii) pay Alfa’s legal costs and (iv) pay damages suffered by Alfa between January 1, 2001 through the date that the applicable products are withdrawn from the market. The specific amount of damages to be paid would be determined in separate enforcement proceedings. We have filed a writ to the Court of Appeals announcing our intention to appeal to the Supreme Court. In late July 2008, the parties agreed in principle to settle the matter and are in the process of finalizing formal settlement documents. In settlement of Alfa’s alleged claims, we agreed to pay Alfa $11,029,000 and a 10% royalty on future product sales until the expiration of Alfa’s patent in 2009.

 

Spear Pharmaceuticals, Inc.:  On December 17, 2007, Spear Pharmaceuticals, Inc. and Spear Dermatology Products, Inc. filed a complaint in federal court for the District of Delaware, Case No. 07-821, against Valeant and investment firm William Blair & Company, LLC. Plaintiffs allege that while William Blair was engaged in connection with the possible sale of plaintiffs’ generic tretinoin business, plaintiffs disclosed to William Blair the development of generic Efudex in their product pipeline. Plaintiffs further allege that William Blair, while under confidentiality obligations to plaintiffs, shared such information with Valeant and that Valeant then filed a Citizen Petition with the FDA requesting that any abbreviated new drug application for generic Efudex include a study on superficial basal cell carcinoma. Arguing that Valeant’s Citizen Petition caused the FDA to delay approval of their

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

generic Efudex, plaintiffs seek damages for Valeant’s alleged breach of contract, trade secret misappropriation and unjust enrichment, in addition to other causes of action against William Blair. We believe this case is without merit and are vigorously defending ourselves in this matter.

 

On April 11, 2008, the Food and Drug Administration (FDA) approved an Abbreviated New Drug Application (“ANDA”) for a 5% fluorouracil cream sponsored by Spear Pharmaceuticals. On April 11, 2008, the FDA also responded to our Citizen Petition that was filed on December 21, 2004 and denied our request that the FDA refrain from approving any ANDA for a generic version of Efudex unless the application contains data from an adequately designed comparative clinical study conducted in patients with superficial basal cell carcinoma. On April 25, 2008, Valeant filed an application for a temporary restraining order (TRO) against Michael O. Leavitt and Andrew C. Von Eschenbach, in their official capacities at the FDA, in the United States District Court seeking to suspend the FDA’s approval of Spear’s ANDA. On May 1, 2008, the Court granted the FDA’s request to stay proceedings on Valeant’s application for a TRO until May 14, 2008. On May 14, 2008, the FDA entered an administrative order staying the approval of the Spear ANDA and initiating a process for reconsidering the approval of the Spear ANDA. Spear Pharmaceuticals agreed to the stay and to the prohibition on marketing, sale and shipment of its product until May 30, 2008. On May 31, 2008, the Court granted our application for a TRO suspending approval of the Spear ANDA. On June 18, 2008 the Court denied our request for a preliminary injunction to continue the suspension of the Spear ANDA and extinguished the TRO. The stay on the Spear ANDA has been removed and the Spear product may be marketed, sold and shipped. Our case against Messrs. Leavitt and Von Eschenbach remains pending before the court.

 

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

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

The following table sets forth the amounts of our segment revenues and operating income for the three and six months ended June 30, 2008 and 2007 (in thousands):

 

 

 

 

VALEANT PHARMACEUTICALS INTERNATIONAL

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

The following table sets forth our total assets by segment as of June 30, 2008 and December 31, 2007 (in thousands):