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 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, 2008, 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 $1,531,002,000.

 

The number of outstanding shares of the Registrant’s common stock as of February 25, 2009 was 82,178,547.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information contained in Valeant Pharmaceuticals International’s definitive Proxy Statement for the 2009 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 report 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, Atralin, Bedoyecta, Bisocard, CeraVe, Cloderm, Diastat, Diastat AcuDial, Efudex/Efudix, Kinerase, Librax, Mestinon, Migranal, M.V.I., Nyal, Virazole and Zelapar 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 Form 10-K, we are referring to Valeant Pharmaceuticals International 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

 

In March 2008, we announced a new company-wide restructuring effort and new strategic initiatives (the “2008 Strategic Plan”). The restructuring was 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.

 

We have built our current business infrastructure by executing our multi-faceted strategy: 1) focus the business on core geographies and therapeutic classes, 2) maximize pipeline assets through strategic partnerships with other pharmaceutical companies, and 3) deploy cash with an appropriate mix of debt repurchases, share buybacks and selective acquisitions. We believe our multi-faceted strategy will allow us to expand our product offerings and upgrade our product portfolio with higher growth, higher margin assets.

 

Prior to the start of the 2008 Strategic Plan, we reviewed our portfolio for products and geographies that did not meet our growth and profitability expectations and, as a result, divested or discontinued certain non-strategic products. In September 2007, we decided to sell our rights to Infergen. We sold these rights to Three Rivers

Pharmaceuticals, LLC in January 2008. In 2007, we also sold product rights to Reptilase and Solcoseryl in Japan, our ophthalmic business in the Netherlands, and certain other products.

 

In March 2008, we sold certain assets in Asia to Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”) 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 certain product rights in Japan. The assets sold to Invida were classified as “held for sale” as of December 31, 2007 in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS 144”).

 

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 AB, an international specialty pharmaceutical company located in Stockholm, Sweden (“Meda”).

 

As a result of these dispositions, the following information has been adjusted to exclude the operations of Infergen and of the WEEMEA business. The results of these operations have also been classified as discontinued operations in our consolidated financial statements for all periods presented in this report.

 

In October 2008, we completed a worldwide License and Collaboration Agreement (“the Collaboration Agreement”) with Glaxo Group Limited, a wholly owned subsidiary of GlaxoSmithKline plc, (“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.

 

In October 2008, we acquired Coria Laboratories Ltd. (“Coria”), a privately-held specialty pharmaceutical company focused on dermatology products in the United States. In November 2008, we acquired DermaTech Pty Ltd (“DermaTech”), an Australian specialty pharmaceutical company focused on dermatology products marketed in Australia. 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.

 

Segment Information

 

In connection with the 2008 Strategic Plan and resulting acquisitions and dispositions, we realigned our organization in the fourth quarter of 2008 in order to improve our execution and align our resources and product development efforts in the markets in which we operate. We have realigned segment financial data for the years ended December 31, 2007 and 2006 to reflect changes in our organizational structure that occurred in 2008.

 

Our products are sold through three segments comprising Specialty Pharmaceuticals, Branded Generics — Europe and Branded Generics — Latin America. The Specialty Pharmaceuticals segment includes product revenues primarily from the United States, Canada, Australia and divested businesses located in Argentina, Uruguay and Asia. The Branded Generics — Europe segment includes product revenues from branded generic pharmaceutical products primarily in Poland, Hungary, the Czech Republic and Slovakia. The Branded Generics — Latin America segment includes product revenues from branded generic pharmaceutical products primarily in Mexico and Brazil.

 

Additionally, we generate alliance revenue, including royalties from the sale of ribavirin by Schering-Plough Ltd. (“Schering-Plough”) and revenues associated with the Collaboration Agreement with GSK. Effective January 1, 2009, we will also generate alliance and services revenue from the development of dermatological products resulting from the acquisition of Dow.

 

For information regarding the revenues, operating profits and identifiable assets attributable to our operating segments, see Note 16 of notes to consolidated financial statements in Item 8 of this annual report on Form 10-K.

Pharmaceutical Products

 

Our current product portfolio comprises approximately 389 products, with approximately 982 stock keeping units. The following table summarizes sales by major branded product for each of the last three years (dollar amounts in thousands):

 

 

 

 

Alliance Revenue and Service Revenue

 

Our royalties have historically been 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. 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 $59.4 million, $67.2 million and $81.2 million for the years ended December 31, 2008, 2007 and 2006, respectively, and accounted for 9%, 10% and 12% of our total revenues in 2008, 2007 and 2006, respectively. Royalty revenues in 2008, 2007 and 2006 were substantially lower than those in prior years. This decrease had been 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 driven by the launch of combination therapy and 4) further market share gains by generic competitors in the United States since they entered the market in April 2004.

 

We expect ribavirin royalties to decline significantly in 2009 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. We expect that royalties from Schering-Plough in Japan will continue after 2009.

 

Beginning in January 2009, we will receive royalties from patent protected formulations developed by Dow and licensed to third parties. In 2008, Dow had royalties of approximately $20.0 million.

 

Beginning in January 2009, we will 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. In 2008, Dow had revenue from contract research services of approximately $25.0 million.

 

Business Acquisitions

 

In December 2008, we acquired Dow for an agreed price of $285.0 million, subject to certain closing adjustments. We paid $242.5 million in cash, net of cash acquired, and incurred transaction costs of $5.4 million. We paid $5.6 million in January 2009. We have remaining payment obligations of $36.0 million, $35.0 million of which we will pay by June 30, 2009 into an escrow account for the benefit of the Dow common stockholders, subject

to any indemnification claims made by us for a period of eighteen months following the acquisition closing. We have granted a security interest to the Dow common stockholders in certain royalties to be paid to us until we satisfy our obligation to fund the $35.0 million escrow account. The accounting treatment for the acquisition requires the recognition of an additional $95.9 million of conditional purchase consideration because the fair value of the net assets acquired exceeded the total amount of the acquisition price. Contingent consideration of up to $235.0 million may be incurred for future milestones related to certain pipeline products still in development. Over 85% of this contingent consideration is dependent upon the achievement of approval and commercial targets. Future contingent consideration paid in excess of the $95.9 million will be treated as an additional cost of the acquisition and result in the recognition of goodwill.

 

In November 2008, we acquired DermaTech for aggregate cash consideration of $15.5 million, including transaction costs and working capital adjustments.

 

In October 2008, we acquired Coria 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.

 

Collaboration Agreement

 

In October 2008, we closed a worldwide License and Collaboration Agreement (the “Collaboration Agreement”) with Glaxo Group Limited, a wholly owned subsidiary of GlaxoSmithKline plc (“GSK”), to collaborate 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.

 

Pursuant to the terms of the Collaboration Agreement, we granted co-development rights and worldwide commercialization rights to GSK. We agreed to collaborate with GSK on the development and marketing of retigabine in the United States, Australia, New Zealand, Canada and Puerto Rico (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 paid us $125.0 million in upfront fees pursuant to the Collaboration Agreement. In addition, GSK has agreed to pay us up to $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. We will share up to 50% of net profits within the United States, Australia, New Zealand, Canada and Puerto Rico, and will receive up to a 20% royalty on net sales of retigabine outside those regions. 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.

 

We will jointly fund research and development and pre-commercialization expenses for retigabine with GSK in 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 payments owed to us under the Collaboration Agreement. GSK will solely fund the development of any backup compound and will be responsible for all expenses outside of the Collaboration Territory. Following the launch of a retigabine product, we will share operating expenses equally with respect to retigabine in the Collaboration Territory. We expect to complete our research and development and pre-commercialization obligations by mid to late 2010.

 

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 the expiration of the Review Period, we would be required to refund to GSK up to $90.0 million of the upfront fee; however, the refundable portion will decline over the time the Collaboration Agreement is in effect. 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 March 31, 2010, with additional reductions over the time the Collaboration Agreement is in effect. 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.

 

Our rights to retigabine are subject to an Asset Purchase Agreement between Meda Pharma GmbH & Co. KG (“Meda Pharma”), the successor to Viatris GmbH & Co. KG, and Xcel Pharmaceuticals, Inc., which was acquired by Valeant in 2005 (the “Meda Pharma Agreement”). Under the terms of the Meda Pharma Agreement, we are required to pay Meda Pharma milestone payments of $8.0 million upon acceptance of the filing of an NDA and $6.0 million upon approval of the NDA for retigabine. We are also required to pay royalty rates which, depending on the geographic market and sales levels, vary from 3% to 8% of net sales. Under the Collaboration Agreement with GSK, these royalties will be treated in the Collaboration Territory as an operating expense and shared by GSK and the Company pursuant to the profit sharing percentage then in effect. 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. We are required to make additional milestone payments to Meda Pharma of up to $5.3 million depending on certain licensing activity. As a result of entering into the Collaboration Agreement with GSK, we paid Meda Pharma a milestone payment of $3.8 million in October 2008. An additional payment of $1.5 million could become due if a certain indication for retigabine is developed and licensed to GSK.

 

During the three months ended December 31, 2008, the combined research and development expenses and pre-commercialization expenses incurred under the Collaboration Agreement by us and GSK were $13.1 million as outlined in the table below. We recorded a credit of $4.1 million against our share of the expenses to equalize our expenses with GSK.

 

The table below outlines the alliance revenue, expenses incurred, associated credits against the expenses incurred, and the remaining upfront payment for the Collaboration Agreement during the following period:

 

 

Research and Development

 

Our research and development organization focuses on the development of products through clinical trials. We currently have two compounds in late-stage clinical development, retigabine and taribavirin, as well as several other product candidates in development that were acquired as part of our Dow acquisition.

 

Our research and development expenses for the years ended December 31, 2008, 2007 and 2006 were $87.0 million, $98.0 million and $105.4 million, respectively. The reduction in research and development expenses in 2008 compared with 2007 is primarily due to the offset of expenses attributable to the Collaboration Agreement with GSK. The reduction in research and development expenses in 2007 compared with 2006 is primarily due to the discontinuation of our discovery operations and the sale of the pradefovir rights to Schering-Plough, partly offset by the increase in clinical development expense for retigabine.

 

As of December 31, 2008, there were 171 employees 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. The results of the key Phase II study indicated that the compound is potentially efficacious with a demonstrated statistically significant reduction in monthly seizure rates of 23% to 35% as adjunctive therapy in patients with partial seizures.

 

Following a Special Protocol Assessment by the FDA, two Phase III trials of retigabine were initiated in 2005. One Phase III trial (“RESTORE 1”; RESTORE stands for Retigabine Efficacy and Safety Trial for partial Onset Epilepsy) was conducted at approximately 50 sites, mainly in the Americas (United States, Central/South America); the second Phase III trial (“RESTORE 2”) was conducted at approximately 70 sites, mainly in Europe.

 

We announced clinical data results for RESTORE 1 on February 12, 2008. RESTORE 1 evaluated the 1200 mg daily dose of retigabine (the highest dose in the RESTORE program) versus placebo in patients taking stable doses

of one to three additional anti-epileptic drugs (“AEDs”). Retigabine demonstrated statistically significant (p< 0.001) results on the primary efficacy endpoints important for regulatory review by both the FDA and the European Medicines Evaluation Agency (“EMEA”).

 

The intent-to-treat (“ITT”) median reduction in 28-day total partial seizure frequency from baseline to the end of the double-blind period (the FDA primary efficacy endpoint), was 44.3% (n=153) and 17.5% (n=152) for the retigabine arm and placebo arm of the trial, respectively. The responder rate, defined as > 50% reduction in 28-day total partial seizure frequency compared with the baseline period, during maintenance (the dual primary efficacy endpoint required for the EMEA submission) was 55.5% (n=119) and 22.6% (n=137) for the retigabine arm and the placebo arm of the trial, respectively.

 

During RESTORE 1, 26.8% of patients in the retigabine arm and 8.6% of patients in the placebo arm withdrew due to adverse events. The most common side effects associated with retigabine in RESTORE 1 included dizziness, somnolence, fatigue, confusion, dysarthria (slurring of speech), ataxia (loss of muscle coordination), blurred vision, tremor, and nausea. Results of the study were presented at the 8th European Congress on Epileptology, Berlin, Germany in September 2008.

 

On May 13, 2008, we announced clinical data results for RESTORE 2. RESTORE 2 evaluated the 600 and 900 mg daily doses of retigabine versus placebo in patients taking stable doses of one to three additional AEDs. Retigabine at both the 600 mg and 900 mg doses demonstrated highly statistically significant results on the primary efficacy endpoints important for regulatory review by both the FDA and the EMEA.

 

The ITT median reduction in 28-day total partial seizure frequency from baseline to the end of the double-blind period (the FDA primary efficacy endpoint), was 15.9% (n=179), 27.9% (n=181) and 39.9% (n=178) for the placebo, retigabine 600 mg and retigabine 900 mg arms of the trial, respectively. The responder rate, defined as > 50% reduction in 28-day total partial seizure frequency compared with the baseline period, during maintenance (the dual primary efficacy endpoint required for the EMEA submission) was 18.9% (n=164), 38.6% (n=158) and 47.0% (n=149) for the placebo, retigabine 600 mg and retigabine 900 mg and placebo arms of the trial, respectively.

 

During RESTORE 2, 14.4% and 25.8% of patients in the retigabine 600 mg and 900 mg arms, respectively, and 7.8% of patients in the placebo arm withdrew due to adverse events. As expected, the most common side effects associated with retigabine in RESTORE 2 included dizziness, somnolence, and fatigue and were generally seen at much lower rates than at the 1200 mg dose in the RESTORE 1 trial. Results of the study were presented at the 62nd American Epilepsy Society annual meeting, Seattle, WA in December 2008.

 

In March 2007, we initiated development of a modified release formulation of retigabine. In addition, in November 2007, we began enrolling patients into a randomized, double-blind, placebo-controlled Phase IIa study to evaluate the efficacy and tolerability of retigabine as a treatment for neuropathic pain resulting from post-herpetic neuralgia. We completed enrollment at the end of 2008.

 

As discussed in more detail in the subsection “Collaboration Agreement” above, in October 2008, we completed a worldwide Collaboration Agreement with GSK for the continued development and pre-commercialization of retigabine and its backup compounds and received $125.0 million in upfront fees from GSK. We will jointly develop and commercialize retigabine in the Collaboration Territory and GSK will develop and commercialize retigabine in the rest of the world. To the extent that our expected development and pre-commercialization expenses under the Collaboration Agreement are less than $100.0 million, the difference will be recognized as alliance revenue over the period prior to the launch of a retigabine product. We expect to complete our development efforts by mid to late 2010.

 

External research and development expenses for retigabine, net of Collaboration Agreement credits in 2008, were $41.8 million and $49.2 million in 2008 and 2007, 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. We are developing taribavirin in oral form for the treatment of hepatitis C.

 

Preclinical studies indicated that taribavirin, a prodrug of ribavirin, has antiviral and immunological activities (properties) similar to ribavirin. In 2006, we reported the results of two pivotal Phase III trials for taribavirin. The Viramidine Safety and Efficacy Versus Ribavirin (“VISER”) trials included two co-primary endpoints: one for safety (superiority to ribavirin in incidence of anemia) and one for efficacy (non-inferiority to ribavirin in sustained viral response (“SVR”)). The results of the VISER trials met the safety endpoint of a reduced incidence of anemia but did not meet the efficacy endpoint.

 

The studies demonstrated that 38-40% of patients treated with taribavirin achieved SVR and that the drug has a safety advantage over ribavirin by significantly reducing the number of subjects who developed anemia, but that it was not comparable to ribavirin in efficacy at the fixed dose of 600 mg which was studied. We believe that the results of the studies were significantly impacted by the dosing methodology which employed a fixed dose of taribavirin for all patients and a variable dose of ribavirin based on a patient’s weight. Our analysis of the study results led us to believe that the dosage of taribavirin, like ribavirin, likely needs to be based on a patient’s weight to achieve efficacy equal or superior to that of ribavirin. Additionally we think that higher doses of taribavirin than those studied in the VISER program may be necessary to achieve our efficacy objectives and to deliver doses of taribavirin derived ribavirin comparable to the doses of ribavirin that are used as standard of care.

 

Based on our analysis, we initiated a Phase IIb study to evaluate the efficacy of taribavirin at 20, 25 and 30 mg/kg in combination with pegylated interferon, compared with ribavirin in combination with pegylated interferon. In the VISER program, taribavirin was administered in a fixed dose of 600 mg BID (approximately equivalent to 13-18 mg/kg).

 

The Phase IIb study is a U.S. multi-center, randomized, parallel, open-label study in 278 treatment naïve, genotype 1 patients evaluating taribavirin at 20 mg/kg, 25 mg/kg, and 30 mg/kg per day in combination with pegylated interferon alfa-2b. The control group is being administered weight-based dosed ribavirin (800/1,000/1,200/1,400 mg daily) and pegylated interferon alfa-2b. Overall treatment duration will be 48 weeks with a post-treatment follow-up period of 24 weeks. The primary endpoints for this study are viral load reduction at treatment week 12 and anemia rates throughout the study.

 

On March 17, 2008, we reported the results of the 12-week analysis of the taribavirin Phase IIb study. The 12-week early viral response (“EVR”) data from the Phase IIb study showed comparable reductions in viral load for weight-based doses of taribavirin and ribavirin. The anemia rate was statistically significantly lower for patients receiving taribavirin in the 20mg/kg and 25mg/kg arms versus the ribavirin control arm. The most common adverse events were fatigue, nausea, flu-like symptoms, headache and diarrhea. The incidence rates among treatment arms were generally comparable except with respect to diarrhea. Diarrhea was approximately twice as common in taribavirin patients as ribavirin patients. However, the diarrhea was not treatment limiting for taribavirin or ribavirin patients.

 

We presented treatment week 24 results from our Phase IIb study evaluating weight-based dosing with taribavirin vs. weight-based ribavirin (both in combination with Peginterferon alfa-2b in naïve, chronic hepatitis C, genotype 1 patients) at the 59th annual American Association for the Study of Liver Disease, San Francisco, CA in November 2008. On November 24, 2008, we published the 48-week end of treatment results in a press release, and these are the subject of a platform presentation at the upcoming European Association for Study of Liver Disease (“EASL”) meeting in Copenhagen in April 2009. These results and the week 60 follow up results continue to demonstrate a consistent and similar viral response rate for both taribavirin and ribavirin at all doses studied, while the beneficial effect of taribavirin on anemia has been maintained throughout the duration of therapy.

 

We are actively seeking potential partners for the taribavirin program. External research and development expenses for taribavirin were $8.5 million and $8.1 million in 2008 and 2007, respectively.

Dermatology Products

 

A number of late stage dermatology product candidates in development were acquired as part of the acquisition of Dow on December 31, 2008. These include, but are not limited to:

 

IDP-107:  IDP-107 is an antibiotic for the treatment of moderate to severe acne vulgaris. Acne is a disorder of the pilosebaceous unit and can be identified by the presence of inflammatory and non-inflammatory lesions, pustules, papules, or pimples. Acne vulgaris is a common skin disorder that affects about 85% of people at some point in their lives. IDP-107 is currently in Phase II studies.

 

IDP-108:  IDP-108 is an antifungal targeted to treat Onychomycosis. It is an investigational topical drug for nail, hair, and skin fungal infections. The mechanism of antifungal activity appears similar to other antifungal triazoles, i.e. ergosterol synthesis inhibition. IDP-108, in a non-lacquer formulation, is currently in Phase II studies.

 

IDP-113:  IDP-113 has the same active pharmaceutical ingredient as IDP-108. IDP-113 is a topical therapy in solution form for the treatment of tinea capitis, which is a fungal infection of the scalp characterized by bald patches. IDP-113 is currently in Phase II studies.

 

IDP-115:  IDP-115 is a product that combines an active ingredient with sunscreen agents providing SPF for the treatment of rosacea. IDP-115 has completed Phase II clinical trials. Rosacea is characterized by erythema that begins on the central face and can spread to the cheeks, nose, and forehead and less commonly affect the neck, chest, ears, and scalp.

 

Other Development Projects

 

Diastat Intranasal:  Our product Diastat AcuDial is a gel formulation of diazepam administered rectally in the management of selected, refractory patients with epilepsy, who require intermittent use of diazepam to control bouts of increased seizure activity. In order to improve the convenience of this product, we had initiated the development of a novel intranasal delivery of diazepam. Our external research and development expenses for Diastat Intranasal were $3.0 million and $1.4 million for 2008 and 2007, respectively. In February 2009, we decided to terminate this development program.

 

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 Abbreviated New Drug Application (“ANDA”), that references the NDA.

 

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. To the extent permitted in foreign jurisdictions, we are pursuing the foreign patent rights that correspond to our United States patents.

 

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. We have various issued patents or pending applications in foreign countries. These patents or patent applications, if issued, have expiration dates ranging from 2012 to 2023.

 

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 2009 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 2009.

 

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.

 

Obtaining FDA approval for new products and manufacturing processes can take a number of years and involve the expenditure of substantial resources. To obtain FDA approval for the commercial sale of a therapeutic agent, the potential product must undergo testing programs on animals, the data from which is used to file an IND with the FDA. In addition, there are three phases of human testing: Phase I consists of safety tests for human clinical experiments, generally in normal, healthy people; Phase II programs expand safety tests and are conducted in people who are sick with the particular disease condition that the drug is designed to treat; and Phase III programs are greatly expanded clinical trials to determine the effectiveness of the drug at a particular dosage level in the affected patient population. The data from these tests is combined with data regarding chemistry, manufacturing and animal toxicology and is then submitted in the form of a New Drug Application or NDA to the FDA. The preparation of an NDA requires the expenditure of substantial funds and the commitment of substantial resources. The review by the FDA can take up to several years. If the FDA determines that the drug is safe and effective, the NDA is approved. A similar process exists in the European Union and in other countries. See Item 1A — Risk Factors for risks associated with government regulation of our business.

 

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.

 

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, Mexico, Poland and Canada. During the year ended December 31, 2008, we derived approximately 77% of our sales from these markets. U.S. sales represented 37% of our total consolidated product net sales in 2008, 2007 and 2006. Poland accounted for 19%, 15% and 12% of our total consolidated net sales in 2008, 2007 and 2006, respectively, while Mexico accounted for 18%, 21% and 26%, respectively. Sales to McKesson Corporation and its affiliates in the United States, Canada and Mexico for the years ended December 31, 2008, 2007 and 2006 were 24%, 24% and 27%, respectively, of our total consolidated product net sales. Sales to Cardinal Healthcare in the United States for the years ended December 31, 2008, 2007 and 2006 were 17%, 12% 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 has exclusive rights to promote Diastat and Diastat AcuDial to U.S. physicians in 2009, with an option to extend the term by mutual agreement. We will continue to record the sales of Diastat and Diastat AcuDial and will be responsible for ongoing brand development.

 

Competition

 

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. In addition, our cosmeceutical Kinerase and CeraVe products also face competition from manufacturers of non-prescription cosmetic products. 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.

Products being developed by our competitors to treat epilepsy include, but are not limited to:

 

 

Products being developed by our competitors to treat hepatitis C include, but are not limited to:

 

 

The success of any of our competitors’ products or products in development could adversely affect our expected revenues for retigabine and taribavirin, if approved.

 

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

 

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. We currently have one significant product, Cesamet, which does not currently have generic competition and which is not protected by patent or regulatory exclusivity. Sales of Cesamet were $37.3 million and $26.7 million in 2008 and 2007, respectively. In mid 2008 the first generic competitor to Efudex, which is not protected by patent or regulatory exclusivity, was launched. Sales of Efudex were $61.2 million and $64.0 million in 2008 and 2007, respectively.

 

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, 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 four manufacturing plants. We reduced the number of manufacturing sites in our global manufacturing and supply chain network from 15 sites in 2003. In June 2007, we sold our former manufacturing facilities in Basel, Switzerland and Puerto Rico to Legacy Pharmaceuticals International, reducing the number of sites in our network to four.

 

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.

In 2009, we estimate that approximately 61% of our products and approximately 63% of our product sales will be 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. We have not experienced any significant shortages in supplies of such raw materials.

 

Employees

 

As of December 31, 2008, we had 2,331 employees. These employees include 788 in production, 991 in sales and marketing, 171 in research and development, 99 in service related positions, and 282 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 had product liability insurance to cover damages resulting from the use of our products since March 2005. Prior to 2005, we obtained product liability insurance coverage only for certain products. We have in place clinical trial insurance in the major markets where we conduct clinical trials.

 

Foreign Operations

 

Approximately 63%, 63% and 67% of our revenues from continuing operations, which includes royalties, for the years ended December 31, 2008, 2007 and 2006, 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.

 

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.

 

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.

 

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.

 

If retigabine, taribavirin 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, taribavirin 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, taribavirin and other product candidates.

 

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

 

In 2008, we made three acquisitions. Part of our 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. Such acquisitions or arrangements may be complex, time consuming and expensive, and may present numerous challenges and risks including:

 

 

 

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, from time to time we may enter into negotiations for acquisitions or arrangements that are not ultimately consummated. We compete for acquisition candidates or arrangements with other entities, some of which have financial and other resources that greatly exceed ours. 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.

 

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 harm 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 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.

 

If we, our partners or licensees cannot successfully develop or obtain future products and commercialize those products, our growth would be delayed.

 

Our future growth will depend, in large 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 an active development program involving compounds which we may commercially develop in the future. Partners or licensees may also help us develop these and other product candidates in the future and are responsible for developing other product candidates that have been licensed to or acquired by them. The process of

successfully commercializing products is time consuming, expensive and unpredictable. There can be no assurance that we, our partners or our licensees will be able to develop or acquire new products, successfully complete clinical trials, obtain regulatory approvals to use these products for proposed or new clinical indications, manufacture the potential products in compliance with regulatory requirements or in commercial volumes, or gain market acceptance for such products. In addition, changes in regulatory policy for product approval during the period of product development and regulatory agency review of each submitted new application may cause delays or rejections. It may be necessary for us to enter into other licensing 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 licensing arrangements on terms favorable to us or at all.

 

There can be no assurance that the clinical trials of any of our product candidates, including retigabine and taribavirin, will be successful, that the product candidates will be granted approval to be marketed for any of the indications being sought or that any of the product candidates will result in a commercially successful product.

 

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 the annual report on Form 10-K, during the year ended December 31, 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.

 

The results from the interim analyses of our Phase IIb study for taribavirin may not be predictive of the final results of the 72-week Phase IIb study or of any subsequent clinical trial necessary for approval of taribavirin.

 

We have reported results of the interim analyses (week 12 and week 48) of the 72-week taribavirin Phase IIb study (see Part II, Item 7, Products in Development). These results may not be predictive of the final results of the full 72-week study or of any subsequent clinical trial necessary for the approval of taribavirin. Thus we give no assurance that taribavirin will ultimately meet its clinical efficacy or safety endpoints, that we will conduct additional trials necessary for approval or that, if we conduct such additional trials, the results will lead to approval of taribavirin by the FDA or similar authority or any foreign government.

 

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.

 

Third parties may be able to sell generic forms of our products or block the sales of our products if our intellectual property rights or data exclusivity rights do not sufficiently protect us; patent rights of third parties may also be asserted against us.

 

Our success depends in part on our ability to obtain and maintain meaningful exclusivity protection for our products and product candidates in key markets throughout the world via patent protection and/or data exclusivity protection. The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. We will be able to protect our products from generic substitution by third parties only to the extent that our technologies are covered by valid and enforceable patents, effectively maintained as trade secrets or protected by data exclusivity. However, our currently pending or future patent applications may not issue as patents. Any patent issued may be challenged, invalidated, held unenforceable or circumvented. Furthermore, our patents may not be sufficiently broad to prevent third parties from producing generic substitutes for our products. Lastly, data exclusivity schemes vary from country to country and may be limited or eliminated as governments seek to reduce pharmaceutical costs by increasing the speed and ease of approval of generic products.

 

In order to protect or enforce patent and/or data exclusivity rights, we may initiate patent litigation against third parties, and we may be similarly sued by others. We may also become subject to interference proceedings conducted in the patent and trademark offices of various countries to determine the priority of inventions. The defense and prosecution, if necessary, of intellectual property and data exclusivity actions are costly and divert technical and management personnel from their normal responsibilities. We may not prevail in any of these suits. An adverse determination of any litigation or defense proceeding, resulting in a finding of non-infringement or invalidity of our patents, or a lack of protection via data exclusivity, may allow the entry of generic substitutes for our products.

 

Furthermore, because of the substantial amount of discovery required in connection with such litigation, there is a risk that some of our confidential information could be compromised by disclosure during such litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could have a substantial negative effect on the trading price of our securities.

 

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. No patent can protect its holder from a claim of infringement of another patent. Therefore, our patent position cannot and does not provide an assurance that the manufacture, sale or use of products patented by us would not infringe a patent right of another.

 

While we know of no actual or threatened claim of infringement that would be material to us, there can be no assurance that such a claim will not be asserted. If such a claim is asserted, there can be no assurance that the resolution of the claim would permit us to continue producing the relevant product on commercially reasonable terms.

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

 

Some 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.

 

We are subject to uncertainty related to health care reform measures and reimbursement policies.

 

The levels at which government authorities, private health insurers, HMOs and other organizations reimburse the cost of drugs and treatments related to those drugs will impact the successful commercialization of our drugs. We cannot be sure that reimbursement in the United States or elsewhere will be available for any drugs we may develop or, if already available, will not be decreased in the future. Also, we cannot be sure that reimbursement amounts will not reduce the demand for, or the price of, our drugs. If reimbursement is not available or is available only on a limited basis, we may not be able to obtain a satisfactory financial return on the manufacture and commercialization of existing and future drugs. Third-party payers may not establish and maintain price levels sufficient for us to realize an appropriate return on our investment in product development or our continued manufacture and sale of existing drug products.

 

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 are a nominal defendant in three shareholder derivative lawsuits which assert claims related to our historic stock option practices. In addition, the SEC has opened a formal 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 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.

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 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.

 

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.

 

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.

 

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. Including ribavirin royalties, approximately 63% of our revenues from continuing operations were generated outside the United States during the years ended December 31, 2008 and 2007. We sell our pharmaceutical products in more than 40 countries around the world and employ approximately 1,834 individuals in countries other than the United States. The international scope of our operations may lead to volatile financial results and difficulties in managing our operations because of, but not limited to, the following:

 

 

If the counterparties to our convertible notes hedge and warrant transactions do not fulfill their obligations, if and when they occur, such a failure could have a material adverse effect on our financial position and results of operations, and result in stockholder dilution.

 

In connection with the issuance of the convertible notes, we entered into convertible notes hedge and warrant transactions with certain financial institutions, each of which we refer to as counterparty. The convertible notes hedge is comprised of purchased call options that are expected to reduce our exposure to the settlement value (potential cash payments or issuance of common stock, or a combination thereof) required to be incurred by us upon the conversion of the notes. The call options may be settled in cash, shares, or a combination thereof, at the option of the company. We have also entered into respective warrant transactions with the counterparties pursuant to which we will have sold to each counterparty warrants for the purchase of shares of our common stock. Together, each of the note hedges and warrant transactions are expected to provide us with some protection against increases in our stock price over the conversion price per share. Although we believe the counterparties are highly rated financial institutions, there are no assurances that the counterparties will be able to perform their respective obligations under the agreements we have with each of them. Any net exposure related to failure of the counterparties to perform their obligations under the agreements we have with them could have a material adverse effect on our financial position and results of operations and depending on how we settle our obligations, could result in stockholder dilution.

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

 

We are involved in several legal proceedings, including those described in Note 19 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.

 

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.

 

Our stockholder rights plan and anti-takeover provisions of our charter documents could provide our board of directors with the ability to delay or prevent a change in control of us.

 

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

 

We are authorized to issue, without stockholder approval, approximately 10 million shares of preferred stock, 200 million shares of common stock and securities convertible into either shares of common stock or preferred stock. The board of directors can also use issuances of preferred or common stock to deter a hostile takeover or change in control of the Company.

 

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.

 

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.

 

If we do not realize the expected benefits from our restructuring plans, our business prospects may suffer and our operating results and financial condition would be adversely affected.

 

Our prior restructuring plans were intended to improve operational efficiencies and our competitiveness. If we are unable to realize the benefits from our restructuring plans, our business prospects may suffer and our operating results and financial condition would be adversely affected.

 

 

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 operations involved.

 

 

See Note 19 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, 2008.

 

 

Price Range of Common Stock

 

Our common stock is traded on the New York Stock Exchange (symbol: VRX). As of February 25, 2009 there were 4,447 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, 2008. The Custom Composite consists of Allergan, Inc., Biovail Corporation, Cephalon, Inc., Forest Laboratories, Inc., Gilead Sciences, Inc., King Pharmaceuticals, Inc., Medicis Pharmaceutical Corporation, Mylan Laboratories Inc., Shire Pharmaceuticals Group plc and Watson Pharmaceuticals, Inc.

 

 

Based on reinvestment of $100 beginning on December 31, 2003

 

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

In June 2007, our board of directors authorized a stock repurchase program. This program authorized us to repurchase up to $200.0 million of our outstanding common stock in a 24-month period. In June 2008, our board of directors increased the authorization to $300.0 million, over the original 24-month period. This program was completed in November 2008. The total number of shares repurchased pursuant to this program was 17,618,920 at an average price of $17.03 per share, including transaction costs.

 

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. 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 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 requirements and alternate investment opportunities. The securities repurchase program may be modified or discontinued at any time. As of December 31, 2008, we repurchased $32.6 million aggregate principal amount of our 3.0% Convertible Subordinated Notes due 2010 for $29.0 million in cash, in addition to the repurchase of 298,961 shares of our common stock for $6.1 million.

 

In addition, as of December, 31, 2008, we have sold 324,474 treasury shares to certain executives in connection with purchase requirements set forth in their executive employment agreements.

Set forth below is the information regarding shares repurchased under the repurchase programs during the fourth quarter of the year ended December 31, 2008:

 

 

Dividend Policy

 

We did not declare and did not pay dividends in 2008 or 2007. Our board of directors reviews our dividend policy from time to time.

 

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, 2008, 2007 and 2006 and the consolidated balance sheet data as of December 31, 2008 and 2007 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, 2005 and 2004 and the consolidated balance sheet data as of December 31, 2006, 2005 and 2004 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:

 

 

 

Company Overview

 

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.

 

Our products are sold through three segments comprising Specialty Pharmaceuticals, Branded Generics — Europe and Branded Generics — Latin America. The Specialty Pharmaceuticals segment includes product revenues primarily from the United States, Canada, Australia and divested businesses located in Argentina, Uruguay and Asia. The Branded Generics — Europe segment includes product revenues from branded generic pharmaceutical products primarily in Poland, Hungary, the Czech Republic and Slovakia. The Branded Generics — Latin America segment includes product revenues from branded generic pharmaceutical products primarily in Mexico and Brazil.

 

Additionally, we generate alliance revenue, including royalties from the sale of ribavirin by Schering-Plough Ltd. (“Schering-Plough”) and revenues associated with the worldwide License and Collaboration Agreement (the “Collaboration Agreement”) with Glaxo Group Limited, a wholly owned subsidiary of GlaxoSmithKline plc, (“GSK”) entered into in 2008.

 

Business Strategy

 

In March 2008, we announced a new company-wide restructuring effort and new strategic initiatives (the “2008 Strategic Plan”). The restructuring was 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.

 

We have built our current business infrastructure by executing our multi-faceted strategy: 1) focus the business on core geographies and therapeutic classes, 2) maximize pipeline assets through strategic partnerships with other pharmaceutical companies, and 3) deploy cash with an appropriate mix of debt repurchases, share buybacks and selective acquisitions. We believe our multi-faceted strategy will allow us to expand our product offerings and upgrade our product portfolio with higher growth, higher margin assets.

 

Prior to the start of the 2008 Strategic Plan, we reviewed our portfolio for products and geographies that did not meet our growth and profitability expectations and, as a result, divested or discontinued certain non-strategic products. In September 2007, we decided to sell our rights to Infergen. We sold these rights to Three Rivers Pharmaceuticals, LLC in January 2008. In 2007, we also sold product rights to Reptilase and Solcoseryl in Japan, our ophthalmic business in the Netherlands, and certain other products.

 

In March 2008, we sold certain assets in Asia to Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”) 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 certain product rights in Japan. The assets sold to Invida were classified as “held for sale” as of December 31, 2007 in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset (“SFAS 144”).

 

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 AB, an international specialty pharmaceutical company located in Stockholm, Sweden (“Meda”).

As a result of these dispositions, the following information has been adjusted to exclude the operations of Infergen and of the WEEMEA business. The results of these operations have also been classified as discontinued operations in our consolidated financial statements for all periods presented in this annual report on Form 10-K.

 

In October 2008, we completed a worldwide License and Collaboration Agreement with Glaxo Group Limited to develop and commercialize retigabine, a first-in-class neuronal potassium channel opener for treatment of adult epilepsy patients with refractory partial onset seizures.

 

In October 2008, we also acquired Coria Laboratories Ltd. (“Coria”), a privately-held specialty pharmaceutical company focused on dermatology products in the United States. In November 2008, we acquired DermaTech Pty Ltd (“DermaTech”), an Australian specialty pharmaceutical company focused on dermatology products marketed in Australia. 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.

 

Pharmaceutical Products

 

Product sales from our pharmaceutical segments accounted for 90% of our total revenues from continuing operations for the year ended December 31, 2008, compared to 87% for the year ended December 31, 2007. Product sales decreased by $9.9 million for the year ended December 31, 2008, as compared to the year ended December 31, 2007.

 

Our current product portfolio comprises approximately 389 products, with approximately 982 stock keeping units. We market our products globally through a marketing and sales force consisting of approximately 991 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 2009 and beyond.

 

Alliance Revenue and Service Revenue

 

Our royalties have historically been 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. 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 $59.4 million, $67.2 million and $81.2 million for the years ended December 31, 2008, 2007 and 2006, respectively, and accounted for 9%, 10% and 12% of our total revenues in 2008, 2007 and 2006, respectively. Royalty revenues in 2008, 2007 and 2006 were substantially lower than those in prior years. This decrease had been 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 sales in Japan from a peak in 2005 driven by the launch of combination therapy and 4) further market share gains by generic competitors in the United States since they entered the market in April 2004.

 

We expect ribavirin royalties to decline significantly in 2009 because 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 2009.

 

Beginning in January 2009, we will receive royalties from patent protected formulations developed by Dow and licensed to third parties. During the year ended December 31, 2008, Dow had royalties of approximately $20.0 million.

 

Beginning in January 2009, we will 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. In 2008, Dow had revenue from contract research services of approximately $25.0 million.

 

Research and Development

 

We are developing product candidates, including two clinical stage programs, retigabine and taribavirin, which target large market opportunities. Retigabine is being developed in partnership with GSK as an adjunctive treatment for partial-onset seizures in patients with epilepsy. Taribavirin is a pro-drug of ribavirin, for the treatment of chronic hepatitis C in treatment-naive patients in conjunction with a pegylated interferon. We are looking for potential partnering opportunities for taribavirin.

 

Epilepsy

 

There are more than 50 million people worldwide who have epilepsy, with approximately 6 million people afflicted with the disease in the United States, the European Union and Japan. The majority of all epilepsy patients are adequately and appropriately treated with the first or second AED they try. However approximately 30% of patients with epilepsy do not respond adequately to existing therapies despite trying multiple different AEDs. These patients are considered to have refractory epilepsy, thus representing the greatest unmet need in epilepsy treatment.

 

Chronic Hepatitis C

 

Worldwide, approximately 170 million individuals are infected with the hepatitis C virus. In the United States alone, 3 to 4 million individuals are infected. Current therapies consist of pegylated interferon alfa and ribavirin with a sustained virological response ranging as high as 54% to 56%.

 

Business Acquisitions

 

In December 2008, we acquired Dow for an agreed price of $285.0 million, subject to certain closing adjustments. We paid $242.5 million in cash, net of cash acquired, and incurred transaction costs of $5.4 million. We paid $5.6 million in January 2009. We have remaining payment obligations of $36.0 million, $35.0 million of which we will pay by June 30, 2009 into an escrow account for the benefit of the Dow common stockholders, subject to any indemnification claims made by us for a period of eighteen months following the acquisition closing. We have granted a security interest to the Dow common stockholders in certain royalties to be paid to us until we satisfy our obligation to fund the $35.0 million escrow account. The accounting treatment for the acquisition requires the recognition of an additional $95.9 million of conditional purchase consideration because the fair value of the net assets acquired exceeded the total amount of the acquisition price. Contingent consideration of up to $235.0 million may be incurred for future milestones related to certain pipeline products still in development. Over 85% of this contingent consideration is dependent upon the achievement of approval and commercial targets. Future contingent consideration paid in excess of the $95.9 million will be treated as an additional cost of the acquisition and result in the recognition of goodwill.

 

In November 2008, we acquired DermaTech for aggregate cash consideration of $15.5 million, including transaction costs and working capital adjustments.

 

In October 2008, we acquired Coria 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.

 

Results of Operations

 

In connection with the 2008 Strategic Plan and resulting acquisitions and dispositions, we realigned our organization in the fourth quarter of 2008 in order to improve our execution and align our resources and product development efforts in the markets in which we operate. We have realigned segment financial data for the years ended December 31, 2007 and 2006 to reflect changes in our organizational structure that occurred in 2008.

Our products are sold through three operating segments comprising Specialty Pharmaceuticals, Branded Generics — Europe and Branded Generics — Latin America. The Specialty Pharmaceuticals segment includes product revenues primarily from the United States., Canada, Australia and divested businesses located in Argentina, Uruguay and Asia. The Branded Generics — Europe segment includes product revenues from branded generic pharmaceutical products primarily in Poland, Hungary, the Czech Republic and Slovakia. The Branded Generics — Latin America segment includes product revenues from branded generic pharmaceutical products primarily in Mexico and Brazil. Certain financial information for our business segments is set forth below (in thousands). 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 16 of notes to consolidated financial statements in Item 8 of this annual report on Form 10-K.

 

 

Year Ended December 31, 2008 Compared to 2007

 

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

 

Product Sales Revenues:  Total consolidated revenues decreased $32.6 million for the year ended December 31, 2008 compared with 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 $24.7 million in 2008 compared with 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 with 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 $14.6 million (10%) to $136.7 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 (including Ribavirin royalties):  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 with $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.

 

We expect ribavirin royalties to continue to decline significantly in 2009 because 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 royalties from Schering-Plough in Japan will continue after 2009.

 

Gross Profit Margin:  Gross profit margin was negatively impacted for the year ended December 31, 2008 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. 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, 2008, 2007 and 2006 (dollar amounts in thousands):

 

 

Selling, General and Administrative Expenses:  Selling, general and administrative (SG&A) expenses were $278.0 million for the year ended December 31, 2008 compared with $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:  Research and development expenses were $87.0 million for the year ended December 31, 2008 compared with $98.0 million for 2007, a reduction of $11.0 million (11%). The decrease in research and development expenses was primarily due to $10.2 million of expense offsets attributable to the GSK Collaboration Agreement, which was effective in October 2008.

Acquired In-Process Research and Development:  Acquired in-process research and development (“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 in-process research and development 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. IDP-107 is an antibiotic targeted to treat moderate to severe inflammatory acne and is in Phase II studies. IDP-108 is an investigational topical drug for nail, hair and skin fungal infections and is in Phase II studies. IDP-115 is a topical treatment for rosacea and has completed Phase II studies.

 

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 with $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, Asset Impairments and Dispositions:  In 2008 and 2007 we incurred $21.3 million and $27.7 million, respectively, in restructuring charges, asset impairments and subsidiary dispositions.

 

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 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 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. 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. 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 includes a restructuring program (the “2008 Restructuring”), which 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, 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 includes actions to divest our operations in markets outside of these core geographic areas through sales of subsidiaries or assets or other strategic alternatives.

 

In December 2007, we signed an agreement with Invida Pharmaceutical Holdings Pte. Ltd. (“Invida”) to sell to Invida certain assets 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 in March 2008. The assets sold to Invida were classified as “held for sale” as of December 31, 2007. 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, on this transaction. We expect to receive additional proceeds of approximately $3.4 million subject to net asset settlement provisions in the agreement.

 

In June 2008, we sold our subsidiaries in Argentina and Uruguay, and recorded a loss on the sale of $2.6 million, in addition to an impairment charge of $7.9 million related to the anticipated sale. These subsidiaries are classified as “held for sale” in accordance with SFAS 144 as of December 31, 2007. Total proceeds received from the sale of these subsidiaries were $13.5 million.

 

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 $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, 2008 and 2007 (in thousands):

 

 

In the year ended December 31, 2008, we recorded inventory obsolescence charges of $21.0 million resulting primarily from decisions to cease promotion of or discontinue certain products, decisions to discontinue certain manufacturing transfers, and product quality failures. These inventory obsolescence charges were recorded in cost of goods sold, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 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 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 years ended December 31, 2007 and 2006 (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 relates to ongoing contractual payments to Legacy Pharmaceuticals International relating to the sale of our former site in Puerto Rico. These payment obligations last until June 30, 2009.

As of December 31, 2008, the restructuring accrual for the 2008 Restructuring was $10.3 million and relates to severance, professional service fees and other obligations and is expected to be paid primarily during the remainder of 2009, 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):

 

 

Certain additional costs under the 2008 Restructuring are expected to be incurred in 2009, including, but not limited to, one-time employee severance costs of $1.1 million related to severance plans approved in 2008 for which the costs are spread over the service period in accordance with SFAS 146.

 

Other Income, 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 with 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.

 

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 $3.3 million gain, net of unamortized loan costs of $0.3 million, as a result of the November 2008 repurchase of $32.6 million aggregate principal amount of our 3.0% Convertible Subordinated Notes for an aggregate purchase price of $29.0 million.

 

Interest Expense and Income:  Interest income decreased $0.5 million during the year ended December 31, 2008 compared to 2007. Interest expense decreased $12.4 million during the year ended December 31, 2008 compared to 2007, 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 repurchase of a portion of the 3.0% Convertible Subordinated Notes.

 

Income Taxes:  In 2008 and 2007, we recorded tax expense of $33.9 million and $13.5 million respectively. The 2008 tax provision amount is the result of no tax benefits being recorded for the in-process research and

development 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 paid-in 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 $142.7 million compared to $151.9 million as of December 31, 2007. The valuation allowance also has the effect of deferring certain amounts that would normally impact the effective tax rate. See Note 9 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:  The income from discontinued operations was $166.5 million in 2008 compared with a loss of $26.8 million for 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.

 

Year Ended December 31, 2007 Compared to 2006

 

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

 

Product Sales Revenues:  Total consolidated revenues increased $4.6 million for the year ended December 31, 2007 compared with 2006. Total product sales decreased $0.7 million to $603.1 million in 2007 from $603.8 million in 2006. Product sales in 2007 included a 4% favorable impact from foreign exchange rate fluctuations and a 2% aggregate increase in price, partly offset by a 6% reduction in volume. A significant factor that contributed to this reduction was the sales decline in Mexico, partly offset by sales increases in Central Europe and Canada. The sales declines in Mexico were also impacted by reserves for product returns and credits memos. The reported sales for the year ended December 31, 2007 include $4.1 million for products divested in 2007 (Reptilase and Solcoseryl in Japan and our former ophthalmic business in the Netherlands), compared with $15.4 million of revenue reported for these products in 2006.

 

In our Specialty Pharmaceuticals segment, revenues for the year ended December 31, 2007 increased $8.4 million (3%) to $326.7 million in 2007 from $318.3 million in 2006. The increase in Specialty Pharmaceuticals sales for the year ended December 31, 2007 was due to a 5% percent increase in price and a 2% positive contribution from the appreciation of the Canadian and Australian Dollar, offset by a 4% decline in volume. This increase reflects the growth in Cesamet sales in Canada, a full year of Zelapar sales in the United States, and sales increases in Librax, Kinerase, and Migranal. Cesamet sales were primarily in Canada. These sales increases were offset by sales decreases of Efudex and Imovane. Decreases in Efudex sales were expected and were a result of our launch of an authorized generic in December 2006.

 

In our Branded Generics — Europe segment, revenues for the year ended December 31, 2007 increased $25.3 million (25%) to $125.1 million from $99.8 million in 2006. Branded Generics — Europe sales in 2007 were impacted by a 14% positive contribution from currency fluctuations and a 15% 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 $14.3 million to revenues in the segment in 2007.

 

In our Branded Generics — Latin America segment, revenues for the year ended December 31, 2007 decreased $34.4 million (19%) to $151.3 million from $185.7 million in 2006. Branded Generics — Latin America sales in 2007 reflected a 20% reduction in volume, partly offset by a 1% benefit from foreign currency. The decrease was due to the reduced shipments to our largest wholesalers in Mexico who had ceased making payments to us because they felt disadvantaged by changes we made in our distribution channel in 2006. This situation affected most of our products in Mexico. Results in Mexico were also impacted by increased reserves for returns and

discounts. Reptilase sales in 2007 decreased $5.3 million because we stopped selling Reptilase with the sale of our Basel, Switzerland manufacturing plant in June 2007.

 

Alliance Revenue (including Ribavirin royalties):  Alliance revenue in the year ended December 31, 2007 included a licensing payment of $19.2 million which we received in the first quarter of 2007 from Schering-Plough as a payment for the license to pradefovir. In September 2007, we announced an agreement with Schering-Plough and Metabasis which returned all pradefovir rights to Metabasis. Alliance revenue in 2006 consisted exclusively of ribavirin royalties.

 

Ribavirin royalties for the year ended December 31, 2007 were $67.2 million compared with $81.2 million for 2006, a decrease of $14.0 million (17%). Ribavirin royalty revenues decreased due to (i) Roche’s discontinuation of royalty payments to us in June 2007, (ii) Schering-Plough’s market share losses in ribavirin sales, and (iii) reduced sales in Japan from a peak in 2005 driven by the launch of combination therapy.

 

Gross Profit Margin:  Gross profit margin, excluding amortization, was unchanged in 2007 compared to 2006. Gross profit margin was negatively impacted in 2007 by increases in reserves for returns and discounts in Mexico, offset by product cost favorability in Central Europe.

 

Selling, General and Administrative Expenses:  SG&A expenses were $292.0 million for the year ended December 31, 2007 compared with $283.6 million for 2006, an increase of $8.4 million (3%). As a percent of product sales, SG&A expenses were 48% for the year ended December 31, 2007 and 47% in 2006. The increase in SG&A expense reflects increased promotional activities related to the newly launched products in our Branded Generics — Europe segment. SG&A expense in 2007 included a $2.8 million bad debt provision for Mexico. SG&A expenses included $11.1 million in stock-based compensation expenses, a reduction of $5.5 million from the corresponding expenses recorded in SG&A expenses in 2006. SG&A expenses in 2007 included information technology improvements, legal, and business development costs, professional service fees, and a payroll tax withholding charge related to a former executive.

 

Research and Development:  Research and development expenses were $98.0 million for the year ended December 31, 2007 compared with $105.4 million for 2006, a reduction of $7.4 million (7%). The decrease in research and development expenses was primarily attributable to the completion of the VISER clinical trials for taribavirin and savings from our strategic restructuring program including the divestment of our discovery operations in December 2006. In January 2007, we licensed the development and commercialization rights to pradefovir to Schering-Plough, who subsequently returned these rights to Metabasis after the results of a long-term preclinical study was released. In December 2006, we sold our HIV and cancer development programs and certain discovery and preclinical assets to Ardea, with an option for us to reacquire rights outside of the United States and Canada to commercialize the compound being developed in the HIV program upon Ardea’s completion of Phase IIb trials. Research and development expenses in 2006 included a $7.0 million milestone payment related to the development of retigabine.

 

Amortization:  Amortization expense was $56.0 million for the year ended December 31, 2007 compared with $51.3 million for 2006, an increase of $4.7 million (9%). The increase was primarily due to amortization of intangibles acquired with the acquisition of the Kinerase product rights, offset in part by a decrease in the amortization of the ribavirin royalty intangible which is being amortized on an accelerated basis.

 

Gain on Litigation Settlement:  The gain on litigation settlement in 2006 included the settlement with the Republic of Serbia relating to the ownership and operations of a joint venture we formerly participated in known as Galenika of $34.0 million of which $28.0 million was received in 2006, and the settlement of litigation with a former chief executive officer, Milan Panic relating to Ribapharm bonuses, for which we received $20.0 million and recorded a gain from litigation of $17.6 million in 2006.

 

Restructuring Charges and Asset Impairments:  In 2007 and 2006, we incurred $27.7 million and $88.6 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, Net, Including Translation and Exchange:  Other income, net, including translation and exchange was income of $1.7 million for the year ended December 31, 2007 compared with income of $0.8 million for 2006. In both 2007 and 2006, 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.

 

Interest Expense and Income:  Interest income increased $5.2 million during the year ended December 31, 2007 compared to 2006 due to higher cash balances. Interest expense decreased $0.6 million during the year ended December 31, 2007 compared to 2006, due to lower interest rates associated with our variable rate debt.

 

Income Taxes:  In 2007 and 2006, we recorded tax expense of $13.5 million and $36.6 million respectively. The 2007 and 2006 tax provisions are the result of no tax benefits being recorded for the U.S. operating losses, credits and temporary items.

 

In 2007 and 2006, 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, 2007 the valuation allowance against deferred tax assets totaled $151.9 million compared to $158.7 million as of December 31, 2006. The valuation allowance also has the effect of deferring certain amounts that would normally impact the effective tax rate. See Note 9 of notes to consolidated financial statements in Item 8 of this annual report on Form 10-K for further information.

 

Loss from Discontinued Operations:  The loss from discontinued operations was $26.8 million in 2007 compared with a loss of $37.3 million for 2006. The net losses in 2007 and 2006 related primarily to our WEEMEA and Infergen businesses that were sold in 2008. 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. The cost of goods sold of discontinued operations in 2007 included a technology transfer payment of $5.3 million made to the future manufacturer of Infergen. In 2006, the loss before income taxes related to the WEEMEA and Infergen operations of $38.9 million and $8.3 million, respectively, was offset in part by the reduction of $5.6 million in an environmental reserve for the discontinued biomedical facility. The loss incurred by the WEEMEA business in 2006 included restructuring and asset impairment charges totaling $49.6 million.

 

Liquidity and Capital Resources

 

Cash and cash equivalents and marketable securities totaled $218.8 million at December 31, 2008 compared with $339.0 million at December 31, 2007. The decrease of $120.2 million resulted in part from $310.5 million paid to redeem the 7.0% Senior Notes, $251.0 million paid for the purchase of Dow, treasury stock purchases of $206.5 million, $95.0 million paid for the purchase of Coria, $29.0 million paid to repurchase a portion the 3.0% Convertible Subordinated Notes, $14.6 million paid for the purchase of DermaTech and other cash flow items, offset in part by the receipt of $428.4 million from Meda as payment for the sale of the WEEMEA business, $125.0 million from GSK for payment of upfront fees pursuant to the Collaboration Agreement, $106.0 million of cash from operations, $70.8 million from Three Rivers Pharmaceuticals, LLC as the initial payment for our Infergen rights, $49.1 million from stock option exercises and employee stock purchases, and $37.9 million received from Invida for the sale of certain of our businesses in Asia. Working capital (excluding assets held for sale and discontinued operations) was $177.8 million at December 31, 2008, compared with $416.6 million at December 31, 2007. The decrease in working capital of $238.8 million primarily resulted from the decrease in cash and cash equivalents and marketable securities and an increase in trade payables and accrued liabilities.

 

Cash provided by operating activities in continuing operations is expected to be our primary source of funds for operations in 2009. During the year ended December 31, 2008, cash provided by operating activities in continuing operations totaled $206.8 million, compared with $100.6 million in 2007. 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. The cash provided by operating activities in continuing operations for 2007 included receipt of $19.2 million related to the pradefovir licensing payment from Schering-Plough and $6.0 million from the Republic of Serbia.

 

Cash used in investing activities in continuing operations was $277.2 million for the year ended December 31, 2008, compared with cash used in investing activities in continuing operations of $47.9 million in 2007. 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. In 2007, cash used in investing activities in continuing operations consisted of the purchase of investments of $72.5 million, capital expenditures of $29.1 million and the purchase of product rights for $22.5 million, offset in part by proceeds from the sale of assets of $38.6 million and proceeds from investments of $35.2 million.

 

Cash used in financing activities in continuing operations was $475.0 million in the year ended December 31, 2008, compared with $86.0 million in 2007 and primarily consisted of payments on long-term debt and notes payable of $329.9 million and the purchase of treasury stock for $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. In 2007, cash flows used in financing activities in continuing operations consisted of purchase of treasury stock of $99.6 million and payments on long-term debt and notes payable of $3.5 million, offset in part by proceeds from stock option exercises and employee stock purchases of $15.3 million.

 

If GSK terminates the Collaboration Agreement prior to the expiration of the Review Period, we would be required to refund to GSK up to $40.0 million of the upfront fee through March 31, 2010; however, the refundable portion will be reduced over the time the Collaboration Agreement is in effect.

 

Historically, our primary sources of liquidity have been our cash, cash flow from operations and issuances of long-term debt securities. Strengthening our balance sheet was one of the six strategic initiatives that management set for 2008. Solid cash flow from operations and proceeds from the sale of various assets in 2008 enabled us to achieve this strategic goal. Cash generated from operations was more than sufficient to meet our operating requirements and in addition, we retired $332.6 million of debt, repurchased $206.5 million of our common stock and financed various acquisitions totaling $352.7 million (Dow $242.5 million, Coria $95.6 million, and DermaTech $14.6 million). Our cash on hand is currently not sufficient to cover all of our outstanding debt but we do not face short-term debt maturities. 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, 2009, to fund capital expenditures, and our clinical development program. We may seek additional debt financing or issue additional equity securities or sell assets to finance future acquisitions or for other purposes.

 

We review our investments routinely with members of our Board of Directors and continue to invest our cash conservatively given the ongoing credit crisis and turmoil in overall markets. As of December 31, 2008, we have over two-thirds of our domestic cash balances invested in money market funds that are guaranteed by the U.S. government. Our foreign cash balances are invested mostly in short dated time deposits, government securities and highly rated industrial commercial paper.

 

We did not declare and did not pay dividends in 2008 or 2007.

 

Contractual Obligations

 

The following table summarizes our contractual obligations as of December 31, 2008, and the effect such obligations are expected to have on our liquidity and cash flow in future periods: