Patheon Inc.

Transcription

Patheon Inc.

New Leadership
New Opportunities
Annual Report 2007
Contents
2
Challenge & Progress
4
Operations & Markets
6
Leadership & Direction
8
Vision & Opportunity
2007 Highlights
Patheon Today
Message from the Board
Message from the CEO
12 Management’s Discussion and Analysis
40 Five -Year Financial Summary
41 Five -Year Summary of Quarterly Results
42 Report of Management’s Accountability
42 Auditors’ Report
43 Audited Consolidated Financial Statements
48 Notes to Audited Consolidated
Financial Statements
68 Board of Directors
68 Corporate Governance
70 Senior Management
71 Global Operations
73 Corporate Information
Financial Highlights
Years ended October 31
(in thousands of U.S. dollars except share information, 2007
2006
per-share amounts and percentages)
$
$
financial results
Revenues
677,074 674,659 %
Change
0%
EBITDA before repositioning expenses
(% of revenues)
Loss from continuing operations
Net loss
Loss per share
Continuing operations
Net loss per share
90,318 70,876 13.3%
10.5%
(84,458)
(288,719)
(94,601) (288,150) 27%
71%
67%
$ (0.91)
$ (1.02)
$ (3.11) $ (3.10) 71%
67%
Balance sheets
Total assets
Working capital
Interest-bearing debt
Shareholders’ equity
829,617 826,183 80,572 (175,765) 363,689 349,617 197,185 250,731 0%
146%
4%
- 21%
EBITDA before repositioning expenses represents earnings from continuing operations before repositioning expenses,
asset impairment charges, depreciation and amortization, foreign exchange losses reclassified from other comprehensive
income, interest, refinancing expenses, write-off of deferred financing costs and income taxes.
Interest-bearing debt includes the debt component of the convertible preferred shares.
Corporate Profile
Patheon is a global client-driven organization dedicated to delivering value-added services to the
world’s pharmaceutical industry. Our one and only focus is to help our clients as they manage their
product life cycles – from the development, testing and launch of new drug products through to
the commercial manufacturing of approved medicines. Patheon currently manufactures more than
650 commercial products and has 197 new drug products in development on behalf of more than
250 companies in North America, Europe and Japan.
Patheon will become
the industry’s
best provider of
pharmaceutical
development and
manufacturing
services.
“We have built a strong foundation of talent and facilities,
and we are uniquely positioned to serve the industry at an
important time in its history.”
Wesley P. Wheeler
Chief Executive Officer
Patheon Inc. 2007 Annual Report
1
2007 Highlights
Challenge & Progress
2007 was a critical year for Patheon, beginning with a review of strategic
alternatives and ongoing challenges at our Puerto Rico operations.
By the end of the year, we had recapitalized the company, reaffirmed
our business model, taken important decisions about our network and
appointed a new CEO to lead Patheon forward.
March 2007
Expansion of PDS
at Milton Park, U.K.
To meet growing demand,
Swindon PDS begins
expansion of its analytical
development operations at
Milton Park, to include Quick
to Clinic™ early phase
development.
April 2007
Successful
Recapitalization
of the Company
Patheon completes a major
capital restructuring process
with a $150 million investment
in preferred shares by
JLL Partners of New York
and new credit arrangements
for the North American and
U.K. operations.
Revenues
Revenues
Patheon supplies product
to Merck & Co., Inc. for
launch of newly approved
JANUMET™ – one of the
first projects included in a
strategic supply agreement
signed in 2006.
(% of revenues)
750
658.9
674.7
677.1
600
432.9
54%
29%
600
Global Pharma
Specialty Pharma
750
450
360.0
300
300
150
150
0
17%
0
2003
2004
2005
2006
Biotechs
2007
Global Pharma
2
New Product
Launch for Client
Client Mix
(in millions
millions of
ofU.S.
U.S.dollars)
dollars)
(in
450
April 2007
Specialty Pharma
Biotechs
2007 Highlights
December 2007
November 2007
Appointment of
Wes Wheeler
as Patheon’s
new CEO
Launch of Clinical
Packaging
Services
June 2007
Product Transfers
Completed
Patheon expands its
successful formulation
development and clinical trial
manufacturing services to
include labeling, packaging,
storage and distribution of
patient kit materials.
In Italy and France, work
was completed on an
ambitious, two-year project
involving the transfer of
multiple products from two
clients into Patheon’s facilities.
These products generated
$48.7 million in revenues in
fiscal 2007.
+27%
Increase in EBITDA Before Repositioning
Operating profitability improved significantly in 2007,
reflecting successful efforts to improve productivity
and efficiencies, and the benefits of foreign exchange gains.
December 2007
Pharmaceutical industry
executive Wes Wheeler
is appointed CEO, to take
the Company forward to
its next phase of growth
and profitability.
Definitive
Agreement to
Sell NiagaraBurlington
OTC Business
As part of its strategy to
focus on prescription
pharmaceutical products,
Patheon divests NiagaraBurlington over-the-counter
commercial manufacturing
operations to Pharmetics Inc.
Revenues
EBITDA Before Repositioning Expenses
(in
of U.S.
U.S. dollars)
dollars)
(in millions
millions of
94.0
100
70.9
75
50
90.3
45.3
49.8
25
0
2003
2004
2005
2006
2007
3
Patheon Today
Operations & Markets
Patheon has established a very competitive and geographically diverse
network of sites, which enables us to attract great talent, offer a full
range of services and build on our impressive list of clients worldwide.
Commercial
Manufacturing
Commercial Manufacturing
(% of total revenues in 2007)
Patheon currently manufactures more
than 650 commercial products on behalf
of our clients. Our comprehensive
services range from conventional dosage
form manufacturing through to highly
specialized sterile, high-potency and
lyophilized manufacturing services.
Pharmaceutical
Development
Pharmaceutical Development
(% of total revenues in 2007)
From start-up in 1995, PDS has
grown to a business today of more
than $100 million. The products being
developed for clients, if approved,
can be an important source of new
business for Patheon’s commercial
manufacturing operations.
4,650+
Employees Worldwide*
83%
Revenues
17%
(in millions of U.S. dollars)
(1) Before Swindon, U.K. repositioning expenses of $4.4 million.
(2) Before global repositioning expenses of $13.8 million.
12 sites
Revenues
Located in U.S., Canada and Europe*
(1) Before Swindon, U.K. repositioning expenses of $4.4 million.
(2) Before global repositioning expenses of $13.8 million.
*As at Dec. 31, 2007, excluding the Niagara-Burlington OTC sites
4
Patheon Today
Europe Swindon Operations
(United Kingdom)*
Canada Toronto Region Operations*
Key facts:
3717 employees
3263,000 square feet
3High-potency, special compounds, solid,
semi-solid and liquid dosage forms
Toronto York Mills Operations
Key facts:
3220 employees
3Solid, semi-solid and liquid dosage forms
Whitby Operations
Key facts:
3393 employees
3Solid, powder and liquid dosage forms
Burlington Century Operations*
Key facts:
3122 employees
345,000 square feet
3Central laboratory services
3Clinical trial materials packaging
United States Cincinnati Operations*
Key facts:
3539 employees
3Solid, semi-solid and liquid dosage forms,
controlled/sustained release, liquid-filled
hard capsules
Caguas (Puerto Rico)*
Key facts:
3387 employees
3Solid, semi-solid and liquid dosage forms
Carolina (Puerto Rico)
Key facts:
3173 employees
3Oral cephalosporin solid dosage forms
Key facts:
3639 employees
3Sterile liquids, sterile powdered and lyophilized
cephalosporins, semi-solid dosage forms
Bourgoin-Jallieu Operations (France)
Key facts:
3280 employees
3Solid and liquid dosage forms
Ferentino (Rome) Operations (Italy)*
Key facts:
3333 employees
3Sterile lyophilized and sterile liquid (parenteral)
dosage forms
Monza Operations (Italy)
Key facts:
3484 employees
3Sterile lyophilized, sterile liquids, solid and
liquid dosage forms
Manatí (Puerto Rico)
Key facts:
3281 employees
3Solid dosage forms
* Includes PDS Centre of Excellence
5
Leadership & Direction
The recapitalization of Patheon is behind us, Puerto Rico is being
addressed and we are divesting non-strategic operations. Patheon is
moving in the right direction and we have appointed a new CEO – a
proven pharmaceutical executive with the knowledge and experience
to lead Patheon forward in a new era of growth.
New directions in 2007
From the Board’s perspective, the immediate priority at
the outset of 2007 was to establish a strong financial
foundation for Patheon, enabling the Company to move
forward with certainty and confidence to grow and enhance
shareholder value. In March, Patheon announced an
investment of US$150 million in convertible preferred shares
by JLL Partners of New York, which was approved by
shareholders in April. Concurrently, the balance of the North
American and U.K. credit facilities were refinanced through
new credit arrangements with J.P. Morgan Securities Inc.
and GE Commercial Finance.
This recapitalization achieved several goals. First, the
Company gained the capital and financial stability essential to
Patheon’s future success. Second, we achieved the benefits of
working with JLL Partners -- experienced, long-term investors
with considerable knowledge of the global healthcare industry
who are making an ongoing contribution to the direction of
Patheon through participation on the Board.
With financial restructuring behind us, the Board moved
decisively to support management’s priorities to position
Patheon for sustainable and profitable growth.
6
These included developing a plan to restore profitability in
Puerto Rico, focusing the overall business on higher-margin
services, and enhancing performance at all operations. In
addition, as we saw operating performance improve, we
looked to establish new long-term direction and leadership to
realize our vision of global leadership and unlock the new
opportunities that we see.
Addressing the challenges
in Puerto Rico
In addition to capital restructuring, the most pressing
challenges last year for Patheon related to continued losses
at our three sites in Puerto Rico. We appointed new senior
management in Puerto Rico earlier this year and, more
recently, completed a comprehensive review and longer-term
business plan for the Puerto Rico operations. As announced in
December, we have decided to sell the Carolina site while
streamlining the Caguas and Manati facilities. Our Puerto Rico
operations are stabilizing and, with the sale of the Carolina
facility, we expect improved results next year.
Focusing our business
In April 2007, we announced a major initiative to focus
Patheon’s capital and resources on the development and
manufacture of prescription pharmaceutical products, which
represent higher-margin revenues, while also improving
profitability. We divested our Niagara-Burlington Operations,
which manufacture over-the-counter pharmaceutical products,
in a transaction that was completed on January 31, 2008.
To further improve capacity utilization, we are transferring
production from our York Mills site in Toronto to our site in
Whitby, Ontario, and have entered into an agreement to sell
the York Mills facility.
Improving operating performance
During fiscal 2007, our other operations in Canada, Europe
and Cincinnati continued to perform well, achieving an
EBITDA before repositioning margin of more than 18% -a considerable improvement over the performance of the
past few years.
New leadership
While working with management to address the challenges
and improve profitability, the Board also took the longer-term
view. We determined that a new start for Patheon and a positive
new direction would be best served by new leadership. The
Board launched a search for a permanent CEO, identifying and
appointing a leading pharmaceutical executive to move
Patheon forward.
258
Clients worldwide in three
main sectors
In Wes Wheeler, we have found a leader with in-depth
knowledge of the pharma industry and a breadth of experience
in manufacturing, research and development and marketing.
We also are very pleased that there has been a positive and
seamless transition of leadership from Riccardo Trecroce,
who guided Patheon so well through the recapitalization and
restructuring process in a watershed year.
Confidence in the future
Patheon has emerged from the uncertainty and challenges
of fiscal 2007 as a focused and strong contender with a
clear vision. We believe the course we have established in
Puerto Rico will address our major challenges and enable
these operations to make a positive contribution to our results.
Patheon is well equipped, with an engaged and experienced
Board, strong new leadership, and a host of opportunities.
We have every confidence in the future of Patheon.
(signed)
Peter A.W. Green
Chairman, Board of Directors
650
Products manufactured by
commercial operations
197
Number of new products being
developed for clients
7
Wes Wheeler,
Vision & Opportunity
Patheon’s vision is clear – we aim to become the best contract
manufacturing and development services provider to the pharmaceutical
industry. We have the facilities, the people and the market opportunity
to realize this vision.
Sharing the vision
I am privileged to join Patheon at this critical point, and
excited to have the opportunity to write the next chapter in
this Company’s history.
Patheon has matured as a global service provider at an
important time for the industry. We have excellent production
and laboratory facilities in five countries, offering a wide range
of manufacturing and development services. As we have grown,
we have attracted excellent talent and technical expertise, while
gaining valuable experience along the way. Being able to work
with the leading pharmaceutical and biotech companies
affords us a unique opportunity to stay current with trends and
develop best practices. In a sense, we are a melting pot of the
industry, and we are using our broad base of talent to foster an
environment of continuous improvement. I believe we have
the foundation, talent and will to realize our vision of being the
best service provider in the industry.
However, we also have had our challenges. Our acquisition of
MOVA in Puerto Rico was strategic but untimely. The financial
losses stemming from our business in Puerto Rico forced us
to pull back and delay pursuit of our goals for several quarters.
During this difficult period we were able to successfully
recapitalize the Company with the leadership of our Board
and JLL Partners. This work is now behind us and we are
pleased to have the financial stability needed to move forward
confidently into the future.
Confidence as we move forward
My confidence in the future of this Company is based on
three fundamental beliefs.
First, pharmaceutical companies are increasingly adopting
outsourcing as a strategic approach. Some of the leading
pharmaceutical companies – our clients – are now focused
on restructuring their networks and reassessing their cost
structures. Plants are being sold or closed and products are
being rationalized. We also are seeing an increased tendency
on the part of our clients to form strategic outsourcing units
and master service agreements. Patheon is well positioned
to serve in this environment of change. Moreover, as we
consolidate this volume into our own capacity, we are more
able to offer cost-effective options for our clients.
9
Second, there is an emergence of specialty pharmaceutical
companies and biotech companies which require both
development and manufacturing services but are not
necessarily investing in their own facilities. These emerging
companies are requesting a broad array of services from us
and we continue to expand our service offerings to meet their
needs. Our Pharmaceutical Development Services business
has evolved to become our fastest-growing business sector
and has grown our client base tremendously. We hope to
convert this development business into longer-term commercial
business as products are approved.
Third, I believe that there will always be a need for
outsourcing companies that focus on customer service.
Many companies talk about being focused on customer needs,
but few actually deliver on this promise. Although this is already
a key focus at Patheon, I believe we can do better. We will set
the bar high for ourselves when it comes to professional
customer service and learn from our shortcomings. We will
benchmark ourselves against the best. We will launch our first
ever ‘Technical Excellence’ program, based on the principles
of ‘lean’ and ‘six sigma’, in order to foster an environment of
continuous improvement. We will earn the loyalty of our clients
by delivering on every one of their requirements.
We are standing at the crossroads of an important time in our
industry, when pharma companies are looking for solutions
and cost efficiency has become more than just a watchword.
And Patheon will be ready to deliver.
Near-term goals and priorities
In moving Patheon forward, we have some very specific
short-term priorities which will be critical as we begin under
new leadership:
1. Stabilize cashflow and restore profitability in
Puerto Rico.
We are proceeding with the sale of the Carolina facility
and are highly focused on restoring the profitability of the
remaining two sites, in Caguas and Manati. The first step is
to work with our new management team in Puerto Rico to
stabilize the business, which should be achieved within this
fiscal year. Our next step is to ensure that these sites make
a positive net contribution to our global network, growth
strategies and profitability. Puerto Rico is a formidable
manufacturing centre for the industry and we are committed
to building a business there. We will invest and focus our
sales teams accordingly.
2. Focus on our clients.
We are a service business. To be the leading contract
manufacturer and service provider, we must build on our
well-established relationships with the top companies in the
industry. We will create customer-facing teams, conduct
frequent surveys and focus on maintaining strong, trusting
relationships at all levels of our business.
219
Client and regulatory audits
conducted in fiscal 2007
10
2,120
University degrees held by
Patheon employees
Pharmaceutical Development Revenues
29%
116.5
120
89.7
98.0
90
64.2
Compound Annual Growth Rate
60
PDS revenues have grown at a
compound annual growth rate of 29% since 2003.
41.8
30
0
2003
Commercial Manufacturing Revenues
569.2
450
576.7
560.6
2006
2007
600
450
368.7
318.2
300
300
Market Opportunity
The size
150 of the market for outsourced dosage form
manufacturing is estimated to be approximately $10 billion.
150
0
0
2003
2004
2005
2006
2007
3. Build a high-performance executive team and
embrace our employees.
Our business is only as good as its people, and our success
relies on their strength, energy and creativity. We have
more than 4,650 employees, including 500 pharmaceutical
development scientists, 76 of whom hold PhDs. They come
from all over the industry, from dozens of countries. They bring
a diversity of knowledge, impressive qualifications, their own
track records of success and a belief in our service model.
We will continue to train, nurture and motivate our people
in each of our sites as a way to develop a competitive
advantage. As we continue to grow, new talent will emerge
and greater diversity of talent and innovation will become
part of our business.
4. Diversify and improve our service offering.
I believe that both large and small players in the global
pharma industry are looking for new technology, new ideas
for lifecycle management, new formulations, broader service
offerings, more ‘one-stop shopping’ and new ways to
supplement their own internal functions. Patheon has done
well to expand its service offerings in recent years, and we will
continue to search for new technology to assist our clients.
2005
$10 billion
600
2004
Great opportunities lie ahead
For me personally, this is a great opportunity. At Patheon,
we have within our grasp the tools to become the leading
service provider to the industry. We are re-capitalized and
financially stable. We are supported by an enthusiastic
Board of Directors. We have very talented people, excellent
facilities and a passion for excellence.
I am very proud to be part of this Company and privileged
to be leading the way forward. Patheon is entering a new
phase of its history, at a time when our clients are demanding
more of their service providers. We will be ready and we will
not let them down.
Thank you for your investment and support.
(signed)
Wesley P. Wheeler
11
Management’s
Discussion and
Analysis
13 Note to the Reader
13 Cautionary Note Regarding Forward-Looking Statements
13 Use of Non-GAAP Financial Measures
14
Company Profile and Strategy
14
15
15
16
17
18
19
21
Performance Analysis
About Patheon
Vision and Strategy
Overview of Pharmaceutical Industry Outsourcing
Competitors
Recent Developments
Selected Annual Financial Information
Key Performance Drivers
21
28
28
28
29
33
34
Risk Management and Accounting Policies
Results of Operations
Selected Quarterly Financial Information
Seasonal Variability of Results
Outlook for 2008
Liquidity and Capital Resources
Additional Information
34 Risk Management
36 Critical Accounting Policies and Estimates
39 Effectiveness of Disclosure Controls and Internal Controls
This management’s discussion and analysis of financial condition and results of operations (“MD&A”) should be read in conjunction with the
Company’s consolidated financial statements and related notes and Auditors’ Report. The consolidated financial statements have been prepared
in accordance with Canadian generally accepted accounting principles (“GAAP”). All amounts are in U.S. dollars unless otherwise indicated.
This information is current to January 22, 2008.
Other information about the Company, including the Annual Information Form and other disclosure documents, reports, statements or other
information that is filed with Canadian securities regulatory authorities can be accessed through SEDAR at www.sedar.com.
12
Management’s Discussion and Analysis
Note to the Reader
Cautionary Note Regarding Forward-Looking Statements
This MD&A contains forward-looking statements which reflect
management’s expectations regarding the Company’s future
growth, results of operations, performance (both operational and
financial) and business prospects and opportunities. Wherever
possible, words such as “plans”, “expects” or “does not expect”,
“forecasts”, “anticipates” or “does not anticipate”, “believes”,
“intends” and similar expressions or statements that certain
actions, events or results “may”, “could”, “would”, “might” or “will”
be taken, occur or be achieved have been used to identify these
forward-looking statements.
Although the forward-looking statements contained in this
MD&A reflect management’s current assumptions based upon
information currently available to management and based upon
what management believes to be reasonable assumptions, the
Company cannot be certain that actual results will be consistent
with these forward-looking statements.
Forward-looking statements necessarily involve significant known
and unknown risks, assumptions and uncertainties that may
cause the Company’s actual results, performance, prospects
and opportunities in future periods to differ materially from those
expressed or implied by such forward-looking statements. These
risks and uncertainties include, among other things: the market
demand for client products; credit and client concentration;
the ability to identify and secure new contracts; regulatory
matters, including compliance with pharmaceutical regulations;
international operations risks; exposure to foreign currency
risks; competition; product liability claims; intellectual property;
environmental, health and safety risks; substantial financial
leverage; interest rates; conditions of MOVA’s tax exemptions;
divestiture of the Carolina site; significant shareholders; risks
associated with information systems; and supply arrangements.
or intended. There can be no assurance that forward-looking
statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements.
Accordingly, readers should not place undue reliance on forwardlooking statements. These forward-looking statements are made
as of the date of this MD&A and, except as required by law, the
Company assumes no obligation to update or revise them to
reflect new events or circumstances.
Use of Non-Gaap Financial Measures
Except as otherwise indicated, references in this MD&A to
“EBITDA before repositioning expenses” are to earnings from
continuing operations before repositioning expenses, asset
impairment charges, depreciation and amortization, foreign
exchange losses reclassified from other comprehensive income,
interest, refinancing expenses, write-off of deferred financing
costs and income taxes. “EBITDA margin before repositioning
expenses” is EBITDA before repositioning expenses as a
percentage of revenues. EBITDA before repositioning expenses
and EBITDA margin before repositioning expenses are measures
of earnings and earnings margin not recognized by GAAP. Since
each of these measures is a non-GAAP measure that does not
have a standardized meaning, it may not be comparable to similar
measures presented by other issuers.
Readers are cautioned that these non-GAAP measures should
not be construed as alternatives to net earnings (loss) determined
in accordance with GAAP as indicators of performance. The
Company has included these measures because it believes that
this information is used by certain investors to assess financial
performance of the Company, in particular the operating earnings
before non-cash charges and large non-recurring costs.
Although the Company has attempted to identify important risks
and factors that could cause actual actions, events or results
to differ materially from those described in forward-looking
statements, there may be other factors and risks that cause
actions, events or results not to be as anticipated, estimated
13
Company Profile and Strategy
About Patheon
Patheon Inc. (“Patheon” or the “Company”) is a public company,
amalgamated under the Canada Business Corporations
Act, which trades under the symbol PTI on the Toronto Stock
Exchange. The Company, organized and managed as a single
business segment, is an independent provider of commercial
manufacturing and pharmaceutical development services (“PDS”)
of prescription (“Rx”) and over-the-counter (“OTC”) drugs to the
international pharmaceutical industry.
Patheon is focused exclusively on providing commercial
manufacturing and pharmaceutical development services to
pharmaceutical companies, biotechnology companies and
specialty pharmaceutical companies located primarily in North
America, Europe and Japan. Patheon serves its international
clientele from its operating facilities in North America (including
Puerto Rico) and Europe.
and packaging process, from sourcing excipient raw materials
and packaging components to delivering the finished product
in consumer-ready form to the client. Typically, Patheon’s clients
supply the active pharmaceutical ingredients used in the
production process.
In 2007, Patheon’s facilities were audited by 201 separate client
audit teams, representing both prospective and existing clients.
Audits by prospective clients permit them to gain confidence
that Patheon’s operations are conducted in accordance with
applicable regulatory requirements. Audits by existing clients
permit these clients to reaffirm that Patheon’s operations, as they
relate to their products, are conducted in accordance with these
requirements. These audits contribute to Patheon’s ongoing
improvement of manufacturing and development practices.
In addition, there were 18 regulatory audits conducted at the
Company’s sites in North America and Europe.
Patheon provides manufacturing services in accordance with
client specifications. Depending on the particular client, Patheon
may be responsible for some or all aspects of the manufacturing
The pharmaceutical development services provided by Patheon
include most of the dosage form development services typically
required by companies conducting clinical trials and preparing
for full-scale commercial production of a new drug. In providing
its pharmaceutical development services, Patheon is able to:
(i) develop an appropriate dosage form; (ii) develop analytical
methods; (iii) manufacture the proposed new drug product to
client specifications during the regulatory drug approval process;
(iv) manufacture pilot batches of proposed new drug products
for the regulatory drug approval process; and (v) provide scale-up
and technology transfer services designed to validate that a drug
can be manufactured commercially.
Client Base
Revenues by Geographic Region
Patheon commercially manufactures Rx and OTC products in
solid, semi-solid, sterile and liquid dosage forms. Conventional
dosage forms include compressed tablets, hard-shell capsules,
powders, ointments, creams, gels, syrups, suspensions, solutions
and suppositories. Sterile dosage forms include liquids and
powders filled in ampoules, vials, bottles or pre-filled syringes.
Sterile lyophilized products are also manufactured in both vials
and ampoules.
(number of clients)
(based on clients’ billing addresses)
254
275
258
225
220
165
192
150
275
52%
44%
220
United States
Europe
165
110
2%
110
Canada
55
55
0
2004
2005
2006
Other
2007
United States
14
2%
0
2003
Europe
Canada
Other
Patheon offers pharmaceutical development services at five
facilities in North America and Europe. In addition to possessing
pharmaceutical development capabilities for a broad range of
dosage forms, each of Patheon’s PDS units provides a different
specialized pharmaceutical development capability (high
potency, sterile, lyophilization, controlled release and liquid filled
hard capsules). At October 31, 2007, the company was working on
a total of 197 of its clients’ projects in the development pipeline,
including nine drug candidates at the New Drug Application
(“NDA”) stage. Since the beginning of fiscal 2001, 19 new
pharmaceutical products developed by Patheon’s PDS units have
progressed to commercial manufacturing, including two in fiscal
2007. A third new product developed by PDS received regulatory
approval in the third quarter of 2007 and, based on advice from
the Company’s client, is expected to be commercialized in 2008.
Vision and Strategy
Patheon’s vision is to become the world leader in providing
pharmaceutical development and manufacturing services.
Patheon strives to be the preferred manufacturing and
pharmaceutical development services partner to the global
pharmaceutical industry. Patheon’s strategy is focused on
providing “best-in-class” manufacturing and development
services, effectively balancing high product quality and reliability
of supply with cost.
Patheon expects, based on its internal analysis and experience,
that stronger manufacturing and development relationships will
continue to emerge between pharmaceutical companies and
service companies as the pharmaceutical industry continues
to re-evaluate its internal manufacturing capabilities and
streamlines its external service-provider network. The Company
is using its position as a comprehensive provider of commercial
manufacturing services to establish and maintain long-term and
strategic relationships with clients on a global basis.
Prior to 2006, a key aspect of Patheon’s strategy was a plan to
expand capacity, expertise and capabilities through acquisitions,
positioning the Company to be the preferred manufacturing
services partner to the pharmaceutical industry. This led to the
acquisition of several pharmaceutical manufacturing facilities and the entry into long-term manufacturing relationships in conjunction with certain of these acquisitions. More recently, Patheon has focused on growing its Rx commercial manufacturing
and PDS business internally by broadening its service offering
to include differentiated and specialized technologies and
capabilities and expanding the level of business from existing
clients, attracting new clients, and entering into commercial
manufacturing agreements for newly approved products for which
the Company has provided development services.
In implementing its strategy, the Company will continue to seek
to maximize capacity utilization and improve efficiency, broaden
its services to include other manufacturing capabilities, and
seek to increase the percentage of more profitable Rx products
manufactured at its facilities. In addition, the Company will seek to expand its PDS capabilities in North America and Europe to better serve the needs of the global pharmaceutical
industry. Pharmaceutical development services are an important
source of new business for commercial manufacturing of
prescription pharmaceuticals.
Overview of Pharmaceutical Industry Outsourcing
The global pharmaceutical industry comprises global, regional and national pharmaceutical manufacturers
and distributors, biotechnology companies and specialty
pharmaceutical companies.
The focus and operational structures of many global
pharmaceutical companies have undergone significant changes
in the past few years. Many global pharmaceutical companies
are relying on the services of contract product development
and commercial manufacturing companies to help them
meet growing demand and bring new drugs to market more
quickly. As a result, certain competencies such as dosage form
manufacturing and dosage form development are increasingly
being restructured or outsourced to service providers such as
Patheon. Over the last approximately eighteen months, several
global pharmaceutical companies have publicly announced
intentions to restructure their site networks to increase operating
efficiencies and to outsource more of their production.
In addition, more products are being developed by biotechnology
companies, focused on new drug discoveries. Many of these
companies have focused their financial resources on the
development and marketing of their products, rather than
investing in their own manufacturing capacity. As a result, the
demand for third-party dosage form manufacturing services
continues to increase as these smaller companies grow in
number and relative representation within the industry.
Finally, specialty pharmaceutical companies (pharmaceutical
companies focused on in-licensing or acquiring products,
rather than new drug discovery) typically operate in a particular
niche segment, such as drug delivery systems or product
portfolios focused on specific therapeutic categories. These
companies are increasingly in-licensing or developing their own
branded products for which they may not have the necessary
manufacturing capacity or capabilities, and therefore, are turning
to third-party service providers to provide manufacturing services.
15
Company Profile and Strategy (continued)
Patheon’s target markets include the global market for the
manufacture of finished dosage forms and for dosage form
research and development. The size of the market for outsourced
dosage form manufacturing, based on publicly available industry
sources, is estimated to be approximately $10 billion – the
majority of which comprises solid and semi-solid dosage forms,
such as tablets, capsules and creams, a third of which consists
of outsourced manufacturing of injectable products, with the
balance comprising specialty dosage forms. In 2006, the top
400 pharmaceutical and biotechnology companies spent an
estimated $100 billion worldwide on research and development.
Patheon’s management estimates that this amount includes
approximately $3 billion spent on dosage form development, of
which approximately $1 billion is outsourced. The number of new
clinical trials started by pharmaceutical companies continues
to increase. A total of 707 commercial Investigational New Drug
Applications were filed with the FDA’s Center for Drug Evaluation
and Research in 2006, up from 608 in 2005. Pharmaceutical and
biotechnology companies are relying increasingly on contract
drug development suppliers to help move high-potential chemical
entities through the various stages of evaluation more quickly.
Demand for outsourced pharmaceutical development
and commercial manufacturing services is expected to
continue to grow. In addition to pressure on pharmaceutical
and biotechnology companies to reduce costs, Patheon’s
management believes that growth of pharmaceutical industry
outsourcing will be driven by the following factors:
3 growth of the global pharmaceutical industry. According
to leading market research firm IMS Health, global
pharmaceutical industry revenues have grown from $354 billion in 2000 to approximately $643 billion in 2006;
3 global research and development expenditures are increasing;
3 the number of product candidates in development continues to expand;
3 consolidation of the pharmaceutical industry, and supply chain restructuring, are providing new opportunities
as companies seek to reduce excess capacity in their
manufacturing networks;
3 increased demand for specialized manufacturing capabilities in key technical niches (for example, lyophilization); and
3 increased demand for back-up sources of supply.
16
Competitors
In North America and Europe, Patheon’s competition includes:
3 companies, both private and public, that are not focused
exclusively on contract manufacturing, but provide this service
as part of a range of services to the pharmaceutical industry;
3 companies that focus on contract manufacturing, but offer
services in a limited number of dosage forms or serve only their
local or national markets;
3 large pharmaceutical companies that offer third-party
manufacturing services to fill excess capacity; and
3 in addition, in Europe there are a large number of privately
owned, dedicated outsourcing companies that serve only their
local or national markets.
The pharmaceutical development services market is composed
of a range of participants:
3 a large number of laboratories, which offer only a limited range
of development services, generally at a small scale;
3 providers focused on specific technologies and/or dosage
forms; and
3 a few fully integrated companies that can provide the full
complement of services necessary to develop, scale-up and
manufacture a wide range of dosage forms.
In recent years a number of companies in Asia, particularly India,
have been entering the pharmaceutical contract manufacturing
and PDS sectors and have been proceeding with obtaining FDA
approval for some of their plants as well as acquiring additional
plants in Europe and North America.
Recent Developments
Financing Arrangements and Strategic Alternatives
On September 11, 2006, the Company announced that its Board
of Directors had established a special committee to evaluate a
range of strategic and financial alternatives for the Company. As
a result of this review, on April 27, 2007 JLL Partners, through its
investment vehicle, JLL Patheon Holdings, LLC (“JLL Partners”)
purchased $150 million of convertible preferred shares and
special voting preferred shares of the Company through a private
placement. On April 27, 2007 the Company also completed
new credit facilities in the aggregate amount of $225 million,
comprising a seven-year $150 million term loan and a five-year
$75 million revolving facility.
The net proceeds from the JLL Partners investment and the seven-year term loan were used to repay the Company’s
obligations under its existing North American and U.K. credit facilities.
Restructuring the Canadian Site Network
On April 17, 2007 the Company announced that as part of its strategy to focus on developing and manufacturing Rx pharmaceutical products and to improve the Company’s
profitability, it plans to restructure its current network of six pharmaceutical manufacturing facilities in Canada.
In connection with this initiative, on December 6, 2007 the Company announced that it had entered into a definitive
agreement to sell its Niagara-Burlington OTC commercial
manufacturing business to Pharmetics Inc. Under the terms of the agreement Pharmetics will acquire the assets, including
equipment, facilities and land at the Company’s facilities in
Fort Erie and Burlington (Gateway Drive). Pharmetics will
provide employment to the entire active workforce of about
250 commercial manufacturing employees at the two sites
and, subject to assignment of third party contracts, will continue
to manufacture and supply all of the products currently
manufactured at these sites. The Company is retaining its leased
Burlington Century facility where its central quality control
laboratory is based.
The transaction is expected to be completed on or about January 31, 2008, subject to closing conditions including
regulatory approvals, the assignment of client and other contracts
and the completion of financing arrangements by the purchaser.
The purchase price for the business is CAD$5.75 million plus
working capital, subject to adjustments.
The Company also plans to close its York Mills, Toronto facility and
transfer substantially all commercial production and development
services to its site in Whitby and sell the land and buildings. A smaller portion of the York Mills operations will be transferred to
the Toronto Region Operations and Cincinnati facilities. Based on
current internal projections, the process of transferring production
to other facilities is expected to be completed by the end of the
first half of fiscal 2009. On December 31, 2007, the Company
entered into a binding agreement of purchase and sale for the sale
of the York Mills property for a purchase price of CAD$12.5 million,
including a non-refundable deposit of CAD$1.0 million. Subject to obtaining the required closing documentation, the sale is
scheduled to close by March 31, 2008, with Patheon leasing back the facility for up to two years in order to facilitate the
decommissioning process. Based on current deployment plans,
the Company expects that most, if not all, of the employees at the
York Mills facility will have an opportunity to transfer to the Whitby
facility or to another site in the Patheon network.
The assets and the related liabilities of the Niagara-Burlington
Operations, along with the York Mills real estate, have been
classified as held for sale on the balance sheet in the consolidated
financial statements.
Restructuring the Puerto Rico Operations
During fiscal 2007, the Company conducted a comprehensive
review of its Puerto Rican operations, with a focus on restructuring
the operations, eliminating operating losses and developing a
long-term plan for the business.
On December 14, 2007, the Company announced that, as a result
of this review, it had decided to retain and continue to streamline
its facilities in Caguas and Manati and to divest its facility in
Carolina, Puerto Rico. The decision follows the genericization
of Omnicef® in May 2007 and the resulting significant drop in
revenues at the facility. (1)
The Carolina site is a 230,000-square-foot facility, with
approximately 200 employees, that specializes in the manufacture
of oral cephalosporin solid dosage forms, including tablets,
capsules and powders for suspension. It currently manufactures
four products on behalf of six clients.
The Company has concluded that Carolina, a high-quality site
with specialized capabilities and expertise, would be of greater
strategic value to another company with a focus on manufacturing
oral cephalosporins. The divestiture will allow the Company to
focus on improving operating performance and growing the
business at the Caguas and Manati facilities.
Based on current divestiture plans and subject to future
negotiation, the Company expects to provide that any purchaser
will assume responsibility for the staff at the Carolina facility and
contracts with third parties, subject to their approval. Patheon has
retained an advisor to manage the sale of the Carolina site.
(1) Omnicef is a registered trademark of Astellas Pharma, Inc.
17
Normal Course Issuer Bid
In October 2007, the Company commenced a normal course
issuer bid, pursuant to which it may acquire from time to time
through the facilities of the Toronto Stock Exchange up to 4.6 million restricted voting shares, representing approximately 5% of the restricted voting shares outstanding at the time of the
bid’s commencement. The Company commenced the normal
course issuer bid because the Board of Directors and
management believed that from time to time the market price of
the restricted voting shares could be such that their repurchase
might be an attractive and appropriate use of corporate funds. As at October 31, 2007, the Company had repurchased and
cancelled 2,334,300 restricted voting shares at a cost of $8.8 million.
The normal course issuer bid will expire in October 2008.
Selected Annual Financial Information
The following is selected financial information for the three most recent fiscal years:
(in thousands of U.S. dollars, except per share amounts)
2007
$
2006
$
2005
$
Revenues
Earnings (loss) from continuing operations before repositioning expenses and asset impairment charge
Basic and diluted earnings (loss) per share from continuing operations before repositioning expenses and asset impairment charge
Net earnings (loss)
Basic and diluted earnings (loss) per share
Total assets
Total long-term liabilities
Cash dividends
677,074 674,659 658,856
(21,791)
(25,185)
19,693
($0.24)
(94,601)
($1.02)
829,617 440,727 –
($0.28)
(288,150)
($3.10)
826,183 144,246 –
$0.23
21,621
$0.25
1,051,568
351,283
–
A reconciliation of net earnings (loss) and earnings (loss) per share from continuing operations, before repositioning expenses and asset
impairment charge, with net earnings (loss) and earnings (loss) per share from continuing operations is as follows:
(in thousands of U.S. dollars, except per share amounts)
18
2007
(Loss)
$
EPS 2006
(Loss)
$
EPS 2005
Earnings $
EPS
Net earnings (loss) from continuing operations
Repositioning expenses
Income taxes related to repositioning expenses
Asset impairment charge
Income taxes related to asset impairment charge
(84,458)
15,800 (932)
48,580 (781)
($0.91)
$0.17 ($0.01)
$0.52 ($0.01)
(288,719)
12,998 (1,564)
254,661 (2,561)
($3.11)
$0.14 ($0.02)
$2.74 ($0.03)
19,693 –
–
–
–
$0.23
–
–
–
–
Net earnings (loss) from continuing operations before repositioning expenses and asset impairment charge
(21,791)
($0.24)
(25,185)
($0.28)
19,693 $0.23
Changes in revenues, net earnings (loss) before repositioning
expenses and asset impairment charge, net earnings (loss) and
related basic and diluted earnings (loss) per share between 2007
and 2006 are explained in the “Results of Operations” section in
this MD&A. The decline in earnings from continuing operations
before repositioning expenses and asset impairment charge
in 2006 relative to 2005 principally reflected a reduction in the
profitability of the Caguas and Carolina operations in Puerto Rico.
In Caguas, profitability was impacted by declines in base business
volumes and the suspension of production during the third quarter
of 2006 of a major product due to concerns over product shelf life.
In Carolina, profitability was impacted during the first half of 2006
by an FDA warning letter, which resulted in additional costs and
operating inefficiencies.
The increase in long-term liabilities in 2007 compared with
2006 is due to the completion of a $150 million long-term senior
secured debt facility and the issue of $150 million of convertible
preferred shares to JLL Partners. The proceeds from these
financing activities were used to repay existing debt facilities in
North America and the U.K. In 2006, these debt facilities were
classified within current liabilities.
The reduction in long-term liabilities in 2006 compared with 2005 was due to the reclassification of long-term debt to short-term indebtedness as a result of the likelihood of potential
future covenant defaults under the Company’s prior North
American credit facilities. The reduction in total assets in 2006
compared with 2005 was principally due to an asset impairment
charge which wrote down the carrying value of long-lived
depreciable assets and goodwill in the Puerto Rico operations, as explained in note 4 to the Company’s 2007 audited
consolidated financial statements.
Key Performance Drivers
The Company has identified several performance drivers that are
key to its operating performance: (i) generating higher-quality
revenues by increasing the percentage of more profitable Rx and
PDS business at its facilities; (ii) improving capacity utilization and
operating efficiencies at its sites; and (iii) managing the impact of
changes in the foreign exchange trading relationship between the
Canadian and U.S. dollar.
(i) Generating higher-quality revenues
Patheon continues to pursue its strategy of focusing resources
and capital on increasing the percentage of revenues
generated from providing higher-margin Rx manufacturing and
pharmaceutical development services. As part of this strategy,
on December 6, 2007 the Company announced that it had
entered into a definitive agreement to sell its Niagara-Burlington
operations that are focused on the commercial manufacturing
of OTC products. In 2007, prescription manufacturing services
and pharmaceutical development services comprised 93% of
revenues from continuing operations, excluding the NiagaraBurlington OTC operations, compared with 90% in 2006.
Patheon’s ability to provide its clients with integrated drug
development, scale-up and commercial manufacturing services
across a broad range of capabilities is a unique offering and a
key competitive advantage. It reduces the need for its clients to
incur costly and time-consuming transfers between facilities of
products in development, thereby providing strategic benefits
to clients who are seeking to bring new drugs to market more
quickly. From the Company’s perspective, pharmaceutical
development services are provided on a fee-for-service basis at
relatively attractive margins, and the products being developed,
if approved, can be an important source of new business for the
Company’s commercial manufacturing operations.
(ii) Improving capacity utilization
and operating efficiency
The Company’s operating sites’ cost structure is largely fixed
in the short term. Therefore, unanticipated fluctuations in
manufacturing activity can have a significant impact on profit
margins. The Company continues to focus on improving capacity
utilization at all of its sites by entering into new commercial
manufacturing agreements with new and existing clients. The
Company also continues to evaluate how to best utilize the
amount of available capacity in its network.
On April 17, 2007, the Company announced that it intends to
close its York Mills site in Toronto and transfer substantially
all commercial production and development services at the
facility to its Whitby, Mississauga and Cincinnati sites. This
closure is expected to improve profitability by reducing excess
manufacturing capacity and reducing ongoing anticipated capital
expenditure requirements. The transfers are expected to be
completed by the end of the first half of fiscal 2009.
On December 14, 2007, the Company also announced that
it intended to divest its facility in Carolina, Puerto Rico that
manufactures oral cephalosporin solid dosage form products.
This decision was made following a significant reduction in
capacity utilization at the facility during the fourth quarter of 2007,
as a result of the emergence of generic competition for Omnicef®,
the single largest volume product manufactured at the site.
19
In 2007, the Company continued with its performance
enhancement program that was initiated in 2006, with an aim of improving operating results. The program consists of three
main initiatives:
3 a global procurement program;
3 a workforce reduction program; and
3 a manufacturing efficiency review by external advisors.
The objective of the global procurement program is to leverage
the Company’s global purchasing power to reduce costs,
reducing the number of vendors and reducing the Company’s
investment in working capital through better payment terms and
vendor managed inventory. The Company successfully negotiated
contracts which resulted in cost savings in fiscal 2007 from
lower pricing and volume rebates on inventory items, such as
excipients and packaging components, as well as non-inventory
consumables and services, including laboratory supplies and
waste management services.
Patheon continued to reduce the size of its global workforce
during 2007 by approximately 520 positions, or 9%, to
approximately 5,100 full-time equivalent positions as at October 31, 2007, (approximately 4,900 at December 31, 2007).
These reductions were undertaken principally in the Caguas and Carolina operations in Puerto Rico to address production
volume declines.
During 2006, Patheon undertook a manufacturing efficiency
review process in respect of its Whitby operations and
implemented a number of operational improvements that led to
significant gains in production throughput and labour efficiency.
In 2007, the Company extended its manufacturing efficiency
review process to other sites in the Company’s network, including
the Toronto Region Operations, Cincinnati and Swindon sites
and PDS in Canada. In 2007, follow-up audits were conducted in
Whitby, Toronto Region Operations, and Cincinnati which verified
improvements in production throughput and labour efficiency. A similar audit is planned for Swindon and PDS Canada in
2008. As well, by late 2007, planning had begun to identify future improvement initiatives in 2008.
20
(iii) Managing the impact of
foreign exchange fluctuations
Because the Company’s client service contracts in North America
are primarily in U.S. dollars, the profitability of the Company’s
Canadian operations can be impacted by significant changes in
the foreign exchange trading relationship between the Canadian
and U.S. dollar. Approximately 70% of revenues and approximately
20% of operating expenses of the Canadian operations are
transacted in U.S. dollars. The Company has to convert a portion
of its net U.S. dollar inflow to Canadian dollars to finance the
Canadian dollar expenses of its Canadian sites. A one-cent
change in the U.S./Canadian dollar exchange rate is estimated
to impact pre tax earnings by approximately $0.9 million on an
annual basis, before the impact of the hedging program. As
discussed in the “Risk Management” section of this MD&A, the
Company employs a hedging program to mitigate the impact of this risk.
At October 31, 2007, the balance sheet of the Company’s
Canadian operations included $229.5 million of U.S. dollar
denominated debt (including the debt component of the
Company’s convertible preferred shares). The Canadian
operations are required to revalue the Canadian dollar equivalent
of the U.S. dollar denominated debt at each period end. At
October 31, 2007, $141.6 million of this debt was designated
as an effective hedge against the Company’s investments in
subsidiaries in the U.S.A. and Puerto Rico. All foreign exchange
gains and losses associated with the debt that is considered to be
an effective hedge are recorded in other comprehensive income.
Foreign exchange gains and losses from the remaining debt are
recorded in earnings. In October 2007, the Company entered into
a forward foreign exchange contract to reduce the related impact
on earnings. In 2007, the Company recorded foreign exchange
gains, net of hedging activities, in the loss from continuing
operations, in connection with this exposure of $12.3 million.
Performance Analysis
Results of Operations
The results of operations for Niagara-Burlington have been segregated and presented separately as discontinued operations. All comparative amounts have been reclassified to conform to the current period presentation.
Results of Consolidated Operations
(in thousands of U.S. dollars, except percentages and per-share amounts)
Revenues
Operating expenses
Foreign exchange gain on debt
Earnings before the following:
2006
$
%
Change
677,074 599,087 (12,331)
674,659 603,783 –
0%
–1%
90,318 70,876 27%
(as a % of revenues)
13.3%
10.5%
Depreciation and amortization
Amortization of intangible assets
Foreign exchange loss on foreign operations
Interest Refinancing expenses
Amortization of deferred financing costs
Write-off of deferred financing costs
15,800 48,580 40,979 6,687 858 29,167 13,471 –
–
12,998 254,661 38,766 11,871 –
21,333 1,643 944 6,332 Loss before income taxes
Provision for (recovery of) income taxes
Current
Future
(65,224)
(277,672)
77%
14,617 4,617 17,725 (6,678)
–18%
–169%
Provision for income taxes 19,234 11,047 74%
(84,458)
(288,719)
71%
Earnings (loss) from discontinued operations
–12.5%
(10,143)
–42.8%
569 –1883%
Net loss for the year
(94,601)
(288,150)
67%
From continuing operations
From discontinued operations
($0.91)
($0.11)
($3.11)
$0.01 71%
–1200%
($1.02)
($3.10)
67%
2007
$
22%
–81%
6%
–44%
37%
720%
21
Performance Analysis (continued)
Revenues
Revenues by Geographic Region and Service Activity
(in thousands of U.S. dollars, except percentages)
2007
$
2006
$
%
Change
North America
Prescription
Over-the-counter
270,515 43,076 309,379 66,327 –13%
–35%
Development Services
313,591 84,532 375,706 74,986 –17%
13%
398,123 450,692 –12%
Europe
Prescription
Over-the-counter
243,554 3,473 197,353 3,646 23%
–5%
247,027 31,924 200,999 22,968 23%
39%
278,951 223,967 25%
Total
Prescription
Over-the-counter
514,069 46,549 506,732 69,973 1%
–33%
560,618 116,456 576,705 97,954 –3%
19%
Consolidated Revenues
677,074 674,659 0%
Revenues
Revenues by Geographic Region*
658.9
700
674.7
677.1
700
700
658.9
674.7
677.1
197.7
217.6
195.1
600
525
500
432.9
360.0
525
350
203.0
139.3
350
300
122.9
600
500
432.9
360.0
400
700
256.4
233.1
400
300
119.0
200
175
0
0
2003
2004
2005
2006
204.8
2003
2004
2005
2006
279.0
100
0
2007
* Based on site location
174.6
224.0
154.5
0
Canada
22
200
82.6
175
100
U.S.
Europe
2007
Consolidated revenues from continuing operations for the year
ended October 31, 2007 increased $2.4 million to $677.1 million
from $674.7 million in 2006. Rx manufacturing and PDS revenues
grew by 1% and 19%, respectively, while OTC manufacturing
revenues declined by 33%.
For the year ended October 31, 2007, revenues excluding the
Puerto Rico operations were $577.3 million, compared with
$544.9 million in 2006.
Prescription manufacturing and development services
represented 93% of revenues in 2007, compared with 90% in
2006. This improvement is consistent with one of the Company’s
key performance drivers of increasing the percentage of highermargin Rx and PDS business.
Geographically, in North America, revenues for the year ended
October 31, 2007 declined by $52.6 million or 12% relative to
the prior year. The decline reflected a significant reduction
in OTC volumes in the Whitby and Cincinnati operations as
certain clients have repatriated products back to their own
manufacturing networks. Rx volumes declined in Caguas and
Carolina, Puerto Rico as a result of lower production of Zocor®
and Omnicef®, both of which were impacted by the introduction
of competitive generic products, and from lower volumes of
Levothyroxine sodium, where the Company’s client suffered a
significant decline in market share (2). Rx revenues were also lower
in Canada principally as a result of lower volumes for a product
where in 2006 the Company’s client was building trade inventory
levels for a newly launched product. The declines in commercial
manufacturing revenues were offset in part by an increase in PDS
revenues in Canada and Cincinnati.
In Europe, revenues for the year ended October 31, 2007 were
$55.0 million or 25% higher than 2006. The increase in revenues
reflected higher Rx manufacturing revenues from operations in
Italy and France, arising from the continued benefits from two
carve out initiatives, where the Company is manufacturing a
range of products for two clients that have closed down facilities
within their own manufacturing networks. In Swindon, U.K. the
PDS operations also continued to show further increases in
volumes, but these gains were offset in part by lower pre-launch
commercial revenues for cephalosporin lyophilization services
and production delays during the fourth quarter. In 2007, the
Euro and U.K. sterling strengthened approximately 9% and 10%,
respectively, against the U.S. dollar compared with the prior year,
increasing reported revenues by approximately $22.9 million. Had
European currencies remained constant to the rates of the prior
year, European revenues would have been 14% higher than in 2006.
Operating Expenses
Operating expenses comprise processing costs (principally
materials, employee and other site-related costs), marketing,
sales, service, corporate support, administrative expenses and
foreign exchange gains and losses relating to operating activities.
For the year ended October 31, 2007 operating expenses were
$599.1 million, compared with $603.8 million in the same period
a year ago, a decline of 1%. The decline reflects savings from
the performance enhancement program, offset in part by the
strengthening European and Canadian currencies relative to the
U.S. dollar. Operating expenses in 2007 are net of an actuarial
gain of $4.3 million arising from a decision to phase out certain
post retirement benefits in the Canadian operations.
Operating expenses as a percentage of revenues were 88.5%,
compared with 89.5% in the prior year.
Revenues by Service Activity
100
11%
100
15%
14%
15%
17%
75
75
72%
50
70%
75%
75%
76%
25
50
25
17%
15%
11%
10%
7%
2003
2004
2005
2006
2007
0
PDS
Rx
0
OTC
(2) Zocor is a registered trademark of Merck & Co., Inc.
23
Foreign Exchange Gain on Debt
The foreign exchange gain of $12.3 million recorded in the year ended October 31, 2007 related to the revaluation of U.S. dollar denominated debt in the Canadian legal entity that is not designated as an effective hedge against its investments in subsidiaries in the U.S.A and Puerto Rico. In October 2007, the Company entered into a forward foreign exchange contract to reduce the future related impact on earnings.
EBITDA Before Repositioning Expenses and
EBITDA Margin Before Repositioning Expenses
In 2007, EBITDA before repositioning expenses, representing
earnings from continuing operations before repositioning
expenses, asset impairment charges, depreciation and
amortization, foreign exchange losses reclassified from other
comprehensive income, interest, refinancing expenses, write-off
of deferred financing costs, and income taxes was $90.3 million,
an increase of $19.4 million, or 27%, from 2006. EBITDA margin
before repositioning expenses was 13.3% in 2007, compared with
10.5% in 2006.
For the year ended October 31, 2007, EBITDA before repositioning
expenses excluding the Puerto Rico operations was $108.6
million, compared with $69.5 million in the same period last
year. This represented an EBITDA margin before repositioning
expenses of 18.8% in 2007, compared with 12.7% in 2006.
The Canadian commercial operations reported EBITDA before
repositioning expenses of $29.5 million in 2007, or $6.9 million
higher than in 2006. This improvement was achieved despite
lower Rx and OTC volumes and reflected savings from the
EBITDA Before Repositioning Expenses
EBITDA before repositioning expenses from the U.S.A. commercial
operations (including Puerto Rico) in 2007 was a loss of $7.2 million,
compared with a profit of $14.0 million in 2006. The decline
principally reflects a reduction in Rx manufacturing volumes in the
Caguas facility in Puerto Rico. In Carolina, volume declines were
offset by benefits from the performance enhancement program.
In Cincinnati, volume declines were offset by savings from the
performance enhancement program and a change in the revenue
mix to higher margin Rx business.
In Europe, EBITDA before repositioning expenses from
commercial operations in 2007 was $36.9 million, being $10.1 million higher than in 2006. The improvement reflects
increased volumes in the operations in Italy and France,
offset in part in Swindon by lower pre-launch revenues for the
cephalosporin lyophilization services, fourth quarter production
delays and foreign exchange losses. The stronger European
currencies relative to the U.S. dollar compared with the same
period last year also had the impact of increasing EBITDA before
repositioning expenses by approximately $2.9 million.
EBITDA Margin Before Repositioning Expenses
(% of revenues)
94.0
100
performance enhancement program, in particular at the Whitby
operations. The improvement also included a significant portion of the actuarial gains arising from a change in the Company’s post retirement benefit plans. EBITDA before repositioning
expenses was not significantly impacted by foreign exchange, as the negative earnings impact of the 3% increase in the average
Canadian dollar exchange rate relative to the U.S. dollar was offset
by foreign exchange gains from the Company’s cash flow hedging program.
90.3 (3)
15
14.3%
100
13.3% (3)
12.6%
50
12
70.9 (2)
75
45.3
11.5%
12
10.5% (2)
75
9
49.8 (1)
9
50
6
25
3
0
0
2003
2004
2005
2006
(1) Before Swindon, U.K. repositioning expenses of $4.4 million
(2) Before global repositioning expenses of $13.0 million
(3) Before global repositioning expenses of $15.8 million 24
15
(1)
2007
6
25
3
0
0
2003
2004
2005
2006
(1) Before Swindon, U.K. repositioning expenses of $4.4 million
2007
EBITDA before repositioning expenses from the global PDS
operations in 2007 was $30.7 million, being $10.7 million higher
than in 2006. The improved profitability was a result of growing
volumes across all operations.
Corporate costs in 2007 reflected a net recovery of $0.4 million,
compared with costs of $12.4 million in 2006. The 2007 recovery
included foreign exchange gains of $12.3 million arising from
the revaluation of U.S. dollar denominated debt, net of hedging
activities, held in the Canadian legal entity. In October 2007, the Company hedged its net U.S. dollar balance sheet exposure,
which is expected to reduce future volatility.
Repositioning Expenses
In 2007, the Company incurred repositioning expenses of $15.8 million in connection with its performance enhancement
program, the site rationalization program in Puerto Rico and
Canada and its review of strategic and financial alternatives.
The expenses included consulting fees associated with the
manufacturing efficiency review, costs associated with reductions
in the workforce and professional and other costs in connection
with the strategic alternatives review.
In 2006, the Company incurred $13.8 million of expenses
in connection with its performance enhancement program,
amendments to its North American bank financing facilities and
its review of strategic and financial alternatives. The expenses
included costs associated with a reduction in the workforce and
consulting and professional fees.
Asset Impairment Charge
In 2007, it was determined that the carrying value of the intangible
assets and depreciable tangible capital assets (collectively the
“long-lived depreciable assets”) at the Company’s operations in
Carolina, Puerto Rico were impaired as a result of volume declines
arising from the genericization of Omnicef®, the largest single
product that is manufactured at the facility. The Company tested
the recoverability of the long-lived depreciable assets at the
Carolina operations and determined that the expected future cash flows over the economic life of the principal assets were less than the carrying value of the long-lived depreciable assets.
As a result, the Company recorded an impairment charge of $48.6 million; $26.1 million for intangible assets and $22.5 million
for tangible capital assets. The fair value of the intangible assets
was determined using a discounted cash flow methodology and the fair value of the tangible capital assets was based on a weighted average continued use and liquidation value.
In 2006, the Company determined that the carrying value of the
long-lived depreciable assets at the Company’s operations in
Caguas and Manati, Puerto Rico and the goodwill associated with all of the Puerto Rico operations were impaired as a result of certain events which occurred during the third quarter of 2006.
These events included: continued deterioration in revenues
culminating in a significant increase in losses reported in the third quarter of 2006; suspension of production of a major product
due to concerns over product shelf life; the risk of a decline in
revenue of another major product as a result of the approval by
the U.S. Food and Drug Administration of a generic version of the
product; and the completion of a long-range plan that showed a
significant reduction in earnings relative to prior forecasts.
The Company tested the recoverability of the long-lived
depreciable assets for all of the Puerto Rico operations and
determined that at Caguas and Manati the expected future cash flows over the economic life of the principal assets were less than the carrying value of the long-lived depreciable assets.
As a result, the Company recorded an impairment charge of
$81.4 million; $51.9 million for intangible assets and $29.5 million
for tangible capital assets. The fair value of the intangible assets
was determined using a discounted cash flow methodology and
the fair value of tangible capital assets was based on a value in
continued use, taking into account utilization levels.
In 2006, the Company also tested the recoverability of the
goodwill associated with Puerto Rico operations using a
discounted cash flow methodology, and recorded an impairment
charge of $172.5 million representing the full value of the Puerto Rico goodwill.
In 2006, the Company, as part of its ongoing review of long-term
investments, concluded that its investment in the shares of a drug
technology company which was accounted for on the cost basis
had an other than temporary decline and wrote down its value by
$0.8 million to its market value as of July 31, 2006.
25
Depreciation and Amortization Expense
Depreciation and amortization expense, excluding amortization of intangible assets, was $41.0 million in 2007, compared with
$38.8 million in 2006, an increase of $2.2 million, or 6%. The
increase principally reflected the effect of the strengthening
European and Canadian currencies relative to the U.S. dollar,
offset in part by lower depreciation charges from the Puerto Rico
operations as a result of the impairment charges recorded in 2007
and 2006. Depreciation and amortization expense includes the
amortization of deferred pre-operating costs.
Amortization of Intangible Assets
The amortization of intangible assets was $6.7 million in 2007,
compared with $11.9 million in 2006. The amortization of
intangible assets relates to the Puerto Rico operations. The
charge was lower than for the same period last year due to the
impact of the impairment charges recorded during the third
quarters of 2007 and 2006.
Foreign Exchange Loss on Foreign Operations
In 2007, the Company recorded a net foreign exchange loss
of $0.9 million. This reflected the recognition of net foreign
exchange translation losses previously recorded in accumulated
other comprehensive income, arising from a change in the
Company’s internal capital structure.
Net Earnings (Loss) From Continuing Operations Before
Repositioning Expenses and Asset Impairment Charge
20
Interest Expense and Amortization
of Deferred Financing Costs
The interest expense in 2007 was $29.2 million, compared with
$21.3 million in 2006. The increase in interest costs in the first
half of the year reflected higher debt levels, along with increased
borrowing costs as a result of the amendments to the Company’s
North American loan facilities. The interest expense in the second
half of 2007 reflected the impact of the Company’s refinancing
that was completed on April 27, 2007 and included a non-cash
accretive interest charge of $7.1 million in respect of the debt
component of the convertible preferred shares.
In 2007, the Company adopted CICA Accounting Standard
Section 3855 for the accounting of financial instruments,
including its policy on deferring costs of obtaining bank and other
debt financing (see “Critical Accounting Policies and Estimates”).
As a result, amounts that in prior periods were recorded as
amortization of deferred financing costs are now recorded in
interest expense.
Refinancing Expenses and Write-off
of Deferred Financing Costs
In 2007, refinancing expenses of $13.5 million were incurred
in connection with the Company’s refinancing that took place
on April 27, 2007 (see “Recent Developments”). The expenses
were made up of transaction costs for the new credit facilities,
transaction costs allocated to the debt portion of the convertible
preferred shares and repayment charges in connection with the
cancellation of certain of the Company’s U.K. debt facilities.
EPS – Basic (Before Repositioning Expenses and
Asset Impairment Charge)
(in U.S. cents)
19.7
16.3
40
12.6 (1)
20
40
32
25 (1)
10
10
23
20
0
20
0
-10
0
-20
-10
0
-20
(25.2) (2)
-30
(21.8) (3)
-20
-20
-30
(28)
-40
-40
2003
2004
2005
2006
2007
(1) Before Swindon U.K. repositioning expenses of $3.1 million after tax
(2) Before global repositioning expenses of $11.4 million after tax and an asset impairment charge of $252.1 million after tax
(3) Before global repositioning expenses of $14.9 million after tax and an asset impairment charge of $47.8 million after tax
26
(2)
(24) (3)
-40
-40
2003
2004
2005
2006
2007
(1) Before Swindon, U.K. repositioning expenses of 6 cents per share after tax
(2) Before global repositioning expenses of 12 cents per share after tax and an asset impairment change of $2.71 after tax
(3) Before global repositioning expenses of 16 cents per share after tax and an asset impairment charge of 51 cents per share after tax
In 2006, the Company incurred charges of $1.6 million in
connection with the cancellation and prepayment of certain of its North American credit facilities. The Company also wrote off $6.3 million in related deferred financing costs.
Loss Before Income Taxes
from Continuing Operations
The Company reported a loss before income taxes of $65.2 million
for the year ended October 31, 2007, compared with a loss before
income taxes of $277.7 million in 2006.
Income Taxes
The income tax expense for the year ended October 31, 2007 was $19.2 million, compared with $11.0 million in 2006. The
income tax charge in 2007 principally reflected high tax rates in Italy where the Company reported increased taxable income,
compounded by tax losses in certain entities in Puerto Rico and Canada, where the tax benefit after valuation reserves was not recognized. The 2007 expense included a charge of $2.1 million in connection with an inter-company dividend
payment and a charge of $1.9 million in connection with the
transfer of net foreign exchange losses from accumulated other comprehensive income. The 2006 charge included a
valuation reserve charge of $6.4 million against future tax asset
balances in the Canadian operations.
Loss and Loss Per Share from Continuing Operations
The Company recorded a loss from continuing operations for the year ended October 31, 2007 of $84.5 million, compared with
a loss of $288.7 million in the same period a year ago. The loss per share was 91¢ compared with $3.11 a year earlier. The loss in 2007 included an after tax asset impairment charge of $47.8 million, or 51¢ per share, after tax repositioning expenses of
$14.9 million, or 16¢ per share and after tax refinancing expenses
of $12.6 million, or 14¢ per share. The loss in 2006 included an after tax asset impairment charge of $252.1 million, or $2.71 per share, after tax repositioning expenses of $11.4 million
or 12¢ per share and after tax refinancing expenses and charges
for the write-off of deferred financing costs of $6.2 million, or 7¢ per share.
Earnings (Loss) and Earnings (Loss) Per Share
from Discontinued Operations
Discontinued operations include the results of the NiagaraBurlington Operations. The results from discontinued operations
for the years ended October 31, 2007 and 2006 were as follows:
(in thousands of U.S. dollars)
2007
$
2006
$
35,244 32,475 37,493
34,580
Earnings before the following:
2,769 2,913
Repositioning expenses (recovery of)
7.9%
12,465 7.8%
–
(397)
844 789
1,112
Earnings (loss) before income taxes
Provision for income taxes (10,143)
–
1,012
443
Earnings (loss) from
discontinued operations
for the year
(10,143)
569
Revenues
Operating expenses
The net loss from discontinued operations for the year ended
October 31, 2007 was $10.1 million, or 10.9¢ per share compared
with net earnings of $0.6 million or 1¢ per share in 2006. The net
loss in 2007 included an asset impairment charge of $12.5 million,
or 13¢ per share to write down the capital assets to their fair
market value less the estimated cost to sell.
Net Loss and Loss Per Share
The Company recorded a net loss for the year ended October 31, 2007 of $94.6 million or $1.02 per share, compared
with a loss of $288.2 million or $3.10 per share in 2006.
Because the Company reported a loss in the years ended October 31, 2007 and 2006 there is no impact of dilution.
27
Selected Quarterly Financial Information
The following is selected financial information for the eight most recent quarters:
Quarter ended
(in thousands of U.S. dollars,
except per share amounts)
Revenues
$
EBITDA
Before
Repositioning
Expenses
$
2007
January 31
April 30
July 31
October 31
162,808 171,966 175,508 166,792 22,793 23,153 23,138 21,234 (2,188)
(22,552)
(50,668)
(9,050)
($0.02)
($0.24)
($0.55)
($0.10)
(2,024)
(21,986)
(63,069)
(7,522)
($0.02)
($0.24)
($0.68)
($0.08)
677,074 90,318 (84,458)
($0.91)
(94,601)
($1.02)
2006
January 31
April 30 July 31 October 31
150,013 180,157 178,739 165,750 13,880 23,244 14,990 18,762 (11,408)
2,549 (257,698)
(22,162)
($0.12)
$0.03 ($2.78)
($0.24)
(11,510)
2,989 (257,213)
(22,416)
($0.12)
$0.03
($2.77)
($0.24)
674,659 70,876 (288,719)
($3.11)
(288,150)
($3.10)
The loss from continuing operations in the quarter ended April 30, 2007 included after tax asset refinancing expenses of $14.9 million or 16¢ per share. The loss from continuing
operations in the quarter ended July 31, 2007 included an after tax asset impairment charge of $47.8 million or 51¢ per share. The loss from continuing operations for the quarter ended January 31, 2006 included refinancing expenses and charges for
the write-off of deferred financing costs of $6.2 million, or 7¢ per
share. The loss from continuing operations for the quarter ending
July 31, 2006 included an after tax asset impairment charge of
$252.1 million, or $2.71 per share. The loss from continuing
operations for the quarter ending October 31, 2006 included an after tax charge for repositioning expenses of $11.4 million, or 12¢ per share.
Seasonal Variability of Results
Historically, the Company’s manufacturing and PDS revenues
typically have been lower in the first fiscal quarter. The Company
attributes this to several factors, including: (i) many clients
reassess their need for additional product in the last quarter of
the calendar year in order to use existing inventories of products;
28
Net Earnings
(Loss) From
Continuing
Operations
$
Basic and Diluted
Earnings (Loss)
Per Share From
Continuing
Operations
$
Net Earnings
(Loss)
$
Basic and Diluted
Earnings (Loss)
Per Share
$
(ii) the lower production of seasonal cough and cold remedies;
(iii) many small pharmaceutical and small biotechnology clients
involved in PDS projects limit their project activity toward the end
of the calendar year in order to reassess progress on their projects
and manage cash resources; and (iv) the Patheon-wide plant
shut-down during a portion of the traditional holiday period in
December and January. Revenues in the fourth fiscal quarter are
also typically impacted by summer shut downs during August in
the European operations.
Outlook for 2008
Due to normal shut downs during December and other seasonal
factors, revenues from continuing operations in the first quarter
of 2008 are anticipated to be lower than the fourth quarter of
2007. Revenues from continuing operations for fiscal 2008 are
expected to be comparable to 2007. This expectation is based on
internal management forecasts, which in turn are based on client
purchase orders and forecasts of anticipated demand and other
factors. These internal management forecasts were prepared
for internal planning purposes and may not be appropriate for
forecasting future financial results or for other purposes.
Liquidity and Capital Resources
Summary of Cash Flows
The following table summarizes the cash flows for the periods indicated:
2007
$
Foreign exchange loss on foreign operations
Accreted interest on convertible preferred shares
Write-off of deferred financing costs
Amortization of deferred financing costs
Employee future benefits, net of contributions
Future income taxes
Amortization of deferred revenues
Other Working capital
Increase in deferred revenues
(84,458)
48,580 47,666 858 (12,331)
7,054 –
1,657 (4,846)
4,617 (2,021)
2,087 (2,442)
2,065 Cash provided by operating activities of continuing operations
Cash provided by operating activities of discontinued operations
8,486 3,105 2006
$
(288,719)
254,661
50,637
–
–
–
6,332
944
1,112
(6,678)
(1,978)
1,587
20,506
9,614
48,018
4,212
Cash provided by operating activities
Cash used in investing activities
Cash provided by financing activities
Other 11,591 (39,938)
4,221 3,960 52,230
(69,752)
44,460
1,278
Net increase (decrease) in cash and cash equivalents
(20,166)
28,216
Cash Provided by Operating Activities
Cash provided by operating activities from continuing operations was $8.5 million in 2007, compared with $48.0 million in 2006. The
deterioration reflects lower earnings before non-cash charges. Cash flows in 2006 also benefitted from a net reduction in the investment
in working capital of $20.5 million, compared with an increase in working capital of $2.4 million in 2007. In 2007, the Company received
$2.1 million from clients to assist in the funding of capital expenditure projects that are tied to specific manufacturing and supply
Cash Provided by Operating Activities
of Continuing Operations
70.8
75
75
60
60
48.0
42.6
45
30
45
28.0
30
15
8.5
0
0
2003
15
2004
2005
2006
2007
29
agreements. This compares with $9.6 million that was received
in 2006. These amounts are recorded as an increase in deferred
revenues and will be recognized as income over the life of the
commercial manufacturing contract.
in 2007 was $3.1 million, compared with $4.2 million in 2006. The
reduction principally reflected an additional benefit from reduced
working capital in 2006 relative to 2007.
Cash Used in Investing Activities
The following table summarizes the cash used in investing
activities for the periods indicated:
2007
$
2006
$
Additions to capital assets
Sustaining
Project-related
(18,034)
(17,768)
(16,975)
(49,617)
Total additions to capital assets
(35,802)
(66,592)
(202)
(49)
(3,659)
(2,204)
(39,663)
(68,845)
(275)
(907)
(39,938)
(69,752)
Net increase in investments
Increase in deferred pre-operating costs
Cash used in investing activities of continuing operations
Cash used in investing activities of discontinued operations
Interest-Bearing Debt to Shareholders’ Equity
During 2007, the Company’s major project-related programs (in millions) were:
3 Swindon facility in U.K., in connection with the construction of a facility for the manufacture of sterile lyophilized cephalosporin products . . . . . . . . . . . . . . . . . . . . . . . $5.3
3 Cincinnati facility in U.S.A., installation of an intermediate-scale process train .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.3
Capital commitments to complete authorized capital projects
were $15.8 million at October 31, 2007. Based on current
internal projections, these expenditures are expected to be
incurred during the fiscal year ending October 31, 2008. These
539.9
550
440
139.4%
150
The Company’s principal ongoing investment activities are
sustaining and project-related capital programs at its network of
sites. The majority of the Company’s capital allocation is normally
invested in project-related programs, which are defined as
outlays that will generate growth in capacity and revenues, while
sustaining expenditures relate to the preservation of existing
assets and capacity. The Company invested $35.8 million in
capital expenditures in 2007 compared with $66.6 million in 2006,
of which project-related expenditures were $17.8 million in 2007
and $49.6 million in 2006.
Shareholders’ Equity
184.4% (1)
200
Cash used in investing activities from continuing operations in
2007 was $39.7 million, compared with $68.8 million in 2006.
The decrease principally reflected lower project-related capital
expenditures on the cephalosporin lyophilization capacity
in the Swindon, U.K. facility. The major expenditures for this
expansion were incurred in 2006. The increase in deferred preoperating costs of $3.7 million in 2007 related to the lyophilized
cephalosporin facility in Swindon, U.K. Deferred pre-operating
costs are amortized over a period of five years from the date of start-up.
550
200
440
150
330
100
59.1%
65.9%
110
0
0
2003
2004
2005
2006
(1) Interest-bearing debt includes the debt component of convertible
preferred shares of $139.9 million
193.9
220
56.1%
50
30
330
100
2007
250.7
221.4
197.2
50
220
110
0
0
2003
2004
2005
2006
2007
expenditures will be financed from cash flows from operations,
existing cash reserves and credit facilities and from a new capital
lease that has been negotiated.
3 Plant expansion in Whitby, Ontario to support the consolidation
of the York Mills operations;
The principal financing activity for the year ended October 31, 2006
was the completion of new credit facilities in North America
in the aggregate amount of $290.0 million ($275.0 million as
amended) to refinance existing debt of the Company and its U.S.
subsidiaries (including those in Puerto Rico). These facilities were
subsequently replaced in 2007. During 2006, the Company’s
Italian subsidiary also entered into a new long-term debt facility in the amount of 28.5 million euros ($33.9 million) to replace
existing loans.
3 Plant expansion at the Toronto Region Operations, Ontario to
support additional capacity for oral contraceptive products;
Financing Arrangements
Project-related capital expenditures in fiscal 2008 are expected
to be higher than in 2007. The major project-related capital
programs currently anticipated for 2008 consist of:
3 Swindon, U.K. facility, completion of the lyophilized
cephalosporin project; and The $150 million 8.5% convertible preferred shares purchased by JLL Partners on April 27, 2007 represent 150,000 units, each
consisting of one Class I Preferred Share, Series C (a convertible
preferred share) and one Class I Preferred Share, Series D (a
special voting preferred share) at a purchase price of $1,000 per unit.
3 Cincinnati facility in U.S.A., continuing costs for installation of
the intermediate-scale process train.
Cash Provided by Financing Activities
The following table summarizes the cash provided by financing
activities for the periods indicated:
Increase (decrease) in bank indebtedness
Increase in long-term debt
Repayment of long-term debt
Issue of convertible preferred shares
Convertible preferred share issue costs – equity component
Issue of restricted voting shares
Repurchase of restricted voting shares
Decrease in restricted cash
Increase in deferred financing costs
2007
$
3,532 198,108 (337,452)
2006
$
(11,096)
416,389
(364,800)
150,000 –
(1,213)
–
24 127
(8,778)
–
–
7,805
–
4,221 (3,965)
44,460
The principal financing activity for the year ended October 31, 2007
was the issue, through a private placement, of $150 million of
convertible preferred shares of the Company to JLL Partners and
the completion of new credit facilities in the aggregate amount of
$225 million, comprising of a seven-year $150 million term loan
and a five-year $75 million revolving facility. The net proceeds from
the JLL Partners investment and the seven-year term loan were
used to repay the Company’s obligations under its existing North
American and U.K. credit facilities.
In 2007, the Company also used $8.8 million of cash to
repurchase 2,334,300 of its restricted voting shares under a normal course issuer bid.
Convertible Preferred Shares
Until October 27, 2009, no cash dividends will be paid, but the
liquidation preference and conversion rate will increase on a
quarterly basis by 2.125%. After October 27, 2009, these increases
in the liquidation preference and conversion rate will continue
until the maturity or prior conversion of the convertible preferred
shares, unless the Company elects to pay a cash dividend for any
applicable quarter, in which case the Company will pay a cash
dividend for such quarter based on an annual dividend rate of
8.5% on the aggregate liquidation preference of the convertible
preferred shares.
At October 31, 2007, each convertible preferred share was
convertible into 218.7154 Patheon restricted voting shares, as
adjusted for any non-cash dividends noted above, at any time at
the holder’s option. The Company will be entitled to require the
holder to convert into restricted voting shares if, at any time after
October 27, 2009, the market price of the restricted voting shares
on the Toronto Stock Exchange exceeds a price equivalent to
US$7.87 for a period of at least 60 days.
If not previously converted, the Company is required to redeem
the convertible preferred shares for cash on April 27, 2017 at
a price equal to the aggregate liquidation preference of the
convertible preferred shares, plus accrued and unpaid dividends
thereon. The Company is also required to redeem the convertible
preferred shares upon the occurrence of a change of control
of Patheon at a price equal to the greater of the aggregate
liquidation preference of the convertible preferred shares, plus
accrued and unpaid dividends thereon, or the price per share
paid to holders of restricted voting shares in the change of control
transaction, multiplied by the number of restricted voting shares
into which the convertible preferred shares are then convertible.
The convertible preferred shares have the right to vote, together with the holders of the restricted voting shares, on an as-if converted basis, in respect of all matters other than the
election of directors. As at October 31, 2007, these convertible
preferred shares were convertible into approximately 32.8 million
31
restricted voting shares of the Company, which would represent
approximately 27% of the restricted voting shares outstanding as at that date, after giving effect to such conversion. The special voting preferred shares have the right to appoint up to three directors.
The convertible preferred shares are considered to be a
compound financial instrument with both a debt and equity
component. On issuance, the fair value of the debt component
was $132.9 million. The remainder of the proceeds, attributable
to shareholders’ equity was $15.9 million, net of apportioned
transaction costs of $1.2 million. (See Convertible Preferred
Shares in “Critical Accounting Policies and Estimates”). At October 31, 2007 the carrying value of the debt component of the convertible preferred shares was $139.9 million.
Financing Ratios
$225 Million Credit Facilities
On April 27, 2007 the Company completed new credit facilities in
the aggregate amount of $225 million, comprising a seven-year
$150 million senior secured term loan and a five-year $75 million
asset based revolving credit facility. The Company is required to
make quarterly installment payments of $375,000 on the term
loan facility, along with additional mandatory repayments based
on certain excess cash flow measures. Interest on the facilities is
at floating rates based on LIBOR, US or CAD prime, or the federal funds effective rate, plus applicable margins. The
Company has entered into interest rate swaps to convert the
interest expense on the $150 million senior secured term loan
from a floating interest rate to a fixed interest rate. The facilities
are secured by substantially all of the assets of the Company’s
Fixed rate
Variable rate based on:
Prime - Canada
U.S. base rate
U.S. LIBOR (1 month)
Euribor (3 months)
U.K. LIBOR
U.K. base rate
operations in Canada, U.S.A., Puerto Rico and the U.K. and the
Company’s investments in the shares of all other operating
subsidiaries. At October 31, 2007 the balance on the senior
secured term loan was $149.3 million and $6.7 million was drawn on the revolving credit facility, including letters of credit of $4.2 million.
Total interest-bearing debt at October 31, 2007 was $363.7 million, being $14.1 million higher than at October 31, 2006.
Total interest-bearing debt in 2007 includes the debt component
of the convertible preferred shares of $139.9 million, as the
consolidated financial statements include an accretive interest
expense in relation to this liability. The Company has no obligation
to pay cash dividends on the convertible preference shares until
after October 27, 2009, at which time the Company can elect to
increase the liquidation preference and conversion rate of the
convertible preferred shares rather than paying a cash dividend.
At October 31, 2007, the Company’s consolidated ratio of interestbearing debt to shareholders’ equity was 184.4%, compared with
139.4% at October 31, 2006. The increase principally reflects the
reduction in shareholders’ equity arising from the losses that the
Company has incurred in the twelve months ended October 31, 2007.
The following table summarizes the fixed and variable
percentages of debt outstanding at October 31, 2007, including
the debt component of the convertible preferred shares, and the
applicable interest rates at the end of each quarter in 2007. The
2007 numbers reflect the impact of interest rate swap contracts
that the Company has entered into:
% of Debt Outstanding
2007
2006
81%
7%
0%
0%
1%
18%
0%
0%
7%
2%
61%
19%
3%
1%
Interest Rates at End of Each Quarter in 2007
Q4
Q3
Q2
Q1
6.25%
8.25%
4.71%
4.60%
6.28%
5.75%
6.25%
8.75%
5.32%
4.26%
6.04%
5.75%
6.00%
8.75%
5.32%
4.02%
5.73%
5.25%
6.00%
8.75%
5.32%
3.78%
5.59%
5.25%
Contractual Obligations
Contractual repayments of long-term debt, commitments under operating leases and purchase obligations are as follows:
Total
Less Than
1 Year
1–3 Years
4–5 Years
After
5 Years
Long-term debt
Operating leases
Purchase obligations
219,411 11,354 15,804 11,902 3,113 15,804 21,521 4,872 –
23,507 2,806 –
162,481
563
–
Total contractual obligations
246,569 30,819 26,393 26,313 163,044
Payments Due by Period
Long-term debt includes capital lease obligations. Purchase obligations relate to capital commitments to complete authorized capital projects.
32
Obligations with Respect to Employee Future Benefit Plans
The Company’s obligations as at October 31, 2007 with respect to employee future benefit plans were:
Defined
Benefit
Pension Plans
Other
Benefit
Plans
Projected benefit obligations
Less plan assets
81,241 (67,311)
6,809 –
88,050
(67,311)
Unfunded amount
Unrecognized past service costs and net actuarial losses
13,930 7,265 6,809 400 20,739
7,665
Amount included in other long-term liabilities
6,665 6,409 13,074
Total
The Company also provides retirement benefits for the majority of its employees at its Canadian, U.S. and Puerto Rican sites under a defined contribution plan. The total expense for the plan amounted to $7.1 million in 2007 (2006 – $7.6 million). Please refer to note 15 to the consolidated financial statements for further information with respect to the Company’s employee future benefit plans.
Off-balance Sheet Arrangements
The Company does not engage in off-balance sheet accounting to structure any of its financial arrangements. The Company does not have any interests in unconsolidated special-purpose or structured finance entities.
Adequacy of Financial Resources
With the completion of the new financing arrangements on April 27, 2007, including the issuance of the convertible preferred shares, the Company believes that, subject to usual
business risks as further described in the Risk Management
section, its financial resources are sufficient to fund projected
capital expenditures, debt service requirements and employee
future benefit obligations in the normal course of business. As at October 31, 2007, the Company had cash balances of $30.6 million and $85.7 million in undrawn credit facilities
available to it. At October 31, 2007, the Company was in
compliance with all covenant requirements under its financing
arrangements. The risks associated with going concern
uncertainty reported in the Company’s 2006 Annual Report have been eliminated.
Additional Information
Share Capital
As of December 31, 2007, the Company had outstanding
90,624,388 restricted voting shares and 150,000 Class I preferred
shares consisting of 150,000 Class I Series C convertible preferred
shares and 150,000 Class I Series D special voting shares. At
December 31, 2007 the Company had 5,675,916 stock options
outstanding of which 4,192,582 were exercisable. Please refer to note 16 to the consolidated financial statements for further information.
Related Party Transactions
Revenues from companies controlled by a director and significant
shareholder of the Company were in the amount of $0.5 million in
2007 (2006 – $3.1 million). These transactions were conducted in
the normal course of business and are recorded at the exchanged
amount. Accounts receivable at October 31, 2007 includes a
balance of $0.4 million (2006 – $0.5) with respect to these related
party transactions.
At October 31, 2007, the Company has an investment of $0.7 million (2006 – $0.2) representing an 18% interest
in two Italian companies (collectively referred to as “BSP Pharmaceuticals”) whose largest investor is an officer of the
Company. These companies will specialize in the manufacturing
of cytotoxic pharmaceutical products.
The Company has accrued management fees owing to it under
a management services agreement with BSP Pharmaceuticals
of $1.6 million for the year ended October 31, 2007 (2006 – nil).
These fees will be invoiced to BSP Pharmaceuticals once it has
finalized all of its bank financing. These services were conducted
in the normal course of business and are recorded at the
exchanged amounts.
33
Risk Management and Accounting Policies
Risk Management
A comprehensive list of risk factors that may affect the Company
are set out in the Company’s most recent Annual Information Form.
Patheon applies rigorous assessment, mitigation and
management practices to seek to reduce the extent of the
operational, financial, regulatory and legal risks affecting its business.
Contractual Arrangements
The Company has commercial manufacturing services contracts
with its clients, typically with multi-year terms. These contracts
formalize the standard business arrangements, including
production based on the delivery of firm purchase orders. In
addition, the contracts generally provide for six to 18 months’
advance notice for the transfer or discontinuance of any product.
The Company’s commercial manufacturing clients generally
provide a yearly forecast of anticipated product demand. Clients
also deliver firm purchase orders, typically three months prior
to scheduled production, after which time clients may adjust
contract quantities or delivery dates within certain limits, provided
that the Company is reimbursed for any expenses incurred in
connection with the adjustment. The client assumes liability for all material commitments made in accordance with purchase
orders. Patheon maintains the right to negotiate increases in
prices based on extraordinary market changes in material costs.
The anticipated revenues to be generated by the Company’s
major client agreements are not determinable with any precision,
as volumes are based on the clients’ market demands from time to time.
The Company’s pharmaceutical development services are
provided on a fee-for-service basis. The Company typically
responds to a request for proposal and, if the proposal is
accepted, it normally forms the basis of the contract with the
client. Frequently, the scope of work in the initial contract changes
over the life of the project in response to research results and
client needs.
Foreign Currency
The Company’s business activities are conducted in several
currencies – Canadian dollars and U.S. dollars for the Canadian
operations, U.S. dollars for the U.S. operations and euros and U.K.
sterling for the European operations.
Since the European and U.S. operations conduct business
principally in their respective local currencies, the exposure to
foreign currency gains and losses is not significant. However, the
Company’s Canadian operations negotiate sales contracts for
34
payment in both U.S. and Canadian dollars, and materials and
equipment are purchased in both U.S. and Canadian dollars.
The majority of its non-material costs (including payroll, facilities
costs and costs of locally sourced supplies and inventory)
are denominated in Canadian dollars. Approximately 70% of
revenues of the Canadian operations and approximately 20% of
its operating expenses are transacted in U.S. dollars. As a result,
the Company may experience trading and translation gains
or losses because of volatility in the exchange rate between
the Canadian and U.S. dollar. Based on the Company’s current
U.S. denominated net inflows, for each one-cent change in the
Canadian-U.S. rate, the impact on annual pre-tax earnings is
approximately $0.9 million.
The Company mitigates this foreign exchange risk by engaging
in foreign currency hedging activities using derivative financial
instruments. At October 31, 2007, the Company had outstanding
foreign exchange forward contracts to sell U.S.$34.2 million at
an exchange rate of $1.0535 Canadian. The contracts mature at
the latest on April 21, 2008 and cover approximately 75% of the
Company’s expected foreign exchange exposure for the first half
of the 2008 fiscal year.
At October 31, 2007, the balance sheet of the Company’s
Canadian operations included $229.5 million of U.S. dollar
denominated debt (including the debt component of the
Company’s convertible preferred shares). The Canadian
operations are required to revalue the Canadian dollar equivalent
of the U.S. dollar denominated debt at each period end. At
October 31, 2007, $141.6 million of this debt was designated as an effective hedge against the Company’s investments in
subsidiaries in the U.S.A. and Puerto Rico. All foreign exchange
gains and losses associated with the debt that is considered to be an effective hedge are recorded in other comprehensive
income. Foreign exchange gains and losses from the remaining
debt are recorded in earnings and are offset in part by gains and
losses on the revaluation of U.S. dollar denominated cash and
receivables. In order to mitigate future earnings volatility, the
Company has entered into a foreign exchange forward contract to buy U.S.$45.0 million at an exchange rate of $1.0015 Canadian.
The mark-to-market value at October 31, 2007 that was recorded
in earnings is an unrealized loss of $2.7 million.
Translation gains and losses related to the carrying value of the
Company’s non U.S. dollar denominated foreign operations are
deferred and included in accumulated other comprehensive
income in shareholders’ equity.
The Company does not purchase any derivative instruments for
speculative purposes.
Product Liability Claims
Environmental and Health and Safety Risks
The Company may be subject to liability claims by those who
purchase its services and the ultimate consumers of clients’
products it manufactures. The Company manages this risk with
a combination of product liability insurance and contractual
indemnities and liability limitations in its agreements with its
clients. Historically, the Company has been able to obtain
liability insurance for the operation of its business. However,
there can be no assurance that existing liability insurance will
be adequate, or that it will be able to be maintained, or that all
possible claims that may be asserted against the Company will be
covered by insurance. A partially or completely uninsured claim,
if successful and if of sufficient magnitude, could have a material
adverse effect on the business, financial condition and results of
operations of the Company.
The Company has a commitment to safeguard the health
of employees and the quality of the environment. Highly
qualified environmental, health and safety professionals at all
Company locations are dedicated to the maintenance and
improvement of programs and procedures to ensure continued
employee and environmental protection. To the best of the
Company’s knowledge, all of its facilities are in compliance with
environmental and occupational health and safety regulations.
Interest Rate Exposure
The Company has exposure to movements in interest rates. The Company has entered into interest rate swaps to convert the
interest expense on its senior secured term loan from a floating
interest rate to a fixed interest rate until March 2010. Taking this
interest rate swap into account, at October 31, 2007, 19% of the
Company’s total debt portfolio, including the debt component of
the convertible preferred shares, was subject to movements in
floating interest rates. Assuming no change to the structure of the
debt portfolio, a 1% change in floating interest rates would have an
impact on annual pre-tax earnings of approximately $0.7 million.
Credit and Client Concentration
The Company, in the normal course of business, monitors the
financial condition of its clients and reviews the credit history of each new client. The Company establishes an allowance for
doubtful accounts that corresponds to the specific credit risk of its clients, historical trends and economic circumstances.
During the year ended October 31, 2007, one client (2006 – two)
accounted for more than 10% of the Company’s total revenues.
As a percentage of revenues from continuing operations this
client amounted to 13% (2006 – 13% and 12%).
The Company believes that the risks related to its reliance on its major clients are reduced by a number of factors, including:
(a)the negotiation of long-term manufacturing agreements with these clients;
(b)the diversity of products and projects undertaken by Patheon; and
(c)the expansion of PDS units in both Europe and North America;
by increasing the variety of service activities, the Company
is increasing its client base, thereby lowering the risk of
depending on a small number of clients for a significant
portion of its revenues.
Regulatory Matters Affecting Manufacturing
and Pharmaceutical Development Services
The Company is required to comply with the regulatory
requirements of the national and international regulatory bodies
having jurisdiction in the countries where it manufactures
products or where its clients’ products are distributed. As a
result, most of the Company’s facilities are subject to regulation
by the FDA, and certain facilities are subject to regulation by
the Health Products and Food Branch (Canada), the Medicines
and Healthcare Products Regulatory Agency (United Kingdom),
the European Medicines Evaluation Agency (Europe) and other
regulatory bodies. These regulatory requirements impact many
aspects of the Company’s operations, including manufacturing,
labeling, packaging, adverse event reporting, storage and record
keeping related to clients’ products. In addition, if new legislation
or regulations are enacted or existing legislation or regulations are
amended or are interpreted or enforced differently, the Company
may be required to obtain additional approvals or operate
according to different manufacturing standards. This may require
the Company to change its manufacturing techniques or make
capital improvements to its facilities. There can be no assurance
that the Company will be able to meet all of the applicable
regulatory requirements in the future. If the company fails to
comply with applicable regulatory requirements, it may be subject
to fines, suspension or withdrawal of regulatory approvals, product
recalls, seizure of products, debarment, exclusion, disgorgement
of profits, operating restrictions and criminal prosecutions, as well
as the loss of contracts and resulting revenue losses. In addition,
such failure to comply could expose the Company to contractual
and product liability claims, including claims for reimbursement by
clients for lost or damaged active pharmaceutical ingredients, the
cost of which could be significant.
To mitigate this risk, the Company employs highly qualified
technical staff at all of its facilities dedicated to maintaining and
improving policies and programs to ensure compliance with
global quality standards. The Company also strives to meet
quality standards through comprehensive and rigorously applied
Standard Operating Procedures (“SOPs”), the ongoing training
of our employees in current Good Manufacturing Practices
(“cGMPs”) and required investment in its facilities, equipment and systems.
35
Risk Management and Accounting Policies (continued)
Critical Accounting Policies and Estimates
General
The Accounting Policies have been reviewed and discussed with the Company’s Audit Committee and are described in note
2 to the audited consolidated financial statements. The most
critical of these policies are those related to revenue recognition,
deferred revenues, impairment of long-lived depreciable
assets, convertible preferred shares, employee future benefits
and income taxes (notes 2, 4, 13, 15, 16 and 18 of the audited
consolidated financial statements).
The preparation of the consolidated financial statements requires
management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses.
These estimates and assumptions are based upon management’s
historical experience and are believed by management to be
reasonable under the circumstances. Such estimates and
assumptions are evaluated on an ongoing basis and form the
basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources.
Actual results could differ significantly from these estimates.
Changes in Accounting Policy
The Company adopted the CICA Handbook Section 3855,
Financial Instruments – Recognition and Measurement; Section 3861, Financial Instruments – Disclosure and Presentation;
Section 3865, Hedges; Section 1530, Comprehensive Income;
and Section 3251, Equity on November 1, 2006. The adoption of
the new standards resulted in changes in accounting for financial
instruments and hedges as well as the recognition of certain
transition adjustments that have been recorded in the deficit
account and in accumulated other comprehensive income in the
consolidated financial statements. The comparative consolidated
financial statements have not been restated as a result of the
adoption of the standards, except as noted below. The principal
changes in the accounting for financial instruments and hedges
due to the adoption of these accounting standards are described below.
Financial Assets and Financial Liabilities
Under the new standards, all financial instruments are classified
into one of the following five categories: held-for-trading, held to maturity investments, loans and receivables, availablefor-sale financial assets and other financial liabilities. All
36
financial instruments, including derivatives, are included in the
consolidated balance sheet and are measured at fair value
except for held to maturity investments, loans and receivables
and other financial liabilities, which are measured at amortized
cost. Held-for-trading financial instruments are recorded at cost
as they are initiated and are subsequently measured at fair value
and all revaluation gains and losses are included in net earnings
(loss) in the period in which they arise. Available-for-sale financial
instruments are also recorded at cost and are subsequently
measured at fair value with all revaluation gains and losses
included in other comprehensive income.
On transition to the new standards, gains from the cancellation
of interest rate swaps that had previously been deferred, were
recognized in accumulated other comprehensive income. In
addition an investment in shares of a publicly traded company
was designated as held-for-trading. Prior to the adoption of the
new standards, this investment had been accounted for on a cost
basis, as adjusted for an other than temporary decline in value.
All other financial assets are accounted for on an amortized cost
basis and financial liabilities are accounted for on an accrual
basis, consistent with prior accounting policies.
In connection with the adoption of the new standards, the
Company changed its accounting policy relating to costs of
obtaining bank and other debt financing. Under the new policy all
transaction costs, including fees paid to advisors and other related
costs, are expensed as incurred. Financing costs, including
underwriting and arrangement fees paid to lenders are deferred
and netted against the carrying value of the related debt and
amortized into interest expense using the effective interest rate
method. The Company previously deferred all transaction and
financing costs associated with obtaining bank and other debt
financing. The Company believes that the new policy is reliable
and more relevant as it results in a more transparent treatment
of transaction costs that the Company has incurred in its recent
refinancing activities and in the carrying value of debt.
The costs of obtaining bank and other debt financing that
were previously reported in deferred costs are now netted
against the carrying value of the related debt and amortized
into interest expense using the effective interest rate method.
Prior to the adoption of the new standards, the amortization of
deferred financing costs was reported as a separate line in the
consolidated statement of earnings (loss) and the amortized
balance disclosed in deferred costs on the consolidated balance sheet.
Derivatives and Hedge Accounting
Impact of Changes in Accounting Policy
The Company enters into foreign currency forward contracts to
reduce its exposure to foreign currency denominated cash flows
and the change in the fair value of foreign denominated assets
and liabilities. The Company also enters into interest rate swap
contracts to reduce its exposure to variable interest rates.
On transition to the new accounting standards, deferred after
tax gains from interest rate swaps of $0.7 million and after tax
losses on the fair value of foreign exchange cash flow hedges of
$1.4 million were recorded in accumulated other comprehensive
income. Accumulated other comprehensive income also includes
gains on net investments in self-sustaining foreign operations,
net of hedging activities of $36.1 million previously recorded in
the cumulative translation adjustment account. As a result, the
previously recorded cumulative translation adjustment account
has been eliminated and the balances have been included in
accumulated other comprehensive income. On transition to the
new standards, the comparative amounts of other comprehensive
income for the period only reflect the amounts previously
recorded in the cumulative translation adjustment account.
All derivative instruments are recorded on the consolidated
balance sheet at fair value unless exempted from derivative
treatment as a normal purchase and sale. All changes in their
fair value are recorded in earnings (loss) unless cash flow hedge
accounting is used, in which case the changes in the fair value
associated with the effective portions of the hedge are recorded
in other comprehensive income. Prior to the adoption of the new
standards, the Company accounted for derivatives that met the
requirements of cash flow hedge accounting on an accrual basis.
The Company also holds foreign currency denominated debt as a
hedge against the carrying value of its equity investment in certain
foreign currency denominated operations. Changes in the fair
value of the foreign denominated debt that is designated as an
effective hedge of the net investments in foreign operations are
recognized in other comprehensive income. Changes in the fair
value of the foreign denominated debt that is not considered to be an effective hedge are recorded in earnings (loss).
Comprehensive Loss and Accumulated
Other Comprehensive Income
Comprehensive loss is comprised of the Company’s net loss
and other comprehensive income (loss). Other comprehensive
income includes foreign currency translation gains and losses
on net investments in self-sustaining operations, net of hedging
activities, and changes in the fair value of derivative instruments
designated as cash flow hedges, all net of income taxes.
Amounts accumulated in other comprehensive income are
reclassified to the consolidated statement of earnings (loss)
in the period in which the hedged item affects the earnings
(loss). Foreign currency gains and losses on net investments
in self-sustaining foreign operations, net of hedging activities,
accumulated in other comprehensive income are reclassified
to the consolidated statement of earnings (loss) upon the
repatriation, reduction or disposal of the investment in the foreign operation.
The change in policy relating to the costs of obtaining bank and
other debt financing had the effect of increasing the retained
deficit at November 1, 2006 by $1.7 million. Refinancing expenses
for the year ended October 31, 2007 include transaction costs
incurred in connection with the completion of the Company’s
senior secured credit facilities and the debt component of the
convertible preferred shares of $11.9 million.
Revenue Recognition
The Company recognizes revenue for its commercial
manufacturing and pharmaceutical development services when
services are completed in accordance with specific agreements
with its clients and when all costs connected with providing these
services have been incurred, the price is fixed or determinable
and collectability is reasonably assured. Customer deposits on
pharmaceutical development services in progress are included in accounts payable and accrued liabilities.
The Company does not receive any fees on signing of contracts.
In the case of pharmaceutical development services, revenue
is recognized on the achievement of specific milestones in
accordance with the respective development services contract.
In the case of commercial manufacturing services, revenue is
recognized when services are complete and the product has met
rigourous quality assurance testing.
37
Risk Management and Accounting Policies (continued)
Deferred Revenues
Employee Future Benefits
The costs of certain capital assets are reimbursed to the
Company by the pharmaceutical companies that are to benefit
from the improvements in connection with the manufacturing
and packaging agreements in force. These reimbursements are
recorded as deferred revenues and are recognized as income
over the remaining minimum term of the agreements. During
2007, $2.0 million was recognized as earnings and $2.1 million
was received as a capital expenditure reimbursement.
The Company provides a number of benefit plans to its employees
including: (a) defined benefit pension plans; (b) post-employment
benefit plans; (c) defined contribution pension plans; and (d) unfunded termination indemnities.
Impairment of Long-lived Depreciable Assets
The Company reviews whether there are any indicators of
impairment of its capital assets and identifiable intangible assets
(“long-lived depreciable assets”). If such indicators are present,
the Company assesses the recoverability of the assets or group of assets by determining whether the carrying value of such assets can be recovered through undiscounted future cash flows. If the sum of undiscounted future cash flows is less than the
carrying amount, the excess of the carrying amount over the
estimated fair value, based on discounted future cash flows, is recorded as a charge to earnings. In 2007 the Company
recorded an impairment charge of $48.6 million.
The Company’s convertible preferred shares are considered to
be a compound financial instrument that contains both a debt
component and an equity component.
On issuance of the convertible preferred shares, the fair value of
the debt component is determined by discounting the expected
future cash flows over the expected life using a market interest
rate for a non-convertible debt instrument with similar terms.
The value is carried as debt on an amortized cost basis until
extinguished on conversion or redemption. The remainder of the
proceeds are allocated as a separate component of shareholders’
equity, net of transaction costs. Transaction costs are apportioned
between the debt and equity components based on their
respective carrying amounts when the instrument was issued.
On conversion, the carrying amount of the debt component and
the equity component are transferred to share capital and no gain
or loss is recognized.
The interest cost recognized in respect of the debt component
represents the accretion of the liability, over its expected life using the effective interest method, to the amount that would be payable if redeemed. In 2007, the interest cost recognized in respect of the debt component of the preferred shares was $7.1 million.
38
The cost of defined benefit pension plans and other postemployment benefits, which include health care and dental
benefits, related to employees’ current service is charged to
earnings annually. The cost is computed on an actuarial basis
using the projected benefit method pro-rated on service and
management’s best estimates of various actuarial factors,
including salary escalation, other cost escalation and retirement
ages of employees.
The valuation of defined benefit pension plan assets is at current market value for purposes of calculating the expected
return on plan assets. Past service costs resulting from plan
amendments are deferred and amortized on a straight-line basis
over the remaining service life of employees active at the time of amendment.
Actuarial gains and losses arise from the difference between the
actual long-term rate of return on plan assets for a period and the
expected long-term rate of return on plan assets for that period,
or from changes in actuarial assumptions used to determine the
accrued benefit obligation. The excess of the net accumulated
actuarial gain or loss over 10% of the greater of the benefit
obligations and the fair value of plan assets is amortized over the average remaining service period of active employees.
The determination of the obligation and expense for defined
benefit pensions and other post-employment benefits is
dependent on the selection of certain assumptions used by
actuaries in calculating such amounts. Those assumptions are
disclosed in note 15 to the Company’s 2007 audited consolidated
financial statements. In 2007, the Company recorded a net
expense of $1.8 million in connection with its defined benefit
pension and other post-employment benefit pension plans. This
included a curtailment gain of $4.3 million in connection with a
decision made to phase out benefits under one of the Company’s
post-employment benefit plans.
The cost of defined contribution pension plans is charged to
earnings as funds are contributed by the Company. In 2007, the
Company recorded an expense of $7.2 million in connection with
these plans.
Income Taxes
The Company follows the liability method of income tax allocation.
Under this method, future tax assets and liabilities are determined
based on differences between the financial reporting and tax
bases of assets and liabilities and are measured using the
substantively enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Preparation of the consolidated financial statements requires
an estimate of income taxes in each of the jurisdictions in which
the Company operates. The process involves an estimate of the
Company’s current tax exposure and an assessment of temporary
differences resulting from differing treatment of items such as
depreciation and amortization for tax and accounting purposes.
These differences result in future tax assets and liabilities and are
reflected in the consolidated balance sheet.
Future tax assets of $31.1 million have been recorded at October 31, 2007. This consists primarily of accounting provisions
related to pension and post-retirement benefits not currently
deductible for tax purposes, the tax benefit of net operating loss
carryforwards related to the U.K. operations, unclaimed R&D
expenditures and deferred financing and share issue costs. The
Company evaluates quarterly the ability to realize its future tax
assets. The factors used to assess the likelihood of realization are
the Company’s forecast of future taxable income and available
tax planning strategies that could be implemented to realize the
future tax assets.
Future tax liabilities of $47.6 million have been recorded at
October 31, 2007. This liability has arisen primarily on tax
depreciation in excess of book depreciation.
The Company’s tax filings are subject to audit by taxation
authorities. Although management believes that it has adequately
provided for income taxes based on the information available,
the outcome of audits cannot be known with certainty and the
potential impact on the financial statements is not determinable.
Effectiveness of Disclosure Controls
and Internal Controls
Disclosure controls and procedures are designed to provide
reasonable assurance that all relevant information is gathered and
reported to senior management, including the Chief Executive
Officer (“CEO”) and the Chief Financial Officer (“CFO”), on a
timely basis so that appropriate decisions can be made regarding
public disclosure. An evaluation of the effectiveness of the
design and operation of the Company’s disclosure controls and
procedures was conducted as of October 31, 2007 by and under
the supervision of the Company’s management, including the
CEO and the CFO. Based on this evaluation, the CEO and the
CFO have concluded that the Company’s disclosure controls
and procedures (as defined in Multilateral Instrument 52-109 –
Certification of Disclosure in Issuers’ Annual and Interim Filings
of the Canadian Securities Administrators) are effective to ensure
that the information required to be disclosed in reports that the
Company files or submits under Canadian securities legislation is
recorded, processed, summarized and reported within the time
periods specified in such legislation.
Under the supervision of the CEO and CFO, the Company has
designed internal controls over financial reporting to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with GAAP. This design evaluation
included documentation activities, management inquiries
and other reviews as deemed appropriate by management in
consideration of the size and nature of the Company’s business.
There were no changes in the Company’s internal controls over
financial reporting during the most recent interim period that have
materially affected, or are reasonably likely to materially affect, its
internal control over financial reporting.
39
Five-Year Financial Summary
Five-Year Financial Summary
(in thousands of U.S. dollars, except share information,
per-share amounts and percentages)
REVENUES AND NET EARNINGS (LOSS)
Revenues
EBITDA before repositioning expenses (1)
(% of revenues)
Depreciation, amortization, and write off of deferred financing costs
Gain on sale of land
Interest, debt prepayment charges, refinancing expenses and foreign exchange loss on foreign operations
Provision for income taxes
Earnings (loss) from continuing operations
(% of revenues)
Earnings (loss) from discontinued operations
Net earnings (loss) for the year
Earnings (loss) per share – diluted
Number of shares (000s)
Outstanding at October 31
Weighted average for the year – basic
FINANCIAL POSITION
Current assets
Current liabilities
Working capital
Total assets
Book value per share at year end (2)
Interest-bearing debt (3)
Return on shareholders’ equity (4)
Interest-bearing debt to shareholders’ equity
Total capitalization (5)
Interest-bearing debt to total capitalization
CASH FLOW
Cash provided by operating activities of continuing operations
Cash provided by operating activities Additions to capital assets from continuing operations
– sustaining
– project-related
Total additions to capital assets from continuing operations
Total additions to capital assets
Acquisitions
Net proceeds from equity issues
2007
$
2006
$
2005
$
2004
$
2003
$
677,074 90,318 13.3%
15,800 48,580 674,659 70,876 10.5%
12,998 254,661 658,856 94,008 14.3%
–
–
432,937 49,807 11.5%
4,407 –
360,025
45,276
12.6%
–
– 47,666 –
57,913 –
50,385 (4,587)
21,813 –
15,451
–
43,496 19,234 (84,458)
–12.5%
(10,143)
(94,601)
($1.02)
($0.91)
($0.11)
22,976 11,047 (288,719)
–42.8%
569 (288,150)
($ 3.10)
($ 3.11)
$0.01 16,449 12,068 19,693 3.0%
1,928 21,621 $0.25 $0.23 $0.02 5,609 8,440 9,538 2.2%
1,140 10,678 $0.21 $0.19 $0.02 4,508
8,993
16,324
4.5%
2,254
18,578
$0.36
$0.32
$0.04
90,625 92,834 92,951 92,868 92,846 86,828 51,556 51,521 51,506
51,384
272,277 191,705 80,572 829,617 $2.00 363,689 197,185 –42.2%
184.4%
560,874 64.8%
255,441 431,206 (175,765)
826,183 $2.70 349,617 250,731 –72.9%
139.4%
600,348 58.2%
251,034 160,434 90,600 1,051,568 $5.81 302,898 539,851 5.4%
56.1%
842,749 35.9%
165,491 138,167 27,324 522,583 $4.29 145,792 221,398 5.2%
65.9%
367,190 39.7%
149,258
110,913
38,345
436,860
$3.77
114,626
193,923
11.4%
59.1%
308,549
37.2%
8,486 11,591 48,018 52,230 70,832 77,166 42,587 40,419 27,982
35,307
18,034 17,768 16,975 49,617 15,135 39,511 10,457 50,709 13,554
38,987
35,802 36,077 –
–
66,592 67,499 –
–
54,646 56,792 211,823 190,261 61,166 62,604 –
–
52,541
53,669
28,220
–
(1) EBITDA before repositioning expenses represents earnings from continuing operations before repositioning expenses, asset impairment charges, depreciation
and amortization, foreign exchange loss on foreign operations reclassified from other comprehensive income, interest, refinancing expenses, write-off of deferred
financing costs and income taxes.
(2) Book value per share is defined as shareholders’ equity, excluding the equity component of the convertible preferred shares, divided by the number of restricted
voting shares outstanding at year end.
(3) Interest-bearing debt includes the debt component of the convertible preferred shares.
(4) Ratio of net earnings (loss) to the average shareholders’ equity during the fiscal year, adjusted for the effect of share proceeds received during the year.
(5) Total capitalization is the sum of interest-bearing debt and shareholders’ equity.
40
Five-Year Summary of Quarterly Results
Five-Year Summary of Quarterly Results
(in thousands of U.S. dollars except per-share amounts)
Q1
$
Q2
$
Q3
$
Q4
$
Year
$
Revenues
FY03
FY04
FY05
FY06
FY07
66,140 99,946 143,119 150,013 162,808 91,010 113,061 171,934 180,157 171,966 100,271 108,134 168,289 178,739 175,508 102,604 111,796 175,514 165,750 166,792 360,025
432,937
658,856
674,659
677,074
EBITDA before repositioning expenses
FY03
FY04
FY05
FY06
FY07
6,357 10,744 20,323 13,880 22,793 9,795 11,700 22,543 23,244 23,153 14,721 13,240 25,394 14,990 23,138 14,403 14,123 25,748 18,762 21,234 45,276
49,807
94,008
70,876
90,318
Earnings (loss) from
continuing operations
FY03
FY04
FY05
FY06
FY07
2,136 2,622 5,352 (11,408)
(2,188)
3,415 2,687 2,799 2,549 (22,552)
5,767 2,206 3,341 (257,698)
(50,668)
5,006 2,023 8,201 (22,162)
(9,050)
16,324
9,538
19,693
(288,719)
(84,458)
Net earnings (loss)
FY03
FY04
FY05
FY06
FY07
3,080 2,589 6,004 (11,510)
(2,024)
4,791 3,102 3,783 2,989 (21,986)
6,097 1,990 3,455 (257,213)
(63,069)
4,610 2,997 8,379 (22,416)
(7,522)
18,578
10,678
21,621
(288,150)
(94,601)
Diluted EPS – continuing operations (US¢)
FY03
FY04
FY05
FY06
FY07
4.1 5.1 7.8 (12.3)
(2.4)
6.5 5.1 2.4 2.7 (24.3)
11.1 4.3 3.3 (277.5)
(54.4)
9.6 3.9 9.1 (23.8)
(9.9)
31.3
18.4
22.6
(310.9)
(91.0)
Diluted EPS (US¢)
FY03
FY04
FY05
FY06
FY07
5.9 5.0 8.7 (12.4)
(2.2)
9.2 5.9 3.4 3.2 (23.6)
11.7 3.9 3.4 (277.0)
(67.9)
8.8 5.8 9.3 (24.1)
(8.2)
35.6
20.6
24.8
(310.3)
(101.9)
41
Report of Management’s Accountability and Auditors’ Report
Report of Management’s Accountability
The accompanying consolidated financial statements have been prepared by management in accordance with Canadian generally
accepted accounting principles.
Management is responsible for ensuring that these statements, which include amounts based upon estimates and judgment, reflect the
Company’s business transactions and financial position.
The integrity and reliability of Patheon’s reporting systems are achieved through the use of formal policies and procedures, the careful
selection of employees, and appropriate delegation of authority and division of responsibilities. Patheon’s Code of Business Conduct
requires employees to maintain high standards in their conduct of the Company’s affairs.
Our shareholders’ independent auditors, Ernst & Young LLP, whose report on their examination follows, have audited the consolidated
financial statements in accordance with Canadian generally accepted auditing standards.
The Board of Directors annually appoints an Audit Committee comprised of directors who are not employees of the Company. This
Committee meets regularly with management and the shareholders’ auditors to review significant accounting, reporting and internal
control matters. The shareholders’ auditors have full and unrestricted access to the Audit Committee to discuss their audit and related
findings. Following its review of the consolidated financial statements and the report of the shareholders’ auditors, the Audit Committee
submits its report to the Board of Directors for formal approval of the consolidated financial statements.
(signed)
(signed)
Wesley Wheeler
John Bell
Chief Financial Officer
Toronto, Canada
January 21, 2008
Auditors’ Report
To the Shareholders of Patheon Inc.
We have audited the consolidated balance sheets of Patheon Inc. as at October 31, 2007 and 2006 and the consolidated statements of loss, changes in shareholders’ equity, comprehensive loss and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation.
In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as
at October 31, 2007 and 2006 and the results of its operations and its cash flows for the years then ended in accordance with Canadian
generally accepted accounting principles.
(signed)
Ernst & Young LLP
Chartered Accountants
Licensed Public Accountants
Toronto, Canada
January 21, 2008
42
Audited Consolidated Financial Statements
Consolidated Balance Sheets
As at October 31
2007
$
2006
$
ASSETS
Current
Cash and cash equivalents (note 5)
Accounts receivable
Inventories (note 6)
Prepaid expenses and other
Assets held for sale (note 3)
30,557
130,801
88,729
12,347
9,843
50,723
117,705
72,057
6,615
8,341
Total current assets
272,277
255,441
Capital assets (note 7)
Intangible assets (note 8) Deferred costs (note 9)
Future tax assets (note 18)
Goodwill (note 10) Investments
Assets held for sale (note 3)
487,423
8,718
8,878
31,055
3,658
946
16,662
467,365
41,447
9,717
21,827
3,077
586
26,723
829,617
826,183
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current
Bank indebtedness (note 11)
Accounts payable and accrued liabilities
Income taxes payable
Current portion of long-term debt (note 12)
Liabilities related to assets held for sale (note 3)
8,224
163,721
4,684
11,902
3,174
3,829
140,254
879
283,717
2,527
Total current liabilities
191,705
431,206
Long-term debt (note 12)
Deferred revenues Future tax liabilities (note 18)
Convertible preferred shares – debt component (note 13)
Other long-term liabilities (note 14)
Liabilities related to assets held for sale (note 3)
203,647
25,994
47,578
139,916
22,069
1,523
62,071
23,366
33,128
—
24,265
1,416
Total liabilities
632,432
575,452
Convertible preferred shares – equity component (note 16)
Restricted voting shares (note 16)
Contributed surplus
Deficit Accumulated other comprehensive income
15,925
391,967
4,049
(286,250)
71,494
—
400,721
3,829
(189,900)
36,081
Total shareholders’ equity
197,185
250,731
829,617
826,183
See accompanying notes.
On behalf of the Board:
(signed)
(signed)
Peter A.W. Green
Director Gregory C. Wilkins
Director
43
Consolidated Statements of Loss
(in thousands of U.S. dollars, except earnings (loss) per share)
2007
$
2006
$
Revenues (note 19)
677,074
674,659
Operating expenses
Foreign exchange gain on debt (note 17)
Repositioning expenses (note 22)
Asset impairment charge (note 4)
Amortization of intangible assets
Foreign exchange loss on foreign operations (note 17) Interest Refinancing expenses (note 23)
Amortization of deferred financing costs Write-off of deferred financing costs (note 23)
599,087
(12,331)
15,800
48,580
40,979
6,687
858
29,167
13,471
—
—
603,783
—
12,998
254,661
38,766
11,871
—
21,333
1,643
944
6,332
Loss from continuing operations before income taxes
(65,224)
(277,672)
Provision for (recovery of) income taxes (note 18)
Current Future 14,617
4,617
19,234
(84,458)
11,047
(288,719)
Earnings (loss) from discontinued operations (note 3)
(10,143)
(94,601)
(288,150)
($0.91)
($0.11)
($3.11)
$0.01
($1.02) 92,834
($3.10)
92,868
Average number of shares outstanding during the year – basic and diluted (in thousands)
44
17,725
(6,678)
569
Consolidated Statements of Changes in Shareholders’ Equity
2007
$
2006
$
Convertible preferred shares – equity component (note 16)
Shares issued during the year, net of issue costs
15,925
—
Balance at end of year
15,925
—
Restricted voting shares (note 16)
Balance at beginning of year
Issued during the year, net of issue costs
Repurchased during the year, net of transaction costs
400,721
24
(8,778)
400,594
127
—
391,967
400,721
Contributed surplus
Stock options
3,829
220
2,901
928
4,049
3,829
Retained earnings (deficit)
Adjustment related to change in accounting policy (note 2)
(189,900)
(1,749)
(94,601)
98,250
—
(288,150)
(286,250)
(189,900)
Accumulated other comprehensive income
Transition adjustment (note 2)
Other comprehensive income (loss) for the year
36,081
(762)
36,175
38,106
—
(2,025)
71,494
36,081
Total shareholders’ equity
197,185
250,731
45
Consolidated Statements of Comprehensive Loss
(94,601)
30,787
2,793
3,723
—
—
(1,128)
—
Other comprehensive income (loss), net of income taxes
Change in foreign currency gains on investments in subsidiaries, net of hedging activities (1)
Foreign currency losses on investments in subsidiaries, net of hedging activities reclassified to consolidated statement of loss (2)
Change in value of derivatives designated as foreign currency and interest rate cash flow hedges (3)
Gains on foreign currency and interest rate cash flow hedges reclassified to consolidated statement of loss (4)
Other comprehensive income (loss) for the year
36,175
Comprehensive loss for the year
(58,426) See accompanying notes.
The amounts disclosed in other comprehensive income have been recorded net of income taxes as follows:
(1) Net of an income tax expense of nil (2006 – $nil).
(2) Net of an income tax recovery of $1,935,000.
(3) Net of an income tax recovery of $373,000.
(4) Net of an income tax recovery of $343,000.
46
2007
$
2006
$
(288,150)
(2,025)
(2,025)
(290,175)
Consolidated Statements of Cash Flows
(84,458)
(288,719)
48,580
47,666
858
(12,331)
7,054
—
1,657
(4,846)
4,617
(2,021)
2,087
254,661
50,637
—
—
—
6,332
944
1,112
(6,678)
(1,978)
1,587
Net change in non-cash working capital balances
related to continuing operations (note 17)
Increase in deferred revenues
8,863
17,898
(2,442)
2,065
20,506
9,614
Cash provided by operating activities of continuing operations
8,486
3,105
48,018
4,212
Cash provided by operating activities
11,591
52,230
INVESTING ACTIVITIES
Additions to capital assets
Net increase in investments
Increase in deferred pre-operating costs
(35,802)
(202)
(3,659)
(66,592)
(49)
(2,204)
Cash used in investing activities of continuing operations
Cash used in investing activities of discontinued operations
(39,663)
(275)
(68,845)
(907)
(39,938)
(69,752)
FINANCING ACTIVITIES
Increase (decrease) in bank indebtedness
Increase in long-term debt
Repayment of long-term debt
Issue of convertible preferred shares (note 13 and note 16)
Convertible preferred share issue costs – equity component (note 16)
Issue of restricted voting shares (note 16)
Repurchase of restricted voting shares (note 16)
Decrease in restricted cash
Increase in deferred financing costs
3,532
198,108
(337,452)
150,000
(1,213)
24
(8,778)
—
—
(11,096)
416,389
(364,800)
—
—
127
—
7,805
(3,965)
Effect of exchange rate changes on cash and cash equivalents
3,960
1,278
Net increase (decrease) in cash and cash equivalents during the year
Cash and cash equivalents, beginning of year
(20,166)
50,723
28,216
22,507
Cash and cash equivalents, end of year
30,557
50,723
Supplemental cash flow information
Interest paid
Income taxes paid
22,183
9,600
22,573
11,460
OPERATING ACTIVITIES
Net loss from continuing operations
Add (deduct) charges to operations not requiring a current cash payment
Asset impairment charge (note 4)
Foreign exchange loss on foreign operations (note 17)
Accreted interest on convertible preferred shares (note 13)
Write-off of deferred financing costs (note 23)
Other non-cash interest
Employee future benefits, net of contributions
Future income taxes
Amortization of deferred revenues Other 2007
$
4,221
2006
$
44,460
47
Notes to Audited Consolidated Financial Statements
October 31, 2007 and 2006
(Dollar information in tabular form is expressed in thousands of U.S. dollars)
Notes to Consolidated Financial Statements
Note 1 Nature of Business
Patheon Inc. (“Patheon” or the “Company”) is a Canadian public company, which trades under the symbol PTI on The Toronto Stock
Exchange (“TSX”). The Company is an independent provider of commercial manufacturing and pharmaceutical development services of prescription (“Rx”) and over-the-counter (“OTC”) drugs to the international pharmaceutical industry.
Patheon’s commercial manufacturing activities relate primarily to Rx and OTC products in solid, semi-solid, liquid and sterile dosage
forms. The Company manufactures to client specifications a wide variety of products in many packaging formats. The Company can be
responsible for each aspect of the manufacturing and packaging process, from sourcing raw materials and packaging components to
delivering the finished product in consumer-ready form to the client’s distribution facilities.
Patheon’s pharmaceutical development services include dosage form development, analytical methods development, pilot batch
manufacture of new products for the regulatory drug approval process and the provision of scale-up services designed to show that a drug can be manufactured in commercial volumes.
Note 2 Summary of Significant Accounting Policies
The consolidated financial statements of the Company have been prepared by management in accordance with Canadian generally
accepted accounting principles. The significant accounting policies followed by the Company are summarized as follows:
Principles of Consolidation
These consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions have
been eliminated.
Use of Estimates in the Preparation of the Consolidated Financial Statements
The preparation of the consolidated financial statements in conformity with Canadian generally accepted accounting principles requires
management to make estimates and assumptions that affect: the reported amounts of assets and liabilities; the disclosure of contingent
assets and liabilities at the date of the consolidated financial statements; and the reported amounts of revenue and expenses in the
reporting period. Management believes that the estimates and assumptions used in preparing its consolidated financial statements are reasonable and prudent; however, actual results could differ from those estimates.
Changes in Accounting Policy
The Company adopted the CICA Handbook Section 3855, Financial Instruments – Recognition and Measurement; Section 3861, Financial
Instruments – Disclosure and Presentation; Section 3865, Hedges; Section 1530, Comprehensive Income; and Section 3251, Equity on
November 1, 2006. The adoption of the new standards resulted in changes in accounting for financial instruments and hedges as well as
the recognition of certain transition adjustments that have been recorded in the deficit account and in accumulated other comprehensive
income. The comparative consolidated financial statements have not been restated as a result of the adoption of the standards, except
as noted below. The principal changes in the accounting for financial instruments and hedges due to the adoption of these accounting
standards are described below.
(a) Financial Assets and Financial Liabilities
Under the new standards, all financial instruments are classified into one of the following five categories: held-for-trading, held to maturity
investments, loans and receivables, available-for-sale financial assets and other financial liabilities. All financial instruments, including
derivatives, are included in the consolidated balance sheet and are measured at fair value except for held to maturity investments, loans
and receivables and other financial liabilities, which are measured at amortized cost. Held-for-trading financial instruments are recorded
at cost as they are initiated and are subsequently measured at fair value and all revaluation gains and losses are included in net earnings
(loss) in the period in which they arise. Available-for-sale financial instruments are also recorded at cost and are subsequently measured at fair value with all revaluation gains and losses included in other comprehensive income.
On transition to the new standards, gains from the cancellation of interest rate swaps that had previously been deferred, were recognized
in accumulated other comprehensive income. In addition, an investment in shares of a publicly traded company was designated as
held-for-trading. Prior to the adoption of the new standards, this investment had been accounted for on a cost basis, as adjusted for an
other than temporary decline in value. All other financial assets are accounted for on an amortized cost basis and financial liabilities are
accounted for on an accruals basis, consistent with prior accounting policies.
48
In connection with the adoption of the new standards, the Company changed its accounting policy relating to costs of obtaining bank
and other debt financing. Under the new policy all transaction costs, including fees paid to advisors and other related costs, are expensed
as incurred. Financing costs, including underwriting and arrangement fees paid to lenders are deferred and netted against the carrying
value of the related debt and amortized into interest expense using the effective interest rate method. The Company previously deferred
all transaction and financing costs associated with obtaining bank and other debt financing. The Company believes that the new policy
is reliable and more relevant as it results in a more transparent treatment of transaction costs that the Company has incurred in its recent
refinancing activities and in the carrying value of debt.
The costs of obtaining bank and other debt financing that were previously reported in deferred costs are now netted against the carrying
value of the related debt and amortized into interest expense using the effective interest rate method. Prior to the adoption of the new
standards, the amortization of deferred financing costs was reported as a separate line in the consolidated statement of earnings (loss)
and the amortized balance disclosed in deferred costs on the consolidated balance sheet.
(b) Derivatives and Hedge Accounting
The Company enters into foreign currency forward contracts to reduce its exposure to foreign currency denominated cash flows and the
change in the fair value of foreign denominated assets and liabilities. The Company also enters into interest rate swap contracts to reduce
its exposure to variable interest rates.
All derivative instruments are recorded on the consolidated balance sheet at fair value unless exempted from derivative treatment as a
normal purchase and sale. All changes in their fair value are recorded in earnings (loss) unless cash flow hedge accounting is used, in
which case the changes in the fair value associated with the effective portions of the hedge are recorded in other comprehensive income.
Prior to the adoption of the new standards, the Company accounted for derivatives that met the requirements of hedge accounting on an
accrual basis.
The Company also holds foreign currency denominated debt as a hedge against the carrying value of its equity investment in certain
foreign currency denominated operations. The change in the fair value of foreign denominated debt that is designated as an effective
hedge of the net investments in foreign operations is recognized in other comprehensive income. The change in the fair value of foreign
denominated debt that is not considered to be an effective hedge is recorded in earnings (loss).
(c) Comprehensive Loss and Accumulated Other Comprehensive Income
Comprehensive loss is comprised of the Company’s net loss and other comprehensive income (loss). Other comprehensive income
includes foreign currency translation gains and losses on net investments in self-sustaining operations net of hedging activities and
changes in the fair value of derivative instruments designated as cash flow hedges, all net of income taxes.
Amounts accumulated in other comprehensive income are reclassified to the consolidated statement of loss in the period in which
the hedged item affects earnings (loss). Foreign currency gains and losses on net investments in self-sustaining foreign operations,
net of hedging activities, accumulated in other comprehensive income are reclassified to the consolidated statement of loss upon the
repatriation, reduction or disposal of the investment in the foreign operation.
(d) Impact of Changes in Accounting Policy
On transition to the new accounting standards, deferred after tax gains from interest rate swaps of $656,000 and after tax losses on the fair
value of cash flow hedges of $1,418,000 were recorded in accumulated other comprehensive income. Accumulated other comprehensive
income also includes gains on net investments in self-sustaining foreign operations, net of hedging activities of $36,081,000 previously
recorded in the cumulative translation adjustment account. As a result, the previously recorded cumulative translation adjustment
account has been eliminated and the balances have been included in accumulated other comprehensive income. On transition to the
new standards, the comparative amounts of other comprehensive income for the year only reflect the amounts previously recorded in the
cumulative translation adjustment account.
The change in policy relating to the costs of obtaining bank and other debt financing had the effect of increasing the retained deficit
at November 1, 2006 by $1,749,000. Refinancing expenses for the year ended October 31, 2007 include transaction costs incurred in
connection with the completion of the Company’s senior secured credit facilities and the debt component of the convertible preferred
shares of $11,889,000 (note 23).
Foreign Exchange Translation
The assets and liabilities of the Company’s operations having a functional currency other than the U.S. dollar are translated into the
Company’s U.S. dollar reporting currency using the exchange rate in effect at the year end and revenues and expenses are translated at
the average rate during each month. Translation gains and losses related to the carrying value of the Company’s foreign operations and
certain foreign currency denominated debt held by the Company and designated as a hedge against the carrying value of certain foreign
subsidiaries, are included in accumulated other comprehensive income in shareholders’ equity. Foreign exchange gains and losses on
transactions occurring in a currency different than an operation’s functional currency are reflected in earnings.
49
Revenue Recognition
The Company recognizes revenue for its commercial manufacturing and pharmaceutical development services when services are
completed in accordance with specific agreements with its clients and when all costs connected with providing these services have
been incurred, the price is fixed or determinable and collectability is reasonably assured. Client deposits on pharmaceutical development
services in progress are included in accounts payable and accrued liabilities.
The Company does not receive any fees on signing of contracts. In the case of pharmaceutical development services, revenue is
recognized on the achievement of specific milestones in accordance with the respective development service contracts. In the case
of commercial manufacturing services, revenue is recognized when services are complete and the product has met rigorous quality
assurance testing.
Deferred Revenues
The costs of certain capital assets are reimbursed to the Company by the pharmaceutical companies that are to benefit from the
improvements in connection with the manufacturing and packaging agreements in force. These reimbursements are recorded as
deferred revenues and are recognized as income over the remaining minimum term of the agreements.
Cash and Cash Equivalents
Cash and cash equivalents include cash in interest-bearing accounts and term deposits with remaining maturities of less than three months
at the date the term deposit was acquired.
Inventories
Inventories consisting of raw materials, packaging components, spare parts and work‑in‑process are valued at the lower of weighted
average cost and net realizable value.
Capital Assets
Capital assets are carried at cost less accumulated depreciation and charges for impairment. The cost of assets disposed of and the
related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in earnings.
Depreciation is provided on the straight-line basis based on estimated useful lives as follows:
Buildings .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Machinery and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Office equipment .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Furniture and fixtures .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
40 – 50 years
5 – 15 years
4 – 10 years
10 years
Repairs and maintenance costs are charged to operations as incurred.
Intangible Assets
Intangible assets represent the values assigned to acquired client contracts and relationships. They are amortized on a straight-line basis
over their estimated economic lives.
Impairment of Long-Lived Depreciable Assets
The Company reviews whether there are any indicators of impairment of its capital assets and identifiable intangible assets (“longlived depreciable assets”). If such indicators are present, the Company assesses the recoverability of the assets or group of assets
by determining whether the carrying value of such assets can be recovered through undiscounted future cash flows. If the sum of
undiscounted future cash flows is less than the carrying amount, the excess of the carrying amount over the estimated fair value, based on discounted future cash flows, is recorded as a charge to earnings.
Deferred Costs
Deferred costs consists of deferred pre-operating costs. During the development and pre-operating phases of new businesses or facilities,
incremental costs are deferred. Once commercial operations have commenced, the costs are amortized on a straight-line basis over five
years. Grants under available government assistance programs, relating to these costs, are reflected as a reduction of amounts deferred.
Prior to the adoption of CICA Handbook Section 3855 “Financial Instrument – Recognition and Measurement” (please refer to the
‘Changes in Accounting Policy’ section), the costs of obtaining bank and other debt financing were deferred and amortized on a straight-line basis over the term of the debt to which they related.
50
Goodwill
Goodwill represents the excess of the purchase price of the Company’s interest in subsidiary companies over the fair value of the
underlying net identifiable assets arising on acquisitions. Goodwill is not subject to amortization but is subject to an annual review for
impairment, or more frequently if events or changes in circumstances indicate that goodwill is impaired. Goodwill impairment is assessed
based on a comparison of the fair value of an individual reporting unit to the underlying carrying value of the reporting unit’s net assets
including goodwill. When the carrying amount of the reporting unit exceeds its fair value, the fair value of the reporting unit’s goodwill,
determined in the same manner as in a business combination, is compared with its carrying amount to measure the amount of the
impairment loss, if any.
Employee Benefit Plans
The Company provides a number of benefit plans to its employees including:
(a) defined benefit pension plans; (b) post-employment benefit plans; (c) defined contribution pension plans; and (d) unfunded
termination indemnities.
The cost of defined benefit pension plans and other post-employment benefits, which include health care and dental benefits, related
to employees’ current service is charged to earnings annually. The cost is computed on an actuarial basis using the projected benefit
method pro-rated on service and management’s best estimates of various actuarial factors, including salary escalation, other cost
escalation and retirement ages of employees.
The valuation of defined benefit pension plan assets is at current market value, based on actuarial valuation, for purposes of calculating
the expected return on plan assets. Past service costs resulting from plan amendments are deferred and amortized on a straight-line basis
over the remaining service life of employees active at the time of amendment.
Actuarial gains and losses arise from the difference between the actual long-term rate of return on plan assets for a period and the
expected long-term rate of return on plan assets for that period, or from changes in actuarial assumptions used to determine the accrued
benefit obligation. The excess of the net accumulated actuarial gain or loss over 10% of the greater of the benefit obligations and the fair
value of plan assets is amortized over the average remaining service period of active employees. The average remaining service period of
the active employees covered by the pension plans and the other retirement benefit plans at the measurement date of October 31, 2007
is 19 years (2006 – 11.8 years).
The cost of defined contribution pension plans is charged to earnings as funds are contributed by the Company.
Unfunded termination indemnities for the employees of the Company’s subsidiary in Italy are accrued based on Italian severance
pay statutes. The liability recorded on the consolidated balance sheets is the amount to which the employees would be entitled if the
employees’ employment with the Company ceased.
Income Taxes
The Company follows the liability method of income tax allocation. Under this method, future tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the substantively
enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The Company evaluates, on a quarterly basis, the ability to realize its future tax assets. The factors used to assess the likelihood of
realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize
the future tax assets.
The Company’s convertible preferred shares are considered to be a compound financial instrument that contains both a debt component
and an equity component.
On issuance of the convertible preferred shares, the fair value of the debt component is determined by discounting the expected future
cash flows over the expected life using a market interest rate for a non-convertible debt instrument with similar terms. The value is carried
as debt on an amortized cost basis until extinguished on conversion or redemption. The remainder of the proceeds are allocated as a
separate component of shareholders’ equity, net of transaction costs. Transaction costs are apportioned between the debt and equity
components based on their respective carrying amounts when the instrument was issued.
On conversion, the carrying amount of the debt component and the equity component are transferred to share capital and no gain or loss is recognized.
The interest cost recognized in respect of the debt component represents the accretion of the liability, over its expected life using the
effective interest method, to the amount that would be payable if redeemed.
51
Stock Options
The fair value of stock options granted, modified or settled on or after November 1, 2003 is recognized on a straight-line basis over the
applicable stock option vesting period as stock-based compensation expense in the consolidated statements of earnings (loss) and
contributed surplus in the consolidated balance sheets. On the exercise of stock options, consideration received and the accumulated
contributed surplus amount is credited to share capital.
For the purposes of calculating the stock-based compensation expense, the fair value of stock options is estimated at the date of the grant
using the Black-Scholes option pricing model and the cost is amortized over the vesting period. This model requires the input of a number
of assumptions including dividend yields, expected stock price volatility, expected time until exercise and risk-free interest rates. Although
the assumptions used reflect management’s best estimates, they involve assumptions based on market conditions generally outside of
the control of the Company.
Earnings (Loss) Per Share
The calculation of earnings (loss) per share – from continuing and discontinued operations is based on the reported net earnings (loss) –
from continuing and discontinued operations divided by the weighted average number of restricted voting shares outstanding during the
year. Diluted earnings per share reflect the assumed conversion of all dilutive securities using the treasury stock method.
Under the treasury stock method:
3 the exercise of options is assumed to be at the beginning of the period (or at the time of issuance, if later);
3 options for which the closing fair market value exceeds the option price are the only ones that are assumed to be dilutive;
3 the proceeds from the exercise of options, plus future period compensation expense on options granted on or after November 1, 2003,
are assumed to be used to purchase restricted voting shares at the average price during the period;
3 the number of restricted voting shares assumed to be dilutive, plus the weighted average number of restricted voting shares
outstanding during the year, is used in the denominator of the diluted earnings per share computation;
3 the convertible preferred shares are assumed to have been converted at the beginning of the period (or at time of issuance, if later),
and the resulting restricted voting shares are included in the denominator; and
3 any expenses applicable to convertible preferred shares are added back to the numerator, net of income taxes.
Since the Company was in a loss position for the years ended October 31, 2007 and 2006, there is no dilutive effect.
Government Financing
The Company makes periodic applications for financial assistance under available government assistance programs in the various
jurisdictions in which the Company operates. Grants relating to capital expenditures are reflected as a reduction of the cost of the related
assets. Grants and tax credits relating to current operating expenditures are generally recorded as a reduction of expenses at the time the
eligible expenses are incurred. In the case of certain foreign subsidiaries, the Company receives investment incentive allowances, which
are accounted for as a reduction of income tax expense.
Recently Issued Accounting Pronouncements
Capital Disclosures
The CICA issued a new accounting standard, Section 1535, Capital Disclosures, which requires the disclosure of both qualitative and
quantitative information that enables users of financial statements to evaluate the entity’s objectives, policies and processes for managing
capital. The Company will adopt this standard beginning November 1, 2007 and is currently evaluating the effect of adopting this standard.
Financial Instruments
The CICA issued two new accounting standards, Section 3862, Financial Instruments – Disclosures, and Section 3863, Financial
Instruments – Presentation, which apply to interim and annual financial statements relating to fiscal years beginning on or after October 1, 2007. These new standards revise and enhance the disclosure requirements, and carry forward, substantially unchanged, the
presentation requirements. These new standards emphasize the significance of financial instruments to the entity’s financial position and
performance, the nature and extent of risks arising from financial instruments, and how these risks are managed. The Company will adopt
this standard beginning November 1, 2007 and is currently evaluating the effect of adopting this standard.
52
Inventories
The CICA issued a new accounting standard, Section 3031, “Inventories,” which requires inventory to be measured at the lower of cost and net realizable value. The standard provides guidance on the types of costs that can be capitalized and requires the reversal of
previous inventory write-downs if economic circumstances have changed to support higher inventory values. The Company will adopt this standard beginning November 1, 2008 and is currently evaluating the effect of adopting this standard.
International Financial Reporting Standards
The CICA plans to converge Canadian GAAP with International Financial Reporting Standards (“IFRS”) over a transition period expected
to end in 2011. Management is reviewing the transition to IFRS on the Company’s consolidated financial statements and has not yet
determined the impact.
Note 3 Discontinued Operations and Assets Held for Sale
On April 17, 2007, the Company announced that as part of its strategy to focus on developing and manufacturing prescription
pharmaceutical products and to improve the Company’s profitability, it plans to restructure its current network of six pharmaceutical
manufacturing facilities in Canada.
In connection with this initiative, on December 6, 2007 the Company announced that it had entered into a definitive agreement to sell its
Niagara-Burlington operations focused on the manufacturing of OTC products to Pharmetics Inc. Please refer to note 25 – “Subsequent
Events” for additional information regarding this transaction.
The Company also plans to close its York Mills, Toronto facility and transfer substantially all commercial production and development
services to its site in Whitby and sell the land and buildings. The process of transferring production to other facilities is expected to be
completed by the first half of fiscal 2009.
The results of the Niagara-Burlington operations have been reported as discontinued operations and prior period amounts have been
reclassified to conform to the current period presentation. During 2007 the Company recorded an impairment charge of $12,465,000 to write down the carrying value of Niagara-Burlington operation’s long-lived assets to their fair value less estimated disposition costs.
The results of discontinued operations for the year ended October 31, 2007 and 2006 are as follows:
2007
$
2006
$
Revenues 35,244
37,493
Operating expenses
Repositioning expenses (recovery)
32,475
(397)
12,465
844
34,580
789
—
1,112
Earnings (loss) before income taxes
(10,143)
—
1,012
443
Net earnings (loss) for the year
(10,143)
569
Assets held for sale and the related liabilities include the Niagara-Burlington Operations and the land and buildings at York Mills. In accordance with Section 3475 of the CICA Handbook, long-lived assets held for sale are measured at the lower of their carrying amount or fair value less cost to sell. Assets held for sale and the related liabilities, as at October 31, 2007 and 2006, are as follows:
2007
$
2006
$
Current assets
Accounts receivable
Inventories
4,376
5,307
160
4,251
3,905
185
Total current assets
9,843
8,341
Capital assets
Current liabilities
Other long-term liabilities
16,662
26,723
3,174
1,523
2,527
1,416
53
Note 4 Asset Impairment Charge
During 2007, it was determined that the carrying value of the intangible assets and depreciable tangible capital assets (collectively the
“long-lived depreciable assets”) at the Company’s operations in Carolina, Puerto Rico were impaired as a result of volume declines arising
from the genericization of Omnicef, this being the largest single product that is manufactured at the facility. The Company tested the
recoverability of the long-lived depreciable assets at the Carolina operations and determined that the expected future cash flows over
the economic life of the principal assets were less than the carrying value of the long-lived depreciable assets. As a result, the Company
recorded an impairment charge of $48,580,000; $26,042,000 for intangible assets and $22,538,000 for tangible capital assets. The fair
value of the intangible assets was determined using a discounted cash flow methodology and the fair value of the tangible capital assets
was based on a weighted average continued use and liquidation value.
During 2006, the Company determined that the carrying value of long-lived depreciable assets at the Company’s operations in Caguas
and Manati, Puerto Rico and the goodwill associated with all the Puerto Rico operations were impaired as a result of certain events which
occurred during 2006. These events included: continued deterioration in revenues culminating in a significant increase in losses reported
by the Puerto Rico operations in the third quarter; suspension of production of a major product due to concerns over product shelf life;
the risk of a decline in revenue of another major product as a result of the approval by the U.S. Food and Drug Administration of a generic
version of the product; and the completion of a long-range plan that showed a significant reduction in earnings relative to prior forecasts.
The Company tested the recoverability of the long-lived depreciable assets for all of the Puerto Rico operations and determined that, in Caguas and Manati, the expected future cash flows over the economic life of the principal assets were less than the carrying value of
the long-lived depreciable assets. As a result the Company recorded an impairment charge of $81,428,000; $51,921,000 for intangible
assets and $29,507,000 for tangible capital assets. The fair value of the intangible assets was determined using a discounted cash flow
methodology and the fair value of tangible capital assets was based on a value in continued use, taking into account utilization levels.
The Company tested the recoverability of the goodwill associated with the Puerto Rico operations using a discounted cash flow
methodology, and recorded an impairment charge of $172,477,000 representing the full value of the Puerto Rico goodwill.
During 2006, the Company, as part of its ongoing review of long-term investments, concluded that its investment in the shares of a drug
technology company which was accounted for on the cost basis had an other than temporary decline and wrote down its value by
$756,000 to its market value.
A summary of the asset impairment charges for the years ended October 31, 2007 and 2006 is as follows:
2007
$
2006
$
Intangible asset impairment
Tangible capital asset impairment
Goodwill impairment
Other investment impairment
26,042
22,538
—
—
51,921
29,507
172,477
756
48,580
254,661
2007
$
2006
$
Interest-bearing balances with banks, with interest rates between 1% to 5%
Term deposits
30,557
—
18,899
31,824
Balance, end of the year
30,557
50,723
2007
$
2006
$
Raw materials and packaging components
Work-in-process
63,154
25,575
44,771
27,286
88,729
72,057
Note 5 Cash and Cash Equivalents
Note 6 Inventories
54
Note 7 Capital Assets
2007
Net
Accumulated
Book Accumulated
Cost
DepreciationValue
Cost
Depreciation
$
$
$
$
$
2006
Net
Book
Value
$
Land Buildings Machinery and equipment
Office equipment
Furniture and fixtures
Construction in progress
42,578
230,939
401,880
43,412
16,400
24,545
—
46,193
176,725
41,093
8,320
—
42,578
184,746
225,155
2,319
8,080
24,545
40,662
232,050
337,938
31,089
18,100
50,627
—
62,207
144,854
24,438
11,602
—
40,662
169,843
193,084
6,651
6,498
50,627
759,754
272,331
487,423
710,466 243,101 467,365
The amount required to complete authorized capital projects at October 31, 2007 is approximately $15,804,000 (2006 – $17,664,000).
The expenditures are expected to be incurred during the year ending October 31, 2008.
Included in capital assets are assets under capital leases with a cost of $16,642,000 at October 31, 2007 (2006 – $17,758,000). The
depreciation of assets under capital leases of $5,411,000 (2006 – $5,765,000) is included in accumulated depreciation at October 31, 2007.
Note 8 Intangible Assets
2007
$
2006
$
Balance, beginning of the year
Amortization
Impairment (note 4)
Foreign currency impact on intangible assets 41,447
(6,687)
(26,042)
—
110,095
(11,871)
(51,921)
(4,856)
8,718
41,447
2007
$
2006
$
Pre-operating costs
Financing costs
8,878
—
6,512
3,205
8,878
9,717
Note 9 Deferred Costs
As a result of changes in the Company’s accounting policies, all deferred financing costs are now netted against the carrying value of the
related debt. Please refer to note 2 – “Summary of Significant Accounting Policies”.
Note 10 Goodwill
2007
$
2006
$
Balance, beginning of the year
Acquisition Impairment (note 4) Foreign currency impact on goodwill 3,077
—
—
581
180,665
2,316
(172,477)
(7,427)
3,658
3,077
55
Note 11 Bank Indebtedness
2007
$
2006
$
Italian short-term operating credit facilities totaling €d19,200,000 (2006 –€ d19,200,000), bearing interest at 3-month Euribor plus spreads between 0.5% and 1.25%. Certain of the short-term credit facilities are collateralized by accounts receivable. Amounts utilized at October 31, 2007 were €d4,000,000; (2006 – €d3,000,000).
Short-term insurance premium financing
5,794
2,430
3,829
—
8,224
3,829
2007
$
2006
$
149,250
—
2,500
—
2,528
3,972
26,244
26,427
34,402
34,354
4,487
—
3,954
277,081
Note 12 Long-Term Debt
Senior secured term loan maturing April 26, 2014, bearing interest at 7.8% based upon floating LIBOR, US or CAD prime, or federal funds effective rates, plus applicable margins.
$75 million senior secured revolving loan facility maturing April 26, 2012, bearing interest at 6.4% based upon floating LIBOR, US, or CAD prime, or federal funds effective rates, plus applicable margins.
U.S. obligations under capital leases bearing interest at fixed rates between 4.4% and 7.8%, maturing over various dates from 2008 to 2011.
Italian mortgage (2007 – €d18,244,638; 2006 – €d20,706,000), bearing interest at 5.9% based upon floating 3-month Euribor, maturing in 2014.
Italian mortgage (2007 – €d23,872,001; 2006 – €d26,917,000), bearing interest at 6.1% based upon floating 3-month Euribor maturing in 2014.
Italian unsecured government loan (2007 – €d3,098,000; 2006 – €d3,098,000), bearing interest at 0.9% per annum, maturing in 2012.
Various long-term debt obligations refinanced during 2007
Total long-term debt outstanding
Less unamortized transaction costs
Less current portion
219,411
3,862
11,902
345,788
—
283,717
203,647
62,071
The Company is required to make quarterly installment payments of $375,000 on the senior secured term loan facility, along with
additional mandatory repayments based on certain excess cash flow measures. The Company’s ability to draw on the senior secured
revolving loan facility is dependent upon the Company’s inventory and trade accounts receivable levels. The senior secured term loan and
the senior secured revolving loan facility contain restrictive covenants typical to such debt agreements, including restrictions on capital
expenditures and the maintenance of certain financial ratios, all of which were met as at October 31, 2007. The senior secured term loan
and the senior secured revolving facility are collateralized by substantially all of the assets of the Company’s operations in Canada, U.S.A.,
Puerto Rico and the U.K. and the Company’s investments in the shares of all other operating subsidiaries.
The Company has entered into interest rate swap contracts to convert interest on the senior secured term loan from a floating rate to a
fixed rate of 7.7% until March 2010.
56
Estimated minimum annual repayments of long-term debt based on current exchange rates for the next five years are:
$
2008 2009 2010 2011 2012 Thereafter
11,902
10,765
10,756
10,802
12,705
162,481
Total payments
219,411
Included within the above future repayments of long-term debt are obligations under capital leases. Future minimum capital lease
payments under capital leases in effect at October 31, 2007 are as follows:
$
990
690
663
654
Total payments
Less capital lease minimum payments representing interest
2,997
469
2,528
2007
$
Fair value of the debt component of the convertible preferred shares upon issuance
Accreted interest
132,862
7,054
139,916
2008
2009
2010
2011
Interest on long-term debt amounted to $22,559,000 (2006 – $22,265,000).
Note 13 Convertible Preferred Shares – Debt Component
On April 27, 2007 JLL Partners, through its investment vehicle, JLL Patheon Holdings, LLC, purchased 150,000 units of Class I convertible
preferred shares of Patheon for $150 million.
The convertible preferred shares are a compound financial instrument with both a debt and equity component. On issuance, the fair value
of the debt component of the preferred shares was $132,862,000. The remainder of the proceeds attributable to shareholders’ equity was
$15,925,000, net of apportioned transaction costs of $1,213,000. Please refer to note 16 – “Shareholders’ Equity”.
Note 14 Other Long-Term Liabilities
2007
$
2006
$
Unfunded termination indemnities (2007 – e6,210,000; 2006 – e6,450,000)
Employee future benefits (note 15)
8,995
13,074
8,228
16,037
22,069
24,265
The unfunded termination indemnities relate to the employees of the Company’s Italian subsidiary. In accordance with Italian severance
pay statutes, an employee benefit is accrued for service to date and is payable when the employees’ employment with the Company
ceases. The termination indemnity liability is calculated in accordance with local civil and labour laws based on each employee’s length
of service, employment category and remuneration. The termination liability is adjusted annually by a cost-of-living index provided
by the Italian Government. There is no vesting period or funding requirement associated with the liability. The liability recorded in the
consolidated balance sheets is the amount to which the employees would be entitled if their employment with the Company ceased. The related expense for the year amounted to $2,312,000 (2006 – $1,971,000).
57
Note 15 Employee Future Benefits
The Company has a number of defined benefit pension plans. In addition, it has other benefit plans that provide post-retirement
healthcare and dental benefits. The Company measured the accrued benefit obligation and the fair value of plan assets for accounting
purposes as at October 31, 2007 for the defined benefit pension and other benefit plans.
Information about the Company’s defined benefit pension and other benefit plans, in aggregate, is as follows:
Defined Benefit Pension Plans 2007
$
Other
Benefit
Plans 2007
$
Defined
Benefit Pension Plans 2006
$
Other
Benefit
Plans
2006
$
Change in benefit obligation
Benefit obligation, beginning of the year
Current service cost
Interest cost
Plan amendments
Member contributions during the year
Benefits paid
Actuarial loss
Curtailment gain
Currency translation
65,920
4,241
3,677
–
991 (2,223)
203
–
8,432
11,196
910
543
–
–
(94)
(1,782)
(5,156)
1,192
58,365
4,999
3,221
(146)
–
(1,984)
(2,669)
–
4,134
9,030
1,202
490
–
–
(79)
63
–
490
Benefit obligation, end of the year
81,241
6,809
65,920
Change in plan assets
Market value of plan assets, beginning of the year
Actual return on plan assets
Member contributions during the year
Employer contributions
Benefits paid
Currency translation
50,149
5,885
991
5,775
(2,206)
6,717
Market value of plan assets, end of the year
67,311
Reconciliation of funded status
Funded status, deficit
Unamortized net actuarial loss
Unamortized past service costs
Accrued benefit liability
–
–
–
94
(94)
–
–
11,196
38,916
4,569
–
4,852
(1,984)
3,796
–
–
–
79
(79)
–
50,149
–
(13,930)
7,206
59
(6,809)
400
–
(15,771)
7,436
(142)
(11,196)
3,636
–
(6,665)
(6,409)
(8,477)
(7,560)
The accrued benefit liability of $13,074,000 (2006 – $16,037,000) is included in other long-term liabilities (note 14). For all of the
Company’s plans, the accrued benefit obligations are in excess of plan assets as at October 31, 2007 and 2006.
Defined benefit pension plan assets consist of:
2007
%
2006
%
Equity securities
Debt securities
Other 86
9
5
88
10
2
Total 100
100
The significant actuarial assumptions adopted in measuring the Company’s accrued benefit obligation and benefit plan expense in
connection with its defined benefit pension and other benefit plans is as follows (weighted average assumptions as at October 31, 2007
and 2006):
58
Accrued benefit obligation
Discount rate
Rate of compensation increase
Benefit costs recognized
Discount rate
Expected long-term rate of return on plan assets
Rate of compensation increase
%
Other
Benefit
Plans 2007
%
Defined
%
Other
Benefit
Plans
2006
%
5.6
4.1
5.8
–
5.0
3.5
5.3
–
5.5
7.3
3.8
5.5
–
–
5.0
7.0
3.5
5.5
–
–
In connection with the other benefit plans, a 4% to 12% annual rate of increase in the per capita cost of covered health care and dental
benefits was assumed for 2007 (2006 – 4% to 10%). The rate was assumed to decrease gradually over the next five years to 6% and
remain at that level thereafter (2006 – 6% and thereafter). The following table outlines the effects of a one-percentage-point increase and decrease in the assumed health care and dental benefit trend rates:
Impact of:
1% increase
1% decrease
Benefit Obligation $
Benefit
Expense
$
941
(815)
116
(98)
The cost components of the Company’s defined benefit pension plan and other benefit plans in aggregate are as follows:
Current service cost
Interest cost
Actual return on plan assets
Actuarial (gain) loss
Elements of employee future benefit costs before adjustments to recognize the long-term nature of employee future benefits
Adjustments to recognize the long-term nature of employee future benefit costs:
Curtailment gains/Settlement
Difference between expected return and actual return on plan assets for the year
Difference between amortization of the net actuarial loss for the year and the actual actuarial loss on accrued benefit obligation for the year
Difference between amortization of past service costs for the year and actual plan amendments for the year
Net benefit cost recognized
$
Other
Benefit
Plans 2007
$
Defined
$
Other
Benefit
Plans
2006
$
4,241
3,677
(5,885)
203
910
543
–
(1,782)
4,999
3,221
(4,569)
(2,668)
1,202
490
–
63
2,236
(329)
–
(4,292)
983
1,755
(1,447)
–
1,728
–
1,462
–
120
2,498
3,166
274
(209)
3,875
–
(2,123)
20
–
4,184
2,029
The net benefit cost recognized for the year ended October 31, 2007, includes a curtailment gain of $4,292,000 arising from a decision to phase out certain post-employment benefits in the Company’s Canadian operations.
The Company also provides retirement benefits for the majority of its employees at its Canadian, U.S. and Puerto Rican sites under defined
contribution pension plans. The total expense for the plans amounted to $7,147,000 (2006 – $7,592,000).
Total cash payments for employee future benefits for 2007 totaled $13,016,000 (2006 – $12,523,000), consisting of cash contributed by the Company to its defined benefit pension plans of $5,775,000 (2006 – $4,852,000), cash payments directly to beneficiaries for its other benefit plans of $94,000 (2006 – $79,000) and cash contributed to its defined contribution pension plans of $7,147,000 (2006 – $7,592,000).
59
Note 16 Shareholders’ Equity
Share Capital
Share capital consists of the following:
Authorized
Unlimited Class I preferred shares – Issuable from time to time in one or more series, each series comprising the number of shares and having the designation, rights, privileges, restrictions and conditions determined by the Company’s board of directors.
Unlimited restricted voting shares.
Issued and outstanding
150,000 Class I preferred shares consisting of 150,000 Series C (“convertible preferred shares”) and 150,000 Series D (“special voting preferred shares”)
Restricted voting shares of 90,624,388 (previously referred to as common shares); 2006 – 92,950,688
2007
$
2006
$
15,925 –
391,967
400,721
On April 27, 2007 JLL Partners, through its investment vehicle, JLL Patheon Holdings, LLC, purchased 150,000 units of Class I convertible
preferred shares of Patheon for $150 million. Each unit consists of a Class I Series C convertible preferred share and a Series D special
voting preferred share. On issuance, the fair value of the debt component of the preferred shares was $132,862,000 (please refer to
note 13 – “Convertible Preferred Shares – Debt Component”). The remainder of the proceeds, attributable to shareholders’ equity was
$15,925,000, net of apportioned transaction costs of $1,213,000.
Until October 27, 2009, no cash dividends will be paid on the preferred shares, but the liquidation preference and conversion rate will
increase on a quarterly basis by 2.125%. After October 27, 2009, these increases in the liquidation preference and conversion rate will
continue until the maturity or prior conversion, unless the Company elects to pay a cash dividend for any applicable quarter, in which case
the Company will pay a cash dividend for such quarter based on an annual dividend rate of 8.5% on the aggregate liquidation preference
of the convertible preferred shares.
At October 31, 2007, each convertible preferred share is convertible into 218.7154 restricted voting shares, as adjusted for any non-cash
dividends noted above, at any time at the holder’s option. The Company will be entitled to require the holder to convert into restricted
voting shares if, at any time after October 27, 2009, the market price of the restricted voting shares on the Toronto Stock Exchange
exceeds a price equivalent to US$7.87 for a period of at least 60 days.
If not previously converted, the Company is required to redeem the convertible preferred shares for cash on April 27, 2017 at a price equal
to the aggregate liquidation preference of the convertible preferred shares, plus accrued and unpaid dividends thereon. The Company
is also required to redeem the convertible preferred shares upon the occurrence of a change of control of Patheon at a price equal to
the greater of the aggregate liquidation preference of the convertible preferred shares, plus accrued and unpaid dividends thereon, or
the price per share paid to holders of restricted voting shares in the change of control transaction, multiplied by the number of restricted
voting shares into which the convertible preferred shares are then convertible.
The convertible preferred shares have the right to vote, together with the holders of the restricted voting shares, on an as-if converted
basis, in respect of all matters other than the election of directors. As at October 31, 2007, these voting rights represent approximately 27% of the voting rights of Patheon. The special voting preferred shares have the right to appoint up to three directors.
Restricted Voting Shares
The Company’s articles were amended on April 26, 2007 to re-designate the common shares as restricted voting shares. This occurred in
connection with the issuance of the convertible preferred shares. The holders of the convertible preferred shares have the right to appoint
three of nine members of the Board of Directors. The holders of Patheon’s restricted voting shares have the right to elect the remaining
members of the Board of Directors. Under the rules of the Toronto Stock Exchange, voting equity securities are not to be designated, or
called, common shares unless they have a right to vote in all circumstances that is not less, on a per share basis, than the voting rights of
each other class of voting securities. Accordingly, the Company amended its articles to re-designate the common shares as restricted
voting shares. This re-designation involves only a change in the name of the securities; the number of shares outstanding and the terms
and conditions of the outstanding shares are not affected by the change.
60
During 2007, the Company repurchased, through a normal course issuer bid, 2,334,300 restricted voting shares at a cost of $8,778,000.
During the year, the Company issued 8,000 (2006 – 105,000) restricted voting shares under the stock option plan for proceeds of $24,000
(2006 – $127,000).
Shareholder Rights Plans
On March 31, 2005, the shareholders approved the renewal of an amended and restated shareholder rights plan (the “Renewal Plan”)
which continued the rights granted under a shareholder rights plan approved by shareholders on March 23, 1999. The Renewal Plan
applies to all restricted voting shares (formerly common shares) and all future issues of restricted voting shares. The Renewal Plan is
designed to encourage fair treatment of all the Company’s shareholders in the event of a take-over bid, to provide shareholders and the
Board of Directors with more time to fully consider any unsolicited take-over bid for the Company, to allow the Board of Directors to pursue,
if appropriate, other alternatives to enhance shareholder value, and to allow additional time for competing bids to emerge. The Renewal
Plan will be in effect until the close of the 2008 annual shareholders’ meeting of the Company.
Under the terms of the Renewal Plan, one right has been granted for each restricted voting share. The rights granted under the Renewal
Plan become exercisable only when a person, including any party related to it, acquires or announces its intention to acquire 20% or more
of the Company’s outstanding restricted voting shares without complying with the “Permitted Bid” provisions or without approval of the
Board of Directors. Should the rights become exercisable, each right would entitle a holder, other than the acquiring person and persons
related to it, to purchase C$100 (US$106) worth of common shares of the Company for C$50 (US$53).
A Permitted Bid is a bid made to all shareholders that is open for at least 60 days. If at the end of 60 days at least 50% of the outstanding
shares, other than those owned by the offeror and certain related parties, have been tendered, then the offeror may take up and pay for
the shares but must extend the bid for a further 10 business days to allow other shareholders to tender.
Incentive Stock Option Plan
The Company has an incentive stock option plan. Persons eligible to participate in the plan are directors, officers, and key employees of the Company and its subsidiaries or any other person engaged to provide ongoing management or consulting services to Patheon. The plan provides that the maximum number of shares that may be issued under the plan is 7.5% of the issued and outstanding restricted
voting shares of the Company at any point in time. As of October 31, 2007, the total number of restricted voting shares issuable under the plan was 6,796,829 shares (2006 – 6,971,302), of which there are stock options outstanding to purchase 3,857,916 shares (2006 – 3,949,815) under the plan. The exercise price of restricted voting shares subject to an option is determined at the time of grant
and the price cannot be less than the weighted average market price of the restricted voting shares of Patheon on the Toronto Stock
Exchange during the two trading days immediately preceding the grant date. Options generally expire 10 years after the grant date and
are also subject to early expiry in the event of death, resignation, dismissal or retirement of an optionee. Options vest over one to three
years, with one-third vesting on each of the first, second and third anniversaries of the grant date for those vesting over three years. Please also refer to note 21 – “Stock-Based Compensation Expense”.
A summary of the plan and changes during each of 2007 and 2006 are as follows:
(Dollar amounts in Canadian dollars)
Shares
Number
2007
Weighted
Average
Exercise
Price
$
Shares
Number
2006
Weighted
Average
Exercise
Price
$
Outstanding, beginning of the year
Granted Exercised
Forfeited 3,949,815
100,000
(8,000)
(183,899)
10.53
4.83
3.53
10.98
3,886,840
547,500
(105,000)
(379,525)
10.66
6.66
1.36
8.75
Outstanding, end of the year
3,857,916
10.38
3,949,815
10.53
Exercisable, end of the year
3,706,249
10.57
3,617,304
10.73
61
The following table summarizes information about options outstanding at October 31, 2007:
(Dollar amounts in Canadian dollars)
Options Outstanding
Options Exercisable
Range of Exercise Prices
Number
Outstanding
Weighted
Average
Remaining
Contractual
Life
Weighted
Average
Exercise
Price
Number
Exercisable
Weighted
Average
Exercise
Price
$2.55 – 4.83
$6.17 – 7.57
$8.15 – 9.91
$10.91 – 13.95
$14.12 – 15.96
372,000
347,500
973,666
1,617,750
547,000
3.1 years
3.8 years
2.4 years
4.0 years
2.6 years
$3.85
$6.67
$8.46
$12.17
$15.30
272,000
315,833
953,666
1,617,750
547,000
$3.49
$6.65
$8.46
$12.17
$15.30
3,857,916
$10.38
3,706,249
$10.57
Note 17 Other Information
Foreign Exchange
During 2007, the foreign exchange loss on operating exposures (including benefits from cash flow hedges and the revaluation of all foreign currency denominated working capital recorded in operating expenses was $3,410,000 (2006 – gain of $817,000).
During 2007, the Company recorded a foreign exchange gain of $12,331,000 on the revaluation of certain U.S. dollar denominated debt,
net of hedging activities, in its Canadian legal entity. During 2007, the Company also recorded a foreign exchange loss of $858,000 in
connection with a change in the Company’s internal capital structure, which resulted in the recognition of foreign exchange translation
losses previously recorded in accumulated other comprehensive income.
Net Change in Non-Cash Working Capital Balances Related to Continuing Operations
The net changes in non-cash working capital balances related to continuing operations are as follows:
2007
$
Accounts receivable
Inventories
Income taxes payable
(813)
(9,351)
(955)
3,961
4,716
9,803
(1,225)
(2,207)
6,560
7,575
(2,442)
20,506
2006
$
Related Party Transactions
Revenues from companies controlled by a director and significant shareholder of the Company were in the amount of $473,000 (2006 –
$3,145,000). These transactions were conducted in the normal course of business and are recorded at the exchanged amount. Accounts
receivable at October 31, 2007 includes a balance of $392,000 (2006 – $446,000) with respect to these related party transactions.
At October 31, 2007 the Company has an investment of $739,000 (2006 – $173,000) representing an 18% interest in two Italian
companies (collectively referred to as “BSP Pharmaceuticals”) whose largest investor is an officer of the Company. These companies will specialize in the manufacturing of cytotoxic pharmaceutical products.
The Company has accrued management fees owing to it under a management services agreement with BSP Pharmaceuticals of
$1,593,000 for the year ended October 31, 2007 (2006 – nil). These fees will be invoiced to BSP Pharmaceuticals once it has finalized all of its bank financing. These services were conducted in the normal course of business and are recorded at the exchanged amounts.
In connection with certain of BSP Pharmaceuticals’ bank financing, the Company has made commitments that it will not dispose of its
interest in BSP Pharmaceuticals prior to January 1, 2011.
62
Note 18 Income Taxes
The following is a reconciliation of the expected income tax expense (recovery) obtained by applying the combined corporate tax rates to
the loss from continuing operations before income taxes:
2007
$
2006
$
Expected income tax expense (recovery) using statutory tax rates Change in valuation allowance
Permanent differences and other:
Foreign
Domestic
Goodwill impairment
Foreign rate differentials
Withholding tax on intercompany dividend
Large Corporations Tax – Domestic
(22,477)
4,797
(95,686)
6,381
6,899
(1,076)
—
28,989
2,102 —
4,067
1,389
59,436
35,412
—
48
19,234
11,047
Effective tax rate
(29.5%)
Canada
Future income tax assets – long-term
Share issue costs
Deferred financing costs
Accounting provisions not currently deductible for tax purposes
Net operating loss carryforward
Unclaimed R&D expenditures
Book depreciation in excess of tax depreciation (federal)
Valuation allowance
1,812
3,188
5,924
1,086
4,748
3,518
(16,072)
1,946
2,509
3,096
—
4,667
—
(6,311)
(4.0%)
Components of future income taxes by jurisdiction are summarized as follows:
2006
$
4,204
5,907
7,957
19,204
1,781
(2,091)
7,537
7,386
997
—
26,851
15,920
Future tax assets
31,055
21,827
Canada
Future income tax liabilities – long-term
Tax depreciation in excess of book depreciation (provincial)
Investment tax credits
Other 4,146
410
—
5,200
—
1,025
4,556
6,225
Foreign
Future income tax liabilities – long-term
Tax depreciation in excess of book depreciation
Other 41,228
1,794
26,549
354
43,022
26,903
47,578
33,128
2007
$
Foreign
Future income tax assets – long-term
Accounting provisions not currently deductible for tax purposes
Net operating loss carryforward
Other Valuation allowance
Future tax liabilities
The Company has tax-effected net operating losses carried forward of $20,290,000; $17,063,000 of the losses have an indefinite life and
$3,227,000 have expiry dates ranging from October 31, 2008 to October 31, 2026.
63
Note 19 Segmented Information
The Company is organized and managed as a single business segment, being the provider of commercial manufacturing and
pharmaceutical development services.
Canadian and foreign operations consist of the following:
Year ended October 31, 2007
Revenues by client’s billing location:
Canada
USA Europe
Other geographic areas
Manufacturing Location
CanadaUSA
$
$
Europe Total
$
$
14,270 137,389 39,235 4,197 1,069 196,690 3,127 2,146 1,128 17,757 254,547 5,519 16,467
351,836
296,909
11,862
Total revenues
195,091 203,032 278,951 677,074
Capital assets
120,808
119,483
247,132
487,423
3,658
–
–
3,658
Canada
$
USA
$
Europe $
Revenues by client’s billing location:
Canada
USA Europe
Other geographic areas
21,323 138,587 53,010 4,696 856 231,184 846 190 1,930 13,751 202,842 5,444 24,109
383,522
256,698
10,330
Total revenues
217,616 233,076 223,967 674,659
Capital assets
103,002
142,491
221,872
467,365
3,077
–
–
3,077
Goodwill Year ended October 31, 2006
Goodwill Manufacturing Location
Total $
Revenues are attributed to countries based on the location of the client’s billing address, capital assets are attributed to the country in which they are located, and goodwill is attributed to the country in which the entity to which the goodwill pertains is located.
During the year ended October 31, 2007, one client (2006 – two clients) accounted for more than 10% of the Company’s total revenues. As a percentage of total revenues, this client amounted to 13% (2006 – 13% and 12%).
Revenue information by service activity is as follows:
Years ended October 31, 2007
$
2006
$
Commercial manufacturing – prescription
Commercial manufacturing – over-the-counter
Development services
514,069 46,549 116,456 76%
7%
17%
506,732 69,973 97,954 75%
10%
15%
677,074 100%
674,659 100%
Note 20 Commitments and Contingencies
Long-Term Operating Leases
The Company has entered into long-term rental agreements expiring at various dates until 2014. The future rental payments for the next five years and thereafter are estimated as follows: 2008 – $3,113,000, 2009 – $2,807,000, 2010 – $2,065,000, 2011 – $1,658,000,
2012 – $1,148,000, and thereafter – $563,000.
64
Other
In the normal course of operations, the Company is subject to litigation and claims from time to time. The Company may also be subject
to lawsuits, investigations and other claims, including environmental, labour, product, customer disputes and other matters. The Company
believes that adequate provisions have been recorded in the accounts where required. Although it is not possible to estimate the extent of
potential costs, if any, the Company believes that the ultimate resolution of such contingencies will not have a material adverse impact on
the results of operations, financial position or liquidity.
The Company’s tax filings are subject to audit by taxation authorities. Although the Company believes that it has adequately provided for
income taxes based on the information available, the outcome of audits cannot be known with certainty and the potential impact on the
financial statements is not determinable.
Note 21 Stock-Based Compensation
For the purposes of calculating the stock-based compensation expense in connection with the Company’s incentive stock option plan, the
fair value of stock options is estimated at the date of the grant using the Black-Scholes option pricing model and the cost is amortized over
the vesting period.
The fair value of stock options is estimated at the date of the grant. The weighted average fair value of stock options granted for the year
ended October 31, 2007 was $1.92 (2006 – $1.73). The fair value of stock options for purposes of determining stock-based compensation
is estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:
Risk free interest rate
Expected volatility
Expected weighted average life of the options
Expected dividend yield
2007
2006
4.2%
42%
6 years
0%
4.2%
42%
4 years
0%
The Company recorded stock-based compensation expense in the year of $220,000 (2006 – $928,000) for options granted on or after
November 1, 2003.
Note 22 Repositioning Expenses
The Company has incurred a number of expenses associated with its performance enhancement program, which is intended to identify
operational improvements and cost reduction initiatives. The related expenses include costs associated with a reduction in the workforce,
project management costs and consulting fees from external specialists who are assisting in identifying operational improvements.
During 2007, the Company also incurred professional fees and other costs in connection with its review of strategic and financial alternatives.
The following is a summary of expenses associated with these initiatives (collectively “repositioning expenses”) for the years ended
October 31, 2007 and 2006:
2007
$
2006
$
Performance enhancement program:
Employee-related expenses
Consulting, professional and project management costs
Strategic alternatives review 8,938
3,507
3,355
8,821
1,193
2,984
Total repositioning expenses
15,800
12,998
As at October 31, 2007, $6,048,000 (2006 – $8,699,000) of the repositioning expenses were unpaid and are recorded in accounts
payable and accrued liabilities. Repositioning expenses paid during the year amounted to $18,998,000 (2006 – $4,215,000).
65
Note 23 Refinancing Expenses
During 2007 the Company incurred expenses of $13,471,000 in connection with its refinancing activities. The expenses consist of
transaction costs for the new senior secured term loan and senior secured revolving loan facility, costs allocated to the debt portion of the
convertible preferred shares and prepayment charges in connection with cancellation of certain of the Company’s U.K. debt facilities.
During 2006, the Company incurred charges of $1,643,000 in connection with the cancellation and prepayment of certain of its North
American credit facilities. The Company also wrote off $6,332,000 in related deferred financing costs.
Note 24 Financial Instruments
(a) Foreign Exchange
The Company utilizes financial instruments to manage the risk associated with fluctuations in foreign exchange and interest rates. The
Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective
and strategy for undertaking various hedge transactions.
As at October 31, 2007, the Company’s Canadian operations had entered into foreign exchange forward contracts to sell an aggregate
amount of US$34,172,000 (2006 – US$60,000,000). These contracts hedge the Canadian operations expected exposure to U.S. dollar
denominated cash flows and mature at the latest on April 21, 2008, at an exchange rate of $1.0535 Canadian. The mark-to-market value on
these financial instruments as at October 31, 2007 was an unrealized gain of $4,052,000 (2006 – unrealized loss of $1,418,000) which has
been recorded in accumulated other comprehensive income in shareholders’ equity.
As at October 31, 2007 the Company has designated $141.6 million of U.S. dollar denominated debt as a hedge against its net investment
in its subsidiaries in the U.S.A. and Puerto Rico. The exchange gains and losses arising from this debt, from the date so designated, are
recorded in accumulated other comprehensive income in shareholders’ equity.
As at October 31, 2007, the Company’s Canadian operations had entered into a foreign exchange contract to purchase US$45,000,000.
The contract matures on January 28, 2010, at an exchange rate of 1.0015. The contract hedges the Canadian operations net US dollar
balance sheet exposure. For accounting purposes, the contract has not been designated as a hedge. The mark-to-market value of this
contract was a loss of $2,699,000, which has been recorded in the loss from continuing operations.
(b) Interest Rate Risk
The Company has exposure to movements in interest rates. The Company has entered into interest rate swaps to convert the interest
expense on the senior secured term loan, until March 2010, from a floating interest rate to a fixed interest rate.
The mark-to-market value of these financial instruments at October 31, 2007 was an unrealized loss of $2,593,000 which has been
recorded in accumulated other comprehensive income in shareholders’ equity.
(c) Fair Value
The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies;
however, considerable judgment is required to develop these estimates. Accordingly, these estimated fair values are not necessarily
indicative of the amounts the Company could realize in a current market exchange. The estimated fair value amounts can be materially
affected by the use of different assumptions or methodologies. The methods and assumptions used to estimate the fair value of financial
instruments are described below:
Cash and cash equivalents, accounts receivable, bank indebtedness, accounts payable and accrued liabilities and
income taxes payable
Due to the short period to maturity of these instruments, the carrying values as presented in the consolidated balance sheets are
reasonable estimates of fair value.
Long-term debt and debt component of convertible preferred shares
With the exception of the senior secured term loan, the fair value of the Company’s remaining long-term debt and the debt component
of the convertible preferred shares, based on current rates for debt with similar terms and maturities, is not materially different from its
carrying value.
As at October 31, 2007, the fair value of the senior secured term loan was estimated to be $142,582,000, based on current rates for debt
with similar terms and maturities.
Foreign exchange forward contracts and interest rate swaps
These financial instruments are measured at their fair value on the balance sheet.
66
(d) Credit Risk
The Company’s financial assets that are exposed to credit risk consist primarily of cash and cash equivalents, accounts receivable and
foreign exchange forward contracts with positive fair values.
As at October 31, 2007, the Company’s cash and cash equivalents were held in interest-bearing balances with banks. It is the Company’s
policy to invest its cash and cash equivalents (including any short-term investments) in entities with an investment grade credit rating.
Credit risk is further reduced by limiting the amount which is invested in any one government or corporation.
The Company, in the normal course of business, is exposed to credit risk from its clients, substantially all of which are in the
pharmaceutical industry. These accounts receivable are subject to normal industry credit risks.
The Company is also exposed to credit risk from potential default by any of its counterparties on its foreign exchange forward contracts.
The Company manages this credit risk by dealing with counterparties which are major financial institutions and which the Company
anticipates will satisfy their obligations under the contracts.
Note 25 Subsequent Events
On December 6, 2007, the Company announced that it had entered into a definitive agreement to sell its Niagara-Burlington commercial
manufacturing business to Pharmetics Inc. Under the terms of the agreement Pharmetics will acquire the assets, including equipment
facilities and land at the Company’s facilities in Fort Erie and Burlington Gateway. Pharmetics will provide employment to all of the
commercial manufacturing employees at the two sites and, subject to assignment of third party contracts, will continue to manufacture
and supply all of the products currently manufactured at these sites.
The transaction is expected to be completed on or about January 31, 2008, subject to closing conditions including regulatory approvals,
the assignment of client and other contracts and the completion of financing arrangements by the purchaser. The purchase price for the
business is CAD$5.75 million plus working capital, subject to adjustments.
On December 14, 2007, the Company announced that as a result of its review of the Puerto Rico operations, with a focus on restructuring
the operations, eliminating operating losses and developing a long-term plan for the business, it has decided to retain and continue to
streamline its facilities in Caguas and Manati and divest of its facility in Carolina.
Revenues for the year ended October 31, 2007 for the Carolina operations were $42.9 million. The Carolina operations reported a profit
before repositioning expenses, asset impairment charge, depreciation and amortization, foreign exchange losses reclassified from other comprehensive income, interest, refinancing charges, write-off of deferred financing costs and income taxes for the year ended October 31, 2007 of $6.1 million.
Note 26 Comparative Amounts
Certain of the comparative amounts have been reclassified to conform to the current year presentation.
67
Board of Directors and Corporate Governance
Board of Directors
Corporate Governance
Peter A.W. Green
Chairman of the Board,
Patheon Inc.
Overview
Wesley P. Wheeler
Chief Executive Officer,
Patheon Inc.
Ramsey A. Frank
Managing Director,
JLL Partners Inc.
Paul S. Levy
Managing Director,
JLL Partners Inc.
Thomas S. Taylor
Senior Principal,
JLL Partners Inc.
Joaquín B. Viso
Corporate Director
(Former Chairman,
MOVA Pharmaceutical
Corporation)
Derek J. Watchorn
President and Chief Executive Officer,
PSPIB Destiny Inc.
Gregory C. Wilkins
Chief Executive Officer and
President,
Barrick Gold Corporation
Patheon’s Board of Directors has stewardship and responsibility,
on behalf of Patheon’s shareholders, for overseeing the proper
and effective management of the Company. In fulfilling its
mandate, the Board reviews and approves governance principles
and guidelines which are consistent with Patheon’s core
principles of integrity, respect and excellence.
Board Composition and Responsibilities
Since 1996, the role of Chair of the Board of Directors has been
separate from that of the Chief Executive Officer and has been
held by an independent director who is not related to the Company.
There were six directors elected at the 2007 annual shareholders
meeting on April 19, 2007. These directors were joined on April 27, 2007 by three representatives of JLL Partners Inc., following
shareholder approval and completion of a US$150 million
convertible preferred share investment in Patheon by JLL
Partners. In June 2007, George L. Ploder resigned as a director
after 15 years of service.
Included on the Board are the Chief Executive Officer of Patheon
and the former non-executive Chairman of Patheon’s Puerto
Rican subsidiary, MOVA Pharmaceutical Corporation. The Board
believes this composition allows for a constructive exchange of
opinions leading to reasoned and informed decision-making on
behalf of Patheon’s shareholders.
Among the Board’s principal responsibilities, as reflected in its Charter, are the following:
3 developing and monitoring Patheon’s approach to corporate governance
3 responsibilities relating to management including:
• satisfying itself as to the integrity of management and the
fostering of a culture of integrity throughout the organization
• succession planning for Patheon’s senior management
• adopting and implementing an executive compensation
policy for Patheon’s senior management
Further Information
For additional biographical information, please refer to the Management Proxy Circular for the 2008 Annual and Special Meeting of Shareholders or Patheon’s web site at www.patheon.com.
68
Corporate Governance
3 oversight of the operation of the business including:
• ensuring that adequate risk management practices and
strategies are in place
• strategic planning
• ensuring the integrity of Patheon’s internal control and
management information systems
• developing and reviewing Patheon’s corporate disclosure
policies
• ensuring appropriate financial reporting
• overseeing pension plan administration and related matters
• monitoring compliance with the Code of Business Conduct.
Generally, a portion of the Board meeting is held in camera at
which only non-management directors are present. In accordance
with procedures of the Corporate Governance Committee,
Board members are able to engage special advisors such as
independent legal counsel, compensation specialists or other
professionals in appropriate circumstances. A copy of the Charter
of the Board of Directors is available for review on Patheon’s
website at www.patheon.com under “Investor Relations/
Corporate Governance”.
Committees
The Board’s principal responsibilities are managed by three
standing committees of the Board: Audit Committee, Corporate
Governance Committee, and Compensation and Human
Resources Committee.
Summaries of the principal duties and responsibilities of these
committees, as reflected in their respective charters and copies
of the full charters are available for review on Patheon’s website
at www.patheon.com under “Investor Relations/Corporate
Governance”. The members of the respective committees and
the number of meetings attended are set out in Patheon’s
Management Proxy Circular for the 2008 Annual and Special
Meeting of Shareholders, a copy of which will be available
on Patheon’s website at www.patheon.com under “Investor
Relations/Corporate Governance”.
Disclosure Policy
Patheon’s Corporate Disclosure Policy guides Patheon in
its interactions with shareholders, financial analysts and the
public. It reflects the underlying principles that disclosure of
material information about the company should be: (i) timely,
factual, accurate and balanced; and (ii) broadly disseminated in
accordance with all applicable legal and regulatory requirements.
The Policy also reflects “best practices” recommended by the
Canadian Investor Relations Institute.
The Corporate Disclosure Policy contains a provision mandating
its review by the Board at least every two years, and it was most
recently reviewed and updated by the Board in January 2008. In
addition, the Corporate Disclosure Policy has been made publicly
available on Patheon’s web site at www.patheon.com under
“Investor Relations/Corporate Governance”.
Code of Business Conduct
The principles of integrity, respect and excellence are
documented in Patheon’s Code of Business Conduct, which was
adopted by the Board of Directors in 2002 to provide guidelines
to employees, board members and agents for addressing issues
and questions relating to Patheon’s business practices. A copy of
Patheon’s Code of Business Conduct is available on Patheon’s
web site at www.patheon.com under “Investor Relations/
Corporate Governance”.
In 2005, Patheon engaged EthicsPoint, Inc. to act as Patheon’s
external service provider with respect to a confidential
whistleblower program and the program was rolled out to
employees during fiscal 2006. The program is both telephone and
web based. Employees may use this service to report any activities
they suspect may be in violation of Patheon’s Code of Business
Conduct, including matters relating to accounting, internal
accounting controls and auditing. The EthicsPoint reporting
system is available to Patheon employees in all jurisdictions
except Italy and France, where certain laws preclude Patheon
from offering an anonymous reporting service to its employees
and, instead, employees in those jurisdictions may report
violations to management only on a non-anonymous basis.
Further Information
Further details of Patheon’s approach to corporate governance
matters are contained in our Proxy Circular for the 2008 Annual
and Special Meeting of Shareholders.
69
Senior Management
Senior Management
Wesley P. Wheeler
Nick A. DiPietro
President and
Chief Operating Officer
John H. Bell, CA
Chief Financial Officer
Shabbir T. Anik, Ph.D., MBA
President,
Global Pharmaceutical
Development Services and
Chief Scientific Officer
Clive V. Bennett
President, Patheon U.S.A.
Aldo Braca
President, Patheon Europe
Kevin D. Duffy
Executive Vice-President,
Global Sales, Marketing and
Business Development
Michael S. Harding
Executive Vice-President,
Global Quality Operations
Jacqueline Le Saux
General Counsel – North America and Corporate Secretary
Further Information
For additional biographical information, please refer to the Management Proxy Circular for the 2008 Annual and Special Meeting of Shareholders or Patheon’s web site at www.patheon.com.
70
Tom L. Ferguson
Senior Vice-President, Global Information
Technology
Steven M. Liberty
Senior Vice-President,
Operations, Canada
Roy J. Wieschkowski
Corporate Human Resources
and Environmental, Health & Safety
Luis Albors
General Manager and Vice-President,
Puerto Rico Operations
Jonathan Arnold
Vice-President, Global Supply Chain
Norman Barras
Vice-President,
Services – Europe
Giuseppe Cassisi
Vice-President and Business Executive
Nicholas M. Dowd, CA
Vice-President and Controller,
Patheon Inc.
Ian Jones, ACA
Vice-President, Finance
European Operations
Andrew Kelley
Vice-President, U.K. and
France Operations
Peter Lucyshyn
Vice-President, Quality Operations, North America
Antonella Mancuso
Vice-President, Italian Operations
Colin M. Minchom, Ph.D.
Vice-President,
Services – Canada
Global Operations
Global Operations
Commercial
Manufacturing
Operations
United States
Europe
Canada
Puerto Rico
Aldo Braca
President, Patheon Europe
Steven M. Liberty
Operations, Canada
European Business Office
Via Morolense 87
03013 Ferentino (FR)
Italy
Tel.: +39 0775 3991
Toronto Region Operations
2100 Syntex Court
Mississauga, Ontario L5N 7K9
Tel.: (905) 821-4001
Debbie Rak
Site Director
Luis Albors
Vice-President and General
Manager,
Puerto Rico Operations
Caguas Operations
Villa Blanca Industrial Park
State Road 1, Km. 34.8
Caguas, Puerto Rico 00725
Tel.: (787) 746-8500
Janet Maldonado
Site Director
Manatí Operations
Manatí, Puerto Rico 00674
Tel.: (787) 854-3005
Ileana Quiñnones
Vice-President, Operations
Carolina Operations
Ave. 65 Infantería Industrial Park, Km. 12.6
Carolina, Puerto Rico 00984
Tel.: (787) 701-0010
Carlos Arroyo
Site Director
CINCINNATI
Clive V. Bennett
President,
Patheon U.S.A.
Cincinnati Operations
2110 East Galbraith Road
Cincinnati, Ohio 45237-6300
Tel.: (513) 948-9111
Bob Zinser
Site Director
U.K. AND FRANCE
Andrew Kelley
Vice-President, U.K. and France Operations
Bourgoin-Jallieu Operations
40, boulevard de Champaret
B.P. 448
38317 Bourgoin-Jallieu,
Cedex
France
Tel.: +33 4 7493 8700
Hugh Packer
Site Director
Swindon Operations
Kingfisher Drive
Covingham, Swindon
Wiltshire SN3 5BZ
England
Tel.: +44 1793 524411
ITALY
Toronto York Mills
Operations
865 York Mills Road
Toronto, Ontario M3B 1Y5
Tel.: (416) 443-9030
Roman Charko
Site Director
Burlington Century
Operations
977 Century Drive
Burlington, Ontario
L7L 5J8
Tel.: (905) 639-5254
Whitby Operations
111 Consumers Drive
Whitby, Ontario L1N 5Z5
Tel.: (905) 668-3368
Roman Charko
Site Director
Antonella Mancuso
Vice-President,
Italian Operations
Ferentino (Rome)
Operations
Via Morolense 87
Italy
Tel.: +39 0775 3991
Monza Operations
Viale G.B. Stucchi, 110
I-20052 Monza
Italy
Tel.: +39 039 2047 1
71
Global Operations
Global Operations (continued)
Pharmaceutical
Development
Services
Shabbir T. Anik, Ph.D., MBA
President,
Global Pharmaceutical
Development Services and
Chief Scientific Officer
United States
Europe
Canada
Caguas
Villa Blanca Industrial Park
Caguas, Puerto Rico 00725
Tel.: (787) 746-8500
Miguel Hernández
Acting Director, PDS, Puerto Rico
Norman Barras
Vice-President,
Services, Europe
Colin Minchom, Ph.D.
Vice-President,
Services, Canada
Swindon Operations
Kingfisher Drive
Covingham, Swindon
Wiltshire SN3 5BZ
England
Tel.: +44 1793 524411
Toronto Region Operations
2100 Syntex Court
Mississauga, Ontario L5N 7K9
Tel.: (905) 821-4001
Cincinnati Operations
2110 East Galbraith Road
Cincinnati, Ohio 45237-6300
Tel.: (513) 948-9111
Paul Wilkinson, Ph.D.
Group Director, PDS,
Cincinnati
Milton Park
151 Milton Park
Abingdon
Oxfordshire OX14 4SD
England
Tel.: +44 1235 433010
Ferentino (Rome)
Operations
Via Morolense 87
Italy
Tel.: +39 0775 3991
72
Corporate Information
Corporate Office
Share Information
7070 Mississauga Road, Suite 350
Mississauga, Ontario L5N 7J8 Canada
Telephone: (905) 821-4001
Fax: (905) 812-6705
Listing: Toronto Stock Exchange (TSX)
Symbol: PTI
Shareholder Account Enquiries
Computershare Investor Services Inc.
100 University Avenue, 9th floor
Toronto, Ontario M5J 2Y1 Canada
Tel: 1-800-564-6253/(514) 982-7555
Fax :1-888-453-0330/(416) 263-9394
Email: [email protected]
Web site: http://www.computershare.com
Transfer Agent and Registrar
Computershare Investor Services Inc.
Investor and Financial Information
John Bell, Chief Financial Officer
Tel: (905) 812-6812
Fax: (905) 812-6613
Shelley Jourard
Director, Corporate Communications
Tel: (905) 812-6614
Fax: (905) 812-6613
Auditors
Ernst & Young LLP
Legal Counsel
Davies Ward Phillips & Vineberg LLP –
Toronto, Canada
Cabinet Ratheaux – Lyon, France
Montanari Brescia e associati – Milan, Italy
Macfarlanes – London, England
Fiddler Gonzalez & Rodriguez, P.S.C. –
Puerto Rico, U.S.A.
Thompson Hine LLP – Cincinnati, U.S.A.
Principal Lenders
J.P. Morgan Securities Inc.
GE Commercial Finance
Banca Intesa S.p.A., Italy
Dividend Policy
The Board of Directors periodically reviews the
dividend policy of Patheon Inc. The Company
currently does not pay dividends on its restricted
voting shares, and has no plans to do so in the
foreseeable future, preferring to reinvest its
cash to enhance the Company’s growth.
As of October 31, 2007:
(All share prices expressed in Canadian dollars)
Shares Outstanding: 90,624,388
Public Float: 79,296,000
High/Low/Close for the Fiscal Year
Ended October 31, 2007:
$6.72/$2.85/$3.50
As of January 31, 2008:
(All share prices expressed in Canadian dollars)
Shares Outstanding: 90,624,388
Public Float: 79,308,000
High/Low/Close for the Twelve Months
Ended January 31, 2008: $5.45/$2.85/$3.40
Patheon Stock Performance vs
S&P/TSX Composite Index – Total Return
(Value of C$100 invested on October 31, 2002)
(all investment values expressed in Canadian dollars)
0DU
15*
0DU
0DU
0DU
0DU
0DU
41549$PNQPTJUF*OEFY°5PUBM3FUVSO
Annual Meeting
Shareholders are invited to attend
Patheon’s Annual and Special Meeting
of Shareholders to be held at 10:30 a.m.
(Eastern Standard Time) on
Thursday, March 27, 2008:
The Westin Harbour Castle
Harbour A Ballroom
One Harbour Square
Toronto, Ontario M5J 1A6
The meeting will be broadcast live over
the Internet on Patheon’s website at
www.patheon.com. An archived version of
the webcast will be available on Patheon’s
website after the meeting.
www.patheon.com

Patheon Inc.

Transcription

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