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EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - Aptalis Pharma Incex31_2.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - Aptalis Pharma Incex32_1.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - Aptalis Pharma Incex31_1.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - Aptalis Pharma Incex32_2.htm


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

FORM 10-Q

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
 
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2010

[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________ to ____________.

Commission File Number 333-153896

AXCAN INTERMEDIATE HOLDINGS INC.
 (Exact Name of Registrant as Specified in Its Charter)

Delaware
(State or Other Jurisdiction of Incorporation or organization)
 
74-3249870
(I.R.S. Employer Identification No.)
 


22 Inverness Center Parkway
Suite 310
Birmingham, AL
(Address of Principal Executive Offices)
 
35242
(Zip Code)
 

(205) 991-8085
(Registrant’s telephone number, including area code)
_______________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes                                No [X] Registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, but is not required to file such reports under such sections.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (paragraph 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes                                No [  ] (Registrant is not subject to the requirements of Rule 405 of Regulation S-T at this time).

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

Large accelerated filer                                           Accelerated filer                                Non-accelerated filer [X]                                           Smaller reporting company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes                                No [X]

As of August 11, 2010, there were 100 shares of common stock of the registrant outstanding, all of which were owned by Axcan MidCo Inc.

 
1

 

AXCAN INTERMEDIATE HOLDINGS INC.

INDEX


Forward-Looking Statements
3
PART I. FINANCIAL INFORMATION
4
Item 1.
Financial Statements.
4
Condensed Consolidated Balance Sheets
4
Condensed Consolidated Statements of Operations
5
Condensed Consolidated Shareholders’ Equity (Deficiency) and Comprehensive Income (Loss)
6
Condensed Consolidated Cash Flows
7
Notes to Condensed Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
33
Item 3.
Quantitative And Qualitative Disclosure About Market Risk
50
Item 4T.
Controls and Procedures
50
PART II. OTHER INFORMATION
51
Item 1A.
Risk Factors
51
SIGNATURES
54
EXHIBIT INDEX
55

 
2

 

Forward-Looking Statements
 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the U.S. federal securities laws. Statements other than statements of historical facts including, without limitation, statements regarding our future financial position, business strategy, budgets, projected costs and plans, future industry growth and objectives of management for future operations, are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “project,” “forecast,” “anticipate,” “believe” or “continue” or the negative thereof or variations thereon or similar terminology.

Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Certain of the important factors that could cause actual results to differ materially from our expectations, or “cautionary statements,” include, but are not limited to, those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I of this Quarterly Report, “Risk Factors” in Item 1A of Part II of this Quarterly Report, as well as elsewhere in this Quarterly Report on Form 10-Q.

We caution you not to place undue reliance on any forward-looking statements and we do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements.
 

 
3

 
 
PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements.


AXCAN INTERMEDIATE HOLDINGS INC.
Condensed Consolidated Balance Sheets

(in thousands of U.S. dollars, except share related data)


   
June 30,
2010
   
September 30,
2009
 
   
(unaudited)
       
   
$
   
$
 
Assets
           
Current assets
           
Cash and cash equivalents
    163,775       126,435  
Accounts receivable, net
    42,887       57,124  
Accounts receivable from the parent company (Note 15)
    450       306  
Income taxes receivable
    1,454       3,391  
Inventories , net (Note 4)
    22,141       44,706  
Prepaid expenses and deposits
    2,327       2,868  
Deferred income taxes (Note 10)
    2,735       15,852  
Total current assets
    235,769       250,682  
Property, plant and equipment, net (Note 5)
    35,931       39,344  
Intangible assets (Note 6)
    354,786       421,290  
Goodwill , net (Note 6)
    72,417       165,823  
Deferred debt issue expenses, net of accumulated amortization of $12,892 ($9,168 as at
September  30, 2009)
    21,687       25,411  
Deferred income taxes (Note 10)
    6,076       12,052  
Total assets
    726,666       914,602  
Liabilities
               
Current liabilities
               
Accounts payable and accrued liabilities
    109,757       87,684  
Income taxes payable (Note 10)
    2,428       2,493  
Installments on long-term debt (Note 8)
    3,198       30,708  
Deferred income taxes  (Note 10)
    -       137  
Total current liabilities
    115,383       121,022  
Long-term debt (Note 8)
    590,766       582,586  
Other long-term liabilities
    9,437       9,448  
Deferred income taxes  (Note 10)
    35,435       37,782  
Total liabilities
    751,021       750,838  
Shareholders’ Equity (Deficiency)
               
Capital Stock (Note 11)
               
Common shares, par value $0.001; 100 shares authorized: 100 issued and outstanding as at
June 30, 2010, and September 30, 2009
    1       1  
Deficit
    (461,999 )     (297,658 )
9.05% Note receivable from the parent company (Note 15)
    (133,154 )     (133,154 )
Additional paid-in capital
    615,834       619,053  
Accumulated other comprehensive loss
    (45,037 )     (24,478 )
Total shareholders’ equity (deficiency)
    (24,355 )     163,764  
Total liabilities and shareholders’ equity (deficiency)
    726,666       914,602  


The accompanying notes are an integral part of the condensed consolidated financial statements.
These interim financial statements should be read in conjunction with the annual consolidated financial statements


On behalf of the Board,



Director
 
Director

 
4

 

AXCAN INTERMEDIATE HOLDINGS INC.
Condensed Consolidated Statements of Operations

(in thousands of U.S. dollars)
(unaudited)


   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Net product sales
    80,480       100,806       284,977       325,545  
Other revenue
    -       5,221       -       5,221  
Total revenue
    80,480       106,027       284,977       330,766  
Cost of goods sold (a)
    20,828       22,093       115,606       76,950  
Selling and administrative expenses (a) (Note 9)
    27,335       28,573       87,980       92,437  
Management fees (Note 15)
    703       4,756       2,558       4,899  
Research and development expenses (a)
    8,611       10,701       24,720       26,840  
Acquired in-process research (Note 16)
    7,948       -       7,948       -  
Depreciation and amortization
    15,138       14,836       45,830       43,788  
Impairment of intangible assets and goodwill (Note 6)
    -       55,665       107,158       55,665  
Total operating expenses
    80,563       136,624       391,800       300,579  
Operating income (loss)
    (83 )     (30,597 )     (106,823 )     30,187  
Financial expenses (Note 9)
    16,212       16,723       48,794       52,955  
Interest income
    (189 )     (18 )     (496 )     (277 )
Other income
    -       (3,500 )     (7,700 )     (3,500 )
Loss (gain) on foreign currencies
    (759 )     (866 )     634       (1,121 )
Total other expenses
    15,264       12,339       41,232       48,057  
Loss before income taxes
    (15,347 )     (42,936 )     (148,055 )     (17,870 )
Income taxes expense (benefit) (Note 10)
    (5,448 )     (21,528 )     16,158       (18,704 )
Net income (loss)
    (9,899 )     (21,408 )     (164,213 )     834  

(a) Excluding depreciation and amortization

The accompanying notes are an integral part of the condensed consolidated financial statements.
These interim financial statements should be read in conjunction with the annual consolidated financial statements.


 
5

 

AXCAN INTERMEDIATE HOLDINGS INC.
Condensed Consolidated Shareholders’ Equity (Deficiency) and Comprehensive Income (Loss)

(in thousands of U.S. dollars, except share related data)
(unaudited)


   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
Common shares (number)
                       
Balance, beginning and end of period
    100       100       100       100  
     
$
     
$
     
$
     
$
 
Common shares
                               
Balance, beginning and end of period
    1       1       1       1  
Deficit
                               
Balance, beginning of period
    (452,100 )     (267,022 )     (297,658 )     (289,264 )
Dividends paid
    -       (500 )     (128 )     (500 )
Net income (loss)
    (9,899 )     (21,408 )     (164,213 )     834  
Balance, end of period
    (461,999 )     (288,930 )     (461,999 )     (288,930 )
Additional paid-in capital
                               
Balance, beginning of period
    615,731       619,087       619,053       617,255  
Stock-based compensation expense
    1,163       1,494       272       5,455  
Stock-based compensation plans redemption
    (8 )     (148 )     (336 )     (148 )
Foreign currency translation adjustments
    -       26       -       -  
Provision on interest receivable from the parent company
    (3,004 )     (3,004 )     (9,012 )     (9,013 )
Interest income from the parent company, net of taxes of [$1,052, $1,052, $3,155 and $3,155]
    1,952       1,952       5,857       5,858  
Balance, end of period
    615,834       619,407       615,834       619,407  
9.05% Note receivable from the parent company
                               
Balance, beginning and end of period
    (133,154 )     (133,154 )     (133,154 )     (133,154 )
Accumulated other comprehensive loss
                               
Balance, beginning of period
    (34,608 )     (36,550 )     (24,478 )     (29,168 )
Hedging contracts adjustments, net of taxes of [$0,
$27, $4 and $214]
    -       (49 )     (7 )     (397 )
Foreign currency translation adjustments
    (10,429 )     6,699       (20,552 )     (335 )
Balance, end of period
    (45,037 )     (29,900 )     (45,037 )     (29,900 )
Total shareholders' equity (deficiency)
    (24,355 )     167,424       (24,355 )     167,424  
Comprehensive income (loss)
                               
Other comprehensive income (loss)
    (11,555 )     6,650       (21,685 )     (732 )
Net income (loss)
    (9,899 )     (21,408 )     (164,213 )     834  
Total comprehensive income (loss)
    (21,454 )     (14,758 )     (185,898 )     102  
Accumulated other comprehensive loss
                               
Amounts related to foreign currency translation adjustments
    (45,037 )     (29,798 )     (45,037 )     (29,798 )
Amounts related to hedging contracts fair value adjustments
    -       (102 )     -       (102 )
Accumulated other comprehensive loss
    (45,037 )     (29,900 )     (45,037 )     (29,900 )


The accompanying notes are an integral part of the condensed consolidated financial statements.
These interim financial statements should be read in conjunction with the annual consolidated financial statements.

 
6

 

AXCAN INTERMEDIATE HOLDINGS INC.
Condensed Consolidated Cash Flows

(in thousands of U.S. dollars)
(unaudited)


   
For the
three-month
period ended
June 30, 2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Cash flows from operating activities
                       
Net income (loss)
    (9,899 )     (21,408 )     (164,213 )     834  
Non-cash items
                               
Non-cash financial expenses
    1,751       1,758       5,259       5,265  
Depreciation and amortization
    15,138       14,836       45,830       43,788  
Stock-based compensation expense (Note 9)
    1,163       1,494       272       5,455  
Loss on disposal and write-down of assets
    27       96       108       117  
Impairment of intangible assets and goodwill (Note 6)
    -       55,665       107,158       55,665  
Foreign currency fluctuations
    (185 )     318       (142 )     2,132  
Change in fair value of derivatives
    -       (58 )     (621 )     815  
Deferred income taxes (Note 10)
    (7,650 )     (29,052 )     11,416       (32,413 )
Other non-cash adjustments related to unapproved PEPs
    14,928       -       68,335       -  
Changes in working capital items
                               
Accounts receivable
    8,640       13,391       11,400       (14,012 )
Accounts receivable from the parent company
    (70 )     2,291       (144 )     687  
Income taxes receivable
    (189 )     (1,793 )     1,482       15,347  
Inventories
    (576 )     (7,374 )     (8,509 )     (7,920 )
Prepaid expenses and deposits
    241       171       443       932  
Accounts payable and accrued liabilities
    (17,626 )     13,656       (13,334 )     17,527  
Income taxes payable
    344       4,969       916       3,702  
Net cash provided by operating activities
    6,037       48,960       65,656       97,921  
Cash flows from investing activities
                               
Acquisition of property, plant and equipment
    (1,609 )     (2,462 )     (5,071 )     (5,382 )
Acquisition of intangible assets
    -       -       -       (10 )
Net cash used in investing activities
    (1,609 )     (2,462 )     (5,071 )     (5,392 )
Cash flows from financing activities
                               
Repayment of long-term debt
    -       (3,281 )     (20,865 )     (7,656 )
Stock-based compensation plans redemption
    (8 )     (148 )     (336 )     (148 )
Dividends paid
    -       (500 )     (128 )     (500 )
Net cash used in financing activities
    (8 )     (3,929 )     (21,329 )     (8,304 )
Foreign exchange gain (loss) on cash held in foreign currencies
    (1,059 )     837       (1,916 )     (529 )
Net increase in cash and cash equivalents
    3,361       43,406       37,340       83,696  
Cash and cash equivalents, beginning of period
    160,414       96,395       126,435       56,105  
Cash and cash equivalents, end of period
    163,775       139,801       163,775       139,801  
Additional information
                               
Interest received
    189       13       496       324  
Interest paid
    1,330       2,037       30,449       32,981  
Income taxes received
    28       -       2,400       16,761  
Income taxes paid
    1,520       3,222       4,128       11,579  


The accompanying notes are an integral part of the condensed consolidated financial statements.
These interim financial statements should be read in conjunction with the annual consolidated financial statements.


 
7

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


1.
Governing Statutes, Description of Business and Basis of Presentation

Axcan Intermediate Holdings Inc., a corporation incorporated on November 28, 2007, under the General Corporation Law of the State of Delaware and its subsidiaries (together the “Company”), commenced active operations with the purchase, through a wholly-owned indirect subsidiary, of all of the outstanding common shares of Axcan Pharma Inc., a company incorporated under the Canada Business Corporation Act. On February 25, 2008, the Company, pursuant to a Plan of Arrangement dated November 29, 2007, and through a wholly-owned indirect subsidiary, completed the acquisition of all common shares of Axcan Pharma Inc. at a price of $23.35 per share. The Company is involved in the research, development, production and distribution of pharmaceutical products mainly in the field of gastroenterology.

The accompanying unaudited condensed consolidated financial statements are presented in U.S. dollars, the reporting currency, and prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial statements and with the requirements of the Securities and Exchange Commission for reporting on Form 10Q. Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete financial statements. The interim financial statements and related notes should be read in conjunction with the Company’s audited financial statements for the fiscal year ended September 30, 2009. When necessary, the financial statements include amounts based on informed estimates and best judgment of management. The results of operations for the interim periods reported are not necessarily indicative of results to be expected for the year. In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for a fair presentation of the results of operation for the periods shown. Certain prior period amounts have been reclassified to conform to the current period presentation. All intercompany transactions and balances have been eliminated on consolidation.

2.
Significant Accounting Policies

The following policies are interim updates to those discussed in Note 2 to the Company’s audited financial statements for the fiscal year ended September 30, 2009.

Revenue recognition

Revenue is recognized when the product is shipped to the Company's customers, provided the Company has not retained any significant risks of ownership or future obligations with respect to the product shipped. Provisions for sales discounts and estimates for chargebacks, managed care and Medicaid rebates, product returns and distribution service agreement fees are recorded as a reduction of product sales revenues at the time such revenues are recognized. These revenue reductions are established by the Company at the time of sale, based on historical experience adjusted to reflect known changes in the factors that impact such reserves. In certain circumstances, returns of products are allowed under the Company’s policy and provisions are maintained accordingly. These revenue reductions are generally reflected as an addition to accrued liabilities. Amounts received from customers as prepayments for products to be shipped in the future are reported as deferred revenue.

The Company presents, on a net basis, taxes collected from customers and remitted to governmental authorities; that is, they are excluded from revenues.

ULTRASE® and VIOKASE®, the Company’s pancreatic enzyme products (“PEPs”) have historically accounted for approximately a 19% of the Company’s net sales in the last three years. Existing products to treat exocrine pancreatic insufficiency have been marketed in the U.S. since before the passage of the Federal Food, Drug, and Cosmetic Act, or FDCA, in 1938 and, consequently, there are currently marketed PEPs that have not been approved under the NDA process by the FDA. In 1995, the FDA issued a final rule requiring that these PEPs be marketed by prescription only, and, in April 2004, the FDA mandated that all manufacturers of exocrine pancreatic insufficiency drug products file an NDA and receive approval for their products by April 2008 or be subject to regulatory action. In October 2007, the FDA published a notice in the Federal Register extending the deadline within which to obtain marketing approval for exocrine pancreatic insufficiency drug products to April 28, 2010, for those companies that were (a) marketing unapproved pancreatic enzyme products as of April 28, 2004; (b) submitted NDAs on or before April 28, 2009; and (c) that continue diligent pursuit of regulatory approval. The FDA required all manufacturers with unapproved NDAs to cease distribution of unapproved products after April 28, 2010, until such time that NDA approval is granted. After this date, the unapproved products may still be available on pharmacy shelves for a short time until stock is depleted. The FDA has stated that it will continue to review NDAs that have been submitted by manufacturers of unapproved PEPs, and will approve additional PEPs beyond  the April 28, 2010 deadline, if they meet the required safety, effectiveness and product quality standards. The Company completed the submission for ULTRASE® in the fourth quarter of fiscal 2008. The submission of the Company’s rolling NDA for VIOKASE® was completed in the first quarter of fiscal 2010.
 
ULTRASE® and VIOKASE® did not receive NDA approval by the April 28, 2010 deadline and the Company has ceased distributing the two products after that date, in compliance with the FDA guideline. For the quarter ended March 31, 2010, the Company recorded a $10,444,000 returns provision which is an estimate of the Company’s liability for ULTRASE® and VIOKASE® that may be returned by the original purchaser in accordance with the Company’s policy as a result of not receiving NDA approval by the April 28, 2010 deadline. At June 30, 2010, the returns provision was of $18,753,000, reflecting an additional provision of $13,009,000 recorded in the quarter ended June 30, 2010, for the sales shipped through  April 28, 2010.This estimate is based on ULTRASE® and VIOKASE® inventory in the distribution channel and related expiration dates of this inventory, estimated erosion of ULTRASE® and VIOKASE® demand based on competition from approved PEP products and the resulting estimated sell-through of ULTRASE® and VIOKASE® and other factors.


 
8

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


Inventory valuation

Inventories of raw materials and packaging material are valued at the lower of cost and replacement cost. Inventories of work in progress and finished goods are valued at the lower of cost and net realizable value. Cost is determined by the first-in, first-out method. Cost for work in progress and finished goods include raw materials, direct labor, subcontracts and an allocation for overhead. Allowances are maintained for slow-moving inventories based on the remaining shelf life of products and estimated time required to sell such inventories. Obsolete inventory and rejected products are written off to cost of goods sold.

Inventory costs associated with products that have not yet received regulatory approval are capitalized if the Company believes there is probable future commercial use and future economic benefit. If future commercial use and future economic benefit are not considered probable, then costs associated with pre-launch inventory that has not yet received regulatory approval are expensed as research and development expense during the period the costs are incurred. The Company could be required to expense previously capitalized costs related to pre-approval inventory if the probability of future commercial use and future economic benefit changes due to denial or delay of regulatory approval, a delay in commercialization, or other factors.

All inventories of ULTRASE® and VIOKASE® amounting to $32,328,000 have been written-off during the nine-month period ended June 30, 2010.
 
Impairment of long lived-assets

The value of goodwill and intangible assets with an indefinite life are subject to an annual impairment test unless events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. The intangible assets with a finite life and property, plant and equipment are subject to an impairment test whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. The Company compares the carrying value of the unamortized portion of property, plant and equipment and intangible assets with a finite life to estimated future undiscounted cash flows.

The goodwill impairment test is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit may be based on one or more faire value measures including present value technique of estimated future cash flows and estimated amounts at which the unit as a whole could be bought or sold in a current transaction between willing parties. If the carrying amount of the reporting unit exceeds the fair value, step two requires the fair value of the reporting unit to be allocated to the underlying tangible and intangible assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the goodwill of the reporting unit exceeds the implied fair value of that goodwill, an impairment loss equal to the excess is recorded in earnings.

The Company’s pancreatic enzyme products did not receive NDA approval from the FDA by the April 28, 2010 deadline. This is a change in circumstance that caused the Company to review the carrying value of its long lived assets including goodwill. Based on this review, an impairment charge of $107,158,000 was recorded during the quarter ended March 31, 2010. (Note 6)

3.
Recently Issued Accounting Standards

In March 2010, the FASB issued guidance related to revenue recognition that applies to arrangements with milestones relating to research or development deliverables. This guidance provides criteria that must be met to recognize consideration that is contingent upon achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. The guidance provides a definition of substantive milestone and should be applied regardless of whether the arrangement includes single or multiple deliverables or units of accounting. This guidance is effective prospectively to milestones achieved in fiscal years, and interim periods within those years, after June 15, 2010, with early adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s condensed consolidated financial statements.

In March 2010, the FASB amended the existing guidance on stock compensation to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, such an award should not be classified as a liability if it otherwise qualifies as equity. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.The adoption of this guidance is not expected to have a material impact on the Company’s condensed consolidated financial statements.

In January 2010, the FASB amended the existing authoritative guidance on disclosures of fair value measurements and clarifies and provides additional disclosure requirements related to recurring and non-recurring fair value measurements. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. The disclosure of the roll forward of activity in Level 3 measurements on a gross basis is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.


 
9

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


In October 2009, the FASB amended the existing guidance on revenue recognition related to accounting for multiple-element arrangements. This amendment addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. This guidance is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and early adoption is permitted. The Company is currently evaluating the impact of the adoption of this guidance on its condensed consolidated financial statements.

In August 2009, the FASB amended the existing guidance on fair value measurements and disclosures to provide clarification in measuring the fair value of liabilities in circumstances when a quoted price in an active market for the identical liability is not available. In such circumstances, a reporting entity is required to measure fair value using one or more of the following methods: 1) a valuation technique that uses the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities or similar liabilities when traded as assets; and/or 2) a valuation technique that is consistent with the principles of fair value measurements (e.g. an income approach or market approach). This guidance is effective for reporting periods including interim periods beginning after August 28, 2009. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In June 2009, the FASB amended the existing authoritative guidance on consolidation regarding variable interest entities for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. According to the revised guidance, an enterprise has a controlling financial interest when it has a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. The guidance also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. The guidance also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. The revised guidance is effective for fiscal years beginning after November 15, 2009, with early adoption prohibited. The Company is currently evaluating the impact of the adoption of the revised guidance on its condensed consolidated financial statements.

In May 2009, the FASB issued authoritative guidance on subsequent events. This guidance establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, the guidance sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The guidance is effective for fiscal years and interim periods ended after June 15, 2009, and will be applied prospectively. In February 2010, the FASB amended the authoritative guidance on subsequent events to amend disclosures related to events occurring subsequent to year end. The amendment removes the requirement for an SEC filer to disclose a date through which subsequent events were evaluated in both issued and revised financial statements. The amendment removes potential conflicts with SEC guidance and is effective upon issuance. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB amended the authoritative guidance on financial instruments to require disclosures about fair value of financial instruments in interim as well as in annual financial statements of publicly traded companies. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on its condensed consolidated financial statements since the Company has provided disclosures about fair value of financial instruments in its interim financial statements prior to the issuance of this guidance.

In April 2009, the FASB issued additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. Guidance on identifying circumstances that indicate a transaction is not orderly was also issued and required additional disclosures. This guidance is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB amended the guidance for investments in debt and equity securities on determining whether impairment for investments in debt securities is other than temporary and requires additional interim and annual disclosure of other-than-temporary impairments in debt and equity securities. Pursuant to the new guidance, an other-than-temporary impairment has occurred if a company does not expect to recover the entire amortized cost basis of the security. In this situation, if the company does not intend to sell the impaired security prior to recovery and it is more likely than not that it will not be required to sell the security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings is limited to the portion attributed to the credit loss. The remaining portion of the other-than-temporary impairment is then recorded in other comprehensive income. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.



 
10

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


In April 2009, the FASB amended the guidance on business combinations previously revised in December 2007 to require that an acquirer recognize assets acquired and liabilities assumed in a business combination that arise from contingencies, at fair value at the acquisition date, if fair value can be determined during the measurement period. If the acquisition-date fair value of such an asset acquired or liability assumed cannot be determined, the acquirer should apply guidance on accounting for contingencies to determine whether the contingency should be recognized at the acquisition date or after it. This guidance is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is after the beginning of the first annual reporting period beginning after December 15, 2008. The Company will apply this guidance for future acquisitions.

In November 2008, the FASB issued guidance that clarifies the accounting for defensive intangible assets acquired in a business combination or an asset acquisition subsequent to their acquisition except for intangible assets that are used in research and development activities. A defensive intangible asset is defined as a separately identifiable intangible asset which an acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. This guidance requires an acquirer in a business combination to account for a defensive intangible asset as a separate unit of accounting and assign a useful life in accordance with the guidance on the determination of useful life of intangible assets. Defensive intangible assets must be recognized at fair value in accordance with the revised guidance on business combinations. This guidance is effective for intangible assets acquired on or after fiscal years beginning after December 15, 2008, with early adoption prohibited. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2008, the FASB issued guidance that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this guidance is to improve the consistency between the useful life of a recognized intangible asset determined in accordance with the guidance on intangible assets and the period of expected cash flows used to measure the fair value of the asset determined in accordance with the amended guidance for business combinations and other authoritative guidance. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In March 2008, the FASB amended the guidance on disclosure requirements related to derivative instruments and hedging activities. The new guidance requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. Pursuant to the new guidance, enhanced disclosures are required about (a) how and why derivative instruments are used, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The fair value of derivative instruments and their gains and losses will need to be presented in tabular format in order to present a more complete picture of the effects of using derivative instruments. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements (see Note 12).

In December 2007, the FASB revised the authoritative guidance for business combinations. The new guidance expands the definition of a business combination and requires the acquisition method of accounting to be used for all business combinations and an acquirer to be identified for each business combination. Pursuant to the new guidance, all assets, liabilities, contingent considerations and contingencies of an acquired business are required to be recorded at fair value at the acquisition date. In addition, the guidance establishes requirements in the recognition of acquisition cost, restructuring costs and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties. This guidance is to be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company will apply this guidance for future acquisitions.

In December 2007, the FASB issued guidance related to collaborative arrangements. The guidance defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. The guidance also establishes the appropriate income statement presentation and classification for joint operating activities and payments between participants, as well as the sufficiency of the disclosures related to these arrangements. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2008, and shall be retrospectively to all prior periods presented for all collaborative arrangements existing as of the effective date. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.



 
11

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


In December 2007, the FASB amended the guidance on consolidation to establish new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, the new guidance requires the recognition of a non-controlling interest (minority interest) as equity in the condensed consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. The guidance clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, the guidance requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. The guidance also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. This guidance is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements, because the Company has wholly-owned subsidiaries.

In September 2006, the FASB issued guidance on fair value measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements and is effective for fair-value measurements already required or permitted by other guidance for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued guidance, that deferred the effective date of the guidance for fair value measurement for one year for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). In October 2008, the FASB issued guidance which clarifies the application of the guidance on fair value measurements in determining the fair value of a financial asset when the market for that asset is not active. This guidance was effective upon issuance, including prior periods for which financial statements had not been issued. On October 1, 2008, the Company adopted the guidance on fair value measurements for financial assets and liabilities. The adoption of the guidance on fair value measurements for financial assets and liabilities carried at fair value did not have a material impact on the Company’s condensed consolidated financial statements (see Note 14). On October 1, 2009, the Company adopted the guidance on fair value measurements for non-financial assets and liabilities. The adoption of the guidance on fair value measurements for non-financial assets and liabilities did not have a material impact on the Company’s condensed consolidated financial statements.

4.      Inventories

   
June 30,
2010
   
September 30,
2009
 
   
$
   
$
 
Raw material and packaging material, net of write-down of $205 related to unapproved PEPs
    11,976       8,416  
Work in progress
    729       886  
Finished goods, net of write-down of $32,123 related to unapproved PEPs and net of reserve for obsolescence of $1,599 ($4,159 on September 30, 2009)
    9,436       35,404  
      22,141       44,706  


As disclosed in Note 2, the Company’s PEPs did not obtain regulatory approval by the April 28, 2010 deadline established by the FDA. As a result, during the nine-month period ended June 30, 2010, the on-hand inventory was written down to net realizable value and was charged to cost of goods sold. In addition, a charge to cost of goods sold has also been recorded for purchase and other materials and supply commitments related to the PEPs.

 
12

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


5.      Property, Plant and Equipment

         
June 30, 2010
 
   
Cost
   
Accumulated
depreciation
   
Net
 
   
$
   
$
   
$
 
Land
    2,194       -       2,194  
Buildings
    22,333       3,895       18,438  
Furniture and equipment
    7,230       2,391       4,839  
Computer equipment and software
    17,715       8,227       9,488  
Leasehold and building improvements
    1,207       235       972  
      50,679       14,748       35,931  


         
September 30, 2009
 
   
Cost
   
Accumulated
depreciation
   
Net
 
   
$
   
$
     
$
 
Land
    2,276       -       2,276  
Buildings
    22,739       2,931       19,808  
Furniture and equipment
    8,321       2,598       5,723  
Computer equipment and software
    15,218       4,805       10,413  
Leasehold and building improvements
    1,181       57       1,124  
      49,735       10,391       39,344  


6.      Impairment of Long-Lived Assets, Including Goodwill

Goodwill

As has been previously disclosed in the Company’s SEC filings, the FDA mandated that all manufacturers of exocrine pancreatic insufficiency drug products file an NDA and receive approval for their products by April 28, 2010. On April 28, 2010, neither of the Company’s two pancreatic insufficiency drug products, ULTRASE® and VIOKASE®, had obtained FDA approval. The Company plans to continue to seek to obtain an NDA approval for these products. Management currently expects that the future cash flows that would be generated from these products will be negatively impacted by market share erosion that will occur between April 28, 2010 and the date of eventual re-launch of the products on the market, and management cannot provide any assurances that the Company will be able to re-launch the products. Management has considered the FDA April 28, 2010 approval deadline to be a triggering event which causes the Company to assess whether any portion of its recorded goodwill balance was impaired. As a result, an estimate of the impact of the above was reflected in certain valuation assumptions of the Company’s goodwill as at March 31, 2010.

The goodwill impairment test is a two step process. Step one of the impairment analysis consisted of a comparison of the fair value of the U.S. reporting unit with its net carrying value, including the goodwill. The Company performed extensive valuation analyses, utilizing both income and market-based approaches, in its goodwill assessment process. The following describes the valuation methodologies used to derive the estimated fair value of the reporting unit.



 
13

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


Income approach

To determine the fair value, the Company discounted the expected future cash flows of the reporting unit, using a discount rate, which reflected the overall level of inherent risk and the rate of return an outside investor would have expected to earn. To estimate cash flows beyond the final year of its model, the Company used a terminal value approach. Under this approach, the Company used estimated operating income before interest, taxes, depreciation and amortization in the final year of its model, adjusted to estimate a normalized cash flow, applied a perpetuity growth assumption, and discounted by a perpetuity discount factor to determine the terminal value. The Company incorporated the present value of the resulting terminal value into its estimate of the fair value.

Based on the “step one” analysis that was performed for the U.S. reporting unit, the Company determined that the carrying amount of the net assets of the reporting unit was in excess of its estimated fair value. As such, the Company was required to perform the “step two” analysis for its U.S. reporting unit, in order to determine the amount of any goodwill impairment. The “step two” analysis consisted of comparing the implied fair value of the goodwill with the carrying amount of the goodwill, with an impairment charge resulting from any excess of the carrying value of the goodwill over the implied fair value of the goodwill, based on a hypothetical allocation of the estimated fair value to the net assets. Based on the preliminary step two analysis, the Company determined that the goodwill allocated to the U.S. reporting unit, in the amount of $91,400,000 was impaired. As a result, the Company recorded a preliminary goodwill impairment charge of $91,400,000 during the three-month period ended March 31, 2010, which represented the Company’s best estimate as of March 31, 2010. During the three-month period ended June 30, 2010, the Company finalized its step two analysis. The finalization of this analysis did not result in any adjustment to the previously recorded impairment.
 
The determination of the fair value of the reporting unit required the Company to make significant estimates and assumptions that affected the reporting unit’s expected future cash flows. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rates, operating income before depreciation and amortization, and capital expenditure forecasts. Additionally, the Company has made assumptions relating to the expected amount of time required to eventually obtain FDA approval for the Company’s pancreatic enzyme products and the eventual market share of these products. Due to the inherent uncertainty involved in making these estimates, actual results could differ significantly from those estimates. In addition, changes in underlying assumptions could have a significant impact on either the fair value of the reporting unit or the goodwill impairment charge.

The hypothetical allocation of the fair value of the reporting unit to individual assets and liabilities within the reporting unit also requires the Company to make significant estimates and assumptions. The hypothetical allocation required several analyses to determine the estimate of the fair value of assets and liabilities of the reporting unit.

The following table reflects the components of goodwill as at June 30, 2010:

Goodwill

     
$
 
Balance as at September 30, 2009
    165,823  
Impairment
    (91,400 )
Foreign exchange
    (2,006 )
Balance as at June 30, 2010
    72,417  


 
14

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


Intangible assets

In conjunction with the goodwill impairment identified during the nine-month period ended June 30, 2010, the Company completed its review of the impairment test for intangible assets with a finite life within the U.S. reporting unit for recoverability. The completion of this analysis did not result in any adjustment to the previously recorded non-cash charge for impairment of intangible assets other than goodwill of $15,758,000 relating to its finite-life assets related to PEPs. Management used a discounted cash flow based approach to value these assets.

The following table reflects the components of intangible assets as at June 30, 2010:

Trademarks, trademark licenses and manufacturing rights with a finite life

   
Cost
   
Accumulated
amortization
   
Net
 
   
$
   
$
   
$
 
Balance as at September 30, 2009
    491,411       70,121       421,290  
Impairment
    (23,694 )     (7,936 )     (15,758 )
Amortization
    -       39,595       (39,595 )
Foreign exchange
    (13,232 )     (2,081 )     (11,151 )
Balance as at June 30, 2010
    454,485       99,699       354,786  


7.
Segmented Information

The Company operates in a single field of activity, the pharmaceutical industry.

The Company operates in the following geographic areas:

   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Total Revenue
                       
United States
                       
Domestic sales
    55,779       79,613       207,926       254,821  
Foreign sales
    530       1,018       3,151       3,768  
Canada
                               
Domestic sales
    7,965       7,498       24,694       22,969  
Foreign sales
    192       118       192       165  
European Union
                               
Domestic sales
    12,057       16,515       40,772       43,443  
Foreign sales
    3,957       1,103       8,242       5,154  
Other
    -       162       -       446  
      80,480       106,027       284,977       330,766  

 
Revenue is attributed to geographic areas based on the country of origin of the sales.

 
15

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)
 

   
June 30,
2010
   
September 30,
2009
 
   
$
   
$
 
Property, plant, equipment and intangible assets
           
Canada
    307,990       333,001  
United States
    17,635       44,448  
European Union
    65,092       83,185  
      390,717       460,634  


   
June 30,
2010
   
September 30,
2009
 
   
$
     
$
 
Goodwill
             
Canada
    61,887       61,887  
United States
    -       91,400  
European Union
    10,530       12,536  
      72,417       165,823  


8.
Long-term Debt


 
June 30,
2010
   
September 30,
2009
 
   
$
   
$
 
Senior notes secured by substantially all of the present and future assets of the Company, bearing interest at 9.25% and maturing in March 2015
    226,069       225,764  
 
Term loans of $138,823 at June 30, 2010, ($159,688 at September 30, 2009),  of whitch $138,823 ($109,688 at September 30, 2009) bear interest at the one-month British Banker Association LIBOR (0.35% as at June 30, 2010, and 0.25% as at September 30, 2009), and $0 ($50,000 at September 30, 2009) bear interest at the three-month British Banker Association LIBOR (0.28% as at September 30, 2009), plus the applicable rate based on the consolidated total leverage ratio of the Company and certain of its subsidiaries for the preceding twelve months, secured by substantially all of the present and future assets of the Company, payable in quarterly installments, maturing in February 2014, subject to interest rate swap agreements as further disclosed in Note 13
    134,886       154,779  
 
Senior unsecured notes, bearing interest at 12.75% and maturing in March 2016
    233,009       232,751  
      593,964       613,294  
Installments due within one year
    3,198       30,708  
      590,766       582,586  



 
16

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


On February 25, 2008, the Company obtained various types of financing in connection with the acquisition of the common shares of Axcan Pharma Inc. The Company issued $228,000,000 aggregate principal amount of its 9.25% Senior Secured Notes due March 1, 2015. The Senior Secured Notes were priced at $0.98737 with a 10% yield to March 1, 2015. The Senior Secured Notes rank pari passu with the Credit Facility.

The Company may redeem some or all of the Senior Secured Notes prior to March 1, 2011, at a redemption price equal to 100% of the principal amount of the Senior Secured Notes redeemed plus a “make-whole” premium and accrued and unpaid interest. On or after March 1, 2011, the Company may redeem some or all of the Senior Secured Notes at the redemption prices (expressed as percentages of principal amount of the Senior Secured Notes to be redeemed) set forth below:


   
Senior
Secured Notes
 
   
%
 
2011
    106.938  
2012
    104.625  
2013
    102.313  
2014 and thereafter
    100.000  


Prior to March 1, 2011, the Company may also redeem up to 35% of the aggregate principal amount of the Senior Secured Notes using the proceeds of one or more equity offerings at a redemption price equal to 109.250% of the aggregate principal amount of the Senior Secured Notes plus accrued and unpaid interest. If there is a change of control as specified in the indenture governing the Senior Secured Notes, the Company must offer to repurchase the Senior Secured Notes at a price in cash equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest.

The Company also obtained a Credit Facility for a total amount of $290,000,000 composed of available term loans totaling $175,000,000 and of a revolving credit facility of $115,000,000 (“Credit Facility”). The Credit Facility bears interest at a variable rate available composed of either the Federal Funds Rate or the British Banker Association LIBOR rate, at the option of the Company, plus the applicable rate based on the consolidated total leverage ratio of the Company and certain of its subsidiaries for the preceding twelve months. The Credit Facility matures on February 25, 2014, with payments on the term loans beginning in fiscal year 2008. As at June 30, 2010, $175,000,000 of term loans had been issued and no amounts had been drawn against the revolving credit facility. The term loans were priced at $0.96 with a yield to maturity of 8.75% before the effect of the interest rate swaps as disclosed in Note 13. The Credit Facility requires the Company to meet certain financial covenants, which were met as at June 30, 2010. The credit agreement governing the Credit Facility requires the Company to prepay outstanding term loans contingent upon the occurrence of events, subject to certain exceptions, with: (1) 100% of the net cash proceeds of any incurrence of debt other than debt permitted under the Credit Facility, (2) commencing with the fiscal year ended September 30, 2009, 50% (which percentage will be reduced to 25% if the senior secured leverage ratio is less than a specified ratio) of the annual excess cash flow (as defined in the credit agreement governing the Credit Facility) and (3) 100% of the net cash proceeds of all non-ordinary course asset sales or other dispositions of property (including casualty events) by the Company or by its subsidiaries, subject to reinvestments rights and certain other exceptions. Pursuant to the annual excess cash flow requirements for the fiscal year 2009 defined in the credit agreement, the Company was required to prepay $17,583,000 of outstanding term loans in the first quarter of fiscal year 2010. As allowed by the credit agreement, the prepayment has been applied to the remaining scheduled installments of principal in direct order of maturity.

On February 25, 2008, as part of the acquisition financing, the Company also obtained $235,000,000 in financing under a senior unsecured bridge facility (the “Bridge Financing”) maturing on February 25, 2009. On May 6, 2008, the Bridge Financing was refinanced on a long-term basis, by repaying the bridge facility with the proceeds from the sale by the Company of $235,000,000 aggregate principal amount of its 12.75% senior unsecured notes due March 1, 2016, (the “Senior Unsecured Notes”). The Senior Unsecured Notes were priced at $0.9884 with a yield to maturity of 13.16%. The Senior Unsecured Notes are subordinated to the Credit Facility and Senior Secured Notes.



 
17

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


The Company may redeem some or all of the Senior Unsecured Notes prior to March 1, 2012, at a redemption price equal to 100% of the principal amount of the Senior Unsecured Notes redeemed plus a “make-whole” premium and accrued and unpaid interest. On or after March 1, 2012, the Company may redeem some or all of the Senior Unsecured Notes at the redemption prices (expressed as percentages of principal amount of the Senior Unsecured Notes to be redeemed) set forth below:


   
Senior
Unsecured Notes
 
   
%
 
2012
    106.375  
2013
    103.188  
2014 and thereafter
    100.000  


Prior to March 1, 2011, the Company may also redeem up to 35% of the aggregate principal amount of the Senior Unsecured Notes using the proceeds of one or more equity offerings at a redemption price equal to 112.750% of the aggregate principal amount of the Senior Unsecured Notes plus accrued and unpaid interest. If there is a change of control as specified in the indenture governing the Senior Unsecured Notes, the Company must offer to repurchase the Senior Unsecured Notes at a price in cash equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest.

Payments required in each of the next five twelve-month periods to meet the retirement provisions of the long-term debt are as follows:


      $  
         
2011
    3,198  
2012
    18,594  
2013
    41,562  
2014
    75,469  
2015
    228,000  
Thereafter
    235,000  
      601,823  
Unamortized original issuance discount
    7,859  
      593,964  



 
18

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


9.
Financial Information Included in the Consolidated Operations

a)
Financial expenses


   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Interest on long-term debt (including amortization of original issuance
discount of $510 and $1,535 ($515 and $1,542 in 2009)
    14,604       15,006       43,983       46,921  
Interest and bank charges
    224       72       649       562  
Interest rate swaps
    -       239       17       1,212  
Financing fees
    143       163       421       537  
Amortization of deferred debt issue expenses
    1,241       1,243       3,724       3,723  
      16,212       16,723       48,794       52,955  


b)
Other information


   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Rental expenses
    920       794       2,797       2,112  
Shipping and handling expenses
    1,758       1,626       5,052       5,747  
Advertizing expenses
    337       2,663       8,191       11,425  
Depreciation of property, plant and equipment
    2,136       1,517       6,235       4,481  
Amortization of intangible assets
    13,002       13,319       39,595       39,307  
Stock-based compensation expenses
    1,163       1,494       272       5,455  
Transaction and integration costs
    1,490       599       2,555       2,536  


c)
Employee benefit plan

A subsidiary of the Company has a defined contribution plan (the “Plan”) for its U.S. employees. Participation is available to substantially all U.S. employees. Employees may contribute up to 15% of their gross pay or up to limits set by the U.S. Internal Revenue Service. The Company may make matching contributions of a discretionary percentage. The Company charged to operations contributions to the plan totaling $378,000 for the three-month period and $780,000 for the nine-month period ended June 30, 2010, ($155,000 for the three-month period and $406,000 for the nine-month period ended June 30, 2009).


 
19

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


10.
Income Taxes

The Company establishes a valuation allowance against deferred tax assets in accordance with U.S. GAAP. At June 30, 2010, the Company has a valuation allowance of $52,616,000 against the Company’s net deferred tax assets generated in the U.S. reporting unit. In future periods, if the deferred tax assets are determined by management to be more likely than not to be realized, the recognized tax benefits relating to the reversal of the valuation allowance will be recorded.

The Company’s effective tax rates for the three-month and nine-month periods ended June 30, 2010 were 35.5% and minus 10.9%, respectively, as compared to 50.1% and 104.7% in the prior year periods, respectively. The effective tax rates for the three-month and nine-month periods ended June 30, 2010, are affected by a number of elements, the most important being the establishment of the valuation allowance of $7,644,000 during the three-month period and $52,616,000 during the nine-month period ended June 30, 2010 resulting from the unapproved status PEPs event.

Effective October 1, 2007, the Company adopted the provisions of the guidance issued by the FASB related to accounting for uncertainty in income taxes. The guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The adoption of the provisions of this guidance did not have a material impact on the Company’s consolidated financial position and results of operations and a cumulative effect adjustment to the opening balance of retained earnings was not necessary. As at June 30, 2010, the Company had unrecognized tax benefits of $11,023,000 ($10,409,000 as at September 30, 2009).

The following table presents a summary of the changes to unrecognized tax benefits:


   
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Balance, beginning of period
    11,318       8,973       10,409       10,446  
Additions based on tax positions related to the current year
    8       15       23       23  
Additions for tax positions of prior years
    120       723       1,040       1,117  
Reductions for tax positions of prior years
    (423 )     -       (449 )     (1,875 )
Balance, end of period
    11,023       9,711       11,023       9,711  


The Company has historically recognized interest relating to income tax matters as a component of financial expenses and penalties related to income tax matters as a component of income tax expense. As at June 30, 2010, the company had accrued $1,000,000 ($649,000 as at September 30, 2009) for interest relating to income tax matters. There were no amounts recorded for penalties as at June 30, 2010.

The Company and its subsidiaries file tax returns in the U.S. federal jurisdiction and various states, local and foreign jurisdictions including Canada and France. In many cases, the Company’s uncertain tax positions are related to tax years that remain subject to examination by relevant tax authorities. The Company is subject to federal and state income tax examination by U.S. tax authorities for fiscal years 2005 through 2009. The Company is subject to Canadian and provincial income tax examination for fiscal years 2005 through 2009. There are numerous other income jurisdictions for which tax returns are not yet settled, none of which is individually significant. The Company is currently being audited by Canada Revenue Agency for fiscal year 2005 to fiscal year 2008.

The Company and its U.S. subsidiaries file as members of a U.S. Federal consolidated income tax return, of which Axcan Holdings Inc. is the parent. The consolidated income tax liability is allocated among the members of the group in accordance with a tax allocation agreement. The tax allocation agreement provides that each member of the group is allocated its share of the consolidated tax provision determined generally on a separate income tax return method.

As at June 30, 2010, the Company had a provision of $3,226,000 for income taxes on the undistributed earnings of the Company’s foreign subsidiaries that the Company does not intend to indefinitely reinvest. The corresponding amount at September 30, 2009, was $2,097,000 net of deferred tax asset of $1,129,000 against which full valuation allowance has now been provided for as at June 30, 2010.


 
20

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


11.
Stock Incentive Plans

Management equity incentive plan

In April 2008, the Company’s indirect parent company adopted a Management Equity Incentive Plan (the “MEIP Plan”), pursuant to which the indirect parent company will grant options to selected employees and directors of the Company. The MEIP Plan provides that a maximum of 3,833,307 shares of common stock of the indirect parent company are issuable pursuant to the exercise of options. The per share purchase price cannot be less than the fair value of the share of common stock of the indirect parent company at the grant date and the option expires no later than ten years from the date of grant. Vesting of these stock options is split into 3 categories: 1) time-based options: 50% of option grants generally vest ratably over 5 years and feature a fixed exercise price equal to the fair value of common stock of the indirect parent company on grant date; 2) premium options: 25% of stock option grants with an exercise price initially equal to the fair value of common stock on grant date that will increase by 10% each year and generally vesting ratably over 5 years; and 3) performance-based options: 25% of stock option grants with a fixed exercise price equal to the fair value of common stock on grant date which vest upon the occurrence of a liquidity event (as defined under the terms of the MEIP Plan) based on the achievement of return targets calculated based on the return received by majority shareholders from the liquidity event. While the time-based options and the premium options are expensed over the requisite service period, the performance-based options will not be expensed until the occurrence of the liquidity event.

Special equity grant

In April 2008, the indirect parent company approved the Restricted Stock Unit grant agreement and the penny option grant agreement (collectively “Equity Grant Agreements”) pursuant to which a one-time grant of equity-based awards of either restricted stock units (“RSUs”) or options to purchase shares of common stock of the indirect parent company for a penny (“Penny Options”) was made to certain employees of the Company. A maximum of 1,343,348 shares of common stock of the indirect parent company are issuable with respect to the special grants. As a result of the option to allow the recipients to elect to have an amount withheld that is in excess of the required minimum withholding under the current tax law, the special grants will be accounted for as liability awards. As a liability award, the fair value on which the expense is based is remeasured each period based on the estimated fair value and the final expense will be based on the fair value of the shares on the date the award is settled. The RSUs and Penny Options expire no later than four years and ten years from the date of grant. One third of the granted RSUs and Penny Options vested immediately on date of grant; one third vested on August 25, 2009, and the remainder shall vest on August 25, 2010.

The carrying value of an RSU or Penny Option is always equal to the estimated fair value of one common share of the indirect parent company. The RSUs and Penny Options entitle the holders to receive common shares of the indirect parent company at the end of a vesting period. The total number of RSUs and Penny Options granted were 1,343,348 with an initial fair value of $10, equal to the share price at the date of grant. As at June 30, 2010, there were 1,188,827 outstanding RSUs and Penny Options (1,275,220 as at September 30, 2009) of which 779,681 (851,490 as at September 30, 2009) were vested.

Annual grant

In June 2008, the Company’s indirect parent company adopted a Long Term Incentive Plan (the “LTIP”), pursuant to which the indirect parent company is expected to grant annual awards to certain employees of the Company (the “participants”). The value of an award is initially based on the participant’s pay grade and base salary and is subsequently adjusted based on the outcome of certain performance conditions relating to the fiscal year. Each award that vests is ultimately settleable, at the option of the participant, in cash or in parent company common stock of equivalent value. The awards vest (i) upon the occurrence of a liquidity event (as defined under the terms of the LTIP) and (ii) in varying percentages based on the level of return realized by majority shareholders as a result of the liquidity event.

The awards granted under this LTIP are classified as liabilities in accordance with the FSAB issued guidance on distinguishing liabilities from equity, since the award is for a fixed amount of value that can be settled, at the option of the participant, in (i) cash, or (ii) a variable number of parent company common stock of equivalent value.

The Company will not recognize any compensation expense until such time as the occurrence of a liquidity event generating sufficient return to the majority shareholders (in order for the award to vest) is probable. If such an event was probable as of June 30, 2010, the value of the awards to be expensed by the Company would range between $3,970,000 and $4,764,000 depending on the level of return expected to be realized by the majority shareholders.


 
21

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


12.
Financial Instruments

Interest rate risk

The Company is exposed to interest rate risk on its variable interest bearing term loans. The term loans bear interest based on British Banker Association LIBOR. As further disclosed in Note 13, the Company may enter into derivative financial instruments to manage its exposure to interest rate changes and reduce its overall cost of borrowing.

Currency risk

The Company is exposed to financial risk arising from fluctuations in foreign exchange rates and the degree of volatility of the rates. The Company does not use derivative instruments to reduce its exposure to foreign currency risk. As at June 30, 2010, the financial assets totaling $206,662,000 ($183,252,000 as at September 30, 2009) include cash and cash equivalents and accounts receivable for CAN$3,795,000, 18,528,000 Euros and 1,134,000 Swiss francs (CAN$3,525,000, 19,014,000 Euros and 2,000,000 Swiss francs as at September 30, 2009). As at June 30, 2010, the financial liabilities totaling $703,721,000 ($700,978,000 as at September 30, 2009) include accounts payable and accrued liabilities and long-term debt of CAN$9,361,000 and 7,250,000 Euros (CAN$11,432,000 and 8,044,000 Euros as at September 30, 2009).

Credit risk

As at June 30, 2010, the Company had $137,806,000 ($98,630,000 as at September 30, 2009) of cash with one financial institution.

Fair value of the financial instruments on the balance sheet

The estimated fair value of the financial instruments is as follows:


   
June 30, 2010
   
September 30, 2009
 
   
Fair
value
   
Carrying
amount
   
Fair
value
   
Carrying
amount
 
   
$
   
$
   
$
   
$
 
Assets
                       
Cash and cash equivalents
    163,775       163,775       126,435       126,435  
Accounts receivable from the parent company
    450       450       306       306  
Accounts receivable, net
    42,437       42,437       56,511       56,511  
Liabilities
                               
Accounts payable and accrued liabilities
    109,757       109,757       87,684       87,684  
Long-term debt
    599,495       593,964       649,689       613,294  


The following methods and assumptions were used to calculate the estimated fair value of the financial instruments on the balance sheet.

a)
Financial instruments for which fair value is deemed equivalent to carrying amount

The estimated fair value of certain financial instruments shown on the consolidated balance sheet is equivalent to their carrying amount. These financial instruments include cash and cash equivalents, accounts receivable, net, accounts receivable from the parent company, accounts payable and accrued liabilities.

b)
Long-term debt

The fair value of the long-term debt bearing interest at fixed rates has been established according to market prices obtained from a large U.S. financial institution. The fair value of the variable interest bearing term loan has been established based on broker-dealer quotes.
 
 
22

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


13.
Derivates and Hedging Activities

Risk management objective of using derivatives

The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk primarily by managing the amount, sources, conditions and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing and duration of the Company’s known or expected cash payments principally related to the Company’s borrowings.

Cash flow hedges of interest rate risk

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. During the nine-month period ended June 30, 2010, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.

Effective March 3, 2008, the Company entered into two pay-fixed, receive-floating interest rate swap agreements, effectively converting $115,000,000 of variable-rate debt under its secured senior credit facilities to fixed-rate debt. Through the first two quarters of 2008, the Company’s two interest rate swaps were designated as effective hedges of cash flows. For the quarter ended September 30, 2008, due to the increased volatility in short-term interest rates and a realignment of the Company’s LIBOR rate election on its debt capital repayment schedule, hedge accounting was discontinued as the hedge relationship ceased to satisfy the strict conditions of hedge accounting. On December 1, 2008, the Company redesignated its $50,000,000 notional interest rate swap that matures in February 2010 anew as a cash flow hedge using an improved method of assessing the effectiveness of the hedging relationship. The Company’s $65,000,000 notional interest rate swap matured in February 2009. Effective March 2009, the Company entered into a pay-fixed, receive-floating interest rate swap of a notional amount of $52,000,000 amortizing to $13,000,000 through February 2010. The Company’s two interest rate swaps with a combined notional amount of $63,000,000 that were designated as cash flow hedges of interest rate risk matured during the quarter ended March 31, 2010, and the Company has not entered into new derivative agreements.

Amounts reported in Accumulated Other Comprehensive Income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt.

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheet as of June 30, 2010, and September 30, 2009.

Tabular disclosure of fair values of derivative instruments


       
Liability Derivatives
             
       
June 30, 2010
 
September 30, 2009
   
Balance sheet location
 
Fair value
 
Fair value
Derivatives designated as hedging instruments
     
$
 
$
Interest rate swaps
 
Other long-term liabilities
 
-
 
610
Total derivatives designated as hedging instruments
     
-
 
610
 
 
23

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


Cash flow hedges of interest rate risk

The tables below present the effect of the Company’s derivative financial instruments on the consolidated operations as at June 30, 2010, and 2009.

Tabular disclosure of the effect of derivative instruments for the three-month and nine-month periods ended June 30, 2010 and 2009


 
Location in the
Condensed Consolidated
Financial
Statements
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
 
Interest rate swaps in cash flow hedging relationships
   
$
   
$
 
Loss recognized in other comprehensive income on derivatives (effective portion), net of tax of $114 in 2009
OCI
    -       (212 )
Gain (loss) reclassified from accumulated comprehensive income into income (effective portion)
Financial expenses
    -       (239 )
Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Financial expenses
    -       -  
Interest rate swaps not designated as hedging instruments
                 
Loss recognized in income on derivatives
Financial expenses
    -       -  


 
Location in the
Condensed Consolidated
Financial
Statements
 
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
Interest rate swaps in cash flow hedging relationships
   
 
   
 
 
Loss recognized in other comprehensive income on derivatives (effective portion), net of tax of $166 ($181 in 2009)
OCI
    (309 )     (521 )
Gain (loss) reclassified from accumulated comprehensive income into income (effective portion)
Financial expenses
    (464 )     (180 )
Gain (loss) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Financial expenses
    447       -  
Interest rate swaps not designated as hedging instruments
                 
Loss recognized in income on derivatives
Financial expenses
    -       (1,032 )


14.
Fair Value Measurements

Effective October 1, 2008, the Company adopted the authoritative guidance for fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

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

Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Inputs that are unobservable and significant to the overall fair value measurement.

If the inputs used to measure the financial assets and liabilities fall within the different levels described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.


 
24

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)


Financial assets and liabilities measured at fair value on a recurring basis as at June 30, 2010, and September 30, 2009, are summarized below:


   
Quoted prices in
active markets for identical assets and liabilities
(Level 1)
   
Significant other observable inputs
(Level 2)
   
Significant unobservable inputs
(Level 3)
   
Balance at
June 30,
2010
 
   
$
   
$
   
$
   
$
 
Liabilities
                       
Derivative financial instruments
    -       -       -       -  


   
Quoted prices in
active markets for identical assets and liabilities
(Level 1)
   
Significant other observable inputs
(Level 2)
   
Significant unobservable inputs
(Level 3)
   
Balance at
September 30, 2009
 
   
$
   
$
   
$
   
$
 
Liabilities
                       
Derivative financial instruments
    -       610       -       610  

Derivative financial instruments consist of interest rate swap agreements as more fully described in Note 13 and are measured at fair value based on observable market interest rate curves as of the measurement date.

During the nine-month period ended June 30, 2010, the Company recorded a goodwill impairment charge of $91,400,000 and an intangible assets impairment charge of $15,758,000. The fair value measurement method used in the Company’s impairment analysis utilized a discounted cash flow model and market approach that incorporates significant unobservable inputs or Level 3 assumptions. These assumptions include, among others, projections of the Company’s future operating results, the implied fair value using an income approach by preparing a discounted cash flow analysis and other subjective assumptions.

15.
Related Party Transactions

As at June 30, 2010, and September 30, 2009, the Company had a note receivable from its parent company amounting to $133,154,000. During the three-month period ended June 30, 2010, the Company earned interest income on the note amounting to $1,952,000 net of taxes amounting to $1,052,000 and $5,857,000 net of taxes amounting to $3,155,000  for the nine-month period ended June 30, 2010, ($1,952,000 net of taxes amounting to $1,052,000 during the three-month period ended June 30, 2009, and $5,858,000 net of taxes amounting to $3,155,000 during the nine-month period ended June 30, 2009) and the related interest receivable from the parent company amounting to $24,093,000 as at June 30, 2010, ($15,078,000 as at September 30, 2009) has been recorded in the shareholder’s equity section of the consolidated balance sheet. As at June 30, 2010, the Company has an account receivable from the parent company amounting to $450,000 ($306,000 as at September 30, 2009).

The Company recorded management fees from a controlling shareholding company amounting to $703,000 for the three-month period ended June 30, 2010, and $2,558,000 for the nine-month period ended June 30, 2010, ($4,756,000 during the three-month period ended June 30, 2009, and $4,899,000 during the nine-month period ended June 30, 2009). As at June 30, 2010, the Company accrued fees payable to a controlling shareholding company amounting to $576,000 ($436,000 as at September 30, 2009).

During the nine-month period ended June 30, 2010, the Company paid a dividend to its parent company amounting to $128,000.

16.
Acquired In-Process Research

During the quarter, the Company entered into an asset purchase and license agreement to acquire rights in and to the intellectual property, assigned contracts, permits and inventories related to a compound to be used in the development of an undisclosed product in the field of gastroenterology. Certain other rights were licensed under the agreement. Pursuant to the agreement, the Company made an upfront payment of $ 8,000,000 on closing and additional payments of up to $86,000,000 based on the achievement of certain development, regulatory and commercialization milestones. In addition, the Company will pay royalties on the basis of net sales. The Company completed the asset acquisition in April 2010 and recorded an expense of $7,948,000 for the payment of acquired in-process research and development in the third quarter of fiscal year 2010.

 
25

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)


17.
Condensed Consolidating Financial Information

As of June 30, 2010, the Company had outstanding $228,000,000 aggregate principal amount of the Senior Secured Notes. The Secured Notes are fully and unconditionally guaranteed, jointly and severally by certain of the Company’s wholly-owned subsidiaries.

The following supplemental tables present condensed consolidating balance sheets for the Company and its subsidiary guarantors and non-guarantors as at June 30, 2010, and September 30, 2009, the condensed consolidating statements of operations for the three-month and nine-month periods ended June 30, 2010, and the three-month and nine-month periods ended June 30, 2009, and the condensed consolidating statement of cash flows for the nine-month period ended June 30, 2010, and the nine-month period ended June 30, 2009.

Condensed consolidating balance sheet balance sheet as at June 30, 2010

   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-
guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
   
$
 
Assets
                             
Current assets
                             
Cash and cash equivalents
    69       117,672       46,034       -       163,775  
Accounts receivable, net
    -       29,110       13,777       -       42,887  
Accounts receivable from the parent company
    48       402       -       -       450  
Intercompany receivables
    41,911       555       620       (43,086 )     -  
Income taxes receivable
    -       1,454       -       -       1,454  
Inventories, net
    -       16,075       6,332       (266 )     22,141  
Prepaid expenses and deposits
    77       1,647       603       -       2,327  
Deferred income taxes
    -       1,825       830       80       2,735  
Total current assets
    42,105       168,740       68,196       (43,272 )     235,769  
Property, plant and equipment, net
    -       28,393       7,538       -       35,931  
Intangible assets, net
    -       297,232       57,554       -       354,786  
Investment in subsidiaries
    (335,784 )     812,202       78,175       (554,593 )     -  
Intercompany advances
    828,263       126,865       674,308       (1,629,436 )     -  
Goodwill
    -       61,887       10,530       -       72,417  
Deferred debt issue expense, net
    19,110       2,577       -       -       21,687  
Deferred income taxes
    -       -       6,076       -       6,076  
Total assets
    553,694       1,497,896       902,377       (2,227,301 )     726,666  
Liabilities
                                       
Current liabilities
                                       
Accounts payable and accrued liabilities
    17,771       83,191       8,795       -       109,757  
Income taxes payable
    -       1,059       1,369       -       2,428  
Short-term intercompany payables
    20       42,497       569       (43,086 )     -  
Installments on long-term debt
    1,348       1,850       -       -       3,198  
Deferred income taxes
    -       -       -       -       -  
Total current liabilities
    19,139       128,597       10,733       (43,086 )     115,383  
Long-term debt
    514,534       76,232       -       -       590,766  
Intercompany advances
    44,376       1,508,843       76,217       (1,629,436 )     -  
Other long-term liabilities
    -       9,437       -       -       9,437  
Deferred income taxes
    -       32,210       3,225       -       35,435  
Total liabilities
    578,049       1,755,319       90,175       (1,672,522 )     751,021  
Shareholders’ Equity (Deficiency)
                                       
Capital stock
                                       
  Common shares
    1       21,020       735,742       (756,762 )     1  
  Preferred shares
    -       78,175       -       (78,175 )     -  
Retained earnings (deficit)
    (461,999 )     (325,656 )     82,453       243,203       (461,999 )
9.05% Note receivable from the parent company
    (133,154 )     -       -       -       (133,154 )
Additional paid-in capital
    615,834       14,075       681       (14,756 )     615,834  
Accumulated other comprehensive loss
    (45,037 )     (45,037 )     (6,674 )     51,711       (45,037 )
Total shareholders’ equity (deficiency)
    (24,355 )     (257,423 )     812,202       (554,779 )     (24,355 )
Total liabilities and shareholders’ equity (deficiency)
    553,694       1,497,896       902,377       (2,227,301 )     726,666  

 
26

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)

 
 
Condensed consolidating balance sheet as at September 30, 2009

   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
   
$
 
Assets
                             
Current assets
                             
Cash and cash equivalents
    702       41,859       83,874       -       126,435  
Accounts receivable, net
    -       41,151       15,973       -       57,124  
Accounts receivable from the parent company
    42       264       -       -       306  
Short-term intercompany receivables
    5,857       5,803       364       (12,024 )     -  
Income taxes receivable
    -       3,383       8       -       3,391  
Inventories, net
    -       39,162       5,688       (144 )     44,706  
Prepaid expenses and deposits
    -       2,289       579       -       2,868  
Deferred income taxes
    588       14,960       304       -       15,852  
Total current assets
    7,189       148,871       106,790       (12,168 )     250,682  
Property, plant and equipment, net
    -       29,846       9,498       -       39,344  
Intangible assets, net
    -       347,604       73,686       -       421,290  
Investments in subsidiaries
    (231,940 )     782,206       -       (550,266 )     -  
Intercompany advances
    898,272       128,793       669,195       (1,696,260 )     -  
Goodwill
    -       153,287       12,536       -       165,823  
Deferred debt issue expense, net
    23,371       2,040       -       -       25,411  
Deferred income taxes
    3,962       4,653       3,437       -       12,052  
Total assets
    700,854       1,597,300       875,142       (2,258,694 )     914,602  
Liabilities
                                       
Current liabilities
                                       
Accounts payable and accrued liabilities
    5,091       71,305       11,432       (144 )     87,684  
Income taxes payable
    3,425       (940 )     8       -       2,493  
Installments on long-term debt
    12,939       17,769       -       -       30,708  
Short-term intercompany payables
    4,795       6,206       1,023       (12,024 )     -  
Deferred income taxes
    588       257       (708 )     -       137  
Total current liabilities
    26,838       94,597       11,755       (12,168 )     121,022  
Long-term debt
    510,755       71,831       -       -       582,586  
Intercompany advances
    19,224       1,593,115       83,921       (1,696,260 )     -  
Other long-term liabilities
    262       9,186       -       -       9,448  
Deferred income taxes
    (19,989 )     60,511       (2,740 )     -       37,782  
Total liabilities
    537,090       1,829,240       92,936       (1,708,428 )     750,838  
Shareholders’ Equity (Deficiency)
                                       
Capital stock
                                       
Common shares
    1       21,034       745,398       (766,432 )     1  
Retained earnings (deficit)
    (297,658 )     (242,700 )     37,332       205,368       (297,658 )
9.05% Note receivable from the parent company
    (133,154 )     -       -       -       (133,154 )
Additional paid-in capital
    619,053       14,204       611       (14,815 )     619,053  
Accumulated other comprehensive loss
    (24,478 )     (24,478 )     (1,135 )     25,613       (24,478 )
Total shareholders’ equity (deficiency)
    163,764       (231,940 )     782,206       (550,266 )     163,764  
Total liabilities and shareholders’ equity (deficiency)
    700,854       1,597,300       875,142       (2,258,694 )     914,602  

 
27

 
AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)
 
 
Condensed consolidating operations for the three-month period ended June 30, 2010

   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
   
$
 
                               
Net product sales
    -       64,305       16,280       (105 )     80,480  
Cost of goods sold
    -       14,634       6,585       (391 )     20,828  
Selling and administrative expenses
    3,905       16,671       6,759       -       27,335  
Management fees
    703       -       -       -       703  
Research and development expenses
    -       7,678       933       -       8,611  
Acquired in-process research
    -       7,948       -       -       7,948  
Depreciation and amortization
    -       13,298       1,840       -       15,138  
Total operating expenses
    4,608       60,229       16,117       (391 )     80,563  
Operating income (loss)
    (4,608 )     4,076       163       286       (83 )
Financial expenses
    14,923       27,989       1,711       (28,411 )     16,212  
Interest income
    (12,154 )     (1,852 )     (14,594 )     28,411       (189 )
Loss (gain) on foreign currencies
    24,824       (17,417 )     (122 )     (8,044 )     (759 )
Total other expenses (income)
    27,593       8,720       (13,005 )     (8,044 )     15,264  
Income (loss) before income taxes
    (32,201 )     (4,644 )     13,168       8,330       (15,347 )
Income taxes expense (benefit)
    (17,726 )     9,691       2,501       86       (5,448 )
Equity in earnings in subsidiaries
    4,576       18,911       -       (23,487 )     -  
Net income (loss)
    (9,899 )     4,576       10,667       (15,243 )     (9,899 )


 
28

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)

 
Condensed consolidating operations for the three-month period ended June 30, 2009

   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
 
   
 
   
 
   
 
   
 
 
Net product sales
    -       88,836       12,391       (421 )     100,806  
Other revenue
    -       -       5,221       -       5,221  
Total revenue
    -       88,836       17,612       (421 )     106,027  
Cost of goods sold
    -       17,514       4,834       (255 )     22,093  
Selling and administrative expenses
    4,882       18,673       5,147       (129 )     28,573  
Management fees
    4,756       -       -       -       4,756  
Research and development expenses
    -       9,683       1,329       (311 )     10,701  
Depreciation and amortization
    -       13,412       1,424       -       14,836  
Partial write-down of intangible assets
    -       55,414       251       -       55,665  
Total operating expenses
    9,638       114,696       12,985       (695 )     136,624  
Operating income (loss)
    (9,638 )     (25,860 )     4,627       274       (30,597 )
Financial expenses
    15,148       29,015       (2,045 )     (25,395 )     16,723  
Interest income (income)
    (13,161 )     2,059       (14,311 )     25,395       (18 )
Other income
    -       (3,500 )     -       -       (3,500 )
Loss on foreign currencies
    -       (680 )     (186 )     -       (866 )
Total other expenses (income)
    1,987       26,894       (16,542 )     -       12,339  
Income (loss) before income taxes
    (11,625 )     (52,754 )     21,169       274       (42,936 )
Income taxes expense (benefit)
    1,854       (24,467 )     1,085       -       (21,528 )
Equity in earnings (loss) in subsidiaries
    (8,203 )     20,084       -       (11,881 )     -  
Net income (loss)
    (21,682 )     (8,203 )     20,084       (11,607 )     (21,408 )

 
29

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)

 
Condensed consolidating operations for the nine-month period ended June 30, 2010


   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
          $  
                                 
Net product sales
    -       236,888       49,500       (1,411 )     284,977  
Cost of goods sold
    -       98,718       18,247       (1,359 )     115,606  
Selling and administrative expenses
    5,250       61,974       20,756       -       87,980  
Management fees
    2,558       -       -       -       2,558  
Research and development expenses
    -       21,448       3,272       -       24,720  
Acquired in-process research
    -       7,948       -       -       7,948  
Depreciation and amortization
    -       39,954       5,876       -       45,830  
Impairment of intangible assets including goodwill
    -       107,158       -       -       107,158  
Total operating expenses
    7,808       337,200       48,151       (1,359 )     391,800  
Operating income (loss)
    (7,808 )     (100,312 )     1,349       (52 )     (106,823 )
Financial expenses
    44,826       84,506       5,476       (86,014 )     48,794  
Interest income
    (36,690 )     (5,782 )     (44,038 )     86,014       (496 )
Other income
    -       (7,700 )     -       -       (7,700 )
Loss (gain) on foreign currencies
    47,689       (31,685 )     (144 )     (15,226 )     634  
Total other expenses (income)
    55,825       39,339       (38,706 )     (15,226 )     41,232  
Income (loss) before income taxes
    (63,633 )     (139,651 )     40,055       15,174       (148,055 )
Income taxes expense (benefit)
    16,245       (1,637 )     1,566       (16 )     16,158  
Equity in earnings (loss) in subsidiaries
    (84,335 )     53,679       -       30,656       -  
Net income (loss)
    (164,213 )     (84,335 )     38,489       45,846       (164,213 )


 
30

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)

 
Condensed consolidating operations for the nine-month period ended June 30, 2009


   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
   
$
 
Net product sales
    -       284,110       45,493       (4,058 )     325,545  
Other revenue
    -       -       5,221       -       5,221  
Total revenue
    -       284,110       50,714       (4,058 )     330,766  
Cost of goods sold
    -       59,131       18,290       (471 )     76,950  
Selling and administrative expenses
    6,741       65,953       19,872       (129 )     92,437  
Management fees
    4,899       -       -       -       4,899  
Research and development expenses
    -       25,748       1,403       (311 )     26,840  
Depreciation and amortization
    -       37,954       5,834       -       43,788  
Partial write-down of intangible assets
    -       55,414       251       -       55,665  
Total operating expenses
    11,640       244,200       45,650       (911 )     300,579  
Operating income (loss)
    (11,640 )     39,910       5,064       (3,147 )     30,187  
Financial expenses
    46,913       89,292       49       (83,299 )     52,955  
Interest income
    (40,406 )     (174 )     (42,996 )     83,299       (277 )
Other income
    -       (3,500 )     -       -       (3,500 )
Loss on foreign currencies
    -       (1,003 )     (118 )     -       (1,121 )
Total other expenses (income)
    6,507       84,615       (43,065 )     -       48,057  
Income (loss) before income taxes
    (18,147 )     (44,705 )     48,129       (3,147 )     (17,870 )
Income taxes benefit
    (6,840 )     (10,522 )     (1,342 )     -       (18,704 )
Equity in earnings in subsidiaries
    15,288       49,471       -       (64,759 )     -  
Net income
    3,981       15,288       49,471       (67,906 )     834  

 
31

 

AXCAN INTERMEDIATE HOLDINGS INC.
Notes to Condensed Consolidated Financial Statements

(amounts in the tables are stated in thousands of U.S .dollars, except share related data)
(unaudited)

 
 
Condensed consolidating cash flows for the nine-month period ended June 30, 2010


   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
       
Cash flows from operating activities
                             
Net cash provided by (used in) operating activities
    (40,940 )     73,672       32,924       -       65,656  
Cash flows from investing activities
                                       
Acquisition of property, plant and equipment
    -       (4,256 )     (815 )     -       (5,071 )
Intercompany advances
    7,408       (42,154 )     -       34,746       -  
Investments in subsidiaries
    -       -       (68,000 )     68,000       -  
Net cash provided by (used in) investing activities
    7,408       (46,410 )     (68,815 )     102,746       (5,071 )
Cash flows from financing activities
                                       
Repayment of long-term debt
    (8,791 )     (12,074 )     -       -       (20,865 )
Stock-based compensation plans redemption
    (336 )     -       -       -       (336 )
Intercompany advances
    42,154       (7,408 )     -       (34,746 )     -  
Dividends paid
    (128 )     -       -       -       (128 )
Issue of shares
    -       68,000       -       (68,000 )     -  
Net cash provided by (used in) financing activities
    32,899       48,518       -       (102,746 )     (21,329 )
Foreign exchange gain (loss) on cash held in foreign currencies
    -       33       (1,949 )     -       (1,916 )
Net increase (decrease) in cash and cash equivalents
    (633 )     75,813       (37,840 )     -       37,340  
Cash and cash equivalents, beginning of period
    702       41,859       83,874       -       126,435  
Cash and cash equivalents, end of period
    69       117,672       46,034       -       163,775  


Condensed consolidating cash flows cash flows for the nine-month period ended June 30, 2009


   
Axcan
Intermediate
Holdings Inc.
   
Subsidiary
guarantors
   
Subsidiary
non-guarantors
   
Eliminations
   
Consolidated
 
   
$
   
$
   
$
   
$
       
Cash flows from operating activities
                             
Net cash provided by (used in) operating activities
    (41,968 )     178,634       (38,745 )     -       97,921  
Cash flows from investing activities
                                       
Acquisition of property, plant and equipment
    -       (4,724 )     (658 )     -       (5,382 )
Acquisition of intangible assets
    -       -       (10 )     -       (10 )
Intercompany advances
    14,054       (104,618 )     7,319       83,245       -  
Net cash provided by (used in) investing activities
    14,054       (109,342 )     6,651       83,245       (5,392 )
Cash flows from financing activities
                                       
Repayment of long-term debt
    (1,111 )     (6,545 )     -       -       (7,656 )
Stock-based compensation cancellation
    (148 )     -       -       -       (148 )
Intercompany advances
    30,907       (31,236 )     83,574       (83,245 )     -  
Dividends paid
    (500 )     -       -       -       (500 )
Net cash provided by (used in) financing activities
    29,148       (37,781 )     83,574       (83,245 )     (8,304 )
Foreign exchange loss on cash held in foreign currencies
    -       (218 )     (311 )     -       (529 )
Net increase in cash and cash equivalents
    1,234       31,293       51,169       -       83,696  
Cash and cash equivalents, beginning of period
    21       26,181       29,903       -       56,105  
Cash and cash equivalents, end of period
    1,255       57,474       81,072       -       139,801  

 
32

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


You should read the following discussion in conjunction with the Condensed Consolidated Financial Statements and the related notes that appear in Part I, Item 1 of this Quarterly Report. The results of operations for the three-month and nine-month periods ended June 30, 2010, and June 30, 2009, reflect the results of operations for Axcan Intermediate Holdings Inc. and its consolidated subsidiaries.

Unless the context otherwise requires, in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the terms "Axcan", "Company", "we", "us" and "our" refer to Axcan Intermediate Holdings Inc. and its consolidated subsidiaries.

This discussion contains forward-looking statements and involves numerous risks and uncertainties, including but not limited to those described in Part 2, Item 1A of this Quarterly Report and “Item 1A Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended September 30, 2009. Actual results may differ materially from those contained in any forward-looking statements.

Overview

Our Business

We are a specialty pharmaceutical company focused on marketing and selling pharmaceutical products used in the treatment of a variety of gastrointestinal, or GI, diseases and disorders, which are those affecting the digestive tract. Our mission is to improve the quality of care and health of patients suffering from gastrointestinal diseases and disorders by providing effective therapies for patients and specialized caregivers.

In addition to our marketing activities, we carry out research and development activities on products at various stages of development. These activities are carried out primarily with respect to products we currently market in connection with lifecycle management initiatives, as well as product candidates acquired or licensed from third parties. By combining our marketing capabilities with our research and development experience, we distinguish ourselves from other specialty pharmaceutical companies that focus solely on product distribution and we offer licensors the prospect of rapidly expanding the potential market for their products on a multinational basis. As a result, we are presented with opportunities to acquire or in-license products that have been advanced to the later stages of development by other companies. Our focus on products in late-stage development enables us to reduce risks and expenses typically associated with new drug development.

We intend to enhance our position as the leading specialty pharmaceutical company concentrating in the field of gastroenterology by pursuing the following strategic initiatives: 1) growing sales of existing products; 2) launching new products; 3) selectively acquiring or in-licensing complementary products; 4) pursuing growth opportunities through a development pipeline; and 5) expanding internationally.

Business Environment

While the ultimate end users of our products are the individual patients to whom our products are prescribed by physicians, our direct customers include a number of large pharmaceutical wholesale distributors and large pharmacy chains. The pharmaceutical wholesale distributors that comprise a significant portion of our customer base sell our products primarily to retail pharmacies, which ultimately dispense our products to the end consumers.

Increasingly, in North America, third-party payors, such as private insurance companies and drug plan benefit managers, aim to rationalize the use of pharmaceutical products and medical treatments, in order to ensure that prescribed products are necessary for the patients’ disorders. Moreover, large drug store chains now account for an increasing portion of retail sales of prescription medicines. The pharmacists and managers of such retail outlets are under pressure to reduce the number of items in inventory in order to reduce costs.

We use a “pull-through” marketing approach that is typical of pharmaceutical companies. Under this approach, our sales representatives actively promote our portfolio by demonstrating the features and benefits of our products to physicians and, in particular, gastroenterologists who may prescribe our products for their patients. The patients, in turn, take the prescriptions to pharmacies to be filled. The pharmacies then place orders, directly or through buying groups, with the wholesalers, to whom we sell our products.

Our expenses are comprised primarily of selling and administrative expenses (including marketing expenses), cost of goods sold (including royalty payments to those companies from which we license some of our commercialized products), research and development expenses, financial expenses as well as depreciation and amortization.

Since 2005, some U.S. wholesalers have changed their business model from one depending on drug price inflation to a fee-for-service arrangement, whereby manufacturers pay wholesalers a fee for inventory management and other services. These fees typically are a percentage of the wholesaler’s purchases from the manufacturer or a fixed charge per item or per unit. The fee-for-service approach results in wholesalers’ compensation being more stable and volume-based as opposed to price-increase based. As a result of the move to a fee-for-service business model, many wholesalers are no longer investing in inventory ahead of anticipated price increases and have reduced their inventories from their historical levels. As a consequence of the new model, manufacturers now realize the benefit of price increases more rapidly in return for paying wholesalers for the services they provide, on a fee-for-service basis. Fees resulting from distribution services agreements, or DSAs, are deducted from gross sales.  We have had DSAs in place with our three largest U.S. wholesalers since the first quarter of fiscal year 2009.


 
33

 

In March 2010, the Health Care and Education Reconciliation Act of 2010 was enacted in the U.S. This healthcare reform legislation contains several provisions that impact our business, which include expanding rebate coverage to managed Medicaid and an increase to the rate of rebates for all our drugs dispensed to Medicaid beneficiaries; expanding the 340(B) drug pricing program requiring drug manufacturers to provide discounted product to reduce the Medicare Part D coverage gap; and assessing a new fee on manufacturers and importers of branded prescription drugs paid for pursuant to coverage provided under specified government programs.  The impact of these changes is further discussed below under the “Healthcare Reform” subsection.

On April 29, 2010, we announced that we had taken steps to cease the distribution of ULTRASE® MT and VIOKASE®, effective April 28, 2010, in response to FDA guidance related the continued distribution of unapproved pancreatic enzyme products, or PEPs. The effects of ceasing to distribute these product lines on our financial statements are summarized in the section “Unapproved pancreatic enzyme products (“PEPs”) event” below. This event was recorded as a recognized subsequent event in the previous quarter ended March 31, 2010.  Reserves recorded at that time were based on Management’s estimates and, as previously disclosed, were subject to change.  We have reflected certain adjustments to these reserves in our financial statements for the three-month and nine-month periods ended June 30, 2010 in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).

FINANCIAL OVERVIEW FOR THE THREE-MONTH AND NINE-MONTH PERIODS ENDED JUNE 30, 2010
 
This discussion and analysis is based on our audited annual consolidated financial statements and the related notes thereto reported under U.S. GAAP. For a description of our products, see the section entitled “Business Products” in Item 1, Part I in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009, filed with the Securities and Exchange Commission.
 
For the three-month period ended June 30, 2010, total revenue was $80.5 million ($106.1 million for the three-month period ended June 30, 2009), operating income was $0.0 million (operating loss of $30.5 million for the three-month period ended June, 2009) and net loss was $9.9 million (net loss of $21.4 million for the three-month period ended June 30, 2009). For the nine-month period ended June, 2010, total revenue was $285.0 million ($330.8 million for the nine-month period ended June 30, 2009), operating loss was $106.8 million (operating income of $30.2 million for the corresponding period of fiscal year 2009) and net loss was $164.2 million (net income of $0.8 million for the corresponding period of fiscal year 2009). Net product sales in the United States were $56.3 million (69.9% of net product sales) for the three-month period ended June 30, 2010, compared to $80.6 million (79.9% of net product sales) for the corresponding period of the preceding fiscal year. In the European Union, net product sales were $16.0 million (19.9% of net product sales) for the three-month period ended June 30, 2010, compared to $12.4 million (12.3% of net product sales) for the corresponding period of the preceding fiscal year. In Canada, net product sales were $8.2 million (10.2% of net product sales) for the three-month period ended June 30, 2010, compared to $7.6 million (7.5% of net product sales) for the corresponding period of the preceding fiscal year.  Net product sales in the United States were $211.1 million (74.1 % of net product sales) for the nine-month period ended June 30, 2010, compared to $258.6 million (79.4% of net product sales) for the corresponding period of the preceding fiscal year. In the European Union, net product sales were $49.0 million (17.2% of net product sales) for the nine-month period ended June 30, 2010, compared to $43.4 million (13.3% of net product sales) for the corresponding period of the preceding fiscal year. In Canada, net product sales were $24.9 million (8.7% of net product sales) for the nine-month period ended June 30, 2010, compared to $23.1 million (7.1% of net product sales) for the corresponding period of the preceding fiscal year.

Unapproved pancreatic enzyme products (“PEPs”) event

As previously disclosed, we ceased distributing both our ULTRASE® MT and VIOKASE® product lines effective April 28, 2010. ULTRASE® MT and VIOKASE® have accounted for approximately 19% of our total net sales in the last three fiscal years.

This action was taken as we did not receive FDA approval for the NDAs filed for ULTRASE® MT and VIOKASE by the date mandated by FDA. In April 2004, the FDA mandated that all manufacturers of PEPs file an NDA and receive approval for their products by April 2008 or be subject to regulatory action. In October 2007, the FDA published a notice in the Federal Register extending the deadline within which to obtain marketing approval for PEPs until April 28, 2010, for those companies that (a) were marketing unapproved PEPs as of April 28, 2004; (b) submitted NDAs on or before April 28, 2009; and (c) continued diligent pursuit of regulatory approval.

We completed the initial submission of our NDA for ULTRASE® MT and, in the fourth quarter of fiscal 2008, received a first complete response letter (formerly known as an “approvable letter’’ prior to recent amendments of the Food Drug and Cosmetics Act, or FDCA). Further to the filing of our response to this letter, we received a second complete response letter in the fourth quarter of fiscal 2009. On May 5, 2010, the FDA issued an additional complete response with respect to our NDA for ULTRASE® MT.  As was the case with prior letters, the FDA  requires that deficiencies raised with respect to the manufacturing and control processes at the manufacturer of the active ingredient of ULTRASE® MT be addressed before approval can be granted. On June 11, 2010, the FDA accepted our latest complete response filing and confirmed a November 28, 2010 Prescription Drug User Fee Act, or PDUFA, date for our ULTRASE® MT NDA. We and the manufacturer of the active pharmaceutical ingredient of ULTRASE® MT (which is the same one for VIOKASE®) are in ongoing discussions with the FDA to address the remaining open issues identified by the FDA.

The submission of our rolling NDA for VIOKASE® was completed in the first quarter of fiscal 2010.  At the time we completed this submission we requested a priority review and the FDA advised us in the second quarter of fiscal 2010 that it would not grant a priority review for this NDA. The PDUFA date for VIOKASE® was August 30, 2010. We have recently received feedback from the FDA regarding the timeline to review the VIOKASE® NDA. The FDA has indicated that the review is progressing and has postponed the PDUFA date to November 30, 2010.

As a result of taking steps to cease distribution of ULTRASE® MT and VIOKASE® and in accordance with U.S. GAAP, we recorded an additional $13.0 million product return reserve for the three-month period ended June 30, 2010, that added to the previously recorded reserve of $10.4 million, for a total of $23.4 million for the nine-month period ended June 30, 2010. These reserves are for product returns as an estimate of our liability for ULTRASE® MT and VIOKASE® that may be returned by the original purchaser under our DSAs or applicable returns policies. The cease distribution order issued by the FDA was not considered as a product recall. The additional reserve recorded in the quarter ended June 30, 2010, is to provide for ULTRASE® MT and VIOKASE®  sales shipped for the April 1, 2010 to April 28, 2010 period, which was prior to the cease distribution order. This provision is based on management estimates of ULTRASE® MT and VIOKASE® inventory in the distribution channel, assumptions on  related expiration dates of this inventory as well as estimated erosion of ULTRASE® MT and VIOKASE® demand, based on competition from approved PEPs and the resulting estimated sell-through of ULTRASE® MT and VIOKASE®, actual return activity and other factors.

We recorded a charge of $1.9 million during the three-month period ended June 30, 2010, that added to an existing charge of $43.0 million for a total of $44.9 million for the nine-month period ended June 30, 2010. This charge to cost of goods sold was recorded to reduce inventories to their net realizable

 
34

 
value and for estimated loss for purchase and other materials and supply commitments related to ULTRASE® MT and VIOKASE® products. We recorded these charges for inventory related to ULTRASE® MT and VIOKASE®, in light of the fact that these products did not obtain regulatory approval by the April 28, 2010 deadline established by the FDA.

This event has also resulted in a change in circumstance that caused us to review the carrying value of our long lived intangible assets, including goodwill. Based on this review, an impairment charge of $107.2 million was recorded during the previous quarter ended March 31, 2010.

The income tax benefits of the above charges were estimated and an additional $5.5 million was recorded in income taxes benefit during the three-month period ended June 30, 2010, in addition to the benefit of $25.6 million recorded in the previous quarter for a total of $31.1 million during the nine-month period ended June 30, 2010. We also recorded an increase in valuation allowance on deferred tax assets of $7.6 million during the three-month period ended June 30, 2010, in addition to the valuation allowance of $45.0 million recorded in the previous quarter, for a total of $52.6 million for the nine-month period ended June 30, 2010.

The charges that we have taken as a result of having ceased distribution of our PEPs reflect many subjective estimates that were required to be made by management. These estimates include:

a)
The quantity and expiration dates of PEPs inventory in the distribution channel;

b)
Short-term prescription demand during the period of time where the products will continue to be available at the pharmacy-level;

c)
Assumptions regarding the probability of obtaining an eventual NDA approval for our PEPs and the time required for such approval;

d)
Assumptions regarding market share growth after an eventual re-launch of our PEPs; and

e)
Other factors.

In future quarters, we will monitor and review the assumptions and estimates and will prospectively record changes to provisions reflected in the nine-month period ended June 30, 2010.

The following table summarizes the assessment by management of the impacts of our ceasing to distribute ULTRASE® MT and VIOKASE®, or the “unapproved PEPs event’’ as it is sometimes referred to herein, on our condensed consolidated interim financial statements of operations for the three-month and nine-month periods ended June 30, 2010:


(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30, 2010
   
For the
nine-month
period ended
June 30, 2010
 
   
$
   
$
 
Net product sales (increase in products returns reserves)(1)
    (13.0 )     (23.4 )
Cost of goods sold (write-down of inventory and estimated loss for purchase and other materials and supply commitments)
    1.9       44.9  
Impairment of intangible assets and goodwill
    -       107.2  
Selling and administrative expenses (decrease in stock-based compensation expense)
    -       (4.9 )
      1.9       147.2  
Operating loss
    (14.9 )     (170.6 )
Income taxes expense (tax benefit of above items, net of an increase in valuation allowance)
    2.1       21.5  
Net loss
    (17.0 )     (192.1 )

(1) The additional reserves recorded in the three-month period ended June 30, 2010 was to provide for ULTRASE® MT and VIOKASE® sales shipped for the April 1, 2010 to April 28, 2010 period, which was prior to the cease distribution order.

 
35

 
Financial highlights

(in millions of U.S. dollars)
 
June 30,
2010
   
September 30,
2009
 
   
$
   
$
 
Total assets
    726.7       914.6  
Long-term debt (a)
    594.0       613.3  
Shareholders’ equity (deficiency)
    (24.4 )     163.8  

(a)
Including the current portion


(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
$
   
$
   
$
   
$
 
Total revenue
    80.5       106.1       285.0       330.8  
EBITDA (1)
    15.9       (11.4 )     (53.9 )     78.6  
Adjusted EBITDA (1)
    41.7       55.6       137.9       151.6  
Net income (loss)
    (9.9 )     (21.4 )     (164.2 )     0.8  


(1)
Reconciliation of net income to EBITDA (a non-U.S. GAAP measure) and from EBITDA to Adjusted EBITDA (a non-U.S. GAAP measure) for the three-month and nine-month periods ended June 30, 2010, and 2009 is as follows:

(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
 
   
 
   
 
   
 
 
Net income (loss)
    (9.9 )     (21.4 )     (164.2 )     0.8  
Financial expenses
    16.3       16.7       48.8       53.0  
Interest income
    (0.2 )     -       (0.5 )     (0.3 )
Income taxes expense (benefit)
    (5.4 )     (21.5 )     16.2       (18.7 )
Depreciation and amortization
    15.1       14.8       45.8       43.8  
EBITDA f)
    15.9       (11.4 )     (53.9 )     78.6  
Transaction, integration, refinancing costs and nonrecurring payments to third parties a)
    1.1       5.0       5.5       6.9  
Management fees b)
    0.6       4.7       2.5       4.9  
Stock-based compensation expense excluding impact of the unapproved PEPs event c)
    1.2       1.6       5.2       5.5  
Impairment of intangible assets and goodwill related to the unapproved PEPs event d)
    -       -       107.2       -  
Partial write-down of intangible assets e)
    -       55.7       -       55.7  
Adjustments related to the unapproved PEPs event f)
    14.9       -       63.4       -  
Acquired in-process research
    8.0       -       8.0       -  
Adjusted EBITDA g)
    41.7       55.6       137.9       151.6  

a)
Represents integration and refinancing costs as well as due diligence costs related to non-recurring transactions, payments to third parties in respect of research and development milestones and other progress payments as defined within our credit agreement.
b)
Represents management fees and other charges associated with the Management Services Agreement with TPG.
c)
Represents stock-based employee compensation expense under the provisions of FASB guidance, excluding the impact of the unapproved PEPs event.
d)
Intangible assets and goodwill write-downs related to the unapproved PEPs event.
e)
Partial write-down of intangible assets related to URSO® products.
f)
Adjustments and other write-downs related to the unapproved PEPs event, including an additional returns provision of $13.0 million during the three-month period and $23.4 million during the nine-month period ended June 30, 2010, inventory write-down and accrual for purchases and other materials and supply commitments of $1.9 million during the three-month period and $44.9 million during the nine-month period ended June 30, 2010, and a stock-based compensation recovery of $4.9 million during the nine-month period ended June 30, 2010.
g)
EBITDA and Adjusted EBITDA are both non-U.S. GAAP financial measures and are presented in this report because our management considers them important supplemental measures of our performance and believes that they are frequently used by interested parties in the evaluation of companies in the industry. EBITDA, as we use it, is net income before financial expenses, interest income, income taxes and depreciation and amortization. We believe that the presentation of EBITDA enhances an investor’s understanding of our financial performance. We believe that EBITDA is a useful financial metric to assess our operating performance from period to period by excluding certain items that we believe are not representative of our core business. The term EBITDA is not defined under U.S. GAAP, and EBITDA is not a measure of net income, operating income or any other performance measure derived in accordance with U.S. GAAP, and is subject to important limitations. Adjusted EBITDA, as we use it, is EBITDA adjusted to exclude certain non-cash charges, unusual or non-recurring items and other adjustments set forth below.
 
36

 
Adjusted EBITDA is calculated in the same manner as “EBITDA” and “Consolidated EBITDA” as those terms are defined under the indentures governing our notes and credit facility further described in the section “Liquidity and Capital Resources—Long-term Debt and New Senior Secured Credit Facility”. We believe that the inclusion of supplementary adjustments applied to EBITDA in presenting Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and unusual or non-recurring items that we do not expect to continue in the future and to provide additional information with respect to our ability to meet our future debt service and to comply with various covenants in our indentures and credit facility. Adjusted EBITDA is not a measure of net income, operating income or any other performance measure derived in accordance with U.S. GAAP, and is subject to important limitations. EBITDA and Adjusted EBITDA have limitations as an analytical tool, and they should not be considered in isolation, or as substitutes for analysis of our results as reported under U.S. GAAP. Some of these limitations are:
 
 
·
EBITDA and Adjusted EBITDA do not reflect all cash expenditures, future requirements for capital expenditures, or contractual commitments;
 
·
EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, working capital needs;
 
·
EBITDA and Adjusted EBITDA do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
 
·
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;
 
·
Adjusted EBITDA reflects additional adjustments as provided in the indentures governing our secured and unsecured notes and new senior secured credit facilities; and
 
·
Other companies in our industry may calculate EBITDA and Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as measures of discretionary cash available to us to invest in our business. Our management compensates for these limitations by relying primarily on the U.S. GAAP results and using EBITDA and Adjusted EBITDA as supplemental information.

Overview of results of operations

(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
$
   
%
 
Net product sales (b)
    80.5       100.9       (20.4 )     (20.2 )
Other revenue
    -       5.2       (5.2 )     (100.0 )
Total revenue
    80.5       106.1       (25.6 )     (24.1 )
Cost of goods sold (a) (b)
    20.8       22.1       (1.3 )     (5.9 )
Selling and administration expenses (a) (b)
    27.4       28.6       (1.2 )     (4.2 )
Management  fees
    0.6       4.7       (4.1 )     (87.2 )
Research and development expenses (a)
    8.6       10.7       (2.1 )     (19.6 )
Acquired in-process research
    8.0       -       8.0       -  
Depreciation and amortization
    15.1       14.8       0.3       2.0  
Impairment of intangible assets and goodwill
    -       55.7       (55.7 )     (100.0 )
      80.5       136.6       (56.1 )     (41.1 )
Operating loss
    -       (30.5 )     30.5       100.0  
Financial expenses
    16.3       16.7       (0.4 )     (2.4 )
Interest income
    (0.2 )     -       (0.2 )     -  
Other income
    -       (3.5 )     3.5       100.0  
Gain on foreign currencies
    (0.8 )     (0.8 )     -       -  
      15.3       12.4       2.9       23.4  
Loss before income taxes
    (15.3 )     (42.9 )     27.6       64.3  
Income taxes benefit (b)
    (5.4 )     (21.5 )     16.1       74.9  
Net loss
    (9.9 )     (21.4 )     11.5       53.7  
 
(a)
Exclusive of depreciation and amortization
(b)
Including one time charges related to the unapproved PEPs event

 
37

 
 
(in millions of U.S. dollars)
 
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
$
   
%
 
Net product sales (b)
    285.0       325.6       (40.6 )     (12.5 )
Other revenue
    -       5.2       (5.2 )     (100.0 )
Total revenue
    285.0       330.8       (45.8 )     (13.8 )
Cost of goods sold (a) (b)
    115.6       77.0       38.6       50.1  
Selling and administration expenses (a) (b)
    88.0       92.4       (4.4 )     (4.8 )
Management fees
    2.5       4.9       (2.4 )     (49.0 )
Research and development expenses (a)
    24.7       26.8       (2.1 )     (7.8 )
Acquired in-process research
    8.0       -       8.0       -  
Depreciation and amortization
    45.8       43.8       2.0       4.6  
Impairment of intangible assets and goodwill (b)
    107.2       55.7       51.5       92.5  
      391.8       300.6       91.2       30.3  
Operating income (loss)
    (106.8 )     30.2       (137.0 )     (453.6 )
Financial expenses
    48.8       53.0       (4.2 )     (7.9 )
Interest income
    (0.5 )     (0.3 )     (0.2 )     (66.7 )
Other income
    (7.7 )     (3.5 )     (4.2 )     (120.0 )
Gain (loss) on foreign currencies
    0.6       (1.1 )     1.7       154.5  
      41.2       48.1       (6.9 )     (14.3 )
Loss before income taxes
    (148.0 )     (17.9 )     (130.1 )     (726.8 )
Income taxes expense (benefit) (b)
    16.2       (18.7 )     34.9       186.6  
Net income (loss)
    (164.2 )     0.8       (165.0 )     N/M (c)
 
(a)
Exclusive of depreciation and amortization
(b)
Including one-time charges due to the unapproved PEPs event
(c)
Not Meaningful

Net product sales

For the three-month period ended June 30, 2010, net product sales were $80.5 million compared to $100.9 million for the corresponding period of the preceding year, a decrease of 20.2%. For the nine-month period ended June 30, 2010, net product sales were $285.0 million compared to $325.6 million for the corresponding period of the preceding year, a decrease of 12.5%.

This decrease was primarily derived from lower sales in the United States, which amounted to $56.3 million for the three-month period ended June 30, 2010, compared to $80.6 million for the corresponding period of the preceding fiscal year, a decrease of 30.1% and $211.1 million for the nine-month period ended June 30, 2010, compared to $258.6 million for the corresponding period of the preceding fiscal year, a decrease of 18.4%. The decrease in sales in the United States is mainly due to the effects of the unapproved PEPs event and to the continued decrease in sales of certain of our URSO® branded products resulting from the entry on the U.S. market of a generic version of URSO® 250 and URSO® FORTE following their approval by the Office of Generic Drugs on May 13, 2009, combined with increases in sales deductions discussed hereafter in the gross-to-net product sales analysis.

During the quarter, ULTRASE® MT and VIOKASE® sales of $13.0 million were recorded as a result of shipments made to the wholesalers during the April 1, 2010 to April 28, 2010 period, which was prior to the cease distribution order.  These sales were fully provided for in the quarter as an addition to product returns reserve further discussed in the gross to net product sales analysis.

Net product sales in the European Union increased 29.0%, from $12.4 million for the corresponding period of the preceding fiscal year, to $16.0 million for the three-month period ended June 30, 2010, and increased 12.9% from $43.4 million for the nine-month period ended June 30, 2009, to $49.0 million for the nine-month period ended June 30, 2010. For the three-month period ended June 30, 2010, the increase in sales is primarily due to an increase in sales volume of certain products, partially offset by the negative impact of currency fluctuations compared to the preceding year. The value of the Euro against the U.S. dollar depreciated by 4.0% during the quarter. For the nine-month period ended June 30, 2010, the increase in sales resulted primarily as a result of an increase in sales volume of certain products combined with the positive impact of currency fluctuations compared to the preceding year, as the value of the Euro against the U.S. dollar improved by 4.6%.

Net product sales in Canada increased 7.9%, from $7.6 million for the three-month period ended June 30, 2009, to $8.2 million for the three-month period ended June 30, 2010, and increased 7.8% from $23.1 million for the nine-month period ended June 30, 2009, to $24.9 million for the nine-month period ended June 30, 2010. The increase in sales resulted mostly from the positive impact of currency fluctuations compared to the corresponding period of the preceding year, as the value of the Canadian dollar improved against the U.S. dollar by 11.6% for the three-month period and by 12.5% for the nine-month period, partially offset by the decrease in sales of URSO® and certain products during the nine-month period ended June 30, 2010.


 
38

 

Net product sales are stated net of deductions for product returns, chargebacks, contract rebates, DSA fees, discounts and other allowances. The following table summarizes our gross-to-net product sales adjustments for each significant category:


(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
 
   
%
 
Gross product sales
    112.2       123.7       (11.5 )     (9.3 )
Gross-to-net product sales adjustments
                               
Product returns
    2.0       2.5       (0.5 )     (20.0 )
Product returns related to the unapproved PEPs event
    13.0       -       13.0       -  
Chargebacks
    7.2       8.8       (1.6 )     (18.2 )
Contract rebates
    6.6       8.5       (1.9 )     (22.4 )
DSA fees
    1.2       0.9       0.3       33.3  
Discounts and other allowances
    1.7       2.1       (0.4 )     (19.0 )
Total gross-to-net product sales adjustments
    31.7       22.8       8.9       39.0  
Total net product sales
    80.5       100.9       (20.4 )     (20.2 )


(in millions of U.S. dollars)
 
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
$
   
$%
 
Gross product sales
    391.2       391.6       (0.4 )     (0.1 )
Gross-to-net product sales adjustments
                               
Product returns
    6.1       6.7       (0.6 )     (9.0 )
Product returns related to the unapproved PEPs event
    23.4       -       23.4       -  
Chargebacks
    32.7       23.2       9.5       40.9  
Contract rebates
    32.6       26.1       6.5       24.9  
DSA fees
    4.7       2.9       1.8       62.1  
Discounts and other allowances
    6.7       7.1       (0.4 )     (5.6 )
Total gross-to-net product sales adjustments
    106.2       66.0       40.2       60.9  
Total net product sales
    285.0       325.6       (40.6 )     (12.5 )


Product returns, chargebacks, contract rebates, DSA fees, discounts and other allowances totalled $31.7 million (28.3% of gross product sales) for the three-month period ended June 30, 2010, and $22.8 million (18.4% of gross product sales) for the corresponding period of the preceding fiscal year. The increase in total deductions as a percentage of gross product sales was mostly due to an increase of 11.3% in product returns, partially offset by a decrease in contract rebates and chargebacks.

Product returns, contract rebates, DSA fees, discounts and other allowances totalled $106.2 million (27.1% of gross product sales) for the nine-month period ended June 30, 2010, and $66.0 million (16.9% of gross product sales) for the nine-month period ended June 30, 2009. The increase in total deductions as a percentage of gross product sales was mostly due to an increase of 5.8% in product returns, 2.4% in chargebacks and 1.7% in contract rebates.

The increases in product returns are mainly due to the additional provision of $13.0 million for the three-month period and $23.4 million for the nine-month period ended June 30, 2010 related to the unapproved PEPs event. Increases in chargebacks and contract rebates  for the nine-month period are primarily due to the fact that we have fixed price contracts with certain third-party payors which, as a result of price increases announced during the preceding fiscal year, resulted in a greater rebate as a percentage of sales being awarded under those contracts.  Due to pricing and contracting actions taken in conjunction with the genericization of URSO® in the U.S., these were more significant for this franchise than for the rest of our product portfolio. Estimated chargebacks and rebates are recorded at the time revenue is recognized and are based on the latest information available at that time, including estimated inventory levels in the distribution channel.

In addition, in May 2009, we entered into an agreement with the Department of Defense, or DOD, to remain eligible for inclusion on the DOD’s formulary and pursuant to which we agreed to pay rebates under the TRICARE retail pharmacy program. We began accounting for these rebates in the third quarter of fiscal year 2009 as contract rebates. Under the contracting process it initiated in 2009, the DOD  further  sought to claim rebates from a large number of pharmaceutical manufacturers, including us,  on all prescriptions of covered  drugs filled under TRICARE for prior periods, starting as and  from January 28, 2008. The DOD’s right to claim rebates for these periods prior to its rulemaking and contracting initiative was challenged in a lawsuit instituted on behalf of pharmaceutical manufacturers. During the first quarter of fiscal year 2010, an additional provision of $1.6 million was recorded to account for the potential unfavourable judicial decision in this lawsuit.

Deductions also increased due to increases in DSA fees resulting from new DSAs signed with two additional major U.S. wholesalers during the previous fiscal year.


 
39

 

Healthcare Reform
 
In March 2010, the Health Care and Education Reconciliation Act of 2010 was enacted in the U.S. This healthcare reform legislation contains several provisions that impact our business.
 
Although many provisions of the new legislation do not take effect immediately, several provisions became effective during the period ended March 31, 2010. These include (1) an increase in the minimum Medicaid rebate to States participating in the Medicaid program on our branded prescription drugs; (2) the extension of the Medicaid rebate to Managed Care Organizations that dispense drugs to Medicaid beneficiaries; and (3) the expansion of the 340(B) Public Health Service Act drug pricing program, which provides outpatient drugs at reduced rates, to include certain children’s hospitals, free standing cancer hospitals, critical access hospitals, and rural referral centers.

In addition, beginning in 2011, the new law requires drug manufacturers to provide a 50% discount to Medicare beneficiaries for any covered prescription drugs purchased during a Medicare Part D coverage gap (i.e. the “donut hole”). Also, beginning in 2011, we will be assessed our share of a new fee assessed on all branded prescription drug manufacturers and importers. This fee will be calculated based upon each organization’s percentage share of total branded prescription drug sales to U.S. government programs (such as Medicare, Medicaid, Department of Veterans Affairs and Department of Defence programs and TRICARE) made during the previous year. The aggregated industry wide fee is expected to total $28 billion through 2019, ranging from $2.5 billion to $4.1 billion annually. Further, the new law also imposes a 2.3% excise tax on sales of certain taxable medical devices, including our FLUTTER® mucus clearance device, that are made after December 31, 2012.

Presently, uncertainty exists as many of the specific determinations necessary to implement this new legislation have yet to be decided and communicated to industry participants. For example, we do not yet know when and how discounts will be provided to the additional hospitals eligible to participate under the 340(B) program. In addition, determinations as to how the Medicare Part D coverage gap will operate and how the annual fee on branded prescription drugs will be calculated and allocated remain to be clarified, though, as noted above, these programs will not be effective until 2011. We have made several estimates with regard to important assumptions relevant to determining the financial impact of this legislation on our business due to the lack of availability of both certain information and a complete understanding of how the process of applying the legislation will be implemented.

In 2010, we expect that the new legislation will reduce our revenues by approximately $2.0 million as a result of the higher rebates and discounts on our products. The impact in terms of additional reserves recorded in contract rebates has been $0.3 million for the three-month period ended June 30, 2010 and $1.1 million for the nine-month period ended June 30, 2010. However, we are still assessing the full extent of this legislation’s longer-term impact on our business. While certain aspects of the new legislation implemented in 2010 are expected to reduce our revenues in 2010 and in future years, other provisions of this legislation may offset, at some level, any reduction in revenues when these provisions become effective. In future years, based on our understanding, these other provisions are expected to result in higher revenues due to an increase in the total number of patients covered by health insurance and an expectation that existing insurance coverage will provide more comprehensive consumer protections. This would include a federal subsidy for a portion of a beneficiary’s out-of-pocket cost under Medicare Part D. However, these higher revenues will be negatively impacted by the branded prescription drug manufacturers’ fee.

Other revenue

During the three-month period ended June 30, 2009, we entered into a license agreement with a leading multi-national company (the “Licensee”) whereby we granted the Licensee the right to use the active ingredient contained in one of our commercialized products, LACTEOL®, to develop and commercialize new food products that will contain this active ingredient. Under the terms of the agreement, the Licensee will have exclusive rights to commercialize these new products. We will continue to own all other rights related to the active ingredient, including the right to use the active ingredient and develop, manufacture and commercialize non-food products containing the active ingredient, including pharmaceutical products. For the three-month period ended June 30, 2009, we received an initial milestone payment of $5.2 million (CHF 6 million).

Cost of goods sold

Cost of goods sold consists principally of the costs of raw materials, royalties and manufacturing costs. We outsource most of our manufacturing requirements. For the three-month period ended June 30, 2010, cost of goods sold decreased $1.3 million (5.9%) to $20.8 million from $22.1 million for the corresponding period of the preceding fiscal year. As a percentage of net product sales, cost of goods sold for the three-month period ended June 30, 2010, increased compared to the three-month period ended June 30, 2009, from 21.9% to 25.8% mostly due to charges related to the unapproved PEPs event.  For the nine-month period ended June 30, 2010, cost of goods sold increased $38.6 million (50.1%) to $115.6 million from $77.0 million for the corresponding period of the preceding fiscal year. As a percentage of net product sales, cost of goods sold for the nine-month period ended June 30, 2010, increased from 23.6% to 40.6% as compared to the nine-month period ended June 30, 2009. The increases in cost of goods sold are mostly due to inventory write-down and purchase commitments reserves totalling $1.9 million for the three-month period ended June 30, 2010, and $44.9 million for the nine-month period ended June 30, 2010 related to the unapproved PEPs event. Excluding the impact related to the unapproved PEPs event, cost of goods sold as a percentage of net product sales would have been 20.2% for the three-month period ended June 30, 2010, and 22.9% for the nine-month period ended June 30, 2010, compared to 21.9% and 23.6% for the corresponding periods of fiscal year 2009.

Selling and administrative expenses

Selling and administrative expenses, on an ongoing basis, consist principally of salaries and other costs associated with our sales force and marketing activities. For the three-month period ended June 30, 2010, selling and administrative expenses decreased $1.2 million (4.2%) to $27.4 million from $28.6 million for the corresponding period of the preceding fiscal year, mainly due to the decrease in our patient support programs. For the nine-month period ended June 30, 2010, selling and administrative expenses decreased $4.4 million (4.8%) to $88.0 million from $92.4 million for the corresponding period of the preceding fiscal year, mainly due to the adjustment of $4.9 million for stock-based compensation further to changes in assumptions affecting our valuation of these expenses due to the impact of the unapproved PEPs event on our business.


 
40

 
 
Management fees

Management fees consist of fees and other charges associated with the Management Services Agreement with TPG. Historically, these fees were previously unallocated to subsidiaries of Axcan Holdings Inc., the indirect parent company of Axcan Intermediate Holdings Inc. In the quarter ended June 30, 2009, they were allocated from the closing date of February 2008 Transactions based on revenue. For the three-month period ended June 30, 2010, management fees decreased $4.1 million (87.2%) to $0.6 million from $4.7 million for the corresponding period of the preceding fiscal year of the preceding fiscal year due to the allocation recorded in the quarter ended June 30, 2009. For the nine-month period ended June 30, 2010, management fees decreased $2.4 million (49.0%) to $2.5 million from $4.9 million for the corresponding period of the preceding fiscal year.  This decrease in management fees for the nine-month period is mostly due to the impact of the unapproved PEPs event on our business.

Research and development expenses

Research and development expenses consist principally of fees paid to outside parties that we use to conduct clinical studies and to submit governmental approval applications on our behalf, as well as the salaries and benefits paid to personnel involved in research and development projects. For the three-month period ended June 30, 2010, research and development expenses decreased $2.1 million (19.6%) to $8.6 million, from $10.7 million for the corresponding period of the preceding fiscal year. For the nine-month period ended June 30, 2010, research and development expenses decreased $2.1 million (7.8%) to $24.7 million, from $26.8 million for the corresponding period of the preceding fiscal year. The research and development expenses include a decrease related to the reduction in expenses related to the development work on PEPs and European clinical trial costs for PYLERA® as compared to the previous fiscal year. This decrease was offset by the effect of foreign currency on some of our expenses denominated in Canadian dollars and in Euros.

Acquired in-process research

During the quarter, we entered into an asset purchase and license agreement to acquire rights in and to the intellectual property, assigned contracts, permits and inventories related to a compound to be used in the development of an undisclosed product in the field of gastroenterology. Certain other rights were licensed under the agreement. Pursuant to the agreement, we made an upfront payment of $8.0 million on closing and additional payments of up to $86.0 million based on the achievement of certain development, regulatory and commercialization milestones. In addition, we will pay royalties on the basis of net sales. We completed the asset acquisition in April 2010 and recorded an expense of $8.0 million for the payment of acquired in-process research in the third quarter of fiscal year 2010.

Depreciation and amortization

Depreciation and amortization consists principally of the amortization of intangible assets with a finite life. Intangible assets include trademarks, trademark licenses and manufacturing rights. For the three-month period ended June 30, 2010, depreciation and amortization increased $0.3 million (2.0%) to $15.1 million from $14.8 million for the corresponding period of the preceding fiscal year. For the nine-month period ended June 30, 2010, depreciation and amortization increased $2.0 million (4.6%) to $45.8 million from $43.8 million. The changes are due to the reduction of the remaining amortizable life of some intangible assets to periods ranging from 6 months to 14 years.

Impairment of intangible assets and goodwill

The value of goodwill and intangible assets with an indefinite life are subject to an annual impairment test unless events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. The intangible assets with a finite life and property, plant and equipment are subject to an impairment test whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable.  As a result of the unapproved PEPs event, we compared the carrying value of the intangible assets with a finite life affected by the unapproved PEPs event to estimated future undiscounted cash flows. The change in circumstances associated with the unapproved PEPs event also caused us to review the carrying value of our long lived intangible assets including goodwill. Based on this review, an impairment charge of $107.2 million was recorded in the previous quarter, reflecting charges of $91.4 million for the goodwill allocated to our U.S. reporting unit and of $15.8 million related to finite life intangible assets.

As a result of certain factors related to the ongoing marketing of certain of our products including the approval of a generic formulation of URSO 250 and URSO FORTE, we reviewed in three-month period ended June 30, 2009, the carrying amount of our intangible assets specifically related to these products. Based on a discounted cash-flow analysis and market prices, we concluded that a $55.7 million reduction to the carrying value of the related intangible assets totalling $83.7 million prior to the write-down was required. In addition, the remaining amortizable life of these intangible assets was reduced to periods ranging from 6 months to 14 years.

Financial expenses

Financial expenses consist principally of interest and fees paid in connection with funds borrowed for acquisitions. For the three-month period ended June 30, 2010, financial expenses decreased $0.4 million (2.4%) to $16.3 million from $16.7 million for the corresponding period of the preceding fiscal year. The decrease in financial expenses is mainly due to the reduction of the interest on long-term debt of $0.4 million. For the nine-month period ended June 30, 2010, financial expenses decreased $4.2 million (7.9%) to $48.8 million from $53.0 million for the corresponding period of the preceding fiscal year. The decrease in financial expenses is mainly due to the reduction of interest on long-term debt of $2.9 million as a result of the decrease in interest rates and the change in the fair value of derivatives of $1.2 million. Our two interest rate swaps with a combined notional amount of $63.0 million that were designated as cash-flow hedges of interest rate risk which matured during the three-month period ended March 31, 2010, and were not renewed.

Interest income

For the three-month period ended June 30, 2010, total interest income increased to $0.2 million from $0.0 million for the corresponding period of the preceding fiscal year. For the nine-month period ended June 30, 2010, total interest income increased $0.2 million (66.7%) to $0.5 million from $0.3 million for the corresponding period of the preceding fiscal year. These increases are mainly due to the increase in interest rates on our cash and cash equivalent investments.
 
41

 

Other income

In June 2007, we initiated a lawsuit under the U.S. Lanham Act against a number of defendants alleging they falsely advertised their products to be similar or equivalent to ULTRASE® MT. During the nine-month periods ended June 30, 2010, an amount of $7.7 million was paid to us pursuant to settlement arrangements entered into with the defendants in these matters.

Income taxes

For the three-month period ended June 30, 2010, income tax benefit amounted to $5.4 million, compared to $21.5 million for the corresponding period of the preceding fiscal year. For the nine-month period ended June 30, 2010, income tax expense amounted to $16.2 million compared to an income tax benefit of $18.7 million for the corresponding period of the preceding fiscal year. The effective tax rate was 35.5% for the three-month period ended June 30, 2010, compared to 50.1% for the three-month period ended June 31, 2009. For the nine-month period ended June 30, 2010, the effective tax rate was minus 10.9%, compared to 104.7% for the nine-month period ended June 30, 2009. The effective tax rates for the three-month and nine-month periods ended June 30, 2010, are affected by a number of elements, the most important being the non-deductible provisions related to the unapproved PEPs event and the valuation allowance taken against deferred tax assets attributable to the U.S. reporting unit. At June 30, 2010, the Company has a valuation allowance of $52.6 million recorded against its net deferred tax assets attributable to the U.S. reporting unit. If, in future periods, the deferred tax assets are determined by management to be more likely than not to be realized, the recognized tax benefits relating to the reversal of the valuation allowance will be recorded.

The difference between our effective tax rate and the statutory income tax rate is summarized as follows:

 (in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
 
   
%
   
 
   
%
   
 
 
Combined statutory rate applied to pre-tax income (loss)
    35.00       (5.4 )     35.00       (15.0 )
Increase (decrease) in taxes resulting from:
                               
Change in promulgated rates
    0.21       (0.0 )     0.00       0.0  
Difference with foreign tax rates
    6.15       (0.9 )     4.99       (2.1 )
Valuation allowance
    (49.80 )     7.6       0.00       0.0  
Tax benefit arising from a financing structure
    25.81       (4.0 )     5.73       (2.5 )
Non-deductible items
    (3.03 )     0.5       (1.79 )     0.8  
Investment tax credits
    4.41       (0.7 )     0.58       (0.3 )
State taxes
    1.57       (0.2 )     3.22       (1.4 )
Other
    15.18       (2.3 )     2.41       (1.0 )
      35.50       (5.4 )     50.14       (21.5 )



(in millions of U.S. dollars)
 
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
 
   
%
   
 
   
%
   
 
 
Combined statutory rate applied to pre-tax income (loss)
    35.00       (51.8 )     35.00       (6.3 )
Increase (decrease) in taxes resulting from:
                               
Change in promulgated rates
    0.01       (0.0 )     0.00       0.0  
Difference with foreign tax rates
    1.66       (2.5 )     12.85       (2.3 )
Valuation allowance
    (35.54 )     52.6       0.00       0.0  
Tax benefit arising from a financing structure
    7.83       (11.6 )     69.69       (12.4 )
Non-deductible items
    (23.53 )     34.8       (7.81 )     1.4  
Investment tax credits
    0.87       (1.3 )     4.47       (0.8 )
State taxes
    2.39       (3.5 )     (0.48 )     0.1  
Other
    0.38       (0.5 )     (9.06 )     1.6  
      (10.93 )     16.2       104.66       (18.7 )
 
 
42

 

Net income (loss)

For the three-month period ended June 30, 2010, net income increased $11.5 million (53.7%) to a net loss of $9.9 million from a net loss of $21.4 million for the corresponding period of the preceding fiscal year. The increase in net income for the three-month period is mainly due to the partial write-down of intangible assets related to our URSO® products amounting to $55.7 million which was recorded during the three-month period ended June 30, 2009 and partially offset by the impact of the unapproved PEPs event amounting to $17.0 million which was recorded during the three-month period ended June 30, 2010.

For the nine-month period ended June 30, 2010, net income decreased $165.0 million to a net loss of $164.2 million from net income of $0.8 million for the corresponding period of the preceding fiscal year. The decrease in net income for the nine-month period is mainly due to the impacts of the unapproved PEPs event amounting to $192.1 million for the nine-month period ended June 30, 2010 and partially offset by the partial write-down of intangible assets related to our URSO® products amounting to $55.7 million which was recorded during the three-month period ended June 30, 2009.



Balance sheets as at June 30, 2010, and September 30, 2009

The following table summarizes balance sheet information as at June 30, 2010, compared to September 30, 2009.

   
June 30,
   
September 30,
       
(in millions of U.S. dollars)
 
2010
   
2009
   
Change
 
   
$
   
$
   
$
   
%
 
Cash and cash equivalents
    163.8       126.4       37.4       29.6  
Current assets
    235.8       250.7       (14.9 )     (5.9 )
Total assets
    726.7       914.6       (187.9 )     (20.5 )
Current liabilities
    115.4       121.0       (5.6 )     (4.6 )
Long-term debt
    590.8       582.6       8.2       1.4  
Total liabilities
    751.0       750.8       (0.2 )     (0.0 )
Shareholders’ equity (deficiency)
    (24.4 )     163.8       (188.2 )     (114.9 )
Working capital
    120.4       129.7       (9.3 )     (7.2 )

Working capital decreased by $9.3 million (7.2%) to $120.4 million as at June 30, 2010, from $129.7 million at September 30, 2009. This decrease was mainly due to net working capital adjustments of $71.5 million related to the unapproved PEPs event. This decrease was partially offset by an increase in cash and cash equivalents of $37.4 million and the reduction in instalments on long-term debt of $27.5 million. Pursuant to our credit agreement we are required to annually prepay amounts equal to a portion of our annual excess cash flow, as defined under our credit agreement.  For fiscal year 2009, we were required to prepay $17.6 million on outstanding term loans under these provisions in the first quarter of fiscal year 2010. The prepayment was made in December 2009. As allowed by the credit agreement, the prepayment has been applied to the remaining scheduled installments of principal in direct order of maturity and the current portion of long-term debt has been reduced accordingly.
 
Total assets decreased $187.9 million (20.5%) to $726.7 million as at June 30, 2010, from $914.6 million as at September 30, 2009. This decrease was mainly due to the write-down of intangible assets and goodwill of $107.2 million, inventory write-down of $32.3 million and deferred tax asset adjustments of $21.5 million related to the unapproved PEPs event.  Long-term debt increased $8.2 million (1.4%) to $590.8 million as at June 30, 2010, from $582.6 million as at September 30, 2009, mostly due to the reclassification from short-term debt to long-term debt pursuant to the allocation of the prepayment made in December 2009 to the remaining scheduled installments of principal in direct order of maturity.
 

Liquidity and Capital Resources

Cash Requirements

As at June 30, 2010, working capital was approximately $120.4 million and $129.7 as at September 30, 2009. Cash generated from operations, which will be affected by the unapproved PEPs event, is used to fund working capital, capital expenditures, milestone payments debt service and business development activities. We regularly review product and other acquisition opportunities and may therefore require additional debt or equity financing. We cannot be certain that such additional financing, if required, will be available on acceptable terms, or at all.

A significant portion of our sales are attributable to the ULTRASE® and VIOKASE® product lines. We reported net sales of $37.6 million for ULTRASE® and $15.4 million for VIOKASE® for the nine-month period ended June 30, 2010. Total nine-month net sales for these two products, which amounted to $53.0 million, are net of the additional reserve of $23.4 million taken due to the effect of the unapproved PEPs event.

The loss of revenues associated with these products is expected to have a material negative effect on the Company’s ability to generate cash used to fund its operations and meet its other capital requirements. While there remain a number of uncertainties, including the Company’s ability to re-introduce these products into the market, the timing of such re-introduction and the resulting sales levels, management is currently evaluating the impact of the unapproved PEPs event on its cash flows and measures it could take to mitigate the negative effect of the withdrawal of these products on its cash flows.

On April 14, 2010, following the announcement that the FDA would require manufacturers of unapproved PEPs to cease distribution, effective April 28, 2010, one of the Company’s bond rating agencies put our credit  ratings “under review”. The review action was completed on July 13, 2010 with the agency maintaining its Corporate Family and Probability of Default ratings in effect prior to the PEP event. The Speculative Grade Liquidity Rating was lowered and a negative outlook issued. This could negatively impact on future borrowing capacity and cost.
 
 
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Contractual Obligations and Other Commitments

The following table summarizes our significant contractual obligations as at June 30, 2010, and the effect such obligations are expected to have on our liquidity and cash flows in future years. This table excludes the payment of amounts already recorded on the balance sheet as current liabilities at June 30, 2010, and certain other purchase obligations as discussed below:

   
For the twelve-month periods ending June 30,
 
(in millions of U.S. dollars)
 
2011
   
2012
   
2013
   
2014
   
2015 and
thereafter
 
   
$
   
$
   
$
   
$
   
$
 
Long-term debt
    3.2       18.6       41.6       75.5       463.0  
Operating leases
    2.5       1.6       1.2       0.9       0.0  
Other commitments
    14.6       0.7       0.1       0.1       0.1  
Interest on long-term debt
  57.0       57.2       57.2       53.3       64.0  
    77.3       78.1       100.1       129.8       527.1  


Purchase orders for raw materials, finished goods and other goods and services are not included in the above table. Management is not able to accurately determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. For the purpose of this table, contractual obligations for purchase of goods or services are only included in other commitments where there exist agreements that are legally binding and enforceable on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on current needs and are fulfilled by our vendors within relatively short timetables. We do not have significant agreements for the purchase of raw materials or finished goods specifying minimum quantities or set prices that exceed our short-term expected requirements. We also enter into contracts for outsourced services; however, the obligations under these contracts are not significant and the contracts generally contain clauses allowing for cancellation without significant penalty. As milestone payments are primarily contingent upon successfully achieving clinical milestones or on receiving regulatory approval for products under development, they do not have defined maturities and therefore are not included in the above table.

The expected timing of payment of the obligations discussed above is estimated based on current information. The timing of payments and actual amounts paid may differ depending on the timing of receipt of goods or services, or, for some obligations, changes to agreed-upon amounts.

As more fully described in Note 10 to the Condensed Consolidated Financial Statements, effective October 1, 2007, we adopted the provisions of the guidance issued by the FASB related to accounting for uncertainty in income taxes. As at June 30, 2010, we had unrecognized tax benefits of $11.0 million ($10.4 million as at September 30, 2009).  Due to the nature and timing of the ultimate outcome of these uncertain tax positions, we cannot make a reasonably reliable estimate of the amount and period of related future payments. Therefore, our unrecognized tax benefits with respect to our uncertain tax positions has been excluded from the above contractual obligations table.

Long-term debt and credit facility

On November 29, 2007, we entered into an Arrangement Agreement with Axcan Pharma Inc., pursuant to which we agreed to, through an indirect wholly-owned subsidiary, acquire all of the common stock of Axcan Pharma Inc. and enter into various other transactions in accordance with the Plan of Arrangement (the “Arrangement”). On February 25, 2008, we obtained various types of financing in connection with the Arrangement. We issued $228.0 million aggregate principal amount of Senior Secured Notes. The Senior Secured Notes were priced at $0.98737 with a yield to March 1, 2015, of 10%. The Senior Secured Notes rank pari passu with our credit facility.

We may redeem some or all of the Senior Secured Notes prior to March 1, 2011, at a redemption price equal to 100% of the principal amount of the Senior Secured Notes redeemed plus a “make-whole” premium and accrued and unpaid interest. On or after March 1, 2011, we may redeem some or all of the Senior Secured Notes at the redemption prices (expressed as percentages of principal amount of the Senior Secured Notes to be redeemed) set forth below:

Year
 
%
 
2011
    106.938  
2012
    104.625  
2013
    102.313  
2014 and thereafter
    100.000  
 
Prior to March 1, 2011, we may also redeem up to 35% of the aggregate principal amount of the Senior Secured Notes using the proceeds of one or more equity offerings at a redemption price equal to 109.250% of the aggregate principal amount of the Senior Secured Notes plus accrued and unpaid interest. If there is a change of control as specified in the indenture governing the senior notes, we must offer to repurchase the Senior Secured Notes at a price in cash equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest.

 
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We also obtained a Credit Facility for a total of $290.0 million composed of term loans totalling $175.0 million and a revolving credit facility of $115.0 million (“Credit Facility”). The Credit Facility bears interest at a variable rate composed of either the Federal Funds Rate or the British Banker Association LIBOR rate, at our option, plus the applicable rate based on our consolidated total leverage ratio and certain of our subsidiaries for the preceding twelve months. The Credit Facility matures on February 25, 2014, with quarterly payments over the term. As at June 30, 2010, $175.0 million of term loans had been issued and no amounts had been drawn against the revolving credit facility. The term loans were priced at $0.96 with a yield to maturity of 8.75% before the effect of the interest rate swaps as further disclosed in our Condensed Consolidated Financial Statements. The Credit Facility requires us to meet certain financial covenants, which were met as at June 30, 2010. The credit agreement governing the Credit Facility requires us to prepay outstanding term loans contingent upon the occurrence of these events, subject to certain exceptions, with: (1) 100% of the net cash proceeds of any incurrence of debt other than debt permitted under the Credit Facility, (2) commencing with the  year ending September 30, 2009, 50% (which percentage will be reduced to 25% if the senior secured leverage ratio is less than a specified ratio) of the annual excess cash flow (as defined in the credit agreement governing the Credit Facility) and (3) 100% of the net cash proceeds of all non-ordinary course asset sales or other dispositions of property (including casualty events) by us or by our subsidiaries, subject to reinvestments rights and certain other exceptions. Based on these requirements, for the fiscal year 2009, we were required to prepay $17.6 million of outstanding term loans in the first quarter of fiscal year 2010.

On February 25, 2008, as part of the Arrangement financing, we also obtained $235.0 million in financing under our senior unsecured bridge facility maturing on February 25, 2009. On May 6, 2008, our senior unsecured bridge facility was refinanced on a long-term basis, by repaying the bridge facility with the proceeds from our sale of $235.0 million aggregate principal amount of the Senior Unsecured Notes. The senior notes were priced at $0.9884 with a yield to March 1, 2016, of 13.16%. The Senior Unsecured Notes are subordinate to the new senior secured credit facility and secured notes.

We may redeem some or all of the senior notes prior to March 1, 2012, at a redemption price equal to 100% of the principal amount of the Senior Unsecured Notes redeemed plus a “make-whole” premium and accrued and unpaid interest. On or after March 1, 2012, we may redeem some or all of the Senior Unsecured Notes at the redemption prices (expressed as percentages of principal amount of the Senior Unsecured Notes to be redeemed) set forth below:

Year
 
%
 
2012
    106.375  
2013
    103.188  
2014 and thereafter
    100.000  


Prior to March 1, 2011, we may also redeem up to 35% of the aggregate principal amount of the Senior Secured Notes using the proceeds of one or more equity offerings at a redemption price equal to 112.750% of the aggregate principal amount of the Senior Unsecured Notes plus accrued and unpaid interest. If there is a change of control as specified in the indenture governing the senior notes, we must offer to repurchase the senior notes at a price in cash equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest.

Certain of our subsidiaries have been designated as guarantors with respect to the credit facility, the Senior Secured Notes and the Senior Unsecured Notes. Our obligations under, and each of the guarantors’ obligations under its guarantee of, the credit facility and the Senior Secured Notes are secured by a first priority security interest in our assets and of such guarantor subsidiaries, respectively.

We may from time to time seek to retire or purchase our outstanding debt through cash purchases in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

Operating leases

We have various long-term operating lease agreements for office space, automotive equipment and other equipment. The latest expiry date for these agreements is in 2015.

Other commitments

Other operating commitments consist primarily of amounts relating to administrative services, clinical studies and other research and development services.

Related party transactions

As at June 30, 2010, and September 30, 2009, we had a note receivable from our parent company amounting to $133.2 million. During the three-month period ended June 30, 2010, we have earned interest income on the note amounting to $1.9 million net of taxes amounting to $1.1 million and $5.9 million net of taxes amounting to $3.2 million for the nine-month period ended June 30, 2010 ($1.9 million net of taxes amounting to $1.1 million during the three-month period ended June 30, 2009, and  $5.9 million net of taxes amounting to $3.2 million during the nine-month period ended June 30, 2009). We have also recorded a related interest receivable on the note receivable from our parent company amounting to $24.1 million as at June 30, 2010 ($15.1 million as at September 30, 2009, which has been recorded in the shareholder’s equity section of the consolidated balance sheet. As at June 30, 2010, we have an account receivable from our parent company amounting to $0.5 million ($0.3 million as at September 30, 2009).

We recorded management fees from a controlling shareholding company amounting to $0.6 million during the three-month period ended June 30, 2010, and $2.5 million during the nine-month period ended June 30, 2010 ($4.7 million during the three-month period ended June 30, 2009, and $4.9 million during the nine-month period ended June 30, 2009). As at June 30, 2010, we accrued fees payable to a controlling shareholding company amounting to $0.6 million ($0.4 million as at September 30, 2009).

During the nine-month period ended June 30, 2010, we paid a dividend to our parent company amounting to $0.1 million to allow for the payment of certain group expenses.

 
45

 
Balance sheet arrangements

We do not have any transactions, arrangements and other relationships with unconsolidated entities that are likely to affect our operating results, our liquidity or capital resources. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity or market or credit risk support, and do not engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the condensed consolidated financial statements.

Cash flows
 
Our cash flows from operating, investing and financing activities for the three-month periods ended June 30, 2010, and 2009 as reflected in the consolidated statements of cash flows, are summarized in the following table:
 

(in millions of U.S. dollars)
 
For the
three-month
period ended
June 30,
2010
   
For the
three-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
$
 
Net cash provided by operating activities
    6.0       48.9       (42.9 )
Net cash used by investing activities
    (1.6 )     (2.5 )     0.9  
Net cash used by financing activities
    -       (3.9 )     3.9  

 
Our cash flows from operating, investing and financing activities for the nine-month periods ended June 30, 2010, and 2009 as reflected in the consolidated statements of cash flows, are summarized in the following table:
 

(in millions of U.S. dollars)
 
For the
nine-month
period ended
June 30,
2010
   
For the
nine-month
period ended
June 30,
2009
   
Change
 
   
$
   
$
   
$
 
Net cash provided by operating activities
    65.7       97.9       (32.2 )
Net cash used by investing activities
    (5.1 )     (5.4 )     0.3  
Net cash used by financing activities
    (21.3 )     (8.3 )     (13.0 )


Cash flows provided by operating activities decreased $42.9 million from $48.9 million for the three-month period ended June 30, 2009, to $6.0 million for the three-month period ended June 30, 2010. Cash flows provided by operating activities decreased $32.2 million from $97.9 million for the nine-month period ended June 30, 2009, to $65.7 million for the nine-month period ended June 30, 2010. The decreases in net cash provided by operating activities are mainly due to the decrease in accounts payable of $18.1 million during the three-month period ended June 30, 2010, and $17.6 million during the nine-month period ended June 30, 2010, compared to the corresponding period of the preceding fiscal year, combined with a decrease in net product sales of $20.4 million during the three-month period ended June 30, 2010, and $17.1 million during the nine-month period ended June 30, 2010 (net of the additional provision in product returns related to the unapproved PEPs event), compared to the corresponding period of the preceding fiscal year.

Cash flows used by investing activities decreased by $0.9 million from $2.5 million of cash used in the three-month period ended Jun 30, 2009, to $1.6 million of cash used in the three-month period ended June 30, 2010.  Cash flows used by investing activities decreased by $0.3 million from $5.4 million of cash used in the nine-month period ended June 30, 2009, to $5.1 million of cash used in the nine-month period ended June 30, 2010.

Cash flows used by financing activities decreased $3.9 million from $3.9 million of cash used in the three-month period ended June 30, 2009, to $0.0 million. Cash flows used by financing activities increased $13.0 million from $8.3 million of cash used in the nine-month period ended Jun 30, 2009, to $21.3 million of cash used in the nine-month period ended June 30, 2010. The increase in cash used by financing activities in the nine-month period ended June 30, 2010, is mainly due to the prepayment of $17.6 million of outstanding term-loans, based on the annual excess cash flow requirements for the fiscal year 2009, as defined in the credit agreement.

Significant Accounting Policies
 
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP, applied on a consistent basis. Some of our critical accounting policies require the use of judgment in their application or require estimates of inherently uncertain matters. Therefore, a change in the facts and circumstances of an underlying transaction could significantly change the application of our accounting policies to that transaction, which could have an effect on our financial statements. The policies that management believes are critical and require the use of complex judgment in their application are discussed below.
 
46

 

Use of Estimates
 
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at the date of the financial statements and also affect the recognized amounts of revenues and expenses during the year. Significant estimates and assumptions made by management include the allocation of the purchase price of acquired assets and businesses, allowances for accounts receivable and inventories, reserves for product returns, rebates, chargebacks and DSA fees, the classification of intangible assets between finite life and indefinite life, the useful lives of long-lived assets, the expected cash flows used in evaluating long-lived assets, goodwill and investments for impairment, stock based compensation costs, pending legal settlements and the establishment of provisions for income taxes including the realizability of deferred tax assets. The estimates are made using the historical information and various other relevant factors available to management. We review all significant estimates affecting the financial statements on a recurring basis and record the effect of any adjustments when necessary. Actual results could differ from those estimates based upon future events, which could include, among other risks, changes in regulations governing the manner in which we sell our products, changes in the healthcare environment, foreign exchange and managed care consumption patterns.
 
The charges that we have recorded as a result of having ceased distribution of our PEPs also reflect many subjective estimates that were required to be made by management. These estimates include:

a)
The quantity and expiration dates of PEPs inventory in the distribution channel;
b)
Short-term prescription demand during the period of time where the products will continue to be available at the pharmacy-level;
c)
Assumptions regarding the probability of obtaining an eventual NDA approval for our PEPs and the time required for such approval;
d)
Assumptions regarding market share growth after an eventual re-launch of our PEPs; and
e)
Other factors

In future quarters, management will monitor and review the assumptions and estimates and will prospectively record changes to provisions reflected in the current quarter.  
 
Revenue is recognized when the product is shipped to our customers, provided we have not retained any significant risks of ownership or future obligations with respect to the product shipped. Provisions for sales discounts and estimates for chargebacks, managed care and Medicaid rebates, product returns and DSA fees are established as a reduction of product sales revenues at the time such revenues are recognized. These revenue reductions are established by us at the time of sale, based on historical experience adjusted to reflect known changes in the factors that impact such reserves. In certain circumstances, product returns are allowed under our policy and provisions are maintained accordingly. These revenue reductions are generally reflected as an addition to accrued liabilities. Amounts received from customers as prepayments for products to be shipped in the future are reported as deferred revenue.
 
The following table summarizes the activity in the accounts related to revenue reductions:

(in millions of U.S. dollars)
 
Product
returns
   
Contract
rebates
   
Charge-
backs
   
DSA
fees
   
Discounts
and other
   
Total
 
   
$
   
$
   
$
   
$
   
$
   
$
 
Balance as at September 30, 2009
    17.2       9.8       9.0       1.0       0.7       37.7  
Provisions
    6.1       32.6       32.7       4.7       6.7       82.8  
Settlements
    (10.4 )     (30.9 )     (32.2 )     (4.6 )     (7.0 )     (85.1 )
Provisions related to the unapproved PEPs event
    23.4       -       -       -       -       23.4  
Settlements related to the unapproved PEPs event
    (4.7 )     -       -       -       -       (4.7 )
Balance as at June 30, 2010
    31.6       11.5       9.5       1.1       0.4       54.1  
 
 
Product returns
 
We do not provide any form of price protection to our wholesale customers and we generally permit product returns only if the product is returned in the six months prior to and twelve months following its expiration date. Under our policy, credit for returns is issued to the original purchaser at current wholesale acquisition cost less 10%.
 
We estimate the proportion of recorded revenue that will result in a return by considering relevant factors, including:

a)
past product returns activity;
b)
the duration of time taken for products to be returned;
c)
the estimated level of inventory in the distribution channels;
d)
product recalls and discontinuances;
e)
the shelf life of products;
f)
the launch of new drugs or new formulations; and
g)
the loss of patent protection or new competition


 
47

 

Our estimate of the level of inventory in the distribution channels is based on inventory data provided by wholesalers, third-party prescription data and, for some product return provisions, estimated retail pharmacy information.

Returns for new products are more difficult to estimate than for established products. For shipments made to support the commercial launch of a new product under standard terms, our estimate of sales return accruals are primarily based on the historical sales returns experience of similar products. Once sufficient historical data on actual returns of the product are available, the returns provision is based on this data and any other relevant factors as noted above.

The accrual estimation process for product returns involves in each case a number of interrelating assumptions, which vary for each combination of product and customer. Accordingly, it would not be meaningful to quantify the sensitivity to change for any individual assumption or uncertainty. However, we do not believe that the effect of uncertainties, as a whole, significantly impacts our financial condition or results of operations.
 
The accrued liabilities include reserves of $31.6 million as at June 30, 2010, and $17.2 million as at September 30, 2009, for estimated product returns.
 
 
As at June 30, 2010, the product return reserve was increased by $18.7 million, net of settlement of $4.7 million, due to the unapproved PEPs event, which represent the management’s estimates of the balance of ULTRASE® MT and VIOKASE® inventory in the distribution channel.  Due to the subjectivity of this estimate, we prepared various sensitivity analyses to ensure our final estimate is within a reasonable range. A change in assumptions that resulted in a 10% change in the quantity of ULTRASE® MT and VIOKASE® inventory in the distribution channel would have resulted in a change in the return reserve of approximately $2.5 million.
 
 
Rebates, Chargebacks and other sales deductions
 
 
In the United States, we establish and maintain reserves for amounts payable to managed care organizations, state Medicaid and other government programs for the reimbursement of portions of the retail price of prescriptions filled that are covered by these programs. We also establish and maintain reserves for amounts payable to wholesale distributors for the difference between their regular sale price and the contract price for the products sold to our contract customers.
 
The amounts are recognized as revenue reductions at the time of sale based on our best estimate of the product’s utilization by these managed care and state Medicaid patients and sales to our contract customers, using historical experience, the timing of payments, the level of reimbursement claims, changes in prices (both normal selling prices and statutory or negotiated prices), changes in prescription demand patterns, and the levels of inventory in the distribution channel.
 
Amounts payable to managed care organizations and state Medicaid programs are based on statutory or negotiated discounts to the selling price. Medicaid rebates generally increase as a percentage of the selling price over the life of the product. As it can take up to six months for information to reach the Company on actual usage of the Company’s products in managed care and Medicaid programs and on the total discounts to be reimbursed, the Company maintains reserves for amounts payable under these programs relating to sold products. We estimate the level of inventory in the distribution channels based on inventory data provided by wholesalers and third-party prescription data.
 
Revisions or clarification of guidelines related to state Medicaid and other government program reimbursement practices which are meant to apply to prior periods, or retrospectively, can result in changes to management’s estimates of the rebates reported in prior periods. However, since the prices of the Company’s products are fixed at the time of sale and the quantum of rebates is therefore reasonably determinable at the outset of each transaction; these factors would not impact the recording of revenues in accordance with U.S. GAAP.

The accrual estimation process for managed care organizations, state Medicaid and other government programs rebates involves in each case a number of interrelating assumptions, which vary for each combination of products and programs. Accordingly, it would not be meaningful to quantify the sensitivity to change for any individual assumption or uncertainty. However, we do not believe that the effect of uncertainties, as a whole, significantly impacts the Company’s financial condition or results of operations, including the impacts of the healthcare reform.
 
Accrued liabilities include reserves of $11.5 million and $9.5 million as at June 30, 2010, and $9.8 million and $9.0 million as at September 30, 2009, respectively, for estimated contract rebates and chargebacks.
 
 
If the levels of chargebacks, fees pursuant to DSAs, managed care, Medicaid and other government rebates, product returns and discounts fluctuate significantly and/or if our estimates do not adequately reserve for these reductions of net product revenues, our reported revenue could be negatively affected.
 

 
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Intangible Assets and Goodwill
 
Intangible assets with a finite life are amortized over their estimated useful lives according to the straight-line method over periods varying from 5 to 20 years. The straight-line method of amortization is used because it reflects, in the opinion of management, the pattern in which the intangible assets with a finite life are used. In determining the useful life of intangible assets, we consider many factors including the intention of management to support the asset on a long-term basis by maintaining the level of expenditure necessary to support the asset, the use of the asset, the existence and expiration date of a patent, the existence of a generic version of, or competitor to, the product and any legal or regulatory provisions that could limit the use of the asset.
 
The following table summarizes the changes to the carrying value of the intangible assets and goodwill from September 30, 2009, to June 30, 2010:


(in millions of U.S. dollars)
 
Intangible
assets
   
Goodwill
 
   
$
   
$
 
Balance as at September 30, 2009
    421.3       165.8  
Depreciation and amortization
    (39.6 )     -  
Impairment of intangible assets and goodwill due to the unapproved PEPs event
    (15.8 )     (91.4 )
Foreign exchange translation adjustment
    (11.1 )     (2.0 )
Balance as at June 30, 2010
    354.8       72.4  


Research and Development Expenses
 
Research and development expenses are charged to operations in the period they are incurred. The cost of intangibles that are purchased from others for a particular research and development project that have no alternative future use are expensed at the time of acquisition.
 

Income taxes
 
Income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are recognized to account for the estimated taxes that will result from the recovery or settlement of assets and liabilities recorded at their financial statement carrying amounts. Deferred income tax assets and liabilities are measured based on enacted tax rates and laws at the date of the financial statements for the years in which the temporary differences are expected to reverse. A valuation allowance is provided for the portion of deferred tax assets that is more likely than not to remain unrealized. Adjustments to the deferred income tax asset and liability balances are recognized in net income as they occur.
 
 
We conduct business in various countries throughout the world and are subject to tax in numerous jurisdictions. As a result of our business activities, we file a significant number of tax returns that are subject to examination by various federal, state, and local tax authorities. Tax examinations are often complex as tax authorities may disagree with the treatment of items reported by us and this may require several years to resolve.
 

Changes in Accounting Standards

See Note 3 to our condensed consolidated financial statements in Item 1 of Part 1 for a description of recently issued accounting standards, including our expected adoption dates and estimated effects, if any, on our results of operations, financial condition and cash flows.


 
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Item 3.
Quantitative And Qualitative Disclosure About Market Risk

For quantitative and qualitative disclosures about market risk affecting us, see “Quantitative and Qualitative Disclosure about Market Risk” in Item 7A of Part II of our Annual Report on Form 10-K for the fiscal year ended September 30, 2009, which is incorporated herein by reference. As of June 30, 2010, our exposure to market risk has not changed materially since September 30, 2009.

Item 4T.
Controls and Procedures

 
Evaluation of disclosure controls and procedures.
 
We conducted an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of June 30, 2010, the end of the period covered by this Quarterly Report on Form 10-Q. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that material information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 
Changes in internal control over financial reporting.
 
In the ordinary course of business, we routinely enhance our information systems by either upgrading our current systems or implementing new systems. During the period covered by the Quarterly Report on Form 10-Q, no change occurred in our internal controls over financial reporting during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
 
 
 
 

 
 
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PART II. OTHER INFORMATION

Item 1A.
Risk Factors

There were no material changes to the risk factors disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2009, except to the extent updated below or previously updated or to the extent additional factual information disclosed elsewhere in this Quarterly Report on Form 10-Q relates to such risk factors. In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2009, which could materially affect our business, financial condition and future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may, in the future, materially adversely affect our business, financial condition or results.

RISKS RELATED TO OUR BUSINESS

Some of our key products face competition from generic products.

Some of our key products, including products from our URSO® and CANASA® lines, currently face competition from generic or unbranded products (such as ACTIGALL™, its generics and the launched generic in the case of URSO® and other rectal dosage forms of mesalamine in the case of CANASA®). Third-party payors and pharmacists can substitute generic for our products even if physicians prescribe our products by name. Particularly in the U.S., government agencies and third-party payors often put pressure on patients to purchase generic products instead of brand-name products as a way to reduce health-care costs.

Products which are no longer protected by marketing exclusivity or patent are subject to generic competition.  For example, in a recent public filing K-V Pharmaceutical Company announced the sale of certain intellectual property and other assets related to its Abbreviated New Drug Application, submitted with the U.S. Food and Drug Administration for the approval to engage in the commercial manufacture and sale of 1gm/10mL
sucralfate suspension, the active pharmaceutical ingredient in our CARAFATE® and SULCRATE® products. We do not have any information on the status of this ANDA.

In a July 2010 posting on clinicaltrial.gov, Sandoz Inc. disclosed that it had initiated in June 2010 a clinical trial to establish therapeutic equivalence of a 1,000 mg rectal mesalamine suppository product to CANASA® rectal suppositories, in the treatment of mild to moderate ulcerative proctitis. The disclosure states that the trial is conducted in India and has an estimated duration of 18 months.

Cadila Healthcare Inc. also recently disclosed that it is going to conduct a similar clinical study in India to establish therapeutic equivalence of a 1,000 mg rectal mesalamine suppository product to CANASA®.

Generic competition against any of our products could potentially lower prices and unit sales and could therefore have a material adverse effect on our results of operations and financial condition.

RISKS RELATED TO OUR PANCREATIC ENZYME PRODUCTS (PEPs)

We have taken steps to cease distribution of ULTRASE® MT and VIOKASE® in response to regulatory requirements and will require FDA approval before resuming sales of these products.

Existing products to treat exocrine pancreatic insufficiency have been marketed in the U.S. since before the passage of the Federal Food, Drug, and Cosmetic Act, or FDCA, in 1938 and, consequently, until recently, there had been marketed PEPs that had not been approved by the FDA, including ULTRASE® MT and VIOKASE®. In 1995, the FDA issued a final rule requiring that these PEPs be marketed by prescription only, and, in April 2004, the FDA mandated that all manufacturers of exocrine pancreatic insufficiency drug products file an NDA and receive approval for their products by April 2008 or be subject to regulatory action. In October 2007, the FDA published a notice in the Federal Register extending the deadline within which to obtain marketing approval for exocrine pancreatic insufficiency drug products until April 28, 2010 for those companies that (a) were marketing unapproved pancreatic enzyme products as of April 28, 2004; (b) submitted NDAs on or before April 28, 2009; and (c) continued diligent pursuit of regulatory approval.

Because we did not receive FDA approval of the NDAs we submitted for both ULTRASE® MT and VIOKASE® by the FDA’s April 28, 2010 deadline, we ceased distribution of both these products, effective April 28, 2010.  We reported net sales of $75.9 million, $58.6 million and $47.5 million for ULTRASE® MT in fiscal 2009, 2008, and 2007, respectively, and $37.6 million for the nine-month period ended June 30, 2010. We reported net sales of $22.7 million, $15.1 million and $11.2 million for VIOKASE® in fiscal 2009, 2008, and 2007, respectively, and $15.4 million for the nine-month period ended June 30, 2010.  Total nine-month net sales for these two products, which amounted to $53.0 million, are net of the additional reserve of $23.4 million taken due to the effect of the unapproved PEPs event. We expect our revenue and cash generated by operations to be adversely affected by our ceasing distribution of these products.

On May 5th, 2010, the FDA issued an additional complete response letter with respect to our NDA for ULTRASE® MT for the treatment of exocrine pancreatic insufficiency.  This letter requires that deficiencies raised with respect to the manufacturing and control processes at the manufacturer of the active ingredient of ULTRASE® MT be addressed before approval can be granted.  We responded to this complete response letter and on June 11, 2010, the FDA accepted our filing and confirmed a November 28, 2010 Prescription Drug User Fee Act, or PDUFA, date for our ULTRASE® MT NDA.

 
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The submission of our rolling NDA for VIOKASE® was completed in the first quarter of fiscal 2010 and the PDUFA date for our NDA for VIOKASE® was August 30, 2010. We have recently received feedback from the FDA regarding the timeline to review the VIOKASE® NDA. The FDA has indicated that the review is progressing and has postponed the PDUFA date to November 30, 2010.  We use the same manufacturer of active pharmaceutical ingredient as ULTRASE® MT for VIOKASE®. Our revenues and results of operations will be adversely affected unless we are able to receive regulatory approval to market these two products, and we cannot provide any assurances as to the receipt of this regulatory approval or the timing of such approval.  In addition, delays in receiving regulatory approval will likely permit our competitors to gain market share in patients using these products, and we expect to face increased competition with respect to these products in the event we receive approval. As reported by a widely accepted provider of information services specializing in medical research information, subsequent to ceasing distribution of ULTRASE® MT and VIOKASE® in the U.S., market shares declined 41% and 52% respectively (June 2010 data).


 
 
 
 
 
 
 
 
 
 

 

 
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Item 6.    Exhibits.
   
Exhibit No.
Exhibit
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
 
 
 
 
 
 
 

 
 
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SIGNATURES

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

 
AXCAN INTERMEDIATE HOLDINGS INC.

Date:  August 11, 2010
BY:
/s/ Steve Gannon
   
Steve Gannon
   
Senior Vice President, Finance, Chief Financial Officer and Treasurer




 
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EXHIBIT INDEX

Exhibit No.
Exhibit
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



 
 
 
 

 
 

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