UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

o		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 333-153896

APTALIS PHARMA 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)

AXCAN INTERMEDIATE HOLDINGS INC.
(Registrant’s Former Name)

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 o No o 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 o No o (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.

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

Yes o No o

As of May 13, 2011, there were 100 shares of common stock of the registrant outstanding, all of which were owned by Aptalis MidHoldings Inc.

 

 

APTALIS PHARMA 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			36
Item 3 Quantitative And Qualitative Disclosure About Market Risk			60
Item 4T Controls and Procedures			60
PART II. OTHER INFORMATION			61
Item 1A Risk Factors			61
Item 5 Other Information			61
Item 6 Exhibits			61
SIGNATURES			62
EXHIBIT INDEX			63
EX-3.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

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.

PART I. FINANCIAL INFORMATION

Item 1		Financial Statements

APTALIS PHARMA INC.
Condensed Consolidated Balance Sheets
(in thousands of U.S. dollars, except share related data)

		March 31,				September 30,
		2011				2010
		(unaudited)				(audited)
		$				$
Assets
Current assets
Cash and cash equivalents			87,330				161,503
Accounts receivable, net			75,717				32,379
Accounts receivable from the parent company (Note 18)			526				487
Income taxes receivable			3,672				2,906
Inventories, net (Note 7)			63,450				23,866
Prepaid expenses and deposits			5,620				3,277
Deferred income taxes, net (Note 13)			6,107				2,331
Total current assets			242,422				226,749
Property, plant and equipment, net (Note 8)			90,268				35,777
Intangible assets, net (Note 9)			731,013				347,962
Goodwill, net (Note 9)			181,718				73,540
Deferred debt issue expenses, net of accumulated amortization of $5,236 ($14,136 as at September 30, 2010) (Note 11)			32,236				20,443
Deferred income taxes, net (Note 13)			14,406				8,706
Total assets			1,292,063				713,177
Liabilities
Current liabilities
Accounts payable and accrued liabilities			131,762				94,673
Income taxes payable (Note 13)			3,275				3,446
Installments on long-term debt (Note 11)			8,918				13,163
Deferred income taxes (Note 13)			620				47
Total current liabilities			144,575				111,329
Long-term debt (Note 11)			972,170				581,312
Other long-term liabilities			11,252				10,028
Employees severance indemnities (Note 12)			5,080				—
Deferred income taxes (Note 13)			95,501				31,540
Total liabilities			1,228,578				734,209
Shareholders’ Equity (Deficiency)
Capital Stock (Note 14)
Common shares, par value $0.001; 100 shares authorized: 100 issued and outstanding as at March 31, 2011, and September 30, 2010			1				1
Deficit			(538,400	)			(468,152	)
9.05% Note receivable from the parent company (Note 18)			(133,154	)			(133,154	)
Additional paid-in capital			757,689				614,113
Accumulated other comprehensive loss			(22,651	)			(33,840	)
Total shareholders’ equity (deficiency)			63,485				(21,032	)
Total liabilities and shareholders’ equity (deficiency)			1,292,063				713,177

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

APTALIS PHARMA INC.
Condensed Consolidated Statements of Operations
(in thousands of U.S. dollars)
(unaudited)

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Net product sales			109,774				94,365				195,712				204,497
Development fees			599				—				599				—
Royalties			987				—				987				—
Total revenue			111,360				94,365				197,298				204,497
Cost of goods sold (a)			31,853				68,150				49,276				94,778
Selling and administrative expenses (a) (Note 12)			39,044				28,406				64,215				60,645
Management fees (Note 18)			730				1,000				1,568				1,855
Research and development expenses (a)			10,983				7,683				17,938				16,109
Other research and development expenses attributable to development fees (a)			855				—				855				—
Depreciation and amortization			18,453				13,999				32,026				30,692
Loss on disposal of product line (Note 6)			7,365				—				7,365				—
Transaction, restructuring and integration costs (Notes 4 and 5)			19,249				—				22,297				—
Impairment of intangible assets and goodwill (Note 9)			—				107,158				—				107,158
Total operating expenses			128,532				226,396				195,540				311,237
Operating income (loss)			(17,172	)			(132,031	)			1,758				(106,740	)
Financial expenses (Note 12)			30,145				16,385				46,374				32,582
Loss on extinguishment of debt (Note 11)			28,311				—				28,311				—
Interest income			(123	)			(159	)			(315	)			(307	)
Other income			—				(7,700	)			—				(7,700	)
Loss on foreign currencies			633				1,408				876				1,393
Total other expenses			58,966				9,934				75,246				25,968
Loss before income taxes			(76,138	)			(141,965	)			(73,488	)			(132,708	)
Income taxes expense (benefit) (Note 13)			(4,469	)			21,795				(3,265	)			21,606
Net loss			(71,669	)			(163,760	)			(70,223	)			(154,314	)

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.

APTALIS PHARMA INC.
Condensed Consolidated Shareholders’ Equity (Deficiency) and Comprehensive Income (Loss)
(in thousands of U.S. dollars, except share related data)
(unaudited)

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
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			(466,706	)			(288,340	)			(468,152	)			(297,658	)
Dividends paid			(25	)			—				(25	)			(128	)
Net loss			(71,669	)			(163,760	)			(70,223	)			(154,314	)
Balance, end of period			(538,400	)			(452,100	)			(538,400	)			(452,100	)
Additional paid-in capital
Balance, beginning of period			613,492				619,195				614,113				619,053
Capital contribution			140,000				—				140,000				—
Stock-based compensation expense (recovery)			5,272				(2,367	)			5,763				(891	)
Stock-based compensation plan redemptions			(35	)			(57	)			(84	)			(328	)
Provision on interest receivable from the parent company			(2,971	)			(2,971	)			(6,008	)			(6,008	)
Interest income from the parent company, net of taxes of ($1,040, $1,040 $2,103, $2,103)			1,931				1,931				3,905				3,905
Balance, end of period			757,689				615,731				757,689				615,731
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			(35,869	)			(27,308	)			(33,840	)			(24,478	)
Hedging contracts fair value adjustments, net of taxes of (nil, ($38), nil, $4)			—				71				—				(7	)
Foreign currency translation adjustments			13,218				(7,371	)			11,189				(10,123	)
Balance, end of period			(22,651	)			(34,608	)			(22,651	)			(34,608	)
Total shareholders’ equity (deficiency)			63,485				(4,130	)			63,485				(4,130	)
Comprehensive income (loss)
Other comprehensive income (loss)			13,218				(7,300	)			11,189				(10,130	)
Net loss			(71,669	)			(163,760	)			(70,223	)			(154,314	)
Total comprehensive loss			(58,451	)			(171,060	)			(59,034	)			(164,444	)
Accumulated other comprehensive loss
Amounts related to foreign currency translation adjustments			(22,651	)			(34,608	)			(22,651	)			(34,608	)
Amounts related to hedging contracts fair value adjustments			—				—				—				—
Accumulated other comprehensive loss			(22,651	)			(34,608	)			(22,651	)			(34,608	)

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.

APTALIS PHARMA INC.
Condensed Consolidated Cash Flows
(in thousands of U.S. dollars)
(unaudited)

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Cash flows from operating activities
Net loss			(71,669	)			(163,760	)			(70,223	)			(154,314	)
Adjustments to reconcile net income to cash flows from operating activities
Non-cash financial expenses			15,281				1,746				17,035				3,508
Inventory stepped-up value expensed			4,382				—				4,382				—
Depreciation and amortization			18,453				13,999				32,026				30,692
Stock-based compensation expense (recovery)			5,272				(2,367	)			5,763				(891	)
Loss on disposal of product line and write-down of assets			7,365				56				7,395				81
Impairment of intangible assets and goodwill (Note 9)			—				107,158				—				107,158
Non-cash loss (gain) on foreign exchange			(733	)			522				(694	)			43
Change in fair value of derivatives			—				(105	)			—				(621	)
Deferred income taxes			(5,633	)			20,436				(7,234	)			19,066
Other non-cash adjustments related to unapproved PEPs (Note 2)			(3,706	)			53,407				(3,706	)			53,407
Changes in working capital items
Accounts receivable			(3,508	)			17,661				(16,116	)			2,760
Accounts receivable from the parent company			(1	)			(74	)			(39	)			(74	)
Income taxes receivable			3,824				(63	)			1,887				1,671
Inventories			2,978				(3,065	)			4,105				(7,933	)
Prepaid expenses and deposits			1,011				466				1,579				202
Accounts payable and accrued liabilities			(14,595	)			(15,822	)			(16,509	)			4,292
Income taxes payable			(3,639	)			910				(873	)			572
Net cash provided by (used in) operating activities			(44,918	)			31,105				(41,222	)			59,619
Cash flows from investing activities
Acquisition, net of cash acquired (Note 4)			(525,667	)			—				(525,667	)			—
Disposal of intangible assets			500				—				500				—
Acquisition of property, plant and equipment			(2,371	)			(2,333	)			(3,506	)			(3,462	)
Net cash used in investing activities			(527,538	)			(2,333	)			(528,673	)			(3,462	)
Cash flows from financing activities
Issuance of long-term debt			746,250				—				746,250				—
Repayment of long-term debt			(355,887	)			—				(369,050	)			(20,865	)
Deferred debt issue expenses			(22,963	)			—				(22,963	)			—
Stock-based compensation plan redemptions			(35	)			(57	)			(84	)			(328	)
Capital contribution			140,000				—				140,000				—
Dividends paid			(25	)			—				(25	)			(128	)
Net cash provided by (used in) financing activities			507,340				(57	)			494,128				(21,321	)
Foreign exchange loss (gain) on cash held in foreign currencies			1,710				(692	)			1,594				(857	)
Net increase (decrease) in cash and cash equivalents			(63,406	)			28,023				(74,173	)			33,979
Cash and cash equivalents, beginning of period			150,736				132,391				161,503				126,435
Cash and cash equivalents, end of period			87,330				160,414				87,330				160,414

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.

APTALIS PHARMA 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

On May 4, 2011, Axcan Intermediate Holdings Inc announced that it has changed its name to Aptalis Pharma 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 on February 25, 2008, of all of the outstanding common shares of Axcan Pharma Inc. at a price of $23.35 per share (“the Acquisition”), a company incorporated under the Canada Business Corporation Act. The Company provides innovative, effective therapies for unmet medical needs including cystic fibrosis and gastrointestinal disorders. The Company has manufacturing and commercial operations in the United States, the European Union and Canada. The Company also formulates and clinically develops, enhanced pharmaceutical and biopharmaceutical products for itself and others using its proprietary technology platforms including bioavailability enhancement of poorly soluble drugs, custom release profiles, and taste-masking/orally disintegration tablet (ODT) formulations.

On February 11, 2011, the Company completed the acquisition of Eurand N.V. (“Eurand”) through a wholly owned indirect subsidiary pursuant to a Share Purchase Agreement dated November 30, 2010 (as amended) resulting in Eurand becoming an indirect subsidiary of the Company. Eurand is a specialty pharmaceutical company that is engaged in the development, manufacturing and commercialization of enhanced pharmaceutical and biopharmaceutical products based on its proprietary pharmaceutical technologies.

As described in Note 4, the Eurand transaction has been accounted for in accordance with the acquisition method of accounting for business combinations. Accordingly, the Company’s condensed consolidated financial statements reflect the assets, liabilities and results of operations of Eurand from the date of acquisition.

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, 2010. 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 Management’s 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, 2010.

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.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

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 three years ended September 30, 2009. Prior to April 28, 2010, products that were marketed in the U.S. to treat exocrine pancreatic insufficiency had been available before the passage of the Federal Food, Drug, and Cosmetic Act, or FDCA, in 1938 and, consequently, there were marketed PEPs that had 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 at April 28, 2004; (b) submitted NDAs on or before April 28, 2009; and (c) that continue diligent pursuit of regulatory approval. The FDA has 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 were still 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 even after the April 28, 2010 deadline has passed, if they meet the required safety, effectiveness and product quality standards. The Company completed the submission for ULTRASE MT in the fourth quarter of fiscal year 2008. The submission of the Company’s rolling NDA for VIOKASE was completed in the first quarter of fiscal year 2010.

ULTRASE MT 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. The Company recorded an additional $23,453,000 sales deductions reserve in its fiscal year ended September 30, 2010. This reserve is for product returns and other sales deductions as an estimate of Company’s liability for ULTRASE MT and VIOKASE that may be returned by the original purchaser under the Company DSAs or applicable return policies. The cease distribution order issued by the FDA was not considered as a product recall. As at March 31, 2011, the remaining reserve was $5,293,000 and was 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. In future periods, the Company will monitor and review the estimates and will prospectively record changes to the reserve.

On November 28, 2010, the FDA issued complete response letters regarding the NDAs for ULTRASE MT and VIOKASE. The letters require that unresolved deficiencies raised with respect to the manufacturing and control processes at the manufacturer of the active ingredient for both ULTRASE MT and VIOKASE be addressed before approval can be granted. The letters also require that deficiencies identified in an FDA inspection of such manufacturer must be resolved before the NDAs can be approved. The Company is in ongoing discussions with the FDA and continues to work with the manufacturer of the active pharmaceutical ingredient to address the remaining open issues identified by the FDA, as soon as possible.

3. Recently Issued Accounting Standards

In December 2010, the FASB amended guidance on disclosure of supplementary pro forma information for business combinations and clarifies that when presenting comparative financial statements, a public entity should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The amendment also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance is effective prospectively for business combinations entered into in fiscal years beginning on or after December 15, 2010, with early adoption permitted. The Company will apply this guidance for future acquisitions on its condensed consolidated financial statements.

In December 2010, the FASB issued guidance that modifies the Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if qualitative factors indicate that it is more likely than not that a goodwill impairment exists. This guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company is currently evaluating the impact of the adoption of this guidance on its condensed consolidated financial statements.

In December 2010, the FASB issued guidance that clarified the recognition and classification of annual fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act in the income statements of pharmaceutical manufacturers. The guidance requires that the liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable. The annual fee shall be presented as an operating expense. This guidance is effective for calendar years beginning after December 31, 2010, when the fee initially becomes effective. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

APTALIS PHARMA 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 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 did not 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 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 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 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.

4. Acquisition of Eurand N.V. (“Eurand”)

Description of the transaction

On February 11, 2011 or the Acquisition Date, Axcan Holdings Inc. (“Axcan Holdings”), the Company’s indirect parent, and Axcan Pharma Holding B.V. (“Axcan AcquisitionCo”), an indirect subsidiary of the Company, pursuant to a Share Purchase Agreement dated November 30, 2010 (as amended) acquired 95.6% (99.1% after giving effect to the additional shares that are guaranteed to be delivered under a notice of guaranteed delivery) of the outstanding shares of Eurand N.V. (“Eurand”) for a purchase price of $12.00 per share in cash resulting in total consideration of approximately $589,555,000 for 100% of such shares. The Company acquired 100% of the outstanding shares of Eurand by March 31, 2011. As a result of the acquisition, Eurand has become an indirect subsidiary. In addition, Axcan AcquisitionCo and other direct and indirect subsidiaries of the Company acquired from Eurand substantially all of Eurand’s assets, including the capital stock of Eurand’s direct and indirect U.S. and foreign subsidiaries, and transferred the capital stock of former Eurand U.S. subsidiaries to the Company.

Prior to the transaction, Eurand was a specialty pharmaceutical company that developed, manufactured and commercialized enhanced pharmaceutical and biopharmaceutical products based on its proprietary pharmaceutical technologies. Eurand has had six products approved by the FDA since 2001 and had a pipeline of product candidates in development for itself and its collaboration partners. Its technology platforms include bioavailability enhancement of poorly soluble drugs, custom release profiles and taste-masking/orally disintegrating tablet (ODT) formulations. Eurand was a global company with facilities in the U.S. and Europe. The acquisition of Eurand will enable the Company to leverage the combination of two leading specialty pharmaceutical players, expand its gastroenterology product portfolio and provide the Company with a proprietary R&D growth engine and technology platforms supported by an extensive patent portfolio to meaningfully diversify its business and expand its geographic and manufacturing footprint.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements (amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

Fair value of consideration transferred

The table below details the consideration transferred to acquire Eurand:

Conversion

Form of

Calculation

Fair Value

Consideration

$

Eurand common stock outstanding as of acquisition date

48,359,433

580,313

Cash

Mutiplied by cash consideration per common share outstanding

12.00

Eurand stock options canceled for a cash payment(a)

9,242

Cash

Total fair value of consideration transferred

589,555

(a)		Each Eurand stock option, whether or not vested and exercisable on the acquisition date, was canceled for a cash payment equal to the excess of the per share value of the acquisition consideration over the per share exercise price of the Eurand stock option.

The aggregate equity purchase price of $589,555,000 plus acquisition costs (including related fees and expenses) were funded by cash equity contributions amounting to $140,000,000 from affiliates of TPG Capital L.P. and certain co-investors made through Aptalis Holdings Inc., the proceeds from the Senior Secured Term Loan Facility (as defined below) under the Company’s amended and restated credit agreement and related security and other agreements and cash on hand from the Company and Eurand.

The amended and restated credit agreement and related security and other agreements is composed of (i) a senior secured revolving credit facility in an aggregate principal amount of $147,000,000 (the “Senior Secured Revolving Credit Facility”) and (ii) a $750,000,000 senior secured term loan facility (the “Senior Secured Term Loan Facility” and, together with the Senior Secured Revolving Credit Facility, collectively, the “Amended and Restated Senior Secured Credit Facilities”). The Senior Secured Revolving Credit Facility is comprised of $115,000,000 of existing revolving credit commitments that were extended or issued on February 11, 2011, (the “ Extended Commitments “) and $32,000,000 of existing revolving credit commitments that were not extended (the “ Unextended Commitments”) pursuant to the Senior Secured Revolving Credit Facility.

The Company borrowed $500,000,000 of the amount available under the Senior Secured Term Loan Facility at the closing of the acquisition. The Senior Secured Revolving Credit Facility remained undrawn at the closing of the acquisition. A portion of the proceeds of the equity and debt financings, together with cash on hand of the Company and Eurand, were also used to repay the outstanding term loan portion amounting to $125,660,000 of the Company’s existing senior secured credit facilities and to pay related fees and expenses. The remaining amount of $250,000,000 of the Senior Secured Term Loan Facility was used on March 15, 2011 to redeem 100% of the Company’s existing 9.25% senior secured notes due 2015.

Basis of presentation

The transaction has been accounted for in accordance with the acquisition method of accounting for business combinations under existing U.S. generally accepted accounting principles (“GAAP”). The acquisition method of accounting requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date including acquired in-process research and development assets.

Assets acquired and liabilities assumed

A preliminary purchase price allocation has been made and the recorded amounts are subject to change. The following recognized amounts are provisional and subject to change:

•

Amounts and useful lives for identifiable intangible assets and property, plant and equipment, pending the finalization of valuation efforts;

•

Amounts for income tax assets and liabilities, pending finalization of estimates and assumptions in respect of certain tax aspects of the transaction, revision to fair value of acquired assets and liabilities, and the filing of Eurand’s pre-acquisition tax returns; and

•

The allocation of goodwill among reporting units.

The Company will finalize the purchase price allocation as it obtains the information necessary to complete the measurement process. Any changes resulting from facts and circumstances that existed as of the acquisition date may result in retrospective adjustments to the provisional amounts recognized at the acquisition date. The Company expects to finalize the purchase price allocation no later than one year from the acquisition date.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements

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

Resulting from the preliminary purchase price allocation, the following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date.

										Amounts
						Step-up to				recognized as of
		Book value				fair value				acquisition date
		$				$				$
Cash and cash equivalents			63,888				—				63,888
Accounts receivable (a)			22,662				—				22,662
Inventories (b)			25,465				18,727				44,192
Other current assets (c)			6,552				—				6,552
Property, plant and equipment (d)			44,652				10,874				55,526
Identifiable intangible assets (d)			7,053				406,876				413,929
Current liabilities (e)			(51,960	)			—				(51,960	)
Long-term debt, including current portion			(3,394	)			—				(3,394	)
Deferred income taxes liabilities, net (f)			(237	)			(61,012	)			(61,249	)
Other non-current liabilities			(8,489	)			2,278				(6,211	)
Total identifiable net asssets			106,192				377,743				483,935
Goodwill (g)			37,540				68,977				106,517
Net assets acquired			143,732				446,720				590,452
Effective settlement of pre-existing relationships (h)			(897	)			—				(897	)
Total fair value of consideration transferred											589,555

(a)		As of acquisition date, the fair value of accounts receivable acquired approximated book value. The gross contractual amount receivable was $23,118,000 of which $456,000 was not expected to be collected.
(b)		Reflects the adjustment to step-up the carrying value of inventory acquired by $18,727,000 to estimated fair value as of February 11, 2011. The stepped-up value is recorded as a charge to cost of goods sold as acquired inventory is sold.
(c)		Includes prepaid assets and income tax receivable.
(d)		The amounts recorded for the major components of acquired identifiable intangible assets are as follows:

		Amounts				Weighted
		recognized as of				average useful
		acquisition date				lives (years)
		$
Trademarks, trademark licenses, manufacturing rights and other intangible assets with a finite life			413,929				17.04
Total identifiable intangible assets			413,929				17.04

		In addition, the estimated aggregate amortization expense for the five succeeding years will be $25,599,000 annually.
(e)		Includes accounts payable, accrued liabilities and income taxes payable.
(f)		Comprises of current deferred tax assets $823,000, non current deferred tax assets $15,703,000, current deferred tax liabilities $3,000 and non current deferred tax liabilities $77,772,000.
(g)		The excess of purchase price over the fair value amounts assigned to the assets acquired and liabilities assumed represents the goodwill amount resulting from the acquisition. The goodwill recorded as part of the acquisition is largely attributable to synergies expected to result from combining the operations of Eurand and the Company and intangible assets that do not qualify for separate recognition. The Company does not expect any portion of this goodwill to be deductible for tax purposes. The allocation of goodwill among reporting units is not complete, pending finalization of the Company’s internal reporting structure and composition of its post-acquisition operating segments and reporting units.
(h)		The Company had entered into an exclusive development license and supply agreement with Eurand. No gain or loss was recognized in conjunction with the effective settlement of the contractual relationship between the Company and Eurand as a result of this acquisition.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements (amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

Transaction related costs

During the six-month period ended March 31, 2011, the Company has expensed $11,292,000 (an additional $1,070,000 was expensed in the fiscal year ended September 30, 2010) of costs relating to legal, financial, valuation and accounting advisory services performed in connection with effecting the transaction with Eurand, which are included in transaction and restructuring costs in the accompanying Statement of Condensed Interim Consolidated Operations.

Actual and proforma information

The revenues derived from the Eurand entities for the period from the Acquisition Date to March 31, 2011 were $25,752,000 and loss before income taxes was $670,000, excluding the effects of the non-recurring acquisition accounting adjustments described above.

The following table presents unaudited pro forma consolidated results of operations as if the acquisition of Eurand had occurred as of October 1, 2009:

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Total revenue			131,530				123,478				261,397				261,358
Loss before income taxes			(27,059	)			(108,865	)			(27,459	)			(117,070	)
Net loss			(24,914	)			(130,002	)			(26,433	)			(134,781	)

The pro forma consolidated results of operations were prepared using the acquisition method of accounting and are based on the historical financial information of the Company and Eurand. The pro forma information does not reflect any synergies and other benefits that the Company may achieve as a result of the acquisition, or the costs necessary to achieve these synergies. In addition, the pro forma information does not reflect the costs to integrate the operations of the Company and Eurand.

The pro forma information is not necessarily indicative of what the Company’s consolidated results of operations actually would have been had the transaction been completed on October 1, 2009. In addition, the pro forma information does not purport to project the future results of operations of the Company. The pro forma information reflects primarily the following pro forma adjustments:

•		elimination of product sales and royalties between Eurand and the Company, an elimination of the Company’s cost of sales for Eurand-sourced inventories, and the elimination of certain PEP-related charges stemming from intercompany transactions;
•		elimination of Eurand’s historical intangible asset amortization expense;
•		additional amortization expense related to the fair value of identifiable intangible assets acquired;
•		additional depreciation expense related to the fair value adjustment to property, plant and equipment acquired;
•		elimination of interest expense and amortization of deferred financing costs related to the Company’s term loan under the legacy senior secured credit facilities and 9.25% senior secured notes due 2015 that were repaid as part of the acquisition transaction;
•		additional interest expense and amortization of deferred financing costs associated with financing obtained under the Amended and Restated Senior Secured Credit Facilities obtained by the Company in connection with the acquisition transaction;
•		reduction of interest income associated with cash and cash equivalents that were used to partially fund the acquisition;
•		elimination of acquisition-related costs and acquisition-related restructuring charges;
•		elimination of $4,382,000 of the acquisition accounting adjustment on Eurand’s inventory that was sold subsequent to the Aquisition Date, which will not have a continuing impact on the Company’s operations.

The pro forma effective tax rate differs from the statutory rate due to the relatively large impact of actual permanent differences on relatively small pro forma income before tax, valuation allowances on deferred tax assets in certain jurisdictions, and the expected impact of foreign withholding taxes upon repatriation of foreign earnings.

APTALIS PHARMA 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. Restructuring and Integration

Acquisition related cost-rationalization and integration initiatives

The Company has initiated restructuring measures in conjunction with the integration of the operations of Eurand. These measures are intended to capture synergies and generate cost savings across the Company.

Restructuring actions taken thus far include workforce reductions across the Company and other organizational changes. These reductions primarily come from the elimination of redundancies and consolidation of staff in the sales and marketing, manufacturing, research and development, and general and administrative functions, as well as from the planned closure of Eurand’s manufacturing facility in Nogent-Oise, France.

During the quarter ended March 31, 2011, the Company recorded a restructuring expense in the amount of $5,025,000 related to planned employee termination costs. Employee termination costs are generally recorded when the actions are probable and estimable and include accrued severance benefits and health insurance continuation, many of which may be paid out during periods after termination.

The following table summarizes restructuring liability activity related to the Eurand acquisition during the quarter ended March 31, 2011:

		Liability								Balance
		Established				Payments				March 31,2011
		$				$				$
Severance and related benefits			5,025				(132	)			4,893

The Company estimates to incur additional costs between $17,172,000 and $21,346,000 in connection with planned employee termination costs. The restructuring actions taken thus far are expected to be substantially completed by the end of 2012.

Through March 31, 2011, the Company has incurred integration costs of $5,980,000 representing certain external, incremental costs directly related to integrating the acquired business and primarily include expenditures for consulting and systems integration. Restucturing and integration costs are included in transaction and restructuring costs in the accompanying Statement of Condensed Consolidated Operations.

6. Disposal of the PHOTOFRIN/PHOTOBARR Product Line

On March 28, 2011, The Company entered into a definitive agreement with Pinnacle Biologics, Inc., which acquired all global assets and rights related to PHOTOFRIN/PHOTOBARR, including inventory, for non-contingent payments amounting to $4,252,000. In addition to the non-contingent payments, additional payments shall be made to the Company after the achievement of certain milestones events. In addition, the Company will be paid royalties on annual net sales of PHOTOFRIN/PHOTOBARR.

During the quarter ended March 31, 2011, The Company recorded a loss of $7,365,000 as a result of the disposal of the PHOTOFRIN/PHOTOBARR product line. Consideration for additional contingent payments to be made to the Company shall be recorded as a gain in the period in which they are received.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements (amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

7. Inventories

		March 31,				September 30,
		2011				2010
		$				$
Raw material and packaging material, net of reserve for obsolescence of $2,498 (nil as at September 30, 2010)			18,065				10,316
Work in progress, net of reserve for obsolescence of $927 (nil as at September 30, 2010)			6,896				595
Finished goods, net of reserve for obsolescence of $1,122 ($758 as at September 30, 2010)			38,489				12,955
			63,450				23,866

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, a charge of $44,883,000 was recorded during the fiscal year ended September 30, 2010, to cost of goods sold to reduce inventories to their net realizable value and for estimated loss for purchase and other materials and supply commitments related to ULTRASE MT and VIOKASE products.

Include the adjustment to step-up the carrying value of inventory acquired by $18,727,000 to estimated fair value as of February 11, 2011, less a charge to cost of goods sold as acquired inventory is sold amounting to $4,382,000.

8. Property, Plant and Equipment

		March 31, 2011
						Accumulated
		Cost				depreciation				Net
		$				$				$
Land			4,865				—				4,865
Buildings			46,542				5,580				40,962
Furniture and equipment			37,303				5,206				32,097
Automotive equipment			30				1				29
Computer equipment and software			24,016				12,322				11,694
Leasehold and building improvements			1,190				569				621
			113,946				23,678				90,268

		September 30, 2010
						Accumulated
		Cost				depreciation				Net
		$				$				$
Land			2,240				—				2,240
Buildings			23,252				4,490				18,762
Furniture and equipment			8,534				3,515				5,019
Computer equipment and software			18,419				9,588				8,831
Leasehold and building improvements			1,220				295				925
			53,665				17,888				35,777

APTALIS PHARMA 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. Goodwill and Intangible Assets

The following table reflects the changes in carrying amount of goodwill from September 30, 2010 to March 31, 2011:

		March 31,				September 30,
		2011				2010
		$				$
Balance, beginning of period			73,540				165,823
Acquisition of Eurand			106,517				—
Impairment			—				(91,400	)
Foreign exchange			1,661				(883	)
Balance, end of period			181,718				73,540

As disclosed in Note 4, the amount recorded as goodwill for the acquisition of Eurand is provisional and subject to the completion of the allocation of the consideration transferred to the assets acquired and liabilities assumed.

The following table reflects the changes in the carrying amount of intangible assets:

Trademarks, trademark licenses, manufacturing rights and other intangible assets with a finite life

		March 31, 2011
						Accumulated
		Cost				amortization				Net
		$				$				$
Balance, as at September 30, 2010			459,207				111,245				347,962
Acquisition of Eurand			413,929				—				413,929
Assets written-off on disposal of Photofrin/Photobarr			(11,749	)			(1,503	)			(10,246	)
Amortization			—				26,335				(26,335	)
Foreign exchange			6,483				780				5,703
Balance, as at March 31, 2011			867,870				136,857				731,013

		September 30, 2010
						Accumulated
		Cost				amortization				Net
		$				$				$
Balance, as at September 30, 2009			491,411				70,121				421,290
Impairment			(26,400	)			(10,642	)			(15,758	)
Amortization			—				52,465				(52,465	)
Foreign exchange			(5,804	)			(699	)			(5,105	)
Balance, as at September 30, 2010			459,207				111,245				347,962

APTALIS PHARMA INC.
Notes to Consolidated Financial Statements (amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

10. Segment Information

Prior to the acquisition of Eurand, the Company operated in one segment, pharmaceutical products. Effective with the acquisition of Eurand, the Management of the Company is reassessing the Company’s internal reporting structure and composition of its operating segments for disclosure in succeeding interim and annual reporting periods.

The Company operates in the following geographic areas:

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Total revenue
United States
Domestic sales			80,078				68,371				138,027				152,147
Foreign sales			2,292				1,243				2,562				2,621
Canada
Domestic sales			8,099				7,862				18,145				16,729
Foreign sales			225				—				361				—
European Union
Domestic sales			16,430				14,691				31,280				28,715
Foreign sales			4,236				2,080				6,923				3,920
Other			—				118				—				365
			111,360				94,365				197,298				204,497

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

		March 31,				September 30,
		2011				2010
		$				$
Property, plant, equipment and intangible assets
Canada			270,669				299,180
United States			52,867				13,906
European Union			497,745				70,653
			821,281				383,739

		March 31,				September 30,
		2011				2010
		$				$
Goodwill
Canada			61,887				61,887
United States			20,931				—
European Union			98,900				11,653
			181,718				73,540

APTALIS PHARMA INC.
Notes to Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

11. Long-term Debt

		March 31,				September 30,
		2011				2010
		$				$
Senior secured term loan of $748,125 as at March 31, 2011, ($0 as at September 30, 2010), bearing interest at a rate per annum equal to an applicable margin plus, at the Company’s option, either (1) a base rate determined by reference to the highest of (a) the prime rate of Banc of America Securities LLC, (b) the federal funds effective rate plus 1/2 of 1.00% and (c) the one-month LIBOR rate plus 1.00% or (2) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs. The applicable margins for borrowings under the Senior Secured Term Loan Facility are 3.00% with respect to base rate borrowings and 4.00% with respect to LIBOR borrowings. In addition, the LIBOR rate and base rate for borrowings under the Senior Secured Term Loan Facility are subject to a floor of 150 basis points and 250 basis points, respectively, secured by substantially all of the present and future assets of the Company, payable in quarterly installments, maturing in February 2017			744,626				—
Term loans of $0 as at March 31, 2011, ($138,823 as at September 30, 2010), bearing interest at the one-month British Banker Association LIBOR (0.26% as at September 30, 2010), 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			—				135,210
Unsecured loan of 2,252 Euros as at March 31, 2011, with a variable interest of 1.6% above Euribor. Euribor interest rate has a cap of 2.5%			3,194				—
Senior unsecured notes, bearing interest at 12.75% and maturing in March 2016			233,268				233,094
Senior notes bearing interest at 9.25%, redeemed on March 15, 2011			—				226,171
			981,088				594,475
Installments due within one year			8,918				13,163
			972,170				581,312

On February 11, 2011, the Company entered into an amended and restated credit agreement and related security and other agreements in connection with the Eurand Acquisition.

The amended and restated credit agreement and related security and other agreements is composed of (i) a senior secured revolving credit facility in an aggregate principal amount of $147,000,000 (the “Senior Secured Revolving Credit Facility”) and (ii) a $750,000,000 senior secured term loan facility (the “Senior Secured Term Loan Facility” and, together with the Senior Secured Revolving Credit Facility, collectively, the “Amended and Restated Senior Secured Credit Facilities”).

The Company borrowed $500,000,000 of the amount available under the Senior Secured Term Loan Facility at the closing of the acquisition. The Senior Secured Revolving Credit Facility remained undrawn at the closing of the acquisition. A portion of the proceeds of the equity and debt financings, together with cash on hand of the Company and Eurand, were used to repay the outstanding term loan portion amounting to $125,660,000 of the Company’s existing senior secured credit facilities. Following the repayment, all unamortized deferred financing fees of $2,653,000 and original issuance discount of $3,188,000 related to the term loan were written off and are included in loss on extinguishment of debt in the accompanying Statement of Condensed Consolidated Operations.

On February 25, 2008, the Company issued $228,000,000 aggregate principal amount of its 9.25% senior secured notes (the “Senior Secured Notes”) due March 1, 2015. The Senior Secured Notes were priced at $0.98737 with a 10% yield to March 1, 2015. On March 15, 2011, $250,000,000 of the Senior Secured Term Loan Facility was drawn to redeem the Company’s Senior Secured Notes at a redemption price of 106.938%. The aggregate redemption amount consisted of $228,000,000 in aggregate principal amount, and $15,819,000 of redemption premium which is included in loss on extinguishment or debt in the accompanying Statement of Condensed Consolidated Operations. Following the redemption all unamortized deferred financing fees of $4,992,000 and original issuance discount of $1,659,000 related to these notes were written off and are included in loss on extinguishment of debt in the accompanying Statement of Condensed Consolidated Operations.

APTALIS PHARMA INC.
Notes to Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

The Company’s Amended and Restated Senior Secured Credit Facilities totaling $897,000,000 is composed of a Senior Secured Term Loan Facility amounting to $750,000,000 and a Senior Secured Revolving Credit Facility totaling $147,000,000. The Senior Secured Revolving Credit Facility is comprised of $115,000,000 of existing revolving credit commitments that were extended or issued (the “ Extended Commitments”) and $32,000,000 of existing revolving credit commitments that were not extended (the “ Unextended Commitments”) pursuant to the Senior Secured Revolving Credit Facility. The Amended and Restated Senior Secured Credit Facilities bear 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 principal amount of the Senior Secured Term Loan Facility amortizes in equal quarterly installments in aggregate annual amounts equal to 1% of the original principal amount with payments beginning in fiscal year 2011. The principal amount outstanding of the loans under the Senior Secured Term Loan Facility will be due and payable on February 11, 2017. The principal amount of outstanding loans under the Senior Secured Revolving Facility will be due and payable on February 11, 2016 with respect to Extended Commitments and on February 25, 2014 with respect to Unextended Commitments.

As at March 31, 2011, $750,000,000 of term loans had been issued and no amounts had been drawn during the quarter against the revolving credit facility. The term loans were priced at $0.995, with a yield to maturity of 5.6%. The Amended and Restated Senior Secured Credit Facility requires the Company to meet certain financial covenants, beginning quarter ending June 30, 2011. The maintenance of these financial covenants is solely with respect to the Senior Secured Revolving Credit Facility. The credit agreement governing the Amended and Restated Senior Secured 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 Amended and Restated Senior Secured Credit Facility, (2) commencing with the fiscal year ending September 30, 2011, 50% (which percentage will be reduced 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 Senior Secured Term Loan 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 defined in the preceding credit agreement, the Company was required to prepay $13,163,000 of outstanding term loans in the first quarter of fiscal year 2011 ($17,583,000 for the fiscal year 2009 which was paid in the first quarter of fiscal year 2010).

On May 6, 2008, the Company issued $235,000,000 of 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.

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

APTALIS PHARMA INC.
Notes to Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

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

		$
2012			8,918
2013			8,918
2014			7,858
2015			7,500
2016			242,500
Thereafter			710,625
			986,319
Unamortized original issuance discount			5,231
			981,088

12. Information Included in the Consolidated Operations and Cash Flows

a) Financial expenses

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Interest on long-term debt (including amortization of original issuance discount of $510 and $1,020 in 2011($511 and $1,027 in 2010)			17,166				14,568				31,772				29,379
Interest and bank charges			277				323				522				425
Interest rate swaps (Note 16)			—				113				—				17
Financing fees			10,422				143				10,557				278
Amortization of deferred debt issue expenses			2,280				1,238				3,523				2,483
			30,145				16,385				46,374				32,582

b) Other information

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Rental expenses			973				973				1,857				1,877
Shipping and handling expenses			1,862				1,678				3,200				3,294
Advertizing expenses			2,512				3,957				4,039				7,854
Depreciation of property, plant and equipment			3,573				2,095				5,691				4,099
Amortization of intangible assets			14,880				11,904				26,335				26,593
Stock-based compensation expense (recovery)			5,272				(2,367	)			5,763				(891	)

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 $194,000 for the three-month period and $361,000 for the six-month period ended March 31, 2011, ($186,000 for the three-month period and $402,000 for the six-month period ended March 31, 2010).

APTALIS PHARMA INC.
Notes to Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

d) Employees severance indemnities

The liability for severance indemnities relates primarily to Eurand ‘s and now the Company’s employees in Italy. The unfunded severance indemnity liability is calculated in accordance with local civil and labor laws based on each employee’s length of service, employment category and remuneration. There is no vesting period or funding requirement associated with the liability. The liability recorded on the balance sheet is the amount the employee would be entitled to if the employee were to immediately terminate their employment involuntary.

e) Cash flows relating to interest and income taxes of operating activities

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Interest received			115				159				307				307
Interest paid			18,678				27,172				20,012				29,119
Income taxes received			744				—				744				2,372
Income taxes paid			3,160				752				5,445				2,608

13. Income Taxes

The Company establishes a valuation allowance against deferred tax assets in accordance with U.S. GAAP. As at March 31, 2011, the Company has a valuation allowance of $112,692,000 against the Company’s net deferred tax assets generated in the U.S. reporting unit and of $4,275,000 against the deferred tax assets generated in its European reporting unit. In future periods, if the deferred tax assets are determined by management to be more likely than not to be realized, the tax benefits relating to the reversal of the valuation allowance will be recorded.

The Company’s effective tax rates for the three-month and six-month periods ended March 31, 2011, were 5.9% and 4.5% respectively, as compared to minus 15.4% and minus 16.3% respectively in the prior year’s periods. The effective tax rate for the three-month and six-month periods ended March 31, 2011, is affected by a number of elements, the most important being the establishment of the valuation allowance of $29,585,000 against the Company’s net deferred tax assets mostly attributable to the U.S. reporting unit during the six-month period ended March 31, 2011.

As at March 31, 2011, with respect to uncertain tax positions, the Company had unrecognized tax benefits of $12,110,000 ($11,485,000 as at September 30, 2010).

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

		For the				For the				For the				For the
		three-month				three-month				six-month				six-month
		period ended				period ended				period ended				period ended
		March 31,				March 31,				March 31,				March 31,
		2011				2010				2011				2010
		$				$				$				$
Balance, beginning of period			10,834				10,896				11,485				10,409
Acquisition of Eurand			401				—				401				—
Additions based on tax positions related to the current year			8				8				16				15
Additions for tax positions of prior years			867				414				1,300				920
Settlements			—				—				(1,063	)			—
Reductions for tax positions of prior years			—				—				(29	)			(26	)
Balance, end of period			12,110				11,318				12,110				11,318

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 March 31, 2011, the Company had accrued $1,237,000 ($1,075,000 as at September 30, 2010) for interest relating to income tax matters. There were no amounts recorded for penalties as at March 31, 2011.

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 2010. The Company is subject to Canadian and provincial income tax examination for fiscal years 2005 through 2010. 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.

APTALIS PHARMA 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 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 March 31, 2011, and September 30, 2010, no provision has been made for income taxes on the undistributed earnings of the Company’s foreign subsidiaries that the Company intends to indefinitely reinvest.

14. 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 grants 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 respectively 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 vested 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 March 31, 2011, there were 1,086,247 outstanding RSUs and Penny Options (1,172,396 as at September 30, 2010) of which 1,082,913 (1,167,396 as at September 30, 2010) 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 FASB 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 March 31, 2011, the value of the awards to be expensed by the Company would range between $6,000,000 and $7,200,000 depending on the level of return expected to be realized by the majority shareholders.

APTALIS PHARMA INC.
Notes to Condensed Consolidated Financial Statements
(amounts in the tables are stated in thousands of U.S. dollars, except share related data)
(unaudited)

15. 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 16, the Company may enter into derivative financial instruments to manage its exposure to interest rate changes and reduce its overall cost of borrowing. As described in the subsequent events (Note 19), the Company entered into two separate pay-fixed, receive-floating interest rate swaps on April 4, 2011.

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 has used derivative instruments historically to reduce its exposure to foreign currencies risk. As at March 31, 2011, no foreign exchange contracts were outstanding. As at March 31, 2011, the financial assets totaling $163,272,000 ($194,005,000 as at September 30, 2010) include cash and cash equivalents and accounts receivable for CAN$7,472,000, 25,888,000 Euros and 1,403,000 Swiss francs respectively (CAN$4,073,000, 18,658,000 Euros and 1,820,000 Swiss francs as at September 30, 2010). As at March 31, 2011, the financial liabilities totaling $1,112,850,000 ($689,148,000 as at September 30, 2010) include accounts payable and accrued liabilities and long-term debt of CAN$8,328,000, 21,359,000 Euros and 29,000 Swiss francs respectively (CAN$10,234,000 and 8,158,000 Euros as at September 30, 2010).

Credit risk

As at March 31, 2011, the Company had $47,484,000 ($134,299,000 as at September 30, 2010) of cash invested in with one financial institution. At times, such deposits may exceed the amount insured by the Federal Deposit Insurance Corporation.

Fair value of the financial instruments on the balance sheet

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

		March 31, 2011								September 30, 2010
		Fair				Carrying				Fair				Carrying
		value				amount				value				amount
		$				$				$				$
Assets
Cash and cash equivalents			87,330				87,330				161,503				161,503
Accounts receivable from the parent company			526				526				487				487
Accounts receivable, net			75,416				75,416				32,015				32,015
Liabilities
Accounts payable and accrued liabilities			131,762				131,762				94,673				94,673
Long-term debt			1,010,662				981,088				608,535				594,475