Patheon announces third quarter results
Website: www.patheon.com
TORONTO, Sept. 7 /CNW/ - Patheon (TSX:PTI), a global provider of drug
development and manufacturing services to the international pharmaceutical
industry, today announced its results for the third quarter ended July 31,
2007. (All amounts are in U.S. dollars unless otherwise indicated.)
The consolidated results for the third quarter of 2007 and comparative
prior periods presented in this news release reflect the results for the
Company's continuing operations. The results for Niagara-Burlington operations
have been segregated and presented separately as discontinued operations in
the consolidated financial statements.
Financial Results
Third Quarter Ended July 31, 2007
Compared With Third Quarter Ended July 31, 2006
- Revenues from continuing operations were $175.5 million, a decrease
of 2%;
- EBITDA before repositioning expenses from continuing operations
improved by 54% to $23.1 million (13.2% of revenues) from
$15.0 million (8.4% of revenues);
- Revenues and EBITDA before repositioning expenses from continuing
operations, excluding Puerto Rico, were $153.5 million and
$30.1 million, respectively, compared with $150.8 million and
$18.0 million;
- Revenues and EBITDA before repositioning expenses from discontinued
operations were $10.5 million and $0.9 million, respectively,
virtually unchanged from a year ago;
- Before write downs and repositioning expenses, the loss from
continuing operations was $1.4 million (1.5 cents per share) versus a
loss of $5.6 million (6.0 cents per share);
- The loss from continuing operations for the quarter was $50.7 million
(54.5 cents per share), compared with a loss of $257.7 million
($2.78 per share) a year ago;
- The net loss including discontinued operations for the quarter was
$63.1 million (67.8 cents per share) compared with a net loss of
$257.2 million ($2.77 per share) a year ago.
Nine Months Ended July 31, 2007
Compared With Nine Months Ended July 31, 2006
- Revenues from continuing operations were $510.3 million versus
$508.9 million;
- EBITDA before repositioning expenses from continuing operations was
$69.1 million (13.5% of revenues), up from $52.1 million (10.2%);
- Revenues and EBITDA before repositioning expenses from continuing
operations, excluding Puerto Rico, were $425.3 million and
$78.1 million, respectively, compared with $413.0 million and
$50.9 million;
- Revenues and EBITDA before repositioning expenses from discontinued
operations were $28.4 million and $2.2 million, respectively,
compared with $28.1 million and $2.1 million;
- Before write downs, repositioning expenses and one-time refinancing
expenses, the loss from continuing operations was $7.0 million
(7.5 cents per share) compared with a loss of $8.3 million (9.0 cents
per share);
- The loss from continuing operations was $75.4 million (81.1 cents per
share) compared with a loss of $266.6 million ($2.87 per share) a
year ago;
- The net loss including discontinued operations for the year-to-date
was $87.1 million (93.7 cents per share) compared with a net loss of
$265.7 million ($2.86 per share) a year ago.
Puerto Rico business review and asset impairment charge
In the third quarter ended July 31, 2007, Patheon recognized a
$48.6 million non-cash asset impairment charge in respect of depreciable
intangible assets and tangible capital assets related to its operations in
Carolina, Puerto Rico. Although the Carolina Operations have been performing
consistently well during this fiscal year, the Company determined that the
carrying value of these assets was impaired as a result of the genericization
of Omnicef(R), which will significantly reduce the profitability of the
Carolina Operations going forward. This asset impairment charge is a non-cash
item recognized to write these assets down to their estimated fair value.
The Company commenced a comprehensive review of the Puerto Rico
Operations in the third quarter, with a focus on restructuring the operations,
eliminating operating losses and developing a long-term plan for the business.
The Company is being assisted in this review by Alix Partners, and the review
and new operating plan is expected to be completed by the end of the calendar
year 2007.
Asset impairment charge - discontinued operations
Patheon also recognized an asset impairment charge of $13.0 million, or
14.0 cents per share, to write down to fair market value the capital assets of
the facilities in Niagara and Burlington that the Company is in the process of
divesting.
Third quarter commentary
"The business, with the exception of Puerto Rico, performed well in the
third quarter, with consolidated revenues of $175 million and EBITDA before
repositioning costs of $23 million," said Riccardo Trecroce, Chief Executive
Officer, Patheon Inc. "Results were particularly strong in Europe, where we
are benefiting from volume gains in Italy and France and strong growth in
pharmaceutical development services at Swindon, U.K. In Canada, EBITDA before
repositioning costs improved on a lower revenue base, reflecting the success
of our efforts to improve operating efficiencies and profitability,
particularly in Whitby."
In Puerto Rico, the Company recorded losses at its Caguas and Manati
sites, which were partially offset by improved performance at the Carolina
facility.
At Caguas, in addition to market-driven volume declines for two key
products, the site incurred significant additional costs in connection with
the launch of a new, large-volume product.
"We have taken several steps to adjust for declining revenues and to
address operational challenges at the Caguas facility," Mr. Trecroce said.
"These have included reducing the size of the workforce at Caguas by an
additional 130 positions since May, bringing the total number of reductions to
225 positions, or almost one-third of the site's workforce, since the
beginning of the fiscal year. We have appointed a new Site Director and are
working diligently to improve the efficiency and operating performance of the
site."
At Manati, there were lower-than-expected volumes of a new product that
was introduced to the site last year, which impacted the site's revenues and
profitability. At Carolina, declines in volumes of branded Omnicef(R) were
almost entirely offset by the production of launch quantities of the
authorized generic version of the product that Patheon manufactured for its
client during the third quarter. In addition, the site achieved cost savings
and efficiency improvements relative to the same period a year ago,
contributing towards an improved year-over-year EBITDA performance.
"We have been and continue to be focused on restructuring the Puerto Rico
operations to eliminate losses as soon as possible," Mr. Trecroce said. "Our
Puerto Rico management team, with the support of the external consulting firm
Alix Partners, has developed cost reduction programs to realign operating
costs with significantly reduced revenues, particularly at Carolina and
Caguas. These initiatives are being implemented during the fourth quarter.
"We have also increased our efforts to secure new business for the Puerto
Rico Operations," Mr. Trecroce added. "We have already identified significant
new business opportunities for Manati which, if successful, could begin to
contribute to results in the latter half of 2008.
"We continue to evaluate the best way to improve the long-term
profitability of the Puerto Rico operations," Mr. Trecroce concluded. "We know
that with the right mix of attractive capacity, first-rate management
expertise and superior operational performance, we will be able to bring
significant new products into the Puerto Rico sites."
Update on Canadian site restructuring
"Our Canadian site restructuring initiative is proceeding on schedule,"
reported Mr. Trecroce. "We have completed preliminary due diligence reviews
with potential purchasers of our Niagara-Burlington OTC manufacturing
business. We are moving forward as quickly as possible, and the next step in
the process will be to negotiate a definitive offer with a preferred party.
"On the York Mills-Whitby consolidation, we have completed the planning
discussions with our clients and will begin the transfer of products to Whitby
this fall," Mr. Trecroce continued.
Patheon also has entered into an agreement for the sale of the land and
buildings at the York Mills location. Patheon will continue to occupy the
site, leasing it from the purchaser, while it completes the process of
transferring commercial manufacturing and development services to its Whitby
facility over the next eighteen months.
Third-quarter operating results from continuing operations
Third-quarter revenues decreased by $3.2 million, or 2%, to
$175.5 million over the same period a year ago. Growth in Rx and PDS revenues
of $8.7 million was offset by a decline of $11.9 million in over-the-counter
(OTC) manufacturing volumes at Whitby and Cincinnati, where clients decided in
2006 to repatriate certain products back to their own manufacturing networks.
Revenues from Rx manufacturing services increased by $5.6 million or 4%
over the same period a year ago, driven by strong year-over-year growth in
Europe, partially offset by declines in Canada and Puerto Rico. The revenue
growth in Europe reflects the full commercial production of multiple products
transferred into Patheon's sites in Italy and France by two clients. Rx
revenues declined in Puerto Rico year-over-year due to the absence of orders
for Zocor(R), which lost patent protection in 2006, and lower revenues for
Omnicef(R) following the emergence of generic competition in May 2007. Patheon
is manufacturing the authorized generic of Omnicef, partially offsetting the
reduction in volumes for the branded product. Rx revenues were down modestly
in Canada, due to lower volumes of a product for which the Company's client
was building inventory levels last year following its commercial launch.
Revenues from pharmaceutical development services (PDS) increased by
$3.2 million, or 12%, due to solid growth, particularly at the Swindon and
Cincinnati PDS operations. Patheon is currently developing 187 new products on
behalf of its clients, up from 165 a year ago. During the third quarter, one
newly approved product that Patheon had developed on behalf of a client was
launched and is being manufactured at the Company's Toronto Region facility.
This brings the total number of new product launches since 2001 to 20.
Consolidated EBITDA before repositioning expenses was $23.1 million in
the third quarter, up 54% from $15.0 million a year ago. The EBITDA margin
before repositioning expense was 13.2% in the third quarter, compared with
8.4% in the third quarter of 2006.
In Canada, despite a decline in revenues, which was particularly
significant at Whitby, EBITDA before repositioning expenses from commercial
manufacturing operations was $7.0 million, or $0.9 million higher than the
same period a year ago. This improvement reflects the success of the
Performance Enhancement Program launched last year to improve operating
results. This program, comprising a reduction in the size of the workforce, a
review of manufacturing efficiency, and more effective procurement, resulted
in improved profitability at all of the Canadian sites.
EBITDA before repositioning expenses from U.S. operations was a loss of
$4.3 million, compared with a loss of $1.2 million in the same period a year
ago. The decline reflects a significant year-over-year decrease at the Caguas,
Puerto Rico facility, mainly attributable to the absence of volumes for
Zocor(R), which lost its patent protection in June 2006 and additional
operating costs incurred in connection with the launch of a new high-volume
product. At Carolina, EBITDA before repositioning costs remained steady year-
over-year, as a result of cost savings and efficiency gains from the
manufacturing review process completed at the site earlier this year. In
Cincinnati, OTC revenue declines were replaced with Rx volumes, reflecting the
site's continuing shift towards higher-margin revenues.
In Europe, EBITDA before repositioning expenses from the commercial
manufacturing operations was $14.7 million, or $6.4 million higher than the
same period a year ago, reflecting volume gains at all four European sites.
The strengthening European currencies relative to the U.S. dollar also had the
impact of increasing EBITDA before repositioning expenses by approximately
$0.9 million.
EBITDA before repositioning expenses from global pharmaceutical
development services was $6.4 million, or $0.5 million higher than the same
period a year ago. The increase reflects improved revenue growth and
operational efficiency savings in Canada, Cincinnati and Europe.
Outlook
Due to normal summer shut downs, particularly in Europe, and declining
volumes in Puerto Rico, particularly at the Carolina site, revenues for the
fourth quarter of 2007 are expected to be lower than the third quarter of
2007.
FORWARD-LOOKING STATEMENTS
Cautionary Note
This news release contains forward-looking statements which reflect
management's expectations regarding the Company's future growth of operations,
performance (both operational and financial) and business prospects and
opportunities.
PLEASE REFER TO THE CAUTIONARY NOTE AT THE END OF THE MANAGEMENT
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
("MD&A") ATTACHED TO AND FORMING PART OF THIS NEWS RELEASE.
WEBCAST CONFERENCE CALL WITH ANALYSTS
Patheon Inc. will host a webcast conference call with financial analysts
on its third quarter results on Friday, September 7, 2007 at 10:00 a.m.
(Eastern Daylight Time). Representing Patheon on the call will be: Riccardo
Trecroce, Chief Executive Officer; Nick DiPietro, President and Chief
Operating Officer; John Bell, Chief Financial Officer; and Shelley Jourard,
Director, Corporate Communications. The call will begin with a brief
presentation, followed by a question-and-answer period with investment
analysts. Interested parties are invited to access the live call, via
telephone, in listen-only mode, at (416) 644-3414 (Toronto and International)
or toll free at (800) 733-7571 (U.S., including Puerto Rico). Listeners are
encouraged to dial in five to 15 minutes in advance to avoid delays. A live
audio webcast, with a slide presentation, will also be available via the web
at www.patheon.com. An archived version of the Q3 webcast will be available on
www.patheon.com for three months.
ABOUT PATHEON
Patheon (TSX:PTI; www.patheon.com) is a leading global provider of drug
development and manufacturing services to the international pharmaceutical
industry. Patheon operates a network of 14 facilities in the United States,
Canada and Europe, employing more than 5,100 people and serving a client base
of 250 pharmaceutical and biotechnology companies.
For further information: Mr. Riccardo Trecroce, Chief Executive Officer,
Tel: (905) 812-6877, Fax: (905) 812-6613, Email: rtrecroce@patheon.com; Mr.
John Bell, Chief Financial Officer, Tel: (905) 812-6812, Fax: (905) 812-6613,
Email: john.h.bell@patheon.com; Ms. Shelley Jourard, Director, Corporate
Communications, Tel: (905) 812-6614, Fax: (905) 812-6613, Email:
sjourard@patheon.com.
Consolidated Statements of Earnings (Loss)
(unaudited)
Three months ended Nine months ended
July 31, July 31,
% %
2007 2006 change 2007 2006 change
-------------------------------------------------------------------------
(in thousands
of U.S. dollars,
except per share
amounts) $ $ $ $
-------------------------------------------------------------------------
Revenues 175,508 178,739 -1.8% 510,282 508,909 0.3%
Operating
expenses 152,370 163,749 -6.9% 441,198 456,795 -3.4%
----------------------------- -----------------------------
Earnings
before
the
following: 23,138 14,990 54.4% 69,084 52,114 32.6%
----------------------------- -----------------------------
(as a % of
revenues) 13.2% 8.4% 13.5% 10.2%
Asset
impairment
charge
(note 4) 48,580 254,661 -80.9% 48,580 254,661 -80.9%
Repositioning
expenses
(note 7) 1,466 - 9,086 -
Depreciation and
amortization 9,826 9,941 -1.2% 30,543 29,090 5.0%
Amortization of
intangible
assets 1,231 2,794 -55.9% 5,594 9,689 -42.3%
Foreign exchange
loss (note 8) - - 858 -
Interest 7,364 5,188 41.9% 21,699 15,086 43.8%
Refinancing
expenses
(note 11) - - 13,471 1,643 719.9%
Amortization of
deferred
financing costs - 136 - 598
Write-off of
deferred
financing
costs (note 11) - - - 6,332
----------------------------- -----------------------------
Earnings
(loss) before
income
taxes (45,329) (257,730) 82.4% (60,747) (264,985) 77.1%
Provision for
(recovery of)
income taxes 5,339 (32) 16784.4% 14,661 1,572 832.6%
----------------------------- -----------------------------
Loss from
continuing
operations (50,668) (257,698) 80.3% (75,408) (266,557) 71.7%
----------------------------- -----------------------------
(as a % of
revenues) -28.9% -144.2% -14.8% -52.4%
Earnings
(loss) from
discontinued
operations
(note 5) (12,401) 485 -2656.9% (11,671) 823 -1518.1%
----------------------------- -----------------------------
Net loss for
the period (63,069) (257,213) 75.5% (87,079) (265,734) 67.2%
----------------------------- -----------------------------
----------------------------- -----------------------------
Basic and
diluted
earnings
(loss) per
share
From
continuing (54.5 (277.5 (81.1 (287.1
operations cents) cents) 80.4% cents) cents) 71.8%
From
discontinued (13.3 0.5 (12.6 0.9
operations cents) cents -2760.0% cents) cents -1500.0%
----------------------------- -----------------------------
(67.8 (277.0 (93.7 (286.2
cents) cents) 75.5% cents) cents) 67.3%
----------------------------- -----------------------------
Average number
of shares
outstanding
during period
(in thousands): `
Basic and
diluted 92,959 92,860 0.1% 92,956 92,851 0.1%
----------------------------- -----------------------------
see accompanying notes
Consolidated Balance Sheets
(unaudited)
As at As at
July 31, October 31,
2007 2006
-------------------------------------------------------------------------
(in thousands of U.S. dollars) $ $
-------------------------------------------------------------------------
Assets
Current
Cash and cash equivalents 40,496 50,723
Accounts receivable 130,887 117,705
Inventories 82,567 72,057
Prepaid expenses and other 13,414 6,615
Assets held for sale (note 5) 8,357 8,341
------------------------
Total current assets 275,721 255,441
------------------------
Capital assets (note 4) 457,844 467,365
Intangible assets (note 4) 9,811 41,447
Deferred costs 8,369 9,717
Future tax assets 26,999 21,827
Goodwill 3,239 3,077
Investments 979 586
Assets held for sale (note 5) 14,052 26,723
------------------------
797,014 826,183
------------------------
------------------------
Liabilities and Shareholders' equity
Current
Bank indebtedness 12,143 3,829
Accounts payable and accrued liabilities 136,236 140,254
Income taxes payable 7,443 879
Current portion of long-term debt (note 10) 10,284 283,717
Liabilities related to assets held for sale
(note 5) 3,974 2,527
------------------------
Total current liabilities 170,080 431,206
------------------------
Long-term debt (note 10) 203,935 62,071
Deferred revenues 25,256 23,366
Future tax liabilities 39,690 33,128
Convertible preferred shares - debt component
(note 10) 136,343 -
Other long-term liabilities 27,494 25,681
------------------------
Total liabilities 602,798 575,452
------------------------
Shareholders' equity
Convertible preferred shares - equity
component (note 10) 15,925 -
Restricted voting shares 400,745 400,721
Contributed surplus 3,997 3,829
Deficit (278,728) (189,900)
Accumulated other comprehensive income 52,277 36,081
------------------------
Total shareholders' equity 194,216 250,731
------------------------
797,014 826,183
------------------------
------------------------
see accompanying notes
Consolidated Statements of Changes in Shareholders' Equity
(unaudited)
Nine months ended July 31,
2007 2006
-------------------------------------------------------------------------
(in thousands of U.S. dollars) $ $
-------------------------------------------------------------------------
Convertible preferred shares - equity component
Balance at beginning of period - -
Shares issued, net of issue costs 15,925 -
------------------------
Balance at end of period 15,925 -
------------------------
Restricted voting shares
Balance at beginning of period 400,721 400,594
Issued during the period, net of issue costs 24 80
------------------------
Balance at end of period 400,745 400,674
------------------------
Contributed surplus
Balance at beginning of period 3,829 2,901
Stock options 168 925
------------------------
Balance at end of period 3,997 3,826
------------------------
Retained earnings (deficit)
Balance at beginning of period (189,900) 98,250
Adjustment related to change in accounting
policy (note 1) (1,749) -
Net loss for the period (87,079) (265,734)
------------------------
Balance at end of period (278,728) (167,484)
------------------------
Accumulated other comprehensive income
Balance at beginning of period 36,081 38,106
Transition adjustment (note 1) (762) -
Other comprehensive income for the period 16,958 2,314
------------------------
Balance at end of period 52,277 40,420
------------------------
Total shareholders' equity at end of period 194,216 277,436
------------------------
------------------------
see accompanying notes
Consolidated Statements of Comprehensive Loss
(unaudited)
Three months Nine months
ended ended
July 31, July 31,
2007 2007
-------------------------------------------------------------------------
(in thousands of U.S. dollars) $ $
-------------------------------------------------------------------------
Net loss for the period (63,069) (87,079)
------------------------
Other comprehensive income, net of income
taxes (note 12)
Change in foreign currency gains on investments
in subsidiaries, net of hedging activities 5,545 12,642
Foreign currency losses on investments in
subsidiaries, net of hedging activities
reclassified to consolidated statement of
earnings (loss) - 2,793
Change in value of derivatives designated as
foreign currency and interest rate cash flow
hedges 370 1,201
(Gains)/losses on foreign currency cash flow
hedges reclassified to consolidated statement
of earnings (loss) (399) 978
Gains on interest rate hedges reclassified to
consolidated statement of earnings (loss) - (656)
------------------------
Other comprehensive income for the period 5,516 16,958
------------------------
------------------------
Comprehensive loss for the period (57,553) (70,121)
------------------------
------------------------
see accompanying notes
Consolidated Statements of Cash Flows
(unaudited)
Three months ended Nine months ended
July 31, July 31,
2007 2006 2007 2006
-------------------------------------------------------------------------
(in thousands of
U.S. dollars) $ $ $ $
-------------------------------------------------------------------------
Operating activities
Net loss from continuing
operations (50,668) (257,698) (75,408) (266,557)
Add (deduct) charges to
operations not requiring
a current cash payment
Asset impairment charge
(note 4) 48,580 254,661 48,580 254,661
Depreciation and
amortization 11,057 12,735 36,137 38,779
Foreign exchange loss
(note 8) - - 858 -
Accretive interest on
convertible preferred
shares (note 1) 3,481 - 3,481 -
Write-off of deferred
financing costs
(note 11) - - - 6,332
Amortization of
deferred financing
costs 126 136 1,506 598
Employee future benefits (65) 941 323 793
Future income taxes 3,104 (5,757) 3,172 (3,164)
Amortization of
deferred revenues (547) (498) (1,516) (1,493)
Other (3,171) 562 (3,820) 1,433
---------------------------------------------
11,897 5,082 13,313 31,382
Net change in non-cash
working capital balances
related to continuing
operations (17,189) 2,896 (24,184) (15,605)
Increase in deferred
revenues 2,057 - 2,057 9,614
---------------------------------------------
Cash provided by (used in)
operating activities of
continuing operations (3,235) 7,978 (8,814) 25,391
Cash provided by (used in)
operating activities of
discontinued operations
(note 5) (89) 1,207 4,232 3,497
---------------------------------------------
Cash provided by (used in)
operating activities (3,324) 9,185 (4,582) 28,888
---------------------------------------------
Investing activities
Additions to capital
assets - sustaining (3,364) (3,766) (8,868) (9,887)
- project related (5,040) (10,680) (12,249) (31,826)
Net increase in
investments (293) - (177) -
Increase in deferred
pre-operating costs (1,116) (1,122) (2,827) (1,579)
---------------------------------------------
Cash used in investing
activities of continuing
operations (9,813) (15,568) (24,121) (43,292)
Cash used in investing
activities of
discontinued operations
(note 5) (121) (153) (275) (431)
---------------------------------------------
Cash used in investing
activities (9,934) (15,721) (24,396) (43,723)
---------------------------------------------
Financing activities
Increase (decrease) in
bank indebtedness 9,078 (1,446) 7,762 (14,137)
Increase in long-term
debt 6,812 62,803 182,652 373,946
Repayment of long-term
debt (7,119) (41,665) (320,072) (353,010)
Issue of convertible
preferred shares - - 150,000 -
Convertible preferred
share issue costs -
equity component - - (1,213) -
Issue of restricted
voting shares - 80 24 80
Decrease in restricted
cash - - - 7,805
Increase in deferred
financing costs - - - (2,790)
---------------------------------------------
Cash provided by
financing activities of
continuing operations 8,771 19,772 19,153 11,894
---------------------------------------------
Cash provided by financing
activities 8,771 19,772 19,153 11,894
---------------------------------------------
Effect of exchange rate
changes on cash and cash
equivalents (1,555) 534 (402) 431
---------------------------------------------
Net increase (decrease) in
cash and cash equivalents
during the period (6,042) 13,770 (10,227) (2,510)
Cash and cash equivalents,
beginning of period 46,538 6,227 50,723 22,507
---------------------------------------------
Cash and cash equivalents,
end of period 40,496 19,997 40,496 19,997
---------------------------------------------
---------------------------------------------
see accompanying notes
Notes to Unaudited Consolidated Financial Statements for the
Nine Months Ended July 31, 2007
(Dollar information in tabular form is expressed in thousands of
U.S. dollars)
1. Accounting policies
Basis of presentation
The accompanying unaudited consolidated financial statements have been
prepared by the Company in accordance with Canadian generally accepted
accounting principles ("GAAP") on a basis consistent with those followed
in the most recent audited consolidated financial statements except as
noted below. These consolidated financial statements do not include all
the information and footnotes required by generally accepted accounting
principles for annual financial statements and therefore should be read
in conjunction with the audited consolidated financial statements and
notes for the year ended October 31, 2006.
The preparation of the consolidated financial statements in conformity
with Canadian generally accepted accounting principles requires
management to make estimates and assumptions that affect: the reported
amounts of assets and liabilities; the disclosure of contingent assets
and liabilities at the date of the consolidated financial statements; and
the reported amounts of revenue and expenses in the reporting period.
Management believes that the estimates and assumptions used in preparing
its consolidated financial statements are reasonable and prudent,
however, actual results could differ from those estimates.
Changes in accounting policy
Effective November 1, 2006 the Company adopted the CICA Handbook Section
3855 "Financial Instruments - Recognition and Measurement", Section 3861
"Financial Instruments - Disclosure and Presentation", Section 3865
"Hedges" and Section 1530 "Comprehensive Income". The adoption of the new
standards resulted in changes in accounting for financial instruments and
hedges as well as the recognition of certain transition adjustments that
have been recorded in accumulated other comprehensive income. The
comparative interim consolidated financial statements have not been
restated except as noted below. The principal changes in the accounting
for financial instruments and hedges due to the adoption of these
accounting standards are described below:
Financial Assets and Financial Liabilities
------------------------------------------
An investment in shares of a publicly traded company have been designated
as held for trading and are accounted for at fair value, with changes in
the fair value being recorded in the consolidated statement of earnings
(loss). Prior to the adoption of the new standards, this investment was
accounted for on a cost basis, as adjusted for an other than temporary
decline in value. All other financial assets are accounted for on an
amortized cost basis and financial liabilities are accounted for on an
accruals basis, consistent with prior accounting policies.
Costs of obtaining bank and other debt financing that were previously
reported in deferred costs are now netted against the carrying value of
the related debt and amortized into interest expense using the effective
interest rate method. Prior to the adoption of the new standards, the
amortization of deferred financing costs was reported as a separate line
in the consolidated statement of earnings (loss) and the amortized
balance disclosed in deferred costs on the consolidated balance sheet.
In the second quarter of 2007 the Company also changed its accounting
policy relating to costs of obtaining bank and other debt financing.
Under the new policy all transaction costs, including fees paid to
advisors and other related costs, are expensed as incurred. Financing
costs, including underwriting and arrangement fees paid to lenders are
deferred and netted against the carrying value of the related debt and
amortized into interest expense using the effective interest rate method.
The Company previously deferred all transaction and financing costs
associated with obtaining bank and other debt financing. The Company
believes that the new policy is reliable and more relevant as it results
in a more transparent treatment of transaction costs that the Company has
incurred in its recent refinancing activities and in the carrying value
of debt.
The change in policy has been made retrospectively effective November 1,
2006 and had the effect of increasing the retained deficit at November 1,
2006 by $1,749,000 and reducing the interest expense and net loss for the
three months ended January 31, 2007 by $612,000. Refinancing expenses for
the three months ended April 30, 2007 include transaction costs incurred
in connection with the completion of the Company's senior secured credit
facilities and the debt component of the convertible preferred shares of
$11,889,000 (see note 11).
In 2006, the Company cancelled its interest rate swaps that were used as
a hedge against changes in interest payments on floating rate debt.
Deferred gains from the cancellation of these interest rate swaps that
had previously been recorded in accounts payable and accrued liabilities
were recorded in accumulated other comprehensive income. In the second
quarter of 2007, all remaining deferred gains on the interest rate swap
were reclassified to the consolidated statement of earnings (loss).
Derivatives and Hedge Accounting
--------------------------------
The Company enters into foreign exchange forward contracts to hedge its
exposure in foreign currency denominated cash flows and holds foreign
currency denominated debt as a hedge against the carrying value of its
equity investment in certain foreign currency denominated operations.
Prior to the adoption of the new standards, the Company accounted for
derivatives that met the requirements of hedge accounting on an accrual
basis. Under the new standards all derivatives, other than those
contracts that are entered into for the Company's own expected
requirements, are recorded at their fair value.
The effective portion of changes in the fair value of cash flow hedges
and hedges of net investments in foreign operations are recognized in
other comprehensive income. Amounts accumulated in other comprehensive
income are reclassified to the consolidated statement of earnings (loss)
in the period in which the hedged item affects the earnings (loss). Any
gain or loss in the fair value relating to the ineffective portion of a
hedge is recognized immediately in the consolidated statement of earnings
(loss).
Comprehensive Income (Loss) and Accumulated Other Comprehensive Income
----------------------------------------------------------------------
Comprehensive income (loss) is comprised of the Company's net loss and
other comprehensive income. Other comprehensive income includes foreign
currency translation gains and losses on net investments in self-
sustaining operations net of hedging activities, changes in the fair
value of derivative instruments designated as cash flow hedges and the
reclassification to net loss of deferred gains on interest rate swaps,
all net of income taxes.
On transition to the new accounting standards, deferred after tax gains
from interest rate swaps of $656,000 and after tax losses on the fair
value of cash flow hedges of $1,418,000 were recorded in accumulated
other comprehensive income. Accumulated other comprehensive income also
includes gains on net investments in self sustaining foreign operations,
net of hedging activities previously recorded in cumulative translation
adjustment. As a result, the previously recorded cumulative translation
adjustment account has been eliminated and the balances have been
included in accumulated other comprehensive income. On transition to the
new standards, the comparative amounts of other comprehensive income for
the period only reflect the amounts previously recorded in the cumulative
translation adjustment account.
Convertible preferred shares
On April 27, 2007 the Company issued $150 million of convertible
preferred shares. The shares are considered to be a compound financial
instrument that contains both a debt component and an equity component.
On issuance of the convertible preferred shares, the fair value of the
debt component was determined by discounting the expected future cash
flows over the expected life using a market interest rate for a non-
convertible debt instrument with similar terms. The value is carried as
debt on an amortized cost basis until extinguished on conversion or
redemption. The remainder of the proceeds were allocated as a separate
component of shareholders' equity, net of transaction costs. Transaction
costs are apportioned between the debt and equity components based on
their respective carrying amounts when the instrument was issued.
On conversion, the carrying amount of the debt component and the equity
component are transferred to share capital and no gain or loss is
recognized.
The interest cost recognized in respect of the debt component represents
the accretion of the liability, over its expected life using the
effective interest method, to the amount that would be payable if
redeemed. The interest expense for the three and nine months ended
July 31, 2007 includes a charge of $3,481,000 for the accretive interest
on the convertible preferred shares.
2. Convertible preferred shares and restricted voting shares
The following table summarizes information on convertible preferred
shares, and restricted voting shares and related matters at July 31,
2007:
Outstanding Exercisable
Convertible preferred shares
Class I preferred shares series C and D 150,000
Restricted voting shares
(previously common shares) 92,958,688
Restricted voting share stock options 3,899,516 3,740,349
The Company's articles were amended on April 26, 2007 to re-designate the
common shares as restricted voting shares. This occurred in connection
with the issuance of the convertible preferred shares. The holders of the
convertible preferred shares have the right to appoint three of nine
members of the Board of Directors. The holders of Patheon's common shares
have the right to elect the remaining members of the Board of Directors.
Under the rules of the Toronto Stock Exchange, voting equity securities
are not to be designated, or called, common shares unless they have a
right to vote in all circumstances that is not less, on a per share
basis, than the voting rights of each other class of voting securities.
Accordingly, the Company has amended its articles to re-designate the
common shares as restricted voting shares. This re-designation involves
only a change in the name of the securities; the number of shares
outstanding and the terms and conditions of the outstanding shares are
not affected by the change.
3. Segmented information
The Company is organized and managed as a single business segment, being
the provider of commercial manufacturing and pharmaceutical development
services.
Canadian and foreign continuing operations consist of:
Manufacturing location
Three months ended July 31, 2007
---------------------------------------------
Canada USA Europe Total
$ $ $ $
-------------------------------------------------------------------------
Revenues
Canada 4,515 554 36 5,105
USA 35,223 45,026 4,257 84,506
Europe 7,669 1,272 74,670 83,611
Other geographic areas 1,221 153 912 2,286
-------------------------------------------------------------------------
Total revenues 48,628 47,005 79,875 175,508
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Capital assets 105,699 118,483 233,662 457,844
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Goodwill 3,239 - - 3,239
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Manufacturing location
Three months ended July 31, 2006
---------------------------------------------
Canada USA Europe Total
$ $ $ $
-------------------------------------------------------------------------
Revenues
Canada 3,648 204 185 4,037
USA 38,418 53,182 6,055 97,655
Europe 18,055 172 55,637 73,864
Other geographic areas 1,693 19 1,471 3,183
-------------------------------------------------------------------------
Total revenues 61,814 53,577 63,348 178,739
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Capital assets 101,318 155,103 208,351 464,772
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Goodwill 3,054 - - 3,054
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Manufacturing location
Nine months ended July 31, 2007
---------------------------------------------
Canada USA Europe Total
$ $ $ $
-------------------------------------------------------------------------
Revenues
Canada 10,741 903 895 12,539
USA 104,917 155,262 11,016 271,195
Europe 26,732 2,227 190,050 219,009
Other geographic areas 2,791 292 4,456 7,539
-------------------------------------------------------------------------
Total revenues 145,181 158,684 206,417 510,282
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Manufacturing location
Nine months ended July 31, 2006
---------------------------------------------
Canada USA Europe Total
$ $ $ $
-------------------------------------------------------------------------
Revenues
Canada 16,186 492 593 17,271
USA 102,855 173,465 9,983 286,303
Europe 43,350 507 153,277 197,134
Other geographic areas 4,196 190 3,815 8,201
-------------------------------------------------------------------------
Total revenues 166,587 174,654 167,668 508,909
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Revenues are attributed to countries based on the location of the
client's billing address, capital assets are attributed to the country in
which they are located, and goodwill is attributed to the country in
which the entity to which the goodwill pertains is located.
Revenue information by service activity is as follows:
Three months ended July 31,
----------------------------------------------
2007 2006
$ $
-------------------------------------------------------------------------
Commercial manufacturing -
prescription 135,467 77% 129,917 73%
Commercial manufacturing -
over-the-counter 11,229 6% 23,171 13%
Development services 28,812 17% 25,651 14%
-------------------------------------------------------------------------
175,508 100% 178,739 100%
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Nine months ended July 31,
----------------------------------------------
2007 2006
$ $
-------------------------------------------------------------------------
Commercial manufacturing -
prescription 394,843 77% 382,116 75%
Commercial manufacturing -
over-the-counter 31,694 6% 57,412 11%
Development services 83,745 17% 69,381 14%
-------------------------------------------------------------------------
510,282 100% 508,909 100%
-------------------------------------------------------------------------
-------------------------------------------------------------------------
4. Asset impairment charge
During the third quarter of 2007 it was determined that the carrying
value of the intangible assets and depreciable tangible capital assets
(collectively the "long-lived depreciable assets") at the Company's
operations in Carolina, Puerto Rico were impaired as a result of volume
declines arising from the genericization of Omnicef(R), this being the
largest single product that is manufactured at the facility. The Company
tested the recoverability of the long-lived depreciable assets at the
Carolina operations and determined that the expected future cash flows
over the economic life of the principal assets were less than the
carrying value of the long-lived depreciable assets. As a result the
Company recorded an impairment charge of $48,580,000; $26,043,000 for
intangible assets and $22,537,000 for tangible capital assets. The fair
value of the intangible assets was determined using a discounted cash
flow methodology and the fair value of the tangible capital assets was
based on a weighted average continued use and liquidation value.
During the third quarter of 2006 the Company determined that the carrying
value of the long-lived depreciable assets at the Company's operations in
Caguas and Manati, Puerto Rico and the goodwill associated with all of
the Puerto Rico operations were impaired as a result of certain events
which occurred during the third quarter of 2006. These events included:
continued deterioration in revenues culminating in a significant increase
in losses reported in the third quarter; suspension of production of a
major product due to concerns over product shelf life; the risk of a
decline in revenue of another major product as a result of the approval
by the U.S. Food and Drug Administration of a generic version of the
product; and the completion of a long range plan that showed a
significant reduction in earnings relative to prior forecasts.
The Company tested the recoverability of the long-lived depreciable
assets for all the Puerto Rico operations and determined that in Caguas
and Manati the expected future cash flows over the economic life of the
principal assets was less than the carrying value of the long-lived
depreciable assets. As a result the Company recorded an impairment charge
of $81,428,000; $51,921,000 for intangible assets and $29,507,000 for
tangible capital assets. The fair value of the intangible assets was
determined using a discounted cash flow methodology and the fair value of
tangible capital assets was based on a value in continued use, taking
into account utilization levels.
During the third quarter of 2006 the Company also tested the
recoverability of the goodwill associated with Puerto Rico operations
using a discounted cash flow methodology, and recorded an impairment
charge of $172,477,000 representing the full value of the Puerto Rico
goodwill.
During the third quarter of 2006 the Company, as part of its ongoing
review of long term investments, concluded that its investment in the
shares of a drug technology company which was accounted for on the cost
basis had an other than temporary decline and wrote down its value by
$756,000 to its market value as of July 31, 2006.
A summary of the asset impairment charges is as follows:
Three and nine months ended July 31,
-------------------------------------------------------------------------
2007 2006
$ $
-------------------------------------------------------------------------
Intangible asset impairment 26,043 51,921
Tangible capital asset impairment 22,537 29,507
Goodwill impairment - 172,477
Other investment impairment - 756
-------------------------------------------------------------------------
48,580 254,661
-------------------------------------------------------------------------
5. Discontinued operations and assets held for sale
On April 17, 2007 the Company announced that as part of its strategy to
focus on developing and manufacturing prescription pharmaceutical
products and to improve the Company's profitability, it plans to
restructure its current network of six pharmaceutical manufacturing
facilities in Canada.
The Company plans to divest its Niagara-Burlington Operations business
that is focused on the commercial manufacturing of OTC products. The
Niagara-Burlington Operations to be divested consist of facilities in
Fort Erie and Burlington Gateway and the commercial operations at
Burlington Century. The Company plans to retain the Burlington Century
facility where its central quality control laboratory is also based.
The Company also plans to close its York Mills, Toronto facility and
transfer substantially all commercial production and development services
to its site in Whitby and sell the land and buildings. The process of
transferring production to other facilities is expected to take
18 months.
The results of operations of the Niagara-Burlington Operations have been
reported as discontinued operations and prior period amounts have been
reclassified to conform to the current period presentation. In the third
quarter of 2007 the Company recorded an impairment charge of $13,029,000
to write down the carrying value of Niagara-Burlington Operations long
lived assets to their fair value less estimated disposition costs. The
results of discontinued operations for the three and nine months ended
July 31, 2007 and July 31, 2006 are as follows:
Three months ended Nine months ended
July 31, July 31,
-------------------------------------------------------------------------
2007 2006 2007 2006
$ $ $ $
-------------------------------------------------------------------------
Revenues 10,499 10,452 28,429 28,128
Operating expenses 9,559 9,443 26,194 26,018
-----------------------------------------
Earnings before the
following: 940 1,009 2,235 2,110
-----------------------------------------
(as a % of revenues) 9.0% 9.7% 7.9% 7.5%
Asset impairment charge 13,029 - 13,029 -
Repositioning expenses - - 33 -
Depreciation and
amortization 312 262 844 844
-----------------------------------------
Earnings (loss) before
income taxes (12,401) 747 (11,671) 1,266
Provision for income taxes - 262 - 443
-------------------------------------------------------------------------
Net earnings (loss) for
the period (12,401) 485 (11,671) 823
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Assets held for sale and the related liabilities include the Niagara-
Burlington Operations and the land and buildings at York Mills. In
accordance with Section 3475 of the CICA Handbook, long lived assets held
for sale are measured at the lower of their carrying amount or fair value
less cost to sell. Assets held for sale and the related liabilities at
July 31, 2007, with comparatives as at October 31, 2006 are as follows:
As at As at
July 31, October 31,
-------------------------------------------------------------------------
2007 2006
$ $
-------------------------------------------------------------------------
Current Assets
Accounts receivable 4,939 4,251
Inventories 3,317 3,905
Prepaid expenses and other 101 185
-----------------------
Total current assets 8,357 8,341
-----------------------
Capital assets 14,052 26,723
Current Liabilities
Accounts payable and accrued liabilities 3,974 2,527
-------------------------------------------------------------------------
6. Stock-based compensation
The Company has an incentive stock option plan. Persons eligible to
participate in the plan are directors, officers, and key employees of the
Company and its subsidiaries or any other person engaged to provide
ongoing management or consulting services to Patheon. The plan provides
that the maximum number of shares that may be issued under the plan is
7.5% of the issued and outstanding restricted voting shares of the
Company at any point in time. As of July 31, 2007, the total number of
restricted voting shares listed and reserved at the TSX for issuance
under the plan was 6,850,427, of which there are stock options
outstanding to purchase 3,899,516 shares under the plan. The exercise
price of restricted voting shares subject to an option is determined at
the time of grant and the price cannot be less than the weighted average
market price of the restricted voting shares of Patheon on the Toronto
Stock Exchange during the two trading days immediately preceding the
grant date. Options generally expire 10 years after the grant date and
are also subject to early expiry in the event of death, resignation,
dismissal or retirement of an optionee. Options vest over one to three
years, with one-third on each of the first, second and third anniversary
of the grant date for those vesting over three years.
For the purposes of calculating the stock-based compensation expense, the
fair value of stock options is estimated at the date of the grant using
the Black-Scholes option pricing model. No options were granted in the
third quarter of 2007. The weighted average fair value of 100,000 options
granted for the nine months ended July 31, 2007 was $1.92. The weighted
average fair value for the stock options granted for the three months and
nine months ended July 31, 2006 was $1.22 and $2.11, respectively. The
following assumptions were used in arriving at the fair value of options
issued during the nine months ended July 31, 2007:
Risk free interest rate 4.2%
Expected volatility 42%
Expected weighted average life of options 6 years
Expected dividend yield 0%
Stock-based compensation expense recorded in the three months ended
July 31, 2007 was $74,000 (2006 - $433,000) for options granted on or
after November 1, 2003. Stock-based compensation expense recorded in the
nine months ended July 31, 2007 was $168,000 (2006 - $925,000) for
options granted on or after November 1, 2003.
7. Repositioning expenses
The Company has incurred a number of expenses associated with its
performance enhancement program, which is intended to identify
operational improvements and cost reduction initiatives. The related
expenses include costs associated with a reduction in the work force and
consulting fees from external specialists who are assisting in
identifying operational improvements.
During the first half of 2007 the Company also incurred professional fees
and other costs in connection with its review of strategic and financial
alternatives.
The following is a summary of expenses associated with these initiatives
(collectively "repositioning expenses") for the three and nine months
ended July 31, 2007:
Three Nine
months months
ended ended
July 31, July 31,
-------------------------------------------------------------------------
2007 2007
$ $
-------------------------------------------------------------------------
Performance enhancement program:
-Employee-related expenses 1,048 2,827
-Consulting and professional fees 418 2,904
Strategic alternatives review - 3,355
-------------------------------------------------------------------------
1,466 9,086
-------------------------------------------------------------------------
-------------------------------------------------------------------------
As at July 31, 2007, $1,492,000 of the repositioning expenses are unpaid
and are recorded in accounts payable and accrued liabilities. This
includes amounts accrued during the 2006 fiscal year. Repositioning
expenses paid during the three months and nine months ended July 31, 2007
amounted to $5,117,000 and $16,722,000, respectively.
8. Other information
Foreign exchange
During the three months ended July 31, 2007, the foreign exchange gain on
operating exposures, net of cash flow hedges, (including the revaluation
of all foreign currency denominated assets and liabilities, other than
those liabilities designated as a hedge against foreign currency
denominated net investments) recorded in operating expenses was
$3,325,000 (2006 loss - $271,000). During the nine months ended July 31,
2007, the foreign exchange gain on operating exposures, net of cash flow
hedges, was $3,094,000 (2006 loss - $124,000).
During the nine months ended July 31, 2007 the Company recorded a foreign
exchange loss of $858,000 in connection with a change in the Company's
internal capital structure, which resulted in the recognition of foreign
exchange translation losses previously recorded in accumulated other
comprehensive income.
Employee future benefits
The employee future benefit expense in connection with defined benefit
pension plans and other post retirement benefit plans for the three
months ended July 31, 2007 was $1,630,000 (2006 - $1,410,000). For the
nine months ended July 31, 2007 the employee future benefit expense was
$4,624,000 (2006 - $3,408,000).
9. Financial instruments
The Company utilizes financial instruments to manage the risk associated
with fluctuations in foreign exchange and interest rates. The Company
formally documents all relationships between hedging instruments and
hedged items, as well as its risk management objective and strategy for
undertaking various hedge transactions.
As at July 31, 2007 the Company's Canadian operations had entered into
foreign exchange forward contracts to sell an aggregate amount of
US$27,000,000. These contracts hedge the Company's expected exposure to
U.S. dollar denominated cash flows and mature at the latest on
October 29, 2007 at exchange rates varying between $1.0847 and $1.16698
Canadian. The mark-to-market value on these financial instruments as at
July 31, 2007 was an unrealized gain of $1,450,000 which has been
recorded in accumulated other comprehensive income in shareholders'
equity.
As at July 31, 2007 the Company has designated $143.8 million of U.S.
dollar denominated debt as a hedge against its net investment in its
subsidiaries in the U.S.A. and Puerto Rico. The exchange gains and losses
arising from this debt, from the date so designated, are recorded in
accumulated other comprehensive income in shareholders' equity.
The Company has entered into interest rate swap contracts to convert all
of the interest costs on its $150 million senior secured term loan from a
floating to a fixed rate of interest until March 30, 2010. The mark-to-
market value of these financial instruments at July 31, 2007 was an
unrealized loss of $805,000 which has been recorded in accumulated other
comprehensive income in shareholders' equity.
10. Refinancing
Convertible Preferred Shares
----------------------------
On April 27, 2007 JLL Partners, through its investment vehicle, JLL
Holdings, LLC, purchased 150,000 convertible preferred shares of Patheon
for $150 million. Until October 27, 2009, no cash dividends will be paid
on the preferred shares, but the liquidation preference and conversion
rate will increase on a quarterly basis by 2.125%. After October 27,
2009, these increases in the liquidation preference and conversion rate
will continue until the maturity or prior conversion, unless the Company
elects to pay a cash dividend for any applicable quarter, in which case
the Company will pay a cash dividend for such quarter based on an annual
dividend rate of 8.5% on the aggregate liquidation preference of the
convertible preferred shares.
Each convertible preferred share is convertible into 214.1644 restricted
voting shares, as adjusted for any non-cash dividends noted above, at any
time at the holder's option. The Company is entitled to require the
holder to convert into restricted voting shares if, at any time after
October 27, 2009, the market price of the restricted voting shares on the
Toronto Stock Exchange exceeds a price equivalent to US$7.87 for a period
of at least 60 days.
If not previously converted, the Company is required to redeem the
convertible preferred shares for cash on April 27, 2017 at a price equal
to the aggregate liquidation preference of the convertible preferred
shares, plus accrued and unpaid dividends thereon. The Company is also
required to redeem the convertible preferred shares upon the occurrence
of a change of control of Patheon at a price equal to the greater of the
aggregate liquidation preference of the convertible preferred shares,
plus accrued and unpaid dividends thereon, or the price per share paid to
holders of restricted voting shares in the change of control transaction,
multiplied by the number of restricted voting shares into which the
convertible preferred shares are then convertible.
On issuance, the fair value of the debt component of the preferred shares
was $132,862,000. The remainder of the proceeds attributable to
shareholders' equity was $15,925,000, net of apportioned transaction
costs of $1,213,000.
Senior Secured Credit Facilities
--------------------------------
On April 27, 2007, the Company completed new credit facilities in the
aggregate amount of $225 million, comprising a seven-year $150 million
senior secured term loan and a five-year $75 million asset based
revolving credit facility. The Company is required to make quarterly
installment payments of $375,000 on the term loan facility, along with
additional mandatory repayments based on certain excess cash flow
measures. Interest on the facilities is at floating rates based on LIBOR,
US prime, or the federal funds effective rate, plus applicable margins.
The facilities are secured by substantially all of the assets of the
Company's operations in Canada, U.S.A., Puerto Rico and the U.K. and the
Company's investments in the shares of all other operating subsidiaries.
Net proceeds from the issue of the convertible preferred shares and the
senior secured term loan facility were used to repay the Company's
obligations under its existing North American and U.K. credit facilities.
11. Refinancing expenses and write-off of deferred financing costs
During the second quarter of 2007 the Company incurred expenses of
$13,471,000 in connection with its refinancing activities. The expenses
are made up of transaction costs for the new credit facilities, costs
allocated to the debt portion of the convertible preferred shares and
prepayment charges in connection with cancellation of certain of the
Company's U.K. debt facilities.
During the first quarter of 2006, the Company incurred charges of
$1,643,000 in connection with the cancellation and prepayment of certain
of its North American credit facilities. The Company also wrote off
$6,332,000 in related deferred financing costs.
12. Other comprehensive income
The amounts disclosed in other comprehensive income are net of income
taxes and take into account valuation reserves for future income taxes in
the Company's Canadian operations. For the three and nine months
ended July 31, 2007 there is no tax expense in connection with the change
in foreign currency gains on investments in subsidiaries, net of hedging
activities. Foreign currency losses on investments in subsidiaries, net
of hedging activities reclassified to the consolidated statement of
earnings (loss) are net of an income tax benefit of $1,935,000 for the
nine months ended July 31, 2007. The change in value of derivatives
designated as foreign currency and interest rate cash flow hedges are net
of a tax benefit of $116,000 for the three and nine months ended July 31,
2007. For the three and nine months ended July 31, 2007 there is no
income tax associated with the gains and losses on foreign currency cash
flow hedges reclassified to the consolidated statement of earnings
(loss). The gains on interest rate hedges reclassified to the
consolidated statement of earnings (loss) are net of an income tax
benefit of $343,000 for the nine months ended July 31, 2007.
13. Related party transactions
Revenues from companies controlled by a director and significant
shareholder of the Company were in the amount of $52,000 and $735,000 for
the three and nine months ended July 31, 2007, respectively. These
transactions were conducted in the normal course of business and are
recorded at the exchanged amount which management believes to be at fair
value. Accounts receivable at July 31, 2007 includes a balance of $88,000
resulting from these transactions.
At July 31, 2007 the Company has an investment of $698,000 representing
an 18% interest in two Italian companies whose largest investor is an
officer of the Company. These newly formed companies will specialize in
the manufacturing of cytotoxic pharmaceutical products.
14. Comparative amounts
Certain comparative amounts have been reclassified to conform to the
current period presentation.
Patheon Inc.
Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following management discussion and analysis of financial condition
and results of operations ("MD&A") of Patheon Inc. ("Patheon" or "the
Company") for the three-month and nine-month periods ended July 31, 2007 and
2006 should be read in conjunction with the Company's consolidated financial
statements and related notes contained in this interim report. This MD&A is
dated as of September 7, 2007.
The purpose of this 2007 third quarter report is to provide an update to
the information contained in the Company's Management's Discussion and
Analysis section of the Company's 2006 Annual Report, which contains a more
comprehensive discussion of the Company's strategy, capabilities to deliver
results, risks and key performance indicators. Management assumes that the
reader of this document has access to the MD&A section of the Company's 2006
Annual Report. This document and other information can be downloaded in
portable document format (PDF) from the Company's web site at www.patheon.com
or from the SEDAR web site for Canadian regulatory filings at www.sedar.com.
To request a printed copy, the reader may also contact Patheon's transfer
agent, Computershare Investor Services Inc., at 1-800-564-6253 or via email at
service@computershare.com, or Patheon at www.patheon.com.
Use of Non-GAAP Financial Measures
Except as otherwise indicated, references in this MD&A to "EBITDA before
repositioning expenses" are to earnings from continuing operations before
repositioning expenses, asset impairment charges, depreciation and
amortization, foreign exchange losses reclassified from other comprehensive
income, interest, refinancing expenses, write-off of deferred financing costs,
and income taxes. "EBITDA margin before repositioning expenses" is EBITDA
before repositioning expenses divided by revenues. EBITDA before repositioning
expenses and EBITDA margin before repositioning expenses are measures of
earnings or earnings margin not recognized by generally accepted accounting
principles in Canada ("Canadian GAAP"). Since each of these measures is a non-
GAAP measure that does not have a standardized meaning, it may not be
comparable to similar measures presented by other issuers. Prospective
investors are cautioned that these, and other non-GAAP measures should not be
construed as alternatives to net earnings determined in accordance with
Canadian GAAP as indicators of performance. The Company has included these
measures because it believes that this information is used by certain
investors to assess the financial performance of the Company, in particular
the operating earnings before non-cash charges and large and non-recurring
costs.
Overview of Patheon
Patheon is focused exclusively on providing commercial manufacturing and
pharmaceutical development services to pharmaceutical, biotechnology and
specialty pharmaceutical companies located primarily in North America, Europe
and Japan. Patheon serves its international clientele from its operating
facilities in North America (including Puerto Rico) and Europe.
Patheon commercially manufactures prescription ("Rx") and over-the-
counter ("OTC") products in solid, semi-solid and liquid dosage forms.
Conventional dosage forms include compressed tablets, hard-shell capsules,
powders, ointments, creams, gels, syrups, suspensions, solutions and
suppositories. Sterile dosage forms include liquids and powders filled in
ampoules, vials, bottles or pre-filled syringes. Sterile lyophilized products
are also manufactured in both vials and ampoules.
Patheon provides manufacturing services for a broad range of products in
many dosage forms and packaging formats in accordance with client
specifications. Depending on the particular client, Patheon may be responsible
for most or all aspects of the manufacturing and packaging process, from
sourcing excipient raw materials and packaging components to delivering the
finished product in consumer-ready form to the client. Typically, Patheon's
clients supply the active pharmaceutical ingredients ("API") used in the
production process.
The pharmaceutical development services provided by Patheon include most
of the pharmaceutical development services typically required by companies
conducting clinical trials and preparing for full-scale commercial production
of a new drug.
At July 31, 2007, there were a total of 187 client products in the
Patheon's pharmaceutical development services ("PDS") pipeline, including
eight drug candidates at the New Drug Application ("NDA") stage. This compares
with a total of 165 client products a year ago. During the third quarter of
2007, one product developed on behalf of a client was launched from the
Company's facilities.
Vision and Strategy
Patheon's vision is to be the leader in pharmaceutical contract
manufacturing. Patheon strives to be the preferred manufacturing and
pharmaceutical development services partner to the global pharmaceutical
industry. Patheon's strategy is focused on providing "best-in-class"
manufacturing and development services effectively balancing high product
quality and reliability of supply with cost.
Patheon expects that stronger manufacturing and development relationships
will continue to emerge between pharmaceutical companies and service companies
as the pharmaceutical industry continues to re-evaluate its internal
manufacturing capabilities and streamlines its external service-provider
network. The Company is using its position as a comprehensive provider of
commercial manufacturing and development services to establish and maintain
long-term, strategic relationships with clients on a global basis.
Prior to 2006, a key aspect of Patheon's strategy was a plan to expand
capacity, expertise and capabilities through acquisitions, positioning the
Company to be the preferred manufacturing services partner to the
pharmaceutical industry. This led to the acquisition of several pharmaceutical
manufacturing facilities and the entry into long-term manufacturing
relationships in conjunction with certain of these acquisitions. More recently
Patheon has focused on growing the business internally by expanding the level
of business from existing clients, attracting new clients, and entering into
commercial manufacturing agreements for newly approved products for which the
Company has provided development services.
In implementing its strategy, the Company will continue to maximize
capacity utilization and improve efficiency, broaden its services to include
other specialized manufacturing capabilities and seek to increase the
percentage of more profitable products manufactured at its facilities. In
addition, the Company will seek to expand its PDS capabilities in North
America and Europe to better serve the needs of the global pharmaceutical
industry. Pharmaceutical development services are an important source of new
business for commercial manufacturing of prescription pharmaceuticals.
Key Performance Drivers
In Patheon's 2006 Annual Report, several key performance drivers for the
Company were identified: (i) generating higher quality revenues by increasing
the percentage of higher margin Rx manufacturing and pharmaceutical
development services; (ii) improving capacity utilization at the Company's
sites which have a large fixed-cost base in the short term; (iii) improving
operating efficiencies through a performance enhancement program with
initiatives focused on a global procurement program, a workforce reduction
program and a manufacturing efficiency review process; and (iv) mitigating the
impact of changes in the foreign exchange trading relationship between the
Canadian and U.S. dollar, since the Company's contracts in North America are
primarily denominated in U.S. dollars, but the operating expenses of its
Canadian sites are primarily denominated in Canadian dollars. An update on our
interim performance relating to these key issues is provided in the sections
below entitled "Recent Developments" and "Results of Operations".
Recent Developments
Financing Arrangements and Strategic Alternatives
On September 11, 2006 the Company announced that its Board of Directors
had established a special committee to evaluate a range of strategic and
financial alternatives for the Company. As a result of this review, on
April 27, 2007 JLL Partners, through its investment vehicle, JLL Patheon
Holdings, LLC ("JLL Partners") purchased $150 million of convertible preferred
shares of the Company through a private placement. On April 27, 2007 the
Company also completed new credit facilities in the aggregate amount of
$225 million, comprising a seven-year $150 million term loan and a five-year
$75 million revolving facility.
The net proceeds from the JLL Partners investment and the seven-year term
loan were used to repay the Company's obligations under its existing North
American and U.K. credit facilities.
Restructuring the Canadian Site Network
On April 17, 2007 the Company announced that as part of its strategy to
focus on developing and manufacturing Rx pharmaceutical products and to
improve the Company's profitability, it plans to restructure its current
network of six pharmaceutical manufacturing facilities in Canada.
The Company plans to divest its Niagara-Burlington Operations business
that is focused on the commercial manufacturing of OTC products. The Niagara-
Burlington Operations to be divested consist of facilities in Fort Erie and
Burlington Gateway and the commercial operations at Burlington Century. The
Company plans to retain the Burlington Century facility where its central
quality control laboratory is also based. The results of operations of the
Niagara-Burlington Operations have been segregated and presented separately as
discontinued operations in the consolidated financial statements.
The Company also plans to close its York Mills, Toronto facility and
transfer substantially all commercial production and development services to
its site in Whitby and sell the land and buildings. The process of
transferring production to other facilities is expected to take 18 months.
The assets and the related liabilities of the Niagara-Burlington
Operations, along with the York Mills real estate have been classified as held
for sale on the balance sheet in the consolidated financial statements.
Results of Operations
The results of operations of the Niagara-Burlington Operations have been
segregated and presented separately as discontinued operations. All
comparative amounts have been reclassified to conform to the current period
presentation.
Revenues by Geographic Region and Service Activity
U.S.$ '000 Three months ended Nine months ended
July 31, July 31,
2007 2006 % 2007 2006 %
Change Change
-------------------------- --------------------------
North America
-------------
Commercial
Manufacturing
Prescription 65,221 74,437 -12% 213,972 231,971 -8%
Over-the-
counter 10,058 21,566 -53% 28,512 54,936 -48%
-------------------------- --------------------------
75,279 96,003 -22% 242,484 286,907 -15%
Development
Services 20,354 19,388 5% 61,381 54,334 13%
-------------------------- --------------------------
95,633 115,391 -17% 303,865 341,241 -11%
-------------------------- --------------------------
Europe
------
Commercial
Manufacturing
Prescription 70,246 55,480 27% 180,871 150,145 20%
Over-the-
counter 1,171 1,605 -27% 3,182 2,476 29%
-------------------------- --------------------------
71,417 57,085 25% 184,053 152,621 21%
Development
Services 8,458 6,263 35% 22,364 15,047 49%
-------------------------- --------------------------
79,875 63,348 26% 206,417 167,668 23%
-------------------------- --------------------------
TOTAL
-----
Commercial
Manufacturing
Prescription 135,467 129,917 4% 394,843 382,116 3%
Over-the-
counter 11,229 23,171 -52% 31,694 57,412 -45%
-------------------------- --------------------------
146,696 153,088 -4% 426,537 439,528 -3%
Development
Services 28,812 25,651 12% 83,745 69,381 21%
-------------------------- --------------------------
CONSOLIDATED
REVENUES 175,508 178,739 -2% 510,282 508,909 0%
-------------------------- --------------------------
-------------------------- --------------------------
Three Months Ended July 31, 2007 Compared with Three Months Ended
July 31, 2006
Revenues
Consolidated revenues for the three-month period ended July 31, 2007
decreased 2%, or $3.2 million, to $175.5 million from $178.7 million in the
same period in 2006. In the third quarter, revenues increased for Rx
manufacturing and PDS, but decreased in OTC. On a consolidated basis, compared
with the third quarter of 2006, Rx and PDS revenues increased by 4% and 12%,
respectively, and OTC revenues declined by 52%.
For the three-month period ended July 31, 2007 revenues excluding the
Puerto Rico operations were $153.5 million, compared with $150.8 million in
the same period last year.
Prescription manufacturing and development services represented 94% of
revenues, compared with 87% for the comparable period in 2006. This
improvement is consistent with one of the Company's key performance drivers of
increasing the percentage of higher margin Rx and PDS business.
Geographically, in North America, revenues declined in the third quarter
by $19.8 million or 17% over the same period a year ago. The decrease reflects
a significant decline in OTC revenues in Whitby and Cincinnati, where certain
clients have repatriated products back to their own manufacturing networks. Rx
revenues declined in Puerto Rico as a result of the elimination of
manufacturing of Zocor(R), which lost its patent protection in June 2006 and
lower revenues for Omnicef(R), which was impacted by the launch of generic
competitive products in May of 2007. The Company is manufacturing the
authorized generic of Omnicef(R) and revenues for the pipeline fill of this
product in the third quarter partially offset the reduction in revenues for
the branded product.
In Europe, revenues for the third quarter of 2007 increased by $16.5
million or 26% over the same period of 2006. The year-over-year increase
reflects higher Rx manufacturing revenues from all operations. Gains in France
and Italy reflect the continuing benefits from two carve out initiatives,
where the Company is manufacturing a range of products for two clients that
have closed down facilities within their own manufacturing network. PDS
operations in Swindon also continued to show further increases in volumes. The
Euro strengthened approximately 7% and U.K. sterling strengthened
approximately 8% against the U.S. dollar relative to the same period last
year, increasing reported revenues by approximately $5.3 million. Had European
currencies remained constant to the rates of the prior year, European revenues
would have been 18% higher than the same period in 2006.
Operating Expenses
Operating expenses comprise processing costs (principally materials,
employee and other site-related costs), marketing, sales, service, corporate
support, administrative expenses and foreign exchange gains and losses. In the
third quarter of 2007, operating expenses were $152.4 million, being
$11.4 million lower than the same period a year ago. Operating expenses were
principally impacted by lower commercial manufacturing volumes, savings from
the performance enhancement program and foreign exchange gains, offset in part
by the strengthening of European and Canadian currencies relative to the U.S.
dollar. Operating expenses as a percentage of revenues were 86.8%, compared
with 91.6% in the same period a year ago.
EBITDA Before Repositioning Expenses and EBITDA Margin Before
Repositioning Expenses
On a consolidated basis in the third quarter of 2007, EBITDA before
repositioning expenses, representing earnings before repositioning expenses,
asset impairment charge, depreciation and amortization, foreign exchange
losses reclassified from other comprehensive income, interest, refinancing
expenses, write-off of deferred financing costs, and income taxes was
$23.1 million, compared with $15.0 million in the same period a year ago.
EBITDA margin before repositioning expenses was 13.2% in the three-month
period, compared with 8.4% in the same period a year ago.
For the three-month period ended July 31, 2007 EBITDA before
repositioning expenses excluding the Puerto Rico operations was $30.1 million,
compared with $18.0 million in the same period last year. This represents an
EBITDA margin before repositioning expenses of 19.6% in the three month
period, compared with 11.9% in the same period last year.
In Canada, EBITDA before repositioning expenses from the commercial
operations was $7.0 million, being $0.9 million higher than the same period
last year. This improvement is despite a significant reduction in volumes at
Whitby and reflects operating efficiency gains and cost savings arising from
the profit enhancement program. EBITDA before repositioning expenses was not
significantly impacted by foreign exchange in the third quarter of 2007, as
the negative earnings impact of the strengthening Canadian dollar relative to
the U.S. dollar, was offset by gains from the Company's foreign exchange cash
flow hedging program.
In the U.S.A. (including Puerto Rico), EBITDA before repositioning
expenses for the commercial operations was a loss of $4.3 million, compared
with a loss of $1.2 million in the same period last year. The significant
decline principally reflects a reduction in Rx manufacturing volumes in the
Caguas, Puerto Rico facility, which previously manufactured Zocor(R). The
Carolina operations were able to offset volume declines in Omnicef(R) with
cost savings and efficiency improvements relative to the same period last
year. OTC revenue declines in Cincinnati were replaced with higher margin Rx
business.
In Europe, EBITDA before repositioning expenses from the commercial
operations was $14.7 million, being $6.4 million higher than the same period a
year ago. The improvement reflects the volume gains in all operations. The
strengthening European currencies relative to the US dollar compared with the
same period last year also had the impact of increasing EBITDA before
repositioning expense by approximately $0.9 million.
EBITDA before repositioning expenses from the global PDS operations was
$6.4 million, being $0.5 million higher than the same period in 2006. The
increase reflects revenue growth across all of the operations, with the
exception of Puerto Rico.
Corporate costs in the third quarter of 2007 were $3.4 million lower than
the same period last year. This reduction principally reflects the benefit of
foreign exchange gains arising from the revaluation of US dollar denominated
debt held in the Canadian legal entity and lower administrative costs.
Asset Impairment Charge
During the third quarter of 2007 it was determined that the carrying
value of the intangible assets and depreciable tangible capital assets
(collectively the "long-lived depreciable assets") at the Company's operations
in Carolina, Puerto Rico were impaired as a result of volume declines arising
from the genericization of Omnicef(R), this being the largest single product
that is manufactured at the facility. The Company tested the recoverability of
the long-lived depreciable assets at the Carolina operations and determined
that the expected future cash flows over the economic life of the principal
assets was less than the carrying value of the long-lived depreciable assets.
As a result the Company recorded an impairment charge of $48.6 million;
$26.1 million for intangible assets and $22.5 million for tangible capital
assets. The fair value of the intangible assets was determined using a
discounted cash flow methodology and the fair value of the tangible capital
assets was based on a weighted average continued use and liquidation value.
During the third quarter of 2006 the Company determined that the carrying
value of the long-lived depreciable assets at the Company's operations in
Caguas and Manati, Puerto Rico and the goodwill associated with all of the
Puerto Rico operations were impaired as a result of certain events which
occurred during the third quarter of 2006. These events included: continued
deterioration in revenues culminating in a significant increase in losses
reported in the third quarter; suspension of production of a major product due
to concerns over product shelf life; the risk of a decline in revenue of
another major product as a result of the approval by the U.S. Food and Drug
Administration of a generic version of the product; and the completion of a
long range plan that showed a significant reduction in earnings relative to
prior forecasts.
The Company tested the recoverability of the long lived depreciable
assets for all of the Puerto Rico operations and determined that at Caguas and
Manati the expected future cash flows over the economic life of the principal
assets were less than the carrying value of the long-lived depreciable assets.
As a result the Company recorded an impairment charge of $81.4 million;
$51.9 million for intangible assets and $29.5 million for tangible capital
assets. The fair value of the intangible assets was determined using a
discounted cash flow methodology and the fair value of tangible capital assets
was based on a value in continued use, taking into account utilization levels.
During the third quarter of 2006 the Company also tested the
recoverability of the goodwill associated with Puerto Rico operations using a
discounted cash flow methodology, and recorded an impairment charge of
$172.5 million representing the full value of the Puerto Rico goodwill.
During the third quarter of 2006 the Company, as part of its ongoing
review of long term investments, concluded that its investment in the shares
of a drug technology company which was accounted for on the cost basis had an
other than temporary decline and wrote down its value by $0.8 million to its
market value as of July 31, 2006.
Repositioning Expenses
During the third quarter of 2007 the Company incurred $1.5 million of
expenses in connection with its performance enhancement program. The expenses
were principally associated with cost saving initiatives being undertaken in
the Caguas and Carolina facilities in Puerto Rico.
Depreciation and Amortization Expense
Depreciation and amortization expense was $9.8 million in the third
quarter of 2007, being comparable with the expense of $9.9 million in the
third quarter of 2006.
Amortization of Intangible Assets
Amortization of intangible assets was $1.2 million in the third quarter
of 2007, compared with $2.8 million for the third quarter of 2006. The
amortization of intangible assets relates to the Puerto Rico operations. The
charge is lower than for the same period last year due to the impact of the
impairment charge booked in the third quarters of 2007 and 2006.
Interest Expense and Amortization of Deferred Financing Costs
Interest expense for the third quarter of 2007 was $7.4 million, compared
with $5.2 million in the third quarter of 2006. The increase in interest costs
principally reflects the impact of the new financing arrangements that were
put in place on April 27, 2007 and includes a non-cash accretive interest
charge of $3.5 million in respect of the debt component of the convertible
preferred shares.
Effective November 1, 2006, the Company adopted CICA Accounting Standard
Section 3855 for the accounting of financial instruments, including its policy
on deferring costs of obtaining bank and other debt financing (see "Critical
Accounting Policies and Estimates"). As a result, amounts that in prior
periods were recorded as amortization of deferred financing costs are now
recorded in interest expense.
Loss Before Income Taxes from Continuing Operations
The Company reported a loss before income taxes of $45.3 million,
compared with a loss of $257.7 million in the same period a year ago.
Income Taxes
The Company recorded an income tax charge of $5.3 million in the third
quarter of 2007, compared with a minor recovery in the same period last year.
The income tax charge in 2007 principally reflects the asset impairment charge
and operating losses in Puerto Rico, where the tax benefits recognized were
minimal, compounded by high tax rates in Italy where the Company reported
significant profits.
Loss and Loss Per Share from Continuing Operations
The Company recorded a loss from continuing operations in the third
quarter of 2007 of $50.7 million, compared with a loss of $257.7 million in
the same period last year. The loss per share was 54.5 cents, compared with a
loss of $2.78 per share a year earlier. The loss in 2007 included an after tax
asset impairment charge of $47.8 million or 51.4 cents per share and after tax
repositioning expenses of $1.5 million or 1.6 cents per share. The loss in
2006 included after tax asset impairment charge of $252.1 million, or $2.72
per share.
Because the Company reported a loss in the third quarter of 2007 and
2006, there is no impact of dilution.
Earnings (Loss) and Earnings (Loss) Per Share from Discontinued
Operations
Discontinued operations include the results of the Niagara-Burlington
Operations. Financial details of the operating activities are disclosed in
Note 5 in the interim consolidated financial statements. The net loss from
discontinued operations in the third quarter of 2007 was $12.4 million, or
13.3 cents compared with net earnings of $0.5 million or 0.5 cents in the same
period last year. The net loss in 2007 includes an asset impairment charge of
$13.0 million, or 14.0 cents per share, to write down the capital assets to
their fair market value less cost to sell.
Nine Months Ended July 31, 2007 Compared with Nine Months Ended July 31,
2006
Revenues
Consolidated revenues for the nine-month period ended July 31, 2007
increased $1.4 million to $510.3 million from $508.9 million in the same
period in 2006. Rx manufacturing and PDS revenues grew by 3% and 21%,
respectively, while OTC manufacturing revenues declined by 45%.
For the nine-month period ended July 31, 2007 revenues excluding the
Puerto Rico operations were $425.3 million, compared with $413.0 million in
the same period last year.
Prescription manufacturing and development services represented 94% of
revenues, compared with 89% for the comparable period in 2006. This
improvement is consistent with one of the Company's key performance drivers of
increasing the percentage of higher margin Rx and PDS business.
Geographically, in North America, revenues for the nine-months ended
July 31, 2007 declined by $37.4 million or 11% over the same period a year
ago. The decline reflects a significant reduction in OTC volumes in the Whitby
and Cincinnati operations as certain clients have repatriated products back to
their own manufacturing network. Rx volumes declined in Caguas, Puerto Rico as
a result of lower production of Zocor(R) and Levothyroxine sodium. This was
offset in part by increased volumes in Carolina during the first quarter of
2007, where in the prior year the facility had been impacted by a temporary
shut down in production to resolve issues with regard to a warning letter
issued by the U.S. Food and Drug Administration ("FDA"). Rx revenues were also
lower in Canada principally as a result of lower volumes for a product where
in 2006 the Company's client was building trade inventory levels for a newly
launched product. The declines in commercial manufacturing revenues were
offset in part by a significant increase in PDS revenues in Canada and
Cincinnati.
In Europe, revenues for the nine-months ended July 31, 2007 were
$38.7 million or 23% higher than the same period of 2006. The year-over-year
increase in revenues reflects higher Rx manufacturing revenues from operations
in Italy and France arising from the continuing benefits from two carve out
initiatives, where the Company is manufacturing a range of products for two
clients that have closed down facilities within their own manufacturing
network. PDS operations in Swindon, U.K. also continued to show further
increases in volumes. These gains were offset in part in the first half of the
year by lower pre-launch commercial revenues for the cephalosporin
lyophilization services in Swindon. The Euro strengthened approximately 9% and
U.K. sterling strengthened approximately 10% against the U.S. dollar relative
to the same period last year, increasing reported revenues by approximately
$17.0 million. Had European currencies remained constant to the rates of the
prior year, European revenues would have been 13% higher than the same period
in 2006.
Operating Expenses
Operating expenses comprise processing costs (principally materials,
employee and other site-related costs), marketing, sales, service, corporate
support, administrative expenses and foreign exchange gains and losses. In the
nine-month period ended July 31, 2007 operating expenses were $441.2 million,
compared with $456.8 million in the same period a year ago, a decline of 3%.
The decline reflects savings from the performance enhancement program and
foreign exchange gains, offset in part by the strengthening European and
Canadian currencies relative to the U.S. dollar.
Operating expenses as a percentage of revenues were 86.5%, compared with
89.8% in the prior year.
EBITDA Before Repositioning Expenses and EBITDA Margin Before
Repositioning Expenses
On a consolidated basis for the nine-month period ended July 31, 2007,
EBITDA before repositioning expenses, representing earnings before
repositioning expenses, asset impairment charges, depreciation and
amortization, foreign exchange losses reclassified from other comprehensive
income, interest, refinancing expenses, write-off of deferred financing costs,
and income taxes was $69.1 million, an increase of $17.0 million, or 33%, from
the comparable period in 2006. EBITDA margin before repositioning expenses was
13.5% in the nine-month period ended July 31, 2007, compared with 10.2% in the
same period a year ago.
For the nine-month period ended July 31, 2007 EBITDA before repositioning
expenses excluding the Puerto Rico operations was $78.1 million, compared with
$50.9 million in the same period last year. This represents an EBITDA margin
before repositioning expenses of 18.4% in the nine month period, compared with
12.3% in the same period last year.
The Canadian commercial operations reported EBITDA before repositioning
expenses of $22.5 million, or $5.2 million higher than the same period last
year. The improvement reflects savings from the performance enhancement
program, in particular at the Whitby operations, offset in part by lower Rx
and OTC volumes. EBITDA before repositioning expenses was not significantly
impacted by foreign exchange, as the negative earnings impact of the 1%
increase in the average Canadian dollar exchange rate relative to the U.S.
dollar was offset by foreign exchange gains from the Company's cash flow
hedging program.
EBITDA before repositioning expenses from the U.S.A. commercial
operations (including Puerto Rico) was a loss of $2.7 million, compared with a
profit of $8.3 million in the same period last year. The decline principally
reflects a reduction in Rx manufacturing volumes in the Caguas facility,
offset in part by higher profitability in Carolina, which in the first quarter
of 2006 was impacted by a temporary shut down in production. The Caguas
operations also incurred significant costs in the third quarter of 2007 in
connection with the launch of a new large-volume product.
In Europe, EBITDA before repositioning expenses from commercial
operations was $33.1 million being $10.5 million higher than the same period
last year. The improvement reflects increased volumes in the operations in
Italy and France, offset in part in the first half of the year by lower pre-
launch revenues for the cephalosporin lyophilization services in Swindon. The
strengthening European currencies against the US dollar compared with the same
period last year also had the impact of increasing EBITDA before repositioning
expense by approximately $2.5 million.
EBITDA before repositioning expenses from the global PDS operations was
$21.2 million, being $7.6 million higher than the same period in 2006. This
reflects improved profitability in Europe, Canada and Cincinnati.
Corporate costs for the nine-month period ended July 31, 2007 were
$4.7 million lower than the same period last year, reflecting cost savings and
the benefit of foreign exchange gains in the third quarter of 2007.
Repositioning Expenses
During the nine-month period ended July 31, 2007 the Company incurred
$9.1 million of expenses in connection with its performance enhancement
program and its review of strategic and financial alternatives. The expenses
include consulting fees associated with the manufacturing efficiency review,
costs associated with reductions in the work force and professional and other
costs in connection with the strategic alternatives review.
Depreciation and Amortization Expense
Depreciation and amortization expense was $30.5 million for the nine
months ended July 31, 2007, compared with $29.1 million in the same period of
2006, an increase of $1.4 million, or 5%. The increase principally reflects
the effect of the strengthening European currencies relative to the U.S.
dollar.
Amortization of Intangible Assets
The amortization of intangible assets was $5.6 million in the nine months
ended July 31, 2007, compared with $9.7 million in the same period of 2006.
The amortization of intangible assets relates to the Puerto Rico operations.
The charge is lower than for the same period last year due to the impact of
the impairment charges made during the third quarters of 2007 and 2006.
Interest Expense and Amortization of Deferred Financing Costs
Interest expense for the nine months ended July 31, 2007 was $21.7
million, compared with $15.1 million in the same period a year ago. The
increase in interest costs in the first half of the year reflected higher debt
levels, along with increased borrowing costs as a result of the amendments to
the Company's North American loan facilities. Interest expense in the third
quarter of 2007 reflects the impact of the Company's refinancing that was
completed on April 27, 2007 and includes a non-cash expense of $3.5 million in
respect of the debt component of the convertible preferred shares.
In 2007, the Company has adopted CICA Accounting Standard Section 3855
for the accounting of financial instruments, including its policy on deferring
costs of obtaining bank and other debt financing (see "Critical Accounting
Policies and Estimates"). As a result, amounts that in prior periods were
recorded as amortization of deferred financing costs are now recorded in
interest expense.
Refinancing Expenses and Write-off of Deferred Financing Costs
All refinancing expenses of $13.5 million for the nine months ended
July 31, 2007 were incurred in connection with the Company's refinancing on
April 27, 2007. The expenses are made up of transaction costs for the new
credit facilities, transaction costs allocated to the debt portion of the
convertible preferred shares and repayment charges in connection with the
cancellation of certain of the Company's U.K. debt facilities.
During the first quarter of 2006, the Company incurred charges of
$1.6 million in connection with the cancellation and prepayment of certain of
its North American credit facilities. The Company also wrote off $6.3 million
in related deferred financing costs.
Loss Before Income Taxes from Continuing Operations
The Company reported a loss before income taxes of $60.7 million in the
nine months ended July 31, 2007, compared with a loss of $265.0 million in the
same period a year ago.
Income Taxes
The income tax expense for the nine months ended July 31, 2007 was
$14.7 million, compared with an expense of $1.6 million for the same period
last year. The income tax charge in 2007 principally reflects tax losses in
certain entities in Puerto Rico and Canada, where the tax benefit after
valuation reserves has not been recognized, compounded by high tax rates in
Italy where the Company reported significant profits. The 2007 expense
includes a charge of $2.1 million in connection with an inter-company dividend
payment and a charge of $1.9 million in connection with the transfer of net
foreign exchange losses from accumulated other comprehensive income.
Loss and Loss Per Share from Continuing Operations
The Company recorded a loss from continuing operations for the nine
months ended July 31, 2007 of $75.4 million, compared with a loss of
$266.6 million in the same period a year ago. The loss per share was
81.1 cents compared with $2.87 a year earlier. The loss for the nine months
ended July 31, 2007 included an after tax asset impairment charge of
$47.8 million, or 51.4 cents per share, after-tax repositioning expenses of
$8.1 million, or 8.7 cents per share and after-tax refinancing expenses of
$12.6 million, or 13.5 cents per share. The loss for the nine months ended
July 31, 2006 included an after-tax asset impairment charge of $252.1 million,
or $2.72 per share and after tax costs for debt prepayment charges and the
write-off of deferred financing costs of $6.2 million, or 6.6 cents per share.
Because the Company reported a loss in the nine months ended July 31,
2007 and 2006 there is no impact of dilution.
Earnings (Loss) and Earnings (Loss) Per Share from Discontinued
Operations
The net loss from discontinued operations in the nine months ended
July 31, 2007 was $11.7 million, or 12.6 cents compared with net earnings of
$0.8 million or 0.9 cents in the same period last year. The net loss in 2007
includes an asset impairment charge of $13.0 million, or 14.0 cents per share
to write down the capital assets to their fair market value less cost to sell.
Seasonal Variability of Results
Historically, the Company's manufacturing and PDS revenues are lower in
the first fiscal quarter. The Company attributes this to several factors,
including: (i) many clients reassess their need for additional product in the
last quarter of the calendar year in order to use existing inventories of
products; (ii) the lower production of seasonal cough and cold remedies; (iii)
many small pharmaceutical and small biotechnology clients involved in PDS
projects limit their project activity toward the end of the calendar year in
order to reassess progress on their projects and manage cash resources; and
(iv) the Patheon-wide plant shut-down during a portion of the traditional
holiday period in December and January.
Liquidity and Capital Resources
Summary of Cash Flows
The following table summarizes the Company's cash flows for the periods
indicated:
Three months ended Nine months ended
July 31, July 31,
2007 2006 2007 2006
-------------------- --------------------
$ $ $ $
-------------------- --------------------
Net loss from continuing
operations (50,668) (257,698) (75,408) (266,557)
Depreciation and amortization 11,057 12,735 36,137 38,779
Write-off of deferred
financing costs - - - 6,332
Asset impairment charge 48,580 254,661 48,580 254,661
Foreign exchange loss - - 858 -
Amortization of deferred
financing costs 126 136 1,506 598
Employee future benefits (65) 941 323 793
Future income taxes 3,104 (5,757) 3,172 (3,164)
Accretive interest on
convertible preferred shares 3,481 - 3,481 -
Amortization of deferred
revenues (547) (498) (1,516) (1,493)
Other (3,171) 562 (3,820) 1,433
Working capital (17,189) 2,896 (24,184) (15,605)
Increase in deferred revenues 2,057 - 2,057 9,614
-------- -------- -------- --------
Cash provided by (used in)
operating activities (3,235) 7,978 (8,814) 25,391
Cash used in investing
activities (9,813) (15,568) (24,121) (43,292)
Cash provided by financing
activities 8,771 19,772 19,153 11,894
Net increase (decrease) in
cash and cash equivalents
from discontinued operations (210) 1,054 3,957 3,066
Other (1,555) 534 (402) 431
-------- -------- -------- --------
Net increase (decrease) in
cash and cash equivalents (6,042) 13,770 (10,227) (2,510)
-------- -------- -------- --------
-------- -------- -------- --------
Cash Provided by (Used in) Operating Activities - Continuing Operations
Cash used in operating activities was $3.2 million in the third quarter
of 2007 compared with a cash inflow of $8.0 million for the comparable period
in 2006. On a year-to-date basis, cash used in operating activities was
$8.8 million, compared with a cash inflow of $25.4 million in the same period
last year. The year-to-date deterioration principally reflects lower earnings
before non-cash charges and the impact of higher receivable and inventory
levels. In addition in 2007, the Company has received $2.1 million from
clients to assist in the funding of capital expenditure projects that are tied
to specific manufacturing and supply agreements. This compares with $9.6
million that was received during the same period last year. These amounts are
recorded as an increase in deferred revenues and will be recognized as income
over the life of the commercial manufacturing contract.
Cash Used in Investing Activities - Continuing Operations
Cash used in investing activities in the third quarter of 2007 was
$9.8 million, compared with $15.6 million in the same period a year ago. On a
year-to-date basis, cash used in investing activities was $24.1 million,
compared with $43.3 million in the same period last year. The decrease for the
third quarter and year-to-date principally reflects lower project related
capital expenditures on the cephalosporin lyophilization capacity in the
Swindon, U.K. facility. The major expenditures for this expansion were
incurred in 2006.
A summary of cash used in investing activities is as follows:
Three months ended Nine months ended
July 31, July 31,
2007 2006 2007 2006
-------------------- --------------------
$ $ $ $
-------------------- --------------------
Additions to capital assets
-sustaining (3,364) (3,766) (8,868) (9,887)
-project related (5,040) (10,680) (12,249) (31,826)
Net increase in investments (293) - (177) -
Increase in deferred
pre-operating costs (1,116) (1,122) (2,827) (1,579)
-------- -------- -------- --------
Cash used in investing
activities of continuing
operations (9,813) (15,568) (24,121) (43,292)
-------- -------- -------- --------
-------- -------- -------- --------
Cash Provided by Financing Activities
The principal financing activity for the nine months ended July 31, 2007
was the issue, through a private placement, of $150 million of convertible
preferred shares of the Company to JLL Partners and the completion of new
credit facilities in the aggregate amount of $225 million, comprising of a
seven-year $150 million term loan and a five-year $75 million revolving
facility. The net proceeds from the JLL Partners investment and the seven-year
term loan were used to repay the Company's obligations under its existing
North American and U.K. credit facilities.
The principal financing activity during the nine months ended July 31,
2006 was the completion of new credit facilities in North America in the
aggregate amount of $290.0 million to refinance existing debt of the Company
and its U.S. subsidiaries. The Company was able to release $7.8 million of
restricted cash that had previously been held as security for certain of the
cancelled facilities. During the first quarter of 2006 the Company's Italian
subsidiary also entered into a new long-term debt facility in the amount of
(euro) 28.5 million ($33.9 million) to replace existing loans.
A summary of cash provided by financing activities is as follows:
Three months ended Nine months ended
July 31, July 31,
2007 2006 2007 2006
-------------------- --------------------
$ $ $ $
-------------------- --------------------
Increase (decrease) in bank
indebtedness 9,078 (1,446) 7,762 (14,137)
Increase in long-term debt 6,812 62,803 182,652 373,946
Repayment of long-term debt (7,119) (41,665) (320,072) (353,010)
Issue of convertible preferred
shares - - 150,000 -
Convertible preferred share
issue costs - equity component - - (1,213) -
Issue of restricted voting
shares - 80 24 80
Decrease in restricted cash - - - 7,805
Increase in deferred
financing costs - - - (2,790)
-------- -------- -------- --------
Cash provided by financing
activities of continuing
operations 8,771 19,772 19,153 11,894
-------- -------- -------- --------
-------- -------- -------- --------
Financing Arrangements and Ratios
Convertible Preferred Shares
----------------------------
The $150 million 8.5% convertible preferred shares purchased by JLL
Partners on April 27, 2007 represent 150,000 units, each consisting of one
Class I Preferred Share, Series C and one Class I Preferred Share, Series D at
a purchase price of $1,000 per unit.
Until October 27, 2009, no cash dividends will be paid, but the
liquidation preference and conversion rate will increase on a quarterly basis
by 2.125%. After October 27, 2009, these increases in the liquidation
preference and conversion rate will continue until the maturity or prior
conversion of the convertible preferred shares, unless the Company elects to
pay a cash dividend for any applicable quarter, in which case the Company will
pay a cash dividend for such quarter based on an annual dividend rate of 8.5%
on the aggregate liquidation preference of the convertible preferred shares.
Each convertible preferred share is convertible into 214.1644 Patheon
restricted voting shares, as adjusted for any non-cash dividends noted above,
at any time at the holder's option. The Company will be entitled to require
the holder to convert into restricted voting shares if, at any time after
October 27, 2009, the market price of the restricted voting shares on the
Toronto Stock Exchange exceeds a price equivalent to US$7.87 for a period of
at least 60 days.
If not previously converted, the Company is required to redeem the
convertible preferred shares for cash on April 27, 2017 at a price equal to
the aggregate liquidation preference of the convertible preferred shares, plus
accrued and unpaid dividends thereon. The Company is also required to redeem
the convertible preferred shares upon the occurrence of a change of control of
Patheon at a price equal to the greater of the aggregate liquidation
preference of the convertible preferred shares, plus accrued and unpaid
dividends thereon, or the price per share paid to holders of restricted voting
shares in the change of control transaction, multiplied by the number of
restricted voting shares into which the convertible preferred shares are then
convertible.
The convertible preferred shares have the right to vote, together with
the holders of the restricted voting shares, on an as-if converted basis, in
respect of all matters other than the election of directors. These voting
rights represent approximately 25% of the voting rights of Patheon. The
special voting preferred shares have the right to appoint up to three
directors. The convertible preferred shares are considered to be a compound
financial instrument with both a debt and equity component. On issuance, the
fair value of the debt component was $132.9 million. The remainder of the
proceeds, attributable to shareholders' equity was $15.9 million, net of
apportioned transaction costs of $1.2 million. See Convertible Preferred
Shares in "Critical Accounting Policies and Estimates" below with regard to
how the Convertible Preferred Shares have been accounted for.
$225 Million Credit Facilities
------------------------------
On April 27, 2007 the Company completed new credit facilities in the
aggregate amount of $225 million, comprising a seven-year $150 million senior
secured term loan and a five-year $75 million asset based revolving credit
facility. The Company is required to make quarterly installment payments of
$375,000 on the term loan facility, along with additional mandatory repayments
based on certain excess cash flow measures. Interest on the facilities is at
floating rates based on LIBOR, US prime, or the federal funds effective rate,
plus applicable margins. The facilities are secured by substantially all of
the assets of the Company's operations in Canada, U.S.A., Puerto Rico and the
U.K and the Company's investments in the shares of all other operating
subsidiaries.
Financial Ratios
----------------
Total interest bearing debt, including the debt component of the
convertible preferred shares, at July 31, 2007 was $362.7 million, being
$13.1 million higher than at October 31, 2006. At July 31, 2007, the Company's
consolidated ratio of interest-bearing debt to shareholders' equity was
186.8%, compared with 139.4% at October 31, 2006. The increase principally
reflects the reduction in shareholders' equity arising from the losses that
the Company has incurred in the nine months ended July 31, 2007.
Adequacy of Financial Resources
With the completion of the new financing arrangements on April 27, 2007,
the Company believes that its financial resources are sufficient to fund
projected capital expenditures, debt service requirements and employee future
benefit obligations in the normal course of business. The risks associated
with going concern uncertainty reported in the Company's 2006 Annual Report
have now been eliminated.
Critical Accounting Policies and Estimates
Changes in and Significant New Accounting Policies
Effective November 1, 2006 the Company adopted the Canadian Institute of
Chartered Accountants Handbook Section 3855 "Financial Instruments -
Recognition and Measurement", Section 3865 "Hedges", Section 1530
"Comprehensive Income" and Section 3861 "Financial Instruments - Disclosure
and Presentation". The adoption of the new standards resulted in changes in
accounting for financial instruments and hedges as well as the recognition of
certain transition adjustments that have been recorded in accumulated other
comprehensive income. The comparative interim consolidated financial
statements have not been restated, except for the reclassification of amounts
previously recorded as cumulative translation adjustment, which are now
included in accumulated other comprehensive income. For a description of the
principal changes in accounting policy see Note 1 to the consolidated
financial statements.
In the second quarter of 2007 the Company changed its accounting policy
relating to costs of obtaining bank and other debt financing. Under the new
policy all transaction costs, including fees paid to advisors and other
related costs, are expensed as incurred. Financing costs, including
underwriting and arrangement fees paid to lenders are deferred and netted
against the carrying value of the related debt and amortized into interest
expense using the effective interest rate method. The Company previously
deferred all transaction and financing costs associated with obtaining bank
and other debt financing. Under the new requirements of CICA Handbook Section
3855, all deferred costs are netted off against the fair value of the debt.
The Company believes that the new policy is reliable and more relevant as it
results in a more transparent treatment of transaction costs that the Company
has incurred in its recent refinancing activities and in the carrying value of
debt. The change in policy has been made retrospectively effective November 1,
2006 and had the effect of increasing the retained deficit at November 1, 2006
by $1.7 million and reducing the interest expense and net loss for the three
months ended January 31, 2007 by $0.6 million.
As a result of the issuance of the convertible preferred shares on April
27, 2007, the Company has also added a new accounting policy for convertible
preferred shares as detailed below.
General
Patheon's significant accounting policies are described in Note 1 to the
2006 audited consolidated financial statements. The most critical of these
policies are those related to revenue recognition, deferred revenues,
intangible assets, impairment of long lived depreciable assets, goodwill,
employee future benefits, and income taxes, (Notes 1, 7, 9, 13 and 17 of the
2006 audited consolidated financial statements).
The preparation of the consolidated financial statements in conformity
with Canadian generally accepted accounting principles requires management to
make estimates and assumptions that affect: the reported amounts of assets and
liabilities; the disclosure of contingent assets and liabilities at the date
of the consolidated financial statements; and the reported amounts of revenue
and expenses in the reporting period. Management believes that the estimates
and assumptions used in preparing its consolidated financial statements are
reasonable and prudent; however, actual results could differ from those
estimates.
The Company's Accounting Policies have been reviewed and discussed with
the Company's Audit Committee.
Revenue Recognition
The Company recognizes revenue for its commercial manufacturing and
pharmaceutical development services when services are completed in accordance
with specific agreements with its clients and when all costs connected with
providing these services have been incurred, the price is fixed or
determinable and collectibility is reasonably assured. Client deposits on
pharmaceutical development services in progress are included in accounts
payable and accrued liabilities.
The Company does not receive any fees on signing of contracts. In the
case of pharmaceutical development services, revenue is recognized on the
achievement of specific milestones in accordance with the respective
development service contracts. In the case of commercial manufacturing
services, revenue is recognized when services are complete and the product has
met rigorous quality assurance testing.
Deferred Revenues
The costs of certain capital assets are reimbursed to the Company by the
pharmaceutical companies that are to benefit from the improvements in
connection with the manufacturing and packaging agreements in force. These
reimbursements are recorded as deferred revenues and are recognized as income
over the remaining minimum term of the agreements. During the third quarter of
2007, $0.5 million was recognized as earnings and $2.1 million was received as
a capital expenditure reimbursement. During the nine months ended July 31,
2007, $1.5 million was recognized as earnings and $2.1 million was received as
a capital expenditure reimbursement.
Intangible Assets
Intangible assets represent the values assigned to acquired client
contracts and relationships. They are amortized on a straight-line basis over
their estimated economic life. During the third quarter of 2007, $1.2 million
was charged to earnings. During the nine months ended July 31, 2007, $5.6
million was charged to earnings.
Impairment of Long Lived Depreciable Assets
On an ongoing basis, the Company reviews whether there are any indicators
of impairment of its capital assets and identifiable intangible assets ("long-
lived depreciable assets"). If such indicators are present, the Company
assesses the recoverability of the assets or group of assets by determining
whether the carrying value of such assets can be recovered through
undiscounted future cash flows. If the sum of undiscounted future cash flows
is less than the carrying amount, the excess of the carrying amount over the
estimated fair value, based on discounted future cash flows, is recorded as a
charge to net earnings. In the third quarter of 2007 the Company recorded an
impairment charge of $48.6 million relating to the long-lived depreciable
assets in Carolina, Puerto Rico.
Valuation of Goodwill
The Company evaluates goodwill for impairment at least annually and
reviews if there are any indicators of impairment on an ongoing basis. If the
carrying value of the reporting unit exceeds its fair value, the fair value of
the reporting units goodwill, determined in the same manner as in a business
combination, is compared with its carrying amount to measure the amount of any
impairment loss, if any.
The goodwill shown on the financial statements for the period ended
July 31, 2007 was $3.2 million and relates to the acquisition in 2000 of the
remaining shares of Global Pharm Inc., which now operates as Toronto York
Mills Operations. The goodwill and the business supporting its value will be
transferred to the Whitby operations on the closure of the York Mills
facility.
Income Taxes
In accordance with Canadian GAAP, the Company uses the liability method
of accounting for future income taxes and provides for future income taxes for
significant temporary timing differences.
Preparation of the consolidated financial statements requires an estimate
of income taxes in each of the jurisdictions in which the Company operates.
The process involves an estimate of the Company's current tax exposure and an
assessment of temporary differences resulting from differing treatment of
items such as depreciation and amortization for tax and accounting purposes.
These differences result in future tax assets and liabilities and are
reflected in the consolidated balance sheet.
Future tax assets of $27.0 million have been recorded at July 31, 2007.
The future tax assets are primarily composed of accounting provisions related
to pension and post-retirement benefits not currently deductible for tax
purposes, the tax benefit of net operating loss carry forwards related to the
U.K., unclaimed R&D expenditures and deferred financing and share issue costs.
The Company evaluates quarterly the ability to realize its future tax assets.
The factors used to assess the likelihood of realization are the Company's
forecast of future taxable income and available tax planning strategies that
could be implemented to realize the future tax assets.
Future tax liabilities of $39.7 million have been recorded at July 31,
2007. This liability has arisen primarily on tax depreciation in excess of
book depreciation.
The Company's tax filings are subject to audit by taxation authorities.
Although management believes that it has adequately provided for income taxes
based on the information available, the outcome of audits cannot be known with
certainty and the potential impact on the financial statements is not
determinable.
Convertible Preferred Shares
On April 27, 2007 the Company issued $150.0 million of convertible
preferred shares. The shares are considered to be a compound financial
instrument that contains both a debt component and an equity component. On
issuance of the convertible preferred shares, the fair value of the debt
component is determined by discounting the expected future cash flows using a
market interest rate for a non-convertible debt instrument with similar terms.
The resulting value is carried as debt on an amortized cost basis until
extinguished on conversion or redemption. The remainder of the proceeds is
allocated as a separate component of shareholders' equity, net of transaction
costs. Transaction costs are apportioned between the debt and equity
components based on their respective carrying amounts when the instrument was
issued. On conversion, the carrying amount of the debt component and the
equity component are transferred to share capital and no gain or loss is
recognized.
Employee Future Benefits
The Company provides to certain retired employees pensions and post-
employment benefits, including medical benefits and dental care. The
determination of the obligation and expense for defined benefit pensions and
post-employment benefits is dependent on the selection of certain assumptions
used by actuaries in calculating such amounts. Those assumptions are disclosed
in note 13 to the Company's 2006 audited consolidated financial statements.
Risk Management
The following are updates to certain risks and uncertainties described in
the Company's Management's Discussion and Analysis for the year ended
October 31, 2006, available on SEDAR (www.sedar.com) or on Patheon's website
(www.patheon.com).
Foreign Currency
The Company's business activities are conducted in several currencies -
Canadian dollars and U.S. dollars for the Canadian operations, U.S. dollars
for the U.S. operations and euros and U.K. sterling for the European
operations.
Since the European and U.S. operations conduct business principally in
their respective local currencies, the exposure to foreign currency gains and
losses is not significant. However, the Company's Canadian operations
negotiate sales contracts for payment in both U.S. and Canadian dollars, and
materials and equipment are purchased in both U.S. and Canadian dollars. The
majority of its non-material costs (including payroll, facilities' costs and
costs of locally sourced supplies and inventory) are denominated in Canadian
dollars. Approximately 60% to 70% of revenues of the Canadian operations and
approximately 10% to 20% of its operating expenses are transacted in U.S.
dollars. As a result, the Company may experience trading and translation gains
or losses because of volatility in the exchange rate between the Canadian
dollar and the U.S. dollar. Based on the Company's current U.S. denominated
net inflows, for each one-cent change in the Canadian-U.S. rate, the impact on
annual pretax earnings, excluding any hedging activities, is approximately
$1.1 million.
The Company mitigates its foreign exchange risk by engaging in foreign
currency hedging activities using derivative financial instruments. At
July 31, 2007 the Company had outstanding foreign exchange forward contracts
to sell US$27.0 million. The contracts mature at the latest on October 29,
2007 and cover approximately 90% of the Company's expected foreign exchange
exposure for the balance of the 2007 fiscal year. The mark-to-market value at
July 31, 2007 that is recorded in accumulated other comprehensive income is an
unrealized gain of $1.5 million. The Company does not purchase any derivative
instruments for speculative purposes.
Translation gains and losses related to the carrying value of the
Company's foreign operations and certain foreign currency denominated debt
held by the Company designated as a hedge against the carrying value of
certain foreign operations, are included in accumulated other comprehensive
income in shareholders' equity. At July 31, 2007, the Company had designated
$143.8 million of US dollar denominated debt as a hedge against its investment
in its U.S.A. and Puerto Rico subsidiaries.
Interest Rate Exposure
The Company has exposure to movements in interest rates. On May 25, 2007
the Company entered into interest rate swaps to convert the interest expense
on the $150 million senior secured term loan from a floating interest rate to
a fixed interest rate. Taking this interest rate swap into account, at
July 31, 2007, 17% of the Company's total debt portfolio, including the debt
component of the convertible preferred shares, was subject to movements in
floating interest rates. Assuming no change to the structure of the debt
portfolio, a 1% change in floating interest rates has an impact on annual pre-
tax earnings of approximately $0.6 million.
Effectiveness of Disclosure Controls and Internal Controls
Disclosure controls and procedures are designed to provide reasonable
assurance that all relevant information is gathered and reported to senior
management, including the Chief Executive Officer ("CEO") and the Chief
Financial Officer ("CFO"), on a timely basis so that appropriate decisions can
be made regarding public disclosure. An evaluation of the effectiveness of the
design and operation of the Company's disclosure controls and procedures was
conducted as of October 31, 2006 by and under the supervision of the Company's
management, including the CEO and the CFO. Based on this evaluation, the CEO
and the CFO have concluded that the Company's disclosure controls and
procedures (as defined in Multilateral Instrument 52-109 - Certification of
Disclosure in Issuers' Annual and Interim Filings of the Canadian Securities
Administrators) are effective to ensure that the information required to be
disclosed in reports that the Company files or submits under Canadian
securities legislation is recorded, processed, summarized and reported within
the time periods specified in such legislation. There have been no changes,
since this last formal assessment, that have materially affected, or are
reasonably likely to materially affect the Company's disclosure controls and
procedures.
Under the supervision of the CEO and CFO, the Company has designed
internal controls over financial reporting to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with GAAP. This
design evaluation included documentation activities, management inquiries and
other reviews as deemed appropriate by management in consideration of the size
and nature of the Company's business. There were no changes in the Company's
internal controls over financial reporting during the most recent interim
period that have materially affected, or are reasonably likely to materially
affect, its internal control over financial reporting.
Selected Quarterly Financial Information
The following is selected financial information for the eight most recent
quarters:
Quarterly Consolidated Financial Information
EBITDA NET EARNINGS (LOSS)
BEFORE EARNINGS PER SHARE FROM
REPOSI- (LOSS) FROM CONTINUING OPERATIONS
TIONING CONTINUING ----------------------
QUARTER ENDED REVENUES EXPENSES OPERATIONS Basic Diluted
(In thousands
of U.S.
dollars,
except per
share amounts) $ $ $ $ $
-------------------------------------------------------------------------
2007
July 31 175,508 23,138 (50,668) ($0.55) ($0.55)
April 30 171,966 23,153 (22,552) ($0.24) ($0.24)
January 31 162,808 22,793 (2,188) ($0.02) ($0.02)
2006
October 31 165,750 18,762 (22,943) ($0.25) ($0.25)
July 31 178,739 14,990 (257,698) ($2.78) ($2.78)
April 30 180,157 23,244 2,549 $0.03 $0.03
January 31 150,013 13,880 (11,408) ($0.12) ($0.12)
2005
October 31 171,086 25,251 7,910 $0.09 $0.08
Additional Information
Share Capital
As of July 31, 2007, the Company had 92,958,688 restricted voting shares
(previously common shares) outstanding and 150,000 each of Class I Preferred
Shares, Series C and Series D.
The Company's articles were amended on April 26, 2007 to redesignate the
common shares as restricted voting shares. This occurred in connection with
the issuance of the convertible preferred shares. The holders of the
convertible preferred shares have the right to elect up to three of nine
members of the Board of Directors. The holders of Patheon's common shares have
the right to elect the remaining members of the Board of Directors. Under the
rules of the Toronto Stock Exchange, voting equity securities are not to be
designated, or called, common shares unless they have a right to vote in all
circumstances that is not less, on a per share basis, than the voting rights
of each other class of voting securities. Accordingly, the Company has amended
its articles to redesignate the common shares as restricted voting shares.
This redesignation involves only a change in the name of the securities; the
number of shares outstanding and the terms and conditions of the outstanding
shares are not affected by the change.
Public Securities Filings
Other information about the Company, including the annual information
form and other disclosure documents, reports, statements or other information
that is filed with Canadian securities regulatory authorities can be accessed
through SEDAR at www.sedar.com.
Outlook
Due to normal summer shut downs, particularly in Europe, and declining
volumes in Puerto Rico, particularly at the Carolina site, revenues for the
fourth quarter of 2007 are expected to be lower than the third quarter of
2007.
Auditor Review
The accompanying unaudited interim consolidated financial statements of
the Company have been prepared by and are the responsibility of management.
The Company's independent auditors have been engaged to perform a review of
these financial statements. The independent auditors have advised the Company
that they have satisfactorily completed their review, except for procedures
that have not yet been completed in respect of the asset impairment charge
that the Company recognized for the third quarter ended July 31, 2007. The
independent auditors were unable to complete the review procedures in respect
of the asset impairment charge before the filing of the accompanying unaudited
interim consolidated financial statements because the valuation of the
relevant assets related to the Company's Carolina, Puerto Rico operations was
not substantially completed until shortly before the deadline for filing the
financial statements.
FORWARD-LOOKING STATEMENTS
This news release and MD&A contains forward-looking statements which
reflect management's expectations regarding the Company's future growth,
results of operations, performance (both operational and financial) and
business prospects and opportunities. Wherever possible, words such as
"plans", "expects" or "does not expect", "forecasts", "anticipates" or "does
not anticipate", "believes", "intends" and similar expressions or statements
that certain actions, events or results "may", "could", "would", "might" or
"will" be taken, occur or be achieved have been used to identify these forward-
looking statements. Although the forward-looking statements contained in this
news release and MD&A reflect management's current assumptions based upon
information currently available to management and based upon what management
believes to be reasonable assumptions, the Company cannot be certain that
actual results will be consistent with these forward-looking statements.
Forward-looking statements necessarily involve significant known and unknown
risks, assumptions and uncertainties that may cause the Company's actual
results, performance, prospects and opportunities in future periods to differ
materially from those expressed or implied by such forward-looking statements.
These risks and uncertainties include, among other things: the market demand
for client products; credit and client concentration; the ability to identify
and secure new contracts; regulatory matters, including compliance with
pharmaceutical regulations; management of expanded operations; international
operations risks; currency; competition; product liability claims;
intellectual property; environmental; interest rates; and conditions of MOVA's
tax exemptions. Although the Company has attempted to identify important risks
and factors that could cause actual actions, events or results to differ
materially from those described in forward-looking statements, there may be
other factors and risks that cause actions, events or results not to be as
anticipated, estimated or intended. There can be no assurance that forward-
looking statements will prove to be accurate, as actual results and future
events could differ materially from those anticipated in such statements.
Accordingly, readers should not place undue reliance on forward-looking
statements. These forward-looking statements are made as of the date of this
news release and MD&A and, except as required by law, the Company assumes no
obligation to update or revise them to reflect new events or circumstances.
%SEDAR: 00001700 E
For further information: Mr. Riccardo Trecroce, Chief Executive Officer,
Tel: (905) 812-6877, Fax: (905) 812-6613, Email: rtrecroce@patheon.com; Mr.
John Bell, Chief Financial Officer, Tel: (905) 812-6812, Fax: (905) 812-6613,
Email: john.h.bell@patheon.com; Ms. Shelley Jourard, Director, Corporate
Communications, Tel: (905) 812-6614, Fax: (905) 812-6613, Email:
sjourard@patheon.com
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