UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission file number 1-9114

 

MYLAN INC.

(Exact name of registrant as specified in its charter)

 

 

(724) 514-1800

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

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

 

               (Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

MYLAN INC. AND SUBSIDIARIES

 

FORM 10-Q
For the Quarterly Period Ended
June 30, 2008

 

INDEX

 

MYLAN INC. AND SUBSIDIARIES

 

Condensed Consolidated Statements of Operations

 

 

See Notes to Condensed Consolidated Financial Statements

MYLAN INC. AND SUBSIDIARIES

 

Condensed Consolidated Balance Sheets

 

 

See Notes to Condensed Consolidated Financial Statements

MYLAN INC. AND SUBSIDIARIES

 

Condensed Consolidated Statements of Cash Flows

 

 

See Notes to Condensed Consolidated Financial Statements

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements (“interim financial statements”) of Mylan Inc. and subsidiaries (“Mylan” or “the Company”) were prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q; therefore, as permitted under these rules, certain footnotes and other financial information included in audited financial statements were condensed or omitted. The interim financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the interim results of operations, financial position and cash flows for the periods presented.

 

These interim financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto in the Company’s Transition Report on Form 10-KT/A for the nine months ended December 31, 2007. Effective October 2, 2007, the Company amended its bylaws, to change its fiscal year from beginning on April 1st and ending on March 31st, to beginning on January 1st and ending on December 31st.

 

The interim results of operations and interim cash flows for the three and six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full fiscal year or any other future period.

 

 

Revenue is recognized for product sales when title and risk of loss transfer to the Company’s customers and when provisions for estimates, including discounts, rebates, price adjustments, returns, chargebacks and other promotional programs are reasonably determinable. No revisions were made to the methodology used in determining these provisions during the six-month period ended June 30, 2008. Accounts receivable are presented net of allowances relating to these provisions. Such allowances were $428.4 million and $423.2 million as of June 30, 2008 and December 31, 2007, respectively. Other current liabilities include $256.0 million and $213.5 million at June 30, 2008, and December 31, 2007, for certain rebates and other adjustments that are payable to indirect customers.

 

In January 2006, the Company announced an agreement with Forest Laboratories Holdings, Ltd. (“Forest”), a wholly-owned subsidiary of Forest Laboratories, Inc., for the commercialization, development and distribution of Bystolic^tm in the United States and Canada (the “2006 Agreement”). Under the terms of that agreement, Mylan received a $75.0 million up front payment and $25.0 million upon approval of the product. Such amounts were being deferred until the commercial launch of the product and were to be amortized over the remaining term of the license agreement. Mylan also had the potential to earn future milestones and royalties on Bystolic sales and an option to co-promote the product, while Forest assumed all future development and selling and marketing expenses.

 

In February 2008, Mylan executed an agreement with Forest whereby Mylan sold to Forest its rights to Bystolic (“the Amended Agreement”). Under the terms of the Amended Agreement, Mylan received a one-time cash payment of $370.0 million, which was deferred along with the $100.0 million received under the 2006 Agreement, and retained its contractual royalties for three years, through 2010. Mylan’s obligations under the 2006 Agreement to supply Bystolic to Forest were unchanged by the Amended Agreement. Mylan believes that these supply obligations represent significant continuing involvement as Mylan remains contractually obligated to manufacture the product for Forest while the product is being commercialized, which is estimated to occur through the end of patent protection in 2020. As a result of this continuing involvement, Mylan will amortize the $470.0 million of deferred revenue ratably through 2020.

 

As such, $9.8 million and $13.1 million are included in other revenues in the Company’s Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2008. However, Mylan and Forest are in the process of transferring all manufacturing responsibilities for the product to Forest and the Company expects this to occur no later than December 2008. Once the manufacturing is transferred, the Company does not believe there to be any further significant continuing involvement and the earnings process will be deemed

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

to be complete. Any remaining deferred revenue at that time will be immediately recognized into other revenues in the Company’s consolidated statement of operations.

 

Future royalties are considered to be contingent consideration and will be recognized in other revenues as earned upon sales of the product by Forest. Such royalties will be recorded at the net royalty rates specified in the Amended Agreement.

 

 

In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, (“FSP No. EITF 03-6-1”). FSP No. EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP No. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting FSP No. EITF 03-6-01 on its consolidated financial statements.

 

In May 2008, the FASB issued FSP No. APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (“FSP No. APB 14-a”). Under the new rules for convertible debt instruments (including our Senior Convertible Notes) that may be settled entirely or partially in cash upon conversion, an entity should separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost. The effect of the new rules for the debentures is that the equity component would be included in the paid-in-capital section of stockholders’ equity on our consolidated balance sheet and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of the Senior Convertible Notes. FSP No. APB 14-a will be effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. Higher interest expense would result through the accretion of the discounted carrying value of the Senior Convertible Notes to their face amount over the term of the Senior Convertible Notes. Prior period interest expense will also be higher than previously reported interest expense due to retrospective application. Early adoption is not permitted. The Company is currently evaluating the proposed new rules and the impact of adopting FSP No. APB 14-a on its consolidated financial statements.

 

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (“FSP No. FAS 142-3”). FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R) and other accounting principles generally accepted in the United States, (“GAAP”). FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting FSP No. FAS 142-3 on its consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51, (“SFAS No. 160”). SFAS No. 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, sometimes called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS No. 160 requires, among other items, that a noncontrolling interest be included in the consolidated balance sheet within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 160 on its consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, including (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This standard is effective for fiscal years beginning after November 15, 2008. As SFAS No. 161 only requires enhanced disclosures, management is currently assessing the impact on the disclosures on the Company’s consolidated financial statements.

 

In March 2008, the Emerging Issues Task Force (“EITF”) issued EITF No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock (“EITF No. 07-5”). EITF No. 07-5 states that if an instrument (or an embedded feature) has the characteristics of a derivative instrument under paragraphs 6-9 of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and is indexed to an entity’s own stock, it is necessary to evaluate whether it is classified in stockholders’ equity (or would be classified in stockholders’ equity if it were a freestanding instrument). EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting EITF No. 07-5 on its consolidated financial statements.

 

On January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option) with changes in fair value reported in earnings. The Company already records marketable securities at fair value in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 115”), and derivative contracts and hedging activities at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133”). The adoption of SFAS No. 159 did not have a material impact on the Company’s Condensed Consolidated Financial Statements as management did not elect the fair value option for any other financial instrument or certain other assets and liabilities.

 

On January 1, 2008, the Company adopted Statement 133 Implementation Issue No. E23, Hedging — General: Issues Involving the Application of the Shortcut Method under Paragraph 58 (“Issue No. E23”). Issue No. E23 provides guidance on certain practice issues related to the application of the shortcut method by amending paragraph 68 of SFAS No. 133 with respect to the conditions that must be met in order to apply the shortcut method for assessing hedge effectiveness of interest rate swaps. In addition to applying the provisions of Issue No. E23 on hedging arrangements designated on or after January 1, 2008, an assessment was required to be made on January 1, 2008 to determine whether preexisting hedging arrangements met the provisions of Issue No. E23 as of their original inception. Management performed such an assessment and determined that the adoption of Issue No. E23 did not have a material impact on preexisting hedging arrangements.

 

In March 2007, the EITF issued EITF No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements (“EITF No. 06-10”). Under the provisions of EITF No. 06-10, an employer is required to recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement with the employee. The provisions of EITF No. 06-10 also require an employer to recognize and measure the asset in a collateral assignment split-dollar life insurance arrangement based on the nature and substance of the arrangement. The Company adopted the provisions of EITF No. 06-10 as of January 1, 2008. As a result of the adoption, the Company recognized a liability of $8.3 million, representing the present value of the future premium payments to be made under the existing policies. In accordance with the transition provisions of EITF No. 06-10, this amount was recorded as a direct decrease to retained earnings.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

In March 2007, the EITF issued EITF No. 06-04, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsed Split-Dollar Life Insurance Arrangements (“EITF No. 06-4”), which concludes that an employer should recognize a liability for post-employment benefits promised an employee based on the substantive arrangement between the employer and the employee. The Company adopted the provisions of EITF No. 06-04 as of January 1, 2008. The adoption of EITF No. 06-04 did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

 

On October 2, 2007, Mylan completed its acquisition of Merck KGaA’s generic business (“Merck Generics”) and paid a purchase price of approximately $7.0 billion. In accordance with SFAS No. 141, Business Combinations (“SFAS No. 141”), the Company used the purchase method of accounting to account for this transaction. Under the purchase method of accounting, the assets acquired and liabilities assumed in the transaction were recorded at the date of acquisition at the preliminary estimate of their respective fair values. The purchase price plus acquisition costs exceeded the preliminary estimate of fair values of acquired assets and assumed liabilities.

 

The purchase price allocation, including the allocation of goodwill, is preliminary and is based on the information that was available as of the acquisition date. Management believes that the information provides a reasonable basis for allocating the purchase price but the Company is awaiting additional information necessary to finalize the purchase price allocation. The fair values reflected in the consolidated financial statements may be adjusted and such adjustments could be significant. The Company expects the purchase price allocation to be finalized as soon as possible but no later than one year from the acquisition date.

 

As disclosed in Note 15 — Restructuring, the Company included a $74.3 million restructuring reserve that was recorded as of the date of the Merck Generics acquisition associated with involuntary termination benefits for certain Merck Generics employees and certain other costs to exit certain activities of Merck Generics. At the date of consummation, management began to assess and formulate a plan to exit certain Merck Generics activities. Management continues to strategically evaluate the Merck Generics business in accordance with the provisions of EITF No. 95-3, Recognition of Liabilities in Connection with a Purchased Business Combination. While management believes there may be additional costs to exit certain Merck Generics activities that could affect the purchase price allocation, it is not possible to estimate such costs at this time with any degree of certainty.

 

In conjunction with the Merck Generics acquisition, the Company assumed certain loss contingencies. As disclosed in Note 16 — Contingencies, Merck KGaA has indemnified Mylan under the provisions of the Share Purchase Agreement for certain of these contingencies. While it is not feasible to predict the ultimate outcome of the remaining assumed loss contingencies that could affect the purchase price allocation, the Company believes that the ultimate outcome of such other proceedings will not have a material adverse effect on its financial position or purchase price allocation. However, an adverse outcome in any such proceedings, or the inability or denial of Merck KGaA to pay on an indemnified claim, could have a material effect on our financial position or purchase price allocation.

 

The operating results of Merck Generics have been included in Mylan’s Condensed Consolidated Financial Statements for the three and six months ended June 30, 2008. The following is a summary of the unaudited pro forma results of operations for the three and six months ended June 30, 2007 and assumes the acquisition occurred on January 1, 2007. This summary of the unaudited pro forma results of operations is not necessarily indicative of what Mylan’s results of operations would have been had Merck Generics been acquired at the beginning of the period indicated, nor does it purport to represent results of operations for any future period.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The unaudited pro forma financial information for the periods below include the following material, non-recurring charges directly attributable to the accounting for the acquisition: amortization of the step-up of inventory of $37.6 million for the three-month period; amortization of the step-up of inventory of $75.0 million and an acquired in-process research and development charge of $1.3 billion in the six-month period. In addition, the pro forma financial information for the periods presented includes the effects of the preferred and common stock offerings, which closed in November 2007, the proceeds of which were used to repay certain temporary financing.

 

 

 

On February 27, 2008, the Company announced that it was reviewing strategic alternatives for its specialty business, Dey, including the potential sale of the business. This decision was based upon several factors, including a strategic review of the business, including the expected performance of the Perforomist^tm product, where anticipated growth was determined to be slower than expected and the timeframe to reach peak sales was determined to be longer than was originally anticipated.

 

As a result of our ongoing review of strategic alternatives, we determined that it was more likely than not that the business will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Accordingly, a recoverability test of Dey’s long-lived assets was performed during the three months ended March 31, 2008 in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). The Company included both cash flow projections and estimated proceeds from the eventual disposition of the long-lived assets. The estimated undiscounted future cash flows exceeded the book values of the long-lived assets and, as a result, no impairment charge was recorded.

 

Upon the closing of the Merck Generics transaction, Dey was defined as the Specialty Segment under the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information (“SFAS No. 131”). Dey is also considered a reporting unit under the provisions of SFAS No. 142. Upon closing of the transaction, the Company allocated $711.2 million of goodwill to Dey.

 

The Company tests goodwill for possible impairment on an annual basis and at any other time events occur or circumstances indicate that the carrying amount of goodwill may be impaired. As we have determined that it is more likely than not that the business will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, the Company was required during the three months ended March 31, 2008 to assess whether any portion of its recorded goodwill balance was impaired.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The first step of the SFAS No. 142 impairment analysis consisted of a comparison of the fair value of the reporting unit with its carrying amount, including the goodwill. We performed extensive valuation analyses, utilizing both income and market approaches, in our goodwill assessment process. The following describes the valuation methodologies used to derive the estimated fair value of the reporting unit.

 

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

 

Market-Based Approach:  To corroborate the results of the income approach described above, Mylan estimated the fair value of its reporting unit using several market-based approaches, including the guideline company method which focuses on comparing its risk profile and growth prospects to a select group of publicly traded companies with reasonably similar guidelines.

 

Based on the SFAS No. 142 “step one” analysis that was performed for Dey, the Company determined that the carrying amount of the net assets of the reporting unit was in excess of its estimated fair value. As such, the Company was required to perform the “step two” analysis for Dey, in order to determine the amount of any goodwill impairment. The “step two” analysis consisted of comparing the implied fair value of the goodwill with the carrying amount of the goodwill, with an impairment charge resulting from any excess of the carrying value of the goodwill over the implied fair value of the goodwill based on a hypothetical allocation of the estimated fair value to the net assets. Based on the second step analysis, the Company concluded that $385.0 million of the goodwill recorded at Dey was impaired. As a result, the Company recorded a non-cash goodwill impairment charge of $385.0 million during the three months ended March 31, 2008, which represented our best estimate as of March 31, 2008. The allocation discussed above is performed only for purposes of assessing goodwill for impairment; accordingly, Mylan has not adjusted the net book value of the assets and liabilities on the Company’s Condensed Consolidated Balance Sheet, other than goodwill, as a result of this process.

 

The determination of the fair value of the reporting unit required the Company to make significant estimates and assumptions that affect the reporting unit’s expected future cash flows. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rates, operating income before depreciation and amortization, and capital expenditures forecasts. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates. In addition, changes in underlying assumptions would have a significant impact on either the fair value of the reporting unit or the goodwill impairment charge.

 

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

 

Refer to Note 9 for a rollforward of the Company’s goodwill.

 

 

Mylan’s shareholders approved the 2003 Long-Term Incentive Plan on July 25, 2003, and approved certain amendments on July 28, 2006 and April 25, 2008 (as amended, the “2003 Plan”). Under the 2003 Plan, 37,500,000 shares of common stock are reserved for issuance to key employees, consultants, independent contractors and non-employee directors of Mylan through a variety of incentive awards, including: stock options, stock appreciation rights, restricted shares and units, performance awards, other stock-based awards and short-term

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

cash awards. Awards are granted at the fair value of the shares underlying the options at the date of the grant, generally become exercisable over periods ranging from three to four years, and generally expire in ten years. In the amended 2003 Plan, no more than 5,000,000 shares may be issued as restricted shares, restricted units, performance shares and other stock-based awards.

 

Upon approval of the 2003 Plan, the 1997 Incentive Stock Option Plan (the “1997 Plan”) was frozen, and no further grants of stock options will be made under that plan. However, there are stock options outstanding from the 1997 Plan, expired plans and other plans assumed through acquisitions.

 

The following table summarizes stock option activity:

 

 

As of June 30, 2008, options outstanding, options vested and expected to vest, and options exercisable had average remaining contractual terms of 6.40 years, 6.30 years and 4.52 years, respectively. Also at June 30, 2008, options outstanding, options vested and expected to vest and options exercisable had aggregate intrinsic values of $6.1 million, $5.8 million and $3.2 million, respectively.

 

A summary of the status of the Company’s nonvested restricted stock and restricted stock unit awards as of June 30, 2008 and the changes during the six-month period ended June 30, 2008, are presented below:

 

 

As of June 30, 2008, the Company had $54.3 million of total unrecognized compensation expense, net of estimated forfeitures, related to all of its stock-based awards, which will be recognized over the remaining weighted average period of 2.04 years. The total intrinsic value of stock-based awards exercised and restricted stock units converted during the six months ended June 30, 2008 and 2007 was $1.5 million and $12.9 million. The total fair value of all restricted awards vested during the six months ended June 30, 2008 and 2007 was $0.3 million for each period.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

Selected balance sheet components consist of the following:

 

 

 

Basic (loss) earnings per share excludes dilution and is computed by dividing net (loss) earnings available to common shareholders by the weighted average number of shares outstanding during the period. Diluted (loss) earnings per share is computed by dividing net (loss) earnings available to common shareholders by the weighted average number of shares outstanding during the period increased by the number of additional shares that would have been outstanding if the impact is dilutive.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Basic and diluted (loss) earnings per common share is calculated as follows:

 

 

Additional stock options or restricted stock awards representing 26,304,823 and 2,013,207 shares were outstanding for the six months ended June 30, 2008 and 2007, but were not included in the computation of diluted earnings per share because the effect would be anti-dilutive. In addition, the Company considered the effect on diluted earnings per share of the preferred stock conversion feature using the if-converted method. The preferred stock is convertible into between a total of 125,234,172 shares and 152,785,775 shares of our common stock, subject to anti-dilution adjustments, depending on the average stock price of our common stock over the 20 trading-day period ending on the third trading day prior to conversion. For the three and six month periods ended June 30, 2008, the preferred stock conversion would have been anti-dilutive and, as such, was not assumed in the computation of diluted earnings per share.

 

On February 15, 2008, the Company paid a dividend of $33.2 million in cash to the holders of the preferred stock. On May 15, 2008, the Company paid a dividend of $34.8 million in cash to the holders of the preferred stock. On July 31, 2008, the Company announced that a quarterly dividend of $16.25 per share was declared (based on the annual dividend rate of 6.5% and a liquidation preference of $1,000 per share) payable on August 15, 2008, to the holders of preferred stock of record as of August 1, 2008.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

A rollforward of goodwill from December 31, 2007 to June 30, 2008 is as follows:

 

 

Intangible assets consist of the following components:

 

 

Amortization expense for the six months ended June 30, 2008 and 2007 was $155.2 million and $24.3 million, respectively, and is expected to be $153.9 million for the remainder of 2008, and $302.6 million, $293.5 million, $284.9 million and $269.6 million for years 2009 through 2012, respectively.

 

 

Fair Value Measurement

 

On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), for financial assets and liabilities and any other assets and liabilities carried at fair value. This pronouncement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Company’s adoption of SFAS No. 157 did not have a material effect on the Company’s Condensed Consolidated Financial Statements for financial assets and liabilities and any other assets and liabilities carried at fair value.

 

As defined in SFAS No. 157, fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, SFAS No. 157 establishes a fair value hierarchy

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

 

Level 1:  Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

Level 2:  Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

 

Level 3:  Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

 

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

 

Financial assets and liabilities carried at fair value as of June 30, 2008 are classified in the table below in one of the three categories described above:

 

 

 

 

 

Due to the lack of observable market quotes on the Company’s auction rate securities (“ARS”) portfolio, the Company utilizes valuation models that rely exclusively on Level 3 inputs, including those that are based on expected cash flow streams and collateral values. The Company has approximately $9.1 million in ARS, which were subject to a failed auction in May 2008. These ARS continue to pay interest according to their terms. The securities were issued by a state educational loan authority and are backed by student loans. The state educational loan authority has requested and received required consent from bondholders to amend the existing indentures governing the securities to add a call provision, which permits the securities to be called at par after August 1, 2008. The Company does not believe these securities are subject to any impairment as the Company has the intent and the ability to hold these securities until maturity or until called.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

For financial assets and liabilities that utilize Level 2 inputs, the Company utilizes both direct and indirect observable price quotes, including the LIBOR yield curve, foreign exchange forward prices, and bank price quotes. Below is a summary of valuation techniques for Level 1 and Level 2 financial assets and liabilities:

 

 

Although the Company has not elected the fair value option for financial assets and liabilities existing at January 1, 2008 or transacted in the six months ended June 30, 2008, any future transacted financial asset or liability will be evaluated for the fair value election as prescribed by SFAS No. 159 and adjusted to fair value as determined under the provisions of SFAS No. 157.

 

 

A summary of long-term debt is as follows:

 

 

 

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

At June 30, 2008 and December 31, 2007, the fair value of the Senior Convertible Notes was approximately $502.9 million and $545.5 million, respectively.

 

 

Comprehensive earnings consists of the following:

 

 

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Accumulated other comprehensive earnings, as reflected on the balance sheet, is comprised of the following:

 

 

 

The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement 109 (“FIN 48”) effective April 1, 2007. FIN 48 clarifies the accounting for uncertain tax positions. This Interpretation provides that the tax effects from an uncertain tax position be recognized in the Company’s financial statements, only if the position is more likely than not of being sustained upon audit, based on the technical merits of the position.

 

The total amount of unrecognized tax benefits was $93.9 million and $77.6 million as of June 30, 2008 and December 31, 2007. The primary reason that additional FIN 48 reserve was recorded this quarter was because of economic nexus that may have been created due to activity in certain states. Accrued interest and penalties increased from $24.4 million at December 31, 2007 to $28.8 million at June 30, 2008.

 

It is anticipated that the amount of unrecognized tax benefits will change in the next 12 months; however, these changes are not expected to have a significant impact on the results of operations, cash flows or the financial position of the Company.

 

The statute of limitations for tax years ending 2005 through 2007 remain open to examination by the Internal Revenue Service. Examinations have been completed for all federal returns through the March 31, 2007 filing as part of the Compliance Assurance Process. The major state taxing jurisdictions applicable to the Company remain open from 2004 through 2007.

 

 

The Company previously had two reportable segments, the “Mylan Segment” and the “Matrix Segment”. With the acquisition of Merck Generics, Mylan now has three reportable segments: the “Generics Segment”, the Specialty Segment”, and the “Matrix Segment”. The Generics Segment primarily develops, manufactures, sells and distributes generic or branded generic pharmaceutical products in tablet, capsule or transdermal patch form. The Specialty Segment engages mainly in the manufacture and sale of branded specialty nebulized and injectable products. The Matrix Segment engages mainly in the manufacture and sale of active pharmaceutical ingredients (“APIs”) and the distribution of certain branded generic products. Additionally, certain general and administrative expenses, as well as litigation settlements, and non-operating income and expenses are reported in Corporate/Other. In accordance with SFAS No. 131, information for earlier periods has been recast.

 

The Company’s chief operating decision maker evaluates the performance of its reportable segments based on total revenues and segment profitability (loss). For the Generics, Specialty, and Matrix Segments, segment profitability (loss) represents segment gross profit less direct research and development expenses and direct selling, general and administrative expenses. Amortization of intangible assets as well as other purchase accounting related items including the write-off of in-process research and development and the amortization of the inventory step-up are excluded from segment profitability (loss). Items below the earnings from operations line on the Company’s Condensed Consolidated Statements of Operations are not presented by segment, since they are

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

excluded from the measure of segment profitability (loss) reviewed by the Company’s chief operating decision maker. The Company does not report depreciation expense, total assets and capital expenditures by segment as such information is not used by the chief operating decision maker.

 

The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies” included in the Company’s Transition Report on Form 10-KT/A for the nine months ended December 31, 2007. Intersegment revenues are accounted for at current market values.

 

The table below presents segment information for the periods identified and provides a reconciliation of segment information to total consolidated information.

 

 

 

 

 

 

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

 

The Company’s Condensed Consolidated Balance Sheet as of June 30, 2008, includes a $70.3 million restructuring reserve, which relates to certain estimated exit costs associated with the acquisition of Merck Generics. The plans related to these exit activities have yet to be finalized and there may be additional costs incurred. Payments of approximately $4.0 million were made during the six months ended June 30, 2008, of which $2.9 million were severance costs and the remaining $1.1 million were other exit costs.

 

The Company announced its intent to restructure certain activities and incur certain related exit costs unrelated to the Merck Generics acquisition. At June 30, 2008, the Company met all the criteria in SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”), and has recorded a reserve for such activities of approximately $0.7 million. This restructuring charge is included in operating expenses in the Company’s Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2008. As finalization of the plan is still in progress, the Company has not yet estimated the total amount expected to be incurred in connection with such activities. However, Mylan expects the majority of such costs will relate to one-time termination benefits and certain asset write-downs and could be significant.

 

 

While it is not possible to determine with any degree of certainty the ultimate outcome of the following legal proceedings, the Company believes that it has meritorious defenses with respect to the claims asserted against it and intends to vigorously defend its position. The Company is also party to certain litigation matters, some of which are described below, for which Merck KGaA has agreed to indemnify the Company, under the terms of the Share Purchase Agreement by which Mylan acquired Merck Generics. An adverse outcome in any of these proceedings, or the inability or denial of Merck KGaA to pay an indemnified claim, could have a material adverse effect on the Company’s financial position and results of operations.

 

Omeprazole

 

On May 17, 2000, Mylan Pharmaceuticals Inc. (“MPI”) filed an Abbreviated New Drug Application (“ANDA”) seeking approval from the U.S. Food and Drug Administration (“FDA”) to manufacture, market and sell omeprazole delayed-release capsules and on August 8, 2000 made Paragraph IV certifications to several patents owned by AstraZeneca PLC (“AstraZeneca”) that were listed in the FDA’s “Orange Book.” On September 8, 2000, AstraZeneca filed suit against MPI and Mylan in the U.S. District Court for the Southern District of New York alleging infringement of several of AstraZeneca’s patents. On May 29, 2003, the FDA approved MPI’s ANDA for the 10 mg and 20 mg strengths of omeprazole delayed-release capsules, and, on August 4, 2003, Mylan announced that MPI had commenced the sale of omeprazole 10 mg and 20 mg delayed-release capsules. AstraZeneca then amended the pending lawsuit to assert claims against Mylan and MPI and filed a separate lawsuit against MPI’s supplier, Esteve Quimica S.A. (“Esteve”), for unspecified money damages and a finding of willful infringement. MPI has certain indemnity obligations to Esteve in connection with this litigation. On May 31, 2007, the district court ruled in Mylan’s and Esteve’s favor by finding that the asserted patents were not infringed by Mylan’s/Esteve’s products. On July 18, 2007, AstraZeneca appealed the decision to the United States Court of Appeals for the Federal Circuit. On June 10, 2008, the appellate court issued a judgment and decision affirming the district court’s finding of noninfringement and the mandate was issued on July 1, 2008.

 

Lorazepam and Clorazepate

 

On June 1, 2005, a jury verdict was rendered against Mylan, MPI, and co-defendants Cambrex Corporation and Gyma Laboratories in the U.S. District Court for the District of Columbia (“D.C.”) in the amount of approximately $12.0 million, which has been accrued for by the Company. The jury found that Mylan and its co-defendants willfully violated Massachusetts, Minnesota and Illinois state antitrust laws in connection with API supply agreements entered into between the Company and its API supplier (Cambrex) and broker (Gyma) for two

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

drugs, lorazepam and clorazepate, in 1997, and subsequent price increases on these drugs in 1998. The case was brought by four health insurers who opted out of earlier class action settlements agreed to by the Company in 2001 and represents the last remaining antitrust claims relating to Mylan’s 1998 price increases for lorazepam and clorazepate. Following the verdict, the Company filed a motion for judgment as a matter of law, a motion for a new trial, a motion to dismiss two of the insurers and a motion to reduce the verdict. On December 20, 2006, the Company’s motion for judgment as a matter of law and motion for a new trial were denied and the remaining motions were denied on January 24, 2008. In post-trial filings, the plaintiffs requested that the verdict be trebled and that request was granted on January 24, 2008. On February 6, 2008, a judgment issued against Mylan and its co-defendants in the total amount of approximately $69.0 million, some or all of which may be subject to indemnification obligations by Mylan. Plaintiffs are also seeking an award of attorneys’ fees and litigation costs in unspecified amounts and prejudgment interest of approximately $9.0 million. The Company and its co-defendants have appealed to the U.S. Court of Appeals for the D.C. Circuit. The appeals have been held in abeyance pending a ruling on the motion for prejudgment interest. In connection with the Company’s appeal of the lorazepam Judgment, the company submitted a surety bond underwritten by a third party insurance company in the amount of $74.5 million. This surety bond is secured by a pledge of a $40.0 million cash deposit (which is included as restricted cash on the Company’s Condensed Consolidated Balance Sheet as of June 30, 2008) and an irrevocable letter of credit for $34.5 million issued under the Senior Credit Agreement.

 

Pricing and Medicaid Litigation

 

On June 26, 2003, MPI and UDL Laboratories Inc. (“UDL”) received requests from the U.S. House of Representatives Energy and Commerce Committee (the “Committee”) seeking information about certain products sold by MPI and UDL in connection with the Committee’s investigation into pharmaceutical reimbursement and rebates under Medicaid. MPI and UDL cooperated with this inquiry and provided information in response to the Committee’s requests in 2003. Several states’ attorneys general (“AG”) have also sent letters to MPI, UDL and Mylan Bertek, demanding that those companies retain documents relating to Medicaid reimbursement and rebate calculations pending the outcome of unspecified investigations by those AGs into such matters. In addition, in July 2004, Mylan received subpoenas from the AGs of California and Florida in connection with civil investigations purportedly related to price reporting and marketing practices regarding various drugs. As noted below, both California and Florida subsequently filed suits against Mylan, and the Company believes any further requests for information and disclosures will be made as part of that litigation.

 

Beginning in September 2003, Mylan, MPI and/or UDL, together with many other pharmaceutical companies, have been named in civil lawsuits filed by state AGs and municipal bodies within the state of New York alleging generally that the defendants defrauded the state Medicaid systems by allegedly reporting “Average Wholesale Prices” (“AWP”) and/or “Wholesale Acquisition Costs” that exceeded the actual selling price of the defendants’ prescription drugs. To date, Mylan, MPI and/or UDL have been named as defendants in substantially similar civil lawsuits filed by the AGs of Alabama, Alaska, California, Florida, Hawaii, Idaho, Illinois, Iowa, Kentucky, Massachusetts, Mississippi, Missouri, South Carolina, Texas, Utah and Wisconsin and also by the city of New York and approximately 40 counties across New York State. Several of these cases have been transferred to the AWP multi-district litigation proceedings pending in the U.S. District Court for the District of Massachusetts for pretrial proceedings. Others of these cases will likely be litigated in the state courts in which they were filed. Each of the cases seeks an unspecified amount in money damages, civil penalties and/or treble damages, counsel fees and costs, and injunctive relief. In each of these matters, Mylan, MPI and/or UDL have either moved to dismiss the complaints or have answered the complaints denying liability. Mylan and its subsidiaries intend to defend each of these actions vigorously.

 

In May 2008, an amended complaint was filed in the U.S. District Court for the District of Massachusetts by a plaintiff on behalf of the United States of America, against Mylan, MPI, UDL and several other generic manufacturers. The original complaint was filed under seal in April 2000, and Mylan, MPI and UDL were added as parties in February 2001. The claims against Mylan, MPI, UDL and the other generic manufacturers were severed

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

from the April 2000 complaint (which remains under seal) as a result of the federal government’s decision not to intervene in the action as to those defendants. The complaint alleges violations of the False Claims Act and sets forth allegations substantially similar to those alleged in the state AG cases mentioned in the preceding paragraph and purports to seek recovery of any and all alleged overpayment of the “federal share” under the Medicaid program. Mylan has not yet responded to this complaint, but intends to deny liability and to defend the action vigorously.

 

In addition, by letter dated January 12, 2005, MPI was notified by the U.S. Department of Justice of an investigation concerning calculations of Medicaid drug rebates. The investigation involves whether MPI and UDL may have violated the False Claims Act or other laws by classifying certain authorized generics launched in the 1990’s and early 2000’s as non-innovator rather than innovator drugs for purposes of Medicaid and other federal healthcare programs until 2005. MPI and UDL deny the government’s allegations and deny that they engaged in any wrongful conduct. Based on our understanding of the government’s allegations, the alleged difference in rebates for the MPI and UDL products currently at issue may be up to approximately $100.0 million, which includes interest. Remedies under the False Claims Act could include treble damages and penalties. MPI and UDL have been cooperating fully with the government’s investigation and are currently in discussions with the government about a possible resolution of the matter. Additionally, the Company believes that it has contractual and other rights to recover from the innovator a substantial portion of any payments that MPI and UDL may remit to the government. The Company has not recorded any amounts in the consolidated financial statements related to this matter.

 

Dey, L.P. is a defendant currently in lawsuits brought by the state AG’s of Arizona, California, Florida, Illinois, Iowa, Kentucky, Mississippi, Pennsylvania, South Carolina (on behalf of the state and the state health plan), Utah and Wisconsin and the city of New York and approximately 40 New York counties. Dey is also named as a defendant in several class actions brought by consumers and third party payors. Dey has reached a settlement of most of these class actions, which has been preliminarily approved by the court. Additionally, the U.S. federal government filed a claim against Dey, L.P. in August 2006. These cases all generally allege that Dey falsely reported certain price information concerning certain drugs marketed by Dey. Dey intends to defend each of these actions vigorously. In conjunction with the Merck Generics acquisition by Mylan, Mylan is entitled to indemnification by Merck KGaA for these Dey pricing related suits.

 

Modafinil Antitrust Litigation and FTC Inquiry

 

Beginning in April 2006, Mylan, along with four other drug manufacturers, has been named as a defendant in civil lawsuits filed in the Eastern District of Pennsylvania by a variety of plaintiffs purportedly representing direct and indirect purchasers of the drug modafinil and a third party payor and one action brought by Apotex, Inc., a manufacturer of generic drugs, seeking approval to market a generic modafinil product. These actions allege violations of federal and state laws in connection with the defendants’ settlement of patent litigation relating to modafinil. These actions are in their preliminary stages, and motions to dismiss each action are pending, with the exception of the third party payor action, in which Mylan’s response to the complaint is not due until the motions filed in the other cases have been decided. Mylan intends to defend each of these actions vigorously. In addition, by letter dated July 11, 2006, Mylan was notified by the U.S. Federal Trade Commission (“FTC”) of an investigation relating to the settlement of the modafinil patent litigation. In its letter, the FTC requested certain information from Mylan, MPI and Mylan Technologies Inc. (“MTI”) pertaining to the patent litigation and the settlement thereof. On March 29, 2007, the FTC issued a subpoena, and on April 26, 2007, the FTC issued a civil investigative demand to Mylan requesting additional information from the Company relating to the investigation. Mylan is cooperating fully with the government’s investigation and completed all requests for information. On February 13, 2008, the FTC filed a lawsuit against Cephalon in the U.S. District Court for the District of Columbia and the case has subsequently been transferred to the U.S. District Court for the Eastern District of Pennsylvania. Mylan is not named as a defendant in the FTC’s lawsuit, although the complaint includes certain allegations pertaining to the Mylan/Cephalon settlement.

 

MYLAN INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Merck Generics Litigation

 

Generics UK Ltd. is accused of having been involved in pricing agreements pertaining to certain drugs during the years 1996 to 2000. Generics UK Ltd. was able to settle civil claims for damages brought by the Health Service in England and Wales out of court, without any admission of liability. Additional claims have been filed against Generics UK Ltd. and others by health authorities in Scotland and Northern Ireland totaling £21.0 ($41.9) million exclusive of interest. In addition to these civil claims, in 2006 criminal proceedings were filed in Southwark Crown Court against Generics UK Ltd. and other companies, as well as against a number of individuals who were alleged to be responsible for decision making in the companies. In early 2008, the House of Lords ruled that a price fixing cartel was not at the relevant times a criminal offense. The case was remanded back to the Crown Court for the prosecution to make an application to amend the indictment. On July 11, 2008, the Crown Court refused to allow the prosecution’s application, quashed the indictment and denied the prosecution’s application for permission to appeal (although the prosecution may still apply directly to the Court of Appeal for permission to appeal).

 

The Company has approximately $130.8 million recorded in other liabilities related to the litigation involving Dey and Generics UK Ltd. As stated above, in conjunction with the Merck Generics acquisition, Mylan is entitled to indemnification from Merck KGaA under the Share Purchase Agreement. As a result, the Company has recorded approximately $132.3 million in other assets.

 

Digitek^® Recall

 

On April 25, 2008, Actavis Totowa LLC, a division of Actavis Group, announced a voluntary, nationwide recall of all lots and all strengths of Digitek^® (digoxin tablets USP). Digitek is manufactured by Actavis and distributed in the United States by MPI and UDL. The Company has tendered its defense and indemnity in all lawsuits and claims arising from this event to Actavis, and Actavis has accepted that tender, subject to a reservation of rights. While the Company is unable to estimate total potential costs with any degree of certainty, such costs could be significant. To date, approximately 70 lawsuits have been filed against Mylan, UDL and Actavis pertaining to the recall. An adverse outcome in these lawsuits, or the inability or denial of Actavis to pay on an indemnified claim could have a materially negative impact on our financial position and results of operations.

 

Levetiracetam

 

In March 2004, Mylan Laboratories, Inc. and MPI, along with Dr. Reddy’s Laboratories, Inc., were named in a civil lawsuit filed in the Northern District of Georgia by UCB Society Anonyme and UCB Pharma, Inc. (“UCB”) alleging infringement of U.S. Patent No. 4,943,639 relating to levetiracetam tablets. This litigation was settled in October 2007. Under the terms of the settlement, Mylan has the right to market 250 mg, 500 mg, and 750 mg levetiracetam tablets in the United States beginning on November 1, 2008, provided that UCB obtains pediatric exclusivity for its product and Mylan obtains final approval for its ANDA from the FDA. Pediatric exclusivity has been granted. In addition, by letter dated November 19, 2007, Mylan was notified by the FTC of an investigation relating to the settlement of the levetiracetam patent litigation. In its letter, the FTC requested certain information from Mylan pertaining to the patent litigation and the settlement thereof. On April 9, 2008, the FTC issued a civil investigative demand to Mylan requesting additional information from Mylan relating to the investigation. Mylan is cooperating fully with the government’s investigation and has complied with all requests for information.

 

Other Litigation

 

The Company is involved in various other legal proceedings that are considered normal to its business, including certain proceedings assumed as a result of the Merck Generics acquisition. While it is not feasible to predict the ultimate outcome of such other proceedings, the Company believes that the ultimate outcome of such other proceedings will not have a material adverse effect on its financial position or results of operations.

 

The following discussion and analysis addresses material changes in the results of operations and financial condition of Mylan Inc. and subsidiaries (“the Company”, “Mylan” or “we”) for the periods presented. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements, the related Notes to Consolidated Financial Statements and Management’s Discussion and Analysis of Results of Operations and Financial Condition included in the Company’s Transition Report on Form 10-KT/A for the nine-month period ended December 31, 2007, the unaudited interim Condensed Consolidated Financial Statements and related Notes included in Part I, Item 1 of this Report on Form 10-Q (“Form 10-Q”) and the Company’s other SEC filings and public disclosures.

 

This Form 10-Q may contain “forward-looking statements”. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may include, without limitation, statements about the Company’s market opportunities, strategies, competition and expected activities and expenditures, and at times may be identified by the use of words such as “may”, “could”, “should”, “would”, “project”, “believe”, “anticipate”, “expect”, “plan”, “estimate”, “forecast”, “potential”, “intend”, “continue” and variations of these words or comparable words. Forward-looking statements inherently involve risks and uncertainties. Accordingly, actual results may differ materially from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, the risks described below under “Risk Factors” in Part II, Item 1A. The Company undertakes no obligation to update any forward-looking statements for revisions or changes after the date of this Form 10-Q.

 

Executive Overview

 

We are a leading global pharmaceutical company and have developed, manufactured, marketed, licensed and distributed high quality generic, branded and branded generic pharmaceutical products for more than 45 years. As a result of our acquisition of Merck Generics in October 2007 and the acquisition of a controlling interest in Matrix in January 2007, we are the third largest generic pharmaceutical company in the world based on 2006 combined calendar year revenues, a leader in branded specialty pharmaceuticals and the second largest active pharmaceutical ingredient (“API”) manufacturer with respect to the number of drug master files, or DMFs, filed with regulatory agencies. We hold a leading sales position in four of the world’s largest generic pharmaceutical markets: the United States, the United Kingdom (“U.K.”), France and Japan, and we also hold leading sales positions in several other key generics markets, including Australia, Belgium, Italy, Portugal and Spain.

 

Mylan previously had two reportable segments, the “Mylan Segment” and the “Matrix Segment”. With the acquisition of Merck Generics, Mylan now has three reportable segments: the “Generics Segment”, the “Specialty Segment”, and the “Matrix Segment”. The former Mylan Segment is included within the Generics Segment. Additionally, certain general and administrative expenses, as well as litigation settlements, and non-operating income and expenses are reported in Corporate/Other. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), information for earlier periods has been recast.

 

The measure of profitability (loss) used by the Company with respect to segments is gross profit less direct research and development expenses (“R&D”) and direct selling, general and administrative expenses (“SG&A”). The amortization of intangible assets, as well as certain purchase accounting related items, including the write-off of in-process research and development and the amortization of the inventory step-up, are excluded from segment profitability (loss).

 

Central & Eastern European Generics Businesses of Merck KGaA

 

On June 2, 2008, Mylan announced that it acquired Merck KGaA’s Central & Eastern Europe (“CEE”) generics businesses, which includes operations in Poland, Hungary, Slovakia, Slovenia and the Czech Republic. Mylan exercised its option to acquire these businesses as part of the original October 2007 agreement in which Mylan acquired Merck KGaA’s generics business in Western Europe, Asia-Pacific, Africa and North America.

Bystolic

 

In January 2006, the Company announced an agreement with Forest Laboratories Holdings, Ltd. (“Forest”), a wholly-owned subsidiary of Forest Laboratories, Inc., for the commercialization, development and distribution of Bystolic^tm in the United States and Canada (the “2006 Agreement”). Under the terms of that agreement, Mylan received a $75.0 million up front payment and $25.0 million upon approval of the product. Such amounts were being deferred until the commercial launch of the product and were to be amortized over the remaining term of the license agreement. Mylan also had the potential to earn future milestones and royalties on Bystolic sales and an option to co-promote the product, while Forest assumed all future development and selling and marketing expenses.

 

In February 2008, Mylan executed an agreement with Forest whereby Mylan sold to Forest its rights to Bystolic (“the Amended Agreement”). Under the terms of the Amended Agreement, Mylan received a one-time cash payment of $370.0 million, which was deferred along with the $100.0 million received under the 2006 Agreement, and retained its contractual royalties for three years, through 2010. Mylan’s obligations under the 2006 Agreement to supply Bystolic to Forest were unchanged by the Amended Agreement. Mylan believes that these supply obligations represent significant continuing involvement as Mylan remains contractually obligated to manufacture the product for Forest while the product is being commercialized, which is estimated to occur through the end of patent protection in 2020. As a result of this continuing involvement, Mylan will amortize the $470.0 million of deferred revenue ratably through 2020.

 

As such, $9.8 million and $13.1 million are included in other revenues in the Company’s Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2008. However, Mylan and Forest are in the process of transferring all manufacturing responsibilities for the product to Forest and we expect this to occur no later than December 2008. Once the manufacturing is transferred, we do not believe there to be any further significant continuing involvement and the earnings process will be deemed to be complete. Any remaining deferred revenue at that time will be immediately recognized into other revenues in the Company’s consolidated statement of operations.

 

Future royalties are considered to be contingent consideration and are recognized in other revenue as earned upon sales of the product by Forest. Such royalties are recorded at the net royalty rates specified in the Amended Agreement.

 

Goodwill Impairment

 

On February 27, 2008, the Company announced that it was reviewing strategic alternatives for its specialty business, Dey, including the potential sale of the business. This decision was based upon several factors, including a strategic review of the business, including the expected performance of the Perforomist^tm product, where anticipated growth was determined to be slower than expected and the timeframe to reach peak sales was determined to be longer than was originally anticipated.

 

As a result of our ongoing review of strategic alternatives, we determined that it was more likely than not that the business will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Accordingly, a recoverability test of Dey’s long-lived assets was performed during the three months ended March 31, 2008 in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). We included both cash flow projections and estimated proceeds from the eventual disposition of the long-lived assets. The estimated undiscounted future cash flows exceeded the book values of the long-lived assets and, as a result, no impairment charge was recorded.

 

Upon the closing of the Merck Generics transaction, Dey was defined as the Specialty Segment under the provisions of SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information (“SFAS No. 131”). Dey is also considered a reporting unit under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). Upon closing of the transaction, the Company allocated $711.2 million of goodwill to Dey.

 

The Company tests goodwill for possible impairment on an annual basis and at any other time events occur or circumstances indicate that the carrying amount of goodwill may be impaired. As we have determined that it is more likely than not that the business will be sold or otherwise disposed of significantly before the end of its previously

estimated useful life, the Company was required during the three months ended March 31, 2008 to assess whether any portion of its recorded goodwill balance was impaired.

 

The first step of the SFAS No. 142 impairment analysis consisted of a comparison of the fair value of the reporting unit with its carrying amount, including the goodwill. We performed extensive valuation analyses, utilizing both income and market approaches, in our goodwill assessment process. The following describes the valuation methodologies used to derive the estimated fair value of the reporting unit.

 

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

 

Market-Based Approach:  To corroborate the results of the income approach described above, we estimated the fair value of our reporting unit using several market-based approaches, including the guideline company method which focuses on comparing our risk profile and growth prospects to a select group of publicly traded companies with reasonably similar guidelines.

 

Based on the SFAS No. 142 “step one” analysis that was performed for Dey, the Company determined that the carrying amount of the net assets of the reporting unit was in excess of its estimated fair value. As such, the Company was required to perform the “step two” analysis for Dey, in order to determine the amount of any goodwill impairment. The “step two” analysis consisted of comparing the implied fair value of the goodwill with the carrying amount of the goodwill, with an impairment charge resulting from any excess of the carrying value of the goodwill over the implied fair value of the goodwill based on a hypothetical allocation of the estimated fair value to the net assets. Based on the second step analysis, the Company concluded that $385.0 million of the goodwill recorded at Dey was impaired. As a result, the Company recorded a non-cash goodwill impairment charge of $385.0 million during the three months ended March 31, 2008, which represented our best estimate as of March 31, 2008. The allocation discussed above is performed only for purposes of assessing goodwill for impairment; accordingly, we have not adjusted the net book value of the assets and liabilities on the Company’s Condensed Consolidated Balance Sheet, other than goodwill, as a result of this process.

 

The determination of the fair value of the reporting unit required the Company to make significant estimates and assumptions that affect the reporting unit’s expected future cash flows. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rates, operating income before depreciation and amortization, and capital expenditures forecasts. Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates. In addition, changes in underlying assumptions would have a significant impact on either the fair value of the reporting unit or the goodwill impairment charge.

 

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

 

NATCO Distribution Agreement

 

On June 10, 2008, Mylan announced that it had signed a license and supply agreement with NATCO Pharma Ltd. (“NATCO”) for NATCO’s glatiramer acetate pre-filled syringes, a generic version of Teva’s Copaxone^®, which is used to treat multiple sclerosis. The agreement grants Mylan exclusive distribution rights in the United States and all major markets in Europe, Australia, New Zealand, Japan and Canada and includes an option to expand into additional territories. NATCO has commercialized successfully its glatiramer acetate product in India and the Ukraine. Teva has reported that worldwide sales of Copaxone were more than $1.7 billion in 2007.

Divalproex Settlement

 

On June 5, 2008, Mylan Inc.’s subsidiary Mylan Pharmaceuticals Inc. (“MPI”) entered into a settlement and license agreement with Abbott Laboratories relating to divalproex extended-release (ER) tablets, the generic version of Abbott’s Depakote ER. Mylan expects to enjoy a 180-day exclusivity period on the 500 mg strength upon launching, which will occur no later than January 1, 2009. This agreement also provides a license for the 250 mg strength also to be launched no later than January 1, 2009. All litigation between Mylan and Abbott relating to divalproex ER tablets has been dismissed. Divalproex ER Tablets had U.S. sales of approximately $825.0 million for the 12 months ending March 31, 2008, with $722.0 million on the 500 mg and $103.0 million on the 250 mg.

 

Paroxetine Launch

 

On May 14, 2008, the Company announced that MPI had launched paroxetine HCI ER, the generic version of GlaxoSmithKline’s Paxil CR^®, under the provisions of a previously announced settlement of patent litigation. Paroxetine HCI ER tablets had U.S. sales of approximately $301.0 million for the 12 months ending March 31, 2008.

 

Financial Summary

 

Mylan’s financial results for the three months ended June 30, 2008, included total revenues of $1.20 billion compared to $546.3 million for the three months ended June 30, 2007. This represents an increase in revenues of $656.8 million. Consolidated gross profit for the current quarter was $414.2 million compared to $296.7 million in the same prior year period, an increase of 40%. For the current quarter, operating earnings of $74.0 million were realized compared to operating earnings of $188.1 million for the three months ended June 30, 2007.

 

The net loss available to common shareholders for the current quarter was $8.4 million compared to net earnings of $79.7 million in the comparable prior year period. This translates into a loss per diluted common share of $0.03 for the three months ended June 30, 2008, compared to earnings per diluted common share of $0.32 for the comparable three-month period. The results were affected by the following items:

 

Three Months Ended June 30, 2008:

 

 

Three Months Ended June 30, 2007:

 

 

In addition to the above, the loss per common share in the current quarter was impacted by the issuance of 55.4 million shares of common stock in November 2007. A more detailed discussion of the Company’s financial results can be found below in the section titled “Results of Operations”.

 

Mylan’s financial results for the six months ended June 30, 2008, include total revenues of $2.28 billion compared to $1.03 billion for the six months ended June 30, 2007. This represents an increase in revenues of $1.24 billion. Consolidated gross profit for the six months ended June 30, 2008 was $764.4 million compared to $531.6 million in the same prior year period, an increase of 44%. For the six months ended June 30, 2008, an operating loss of $297.5 million was realized compared to operating earnings of $180.3 million for the same prior year period.

 

The net loss available to common shareholders for the six months ended June 30, 2008 was $452.3 million compared to net earnings of $8.4 million in the comparable prior year period. This translates into a loss per diluted

common share of $1.49 for the six months ended June 30, 2008, compared to earnings per diluted common share of $.03 for the comparable six-month period. The results were affected by the following items:

 

Six Months Ended June 30, 2008:

 

 

Six Months Ended June 30, 2007:

 

 

In addition to the above, the loss per common share in the first six months of 2008 was impacted by the issuance of 26.2 million shares of common stock in March 2007 and the issuance of 55.4 million shares of common stock in November 2007. Because the first offering occurred in March 2007, the loss per common share for the six months ended June 30, 2007 did not bear the full impact of the new shares. However, these 26.2 million shares, as well as the additional 55.4 million shares were outstanding for the full six months ended June 30, 2008. A more detailed discussion of the Company’s financial results can be found below in the section titled “Results of Operations”.

 

Results of Operations

 

Three Months Ended June 30, 2008, Compared to Three Months Ended June 30, 2007

 

Total Revenues and Gross Profit

 

For the current quarter, Mylan reported total revenues of $1.20 billion compared to $546.3 million in the same prior year period. This represents an increase of $656.8 million. The acquisition of Merck Generics contributed revenues of $669.3 million, of which $563.4 million are included in the Generics Segment and $105.9 million are included in the Specialty Segment. Matrix contributed third party revenues of $104.6 million compared to $91.3 million in the comparable three-month period.

 

Gross profit for the three months ended June 30, 2008 was $414.2 million and gross margins were 34.4%. For the three months ended June 30, 2007, gross profit was $296.7 million and gross margins were 54.3%. Gross profit is impacted by certain purchase accounting related items recorded during the three months ended June 30, 2008 of approximately $112.1 million, which consisted primarily of incremental amortization related to purchased intangible assets and the amortization of the inventory step-up associated with the acquisition of Merck Generics. Excluding such items, gross margins would have been approximately 43.7%. Prior year gross profit is also impacted by similar purchase accounting related items recorded with respect to the Matrix acquisition in the amount of $18.8 million. Excluding such items, gross margins in the prior year would have been approximately 57.7%.

 

The decrease in gross margins excluding certain purchase accounting amounts related to the acquisition of Merck Generics and Matrix is due to the fact that on average, the newly acquired Merck Generics entities, particularly in countries outside of the United States, contribute margins that are lower than those realized by Mylan’s domestic subsidiaries. Additionally, margins were negatively impacted by the loss of exclusivity on certain products. Products generally contribute most significantly to gross margin at the time of their launch and even more so in periods of market exclusivity or limited generic competition. For a period of time during the three months ended June 30, 2007, Mylan had exclusivity on both amlodipine and oxybutynin.

Generics Segment

 

For the current quarter, the Generics Segment reported total revenues of $992.9 million. Generics Segment total revenues are derived from sales primarily in or from the U.S. and Canada (collectively, “North America”), Europe, the Middle East and Africa (collectively, “EMEA”) and Australia, Japan and New Zealand (collectively, “Asia Pacific”).

 

Total revenues from North America were $461.8 million for the three-month period ended June 30, 2008 compared to $455.0 million for the three months ended June 30, 2007, representing an increase of $6.8 million. In the current quarter, revenue of $32.4 million is the result of the acquisition of Merck Generics. Excluding the impact of the acquisition, total North America revenues decreased by $25.6 million or 6%. This decrease is the result of unfavorable pricing as discussed below, partially offset by revenue from new products and increased volume, as doses shipped during the quarter, excluding the impact of the acquisition, increased by approximately 15% to 4.06 billion.

 

Fentanyl, Mylan’s AB-rated generic alternative to Duragesic^®, continued to contribute significantly to the financial results, accounting for approximately 7% of net revenues in the Generics Segment despite the entrance into the market of additional generic competition in August 2007. As expected, the additional competition had an unfavorable impact on fentanyl pricing. However, this was offset by increased volumes of fentanyl, which Mylan was able to supply to the market as certain competitors recalled their versions of the fentanyl patch. The entrance into the market of additional generic competition upon Mylan’s loss of exclusivity on amlodipine also had a significant unfavorable impact on the current quarter sales as compared to the prior year period. Pricing on certain other products in the Company’s portfolio was also impacted by increased competition. As is the case in the generic industry, the entrance into the market of additional competition generally has a negative impact on the volume and pricing of the affected products. In order to offset decreases in sales as a result of additional competition, generic pharmaceutical manufacturers must be able to successfully bring to market new products. During the three months ended June 30, 2008, new products contributed $75.6 million to total revenues, consisting primarily of paroxetine HCI ER and felodipine ER.

 

Total revenues from EMEA were $389.8 million for the three months ended June 30, 2008, all of which were the result of the acquisition of Merck Generics. Within EMEA, approximately 67% of net revenues are derived from the three largest markets: France, the U.K. and Germany.

 

Total revenues from Asia Pacific were $141.4 million for the current quarter, all of which were the result of the acquisition of Merck Generics. The majority of revenues from Asia Pacific are contributed by Alphapharm, Mylan’s Australian subsidiary, with the remainder comprised of sales in Japan and New Zealand.

 

Certain markets in which the Company does business have recently undergone, some for the first time, or will soon undergo, government-imposed price reductions on pharmaceutical products. This is true in France and Australia, though this issue is not limited to just these markets. In addition, a number of markets in which we operate have implemented or may implement “tender systems” for generic pharmaceuticals in an effort to lower prices. Such measures are likely to have a negative impact on sales and gross profit in these markets. However, certain pro-generic government initiatives in certain markets could help to offset some of this unfavorability by potentially increasing generic substitution.

 

For the three months ended June 30, 2008, segment profitability for the Generics Segment was $236.1 million compared to $248.2 million in the comparable three month period. Of the current year amount, approximately $46.3 million is due to the acquisition of Merck Generics. Excluding this amount, segment profitability decreased by $58.4 million. This decrease is the result of lower revenues, as discussed above, as well as increased R&D expense, which is explained below.

 

Specialty Segment

 

For the current quarter, the Specialty Segment reported total revenues of $116.0 million, of which $105.9 million represented sales to third parties. The Specialty Segment consists of Dey, an entity acquired as part of the Merck Generics acquisition, that focuses on the development, manufacturing and marketing of specialty pharmaceuticals in the respiratory and severe allergy markets. The most significant contributor to the Specialty Segment revenues is

EpiPen, an epinephrine auto-injector, which is used in the treatment of severe allergies. EpiPen is the number one prescribed treatment for severe allergic reactions, with a market share of over 95%.

 

Another product marketed by the Specialty Segment is DuoNeb, a nebulized unit dose formulation of ipratropium bromide and albuterol sulfate for treatment of chronic obstructive pulmonary disorder. DuoNeb lost exclusivity in July 2007, at which time authorized generic competition entered the market. At the end of December 2007 and early January 2008, several other generics entered the market. As expected, sales and gross profit of this product have declined as a result of additional competition.

 

Segment profitability for the Specialty Segment for the three months ended June 30, 2008 was $19.7 million.

 

Matrix Segment

 

For the three months ended June 30, 2008, the Matrix Segment reported total revenues of $118.8 million, of which $104.6 million represented third-party sales compared to total revenues of $100.5 million, of which $91.3 million represented third party sales during the comparable period of the prior year. Approximately 60% of the Matrix Segment’s third-party net revenues come from the sale of API and intermediates, approximately 20% comes from the distribution of branded generic products in Europe, and the majority of the remainder comes from the sale of Matrix’s finished dosage form (“FDF”) anti-retroviral (“ARV”) products. Matrix launched its FDF business in late calendar year 2007. In addition to its net revenue, Matrix realized other revenue of $11.3 million through intersegment product development agreements. Intersegment net revenue consists of API sales to the Generics Segment primarily in conjunction with Mylan’s vertical integration strategy.

 

Segment profitability for the Matrix Segment for the current quarter was $6.3 million compared to $7.1 million in the comparable three-month period. A higher investment in R&D in the current year offset increased gross profit in the current year, which resulted in the overall decrease in segment profitability.

 

Operating Expenses

 

R&D expense for the three months ended June 30, 2008 was $80.8 million compared to $31.7 million in the same prior year period. For the current quarter, R&D expense includes approximately $40.9 million related to the newly acquired Merck Generics entities, all of which was incremental to the prior year. Excluding these amounts, R&D expense increased by $8.1 million or 26% primarily as a result of increased Abbreviated New Drug Application (“ANDA”) submissions.

 

SG&A expense for the current quarter was $259.5 million compared to $76.9 million for the same period in the prior year, an increase of $182.5 million. For the current quarter, SG&A expense includes approximately $152.9 million related to the newly acquired Merck Generics entities, all of which was incremental to the prior year. Excluding these amounts, SG&A expense increased by $29.5 million or 38%. This increase was primarily realized by Corporate/Other. The increase in Corporate/Other SG&A expense is due primarily to an increase in professional and consulting fees, as well as higher payroll and payroll related costs associated primarily with the ongoing integration of Merck Generics and the build-up of additional corporate infrastructure, also a direct result of the Merck Generics acquisition.

 

Interest Expense

 

Interest expense for the three months ended June 30, 2008 totaled $86.5 million compared to $22.9 million for the three months ended June 30, 2007. The increase is due to the additional debt incurred to finance the acquisition of Merck Generics.

 

Other Income, net

 

Other income, net, was $7.9 million in the current quarter, comprised mostly of dividend and interest income, compared to net expense of $36.4 million in the comparable three-month period. The comparable quarter of 2007 included a $57.5 million non-cash mark to market unrealized loss on a deal-contingent foreign currency option contract that was entered into for the then pending acquisition of Merck Generics. Excluding this unrealized loss,

the decrease in other income, net, in the current quarter is due primarily to lower interest and dividend income as a result of lower cash and available for sale securities.

 

Income Tax Expense

 

The Company recognized an income tax benefit of $31.0 million for the three month period ended June 30, 2008 compared to expense of $49.2 million in the comparable prior year quarter.

 

Six Months Ended June 30, 2008, Compared to Six Months Ended June 30, 2007

 

Total Revenues and Gross Profit

 

For the six months ended June 30, 2008, Mylan reported total revenues of $2.28 billion compared to $1.03 billion in the same prior year period. This represents an increase of $1.24 billion. The acquisition of Merck Generics contributed revenues of $1.30 billion, of which $1.12 billion are included in the Generics Segment and $183.0 million are included in the Specialty Segment. Matrix contributed third party revenues of $192.3 million compared to $170.7 million in the comparable six-month period.

 

Gross profit for the six months ended June 30, 2008 was $764.4 million and gross margins were 33.6%. For the six months ended June 30, 2007, gross profit was $531.6 million and gross margins were 51.4%. Gross profit is impacted by certain purchase accounting related items recorded during the six months ended June 30, 2008 of approximately $230.2 million, which consisted primarily of incremental amortization related to purchased intangible assets and the amortization of the inventory step-up associated with the acquisition of Merck Generics. Excluding such items, gross margins would have been approximately 43.7%. Prior year gross profit is also impacted by similar purchase accounting related items recorded with respect to the Matrix acquisition in the amount of $40.7 million. Excluding such items, gross margins in the prior year would have been approximately 55.4%.

 

The decrease in gross margins excluding amounts related to the acquisition of Merck Generics and Matrix, is due to the fact that on average, the newly acquired Merck Generics entities, particularly in countries outside of the United States, contribute margins that are lower than those realized by Mylan’s domestic subsidiaries. Additionally, margins were negatively impacted by the loss of exclusivity on certain products. Products generally contribute most significantly to gross margin at the time of their launch and even more so in periods of market exclusivity or limited generic competition. For a period of time during the six months ended June 30, 2007, Mylan had exclusivity on both amlodipine and oxybutynin.

 

Generics Segment

 

For the six months ended June 30, 2008, the Generics Segment reported total revenues of $1.90 billion. Generics Segment total revenues are derived from sales primarily in or from the U.S. and Canada (collectively, “North America”), Europe, the Middle East and Africa (collectively, “EMEA”) and Australia, Japan and New Zealand (collectively, “Asia Pacific”).

 

Total revenues from North America were $853.9 million for the six-month period ended June 30, 2008 compared to $862.9 million for the six months ended June 30, 2007, representing a decrease of $9.0 million. In the current six-month period, revenue of $67.2 million is the result of the acquisition of Merck Generics. Excluding the impact of the acquisition, total North America revenues decreased by $76.2 million or 9%. This decrease is the result of unfavorable pricing as discussed below, partially offset by increased volume, as doses shipped during the six months, excluding the impact of the acquisition, increased by over 12% to 8.07 billion.

 

Fentanyl continued to contribute significantly to the financial results, accounting for approximately 7% of net revenues in the Generics Segment despite the entrance into the market of additional generic competition in August 2007. As expected, the additional competition had an unfavorable impact on fentanyl pricing. However, this was offset by increased volumes of fentanyl which Mylan was able to supply to the market as certain competitors recalled their versions of the fentanyl patch. Additional generic competition resulted in unfavorable pricing on several other significant products in the Company’s portfolio. For two of these, amlodipine and oxybutynin, Mylan had market exclusivity for a portion of the prior year. As is the case in the generic industry, the entrance into the market of additional competition generally has a negative impact on the volume and pricing of the affected

products. Helping to offset some of the unfavorable pricing experienced in the current year were products launched subsequent to June 30, 2007, which contributed revenues of $95.5 million.

 

Total revenues from EMEA were $778.7 million for the six months ended June 30, 2008, all of which were the result of the acquisition of Merck Generics. Within EMEA, approximately 68% of net revenues are derived from the three largest markets: France, the U.K. and Germany.

 

Total revenues from Asia Pacific were $270.2 million for the six months ended June 30, 2008, all of which were the result of the acquisition of Merck Generics. The majority of revenues from Asia Pacific are contributed by Alphapharm, Mylan’s Australian subsidiary, with the remainder comprised of sales in Japan and New Zealand.

 

Certain markets in which the Company does business have recently undergone, some for the first time, or will soon undergo, government-imposed price reductions on pharmaceutical products. This is true in France and Australia, though this issue is not limited to just these markets. In addition, a number of markets in which we operate have implemented or may implement “tender systems” for generic pharmaceuticals in an effort to lower prices. Such measures are likely to have a negative impact on sales and gross profit in these markets. However, certain pro-generic government initiatives in certain markets could help to offset some of this unfavorability by potentially increasing generic substitution.

 

For the six months ended June 30, 2008, segment profitability for the Generics Segment was $432.2 million compared to $440.0 million in the comparable six month period. Of the current year amount, approximately $105.9 million is due to the acquisition of Merck Generics. Excluding this amount, segment profitability decreased by $113.7 million. This decrease is the result of lower revenues, as discussed above, as well as increased R&D expense, which is explained below.

 

Specialty Segment

 

For the six months ended June 30, 2008, the Specialty Segment reported total revenues of $205.4 million, of which $183.0 million represented sales to third parties. The Specialty Segment consists of Dey, an entity acquired as part of the Merck Generics acquisition that focuses on the development, manufacturing and marketing of specialty pharmaceuticals in the respiratory and severe allergy markets. The most significant contributor to the Specialty Segment revenues is EpiPen, an epinephrine auto-injector, which is used in the treatment of severe allergies. EpiPen is the number one prescribed treatment for severe allergic reactions with a market share of over 95%.

 

DuoNeb is a nebulized unit dose formulation of ipratropium bromide and albuterol sulfate for treatment of chronic obstructive pulmonary disorder. DuoNeb lost exclusivity in July 2007, at which time authorized generic competition entered the market. At the end of December 2007 and early January 2008, several other generics entered the market. As expected, sales and gross profit of this product have declined as a result of additional competition.

 

Segment loss for the Specialty Segment for the six months ended June 30, 2008 was $362.8 million, which includes the $385.0 million non-cash goodwill impairment charge.

 

Matrix Segment

 

For the six months ended June 30, 2008, the Matrix Segment reported total revenues of $222.3 million, of which $192.3 million represented third-party sales compared to total revenues of $196.3 million, of which $170.7 million represented third party sales during the prior year comparable period. Approximately 60% of the Matrix Segment’s third-party net revenues comes from the sale of API and intermediates, approximately 20% comes from the distribution of branded generic products in Europe, and the majority of the remainder comes from the sale of Matrix’s FDF ARV products. Matrix launched its FDF business in late calendar year 2007. In addition to its net revenue, Matrix realized other revenue of $23.0 million through intersegment product development agreements. Intersegment net revenue consists of API sales to the Generics Segment primarily in conjunction with Mylan’s vertical integration strategy.

Segment profitability for the Matrix Segment for the current six-month period was $10.0 million compared to $15.7 million in the comparable six-month period. While current year sales and gross profit were higher, an increase in operating expenses resulted in the lower year over year segment profitability.

 

Operating Expenses

 

R&D expense for the six months ended June 30, 2008 was $164.6 million compared to $68.6 million in the same prior year period. For the six months ended June 30, 2008, R&D expense includes approximately $84.5 million related to the newly acquired Merck Generics entities, all of which was incremental to the prior year. Excluding these amounts, R&D expense increased by $11.5 million or 17% primarily as a result of increased ANDA submissions.

 

During the six months ended June 30, 2007, the Company recognized a charge of $147.0 million to write-off acquired in-process R&D associated with the Matrix acquisition. This amount represents the fair value of purchased in-process technology for research projects that, as of the closing date of the acquisition, had not reached technological feasibility and had no alternative future use.

 

SG&A expense for the six months ended June 30, 2008 was $512.4 million compared to $139.7 million for the same period in the prior year, an increase of $372.7 million. For the six months, SG&A expense includes approximately $305.6 million related to the newly acquired Merck Generics entities, all of which was incremental to the prior year. Excluding these amounts, SG&A expense increased by $67.1 million or 48%. This increase was primarily realized by Corporate/Other. The increase in Corporate/Other SG&A expense is due primarily to an increase in professional and consulting fees as well as higher payroll and payroll related costs. The increase in professional and consulting fees is associated primarily with the ongoing integration of Merck Generics. The increase in payroll and related costs is principally attributable to the build-up of additional corporate infrastructure as a direct result of the Merck Generics acquisition.

 

Interest Expense

 

Interest expense for the six months ended June 30, 2008 totaled $177.2 million compared to $43.9 million for the six months ended June 30, 2007. The increase is due to the additional debt incurred to finance the acquisition of Merck Generics.

 

Other Income, net

 

Other income, net, was $14.8 million for the six months ended June 30, 2008, compared to net expense of $25.9 million in the comparable six-month period. The comparable period of 2007 included a $57.5 million non-cash mark to market unrealized loss on a deal-contingent foreign currency option contract that was entered into for the then pending acquisition of Merck Generics. Excluding this unrealized loss, the decrease in other income, net, in the current year is due primarily to lower interest and dividend income as a result of lower cash and available for sale securities.

 

Income Tax Expense

 

For the six month period ending June 30, 2008, the income tax benefit was $75.1 million as compared to expense of $102.0 million for the comparable six month period in the prior year. The effective tax rate in 2008 has been largely influenced by operating losses offset by the non-deductible impairment charge related to Dey. The effective tax rate reported in the prior year was impacted by the write-off of acquired in-process research and development related to the Matrix acquisition.

 

Liquidity and Capital Resources

 

Cash flows from operating activities were $162.3 million for the six months ended June 30, 2008, consisting primarily of net income (after the non-cash add-backs for depreciation and amortization expense and the $385.0 million of goodwill impairment related to Dey), as well as an increase in deferred revenue of $348.4 million.

Partially offsetting these items are the deferred tax benefit of $216.3 million and a net usage of cash through changes in working capital items such as accounts receivable, net, inventory and other assets and liabilities.

 

The higher accounts receivable balance is the result of increased sales and the timing of cash collections from our customers, while inventory balances have increased in line with forecasted production plans. A decrease in other current liabilities, including payroll and payroll related liabilities such as bonus and profit sharing, have also resulted in a use of cash. The increase in deferred revenue, as well as a significant component of the current year change in deferred tax benefit, is due to the Bystolic agreement with Forest.

 

Cash used in investing activities was $83.1 million for the six months ended June 30, 2008. Net sales of investments in available for sale securities, which consist of a variety of high-credit quality debt securities, including U.S. government, state and local government and corporate obligations, generated a net $38.0 million in cash. These investments are highly liquid and available for working capital and other needs. As these instruments mature, the funds are generally reinvested in instruments with similar characteristics.

 

Capital expenditures during the six months ended June 30, 2008 were $71.0 million. These expenditures were incurred primarily for equipment, including with respect to the Company’s previously announced planned expansions and integration plans with respect to the Merck Generics acquisition. Also included in investing activities was a cash outflow of $40.0 million for the purchase of a surety bond with respect to the Company’s lorazepam and clorazepate litigation.

 

Cash used in financing activities was $95.4 million for the six months ended June 30, 2008. Cash dividends of $68.0 million were paid on the Company’s 6.50% mandatory convertible preferred stock. Additionally, the Company made repayments on its long-term debt in the amount of $76.4 million, offset partially by $41.0 million of short-term borrowings.

 

The Company is involved in various legal proceedings that are considered normal to its business (see Note 16 of our Condensed Consolidated Financial Statements). While it is not feasible to predict the outcome of such proceedings, an adverse outcome in any of these proceedings could materially affect the Company’s financial position and results of operations.

 

The Company’s Condensed Consolidated Balance Sheet at June 30, 2008, includes $70.3 million of remaining restructuring reserve, which relates to certain estimated exit costs associated with the acquisition of Merck Generics (see Note 15 of our Condensed Consolidated Financial Statements). The plans related to these exit activities have yet to be finalized and there may be additional costs incurred. Payments of approximately $4.0 million were made during the six months ended June 30, 2008, of which $2.9 million were severance costs and the remaining $1.1 million were other exit costs.

 

The Company announced its intent to restructure certain activities and incur certain exit costs unrelated to the Merck Generics acquisition. At June 30, 2008, the Company met all the criteria in SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, and has recorded a restructuring reserve of approximately $0.7 million. This restructuring charge is included in operating expenses in the Company’s Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2008. As finalization of the plan is still in progress, we have not yet estimated the total amount expected to be incurred in connection with such activities. However, we expect the majority of such costs will related to one-time termination benefits and certain asset write-downs and could be significant.

 

The Company is actively pursuing, and is currently involved in, joint projects related to the development, distribution and marketing of both generic and brand products. Many of these arrangements provide for payments by the Company upon the attainment of specified milestones. While these arrangements help to reduce the financial risk for unsuccessful projects, fulfillment of specified milestones or the occurrence of other obligations may result in fluctuations in cash flows.

 

The Company is continuously evaluating the potential acquisition of products, as well as companies, as a strategic part of its future growth. Consequently, the Company may utilize current cash reserves or incur additional indebtedness to finance any such acquisitions, which could impact future liquidity.

In addition, the Company has an ongoing process that includes a review of our operations. This process includes evaluating potential divestures of products and businesses as part of our future strategy. Initially, we are focused on Dey, our specialty branded business.

 

To that end, we have engaged outside advisors to assist us in considering our alternatives, including the potential sale of the business. Any divestitures could impact future liquidity.

 

Recent Accounting Pronouncements

 

In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities, (“FSP No. EITF 03-6-1”). FSP No. EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP No. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting FSP No. EITF 03-6-01 on its consolidated financial statements.

 

In May 2008, the FASB issued FSP No. APB 14-a, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (“FSP No. APB 14-a”). Under the new rules for convertible debt instruments (including our Senior Convertible Notes) that may be settled entirely or partially in cash upon conversion, an entity should separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost. The effect of the new rules for the debentures is that the equity component would be included in the paid-in-capital section of stockholders’ equity on our consolidated balance sheet and the value of the equity component would be treated as original issue discount for purposes of accounting for the debt component of the Senior Convertible Notes. FSP No. APB 14-a will be effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. Higher interest expense would result through the accretion of the discounted carrying value of the Senior Convertible Notes to their face amount over the term of the Senior Convertible Notes. Prior period interest expense will also be higher than previously reported interest expense due to retrospective application. Early adoption is not permitted. The Company is currently evaluating the proposed new rules and the impact of adopting FSP No. APB 14-a on our consolidated financial statements.

 

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets, (“FSP No. FAS 142-3”). FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets, (“SFAS No. 142”) in order to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R) and other accounting principles generally accepted in the United States, (“GAAP”). FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting FSP No. FAS 142-3 on our consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51, (“SFAS No. 160”). SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This standard defines a noncontrolling interest, sometimes called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS No. 160 requires, among other items, that a noncontrolling interest be included in the consolidated balance sheet within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statement of operations; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 160 on our consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, including (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This standard is effective for fiscal years beginning after November 15, 2008. As SFAS No. 161 only requires enhanced disclosures, management is currently assessing the impact on the disclosures on the Company’s consolidated financial statements.

 

In March 2008, the Emerging Issues Task Force (“EITF”) issued EITF No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock (“EITF No. 07-5”). EITF No. 07-5 states that if an instrument (or an embedded feature) has the characteristics of a derivative instrument under paragraphs 6-9 of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and is indexed to an entity’s own stock, it is necessary to evaluate whether it is classified in stockholder’s equity (or would be classified in stockholders’ equity if it were a freestanding instrument). EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of adopting EITF No. 07-5 on our consolidated financial statements.

 

On January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option) with changes in fair value reported in earnings. The Company already records marketable securities at fair value in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 115”), and derivative contracts and hedging activities at fair value in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133”). The adoption of SFAS No. 159 did not have a material impact on the Company’s Condensed Consolidated Financial Statements as management did not elect the fair value option for any other financial instrument or certain other assets and liabilities.

 

On January 1, 2008, the Company adopted Statement 133 Implementation Issue No. E23, Hedging — General: Issues Involving the Application of the Shortcut Method under Paragraph 58 (“Issue No. E23”). Issue No. E23 provides guidance on certain practice issues related to the application of the shortcut method by amending paragraph 68 of SFAS No. 133 with respect to the conditions that must be met in order to apply the shortcut method for assessing hedge effectiveness of interest rate swaps. In addition to applying the provisions of Issue No. E23 on hedging arrangements designated on or after January 1, 2008, an assessment was required to be made on January 1, 2008 to determine whether preexisting hedging arrangements met the provisions of Issue No. E23 as of their original inception. Management performed such an assessment and determined that the adoption of Issue No. E23 did not have a material impact on preexisting hedging arrangements.

 

In March 2007, the EITF issued EITF No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements (“EITF No. 06-10”). Under the provisions of EITF No. 06-10, an employer is required to recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement with the employee. The provisions of EITF No. 06-10 also require an employer to recognize and measure the asset in a collateral assignment split-dollar life insurance arrangement based on the nature and substance of the arrangement. The Company adopted the provisions of EITF No. 06-10 as of January 1, 2008. As a result of the adoption, the Company recognized a liability of $8.3 million, representing the present value of the future premium payments to be made under the existing policies. In accordance with the transition provisions of EITF No. 06-10, this amount was recorded as a direct decrease to retained earnings.

 

In March 2007, the EITF issued EITF No. 06-04, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsed Split-Dollar Life Insurance Arrangements (“EITF No. 06-4”), which concludes that an employer should recognize a liability for post-employment benefits promised an employee based on the substantive arrangement between the employer and the employee. The Company adopted the provisions of EITF No. 06-04 as of January 1, 2008. The adoption of EITF No. 06-04 did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

For a discussion of the Company’s market risk, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in the Company’s Transition Report filed on Form 10-KT/A.

 

During the six months ended June 30, 2008, we executed an incremental $500.0 million of notional interest rate swaps in order to fix the interest rate on a portion of our U.S. dollar debt under the Senior Credit Agreement. These swaps are designated as cash flow hedges of the variability of interest expense related to our variable rate debt and fix a rate of 5.44% until March 2010.