Q3 2013 10Q
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _________________________________________
FORM 10-Q
 _________________________________________
S
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2013
OR
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 000-54283
________________________________________ 
PATHEON INC.
(Exact name of registrant as specified in its charter)
 _________________________________________
Canada
 
Not Applicable
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
c/o Patheon Pharmaceuticals Services Inc.
4721 Emperor Boulevard, Suite 200
Durham, NC
 
27703
(Address of principal executive offices)
 
(Zip Code)
919-226-3200
(Registrant's telephone number, including area code) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  S    No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  S    No  £
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):
Large accelerated filer
£
 
Accelerated filer
S
Non-accelerated filer
£
 (Do not check if a smaller reporting company)
Smaller reporting company
£
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  S
As of August 30, 2013, the registrant had 140,928,525 restricted voting shares outstanding.


Table of Contents


Patheon Inc.
TABLE OF CONTENTS

 
PART I -
Financial Information
 
Item 1.
 
 
 
 
Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended July 31, 2013 and 2012
 
Unaudited Consolidated Statement of Changes in Shareholders' Equity for the Nine Months Ended July 31, 2013
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
PART II -
Item 1.
Item 1A.
Item 6.
 
 



Table of Contents


Item 1.        Financial Statements

Patheon Inc.
CONSOLIDATED BALANCE SHEETS
(unaudited)
 
 
As of July 31,
2013
 
As of October 31,
2012
(in millions of U.S. dollars)
$
 
$
Assets
 
 
 
Current
 
 
 
Cash and cash equivalents
40.9

 
39.4

Accounts receivable
181.7

 
161.7

Inventories
144.3

 
82.3

Income taxes receivable
21.0

 
0.4

Prepaid expenses and other
21.7

 
11.9

Deferred tax assets - short-term
6.6

 
4.3

Total current assets
416.2

 
300.0

Capital assets
492.2

 
416.4

Intangible assets
70.6

 

Deferred financing costs
21.0

 
4.9

Goodwill
45.3

 
3.5

Investments
8.5

 
6.3

Other long-term assets
17.3

 
11.8

Total assets
1,071.1

 
742.9

Liabilities and shareholders' equity
 
 
 
Current
 
 
 
Short-term borrowings
5.2

 
2.4

Accounts payable and accrued liabilities
205.7

 
186.2

Income taxes payable
2.2

 
5.7

Deferred revenues - short-term
14.8

 
13.9

Deferred tax liabilities - short-term
0.3

 

Current portion of long-term debt
6.8

 

Total current liabilities
235.0

 
208.2

Long-term debt
598.4

 
310.7

Deferred revenues
21.8

 
28.9

Deferred tax liabilities
57.4

 
23.0

Other long-term liabilities
44.6

 
47.8

Total liabilities
957.2

 
618.6

Shareholders' equity
 
 
 
Restricted voting shares
610.5

 
572.5

Contributed surplus
15.9

 
16.5

Accumulated deficit
(525.5
)
 
(478.6
)
Accumulated other comprehensive income
13.0

 
13.9

Total shareholders' equity
113.9

 
124.3

Total liabilities and shareholders' equity
1,071.1

 
742.9

see accompanying notes


1

Table of Contents


Patheon Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
  
Three months ended July 31,
 
Nine months ended July 31,
  
2013
 
2012
 
2013
 
2012
(in millions of U.S. dollars, except per share information)
$
 
$
 
$
 
$
Revenues
265.7

 
203.7

 
733.1

 
539.1

Cost of goods sold
194.6

 
148.2

 
562.6

 
435.2

Gross profit
71.1

 
55.5

 
170.5

 
103.9

Selling, general and administrative expenses
44.8

 
29.9

 
121.6

 
99.0

Research and development
2.8

 

 
7.4

 

Repositioning expenses
4.5

 
0.1

 
11.0

 
6.9

Acquisition and integration costs
1.2

 

 
9.3

 

Impairment charge
1.2

 

 
11.3

 
57.9

Gain on sale of capital assets

 

 
(1.6
)
 

Operating income (loss)
16.6

 
25.5

 
11.5

 
(59.9
)
Interest expense, net
12.6

 
6.8

 
35.0

 
19.8

Foreign exchange loss, net

 
0.4

 
1.5

 
0.6

Refinancing expenses

 

 
29.2

 

Other income, net
(1.2
)
 
(0.5
)
 
(1.8
)
 
(0.6
)
Income (loss) from continuing operations before income taxes
5.2

 
18.8

 
(52.4
)
 
(79.7
)
Provision for (benefit from) income taxes
0.9

 
3.3

 
(5.5
)
 
3.6

Income (loss) from continuing operations
4.3

 
15.5

 
(46.9
)
 
(83.3
)
Loss from discontinued operations

 

 

 
(0.2
)
Net income (loss) attributable to restricted voting shareholders
4.3

 
15.5

 
(46.9
)
 
(83.5
)
Basic income (loss) per share
 
 
 
 
 
 
 
From continuing operations

$0.031

 

$0.120

 

($0.337
)
 

($0.643
)
From discontinued operations

 

 

 

($0.002
)
Net income (loss) per share, basic

$0.031

 

$0.120

 

($0.337
)
 

($0.645
)
Diluted income (loss) per share
 
 
 
 
 
 
 
From continuing operations

$0.030

 

$0.120

 

($0.337
)
 

($0.643
)
From discontinued operations

 

 

 

($0.002
)
Net income (loss) per share, diluted

$0.030

 

$0.120

 

($0.337
)
 

($0.645
)
Weighted-average number of shares outstanding (in thousands)
 
 
 
 
 
 
 
Basic
140,640

 
129,639

 
139,232

 
129,639

Diluted
145,694

 
129,692

 
139,232

 
129,639

see accompanying notes

2

Table of Contents


Patheon Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)


  
Three months ended July 31,
 
Nine months ended July 31,
  (in millions of U.S. dollars)
2013
 
2012
 
2013
 
2012
 
$
 
$
 
$
 
$
Net income (loss) attributable to restricted voting shareholders
4.3

 
15.5

 
(46.9
)
 
(83.5
)
Other comprehensive income (losses), net of income taxes
 
 
 
 
 
 
 
Change in foreign currency (losses) gains on investments in subsidiaries, net of hedging activities
(1.9
)
 
(13.6
)
 
2.4

 
(20.5
)
Change in value of derivatives designated as foreign currency cash flow hedges
(2.3
)
 
(0.7
)
 
(3.2
)
 
1.2

(Losses) gains on foreign currency cash flow hedges reclassified to consolidated statements of loss
(0.2
)
 
0.5

 
(1.0
)
 
0.6

Net change in pension liability
0.3

 

 
0.9

 
0.3

Curtailment impact and plan asset remeasurement, net of tax

 

 

 
6.0

Comprehensive income (loss) attributable to restricted voting shareholders
0.2

 
1.7

 
(47.8
)
 
(95.9
)
see accompanying notes



3

Table of Contents


Patheon Inc.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited)
 
(in millions of U.S. dollars)
Restricted Voting Shares
 
Contributed Surplus
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total Shareholders' Equity
Balance at October 31, 2012
$
572.5

 
$
16.5

 
$
(478.6
)
 
$
13.9

 
$
124.3

Proceeds from equity offering, net
29.2

 

 

 

 
29.2

Stock options exercised
8.8

 
(3.0
)
 

 

 
5.8

Stock-based compensation

 
2.4

 

 

 
2.4

Comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Net loss attributable to restricted voting shareholders

 

 
(46.9
)
 

 
(46.9
)
Change in foreign currency gains on investments in subsidiaries, net of hedging activities

 

 

 
2.4

 
2.4

Change in value of derivatives designated as foreign currency cash flow hedges

 

 

 
(3.2
)
 
(3.2
)
Losses on foreign currency hedges reclassified to consolidated statement of operations

 

 

 
(1.0
)
 
(1.0
)
Net change in pension liability

 

 

 
0.9

 
0.9

Subtotal

 

 
(46.9
)
 
(0.9
)
 
(47.8
)
Balance at July 31, 2013
$
610.5

 
$
15.9

 
$
(525.5
)
 
$
13.0

 
$
113.9

see accompanying notes

4

Table of Contents


Patheon Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
  
Nine months ended July 31,
  
2013
 
2012
(in millions of U.S. dollars)
$
 
$
Operating activities
 
 
 
Loss from continuing operations
(46.9
)
 
(83.3
)
Adjustments to reconcile loss from continuing operations to cash (used in) provided by operating activities
 
 
 
Depreciation and amortization
35.6

 
30.8

Impairment charge
11.3

 
57.9

Foreign exchange loss on debt
0.4

 

Other non-cash interest
8.2

 
0.9

Change in other long-term assets and liabilities
(10.7
)
 
(1.7
)
Deferred income taxes
0.9

 
(0.3
)
Amortization of deferred revenues
(13.5
)
 
(7.6
)
Gain on sale of capital assets
(1.6
)
 

Stock-based compensation expense
2.4

 
2.5

Other
(1.7
)
 
(0.8
)
 
(15.6
)
 
(1.6
)
Net change in non-cash working capital balances related to continuing operations
(22.3
)
 
(9.9
)
Increase in deferred revenues
12.3

 
18.7

Cash (used in) provided by operating activities of continuing operations
(25.6
)
 
7.2

Cash used in operating activities of discontinued operations
(0.1
)
 
(0.4
)
Cash (used in) provided by operating activities
(25.7
)
 
6.8

Investing activities
 
 
 
Additions to capital assets
(34.2
)
 
(32.9
)
Proceeds on sale of capital assets
6.6

 
0.1

Acquisitions, net of cash acquired
(256.1
)
 

Cash used in investing activities of continuing operations
(283.7
)

(32.8
)
Cash provided by investing activities of discontinued operations


0.1

Cash used in investing activities
(283.7
)
 
(32.7
)
Financing activities
 
 
 
Decrease in short-term borrowings


(1.3
)
Proceeds from long-term borrowings
633.8


35.5

Increase in deferred financing costs
(22.7
)
 

Repayment of debt, net of penalty payment
(337.8
)

(3.9
)
Share issuance costs
(0.8
)
 

Proceeds on issuance of restricted voting shares
35.8

 

Cash provided by financing activities
308.3

 
30.3

Effect of exchange rate changes on cash and cash equivalents
2.6

 
(2.4
)
Net increase in cash and cash equivalents during the period
1.5

 
2.0

Cash and cash equivalents, beginning of period
39.4

 
33.4

Cash and cash equivalents, end of period
40.9

 
35.4

see accompanying notes

5

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)


1.    BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying unaudited consolidated financial statements have been prepared by Patheon Inc. (the "Company" or "Patheon") in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). Operating results for the three and nine months ended July 31, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending October 31, 2013 ("fiscal 2013"). These consolidated financial statements do not include all the information and footnotes required by U.S. GAAP for annual financial statements and therefore should be read in conjunction with the audited consolidated financial statements and notes for the fiscal year ended October 31, 2012 ("fiscal 2012") contained in the Company's Annual Report on Form 10-K for the year then ended.
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect: the reported amounts of assets and liabilities; the disclosure of contingent assets and liabilities at the date of the consolidated financial statements; and the reported amounts of revenue and expenses in the reporting period. Management believes that the estimates and assumptions used in preparing its consolidated financial statements are reasonable and prudent, however, actual results could differ from those estimates.
Changes in significant accounting policies
In connection with the Banner Acquisition (described in Note 2), the following accounting policies became more significant to the Company:
Revenue recognition on product sales

The Company now manufactures and sells proprietary products. With respect to the sales of these products, the Company recognizes revenue when title has transferred to the customer and the customer has assumed the risks and rewards of ownership. The Company also has agreements with various distributors that allow the Company to share in product profits. The Company recognizes these profits once the distributor ships the product and title passes to the distributor's customer. The Company does not offer return policies to its customers except for defective products.
 
Goodwill
As a result of the Banner Acquisition, the Company recorded goodwill representing the excess of the purchase price over the fair value of the assets acquired and the liabilities assumed. The Company tests goodwill for impairment at least annually in the fiscal fourth quarter, or when indications of potential impairment exist. The Company monitors for the existence of potential impairment indicators throughout the fiscal year. Testing is performed with respect to each of the Company's reporting units that have been allocated goodwill, which the Company has determined are the sites within its CMO segment.
If the Company's qualitative assessment reveals that goodwill impairment is more likely than not, the Company performs the two-step impairment test. Alternatively, the Company may bypass the qualitative test and initiate goodwill impairment testing with the first step of the two-step goodwill impairment test.
During the first step of the goodwill impairment test, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, then the Company concludes that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, the Company performs the second step of the goodwill impairment test to measure possible goodwill impairment loss. During the second step, the Company hypothetically values the reporting unit's tangible and intangible assets and liabilities as if the reporting unit had been acquired in a business combination. The Company then compares the implied fair value of the reporting unit's goodwill to the carrying value of its goodwill. If the carrying value of the reporting unit's goodwill exceeds the implied fair value of the goodwill, the Company recognizes an impairment loss in an amount equal to the excess, not to exceed the carrying value of the reporting unit's goodwill. Once an impairment loss is recognized, the adjusted carrying value of the goodwill becomes the new accounting basis of the goodwill for the reporting unit.
Intangible Assets

As a result of the Banner Acquisition, the Company has recorded various intangible assets, including technology, in process research and development, customer relationships and trade names. The Company tests for impairment of definite lived intangible assets whenever events or changes in circumstances indicate that the carrying amount will not be recoverable.


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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

If such indicators are present, the Company assesses the recoverability of the intangible assets by determining whether the carrying value of such assets can be recovered through undiscounted future cash flows. If the sum of the undiscounted cash flows is less than the carrying amount, the excess of the carrying amount over the estimated fair value, based on the discounted cash flows, is recorded as a charge to earnings.

For indefinite-lived intangible assets other than goodwill, the Company compares the fair value of the intangible asset with the asset's carrying amount. If the fair value is less than the carrying amount, the Company recognizes an impairment. This impairment test for indefinite-lived intangible assets other than goodwill is conducted annually, concurrently with the goodwill impairment test.
Research and development expenses
The Company now has research and development costs that are expensed as incurred. These expenses relate to proprietary research and development efforts and consist of salaries and benefits, supplies and other costs.
Recently adopted accounting pronouncements

Effective November 1, 2012, the Company adopted Accounting Standards Update ("ASU") 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment" ("ASU 2011-08"), which amends U.S. GAAP Accounting Standards Codification ("ASC") 350, "Intangible Assets-Goodwill and Other." Under ASU 2011-08, an entity may elect the option to assess qualitative factors to determine whether it is necessary to perform the first step in the two-step impairment testing process. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of this guidance did not have a material impact on the Company's financial statements.

Effective November 1, 2012, the Company adopted ASU 2012-02, "Testing Indefinite-Lived Intangible Assets for Impairment" ("ASU 2012-02"). ASU 2012-02, was promulgated to reduce the cost and complexity of testing indefinite-lived intangible assets other than goodwill for impairment. ASU 2012-02 is intended to simplify indefinite-lived intangible impairment testing by allowing an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of an asset is less than its carrying amount as a basis for determining whether it is necessary to perform a quantitative impairment test. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The adoption of this guidance did not have a material impact on the Company's financial statements.

Effective November 1, 2012, the Company adopted ASU 2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income in U.S. GAAP" ("ASU 2011-05"). ASU 2011-05 requires that comprehensive income and the related components of net income and of other comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 also requires reclassification adjustments from other comprehensive income to net income be presented on the face of the financial statements. The amendments are effective for annual reporting periods beginning on or after December 15, 2011, and interim periods within those annual periods. However, in December 2011, the Financial Accounting Standards Board ("FASB") issued ASU 2011-12, "Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05" to defer the requirement to present reclassification adjustments from other comprehensive income on the face of the financial statements and allow entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the requirements in effect before ASU 2011-05. Other than a change in presentation, the adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
Recently issued accounting pronouncements

In July 2013, the FASB issued ASU 2013-11, “Income Taxes, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” (“ASU 2013-11”). ASU 2013-11 states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in ASU 2013-11 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging, Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes” (“ASU No. 2013-10”). ASU 2013-10 permits the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to UST and LIBOR. The amendments also remove the restriction on using different benchmark rates for similar hedges. Prior to the amendments in this ASU, only U.S. Treasury and the LIBOR swap rates were considered benchmark interest rates. Including the Fed Funds Effective Swap Rate (OIS) as an acceptable U.S. benchmark interest rate in addition to U.S. Treasury and LIBOR rates provides a more comprehensive spectrum of interest rates to be utilized as the designated benchmark interest rate risk component under the hedge accounting guidance. The amendments in ASU 2013-10 are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.

In March 2013, the FASB issued ASU 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity" ("ASU 2013-05"). ASU 2013-05 resolves the diversity in practice concerning the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets within a foreign entity. The guidance is effective for fiscal years and interim reporting periods within those fiscal years beginning after December 15, 2013. The amendments described in the ASU are to be applied prospectively to derecognition events occurring after the effective date; prior periods are not to be adjusted. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.

In February 2013, the FASB issued ASU 2013-04, "Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date" ("ASU 2013-04"). ASU 2013-04 provides guidance for the recognition, measurement and disclosure resulting from joint and several liability arrangements. Examples of obligations that fall within the scope of the ASU include certain debt arrangements, other contractual obligations and settled litigation. The new guidance is effective on a retrospective basis for fiscal years and interim periods within those fiscal years beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.

In February 2013, the FASB issued ASU 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" ("ASU 2013-02"). ASU 2013-02 requires enhanced disclosures about items reclassified out of accumulated other comprehensive income ("AOCI"). For items reclassified to net income in their entirety, the ASU requires information about the effect of significant reclassification items to appear on separate line items of net income. For those items where direct reclassification to net income is not required, companies must provide cross-references to other disclosures that provide details about the effects of the reclassification out of AOCI. Expanded disclosures concerning current period changes in AOCI balances are also required for each component of other comprehensive income on the face of the financial statements or in the notes. ASU 2013-02 is effective prospectively for fiscal years beginning after December 15, 2012, and interim periods within those fiscal years. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.

In December 2011, the FASB issued ASU 2011-11, "Disclosures about Offsetting Assets and Liabilities," which requires enhanced disclosures about financial instruments and derivative instruments that are either (i) offset in accordance with either Section 210-20-45 or 815-10-45 or (ii) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. The amendments are effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods. The amendments are required to be applied retrospectively for all prior periods presented. The adoption of this guidance is not expected to have a material impact on the Company's financial statements.
 

8

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)


2.    BANNER ACQUISITION

Background
On December 14, 2012, the Company completed the acquisition of all of the issued and outstanding shares of capital stock of Sobel USA Inc., a Delaware corporation, and Banner Pharmacaps Europe B.V., a private limited company organized under the laws of The Netherlands (collectively "Banner") from Sobel Best N.V. and VION Holding, N.V., each corporation is organized under the laws of The Netherlands, for a net aggregate purchase price of approximately $269.0 million (the "Banner Acquisition"). Banner is a pharmaceutical business focused on delivering proprietary softgel formulations, with four manufacturing facilities and a number of proprietary technologies and products.

Purchase price allocation

The Banner Acquisition is accounted for using the acquisition method of accounting in accordance with ASC Subtopic 805-10, "Business Combinations," and the fair value concepts set forth in ASC Subtopic 820-10, "Fair Value Measurements and Disclosures". Under ASC 805-10, the total purchase price for Banner was allocated to the assets acquired and liabilities assumed based on their respective fair values as of the acquisition date. The allocation of the purchase price is based on estimates and assumptions that are subject to change within the measurement period. The excess of the purchase price over the fair values of the assets acquired and liabilities assumed was recorded as goodwill. Goodwill largely consists of geographic expansion of product sales, manufacturing and other synergies of the combined companies, and the value of the assembled workforce.

The estimated purchase price allocation for the Banner Acquisition is as follows:
 
$
Cash and cash equivalents
12.7

Accounts receivable
53.4

Inventories
53.7

Income taxes receivable
4.3

Prepaid expenses and other
3.6

Deferred tax assets-short-term
1.7

Capital assets
91.0

Intangible assets
75.1

Goodwill
41.9

Deferred tax assets - long-term
0.1

Other long-term assets
0.3

Accounts payable and accrued liabilities
(32.6
)
Deferred tax liabilities - short-term
(0.4
)
Other long-term liabilities
(3.5
)
Deferred tax liabilities-long-term
(32.3
)
Total purchase price
269.0


The Company recorded all of the $41.9 million of goodwill to its CMO segment. In addition, the Company does not expect any of the goodwill to be tax deductible.

Valuations of intangible assets acquired

The weighted-average life of the acquired intangible assets is approximately 11.0 years. The following table sets forth the components of the acquired intangible assets by type:

9

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

  
Estimated Fair Value
 
Estimated Useful Life (in years)
 
$
 
 
Trade names
0.8

 
5-6
Technology
46.4

 
10-12
Customer relationships
11.1

 
7-12
In-process research and development(1)
16.8

 
Indefinite
Total
75.1

 
 
(1) In process research and development is currently classified as indefinite-lived intangible assets and will either begin to be amortized upon product approvals or written-off if not approved.

Purchase price allocation and pre-acquisition adjustments

The Company continues to evaluate pre-acquisition contingencies, working capital and tax balances including deferred tax assets and liabilities relating to Banner that existed as of the acquisition date. If the Company makes changes to the amounts recorded or identifies additional pre-acquisition contingencies during the remainder of the measurement period, such amounts recorded will be included as an adjustment to the purchase price allocation during the measurement period.

Financial results of the acquired business

The revenues and net loss of Banner for the period from December 15, 2012 through July 31, 2013 included in the consolidated statement of operations are as follows: 
  
Three months ended July 31,
 
Nine months ended July 31,
  
2013
 
2012
 
2013
 
2012
 
$
 
$
 
$
 
$
Revenues
66.4

 

 
144.2

 

Loss from continuing operations
(13.3
)
 

 
(42.9
)
 


Pro forma financial information
The following table presents pro forma results of operations and gives effect to the Banner Acquisition as if the transaction had been consummated on November 1, 2011. This unaudited pro forma financial information is provided for informational purposes only and is not necessarily indicative of what the actual results of operations would have been had the transactions taken place on November 1, 2011, nor is it indicative of the future consolidated results of operations or financial position of the combined companies.
  
Three months ended July 31,
 
Nine months ended July 31,
  
2013
 
2012
 
2013
 
2012
 
$
 
$
 
$
 
$
Revenues
265.7

 
269.1

 
766.7

 
738.5

Income (loss) from continuing operations
5.4

 
10.8

 
(21.3
)
 
(91.8
)
Income (loss) per share from continuing operations, basic
$
0.038

 
$
0.083

 
$
(0.153
)
 
$
(0.708
)
Income (loss) per share from continuing operations, diluted
$
0.037

 
$
0.083

 
$
(0.153
)
 
$
(0.708
)

The unaudited pro forma financial information was prepared using the acquisition method of accounting and is based on the historical financial information of the Company and Banner, reflecting the Company's and Banner's combined results of operations for the three and nine month periods ended July 31, 2013 and 2012. The historical financial information has been adjusted to give effect to the pro forma events that are (i) directly attributable to the Banner Acquisition, (ii) factually supportable and (iii) expected to have a continuing impact on the combined results of the Company and Banner. The unaudited pro forma consolidated results reflect primarily the following pro forma adjustments:
additional interest expense and related refinancing costs related to the long-term debt used to fund the acquisition;
additional amortization expense related to the fair-value of identifiable intangible assets acquired;

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

additional cost of goods sold resulting from an increase in the fair value of acquired inventory and an increase in depreciation expense relating to the fair values of acquired property and equipment; and
removal of acquisition-related costs.
 

3.    DISCONTINUED OPERATIONS, PLANT CONSOLIDATIONS, SALES AND ASSET IMPAIRMENTS
Puerto Rico

The Company previously announced its plan to consolidate its Puerto Rico operations into its manufacturing site located in Manati and sell its plant in Caguas and that additional time was required to transition manufacturing operations from Caguas to Manati due to longer than expected customer regulatory time lines and increased product demand. The Company now estimates the total project repositioning expenses to be $13.7 million, of which an additional $0.4 million was recorded in the nine months ended July 31, 2013. Because the business in the Caguas facility is being transferred within the existing site network, its results of operations are included in continuing operations in the consolidated financial statements.

As previously announced, on February 28, 2013, the Company entered into a sale-leaseback agreement for the Caguas facility for $7.0 million. The lease agreement is a month to month tenancy with a target, non-binding, termination date of December 31, 2013. The Company has the option to holdover the lease in the event further time is necessary to complete the transfer out of Caguas to Manati. In the event of a holdover, the term may be extended on a month to month basis. As a result of the sale leaseback, the Company recorded a prepaid rent asset for $1.5 million during the second quarter, which it began amortizing immediately. A gain of $1.1 million was recognized upon the sale.

The results of discontinued operations for the Company's Carolina facility (which the Company closed effective January 31, 2009) for the three and nine months ended July 31, 2013 and 2012 are as follows:
 
Three months ended July 31,
 
Nine months ended July 31,
 
2013
 
2012
 
2013
 
2012
 
$
 
$
 
$
 
$
Revenues

 

 

 

Cost of goods sold

 

 

 

Gross loss

 

 

 

Selling, general and administrative expenses

 

 

 
0.3

Gain on sale of capital assets

 

 

 
(0.1
)
Operating loss

 

 

 
(0.2
)
Loss before income taxes

 

 

 
(0.2
)
Net loss for the period

 

 

 
(0.2
)
 
On February 17, 2012, the Company finalized the sale of its Carolina, Puerto Rico facility for a nominal amount.
Canada

Subsequent to the closing of the Banner Acquisition, the Company performed a review of Banner's facilities and decided to close the Olds, Canada facility by October 31, 2013. As a result of this decision, the Company conducted an impairment analysis on the long-term assets at this facility. Based on this analysis, which is discussed more fully below, the Company concluded that a non-cash impairment charge of $10.0 million was required to reduce the carrying value of the long-term assets to their fair value and that a non-cash impairment charge of $0.1 million was required to reduce the carrying value of the goodwill allocated to the Olds, Canada reporting unit to its fair value. The impairment charges reduced assets in the CMO segment by a total of $10.1 million. The carrying value of this property was reduced to its estimated fair value of $4.9 million, which represents the salvage value of the building and land, less costs to sell, that was determined based upon an appraisal value (Level 2 valuation inputs). These facility assets will remain as held and used until a plan of sale has been initiated and the site is in a condition for immediate sale.

To determine whether any impairment charge was required with respect to the long-term assets at the Olds, Canada Facility, the Company performed a cash flow analysis over the remaining useful life of these assets, which following the

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

decision to close the facility was nine months. Because the expected operating cash flows were less than the carrying value of the assets, an impairment analysis was completed to calculate the amount of the impairment loss. Following this analysis, the Company reduced the book value of the site's long-term assets to the fair value of the facility, the book value of any assets that will be transferred to other sites and a minimal amount of value for residual equipment to be sold on the used equipment market.

Following the completion of the impairment analysis for the long-term assets at the Olds, Canada facility, the Company evaluated whether the goodwill allocated to the Olds, Canada reporting unit was impaired. The Company bypassed the qualitative assessment of whether it was more likely than not that goodwill was impaired, and performed the two-step impairment test. Because the reporting unit's carrying value is being reduced to net working capital plus the salvage value of the property, plant and equipment, the Company determined that there was no remaining value for the goodwill and thus it was fully impaired. The net amount required to be booked for the impairment of goodwill in the first quarter of fiscal 2013 was
$0.1 million.


4.    SUPPLEMENTAL BALANCE SHEET INFORMATION

Inventories

Inventories consisted of the following as of July 31, 2013 and October 31, 2012:
 
July 31, 2013
 
October 31, 2012
 
$
 
$
Raw materials, packaging components and spare parts
79.6

 
47.9

Work-in-process
45.0

 
34.4

Finished goods
19.7

 

Balance, end of period
144.3

 
82.3


Accounts payable and accrued liabilities
The following is the breakdown of accounts payable and accrued liabilities:
 
 
July 31, 2013
 
October 31, 2012
 
$
 
$
Trade payables
116.6

 
101.2

Interest payable
1.8

 
1.0

Accrued salaries and related expenses
50.3

 
51.4

Customer deposits
17.3

 
16.4

Other accruals
19.7

 
16.2

Balance, end of period
205.7

 
186.2


Intangible assets

As part of the Banner Acquisition, the Company obtained intangible assets. The following table summarizes gross carrying amounts and accumulated amortization related to the Company's identifiable intangible assets as of July 31, 2013:
 

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
Gross carrying value
 
Accumulated amortization
 
Impairment
 
Net carrying value
 
 
 
 
 
 
 
 
Trade names
0.8

 
(0.1
)
 

 
0.7

Technology
46.4

 
(2.6
)
 

 
43.8

Customer relationships
11.1

 
(0.7
)
 

 
10.4

In-process research and development
16.8

 

 
(1.2
)
 
15.6

Foreign exchange
0.1

 

 

 
0.1

Balance, end of period
75.2

 
(3.4
)
 
(1.2
)
 
70.6


Banner's in-process research and development (“IP R&D”) is classified as definite-lived or indefinite-lived depending on whether the product has been approved. IP R&D for products that have been approved is classified as a definite-lived intangible asset and is amortized over the life of the product. IPR&D for products that have not been approved is classified as an indefinite-lived intangible asset and either begins to be amortized upon approval or is written-off if the product is not approved. During the three months ended July 31, 2013, the Company curtailed two Banner IP R&D projects which resulted in a $1.2 million impairment charge.

Goodwill
The following table summarizes the changes between October 31, 2012 and July 31, 2013 in the carrying amount of goodwill in total and by reporting segment:  
 
Commercial
 
PDS
 
Corp. & Other
 
Total
Balance at October 31, 2012
3.5

 

 

 
3.5

Additions
42.0

 

 

 
42.0

Impairments
(0.1
)
 

 

 
(0.1
)
Foreign currency translation adjustments
(0.1
)
 

 

 
(0.1
)
Balance at July 31, 2013
45.3

 

 

 
45.3



5.    PREFERRED SHARES AND RESTRICTED VOTING SHARES
The following table summarizes information regarding the Company's outstanding preferred shares, restricted voting shares and restricted voting share stock options as of July 31, 2013:
 
 
Outstanding
 
Exercisable
Class I preferred shares series D
150,000

 
N/A

Restricted voting shares
140,928,525

 
N/A

Restricted voting share stock options
11,042,625

 
2,947,975


On December 31, 2012, the Company completed an offering of $30.0 million offering of transferable subscription rights, with every 13.75 rights entitling each holder of the Company's outstanding restricted voting shares to subscribe for one whole restricted voting share at a price of, at such holder's choice, either US$3.19 per whole share or CAD$3.19 per whole share (the "Rights Offering").
Patheon issued 9,403,483 restricted voting shares as a result of the Rights Offering. This issuance represents approximately 7.2% of the Company's restricted voting shares issued and outstanding prior to the Rights Offering.  Upon the issuance of these new restricted voting shares, the Company had 139,701,375 restricted voting shares outstanding. The Company used the proceeds from the Rights Offering to partially finance the Banner Acquisition.

An affiliate of JLL Partners Fund V, L.P., a related party of the Company ("JLL Partners Fund V"), exercised its subscription rights in full, including its over-subscription privilege, up to the full amount of the Rights Offering. All excess subscription payments received from over-subscribing rights holders, including JLL Partners Fund V, were returned, without interest or penalty.  As a result of the rights offering, JLL Partners Fund V received 5,786,805 restricted voting shares (524,392 of which were received pursuant to the exercise of its over-subscription privilege), and as a result, JLL Partners Fund V's

13

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

ownership of restricted voting shares, together with its affiliates, is approximately 55.7% of the Company's issued and outstanding restricted voting shares.
The Rights Offering contained a subscription price that was less than the fair value of the Company's restricted voting shares on the last day the rights could be exercised, which created a bonus element similar to a stock dividend. Because of this bonus element, the Company adjusted both the weighted-average basic and diluted shares outstanding immediately prior to the completion of the Rights Offering by multiplying those weighted-average shares by an adjustment factor that represented the fair value per restricted voting share immediately prior to the exercise of the basic and over-subscription privileges under the Rights Offering divided by the theoretical ex-rights fair value per restricted voting share immediately prior to the exercise of the basic and over-subscription privileges under the Rights Offering. Weighted-average basic and diluted shares outstanding and net loss per weighted-average basic and diluted share for the three and nine months ended July 31, 2012 as originally reported and as adjusted for this bonus element were as follows:
 
As originally reported
 
As adjusted
 
Effect of change
Three months ended July 31, 2012
 
 
 
 
 
Weighted-average basic and diluted shares outstanding
129,168

 
129,639

 
471

Net loss per basic and diluted share
0.120

 
0.119

 
(0.001
)
 
As originally reported
 
As adjusted
 
Effect of change
Nine months ended July 31, 2012
 
 
 
 
 
Weighted-average basic and diluted shares outstanding
129,168

 
129,639

 
471

Net loss per basic and diluted share
(0.647
)
 
(0.645
)
 
0.002





6.    SEGMENTED INFORMATION
The Company is organized and managed in two business segments: CMO and PDS. These segments are organized around the service activities provided to the Company's customers.

 
As of and for the three months ended July 31, 2013
 
Commercial
 
PDS
 
Corp. & Other
 
Total
 
$
 
$
 
$
 
$
Revenues
227.8

 
37.9

 

 
265.7

Adjusted EBITDA
39.6

 
12.0

 
(10.6
)
 
41.0

Depreciation
11.3

 
0.9

 
0.2

 
12.4

Impairment charge
1.2

 

 

 
1.2

Capital expenditures
14.3

 
1.4

 

 
15.7


 
As of and for the three months ended July 31, 2012
 
Commercial
 
PDS
 
Corp. & Other
 
Total
 
$
 
$
 
$
 
$
Revenues
168.3

 
35.4

 

 
203.7

Adjusted EBITDA
36.6

 
8.6

 
(8.8
)
 
36.4

Depreciation
7.9

 
1.2

 
0.2

 
9.3

Capital expenditures
14.7

 
0.5

 
0.1

 
15.3



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Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
As of and for the nine months ended July 31, 2013
 
Commercial
 
PDS
 
Corp. & Other
 
Total
 
$
 
$
 
$
 
$
Revenues
627.4

 
105.7

 

 
733.1

Adjusted EBITDA
99.1

 
27.6

 
(31.5
)
 
95.2

Total assets
863.2

 
70.9

 
137.0

 
1,071.1

Depreciation
32.2

 
2.8

 
0.6

 
35.6

Goodwill
45.3

 

 

 
45.3

Impairment charge
11.3

 

 

 
11.3

Capital expenditures
30.7

 
3.4

 
0.1

 
34.2


 
As of and for the nine months ended July 31, 2012
 
Commercial
 
PDS
 
Corp. & Other
 
Total
 
$
 
$
 
$
 
$
Revenues
438.1

 
101.0

 

 
539.1

Adjusted EBITDA
56.7

 
19.1

 
(24.8
)
 
51.0

Total assets
587.9

 
68.0

 
98.9

 
754.8

Depreciation
26.3

 
3.8

 
0.7

 
30.8

Goodwill
3.4

 

 

 
3.4

Impairment charge
55.1

 
2.8

 

 
57.9

Capital expenditures
29.4

 
2.5

 
1.0

 
32.9


Cash and cash equivalents as well as deferred tax assets are considered to be part of "Corp. & Other" in the breakout of total assets shown above. In the first quarter of fiscal 2013, the Company announced the closure of its Olds, Canada facility and recorded impairment charges of $10.1 million to its CMO segment. In the third quarter of fiscal 2013, the Company curtailed two Banner IP R&D projects resulting in an impairment charge of $1.2 million. Additionally, during the second quarter of fiscal 2013 the CMO segment recorded product returns from the packaging site and inventory write-offs of $6.1 million , related to a manufacturing problem at Banner due to a change in raw materials and operational processes qualified prior to the acquisition that did not perform as expected, which are reflected in gross profit in the consolidated statements of operations.

The Company evaluates the performance of its segments based on segment Adjusted EBITDA. Commencing in fiscal 2013, the Company has revised its calculation of Adjusted EBITDA to exclude stock-based compensation expense, consulting costs related to the Company's operational initiatives, purchase accounting adjustments and acquisition-related litigation expenses (as discussed in Note 10). The Company has determined that excluding these items from Adjusted EBITDA better reflected the underlying performance of the Company's segments. Based on the revisions to the Company's segment performance measure, the Company has recast the presentation of its segment results for the prior periods to be consistent with the current period presentation. Following the change in the segment performance measure, the Company's definition of Adjusted EBITDA is now income (loss) from continuing operations before repositioning expenses, interest expense, foreign exchange losses reclassified from other comprehensive income (loss), refinancing expenses, acquisition and integration costs (including certain product returns and inventory write-offs recorded in gross profit), gains and losses on sale of capital assets, income taxes, asset impairment charges, depreciation and amortization, stock-based compensation expense, consulting costs related to the Company's operational initiatives, purchase accounting adjustments, acquisition-related litigation expenses and other income and expenses. The Company's presentation of Adjusted EBITDA may not be comparable to similarly-titled measures used by other companies and is not equivalent to "Consolidated EBITDA" as defined in the Credit Agreement (as discussed in Note 12).

Below is a reconciliation of Adjusted EBITDA to its closest U.S. GAAP measure.

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
Three months ended July 31,
 
Nine months ended July 31,
 
2013
2012
 
2013
2012
 
$
$
 
$
$
Total Adjusted EBITDA
41.0

36.4

 
95.2

51.0

Depreciation and amortization
(12.4
)
(9.3
)
 
(35.6
)
(30.8
)
Repositioning expenses
(4.5
)
(0.1
)
 
(11.0
)
(6.9
)
Acquisition and integration costs
(1.2
)

 
(15.4
)

Interest expense, net
(12.6
)
(6.8
)
 
(35.0
)
(19.8
)
Impairment charge
(1.2
)

 
(11.3
)
(57.9
)
Gain on sale of capital assets


 
1.6


(Provision for) benefit from income taxes
(0.9
)
(3.3
)
 
5.5

(3.6
)
Refinancing expenses


 
(29.2
)

Operational initiatives related consulting costs
(0.4
)
(1.0
)
 
(2.3
)
(13.3
)
Acquisition-related litigation expenses
(4.0
)

 
(4.0
)

Stock-based compensation expense
(0.7
)
(0.7
)
 
(2.4
)
(2.5
)
Purchase accounting adjustments


 
(5.0
)

Other
1.2

0.3

 
2.0

0.5

Income (loss) from continuing operations
4.3

15.5

 
(46.9
)
(83.3
)

As illustrated in the table below, revenues are attributed to countries based on the location of the customer's billing address, capital assets are attributed to the country in which they are located and goodwill is attributed to the country in which the entity to which the goodwill pertains is located:
 
 
 
As of and for the three months ended July 31, 2013
 
 
Canada
$
 
US
$
 
Europe
$
 
Other
$
 
Total
$
Revenues
 
3.9

 
155.5

 
81.7

 
24.6

 
265.7

 
 
As of and for the three months ended July 31, 2012
 
 
Canada
 
US*
 
Europe
 
Other
 
Total
 
 
$
 
$
 
$
 
$
 
$
Revenues
 
4.3

 
109.4

 
79.8

 
10.2

 
203.7

 
 
 
As of and for the nine months ended July 31, 2013
 
 
Canada**
$
 
US*
$
 
Europe
$
 
Other
$
 
Total
$
Revenues
 
15.4

 
429.6

 
226.3

 
61.8

 
733.1

Capital assets
 
114.4

 
193.2

 
183.1

 
1.5

 
492.2

Goodwill
 
3.4

 
31.5

 
6.9

 
3.5

 
45.3

* Includes Puerto Rico
**Canada assets reflect the fiscal 2013 impairment of Olds, Canada assets.
 
 
As of and for the nine months ended July 31, 2012
 
 
Canada
 
US*
 
Europe ***
 
Other
 
Total
 
 
$
 
$
 
$
 
$
 
$
Revenues
 
9.1

 
310.8

 
191.5

 
27.7

 
539.1

Capital assets
 
112.5

 
144.5

 
140.7

 
1.5

 
399.2

Goodwill
 
3.4

 

 

 

 
3.4

* Includes Puerto Rico
*** European assets reflect the fiscal 2012 impairment of Swindon assets.


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Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)



7.    STOCK-BASED COMPENSATION
The Company has an incentive stock option plan in which directors, officers and key employees of the Company and its subsidiaries, as well as other persons engaged to provide ongoing management or consulting services to Patheon, are eligible to participate. On March 10, 2011, the Company's shareholders approved an amendment to the stock option plan, which, among other things, provides that the maximum number of shares that may be issued under the plan is 15,500,151, which currently represents 11% of the issued and outstanding restricted voting shares. As of July 31, 2013 and 2012, the total number of restricted voting shares issuable under the plan was 15,500,151 shares, respectively, of which there were stock options outstanding to purchase 11,042,625 shares and 13,028,718 shares, respectively, under the plan. Before the March 2011 amendments, the plan provided that the exercise prices of options were determined at the time of grant and could not be less than the weighted-average market price of the restricted voting shares of Patheon on the Toronto Stock Exchange ( the "TSX") during the two trading days immediately preceding the grant date. Following the March 2011 amendments, the exercise prices of the options may not be less than the closing price of the restricted voting shares on the TSX (or on such other stock exchange in Canada or the United States on which restricted voting shares may be then listed and posted) on the date of the grant. Options generally expire in no more than 10 years after the grant date and are subject to early expiry in the event of death, resignation, dismissal or retirement of an optionee. Options generally have vesting periods of either three years or five years, with either one-third or one-fifth vesting on each anniversary of the grant date, respectively.
On June 18, 2012 the Company granted 1,291,750 options to its executive committee members with a vesting based upon the parameters that all granted options will have cliff performance vesting which will vest at the earlier of the achievement of an adjusted EBITDA target or five years after date of grant.
For the purposes of calculating the stock-based compensation expense in connection with the Company's incentive stock option plan, the fair value of stock options is estimated at the date of the grant using the Black-Scholes option pricing model and the cost is amortized over the vesting period.
Stock-based compensation expense recorded in the three and nine months ended July 31, 2013 was $0.7 million and $2.4 million. Stock-based compensation expense recorded in the three and nine months ended July 31, 2012 was $0.7 million and $2.5 million.
A summary of the plan activity during the nine months ended July 31, 2013 is as follows:
 
(Dollar amounts in Canadian dollars)
Number of shares
 
Weighted-
average
exercise price
 
Weighted-average contractual term
 
Aggregate intrinsic value
 
 
 
$
 
 
 
$
Outstanding as of October 31, 2012
12,479,677

 
2.54

 
 
 
15,634,784

Granted
1,610,000

 
4.16

 
 
 

Exercised
(2,227,150
)
 
2.66

 
 
 
3,113,942

Forfeited
(810,902
)
 
2.91

 
 
 
1,749,806

Expired
(9,000
)
 
13.21

 
 
 

Outstanding as of July 31, 2013
11,042,625

 
2.71

 
7.78
 
33,109,017

Exercisable as of July 31, 2013
2,947,975

 
2.69

 
6.32
 
9,000,749

The total fair value of shares that vested during the three months ended July 31, 2013 and 2012 was $2.3 million and $2.4 million, respectively. As of July 31, 2013, the total unrecognized compensation cost related to the nonvested stock options was $5.4 million, which is expected to be recognized through the fiscal year ending October 31, 2018, with a weighted-average remaining vesting period of 2.28 years.


8.    PENSION AND POST-RETIREMENT BENEFITS

Employee future benefits
The components of net periodic benefit cost for the defined benefit plans and other benefit plans for the nine months ended July 31, 2013 and 2012 were as follows: 

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
Nine months ended July 31,
 
2013
 
2012
 
Defined benefit
pension plans
 
Other benefit
plans
 
Defined benefit
pension plans
 
Other benefit
plans
 
$
 
$
 
$
 
$
Service cost
1.7

 
0.1

 
1.7

 

Interest cost
4.2

 
0.3

 
3.8

 
0.3

Expected return on plan assets
(4.3
)
 

 
(4.0
)
 

Amortization of actuarial loss
0.9

 

 
0.8

 

Net periodic benefit costs
2.5

 
0.4

 
2.3

 
0.3


Amounts for fiscal 2013 include the defined benefit pension plans for Mexico and The Netherlands under which the Company became obligated in connection with the Banner Acquisition.

Based on current information available from actuarial estimates, the Company anticipates that contributions required under its defined benefit pension plans and other benefit plans for fiscal 2013 will be approximately $6.6 million compared to contributions of $5.8 million that were made in fiscal 2012. Required contributions to defined benefit pension plans in future years may vary and will be dependent upon a number of variables, including the long-term rate of return on plan assets.

The defined benefit and other benefit plans estimates above do not include the unfunded termination indemnities related to the employees of the Company's Italian subsidiary. In accordance with Italian severance pay statutes, an employee benefit is accrued for service to date and is payable when the employee's employment with the Company ceases. The termination indemnity liability is calculated in accordance with local civil and labor laws based on each employee's length of service, employment category and remuneration. The termination liability is adjusted annually by a cost-of-living index provided by the Italian government. Although there is no vesting period, the Italian government has established private accounts for these benefits and has required the Company to contribute $3.8 million and $3.2 million in fiscal 2013 and 2012, respectively, to these accounts, with additional contributions in the future. The liability recorded in the consolidated balance sheets is the amount to which the employees would be entitled if their employment with the Company ceased. The related expenses for the nine months ended July 31, 2013 and 2012 was $2.3 million and $2.3 million, respectively.

The defined benefit and other benefit plans estimates above also do not include the unfunded termination indemnities related to the employees of the Company's Mexican subsidiary, which the Company acquired as part of the Banner Acquisition. According to the Mexican labor law, a termination indemnity is payable when a company terminates an employment relationship without justified cause (as defined in the labor law) and is equal to three months of salary and benefits, plus 20 days of salary and benefits per each credited service year. The termination indemnity liability is unfunded; therefore the liability is recognized through a reserve calculated by the actuaries. The related expected expense for fiscal 2013 is less than $0.1 million, and the reserve is recorded on the consolidated balance sheet as of July 31, 2013.
The employee future benefit expense in connection with defined benefit pension plans, other post retirement benefit plans and the unfunded termination indemnities for the nine months ended July 31, 2013 and 2012 was $5.2 million and $4.9 million, respectively.

9.    REPOSITIONING EXPENSE
During the three and nine months ended July 31, 2013, the Company incurred $4.5 million and $11.0 million, respectively, in repositioning expenses, which related to Banner synergy initiatives; the plan of termination the Company announced on May 9, 2012 (the "Plan of Termination"), which is discussed below; restructuring initiatives at the Bourgoin, France facility; and the shutdown of the Caguas facility. During the three and nine months ended July 31, 2012, the Company incurred $0.1 million and $6.9 million in repositioning expenses, all of which related to the Plan of Termination and the shutdown of the Caguas facility.
On May 9, 2012, the Company announced the Plan of Termination to reduce the Company's workforce by approximately 91 employees across the Company's global PDS and CMO segments. In connection with the Plan of Termination, the Company recorded approximately $4.4 million of estimated expenses associated with employee termination benefits during fiscal 2012. The Company anticipates that it may further adjust the size of the workforce at the Swindon or other facilities as it continues its transformation process.
 

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

The following is a summary of these expenses and other charges associated with operational improvements (collectively "repositioning expenses") as of and for the three and nine months ended July 31, 2013 and 2012:

 
As of and for the three months ended July 31, 2013
 
Commercial
$
 
PDS
$
 
Corporate
$
 
Total
$
Total repositioning liabilities at April 30, 2013
 
 
 
 
 
 
7.7

Employee-related expenses
4.5

 
(0.3
)
 
0.2

 
4.4

Consulting, professional and project management costs
0.1

 

 

 
0.1

Total expenses
4.6

 
(0.3
)
 
0.2

 
4.5

Repositioning expenses paid, net of reimbursements
 
 
 
 
 
 
(5.4
)
Total repositioning liabilities at July 31, 2013
 
 
 
 
 
 
6.8


 
As of and for the three months ended July 31, 2012
 
Commercial
 
PDS
 
Corporate
 
Total
 
$
 
$
 
$
 
$
Total repositioning liabilities at April 30, 2012
 
 
 
 
 
 
9.2

Employee-related expenses
0.1

 

 

 
0.1

Total expenses
0.1

 

 

 
0.1

Repositioning expenses paid
 
 
 
 
 
 
(0.9
)
Foreign exchange
 
 
 
 
 
 
(0.4
)
Total repositioning liabilities at July 31, 2012
 
 
 
 
 
 
8.0


 
As of and for the nine months ended July 31, 2013
 
Commercial
$
 
PDS
$
 
Corporate
$
 
Total
$
Total repositioning liabilities at October 31, 2012
 
 
 
 
 
 
5.5

Employee-related expenses
6.7

 
0.3

 
3.7

 
10.7

Consulting, professional and project management costs
0.3

 

 

 
0.3

Total expenses
7.0

 
0.3

 
3.7

 
11.0

Repositioning expenses paid, net of reimbursements
 
 
 
 
 
 
(9.7
)
Total repositioning liabilities at July 31, 2013
 
 
 
 
 
 
6.8


 
As of and for the nine months ended July 31, 2012
 
Commercial
 
PDS
 
Corporate
 
Total
 
$
 
$
 
$
 
$
Total repositioning liabilities at October 31, 2011
 
 
 
 
 
 
6.7

Employee-related expenses
4.4

 
1.3

 

 
5.7

Consulting, professional and project management costs
1.2

 

 

 
1.2

Total expenses
5.6

 
1.3

 

 
6.9

Repositioning expenses paid
 
 
 
 
 
 
(5.6
)
Total repositioning liabilities at July 31, 2012
 
 
 
 
 
 
8.0


10.    OTHER INFORMATION

Foreign exchange

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

During the three and nine months ended July 31, 2013, the Company recorded foreign exchange losses of nil and $1.5 million. These losses were primarily from operating exposures, partially offset by hedge gains. During the three and nine months ended July 31, 2012, the Company recorded foreign exchange losses of $0.4 million and $0.6 million. These losses were primarily from hedge losses, partially offset by operating gains.
 
Contingencies

On December 10, 2012, Procaps S.A. (“Procaps”) filed a complaint against the Company in the United States District Court for the Southern District of Florida (Case No. 12-cv-24356-DLG).  The complaint involves the Company's collaboration agreement with Procaps, pursuant to which both companies agreed to work together with respect to the marketing of a line of certain prescription pharmaceutical soft-gel development and manufacturing services. Procaps alleges that the Company's acquisition of Banner, a business that historically has generated less than 10% of its revenues from softgel services for prescription pharmaceuticals, transformed the collaboration agreement into an anticompetitive restraint of trade and an agreement between direct competitors to set prices, divide markets and/or allocate geographic territories.  Procaps seeks (i) a declaratory judgment that the collaboration agreement must cease and/or terminate; (ii) an injunction requiring that the Company divest all of Banner's soft-gel manufacturing capabilities; and (iii) monetary damages under federal and state antitrust and unfair competition laws, including treble damages for violations of the Sherman Act. The Company subsequently answered Procaps' complaint and filed its affirmative defenses to the complaint.  On May 15, 2013, Procaps served its supplemental initial disclosures pleading damages.  The parties are currently conducting discovery and trial is scheduled to commence in June 2014.
The Company has not included any accrual in the consolidated financial statements as of July 31, 2013 related to the matter as a result of its assessment that the likelihood of a material loss in connection with the matter is not probable. Due to the early stage of the lawsuit, an estimate of the potential damages or range of damages cannot be made at this time.  However, an adverse outcome in this matter could have a material adverse effect on the Company's business, results of operations and financial condition.
 
One putative class action and four individual plaintiff actions are pending in the United States against one of the Company's customers in connection with the recall of certain lots of allegedly defective products manufactured by the Company for the customer. The Company has also been named in the putative class action and in three of the individual plaintiff actions. The customer has given the Company notice of its intent to seek indemnification from the Company for all damages, costs and expenses, pursuant to the manufacturing services agreement between the customer and the Company. As these cases are at an early stage, the Company is unable to estimate the number of potential claimants or the amount of potential damages for which the Company may be directly or indirectly liable in the above actions.


11.    FINANCIAL INSTRUMENTS, FAIR VALUE AND RISK MANAGEMENT
The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies; however, considerable judgment is required to develop these estimates. The fair values of the Company's financial instruments are not materially different from their carrying values.
As of October 31, 2012, the carrying amount of the financial assets that the Company has pledged as collateral for its long-term debt facilities was $131.2 million. The Company's Credit Agreement (as discussed in Note 12) is not collateralized by accounts receivable and inventory.
Fair value measurements
The fair value is principally applied to financial assets and liabilities such as derivative instruments consisting of foreign exchange forward contracts and collars. The following table provides a summary of the financial assets and liabilities that are measured at fair value as of July 31, 2013 and October 31, 2012:


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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

Assets measured at fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair value measurement at
July 31, 2013 using:
 
Fair value measurement at
October 31, 2012 using:
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
$
 
$
 
$
 
$
 
$
 
$
 
$
 
$
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contracts

 

 

 

 

 
2.1

 

 
2.1

Total assets

 

 

 

 

 
2.1

 

 
2.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration receivable

 

 
0.3

 
0.3

 

 

 
0.3

 
0.3

Total assets

 

 
0.3

 
0.3

 

 

 
0.3

 
0.3


Liabilities measured at fair value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair value measurement at
July 31, 2013 using:
 
Fair value measurement at
October 31, 2012 using:
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
$
 
$
 
$
 
$
 
$
 
$
 
$
 
$
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange forward contracts

 
1.9

 

 
1.9

 

 

 

 

Foreign exchange collars

 
0.9

 

 
0.9

 

 
0.7

 

 
0.7

Total liabilities

 
2.8

 

 
2.8

 

 
0.7

 

 
0.7

Level 1 - Based on quoted market prices in active markets.
Level 2 - Inputs, other than quoted prices in active markets, that are observable, either directly or indirectly.
Level 3 - Unobservable inputs that are not corroborated by market data.
 
The following table presents the fair value of the Company's derivative financial instruments and their classifications on the consolidated balance sheets as of July 31, 2013 and October 31, 2012:
Fair values of derivative instruments
 
 
Asset derivatives as of July 31, 2013
 
Asset derivatives as of October 31, 2012
 
Balance sheet location
 
Fair value
 
Balance sheet location
 
Fair value
 
 
 
$
 
 
 
$
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expenses and other
 

 
Prepaid expenses and other
 
1.8

Foreign exchange forward contracts
Other long-term assets
 

 
Other long-term assets
 
0.3

Total designated derivatives
 
 

 
 
 
2.1

 
 
 
 
 
 
 
 
Contingent consideration receivable
Other long-term assets
 
0.3

 
Other long-term assets
 
0.3

Total non-designated derivatives
 
 
0.3

 
 
 
0.3


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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
Liability derivatives as of July 31, 2013
 
Liability derivatives as of October 31, 2012
 
Balance sheet location
 
Fair value
 
Balance sheet location
 
Fair value
 
 
 
$
 
 
 
$
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange forward contracts
Other long-term liabilities
 
0.8

 
Other long-term liabilities
 

Foreign exchange forward contracts
Accounts payable and accrued liabilities
 
1.1

 
Accounts payable and accrued liabilities
 
0.3

Foreign exchange collars
Accounts payable and accrued liabilities
 
0.9

 
Other long-term liabilities
 
0.4

Total designated derivatives
 
 
2.8

 
 
 
0.7


On August 31, 2012, the Company completed the sale of its global secondary clinical packaging and clinical distribution services business to Bellwyck Packaging Solutions. The total consideration for the sale of this business was approximately $2.7 million, of which $1.35 million was paid in cash at closing (subject to the retention of certain amounts in escrow) and $1.35 million will be paid in 24 months from the closing date if certain revenue targets are met by the new owner.

The $1.35 million that will be paid 24 months following closing is treated as a contingent consideration receivable for accounting purposes. The contingent consideration receivable was valued at $0.3 million on the closing date at fair value based upon the present value of the agreed-upon revenue targets. The fair value of the contingent consideration receivable will be marked to market on a quarterly basis with an adjustment to the related receivable and the gain/loss on sale of assets.

There was no change in the fair value of the Company's Level 3 financial instrument as of July 31, 2013.

Foreign exchange forward contracts and other hedging arrangements
The Company utilizes financial instruments to manage the risk associated with fluctuations in foreign exchange and interest rates. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions.
As of July 31, 2013, the Company's Canadian operations had entered into foreign exchange forward contracts to sell an aggregate amount of US$94.8 million. These contracts hedge the Canadian operations' expected exposure to U.S. dollar denominated receivables and mature at the latest on April 1, 2015, at an average exchange rate of $1.0129 Canadian. The mark-to-market value of these financial instruments as of July 31, 2013 was an unrealized loss of $1.9 million, which has been recorded in accumulated other comprehensive income in shareholders' equity, net of associated income tax.
As of July 31, 2013, the Company's Canadian operations had entered into foreign exchange forward contracts to sell an aggregate amount of €2.0 million. These contracts hedge the Canadian operations' expected exposure to Euro denominated receivables and mature at the latest on October 8, 2013, at an average exchange rate of $1.2811 Canadian. The mark-to-market value of these financial instruments as of July 31, 2013 was an unrealized loss of $0.1 million, which has been recorded in accumulated other comprehensive income in shareholders' equity, net of associated income tax.
As of July 31, 2013, the Company's Canadian operations had entered into foreign exchange collars to sell an aggregate amount of US$36.2 million. These contracts hedge the Canadian operations' expected exposure to U.S. dollar denominated receivables and mature at the latest on July 2, 2014, at an average exchange rate of $0.9950 Canadian. The mark-to-market value of these financial instruments as of July 31, 2013 was an unrealized loss of $0.8 million, which has been recorded in accumulated other comprehensive income in shareholders' equity, net of associated income tax.
Risks arising from financial instruments and risk management
The Company's activities expose it to a variety of financial risks: market risk (including foreign exchange and interest rate), credit risk and liquidity risk. The Company's overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on the Company's financial performance. The Company uses derivative financial instruments to hedge certain risk exposures. The Company does not purchase any derivative financial instruments for speculative purposes.
Financial risk management is the responsibility of the Company's corporate finance team. The corporate finance team works with the Company's operational personnel to identify, evaluate and, where appropriate, hedge financial risks. The

22

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

Company's corporate finance team also monitors material risks and discusses them with the Audit Committee of the Board of Directors.
 
Foreign exchange risk
As of July 31, 2013, the Company operated in Canada, the United States, Italy, France, the United Kingdom, The Netherlands, Mexico and Japan. Foreign exchange risk arises because the value of the local currency receivable or payable for transactions denominated in foreign currencies may vary due to changes in exchange rates ("transaction exposures") and because the non-U.S. dollar denominated financial statements of the Company may vary on consolidation into the reporting currency of U.S. dollars ("translation exposures").
The Company's most significant transaction exposures arise in its Canadian operations. Approximately 90% of the revenues of the Canadian operations and approximately 10% of its operating expenses are transacted in U.S. dollars. As a result, the Company may experience transaction exposures because of volatility in the exchange rate between the Canadian and U.S. dollar. Based on the Company's current U.S. denominated net inflows, as of July 31, 2013, fluctuations of +/-10% would, everything else being equal, have an annual effect on (loss) income from continuing operations before income taxes of approximately +/- $4.8 million, prior to hedging activities.
The objective of the Company's foreign exchange risk management activities is to minimize transaction exposures and the resulting volatility of the Company's earnings. The Company manages this risk by entering into foreign exchange contracts. As of July 31, 2013, the Company has entered into foreign exchange contracts to cover approximately 80% of its Canadian-U.S. dollar cash flow exposures for fiscal 2013. The Company does not currently hedge any translation exposures.
Translation gains and losses related to certain foreign currency denominated intercompany loans are included as part of the net investment in certain foreign subsidiaries, and are included in accumulated other comprehensive income (loss) in shareholders' equity.
Credit risk
Credit risk arises from cash and cash equivalents held with banks and financial institutions, derivative financial instruments (foreign exchange contracts with positive fair values), and credit exposure to customers, including outstanding accounts receivable. The maximum exposure to credit risk is equal to the carrying value of the financial assets.
The objective of managing counterparty credit risk is to prevent losses in financial assets. The Company regularly assesses the credit quality of the counterparties, taking into account their financial position, past experience and other factors. Management also regularly monitors the utilization of credit limits. In cases where the credit quality of a customer does not meet the Company's requirements, a cash deposit is received before any services are provided. As of July 31, 2013 and October 31, 2012, the Company held deposits of $17.3 million and $16.4 million, respectively.

Liquidity risk
Liquidity risk arises when financial obligations exceed financial assets available at a particular point in time. The Company's objective in managing liquidity risk is to maintain sufficient readily available reserves in order to meet its liquidity requirements at all times. The Company mitigates liquidity risk by maintaining cash and cash equivalents on-hand and through the availability of funding from credit facilities. As of July 31, 2013, the Company was holding cash and cash equivalents of $40.9 million and had undrawn lines of credit available to it of $63.4 million.


12.    LONG-TERM OBLIGATIONS AND OTHER SHORT-TERM BORROWINGS
Long-term debt in the accompanying consolidated balance sheets at July 31, 2013 and October 31, 2012 consists of the following: 

23

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

 
As of July 31,
2013
 
As of October 31,
2012
 
$
 
$
Floating LIBOR plus 6.00% with LIBOR floor of 1.25% (currently 7.25%) due December 14, 2018 (the "Secured Term Loan")
570.7

 

Italian subsidized loan with annual interest rate of 0.5%, and maturity date of June 30, 2020
7.0

 

Italian bank loan with Euribor 6-month + 7.1% rate, and maturity date of June 30, 2020
1.0

 

8.625% senior secured notes due April 15, 2017 (the "Notes")

 
280.0

$85 million secured revolving credit facility maturing December 14, 2017, bearing interest ranging from 5.8% to 7.75% (the "Secured Revolving Facility")
42.3

 

$75 million senior secured revolving loan facility maturing April 23, 2014, bearing interest ranging from 4.03% to 5.75% based upon floating LIBOR, US, or CAD prime, or federal funds effective rates, plus applicable margins (the "ABL")

 
30.7

Total long-term debt outstanding
621.0

 
310.7

Less original issue discount, net of accumulated amortization of $1.5 million
(15.8
)
 

Less current portion
(6.8
)
 

Balance, end of the period
598.4

 
310.7


On December 14, 2012, the Company completed the refinancing of its existing debt (the "Refinancing"), pursuant to which it entered into a credit agreement (the "Credit Agreement") for a secured term loan in the amount of $575.0 million (the "Secured Term Loan") and a secured revolving credit facility of up to $85.0 million (the "Secured Revolving Facility" and, together with the Secured Term Loan, the "Credit Facility"). Up to $30.0 million of the Secured Revolving Facility is available for letters of credit. The Secured Term Loan matures on December 14, 2018, and the Secured Revolving Facility matures on December 14, 2017. The Secured Term Loan bears interest at a rate per annum equal to, at the option of the Company, LIBOR plus 6.00%, with a LIBOR "floor" of 1.25%, or an alternate base rate plus 5.00%, with an alternate base rate "floor" of 2.25%. Borrowings under the Secured Revolving Facility bear interest for eurodollar loans at Libor plus 5.50% and base rate loans at the base rate plus 4.50%. The Company will also pay a commitment fee of 0.50% per annum on the unused portion of the Secured Revolving Facility with a step down to 0.375% when the First Lien Leverage Ratio (as defined in the Credit Agreement) is less than or equal to 3.00 to 1.00.

First Lien Leverage Ratio is generally defined in the Credit Agreement as the ratio of (i) the sum of the aggregate principal amount of the Company's and its restricted subsidiaries' indebtedness for borrowed money, principal amount of capital lease obligations and debt obligations evidenced by promissory notes or similar instruments plus the unrestricted cash of the Company and its restricted subsidiaries, in each case as set forth in the Credit Agreement, to (ii) Consolidated EBITDA. Consolidated EBITDA is generally defined in the Credit Agreement as income (loss) from continuing operations before repositioning expenses, interest expense, foreign exchange losses reclassified from other comprehensive income (loss), refinancing expenses, acquisition-related costs, gains and losses on sale of capital assets, income taxes, asset impairment charges, depreciation and amortization, stock-based compensation expense, consulting costs related to the Company's operational initiatives, purchase accounting adjustments, other income and expenses, non-cash charges, expenses related to the Banner Acquisition, pro forma cost savings from operational excellence initiatives and plant consolidations, pro forma synergies from the Banner Acquisition, and proceeds from business interruption insurance, among other adjustments. Consolidated EBITDA is not equivalent to Adjusted EBITDA, which, as discussed in Note 6, is the Company's measure of segment performance.

The Company is required to make the following mandatory prepayments in respect of the Secured Term Loan: (i) 50% of Excess Cash Flow (as defined in the Credit Agreement) when the Company maintains a First Lien Leverage Ratio of greater than 3.50 to 1.00, with step downs to (a) 25% when the Company maintains a First Lien Leverage Ratio of less than or equal to 3.50 to 1.00 but greater than 3.00 to 1.00 and (b) 0% when the Company maintains a First Lien Leverage Ratio of less than or equal to 3.00 to 1.00; (ii) 100% of the net cash proceeds of certain asset sales (including insurance and condemnation proceeds), subject to thresholds, reinvestment rights and certain other exceptions; and (iii) 100% of the net cash proceeds of issuances of debt obligations, subject to certain exceptions and thresholds. Excess Cash Flow is generally defined in the Credit Agreement as Consolidated EBITDA (as defined in the Credit Agreement) plus, without duplication, (i) decreases in working capital, (ii) extraordinary or nonrecurring income or gains and (iii) certain other adjustments, minus, without duplication, (a) interest, (b) taxes, (c) increases in working capital, (d) capital expenditures paid in cash and (e) certain other adjustments, in each case as set forth in the Credit Agreement. In the event the Secured Term Loan is prepaid, refinanced, substituted or replaced (including by way of amendment) in whole or in part prior to December 14, 2013 concurrently with the incurrence of indebtedness similar to

24

Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

the Secured Term Loan with a lower all-in yield than that of the Secured Term Loan, any amounts so prepaid, refinanced, substituted or replaced will be subject to a prepayment fee of 1.00%.
Under the Credit Agreement, the Company is required to maintain a First Lien Leverage Ratio below a certain amount for each of the Testing Periods as set forth in the Credit Agreement. For purposes of the Credit Agreement, a Testing Period means a single period consisting of the most recent four consecutive fiscal quarters ending on the covenant determination date. The following table discloses the maximum permitted First Lien Leverage Ratios permitted under the Credit Agreement:

Testing Period Ending
  
Maximum Ratio
April 30, 2013 through July 31, 2014
  
5.50 to 1.00
October 31, 2014 through July 31, 2015
  
5.00 to 1.00
October 31, 2015 through April 30, 2016
  
4.75 to 1.00
July 31, 2016 through October 31, 2016
  
4.50 to 1.00
January 31, 2017 and thereafter
  
4.25 to 1.00

The Credit Agreement also provides for (i) certain representations, warranties and affirmative covenants, (ii) certain negative covenants in addition to the requirement to maintain the First Lien Leverage Ratio levels described above, including limitations on incurring indebtedness, liens, fundamental changes, asset sales, investments, dividends and repayment of certain indebtedness, and transactions with affiliates, in each case with baskets, thresholds and exceptions, and (iii) certain events of default, including for non-payment of principal and interest, breach of affirmative or negative covenants, certain cross defaults, change in control, bankruptcy events, certain ERISA events, certain unsatisfied judgments and actual or asserted invalidity of guarantees or security documents.
The Company's failure to maintain the required First Lien Leverage Ratio or its breach of the other covenants and requirements contained in the Credit Agreement could result in an event of default, which may allow the Company's lenders to accelerate the Company's debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. As of July 31, 2013, the Company was in compliance with the covenants and other requirements in the Credit Agreement.
Provided that the Company is in compliance with the First Lien Leverage Ratio test and no default under the Credit Agreement is continuing or would result therefrom, the covenant in the Credit Agreement that limits the Company's ability to pay dividends or make other distributions to its shareholders generally permits (with certain exceptions and qualifications) the Company to pay dividends or make such distributions in an aggregate amount, when taken together with the aggregate amount of any prepayment, repurchase, redemption or defeasance of subordinated indebtedness, not to exceed (i) $15.0 million plus (ii) (a) $7.5 million plus (b) the aggregate amount of Excess Cash Flows for all fiscal years beginning with fiscal 2013 (net of required prepayments) and proceeds from equity issuances. The Company historically has not paid dividends on its restricted voting shares.
The Credit Facility is guaranteed by certain wholly owned subsidiaries of the Company and secured by a first priority pledge on substantially all of the assets of the Company and the subsidiary guarantors, in each case subject to certain exceptions.
As part of the Refinancing, effective December 14, 2012, the Company terminated all commitments and repaid all amounts owed under its $75.0 million asset-based revolving credit facility (the "ABL"). In addition, on November 26, 2012, the Company commenced a cash tender offer for its $280 million of 8.625% senior secured notes (the "Notes"). As of 12:00 midnight, New York City time, on December 13, 2012, $279.4 million principal amount of the Notes had been tendered and not validly withdrawn, representing approximately 99.80% of the aggregate outstanding principal amount of the Notes. On December 14, 2012, the Company paid an aggregate of approximately $307.2 million in order to purchase the Notes tendered prior to December 14, 2012. In addition, the Company deposited with the trustee in respect of the Notes sufficient funds to redeem the remaining outstanding Notes on January 23, 2013 and pay accrued and unpaid interest thereon. As a result, the Company was released from its obligations under the Notes and the indenture governing the Notes pursuant to the satisfaction and discharge provisions of such indenture.

During the nine months ended July 31, 2013, the Company incurred $29.2 million of refinancing expense comprised of a $23.8 million early redemption penalty related to the repayment of the Notes, and $5.3 million related to the write-off of deferred financing costs on the Notes and the ABL and other related charges. In addition, new creditor and third party fees of

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

$22.7 million were capitalized in long term assets and an original issue discount of $17.3 million was capitalized and netted against the carrying value of the related debt. Both the new fees and the original issue discount will be amortized to interest expense over the term of the Credit Agreement.
During the three months ended July 31, 2013, the Company received assistance from the Italian government in the form of two loans. One loan is a subsidized loan for approximately €6.0 million, of which the Company received €5.4 million during the three months ended July 31, 2013 with the remaining €0.6 million to be received in the fiscal year ending October 31, 2014 ("fiscal 2014"). The subsidized loan has an annual interest rate of 0.5%, a maturity date of June 30, 2020 with fixed semi- annual payments. The other loan is a bank loan for approximately €0.7 million, of which the Company received €0.6 million during the three months ended July 31, 2013 with the remaining €0.1 million to be received in fiscal 2014. The bank loan has a Euribor 6-month + 7.1% annual interest rate, a maturity date of June 30, 2020 and six variable semi-annual payments beginning December 2017.

In addition to the two loans above, the Company was also approved to receive a grant for approximately €0.7 million to reimburse the Company for research and development costs incurred and was booked against the cost of goods sold in the three months ended July 31, 2013.

13.    RELATED PARTY TRANSACTIONS

Revenues for contract manufacturing from a company controlled by Joaquin B. Viso (the "Viso Affiliate"), a director and significant shareholder of the Company, were nil for the three and nine months ended July 31, 2013, and $0.2 million and $0.3 million for the three and nine months ended July 31, 2012. These transactions were conducted in the normal course of business and are recorded at the exchanged amounts. Accounts receivable at July 31, 2013 and October 31, 2012 were nil, respectively, resulting from these transactions. In addition, Patheon manufactures a product for a third party for which the product's intellectual property is owned by the Viso Affiliate. The manufacturing agreement was originally contracted between the third party and the Viso Affiliate, but has been administered directly between Patheon and the third party on normal commercial terms since 2003.
 
As of July 31, 2013 and October 31, 2012, the Company had an investment of $6.0 million and $4.0 million, respectively, representing an 18% interest in two Italian companies (collectively referred to as "BSP Pharmaceuticals") whose largest investor was previously an officer of the Company until December 31, 2009. These companies specialize in the manufacture of cytotoxic pharmaceutical products. As a result of the shareholders' agreement with the other investors in BSP Pharmaceuticals that provides the Company with significant influence over BSP Pharmaceuticals' operations, the Company accounts for its investment in BSP Pharmaceuticals using the equity method. Accordingly, for the nine months ended July 31, 2013 and 2012, the Company recorded investment income of approximately $1.8 million and $0.4 million, respectively.
In connection with its investment in BSP Pharmaceuticals, the Company has a management services agreement with BSP Pharmaceuticals that provides on-going sales and marketing services, and provided engineering and operational services during the construction of the BSP facility which was completed in 2008. There were no management fees recorded under this agreement for the three months ended July 31, 2013 and 2012, respectively. There was no accounts receivable balance at July 31, 2013 and October 31, 2012 in connection with the management services agreement, respectively. These services were conducted in the normal course of business and are recorded at the exchanged amounts.
In connection with certain of BSP Pharmaceuticals' bank financing, the Company had made commitments that it would not dispose of its interest in BSP Pharmaceuticals prior to January 1, 2011, and if needed, on an ongoing basis irrevocably inject equity (pro-rata) in order to ensure BSP complies with certain specific bank covenants. The Company has not made any injections since fiscal 2010.

14.    INCOME TAXES

The Company accounts for income taxes under FASB ASC 740, Income Taxes ("ASC 740"). The Company calculates its quarterly tax provision consistent with the guidance provided by ASC 740-270, whereby the Company forecasts its estimated annual effective tax rate then applies that rate to its year-to-date pre-tax book (loss) income. The effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective rate, including factors such as the valuation allowances against deferred tax assets, the recognition or de-recognition of tax benefits related to uncertain tax positions, or changes in or the interpretation of tax laws in jurisdictions where the Company conducts business. The Company has recorded valuation allowances against certain Canadian and foreign jurisdictions due to insufficient evidence supporting the Company's ability to use these assets in the future.

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Table Of Contents
Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2013
(Dollar information in tabular form is expressed in millions of U.S. dollars, except per share information)

During the three months ended January 31, 2013, the Company released $0.5 million of the valuation allowance against the U.S. deferred tax assets and recognize a tax benefit, due to the creation of deferred tax liabilities from the Banner Acquisition. During the three months ended April 30, 2013, the Company recorded a $3.0 million discrete tax benefit as a result of changes in tax laws and rates taking effect in 2013. In addition, during the three months ended July 31, 2013, the Company recorded a $0.4 million discrete tax benefit as a result of changes in tax laws and rate taking effect in 2013.
For the nine months ended July 31, 2013, the Company increased uncertain tax benefits by $2.7 million related to the Banner Acquisition, of which $2.1 million was recorded as an adjustment to goodwill. The Company does not reasonably expect material changes to the amount of uncertain tax positions within the next 12 months.

15.    BASIC AND DILUTED INCOME (LOSS) PER SHARE
Shares used in basic earnings per share are computed using the weighted-average number of common shares outstanding during each period. Shares used in diluted earnings per share include the dilutive effect of unvested restricted voting share stock options under the incentive stock option plan using the treasury stock method. For the three months ended July 31, 2013 and 2012, 5,054,113 and 52,827 weighted-average restricted voting shares options had a grant price that was less than the average market price. The computation of net income per share did not include 5,988,512 and 12,975,891 outstanding options in the three months ended July 31, 2013 and 2012 because such options were anti-dilutive in nature. The computation of net income per share did not include