PIMCO Tactical Income Units Class A T.PTI

q3 numbers

[mark5698]

Patheon reports third quarter 2004 results TORONTO, Sept. 2 /CNW/ - Patheon (TSX:PTI), a leading service provider in the rapidly growing pharmaceutical outsourcing sector, announces its results for the third quarter ended July 31, 2004. (All amounts are in U.S. dollars unless otherwise indicated.) The quarter was challenging as the Company continues in a year of transition. Third Quarter Results - Revenues increased 3% to $116.8 million; - EBITDA margin before repositioning costs improved sequentially over the first and second quarters to 11.3%; - Effective tax rate before the impact of the repositioning costs increased 4.7 points to 42.1%; - Net earnings before repositioning costs were $3.5 million (6.8 cents per share) versus $6.1 million (11.9 cents per share) a year ago; - Cash provided from operations was $9.1 million, after reflecting the impact of the repositioning costs. Year-to-Date Results - Revenues increased 17% to $347.4 million; - EBITDA before repositioning costs rose 3.6% to $36.8 million; the EBITDA margin before repositioning costs was 10.6%; - Effective tax rate before the impact of the repositioning costs increased 8.9 points to 43.1%; - Net earnings before repositioning costs were $9.2 million (17.8 cents per share) compared with $14.0 million (27.2 cents per share) a year ago; - Cash provided from operations increased 12% to $29.6 million, after reflecting the impact of the repositioning costs in the third quarter of 2004. "During the third quarter, we continued to make progress in our strategy to serve the innovators by providing drug development and manufacturing services that generate revenues with a higher contribution to profitability," said Robert C. Tedford, Chief Executive Officer, Patheon Inc. "Since the beginning of fiscal 2004, four products for which we provided development services on behalf of our clients have received FDA approval and are being launched from our commercial facilities," he said. "Two were approved during the third quarter of 2004 and a third was approved subsequent to quarter end. This is an exciting achievement that demonstrates the success of our integrated, full-service approach and our ability to generate longer- stream revenues. "We have made significant progress in our previously announced plan to reposition our facility in Swindon, United Kingdom," he continued. "The voluntary workforce reduction program is proceeding on schedule and will be completed by year end. We have also begun to invest in new equipment and process flow improvements that will enhance the site's ability to focus on sterile manufacturing opportunities and improve its operating performance." Impact of Repositioning As announced on July 14, 2004, Patheon has adopted a repositioning plan at its facility in Swindon, United Kingdom, which will result in pre-tax expenses of approximately $5.0 million or 7 cents per share in fiscal 2004. In the third quarter, the Company recorded $2.1 million of these expenses, or 2.9 cents per share. << Three months Nine months ended July 31, ended July 31, 2004 2003 2004 2003 --------------------- --------------------- $ $ $ $ --------------------- --------------------- (In thousands of U.S. dollars, except per share amounts) Revenues 116,840 113,379 347,438 297,447 EBITDA 11,035 15,442 34,620 35,482 Net earnings 1,990 6,097 7,681 13,968 Earnings per share 3.9 cents 11.9 cents 14.9 cents 27.2 cents EBITDA before repositioning expenses 13,177 15,442 36,762 35,482 (as a % of revenues) 11.3% 13.6% 10.6% 11.9% Net earnings before repositioning expenses(1) 3,489 6,097 9,180 13,968 (as a % of revenues) 3.0% 5.4% 2.6% 4.7% Earnings per share before repositioning expenses(1) 6.8 cents 11.9 cents 17.8 cents 27.2 cents ------------------------------------------------------------------------- (1) Net earnings before repositioning expenses have been determined by adding net earnings and repositioning expenses for the period, and then deducting the provision for income taxes applicable to the repositioning expenses. Earnings per share before repositioning expenses have been determined by dividing net earnings before repositioning expenses by the average number of shares outstanding during the period. A reconciliation of net earnings and earnings per share before repositioning expenses with net earnings and earnings per share is as follows: Three months Three months ended July 31, 2004 ended July 31, 2003 Earnings EPS Earnings EPS --------------------- --------------------- $ cents $ cents --------------------- --------------------- (In thousands of U.S. dollars, except per share amounts) Net earnings 1,990 3.9 cents 6,097 11.9 cents Repositioning expenses 2,142 4.1 cents - - Income taxes related to repositioning expenses (643) (1.2 cents) - - --------------------- --------------------- Net earnings before repositioning expenses 3,489 6.8 cents 6,097 11.9 cents --------------------- --------------------- ------------------------------------------------------------------------- Net earnings before repositioning expenses and earnings per share before repositioning expenses are not recognized as measures for financial statement presentation under Canadian generally accepted accounting principles ("GAAP"). We have included these measures because we believe that this information is used by certain investors to assess financial performance. However, non-GAAP measures (such as net earnings before repositioning expenses and earnings per share before repositioning expenses) do not have standardized meaning and are therefore unlikely to be comparable to similar measures presented by other issuers. Revenues and Margins Consolidated revenues in the quarter increased 3% or $3.4 million year over year - all internal growth or net new business from existing sites. On a consolidated basis, pharmaceutical development services (PDS) revenues were up 38% and prescription (Rx) revenues were up 4%. Over-the-counter (OTC) revenues were down 13% in the quarter. In North America, revenues were up 5%, reflecting strong growth in Rx manufacturing and PDS, offset by softness in OTC volumes at Canadian sites. North American prescription revenues increased 16% in the quarter, principally driven by stronger Rx manufacturing volumes at Cincinnati. PDS revenues were up 21% as a result of preparations leading to new product launches at our Canadian sites. In Europe, revenues were flat compared with the same quarter a year ago. Strong demand for lyophilization services at the Italian facilities and continued momentum in PDS revenues were offset by waning commercial volumes of mature products at the Swindon, U.K. site. During the quarter, the euro strengthened by approximately 6% and the British sterling by approximately 12% against the U.S. dollar. Had European currencies remained constant to the rates of the prior year, European revenues would have been approximately 7% lower than the same period in 2003. For the year to date, consolidated revenues increased $50.0 million or 17%. Rx and PDS revenues grew 20% and 65%, respectively, and OTC revenues declined 8%. Of the increase of $50.0 million, $13.3 million was strategic growth representing two additional months of revenues from the Cincinnati site acquired in December 2002. The balance of the increase, or $36.7 million, was internal growth - 11% in North America and 14% (1% on a CER basis) in Europe. The EBITDA margin before repositioning costs was 11.3% in the third quarter, compared with 13.6% a year ago. On a sequential basis, the third quarter margin of 11.3% increased from 10.3% in the second quarter and 10.2% in the first quarter as a result of an improved mix of prescription manufacturing products. Year over year, margins were affected by higher operating losses at the Swindon site and the recording of stock-based compensation expense. Margins were also affected by higher infrastructure costs at the Canadian sites to support anticipated future orders by our clients in connection with new product launches and related growth in commercial revenues. For the year to date, the EBITDA margin before repositioning costs was 10.6% compared with 11.9% in 2003, reflecting the significant impact of the stronger Canadian dollar on results for the first half of 2004. In the first half of 2004, the Canadian dollar strengthened 15% against the U.S dollar, negatively impacting EBITDA margins by about 2%. In the quarter, the Company recorded $2.1 million of the total estimated costs of $5.0 million relating to the repositioning of the Swindon, U.K facility. The remaining costs of $2.9 million will be recorded as they are incurred in the fourth quarter. The Company began to record the expense of stock-based compensation in the first quarter of 2004. The expense in the third quarter was $0.4 million and $0.9 million for the year to date, which reduced the EBITDA margin by 0.4 points in the third quarter and 0.3 points in the year to date. The effective income tax rate before repositioning costs in the third quarter was 42.1%, compared with 37.4% in the same period in the prior year. The higher effective tax rate reflects the greater earnings in the higher tax jurisdictions of Ohio, USA and Italy, tax relief on losses incurred in the U.K. that are recorded at a lower rate of 30%, as well as the impact of accounting for stock-based compensation. Under current income tax legislation in Canada, the expense of recording stock options is not deductible, which increased the effective tax rate by 2.8 points in the quarter and 2.3 points year to date. Depreciation and amortization was $5.7 million in the third quarter, comparable to the amount recorded in the second quarter and $1.3 million higher than in the same period a year ago. Of the increase, $0.2 million is attributable to the translation impact to U.S. dollars of depreciation of the Canadian and European assets. The remainder relates principally to the coming on-stream of expanded lyophilization capacity at the Italian sites and capital programs at the Cincinnati site. For the year to date, depreciation and amortization was $16.8 million compared with $11.0 million a year ago. Of the increase of $5.8 million, $1.5 million represents the translation impact to U.S. dollars, $0.5 million relates to the additional two months of operations of the Cincinnati site and the remainder is attributable principally to the Italian and Cincinnati capital programs. In the third quarter, net earnings before repositioning costs as a percentage of revenues were 3.0% compared with 5.4% in the same period a year ago. For the year to date, net earnings before repositioning costs were 2.6% of revenues compared with 4.7% a year ago. Cash Flow and Liquidity In the third quarter, cash provided from operations was $9.1 million, after reflecting the impact of the Swindon repositioning costs in the quarter. Higher working capital requirements of $8.4 million, principally for inventories to support the new product launches, and capital spending in the quarter of $12.1 million were financed by cash from operations of $9.1 million, a drawdown of cash balances of $7.4 million and an increase in debt of $4.0 million. On a year-to-date basis, cash provided from operations increased 12% to $29.6 million. Capital spending for the year to date has amounted to $42.9 million compared with $30.6 million in the same period of 2003. Major capital programs are ongoing at our Italian, Cincinnati and Toronto facilities. In addition, capital programs have commenced relating to the repositioning of our Swindon, U.K. facility. For the year-to-date, working capital requirements of $9.8 million and capital spending of $42.9 million, were financed by cash from operations of $29.6 million, a drawdown of cash balances of $5.8 million and the remainder by debt. During the quarter, the Company completed a financing agreement with four Canadian banks. The committed facility, which replaces demand facilities of C$68 million with two Canadian lenders, comprises two parts: i) C$45 million is to finance operating requirements and is for 364 days and ii) C$65 million is a two-year, revolving term loan. At the end of the quarter, C$78.7 million (US$59.2 million), or approximately 72%, was drawn under this new facility. At quarter end, the Company's consolidated ratio of interest-bearing-long term debt to shareholders' equity was 58% compared with 56% at the end of the second quarter and 53% at year end. Approximately 44% of the debt outstanding at the quarter end was with respect to the Canadian financing agreement, approximately 41% related to financing of the Italian operations, and the balance related to other operations. The Company is currently in negotiations for additional credit facilities for its Cincinnati and Swindon operations. Outlook "As we complete the current fiscal year, we are beginning to realize the tangible benefits of our focused PDS strategy," said Mr. Tedford. "Having made the investments in infrastructure, we are now working with clients on the launch of four new Rx products that were recently approved by the regulatory authorities for commercialization. Client volume forecasts are subject to volatility during the early stages of commercialization. However, these new products are expected to generate commercial manufacturing revenues in 2004 and beyond. "Based on the growing momentum of our PDS business in both Europe and North America, we have good reason to believe that it will continue to enhance the internal growth of our Rx manufacturing," added Mr. Tedford. "At the end of the third quarter, there were 109 projects in our PDS pipeline, up 27% from a year ago. Of these projects, four are at the NDA (New Drug Application) stage, including three in line for approval in fiscal 2005. "Our Swindon repositioning plan is progressing well and all repositioning charges will be taken before the end of fiscal 2004," said Mr. Tedford. "This should result in better operating results at this site in 2005 and a return to profitability in the 2006 fiscal year. We are confident that Swindon will continue to be a strategic asset in Patheon's global network. "Commercial revenue opportunities continue to grow from the high lead generation at the end of fiscal 2003," concluded Mr. Tedford. "In particular, we are encouraged by the new opportunities that we have secured for the OTC business in Canada. We expect that OTC volumes in Canada will return to pre-2004 levels as we move into the 2005 fiscal year. "The Board of Directors has accepted, with regret, the recent resignation of Mr. Bryce Douglas from the Board for personal reasons," said Mr. Tedford. "Mr. Douglas has served with commitment and distinction on our Board since September 2000. We wish him well in his desire to have more time and flexibility to pursue a range of personal interests." This news release contains forward-looking statements with respect to the Company, including its business operations and strategy and financial performance and condition. Although management believes that the expectations reflected in such forward-looking statements are reasonable, such statements involve risks and uncertainties. Actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from expectations include, but are not limited to, currency fluctuations, the level of outsourcing services required by the pharmaceutical companies (and in particular our clients), the impact of changes in pharmaceutical development and manufacturing regulations and general economic and market factors (including inflation and changes in laws) and other factors discussed in materials filed with applicable securities regulatory authorities from time to time. All amounts reported are in U.S. dollars unless otherwise indicated. Patheon Inc. will host a webcast conference call with financial analysts on its third quarter results on Thursday, September 2, 2004 at 10:00 a.m. (Eastern Standard Time). Representing Patheon on the call will be: Robert Tedford, Chief Executive Officer; Nick DiPietro, President and Chief Operating Officer; and Ron Mitchell, Chief Financial Officer. Interested parties are invited to access the call live, via telephone, in listen-only mode, at [phone] or toll-free, at 1-800-814-4857. (Please call between five and fifteen minutes in advance.) A live audio webcast, with a slide presentation, will be available on www.patheon.com. An archived version of the Q3 webcast will be available on www.patheon.com. ABOUT PATHEON Patheon (TSX:PTI; www.patheon.com) is a leading global provider of drug development and manufacturing services in the rapidly growing pharmaceutical outsourcing sector. Patheon operates a network of eleven facilities in the United States, Canada and Europe, employing 3,800 people. The Company serves a client base of 150 pharmaceutical and biotechnology companies, including 17 of the world's 20 largest pharmaceutical companies. Consolidated Statements of Earnings (unaudited) Three months ended July 31, Nine months ended July 31, % % 2004 2003 change 2004 2003 change ------------------------------------------------------------------------- (in thousands of U.S. dollars, except per share amounts) $ $ $ $ ------------------------------------------------------------------------- Revenues 116,840 113,379 3.1% 347,438 297,447 16.8% Operating expenses 103,230 97,937 5.4% 309,748 261,965 18.2% Repositioning expenses (note 12) 2,142 - 2,142 - Stock-based compensation (note 3) 433 - 928 - ------------------------ ------------------------- Earnings before depreciation and amortization, interest and income taxes 11,035 15,442 -28.5% 34,620 35,482 -2.4% ------------------------ ------------------------- (as a % of revenues) 9.4% 13.6% 10.0% 11.9% Depreciation and amortization 5,743 4,435 29.5% 16,814 11,000 52.9% Interest 1,404 1,273 10.3% 3,811 3,258 17.0% ------------------------ ------------------------- Earnings before income taxes 3,888 9,734 -60.1% 13,995 21,224 -34.1% Provision for income taxes (note 4) 1,898 3,637 -47.8% 6,314 7,256 -13.0% ------------------------ ------------------------- Net earnings for the period 1,990 6,097 -67.4% 7,681 13,968 -45.0% ------------------------ ------------------------- ------------------------ ------------------------- (as a % of revenues) 1.7% 5.4% 2.2% 4.7% Earnings per share (note 2) Basic 3.9 11.9 -67.2% 14.9 27.2 -45.2% cents cents cents cents ------------------------ ------------------------- Diluted 3.9 11.7 -66.7% 14.8 26.8 -44.8% cents cents cents cents ------------------------ ------------------------- Average number of shares outstanding during period: Basic (in thousands) 51,515 51,502 0.0% 51,509 51,344 0.3% ------------------------ ------------------------- Diluted (in thousands) 51,973 52,344 -0.7% 52,007 52,147 -0.3% ------------------------ ------------------------- ------------------------ ------------------------- see accompanying notes Consolidated Statements of Retained Earnings (unaudited) Nine months ended July 31, 2004 2003 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ ------------------------------------------------------------------------- Retained earnings, beginning of the year 65,951 47,373 Net earnings for the period 7,681 13,968 ------------------------ Retained earnings, end of period 73,632 61,341 ------------------------ ------------------------ see accompanying notes Consolidated Balance Sheets (unaudited) As at As at July 31, October 31, 2004 2003 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ ------------------------------------------------------------------------- Assets Current Cash and cash equivalents 3,416 9,170 Accounts receivable 86,870 93,642 Inventories 58,827 46,446 Income taxes receivable 572 - ---------------------- Total current assets 149,685 149,258 ---------------------- Capital assets, net 299,156 267,587 Future tax assets 14,941 10,730 Goodwill 2,599 2,619 Deferred pre-operating and financing costs 5,807 5,244 Investment 1,412 1,422 ---------------------- 473,600 436,860 ---------------------- ---------------------- Liabilities and Shareholders' equity Current Bank indebtedness 16,204 12,113 Accounts payable and accrued liabilities 87,386 89,292 Income taxes payable - 1,810 Current portion of long-term debt (note 11) 10,397 7,698 ---------------------- Total current liabilities 113,987 110,913 ---------------------- Long-term debt (note 11) 108,596 94,655 Other long-term liabilities 19,409 17,627 Future tax liabilities 25,544 19,742 ---------------------- Total liabilities 267,536 242,937 ---------------------- Shareholders' equity Share capital 118,079 118,932 Contributed surplus (note 9) 928 - Retained earnings 73,632 65,951 Cumulative translation adjustment 13,425 9,040 ---------------------- Total shareholders' equity 206,064 193,923 ---------------------- 473,600 436,860 ---------------------- ---------------------- see accompanying notes Consolidated Statements of Cash Flows (unaudited) Three months ended Nine months ended July 31, July 31, 2004 2003 2004 2003 ------------------------------------------------------------------------- (in thousands of U.S. dollars, except per share amounts) $ $ $ $ ------------------------------------------------------------------------- Cash provided by (used in): Operating activities Net earnings for the period 1,990 6,097 7,681 13,968 Add (deduct) charges to operations not requiring a current cash payment Depreciation and amortization 5,743 4,435 16,814 11,000 Employee future benefits 664 257 1,807 458 Future income taxes (469) 1,183 1,655 1,099 Equipment write-down (note 12) 750 - 750 - Stock-based compensation (note 3) 433 - 928 - -------------------------------------- Cash provided from operations 9,111 11,972 29,635 26,525 Net change in non-cash working capital balances related to operations (8,370) 12,269 (9,831) (12,440) -------------------------------------- Cash provided by operating activities 741 24,241 19,804 14,085 -------------------------------------- Investing activities Acquisition of new manufacturing site - - - (28,220) Additions to capital assets - sustaining (2,690) (3,538) (8,041) (8,249) - project-related (9,454) (10,916) (34,880) (22,369) Increase in deferred pre-operating and financing costs (1,512) - (1,512) (120) -------------------------------------- Cash used in investing activities (13,656) (14,454) (44,433) (58,958) -------------------------------------- Financing activities Increase (decrease) in bank indebtedness (729) (15,757) 3,719 7,665 Increase in term loans 47,033 14,047 61,303 47,088 Repayment of long-term debt and other long-term liabilities (40,421) (6,258) (45,988) (8,081) Issue of common shares 22 14 22 625 -------------------------------------- Cash provided by (used in) financing activities 5,905 (7,954) 19,056 47,297 -------------------------------------- Effect of exchange rate changes on cash and cash equivalents (378) 470 (181) 648 -------------------------------------- Net increase (decrease) in cash and cash equivalents during the period (7,388) 2,303 (5,754) 3,072 Cash and cash equivalents, beginning of period 10,804 6,645 9,170 5,876 -------------------------------------- Cash and cash equivalents, end of period 3,416 8,948 3,416 8,948 -------------------------------------- -------------------------------------- see accompanying notes Patheon Inc. Notes to Unaudited Consolidated Financial Statements for the Nine Months Ended July 31, 2004 (Dollar information in tabular form is expressed in thousands of U.S. dollars) 1. Accounting policies The accompanying consolidated financial statements have been prepared by the Company in accordance with Canadian generally accepted accounting principles on a basis consistent with those followed in the most recent audited financial statements, except for the accounting for stock-based compensation as described in note 3. These consolidated financial statements do not include all the information and footnotes required by generally accepted accounting principles for annual financial statements and therefore should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report for the year ended October 31, 2003. 2. Earnings per share The following is a reconciliation of the weighted average number of basic and diluted shares: Three months ended July 31, 2004 2003 ------------------------------------------------------------------------- Weighted average number of common shares outstanding 51,514,518 51,501,882 Effect of dilutive stock options 458,150 842,084 ------------------------------------------------------------------------- Weighted average number of common shares outstanding - diluted 51,972,668 52,343,966 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Nine months ended July 31, 2004 2003 ------------------------------------------------------------------------- Weighted average number of common shares outstanding 51,508,742 51,344,121 Effect of dilutive stock options 498,195 802,782 ------------------------------------------------------------------------- Weighted average number of common shares outstanding - diluted 52,006,937 52,146,903 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 3. Accounting change - Stock-based compensation Effective November 1, 2003, the Company adopted the revised recommendations of the Canadian Institute of Chartered Accountants ("CICA") with respect to the recognition and measurement of stock-based compensation and other stock-based payments at fair value. Stock options granted after November 1, 2003 are accounted for under the fair value method. Under this method, compensation expense is measured at fair value at the grant date using the Black-Scholes option pricing model and recognized, over the vesting period, with a corresponding credit to contributed surplus. On the exercise of stock options, consideration received and the accumulated contributed surplus account are credited to share capital. On January 9, 2004 and April 21, 2004, the Company issued 582,000 and 40,000 options, respectively. Stock-based compensation expense related to these options was $433,000 in the third quarter and $928,000 for the nine months ended July 31, 2004. The effect of this change was to decrease net earnings by $433,000 ($0.008 per share) in the third quarter and to decrease net earnings by $928,000 ($0.018 per share) for the nine months ended July 31, 2004. Stock options granted prior to November 1, 2003 continue to be accounted for using the intrinsic value method, which does not give rise to compensation expense. Pro-forma earnings disclosure for stock options granted prior to November 1, 2003 is included in note 7. 4. Income tax provision For the nine months ended July 31, 2003, the Company recorded a tax credit of $543,000. No amount was recorded for the nine months ended July 31, 2004 or for the three months ended July 31, 2004 and 2003. This one-time tax credit related to an incentive for specified qualifying capital expenditures made in Italy during a specified period of time and was derived from the total capital spending on new and refurbished equipment in excess of historical amounts. 5. Share capital The following table summarizes information on share capital and related matters at July 31, 2004: Outstanding Exercisable Common shares 51,555,822 Common share stock options 3,562,645 2,708,658 6. Segmented information The Company is organized and managed as a single business segment, being the provider of commercial manufacturing and pharmaceutical development services. North American and European operations consist of: Three months ended July 31, 2004 --------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues Canada 6,327 469 120 6,916 USA 28,426 28,118 2,578 59,122 Europe 10,128 723 38,433 49,284 Other geographic areas 571 68 879 1,518 ------------------------------------------------------------------------- Total revenues 45,452 29,378 42,010 116,840 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital assets 102,035 31,130 165,991 299,156 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill 2,599 - - 2,599 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three months ended July 31, 2003 --------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues Canada 9,514 441 105 10,060 USA 30,813 22,282 745 53,840 Europe 7,717 166 41,263 49,146 Other geographic areas 58 205 70 333 ------------------------------------------------------------------------- Total revenues 48,102 23,094 42,183 113,379 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital assets 89,815 22,506 126,067 238,388 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill 2,456 - - 2,456 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Nine months ended July 31, 2004 --------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues Canada 19,715 1,411 297 21,423 USA 80,664 84,527 3,892 169,083 Europe 27,483 1,996 123,282 152,761 Other geographic areas 1,973 370 1,828 4,171 ------------------------------------------------------------------------- Total revenues 129,835 88,304 129,299 347,438 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Nine months ended July 31, 2003 --------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues Canada 18,349 678 105 19,132 USA 85,264 53,833 1,238 140,335 Europe 25,264 199 111,958 137,421 Other geographic areas 147 342 70 559 ------------------------------------------------------------------------- Total revenues 129,024 55,052 113,371 297,447 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Revenue is attributed to countries based on the location of the client's billing address and capital assets and goodwill are based in the country in which they are located. Revenue information by service activity is as follows: Three months ended July 31, --------------------------------------- 2004 2003 $ $ ------------------------------------------------------------------------- Commercial manufacturing - prescription 74,442 64% 71,518 63% Commercial manufacturing - over-the-counter 25,995 22% 30,004 27% Development services 16,403 14% 11,857 10% ------------------------------------------------------------------------- 116,840 100% 113,379 100% ------------------------------------------------------------------------- ------------------------------------------------------------------------- Nine months ended July 31, --------------------------------------- 2004 2003 $ $ ------------------------------------------------------------------------- Commercial manufacturing - prescription 225,861 65% 187,897 63% Commercial manufacturing - over-the-counter 74,518 21% 81,033 27% Development services 47,059 14% 28,517 10% ------------------------------------------------------------------------- 347,438 100% 297,447 100% ------------------------------------------------------------------------- ------------------------------------------------------------------------- 7. Stock-based compensation The Company has an incentive stock option plan, which provides for the granting of options for the benefit of employees, officers and directors. The total number of Company shares that may be issued under this plan is 6,422,923. However, between inception of the plan and July 31, 2004, 2,107,628 common shares were issued on the exercise of options granted under the plan. At July 31, 2004, the total number of common shares still available to be issued under the plan was 4,315,295 of which 3,562,645 were reserved for options granted and outstanding under the incentive stock option plan. The exercise price per share will be the market price at the time of granting and the maximum term is 10 years. Options generally vest equally after the end of the first, second and third year of a grant; however, under certain circumstances, options vest immediately. Stock options granted prior to November 1, 2003 are accounted for using the intrinsic value method, which does not give rise to compensation expense. Had these stock options been accounted for at fair value, the impact on pro-forma net earnings and earnings per share would have been: Three months Nine months ended July 31, ended July 31, 2004 2003 2004 2003 ------------------------------------- $ $ $ $ ------------------------------------- Net earnings as reported 1,990 6,097 7,681 13,968 Pro-forma adjustments for the fair value of stock options granted prior to November 1, 2003 (84) (380) (786) (1,013) ------------------------------------- Pro-forma net earnings 1,906 5,717 6,895 12,955 ------------------------------------- ------------------------------------- Pro-forma earnings per share: Basic 3.7 11.1 13.4 25.2 cents cents cents cents Diluted 3.7 11.0 13.3 24.9 cents cents cents cents The fair value of stock options is estimated at the date of the grant. There were no options granted for the three months ended July 31, 2004. The weighted average fair value of stock options granted for the nine months ended July 31, 2004 was $3.94. The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: Risk free interest rate 3.7% Expected volatility 48% Expected weighted average life of the options 5 years Expected dividend yield 0% 8. Other information Cumulative translation adjustment The cumulative translation adjustment amount will be impacted by fluctuations in the value of the U.S. dollar relative to the Canadian dollar, the euro and the British sterling. Unrealized translation adjustments, which arise on the translation to U.S. dollars of the Company's assets and liabilities, resulted in a net unrealized currency translation gain of $566,000 for the three months ended July 31, 2004 (2003 - unrealized currency translation loss of $172,000). For the nine months ended July 31, 2004, the unrealized currency translation gain is $4,385,000 (2003 - unrealized currency translation gain of $4,146,000). The net unrealized gain in the quarter of $566,000 is attributable primarily to the weakening of the U.S. dollar against the euro, the British sterling and the Canadian dollar as measured at July 31, 2004 and April 30, 2004. On a year-to-date basis, the net unrealized gain of $4,385,000 is attributable to the weakening of the U.S. dollar against the euro and British sterling as measured at July 31, 2004 and October 31, 2003, offset in part by a strengthening of the U.S. dollar against the Canadian dollar. Foreign exchange During the three months ended July 31, 2004, the foreign exchange loss was $379,000 (2003 loss - $448,000). For the nine months ended July 31, 2004, the foreign exchange gain was $638,000 (2003 loss - $307,000). 9. Contributed surplus Contributed surplus arises solely from the recording of stock-based compensation expense, as described in notes 3 and 7. 10. Financial instruments The Company utilizes financial instruments to manage the risk associated with fluctuations in foreign exchange rates. The Company has entered into foreign exchange expandable forward contracts with an aggregate amount of between US$29,000,000 and US$37,500,000 as at July 31, 2004. These contracts mature at the latest on March 30, 2005 at exchange rates varying between 1.3300 and 1.4065 Canadian. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and the strategy for undertaking various hedge transactions. The mark-to-market value of these financial instruments as at July 31, 2004 was an unrealized gain of US$977,000. 11. Long-term debt On July 9, 2004, the Company completed a financing agreement with a consortium of Canadian banks. This revolving, floating rate committed facility comprises two parts: i) C$45,000,000 (US$34,000,000) relates to operating requirements and is for 364 days, extendible at the option of the lenders, and ii) C$65,000,000 (US$49,000,000) is a two-year, revolving term loan. The facility is collateralized by general security agreements and fixed and floating charge debentures covering the assets of the borrower and the Canadian operations. 12. Repositioning expenses During the quarter, the Company adopted a repositioning plan for its Swindon, UK commercial operations designed to reduce operating losses. The plan includes both a reduction in the work force and a reorganization of production processes. The total expected pre-tax cost of the plan is $5,000,000, of which the following was recorded in the quarter: ------- $ ------- Employee-related expenses 1,263 Equipment write-down 750 Other 129 ------- 2,142 ------- ------- 13. Comparative amounts Certain of the comparative amounts have been reclassified to conform to the current year presentation. Patheon Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of financial condition and results of operations of Patheon Inc. ("Patheon" or "the Company") for the three-month and nine- month periods ended July 31, 2004 and 2003 should be read in conjunction with the Company's consolidated financial statements and related notes contained in this interim report and the Company's Management Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and related notes contained in the 2003 Annual Report. Results of Operations --------------------- On December 31, 2002, the Company acquired a pharmaceutical manufacturing and development facility located in Cincinnati, Ohio, U.S.A. and entered into new long-term supply agreements in connection with the acquisition. In addition, the Company assumed responsibilities under existing service contracts with third-party pharmaceutical companies. The results for the three- month and nine-month periods ended July 31, 2004 include the operations of this site for three months and nine months, respectively, while the results of the comparative period include the operations of this site for three months and seven months, respectively. Revenues by Geographic Region and Service Activity Three months ended Nine months ended July 31, July 31, 2004 2003 % Change 2004 2003 % Change --------------------------------------------------- North America ------------- Commercial Manufacturing Prescription 36,332 31,443 16% 105,922 79,031 34% Over-the-counter 25,626 29,072 -12% 73,348 79,349 -8% --------------------------------------------------- 61,958 60,515 2% 179,270 158,380 13% Development Services 12,872 10,681 21% 38,869 25,696 51% --------------------------------------------------- 74,830 71,196 5% 218,139 184,076 19% --------------------------------------------------- Europe ------ Commercial Manufacturing Prescription 38,110 40,075 -5% 119,939 108,866 10% Over-the-counter 369 932 -60% 1,170 1,683 -30% --------------------------------------------------- 38,479 41,007 -6% 121,109 110,549 10% Development Services 3,531 1,176 200% 8,190 2,822 190% --------------------------------------------------- 42,010 42,183 0% 129,299 113,371 14% --------------------------------------------------- TOTAL ----- Commercial Manufacturing Prescription 74,442 71,518 4% 225,861 187,897 20% Over-the-counter 25,995 30,004 -13% 74,518 81,032 -8% --------------------------------------------------- 100,437 101,522 -1% 300,379 268,929 12% Development Services 16,403 11,857 38% 47,059 28,518 65% --------------------------------------------------- CONSOLIDATED REVENUES 116,840 113,379 3% 347,438 297,447 17% --------------------------------------------------- --------------------------------------------------- As announced on July 14, 2004, the Company has adopted a repositioning plan at its facility in Swindon, United Kingdom, which will result in pre-tax expenses of approximately $5.0 million or 7 cents per share in fiscal 2004. In the third quarter, the Company recorded $2.1 million of these expenses, or 2.9 cents per share. Three months Nine months ended July 31, ended July 31, 2004 2003 2004 2003 ------------------ ------------------ (In thousands of U.S. dollars, except per share amounts) $ $ $ $ ------------------ ------------------ Revenues 116,840 113,379 347,438 297,447 EBITDA 11,035 15,442 34,620 35,482 Net earnings 1,990 6,097 7,681 13,968 Earnings per share 3.9 11.9 14.9 27.2 cents cents cents cents EBITDA before repositioning expenses 13,177 15,442 36,762 35,482 (as a % of revenues) 11.3% 13.6% 10.6% 11.9% Net earnings before repositioning expenses(1) 3,489 6,097 9,180 13,968 (as a % of revenues) 3.0% 5.4% 2.6% 4.7% Earnings per share before repositioning expenses(1) 6.8 11.9 17.8 27.2 cents cents cents cents ------------------------------------------------------------------------- (1) Net earnings before repositioning expenses have been determined by adding net earnings and repositioning expenses for the period, and then deducting the provision for income taxes applicable to the repositioning expenses. Earnings per share before repositioning expenses have been determined by dividing net earnings before repositioning expenses by the average number of shares outstanding during the period. A reconciliation of net earnings and earnings per share before repositioning expenses with net earnings and earnings per share is as follows: Three months Three months ended July 31, 2004 ended July 31, 2003 Earnings EPS Earnings EPS --------------------- --------------------- $ cents $ cents --------------------- --------------------- (In thousands of U.S. dollars, except per share amounts) Net earnings 1,990 3.9 cents 6,097 11.9 cents Repositioning expenses 2,142 4.1 cents - - Income taxes related to repositioning expenses (643) (1.2 cents) - - --------------------- --------------------- Net earnings before repositioning expenses 3,489 6.8 cents 6,097 11.9 cents --------------------- --------------------- ------------------------------------------------------------------------- Net earnings before repositioning expenses and earnings per share before repositioning expenses are not recognized as measures for financial statement presentation under Canadian generally accepted accounting principles ("GAAP"). The Company has included these measures because it believes that this information is used by certain investors to assess financial performance. However, non-GAAP measures (such as net earnings before repositioning expenses and earnings per share before repositioning expenses) do not have standardized meaning and are therefore unlikely to be comparable to similar measures presented by other issuers. Three Months Ended July 31, 2004 Compared with Three Months Ended July 31, 2003 Consolidated revenues for the quarter ended July 31, 2004 increased 3% or $3.4 million to $116.8 million from $113.4 million in the same period in 2003. In the third quarter, strong growth in pharmaceutical development services (PDS) was offset by declines in over-the-counter (OTC) volumes, principally in North America. Prescription (Rx) revenues were up 16% in North America, offset somewhat by declines in Europe, as compared with the same period in 2003. On a consolidated basis, commercial manufacturing revenues were down 1%, with Rx manufacturing up 4%, principally due to growth in Rx volumes at Cincinnati, offset by declines in OTC of $4.0 million, or 13%, over the same period in 2003. Pharmaceutical development services (PDS) revenues grew 38%, a reflection of continuing strong performance in both North America and Europe, as compared with the same period in 2003. The revenue increase in the third quarter consisted entirely of internal growth, or new business from existing sites. Geographically, North American revenue growth in the quarter was $3.6 million or 5% over the same period in the prior year, all internal growth. The North American operations demonstrated continued strong growth in PDS and Rx manufacturing services with PDS up $2.2 million, or 21%, and Rx manufacturing services up $4.9 million, or 16%. Year-over-year shortfalls in OTC volumes of $3.4 million or 12% related principally to the Canadian sites. Revenues from sites in North America represented 64% of total revenues compared with 63% a year earlier. This principally reflects the ongoing contribution of Cincinnati to North American revenues. In Europe, revenues were flat to the same quarter of 2003. European currencies remained strong against the U.S. dollar through the third quarter. Compared with the same three-month period last year, the euro strengthened approximately 6% and the British sterling strengthened approximately 12% against the U.S. dollar, increasing reported revenues by approximately $2.7 million. Had European currencies remained constant to the rates of the prior year, European revenues would have been 7% lower than the same period in 2003. The impact on net earnings was not significant. The decrease in revenues compared with the same three-month period in 2003, is principally a result of decreased commercial volumes at the Swindon, UK site. EBITDA before repositioning expenses, representing earnings before repositioning expenses, interest, income taxes and depreciation and amortization, was $13.2 million, a $2.3 million or 15% decrease over the same period a year ago. As a percentage of consolidated revenues, EBITDA before repositioning expenses was 11.3% in the third quarter compared with 13.6% in the same period a year ago. The EBITDA margin before repositioning expenses improved to 11.3% in the third quarter, compared with 10.3% in the second quarter and 10.2% in the first quarter of 2004. The trading impact of the stronger Canadian dollar did not significantly impact the third quarter results relative to the prior year. However, as in prior quarters in 2004, margins were affected by higher year-over-year operating losses at the Swindon site, the recording of stock-based compensation expense, and higher infrastructure costs at the Canadian sites to support our clients' new product launches and related growth in commercial revenues. Depreciation expense in the third quarter was $5.7 million, comparable to the second quarter, but $1.3 million higher than a year ago. Of the increase, $0.2 million is attributable to the effect of translation to U.S. dollars of depreciation related to Canadian and European sites, and the remainder principally related to the coming on-stream of expanded lyophilization capacity at the Italian sites and capital programs at the Cincinnati site. Interest expense for the quarter was $1.4 million compared with $1.3 million in the third quarter of 2003 and $1.3 million in the second quarter of 2004. Excluding the impact of UK repositioning expenses, earnings before income taxes decreased 38% to $6.0 million in the third quarter, from $9.7 million in the same quarter of 2003. The effective income tax rate in the third quarter, before repositioning expenses, was 42.1%, compared with 37.4% in the same period in the prior year. The higher effective tax rate reflects greater earnings in higher tax jurisdictions and tax relief on losses incurred in the UK that are recorded at a lower rate of 30%, as well as the impact of accounting for stock-based compensation. Under current income tax legislation in Canada, the expense of recording stock options is not deductible for tax purposes, which increased the effective tax rate, before repositioning expenses, by 2.8 points in the quarter. Net earnings for the period, before repositioning expenses, were $3.5 million, compared with $6.1 million in the same period last year. Net earnings as a percentage of revenues, before repositioning expenses, were 3.0% compared with 5.4% in the same period last year. Excluding the impact of UK repositioning expenses and the recording of stock based compensation expense, net earnings as a percentage of revenues would have been 3.4%. Basic earnings per share, before repositioning expenses, were 6.8 cents compared with 11.9 cents for the third quarter of 2003, a decrease of 43%. Earnings per share on the diluted basis were 6.8 cents compared with 11.7 cents in the third quarter of 2003, a decrease of 42%. Dilution arises solely from options issued under the Company's stock option plan. The average number of shares outstanding during the quarter, determined on the basic and diluted bases, increased 0.0% and decreased 0.7%, respectively. Nine Months Ended July 31, 2004 Compared with Nine Months Ended July 31, 2003 Consolidated revenues for the nine-month period ended July 31, 2004 increased 17% or $50.0 million to $347.4 million from $297.4 million in the same period in 2003. On a consolidated basis, commercial manufacturing revenues grew 12%, with Rx manufacturing up 20%, offset somewhat by declines in OTC volumes of 8%. Pharmaceutical development services (PDS) revenues grew 65%, a reflection of strong performance in both North America and Europe, compared with the same period in 2003. The revenue increase from internal growth, or new business from existing sites, was $36.7 million, or 12%, for the first nine months, 11% in North America and 14% in Europe. Prescription manufacturing and development services represented 79% of revenues, compared with 73% for the comparable period in 2003, driven by increased Rx volumes from the North American operations, principally Cincinnati, combined with increased Rx volumes in Italy and France. Development services increases were strong throughout North America and Europe, as compared with the same nine-month period of 2003. Geographically, North American revenue growth in the first nine months was $34.1 million or 19% over the same period in the prior year. Of the revenue increase, $13.3 million was strategic growth related to the additional two months of revenues from the Cincinnati operations. Net internal growth was $20.8 million, reflecting strong growth in PDS at both the U.S. and Canadian sites and strong growth in Rx manufacturing services, principally from the Cincinnati operations. Revenues from sites in North America represented 63% of total revenues compared with 62% for the same nine-month period in 2003. In Europe, revenues were 14% higher than the same period of 2003. European currencies remained strong against the U.S. dollar through the first nine months compared with the same period last year. The euro strengthened approximately 11% and the British sterling strengthened approximately 12% against the U.S. dollar, increasing reported revenues by approximately $14.3 million. Had European currencies remained constant to the rates of the prior year, European revenues would have been 1% higher than the same period in 2003. The impact on net earnings was approximately 0.9 cents per share. EBITDA before repositioning expenses for the first nine months, representing earnings before repositioning expenses, interest, income taxes, and depreciation and amortization, increased by $1.3 million, or 4%, to $36.8 million from $35.5 million for the comparable period in 2003. As a percentage of consolidated revenues, EBITDA before repositioning expenses was 10.6% in the first nine months of 2004 compared with 11.9% in the same period a year ago. Despite the strong growth in revenues, the performance was not reflected in profitability. The strength of the Canadian dollar against the U.S. dollar had a significant impact on results for the first nine months of 2004, almost entirely in the first half. On a year-over-year basis, the Canadian dollar strengthened 8% in the first nine months. This has a significant impact on the operating profits of the Canadian facilities as they transact approximately 60% of their revenues in U.S. dollars but require Canadian dollars to finance some capital requirements and the majority of operating costs. Depreciation expense was $16.8 million in the first nine months of 2004, compared with $11.0 million in the comparable period of 2003, an increase of $5.8 million, or 53%. Of the increase, $1.5 million is attributable to the effect of translation to U.S. dollars of depreciation related to Canadian and European sites, $0.5 million is attributable to two additional months of depreciation of the Cincinnati assets and the remainder principally related to the coming on-stream of expanded lyophilization capacity at the Italian sites and capital programs at the Cincinnati site. Interest expense for the nine-month period was $3.8 million compared with $3.3 million in the first nine months of 2003. The increase, compared with the prior year, is principally related to the increased capital spending program in Italy and the impact of financing the Cincinnati acquisition for a full nine months in 2004, compared with seven months in 2003 and the cost to finance additional working capital requirements to support new product launches. Earnings before income taxes, before repositioning expenses, decreased 24% to $16.1 million in the first nine months of 2004, down from $21.2 million in the same period of 2003. The effective income tax rate before repositioning expenses in 2004 was 43.1%. After adjusting for the non-recurring Italian tax credit in 2003, the comparable rate is 36.7%. The higher effective tax rate reflects greater earnings in the higher tax jurisdictions of Ohio, U.S.A. and Italy and tax relief on losses incurred in the UK that are recorded at a lower rate of 30%, as well as the impact of accounting for stock-based compensation. Under current income tax legislation in Canada, the expense of recording stock options is not deductible for tax purposes, which increased the effective tax rate, before repositioning expenses, by 2.3 points in the first nine months of 2004. Net earnings before repositioning expenses for the period were $9.2 million, compared with $14.0 million in the same period last year. Net earnings before repositioning expenses, as a percentage of revenues were 2.6% compared with 4.7% in the same period last year. Prior year results include the recording of the non-recurring Italian tax credit of $0.5 million. Excluding the impact of the Italian tax credit in the same period last year, net earnings as a percentage of revenues would have been 4.5%. Basic earnings per share before repositioning expenses for the first nine months of 2004 were 17.8 cents compared with 27.2 cents for the first nine months of 2003, a decrease of 35%. Excluding the impact of the recording of the Italian tax credit, earnings per share for the first nine months of 2003, would have been 26.1 cents. Earnings per share on the diluted basis before repositioning expenses were 17.7 cents compared with 26.8 cents in the first nine months of 2003, a decrease of 34%. Excluding the impact of the recording of the Italian tax credit, earnings per share on the diluted basis for the first nine months of 2003 would have been 25.7 cents. Dilution arises solely from options issued under the Company's stock option plan. The average number of shares outstanding during the nine-month period, determined on the basic and diluted bases, increased 0.3% and decreased 0.3%, respectively. Liquidity and Capital Structure Working capital at July 31, 2004 was $35.7 million compared with $38.3 million at October 31, 2003. On July 9, 2004, the Company completed a financing agreement with a consortium of Canadian banks. This revolving, floating rate committed facility comprises two parts: i) C$45,000,000 (US$34,000,000) relates to operating requirements and is for 364 days, extendible at the option of the lenders, and ii) C$65,000,000 (US$49,000,000) is a two-year, revolving term loan. The facility is collateralized by general security agreements and fixed and floating charge debentures covering the assets of the borrower and the Canadian operations. In the third quarter, the Company invested $12.1 million in capital expenditures compared with $14.5 million in the third quarter of 2003 and $17.3 million in the second quarter of 2004. In the first nine months of 2004, the Company invested $42.9 million in capital expenditures compared with $30.6 million in the same period last year. Currently, the Company's major project-related programs are at its Monza and Ferentino facilities in Europe, in connection with the expansion of sterile lyophilization services, at its Toronto Region facility in Canada, in connection with improvements related to high-potency pharmaceutical manufacturing services, and at its Cincinnati, U.S.A. facility, in connection with raw materials receipt, staging and dispensing. At July 31, 2004, the Company's consolidated ratio of interest-bearing long-term debt (including current portion) to shareholders' equity was 57.7% compared with 55.7% at the end of the second quarter and 52.8% at the end of the previous fiscal year. The increase is principally due to the Company's capital programs and financing of working capital requirements. At July 31, 2004, the Company's consolidated ratio of interest-bearing debt (including current portion and bank indebtedness) to shareholders' equity was 65.6% compared with 59.1% at the end of the 2003 fiscal year. This increase also reflects the increase in the financing requirements of the Company's capital program and working capital requirements to support internal growth. Approximately 44% of the debt outstanding at the end of the third quarter was with respect to the Canadian financing agreement, approximately 41% related to the financing of the Italian operations and the balance related to other operations. The Company is currently in negotiations for additional credit facilities for its Cincinnati and Swindon operations. Cash provided from operations, after reflecting the impact of UK repositioning expenses, in the third quarter of 2004 decreased 24% to $9.1 million, from $12.0 million for the same period in 2003. Cash provided from operations, after reflecting the impact of UK repositioning expenses in the first nine months of 2004 increased 12% to $29.6 million, from $26.5 million for the same period in 2003. For the year-to-date, working capital requirements of $9.8 million and capital spending of $42.9 million, were financed by cash from operations of $29.6 million, a drawdown of cash balances of $5.8 million and the remainder by debt. At July 31, 2004, shareholders' equity was $206.1 million, compared with $193.9 million at October 31, 2003 and $199.5 million at April 30, 2004. Of the increase of $6.6 million in the quarter, $0.6 million related to the change in the cumulative translation adjustment arising primarily from the strengthening of the euro, the British sterling and the Canadian dollar against the U.S. dollar. Refer to note 8 of the financial statements included herein. Accounting Policies Effective November 1, 2003, the Company adopted the revised recommendations of the Canadian Institute of Chartered Accountants ("CICA") with respect to the recognition and measurement of stock-based compensation and other stock-based payments at fair value. Stock options granted after November 1, 2003, are accounted for under the fair value method. Under this method, compensation expense is measured at fair value at the grant date using the Black-Scholes option pricing model and recognized over the vesting period, with a corresponding credit to contributed surplus. On the exercise of stock options, consideration received and the accumulated contributed surplus account are credited to share capital. On January 9, 2004 and April 21, 2004, the Company issued 582,000 and 40,000 options, respectively. Stock-based compensation expense related to these options was $433,000 in the third quarter and $928,000 for the nine months ended July 31, 2004. The effect of this change was to decrease net earnings by $433,000 ($0.008 per share) in the third quarter and to decrease net earnings by $928,000 ($0.018 per share) for the nine months ended July 31, 2004. Stock options granted prior to November 1, 2003 continue to be accounted for using the intrinsic value method, which does not give rise to compensation expense. Pro-forma earnings disclosure for stock options granted prior to November 1, 2003 is included in note 7. Change in Reporting Currency Effective August 1, 2003, the Company adopted the U.S. dollar as its reporting currency. In accordance with Canadian generally accepted accounting principles, the Company is required to restate all amounts presented into U.S. dollars, using the current rate method whereby all revenues, expenses and cash flows are translated at the average rates that were in effect at the end of these periods. For periods after August 1, 2003, the assets and liabilities of the Company's operations having a functional currency other than U.S. dollars, are translated into U.S. dollars using the exchange rate in effect at the month end and revenues and expenses are translated at the average rate during the period. Exchange gains and losses on translation of the Company's net equity investment in these operations are deferred as a separate component of shareholders' equity. Outlook As the Company completes the current fiscal year, it is beginning to realize the tangible benefits of its focused PDS strategy. Having made the investments in infrastructure, the Company is currently working with clients on the launch of four new Rx products that were recently approved by the regulatory authorities for commercialization. Client volume forecasts are subject to volatility during the early stages of commercialization. However, these new products are expected to generate commercial manufacturing revenues in 2004 and beyond. Based on the growing momentum of the PDS business in both Europe and North America, the Company expects to continue to enhance the internal growth of its Rx manufacturing. At the end of the third quarter, there were 109 projects in the PDS pipeline, up 27% from a year ago. Of these projects, four are at the NDA (New Drug Application) stage, including three in line for approval in fiscal 2005. The Swindon repositioning plan is progressing well and all repositioning charges will be taken before the end of fiscal 2004. This should result in better operating results at this site in 2005 and a return to profitability in the 2006 fiscal year. The Company is confident that Swindon will continue to be a strategic asset in its global network. Commercial revenue opportunities continue to grow from the high lead generation at the end of fiscal 2003. The Company is encouraged by the new opportunities secured for the OTC business in Canada and it expects that OTC volumes in Canada will return to pre-2004 levels as the Company moves into the 2005 fiscal year. The Board of Directors has accepted, with regret, the recent resignation of Mr. Bryce Douglas from the Board for personal reasons. Mr. Douglas has served with commitment and distinction on our Board since September 2000. The Company wishes him well in his desire to have more time and flexibility to pursue a range of personal interests. Forward-looking Information This management's discussion and analysis of financial condition and results of operations contains forward-looking statements with respect to the Company, including its business operations and strategy and financial performance and condition. Although management believes that the expectations reflected in such forward-looking statements are reasonable, such statements involve risks and uncertainties. Actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from expectations include, but are not limited to, currency fluctuations, the level of outsourcing services required by the pharmaceutical companies (and in particular the Company's clients), the impact of changes in pharmaceutical development and manufacturing regulations and general economic and market factors (including inflation and changes in laws) and other factors discussed in materials filed with applicable securities regulatory authorities from time to time. >> %SEDAR: 00001700E For further information: Contacts: Mr. Robert C. Tedford, Chief Executive Officer, Tel: [phone], Fax: [phone], [e-mail]; Mr. Ronald B. Mitchell, Chief Financial Officer, Tel: [phone], Fax: [phone], [e-mail]