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VALEANT PHARMACEUTICALS INTERNATIONAL, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) INTRODUCTION The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, prepared in accordance with United States ("U.S.") generally accepted accounting principles ("GAAP") for the interim period ended September 30, 2014 (the "unaudited consolidated financial statements"). This MD&A should also be read in conjunction with the annual MD&A and the audited consolidated financial statements and notes thereto prepared in accordance with U.S. GAAP that are contained in our Annual Report on Form 10-K for the year ended December 31, 2013 (the "2013 Form 10-K"). Additional information relating to the Company, including the 2013 Form 10-K, is available on SEDAR at www.sedar.com and on the U.S. Securities and Exchange Commission (the "SEC") website at www.sec.gov. Unless otherwise indicated herein, the discussion and analysis contained in this MD&A is as of October 24, 2014. All dollar amounts are expressed in U.S. dollars, unless otherwise noted. COMPANY PROFILE We are a multinational, specialty pharmaceutical and medical device company that develops, manufactures, and markets a broad range of branded, generic and branded generic pharmaceuticals, over-the-counter ("OTC") products, and medical devices (contact lenses, intraocular lenses, ophthalmic surgical equipment, and aesthetics devices), which are marketed directly or indirectly in over 100 countries. In the Developed Markets segment, we focus most of our efforts in the eye health, dermatology and neurology therapeutic classes. In the Emerging Markets segment, we focus primarily on branded generics, OTC products, and medical devices. We are diverse not only in our sources of revenue from our broad drug and medical device portfolio, but also among the therapeutic classes and geographies we serve. On August 5, 2013, we acquired Bausch & Lomb Holdings Incorporated ("B&L"), pursuant to an Agreement and Plan of Merger (the "Merger Agreement") dated May 24, 2013, as amended. Subject to the terms and conditions set forth in the Merger Agreement, B&L became a wholly-owned subsidiary of Valeant Pharmaceuticals International ("Valeant"), our wholly-owned subsidiary (the "B&L Acquisition"). B&L is a global eye health company that focuses primarily on the development, manufacture and marketing of eye health products, including contact lenses, contact lens care solutions, ophthalmic pharmaceuticals and ophthalmic surgical products. We believe we will continue to grow the B&L business due primarily to the expected growth of the overall eye health market and the introduction of new products. Further, we have substantially integrated the B&L business into our decentralized structure which has allowed us to realize operational efficiencies and cost synergies. For more information regarding the B&L Acquisition, see note 3 to the unaudited consolidated financial statements. Our strategy is to focus the business on core geographies and therapeutic classes that offer attractive growth opportunities while maintaining our lower selling, general and administrative cost model and decentralized operating structure. We have an established portfolio of durable products with a focus in the eye health and dermatology therapeutic areas. Further, we have completed numerous transactions over the past few years to expand our portfolio offering and geographic footprint, including, among others, the acquisitions of B&L and Medicis Pharmaceutical Corporation ("Medicis"), and we will continue to pursue value-added business development opportunities as they arise. The growth of our business is further augmented through our lower risk research and development model, which allows us to advance certain development programs to drive future commercial growth, while minimizing our research and development expense. We believe this strategy will allow us to maximize both the growth rate and profitability of the Company and to enhance shareholder value. BUSINESS DEVELOPMENT We have completed several transactions including, among others, the following acquisitions and divestitures in 2014: 43 --------------------------------------------------------------------------------Acquisition Acquisitions of businesses and product rights Date Solta Medical, Inc. ("Solta Medical") January 2014 PreCision Dermatology, Inc. ("PreCision") July 2014 Divestiture Divestitures Date Filler and toxin assets July 2014 Metronidazole 1.3% July 2014Tretin-X® (tretinoin) cream and generic tretinoin gel and cream products(1) July 2014 ___________________________________ (1) In connection with the acquisition of PreCision, we were required by the Federal Trade Commission to divest the rights to PreCision's Tretin-X® (tretinoin) cream product and PreCision's generic tretinoin gel and cream products. In addition, in April 2014, the Company announced that it had submitted a merger proposal to the Board of Directors of Allergan, Inc. ("Allergan"). For further information regarding the proposal to merge with Allergan, see note 18 and note 20 to the unaudited consolidated financial statements. For more information regarding our acquisitions and divestitures, see note 3 and note 4 to the unaudited consolidated financial statements. RESTRUCTURING AND INTEGRATION In connection with the B&L and Medicis acquisitions, as well as other smaller acquisitions, we have implemented cost-rationalization and integration initiatives to capture operating synergies and generate cost savings across the Company. These measures included: • workforce reductions across the Company and other organizational changes; • closing of duplicative facilities and other site rationalization actions company-wide, including research and development facilities, sales offices and corporate facilities; • leveraging research and development spend; and • procurement savings. B&L Acquisition-Related Cost-Rationalization and Integration Initiatives The complementary nature of the Company and B&L businesses has provided an opportunity to capture significant operating synergies from reductions in sales and marketing, general and administrative expenses, and research and development. In total, we have identified greater than $900 million of cost synergies on an annual run rate basis that we expect to substantially achieve by the end of 2014. This amount does not include potential revenue synergies or the potential benefits of incorporating B&L's operations into the Company's corporate structure. We estimate that we will incur total costs of approximately $600 million (excluding the charges of $52.8 million described in note 6 to the unaudited consolidated financial statements) in connection with these cost-rationalization and integration initiatives, which are expected to be substantially completed by the end of 2014. Medicis Acquisition-Related Cost-Rationalization and Integration Initiatives The complementary nature of the Company and Medicis businesses has provided an opportunity to capture significant operating synergies from reductions in sales and marketing, general and administrative expenses, and research and development. In total, we realized over $300 million of cost synergies on a run rate basis as of December 31, 2013. We estimate that we will incur total costs of approximately $200 million in connection with these cost-rationalization and integration initiatives, which were substantially completed by the end of 2013. However, additional costs have been incurred in 2014, and we expect to incur certain costs during the next six months. See note 6 to the unaudited consolidated financial statements for detailed information summarizing the major components of costs incurred in connection with our B&L and Medicis acquisition-related initiatives through September 30, 2014. 44 --------------------------------------------------------------------------------SELECTED FINANCIAL INFORMATION The following table provides selected financial information for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions, except per share data) $ $ $ % $ $ $ % Revenues 2,056.2 1,541.7 514.5 33 5,983.5 3,705.8 2,277.7 61 Operating expenses 1,372.3 2,433.2 (1,060.9 ) (44 ) 4,587.9 4,338.8 249.1 6 Net income (loss) attributable to Valeant Pharmaceuticals International, Inc. 275.4 (973.2 ) 1,248.6 NM 378.6 (989.9 ) 1,368.5 NM Earnings (loss) per share attributable to Valeant Pharmaceuticals International, Inc.: Basic 0.82 (2.92 ) 3.74 NM 1.13 (3.13 ) 4.26 NM Diluted 0.81 (2.92 ) 3.73 NM 1.11 (3.13 ) 4.24 NM ____________________________________ NM - Not meaningful Financial Performance Changes in Revenues Total revenues increased $514.5 million, or 33%, to $2.1 billion in the third quarter of 2014, compared with $1.5 billion in the third quarter of 2013 and increased $2.3 billion, or 61%, to $6.0 billion in the first nine months of 2014, compared with $3.7 billion in the first nine months of 2013, primarily due to incremental product sales revenue of $343.5 million and $2,184.9 million, in the aggregate, from all 2013 acquisitions and all 2014 acquisitions in the third quarter and first nine months of 2014, respectively, partially offset by (i) a negative impact from divestitures and discontinuations of $81.7 million, in the aggregate, in the third quarter of 2014, and a negative impact from divestitures, discontinuations and supply interruptions of $226.1 million, in the aggregate, in the first nine months of 2014, (ii) a decrease in product sales of $33.7 million and $141.2 million in the third quarter and first nine months of 2014, respectively, due to the impact of generic competition in the Developed Markets segment, and (iii) a negative foreign currency impact on the existing business of $24.9 million and $56.6 million in the third quarter and first nine months of 2014, respectively. Excluding the items described above, we realized incremental product sales revenue of $313.3 million and $498.3 million in the third quarter and first nine months of 2014, respectively, related to growth from the remainder of the existing business. The above changes in revenues are further described below under "Results of Operations - Revenues by Segment". As is customary in the pharmaceutical industry, our gross product sales are subject to a variety of deductions in arriving at reported net product sales. Provisions for these deductions are recorded concurrently with the recognition of gross product sales revenue and include cash discounts and allowances, chargebacks, and distribution fees, which are paid to direct customers, as well as rebates and returns, which can be paid to both direct and indirect customers. Provision balances relating to estimated amounts payable to direct customers are netted against accounts receivable, and balances relating to indirect customers are included in accrued liabilities. The provisions recorded to reduce gross product sales to net product sales were as follows: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 ($ in millions) $ $ $ $ Gross product sales 2,980.2 2,108.6 8,180.3 5,011.8 Provisions to reduce gross product sales to net product sales 957.3 602.2 2,312.2 1,403.0 Net product sales 2,022.9 1,506.4 5,868.1 3,608.8 Percentage of provisions to gross sales 32 % 29 % 28 % 28 % Provisions as a percentage of gross sales increased to 32% for the three months ended September 30, 2014 from 29% in the prior year period. The increase was driven primarily by higher provisions for returns and rebates, including the new co-pay assistance programs for launch products including Jublia®, Luzu™, and Retin-A Micro® Microsphere 0.08% ("RAM 0.08%"), as well as increased sales of generic products and Wellbutrin XL® (to the U.S. government), which have higher rebate percentages. 45 -------------------------------------------------------------------------------- Changes in Earnings Attributable to Valeant Pharmaceuticals International, Inc. Net income attributable to Valeant Pharmaceuticals International, Inc. was $275.4 million in the third quarter of 2014, compared with net loss attributable to Valeant Pharmaceuticals International, Inc. of $973.2 million in the third quarter of 2013. Net income attributable to Valeant Pharmaceuticals International, Inc. was $378.6 million in the first nine months of 2014, compared with net loss attributable to Valeant Pharmaceuticals International, Inc. of $989.9 million in the first nine months of 2013, reflecting the following factors: (i) an increase in contribution (product sales revenue less cost of goods sold, exclusive of amortization and impairments of finite-lived intangible assets) of $531.5 million and $1,768.7 million in the third quarter and first nine months of 2014, respectively, as further described below under "Results of Operations - Segment Profit" and (ii) a decrease in operating expenses (driven largely by higher impairment charges in the prior year), as further described below under "Results of Operations - Operating Expenses". Net Income (Loss) Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest was $1.0 million in the third quarter of 2014 and net loss attributable to noncontrolling interest was $0.5 million in the first nine months of 2014. Net income attributable to noncontrolling interest was $1.3 million in both the third quarter and first nine months of 2013. Net income (loss) attributable to noncontrolling interest is primarily related to the performance of joint ventures acquired in connection with the B&L Acquisition. RESULTS OF OPERATIONS Reportable Segments We have two operating and reportable segments: (i) Developed Markets, and (ii) Emerging Markets. The following is a brief description of our segments: • Developed Markets consists of (i) sales in the U.S. of pharmaceutical products, OTC products, and medical device products, as well as alliance and contract service revenues, in the areas of eye health, dermatology and podiatry, aesthetics, and dentistry, (ii) sales in the U.S. of pharmaceutical products indicated for the treatment of neurological and other diseases, as well as alliance revenue from the licensing of various products we developed or acquired, and (iii) pharmaceutical products, OTC products, and medical device products sold in Canada, Australia, New Zealand, Western Europe and Japan. • Emerging Markets consists of branded generic pharmaceutical products and branded pharmaceuticals, OTC products, and medical device products. Products are sold primarily in Central and Eastern Europe (primarily Poland and Russia), Asia, Latin America (Mexico, Brazil, and Argentina and exports out of Mexico to other Latin American markets), Africa and the Middle East. Revenues By Segment The following table displays revenues by segment for the third quarters and first nine months of 2014 and 2013, the percentage of each segment's revenues compared with total revenues in the respective period, and the dollar and percentage change in the dollar amount of each segment's revenues. Percentages may not add due to rounding. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions) $ % $ % $ % $ % $ % $ % Developed Markets 1,507.9 73 1,142.7 74 365.2 32 4,409.4 74 2,722.8 73 1,686.6 62 Emerging Markets 548.3 27 399.0 26 149.3 37 1,574.1 26 983.0 27 591.1 60 Total revenues 2,056.2 100 1,541.7 100 514.5 33 5,983.5 100 3,705.8 100 2,277.7 61 Total revenues increased $514.5 million, or 33%, to $2.1 billion in the third quarter of 2014, compared with $1.5 billion in the third quarter of 2013 and increased $2.3 billion, or 61%, to $6.0 billion in the first nine months of 2014, compared with $3.7 billion in the first nine months of 2013. Approximately 50% of the growth in the third quarter of 2014 was driven by volume. The growth was mainly attributable to the effect of the following factors: Developed Markets segment: 46 --------------------------------------------------------------------------------• the incremental product sales revenue of $254.2 million and $1,628.6 million, in the aggregate, from all 2013 acquisitions and all 2014 acquisitions in the third quarter and first nine months of 2014, respectively, primarily from (i) the 2013 acquisitions of B&L (driven by Ocuvite®/PreserVision®, Lotemax®, ReNu Multiplus®, and Biotrue® MultiPurpose Solution product sales) and (ii) the 2014 acquisitions of Solta Medical (mainly driven by Thermage CPT® system product sales) and PreCision (mainly driven by Clindagel® product sales). This factor was partially offset by: • a negative impact from divestitures and discontinuations of $75.5 million in the third quarter of 2014, and a negative impact from divestitures, discontinuations and supply interruptions of $176.0 million in first nine months of 2014. The largest contributors were the divestitures of facial injectables products (filler and toxin assets) in the third quarter of 2014, the discontinuation of Maxair® and the divestiture of Buphenyl® in 2013; • a decrease in product sales of $33.7 million and $141.2 million, in the aggregate, in the third quarter and first nine months of 2014, respectively, due to generic competition. The decrease in the third quarter of 2014 related to a decline in sales of the Vanos® franchise and Wellbutrin® XL (Canada). The decrease in the first nine months of 2014 related to a decline in sales of the Vanos®, Retin-A Micro® (excluding RAM 0.08%), and Zovirax® franchises and Wellbutrin® XL (Canada). We anticipate a continuing decline in sales of the Vanos® franchise and Wellbutrin® XL (Canada) due to continued generic erosion. However, the rate of decline is expected to decrease in the future, and these brands are expected to represent a declining percentage of total revenues primarily due to anticipated growth in other parts of our business and recent acquisitions; and • a negative foreign currency exchange impact on the existing business of $7.7 million and $25.1 million in the third quarter and first nine months of 2014, respectively. Excluding the items described above, we realized incremental product sales revenue from the remainder of the existing business of $233.1 million and $386.0 million in the third quarter and first nine months of 2014, respectively. For the third quarter of 2014, slightly more than half of the growth came from price. The growth for the first nine months of 2014 was driven primarily by price. The growth included higher sales of (i) Elidel®, (ii) Solodyn®, (iii) Wellbutrin XL® (U.S.), (iv) Targretin®, and (v) orphan products (Syprine® and Xenazine®). The growth also reflected higher sales from recent product launches, including the launches of Jublia®, Luzu™, and RAM 0.08%. Emerging Markets segment: • the incremental product sales revenue of $89.3 million and $556.3 million, in the aggregate, from all 2013 acquisitions and all 2014 acquisitions in the third quarter and first nine months of 2014, respectively, primarily from the 2013 acquisition of B&L (driven by ReNu Multiplus®, Ocuvite®, and Artelac™ product sales) and the 2014 acquisition of Solta Medical (mainly driven by Thermage CPT® system product sales). This factor was partially offset by: • a negative impact from divestitures and discontinuations of $6.2 million in the third quarter of 2014, and a negative impact from divestitures, discontinuations and supply interruptions of $50.1 million in the first nine months of 2014, primarily from Eastern Europe and Brazil; and • a negative foreign currency exchange impact on the existing business of $17.2 million and $31.5 million in the third quarter and first nine months of 2014, respectively. Excluding the items described above, we realized incremental product sales revenue from the remainder of the existing business of $80.2 million and $112.3 million in the third quarter and first nine months of 2014, respectively. The vast majority of this growth was driven by volume. The growth reflected higher sales in Russia, Southeast Asia, South Africa, and Mexico. Segment Profit (Loss) Segment profit (loss) is based on operating income after the elimination of intercompany transactions. Certain costs, such as restructuring and acquisition-related costs, in-process research and development impairments and other charges and other (income) expense, are not included in the measure of segment profit (loss), as management excludes these items in assessing segment financial performance. In addition, a portion of share-based compensation is not allocated to segments, since the amount of such expense depends on company-wide performance rather than the operating performance of any single segment. 47 -------------------------------------------------------------------------------- The following table displays profit (loss) by segment for the third quarters and first nine months of 2014 and 2013, the percentage of each segment's profit (loss) compared with corresponding segment revenues in the respective period, and the dollar and percentage change in the dollar amount of each segment's profit (loss). Percentages may not add due to rounding. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions) $ %(1) $ %(1) $ % $ %(1) $ %(1) $ % Developed Markets 478.0 32 (328.6 ) (29 ) 806.6 NM 1,375.3 31 106.3 4 1,269.0 NM Emerging Markets 104.0 19 19.5 5 84.5 NM 268.1 17 63.9 7 204.2 NM Total segment profit (loss) 582.0 28 (309.1 ) (20 ) 891.1 NM 1,643.4 27 170.2 5 1,473.2 NM ____________________________________ (1) - Represents profit as a percentage of the corresponding revenues. NM - Not meaningful Total segment profit increased $891.1 million to $582.0 million in the third quarter of 2014, compared with segment loss of $309.1 million in the third quarter of 2013, and increased $1.5 billion to $1.6 billion in the first nine months of 2014, compared with $170.2 million in the first nine months of 2013, mainly attributable to the effect of the following factors: Developed Markets segment: • an increase in contribution of $153.7 million and $1,096.2 million, in the aggregate, from all 2013 acquisitions and all 2014 acquisitions in the third quarter and first nine months of 2014, respectively, primarily from the product sales of B&L and Solta Medical, including higher expenses for acquisition accounting adjustments related to inventory of $10.6 million and $24.1 million, in the aggregate, in the third quarter and first nine months of 2014, respectively; • a decrease in operating expenses (including amortization and impairments of finite-lived intangible assets) of $410.2 million in third quarter of 2014 primarily due to an impairment charge of $551.6 million related to ezogabine/retigabine in the third quarter of 2013, partially offset by the acquisitions of new businesses within the segment; and • a favorable impact of $122.2 million and $187.8 million related to the existing business acquisition accounting adjustments related to inventory in the third quarter and first nine months of 2013, respectively, that did not similarly occur in the third quarter and first nine months of 2014. Those factors were partially offset by: • a decrease in contribution related to divestitures and discontinuations of $60.3 million in the third quarter of 2014, and a decrease in contribution related to divestitures, discontinuations and supply interruptions of $144.6 million in the first nine months of 2014; • a decrease in contribution of $31.5 million and $134.6 million in the third quarter and first nine months of 2014, respectively, as a result of the continued impact of generic competition. The decrease in the third quarter of 2014 related to a decline in sales of the Vanos® franchise and Wellbutrin® XL (Canada). The decrease in the first nine months of 2014 related to a decline in sales of the Vanos®, Retin-A Micro® (excluding RAM 0.08%), and Zovirax® franchises and Wellbutrin® XL (Canada); • an increase in operating expenses (including amortization and impairments of finite-lived intangible assets) of $89.7 million in the first nine months of 2014 primarily due to the acquisitions of new businesses within the segment, partially offset by the impairment charge of $551.6 million related to ezogabine/retigabine in the third quarter of 2013; and• a negative foreign currency exchange impact on the existing business contribution of $5.9 million and $19.2 million in the third quarter and first nine months of 2014, respectively. Excluding the items described above, we realized incremental contribution from product sales from the remainder of the existing business of $220.8 million and $356.3 million in the third quarter and first nine months of 2014, respectively, driven by sales of (i) Elidel®, (ii) Solodyn®, (iii) Wellbutrin XL® (U.S.), (iv) Targretin®, and (v) orphan products (Syprine® and Xenazine®). The growth also reflected higher sales from recent product launches, including the launches of Jublia®, Luzu™, and RAM 0.08%. 48 -------------------------------------------------------------------------------- Emerging Markets segment: • an increase in contribution of $55.2 million and $365.2 million, in the aggregate, from all 2013 acquisitions and all 2014 acquisitions, in the third quarter and first nine months of 2014, respectively, primarily from the sale of B&L and Solta Medical products; and • a favorable impact of $27.2 million and $31.4 million related to the existing business acquisition accounting adjustments related to inventory in the third quarter and first nine months of 2013, respectively, that did not similarly occur in the third quarter and first nine months of 2014. Those factors were partially offset by: • an increase in operating expenses (including amortization and impairments of finite-lived intangible assets) of $45.3 million and $220.5 million in the third quarter and first nine months of 2014, respectively, primarily associated with the acquisitions of new businesses within the segment; • a decrease in contribution related to divestitures and discontinuations of $3.8 million in the third quarter of 2014, and a decrease in contribution related to divestitures, discontinuations and supply interruptions of $31.1 million in the first nine months of 2014; and • a negative foreign currency exchange impact on the existing business contribution of $10.7 million and $19.6 million in the third quarter and first nine months of 2014, respectively. Excluding the items described above, we realized incremental contribution from product sales from the remainder of the existing business of $61.9 million and $78.4 million in the third quarter and first nine months of 2014, respectively. The growth reflected higher sales in Russia, Southeast Asia, South Africa, and Mexico. Operating Expenses The following table displays the dollar amount of each operating expense category for the third quarters and first nine months of 2014 and 2013, the percentage of each category compared with total revenues in the respective period, and the dollar and percentage changes in the dollar amount of each category. Percentages may not add due to rounding. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions) $ %(1) $ %(1) $ % $ %(1) $ %(1) $ % Cost of goods sold (exclusive of amortization and impairments of finite-lived intangible assets shown separately below) 545.8 27 560.8 36 (15.0 ) (3 ) 1,619.5 27 1,128.9 30 490.6 43 Cost of other revenues 15.0 1 14.4 1 0.6 4 45.3 1 44.3 1 1.0 2 Selling, general and administrative 504.1 25 355.7 23 148.4 42 1,501.8 25 854.9 23 646.9 76 Research and development 59.1 3 49.0 3 10.1 21 186.9 3 97.3 3 89.6 92 Amortization and impairments of finite-lived intangible assets 393.1 19 910.2 59 (517.1 ) (57 ) 1,113.9 19 1,540.0 42 (426.1 ) (28 ) Restructuring, integration and other costs 61.7 3 243.1 16 (181.4 ) (75 ) 337.4 6 345.7 9 (8.3 ) (2 ) In-process research and development impairments and other charges 19.9 1 124.0 8 (104.1 ) (84 ) 40.3 1 128.8 3 (88.5 ) (69 ) Acquisition-related costs 1.6 - 8.6 1 (7.0 ) (81 ) 3.7 - 24.4 1 (20.7 ) (85 ) Acquisition-related contingent consideration 4.0 - (35.0 ) (2 ) 39.0 NM 14.8 - (33.5 ) (1 ) 48.3 NM Other (income) expense (232.0 ) (11 ) 202.4 13 (434.4 ) NM (275.7 ) (5) 208.0 6 (483.7 ) NM Total operating expenses 1,372.3 67 2,433.2 158 (1,060.9 ) (44 ) 4,587.9 77 4,338.8 117 249.1 6 ____________________________________ (1) - Represents the percentage for each category as compared to total revenues. NM - Not meaningful Cost of Goods Sold (exclusive of amortization and impairments of finite-lived intangible assets) Cost of goods sold decreased $15.0 million, or 3%, to $545.8 million in the third quarter of 2014, compared with $560.8 million in the third quarter of 2013, and increased $490.6 million, or 43%, to $1.6 billion in the first nine months of 2014, 49 -------------------------------------------------------------------------------- compared with $1.1 billion in the first nine months of 2013. As a percentage of revenue, Cost of goods sold decreased to 27% in both the third quarter and first nine months of 2014, as compared to 36% and 30% for the third quarter and first nine months of 2013, respectively, primarily due to: • the impact of lower acquisition accounting adjustments of $137.2 million and $197.3 million in the third quarter and first nine months of 2014, respectively, primarily related to the fair value step-up for acquired inventory from the B&L and Medicis acquisitions which was expensed in the third quarter and first nine months of 2013 that did not similarly occur in the third quarter and first nine months of 2014; and • a favorable impact from product mix driven by new product launches, including Jublia®, Luzu™, and RAM 0.08%. These products have a higher gross profit margin than our overall margin. Those factors were partially offset by: • an unfavorable impact from product mix related to (i) the product portfolio acquired as part of the B&L Acquisition and (ii) decreased sales of certain products in the Developed Markets segment due to generic competition (as described above) which have a higher gross profit margin than our overall margin. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $148.4 million, or 42%, to $504.1 million in the third quarter of 2014, compared with $355.7 million in the third quarter of 2013, and increased $646.9 million, or 76%, to $1.5 billion in the first nine months of 2014, compared with $854.9 million in the first nine months of 2013, primarily due to increased expenses in our Developed Markets segment ($106.8 million and $487.2 million in the third quarter and first nine months of 2014, respectively) and Emerging Markets segment ($33.8 million and $157.8 million in the third quarter and first nine months of 2014, respectively), primarily driven by the acquisitions of new businesses within each segment, including the B&L Acquisition, partially offset by the realization of cost synergies related primarily to headcount reductions. As a percentage of revenue, Selling, general and administrative expenses increased to 25% in both the third quarter and first nine months of 2014, respectively, as compared to 23% in both the third quarter and first nine months of 2013, primarily due to (i) costs incurred related to the B&L Acquisition, (ii) higher expenses related to recent and upcoming product launches, including the recent launches of Jublia®, Luzu™, and RAM 0.08%, (iii) expenses associated with sales force expansion for the dermatology and dental businesses, and (iv) higher share-based compensation expenses. See note 12 to the unaudited consolidated financial statements for additional information related to share-based compensation. Research and Development Expenses Research and development expenses increased $10.1 million, or 21%, to $59.1 million in the third quarter of 2014, compared with $49.0 million in the third quarter of 2013, and increased $89.6 million, or 92%, to $186.9 million in the first nine months of 2014, compared with $97.3 million in the first nine months of 2013, primarily due to spending on programs acquired in the B&L Acquisition, including latanoprostene bunod, Lotemax® life cycle programs, and brimonidine, partially offset by lower spending on Jublia® (efinaconazole 10% topical solution). In June 2014, the U.S. Food and Drug Administration approved the New Drug Application for Jublia®, and the product was launched. See note 3 to the unaudited consolidated financial statements for additional information relating to the B&L Acquisition. Amortization and Impairments of Finite-Lived Intangible Assets Amortization and impairments of finite-lived intangible assets decreased $517.1 million, or 57%, to $393.1 million in the third quarter of 2014, compared with $910.2 million in the third quarter of 2013, and decreased $426.1 million, or 28%, to $1.1 billion in the first nine months of 2014, compared with $1.5 billion in the first nine months of 2013, primarily due to (i) a decrease of $578.1 million and $631.1 million for ezogabine/retigabine in the third quarter and first nine months of 2014, respectively, due to the impairment charge of $551.6 million recognized in the third quarter of 2013 (which also resulted in lower amortization expense in the current year), (ii) impairment charges of $31.5 million recognized in the first nine months of 2013 related to the write-down of the carrying values of assets held for sale related to certain suncare and skincare brands sold primarily in Australia, and (iii) a $22.2 million write-off recognized in the first quarter of 2013 related to the Opana® intangible asset, partially offset by (iv) an increase in amortization of the B&L and Solta Medical identifiable intangible assets of $43.1 million and $227.4 million, in the aggregate, in the third quarter and first nine months of 2014, respectively, and (v) a $32.4 million write-off in the third quarter of 2014 of the Grifulvin® intangible asset. 50 -------------------------------------------------------------------------------- As part of our ongoing assessment of potential impairment indicators related to our finite-lived and indefinite-lived intangible assets, we will closely monitor the performance of our product portfolio. If our ongoing assessments reveal indications of impairment, we may determine that an impairment charge is necessary and such charge could be material. Restructuring, Integration and Other Costs We recognized restructuring, integration and other costs of $61.7 million and $337.4 million in the third quarter and first nine months of 2014, respectively, primarily related to the B&L, PreCision and Solta Medical acquisitions. Refer to note 6 of notes to unaudited consolidated financial statements for further details. In-Process Research and Development Impairments and Other Charges In the third quarter and first nine months of 2014, we recognized in-process research and development charges of $19.9 million and $40.3 million, respectively, primarily related to (i) the write-off of an IPR&D asset of $12.5 million in the third quarter of 2014 related to analysis of Phase 2 study data for a dermatological product candidate acquired in the December 2012 Medicis acquisition, (ii) an up-front payment of $12.0 million made in connection with an amendment to a license and distribution agreement with a third party in the first quarter of 2014, and (iii) payments to third parties associated with the achievement of specific developmental and regulatory milestones under our research and development programs, including Jublia®, in the second quarter of 2014. In the third quarter of 2013, we recognized in-process research and development charges of $124.0 million primarily due to the write-off of (i) $93.8 million of IPR&D assets related to the modified-release formulation of ezogabine/retigabine and (ii) $27.3 million of IPR&D assets acquired by Valeant as part of the Aton Pharma, Inc. acquisition in May 2010, mainly related to the termination of the A007 (Lacrisert®) development program. Acquisition-Related Costs Acquisition-related costs decreased $7.0 million, or 81%, to $1.6 million in the third quarter of 2014, compared with $8.6 million in the third quarter of 2013, and decreased $20.7 million, or 85%, to $3.7 million in the first nine months of 2014, compared with $24.4 million in the first nine months of 2013, reflecting higher expenses incurred in the third quarter and first nine months of 2013 related to the B&L, Obagi Medical Products, Inc. ("Obagi") and Natur Produkt International, JSC ("Natur Produkt") acquisitions, as well as other acquisitions, partially offset by acquisition activities in the third quarter and first nine months of 2014, primarily related to the PreCision and Solta Medical acquisitions. Refer to note 3 of notes to unaudited consolidated financial statements for additional information regarding business combinations. Acquisition-Related Contingent Consideration In the third quarter and first nine months of 2014, we recognized an acquisition-related contingent consideration loss of $4.0 million and $14.8 million, respectively. The net loss was primarily driven by fair value adjustments to reflect accretion for the time value of money related to the Elidel®/Xerese®/Zovirax® agreement entered into with Meda Pharma SARL ("Meda") in June 2011 (the "Elidel®/Xerese®/Zovirax® agreement"). In the third quarter and first nine months of 2013, we recognized an acquisition-related contingent consideration gain of $35.0 million and $33.5 million, respectively. The net gain was primarily driven by a net gain related to the Elidel®/Xerese®/Zovirax® agreement. As a result of analysis in the third quarter of 2013 of performance trends since the launch of a generic Zovirax® ointment in April 2013, we adjusted the projected revenue forecast, resulting in an acquisition-related contingent consideration net gain of $25.6 million and $23.8 million in the third quarter and first nine months of 2013, respectively. Also contributing to the acquisition-related contingent net gain was a net gain of $6.9 million, which resulted from the termination, in the third quarter of 2013, of the A007 (Lacrisert®) development program, which impacted the probability associated with potential milestone payments. Other (Income) Expense We recognized other income of $232.0 million and $275.7 million in the third quarter and first nine months of 2014, respectively, primarily related to (i) a net gain of $323.9 million related to the divestiture of filler and toxin assets in the third quarter of 2014 and (ii) the reversal of a $50.0 million reserve related to the AntiGrippin® litigation in the first quarter of 2014, partially offset by (iii) a net loss of $58.5 million related to the divestiture of Metronidazole 1.3% in the third quarter of 2014, (iv) a post-combination expense of $20.4 million in the third quarter of 2014 related to the acceleration of unvested stock options for PreCision employees, and (v) a loss on sale of $8.8 million related to the divestiture of the generic tretinoin product rights 51 -------------------------------------------------------------------------------- in the third quarter of 2014, acquired in the PreCision acquisition. Refer to note 4, note 18 and note 3 of notes to unaudited consolidated financial statements for further details related to the divestitures of filler and toxin assets and Metronidazole 1.3%, the AntiGrippin® litigation and the acquisition of PreCision, respectively. We recognized other expense of $202.4 million and $208.0 million in the third quarter and first nine months of 2013, respectively, primarily due to (i) a charge of $142.5 million in the third quarter of 2013 related to a settlement agreement with Anacor Pharmaceuticals, Inc. and (ii) a post-combination expense of $52.8 million, in the aggregate, related to B&L's previously cancelled performance-based options and the acceleration of unvested stock options for B&L employees as a result of the B&L Acquisition. Refer to note 3 of notes to unaudited consolidated financial statements for further details related to the B&L Acquisition. Non-Operating Income (Expense) The following table displays the dollar amounts of each non-operating income or expense category in the third quarters and first nine months of 2014 and 2013 and the dollar and percentage changes in the dollar amount of each category. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions; Income (Expense)) $ $ $ % $ $ $ % Interest income 0.8 2.8 (2.0 ) (71 ) 3.8 5.4 (1.6 ) (30 ) Interest expense (258.4 ) (249.3 ) (9.1 ) 4 (746.1 ) (581.4 ) (164.7 ) 28 Loss on extinguishment of debt - (8.2 ) 8.2 (100 ) (93.7 ) (29.6 ) (64.1 ) NM Foreign exchange and other (53.0 ) 5.1 (58.1 ) NM (63.0 ) (3.5 ) (59.5 ) NM Gain on investments, net 3.4 - 3.4 NM 5.9 5.8 0.1 2 Total non-operating expense (307.2 ) (249.6 ) (57.6 ) 23 (893.1 ) (603.3 ) (289.8 ) 48 ____________________________________ NM - Not meaningful Interest Expense Interest expense increased $9.1 million, or 4%, to $258.4 million in the third quarter of 2014, compared with $249.3 million in the third quarter of 2013 and increased $164.7 million, or 28%, to $746.1 million in the first nine months of 2014, compared with $581.4 million in the first nine months of 2013. The increase in the first nine months of 2014 was primarily due to an increase of $183.6 million, in the aggregate, related to higher debt balances, driven by the borrowings in the third quarter of 2013 in conjunction with the B&L Acquisition, partially offset by a decrease of $12.4 million, in the aggregate, related to the non-cash amortization and write-off of debt discounts and debt issuance costs. As a result of the financing obtained in the third quarter of 2013 in connection with the B&L Acquisition, we expect an increase in interest expense for the full year 2014 as compared to 2013. Loss on Extinguishment of Debt In the first quarter of 2014, we recognized losses of $93.7 million, related to the refinancing of our Series E tranche B term loan facility on February 6, 2014 (as described below under "Financial Condition, Liquidity and Capital Resources - Financial Assets (Liabilities)"). In the third quarter and first nine months of 2013, we recognized losses of $8.2 million and $29.6 million, respectively, related primarily to (i) the repricing of our Series D tranche B term loan facility and our Series C tranche B term loan facility on February 21, 2013 and (ii) the redemption of 9.875% senior notes assumed in connection with the B&L Acquisition in the third quarter of 2013 (see note 3 to unaudited consolidated financial statements for additional information). Foreign Exchange and Other In the third quarter and first nine months of 2014, we recognized foreign exchange and other losses of $53.0 million and $63.0 million, respectively, primarily due to a foreign exchange loss on a euro-denominated intercompany loan in the third quarter of 2014. 52 -------------------------------------------------------------------------------- Gain on Investments, Net In the third quarter and first nine months of 2014, we recognized gain on investment, net of $3.4 million and $5.9 million, respectively. The gain on investment, net in both periods was primarily driven by a realized gain of $3.4 million on the sale of available-for-sale equity securities (see note 7 to unaudited consolidated financial statements for additional information). In the first nine months of 2013, we recognized gain on investment, net of $5.8 million. The gain on investment, net was primarily driven by a realized gain of $4.0 million on the sale of an equity investment assumed in connection with the Medicis Acquisition in December 2012. Income Taxes The following table displays the dollar amounts of the current and deferred provision (recovery of) for income taxes in the third quarters and first nine months of 2014 and 2013 and the dollar and percentage changes in the dollar amount of each provision. Percentages may not add due to rounding. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions; Expense (Income)) $ $ $ % $ $ $ % Current income tax expense 25.7 16.4 9.3 57 61.2 38.5 22.7 59 Deferred income tax expense (recovery) 74.6 (185.6 ) 260.2 NM 63.2 (286.2 ) 349.4 NM Total provision (recovery of) for income taxes 100.3 (169.2 ) 269.5 NM 124.4 (247.7 ) 372.1 NM ____________________________________ NM - Not meaningful In the three-month period ended September 30, 2014, we recognized an income tax expense of $100.3 million, comprised of $101.4 million related to the expected tax expense in tax jurisdictions outside of Canada and an income tax benefit of $1.1 million related to Canadian income taxes. In the nine-month period ended September 30, 2014, we recognized an income tax expense of $124.4 million, comprised of $130.7 million related to the expected tax expense in tax jurisdictions outside of Canada and an income tax benefit of $6.3 million related to Canadian income taxes. In the three-month period ended September 30, 2014, our effective tax rate was different from our statutory Canadian tax rate due to (i) tax expense generated from our annualized mix of earnings by jurisdiction, (ii) a tax benefit on losses in Canada associated with unrealized gains in other comprehensive (loss) income, (iii) tax expense of $97.2 million associated with the divestiture of filler and toxin assets to Galderma, and (iv) tax benefit of $22.2 million related to the U.S. Federal tax return filing update to the prior year estimate of taxes. In addition to the points noted immediately above, the nine-month period ended September 30, 2014 was also impacted by (i) tax expense incurred in the first quarter of 2014 of approximately $13.3 million, associated with an out-of-period adjustment for the tax impacts of intercompany profit in ending inventory and (ii) a tax benefit of approximately $20.4 million, inclusive of an out of period adjustment of $15.9 million, associated with the adjustment of various uncertain tax positions previously accrued by us in the second quarter of 2014. Management does not believe that these adjustments are material to the current or prior periods. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Selected Measures of Financial Condition The following table displays a summary of selected measures of our financial condition as of September 30, 2014 and December 31, 2013: As of As of September 30, December 31, 2014 2013 Change ($ in millions; Asset (Liability)) $ $ $ % Cash and cash equivalents 808.8 600.3 208.5 35 Long-lived assets(1) 22,388.6 23,834.5 (1,445.9 ) (6 ) Total debt, including current portion (16,274.9 ) (17,367.7 ) 1,092.8 (6 ) __________________ 53 -------------------------------------------------------------------------------- (1)Long-lived assets comprise property, plant and equipment, intangible assets and goodwill. Cash and Cash Equivalents Cash and cash equivalents increased $208.5 million, or 35%, to $808.8 million as of September 30, 2014, which primarily reflected the following sources of cash: • $1.5 billion in operating cash flows; and • $1.5 billion of net cash proceeds from divestitures primarily related to the divestitures of filler and toxin assets in July 2014. Refer to note 4 to the unaudited consolidated financial statements for additional information. Those factors were partially offset by the following uses of cash: • $1.2 billion in net repayments, in the aggregate, under our senior secured credit facilities in the first nine months of 2014; • $1.1 billion paid, in the aggregate, in connection with the purchases of businesses and intangible assets, mainly in respect of the PreCision and Solta Medical acquisitions in the first nine months of 2014; • purchases of property, plant and equipment of $211.2 million; • contingent consideration payments within financing activities of $96.6 million primarily related to the OraPharma Topco Holdings, Inc. acquisition in June 2012, the Eisai (Targretin®) acquisition in February 2013 and the Elidel®/Xerese®/Zovirax® agreement entered into in June 2011; • $75.9 million payment related to the investment in PS Fund 1, LLC ("PS Fund 1"), a newly formed company jointly owned by Pershing Square Capital Management, L.P. ("Pershing Square") and Valeant in connection with a merger proposal to the Board of Directors of Allergan. Refer to note 20 to the unaudited consolidated financial statements for additional information; • $38.5 million of employee withholding taxes paid in connection with the exercise of share-based awards; and • $21.0 million related to debt issue costs paid primarily due to the refinancing of our Series E tranche B term loan facility in February 2014 (as described below under "Financial Condition, Liquidity and Capital Resources - Financial Assets (Liabilities)"). Long-Lived Assets Long-lived assets decreased $1.4 billion, or 6%, to $22.4 billion as of September 30, 2014, primarily due to: • the depreciation of property, plant and equipment and amortization of intangible assets of $1.2 billion, in the aggregate; • a reduction of the carrying amount of intangible assets and goodwill of $1.0 billion and $91.0 million, in the aggregate, related to the divestitures of (i) filler and toxin assets and (ii) Metronidazole 1.3%, respectively, which were divested in July 2014. Refer to note 4 to the unaudited consolidated financial statements for additional information; and • a negative foreign currency exchange impact of $431.8 million. Those factors were partially offset by: • the inclusion of the identifiable intangible assets, goodwill and property, plant and equipment from the 2014 acquisitions of $1.0 billion, in the aggregate, primarily related to the PreCision and Solta Medical acquisitions; and • purchases of property, plant and equipment of $211.2 million. Long-Term Debt Long-term debt (including the current portion) decreased $1.1 billion, or 6%, to $16.3 billion, primarily due to repayments under our (i) Series A-1, Series A-2 and Series A-3 of tranche A term loan facilities, (ii) Series E-1 tranche B term loan facility, and (iii) Series D-2 and Series C-2 of tranche B term loan facilities. Cash Flows 54 -------------------------------------------------------------------------------- Our primary sources of cash include: cash collected from customers, funds available from our revolving credit facility, issuances of long-term debt and issuances of equity. Our primary uses of cash include: business development transactions, funding ongoing operations, interest and principal payments, securities repurchases and restructuring activities. The following table displays cash flow information for the third quarters and first nine months of 2014 and 2013: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change ($ in millions) $ $ $ % $ $ $ % Net cash provided by operating activities 618.7 201.7 417.0 NM 1,479.0 762.1 716.9 94 Net cash provided by (used in) investing activities 756.3 (4,469.2 ) 5,225.5 NM 105.8 (5,235.8 ) 5,341.6 NM Net cash (used in) provided by financing activities (1,082.1 ) 2,318.4 (3,400.5 ) NM (1,361.4 ) 4,158.6 (5,520.0 ) NM Effect of exchange rate changes on cash and cash equivalents (15.3 ) 6.0 (21.3 ) NM (14.9 ) (4.7 ) (10.2 ) NM Net increase (decrease) in cash and cash equivalents 277.6 (1,943.1 ) 2,220.7 NM 208.5 (319.8 ) 528.3 NM Cash and cash equivalents, beginning of period 531.2 2,539.4 (2,008.2 ) (79 ) 600.3 916.1 (315.8 ) (34 ) Cash and cash equivalents, end of period 808.8 596.3 212.5 36 808.8 596.3 212.5 36 ____________________________________ NM - Not meaningful Operating Activities Net cash provided by operating activities increased $417.0 million to $618.7 million in the third quarter of 2014, compared with $201.7 million in the third quarter of 2013, primarily due to: • the inclusion of cash flows in the third quarter of 2014 from all 2013 acquisitions, primarily the B&L Acquisition, as well as all 2014 acquisitions; and • incremental cash flows from the continued growth of the existing business, including new product launches, partially offset by a decrease in contribution of $31.5 million in the third quarter of 2014 related to the lower sales of the Vanos® franchise and Wellbutrin® XL (Canada) as a result of generic competition. Those factors were partially offset by: • an increased investment in working capital of $69.4 million in the third quarter of 2014, primarily related to (i) an increase in receivables driven by higher gross sales and product mix and (ii) the impact of changes related to timing of payments, including interest, severance, and integration payments, and receipts in the ordinary course of business, partially offset by an increase in accrued liabilities due to higher sales reserves. Net cash provided by operating activities increased $716.9 million, or 94%, to $1.5 billion in the first nine months of 2014, compared with $762.1 million in the first nine months of 2013, primarily due to: • the inclusion of cash flows in the first nine months of 2014 from all 2013 acquisitions, primarily the B&L and Obagi acquisitions, as well as all 2014 acquisitions; and • incremental cash flows from the continued growth of the existing business, including new product launches, partially offset by a decrease in contribution of $134.6 million in the first nine months of 2014 related to the lower sales of the Vanos®, Retin-A Micro® (excluding RAM 0.08%), and Zovirax® franchises and Wellbutrin® XL (Canada) as a result of generic competition. Those factors were partially offset by: • higher payments of $147.9 million related to restructuring, integration and other costs in the first nine months of 2014; and • an increased investment in working capital of $146.7 million in the first nine months of 2014, primarily related to (i) an increase in receivables driven by higher gross sales and product mix and (ii) the impact of changes related to timing of payments, including interest, severance, and integration payments, and receipts in the ordinary course of business, partially offset by an increase in accrued liabilities due to higher sales reserves. Investing Activities 55 -------------------------------------------------------------------------------- Net cash provided by investing activities was $756.3 million in the third quarter of 2014, compared with the net cash used in investing activities of $4.5 billion in the third quarter of 2013, reflecting an increase of $5.2 billion, primarily due to: • an increase of $3.8 billion, in the aggregate, related to higher purchases of businesses (net of cash acquired) and intangible assets in the prior year, driven mainly by the August 2013 B&L Acquisition; and • an increase of $1.5 billion, related to higher proceeds from the sale of assets and businesses, net of costs to sell, primarily attributable to the cash proceeds of approximately $1.4 billion for the divestiture of filler and toxin assets to Galderma in the third quarter of 2014. Net cash provided by investing activities was $105.8 million in the first nine months of 2014, compared with the net cash used in investing activities of $5.2 billion in the first nine months of 2013, reflecting an increase of $5.3 billion, primarily due to: • an increase of $4.1 billion, in the aggregate, related to higher purchases of businesses (net of cash acquired) and intangible assets in the prior year, driven mainly by the August 2013 B&L Acquisition; and • an increase of $1.5 billion, related to higher proceeds from the sale of assets and businesses, net of costs to sell, primarily attributable to the cash proceeds of approximately $1.4 billion for the divestiture of filler and toxin assets to Galderma in the third quarter of 2014. Those factors were partially offset by: • a decrease of $159.5 million related to higher purchases of property, plant and equipment; and • a decrease of $75.9 million related to the investment in the PS Fund 1, a newly formed company jointly owned by Pershing Square and Valeant, formed in connection with a merger proposal to the Board of Directors of Allergan. Financing Activities Net cash used in financing activities was $1.1 billion in the third quarter of 2014, compared with the net cash provided by financing activities of $2.3 billion in the third quarter of 2013, reflecting a decrease of $3.4 billion, primarily due to: • a decrease of $3.4 billion related to borrowings under our senior secured credit facilities primarily due to the borrowings in the third quarter of 2013 in connection with the B&L Acquisition; • a decrease related to net proceeds of $3.2 billion from the issuance of senior notes in the third quarter of 2013; and • a decrease of $1.0 billion related to higher repayments under our senior secured credit facilities in the third quarter of 2014. Refer to note 10 to the unaudited consolidated financial statements for additional information. Those factors were partially offset by: • an increase of $4.2 billion related to the repayment of long-term debt assumed in connection with the B&L Acquisition in the third quarter of 2013 that did not similarly occur in the third quarter of 2014. Net cash used in financing activities was $1.4 billion in the first nine months of 2014, compared with the net cash provided by financing activities of $4.2 billion in the first nine months of 2013, reflecting a decrease of $5.5 billion, primarily due to: • a decrease of $3.4 billion related to borrowings under our senior secured credit facilities in the third quarter of 2014 primarily due to the borrowings in the third quarter of 2013 in connection with the B&L Acquisition; • a decrease related to net proceeds of $3.2 billion from the issuance of senior notes in the third quarter of 2013; • a decrease of $2.3 billion related to the net proceeds from the issuance of common stock in June 2013, which were utilized to fund the B&L Acquisition; and • a decrease of $1.2 billion related to the higher repayments under our senior secured credit facilities in the first nine months of 2014, primarily driven by the principal payments of $1.0 billion, in the aggregate, in the third quarter of 2014. Refer to note 10 to the unaudited consolidated financial statements for additional information. Those factors were partially offset by: • an increase of $4.2 billion related to the repayment of long-term debt assumed in connection with the B&L Acquisition in the third quarter of 2013 that did not similarly occur in the third quarter of 2014; 56--------------------------------------------------------------------------------• an increase of $233.6 million related to the repayments of long-term debt assumed in connection with the Medicis acquisition in the first nine months of 2013 that did not similarly occur in the first nine months of 2014; • an increase of $59.5 million related to the lower debt issue costs paid in the first nine months of 2014 due to the lower refinancing activities in the first nine months of 2014; • an increase of $55.6 million related to the repurchases of common shares in the first nine months of 2013 that did not similarly occur in the first nine months of 2014; and • an increase of $37.6 million related to the repayments of short-term borrowings and long-term debt, in the aggregate, assumed in connection with the Natur Produkt acquisition in the first nine months of 2013 that did not similarly occur in the first nine months of 2014. Debt See note 10 to the unaudited consolidated financial statements for detailed information regarding our long-term debt and any transactions described below. On February 6, 2014, we and certain of our subsidiaries as guarantors entered into a joinder agreement to reprice and refinance the Series E tranche B term loans (the "Series E Tranche B Term Loan Facility") by the issuance of $2.95 billion in new term loans (the "Series E-1 Tranche B Term Loan Facility"). Term loans under our Series E Tranche B Term Loan Facility were either exchanged for, or repaid with the proceeds of, the Series E-1 Tranche B Term Loan Facility and proceeds from the additional Series A-3 tranche A term loans issuance (the "Series A-3 Tranche A Term Loan Facility") described below. In connection with this transaction, we recognized a loss on extinguishment of debt of $93.7 million in the three-month period ended March 31, 2014. Concurrently, on February 6, 2014, we and certain of our subsidiaries as guarantors entered into a joinder agreement for the issuance of $225.6 million in incremental term loans under the Series A-3 Tranche A Term Loan Facility. Proceeds from this transaction were used to repay part of the term loans outstanding under the Series E Tranche B Term Loan Facility. On October 15, 2014, Valeant redeemed all of the outstanding $500.0 million aggregate principal amount of its 6.75% senior notes due 2017 (the "2017 Notes") for $518.2 million, including a call premium of $16.9 million, plus accrued and unpaid interest, and satisfied and discharged the 2017 Notes indenture, solely with respect to the 2017 Notes (the 7.00% senior notes due 2020, issued under the same indenture, remain outstanding at this time). The senior notes issued by us are our senior unsecured obligations and are jointly and severally guaranteed on a senior unsecured basis by each of our subsidiaries that is a guarantor under our Senior Secured Credit Facilities. The senior notes issued by our subsidiary Valeant are senior unsecured obligations of Valeant and are jointly and severally guaranteed on a senior unsecured basis by us and each of our subsidiaries (other than Valeant) that is a guarantor under our Senior Secured Credit Facilities. Certain of the future subsidiaries of the Company and Valeant may be required to guarantee the senior notes. The non-guarantor subsidiaries had total assets of $6.2 billion and total liabilities of $2.3 billion as of September 30, 2014, and net revenues of $1.5 billion and net earnings from operations of $413.4 million for the nine-month period ended September 30, 2014. Our primary sources of liquidity are our cash, cash collected from customers, funds available from our revolving credit facility, issuances of long-term debt and issuances of equity. We believe these sources will be sufficient to meet our current liquidity needs. We have commitments approximating $100 million for expenditures related to property, plant and equipment. Since part of our business strategy is to expand through strategic acquisitions, we may be required to seek additional debt financing, issue additional equity securities or sell assets, as necessary, to finance future acquisitions, including the proposed merger with Allergan (see note 20 to the unaudited consolidated financial statements for information regarding our proposed merger with Allergan), or for other general corporate purposes. Our current corporate credit rating is Ba3 for Moody's Investors Service and BB- for Standard and Poor's. A downgrade may increase our cost of borrowing and may negatively impact our ability to raise additional debt capital. As of September 30, 2014, we were in compliance with all of our covenants related to our outstanding debt. As of September 30, 2014, our short-term portion of long-term debt of $690.6 million, in the aggregate, primarily consisted of (i) the 2017 Notes redeemed in October 2014 (as described above) and (ii) the term loans outstanding under the Senior Secured Credit Facilities, due in quarterly installments. We believe our existing cash and cash generated from operations will be sufficient to cover these short-term debt maturities as they become due. 57 -------------------------------------------------------------------------------- Securities Repurchase Programs See note 11 to the unaudited consolidated financial statements for detailed information regarding our various securities repurchase programs. OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS We have no off-balance sheet arrangements that have a material current effect or that are reasonably likely to have a material future effect on our results of operations, financial condition, capital expenditures, liquidity, or capital resources. The following table summarizes our contractual obligations related to our long-term debt, including interest as of September 30, 2014: Payments Due by Period 2015 and 2017 and Total 2014 2016 2018 Thereafter ($ in millions) $ $ $ $ $ Long-term debt obligations, including interest(1) 21,725.9 728.6 2,623.2 5,684.5 12,689.6 ___________________________________ (1) Expected interest payments assume repayment of the principal amount of the debt obligations at maturity. On October 15, 2014, we redeemed all of the outstanding $500.0 million aggregate principal amount of our 6.75% senior notes due 2017. Refer to note 10 to the unaudited consolidated financial statements titled "LONG-TERM DEBT" for further information. There have been no other material changes outside the normal course of business to the items specified in the contractual obligations table and related disclosures under the heading "Off-Balance Sheet Arrangements and Contractual Obligations" in the annual MD&A contained in the 2013 Form 10-K. OUTSTANDING SHARE DATA Our common shares are listed on the TSX and the NYSE under the ticker symbol "VRX". At October 21, 2014, we had 335,672,637 issued and outstanding common shares. In addition, as of October 21, 2014, we had outstanding 8,012,556 stock options and 848,725 time-based RSUs that each represent the right of a holder to receive one of the Company's common shares, and 1,160,441 performance-based RSUs that represent the right of a holder to receive up to 400% of the RSUs granted. A maximum of 2,827,136 common shares could be issued upon vesting of the performance-based RSUs outstanding. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Critical accounting policies and estimates are those policies and estimates that are most important and material to the preparation of our consolidated financial statements, and which require management's most subjective and complex judgment due to the need to select policies from among alternatives available, and to make estimates about matters that are inherently uncertain. There have been no material changes to our critical accounting policies and estimates disclosed under the heading "Critical Accounting Policies and Estimates" in the annual MD&A contained in the 2013 Form 10-K. NEW ACCOUNTING STANDARDS Adoption of New Accounting Standards Information regarding the adoption of new accounting guidance is contained in note 2 to the unaudited consolidated financial statements. Recently Issued Accounting Standards, Not Adopted as of September 30, 2014 In May 2014, the Financial Accounting Standard Board ("FASB") and the International Accounting Standards Board issued converged guidance on recognizing revenue from contracts with customers. The core principle of the revenue model is 58 -------------------------------------------------------------------------------- that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity will: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. In addition to these provisions, the new standard provides implementation guidance on several other topics, including the accounting for certain revenue-related costs, as well as enhanced disclosure requirements. The new guidance requires entities to disclose both quantitative and qualitative information that enables users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The guidance is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early application is not permitted. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance. We are in the process of evaluating the impact of adoption of this guidance on our financial position and results of operations. In August 2014, the FASB issued guidance which requires management to assess an entity's ability to continue as a going concern and to provide related disclosures in certain circumstances. Under the new guidance, disclosures are required when conditions give rise to substantial doubt about an entity's ability to continue as a going concern within one year from the financial statement issuance date. The guidance is effective for annual periods ending after December 15, 2016, and all annual and interim periods thereafter. Early application is permitted. The adoption of this guidance will not have any impact on our financial position and results of operations and, as this time, we do not expect any impact on our disclosures. FORWARD-LOOKING STATEMENTS Caution regarding forward-looking information and statements and "Safe-Harbor" statements under the U.S. Private Securities Litigation Reform Act of 1995: To the extent any statements made in this MD&A contain information that is not historical, these statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and may be forward-looking information within the meaning defined under applicable Canadian securities legislation (collectively, "forward-looking statements"). These forward-looking statements relate to, among other things: the expected benefits of our acquisitions and other transactions, such as cost savings, operating synergies and growth potential of the Company; business plans and prospects, prospective products or product approvals, future performance or results of current and anticipated products; exposure to foreign currency exchange rate changes and interest rate changes; the outcome of contingencies, such as certain litigation and regulatory proceedings; general market conditions; and our expectations regarding our financial performance, including revenues, expenses, gross margins, liquidity and income taxes. Forward-looking statements can generally be identified by the use of words such as "believe", "anticipate", "expect", "intend", "estimate", "plan", "continue", "will", "may", "could", "would", "should", "target", "potential", "opportunity", "tentative", "positioning", "designed", "create", "predict", "project", "seek", "ongoing", "increase", or "upside" and variations or other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements may not be appropriate for other purposes. Although we have indicated above certain of these statements set out herein, all of the statements in this Form 10-Q that contain forward-looking statements are qualified by these cautionary statements. These statements are based upon the current expectations and beliefs of management. Although we believe that the expectations reflected in such forward-looking statements are reasonable, such statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are applied in making forward-looking statements, including, but not limited to, factors and assumptions regarding the items outlined above. Actual results may differ materially from those expressed or implied in such statements. Important factors that could cause actual results to differ materially from these expectations include, among other things, the following: • the challenges and difficulties associated with managing the rapid growth of our Company and a larger, more complex business; • the introduction of generic competitors of our brand products; • the introduction of products that compete against our products that do not have patent or data exclusivity rights, which products represent a significant portion of our revenues; 59--------------------------------------------------------------------------------• our ability to compete against companies that are larger and have greater financial, technical and human resources than we do, as well as other competitive factors, such as technological advances achieved, patents obtained and new products introduced by our competitors; • our ability to identify, finance, acquire, close and integrate acquisition targets successfully and on a timely basis; • factors relating to the integration of the companies, businesses and products acquired by the Company (including the integration relating to our recent acquisitions of PreCision, Solta Medical, and B&L, such as the time and resources required to integrate such companies, businesses and products, the difficulties associated with such integrations (including potential disruptions in sales activities and potential challenges with information technology systems integrations), the difficulties and challenges associated with entering into new business areas and new geographic markets, the difficulties, challenges and costs associated with managing and integrating new facilities, equipment and other assets, and the achievement of the anticipated benefits from such integrations; • factors relating to our ability to achieve all of the estimated synergies from our acquisitions as a result of cost-rationalization and integration initiatives. These factors may include greater than expected operating costs, the difficulty in eliminating certain duplicative costs, facilities and functions, and the outcome of many operational and strategic decisions, some of which have not yet been made; • the ultimate outcome of any possible transaction between the Company and Allergan, Inc. ("Allergan"), including the ultimate removal or the failure to render inapplicable the obstacles to consummation of such transaction, or the possibility that the Company will not continue to pursue a transaction with Allergan and factors relating to the time, resources and efforts expended in pursuing a transaction with Allergan; • ability to obtain regulatory approvals and meet other closing conditions to the proposed Allergan transaction, including all necessary stockholder approvals, on a timely basis; • if a transaction between the Company and Allergan occurs, the ultimate outcome and results of integrating the operations of the Company and Allergan, the ultimate outcome of the Company's pricing and operating strategy applied to Allergan and the ultimate ability to realize synergies; • the effects of the business combination of the Company and Allergan, including the combined company's future financial condition, operating results, strategy and plans; • our ability to secure and maintain third party research, development, manufacturing, marketing or distribution arrangements; • our eligibility for benefits under tax treaties and the continued availability of low effective tax rates for the business profits of certain of our subsidiaries; • our substantial debt and debt service obligations and their impact on our financial condition and results of operations; • our future cash flow, our ability to service and repay our existing debt and our ability to raise additional funds, if needed, in light of our current and projected levels of operations, acquisition activity and general economic conditions; • interest rate risks associated with our floating rate debt borrowings; • the risks associated with the international scope of our operations, including our presence in emerging markets and the challenges we face when entering new geographic markets (including the challenges created by new and different regulatory regimes in those markets); • adverse global economic conditions and credit market and foreign currency exchange uncertainty in the countries in which we do business (such as the recent instability in Russia, Ukraine and the Middle East); • economic factors over which the Company has no control, including changes in inflation, interest rates, foreign currency rates, and the potential effect of such factors on revenues, expenses and resulting margins; • our ability to retain, motivate and recruit executives and other key employees; • our ability to obtain and maintain sufficient intellectual property rights over our products and defend against challenge to such intellectual property; • the outcome of legal proceedings, investigations and regulatory proceedings; 60 --------------------------------------------------------------------------------• the risk that our products could cause, or be alleged to cause, personal injury and adverse effects, leading to potential lawsuits and/or withdrawals of products from the market; • the availability of and our ability to obtain and maintain adequate insurance coverage and/or our ability to cover or insure against the total amount of the claims and liabilities we face, whether through third party insurance or self-insurance; • the difficulty in predicting the expense, timing and outcome within our legal and regulatory environment, including, but not limited to, the U.S. Food and Drug Administration, Health Canada and other regulatory approvals, legal and regulatory proceedings and settlements thereof, the protection afforded by our patents and other intellectual and proprietary property, successful generic challenges to our products and infringement or alleged infringement of the intellectual property of others; • the results of continuing safety and efficacy studies by industry and government agencies; • the availability and extent to which our products are reimbursed by government authorities and other third party payors, as well as the impact of obtaining or maintaining such reimbursement on the price of our products; • the inclusion of our products on formularies or our ability to achieve favorable formulary status, as well as the impact on the price of our products in connection therewith; • the impact of price control restrictions on our products, including the risk of mandated price reductions; • the success of preclinical and clinical trials for our drug development pipeline or delays in clinical trials that adversely impact the timely commercialization of our pipeline products, as well as factors impacting the commercial success of our currently marketed products, which could lead to material impairment charges; • the results of management reviews of our research and development portfolio, conducted periodically and in connection with certain acquisitions, the decisions from which could result in terminations of specific projects which, in turn, could lead to material impairment charges; • negative publicity or reputational harm to our products and business, including as faced in connection with our proposed transaction with Allergan; • the uncertainties associated with the acquisition and launch of new products, including, but not limited to, the acceptance and demand for new pharmaceutical products, and the impact of competitive products and pricing; • our ability to obtain components, raw materials or finished products supplied by third parties and other manufacturing and related supply difficulties, interruptions and delays; • the disruption of delivery of our products and the routine flow of manufactured goods; • the seasonality of sales of certain of our products; • declines in the pricing and sales volume of certain of our products that are distributed by third parties, over which we have no or limited control; • compliance with, or the failure to comply with, health care "fraud and abuse" laws and other extensive regulation of our marketing, promotional and pricing practices, worldwide anti-bribery laws (including the U.S. Foreign Corrupt Practices Act), worldwide environmental laws and regulation and privacy and security regulations; • the impacts of the Patient Protection and Affordable Care Act (as amended) and other legislative and regulatory healthcare reforms in the countries in which we operate; • interruptions, breakdowns or breaches in our information technology systems; and • other risks detailed from time to time in our filings with the SEC and the Canadian Securities Administrators (the "CSA"), as well as our ability to anticipate and manage the risks associated with the foregoing. Additional information about these factors and about the material factors or assumptions underlying such forward-looking statements may be found elsewhere in this MD&A, as well as under Item 1A. "Risk Factors" of the Company's Annual Report on Form 10-K for the year ended December 31, 2013, and in the Company's other filings with the SEC and CSA. We caution that the foregoing list of important factors that may affect future results is not exhaustive. When relying on our forward-looking 61 -------------------------------------------------------------------------------- statements to make decisions with respect to the Company, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. These forward-looking statements speak only as of the date made. We undertake no obligation to update any of these forward-looking statements to reflect events or circumstances after the date of this Form 10-Q or to reflect actual outcomes, except as required by law. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to our exposures to market risks as disclosed under the heading "Quantitative and Qualitative Disclosures About Market Risks" in the annual MD&A contained in the 2013 Form 10-K. Interest Rate Risk As of September 30, 2014, we had $9.7 billion and $6.7 billion principal amount of issued fixed rate debt and variable rate debt, respectively, that requires U.S. dollar repayment. The estimated fair value of our issued fixed rate debt as of September 30, 2014 was $10.1 billion. If interest rates were to increase by 100 basis-points, the fair value of our long-term debt would decrease by approximately $316.6 million. If interest rates were to decrease by 100 basis-points, the fair value of our long-term debt would increase by approximately $220.6 million. We are subject to interest rate risk on our variable rate debt as changes in interest rates could adversely affect earnings and cash flows. A 100 basis-points increase in interest rates, based on 3-month LIBOR, would have an annualized pre-tax effect of approximately $43.8 million in our consolidated statements of income (loss) and cash flows, based on current outstanding borrowings and effective interest rates on our variable rate debt. For the tranches in our credit facility that have a LIBOR floor, an increase in interest rates would only impact interest expense on those term loans to the extent LIBOR exceeds the floor. While our variable-rate debt may impact earnings and cash flows as interest rates change, it is not subject to changes in fair value. Item 4. Controls and Procedures Disclosure Controls and Procedures Our management, with the participation of our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), has evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2014. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2014. Changes in Internal Control Over Financial Reporting There were no changes in our internal controls over financial reporting that occurred during the nine-month period ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. 62-------------------------------------------------------------------------------- |