UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended June 30, 2011
OR
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¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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Commission File Number 1-10269
Allergan, Inc.
(Exact Name of Registrant as Specified in its Charter)
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Delaware
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95-1622442
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(State or Other Jurisdiction of
Incorporation or Organization)
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(I.R.S. Employer Identification No.)
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2525 Dupont Drive
Irvine, California
(Address of Principal Executive Offices)
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92612
(Zip Code)
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(714) 246-4500
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer
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x
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Accelerated filer
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¨
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Non-accelerated filer
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¨
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(Do not check if a smaller reporting company)
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Smaller reporting company
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¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
As of August 1, 2011, there were 307,511,888 shares of common stock outstanding (including 2,453,509 shares held in treasury).
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2011
INDEX
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Page
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3
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4
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5
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6
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24
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42
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46
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47
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48
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49
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50
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50
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50
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50
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51
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52
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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except per share amounts)
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Three months ended
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Six months ended
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June 30,
2011
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June 30,
2010
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June 30,
2011
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June 30,
2010
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Revenues:
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Product net sales
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$ |
1,400.4 |
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$ |
1,231.7 |
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$ |
2,653.2 |
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$ |
2,337.5 |
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Other revenues
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16.8 |
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15.5 |
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35.2 |
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64.4 |
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Total revenues
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1,417.2 |
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1,247.2 |
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2,688.4 |
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2,401.9 |
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Operating costs and expenses:
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Cost of sales (excludes amortization of acquired intangible assets)
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195.3 |
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191.3 |
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378.6 |
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361.5 |
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Selling, general and administrative
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566.7 |
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499.0 |
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1,156.2 |
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972.8 |
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Research and development
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257.4 |
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187.6 |
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455.1 |
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410.3 |
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Amortization of acquired intangible assets
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31.2 |
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37.3 |
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63.7 |
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74.4 |
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Intangible asset impairment and related costs
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3.3 |
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— |
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19.4 |
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— |
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Restructuring charges
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0.1 |
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0.1 |
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4.7 |
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0.7 |
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Operating income
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363.2 |
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331.9 |
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610.7 |
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582.2 |
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Non-operating income (expense):
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Interest income
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1.5 |
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1.2 |
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3.8 |
|
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2.5 |
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Interest expense
|
|
|
(15.2 |
) |
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|
(13.9 |
) |
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|
(39.9 |
) |
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(30.5 |
) |
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Other, net
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(5.5 |
) |
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14.3 |
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(15.4 |
) |
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11.3 |
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(19.2 |
) |
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1.6 |
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(51.5 |
) |
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(16.7 |
) |
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Earnings before income taxes
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344.0 |
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333.5 |
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559.2 |
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565.5 |
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Provision for income taxes
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95.4 |
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92.0 |
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151.8 |
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155.0 |
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Net earnings
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248.6 |
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241.5 |
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407.4 |
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410.5 |
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Net earnings attributable to noncontrolling interest
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2.0 |
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1.4 |
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2.5 |
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2.5 |
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Net earnings attributable to Allergan, Inc.
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$ |
246.6 |
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$ |
240.1 |
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$ |
404.9 |
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$ |
408.0 |
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Earnings per share attributable to Allergan, Inc. stockholders:
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Basic
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$ |
0.81 |
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$ |
0.79 |
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$ |
1.33 |
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$ |
1.34 |
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Diluted
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$ |
0.79 |
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$ |
0.78 |
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$ |
1.30 |
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$ |
1.33 |
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See accompanying notes to unaudited condensed consolidated financial statements.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
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|
June 30,
2011
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December 31,
2010
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ASSETS
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Current assets:
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Cash and equivalents
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$ |
1,856.5 |
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$ |
1,991.2 |
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Short-term investments
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299.8 |
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749.1 |
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Trade receivables, net
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744.2 |
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647.3 |
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Inventories
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242.4 |
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229.4 |
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Other current assets
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449.7 |
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376.7 |
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Total current assets
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3,592.6 |
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3,993.7 |
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Investments and other assets
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|
261.6 |
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261.4 |
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Deferred tax assets
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|
249.2 |
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|
217.8 |
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Property, plant and equipment, net
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|
|
795.1 |
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|
800.6 |
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Goodwill
|
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|
2,050.7 |
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|
2,038.6 |
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Intangibles, net
|
|
|
930.4 |
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|
996.0 |
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Total assets
|
|
$ |
7,879.6 |
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|
$ |
8,308.1 |
|
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LIABILITIES AND EQUITY
|
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Current liabilities:
|
|
|
|
|
|
|
|
|
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Notes payable
|
|
$ |
76.1 |
|
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$ |
28.1 |
|
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Convertible notes
|
|
|
— |
|
|
|
642.5 |
|
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Accounts payable
|
|
|
200.3 |
|
|
|
222.5 |
|
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Accrued compensation
|
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|
170.9 |
|
|
|
182.4 |
|
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Other accrued expenses
|
|
|
474.2 |
|
|
|
436.8 |
|
|
Income taxes
|
|
|
— |
|
|
|
16.1 |
|
|
Total current liabilities
|
|
|
921.5 |
|
|
|
1,528.4 |
|
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Long-term debt
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1,510.3 |
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1,534.2 |
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Other liabilities
|
|
|
459.1 |
|
|
|
464.4 |
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Commitments and contingencies
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Equity:
|
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|
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Allergan, Inc. stockholders’ equity:
|
|
|
|
|
|
|
|
|
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Preferred stock, $.01 par value; authorized 5,000,000 shares; none issued
|
|
|
— |
|
|
|
— |
|
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Common stock, $.01 par value; authorized 500,000,000 shares; issued 307,512,000 shares as of June 30, 2011 and December 31, 2010
|
|
|
3.1 |
|
|
|
3.1 |
|
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Additional paid-in capital
|
|
|
2,702.4 |
|
|
|
2,815.5 |
|
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Accumulated other comprehensive loss
|
|
|
(100.3 |
) |
|
|
(152.9 |
) |
|
Retained earnings
|
|
|
2,530.3 |
|
|
|
2,225.9 |
|
| |
|
|
5,135.5 |
|
|
|
4,891.6 |
|
|
Less treasury stock, at cost (2,210,000 shares as of June 30, 2011 and 1,987,000 shares as of December 31, 2010)
|
|
|
(171.6 |
) |
|
|
(133.9 |
) |
|
Total stockholders’ equity
|
|
|
4,963.9 |
|
|
|
4,757.7 |
|
|
Noncontrolling interest
|
|
|
24.8 |
|
|
|
23.4 |
|
|
Total equity
|
|
|
4,988.7 |
|
|
|
4,781.1 |
|
|
Total liabilities and equity
|
|
$ |
7,879.6 |
|
|
$ |
8,308.1 |
|
See accompanying notes to unaudited condensed consolidated financial statements.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
| |
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
Net earnings
|
|
$ |
407.4 |
|
|
$ |
410.5 |
|
|
Non-cash items included in net earnings:
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
125.9 |
|
|
|
132.6 |
|
|
Amortization of original issue discount and debt issuance costs
|
|
|
8.8 |
|
|
|
13.9 |
|
|
Amortization of net realized gain on interest rate swap
|
|
|
(0.7 |
) |
|
|
(0.7 |
) |
|
Deferred income tax benefit
|
|
|
(44.2 |
) |
|
|
(5.9 |
) |
|
(Gain) loss on disposal and impairment of assets
|
|
|
(2.1 |
) |
|
|
0.7 |
|
|
Unrealized loss (gain) on derivative instruments
|
|
|
4.8 |
|
|
|
(8.2 |
) |
|
Expense of share-based compensation plans
|
|
|
41.9 |
|
|
|
35.3 |
|
|
Intangible asset impairment
|
|
|
16.1 |
|
|
|
— |
|
|
Expense from changes in fair value of contingent consideration
|
|
|
2.3 |
|
|
|
— |
|
|
Restructuring charges
|
|
|
4.7 |
|
|
|
0.7 |
|
|
Gain on investments, net
|
|
|
(0.9 |
) |
|
|
— |
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Trade receivables
|
|
|
(79.8 |
) |
|
|
(47.9 |
) |
|
Inventories
|
|
|
(5.2 |
) |
|
|
8.4 |
|
|
Other current assets
|
|
|
(12.5 |
) |
|
|
14.6 |
|
|
Other non-current assets
|
|
|
(6.5 |
) |
|
|
(2.5 |
) |
|
Accounts payable
|
|
|
(29.0 |
) |
|
|
(22.2 |
) |
|
Accrued expenses
|
|
|
2.8 |
|
|
|
1.5 |
|
|
Income taxes
|
|
|
(67.9 |
) |
|
|
0.7 |
|
|
Other liabilities
|
|
|
15.4 |
|
|
|
(20.2 |
) |
|
Net cash provided by operating activities
|
|
|
381.3 |
|
|
|
511.3 |
|
| |
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Purchases of short-term investments
|
|
|
(324.8 |
) |
|
|
— |
|
|
Acquisitions, net of cash acquired
|
|
|
(7.0 |
) |
|
|
(63.7 |
) |
|
Additions to property, plant and equipment
|
|
|
(46.3 |
) |
|
|
(30.0 |
) |
|
Additions to capitalized software
|
|
|
(6.1 |
) |
|
|
(6.7 |
) |
|
Contractual purchase price adjustment to prior acquisition
|
|
|
— |
|
|
|
(1.7 |
) |
|
Proceeds from maturities of short-term investments
|
|
|
774.1 |
|
|
|
— |
|
|
Proceeds from sale of investments
|
|
|
0.9 |
|
|
|
— |
|
|
Proceeds from sale of property, plant and equipment
|
|
|
0.8 |
|
|
|
— |
|
|
Net cash provided by (used in) investing activities
|
|
|
391.6 |
|
|
|
(102.1 |
) |
| |
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Repayments of convertible borrowings
|
|
|
(808.9 |
) |
|
|
— |
|
|
Dividends to stockholders
|
|
|
(30.6 |
) |
|
|
(30.3 |
) |
|
Payments to acquire treasury stock
|
|
|
(299.0 |
) |
|
|
(135.7 |
) |
|
Payments of contingent consideration
|
|
|
(3.0 |
) |
|
|
— |
|
|
Net borrowings (repayments) of notes payable
|
|
|
22.9 |
|
|
|
(8.4 |
) |
|
Sale of stock to employees
|
|
|
178.2 |
|
|
|
56.8 |
|
|
Excess tax benefits from share-based compensation
|
|
|
17.7 |
|
|
|
1.0 |
|
|
Net cash used in financing activities
|
|
|
(922.7 |
) |
|
|
(116.6 |
) |
| |
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and equivalents
|
|
|
15.1 |
|
|
|
(20.1 |
) |
|
Net (decrease) increase in cash and equivalents
|
|
|
(134.7 |
) |
|
|
272.5 |
|
|
Cash and equivalents at beginning of period
|
|
|
1,991.2 |
|
|
|
1,947.1 |
|
|
Cash and equivalents at end of period
|
|
$ |
1,856.5 |
|
|
$ |
2,219.6 |
|
| |
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information
|
|
|
|
|
|
|
|
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
|
Interest (net of amount capitalized)
|
|
$ |
34.3 |
|
|
$ |
24.2 |
|
|
Income taxes, net of refunds
|
|
$ |
237.8 |
|
|
$ |
161.9 |
|
See accompanying notes to unaudited condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation
In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary (consisting only of normal recurring accruals) to present fairly the financial information contained therein. These statements do not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP) for annual periods and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2010. The Company prepared the unaudited condensed consolidated financial statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted. The results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011 or any other period(s).
Reclassifications
Certain reclassifications of prior year amounts have been made to conform with the current year presentation.
Recently Adopted Accounting Standards
In December 2010, the Financial Accounting Standards Board (FASB) issued an accounting standards update that provides guidance on the recognition and classification of the annual fee imposed by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Affordability Reconciliation Act on pharmaceutical companies that sell branded prescription drugs or biologics to specified government programs in the United States. Under this guidance, the annual fee should be estimated and recognized in full as a liability upon the first qualifying sale with a corresponding deferred cost that is amortized to operating expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year in which it is payable. The annual fee ranges from $2.5 billion to $4.1 billion for all affected entities in total, a portion of which will be allocated to the Company on the basis of the amount of its branded prescription drug sales for the preceding year as a percentage of the industry’s branded prescription drug sales for the same period. The annual fee is not deductible for federal income tax purposes. This guidance became effective for calendar years beginning after December 31, 2010. The Company adopted the provisions of the guidance in the first quarter of 2011 and currently estimates the annual fee for 2011 to be approximately $20.4 million.
In December 2010, the FASB issued an accounting standards update that requires an entity to perform Step 2 of the goodwill impairment test for its reporting units with a zero or a negative carrying amount if there are qualitative factors indicating that it is more likely than not that a goodwill impairment exists. This guidance became effective for fiscal years beginning after December 15, 2010 and was applied as a change in accounting principle with any impairment recorded as a cumulative-effect adjustment to beginning retained earnings. The Company adopted the provisions of the guidance in the first quarter of 2011. The adoption did not have a material impact on the Company’s consolidated financial statements.
In December 2010, the FASB issued an accounting standards update that requires an entity to disclose pro forma revenue and earnings of the combined entity for both the year in which a business combination occurred and the prior year as if the business combination had occurred as of the beginning of prior year only. This guidance became effective prospectively for business combinations occurring in fiscal years beginning after December 15, 2010. The Company adopted the provisions of the guidance in the first quarter of 2011. The adoption did not have a material impact on the Company’s consolidated financial statements.
In April 2010, the FASB issued an accounting standards update that provides guidance on the milestone method of revenue recognition for research and development arrangements. This guidance allows an entity to make an accounting policy election to recognize revenue that is contingent upon the achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. This guidance became effective for fiscal years beginning on or after June 15, 2010 and may be applied prospectively to milestones achieved after the adoption date or retrospectively for all periods presented, with earlier application permitted. The Company made an accounting policy election to apply the guidance prospectively beginning in the first quarter of 2011 to recognize revenue in its entirety in the period in which a substantive milestone is achieved. The adoption did not have a material impact on the Company’s consolidated financial statements. As of June 30, 2011, the Company has potential future milestone receipts of approximately $473.0 million for the achievement of development, regulatory, and sales milestones in connection with certain collaboration agreements, including $373.0 million related to a development and commercialization agreement that the Company entered into in 2010 with Bristol-Myers Squibb Company that granted Bristol-Myers Squibb Company exclusive worldwide rights to develop, manufacture and commercialize an investigational drug for neuropathic pain. Due to the challenges associated with developing and obtaining
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
approval for pharmaceutical products, there is substantial uncertainty whether any of the future milestones will be achieved. The Company evaluates whether milestone payments are substantive based on the facts and circumstances associated with each milestone payment.
In October 2009, the FASB issued an accounting standards update that requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices, eliminates the use of the residual method of allocation, and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue of an arrangement with multiple deliverables. This guidance became effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. The Company adopted the provisions of the guidance in the first quarter of 2011. The adoption did not have a material impact on the Company’s consolidated financial statements.
New Accounting Standards Not Yet Adopted
In June 2011, the FASB issued an accounting standards update that eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires an entity to present items of net income and other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance also requires an entity to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. This guidance will be effective for fiscal years beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued an accounting standards update that clarifies and amends the existing fair value measurement and disclosure requirements. This guidance will be effective prospectively for interim and annual periods beginning after December 15, 2011, which will be the Company’s fiscal year 2012, with early adoption prohibited. The Company does not expect the adoption of the guidance will have a material impact on the Company’s consolidated financial statements.
Note 2: Acquisitions and Collaborations
Purchase of Distributor’s Business in Turkey
On July 1, 2010, the Company terminated its existing distributor agreement in Turkey and completed the purchase from its distributor of all licenses, registrations and other assets related to the selling of the Company’s products in Turkey. Additionally, former employees of the distributor who were primarily engaged in the selling and marketing of the Company’s products were transferred to the Company on that date. The termination of the existing distributor agreement and purchase of the commercial assets enabled the Company to initiate direct selling operations in Turkey.
In conjunction with the termination of the existing distributor agreement, the Company paid $33.0 million, including a termination fee and related taxes, which was included in selling, general and administrative (SG&A) expenses in the third quarter of 2010. The purchase of the commercial assets was accounted for as a business combination. In connection with the purchase of the assets, the Company paid $6.1 million and is required to pay additional contingent consideration based on specified percentages of revenue in Turkey over a five year period from the acquisition date. The estimated fair value of the contingent consideration as of the acquisition date was $36.7 million. The Company recognized goodwill of $31.5 million and intangible assets of $11.3 million based on their estimated fair values at the purchase date. No liabilities were assumed in connection with the purchase. During the three and six month periods ended June 30, 2011, the Company recognized $2.3 million of expense related to the change in the estimated fair value of the contingent consideration liability, which is included in SG&A expenses. During the six month period ended June 30, 2011, the Company made contingent consideration payments of $3.0 million. As of June 30, 2011, the total estimated fair value of the contingent consideration was $41.8 million, of which $5.1 million was included in “Accounts payable” and $36.7 million was included in “Other liabilities.”
Serica Acquisition
On January 15, 2010, the Company completed the acquisition of Serica Technologies, Inc. (Serica), a development stage medical device company based in the United States focused on developing biodegradable silk-based scaffolds for use in tissue reinforcement, for an aggregate purchase price of approximately $63.7 million, net of cash acquired. In connection with the acquisition, the Company acquired assets with a fair value of $96.0 million and assumed liabilities of
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
$32.3 million. The acquisition was funded from the Company’s cash and equivalents balances. The Serica acquisition provides the Company with an approved technology that has potential future application in a variety of medical device applications.
Alacer Acquisition
On June 17, 2011, the Company completed the acquisition of Alacer Biomedical, Inc. (Alacer), a development stage medical device company focused on tissue reinforcement, for an aggregate purchase price of approximately $7.0 million, net of cash acquired. In connection with the acquisition, the Company acquired assets with a fair value of $12.3 million, consisting of goodwill of $3.3 million and intangible assets of $9.0 million, and assumed liabilities of $5.3 million, consisting of accrued liabilities of $2.0 million and non-current deferred tax liabilities of $3.3 million.
Collaborations
In March 2010, the Company and Serenity Pharmaceuticals, LLC (Serenity) entered into an agreement for the license, development and commercialization of a Phase III investigational drug currently in clinical development for the treatment of nocturia, a common urological disorder in adults characterized by frequent urination at night time. Under the terms of the agreement, the Company receives exclusive worldwide rights to develop, manufacture and commercialize the investigational drug for all potential indications except primary nocturnal enuresis (pediatric bedwetting). In conjunction with the agreement, the Company made an upfront payment to Serenity of $43.0 million in 2010. The terms of the agreement also include potential future development and regulatory milestone payments to Serenity of up to $122.0 million, as well as potential future sales milestone and royalty payments. Because the technology has not yet achieved regulatory approval, the Company recorded the upfront payment of $43.0 million as research and development (R&D) expense in the first quarter of 2010.
In December 2010, the Company and Serenity executed a letter agreement which specified certain terms and conditions governing additional development activities for a new Phase III trial which were not set forth in the original agreement. Under the letter agreement, the Company has agreed to share 50% of the cost of additional development activities. The execution of the letter agreement was a reconsideration event for the Company’s variable interest in the collaboration agreement with Serenity, and since the Company is providing a significant amount of the funding for the new Phase III trial, it determined that Serenity had become a variable interest entity (VIE). However, the Company determined that it is not the primary beneficiary of the VIE because it does not possess the power to direct Serenity’s research and development activities, which are the activities that most significantly impact Serenity’s economic performance. The Company’s maximum exposure to loss is the upfront payment of $43.0 million made to Serenity and any shared costs of additional development activities.
On January 28, 2011, the Company entered into a collaboration agreement and a co-promotion agreement with MAP Pharmaceuticals, Inc. (MAP) for the exclusive development and commercialization by the Company and MAP of Levadex® within the United States to certain headache specialist physicians for the acute treatment of migraine in adults, migraine in adolescents and other indications that may be approved by the parties. Levadex® is a self-administered, orally inhaled therapy consisting of a proprietary formulation of dihydroergotamine delivered using MAP’s proprietary Tempo® delivery system, which has completed Phase III clinical development for the acute treatment of migraine in adults. MAP submitted its New Drug Application for Levadex® to the United States Food and Drug Administration (FDA) in May 2011, which the FDA accepted in August 2011. Under the terms of the agreements, the Company made a $60.0 million upfront payment to MAP in February 2011, which was recorded as SG&A expense in the first quarter of 2011. The upfront payment was expensed because Levadex® has not yet achieved regulatory approval. The terms of the agreements also include up to $97.0 million in additional payments to MAP upon MAP meeting certain development and regulatory milestones. If Levadex® receives FDA approval, the Company and MAP will equally share profits from sales of Levadex® generated from its commercialization to neurologists and pain specialists in the United States.
On May 4, 2011, the Company announced a license agreement with Molecular Partners AG pursuant to which the Company obtained exclusive global rights in the field of ophthalmology for MP0112, a Phase II proprietary therapeutic DARPin® protein targeting vascular endothelial growth factor receptors under investigation for the treatment of retinal diseases. Under the terms of the agreement, the Company made a $45.0 million upfront payment to Molecular Partners AG in May 2011, which was recorded as R&D expense in the second quarter of 2011. The terms of the agreement also include potential future development, regulatory and sales milestone payments to Molecular Partners AG of up to $375.0 million, as well as potential future royalty payments.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 3: Restructuring Charges and Integration Costs
Discontinued Development of EasyBand™
In March 2011, the Company decided to discontinue development of the EasyBand™ Remote Adjustable Gastric Band System (EasyBand™), a technology that the Company acquired in connection with its 2007 acquisition of EndoArt SA, and close the related research and development facility in Switzerland.
As a result of discontinuing the development of EasyBand™ and the closure of the related research and development facility, in the first quarter of 2011 the Company recorded a pre-tax impairment charge of $16.1 million for the intangible assets associated with the EasyBand™ technology, fixed asset impairment charges of $2.3 million and a gain of $9.4 million from the substantially complete liquidation of the Company’s investment in a foreign subsidiary. In addition, the Company recorded $4.6 million of restructuring charges, consisting of $3.0 million of employee severance and other one-time termination benefits for approximately 30 people affected by the facility closure, $1.5 million of contract termination costs and $0.1 million of other related costs. In the second quarter of 2011, the Company recorded an additional $0.1 million of restructuring charges primarily related to contract termination costs and a reversal of fixed asset impairment charges of $0.1 million.
Other Restructuring Activities and Integration Costs
The Company did not incur any other restructuring charges during the three and six month periods ended June 30, 2011.
Included in the three and six month periods ended June 30, 2010 are $0.4 million and $0.8 million, respectively, of restructuring charges primarily for employee severance related to the Serica acquisition. Included in the three and six month periods ended June 30, 2010 are a $0.3 million restructuring charge reversal primarily for employee severance, one-time termination benefits and contract termination costs related to the Company’s closure of its breast implant manufacturing facility in Arklow, Ireland. Included in the six month period ended June 30, 2010 are $0.1 million of restructuring charges primarily for employee severance and other one-time termination benefits related to the Company’s fiscal year 2009 restructuring plan and $0.1 million of restructuring charges for an abandoned leased facility related to the Company’s fiscal year 2005 restructuring and streamlining of its European operations.
Included in the three and six month periods ended June 30, 2011 are $0.6 million and $1.6 million, respectively, of SG&A expenses related to transaction and integration costs associated with the purchase of various businesses, licensing agreements and collaboration and co-promotion agreements. Included in the three and six month periods ended June 30, 2010 are $0.5 million and $1.5 million, respectively, of SG&A expenses related to transaction and integration costs associated with the purchase of various businesses and a license, development and commercialization agreement.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 4: Intangibles and Goodwill
Intangibles
At June 30, 2011 and December 31, 2010, the components of intangibles and certain other related information were as follows:
| |
|
June 30, 2011
|
|
|
December 31, 2010
|
|
| |
|
Gross
Amount
|
|
|
Accumulated
Amortization
|
|
|
Weighted
Average
Amortization
Period
|
|
|
Gross
Amount
|
|
|
Accumulated
Amortization
|
|
|
Weighted
Average
Amortization
Period
|
|
| |
|
(in millions)
|
|
|
(in years)
|
|
|
(in millions)
|
|
|
(in years)
|
|
|
Amortizable Intangible Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Developed technology
|
|
$ |
1,119.5 |
|
|
$ |
(396.0 |
) |
|
|
13.4 |
|
|
$ |
1,129.6 |
|
|
$ |
(353.2 |
) |
|
|
13.4 |
|
|
Customer relationships
|
|
|
42.3 |
|
|
|
(42.3 |
) |
|
|
3.1 |
|
|
|
42.3 |
|
|
|
(42.3 |
) |
|
|
3.1 |
|
|
Licensing
|
|
|
185.8 |
|
|
|
(127.1 |
) |
|
|
9.3 |
|
|
|
185.6 |
|
|
|
(116.7 |
) |
|
|
9.3 |
|
|
Trademarks
|
|
|
27.7 |
|
|
|
(25.5 |
) |
|
|
6.3 |
|
|
|
27.4 |
|
|
|
(24.2 |
) |
|
|
6.3 |
|
|
Core technology
|
|
|
185.9 |
|
|
|
(67.0 |
) |
|
|
15.1 |
|
|
|
189.6 |
|
|
|
(61.5 |
) |
|
|
15.2 |
|
|
Other
|
|
|
16.8 |
|
|
|
(3.0 |
) |
|
|
9.0 |
|
|
|
17.0 |
|
|
|
(1.9 |
) |
|
|
9.1 |
|
| |
|
|
1,578.0 |
|
|
|
(660.9 |
) |
|
|
12.7 |
|
|
|
1,591.5 |
|
|
|
(599.8 |
) |
|
|
12.7 |
|
|
Unamortizable Intangible Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
|
13.3 |
|
|
|
— |
|
|
|
|
|
|
|
4.3 |
|
|
|
— |
|
|
|
|
|
| |
|
$ |
1,591.3 |
|
|
$ |
(660.9 |
) |
|
|
|
|
|
$ |
1,595.8 |
|
|
$ |
(599.8 |
) |
|
|
|
|
Developed technology consists primarily of current product offerings, primarily breast aesthetics products, obesity intervention products, dermal fillers, skin care products and eye care products acquired in connection with business combinations, asset acquisitions and initial licensing transactions for products previously approved for marketing. Customer relationship assets consist of the estimated value of relationships with customers acquired in connection with the Company’s 2006 acquisition of Inamed Corporation (Inamed), primarily in the breast implant market in the United States. Licensing assets consist primarily of capitalized payments to third party licensors related to the achievement of regulatory approvals to commercialize products in specified markets and up-front payments associated with royalty obligations for products that have achieved regulatory approval for marketing. Core technology consists of proprietary technology associated with silicone gel breast implants, gastric bands and intragastric balloon systems acquired in connection with the Inamed acquisition, dermal filler technology acquired in connection with the Company’s 2007 acquisition of Groupe Cornéal Laboratoires, and a drug delivery technology acquired in connection with the Company’s 2003 acquisition of Oculex Pharmaceuticals, Inc. Other intangible assets consist primarily of acquired product registration rights, distributor relationships, government permits and non-compete agreements. The in-process research and development assets consist of a tissue reinforcement technology that has not yet achieved regulatory approval acquired in connection with the Company’s 2010 acquisition of Serica and an intangible asset associated with technology that is not yet commercialized acquired in connection with the Company’s acquisition of Alacer in June 2011.
In the first quarter of 2011, the Company recorded a pre-tax charge of $16.1 million related to the impairment of the developed technology and core technology associated with EasyBand™ as a result of the discontinued development of the technology.
The following table provides amortization expense by major categories of acquired amortizable intangible assets for the three and six month periods ended June 30, 2011 and 2010, respectively:
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Developed technology
|
|
$ |
22.4 |
|
|
$ |
26.8 |
|
|
$ |
45.0 |
|
|
$ |
53.4 |
|
|
Customer relationships
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
0.3 |
|
|
Licensing
|
|
|
5.1 |
|
|
|
6.1 |
|
|
|
10.2 |
|
|
|
11.9 |
|
|
Trademarks
|
|
|
0.1 |
|
|
|
1.1 |
|
|
|
1.2 |
|
|
|
2.2 |
|
|
Core technology
|
|
|
3.1 |
|
|
|
3.1 |
|
|
|
6.3 |
|
|
|
6.2 |
|
|
Other
|
|
|
0.5 |
|
|
|
0.2 |
|
|
|
1.0 |
|
|
|
0.4 |
|
| |
|
$ |
31.2 |
|
|
$ |
37.3 |
|
|
$ |
63.7 |
|
|
$ |
74.4 |
|
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Amortization expense related to acquired intangible assets generally benefits multiple business functions within the Company, such as the Company’s ability to sell, manufacture, research, market and distribute products, compounds and intellectual property. The amount of amortization expense excluded from cost of sales consists primarily of amounts amortized with respect to developed technology and licensing intangible assets.
Estimated amortization expense is $126.4 million for 2011, $120.5 million for 2012, $106.3 million for 2013, $101.3 million for 2014 and $96.2 million for 2015.
Goodwill
Changes in the carrying amount of goodwill by operating segment through June 30, 2011 were as follows:
| |
|
Specialty
Pharmaceuticals
|
|
|
Medical
Devices
|
|
|
Total
|
|
| |
|
(in millions)
|
|
|
Balance at December 31, 2010
|
|
$ |
106.4 |
|
|
$ |
1,932.2 |
|
|
$ |
2,038.6 |
|
|
Alacer acquisition
|
|
|
— |
|
|
|
3.3 |
|
|
|
3.3 |
|
|
Foreign exchange translation effects
|
|
|
0.2 |
|
|
|
8.6 |
|
|
|
8.8 |
|
|
Balance at June 30, 2011
|
|
$ |
106.6 |
|
|
$ |
1,944.1 |
|
|
$ |
2,050.7 |
|
Note 5: Inventories
Components of inventories were:
| |
|
June 30,
2011
|
|
|
December 31,
2010
|
|
| |
|
(in millions)
|
|
|
Finished products
|
|
$ |
160.6 |
|
|
$ |
148.2 |
|
|
Work in process
|
|
|
31.3 |
|
|
|
41.1 |
|
|
Raw materials
|
|
|
50.5 |
|
|
|
40.1 |
|
|
Total
|
|
$ |
242.4 |
|
|
$ |
229.4 |
|
At June 30, 2011 and December 31, 2010, approximately $7.3 million and $6.4 million, respectively, of the Company’s finished goods inventories, primarily breast implants, were held on consignment at a large number of doctors’ offices, clinics and hospitals worldwide. The value and quantity at any one location are not significant.
Note 6: Convertible Notes
In 2006, the Company issued its 1.50% Convertible Senior Notes due 2026 (2026 Convertible Notes) for an aggregate principal amount of $750.0 million. The 2026 Convertible Notes were unsecured and paid interest semi-annually on the principal amount of the notes at a rate of 1.50% per annum. The 2026 Convertible Notes were scheduled to mature on April 1, 2026, unless previously redeemed by the Company or earlier converted by the note holders. The Company was permitted to redeem the 2026 Convertible Notes at the principal amount plus accrued interest at any time on or after April 5, 2011.
The 2026 Convertible Notes were convertible into cash and, if applicable, shares of the Company’s common stock based on a conversion rate of 15.7904 shares of the Company’s common stock per $1,000 principal amount of the 2026 Convertible Notes if the Company’s stock price reached certain specified thresholds or the Company called the 2026 Convertible Notes for redemption. The Company separately measured and accounted for the liability and equity components of the 2026 Convertible Notes.
In the first quarter of 2009, the Company paid $98.3 million to repurchase $100.3 million principal amount of the 2026 Convertible Notes. On March 8, 2011, the Company announced its intention to redeem the remaining 2026 Convertible Notes at the principal amount plus accrued interest on April 5, 2011. Most note holders elected to exercise the conversion feature of the 2026 Convertible Notes prior to redemption. Pursuant to the terms of the 2026 Convertible Notes, the Company elected to pay the full conversion value in cash. The conversion value of a note was based on an average of the daily closing price of the Company’s stock over an averaging period that commenced after the Company received a conversion notice from a note holder. The Company paid approximately $800.3 million in aggregate conversion value for the converted notes at the end of the applicable averaging periods in May 2011. The difference between the amount paid and the principal amount of the converted notes of $641.1 million was recognized as a decrease to additional paid-in capital. In addition, on April 5, 2011 the Company redeemed notes with a principal amount of $8.6 million that were not converted.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 7: Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally less than the U.S. federal statutory rate, primarily because of lower tax rates in certain non-U.S. jurisdictions, R&D tax credits available in the United States, California and other foreign jurisdictions and deductions available in the United States for domestic production activities. The effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pre-tax earnings in the various tax jurisdictions in which the Company operates, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, expected utilization of R&D tax credits and changes in or the interpretation of tax laws in jurisdictions where the Company conducts business. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of its assets and liabilities along with net operating loss and tax credit carryovers.
The Company records a valuation allowance against its deferred tax assets to reduce the net carrying value to an amount that it believes is more likely than not to be realized. When the Company establishes or reduces the valuation allowance against its deferred tax assets, the provision for income taxes will increase or decrease, respectively, in the period such determination is made. The valuation allowance against deferred tax assets was $23.8 million and $4.3 million as of June 30, 2011 and December 31, 2010, respectively. The increase in the valuation allowance was primarily due to a corresponding increase in a deferred tax asset that the Company determined required a valuation allowance.
The total amount of unrecognized tax benefits was $39.3 million and $32.5 million as of June 30, 2011 and December 31, 2010, respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $33.6 million and $27.5 million as of June 30, 2011 and December 31, 2010, respectively. The Company expects that during the next 12 months it is reasonably possible that unrecognized tax benefit liabilities will decrease by approximately $7.0 million to $9.0 million due to the settlement of income tax audits in the United States and certain foreign jurisdictions.
Total interest accrued related to uncertainty in income taxes included in the Company’s unaudited condensed consolidated balance sheet was $8.1 million as of June 30, 2011 and December 31, 2010.
The Company has not provided for withholding and U.S. taxes for the unremitted earnings of certain non-U.S. subsidiaries because it has currently reinvested these earnings indefinitely in these foreign operations. At December 31, 2010, the Company had approximately $2,109.4 million in unremitted earnings outside the United States for which withholding and U.S. taxes were not provided. Income tax expense would be incurred if these funds were remitted to the United States. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against the Company’s U.S. tax liability, if any. The Company annually updates its estimate of unremitted earnings outside the United States after the completion of each fiscal year.
Note 8: Share-Based Compensation
The Company recognizes compensation expense for all share-based awards made to employees and directors. The fair value of share-based awards is estimated at the grant date using the Black-Scholes option-pricing model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period using the straight-line single option method. The fair value of modifications to share-based awards is generally estimated using a lattice model.
The determination of fair value using the Black-Scholes and lattice option-pricing models is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors. The Company currently estimates stock price volatility based upon an equal weighting of the historical average over the expected life of the award and the average implied volatility of at-the-money options traded in the open market. The Company estimates employee stock option exercise behavior based on actual historical exercise activity and assumptions regarding future exercise activity of unexercised, outstanding options.
Share-based compensation expense is recognized only for those awards that are ultimately expected to vest, and the Company has applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
For the three and six month periods ended June 30, 2011 and 2010, share-based compensation expense was as follows:
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Cost of sales
|
|
$ |
1.4 |
|
|
$ |
1.1 |
|
|
$ |
2.9 |
|
|
$ |
2.2 |
|
|
Selling, general and administrative
|
|
|
14.3 |
|
|
|
11.7 |
|
|
|
27.9 |
|
|
|
24.6 |
|
|
Research and development
|
|
|
5.4 |
|
|
|
4.3 |
|
|
|
11.1 |
|
|
|
8.5 |
|
|
Pre-tax share-based compensation expense
|
|
|
21.1 |
|
|
|
17.1 |
|
|
|
41.9 |
|
|
|
35.3 |
|
|
Income tax benefit
|
|
|
6.7 |
|
|
|
5.6 |
|
|
|
14.1 |
|
|
|
11.2 |
|
|
Net share-based compensation expense
|
|
$ |
14.4 |
|
|
$ |
11.5 |
|
|
$ |
27.8 |
|
|
$ |
24.1 |
|
As of June 30, 2011, total compensation cost related to non-vested stock options and restricted stock not yet recognized was approximately $201.8 million, which is expected to be recognized over the next 48 months (35 months on a weighted-average basis). The Company has not capitalized as part of inventory any share-based compensation costs because such costs were negligible as of June 30, 2011.
Note 9: Employee Retirement and Other Benefit Plans
The Company sponsors various qualified defined benefit pension plans covering a substantial portion of its employees. In addition, the Company sponsors two supplemental nonqualified plans covering certain management employees and officers and one retiree health plan covering U.S. retirees and dependents.
Components of net periodic benefit cost for the three and six month periods ended June 30, 2011 and 2010, respectively, were as follows:
| |
|
Three months ended
|
|
| |
|
Pension Benefits
|
|
|
Other Postretirement Benefits
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Service cost
|
|
$ |
6.0 |
|
|
$ |
5.0 |
|
|
$ |
0.5 |
|
|
$ |
0.5 |
|
|
Interest cost
|
|
|
10.7 |
|
|
|
9.7 |
|
|
|
0.8 |
|
|
|
0.9 |
|
|
Expected return on plan assets
|
|
|
(11.1 |
) |
|
|
(11.5 |
) |
|
|
— |
|
|
|
— |
|
|
Amortization of prior service costs
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Recognized net actuarial losses
|
|
|
4.3 |
|
|
|
2.6 |
|
|
|
0.2 |
|
|
|
0.2 |
|
|
Net periodic benefit cost
|
|
$ |
9.9 |
|
|
$ |
5.8 |
|
|
$ |
1.5 |
|
|
$ |
1.6 |
|
| |
|
Six months ended
|
|
| |
|
Pension Benefits
|
|
|
Other Postretirement Benefits
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Service cost
|
|
$ |
12.0 |
|
|
$ |
10.1 |
|
|
$ |
1.1 |
|
|
$ |
1.1 |
|
|
Interest cost
|
|
|
21.4 |
|
|
|
19.5 |
|
|
|
1.6 |
|
|
|
1.7 |
|
|
Expected return on plan assets
|
|
|
(22.2 |
) |
|
|
(23.1 |
) |
|
|
— |
|
|
|
— |
|
|
Amortization of prior service costs
|
|
|
— |
|
|
|
— |
|
|
|
(0.1 |
) |
|
|
(0.1 |
) |
|
Recognized net actuarial losses
|
|
|
8.6 |
|
|
|
5.1 |
|
|
|
0.4 |
|
|
|
0.5 |
|
|
Net periodic benefit cost
|
|
$ |
19.8 |
|
|
$ |
11.6 |
|
|
$ |
3.0 |
|
|
$ |
3.2 |
|
In 2011, the Company expects to pay contributions of between $35.0 million and $45.0 million for its U.S. and non-U.S. pension plans and between $1.0 million and $2.0 million for its other postretirement plan.
In June 2011, the Company amended its U.S. retiree health plan to incorporate health reimbursement arrangement accounts, transition plan participants to individual plans, and cap future medical premium subsidies. In connection with the amendment, the Company remeasured its retiree health plan liability resulting in a reduction of accrued benefit costs associated with the plan of $20.5 million, a decrease in related deferred tax assets of $7.4 million, and an increase in net other comprehensive income of $13.1 million.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 10: Legal Proceedings
The following supplements and amends the discussion set forth in Note 10 “Legal Proceedings” in the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011 and in Note 13 “Legal Proceedings” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and is limited to certain recent developments concerning the Company’s legal proceedings.
Kramer et al. v. Allergan, Inc.
In June 2011, the Company reached a settlement with plaintiff Doolittle.
Stockholder Derivative Litigation
Louisiana Municipal Police Employees’ Retirement System Action
In June 2011, the court ordered that U.F.C.W. Local 1776 & Participating Employers Pension Fund (U.F.C.W.) may intervene in this action. In July 2011, Louisiana Municipal Police Employees’ Retirement System (LMPERS) and U.F.C.W. filed a second amended complaint. In July 2011, the Company filed a motion to dismiss the second amended complaint.
U.F.C.W. Local 1776 & Participating Employers Pension Fund Action
In April 2011, the court ordered that the Company produce a limited number of documents to the court for in camera inspection, which the Company did. In April 2011, the court ordered that the Company produce a limited number of documents to U.F.C.W., which the Company did in May 2011. In May 2011, U.F.C.W. filed a request for the production of additional documents. In May 2011, the court denied U.F.C.W.’s request and held that these proceedings were concluded.
Pompano Beach Police & Firefighters’ Retirement System Action
In April 2011, the court granted the motions to dismiss the consolidated complaint with leave to amend. In April 2011, the Company filed a request to withdraw the motion for partial stay of the consolidated action, which the court granted. In July 2011, the plaintiffs filed a first amended verified consolidated complaint.
The Company is involved in various other lawsuits and claims arising in the ordinary course of business. These other matters are, in the opinion of management, immaterial both individually and in the aggregate with respect to the Company’s consolidated financial position, liquidity or results of operations. Because of the uncertainties related to the incurrence, amount and range of loss on any pending litigation, investigation, inquiry or claim, management is currently unable to predict the ultimate outcome of any litigation, investigation, inquiry or claim, determine whether a liability has been incurred or make an estimate of the reasonably possible liability that could result from an unfavorable outcome. The Company believes however, that the liability, if any, resulting from the aggregate amount of uninsured damages for any outstanding litigation, investigation or claim will not have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations. However, an adverse ruling in a patent infringement lawsuit involving the Company could materially affect the Company’s ability to sell one or more of its products or could result in additional competition. In view of the unpredictable nature of such matters, the Company cannot provide any assurances regarding the outcome of any litigation, investigation, inquiry or claim to which the Company is a party or the impact on the Company of an adverse ruling in such matters.
Note 11: Contingencies
In 2009, the Company established a reserve for a contingent liability associated with regulation changes resulting from a final rule issued by the U.S. Department of Defense (DoD) that placed retroactive and prospective pricing limits on certain branded pharmaceuticals under the TRICARE Retail Pharmacy Program, even though such branded pharmaceuticals have not historically been subject to a contract with the Company. The Company is currently in negotiations with the DoD to seek a waiver of retroactive rebates. As of June 30, 2011, the reserve for the contingent liability is $13.0 million and is included in “Other accrued expenses.”
In the third quarter of 2009, the Company entered into a co-promotion agreement with Quintiles Transnational Corp. (Quintiles), under which Quintiles co-promoted Sanctura XR®, Latisse® and Aczone®, generally targeting primary care physicians. Due to significantly lower than anticipated performance under the agreement, the Company terminated this co-promotion agreement in the third quarter of 2010 and established a reserve for the contingent liability. In the second quarter
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
of 2011, the Company settled all outstanding obligations with Quintiles and recorded additional costs of $3.3 million related to the settlement. The aggregate settlement amount, including such related costs, was within the previously disclosed estimated liability range.
Consistent with market practice, the Company recently elected to largely self-insure for future product liability losses related to Botox® and Botox® Cosmetic for injuries alleged to have occurred on or after June 1, 2011. Future product liability losses associated with Botox® and Botox® Cosmetic are, by their nature, uncertain and are based upon complex judgments and probabilities. The Company accrues for certain potential product liability losses estimated to be incurred, but not reported, to the extent they can be reasonably estimated. The Company estimates these accruals for potential losses based primarily on historical claims experience and data regarding product usage.
Note 12: Guarantees
The Company’s Amended and Restated Certificate of Incorporation provides that the Company will indemnify, to the fullest extent permitted by the Delaware General Corporation Law, each person that is involved in or is, or is threatened to be, made a party to any action, suit or proceeding by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director or officer of the Company or was serving at the request of the Company as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise. The Company has also entered into contractual indemnity agreements with each of its directors and executive officers pursuant to which, among other things, the Company has agreed to indemnify such directors and executive officers against any payments they are required to make as a result of a claim brought against such executive officer or director in such capacity, excluding claims (i) relating to the action or inaction of a director or executive officer that resulted in such director or executive officer gaining illegal personal profit or advantage, (ii) for an accounting of profits made from the purchase or sale of securities of the Company within the meaning of Section 16(b) of the Securities Exchange Act of 1934, as amended, or similar provisions of any state law or (iii) that are based upon or arise out of such director’s or executive officer’s knowingly fraudulent, deliberately dishonest or willful misconduct. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. However, the Company has purchased directors’ and officers’ liability insurance policies intended to reduce the Company’s monetary exposure and to enable the Company to recover a portion of any future amounts paid. The Company has not previously paid any material amounts to defend lawsuits or settle claims as a result of these indemnification provisions, but makes no assurance that such amounts will not be paid in the future. The Company currently believes the estimated fair value of these indemnification arrangements is minimal.
The Company customarily agrees in the ordinary course of its business to indemnification provisions in agreements with clinical trials investigators in its drug, biologics and medical device development programs, in sponsored research agreements with academic and not-for-profit institutions, in various comparable agreements involving parties performing services for the Company in the ordinary course of business, and in its real estate leases. The Company also customarily agrees to certain indemnification provisions in its discovery and development collaboration agreements. With respect to the Company’s clinical trials and sponsored research agreements, these indemnification provisions typically apply to any claim asserted against the investigator or the investigator’s institution relating to personal injury or property damage, violations of law or certain breaches of the Company’s contractual obligations arising out of the research or clinical testing of the Company’s products, compounds or drug candidates. With respect to real estate lease agreements, the indemnification provisions typically apply to claims asserted against the landlord relating to personal injury or property damage caused by the Company, to violations of law by the Company or to certain breaches of the Company’s contractual obligations. The indemnification provisions appearing in the Company’s collaboration agreements are similar, but in addition provide some limited indemnification for the collaborator in the event of third party claims alleging infringement of intellectual property rights. In each of the above cases, the terms of these indemnification provisions generally survive the termination of the agreement. The maximum potential amount of future payments that the Company could be required to make under these provisions is generally unlimited. The Company has purchased insurance policies covering personal injury, property damage and general liability intended to reduce the Company’s exposure for indemnification and to enable the Company to recover a portion of any future amounts paid. The Company has not previously paid any material amounts to defend lawsuits or settle claims as a result of these indemnification provisions. As a result, the Company believes the estimated fair value of these indemnification arrangements is minimal.
Note 13: Product Warranties
The Company provides warranty programs for breast implant sales primarily in the United States, Europe and certain other countries. Management estimates the amount of potential future claims from these warranty programs based on actuarial analyses. Expected future obligations are determined based on the history of product shipments and claims and are
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
discounted to a current value. The liability is included in both current and long-term liabilities in the Company’s consolidated balance sheets. The U.S. programs include the ConfidencePlus® and ConfidencePlus® Premier warranty programs. The ConfidencePlus® program currently provides lifetime product replacement, $1,200 of financial assistance for surgical procedures within ten years of implantation and contralateral implant replacement. The ConfidencePlus® Premier program, which normally requires a low additional enrollment fee, generally provides lifetime product replacement, $2,400 of financial assistance for saline breast implants and $3,500 of financial assistance for silicone gel breast implants for surgical procedures within ten years of implantation and contralateral implant replacement. The enrollment fee is deferred and recognized as income over the ten year warranty period for financial assistance. The warranty programs in non-U.S. markets have similar terms and conditions to the U.S. programs. The Company does not warrant any level of aesthetic result and, as required by government regulation, makes extensive disclosures concerning the risks of the use of its products and breast implant surgery. Changes to actual warranty claims incurred and interest rates could have a material impact on the actuarial analysis and the Company’s estimated liabilities. A large majority of the product warranty liability arises from the U.S. warranty programs. The Company does not currently offer any similar warranty program on any other product.
The following table provides a reconciliation of the change in estimated product warranty liabilities through June 30, 2011:
| |
|
(in millions)
|
|
|
Balance at December 31, 2010
|
|
$ |
30.1 |
|
|
Provision for warranties issued during the period
|
|
|
3.3 |
|
|
Settlements made during the period
|
|
|
(2.6 |
) |
|
Decreases in warranty estimates
|
|
|
(0.1 |
) |
|
Balance at June 30, 2011
|
|
$ |
30.7 |
|
| |
|
|
|
|
|
Current portion
|
|
$ |
6.7 |
|
|
Non-current portion
|
|
|
24.0 |
|
|
Total
|
|
$ |
30.7 |
|
Note 14: Earnings Per Share
The table below presents the computation of basic and diluted earnings per share:
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions, except per share amounts)
|
|
| |
|
|
|
|
|
|
|
|
|
|
Net earnings attributable to Allergan, Inc.
|
|
$ |
246.6 |
|
|
$ |
240.1 |
|
|
$ |
404.9 |
|
|
$ |
408.0 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding
|
|
|
304.6 |
|
|
|
303.3 |
|
|
|
304.6 |
|
|
|
303.4 |
|
|
Net shares assumed issued using the treasury stock method for options and non-vested equity shares and share units outstanding during each period based on average market price
|
|
|
5.7 |
|
|
|
4.0 |
|
|
|
5.4 |
|
|
|
3.8 |
|
|
Dilutive effect of assumed conversion of convertible notes outstanding
|
|
|
— |
|
|
|
— |
|
|
|
0.5 |
|
|
|
— |
|
|
Diluted shares
|
|
|
310.3 |
|
|
|
307.3 |
|
|
|
310.5 |
|
|
|
307.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share attributable to Allergan, Inc. stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.81 |
|
|
$ |
0.79 |
|
|
$ |
1.33 |
|
|
$ |
1.34 |
|
|
Diluted
|
|
$ |
0.79 |
|
|
$ |
0.78 |
|
|
$ |
1.30 |
|
|
$ |
1.33 |
|
For the three and six month periods ended June 30, 2011, options to purchase 4.7 million and 4.8 million shares of common stock at exercise prices ranging from $73.04 to $81.06 and $62.71 to $81.06 per share, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect from the assumed exercise of these options calculated under the treasury stock method would be anti-dilutive.
For the three and six month periods ended June 30, 2010, options to purchase 9.1 million and 10.1 million shares of common stock at exercise prices ranging from $55.60 to $65.63 and $47.10 to $65.63 per share, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect from the assumed
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
exercise of these options calculated under the treasury stock method would be anti-dilutive. There were no potentially diluted common shares related to the Company’s 2026 Convertible Notes for the three and six month periods ended June 30, 2010, as the Company’s average stock price for the respective periods was less than the conversion price of the notes.
Note 15: Comprehensive Income (Loss)
The following table summarizes the components of comprehensive income (loss) for the three and six month periods ended June 30, 2011 and 2010:
| |
|
Three months ended
|
|
| |
|
June 30, 2011
|
|
|
June 30, 2010
|
|
| |
|
Before Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
|
Before Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
| |
|
(in millions)
|
|
|
Foreign currency translation adjustments
|
|
$ |
18.9 |
|
|
$ |
— |
|
|
$ |
18.9 |
|
|
$ |
(44.8 |
) |
|
$ |
— |
|
|
$ |
(44.8 |
) |
|
Amortization of deferred holding gains on derivatives designated as cash flow hedges
|
|
|
(0.4 |
) |
|
|
0.2 |
|
|
|
(0.2 |
) |
|
|
(0.4 |
) |
|
|
0.2 |
|
|
|
(0.2 |
) |
|
Net gain on re-measurement of postretirement benefit plan liability
|
|
|
20.5 |
|
|
|
(7.4 |
) |
|
|
13.1 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Other comprehensive income (loss)
|
|
$ |
39.0 |
|
|
$ |
(7.2 |
) |
|
|
31.8 |
|
|
$ |
(45.2 |
) |
|
$ |
0.2 |
|
|
|
(45.0 |
) |
|
Net earnings
|
|
|
|
|
|
|
|
|
|
|
248.6 |
|
|
|
|
|
|
|
|
|
|
|
241.5 |
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
280.4 |
|
|
|
|
|
|
|
|
|
|
|
196.5 |
|
|
Comprehensive income (loss) attributable to noncontrolling interest
|
|
|
|
|
|
|
|
|
|
|
2.4 |
|
|
|
|
|
|
|
|
|
|
|
(0.2 |
) |
|
Comprehensive income attributable to Allergan, Inc.
|
|
|
|
|
|
|
|
|
|
$ |
278.0 |
|
|
|
|
|
|
|
|
|
|
$ |
196.7 |
|
| |
|
Six months ended
|
|
| |
|
June 30, 2011
|
|
|
June 30, 2010
|
|
| |
|
Before Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
|
Before Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
| |
|
(in millions)
|
|
|
Foreign currency translation adjustments
|
|
$ |
40.9 |
|
|
$ |
— |
|
|
$ |
40.9 |
|
|
$ |
(64.0 |
) |
|
$ |
— |
|
|
$ |
(64.0 |
) |
|
Amortization of deferred holding gains on derivatives designated as cash flow hedges
|
|
|
(0.7 |
) |
|
|
0.3 |
|
|
|
(0.4 |
) |
|
|
(0.7 |
) |
|
|
0.3 |
|
|
|
(0.4 |
) |
|
Net gain on re-measurement of postretirement benefit plan liability
|
|
|
20.5 |
|
|
|
(7.4 |
) |
|
|
13.1 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Other comprehensive income (loss)
|
|
$ |
60.7 |
|
|
$ |
(7.1 |
) |
|
|
53.6 |
|
|
$ |
(64.7 |
) |
|
$ |
0.3 |
|
|
|
(64.4 |
) |
|
Net earnings
|
|
|
|
|
|
|
|
|
|
|
407.4 |
|
|
|
|
|
|
|
|
|
|
|
410.5 |
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
461.0 |
|
|
|
|
|
|
|
|
|
|
|
346.1 |
|
|
Comprehensive income attributable to noncontrolling interest
|
|
|
|
|
|
|
|
|
|
|
3.5 |
|
|
|
|
|
|
|
|
|
|
|
1.6 |
|
|
Comprehensive income attributable to Allergan, Inc.
|
|
|
|
|
|
|
|
|
|
$ |
457.5 |
|
|
|
|
|
|
|
|
|
|
$ |
344.5 |
|
Note 16: Financial Instruments
In the normal course of business, operations of the Company are exposed to risks associated with fluctuations in interest rates and foreign currency exchange rates. The Company addresses these risks through controlled risk management that includes the use of derivative financial instruments to economically hedge or reduce these exposures. The Company does not enter into derivative financial instruments for trading or speculative purposes.
The Company has not experienced any losses to date on its derivative financial instruments due to counterparty credit risk.
To ensure the adequacy and effectiveness of its interest rate and foreign exchange hedge positions, the Company continually monitors its interest rate swap positions and foreign exchange forward and option positions both on a stand-alone basis and in conjunction with its underlying interest rate and foreign currency exposures, from an accounting and economic perspective.
However, given the inherent limitations of forecasting and the anticipatory nature of the exposures intended to be
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
hedged, the Company cannot assure that such programs will offset more than a portion of the adverse financial impact resulting from unfavorable movements in either interest or foreign exchange rates. In addition, the timing of the accounting for recognition of gains and losses related to mark-to-market instruments for any given period may not coincide with the timing of gains and losses related to the underlying economic exposures and, therefore, may adversely affect the Company’s consolidated operating results and financial position.
Interest Rate Risk Management
The Company’s interest income and expense is more sensitive to fluctuations in the general level of U.S. interest rates than to changes in rates in other markets. Changes in U.S. interest rates affect the interest earned on cash and equivalents and short-term investments and interest expense on debt, as well as costs associated with foreign currency contracts.
On January 31, 2007, the Company entered into a nine-year, two-month interest rate swap with a $300.0 million notional amount with semi-annual settlements and quarterly interest rate reset dates. The swap receives interest at a fixed rate of 5.75% and pays interest at a variable interest rate equal to 3-month LIBOR plus 0.368%, and effectively converts $300.0 million of the Company’s $800.0 million in aggregate principal amount of 5.75% Senior Notes due 2016 (2016 Notes) to a variable interest rate. Based on the structure of the hedging relationship, the hedge meets the criteria for using the short-cut method for a fair value hedge. The investment in the derivative and the related long-term debt are recorded at fair value. At June 30, 2011 and December 31, 2010, the Company recognized in its consolidated balance sheets an asset reported in “Investments and other assets” and a corresponding increase in “Long-term debt” associated with the fair value of the derivative of $43.2 million and $42.3 million, respectively. The differential to be paid or received as interest rates change is accrued and recognized as an adjustment of interest expense related to the 2016 Notes. During the three and six month periods ended June 30, 2011, the Company recognized $3.9 million and $7.7 million, respectively, as a reduction of interest expense due to the differential to be received. During the three and six month periods ended June 30, 2010, the Company recognized $3.7 million and $7.5 million, respectively, as a reduction of interest expense due to the differential to be received.
In February 2006, the Company entered into interest rate swap contracts based on 3-month LIBOR with an aggregate notional amount of $800.0 million, a swap period of 10 years and a starting swap rate of 5.198%. The Company entered into these swap contracts as a cash flow hedge to effectively fix the future interest rate for the 2016 Notes. In April 2006, the Company terminated the interest rate swap contracts and received approximately $13.0 million. The total gain was recorded to accumulated other comprehensive loss and is being amortized as a reduction to interest expense over a 10 year period to match the term of the 2016 Notes. During the three and six month periods ended June 30, 2011 and 2010, the Company recognized $0.4 million and $0.7 million, respectively, as a reduction of interest expense due to the amortization of deferred holding gains on derivatives designated as cash flow hedges. These amounts were reclassified from accumulated other comprehensive loss. As of June 30, 2011, the remaining unrecognized gain of $6.2 million ($3.7 million, net of tax) is recorded as a component of accumulated other comprehensive loss. The Company expects to reclassify an estimated pre-tax amount of $1.3 million from accumulated other comprehensive loss as a reduction in interest expense during fiscal year 2011 due to the amortization of deferred holding gains.
No portion of amounts recognized from contracts designated as cash flow hedges was considered to be ineffective during the three and six month periods ended June 30, 2011 and 2010, respectively.
Foreign Exchange Risk Management
Overall, the Company is a net recipient of currencies other than the U.S. dollar and, as such, benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect the Company’s consolidated revenues or operating costs and expenses as expressed in U.S. dollars.
From time to time, the Company enters into foreign currency option and forward contracts to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on its core business issues. Accordingly, the Company enters into various contracts which change in value as foreign exchange rates change to economically offset the effect of changes in the value of foreign currency assets and liabilities, commitments and anticipated foreign currency denominated sales and operating expenses. The Company enters into foreign currency option and forward contracts in amounts between minimum and maximum anticipated foreign exchange exposures, generally for periods not to exceed 18 months. The Company does not designate these derivative instruments as accounting hedges.
The Company uses foreign currency option contracts, which provide for the sale or purchase of foreign currencies to
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
offset foreign currency exposures expected to arise in the normal course of the Company’s business. While these instruments are subject to fluctuations in value, such fluctuations are anticipated to offset changes in the value of the underlying exposures.
Probable but not firmly committed transactions are comprised of sales of products and purchases of raw material in currencies other than the U.S. dollar. A majority of these sales are made through the Company’s subsidiaries in Europe, Asia Pacific, Canada and Brazil. The Company purchases foreign exchange option contracts to economically hedge the currency exchange risks associated with these probable but not firmly committed transactions. The duration of foreign exchange hedging instruments, whether for firmly committed transactions or for probable but not firmly committed transactions, generally does not exceed 18 months.
All of the Company’s outstanding foreign currency option contracts are entered into to reduce the volatility of earnings generated in currencies other than the U.S. dollar, primarily earnings denominated in the Canadian dollar, Mexican peso, Australian dollar, Brazilian real, euro, Korean won and Turkish lira. Current changes in the fair value of open foreign currency option contracts and any realized gains (losses) on settled contracts are recorded through earnings as “Other, net” in the accompanying unaudited condensed consolidated statements of earnings. During the three and six month periods ended June 30, 2011, the Company recognized realized gains on settled foreign currency option contracts of $0.2 million and $0.7 million, respectively, and net unrealized gains (losses) on open foreign currency option contracts of $2.1 million and $(4.8) million, respectively. During the three and six month periods ended June 30, 2010, the Company recognized realized gains on settled foreign currency option contracts of $5.8 million and $7.8 million, respectively, and net unrealized gains on open foreign currency option contracts of $8.9 million and $8.2 million, respectively. The premium costs of purchased foreign exchange option contracts are recorded in “Other current assets” and amortized to “Other, net” over the life of the options.
All of the Company’s outstanding foreign exchange forward contracts are entered into to offset the change in value of certain intercompany receivables or payables that are subject to fluctuations in foreign currency exchange rates. The realized and unrealized gains and losses from foreign currency forward contracts and the revaluation of the foreign denominated intercompany receivables or payables are recorded through “Other, net” in the accompanying unaudited condensed consolidated statements of earnings. During the three and six month periods ended June 30, 2011, the Company recognized total realized and unrealized (losses) gains from foreign exchange forward contracts of $(0.6) million and $1.1 million, respectively. During the three and six month periods ended June 30, 2010, the Company recognized total realized and unrealized gains from foreign exchange forward contracts of $3.5 million and $4.2 million, respectively.
The fair value of outstanding foreign exchange option and forward contracts, collectively referred to as foreign currency derivative financial instruments, are recorded in “Other current assets” and “Accounts payable.” At June 30, 2011 and December 31, 2010, foreign currency derivative assets associated with the foreign exchange option contracts of $4.0 million and $10.4 million, respectively, were included in “Other current assets.” At June 30, 2011, net foreign currency derivative assets associated with the foreign exchange forward contracts of $0.3 million were included in “Other current assets.” At December 31, 2010, net foreign currency derivative liabilities associated with the foreign exchange forward contracts of $0.7 million were included in “Accounts payable.”
At June 30, 2011 and December 31, 2010, the notional principal and fair value of the Company’s outstanding foreign currency derivative financial instruments were as follows:
| |
|
June 30, 2011
|
|
|
December 31, 2010
|
|
| |
|
Notional
Principal
|
|
|
Fair
Value
|
|
|
Notional
Principal
|
|
|
Fair
Value
|
|
| |
|
(in millions)
|
|
|
Foreign currency forward exchange contracts
(Receive U.S. dollar/pay foreign currency)
|
|
$ |
43.6 |
|
|
$ |
(0.6 |
) |
|
$ |
25.6 |
|
|
$ |
(0.9 |
) |
|
Foreign currency forward exchange contracts
(Pay U.S. dollar/receive foreign currency)
|
|
|
42.6 |
|
|
|
0.9 |
|
|
|
39.9 |
|
|
|
0.2 |
|
|
Foreign currency sold — put options
|
|
|
289.2 |
|
|
|
4.0 |
|
|
|
346.4 |
|
|
|
10.4 |
|
The notional principal amounts provide one measure of the transaction volume outstanding as of June 30, 2011 and December 31, 2010, and do not represent the amount of the Company’s exposure to market loss. The estimates of fair value are based on applicable and commonly used pricing models using prevailing financial market information as of June 30, 2011 and December 31, 2010. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Other Financial Instruments
At June 30, 2011 and December 31, 2010, the Company’s other financial instruments included cash and equivalents, short-term investments, trade receivables, equity investments, accounts payable and borrowings. The carrying amount of cash and equivalents, short-term investments, trade receivables and accounts payable approximates fair value due to the short-term maturities of these instruments. The fair value of non-marketable equity investments which represent investments in start-up technology companies or partnerships that invest in start-up technology companies, are estimated based on the fair value and other information provided by these ventures. The fair value of notes payable, convertible notes and long-term debt are estimated based on quoted market prices and interest rates.
The carrying amount and estimated fair value of the Company’s other financial instruments at June 30, 2011 and December 31, 2010 were as follows:
| |
|
June 30, 2011
|
|
|
December 31, 2010
|
|
| |
|
Carrying
Amount
|
|
|
Fair
Value
|
|
|
Carrying
Amount
|
|
|
Fair
Value
|
|
| |
|
(in millions)
|
|
|
Cash and equivalents
|
|
$ |
1,856.5 |
|
|
$ |
1,856.5 |
|
|
$ |
1,991.2 |
|
|
$ |
1,991.2 |
|
|
Short-term investments
|
|
|
299.8 |
|
|
|
299.8 |
|
|
|
749.1 |
|
|
|
749.1 |
|
|
Non-current non-marketable equity investments
|
|
|
7.7 |
|
|
|
7.7 |
|
|
|
7.7 |
|
|
|
7.7 |
|
|
Notes payable
|
|
|
76.1 |
|
|
|
77.3 |
|
|
|
28.1 |
|
|
|
28.1 |
|
|
Convertible notes
|
|
|
— |
|
|
|
— |
|
|
|
642.5 |
|
|
|
651.1 |
|
|
Long-term debt
|
|
|
1,510.3 |
|
|
|
1,599.3 |
|
|
|
1,534.2 |
|
|
|
1,612.3 |
|
Concentration of Credit Risk
Financial instruments that potentially subject the Company to credit risk principally consist of trade receivables. Wholesale distributors, major retail chains and managed care organizations account for a substantial portion of trade receivables. This risk is limited due to the number of customers comprising the Company’s customer base, and their geographic dispersion. At June 30, 2011, no single customer represented more than 10% of trade receivables, net. Ongoing credit evaluations of customers’ financial condition are performed and, generally, no collateral is required. The Company has purchased an insurance policy intended to reduce the Company’s exposure to potential credit risks associated with certain U.S. customers. To date, no claims have been made against the insurance policy. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not exceeded management’s estimates.
Note 17: Fair Value Measurements
The Company measures fair value based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
As of June 30, 2011, the Company has certain assets and liabilities that are required to be measured at fair value on a recurring basis. These include cash equivalents, short-term investments, foreign exchange derivatives, the $300.0 million notional amount interest rate swap and contingent consideration. These assets and liabilities are classified in the table below in one of the three categories of the fair value hierarchy described above.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
| |
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
| |
|
(in millions)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
$ |
1,206.6 |
|
|
$ |
— |
|
|
$ |
1,206.6 |
|
|
$ |
— |
|
|
Foreign time deposits
|
|
|
224.3 |
|
|
|
— |
|
|
|
224.3 |
|
|
|
— |
|
|
Other cash equivalents
|
|
|
582.4 |
|
|
|
— |
|
|
|
582.4 |
|
|
|
— |
|
|
Foreign exchange derivative assets
|
|
|
4.3 |
|
|
|
— |
|
|
|
4.3 |
|
|
|
— |
|
|
Interest rate swap derivative asset
|
|
|
43.2 |
|
|
|
— |
|
|
|
43.2 |
|
|
|
— |
|
| |
|
$ |
2,060.8 |
|
|
$ |
— |
|
|
$ |
2,060.8 |
|
|
$ |
— |
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap derivative liability
|
|
$ |
43.2 |
|
|
$ |
— |
|
|
$ |
43.2 |
|
|
$ |
— |
|
|
Contingent consideration liability
|
|
|
41.8 |
|
|
|
— |
|
|
|
— |
|
|
|
41.8 |
|
| |
|
$ |
85.0 |
|
|
$ |
— |
|
|
$ |
43.2 |
|
|
$ |
41.8 |
|
Cash equivalents consist of commercial paper, foreign time deposits and other cash equivalents. Short-term investments consist of commercial paper. Cash equivalents and short-term investments are valued at cost, which approximates fair value due to the short-term maturities of these instruments. Foreign currency derivative assets and liabilities are valued using quoted forward foreign exchange prices and option volatility at the reporting date. The interest rate swap derivative asset and liability are valued using LIBOR yield curves at the reporting date. The Company believes the fair values assigned to its derivative instruments as of June 30, 2011 are based upon reasonable estimates and assumptions.
The contingent consideration liability represents future amounts the Company will be required to pay in conjunction with the 2010 purchase of commercial assets from a distributor in Turkey that was accounted for as a business combination. The ultimate amount of future payments is based on specified percentages of the Company’s revenues in Turkey over a five year period from the acquisition date. The Company estimates the fair value of the contingent liability using the income approach, which involves forecasting estimated future net cash flows and discounting the net cash flows to their present value using a risk-adjusted rate of return. As of June 30, 2011 and December 31, 2010, the total estimated fair value of the contingent consideration was $41.8 million and $44.5 million, respectively. The following table provides a reconciliation of the change in the contingent consideration liability through June 30, 2011:
| |
|
(in millions)
|
|
|
Balance at December 31, 2010
|
|
$ |
44.5 |
|
|
Change in the estimated fair value of the contingent consideration liability
|
|
|
2.3 |
|
|
Settlements made during the period
|
|
|
(3.0 |
) |
|
Foreign exchange translation effects
|
|
|
(2.0 |
) |
|
Balance at June 30, 2011
|
|
$ |
41.8 |
|
Note 18: Business Segment Information
The Company operates its business on the basis of two reportable segments — specialty pharmaceuticals and medical devices. The specialty pharmaceuticals segment produces a broad range of pharmaceutical products, including: ophthalmic products for dry eye, glaucoma, retinal diseases and ocular surface disease; Botox® for certain therapeutic and aesthetic indications; skin care products for acne, psoriasis, eyelash growth and other prescription and over-the-counter skin care products; and urologics products. The medical devices segment produces a broad range of medical devices, including: breast implants for augmentation, revision and reconstructive surgery; obesity intervention products, including the Lap-Band® System and the Orbera™ Intragastric Balloon System; and facial aesthetics products. The Company provides global marketing strategy teams to ensure development and execution of a consistent marketing strategy for its products in all geographic regions that share similar distribution channels and customers.
The Company evaluates segment performance on a revenue and operating income basis exclusive of general and administrative expenses and other indirect costs, legal settlement expenses, intangible asset impairment and related costs, restructuring charges, in-process research and development expenses, amortization of certain identifiable intangible assets related to business combinations and asset acquisitions and related capitalized licensing costs and certain other adjustments, which are not allocated to the Company’s segments for performance assessment by the Company’s chief operating decision maker. Other adjustments excluded from the Company’s segments for performance assessment represent income or expenses that do not reflect, according to established Company-defined criteria, operating income or expenses associated with the Company’s core business activities. Because operating segments are generally defined by the products they design and sell, they do not make sales to each other. The Company does not discretely allocate assets to its operating segments, nor does the
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Company’s chief operating decision maker evaluate operating segments using discrete asset information.
Operating Segments
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Product net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty pharmaceuticals
|
|
$ |
1,155.3 |
|
|
$ |
1,013.2 |
|
|
$ |
2,183.7 |
|
|
$ |
1,920.5 |
|
|
Medical devices
|
|
|
245.1 |
|
|
|
218.5 |
|
|
|
469.5 |
|
|
|
417.0 |
|
|
Total product net sales
|
|
|
1,400.4 |
|
|
|
1,231.7 |
|
|
|
2,653.2 |
|
|
|
2,337.5 |
|
|
Other corporate and indirect revenues
|
|
|
16.8 |
|
|
|
15.5 |
|
|
|
35.2 |
|
|
|
64.4 |
|
|
Total revenues
|
|
$ |
1,417.2 |
|
|
$ |
1,247.2 |
|
|
$ |
2,688.4 |
|
|
$ |
2,401.9 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Specialty pharmaceuticals
|
|
$ |
468.6 |
|
|
$ |
386.6 |
|
|
$ |
852.8 |
|
|
$ |
698.5 |
|
|
Medical devices
|
|
|
77.9 |
|
|
|
66.8 |
|
|
|
145.4 |
|
|
|
133.9 |
|
|
Total segments
|
|
|
546.5 |
|
|
|
453.4 |
|
|
|
998.2 |
|
|
|
832.4 |
|
|
General and administrative expenses, other indirect costs and other adjustments
|
|
|
154.6 |
|
|
|
90.1 |
|
|
|
311.5 |
|
|
|
186.8 |
|
|
Amortization of acquired intangible assets (a)
|
|
|
25.3 |
|
|
|
31.3 |
|
|
|
51.9 |
|
|
|
62.7 |
|
|
Intangible asset impairment and related costs
|
|
|
3.3 |
|
|
|
— |
|
|
|
19.4 |
|
|
|
— |
|
|
Restructuring charges
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
4.7 |
|
|
|
0.7 |
|
|
Total operating income
|
|
$ |
363.2 |
|
|
$ |
331.9 |
|
|
$ |
610.7 |
|
|
$ |
582.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) Represents amortization of certain identifiable intangible assets related to business combinations and asset acquisitions and related capitalized licensing costs, as applicable.
Product net sales for the Company’s various global product portfolios are presented below. The Company’s principal markets are the United States, Europe, Latin America and Asia Pacific. The U.S. information is presented separately as it is the Company’s headquarters country. U.S. sales represented 58.7% and 63.6% of the Company’s total consolidated product net sales for the three month periods ended June 30, 2011 and 2010, respectively. U.S. sales represented 59.7% and 63.1% of the Company’s total consolidated product net sales for the six month periods ended June 30, 2011 and 2010, respectively.
Sales to two customers in the Company’s specialty pharmaceuticals segment each generated over 10% of the Company’s total consolidated product net sales. Sales to Cardinal Health, Inc. for the three month periods ended June 30, 2011 and 2010 were 12.7% and 14.2%, respectively, of the Company’s total consolidated product net sales, and 13.6% and 13.2%, respectively, of the Company’s total consolidated product net sales for the six month periods ended June 30, 2011 and 2010. Sales to McKesson Drug Company for the three month periods ended June 30, 2011 and 2010 were 11.9% and 10.7%, respectively, of the Company’s total consolidated product net sales and 13.1% and 12.3%, respectively, of the Company’s total consolidated product net sales for the six month periods ended June 30, 2011 and 2010. No other country or single customer generates over 10% of the Company’s total consolidated product net sales. Net sales for the Europe region also include sales to customers in Africa and the Middle East, and net sales in the Asia Pacific region include sales to customers in Australia and New Zealand.
ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Product Net Sales by Product Line
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
Specialty Pharmaceuticals:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eye Care Pharmaceuticals
|
|
$ |
657.6 |
|
|
$ |
577.8 |
|
|
$ |
1,249.5 |
|
|
$ |
1,089.8 |
|
|
Botox®/Neuromodulator
|
|
|
418.4 |
|
|
|
360.5 |
|
|
|
782.9 |
|
|
|
691.5 |
|
|
Skin Care
|
|
|
65.3 |
|
|
|
59.3 |
|
|
|
124.0 |
|
|
|
109.9 |
|
|
Urologics
|
|
|
14.0 |
|
|
|
15.6 |
|
|
|
27.3 |
|
|
|
29.3 |
|
|
Total Specialty Pharmaceuticals
|
|
|
1,155.3 |
|
|
|
1,013.2 |
|
|
|
2,183.7 |
|
|
|
1,920.5 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical Devices:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Breast Aesthetics
|
|
|
95.5 |
|
|
|
81.6 |
|
|
|
179.6 |
|
|
|
159.5 |
|
|
Obesity Intervention
|
|
|
54.4 |
|
|
|
61.9 |
|
|
|
106.5 |
|
|
|
123.1 |
|
|
Facial Aesthetics
|
|
|
95.2 |
|
|
|
75.0 |
|
|
|
183.4 |
|
|
|
134.4 |
|
|
Total Medical Devices
|
|
|
245.1 |
|
|
|
218.5 |
|
|
|
469.5 |
|
|
|
417.0 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total product net sales
|
|
$ |
1,400.4 |
|
|
$ |
1,231.7 |
|
|
$ |
2,653.2 |
|
|
$ |
2,337.5 |
|
Geographic Information
Product Net Sales
| |
|
Three months ended
|
|
|
Six months ended
|
|
| |
|
June 30,
2011
|
|
|
June 30,
2010
|
|
|
June 30,
2011
|
|
|
June 30,
2010
|
|
| |
|
(in millions)
|
|
|
(in millions)
|
|
|
United States
|
|
$ |
822.4 |
|
|
$ |
783.7 |
|
|
$ |
1,585.1 |
|
|
$ |
1,474.5 |
|
|
Europe
|
|
|
304.9 |
|
|
|
234.7 |
|
|
|
564.9 |
|
|
|
459.6 |
|
|
Latin America
|
|
|
101.9 |
|
|
|
79.7 |
|
|
|
186.3 |
|
|
|
143.6 |
|
|
Asia Pacific
|
|
|
104.7 |
|
|
|
76.9 |
|
|
|
196.9 |
|
|
|
155.5 |
|
|
Other
|
|
|
66.5 |
|
|
|
56.7 |
|
|
|
120.0 |
|
|
|
104.3 |
|
|
Total product net sales
|
|
$ |
1,400.4 |
|
|
$ |
1,231.7 |
|
|
$ |
2,653.2 |
|
|
$ |
2,337.5 |
|
Long-Lived Assets
| |
|
June 30,
2011
|
|
|
December 31,
2010
|
|
| |
|
(in millions)
|
|
|
United States
|
|
$ |
3,198.1 |
|
|
$ |
3,222.4 |
|
|
Europe
|
|
|
521.4 |
|
|
|
563.1 |
|
|
Latin America
|
|
|
64.9 |
|
|
|
65.0 |
|
|
Asia Pacific
|
|
|
56.7 |
|
|
|
56.3 |
|
|
Other
|
|
|
3.4 |
|
|
|
3.7 |
|
|
Total
|
|
$ |
3,844.5 |
|
|
$ |
3,910.5 |
|
Note 19: Subsequent Events
Effective July 1, 2011, the Company established direct operations in South Africa by acquiring the Company-related parts of Genop Healthcare’s business and assumed responsibility for promotion, marketing and distribution of all of the Company’s products in South Africa. The acquisition was accounted for as a business combination, the terms of which are not material.
On July 22, 2011, the Company acquired all of the outstanding equity securities of Vicept Therapeutics, Inc., a privately-held dermatology company, for an upfront payment of $75.0 million in cash plus up to an aggregate of $200.0 million in payments contingent upon achieving certain future development and regulatory milestones plus additional payments contingent upon acquired products achieving certain sales milestones.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This financial review presents our operating results for the three and six month periods ended June 30, 2011 and 2010, and our financial condition at June 30, 2011. The following discussion contains forward-looking statements which are subject to known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors throughout this report and specifically under the caption “Risk Factors” in Part II, Item 1A below. The following review should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three and six month periods ended June 30, 2011 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2010 included in our 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
Critical Accounting Policies, Estimates and Assumptions
The preparation and presentation of financial statements in conformity with accounting principles generally accepted in the United States, or GAAP, requires us to establish policies and to make estimates and assumptions that affect the amounts reported in our consolidated financial statements. In our judgment, the accounting policies, estimates and assumptions described below have the greatest potential impact on our consolidated financial statements. Accounting assumptions and estimates are inherently uncertain and actual results may differ materially from our estimates.
Revenue Recognition
We recognize revenue from product sales when goods are shipped and title and risk of loss transfer to our customers. A substantial portion of our revenue is generated by the sale of specialty pharmaceutical products (primarily eye care pharmaceuticals, skin care and urologics products) to wholesalers within the United States, and we have a policy to attempt to maintain average U.S. wholesaler inventory levels at an amount less than eight weeks of our net sales. A portion of our revenue is generated from consigned inventory of breast implants maintained at physician, hospital and clinic locations. These customers are contractually obligated to maintain a specific level of inventory and to notify us upon the use of consigned inventory. Revenue for consigned inventory is recognized at the time we are notified by the customer that the product has been used. Notification is usually through the replenishing of the inventory, and we periodically review consignment inventories to confirm the accuracy of customer reporting.
We generally offer cash discounts to customers for the early payment of receivables. Those discounts are recorded as a reduction of revenue and accounts receivable in the same period that the related sale is recorded. The amounts reserved for cash discounts were $4.1 million and $4.4 million at June 30, 2011 and December 31, 2010, respectively. Provisions for cash discounts deducted from consolidated sales in the second quarter of 2011 and 2010 were $15.9 million and $13.7 million, respectively. Provisions for cash discounts deducted from consolidated sales in the first six months of 2011 and 2010 were $30.2 million and $26.1 million, respectively.
We permit returns of product from most product lines by any class of customer if such product is returned in a timely manner, in good condition and from normal distribution channels. Return policies in certain international markets and for certain medical device products, primarily breast implants, provide for more stringent guidelines in accordance with the terms of contractual agreements with customers. Our estimates for sales returns are based upon the historical patterns of product returns matched against sales, and management’s evaluation of specific factors that may increase the risk of product returns. The amount of allowances for sales returns recognized in our consolidated balance sheets at June 30, 2011 and December 31, 2010 were $61.6 million and $52.3 million, respectively, and are recorded in “Other accrued expenses” and “Trade receivables, net” in our consolidated balance sheets. Provisions for sales returns deducted from consolidated sales were $108.8 million and $104.7 million in the second quarter of 2011 and 2010, respectively. Provisions for sales returns deducted from consolidated sales were $212.7 million and $191.8 million in the first six months of 2011 and 2010, respectively. The increases in the amount of allowances for sales returns at June 30, 2011 compared to December 31, 2010 and the provisions for sales returns in the second quarter and the first six months of 2011 compared to the second quarter and the first six months of 2010 are primarily due to increased sales returns related to breast implant products, principally due to increased product sales volume, and an increase in estimated product return rates for our skin care products in the first six months of 2011 compared to the first six months of 2010. Historical allowances for cash discounts and product returns have been consistent with the amounts reserved or accrued.
We participate in various managed care sales rebate and other incentive programs, the largest of which relates to Medicaid, Medicare and the Department of Veterans Affairs. Sales rebate and other incentive programs also include contractual volume rebate programs and chargebacks, which are contractual discounts given primarily to federal government
agencies, health maintenance organizations, pharmacy benefits managers and group purchasing organizations. We also offer rebate and other incentive programs for our aesthetic products and certain therapeutic products, including Botox® Cosmetic, Juvéderm®, Latisse®, Acuvail®, Aczone®, Sanctura XR® and Restasis®, and for certain other skin care products. Sales rebates and incentive accruals reduce revenue in the same period that the related sale is recorded and are included in “Other accrued expenses” in our consolidated balance sheets. The amounts accrued for sales rebates and other incentive programs were $226.1 million and $186.5 million at June 30, 2011 and December 31, 2010, respectively. Provisions for sales rebates and other incentive programs deducted from consolidated sales were $182.2 million and $133.3 million in the second quarter of 2011 and 2010, respectively. Provisions for sales rebates and other incentive programs deducted from consolidated sales were $356.7 million and $265.0 million in the first six months of 2011 and 2010, respectively. The increases in the amounts accrued at June 30, 2011 compared to December 31, 2010 and the provisions for sales rebates and other incentive programs in the second quarter and the first six months of 2011 compared to the second quarter and the first six months of 2010 are primarily due to an increase in activity under previously established rebate and incentive programs, principally related to our eye care pharmaceuticals, Botox® Cosmetic, urology, skin care and facial aesthetics products, an increase in the number of incentive programs offered, additional contractual discounts to federal government agencies related to the recently enacted health care reform legislation, and increased overall product sales volume. In addition, an increase in our published list prices in the United States for pharmaceutical products, which occurred for several of our products in each of 2011 and 2010, generally results in higher provisions for sales rebates and other incentive programs deducted from consolidated sales.
Our procedures for estimating amounts accrued for sales rebates and other incentive programs at the end of any period are based on available quantitative data and are supplemented by management’s judgment with respect to many factors, including but not limited to, current market dynamics, changes in contract terms, changes in sales trends, an evaluation of current laws and regulations and product pricing. Quantitatively, we use historical sales, product utilization and rebate data and apply forecasting techniques in order to estimate our liability amounts. Qualitatively, management’s judgment is applied to these items to modify, if appropriate, the estimated liability amounts. There are inherent risks in this process. For example, customers may not achieve assumed utilization levels; customers may misreport their utilization to us; and actual movements of the U.S. Consumer Price Index for All Urban Consumers, or CPI-U, which affect our rebate programs with U.S. federal and state government agencies, may differ from those estimated. On a quarterly basis, adjustments to our estimated liabilities for sales rebates and other incentive programs related to sales made in prior periods have not been material and have generally been less than 0.5% of consolidated product net sales. An adjustment to our estimated liabilities of 0.5% of consolidated product net sales on a quarterly basis would result in an increase or decrease to net sales and earnings before income taxes of approximately $7.0 million to $8.0 million. The sensitivity of our estimates can vary by program and type of customer. Additionally, there is a significant time lag between the date we determine the estimated liability and when we actually pay the liability. Due to this time lag, we record adjustments to our estimated liabilities over several periods, which can result in a net increase to earnings or a net decrease to earnings in those periods. Material differences may result in the amount of revenue we recognize from product sales if the actual amount of rebates and incentives differ materially from the amounts estimated by management.
We recognize license fees, royalties and reimbursement income for services provided as other revenues based on the facts and circumstances of each contractual agreement. In general, we recognize income upon the signing of a contractual agreement that grants rights to products or technology to a third party if we have no further obligation to provide products or services to the third party after entering into the contract. We recognize contingent consideration earned from the achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. We defer income under contractual agreements when we have further obligations that indicate that a separate earnings process has not been completed.
Pensions
We sponsor various pension plans in the United States and abroad in accordance with local laws and regulations. Our U.S. pension plans account for a large majority of our aggregate pension plans’ net periodic benefit costs and projected benefit obligations. In connection with these plans, we use certain actuarial assumptions to determine the plans’ net periodic benefit costs and projected benefit obligations, the most significant of which are the expected long-term rate of return on assets and the discount rate.
Our assumption for the weighted average expected long-term rate of return on assets in our U.S. funded pension plan for determining the net periodic benefit cost is 7.25% and 8.25% for 2011 and 2010, respectively. Our assumptions for the weighted average expected long-term rate of return on assets in our non-U.S. funded pension plans are 5.70% and 5.85% for 2011 and 2010, respectively. For our U.S. funded pension plan, we determine, based upon recommendations from our pension plan’s investment advisors, the expected rate of return using a building block approach that considers diversification and rebalancing for a long-term portfolio of invested assets. Our investment advisors study historical market returns and preserve long-term historical relationships between equities and fixed income in a manner consistent with the widely-
accepted capital market principle that assets with higher volatility generate a greater return over the long run. They also evaluate market factors such as inflation and interest rates before long-term capital market assumptions are determined. For our non-U.S. funded pension plans, the expected rate of return was determined based on asset distribution and assumed long-term rates of return on fixed income instruments and equities. Market conditions and other factors can vary over time and could significantly affect our estimates of the weighted average expected long-term rate of return on plan assets. The expected rate of return is applied to the market-related value of plan assets. As a sensitivity measure, the effect of a 0.25% decline in our rate of return on assets assumptions for our U.S. and non-U.S. funded pension plans would increase our expected 2011 pre-tax pension benefit cost by approximately $1.6 million.
The weighted average discount rates used to calculate our U.S. and non-U.S. pension benefit obligations at December 31, 2010 were 5.51% and 5.57%, respectively. The weighted average discount rates used to calculate our U.S. and non-U.S. net periodic benefit costs for 2011 were 5.51% and 5.57%, respectively, and for 2010 were 6.04% and 6.16%, respectively. We determine the discount rate based upon a hypothetical portfolio of high quality fixed income investments with maturities that mirror the pension benefit obligations at the plans’ measurement date. Market conditions and other factors can vary over time and could significantly affect our estimates for the discount rates used to calculate our pension benefit obligations and net periodic benefit costs for future years. As a sensitivity measure, the effect of a 0.25% decline in the discount rate assumption for our U.S. and non-U.S. pension plans would increase our expected 2011 pre-tax pension benefit costs by approximately $4.1 million and increase our pension plans’ projected benefit obligations at December 31, 2010 by approximately $34.7 million.
Share-Based Compensation
We recognize compensation expense for all share-based awards made to employees and directors. The fair value of share-based awards is estimated at the grant date using the Black-Scholes option-pricing model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period using the straight-line single option method. The fair value of modifications to share-based awards is generally estimated using a lattice model.
The determination of fair value using the Black-Scholes and lattice option-pricing models is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors. We currently estimate stock price volatility based upon an equal weighting of the historical average over the expected life of the award and the average implied volatility of at-the-money options traded in the open market. We estimate employee stock option exercise behavior based on actual historical exercise activity and assumptions regarding future exercise activity of unexercised, outstanding options.
Share-based compensation expense is recognized only for those awards that are ultimately expected to vest, and we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
Product Liability Self-Insurance
Consistent with market practice in our industry, we recently elected to largely self-insure for future product liability losses related to Botox® and Botox® Cosmetic for injuries alleged to have occurred on or after June 1, 2011. Future product liability losses associated with Botox® and Botox® Cosmetic are, by their nature, uncertain and are based upon complex judgments and probabilities. The factors to consider in developing product liability reserves include the merits and jurisdiction of each claim, the nature and the number of other similar current and past claims, the nature of the product use, and the likelihood of settlement. In addition, we accrue for certain potential product liability losses estimated to be incurred, but not reported, to the extent they can be reasonably estimated. We estimate these accruals for potential losses based primarily on historical claims experience and data regarding product usage.
Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally less than the U.S. federal statutory rate, primarily because of lower tax rates in certain non-U.S. jurisdictions, research and development, or R&D, tax credits available in the United States, California and other foreign jurisdictions and deductions available in the United States for domestic production activities. Our effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pre-tax earnings in the various tax jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, expected utilization of R&D tax credits and changes in or the interpretation of tax laws in jurisdictions where we conduct business. We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and
the tax basis of our assets and liabilities along with net operating loss and tax credit carryovers.
We record a valuation allowance against our deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. When we establish or reduce the valuation allowance against our deferred tax assets, our provision for income taxes will increase or decrease, respectively, in the period such determination is made. Valuation allowances against deferred tax assets were $23.8 million and $4.3 million at June 30, 2011 and December 31, 2010, respectively. The increase in the valuation allowance was primarily due to a corresponding increase in a deferred tax asset that we determined required a valuation allowance. Changes in the valuation allowances, when they are recognized in the provision for income taxes, are included as a component of the estimated annual effective tax rate.
We have not provided for withholding and U.S. taxes for the unremitted earnings of certain non-U.S. subsidiaries because we have currently reinvested these earnings indefinitely in these foreign operations. At December 31, 2010, we had approximately $2,109.4 million in unremitted earnings outside the United States for which withholding and U.S. taxes were not provided. Income tax expense would be incurred if these funds were remitted to the United States. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against our U.S. tax liability, if any. We annually update our estimate of unremitted earnings outside the United States after the completion of each fiscal year.
Acquisitions
The accounting for acquisitions requires extensive use of estimates and judgments to measure the fair value of the identifiable tangible and intangible assets acquired, including in-process research and development, and liabilities assumed. Additionally, we must determine whether an acquired entity is considered to be a business or a set of net assets, because the excess of the purchase price over the fair value of net assets acquired can only be recognized as goodwill in a business combination.
On July 1, 2010, we completed a business combination agreement and effected a revised distribution agreement with our distributor in Turkey. We paid $33.0 million for the termination of the original distribution agreement and purchased the commercial assets related to the selling of our products in Turkey for $6.1 million in cash and estimated contingent consideration of $36.7 million as of the acquisition date. On January 15, 2010, we acquired Serica Technologies, Inc., or Serica, for an aggregate purchase price of approximately $63.7 million, net of cash acquired. On June 17, 2011, we acquired Alacer Biomedical, Inc., or Alacer, for an aggregate purchase price of approximately $7.0 million, net of cash acquired. We accounted for these acquisitions as business combinations. The tangible and intangible assets acquired and liabilities assumed in connection with these acquisitions were recognized based on their estimated fair values at the acquisition dates. The determination of estimated fair values requires significant estimates and assumptions including, but not limited to, determining the timing and estimated costs to complete the in-process projects, projecting regulatory approvals, estimating future cash flows and developing appropriate discount rates. We believe the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions.
Impairment Evaluations for Goodwill and Purchased Intangible Assets
We evaluate goodwill for impairment on an annual basis, or more frequently if we believe indicators of impairment exist, by comparing the carrying value of each of our reporting units to their estimated fair value. We have identified two reporting units, specialty pharmaceuticals and medical devices, and currently perform our annual evaluation as of October 1 each year.
We primarily use the income approach and the market approach to valuation that include the discounted cash flow method, the guideline company method, as well as other generally accepted valuation methodologies to determine the fair value of our reporting units. Upon completion of the October 2010 annual impairment assessment, we determined that no impairment was indicated as the estimated fair value of each of the two reporting units exceeded its respective carrying value. As of June 30, 2011, we do not believe any significant indicators of impairment exist for our goodwill that would require additional analysis.
We also review purchased intangible assets for impairment when events or changes in circumstances indicate that the carrying value of our intangible assets may not be recoverable. An impairment in the carrying value of an intangible asset is recognized whenever anticipated future undiscounted cash flows from an intangible asset are estimated to be less than its carrying value.
In March 2011, we decided to discontinue development of the EasyBand™ Remote Adjustable Gastric Band System, or EasyBand™, a technology that we acquired in connection with our 2007 acquisition of EndoArt SA, or EndoArt. As a result,