Patheon Reports Third Quarter 2008 Results

TORONTO, Sep. 5, 2008 (Canada NewsWire via COMTEX) -- PTI | Quote | Chart | News | PowerRating -- Revenue advances 18% (12% in local currencies) over prior year

Patheon (TSX:PTI) today announced its results for the third quarter ended July 31, 2008 with revenue of $195.0 million, 18% higher than last year (12% in local currencies), and EBITDA before repositioning expenses of $24.7 million versus $20.6 million in the prior year. The current year EBITDA growth was achieved after absorbing incremental costs of $3.3 million related to a previously announced early retirement program in Cincinnati, a $1.3 million non-cash foreign exchange loss (versus a $3.6 million gain in the prior year) and operating expenses associated with a wide range of initiatives related to the restructuring of the Company.

"This quarter we experienced strong revenue growth from a broad base of existing customers. In addition we continued to improve the underlying profitability of the operations, the benefits of which are somewhat masked by our near term restructuring actions" said Wes Wheeler, President and Chief Executive Officer, Patheon Inc. "Our focus this quarter was to implement people, process and operational changes to build a great company. Many of these initiatives required additional spending in the quarter. To date we've invested in global training of staff in our Patheon Advantage(TM) (LeanSixSigma) program, reduced headcount with severance programs to streamline operations, continued to build our executive team and entered into an agreement to change the terms of our Preferred Shares that will simplify our financial reporting and will eliminate a major source of foreign exchange volatility. All of these initiatives are important elements of our turnaround strategy."

Third Quarter 2008 Operating Results from Continuing Operations

Consolidated revenue increased 18% (12% in local currencies) to $195.0 million over the prior year consolidated revenue of $164.8 million.

Commercial Manufacturing revenues increased 15% year-over-year to $157.3 million driven by strong growth in Europe's existing business base. Revenue increased at all North America locations with the exception of Cincinnati, which was impacted by customer related raw material supply constraints.

Pharmaceutical Development Services (PDS) Q3 2008 revenues increased 32% year-over-year to $37.7 million, with both North America and Europe experiencing strong growth as a result of higher order backlog from contracts signed in the second quarter. "The PDS business growth is a clear demonstration that we offer a unique blend of services that our customers require. We offer talented staff that includes 100 PhD's in six development facilities, most of which are co-located with sophisticated commercial manufacturing equipment" said Wes Wheeler.

Consolidated EBITDA before repositioning expenses was $24.7 million for an EBITDA margin of 12.7% in the third quarter, compared with $20.6 million for an EBITDA margin of 12.5% in the same period last year. The current period includes non-cash net foreign exchange losses on U.S. dollar denominated debt in Canada of $1.3 million compared with a gain of $3.6 million for the same period last year. Additional costs were incurred during the quarter in connection with recruiting executive and senior management positions, consulting fees related to new operational and strategic initiatives, and severance costs.

EBITDA before repositioning expenses for the global commercial operations was $21.7 million in the third quarter of 2008, $6.8 million higher than the same period in 2007. EBITDA growth was achieved across all regions with the exception of Cincinnati, reflecting the benefits of revenue growth and cost saving initiatives. Cincinnati was impacted by customer-related raw material supply constraints and a $3.3 million charge for an early retirement program, the benefits of which will begin in the fourth quarter of 2008.

EBITDA before repositioning expenses for the global PDS operations was $13.9 million in the third quarter of 2008, $7.5 million higher than the same period in 2007. The PDS operations benefited from strong growth in all regions.

Repositioning expenses for the quarter were $6.7 million attributable to severance accruals for the planned 2009 consolidation of the York Mills and Whitby operations in Canada, and downsizing expense related to establishing the Caguas, Puerto Rico site as a satellite plant to the Manati operation.

<< Third Quarter Year to Date 2008 Operating Results from Continuing Operations >>

Consolidated revenue grew 15% year-over-year (9% in local currencies) to $545.1 million vs. $472.3 million for the prior year. Consolidated EBITDA before repositioning expenses was $57.9 million reflecting an EBITDA margin of 10.6% year to date, compared with $60.5 million for an EBITDA margin of 12.8% in the same period last year. This included non-cash net foreign exchange losses on U.S. dollar denominated debt in Canada of $4.1 million compared with a gain of $4.8 million for the same period last year. As noted above, these results also reflect additional costs incurred in connection with recruiting executive and senior management positions, consulting fees related to new operational and strategic initiatives, and severance costs.

Commercial manufacturing revenues increased 14% year-over-year to $442.4 million reflecting growth from the existing customer base in the European and Canadian operations. The growth performance more than offset the loss of two products due to a product market withdrawal and the decision by a customer to repatriate a product. EBITDA before repositioning expenses from the Commercial operations was $53.4 million year to date, $8.9 million higher than the same period in 2007. This EBITDA growth included a benefit of $4.7 million related to weakness of the U.S. dollar, steady improvement in performance in Europe, Canada and Puerto Rico, partially offset by higher energy costs, other restructuring activities and the third quarter results of Cincinnati.

PDS revenues grew 24% year-over-year to $102.7 million reflecting continued broad based growth in all regions. Further growth capacity is currently coming online due to the completion of a new PDS lab facility in Research Triangle Park, N.C., the recently launched clinical packaging operations and a new intermediate scale solid dose pilot facility in Cincinnati. EBITDA before repositioning expenses from the global PDS operations was $29.4 million year to date, $8.4 million higher than the same period in 2007. This reflected the benefit of volume gains in all regions.

Restructuring Activities

Repositioning expenses were $17.3 million during the nine-month period compared to $8.1 million for the same period last year attributable to changes in executive and senior management, the previously announced workforce reduction in Swindon and the on-going York Mills/Whitby consolidation and restructuring of the Puerto Rico operations. The early retirement costs at Cincinnati were included in operating costs, as noted above.

The Company is making significant headcount reductions to increase productivity and drive future profitability. Severance expenses booked year-to-date, planned divestitures and completed divestitures will account for a total headcount reduction relative to October 2007 of approximately 850 or 16% of the Patheon workforce.

Update on Restructuring the Canadian Operations

The Company's plan to close its York Mills facility is on track to transfer the facility's commercial production and development services to the Whitby facility by mid-2009. In the third quarter 2008 the company booked a severance accrual of $4.4 million for employee related repositioning expenses at York Mills and Whitby. The consolidation of the York Mills and Whitby operations will provide the company with an efficient plant structure in Canada, the benefits of which will begin to be realized in the second half of 2009.

Update on Carolina Facilities

The Carolina operations are classified as a discontinued operation, with related assets and liabilities being classified as held for sale. Based on discussions with interested third parties, it has been determined that the carrying value of the assets is impaired. The loss from discontinued operations for the three months ended July 31, 2008 includes an impairment charge of $7.7 million to write down the Carolina assets to their fair market value less estimated disposition costs.

Outlook

Due to normal summer shutdowns, particularly in Europe, revenues for the fourth quarter of 2008 are expected to be lower than revenues for the third quarter of 2008 and could be subject to fluctuations in the strength of the U.S. dollar.

These expectations are based on internal management forecasts, which in the case of the revenue forecasts, are based on client purchase orders and forecasts of anticipated demand and other factors. These internal management forecasts were prepared for internal planning purposes and may not be appropriate for forecasting future financial results or for other purposes.

Convertible Preferred Shares

The Company is also announcing today that it has entered into an agreement with JLL Patheon Holdings, LLC under which JLL has agreed to waive its right to the mandatory redemption provision of the Company's convertible preferred shares. In consideration JLL will receive 400,000 restricted voting shares of the Company. The Patheon Board of Directors has also agreed to a limited waiver of the standstill provision under the investor agreement with JLL that will allow JLL to acquire restricted voting shares in the open market over 12 months equal to no more than 1% of the equity of the Company including the restricted voting shares issuable under the convertible preferred shares.

"The change in the terms of the agreement allows Patheon to reclassify to equity from a combination of debt and equity the full value of the preferred shares. This eliminates both a non-cash accretive interest charge and a significant foreign exchange exposure, and results in a revised financial statement presentation that clarifies the true financial nature of the convertible preferred shares. It also eliminates a potential cash redemption of the preferred shares in 2017 that would have been at least $185 million" said Eric Evans, Chief Financial Officer of Patheon.

The change in terms will result in a deemed repayment of the debt and equity components of the preferred shares. Based on current market conditions the Company anticipates that it will recognize in the fourth quarter a non-cash gain of approximately $28 million on the deemed repayment of the debt component. The agreement will result in a net increase in shareholders' equity of approximately $152 million.

The agreement is subject to TSX approval and is expected to be completed during the fourth quarter. Additional details on the Agreement can be found in the Company's third quarter MD&A.

Notes

The consolidated results for the third quarter of 2008 and comparative prior periods presented in this news release reflect the results for the Company's continuing operations. The results for Niagara-Burlington operations, which were divested at the end of the first quarter 2008 and the Carolina, Puerto Rico operations have been segregated and presented separately as discontinued operations in the consolidated financial statements. All amounts are in U.S. dollars unless otherwise indicated.

ABOUT PATHEON

Patheon Inc. (TSX:PTI; www.patheon.com) is a leading global provider of contract development and manufacturing services to the global pharmaceutical industry. Patheon prides itself in providing the highest quality products and services to more than 300 of the world's leading pharmaceutical and biotechnology companies. Patheon's services range from preclinical development through commercial manufacturing of a full array of dosage forms including parenteral, solid, semi-solid and liquid forms. Patheon uses many innovative technologies including single-use disposables, Liquid-Filled Hard Capsules and a variety of modified release technologies.

Patheon's comprehensive range of fully integrated Pharmaceutical Development Services includes pre-formulation, formulation, analytical development, clinical manufacturing, scale-up and commercialization. Patheon can take customers direct to clinic with global clinical packaging and distribution services and Patheon's Quick to Clinic(TM) programs can accelerate early phase development project to clinical trials while minimizing the consumption of valuable API.

Patheon's integrated development and manufacturing network of 11 facilities, and 6 development centers across North America and Europe, strives to ensure that customer products can be launched with confidence anywhere in the world.

Caution Concerning Forward-Looking Statements

This news release contains forward-looking statements which reflect management's expectations regarding the Company's future growth, results of operations, performance (both operational and financial) and business prospects and opportunities. Wherever possible, words such as "plans", "expects" or "does not expect", "forecasts", "anticipates" or "does not anticipate", "believes", "intends" and similar expressions or statements that certain actions, events or results "may", "could", "would", "might" or "will" be taken, occur or be achieved have been used to identify these forward-looking statements. Although the forward-looking statements contained in this press release reflect management's current assumptions based upon information currently available to management and based upon what management believes to be reasonable assumptions, the Company cannot be certain that actual results will be consistent with these forward-looking statements. Current material assumptions relate to customer volumes, regulatory compliance and foreign exchange rates. Forward-looking statements necessarily involve significant known and unknown risks, assumptions and uncertainties that may cause the Company's actual results, performance, prospects and opportunities in future periods to differ materially from those expressed or implied by such forward-looking statements. These risks and uncertainties include, among other things: the inability to complete transactions as a result of failure to satisfy closing conditions, including receipt of regulatory approvals, regulatory approval of and market demand for client products; credit and client concentration; the ability to identify and secure new contracts; regulatory matters, including compliance with pharmaceutical regulations; international operations risks; exposure to foreign currency risks; competition; product liability claims; intellectual property; environmental, health and safety risks; substantial financial leverage; interest rates; proposed divestiture of the Carolina site; initiatives to reduce operating expenses; use of non-GAAP financial measures, significant shareholders; risks associated with information systems; and supply arrangements. Although the Company has attempted to identify important risks and factors that could cause actual actions, events or results to differ materially from those described in forward-looking statements, there may be other factors and risks that cause actions, events or results not to be as anticipated, estimated or intended. There can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Accordingly, readers should not place undue reliance on forward-looking statements. These forward-looking statements are made as of the date of this news release and, except as required by law, the Company assumes no obligation to update or revise them to reflect new events or circumstances.

Webcast Conference Call with Analysts

Patheon Inc. will host a webcast conference call with financial analysts on its third quarter 2008 results on Friday, September 5, 2008 at 10:00 a.m. (Eastern Time). The call will begin with a brief presentation, followed by a question-and-answer period with investment analysts. Interested parties are invited to access the live call, via telephone, in listen-only mode, at (416) 644-3414 (Toronto and International) or toll free at (800) 733-7571 (U.S., including Puerto Rico). Listeners are encouraged to dial in five to 15 minutes in advance to avoid delays. A live audio webcast will also be available via the web at www.patheon.com. An archived version of the Q3 webcast will be available on www.patheon.com for three months.

<< Unaudited Consolidated Financial Statements for the three and nine months ended July 31, 2008 Consolidated Statements of Loss (unaudited) Three months ended July 31, Nine months ended July 31, 2008 2007 % 2008 2007 % ------------------------------------------------------------------------- (in thousands of U.S. dollars, except loss per share) $ $ Change $ $ Change ------------------------------------------------------------------------- Revenues 194,976 164,737 18.4% 545,145 472,325 15.4% -------------------------- --------------------------- Operating expenses 168,977 147,722 14.4% 483,165 416,652 16.0% Foreign exchange loss (gain) on debt (note 7) 1,281 (3,634) -135.3% 4,105 (4,790) -185.7% Repositioning expenses (note 6) 6,685 1,189 462.2% 17,332 8,131 113.2% Depreciation and amortization 12,034 9,390 28.2% 33,890 28,935 17.1% Amortization of intangible assets 471 471 0.0% 1,413 1,414 -0.1% Foreign exchange loss on foreign operations - - - 858 Interest 8,342 7,356 13.4% 24,117 21,659 11.3% Refinancing expenses - - - 13,471 --------------------------- -------------------------- Earnings (loss) from continuing operations before income taxes (2,814) 2,243 -225.5% (18,877) (14,005) -34.8% Provision for income taxes 1,721 5,608 -69.3% 4,344 14,886 -70.8% --------------------------- -------------------------- Loss from continuing operations (4,535) (3,365) -34.8% (23,221) (28,891) 19.6% --------------------------- -------------------------- (as a % of revenues) -2.3% -2.0% -4.3% -6.1% Loss from discontinued operations (note 2) (10,147) (59,704) 83.0% (15,124) (58,188) 74.0% --------------------------- -------------------------- Net loss for the period (14,682) (63,069) 76.7% (38,345) (87,079) 56.0% --------------------------- -------------------------- --------------------------- -------------------------- Basic and diluted loss per share From continuing (5.0 (3.7 (25.6 (31.1 operations cents) cents) -35.1% cents) cents) 17.7% From discontinued (11.2 (64.2 (16.7 (62.6 operations cents) cents) 82.6% cents) cents) 73.3% --------------------------- -------------------------- (16.2 (67.9 (42.3 (93.7 cents) cents) 76.1% cents) cents) 54.9% --------------------------- -------------------------- Average number of shares outstanding during period - basic and diluted (in thousands) 90,742 92,959 -2.4% 90,667 92,956 -2.5% --------------------------- -------------------------- see accompanying notes Consolidated Balance Sheets (unaudited) As at As at July 31, October 31, 2008 2007 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ ------------------------------------------------------------------------- Assets Current Cash and cash equivalents 34,054 30,557 Accounts receivable 146,302 127,691 Inventories 83,884 85,991 Prepaid expenses and other 11,411 11,887 Current assets held for sale (note 2) 1,546 16,151 ------------------------ Total current assets 277,197 272,277 ------------------------ Capital assets 478,859 479,682 Intangible assets 5,357 6,770 Deferred costs 7,092 8,878 Future tax assets 34,318 31,039 Goodwill 3,375 3,658 Investments 2,178 946 Long-term assets held for sale (note 2) 1,942 26,367 ----------------------- 810,318 829,617 ----------------------- ----------------------- Liabilities and Shareholders' equity Current Bank indebtedness 20,834 8,224 Accounts payable and accrued liabilities 170,001 159,335 Income taxes payable 7,759 4,684 Current portion of long-term debt 11,984 11,719 Current liabilities related to assets held for sale (note 2) 17 7,743 ------------------------ Total current liabilities 210,595 191,705 ------------------------ Long-term debt 208,390 203,615 Deferred revenues 25,185 25,994 Future tax liabilities 43,634 47,397 Convertible preferred shares - debt component 151,205 139,916 Other long-term liabilities 20,968 22,069 Long-term liabilities related to assets held for sale (note 2) 20 1,736 ------------------------ Total liabilities 659,997 632,432 ------------------------ Shareholders' equity Convertible preferred shares - equity component 15,925 15,925 Restricted voting shares 392,395 391,967 Contributed surplus 6,164 4,049 Deficit (324,595) (286,250) Accumulated other comprehensive income 60,432 71,494 ------------------------ Total shareholders' equity 150,321 197,185 ------------------------ 810,318 829,617 ------------------------ ------------------------ see accompanying notes Consolidated Statements of Changes in Shareholders' Equity (unaudited) Nine months ended July 31, 2008 2007 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ ------------------------------------------------------------------------- Convertible preferred shares - equity component Balance at beginning of period 15,925 - Shares issued during the period, net of issue costs - 15,925 ----------------------- Balance at end of period 15,925 15,925 ----------------------- Restricted voting shares Balance at beginning of period 391,967 400,721 Shares issued during the period, net of issue costs 428 24 ----------------------- Balance at end of period 392,395 400,745 ----------------------- Contributed surplus Balance at beginning of period 4,049 3,829 Stock options 2,115 168 ----------------------- Balance at end of period 6,164 3,997 ----------------------- Deficit Balance at beginning of period (286,250) (189,900) Adjustment related to change in accounting policy - (1,749) Net loss for the period (38,345) (87,079) ----------------------- Balance at end of period (324,595) (278,728) ----------------------- Accumulated other comprehensive income Balance at beginning of period 71,494 36,081 Transition adjustment - (762) Other comprehensive income (loss) for the period (11,062) 16,958 ----------------------- Balance at end of period 60,432 52,277 ----------------------- Total shareholders' equity at end of period 150,321 194,216 ----------------------- ----------------------- see accompanying notes Consolidated Statements of Comprehensive Loss (unaudited) Three months ended Nine months ended July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ $ $ ------------------------------------------------------------------------- Net loss for the period (14,682) (63,069) (38,345) (87,079) ------------------ ------------------ Other comprehensive income (loss), net of income taxes Change in foreign currency gains on investments in subsidiaries, net of hedging activities(1) (810) 5,545 (4,596) 12,642 Foreign currency losses on investments in subsidiaries, net of hedging activities reclassified to consolidated statement of loss(2) - - - 2,793 Change in value of derivatives designated as foreign currency and interest rate cash flow hedges(3) 1,248 370 (2,115) 1,201 (Gains) losses on foreign currency and interest rate cash flow hedges reclassified to consolidated statement of loss(4) (1,116) (399) (4,351) 322 ------------------ ------------------ Other comprehensive income (loss) for the period (678) 5,516 (11,062) 16,958 ------------------ ------------------ ------------------ ------------------ Comprehensive loss for the period (15,360) (57,553) (49,407) (70,121) ------------------ ------------------ ------------------ ------------------ see accompanying notes The amounts disclosed in other comprehensive income have been recorded net of income taxes as follows: (1) Net of an income tax expense of nil (2007 - nil). (2) Net of an income tax expense of nil (Nine months ended July 31, 2007, recovery of $1,935,000). (3) Net of an income tax expense of $363,000 and income tax recovery of $168,000 for the three and nine months ended July 31, 2008, respectively. (Three and nine months ended July 31, 2007, recovery of $116,000). (4) Net of an income tax recovery of $135,000 and $204,000 for the three and nine months ended July 31, 2008, respectively. (Three and nine months ended July 31, 2007, recovery of $323,000 and $343,000, respectively). Patheon Inc. Consolidated Statements of Cash Flows (unaudited) Three months ended Nine months ended July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- (in thousands of U.S. dollars) $ $ $ $ ------------------------------------------------------------------------- Operating activities Net loss from continuing operations (4,535) (3,365) (23,221) (28,891) Add (deduct) charges to operations not requiring a current cash payment Depreciation and amortization 12,505 9,861 35,303 30,349 Foreign exchange loss (gain) on debt 1,893 (3,634) 4,717 (4,790) Foreign exchange loss on foreign operations - - - 858 Accreted interest on convertible preferred shares 3,861 3,481 11,289 3,481 Other non-cash interest 161 126 421 1,506 Employee future benefits, net of contributions (313) (65) (1,878) 323 Future income taxes (3,240) 2,980 (8,794) 3,146 Amortization of deferred revenues (504) (547) (1,513) (1,516) Other 838 463 2,183 970 ------------------ ------------------ 10,666 9,300 18,507 5,436 Net change in non-cash working capital balances related to continuing operations 5,156 (20,272) (8,949) (27,715) Increase in deferred revenues 623 2,057 2,101 2,057 ------------------ ------------------ Cash provided by (used in) operating activities of continuing operations 16,445 (8,915) 11,659 (20,222) Cash provided by (used in) operating activities of discontinued operations (349) 5,591 (6,545) 15,640 ------------------ ------------------ Cash provided by (used in) operating activities 16,096 (3,324) 5,114 (4,582) ------------------ ------------------ Investing activities Additions to capital assets (15,200) (8,186) (34,050) (20,600) Proceeds on sale of capital assets - - 12,089 - Net increase in investments (926) (293) (1,311) (177) Increase in deferred pre-operating costs - (1,116) - (2,827) ------------------ ------------------ Cash used in investing activities of continuing operations (16,126) (9,595) (23,272) (23,604) Cash provided by (used in) investing activities of discontinued operations - (339) 10,439 (792) ------------------ ------------------ Cash used in investing activities (16,126) (9,934) (12,833) (24,396) ------------------ ------------------ Financing activities Increase in bank indebtedness 3,728 9,078 11,801 7,762 Increase in long-term debt 7,882 6,812 23,822 182,652 Repayment of long-term debt (8,408) (7,018) (23,984) (319,605) Issue of convertible preferred shares - - - 150,000 Convertible preferred share issue cost - equity component - - - (1,213) Issue of restricted voting shares 403 - 428 24 ------------------ ------------------ Cash provided by financing activities of continuing operations 3,605 8,872 12,067 19,620 Cash used in financing activities of discontinued operations (6) (101) (179) (467) ------------------ ------------------ Cash provided by financing activities 3,599 8,771 11,888 19,153 ------------------ ------------------ Effect of exchange rate changes on cash and cash equivalents (279) (1,555) (672) (402) ------------------ ------------------ Net increase (decrease) in cash and cash equivalents during the period 3,290 (6,042) 3,497 (10,227) Cash and cash equivalents, beginning of period 30,764 46,538 30,557 50,723 ------------------ ------------------ Cash and cash equivalents, end of period 34,054 40,496 34,054 40,496 ------------------ ------------------ ------------------ ------------------ see accompanying notes Notes to Unaudited Consolidated Financial Statements for the Three and Nine Months Ended July 31, 2008 (Dollar information in tabular form is expressed in thousands of U.S. dollars) 1. Accounting policies Basis of presentation The accompanying unaudited consolidated financial statements have been prepared by the Company in accordance with Canadian generally accepted accounting principles on a basis consistent with those followed in the most recent audited consolidated financial statements except as noted below. These consolidated financial statements do not include all the information and footnotes required by generally accepted accounting principles for annual financial statements and therefore should be read in conjunction with the audited consolidated financial statements and notes for the year ended October 31, 2007. The preparation of the consolidated financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect: the reported amounts of assets and liabilities; the disclosure of contingent assets and liabilities at the date of the consolidated financial statements; and the reported amounts of revenue and expenses in the reporting period. Management believes that the estimates and assumptions used in preparing its consolidated financial statements are reasonable and prudent, however, actual results could differ from those estimates. Changes in accounting policy Effective November 1, 2007, the Company adopted the Canadian Institute of Chartered Accountants ("CICA") accounting standards Section 3862 "Financial Instruments - Disclosure", Section 3863 "Financial Instruments - Presentation", Section 1535 "Capital Disclosures" and Section 1506 "Accounting Changes". The adoption of the new standards resulted in additional disclosures with regard to financial instruments and the Company's objectives, policies and process for managing capital (notes 8 and 9). The new standards have no impact on the classification and valuation of the Company's consolidated financial instruments. Recently issued accounting pronouncements (a) Inventories The CICA issued a new accounting standard, Section 3031 "Inventories", which requires inventory to be measured at the lower of cost and net realizable value. The standard provides guidance on the types of costs that can be capitalized and requires reversal of previous inventory write-downs if economic circumstances have changed to support the higher inventory values. The Company will adopt this standard beginning November 1, 2008 and is currently evaluating the effects of adopting the new requirements of this standard. (b) General Standards of Financial Statement Presentation The CICA amended Section 1400 "General Standards of Financial Statement Presentation", to include requirements to assess and disclose an entity's ability to continue as a going concern. The Company will adopt the amendments to this standard beginning November 1, 2008 and is currently evaluating the effects of adopting the new requirements of this standard. (c) Goodwill, Intangible Assets and Financial Statement Concepts The CICA has issued a new accounting standard, Section 3064 "Goodwill and Intangible Assets", which clarifies that costs can be deferred only when they relate to an item that meets the definition of an asset, and as a result, start-up costs must be expensed as incurred. Section 1000 "Financial Statement Concepts", was also amended to provide consistency with this new standard. The new and amended standards are effective for the Company beginning November 1, 2008. The Company is currently assessing the impact of these standards on its consolidated financial statements. (d) International Financial Reporting Standards In February 2008, the Canadian Accounting Standards Board announced the adoption of International Financial Reporting Standards ("IFRS") for publicly accountable enterprises. Patheon will be required to adopt IFRS no later than November 1, 2011. The Company is currently evaluating the effects of adopting these standards. 2. Discontinued operations and assets held for sale On April 17, 2007 the Company announced that as part of its strategy to focus on developing and manufacturing prescription pharmaceutical products and to improve the Company's profitability, it planned to restructure its network of pharmaceutical manufacturing facilities in Canada. In connection with this initiative, on January 31, 2008, the Company completed the sale of its Niagara-Burlington commercial manufacturing business to Pharmetics Inc. Pharmetics acquired the assets, including equipment, facilities and land, at the Company's facilities in Fort Erie and Burlington (Gateway Drive) in Ontario. Pharmetics offered employment to all of the commercial manufacturing employees at the two sites and continues to manufacture and supply all of the products manufactured at these sites. Proceeds from the divestiture, net of transaction costs and including post closing adjustments, were $10,492,000. The Company recorded a loss of $601,000 on the disposal. The Company also plans to close its York Mills, Toronto facility and is currently in the process of transferring all commercial production and development services undertaken at its York Mills facility to its site in Whitby. In accordance with this plan, on April 15, 2008 the Company completed the sale of the York Mills property for net proceeds of $11,864,000 and has entered into a lease for up to two years in order to facilitate the decommissioning process. On December 14, 2007, the Company announced that as a result of its comprehensive review of the Puerto Rico operations, with a focus on restructuring the operations, eliminating operating losses and developing a long-term plan for the business, it has decided to retain and continue to streamline its facilities in Caguas and Manati and divest its facility in Carolina. The decision follows the genericization of Omnicef(R) in May 2007 and the resulting significant drop in revenue at the facility. The results of the Niagara-Burlington and Carolina operations have been reported as discontinued operations. Because the business in the York Mills, Toronto facility is being transferred within the existing site network, its results of operations are included in continuing operations. All prior period amounts have been reclassified to conform to the current period presentation. In the third quarter of 2008, based on discussions with third parties interested in purchasing the facilities, the Company recorded an impairment charge of $7,700,000 to write down the carrying value of the Carolina operations long-lived assets to their fair value less estimated disposition costs. In the third quarter of 2007, the Company recorded an impairment charge of $61,609,000. This included a charge of $48,580,000 to write down the carrying value of the Carolina long-lived depreciable assets to their estimated fair value and a charge of $13,029,000 to write down the carrying value of the Niagara-Burlington operations' long-lived assets to their fair value less estimated disposition costs. The results of discontinued operations for the three and nine months ended July 31, 2008 and 2007 are as follows: Three months ended Nine months ended July 31, July 31, 2008 2007 2008 2007 $ $ $ $ ------------------------------------------------------------------------- Revenues 1,689 21,270 16,849 66,386 ------------------------------------------------------------------------- Operating expenses 4,092 17,841 22,946 55,530 Repositioning expenses 24 277 190 988 Asset impairment charge 7,700 61,609 7,700 61,609 Depreciation and amortization - 748 45 2,452 Amortization of intangible assets - 760 324 4,180 Loss on disposal of discontinued operations - - 601 - Interest 20 8 32 40 ------------------------------------------------------------------------- Loss before income taxes (10,147) (59,973) (14,989) (58,413) Provision for (recovery of) income taxes - (269) 135 (225) ------------------------------------------------------------------------- Net loss for the period (10,147) (59,704) (15,124) (58,188) ------------------------------------------------------------------------- ------------------------------------------------------------------------- As at July 31, 2008, the assets and liabilities held for sale relate to the Carolina operations. As at October 31, 2007, the assets held for sale and the related liabilities included the Niagara-Burlington and Carolina operations and the land and buildings at York Mills. In accordance with Section 3475 of the CICA Handbook, long-lived assets held for sale are measured at the lower of their carrying amount or fair value less cost to sell. Assets held for sale and the related liabilities are as follows: As at As at July 31, October 31, ------------------------------------------------------------------------- 2008 2007 $ $ ------------------------------------------------------------------------- Current assets Accounts receivable 317 7,486 Inventories 707 8,045 Prepaid expenses and other 522 620 ------------------------------------------------------------------------- Total current assets 1,546 16,151 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Long-term assets Capital assets 1,942 24,403 Intangible assets - 1,948 Future tax assets - 16 ------------------------------------------------------------------------- Total long-term assets 1,942 26,367 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Current liabilities Accounts payable and accrued liabilities - 7,743 Current portion of long-term debt 17 - ------------------------------------------------------------------------- Total current liabilities 17 7,743 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Long-term liabilities Long-term debt 20 213 Future tax liabilities - - Other long-term liabilities - 1,523 ------------------------------------------------------------------------- Total long-term liabilities 20 1,736 ------------------------------------------------------------------------- 3. Convertible preferred shares and restricted voting shares The following table summarizes information on convertible preferred shares, and restricted voting shares and related matters at July 31, 2008: Outstanding Exercisable Class I preferred shares series C and D outstanding 150,000 Restricted voting shares outstanding 90,749,388 Restricted voting share stock options 6,169,770 3,192,093 Please refer to note 11 "Subsequent Events" with regard to an agreed waiver in the mandatory redemption provision in the Class I preferred shares series C and D. 4. Segmented information The Company is organized and managed as a single business segment, being the provider of commercial manufacturing and pharmaceutical development services. Canadian and foreign continuing operations consist of: Manufacturing location Three months ended July 31, 2008 --------------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues by client's billing location: Canada 5,503 129 2,923 8,555 USA 39,763 36,025 9,614 85,402 Europe 12,468 1,374 79,846 93,688 Other geographic areas 1,456 164 5,711 7,331 ------------------------------------------------------------------------- Total revenues 59,190 37,692 98,094 194,976 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital assets 117,378 114,009 247,472 478,859 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill 3,375 - - 3,375 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Manufacturing location Three months ended July 31, 2007 --------------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues by client's billing locations: Canada 4,515 554 36 5,105 USA 35,223 34,255 4,257 73,735 Europe 7,669 1,272 74,670 83,611 Other geographic areas 1,221 153 912 2,286 ------------------------------------------------------------------------- Total revenues 48,628 36,234 79,875 164,737 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital assets 105,699 110,965 233,662 450,326 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill 3,239 - - 3,239 ------------------------------------------------------------------------- Manufacturing location Nine months ended July 31, 2008 --------------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues by client's billing location: Canada 14,838 616 3,029 18,483 USA 106,220 112,787 31,184 250,191 Europe 39,535 3,356 218,491 261,382 Other geographic areas 3,473 1,737 9,879 15,089 ------------------------------------------------------------------------- Total revenues 164,066 118,496 262,583 545,145 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Manufacturing location Nine months ended July 31, 2007 --------------------------------------------- Canada USA Europe Total $ $ $ $ ------------------------------------------------------------------------- Revenues by client's billing locations: Canada 10,741 903 895 12,539 USA 104,917 117,305 11,016 233,238 Europe 26,732 2,227 190,050 219,009 Other geographic areas 2,791 292 4,456 7,539 ------------------------------------------------------------------------- Total revenues 145,181 120,727 206,417 472,325 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Revenues are attributed to countries based on the location of the client's billing address, capital assets are attributed to the country in which they are located, and goodwill is attributed to the country in which the entity to which the goodwill pertains is located. Revenue information by service activity is as follows: Three months ended July 31, --------------------------------------------- 2008 2007 $ $ ------------------------------------------------------------------------- Commercial manufacturing - prescription 146,046 75% 124,950 76% Commercial manufacturing - over-the-counter 11,227 6% 11,229 7% Development services 37,703 19% 28,558 17% ------------------------------------------------------------------------- 194,976 100% 164,737 100% ------------------------------------------------------------------------- ------------------------------------------------------------------------- Nine months ended July 31, --------------------------------------------- 2008 2007 $ $ ------------------------------------------------------------------------- Commercial manufacturing - prescription 397,754 73% 357,498 76% Commercial manufacturing - over-the-counter 44,645 8% 31,694 6% Development services 102,746 19% 83,133 18% ------------------------------------------------------------------------- 545,145 100% 472,325 100% ------------------------------------------------------------------------- ------------------------------------------------------------------------- 5. Stock-based compensation The Company has an incentive stock option plan. Persons eligible to participate in the plan are directors, officers, and key employees of the Company and its subsidiaries or any other person engaged to provide ongoing management or consulting services to Patheon and its subsidiaries. The plan provides that the maximum number of shares that may be issued under the plan is 7.5% of the sum, at any point in time, of the issued and outstanding restricted voting shares of the Company and the aggregate number of restricted voting shares issuable upon exercise of the conversion rights attaching to the issued and outstanding Class I Preferred Shares, Series C of the Company. As of July 31, 2008, the total number of restricted voting shares issuable under the plan was 9,426,970 of which there are stock options outstanding to purchase 6,169,770 shares. The exercise price of restricted voting shares subject to an option is determined at the time of grant and the price cannot be less than the weighted average market price of the restricted voting shares of Patheon on the Toronto Stock Exchange during the two trading days immediately preceding the grant date. Options generally expire seven to ten years after the grant date and are also subject to early expiry in the event of death, resignation, dismissal or retirement of an optionee. Options generally vest over one to three years, with one-third vesting on each of the first, second and third anniversaries of the grant date for those vesting over three years. For the purposes of calculating the stock-based compensation expense, the fair value of stock options is estimated at the date of the grant using the Black-Scholes option pricing model and the cost is amortized over the vesting period. During the three and nine months ended July 31, 2008, the Company granted 357,140 and 3,560,876 options, respectively. The weighted average fair value of the options granted for the three and nine months ended July 31, 2008 was $1.75 and $1.39, respectively. No options were granted in the third quarter of 2007. The weighted average fair value of 100,000 options granted for the nine months ended July 31, 2007 was $1.92. The following assumptions were used in arriving at the fair value of options issued during the three and nine months ended July 31, 2008: Three months ended Nine months ended July 31, 2008 July 31, 2008 Risk free interest rate 3.6% 3.7% Expected volatility 43% 43% Expected weighted average life of options 5 years 5 years Expected dividends yield 0% 0% Stock-based compensation expense recorded in the three months ended July 31, 2008 was $626,000 (2007 - $74,000). Stock-based compensation expense recorded in the nine months ended July 31, 2008 was $2,115,000 (2007 - $168,000). 6. Repositioning expenses The Company has incurred a number of expenses associated with operational improvements, cost reduction initiatives and in connection with changes in executive management. During the first half of fiscal 2007, the Company also incurred professional fees and other costs in connection with its review of strategic and financial alternatives. The following is a summary of expenses associated with these initiatives (collectively "repositioning expenses") for the three and nine months ended July 31: Three months ended Nine months ended July 31, July 31, ------------------------------------------------------------------------- 2008 2007 2008 2007 $ $ $ $ ------------------------------------------------------------------------- Employee-related expenses 6,832 771 16,800 2,319 Consulting, professional and pro

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