News Column

IMPAX LABORATORIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 25, 2014

The following discussion and analysis, as well as other sections in this report, should be read in conjunction with the consolidated financial statements and related Notes to Consolidated Financial Statements included elsewhere herein. All references to years mean the relevant 12-month period ended December 31. Overview General We are a technology based, specialty pharmaceutical company applying formulation and development expertise, as well as our drug delivery technology, to the development, manufacture and marketing of controlled-release and niche generics, in addition to the development of branded products. As of February 7, 2014, we marketed 117 generic pharmaceuticals, which represent dosage variations of 38 different pharmaceutical compounds through our own Global Pharmaceuticals division; another eight of our generic pharmaceuticals representing dosage variations of three different pharmaceutical compounds are marketed by our alliance and collaboration agreement partners. As of February 7, 2014, we had 35 applications pending at the FDA, in addition to one application tentatively approved by the FDA, and 42 other products in various stages of development for which applications have not yet been filed. In the generic pharmaceuticals market, we focus our efforts on controlled-release generic versions of selected brand-name pharmaceuticals covering a broad range of therapeutic areas and having technically challenging drug-delivery mechanisms or unique product formulations. We employ our technologies and formulation expertise to develop generic products that will reproduce the brand-name product's physiological characteristics but not infringe any valid patents relating to the brand-name product. We generally focus on brand-name products as to which the patents covering the active pharmaceutical ingredient have expired or are near expiration, and we employ our formulation expertise to develop controlled-release versions that do not infringe valid patents covering the brand-name products. We develop specialty generic pharmaceuticals that we believe present certain competitive advantages, such as difficulty in raw materials sourcing, complex formulation or development characteristics or special handling requirements. We have also recently expanded our generic pharmaceutical products portfolio to include alternative dosage form products primarily through alliance and collaboration agreements with third parties. In the brand-name pharmaceuticals market, we are developing products for the treatment of central nervous system ("CNS") disorders. Our brand-name product portfolio currently consists of one late stage branded pharmaceutical product candidate which we are developing internally, RYTARY™ for the treatment of symptomatic Parkinson's disease, and other development-stage projects to which we are applying our formulation and development expertise to develop differentiated, modified, or controlled-release versions of currently marketed (either in the U.S. or outside the U.S.) drug substances. We also sell and promote branded pharmaceutical products developed by an unrelated third-party pharmaceutical company through our direct sales force. We intend to expand our brand-name products portfolio primarily through internal development and also through licensing and acquisition.



We operate in two segments, referred to as the "Global Pharmaceuticals Division" or "Global Division" and the "Impax Pharmaceuticals Division" or "Impax Division."

52 -------------------------------------------------------------------------------- The Global Division develops, manufactures, sells, and distributes generic pharmaceutical products primarily through the following sales channels: the Global Products sales channel, for sales of generic prescription products we sell directly to wholesalers, large retail drug chains, and others; the Private Label Product sales channel, for generic pharmaceutical over-the-counter and prescription products we sell to unrelated third-party customers who in-turn sell the product to third parties under their own label; the Rx Partner sales channel, for generic prescription products sold through unrelated third-party pharmaceutical entities under their own label pursuant to alliance agreements; and the OTC Partner sales channel, for sales of generic pharmaceutical over-the-counter products sold through unrelated third-party pharmaceutical entities under their own label pursuant to alliance agreements. We sell our Global Division products within the continental United States and the Commonwealth of Puerto Rico. We have no sales in foreign countries. Revenues from Global Product sales channel and the Private Label Product sales channel are reported under the caption "Global Product Sales, net" in our consolidated results of operations. We also generate revenue in our Global Division from research and development services provided under a joint development agreement with another pharmaceutical company, and we report such revenue under the caption "Other Revenues" in "Item 15. Exhibits and Financial Statement Schedules - Note 20 - Supplementary Financial Information." The Impax Division is engaged in the development of proprietary branded pharmaceutical products through improvements to already-approved pharmaceutical products to address central nervous system (CNS) disorders. We have one late stage branded pharmaceutical product candidate which we are developing internally, RYTARY™ for the treatment of symptomatic Parkinson's disease, for which the NDA was accepted for filing by the FDA in February 2012. In January 2013, the FDA issued a Complete Response Letter regarding the NDA for RYTARY™. A Complete Response Letter is issued by the FDA'sCenter for Drug Evaluation and Research when the review cycle for a pharmaceutical product candidate is complete and the application is not yet ready for approval. In the Complete Response Letter, the FDA indicated that it required a satisfactory re-inspection of our Hayward manufacturing facility as a result of the warning letter issued to us in May 2011 before the NDA may be approved by the FDA due to the facility's involvement in the development of RYTARY™ and supportive manufacturing and distribution activities. During the assessment of the NDA, we withdrew our Hayward site as an alternative site of commercial production at launch for RYTARY™. We are currently working with the FDA on the appropriate next steps for the RYTARY™ NDA and on resolving the warning letter. The Impax Division also has a number of other product candidates that are in varying stages of development. In addition, the Impax Division is engaged in product sales through a direct sales force focused on selling to physicians, primarily in the CNS community, pharmaceutical products developed by an unrelated third-party pharmaceutical company pursuant to a Distribution, License, Development and Supply Agreement. Additionally, we generate revenue in the Impax Division from research and development services provided under a development and license agreement with another unrelated third-party pharmaceutical company, and we report such revenue in the line item "Research Partner" in our consolidated results of operations. We have entered into several alliance, collaboration or license and distribution agreements with respect to certain of our products and services and may enter into similar agreements in the future. These agreements may require us to relinquish rights to certain of our technologies or product candidates, or to grant licenses on terms which ultimately may prove to be unfavorable to us. Relationships with alliance and collaboration partners may also include risks due to the failure of a partner to perform under the agreement, incomplete marketplace information, inventories, development capabilities, regulatory compliance and commercial strategies of our partners and our agreements may be the subject of contractual disputes. If we, or our partners, are not successful in commercializing the products covered by the agreements, such commercial failure could adversely affect our business. Pursuant to a license and distribution agreement, we are dependent on an unrelated third-party pharmaceutical company to supply us with our authorized generic Adderall XRŪ, which we market and sell. We experienced disruptions related to the supply of our authorized generic Adderall XRŪ under the license and distribution agreement during each of the years ended December 31, 2012, 2011 and 2010. In November 2010, we filed suit against the third party supplier of our authorized generic of Adderall XRŪ for breach of contract and other related claims due to a failure to fill our orders as required by the license and distribution agreement. We entered into a settlement agreement with the third party supplier in February 2013. If we suffer supply disruptions related to our authorized generic Adderall XRŪ product in the future, our revenues and relationships with our customers may be materially adversely affected. Further, we may enter into similar license and distribution agreements in the future. 53

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Critical Accounting Policies and Use of Estimates

The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States (GAAP) and the rules and regulations of the U.S. Securities & Exchange Commission (SEC) require the use of estimates and assumptions, based on complex judgments considered reasonable, and affect the reported amounts of assets and liabilities and disclosure of contingent assets and contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant judgments are employed in estimates used in determining values of tangible and intangible assets, legal contingencies, tax assets and tax liabilities, fair value of share-based compensation related to equity incentive awards issued to employees and directors, and estimates used in applying the Company's revenue recognition policy including those related to accrued chargebacks, rebates, distribution service fees, product returns, Medicare, Medicaid, and other government rebate programs, shelf-stock adjustments, and the timing and amount of deferred and recognized revenue and deferred and amortized product manufacturing costs under the Company's several alliance and collaboration agreements. Actual results may differ from estimated results. Certain prior year amounts have been reclassified to conform to the presentation for the year ended December 31, 2013. Although we believe our estimates and assumptions are reasonable when made, they are based upon information available to us at the time they are made. We periodically review the factors having an influence on our estimates and, if necessary, adjust such estimates. Although historically our estimates have generally been reasonably accurate, due to the risks and uncertainties involved in our business and evolving market conditions, and given the subjective element of the estimates made, actual results may differ from estimated results. This possibility may be greater than normal during times of pronounced economic volatility. Global Product sales, net, and Impax Product sales, net. We recognize revenue from direct sales in accordance with SEC Staff Accounting Bulletin No. 104, Topic 13, "Revenue Recognition" ("SAB 104"). We recognize revenue from direct product sales at the time title and risk of loss pass to customers, which is generally when product is received by the customer. We establish accrued provisions for estimated chargebacks, rebates, distribution service fees, product returns, shelf-stock and other pricing adjustments in the period we record the related sales. Consistent with industry practice, we record an accrued provision for estimated deductions for chargebacks, rebates, distribution service fees, product returns, Medicare, Medicaid, and other government rebate programs, shelf-stock adjustments, and other pricing adjustments, in the same period when revenue is recognized. The objective of recording provisions for these deductions at the time of sale is to provide a reasonable estimate of the aggregate amount we expect to ultimately credit our customers. Since arrangements giving rise to the various sales credits are typically time driven (i.e. particular promotions entitling customers who make purchases of our products during a specific period of time, to certain levels of rebates or chargebacks), these deductions represent important reductions of the amounts those customers would otherwise owe us for their purchases of those products. Customers typically process their claims for deductions in a reasonably timely manner, usually within the established payment terms. We monitor actual credit memos issued to our customers and compare such actual amounts to the estimated provisions, in the aggregate, for each deduction category to assess the reasonableness of the various reserves at each quarterly balance sheet date. Differences between our estimated provisions and actual credits issued have not been significant, and are accounted for in the current period as a change in estimate in accordance with GAAP. We do not have the ability to specifically link any particular sales credit to an exact sales transaction and since there have been no material differences, we believe our systems and procedures are adequate for managing our business. An event such as the failure to report a particular promotion could result in a significant difference between the estimated amount accrued and the actual amount claimed by the customer, and, while there have been none to date, we would evaluate the particular events and factors giving rise to any such significant difference in determining the appropriate accounting. 54 -------------------------------------------------------------------------------- Chargebacks. We have agreements establishing contract prices for specified products with some of our indirect customers, such as managed care organizations, hospitals, and government agencies who purchase our products from drug wholesalers. The contract prices are lower than the prices the customer would otherwise pay to the wholesaler, and the difference is referred to as a chargeback, which generally takes the form of a credit memo issued by us to reduce the gross sales amount we invoiced to our wholesaler customer. We recognize an estimated accrued provision for chargeback deductions at the time we ship the products to our wholesaler customers. The primary factors we consider when estimating the accrued provision for chargebacks are the average historical chargeback credits given, the mix of products shipped, and the amount of inventory on hand at the major drug wholesalers with whom we do business. We monitor aggregate actual chargebacks granted and compare them to the estimated accrued provision for chargebacks to assess the reasonableness of the chargeback reserve at each quarterly balance sheet date. The following table is a roll-forward of the activity in the chargeback reserve for the years ended December 31, 2013, 2012 and 2011: As of December 31, 2013 2012 2011 ($ in 000s) Chargeback reserve Beginning balance $ 18,410$ 22,161$ 14,918 Provision recorded during the period 389,707 209,452



166,504

Credits issued during the period (371,051 ) (213,203 ) (159,261 ) Ending balance $ 37,066$ 18,410



$ 22,161

Provision as a percent of gross product sales 34 % 22 % 23 % The aggregate provision for chargebacks, as a percent of gross product sales, increased to 34% in 2013 from 22% in 2012 primarily as a result of an increase in the estimated provision for chargebacks related to our authorized generic Adderall XRŪ products during the year ended December 31, 2013 due to price erosion resulting from increased competition. In June 2012, an unrelated pharmaceutical company received FDA approval for a competitor product to our authorized generic Adderall XRŪ products and began marketing their product. See "Results of Operations" below for additional discussion on the impact of our authorized generic of Adderall XRŪ product sales on our financial condition. The aggregate provision for chargebacks, as a percent of gross product sales, decreased slightly from 2011 to 2012 primarily as a result of sales of Impax-labeled branded ZomigŪ, which we began selling during the year ended December 31, 2012, and which carries a lower average chargeback amount relative to our other products. The lower chargebacks on Impax-labeled branded ZomigŪ were partially offset by higher chargebacks on sales of our authorized generic Adderall XRŪ and fenofibrate products during the year ended December 31, 2012 which resulted in lower net selling prices for those products. The lower net selling prices on our authorized generic Adderall XRŪ and fenofibrate products were the result of increased competition during the year ended December 31, 2012. With respect to our authorized generic Adderall XRŪ products, in June 2012, an unrelated pharmaceutical company received FDA approval for a competitor product to ours and began marketing their product. With respect to our fenofibrate products, in October 2012, an unrelated pharmaceutical company received FDA approval for a competitor product to our fenofibrate capsules and began marketing their product. See "Results of Operations" below for additional discussion on the impact of our authorized generic of Adderall XRŪ and fenofibrate product sales on our financial condition. 55 -------------------------------------------------------------------------------- Rebates. In an effort to maintain a competitive position in the marketplace and to promote sales and customer loyalty, we maintain various rebate programs with our customers to whom we market our products through our Global Division Global Products sales channel. The rebates generally take the form of a credit memo to reduce the invoiced gross sales amount charged to a customer for products shipped. We recognize an estimated accrued provision for rebate deductions at the time of product shipment. The primary factors we consider when estimating the provision for rebates are the average historical experience of aggregate credits issued, the mix of products shipped and the historical relationship of rebates as a percentage of total gross product sales, the contract terms and conditions of the various rebate programs in effect at the time of shipment, and the amount of inventory on hand at the major drug wholesalers with which we do business. We also monitor aggregate actual rebates granted and compare them to the estimated aggregate provision for rebates to assess the reasonableness of the aggregate rebate reserve at each quarterly balance sheet date. The following table is a roll-forward of the activity in the rebate reserve for the years December 31, 2013, 2012 and 2011: As of December 31, 2013 2012 2011 ($in 000s) Rebate reserve Beginning balance $ 46,011$ 29,164$ 23,547 Provision recorded during the period 193,288 111,099



79,697

Credits issued during the period (150,850 ) (94,252 ) (74,080 ) Ending balance $ 88,449$ 46,011



$ 29,164

Provision as a percent of gross product sales 17 % 12 % 11 % The increase in the provision for rebates as a percent of gross product sales from 2012 to 2013 was principally the result of product sales mix, as well as higher levels of rebates offered on our authorized generic Adderall XRŪ products. The increase in the provision for rebates as a percent of gross product sales from 2011 to 2012 was principally the result of increased competition on our authorized generic Adderall XRŪ and fenofibrate products during the year ended December 31, 2012 which resulted in lower net selling prices. With respect to our authorized generic Adderall XRŪ products, in June 2012, an unrelated pharmaceutical company received FDA approval for a competitor product to ours and began marketing their product. With respect to our fenofibrate products, in October 2012, an unrelated pharmaceutical company received FDA approval for a competitor product to our fenofibrate capsules and began marketing their product. See "Results of Operations" below for additional discussion on the impact of our authorized generic of Adderall XRŪ and fenofibrate product sales on our financial condition. 56

-------------------------------------------------------------------------------- Returns. We allow our customers to return product (i) if approved by authorized personnel in writing or by telephone with the lot number and expiration date accompanying any request and (ii) if such products are returned within six months prior to, or until 12 months following, the products' expiration date. We estimate and recognize an accrued provision for product returns as a percentage of gross sales based upon historical experience of product sales. We estimate the product return reserve using a historical lag period, which is the time between when the product is sold and when it is ultimately returned, and return rates, adjusted by estimates of the future return rates based on various assumptions, which may include changes to internal policies and procedures, changes in business practices, and commercial terms with customers, competitive position of each product, amount of inventory in the wholesaler supply chain, the introduction of new products and changes in market sales information. We also consider other factors, including significant market changes which may impact future expected returns, and actual product returns. We monitor aggregate actual product returns on a quarterly basis and we may record specific provisions for product returns we believe are not covered by historical percentages. The following table is a roll-forward of the activity in the accrued product returns for the years ended December 31, 2013, 2012 and 2011: As of December 31, 2013 2012 2011 ($in 000s) Returns reserve Beginning balance $ 23,440$ 24,101$ 33,755 Provision recorded during the period 11,015 3,003



688

Credits issued during the period (6,366 ) (3,664 ) (10,342 ) Ending balance $ 28,089$ 23,440 $



24,101

Provision as a percent of gross product sales 1.0 % 0.3 %

0.1 % The provision for returns as a percent of gross product sales increased to 1.0% in 2013 as compared to 0.3% in 2012. The primary factor driving the 2013 rate is due to a shifting sales mix within both the generic and brand product divisions. The provision for returns as a percent of gross product sales remained relatively low during the years ended December 31, 2011 and 2012 as the result of low levels of returns for high volume products such as authorized generic Adderall XRŪ and fenofibrate. Credits issued during 2011 included $5.8 million related to a recall of our authorized generic Adderall XRŪ products which was initiated by our unrelated third-party manufacturer of those products. Other credits issued during 2011 amounted to $4.5 million, similar to the total credits issued in 2012. Medicaid and Other Government Pricing Programs. As required by law, we provide a rebate payment on drugs dispensed under the Medicaid, Medicare Part D, TRICARE, and other U.S. government pricing programs. We determine our estimates of the accrued rebate reserve for government programs primarily based on historical experience of claims submitted by the various states, and other jurisdictions, and any new information regarding changes in the pricing programs which may impact our estimate of rebates. In determining the appropriate accrual amount, we consider historical payment rates and processing lag for outstanding claims and payments. We record estimates for government rebate payments as a deduction from gross sales, with corresponding adjustments to accrued liabilities. The accrual for payments under government pricing programs totaled $15,163,000 and $33,794,000 as of December 31, 2013 and 2012, respectively. Shelf-Stock Adjustments. Based upon competitive market conditions, we may reduce the selling price of some of our products to customers for certain future product shipments. We may issue a credit against the sales amount to a customer based upon their remaining inventory of the product in question, provided the customer agrees to continue to make future purchases of product from the Company. This type of customer credit is referred to as a shelf-stock adjustment, which is the difference between the sales price and the revised lower sales price, multiplied by an estimate of the number of product units on hand at a given date. Decreases in selling prices are discretionary decisions made by us in response to market conditions, including estimated launch dates of competing products and estimated declines in market price. The accrued reserve for shelf-stock adjustments totaled $774,000 and $390,000 as of December 31, 2013 and 2012, respectively. Historically, differences between our estimated and actual credits issued for shelf stock adjustments have not been significant. 57

-------------------------------------------------------------------------------- Rx Partner and OTC Partner. Each of our Rx Partner and OTC Partner agreements contain multiple deliverables in the form of products, services and/or licenses over extended periods. Financial Accounting Standards Board ("FASB") Accounting Standards Codification TM ("ASC") Topic 605-25 supplemented SAB 104 and provides guidance for accounting for such multiple-element revenue arrangements. With respect to our multiple-element revenue arrangements that are material to our financial results, we determine whether any or all of the elements of the arrangement should be separated into individual units of accounting under FASB ASC Topic 605-25. If separation into individual units of accounting is appropriate, we recognize revenue for each deliverable when the revenue recognition criteria specified by SAB 104 are achieved for the deliverable. If separation is not appropriate, we recognize revenue and related direct manufacturing costs over the estimated life of the agreement or our estimated expected period of performance using either the straight-line method or a modified proportional performance method. The Rx Partners and OTC Partners agreements obligate us to deliver multiple goods and/or services over extended periods. Such deliverables include manufactured pharmaceutical products, exclusive and semi-exclusive marketing rights, distribution licenses, and research and development services. In exchange for these deliverables, we receive payments from our agreement partners for product shipments and research and development services, and may also receive other payments including royalty, profit sharing, upfront payments, and periodic milestone payments. Revenue received from our partners for product shipments under these agreements is generally not subject to deductions for chargebacks, rebates, product returns, and other pricing adjustments. Royalty and profit sharing amounts we receive under these agreements are calculated by the respective agreement partner, with such royalty and profit share amounts generally based upon estimates of net product sales or gross profit which include estimates of deductions for chargebacks, rebates, product returns, and other adjustments the alliance agreement partners may negotiate with their customers. We record the agreement partner's adjustments to such estimated amounts in the period the agreement partner reports the amounts to us. We apply the updated guidance of ASC 605-25, "Multiple Element Arrangements", to the Strategic Alliance Agreement with Teva Pharmaceuticals Curacao N.V., a subsidiary of Teva Pharmaceutical Industries Ltd. ("Teva Agreement"). We look to the underlying delivery of goods and/or services which give rise to the payment of consideration under the Teva Agreement to determine the appropriate revenue recognition. Consideration received as a result of research and development-related activities performed under the Teva Agreement is initially deferred and recorded as a liability captioned "Deferred revenue". We recognize the deferred revenue on a straight-line basis over our expected period of performance for such services. Consideration received as a result of the manufacture and delivery of products under the Teva Agreement is recognized at the time title and risk of loss passes to the customer which is generally when the product is received by Teva. We recognize profit share revenue in the period earned. OTC Partner revenue is related to our alliance and collaboration agreement with Pfizer, Inc., formerly Wyeth LLC ("Pfizer") and our supply agreement with L. Perrigo Company ("Perrigo") with respect to the supply of over-the-counter pharmaceutical products. The OTC Partner sales channel is no longer a core area of our business, and the over-the-counter pharmaceutical products we sell through this sales channel are older products which are only sold to Pfizer and Perrigo, and which we sell at a loss. We are currently only required to manufacture the over-the-counter pharmaceutical products under our agreements with Pfizer and Perrigo. In order to avoid deferring the losses we incur upon shipment of these products to Pfizer and Perrigo, we recognize revenue, and the associated manufacturing costs, at the time title and risk of loss passes to Pfizer or Perrigo, as applicable, which is generally when the product is shipped by us. We recognize profit share revenue in the period earned. Research Partner. We have entered into development agreements with unrelated third-party pharmaceutical companies under which we are collaborating in the development of five dermatological products, including four generic products and one branded dermatological product, and one branded CNS product. Under each of the development agreements, we received an upfront fee with the potential to receive additional milestone payments upon completion of contractually specified clinical and regulatory milestones. Additionally, we may also receive royalty payments from the sale, if any, of a successfully developed and commercialized branded product under one of the development agreements. We defer and recognize revenue received from the provision of research and development services, including the upfront payment and the milestone payments received before January 1, 2011 on a straight line basis over the expected period of performance of the research and development services. We recognize revenue received from the achievement of contingent research and development milestones after January 1, 2011 currently in the period such payment is earned. We will recognize royalty fee income, if any, as current period revenue when earned. 58 -------------------------------------------------------------------------------- Promotional Partner. We entered into a promotional services agreement with an unrelated third-party pharmaceutical company under which we provided physician detailing sales calls services to promote certain of the unrelated third-party company's branded drug products. We received service fee revenue in exchange for providing this service. We recognized revenue from the provision of physician detailing sales calls as such services were rendered. Our obligation to provide physician detailing sales calls under the promotional services agreement ended on June 30, 2012. Estimated Lives of Alliance and Collaboration Agreements. Because we may defer revenue we receive under our alliance agreements, and recognize it over the estimated life of the related agreement, or our expected period of performance, we are required to estimate the recognition period under each such agreement in order to determine the amount of revenue to be recognized in each period. Sometimes this estimate is based on the fixed term of the particular alliance agreement. In other cases the estimate may be based on more subjective factors as noted in the following paragraphs. While changes to the estimated recognition periods have been infrequent, such changes, should they occur, may have a significant impact on our consolidated financial statements. As an illustration, the consideration received from the provision of research and development services under the Joint Development Agreement with Valeant Pharmaceuticals International, Inc. ("Valeant Agreement"), including the upfront fee and milestone payments received before January 1, 2011, have been initially deferred and are being recognized as revenue on a straight-line basis over our expected period of performance to provide research and development services under the Valeant Agreement. The completion of the final deliverable under the Valeant Agreement represents the end of our estimated expected period of performance, as we will have no further contractual obligation to perform research and development services under the Valeant Agreement, and therefore the earnings process will be complete. The expected period of performance was initially estimated to be a 48 month period, starting in December 2008, upon receipt of the $40.0 million upfront payment, and ending in November 2012. During the year ended December 31, 2012, we extended the end of the revenue recognition period for the Valeant Agreement from November 2012 to November 2013 and during the three month period ended March 31, 2013, we further extended the end of the revenue recognition period for the agreement from November 2013 to December 2014 due to changes in the estimated timing of completion of certain research and development activities under the agreement. This change in estimate was made on a prospective basis and resulted in a reduced periodic amount of revenue recognized in current and future periods. If there are additional changes in the estimated timing of the completion of the final deliverable under the Valeant Agreement, the revenue recognition period will change on a prospective basis at such time the event occurs. If we were to conclude significantly more time will be required to fulfill our contractual obligations, then we would further extend the revenue recognition period, which would further reduce the amount of revenue recognized in future periods. Third-Party Research Agreements. In addition to our own research and development resources, we may use unrelated third-party vendors, including universities and independent research companies, to assist in our research and development activities. These vendors provide a range of research and development services to us, including clinical and bio-equivalency studies. We generally sign agreements with these vendors which establish the terms of each study performed by them, including, among other things, the technical specifications of the study, the payment schedule, and timing of work to be performed. Third-party researchers generally earn payments either upon the achievement of a milestone, or on a pre-determined date, as specified in each study agreement. We account for third-party research and development expenses as they are incurred according to the terms and conditions of the respective agreement for each study performed, with an accrued expense at each balance sheet date for estimated fees and charges incurred by us, but not yet billed to us. We monitor aggregate actual payments and compare them to the estimated provisions to assess the reasonableness of the accrued expense balance at each quarterly balance sheet date. Share-Based Compensation. We recognize the grant date fair value of each option and restricted share over its vesting period. Options and restricted shares granted under the 2002 Plan generally vest over a three or four year period and have a term of ten years. We estimate the fair value of each stock option award on the grant date using the Black-Scholes-Merton option-pricing model, wherein expected volatility is based on historical volatility of our common stock. We base the expected term calculation on the "simplified" method described in SAB No. 107, Share-Based Payment and SAB No. 110, Share-Based Payment, because it provides a reasonable estimate in comparison to our actual experience. We base the risk-free interest rate on the U.S. Treasury yield in effect at the time of grant for an instrument with a maturity that is commensurate with the expected term of the stock options. The dividend yield is zero as we have never paid cash dividends on our common stock, and have no present intention to pay cash dividends. 59

-------------------------------------------------------------------------------- Income Taxes. We are subject to U.S. federal, state and local income taxes, Netherlands income tax and Taiwan R.O.C. income taxes. We create a deferred tax asset, or a deferred tax liability, when we have temporary differences between the financial statement carrying values (GAAP) and the tax bases of our assets and liabilities. Fair Value of Financial Instruments. Our cash and cash equivalents include a portfolio of high-quality credit securities, including U.S. Government sponsored entity securities, treasury bills, corporate bonds, short-term commercial paper, and/or high rated money market funds. Our entire portfolio matures in less than one year. The carrying value of the portfolio approximated the market value at December 31, 2013. We carry our deferred compensation liability at fair value, based upon observable market values. We had no debt outstanding as of December 31, 2013. Our only remaining debt instrument at December 31, 2013 was our credit facility with Wells Fargo Bank, N.A., which would be subject to variable interest rates and principal payments should we decide to borrow under it. Contingencies. In the normal course of business, we are subject to loss contingencies, such as legal proceedings and claims arising out of our business, covering a wide range of matters, including, among others, patent litigation, stockholder lawsuits, and product and clinical trial liability. In accordance with FASB ASC Topic 450 - Contingencies, we record accrued loss contingencies when it is probable a liability will be incurred and the amount of loss can be reasonably estimated and we do not recognize gain contingencies until realized. Goodwill. In accordance with FASB ASC Topic 350, "Goodwill and Other Intangibles", rather than recording periodic amortization of goodwill, goodwill is subject to an annual assessment for impairment by applying a fair-value-based test. Under FASB ASC Topic 350, if the fair value of the reporting unit exceeds the reporting unit's carrying value, including goodwill, then goodwill is considered not impaired, making further analysis not required. We consider each of our Global Division and Impax Division operating segments to be a reporting unit, as this is the lowest level for each of which discrete financial information is available. We attribute the entire carrying amount of goodwill to the Global Division. We concluded the carrying value of goodwill was not impaired as of December 31, 2013 and 2012, as the fair value of the Global Division exceeded its carrying value at each date. We perform our annual goodwill impairment test in the fourth quarter of each year. We estimate the fair value of the Global Division using a discounted cash flow model for both the reporting unit and the enterprise, as well as earnings and revenue multiples per common share outstanding for enterprise fair value. In addition, on a quarterly basis, we perform a review of our business operations to determine whether events or changes in circumstances have occurred that could have a material adverse effect on the estimated fair value of the reporting unit, and thus indicate a potential impairment of the goodwill carrying value. If such events or changes in circumstances were deemed to have occurred, we would perform an interim impairment analysis, which may include the preparation of a discounted cash flow model, or consultation with one or more valuation specialists, to analyze the impact, if any, on our assessment of the reporting unit's fair value. To date, we have not deemed there to be any significant adverse changes in the legal, regulatory or business environment in which we conduct our operations. 60

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Results of Operations



Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Overview:



The following table sets forth our summarized, consolidated results of operations for the years ended December 31, 2013 and 2012:

Year Ended December 31, December 31, Increase/ 2013 2012 (Decrease) (in $000's) $ % Total revenues $ 511,502$ 581,692$ (70,190 ) (12)% Gross profit 199,300 282,554 (83,254 ) (29)% (Loss) income from operations (6,387 ) 82,992



(89,379 ) nm

Income before income taxes 146,940 83,311 63,629 76% Provision for income taxes 45,681 27,438 18,243 66% Net income $ 101,259$ 55,873$ 45,386 81% nm - not meaningful Consolidated total revenues for 2013 decreased $70.2 million, or 12%, as compared to 2012. New product launches increased revenues during the year ended December 31, 2013 by $97.1 million, or 17% compared to the prior year period, primarily related to our January 2013 launch of non-AB rated Oxymorphone Hydrochloride Extended-Release Tablets and our July 2013 launch of authorized generic TrilipixŪ delayed release capsules. Decreased product volumes (excluding new product launches) decreased revenues during the year ended December 31, 2013 by $85.5 million, or 15% compared to the prior year period, while selling price and product mix decreased revenues by $81.8 million, or 14% compared to the prior year period. Revenues from our Global Division decreased $50.3 million during the year ended December 31, 2013, as compared to the prior year period, driven primarily by lower sales of our authorized generic Adderall XRŪ and fenofibrate products, as discussed below. Revenues from our Impax Division decreased $19.8 million in 2013 as compared to 2012, as a result of a decline in sales of our Impax-labeled branded ZomigŪ products. In May 2013, our exclusivity period for branded ZomigŪ tablets and orally disintegrating tablets expired and we launched authorized generic versions of those products in the United States. Net income for the year ended December 31, 2013 was $101.3 million, an increase of $45.4 million as compared to $55.9 million for the year ended December 31, 2012. The increase from the prior year period is primarily attributable to a $102.0 million gain in connection with the settlement of litigation under the June 2010 Endo Settlement Agreement which we recorded as Other Income in the three month period ended March 31, 2013, as well as the receipt of a $48.0 million payment from Shire in the three month period ended March 31, 2013, in connection with the settlement of litigation. 61 --------------------------------------------------------------------------------

Global Division



The following table sets forth results of operations for the Global Division for the years ended December 31, 2013 and 2012:

Year Ended December 31, December 31, Increase/ 2013 2012 (Decrease) (in $000's) $ % Revenues Global Product sales, net $ 383,652$ 421,875$ (38,223 ) (9)% Rx Partner 11,639 6,445 5,194 81% Other Revenues 3,049 20,362 (17,313 ) (85)% Total revenues 398,340 448,682 (50,342 ) (11)% Cost of revenues 253,836 229,355 24,481 11% Gross profit 144,504 219,327 (74,823 ) (34)% Operating expenses: Research and development 41,384 48,604 (7,220 ) (15)% Patent litigation 16,545 9,772 6,773 69% Selling, general and administrative 17,684 15,377 2,307 15% Total operating expenses 75,613 73,753 1,860 3% Income from operations $ 68,891$ 145,574$ (76,683 ) (53)% Revenues Total revenues for the Global Division for the year ended December 31, 2013, were $398.3 million, a decrease of 11% from 2012, resulting from decreases in Global Product sales, net, and Other Revenues, as discussed below. Global Product sales, net, were $383.7 million for the year ended December 31, 2013, a decrease of 9% from the same period in 2012, primarily as a result of lower sales of our authorized generic Adderall XRŪ and our fenofibrate products. With respect to our authorized generic Adderall XRŪ products, we have experienced significant declines in both market share and average net selling prices as a result of an unrelated pharmaceutical company receiving FDA approval in June 2012 for a competitor product that was launched in the market. With respect to sales of our fenofibrate products, the entrance of a competitor in late 2012 to the fenofibrate capsules market adversely impacted our 2013 results. Any further significant diminution in the consolidated revenue and/or gross profit of our authorized generic Adderall XRŪ and fenofibrate products, or any of our other products, due to competition and/or product supply or any other reasons in future periods may materially and adversely affect our consolidated results of operations in such future periods. Rx Partner revenues were $11.6 million for 2013, an increase of 81% over the prior year period resulting primarily from higher profit share receipts earned under the Teva Agreement. Rx Partner revenue also included a charge of $2.0 million in the year ended December 31, 2012 related to the voluntary market withdrawal of our buproprion XL 300 mg products for which there was no similar charge in the current year. Other Revenues were $3.0 million for the year ended December 31, 2013, with the decrease from the prior year period resulting from the recognition of $9.0 million of previously deferred revenue related to our product marketed under our OTC Partner alliance agreement with Pfizer during the year ended December 31, 2012, for which there was no similar amount in the current year, as well as a $6.9 million decrease related to the extension of the revenue recognition period for the Valeant Agreement from November 2012 to November 2013 which resulted from changes in the estimated timing of completion of certain research and development activities under the agreement. 62 --------------------------------------------------------------------------------

Cost of Revenues Cost of revenues was $253.8 million for the year ended December 31, 2013 and $229.4 million for the prior year, an increase of $24.5 million compared to the prior year period. Cost of revenues increased primarily as a result of an intangible asset impairment charge of $13.2 million, as discussed in "Note 8 - Goodwill and Intangible Assets," in addition to an increase in remediation-related costs, manufacturing inefficiencies related to lower production activity, separation expenses and inventory reserves for products discontinued by the Company and other reserves for pre-launch inventory due to delays caused by the warning letter related to our Hayward, California manufacturing facility. These costs were partially offset by lower profit share expense related to sales of our authorized generic Adderall XRŪ during the year ended December 31, 2013 compared to the prior year period.



Gross Profit

Gross profit for the year ended December 31, 2013 was $144.5 million, or approximately 36% of total revenues, as compared to $219.3 million, or approximately 49% of total revenues, in the prior year. Gross profit as a percent of total revenues decreased in 2013 as compared to the prior year period primarily as the result of the intangible asset impairment charge noted above and an increase in expenses associated with new product launch delays caused by the warning letter related to our Hayward, California manufacturing facility, including a $6.4 million charge related to pre-launch inventory for products which will no longer be marketed and $6.7 million of inventory reserves recorded in the three month period ended March 31, 2013 for products discontinued by the Company during the period. Partially offsetting these reductions in gross profit margin was the benefit of lower profit share expenses related to sales of our authorized generic Adderall XRŪ during the year ended December 31, 2013 compared to the prior year period.



Research and Development Expenses

Total research and development expenses for the year ended December 31, 2013 were $41.4 million, a decrease of 15%, as compared to the same period of the prior year. Generic research and development expenses decreased in 2013 compared to the prior year period primarily due to the timing of completion of certain research and development projects.



Patent Litigation

Patent litigation for the year ended December 31, 2013 was $16.5 million, an increase of 69%, as compared to the same period of the prior year. The increase in patent litigation expenses in 2013 of $6.8 million compared to the prior year period was primarily the result of the receipt of $5.0 million in the prior year period for the reimbursement of legal fees received pursuant to the settlement of patent litigation.



Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended December 31, 2013 were $17.7 million, a 15% increase over the prior year period. The increase resulted primarily from an increase in marketing expenses of $1.5 million, in addition to an increase in freight expenses of $0.8 million due to higher product unit volume compared to the prior year period. 63 --------------------------------------------------------------------------------

Impax Division



The following table sets forth results of operations for the Impax Division for the years ended December 31, 2013 and 2012:

Year Ended December 31, December 31, Increase/ 2013 2012 (Decrease) (in $000's) $ % Revenues Impax Product sales, net $ 111,900$ 118,115$ (6,215 ) (5)% Other Revenues 1,262 14,895 (13,633 ) (92)% Total revenue 113,162 133,010 (19,848 ) (15)% Cost of revenues 58,366 69,783 (11,417 ) (16)% Gross profit 54,796 63,227 (8,431 ) (13)% Operating expenses: Research and development 27,470 32,716 (5,246 ) (16)% Selling, general and administrative 44,915 37,896 7,019 19% Total operating expenses 72,385 70,612 1,773 3% Loss from operations $ (17,589 )$ (7,385 )$ (10,204 ) nm nm - not meaningful Revenues Total revenues were $113.2 million for the year ended December 31, 2013, a decrease of $19.8 million compared to 2012, due primarily to a decline in sales of our Impax-labeled branded ZomigŪ products. Other Revenues for the year ended December 31, 2012 included $6.5 million in revenue for amortization of the $11.5 million upfront payment received under our License, Development and Commercialization Agreement with GSK in December 2010, which we recognized as revenue on a straight-line basis over the 24 month development period that ended in December 2012. In addition, our Co-Promotion Agreement with Pfizer ended on June 30, 2012, resulting in the $7.1 million decrease in Promotional Partner revenue for the year ended December 31, 2013.



Cost of Revenues

Cost of revenues was $58.4 million for the year ended December 31, 2013, a decrease of $11.4 million over the prior year period primarily as a result of a decrease of $10.6 million in costs during 2013 compared to the prior year period related to our Impax-labeled branded ZomigŪ products which we commenced selling during 2012. In addition, cost of revenues for the year ended December 31, 2012 included $5.8 million in charges related to our branded products sales force, for which there were no similar amounts included in cost of revenues in the current year period. Charges for our branded products sales force had been included as a component of cost of revenues in the prior year period as the sales force was previously engaged in providing co-promotion services to Pfizer under an agreement which ended on June 30, 2012. Partially offsetting these decreases was a $5.0 million reserve recorded in the three month period ended March 31, 2013 for pre-launch inventory related to RYTARY™, as a result of the Complete Response Letter we received from the FDA during the year ended December 31, 2013. Gross Profit Gross profit for the year ended December 31, 2013 was $54.8 million, a decrease of $8.4 million over the prior year period primarily resulting from recognition of other revenues and related charges in the year ended December 31, 2012 noted above.



Research and Development Expenses

Total research and development expenses for the year ended December 31, 2013 were $27.5 million, a decrease of 16%, as compared to $32.7 million in the prior year period. The $5.2 million decrease for the year ended December 31, 2013 compared to the prior year period was principally driven by a reduction in research and development expenses related to our branded product initiatives. 64

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Selling, General and Administrative Expenses

Selling, general and administrative expenses were $44.9 million in the year ended December 31, 2013 as compared to $37.9 million in the prior year period. Charges for our branded products sales force of $5.8 million had been included as a component of cost of revenues in the prior year period as the sales force was previously engaged in providing co-promotion services to Pfizer under an agreement which ended on June 30, 2012. We also incurred $4.5 million in increased compensation costs related to the expansion of the sales, marketing and administrative group and $1.8 million in increased expenses for administrative support. These increases were partially offset by a $1.2 million and $3.1 million reduction, respectively, in advertising and promotion expenses for ZomigŪ (due to loss of our exclusivity period for branded ZomigŪ tablets and orally disintegrating tablets during 2013) and pre-launch support for RYTARY™. 65

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Corporate and other The following table sets forth corporate general and administrative expenses, as well as other items of income and expense presented below income from operations for the years ended December 31, 2013 and 2012: Year Ended December 31, December 31, Increase/ 2013 2012 (Decrease) (in $000's) $ % General and administrative expenses $ 57,689$ 55,197$ 2,492 5% Total operating expenses 57,689 55,197 2,492 5% Loss from operations (57,689 ) (55,197 ) (2,492 ) (5)% Other income (expense), net 152,447 (138 ) 152,585 nm Interest income 1,299 1,089 210 19% Interest expense 419 632 (213 ) (34)% Income (loss) before income taxes 95,638 (54,878 ) 150,516 nm Provision for income taxes $ 45,681$ 27,438$ 18,243 66% nm - not meaningful



General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2013 were $57.7 million, a $2.5 million increase over the prior period. The increase was principally driven by higher executive severance of $3.1 million and an increase in personnel expenses of $2.5 million, in addition to an increase in information technology resource expenses of $1.0 million compared to the prior year period, partially offset by a decrease in litigation expenses of $2.7 million and a decrease in outside consulting expenses of $1.7 million compared to the prior year period. Other Income (Expense), Net Other income, net of $152.4 million in the year ended December 31, 2013, an increase of $152.6 million from the prior year period, primarily due to a $102.0 million gain in connection with the settlement of litigation under the June 2010 Endo Settlement Agreement which we recorded as Other Income in the three month period ended March 31, 2013, as well as a $48.0 million payment received from Shire in connection with the settlement of litigation in the three month period ended March 31, 2013. In addition, we recorded a $3.0 million gain in connection with the settlement of litigation in Other Income during the three month period ended June 30, 2013. Partially offsetting this income was a $0.9 million loss on disposal of software in the three month period ended March 31, 2013.



Interest Income

Interest income in the year ended December 31, 2013 was $1.3 million, a slight increase from the same period in 2012.

Interest Expense

Interest expense in the year ended December 31, 2013 was $0.4 million, a slight decrease from the same period in 2012.

Income Taxes

During the year ended December 31, 2013, we recorded an aggregate tax provision of $45.7 million for U.S. domestic income taxes and for foreign income taxes. During the year ended December 31, 2012, we recorded an aggregate tax provision of $27.4 million for U.S. domestic income taxes and for foreign income taxes. The increase in the tax provision during 2013 compared to the prior year period resulted from higher income before taxes in the year ended December 31, 2013 as compared to the prior year. The effective tax rate decreased to 31% for the year ended December 31, 2013 as compared to 33% for the year ended December 31, 2012. 66

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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Overview:



The following table sets forth our summarized, consolidated results of operations for the years ended December 31, 2012 and 2011:

Year Ended December 31 December 31 Increase/ 2012 2011 (Decrease) (in $000's) $ % Total revenues $ 581,692$ 512,919$ 68,773 13% Gross profit 282,554 258,295 24,259 9% Income from operations 82,992 99,611 (16,619 ) (17)% Income before income taxes 83,311 98,111 (14,800 ) (15)% Provision for income taxes 27,438 32,616 (5,178 ) (16)% Net income $ 55,873$ 65,495$ (9,622 ) (15)% Consolidated total revenues for 2012 increased $68.8 million, or 13%, as compared to 2011. New product launches increased revenues during the year ended December 31, 2012 by $119.7 million, or 23.3% compared to the prior year period, primarily related to the launch of the Impax labeled branded ZomigŪ products. Increased product volumes (excluding new product launches) increased revenues during the year ended December 31, 2012 by $93.5 million, or 18.2% compared to the prior year period, while selling price and product mix decreased revenues by $144.4 million, or 28.2% compared to the prior year period. In our Global Division, sales of our generic Adderall XRŪ products experienced significant declines in average net selling prices due to increased competition, which were partially offset by higher sales volumes of our fenofibrate products. Net income for the year ended December 31, 2012 was $55.9 million, a decrease of $9.6 million as compared to $65.5 million for the year ended December 31, 2011, primarily attributable to higher selling, general and administrative expenses, and partially offset by sales of Impax-labeled branded ZomigŪ tablets which we began selling in the three month period ended June 30, 2012, and sales of Impax-labeled branded ZomigŪ orally-disintegrating tablets and nasal spray which we began selling in the three month period ended September 30, 2012, and lower income taxes. We continued to earn significant revenues and gross profit from sales of our authorized generic Adderall XRŪ products and fenofibrate products during the year ended December 31, 2012. With respect to our authorized generic Adderall XRŪ products we have experienced significant declines in both market share and average net selling prices as a result of an unrelated pharmaceutical company receiving FDA approval in June 2012 for a competitor product and beginning to market their product. Furthermore, we are dependent on a third-party pharmaceutical company to supply us with the finished product we market and sell through our Global Division and we have experienced disruptions related to the supply of our authorized generic Adderall XRŪ from this third-party pharmaceutical company. With respect to our fenofibrate products, in October 2012, a competitor product to our fenofibrate capsule product was approved for sale by the FDA and began being marketed. 67 --------------------------------------------------------------------------------

Global Division



The following table sets forth results of operations for the Global Division for the years ended December 31, 2012 and 2011:

Year Ended December 31 December 31 Increase/ 2012 2011 (Decrease) (in $000's) $ % Revenues Global Product sales, net $ 421,875$ 443,818$ (21,943 ) (5)% Rx Partner 6,445 26,333 (19,888 ) (76)% Other Revenues 20,362 21,559 (1,197 ) (6)% Total revenues 448,682 491,710 (43,028 ) (9)% Cost of revenues 229,355 242,713 (13,358 ) (6)% Gross profit 219,327 248,997 (29,670 ) (12)% Operating expenses: Research and development 48,604 46,169 2,435 5% Patent litigation 9,772 7,506 2,266 30% Selling, general and administrative 15,377 11,313 4,064 36% Total operating expenses 73,753 64,988 8,765 13% Income from operations $ 145,574$ 184,009$ (38,435 ) (21)% Revenues Total revenues for the Global Division for the year ended December 31, 2012, were $448.7 million, a decrease of 9% from 2011, principally resulting from the decrease in Global Product sales, net and Rx Partner revenues, as discussed below. Global Product sales, net, were $421.9 million for the year ended December 31, 2012, a decrease of 5% from the same period in 2011, primarily as a result of lower sales of our authorized generic Adderall XRŪ, which were partially offset by higher sales of our fenofibrate products. With respect to our authorized generic Adderall XRŪ products we have experienced significant declines in both market share and average net selling prices as a result of an unrelated pharmaceutical company receiving FDA approval in June 2012 for a competitor product and beginning to market such product. With respect to sales of our fenofibrate products, while we experienced an increase resulting from overall market growth during the year ended December 31, 2012, a competitor product to our fenofibrate capsule product was approved for sale by the FDA in October 2012, and began being marketed. Rx Partner revenues were $6.4 million for 2012, a decrease of 76% over the prior year resulting from a profit-share adjustment from Teva under the Teva Agreement realized by us in the year ended December 31, 2011, for which there was no similar amount realized in 2012, as well as lower sales of our generic products marketed through the Teva Agreement. Rx Partner revenue also includes a charge of $2.0 million in the year ended December 31, 2012 related to the voluntary market withdrawal of our buproprion XL 300 mg products in 2012 for which there was no similar charge in the prior year. Other Revenues were $20.4 million for the year ended December 31, 2012, a decrease of $1.2 million resulting from the recognition of a $3.0 million milestone payment in the prior year for which there was no such milestone payment recognized during the year ended December 31, 2012, and a $4.8 million decrease related to the extension of the revenue recognition period for the Valeant Agreement from November 2012 to November 2013 which resulted from changes in the estimated timing of completion of certain research and development activities under the agreement. Partially offsetting this decrease was the recognition of $9.0 million of previously deferred revenue related to our product marketed under our OTC Partner alliance agreement with Pfizer. For additional information on the OTC Partner agreement with Pfizer, see "Item 15. Exhibits and Financial Statement Schedules - Note 12. Alliance and Collaboration Agreements - OTC Partner Alliance Agreement." 68 --------------------------------------------------------------------------------

Cost of Revenues Cost of revenues was $229.4 million for the year ended December 31, 2012 and $242.7 million for the prior year, a decrease of $13.3 million, primarily as a result of lower profit share expense related to sales of our authorized generic Adderall XRŪ. Gross Profit Gross profit for the year ended December 31, 2012 was $219.3 million, or approximately 49% of total revenues, as compared to $249.0 million, or approximately 51% of total revenues, in the prior year. Gross profit in 2012 decreased compared to gross profit in the prior year period primarily as the result of lower sales of our authorized generic Adderall XRŪ products and lower profit share recognized under the Teva Agreement both as described above.



Research and Development Expenses

Total research and development expenses for the year ended December 31, 2012 were $48.6 million, an increase of 5%, as compared to the same period of the prior year. Generic research and development expenses increased primarily due to a $1.0 million increase in spending on FDA remediation matters and a $1.0 million increase in Generic Drug User Fee Act ("GDUFA") filing fees incurred during the year ended December 31, 2012. There were no GDUFA fees in the prior year. Patent Litigation Patent litigation for the year ended December 31, 2012 was $9.8 million, an increase of 30%, as compared to the same period of the prior year. Patent litigation expenses for the year ended December 31, 2012 include a $5.0 million reimbursement of legal fees received pursuant to the settlement of a lawsuit. The increase in patent litigation expenses before the $5.0 million reimbursement was the result of legal activity related to several cases which were not present in the prior year period.



Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended December 31, 2012 were $15.4 million, a 36% increase over the prior year. The increase resulted primarily from a $1.6 million increase in executive-level compensation costs as a result of hiring compared to the prior year period, increased marketing expenses of $1.0 million and increased business development expenses of $0.7 million. 69

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Impax Division



The following table sets forth results of operations for the Impax Division for the years ended December 31, 2012 and 2011:

Year Ended December 31 December 31 Increase/ 2012 2011 (Decrease) (in $000's) $ % Revenues Impax Product sales, net $ 118,121 $ - $ 118,121 nm Other Revenues 14,889 21,209 (6,320 ) (30)% Total revenue 133,010 21,209 111,801 527% Cost of revenues 69,783 11,911 57,872 486% Gross profit 63,227 9,298 53,929 580% Operating expenses: Research and development 32,716 36,532 (3,816 ) (10)% Selling, general and administrative 37,896 7,435 30,461 410% Total operating expenses 70,612 43,967 26,645 61% Loss from operations $ (7,385 )$ (34,669 )$ 27,284 79% nm-not meaningful Revenues Total revenues were $133.0 million for the year ended December 31, 2012, an increase of $111.8 million compared to 2011, due to sales of our Impax-labeled branded ZomigŪ tablets which we began selling during the three month period ended June 30, 2012, and our Impax-labeled branded ZomigŪ orally disintegrating tablets and nasal spray which we began selling during the three month period ended September 30, 2012. Other Revenues includes the recognition of the $11.5 million upfront payment received under our License, Development and Commercialization Agreement with GSK in December 2010, which we recognized as revenue on a straight-line basis over the 24 month development period that ended in December 2012, and $0.8 million received from GSK for clinical trial batches which were shipped to GSK during the year ended December 31, 2012. In addition, under a Development and Co-Promotion Agreement with Endo Pharmaceuticals, Inc. we received an initial $10.0 million upfront payment in June 2010 which we are recognizing as Other Revenue on a straight-line basis over our expected period of performance during the development period, which we currently estimate to be the 91 month period ending December 2017. Finally, our Co-Promotion Agreement with Pfizer ended on June 30, 2012, resulting in the $7.1 million decrease in Other Revenue for the year ended December 31, 2012.



Cost of Revenues

Cost of revenues was $69.8 million for the year ended December 31, 2012, an increase of $57.9 million over the prior year period as a result of $64.0 million in costs related to our Impax-labeled branded ZomigŪ products which we commenced selling during 2012. During the year ended 2011, we included $11.9 million in charges related to our branded products sales force in cost of revenues while we included charges related to our branded products sales force in selling, general and administrative expenses during the six month period ended December 31, 2012. Charges for our branded products sales force had been included as a component of cost of revenues in the prior year period as the sales force was previously engaged in providing co-promotion services to Pfizer under an agreement which ended on June 30, 2012.



Gross Profit

Gross profit for the year ended December 31, 2012 was $63.2 million, an increase of $53.9 million over the prior year period primarily resulting from the commencement of sales of our Impax-labeled branded ZomigŪ products during 2012.

Research and Development Expenses

Total research and development expenses for the year ended December 31, 2012 were $32.7 million, a decrease of 10%, as compared to $36.5 million in the prior year period. The $3.8 million decrease was principally driven by lower clinical study costs of $3.9 million, and $1.8 million of FDA fees related to the filing of the RYTARY™ NDA in December 2011, partially offset by higher outside drug development costs of $1.7 million. 70 --------------------------------------------------------------------------------



Selling, General and Administrative Expenses

Selling, general and administrative expenses were $37.9 million in the year ended December 31, 2012 as compared to $7.4 million in the prior year period. The increase primarily related to an $8.9 million charge related to our branded products sales force as selling, general and administrative expenses during the year ended December 31, 2012. As noted above in our discussion above regarding cost of revenues, we had included charges related to our branded products sales force in cost of revenues during the year ended December 31, 2011 as the branded product sales force had previously been engaged in providing co-promotion services to Pfizer under an agreement which expired on June 30, 2012. The increase in total selling, general and administrative expenses was also driven by $7.9 million of higher sales and marketing expenses related to ZomigŪ, which we launched in April 2012, $5.9 million in pre-launch marketing expenses related to RYTARY™, and higher compensation costs of $5.3 million related to the expansion of the sales and marketing group. 71 --------------------------------------------------------------------------------

Corporate and other The following table sets forth corporate general and administrative expenses, as well as other items of income and expense presented below Income from operations for the years ended December 31, 2012 and 2011: Year Ended December 31 December 31 Increase/ 2012 2011 (Decrease) (in $000's) $ % General and administrative expenses $ 55,197$ 49,729$ 5,468 11% Total operating expenses 55,197 49,729 5,468 11% Loss from operations (55,197 ) (49,729 ) (5,468 ) (11)% Other expense, net (138 ) (2,492 ) 2,354 (94)% Interest income 1,089 1,149 (60 ) (5)% Interest expense 632 157 475 303% Loss before income taxes (54,878 ) (51,229 ) (3,649 ) (7)% Provision for income taxes $ 27,438$ 32,616$ (5,178 ) (16)%



General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2012 were $55.2 million, a $5.5 million increase over the prior period. The increase was driven by higher employee compensation expenses of $3.8 million principally related to an increase in the number of employees over the prior year period, $1.9 million of severance-related charges in 2012, higher professional fees and IT initiatives of $2.1 million in support of strategic growth, partially reduced by lower litigation expenses of $3.8 million.



Other Expense, Net

Other expense, net for the year ended December 31, 2012 decreased primarily due to a charge of $2.3 million in the year ended December 31, 2011 related to the settlement of the Budeprion XL Litigation for which there was no similar charge in 2012. Interest Income Interest income in the year ended December 31, 2012 was $1.1 million, a decrease of $0.1 million from 2011 resulting from lower average balances of short-term investments. Interest Expense Interest expense in the year ended December 31, 2012 was $0.6 million, representing an increase of $0.5 million over the prior year period which was primarily the result of an accrual for estimated interest payable to the IRS related to adjustments to our 2009 U.S. federal income tax return.



Income Taxes

During the year ended December 31, 2012, we recorded an aggregate tax provision of $27.4 million for U.S. domestic income taxes and for foreign income taxes. In the year ended December 31, 2011, we recorded an aggregate tax provision of $32.6 million for U.S. domestic income taxes and for foreign income taxes. The decrease in the tax provision resulted from lower income before taxes in the year ended December 31, 2012 as compared to the prior year. The effective tax rate remained consistent at 33% for the years ended December 31, 2011 and 2012. 72

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Liquidity and Capital Resources

We generally fund our operations with cash from operations; however, we have used proceeds from the sale of debt and equity securities in the past. Our cash from operations consists primarily of the proceeds from the sales of our products and services. We expect to incur significant operating expenses, including research and development activities and patent litigation expenses, for the foreseeable future. In addition, we are generally required to make cash expenditures to manufacture or acquire finished product inventory in advance of selling the finished product to our customers and collecting payment, which may result in significant periodic uses of cash. We believe our existing cash and cash equivalents and short-term investment balances, together with cash expected to be generated from operations, and our bank revolving line of credit, will be sufficient to meet our financing requirements through the next 12 months. We may, however, seek additional financing through alliance, collaboration, and/or licensing agreements, as well as from the debt and equity capital markets to fund capital expenditures, research and development plans, potential acquisitions, and potential revenue shortfalls due to delays in new product introductions or otherwise. Cash and Cash Equivalents At December 31, 2013, we had $184.6 million in cash and cash equivalents, an increase of $42.5 million as compared to December 31, 2012. As more fully discussed below, the increase in cash and cash equivalents during the year ended December 31, 2013 was driven by $149.9 million of cash provided by operating activities and $9.0 million received from the exercise of stock options and employee stock purchase plan contributions, including the related tax benefit, partially offset by net cash used in investing activities of $115.9 million. Cash Flows



Year Ended December 31, 2013 Compared to Year Ended December 31, 2012.

Net cash provided by operating activities for the year ended December 31, 2013 was $149.9 million, an increase of $44.1 million as compared to the prior year $105.8 million net cash provided by operating activities. The period-over-period change in net cash provided by operating activities was driven by higher net income as a result of the payments received in connection with various legal settlements in 2013 partially offset by lower business levels, higher remediation expenses and charges for inventory reserves incurred in relation to the FDA warning letter regarding our Hayward facility. In addition, lower cash payments related to our profit share arrangements were largely offset by an investment in working capital in 2013 versus a reduction of working capital in 2012. The net investment in working capital compared to the prior year was largely driven by accounts receivable and inventory. The 2013 increase in accounts receivable was primarily due to lower cash collections as we experienced some delays in payments. The 2012 decrease in accounts receivable was largely the result of lower sales in the last two months of the year compared to 2011. Net cash used in investing activities for the year ended December 31, 2013, was $115.9 million as compared to $85.8 million for the prior year. The increase in cash used in investing activities was due to a year over year decrease in cash provided by net maturities of short-term investments of $157.0 million. This decrease was partially offset by a decrease in licensing payments of $92.8 million, representing a decrease of $83.8 million of licensing payments to AstraZeneca under the AZ Agreement, net of amounts received from AstraZeneca during the transition period, and a decrease of $9.0 million of licensing payments to Tolmar under the Tolmar Agreement. Purchases of property, plant and equipment for the year ended December 31, 2013 were $32.8 million as compared to $66.9 million for the prior year period. Net cash provided by financing activities for the year ended December 31, 2013 was $9.0 million, representing a decrease of $8.3 million as compared to the prior year $17.3 million of net cash provided by financing activities. The year-over-year decrease in net cash provided by financing activities was due to a $4.4 million decrease in the cash proceeds received from the exercise of stock options and contributions to the employee stock purchase plan and a $3.9 million decrease in tax benefits related to the exercise of employee stock options. 73 --------------------------------------------------------------------------------



Year Ended December 31, 2012 Compared to Year Ended December 31, 2011.

Net cash provided by operating activities for the year ended December 31, 2012 was $105.8 million, an increase of $99.7 million as compared to the prior year $6.1 million net cash provided by operating activities. The period-over-period increase in net cash provided by operating activities principally resulted from higher cash collections from customers resulting in lower levels of accounts receivable, partially offset by higher inventory. The balance of accounts receivable was $92.2 million at December 31, 2012, resulting in a $61.5 million source of cash for the year ended December 31, 2012, compared to the prior year when accounts receivable resulted in a $71.9 million use of cash. The increase in cash provided by accounts receivable for the year ended December 31, 2012, as compared to the prior year, was primarily the result of higher sales of our fenofibrate products, and the commencement of sales of our Impax-labeled ZomigŪ products in 2012, as described above. In addition, higher inventory, primarily finished goods, at December 31, 2012 resulted in a $33.7 million use of cash, as compared to a $5.5 million use of cash in the prior year period. Net cash used in investing activities for the year ended December 31, 2012, amounted to $85.8 million, an increase of $70.8 million in the amount of cash used in investing activities as compared to the prior year of $15.0 million. The increase in cash used in investing activities was due to $83.8 million of licensing payments to AstraZeneca under the AZ Agreement, net of amounts received from AstraZeneca during the transition period, $21.0 million of licensing payments to Tolmar under the Tolmar Agreement and higher capital expenditures of $36.4 million, partially offset by a year-over-year increase in cash provided by net maturities of short-term investments of $70.4 million. Net maturities of short-term investments during the year ended December 31, 2012 resulted in an $85.9 million source of cash, as compared to a $15.5 million source of cash from net maturities during the prior year. Purchases of property, plant and equipment for the year ended December 31, 2012 were $66.9 million as compared to $30.5 million for the prior year period. The decrease in inventory in the year ended December 31, 2013 was due to the charges noted above as well as reduced business levels. The increase in inventory in the year ended December 31, 2012 was largely due to the launch of oxymorphone in the quarter ended March 31, 2013 as well as increased safety stock levels to alleviate stock outs as well as support transfers to our Taiwan facility. Net cash provided by financing activities for the year ended December 31, 2012 was $17.3 million, representing a decrease of $4.0 million as compared to the prior year $21.3 million of net cash provided by financing activities. The year-over-year decrease in net cash provided by financing activities was due to a $2.2 million decrease in the cash proceeds received from the exercise of stock options and contributions to the employee stock purchase plan and a $1.8 million decrease in tax benefits related to the exercise of employee stock options. 74 --------------------------------------------------------------------------------



Commitments and Contractual Obligations

Our contractual obligations as of December 31, 2013 were as follows:

Payments Due by Period Less More Than 1 1-3 3-5 Than 5 ($ in 000s) Total Year Years Years Years Contractual Obligations: Open Purchase Order Commitments $ 48,820$ 48,820 $ --- $ --- $ --- Operating Leases(a) 7,373 2,253 2,106 652 2,362 Construction Contracts(b) 9,750 9,750 --- --- --- Total(c) $ 62,106$ 60,528$ 1,516$ 62 $ --- _____________________________



(a) We lease office, warehouse, and laboratory facilities under non-cancelable

operating leases through December 2015. We also lease certain equipment under

various non-cancelable operating leases with various expiration dates through

May 2016.



(b) Construction contracts are related to ongoing expansion activities at our

manufacturing facility in Taiwan.



(c) Liabilities for uncertain tax positions FASB ASC Topic 740, Sub-topic 10,

were excluded as we are not able to make a reasonably reliable estimate of

the amount and period of related future payments. As of December 31, 2013, we

had a $4.7 million provision for uncertain tax positions.



Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of December 31, 2013.

75 --------------------------------------------------------------------------------

Outstanding Debt Obligations



Senior Lenders; Wells Fargo Bank, N.A.

We have a Credit Agreement, as amended (the "Credit Agreement") with Wells Fargo Bank, N.A., as a lender and as administrative agent (the "Administrative Agent"). The Credit Agreement provides us with a revolving line of credit in the aggregate principal amount of up to $50,000,000 (the "Revolving Credit Facility"). Under the Revolving Credit Facility, up to $10,000,000 is available for letters of credit, the outstanding face amounts of which reduce availability under the Revolving Credit Facility on a dollar for dollar basis. Proceeds under the Credit Agreement may be used for working capital, general corporate and other lawful purposes. We have not yet borrowed any amounts under the Revolving Credit Facility. Our borrowings under the Credit Agreement are secured by substantially all of our personal property assets pursuant to a Security Agreement (the "Security Agreement") entered into by us and the Administrative Agent. As further security, we also pledged to the Administrative Agent, 65% of our equity interest in our wholly owned subsidiary Impax Laboratories (Taiwan), Inc., all of our equity interests in our wholly owned domestic subsidiaries and must similarly pledge all or a portion of our equity interest in future subsidiaries. Under the Credit Agreement, among other things:



? The outstanding principal amount of all revolving credit loans, together with

accrued and unpaid interest thereon, will be due and payable on the maturity

date, which will occur four years following the February 11, 2011 closing

date.



? Borrowings under the Revolving Credit Facility will bear interest, at our

option, at either an Alternate Base Rate (as defined in the Credit Agreement)

plus the applicable margin in effect from time to time ranging from 0.5% to

1.5%, or a LIBOR Rate (as defined in the Credit Agreement) plus the applicable

margin in effect from time to time ranging from 1.5% to 2.5%. We are also

required to pay an unused commitment fee ranging from 0.25% to 0.45% per annum

based on the daily average undrawn portion of the Revolving Credit Facility.

The applicable margin described above and the unused commitment fee in effect

at any given time will be determined based on our Total Net Leverage Ratio (as

defined in the Credit Agreement), which is based upon our consolidated total

debt, net of unrestricted cash in excess of $100 million, compared to

Consolidated EBITDA (as defined in the Credit Agreement) for the immediately

preceding four quarters.

? We may prepay any outstanding loan under the Revolving Credit Facility without

premium or penalty.

? We are required under the Credit Agreement and the Security Agreement to

comply with a number of affirmative, negative and financial covenants. Among

other things, these covenants (i) require us to provide periodic reports,

notices of material events and information regarding collateral, (ii) restrict

our ability, subject to certain exceptions and baskets, to incur additional

indebtedness, grant liens on assets, undergo fundamental changes, change the

nature of its business, make investments, undertake acquisitions, sell assets,

make restricted payments (including the ability to pay dividends and

repurchase stock) or engage in affiliate transactions and (iii) require us to

maintain a Total Net Leverage Ratio (which is, generally, total funded debt,

net of unrestricted cash in excess of $100 million, over EBITDA for the

preceding four quarters) of less than 3.75 to 1.00, a Senior Secured Leverage

Ratio (which is, generally, total senior secured debt over EBITDA for the

preceding four quarters) of less than 2.50 to 1.00 and a Fixed Charge Coverage

Ratio (which is, generally, EBITDA for the preceding four quarters over the

sum of cash interest expense, cash tax payments, scheduled funded debt

payments and capital expenditures during such four quarter period, subject to

certain specified exceptions) of at least 2.00 to 1.00 (with each such ratio

as more particularly defined as set forth in the Credit Agreement). As of

December 31, 2013, we were in compliance with the various covenants contained

in the Credit Agreement and the Security Agreement. We entered into an

amendment to the Credit Agreement on February 20, 2014 which amended certain

of the financial covenants under the Credit Agreement as follows: (A) addition

to the calculation of Consolidated EBITDA of (x) non-recurring remediation and

restructuring charges not to exceed $25.0 million and (y) non-cash charges

related to the impairment of intangible assets, in each case as incurred by us

and our subsidiaries during fiscal year 2014; (B) revision to the Fixed Charge

Coverage Ratio covenant (as described above) such that we are not required to

maintain a Fixed Charge Ratio after the year ended December 31, 2013; and (C)

addition of two covenants requiring us to maintain Consolidated EBITDA of at

least $50.0 million and Minimum Liquidity (which is, generally unrestricted

cash and cash equivalents) of at least $100.0 million, in each case beginning

with the quarter ended March 31, 2014. ? The Credit Agreement contains customary events of default (subject to



customary grace periods, cure rights and materiality thresholds), including,

among others, failure to pay principal, interest or fees, violation of

covenants, material inaccuracy of representations and warranties,

cross-default and cross-acceleration of material indebtedness and other

obligations, certain bankruptcy and insolvency events, certain judgments,

certain events related to the Employee Retirement Income Security Act of 1974,

as amended, and a change of control.



? Following an event of default under the Credit Agreement, the Administrative

Agent would be entitled to take various actions, including the acceleration of

amounts due under the Credit Agreement and seek other remedies that may be taken by secured creditors. 76

--------------------------------------------------------------------------------



During the years ended December 31, 2013, 2012 and 2011, unused line fees incurred under the Credit Agreement and our former credit agreement, which we terminated in February 2011, were $139,000, $95,000 and $144,000, respectively.

Recent Accounting Pronouncements

In December 2011, the FASB issued its updated guidance on balance sheet offsetting. This new standard provides guidance to determine when offsetting in the balance sheet is appropriate. The guidance is designed to enhance disclosures by requiring improved information about financial instruments and derivative instruments. The goal is to provide users of the financial statements the ability to evaluate the effect or potential effect of netting arrangements on an entity's statement of financial position. This guidance will only impact the disclosures within an entity's financial statements and notes to the financial statements and does not result in a change to the accounting treatment of financial instruments and derivative instruments. We were required to adopt this guidance on January 1, 2013 and it did not have a material effect on our consolidated financial statements. In March 2013, the FASB issued updated guidance on foreign currency matters. The update applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets within a foreign entity. We are required to adopt this guidance on January 1, 2014 and we do not expect the adoption to have a material effect on its consolidated financial statements. In July 2013, the FASB issued updated guidance related to presentation of an unrecognized tax benefit. The guidance requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss (NOL) carryforward, or similar tax loss, or tax credit carryforward, rather than as a liability under certain circumstances. We are required to adopt this guidance on January 1, 2014 and we do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.


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