20-F 1 d449828d20f.htm FORM 20-F Form 20-F
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                         

Commission file number 001-35463

 

 

TARO PHARMACEUTICAL INDUSTRIES LTD.

(Exact name of Registrant as specified in its charter)

 

 

N/A

(Translation of Registrant’s name into English)

Israel

(Jurisdiction of incorporation or organization)

14 Hakitor Street, Haifa Bay 26110, Israel

(Address of principal executive offices)

Michael Kalb

Interim Chief Financial Officer

Taro Pharmaceutical Industries Ltd.

c/o Taro Pharmaceuticals U.S.A., Inc.

3 Skyline Drive

Hawthorne, NY 10532

Tel: 914-345-9000

Fax: 914-345-6169

Email: Michael.Kalb@taro.com

(Name, telephone, email and/or facsimile number and address of Company contact person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

None

(Title of Class)

Securities registered or to be registered pursuant to Section 12(g) of the Act:

Ordinary Shares, NIS 0.0001 nominal (par) value per share

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the Annual Report:

44,768,087 Ordinary Shares, NIS 0.0001 nominal (par) value per share, and 2,600 Founders’ Shares NIS 0.00001

nominal (par) value per share were issued and outstanding as of March 31, 2013

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes    þ  No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    ¨  Yes    þ  No

Note—checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    þ  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    þ  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

¨  Large Accelerated Filer    þ  Accelerated Filer    ¨  Non-Accelerated Filer

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  þ    International Financial Reporting Standards as issued
by the International Accounting Standards Board  ¨
   Other  ¨

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    ¨  Item 17    ¨  Item 18

If this is an Annual Report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    þ  No

 

 

 


Table of Contents

INTRODUCTION

We, among other business activities, develop, manufacture and market prescription and over-the-counter (“OTC”) pharmaceutical products, primarily in the United States (the “U.S.”), Canada and Israel. We also develop and manufacture active pharmaceutical ingredients (“APIs”), primarily for use in our finished dosage form products. We were incorporated in 1959 under the laws of the State of Israel. In 1961, we completed the initial public offering of our ordinary shares in the United States. As of March 22, 2012, our ordinary shares are traded on the New York Stock Exchange (the “NYSE”), under the symbol “TARO.”

As used in this Annual Report on Form 20-F for the year ended March 31, 2013 (the “2013 Annual Report”), the terms “we,” “us,” “our,” “Taro” and the “Company” mean Taro Pharmaceutical Industries Ltd. (“Taro Israel”) and its subsidiaries, unless otherwise indicated.

During 2012, our Board of Directors (the “Board”) approved a change in our fiscal year end from December 31 to March 31. The new fiscal year end was effectuated to align our fiscal reporting period and our annual budget planning with that of our major shareholder, Sun Pharmaceutical Industries Ltd. (Reuters: SUN.BO, Bloomberg: SUNP IN, NSE: SUNPHARMA, BSE: 524715) (“Sun Pharma”).

This 2013 Annual Report is being filed in respect of the year ended March 31, 2013, and contains the audited consolidated financial statements for the year then ended. To disclose information as of the latest practicable date and to provide material information to shareholders, this 2013 Annual Report discloses events and other information occurring after the fiscal year ended March 31, 2013.

FORWARD-LOOKING STATEMENTS

Except for the historical information contained in this 2013 Annual Report, the statements contained herein, in particular with respect to our business, financial condition and results of operations, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in “Item 3D – Key Information: Risk Factors” and elsewhere in this Annual Report. We urge you to consider that statements which use the terms “believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate,” “should,” “will,” “may,” “hope” and similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and are subject to risks and uncertainties. Except as required by applicable law, including the securities laws of the United States, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PRESENTATION OF FINANCIAL INFORMATION

Our consolidated financial statements appearing in this 2013 Annual Report are reported in United States dollars in thousands, unless otherwise indicated, and are prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). Totals presented in this 2013 Annual Report may not total correctly due to rounding of numbers.

All references in this 2013 Annual Report to “dollars,” or “$,” are to United States dollars and all references in this Annual Report to “NIS” are to New Israeli Shekels. The published (1) representative exchange rate between the NIS and the dollar for March 31, 2013 was NIS 3.65 per $1.00. The published (2) representative exchange rate between the Canadian dollar and the dollar for March 31, 2013 was $1.02 Canadian dollar per $1.00. No representation is made that the NIS amounts or Canadian dollar amounts could have been, or could be, converted into dollars at rates specified herein or any other rate.

 

 

(1) 

As published by The Bank of Israel.

(2) 

As published by The Bank of Canada.

 

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TABLE OF CONTENTS

 

PART I

     1   

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     1   

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     1   

ITEM 3. KEY INFORMATION

     1   

A. SELECTED FINANCIAL DATA

     1   

B. CAPITALIZATION AND INDEBTEDNESS

     2   

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

     2   

D. RISK FACTORS

     2   

ITEM 4. INFORMATION ON THE COMPANY

     19   

A. HISTORY AND DEVELOPMENT OF THE COMPANY

     19   

B. BUSINESS OVERVIEW

     19   

C. ORGANIZATIONAL STRUCTURE

     28   

D. PROPERTY, PLANT AND EQUIPMENT

     29   

ITEM 4A. UNRESOLVED STAFF COMMENTS

     30   

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     31   

A. OPERATING RESULTS

     31   

B. LIQUIDITY AND CAPITAL RESOURCES

     41   

C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES

     42   

D. TREND INFORMATION

     44   

E. OFF-BALANCE SHEET ARRANGEMENTS

     44   

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

     44   

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     45   

A. DIRECTORS AND SENIOR MANAGEMENT

     45   

B. COMPENSATION

     47   

C. BOARD PRACTICES

     48   

D. EMPLOYEES

     53   

E. SHARE OWNERSHIP

     54   

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     58   

A. MAJOR SHAREHOLDERS

     58   

B. RELATED PARTY TRANSACTIONS

     58   

C. INTERESTS OF EXPERTS AND COUNSEL

     59   

ITEM 8. FINANCIAL INFORMATION

     59   

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

     59   

ITEM 9. THE OFFER AND LISTING

     60   

A. OFFER AND LISTING DETAILS

     60   

B. PLAN OF DISTRIBUTION

     61   

C. MARKETS

     61   

D. SELLING SHAREHOLDERS

     62   

E. DILUTION

     62   

F. EXPENSES OF THE ISSUE

     62   

ITEM 10. ADDITIONAL INFORMATION

     62   

A. SHARE CAPITAL

     62   

B. ISRAELI COMPANIES LAW AND OUR DOCUMENTS OF INCORPORATION

     62   

C. MATERIAL CONTRACTS

     68   

D. EXCHANGE CONTROLS

     68   

E. TAXATION

     68   

F. DIVIDENDS AND PAYING AGENTS

     78   

G. STATEMENT BY EXPERTS

     78   

H. DOCUMENTS ON DISPLAY

     78   

I. SUBSIDIARY INFORMATION

     79   

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     79   

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     80   

 

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PART II

     80   

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     80   

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     80   

ITEM 15. CONTROLS AND PROCEDURES

     80   

ITEM 16. [RESERVED]

     81   

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     81   

ITEM 16B. CODE OF ETHICS

     81   

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     81   

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     82   

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     82   

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     82   

ITEM 16G. CORPORATE GOVERNANCE

     82   

ITEM 16H. MINE SAFETY DISCLOSURE

     85   

PART III

     85   

ITEM 17. FINANCIAL STATEMENTS

     85   

ITEM 18. FINANCIAL STATEMENTS

     85   

ITEM 19. EXHIBITS

     86   

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

A. SELECTED FINANCIAL DATA

We have derived the following selected consolidated financial data for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010 and as of March 31, 2013 and March 31, 2012, from our audited consolidated financial statements set forth elsewhere in this 2013 Annual Report that have been prepared in accordance with U.S. GAAP. We have derived the consolidated selected financial data for each of the years ended December 31, 2009 and 2008 and as of December 31, 2011, 2010, 2009 and 2008 from our audited consolidated financial statements not included in this annual report. You should read the selected consolidated financial data together with “Item 5—Operating and Financial Review and Prospects” and our consolidated financial statements, related notes and other financial information included elsewhere in this 2013 Annual Report. In 2012, we changed our fiscal year end from December 31 to March 31.

 

     Year Ended
March 31,
    Three months
Ended March 31,
    Year Ended December 31,  
     2013     2012     2011     2010     2009     2008  
     U.S. dollars and shares in thousands (except per share data)  

Consolidated Statements of Operations Data:

    

Sales, net

   $ 670,954      $ 145,141      $ 505,668      $ 392,535      $ 355,936      $ 327,351   

Cost of sales

     176,128        45,971        176,143        159,158        147,091        139,510   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     494,826        99,170        329,525        233,377        208,845        187,841   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Research and development, net

     46,508        9,847        30,867        36,393        33,303        33,681   

Selling, marketing, general and administrative

     86,438        23,101        93,918        107,902        100,344        97,125   

Settlements and loss contingencies

     33,300        —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     166,246        32,948        124,785        144,295        133,647        130,806   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     328,580        66,222        204,740        89,082        75,198        57,035   

Financial (income) expenses, net

     (3,931     1,000        (3,697     11,840        13,575        (1,754

Other gain (loss), net

     3,352        (94     609        755        548        469   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     335,863        65,128        209,046        77,997        62,171        59,258   

Tax expense (benefit)

     67,799        17,791        24,551        10,477        (69,657     13,541   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     268,064        47,337        184,495        67,520        131,828        45,717   

Net (loss) income from discontinued operations

     (1,194     66        (1,217     (2,969     (15,077     (15,196
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     266,870        47,403        183,278        64,551        116,751        30,521   

Net income attributable to non-controlling interest

     664        151        598        473        2,728        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

   $ 266,206      $ 47,252      $ 182,680      $ 64,078      $ 114,023      $ 30,521   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income from continuing operations attributable to Taro

   $ 267,400      $ 47,186      $ 183,897      $ 67,047      $ 129,100      $ 45,717   

Net (loss) income from discontinued operations attributable to Taro

     (1,194     66        (1,217     (2,969     (15,077     (15,196
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

   $ 266,206      $ 47,252      $ 182,680      $ 64,078      $ 114,023      $ 30,521   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income per ordinary share from continuing operations attributable to Taro:

            

Basic

   $ 5.99      $ 1.06      $ 4.14      $ 1.66      $ 3.29      $ 1.17   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 5.98      $ 1.06      $ 4.14      $ 1.60      $ 3.18      $ 1.14   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) gain per ordinary share from discontinued operations attributable to Taro:

            

Basic

   $ (0.03   $ —     $ (0.03   $ (0.07   $ (0.38   $ (0.39
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.03   $ —     $ (0.03   $ (0.07   $ (0.37   $ (0.38
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income per ordinary share attributable to Taro:

            

Basic

   $ 5.96      $ 1.06      $ 4.11      $ 1.59      $ 2.91      $ 0.78   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 5.95      $ 1.06      $ 4.11      $ 1.53      $ 2.81      $ 0.76   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of ordinary shares used to compute net income per share:

            

Basic

     44,678        44,476        44,406        40,272        39,232        39,200   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     44,715        44,589        44,491        41,850        40,568        40,423   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Amount is less than $0.01

 

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     As of March 31,      As of December 31,  
     2013      2012      2011      2010      2009      2008  
     (In thousands of U.S. dollars)  

Consolidated Balance Sheet Data:

                 

Working capital (deficiency)

   $ 717,240       $ 454,762       $ 391,048       $ 165,851       $ 59,095       $ (12,773

Property, plant and equipment, net

     145,265         150,750         152,532         163,596         176,168         186,543   

Total assets

     1,106,636         856,424         795,845         556,442         575,889         473,098   

Short-term debt, including current maturities of long-term debt

     11,330         10,957         17,073         28,195         125,367         130,004   

Long-term debt, net of current maturities

     17,269         27,949         27,614         31,225         38,380         58,019   

Shareholders’ equity

     890,961         622,958         571,063         384,513         295,696         164,217   

Dividends

We have never paid cash dividends and we do not anticipate paying any cash dividends in the foreseeable future. Our dividend policy is set forth below in “Item 8.A – Consolidated Statements and Other Financial Information.”

B. CAPITALIZATION AND INDEBTEDNESS

Not applicable.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

D. RISK FACTORS

Our business, operating results and financial condition may be seriously harmed due to any of the following risks, among others. If we do not successfully address the risks facing us, we may experience a material adverse change in on our business, results of operations and financial condition and our share price may decline. We cannot assure you that we will successfully address any of these risks.

Risks Relating to Our Industry

The pharmaceutical industry in which we operate is intensely competitive. We are particularly subject to the risks of competition. For example, the competition we encounter may have a negative impact upon the prices we charge for our products, the market share of our products and our revenue and profitability.

The pharmaceutical industry in which we operate is intensely competitive. The competition which we encounter has an effect on our product prices, market share, revenue and profitability. Depending upon how we respond to this competition, it may have a material adverse effect on us. We compete with:

 

   

generic manufacturers of our brand-name drugs;

 

   

the original manufacturers of the brand-name equivalents of our generic products;

 

   

other drug manufacturers (including brand-name companies that also manufacture generic drugs);

 

   

other generic drug manufacturers; and

 

   

manufacturers of new drugs that may compete with our generic drugs and proprietary products.

Most of the products that we sell are either generic drugs or drugs for which related patents have expired. Most of these products do not benefit from patent protection and are therefore subject to an increased risk of competition. In addition, because many of our competitors have substantially greater financial, production and research and development resources, substantially larger sales and marketing organizations, and substantially greater name recognition than we have, we are particularly subject to the risks inherent in competing with them. For example, many of our competitors may be able to develop products and processes competitive with, or superior to, our own. Furthermore, we may not be able to differentiate our products from those of our competitors, successfully develop or introduce new products that are less costly or offer better performance than those of our competitors or offer purchasers of our products payment and other commercial terms as favorable as those offered by our competitors.

 

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Other pharmaceutical companies frequently take actions to prevent or discourage the use of generic drug products such as ours.

Other pharmaceutical companies have increasingly taken actions, including the use of state and federal legislative and regulatory mechanisms, to prevent, delay or discourage the use of generic equivalents to their products, including generic products that we manufacture or market. If these efforts to delay or prevent generic competition are successful, our ability to sell our generic versions of products may be limited or prevented. This could have a material adverse effect on our future results of operations. These efforts have included, among others:

 

   

filing new patents or extensions of existing patents on products whose original patent protection is about to expire, which could extend patent protection for the product and delay launch of generic equivalents;

 

   

developing patented controlled-release products or other product improvements;

 

   

developing and marketing branded products as OTC products;

 

   

pursuing pediatric exclusivity for brand-name products;

 

   

submitting citizen petitions to request that the Commissioner of the U.S. Food and Drug Administration (“FDA”) take administrative action with respect to an abbreviated new drug application (“ANDA”) approval;

 

   

attaching special patent extension amendments to unrelated federal legislation;

 

   

engaging in state-by-state initiatives to enact legislation that restricts the substitution of some brand-name drugs with generic drugs;

 

   

making arrangements with managed care companies and insurers to reduce the economic incentives to purchase generic pharmaceuticals;

 

   

introducing authorized generics or their own generic equivalents to the marketplace; and

 

   

setting the price of brand-name drugs at or below the price of generic equivalents.

Generally, no additional regulatory approvals are required for brand-name manufacturers to sell directly or through a third party to the generic market. Brand-name products that are licensed to third parties and are marketed under their generic names at discounted prices are known as authorized generics. Such licensing facilitates the sale of generic equivalents of a company’s own brand-name products. Because many brand-name companies are substantially larger than we are and have substantially greater resources than we have, we are particularly subject to the risks of their undertaking to prevent or discourage the use of our products that compete with theirs. Moreover, the introduction of authorized generics may make competition in the generic market more intense. It may also reduce the likelihood that a generic company that obtains the first ANDA approval for a particular product will be the first to market and/or the only generic alternative offered to the market and thus may diminish the economic benefit associated with this position.

We may experience declines in the sales volume and prices of our products as the result of the continuing trend of consolidation of certain customer groups, such as the wholesale drug distribution and retail pharmacy industries, as well as the emergence of large buying groups. The result of such developments could have a material adverse effect on our business, financial position and results of operations, and could cause the market value of our ordinary shares to decline.

We make a significant portion of our sales to a relatively small number of wholesalers, retail drug chains, food chains and mass merchandisers. If demand decreases significantly, our profitability could be negatively impacted. Also, these customers constitute an essential part of the distribution chain for generic pharmaceutical products and continue to undergo significant consolidation. This consolidation may result in these groups gaining additional purchasing leverage and consequently increasing product pricing pressures facing us. In addition, the emergence of large buying groups representing independent retail pharmacies and the prevalence and influence of managed care organizations and similar institutions, potentially enables those groups to negotiate price discounts on our products. The result of these developments may have a material adverse effect on our business, financial position and results of operations, and could cause the market value of our ordinary shares to decline.

 

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New developments by others could make our products or technologies non-competitive or obsolete.

The markets in which we compete and intend to compete continue to undergo rapid and significant technological change. Our competitors may succeed in developing products and technologies that are more effective or less costly than any that we are developing, or that would render our products obsolete and non-competitive.

We anticipate that we will face increased competition in the future as new companies enter the market and novel or advanced technologies emerge. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. Many of our competitors have significantly greater research and development, financial, sales and marketing, manufacturing and other resources than we have. As a result, they may be able to devote greater resources to the development, manufacture, marketing or sale of their products, initiate or withstand substantial price competition, or more readily take advantage of acquisitions or other opportunities.

Our ability to market products successfully depends, in part, upon the acceptance of our products not only by consumers, but also by independent third parties.

Our ability to market generic or proprietary pharmaceutical products successfully depends, in part, on the acceptance of the products by independent third parties (including physicians, pharmacies, government formularies, managed care providers, insurance companies and retailers), as well as patients. In addition, unanticipated side effects or unfavorable publicity concerning any of our products, or any brand-name product of which our generic product is the equivalent, could have an adverse effect on our ability to achieve acceptance by prescribing physicians, managed care providers, pharmacies and other retailers, customers and patients.

Our future profitability depends upon our ability to continue monitoring our inventory levels in the distribution channel.

Our future profitability depends, in part, upon our ability to continue monitoring our inventory levels in the distribution channel. We obtain reports of the amount of our products held in inventory by our wholesaler customers. We use these reports as part of our process for monitoring inventory levels in our distribution channel and our exposure to product returns. If we lose access to these reports, we may not be able to adequately monitor our inventory levels in the distribution channel. The loss of our visibility into the distribution channel could cause inventory levels to build, exceeding market demand and resulting in our incurring significant and unanticipated expenditures to reimburse these wholesaler customers for product returns, which could materially affect our profitability and cash flows in an adverse manner.

Our future profitability depends upon our ability to introduce new generic or innovative products on a timely basis.

Our future profitability depends, to a significant extent, upon our ability to introduce, on a timely basis, new generic or innovative products for which we either are the first-to-market (or among the first-to-market) or can otherwise gain significant market share. Our ability to achieve any of these objectives is dependent upon, among other things, the timing of regulatory approval of these products and the number and timing of regulatory approvals of competing products. Inasmuch as this timing is not within our control, we may not be able to develop and introduce new generic and innovative products on a timely basis, if at all.

To the extent that we succeed in being the first-to-market generic version of a significant product, and particularly if we obtain the 180-day period of market exclusivity for the U.S. market provided under the Drug Price Competition and Patent Term Restoration Act of 1984 (the “Hatch-Waxman Act”), our sales, profits and profitability can be substantially increased in the period following the introduction of such product and prior to a competitor’s introduction of an equivalent product. However, after the end of the 180-day exclusivity period, these sales, along with the profits therefrom, may diminish precipitously.

Our revenue and profits from individual generic pharmaceutical products typically decline as our competitors introduce their own generic equivalents.

Revenue and gross profit derived from generic pharmaceutical products tend to follow a pattern based on regulatory and competitive factors unique to the generic pharmaceutical industry. As the patents for a brand-name product and the related exclusivity periods expire, the first generic manufacturer to receive regulatory approval for a generic equivalent of the product is

 

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often able to capture a substantial share of the market. However, as other generic manufacturers receive regulatory approvals for competing products, or brand-name manufacturers introduce authorized generics, that market share and the price of that product typically decline. Our overall profitability depends on, among other things, our ability to continuously, and on a timely basis, introduce new products.

Risks Relating to Regulatory Matters

We are subject to extensive government regulation that increases our costs and could delay or prevent us from marketing or selling our products.

We are subject to extensive regulation by the United States, Canada, Israel and other jurisdictions. These jurisdictions regulate the approval, testing, manufacture, labeling, marketing and sale of pharmaceutical products. For example, approval by the FDA is generally required before any new drug or the generic equivalent to any previously approved drug may be marketed in the United States. In order to receive approval from the FDA for each new drug product we wish to market, we must demonstrate, through rigorous clinical trials, that the new drug product is safe and effective for its intended use and that our manufacturing process for that product candidate complies with current Good Manufacturing Practices (“cGMP”). We cannot provide an assurance that the FDA will, in a timely manner, or ever, approve our applications for new drug products. The FDA may require substantial additional clinical testing or find that our drug product does not satisfy the standards for approval. In addition, in order to obtain approval for our product candidates that are generic versions of brand-name drugs, we must demonstrate to the FDA that each generic product candidate is bioequivalent to a drug previously approved by the FDA through the new drug approval process, known as an innovator, or brand-name reference drug. Bioequivalency may be demonstrated by comparing the generic product to the innovator drug product in dosage form, strength, route of administration, quality, performance characteristics and intended use. If the FDA determines that an ANDA for a generic drug product is not adequate to support approval, it could deny our application or request additional information, including clinical trials, which could delay approval of the product and impair our ability to compete with other versions of the generic drug product.

If our product candidates receive FDA approval, the labeling claims and marketing statements that we can make for our new generic products are limited by statutes and regulations and, with respect to our generic drugs, by the labeling claims made in the brand-name product’s packaging. In addition, if the FDA and/or a foreign regulatory authority approves any of our products, the labeling, packaging, adverse event reporting, storage, advertising and promotion for the product will be subject to extensive and ongoing regulatory requirements. As a manufacturer of pharmaceutical products distributed in the United States, we must also comply with cGMPs, which include requirements related to production processes, quality control and assurance and recordkeeping. Products that we manufacture and distribute in foreign jurisdictions may be regulated under comparable laws and regulations in those jurisdictions. The facilities of Taro Pharmaceuticals U.S.A., Inc. (“Taro U.S.A.”), our U.S. subsidiary, our manufacturing facilities and procedures and those of our suppliers are subject to periodic inspection by the FDA and foreign regulatory agencies. Any material deviations from cGMPs or other applicable standards identified during such inspections may result in enforcement actions, including delaying or preventing new product approvals, a delay or suspension in manufacturing operations, consent decrees or civil or criminal penalties. Further, discovery of previously unknown problems with a product or manufacturer may result in restrictions or sanctions with respect to the product, including withdrawal of the product from the market.

In addition, because we market a controlled substance in the United States and other controlled substances in Israel, we must meet the requirements of the United States Controlled Substances Act and its equivalents in Israel, as well as the regulations promulgated thereunder in each country. These regulations include stringent requirements for manufacturing controls, importation, receipt and handling procedures and security to prevent diversion of, or unauthorized access to, the controlled substances in each stage of the production and distribution process. The United States Drug Enforcement Administration (“DEA”) and comparable regulatory authorities in Israel and Canada may periodically inspect our facilities for compliance with the United States Controlled Substances Act and its equivalents in Israel and Canada. Any failure to comply with these laws and regulations could lead to a variety of sanctions, including the revocation, or a denial of renewal, of our DEA registration (or Israeli or Canadian equivalent), injunctions, or civil or criminal penalties.

Furthermore, all of the products that we manufacture and most of the products we distribute are manufactured outside the United States and must be shipped into the United States. The FDA and the DEA, in conjunction with the United States Customs Service, can exercise greater legal authority over goods that we seek to import into the United States than they can over products that are manufactured in the United States.

Although we devote significant time, effort and expense to addressing the extensive government regulations applicable to our business and obtaining regulatory approvals, we remain subject to the risk of being unable to obtain necessary approvals on a timely basis, if at all. Delays in receiving regulatory approvals could adversely affect our ability to market our products.

 

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Product approvals by the FDA and by comparable foreign regulatory authorities may be withdrawn if compliance with regulatory standards is not maintained or if problems relating to the products are experienced after initial approval. In addition, if we fail to comply with governmental regulations we may be subject to fines, unanticipated compliance expenditures, interruptions of our production and/or sales, prohibition of importation, seizures and recalls of our products, criminal prosecution and debarment of us and our employees from the generic drug approval process.

Regulatory authorities may require New Drug Applications for products marketed under the Drug Efficacy Study Implementation Review and Compliance Policy.

Certain drug products were considered safe by the FDA as part of the Drug Efficacy Study Implementation (“DESI”) Review and Compliance Policy Guide Chapter 4, Subchapter 440 of 1968. These products have been marketed for many years and, while considered to be safe for their indicated use, lack data supporting effectiveness. Therefore, the FDA may at any time, or from time to time, review a product on the DESI list to determine if the product requires the submission of a New Drug Application (“NDA”), for the continued marketing of the product in the United States. The filing of an NDA may be expensive, time consuming and require more resources than those available to the Company to support the research for the NDA, thus requiring us to withdraw such DESI products, which we may market from time to time, from the market or to cease marketing them.

Changes in regulatory environment may prevent us from utilizing the exclusivity periods that are important for the success of some of our generic products.

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Medicare Act”) provides that the 180-day market exclusivity period provided under the Hatch-Waxman Act is only triggered by commercial marketing of the product. However, the Medicare Act also contains forfeiture provisions which would deprive the first “Paragraph IV” filer (as defined below) of exclusivity if certain conditions are met. Accordingly, in situations where we are the first “Paragraph IV” filer, we may face the risk of forfeiture and therefore may not be able to exploit a given exclusivity period for specific products.

Under the terms of the Hatch-Waxman Act, a generic applicant must make certain certifications with respect to the patent status of the drug for which it is seeking approval. In the event that such applicant plans to challenge the validity or enforceability of an existing listed patent or asserts that the proposed product does not infringe an existing listed patent, it files a so-called “Paragraph IV” certification. The Hatch-Waxman Act provides for a potential 180-day period of generic exclusivity for the first company to submit an ANDA with a Paragraph IV certification and also lawfully maintains such certification. Such exclusivity prevents the approval of a subsequently submitted ANDA containing a Paragraph IV certification. The Medicare Act modified certain provisions of the Hatch-Waxman Act. Under the Medicare Act, final ANDA approval for a product subject to Paragraph IV patent litigation may be obtained upon the earlier of a favorable district court decision or 30 months from notification to the patent holder of the Paragraph IV filing. Exclusivity rights for the first “Paragraph IV” filer may be forfeited pursuant to the Medicare Act if the product is not marketed within 75 days of the final court decision, if tentative approval or final approval is not timely granted, and under other specified circumstances. Some of the changes made by the Medicare Act apply to ANDAs where the first certification was filed after the enactment of the Medicare Act; previously filed ANDAs generally continue to be governed by the previous law.

Pharmaceutical companies are required by international law to comply with adverse event reporting requirements.

Our failure to meet these reporting requirements in any jurisdiction could result in actions by regulatory authorities in that and/or other jurisdictions, including any of the following: warning letters, public announcements, restriction or suspension of marketing authorizations, revocation of marketing authorizations, fines or a combination of any of these actions.

Health care reform may have an impact on all segments of the health care industry.

On March 23, 2010, the U.S. government enacted the Patient Protection and Affordable Care Act (“PPACA”). A companion bill, the Health Care Education Affordability Reconciliation Act of 2010, which was enacted by the U.S. government on March 30, 2010, contains amendments to the PPACA that reconcile the Senate and House versions of the legislation. Together, these bills (the “Acts”) represent the most comprehensive overhaul ever enacted of both the public and private health care systems in the U.S.A.

 

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The Acts impose on manufacturers a variety of additional rebates, discounts, fees, taxes and reporting and regulatory requirements. In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2010-27, “Other Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers (a consensus of the FASB Emerging Issues Task Force).” This standard addresses how fees mandated by the Acts should be recognized and classified in the income statements of pharmaceutical manufacturers. Under the proposal, the annual fee would be recognized as a liability for the total amount and a corresponding deferred cost over the calendar year and presented as an operating expense. This ASU is effective for calendar years beginning after December 31, 2010. The adoption of ASU 2010-27 did not impact our financial statements during fiscal year ended March 31, 2013 as there were nominal fees charged and we anticipate the fees to be nominal in fiscal year ended March 31, 2014.

Reimbursement policies of third-parties, cost containment measures and healthcare reform could adversely affect the demand for our products and limit our ability to sell our products.

Our ability to market our products depends, in part, on reimbursement levels for them and related treatment established by healthcare providers (including government authorities), private health insurers and other organizations, including health maintenance organizations and managed care organizations. Reimbursement may not be available for some of our products and, even if granted, may not be maintained. Limits placed on reimbursement could make it more difficult for people to buy our products and reduce, or possibly eliminate, the demand for our products. In the event that governmental authorities enact additional legislation or adopt regulations which affect third-party coverage and reimbursement, demand for our products may be reduced with a consequent adverse effect, which may be material, on our sales and profitability.

In addition, the purchase of our products could be significantly influenced by the following factors, among others:

 

   

trends in managed healthcare in the United States;

 

   

developments in health maintenance organizations, managed care organizations and similar enterprises;

 

   

legislative proposals to reform healthcare and government insurance programs; and

 

   

price controls and reimbursement policies.

The Acts are a sweeping measure intended to expand healthcare coverage in the U.S., primarily through the imposition of health insurance mandates on employers and individuals and expansion of the Medicaid program. Among other things, the Acts contain provisions that will change payment levels for pharmaceuticals under Medicaid and increase pharmaceutical rebates under the Medicaid Drug Rebate Program. Effective October 1, 2010, the law changed the formula for calculating federal upper limits (“FUL”), which are a type of cap on the amount a state Medicaid program can reimburse pharmacies for multiple source drugs (drugs for which there are at least three equivalent versions on the market). When these provisions are implemented, the FUL will be calculated based on the weighted-average of the average manufacturer prices (“AMPs”) of the equivalent drugs on the market. In addition, the law changed the preexisting definition of AMP so that it is based only on direct sales to retail community pharmacies and sales to wholesalers who sell to retail community pharmacies. The Centers for Medicare & Medicaid Services (“CMS”) has not yet begun to implement the new FUL provisions and has not issued final regulations to implement the new statutory definition of AMP. We do not know how the new methodology for calculating federal upper limits will affect our pharmacy customers.

In addition, the Acts require CMS to publish and provide states with the weighted-average monthly AMPs for multiple source drugs. CMS has encouraged state Medicaid programs to utilize these AMPs as a benchmark for prescription drug reimbursement in place of the current, widely used benchmark of average wholesale price (“AWP”). CMS has not yet begun to make weighted-average AMPs available to the states or the public. When implemented, the disclosure may have the effect of reducing Medicaid reimbursement rates. We cannot predict how the public disclosure of this information may affect competition in the market place. In addition, a proposed regulation published by CMS would require state Medicaid programs to base their reimbursement rates for brand drugs on pharmacies’ actual acquisition costs, rather than using the current methodologies based on published benchmarks such as AWP or wholesaler acquisition cost. The proposed regulation does not establish a deadline for this transition. If this regulation is finalized as proposed, we do not know how the new Medicaid reimbursement rates will affect our pharmacy customers.

 

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Effective January 1, 2010, the Acts also increased the minimum Medicaid rebate rate from 15.1% to 23.1% of AMP for drugs approved under a NDA, and increased the Medicaid rebate from 11% to 13% of AMP for drugs approved under an ANDA. Also, the volume of rebated drugs has been expanded to include drugs dispensed to beneficiaries in Medicaid managed care organizations. In addition, when CMS issues final implementing regulations, which are expected in 2013, an alternative higher rebate may be imposed on drugs that are line extensions of previously approved drugs. These measures have increased our cost of selling to the Medicaid market.

The full effects of the Acts on Medicaid payment and on our Medicaid rebates cannot be known until all of these provisions are implemented and the CMS issues applicable regulations or guidance, but may have an adverse impact on our results of operations.

Any failure to comply with the complex reporting and payment obligations under the Medicare and Medicaid programs may result in further litigation or sanctions, in addition to the lawsuits.

The U.S. laws and regulations regarding Medicare and/or Medicaid reimbursement and rebates and other governmental programs are complex. Some of the applicable laws may impose liability even in the absence of specific intent to defraud. The subjective decisions and complex methodologies used in making calculations under these programs are subject to review and challenge, and it is possible that such reviews could result in material changes. A number of state attorneys general and others have filed lawsuits alleging that we and other pharmaceutical companies reported inflated average wholesale prices, leading to excessive payments by Medicare and/or Medicaid for prescription drugs. Such allegations could, if proven or settled, result in monetary penalties and possible exclusion from Medicare, Medicaid and other programs. In addition, we are notified from time to time of governmental investigations regarding drug reimbursement or pricing issues.

We are susceptible to product liability claims that may not be covered by insurance and could require us to pay substantial sums.

We face the risk of loss resulting from, and adverse publicity associated with, product liability lawsuits, whether or not such claims are valid. We may not be able to avoid such claims. In addition, our product liability insurance may not be adequate to cover such claims or we may not be able to obtain adequate insurance coverage in the future at acceptable costs. A successful product liability claim that exceeds our policy limits could require us to pay substantial sums. In addition, product liability coverage for pharmaceutical companies is becoming more expensive and, as a result, we may not be able to obtain the type and amount of coverage we desire or to maintain our current coverage.

Product recalls could harm our business.

Product recalls or product field alerts may be issued at our discretion or at the discretion of the FDA, other governmental agencies or other companies having regulatory authority for pharmaceutical product sales. From time to time, we may recall products for various reasons, including failure of our products to maintain their stability through their expiration dates. Any recall or product field alert has the potential of damaging the reputation of the product or our reputation. Any significant recalls could materially affect our sales. In these cases, our business, financial condition, results of operations and cash flows could be materially adversely affected.

Our reputation among consumers and our customers in the pharmacy trade may be negatively impacted by incidents of counterfeiting of our products.

The counterfeiting of pharmaceutical products is a widely reported problem for pharmaceutical manufacturers, distributors, retailers and consumers in the United States, which is our largest market. Such counterfeiting may take the form of illicit producers manufacturing cheaper and less effective counterfeit versions of our products, or producing imitation products containing no active ingredients, and then packaging such counterfeit products in a manner which makes them look like our products. If incidents occurred in which such products prove to be ineffective, or even harmful, to the individuals who used them, consumers and our customers might not buy our products out of fear that they might be ineffective or dangerous counterfeits. In addition, sales of counterfeit products could reduce sales of our legitimate products, which could have a material negative impact on our sales and net income.

 

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The manufacture and storage of pharmaceutical and chemical products are subject to environmental regulation and inherent risk.

Because chemical ingredients are used in the manufacture of pharmaceutical products and due to the nature of the manufacturing process itself, there is a risk of damage caused by or during the storage or manufacture of both the chemical ingredients and the finished pharmaceutical products. Although we have never incurred any material liability for damage of this nature, we may be subject to liability in the future. In addition, while we believe our insurance coverage is adequate, it is possible that a successful claim would exceed our coverage, requiring us to pay a substantial sum.

The pharmaceutical industry is furthermore subject to extensive environmental regulation. We therefore face the risk of incurring liability for damages or the costs of remedying environmental issues because of the chemical ingredients contained in pharmaceutical products and the nature of their manufacturing process. Although we have never incurred any such liability in any material amount, we may be subject to liability in the future. We may also be required to increase expenditures to remedy environmental issues and comply with applicable regulations. If we fail to comply with environmental regulations to use, discharge or dispose of hazardous materials appropriately or otherwise to comply with the conditions attached in our operating licenses, the licenses could be revoked and we could be subject to criminal sanctions and substantial liability. We could also be required to suspend or modify our manufacturing operations.

Testing required for the regulatory approval of our products is sometimes conducted by independent third-parties. Any failure by any of these third-parties to perform this testing properly may have an adverse effect upon our ability to obtain regulatory approvals.

Our applications for the regulatory approval of our products incorporate the results of testing and other information that are sometimes provided by independent third-parties (including, for example, manufacturers of raw materials, testing laboratories, contract research organizations or independent research facilities). The likelihood that the products being tested will receive regulatory approval is, to some extent, dependent upon the quality of the work performed by these third-parties, the quality of the third-parties’ facilities and the accuracy of the information provided by these third-parties. We have little or no control over any of these factors.

Some of our products are manufactured by independent third-parties. Any failure by any of these third-parties to perform this manufacturing properly or follow cGMPs, may have an adverse effect upon our ability to maintain regulatory approvals or continue marketing our products.

Certain products are manufactured by independent third-parties. Their compliance with cGMPs and other regulatory requirements is essential to our obtaining and maintaining regulatory approvals and marketing authorization for these products in the countries in which they are sold. Any failure by any of these third-parties to perform this manufacturing properly or follow cGMPs, may have an adverse effect upon our ability to maintain regulatory approvals or continue marketing our products.

Risks Relating to Our Company and Our Operations

Sun currently controls 77.3% of the voting power in our Company.

Dilip Shanghvi and members of his immediate family (two of whom are directors of our board of directors) currently control, through their beneficial ownership of 65.9% of our outstanding ordinary shares and 100% of our founders’ shares through Sun, 77.3% of the voting power in our Company. Dilip Shanghvi, along with entities controlled by him and members of his family, control 63.7% of Sun Pharma. Sun would be able to control shareholder votes requiring a majority of the votes.

50% of the voting power in our subsidiary Taro U.S.A. is held by a corporation which is controlled by Sun.

The share capital of Taro U.S.A. is divided into two classes. Taro Israel owns 96.9% of the shares that have economic rights and 50% of the shares that have voting rights in Taro U.S.A. Taro Development Corporation (“TDC”) owns 3.1% of the shares that have economic rights and 50% of the shares that have voting rights in Taro U.S.A. Sun owns all of the outstanding voting shares of TDC and thereby controls TDC. Although TDC has agreed to vote all of its shares in Taro U.S.A. for the election to its board of directors of such persons as Taro Israel may designate, TDC may terminate the agreement upon one year written notice. In the event that TDC were to cease voting its shares in Taro U.S.A. for our designees, or otherwise, in accordance with Taro Israel’s preference, TDC could prevent Taro Israel from electing a majority of the board of directors of Taro U.S.A., effectively block actions that require approval of a majority of the voting power in Taro U.S.A. and potentially preclude the Company from consolidating Taro U.S.A. into the Company’s financial statements. Taro U.S.A. accounted for 88% of the Company’s consolidated revenue for the year ended March 31, 2013, 84% of the Company’s consolidated revenue for the three months ended March 31, 2012 and the year ended December 31, 2011, and 78% of the Company’s consolidated revenue for the year ended December 31, 2010.

 

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Wholesaler customers account for a substantial portion of our consolidated sales.

We have no long-term agreements with the wholesalers that require them to purchase our products and they may therefore reduce or cease their purchases from us at any time. Any cessation or significant reduction of their purchases from us would likely have a material adverse effect on the results of our operations and our financial condition. Furthermore, changes in their buying patterns or in their policies and practices in relation to their working capital and inventory management may result in a reduction of, or a change in the timing of, their purchases of our products. While we receive periodic inventory reports from the wholesalers, we have no ability to obtain advance knowledge of such changes. We base our manufacturing schedules, inventories and internal sales projections principally on historical data. To the extent that actual orders from these wholesalers differ substantially from our internal projections, we may either find ourselves with excess inventory or in an out-of-stock position, which could have a material adverse effect upon our operating results.

The nature of our business requires us to estimate future charges against wholesaler accounts receivable. If these estimates are not accurate, the results of our operations and financial condition could be adversely affected.

Sales to third-parties, including government institutions, hospitals, hospital buying groups, pharmacy buying groups, pharmacy chains and others generally are made through wholesalers. We sell our products to wholesalers, and the wholesalers resell the products to third-parties at times and in quantities ordered by the third-parties. Typically, we have a contract price with a third-party to which a wholesaler resells our products that may be equal to or less than the price at which we sold the products to the wholesaler. In such a case, following the purchase of the product by a third-party purchaser from the wholesaler, the wholesaler charges us back for any shortfall. At the time of any individual sale by us to a wholesaler, we do not know under which contracts the wholesaler will resell products to third-parties. Therefore, we estimate the amount of chargebacks and other credits that may be associated with these sales and we reduce our revenue accordingly. One factor in calculating these estimates is information on customer inventory levels provided to us by our customers. We obtain official reports of the amount of our products held in inventory by our wholesaler customers. If this information is inaccurate or not forthcoming, this may result in erroneously estimated reserves for chargebacks, returns or other deductions. In addition, from time to time, the amount of such chargebacks and other credits reported by a wholesaler may be different from our estimates. Discrepancies of this nature may result in a reduction in the value of our accounts receivable and a related charge to net income. The reconciliation of our accounts with wholesalers may, from time to time, delay, or otherwise impact, the collection of our accounts receivable or result in a decrease in their value and in a related charge to our net income.

Our inventories of finished goods have expiration dates after which they cannot be sold.

Industry standards require that pharmaceutical products be made available to customers from existing stock levels rather than on a made-to-order basis. Therefore, in order to accommodate market demand adequately, we strive to maintain sufficiently high levels of inventories. However, inventories prepared for sales that are not realized as or when anticipated may approach their expiration dates and may have to be written off. These write-offs, if any, could have an adverse effect on the results of our operations and financial condition.

Our future success depends on our ability to develop, manufacture and sell new products.

Our future success is largely dependent upon our ability to develop, manufacture and market new commercially viable pharmaceutical products and generic equivalents of proprietary pharmaceutical products whose patents and other exclusivity periods have expired. Delays in the development, manufacture and marketing of new products could negatively impact the results of our operations. Each of the steps in the development, manufacture and marketing of our products involves significant time and expense. We are, therefore, subject to the risks, among others, that:

 

   

any products under development, if and when fully developed and tested, will not perform in accordance with our expectations;

 

   

any generic product under development will, when tested, not be bioequivalent to its brand-name counterpart;

 

   

necessary regulatory approvals will not be obtained in a timely manner, if at all;

 

   

any new product cannot be successfully and profitably produced and marketed;

 

   

quality control problems may adversely impact our reputation for high quality production;

 

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other companies may launch their version of generic products, either prior to or following the launch of our newly approved generic version of the same product;

 

   

brand-name companies may launch their products, either themselves or through third-parties, in the form of authorized generic products which can reduce sales, prices and profitability of our newly approved generic products;

 

   

generic companies may launch generic versions of our brand-name drugs; or

 

   

our products may not be priced at levels acceptable to our customers.

If we are unable to obtain raw materials, our operations could be seriously impaired.

While the majority of our products are either synthesized by us or are derived from multiple source materials, some raw materials and certain products are currently obtained from single domestic or foreign suppliers. Although we have not experienced significant difficulty in obtaining raw materials to date, material supply interruptions may occur in the future and we may have to obtain substitute raw materials or products. For most raw materials we do not have any long-term supply agreements and therefore we are subject to the risk that our suppliers of raw materials may not continue to supply us with raw materials on satisfactory terms or at all.

Furthermore, obtaining the regulatory approvals required for adding alternative suppliers of raw materials for finished products we manufacture may be a lengthy process. We strive to maintain adequate inventories of single source raw materials in order to ensure that any delays in receiving regulatory approvals will not have a material adverse effect upon our business. However, we may not be successful in doing so and consequently, we may be unable to sell some products pending approval of one or more alternate sources of raw materials. Any significant interruption in our supply stream could have a material adverse effect on our operations.

Research and development efforts invested in our innovative pipeline may not achieve expected results.

We invest increasingly greater resources to develop our innovative pipeline, both through our own efforts and through collaborations with third-parties, which results in higher risks.

The time from discovery to a possible commercial launch of an innovative product is substantial and involves multiple stages during which the product may be abandoned as a result of serious developmental problems, the inability to achieve our clinical goals, the inability to obtain necessary regulatory approvals in a timely manner, if at all, or the inability to produce and market such innovative products successfully and profitably. In addition, we face the risk that some of the third-parties we collaborate with may fail to perform their obligations. Accordingly, our investment in research and development of innovative products can involve significant costs with no assurances of future revenues or profit.

We are continuing our efforts to develop new proprietary pharmaceutical products, but these efforts are subject to risk and may not be successful.

Our principal business has traditionally been the development, manufacture and marketing of generic equivalents of pharmaceutical products first introduced by other companies. However, we have increased our efforts to develop new proprietary products.

Expanding our focus beyond generic products and broadening our product pipeline to include new proprietary products may require additional internal expertise or external collaboration in areas in which we currently do not have substantial resources and personnel. We may have to enter into collaborative arrangements with others that may require us to relinquish rights to some of our technologies or products that we would otherwise pursue independently. We may not be able to acquire the necessary expertise or enter into collaborative agreements on acceptable terms, if at all, to develop and market new proprietary products.

In addition, although a newly developed product may be successfully manufactured in a laboratory setting, difficulties may be encountered in scaling up for manufacture in commercially-sized batches. For this reason and others, in the pharmaceutical industry only a small minority of all new proprietary research and development programs ultimately result in commercially successful drugs.

In order to obtain regulatory approvals for the commercial sale of new proprietary products, we are required to complete extensive clinical trials in humans to demonstrate the safety and efficacy of the products to the satisfaction of FDA and regulatory authorities abroad. Conducting clinical trials is a lengthy, time-consuming and expensive process, and the results of such trials are inherently uncertain. We may have limited experience in conducting clinical trials in these new product areas.

 

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A clinical trial may fail for a number of reasons, including:

 

   

failure to enroll a sufficient number of patients meeting eligibility criteria;

 

   

failure of the new product to demonstrate safety and/or efficacy;

 

   

the development of serious (including life threatening) adverse events (including, for example, side effects caused by or connected with exposure to the new product); or

 

   

the failure of clinical investigators, trial monitors and other consultants or trial subjects to comply with the trial plan or protocol.

The results from early clinical trials may not be predictive of results obtained in later clinical trials. Clinical trials may not demonstrate the safety and efficacy of a product sufficient to obtain the necessary regulatory approvals, or to support a commercially viable product. Any failure of a clinical trial for a product in which we have invested significant time or other resources could have a material adverse effect on our results of operations and financial condition.

Even if launched commercially, our proprietary products may face competition from existing or new products of other companies. These other companies may have greater resources, market access, and consumer recognition than we have. Thus, there can be no assurance that our proprietary products will be successful or profitable. In addition, advertising and marketing expenses associated with the launch of a proprietary product may, if not successful, adversely affect the results of our operations and our financial condition.

We may not be able to successfully identify, consummate and integrate future acquisitions.

We have in the past, and may in the future, pursue acquisitions of product lines and/or companies and seek to integrate them into our operations. Acquisitions of additional product lines and companies involve risks that could adversely affect our future results of operations. Any one or more of the following examples may apply:

 

   

we may not be able to identify suitable acquisition targets or acquire companies on favorable terms;

 

   

we compete with other companies that may have stronger financial positions and are therefore better able to acquire product lines and companies. We believe that this competition will increase and may result in decreased availability or increased prices for suitable acquisition targets;

 

   

we may not be able to obtain the necessary financing, on favorable terms or at all, to finance any of our potential acquisitions;

 

   

we may not be able to obtain the necessary regulatory approvals, including the approval of antitrust regulatory bodies, in any of the countries in which we may seek to consummate potential acquisitions;

 

   

we may ultimately fail to complete an acquisition after we announce that we plan to acquire a product line or a company;

 

   

we may fail to integrate our acquisitions successfully in accordance with our business strategy;

 

   

we may choose to acquire a business that is not profitable, either at the time of acquisition or thereafter;

 

   

acquisitions may require significant management resources and divert attention away from our daily operations, result in the loss of key customers and personnel, and expose us to unanticipated liabilities;

 

   

we may not be able to retain the skilled employees and experienced management that may be necessary to operate businesses we acquire, and if we cannot retain such personnel, we may not be able to locate and hire new skilled employees and experienced management to replace them; and

 

   

we may purchase a company that has contingent liabilities that include, among others, known or unknown intellectual property or product liability claims.

 

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Our tax liabilities could be larger than anticipated.

We are subject to tax in many jurisdictions, and significant judgment is required in determining our provision for income taxes. Likewise, we are subject to audit by tax authorities in many jurisdictions. In such audits, our interpretation of tax legislation might be challenged and tax authorities in various jurisdictions may disagree with, and subsequently challenge, the amount of profits taxed in such jurisdictions under our inter-company agreements. Although we believe our estimates are reasonable, the ultimate outcome of such audits and related litigation could be different from our provision for taxes and might have a material adverse effect on our consolidated financial statements.

Risks Relating to Our Intellectual Property

We depend on our ability to protect our intellectual property and proprietary rights, but we may not be able to maintain the confidentiality, or assure the protection, of these assets.

Our success depends, in large part, on our ability to protect our current and future technologies and products and to defend our intellectual property rights. If we fail to protect our intellectual property adequately, competitors may manufacture and market products similar to ours. Numerous patents covering our technologies have been issued to us, and we have filed, and expect to continue to file, patent applications seeking to protect newly developed technologies and products in various countries, including the United States. Some patent applications in the United States are maintained in secrecy until the patent is issued. Because the publication of discoveries tends to follow their actual discovery by many months, we may not be the first to invent, or file patent applications on any of our discoveries. Patents may not be issued with respect to any of our patent applications and existing or future patents issued to or licensed by us may not provide competitive advantages for our products. Many provisions of the America Invents Act went into effect March 16, 2013 and may change or otherwise affect our ability to protect our intellectual property. Patents that are issued may be challenged, invalidated or circumvented by our competitors. Furthermore, our patent rights may not prevent our competitors from developing, using or commercializing products that are similar or functionally equivalent to our products. Where trade secrets are our sole protection, we may not be able to prevent third-parties from marketing generic equivalents to our products, reducing prices in the marketplace and reducing our profitability.

We also rely on trade secrets, non-patented proprietary expertise and continuing technological innovation that we seek to protect, in part, by entering into confidentiality agreements with licensees, suppliers, employees, consultants and others. These agreements may be breached and we may not have adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from our research, we may not be able to maintain the confidentiality of information relating to these products.

Third-parties may claim that we infringe on their proprietary rights and may prevent us from manufacturing and selling such products.

There has been substantial litigation in the pharmaceutical industry with respect to the manufacture, use and sale of new products. These lawsuits relate to the validity and infringement of patents or proprietary rights of third-parties. We may be required to commence or defend against charges relating to the infringement of patent or proprietary rights. Any such litigation could:

 

   

require us to incur substantial expenses, even if we are insured or successful in the litigation;

 

   

require us to divert significant time and effort of our technical and management personnel;

 

   

result in the loss of our rights to develop or make certain products;

 

   

require us to pay substantial monetary damages or royalties in order to license proprietary rights from third-parties; and

 

   

prevent us from launching a developed, tested and approved product.

 

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Although patent and intellectual property disputes within the pharmaceutical industry have often been settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include the long-term payment of royalties. These arrangements may be investigated by United States regulatory agencies and, if improper, may be invalidated. Furthermore, the required licenses may not be made available to us on acceptable terms. Accordingly, an adverse determination in a judicial or administrative proceeding or a failure to obtain necessary licenses could prevent us from manufacturing and selling some of our products or increase our costs to market these products.

From time to time, we seek to market patented products before the related patents expire. In order to do so in the United States, we must challenge the patent under the procedures set forth in the Hatch-Waxman Act. In the United States, in order to obtain a final approval for a generic product prior to expiration of certain of the innovator’s patents, we must, under the terms of the Hatch-Waxman Act, as amended by the Medicare Act, notify the patent holder as well as the owner of an NDA, that we believe that the patents listed in the Approved Drug Products with Therapeutic Equivalence Evaluations contained on the FDA website (the “Orange Book”) for the new drug are either invalid or not infringed by our product. To the extent that we engage in patent challenge procedures, we are involved and expect to be involved in patent litigation regarding the validity or infringement of the originator’s patent. In addition, when seeking regulatory approval for some of our products, we are required to certify to the FDA and its equivalents in foreign countries, that such products do not infringe upon third-party patent rights. Filing a certification against a patent gives the patent holder the right to bring a patent infringement lawsuit against us. Any lawsuit would delay regulatory approval by the FDA until the earlier of the resolution of such claim or 30 months from the patent holder’s receipt of notice of certification.

In addition, it is not required that pharmaceutical patents be listed with the FDA or other regulatory authorities. For example, patents relating to antibiotics might not be listed in the Orange Book. Any launch of a pharmaceutical product by us that may infringe a patent, whether listed or not, may involve us in litigation.

Patent challenges are complex, costly and can take a significant amount of time to complete. A claim of infringement and the resulting delay could result in substantial expenses and even prevent us from manufacturing and selling products and, in certain circumstances, such litigation may result in significant damages which could have a material adverse effect on the results of our operations and financial condition.

Our launch of a product prior to a final court decision, settlement with the patent owner or the expiration of a patent held by a third-party may result in substantial damages to us. Depending upon the circumstances, a court may award the patent holder damages equal to three times the patent holder’s loss of income. If we are found to infringe a patent held by a third-party and become subject to significant damages, these damages could have a material adverse effect on the results of our operations and financial condition.

Security breaches could compromise sensitive information belonging to us and could harm our business (including our intellectual property) and reputation.

The safeguarding of our information technology infrastructure is important to our business. A cyber-attack that bypasses our information technology (“IT”) security systems causing an IT security breach may lead to a material disruption of our IT business systems and/or the loss of business information, resulting in adverse business impact. Adverse effects could include:

 

   

the theft, destruction, loss, misappropriation or release of our confidential data or our intellectual property;

 

   

operational or business delays resulting from the disruption of IT systems and subsequent clean-up and mitigation activities; and

 

   

negative publicity resulting in reputation or brand damage with our customers, partners or industry peers.

Risks Relating to Our Compliance with Sarbanes-Oxley

We have, in the recent past, and could in the future, fail to maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) imposes certain duties on us and our executives and directors. Our efforts to comply with the requirements of Sarbanes-Oxley, and in particular with Section 404 thereof, have resulted in diversion of our management’s time and attention, and we expect these efforts to require the continued commitment of resources.

 

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We have in the past, and may, in the future, identify material weaknesses in our internal controls that evidence that we fail to maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley. As of March 31, 2013, we eliminated all material weaknesses in internal controls that had been identified in prior years’ annual reports. Failure to maintain adequate internal controls could negatively affect shareholder and customer confidence.

Material weaknesses in our disclosure controls and procedures could negatively affect shareholder and customer confidence.

Under Sarbanes-Oxley, we are required to assess the effectiveness of our disclosure controls and procedures (as defined in Sarbanes-Oxley) on an annual basis. The ineffectiveness of our disclosure controls and procedures could negatively affect shareholder and customer confidence and have a material adverse impact on the market price of our ordinary shares.

Risks Relating to Investment in Our Ordinary Shares

Volatility of the market price of our ordinary shares could adversely affect us and our shareholders.

The market price of our ordinary shares may be volatile, and may, in the future, be subject to wide fluctuations, for the following reasons, among others:

 

   

actual or anticipated variations in our quarterly operating results or those of our competitors;

 

   

announcements by us or our competitors of new or enhanced products;

 

   

market conditions or trends in the pharmaceutical industry;

 

   

developments or disputes concerning proprietary rights;

 

   

introduction of technologies or product enhancements by others that reduce the need for our products;

 

   

general economic and political conditions;

 

   

departures of key personnel;

 

   

changes in the market valuations of our competitors;

 

   

regulatory considerations; and

 

   

the other risk factors listed in this section.

No citizen or resident of the United States who acquired or acquires any of our ordinary shares at any time after October 21, 1999, is permitted to exercise more than 9.9% of the voting power in our Company, with respect to such ordinary shares, regardless of how many shares the shareholder owns.

In order to reduce our risk of being classified as a Controlled Foreign Corporation (“Controlled Foreign Corporation”) under the United States Internal Revenue Code of 1986, as amended (the “Code”), we amended our Articles of Association in 1999 to provide that no owner of any of our ordinary shares is entitled to any voting right of any nature whatsoever with respect to such ordinary shares if (a) the ownership or voting power of such ordinary shares was acquired, either directly or indirectly, by the owner after October 21, 1999 and (b) the ownership would result in our being classified as a Controlled Foreign Corporation. This provision has the practical effect of prohibiting each citizen or resident of the United States who acquired or acquires our ordinary shares after October 21, 1999 from exercising more than 9.9% of the voting power in our Company, with respect to such ordinary shares, regardless of how many shares the shareholder owns. The provision may therefore discourage United States persons from seeking to acquire, or from accumulating, 15% or more of our ordinary shares (which, due to the voting power of the founders’ shares, would represent 10% or more of the voting power of our Company).

 

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Risks Relating to Our International Operations

We face risks related to foreign currency exchange rates.

Because some of our revenue, operating expenses, assets and liabilities are denominated in foreign currencies, we are subject to foreign exchange risks that could adversely affect our operations and reported results. To the extent that we incur expenses in one currency but earn revenue in another, any change in the values of those foreign currencies relative to the United States dollar could cause our profits to decrease or our products to be less competitive against those of our competitors. To the extent that our foreign currency holdings and other assets denominated in a foreign currency are greater or less than our liabilities denominated in a foreign currency, we have foreign exchange exposure.

The recent financial crisis and current uncertainty in global economic conditions could negatively affect the Company’s operating results.

The recent financial crisis and ensuing uncertainty in global economic conditions have resulted in substantial volatility in the credit markets and a low level of liquidity in many financial markets. These conditions may result in a further slowdown to the global economy that could affect our business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed healthcare providers may be able or willing to pay for our products or by reducing the demand for our products, which could in turn negatively impact our sales and revenue generation and result in a material adverse effect on our business, cash flow, results of operations, financial position and prospects.

Our business requires us to move goods across international borders. Any events that interfere with, or increase the costs of, the transfer of products across international borders could have a material adverse effect on our business.

We transport most of our products across international borders, primarily those of the United States, Canada and Israel. Since September 11, 2001, there has been more intense scrutiny of products that are transported across international borders. As a result, we may face delays, and increases in costs due to such delays, in delivering products to our customers. Any events that interfere with, or increase the costs of the transfer of products across international borders could have a material adverse effect on our business.

Risks Relating to Key Employees

Our future success is highly dependent on our continued ability to attract and retain key personnel. Any failure to do so could have a material adverse effect on our business, financial position and results of operations and could cause the market value of our ordinary shares to decline.

The pharmaceutical industry, and our company in particular, is science based. It is therefore imperative that we attract and retain qualified personnel in order to develop new products and compete effectively. If we fail to attract and retain key scientific, technical or management personnel, our business could be affected adversely. If we are unsuccessful in retaining or replacing key employees, it could have a material adverse effect on our business, financial position and results of operations and could cause the market value of our ordinary shares to decline.

Risks Relating to Our Location in Israel

Conditions in Israel affect our operations and may limit our ability to produce and sell our products.

We are incorporated under Israeli law and a significant component of our manufacturing and research and development facilities are located in Israel. Political, economic and military conditions in Israel may directly affect our operations, and we could be adversely affected by hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners or a significant downturn in the economic or financial condition of Israel. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, Israel frequently has been subject to civil unrest and terrorist activity, with varying levels of severity. The impact of civil disturbances in various countries in the Middle East may also adversely affect our operations. Furthermore, certain parties with whom we do business periodically have declined to travel to Israel, forcing us to make alternative arrangements where necessary, and the United States Department of State has issued an advisory regarding travel to Israel. As a result, the FDA has at various times curtailed or prohibited its inspectors from traveling to Israel to inspect the facilities of Israeli companies, which, should it occur with respect to our Company, could result in the FDA withholding approval for new products we intend to produce at those facilities.

If terrorist acts were to result in substantial damage to our facilities, our business activities would be disrupted since, with respect to some of our products, we would need to obtain prior FDA approval for a change in manufacturing site. Our business interruption insurance may not adequately compensate us for losses that may occur and any losses or damages sustained by us could have a material adverse effect on our business.

 

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Many male Israeli citizens, including our employees, are subject to compulsory annual reserve military service through middle age. Additionally, these employees are subject to being called to active duty at any time under emergency circumstances. Ongoing and revived hostilities with other countries might require more widespread military reserve service by some of our employees. Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of our other employees due to obligatory military service requirement. Any disruption in our operations could harm our business.

We may be affected by fluctuations in the NIS relative to the U.S. Dollar

A substantial portion of our expenses, primarily labor and occupancy expenses in Israel, is incurred in NIS. As a result, the cost of our operations in Israel, as measured in United States dollars, is subject to the risk of exchange rate fluctuations among the U.S. dollar and the NIS. During the year-ended March 31, 2013, the value of the NIS increased 1.8% with respect to the United States dollar. Such an increase adversely affects our United States dollar-measured results of operations.

Our operations may be affected by negative labor conditions in Israel.

Strikes and work-stoppages occur relatively frequently in Israel. If Israeli trade unions threaten additional strikes or work-stoppages and such strikes or work-stoppages occur, those may, if prolonged, have a material adverse effect on the Israeli economy and on our business, including our ability to deliver products to our customers and to receive raw materials from our suppliers in a timely manner.

Government price control policies can materially impede our ability to set prices for our products.

All pharmaceutical products sold in Israel are subject to government price controls. Permitted price increases and decreases are enacted by the Israeli government as part of a formal review process. The inability to control the prices of our products may adversely affect our operations.

We may benefit from government programs and tax benefits, both or either of which may be discontinued or reduced.

We have, in the past, received grants and substantial tax benefits under government of Israel programs, including the Approved Enterprise program and programs of the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor of the State of Israel (“OCS”). In order to be eligible for these programs and benefits, we must meet specified conditions including making specified investments in fixed assets from our equity and paying royalties with respect to grants received. In addition, some of these programs could restrict our ability to manufacture particular products and transfer particular technology outside of Israel. If we fail to comply with these conditions in the future, the benefits received could be canceled and we could be required to refund payments previously received under these programs or pay increased payments and/or taxes. In the future, the government of Israel may discontinue or curtail these and the tax benefits available under these programs. If the government of Israel ends these programs and tax benefits while we are recipients, our business, financial condition and results of operations could be materially adversely affected.

Provisions of Israeli law may delay, prevent or make more difficult a merger or acquisition. This could prevent a change of control and depress the market price of our ordinary shares.

Provisions of Israeli corporate and tax law may have the effect of delaying, preventing or making more difficult a merger or acquisition. The Israeli Companies Law, 1999 (the “Israeli Companies Law”) and the regulations promulgated thereunder, generally require that a merger be approved by a company’s board of directors and by a shareholder vote at a shareholders’ meeting that has been called on at least 35 days’ advance notice by each of the merger parties. Under our Articles of Association, the required shareholder vote is a supermajority of at least 75% of the shares voting in person or by proxy on the matter. Any creditor of a merger party may seek a court order blocking a merger if there is a reasonable concern that the surviving company will not be able to satisfy all of the obligations of any party to the merger. Moreover, a merger may not be completed until at least 50 days have passed from the time that a merger proposal has been delivered to the Israeli Registrar of Companies and at least 30 days have passed from the time each merging company received shareholder approval.

Other potential means of acquiring a public Israeli company such as ours might involve additional obstacles. In addition, a body of case law has not yet developed with respect to the Israeli Companies Law. Until this happens, uncertainties will exist regarding its interpretation.

 

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Finally, Israeli tax law treats some acquisitions, such as stock-for-stock exchanges between an Israeli company and a foreign company, less favorably than do United States tax laws. The provisions of Israeli corporate and tax law and the uncertainties surrounding such laws may have the effect of delaying, preventing or making more difficult a merger or acquisition. This could prevent a change of control of the Company and depress the market price of our ordinary shares which otherwise might rise as a result of such a change of control.

It may be difficult to effect service of process and enforce judgments against our directors and officers.

We are incorporated in Israel. The majority of our executive officers and directors are non-residents of the United States and a substantial portion of our assets and the assets of such persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any of those persons or to effect service of process upon those persons. It may also be difficult to enforce civil liabilities under United States federal securities laws in original actions instituted in Israel.

We are subject to government regulation that increases our costs and could prevent us from marketing or selling our products.

We are subject to extensive pharmaceutical industry regulations in countries where we operate. We cannot predict the extent to which we may be affected by legislative and other regulatory developments concerning our products.

In Israel, the manufacture and sale of pharmaceutical products is regulated in a manner substantially similar to that in the United States. Legal requirements generally prohibit the handling, manufacture, marketing and importation of any pharmaceutical product unless it is properly registered in accordance with applicable law. The registration file relating to any particular product must contain medical data related to product efficacy and safety, including results of clinical testing and references to medical publications, as well as detailed information regarding production methods and quality control. Health ministries are authorized to cancel the registration of a product if it is found to be harmful or ineffective or manufactured and marketed other than in accordance with registration conditions.

We are subject to legislation in Israel, primarily relating to patents and data exclusivity provisions. Modifications of this legislation or court decision regarding this legislation may adversely affect us and may prevent us from exporting Israeli-manufactured products in a timely fashion. Additionally, the existence of third-party patents in Israel, with the attendant risk of litigation, may cause us to move production outside of Israel or otherwise adversely affect our ability to export certain products from Israel.

Risks Relating to Our Location in Canada

Government price control policies can materially impede our ability to set prices for our products.

The Canadian Government Patented Medicine Prices Review Board (“PMPRB”) monitors and controls prices of patented drug products marketed in Canada by persons holding, or licensed under, one or more patents. The PMPRB will approve an introductory price (based on a comparative analysis) and will require that the price not be increased each year thereafter by more than the annual increase of the Canadian Consumer Price Index. Consequently, the existence of one or more patents relating to a drug product, while providing some level of proprietary protection for the product, also triggers a governmental price control regime that significantly affects the Canadian pharmaceutical industry’s ability to set pricing. The inability to control the prices of our products may adversely affect our operations.

Sales of our products in Canada depend, in part, upon their being eligible for reimbursement from drug benefit formularies.

In each province of Canada there is a drug benefit formulary. A formulary lists the drugs for which a provincial government will reimburse qualifying persons and the prices at which the government will reimburse such persons. There is not complete uniformity among provinces. However, provincial governments generally will reimburse the lowest available price of the generic equivalents of any drug listed on the formulary list of the province. The formularies can also provide for drug substitution, even for patients who do not qualify for government reimbursement. The effect of these provincial formulary regimes is to encourage the sale of lower-priced versions of pharmaceutical products. The potential lack of reimbursement represents a significant threat to our business. Additionally, the substitution effect may adversely affect our ability to profitably market our products.

 

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We may be adversely affected if the rate of inflation in Canada exceeds the rate of devaluation of the Canadian dollar against the United States dollar.

A substantial portion of our expenses, primarily labor, occupancy, marketing and research and development expenses in Canada, is incurred in Canadian dollars. As a result, the cost of our operations in Canada, as measured in United States dollars, is subject to the risk that the rate of inflation in Canada will exceed the rate of devaluation of the Canadian dollar in relation to the United States dollar or that the timing of any devaluation will lag behind inflation in Canada. During the year-ended March 31, 2013, the value of the Canadian dollar decreased 1.7% with respect to the United States dollar. This decrease in the value of the Canadian dollar has had the effect of decreasing the United States dollar cost of our goods manufactured in Canada. If the United States dollar cost of our operations in Canada continues to decrease, our United States dollar-measured results of operations will continue to be positively affected, however, if the value of the Canadian dollar increases in the future it may have an adverse effect on our results of operations.

 

ITEM 4. INFORMATION ON THE COMPANY

A. HISTORY AND DEVELOPMENT OF THE COMPANY

The legal and commercial name of our company is Taro Pharmaceutical Industries Ltd. We were incorporated under the laws of the State of Israel in 1959 under the name Taro-Vit Chemical Industries Ltd. In 1984, we changed our name to Taro Vit Industries Ltd. and in 1994 we changed our name to Taro Pharmaceutical Industries Ltd., which was the name of a subsidiary of Taro Vit Industries Ltd. incorporated under the laws of the State of Israel in 1950.

In 1961, we completed the initial public offering of our ordinary shares. In that year, we also acquired 97% of the outstanding stock of an Israeli corporation, then known as Taro Pharmaceutical Industries Ltd. (“TPIL”), which was founded in 1950. In 1981, we sold 37% of our interest in TPIL. In 1993, after acquiring all of the outstanding shares of TPIL, we merged TPIL into our company. In July 2001, we completed a stock split by distributing one ordinary share for each ordinary share then outstanding and one ordinary share for every ten founders’ shares then outstanding. In October 2001, we sold 3,950,000 of our ordinary shares, and shareholders sold 1,800,000 of our ordinary shares, in a public offering. Since March 22, 2012, our ordinary shares have been traded on the NYSE under the symbol “TARO.”

Our registered office is located at 14 Hakitor Street, Haifa Bay 26110, Israel. Our telephone number at that address is +972-4-847-5700. Our agent for service of process in the United States is Taro Pharmaceuticals U.S.A., Inc., 3 Skyline Drive, Hawthorne, NY 10532. Our telephone number at that address is +1-914-345-9000.

Capital Expenditures

During the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, our capital expenditures were $9.5 million, $1.6 million, $6.3 million and $5.7 million, respectively. The focus of our capital expenditure program has been the expansion and upgrade of our manufacturing facilities and information technology systems in order to enable us to increase operational efficiencies, remain in compliance with cGMP, accommodate anticipated increased demand for our products, and maintain a competitive position in the marketplace.

The major projects undertaken during these three years, as part of our capital expenditure program, include:

 

   

the acquisition of additional production and packaging equipment;

 

   

expanding and upgrading our research and development laboratories in Israel and Canada; and

 

   

the upgrade of our information technology systems.

For a detailed presentation of our property, plant and equipment, see Note 7 to our consolidated financial statements included elsewhere in this 2013 Annual Report. Also see Item 4.D. – “Property, Plant and Equipment.”

B. BUSINESS OVERVIEW

We are a multinational, science-based pharmaceutical company. We develop, manufacture and market prescription and OTC pharmaceutical products primarily in the United States, Canada and Israel. Our primary areas of focus include pediatric creams and ointments, liquids, capsules and tablets, mainly in the dermatological and topical, cardiovascular, neuropsychiatric and anti-inflammatory therapeutic categories. Nystatin/Triamcinolone accounted for 14.1% of our sales in fiscal year ended March 31, 2013.

 

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We operate principally through three entities: Taro Pharmaceutical Industries Ltd. (“Taro Israel”), and two of its subsidiaries (including indirect), Taro Pharmaceuticals Inc. (“Taro Canada”) and Taro U.S.A. The principal activities and primary product lines of these subsidiaries may be summarized as follows:

 

Entity

 

Principal Activities

 

Primary Product Lines

Taro Israel

 

•      Manufactures more than 160 finished dosage form pharmaceutical products for sale in Israel and for export

•      Produces APIs used in the manufacture of finished dosage form pharmaceutical products

•      Markets and distributes both proprietary and generic products in the local Israeli market

•      Performs research and development

 

•      Dermatology: Prescription and OTC semi-solid products (creams, ointments and gels) and liquids

 

•      Cardiology and Neurology: Prescription oral dosage products

 

•      Oral analgesics, prescription and OTC

 

•      OTC oral and nasal sprays and ophthalmic products

Taro Canada

 

•      Manufactures more than 70 finished dosage form pharmaceutical products for sale in Canada and for export

•      Markets and distributes both proprietary and generic products in the Canadian market

•      Performs research and development

 

•      Dermatology: Prescription and OTC semi-solid products (creams, ointments and gels) and liquids

•      Cardiology, Oncology, Gastrointestinal and Neurology:   Prescription oral and injectable dosage products

•      Allergy (Antihistamine): OTC oral dosage products

Taro U.S.A.

 

•      Markets and distributes both proprietary and generic products in the U.S. market

•      Performs research and development

 

•      Dermatology: Prescription and OTC semi-solid products (creams, ointments and gels) and liquids

•      Cardiology and Neurology: Prescription oral dosage products

•      Other prescription and OTC products

As of March 31, 2013, 22 of our products were being reviewed by the FDA. During the fiscal year ended March 31, 2013, Taro filed nine ANDAs and one NDA with the FDA. In addition, there are several products for which either development or internal regulatory work is in process. The applications pending before the FDA are at various stages in the review process, and there can be no assurance that we will be able to successfully complete any remaining testing or that, upon completion of such testing, approvals will be granted. In addition, there can be no assurance that the FDA will not grant approvals for competing products submitted by our competitors, prior to, simultaneous with or after granting approval to us.

 

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The Generic Pharmaceutical Industry

Generic pharmaceuticals are the chemical and therapeutic equivalents of brand-name drugs and are typically marketed after the patents for brand-name drugs have expired. Generic pharmaceuticals generally must undergo clinical testing that demonstrates that they are bioequivalent to their branded equivalents and are manufactured to the same standards. Proving bioequivalence generally requires data demonstrating that the generic formulation results in a product whose rate and extent of absorption are within an acceptable range of the results achieved by the brand-name reference drug. In some instances, bioequivalence can be established by demonstrating that the therapeutic effect of the generic formula falls within an acceptable range of the therapeutic effects achieved by the brand-name reference drug.

Generic pharmaceutical products must meet the same quality standards as branded pharmaceutical products although they are generally sold at prices that are substantially lower than those of their branded counterparts. As a result, generic pharmaceuticals represent a much larger percentage of total drug prescriptions dispensed than their corresponding percentage of total sales. This discount tends to increase (and margins tend to decrease) as the number of generic competitors increases for a given product. Because of this pricing dynamic, companies that are among the first to develop and market a generic pharmaceutical tend to earn higher profits than companies that subsequently enter the market for that product. Furthermore, products that are difficult to develop or are intended for niche markets generally attract fewer generic competitors and therefore may offer higher profit margins than those products that attract a larger number of competitors. However, profit is influenced by many factors other than the number of competitors for a given drug or the size of the market. Depending on the actions of each of our competitors, price discounts can be just as significant for a specific product with only a few competitors or a small market, as for a product with many competitors or a large market.

In recent years, the market for generic pharmaceuticals has grown. We believe that this growth has been driven by the following factors, among others:

 

   

efforts by governments, employers, third-party payers and consumers to control healthcare costs;

 

   

increased acceptance of generic products by physicians, pharmacists and consumers; and

 

   

the increasing number of pharmaceutical products whose patents have expired and are therefore subject to competition from, and substitution by, generic equivalents.

 

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Products

We currently market more than 180 pharmaceutical products in over 25 countries. The following table represents some of our key product groups and the major markets in which they are sold:

 

Generic Name

  

Dosage Form

  

Brand

Name(1)

  

Therapeutic
Category

  

Major

Markets

  

Rx/OTC

Acetazolamide    tablets    Diamox®    Diuretic    U.S., Israel    Rx
Acetaminophen, Codeine and Caffeine    tablets, gelcaps    Rokacet®(2)    Analgesic    Israel    OTC
Adapalene    gel    Differin®    Dermatologics and topicals    U.S.    Rx
Amiodarone Hydrochloride    tablets    Cordarone®    Cardiovascular    U.S.    Rx
Ammonium Lactate    cream, lotion    Lac-Hydrin®    Dermatologics and topicals    U.S., Canada    Rx
Augmented Betamethasone Dipropionate    lotion    Diprolene AF®    Dermatologics and topicals    U.S.    Rx
Betamethasone Valerate    cream, ointment, lotion    Celestoderm®    Dermatologics and topicals    Canada    Rx
Calcipotriene    ointment    Dovonex®    Dermatologics and topicals    U.S.    Rx
Carbamazepine    tablets, controlled release tablets, chewable tablets, oral suspension    Tegretol®    Anticonvulsant    U.S., Israel, Canada    Rx
Cetirizine Hydrochloride    solution    Zyrtec®    Allergy    U.S.    OTC
Clobetasol Propionate    cream, ointment, gel, topical solution    Temovate®    Dermatologics and topicals    U.S., Canada    Rx
Clomipramine Hydrochloride    capsule    Anafranil®    Neuropsychiatric    U.S.    Rx
Clorazepate Dipotassium    tablets    Tranxene®    Neuropsychiatric    U.S.    Rx
Clotrimazole    cream, topical solution, vaginal cream   

Lotrimin®

Gyne-Lotrimin®

   Dermatologics and topicals    U.S., Canada    Rx/OTC
Clotrimazole and Betamethasone Dipropionate    cream, lotion    Lotrisone®    Dermatologics and topicals    U.S., Israel    Rx
Desonide    cream, ointment    Tridesilon®    Dermatologics and topicals    U.S.    Rx
Desoximetasone    cream, ointment, gel    Topicort®(2)    Dermatologics and topicals    U.S.    Rx
Diflorasone Diacetate    cream, ointment    Psorcon®    Dermatologics and topicals    U.S.    Rx
Docusate Sodium    capsule    Colace®    Gastrointestinal    Canada    OTC
Econazole Nitrate    cream    Spectazole®    Dermatologics and topicals    U.S.    Rx
Enalapril Maleate    tablets    Vasotec®    Cardiovascular    U.S.    Rx
Enalapril Maleate and Hydrochlorothiazide    tablets    Vaseretic®    Cardiovascular    U.S.    Rx
Etodolac    tablets, capsules, extended release tablets    Etopan®(2) Lodine®    Anti-Inflamatory & Analgesic    U.S., Israel    Rx
Fluconazole    tablets    Diflucan®    Dermatologics and topicals    U.S.    Rx
Fluocinonide    cream, ointment, gel, topical solution    Lidex®    Dermatologics and topicals    U.S., Canada    Rx
Fluorouracil    topical solution, cream    Efudex®    Topical Anti-neoplastic    U.S.    Rx
Halobetasol Propionate    cream, ointment    Ultravate®    Dermatologics and topicals    U.S.    Rx
Hydrocortisone Valerate    cream, ointment    Westcort®    Dermatologics and topicals    U.S., Canada    Rx
Hydrocortisone    cream, ointment    Cortizone 10®    Dermatologics and topicals    U.S., Canada    Rx/OTC
Hydroquinone    cream    Lustra®(2)    Dermatologics and topicals    U.S., Canada    Rx
Imiquimod    cream    Aldara®    Dermatological and topcial    U.S.    Rx
Ketoconazole    tablets, cream    Nizoral®    Dermatologics and topicals / Antifungal    U.S., Canada    Rx
Lamotrigine    tablets    Lamictal®    Anticonvulsant    U.S.    Rx
Loratadine    solution, tablets    Claritin®    Allergy    U.S., Canada    OTC
Malathion    lotion    Ovide®(2)    Dermatologics and topicals    U.S.    Rx
Metronidazole    gel    MetroGel®    Dermatologics and topicals    U.S.    Rx
Miconazole Nitrate    vaginal cream, cream    Monistat® 3 Monistat® 7 Micatin®    Dermatologics and topicals    U.S., Canada    OTC
Mometasone Furoate    cream, ointment, lotion    Elocon®    Dermatologics and topicals    U.S., Canada    Rx
Mupirocin    ointment    Bactroban®    Dermatologics and topicals    Canada    Rx
Nystatin    oral suspension, vaginal cream    Mycostatin®    Dermatologics and topicals    U.S., Israel, Canada    Rx
Nystatin/Triamcinolone    cream, ointment    Mycogen® II, Mycolog® II, Myconel®    Antifungal    U.S.    Rx
Ondansetron Hydrochloride    solution    Zofran®    Antinauseant    U.S.    Rx
Oxcarbazepine    tablets    Trileptal®    Anticonvulsant    U.S.    Rx
Phenytoin Sodium    extended release capsules, suspension    Dilantin®    Anticonvulsant    U.S., Canada    Rx
Terconazole    vaginal cream    Terazol®    Dermatologics and topicals    U.S., Canada    Rx
Terbinafine Hydrochloride    cream    Lamisil®    Dermatologics and topicals    U.S.    OTC
Triamcinolone Acetonide    cream, ointment, dental paste    Kenalog®    Dermatologics and topicals    U.S., Canada, Israel    Rx
Warfarin Sodium    tablets    Coumadin®    Cardiovascular    U.S., Israel, Canada    Rx

 

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(1) 

Presented in this column are the brand-names under which the products are most commonly prescribed in the United States. Except as noted below, we do not own any of the specific names. In some cases, we manufacture and sell the generic equivalent of the product sold by the third-party owner of such name. For example, we sell our product warfarin sodium tablets under that name in the United States. Warfarin sodium is the generic equivalent of Coumadin, a product sold under that name in the United States by the third-party owner of the United States rights to that name and by us in Israel, where we own the right to use that name.

(2) 

Taro brands.

Topical corticosteroids are used in the treatment of some dermatologic conditions (including psoriasis, eczema and various types of skin rashes). Topical antineoplastics are used in the treatment of cancer (including skin cancer). Antifungals are used in the treatment of some infections (including athlete’s foot, ringworm and vaginal yeast infections). Anticonvulsants are used in the treatment of various seizure disorders (including epilepsy). Cardiovascular products are used in the treatment of heart disease. There are several categories of cardiovascular drugs, including anticoagulants, antihypertensive and antiarrhythmics. Anticoagulants, commonly known as blood thinners, are used in the treatment of heart disease and stroke associated with heart disease.

Some of our products are subject to seasonality, such as allergy drugs, however, in the aggregate our products are not materially subject to seasonality.

Sales and Marketing

In the United States, Israel and Canada, our sales are primarily generated by our own dedicated sales force. In other countries, we sell through agents and other distributors. Our sales force is supported by our medical affairs, customer service and marketing employees.

The following is a breakdown of our net sales by geographic region, including the percentage of our total consolidated net sales for each period:

 

     Year ended     Three months ended     Years ended December 31,  
     March 31, 2013     March 31, 2012     December 31, 2011     December 31, 2010  
     Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
 

U.S.A.

   $ 587,851         88   $ 122,472         84   $ 424,950         84   $ 305,858         78

Canada

     52,452         8     13,167         9     43,720         9     44,169         11

Israel

     19,929         3     5,472         4     21,528         4     19,589         5

Other

     10,722         1     4,030         3     15,470         3     22,919         6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 670,954         100   $ 145,141         100   $ 505,668         100   $ 392,535         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

In fiscal year ended March 31, 2013, revenue in the United States accounted for 88% of total consolidated net sales. In addition to marketing prescription drugs, we market our generic OTC products primarily as store brands under its customers’ labels to wholesalers, drug chains, food chains and mass merchandisers. During fiscal year ended March 31, 2013, we sold to approximately 124 customers in the United States. The following table represents sales to our three largest customers as a percent of consolidated sales:

 

Customer

   March 31, 2013     March 31, 2012     December 31, 2011     December 31, 2010  

Customer A

     20.8     24.1     18.9     15.9

Customer B

     14.0     12.7     12.4     11.0

Customer C

     12.2     11.9     11.8     10.5

 

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The following table sets forth the percentage of consolidated net sales by each type of customer in the U.S.A. in fiscal year ended March 31, 2013:

 

Customer Type

   Percentage of
Consolidated  Sales
 

Drug wholesalers and store chains

     45

Generic drug distributors

     25

Mass merchandisers, food and retail chains

     11

Managed care organizations

     5

Other

     2

In fiscal year ended March 31, 2013, sales in Canada accounted for 8% of our total consolidated net sales. During fiscal year ended March 31, 2013, Taro Canada had approximately 63 customers.

The following table sets forth the percentage of consolidated net sales by each type of customer in Canada in fiscal year ended March 31, 2013:

 

Customer Type

   Percentage of
Consolidated Sales
 

Drug wholesalers

     6

Drug chains, independent pharmacies and others

     2

In fiscal year ended March 31, 2013, sales in Israel accounted for 3% of our total consolidated net sales. The marketing, sales and distribution of prescription pharmaceuticals and OTC products in Israel is closely monitored by the Israeli government. The market for these products is dominated by institutions that are similar to health maintenance organizations in the United States, as well as private pharmacies. Most of our marketing efforts in Israel focus on selling directly to these groups.

All pharmaceutical products sold in Israel are subject to price controls. Permitted price increases and decreases are enacted by the Israeli government as part of a formal review process. There are no restrictions on the import of pharmaceuticals, provided that they comply with registration requirements of the Israeli Ministry of Health.

In Israel, the pharmaceutical market generally is divided into two market segments: (i) the private market, which includes drug store chains, private pharmacies and wholesalers; and (ii) the institutional market, which includes Kupat Holim Clalit (“Kupat Holim”) (the largest health maintenance organization in Israel), other health maintenance organizations, the Israel Ministry of Health and the Armed Forces.

In fiscal year ended March 31, 2013, sales to other international markets accounted for approximately 1% of consolidated net sales.

The following table sets forth the percentage of consolidated net sales by each type of customer in Israel and other international markets in fiscal year ended March 31, 2013:

 

Customer Type

   Percentage of
Consolidated  Sales
 

Institutional

     1

Private

     2

Other international

     1

We have expanded the production capacity of our Israeli and Canadian operations to meet anticipated greater demand for our products in future years. As discussed below under “Industry Practice Relating to Working Capital Items,” future demand for our products may not increase at a rate we previously anticipated. In addition, we utilize contract manufacturing for certain products to satisfy customer demand in a timely manner. As a result, in each of the years ended March 31, 2013 and December 31, 2011 and 2010, backorders represented less than 5% of our consolidated sales.

 

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Competition and Pricing

The pharmaceutical industry is intensely competitive. We compete with the original manufacturers of the brand-name equivalents of our generic products, other generic drug manufacturers (including brand-name companies that also manufacture generic drugs or license their products to other generic drug manufacturers) and manufacturers of new drugs that may compete with our generic drugs. Many of our competitors have greater financial, production and research and development resources, substantially larger sales and marketing organizations, and substantially greater name recognition than we have.

Historically, brand-name drug companies have attempted to prevent generic drug manufacturers from producing certain products and to prevent competing generic drug products from being accepted as equivalent to their brand-name products. We expect such efforts to continue in the future. Also, some brand-name competitors, in an attempt to participate in the generic drug sales of their branded products, have introduced generic equivalents of their own branded products, both prior and subsequent to the expiration of their patents or FDA exclusivity periods for such drugs. These competitors have also introduced authorized generics or generic equivalents of brand-name drug products.

In the United States, we compete with branded pharmaceutical manufacturers such as Bristol-Myers Squibb, GlaxoSmithKline, Merck, Novartis, Pfizer/Wyeth, Valeant, Galderma and Merck/Schering-Plough, as well as with generic companies such as Teva Pharmaceuticals U.S.A., Mylan Laboratories, Perrigo Company, Ranbaxy Pharmaceuticals Inc. and Sandoz Pharmaceuticals (the generics subsidiary of Novartis). Many of these companies have more resources, market and name recognition and better access to customers than we have. Therefore, there can be no assurance that we can compete successfully with them.

We compete in the Canadian market with Merck Canada Inc., Pfizer Canada Inc., Janssen Inc., Schering-Plough Canada, Novartis Pharmaceuticals Canada Inc., GlaxoSmithKline Inc., Bayer Inc. and Bristol-Myers Squibb Canada, as well as with other manufacturers of generic products, such as Apotex Inc., Teva Canada Limited, Mylan Pharmaceuticals ULC, Sandoz Canada Incorporated and Pharmascience Inc.

Depending on the product, pricing in Canada is established by competitive factors or by Canadian provincial formulary price lists published by the Canadian provinces.

In Israel, we compete with Teva Pharmaceutical Industries Ltd., Perrigo Israel Pharmaceuticals Ltd., Dexxon Ltd., and Rafa Laboratories Ltd., among others. In addition, many leading multinational companies, including Bayer AG, Eli Lilly and Company, Merck & Co., Inc. and Pfizer Inc., market their products in Israel.

In Israel, the government establishes the prices for pharmaceutical products as part of a formal review process. There are no restrictions on the import of pharmaceuticals provided that they comply with registration requirements of the Israeli Ministry of Health.

Manufacturing and Raw Materials

We currently manufacture finished pharmaceutical products at our government approved facilities in Canada and Israel and APIs at our facilities in Israel. We have expanded our research and development and warehousing facilities in Israel.

For the manufacture of our finished dosage form pharmaceutical products, we use pharmaceutical chemicals that we either produce ourselves or purchase from chemical manufacturers in the open market globally. Substantially all of such chemicals are obtainable from a number of sources, subject to regulatory approval. However, we purchase certain raw materials from single source suppliers. The decision to purchase APIs is a function of our sales forecast and prevailing prices in the market. When appropriate purchasing opportunities arise, the Company may acquire certain APIs in excess of its ordinary requirements or rate of growth. Obtaining the regulatory approvals required to add alternative suppliers of such raw materials for products sold in the United States or Canada may be a lengthy process. We strive to maintain adequate inventories of single source raw materials in order to ensure that any delays in receiving such regulatory approvals will not have a material adverse effect on our business. However, we may become unable to sell certain products in the United States or Canada pending approval of one or more alternate sources of raw materials.

 

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We synthesize the APIs used in some of our key products, including our warfarin sodium tablets, carbamazepine products, etodolac tablets, terbinafine cream, oxcarbazepine tablets and clorazepate dipotassium tablets. We also synthesize the API for our Ovide® lotion. We plan to continue the strategic selection of APIs for synthesis in order to maximize the advantages from this scientific and manufacturing capability.

Although, prices of principal raw materials have been relatively stable, the Company has instituted programs to keep the cost of APIs consistent or to improve upon them; for example, through the qualification of alternate suppliers.

Industry Practices Relating to Working Capital Items

Certain customary industry selling practices affect our working capital, including, but not limited to, providing favorable payment terms to customers and discounting selling prices through the issuance of free products as well as other incentives within a specified time frame if a customer purchases more than a specified threshold of a product. These incentives are provided principally with the intention of maintaining or expanding our distribution to the detriment of competing products.

Industry practice requires that pharmaceutical products be made available to customers from existing stock rather than on a made-to-order basis. Therefore, in order to accommodate market demand adequately, we strive to maintain a sufficient level of inventory.

Government Regulation

We are subject to extensive pharmaceutical industry regulations in the United States, Canada, Israel and other jurisdictions, and may be subject to future legislative and other regulatory developments concerning our products and the healthcare field generally. Any failure by us to comply with applicable policies and regulations of any of the numerous authorities that regulate our industry could have a material adverse effect on our results of operations.

In the United States, Canada, Israel and other jurisdictions, the manufacture and sale of pharmaceutical products are regulated in a similar manner. Legal requirements generally prohibit the handling, manufacture, marketing and importation of any pharmaceutical product unless it is properly registered in accordance with applicable law. In addition, approval is required before any new drug or a generic equivalent to a previously approved drug can be marketed. Furthermore, each country requires approval of manufacturing facilities, including adherence to cGMPs during the production and storage of pharmaceutical components, including, but not limited to, raw materials and finished products. As a result, we have had periodic inspections of our facilities and records.

Regulatory authorities in each country also have extensive enforcement powers over the activities of pharmaceutical manufacturers, including the power to seize, force the recall of and prohibit the sale or import of non-complying products and to halt the operations of and criminally prosecute and fine non-complying manufacturers. These regulatory authorities also have the power to revoke approvals previously granted and remove from the market previously approved drug products.

In the United States, Canada, Israel and other jurisdictions, we, as well as other manufacturers of drugs, are dependent on obtaining timely approvals for products. The approval process in each country has become more rigorous and costly in recent years. There can be no assurance that approvals will be granted in a timely manner or at all. In the United States, Canada, Israel and other jurisdictions, the procedure for drug product approvals, if such approval is ultimately granted, generally takes longer than one year. The review processes in Canada and Israel are substantively similar to the review process in the United States. Inability or delay in obtaining approvals for our products could adversely affect our product introduction plans and our results of operations.

In the United States, any drug that is not generally recognized as safe and effective by qualified experts for its intended use is deemed to be a new drug which generally requires FDA approval. Approval is obtained, either by the submission of an ANDA or a NDA. If the new drug is a new dosage form, a strength not previously approved, a new indication or an indication for which the ANDA procedure is not available, an NDA is required.

We generally receive approval for generic products by submitting an ANDA to the FDA. When processing an ANDA, the FDA waives the requirement of conducting complete clinical studies, although it may require bioavailability and/or bioequivalence studies. Bioavailability is generally determined by the rate and extent of absorption and levels of concentration of a drug product in the blood stream needed to produce a therapeutic effect. Bioequivalence compares the bioavailability of one drug product with another and, when established, indicates that the rate of absorption and levels of concentration of a generic drug in the body or on

 

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the skin are substantially equivalent to the previously approved brand-name reference drug. An ANDA may be submitted for a drug on the basis that it is bioequivalent to a previously listed drug, contains the same active ingredient, has the same route of administration, dosage form, and strength as the listed drug, and otherwise complies with legal and regulatory requirements. There can be no assurance that approval for ANDAs can be obtained in a timely manner, or at all. ANDA approvals are granted after the review by the FDA of detailed information submitted as part of the ANDA regarding the pharmaceutical ingredients, drug production methods, quality control, labeling, and demonstration that the product is therapeutically equivalent or bioequivalent to the brand-name reference drug. Demonstrating bioequivalence generally requires data demonstrating that the generic formula results in a product whose rate and extent of absorption are within an acceptable range of the results achieved by the brand-name reference drug. In some instances, bioequivalence can be established by demonstrating that the therapeutic effect of the generic formula falls within an acceptable range of the therapeutic effects achieved by the brand-name reference drug. Approval of an ANDA, if granted, generally takes more than two years from the submission of the application.

Products resulting from our proprietary drug program may require us to submit an NDA to the FDA. When processing an NDA, the FDA generally requires, in addition to the ANDA requirements (except for bioequivalence), complete pharmacological and toxicological studies in animals and humans to establish the safety and efficacy of the drug. The clinical studies required prior to the NDA submission are both costly and time consuming, and often take five to seven years or longer, depending, among other factors, on the nature of the chemical ingredients involved and the indication for which the approval is sought. Approval of an NDA, if granted, generally takes one year from the submission of the application to the FDA.

Among the requirements for drug approval by the FDA is that manufacturing procedures and operations conform to cGMP. The cGMP regulations must be followed at all times during the manufacture of pharmaceutical products. In complying with the standards set forth in the cGMP regulations, a manufacturer must expend time, money and effort in the areas of production and quality control to ensure full compliance.

If the FDA believes a company is not in compliance with cGMP, certain sanctions may be imposed, including: (i) withholding new drug approvals as well as approvals for supplemental changes to existing applications; (ii) preventing the receipt of necessary licenses to export products; (iii) preventing the importation of certain products into the United States; (iv) classifying the company as an unacceptable supplier and thereby disqualifying the company from selling products to federal agencies; and (v) pursuing a consent decree or court action that limits company operations or imposes monetary fines.

In addition, because we market a controlled substance in the United States and other controlled substances in Israel, we must meet the requirements of the United States Controlled Substances Act and its equivalent in Israel, as well as the regulations promulgated thereunder in each country. These regulations include stringent requirements for manufacturing controls, receipt and handling procedures and security to prevent diversion of, or the unauthorized access to, the controlled substances in each stage of the production and distribution process.

In May 1992, the Generic Drug Enforcement Act of 1992 (the “Generic Act”) was enacted. The Generic Act, a result of legislative hearings and investigations into the generic drug approval process, allows the FDA to impose debarment and other penalties on individuals and companies that commit certain illegal acts relating to the generic drug approval process. In some situations, the Generic Act requires the FDA not to accept or review, for a period of time, ANDAs from a company or an individual that has committed certain violations. It also provides for temporary denial of approval of applications during the investigation of certain violations that could lead to debarment and also, in more limited circumstances, provides for the suspension of the marketing of approved drugs by the affected company.

Lastly, the Generic Act allows for civil penalties and withdrawal of previously approved applications. To our knowledge, neither we nor any of our employees has ever been subject to debarment.

It is expected that the Acts that were enacted in March 2010 will have an impact on all segments of the health care industry. Pharmaceutical and medical device manufacturers may see an increase in revenues by virtue of an additional 30 million Americans who will have access to health insurance beginning in 2014; however, the legislation imposes on manufacturers a variety of additional rebates, discounts and fees that would curtail that increase in revenues. For example, Medicare Part D beneficiaries within the coverage gap receive a 52.5% point-of-sale discount (in 2013) off of negotiated prices for brand drugs (approved via an NDA or Biologics License Application), of which all but 2.5% is subsidized by manufacturer rebates. Similarly, beneficiaries within the coverage gap receive a 21% discount (in 2013) off the negotiated prices for generic drugs (approved via an ANDA). Also, annual fees are imposed on each manufacturer and importer of branded prescription drugs or biologics, based on the ratio of its sales to the sales of all covered entities during the prior year, and based on different sales dollar tiers (the highest being over $400 million in brand sales, and the lowest being at least $5 million in brand sales).

 

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The legislation also imposes reporting and regulatory requirements that could increase a company’s regulatory liability. For example, the “sunshine” provisions impose reporting requirements and public disclosure requirements on a drug manufacturer’s payments to physicians and teaching hospitals, and on drug sample distributions. The Company’s obligation to begin the data capture requirement begins in August 2013 and the first report is due in March 2014.

In addition, the legislation advances the policy of comparative clinical effectiveness research on medical treatments, services and items, including drugs and devices. Taken together, these government-adopted health care reform measures may adversely impact the pricing of healthcare products and services in the United States and the amount of reimbursement available from governmental agencies or other third party payors. Government cost control initiatives could decrease the price that we or any current or potential collaborators could receive for any of our products and could adversely affect our profitability.

Environmental Compliance

We believe that we are currently in compliance with all applicable environmental laws and regulations in Israel, Canada and the United States.

C. ORGANIZATIONAL STRUCTURE

The legal and commercial name of our company is Taro Pharmaceutical Industries Ltd. We were incorporated under the laws of the State of Israel in 1959 under the name Taro-Vit Chemical Industries Ltd. In 1984, we changed our name to Taro Vit Industries Ltd., and in 1994, we changed our name to Taro Pharmaceutical Industries Ltd.

The following is a list of our significant subsidiaries and their countries of incorporation as of March 31, 2013:

 

Name of Subsidiary

  

Country of Incorporation

Taro Pharmaceuticals U.S.A., Inc.

   United States

Taro Pharmaceuticals Inc.

   Canada

Taro Pharmaceuticals North America, Inc.

   Cayman Islands

Taro Pharmaceuticals Europe B.V.

   Netherlands

Taro International Ltd.

   Israel

The share capital of Taro U.S.A. is divided into two classes. The Company owns 96.9% of the shares that have economic rights and 50% of the shares that have voting rights in Taro U.S.A. TDC owns 3.1% of the shares that have economic rights and 50% of the shares that have voting rights in Taro U.S.A. TDC has agreed to vote all of its shares in Taro U.S.A. for such persons as we may designate for any election to its board of directors; however, TDC may terminate the agreement upon one year’s written notice.

On July 12, 2012, Taro Research Institute Ltd., a wholly owned subsidiary of the Company, was merged into the Company and deleted from registration at the Companies’ Registrar in Israel.

The Company owns 100% of the shares of Taro International Ltd. The Company owns 100% of Taro Pharmaceuticals North America, Inc., which owns 100% of Taro Canada. The Company owns 99.75% of Taro Pharmaceuticals Europe B.V. and Taro Pharmaceuticals North America, Inc. owns the remaining 0.25%.

Sun beneficially owns 77.3% of the voting power of the Company.

 

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D. PROPERTY, PLANT AND EQUIPMENT

The following is a list of our principal facilities as of March 31, 2013:

 

Location

   Square
Footage
    

Main Use

  

Own/Lease

Haifa Bay, Israel1

     890,000      Pharmaceutical manufacturing, production laboratories, offices, warehousing, chemical production (including tank farm and chemical finishing plant), and research   

Long-term Lease

Own

Lease

Use permit

Yakum, Israel

     15,000      Administrative offices    Lease

Brampton, Canada

     156,000      Pharmaceutical manufacturing, production laboratories, administration, distribution and warehousing    Own

Brampton, Canada

     75,400      Administration and warehousing    Lease

Hawthorne, New York

     124,000      Administrative offices    Own

South Brunswick, New Jersey

     315,000      Distribution facility    Own

Roscrea, Ireland2

     124,000      Pharmaceutical manufacturing, research laboratories and warehousing    Own

 

1. The majority of the land is held by the Company under a long-term lease from the Israeli Land Authority (“ILA”), which has not yet provided approval for the change of control of the Company.
2. The Irish facility is a discontinued operation and is held for sale.

From January 1, 2010 through March 31, 2013, we invested $23.1 million in property, plant and equipment (“PP&E”). Most of these projects have been completed and are subject to depreciation in accordance with our accounting policy of capitalizing costs that are direct and incremental to the activities required to bring the facilities to commercial production.

Our plant, research and office facilities in Haifa Bay, Israel, are located in a complex of buildings with an aggregate area of 890,000 square feet. We lease much of the land underlying these facilities from the ILA pursuant to long-term ground leases that expire between 2018 and 2058. We have the option to renew each lease for an additional 49 years. We also lease approximately 10,000 square feet of adjacent space in Haifa Bay. The lease for this property commenced on September 30, 1994. For additional information, please refer to Note 2.i. and 2.j.to our consolidated financial statements included elsewhere in this 2011 Annual Report.

We lease approximately 15,000 square feet of space in a facility located in Yakum, Israel, which is used for administrative and marketing offices. We plan on closing the office in Yakum and transferring the activities performed there to our Haifa site, which decision has been communicated to the employees at the Yakum site.

In February 2002, Taro Canada purchased 74,000 square feet of space that it had leased since March 1997, adjacent to the 68,000 square foot main manufacturing facility which it has owned since 1992 in Brampton, Canada. In 2003, Taro Canada added a 14,000 square foot addition to the main manufacturing facility. In September 2000, Taro Canada leased an additional 75,400 square feet of office and warehouse space, adjacent to the other two facilities, which lease term continues to 2015. In December 2003, Taro Canada purchased a 108,797 square foot building in close proximity to its existing facilities for $3.6 million. This building was used primarily for warehousing and was sold for net proceeds of $5.2 million on March 29, 2007.

In August 2002, Taro U.S.A. purchased a 32% interest in a 124,000 square foot building in Hawthorne, New York, for $4.4 million. In February 2005, Taro U.S.A. exercised its option to purchase the remaining 68% interest in this building. As of March 31, 2013, a subsidiary of Taro U.S.A. had a mortgage on this property of $7.6 million.

In January 2004, Taro U.S.A. purchased a 315,000 square foot distribution facility in South Brunswick, New Jersey for $18.0 million. In February 2012, the Company repaid the mortgage on this facility.

In the pharmaceutical industry, both manufacturing plants and equipment must be constructed and installed in accordance with regulations designed to meet stringent quality and sterility guidelines, among others. In order to meet these requirements, certain validation processes are required to be completed prior to commencing commercial production.

Design qualification (“DQ”), installation qualification (“IQ”), operational qualification (“OQ”), performance qualification (“PQ”) and validation are the steps required by cGMPs to bring plants and/or equipment to the status of their intended use. In the performance of these activities, the Company uses both internal and external resources. The Company capitalizes external costs and those internal costs that are direct and incremental to the activities required to bring the facilities and activities to commercial production.

 

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In the pharmaceutical industry, project life cycles (e.g., the construction of a new manufacturing facility) are typically longer than those in other industries. Such projects are technically complicated due to the highly regulated nature of the industry and the necessity of complying with specific detailed demands of regulatory authorities such as the FDA.

Certain internal resources utilized in bringing these facilities to the status required for their intended use are completely dedicated to these projects. The costs of personnel involved in such a process are capitalized only to the extent that they are directly dedicated to the completion of the facilities.

As fully described below, the nature of the activities performed by the employees whose salaries were capitalized include only the work and the direct costs associated with the factory acceptance test (“FAT”), the installation of equipment and the qualification and testing of the equipment prior to its commercial use.

The typical stages for defining the beginning and the completion of such construction projects include: planning and design of the facilities; construction; purchase, transportation and installation of equipment; equipment and facility validation (run in tests); and process and product validation.

All new equipment must undergo IQ, OQ and PQ in order to test and verify, according to written protocols, that all aspects of the equipment meet pre-determined specifications. IQ is defined as the documented evidence that the equipment has been installed according to the approved drawings and specifications. OQ is the documented evidence that all aspects of the equipment and the facility operate as intended within pre-determined ranges, according to the operational specifications. PQ is defined as the documented evidence that all aspects of the facility, utility or equipment that can affect product quality perform as intended in the pre-determined acceptance criteria.

Such qualification and validation activities are required for all equipment and systems that have an impact on or affect product quality and are required prior to commencing commercial production. At the time of installation and validation, all employees who will operate and maintain the equipment from the engineering, technology and maintenance departments are appropriately trained. At this stage in the installation and validation process, experts from the equipment manufacturer are on site, as part of the purchase contract, to provide training to Company employees in the operation and maintenance of the equipment.

This phase, which is necessary to bring the asset to the condition required for its intended use, is handled by a multi-functional team of engineers and technologists. The direct costs are the direct labor and the material consumed during this stage of installation and validation such as bottles, ampoules and raw materials. Incremental costs, which have arisen in direct response to the additional activity, include the expenses directly attributable to any employee’s time fully dedicated to the project in question. After the equipment has passed all IQ, OQ and PQ tests, it is then tested for its ability to actually manufacture the specific products that are intended to be produced on the equipment. Three consecutive successful validation batches must be produced. This process is performed jointly by the technology and the manufacturing departments. In addition, the cleaning of the equipment must be validated to assure that there is no carry-over residue to the next product to be manufactured using the equipment. Only after the validation batches that are manufactured using the new equipment pass quality control and quality assurance tests can they be released for sale, completing the validation process. No further costs are capitalized. This process is performed for all products.

During the installation process, materials from inventory are consumed. For example, in order to qualify a tablet press machine or an ampoule filling machine, we use raw materials, including APIs and excipients, to run the qualification test. As part of this test, actual tablets are manufactured and costs are incurred. These tablets may neither be distributed nor sold. These qualification procedures are part of cGMPs mandated by the FDA and its international counterparts. The amount of inventory capitalized as part of these projects is less than one percent of the total cost of the assets. We do not capitalize, as part of the asset cost, inventories that are routinely produced in commercial quantities on a repetitive basis.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A. OPERATING RESULTS

The following discussion should be read in conjunction with our consolidated financial statements and related notes for the year ended March 31, 2013, the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010, which are included elsewhere in this 2013 Annual Report.

OVERVIEW

We are a multinational, science-based pharmaceutical company. We develop, manufacture and market prescription and OTC pharmaceutical products, primarily in the United States, Canada and Israel. We also develop and manufacture APIs primarily for use in our finished dosage form products. Our primary areas of focus include topical creams and ointments, liquids, capsules and tablets. We operate principally through three entities: Taro Israel and two of its subsidiaries, Taro Canada and Taro U.S.A.

The pharmaceutical industry is affected by demographic and socioeconomic trends, such as aging populations and increased demand for pharmaceuticals, as well as broad economic trends, resulting in a corresponding increase in healthcare costs, effects on reimbursement pricing, and spending decisions of healthcare organizations, all of which lead to increased recognition of the importance of generics as providing access to affordable pharmaceuticals. We believe our business model is appropriately structured to take advantage of these trends.

The following is a breakdown of net sales by geographic region, including the percentage of our total consolidated net sales for each period:

 

     Year ended     Three months ended     Years ended December 31,  
     March 31, 2013     March 31, 2012     December 31, 2011     December 31, 2010  
     Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
    Sales
(in  thousands)
     % of
total sales
 

U.S.A.

   $ 587,851         88   $ 122,472         84   $ 424,950         84   $ 305,858         78

Canada

     52,452         8     13,167         9     43,720         9     44,169         11

Israel

     19,929         3     5,472         4     21,528         4     19,589         5

Other

     10,722         1     4,030         3     15,470         3     22,919         6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 670,954         100   $ 145,141         100   $ 505,668         100   $ 392,535         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

We generate most of our revenue from the sale of prescription and OTC pharmaceutical products. Portions of our OTC products are sold as private label products primarily to chain drug stores, food stores, drug wholesalers, drug distributors and mass merchandisers in the United States. Three customers in the United States accounted for the following proportion of our total consolidated net sales:

 

     Year ended March 31,     Three months ended
March 31,
    Year ended December 31,  
     2013     2012     2011     2010  

Customer

   Sales
(in millions)
     Percent     Sales
(in millions)
     Percent     Sales
(in millions)
     Percent     Sales
(in millions)
     Percent  

Customer A

   $ 139.3         20.8   $ 35.0         24.1   $ 95.7         18.9   $ 62.6         15.9

Customer B

   $ 94.0         14.0   $ 18.4         12.7   $ 62.8         12.4   $ 43.3         11.0

Customer C

   $ 82.0         12.2   $ 17.3         11.9   $ 59.8         11.8   $ 40.7         10.5

Due to increased competition from other generic pharmaceutical manufacturers as they gain regulatory approvals to market generic products, selling prices and related profit margins tend to decrease as products mature. Thus, our future operating results are dependent on, among other factors, our ability to introduce new products. In addition, our operating results are dependent on the impact of pricing pressures on existing products. These pricing pressures are inherent in the generic pharmaceutical industry.

 

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Percentage of net sales of certain products on a consolidated basis greater than 10% of our total consolidated sales:

 

     Year ended
March 31,
    Three months
ended March 31,
     Year ended December 31,  

Product

   2013     2012      2011      2010  

Nystatin/Triamcinolone

     14.1     *         *         *   

Desoximetasone

     *        *         *         12.7

Warfarin

     *        *         *         12.2

 

* Less than 10%

Our sales of these and other product lines are subject to market conditions and other factors. We are therefore unable to predict the extent, if any, to which the relative contribution to our total revenue of these three product lines as well as other product lines may increase or decrease in the future.

Cost of goods sold consists of direct costs and allocated costs. Direct costs consist of raw materials, packaging materials and direct labor identified with a specific product. Allocated costs are costs not associated with a specific product.

Certain customary industry selling practices affect our level of working capital; for example, industry practice requires that pharmaceutical products be made available to customers on demand from existing stock levels rather than on a made-to-order basis. Therefore, in order to accommodate market demand, we try to maintain adequate levels of inventories. Increased demand for existing products and preparation for new product launches, the exact timing of which cannot be determined accurately, have generally resulted in higher levels of inventory. However, anticipated growth in sales of any individual product, or of all products, may not materialize. Consequently, inventories prepared for these sales may become obsolete and have to be written off.

Another industry practice causes us to provide our customers with limited rights to return products, receive rebates, assert chargebacks and take other deductions with respect to sales that we make to them. See Item 5.A – “Critical Accounting Policies – Allowance for Sales Deductions and Product Returns.” The exercise of these rights by customers to whom we have granted them has an impact, which may be substantial, upon our working capital.

We continuously monitor our aged receivables and our customers’ creditworthiness. We also engage in active and intensive collection efforts as necessary.

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are described in Note 2 to our consolidated financial statements, which are prepared in conformity with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate, on an ongoing basis, our estimates, including those related to bad debts, income taxes and contingencies. We base our estimates on currently available information, our historical experience and various other assumptions that we believe to be reasonable under the circumstances. The results of these assumptions are the basis for determining the carrying values of assets and liabilities that are not readily apparent from other sources. Since the factors underlying these assumptions are subject to change over time, the estimates on which they are based are subject to change accordingly.

The following is a summary of certain policies that have a critical impact upon our financial statements and, we believe, are most important to keep in mind in assessing our financial condition and operating results.

Use of Estimates. In preparing the consolidated financial statements, we use certain estimates and assumptions that affect reported amounts and disclosures. These estimates and underlying assumptions can impact all elements of our financial statements. Taro uses estimates when accounting for product returns and sales deductions from revenues, determining the valuation and recoverability of assets (for example: accounts receivables, inventories, and intangible assets), and the reported amounts of accrued liabilities. We regularly evaluate our estimates and assumptions, using historical experience, third-party data, and market and external factors. Our estimates are often based on complex judgments, probabilities and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. As future events and their effects cannot be determined with precision, our estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. We adjust our estimates and assumptions when facts and circumstances indicate the need for change. It is possible that other professionals, applying reasonable judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts.

 

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Revenue Recognition. We sell our products directly to wholesalers, retail drug store chains, mass merchandisers, grocery chains and other direct purchasers and customers that acquire our products indirectly through wholesalers.

We recognize revenue from product sales when title and risk of loss have transferred to our customers and when the criteria in FASB Accounting Standards Codification, (“ASC”) Subtopic 605-15, “Revenue Recognition – Products” have been satisfied. Those criteria generally require that (i) persuasive evidence of an arrangement exists; (ii) product delivery has occurred; (iii) our price to our customers is fixed or determinable; (iv) collectibility is reasonably assured; and (v) the amount of product returns, chargebacks, rebates and other sales deductions can be reasonably estimated. We ship products to our customers only in response to, and to the extent of, the orders that customers submit to us. Depending on the terms of our customer arrangements, revenue is recognized when the product is received by the customer (“FOB Destination Point”) or at the time of shipment (“FOB Shipping Point”).

Allowance for Sales Deductions and Product Returns. When we recognize and record revenue from the sale of our pharmaceutical products, we record an estimate in the same financial reporting period for product returns, chargebacks, rebates and other sales deductions, which are reflected as reductions of the related gross revenue. We regularly monitor customer inventory information at our three largest wholesale customers to assess whether any excess product inventory levels may exist. We review this information along with historical product and customer experience, third-party prescription data, industry and regulatory changes and other relevant information and revise our estimates as necessary.

Our estimates of inventory in the distribution channel are based on inventory information reported to us by our major wholesale customers, historical shipment and return information from our accounting records and third-party data on prescriptions filled. Our estimates are subject to inherent limitations pertaining to reliance on third-party information.

Product returns. Consistent with industry practice, we generally offer our customers the right to return inventory within three to six months prior to product expiration and up to 12 months thereafter (the “return period”). Product returns are identified by their manufacturing lot number. Because we manufacture in bulk, lot sizes are generally large and, therefore, shipments of a particular lot may occur over a one-to-three month period. As a result, although we cannot associate a product return with the actual shipment in which such lot was included, we can reasonably estimate the period (in months) over which the entire lot was shipped and sold. We use this information to estimate the average time period between lot shipment (and sale) and return for each product, which we refer to as the “return lag.” The shelf life of most of our products ranges between 18-36 months. Because returns of expired products are heavily concentrated during the return period, and given our historical data, we are able to reasonably estimate return lags for each of our products. These return lags are periodically reviewed and updated, as necessary, to reflect our best knowledge of facts and circumstances. Using sales and return data (including return lags), we determine a rolling average monthly return rate to estimate our return reserves. We supplement this calculation with additional information including customer and product specific channel inventory levels, competitive developments, external market factors, our planned introductions of similar new products and other qualitative factors in evaluating the reasonableness of our return reserve. We continuously monitor factors that could affect our estimates and revise the reserves as necessary. Our estimates of expected future returns are subject to change based on unforeseen events and uncertainties.

We monitor the levels of inventory in our distribution channels to assess the adequacy of our product returns reserve and to identify potential excess inventory on hand that could have an impact on our revenue recognition. We do not ship product to our wholesalers when it appears that they have an excess of inventory on hand, based on demand and other relevant factors, for that particular product. Additionally, as a general practice, we do not ship products that have less than 12 months until expiration (i.e., “short-dated sales”).

Chargebacks. We have arrangements with certain customers that allow them to buy our products directly from our wholesalers at specific prices. Typically these price arrangements are lower than the wholesalers’ acquisition costs or invoice prices. In exchange for servicing these third party contracts, our wholesalers can submit a “chargeback” claim to us for the difference between the price sold to the third-party and the price at which it purchased the product from us. We generally pay chargebacks on generic products, whereas branded products are typically not eligible for chargeback claims. We consider many factors in establishing our chargeback reserves including inventory information from our largest wholesale customers and the completeness of their reports, estimates of Taro inventory held by smaller wholesalers and distributors, processing time lags, contract and non-contract sales trends, average historical contract pricing, actual price changes, actual chargeback claims received from the wholesalers, Taro sales to the wholesalers and other relevant factors. Our chargeback provision and related reserve varies with changes in product mix, changes in pricing, and changes in estimated wholesaler inventory. We review the methodology utilized in estimating the reserve for chargebacks in connection with analyzing our product return reserve each quarter and make revisions as considered necessary to reasonably estimate our potential future obligation.

 

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Rebates and other deductions. We offer our customers various rebates and other deductions based primarily on their volume of purchases of our products. Chain wholesaler rebates are rebates that certain chain customers claim for the difference in price between what the chain customer paid a wholesaler for a product purchase and what the chain customer would have paid if such customer had purchased the same product directly from us. Cash discounts, which are offered to our customers, are generally 2% of the gross sales price, and provide our customers an incentive for paying within a specified time period after receipt of invoice. Medicaid rebates are earned by states based on the amount of our products dispensed under the Medicaid plan. Billbacks are special promotions or discounts provided over a specific time period to a defined customer base, and for a defined product group. Distribution allowances are a fixed percentage of gross purchases for inventory shipped to a national distribution facility that we pay to our top wholesalers on a monthly basis. Administration fees are paid to certain wholesalers, buying groups, and other customers for stocking our products and managing contracts and servicing other customers. Shelf stock adjustments, which are customary in the generic pharmaceutical industry, are based on customers’ existing levels of inventory and the decrease in the market price of the related product. When market prices for our products decline, we may, depending on our contractual arrangements, elect to provide shelf-stock adjustments and thereby allow our customers with existing inventories to compete at the lower product price. We use these shelf-stock adjustments to support our market position and to promote customer loyalty.

The Company establishes reserves for rebates and these other various sales deductions based on contractual terms and customer purchasing activity, tracking and analysis of rebate programs, processing time lags, the level of inventory in the distribution channel and other relevant information. Based on our historical experience, substantially all claims for rebates and other sales deductions are received within 24 months.

Three-year summary

The following tables summarize the activities for sales deductions and product returns for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010:

 

     For the year ended March 31, 2013 (in thousands)  
     Beginning balance     Provision recorded
for current period sales
    Credits processed/ Payments      Ending balance  

Accounts Receivable Reserves

  

Chargebacks

   $ (20,789   $ (263,330   $ 261,327       $ (22,792

Rebates and Other

     (69,435     (192,115     167,139         (94,411
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (90,224   $ (455,445   $ 428,466       $ (117,203
  

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

   $ (33,426   $ (37,977   $ 21,702       $ (49,701

Other (1)

     (33,837     (43,184     49,324         (27,697
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (67,263   $ (81,161   $ 71,026       $ (77,398
  

 

 

   

 

 

   

 

 

    

 

 

 

 

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      For the three months ended March 31, 2012 (in thousands)  
     Beginning balance     Provision recorded
for current period sales
    Credits processed/ Payments      Ending balance  

Accounts Receivable Reserves

  

Chargebacks

   $ (20,145   $ (51,711   $ 51,067       $ (20,789

Rebates and Other

     (65,940     (50,349     46,854         (69,435
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (86,085   $ (102,060   $ 97,921       $ (90,224
  

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

   $ (30,722   $ (6,292   $ 3,588       $ (33,426

Other (1)

     (32,606     (11,215     9,984         (33,837
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (63,328   $ (17,507   $ 13,572       $ (67,263
  

 

 

   

 

 

   

 

 

    

 

 

 
     For the year ended December 31, 2011 (in thousands)  
     Beginning balance     Provision recorded
for current period sales
    Credits processed/ Payments      Ending balance  

Accounts Receivable Reserves

  

Chargebacks

   $ (26,559   $ (224,112   $ 230,526       $ (20,145

Rebates and Other

     (41,567     (150,799     126,426         (65,940
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (68,126   $ (374,911   $ 356,952       $ (86,085
  

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

   $ (21,962   $ (23,242   $ 14,482       $ (30,722

Other (1)

     (13,099     (51,462     31,955         (32,606
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (35,061   $ (74,704   $ 46,437       $ (63,328
  

 

 

   

 

 

   

 

 

    

 

 

 
     For the year ended December 31, 2010 (in thousands)  
     Beginning Balance     Provision recorded
for current period sales
    Credits processed      Ending balance  

Accounts Receivable Reserves

         

Chargebacks

   $ (19,360   $ (170,887   $ 163,688       $ (26,559

Rebates and Other

     (36,119     (85,861     80,413         (41,567
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (55,479   $ (256,748   $ 244,101       $ (68,126
  

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

   $ (22,514   $ (13,146   $ 13,698       $ (21,962

Others (1)

     (15,264     (25,979     28,144         (13,099
  

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ (37,778   $ (39,125   $ 41,842       $ (35,061
  

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) Includes indirect rebates and others.

Inventory. Inventories are stated at the lower of cost or market. Cost is determined as follows: raw and packaging materials—mainly on an average cost basis; finished goods products and products still in process, mainly on an average production cost including direct and indirect, or overhead, manufacturing expenses. Our finished goods inventories generally have a limited shelf life and are subject to obsolescence as they approach their expiration dates. As a result, we record a reserve against our entire finished goods inventory with expiration dates of less than 12 months and use historical experience to estimate the reserve for products with expiration dates of more than 12 months from the balance sheet date. When available, we use actual data to validate our estimates. We regularly evaluate our policies and the carrying value of our inventories and establish a reserve against the carrying value of our inventories. The determination that a valuation reserve is required, as well as the appropriate level of such reserve, requires us to utilize significant judgment. Although we make every effort to ensure the accuracy and reasonableness of our forecasts of future demand for our products, any significant unanticipated decreases in demand, or unanticipated changes in our major customer inventory management policies, could have a material impact on the carrying value of our inventories and reported operating results.

Valuation of Long-Lived Assets and Goodwill. We evaluate our long-lived assets for impairment and perform annual impairment testing for goodwill and other indefinite-lived intangible assets and other long-lived assets at fiscal year-end, on March 31 (formerly December 31), when impairment indicators exist. Impairments are recorded for the excess of a long-lived asset’s carrying value over fair value. Some examples of impairment indicators are as follows:

 

   

Changes in legal or business climate that could affect an asset’s value. For example, a failure to gain regulatory approval for a product or the extension of an existing patent that prevents our ability to produce a generic equivalent.

 

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Changes in our ability to continue using an asset. For example, restrictions imposed by the FDA could reduce our production and sales volume.

 

   

Decreases in the pricing of our products. For example, consolidation among our wholesale and retail customers could place downward pressure on the prices of some of our products.

We estimate the fair value of our long-lived assets other than goodwill, such as product rights, using a discounted cash flow analysis or market approach where appropriate when required under applicable U.S. GAAP. Under the discounted cash flow method, we estimate cash flows based on our forecasts and discount these cash flows using the appropriate rate to determine the net present value of the asset. The net present value of our assets is affected by several estimates, such as:

 

   

The timing and amount of forecasted cash flows

 

   

Discount rates

 

   

Tax rates

 

   

Regulatory actions

 

   

Amount of competition

 

   

Manufacturing efficiencies

 

   

The number and size of our customers

For the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, we recorded $1.0 million, $0, $0.8 million and $2.6 million impairment charge, respectively, in discontinued operations, related to the fixed assets of our Irish facility. We may have additional impairments related to our manufacturing facilities in future years.

We estimate the fair value of goodwill using a two step procedure. First, we compare the market value of our equity to the carrying value of our equity. If the carrying value exceeds the market value of our equity, we calculate the implied fair value of our goodwill by taking the excess of our market capitalization over the fair value of our assets other than goodwill and obligations. An impairment is recorded for the difference between the implied fair value and carrying value of goodwill. The implied fair value of goodwill and any potential impairment is sensitive to estimates of the fair value of other assets and liabilities. We have not recorded any impairments of goodwill for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010.

Income Taxes. We determine deferred taxes by utilizing the asset and liability method based on the estimated future tax effects of differences between the financial accounting and tax basis of assets and liabilities under the applicable tax laws. Deferred taxes are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. As of March 31, 2013, December 31, 2011 and 2010, Management determined that it was more likely than not that we will not benefit from the deferred tax assets in the Ireland and certain other subsidiaries. Therefore, for these locations a full valuation allowance was provided against the deferred tax assets. In future years, if it is more likely than not that we will be in a position to utilize its deferred tax asset, the valuation allowance for such assets may be modified.

Stock Options. We account for stock-based compensation in accordance with the provisions of ASC Topic 718 “Compensation – Stock Compensation.” Under the fair value recognition provisions of ASC 718, stock-based compensation cost is estimated at the grant date based on the fair value of the award and is recognized as expense ratably over the requisite service period of the award. We estimate the fair value of stock options granted using the Black-Scholes-Merton option-pricing model. We recognize compensation expense for the value of our awards granted subsequent to January 1, 2006, based on the straight-line method over the requisite service period of each of the awards, net of estimated forfeitures.

The fair value of an award is affected by our stock price on the date of grant and other assumptions, including the estimated volatility of our stock price over the term of the awards and the estimated period of time that we expect an employee to hold his or her stock options.

 

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Discontinued Operations. Under ASC Subtopic 205-20, “Presentation of Financial Statements – Discontinued Operations,” when a component of an entity has been disposed of or classified as held for sale, the results of its operations, including the gain or loss on the disclosed component, should be classified as discontinued operations and the assets and liabilities of such component should be classified as assets and liabilities attributed to discontinued operations; that is, provided that the operations, assets and liabilities of the component have been eliminated from the entity’s consolidated operations and the entity will no longer have any significant continuing involvement in the operations of the component.

Recent Accounting Pronouncements that may have an impact on future consolidated financial statements.

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Testing Disclosures about Offsetting Assets and Liabilities.” This standard requires additional disclosure about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. The amendments in this update are effective for interim and annual reporting periods beginning on or after January 1, 2013. Although this standard will not have a financial impact on our financial statements, it will require additional disclosure in the event we enter into offsetting financial and derivative instruments.

In July 2012, the FASB issued ASU No. 2012-02,Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” This standard amends ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment,” and permits, but does not require, an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30, “Intangibles—Goodwill and Other—General Intangibles Other than Goodwill.” The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued. The adoption of ASU 2012-02 is not expected to have a material impact on our financial position or results of operations.

In February 2013, the FASB issued ASU No. 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” This standard clarifies the intended scope of the disclosures required by Section 210-20-50 relating to financial and derivative instruments that are offset or are subject to an enforceable master netting arrangement or similar agreement. The amendments in this update will be effective for fiscal periods beginning on or after January 1, 2013. The adoption of ASU 2013-01 is not expected to have a material impact on our financial position or results of operations as we do not currently have this type of financial or derivative instrument.

In February 2013, the FASB issued ASU No. 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This standard improves the reporting of reclassifications out of accumulated other comprehensive income (“AOCI”) by showing the effect of significant reclassifications by the respective line items in net income and cross-referencing other disclosures for those other amounts not reclassed in their entirety from AOCI. The amendments in this update will be effective for reporting periods beginning after December 15, 2012 on a prospective basis with early adoption available. Although the adoption of ASU 2013-02 does not have a material financial impact on our financial statements, it changes how we present reclassifications out of AOCI.

In February 2013, the FASB issued ASU No. 2013-04, “Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date (a consensus of the FASB Emerging Issues Task Force).” This standard provides guidance for the recognition, measurement, and disclosure for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. The amendments in this update will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-04 is not expected to have a material impact on our financial position or results of operations.

In March 2013, the FASB issued ASU No. 2013-05, “Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (a consensus of the FASB Emerging Issues Task Force).” The amendments in this standard clarify when to release the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity. The amendments in this update will be effective prospectively for fiscal years and interim reporting periods within those years beginning after December 15, 2013. The adoption of ASU 2013-05 is not expected to have a material impact on our financial position or results of operations.

 

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RESULTS OF OPERATIONS

The following table sets forth selected items from our consolidated statements of operations as a percentage of total sales:

 

     For the year ended
March 31,
    For the three
months ended
March 31,
    For the
year ended
December 31,
 
     2013     2012     2012     2011     2011     2010  
           Unaudited           Unaudited              

Consolidated Statements of Operations

            

Sales, net

     100.0     100.0     100.0     100.0     100.0     100.0

Cost of sales

     26.3     32.7     31.7     41.4     34.8     40.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     73.7     67.3     68.3     58.6     65.2     59.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses: 

            

Research and development, net

     6.9     6.2     6.8     6.7     6.1     9.3

Selling, marketing, general and administrative

     12.9     17.4     15.9     20.9     18.6     27.5

Settlements and loss contingencies

     4.9     0.0     0.0     0.0     0.0     0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     24.7     23.6     22.7     27.6     24.7     36.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     49.0     43.7     45.6     31.0     40.5     22.7

Financial (income) expenses, net

     (0.6 %)      (0.7 %)      0.6     1.1     (0.8 %)      3.0

Other gain (loss), net

     0.5     *        (0.1 %)      0.2     0.1     0.2

Income before income taxes

     50.1     44.5     44.9     30.1     41.4     19.9

Tax expense

     10.1     6.6     12.3     5.9     4.9     2.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     40.0     37.9     32.6     24.2     36.5     17.2

Net (loss) income from discontinued operations

     (0.2 %)      (0.2 %)      *        (0.1 %)      (0.3 %)      (0.8 %) 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     39.8     37.7     32.7     24.1     36.2     16.4

Net income attributable to non-controlling interest

     0.1     0.1     0.1     0.3     0.1     0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

     39.7     37.6     32.6     23.8     36.1     16.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Less than 0.05%

YEAR ENDED MARCH 31, 2013 COMPARED WITH YEAR ENDED MARCH 31, 2012

Sales. For the year ended March 31, 2013, sales increased $127.9 million, or 23.5%, compared to the same period in 2012. Sales in the United States during the year ended March 31, 2013 increased $127.4 million, or 27.7%, compared to the same period in 2012, primarily due to price adjustments and increased market share of select products. Certain of the price adjustments were due to exclusivity or limited market availability of the respective products in the market. These pricing actions existed given these products were, and continue to be, high quality and cost effective to patients compared to a number of alternative treatment options available in the market. In general, as competition on any specific product increases, our pricing may not be sustainable and sales volumes may decline. Approximately $106.9 million relates to price adjustments on six prescription generic products, which represented 28.9% of consolidated net sales for the year ended March 31, 2013 and 16.0% in 2012, including Nystatin/Triamcinolone (“N/T”), which represents approximately 14.1% of consolidated net sales in 2013 and 5.7% in 2012. We were the exclusive supplier to the market of N/T during the year ended March 31, 2013. Subsequent to year end, analysis of market data indicates that competition has re-entered the market resulting in a decline in our sales of N/T. No other product represents more than 10.0% of consolidated net sales. Approximately $17.1 million of the increase is attributable to increased sales of Calcitrene®/calcipotriene ointment, which the Company promotes by marketing directly to physicians. The Company actively manages its product portfolio to assess pricing relative to market dynamics. Sales in Israel and other international markets decreased $5.5 million, or 15.3%, primarily related to decreased volumes. Sales in Canada increased $6.0 million, or 12.8%, compared to the year ended March 31, 2012, primarily related to increased volume.

Cost of Sales. Cost of sales, as a percentage of net sales, decreased to 26.3% in the year ended March 31, 2013, compared to 32.7% in the same period in 2012. This decrease is primarily related to the price adjustments noted above, which had no impact on costs.

Gross Profit. The Company’s gross profit was $494.8 million, or 73.7% of net sales, in the year ended March 31, 2013, while gross profit was $365.6 million, or 67.3% of sales, in the same period in 2012. The increase in 2013 was primarily the result of price adjustments on select products, as noted above.

Research and Development. Research and development (“R&D”) expenses increased $13.1 million, or 39.0%, in the year ended March 31, 2013 compared to the same period in the previous year. The increase in R&D expenses was primarily the result of an increase in clinical studies related to development of generic products.

 

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Selling, Marketing, General and Administrative. In the year ended March 31, 2013, selling, marketing, general and administrative (“SMG&A”) expenses decreased $8.1 million primarily as a result of decreased consulting fees. As a percentage of net sales, SMG&A decreased to 12.9% from 17.4% in 2012.

Settlements and Loss Contingencies. Settlements and loss contingencies were $33.3 million in the year ended March 31, 2013, which primarily related to certain price reporting litigations.

Operating Income. In the year ended March 31, 2013, the Company had operating income of $328.6 million compared to $237.6 million in the same period in 2012, an increase of $91.0 million. This increase is primarily attributed to the increase in gross profit. Operating income, as a percentage of sales, increased to 49.0% in the year ended March 31, 2013 from 43.7% in the same period in 2012.

Financial Expenses. Financial expenses result from interest expense and income and the impact of foreign currency exchange rate fluctuations. Net financial income remained relatively flat at $3.9 million for the years ended March 31, 2013 and 2012, as the increase in interest income of $3.8 million was offset by a reduction of $3.8 million in foreign exchange income.

Taxes. Tax expense in the year ended March 31, 2013 was $67.8 million, compared to $36.0 million in the same period in 2012, an increase of $31.8 million. The increase relates to the increase in operating results. As of March 31, 2013, on an unconsolidated basis, we have available carryforward tax losses of $0.8 million in Taro International, $10.4 million in the United Kingdom and $73.4 million in Ireland.

Net Income attributable to Taro. Our net income increased $61.9 million from net income of $204.3 million in the year ended March 31, 2012 to net income of $266.2 million in the same period in 2013, by reason of the factors noted above.

THREE MONTHS ENDED MARCH 31, 2012 COMPARED WITH THREE MONTHS ENDED MARCH 31, 2011

Sales. For the three months ended March 31, 2012, sales increased $37.4 million, or 34.7%, compared to the same period in 2011. Sales in the United States during the three months ended March 31, 2012 increased $35.4 million, or 40.7%, compared to the same period in 2011. Approximately $27.0 million of the increase resulted from price increases on seven dermatological topical products. These seven products represented 24.6% and 8.1% of consolidated net sales for the three month periods ended March 31, 2012 and 2011, respectively. None of these products individually represented net sales constituting over 10% of our sales on a consolidated basis for the three month periods ended March 31, 2012 and 2011. For the period ended March 31, 2012, pricing opportunities existed given these products were, and continue to be, cost effective to patients compared to a number of alternative treatment options available in the market. Approximately $7.2 million of the increase in U.S. sales was attributable to increased sales volumes on six products including imiquimod cream, Calcitrene®/calcipotriene ointment, mupirocin ointment, adapalene gel and ketoconazole cream. Included in this amount is approximately $5.0 million for products which were not sold in the same period of 2011. As competition enters the market, Taro’s pricing may not be sustainable and sales volumes may decline. Sales in Israel and other international markets decreased $0.8 million, or 7.7%, and sales in Canada increased $2.8 million, or 26.7%, compared to the three months ended March 31, 2011.

Cost of Sales. Cost of sales, as a percentage of sales, decreased to 31.7% in the three months ended March 31, 2012, compared to 41.4% in the same period in 2011. This decrease is primarily related to the price increases noted above, which had no impact on costs.

Gross Profit. The Company’s gross profit was $99.2 million, or 68.3% of sales, in the three months ended March 31, 2012, while gross profit was $63.1 million, or 58.6% of sales, in the same period in 2011. The increase for 2012 was primarily the result of higher sales due to price increases on select products, as noted above.

Research and Development. Net research and development (“R&D”) expenses increased $2.6 million, or 35.7%, in the three months ended March 31, 2012 compared to the same period in the previous year. The increase in R&D expenses was primarily the result of an increase in clinical studies.

Selling, Marketing, General and Administrative. In the three months ended March 31, 2012, selling, marketing, general and administrative expenses remained relatively flat from the amount expended in the same period in 2011.

Operating Income. In the three months ended March 31, 2012, the Company had operating income of $66.2 million compared to $33.4 million in the same period in 2011, an increase of $32.8 million. This increase is primarily attributed to the increase in gross profit. Operating income, as a percentage of sales, increased to 45.6% in the three months ended March 31, 2012 from 31.0% in the same period in 2011.

 

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Financial Expenses. Financial expenses result from interest expense and income and the impact of foreign currency exchange rate fluctuations. Net financial expense remained relatively flat at $1.0 million in the three months ended March 31, 2012, compared to expense of $1.2 million in the same period in 2011.

Taxes. Tax expense in the three months ended March 31, 2012 was $17.8 million, compared to $6.4 million in the same period in 2011, an increase of $11.4 million. The increase relates to the increases in operating results. As of March 31, 2012, on an unconsolidated basis, we have available carryforward tax losses of $1.3 million in the Company and our research institute in Israel, $10.6 million in the United Kingdom and $72.1 million in Ireland.

Net Income attributable to Taro. Our net income increased $21.6 million from net income of $25.7 million in the three months ended March 31, 2011 to net income of $47.3 million in the same period in 2012, by reason of the factors noted above.

YEAR ENDED DECEMBER 31, 2011 COMPARED WITH YEAR ENDED DECEMBER 31, 2010

Sales. During 2011, sales increased $113.1 million, or 28.8%, compared to 2010. Sales in the United States (“U.S.”) during 2011 increased $119.1 million, or 38.9%, compared to 2010, primarily due to price increases on select products. Overall sales volumes increased in the U.S. approximately 5.0%. In addition, the Company’s new product launches, including imiquimod cream, and increased sales volumes on select products, including Calcitrene®/calcipotriene ointment, fluorouracil cream, carbamezapine extended release tablets, adapalene gel and ketoconazole cream contributed $35.2 million. Sales in Israel and other international markets decreased $5.5 million, or 13.0%, compared to 2010 sales, primarily due to a decrease in sales of warfarin. Sales in Canada remained relatively flat compared to 2010.

Cost of Sales. Cost of sales, as a percentage of sales, decreased to 34.8% in 2011 compared to 40.5% in 2010. This decrease is primarily related to the price increases noted above, which had no impact on costs.

Gross Profit. The Company’s gross profit was $329.5 million, or 65.2% of sales, in 2011, while gross profit was $233.4 million, or 59.5% of sales, in 2010. The increase for 2011 was primarily the result of higher sales due to price increases on select products and increased sales volume as noted above.

Research and Development. Net research and development (“R&D”) expenses decreased $5.5 million, or 15.2%, in 2011 compared to the previous year. The decrease in R&D expenses was primarily the result of a reduction in the number of clinical studies performed during 2011. The majority of the R&D investment focused on our core business, including our generic pipeline, with the remainder focused on our proprietary pipeline.

Selling, Marketing, General and Administrative. In 2011, selling, marketing, general and administrative (“SMG&A”) expenses decreased $14.0 million, or 13.0%, from the amount expended in 2010. The decrease is primarily due to reductions in legal fees, in part attributable to the litigation involving the Company and Sun which ended in September 2010, audit fees, director and officer insurance costs and severance expenses associated with the termination of certain executives, which were partially offset by increased consulting fees.

Operating Income. In 2011, the Company had operating income of $204.7 million compared to $89.1 million in 2010, an increase of $115.6 million. This increase reflects the increase in gross profit and the reductions in operating expenses. Operating income, as a percentage of sales, increased from 22.7% in 2010 to 40.5% in 2011.

Financial (Income) Expenses. Financial (income) expenses result from interest expense and income and the impact of foreign currency exchange rate fluctuations. Net financial income was $3.7 million in 2011, compared to expense of $11.8 million in 2010, a change of $15.5 million, or 131.2%. The change in financial (income) expenses from 2010 to 2011 reflects the favorable impact of the change in the foreign currency exchange rates related to the intercompany balances in Canada combined with lower interest expenses due to the payoff of debt of $14.7 million and increased interest income resulting from higher cash balances throughout 2011.

Taxes. Tax expense in 2011 of $24.6 million, compared to $10.5 million in 2010, an increase of $14.1 million. The increase relates to the increases in operating results coupled with the favorable change in financial (income) expense noted above. As of December 31, 2011, on an unconsolidated basis, we have available carryforward tax losses of $1.3 million in the Company and our research institute in Israel, $10.8 million in the United Kingdom, $67.1 million in Ireland and $7.5 million in the United States.

 

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Net Income attributable to Taro. Our net income increased $118.6 million, from net income of $64.1 million in 2010 to net income of $182.7 million in 2011, by reason of the factors noted above.

IMPACT OF INFLATION, DEVALUATION (APPRECIATION) AND EXCHANGE RATES ON RESULTS OF OPERATIONS, LIABILITIES AND ASSETS

We conduct manufacturing, marketing and research and development operations primarily in Israel, Canada and the United States. As a result, we are subject to risks associated with fluctuations in the rates of inflation and foreign exchange in each of these countries.

The following table sets forth the annual rate of inflation, the devaluation (appreciation) rate of the NIS and the Canadian dollar against the United States dollar and the exchange rates between the United States dollar and each of the NIS and the Canadian dollar at the end of the period indicated:

 

     Rate of Inflation     Rate of  (Appreciation)
Devaluation
Against U.S. Dollar
    Rate of Exchange of
U.S. Dollar
 

Period ended

   Israel (1)     Canada (2)     Israel (1)     Canada (2)     Israel (1)      Canada (2)  

12/31/2008

     3.80     2.33     (1.14 %)      23.93     3.80         1.22   

12/31/2009

     3.91     1.32     (0.71 %)      (14.54 %)      3.78         1.05   

12/31/2010

     2.66     2.35     (5.99 %)      (4.97 %)      3.55         0.99   

12/31/2011

     2.17     2.30     7.66     2.25     3.82         1.02   

3/31/2012

     0.38     1.25     (2.77 %)      (1.76 %)      3.72         1.00   

3/31/2013

     1.27     0.99     (1.80 %)      1.65     3.65         1.02   

 

(1) Bank of Israel.
(2) Bank of Canada.

B. LIQUIDITY AND CAPITAL RESOURCES

Cash, including short-term deposits, restricted short-term deposits and marketable securities, increased $226.2 million to $560.5 million at, principally due to income from operations. Total Shareholders’ equity increased from $623.0 million at March 31, 2012 to $891.0 million at March 31, 2013, principally due to net income of $266.9 million.

Net cash provided by operating activities for the year ended March 31, 2013 was $248.7 million, compared to $235.1 million in the year ended March 31, 2012, an increase of $13.6 million. For the year ended March 31, 2013, the Company had net cash used in investing activities of $243.9 million compared to $53.8 million for the year ended March 31, 2012. For the year ended March 31, 2013, the Company had net cash used in financing activities of $3.3 million compared to $21.6 million for the year ended March 31, 2012.

The change in our liquidity for the year ended March 31, 2013 resulted from a number of factors, including:

 

   

Net cash provided by operating activities consists of the sale of long-lived assets and marketable securities, increase in long-term debt due to currency fluctuations and change in derivative instruments and impairment of long lived assets of $2.9 million and non-cash items of depreciation and amortization of $17.8 million. These items were offset by increases in trade receivables of $8.9 million, an increase of other receivables, prepaid and other of $19.6 million and a decrease in trade and other payables of $8.3 million.

 

   

Net cash used in investing activities consists of the investment in plant, property and equipment, which consumed $9.5 million, investment in short-term bank deposits of $241.7 million offset by proceeds from restricted deposits of $8.2 million.

 

   

Net cash used in financing activities consists of the repayment of long-term debt of $10.8 million offset by proceeds from issuance of shares and excess tax benefits from share-based payment arrangements of $7.4 million.

 

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Debt

As of March 31, 2013, we had total debt, including current maturities, of $28.6 million. (For more on our debt obligations, see Note 13 to the consolidated financial statements included in this 2013 Annual Report.)

During the year ended March 31, 2013, we did not incur any additional indebtedness, including increases in our borrowing capacity under any refinancings. We have been current with all our payment obligations due to our various lenders under their respective indentures and loan agreements.

As of March 31, 2013, we are in compliance with all our debt covenants.

As of March 31, 2013, our total long-term debt obligations (including current maturities) are as follows:

 

   

bonds of $21.0 million with various investors; and

 

   

a mortgage of $7.6 million.

Our currency denominations, interest rates and maturities regarding our long-term debt obligations, including current maturities (excluding mortgages), consist of the following:

 

         Amount              Linkage           Rate             Maturity      

Bonds 11/2003 NIS

   $  20,205       Israel CPI(a)     5.80     Nov. 2014   

Bonds 11/2003 USD

     842       Dollar     6.10     Nov. 2014   
  

 

 

        

Total

   $ 21,047          
  

 

 

        

 

(a) We have a contract to hedge our exposure to CPI fluctuations in Israel.

On February 3, 2012, the Company paid $5.9 million, comprised of $5.8 million of principal and $0.1 million of interest, in order to retire a mortgage.

As of March 31, 2013, we have no lines of credit.

Liquidity

On March 31, 2013, we had total unrestricted cash and cash equivalents and short-term bank deposits of $549.9 million and total indebtedness to our financial creditors of $28.6 million. We expect that existing cash resources and cash from operations will be sufficient to finance our foreseeable working capital requirements. None of our cash and cash equivalents is held captive by any financial covenants or government regulation. As of March 31, 2013 and 2012, we had no commitment for capital expenditures which we consider to be material to our consolidated financial position. The Company had no available and undrawn credit facilities in place at March 31, 2013.

Capital Expenditures

We invested $9.5 million in capital equipment and facilities in the year ended March 31, 2013 and $7.0 million in the year ended March 31, 2012. These investments are principally related to our pharmaceutical and chemical manufacturing facilities, expanding and upgrading our research and development laboratories in Israel and Canada and maintaining compliance with cGMPs. In addition to facility-related investments, we acquired certain manufacturing and packaging equipment to increase production capacity. We also continued to upgrade our information systems infrastructure to enable more efficient production scheduling and enhanced inventory analysis. (See Note 7 to our consolidated financial statements included in this 2013 Annual Report.)

C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES

We believe that our research and development activities have been a principal contributor to our achievements to date and that our future performance will depend, to a significant extent, upon the results of these activities.

Recruiting talented scientists is essential to the success of our research and development programs. Approximately 10% of our employees work in our worldwide research and development programs.

 

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We currently conduct research and development in three principal areas:

 

   

generic pharmaceuticals, where our programs have resulted in our developing and introducing a wide range of pharmaceutical products (including tablets, capsules, suspensions, solutions, syrups, creams, ointments and gels) that are equivalent to numerous brand-name products whose patents and FDA exclusivity periods have expired;

 

   

proprietary pharmaceuticals and delivery systems; and

 

   

organic and steroid chemistry, where our programs have enabled us to synthesize the active ingredients used in many of our products.

Taro’s management estimates that research and development expenses were allocated 75% to generic pharmaceuticals, 10% to proprietary pharmaceuticals and delivery systems and 15% to organic and steroid chemistry, for the fiscal year ended March 31, 2013.

Pharmaceutical Products

In the fiscal year ended March 31, 2013, we received two approvals for products manufactured in Canada. The following table sets forth the approvals received in the United States from the FDA from April 1, 2012 through March 31, 2013:

 

FINAL ANDA APPROVALS
     Brand Name*

Escitalopram Oxalate Oral Solution, 5 mg (base)/5 mL

  

Lexapro®

Clobetasol Propionate Lotion, 0.05%

  

Clobex®

TENTATIVE ANDA APPROVALS

 

Gabapentin Capsules, 100 mg, 300 mg and 400 mg **

  

Neurontin®

Gabapentin Oral Solution, 250 mg/5 mL **

  

Neurontin®

Fluocinonide Cream USP, 0.1%

  

Vanos®

 

* The above trademarks are the property of their respective owners.
** Tentative approval received prior to January 1, 2010 but currently under review by the FDA.

As of March 31, 2013, 22 of our ANDAs and the three tentative approvals listed above were under review by the FDA. In addition, there are multiple products for which either developmental or internal regulatory work is in process. The applications pending before the FDA are at various stages in the review process, and there can be no assurance that we will be able to successfully complete any remaining testing or that, upon completion of such testing, approvals for any of the applications currently under review at the FDA will be granted. In addition, there can be no assurance that the FDA will not grant approvals for competing products.

Patents, Trademarks and Licenses

We have filed and received patents in the United States and other countries for a variety of products, processes and methods of treatment, including:

 

   

a novel class of drug with utility as anticonvulsants, tranquilizers, muscle relaxants and agents for treatment of movement disorders;

 

   

novel oral delivery for pharmaceutical and related products; and

 

   

the synthesis and formulation of certain products.

 

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With the exception of the Ovide® patents granted in July 2009 and 2011 and patents covering Flo-Pred®, which have been granted between 1999 and 2010, we do not believe that any single patent or license is of material importance to us in relation to our current commercial activities. Our Flo-Pred® utilizes our patented NonSpil® liquid drug delivery system, which allows liquid medications to pour, but resist spilling, thereby providing accuracy of dosage and ease of use. In September 2012, a patent covering our Topicort® spray product was granted, which we commercialized in April 2013.

We have registered trademarks in the United States, Canada and other countries. Taro U.S.A. typically does not use trademarks in the sale and marketing of its generic multi-source non-innovator products.

From time to time, we seek to develop products for sale in various countries prior to patent expiration. In the United States, in order to obtain a final approval for a generic product prior to expiration of certain innovator’s patents, we must, under the terms of the Hatch-Waxman Act, as amended by the Medicare Prescription Drug Improvement and Modernization Act of 2003, notify the patent holder as well as the owner of an NDA, that we believe that the patents listed in the Orange Book for the new drug are either invalid or not infringed by our product. To the extent that we seek to utilize this mechanism to obtain approval to sell products, we are involved and expect to be involved in patent litigation regarding the validity, enforceability or infringement of patents listed in the Orange Book, as well as other patents, for a particular product for which we have sought approval. We may also be involved in patent litigation with third parties to the extent that claims are made that our finished product, an ingredient in our product or our manufacturing process, may infringe the innovator’s or third party’s process patents. We may also become involved in patent litigation in other countries where we conduct business, including Israel, Canada and various countries in Europe.

D. TREND INFORMATION

See Item 4 – “Information on the Company” and Item 5 – “Operating and Financial Review and Prospects” for trend information.

E. OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have any off-balance sheet arrangements.

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table describes the payment schedules of our contractual obligations as of March 31, 2013:

 

Type of Contractual Obligation

   Total      Less than
1 year
     1-3 years      3-5 years      Over 5 years  

Long-term debt obligations

   $ 28.60       $ 11.33       $ 12.29       $ 2.00       $ 2.98   

Operating lease obligations

     4.34         2.07         2.27         —           —     

Other Long-term liabilities (1)

     5.88         1.11         1.94         1.50         1.33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 38.82       $ 14.51       $ 16.50       $ 3.50       $ 4.31   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes severance commitments and tax accruals.

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. DIRECTORS AND SENIOR MANAGEMENT

The following table lists our directors and executive officers as of March 31, 2013:

 

Name

  

Age

    

Position

Kal Sundaram

     59       Director and Chairman of the Board

Aalok Shanghvi

     29       Director

Sudhir Valia

     57       Director

Ilana Avidov-Mor

     61       Director

Dan Biran

     70       Director and Chairman of the Audit Committee

Dov Pekelman

     73       Director and Chairman of the Special Committee

James Kedrowski

     61       Director and Interim Chief Executive Officer

Michael Kalb, C.P.A. (New York)

     42       Interim Chief Financial Officer and Chief Accounting Officer and Chief Financial Officer, U.S.A.

Stephen Manzano, Esq.

     48       Interim General Counsel and Vice President of Corporate Compliance

Avi Avramoff, Ph.D.

     48       Global Vice President, Research and Development

Rami Zajicek, Esq.

     49       Group Vice President, Haifa Site Manager

Michael Teiler

     50       Group Vice President, Portfolio Management

Sunil Mehta

     53       Group Vice President, General Manager, Canada

Mariana Bacalu

     61       Group Vice President, Quality Affairs

Michael Perfetto

     52       Chief Commercial Officer of the Generic Rx Business, U.S.A.

Brant Schofield

     47       Vice President, Sales & Marketing, TPHA, U.S.A.

Michele Visosky

     47       Vice President, Human Resources, U.S.A.

Jayesh Shah

     57       Head of Procurement, U.S.A.

Certain Familial Relationships

Mr. Aalok Shanghvi is the son, and Mr. Sudhir Valia is a brother-in-law, of Mr. Dilip Shanghvi. Mr. Dilip Shanghvi is the beneficial majority owner of Sun.

Business Experience

Kalyanasundaram Subramanian, known in industry circles as Kal Sundaram, became a member and Chairman of the Taro Board of Directors in April 2012. He was Sun Pharma’s Chief Executive Officer from April 2010 to April 2012 (and a director of the Sun Pharma Board of Directors until March 2012), and in this role he focused on accelerating Sun Pharma’s growth in India and other emerging market countries and developing broad, strategic alliances with other leading companies in the pharmaceutical industry. Mr. Sundaram has almost three decades of regional/global experience much of which has been in the pharmaceutical industry, largely with GlaxoSmithKline plc (“GSK,” LSE: GSK, NYSE: GSK) in India, where he has held country, regional and global responsibilities. As its Managing Director, he led the turnaround of GSK India; and in the regional role, he spearheaded the company’s differentiated and region-specific Emerging Markets strategy.

Aalok Shanghvi became a member of the Taro Board of Directors in September 2010. Mr. Aalok Shanghvi works as a Senior General Manager in International Marketing for Sun Pharma. He also founded PV Powertech Pvt. Ltd., a manufacturer and exporter of photo-voltaic solar panels.

Sudhir Valia became a member of the Taro Board of Directors in September 2010. Mr. Valia joined Sun Pharma as a director in January 1994 and has been a full-time director since his appointment in April 1994. He currently supports finance, commercial, operations, projects and quality control. Prior to then, Mr. Valia was a chartered accountant in private practice. Mr. Valia is on the Board of Directors of a number of companies in Sun’s group, including Sun Pharma Advanced Research Company Ltd. Mr. Valia is a qualified chartered accountant in India.

Ilana Avidov-Mor is a Certified Accountant who became a member of the Taro Board of Directors and Audit Committee in December 2010, the Special Committee in November 2011, the Stock Option Committee in March 2012 and the Compensation Committee in February 2013. Until January 2013, she served as Chief Executive Officer of a private company which gives services to advanced study Funds and to Provident Funds. Ms. Avidov-Mor formerly worked at Bank Yahav Ltd. for civil servants (the “Bank”), Israel, fulfilling various positions between 1994 and 2009. Among these positions, Ms. Avidov-Mor served as Deputy General Manager of the Bank for over a decade and as Comptroller for eight years. Between the years 1974 and 1994, Ms. Avidov-Mor worked for Braude & Partners Accountants. Ms. Avidov-Mor is also a former member of the following Directorates: Intercosma Ltd. (a company for the manufacture and marketing of cosmetics and toiletries) and three pension funds for doctors, nurses and para-medicals (Director on behalf of the Bank). Ms. Avidov-Mor is a former General Manager on behalf of Bank Yahav of four pension funds owned by the bank. Ms. Avidov-Mor earned her B.A. in Economics and Accounting at the Tel Aviv University, and her M.A. in Business Administration (Financing and Banking) at the Hebrew University of Jerusalem.

 

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Dan Biran became a member of the Taro Board of Directors and Audit Committee in December 2010, the Special Committee in November 2011, the Stock Option Committee in March 2012 and the Compensation Committee in February 2013. Mr. Biran currently serves as Chairman of the Board of Directors of Galam Ltd. K. Maanit. Between the years 2007 and July 2012, Mr. Biran served as the Chairman of the Board of Directors of Biological Industries Ltd. and Ducart Ltd. Between the years 2009 and 2011, Mr. Biran served as a Director of Netafim Ltd. And Enzymotec Ltd. Between the years 1992 and 2006, Mr. Biran served as a Chief Executive Officer of Arkal Filtration Systems. Between the years 2004 and 2006, Mr. Biran served as the Chairman of the Board of Directors of Pep Filters Inc. He also served as an external director of Maachteshim – Agan Ind. during the years 1997 and 2004, as well as the Chief Executive Officer of Netafim – Magal during the years 1983 and 1992. Mr. Biran also served as a director of Netafim USA during the years 1986 and 1992. Mr. Biran has fulfilled various management positions in the Unified Kibbutz Movement, Israel and at Kibbutz Magal, Israel.

Dov Pekelman became a member of the Taro Board of Directors and Audit Committee in August 2011, Chairman of the Special Committee in November 2011, the Stock Option Committee in March 2012 and the Compensation Committee in February 2013. Professor Pekelman is currently Chairman of Atera Networks Ltd., as well as Gilon Investments (TASE: GILN). He lectures at the Arison School of Business of the Interdisciplinary Center (IDC), Herzliya, Israel, serves on the Board of Directors of the IDC and is Chairman of the IDC Corporation, the center’s economic arm. Professor Pekelman served as a senior consultant to Teva Pharmaceutical Industries Ltd. (NASDAQ: TEVA) from 1985 to 2008 and also founded and ran a leading, Israeli-based management-consulting firm, P.O.C. Ltd. Professor Pekelman served on the Board of Directors of several large industrial corporations, including Koor Industries Ltd. (TASE: KOR) and served for 22 years on the Board of Directors of Makhteshim Agan Industries Ltd. (TASE: MAIN). Professor Pekelman was also a member of the advisory committee of the Bank of Israel. He holds a Ph.D. from the University of Chicago and a B.S. from the Technion, Israeli Institute of Technology. Professor Pekelman is a published author writing on various aspects of business operations.

James Kedrowski was appointed interim Chief Executive Officer of Taro in October 2010 and member of the Board of Directors of the Company in May 2011. Mr. Kedrowski has been with Chattem Chemicals, an indirect subsidiary of Sun Pharma since 1997 and is currently its Executive Vice President. Mr. Kedrowski’s prior experience includes over twenty years with Alcoa Inc., starting in sales, then purchasing roles culminating as senior purchasing agent for all Chemicals, Energy, and Carbon. Subsequently, Mr. Kedrowski was in progressive P&L business management positions in the USA before heading to Tokyo for four years of international experience running Alcoa’s Industrial Chemicals business in Asia. Mr. Kedrowski then returned to the U.S.A. as Operational Vice President for seven North American Industrial Chemicals plants.

Michael Kalb, C.P.A. became Interim Chief Financial Officer of the Company in November 2010. Mr. Kalb has been GVP, Chief Accounting Officer of the Company since May 2010 and Chief Financial Officer of Taro U.S.A. since June 2009. Mr. Kalb has over nineteen years of financial and accounting advisory experience. From June 2004 to June 2009, Mr. Kalb was a Director in the Accounting and Financial Consulting Group of Huron Consulting Group, Inc. (“Huron”). Mr. Kalb’s experience also includes over ten years at Ernst & Young, LLP within the Transaction Advisory Services Group and Audit and Assurance Services Group.

Stephen Manzano, Esq. became Interim General Counsel of the Company in June 2012 and is responsible for the legal affairs of Taro. He was also appointed Vice President of Corporate Compliance in order to lead Taro’s emphasis on its fulfilling its corporate responsibilities. Mr. Manzano had been VP, Corporate Affairs, Secretary and Associate General Counsel of Taro U.S.A. since September 2010 after joining Taro in September 2008 as Associate General Counsel of Taro U.S.A. Prior to joining Taro, Mr. Manzano was in private practice since 1992, which included being a partner at Kennedy Covington and beginning his legal career as an associate at Dewey Ballantine.

Avi Avramoff, Ph.D. joined our Company in October 2011 as Global Vice President, Research & Development. He is responsible for the Company’s new products development and is responsible for the management of the R&D Pharma and Chemistry, R & D Analytical Laboratories, Clinical studies, Regulatory Affairs, Pharmacovigilance, and the Intellectual Property Departments in all Taro’s sites. He has penned various publications and abstracts in the field of pharmacy, as well as several patents and patent applications. Prior to joining our Company, Dr. Avramoff worked from 1993 to 1997 as the Pharmacokinetic Center Manager and later on from 1997 to 2011 as Vice President, Research & Development at Dexcel Pharma.

Rami Zajicek, Esq. joined our Company in April of 2006 as Group Vice President, Haifa Site Manager. From 2002 to 2006, he was a partner of Tefen USA, Ltd., an international operations consulting firm. From 1998 to 2001, Mr. Zajicek was President and CEO of ProActivity Inc.

Michael Teiler joined our Company in 2011 and currently serves as Group Vice President, Portfolio Management. He is responsible for the new product introduction process, from selection to launch. From 1987 to 2011, Mr. Teiler served at Teva Pharmaceutical Industries Ltd. in several generic R&D and Portfolio Management positions, most recently as VP Generic R&D for the Teva International Group.

 

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Sunil Mehta joined our Company in January 2012 and currently is the General Manager of our Canadian operations. Prior to working for Taro, Mr. Mehta worked at Sun Pharma since 1997, where he held a variety of senior managerial positions in operations, manufacturing and supply chains. During his time at Sun Pharma, Mr. Mehta was deeply involved in acquisitions and integrations and exploring overseas operations, including Sun Pharma’s acquisition of a controlling interest in Taro.

Mariana Bacalu joined our Company in 1984 as Senior Analyst in the Quality Control Laboratory. Ms. Bacalu held increasingly responsible positions at Taro, especially in Quality Control, Quality Assurance and Production areas. Currently, as Group Vice President of Quality Affairs, she has overall responsibility of all Taro sites. Prior to joining Taro, Ms. Bacalu served as a production manager for Polymer Industry in Romania. Ms. Bacalu has a M.Sc. degree in Chemical Engineering.

Michael Perfetto joined our Company as the Chief Commercial Officer of the Generic Rx, OTC, U.S.A. business in January 2013. In his new role, Mr. Perfetto is the commercial lead of our U.S. generic and OTC product lines that includes Sales, Marketing, Sales Operations, and Distribution. Mr. Perfetto has over 25 years of pharmaceutical Sales and Marketing experience. Prior to joining Taro, Mr. Perfetto was with Actavis Inc. since 2003, where he served as Vice President of Rx Sales and Marketing. Prior to Actavis, Mr. Perfetto worked in National Accounts Sales positions for Barr Laboratories and Fisons Pharma.

Brant Schofield joined our Company in June, 2011 as Vice President of Sales and Marketing for TPHA (branded products). He is responsible for all aspects of the branded pharmaceutical business for Taro. Prior to Taro, Mr. Schofield spent 17 years with Galderma Laboratories in commercial and financial roles in the US, Europe and Latin America.

Michele Visosky joined our Company in January 2004 in the Human Resources department. She is currently Vice President, Human Resources and heads the department in the U.S. Ms. Visosky has 24 years of human resources experience, of which 17 were spent in management level roles. Prior to joining Taro, Ms. Visosky worked at Micro Warehouse, Inc. and Price Waterhouse, holding progressively responsible human resources positions, with the last one as Senior Vice President, Human Resources.

Jayesh Shah joined our Company in December 2011 as Head of Procurement. His responsibilities at Taro include procurement of raw materials, capital items and services for North America. Mr. Shah joined Caraco Pharmaceuticals USA, a wholly owned subsidiary of Sun Pharma, in 2000 and worked there until 2011. Prior to that, Mr. Shah worked at Sun Pharma in India from 1997 to 2000. From 1977 to 1997, Mr. Shah was a proprietor of J.B. Trading Corporation, an import/export company located in Mumbai, India.

B. COMPENSATION

Our directors are paid NIS 115,400 per year for their service as directors and NIS 3,470 for each board meeting and committee thereof they attend, linked to the Israeli CPI, for their service as directors. Kal Sundaram elected not to receive compensation for his services as director and Chairman of the Board. Aalok Shanghvi and Sudhir Valia are each paid $0.5 million per year for their service in addition to their duties as directors. The compensation for our statutory external directors, as defined under Israeli law, is not in excess of the amounts set forth in the Israeli Companies Law and regulations promulgated thereunder.

We paid an aggregate of approximately $5.7 million to all of our then current directors and executive officers for services rendered to us in all capacities during the year ended March 31, 2013. This amount does not include certain additional benefits which, as to all directors and executive officers as a group, aggregated less than $0.1 million. In addition, approximately $0.3 million was set aside in 2013 to provide all executive officers and directors with pension, retirement or similar benefits. During the year ended March 31, 2013, the Company’s executive officers and directors did not receive any options to purchase Taro‘s ordinary shares.

As of March 31, 2013, the Company’s executive officers and directors held options to purchase an aggregate of 3,500 ordinary shares, at exercise prices ranging from $24.68 to $68.51 per share, under Taro’s 1999 stock option plan; such options have original expiration dates between December 2013 and October 2014.

On February 4, 2013, the Company established a Compensation Committee to comply with the requirement of Amendment 20 to the Israeli Companies Law (“Amendment 20”) effective as of December 2012. Our Compensation Committee is comprised solely of Independent Directors and all of our statutory external directors are members of the Compensation Committee. See “Compensation Committee” in Item 6.C hereof.

 

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C. BOARD PRACTICES

We are incorporated in Israel and, therefore, we are subject to the provisions of the Israeli Companies Law, in addition to the relevant provisions of U.S. laws.

Board of Directors

According to the Israeli Companies Law, the Board of Directors sets the policy of a company and supervises the general manager (i.e., the chief executive officer) of a company in the performance of his or her role. The Board has residual powers so that it may exercise any power of the company not granted to any other body either by law or by our Articles of Association. According to our Articles of Association, as part of its powers, our Board may cause us to borrow or secure payments of any sum or sums of money for our purposes, at times and upon conditions as it thinks fit, including the grant of security interests on all or any part of our property.

According to our Articles of Association, our Board may neither consist of fewer than five, nor more than 25, directors.

Our directors, other than our statutory external directors, are elected at annual general meetings of our shareholders, which are required to be held at least once during every calendar year and not more than 15 months after the last preceding meeting. Directors may also be appointed to fill vacancies, or may be appointed to serve as additional members of the Board, by an ordinary resolution passed at an extraordinary general meeting of our shareholders. Likewise, in the event of a vacancy, the Board is empowered to appoint a director to fill such vacancy until the next annual general meeting of shareholders. A director, other than a statutory external director, holds office until the next annual general meeting, unless such directorship is earlier vacated in accordance with the provisions of any applicable law or regulation or under our Articles of Association.

We do not have any service contracts with any of our directors that would provide for benefits upon termination of employment.

Our Board currently consists of seven directors. The following members of our Board have been determined to be independent within the meaning of applicable NYSE regulations: Ilana Avidov-Mor, Dan Biran and Dov Pekelman.

Statutory External Directors

Qualifications of Statutory External Directors

Under the Israeli Companies Law, companies incorporated under the laws of the State of Israel whose shares, inter alia, are listed for trading on a stock exchange or have been offered to the public by a prospectus and are held by the public, are required to have at least two statutory external directors. The Israeli Companies Law provides that a person may not be elected as a statutory external director if the person is a relative of a controlling shareholder and/or the person or the person’s relative (as defined below), partner, employer, anyone to whom the person is subordinate, directly or indirectly, or any entity under the person’s control has, as of the date of the person’s election to serve as a statutory external director, or had, during the two years preceding that date, any affiliation (as defined below) with:

 

   

our company;

 

   

any entity controlling our company or relative thereof as of the date of the election; or

 

   

any entity controlled by our company or under common control with our company as of the date of the election or during the two years preceding that date.

The term “affiliation” includes an employment relationship, a business or professional relationship even if not maintained on a regular basis (but excluding insignificant relationships), or control of the company, and service as an office holder (as defined below).

Under the Israeli Companies Law, “relative” is defined as a spouse, brother or sister, parent, grandparent, child and a child/brother/sister/parent of such person’s spouse or the spouse of any of the preceding.

 

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The Israeli Companies Law defines the term “office holder” as general manager (i.e., chief executive officer), chief business manager, deputy general manager, vice general manager, any other person assuming the responsibilities of any of the foregoing positions without regard to such person’s title, and any director or manager that reports directly to the general manager.

The Israeli Companies Law provides that no person can serve as a statutory external director if the person’s other positions or other business creates, or may create, a conflict of interest with the person’s responsibilities as a statutory external director or may otherwise interfere with the person’s ability to serve as a statutory external director, or if the person is an employee of the Israel Securities Authority or of an Israeli stock exchange. Until the lapse of two years from termination of office as statutory external director, a company, its controlling shareholder and any entity controlled by the controlling shareholder, may not grant a former statutory external director, his/her spouse or child any benefits, directly or indirectly, including engaging the former statutory external director, his/her spouse or child to serve as an office holder in the company or in any company controlled by the controlling shareholder of the company and cannot employ or receive professional services from that person for consideration, either directly or indirectly, including through a corporation controlled by such former statutory external director. The same shall apply to a relative, who is not a former statutory external director’s spouse or child, for a period of one year from termination of office as statutory external director.

A person shall be qualified to serve as a statutory external director only if he or she possesses accounting and financial expertise or professional competence, as defined in the regulations promulgated under the Israeli Companies Law. At least one statutory external director must possess accounting and financial expertise.

The Israeli Companies Law also provides that a shareholders’ general meeting at which the appointment of a statutory external director is to be considered will not be called unless the nominee has declared to the company that he or she complies with the qualifications for appointment as a statutory external director.

Election of Statutory External Directors

Statutory external directors are elected by a majority vote at a shareholders’ meeting, provided that either:

 

   

the majority includes the majority of the total votes of non-controlling shareholders (as defined in the Israeli Companies Law) or shareholders who do not have a personal interest in such election present at the meeting in person or by proxy (abstentions will not be taken into account); or

 

   

the total number of votes against the election of the statutory external director by the non-controlling shareholders who do not have a personal interest in such election may not exceed two percent of the aggregate voting rights in the company.

For purposes of determining a controlling shareholder, Section 1 of the Israeli Companies Law defines “control” by reference to the definition of the Securities Law, 5728-1968 (the “Securities Law”), which defines “control” as “the ability to direct the activity of a corporation, excluding an ability deriving merely from holding an office of director or another office in the corporation, and a person shall be presumed to control a corporation if he or she holds half or more of a certain type of means of control of the corporation.” “Means of control” in Section 1 of the Securities Law is defined as “any one of the following: (1) the right to vote at a general meeting of a company or a corresponding body of another corporation; or (2) the right to appoint directors of the corporation or its general manager.”

The initial term of a statutory external director is three years and may be extended for two consecutive terms of three years each, provided that his or her service for each such additional term is recommended by one or more shareholders holding at least one percent of the company’s voting rights and is approved by a majority at a shareholders meeting, which majority must include either of the criteria described above with respect to his or her initial election. In accordance with the regulations under the Israeli Companies Law, companies whose securities are listed on one of a number of non-Israeli stock exchanges (including the New York Stock Exchange, where our ordinary shares are listed) may re-appoint an external director for additional three-year terms, in excess of the nine years described above, if the audit committee and the board of directors confirm that, due to the expertise and special contribution of the external director to the work of the board and its committees, his or her re-appointment is in the best interests of the company. The same special majority is required for election of the statutory external director for each additional three-year term (as was required for the initial term), with the additional requirement that the arguments of the board of directors and audit committee in favor of election for such additional term, and the number of terms already served by the external director, be presented to the general meeting prior to the vote.

 

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Statutory external directors may be removed from office only by the same percentage of votes as is required for election or by a court, if the statutory external director ceases to meet the statutory qualifications for his or her appointment or if he or she violates his or her duty of loyalty to the company.

Each committee of a company’s board of directors that is empowered to exercise one of the functions of the board of directors is required to include at least one statutory external director, except for the Audit Committee and Compensation Committee which are required to include all of the statutory external directors.

A statutory external director is entitled to compensation determined by the board within the scope provided in regulations adopted under the Israeli Companies Law.

Ilana Avidov-Mor and Dan Biran currently serve as statutory external directors on the Company’s Board. Our Board has determined that Ilana Avidov-Mor possesses accounting and financial expertise, whereas Dan Biran possesses professional competence, as required of our statutory external directors under the Israeli Companies Law.

Qualifications of Directors Generally Under the Israeli Companies Law

Under the Israeli Companies Law, the board of directors of a publicly traded company is required to make a determination as to the minimum number of directors (not merely statutory external directors) who must have accounting and financial expertise (according to the same criteria described above with respect to statutory external directors). In accordance with the Israeli Companies Law, the determination of the board should be based on, among other things, the type of the company, its size, the volume and complexity of its activities and the number of directors. Based on the foregoing considerations, our board determined that the number of directors with accounting and financial expertise in our company shall not be less than one. As described above, currently Ms. Avidov-Mor has been determined by the board to possess such accounting and financial expertise.

Unaffiliated Directors Under the Israeli Companies Law

Under the Israeli Companies Law, the audit committee of a publicly traded company must consist of a majority of unaffiliated directors. An “unaffiliated director” is defined as a statutory external director or a director who meets the following criteria:

 

   

he or she meets the qualifications for being appointed as a statutory external director, as approved by the Audit Committee, except for (i) the requirement that the director be an Israeli resident (in the case of a company such as ours whose securities have been offered outside of Israel or are listed outside of Israel) and (ii) the requirement for accounting and financial expertise or professional qualifications; and

 

   

he or she has not served as a director of the company for a period exceeding nine consecutive years. For this purpose, a break of less than two years in the service shall not be deemed to interrupt the continuation of the service.

The Israeli Companies Law further provides that a company may also elect to impose, via the adoption of a proposed set of corporate governance rules, certain independence requirements with respect to the composition of the board of directors as a whole. Those requirements, if undertaken by a company, mandate that (i) if the company has no controlling shareholder or no shareholder that holds at least 25% of the company’s voting rights, most of the members of the board must be unaffiliated directors, whereas (ii) if the company has a controlling shareholder or a shareholder that holds at least 25% of the voting rights, then at least one-third of the directors need to be unaffiliated directors.

As of the date of this annual report, we have not elected to adopt these corporate governance rules.

Alternate Directors

Pursuant to our Articles of Association and the Israeli Companies Law, any director may appoint, by written notice to us, any person who is not serving as a director, or as an alternate director, to serve as an alternate director and may also remove such alternate director. An alternate director possesses all of the rights and obligations of the appointing director except that the alternate, in his capacity as such, has no standing at any meeting if the appointing director is present. Unless the appointing director limits the time or scope of the appointment, it shall be effective for all purposes until the appointing director ceases to be a director or terminates the appointment. The appointment of an alternate director does not diminish the responsibility of the appointing director as a director. A statutory external director may not appoint an alternate except in certain circumstances provided by the Israeli Companies Law.

 

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Committees

Subject to the provisions of the Israeli Companies Law, our Board may delegate its powers to certain committees comprised of Board members. Pursuant to the Israeli Companies Law, any committee of the board of directors that is authorized to perform any function of the board (other than committees constituted solely as advisory committees), must include at least one statutory external director and the audit committee and compensation committee must include all statutory external directors. Our Board has formed audit, stock option and compensation committees.

Audit Committee

Under the Israeli Companies Law and our Articles of Association, our Board is required to appoint an Audit Committee of at least three directors, a majority of whom must be unaffiliated directors, and which must include all statutory external directors (at least two), but excluding:

 

   

the chairman of the board of directors and a director employed by our company, or by the company’s controlling shareholder, directly or indirectly, or who provides services to any of the foregoing on a regular basis and a director whose main livelihood stems from the controlling shareholder; and

 

   

a controlling shareholder or a relative of a controlling shareholder.

The chairman of the Audit Committee shall be a statutory external director.

A person who is not qualified to serve as a member of the audit committee shall not be present at the committee’s meetings and at the time resolutions are adopted thereby, unless such person’s participation is required in order to present to the committee a particular matter.

Currently, our Audit Committee consists of the following directors: Dan Biran, Ilana Avidov-Mor and Dov Pekelman, all of whom have been determined by our Board to be independent as defined by the applicable NYSE rules and those of the SEC. Ilana Avidov-Mor and Dan Biran are statutory external directors. Dan Biran is the chairman of the Audit Committee.

Under the Israeli Companies Law (under an amendment adopted in 2011) and our restated Audit Committee charter adopted in March 2011, our Audit Committee is responsible for (i) determining whether there are delinquencies in the business management practices of the company, including in consultation with the company’s internal auditor or the independent auditor, and making recommendations to the Board to improve such practices, (ii) determining whether to approve certain related party transactions or transactions in which an office holder has a personal interest and whether such transaction is material, (iii) where the Board of Directors approves the working plan of the internal auditor, examining such working plan before its submission to the Board and proposing amendments thereto, (iv) examining the company’s internal controls and internal auditor’s performance, including whether the internal auditor has sufficient resources and tools to dispose of his responsibilities (taking into consideration the company’s special needs and size), (v) examining the scope of the company’s auditor’s work and compensation and submit its recommendation with respect thereto to the corporate organ considering the appointment thereof (either the Board or the general meeting of shareholders) and (vi) determining procedures with respect to the treatment of company employees’ complaints as to the management of the company’s business and the protection to be provided to such employees. Our Audit Committee also approves our financial statements in its role as a committee of the Board under the Israeli Companies Law.

In accordance with Sarbanes-Oxley requirements and our Audit Committee charter, our Audit Committee is directly responsible for the appointment, compensation and oversight of our independent auditors. In addition, the Audit Committee is also responsible for, among other things, assisting the Board in reviewing, and recommending actions to the Board with respect to, our financial statements, the effectiveness of our internal controls and our compliance with legal and regulatory requirements.

The Audit Committee has reviewed and discussed with Management the Company’s audited consolidated financial statements as of and for the year ended March 31, 2013. The Audit Committee has also discussed with our independent registered public accounting firm the matters required to be discussed by the Statement on Auditing Standards No. 114, “The Auditor’s Communication With Those Charged With Governance,” issued by the Auditing Standards Board of the American Institute of Certified Public Accountants which replaced SAS No. 61, “Communication With Audit Committees.” Based on the reviews and discussions referred to above, the Audit Committee has recommended to the Board that the audited consolidated financial statements referred to above be included in this 2013 Annual Report.

 

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Approval of Interested Party Transactions

Under the Israeli Companies Law, the approval of the Audit Committee (or, for transactions involving compensatory matters, the approval of the Compensation Committee) is required to effect certain actions and transactions with office holders, controlling shareholders and entities in which they have a personal interest. Such interested party transactions (including matters described in the following paragraph) require the approval of the Audit Committee (or the Compensation Committee, if involving a compensatory matter), the Board and in certain cases, the shareholders. Such shareholders approval, in certain cases, also requires a special voting majority. See “Disclosure of Personal Interests of a Controlling Shareholder” in Item 10.B hereof.

Internal Auditor

Under the Israeli Companies Law, the board of directors of a public company is required to appoint an internal auditor proposed by the Audit Committee. The internal auditor may not be an interested party (i.e., a holder of 5% or more of the voting rights in the company or of the issued share capital), the chief executive officer of the company or any of its directors, or a person who has the authority to appoint the company’s chief executive officer or any of its directors, or a relative of an office holder or of an interested party, nor may the internal auditor be our external independent auditors or their representatives. The role of the internal auditor is to examine, among other things, whether our actions comply with the law and orderly business procedure. Mrs. Rita Gerson is the internal auditor of the Company. The internal auditor has the right to demand that the chairman of the Audit Committee convene an Audit Committee meeting and the internal auditor may participate in all Audit Committee meetings.

Stock Option Committee

In March 2012, after the Company’s shares were listed on NYSE for trading, the Company established a Stock Option Committee to administrate the activities under the Company’s incentive stock option plans. The Stock Option Committee’s authority under the plans is mainly with respect to grants, as well as resolution of claims.

The Stock Option Committee complies with the requirements of Rule 16b-3 of the Securities Exchange Act of 1934, or the Exchange Act (which will become relevant to the extent that we ever lose our status as a foreign private issuer under the Exchange Act in the future and thereby become subject to Section 16 of the Exchange Act) and is comprised solely of Independent Directors.

Compensation Committee

On February 4, 2013, the Company established a Compensation Committee to comply with the requirements of Amendment 20 effective as of December 2012. Our Compensation Committee is comprised solely of Independent Directors and all of our statutory external directors are members of the Compensation Committee.

Amendment 20 also requires us to adopt a compensation policy by September 12, 2013, which will set forth our policy regarding the terms of office and employment of office holders, including compensation, equity awards, severance and other benefits, exemption from liability and indemnification (“Terms of Office and Employment”).

The compensation policy must be approved by the board of directors, after considering the recommendations of the Compensation Committee. The compensation policy must also be approved by a majority vote at a shareholders meeting provided that either:

 

   

the majority includes the majority of the total votes of non-controlling shareholders (as defined in the Israeli Companies Law) or shareholders who do not have a personal interest in the matter present at the meeting in person or by proxy (abstentions will not be taken into account); or

 

   

the total number of votes against the policy by the non-controlling shareholders or shareholders who do not have a personal interest in the matter does not exceed two percent of the aggregate voting rights in the company.

The compensation policy must be approved by our Board and shareholders every three years. If the compensation policy is not approved by the shareholders, the Compensation Committee and the Board may nonetheless approve the policy, following further discussion of the matter and for specified reasons.

Under Amendment 20, the Terms of Office and Employment of office holders require the approval of the Compensation Committee and the Board (assuming that they are consistent with the then-effective compensation policy). The Terms of Office and Employment of directors and the chief executive officer (or any other office holder whose compensation deviates from the then-effective compensation policy, as described below) must also be approved by shareholders.

 

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Changes to existing Terms of Office and Employment of office holders (other than directors) can be made with the approval of the Compensation Committee only, if the committee determines that the change is not substantially different from the existing terms.

Under certain circumstances, the Compensation Committee and the Board may approve an arrangement that deviates from the compensation policy, provided that such arrangement is approved by the special majority of the company’s shareholders mentioned above. Such special shareholder approval will also be required with respect to determining the Terms of Office and Employment of a director or the chief executive officer during the transition period until the company adopts a compensation policy.

The Company intends to take all necessary steps in order to complete the adoption of a compensation policy by September 12, 2013.

Special Committee

In November 2011, the Company’s Board of Directors formed a Special Committee of independent directors, comprised of Dov Pekelman (Chairman of the Special Committee), Ilana Avidov-Mor and Dan Biran, to review and evaluate the non-binding proposal by Sun to acquire all of the issued and outstanding shares of Taro, not currently held by Sun, at a price of $24.50 per share, in cash. In August 2012, the Company and Sun entered into a merger agreement whereby Sun would purchase all of the issued and outstanding shares of Taro, not currently held by Sun, at a price of $39.50 per share, in cash, upon the closing of the proposed merger. On February 8, 2013, the parties announced that they mutually agreed to terminate the merger agreement. Following the termination of the merger agreement, the Special Committee was dissolved.

D. EMPLOYEES

The following table sets forth the number of full time equivalents as of March 31, 2013*:

 

     March 31, 2013                       
     U.S.A.      Canada      Israel      Other      Total  

Sales and Marketing

     115.0         34.0         35.0         —           184.0   

Administration

     61.0         30.0         46.5         —           137.5   

Research and Development

     14.0         47.0         71.0         —           132.0   

Production and Quality Control

     —           310.0         530.5         —           840.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     190.0         421.0         683.0         —           1,294.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the number of full time equivalents as of March 31, 2012*:

 

     March 31, 2012                       
     U.S.A.      Canada      Israel      Other      Total  

Sales and Marketing

     110.0         35.0         38.0         —           183.0   

Administration

     62.0         31.0         49.5         1.0         143.5   

Research and Development

     12.0         42.0         69.0         —           123.0   

Production and Quality Control

     —           292.0         537.5         —           829.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     184.0         400.0         694.0         1.0         1,279.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the number of full time equivalents as of December 31, 2011*:

 

     December 31, 2011                       
     U.S.A.      Canada      Israel      Other      Total  

Sales and Marketing

     134.0         31.0         41.0         —           206.0   

Administration

     63.0         30.0         50.5         1.0         144.5   

Research and Development

     12.0         40.0         84.0         —           136.0   

Production and Quality Control

     —           278.0         508.5         —           786.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     209.0         379.0         684.0         1.0         1,273.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table sets forth the number of full time equivalents as of December 31, 2010*:

 

     December 31, 2010                       
     U.S.A.      Canada      Israel      Other      Total  

Sales and Marketing

     127.0         36.0         41.0         1.0         205.0   

Administration

     71.0         31.0         48.5         2.0         152.5   

Research and Development

     13.0         40.0         116.0         1.0         170.0   

Production and Quality Control

     —           244.0         442.5         —           686.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     211.0         351.0         648.0         4.0         1,214.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* In the U.S.A., distribution employees are included in the Sales and Marketing category.

In general, we believe that our relationship with our employees is satisfactory. Since we are members of the Manufacturers Association, certain general collective agreements apply to us. These agreements concern principally the length of the workday, minimum daily wages for professional workers, insurance for work-related accidents, procedures for dismissing employees, pension payments, and other conditions of employment. We generally provide our employees with benefits and working conditions beyond the required minimums.

On April 29, 2011, the Board ratified a collective bargaining agreement dated as of April 6, 2011 (the “Collective Bargaining Agreement”) among Taro, the Histadrut Trade Union and Taro’s Employees Committee on behalf of Taro’s Israeli employees. The Collective Bargaining Agreement has a term of five years and automatically renews for two-year periods unless notice is provided by either side prior to the end of a term. The Collective Bargaining Agreement memorializes current employee-employer relations practices of Taro as well as additional rights relating to job security, compensation and other benefits. Additionally, the Collective Bargaining Agreement, inter alia, provided for a one-time payment of $1.5 million (payable in NIS) to be divided among Taro’s Israeli employees as of the date of the Collective Bargaining Agreement.

On January 23, 2013, the Company entered into a special collective bargaining agreement (the “Special Collective Bargaining Agreement”) among Taro, the Histadrut Trade Union and Taro’s Employees Committee on behalf of Taro’s Israeli employees. The Special Collective Bargaining Agreement memorializes the rights of the Company’s employees at the Yakum site in Israel, following the Company’s decision to transfer the activities performed at the Yakum site to the Company’s existing Haifa site.

Israeli law generally requires severance pay upon the retirement or death of an employee or termination of employment in certain other circumstances. In addition, as of May 2006, under a collective agreement signed by the Manufacturers Association, we are obligated to contribute to a pension plan amounts equal to a certain percentage of the employees’ wages, for all employees, and Section 14 of the Severance Pay Law applies to most of our employees. We are complying with these obligations. We fund our ongoing severance obligations by contributing a sum equal to 8.3% of the employee’s wages to funds known as Pension Funds or the Managers’ Insurance. These funds provide different combinations of savings plan, life insurance and severance pay benefits to our employees, and each employee, according to the fund chosen by them, receives a lump sum payment upon retirement and severance pay, if the employee is legally entitled to it, upon termination of employment. Each employee contributes an amount equal to 5%-7% of their salary. The Company contributes an additional sum between 5% and 7.5% of the employee’s salary. Under Section 14 of the Severance Pay Law, in the event of dismissal, all payments made to pension funds or any other similar funds serve as severance pay and the Company is not obliged to pay the employee any other severance pay. In addition, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute (an agency similar to the United States Social Security Administration), which include payments for national health insurance. The payments to the National Insurance Institute are approximately 17.7% of an employee’s wages (up to a specified amount), of which the employee contributes approximately 12.2% and we contribute approximately 5.7%.

E. SHARE OWNERSHIP

The following table sets forth certain information regarding the ownership of our ordinary shares by our directors and executive officers as of March 31, 2013. The percentage of ownership is based on ordinary shares outstanding as of March 31, 2013. Ordinary shares subject to options currently exercisable as of, or exercisable within 60 days of, March 31, 2013, are deemed outstanding for computing the percentage ownership of the person holding such options, but are not deemed outstanding for computing the percentage ownership of any other person. None of the ordinary shares owned by any of our directors and executive officers has voting rights different from those possessed by other holders of our ordinary shares.

 

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Name

   Number of
Ordinary Shares
     Percentage of
Outstanding Ordinary
Shares
 

Kal Sundaram (1)

     —           0.00

Aalok Shanghvi

     —           0.00

Sudhir Valia

     —           0.00

Ilana Avidov-Mor

     —           0.00

Dan Biran

     —           0.00

Dov Pekelman

     —           0.00

James Kedrowski

     —           0.00

Michael Kalb, C.P.A. (New York)

     —           0.00

Stephen Manzano, Esq.

     —           0.00

Avi Avramoff, Ph.D.

     —           0.00

Rami Zajicek, Esq.

     *         *   

Michael Teiler

     —           0.00

Mariana Bacalu

     *         *   

Michael Perfetto

     —           0.00

Brant Schofield

     —           0.00

Michele Visosky

     *         *   

Jayesh Shah

     —           0.00

Total for all directors and officers (17 persons) listed above, as a group

     *         *   

 

* Less than 1%

The following table sets forth certain information regarding the ownership of our founders’ shares by our directors and officers as of March 31, 2013. The percentage of ownership is based on 2,600 founders’ shares outstanding as of March 31, 2013.

 

Name

   Number of
Founders’
Shares
     Percentage of
Outstanding Founders’
Shares
 

Alkaloida (1)

     2,600         100.00

 

(1) Alkaloida, a subsidiary of Sun, owns all 2,600 of our outstanding founders’ shares, whose holders are entitled to exercise one-third of the total voting power in our company regardless of the number of ordinary shares then outstanding. As a result of the control that may be deemed to be held of Alkaloida, each of Sudhir Valia and Aalok Shanghvi may be deemed to beneficially own the founders’ shares held by Alkaloida. Each such person disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest therein.

As of March 31, 2013, the directors and executive officers listed above, as a group, held options to purchase 3,500 of our ordinary shares at exercise prices ranging from $24.68 to $68.51, such options have expiration dates between December 2013 and October 2014.

Stock Option Plans

The Company has not granted options to purchase our ordinary shares since January 14, 2009. As of March 31, 2013, there were 25,500 options outstanding to acquire our ordinary shares.

 

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Compensation Pursuant to Plans

1991 Stock Incentive Plan

Our 1991 Stock Incentive Plan was unanimously adopted by our Board on November 19, 1991, and approved by our shareholders on April 10, 1992. The purpose of the 1991 Stock Incentive Plan is to attract, retain and provide incentives to key employees, including directors and officers who are key employees, and to consultants and directors who are not our employees by enabling them to participate in our long-term growth. As of March 31, 2013, the Company’s ability to issue additional options under the 1991 Stock Incentive Plan has been terminated.

The 1991 Stock Incentive Plan permits the grant of options and stock appreciation rights (“SARs”). Options outstanding are non-qualified stock options (“NQSOs”). The total number of our ordinary shares with respect to which options and SARs may be granted under the 1991 Plan may not exceed 1,000,000, subject to appropriate adjustment in the event of stock dividends, stock splits and similar transactions.

All key employees, consultants to us, and our directors, including officers and directors who are key employees, other than the optionees, and members of our Plan Committee, as defined in the 1991 Stock Incentive Plan, were eligible to participate in the 1991 Stock Incentive Plan. Under the plan, directors, excluding Identified Public Directors who are not our employees or Outside Directors, both as defined in the 1991 Stock Incentive Plan, are granted, on the date that such individual is initially elected a director, a one-time non-qualified option to purchase 4,000 ordinary shares (the “Initial Outside Director Award”).

The 1991 Stock Incentive Plan is administered by our Board (as required by the Israeli Companies Law) and by a Plan Committee, composed of not less than two members, each of whom must be disinterested persons as defined by the SEC (as required by United States law). Within the limits of the 1991 Stock Incentive Plan, the Board and Plan Committee are authorized to determine, among other things, to whom and the time or times at which options and SARs are to be granted, the types of options and SARs to be granted, the number of shares which will be subject to any option or SAR, the term of each option and SAR, the exercise price of each option and base price of each SAR, and the time or times and conditions under which options and SARs may be exercised. The Board and the Plan Committee may, with the consent of the holder of the option or SAR, cancel or modify an option or SAR or grant an option or SAR in substitution for any canceled option or SAR, provided that any substituted option or SAR and any modified option or SAR is permitted to be granted on such date under the terms of the 1991 Stock Incentive Plan and the Code. In such case, the Board and the Plan Committee may give credit toward any required vesting period for the substituted option or SAR for the period during which the employee held the canceled option or SAR.

The exercise price of an option or base price of a SAR granted under the 1991 Stock Incentive Plan, other than the Initial Outside Director Award, shall be determined by the Board and the Plan Committee, but may not be less than 100% of the fair market value of the ordinary shares on the date of grant or 110% of such fair market value in the case of an ISO granted to an optionee who owns or is deemed to own stock possessing more than 10% of the combined voting power of all classes of our stock. The exercise price of an Initial Outside Director Award shall equal the fair market value of the ordinary shares subject to such option on the date of grant.

Upon exercise of a SAR, subject to applicable law, the holder is entitled to receive an amount in cash, ordinary shares or a combination of the two, as determined by the Board and the Plan Committee, equal to the excess of the fair market value of the shares with respect to which the SAR is exercised, calculated as of the exercise date, over the base price.

The term of each option and SAR other than an Initial Outside Director Award will be for such period, and such option or SAR may be exercised at such times during such period and on such terms and conditions, as the Board and the Plan Committee may determine, consistent with the terms of the 1991 Stock Incentive Plan. The term of an Initial Outside Director Award will be five years. Each Initial Outside Director Award will become exercisable in each of the four years commencing one year after the date of grant to the extent of one-fourth of the number of our ordinary shares originally subject to the option granted therein. Ordinary shares not purchased pursuant to an Initial Outside Director Award in any one exercise period may be purchased in any subsequent exercise period prior to the termination of the award. The term of any option or SAR may not exceed ten years, or five years with respect to ISOs granted to optionees who own or are deemed to own stock representing more than 10% of the combined voting power of all classes of our shares.

There is no limit on the number of shares for which options or SARs may be granted or awarded to any eligible employee, consultant or director. However, the aggregate fair market value (determined as of the date of grant) of ordinary shares with respect to which ISOs granted to any employee may be first exercisable in any calendar year under all of our incentive stock option plans may not exceed $100,000. To the extent such limit is exceeded, the excess will be treated as a separate NQSO.

As of March 31, 2013, there were no outstanding options under the 1991 Stock Incentive Plan.

 

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1999 Stock Incentive Plan

Our 1999 Stock Incentive Plan was unanimously adopted by our Board on March 10, 1999, and was approved at the annual meeting of shareholders held on July 29, 1999. An amendment that had been previously adopted by our Board was approved at the annual meeting of shareholders held on August 5, 2004. The purpose of the 1999 Stock Incentive Plan is to attract, retain and provide incentives to key employees (including directors and officers who are key employees) and to consultants and directors who are not our employees by enabling them to participate in our long-term growth. The total number of ordinary shares with respect to which options and SARs may be granted under the 1999 Stock Incentive Plan may not exceed 2,100,000 subject to appropriate adjustment in the event of stock dividends, stock splits and similar transactions. As of March 10, 2009, no further options are available for future grants.

The 1999 Stock Incentive Plan permits the grant of options and SARs. Options outstanding are NQSOs. SARs may be granted either alone or in tandem with ISOs or NQSOs, and may be granted before, simultaneously with or subsequent to the grant of an option. Any option granted in tandem with a SAR would no longer be exercisable to the extent the SAR is exercised and the exercise of the related option would cancel the SAR to the extent of such exercise.

All key employees and directors of, and consultants to us (as defined in the 1999 Stock Incentive Plan), are eligible to participate in the 1999 Stock Incentive Plan. However, ISOs may only be granted to employees (including officers and directors who are also employees). Each Outside Director, including statutory external directors, shall be granted, on the date initially elected a director, a one-time non-qualified option to purchase the Initial Outside Director Award.

The 1999 Stock Incentive Plan is administered by our Board (as required by the Israeli Companies Law), and by a committee of our Board, which shall contain at least the minimum number of and type of directors (the Administrators) that may be required in order for options granted under such plan to be entitled to benefits under Section 162(m) of the Code. Within the limits of the 1999 Stock Incentive Plan, the Administrators are authorized to determine, among other things, to whom and the time or times at which, options and SARs are to be granted, the types of options and SARs to be granted, the number of shares which will be subject to any option or SAR, the term of each option and SAR, the exercise price of each option and base price of each SAR, and the time or times and conditions under which options and SARs may be exercised. The Administrators may (with the consent of the holder of the option or SAR) cancel or modify an option or SAR, or grant an option and/or SAR in substitution for any canceled option or SAR, provided that any substituted option or SAR and any modified option or SAR is permitted to be granted on such date under the terms of the 1999 Stock Incentive Plan and the Code. In such case, the Administrators may give credit toward any required vesting period for the substituted option or SAR for the period during which the employee held the canceled option or SAR.

The exercise price of an option or base price of a SAR granted under the 1999 Stock Incentive Plan shall be determined by the Administrators, but may not be less than 100% of the fair market value of the ordinary shares on the date of grant (110% of such fair market value in the case of an ISO granted to an optionee who owns or is deemed to own stock possessing more than 10% of the combined voting power of all classes of our stock). The exercise price of an Initial Outside Director Award shall equal the fair market value of the ordinary shares subject to such option on the date of grant.

Upon exercise of a SAR, the holder is entitled to receive an amount in cash, ordinary shares or a combination of the two, as determined by the Administrators, equal to the excess of the fair market value of the shares with respect to which the SAR is exercised (calculated as of the exercise date) over the base price.

The term of each option and SAR, subject to applicable law, other than an Initial Outside Director Award will be for such period, and such option or SAR may be exercised at such times, during such period, and on such terms and conditions, as the Administrators may determine, consistent with the terms of the 1999 Stock Incentive Plan. The term of an Initial Outside Director Award will be five years. Each Initial Outside Director Award will become exercisable in each of the four years commencing one year after the date of grant to the extent of one-fourth of the number of ordinary shares originally subject to the option granted therein.

Ordinary shares not purchased pursuant to an Initial Outside Director Award in any one exercise period may be purchased in any subsequent exercise period prior to the termination of the award. The term of any ISO may not exceed ten years (five years with respect to ISOs granted to optionees who own or are deemed to own stock representing more than 10% of the combined voting power of all classes of our shares).

 

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The maximum number of shares for which options may be granted or awarded in any calendar year to any eligible employee is 1,000,000. There is no limit on the number of shares for which options may be granted or awarded to any consultant or director, or for which SARs may be granted or awarded to any eligible employee, consultant or director. However, the aggregate fair market value (determined as of the date of grant) of ordinary shares in respect of which ISOs granted to any employee may be first exercisable in any calendar year under all incentive stock option plans of our company may not exceed $100,000. To the extent such limit is exceeded, the excess will be treated as a separate NQSO.

As of March 31, 2013, 25,500 ordinary shares were subject to outstanding options. Of such options, 3,500 (at an average exercise price of $53.36 per share) were held by executive officers; none were held by directors who are not executive officers; and 22,000 (at an average exercise price of $52.15 per share) were held by other persons. None of such options was an SAR.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. MAJOR SHAREHOLDERS

Ordinary Shares

The following table sets forth certain information as of May 31, 2013, with respect to the ownership of our ordinary shares by all persons who are known to us to beneficially own 5% or more of our outstanding ordinary shares. Beneficial ownership is determined in accordance with rules of the SEC and generally includes voting and investment power with respect to our ordinary shares, as well as the right to receive the economic benefit of ownership of such shares. The holder of the ordinary shares listed in the below table does not have voting rights with respect to such shares that are different from those possessed by other holders of our ordinary shares. Percentage ownership is based on 44,768,087 ordinary shares outstanding as of March 31, 2013.

 

Name

   Ordinary Shares
Beneficially Owned
     Percent of Ordinary
Shares Outstanding
 

Sun (1)

     29,479,933         65.9

 

(1) As reported on the Schedule 13D/A filed by Sun on February 8, 2013.

There was no significant change in percentage ownership held by the aforementioned major shareholder from March 31, 2010 to March 31, 2013.

 

Name

   Change in
Percentage Ownership

Sun

   0.0% Increase

Founders’ Shares

At the formation of our company in 1959, two classes of shares were created, founders’ shares and ordinary shares. One-third of the voting power of all of our voting shares is allocated to the founders’ shares. Alkaloida, which is a subsidiary of Sun Pharma, owns all of the 2,600 outstanding founders’ shares.

Voting Power

As of March 31, 2013, Sun controls 77.3% of the voting power in our Company by reason of their (i) beneficial ownership of an aggregate of approximately 65.9% of our ordinary shares and (ii) ownership of the founders’ shares, which constitute one-third of the voting power of our shares.

B. RELATED PARTY TRANSACTIONS

The Company has substantial relationships with Sun. Certain of Taro’s Board members are also on Sun Pharma’s Board of Directors. In addition, certain of Taro’s officers and executives are also executives of Sun. Taro’s Interim Chief Executive Officer, who is also a member of the Board of Directors of Taro, is an officer of an indirect subsidiary of Sun Pharma.

 

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During 2012 to 2013, Taro entered into various commercial transactions, including product distribution and service agreements with Sun in the ordinary course of our business. The Company does not currently deem any of these transactions material or unusual and believes that terms of these transactions are comparable to those offered by or that could be obtained from unrelated third parties. Additionally, pursuant to Israeli requirements, each of the transactions was presented to the Audit Committee, which determined that each such transaction was not considered extraordinary pursuant to Israeli legal requirements and therefore did not require shareholder approval.

On October 18, 2011, the Company received a letter from Sun making a non-binding proposal for the acquisition of all of the issued and outstanding shares of Taro, not currently held by Sun, at a price of $24.50 per share, in cash. The Company’s Board of Directors formed an independent Special Committee, comprised of Dov Pekelman (Chairman of the Special Committee), Ilana Avidov-Mor and Dan Biran, to review and evaluate the offer with its independent financial and legal advisors. The parties entered into a merger agreement in August 2012 whereby Sun would purchase all of the issued and outstanding shares of Taro, not currently held by Sun, at a price of $39.50 per share, in cash, upon the closing of the proposed merger. On February 8, 2013, the parties announced that they mutually agreed to terminate the merger agreement. For further information regarding Sun’s proposal see Note 22 to our consolidated financial statements included elsewhere in this 2013 Annual Report.

C. INTERESTS OF EXPERTS AND COUNSEL

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

The financial statements required by this item are found at the end of this 2013 Annual Report, beginning on page F-1.

Other Financial Information

We manufacture pharmaceutical products in our facilities in Israel and Canada. A substantial amount of these products are exported, both to our affiliates and non-affiliates. For a breakdown of our sales by geographic market for the past three years, see “Item 4 — Information on the Company — Business Overview — Sales and Marketing.”

Legal Proceedings

From time to time, we are a party to routine litigation incidental to our business, none of which, individually or in the aggregate, is expected to have a significant effect on our financial position or profitability. Other litigation, as disclosed herein, may have a material adverse effect on our financial position or profitability.

A group of former Israeli soldiers have filed three lawsuits for personal injury against the Municipality of Haifa, The Israel Oil Refineries Ltd., The Haifa Town Union Sewage and Haifa Chemicals Ltd. alleging that they contracted serious illnesses as a result of their military service which included diving in the Kishon River near Haifa Bay. In 2005, the Company and over 40 municipalities, governmental entities (including the State of Israel), cooperative villages (kibbutzim) and other companies, were named as third party defendants in these lawsuits. On June 17, 2013, the court dismissed the lawsuits and ruled that the plaintiffs were unable to prove that their exposure to dangerous substances in the Kishon River water was the cause of their illnesses. The plaintiffs may appeal to the Supreme Court within the time frame set by law (45 days from the court ruling). The hearing of the lawsuits filed by a group of fishermen also claiming to suffer from serious illnesses as a result of their activities in the Kishon River is still pending and currently the parties are presenting the evidence in the case to the court.

On June 15, 2008, the Company brought a lawsuit in the Tel-Aviv district court seeking a declaratory ruling and permanent injunction against Sun from taking actions to hinder the Company’s efforts to sell its Irish operations. This is legacy litigation from the change in control of the Company in September 2010, and the lawsuit, at this time, is dormant.

Taro is a defendant in two actions brought against various pharmaceutical manufacturers in the States of Utah and Louisiana. The actions relate to drug price reporting by these manufacturers. In addition, Taro has received an investigative demand that also relates to drug price reporting from a third State. In May 2008, the State of Utah filed a lawsuit against the Company and a number of other pharmaceutical manufacturers and in November 2010, the State of Louisiana filed a lawsuit in state court against the Company and a number of other pharmaceutical manufacturers. Generally speaking, the lawsuits allege that

 

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the defendants caused the State to overpay pharmacies under the State Medicaid Program by reporting inflated published prices (AWP). The Utah trial court dismissed the case with prejudice in February 2010. However, in March 2010, the plaintiff appealed the decision and the Utah Supreme Court issued its decision in June 2012. The ruling generally affirmed that the complaint by the plaintiff is inadequate and the State was given leave by the court to re-plead its case, which it did. A motion to dismiss filed by the defendants in this case is currently pending before the court. In the Louisiana action, the parties are currently in the discovery phase of the litigation. Taro has responded to the investigative demand from the third state. During the year ended March 31, 2013, the Company recorded a provision of $30 million as management’s best estimate of potential litigation and related costs to these AWP-related matters.

On March 7, 2011, the Company was sued by The Blackstone Group L.P. (“Blackstone”) in the Supreme Court of the State of New York, County of New York. The lawsuit alleges breach of contract relating to fees under an agreement whereby Blackstone would provide certain financial advisory services to the Company. Blackstone originally sought $6.3 million in fees and expenses and has subsequently amended its pleadings to adjust its claim to $3.7 million. On January 1, 2013 a judgment was entered in favor of Blackstone and in February 2013 Taro paid Blackstone a net settlement amount of $4.4 million.

On April 28, 2011, the Company filed a lawsuit against Suven Life Sciences Ltd. (“Suven”) in the United States District Court of New Jersey for infringement of its United States Patent No. 7,560,445 covering its Ovide® (malathion) Lotion, 0.5%. The Company then filed an amended complaint on August 22, 2011 to include a newly issued patent, United States Patent No. 7,977,324. The suit alleges that Suven’s ANDA to sell its own malathion lotion infringes Taro’s patents.

On February 21, 2012, the Company entered into a License and Settlement Agreement (the “Medicis Settlement Agreement”) with Medicis Pharmaceutical Corporation. In connection with the Medicis Settlement Agreement, we agreed to settle all legal disputes between the parties relating to Medicis’ LOPROX® Shampoo and Medicis agreed to withdraw its complaint against Taro pending in the U.S. District Court for the Southern District of New York for alleged patent infringement. Subject to the terms and conditions contained in the Medicis Settlement Agreement, Medicis granted Taro a non-exclusive, royalty-bearing license to make and sell limited quantities of our generic version of LOPROX® Shampoo.

On March 28, 2013, the Company was sued by Mallinckrodt LLC, Mallinckrodt Inc. (“Mallinckrodt”) and Nuvo Research Inc. (“Nuvo”) in the United States District Court for the District of Delaware for alleged infringement of Nuvo’s United States Patent No. 8,217,078, which covers the use of Mallinckrodt’s Pennsaid® product, due to the Company’s filing of an ANDA for the generic version of Pennsaid®. We are not in a position to quantify the likely outcome of this case.

Dividend Policy

We have never paid cash dividends and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain our earnings to finance the development of our business, but such policy may change depending upon, among other things, our earnings, financial condition and capital requirements.

B. SIGNIFICANT CHANGES

There have been no significant changes as of March 31, 2013.

 

ITEM 9. THE OFFER AND LISTING

A. OFFER AND LISTING DETAILS

On December 13, 2006, as a result of our late filing, our ordinary shares were de-listed from the NASDAQ Global Select Market and were quoted on the Pink Sheets under the symbol “TAROF” until our shares were listed on the NYSE on March 22, 2012, under the symbol “TARO.” The following table sets forth the high and low closing sale prices of our ordinary shares as quoted on the Pink Sheets and NYSE during the last five years as of the end of the reporting period of this 2013 Annual Report:

 

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         High              Low      

12/31/2008

   $  10.80       $ 7.25   

12/31/2009

   $ 9.94       $ 8.10   

12/31/2010

   $ 14.50       $ 9.30   

12/31/2011

   $ 29.50       $  14.10   

3/31/2013

   $ 59.31       $ 35.55   

The following table sets forth the high and low closing sale prices of our ordinary shares as quoted on the Pink Sheets and NYSE, during each fiscal quarter of the most recent two fiscal years, as of the end of the respective reporting period of this 2013 Annual Report, and any subsequent period:

 

         High              Low      

First Quarter 2011

   $ 14.78       $ 14.10   

Second Quarter 2011

   $ 20.88       $ 14.23   

Third Quarter 2011

   $ 22.00       $ 18.25   

Fourth Quarter 2011

   $ 29.50       $ 19.35   

March 2012

   $ 39.60       $ 29.10   

First Quarter Mar 2013

   $ 48.17       $ 35.55   

Second Quarter Mar 2013

   $ 46.70       $ 35.69   

Third Quarter Mar 2013

   $ 48.91       $ 45.32   

Fourth Quarter Mar 2013

   $ 59.31       $ 46.05   

The following table sets forth the high and low closing sale prices of our ordinary shares as quoted on the NYSE during the last six months:

 

         High              Low      

Oct-12

   $ 46.40       $ 45.40   

Nov-12

   $ 46.96       $ 45.81   

Dec-12

   $ 48.91       $ 45.32   

Jan-13

   $ 49.68       $ 46.05   

Feb-13

   $ 57.04       $ 48.49   

Mar-13

   $ 59.31       $ 56.84   

B. PLAN OF DISTRIBUTION

Not applicable.

C. MARKETS

Our ordinary shares have been traded in the over-the-counter market in the United States since 1961. Our ordinary shares were first registered for trading on NASDAQ in 1982. Our ordinary shares first became quoted on the NASDAQ National Market in 1993 under the symbol “TARO.” On July 1, 2006, the NASDAQ National Market was renamed the NASDAQ Global Market and our ordinary shares became quoted on the NASDAQ Global Select Market, a segment of the NASDAQ Global Market. On December 13, 2006, our ordinary shares were de-listed from the NASDAQ Global Select Market and were then quoted on the Pink Sheets under the symbol “TAROF.” As of March 22, 2012, our ordinary shares have been listed on the NYSE under the symbol “TARO.” There is no non-United States trading market for our ordinary shares.

 

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D. SELLING SHAREHOLDERS

Not applicable.

E. DILUTION

Not applicable.

F. EXPENSES OF THE ISSUE

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

A. SHARE CAPITAL

Not applicable.

B. ISRAELI COMPANIES LAW AND OUR DOCUMENTS OF INCORPORATION

Our registration number at the Israeli Registrar of Companies is 52-002290-6.

Objects and Purposes

Our Memorandum of Association provides that our main objects and purposes include any business connected with the developing, manufacturing, processing, supplying, marketing and distributing of prescription, OTC medical and other health care products.

In February 2000, the Company’s Ordinance (New Version — 1983) was replaced with the Israeli Companies Law. Because our Articles of Association were adopted before the enactment of the Israeli Companies Law, they are not always consistent with the provisions of the new law. In all instances in which the Israeli Companies Law changes or amends provisions in the Companies Ordinance, and, as a result, our Articles of Association are not consistent with the Israeli Companies Law, the provisions of the Israeli Companies Law apply unless specifically stated otherwise in the Israeli Companies Law.

Approval of Specified Related Party Transactions Under Israeli Law and Our Articles of Association

The Israeli Companies Law requires the approval of the audit committee, thereafter the approval of the board of directors and, in certain cases, the approval of the shareholders, in order to effect specified related parties transactions, other than compensatory arrangement, for which the approval of the compensation committee, board of directors and, in certain cases, the shareholders is required.

Pursuant to the provisions of the Israeli Companies Law, the Audit Committee of the Company preapproved criteria for the classification of transactions with related parties as extraordinary or ordinary transactions. According to the Company’s policy, if a transaction is deemed an ordinary transaction as per the preapproved criteria, the transaction will require only Board of Directors’ approval; if, however, a transaction is not covered by the preapproved criteria, it has to be first brought before the Audit Committee for its determination. Under the Companies Law, an extraordinary transaction is generally a transaction other than in the ordinary course of business, other than according to prevailing market terms, or that is likely to have a material impact on the company’s profitability, assets or liabilities.

Fiduciary Duties of Office Holders

The Israeli Companies Law imposes fiduciary duties that “office holders” (as defined in the Israeli Companies Law and described above in this annual report) owe to a company. An office holder’s fiduciary duties consist of a duty of care and a duty of loyalty. The duty of care requires an office holder to act with the level of care that a reasonable office holder in the same position would have acted with under the same circumstances. The duty of care includes a duty to use reasonable means to obtain information on the advisability of a given action brought for the office holder’s approval or performed by the office holder by virtue of his or her position and all other information of importance with respect to these actions.

 

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The duty of loyalty generally requires an office holder to act in good faith and for the good of the company. This includes the requirement that an office holder must avoid any conflict of interest between the office holder’s position in the company and his or her other positions or personal affairs. In addition, an office holder must avoid competing against the company or exploiting any business opportunity of a company to receive a personal gain for himself, herself or others. An office holder must also disclose to the company any information or documents relating to that company’s affairs that the office holder has received due to his or her position in the company.

Compensation of Office Holders

Under the Israeli Companies Law, arrangements as to compensation of a public company’s office holders who are directors or the chief executive officer require the approval of the compensation committee, the board of directors and the shareholders approval, in that order, except where the regulations adopted under the Israeli Companies Law provide for certain easements from such requirements. Arrangements as to compensation of a public company’s office holders who are not directors or the chief executive officer generally (assuming that the arrangement conforms to the then-effective compensation policy) require the approval of the compensation committee and the board of directors in that order as detailed above in “Approval of Interested Party Transactions” in Item 6.C.

Disclosure of Personal Interest of an Office Holder

The Company’s Articles of Association provide that a director must disclose his interest in a contract or arrangement at the meeting of the Board of Directors at which such contract or arrangement is first taken into consideration. The Israeli Companies Law requires that an office holder (including a director) or a controlling shareholder who is aware that he or she has a personal interest in connection with any existing or proposed transaction by the company, promptly disclose to the company the nature of any personal interest that he or she may have, including all related material information or documents known to him or her. “Personal Interest”, as defined by the Israeli Companies Law, includes an interest of any person in an act or transaction of the company, including interest of his relative or of a corporate body in which such person or his relative is either a holder of 5% or more of the corporate body shares or voting power, is a director or a general manager, or is entitled to appoint at least one director or the general manager and including the personal interest of a person voting by a proxy granted to him/her by another person, even if the person so granting the proxy does not have a personal interest in the transaction. In addition, the vote of a person who was granted a proxy from another person who has a personal interest shall be deemed the vote of a person having a personal interest, regardless of whether the proxy holder has discretion on how to vote. Personal Interest does not apply to an interest stemming merely from the fact that the person is also a shareholder in the company. In the case of an extraordinary transaction, the office holder’s duty to disclose applies also to a personal interest of the office holder’s relative.

Under the Israeli Companies Law, the office holder must disclose his personal interest without delay and no later than the first meeting of the company’s board that discusses the particular transaction. Once disclosure is made in compliance with the above disclosure requirement, the board of directors may approve the transaction between the company and an office holder or a third party in which an office holder has a personal interest, unless the company’s articles of association provide otherwise. A transaction that is adverse to the company’s interest may not be approved. If the transaction concerns exemption, indemnification or insurance of an office holder, then it must first be approved by the company’s compensation committee and then by the board of directors, and, under certain circumstances, by the shareholders of the company, in that order.

A director who has a personal interest in a matter that is considered at a meeting of the board of directors, the audit committee (unless in circumstances of non extraordinary transactions) or the compensation committee may not be present at this meeting, unless the chairman of the audit committee, compensation committee or the board of directors determined that the participation of such director is required in order to present the transaction. A director who has a personal interest in a matter that is considered at a meeting of the board of directors, the audit committee or compensation committee may not vote on this matter, unless a majority of the members of the board of directors or such committee, as the case may be, has a personal interest in the matter, in which case shareholder approval is also required.

 

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Disclosure of Personal Interests of a Controlling Shareholder

Under the Israeli Companies Law, the disclosure requirements that apply to an office holder also apply to a controlling shareholder of a public company. For these purposes, a controlling shareholder is a shareholder who has the ability to direct the activities of a company (other than solely from his or her position on the board of directors or any other position with the company), including a shareholder who holds 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights. For purposes of attribution, the Israeli Companies Law provides that if two or more persons, holding voting rights in the company, each have a personal interest in the approval of the same transaction, such persons will be deemed to be one holder.

Extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, including a private offering in which the controlling shareholder has a personal interest, and the engagement of a controlling shareholder or his or her relative with a public company, as an office holder or employee, require the approval of the audit committee, the board of directors and the shareholders of the company, in that order. The compensation or indemnification of a controlling shareholder or his or her relative with a public company requires the approval of the compensation committee, the board of directors and the shareholders, in that order. The shareholder approval must, in each case be by a majority of the votes cast at the meeting, whether in person or by proxy, provided that:

 

   

the majority includes at least the majority of the total votes of the non-controlling shareholders who lack an interest in approval of the transaction or compensation (as applicable), or anyone voting on their behalf present at the meeting in person or by proxy; or

 

   

the total number of votes of the non-controlling, disinterested shareholders that are voted against the transaction does not exceed two percent (2%) of the voting rights in the company.

Director Qualifications

Our Articles of Association do not require directors to hold shares in the Company. According to the Articles, the number of directors of the Company should be not less than five or more than twenty-five. Under the Israeli Companies Law, we must have at least two statutory external directors on the Board of Directors (see “Qualifications of Statutory External Directors” in Item 6.C above).

Voting, Rights Attached to Shares, Shareholders’ Meetings and Resolutions

Our directors, other than our statutory external directors, are elected at annual general meetings of our shareholders. A director holds office until the next annual general meeting, unless he or she resigns or is earlier removed from office by an ordinary resolution passed at an extraordinary general meeting of our shareholders.

Our share capital is divided into founders’ shares and ordinary shares. Holders of each paid-up share are entitled to participate equally in the payment of dividends and other distributions and, in the event of liquidation, in all distributions after the discharge of liabilities to creditors. In addition, all ordinary shares shall together entitle their holders to two-thirds of the voting power of our Company. All founders’ shares shall together entitle their holders to one-third of the voting power of our Company. Under our Articles of Association, an increase to the share capital, creation of preferred shares or shares with special rights, consolidation or division of share capital, cancellation of shares and reduction in share capital, require a special resolution of the shareholders, i.e. an affirmative vote of 75% of the voting power voting in person or by proxy. The rights attached to any class of shares may be modified with the consent in writing of the holders of three-fourths of the issued shares of that class or by way of a special resolution of the shareholders.

According to our Articles of Association, dividends on our ordinary shares may be paid out of profits and other surplus, as defined in the Israeli Companies Law or as otherwise approved by a court of law, provided that there is no reasonable concern that the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due.

Under the Israeli Companies Law and our Articles of Association, an ordinary resolution of the shareholders (for example, with respect to the appointment of auditors) requires the affirmative vote of a majority of the voting power voting in person or by proxy, whereas a special resolution (for example, a resolution amending the Articles of Association or authorizing changes in capitalization or in the rights attached to a class of shares) requires the affirmative vote of at least 75% of the voting power voting in person or by proxy. Rights pertaining to a particular class of shares require the vote of 75% of such class of shares in order to change such rights in addition to the approval of 75% of the voting power of the shareholders voting in person, or by proxy, on such resolution. The quorum required for a meeting of shareholders consists of at least three shareholders present, in person or by proxy, who hold or represent between them at least one-third of the outstanding voting power unless otherwise required by applicable rules. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the board of directors may designate. If at such reconvened meeting the required quorum is not present, any two shareholders present in person, or by proxy, shall constitute a quorum.

 

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Shareholder Meetings

According to our Articles of Association, a general meeting of the shareholders must be held at least once in every calendar year, but not more than fifteen months after the last preceding meeting. All general meetings must be held in Israel. The Board of Directors may call an extraordinary general meeting of the shareholders at any time. The Board shall convene an extraordinary general meeting of the shareholders, at the request of shareholders representing not less than 10% of the voting power in the Company, provided that the request complies with the requirements provided by the Article, including but not limited to statement of the object of the meeting. Any member may appoint by power of attorney a person to act as his representative at a meeting. The original instrument appointing a representative or a notarially certified copy must be deposited at the principal office of the Company at least forty-eight (48) hours before the meeting.

Restriction on Voting

In order to reduce our risk of being classified as a Controlled Foreign Corporation under the Code, we amended our Articles of Association in 1999 to provide that no owner of any of our ordinary shares is entitled to any voting right of any nature whatsoever with respect to such ordinary shares if (a) the ownership or voting power of such ordinary shares was acquired, either directly or indirectly, by the owner after October 21, 1999 and (b) the ownership would result in our being classified as a Controlled Foreign Corporation. This provision has the practical effect of prohibiting each citizen or resident of the United States who acquired or acquires our ordinary shares after October 21, 1999 from exercising more than 9.9% of the voting power in our company, with respect to such ordinary shares, regardless of how many shares the shareholder owns. The provision may therefore discourage United States persons from seeking to acquire, or from accumulating, 15% or more of our ordinary shares (which, due to the voting power of the founders’ shares, would represent 10% or more of the voting power of our company).

Duties of Shareholders

Under the Israeli Companies Law, each and every shareholder has a duty to act in good faith and in an acceptable manner in exercising his, her or its rights and fulfilling his, her, or its obligations towards the company and other shareholders and to refrain from abusing his, her or its power, such as in voting in the general meeting of shareholders and/or in a meeting of a different class of shares, on the following matters:

 

   

any amendment to the articles of association;

 

   

an increase of the authorized share capital;

 

   

a merger; or

 

   

the approval of actions of office holders in breach of their duty of loyalty and of interested party transactions.

In addition, each and every shareholder has the general duty to refrain from depriving other shareholders of their rights.

Furthermore, a duty to act in fairness towards the company applies to any controlling shareholder, any shareholder who knows that he possesses the power to determine the outcome of a shareholder vote and any shareholder that, pursuant to the provisions of the Articles of Association, has the power to appoint or to prevent the appointment of an office holder in the company or any other power in regard to the company. The Israeli Companies Law does not describe the substance of this duty to act in fairness.

These various shareholder duties may restrict the ability of a shareholder to act in what the shareholder perceives to be his, her or its own best interests.

Transfer of Shares

Fully paid ordinary shares are issued in registered form and may be freely transferred under our Articles of Association unless the transfer is restricted or prohibited by another instrument (or by any other limitation described herein).

 

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Mergers and Acquisitions under Israeli Law

The Israeli Companies Law and the regulations promulgated thereunder include provisions that allow a merger transaction, in general, and require that each company that is a party to a merger has the transaction approved by its board of directors and a vote of the majority of the voting power of its shares at a shareholders’ meeting called on at least 35 days’ prior notice by each of the merger parties. Under the Articles of Association, the required shareholder vote is a supermajority of at least 75% of the shares voting in person or by proxy on the matter. A court may determine that a company duly approved a merger, in certain cases, upon the request of shareholders holding 25% or more of the voting power in the company. A court may not approve a merger unless it is convinced that the merger offer is fair and reasonable, in light of the valuation of the merging companies and the consideration which has been offered to the shareholders. Upon the request of a creditor of either party of the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least 30 days have passed from the time that the shareholders of each company have approved the merger and 50 days have passed from the time that a merger proposal has been delivered to the Israeli Registrar of Companies.

In general, the Israeli Companies Law also provides that an acquisition of shares of a public company is to be made by means of a special tender offer if, as a result of the acquisition, the purchaser would become a holder of 25% or more of the voting rights in the company if there is no existing holder of 25% or more of the voting rights in the company. If there is no existing holder of more than 45% of the voting rights in the company, in general, the Israeli Companies Law provides that an acquisition of shares of a public company is to be made by means of a special tender offer if as a result of the acquisition the purchaser would become a holder of more than 45% of the voting rights in the company.

These requirements do not apply if, in general, the acquisition (1) was made in a private placement that received shareholders’ approval (confirming that the purchaser would become a holder of 25% or more, or more than 45%, or more, of the voting power in the company, unless there is already a holder of 25% or more or more than 45%, respectively, of the voting power in the company), (2) was from a holder of 25% or more of the voting power in the company which resulted in the acquirer becoming a holder of 25% or more of the voting power in the company, or (3) was from a holder of more than 45% of the voting power in the company which resulted in the acquirer becoming a holder of more than 45% of the voting power in the company. The tender offer must be extended to all shareholders, but the offeror is not required to purchase more than 5% of the company’s outstanding shares, regardless of how many shares are tendered by shareholders. The tender offer may be consummated only if (i) at least 5% of the company’s outstanding shares will be acquired by the offeror and (ii) the number of shares tendered in the offer exceeds the number of shares whose holders objected to the offer.

If as a result of any acquisition of shares, the acquirer will hold more than 90% of the company’s issued and outstanding share capital or of a class of shares or more than 90% of the voting power of the company, the acquisition may not be made other than through a tender offer to acquire all of the shares or all of the shares of such class. If the shares represented by the shareholders who did not tender their shares in the tender offer constitute less than 5% of the issued and outstanding share capital of the company or of a class of shares (or voting power thereof), and a majority of the shareholders offered such tender who do not have a personal interest in receipt of such tender accepted such tender (which condition shall not apply if, following consummation of the tender offer, the acquirer holds at least 98% of all of the company’s outstanding shares or voting rights), all of the shares that the acquirer offered to purchase will be transferred to the acquirer by operation of law. If the dissenting shareholders hold 5% or more of the issued and outstanding share capital (or voting power) of the company or of a class of shares, the acquirer may not acquire additional shares of the company from shareholders who accepted the tender offer to the extent that following such acquisition the acquirer would then own over 90% of the company’s issued and outstanding share capital or of a class of shares. Shareholders may petition the court to alter the consideration for the acquisition to reflect a fair value. Such petition may be submitted within 6 months from the date the tender offer has been accepted. However, the acquirer may provide in the tender offer documents that a shareholder that accepts the offer may not seek such a court appraisal.

Finally, Israeli tax law may treat stock-for-stock acquisitions between an Israeli company and a foreign company less favorably than does United States tax law. For example, unless the stock-for-stock transaction is considered a tax-deferred merge