DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

6 Months Ended

Jun. 30, 2012

DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

1.DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Nature of Operations

Angiotech Pharmaceuticals, Inc. (“Angiotech” or the “Company”) is incorporated under the Business Corporations Act (British Columbia). The Company develops, manufactures and markets medical device products and technologies.  Angiotech’s products are designed to serve physicians and patients primarily in the areas of interventional oncology, wound closure and ophthalmology. The Company generates revenue through sales of these products, as well as through royalties derived from sales by its partners of products, which utilize certain of the Company’s proprietary technologies. Accordingly, the Company currently operates in two business segments: Medical Device Technologies and Licensed Technologies.

Basis of Presentation

These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America (“U.S. GAAP”) and the U.S. Securities and Exchange Commission’s (“SEC”) rules and regulations on interim reporting. Accordingly, certain information and footnote disclosures normally included in the annual financial statements have been omitted. The accounting policies used in the preparation of these interim consolidated financial statements are the same as those described in the Company’s 2011 Annual Report filed on Form 10-K. In management’s opinion, all adjustments (including reclassification and normal recurring adjustments) necessary for the fair presentation of the unaudited interim consolidated financial statements have been made. All amounts herein are expressed in U.S. dollars and thousands of U.S. dollars, except share and per share data, unless otherwise noted. The information included in this Quarterly Report on Form 10-Q should therefore be read in conjunction with the Company’s 2011 Annual Report filed on Form 10-K with the SEC on March 29, 2012.

On May 12, 2011 (the “Plan Implementation Date” or the “Effective Date”), Angiotech implemented a recapitalization transaction that, among other things, eliminated its $250 million 7.75% Senior Subordinated Notes due in 2014 (“Subordinated Notes”) and $16 million of related interest obligations in exchange for new common shares of Angiotech (the “Recapitalization Transaction”). In connection with the execution of this Recapitalization Transaction, on January 28, 2011, Angiotech and certain of its subsidiaries (the “Angiotech Entities”) filed for creditor protection under the Companies’ Creditors Arrangement Act (“CCAA”) in Canada and Chapter 15 of Title 11 of the Bankruptcy Code in the U.S (the “Creditor Protection Proceedings”). For additional information on the Recapitalization Transaction and related Creditor Protection Proceedings, refer to the annual audited consolidated financial statements included in the 2011 Annual Report filed with the SEC on Form 10-K on March 29, 2012.

Upon commencement of the Creditor Protection Proceedings through to the Convenience Date (as described below), the Company adopted Accounting Standards Codification (“ASC”) No. 852 — Reorganization to prepare its interim and annual consolidated financial statements. During Creditor Protection Proceedings, ASC No. 852 required that the Company distinguish transactions and events directly associated with the Recapitalization Transaction (described in note 3) from ongoing operations of the business as follows: (i) certain expenses, recoveries, loss provisions, and other charges incurred during Creditor Protection Proceedings were reported as Reorganization Items on the Consolidated Statement of Operations (see note 3) and (ii) specific cash flow items directly related to the Reorganization Items were segregated on the Consolidated Statement of Cash Flows. In addition, in accordance with the terms of the recapitalization plan, the Company ceased to accrue interest from January 28, 2011 onwards on its pre-petition Subordinated Notes.

Upon emergence from Creditor Protection Proceedings and completion of the Recapitalization Transaction on May 12, 2011 (the “Effective Date”), the Company was required to adopt fresh-start accounting in accordance with ASC No. 852. The Company applied fresh start accounting on April 30, 2011 (the “Convenience Date”) after concluding that the operating results between the Convenience Date and the Effective Date did not result in a material difference. Given that the reorganization and adoption of fresh-start accounting resulted in a new entity for financial reporting purposes, the Company is referred to as the “Predecessor Company” for all periods preceding the Convenience Date and the “Successor Company” for all periods subsequent to the Convenience Date.

Overall, the implementation of fresh start accounting resulted in: (i) a comprehensive revaluation of Predecessor Company’s assets and liabilities to their estimated fair values; (ii) the elimination of the Predecessor Company’s deficit, additional paid-in-capital and accumulated other comprehensive income balances; and (iii) reclassification of certain balances.  Given these material changes to Angiotech’s consolidated financial statements, the results of the Successor Company may not be comparable in certain respects to those of the Predecessor Company.

Liquidity Risk

Liquidity risk is the risk that the Successor Company will encounter difficulty in meeting its contractual obligations and financial liabilities. Angiotech faces a number of risks and uncertainties that may adversely impact its ability to generate sufficient future cash flows from operations to meet its contractual obligations and support capital expenditures and other initiatives. These risks and uncertainties may continue to materially impact the Successor Company’s liquidity position, cash flows and future operating results throughout 2012 and the future. The more significant risks and uncertainties have been summarized as follows:

·As at June 30, 2012, the Successor Company’s most significant financial liability was its $325 million of Senior Floating Rate Notes (the “Existing Notes”) due December 1, 2013. As discussed in note 12, on July 3, 2012, the Successor Company launched an offer to exchange up to a maximum of $200 million in aggregate principal amount of the outstanding Existing Notes (“Maximum Principal Exchange Amount”) for new 9% Senior Notes due December 1, 2016 issued by Angiotech Pharmaceuticals (US), Inc. (the “New Notes”) pursuant to an Offering Memorandum and Consent Solicitation Statement (the “Exchange Offer”). On July 27, 2012, as a result of significant demand for New Notes by holders of the Existing Notes, Angiotech elected to amend the Exchange Offer to increase the Maximum Principal Exchange Amount to $225 million.  On August 13, 2012, $225 million of the $255.5 million tendered Existing Notes were irrevocably extinguished and exchanged, on a pro rata basis, for approximately $230 million of New Notes. All Existing Notes were tendered by the prescribed July 23, 2012 early tender date and, therefore, the holders of such Existing Notes received the New Notes with a principal amount constituting a 2% premium (the “Early Tender Premium”) to the principal amount of the Existing Notes so exchanged.  This refinancing significantly alleviates the Successor Company’s near term liquidity risk due to the three-year extension of the maturity date. Management expects that the remaining $100 million of Existing Notes may be repaid with excess cash generated from operating activities or potential contingent consideration to be received from the Quill transaction discussed below, or may be refinanced at or prior to their maturity.

The interest rate on the Existing Notes resets quarterly to an interest rate of 3-month London Interbank Offered Rate (“LIBOR”) plus 3.75%, subject to a LIBOR floor of 1.25%. The Existing Notes bore an interest rate of 5.0% on June 30, 2012 (December 31, 2011 — 5.0%). During the three and six months ended June 30, 2012, the Successor Company incurred $4.1 million and $8.2 million of interest expense, respectively, on the Existing Notes. Any increases in LIBOR applicable to the Existing Notes, outstanding at any given time, could adversely impact the Successor Company’s ability to service its future interest obligations.

·On April 4, 2012 the Successor Company and certain of its subsidiaries entered into an Asset Sale and Purchase Agreement (“APA”) with Ethicon, LLC and Ethicon, Inc. (collectively termed “Ethicon”). Pursuant to the terms of the APA, the Successor Company and the named subsidiaries sold certain intellectual property and manufacturing equipment related to its Quill wound closure products. On April 4, 2012, Ethicon made a non-refundable initial payment of $20.4 million for the purchase of these assets. Under the terms of the Existing Notes Indenture (described in note 12(a)), should the Company not find a qualified alternative use for $20 million of these proceeds from Ethicon, the Company may be required to make a bona fide offer to holders of the Existing Notes (described under note 12(a)) to repurchase up to an equivalent amount of outstanding notes by October 4, 2012. In the future, the Successor Company may receive up to an additional $42.0 million of contingent consideration payments from Ethicon based on the Successor Company fulfilling various performance obligations. As discussed above, a portion of these current and future funds may be used to prepay a portion of the Existing Notes prior to their maturity date. For more detail on the Quill transaction, refer to note 11(b).

·The Successor Company has a $28.0 million Revolving credit facility (“Revolving Credit Facility”) with Wells Fargo Capital Finance, LLC (“Wells Fargo”). As at June 30, 2012 the Successor Company had nil borrowings outstanding under the Revolving Credit Facility, $2.7 million in secured letters of credit issued under the Revolving Credit Facility and $21.1million of available borrowing capacity. The Successor Company is subject to a monthly stand-by charge on the unutilized portion of the facility and may incur additional interest charges on any future potential borrowings under the Revolving Credit Facility. Utilization of the Revolving Credit Facility is subject to a borrowing base formula based on the value of certain eligible inventory, accounts receivable and real property, net of applicable reserves. The utilization of the Revolving Credit Facility is also subject to certain restrictive covenants pertaining to operations and the maintenance of minimum levels of Adjusted EBITDA, liquidity and fixed charge coverage ratios. While the Successor Company is currently in compliance with the applicable minimum levels of Adjusted EBITDA, liquidity and fixed charge coverage covenants, there is no assurance that it will continue to comply with the covenants specified under the Revolving Credit Facility and future borrowing arrangements in 2012 and beyond. A breach of these covenants and failure to obtain waivers to cure any further breaches of the covenants and restrictions set forth under the Revolving Credit Facility may limit the Successor Company’s ability to obtain future advances or result in demands for accelerated repayment of any amounts outstanding at the time.

·Angiotech has a history of reporting operating losses. For the six months ended June 30, 2012, the Successor Company recorded a net loss of $2.9 million, compared to a net loss of $14.2 million incurred by the Predecessor Company during the two months ended June 30, 2011. However, during the three months ended June 30, 2012, Angiotech’s cash resources increased by $22.9 million. The net $22.9 million increase is primarily due to the $20.4 million of consideration received from Ethicon related to the sale of certain Quill related intellectual property and manufacturing equipment (see note 11) and $3.4 million of funds generated from operating activities, which were offset by $1.4 million of funds used for financing activities. For the six months ended June 30, 2012, Angiotech’s cash resources increased by $35.8 million. The net $35.8 million increase is primarily due to the $20.4 million of Quill consideration discussed above; $2.3 million of proceeds received from the liquidation of one of our investments; and $15.2 million of funds generated from operating activities; which were offset by $1.7 million of funds used for financing activities.  Although the Company has been generating positive cash flows in recent quarters, future operating losses or negative operating cash flows would adversely impact the Successor Company’s liquidity position and its ability to meet its future obligations.

The Successor Company’s ability to maintain and sustain its future operations may depend upon its ability to: (i) complete the repayment or refinancing of existing debt obligations; (ii) remain in compliance with its debt covenants; (iii) achieve continued revenue growth and improvement in gross margins; and (iv) achieve continued improvement in operating efficiencies or reduced expenses.

The Successor Company’s future plans and current initiatives to manage its operating and liquidity risks include, but are not limited to the following:

·Potential repayment or refinancing of the $100 million of Existing Notes prior to the December 1, 2013 due date;

·Maintenance and potential utilization of the Revolving Credit Facility;

·Implementation of selected operations and gross margin improvement initiatives;

·Continued exploration of various strategic and financial alternatives, including but not limited to raising new equity or debt capital or exploring sales of various assets or businesses;

·Continued evaluation of potential cost savings in certain sales and marketing activities and certain research and development activities; and

·      Potential sale of selected property, plant and equipment assets or other core or non-core assets.

Management continues to closely monitor and manage liquidity by regularly preparing rolling cash flow forecasts, monitoring the condition and value of assets available to be used as security in financing arrangements, seeking flexibility in financing arrangements and maintaining processes to ensure compliance with the terms of financing arrangements.

While management believes that it has developed planned courses of action and identified other opportunities to mitigate the operating and liquidity risks outlined above, there is no assurance that the Successor Company will be able to complete any or all of the plans or initiatives that have been identified or obtain sufficient liquidity to execute its business plan. Furthermore, there may be other material risks and uncertainties that may impact the Successor Company’s liquidity position that have not yet been identified.