10-Q 1 agn10-qq22014.htm 10-Q AGN 10-Q Q2 2014

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
————————————————————
FORM 10-Q
————————————————————

(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 30, 2014
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

Commission File Number 1-10269
Allergan, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
95-1622442
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer Identification No.)
 
 
2525 Dupont Drive
Irvine, California
(Address of Principal Executive Offices)
92612
(Zip Code)
(714) 246-4500
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ  No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 Large accelerated filer  þ
Accelerated filer  ¨
 Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨ No þ
As of July 31, 2014, there were 307,605,860 shares of common stock outstanding (including 10,422,051 shares held in treasury).
 
 
 
 
 



ALLERGAN, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2014
INDEX
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I — FINANCIAL INFORMATION
Item 1.  Financial Statements
 
ALLERGAN, INC.
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(in millions, except per share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
Revenues:
 
 
 
 
 
 
 
 
Product net sales
 
$
1,827.3

 
$
1,577.0

 
$
3,446.4

 
$
3,009.5

Other revenues
 
36.9

 
20.7

 
63.9

 
47.8

Total revenues
 
1,864.2

 
1,597.7

 
3,510.3

 
3,057.3

 
 
 
 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
 

 
 

Cost of sales (excludes amortization of intangible assets)
 
222.2

 
199.1

 
426.7

 
399.0

Selling, general and administrative
 
718.9

 
609.9

 
1,377.5

 
1,214.7

Research and development
 
288.7

 
266.5

 
637.7

 
515.3

Amortization of intangible assets
 
28.0

 
29.0

 
55.8

 
59.7

Restructuring charges (reversal)
 
(1.5
)
 

 
22.8

 
4.3

Operating income
 
607.9

 
493.2

 
989.8

 
864.3

 
 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 
 
 
 
 

 
 

Interest income
 
2.4

 
2.0

 
4.2

 
3.6

Interest expense
 
(19.7
)
 
(20.0
)
 
(35.4
)
 
(37.4
)
Other, net
 
(16.2
)
 
11.2

 
(22.6
)
 
2.5

 
 
(33.5
)
 
(6.8
)
 
(53.8
)
 
(31.3
)
 
 
 
 
 
 
 
 
 
Earnings from continuing operations before income taxes
 
574.4

 
486.4

 
936.0

 
833.0

Provision for income taxes
 
156.0

 
132.4

 
259.1

 
206.0

 
 
 
 
 
 
 
 
 
Earnings from continuing operations
 
418.4

 
354.0

 
676.9

 
627.0

 
 
 
 
 
 
 
 
 
Discontinued operations:
 
 
 
 
 
 
 
 
Earnings from discontinued operations, net of applicable income tax expense of $3.7 million for the three and six months ended June 30, 2013, respectively
 

 
7.2

 

 
7.6

Loss on sale of discontinued operations, net of applicable income tax benefit of $0.3 million and $87.2 million for the six months ended June 30, 2014 and 2013, respectively
 

 

 
(0.6
)
 
(259.0
)
Discontinued operations
 

 
7.2

 
(0.6
)
 
(251.4
)
 
 
 
 
 
 
 
 
 
Net earnings
 
418.4

 
361.2

 
676.3

 
375.6

Net earnings attributable to noncontrolling interest
 
1.2

 
1.3

 
1.8

 
3.2

Net earnings attributable to Allergan, Inc.
 
$
417.2

 
$
359.9

 
$
674.5

 
$
372.4

 
 
 
 
 
 
 
 
 
Basic earnings per share attributable to Allergan, Inc. stockholders:
 
 
 
 
 
 
 
 
Continuing operations
 
$
1.40

 
$
1.19

 
$
2.27

 
$
2.10

Discontinued operations
 

 
0.03

 

 
(0.85
)
Net basic earnings per share attributable to Allergan, Inc. stockholders
 
$
1.40

 
$
1.22

 
$
2.27

 
$
1.25

 
 
 
 
 
 
 
 
 
Diluted earnings per share attributable to Allergan, Inc. stockholders:
 
 
 
 
 
 
 
 
Continuing operations
 
$
1.37

 
$
1.17

 
$
2.22

 
$
2.06

Discontinued operations
 

 
0.02

 

 
(0.83
)
Net diluted earnings per share attributable to Allergan, Inc. stockholders
 
$
1.37

 
$
1.19

 
$
2.22

 
$
1.23

See accompanying notes to unaudited condensed consolidated financial statements.

3


ALLERGAN, INC.
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
 
 
 
 
 
 
 
 
Net earnings
 
$
418.4

 
$
361.2

 
$
676.3

 
$
375.6

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
8.0

 
(17.2
)
 
11.0

 
(39.1
)
Amortization of deferred holding gains on derivatives designated as cash flow hedges included in net earnings, net of income tax benefit of $0.1 million for the three months ended June 30, 2014 and 2013, respectively, and $0.3 million for the six months ended June 30, 2014 and 2013, respectively(a)
 
(0.2
)
 
(0.2
)
 
(0.4
)
 
(0.4
)
Other comprehensive income (loss)
 
7.8

 
(17.4
)
 
10.6

 
(39.5
)
 
 
 
 
 
 
 
 
 
Total comprehensive income
 
426.2

 
343.8

 
686.9

 
336.1

Comprehensive income attributable to noncontrolling interest
 
1.2

 

 
2.0

 
1.2

 
 
 
 
 
 
 
 
 
Comprehensive income attributable to Allergan, Inc.
 
$
425.0

 
$
343.8

 
$
684.9

 
$
334.9

——————————
(a)
Reclassified into "Interest expense" in the unaudited condensed consolidated statements of earnings.


See accompanying notes to unaudited condensed consolidated financial statements.

4


ALLERGAN, INC.
 
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)

 
June 30,
2014
 
December 31,
2013
ASSETS
Current assets:
 
 
 
Cash and equivalents
$
3,189.9

 
$
3,046.1

Short-term investments
525.6

 
603.0

Trade receivables, net
1,055.0

 
883.3

Inventories
299.9

 
285.3

Other current assets
631.3

 
493.0

Assets of discontinued operations
1.2

 
9.0

Total current assets
5,702.9

 
5,319.7

Investments and other assets
238.7

 
213.2

Deferred tax assets
121.5

 
128.8

Property, plant and equipment, net
977.9

 
923.2

Goodwill
2,340.6

 
2,339.4

Intangibles, net
1,609.2

 
1,650.0

Total assets
$
10,990.8

 
$
10,574.3

LIABILITIES AND EQUITY
Current liabilities:
 

 
 

Notes payable
$
60.9

 
$
55.6

Accounts payable
300.0

 
283.2

Accrued compensation
211.6

 
269.1

Other accrued expenses
833.9

 
597.5

Income taxes

 
38.9

Total current liabilities
1,406.4

 
1,244.3

Long-term debt
2,091.8

 
2,098.3

Other liabilities
698.3

 
762.2

Commitments and contingencies


 


Equity:
 

 
 

Allergan, Inc. stockholders’ equity:
 

 
 

Preferred stock, $.01 par value; authorized 5,000,000 shares; none issued

 

Common stock, $.01 par value; authorized 500,000,000 shares; issued 307,605,860 shares as of June 30, 2014 and 307,554,060 shares as of December 31, 2013
3.1

 
3.1

Additional paid-in capital
3,193.4

 
3,032.8

Accumulated other comprehensive loss
(216.1
)
 
(226.6
)
Retained earnings
5,138.8

 
4,646.7

 
8,119.2

 
7,456.0

Less treasury stock, at cost (10,695,411 shares as of June 30, 2014 and 9,947,345 shares as of December 31, 2013)
(1,333.2
)
 
(992.8
)
Total stockholders’ equity
6,786.0

 
6,463.2

Noncontrolling interest
8.3

 
6.3

Total equity
6,794.3

 
6,469.5

Total liabilities and equity
$
10,990.8

 
$
10,574.3

See accompanying notes to unaudited condensed consolidated financial statements.

5


ALLERGAN, INC.
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
Cash flows from operating activities:
 
 
 
Net earnings
$
676.3

 
$
375.6

Non-cash items included in net earnings:
 

 
 

Depreciation and amortization
121.0

 
134.4

Amortization of original issue discount and debt issuance costs
1.4

 
1.2

Amortization of net realized gain on interest rate swaps
(7.4
)
 
(7.2
)
Deferred income tax provision (benefit)
3.9

 
(101.3
)
Loss on disposal and impairment of assets
0.7

 
1.2

Unrealized loss (gain) on derivative instruments
15.1

 
(11.9
)
Expense of share-based compensation plans
66.1

 
56.8

Loss on sale of discontinued operations

 
346.2

Expense from changes in fair value of contingent consideration
3.4

 
3.3

Restructuring charges
22.8

 
4.3

Loss on investment

 
3.7

Changes in operating assets and liabilities:
 

 
 

Trade receivables
(158.5
)
 
(193.0
)
Inventories
(10.8
)
 
(19.6
)
Other current assets
4.2

 
28.7

Other non-current assets
(16.8
)
 
(8.6
)
Accounts payable
16.0

 
(6.4
)
Accrued expenses
35.6

 
(18.8
)
Income taxes
(114.4
)
 
(14.1
)
Other liabilities
(19.5
)
 
26.6

Net cash provided by operating activities
639.1

 
601.1

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(1,109.9
)
 
(184.8
)
Purchase of non-marketable equity investment
(10.0
)
 

Acquisitions, net of cash acquired

 
(892.1
)
Additions to property, plant and equipment
(109.9
)
 
(62.4
)
Additions to capitalized software
(8.6
)
 
(5.6
)
Additions to intangible assets
(10.0
)
 
(0.3
)
Proceeds from maturities of short-term investments
1,185.4

 
260.6

Proceeds from sale of business
1.8

 

Proceeds from sale of property, plant and equipment
0.2

 
0.1

Net cash used in investing activities
(61.0
)
 
(884.5
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Dividends to stockholders
(29.8
)
 
(29.7
)
Payments to acquire treasury stock
(834.0
)
 
(649.1
)
Payments of contingent consideration
(10.2
)
 
(11.1
)
Net borrowings of notes payable
5.3

 
2.8

Sale of stock to employees
335.8

 
140.6

Excess tax benefits from share-based compensation
97.9

 
31.8

Debt issuance costs

 
(4.8
)
Proceeds from issuance of senior notes, net of discount

 
598.5

Net cash (used in) provided by financing activities
(435.0
)
 
79.0

 
 
 
 
Effect of exchange rate changes on cash and equivalents
0.7

 
(13.4
)
Net increase (decrease) in cash and equivalents
143.8

 
(217.8
)
Cash and equivalents at beginning of period
3,046.1

 
2,701.8

Cash and equivalents at end of period
$
3,189.9

 
$
2,484.0

 
 
 
 
Supplemental disclosure of cash flow information
 

 
 

Cash paid for:
 

 
 

Interest, net of amount capitalized
$
41.9

 
$
36.2

Income taxes, net of refunds
$
291.3

 
$
191.6

See accompanying notes to unaudited condensed consolidated financial statements.

6


ALLERGAN, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1:  Basis of Presentation
In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary (consisting only of normal recurring accruals) to present fairly the financial information contained therein. These statements do not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP) for annual periods and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2013. The Company prepared the unaudited condensed consolidated financial statements following the requirements of the U.S. Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted. The results of operations for the three and six month periods ended June 30, 2014 are not necessarily indicative of the results to be expected for the year ending December 31, 2014 or any other period(s).
Recently Adopted Accounting Standards
In July 2013, the Financial Accounting Standards Board (FASB) issued an accounting standards update that requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. This guidance became effective for fiscal years beginning after December 15, 2013, with early adoption permitted. The Company adopted the provisions of the guidance in the first quarter of 2014. The adoption did not have a material impact on the Company’s consolidated financial statements.
In March 2013, the FASB issued an accounting standards update that provides guidance on the accounting for the cumulative translation adjustment (CTA) upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. Under this guidance, an entity should recognize the CTA in earnings based on meeting certain criteria, including when it ceases to have a controlling financial interest in a subsidiary or group of assets within a consolidated foreign entity or upon a sale or transfer that results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets resides. This guidance became effective for fiscal years beginning on or after December 15, 2013, with early adoption permitted. The Company adopted the provisions of the guidance in the first quarter of 2014. The adoption did not have a material impact on the Company’s consolidated financial statements.
New Accounting Standards Not Yet Adopted
In June 2014, the FASB issued an accounting standards update that requires a performance target that affects vesting of a share-based payment award and that could be achieved after the requisite service period to be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized over the required service period, if it is probable that the performance target will be achieved. This guidance will be effective for fiscal years beginning after December 15, 2015, which will be the Company's fiscal year 2016, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that creates a single source of revenue guidance for companies in all industries. The new standard provides guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers, unless the contracts are within the scope of other accounting standards. It also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets. This guidance must be adopted using either a full retrospective approach for all periods presented or a modified retrospective approach and will be effective for fiscal years beginning after December 15, 2016, which will be the Company's fiscal year 2017. The Company has not yet evaluated the potential impact of adopting the guidance on the Company's consolidated financial statements.
In April 2014, the FASB issued an accounting standards update that raises the threshold for disposals to qualify as discontinued operations and allows companies to have significant continuing involvement with and continuing cash flows from or to the discontinued operation. It also requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This guidance will be effective for fiscal years beginning after December 15, 2014, which will be the Company's fiscal year 2015, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company's consolidated financial statements.

7

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Stockholder Rights Plan
On April 22, 2014, Allergan’s Board of Directors adopted a one-year stockholder rights plan (the Plan) and declared a dividend distribution of one preferred share purchase right on each outstanding share of the Company’s common stock. The Plan is not intended to prevent an acquisition of the Company on terms that the Board of Directors considers favorable to, and in the best interests of, all stockholders. Rather, the Plan aims to provide the Board with adequate time to fully assess any proposal. The Plan is scheduled to expire on April 22, 2015.

Under the terms of the Plan, stockholders of record at the close of business on May 8, 2014 received one right to purchase one one-thousandth of a share of Series A Junior Participating Preferred Stock, par value $0.01, at a price of $500.00 for each share of Allergan common stock held on that date. Subject to limited exceptions, the rights will become exercisable if a person or group acquires a beneficial ownership of 10% or more of Allergan’s common stock. In that situation, each holder of a right, other than the person or group with beneficial ownership of 10% or more of Allergan’s common stock, will be effectively entitled to purchase a number of Allergan’s common shares for $500.00 that have a market value of twice the exercise price of the right.

Note 2:  Acquisitions and Collaborations
MAP Acquisition
On March 1, 2013, the Company completed the acquisition of MAP Pharmaceuticals, Inc. (MAP), a biopharmaceutical company based in the United States focused on developing and commercializing new therapies in neurology, including SempranaTM, formerly referred to as Levadex®, an orally inhaled drug for the potential acute treatment of migraine in adults, for an aggregate purchase price of approximately $871.7 million, net of cash acquired. The acquisition was funded from a combination of current cash and equivalents and short-term investments.
The Company recognized tangible and intangible assets acquired and liabilities assumed in connection with the MAP acquisition based on their estimated fair values at the acquisition date. The excess of the purchase price over the fair value of net assets acquired was recognized as goodwill. The goodwill acquired in the MAP acquisition is not deductible for federal income tax purposes. In connection with the acquisition, the Company acquired assets with a fair value of $1,233.6 million, consisting of current assets of $2.3 million, property, plant and equipment of $7.7 million, other non-current assets of $0.3 million, deferred tax assets of $132.7 million, intangible assets of $915.6 million and goodwill of $175.0 million, and assumed liabilities of $361.9 million, consisting of current liabilities of $27.3 million and deferred tax liabilities of $334.6 million.
The intangible assets consist of an in-process research and development asset of $683.5 million associated with SempranaTM and a core technology asset of $232.1 million associated with MAP's proprietary Tempo® delivery system that has an estimated useful life of 15 years.
Goodwill represents the excess of the MAP purchase price over the sum of the amounts assigned to assets acquired less liabilities assumed. The MAP acquisition broadens the Company's product offering for the treatment of migraine headaches and MAP's proprietary drug particle and inhalation technology provides the potential for new product development opportunities, which the Company believes support the amount of goodwill recognized as a result of the purchase price paid for MAP, in relation to other acquired tangible and intangible assets.
Exemplar Acquisition
On April 12, 2013, the Company completed the acquisition of Exemplar Pharma, LLC (Exemplar), a third party contract manufacturer for MAP's Tempo® delivery system, for an aggregate purchase price of approximately $16.1 million, net of cash acquired. Prior to the acquisition, the Company also had a $1.9 million payable to Exemplar, which was effectively settled upon the acquisition. In connection with the acquisition, the Company acquired assets with a fair value of $16.6 million, consisting of current assets of $0.5 million, property, plant and equipment of $2.1 million and goodwill of $14.0 million, and assumed current liabilities of $0.5 million. The goodwill acquired in the Exemplar acquisition is deductible for federal income tax purposes.
The Company believes that the fair values assigned to the assets acquired and liabilities assumed were based on reasonable assumptions.
Medytox Collaboration
On September 25, 2013, the Company announced that it had entered into a license agreement with Medytox, Inc. (Medytox), contingent on obtaining certain government approvals. In January 2014, the Company closed the transaction. Under the terms of

8

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

the agreement, the Company made an upfront payment to Medytox of $65.0 million in January 2014 and Medytox granted the Company exclusive rights, worldwide outside of Korea with co-exclusive rights in Japan, to develop and, if approved, commercialize certain neurotoxin product candidates currently in development, including a potential liquid-injectable product. The upfront payment of $65.0 million was recorded as research and development (R&D) expense in the first quarter of 2014 because the technology has not yet achieved regulatory approval. The terms of the agreement also include potential future development milestone payments of up to $116.5 million and potential future sales milestone payments of up to $180.5 million, as well as potential future royalty payments.
Other Acquisitions and Collaborations
In March 2014, the Company completed the acquisition of certain assets from Aline Aesthetics, LLC and Tautona Group, L.P. for an upfront payment of $10.0 million and potential future payments for certain milestone events. The Company accounted for the acquisition as a purchase of net assets. The acquired assets primarily consist of intellectual property related to technology under development for use as a dermal filler that has not achieved regulatory approval. The upfront payment was accrued and recorded as R&D expense in the first quarter of 2014 and was paid in the second quarter of 2014.
In November 2013, the Company purchased a noncontrolling interest in a subsidiary from a minority shareholder for $18.0 million. The Company accounted for the purchase as an equity transaction and recorded the difference between the cash consideration and the carrying amount of the noncontrolling interest, including its share of accumulated other comprehensive income, as a decrease in additional paid-in capital of $1.3 million.
On September 10, 2013, the Company entered into a license and collaboration agreement with a third party pursuant to which the Company obtained exclusive global rights to research, manufacture and commercialize certain technologies for the treatment of ocular disease. Under the terms of the agreement, the Company made a $6.5 million upfront payment, which was recorded as R&D expense in the third quarter of 2013 because the technology has not yet achieved regulatory approval. The terms of the agreement also include potential future payments to the third party related to the Company’s achievement of development, regulatory and sales milestone events, as well as potential future royalty payments.
In connection with various business development transactions where the Company has outlicensed its technology to third parties, the Company has aggregate potential future milestone receipts of approximately $45.9 million as of June 30, 2014, none of which are individually significant. Of that amount, approximately $3.5 million relates to achievement of certain development milestones, approximately $17.0 million relates to achievement of certain regulatory milestones, and approximately $25.4 million relates to achievement of certain commercial sales milestones. Due to the challenges associated with developing and obtaining approval for pharmaceutical products, there is substantial uncertainty whether any of the future milestones will be achieved. The Company evaluates whether milestone payments are substantive based on the facts and circumstances associated with each milestone payment.

Note 3:  Discontinued Operations
On February 1, 2013, the Company formally committed to pursue a sale of its obesity intervention business unit, including the assets related to the Lap-Band® gastric band system and the Orberaintra-gastric balloon system. Accordingly, beginning in the first quarter of 2013, the Company has reported the financial results from that business unit as discontinued operations in the consolidated statements of earnings. In the first quarter of 2013, the Company reported an estimated pre-tax disposal loss of $346.2 million ($259.0 million after tax) related to the obesity intervention business unit from the write-down of the net assets held for sale to their estimated fair value less costs to sell.
On December 2, 2013, the Company completed the sale of its obesity intervention business to Apollo Endosurgery, Inc. (Apollo) for cash consideration of $75.0 million, subject to certain adjustments, and certain additional consideration, including a minority equity interest in Apollo with an estimated fair value of $15.0 million and contingent consideration of up to $20.0 million to be paid by Apollo upon the achievement of certain regulatory and sales milestones.
At the closing date, the cash consideration was reduced by the amount of inventories held outside of the United States of $7.6 million and net trade accounts receivable and payable of $19.4 million, which the Company retained pursuant to the sale and transition services agreements with Apollo. The Company expects to realize the value of these retained assets in the normal course of business within one year from the closing date.
For the year ended December 31, 2013, the Company reported a total pre-tax loss of $408.2 million ($297.9 million after tax) on the disposal of the obesity intervention business unit net assets. The pre-tax loss includes transaction costs of approximately

9

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

$2.6 million, consisting primarily of investment banking fees. In the first quarter of 2014, the Company recognized an additional pre-tax loss of $0.9 million ($0.6 million after tax) on the disposal of the obesity intervention business unit net assets.
The assets of discontinued operations of $1.2 million and $9.0 million as of June 30, 2014 and December 31, 2013, respectively, consist of net trade receivables. The remaining balance of retained inventories at June 30, 2014 was included in continuing operations and will be sold to Apollo pursuant to the transition services agreements.
In connection with the sale of the obesity intervention business, the Company also entered into certain transitional service agreements designed to facilitate the orderly transfer of business operations to Apollo. These agreements primarily relate to administrative services in the United States and distribution services outside of the United States, all of which are generally to be provided for a period of up to 12 months. The Company will also manufacture and supply products to Apollo for a transitional period not to exceed 24 months in order to allow Apollo adequate time to obtain regulatory approval for licenses and manufacturing facilities. The continuing cash flows from these agreements are not significant. Net sales made pursuant to the manufacturing and distribution agreements are recorded as product net sales in the Company's consolidated statements of earnings and are reflected as other medical devices product net sales.
The results of operations from discontinued operations presented below include certain allocations that management believes fairly reflect the utilization of services provided to the obesity intervention business. The allocations do not include amounts related to general corporate administrative expenses or interest expense. Therefore, the results of operations from the obesity intervention business unit do not necessarily reflect what the results of operations would have been had the business operated as a stand-alone entity.
The following table summarizes the results of operations from discontinued operations for the three and six month periods ended June 30, 2013:
 
June 30, 2013
 
Three Months
 
Six Months
 
(in millions)
Product net sales
$
31.9

 
$
65.2

 
 
 
 
Operating costs and expenses:
 
 
 

   Cost of sales (excludes amortization of intangible assets)
5.2

 
10.5

   Selling, general and administrative
14.6

 
30.4

   Research and development
1.2

 
2.7

   Amortization of intangible assets

 
10.3

 
 
 
 
Earnings from discontinued operations before income taxes
$
10.9

 
$
11.3

 
 
 
 
Earnings from discontinued operations, net of income taxes
$
7.2

 
$
7.6


Note 4:  Restructuring Charges and Integration Costs
January 2014 Restructuring Plan
In January 2014, the Company initiated a restructuring plan that includes certain sales force realignments and position eliminations, certain facility relocations and closures in the United States and Europe and the realignment of certain other business support functions, which affected approximately 250 employees. The Company currently estimates that the total costs related to this restructuring plan will be between $40 million and $45 million, which includes severance and other one-time termination benefits, lease exit and contract termination costs, accelerated depreciation and share-based compensation expenses, and relocation and duplicate operating expenses.
The Company began to record costs associated with the January 2014 restructuring plan in the first quarter of 2014 and expects that the majority of the expenses will be incurred in 2014 with the exception of certain expenses related to the relocation of a minor manufacturing facility to be incurred in 2015. The restructuring charges primarily consist of employee severance, one-time termination benefits and contract termination costs associated with the restructuring plan. In the first quarter of 2014, the Company recorded restructuring charges of $24.0 million and recognized additional costs of $6.5 million related to accelerated

10

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

depreciation and share-based compensation expenses and duplicate operating expenses, consisting of $0.8 million of cost of sales, $4.3 million in selling, general and administrative (SG&A) expenses and $1.4 million in R&D expenses. In the second quarter of 2014, the Company recorded a $2.3 million restructuring charge reversal and recognized additional costs of $2.3 million related to accelerated depreciation and share-based compensation expenses and duplicate operating expenses, consisting of $0.9 million of cost of sales, $0.9 million in SG&A expenses and $0.5 million in R&D expenses.
The following table presents the restructuring charges related to the January 2014 restructuring plan during the six month period ended June 30, 2014:
 
 
Employee Severance
 
Other
 
Total
 
 
(in millions)
Restructuring charges during the six month period ended June 30, 2014
 
$
19.4

 
$
2.3

 
$
21.7

Spending
 
(11.4
)
 
(1.3
)
 
(12.7
)
Balance at June 30, 2014 (included in "Other accrued expenses")
 
$
8.0

 
$
1.0

 
$
9.0

Other Restructuring Activities and Integration Costs
In connection with the March 2013 acquisition of MAP, the April 2013 acquisition of Exemplar and the December 2012 acquisition of SkinMedica, Inc., the Company initiated restructuring activities in 2013 to integrate the operations of the acquired businesses with the Company's operations and to capture synergies through the centralization of certain research and development, manufacturing, general and administrative and commercial functions. For the year ended December 31, 2013, the Company recorded $4.5 million of restructuring charges, including $4.3 million in the first quarter of 2013 and a $0.9 million restructuring charge reversal in the second quarter of 2013, primarily consisting of employee severance and other one-time termination benefits for approximately 111 people. In the first quarter of 2014, the Company recorded an additional $0.4 million of restructuring charges.
Included in the three month period ended June 30, 2014 are $0.8 million of restructuring charges for lease terminations, $0.1 million of SG&A expenses and $0.1 million of R&D expenses, and in the six month period ended June 30, 2014 are $0.7 million of restructuring charges for lease terminations and employee severance and other one-time termination benefits, $0.1 million of SG&A expenses and $0.5 million of R&D expenses related to the realignment of various business functions initiated in prior years. Included in the three month period ended June 30, 2013 are $0.9 million of restructuring charges for employee severance and other one-time termination benefits, $0.1 million of SG&A expenses and $0.7 million of R&D expenses, and in the six month period ended June 30, 2013 are $0.9 million of restructuring charges for employee severance and other one-time termination benefits, $0.2 million of SG&A expenses and $0.7 million of R&D expenses related to the realignment of various business functions initiated in prior years.
Included in the three month period ended June 30, 2014 are $0.2 million of SG&A expenses and in the six month period ended June 30, 2014 are $1.0 million of SG&A expenses and $0.4 million of R&D expenses related to transaction and integration costs associated with the purchase of various businesses and collaboration agreements. Included in the three month period ended June 30, 2013 are $0.1 million of cost of sales and $3.7 million of SG&A expenses and in the six month period ended June 30, 2013 are $0.1 million of cost of sales and $15.1 million of SG&A expenses related to transaction and integration costs associated with the purchase of various businesses and collaboration agreements. The SG&A expenses for the six month period ended June 30, 2013 primarily consist of investment banking and legal fees.


11

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Note 5:  Intangibles and Goodwill
Intangibles
At June 30, 2014 and December 31, 2013, the components of intangibles and certain other related information were as follows:
 
June 30, 2014
 
December 31, 2013
 
Gross
Amount
 
Accumulated
Amortization
 
Weighted
Average
Amortization
Period
 
Gross
Amount
 
Accumulated
Amortization
 
Weighted
Average
Amortization
Period
 
(in millions)
 
(in years)
 
(in millions)
 
(in years)
Amortizable Intangible Assets:
 
 
 
 
 
 
 
Developed technology
$
657.3

 
$
(372.5
)
 
11.1
 
$
647.7

 
$
(343.8
)
 
11.1
Customer relationships
54.7

 
(32.1
)
 
2.7
 
54.7

 
(21.8
)
 
2.7
Licensing
191.0

 
(166.5
)
 
9.3
 
185.8

 
(164.8
)
 
9.3
Trademarks
89.7

 
(32.0
)
 
12.3
 
89.6

 
(29.7
)
 
12.4
Core technology
327.4

 
(77.8
)
 
14.8
 
327.5

 
(66.9
)
 
14.8
Other
31.0

 
(14.8
)
 
7.6
 
30.7

 
(12.8
)
 
7.6
 
1,351.1

 
(695.7
)
 
11.4
 
1,336.0

 
(639.8
)
 
11.4
Unamortizable Intangible Assets:
 

 
 

 
 
 
 

 
 

 
 
In-process research and development
953.8

 

 
 
 
953.8

 

 
 
 
$
2,304.9

 
$
(695.7
)
 
 
 
$
2,289.8

 
$
(639.8
)
 
 
Developed technology consists primarily of current product offerings, primarily breast aesthetics products, dermal fillers, skin care products and eye care products acquired in connection with business combinations, asset acquisitions and initial licensing transactions for products previously approved for marketing. Customer relationship assets consist of the estimated value of relationships with customers acquired in connection with business combinations. Licensing assets consist primarily of capitalized payments to third party licensors related to the achievement of regulatory approvals to commercialize products in specified markets and up-front payments associated with royalty obligations for products that have achieved regulatory approval for marketing. Core technology consists of a drug delivery technology acquired in connection with the Company's 2013 acquisition of MAP, proprietary technology associated with silicone gel breast implants acquired in connection with the Company's 2006 acquisition of Inamed Corporation, dermal filler technology acquired in connection with the Company’s 2007 acquisition of Groupe Cornéal Laboratoires and a drug delivery technology acquired in connection with the Company’s 2003 acquisition of Oculex Pharmaceuticals, Inc. Other intangible assets consist primarily of acquired product registration rights, distributor relationships, distribution rights, government permits, non-compete agreements and a defensive asset associated with developed technology that has been commercialized. The in-process research and development assets consist primarily of an orally inhaled drug for the potential acute treatment of migraine in adults acquired in connection with the Company's 2013 acquisition of MAP and a novel compound to treat erythema associated with rosacea acquired in connection with the Company’s 2011 acquisition of Vicept Therapeutics, Inc. that is currently under development.

12

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The following table provides amortization expense by major categories of intangible assets for the three and six month periods ended June 30, 2014 and 2013, respectively:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Developed technology
$
14.6

 
$
14.3

 
$
29.0

 
$
28.6

Customer relationships
5.1

 
5.1

 
10.2

 
10.2

Licensing
0.8

 
0.8

 
1.5

 
6.0

Trademarks
1.1

 
1.1

 
2.2

 
2.2

Core technology
5.6

 
5.5

 
11.1

 
8.4

Other
0.8

 
2.2

 
1.8

 
4.3

 
$
28.0

 
$
29.0

 
$
55.8

 
$
59.7

Amortization expense related to acquired intangible assets generally benefits multiple business functions within the Company, such as the Company’s ability to sell, manufacture, research, market and distribute products, compounds and intellectual property. The amount of amortization expense excluded from cost of sales consists primarily of amounts amortized with respect to developed technology and licensing intangible assets. 
Estimated amortization expense is $111.4 million for 2014, $98.2 million for 2015, $77.9 million for 2016, $59.4 million for 2017 and $57.4 million for 2018.
Goodwill
Changes in the carrying amount of goodwill by operating segment through June 30, 2014 were as follows:
 
Specialty
 Pharmaceuticals
 
Medical
Devices
 
Total
 
(in millions)
Balance at December 31, 2013
$
501.2

 
$
1,838.2

 
$
2,339.4

Foreign exchange translation effects
1.6

 
(0.4
)
 
1.2

Balance at June 30, 2014
$
502.8

 
$
1,837.8

 
$
2,340.6


Note 6:  Inventories
Components of inventories were:
 
June 30,
2014
 
December 31,
2013
 
(in millions)
Finished products
$
192.7

 
$
180.0

Work in process
45.3

 
44.1

Raw materials
61.9

 
61.2

Total
$
299.9

 
$
285.3

At June 30, 2014 and December 31, 2013, approximately $12.6 million and $11.7 million, respectively, of the Company’s finished goods inventories, primarily breast implants, were held on consignment at a large number of doctors’ offices, clinics and hospitals worldwide. The value and quantity at any one location are not significant.
 
Note 7:  Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally less than the U.S. federal statutory rate, primarily because of lower tax rates in certain non-U.S. jurisdictions, R&D tax credits available in

13

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

California and other foreign jurisdictions and deductions available in the United States for domestic production activities. The Company currently expects the U.S. R&D tax credit to be renewed in the fourth quarter of 2014, with retroactive effect to January 1, 2014; however, until appropriate legislation is enacted in the United States to renew the R&D tax credit, the estimated annual effective tax rate for fiscal year 2014 must exclude any potential benefit for this credit. The effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pre-tax earnings in the various tax jurisdictions in which the Company operates, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, expected utilization of R&D tax credits and acquired net operating losses, and changes in or the interpretation of tax laws in jurisdictions where the Company conducts business. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of its assets and liabilities along with net operating loss and tax credit carryovers.
The Company records a valuation allowance against its deferred tax assets to reduce the net carrying value to an amount that it believes is more likely than not to be realized. When the Company establishes or reduces the valuation allowance against its deferred tax assets, the provision for income taxes will increase or decrease, respectively, in the period such determination is made. The valuation allowance against deferred tax assets was $48.9 million at June 30, 2014 and December 31, 2013.
The total amount of unrecognized tax benefits was $51.3 million and $77.3 million as of June 30, 2014 and December 31, 2013, respectively. The decrease in unrecognized tax benefits is primarily attributable to changes in estimates of certain transfer-pricing positions related to prior year filings and provision to return adjustments. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $45.8 million and $70.5 million as of June 30, 2014 and December 31, 2013, respectively. The Company expects that during the next 12 months it is reasonably possible that unrecognized tax benefit liabilities will decrease by approximately $14.0 million to $15.0 million due to the settlement of income tax audits, Appeals proceedings and Competent Authority negotiations in the United States and certain foreign jurisdictions.
During the third quarter of 2013, the Company reached a preliminary settlement for the Company’s acquired subsidiary, Inamed, for tax year 2005 with the IRS that was pending final review and approval by the U.S. Tax Court. The U.S. Tax Court approved the settlement in the first quarter of 2014. The impact of this settlement is not considered material.
Total interest accrued related to uncertain tax positions included in the Company's unaudited condensed consolidated balance sheets was $7.1 million and $9.8 million as of June 30, 2014 and December 31, 2013, respectively. 
The Company has not provided for withholding and U.S. taxes for the unremitted earnings of certain non-U.S. subsidiaries because it has currently reinvested these earnings indefinitely in these foreign operations. At December 31, 2013, the Company had approximately $3,828.0 million in unremitted earnings outside the United States for which withholding and U.S. taxes were not provided. Income tax expense would be incurred if these earnings were remitted to the United States. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against the Company's U.S. tax liability, if any. The Company annually updates its estimate of unremitted earnings outside the United States after the completion of each fiscal year.

Note 8:  Share-Based Compensation
The Company recognizes compensation expense for all share-based awards made to employees and directors. The fair value of share-based awards is estimated at the grant date and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.
The fair value of stock option awards that vest based solely on a service condition is estimated using the Black-Scholes option-pricing model. The fair value of share-based awards that contain a market condition is generally estimated using a Monte Carlo simulation model, and the fair value of modifications to share-based awards is generally estimated using a lattice model.
The determination of fair value using the Black-Scholes, Monte Carlo simulation and lattice models is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors. The Company currently estimates stock price volatility based upon an equal weighting of the historical average over the expected life of the award and the average implied volatility of at-the-money options traded in the open market. The Company estimates employee stock option exercise behavior based on actual historical exercise activity and assumptions regarding future exercise activity of unexercised, outstanding options.

14

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Share-based compensation expense is recognized only for those awards that are ultimately expected to vest, and the Company has applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs. Compensation expense for share-based awards based on a service condition is recognized using the straight-line single option method.
For the three and six month periods ended June 30, 2014 and 2013, share-based compensation expense was as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Cost of sales
$
1.8

 
$
1.8

 
$
3.7

 
$
3.6

Selling, general and administrative
20.8

 
18.0

 
44.0

 
37.4

Research and development
8.8

 
7.5

 
18.4

 
14.8

Pre-tax share-based compensation expense
31.4

 
27.3

 
66.1

 
55.8

Income tax benefit
10.3

 
8.7

 
21.0

 
18.1

Net share-based compensation expense
$
21.1

 
$
18.6

 
$
45.1

 
$
37.7

As of June 30, 2014, total compensation cost related to non-vested stock options and restricted stock not yet recognized was approximately $253.4 million, which is expected to be recognized over the next 46 months (34 months on a weighted-average basis). The Company has not capitalized as part of inventory any share-based compensation costs because such costs were negligible as of June 30, 2014.
Note 9:  Employee Retirement and Other Benefit Plans
The Company sponsors various qualified defined benefit pension plans covering a substantial portion of its employees. In addition, the Company sponsors two supplemental nonqualified plans covering certain management employees and officers and one retiree health plan covering U.S. retirees and dependents.
Components of net periodic benefit cost for the three and six month periods ended June 30, 2014 and 2013, respectively, were as follows:
 
Three Months Ended
 
Pension Benefits
 
Other Postretirement Benefits
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Service cost
$
6.9

 
$
7.1

 
$
0.4

 
$
0.5

Interest cost
13.3

 
11.5

 
0.6

 
0.5

Expected return on plan assets
(13.2
)
 
(11.2
)
 

 

Amortization of prior service costs
(0.1
)
 

 
(0.7
)
 
(0.6
)
Recognized net actuarial losses
4.8

 
7.7

 
0.2

 
0.3

Net periodic benefit cost
$
11.7

 
$
15.1

 
$
0.5

 
$
0.7


15

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

 
Six Months Ended
 
Pension Benefits
 
Other Postretirement Benefits
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Service cost
$
13.8

 
$
14.2

 
$
0.8

 
$
0.9

Interest cost
26.6

 
23.1

 
1.2

 
1.0

Expected return on plan assets
(26.3
)
 
(22.5
)
 

 

Amortization of prior service costs
(0.1
)
 

 
(1.4
)
 
(1.3
)
Recognized net actuarial losses
9.5

 
15.5

 
0.4

 
0.7

Net periodic benefit cost
$
23.5

 
$
30.3

 
$
1.0

 
$
1.3

In 2014, the Company expects to pay contributions of between $30.0 million and $40.0 million for its U.S. and non-U.S. pension plans and between $1.0 million and $2.0 million for its other postretirement plan.

Note 10:  Contingencies
Legal Proceedings
In the ordinary course of business, the Company is involved in various legal actions, government investigations and environmental proceedings, and we anticipate that additional actions will be brought against us in the future. The most significant of these actions, proceedings and investigations are described below. The following supplements the discussion set forth in Note 13 “Commitments and Contingencies - Legal Proceedings” in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 and Note 10 “Contingencies - Legal Proceedings” in the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2014 and is limited to certain recent developments concerning the Company's legal proceedings.
The Company's legal proceedings range from cases brought by a single plaintiff to a class action with thousands of putative class members. These legal proceedings, as well as other matters, involve various aspects of the Company's business and a variety of claims (including but not limited to patent infringement, marketing, product liability, pricing and trade practices and securities law), some of which present novel factual allegations and/or unique legal theories. Complex legal proceedings frequently extend for several years, and a number of the matters pending against the Company are at very early stages of the legal process. As a result, some pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable the Company to determine whether the proceeding is material to the Company or to estimate a range of possible loss, if any. Unless otherwise disclosed, the Company is unable to estimate the possible loss or range of loss for the legal proceedings described below. While it is not possible to accurately predict or determine the eventual outcomes of these items, an adverse determination in one or more of these items currently pending could have a material adverse effect on the Company's consolidated results of operations, financial position or cash flows.
Stockholder Derivative Litigation
Botox® Settlement-Related Actions
In June 2014, the U.S. Court of Appeals for the Ninth Circuit heard oral argument on plaintiffs’ appeal regarding the U.S. District Court for the Central District of California’s granting of the Company’s and the individual defendants’ motion to dismiss and took the matter under submission.
2011 Incentive Award Plan Action
In May 2014, the U.S. District Court for the District of Delaware dismissed this matter with prejudice.
Patent Litigation
We are involved in patent litigation matters, including certain paragraph 4 invalidity and non-infringement claims brought under the Hatch-Waxman Act in the United States described below.

16

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Latisse® 
In June 2014, the U.S. Court of Appeals for the Federal Circuit reversed the finding of the U.S. District Court for the Middle District of North Carolina and held that U.S. Patent Numbers 7,351,404 and 7,388,029 are invalid.
In June 2014, Apotex Corp. (Apotex) filed an ANDA seeking approval of a generic form of Latisse® 0.03% bimatoprost ophthalmic solution. The Company subsequently received a paragraph 4 invalidity and noninfringement certification from Apotex contending that U.S. Patent Numbers 8,632,760 (‘760 Patent) and 8,541,466 (‘466 Patent) are invalid or not infringed by Apotex’s proposed generic product.
In June 2014, Sandoz, Inc. (Sandoz) filed an ANDA seeking approval of a generic form of Latisse® 0.03% bimatoprost ophthalmic solution. The Company subsequently received a paragraph 4 invalidity and noninfringement certification from Sandoz contending that U.S. Patent Numbers 8,038,988, 8,101,161, 8,263,054, ‘760 Patent, and ‘466 Patent are invalid or not infringed by Sandoz’s proposed generic product.
Restasis® 
In April 2014, the Company received a purported paragraph 4 certification from Watson Laboratories, Inc., a subsidiary of Actavis plc (Watson), contending that it had filed an ANDA seeking approval of a generic form of Restasis® (cyclosporine) ophthalmic emulsion, 0.05%, and that U.S. Patent Numbers 8,633,162, 8,642,556, 8,648,048, and 8,685,930 (Restasis Patents) are invalid, unenforceable and/or not infringed. In May 2014, the Company filed a complaint against Watson in the U.S. District Court for the Eastern District of Texas alleging that Watson sent a premature, improper, null and void paragraph 4 certification and, in the alternative, that its proposed product infringes the Restasis Patents. In April 2014, Watson filed a motion to dismiss for lack of personal jurisdiction. In June 2014, the Company filed a motion for summary judgment on its false paragraph 4 notification claims and a motion to dismiss its patent infringement claims.
Other Litigation
Allergan, Inc. v. Cayman Chemical Company, et al.
In May 2014, Athena Cosmetics, Inc. filed a Petition for Writ of Certiorari to the U.S. Supreme Court.
Valeant and Pershing Square Insider Trading Action
In August 2014, the Company filed a complaint in the U.S. District Court for the Central District of California against Valeant Pharmaceuticals International, Inc. (Valeant), Pershing Square Capital Management, L.P. (Pershing Square) and its principal, William A. Ackman, alleging that Valeant, Pershing Square and Mr. Ackman violated federal securities laws prohibiting insider trading, engaged in other fraudulent practices, and failed to disclose legally required information. The complaint alleges that Valeant, Pershing Square and Mr. Ackman, violated Sections 13(d), 14(a), and 14(e) of the Securities Exchange Act of 1934, as amended (Exchange Act), which prohibit insider trading and require full and fair disclosure for stockholders in the context of proxy solicitations and tender offers, and the rules promulgated by the U.S. Securities and Exchange Commission under those Sections, including Rule 14e-3. In its complaint, the Company is seeking, among other remedies, a declaration from the court that Pershing Square and Valeant violated insider trading and disclosure laws, and an order rescinding Pershing Square’s purchase of the Company shares it acquired illegally.
Contingencies
The Company is largely self-insured for future product liability losses related to all of its products. The Company has historically been and continues to be self-insured for any product liability losses related to its breast implant products. Future product liability losses are, by their nature, uncertain and are based upon complex judgments and probabilities. The Company accrues for certain potential product liability losses estimated to be incurred, but not reported, to the extent they can be reasonably estimated. The Company estimates these accruals for potential losses based primarily on historical claims experience and data regarding product usage. The total value of self-insured product liability claims settled in the second quarter and the first six months of 2014 and 2013, respectively, and the value of known and reasonably estimable incurred but unreported self-insured product liability claims pending as of June 30, 2014 are not material.
The Company has provided reserves for contingencies related to various lawsuits, claims and contractual disputes that management believes are probable and reasonably estimable. The amounts reserved for these contingencies as of June 30, 2014 are not material.

17

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Note 11:  Guarantees
The Company’s Amended and Restated Certificate of Incorporation provides that the Company will indemnify, to the fullest extent permitted by the Delaware General Corporation Law, each person that is involved in or is, or is threatened to be, made a party to any action, suit or proceeding by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was a director or officer of the Company or was serving at the request of the Company as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise. The Company has also entered into contractual indemnity agreements with each of its directors and executive officers pursuant to which, among other things, the Company has agreed to indemnify such directors and executive officers against any payments they are required to make as a result of a claim brought against such executive officer or director in such capacity, excluding claims (i) relating to the action or inaction of a director or executive officer that resulted in such director or executive officer gaining illegal personal profit or advantage, (ii) for an accounting of profits made from the purchase or sale of securities of the Company within the meaning of Section 16(b) of the Exchange Act, or similar provisions of any state law or (iii) that are based upon or arise out of such director’s or executive officer’s knowingly fraudulent, deliberately dishonest or willful misconduct. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. However, the Company has purchased directors’ and officers’ liability insurance policies intended to reduce the Company’s monetary exposure and to enable the Company to recover a portion of any future amounts paid. The Company has not previously paid any material amounts to defend lawsuits or settle claims as a result of these indemnification provisions, but makes no assurance that such amounts will not be paid in the future. The Company currently believes the estimated fair value of these indemnification arrangements is minimal.
 The Company customarily agrees in the ordinary course of its business to indemnification provisions in agreements with clinical trials investigators in its drug, biologics and medical device development programs, in sponsored research agreements with academic and not-for-profit institutions, in various comparable agreements involving parties performing services for the Company in the ordinary course of business, in agreements with financial advisors, and in its real estate leases. The Company also customarily agrees to certain indemnification provisions in its acquisition agreements and discovery and development collaboration agreements. With respect to the Company’s clinical trials and sponsored research agreements, these indemnification provisions typically apply to any claim asserted against the investigator or the investigator’s institution relating to personal injury or property damage, violations of law or certain breaches of the Company’s contractual obligations arising out of the research or clinical testing of the Company’s products, compounds or drug candidates. With respect to financial advisor agreements, the indemnification provisions typically apply to any claim asserted against the advisors relating to their scope of work for the Company, including claims related to acquisition or merger transactions. With respect to real estate lease agreements, the indemnification provisions typically apply to claims asserted against the landlord relating to personal injury or property damage caused by the Company, to violations of law by the Company or to certain breaches of the Company’s contractual obligations. The indemnification provisions appearing in the Company’s acquisition agreements and collaboration agreements are similar, but in addition often provide indemnification for the collaborator in the event of third party claims alleging infringement of intellectual property rights. In each of the above cases, the terms of these indemnification provisions generally survive the termination of the agreement. The maximum potential amount of future payments that the Company could be required to make under these provisions is generally unlimited. The Company has purchased insurance policies covering personal injury, property damage and general liability intended to reduce the Company’s exposure for indemnification and to enable the Company to recover a portion of any future amounts paid. The Company has not previously paid any material amounts to defend lawsuits or settle claims as a result of these indemnification provisions. As a result, the Company believes the estimated fair value of these indemnification arrangements is minimal.

Note 12:  Product Warranties
The Company provides warranty programs for breast implant sales primarily in the United States, Europe and certain other countries. Management estimates the amount of potential future claims from these warranty programs based on actuarial analyses. Expected future obligations are determined based on the history of product shipments and claims and are discounted to a current value. The liability is included in both current and long-term liabilities in the Company’s consolidated balance sheets. The U.S. programs include the ConfidencePlus® and ConfidencePlus® Premier warranty programs. The ConfidencePlus® program, which is limited to saline breast implants, currently provides lifetime product replacement, $1,200 of financial assistance for surgical procedures within ten years of implantation and contralateral implant replacement. The ConfidencePlus® Premier program, which is standard for silicone gel implants and requires a low enrollment fee for saline breast implants, generally provides lifetime product replacement, $2,400 of financial assistance for saline breast implants and $3,500 of financial assistance for silicone gel breast implants for surgical procedures within ten years of implantation and contralateral implant replacement. The warranty programs in non-U.S. markets have similar terms and conditions to the U.S. programs. The Company does not warrant any level of aesthetic result and, as required by government regulation, makes extensive disclosures concerning the risks of the use of its products and breast implant surgery. Changes to actual warranty claims incurred and interest rates could have a material impact

18

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

on the actuarial analysis and the Company’s estimated liabilities. A large majority of the product warranty liability arises from the U.S. warranty programs. The Company does not currently offer any similar warranty program on any other product. 
The following table provides a reconciliation of the change in estimated product warranty liabilities through June 30, 2014:
 
(in millions)
Balance at December 31, 2013
$
33.6

Provision for warranties issued during the period
5.4

Settlements made during the period
(5.0
)
Balance at June 30, 2014
$
34.0

 
 

Current portion
$
7.6

Non-current portion
26.4

Total
$
34.0


Note 13:  Earnings Per Share
The table below presents the computation of basic and diluted earnings per share:
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
 
 
 
 
 
 
 
 
Net earnings attributable to Allergan, Inc.:
 
 
 
 
 
 
 
Earnings from continuing operations attributable to Allergan, Inc.:
 
 
 
 
 
 
 
Earnings from continuing operations
$
418.4

 
$
354.0

 
$
676.9

 
$
627.0

Less net earnings attributable to noncontrolling interest
1.2

 
1.3

 
1.8

 
3.2

Earnings from continuing operations attributable to Allergan, Inc.
417.2

 
352.7

 
675.1

 
623.8

Earnings (loss) from discontinued operations

 
7.2

 
(0.6
)
 
(251.4
)
Net earnings attributable to Allergan, Inc.
$
417.2

 
$
359.9

 
$
674.5

 
$
372.4

 
 
 
 
 
 
 
 
Weighted average number of shares outstanding
297.6

 
296.0

 
297.7

 
296.9

Net shares assumed issued using the treasury stock method for options and non-vested equity shares and share units outstanding during each period based on average market price
6.3

 
5.3

 
6.0

 
5.6

Diluted shares
303.9

 
301.3

 
303.7

 
302.5

 
 
 
 
 
 
 
 
Basic earnings per share attributable to Allergan, Inc. stockholders:
 
 
 
 
 

 
 

Continuing operations
$
1.40

 
$
1.19

 
$
2.27

 
$
2.10

Discontinued operations

 
0.03

 

 
(0.85
)
Net basic earnings per share attributable to Allergan, Inc. stockholders
$
1.40

 
$
1.22

 
$
2.27

 
$
1.25

 
 
 
 
 
 
 
 
Diluted earnings per share attributable to Allergan, Inc. stockholders:
 
 
 
 
 

 
 

Continuing operations
$
1.37

 
$
1.17

 
$
2.22

 
$
2.06

Discontinued operations

 
0.02

 

 
(0.83
)
Net diluted earnings per share attributable to Allergan, Inc. stockholders
$
1.37

 
$
1.19

 
$
2.22

 
$
1.23

For the three and six month periods ended June 30, 2014, options to purchase 3.6 million and 5.5 million shares of common stock at exercise prices ranging from $125.07 to $166.32 and $104.77 to $166.32 per share, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect from the assumed exercise of these options calculated under the treasury stock method would be anti-dilutive.

19

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

For the three and six month periods ended June 30, 2013, options to purchase 4.4 million and 4.3 million shares of common stock at exercise prices ranging from $90.78 to $105.87 per share, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effect from the assumed exercise of these options calculated under the treasury stock method would be anti-dilutive.

Note 14:  Financial Instruments
In the normal course of business, operations of the Company are exposed to risks associated with fluctuations in interest rates and foreign currency exchange rates. The Company addresses these risks through controlled risk management that includes the use of derivative financial instruments to economically hedge or reduce these exposures. The Company does not enter into derivative financial instruments for trading or speculative purposes.
The Company has not experienced any losses to date on its derivative financial instruments due to counterparty credit risk.
The Company assesses the adequacy and effectiveness of its interest rate and foreign exchange hedge positions by continually monitoring its interest rate swap and foreign exchange forward and option positions both on a stand-alone basis and in conjunction with its underlying interest rate and foreign currency exposures, from an accounting and economic perspective.
However, given the inherent limitations of forecasting and the anticipatory nature of the exposures intended to be hedged, the Company cannot assure that such programs will offset more than a portion of the adverse financial impact resulting from unfavorable movements in either interest or foreign exchange rates. In addition, the timing of the accounting for recognition of gains and losses related to mark-to-market instruments for any given period may not coincide with the timing of gains and losses related to the underlying economic exposures and, therefore, may adversely affect the Company’s consolidated operating results and financial position.
Interest Rate Risk Management
The Company’s interest income and expense are more sensitive to fluctuations in the general level of U.S. interest rates than to changes in rates in other markets. Changes in U.S. interest rates affect the interest earned on cash and equivalents and short-term investments and interest expense on debt, as well as costs associated with foreign currency contracts.
On January 31, 2007, the Company entered into a nine-year, two month interest rate swap with a $300.0 million notional amount. The swap received interest at a fixed rate of 5.75% and paid interest at a variable interest rate equal to 3-month LIBOR plus 0.368%, and effectively converted $300.0 million of the Company’s $800.0 million in aggregate principal amount of 5.75% Senior Notes due 2016 (2016 Notes) to a variable interest rate. Based on the structure of the hedging relationship, the hedge met the criteria for using the short-cut method for a fair value hedge. In September 2012, the Company terminated the interest rate swap and received $54.7 million, which included accrued interest of $3.7 million. Upon termination of the interest rate swap, the Company added the net fair value received of $51.0 million to the carrying value of the 2016 Notes. The amount received for the termination of the interest rate swap is being amortized as a reduction to interest expense over the remaining life of the debt, which effectively fixes the interest rate for the remaining term of the 2016 Notes at 3.94%. During the three and six month periods ended June 30, 2014, the Company recognized $3.4 million and $6.8 million, respectively, as a reduction of interest expense due to the effect of the interest rate swap. During the three and six month periods ended June 30, 2013, the Company recognized $3.3 million and $6.5 million, respectively, as a reduction of interest expense due to the effect of the interest rate swap.
In February 2006, the Company entered into interest rate swap contracts based on 3-month LIBOR with an aggregate notional amount of $800.0 million, a swap period of 10 years and a starting swap rate of 5.198%. The Company entered into these swap contracts as a cash flow hedge to effectively fix the future interest rate for the 2016 Notes. In April 2006, the Company terminated the interest rate swap contracts and received approximately $13.0 million. The total gain was recorded to accumulated other comprehensive loss and is being amortized as a reduction to interest expense over a 10 year period to match the term of the 2016 Notes. During the three and six month periods ended June 30, 2014 and 2013, the Company recognized $0.3 million and $0.7 million, respectively, as a reduction of interest expense due to the amortization of deferred holding gains on derivatives designated as cash flow hedges. These amounts were reclassified from accumulated other comprehensive loss. As of June 30, 2014, the remaining unrecognized gain of $2.3 million ($1.4 million, net of tax) is recorded as a component of accumulated other comprehensive loss. The Company expects to reclassify an estimated pre-tax amount of $1.3 million from accumulated other comprehensive loss as a reduction in interest expense during fiscal year 2014 due to the amortization of deferred holding gains on derivatives designated as cash flow hedges.

20

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Foreign Exchange Risk Management
Overall, the Company is a net recipient of currencies other than the U.S. dollar and, as such, benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect the Company’s consolidated revenues or operating costs and expenses as expressed in U.S. dollars.
From time to time, the Company enters into foreign currency option and forward contracts to reduce earnings and cash flow volatility associated with foreign exchange rate changes to allow management to focus its attention on its core business issues. Accordingly, the Company enters into various contracts which change in value as foreign exchange rates change to economically offset the effect of changes in the value of foreign currency assets and liabilities, commitments and anticipated foreign currency denominated sales and operating expenses. The Company enters into foreign currency option and forward contracts in amounts between minimum and maximum anticipated foreign exchange exposures. The Company does not designate these derivative instruments as accounting hedges.
The Company uses foreign currency option contracts, which provide for the sale or purchase of foreign currencies, to economically hedge the currency exchange risks associated with probable but not firmly committed transactions that arise in the normal course of the Company’s business. Probable but not firmly committed transactions are comprised primarily of sales of products and purchases of raw material in currencies other than the U.S. dollar. The foreign currency option contracts are entered into to reduce the volatility of earnings generated in currencies other than the U.S. dollar. While these instruments are subject to fluctuations in value, such fluctuations are anticipated to offset changes in the value of the underlying exposures.
Changes in the fair value of open foreign currency option contracts and any realized gains (losses) on settled contracts are recorded through earnings as “Other, net” in the accompanying unaudited condensed consolidated statements of earnings. During the three and six month periods ended June 30, 2014, the Company recognized realized gains on settled foreign currency option contracts of $2.2 million and $6.2 million, respectively, and net unrealized losses on open foreign currency option contracts of $10.9 million and $15.1 million, respectively. During the three and six month periods ended June 30, 2013, the Company recognized realized gains on settled foreign currency option contracts of $0.6 million and $1.6 million, respectively, and net unrealized gains on open foreign currency option contracts of $10.6 million and $11.9 million, respectively. The premium costs of purchased foreign exchange option contracts are recorded in “Other current assets” and amortized to “Other, net” over the life of the options.
All of the Company’s outstanding foreign exchange forward contracts are entered into to offset the change in value of certain intercompany receivables or payables that are subject to fluctuations in foreign currency exchange rates. The realized and unrealized gains and losses from foreign currency forward contracts and the revaluation of the foreign denominated intercompany receivables or payables are recorded through “Other, net” in the accompanying unaudited condensed consolidated statements of earnings. During the three and six month periods ended June 30, 2014, the Company recognized total realized and unrealized losses from foreign exchange forward contracts of $0.8 million and $0.7 million, respectively. During the three and six month periods ended June 30, 2013, the Company recognized total realized and unrealized gains from foreign exchange forward contracts of $3.8 million and $3.2 million, respectively.
The fair value of outstanding foreign exchange option and forward contracts, collectively referred to as foreign currency derivative financial instruments, are recorded in “Other current assets” and “Accounts payable.” At June 30, 2014 and December 31, 2013, foreign currency derivative assets associated with the foreign exchange option contracts of $25.5 million and $20.2 million, respectively, were included in “Other current assets.” At June 30, 2014 and December 31, 2013, net foreign currency derivative assets associated with the foreign exchange forward contracts of $1.2 million and $0.2 million, respectively, were included in “Other current assets.”

21

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

At June 30, 2014 and December 31, 2013, the notional principal and fair value of the Company’s outstanding foreign currency derivative financial instruments were as follows:
 
June 30, 2014
 
December 31, 2013
 
Notional
Principal
 
Fair
Value
 
Notional
Principal
 
Fair
Value
 
(in millions)
Foreign currency forward exchange contracts
(Receive U.S. dollar/pay foreign currency)
$
43.6

 
$
(0.7
)
 
$
35.0

 
$
0.1

Foreign currency forward exchange contracts
(Pay U.S. dollar/receive foreign currency)
162.5

 
1.9

 
41.3

 
0.1

Foreign currency sold — put options
854.0

 
25.5

 
560.8

 
20.2

The notional principal amounts provide one measure of the transaction volume outstanding as of June 30, 2014 and December 31, 2013, and do not represent the amount of the Company’s exposure to market loss. The estimates of fair value are based on applicable and commonly used pricing models using prevailing financial market information as of June 30, 2014 and December 31, 2013. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.
Other Financial Instruments
At June 30, 2014 and December 31, 2013, the Company’s other financial instruments included cash and equivalents, short-term investments, trade receivables, non-marketable equity investments, accounts payable and borrowings. The carrying amount of cash and equivalents, short-term investments, trade receivables and accounts payable approximates fair value due to the short-term maturities of these instruments. The fair value of non-marketable equity investments, which represent investments in start-up technology companies, are estimated based on information provided by these companies. The fair value of notes payable and long-term debt are estimated based on quoted market prices and interest rates. 
The carrying amount and estimated fair value of the Company’s other financial instruments at June 30, 2014 and December 31, 2013 were as follows:
 
June 30, 2014
 
December 31, 2013
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
(in millions)
Cash and equivalents
$
3,189.9

 
$
3,189.9

 
$
3,046.1

 
$
3,046.1

Short-term investments
525.6

 
525.6

 
603.0

 
603.0

Non-current non-marketable equity investments
30.8

 
30.8

 
20.8

 
20.8

Notes payable
60.9

 
60.9

 
55.6

 
55.6

Long-term debt
2,091.8

 
2,112.3

 
2,098.3

 
2,163.8

In the first quarter of 2013, the Company recorded an impairment charge of $3.7 million included in "Other, net" non-operating expense due to the other than temporary decline in value of a non-marketable equity investment.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to credit risk principally consist of trade receivables. Wholesale distributors, major retail chains and managed care organizations account for a substantial portion of trade receivables. This risk is limited due to the number of customers comprising the Company’s customer base, and their geographic dispersion. At June 30, 2014, no single customer represented more than 10% of trade receivables, net. Ongoing credit evaluations of customers’ financial condition are performed and, generally, no collateral is required. The Company has purchased an insurance policy intended to reduce the Company’s exposure to potential credit risks associated with certain U.S. customers. To date, no claims have been made against the insurance policy. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not historically exceeded management’s estimates.


22

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Note 15:  Fair Value Measurements
The Company measures fair value based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
As of June 30, 2014 and December 31, 2013, the Company has certain assets and liabilities that are required to be measured at fair value on a recurring basis. These include cash equivalents, short-term investments, foreign exchange derivatives, deferred executive compensation investments and liabilities and contingent consideration liabilities. These assets and liabilities are classified in the table below in one of the three categories of the fair value hierarchy described above.
 
June 30, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets
 
 
 
 
 
 
 
Commercial paper
$
2,108.3

 
$

 
$
2,108.3

 
$

Foreign time deposits
334.4

 

 
334.4

 

Other cash equivalents
1,047.5

 

 
1,047.5

 

Foreign exchange derivative assets
26.7

 

 
26.7

 

Deferred executive compensation investments
108.7

 
88.3

 
20.4

 

 
$
3,625.6

 
$
88.3

 
$
3,537.3

 
$

Liabilities
 

 
 

 
 

 
 

Deferred executive compensation liabilities
101.3

 
80.9

 
20.4

 

Contingent consideration liabilities
218.8

 

 

 
218.8

 
$
320.1

 
$
80.9

 
$
20.4

 
$
218.8

 
 
 
 
 
 
 
 
 
December 31, 2013
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets
 
 
 
 
 
 
 
Commercial paper
$
2,016.8

 
$

 
$
2,016.8

 
$

Foreign time deposits
370.3

 

 
370.3

 

Other cash equivalents
1,080.4

 

 
1,080.4

 

Foreign exchange derivative assets
20.4

 

 
20.4

 

Deferred executive compensation investments
100.7

 
80.4

 
20.3

 

 
$
3,588.6

 
$
80.4

 
$
3,508.2

 
$

Liabilities
 

 
 

 
 

 
 

Deferred executive compensation liabilities
$
93.0

 
$
72.7

 
$
20.3

 
$

Contingent consideration liabilities
225.2

 

 

 
225.2

 
$
318.2

 
$
72.7

 
$
20.3

 
$
225.2

Cash equivalents consist of commercial paper, foreign time deposits and other cash equivalents. Other cash equivalents consist primarily of money-market fund investments. Short-term investments consist of commercial paper and foreign time deposits. Cash equivalents and short-term investments are valued at cost, which approximates fair value due to the short-term maturities of these instruments. Foreign currency derivative assets and liabilities are valued using quoted forward foreign exchange

23

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

prices and option volatility at the reporting date. The Company believes the fair values assigned to its derivative instruments as of June 30, 2014 and December 31, 2013 are based upon reasonable estimates and assumptions. Assets and liabilities related to deferred executive compensation consist of actively traded mutual funds classified as Level 1 and money-market funds classified as Level 2.
Contingent consideration liabilities represent future amounts the Company may be required to pay in conjunction with various business combinations. The ultimate amount of future payments is based on specified future criteria, such as sales performance and the achievement of certain future development, regulatory and sales milestones and other contractual performance conditions. The Company evaluates its estimates of the fair value of contingent consideration liabilities on a periodic basis. Any changes in the fair value of contingent consideration liabilities are recorded as SG&A expense.
The Company estimates the fair value of the contingent consideration liabilities related to sales performance using the income approach, which involves forecasting estimated future net cash flows and discounting the net cash flows to their present value using a risk-adjusted rate of return. The Company estimates the fair value of the contingent consideration liabilities related to the achievement of future development and regulatory milestones by assigning an achievement probability to each potential milestone and discounting the associated cash payment to its present value using a risk-adjusted rate of return. The Company estimates the fair value of the contingent consideration liabilities associated with sales milestones by employing Monte Carlo simulations to estimate the volatility and systematic relative risk of revenues subject to sales milestone payments and discounting the associated cash payment amounts to their present values using a credit-risk-adjusted interest rate. The fair value of other contractual performance conditions is measured by assigning an achievement probability to each payment and discounting the payment to its present value using the Company's estimated cost of borrowing. The unobservable inputs to the valuation models that have the most significant effect on the fair value of the Company's contingent consideration liabilities are the probabilities that certain in-process development projects will meet specified development milestones, including ultimate approval by the FDA. The Company currently estimates that the probabilities of success in meeting the specified development milestones are between 65% and 75%.
The following table provides a reconciliation of the change in the contingent consideration liabilities through June 30, 2014:
 
(in millions)
Balance at December 31, 2013
$
225.2

Change in the estimated fair value of the contingent consideration liabilities
3.4

Payments made during the period
(10.2
)
Foreign exchange translation effects
0.4

Balance at June 30, 2014
$
218.8


Note 16:  Business Segment Information
The Company operates its business on the basis of two reportable segments — specialty pharmaceuticals and medical devices. The specialty pharmaceuticals segment produces a broad range of pharmaceutical products, including: ophthalmic products for dry eye, glaucoma, inflammation, infection, allergy and retinal disease; Botox® for certain therapeutic and aesthetic indications; skin care products for acne, psoriasis, eyelash growth and other prescription and physician-dispensed skin care products; and urologics products. The medical devices segment produces a broad range of medical devices, including: breast implants for augmentation, revision and reconstructive surgery and tissue expanders; and facial aesthetics products. The Company provides global marketing strategy teams to ensure development and execution of a consistent marketing strategy for its products in all geographic regions that share similar distribution channels and customers.
The Company evaluates segment performance on a product net sales and operating income basis exclusive of general and administrative expenses and other indirect costs, legal settlement expenses, impairment of intangible assets and related costs, restructuring charges, amortization of certain identifiable intangible assets related to business combinations, asset acquisitions and related capitalized licensing costs and certain other adjustments, which are not allocated to the Company’s segments for performance assessment by the Company’s chief operating decision maker. Other adjustments excluded from the Company’s segments for performance assessment represent income or expenses that do not reflect, according to established Company-defined criteria, operating income or expenses associated with the Company’s core business activities. Because operating segments are generally defined by the products they design and sell, they do not make sales to each other. The Company does not discretely allocate assets

24

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

to its operating segments, nor does the Company’s chief operating decision maker evaluate operating segments using discrete asset information.
Operating Segments
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Product net sales:
 
 
 
 
 
 
 
Specialty pharmaceuticals
$
1,526.1

 
$
1,347.7

 
$
2,885.4

 
$
2,579.5

Medical devices
301.2

 
229.3

 
561.0

 
430.0

Total product net sales
1,827.3

 
1,577.0

 
3,446.4

 
3,009.5

Other revenues
36.9

 
20.7

 
63.9

 
47.8

Total revenues
$
1,864.2

 
$
1,597.7

 
$
3,510.3

 
$
3,057.3

 
 
 
 
 
 
 
 
Operating income:
 
 
 
 
 

 
 

Specialty pharmaceuticals
$
685.7

 
$
569.4

 
$
1,256.0

 
$
1,059.4

Medical devices
100.2

 
75.1

 
175.9

 
129.7

Total segments
785.9

 
644.5

 
1,431.9

 
1,189.1

General and administrative expenses, other indirect costs and other adjustments
153.1

 
123.7

 
366.3

 
267.8

Amortization of intangible assets (a)
26.4

 
27.6

 
53.0

 
52.7

Restructuring charges (reversal)
(1.5
)
 

 
22.8

 
4.3

Total operating income
$
607.9

 
$
493.2

 
$
989.8

 
$
864.3

 ——————————
(a)
Represents amortization of certain identifiable intangible assets related to business combinations and asset acquisitions and related capitalized licensing costs, as applicable.
Product net sales for the Company’s various global product portfolios are presented below. The Company’s principal geographic markets are the United States, Europe, Latin America and Asia Pacific. The U.S. information is presented separately as it is the Company’s headquarters country. U.S. sales represented 61.9% and 61.1% of the Company’s total consolidated product net sales for the three month periods ended June 30, 2014 and 2013, respectively. U.S. sales represented 62.1% and 61.0% of the Company’s total consolidated product net sales for the six month periods ended June 30, 2014 and 2013, respectively.
Sales to three customers in the Company’s specialty pharmaceuticals segment each generated over 10% of the Company’s total consolidated product net sales. Sales to McKesson Drug Company for the three month periods ended June 30, 2014 and 2013 were 14.1% and 14.0%, respectively, of the Company’s total consolidated product net sales, and 13.9% and 14.1%, respectively, of the Company’s total consolidated product net sales for the six month periods ended June 30, 2014 and 2013. Sales to AmerisourceBergen Corporation for the three month period ended June 30, 2014 were 10.1% of the Company’s total consolidated product net sales. Sales to Cardinal Health, Inc. for the three month period ended June 30, 2013 were 14.2% of the Company’s total consolidated product net sales, and 10.1% and 14.3%, respectively, of the Company’s total consolidated product net sales for the six month periods ended June 30, 2014 and 2013. No other country or single customer generates over 10% of the Company’s total consolidated product net sales. Other medical devices product net sales represent sales made pursuant to certain transitional manufacturing and distribution service agreements with Apollo related to the sale of the Company's obesity intervention business unit. Net sales for the Europe region also include sales to customers in Africa and the Middle East, and net sales in the Asia Pacific region include sales to customers in Australia and New Zealand.

25

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

Product Net Sales by Product Line
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Specialty Pharmaceuticals:
 
 
 
 
 
 
 
Eye Care Pharmaceuticals
$
827.0

 
$
722.4

 
$
1,557.4

 
$
1,391.0

Botox®/Neuromodulators
579.4

 
513.0

 
1,081.2

 
970.9

Skin Care and Other
119.7

 
112.3

 
246.8

 
217.6

Total Specialty Pharmaceuticals
1,526.1

 
1,347.7

 
2,885.4

 
2,579.5

 
 
 
 
 
 
 
 
Medical Devices:
 
 
 
 
 

 
 

Breast Aesthetics
110.2

 
106.8

 
209.7

 
196.4

Facial Aesthetics
178.3

 
122.5

 
326.2

 
233.6

Core Medical Devices
288.5

 
229.3

 
535.9

 
430.0

Other
12.7

 

 
25.1

 

Total Medical Devices
301.2

 
229.3

 
561.0

 
430.0

 
 
 
 
 
 
 
 
Total product net sales
$
1,827.3

 
$
1,577.0

 
$
3,446.4

 
$
3,009.5

Geographic Information
 
Three Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
 
(in millions)
Product net sales:
 
 
 
 
 
 
 
United States
$
1,131.0

 
$
963.3

 
$
2,141.7

 
$
1,836.3

Europe
382.8

 
323.7

 
730.3

 
626.9

Latin America
101.1

 
100.7

 
181.5

 
181.9

Asia Pacific
134.1

 
118.5

 
248.1

 
230.9

Other
78.3

 
70.8

 
144.8

 
133.5

Total product net sales
$
1,827.3

 
$
1,577.0

 
$
3,446.4

 
$
3,009.5

 
June 30,
2014
 
December 31,
2013
 
(in millions)
Long-lived assets:
 
 
 
United States
$
4,241.0

 
$
4,274.7

Europe
618.1

 
569.9

Latin America
52.1

 
52.2

Asia Pacific
51.5

 
51.2

Other
1.3

 
1.4

Total long-lived assets
$
4,964.0

 
$
4,949.4


Note 17:  Subsequent Event
In July 2014, the Company completed a global review of its structures and processes, portfolio of research and development projects and marketed products, and its geographies in an effort to prioritize the highest value investments. As a result of this review, the Company will execute a restructuring in the remainder of 2014 in an effort to improve efficiency and productivity.

26

ALLERGAN, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The Company currently estimates that it will incur total non-recurring pre-tax charges of between $375 million and $425 million in connection with the restructuring and other costs, of which $65 million to $75 million will be a non-cash charge associated with the acceleration of previously unrecognized share-based compensation costs and certain other non-cash accounting adjustments. As part of the restructuring, the Company will reduce its workforce by approximately 1,500 employees, or approximately 13 percent of its current global headcount, and eliminate an additional approximately 250 vacant positions. The restructuring charges and other costs will primarily consist of employee severance and other one-time termination benefits, facility lease and other contract terminations, accelerated depreciation and asset write-downs, accelerated equity-based compensation, temporary labor and duplicate operating expenses. These non-recurring charges will be incurred beginning in the third quarter of 2014 and are expected to continue through the second quarter of 2015.

27


ALLERGAN, INC.
 Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
This financial review presents our operating results for the three and six month periods ended June 30, 2014 and 2013, and our financial condition at June 30, 2014. The following discussion contains forward-looking statements which are subject to known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors throughout this report and specifically under the caption “Risk Factors” in Part II, Item 1A below. The following review should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three and six month periods ended June 30, 2014 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2013 included in our 2013 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission. 
 
Critical Accounting Policies, Estimates and Assumptions
The preparation and presentation of financial statements in conformity with accounting principles generally accepted in the United States, or GAAP, requires us to establish policies and to make estimates and assumptions that affect the amounts reported in our consolidated financial statements. In our judgment, the accounting policies, estimates and assumptions described below have the greatest potential impact on our consolidated financial statements. Accounting assumptions and estimates are inherently uncertain and actual results may differ materially from our estimates.
Revenue Recognition
We recognize revenue from product sales when goods are shipped and title and risk of loss transfer to our customers. A substantial portion of our revenue is generated by the sale of specialty pharmaceutical products (primarily eye care pharmaceuticals and skin care and other products) to wholesalers within the United States, and we have a policy to attempt to maintain average U.S. wholesaler inventory levels at an amount less than eight weeks of our net sales. A portion of our revenue is generated from consigned inventory of breast implants maintained at physician, hospital and clinic locations. These customers are contractually obligated to maintain a specific level of inventory and to notify us upon the use of consigned inventory. Revenue for consigned inventory is recognized at the time we are notified by the customer that the product has been used. Notification is usually through the replenishing of the inventory, and we periodically review consignment inventories to confirm the accuracy of customer reporting.
We generally offer cash discounts to customers for the early payment of receivables. Those discounts are recorded as a reduction of revenue and accounts receivable in the same period that the related sale is recorded. The amounts reserved for cash discounts were $7.3 million and $6.3 million at June 30, 2014 and December 31, 2013, respectively. Provisions for cash discounts deducted from consolidated sales in the second quarter of 2014 and 2013 were $21.9 million and $18.7 million, respectively. Provisions for cash discounts deducted from consolidated sales in the first six months of 2014 and 2013 were $41.2 million and $36.3 million, respectively.
We permit returns of product from most product lines by any class of customer if such product is returned in a timely manner, in good condition and from normal distribution channels. Return policies in certain international markets and for certain medical device products, primarily breast implants, provide for more stringent guidelines in accordance with the terms of contractual agreements with customers. Our estimates for sales returns are based upon the historical patterns of product returns matched against sales, and management’s evaluation of specific factors that may increase the risk of product returns. The amount of allowances for sales returns recognized in our consolidated balance sheets at June 30, 2014 and December 31, 2013 were $86.3 million and $84.4 million, respectively, and are recorded in “Other accrued expenses” and “Trade receivables, net” in our consolidated balance sheets. Provisions for sales returns deducted from consolidated sales were $118.9 million and $114.7 million in the second quarter of 2014 and 2013, respectively. Provisions for sales returns deducted from consolidated sales were $228.0 million and $216.9 million in the first six months of 2014 and 2013, respectively. The increase in the provisions for sales returns in the second quarter and the first six months of 2014 compared to the second quarter and the first six months of 2013 is primarily due to increased overall product sales volume, partially offset by a decrease in estimated product sales return rates for our breast aesthetics products. Actual historical allowances for cash discounts and product returns have been consistent with the amounts reserved or accrued.
We participate in various U.S. federal and state government rebate programs, the largest of which are Medicaid, Medicare and the U.S. Department of Veterans Affairs. We also have contracts with various managed care and group purchasing organizations that provide for sales rebates and other contractual discounts. In the United States, we also incur chargebacks, which are reimbursements to wholesalers for honoring contracted prices to third parties. Outside of the United States, we incur sales allowances based on contractual provisions and legislative mandates. We also offer rebate and other incentive programs directly to our customers for our aesthetic products and certain therapeutic products, including Botox® for both therapeutic and cosmetic uses, the Juvéderm®

28


franchise, Latisse®, Natrelle®, Acuvail®, Aczone® and Restasis®, and for certain other skin care products. Sales rebates and incentive accruals reduce revenue in the same period that the related sale is recorded and are included in “Other accrued expenses” in our consolidated balance sheets. The amounts accrued for sales rebates and other incentive programs were $359.7 million and $279.3 million at June 30, 2014 and December 31, 2013, respectively.
Provisions for sales rebates and other incentive programs deducted from consolidated sales were $374.3 million in the second quarter of 2014 compared to $267.6 million in the second quarter of 2013. The $106.7 million increase in the provisions for sales rebates and other incentive programs in the second quarter of 2014 is due to a $39.6 million increase in provisions for rebates associated with U.S. federal and state government programs, a $6.5 million increase in managed health care rebates and other contractual discounts, a $22.4 million increase in chargebacks, primarily due to increases in the list prices of certain eye care pharmaceuticals products that are subject to fixed contractual prices with government agencies, an $11.9 million increase in sales allowances outside of the United States and a $26.3 million increase in provisions for consumer coupons and other customer incentives. Provisions for sales rebates and other incentive programs deducted from consolidated sales were $717.4 million in the first six months of 2014 compared to $538.9 million in the first six months of 2013. The $178.5 million increase in the provisions for sales rebates and other incentive programs in the first six months of 2014 is due to a $76.3 million increase in provisions for rebates associated with U.S. federal and state government programs, a $13.2 million increase in managed health care rebates and other contractual discounts, a $44.8 million increase in chargebacks, primarily due to increases in the list prices of certain eye care pharmaceuticals products that are subject to fixed contractual prices with government agencies, a $12.8 million increase in sales allowances outside of the United States and a $31.4 million increase in provisions for consumer coupons and other customer incentives. The increase in the provisions for sales rebates and other incentive programs in the three and six month periods ended June 30, 2014 compared to the respective periods in 2013 is primarily due to increased eye care pharmaceutical sales in the United States and a shift in U.S. patient populations to government reimbursed programs, which typically have higher rebate percentages than other managed care programs. Rebates related to the Medicare Part D coverage gap in the United States increased in the three and six month periods ended June 30, 2014 compared to the respective periods in 2013, primarily due to higher estimated utilization rates. In addition, an increase in our published list prices in the United States for pharmaceutical products, which occurred for several of our products in each of 2014 and 2013, generally results in higher provisions for sales rebates and other incentive programs deducted from consolidated sales.
Our procedures for estimating amounts accrued for sales rebates and other incentive programs at the end of any period are based on available quantitative data and are supplemented by management’s judgment with respect to many factors, including but not limited to, current market dynamics, changes in contract terms, changes in sales trends, an evaluation of current laws and regulations and product pricing. Quantitatively, we use historical sales, product utilization and rebate data and apply forecasting techniques in order to estimate our liability amounts. Qualitatively, management’s judgment is applied to these items to modify, if appropriate, the estimated liability amounts. There are inherent risks in this process. For example, customers may not achieve assumed utilization levels; customers may misreport their utilization to us; actual utilization and reimbursement rates under government rebate programs may differ from those estimated; and actual movements of the U.S. Consumer Price Index for All Urban Consumers, or CPI-U, which affect our rebate programs with U.S. federal and state government agencies, may differ from those estimated. On a quarterly basis, adjustments to our estimated liabilities for sales rebates and other incentive programs related to sales made in prior periods have not been material and have generally been less than 0.5% of consolidated product net sales. An adjustment to our estimated liabilities of 0.5% of consolidated product net sales on a quarterly basis would result in an increase or decrease to net sales and earnings before income taxes of approximately $9.0 million to $10.0 million. The sensitivity of our estimates can vary by program and type of customer. Additionally, there is a significant time lag between the date we determine the estimated liability and when we actually pay the liability. Due to this time lag, we record adjustments to our estimated liabilities over several periods, which can result in a net increase to earnings or a net decrease to earnings in those periods. Material differences may result in the amount of revenue we recognize from product sales if the actual amount of rebates and incentives differ materially from the amounts estimated by management.
We recognize license fees, royalties and reimbursement income for services provided as other revenues based on the facts and circumstances of each contractual agreement. In general, we recognize income upon the signing of a contractual agreement that grants rights to products or technology to a third party if we have no further obligation to provide products or services to the third party after entering into the contract. We recognize contingent consideration earned from the achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. We defer income under contractual agreements when we have further obligations that indicate that a separate earnings process has not been completed.
Contingent Consideration
Contingent consideration liabilities represent future amounts we may be required to pay in conjunction with various business combinations. The ultimate amount of future payments is based on specified future criteria, such as sales performance and the achievement of certain future development, regulatory and sales milestones and other contractual performance conditions. We estimate the fair value of the contingent consideration liabilities related to sales performance using the income approach, which

29


involves forecasting estimated future net cash flows and discounting the net cash flows to their present value using a risk-adjusted rate of return. We estimate the fair value of the contingent consideration liabilities related to the achievement of future development and regulatory milestones by assigning an achievement probability to each potential milestone and discounting the associated cash payment to its present value using a risk-adjusted rate of return. We estimate the fair value of the contingent consideration liabilities associated with sales milestones by employing Monte Carlo simulations to estimate the volatility and systematic relative risk of revenues subject to sales milestone payments and discounting the associated cash payment amounts to their present values using a credit-risk-adjusted interest rate. The fair value of other contractual performance conditions is measured by assigning an achievement probability to each payment and discounting the payment to its present value using our estimated cost of borrowing. We evaluate our estimates of the fair value of contingent consideration liabilities on a periodic basis. Any changes in the fair value of contingent consideration liabilities are recorded through earnings as “Selling, general and administrative” in the accompanying unaudited condensed consolidated statements of earnings. The total estimated fair value of contingent consideration liabilities was $218.8 million and $225.2 million at June 30, 2014 and December 31, 2013, respectively, and was included in “Other accrued expenses” and “Other liabilities” in our consolidated balance sheets.
Pensions
We sponsor various pension plans in the United States and abroad in accordance with local laws and regulations. Our U.S. pension plans account for a large majority of our aggregate pension plans' net periodic benefit costs and projected benefit obligations. In connection with these plans, we use certain actuarial assumptions to determine the plans' net periodic benefit costs and projected benefit obligations, the most significant of which are the expected long-term rate of return on assets and the discount rate.
Our assumption for the weighted average expected long-term rate of return on assets in our U.S. funded pension plan for determining the net periodic benefit cost is 6.25% for 2014 and 2013. Our assumptions for the weighted average expected long-term rate of return on assets in our non-U.S. funded pension plans are 4.56% and 4.36% for 2014 and 2013, respectively. For our U.S. funded pension plan, we determine, based upon recommendations from our pension plan's investment advisors, the expected rate of return using a building block approach that considers diversification and rebalancing for a long-term portfolio of invested assets. Our investment advisors study historical market returns and preserve long-term historical relationships between equities and fixed income in a manner consistent with the widely-accepted capital market principle that assets with higher volatility generate a greater return over the long run. They also evaluate market factors such as inflation and interest rates before long-term capital market assumptions are determined. For our non-U.S. funded pension plans, the expected rate of return was determined based on asset distribution and assumed long-term rates of return on fixed income instruments and equities. Market conditions and other factors can vary over time and could significantly affect our estimates of the weighted average expected long-term rate of return on plan assets. The expected rate of return is applied to the market-related value of plan assets. As a sensitivity measure, the effect of a 0.25% decline in our rate of return on assets assumptions for our U.S. and non-U.S. funded pension plans would increase our expected 2014 pre-tax pension benefit cost by approximately $2.3 million.
The weighted average discount rates used to calculate our U.S. and non-U.S. pension benefit obligations at December 31, 2013 were 5.05% and 4.19%, respectively. The weighted average discount rates used to calculate our U.S. and non-U.S. net periodic benefit costs for 2014 were 5.05% and 4.19%, respectively, and for 2013, 4.23% and 4.55%, respectively. We determine the discount rate based upon a hypothetical portfolio of high quality fixed income investments with maturities that mirror the pension benefit obligations at the plans' measurement date. Market conditions and other factors can vary over time and could significantly affect our estimates for the discount rates used to calculate our pension benefit obligations and net periodic benefit costs for future years. As a sensitivity measure, the effect of a 0.25% decline in the discount rate assumption for our U.S. and non-U.S. pension plans would increase our expected 2014 pre-tax pension benefit costs by approximately $5.3 million and increase our pension plans' projected benefit obligations at December 31, 2013 by approximately $52.7 million.
Share-Based Compensation
We recognize compensation expense for all share-based awards made to employees and directors. The fair value of share-based awards is estimated at the grant date and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.
The fair value of stock option awards that vest based on a service condition is estimated using the Black-Scholes option-pricing model. The fair value of share-based awards that contain a market condition is generally estimated using a Monte Carlo simulation model, and the fair value of modifications to share-based awards is generally estimated using a lattice model.
The determination of fair value using the Black-Scholes, Monte Carlo simulation and lattice models is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors. We currently estimate stock price volatility based upon an equal weighting of the historical average over the expected life of the award and the average implied

30


volatility of at-the-money options traded in the open market. We estimate employee stock option exercise behavior based on actual historical exercise activity and assumptions regarding future exercise activity of unexercised, outstanding options.
Share-based compensation expense is recognized only for those awards that are ultimately expected to vest, and we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs. Compensation expense for share-based awards based on a service condition is recognized using the straight-line single option method.
Product Liability Self-Insurance
We are largely self-insured for future product liability losses related to all of our products. We have historically been and continue to be self-insured for any product liability losses related to our breast implant products. Future product liability losses are, by their nature, uncertain and are based upon complex judgments and probabilities. The factors to consider in developing product liability reserves include the merits and jurisdiction of each claim, the nature and the number of other similar current and past claims, the nature of the product use and the likelihood of settlement. In addition, we accrue for certain potential product liability losses estimated to be incurred, but not reported, to the extent they can be reasonably estimated. We estimate these accruals for potential losses based primarily on historical claims experience and data regarding product usage. The total value of self-insured product liability claims settled in the second quarter and the first six months of 2014 and 2013, respectively, and the value of known and reasonably estimable incurred but unreported self-insured product liability claims pending as of June 30, 2014 are not expected to have a material effect on our results of operations or liquidity.
Income Taxes
The provision for income taxes is determined using an estimated annual effective tax rate, which is generally less than the U.S. federal statutory rate, primarily because of lower tax rates in certain non-U.S. jurisdictions, research and development, or R&D, tax credits available in California and other foreign jurisdictions and deductions available in the United States for domestic production activities. We currently expect the U.S. R&D tax credit to be renewed in the fourth quarter of 2014, with retroactive effect to January 1, 2014; however, until appropriate legislation is enacted in the United States to renew the R&D tax credit, our estimated annual effective tax rate for fiscal year 2014 must exclude any potential benefit for this credit. Our effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as the mix of pre-tax earnings in the various tax jurisdictions in which we operate, valuation allowances against deferred tax assets, the recognition or derecognition of tax benefits related to uncertain tax positions, expected utilization of R&D tax credits and acquired net operating losses and changes in or the interpretation of tax laws in jurisdictions where we conduct business. We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along with net operating loss and tax credit carryovers.
We record a valuation allowance against our deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. When we establish or reduce the valuation allowance against our deferred tax assets, our provision for income taxes will increase or decrease, respectively, in the period such determination is made. The valuation allowance against deferred tax assets was $48.9 million at June 30, 2014 and December 31, 2013.
We have not provided for withholding and U.S. taxes for the unremitted earnings of certain non-U.S. subsidiaries because we have currently reinvested these earnings indefinitely in these foreign operations. At December 31, 2013, we had approximately $3,828.0 million in unremitted earnings outside the United States for which withholding and U.S. taxes were not provided. Income tax expense would be incurred if these earnings were remitted to the United States. It is not practicable to estimate the amount of the deferred tax liability on such unremitted earnings. Upon remittance, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against our U.S. tax liability, if any. We annually update our estimate of unremitted earnings outside the United States after the completion of each fiscal year.
Acquisitions
The accounting for acquisitions requires extensive use of estimates and judgments to measure the fair value of the identifiable tangible and intangible assets acquired, including in-process research and development, and liabilities assumed. Additionally, we must determine whether an acquired entity is considered to be a business or a set of net assets, because the excess of the purchase price over the fair value of net assets acquired can only be recognized as goodwill in a business combination.
On March 1, 2013, we acquired MAP Pharmaceuticals, Inc., or MAP, for an aggregate purchase price of approximately $871.7 million, net of cash acquired. On April 12, 2013, we acquired Exemplar Pharma, LLC, or Exemplar, for an aggregate purchase price of approximately $16.1 million, net of cash acquired. We accounted for these acquisitions as business combinations.  In March 2014, we completed the acquisition of certain assets related to technology under development for use as a dermal filler

31


from Aline Aesthetics, LLC and Tautona Group, L.P. for an upfront payment of $10.0 million and potential future payments for certain milestone events. We accounted for this acquisition as a purchase of net assets. The tangible and intangible assets acquired and liabilities assumed in connection with these acquisitions were recognized based on their estimated fair values at the acquisition dates. The determination of estimated fair values requires significant estimates and assumptions including, but not limited to, determining the timing and estimated costs to complete the in-process projects, projecting regulatory approvals, estimating future cash flows and developing appropriate discount rates. We believe the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions.
Impairment Evaluations for Goodwill and Intangible Assets
We evaluate goodwill for impairment on an annual basis, or more frequently if we believe indicators of impairment exist. We have identified two reporting units, specialty pharmaceuticals and medical devices, and perform our annual evaluation as of October 1 each year.
For our specialty pharmaceuticals reporting unit, we performed a qualitative assessment to determine whether it is more likely than not that its fair value is less than its carrying amount. For our medical devices reporting unit, we evaluated goodwill for impairment by comparing its carrying value to its estimated fair value. We primarily use the income approach and the market approach that include the discounted cash flow method, the guideline company method, as well as other generally accepted valuation methodologies to determine the fair value. Upon completion of the October 2013 annual impairment assessment, we determined that no impairment was indicated.
As of June 30, 2014, we are not aware of any significant indicators of impairment that exist for our goodwill that would require additional analysis.
We also review intangible assets for impairment when events or changes in circumstances indicate that the carrying value of our intangible assets may not be recove