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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

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

OR

 

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

For the fiscal year ended March 31, 2013

OR

 

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

For the transition period from                  to                 

OR

 

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

Date of event requiring this shell company report                         

Commission file number 001-35463

 

 

TARO PHARMACEUTICAL INDUSTRIES LTD.

(Exact name of Registrant as specified in its charter)

 

 

N/A

(Translation of Registrant’s name into English)

Israel

(Jurisdiction of incorporation or organization)

14 Hakitor Street, Haifa Bay 26110, Israel

(Address of principal executive offices)

Michael Kalb

Interim Chief Financial Officer

Taro Pharmaceutical Industries Ltd.

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

3 Skyline Drive

Hawthorne, NY 10532

Tel: 914-345-9000

Fax: 914-345-6169

Email: Michael.Kalb@taro.com

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

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

None

(Title of Class)

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

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

(Title of Class)

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

None

(Title of Class)

 

 

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

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

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

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

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

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

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

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

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

 

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

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

 

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

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

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

 

 

 


Table of Contents

INTRODUCTION

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

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

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

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

FORWARD-LOOKING STATEMENTS

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

PRESENTATION OF FINANCIAL INFORMATION

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

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

 

 

(1)  

As published by The Bank of Israel.

(2)  

As published by The Bank of Canada.

 

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TABLE OF CONTENTS

 

PART I

     1   

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     1   

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     1   

ITEM 3. KEY INFORMATION

     1   

A. SELECTED FINANCIAL DATA

     1   

B. CAPITALIZATION AND INDEBTEDNESS

     2   

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

     2   

D. RISK FACTORS

     2   

ITEM 4. INFORMATION ON THE COMPANY

     19   

A. HISTORY AND DEVELOPMENT OF THE COMPANY

     19   

B. BUSINESS OVERVIEW

     19   

C. ORGANIZATIONAL STRUCTURE

     28   

D. PROPERTY, PLANT AND EQUIPMENT

     29   

ITEM 4A. UNRESOLVED STAFF COMMENTS

     30   

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     31   

A. OPERATING RESULTS

     31   

B. LIQUIDITY AND CAPITAL RESOURCES

     41   

C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES

     42   

D. TREND INFORMATION

     44   

E. OFF-BALANCE SHEET ARRANGEMENTS

     44   

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

     44   

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     45   

A. DIRECTORS AND SENIOR MANAGEMENT

     45   

B. COMPENSATION

     47   

C. BOARD PRACTICES

     48   

D. EMPLOYEES

     53   

E. SHARE OWNERSHIP

     54   

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     58   

A. MAJOR SHAREHOLDERS

     58   

B. RELATED PARTY TRANSACTIONS

     58   

C. INTERESTS OF EXPERTS AND COUNSEL

     59   

ITEM 8. FINANCIAL INFORMATION

     59   

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

     59   

ITEM 9. THE OFFER AND LISTING

     60   

A. OFFER AND LISTING DETAILS

     60   

B. PLAN OF DISTRIBUTION

     61   

C. MARKETS

     61   

D. SELLING SHAREHOLDERS

     62   

E. DILUTION

     62   

F. EXPENSES OF THE ISSUE

     62   

ITEM 10. ADDITIONAL INFORMATION

     62   

A. SHARE CAPITAL

     62   

B. ISRAELI COMPANIES LAW AND OUR DOCUMENTS OF INCORPORATION

     62   

C. MATERIAL CONTRACTS

     68   

D. EXCHANGE CONTROLS

     68   

E. TAXATION

     68   

F. DIVIDENDS AND PAYING AGENTS

     78   

G. STATEMENT BY EXPERTS

     78   

H. DOCUMENTS ON DISPLAY

     78   

I. SUBSIDIARY INFORMATION

     79   

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     79   

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     80   

 

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PART II

     80   

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     80   

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

     80   

ITEM 15. CONTROLS AND PROCEDURES

     80   

ITEM 16. [RESERVED]

     81   

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     81   

ITEM 16B. CODE OF ETHICS

     81   

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     81   

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

     82   

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

     82   

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

     82   

ITEM 16G. CORPORATE GOVERNANCE

     82   

ITEM 16H. MINE SAFETY DISCLOSURE

     85   

PART III

     85   

ITEM 17. FINANCIAL STATEMENTS

     85   

ITEM 18. FINANCIAL STATEMENTS

     85   

ITEM 19. EXHIBITS

     86   

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

A. SELECTED FINANCIAL DATA

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

 

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

Consolidated Statements of Operations Data:

    

Sales, net

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

Cost of sales

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Research and development, net

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

Selling, marketing, general and administrative

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

Settlements and loss contingencies

     33,300        —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

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

Financial (income) expenses, net

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

Other gain (loss), net

     3,352        (94     609        755        548        469   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

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

Tax expense (benefit)

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

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

Net (loss) income from discontinued operations

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

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

Net income attributable to non-controlling interest

     664        151        598        473        2,728        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income from continuing operations attributable to Taro

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

Net (loss) income from discontinued operations attributable to Taro

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

            

Basic

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

            

Basic

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income per ordinary share attributable to Taro:

            

Basic

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

            

Basic

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Amount is less than $0.01

 

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

Consolidated Balance Sheet Data:

                 

Working capital (deficiency)

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

Property, plant and equipment, net

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

Total assets

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

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

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

Long-term debt, net of current maturities

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

Shareholders’ equity

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

Dividends

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

B. CAPITALIZATION AND INDEBTEDNESS

Not applicable.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not applicable.

D. RISK FACTORS

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

Risks Relating to Our Industry

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

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

 

   

generic manufacturers of our brand-name drugs;

 

   

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

 

   

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

 

   

other generic drug manufacturers; and

 

   

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

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

 

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

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

 

   

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

 

   

developing patented controlled-release products or other product improvements;

 

   

developing and marketing branded products as OTC products;

 

   

pursuing pediatric exclusivity for brand-name products;

 

   

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

 

   

attaching special patent extension amendments to unrelated federal legislation;

 

   

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

 

   

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

 

   

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

 

   

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

 

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

Risks Relating to Regulatory Matters

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

 

   

trends in managed healthcare in the United States;

 

   

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

 

   

legislative proposals to reform healthcare and government insurance programs; and

 

   

price controls and reimbursement policies.

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

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

 

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

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

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

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

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

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

Product recalls could harm our business.

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

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

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

 

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

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

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

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

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

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

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

Risks Relating to Our Company and Our Operations

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

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

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

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

 

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

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

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

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

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

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

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

 

   

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

 

   

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

 

   

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

   

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

 

   

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

 

   

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

 

   

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

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

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

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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Our tax liabilities could be larger than anticipated.

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

Risks Relating to Our Intellectual Property

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

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

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

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

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

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

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

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

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

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

 

   

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

 

   

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

 

   

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

Risks Relating to Our Compliance with Sarbanes-Oxley

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

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

 

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

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

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

Risks Relating to Investment in Our Ordinary Shares

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

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

 

   

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

 

   

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

 

   

market conditions or trends in the pharmaceutical industry;

 

   

developments or disputes concerning proprietary rights;

 

   

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

 

   

general economic and political conditions;

 

   

departures of key personnel;

 

   

changes in the market valuations of our competitors;

 

   

regulatory considerations; and

 

   

the other risk factors listed in this section.

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

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

 

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Risks Relating to Our International Operations

We face risks related to foreign currency exchange rates.

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

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

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

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

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

Risks Relating to Key Employees

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

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

Risks Relating to Our Location in Israel

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

Risks Relating to Our Location in Canada

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

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

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

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

 

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

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

 

ITEM 4. INFORMATION ON THE COMPANY

A. HISTORY AND DEVELOPMENT OF THE COMPANY

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

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

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

Capital Expenditures

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

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

 

   

the acquisition of additional production and packaging equipment;

 

   

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

 

   

the upgrade of our information technology systems.

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

B. BUSINESS OVERVIEW

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

 

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

 

Entity

 

Principal Activities

 

Primary Product Lines

Taro Israel

 

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

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

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

•      Performs research and development

 

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

 

•      Cardiology and Neurology: Prescription oral dosage products

 

•      Oral analgesics, prescription and OTC

 

•      OTC oral and nasal sprays and ophthalmic products

Taro Canada

 

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

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

•      Performs research and development

 

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

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

•      Allergy (Antihistamine): OTC oral dosage products

Taro U.S.A.

 

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

•      Performs research and development

 

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

•      Cardiology and Neurology: Prescription oral dosage products

•      Other prescription and OTC products

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

 

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The Generic Pharmaceutical Industry

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

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

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

 

   

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

 

   

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

 

   

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

 

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Products

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

 

Generic Name

  

Dosage Form

  

Brand

Name (1)

  

Therapeutic
Category

  

Major

Markets

  

Rx/OTC

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

Lotrimin ®

Gyne-Lotrimin ®

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

 

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(1)  

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

(2)  

Taro brands.

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

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

Sales and Marketing

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

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

 

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

U.S.A.

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

Canada

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

Israel

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

Other

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

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

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

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

 

Customer

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

Customer A

     20.8     24.1     18.9     15.9

Customer B

     14.0     12.7     12.4     11.0

Customer C

     12.2     11.9     11.8     10.5

 

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

 

Customer Type

   Percentage of
Consolidated  Sales
 

Drug wholesalers and store chains

     45

Generic drug distributors

     25

Mass merchandisers, food and retail chains

     11

Managed care organizations

     5

Other

     2

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

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

 

Customer Type

   Percentage of
Consolidated Sales
 

Drug wholesalers

     6

Drug chains, independent pharmacies and others

     2

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

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

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

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

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

 

Customer Type

   Percentage of
Consolidated  Sales
 

Institutional

     1

Private

     2

Other international

     1

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

 

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Competition and Pricing

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

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

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

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

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

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

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

Manufacturing and Raw Materials

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

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

 

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

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

Industry Practices Relating to Working Capital Items

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

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

Government Regulation

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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

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

Environmental Compliance

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

C. ORGANIZATIONAL STRUCTURE

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

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

 

Name of Subsidiary

  

Country of Incorporation

Taro Pharmaceuticals U.S.A., Inc.

   United States

Taro Pharmaceuticals Inc.

   Canada

Taro Pharmaceuticals North America, Inc.

   Cayman Islands

Taro Pharmaceuticals Europe B.V.

   Netherlands

Taro International Ltd.

   Israel

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

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

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

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

 

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D. PROPERTY, PLANT AND EQUIPMENT

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

 

Location

   Square
Footage
    

Main Use

  

Own/Lease

Haifa Bay, Israel 1

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

Long-term Lease

Own

Lease

Use permit

Yakum, Israel

     15,000      Administrative offices    Lease

Brampton, Canada

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

Brampton, Canada

     75,400      Administration and warehousing    Lease

Hawthorne, New York

     124,000      Administrative offices    Own

South Brunswick, New Jersey

     315,000      Distribution facility    Own

Roscrea, Ireland 2

     124,000      Pharmaceutical manufacturing, research laboratories and warehousing    Own

 

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A. OPERATING RESULTS

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

OVERVIEW

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

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

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

 

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

U.S.A.

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

Canada

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

Israel

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

Other

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

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

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

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

 

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

Customer

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

Customer A

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

Customer B

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

Customer C

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

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

 

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

 

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

Product

   2013     2012      2011      2010  

Nystatin/Triamcinolone

     14.1     *         *         *   

Desoximetasone

     *        *         *         12.7

Warfarin

     *        *         *         12.2

 

* Less than 10%

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

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

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

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

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

CRITICAL ACCOUNTING POLICIES

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

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

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

 

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

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

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

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

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

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

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

 

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

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

Three-year summary

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

 

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

Accounts Receivable Reserves

  

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

 

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

Accounts Receivable Reserves

  

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

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

Accounts Receivable Reserves

  

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

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

Accounts Receivable Reserves

         

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Others (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) Includes indirect rebates and others.

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

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

 

   

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

 

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

 

   

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

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

 

   

The timing and amount of forecasted cash flows

 

   

Discount rates

 

   

Tax rates

 

   

Regulatory actions

 

   

Amount of competition

 

   

Manufacturing efficiencies

 

   

The number and size of our customers

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

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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RESULTS OF OPERATIONS

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

 

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

Consolidated Statements of Operations

            

Sales, net

     100.0     100.0     100.0     100.0     100.0     100.0

Cost of sales

     26.3     32.7     31.7     41.4     34.8     40.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     73.7     67.3     68.3     58.6     65.2     59.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:  

            

Research and development, net

     6.9     6.2     6.8     6.7     6.1     9.3

Selling, marketing, general and administrative

     12.9     17.4     15.9     20.9     18.6     27.5

Settlements and loss contingencies

     4.9     0.0     0.0     0.0     0.0     0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     24.7     23.6     22.7     27.6     24.7     36.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     49.0     43.7     45.6     31.0     40.5     22.7

Financial (income) expenses, net

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

Other gain (loss), net

     0.5     *        (0.1 %)      0.2     0.1     0.2

Income before income taxes

     50.1     44.5     44.9     30.1     41.4     19.9

Tax expense

     10.1     6.6     12.3     5.9     4.9     2.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     40.0     37.9     32.6     24.2     36.5     17.2

Net (loss) income from discontinued operations

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     39.8     37.7     32.7     24.1     36.2     16.4

Net income attributable to non-controlling interest

     0.1     0.1     0.1     0.3     0.1     0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

     39.7     37.6     32.6     23.8     36.1     16.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Less than 0.05%

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

 

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

Period ended

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

12/31/2008

     3.80     2.33     (1.14 %)      23.93     3.80         1.22   

12/31/2009

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

12/31/2010

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

12/31/2011

     2.17     2.30     7.66     2.25     3.82         1.02   

3/31/2012

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

3/31/2013

     1.27     0.99     (1.80 %)      1.65     3.65         1.02   

 

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

B. LIQUIDITY AND CAPITAL RESOURCES

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

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

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

 

   

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

 

   

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

 

   

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

 

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Debt

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

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

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

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

 

   

bonds of $21.0 million with various investors; and

 

   

a mortgage of $7.6 million.

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

 

         Amount              Linkage           Rate             Maturity      

Bonds 11/2003 NIS

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

Bonds 11/2003 USD

     842       Dollar     6.10     Nov. 2014   
  

 

 

        

Total

   $ 21,047          
  

 

 

        

 

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

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

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

Liquidity

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

Capital Expenditures

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

C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES

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

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

 

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We currently conduct research and development in three principal areas:

 

   

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

 

   

proprietary pharmaceuticals and delivery systems; and

 

   

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

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

Pharmaceutical Products

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

 

FINAL ANDA APPROVALS
     Brand Name*

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

  

Lexapro ®

Clobetasol Propionate Lotion, 0.05%

  

Clobex ®

TENTATIVE ANDA APPROVALS

 

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

  

Neurontin ®

Gabapentin Oral Solution, 250 mg/5 mL **

  

Neurontin ®

Fluocinonide Cream USP, 0.1%

  

Vanos ®

 

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

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

Patents, Trademarks and Licenses

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

 

   

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

 

   

novel oral delivery for pharmaceutical and related products; and

 

   

the synthesis and formulation of certain products.

 

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

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

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

D. TREND INFORMATION

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

E. OFF-BALANCE SHEET ARRANGEMENTS

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

F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

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

 

Type of Contractual Obligation

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

Long-term debt obligations

   $ 28.60       $ 11.33       $ 12.29       $ 2.00       $ 2.98   

Operating lease obligations

     4.34         2.07         2.27         —           —     

Other Long-term liabilities (1)

     5.88         1.11         1.94         1.50         1.33   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 38.82       $ 14.51       $ 16.50       $ 3.50       $ 4.31   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes severance commitments and tax accruals.

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. DIRECTORS AND SENIOR MANAGEMENT

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

 

Name

  

Age

    

Position

Kal Sundaram

     59       Director and Chairman of the Board

Aalok Shanghvi

     29       Director

Sudhir Valia

     57       Director

Ilana Avidov-Mor

     61       Director

Dan Biran

     70       Director and Chairman of the Audit Committee

Dov Pekelman

     73       Director and Chairman of the Special Committee

James Kedrowski

     61       Director and Interim Chief Executive Officer

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

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

Stephen Manzano, Esq.

     48       Interim General Counsel and Vice President of Corporate Compliance

Avi Avramoff, Ph.D.

     48       Global Vice President, Research and Development

Rami Zajicek, Esq.

     49       Group Vice President, Haifa Site Manager

Michael Teiler

     50       Group Vice President, Portfolio Management

Sunil Mehta

     53       Group Vice President, General Manager, Canada

Mariana Bacalu

     61       Group Vice President, Quality Affairs

Michael Perfetto

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

Brant Schofield

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

Michele Visosky

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

Jayesh Shah

     57       Head of Procurement, U.S.A.

Certain Familial Relationships

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

Business Experience

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

B. COMPENSATION

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

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

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

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

 

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C. BOARD PRACTICES

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

Board of Directors

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

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

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

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

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

Statutory External Directors

Qualifications of Statutory External Directors

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

 

   

our company;

 

   

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

 

   

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

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

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

 

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

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

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

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

Election of Statutory External Directors

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

 

   

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

 

   

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

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

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

 

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

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

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

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

Qualifications of Directors Generally Under the Israeli Companies Law

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

Unaffiliated Directors Under the Israeli Companies Law

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

 

   

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

 

   

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

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

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

Alternate Directors

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

 

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Committees

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

Audit Committee

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

 

   

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

 

   

a controlling shareholder or a relative of a controlling shareholder.

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

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

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

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

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

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

 

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Approval of Interested Party Transactions

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

Internal Auditor

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

Stock Option Committee

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

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

Compensation Committee

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

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

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

 

   

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

 

   

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

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

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

 

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

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

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

Special Committee

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

D. EMPLOYEES

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

 

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

Sales and Marketing

     115.0         34.0         35.0         —           184.0   

Administration

     61.0         30.0         46.5         —           137.5   

Research and Development

     14.0         47.0         71.0         —           132.0   

Production and Quality Control

     —           310.0         530.5         —           840.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     190.0         421.0         683.0         —           1,294.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

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

Sales and Marketing

     110.0         35.0         38.0         —           183.0   

Administration

     62.0         31.0         49.5         1.0         143.5   

Research and Development

     12.0         42.0         69.0         —           123.0   

Production and Quality Control

     —           292.0         537.5         —           829.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     184.0         400.0         694.0         1.0         1,279.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

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

Sales and Marketing

     134.0         31.0         41.0         —           206.0   

Administration

     63.0         30.0         50.5         1.0         144.5   

Research and Development

     12.0         40.0         84.0         —           136.0   

Production and Quality Control

     —           278.0         508.5         —           786.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     209.0         379.0         684.0         1.0         1,273.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

 

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

Sales and Marketing

     127.0         36.0         41.0         1.0         205.0   

Administration

     71.0         31.0         48.5         2.0         152.5   

Research and Development

     13.0         40.0         116.0         1.0         170.0   

Production and Quality Control

     —           244.0         442.5         —           686.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     211.0         351.0         648.0         4.0         1,214.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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

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

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

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

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

E. SHARE OWNERSHIP

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

 

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Name

   Number of
Ordinary Shares
     Percentage of
Outstanding Ordinary
Shares
 

Kal Sundaram (1)

     —           0.00

Aalok Shanghvi

     —           0.00

Sudhir Valia

     —           0.00

Ilana Avidov-Mor

     —           0.00

Dan Biran

     —           0.00

Dov Pekelman

     —           0.00

James Kedrowski

     —           0.00

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

     —           0.00

Stephen Manzano, Esq.

     —           0.00

Avi Avramoff, Ph.D.

     —           0.00

Rami Zajicek, Esq.

     *         *   

Michael Teiler

     —           0.00

Mariana Bacalu

     *         *   

Michael Perfetto

     —           0.00

Brant Schofield

     —           0.00

Michele Visosky

     *         *   

Jayesh Shah

     —           0.00

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

     *         *   

 

* Less than 1%

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

 

Name

   Number of
Founders’
Shares
     Percentage of
Outstanding Founders’
Shares
 

Alkaloida (1)

     2,600         100.00

 

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

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

Stock Option Plans

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

 

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Compensation Pursuant to Plans

1991 Stock Incentive Plan

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

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

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

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

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

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

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

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

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

 

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1999 Stock Incentive Plan

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

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

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

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

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

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

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

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

 

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

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

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. MAJOR SHAREHOLDERS

Ordinary Shares

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

 

Name

   Ordinary Shares
Beneficially Owned
     Percent of Ordinary
Shares Outstanding
 

Sun (1)

     29,479,933         65.9

 

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

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

 

Name

   Change in
Percentage Ownership

Sun

   0.0% Increase

Founders’ Shares

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

Voting Power

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

B. RELATED PARTY TRANSACTIONS

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

 

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

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

C. INTERESTS OF EXPERTS AND COUNSEL

Not applicable.

 

ITEM 8. FINANCIAL INFORMATION

A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

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

Other Financial Information

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

Legal Proceedings

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

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

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

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

 

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

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

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

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

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

Dividend Policy

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

B. SIGNIFICANT CHANGES

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

 

ITEM 9. THE OFFER AND LISTING

A. OFFER AND LISTING DETAILS

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

 

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         High              Low      

12/31/2008

   $  10.80       $ 7.25   

12/31/2009

   $ 9.94       $ 8.10   

12/31/2010

   $ 14.50       $ 9.30   

12/31/2011

   $ 29.50       $  14.10   

3/31/2013

   $ 59.31       $ 35.55   

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

 

         High              Low      

First Quarter 2011

   $ 14.78       $ 14.10   

Second Quarter 2011

   $ 20.88       $ 14.23   

Third Quarter 2011

   $ 22.00       $ 18.25   

Fourth Quarter 2011

   $ 29.50       $ 19.35   

March 2012

   $ 39.60       $ 29.10   

First Quarter Mar 2013

   $ 48.17       $ 35.55   

Second Quarter Mar 2013

   $ 46.70       $ 35.69   

Third Quarter Mar 2013

   $ 48.91       $ 45.32   

Fourth Quarter Mar 2013

   $ 59.31       $ 46.05   

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

 

         High              Low      

Oct-12

   $ 46.40       $ 45.40   

Nov-12

   $ 46.96       $ 45.81   

Dec-12

   $ 48.91       $ 45.32   

Jan-13

   $ 49.68       $ 46.05   

Feb-13

   $ 57.04       $ 48.49   

Mar-13

   $ 59.31       $ 56.84   

B. PLAN OF DISTRIBUTION

Not applicable.

C. MARKETS

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

 

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D. SELLING SHAREHOLDERS

Not applicable.

E. DILUTION

Not applicable.

F. EXPENSES OF THE ISSUE

Not applicable.

 

ITEM 10. ADDITIONAL INFORMATION

A. SHARE CAPITAL

Not applicable.

B. ISRAELI COMPANIES LAW AND OUR DOCUMENTS OF INCORPORATION

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

Objects and Purposes

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

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

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

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

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

Fiduciary Duties of Office Holders

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

 

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

Compensation of Office Holders

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

Disclosure of Personal Interest of an Office Holder

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

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

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

 

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Disclosure of Personal Interests of a Controlling Shareholder

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

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

 

   

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

 

   

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

Director Qualifications

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

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

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

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

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

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

 

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Shareholder Meetings

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

Restriction on Voting

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

Duties of Shareholders

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

 

   

any amendment to the articles of association;

 

   

an increase of the authorized share capital;

 

   

a merger; or

 

   

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

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

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

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

Transfer of Shares

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

 

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Mergers and Acquisitions under Israeli Law

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

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

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

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

Finally, Israeli tax law may treat stock-for-stock acquisitions between an Israeli company and a foreign company less favorably than does United States tax law. For example, unless the stock-for-stock transaction is considered a tax-deferred merger which relates to a transfer of at least 80% of the shares in the transferred company, Israeli tax law subjects a shareholder who exchanges his ordinary shares for shares in another corporation (which is listed for trading on a stock exchange) to taxation on half the shareholder’s shares two years following the exchange and on the balance four years thereafter even if the shareholder has not yet sold the new shares.

 

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Indemnification and Insurance of Office Holders

Insurance of Office Holders

Subject to the provisions of the Israeli Companies Law, our Articles of Association provide that we may enter into an insurance contract that would provide coverage in respect of liability imposed on any of our office holders with respect to an act performed in the capacity of an office holder for:

 

   

a breach of the office holder’s duty of care to the company or to another person;

 

   

a breach of the office holder’s duty of loyalty to the company, provided that the office holder acted in good faith and had reasonable cause to assume that his or her act would not prejudice the good of the company; or

 

   

a financial liability imposed upon him or her in favor of another person.

We have obtained liability insurance covering our officers and directors.

Indemnification of Office Holders

Subject to the provisions of the Israeli Companies Law, our Articles of Association provide that we may indemnify any of our office holders, in advance and retroactively, against the following liabilities imposed or expenses incurred on the office holder with respect to an act performed in the capacity of an office holder:

 

   

a monetary obligation imposed on him or her in favor of another person by a court judgment, including a compromise judgment or an arbitrator’s award approved by the court;

 

   

reasonable litigation expenses, including attorneys’ fees, expended by the office holder due to an investigation or a proceeding instituted against him or her by an authority competent to administer such an investigation or proceeding that was either finalized without the filing of an indictment (as defined in the Israeli Companies Law) against him or her and “without any monetary obligation imposed in lieu of criminal proceedings” (as defined in the Israeli Companies Law) or finalized “without the filing of an indictment” against him or her with a “monetary obligation imposed in lieu of criminal proceedings” relating to an offense that does not require proof of criminal intent; and

 

   

reasonable litigation expenses, including attorneys’ fees, expended by the office holder or charged to him or her by a court in connection with proceedings we institute against him or her or that are instituted on our behalf or by another person or a criminal charge from which he or she is acquitted, or a criminal charge in which he or she is convicted of an offense that does not require proof of criminal intent.

Under the Israeli Companies Law, indemnification in advance in respect to monetary liabilities to third parties are limited to those events which, in the opinion of the board of directors, are to be expected in light of the company’s actual activities when the indemnification is granted and to a sum or a standard which the board of directors determines that are reasonable in the circumstances.

Exemption of Office Holders

The Israeli Companies Law provides that a company may exempt an office holder in advance from liability for damages flowing from breach of his duty of care to the company.

Limitations on Exemption, Insurance and Indemnification

The Israeli Companies Law provides that a company may not exempt or indemnify an office holder for, or enter into an insurance contract that would provide coverage for any monetary liability incurred as a result of, any of the following:

 

   

a breach by the office holder of his or her duty of loyalty unless, with respect to indemnification and insurance coverage, the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the good of the company;

 

   

a breach by the office holder of his or her duty of care which was committed intentionally or recklessly, except when it was committed solely by negligence;

 

   

any act or omission done with the intent to derive an illegal personal benefit; or

 

   

any fine or forfeiture imposed against the office holder.

 

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In addition, under the Israeli Companies Law, exemption, indemnification, and procurement of insurance coverage (except where the companies regulations provide for certain easements from such requirements with respect to insurance) for office holders must be approved by the compensation committee and board of directors of a company and, if the beneficiary is a director (as well as to controlling shareholders and their relatives), by the shareholders, in that order.

Prior to Amendment 20 becoming effective and following approval by the Audit Committee and Board of Directors and, in the case of directors, shareholders, we entered into exemption and indemnification agreements with our directors and certain officers.

C. MATERIAL CONTRACTS

During the two years preceding the date of this 2013 Annual Report, neither we nor any of our affiliates and subsidiaries entered into any material contracts, other than contracts entered into in the ordinary course of business.

D. EXCHANGE CONTROLS

Israeli law and regulations do not impose any material foreign exchange restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new general permit was issued under the Israeli Currency Control Law, 1978, which removed most of the restrictions that previously existed under the law, and enabled Israeli citizens to freely invest outside of Israel and freely convert Israeli currency into non-Israeli currencies.

Dividends, if any, paid to our ordinary shareholders, and any amounts payable upon our dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of our ordinary shares to an Israeli resident, may be paid in non-Israeli currency or, if paid in Israeli currency, may be converted into freely repatriable dollars at the rate of exchange prevailing at the time of conversion.

E. TAXATION

General

The following is a summary of the current tax structure applicable to companies in Israel with reference to its effect on us. The following also contains a discussion of material Israeli and United States tax consequences to our shareholders and Israeli government programs benefiting us. We cannot assure you that the tax authorities will accept the views expressed in the discussion in question. The discussion is not intended, and should not be construed, as legal or professional tax advice and is not exhaustive of all possible tax considerations. Holders of our ordinary shares should consult their own tax advisors as to the United States, Israeli or other tax consequences of the purchase, ownership and disposition of ordinary shares, including, in particular, the effect of any foreign, state or local taxes.

Israeli Tax Considerations and Government Programs

General Corporate Tax Structure

Generally, in 2012, Israeli companies are subject to corporate tax at the rate of 25% on their taxable income. However, the effective tax rate payable by a company that derives income from an Approved Enterprise, a Benefited Enterprise or a Preferred Enterprise, as discussed below, may be considerably less. Beginning as of 2010, Israeli companies are subject to regular corporate tax rate for their capital gain.

Tax Benefits under the Law for the Encouragement of Capital Investments, 1959

The Law for the Encouragement of Capital Investments, 5719-1959 (the “Investment Law”), provides certain incentives for capital investments in production facilities (or other eligible assets). Generally, an investment program that is implemented in accordance with the provisions of the Investment Law, referred to as an Approved Enterprise, a Benefited Enterprise or a Preferred Enterprise, is entitled to benefits as discussed below. These benefits may include cash grants from the Israeli government and tax benefits, based upon, among other things, the location of the facility in which the investment is made or the election of the grantee. In order to qualify for these incentives, an Approved Enterprise, a Benefited Enterprise or a Preferred Enterprise is required to comply with the requirements of the Investment Law. Various production and development facilities of our companies in Israel, have been granted “Approved Enterprise” and “Benefited Enterprise” status, which provides certain benefits, including tax exemptions and reduced tax rates for a defined period.

 

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The Investment Law was significantly amended on April 1, 2005 (the “2005 Amendment”) and as of January 1, 2011 (the “2011 Amendment”). Pursuant to the 2005 Amendment, tax benefits granted in accordance with the provisions of the Investment Law prior to its revision by the 2005 Amendment remained in force, but any benefits granted subsequently were subject to the provisions of the 2005 Amendment. Similarly, the 2011 Amendment introduced new benefits instead of the benefits granted in accordance with the provisions of the Investment Law prior to the 2011 Amendment. However, companies entitled to benefits under the Investment Law as in effect up to January 1, 2011 may choose to continue to enjoy such benefits, provided that certain conditions are met, or instead may elect irrevocably to forego such benefits and elect the benefits of the 2011 Amendment.

The following discussion is a summary of the Investment Law prior to the 2005 Amendment and 2011 Amendment as well as the relevant changes contained in such amendments and in the new legislation.

Tax Benefits Before the 2005 Amendment

An investment program that is implemented in accordance with the provisions of the Investment Law prior to the 2005 Amendment, referred to as an “Approved Enterprise”, is entitled to certain benefits. These benefits may include cash grants from the Israeli government and tax benefits, based upon, among other things, the location of the facility in which the investment is made or the election of the grantee. A company that wished to receive benefits had to receive an approval from the Investment Center of the Israel Ministry of Industry, Trade and Labor (the “Investment Center”). Each certificate of approval for an Approved Enterprise relates to a specific investment program, delineated both by the financial scope of the investment and by the physical characteristics of the facility or the asset. The tax benefits from any certificate of approval relate only to taxable profits attributable to the specific Approved Enterprise. Income derived from activity that is not integral to the activity of the Approved Enterprise will not enjoy tax benefits.

A company owning an Approved Enterprise may elect to forego certain government grants extended to an Approved Enterprises in return for an alternative package of tax benefits, or the Alternative Benefits Program. Under the Alternative Benefits Program, a company’s undistributed income derived from an Approved Enterprise is exempt from corporate tax for a period of between two and ten years, or the Exemption Period, beginning with the first year in which the company derives taxable income under the program after the commencement of production, depending on the geographic location of the Approved Enterprise within Israel. After the Exemption Period, the company will be eligible for the reduced tax rates of 10%-25%, depending on the extent of foreign investment in the company. These tax benefits are granted for a limited period not exceeding seven years, or ten years for a company whose foreign investment level exceeds 25%, from the first year in which the Approved Enterprise has taxable income, after the year in which production commenced (as determined by the Investment Center). However, the period of benefits may in no event exceed the lesser of twelve years from the year in which the production commenced (as determined by the Investment Center) or fourteen years from the year of receipt of Approved Enterprise status, whichever ends earlier. If a company has more than one Approved Enterprise program or if only a portion of its capital investments are approved, the company’s effective tax rate reflects the weighted average of the applicable rates.

The tax benefits under the Investment Law also apply to a company’s income that is generated from (i) the grant of a right of use with respect to know-how developed by the Approved Enterprise, (ii) income generated from royalties and (iii) income derived from a service which is ancillary to such right of use or royalties, provided that such income is generated within the Approved Enterprise’s ordinary course of business. The tax benefits under the Investment Law are generally not available with respect to income derived from products manufactured outside of Israel.

A company that has an Approved Enterprise program is eligible for further tax benefits if it qualifies as a Foreign Investors’ Company (FIC). An FIC that is eligible for benefits is essentially a company with a level of foreign investment, as defined in the Investment Law, of more than 25%. The level of foreign investment is measured as the percentage of rights in the company (in terms of shares, rights to profits, voting and appointment of directors), and of combined share and loan capital, that are owned, directly or indirectly, by persons who are not residents of Israel. The determination as to whether or not a company qualifies as an FIC is made on an annual basis. An FIC that has an Approved Enterprise program will be eligible for an extension of the period during which it is entitled to tax benefits under its Approved Enterprise status (so that the benefit periods may be up to ten years) and for further tax benefits if the level of foreign investment exceeds 49%. If a company that has an Approved Enterprise program is a wholly-owned subsidiary of another company, then the percentage of foreign investments is determined based on the percentage of foreign investment in the parent company.

 

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The following table sets forth the tax rates and related levels of foreign investments with respect to an FIC that has an Approved Enterprise program.

 

Percentage of non-Israeli ownership

   Tax Rate  

Over 25% but less than 49%

     25

49% or more but less than 74%

     20

74% or more but less than 90%

     15

90% or more

     10

Dividends paid out of income generated by an Approved Enterprise (or out of dividends received from a company whose income is generated by an Approved Enterprise) are generally subject to withholding tax at the rate of 15%, or at the lower rate under an applicable tax treaty. This withholding tax is deductible by the company. The 15% tax rate is limited to dividends and distributions out of income derived during the benefits period and actually paid at any time up to twelve years thereafter. After such period, the withholding tax is applied at a rate of up to 30%, or at the lower rate under an applicable tax treaty. In the case of an FIC, the 12-year limitation on reduced withholding tax on dividends does not apply. Under the Investment Law, a company that has participated in an Alternative Benefits Program is not obligated to distribute retained profits, and may generally decide from which year’s profits to declare dividends. In addition, a company that pays a dividend out of tax-exempt income generated by its Approved Enterprise will be required to recapture the deferred corporate income tax applicable to the amount distributed (grossed up to reflect such tax) at the rate which would have been applicable to such income had such income not been exempted from tax under the Investment Law. This rate generally ranges from 10% to 25%, depending on the extent of non-Israeli shareholdings in the company. We have elected to use the Alternative Benefits Program, but currently intend to reinvest any income derived from our Approved Enterprise program and not to distribute such income as a dividend.

The Investment Law also provides that an Approved Enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved investment program. This benefit is an incentive granted by the Israeli government regardless of whether an Alternative Benefits Program is elected.

The entitlement to the above benefits is based upon the fulfillment of the conditions stipulated by the law, the regulations published thereunder and the instruments of approval for the specific investments in the Approved Enterprise. In the event of failure to comply with these conditions, the company is required to refund the amount of tax benefits, plus a Consumer Price Index (CPI) linkage adjustment and interest.

Tax Benefits Subsequent to the 2005 Amendment

The 2005 Amendment includes revisions to the criteria for investments qualified to receive tax benefits. This amendment applies to new investment programs and investment programs commencing in 2004 and thereafter, but does not apply to investment programs approved prior to March 31, 2005. However, the 2005 Amendment provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the Investment Law as they were on the date of such approval. The tax benefits available under any instrument of approval relate only to taxable profits attributable to the specific program and are contingent upon meeting the criteria set out in the instrument of approval. Furthermore, the Investment Center will continue to grant Approved Enterprise status to qualifying investments.

Pursuant to the 2005 Amendment, it is no longer necessary for a company to obtain the Investment Center’s approval in advance in order to receive tax benefits. Rather, a company may claim the tax benefits offered by the Investment Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set out by the 2005 Amendment (a “Benefited Enterprise”). Companies may, at their discretion, in order to provide greater certainty, elect to apply for a pre-ruling from the ITA regarding their eligibility for benefits under the 2005 Amendment. The Investment Law includes provisions attempting to ensure that a company will not enjoy both government grants and tax benefits for the same investment program.

Tax benefits are available under the 2005 Amendment for production facilities (or other eligible facilities), which are generally required to derive more than 25% of their business income from export to specific markets with a population of at least 12 million people. In order to receive the tax benefits, the amendment states that the company must make an investment in fixed assets in the Benefited Enterprise that meets all the conditions set out in the amendment for tax benefits and that exceeds a minimum amount specified in the Investment Law. Such investment allows the company to receive a Benefited Enterprise status and may be made over a period of no more than three years ending at the end of the year in which the company requested to have the tax benefits apply to the Benefited Enterprise (the “Year of Election”). Where the company requests to have the tax benefits apply to an

 

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expansion of existing facilities, then only the expansion will be considered a Benefited Enterprise and the company’s effective tax rate will be the result of a weighted-average of the applicable rates. In the case of an expansion of existing facilities, the minimum investment required in order to qualify as a Benefited Enterprise is required to exceed a minimum amount or certain percentage of the company’s production assets, determined as of the end of the year before the expansion.

The duration of tax benefits is subject to a limitation of seven to ten years from the Commencement Year (the Commencement Year being defined as the later of: (i) the first tax year in which the company had derived income for tax purposes from the Benefited Enterprise or (ii) the Year of Election) provided that 12 years have not elapsed from the first day of the Year of Election. The tax benefits granted to a Benefited Enterprise are determined, as applicable to its geographic location within Israel, according to one of the following new tax routes, which may be applicable to the company:

 

   

Similar to the Alternative Benefits Program, exemption from corporate tax on undistributed income for a period of two to ten years, depending on the geographic location of the Benefited Enterprise within Israel, and a reduced corporate tax rate of 10% to 25% for the remainder of the benefits period, depending on the level of foreign investment in each year. Benefits may be granted for a term of seven to ten years, depending on the level of foreign investment in the company. If the company pays a dividend out of income derived from the Benefited Enterprise during the tax Exemption Period, such income will be subject to corporate tax at the applicable rate (10%-25%) in respect of the gross amount of the dividend that may be distributed. The company is required to withhold tax at the source at a rate of 15% from any dividends distributed from income derived from the Benefited Enterprise; and

 

   

A special tax route, which enables companies owning facilities in certain geographical locations in Israel to pay corporate tax at the rate of 11.5% on income of the Benefited Enterprise. The benefits period is ten years. Upon payment of dividends, the company is required to withhold tax at source at a rate of 15% for Israeli residents and at a rate of 4% for foreign residents.

The Investment Law also provides that a Benefited Enterprise is entitled to accelerated depreciation on its property and equipment that are productive assets as defined by the 2005 Amendment.

The benefits available to a Benefited Enterprise are subject to the fulfillment of conditions stipulated in the Investment Law and its regulations. If a company does not meet these conditions, then it may be required to refund the amount of tax benefits, together with the CPI linkage adjustment and interest, or other monetary penalty.

Our facilities in Israel have received Approved Enterprise status which entitles us to receive certain tax benefits. We currently have three active plans, two Approved Enterprises under the Alternative Benefits Programs (Plans 3+4 and plan 5) and one Benefited enterprise (Plan 6), granting us a package of benefits, subject to compliance with applicable requirements. Under Plan 3+4’s approval (benefit period starting 2003), our undistributed income was exempt from corporate tax for a period of two years following implementation of the plan and we will be eligible for a reduced tax rate of between 10% and 25% for an additional thirteen years thereafter. Under Plan 5 (benefit period starting 2007), our undistributed income, derived from this approval, was exempted from corporate tax for a period of two years following implementation and we will be eligible for a reduced tax rate of 10% to 25% for eight additional years thereafter. We filed a request for an additional five years of reduced tax rates for such plan. Approval is still pending. With respect to Plan 6, the Company notified the Israeli Tax Authority within 12 months of the end of 2010 that its facilities meet the criteria for tax benefits set out by the 2005 Amendment. The Company was exempt from corporate tax for a period of two years as of the election year (2010) and we will be eligible for a reduced tax rate of 10% to 25% for eight additional years thereafter.

All of these programs are subject to the time limits imposed by the Investment Law and based upon the level of foreign ownership in the company in each tax year. To retain the most favorable rates we must maintain a foreign shareholders’ level of at least 90%. We believe that we currently exceed this level but there can be no assurance that we will be able to reach or maintain this level of foreign ownership for each subsequent year.

Tax benefits under the 2011 Amendment

The 2011 Amendment canceled the availability of the benefits granted in accordance with the provisions of the Investment Law prior to 2011 and instead introduced new benefits for income generated by a “Preferred Company” through its Preferred Enterprise (as such term is defined in the Investment Law) effective as of January 1, 2011 and onward. A Preferred Company is defined as either (i) a company incorporated in Israel and not fully owned by a governmental entity or (ii) a limited partnership (a) that was registered under the Israeli Partnerships Ordinance and (b) all limited partners of which are companies incorporated in Israel, but not all of them are governmental entities, which, in the case of the company and limited partnership referenced in clauses (i) and

 

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(ii), have, among other things, Preferred Enterprise status and are controlled and managed from Israel. Pursuant to the 2011 Amendment, a Preferred Company is entitled to a reduced corporate tax rate of 15% with respect to its preferred income derived by its Preferred Enterprise in 2011-2012, unless the Preferred Enterprise is located in a specified development zone, in which case the rate will be 10%. Such corporate tax rate will be reduced to 12.5% and 7%, respectively, in 2013-2014 and to 12% and 6% in 2015 and thereafter, respectively. Income derived by a Preferred Company from a “Special Preferred Enterprise” (as such term is defined in the Investment Law) would be entitled, during a benefits period of 10 years, to further reduced tax rates of 8%, or to 5% if the Special Preferred Enterprise is located in a certain development zone.

Dividends paid out of income attributed to a Preferred Enterprise are generally subject to withholding tax at source at the rate of 15% or such lower rate as may be provided in an applicable tax treaty. However, if such dividends are paid to an Israeli company, no tax will be withheld (although upon a subsequent distribution to individuals or a non-Israeli company, a withholding tax of 15% or such lower rate as may be provided in an applicable tax treaty, will apply).

Furthermore, the 2011 Amendment provides relief with respect to tax paid on a dividend received by an Israeli company from profits of an Approved or Benefited Enterprise that was accrued during the benefits period according to the Investment Law prior to its amendment, if the company distributing the dividend notifies the Israeli Tax Authority by June 30, 2015 that it is applying the provisions of the 2011 Amendment and the dividend is distributed after the date of the notice.

The 2011 Amendment also provided transitional provisions to address companies already enjoying current benefits. These transitional provisions provide, among other things, that unless an irrevocably request is made to apply the provisions of the Investment Law as amended in 2011 with respect to income to be derived as January 1, 2011: (i) terms and benefits included in any certificate of approval that was granted to an Approved Enterprise that chose to receive grants, before the 2011 Amendment came into effect, will remain subject to the provisions of the Investment Law as in effect on the date of such approval, and subject to certain conditions; (ii) terms and benefits included in any certificate of approval that was granted to an Approved Enterprise, which had participated in an Alternative Benefits Program, before the 2011 Amendment came into effect will remain subject to the provisions of the Investment Law as in effect on the date of such approval, provided that certain conditions are met.; and (iii) a Benefited Enterprise can elect to continue to benefit from the benefits provided to it before the 2011 Amendment came into effect, provided that certain conditions are met.

We have evaluated the likely effect of the 2011 Amendment and, and have currently decided not to file a request to apply the new benefits under the 2011 Amendment. We may decide in the future to make the above-mentioned election.

Temporary, Partial Tax Relief for Repatriation of Exempt Income

Pursuant to a recent amendment to the Investments Law which became effective on November 12, 2012, a company that elects by November 11, 2013 to pay a reduced corporate tax rate as set forth in that amendment (rather than the regular corporate tax rate applicable to Approved Enterprise income) with respect to undistributed exempt income accumulated by the company until December 31, 2011 will be entitled to distribute a dividend from such income without being required to pay additional corporate tax with respect to such dividend. A company that has so elected must make certain qualified investments in Israel over the five-year period commencing in 2013. A company that has elected to apply the amendment cannot withdraw from its election. We are currently reviewing such new relief and its implications to the company.

Tax Benefits under the Law for the Encouragement of Industry (Taxes), 1969

The Law for the Encouragement of Industry (Taxes), 1969 (the “Industry Encouragement Law”) provides several tax benefits for Industrial Companies. An Industrial Company is defined as a company resident in Israel, at least 90% of the income of which in a given tax year (exclusive of income from specified government loans), is derived from an Industrial Enterprise owned by it. An Industrial Enterprise is defined as an enterprise whose major activity in a given tax year is industrial production activity.

 

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Under the Industry Encouragement Law, Industrial Companies are entitled to a number of corporate tax benefits, including:

 

   

Deduction of the cost of purchase of patents or the right to use a patent or know-how used for the development or promotion of the Industrial Enterprise, over an eight-year period commencing on the year in which such rights were first exercised;

 

   

The right to elect, under specified conditions, to file a consolidated tax return with additional related Israeli industrial companies and an industrial holding company;

 

   

Accelerated depreciation rates on equipment and buildings; and

 

   

A straight-line deduction of expenses related to a public offering over a three-year period commencing in the year of offering.

Under some tax laws and regulations, an Industrial Enterprise may be eligible for special depreciation rates for machinery, equipment and buildings. These rates differ based on various factors, including the date the operations begin and the number of work shifts. An Industrial Company owning an Approved Enterprise may choose between these special depreciation rates and the depreciation rates available to the Approved Enterprise.

Eligibility for benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority.

We believe that we currently qualify as an Industrial Company within the definition of the Industry Encouragement Law. We cannot assure you that the ITA will agree that we qualify, or, if we qualify, that we will continue to qualify as an Industrial Company or that the benefits described above will be available to us in the future.

Grants under the Law for the Encouragement of Industrial Research and Development, 1984

Under the Law for the Encouragement of Industrial Research and Development, 1984 (the “Research Law”), research and development programs that meet specified criteria and are approved by a governmental committee of the Office of the OCS are eligible for grants of up to 50% of the project’s expenditures, as determined by the research committee, in exchange for the payment of royalties from the sale of products developed under the program. Regulations under the Research Law generally provide for the payment of royalties to the OCS of 3-3.5% on sales of products and services derived from a technology developed using these grants until 100% of the dollar-linked grant is repaid. Our obligation to pay these royalties is contingent on our actual sale of such products and services. In the absence of such sales, no payment is required. Effective for grants received from the OCS under programs approved after January 1, 1999, the outstanding balance of the grants will be subject to interest at a rate equal to the 12 month LIBOR applicable to dollar deposits that is published on the first business day of each calendar year. Following the full repayment of the grant, there is no further liability for royalties.

The terms of the Israeli government participation also require that the manufacture of products developed with government grants be undertaken in Israel. However, under the regulations of the Research Law, if any of the manufacturing is undertaken outside of Israel, assuming we receive approval from the OCS for the foreign manufacturing, we may be required to pay increased royalties. The increase in royalties depends upon the extent of the manufacturing volume that is performed outside of Israel as follows:

 

Extent of manufacturing
volume outside of Israel

         Royalties to the Chief Scientist
as a percentage of grant

Less than 50%

     120%

between 50% and 90%

     150%

90% and more

     300%

A recent amendment to the Research Law has provided that the restriction on manufacturing outside of Israel shall not apply to the extent that plans to so manufacture were declared at the time of application for funding.

In general, the technology developed with OCS grants may not be transferred to Israeli third parties without the prior approval of a governmental committee under the Research Law and may not be transferred to non-Israeli third parties. A recent amendment to the Research Law has stressed that it is not just transfer of know-how that is prohibited, but also transfer of any rights in such know-how. This approval, however, is not required for the export of any final products developed using the grants. Approval of

 

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the transfer of technology may be granted in specific circumstances only if the recipient abides by the provisions of the Research Law and related regulations, including the restrictions on the transfer of know-how and the obligation to pay royalties in an amount that may be increased. We cannot assure you that any consent, if requested, will be granted, or if granted, will be on reasonable commercial terms.

The Israeli authorities have indicated that the government may reduce or abolish grants from the OCS in the future. Even if these grants are maintained, we cannot assure you that we will receive OCS grants in the future. In addition, each application to the OCS is reviewed separately, and grants are based on the program approved by the research committee. Generally, expenditures supported under other incentive programs of the State of Israel are not eligible for grants from the OCS. We cannot assure you that applications to the OCS will be approved and, until approved, the amounts of any grants are not determinable.

Tax Benefits and Grants for Research and Development

Israeli tax law allows, under specific conditions, a tax deduction in the year incurred for expenditures, including depreciation, relating to scientific research and development projects, provided that the expenditures are approved by the relevant Israeli government ministry, determined by the field of research, if:

 

   

the research and development is for the promotion or development of the company in one of the fields specified in the Israeli Income Tax Ordinance (new version), 1961 (“Tax Ordinance”); or

 

   

the research and development is carried out by or on behalf of the company seeking the deduction in such field.

Expenditures not so approved are deductible over a three-year period, from the first year that the expenditures were made. However, the amount of the government grant given will be subtracted from the amount of expenses which may be deducted.

Taxation of Non-Resident Holders of our Ordinary Shares

Taxation of Non-Israeli Shareholders on Receipt of Dividends . Non-residents of Israel (whether individuals or corporations) are generally subject to Israeli income tax on the receipt of dividends paid on our ordinary shares at the rate of 25% (30% if the dividend recipient is a “substantial shareholder” at the time of distribution or at any time during the preceding 12-month period), unless a reduced rate is provided under an applicable tax treaty. A “substantial shareholder” is generally a person who alone or together with such person’s relative or another person who collaborates with such person on a permanent basis, holds, directly or indirectly, at least 10% of any of the “means of control” of the corporation. “Means of control” generally include the right to vote, receive profits, nominate a director or an officer, receive assets upon liquidation, or order someone who holds any of the aforesaid rights how to act, and all regardless of the source of such right. However, distribution of dividends from income attributed to an Approved Enterprise, Benefited Enterprise or Preferred Enterprise is subject to Israeli income tax at a rate of 15%, unless a reduced tax rate is provided under an applicable tax treaty. For example, under the Convention Between the Government of the United States of America and the Government of Israel with Respect to Taxes on Income, as amended (the “U.S.-Israel Tax Treaty”), the maximum rate of tax withheld in Israel on dividends paid to a holder of our ordinary shares who is a U.S. resident (for purposes of the U.S.-Israel Tax Treaty) is 25%. However, generally, the maximum rate of withholding tax on dividends, not generated by an Approved Enterprise, Benefited Enterprise or Preferred Enterprise, that are paid to a U.S. corporation holding 10% or more of the outstanding voting rights throughout the tax year in which the dividend is distributed as well as the previous tax year, is 12.5%, provided that not more than 25% of the gross income for such preceding year consists of certain types of dividends and interest. Furthermore, dividends paid from income derived from an Approved Enterprise, Benefited Enterprise or Preferred Enterprise are subject, under certain conditions, to withholding at the rate of 15%. We cannot assure you that we will designate the profits that are being distributed in a way that will reduce shareholders’ tax liability. If the dividend is partly attributable to income derived from an Approved Enterprise, Benefited Enterprise or Preferred Enterprise, and partly to other sources of income, the withholding rate will be a blended rate reflecting the relative portions of the two types of income. U.S. residents who are subject to Israeli withholding tax on a dividend may be entitled to a credit or deduction for United States federal income tax purposes in the amount of the taxes withheld, subject to detailed rules contained in U.S. tax legislation.

A non-resident of Israel who receives dividends from which tax was duly withheld is generally exempt from the duty to file returns in Israel in respect of such income, provided such income was not derived from a business conducted in Israel by the taxpayer, and the taxpayer has no other taxable sources of income in Israel.

 

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Capital Gains Taxes Applicable to Non-Israeli Resident Shareholders . Israeli law generally imposes a capital gains tax on the sale of any capital assets by residents of Israel, as defined for Israeli tax purposes, and on the sale of assets located in Israel, including shares in Israeli companies, by both residents and non-residents of Israel, unless a specific exemption is available or unless a tax treaty between Israel and the shareholder’s country of residence provides otherwise. The law distinguishes between real gain and inflationary surplus. The inflationary surplus is a portion of the total capital gain which is equivalent to the increase of the relevant asset’s purchase price which is attributable to the increase in the Israeli CPI or, in certain circumstances, a foreign currency exchange rate, between the date of purchase and the date of sale. The real gain is the excess of the total capital gain over the inflationary surplus.

Non-Israeli residents are generally exempt from Israeli capital gains tax on any gains derived from the sale, exchange or disposition of shares in an Israeli corporation publicly traded on a foreign stock exchange, provided such gains do not derive from a permanent establishment of such shareholders in Israel and provided that such shareholders did not acquire their shares prior to the issuer’s initial public offering. However, non-Israeli corporations will not be entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary of or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.

Additionally, a sale of securities may be exempt from Israeli capital gains tax under the provisions of an applicable tax treaty. For example, under the U.S.-Israel Tax Treaty, the sale, exchange (whether from merger, acquisition or similar transaction) or disposition of our ordinary shares by a shareholder who is both a U.S. resident (for purposes of that treaty) holding the ordinary shares as a capital asset and entitled to claim the benefits afforded to such resident by the U.S.-Israel Tax Treaty (called a “Treaty U.S. Resident”) is generally exempt from Israeli capital gains tax unless either (i) such Treaty U.S. Resident is an individual and was present in Israel for more than 183 days during the relevant taxable year; or (ii) such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more of our voting power during any part of the 12-month period preceding such sale, exchange or disposition, subject to certain conditions; or (iii) the capital gain arising from such sale, exchange or disposition is attributable to a permanent establishment of the Treaty U.S. Resident located in Israel. In any of these cases, the sale, exchange or disposition of our ordinary shares would be subject to Israeli tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be permitted to claim a credit for the tax against the U.S. federal income tax imposed with respect to the sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits.

Israeli Transfer Pricing Regulations

On November 29, 2006, Income Tax Regulations (Determination of Market Terms), 2006, promulgated under Section 85A of the Tax Ordinance, came into effect (“TP Regulations”). Section 85A of the Tax Ordinance and the TP Regulations generally require that all cross-border transactions carried out between related parties be conducted on an arm’s length principle basis and will be taxed accordingly.

United States Federal Income Tax Considerations

Subject to the limitations described in the next paragraph, the following discussion describes the material United States federal income tax consequences to a holder of our ordinary shares (a “U.S. Holder”) that is:

 

   

a citizen or resident of the United States;

 

   

a corporation, or other entity taxable as a corporation for United States federal income tax purposes, created or organized in the United States or under the laws of the United States, any state thereof or the District of Columbia;

 

   

an estate, the income of which is includable in gross income for United States federal income tax purposes regardless of its source; or

 

   

a trust, if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust or if the trust has validly elected to be treated as a United States person under applicable Treasury regulations.

In addition, certain material aspects of United States federal income tax relevant to a holder who is not a partnership and is not a U.S. Holder (a “Non-U.S. Holder”) are discussed below.

If a partnership, or other entity treated as a partnership for United States federal income tax purposes, holds ordinary shares, the tax treatment of a partner generally will depend upon the status of the partner and the activities of the partnership. A partner in a partnership that holds ordinary shares is urged to consult its own tax advisor regarding the specific tax consequences of owning and disposing of ordinary shares.

 

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This summary is for general information purposes only. It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to each person’s decision to own our ordinary shares.

This discussion is based on current provisions of the Code, current and proposed Treasury regulations promulgated thereunder, and administrative and judicial decisions as of the date hereof, all of which are subject to change, possibly on a retroactive basis. Any such change could materially affect the continued validity of this discussion and the tax consequences described herein. This discussion does not address all aspects of United States federal income taxation that may be relevant to any particular shareholder based on such shareholder’s individual circumstances. In particular, this discussion considers only U.S. Holders that will own ordinary shares as capital assets and does not address the potential application of the alternative minimum tax or United States federal income tax consequences to U.S. Holders that are subject to special treatment, including U.S. Holders that:

 

   

are broker-dealers or insurance companies;

 

   

are certain former citizens or long-term residents of the U.S.;

 

   

are persons subject to the alternative minimum tax;

 

   

have elected mark-to-market accounting;

 

   

are tax-exempt organizations;

 

   

are financial institutions or financial services entities;

 

   

hold ordinary shares as part of a straddle, hedge or conversion transaction with other investments;

 

   

own directly, indirectly or by attribution at least 10% of our voting power;

 

   

have a functional currency that is not the United States dollar;

 

   

are carrying on a trade or business in Israel through a permanent establishment; or

 

   

acquire ordinary shares as compensation.

In addition, this discussion does not address any aspect of state, local or non-United States tax laws and does not consider the possible application of United States federal gift or estate tax or the Medicare tax on net investment income.

Each holder of ordinary shares is advised to consult such person’s own tax advisor with respect to the specific tax consequences to such person of purchasing, holding or disposing of our ordinary shares.

Taxation of Ordinary Shares

Taxation of Distributions Paid On Ordinary Shares

Subject to the discussion below under “Tax Consequences if We Are a Passive Foreign Investment Company,” a U.S. Holder will be required to include in gross income as ordinary income the amount of any distribution paid on our ordinary shares, including any Israeli taxes withheld from the amount paid, on the date the distribution is actually or constructively received to the extent the distribution is paid out of our current or accumulated earnings and profits as determined for United States federal income tax purposes. Distributions in excess of such earnings and profits will be applied against and will reduce the U.S. Holder’s basis in the ordinary shares and, to the extent in excess of such basis, will be treated as gain from the sale or exchange of ordinary shares.

With respect to non-corporate U.S. Holders, including individual U.S. Holders, dividends may constitute “qualified dividend income” eligible to be taxed at the preferential rate applicable to long-term capital gains (currently a maximum rate of 20%), provided that (1) (a) our ordinary shares are readily tradable on an established securities market in the United States or (b) we qualify for benefits under an income tax treaty with the United States which includes an information exchange program and such treaty is determined by the United States Internal Revenue Service (“IRS”), to be satisfactory, (2) we are not a passive foreign

 

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investment company (“PFIC”) (as discussed below) for either our taxable year in which the dividend was paid or the preceding taxable year, and (3) the U.S. holders satisfy certain minimum holding period requirements. Our shares are now traded on the New York Stock Exchange and we believe the requirements of 1(a), (1)(b) and (2) are met. Therefore, dividends on our shares would qualify as qualified dividend income so long as a U.S. Holder meets requirement (3).

You should consult your tax advisor regarding the availability of the lower rate for dividends paid with respect to our ordinary shares.

Any dividends paid by us to a U.S. Holder on our ordinary shares will be treated as foreign source income and will generally be categorized as “passive income” for United States foreign tax credit purposes. Subject to the limitations in the Code, as modified by the U.S.-Israel Tax Treaty, a U.S. Holder may elect to claim a foreign tax credit against its United States federal income tax liability for Israeli income tax withheld from dividends received in respect of ordinary shares. U.S. Holders who do not elect to claim the foreign tax credit may instead claim a deduction for Israeli income tax withheld, but only for a year in which the U.S. Holder elects to do so with respect to all foreign income taxes. A deduction does not reduce United States tax on a dollar-for-dollar basis like a tax credit. The deduction, however, is not subject to the limitations applicable to foreign tax credits. The rules relating to the determination of the foreign tax credit are complex. Accordingly, if you are a U.S. Holder of ordinary shares you should consult your own tax advisor to determine whether and to what extent you would be entitled to the credit.

Taxation of the Disposition of Ordinary Shares

Subject to the discussion below under “Tax Consequences if We Are a Passive Foreign Investment Company,” upon the sale, exchange or other taxable disposition of our ordinary shares, a U.S. Holder will recognize a capital gain or loss in an amount equal to the difference between such U.S. Holder’s basis in the ordinary shares, which is usually the cost of such shares in United States dollars, and the amount realized on the disposition in United States dollars. Any gain or loss recognized upon the sale, exchange or other taxable disposition of the ordinary shares will be treated as long-term capital gain or loss if, at the time of the sale, exchange or other taxable disposition, the holding period of the ordinary shares exceeds one year. In the case of individual U.S. Holders, capital gains generally are subject to United States federal income tax at preferential rates if specified minimum holding periods are met. The deductibility of capital losses is subject to significant limitations. U.S. Holders should consult their own tax advisors in this regard.

In general, gain or loss recognized by a U.S. Holder on the sale, exchange or other taxable disposition of our ordinary shares will be United States source income or loss for United States foreign tax credit purposes. In certain instances, a U.S. Holder who is subject to tax in Israel on the sale of our shares and who is entitled to the benefits of the U.S.–Israel Tax Treaty may treat such gain as Israeli source income and thus could, subject to other United States foreign tax credit limitations, credit the Israeli tax on such sale against such U.S. Holder’s United States federal income tax on the gain from that sale.

Tax Consequences if We Are a Passive Foreign Investment Company

We will be a PFIC if 75% or more of our gross income in a taxable year, including the pro rata share of the gross income of any company, United States or foreign, in which we are considered to own, directly or indirectly, 25% or more of the shares by value, is passive income. Alternatively, we will be considered to be a PFIC if at least 50% of our assets in a taxable year, averaged quarterly over the year and ordinarily determined based on fair market value and including the pro rata share of the assets of any company in which we are considered to own, directly or indirectly, 25% or more of the shares by value, are held for the production of, or produce, passive income. Passive income includes, among other amounts, amounts derived by reason of the temporary investment of funds raised in our public offerings.

We do not believe that we are a PFIC. However, the tests for determining PFIC status are applied annually and it is difficult to make accurate predictions of future income and assets, which are relevant to this determination. Accordingly, there can be no assurance that we will not become a PFIC. If we were characterized as a PFIC for any taxable year, a U.S. Holder would suffer adverse tax consequences. These consequences may include having the gains that are realized on the disposition of ordinary shares treated as ordinary income rather than capital gains and being subject to punitive interest charges with respect to certain dividends and gains and on the sale or other disposition of the ordinary shares. Furthermore, dividends paid by a PFIC are not eligible to be treated as “qualified dividend income” (as discussed above). In addition, if a U.S. Holder holds ordinary shares in any year in which we are treated as a PFIC, such U.S. Holder will be subject to additional tax form filing and reporting requirements (including additional filing requirements under recently-enacted legislation).

 

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If we determine that we have become a PFIC, we will notify our U.S. Holders and provide them with the information necessary to comply with the “qualified electing fund” (“QEF”) rules (which can mitigate some of the adverse effects of our being a PFIC). U.S. Holders are urged to consult their tax advisors about the PFIC rules, including the consequences to them of making any elections with respect to our ordinary shares in the event that we qualify as a PFIC.

Tax Consequences for Non-U.S. Holders of Ordinary Shares

Except as described in “Information Reporting and Backup Withholding” below, a Non-U.S. Holder of ordinary shares will not be subject to United States federal income or withholding tax on the payment of dividends on, and the proceeds from the sale, exchange or other taxable disposition of, our ordinary shares, unless:

 

   

such item is effectively connected with the conduct by the Non-U.S. Holder of a trade or business in the United States and, in the case of a resident of a country which has a treaty with the United States, such item is attributable to a permanent establishment or, in the case of an individual, a fixed place of business, in the United States;

 

   

the Non-U.S. Holder is an individual who holds the ordinary shares as a capital asset and is present in the United States for 183 days or more in the taxable year of the disposition and certain other conditions are met; or

 

   

the Non-U.S. Holder is subject to tax pursuant to the provisions of United States tax law applicable to United States expatriates.

Information Reporting and Backup Withholding

U.S. Holders generally are subject to information reporting requirements with respect to dividends paid in the United States on, or the proceeds from the taxable disposition of, our ordinary shares, unless the U.S. Holder is an exempt recipient. U.S. Holders are also generally subject to backup withholding on dividends paid in the United States on, or the proceeds from the taxable disposition of, our ordinary shares unless the U.S. Holder provides IRS Form W-9 or otherwise establishes an exemption.

Non-U.S. Holders generally are not subject to information reporting or backup withholding with respect to dividends paid on, or upon the taxable disposition of, ordinary shares. Such holders, however, may be required to provide certification of non-U.S. status (generally on IRS Form W-8BEN) in connection with payments received in the United States or through certain U.S.-related financial intermediaries.

The amount of any backup withholding may be allowed as a credit against a U.S. or Non-U.S. Holder’s United States federal income tax liability and may entitle such holder to a refund, provided that certain required information is timely furnished to the IRS.

U.S. Holders should also be aware that additional reporting requirements apply with respect to the holding of certain foreign financial assets, including stock of foreign issuers that is not held in an account maintained by a financial institution, if the aggregate value of all such assets exceeds U.S. $50,000. U.S. Holders should consult their own tax advisors regarding the application of these and other information reporting rules applicable to an investment in our ordinary shares based on their particular situation.

F. DIVIDENDS AND PAYING AGENTS

Not applicable.

G. STATEMENT BY EXPERTS

Not applicable.

H. DOCUMENTS ON DISPLAY

We are subject to the informational requirements of the Exchange Act applicable to foreign private issuers and fulfill the obligation with respect to such requirements by filing reports with the SEC. You may inspect and copy such material at the public reference facilities maintained by the SEC, 100 F Street, N.E., Washington, D.C. 20549. You may also obtain copies of such material from the SEC at prescribed rates by writing to the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC maintains an

 

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Internet website at http://www.sec.gov that contains reports, proxy statements, information statements and other material that are filed through the SEC’s Electronic Data Gathering, Analysis and Retrieval (“EDGAR”) system. We began filing through the EDGAR system on December 3, 2002.

As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as United States companies whose securities are registered under the Exchange Act. A copy of each report submitted in accordance with applicable United States law is available for public review at our principal executive offices and on our website at www.taro.com.

I. SUBSIDIARY INFORMATION

Not applicable.

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk, which primarily consists of interest rate and foreign exchange risk. We use derivative instruments to partially mitigate our exposure to these risks. Our objective is to reduce volatility in cash flows due to changes in interest and foreign exchange rates.

Foreign Exchange Rate Risk

We and Taro U.S.A. use the United States dollar as our reporting currency and are exposed to foreign exchange rate risk from transactions conducted in different currencies.

In 2013, 88% of our revenue was generated in United States dollars. However, the remainder of our sales was denominated in the local currencies of the countries in which the sales occurred. As a result, our reported profits and cash flows are exposed to changing exchange rates. If these foreign currencies weaken relative to the United States dollar, the earnings generated in these foreign currencies will, in effect, decrease when converted into United States dollars, and vice versa. Therefore, from time to time we attempt to manage exposures that arise in the normal course of business related to fluctuations in foreign currency exchange rates by entering into offsetting positions through the use of foreign exchange forward contracts.

Due to the relatively low level of non-United States dollar revenues, the effects of currency fluctuations on consolidated net revenue and operating income were not significant in 2013.

Intercompany Foreign Exchange Transactions

Our most significant foreign exchange rate risk relates to our Canadian subsidiary’s transactions with Taro U.S.A. that are denominated in U.S. dollars. These transactions increase the volatility of our earnings since our Canadian subsidiary records gains or losses on foreign exchange transactions under U.S. GAAP.

In October 2011, we entered into forward contracts to off-set the variability of cash flows in U.S. dollars due to changes in the exchange rate with the Canadian Dollar. The total amount of the forward contracts to purchase the Canadian dollar was $96.1 million at a weighted average forward rate of 1.02 Canadian dollars per U.S. dollar for which we posted collateral of $11.0 million. During 2012, the collateral was reduced to $5.0 million. This collateral is recorded as restricted cash on the consolidated balance sheet. The contracts are over a one-year term and are settled in monthly installments of $9.3 million for the first five months and $8.3 million for the last six months. We do not account for this derivative as a hedge and are therefore subject to earnings volatility due to fluctuations in the fair value of the forward contract. We recorded a net loss of $1.3 million on the forward contracts for the year ended March 31, 2013.

Our second most significant foreign exchange rate risk relates to our Israeli company’s transactions with Taro U.S.A. that are denominated in U.S. dollars. The total amount of the forward contract to purchase the NIS was $41.0 million at a weighted average forward rate of 3.65 NIS per U.S. dollar for which we posted collateral of $2.4 million. This collateral is recorded as restricted cash on the consolidated balance sheet. The contracts are over a one-year term and are settled in monthly installments of $4.0 million for the first five months and $3.5 million for the last six months. We do not account for this derivative as a hedge and are therefore subject to earnings volatility due to fluctuations in the fair value of the forward contract. We recorded a net gain of $1.0 million on the forward contracts for the year ended March 31, 2013.

 

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Debt Denominated in NIS and Related Hedges

We have debt denominated in NIS that exposes us to foreign exchange rate risk. We have economically hedged the foreign exchange rate risk by entering into cross-currency swaps, which converts our debt payments into U.S. dollars. We do not account for these derivatives as hedges and are therefore subject to earnings volatility from fluctuations in the fair value of these cross-currency swaps.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates mainly to our long-term debt. Our interest expense is primarily sensitive to LIBOR and CPI as most of our long-term debt bears a LIBOR or CPI-linked interest rate.

Taro U.S.A. has an interest rate swap in place as of March 31, 2013, which converts a variable rate mortgage of LIBOR +1.25% to a fixed rate of 6.16%. The outstanding principal on this mortgage at March 31, 2013 was $7.6 million. We do not use hedge accounting for this interest rate swap and are therefore subject to earnings volatility due to fluctuations in the fair value of this interest rate swap.

As of March 31, 2013, our total outstanding debt of $28.6 million bears an average interest rate of 4.67%. Of the $28.6 million, only $1.2 million is exposed to interest rate fluctuation. Consequently, each 0.25% increase in interest rates will reduce pretax income less than $0.1 million.

Under current conditions, we do not believe that our exposure to market risks will have a material impact on future earnings.

We manage our exposure to debt obligations denominated in currencies other than its functional currency by opportunistically using cross-currency swaps to convert its foreign currency debt payments into its functional currency. These cross-currency swaps are not designated as hedges and changes in fair value of these derivatives are reflected in earnings.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not applicable.

PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

None.

 

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

Not applicable.

 

ITEM 15. CONTROLS AND PROCEDURES

 

a. Disclosure Controls and Procedures

Taro’s interim chief executive officer and interim chief financial officer, after evaluating the effectiveness of Taro’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this annual report, have concluded that, as of such date, Taro’s disclosure controls and procedures were effective to ensure that the information required in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and such information is accumulated and communicated to its management, including its interim chief executive officer and interim chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

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b. Report of Taro Management on Internal Control Over Financial Reporting

Taro’s board of directors and management are responsible for establishing and maintaining adequate internal control over financial reporting. Taro’s internal control system was designed to provide reasonable assurance to Taro’s management and board of directors regarding the reliability of financial reporting and the preparation and fair presentation of its published consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Taro’s management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2013. In making this assessment, it used the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on such assessment, management has concluded that, as of March 31, 2013, Taro’s internal control over financial reporting is effective based on those criteria.

 

c. Attestation Report of the Registered Public Accounting Firm

Taro’s internal control over financial reporting as of March 31, 2013, has been audited by Ziv Haft, an independent registered public accounting firm in Israel and a BDO Member Firm, as stated in their report, which is included under “Item 18 – Financial Statements” on Page F-3 of this annual report.

 

d. Changes in Internal Control Over Financial Reporting

There were no changes to Taro’s internal control over financial reporting that occurred during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, Taro’s internal control over financial reporting.

 

ITEM 16. [RESERVED]

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

Our Board has determined that Ilana Avidov-Mor, a member of the Audit Committee, is an audit committee financial expert, as defined by applicable SEC regulations, and is independent in accordance with applicable SEC and NYSE regulations. See Item 6.A for a summary of Ilana Avidov-Mor’s relevant professional experience.

 

ITEM 16B. CODE OF ETHICS

We have adopted a code of conduct applicable to our directors and all employees. We have also adopted a code of ethics that applies to our chief executive officer, chief financial officer and other senior officers. A copy of the code of conduct or the code of ethics may be obtained, without charge, upon a written request addressed to: Corporate Affairs Department, Taro Pharmaceutical Industries Ltd., c/o Taro Pharmaceuticals U.S.A., Inc., 3 Skyline Drive, Hawthorne, NY 10532. Any waivers of the code of conduct or the code of ethics for executive officers or directors will be disclosed through the filing of a Report on Form 6-K.

 

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Principal Accountant Fees and Services

We paid the following fees for professional services rendered by Ziv Haft, a BDO Member Firm (“Ziv Haft”), for the year ended March 31, 2013, the three months ended March 31, 2012, and the year ended December 31, 2011, respectively.

 

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     Year ended
March 31, 2013
     Three months ended
March 31, 2012
     Year ended
December 31, 2011
 
     (In millions of U.S. Dollars)  

Audit fees

   $ 0.76       $ 0.30       $ 1.68   

Tax fees

     0.19         0.14         0.25   
  

 

 

    

 

 

    

 

 

 

Total  

   $ 0.95       $ 0.44       $ 1.93   
  

 

 

    

 

 

    

 

 

 

The audit fees for the year ended March 31, 2013, the three months ended March 31, 2012, and the year ended December 31, 2011, respectively, represent fees for professional services rendered for the audits of our annual consolidated financial statements, statutory or regulatory audits of us and our subsidiaries, consents and assistance with review of documents filed with the SEC. All non-audit services provided by the Company’s independent auditors were approved by the Audit Committee.

Tax fees represents fees for professional services related to tax compliance, including the preparation of tax returns and claims for refund, and tax planning and tax advice, including assistance with tax audits and appeals, tax services for employee benefit plans and assistance with respect to requests for rulings from tax authorities.

Policy on Pre-Approval of Audit and Non-Audit Services of Independent Auditors

Our Audit Committee is responsible for the oversight of our independent auditors’ work. The Audit Committee’s policy is to pre-approve all audit and non-audit services provided by our independent registered public accounting firm, Ziv Haft. These services may include audit services, audit-related services, tax services and other services, as further described below. The Audit Committee sets forth the basis for its pre-approval in detail, listing the particular services or categories of services that are pre-approved, and setting forth a specific budget for such services. Additional services may be pre-approved by the Audit Committee on an individual basis. Once services have been pre-approved, Ziv Haft and our Management then report to the Audit Committee on a periodic basis regarding the extent of services actually provided in accordance with the applicable pre-approval, and regarding the fees for the services performed.

 

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

Not applicable.

 

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

Not applicable.

 

ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT

Not applicable.

 

ITEM 16G. CORPORATE GOVERNANCE

Under the rules of the NYSE, foreign private issuers may elect to be subject to a more limited set of corporate governance requirements than U.S. domestic issuers. Despite any such election, Taro, as a foreign private issuer, must comply with four principal NYSE corporate governance rules: (1) Taro must satisfy the requirements of Exchange Act Rule 10A-3; (2) Taro’s Chief Executive Officer must promptly notify the NYSE in writing after any executive officer becomes aware of any material non-compliance with the applicable NYSE corporate governance rules; (3) Taro must provide the NYSE with annual and interim written affirmations as required under the NYSE corporate governance rules; and (4) Taro must provide a brief description of any significant differences between its corporate governance practices and those followed by U.S. companies under NYSE listing standards. The table below briefly describes the significant differences between Taro’s domestic practice and the NYSE corporate governance rules.

 

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Section

  

NYSE Corporate Governance Rule for

U.S. Domestic Issuers

  

Taro’s Approach

303A.01   

A listed company must have a majority of independent directors.

 

“Controlled companies” are not required to comply with this requirement.

   Taro is a controlled company because more than a majority of its voting power is controlled by Sun. As a controlled company, Taro would not be required to comply with the majority of independent directors’ requirements if it were a U.S. domestic issuer. There is not a similar requirement under Israeli practice or the Israeli Companies Law that requires Taro to have a majority of independent directors. Rather, the statutory director provisions under the Israeli Companies Law require Taro, as a public company, to have at least two outside/external directors.
303A.03    The non-management directors of a listed company must meet at regularly scheduled executive sessions without management.    There is not a similar requirement under Israeli practice or the Israeli Companies Law, and non-management directors of Taro do not meet at regularly scheduled executive sessions without management.
303A.04   

A listed company must have a Nominating/Corporate Governance Committee composed entirely of independent directors, with a written charter that covers certain minimum specified duties.

 

“Controlled companies” are not required to comply with this requirement.

   Taro does not have a nominating committee. As a controlled company, Taro would not be required to comply with the nominating/corporate governance committee requirements if it were a U.S. domestic issuer. There is not a similar requirement under the Israeli Companies Law.
303A.05   

A listed company must have a compensation

committee composed entirely of independent

directors, with a written charter that covers certain minimum specified duties.

 

“Controlled companies” are not required to comply with this requirement.

   Taro has a compensation committee currently comprised of three directors, Under the Israeli Companies Law, which provides standards for the independence of the compensation committee, the compensation committee shall have no less than three members and all of the external directors shall be members thereof.
303A.06/303A.07    A listed company must have an audit committee with a minimum of three independent directors who satisfy the independence requirements of Rule 10A-3 under the Exchange Act, with a written charter that covers certain minimum specified duties.    Taro has an audit committee currently comprised of three directors. Under the Israeli Companies Law, which provides standards for the independence of the audit committee, the Audit Committee shall have no less than three members and all of the external directors shall be members thereof. All of the directors that are members of the audit committee meet the NYSE independence requirements that would apply to the audit committee members in absence of our reliance on Exchange Act Rule 10A-3(C)(3).

 

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303A.07        The audit committee of a listed company to be directly responsible, to the extent permitted by law, for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for the purpose of preparing or issuing an audit report or performing other audit, review, or attest services, and that each such firm must report directly to the audit committee.    Pursuant to the Israeli Companies Law, Taro’s audit committee is responsible for determining the scope of the work of, and the compensation to be paid to, Taro’s external auditors, whereas the actual appointment of the external auditors and approval of their compensation is carried out by Taro’s shareholders at the annual meeting of shareholders. Furthermore, pursuant to the Israeli Companies Law, Taro’s audit committee is responsible for supervising the work of Taro’s external auditors with respect to the audit of Taro’s financial statements, whereas actual final approval of the financial statements is provided by Taro’s board of directors as a whole.

303A.08

   Shareholders must be given the opportunity to vote on all equity-compensation plans and material revisions thereto, with limited exemptions set forth in the NYSE rules.    Under the Israeli Companies Law, shareholder pre-approval is not required for the adoption of equity compensation plans. Shareholder approval is required prior to any grants under the plan to directors or the chief executive officer of Taro.

303A.09

   A listed company must adopt and disclose corporate governance guidelines that cover certain minimum specified subjects.    Taro does not have formal corporate governance guidelines that address all of the matters specified in the NYSE rules. There is not a similar requirement under the Israeli Companies Law.

303A.10

   A listed company must adopt and disclose a code of business conduct and ethics for directors, officers and employees, and promptly disclose any waivers of the code for directors or executive officers.   

Taro has adopted a formal code of ethical and compliant conduct, which applies to its directors, officers and employees.

 

Taro reports each year under Item 16B of its annual report on Form 20-F any waivers of the code of ethical conduct granted for directors and executive officers. Taro’s code of ethical conduct has a scope that is similar, but not identical, to that required for a U.S. domestic company under the NYSE rules.

 

Taro also has a code of ethics that applies specifically to Taro’s Chief Executive Officer, Chief Financial Officer and other senior officers.

303A.12

   Each listed company CEO must certify to the NYSE each year that he or she is not aware of any violation by the company of NYSE corporate governance listing standards.    Taro’s CEO will promptly notify the NYSE in writing if any executive officer of Taro becomes aware of any material noncompliance with any applicable provisions of the NYSE corporate governance rules.

 

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ITEM 16H. MINE SAFETY DISCLOSURE

Not applicable.

PART III

 

ITEM 17. FINANCIAL STATEMENTS

We have responded to Item 18 in lieu of this item.

 

ITEM 18. FINANCIAL STATEMENTS

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

The Financial Statement Schedule II – Valuation and Qualifying Accounts is found on page S-1 following the financial statements.

 

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ITEM 19. EXHIBITS

The exhibits filed with or incorporated into this 2013 Annual Report are listed on the index of exhibits below.

 

Exhibit
No.

 

Description

1.1   Memorandum of Association of Taro Pharmaceutical Industries Ltd. (1)
1.2   Articles of Association of Taro Pharmaceutical Industries Ltd., as amended
2.1   Form of ordinary share certificate (1)
4.1   Taro Vit Industries Limited 1991 Stock Incentive Plan (2)
4.3   Taro Pharmaceutical Industries 1999 Stock Incentive Plan (3)
4.4   Amendment No. 1 to Taro Pharmaceutical Industries 1999 Stock Incentive Plan (4)
4.5   Amendment No. 2 to Taro Pharmaceutical Industries 1999 Stock Incentive Plan (4)
8   List of Subsidiaries (See “Organizational Structure” in Item 4.C of this Form 20-F)
12.1   Certification of the Interim Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
12.2   Certification of the Interim Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
13   Certification of the Interim Chief Executive Officer and Group Vice President, Interim Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
15(a).3   Loan agreements dated May 20, 2003 and November 27, 2003 among Taro Pharmaceutical Industries Ltd. and various lenders (5)
101 INS   XBRL Instance Document
101 SCH   XBRL Taxonomy Extension Schema Document
101 CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101 DEF   XBRL Taxonomy Extension Definition Linkbase Document
101 LAB   XBRL Taxonomy Extension Label Linkbase Document
101 PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Previously filed as an exhibit to our Registration Statement on Form F-1 (No. 333-63464), as amended, and incorporated herein by reference.
(2) Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 33-80802) and incorporated herein by reference.
(3) Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 333-13840) and incorporated herein by reference.
(4) Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2005, and incorporated herein by reference.
(5) Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2003 and incorporated herein by reference.

 

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SIGNATURE

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this 2013 Annual Report on its behalf.

 

TARO PHARMACEUTICAL INDUSTRIES LTD.
By:   /s/ Michael Kalb
  Michael Kalb
  Group Vice President, Interim Chief Financial Officer and Chief Accounting Officer

Dated: July 1, 2013

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

 

     Page

Report of Independent Registered Public Accounting Firm

   F-2 – F-3

Consolidated Balance Sheets

   F-4 – F-5

Consolidated Statements of Operations

   F-6

Consolidated Statements of Comprehensive Income  

   F-7

Statements of Changes in Shareholders’ Equity

   F-8

Consolidated Statements of Cash Flows

   F-9 – F-10

Notes to Consolidated Financial Statements

   F-11 – F-49

 

F-1


Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

Taro Pharmaceutical Industries Ltd.

We have audited the accompanying consolidated balance sheets of Taro Pharmaceutical Industries Ltd. (the “Company”) and its subsidiaries as of March 31, 2013 and 2012, and the related consolidated statements of operations, of comprehensive income, of shareholders’ equity and cash flows for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and its subsidiaries as of March 31, 2013 and 2012, and the results of their operations, changes in comprehensive income, changes in equity and their cash flows for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010 , in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of March 31, 2013, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 1, 2013 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

Tel Aviv, Israel       /s/ Ziv Haft
      Ziv Haft
July 1, 2013      

Certified Public Accountants (Isr)

BDO Member Firm

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Taro Pharmaceutical Industries Ltd.

We have audited the internal control over financial reporting of Taro Pharmaceutical Ltd. and its subsidiaries (the “Company”) as of March 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on that risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2013, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), financial position of the Company and its subsidiaries as of March 31, 2013 and 2012, and the results of their operations, of comprehensive income, of shareholders’ equity and their cash flows for the year ended March 31, 2013, the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010 and our report dated July 1, 2013 expressed an unqualified opinion on those consolidated financial statements.

 

Tel Aviv, Israel       /s/ Ziv Haft
      Ziv Haft
July 1, 2013      

Certified Public Accountants (Isr)

BDO Member Firm

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands (except share and per share data)

 

     March 31,  
     2013      2012  

ASSETS

     

CURRENT ASSETS:

     

Cash and cash equivalents

   $ 237,284       $ 238,266   

Short-term bank deposits

     312,603         72,440   

Restricted short-term bank deposits

     7,430         15,780   

Marketable securities

     3,183         7,835   

Accounts receivable and other:

     

Trade, net

     119,810         111,130   

Other receivables and prepaid expenses

     119,768         98,501   

Inventories

     109,626         109,638   

Long-term assets held for sale, net

     67         71   
  

 

 

    

 

 

 

TOTAL CURRENT ASSETS

     909,771         653,661   

LONG-TERM RECEIVABLES AND OTHER ASSETS

     23,227         19,972   

PROPERTY, PLANT AND EQUIPMENT, NET

     145,265         150,750   

GOODWILL

     7,277         7,284   

INTANGIBLE ASSETS AND DEFERRED COSTS, NET

     15,607         18,308   

DEFERRED INCOME TAXES

     5,489         6,449   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 1,106,636       $ 856,424   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands (except share and per share data)

 

     March 31,  
     2013     2012  

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

CURRENT LIABILITIES:

    

Current maturities of long-term debt

   $ 11,330      $ 10,957   

Accounts payable:

    

Trade payables

     19,387        22,977   

Other current liabilities

     161,814        164,965   
  

 

 

   

 

 

 

TOTAL CURRENT LIABILITIES

     192,531        198,899   

LONG-TERM LIABILITIES:

    

Long-term debt, net of current maturities

     17,269        27,949   

Deferred income taxes

     1,879        2,205   

Other long-term liabilities

     3,996        4,413   
  

 

 

   

 

 

 

TOTAL LONG-TERM LIABILITIES

     23,144        34,567   

COMMITMENTS AND CONTINGENT LIABILITIES

    

TOTAL LIABILITIES

     215,675        233,466   
  

 

 

   

 

 

 

SHAREHOLDERS’ EQUITY:

    

Taro shareholders’ equity:

    

Ordinary shares of NIS 0.0001 par value:

    

Authorized at March 31, 2013 and March 31, 2012: 200,000,000 shares; Issued at March 31, 2013 and March 31, 2012: 45,091,562 and 44,800,007 shares, respectively Outstanding at March 31, 2013 and March 31, 2012: 44,768,087 and 44,476,532 shares, respectively

     679        679   

Founders’ shares of NIS 0.00001 par value:

    

Authorized, issued and outstanding at March 31, 2013 and March 31, 2012: 2,600 shares

     1        1   

Additional paid-in capital

     261,008        253,584   

Accumulated other comprehensive income, net of taxes

     16,743        23,034   

Treasury stock: 323,475 shares at March 31, 2013 and March 31, 2012

     (1,329     (1,329

Accumulated earnings

     609,245        343,039   
  

 

 

   

 

 

 

Taro shareholders’ equity

     886,347        619,008   

Non-controlling interest

     4,614        3,950   
  

 

 

   

 

 

 

TOTAL SHAREHOLDERS’ EQUITY

     890,961        622,958   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,106,636      $ 856,424   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

U.S. dollars and shares in thousands (except per share data)

 

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

Sales, net

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

Cost of sales

     176,128        45,971        176,143        159,158   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     494,826        99,170        329,525        233,377   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Research and development, net

     46,508        9,847        30,867        36,393   

Selling, marketing, general and administrative

     86,438        23,101        93,918        107,902   

Settlements and loss contingencies

     33,300        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 
     166,246        32,948        124,785        144,295   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     328,580        66,222        204,740        89,082   

Financial (income) expenses, net

     (3,931     1,000        (3,697     11,840   

Other gain (loss), net

     3,352        (94     609        755   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     335,863        65,128        209,046        77,997   

Tax expense

     67,799        17,791        24,551        10,477   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     268,064        47,337        184,495        67,520   

Net (loss) income from discontinued operations

     (1,194     66        (1,217     (2,969
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     266,870        47,403        183,278        64,551   

Net income attributable to non-controlling interest

     664        151        598        473   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

   $ 266,206      $ 47,252      $ 182,680      $ 64,078   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income from continuing operations attributable to Taro

   $ 267,400      $ 47,186      $ 183,897      $ 67,047   

Net (loss) income from discontinued operations attributable to Taro

     (1,194     66        (1,217     (2,969
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Taro

   $ 266,206      $ 47,252      $ 182,680      $ 64,078   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Basic

   $ 5.99      $ 1.06      $ 4.14      $ 1.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 5.98      $ 1.06      $ 4.14      $ 1.60   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Basic

   $ (0.03   $ —      $ (0.03   $ (0.07
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.03   $ —      $ (0.03   $ (0.07
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per ordinary share attributable to Taro:

        

Basic

   $ 5.96      $ 1.06      $ 4.11      $ 1.59   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 5.95      $ 1.06      $ 4.11      $ 1.53   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Basic

     44,678        44,476        44,406        40,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     44,715        44,589        44,491        41,850   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

* Amount is less than $0.01

The accompanying notes are an integral part of these consolidated financial statements.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

U.S. dollars and shares in thousands (except per share data)

 

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

Net income attributable to Taro

   $ 266,206      $ 47,252       $ 182,680      $ 64,078   

Other comprehensive (loss) income

         

Foreign currency translation adjustments

     (6,340     4,460         (5,943     2,436   

Unrealized gain (loss) from marketable securities

     49        25         291        (230

Realized gain from sale of marketable securities

     —          —           15        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other comprehensive (loss) income attributable to Taro

     (6,291     4,485         (5,637     2,206   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total comprehensive income attributable to Taro

   $ 259,915      $ 51,737       $ 177,043      $ 66,284   
  

 

 

   

 

 

    

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

U.S. dollars in thousands  

 

    Taro Shareholders’ Equity              
    Number of
Shares
    Share
Capital
    Additional
Paid-in

Capital
    Accumulated
Other
Comprehensive
Income

(Loss)
    Treasury
Shares
    Retained
Earnings
    Total Taro
Shareholders’

Equity
    Non-controlling
Interest
    Total
Shareholders’
Equity
 

Balance at January 1, 2010

    39,186      $  680      $ 222,608      $  21,980      $ (1,329   $ 49,029      $ 292,968      $ 2,728      $ 295,696   

Exercise of options and issuance of shares of ESPP

    44        —       186        —          —          —          186        —          186   

Exercise of Sun warrants

    3,788        —          21,589        —          —          —          21,589        —          21,589   

Share-based compensation

    —          —          285        —          —          —          285        —          285   

Comprehensive income, net of tax:

    —          —          —          2,206        —          —          2,206        —          2,206   

Net income

    —          —          —          —          —          64,078        64,078        473        64,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2010

    43,018        680        244,668        24,186        (1,329     113,107        381,312        3,201        384,513   

Exercise of options and issuance of shares of ESPP

    33        —       300        —          —          —          300        —          300   

Issuance of shares to Sun and exercise of Sun warrants

    1,425        —          8,550        —          —          —          8,550        —          8,550   

Share-based compensation

    —          —          59        —          —          —          59        —          59   

Comprehensive loss, net of tax:

    —          —          —          (5,637     —          —          (5,637     —          (5,637

Net income

    —          —          —                 —          182,680        182,680        598        183,278   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

    44,476        680        253,577        18,549        (1,329     295,787        567,264        3,799        571,063   

Exercise of options and issuance of shares of ESPP

    1        —       7        —          —          —          7        —          7   

Comprehensive income, net of tax:

    —          —          —          4,485        —          —          4,485        —          4,485   

Net income

    —          —          —                 —          47,252        47,252        151        47,403   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

    44,477        680        253,584        23,034        (1,329     343,039        619,008        3,950        622,958   

Exercise of options and issuance of shares of ESPP

    291        —       7,416        —          —          —          7,416        —          7,416   

Share-based compensation

    —          —          8        —          —          —          8        —          8   

Comprehensive loss, net of tax:

    —          —          —          (6,291     —          —          (6,291     —          (6,291

Net income

    —          —          —          —          —          266,206        266,206        664        266,870   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2013

    44,768      $ 680      $ 261,008      $ 16,743      $ (1,329   $ 609,245      $ 886,347      $  4,614      $ 890,961   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Amount is less than $500

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands

 

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

Cash flows from operating activities:

        

Net income

     $266,870        $47,403        $183,278        $64,551   

Adjustments required to reconcile net income to net cash provided by operating activities:

        

Depreciation and amortization

     17,765        4,598        18,730        18,827   

Change in deferred charges and other assets

     26        8        30        42   

Impairment of long-lived assets

     969        —          784        2,730   

Share-based compensation expense

     8        —          59        285   

Accrued severance pay and other long-term liabilities, net

     55        (210     (786     (122

Loss on sale of long-lived assets

     13        22        526        65   

Realized (gain) loss on sale of marketable securities

     (57     —          45        (32

Change in derivative instruments, net

     1,550        (3,392     5,239        (2,140

Effect of exchange differences on inter-company balances

     (1,510     2,104        (3,249     307   

Increase (decrease) in long-term debt due to currency fluctuations

     440        814        (1,835     3,362   

Deferred income taxes, net

     (18,822     4,075        (21,374     6,720   

(Increase) decrease in trade receivables, net

     (8,912     9,879        (47,565     (11,519

(Increase) decrease in other receivables, prepaid expenses and other

     (1,339     (535     (622     3,251   

Increase in inventories, net

     (630     (1,583     (24,464     (14,464

Decrease in long-term receivables, prepaid expenses and other

     301        53        196        2,544   

Decrease (increase) in income tax receivables

     —          —          291        (18

(Decrease) increase in trade payables

     (3,483     (521     1,664        (6,367

Increase in other accounts payable and accrued expenses

     43,500        3,241        26,603        5,605   

(Decrease) increase in income tax payables

     (48,094     12,138        43,857        (3,143
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     248,650        78,094        181,407        70,484   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS 

U.S. dollars in thousands

 

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

Cash flows from investing activities:

        

Purchase of property, plant and equipment

     (9,466     (1,610     (6,293     (5,656

Investment in other intangible assets

     (777     —          —          (5,097

(Investment in) proceeds from short-term bank deposits

     (241,671     18,045        (60,033     (10,026

Proceeds from (investment in) restricted bank deposits

     8,224        4,014        (15,562     900   

(Investment in) proceeds from long-term deposits and other assets

     (5,000     18        74        (310

Proceeds from sale of (investment in) marketable securities, net

     4,758        (4,909     1,053        (3,891

Proceeds from sale of long-lived assets

     1        28        431        69   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (243,931     15,586        (80,330     (24,011
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

        

Excess tax benefits from share-based payment arrangements

     838        —          —          —     

Proceeds from issuance of shares, net

     6,584        7        8,850        21,775   

Repayment of short-term bank debt, net

     —          —          —          (73,331

Proceeds from long-term debt and capital leases

     —          —          —          22   

Repayment of long-term debt

     (10,748     (6,595     (12,898     (34,579
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (3,326     (6,588     (4,048     (86,113
  

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (2,375     1,173        (1,172     477   
  

 

 

   

 

 

   

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     (982     88,265        95,857        (39,163

Cash and cash equivalents at the beginning of the period

     238,266        150,001        54,144        93,307   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at the end of the period

   $ 237,284      $ 238,266      $ 150,001      $ 54,144   
  

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow transactions:

        

Cash paid during the year for:

        

Interest

   $ 2,230      $ 216      $ 3,447      $ 6,171   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income taxes

   $ 133,612      $ 1,039      $ 5,102      $ 9,454   
  

 

 

   

 

 

   

 

 

   

 

 

 

(a) Non-cash investing and financing transactions:

        

Purchase of property, plant and equipment on credit

   $ 1,573      $ 633      $ 790      $ 397   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

 

Notes to consolidated financial statements

U.S. dollars in thousands

NOTE 1: — GENERAL

 

  a. Taro Pharmaceutical Industries Ltd. (the “Company” or “Taro”) is an Israeli corporation, which operates in Israel and elsewhere through its Israeli, North American, and European subsidiaries (the “Group”). The principal business activities of the Group are the production, research, development and marketing of pharmaceutical products. As of March 22, 2012, the Company’s ordinary shares are traded on the New York Stock Exchange (the “NYSE”), under the symbol “TARO.” Prior to the move to the NYSE, the Company’s ordinary shares were quoted on the Pink Sheets Electronic Quotation Service (“Pink Sheets”) under the symbol TAROF. As used herein, the terms “we,” “us,” “our,” “Taro” and the “Company” mean Taro Pharmaceutical Industries Ltd. and its subsidiaries, unless otherwise indicated.

The activities of the Group in North America are performed by Taro Pharmaceuticals Inc., Taro Pharmaceuticals North America, Inc. and Taro Pharmaceuticals U.S.A., Inc. (“Taro U.S.A.”). Taro Research Institute Ltd. in Israel provided research and development services to the Group, which, as of its merger with and into Taro, are now performed by Taro. Taro International Ltd. in Israel and Taro’s subsidiary in the United Kingdom are engaged in the pharmaceutical activities of the Group outside North America.

The Group manufactures generic and proprietary drug products in facilities located in Israel and Canada, and manufactures bulk active pharmaceutical ingredients in its Israel facility. The Group’s research facilities are located in Israel and Canada. The majority of the Group’s sales are in North America.

In North America, the Company sells and distributes its products principally to drug industry wholesalers, drug store chains and mass merchandisers. In Israel, the Group sells and distributes its products principally to healthcare institutions and private pharmacies.

In the generic pharmaceutical industry, selling prices and related profit margins tend to decrease as products mature due to increased competition from other generic pharmaceutical manufacturers as they gain approval from the U.S. Food and Drug Administration (the “FDA”), the Canadian Health Products and Food Branch Inspectorate, and the Israeli and other Ministries of Health (“Government Agencies”) to manufacture equivalent products. The Group’s future operating results are dependent on, among other things, its ability to introduce new products and maintain its approvals to market existing drugs.

While non-compliance with Government Agencies’ regulations can result in refusal to allow country entry, seizure, fines or injunctive actions to prevent the sale of products, no material actions against the Group or its products have recently occurred. The Group believes that it is in material compliance with all Government Agencies’ regulations.

While the majority of the Company’s products are either synthesized by the Company itself or are derived from multiple source materials, some raw materials and certain products are currently obtained from single suppliers. The Company does not believe that any interruption of supply from a single supplier would have a material adverse effect on the Company’s results of operations and financial position. To date, the Group has not experienced difficulties in obtaining raw materials or other materials.

Sun Pharmaceutical Industries Ltd. (Reuters: SUN.BO, Bloomberg: SUNP IN, NSE: SUNPHARMA, BSE: 524715) (“Sun Pharma”) and its affiliates (“Sun”), the Company’s majority shareholder, owns, or controls, 29,497,933, or 65.9%, of the Company’s ordinary shares, and with the Company’s founders’ shares, 77.3% of the vote attributable to the share equity of the Company.

On October 18, 2011, the Company received a letter from Sun making a non-binding proposal for the acquisition of all of the issued and outstanding shares of Taro, not currently held by Sun, at a price of $24.50 per share, in cash. The Company’s Board of Directors formed an independent Special Committee to review and evaluate the offer. In August 2012, the Company and Sun entered into a merger agreement whereby Sun would purchase all of the issued and outstanding shares of Taro, not then held by Sun, at a price of $39.50 per share, in cash, upon the closing of the proposed merger. On February 8, 2013, the parties announced that they mutually agreed to terminate the merger agreement. Following the termination of the merger agreement, the Special Committee was disbanded.

 

F-11


Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 2: — SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements are prepared according to U.S. GAAP.

 

  a. Use of estimates:

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgements and assumptions. The Company’s management believes that the estimates, judgements and assumptions used are reasonable based upon information available at the time they are made. These estimates, judgements and assumptions can affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

The Company’s most critical estimates are used in its determination of its sales incentives reserves (see Note 5), inventory reserves, income taxes, fixed assets, intangible assets, derivative instruments and contingencies.

 

  b. Financial statements in U.S. dollars:

A majority of the revenue of the Company and certain of its subsidiaries (exclusive of its Canadian, Irish, and U.K. subsidiaries – see below) is generated in U.S. dollars (“dollars”). In addition, a substantial portion of the costs of the Company and these subsidiaries is incurred in dollars. The Company’s management believes that dollars is the primary currency of the economic environment in which the Company and these subsidiaries operate. Thus, the functional and reporting currency of the Company and its subsidiaries is the dollar, requiring re-measurement from the local currency into dollars for each of these entities. All exchange gains and losses resulting from the re-measurement are reflected in the statement of operations as financial income or expenses, as appropriate.

The functional currency of the Company’s Canadian, Irish, and U.K. subsidiaries are the Canadian dollar, the Euro, and the British Pound, respectively.

Accordingly, the financial statements of the Canadian, Irish, and U.K. subsidiaries have been translated into dollars. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Amounts recorded in the statements of operations have been translated using the average exchange rate prevailing during the year. The resulting translation adjustments are reported as a component of shareholders’ equity under accumulated other comprehensive income.

 

  c. Principles of consolidation:

The consolidated financial statements include the accounts of the Company and its subsidiaries. Inter-company transactions and balances have been eliminated in consolidation and non-controlling interest is included in shareholders’ equity.

Sun, through its wholly owned subsidiary, Taro Development Corporation (“TDC”), owns 3.125% of the shares that have economic rights and has 50% of the voting rights in Taro U.S.A.; with the Company owning the remaining shares and voting rights. In 1993, TDC signed an agreement with the Company to vote all of its shares in Taro U.S.A. in all elections of directors of Taro U.S.A. as the Company shall instruct. In May 2011, TDC renewed its commitment to the Company. TDC may terminate the agreement upon one year written notice and no such notice of termination has been provided. TDC is a minority shareholder in the Company by way of its ownership of Taro U.S.A. shares that have economic rights.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  d. Cash and cash equivalents:

Cash equivalents are short-term, highly-liquid investments that are readily convertible into cash with original maturities of three months or less at the date acquired.

Short-term bank deposits:

Bank deposits with maturities of more than three months but less than one year are included in short-term deposits. Such deposits are stated at cost which approximates market values and are invested at an average interest rate of 1.19% and 0.96% for March 31, 2013 and 2012, respectively.

Restricted short-term bank deposits:

Restricted short-term bank deposits consist of cash balance requirements related to forward contracts to purchase the Israeli Shekel and the Canadian dollar. See Note 10.

 

  e. Marketable securities:

Marketable securities are comprised primarily of bonds issued by government municipalities. These marketable securities covered by FASB ASC Section 320-10-25, “ Investments: Debt and Equity Securities – Overall – Recognition,” were designated as available-for-sale. Accordingly, these securities are stated at fair value, with unrealized gains and losses reported in accumulated other comprehensive income, a separate component of shareholders’ equity.

Realized gains and losses on sale of investments are included in “financial (income) expenses, net” and are derived using the specific identification method for determining the cost of securities.

The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization together with interest and dividends on securities are included in “financial (income) expenses, net.”

The Company recognizes an impairment charge when a decline in the fair value of its investments in debt securities is below the cost basis of such securities is judged to be other-than-temporary. Factors considered in making such a determination include the duration and severity of the impairment, the reason for the decline in value, the potential recovery period and the Company’s intent to sell, including whether it is more likely than not that the Company will be required to sell the investment before recovery of cost basis. For securities that are deemed other-than-temporarily impaired, the amount of impairment is recognized in “financial (income) expenses, net” in the Consolidated Statements of Operations and is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.

During the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, the Company did not own nor sell any marketable securities previously impaired.

 

  f. Allowance for doubtful accounts:

The allowance for doubtful accounts is calculated primarily with respect to specific balances, which, in the opinion of the Company’s management, are doubtful of collection. The allowance, in the opinion of the Company’s management, is sufficient to cover probable uncollectible balances. See Note 4.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  g. Inventories:

Inventories are stated at the lower of cost or net realizable value. Inventory reserves are provided to cover risks arising from slow-moving items, short-dated inventory, excess inventory or obsolescence. Changes in these provisions are charged to cost of sales. Cost is determined as follows:

Raw and packaging materials – average cost basis.

Finished goods and work in progress – average production costs including materials, labor and direct and indirect manufacturing expenses.

Purchased products for commercial purposes – average cost basis.

 

  h. Deferred income taxes:

Deferred income taxes are determined utilizing the “asset and liability” method based on the estimated future tax effects of temporary differences between the financial accounting and tax basis of assets and liabilities under the applicable tax laws, and on tax rates anticipated to be in effect when the deferred taxes are expected to be paid or realized. A valuation allowance is provided if, based upon the weight of available evidence, it is “more likely than not” that a portion of the deferred tax assets will not be realized. Deferred tax liabilities and assets are classified as current or non-current based on the classification of the related asset or liability for financial reporting, or according to the expected reversal dates of the specific temporary differences where appropriate.

 

  i. Property, plant and equipment:

 

  (1) Property, plant and equipment is stated at cost, net of accumulated depreciation. Payroll and other costs that are direct incremental costs necessary to bring an asset to the condition of its intended use incurred during the construction and validation period of property, plant and equipment are capitalized to the cost of such assets.

 

  (2) Interest costs are capitalized in accordance with FASB ASC Subtopic 835-20, “ Interest – Capitalization of Interest.”

 

  (3) Depreciation is calculated utilizing the straight-line method over the estimated useful lives of the assets, from the date the assets are ready for their intended use, at the following annual rates:

 

    

%

Buildings

   2.5 - 10

Machinery and equipment

   5 - 20 (mainly 10)

Motor vehicles

   15 - 20

Furniture, fixtures, office equipment and computer equipment

   6 - 33 (mainly 20)

Leasehold improvements are depreciated using the straight-line method over the shorter of their useful lives or the terms of the leases (generally 5-10 years).

 

  (4) The Group accounts for costs of computer software developed or obtained for internal use in accordance with FASB ASC Subtopic 350-40, “ Intangibles: Goodwill and Other – Internal-Use Software.” FASB ASC Subtopic 350-40 requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software during the application development stage. As of March 31, 2013 and 2012, the Group capitalized $4,609 and $10 of software costs, respectively. Software costs are amortized using the straight-line method over their estimated useful life of three years.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  j. Lease of land from Israel Land Administration:

The Company leases several parcels of land from the Israel Land Administration (“ILA”), which is accounted for pursuant to FASB ASC Subtopic 840-20, “ Leases – Operating Leases.” The lease period of the industrial parcels ends between 2018 and 2058. The Company has the right to extend each of the lease agreements for an additional period of 49 years. The ILA lease agreements are standard agreements covering substantial portions of the land of Israel. The standard agreements call for a Lease Period of 49 years, with an option for one additional Lease Period (i.e., total of 98 years). The ownership of the land is not transferred at the end of the lease period and there is no option to buy the land at the end of such period. The expectation, based on practice and accumulated experience is that the renewal price would be substantially below fair market value. Since such leases do not qualify as a capital lease, they are being accounted for as operating leases. The prepaid lease amount is included in long-term receivables and other assets and amortized over the term of the lease.

 

  k. Goodwill:

The Company follows the provisions of FASB ASC Subtopic 350-20, “ Intangibles: Goodwill and Other – Goodwill.” Goodwill is not amortized, but rather is subject to an annual impairment test (or more frequently if impairment indicators arise).

The Company operates in one operating segment, comprising its only reporting unit. The goodwill impairment tests are conducted in two steps. In the first step, the Company determines the fair value of the reporting unit. If the net book value of the reporting unit exceeds its fair value, the Company would then perform the second step of the impairment test which requires allocation of the reporting unit’s fair value of all of its assets and liabilities in a manner similar to an acquisition cost allocation, with any residual fair value being allocated to goodwill. The implied fair value of the goodwill is then compared to the carrying value to determine impairment, if any.

The Company determined the fair value of a reporting unit using the market approach which is based on the market capitalization by using the share price of the Company in the NYSE stock exchange and an appropriate control premium. As of March 31, 2013 market capitalization of the Company was significantly higher than the net book value of the reporting unit and therefore there was no need to continue to step 2. Taro determined the goodwill was not subject to impairment as of March 31, 2013 and 2012.

 

  l. Contingencies:

The Company is involved in various patent, product liability, consumer, commercial and environmental claims, government investigations, and other legal proceedings that arise from time to time in the ordinary course of business. Except for income tax contingencies, the Company records accruals for these types of contingencies to the extent that the Company concludes their occurrence is probable and that the related liabilities are estimable. The Company records anticipated recoveries under existing insurance contracts that are probable of occurring and at the gross amount that is expected to be collected.

 

  m. Tax contingencies:

FASB ASC 740, “ Income Taxes ” contains a two-step approach to recognizing and measuring a liability for uncertain tax positions. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. In addition, the Company classifies interest and penalties recognized in the financial statements relating to uncertain tax positions under the provision for income taxes. Liability for unrecognized tax benefits was recorded as a result of the implementation of ASC 740 amounted of $6,634 and $13,828 as of March 31, 2013 and 2012, respectively.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  n. Intangible assets and deferred charges and long-lived assets:

Intangible assets and deferred charges:

Acquired intangible assets and product rights to be held and used are not considered to have an indefinite useful life and are amortized over their useful life of a weighted-average amortization period of 14 years using a straight-line method of amortization that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up, in accordance with FASB ASC Topic 350, “ Intangibles-Goodwill and Other .”

Debt issuance costs in respect to long-term loans from institutional investors and bondholders are deferred and amortized under the effective interest method over the term of the loans from institutional investors and bondholders.

Long-lived assets:

The Group’s long-lived assets, excluding goodwill, are reviewed for impairment in accordance with FASB ASC Topic 360, “ Property, Plant and Equipment, ” whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment exists when the carrying amount of the asset exceeds the aggregate future undiscounted cash flows expected to be generated by the asset. The impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the asset. In the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, the Company recorded $969, $0, $784 and $2,617 impairment loss, respectively, as these losses related to the fixed assets of its Irish facility, they were included in discontinued operations.

 

  o. Comprehensive income:

The Company accounts for comprehensive income in accordance with FASB ASC Topic No. 220, “ Comprehensive Income. ” This statement establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income generally represents all changes in shareholders’ equity during the period except those resulting from investments by, or distributions to, shareholders. The Company determined that its items of other comprehensive income relates to gain and loss on hedging derivative instruments, unrealized gains and losses on available for sale securities and foreign currency translation adjustments. In accordance with the changes with the implementation of ASU No. 2011-05, “ Comprehensive Income (Topic 220): Presentation of Comprehensive Income,” and ASU No. 2011-12, “ Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” the Company presents comprehensive income on the consolidated statements of comprehensive income which follows the consolidated statements of operations.

 

  p. Treasury shares:

The Company repurchases its ordinary shares from time to time on the open market and holds such shares as treasury stock. The Company presents the cost to repurchase treasury stock as a reduction of shareholders’ equity.

From time to time the Company may reissue treasury shares upon exercise of options. When treasury stock is reissued, the Company accounts for their issuance in accordance with FASB ASC Subtopic 505-30, “ Equity – Treasury Stock,” and charges the excess of the purchase cost, including related stock-based compensation expenses, over their issuance price (loss) to retained earnings. The purchase cost is calculated based on the specific identification method.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

In cases where the purchase cost is lower than the re-issuance price, the Company credits the difference to additional paid-in capital.

 

  q. Revenue recognition:

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

When the Company recognizes and records revenue from the sale of its pharmaceutical products, the Company, in the same financial reporting period, records an estimate of various future deductions related to the sale. This has the effect of reducing the amount of reported product sales. These deductions include the Company’s estimates, which may require significant judgement of chargebacks, product returns, rebates, cash discounts and other sales deductions.

Chargebacks result from pricing arrangements the Company has with end-user customers establishing contract prices which are lower than the wholesalers’ acquisition costs or invoice prices. When these customers buy the Company’s products from their wholesaler of choice, the wholesaler issues a credit memo (chargeback) to the Company for the difference between the invoice price and the end-user contract price. Chargeback reserves are estimated using current wholesaler inventory data beyond the Company’s control, and historical data.

Product returns result from agreements allowing the Company’s customers to return unsold inventory that is expired or close to expiration. Product return reserves are calculated using the average lag period between sales and product expiry, historical product returns experience, and specific return exposures to estimate the potential obligation for returns of inventory in the distribution channel.

Rebates result from contractual agreements with the Company’s customers and are earned based on the Company’s direct sales to customers or the Company’s customers’ sales to third parties. Rebate reserves from the Company’s direct sales to customers and the Company’s customers’ sales to third parties are estimated using historical and contractual data.

The Company generally offers discounts to its customers for payments within a certain period of time. Cash discount reserves are calculated by multiplying the specified discount percentage by the outstanding receivable at the end of each period.

Reserves for returns, Medicaid and indirect rebates are included in current liabilities. All other sales deductions allowances are recorded as accounts receivable reserves. The reserve for returns is included in current liabilities as substantially all of these returns will not be realized until after the year-end accounts receivable balances are settled. Medicaid and indirect rebates are included in current liabilities because the Company does not have direct customer relationships with any of the payees. See Notes 5 and 12.

The Company offers incentives to certain resellers and retailers through various marketing programs where the Company agrees to reimburse them for advertising costs incurred to include the Company’s products. The Company accounts for these in accordance with FASB ASC Subtopic 605-50, “ Revenue Recognition – Customer Payments and Incentives,” as reductions of revenue unless the customer receives an identifiable benefit in exchange for the consideration that is sufficiently separable from the customer’s purchase of the products and the fair value of the benefits can be reasonably estimated.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  r. Research and development:

Research and development expenses, net of grants received, are charged to expense as incurred. Payments made for research and development services prior to the services being rendered are recorded as prepaid assets on our balance sheet and expensed as provided.

 

  s. Royalty-bearing grants:

Royalty-bearing grants from the government of Israel through the Office of the Chief Scientist for funding approved research and development projects are recognized at the time the Company is entitled to such grants, on the basis of the related costs incurred. The Company did not earn any grants during the year ended March 31, 2013, the three months ended March 31, 2012, or the years ended December 31, 2011 and 2010.

 

  t. Advertising expenses:

The Group expenses advertising costs as incurred. Product samples are recorded within prepaid expense on the consolidated balance sheet and recorded within advertising expenses when provided to potential customers. Advertising expenses were $7,213, $2,166, $7,270 and $6,827 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

  u. Income taxes:

Income taxes are accounted for in accordance with FASB ASC Topic 740, “ Income Taxes”. FASB ASC Topic 740 prescribes the use of the liability method, whereby deferred tax asset and liability account balances are determined for temporary differences between the financial reporting and tax basis of assets and liabilities, and for carryforward losses and credits. Deferred taxes are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. As of March 31, 2013 and 2012, the Company’s management determined that it was more likely than not that the Company will not benefit from the deferred tax assets in the Irish and certain other subsidiaries. Therefore, for these locations a full valuation allowance was provided against the deferred tax assets. In future years, if it is more likely than not that the Company will be in a position to utilize its deferred tax asset, the valuation allowance for such assets may be modified.

 

  v. Sales and other taxes collected and remitted to governmental authorities:

The Company collects various taxes from customers and remits them to governmental authorities. These taxes are recorded on a net basis and therefore do not impact the statement of operations.

 

  w. Basic and diluted net income per share attributable to Taro:

Basic net income per share is calculated based on the weighted-average number of ordinary shares outstanding during each year. Diluted net income per share is calculated based on the weighted-average number of ordinary shares outstanding during each year, plus potential dilutive ordinary shares considered outstanding during the year (except where anti-dilutive), in accordance with FASB ASC Topic 260, “ Earnings per Share.”

 

  x. Freight and distribution costs:

In accordance with FASB ASC Subtopic 605-45, “ Revenue Recognition – Principal Agent Considerations,” the Company’s accounting policy is to classify shipping and handling costs as a part of sales and marketing expense. Freight and distribution costs and distribution warehousing costs related to shipping and handling to customers, primarily through the use of common carriers or external distribution services amounted to $9,830, $2,537, $8,169 and $11,689 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  y. Accounting for stock-based compensation:

The Company recognizes compensation expense in accordance with FASB ASC Topic 718, “ Compensation: Stock Compensation,” for the value of its awards granted subsequent to January 1, 2006, based on the straight-line method over the requisite service period of each of the awards, net of estimated forfeitures. FASB ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Estimated forfeitures are based on actual historical pre-vesting forfeitures. Upon the adoption of FASB ASC Topic 718, the expected life of the option is estimated using the “simplified” method as provided in Staff Accounting Bulletin (“SAB”) 107. Under this method, the expected life equals the arithmetic average of the vesting term and the original contractual term of the option. On December 21, 2007, the SEC issued SAB No. 110 (“SAB 110”), codified as Topic 14.D.2 which, effective January 1, 2008, amends and replaces SAB 107. The Company currently uses the simplified method as adequate historical experience is not available to provide a reasonable estimate. The Company adopted SAB 110 effective January 1, 2008 and will continue to apply the simplified method until sufficient historical experience is available to provide a reasonable estimate of the expected term for stock option grants.

Stock Options : The Company did not grant any options for the year ended March 31, 2013, the three months ended March 31, 2012 or the years ended December 31, 2011 and 2010.

The Company applies FASB ASC Subtopic 505-50, “Equity—Equity-Based Payments to Non-Employees” with respect to options issued to non-employees. FASB ASC Subtopic 505-50 requires the use of option valuation models to measure the fair value of the options granted. Compensation expense to non-employees was not material.

Estimated forfeitures are based on estimates for the year ended March 31, 2013, the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010.

 

  z. Concentrations of credit risk:

Financial instruments that potentially subject the Group to concentrations of credit risk consist principally of cash and cash equivalents, bank deposits and trade receivables. Cash and cash equivalents and bank deposits are principally invested in major banks in Israel, the United States, Canada and the Cayman Islands. Such deposits in the United States may be in excess of insured limits and are not insured in other jurisdictions. Management believes that the financial institutions that hold the Group’s cash and cash equivalents and bank deposits are financially sound and that low credit risk therefore exists with respect to these financial instruments. These deposits may be redeemed upon demand and, therefore, bear minimal risk.

The Group’s trade accounts receivables are mainly derived from sales to customers in the United States, Canada, Europe and Israel. At March 31, 2013, four different customers represented approximately 19.2%, 18.7%, 11.5% and 10.3% of the Company’s trade accounts receivable. The Group has adopted credit policies and standards intended to mitigate inherent risk while accommodating sales growth. The Group performs ongoing credit evaluations of its customers’ financial condition when deemed necessary, but does not require collateral for its customers’ accounts receivable.

 

  aa. Fair value of financial instruments:

The carrying amounts of cash and cash equivalents, bank deposits, trade and other receivables and trade and other payables approximate their fair value, due to the short-term maturities of these instruments.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

The carrying amount of long-term bank deposits approximates their fair value because such deposits bear market interest rates.

The carrying amounts of the Group’s borrowing arrangements under its debt agreements approximate their fair value since the loans bear interest at rates that approximate the Group’s incremental borrowing rates for similar types of borrowing arrangements.

The fair value of currency and interest rate contracts is determined by discounting to the present all future cash flows of the currencies to be exchanged at interest rates prevailing in the market for the period the currency exchanges are due and expressing the results in U.S. dollars at the current spot foreign currency exchange rate.

 

  bb. Accounting for derivatives:

FASB ASC Topic 815, “ Derivatives and Hedging,” requires companies to recognize all of their derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes (i.e., gains or losses) in the fair value of a derivative instrument depends on whether the instrument has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. For derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For derivatives which qualify as a fair value hedge, changes in fair value are reported with the carrying amount of the hedged asset or liability with cash flows reported on the consolidated statement of cash flows consistent with the classification of cash flows from the underlying items being hedged. For derivatives that qualify as a cash flow hedge, the effective portion of these derivatives’ fair value is initially reported as a component of other comprehensive income with cash flows reported on the consolidated statement of cash flows consistent with the classification of cash flows from the underlying items being hedged. The designation is based upon the nature of the exposure being hedged. At March 31, 2013 and 2012, no derivative instruments were designated as hedging instruments.

For derivative instruments not designated as hedging instruments, the gain or loss is recognized in financial income/expense, net in the consolidated statement of operations during the period of change with the cash flows reported on the consolidated statements of cash flows consistent with the classification of cash flows from the underlying items being hedged. See Note 10.

 

  cc. Fair value measurements:

The Company adopted FASB ASC Topic 820, “ Fair Value Measurements and Disclosures” which provides a fair value hierarchy that distinguishes between assumptions based on market data obtained from independent sources (observable inputs) and those based on an entity’s own assumptions (unobservable inputs). FASB ASC Topic 820 also requires additional disclosure about fair value measurements.

 

  dd. Discontinued operations:

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

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  ee. Impact of recently issued accounting standards:

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

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

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

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

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

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

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 3: — SHORT-TERM INVESTMENTS

 

  a. The following is a summary of marketable securities which are classified as available-for-sale:

 

     March 31,  
     2013      2012  
     Amortized
cost
     Unrealized
gain
     Market
value
     Amortized
cost
     Unrealized
gain
     Market
value
 

Available-for-sale:
Government debentures

   $ 3,134       $ 49       $ 3,183       $ 7,810       $ 25       $ 7,835   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  b. The estimated fair value of available-for-sale investments as of March 31, 2013 and 2012 by contractual maturity, are as follows:

 

     March 31,  
     2013      2012  
     Cost      Market
Value
     Cost      Market
Value
 

Available-for-sale government debentures:

           

Matures in one year

   $ —         $ —         $ 4,913       $ 4,913   

Matures in more than five years

     3,076         3,183         2,848         2,922   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,076       $ 3,183       $ 7,761       $ 7,835   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 4: — ACCOUNTS RECEIVABLE AND OTHER

 

  a. Trade, net:

The following tables summarize the impact of accounts receivable reserves and allowance for doubtful accounts on the gross trade accounts receivable balances at each balance sheet date:

 

     March 31,  
     2013     2012  

Trade accounts receivable, gross

   $ 237,013      $ 201,354   

Reserves for sales deductions:

    

Chargebacks

     (22,792     (20,789

Customer rebates

     (32,005     (31,774

Other sales deductions

     (62,288     (37,547

Allowance for doubtful accounts

     (118     (114
  

 

 

   

 

 

 

Trade accounts receivable, net

   $ 119,810      $ 111,130   
  

 

 

   

 

 

 

 

  b. Other receivables and prepaid expenses:

 

     March 31,  
     2013      2012  

Prepaid expenses

   $ 8,003       $ 8,526   

Deferred income taxes

     104,509         85,020   

Government authorities

     1,515         1,017   

Advances to suppliers

     861         121   

Derivative instruments

     3,643         3,134   

Other

     1,237         683   
  

 

 

    

 

 

 
   $ 119,768       $ 98,501   
  

 

 

    

 

 

 

NOTE 5: — SALES INCENTIVES

When the Company recognizes and records revenue from the sale of its pharmaceutical products, it records an estimate in the same financial reporting period for product returns, chargebacks, rebates and other sales deductions, which are reflected as reductions of the related gross revenue. The Company regularly monitors customer inventory information at its three largest wholesale customers to assess whether any excess product inventory levels may exist. The Company reviews this information together with historical product and customer experience, third-party prescription data, industry and regulatory changes and other relevant information and revises its estimates as necessary.

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

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

The Company considers all information available subsequent to the balance sheet date, but before the issuance of the financial statements, that provides additional evidence with respect to conditions existing at the balance sheet date and adjusts the reserves accordingly.

Product returns:

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

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

Chargebacks:

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

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

Rebates and other deductions:

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

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

As discussed above, the Company believes it has the experience and information that it believes are necessary to reasonably estimate the amounts of reserves for its sales incentives programs. Several of the assumptions used by the Company for certain estimates are based on information received from third parties, such as wholesale customer inventory levels, market data, and other factors beyond the Company’s control. The most critical estimates in determining these reserves, and the ones therefore that would have the largest impact if these estimates were not accurate, are related to contract sales volumes, average contract pricing, customer inventories and return volumes. The Company regularly reviews the information related to these estimates and adjusts its reserves accordingly, if and when actual experience differs from previous estimates.

Use of estimates in reserves:

The Company believes that its reserves, allowances and accruals for items that are deducted from gross revenue are reasonable and appropriate based on current facts and circumstances. Changes in actual experience or changes in other qualitative factors could cause the Company’s allowances and accruals to fluctuate, particularly with newly launched or acquired products. The Company regularly reviews the rates and amounts in its reserve estimates. If future estimated rates and amounts are significantly greater than those reflected in the Company’s recorded reserves, the resulting adjustments to those reserves would decrease the Company’s reported net revenue; conversely, if actual product returns, rebates and chargebacks are significantly less than those reflected in the Company’s recorded reserves, the resulting adjustments to those reserves would increase the Company’s reported net revenue. If the Company were to change its assumptions and estimates, its reserves would change, impacting the net revenue that the Company reports. The Company regularly reviews the information related to these estimates and adjusts its reserves accordingly, if and when actual experience differs from previous estimates.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

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

 

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

Accounts Receivable Reserves

         

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

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

Accounts Receivable Reserves

         

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

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

Accounts Receivable Reserves

         

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 
     For the year ended December 31, 2010               
     Beginning balance     Provision recorded
for current period sales
    Credits processed/
Payments
     Ending balance  

Accounts Receivable Reserves

         

Chargebacks

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

Rebates and Other

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

Current Liabilities

         

Returns

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

Other (1)

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

 

 

   

 

 

   

 

 

    

 

 

 

Total

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

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) Includes indirect rebates.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 6: — INVENTORIES

 

                                     
     March 31,  
     2013      2012  

Raw and packaging materials

   $ 33,293       $ 34,678   

Finished goods

     48,549         51,430   

Work in progress

     21,079         17,595   

Purchased products for commercial purposes and other

     6,705         5,935   
  

 

 

    

 

 

 
   $ 109,626       $ 109,638   
  

 

 

    

 

 

 

As of March 31, 2013 and 2012, reserves recorded against inventories for slow-moving, short-dated, excess and obsolete inventory totaled $15,274 and $17,406, respectively.

As of March 31, 2013 and 2012, there were no pledges of inventory.

NOTE 7: — PROPERTY, PLANT AND EQUIPMENT

 

  a. Composition of assets grouped by major classifications are as follows:

 

                                     
     March 31,  
     2013      2012  

Cost:

     

Land

   $ 8,905       $ 9,607   

Buildings

     144,038         142,411   

Leasehold improvements

     1,757         3,270   

Machinery and equipment

     157,086         151,734   

Computer equipment

     33,621         33,253   

Motor vehicles

     220         236   

Furniture, fixtures and office equipment

     9,148         9,065   

Advances for property and equipment

     1,333         260   
  

 

 

    

 

 

 
     356,108         349,836   
  

 

 

    

 

 

 

Accumulated depreciation and impairment charges:

     

Buildings

   $ 47,987       $ 43,280   

Leasehold improvements

     1,750         3,214   

Machinery and equipment

     121,044         113,315   

Computer equipment

     32,485         31,843   

Motor vehicles

     152         231   

Furniture, fixtures and office equipment

     7,425         7,203   
  

 

 

    

 

 

 
     210,843         199,086   
  

 

 

    

 

 

 

Depreciated cost

   $ 145,265       $ 150,750   
  

 

 

    

 

 

 

 

  a. Depreciation expenses were $14,329, $3,731, $15,154 and $15,745 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively. For related impairment charges, see Note 2.m.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  b. Cost of property, plant and equipment includes capitalized interest expense, capitalized direct incremental costs (such as payroll and related expenses) and other internal costs incurred in order to bring the assets to their intended use in the amount of $16,832 as of March 31, 2013 and 2012. There were no additional capitalized interest and other costs as of March 31, 2013 and 2012, respectively.

 

  c. Cost of computer equipment includes capitalized development costs of computer software developed for internal use in the amount of $4,609 and $4,699 as of March 31, 2013 and 2012, respectively.

 

  d. As for pledges – see Note 14.

NOTE 8: — INTANGIBLE ASSETS AND DEFERRED COSTS

 

  a. Composition:

 

     March 31,  
     2013      2012  

Cost:

     

Product and distribution rights

   $ 73,961       $ 73,438   

Deferred charges in respect of loans and bonds from institutional investors

     193         194   

Other deferred costs

     1,541         1,541   
  

 

 

    

 

 

 
     75,695         75,173   
  

 

 

    

 

 

 

Accumulated amortization and impairment charges:

     

Product and distribution rights

     58,366         55,168   

Deferred charges in respect of loans and bonds from institutional investors

     187         179   

Other deferred costs

     1,535         1,518   
  

 

 

    

 

 

 
     60,088         56,865   
  

 

 

    

 

 

 

Amortized cost

   $ 15,607       $ 18,308   
  

 

 

    

 

 

 

 

  b. Amortization expenses related to product and distribution rights were $3,436, $867, $3,576 and $3,083 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

  c. As of March 31, 2013, the estimated amortization expense of product and distribution rights for 2014 to 2018 is as follows: 2014—$3,382; 2015—$3,134; 2016—$3,007; 2017—$3,004; 2018—$2,330.

 

  d. The weighted-average amortization period for product rights is approximately 6 years.

 

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Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 9: — LONG-TERM RECEIVABLES AND OTHER ASSETS

 

     March 31,  
     2013      2012  

Prepayment of land leased from Israel Land Administration (1)

   $ 13,682       $ 13,903   

Long-term deposits

     5,000         —     

Derivative instruments (2)

     1,767         2,866   

Severance pay fund (3)

     2,594         2,939   

Long-term security deposit

     133         218   

Other

     51         46   
  

 

 

    

 

 

 
   $ 23,227       $ 19,972   
  

 

 

    

 

 

 

 

(1) The land is leased for a period of 49 years and is subject to renewal. This amount was prepaid. See Note 2.j.
(2) See Note 10.
(3) Under Israeli law, the Company and its Israeli subsidiaries are required to make severance or pension payments to dismissed employees and to employees terminating employment under certain other circumstances. Deposits are made with a pension fund or other insurance plans to secure pension and severance rights for the employees in Israel. These amounts represent the balance of the deposits in those funds (including profits) that will be used to cover the Company’s severance obligations. See Note 12.b.

The Company’s non-Israeli subsidiaries maintain defined contribution retirement savings plans covering substantially all of their employees. Under the plans, contributions are based on specific percentages of pay and are subject to statutory limits. The subsidiaries’ matching contribution to the plan was approximately $987, $233, $861 and $839 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

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

Pension, retirement savings and severance expenses

   $ 6,009       $ 1,690       $ 6,765       $ 7,614   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 10: — DERIVATIVE INSTRUMENTS AND FINANCIAL RISK MANAGEMENT

The Company’s operations are exposed to market risks from changes in interest rates and currency exchange rates. Exposure to these risks is managed through normal operating and financing activities and, when appropriate, through derivative instruments.

 

  a. Interest rates:

The Company manages its risk to fluctuating interest rates by opportunistically using interest rate swaps to convert its floating rate debt into fixed rate obligations. These interest rate swaps are not designated as hedges and changes in the fair value of these instruments are reflected in earnings.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

In September 2005, the Company entered into a mortgage agreement for its New York facility and concurrently entered into an interest rate swap with the intention to mitigate the variable mortgage interest rate risk by effectively establishing the mortgage rate at a fixed rate of 6.16%. At March 31, 2013 and 2012, the fair market value of the swap was a liability of $1,206 and $1,333, respectively, and was recorded in other long-term liabilities on the consolidated balance sheet. The Company recorded an unrealized gain (loss) of $127, $91, ($303) and ($268) within financial expenses, net for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively. See Note 13.a.2.

 

  b. Currency exchange rates:

The Company manages its exposure to debt obligations denominated in currencies other than its functional currency by opportunistically using cross-currency swaps to convert its foreign currency debt payments into its functional currency. These cross-currency swaps are not designated as hedges and changes in fair value of these derivatives are reflected in earnings.

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

 

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

Period ended

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

3/31/2012

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

3/31/2013

     1.27     0.99     (1.80 %)      1.65     3.65         1.02   

 

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

From July 1999 to November 2000, the Company issued $24,000 of CPI plus 8.25% bonds denominated in NIS with terms of 10 years. At the same time, the Company entered into 9-10 year cross-currency swaps in which the Company received CPI plus 6% to 8.25% in NIS and paid LIBOR plus 0.6% to 3.3% in USD, based on the outstanding amount of the bonds. The last tranche of bonds matured in November 2010 along with the corresponding swaps. For the year ended December 31, 2010, a net gain of $102 was recorded within financial expenses, net for these swaps.

In November 2003, the Company entered into loan agreements to borrow, in Israel, NIS 210,800 for an eleven-year term at an annual interest rate of 5.8%. At the same time, the Company entered into a USD/NIS, 5-year, CPI-adjusted currency swap in which it will receive at the end of the period the NIS amount linked to the CPI plus interest equal to 5.8% of the outstanding NIS balance, and will pay $47,190 plus a fixed rate of 5.9%. This swap matured on November 28, 2008, and was replaced on the maturity date by a USD/NIS, CPI-adjusted, 6-year currency swap. In accordance with this swap agreement, the Company will receive NIS 201,270 in six annual payments (equivalent of the remaining debt balance as of November 28, 2008), which is linked to the CPI plus additional interest equal to 5.8% of the outstanding NIS balance. The Company is required to pay $51,344 plus a fixed rate of 6.59%. At March 31, 2013, the fair market value of the swap was $3,431 comprised of a $1,664 asset (recorded in other receivables and prepaid expenses) and a $1,767 asset (recorded in long-term receivables and other assets). At March 31, 2012, the fair market value of the swap was $4,163 comprised of a $1,297 asset (recorded in other receivables and prepaid expenses) and a $2,866 asset (recorded in long-term receivables and other assets). The Company recorded net gains of $255, $998, $2,892 and $3,356 within financial expenses, net for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

In October 2011, the Company entered into separate forward contracts to purchase the Israeli Shekel and the Canadian dollar on a monthly basis at agreed upon spot rates to hedge the variability of cash flows in U.S. dollars due to changes in the respective exchange rates. The forward contract to purchase the Shekel is for a total amount of $41,042 which is settled in monthly installments of $3,958 for the first five months and $3,542 for the remaining six months. The Company recorded a gain (loss) of $990, $1,035 and ($1,705) for the year ended March 31, 2013, the three months ended March 31, 2012 and the year ended December 31, 2011, respectively, for this contract. The forward contract to purchase the Canadian dollar is for a total amount of $96,100 which is settled in monthly installments of $9,300 for the first five months and $8,267 for the remaining six months. The Company recorded a net (loss) gain of ($1,303), $1,649 and $822 for the year ended March 31, 2013, the three months ended March 31, 2012 and the year ended December 31, 2011, respectively, for this contract.

NOTE 11: — FAIR VALUE MEASUREMENTS

FASB ASC Topic 820 defines fair value as the price that would be received for an asset or paid to transfer a liability, from a selling party’s perspective, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC Topic 820 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1: Quoted market prices in active markets for identical assets and liabilities. Active market means a market in which transactions for assets or liabilities occur with “sufficient frequency” and volume to provide pricing information on an ongoing unadjusted basis.

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company’s Level 2 assets primarily include derivative instruments. The Level 2 asset values are determined using valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and consider counterparty credit risk in the assessment of fair value.

Level 3: Unobservable inputs that are not corroborated by market data. The Company has no Level 3 assets or liabilities.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

The fair value of the Company’s financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2013 and 2012 were as follows:

 

                                                                          
     March 31, 2013  
     Quoted Market Prices
of Identical Assets (Level 1)
     Significant Other
Observable Inputs (Level 2)
     Significant Unobservable
Inputs (Level 3)
 

Assets

        

Marketable securities

   $ 3,183       $ —         $ —     

Forward contracts

     —           1,979         —     

Cross-currency swaps

     —           3,431         —     
  

 

 

    

 

 

    

 

 

 
   $ 3,183       $ 5,410       $ —     
  

 

 

    

 

 

    

 

 

 

Liabilties

        

Interest rate swap

   $ —         $ 1,206       $ —     

Forward contracts

     —           1,318         —     
  

 

 

    

 

 

    

 

 

 
   $ —         $ 2,524       $  —     
  

 

 

    

 

 

    

 

 

 
     March 31, 2012  
     Quoted Market Prices      Significant Other      Significant Unobservable  
     of Identical Assets (Level 1)      Observable Inputs (Level 2)      Inputs (Level 3)  

Assets

        

Marketable securities

   $ 7,835       $ —         $ —     

Forward contracts

     —           1,837         —     

Cross-currency swaps

     —           4,163         —     
  

 

 

    

 

 

    

 

 

 
   $ 7,835       $ 6,000       $ —     
  

 

 

    

 

 

    

 

 

 

Liabilties

        

Interest rate swap

   $ —         $ 1,333       $ —     

Forward contracts

     —           237         —     
  

 

 

    

 

 

    

 

 

 
   $ —         $ 1,570       $ —     
  

 

 

    

 

 

    

 

 

 

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 12: — OTHER LIABILITIES

 

  a. Other current liabilities:

 

                                           
     March 31,  
     2013      2012  

Returns reserve

   $ 49,701       $ 33,426   

Due to customers

     497         459   

Employees and payroll accruals

     16,667         15,524   

Deferred revenue

     351         —      

Medicaid and indirect rebates

     27,200         33,378   

Accrued income taxes

     20,055         68,507   

Legal and audit fees

     1,206         658   

Settlements and loss contingencies

     30,000         —     

Accrued expenses

     7,682         7,091   

Interest payable

     458         639   

Deferred taxes

     326         302   

Derivative instruments

     1,318         237   

Other royalties

     3,488         2,774   

Other

     2,865         1,970   
  

 

 

    

 

 

 
   $ 161,814       $ 164,965   
  

 

 

    

 

 

 

 

  b. Other long-term liabilities:

 

                                           
     March 31,  
     2013      2012  

Accrued severance pay

   $ 2,730       $ 3,020   

Interest rate swap

     1,206         1,333   

Accrued taxes

     60         60   
  

 

 

    

 

 

 
   $ 3,996       $ 4,413   
  

 

 

    

 

 

 

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 13: — LONG-TERM DEBT

 

  a. Composed as follows:

 

                                           
     March 31,  
     2013      2012  

Loans from institutional investors and bonds (1)

   $ 21,047       $ 30,597   

Mortgage for U.S. headquarters facility (2)

     7,552         8,309   
  

 

 

    

 

 

 
     28,599         38,906   
  

 

 

    

 

 

 

Less: current maturities

     11,330         10,957   
  

 

 

    

 

 

 
   $ 17,269       $ 27,949   
  

 

 

    

 

 

 

 

(1) In 2003, the Company entered into two series of loan agreements, subsequently amended, with multiple lenders in Israel. At March 31, 2013, the outstanding loans are comprised of $842 (issued in U.S. dollars) at an interest rate of 6.1% with the remaining loans of $20,205 (issued in NIS) at a rate of Israeli CPI plus 5.8%. The debentures mature in November 2014. The debentures provide certain undertakings, including (i) not to encumber any of its assets, unless to secure indebtedness, as defined in such agreements, which in the aggregate does not exceed $20,000, or unless to encumber newly acquired assets to secure financing provided to acquire such assets, and (ii) not to incur any additional indebtedness as long as the ratio of EBITDA to total net interest expense and current principal payable on long-term indebtedness is less than 2:1. The test is based on the Company’s audited financial statements, and is performed on April 1 of each year with respect to the prior calendar year.
(2) In 2005, Taro U.S.A. and two of its subsidiaries entered into obligations, secured by mortgages on the Company’s U.S. headquarters facility located in New York and distribution facility located in New Jersey (subsequently retired in February 2012). The Company guaranteed these obligations. The mortgage on the New York facility was $7,552 and $8,309 as of March 31, 2013 and 2012, respectively, was for an original term of 15 years, bears interest at the rate of LIBOR plus 1.25%, and has a graduating debt service coverage ratio covenant of 1.90. At March 31, 2013 and 2012, the debt service coverage ratio was 2.20 and 2.15, respectively. The interest rate of this mortgage is effectively fixed at 6.16%, as the Company has an interest rate swap in place which is concurrent with the 15-year term of the mortgage. As of March 31, 2013, the Company is in compliance with all of its covenants.

 

  b. Classified by currency, linkage terms and interest rates, the total amount of the liabilities (including current maturities and the reclassified short-term portion) is as follows:

 

                                                                           
     Weighted-Average Interest Rate     Amount  
     March 31,     March 31,  
     2013     2012     2013      2012  

In, or linked to, U.S. dollars (1)

     1.96     2.15   $ 8,394       $ 9,574   

In Israeli currency – linked to CPI

     5.80     5.80     20,205         29,332   
      

 

 

    

 

 

 
       $ 28,599       $ 38,906   
      

 

 

    

 

 

 

 

(1) Includes loans in the amount of $7,552 and $8,309 as of March 31, 2013 and 2012, respectively, which are subject to variable interest rates linked to LIBOR. The remaining outstanding debt is subject to fixed interest rates.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  c. The debt matures as follows:

 

     March 31,
2013
 

3/31/2014

   $ 11,330   

3/31/2015

     11,381   

3/30/2016

     912   

3/31/2017

     969   

3/31/2018

     1,031   

Thereafter

     2,976   
  

 

 

 
   $ 28,599   
  

 

 

 

As of the date of these financial statements, the Company has met all of its scheduled debt obligations.

For collateral, see Note 14.

NOTE 14: — LIABILITIES COLLATERALIZED BY PLEDGES

Balance of liabilities collateralized by pledges is as follows:

 

     March 31,  
     2013      2012  

Long-term debt (including current maturities) (1)

   $ 7,552       $ 8,309   
  

 

 

    

 

 

 

 

(1) Includes mortgages secured by facilities in the U.S.A.

For further discussion of collateralized assets see Note 13a (2).

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 15: — COMMITMENTS AND CONTINGENT LIABILITIES

 

  a. Companies of the Group have leased offices, warehouse space and equipment under operating leases for periods through 2016. The minimum annual rental payments, under non-cancelable lease agreements, are as follows:

 

     March 31,  
     2013  

3/31/2014

   $ 2,071   

3/31/2015

     1,560   

3/30/2016

     708   
  

 

 

 
   $ 4,339   
  

 

 

 

Total rent expenses were $3,479, $921, $3,755 and $3,285 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

  b. Royalty commitments:

The Company is committed to pay royalties at the rate of 3.0% to 3.5% to the government of Israel through the Office of the Chief Scientist (“OCS”) on proceeds from sales of products in which the government participates in the research and development by way of grants. The obligation to pay these royalties is contingent on actual sales of the products and, in the absence of such sales, no payment is required. The commitment is on a product by product basis, in an amount not exceeding the total of the grants received by the Company, including interest accrued thereon, and is linked to the U.S. dollar. Commencing in 1999, grants are subject to interest at a rate of LIBOR (cost of borrowing funds in U.S. dollars). As of March 31, 2013 and 2012, the aggregate contingent liability to the OCS was $10,972 and $10,735, respectively.

Royalty payments to the OCS were $0, $0, $736 and $990 for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively.

 

  c. Legal proceedings:

From time to time the Company is subject to litigation arising in the ordinary course of business. The Company records a provision in its financial statements to the extent that it concludes that a contingent liability is probable and the amount thereof is estimable. Based upon the status of these cases, management’s assessment of the likelihood of damages, and the advice of counsel, no provisions have been made except as noted below. Because litigation outcomes and contingencies are unpredictable, and because excessive verdicts can occur, these assessments involve complex judgements about future events and can rely heavily on estimates and assumptions. The Company is party to certain lawsuits disclosed herein; whose outcome the Company does not believe will have a material adverse effect on its consolidated financial statements.

 

  1. Legal actions commenced by the Company:

 

  i.

Company’s lawsuit related to Ovide ® (malathion) Lotion:

On April 28, 2011, the Company filed a lawsuit against Suven Life Sciences Ltd. (“Suven”) in the United States District Court of New Jersey for infringement of its United States Patent No. 7,560,445 covering its Ovide ® (malathion) Lotion, 0.5%. The suit alleges that Suven’s ANDA seeking approval from the FDA to sell its own malathion lotion infringes Taro’s patent.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  2. Litigation related to Israeli taxation:

 

  i. The Company challenged a tax assessment by the Israel Income Tax Authority (“ITA”) on certain options granted in 1992 to certain officers of Taro U.S.A. The ITA claimed that taxes should have been withheld by the Company and assessed a payment of approximately $34,000 nominal amount of tax and approximately $19,000 in interest and other charges to be paid by Taro. In January 2008, the Company filed an appeal against the assessment with the Haifa District Court. In addition, applications for the conduct of Mutual Agreement Proceedings (“MAP”) pursuant to the Israel-United States tax treaty with respect to this matter have been filed both with the Israel Tax Authority and the U.S. Internal Revenue Service. MAP proceedings are intended to resolve matters of double taxation; the Company itself is not a party to those MAP proceedings. The Company and the ITA reached an agreement related to the tax assessment and the Company paid the ITA NIS 7,500 on October 5, 2011.

 

  3. Other Legal Actions:

On November 10, 2004, the Company was sued in the Superior Court of New Jersey in Atlantic County along with other defendants in a purported class action lawsuit for alleged personal injuries related to defendants’ sale of amiodarone. On June 9, 2010, the class action case was dismissed with prejudice, with a window of 150 days for individual claimants to file lawsuits. Only one suit was commenced against the Company. In early 2011, an agreement to resolve this matter was reached which had no material impact on the Company’s financial position.

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

Taro is party to two actions brought against various pharmaceutical manufacturers in the States of Utah and Louisiana that relate to drug price reporting by manufacturers, as well as one investigative demand brought by a third State. In May 2008, the State of Utah filed a lawsuit against the Company and a number of other pharmaceutical manufacturers and in November 2010, the State of Louisiana filed a lawsuit in state court against the Company and a number of other pharmaceutical manufacturers. Generally speaking, the lawsuits allege that the defendants caused the State to overpay pharmacies under the State Medicaid Program by reporting inflated published prices (average wholesale prices or “AWP”). The Utah trial court dismissed the case with prejudice in February 2010. However, in March 2010, the plaintiff appealed the decision and the Utah Supreme Court issued its decision in June 2012. The ruling generally affirmed that the complaint by the plaintiff is inadequate and the State was given leave by the court to re-plead its case, which it did. A motion to dismiss filed by the defendants in this case is currently pending before the court. In the Louisiana action, the parties are currently in the discovery phase of the litigation. During the year ended March 31, 2013, the Company recorded a provision of $30 million as management’s best estimate of potential litigation and related costs to these AWP-related matters.

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

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

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

 

  d. In 2008, the Company entered into severance agreements tied to a change in control, with certain executives whereby each executive would receive salary and benefits for a period of time if terminated after a change in control. In November 2010 and April 2011, the Company terminated the employment of certain of these executives.

 

  e. On April 29, 2011, the Board ratified a collective bargaining agreement dated as of April 6, 2011 (the “Agreement”) among Taro, the Histadrut Trade Union and Taro’s Employees Committee on behalf of Taro’s Israeli employees. The Agreement has a term of five years and automatically renews for two-year periods unless notice is provided by either side prior to the end of a term. The Agreement memorializes current employee-employer relations practices of Taro as well as additional rights relating to job security, compensation and other benefits. Additionally, the Agreement, inter alia, provided for a one-time payment of $1,500 (payable in NIS) to be divided among Taro’s Israeli employees as of the date of the Agreement.

 

  f. Licensing Agreements:

 

  1.

In May 2010, Taro and Quinnova Pharmaceuticals, Inc. (“Quinnova”) entered into an agreement under which Taro manufactured and Quinnova co-promoted Taro’s Topicort ® and desoximetasone products. The parties mutually agreed to terminate the agreement in January 2011.

 

  2. In May 2010, Taro and Glenmark Generics Inc., USA, a wholly owned subsidiary of Glenmark Generics Ltd., India (“Glenmark”), entered into an exclusive license and supply agreement for a branded product. Glenmark manufactures the product and Taro distributes the product to customers. Taro made an up-front payment of $2,500 for distribution rights and an additional payment of $2,500 upon the first shipment to customers, for a total of $5,000, which is being amortized over six years. Taro also pays royalties based on the amounts of sales to its customers.

 

  3.

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

 

  g. Other:

Payments to pharmacies for Medicaid-covered outpatient prescription drugs are set by the states. For multiple source drugs with respect to which FDA has rated at least three drugs as therapeutically equivalent, the amount that states may reimburse pharmacies is subject to a Federal upper limit (FUL) ceiling. Health care reform legislation enacted in March 2010 changed the methodology by which the Centers for Medicare & Medicaid Services (CMS) calculates the

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

FULs so that the FUL is based on 175 percent of the weighted-average of the average manufacturer prices (AMPs) reported to the government by manufacturers of each of the therapeutically equivalent multiple source drugs. The change in FUL methodology has not been implemented yet by CMS, but is expected to be implemented in the near future. Effective October 1, 2010, the legislation also changed the definition of AMP to exclude sales to certain customer classes that were previously included. In addition, under the Medicaid Drug Rebate Program, manufacturers are required, as a condition of Federal payment for their drugs under Medicaid and Medicare Part B, to pay rebates to state Medicaid programs on drugs dispensed to Medicaid beneficiaries in the state. The amount of the rebate is based on the AMP and (for innovator drugs) the best price of the drug. Besides changing the definition of AMP, the health care reform legislation increased the minimum Medicaid Rebate, effective January 1, 2010.

Pending implementation of the new FUL methodology, CMS has been using Average Wholesaler Price (“AWP”) or Wholesaler Acquisition Cost (“WAC”) in the calculation of FULs. States have also historically used AWP or WAC in setting Medicaid reimbursement rates for drugs. Many pharmaceutical companies have been named in civil lawsuits alleging generally that the defendants overstated AWPs or WACs, which were used by state agencies to calculate drug reimbursements to healthcare providers.

NOTE 16: — SHAREHOLDERS’ EQUITY

 

  a. Pertinent rights and privileges of ordinary shares:

 

  1. 100% of the rights to profits are allocated to the ordinary shares.

 

  2. 100% of the dissolution rights are allocated to the ordinary shares.

 

  3. Two-thirds of the voting power of all of the Company’s shares is allocated to the ordinary shares.

 

  b. Founders’ shares:

One-third of the voting power of all of the Company’s shares is allocated to the founders’ shares.

 

  c. Stock option plans:

 

  1. The Company’s 1991 Stock Incentive Plan provided for the issuance of incentive stock options, non-qualified stock options, or stock appreciation rights to key employees and associates of the Group.

The options were granted with an exercise price equal to 100% of the fair market value of the stock on the date of grant, and none of the options granted include stock appreciation rights. The options were granted to employees and associates, have a four-year graded vesting term and expire ten years after the date of the grant. Each option entitles its holder the right to purchase one ordinary share. As of March 31, 2013 and 2012, an aggregate of 0 and 6,425 options in respect of the 1991 plan were outstanding, respectively, and no further options in respect of the 1991 plan are available for future grants. The Company issues new shares to employees and associates exercising their stock options.

 

  2. The Company’s 1999 Stock Incentive Plan (“1999 plan”) provides for the issuance of incentive stock options, non-qualified stock options, or stock appreciation rights to key employees and associates of the Group.

The options are substantially granted with an exercise price equal to 100% of the fair market value of the stock on the date of grant and the aggregate amount of the options granted may not exceed 2,100,000 and none of the options granted include stock appreciation rights. The options were granted to employees and associates, have a

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

four to five-year graded vesting term and expire ten years after the date of the grant. Each option entitles its holder the right to purchase one ordinary share of NIS 0.0001 par value (subject to adjustments). As of March 31, 2013 and 2012, an aggregate of 25,500 and 322,630 options in respect of the 1999 plan were outstanding, respectively, and no further options in respect of the 1999 plan are available for future grants. The Company issues new shares to employees and directors exercising their stock options.

 

  3. A summary of the Company’s stock option activity (except options to non-employees) and related information for the year ended March 31, 2013 is as follows:

 

                                                                                                             
     Number of
options
    Exercise
price
     Weighted-
average
exercise
price
     Weighted-
average remaining
contractual terms
     Aggregate
intrinsic value
 
                         (in years)         

Outstanding at March 31, 2012

     329,055      $ 2.38—$68.51       $ 25.99         

Exercised

     (291,555   $ 2.38—$54.53       $ 22.58         

Forfeited

     (12,000   $ 39.03—$68.51       $ 52.66         

Granted

     —        $ —          $ —            
  

 

 

            

Outstanding at March 31, 2013

     25,500      $ 24.68—$68.51       $ 52.32         0.89       $ 220   
  

 

 

            

Exercisable at March 31, 2013

     25,500         $ 52.32         0.89       $ 220   
  

 

 

            

Vested at March 31, 2013

     25,500         $ 52.32         0.89       $ 220   

There were 291,555, 500, 32,775 and 44,975 options exercised in the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, respectively, with a total intrinsic value of approximately $5,286, $12, $378 and $410, respectively.

As of March 31, 2013, the compensation costs related to share-based compensation arrangements granted under the Company’s stock option plan was fully amortized. For the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010, the Company recognized $8, $0, $59 and $285, respectively, in stock-based compensation expense.

The number of options exercisable as of March 31, 2013 and 2012, were 25,500 and 329,055, respectively. The weighted-average exercise prices for the options exercisable as of March 31, 2013 and 2012 were $52.32 and $25.99, respectively.

The stock options outstanding and exercisable as of March 31, 2013 have been classified into ranges of exercise prices as follows:

 

Options outstanding

     Options exercisable  

      Range of

      exercise

        price        

   Outstanding
as of
March 31,
2013
     Weighted-
average
remaining
contractual
life
     Weighted-
average
exercise
price
     Exercisable
as of
March 31,
2013
     Weighted-
average

exercise
price
 
            (in years)                       

$24.68 – $30.00

     2,750         1.58       $ 25.19         2,750       $ 25.19   

$30.01 – $40.00

     2,000         1.83       $ 30.02         2,000       $ 30.02   

$40.01 – $68.51

     20,750         0.71       $ 58.06         20,750       $ 58.06   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     25,500         0.89       $ 52.32         25,500       $ 52.32   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  4. There were 3,000 stock options forfeited for non-employees during the year ended December 31, 2011.

 

d. Dividends:

The Company may declare and pay dividends from retained earnings. For restrictions on dividend distribution, see Note 17.d.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

e. Net income per share:

 

    Year ended
March 31, 2013
    Three months ended
March 31, 2012
    Year ended
December 31, 2011
    Year ended
December 31, 2010
 
    Net income
attributable
to Taro
(numerator)
    Shares
(denomi-
nator)
    Per
Share
Amount
    Net  income
attributable
to Taro
(numerator)
    Shares
(denomi-
nator)
    Per
Share
Amount
    Net  income
attributable
to Taro
(numerator)
    Shares
(denomi-
nator)
    Per
Share
Amount
    Net income
attributable
to Taro
(numerator)
    Shares
(denomi-
nator)
    Per
Share
Amount
 

Basic EPS:

  $ 266,206        44,677,603      $ 5.96      $ 47,252        44,476,429      $ 1.06      $ 182,680        44,405,539      $ 4.11      $ 64,078        40,271,669      $ 1.59   

Effect of dilutive securities:

                       

Stock options

    —           37,508        —           —           112,578        —           —           85,943        —           —           68,169        —      

Sun Stock Warrants

    —             —           —             —           —             —           —           1,510,486        —      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted EPS:

  $ 266,206        44,715,111      $ 5.95      $ 47,252        44,589,007      $ 1.06      $ 182,680        44,491,482      $ 4.11      $ 64,078        41,850,324      $ 1.53   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 17: — INCOME TAXES

 

  a. Corporate tax rate in Israel:

Taxable income of Israeli companies is subject to tax at the rate of 25% in 2010, 24% in 2011 and 25% in 2012 and onwards.

 

  b. Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969:

The Company is an “industrial company” as defined by this law and, as such, is entitled to certain income tax benefits, mainly accelerated depreciation in respect of machinery and equipment (as prescribed by regulations published under the Inflationary Adjustments Law) and the right to claim public issuance expenses, amortization of patents and other intangible property rights as deductions for tax purposes.

 

  c. Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (“the Law”):

Various production and development facilities of the Company have been granted “Approved Enterprise” and “Benefited Enterprise” status, which provides certain benefits, including tax exemptions and reduced tax rates for a defined period. The benefits available to an Approved Enterprise and Benefited Enterprise relate only to taxable income attributable to the specific investment program and are conditioned upon terms stipulated in the Law and the related regulations and the criteria set forth in the applicable certificate of approval (for an Approved Enterprise). If the Company does not fulfill these conditions, in whole or in part, the benefits can be cancelled and the Company may be required to refund the benefits, in an amount linked to the Israeli consumer price index plus interest.

The Company has three active plans, two Approved Enterprises under the Alternative Benefits Programs (Plans 3+4 and plan 5) and one Benefited Enterprise (Plan 6), granting us a package of benefits, subject to compliance with applicable requirements. Under Plan 3+4’s approval (benefit period starting 2003), our undistributed income was exempt from corporate tax for a period of two years following implementation of the plan and we will be eligible for a reduced tax rate of between 10% and 25% for an additional thirteen years thereafter. Under Plan 5 (benefit period starting 2007), our undistributed income, derived from this approval, was exempted from corporate tax for a period of two years following implementation and we will be eligible for a reduced tax rate of 10% to 25% for eight additional years thereafter. We filed a request for an additional five years of reduced tax rates for such plan. Approval is still pending. With respect to Plan 6, the Company notified the Israeli Tax Authority within 12 months of the end of 2010 that its facilities meet the criteria for tax benefits set out by the 2005 Amendment. The Company was exempt from corporate tax for a period of two years as of the election year (2010) and we will be eligible for a reduced tax rate of 10% to 25% for eight additional years thereafter.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

The entitlement to these benefits is conditional upon the Company fulfilling the requirements of the Law, regulations published thereunder and the instruments of approval for the specific investments in Approved Enterprises. In the event of failure to comply with these requirements, the benefits may be canceled and the Company may be required to refund the amount of the benefits, in whole or in part, including interest. As of March 31, 2013, management believes that the Company is meeting all of the aforementioned requirements.

If the Company pays a dividend out of income derived from the Approved and/or Benefited Enterprises incurred during the tax exemption period, the Company will be subject to corporate tax in the year the dividend is distributed in respect of the gross amount of dividend distributed.

The income subject to reduced tax rates, attributable to the Approved and/or Benefited Enterprises, cannot be distributed to shareholders without subjecting the Company to additional taxes. The Company has decided not to declare dividends out of such tax-exempt income. Accordingly, no deferred income taxes have been provided on income attributable to the Company’s Approved and/or Benefited Enterprises as the undistributed tax exempt income is essentially permanent by reinvestment.

For the year ended March 31, 2013, income not eligible for Approved and/or Benefited Enterprise benefits is taxed at a regular rate, which was 25% in 2012 (see above).

Temporary, partial tax relief for repatriation of exempt income:

Pursuant to a recent amendment to the Investments Law which became effective on November 12, 2012, a company that elects by November 11, 2013 to pay a reduced corporate tax rate as set forth in that amendment (rather than the regular corporate tax rate applicable to Approved Enterprise income) with respect to undistributed exempt income accumulated by the company until December 31, 2011 will be entitled to distribute a dividend from such income without being required to pay additional corporate tax with respect to such dividend. A company that has so elected must make certain qualified investments in Israel over the five-year period commencing in 2013. A company that has elected to apply the amendment cannot withdraw from its election. The Company is currently reviewing the new amendment and its implications to the Company.

 

  d. Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985 of Israel:

With respect to the Israeli entity, commencing in taxable year 2003, the Company elected to measure its taxable income and file its tax return under the Israeli Income Tax Regulations, 1986 (Principles Regarding the Management of Books of Account of Foreign Invested Companies and Certain Partnerships and the Determination of Their Taxable Income). Such an election obligates the Company for three years. Accordingly, commencing taxable year 2003, results for tax purposes are measured in U.S. Dollar terms. After the initial three-year term, the Company has to make the election on an annual basis. Through taxable year 2013, the Company has consistently elected, for tax purposes, to measure its earnings in U.S. dollars.

 

  e. Income from continuing and discontinued operations before income taxes comprises of the following:

 

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

Domestic (Israel)

   $ 65,934       $ 26,241       $ 78,499       $ 37,371   

Foreign (North America, the Cayman Islands, Ireland and the U.K.)

     268,735         38,953         129,330         37,657   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing and discontinued operations before taxes

   $ 334,669       $ 65,194       $ 207,829       $ 75,028   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  f. Taxes on income are comprised of the following:

 

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

Current taxes

   $ 93,165      $ 9,352       $ 48,502      $ 7,021   

Prior years’ (benefits) taxes

     (6,544     4,364         (2,577     (3,264

Deferred income (benefits) taxes

     (18,822     4,075         (21,374     6,720   
  

 

 

   

 

 

    

 

 

   

 

 

 
   $ 67,799      $ 17,791       $ 24,551      $ 10,477   
  

 

 

   

 

 

    

 

 

   

 

 

 

Domestic

   $ 1,139      $ 1,730       $ 3,993      $ 1,400   

Foreign

     66,660        16,061         20,558        9,077   
  

 

 

   

 

 

    

 

 

   

 

 

 
   $ 67,799      $ 17,791       $ 24,551      $ 10,477   
  

 

 

   

 

 

    

 

 

   

 

 

 

Included within current and deferred income tax expense are benefits relating to investment tax credits at Taro Canada of $1,320, $613, $1,954 and $1,751 for the year ended March 31, 2013, the three months ended March 31, 2012 and the years ended December 31, 2011 and 2010, respectively. Taro Canada uses the “flow-through” method and therefore records the benefits in earnings in the period the tax credits are utilized.

 

  g. Reconciliation of the statutory tax rate of the parent company in Israel to the effective consolidated tax rate:

 

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

Statutory tax rate (In Israel)

     25     24     24     25

(Decrease) increase in effective tax rate due to:

        

Tax benefits from reduced tax rates under benefit programs

     (4 %)      (4 %)      (5 %)      (12 %) 

Different tax rates applicable to non-Israeli subsidiaries

     1     1     (3 %)      (1 %) 

Uncertain tax positions, net

     (3 %)      (1 %)      (3 %)      2

Taxes (benefits) from prior years

     1     7     (1 %)      0
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective consolidated tax rate

     20     27     12     14
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  h. Current taxes are calculated at the following rates:

 

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

On Israeli operations (not including “Approved Enterprise”)

     25.0     24.0     24.0     25.0

On U.S. operations *

     35.0     35.0     35.0     35.0

On Canadian operations *

     25.0     25.0     26.5     31.0

On U.K. operations *

     24.0     26.5     26.5     26.0

On Ireland operations *

     12.5     12.5     12.5     12.5

 

* The U.S., Canadian, U.K., and Irish subsidiaries are taxed on the basis of the tax laws prevailing in their countries of residence. The Canadian subsidiary qualifies for research and development tax credits and manufacturing and processing credits, thereby reducing its effective tax rate.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  i. Deferred income taxes:

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and carryforward losses.

 

                                     
     March 31,  
     2013     2012  

Deferred tax assets:

    

Net operating loss carryforward

   $ 11,574      $ 11,844   

Deferred revenue

     16,146        18,459   

Property, plant, and equipment

     1,507        1,843   

Accrued expenses

     78,192        54,087   

Bad debt allowance

     36        37   

Amortization and impairment

     6,301        7,222   

Other, net

     9,323        11,665   
  

 

 

   

 

 

 

Total deferred tax assets

     123,079        105,157   

Valuation allowance for deferred tax assets

     (13,082     (13,688
  

 

 

   

 

 

 

Net deferred tax assets

     109,997        91,469   
  

 

 

   

 

 

 

Deferred tax liabilities:

    

Property, plant, and equipment

     (1,879     (2,205

Other, net

     (326     (302
  

 

 

   

 

 

 

Total deferred tax liabilities

     (2,205     (2,507
  

 

 

   

 

 

 

Net deferred tax assets

   $ 107,792      $ 88,962   
  

 

 

   

 

 

 

Domestic

   $ 5,162      $ 5,655   

Foreign

     102,630        83,307   
  

 

 

   

 

 

 
   $ 107,792      $ 88,962   
  

 

 

   

 

 

 

The deferred income taxes are presented in the balance sheet as follows:

 

                                     
     March 31,  
     2013     2012  

Among current assets (“other receivables and prepaid expenses”)

   $ 104,509      $ 85,020   

Long-term deferred income tax assets

     5,488        6,449   

Among short-term liabilities

     (326     (302

Among long-term liabilities

     (1,879     (2,205
  

 

 

   

 

 

 
   $ 107,792      $ 88,962   
  

 

 

   

 

 

 

 

  j. Carryforward tax losses:

 

  1. The Company:

As of March 31, 2013, one of the Israeli subsidiaries has carryforward tax losses of $828.

 

  2. Canadian subsidiary:

As of March 31, 2013, this subsidiary has no carryforward tax losses.

 

  3. U.K. subsidiary:

As of March 31, 2013, this subsidiary has carryforward tax losses of $10,382, which may be carried forward and offset against taxable income for an indefinite period in the future. As discussed in Note 2.t, there is a full valuation allowance provided against these losses.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  4. Irish subsidiary:

As of March 31, 2013, this subsidiary has carryforward tax losses of $73,386. Taro Ireland commenced trade in 2006 and therefore has satisfied any expiration deadlines. As discussed in Note 2.t, a full valuation allowance is provided against these losses.

 

  5. U.S. subsidiary:

As of March 31, 2013, this subsidiary has no carryforward tax losses. This subsidiary has been examined by the U.S. tax authorities through 2008; however due to the fact that this subsidiary has a past net operating loss carryforward, the U.S. subsidiary remained subject to examination by the U.S. tax authorities from 2002 onward, but only to the extent of the amount of the net operating loss carryforward.

 

  6. Hungarian subsidiary:

As of March 31, 2013, this subsidiary has no carryforward tax losses.

 

  k. The Company’s Board of Directors has determined that its U.S. subsidiary will not pay any dividend as long as such payment will result in any tax expense for the Company.

 

  l. At March 31, 2013, deferred income taxes were not provided for on a cumulative total of $371,020 of the undistributed earnings of Taro Canada, which are not taxable provided earnings remain undistributed. Taro Canada intends to invest these earnings indefinitely in its operations.

 

  m. Foreign withholding taxes have been accrued as necessary by the Company and its subsidiaries.

 

  n. Tax assessments:

The Company completed its tax assessments with the Israeli tax authorities for years through 2009. The Company’s tax provision was adequate to satisfy these assessments. The Company remains subject to examination by the Israeli tax authorities for years 2010 and onward. The Company believes that its tax provision is adequate to satisfy any assessments resulting from examinations related to these years.

The Company’s U.S. subsidiary has been examined by U.S. tax authorities through 2008; however, due to the fact that this subsidiary has a past net operating loss carryforward, the U.S. subsidiary remains subject to examination by the U.S. tax authorities only to the extent of the amount of the net operating loss carryforward.

The Company completed its tax assessments with the Canadian tax authorities for the years through 2005. The Company’s tax provision was adequate to satisfy these assessments. Taro Canada has the 2009, 2010 and 2011 tax years currently under examination and remains subject to examination by the Canadian tax authorities for years after 2006. The Company believes that its tax provision is adequate to satisfy any assessments resulting from examinations related to these years.

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

  o. Uncertain tax positions:

The Company adopted FASB ASC Section 740-10-25, “ Income taxes-Overall-Recognition,” effective January 1, 2007, which prescribes a model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return (see Note 2.t).

 

     March 31,  
     2013     2012  

Unrecognized tax exposure at beginning of year

   $ 13,828      $ 14,425   

Increases as a result of positions taken in prior period

     1,912        92   

Decreases as a result of positions taken in prior period

     (115     —     

Increases as a result of positions taken in current period

     1,495        36   

Decreases as a result of positions taken in current period

     —          (725

Decreases due to settlements with tax authorities

     (10,216     —     

Decreases due to expiration of statute of limitations

     (270     —     
  

 

 

   

 

 

 

Unrecognized tax exposure at end of year

   $ 6,634      $ 13,828   
  

 

 

   

 

 

 

The total amount of interest and penalties recognized on the consolidated statement of operations for the years ended March 31, 2013, the three months ended March 31, 2012 and December 31, 2011 and 2010 were ($2,730), $806, $60 and $1,296, respectively. The total amount of interest and penalties recognized on the consolidated balance sheet at March 31, 2013 and 2012 were $1,968 and $4,354, respectively.

The total amount of unrecognized tax benefits, which would impact the effective tax rate if recognized, was $6,634 and $13,828 at March 31, 2013 and 2012, respectively.

NOTE 18: — SELECTED STATEMENTS OF INCOME DATA

 

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

Sales by location of customers :

        

Israel

   $ 19,929      $ 5,472      $ 21,528      $ 19,589   

Canada

     52,452        13,167        43,720        44,169   

U.S.A.

     587,851        122,472        424,950        305,858   

Other

     10,722        4,030        15,470        22,919   
  

 

 

   

 

 

   

 

 

   

 

 

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

 

 

   

 

 

   

 

 

   

 

 

 

Selling, marketing, general and administrative expenses:

        

Selling and marketing

   $ 43,938      $ 12,192      $ 42,247      $ 41,673   

Advertising

     7,213        2,166        7,270        6,827   

General and administrative *

     35,287        8,743        44,401        59,402   

Settlements and loss contingencies

     33,300        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 119,738      $ 23,101      $ 93,918      $ 107,902   
  

 

 

   

 

 

   

 

 

   

 

 

 

* Including provision for doubtful accounts

   $ 4      $ (50   $ 90      $ (473
  

 

 

   

 

 

   

 

 

   

 

 

 

Financial (income) expenses:

        

Interest and exchange differences on long-term liabilities

   $ 2,512      $ 368      $ 4,671      $ 5,252   

Income in respect of deposits

     (4,026     (510     (1,520     (985

Expenses in respect of short-term credit

     —          35        72        2,291   

Foreign currency transaction losses

     (2,417     1,107        (6,920     5,282   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (3,931   $ 1,000      $ (3,697   $ 11,840   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 19: — SEGMENT INFORMATION

 

  a. Geographic Area Information:

The Group operates in one industry segment, which produces, researches, develops and markets pharmaceutical products. Management organizes the Company’s operations based on geographic segments, which are presented below in accordance with FASB ASC Paragraph 280-10-50-1, “ Segment Reporting – Overall – Disclosure – Operating Segments.”

 

     Israel      Canada*      U.S.A.      Other      Consolidated  

Year ended March 31, 2013 and as of
March 31, 2013:

              

Sales to unaffiliated customers **

   $ 19,929       $ 52,452       $ 587,851       $ 10,722       $ 670,954   

Long-lived assets ***

   $ 87,912       $ 38,614       $ 40,383       $ 1,240       $ 168,149   

Three months ended March 31, 2012 and as of
March 31, 2012:

              

Sales to unaffiliated customers **

   $ 5,472       $ 13,167       $ 122,472       $ 4,030       $ 145,141   

Long-lived assets ***

   $ 91,245       $ 40,148       $ 42,607       $ 2,342       $ 176,342   

Year ended December 31, 2011 and as of
December 31, 2011 :

              

Sales to unaffiliated customers **

   $ 21,528       $ 43,720       $ 424,950       $ 15,470       $ 505,668   

Long-lived assets ***

   $ 92,547       $ 41,010       $ 43,133       $ 2,291       $ 178,981   

Year ended December 31, 2010 and as of
December 31, 2010:

              

Sales to unaffiliated customers **

   $ 19,589       $ 44,169       $ 305,858       $ 22,919       $ 392,535   

Long-lived assets ***

   $ 99,353       $ 45,718       $ 45,334       $ 3,247       $ 193,652   

 

* Includes operations in both Canada and Cayman Islands.
** Based on customer’s location.
*** Includes property, plant and equipment, net; goodwill and intangible assets, net.

 

  b. For the year ended March 31, 2013, the Company had net sales to three different customers of 20.8%, 14.0% and 12.2% of consolidated net sales. For the three months ended March 31, 2012, the Company had net sales to three different customers of 24.1%, 12.7% and 11.9% of consolidated net sales. For the year ended December 31, 2011, the Company had net sales to three different customers of 18.9%, 12.4% and 11.8% of consolidated net sales. For the year ended December 31, 2010, the Company had net sales to three different customers of 15.9%, 11.0% and 10.5% of consolidated net sales.

 

  c. Sales by therapeutic category, as a percentage of total sales for the year ended March 31, 2013, the three months ended March 31, 2012, and the years ended December 31, 2011 and 2010:

 

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

Category

   2013      2012      2011      2010  
     %  

Dermatological and topical

     77         70         67         60   

Neuropsychiatric

     9         10         13         14   

Cardiovascular

     6         9         9         14   

Anti-inflammatory

     4         4         5         5   

Other

     4         7         6         7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100         100         100         100   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

F-47


Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 20: — DISCONTINUED OPERATIONS

 

  a. During 2010, the Company’s management decided to sell its Irish facility. The results of operations of the Irish facility have been classified as discontinued operations in the Consolidated Statements of Operations.

 

  b. The following is the detail of discontinued operations:

 

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

Sales, net

   $ —        $ (9   $ (54   $ (931

Cost of sales

     1,170        72        1,070        5,895   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross loss

     1,170        63        1,016        4,964   

Operating expenses:

        

Research and development, net

     10        —          88        267   

Selling, marketing, general and administrative

     216        34        295        921   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     1,396        97        1,399        6,152   

Financial expenses (income), net

     213        (103     (144     (3,139

Other income, net

     (415     (60     (38     (44
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss (income) before income taxes

     1,194        (66     1,217        2,969   

Tax expense

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss (income) from discontinued operations

   $ 1,194      $ (66   $ 1,217      $ 2,969   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 21: — RELATED PARTY TRANSACTIONS

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

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

 

F-48


Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

NOTE 22: — SUBSEQUENT EVENTS

 

  a. Stock options:

Between April 1, 2013 and June 14, 2013, no stock options were granted to the Company’s directors or employees, however, 5,564 stock options were exercised at prices ranging from $43.53 to $60.38.

End of consolidated financial statements

 

F-49


Table of Contents

TARO PHARMACEUTICAL INDUSTRIES LTD.

Notes to consolidated financial statements

U.S. dollars in thousands

 

SCHEDULE II: — VALUATION AND QUALIFYING ACCOUNTS

Schedules have been omitted as the required information is provided elsewhere in these financial statements.

 

S-1

Exhibit 1.2

THE COMPANIES ORDINANCE

ARTICLES OF ASSOCIATION

OF

TARO PHARMACEUTICAL INDUSTRIES LTD.

(Name Changed as of February 8, 1994)

PRELIMINARY

 

1. The regulations contained in Table A of the Third Schedule to the Companies Ordinance shall not apply to this Company except so far as same are repeated, contained or made applicable in these Articles.

 

2. In these Articles the following expressions shall have the respective meaning set opposite them, unless the context otherwise requires:

 

“THE COMPANY”   

-   the above named Company.

“THE COMPANIES ORDINANCE”   

-   the Companies Ordinance as amended from time to time.

“THE BOARD OF DIRECTORS”   

-   the Board of Directors of the Company for the time being.

“THE PRINCIPAL OFFICE”   

-   the registered office for the time being of the Company.

“THE REGISTER”   

-   the Register of Members to be kept pursuant to Section 29 of the Companies Ordinance and includes the Principal Register and the Branch Register in accordance with these Articles.

“IN WRITING AND WRITTEN”   

-   Written, printed, typewritten or in any other legible form.

“THE SECRETARY”   

-   the Company’s Secretary and includes the person duly appointed to perform temporarily the duties of the secretary.

“THE BRANCH OFFICE”   

-   the office of the Company for the time being in the State of New York of the United States of America.

 

 

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3. In these Articles, unless the context otherwise requires, the expressions defined in the Memorandum of Association of the Company shall have the meaning defined, and, subject thereto the expressions defined in the Companies Ordinance shall have the meaning so defined, and, subject thereto, the expressions defined in the Interpretation Ordinance shall have the meaning so defined; and words importing the singular shall include the plural, and vice versa, and words importing the masculine gender shall include females. The captions in these Articles shall not be taken into account in the construction thereof.

BUSINESS

 

4. The business of the Company may be commenced as soon after the incorporation of the Company as the provisions of Section 92 (2) of the Companies Ordinance have been complied with, and the Registrar of Companies has issued the prescribed certificate.

 

5. Subject as aforesaid, any branch or kind of business which, by the Memorandum of Association of the Company, or these Articles, is either expressly or by implication, authorized to be undertaken by the Company, may be undertaken by the Board of Directors at such time or times as they shall think fit, and further may be suffered by them to be in abeyance, whether such branch or kind of business may have been actually commenced or not, so long as the Board of Directors may deem it expedient not to commence or proceed with such branch or kind of business.

 

6. The Principal Office shall be in such place in Israel as the Board of Directors shall from time to time appoint.

SHARE CAPITAL

 

7. The share capital of the Company is NIS 20,000.026 (Twenty Thousand and Point Zero Two Six New Israeli Shekels), divided into 2,600 (Two Thousand and Six Hundred) Founders’ Shares, of NIS 0.00001 each, and 200,000,000 (Two Hundred Million) Ordinary Shares of NIS 0.0001 each.

(Amended August 30, 2001)

 

8. The amount payable to the Company on application on each share of the Company shall not be less than 5% (five percent) of the nominal value of the share.

 

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9. The Company may issue any share with such preferred, deferred, or other special rights, or such restrictions, whether in regard to dividend, voting, return of share capital, participation in surplus of assets or otherwise, as the Company may from time to time by Special Resolution determine and any Preference Share may, with the sanction of a Special Resolution, be issued on the terms that it is, or that it is at the option of the Company, liable to be redeemed.

 

10. If at any time the share capital is divided into different classes of shares, the rights attached to any class, unless otherwise provided by the terms of issue of the shares of that class, may be modified, abrogated or otherwise dealt with by the Company, with the consent in writing of the holders of three-fourths of the issued shares of that class or with the sanction of a Special Resolution passed at a separate general meeting of the holders of the shares of the class. The provisions of these regulations relating to general meetings and to the convening thereof and to notices in respect thereof and to resolutions to be passed thereat shall mutatis mutandis apply to every such special general meeting.

 

11. The shares shall be under the control of the Board of Directors, who may allot them or otherwise dispose of them to such persons, on such terms and conditions and either at par or at a premium or at a discount and at such times as the Board of Directors may deem fit, and with full power to give to any person the call of any shares either at par or at a premium or, subject aforesaid, at a discount, during such time and for such consideration as the Board of Directors may deem fit.

For the avoidance of any doubt, and not withstanding anything to the contrary in these Articles, the Board of Directors shall be entitled to allot and distribute any authorized and unissued shares as bonus shares.

(Amended June 28, 2001)

 

12. The Company may make arrangements on the issue of shares for a difference between the holders of such shares in the amount of calls to be paid and the time of payments of such calls.

 

13. If by the conditions of allotment of any share the whole or part of the amount or issue price thereof shall be payable by instalments, every such instalment shall, when due, be paid to the Company by the person who for the time being and from time to time shall be registered holder of the shares or his legal personal representative.

 

14. The joint holders of a share shall be severally as well as jointly liable for the payment of all instalments and calls due in respect of such share.

 

-3-


15. The Company may at any time pay a commission to any person for subscribing or agreeing to subscribe, whether absolutely or conditionally for any share, debenture or debenture stock of the Company, or procuring or agreeing to procure subscriptions whether absolute or conditional, for any share, debenture or debenture stock of the Company but so that if the commission in respect of shares shall be paid or payable out of capital, the statutory conditions and requirements and the conditions and requirements of the Memorandum and Articles of the Company shall be observed and complied with. The commission may be paid or satisfied in cash or in shares, debentures or debenture stock of the Company.

 

16. Save as in these Articles otherwise provided, the Company shall be entitled to treat the registered holder of any share as the absolute owner thereof, and shall not, except as otherwise ordered by a Court of competent jurisdiction or as by law required, be bound to recognize any equitable or other claim to, or interest in, any such share on the part of any other person.

 

17. No shareholder shall be entitled to receive any dividend or to be present or vote at any meeting either on a show of hands or upon a poll, or to exercise any privilege as a member, until he shall have paid all calls for the time being due and payable on every share held by him, whether alone or jointly with any other person, together with interest and expense (if any).

CERTIFICATES

 

18. The certificate of title to shares shall be sealed with the Seal of the Company and shall bear the signature of at least two Directors or of one Director and the Secretary or any other person, appointed by the Board of Directors.

 

19. Every Member shall without payment be entitled to receive within two months after allotment or registration of transfer unless the conditions of issue provide for a longer interval, a certificate under the Seal of the Company specifying the shares allotted or transferred to him, and the amount paid up thereon, provided that in the case of joint holders the Company shall not be bound to issue more than one certificate to all the joint holders, and delivery of such certificate to any one of them shall be sufficient delivery to all.

A Member holding more than one share shall be entitled to apply for and receive a separate certificate in respect of any one or more shares held by him, upon payment to the Company of 25 agorot for each certificate other than the first certificate.

 

-4-


20. If any certificate be worn out or defaced, then upon production thereof to the Board of Directors they may order the same to be cancelled and may issue a new certificate in lieu thereof, and if any certificate be lost or destroyed then upon proof thereof to the satisfaction of the Board of Directors and on such undertaking as to indemnity as the Board of Directors may deem fit being given, a new certificate in lieu thereof shall be given to the party entitled to such lost or destroyed certificate. The sum of 25 agorot shall be paid to the Company for every certificate given under this Article. In case of destruction or loss, the Member to whom such renewed certificate is given shall also bear and pay to the Company upon demand all expenses incidental to the investigation by the Company of the evidence of such destruction or loss.

REGISTER OF MEMBERS

 

21. The Company shall keep in a book a register of its Members (hereinafter referred to as the “Principal Register”) and shall enter therein the following particulars:

 

  (a) The names and addresses of the Members and a statement of the shares held by each Member, distinguishing each share by its number and of the amount paid, or agreed to be, considered as paid on the shares of each Member; and

 

  (b) The date at which any person was entered in the Register as a Member; and

 

  (c) The date at which any person ceased to be a Member; and

 

  (d) The amount of the calls, if any, still outstanding on the shares of each Member; and

 

  (e) Such other particulars as are by the Companies Ordinance or by these Articles required or permitted to be recorded therein.

 

22. The Company shall keep an index of the names of the Members of the Company which shall in respect of each Member contain a sufficient indication to enable the record of that Member to be readily found.

The Company shall within fourteen days after the date on which any alteration is made in the Principal Register make any necessary alteration in the index.

 

23. The Principal Register and the index shall be kept at the Principal Office and, except when closed under the provisions of the Companies Ordinance or of these Articles, shall during all regular business hours be open to the inspection of any Member gratis and to the inspection of any other person on the payment of 25 agorot or such lesser fees as the Company may prescribe for each inspection.

 

-5-


24. The Principal Register shall be closed during the fourteen days immediately preceding every Ordinary General Meeting of the Company and at such other times (if any) and for such period as the Board of Directors may from time to time determine; Provided always that the Principal Register shall not be closed for more than a period exceeding thirty days in any one year; and provided further that it shall not be closed unless notice is advertised in compliance with Section 29 (6) of the Companies Ordinance.

BRANCH REGISTER

 

25. The Company may cause to be kept in the State of New York of the United States of America a Branch Register of Members resident in the United States of America (hereinafter referred to as “the Branch Register”) and the Board of Directors may, subject to the provisions of the Companies Ordinance and of these Articles make and vary such regulations as they may think fit respecting the keeping of the Branch Register.

 

26. The Branch Register if and when opened shall be kept at the Branch Office which shall be in such place in the State of New York as the Board of Directors shall from time to time appoint.

 

27. The Company shall give to the Registrar of Companies notice of the situation of the Branch Office and of any change in its situation. Any such notice shall be given within a month of the opening of the Branch Office, or of the change, as the case may be.

 

28. (1)     The Branch Register shall be deemed part of the Principal Register.

 

  (2) The Branch Register shall be kept in the same manner in which the Principal Register is by the Companies Ordinance and these Articles required to be kept, except that the advertisement before closing the Branch Register shall be inserted in some newspaper circulating in the City of New York, State of New York, United States of America.

 

  (3) The Company shall transmit to the Principal Office a copy of every entry in the Branch Register as soon as may be after the entry is made; and shall cause to be kept at the Principal Office duly entered up from time to time a duplicate of the Branch Register. The duplicate shall be deemed to be part of the Principal Register.

 

  (4) Subject to the provisions of these Articles with regard to the duplicate of the Branch Register, the shares registered in the Branch Register shall be distinguished from the shares registered in the Principal Register and no transaction with respect to any shares registered in the Branch Register shall, during the continuation of that registration, be registered in the Principal Register.

 

-6-


CALLS

 

29. The Board of Directors may, from time to time, make such calls as they think fit upon the Members in respect of all moneys unpaid on the shares held by them respectively, and not by the conditions of allotment thereof made payable at fixed times, and each Member shall pay the amount of every call so made on him to the persons and at the times and places appointed by the Board of Directors. A call may be made payable by instalments, and shall be deemed to have been made when the resolution of the Board of Directors authorizing such call was passed.

 

30. A month’s notice of any call shall be given specifying the time and place of payment, and to whom such call shall be paid, provided that before the time for payment of such call the Board of Directors may, by notice in writing to the Members, revoke the same or extend the time for payment thereof.

 

31. If by the terms of issue of any share or otherwise any amount is made payable at any fixed time or by instalments at fixed times, every such amount or instalment shall be payable as if it were a call duly made by the Board of Directors and of which due notice had been given and all the provisions herein contained in respect of such calls shall relate to such amount or instalment accordingly.

 

32. If the sum in respect of any call or instalment be not paid on or before the day appointed for payment thereof, the holder for the time being of the share in respect of which the call shall have been made, or the instalment shall be due, shall pay interest for the same at the maximum rate of interest permissible under the Law prevailing in Israel for the time being from the day appointed for the payment thereof to the time of the actual payment. But the Board of Directors may dispense with payment of the interest in whole or in part.

 

33. The Board of Directors may, if they think fit, receive from any Member willing to advance the same, the sums outstanding upon all or any of the shares held by him beyond the sums actually called for. The Board of Directors may, upon the amounts so paid in advance or any part thereof, pay interest (up to the date the amount would become payable, if it were not paid in advance) at such rate as the Board of Directors and the Members paying in advance as aforesaid may agree upon.

 

-7-


FORFEITURE AND LIEN

 

34. If any Member fail to pay any call or instalment on or before the day appointed for the payment of the same, the Board of Directors may at any time thereafter, during such time as the call or instalment remains unpaid, serve a notice on such Member requiring him to pay the same together with any interest that may have accrued, and all expenses that may have been incurred by the Company by reason of such non-payment. In the event of the Member failing to pay the amount due by the date fixed in such notice, (which shall be at least one month) the shares in respect of which such notice shall have been given shall be forfeited by a resolution of the Board of Directors to that effect. The provisions of this Article shall apply subject to the conditions made (if made expressly and in writing) at the time of the allotment of any share.

 

35. A certificate in writing under the hands of two Directors stating that the call in respect of a share was made, and that the forfeiture of the share was made by a resolution of the Board of Directors to that effect, shall be conclusive evidence of the facts stated therein as against all persons entitled to such share.

 

36. Any share so forfeited shall be the property of the Company and the Board of Directors may sell, deliver, re-allot, or otherwise dispose of the same to any person, including the original holder thereof, upon such terms and conditions and in such manner as they may deem fit.

 

37. The Company may receive the consideration, if any, given for the share on any sale, delivery, re-allotment or other disposition thereof and the person to whom such share is sold, delivered, re-allotted or disposed of, may be registered as the holder of the share and shall not be bound to see to the application of the consideration, if any, nor shall his title to the share be affected by any irregularity or invalidity in the proceedings in reference to the forfeiture, sale, re-allotment or other disposal of the share.

 

38. The Board of Directors may at any time before any share so forfeited shall have been sold, delivered, re-allotted or otherwise disposed of, annul the forfeiture thereof upon such terms and conditions as they think fit.

 

39. Any Member whose shares shall have been forfeited, shall notwithstanding be liable to pay, and shall forthwith pay to the Company, all calls, instalments, interest and expenses owing upon or in respect of such shares at the time of the forfeiture, together with interest thereon from the time of the forfeiture, until payment, at the maximum rate of interest permissible under the Law prevailing in Israel for the time being and the Board of Directors may enforce the payment of such moneys or any part thereof if they think fit, but shall not be under any obligation so to do.

 

-8-


40. The Company shall have a first and paramount lien upon all the shares registered in the name of each Member and upon the proceeds of the sale thereof for all moneys unpaid in respect of any of his shares whether called or uncalled, and for his debts, liabilities and engagements solely or jointly with any person, to or with the Company, whether the period for the payment, fulfillment or discharge thereof shall have actually arrived or not; and no equitable interest in any share shall be created except upon the footing and condition that Article 16 hereof is to have full effect, and such lien shall extend to all dividends from time to time declared in respect of such shares. Provided always that:

 

  (a) The registration by the Company of a transfer of a fully paid up share shall operate as a waiver by the Company of its lien on such share and the dividends in respect thereof; and

 

  (b) The registration by the Company of a transfer of a share shall not operate as a waiver by the Company of its lien on such share and the dividends in respect thereof, insofar as such lien is for any moneys unpaid in respect of such share, whether called or uncalled, but shall operate as a waiver of such lien insofar as it is for any other debt, liability or engagement of the transferor towards the Company; and

 

  (c) The registration of a transfer of a share as aforesaid shall not serve as a discharge to the transferor of any debt, liability or engagement of the transferor towards the Company, otherwise than in respect of any moneys unpaid in respect of such share.

 

41. The Board of Directors may for the purpose of enforcing such lien, sell the shares subject thereto in such manner as they may deem fit, but no sale shall be made until notice in writing of the intention to sell shall have been served on such Member his executors and administrators and default shall have been made by him or them of the payment, discharge or fulfillment of such debts, liabilities or engagements for 14 days after such notice.

 

42. The net proceeds of any such sale after payment of the costs of such sale shall be applied in or towards the satisfaction of the debts, liabilities or engagements of such Member and the residue (if any) paid to him, his executors, administrators or assigns.

TRANSFER AND TRANSMISSION OF SHARES

 

43. Any Member may transfer all or any of his shares, but no transfer shall be registered unless a proper instrument of transfer has been left at the Principal Office for registration, accompanied by the certificate of the shares to be transferred and such other evidence (if any) as the Board of Directors may require to prove the title of the transferor.

 

-9-


The instrument of transfer of any share shall be signed both by the transferor and the transferee, and the transferor shall be deemed to remain the holder of the share until the name of the transferee is entered in the Register of Members in respect thereof.

 

44. The instrument of transfer of any share shall be in writing in the usual common form or in the following form or as near thereto as circumstances will admit:

“I                  of                  in consideration of the sum of                  paid to me by                      of                      (hereinafter called “the transferee”) do hereby transfer to the transferee the                  shares numbered          to      inclusive in Taro Pharmaceutical Industries Limited to hold unto the transferee, his executors, administrators and assigns, subject to the several conditions on which I held the same immediately before the execution hereof; and I, the transferee do hereby agree to take the said share(s) subject to the conditions aforesaid. As witness our hands this          day of          19      .

 

Signature of the transferor       
Address and occupation of transferor       
Witness to the signature       
Signature of transferee       
Address and occupation of transferee       
Witness to signature       

 

45. Notwithstanding the provisions of Article 43 hereof:

 

  (a) The Board of Directors may, in their discretion, and without assigning any reason therefor, refuse to register the transfer of any share (not being a fully paid share) to any person whom they shall not approve as transferee.

 

  (b) The Board of Directors may also refuse to register any transfer of shares on which the Company has a lien.

 

  (c) Whenever the Board of Directors shall refuse to register any transfer of shares they shall give notice thereof to the transferee.

 

46. Such fee not exceeding 25 agorot for each transfer as the Board of Directors may from time to time determine shall be charged for the registration of a transfer.

 

47. The executors or administrators or heirs of a deceased Member (not being one of the several joint holders) shall be the only persons recognized by the Company as having any title to the shares registered in the name of such Member, and in the case of the death of any one or more of the joint holders of any registered share, the survivor or survivors shall alone be recognized by the Company as having any title to, or interest in, such share.

 

-10-


48. Any person becoming entitled to a share in consequence of the death, or bankruptcy of a Member, upon such evidence being produced as may from time to time be required by the Board of Directors of grant of Probate or Letters of Administration or Declaration of Succession or Order or Certificate in accordance with the Laws of Bankruptcy or such other evidence that he sustains the character in respect of which he proposes to act under this Article, or of his title as the Board of Directors think sufficient, shall be entitled to be registered as a Member in respect of such share, or may, subject to the regulations as to transfer herein contained, make such transfer of the share as the deceased when alive or the bankrupt person prior to his bankruptcy himself could have made.

 

49. A person becoming entitled to a share by reason of the death, or bankruptcy of the holders thereof shall be entitled to the same dividends and other advantages to which he would be entitled if he were the registered holder of the share, except that he shall not, before being registered as a Member in respect of that share, be entitled in respect of it to exercise any right, conferred by membership in relation to meetings of the Company.

SHARE WARRANTS TO BEARER

 

50. Articles 51 to 58, both inclusive, shall apply only if the Company be authorized, as long as such authorization be required by law, by the competent authority to issue share warrants to bearer.

 

51. The Company may issue share warrants to bearer and accordingly the Board of Directors may in their discretion with respect to any share which is fully paid up and in respect of which the Company has no lien for the time being, on application in writing signed by the person registered as holder of the share and authenticated by such evidence, if any, as the Board of Directors may from time to time require, as to the identity of the person signing the request, and on receiving the certificate, if any, of the share and the amount of stamp duty on the warrant, and such fee not exceeding 25 agorot, as the Board of Directors may from time to time require, issue under the Company’s Seal a warrant duly stamped, stating that the bearer of the warrant is entitled to the shares therein specified and may provide by coupons or otherwise for the payment of dividends or other moneys on the shares included in the warrant.

 

52. On the issue of a share warrant the Board of Directors shall strike off the Register the name of the Member then entered therein as holding the share specified in the warrant, as he had ceased to be a Member in virtue thereof, and shall enter in the Register the following particulars, namely:

 

  (a) the fact of the issue of the warrant; and

 

  (b) the statement of the shares included in the warrant; distinguishing each share by its number; and

 

  (c) the date of the issue of the warrant.

 

-11-


53. A share warrant shall entitle the bearer to the shares included in it, and such shares shall be transferred by the delivery of the share warrant, and the provisions of these Articles with respect to transfer and transmission of shares shall not apply thereto. The bearer of a share warrant shall on surrender of the warrant to the Company for cancellation, and on payment of such sum not exceeding 25 agorot as the Board of Directors may from time to time prescribe, be entitled to have his name entered as a Member in the Register in respect of the shares included in the warrant.

 

54. The bearer of a share warrant may at any time deposit the warrant at the Principal Office or at the Branch Office and so long as the warrant remains so deposited, the depositor shall have the same right of signing a requisition for calling a meeting of the Company, and of attending and voting and exercising the other privileges of a Member at any meeting held after the expiration of two clear days from the time of deposit, as if his name were inserted in the Register as the holder of the shares included in the deposited warrant, provided the shares be of a class conferring the aforesaid rights on their registered holders. Not more than one person shall be recognized as depositor of the share warrant.

 

55. To any person so depositing a warrant there shall be delivered a certificate stating his name and address and describing the shares included in the warrant so deposited and bearing the date of issue of the certificate.

 

56. Upon surrender of the certificate to the Company the bearer of the certificate shall be entitled to receive the warrant in respect of which the certificate was delivered.

 

57. Subject as herein otherwise expressly provided, no person shall, as bearer of a share warrant, sign a requisition for calling a meeting of the Company, or attend, or vote or exercise any other privilege of a Member at a meeting of the Company, or be entitled to receive any notices from the Company, but the bearer of a share warrant shall be entitled in all other respects to the same privileges and advantages as if he were named in the Register as the holder of the shares included in the warrant and he shall be a Member of the Company.

 

58. The Board of Directors may from time to time make rules as to the terms on which, if they shall think fit, a new share warrant or coupon may be issued by way of renewal in case of defacement, loss or destruction of the original share warrant or coupon.

 

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REDEEMABLE PREFERENCE SHARES

 

59. The Company may at its option issue redeemable preference shares. On redemption of such shares the Company shall comply with the provisions of Section 38 of the Companies Ordinance.

INCREASE, REDUCTION AND ALTERATION OF CAPITAL

 

60. The Company may, in general meeting, by Special Resolution, increase the share capital from time to time by such sums, to be divided into shares of such amount, of such classes and conferring such rights and privileges, as the Company may by Special Resolution resolve.

 

61. Except so far as otherwise provided by the Special Resolution creating the increase of share capital, the new shares shall be subject to the same provisions applying to the shares of the original capital with reference to the payment of calls, forfeiture and lien, transfer and transmission and otherwise.

 

62. The Company may, by Special Resolution:

 

  (a) Consolidate and divide its share capital or any part thereof, into shares of larger amount than the existing shares;

 

  (b) By sub-division of its existing shares, or any of them, divide the whole, or any part of its share capital into shares of smaller amount than is fixed by the Memorandum of Association, subject nevertheless, to the provisions of paragraph (d) of sub-section 1 of Section 43 of the Companies Ordinance.

 

  (c) Cancel any shares, which, at the date of the passing of the resolution, have not been taken, or agreed to be taken by any person;

 

  (d) Reduce its share capital in any manner and with and subject to any incident authorized and consent required, by law.

BORROWING POWERS

 

63. The Board of Directors may from time to time at their discretion, borrow or secure the payment of any sum or sums of money for the purpose of the Company.

 

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64. The Board of Directors may raise or secure the repayment of such sum or sums in such manner and upon such terms and conditions in all respects as they think fit, and in particular by the issue of bonds, debentures or debenture stock, or any mortgage, charge, other security on the undertaking or the whole or any part of the property of the Company (both present and future) including its uncalled capital for the time being.

 

65. Any bonds, debentures, debenture stock, obligations or other securities (issued or to be issued by the Company) shall be under the control of the Board of Directors who may issue them upon such terms and conditions and in such manner and for such consideration as they shall consider to be for the benefit of the Company.

 

66. Debentures, debenture stock, bonds, obligations or other securities may be made assignable free from any equities between the Company and the person to whom the same may be issued.

 

67. If any uncalled capital of the Company is included in or charged by any mortgage, bond, debenture, debenture stock, obligation or other security, the Board of Directors may authorize the person in whose favor such mortgage, bond, debenture, debenture stock, obligation or security is executed or any other person in trust for him, to make calls on Members in respect of such uncalled capital and the provisions hereinbefore contained with regard to calls shall mutatis mutandis apply to calls made under such authority and such authority may be made exercisable either conditionally or unconditionally and either presently or contingently and either to the exclusion of the power of the Board of Directors or otherwise and shall be assignable if expressed so to be.

 

68. If any of the Directors or officers of the Company or any other person shall become personally liable for the payment of any sum for which the Company is primarily liable, the Board of Directors may execute or cause to be executed any mortgage, charge or security over or affecting the whole or any part of the assets of the Company by way of indemnity to secure such Director or officer of the Company or such other person aforesaid from any loss in respect of such liability.

 

69. The Company shall keep a proper register in accordance with the provisions of the Companies Ordinance of all mortgages, debentures and charges affecting the property of the Company.

 

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GENERAL MEETING

 

70. A General Meeting of the Company shall be held once at least in every calendar year at such time, not being more than fifteen months after the holding of the last preceding General Meeting, and at such place as may be determined by the Board of Directors. Such General Meetings shall be called Ordinary General Meetings, and all other general meetings of the Company, shall be called Extraordinary General Meetings. All General Meetings shall be held in Israel.

 

71. The Board of Directors may call an Extraordinary General Meeting whenever they think fit.

 

72.     (1) The Board of Directors shall, on the requisition of Members of the Company representing not less than one-tenth of the total voting rights of all the Members having on the date of the requisition a right to vote at General Meetings of the Company, forthwith proceed to convene an Extraordinary General Meeting of the Company.

 

  (2) The requisition must state the object of the proposed Extraordinary General Meeting and must be signed by the requisitionists and deposited at the Principal Office and may consist of several documents in like form, each signed by one or more of the requisitionists. A requisition by joint holders of shares must be signed by all such holders.

 

  (3) If the Board of Directors do not within 21 days from the date of the requisition being so deposited, or if the requisition consists of several documents from the date of the deposit of the document which completes the required minimum proscribed in paragraph (1) of this Article, proceed to convene the Extraordinary General Meeting so requisitioned, the requisitionists or any of them representing more than one half of the voting rights of all of them, may themselves convene the Meeting, but any Meeting so convened shall not be held after three months from the date of the deposit of the requisition.

 

  (4) Any Extraordinary General Meeting convened under this Article by the requisitionists shall be convened in the same manner as nearly as possible as that in which General Meetings are to be convened by the Board of Directors.

 

  (5) Any reasonable expenses incurred by the requisitionists by reason of the failure of the Board of Directors duly to convene an Extraordinary General Meeting, shall be repaid to the requisitionists by the Company and any sum so repaid shall be retained by the Company out of any sums due or to become due from the Company by way of fees or other remuneration for their services to such of the Directors as were in default.

 

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73. Not less than 7 days’ prior notice shall be given of every General Meeting, whether Ordinary or Extraordinary, (other than a meeting at which it is proposed to pass a Special Resolution), by whomsoever convened, specifying the day, hour and place of the Meeting and subject to the provisions of Article 164 hereof, stating the business to be transacted at the Meeting (and in case it is proposed to pass an Extraordinary Resolution), stating the intention to propose a resolution as an Extraordinary Resolution, shall be given to the persons entitled to receive such notice, under, and in the manner provided by the Companies Ordinance and these Articles.

(Amended June 22, 1995)

 

74. Where it is proposed to pass a Special Resolution at any General Meeting, whether Ordinary or Extraordinary, by whomsoever convened, a twenty-one days’ notice at least of the Meeting specifying the intention to propose a Resolution as a Special Resolution and specifying the day, hour and place of the Meeting, and, subject to the provisions of Article 164 hereof and specifying the nature of the business to be transacted shall be given to the persons entitled to receive such notice under, and in the manner provided by the Companies Ordinance and these Articles.

 

75. A notice of a General Meeting convened by the Board of Directors shall be given by them or, on their behalf, by the Secretary or by any one or more persons authorized by the Board of Directors and, if convened by requisitionists, such notice shall be given by the requisitionists, or by any of them representing more than one half of the total voting of all of them. Notices of General Meetings shall all be in writing.

PROCEEDINGS AT GENERAL MEETINGS

 

76. Three Members present in person or by proxy at any General Meeting holding between them a number of shares entitling them to a third of the total number of votes in the Company, shall constitute a quorum, and no business shall be transacted at any General Meeting unless the requisite quorum is present at the time when the Meeting proceeds to business.

 

77. The Chairman of the Board of Directors shall take the Chair at every General Meeting. If there be no chairman or, if at any Meeting he shall not be present within 15 minutes after the time appointed for holding such Meeting or though present he shall be unable or unwilling to act, the Directors present, or failing them, the Members present in person or by proxy, may elect one of the Directors present, who shall be able and willing so to act, to act as Chairman of the Meeting, and if no more than one Director shall be present at the Meeting, such Director shall act as Chairman of the Meeting, or if no Director shall be present or though present he shall be unable or unwilling to act, and no Chairman shall have been elected as aforesaid, the Members present in person or by a proxy shall elect one of those present, whether as a Member or as a proxy, to be Chairman of the Meeting.

 

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78. No business shall be discussed at any General Meeting whilst the Chair is vacant, except the election of a Chairman.

 

79. If within half an hour after the time appointed for the holding of a General Meeting a quorum be not present, the Meeting, if convened on the requisition of Members, shall be dissolved and in every other case shall stand adjourned to the same day in the next week at same time and place or to such other day, time and place as the Board of Directors may, by notice to the Members entitled to receive notices of General Meetings, appoint. If at such adjourned meeting a quorum be not present, any two Members entitled to be present and present at the Meeting, in person or by proxy, shall be a quorum and may transact the business for which the Meeting was convened.

 

80. The Chairman, with the consent of any Meeting at which a quorum is present, may adjourn the Meeting from time to time, and from place to place, as the Meeting shall determine. Whenever a Meeting is adjourned for twenty-eight days or more, notice of the adjourned Meeting shall be given in the same manner as of the original Meeting. Save as aforesaid, the Members shall not be entitled to any notice of an adjournment, or of the business to be transacted at any adjourned Meeting. Except as provided by the Companies Ordinance in a case of the Statutory Meeting, no business shall be transacted at any adjourned Meeting other than the business which might have been transacted at the original Meeting.

 

81. A Resolution put to the vote at any General Meeting shall be decided on a show of hands, unless a poll is (before or on the declaration of the result of the show of hands) demanded by any Member present at the Meeting in person or by proxy. Unless a poll is so demanded, a declaration by the Chairman that a Resolution has on a show of hands been carried or carried unanimously or by a particular majority, or lost, and an entry to that effect in the book of Minutes of General Meetings of the Company shall be conclusive evidence of the fact without further proof of the number or proportion of the votes recorded in favor of or against that Resolution.

 

82. If a poll is demanded as aforesaid, it shall be taken in such manner and at such time and place in Israel as the Chairman of the Meeting directs and either at once or after an interval or adjournment, and the results of the poll shall be deemed to be the resolution of the Meeting at which the poll was demanded. Provided always that the Chairman of a Meeting at which a poll is demanded shall not direct the poll to be taken after an adjournment unless the Meeting consents thereto.

 

83. In the case of an equality of votes, whether on a show of hands or on a poll, the proposed resolution shall fall.

 

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84. Any poll duly demanded on the election of a Chairman of a Meeting or on any question of adjournment shall be taken at the Meeting and without adjournment.

 

85. The demand of a poll shall not prevent the continuance of a Meeting for the transaction of any business contained in the agenda other than the question on which a poll was demanded.

 

86. Any resolution of the Company in General Meeting shall be deemed duly passed if it be passed by a simple majority of votes, whether voted upon by a show of hands or upon a poll (unless a different majority is required by law or by these Articles).

VOTES OF MEMBERS

 

87. Whether on a show of hands or on a poll:

 

  (a)(1) Every Ordinary Share shall entitle the holder thereof to one vote;

 

       (2) All Ordinary Shares issued at any time shall together entitle the holders thereof to two-thirds of the voting powers in the Company;

 

  (b)(1) All Founders’ Shares issued at any time shall together entitle the holders thereof to one-third of the voting power in the Company;

 

       (2) Every Founders’ Share shall entitle the holder thereof to such number of votes as shall be equal to the quotient arrived at by the division of the aggregate number of votes which all the holders of the Founders’ Share issued for the time being shall be entitled to by the number of the Founders’ Shares issued for the time being.

 

88. The instrument appointing a proxy, whether for a particular Meeting or otherwise shall be in writing under the hand of the appointer, or of a person duly authorized in writing for that purpose and shall, as nearly as circumstances will admit, be in the following form:

“Taro Pharmaceutical Industries Limited

I                      of                      , being a Member of Taro Pharmaceutical Industries Limited, hereby appoint                      of                      as my proxy, to vote for me and on my behalf at the (Ordinary/Extraordinary) General Meeting of the Company to be held on the          day of          19      and at my adjournment thereof.”

“As witness my/our hand this          day of              19     

 

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or in such other form as the Board of Directors may from time to time approve. Notwithstanding anything herein to the contrary, the Members of the Company have been and shall continue to be entitled for all meetings of the Members, to appoint a proxy by telephone, the Internet or any other electronic means that the Board of Directors may approve from time to time.

(Amended October 10, 2002)

 

89. Any person (as defined in the Memorandum of Association of this Company) whether he be a Member of the Company or not, may be appointed to act as a proxy.

 

90. Any company which is a Member of this Company, may, by Resolution of its Directors authorize any person, whether or not he is a Member of the Company, to act as its representative in any Meeting of the Company and such representative shall be entitled to exercise the same powers on behalf of the company which he represents, including the power to vote on a show of hands, as if he had been an individual Member present in person at the Meeting. The Resolution shall be evidenced by a Minute, or by such other instrument as may be authorized by the statutes of the appointing company, or by a duly certified true copy of such minutes or instrument.

 

91. Any Member may appoint by power of attorney, any person, whether or not he is a Member of the Company, to act as his representative at Meetings of the Company and such representative shall be entitled to exercise at any Meeting the same powers, including the power to vote on a show of hands on behalf of the Member whom he represents as if the representative had been a Member present at such Meeting. Furthermore, the appointing Member may confer upon such representative any powers, rights or privileges in the Company.

 

92. The instrument appointing a proxy and the power of attorney or other authority, if any, under which it is signed, or a notarially certified copy of such power or authority, or the documents evidencing the authorization of any person to act as a representative of any company which is a Member of this Company shall be deposited at the Principal Office at least forty-eight hours before the time appointed for holding the Meeting or adjourned Meeting at which the proxy or representative proposes to vote.

 

93. A vote, if given in accordance with the terms of an instrument of appointment of representative or proxy, shall be valid notwithstanding the previous death of the principal, or revocation of the appointment, or transfer of the share in respect of which the vote is given, provided no intimation in writing of the death, revocation or transfer shall have been received at the Principal Office or by the Chairman of the Meeting before the vote is given.

 

94. A Member of unsound mind or in respect of whom an order has been made by any Court having jurisdiction in lunacy, may vote, whether on a show of hands or on a poll, by his committee, curator or other person exercising the functions of a committee or curator or any person appointed by such committee, curator or person.

 

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95. In the case of joint holders, the vote of the senior who tenders the vote, whether in person or by proxy, shall be accepted to the exclusion of the votes of the other joint holders. For this purpose seniority shall be determined by the order in which the names stand in the Register.

 

95a. Notwithstanding anything to the contrary set forth in these Articles, no Owner of any Ordinary Share of the Company shall have any voting right of any nature whatsoever with respect to such Ordinary Share (a) if the Ownership of (I) such Ordinary Share or, (II) any voting power associated with such Ordinary Share, was acquired, either directly or indirectly, by such Owner after October 21, 1999 and (b) so long as (but only so long as) such Ownership by such Owner would, in the event that such Owner had a voting right with respect to such Ordinary Share, result in the Company being classified as a Controlled Foreign Corporation. For purposes of this Article 95a, a person shall be deemed the Owner of such shares as may be ascribed to such person under the relevant provisions of the United States Internal Revenue Code, or any successor statute of the United States, as in effect from time to time (the “Code”), and the term “Controlled Foreign Corporation” shall have the meaning ascribed to it in the relevant provisions of the Code.

(Amended October 21, 1999)

 

95b. Any factual or legal determination required in connection with Article 95a shall be conclusively made by the Chairman of the Board of Directors upon the advice of legal counsel.

(Amended October 21, 1999)

 

THE BOARD OF DIRECTORS

 

96. The number of directors of the Company shall not be less than five nor more than twenty-five.

(Amended October 10, 2002)

 

97. The Directors of the Company shall be elected at the annual ordinary general meeting of the Company, and each of them shall hold office until the next annual general meeting.

 

98. Notwithstanding the provisions of Article 97, A Director may be appointed in place of a Director vacating office or as an additional Director, or may be removed from office, by an ordinary resolution passed at an Extraordinary General Meeting. Likewise, in the event of a Director vacating office, the Board of Directors is empowered to appoint a Director to fill the vacancy. Any Director appointed under this article shall hold office until the next Annual General Meeting of the Company or unless his office is vacated prior thereto in accordance with the provisions of Article 104.

(Amended August 12, 1984)

 

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99. The continuing Directors may act notwithstanding any vacancy in the Board of Directors and shall continue to constitute the Board of Directors.

 

100. No Director shall be required to hold any shares in the Company.

 

101. A Director who ceases to hold office by virtue of Article 98 hereof shall be eligible for re-election as a Director.

 

102. No Director shall be disqualified by his office from holding any office or place of profit under the Company or under any company which is a shareholder or otherwise interested in this Company, or under any company in which this Company shall be a shareholder or otherwise interested, or from contracting with the Company either as vendor, purchaser or otherwise, nor shall any such contract or any contract or arrangement entered into for or on behalf of the Company in which any Director shall be in any way interested, be avoided, nor shall any Director be liable to account to the Company for any profit arising from such office or place of profit or realized by any such contract or arrangement by reason only of such Director holding that office or of fiduciary relations thereby established.

The nature of the Director’s interest must be disclosed by him at the meeting of the Board of Directors at which the contract or arrangement is first taken into consideration if his interest then exists, or in any other case at the first meeting of the Board of Directors after the acquisition of his interest.

A general notice that a Director is a member of any specific firm or company, and is to be regarded as interested in all transactions with the firm or company shall be sufficient disclosure under this Article, as regards such Director and the said transactions.

 

103. A Director interested may notwithstanding his interest be counted in a quorum of a meeting of the Board of Directors, participate in the discussion thereat and may vote on every question which may be considered and voted upon thereat; Provided that the vote of an interested Director on any questions in respect of which he has an interest, shall be deemed void ab initio if he failed to disclose his interest as aforesaid.

 

104. The office of a Director shall ipso facto be vacated in the following events:

 

  (1) Upon his death;

 

  (2) If he be adjudged bankrupt or suspend payment or compound with his creditors;

 

  (3) If he be found lunatic;

 

  (4) If by notice in writing delivered to the Company he resigns his office;

 

  (5) If he is removed from office under Article 98.

 

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105.   (1) A Director may appoint any person to be his Alternate Director either generally or for a specified time or during the continuance of any specified state of affairs.

 

  (2) The appointment shall be made by an instrument in writing, signed by both the appointor and appointee.

 

  (3) The instrument of appointment may impose such limitations and qualifications on the Alternate Director as to time or otherwise as the appointor may deem fit, but subject thereto an Alternate Director shall be entitled to notices of meetings of the Board of Directors, and to attend and vote thereat provided that an Alternate Director shall not vote at any meeting of the Board of Directors at which the Director who had appointed him is present. Furthermore, an Alternate Director shall have and exercise in lieu of the Director whom he substitutes all the rights and powers and privileges as Director excluding the power to appoint a substitute.

 

  (4) The instrument of appointment shall, as nearly as circumstances admit, be in the following form:

“Taro Pharmaceutical Industries Limited

I                  of                  being a director of Taro Pharmaceutical Industries Limited do hereby appoint                              ofto be my Alternate Director (during any absence of mine from Israel)/(during the period of                  commencing on the          day of                  19      ) to attend and vote at any Meetings of the Board of Directors, and to have and exercise all the rights, powers and privileges as Director in accordance with Article 105 of the Articles of Association of the Company. As witness our hands this                  day of              19     

Signature of appointer                     

And I, the abovementioned appointee, confirm that I agree to accept the said appointment and to act as an Alternate Director in the said Company.

Signature of appointee                          .”

 

  (5) The appointment of an Alternate Director shall have effect as from the time of the delivery of the duly signed instrument of appointment to the Principal Office, or as from such later time as may be specified in the instrument of appointment.

 

  (6) Two or more Directors may be represented by the same Alternate Director who shall be entitled to a separate vote for each Director whom he represents in addition to any vote to which he may be entitled in his own right.

 

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  (7) The Office of an Alternate Director shall ipso facto be vacated in any one of the following events:

 

  (a) Upon the happening to him of any one of the events enumerated in Article 104 hereof;

 

  (b) If his appointment be made for a definite time or during the continuance of any state of affairs and such time or state of affairs expires;

 

  (c) If a notice of his removal signed by the appointor be delivered at the Principal Office;

 

  (d) If the Director who had appointed him ceased to be a Director of the Company.

 

106. The Board of Directors may allow and pay to any Director or Alternate Director such sum as the Board of Directors may consider fair compensation for travelling and hotel expenses incurred by him for the purpose of attending meetings of the Board of Directors.

 

107. If any Director or Alternate Director, being willing, shall be called upon to perform extra services or to make any special exertions in going out to or residing at a particular place or otherwise for any of the purposes of the Company, the Company may remunerate such Director by a fixed sum as may be determined by the Board of Directors.

PROCEEDINGS OF THE BOARD OF DIRECTORS

 

108. The Board of Directors may meet together for the despatch of business, adjourn and otherwise regulate their meetings and proceedings as they think fit.

 

109. The majority of the Directors holding office for the time being shall constitute the quorum at any meeting of the Board of Directors. If after half an hour of the time fixed for the holding of the meeting of the Board of Directors a quorum shall not be present the meeting shall be adjourned to the same day in the following week at the same time and place, and if at the adjourned meeting the quorum shall not be present, the meeting shall be adjourned again to the same day in the following week at the same time and place, and if at the twice adjourned meeting the quorum shall not be present then two Directors will constitute a quorum. At any adjourned meeting of the Board of Directors matters for which the original meeting was called may be dealt with.

 

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110. A meeting of the Board of Directors at which a quorum is present, either in person, by telephone or by video conference, for which meeting written minutes have been signed by the Chairman of the meeting, shall be competent to exercise all or any of the authorities, powers and discretions by or under the regulations of the Company vested in or exercisable by the Board of Directors generally.

(Amended June 22, 1995)

 

111. The Chairman may at any time and the Secretary upon the request of a Director shall convene a meeting of the Board of Directors.

 

112. Not less than one day’s prior notice shall be given of every meeting of the Board of Directors to each Director or – in his absence – to his alternate unless all directors and/or alternate directors present at the time in Israel agree, upon shorter notice. Any notice as aforesaid may be given orally – in person or by telephone, or in writing – by letter, facsimile (telecopier), cable, or any form of electronic communications.

(Amended June 22, 1995)

 

113. Any Director who has not appointed an Alternate Director may vote by letter or by cable.

 

114. The accidental omission to give notice of any meeting of the Board of Directors to a Director or to an Alternate Director shall not invalidate any resolution passed at such meeting.

 

115. The Directors may elect one of their number to be Chairman of the meetings of the Board of Directors and determine the period for which he is to hold office; but if no such Chairman is elected, or if at any meeting the Chairman is not present within fifteen minutes after the appointed for holding the same, the Directors present may choose one of their number to be chairman of such meeting.

 

116. Questions arising at any meeting of the Board of Directors shall be decided by a majority of votes; and in case of an equality of votes, the Chairman of the meeting shall have a second or casting vote.

 

117.  (a) The Board of Directors may from time to time by resolution appoint an Executive Committee, with such powers and authorities (not exceeding those vested in the Board of Directors for the time being) as the Board of Directors may from time to time determine. The Executive Committee shall consist of such number of Directors as the Board of Directors may from time to time determine; until otherwise determined, the number of members of the Executive Committee shall not be less than three and not more than five. The Board of Directors may from time to time by resolution remove any member of the Executive Committee and appoint another in his place. Any person acting as an Alternate Director for any Director who is a member of the Executive Committee may act as his alternate on the Executive Committee.

 

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  (b) In addition to, and without in any way affecting, the provisions of sub- Clause (a) hereof, the Board of Directors may from time to time by resolution delegate any of their powers to a committee consisting of such Director or Directors and/or of such other person or persons, as the Board of Directors may deem fit.

The Executive Committee or any other committee formed as aforesaid shall, in the exercise of the powers delegated to it, conform to any regulations that may from time to time be imposed upon it by the Board of Directors. The delegation of any power delegated as aforesaid may be revoked by resolution of the Board of Directors.

 

118. A resolution in writing signed by a majority of the Directors entitled to vote thereon passed without any meeting of the Board of Directors shall be as valid and effectual as a resolution duly passed at a meeting of the Board of Directors, called and held in accordance with the provisions of these Articles.

(Amended October 21, 1999)

 

119. A resolution in writing signed by a majority of the members for the time being of the Executive Committee or of any other committee appointed under Article 117b hereof, entitled to vote thereon, and passed without any meeting of the Executive Committee or of such other committee, as the case may be, shall, be as valid and effectual as a resolution duly passed at a meeting of the Executive Committee or such other committee, as the case may be, called and held in accordance with the provisions of these Articles.

(Amended October 21, 1999)

 

120. All acts done at any meeting of the Board of Directors or by the Executive Committee or any other committee, or by any person acting as a Director, shall, notwithstanding that it shall afterwards be discovered that there was some defect in the appointment of such Directors or persons acting as Directors as aforesaid, or that any of them was disqualified from acting as such, be as valid as if every such person had been duly appointed to be a Director and qualified to act as such.

POWERS OF THE BOARD OF DIRECTORS

 

121.

The business of the Company shall be managed by the Board of Directors who may pay all expenses of and incidental to the formation and the registration of the Company and they may exercise all such powers and do all such act and things as the Company by its Memorandum of Association or otherwise is authorized to exercise and do as are not by these presents or by law directed or

 

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  required to be exercised or done by the Company in General Meeting, but subject nevertheless to the provisions of the Company Ordinance and of the Memorandum of Association and these presents and to any regulations not being inconsistent with the Memorandum of Association and these presents from time to time made by the Company in General Meeting, provided that no such regulation shall invalidate any prior act of the Directors which would have been valid if such regulation had not been made.

 

122. Without prejudice to the general powers conferred by Article 121 hereof and the other powers conferred by these presents and without thereby in any way limiting or restricting any or all those powers, it is hereby expressly declared that the Board of Directors shall have the following powers:

 

  (a) To appoint any person or persons (whether incorporated or not) to accept and hold in trust for the Company any property belonging to the Company or in which it is interested, or for any other purposes and to execute and do all such acts, deeds and things as may be requisite in relation to any such trust and to provide for the remuneration of such trustee or trustees.

 

  (b) To institute, conduct, defend, compound, or abandon any legal proceeding by or against the Company or its officers or otherwise concerning the affairs of the Company, and also to compound and allow time for payment or satisfaction of any debt due, or of any claim or demands by or against the Company.

 

  (c) To refer any claim or demand by or against the Company to arbitration.

 

  (d) To determine from time to time who shall be entitled to sign on the Company’s behalf bills of exchange, promissory notes, receipts, acceptances, endorsements, checks, dividend warrants, releases, contracts and other documents.

 

  (e) To appoint and, at their discretion, remove or suspend a General Manager and any such Manager, Officer, clerk, employee or agent, whether employed permanently, temporarily or for special services as they may from time to time think fit, and to determine their powers and duties and fix their salaries and emoluments and require security in such instances and for such amounts as they may think fit.

 

  (f)

From time to time and at any time to establish any local Board for managing any of the affairs of the Company in any specified locality in Israel or elsewhere and to appoint any persons to be members of any local Boards and to fix their remuneration and to remove any such persons from office. And from time to time, at any time to delegate to any person so appointed any of the powers, authorities and discretions for the time being vested in the Board of Directors and to authorize the members for the time being of any such Local Board, or any of them to

 

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  fill up any vacancies therein and to act notwithstanding any vacancies therein and any such appointment or delegation may be made on such terms and subject to such conditions as the Board of Directors may think fit, and the Board of Directors may at any time remove any person so appointed and may annul or vary any such delegation. Any such delegates may be authorized by the Board of Directors to subdelegate all or any of the powers, authorities and discretions for the time being vested in them.

 

  (g) At any time and from time to time by Power of Attorney to appoint any person or persons to be the attorney or attorneys of the Company for such purposes, with such powers, authorities and discretions (not exceeding those vested in or exercisable by the Board of Directors under these presents) and for such period and subject to such conditions as the Board of Directors may from time to time think fit and any such appointment (if the Board of Directors think fit) may be made in favor of the members or any of the members of any Local Board established as aforesaid, or in favor of any company or the members, directors, nominees or managers of any company or firm or in favor of any person determined by any company or firm or otherwise in favor of any fluctuating body of persons whether nominated directly or indirectly by the Board of Directors. Any such power of attorney may contain such powers for the protection or convenience of persons dealing with such attorneys as the Board of Directors may think fit.

 

  (h) The Board of Directors shall be entitled to appoint, on behalf of the Company, an advocate or advocates in Israel or abroad, to represent the Company before all Courts, judicial bodies, quasi-judicial bodies, government, municipal and other offices or bodies in Israel or abroad and to confer upon any such advocate such powers as may be deemed expedient, including the power to delegate his powers, in whole or in part, to another or others.

 

  (i) Generally subject to the provisions of the Companies Ordinance and these Articles to delegate the powers, authorities and discretions vested in the Board of Directors to any person, firm, company or fluctuating body of persons as aforesaid.

 

  (j) In the interim between meetings of the Board of Directors, the Chairman of the Board shall be responsible for assuring that the directives and policies of the Board of Directors are carried out in an appropriate manner.

(Amended October 21, 1999)

 

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GENERAL MANAGER

 

123. The Board of Directors may from time to time appoint any one person or more whom they deem fit, to be General Manager of the Company either for a definite or indefinite term and may from time to time remove or dismiss such person(s) from office and appoint instead another person or other persons whom they deem fit for a definite or indefinite period. If a General Manager of the Company is also a Director of the Company, such person shall be called a “Managing Director.”

(Amended October 21, 1999)

 

124. The Board of Directors may from time to time confer upon the General Manager for the time being such of the powers (except the power to make calls exercisable under these presents by the Board of Directors) as they may think fit, and may confer such powers for such times and to be exercised for such objects and purposes and upon such terms and conditions and with such restrictions, as they think fit, and they may confer such powers either collaterally with, or in substitution for any of the powers of the Board of Directors in that behalf; and they may from time to time revoke, withdraw, alter or vary all or any of such powers.

SECRETARY

 

125. The Board of Directors may from time to time appoint a Secretary to the Company for such term, at such remuneration and upon such condition as they may think fit. Any Secretary so appointed may be removed by the Board of Directors.

MINUTES

 

126. The Board of Directors shall cause Minutes to be duly entered into books provided for the purpose of:

 

  (a) All appointments of officers;

 

  (b) The names of the Directors present at each meeting of the Board of Directors or at any meeting of the Executive Committee or a Committee of Directors;

 

  (c) All orders made by the Board of Directors;

 

  (d) All resolutions and proceedings of General Meetings and of meetings of the Board of Directors and of Committees of the Board of Directors and of the Executive Committee.

 

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Each Minute of a meeting of the Board of Directors or of the Executive Committee or of a Committee of the Company, if purporting to be signed by the Chairman of such meeting or by the Chairman of the next succeeding meeting, shall be receivable as prima facie evidence of the matters stated in such Minute. The Minutes Books of the General Meetings shall be kept at the Principal Office and be available for gratuitous inspection by the Members during two hours of every working day of the Principal Office.

THE SEAL

 

127. The Board of Directors shall provide a Seal for the purposes of the Company and shall have power from time to time to destroy the same and substitute a new Seal in lieu thereof. The Board of Directors shall provide for the safe custody of the Seal for the time being. The Seal shall never be used except by or under the authority of a resolution of the Board of Directors or of a Committee of Directors and in the presence of two Directors at least, who shall sign every instrument to which the Seal is affixed provided that certificates of shares may be sealed in the manner provided in Article 18 hereof.

 

128. The Company shall have at least one rubber stamp, and the Board of Directors shall provide for the safe custody of such rubber stamp, and the stamp shall not be used except in the presence of the persons authorized to sign on behalf of the Company, who shall sign every instrument to which the stamp is affixed.

 

129. The Board of Directors may authorize any person or persons (even if they are not members of the Board of Directors) to act and sign on behalf of the Company, and the acts and signatures of such person or persons as aforesaid shall bind the Company insofar as such person or persons acted and signed within their powers aforesaid.

 

130. The Company may have for use in any territory, district or place not situate in Israel, an official seal, which shall be a facsimile of the Seal of the Company, with the addition on its face of the name of every territory, district or place where it is to be used. The Company may exercise the powers conferred by Section 84 of the Companies Ordinance and such powers as well as the powers under this Article shall accordingly be vested in the Board of Directors.

RESERVE FUND, DIVIDEND AND CAPITALIZATION

 

131.

The Board of Directors may before recommending any dividend in respect of any financial year set aside out of the profits of the Company such sums as they may think proper as a reserve fund for the purpose of meeting expenses and contingencies of any kind and nature whatsoever, or for repairing and maintaining any of the works, buildings, apparatus, machinery or undertakings connected with the business of the Company or for the redemption of

 

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  debentures, or for meeting the loss due to amortisation or any other depreciation or diminution in the value of any of the property of the Company or for the preparation of sources of meeting losses or extraordinary expenses, or for the enlargement or development of the business of the Company or for any other purpose for which the moneys of the Company may be used.

 

132. The Board of Directors shall submit to every Ordinary General Meeting of the Company a statement as to the net profits, if any, of the Company available for dividend for the financial year immediately preceding that Ordinary General Meeting. If the statement shows that there are sufficient profits available for dividend, the Board of Directors may in its discretion recommend the declaration by the Meeting of dividend for the said financial year.

 

133. The Company may at any Ordinary General Meeting declare such dividend as the Board of Directors shall have recommended, or any smaller dividend but no larger dividend shall be declared than is so recommended.

 

134. No dividend shall be payable except out of the profits of the Company and no dividend shall carry interest as against the Company.

 

135. The Board of Directors may from time to time pay such interim dividends as in their judgment the position of the Company justifies.

 

136. Where capital is paid up in advance of calls upon the footing that the same shall carry interest, such capital shall not whilst carrying interest, confer a right to participate in profits.

 

137. Subject to the provisions of the Companies Ordinance the Board of Directors, shall be entitled by resolution to withhold from any Member the payment to him of any dividend in respect of his share or shares whilst any money may be due or owing from him to the Company in respect of such share or shares or otherwise howsoever either alone or jointly with any other person or persons and the Board of Directors may deduct from the interest or dividend payable to such Member all sums of money so due from him to the Company.

 

138. A transfer of shares shall not pass the right to any dividend declared thereon before the registration of the transfer.

 

139. Subject to the provisions of these presents as to the reserve fund and as to the rights of the different classes of shares, the profits of the Company shall be divisible among the Members of the Company in proportion of the amount of capital paid up on the nominal amount of the shares of the Company held by each Member at the date of the declaration of the dividend. Provided that any amount paid on a share during the period in respect of which the dividend has been declared, shall entitle the holder of such share only to a proportionate amount of the dividend having regard to the date of the payment of the said amount of capital.

 

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140. Any dividend may be paid to a Member by crossed cheque sent by registered mail to the registered address of the Member or person entitled thereto or in case of joint holders to that one of them first named in the Register in respect of the joint holding. Every such cheque shall be made payable to the order of the person to whom it is sent. The Company shall not be liable or responsible for any cheque or warrant lost in transmission or for any dividend lost to the Member or person entitled thereto by the forged endorsement of any cheque or warrant or the fraudulent or improper recovery thereof by any other means.

 

141. Any one of several persons who are registered as the joint holders of any share may give effectual receipts for all dividends and payments on account of dividends in respect of such share.

 

142. All dividends unclaimed for one year after having been declared may be invested or otherwise made use of by the Board of Directors for the benefit of the Company, until claimed.

 

143. Any Ordinary General Meeting declaring a dividend may resolve that such dividend be paid wholly or in part by the distribution of specific assets of the Company, including fully paid up shares, debentures or debenture stock of the Company, or shares, debentures or debenture stock of any other company or in any other way whatsoever.

 

144. Any General Meeting of the Company may resolve that any moneys, investments or other assets forming the undivided profits of the Company, standing to the credit of the reserve fund, or in the hands of the Company available for the payment of dividends be capitalised and distributed among such of the shareholders as would be entitled to receive same, if distributed by way of dividend in the same proportion on the footing that they become entitled thereto as capital and that all or part of such capitalised fund be applied on behalf of such shareholders in paying up in full or in part, whether at par or at such discount or at such premium as the resolution may provide, any unissued shares or debentures or debenture stock of the Company, which shall be distributed accordingly or in or towards the payment of uncalled liability on any issued shares or debentures or debenture stock, and that such distribution or payment be accepted by such shareholders in full and complete satisfaction and settlement of their claims to, and interest in, the said capitalised sum.

 

145.

For the purpose of giving effect to any resolution under the two preceding Articles, the Board of Directors may, in its absolute discretion, settle any difficulty (if any) which may arise in regard to the distribution as they think expedient and in particular may issue fractional certificates and may fix the value for distribution of any specific assets, and may determine that such payment shall be made to any Members upon the footing of the value as fixed or that fractions of less value than IL 1.00 may be disregarded in order to adjust the rights of all parties, and may vest any such cash or specific assets in absolute trusteeship in trustees upon such trusts for the persons entitled to the dividends

 

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  or capitalised fund as may seem expedient to the Board of Directors; where requisite, a proper contract shall be filed in accordance with Section 93 of the Companies Ordinance and the Board of Directors may appoint any person to sign such contract on behalf of the persons entitled to the dividend or capitalised fund, and such appointment shall be effective.

ACCOUNTS

 

146. The Board of Directors shall cause true accounts to be kept of the sums of money received and expended by the Company, and the matters in respect of which such receipt and expenditure takes place and of the assets, credits and liabilities of the Company. The books of account shall be kept at the Principal Office or at such other place or places as the Board of Directors may from time to time think fit.

 

147. At the Ordinary General Meeting in every year, the Board of Directors shall lay before the Company a profit and loss account and a balance sheet containing a summary of the assets and liabilities of the Company in accordance with Section 106 of the Companies Ordinance. Every such account and balance sheet shall be accompanied by a report of the Board of Directors as to the state and condition of the Company and by a statement under Article 132 hereof, as the case may be. The report shall be signed by two Directors and countersigned by the Secretary, if any, of the Company.

 

148. The Board of Directors shall from time to time decide in which manner and to what extent and at what time and place and on what terms and regulations the books, the accounts or documents of the Company shall be open to inspection by Members who are not Directors. A Member who is not a Director shall not have the right to inspect any book, account or document of the Company unless he is given such right by law or he has been authorized thereto by the Board of Directors or by the Company in General Meeting.

AUDIT

 

149. Once at least in every year the accounts of the Company shall be examined and correctness of the profit and loss account and balance sheet ascertained by an auditor.

 

150. The Company shall at each Ordinary General Meeting appoint an auditor to hold office until the next Ordinary General Meeting. In case the Company in General Meeting wishes to appoint another auditor or other auditors in lieu of the retiring auditor or auditors, the new appointment or appointments shall be made in accordance with the provisions of Section 105 of the Companies Ordinance.

 

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151. Every auditor of the Company shall have a right of access at all times to the books and accounts and vouchers of the Company and shall be entitled to require from the Directors and Officers of the Company such information and explanation as may be necessary for the performance of the duties of the auditor.

 

152. The auditor shall make a report to the Members on the accounts examined by him and on every balance sheet laid before the Company in General Meeting during his tenure of office in accordance with the provisions of the Companies Ordinance.

 

153. The auditor of the Company shall be entitled to receive notice of and to attend any General Meeting of the Company at which any accounts which have been examined or reported on by him are to be laid before the Company and may make any statement or explanation he desires with respect to the accounts.

 

154. Every account when audited and approved by a General Meeting shall be conclusive except as regards any error discovered therein within three months after the approval thereof. Whenever any such error is discovered within that period, the account shall forthwith be corrected and thenceforth shall be conclusive.

NOTICE

 

155. A notice may be served by the Company upon any Member, either personally or by sending it through the post in a prepaid letter, envelope or wrapper, addressed to such Member at his registered address in Israel.

 

156. A Member whose registered address is not in Israel, may from time to time notify in writing to the Company an address in Israel, which shall be deemed his registered address within the meaning of the last preceding clause.

 

157. If a Member has no registered address in Israel and has not supplied the Company with an address within Israel for the giving of notices to him, a notice addressed to him at the Principal Office or a notice addressed to him or to the shareholders in general, or to any class of shareholders and published in a newspaper circulating in the neighborhood of the Principal Office shall be deemed to be duly given to him on the day on which the newspaper containing the notice appears.

 

158. All notices shall, with respect to any shares to which persons are jointly entitled, be given to whoever of such persons is named first in the Register and notice so given shall be sufficient notice to all the holders of such shares.

 

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159. Any notice sent by post to an address in Israel shall be deemed to have been served on the day following that on which the letter, envelope, or wrapper containing the same is posted and in proving such service it shall be sufficient to prove that the letter, envelope or wrapper containing the notice was properly addressed and put into a post-office. A certificate in writing signed by the Secretary or manager or other officer of the Company that the letter, envelope or wrapper containing the notice was so addressed and posted shall be conclusive evidence thereof.

 

160. Any notice sent by post to an address out of Israel shall be deemed to have been served in the ordinary course of post, and in proving such service, it shall be sufficient to prove that the letter, envelope or wrapper containing the notice was properly addressed and put into a post-office. A certificate in writing signed by the Secretary, or any manager or other officer of the Company, that the letter, envelope or wrapper containing the notice was so addressed and posted shall be conclusive evidence thereof.

 

161. Every person who, by operation of law, transfer or other means whatsoever, shall become entitled to any share, shall be bound by every notice in respect of such share which, previously to his name and address being entered on the Register shall be duly given to the person from whom he derives his title to such share.

 

162. Any notice or document sent by post to, or left at the registered address of, any Member, in pursuance of these presents, or if published to him under Article 157 hereof, shall, notwithstanding such Member be then deceased, and whether or not the Company have notice of his decease, be deemed to have been duly served in respect of any registered shares, whether held solely or jointly with other persons by such Member, until some other person be registered in his stead as the holder or joint holder thereof, and such service shall for all purposes of these presents be deemed a sufficient service of such notice or document on his personal representatives and all persons, if any, jointly interested with him in any such shares.

 

163. Any failure in giving notice of a Meeting to a Member through inadvertence or any failure of such notice reaching a Member, shall not affect the validity of any resolution passed at such Meeting.

 

164. It shall not be necessary to set out in a notice of a General Meeting of the Company the text of the resolution (whether Ordinary, Extraordinary or Special) to be considered in that Meeting, and it shall be sufficient if the notice states in most general terms the nature of the question to be considered. It shall, however, be sufficient (but not obligatory) to state in any notice of a General Meeting – instead of stating in general terms the nature of the questions as aforesaid – that a resolution will be put forward for consideration and voting at the Meeting and that the text of the resolution may be inspected, provided that the notice indicates the place or places in Israel and the time or times fixed for inspection of the text of the resolution.

 

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WAIVER

 

165. It shall be lawful for any shareholder and Director of the Company to waive the right to notice, or the right to notice for any specific time, or to agree that a General Meeting be held even though shorter notice of the Meeting than the prescribed time for the notice has been given, subject always to any provisions of the law prohibiting such waiver or agreement. If all the Members entitled to attend and vote at a General Meeting so agree, a resolution may be proposed and passed (whether as an Ordinary Resolution, Extraordinary Resolution or Special Resolution) at a General Meeting, notice of which was shorter than prescribed by or under the Companies Ordinance or these Articles.

MISCELLANEOUS PROVISIONS

 

166. Notwithstanding anything contained in these Articles, the following provisions shall apply to the Branch Register, the Members registered for the time being in the Branch Register (in this Article referred to as “Branch Members”) to the Branch Office, to the administration of the Branch Register and of the Branch Office and the matters incidental thereto, to with: -

 

  (a) On or before the opening of the Branch Register or so soon thereafter as may be practicable, the Board of Directors shall, in exercise of the powers conferred upon it under Article 122(f) hereof, appoint a local Board for the United States of America with its seat at the Branch Office (in this Article referred to as “the Branch Board”) to consist of such person or persons, whether or not such person or persons be Director(s) or officer(s) of the Company, and shall confer upon the Branch Board such powers and authorities and discretions to be exercised in all matters including financial matters to be exercised in such manner and be subject to such restrictions and limitations as the Board of Directors may, from time to time, resolve.

 

  (b) The provisions in these Articles contained and relating to the proceedings of the Board of Directors, including the provisions of Articles 118 and 119 hereof (but substituting the word “Israel” wherever it appears therein by the words “United States of America”) shall mutatis mutandis apply to the Branch Board.

 

  (c) The provisions of Article 126 hereof shall mutatis mutandis apply to a Minutes Book to be kept by the Branch Board at the Branch Office; but the Branch Board shall transmit to the Principal Office a copy of every entry in the Minutes Book aforesaid as soon as may be after the entry is made.

 

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  (d) On or before the date of opening of the Branch Register or so soon thereafter as may be practicable, the Board of Directors shall cause a facsimile of the Seal of the Company to be kept at the Branch Office which shall be under the control of the Branch Board.

 

  (e) Any payment to the Company by Branch Members may be effected at the Branch Office or at such place or places in the United States of America as the Branch Board may from time to time by notice to the Branch Members determine.

 

  (f) Shares registered in the Branch Register shall be transferred in the same manner as shares registered in the Principal Register, as specified in Articles 43-49 inclusive, except that as regards the transfer of such shares, the powers and duties of the Board of Directors according to the above-mentioned Articles will be exercised by the Branch Board and all acts or entries which should be done in the Principal Office or in the Principal Register according to the above-mentioned Articles, will be done, mutatis mutandis, in the Branch Office or in the Branch Register.

 

  (g) In case the Board of Directors have resolved to issue share warrants, the powers and duties of the Board of Directors under Articles 51 to 58 (both inclusive), shall in respect of the shares registered in the Branch Register be exercised by the Branch Board, and all transactions which may be effected under the said Articles at the Principal Office shall mutatis mutandis be effected at the Branch Office.

 

  (h) Any requisition under Article 73(1) hereof if made by a Branch Member may be delivered to the Branch Office.

 

  (i) The provisions of Article 157 shall not apply to Branch Members.

 

  (j) With respect to Branch Members, the provisions of Articles 155, 157, 159 and 164 shall be deemed altered by the substitution of the words “Israel” and “Principal Office” wherever appearing therein by the words “The United States of America” and the “Branch Office” respectively.

 

  (k) The provisions of Article 160 shall not apply to Branch Members.

WINDING UP

 

167. The winding up of the Company shall not be resolved upon unless by a Special Resolution, or by an Extraordinary Resolution, if it cannot by reason of its liabilities continue its business and it is advisable to wind up.

 

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168. If the Company shall be wound-up, whether voluntarily or otherwise, and the assets available for distribution among the Members as such shall be insufficient to repay to the Members the whole of the capital paid upon the nominal amount of the shares, such assets shall be distributed so that as nearly as may be the losses shall be borne by the Members in proportion to the capital paid up.

 

169. If the Company shall be wound up, whether voluntarily or otherwise, the liquidator may, with the sanction of a Special Resolution, divide amongst the contributors in specie or kind, any part of the Company and may, with the like sanction vest any part of the assets of the Company in Trustees upon such trusts for the benefit of the contributories or any of them, as the liquidator with the like sanction shall think fit.

170. INSURANCE

Subject to the provisions of the Companies Law, and subject further to Article 173, the Company may enter into a contract for the insurance of all or part of the liability of any Officer imposed on him in consequence of an act which he has performed by virtue of being an Officer, including, in respect of one or more of the following:

 

  a) a breach of his duty of care to the Company or to another person;

 

  b) a breach of his fiduciary duty to the Company, provided that the Officer acted in good faith and had reasonable cause to assume that such act would not prejudice the interests of the Company;

 

  c) a financial obligation imposed on him in favor of another person;

 

  d) any other circumstances arising under the law with respect to which the Company may, or will be able to, insure an Officer of the Company (including, without limitation, indemnification with respect to the matters referred to under Section 56h(b)(1) of the Israeli Securities Law 5728-1968, as amended (the “Securities Law”), if applicable); and/or

 

  e) a financial obligation imposed upon an Officer and reasonable litigation expenses, including attorney fees, expended by the Officer as a result of an administrative proceeding instituted against him. Without derogating from the generality of the foregoing, such obligation or expense will include a payment which the Officer is obligated to make to an injured party as set forth in Section 52(54)(a)(1)(a) of the Securities Law and expenses that the Officer incurred in connection with a proceeding under Chapters H’3, H’4 or I’1 of the Securities Law, including reasonable legal expenses, which term includes attorney fees.

(Amended December 29, 2012)

 

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171. INDEMNITY

 

  a) Subject to the provisions of the Companies Law, and subject further to Article 173, the Company may indemnify an Officer, retroactively, in respect of any liability or expense for which indemnification may be provided under the Companies Law, including the following liabilities or expenses, imposed on such Officer or incurred by him in consequence of an act which he has performed by virtue of being an Officer:

 

  (1) a financial liability imposed on such Officer in favor of any person pursuant to a judgment, including a judgment rendered in the context of a settlement or an arbitrator’s award approved by a court; the term “person” in this Article 171 shall include, without limitation, a natural person, firm, partnership, joint venture, trust, company, corporation, limited liability entity, unincorporated organization, estate, government, municipality, or any political, governmental, regulatory or similar agency or body;

 

  (2) reasonable Litigation Expenses (as defined below) incurred by an Officer as a result of an investigation or any proceeding instituted against the Officer by an authority that is authorized to conduct an investigation or proceeding, and that was concluded without filing an indictment against the Officer and without imposing on the Officer a financial obligation in lieu of a criminal proceeding, or that was concluded without filing an indictment against the Officer but imposing a financial obligation in lieu of a criminal proceeding in an offence that does not require proof of mens rea, or in connection with a financial sanction. In this section “conclusion of a proceeding without filing an indictment in a matter in which a criminal investigation has been instigated” and “financial liability in lieu of a criminal proceeding” shall have the meaning assigned to such terms under the Companies Law, and the term “financial sanction” shall mean such term as referred to in Section 260(a)(1a) of the Companies Law. The term “Litigation Expenses” in this Article 2 shall include, without limitation, attorneys’ fees and all other costs, expenses and obligations paid or incurred by Indemnitee in connection with investigating, defending, being a witness in or participating in (including on appeal), or preparing to defend, be a witness in or participate in any claim relating to any matter for which indemnification hereunder may be provided;

 

  (3) reasonable Litigation Expenses, including attorneys’ fees, incurred by an Officer or charged to him by a court, in a proceeding instituted against him by the Company or on its behalf or by another person, or in a criminal charge from which he was acquitted or in which he was convicted of an offence that does not require proof of mens rea;

 

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  (4) a financial obligation imposed upon an Officer and reasonable litigation expenses, including attorney fees, expended by the Officer as a result of an administrative proceeding instituted against him. Without derogating from the generality of the foregoing, such obligation or expense will include a payment which the Officer is obligated to make to an injured party as set forth in Section 52(54)(a)(1)(a) of the Securities Law and expenses that the Officer incurred in connection with a proceeding under Chapters H’3, H’4 or I’1 of the Securities Law, including reasonable legal expenses, which term includes attorney fees; and/or

 

  (5) any other event, occurrence or circumstances in respect of which the Company may lawfully indemnify an Officer of the Company.

 

  b) Subject to the provisions of the Companies Law and subject further to Article 173, the Company may undertake to indemnify an Officer, in advance, in respect of the following liabilities or expenses, imposed on such Officer or incurred by him in consequence of an act which he has performed by virtue of being an Officer:

 

  (1) As set forth in Article a)(1), provided that the undertaking to indemnity shall be limited to events which the Board of Directors believes are predictable in light of the Company’s business de facto at the time the undertaking to indemnify is granted, and to amounts or criterion that the Board of Directors had determined to be reasonable in the circumstances, and that the undertaking to indemnity shall specify such predictable event and the amounts or criterion so determined.

 

  (2) As set forth in Articles a)(2), a)(3) and a)(5).

(Amended December 29, 2012)

172. RELEASE

Subject to the provisions of the Companies Law and subject further to Article 173, the Company may release, in advance, an Officer from all or any part of the liability due to damages arising out of the breach of duty of care towards the Company.

(Amended December 29, 2012)

173. GENERAL

 

  a) Notwithstanding anything to the contrary contained herein and subject to applicable law, these Articles are not intended, and shall not be interpreted, to restrict the Company in any manner in respect of the procurement of insurance and/or in respect of indemnification:

 

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  (1) in connection with any person who is not an Officer, including, without limitation, any employee, agent, consultant or contractor of the Company who is not an Officer, and/or

 

  (2) in connection with any Officer to the extent that such insurance and/or indemnification is not specifically prohibited under law;

provided that if the Company has an Audit Committee, the procurement of any such insurance and/or the provision of any such indemnification shall be approved by the Audit Committee of the Company.

 

  b) Notwithstanding anything to the contrary in these Articles or any other agreement or instrument, the Company shall not insure, indemnify or release the Officer with respect to events or circumstances for which insurance, indemnification or release are not permitted under law.

(Amended December 29, 2012)

 

174. Any amendment to the Companies Law or other applicable law adversely affecting the right of any Officer to be indemnified, insured or released pursuant to Articles 1 to 4 above shall be prospective in effect, and shall not affect the Company’s obligation or ability to indemnify or insure an Officer for any act or omission occurring prior to such amendment, unless otherwise provided by applicable law.

(Amended December 29, 2012)

 

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Exhibit 12.1

CERTIFICATION

I, James Kedrowski, certify that:

 

  1. I have reviewed this annual report on Form 20-F of Taro Pharmaceutical Industries Ltd.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;

 

  4. The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the company and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared.

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and


  5. The company’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting.

Date: July 1, 2013

 

/s/ James Kedrowski

Name:   James Kedrowski
Title:   Interim Chief Executive Officer and Director

Exhibit 12.2

CERTIFICATION

I, Michael Kalb, certify that:

 

  1. I have reviewed this annual report on Form 20-F of Taro Pharmaceutical Industries Ltd.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;

 

  4. The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the company and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared.

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and


  5. The company’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting.

Date: July 1, 2013

 

/s/ Michael Kalb

Name:   Michael Kalb
Title:   Group Vice President, Interim Chief Financial Officer and Chief Accounting Officer

Exhibit 13

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT 2002

In connection with the Annual Report of Taro Pharmaceutical Industries Ltd. (the “Company”) on Form 20-F for the period ended March 31, 2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we James Kedrowski, Interim Chief Executive Officer and Director of the Company, and Michael Kalb, Group Vice President, Interim Chief Financial Officer and Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:

 

  1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

  2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Date: July 1, 2013   By:  

/s/ James Kedrowski

    James Kedrowski
    Interim Chief Executive Officer and Director
  By:  

/s/ Michael Kalb

    Michael Kalb
    Group Vice President, Interim Chief Financial Officer and Chief Accounting Officer