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Draxis Health 20-F 2007 Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
FORM 20-F (Mark One) o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-17434
DRAXIS HEALTH INC. (Exact name of Registrant as specified in its charter)
CANADA (Jurisdiction of incorporation or organization)
6870 GOREWAY DRIVE, 2nd FLOOR, MISSISSAUGA, ONTARIO, CANADA L4V 1P1 (Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Securities registered or to be registered pursuant to Section 12(g) of the Act.
NONE (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.
Shares – 41,522,138 common shares (as of 12/31/06)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
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 o No x
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. Yes x No o
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 o Accelerated filer x Non-accelerated filer o
Indicate by check mark which financial statement item the Registrant has elected to follow. Item 17 o Item 18 x
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 o No x
i Item 1. Identity of Directors, Senior Management and Advisers Not Applicable Item 2. Offer Statistics and Expected Timetable Not Applicable DRAXIS Health Inc. (“DRAXIS” or the “Company”) is a specialty pharmaceutical company providing products in three categories: sterile products, non-sterile products and radiopharmaceuticals. Sterile products include liquid and freeze-dried (lyophilized) injectables and sterile ointments. Non-sterile products are produced as solid oral, liquid and semi-solid dosage forms. Radiopharmaceuticals are used for both therapeutic and diagnostic molecular imaging applications. In the radiopharmaceutical category, DRAXIS has its own products and a targeted research and development program for new products. As of January 1, 2005, all of the operations of the Company are carried out through our wholly owned subsidiary DRAXIS Specialty Pharmaceuticals Inc., which operates two major divisions, DRAXIS Pharma (contract manufacturing) and DRAXIMAGE (radiopharmaceuticals). Our operations are carried out at our sole manufacturing facilities located at 16751, Trans-Canada Highway, Kirkland, Québec, H9H 4J4, Canada (our “manufacturing facilities” or “facility”). For the year ended December 31, 2006, 72.8% of our consolidated revenues were derived from DRAXIS Pharma (contract manufacturing) and 24.2% of our consolidated revenues were derived from DRAXIMAGE (radiopharmaceuticals). Our subsidiary Deprenyl Animal Health, Inc. (“DAHI”) receives licensing and royalty revenue related solely to ANIPRYL®, a companion animal health product. It does not engage in any operations. Our registered and principal office is located at 6870 Goreway Drive, 2nd Floor, Mississauga, Ontario, L4V 1P1, Canada. Unless otherwise indicated herein, the information presented in this Annual Report (Form 20-F) is for the year ended December 31, 2006. The selected data set forth in the following table are expressed in U.S. dollars and in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). All data presented below should be read in conjunction with, and is qualified in its entirety by, reference to our audited Consolidated Financial Statements and Notes thereto for the year ended December 31, 2006 which are included in this annual report. 1
Selected Five-Year Review (in thousands of U.S. dollars except share related data)
OverviewThis Annual Report (Form 20-F) contains forward-looking statements (within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended) and information that are based on management’s beliefs, as well as assumptions made by and information currently available to management. When used in this Annual Report (Form 20-F), the words “anticipate,” “estimate,” “forecast”, “plan”, “believe,” “expect,” “potential,” “intend,” “projected” “designed” and “should” and similar expressions are intended to identify forward-looking 2 statements. These forward-looking statements necessarily make numerous assumptions with respect to: industry performance; general business, economic and regulatory conditions; access to markets and materials; and other matters, all of which are inherently subject to significant uncertainties and contingencies and many of which are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions made or factors considered in making a forward looking statement prove incorrect, actual results may vary materially from those anticipated, estimated or projected. We believe that any of the following risk factors could cause our actual results to differ from those that may have been or may be projected in forward-looking statements made by us or on our behalf from time to time. The forward-looking statements in this Annual Report (Form 20-F) are contained principally under Items 4 and 5. RISK FACTORS Our future financial condition, results of operations and business could be materially affected by the risks and uncertainties discussed below, or otherwise, and historic trends should not be used to anticipate results or trends in future periods: Risks Related to our Industry WE MAY NOT BE ABLE TO GET TIMELY REGULATORY APPROVAL FOR OUR PRODUCTS AND WE MUST COMPLY WITH REGULATORY REQUIREMENTS TO MANUFACTURE AND MARKET OUR PRODUCTS. The manufacturing and marketing of our existing and potential products, as well as preclinical studies and clinical trials, are subject to extensive regulation and approval by the Therapeutic Products Directorate (“TPD”) of the Health Products and Food Branch Inspectorate of Health Canada (“HPFBI”) and other authorities in Canada and by numerous federal, state and local government authorities in the United States, including the Food and Drug Administration (“FDA”). Similar regulatory requirements exist in Europe and other countries. To the extent we choose to distribute our products in foreign markets, we may rely on licensees to obtain regulatory approvals in such countries. Any failure or delay by us, our collaborators or licensees to comply with applicable requirements or obtain regulatory approvals for our products could adversely affect the marketing of products developed or licensed by us and our ability to receive product or royalty revenue. As of December 31, 2006, DRAXIMAGE had five regulatory submissions filed with European regulatory authorities: four with the Medicines Evaluation Board in the Netherlands and one with the Danish Medicines Agency. The submission dates for these radiopharmaceutical products range from June 2003 to December 2004. All of the approvals sought by DRAXIMAGE in Europe are for marketing authorizations through the mutual recognition procedure, which involves obtaining approval in one state (the “reference member state”) and recognition of that approval in other member states. All of the approvals being sought by DRAXIMAGE in Europe are for radiopharmaceutical products already approved in Canada or the U.S. Two of these five European submissions were for DRAXIMAGE’s kit for the Preparation of Technetium Tc-99m Albumin Aggregated Injection (MAA Kit) for which DRAXIMAGE received approval in one reference member state, the Netherlands, in February 2005 and for the Preparation of Technetium Tc-99m MethyleneDiphosphonic Acid Injection (MDP Kit) for which DRAXIMAGE received approval in one reference member state, the Netherlands, in March 2006. The regulatory process for innovative products generally involves preclinical studies and clinical trials of each compound to establish its safety and efficacy, takes many years and requires the expenditure of substantial resources. For generic products, the regulatory process does not typically involve clinical studies. Moreover, if regulatory approval of a drug or diagnostic product is granted, such 3 approval may entail limitations on the indicated uses for which it may be marketed. Our failure to comply with applicable regulatory requirements can, among other things, result in the suspension of our regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. Further, government policy may change and additional government regulations may be established that could prevent or delay regulatory approvals for our products. In addition, a marketed drug and its manufacturer are subject to continual review. Later discovery of previously unknown problems with the product or manufacturer may result in restrictions on such product or manufacturer, including withdrawal of the product from the market. On February 2, 2007, DRAXIMAGE announced it had submitted an Abbreviated New Drug Application (“ANDA”) to the FDA for its generic kit for the preparation of Tc-99m Sestamibi for injection (DRAXIMAGEÒ Sestamibi), a nuclear medicine imaging agent used in myocardial perfusion imaging (“MPI”) to evaluate blood flow to the heart in patients undergoing cardiac tests. DRAXIMAGE manufactures approximately 65% of the active pharmaceutical ingredients that are used in the radiopharmaceutical products it manufactures. The final products in which the active pharmaceutical ingredients are used are subject to regulation for safety and efficacy by the FDA, TPD and regulatory authorities in other jurisdictions, as the case may be. All of the final products that DRAXIMAGE or DRAXIS Pharma manufactures must be approved by the FDA, TPD and the regulatory authorities in other jurisdictions, as the case may be, before they can be commercially marketed. The process of obtaining regulatory clearance for marketing is uncertain, costly and time-consuming. We cannot predict how long the necessary regulatory approvals will take or whether we or our customers for whom we manufacture products will ever obtain such approval for products. To the extent that we and/or our customers do not obtain the necessary regulatory approvals for marketing new products, our product sales could be adversely affected. All products manufactured by us (including those manufactured for our contract manufacturing customers) have to comply with the current Good Manufacturing Practices (“cGMP”) imposed under the laws of the U.S., Canada and other jurisdictions, as well as the guidelines and policies of TPD, FDA and the regulatory authorities in other jurisdictions, as the case may be. In addition, products containing radioactive isotopes will have to comply with the guidelines and regulations of the Canadian Nuclear Safety Commission in Canada and the United States Nuclear Regulatory Commission and other similar regulations in other countries. Compliance with cGMP regulations requires us to expend time, money and effort on our production facilities and to maintain precise and extensive records and quality control to ensure that our products meet applicable specifications and other requirements. The FDA, TPD and other regulators may periodically inspect our drug manufacturing facilities to ensure compliance with applicable cGMP requirements. In addition, our customers also periodically inspect our manufacturing facilities to ascertain compliance with cGMP requirements. If we fail to comply with the cGMP requirements, we may become subject to possible regulatory action, and manufacturing at the facility could consequently be suspended, causing possible loss of profit, regulatory fines and third-party liability. To date we have not been subject to any notice of material non-compliance. The FDA, TPD or other regulatory authorities may also require us to submit specific batches or lots of a particular product for inspection. If the product lot fails to meet applicable requirements, then the following actions might be taken: (i) restrict the release of the product; (ii) suspend manufacturing of the specific product lot; (iii) order a recall of the product lot; or (iv) order a seizure of the product lot. 4 WE MAY NOT BE ABLE TO OBTAIN AND ENFORCE EFFECTIVE PATENTS TO PROTECT OUR PROPRIETARY RIGHTS FROM USE BY COMPETITORS, AND THE PATENTS OF OTHER PARTIES COULD REQUIRE US TO STOP USING OR TO ACQUIRE A LICENSE FOR CONDUCTING CERTAIN BUSINESS ACTIVITIES, AND OUR COMPETITIVE POSITION AND PROFITABILITY COULD SUFFER AS A RESULT. Our success depends, in part, on our ability to obtain, enforce and maintain patent protection for our radiopharmaceutical and ANIPRYL® technologies in Canada, the United States and other countries. Patents for our radiopharmaceutical technologies have expiry dates ranging from November 2008 to December 2021. Patents issued to our subsidiary DAHI for our ANIPRYL® technology, have expiry dates ranging from August 2010 to June 2016. We cannot assure you that patents will be issued from any pending applications or that claims now or in the future, if any, allowed under issued patents will be sufficiently broad to protect our technology. In addition, we cannot assure you that any patents issued to or licensed by us will not be challenged, invalidated, infringed or circumvented, or that the rights granted under these patents will provide continuing competitive advantages to us. The patent positions of pharmaceutical and biotechnology firms, including ours, are generally uncertain and involve complex legal and factual questions. In addition, we do not know whether any of our current research endeavors will result in the issuance of patents in Canada, the United States or elsewhere, or if any patents already issued will provide significant proprietary protection or will be circumvented or invalidated. Since patent applications in the United States and Canada are maintained in secrecy for at least 18 months from the date of filing, and since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months, we cannot be certain that we will be the first to create inventions claimed by pending patent applications or that we will be the first to file patent applications for such inventions. Our failure to obtain patents for our products could negatively affect our competitive position. Our commercial success also depends in part on our not infringing patents or proprietary rights of others and not breaching the licenses granted to us. In the event that we are found to have infringed other parties’ patents, licenses may not be available to us on terms that are commercially favorable or at all. In addition, the degree of patent protection afforded to pharmaceutical or biotechnological inventions around the world is uncertain and varies significantly among different countries. There can be no assurance that we will be able to license third-party technology or patents that we may require to conduct our business or that such technology or patents can be licensed at a reasonable cost. Failure by us or our collaborators or customers to license any technology or patents that we may need to commercialize our technologies or manufacture our products may result in delays in marketing our products or may impede our inability to proceed with the development, manufacture or sale of products requiring such licenses. We may be required to engage in litigation and other patent proceedings to enforce patents issued to us, to defend our right, title and interest in patents related to our products and to determine the scope and validity of other parties proprietary rights. These proceedings can be costly, and if the outcome of any such proceedings is adverse to us, we could lose the right to sell some of our products or could be required to pay damages, which may be substantial. We also rely on unpatented trade secrets, improvements and know-how with respect to our contract manufacturing operations and all of our operations associated with our radiopharmaceutical kit business to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our customers, collaborators, employees and consultants. These agreements could be breached, and we may not have adequate remedies for any breach. Further, our trade secrets could otherwise become known or be independently discovered by our competitors. 5 ALTHOUGH WE CARRY PRODUCT LIABILITY INSURANCE, A SUCCESSFUL LIABILITY CLAIM COULD NEGATIVELY IMPACT OUR BUSINESS. We may be subject to liability claims by those who purchase our contract manufacturing services, for the use of any of our products under clinical development and the sale and use of any of our approved products. Such claims may be made directly by customers, consumers, healthcare providers or pharmaceutical companies or others selling such products. Although we believe that our insurance coverage is reasonably adequate to insulate us from potential product liability claims and we have not historically experienced any problems associated with claims by those who purchase our contract manufacturing services or users of our products under clinical development or that we manufacture, we cannot provide any assurance that we will be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to this potential liability. We may not be able to maintain or obtain additional commercially reasonable product liability insurance for any products approved for marketing and sale. Even unsuccessful product liability claims could result in the expenditure of funds in litigation and the diversion of management time and resources and could damage our reputation and impair the marketability of our products, which could have a material adverse effect on our financial condition and results of operation. On July 22, 2005, we announced that, together with other defendants, we had received a Statement of Claim filed before the Superior Court of Justice of Ontario alleging that PermaxÒ, a drug that we distributed in Canada for a third party manufacturer prior to July 2003, causes “compulsive/obsessive behaviour, including pathological gambling”. The plaintiff is seeking to have this action certified as a class action. We believe this claim against us is without merit and we intend to vigorously defend this proceeding and any motion for certification. Prior to July 2003, PermaxÒ was distributed in Canada by DRAXIS Pharmaceutica, our Canadian pharmaceutical sales and marketing division. In July 2003, we sold the DRAXIS Pharmaceutica division to Shire BioChem Inc. (“Shire”). As of December 31, 2006, there have been no developments in this action. IF THE MARKET DOES NOT ACCEPT OUR PRODUCTS CURRENTLY IN DEVELOPMENT, OUR BUSINESS COULD BE HARMED. There can be no assurance that any of our products currently in development or our recently approved products will achieve market acceptance. The degree of market acceptance will depend upon a number of factors, including the receipt of regulatory approvals (generic and innovative products), the establishment and demonstration in the medical community of the clinical efficacy and safety of our products (innovative products), the establishment and demonstration of their potential advantages to existing and new diagnostic and treatment methods and the reimbursement policies of government and third-party payers and, most importantly, the launching of competing products by our competitors that become established prior to the launch of our products in development. There can be no assurance that physicians, patients, payers or the medical community in general will accept and utilize any existing or future products. We anticipate that we will face increased competition in the future as new products enter the market and advanced technologies become available. There can be no assurance that existing products or new products developed by our competitors will not be more effective, or be more effectively marketed and sold, than any of the products that may be developed, manufactured or sold by us. Competitive products may render our products obsolete and uncompetitive prior to recovering our research, development or commercialization expenses incurred with respect to any such products. For example, in a press release dated March 27, 2006, we announced that although our product FIBRIMAGEÒ had met primary end points in its Phase III clinical trial in Canada, further market 6 analysis had shown that new technologies had successfully captured the current deep venous thrombosis indications and there was no longer an economically interesting market opportunity at this time in either the at-risk asymptomatic patient, or those with symptoms. We further indicated that we had decided that no significant further work would be conducted in the development of this product for its current indications but that other potential opportunities for this product would be explored. In 2006, no other potential opportunities were uncovered. We currently have other products in development such as INFECTONÒ, Technetium Generators and DRAXIMAGEÒ I-131 MIBG that could be exposed to this risk. With respect to our radiopharmaceutical operations, we believe that the only radiopharmaceutical imaging products on the market at this time which may compete with DRAXIMAGE’s INFECTON® product under clinical development is LeukoScan®. Immunomedics, Inc. (NASDAQ: IMMU) announced in January 2005 that it received Health Canada approval for the marketing and use of LeukoScan® for the detection of osteomyelitis. However, according to Immunomedics, Inc.’s website, the product is not presently sold in Canada. LeukoScan® is a murine monoclonal IgG antibody fab’ fragment labeled with Tc-99m. We believe that INFECTON® would offer a more convenient alternative to white blood cell labelling currently used which uses a process of removing blood from a patient, isolating white blood cells in the patient’s blood, radiolabelling the white blood cells with an isotope such as Indium-111 or Technetium coupled with a carrier molecule and reinjecting the white blood cells into the patient. INFECTON® is a radiolabeled imaging agent which is injected directly into the patient without the complexities associated with labelling the patient’s own white cells. We also believe that AZEDRAÔ, being developed by Molecular Insight Pharmaceuticals, Inc. (“MIPI”) may compete with our DRAXIMAGEÒ I-131 MIBG product under clinical development. AZEDRAÔ has received Orphan Drug status and a Fast Track designation by the FDA. According to information set forth in its website, MIPI is conducting a Phase I clinical trial with AZEDRAÔ in adults at Duke University. The initial target market for AZEDRAÔ is the treatment of metastatic neuroendocrine tumours such as pheochromocytoma, carcinoid and neuroblastoma that are not amenable to treatment with surgery or conventional chemotherapy. Metastatic tumours are tumours that spread to other organs or parts of the body. With respect to our licensed technology, no significant competition for ANIPRYL® has been experienced to date in Canada or the United States from products approved for veterinary or human use. However, there are other treatments available that have not been approved in Canada or the United States to treat canine Cushing’s disease, but which we believe may be being used off-label for canine Cushing’s disease: LYSODREN® (mitotane) by Bristol-Myers Squibb Co. (NYSE: BMY), which was approved for use in the treatment of human inoperable cancer of the adrenal gland, and NIZORAL® (ketoconazote) tablets by Johnson & Johnson, Inc., an anti-fungal medication, which was approved for the treatment of various internal and external fungal and yeast infections in humans. We believe that human use selegiline used for the treatment of Parkinson’s disease, although not approved for veterinary use, may also compete with the use of ANIPRYL® in dogs. WE DO NOT HAVE THE SAME AMOUNT OF RESOURCES AS SOME OF OUR COMPETITORS. Many of our existing or potential competitors, particularly large pharmaceutical companies, have substantially greater financial, technical and human resources than we do. In addition, many of these competitors have significantly greater experience in undertaking research, preclinical studies and human clinical trials of new pharmaceutical products, obtaining regulatory approvals, 7 manufacturing and marketing such products. Accordingly, our competitors may succeed in commercializing or manufacturing products more rapidly or effectively than we can. WE OPERATE IN A VERY COMPETITIVE MARKET. DRAXIS Pharma, our contracting manufacturing division, competes with pharmaceutical companies that have in-house manufacturing capabilities as well as with third-party contract manufacturers, including Hospira Inc., Boehringer Ingelheim, Cardinal Health, Inc., DPT Laboratories, Haupt Pharma AG, Patheon Inc., Hollister-Stier Laboratories LLC and DSM Pharmaceuticals, Inc. DRAXIMAGE, our radiopharmaceuticals division, competes with the following companies that have significant radiopharmaceutical operations: Bristol-Myers Squibb Company, GE Healthcare, Mallinckrodt Inc., a division of Tyco Healthcare, CISBio, and Bracco SpA. In addition, there are a number of companies that are developing and/or marketing other radiopharmaceutical products, including MDS Nordion Inc., Immunomedics, Inc., Cytogen Corporation, Biogen Idec Inc. and Molecular Insight Pharmaceuticals, Inc. FAILURE OF ONE OF OUR CURRENT OR FUTURE CLINICAL TRIALS COULD HAVE A MATERIALLY NEGATIVE IMPACT ON OUR FUTURE PROSPECTS. The development of new products is subject to a number of significant risks. Potential products that appear to be promising in various stages of development may not reach the market for a number of reasons. Such reasons include, but are not limited to, the possibility that the potential product will be found ineffective or unduly toxic during preclinical or clinical trials, fails to receive necessary regulatory approvals, will be difficult to manufacture on a large scale, will be uneconomical to market or not achieve market acceptance, will not qualify for third-party reimbursement, or will be precluded from commercialization by proprietary rights of third parties. Certain products we are attempting to develop have never been manufactured on a commercial scale, and there can be no assurance that such products can be manufactured at a cost or in a quantity to render such products commercially viable. Production of such products may require the development of new manufacturing technologies and expertise. The impact on our business in the event that new manufacturing technologies and expertise would have to be developed is uncertain. Many of our potential products will require significant additional research and development efforts and significant additional preclinical and clinical testing prior to any commercial use. We cannot assure you that we will successfully meet any of these technological challenges or others that may arise in the course of product development. Before obtaining regulatory approval for the commercial sale of any innovative product under development, we must demonstrate through preclinical studies and clinical trials that the product is safe and efficacious. In November 2006, we announced that DRAXIMAGE had received approval from the FDA to run two clinical trials using radioactive Iobenguane I-131 Injection (also known as I-131 MIBG) to treat high-risk neuroblastoma, a rare form of cancer that affects mostly infants and young children, one trial is a Phase II study and another is a Phase I study. As of December 31, 2006, our INFECTONÒ product had completed three Phase II trials in Canada, and the U.S. A fourth Phase II trial was discontinued due to a change of market focus. An expert panel, comprised of respected nuclear medicine specialists and microbiologists, was assembled and this expert panel reviewed the preliminary scientific and clinical data together with the outcome of the market research studies. The role of the expert panel was to assess the results to date, review potential target markets, and advise DRAXIMAGE on the design of future clinical studies and appropriate indications. The preliminary report of the expert panel recommended that the product be reformulated for orthopaedic-related indications and the assessment of such formulations is under way. The results of preclinical studies and early-stage clinical trials may not be totally predictive of results obtained in larger late-stage clinical trials, and there can be 8 no assurance that our clinical trials will demonstrate safety and efficacy, achieve regulatory approvals or result in marketable products. A number of companies in the biotechnology and pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after achieving promising results in earlier clinical trials. OUR PROFIT DEPENDS IN PART ON REIMBURSEMENT POLICIES AND REGULATIONS OF GOVERNMENT HEALTH ADMINISTRATION AUTHORITIES, PRIVATE HEALTH INSURERS AND OTHER ORGANIZATIONS. The business and financial condition of pharmaceutical companies will continue to be affected by the efforts of governments and third-party payers to contain or reduce the costs of healthcare through various means. For example, in certain markets, pricing or profitability of pharmaceutical products, medical devices and diagnostic products is subject to government control. In Canada, the Patented Medicine Prices Review Board (“PMPRB”) monitors and controls prices of patented drug products marketed in Canada. The PMPRB may assert jurisdiction over our products under development which may limit the prices that can be charged for such products in Canada. We may not be able to obtain prices for our products under development that will make them commercially viable exclusively in Canada. In the United States there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar pricing controls by government. In addition, the emphasis on managed healthcare in the United States has increased and will continue to increase the pressure on pharmaceutical pricing. While we cannot predict whether such legislative or regulatory proposals will be adopted or the effects such proposals or managed healthcare efforts may have on our business, the announcement of such proposals or efforts could have a material adverse effect on the market price of our securities and, if adopted, on our business and financial condition and that of our current and prospective customers. Accordingly, our ability to establish strategic alliances may be adversely affected. In addition, in Canada, the United States and elsewhere, sales of prescription pharmaceutical products and radiopharmaceutical products are dependent, in part, on the availability of reimbursement to the consumer from third-party payers, such as government and private insurance plans. Third-party payers are increasingly challenging the prices charged for medical products and services. To the extent we succeed in bringing new products to market, we cannot assure you that these products will be considered cost-effective and that reimbursement to consumers will be available or will be sufficient to allow the sale of these products on a competitive basis. Risks Related to our Company WE ONLY HAVE ONE MANUFACTURING FACILITY AND FACTORS BEYOND OUR CONTROL COULD CAUSE AN INTERRUPTION IN OUR MANUFACTURING OPERATIONS, WHICH WOULD ADVERSELY AFFECT OUR REPUTATION IN THE MARKETPLACE AND OUR RESULTS OF OPERATIONS. All of our manufacturing facilities are located in the same location in Kirkland, Québec. To succeed, we must be able to operate our manufacturing facilities without significant interruption and deliver radiopharmaceutical and contract manufacturing products in a timely manner. We could suffer an interruption in our manufacturing operations caused by damage from a variety of sources, many of which are not within our control, including fire, flood, earthquake and other natural disasters; power loss and telecommunication failure; disruption to transportation systems; major equipment or machinery failure; software and hardware errors, failures or crashes and similar disruptions; or undue delays or restrictions with air transport systems and cross-border shipments. Any significant interruptions in our manufacturing operations or our ability to deliver time-sensitive products would damage our reputation in the marketplace and have a negative impact on our results of operations. For example, during the third quarter of 2005, DRAXIS Pharma, our contract manufacturing operating division, extended its regularly 9 scheduled summer shutdown period at the beginning of the third quarter in the sterile area of our manufacturing facility, in order to correct an electrical panel failure and make associated repairs. The revalidation of the entire sterile area following these repairs and the related recalibration of production schedules due to this interruption had material financial implications which negatively affected third and fourth quarter 2005 results. As a further example, if there were a cessation of flights leaving Canada for the U.S., then the radiopharmaceutical products manufactured by DRAXIMAGE, which are delivered in part via airplanes, could not be delivered to customers on a timely basis and our products would be harmed due to their short shelf-life. Also, if there were a prolonged loss of hydroelectric power at our sole manufacturing facility, then the manufacturing of our products may be impaired because we may not have sufficient back-up electrical power from independent generators for the duration of the hydroelectric interruption. Although we believe that we carry adequate property and business interruption insurance, we cannot assure you that we will be able to maintain such insurance coverage at a reasonable cost or in sufficient amounts to protect us against all potential eventualities. IF OUR COLLABORATIVE AND COMMERCIAL RELATIONSHIPS WITH THIRD PARTIES ON WHOM WE RELY ARE UNSUCCESSFUL, OUR BUSINESS MAY SUFFER. To be successful, we must continually establish and maintain strategic or key relationships with other companies or organizations in a number of biotechnology and pharmaceutical industry segments. This is critical to our success because such relationships enable us to extend the reach of our products and sales in various jurisdictions, generate additional revenue and develop and deploy new products in various marketplaces. Entering into strategic relationships is complicated, as some of our current and future strategic partners may decide to compete with us in some or all of the markets in which we operate or refuse to fulfill or honor their contractual obligations to us. In addition, our relationships with customers always require us to manufacture products in accordance with their specifications that are issued to us from time to time. If we are unable to meet our customers’ specifications, our strategic relationships would be harmed. We currently have strategic relationships with our three largest customers (i) Genzyme Corporation (“Genzyme”) to manufacture Hectorol® Injection, (ii) GlaxoSmithKline Inc. (“GSK”) to supply it with established sterile products marketed by GSK in multiple international markets and a prescription sterile injectable product for the U.S. market, and (iii) Johnson & Johnson, Inc. (“J&J”) (prior to December 20, 2006, Pfizer Consumer Healthcare, a division of Pfizer Canada, Inc.), that covers several non-prescription products for the Canadian market, including Polysporin®, Sudafed®, Actifed® and Zincofax®. We also have a key relationship with Cardinal Health 414, Inc. with respect to our Iodine I-131 kits, MAA, DTPA and MDP products sold in the U.S. A SIGNIFICANT PORTION OF OUR BUSINESS IS DEPENDENT ON A SMALL NUMBER OF KEY CUSTOMERS. For the year ended December 31, 2006, our three largest customers, Genzyme, GSK and J&J (prior to December 20, 2006, Pfizer Consumer Healthcare, a division of Pfizer Canada, Inc.), represented 56% of our consolidated revenues (23%, 23% and 10% respectively). The termination by any of these customers of its relationship with us would have a material adverse effect on our business, financial condition and results of operations unless we could replace these customers in a timely fashion. IF OUR COLLABORATORS, EMPLOYEES, OR CONSULTANTS DISCLOSE OUR CONFIDENTIAL INFORMATION TO OTHERS DESPITE CONFIDENTIALITY AGREEMENTS IN PLACE, OUR BUSINESS MAY SUFFER. Our practice is to require our employees, collaborators, consultants and outside scientific advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships. These agreements provide that all confidential information developed or made known to 10 the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties, subject to certain specific limited exceptions. In the case of employees, the agreements provide that all inventions conceived by the individual shall be our exclusive property. These agreements, however, may not provide meaningful protection for our trade secrets or adequate remedies in the event of unauthorized use or disclosure of such information. For example, trade secrets regarding the recipe to manufacture one of our radiopharmaceutical kit or capsule products could be disclosed, allowing our competitors to copy the recipe and manufacture a competing product. WE ARE SUBJECT TO REGULATION BY GOVERNMENTS IN MANY JURISDICTIONS AND, IF WE DO NOT COMPLY WITH MANUFACTURING, NUCLEAR SAFETY AND ENVIRONMENTAL REGULATIONS, OUR EXISTING AND FUTURE OPERATIONS MAY BE CURTAILED, AND WE COULD BE SUBJECT TO LIABILITY. Pharmaceutical drug manufacturing is a highly regulated industry, requiring significant documentation and validation of manufacturing processes and quality control assurance prior to approval of the facility to manufacture a specific drug. There can be considerable transition time between the initiation of a contract to manufacture a product and the actual initiation of manufacture of that product. Any lag time in the initiation of a contract to manufacture a product and the actual initiation of the manufacturing at our facilities could cause us to lose profits. We have in place facilities and procedures designed to reduce and, to the extent possible, eliminate the risk of environmental contamination resulting from the processing of raw materials and, more specifically, from the radiopharmaceutical business of DRAXIMAGE and the contract manufacturing business of DRAXIS Pharma. We also have in place regular maintenance programs to ensure continued compliance with all applicable health and safety, environmental and nuclear safety regulations. We believe that the operations at our manufacturing facilities comply in all material respects with applicable health and safety, environmental and nuclear safety laws. As of December 31, 2006, we have not received any notice stating that we are not in compliance with any such legislation applicable to us. Canadian and U.S. federal, state, local and provincial regulations govern extensively the use, manufacture, storage, handling, transport and disposal of hazardous material and associated waste products. Although we believe that the operations at our facilities comply in all material respects with applicable laws, we cannot completely eliminate the risk of substantial environmental liabilities especially in respect of environmental contamination resulting from the processing of raw materials from the radiopharmaceutical business of DRAXIMAGE and the manufacturing business of DRAXIS Pharma. Any failure by us or any of our subsidiaries to comply with such present or future laws could result in any of the following: (i) cessation of portions or all of our or our subsidiaries’ operations; (ii) imposition of fines; (iii) restrictions on our or our subsidiaries’ ability to carry on or expand our operations; (iv) significant expenditures by us in order to comply with laws and regulations; or (v) liabilities in excess of our resources. OUR BUSINESS COULD BE HARMED IF THERE WERE A DISPUTE OR DISRUPTION WITH OUR UNIONIZED EMPLOYEES. The products manufactured by DRAXIS Pharma represent a significant amount of our consolidated revenues. For the year ended December 31, 2006, 72.8% of our consolidated revenues were derived from DRAXIS Pharma. Although a collective agreement with a five-year term to April 30, 2008 between DRAXIS Pharma and the United Food & Commercial Workers International Union, Local 291 (AFL-CIO) was ratified in February 2004, we cannot assure you that future labor difficulties will not arise, and if they did arise then the production and delivery of those products manufactured by DRAXIS 11 Pharma would be impaired for the duration of those labor difficulties and those products manufactured by DRAXIMAGE may also be impaired if access to our sole manufacturing facilities is hindered by these labor difficulties. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO GROW, AND IF WE ARE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY, WE MAY INCUR UNEXPECTED EXPENSES AND BE UNABLE TO MEET OUR CUSTOMERS’ REQUIREMENTS. We will need to maintain, expand and upgrade our manufacturing facilities and operations to execute current commercial obligations to customers, widen our customer base and increase manufacturing efficiencies over the next few years. We cannot be certain that DRAXIS Pharma will be able to enter into enough lucrative third-party manufacturing contracts to increase its profitability. If we do secure advantageous agreements, we cannot be certain that our employees, systems, procedures, controls, productive capacity and existing space will be adequate to support expansion of the operations. Our future operating results will depend on the ability of our officers and key employees to manage changing business conditions and to implement and improve our technical, administrative, financial control and reporting systems and operational excellence in order to achieve established business objectives. An unexpectedly large increase in the volume of manufacturing business or the number of orders placed by customers may require us to expand capacity and further upgrade our manufacturing facilities and the technology related to our manufacturing. We may not be able to project the rate of timing of such increases or customer demands accurately or to expand and upgrade our manufacturing facilities and supporting systems and infrastructure to accommodate such increases. Difficulties in managing future growth and meeting customers’ expanded requirements could have a significant negative impact on our business and its profitability. OUR FINANCIAL RESULTS MAY FLUCTUATE, AND OUR FUTURE REVENUE AND PROFITABILITY ARE UNCERTAIN. Our ability to achieve and maintain profitability in the foreseeable future depends on the commercial success of our products and services. Because we have recently launched new products in new markets such as our Sodium I-131 Capsules USP, Diagnostic Oral in the U.S., revenues are difficult to predict and may fluctuate substantially from period to period. In addition, product development programs will require substantial additional investment, including the cost of clinical trials for innovative products (such as the costs of our clinical trials for DRAXIMAGEÒ I-131 MIBG and INFECTONÒ), obtaining additional regulatory approvals, if necessary, and marketing and sales expenses associated with potential new product introductions such as DRAXIMAGEÒ Sestamibi for which we filed an ANDA with the FDA in February 2007. Our sole manufacturing facilities will continue to require capital investment in order to maintain, upgrade and expand their operations. The success of DRAXIMAGE and DRAXIS Pharma will rely significantly on the ability of both divisions to maintain and to substantially increase their manufacturing capabilities to satisfy customer demand. There can be no assurance that, or when, we will successfully develop, receive regulatory approvals for, or manufacture or market any new products for our own marketing purposes or for third parties. DRAXIS Pharma may fail to renew its existing manufacturing contracts. DRAXIS Pharma may fail to secure sufficiently lucrative new third-party manufacturing contracts to increase its profitability. In addition, DRAXIS Pharma may lose anticipated volumes of products if the customers for whom it manufactures said products do not receive required approvals for the commercial sale of same. DRAXIS Pharma may also lose anticipated volumes of existing products if its customers lose market share for products due to decreased demand for said products. DRAXIMAGE may fail to increase its market penetration of its radioactive products, particularly in the U.S. DRAXIMAGE may also fail to increase its international sales of its key Tc-99m kits and Iodine I-131 products, particularly in Europe, if it does not receive approvals to market said products. DRAXIMAGE may not receive timely approval of its DRAXIMAGEÒ Sestamibi product.
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The research, development, production and marketing of new products will require the application of considerable technical and financial resources by us and our customers, while revenues that are generated by such products, if successfully developed and marketed, may not be realized for several years. We may not be able to sustain current and planned levels of profitability. We may require external financing to complete certain aspects of our three-year strategic plan, and external sources of capital may not be available to us at an acceptable cost, if at all. IF WE CANNOT ADAPT TO CHANGING TECHNOLOGIES, OUR PRODUCTS AND SERVICES MAY BECOME OBSOLETE AND OUR BUSINESS COULD SUFFER. Because the biotechnology, pharmaceutical and radiopharmaceutical industry is characterized by technology change and obsolescence, we may be unable to anticipate changes in our current and potential customer requirements that could make our existing technology obsolete. Our success will depend, in part, on our ability to continue to enhance our existing products and services, develop new technology that addresses the increasing sophistication and varied needs of our respective customers, license leading technologies and respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis. The development of our proprietary technology and investing in certain niche markets entails significant technical and business risks. We may not be successful in using our new technologies or exploiting our niche markets effectively or adapting our businesses to evolving customer requirements or emerging industry standards. WE ARE EXPOSED TO EXCHANGE RATE FLUCTUATIONS WHICH COULD NEGATIVELY AFFECT OUR BUSINESS. A substantial portion of our consolidated revenues are now, and are expected to continue to be, realized in U.S. dollars. Our operating expenses are primarily paid in Canadian dollars. We may be adversely affected by a significant and rapid strengthening of the Canadian dollar against the U.S. dollar, should the Canadian dollar rise in value compared to the U.S. dollar by more than 10 cents. We do not currently use derivative instruments to hedge our foreign exchange risk and currently have no plans to do so in the near future. For fiscal year 2006, U.S. dollar revenue accounted for approximately 53.8% of the Company’s consolidated revenue. During this same period, the value of the U.S. dollar versus the Canadian dollar strengthened by 0.2% from January 1, 2006 to December 31, 2006. As a result, in 2006 we had to charge to income $282,000 due to foreign exchange translation gain related to the strengthening of the U.S. dollar. IF WE LOSE THE SERVICES OF KEY PERSONNEL, WE MAY BE UNABLE TO REPLACE THEM, AND OUR BUSINESS COULD BE NEGATIVELY AFFECTED. Our success depends on the retention of principal members of our management staff, including Dr. Martin Barkin (Chief Executive Officer and President), Mr. Dan Brazier (Chief Operating Officer), Mr. Jean-Pierre Robert (President, DRAXIMAGE division) and Mr. John Durham (President, DRAXIS Pharma division) and on our ability to continue to attract, motivate and retain additional key personnel. We have employment agreements with all our key management, with no fixed terms of duration. We have key man insurance on the lives of Dr. Martin Barkin, Mr. Jean-Pierre Robert and Mr. John Durham. The market for retaining and obtaining such key personnel is intensely competitive, and the loss of the services of key personnel or the failure to recruit necessary replacement and additional personnel in a timely manner could materially and adversely affect operations. ALTHOUGH WE CONSIDER THE COMPANY TO HAVE GOOD DEFENSES TO SUCH ACTIONS, SHOULD THE CURRENT LAWSUITS AGAINST US SUCCEED, WE COULD INCUR A SUBSTANTIAL LOSS. 13 In 1998, a Canadian legal proceeding was launched against us and our subsidiary DAHI by a former consultant, Jozsef Knoll, claiming royalty entitlements based on the net profit from sales of ANIPRYL®. Total damages claimed are $100 million, including a claim to certain shares of DAHI. However, the plaintiff has taken no steps in the last seven years to move the claim forward. While we believe that we have good defenses to the Knoll proceeding, this dispute may not be resolved in our favor, if it is pursued. It is possible that a court or arbitration tribunal may find us to be in breach of certain agreements, or infringing validly issued patents of third parties or practicing the intellectual property of others. In that event, in addition to the cost of defending the underlying proceeding, we may have to pay license fees, additional royalties and/or damages and may be ordered to assign certain ANIPRYL®-related patents and be prohibited from conducting certain activities. Under such circumstances, we could incur substantial loss and our business could be negatively affected. On July 22, 2005, we announced that, together with other defendants, we had received a Statement of Claim filed before the Superior Court of Justice of Ontario alleging that PermaxÒ, a drug that we distributed in Canada for a third party manufacturer prior to July 2003, causes “compulsive/obsessive behaviour, including pathological gambling”. The plaintiff is seeking to have this action certified as a class action. We believe this claim against us is without merit and we intend to vigorously defend this proceeding and any motion for certification. Prior to July 2003, PermaxÒ was distributed in Canada by DRAXIS Pharmaceutica, our Canadian pharmaceutical sales and marketing division. In July 2003, we sold the DRAXIS Pharmaceutica division to Shire. As of December 31, 2006, there have been no developments in this action. Risks Related to our Common Shares OUR COMMON SHARE PRICE HAS BEEN, AND IS LIKELY TO CONTINUE TO BE, VOLATILE. The market prices for the securities of smaller pharmaceutical and biotechnology companies, including ours, have historically been volatile, and the market has, from time to time, experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. For the last two fiscal years, the price of our stock has ranged from a low of $3.90, to a high of $5.84 on NASDAQ (CDN$4.32 to CDN$7.05 on the Toronto Stock Exchange). We believe that in the first half of 2006 the volatility in the share price and volumes of shares traded was impacted by financial results that differed from market expectations as a continuing result of the extended shutdown in 2005 of production of sterile products at DRAXIS Pharma. We believe that the appreciation of the share price and volumes of shares trading in the second half of 2006 occurred as a result of improved financial results that came closer to market expectations and a growing recognition of the potential value of new products in development. We believe that the extended shutdown of production at DRAXIS Pharma for sterile products in 2005 and the resulting financial results that differed from market expectations were the most prominent factors that impacted the volatility in the share price and the volumes traded in that year. Factors such as fluctuations in our operating results, announcements of competing technological innovations or new products by our competitors, clinical trial results, governmental regulation and enforcement actions, developments in patent or other proprietary rights, public concern as to the safety of drugs developed by us or others and general market conditions can have an adverse effect on the market price of our shares. In particular, the realization of any of the risks described herein could have a material adverse impact on such market price. Unusual sales of substantial amounts of our shares in the public market over a relatively short time period, or the perception that such sales will occur, could also adversely affect the market price of our shares and make it more difficult in the future for us to raise funds through equity offerings. 14 Item 4. Information on the Company DRAXIS is a specialty pharmaceutical company providing products in three categories: sterile products, non-sterile products and radiopharmaceuticals. Sterile products include liquid and freeze-dried (lyophilized) injectables and sterile ointments. Non-sterile products are produced as solid oral, liquid and semi-solid dosage forms. Radiopharmaceuticals are used for both therapeutic and diagnostic molecular imaging applications. In the radiopharmaceutical category, DRAXIS has its own products and a targeted research and development program for new products. As of January 1, 2005, all of the operations of the Company are carried out through our wholly owned subsidiary DRAXIS Specialty Pharmaceuticals Inc., which operates two major divisions, DRAXIS Pharma (contract manufacturing) and DRAXIMAGE (radiopharmaceuticals). For the year ended December 31, 2006, 72.8% of our consolidated revenues were derived from DRAXIS Pharma (contract manufacturing) and 24.2% of our consolidated revenues were derived from DRAXIMAGE (radiopharmaceuticals). In addition, DRAXIS has continuing financial interests associated with its collaboration agreements with Pfizer Inc. with respect to ANIPRYL®, and with Shire with respect to Canadian sales of products divested in 2003. Our consolidated operations are integrated across research, product development, manufacturing, sales and marketing, as well as the in-licensing and commercial development of radiopharmaceutical products and technologies. DRAXIS has emerged from a transitional phase of its development. In past years, we were reliant on income earned from ANIPRYL®. For the year ended December 31, 2006, our collaboration agreement with Pfizer Inc. with respect to ANIPRYL® represented 5.2% of our consolidated revenues which represented the majority of our income from royalties and licensing. The common shares of DRAXIS are listed on the Toronto Stock Exchange (ticker symbol DAX) and on NASDAQ (ticker symbol DRAX). The shares of DRAXIS have been included in the NASDAQ Healthcare IndexÒ (symbol: IXHC) since July 27, 2005 and the NASDAQ Global Select MarketSM since July 3, 2006. Our registered and head office is located at 6870 Goreway Drive, 2nd Floor, Mississauga, Ontario, Canada L4V 1P1. Telephone: (905) 677-5500. Fax: (905) 677-5494. The Company’s only manufacturing, research and development facilities are located at 16751 Trans-Canada Road, Kirkland, Québec, Canada H9H 4J4. The Company’s website is: www.draxis.com. History and Development of the CompanyThe Company was incorporated under the name Deprenyl Research Limited on October 13, 1987 under the Canada Business Corporations Act. The Company was founded principally to engage in the marketing in Canada of prescription pharmaceuticals discovered, developed or acquired by Chinoin Pharmaceutical and Chemical Works Co. Ltd., the first of which was ELDEPRYL® (selegiline; 1-deprenyl), for the treatment of Parkinson’s disease. We changed our name to DRAXIS Health Inc. in May 1994. We completed an initial public offering of our common shares in February 1988 on the Toronto Stock Exchange. Our common shares were listed on NASDAQ in August 1989. 15 Beginning in 1990, we expanded our scientific knowledge of selegiline through contract research arrangements, to use with companion animal. This ultimately resulted in the formation of our subsidiary DAHI, through which we developed and commercialized a companion animal health product, ANIPRYL®. In 1991, we began to invest in the applications of aminolevulinic acid photodynamic therapy, which resulted in the formation of a subsidiary, DUSA Pharmaceuticals, Inc. (“DUSA”). Through a series of transactions from 1991 to 1996, we divested all of our interest in DUSA. By late 1992, we faced considerable uncertainty due to the impending threat of generic competition for ELDEPRYL®, which, at that time, still accounted for almost 100% of our consolidated revenues. Faced with this as well as other business challenges, in 1992 we began the process of recruiting new senior management to develop and implement a new strategic business plan for the Company to (i) address the generic threat to our lead drug by expanding and diversifying our established Canadian pharmaceuticals franchise; (ii) strengthen our financial position; and (iii) diversify from our historical Canadian base through the acquisition of niche pharmaceutical products and/or manufacturing-oriented businesses with international growth potential. In 1993, the leadership of the Company changed with the appointment of Dr. Martin Barkin as President and Chief Executive Officer. Several measures were taken to strengthen our financial position and to address the threat of generic competition for EldeprylÒ, including (i) expanding and diversifying our established Canadian pharmaceutical business, and (ii) diversifying our product mix through the acquisition of niche pharmaceutical products which the Company believed had the potential for global growth. In April 1996, a public offering of 3,000,000 common shares generated net proceeds of $8.5 million. In November 1996, we acquired the shares of DAHI that we did not previously own through a mandatory share exchange transaction valued at $17.4 million. In July 1997, we acquired from Merck Frosst Canada Inc. its radiopharmaceutical business, which became DRAXIMAGE Inc. (since January 1, 2005, known as DRAXIMAGE, a division of DRAXIS Specialty Pharmaceuticals Inc.). In December 1997, we licenced the worldwide marketing rights for AniprylÒ to Pfizer but retained manufacturing rights for the product. Cumulatively to December 31, 2006 $45.5 million has been received in upfront and milestone payments, royalties and royalty-related payments from Pfizer. In May 1998, we acquired our current manufacturing facility in Kirkland, Québec for $11.1 million. During the period of 1998 to 2000, we undertook a capital expansion plan, adding our lyophilization and our radiopharmaceutical operations. Our operations subsequently expanded over the following two years to support of our new contract manufacturing and radiopharmaceutical business, respectively. In 2000, we sold a 34.1% equity interest in DRAXIS Pharma Inc. (since January 1, 2005 know as DRAXIS Pharma, a division of DRAXIS Specialty Pharmaceuticals Inc.) to SGF Santé Inc. (“SGF”) and DRAXIS Pharma senior management to help finance the lyophilization expansion at our facilities. In 2000, we also divested our dermatology product lines to Block Drug Company (Canada) Limited (now part of GlaxoSmithKline Consumer Healthcare). 16 In 2001, we began producing DRAXIMAGE products in our facilities and in-licenced the rights for INFECTONÒ from BTG International Limited for Canada, the U.S., South America and Europe. We also launched BrachySeedÒ I-125 and initiated production of Bracco Diagnostic Inc.’s Sodium Iodide I-131 radiotherapy capsules. In 2001, DRAXIS Pharma signed a long term supply agreement to manufacture several GSK products for multiple international markets. In 2003, we launched a new radiotherapeutic Iodine I-131 kit in the U.S. for the treatment of thyroid cancer and hyper-thyroidism and received $6.5 million from affiliates of Elan Corporation, plc (“Elan”) for the return of Canadian rights for several neurology products. In July 2003, we also sold DRAXIS Pharmaceutica, our Canadian sales and marketing division, to Shire BioChem Inc. for $9.6 million in cash plus up to $2-9 million in market driven contingent milestones. On April 22, 2004, we issued 3,053,436 units of the Company at a purchase price of $4.82 (CDN$6.55) per unit, for aggregate proceeds net of related expenses of $13.4 million (CDN$18.2 million). Each unit consists of one common share of DRAXIS and one-half of one share purchase warrant. Each whole warrant entitled the holder to acquire one common share of DRAXIS at a price of CDN$8.50 at any time prior to April 24, 2006. The warrants are transferable. Holders of warrants do not, as such, have any voting rights or other right attaching to the common shares until the warrants are properly exercised and common shares issuable upon the exercise of the warrants are issued. All warrants expired unexercised on April 24, 2006. On April 22, 2004, DRAXIS acquired SGF’s 32.7% interest in DRAXIS Pharma for cash consideration of $9.6 million (CDN$13 million). DRAXIS used part of the proceeds from the offering completed in April 2004 to pay for the acquisition and to repay $3.1 million (CDN$4.2 million) in debt owed by DRAXIS Pharma to SGF and $1.7 million (CDN$2.3 million) in debt owed by DRAXIS Pharma to Investissement Québec. The DRAXIS Pharma senior management interest was also bought so that the Company became the sole shareholder of DRAXIS Pharma. In June 2004, we negotiated new credit facilities with our bankers, the National Bank of Canada, providing an operating facility of CDN$15 million (or U.S. equivalent), payable within 364 days of drawing upon the facility and a term facility of CDN$10 million (or U.S. equivalent), repayable in full in three years. As at December 31, 2006, no amount was drawn on either facility. In November 2004, we received FDA approval for a DRAXIMAGEÒ brand of Iodine-131 therapeutic capsules. In December 2004, we repaid all of our third-party debt. As of January 1, 2005, we amalgamated our two wholly-owned subsidiaries, DRAXIS Pharma Inc. and DRAXIMAGE Inc., to achieve certain business and tax efficiencies. The amalgamated subsidiary, called DRAXIS Specialty Pharmaceuticals Inc., continues to conduct business as two divisions, DRAXIS Pharma (contract manufacturing) and DRAXIMAGE (radiopharmaceuticals), and serves as our operating arm. In February 2005, we announced that DRAXIMAGE had received approval from the Dutch regulatory authority for its kit for the preparation of Technetium Tc-99m Albumin Aggregated Injection 17 (“MAA Kit”). This approval allowed DRAXIMAGE to initiate the Mutual Recognition Procedure (“MRP”) in pursuit of further regulatory approvals for the diagnostic imaging product in additional European Union countries. In April 2005, we announced the appointment of Mr. Jean-Pierre Robert as the new President of the DRAXIMAGE division effective as of May 9, 2005. In October 2005, we announced the appointment of Mr. Dan Brazier to the newly created position of Chief Operating Officer. In November 2005, DRAXIMAGE announced that it would discontinue the manufacture and sale of implantable brachytherapy seeds as of December 15, 2005. In January 2006, we announced we had received approval from the FDA for our supplemental drug application for Sodium Iodide I-131 Capsules USP, Diagnostic-Oral. We began selling these capsules in the U.S. in May 2006. In March 2006, we provided an update on DRAXIMAGE’s research and product development strategy. We indicated that in the near term of one to three years DRAXIMAGE would focus on currently marketed significant radiopharmaceutical and imaging products whose patents have expired or are close to expiring and, in particular, sestamibi injection (for cardiac imaging). We also announced that a major opportunity under development by DRAXIMAGE was the production and distribution of a “next generation” version of a Technetium Generator, which is the source of Tc-99m in virtually every radiopharmacy. We indicated that for the medium term, in a three to five year horizon, the highest priority opportunity being pursued by DRAXIMAGE was the continued development of INFECTONÒ. We also announced that although our product FIBRIMAGEÒ had met primary end points in its Phase III clinical trial in Canada, further market analysis had shown that new technologies have successfully captured the current deep venous thrombosis indications and that there was no longer an economically interesting market opportunity at the time in either the at-risk asymptomatic patient, or those with symptoms. We further indicated that we had decided that no significant further work would be conducted in the development of this product for its current indications but other potential opportunities for this product would be explored. In 2006, no other potential opportunities were uncovered. In November 2006, DRAXIMAGE was approved by the FDA to run two clinical trials using radioactive Iobenguane I-131 Injection (also known as 131 I-Metaiodobenzylguanidine or I-131 MIBG) to treat high risk neuroblastoma, a rare form of cancer that affects mostly infants and young children. Recent DevelopmentsIn February 2007, DRAXIMAGE announced it had submitted an ANDA to the FDA for its generic kit for the preparation of Tc-99M Sestamibi for Injection (DRAXIMAGEÒ Sestamibi), a nuclear medicine imaging agent used in myocardial perfusion imaging (MPI) to evaluate blood flow to the heart in patients undergoing cardiac tests. For information concerning the Company’s capital expenditures and methods of financing, please see Item 5: Operating and Financial Review and Prospects. 18 Business StrategyWe believe that both DRAXIMAGE and DRAXIS Pharma have significant long-term growth potential and have invested considerable financial and management resources in developing these businesses. Our general business strategy is to: · Focus on specialty pharmaceutical markets in which we can develop and sustain a competitive advantage. · DRAXIS has focused its operations on two core businesses: radiopharmaceuticals and specialty pharmaceutical contract manufacturing. Both businesses target highly differentiated, specialized markets which feature significant regulatory requirements and specialized manufacturing requirements and standards. · Develop new pharmaceutical products and services consistent with our strengths and capabilities. · DRAXIS has established a growing franchise in the highly differentiated radiopharmaceutical segment with a portfolio of 33 currently marketed products plus innovative proprietary products in various stages of development, including DRAXIMAGEÒ Sestamibi for which DRAXIMAGE filed an ANDA with the FDA in February 2007. In addition to our radiopharmaceutical platform, our expanding lyophilization capability positions us to offer new services to customers and to take advantage of growth opportunities in contract manufacturing. · Pursue growth opportunities with international market potential. · We are leveraging our capabilities, experience and regulatory compliance in radiopharmaceuticals and manufacturing to expand our product and service offerings in the United States, Europe and other international markets. · Leverage alliances with customers. · We are pursuing multiple opportunities with new and existing customers. Meeting the strict quality and service standards of such customers positions us to expand on these relationships in both our radiopharmaceuticals and pharmaceutical contract manufacturing businesses. Our primary operational focus for 2007 continues to be: (i) improving near-term financial and operational performance of our radiopharmaceutical and manufacturing businesses through increasing sales of existing products and services, improving manufacturing efficiency and effectiveness, and obtaining additional regulatory approvals; and (ii) securing and advancing our base for long-term growth through the development of our existing product pipeline as well as identifying new business opportunities that are consistent with our capabilities and that contribute to the long-term value of the Company. Consistent with this strategic focus, we divested our dermatology product lines in 2001 and in 2003 completed the sale of our prescription pharmaceutical sales and marketing business, DRAXIS Pharmaceutica. We also realigned our senior management responsibilities in 2003 to focus on our core businesses. In 2005, we created the position of Chief Operating Officer to provide executive oversight to our core operating businesses and established a new management team for our DRAXIMAGE business unit. 19 The following is a description of the principal markets in which we operate and a breakdown of total revenues by segment and geographic market for the three most recent financial years (1):
(1) See Note 19 in our 2006 Consolidated Financial Statements and Notes beginning on page F-1 (2) Revenues are attributable to countries based upon the location of the customer.
Our two main operating businesses, radiopharmaceuticals and contract manufacturing (sterile and non-sterile products), are not characterized by significant seasonality. However, plant activities at DRAXIS Pharma (contract manufacturing) are generally reduced or shut down once a year, usually during our third quarter, for approximately two to four weeks in order to conduct regular required maintenance. DRAXIMAGE’s principal raw materials are radioactive isotopes that are used to label other compounds that act as carriers or molecular targeting agents. The isotopes are obtained from companies and agencies that are licensed by governmental regulators to produce purified radioactive chemicals. Radioactive materials, by their nature, decay over time — some rapidly and some more slowly, depending on specific isotopes. Therefore, DRAXIMAGE receives shipments of chemical-grade radioisotopes several times each week and converts these to finished pharmaceutical-grade products within days or weeks. While prices of selected isotopes can be somewhat volatile over the medium term, DRAXIMAGE endeavors to negotiate long-term supply arrangements with appropriate suppliers, especially for the more important isotopes such as radioactive Iodine. DRAXIS Pharma, as a contract manufacturer of pharmaceutical products, obtains its chemical raw materials from approved chemical suppliers of both active pharmaceutical ingredients (“API”) and inactive or excipient ingredients such as fillers, stabilizers, preservative agents and coloring agents. In many instances the API is supplied by the customer. DRAXIS Pharma conducts full quality control testing of all ingredients and packaging materials before they are incorporated into the finished product. Prices of principal API are not generally volatile, although prices can vary between alternative suppliers. Contract Manufacturing (DRAXIS Pharma)Contract manufacturing accounted for 72.8% of our consolidated revenues for the year ended December 31, 2006. Our DRAXIS Pharma division is responsible for our contract pharmaceutical manufacturing and has capabilities in a broad range of dosage forms, specializing in liquid and lyophilized (freeze-dried) injectables and other sterile products. Operating out of a cGMP-compliant 20 247,000-square-foot facility located in Kirkland, Québec, DRAXIS Pharma manufactures pharmaceutical products for DRAXIMAGE, as well as for over 25 other pharmaceutical clients in many international jurisdictions. Key business development transactions involving DRAXIS Pharma have included: · May 1998 — $11.1 million acquisition of DRAXIS Pharma’s pharmaceutical manufacturing facility. · July 1999 — signing of a five-year manufacturing supply agreement with Warner-Lambert Canada Inc. (which then became known as Pfizer Consumer Healthcare, a division of Pfizer Canada Inc.). In September 2005, the Company announced that Pfizer Canada had renewed this agreement for a three year term effective January 1, 2005. On December 20, 2006, DRAXIS Pharma was advised that J&J had purchased Pfizer’s consumer healthcare business and that the agreement had been assigned to J&J. · February 2000 — sale of 34.1% equity interest to SGF and DRAXIS Pharma senior management for net proceeds of $5.4 million. · December 2001 — signing of a long-term manufacturing and supply agreement for the renewal and expansion of DRAXIS Pharma’s existing contract manufacturing relationship with GSK. · March 2003 — initiation of production under a manufacturing and supply agreement with Bone Care International, Inc. (now Genzyme) for Hectorol® Injection. · April 2004 — acquisition by the Company of SGF’s 32.7% interest in DRAXIS Pharma and repayment of $3.1 million (CDN$4.2 million) in debt owed by DRAXIS Pharma to SGF and $1.7 million (CDN$2.3 million) in debt owed by DRAXIS Pharma to Investissement Québec. The DRAXIS Pharma senior management interest was also bought so that the Company became the sole shareholder of DRAXIS Pharma. In 2004, we completed a three-year, $12 million capital plan at DRAXIS Pharma, including the installation of a second lyophilizer. The capital plan also included new sterile manufacturing capabilities to support recently announced contracts, improvements to production line efficiency, improvements to infrastructure, new raw material handling facilities and support systems to maintain the DRAXIS Pharma facility at the forefront of regulatory compliance. DRAXIS Pharma’s three-year, $12 million capital plan was initially financed through loans and equity investment from DRAXIS Pharma’s shareholders, loans from Investissement Québec and internally generated funds. The equity was repurchased and the loans were repaid in April 2004 from the proceeds of the Company’s public offering. Since DRAXIS acquired DRAXIS Pharma, DRAXIS Pharma’s revenues have risen from $6.1 million for the eight-month period ended December 31, 1998 to $64.7 million for the year ended December 31, 2006. DRAXIS Pharma’s business goal is to be a leading supplier of high-value-added, high-margin contract pharmaceutical manufacturing services. Key components of DRAXIS Pharma’s strategy to achieve this goal include: 21 · obtaining and maintaining all required regulatory approvals for DRAXIS Pharma’s manufacturing facility; · securing additional manufacturing contracts with existing and new customers; · focusing on DRAXIS Pharma’s distinctive capabilities in sterile and lyophilized product manufacturing; · providing manufacturing and related services to DRAXIS’ other businesses; and · focusing on operational excellence, including regulatory compliance, cost-effectiveness and customer service. Overview of Pharmaceutical Contract ManufacturingIn a report prepared by CIBC World Markets (Equity Research) and dated December 3, 2002 entitled “Pharmaceutical Contract Manufacturing”, it was estimated that the manufacturing portion of the $400 billion global pharmaceutical market was $50 billion, with approximately $13 billion outsourced. Since 2002, we believe that the contract manufacturing market for pharmaceuticals has continued to grow. The secondary, or dosage-form, manufacturing segment that is currently outsourced was further estimated to be approximately $5.5 billion with an anticipated near-term growth in the 10% — 15% range. The reasons pharmaceutical companies outsource manufacturing include: · productivity benefits — plant utilization rates in the pharmaceutical industry are declining and have created increased need to lower operating costs; · moving assets off the balance sheet — contract manufacturers are a solution to high levels of industry assets tied up in under-utilized facilities; · leveraging external expertise — third-party contractors provide a logical route to specialist services and access to updated technologies; and · pharmaceutical industry consolidation — continuing mergers will likely force rationalization of manufacturing capacity. The Company believes that there is currently a significant global shortage of sterile lyophilization capacity and that this sector offers significantly higher margin growth potential for DRAXIS Pharma due to its technical complexity and its increasing demand as a favored dosage form for biotechnology products in particular. DRAXIS Pharma believes that the key competitive factors in the contract manufacturing industry include the reliability of supply, quality of product, strict compliance with governmental regulations, capacity availability, competitive pricing and the technical and manufacturing ability to produce a full range of quantities — from small pilot batches often required for clinical trials to larger commercial quantities. CompetitionDRAXIS Pharma competes with pharmaceutical companies that have in-house manufacturing capabilities as well as with third-party contract manufacturers, including Hospira Inc., Boehringer 22 Ingelheim, Cardinal Health, Inc., Hollister-Stier Laboratories LLC, DPT Laboratories, Haupt Pharma AG, Patheon Inc. and DSM Pharmaceuticals, Inc. Manufacturing CapabilitiesDRAXIS Pharma is a customer-driven pharmaceutical contract manufacturing division that is positioned to manufacture a variety of dosage forms. DRAXIS Pharma is one of a few existing full-scale pharmaceutical contract manufacturing facilities in Canada that has FDA-approved sterile manufacturing and sterile lyophilization capabilities. In 2006, the organization of this contract manufacturing business was further refined as we implemented separate business unit accountability for sterile and non sterile product operations to achieve a flatter, more responsive organization. Plant operations at our sole manufacturing facilities in Kirkland, Québec are further organized into four manufacturing areas, supported by packaging and warehousing and distribution functions. Sterile Lyophilization Lyophilization is the preferred dosage form for a broad range of sterile products that are unstable in liquid form. Lyophilization is a complex process of freeze-drying in which a liquid solution is frozen under vacuum and all water is removed, leaving behind a stable, dry, sterile powder that has a relatively long shelf life and is easily reconstituted into a liquid form prior to use. Products delivered in a lyophilized dosage form include injectable pharmaceuticals, vaccines, biotechnology proteins or peptides and diagnostic products. DRAXIS Pharma’s existing sterile manufacturing capabilities were enhanced by the addition of sterile lyophilization, which became fully operational and approved by the FDA in the latter half of 2001. This fully automated line includes a vial washer, a depyrogenation tunnel, an in-line filling machine, robot loaders and unloaders, the freeze-drier unit and a capper. This first freeze-drier has a capacity based on 11 square meters (120 square feet) of shelf space, while the second unit installed in 2004, with 24 square meters (254 square feet) of shelf space, has double the shelf space. In 2004, the Company completed a three-year, $12 million capital plan for DRAXIS Pharma, including the addition of the second lyophilizer, new sterile manufacturing capabilities to support recently announced contracts, improvements to production line efficiency, improvements to infrastructure, new raw material handling facilities and supporting systems to maintain DRAXIS Pharma at the forefront of regulatory compliance. The second lyophilizer was incorporated into DRAXIS Pharma’s existing lyophilization facility. The specialized facility was originally designed to readily accommodate this second lyophilizer at a cost significantly less than that of the initial installation with minimal disruption to ongoing production. The second lyophilization unit completed validation and began commercial production during 2005. At optimum configuration and given the appropriate mix of lyophilization cycles, the second lyophilizer could potentially allow us to approximately triple existing lyophilization capacity over time. We did not achieve full capacity utilization of the new lyophilizer in 2006; however the transfer of some current products and the introduction of new products will continue to occur in 2007 and beyond.
23 Other Sterile Products The Sterile Products Department (“SPD”) includes preparation and pharmaceutical areas with manufacturing, filling and inspection rooms for the manufacture of injectable liquids, ophthalmic and otic products. We believe that DRAXIS Pharma possesses one of the most modern facilities of its kind in Canada approved for the manufacture of sterile prescription pharmaceuticals for Canada, the United States and other global markets. Including the new lyophilization line, SPD covers approximately 17,100 square feet and is designed for segregated operations complemented by secure access controls. Computerized systems are utilized for both topical and automated ointment lines in order to optimize process control. Both of these lines are closed-loop systems to ensure sterile integrity. The sterile ointment system utilizes an automated system to place tubes on the fillers, thereby minimizing human intervention. The processes that are incorporated in the operation include aseptic manufacturing and filling, terminal sterilization, clean in place (“CIP”), and sterilize in place (“SIP”). The dosage forms/product types manufactured include solutions in ampoules and vials, suspensions and solutions in drop dose form and ointments in tubes. The department currently has the capacity to fill vials ranging in size from 1 ml to 30 ml, ampoules ranging in size from 1 ml to 10 ml, and 3.5 g to 4.5 g tubes. Ointments, Creams and Liquids The 16,000-square-foot Ointments, Creams and Liquids (“OCL”) Department offers substantial flexibility in production scale. Production of ointments and creams utilizes a gravity-fed system and incorporates segregated wash areas and clean storage areas for equipment. Batch capability in the OCL Department varies from 200 to 18,000 liters and incorporates three dedicated packaging lines. Interconnecting tanks can be utilized where required, thereby providing production flexibility. Fully automatic validated CIP systems ensure the purity of each customer’s product. Product is pumped to two of the packaging lines and gravity fed to the other two lines. Dosage forms/product types manufactured include creams, ointments, lotions, syrups, shampoos, gels and suspensions. Solid Dosage The Solid Dosage Department covers approximately 10,300 square feet of space and is comprised of two suites for granulating powders prior to compression plus four isolated compression suites in which the powders are pressed into tablets and caplets of various forms and sizes. The first granulation suite is designed for large-batch blending, granulating and drying, while the second granulation suite is equipped with smaller scale equipment that can be used for small production or pilot batches. Each granulation and compression suite has its own testing equipment and cleaning area. The rooms are isolated and have purpose-built airflow systems to contain powder. Dosage forms and product types manufactured in this department include tablets in bottles and blisters, caplets in bottles and blisters, and powders. 24 PackagingThe Packaging Department covers approximately 51,000 square feet and incorporates an open space with movable separations that provide flexibility in the packaging area featuring several packaging lines. Segregated zones are defined for de-boxing, filling and secondary packaging. Bar coding ensures complete control of all packaging components. Within the department there are packaging lines for ointments and creams, a line for liquid packaging, lines for tablets (bottles and blisters), a sterile product packaging line which includes automatic inspection and a line dedicated for lyophilized products and topical packaging. The inspection of finished sterile products in glass ampoules includes automated inspection by a leak pinhole detector. An automatic inspection machine has been validated to detect particles in sterile products packaged in vials and ampoules. These products may also be inspected manually. RegulatoryManufacturing operations at DRAXIS Pharma, from receipt of raw material and packaging ingredients, through compounding, dosage form processing, filling, labeling and packaging, to final product release by quality control, are all conducted in accordance with cGMP requirements and other appropriate international regulatory standards. Regular inspections of facilities, production processes, and control and validation systems, as well as employee training programs, are conducted by DRAXIS Pharma, by U.S., Canadian and international governmental regulatory agencies and by customer inspection teams throughout the year. DRAXIS Pharma maintains a distinct internal team to provide effective liaison with various external inspection groups. DRAXIS Pharma has a strong regulatory track record. This includes 13 successful audits of our facilities in 2006 (0 regulatory inspections and 13 client audits) and 12 successful audits of our facilities in 2005 (2 regulatory inspection and 10 client audits). Warehousing and DistributionThe warehousing and distribution facilities at DRAXIS Pharma at our facilities in Kirkland, Québec, allow additional manufacturing flexibility and efficiency. A five-tier pallet-racking warehouse has a full height of 29 feet, covers approximately 48,900 square feet of space and has six shipping and receiving docks. The warehouse has separately locked areas, including refrigeration units to control sensitive raw materials and finished goods. DRAXIS Pharma also has a raw material storage and dispensing area, which provides an improved environment for the handling and accurate dispensing of raw materials. This installation improves the flow of material and personnel. CustomersThird-Party Contract ManufacturingDRAXIS Pharma manufactures prescription and non-prescription pharmaceutical products for more than 20 pharmaceutical companies (excluding inter-company manufacturing) pursuant to manufacturing supply contracts. Such contract manufacturing represented 72.8% of our consolidated revenues for the year ended December 31, 2006. A significant portion of this contract manufacturing business is focused on our three largest customers, Genzyme, GSK and Johnson & Johnson, Inc. (prior to December 20, 2006 Pfizer Consumer Healthcare, a division of Pfizer Canada Inc.) which represented 25 56% of our consolidated revenues in 2006. See “Risk Factors — Risks Related to our Company — A Significant Portion of our Business is Dependent on a Small Number of Key Customers”. In April 2002, DRAXIS Pharma entered into an agreement with Bone Care International, Inc. (now Genzyme) to produce Hectorol® Injection for sale in the U.S., and we began commercial shipments of the sterile injectable product in March 2003. A manufacturing and supply agreement was signed on March 3, 2003. The agreement is for a five-year term and is automatically renewed at the end of its term for one year period unless either party gives written notice of non renewal to the other party one year prior to the end of the term or the end of a renewal period. On December 18, 2001, DRAXIS Pharma finalized supply and related agreements with GSK for the renewal and expansion of an existing contract manufacturing relationship between the companies. The products transferred to DRAXIS Pharma were all established, sterile products marketed by GSK in multiple international markets. In 2002, a prescription sterile injectable product for the U.S. market was added under this contract and commercial production of this product commenced in the second quarter of 2002. During 2002, site transfer and related activities associated with the other GSK products were undertaken and production started in the second quarter of 2003 and ramped up through 2003 and 2004 with full production of all products achieved by the end of 2004. DRAXIS Pharma will manufacture the products covered by the agreement until it receives a termination notice from GSK which may be given by a two-year advance written notice given on or after December 31, 2007. On July 1, 1999, DRAXIS Pharma entered into a five-year manufacturing and supply agreement with Warner-Lambert Canada Inc. (which then became known as Pfizer Consumer Healthcare, a Division of Pfizer Canada Inc.) covering several non-prescription products for the Canadian market, including Polysporin®, Sudafed®, Actifed® and Zincofax®. Manufacturing of these products commenced in early 2000. On September 1, 2005, DRAXIS announced it had renewed its agreement with Pfizer Canada for a three-year term, effective January 1, 2005. On December 20, 2006, DRAXIS Pharma was advised that J&J had purchased Pfizer’s consumer healthcare business and that the agreement had been assigned to J&J. Inter-CompanyBeginning in early 2002, DRAXIS Pharma became the FDA-approved manufacturing site for DRAXIMAGE’s lyophilized Tc-99m Kits. In addition, DRAXIS Pharma has been qualified as the manufacturing site for ANIPRYL® tablets. EmployeesAs at December 31, 2006, DRAXIS Pharma had 404 employees (representing approximately 80% of the Company’s employees), consisting of: 64 managerial employees, 43 clerical employees, 62 quality operations employees and 235 unionized hourly employees. The unionized hourly employees are represented by the United Food & Commercial Workers International Union, Local 291 (AFL-CIO). A collective agreement with a five-year term to April 30, 2008 was ratified in February 2004. DRAXIS Pharma currently has no significant unresolved issues with the union. See “Risk Factors — Risks Related to our Company — Our Business Could be Harmed if there were a Dispute or Disruption with our Unionized Employees”. Former Equity PartnersFrom February 2000 to April 2004, SGF and senior management of DRAXIS Pharma held a non-controlling equity interest in DRAXIS Pharma Inc. (now known as DRAXIS Pharma, a division of 26 DRAXIS Specialty Pharmaceuticals Inc.). In 2002 and 2003, DRAXIS Pharma Inc. (now known as DRAXIS Pharma, a division of DRAXIS Specialty Pharmaceuticals Inc.) repurchased and cancelled shares held by a former DRAXIS Pharma employee and members of DRAXIS Pharma’s management team in exchange for cash and settlement of existing loans. In April 2004, the Company acquired from SGF its 32.7% interest in DRAXIS Pharma and also repaid $3.1 million (CDN$4.2 million) in debt owed by DRAXIS Pharma to SGF. The DRAXIS Pharma senior management interest was also bought so that the Company became the sole shareholder of DRAXIS Pharma. RadiopharmaceuticalsRadiopharmaceuticals accounted for 24.2% of our consolidated revenues for the year ended December 31, 2006. Our DRAXIMAGE division is responsible for discovering, developing, manufacturing, and marketing our diagnostic imaging and therapeutic radiopharmaceutical products for the global nuclear medicine marketplace. Nuclear medicine entails the use of radioactive drugs (radiopharmaceuticals) for imaging and therapeutic purposes. The energy released as these products decay can be harnessed to: (i) elicit a visual representation of various organs and tissues (nuclear imaging); or (ii) destroy cancerous cells (radiotherapy). Products currently marketed by DRAXIMAGE include a line of lyophilized Technetium-99m kits (“Tc-99m”) used in nuclear imaging procedures and a line of imaging and therapeutic products labeled with a variety of isotopes, including iodine. As announced on February 2, 2007, DRAXIMAGE submitted an ANDA to the FDA for its generic kit for the preparation of Tc-99m Sestamibi for injection (“DRAXIMAGEÒ Sestamibi”), a nuclear medicine imaging agent used in myocardial perfusion imaging (“MPI”) to evaluate blood flow to the heart in patients undergoing cardiac tests. According to AMR/Arlington Medical Resources, in 2006 there were more than seven (7) million cardiac studies conducted in the U.S. out of a total of over 15 million nuclear medicine procedures, making MPI the most widely performed nuclear medicine scan. Recent market research indicates that existing MPI products generate revenues in excess of $500 million annually in the U.S. and that the imaging agent most often used in conducting MPI procedures is sestamibi labeled with the radioactive isotope Technetium-99m (“Tc-99m Sestamibi”). Once its product is approved, DRAXIMAGE plans to enter the MPI market after the key patent for the currently marketed Tc-99m Sestamibi product expires, which is expected to be in 2008 for the United States. DRAXIMAGE also plans to file for marketing approvals in other jurisdictions, including European countries. DRAXIMAGE also has a number of products in development, including a Technetium-99m-based diagnostic imaging product, INFECTON®, for which three of four Phase II trials conducted in Canada and the U.S. have been completed. A fourth trial was discontinued due to a change in market focus. An expert panel, comprised of respected nuclear medicine specialists and microbiologists, was assembled and this expert panel reviewed the preliminary scientific and clinical data together with the outcome of the market research studies. The role of the expert panel was to assess the results to date, review potential target markets, and advise DRAXIMAGE on the design of future clinical studies and appropriate indications. The preliminary report of the expert panel recommended that the product be reformulated for orthopaedic-related indications and the assessment of such formulations is under way. DRAXIMAGE has also received approval in November 2006 from the FDA to run two clinical trials in the U.S. using radioactive Iobenguane I-131 Injection (also known as 131 I-metaiodobenzylguanidine, or I-131 MIBG) to treat high-risk neuroblastoma, a rare form of cancer that affects mostly infants and young children. Given the inherent uncertainties associated with new drug development, it is difficult to predict if, or when, these products will achieve commercialization. See “Risk Factors — Risks Related to our 27 Industry — If the Market Does Not Accept our Products Currently in Development, our Business Could Be Harmed”. Founded in 1950 as a division of Charles E. Frosst & Co., the predecessor business to DRAXIMAGE pioneered and became a leader in the medical application of nuclear technology after assuming the development function from Atomic Energy of Canada Ltd. Following the 1965 acquisition of Charles E. Frosst & Co. by Merck Inc. (“Merck”), the business continued operations as a division of Merck’s Canadian subsidiary, Merck Frosst Canada and Co. (“Merck Frosst”), until its acquisition by DRAXIS in 1997. As part of the acquisition, the Company retained all of the business’s managers, scientists and employees as well as its existing products and intellectual property. The acquisition of this business was consistent with our strategy of acquiring specialty pharmaceutical platforms with potential for expansion into global markets. We believe that DRAXIMAGE is the only company that manufactures I-131 radiopharmaceutical products in Canada. DRAXIMAGE and its predecessor have a long history of technological and scientific progress in the field of radiopharmaceuticals. Notable achievements include the development of lyophilized kits for the in-situ preparation of Technetium-99m radiopharmaceutical products for nuclear medical imaging (“Tc-99m Kits”); the development of chelates for the indium/yttrium and Technetium/rhenium groups of metals; and the development of stabilizers for use in iodinated radiopharmaceuticals, which resulted in DRAXIMAGE being one of the few providers to market iodinated products that do not require refrigeration. Key business development transactions involving DRAXIMAGE have included: · July 1997 — $8.6 million acquisition of the Canadian radiopharmaceutical division of Merck Frosst, which began operations through DRAXIMAGE Inc. (now known as DRAXIMAGE, a division of DRAXIS Specialty Pharmaceuticals Inc.). · October 1999 — licensing from Isogenic Science Ltd. (“Isogenic”) of the rights to Isogenic’s proprietary technology related to radioactive brachytherapy implants (“BrachySeed®”) for the treatment of various localized cancers. · July 2000 — signing of a non-exclusive distribution agreement with Syncor International Corporation (now known as Cardinal Health 414, Inc.) for the production of a kit for the preparation of Sodium Iodide I-131 Capsules and Oral Solution indicated for the treatment of thyroid cancer and hyperthyroidism for sale in the U.S. · December 2000 — entering into license, distribution and supply agreements for BrachySeed® for the U.S. market with Cytogen Corporation. · March 2001 — licensing from BTG International Limited (formerly known as the British Technology Group) of the rights to INFECTON®, an agent for imaging infection. · October 2001 — long-term third-party manufacturing agreement to supply Bracco Diagnostics Inc. with sodium iodide I-131 radiotherapy capsules for the U.S. market. · April 2003 — termination of license, distribution and supply agreements with Cytogen Corporation for BrachySeed® for the U.S. market. 28 · May 2003 — expansion of agreements with Isogenic for global rights to proprietary technology related to brachytherapy implants. · July 2003 — extension and expansion of strategic partnership with Bristol-Myers Squibb Canada Co. (“Bristol-Myers Canada”) for the marketing and distribution of radiopharmaceutical products in Canada. · August 2003 — amendment to the July 2000 agreement with Cardinal Health, 414 Inc. to enable DRAXIMAGE to distribute the new radioactive Iodine I-131 kit product to independent radiopharmacies in the U.S. · February 2005 — announcement that DRAXIMAGE had received approval from the Dutch regulatory authority for its kit for the Preparation of Technetium Tc-99m Albumin Aggregated Injection (“MAA Kit”). This approval allowed DRAXIMAGE to initiate the Mutual Recognition Procedure (“MRP”) in pursuit of further regulatory approvals for the diagnostic imaging product in additional European Union countries. · April 2005 — announcement of the appointment of Mr. Jean-Pierre Robert as the new President of the DRAXIMAGE division. · November 2005 — DRAXIMAGE announced it would discontinue the manufacture and sale of implantable brachytherapy seeds as of December 15, 2005. · January 2006 — DRAXIMAGE announced it had received approval from the FDA for its supplemental new drug application for Sodium Iodide I-131 Capsules USP, Diagnostic-Oral. · November 2006 — DRAXIMAGE announced it had been approved by FDA to run two clinical trials using radioactive Iobenguane I-131 Injection (also known as 131I-metaiodobenzylguanidine or I-131 MIBG) to treat high risk neuroblastoma, a rare form of cancer that affects mostly infants and young children. · February 2007 — DRAXIMAGE announced it had submitted an ANDA to the FDA for its generic kit for the preparation of Tc-99M Sestamibi for Injection (DRAXIMAGEÒ Sestamibi), a nuclear medicine imaging agent used in myocardial perfusion imaging (MPI) to evaluate blood flow to the heart in patients undergoing cardiac tests. DRAXIMAGE’s growth strategy is to leverage its history and experience in the research, development, manufacture and distribution of radiopharmaceutical products and services and to capitalize on its manufacturing capabilities. In particular, DRAXIMAGE’s business strategy includes: · Increasing the market penetration of its radioactive products, particularly in the U.S.; · Increasing international sales of its key Tc-99m Kits and Iodine I-131 products, particularly in Europe; · Timely, cost-effective development of its portfolio of proprietary, innovative imaging and therapeutic radiopharmaceutical products; and 29 · Identifying and capitalizing on additional new business opportunities and strategic partnerships which are consistent with DRAXIMAGE’s capabilities, including the monitoring of products that will come off patent protection in key markets that can be manufactured, marketed and sold by DRAXIMAGE and monitoring products that are owned by third parties and which could be divested in the consolidation that is taking place in the radiopharmaceutical industry. Overview of RadiopharmaceuticalsThe medical specialty of nuclear medicine involves the use of short-lived radioisotopes for both diagnostic imaging and therapeutic applications. Pharmaceutical products used in such applications are commonly called radiopharmaceuticals. Radiopharmaceuticals represent a well-defined, growing niche market that involves challenges such as regulatory approvals, specialized manufacturing standards, access to supply and critical delivery logistics. Diagnostic Imaging ApplicationsThe diagnostic imaging applications of nuclear medicine normally involve the intravenous administration of a radiopharmaceutical consisting of a targeting molecule, which has a particular binding affinity for a specific organ or tissue linked to a low intensity, short-lived, gamma-emitting radioisotope such as Tc-99m. Following administration, the radiopharmaceutical with its radioactive isotope concentrates at the biological target, which is then imaged using a scanning device such as a gamma camera. A gamma camera consists of a scintillation crystal which, when placed over a region of the body, is capable of detecting gamma rays emitted by radionuclides in underlying tissues. The gamma camera and its associated computerized peripheral devices accurately measure the radiation being emitted by the radioisotope and so provide both a visual picture of the target and quantitative data concerning the distribution of radioactivity. A nuclear medicine image provides both static and functional, or dynamic, information about a biological target, thereby revealing functional and morphological information normally unobtainable by other imaging techniques such as X-ray, magnetic resonance imaging, computer tomography, and ultrasound, all of which provide primarily anatomical information. Nuclear medical imaging procedures are established and trusted medical procedures with many years of safe and effective use. Most procedures are non-invasive, are performed with a minimum of discomfort and inconvenience to the patient and are normally less costly and involve less risk than other currently available high-tech alternative techniques. Therapeutic ApplicationsIncreasingly, therapeutic radiopharmaceuticals are being used and new products are being developed for the treatment of disease, particularly for the treatment of various cancers. Examples of currently marketed therapeutic radiopharmaceuticals include: · various sodium iodide I-131 products for the diagnosis and treatment of thyroid cancer and hyperthyroidism; · phosphorous-32 for the palliative treatment of bone pain for patients with advanced metastatic bone cancer; and 30 · I-131 meta-iodobenzylguanidine (MIBG) for the treatment of neuroblastoma. New generations of anti-cancer agents based on targeting molecules such as peptides, proteins, metabolites and monoclonal antibodies that have binding affinities to the surface of cancerous cells are being developed to be linked to more potent, higher-intensity, beta-emitting radioisotopes such as yttrium-90, rhenium-186, holmium-166 and lutetium-199. There is a growing body of scientific evidence that molecules, thus bound, will permit the delivery of therapeutic quantities of radiation directly to malignant cells. CompetitionThe radiopharmaceutical field is highly specialized, particularly in the therapeutic area. Challenges include meeting pharmaceutical product and nuclear regulatory requirements, having the ability to handle radioactive materials and establishing facilities and procedures to manufacture products in a sterile lyophilized or freeze-dried form, which involves manufacturing standards higher than those typically employed for most pharmaceutical products. In addition, manufacturing and distribution logistics systems must be well-integrated and supportive to ensure that radiopharmaceutical products can be produced rapidly and delivered to the end user in a timely manner with the prescribed level of strength. Companies with significant radiopharmaceutical operations include Bristol-Myers Squibb Company, GE Healthcare - Amersham, Mallinckrodt, Inc., a division of Tyco Healthcare, CISBio, and Bracco SpA. In addition, there are a number of companies that are developing and/or marketing other radiopharmaceutical products, including MDS Nordion Inc., Immunomedics, Inc., Cytogen Corporation, Biogen Idec Inc. and Molecular Insights Pharmaceuticals, Inc. Marketed ProductsDRAXIMAGE’s products are divided into two groups: (i) radioactive products, which are in a radioactive and ready-to-use form when shipped to customers, and (ii) non-radioactive products (predominantly Tc-99m Kits). The non-radioactive kit products are sold in lyophilized (freeze-dried), non-radioactive form consisting of sterile, pyrogen-free complexes of chemical and/or biological substances. Tc-99m Kits are reconstituted with radioactive Tc-99m in the nuclear medicine laboratory of a hospital or a unit-dose service supplier, or radiopharmacy, prior to use. Radioactive ProductsRadioactive products, which are shipped by DRAXIMAGE with the radioactive isotope already incorporated, are distributed to the nuclear medicine departments of hospitals or diagnostic clinics in a ready-to-use form. The following table summarizes the DRAXIMAGE radioactive products. All products listed have received approval for sale by the applicable regulatory body in the territory in which the product is sold. 31
Sodium Iodide I-131 Radiotherapy In October 2001, DRAXIMAGE entered into a third-party manufacturing contract to supply sodium iodide I-131 radiotherapy capsules for Bracco Diagnostics Inc. for the U.S. market for the treatment of thyroid cancer and hyperparathyroidism. In January 2003, DRAXIMAGE received FDA approval to produce and market a new radiopharmaceutical kit product for the preparation of Sodium Iodide I-131 Capsules and Oral Solution for the treatment of thyroid cancer and hyperthyroidism. This was the first such product on the market that allows physicians and radiopharmacists to prepare an FDA-approved I-131 gelatin capsule or oral solution. In March 2003, DRAXIMAGE launched the new kit product and initiated shipments to the Nuclear Pharmacy Services group of Cardinal Health 414, Inc., under a five-year, non-exclusive distribution agreement for the product for the United States and its possessions. As of 2003, this product was made available to other customers and distributors in the U.S. 32 In November 2004, DRAXIMAGE received FDA approval for a DRAXIMAGEÒ brand of I-131 therapeutic capsules. In November 2005, DRAXIMAGE announced it had received FDA approval for a new larger format version of its I-131 kit for the preparation of Sodium Iodide I-131 Capsules and Oral Solution. DRAXIMAGE introduced this product in the U.S. market in January 2006. In January 2006, DRAXIMAGE announced it had received approval from the FDA for its supplemental new drug application for Sodium Iodide I-131 Capsules USP, Diagnostic-Oral. These diagnostic Sodium Iodide I-131 Capsules are intended to be used by physicians to perform the radioactive iodide (RAI) uptake test to evaluate thyroid function prior to treatment with stronger therapeutic doses of Sodium Iodide I-131. Diagnostic doses of Sodium Iodide I-131 may also be employed in localizing metastases associated with thyroid malignancies. DRAXIMAGE introduced the new diagnostic capsules into the U.S. market in May 2006. Non-Radioactive ProductsDRAXIMAGE currently markets the following non-radioactive products. All products listed have received approval for sale by the applicable regulatory body in the territory in which the product is sold.
DRAXIMAGE’s major non-radioactive products are its MDP, DTPA and MAA Tc-99m diagnostic imaging kits. While these products would technically be classified as generic pharmaceutical products, DRAXIMAGE’s versions are proprietary and are sold under the DRAXIMAGEÒ trademark or that of its local distributors. All three of these products feature a proprietary formulation that provides additional shelf life following reconstitution compared to competitive products. 33 On October 25, 1995, Frosst Radiopharmaceuticals, a division of Merck Frosst Canada Inc. (now known as DRAXIMAGE) entered into a non-exclusive distribution agreement with Syncor International Corporation (now known as Cardinal Health 414, Inc.) for distribution in the U.S. of DTPA, a kit used to prepare Tc-99m Pentetate to study kidney clearance, and MDP, a kit used to prepare Tc-99m Methylene Diphosphonic Acid to study bone metabolism. The initial term was for five years, with automatic renewal of the agreement for successive two-year periods. Prior to 2002, DRAXIMAGE produced Tc-99m kits at its Merck Frosst location. Following FDA approval of the Company’s new lyophilization production facilities in early 2002, the resulting increased manufacturing capacity provided the opportunity to increase sales volumes of these products in existing markets in the U.S. and Canada and to build new markets in Europe and Asia, territories in which product approvals are either already in place or expected to be granted in the near future. In March 2004, DRAXIMAGE received approval from the FDA to produce and market a new formulation of MDP, called MDP-25, a kit for the preparation of Technetium Tc-99m Medronate Injection. In September 2005, MDP-25 was approved by Health Canada. Products under DevelopmentAs of March 19, 2007, DRAXIMAGE had the following products under development:
The clinical development of radiopharmaceutical imaging agents differs from that of therapeutics in several areas. While therapeutics are developed to offer improved efficacy and safety in the treatment of a specific disorder, radiopharmaceutical imaging agents are elaborated for demonstrating the existence and extent of a specific condition. Therefore the trial design for establishing efficacy is not the same. In the case of radiopharmaceutical imaging agents the endpoint is the actual image. The analysis is therefore centered around various quantitative and qualitative aspects of the image. For example, the image quality is assessed at various time points to determine the time to best quality. Also a blinded read of images is conducted to determine the accuracy as well as the sensitivity and specificity of the test in comparison to the modality that is currently accepted as the gold standard. In order for the test to be useful across clinical sites the inter-rater reliability should also be high. This is an important endpoint that is measured by a weighted Kappa test. These are the main efficacy considerations for radiopharmaceutical imaging agents. The analysis of safety is similar to that of therapeutic agents and includes the usual vital sign monitoring as well as the capturing of side effects through adverse event reporting. 34 INFECTON®Description - INFECTON®, a complex of Tc-99m and the anti-bacterial agent ciprofloxacin, is a novel agent for the specific imaging of infection. INFECTON® acts by binding directly to infecting organisms and so is expected to be highly specific for imaging infection. It is anticipated that INFECTON® may be used to image orthopedic bone infection. Technology Partner - INFECTON® was discovered by Drs. Britton and Solanki at St. Bartholomew’s Hospital in London, England. In March 2001, DRAXIMAGE entered into an agreement with BTG International Limited (formerly known as the British Technology Group). The agreement gives DRAXIMAGE exclusive rights to manufacture and sell INFECTON® in the U.S., Canada, South America and Europe. DRAXIMAGE has a sub-license from Bayer AG for the diagnostic imaging use of its ciprofloxacin. Regulatory Status - INFECTON’s® proof of principle was established in a series of clinical trials sponsored by the International Atomic Energy Agency involving 879 patients in several countries outside North America in which INFECTON® displayed excellent results, with a sensitivity of 88.3%, a specificity of 86.5%, and an accuracy of 87.6%. The clinical studies showed that the agent achieved up to 96% specificity in detecting bacteria in the lungs, bones and tissues — areas where other diagnostics have failed in the past. In January 2003, DRAXIMAGE initiated a Phase I clinical trial of INFECTON® in Canada, conducted by Dr. Raymond Taillefer at Hôpital Hotel-Dieu at the Centre Hospitalier du l’Université de Montréal. The study involved 10 healthy subjects in an open-label, single-center, single-dose safety, pharmacokinetic and radiation dosimetry study. Whole body images were taken at various intervals after injection of INFECTON® to visualize distribution of the imaging agent throughout the body over time. The Phase I study was completed during the first half of 2003. INFECTON® was found to be safe and well tolerated by the subjects at the administered dosages. The results of a Phase I trial do not provide enough evidence regarding safety to support an application for marketing with the FDA or the HPFBI, as applicable and additional tests are conducted and submitted in support of any application for approval. Subsequent results often do not corroborate earlier results. In July 2003, DRAXIMAGE initiated two Phase II clinical studies of INFECTON® in Canada. The first of the Phase II studies was a single-dose, open-label, multi-center trial involving 30 diabetic patients suffering from clinically confirmed bacterial infections of the foot. The second study examined and compared the uptake of INFECTON® in patients with either a known soft tissue infection or a chronic inflammatory condition that is sterile. A total of 50 patients with definitive bacterial infections or confirmed chronic aseptic inflammatory conditions were enrolled in the single-dose, open-label, multi-center trial. Twenty-five patients from each group were included in the trials. These studies have been completed. In September 2004, the Company received approval from the FDA to initiate a Phase II clinical trial in the U.S. - single-dose, open-label, multi center trial involving 22 patients suffering from bacterial osteomyelitis. Enrolment in this Phase II trial was fully completed by the end of 2005. In March 2005, the Company initiated a fourth Phase II clinical trial in the U.S. to examine patients suffering from expected appendicitis, but this trial was discontinued due to a change in market focus by the Company. An expert panel, comprised of respected nuclear medicine specialists and microbiologists, was assembled and this expert panel reviewed the preliminary scientific and clinical data together with the outcome of the market research studies. The role of the expert panel was to assess the results to date, review potential target markets, and advise DRAXIMAGE on the design of future clinical studies and appropriate indications. The preliminary report of the expert panel recommended that the product be reformulated for orthopaedic-related indications and the assessment of such potential formulations is 35 under way. Given the inherent uncertainties associated with new drug development, it is difficult to predict if, or when, this product candidate will achieve commercialization. Competing Diagnostic Modalities - The most specific current procedure for medical imaging of inflammation due to infection involves removing blood from the patient, isolating white blood cells in the patient’s blood, radiolabelling the white blood cells with an isotope such as indium-111 or Technetium coupled with a carrier molecule and then injecting the white blood cells back into the patient. These white blood cells localize around the site of the infection and the associated radiation can be detected using a gamma camera. White blood cells are not highly specific and cannot readily distinguish infection from inflammation. Immunomedics, Inc. (NASDAQ: IMMU) announced in January 2005 that it had received Health Canada approval for the marketing and use of its product LeukoScan® for the detection of osteomyelitis. However, according to Immunomedics, Inc.’s website, the product is not presently sold in Canada. LeukoScan® is a murine monoclonal IgG antibody fab’ fragment labeled with Tc-99m. We believe that INFECTON® would offer a more convenient alternative to white blood cell labelling currently used which uses a process of removing blood from a patient, isolating white blood cells in the patient’s blood, radiolabelling the white blood cells when an isotope such as Indium-111 or Technetium coupled with a carrier molecule and reinjecting the white blood cells into the patient. INFECTON® is a radiolabeled imaging agent which is injected directly into the patient without the complexities associated with labelling the patient’s own white cells. Potential Advantages of INFECTON® - Preliminary investigations suggest the possibility that INFECTON® may be capable of distinguishing inflammation from infection. DRAXIMAGEÒ I-131 MIBG Description - DRAXIMAGEÒ I-131 MIBG is used to treat neuroendocrine (cardinoid) tumours, adrenal tumors (neuroblastoma in children and phaechromocytoma) and on rare occasions it can be used to treat thyroid cancer. Iobenguage is m-iodo-benzylguanidine (MIBG), a guanethidine derivative structurally resembling norepinephrine. There exists extensive literature reports that indicate that I-131 MIBG has been used over the last two decades as a therapeutic agent for the treatment of pheochromocytoma, paraganglioma, neuroblastoma, carcinoid, and medullar thyroid carcinoma. The diagnostic use of I-131 MIBG is approved in Europe, the U.S. and Canada. The therapeutic use of I-131 MIBG is approved in Europe but is investigational in the United States and Canada. DRAXIMAGE manufactures the I-131 MIBG at its facility. Regulatory Status - DRAXIMAGE will provide I-131 MIBG for two clinical trials approved by the FDA under a recently submitted Investigational New Drug (“IND”) application. One trial is a Phase II study in which I-131 MIBG will be administered with intensive chemotherapy and autologous stem cell rescue for high-risk neuroblastoma patients. The second trial is a Phase I study in which irinotecan and vincristine, two common chemotherapy agents, will be administered in combination with I-131 MIBG to determine safety and tolerability in patients with resistant/relapsed high-risk neuroblastoma. Both clinical trials will be coordinated by a group of eleven children’s hospitals and two universities in the United States known as the New Advances in Neuroblastoma Therapy (NANT) consortium. These two trials are continuations of earlier NANT studies. They are expected to start in early 2007. NANT member institutions are: · C.S. Mott Children’s Hospital, University of Michigan — Ann Arbor, MI · Children’s Healthcare of Atlanta — Atlanta, Georgia · Children’s Hospital and Regional Medical Center — Seattle, WA · Children’s Hospital Boston, Dana-Farber Cancer Institute — Boston, MA 36 · Children’s Hospital Los Angeles — Los Angeles, CA · Children’s Hospital Medical Center — Cincinnati, OH · Children’s Hospital of Philadelphia — Philadelphia, PA · Children’s Memorial Hospital — Chicago, IL · Lucile Packard Children’s Hospital — Palo Alto, CA · Riley Hospital for Children, Indiana University — Indianapolis, IN · Texas Children’s Cancer Center, Baylor College of Medicine — Houston, TX · University of California, San Francisco — San Francisco, CA · University of Wisconsin Comprehensive Cancer Center — Madison, WI Competing Therapeutic Products - We also believe that AZEDRAÔ, being developed by Molecular Insight Pharmaceuticals, Inc. (“MIPI”) may compete with our DRAXIMAGEÒ I-131 MIBG product under clinical development. AZEDRAÔ has received Orphan Drug status and a Fast Track designation by the FDA. According to information set forth in its website, MIPI is conducting a Phase I clinical trial with AZEDRAÔ in adults at Duke University. The initial target market for AZEDRAÔ is the treatment of metastatic neuroendocrine tumours such as pheochromocytoma, carcinoid and neuroblastoma that are not amenable to treatment with surgery or conventional chemotherapy. Metastatic tumours are turmours that spread to other organs or parts of the body. Technetium GeneratorsDRAXIMAGE is developing a “next-generation” version of a Technetium Generator, which is the source of Technetium in virtually every radiopharmacy worldwide. According to the Bio-Tech Report 250 (issued in October 2006), entitled “The U.S. Market for Diagnostic Radiopharmaceuticals”, the generator market in the United States is currently estimated at approximately US$160 million and is growing at 8% annually. Nearly 90% of generators are located in radiopharmacies and the rest are in other institutions such as hospitals and clinics. Technetium (Tc 99m) is one of the most widely used radiopharmaceuticals. Due to its short half-life, it has to be produced on site or nearby by generators shipped with a longer half-life mother isotope, the molybdenum (Mo99). In other words, generators are used to produce technetium on site at the hospital or radiopharmacy. A generator consists of a column loaded with Mo99, encased within lead shielding designed to provide protection from radiation. It can typically provide Tc 99m for a period of approximately one week, depending on the degree of usage by the radiopharmacy. Other Development ProductsSOMATOSCAN®/Somatostatin TherapyDescription - SOMATOSCAN® and Somatostatin Therapy are radiolabelled somatostatin peptides derived from a synthetic peptide based on MK-678, originally developed by Merck, which shows a high binding affinity for the somatostatin receptors expressed in neuroendocrine tumors, lymphoma and carcinoid and small-cell lung cancer. This peptide may be developed as both a diagnostic imaging agent (SOMATOSCAN®) and therapeutic product (Somatostatin Therapy) and we believe that it may permit the identification and treatment of primary tumors and the correct diagnosis of metastatic lesions. No substantial work related to SOMATOSCANÒ or Somatostatin Therapy was carried out in 2005 or 2006. 37 PaclitaxelDescription - Paclitaxel is a novel, anti-tumor agent referred to in some scientific and medical literature as “taxol.” Paclitaxel is currently marketed in the U.S. under the brand name TaxolÒ by Bristol-Myers Squibb Company. In January 1997, DRAXIS acquired from Mylan Laboratories Inc. (“Mylan”) the exclusive Canadian marketing rights to the Mylan formulation of paclitaxel. In June 1998, DRAXIS filed with the HPFBI a New Drug Submission in Canada for paclitaxel, and the HPFBI has completed its review process. Prior to approval, DRAXIS must comply with Canadian Patented Medicines Regulations with respect to generic competition. Mylan is currently assessing the status of patent infringement litigation in Canada regarding paclitaxel, and the Company has agreed to defer launch in Canada until such issues have been clarified. Under the agreement, DRAXIS and Mylan will share the profits from marketing and selling paclitaxel in Canada according to a formula agreed to between the parties. ManufacturingRadioactive ProductsDRAXIMAGE manufactures its radioactive products in its cGMP compliant manufacturing facility located in Kirkland, Québec supported by a full quality control department licensed by regulatory agencies in Canada and the U.S. In 2001, DRAXIMAGE completed the expansion of its radiopharmaceutical production area in anticipation of increasing sales volumes of its radiopharmaceutical line in the U.S. and other markets. This expansion has approximately doubled the size of the original facility to 19,000 square feet. Most of the radioisotopes used to produce radiopharmaceuticals are supplied to DRAXIMAGE primarily, but not exclusively, by MDS Nordion, a subsidiary of MDS Inc. (NYSE: MDZ; TSX: MDS) and one of the world’s largest supplier of chemical-grade isotopes for use as medical radioisotopes. A key distinguishing characteristic of the radiopharmaceuticals business is the need for a sophisticated logistics system. Radiopharmaceuticals, by their nature, decay continually over time, thereby losing their potency. Therefore, manufacturing and product delivery systems must be well coordinated to ensure that the level of radioactivity present in the product supplied to the physician is correct at the time of administration. Lyophilized ProductsDRAXIMAGE’s Tc-99m Kits are currently manufactured by DRAXIS Pharma in its Kirkland, Québec facility, which was first accepted as a manufacturing site by the FDA in October 2001. Subsequent manufacturing site transfer approvals for the Tc-99m Kits were received during the period December 2001 to March 2002. Regulatory In the period December 2001 through March 2002, DRAXIMAGE was approved by the FDA to transfer production of its line of lyophilized medical imaging products in-house to the DRAXIS Pharma lyophilization production facility. 38 In January 2003, DRAXIMAGE received FDA approval to produce and market a new radiotherapeutic kit product for the preparation of Sodium Iodide I-131 Capsules and Oral Solution. In March 2004, DRAXIMAGE received FDA approval to produce and market a new formulation of MDP called MDP-25, a diagnostic product for preparing a skeletal imaging agent. In November 2004, DRAXIMAGE received FDA approval for a DRAXIMAGE brand of I-131 therapeutic capsules. In September 2005, MDP-25 was approved by Health Canada but is not currently sold by DRAXIMAGE. In November 2005, DRAXIMAGE announced it had received FDA approval for a new larger format version of its I-131 kit for the preparation of Sodium Iodide I-131 Capsules and Oral Solution. DRAXIMAGE introduced this product in the U.S. market in January 2006. In January 2006, DRAXIMAGE announced it had received approval from the FDA for its supplemental new drug application for Sodium Iodide I-131 Capsules USP, Diagnostic-Oral. These diagnostic Sodium Iodide I-131 capsules are intended to be used by physicians to perform the radioactive iodide (RAI) uptake test to evaluate thyroid function prior to treatment with stronger therapeutic doses of Sodium Iodide I-131. Diagnostic doses of Sodium Iodide I-131 may also be employed in localizing metastases associated with thyroid malignancies. We introduced the new diagnostic capsules in the U.S. market in May 2006. In November 2006, DRAXIMAGE announced it had been approved by the FDA to run two clinical trials using radioactive Iobenguane I-131 Injection (also known as 131I-metaiodobenzylguanidine, or I-131 MIBG) to treat high-risk neuroblastoma, a rare form of cancer that affects mostly infants and young children. See “Products under Development”. DRAXIMAGE has a strong regulatory track record. This includes 2 successful audits of our facilities in 2006 (1 regulatory inspections and 1 client audits) and 4 successful audits of our facilities in 2005 (2 regulatory inspections and 2 client audits). Sales and MarketingAt the present time, DRAXIMAGE’s products are marketed primarily in the U.S. and Canada. As many of the products marketed by DRAXIMAGE have the potential for global approvals, it is expected that non-North American based revenues will increase in the future. The most active growth areas are expected to be U.S. and Europe. In January 2003, DRAXIMAGE entered into a marketing and distribution agreement with Netherlands-based IDB Holland B.V. for the Benelux countries. United StatesDRAXIMAGE sells Tc-99m Kits in the U.S. to several customers and distributors including Cardinal Health, Inc., which operates the largest chain of radiopharmacies, Mallinckrodt Inc., a division of Tyco Healthcare, GE Healthcare, United Pharmacy Partners Inc. and large university hospitals. Tc-99m Kits sold in the U.S. are marketed under the DRAXIMAGE trademark. On February 2, 2007, DRAXIMAGE announced it had submitted an ANDA to the FDA for its generic kit for the preparation of Tc-99m Sestamibi for injection (DRAXIMAGEÒ Sestamibi), a nuclear 39 medicine imaging agent used in myocardial perfusion imaging (“MPI”) to evaluate blood flow to the heart in patients undergoing cardiac tests. According to AMR/Arlington Medical Resources, in 2005 there were more than 7 million cardiac studies conducted in the U.S. out of a total of over 15 million nuclear medicine procedures, making MPI the most widely performed nuclear medicine scan. Recent market research indicates that existing MPI products generate revenues in excess of $500 million annually in the U.S. and that the imaging agent most often used in conducting MPI procedures is sestamibi labeled with the radioactive isotope Technetium-99m (“Tc-99m Sestamibi”). The sestamibi kit is used in nuclear medicine imaging to show how well the heart muscle (myocardium) is supplied with blood (perfused) both at rest and during strenuous activity. The radioisotope Technetium-99m is attached to the sestamibi molecule forming Tc-99m Sestamibi. When injected into the bloodstream this radiopharmaceutical agent is distributed throughout the heart muscle in proportion to the blood flow received by various portions of the heart. Heart images are then obtained using a gamma camera that can detect the Technetium-99m. Two sets of images are typically taken, one while the patient is at rest and a second set while the patient is under stress, often by exercising on a treadmill or stationary bicycle. The resulting two sets of images are compared with each other to diagnose the presence of coronary heart disease by detecting areas of the heart that may not be receiving normal blood flow. This imaging technique is known as cardiac stress testing or myocardial perfusion imaging (MPI). Once its product is approved, DRAXIMAGE plans to enter the MPI market after the key patent for the currently marketed Tc99m Sestamibi product expires, which is expected to be in 2008 for the United States. DRAXIMAGE also plans to file for marketing approvals in other jurisdictions, including European countries and Canada. CanadaIn Canada, DRAXIMAGE currently markets most of its products directly to end-users through a co-operative agreement with Bristol-Myers Canada, pursuant to which Bristol-Myers Canada’s sales force promotes the non-competitive product lines of each party. This distribution agreement terminates on December 31, 2007 and has not been renewed. As of January 1, 2008, DRAXIMAGE intends to market its products in Canada directly and through non-exclusive distributors. For many years, DRAXIMAGE has been the primary Canadian supplier of Iodine-131 and Iodine-125 labeled radiopharmaceuticals, including solutions and capsules used primarily for the diagnosis and treatment of thyroid gland disorders. EuropeThe radiopharmaceutical market in Europe is characterized by strong regional fragmentation, which gives the leading market share to the individual manufacturer located in each of the major countries (e.g. GE Amersham Health in the UK, Tyco Healthcare in Holland and CIS Bio in France). DRAXIMAGE’s marketing activities in Europe are at their earliest stages pending regulatory approvals in this jurisdiction. As of December 31, 2005, DRAXIMAGE had five regulatory submissions filed with European regulatory authorities: four with the Medicines Evaluation Board in the Netherlands and one with the Danish Medicines Agency. The submission dates for these radiopharmaceutical products range from June 2003 to December 2004. All of the approvals sought by DRAXIMAGE in Europe are for marketing authorizations through the mutual recognition procedure which involves obtaining approval in one state (the “reference member state”) and recognition of that approval in other member states. All of 40 the approvals being sought in Europe are for radiopharmaceutical products already approved in Canada or the U.S. Two of these five European submissions were for DRAXIMAGE’s kit for the Preparation of Technetium Tc-99m Albumin Aggregated Injection (MAA Kit) for which DRAXIMAGE received approval in one reference member state, the Netherlands, in February 2005 and for the Preparation of Technetium Tc-99m MethyleneDiphosphonic Acid Injection (MDP Kit) for which DRAXIMAGE received approval in one reference member state, the Netherlands, in March 2006. DRAXIMAGE has concluded one distribution agreement in respect of the Benelux countries, with Netherlands-based IDB Holland B.V. DRAXIMAGE is seeking to expand its distribution network in Europe through strategic alliances with commercial partners. Research and DevelopmentDRAXIMAGE conducts both basic research on its own products and development work on in-licensed products and technology developed by other firms, predominantly in the biotechnology field. DRAXIMAGE applies its chelating expertise and technologies to link these compounds with radioisotopes to create innovative diagnostic and therapeutic radiopharmaceuticals. In October 2003, DRAXIMAGE received a U.S. patent for a new family of chelating compounds that have significant potential for the development of imaging and radiotherapeutic agents to diagnose and treat diseases, including cancerous tumors or metastases. We believe that the new family of chelating compounds will permit the discovery of diagnostic imaging agents to visualize important biological receptors or receptor-positive tumors when combined with gamma-emitting radioisotopes. We believe that the compounds are also potentially useful as therapeutic radiopharmaceuticals for the in-vivo treatment of tumors and metastases. DRAXIMAGE is also able to provide labeling technology for other companies for use with monoclonal antibodies and peptides. We are also working on the development of novel therapeutic uses of radioactivity. DRAXIMAGE personnel have extensive experience developing and optimizing formulations applicable to the lyophilization manufacturing processes used in the production of cold Tc-99m Kit products. EmployeesAs at December 31, 2006, DRAXIMAGE had 87 employees (representing approximately 17% of the Company’s employees), consisting of 9 general management and administration employees, 12 marketing, selling and customer service employees, 20 quality operations employees, 36 manufacturing employees, and 10 research and development employees. None of these employees is unionized. PatentsMost of DRAXIMAGE’s products are covered by patents held by DRAXIMAGE or licensed from third parties. DRAXIMAGE has numerous patents issued and allowed and patent applications pending in the United States, Canada, Europe and Japan. For example, DRAXIMAGE has various U.S. issued patents related to chelates for radiopharmaceutical applications and process patents for the preparation of certain radiopharmaceuticals. The patents held by DRAXIMAGE have expiry dates ranging from November 2008 to December 2021. In addition, DRAXIMAGE has licensed from BTG International Limited (formerly known as the British Technology Group) certain U.S. patents covering its INFECTONÒ product. 41 DRAXIMAGE also relies on trade secrets, know-how and other proprietary information to protect its current products and technologies. To protect DRAXIMAGE’s rights in these areas, it requires all licensors, licensees, customers and significant employees to enter into confidentiality agreements. There can be no assurance, however, that these agreements will provide meaningful protection to DRAXIMAGE’s patents, trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure of such patents, trade secrets, know-how or other proprietary information. Other Collaboration Agreements We have continuing financial interests associated with our collaboration agreements with Pfizer with respect to ANIPRYL® and with Shire with regard to Canadian sales of products divested in 2003. As of January 31, 2005 all deferred revenue related to the SpectroPharmÒ line of products from GSK was fully amortized by the Company. Beginning in 1990, we expanded on our knowledge and experience with selegiline by initiating directly on our own behalf, as well as through contract research arrangements, studies designed to investigate the potential of selegiline for companion animal use. This initiative ultimately resulted in the formation of our subsidiary DAHI, through which the Company developed and commercialized a companion animal health product, ANIPRYL®. ANIPRYL® is a selegiline product developed for use in veterinary prescriptive applications, particularly in dogs. The two indications for which ANIPRYL® is currently approved are canine Cushing’s disease and canine cognitive dysfunction syndrome (“CDS”). Cushing’s disease refers to increased blood cortisol and the presence of one or more typical clinical signs, such as change in appetite, obesity, frequent urination, abdominal distension, loss of hair, lethargy and other behavioral changes. Canine Cushing’s disease is the form of the disorder that is due to primary hyperfunction of the pituitary gland. CDS, sometimes known as “Old Dog Syndrome,” refers to the onset in elderly dogs of behavioral problems unrelated to a generalized medical condition such as neoplasia, infection or organ failure. Typical signs of this disorder can include confusion, disorientation, decreased activity, changes in sleep/wake cycles, loss of house training and loss of interest in or ability to interact with its owner and environment. From March 1991 to November 1996, DAHI’s common shares were publicly traded on NASDAQ. In November 1996, the Company took DAHI private in a mandatory share exchange transaction. In December 1997, we entered into an alliance with Pfizer whereby Pfizer was granted a perpetual exclusive license to market, sell and distribute ANIPRYL® in exchange for non-refundable fees, royalties based on the worldwide sales of ANIPRYL®, a manufacturing and supply agreement and a research collaboration. In December 1999, the Company and Pfizer amended the terms of the alliance (the “First Amendment”) whereby $9.0 million of potential additional non-refundable fees were eliminated in exchange for the Company receiving additional regulatory support for a potential new indication and additional manufacturing data. These potential additional non-refundable fees would have become 42 payable if Pfizer had exercised its rights to acquire product registrations following regulatory approval of ANIPRYL® in designated European countries. In April 2001, we received a payment of $1.5 million with respect to minimum royalty entitlements for the first three-year period ended December 31, 2000. In December 2001, the Company and Pfizer further amended the term of the alliance (the “Second Amendment”) whereby the Company received a payment of $3.1 million with respect to minimum royalty entitlements for the second and third three-year periods ended December 31, 2001 and 2002 and modifications to future royalty entitlements. The Second Amendment also resulted in all rights to ANIPRYL® outside of North America reverting back to the Company, forfeiture of any additional minimum royalty entitlements and the termination of any future collaborative research on new indications or formulations for ANIPRYL®. Cumulatively to December 31, 2006, we received a total of $28.1 million in non-refundable fees and $17.4 million in royalties and royalty-related payments relating to ANIPRYLÒ. Under the amended arrangement, we will not be entitled to receive any additional non-refundable fees but will continue to earn royalties on Pfizer’s sales of ANIPRYL® in the United States and Canada. The $28.1 million of non-refundable fees already received from Pfizer have been deferred and were recognized as revenue on a straight-line basis over the period to December 31, 2006 in conformity with Staff Accounting Bulletin No. 101 published by the U.S. Securities and Exchange Commission. The amortization of these deferred revenues terminated on December 31, 2006. We currently do not intend to pursue any additional or expanded indications for ANIPRYL®. ANIPRYL® is currently approved for sale in Canada, the United States, Australia, United Kingdom, New Zealand and Brazil. However, ANIPRYL® is not currently sold in Australia, New Zealand, the United Kingdom or Brazil. In 1997, DAHI filed for regulatory approval of ANIPRYL® in Europe by using the decentralized procedure. This procedure allows DAHI to file the ANIPRYL® submission in a country of its choice, and to designate five additional member states of the European Union as the countries that will review and approve the regulatory submissions. DAHI chose the United Kingdom as the country in which to file the initial ANIPRYL® applications. In July 2003, DAHI received authorization from the Veterinary Medicines Directorale (“VMD”) to market ANIPRYL® tablets for dogs in the United Kingdom. The United Kingdom submission has been reformatted in order to be suitable for submission to other European Union member states. The VMD has acted as DAHI’s advocate in this procedure. Sales and MarketingUnder the terms of the amended arrangement, Pfizer will continue to market and sell ANIPRYL® in the United States and Canada. In July 2003 DRAXIS granted Ceva Santé Animale S.A. (“CEVA”) an exclusive license for Europe for the marketing and distribution of ANIPRYL®. 43 ManufacturingDAHI’s primary supplier of selegiline for the production of ANIPRYL® is Chinoin Pharmaceutical and Chemical Works Co. Ltd (“Chinoin”). In 1995, DAHI developed the data required to qualify an alternative source of supply for selegiline, and the BVA and the FDA have accepted the data. Under its supply agreement with Pfizer, DAHI is entitled to designate a third-party supplier or to manufacture ANIPRYL® itself in a qualified facility. During 2000, Pfizer qualified one of its own facilities to manufacture ANIPRYL® for the North American marketplace. During 2000 and up to the second quarter of 2005, Pfizer manufactured ANIPRYL®. Since the second quarter of 2005, DRAXIS Pharma manufactures ANIPRYL® at its manufacturing facilities in Kirkland, Québec. CompetitionThe animal health marketplace is generally served by veterinary, agricultural or animal health divisions of large international pharmaceutical and chemical companies that are involved in research and development activities. Products resulting from their activities may, in the future, compete directly with ANIPRYL®. We are not aware of any other HPFBI, BVA or FDA approved product available at this time that competes directly with ANIPRYL®. In the United States, the 1988 generic animal drug law offers marketing protection from veterinary generic applicants in the United States for a period of five years. This period ended in 2002, in the case of ANIPRYL®. However, that law does not prevent other companies from repeating the full clinical New Drug Application process to seek FDA approval for a bio-equivalent product, nor does it prohibit human generic versions of ANIPRYL® from being sold to veterinarians. Any such competitor, including sellers of a human or veterinary generic selegiline, would be subject to DAHI’s U.S. and international patent rights. No significant competition for ANIPRYL® has been experienced to date in Canada or the United States from products approved for veterinary or human use. However, there are two other treatments available that have not been approved in Canada or the United States to treat canine Cushing’s disease, that we believe may be being used off-label for canine Cushing’s disease: LYSODREN® (mitotane) by Bristol-Myers Squibb Co., which was approved for use in the treatment of human inoperable cancer of the adrenal gland and NIZORAL® (ketoconazote) tablets by Johnson & Johnson, Inc., an anti-fungal medication, which was approved for the treatment of various internal and external fungal and yeast infection in humans. These competitive treatments work by selectively killing the outer layer of the adrenal gland, thereby limiting production of corticosteroid. The human generic version of ELDEPRYL® is not approved for the treatment of canine Cushing’s disease or CDS in Canada, the United States or elsewhere. However, we believe that such use of human selegiline may compete with the use of ANIPRYL® in dogs. The dosage required for dogs suffering from canine Cushing’s disease and CDS, in most cases, is much higher than the human 5mg dose for selegiline. Patents for the use of ANIPRYL® for the treatment of dogs with conditions including canine Cushing’s disease and CDS are issued in Canada, the United States and other jurisdictions. We believe DAHI is positioned to enforce its proprietary patent rights and defend itself against infringement by other parties. 44 PatentsIn September 1992, the United States Patent and Trademark Office issued a patent to DAHI entitled “Use of l-deprenyl for Retention of Specific Physiological Function.” The patent claims specific uses of l-deprenyl for use in treating dogs and covers currently sold products. Similar patents have also issued to DAHI in many foreign jurisdictions, including Canada, New Zealand, Venezuela and Europe. Six additional U.S. patents have also issued to DAHI. These patents cover various veterinary pharmaceutical uses of l-deprenyl such as treatment of Cushing’s Disease, weight loss, treatment of immune system dysfunction, extension of life expectancy of dogs, and treatment of hearing loss. Four of these six patents were also filed in foreign countries that have major companion animal markets. The markets for the cognitive disease patents are Canada, U.S., Europe, Japan, Mexico, Venezuela, New Zealand and Malaysia. The markets for the Cushing’s Disease patent are Europe, Canada and the U.S. The markets for the survival cure shifting patent are Canada, Norway, Finland and Europe. The markets for the treatment of hearing loss patent are Japan and Canada. The patents held by DAHI have expiry dates ranging from August 31, 2010 to June 3, 2016. The European CDS patent was subject to an opposition procedure initiated by Ceva. Ceva holds patents in the United States, Canada and Europe relating to the use of selegiline for treating behavioral disorders with change of mood in dogs and cats. Ceva’s European patent was subject to an opposition procedure by DAHI. In July 2003, DRAXIS and Ceva agreed to discontinue the opposition proceedings between them before the EPO. DRAXIS also granted Ceva an exclusive license for Europe for the marketing and distribution of ANIPRYL® or the use of ANIPRYL® claims. In return, Ceva agreed to pay DAHI a percentage royalty on European sales of ANIPRYL® and/or the use of ANIPRYL® claims, in addition to nominal milestone payments upon the regulatory approval of ANIPRYL® in the UK and in subsequent additional jurisdictions within the European Community. The agreement also gave DAHI the rights to use Chinoin selegiline in any jurisdiction. SpectroPharm® Product Line In May 2000, we entered into an arrangement with Block Drug Company (Canada) Limited, now part of GlaxoSmithKline Consumer Healthcare, with respect to the SpectroPharm® line of non-prescription dermatology products, which included the sale of product rights by the Company in exchange for a non-refundable fee, the acquisition of inventory on hand, a supply agreement and a technical services arrangement. The $9 million we received with respect to the SpectroPharm® product rights was deferred and was recognized as revenue on a straight-line basis over the period to January 31, 2005. As of January 31, 2005, all deferred revenue related to the SpectroPharmÒ line of products was fully amortized. Discontinued Operations (DRAXIS Pharmaceutica)In July 2003, we completed the divestiture of our Canadian pharmaceutical sales and marketing division, DRAXIS Pharmaceutica, with the sale to Shire of substantially all remaining products of the division, including the Canadian product rights for Alertec®, Diastat®, Hectorol®, Permax® and Zanaflex®. Shire agreed to pay DRAXIS through a combination of cash and contingent milestone payments plus royalties on future product sales. We have received $9.6 million in cash from Shire and could receive up to an additional $2.9 million in market-driven contingent milestones over the next several years. In addition, Shire assumed responsibility for the financial provisions of the license agreement related to Permax®. This transaction is in addition to the $6.5 million received by DRAXIS in March 2003 from affiliates of Elan for the return of Canadian rights for several of Elan’s neurology products that had not achieved regulatory approval in Canada. 45 Government RegulationOur business is governed by a variety of industry-specific statutes and regulations in Canada, the United States and other countries. DRUGS Drug Approval ProcessHuman PharmaceuticalsIn Canada, pharmaceutical research, development and marketing activities are regulated by the Food and Drugs Act (Canada) and the rules, regulations, policies and guidelines made thereunder. The Food and Drugs Act (Canada) is administered by the Therapeutic Products Directorate of the Health Products and Food Branch (“TPD”), which regulates the use and sale of diagnostic and therapeutic products in Canada. In the United States, these activities are regulated under laws administered by the Food and Drug Administration (“FDA”), which also have a significant impact on the Company’s activities. The drug research and development process consists of both pre-clinical and clinical phases. The pre-clinical phase consists of screening compounds to identify the most promising leads for continued drug development prior to human clinical trials and evaluating the drug’s toxic and pharmacologic effects to show that the drug is reasonably safe for use in the initial clinical studies. The clinical phase involves clinical trials with healthy participants, as well as patients with specific diseases or conditions. Before commencing clinical trials in Canada or the United States, a Clinical Trial Application (“CTA”) must be submitted with the TPD (in the United States an Investigational New Drug (“IND”) application must be submitted with the FDA). The CTA or IND application includes manufacturing data, pre-clinical data, information about use of the drug in humans for other purposes and a detailed protocol for the conduct of clinical trials. In Canada and the United States, clinical trials of new pharmaceutical products involve three phases. In Phase I, the product’s safety is assessed during clinical trials involving a limited number of healthy volunteers or patients. In Phase II, the product’s efficacy, dosage and safety are tested on a small number of patients with a known disease. In Phase III, controlled clinical trials are conducted in which the product is administered to a larger number of patients with a known disease, and further information relating to safety and efficacy is gathered. Further, in Phase III, the effectiveness of the product is, in certain cases, compared to that of accepted methods of treatment. If clinical studies establish that the product has value, an applicant files a New Drug Submission with the TPD (or a New Drug Application, or Product License Application or Biologic License Application (for biological products) with the FDA) to obtain marketing approval for the product. The New Drug Submission/New Drug Application/Product License Application/Biologic License Application includes a comprehensive summary and analysis of the results of the clinical trials, information relating to proposed labeling and packaging materials, and data relating to the proposed manufacturing and quality control procedures. If the New Drug Submission/New Drug Application/Product License Application/Biologic License Application is found to be satisfactory, a marketing authorization is issued (in Canada, the TPD issues a Notice of Compliance). The process of completing clinical trials and obtaining regulatory approvals for a new drug will, in general, take a number of years and require the expenditure of substantial resources. Once a New Drug Application/New Drug Submission or Product License Application/Biologic License Application is submitted, there can be no assurance that the TPD or FDA will review and approve the application in a 46 timely manner. In certain limited circumstances, the TPD will permit a New Drug Submission to be subject to a priority review. The TPD’s Priority Review Process allows for a faster review to make available promising drug products for a serious, life-threatening or severely debilitating illness or condition for which there is substantial evidence of clinical effectiveness that the drug provides: (i) effective treatment, prevention or diagnosis of a disease or condition for which no drug is presently marketed in Canada; or (ii) a significant increase in efficacy and/or significant decrease in risk such that the overall benefit/risk profile is improved over existing therapies, preventatives or diagnostic agents for a disease or condition that is not adequately managed by a drug marketed in Canada. Even after initial approval has been obtained, further studies, including post-marketing studies, may be required to provide additional data on safety necessary to gain approval for the use of the product as a treatment for clinical indications other than those for which the product was initially tested. The TPD and FDA may also require post-marketing surveillance programs in order to monitor long-term risks and benefits of the drug, to study different dosages or evaluate different safety and efficacy parameters. Results of post-marketing studies may limit or expand the further marketing of products. A serious safety or effectiveness problem involving an approved new drug may result in TPD or FDA action requiring withdrawal of the product from the market and possible civil action. The Special Access Program of the TPD provides practitioners with access to pharmaceutical, biologic and radiopharmaceutical products that are not yet approved for sale in Canada to treat patients with serious or life-threatening illness or conditions when conventional therapies have failed, are unsuitable or unavailable. The FDA administers a similar program in the United States to treat patients with immediately life-threatening diseases. Outside of Canada and the United States, the regulatory approval process for the manufacture and sale of pharmaceuticals varies from country to country, and the time required may be longer or shorter than that required for TPD or FDA approval. To the extent it chooses to explore foreign markets, the Company may rely on foreign licensees to obtain regulatory approval for marketing its products in foreign countries. Veterinary PharmaceuticalsIn Canada, the drug approval process for veterinary pharmaceuticals is similar to the process for obtaining approvals for human pharmaceuticals. To receive regulatory approval, a new animal drug must successfully complete a number of developmental phases which include the establishment of safety and efficacy in target species, establishment of manufacturing procedures and the conduct of controlled clinical trials in which the drug is administered to a large number of animals in order to gather further information relating to safety and efficacy. Following the completion of clinical trials, an applicant files a New Drug Submission to the Veterinary Drugs Directorate. Drug MarketingHuman PharmaceuticalsPrescription drug products generally are made known to healthcare professionals through advertisements and visits to such professionals, known as “detailing.” In Canada, unlike the United States, product-specific advertising to the general public is generally not permitted, subjected to very limited exceptions. 47 An increasing percentage of sales of prescription pharmaceuticals relates to sales of products which are paid for, in whole or in part, by government or private insurance drug plans. In many jurisdictions, governments have established regimes to control drug pricing at the retail pharmacy level. Most Canadian provinces have implemented drug benefit formularies. A formulary lists the drugs for which a provincial government will reimburse qualifying persons and the prices at which those drugs will be reimbursed. Although there is not complete uniformity among provinces, generally speaking, provincial governments will reimburse an amount equal to the lowest available price of the generic versions of any drug listed on the provincial formulary. The legislative regimes of most provinces also permit generic drug substitution, even for patients who do not qualify for government reimbursement. The effect of these initiatives is to encourage the sale of lower-priced generic versions of pharmaceutical products. In the United States, beginning in 2006, Medicare beneficiaries will be offered a prescription drug benefit. Medicare will contract with at least two risk-bearing drug plans in each of 34 regions to provide the new benefit. The prescription drug plans will cover at least two drugs in each therapeutic class or category of covered drugs, but may establish formularies and tiered-cost amounts. The prescription drug plans may limit their coverage to two drugs in each therapeutic class or category of covered drugs. The effect of this new program will allow prescription drug plans to negotiate price discounts and rebates with drug companies. Furthermore, there have been, and the Company expects that there will continue to be, an increasing number of proposals to implement government and other third-party payer restrictions on the pricing of prescription pharmaceuticals as a result of continuing efforts to contain or reduce the costs of healthcare throughout North America. See Item 3: Key Information - Risk Factors. Notably, in Canada, the Patented Medicines Prices Review Board (“PMPRB”) sets the maximum price that can be charged for a patented drug (see discussion below on Patent Protection and Price Controls). Veterinary PharmaceuticalsIn Canada, veterinary “prescription” pharmaceuticals are available only through veterinarians. Veterinary prescription drugs are generally promoted by manufacturers through advertisements to veterinarians and sales visits to animal health clinics. In Canada, unlike the United States, product-specific advertising to the general public is generally not permitted, subjected to very limited exceptions. The PMPRB has the jurisdiction to regulate maximum pricing of veterinary drugs (see below). There are no government reimbursement plans in the veterinary pharmaceutical marketplace. There are a few private pet insurance plans; however, these plans do not cover a significant portion of the purchase for veterinary drugs. Accordingly, the veterinary marketplace is not subject to the same cost containment measures that are prevalent in the human pharmaceutical market. Patent Protection and Price ControlsCompanies that have invented human or veterinary drugs can apply for patent protection virtually worldwide, subject to strict rules relating to timing, subject matter and the scope of protection sought. Patents can cover many aspects of a pharmaceutical product, including the drug itself, processes for preparing the drug, delivery systems and new uses for the drug. Patents do not, however, guarantee that the owner of the patent or its licensee can utilize the patented invention because there may be pre-existing patent rights owned by a third party. While a patent permits the owner or its licensee to prevent others from doing what is covered by the patent, competitors are always free to market products that do not infringe the particular patent, provided such competitors otherwise comply with health regulatory requirements. 48 Historically, pharmaceutical companies have relied heavily upon patents to protect proprietary positions in respect of drug products. The Company’s policy is to protect its technology, inventions and improvements by, among other things, filing patent applications for technology it considers important to the development of its business. The Company also relies upon trade secrets, know-how and licensing opportunities to develop and maintain its competitive position. Under United States patent law, a patent is issued to the person who made the invention first, rather than to the first person to file an application therefor, as is common in other countries, such as Canada. Consequently, in determining who is entitled to a United States patent for a particular technology, it is important to consider that it is possible for an inventor to establish an entitlement based on a prior invention, notwithstanding an earlier filed patent application. Prior invention may not be established before December 8, 1993, in a NAFTA country other than the United States, or before January 1, 1996, in a WTO member country other than a NAFTA country. Remedies for patent infringement are created under the laws of Canada and the United States. In addition to the standard legal action for patent infringement, in 1993, the Canadian Government enacted Regulations under the Patent Act (Canada) whereby a company proposing a generic version for a drug which has been marketed in Canada under a Notice of Compliance and in respect of which patents have been listed on the Patent Register, must address those patents before a Notice of Compliance may be granted. The originator of the drug may apply to the Federal Court of Canada for an order prohibiting the Minister of National Health and Welfare from issuing a Notice of Compliance until the issue of possible patent infringement has been resolved. Similar proceedings are available in the United States if a generic drug manufacturer seeks approval for a drug in respect of which patents have been listed in the Orange Book (the United States equivalent of the Patent Register). As mentioned above, in Canada, the PMPRB monitors and controls prices of drug products marketed in Canada by persons holding, or licensed under, one or more patents relating to those drug products. The PMPRB approves the introductory price of a drug product (based on a comparative analysis) and requires that subsequent price increases do not exceed the annual increase of the Canadian Consumer Price Index. Thus, in Canada, 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 which significantly impacts on the Canadian pharmaceutical industry’s ability to set pricing. Drug ManufacturingPharmaceutical companies are required to submit as part of their New Drug Submission in Canada, or as part of their New Drug Application in the United States, detailed descriptions regarding the proposed manufacturing and packaging process and the identities of the manufacturers in respect of a particular drug. A decision to manufacture or package products in a facility other than that originally approved under the New Drug Application or New Drug Submission (as may be the case with contract manufacturing outsourcing) requires notification of the regulatory authorities and can result in significant delays in production. Pharmaceutical manufacturing facilities are subject to strict quality control standards including current good manufacturing practices (“cGMPs”). Production processes within a facility are subject to one-time validation testing, as well as periodic review. In the case of sterile product manufacturing, including lyophilized products, the standards are even higher than for the manufacturing of non sterile products. The manufacture of radioactive drugs is subject not only to cGMPs but also the environmental safety, handling and transportation requirements of the Canadian Nuclear Safety Commission (“CNSC”) and the United States Nuclear Regulatory Commission (“NRC”). There are no issues with respect to 49 radioactive waste disposal since all of the isotopes used in nuclear medicine are short-lived and can be easily stored on site until decayed and then disposed of. The FDA, HPFBI, CNSC and NRC conduct regular audits of the Company’s facilities to ensure compliance with cGMPs and other statutory requirements. See Item 3: Key Information - Risk Factors. ENVIRONMENTAL LAWS Canadian and U.S. federal, state, local and provincial regulations govern extensively the use, manufacture, storage, handling, transport and disposal of hazardous materials and associated waste products. The Company is not aware of any material environmental issues that affect the Company’s utilization of its assets. As of December 31, 2006, the Company has not received any notice stating that it is not in compliance with environmental legislation applicable to it. 50 ORGANIZATIONAL STRUCTURE The following chart illustrates the corporate organization and jurisdictions of the Company and its significant affiliates as at March 30, 2007. All of the below-depicted companies are wholly owned subsidiaries of DRAXIS Health Inc.
(1) DRAXIS Specialty Pharmaceuticals Inc. has two divisions, DRAXIMAGE (radiopharmaceuticals) and DRAXIS Pharma (contract manufacturing). PROPERTY, PLANTS AND EQUIPMENT Our sole operating facility is a 247,000-square-foot pharmaceutical manufacturing facility which houses the DRAXIMAGE and DRAXIS Pharma operations. The facility is owned by DRAXIS Specialty Pharmaceuticals Inc., a wholly-owned subsidiary of the Company and is located at 16751 Trans-Canada Road, Kirkland, Québec, Canada, H9H 4J4. See “Risk Factors — Risks Related to our Company — Our Manufacturing Operations are Concentrated in One Location”. Factors beyond our control could cause an interruption in our manufacturing operations, which could adversely affect our reputation in the market place and our results of operations”. 51 We believe that the above-noted property is suitable and adequate for its business purposes as presently contemplated. We have an undrawn credit line issued by our principal bankers, the National Bank of Canada who have a first ranking mortgage on all of our assets. However, as of March 30, 2007, we had no third-party debt outstanding. Item 4A Unresolved Staff Comments None. Item 5. Operating and Financial Review and Prospects The following discussion and analysis of the financial condition and results of operations of DRAXIS Health Inc. (the “Company”) should be read in conjunction with the Company’s audited consolidated financial statements for the referenced periods and notes thereto. All amounts referred to herein are expressed in U.S. dollars and are in accordance with U.S. generally accepted accounting principles (“GAAP”), unless otherwise indicated. Other noteworthy accounting issues are discussed under “Accounting Matters”. Readers are cautioned not to place undue reliance on forward-looking statements contained in the following Operating and Financial Review and Prospects since actual results could differ materially from what we expect if known or unknown risks affect our business or if an estimate or assumption turns out to be inaccurate. Unless otherwise required by applicable securities laws, the Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. See “Forward-Looking Statements” on page 78 hereof. The discussion and analysis contained in the following Operating and Financial Review of Prospects are as of February 23, 2007. Overview DRAXIS is a specialty pharmaceutical company providing pharmaceutical products in three major categories: sterile, including sterile lyophilized (freeze-dried) pharmaceuticals; non-sterile specialty pharmaceuticals, and radiopharmaceuticals. In the radiopharmaceutical category, DRAXIS has its own products and a targeted research and development (“R&D”) program for new and/or improved products. The Company is increasingly focusing on the use of GAAP measures both in reporting externally and monitoring management performance. Specifically, the key metrics the Company uses to evaluate divisional and consolidated performance are gross profit margin, operating income, net income and operating cash flow. Non-GAAP financial measures, specifically EBITDA, will continue to be disclosed to provide a comparative link between our historical disclosures as the Company transitions to more traditional GAAP measures. The Company will continue to reconcile any non-GAAP financial measures used with GAAP line items. The Company additionally uses, as a performance measure, cash flows from operating activities less cash flows used in investing activities. Termination of Amortization of Anipryl® Deferred Revenues As indicated in prior disclosures, substantially all deferred revenues related to the amortization of previously received Anipryl® milestones terminated on December 31, 2006. The amortization of these deferred revenues has previously resulted in non-cash revenues of $0.8 million per quarter, which has contributed approximately 7 cents of earnings per share (“EPS”) per full year. The termination of this 52 source of non-cash revenue and operating income has no effect on cash flows but will affect year-over-year comparisons of operating results going forward (see Corporate and Other and Outlook). 2006 Financial Results The Company successfully achieved and surpassed its 2006 financial targets for both EPS and net operating cash flows. Specifically with respect to EPS, the Company achieved 28 cents per share for 2006 (or 21 cents excluding the amortization to income of Anipryl® deferred revenues), which is 9 cents per share stronger compared to the same period of 2005 despite the following factors: · During 2005, the Company benefited from a contingent milestone payment from Shire BioChem Inc. (“Shire”), which contributed approximately 1.4 cents to EPS for 2005. · Effective January 1, 2006, the Company has included stock-based compensation costs in selling, general and administration (“SG&A”) expenses as a non-cash item. This had the effect of lowering EPS by 2.3 cents for 2006 relative to 2005. Operating income for 2006 was $15.0 million, up 53% from $9.8 million in 2005. Net cash flows from operating activities were $16.5 million for 2006 compared to $9.7 million for 2005. 53 CONSOLIDATED RESULTS OF OPERATIONS AND RECONCILIATION OF NON-GAAP FINANCIAL MEASURES (in thousands of U.S. dollars, except share related data) (U.S. GAAP)
(1) Income from continuing operations before depreciation and amortization, financial income (expense), foreign exchange gain (loss), other income, income taxes and minority interest. This earnings measure does not have a standardized meaning prescribed by U.S. GAAP and therefore may not be comparable to similar measures used by other companies. Such measures should not be construed as the equivalent of net cash flows from operating activities (see “Accounting Matters — Non-GAAP Financial Measures”). 54 The following provides a high level overview of the consolidated results of the Company. Please refer to the segmented results for more detailed explanations. Comparison of Years Ended December 31, 2006 and 2005 The financial results for the year ended December 31, 2005 were negatively affected by the extended shutdown period that occurred in the sterile products area of the Company’s contract manufacturing. Accordingly, all comparative variances on a consolidated basis and in the contract manufacturing section reflect the impact of the extended shutdown in 2005. Consolidated revenues for the year ended December 31, 2006 are 12% higher compared to 2005. Consolidated product sales have grown by $11 million, or 15%, for the year ended December 31, 2006 compared to 2005, driven by lyophilization revenue (sterile products) in contract manufacturing and Sodium Iodide I-131 sales in the radiopharmaceutical business. (see the Contract Manufacturing segment discussion below). Radiopharmaceutical product sales grew 12% driven by radioiodine sales in the U.S. including diagnostic capsules which were introduced in the U.S. market place in the second quarter of 2006. Consolidated product gross margin percentages for the year ended December 31, 2006 increased to 44% as compared with 36% for 2005. The increase reflects a better mix of higher margin business in both operating segments, especially sterile product volume in contract manufacturing. Royalty and licensing revenue decreased for the year ended December 31, 2006 compared with 2005. The decrease in royalty and licensing revenue for the year ended December 31, 2006 compared to 2005 reflects the receipt of a $0.9 million contingent milestone payment from Shire in 2005. As a percentage of product sales, SG&A expenses were 23% for the year ended December 31, 2006 compared to 22% for 2005. The 20% increase in SG&A expenses in absolute dollar terms (excluding the impact of foreign currency translation) for the year ended December 31, 2006 as compared with 2005 was driven by the inclusion of non-cash stock-based compensation costs beginning January 1, 2006 coupled with increased incentive plan accruals based on the Company’s financial performance for 2006 relative to 2005. The impact of the strengthening of the Canadian dollar for much of 2006 relative to 2005 increased the nominal value of SG&A expenses for 2006 relative to 2005. R&D expenditures increased slightly for the year ended December 31, 2006 compared to 2005 due to the work related to specific phases of the Company’s development activities related to Sestamibi and the “next-generation” Technetium Generators as the Company completed stages of activities with respect to both initiatives late in 2006. These products are described in the Radiopharmaceuticals section. Depreciation and amortization expense for the year ended December 31, 2006 increased by 13% over 2005 following the commencement of depreciation charges on the Company’s contract manufacturing capital upgrades. The majority of the costs of the Canadian operations are denominated in Canadian dollars. As the level of revenues denominated in U.S. dollars and other foreign currencies increases relative to the underlying cost structure, the Company’s overall gross profit margins and SG&A expenses are affected. The impact is not material on the overall financial performance for the year. The net foreign exchange gain for the year ended December 31, 2006 was $282,000 compared to a loss of $398,000 for 2005. As a result of the impact of the weakening of the Canadian dollar late in 2006, a foreign exchange gain was earned on U.S. dollar denominated monetary items in 2006, whereas the strengthening of the Canadian dollar late in 2005 created a foreign exchange loss. 55 Net financial income for 2006 was $347,000 compared to an expense of $29,000 in 2005 due to significant interest income generated from surplus cash. For the year ended December 31, 2006, the Company recorded an income tax expense, expressed as a percentage of pre-tax earnings of 26%. The Company’s effective tax rate will vary from the statutory tax rate depending on the mix of income combined with the statutory rates in the respective jurisdictions in which the Company operates. The level of tax credits generated from R&D activities in the radiopharmaceutical business also has the impact of lowering effective tax rates. Benefits related to loss carryforwards not previously recognized were not material in 2006 compared to 2005. The effective tax rate for 2006 was higher than in 2005 due to a one-time adjustment to revalue the Company’s income tax assets to a lower rate following the enactment of a statutory rate change to Canadian federal taxes in the second quarter of 2006. The basic weighted average number of common shares outstanding during 2006 was 41,592,507 and increased from 41,471,798 for 2005, primarily as a result of the exercise of stock options offset by the shares purchased for cancellation under the Company’s Normal Course Issuer Bid. Comparison of Years Ended December 31, 2005 and 2004 Consolidated revenues of $79.4 million for the year ended December 31, 2005 represented an increase of 15% compared with 2004. Product sales increased 18% or $11.3 million for the year ended December 31, 2005 compared to 2004. The increase related to continued growth in contract manufacturing revenues, specifically sterile operations, coupled with growth in the radiopharmaceutical segment and specifically Sodium Iodide I-131 sales to the U.S. The growth in contract manufacturing was restrained during the second half of 2005 as a result of the extended shutdown period in contract manufacturing. Product gross margin percentages for the year ended December 31, 2005 were similar compared to 2004. While overall volumes increased, the business mix shifted from the higher margin radiopharmaceutical business to the relatively lower margin contract manufacturing businesses. Furthermore, as a result of the extended shutdown period in contract manufacturing, unabsorbed fixed manufacturing costs and the cost of unused capacity related to reduced production had a negative impact on margins for the second half of 2005. Since increased revenues related to growth in the sterile contract manufacturing operations and sterile product margins generally are lower than radiopharmaceutical margins, the overall result is that the increased volumes do not result in an overall increase to consolidated gross profit margins. Accordingly, the Company believes that product gross margins are best reviewed at the segmental level. Absolute product gross margins increased for the year ended December 31, 2005 relative to 2004 as a result of a stronger Canadian dollar and its positive impact on margins for products priced in Canadian dollars. However, the impact is largely offset by the increase in SG&A costs strictly related to foreign currency translation. Since almost all SG&A expenses are incurred in Canadian dollars, the strengthening of the Canadian dollar beginning in early 2004 has resulted in an increase in SG&A expenses in 2005 relative to 2004. Changes to foreign exchange rates did not, however, have a material impact on product gross margin percentages or net income. For the year ended December 31, 2005 compared with 2004, royalty and license revenues decreased 16%; however, the impact of the completion of the amortization of the deferred revenue related to the SpectroPharm product line as of January 31, 2005 was partially offset by the receipt of $0.9 million in contingent milestones from Shire, which the Company earned in the first quarter of 2005. In absolute dollar terms, the increase in SG&A expenses was 22% for the year ended December 31, 2005 (or 14% excluding foreign currency fluctuations) over 2004. Excluding the impact of foreign currency reporting as described below, the increase in SG&A expenses was due to the one-time costs related to the 56 Company’s exiting the BrachySeed® product line, severance costs related to the Company’s initial steps taken to reduce its overhead cost structure and process improvement initiatives focused in contract manufacturing. Approximately $1.1 million of the increase in SG&A spending for the year ended December 31, 2005 relative to 2004 was a consequence of increased costs in Canadian dollars relative to U.S. dollars as a result of the strengthening of the Canadian dollar beginning in early 2004. This resulted from virtually all SG&A costs being denominated in Canadian dollars. For the year ended December 31, 2005, R&D costs increased 8% relative to 2004 due to activities related to FIBRIMAGE® and INFECTON®. The increased expenditures were primarily attributable to clinical trial activities for INFECTON®, coupled with costs associated with the detailed review of FIBRIMAGE® Canadian Phase III results and the assessment of optimal Phase III protocols for the U.S. by the expert medical advisory panel assembled by the Company. Depreciation and amortization expenses for the year ended December 31, 2005 increased 1% over 2004 following the completion of the installation and the validation of the Company’s second lyophilization unit. This expense was offset by the completion of amortization of intangibles related to the SpectroPharm product line. For the years ended 2004 and 2005, the impact of foreign exchange on the Company’s results was similar due to the strengthening of the Canadian dollar over those two years. Interest expense and bank charges decreased for the year 2005 compared to 2004 due to repayment of third party debt at the end of 2004. The effective tax rate for the year ended December 31, 2005 was 17%, or 24% excluding the benefits of R&D tax credits. The Company benefited during 2005 from statutory tax rate changes that increased the value of the Company’s loss carryforwards and from tax credits related to R&D spending. During 2005 the Company further benefited by approximately $400,000 through recognition of the lower effective statutory tax rate attributable to milestone payments received and through withholding tax refunds received in the quarter but not previously estimated to be recoverable. The Company’s effective tax rate will vary from the statutory tax rate depending on the mix of net income and the statutory rates in the respective jurisdictions in which the Company operates. The level of tax credits generated from R&D activities in the radiopharmaceutical business also had the impact of lowering effective tax rates by $642,000 for 2005. The basic weighted-average number of common shares outstanding during 2005 was 41,471,798 and increased from 39,886,219 in 2004 due mainly to the exercise of stock options. 57 RADIOPHARMACEUTICALS (in thousands of U.S. dollars) (U.S. GAAP)
(1) See “Accounting Matters — Non-GAAP Financial Measures.” Nuclear medicine imaging and therapeutic agents are the focus of the Company’s radiopharmaceutical division, DRAXIMAGE, which develops, manufactures and markets diagnostic imaging and therapeutic radiopharmaceutical products for the global marketplace. Products currently marketed by DRAXIMAGE include a line of lyophilized Technetium-99m (“TC-99m”) kits used in nuclear medicine imaging procedures and a line of imaging and therapeutic products labelled with a variety of isotopes including Sodium Iodide I-131. DRAXIMAGE has a number of products in late-stage development including a generic Sestamibi injection (for which the Company filed an Abbreviated New Drug Approval (“ANDA”) with the U.S. Food and Drug Administration (“FDA”) in February 2007), a lyophilized product that is widely used for Technetium-based cardiac imaging studies, a “next-generation” version of a Technetium Generator, and INFECTON®, for imaging infection. Comparison of Years Ended December 31, 2006 and 2005 Revenues for the year ended December 31, 2006 increased by 11% (or close to 20% excluding brachytherapy products, which the Company stopped selling late in 2005) compared to 2005 primarily as a result of the increase in product sales from radioiodine products and, specifically, Sodium Iodide I-131 sales to the U.S. , including diagnostic capsules. The increase is related to higher volumes resulting from greater U.S. market penetration. On January 13, 2006, the Company received approval from the FDA regarding its supplemental new drug application for Sodium Iodide I-131 Capsules USP, Diagnostic-Oral. These diagnostic Sodium Iodide I-131 capsules are intended to be used by physicians to perform radioactive iodide uptake tests to evaluate thyroid function prior to treatment with stronger therapeutic doses of Sodium Iodide I-131. The Company introduced the new diagnostic capsules into the U.S. marketplace during the second quarter of 2006 to qualified/approved nuclear physicians and/or radiopharmacists. For the year ended December 31, 2006 product gross margin increased to 63% for the year ended December 31, 2006 compared to 2005, reflecting the positive impact of Sodium Iodide I-131 sales and the strategic focus on higher margin products that led to the divestment of the brachytherapy product line in late 2005. R&D expenditures for the year ended December 31, 2006 as compared to 2005 increased 13% due to the ramping up of product development activities, in particular activities related to Sestamibi and Technetium Generators (see below). 58 SG&A expenses decreased by $0.3 million for the year ended December 31, 2006 compared to 2005 due mainly to one-time costs relating to the Company’s exit from the brachytherapy business during the fourth quarter of 2005. Operating income increased 47% to $5.6 million for 2006 as compared to 2005 driven by increased volumes and margins as described above. Depreciation and amortization expense for this segment was relatively unchanged in nominal dollars in 2006 compared to the year ended December 31, 2005. Radiopharmaceutical Product Development Strategy On March 27, 2006 the Company announced that it had realigned its priorities for the R&D of new radiopharmaceutical products that it believes will drive future growth. Priorities for product development were established based on several factors, including time to market, customer needs, size of target markets, cost of development and expected regulatory challenges for the various opportunities. The Company believes that this realignment will be the significant driver for material growth in the radiopharmaceutical segment. DRAXIMAGE is now focused on developing products that it believes will replace or improve upon several products that are currently in the nuclear medicine marketplace, but that have or will have ceased to be protected by patents in key markets in the near term. The following summarizes the status of current significant initiatives: DRAXIMAGE® Sestamibi As announced on February 2, 2007, DRAXIMAGE submitted an ANDA to the FDA for its generic kit for the preparation of Tc-99m Sestamibi for injection (“DRAXIMAGE® Sestamibi”), a nuclear medicine imaging agent used in myocardial perfusion imaging (“MPI”) to evaluate blood flow to the heart in patients undergoing cardiac tests. According to AMR/Arlington Medical Resources, in 2005 there were more than 7 million cardiac studies conducted in the U.S. out of a total of over 15 million nuclear medicine procedures, making MPI the most widely performed nuclear medicine scan. Recent market research indicates that existing MPI products generate revenues in excess of $500 million annually in the U.S. and that the imaging agent most often used in conducting MPI procedures is Sestamibi labelled with the radioactive isotope Tc-99m. The filing of the ANDA with the FDA represented the achievement of a key milestone in the DRAXIMAGE® Sestamibi project schedule. Technetium Generators A second opportunity that is currently being pursued by DRAXIMAGE is the production and distribution of a “next-generation” version of a Technetium Generator, which is the source of Technetium in virtually every radiopharmacy worldwide. Nearly 90% of generators are located in radiopharmacies and the rest are in other institutions, such as hospitals and clinics. DRAXIMAGE is in discussion with potential development, marketing and distribution partners for this project. Prototype versions of our “next-generation” Technetium Generator have been built and are undergoing evaluation. The feedback from our evaluation will help drive the product development process. European Entry DRAXIMAGE is continuing its efforts to obtain registrations in European markets for four of its existing products that are currently approved and sold in Canada or the U.S. In February 2005, DRAXIMAGE received approval from the Dutch regulatory authority for its Kit for the Preparation of Technetium Tc-99m Albumin Aggregated Injection (“MAA Kit”). Initial approval in the Netherlands allowed DRAXIMAGE to initiate the Mutual Recognition Procedure (“MRP”) in pursuit of further regulatory approvals for this product in several additional European Union countries. 59 Additional initial European approvals for the majority of other diagnostic imaging products are anticipated to be received during 2007. DRAXIMAGE is in advanced discussions with a potential European based commercial partner to initially target the larger markets in Germany, France, Italy, Spain and the U.K. via a strategic alliance. The strategic alliance could also potentially serve as a means for DRAXIMAGE to expand its product catalogue in North America as well as in Europe. The Company expects to conclude such discussions during 2007. For the medium term, the key opportunity being pursued by DRAXIMAGE is the continued development of INFECTON®, a novel diagnostic radiopharmaceutical product for imaging infection. Three Phase II clinical trials were completed and a fourth was discontinued due to a change of market focus. Studies to define the target market population and appropriate clinical trial applications are now being used to guide preparations for further development studies. An expert panel, comprised of respected nuclear medicine specialists and microbiologists, was assembled and this expert panel reviewed the preliminary scientific and clinical data together with the outcome of the market research studies. The role of the expert panel was to assess the results to date, review potential target markets, and advise DRAXIMAGE on the design of future clinical studies and appropriate indications. The preliminary report of the expert panel recommended that the product be reformulated for orthopaedic-related indications and the assessment of such potential formulations is under way. Others DRAXIMAGE has also identified additional new product opportunities in the area of non-radioactive contrast media that are used in the medical imaging field and is pursuing potential product development strategies to leverage both its position in the marketplace and its preferred access to appropriate production process expertise. Contrast media products are injectable liquids produced in highly-specialized cGMP sterile production facilities, such as those in place at DRAXIS’ facilities that are currently used to produce certain diagnostic imaging products marketed by DRAXIMAGE. The North American market for contrast media has been estimated to be valued at approximately $1.6 billion and it is believed to be growing, driven largely by the continued growth of computer tomography (“CT”) and enhanced magnetic resonance imaging (“MRI”) procedures. DRAXIMAGE has received approval from the FDA to run two clinical trials using radioactive Iobenguane I-131 Injection (also known as “131I-metaiodobenzylguanidine”, or “I-131 MIBG”) to treat high risk neuroblastoma, a rare form of cancer that affects mostly infants and young children. DRAXIMAGE will provide I-131 MIBG for two clinical trials approved by the FDA under a recently submitted Investigational New Drug (“IND”) application. One trial is a Phase II study in which I-131 MIBG will be administered with intensive chemotherapy and autologous stem cell rescue for high risk neuroblastoma patients. The second trial is a Phase I study in which irinotecan and vincristine, two common chemotherapy agents, will be administered in combination with I-131 MIBG to determine safety and tolerability in patients with resistant/relapsed high risk neuroblastoma. Comparison of Years Ended December 31, 2005 and 2004 Revenues for the year ended December 31, 2005 increased 12% compared with 2004, primarily as a result of higher product sales from radioiodine products and, specifically, Sodium Iodide I-131 sales to the U.S. The increase was related to higher volumes resulting from greater U.S. market penetration. As described above, during the first quarter of 2005, the Company received approval from the Dutch regulatory authority for its Kit for the Preparation of Technetium Tc-99m Albumin Aggregated Injection (MAA Kit). Approval in the Netherlands allowed DRAXIMAGE to initiate the MRP in pursuit of further regulatory approvals for this diagnostic imaging product in additional European Union countries. This 60 approval was a key milestone in the strategic plan to introduce several additional DRAXIMAGE branded products into a number of European markets. For the year ended December 31, 2005, product gross margin was stronger compared to 2004 due to the increased market penetration of higher margined products like Sodium Iodide I-131coupled with the positive impact of the Company’s decision to exit the brachytherapy market. R&D expenditures increased slightly for the year ended December 31, 2005 as compared to 2004 due to the activities related to FIBRIMAGE® and INFECTON®. Specifically, the increased expenditures were mainly for clinical trial activities for INFECTON® coupled with costs associated with the ongoing detailed review of FIBRIMAGE® Canadian Phase III results and activities of the expert medical panel related to the strategy for the further product development and design and assessment of Phase III clinical trial protocols for the U.S. The report and recommendations of this expert panel were used to assess the strategy for further development of FIBRIMAGE® and design and assessment of Phase III clinical trial protocols for the U.S. No significant work related to FIBRIMAGE® took place following the recommendations of the expert panel in 2006. SG&A expenses increased for the year ended December 31, 2005 compared to 2004 mainly due to one-time costs relating to the Company’s exit from the brachytherapy market and costs of market research studies and activities. The Company incurred approximately $457,000 of one-time costs associated with the exit of the brachytherapy business during 2005. Over 60% of the costs incurred related to accrual of license termination costs related to the business and is included in SG&A expense. The remainder of the exit costs related to unused inventory components is included in cost of goods sold. The majority of capital equipment used in the BrachySeed® product line, specifically the robotic equipment, is being redeployed in both the radiopharmaceutical and contract manufacturing segments. Depreciation and amortization expense for this segment increased 10% for the year ended December 31, 2005 compared to 2004 due to the amortization of costs related to the upgrade of warehousing and shipping facilities completed late in 2004. 61 CONTRACT MANUFACTURING (in thousands of U.S. dollars) (U.S. GAAP)
(1) See “Accounting Matters — Non-GAAP Financial Measures.” Manufacturing comprises the Company’s manufacturing division, DRAXIS Pharma, which is a pharmaceutical contract manufacturer with capabilities in a broad range of dosage forms, specializing in liquid and lyophilized (freeze-dried) injectables and other sterile products. Operating out of a cGMP-compliant 247,000 square foot facility located in Montreal, Canada, DRAXIS Pharma manufactures certain pharmaceutical products (specifically, cold kits) for DRAXIMAGE, as well as for over 25 other pharmaceutical clients in many international jurisdictions. Comparison of Years Ended December 31, 2006 and 2005 As stated in prior disclosures, beginning in March 2006, production run rates in the sterile area were back at levels expected for the contract manufacturing operations prior to the shutdown issues of late 2005 and actually exceeded previous normalized levels in part due to the contribution of the second lyophilization unit, which came on line in 2005. The impact of the extended shutdown in 2005 also negatively affected results for the fourth quarter of 2005. Since the shutdown for 2006 was completed in the third quarter of 2006 as planned, fourth quarter results for 2006 as compared to 2005 are significantly stronger. For the year ended December 31, 2006, revenues increased by $10 million or 18% over 2005. The increase was due to increased commercial production of Hectorol® Injection for Genzyme Corporation (“Genzyme”), growth in GlaxoSmithKline (“GSK”) volumes and increases in lyophilized product production. For the year ended December 31, 2006, sterile volumes accounted for 80% of product revenues compared to 76% for 2005. Product gross margin percentage for the year ended December 31, 2006 increased to 36% compared to 27% for 2005, driven by a higher ratio of sterile to non-sterile product revenues and the dilutive impact of the extended shutdown on 2005 product gross margins. The extended shutdown period in 2005 negatively affected product gross margin percentage by at least 5% during the second half of 2005. For the year ended December 31, 2006, SG&A expenses rose by $1.4 million compared to 2005 as a result of incentive plan accruals, the provision for past due receivables and process improvement initiatives, including information system and technology initiatives. Historically, the Company has not incurred significant provisions for past due receivables. SG&A expenses are also inflated for the year ended December 31, 2006 by the strengthening of the Canadian dollar relative to the U.S. dollar for most of 2006 (relative to 2005), since the vast majority of SG&A expenses are denominated in Canadian dollars. 62 Depreciation and amortization for the year ended December 31, 2006 increased 19% over 2005, due principally to completed capital projects in 2005, which provided for increased lyophilization and autoclave capacity. Operating income for all of 2006 increased to $13 million (20% of revenues) compared to $6 million (12% of revenues) for 2005. The increase was driven by higher product sales and product gross margins, partially offset by higher SG&A expenses. While the Company’s success has been driven by its strategy to focus on higher margin sterile products, the Company also believes there is opportunity to benefit from the unused capacity in its non-sterile area. The Company is currently in the advanced stages of negotiations to secure significant new non-sterile business but has not yet concluded contractual arrangements for such business. It is difficult to predict when contractual arrangements will be finalized if the negotiations are successful as such arrangements can take months to negotiate and close. Disclosure of the nature of any contractual arrangements will be made upon signing of a definitive agreement. Comparison of Years Ended December 31, 2005 and 2004 The Company had originally planned to shut down its sterile operations in contract manufacturing for a period of two to three weeks for regular maintenance in the third quarter of 2005, as is its normal practice. Near the end of this planned shutdown, it became necessary to upgrade additional pieces of equipment in the sterile area, including in its lyophilized products area. This required further cleaning and validation of the facility’s sterile core, thus extending the planned shutdown period to approximately seven weeks. The Company took these significant measures as a result of its internal quality standards. However, as a result of having to recalibrate sterile production schedules based on discussions with clients, which continued into mid to late November 2005, the quality control process required for sterile products prior to shipment, and a delay in receiving component parts from a third party manufacturer in the fourth quarter of 2005, product sales in the second half of 2005 were negatively impacted relative to 2004. However, production levels in the sterile area returned to pre-shutdown levels by November 2005. Revenues for the year ended December 31, 2005 increased $8.3 million or 18% over 2004, even factoring in the negative impact of the extended shutdown. The increase was due to increased demand for the production of Hectorol® Injection for Genzyme and products under the Company’s GSK contract. GSK production rose throughout 2004 as GSK obtained regulatory approvals for products manufactured by the Company in additional foreign markets. Throughout 2004 and into 2005, the Company increased its output capacity through additional production shifts for its sterile business and intends to continue to do so as a result of increasing demand. Sterile products have accounted for all of the product sales growth on a year-to-date basis. Sterile products represented 76% of manufacturing revenues on a year-to-date basis in 2005 compared to 67% for 2004. The second lyophilization unit, which was fully installed and validated by early 2005, did not contribute a significant amount of incremental revenues in 2005 since much of the activity on the second lyophilizer was in support of meeting customer demand displaced from the third quarter of 2005 as a result of the extended shutdown period. The extended shutdown did, however, significantly slow the pace at which the Company was able to carry the normal commercial activities on its second lyophilization unit. This resulted from the focus being placed on ensuring that existing customer demand and requirements were met. Capacity was, accordingly, largely reserved for that purpose in the latter part of 2005. Product transfer and validation activities are necessary as a precursor to significant commercial volumes and do not create significant revenues, although they consume significant available capacity. Revenues from the second lyophilization unit increased beginning in 2006 and are expected to increase more significantly into 2007 since the Company refocused activities back to new product introductions and new contract negotiations in 2006. 63 Product gross margin percentage for the year ended December 31, 2005 increased to 27% from 25% compared to 2004. The increases were related to volume growth, principally of higher margin sterile products, that had taken place prior to the extended shutdown period. The volume growth was made possible by increasing the capacity for manufacturing sterile products through the introduction of additional production labour. Improved capacity utilization directly resulted in higher margins through substantially improved absorption of overhead costs. The extended shutdown in 2005 had the impact of lowering product gross margin percentage for the full year by between 2% to 4% and at least 5% over the final six months of 2005. Excluding the impact of foreign currency translation, the increase in SG&A expenses for the year ended 2005 compared to 2004 related to the investment in process improvement initiatives and severance costs of $250,000 related to steps taken to reduce the overhead cost structure in contract manufacturing. The Company has embarked on process improvement initiatives aimed at enhancing information systems and information technology to improve efficiency and productivity in the key processes of production planning, manufacturing and quality control product release. We believe the process improvement initiatives will, over time, increase throughput of volumes within the existing manufacturing footprint and thereby increase capacity. Furthermore, the Company expects to increase operating margins over time through the application of more efficient processes. Since virtually all SG&A costs are denominated in Canadian dollars and translated into U.S. dollars, the strengthening of the Canadian dollar beginning in early 2004 resulted in inflated SG&A costs upon translation into U.S. dollars of about $346,000 for the year ended December 31, 2005. These costs were offset by overall growth of absolute margins upon translating Canadian denominated sales into U.S. dollars. Depreciation and amortization increased 29% for the year ended December 31, 2005 over 2004, due principally to completed capital projects including additional autoclave capacity, and following the completion of the installation and validation of the Company’s second lyophilization unit in the second quarter of 2005. The Company announced on September 1, 2005 that it renewed its production outsourcing arrangement with Pfizer Canada Inc., Pfizer Consumer Healthcare division. The new three-year manufacturing agreement became effective as of January 1, 2005 and will allow the Company to continue to produce several non-prescription products as one of a select number of approved suppliers to Pfizer Consumer Healthcare Canada. On December 20, 2006 the Company was advised that Johnson & Johnson, Inc. had purchased Pfizer’s Consumer Healthcare business and that the agreement was assigned to Johnson & Johnson, Inc. 64 CORPORATE AND OTHER (in thousands of U.S. dollars) (U.S. GAAP)
(1) See “Accounting Matters — Non-GAAP Financial Measures.” The Corporate and Other segment comprises: amortization of deferred revenues, royalties and expenses associated with the Company’s business agreements with Pfizer Inc. with respect to Anipryl®; revenues related to royalties and milestones from Shire in connection with the divestiture of DRAXIS Pharmaceutica; non-allocated corporate expenses and intercompany eliminations. The Company follows a policy of not allocating its central corporate expenses to its operating business segments. Comparison of Years Ended December 31, 2006 and 2005 Corporate revenues for the year ended December 31, 2006 were $2.7 million lower compared to 2005 due to the receipt of a contingent milestone payment of $0.9 million from Shire included in 2005 results and higher intercompany eliminations. Intercompany eliminations increased for the year ended December 31, 2006 compared to 2005 due to higher volumes of cold kits manufactured by the contract manufacturing segment for the radiopharmaceutical segment. As indicated in prior disclosures, substantially all deferred revenues related to the amortization of previously received Anipryl® milestones terminated on December 31, 2006. The amortization of these deferred revenues has previously resulted in non-cash revenues of $0.8 million per quarter or $3.3 million per year (see Outlook). Depreciation and amortization expense in this segment in 2006 was relatively flat as compared to 2005 since the Company had fully amortized product rights related to the SpectroPharm line in January 2005. Operating loss for the year ended December 31, 2006 was $3.2 million higher than for 2005 due to the receipt of a contingent milestone payment of $0.9 million from Shire included in 2005 results, the inclusion of stock-based compensation costs in SG&A expenses effective January 1, 2006 and increased incentive accruals for 2006. Comparison of Years Ended December 31, 2005 and 2004 Revenues related to the corporate segment were lower in 2005 compared to the fourth quarter 2004 due to a reduction of deferred revenue amortization offset by lower inter-segment eliminations. In addition, as of January 31, 2005, all deferred revenue related to the SpectroPharm line of products was fully amortized. The amortization of deferred revenue related to the SpectroPharm line had accounted for approximately $500,000 of non-cash revenues per full quarter. Also during 2005, revenues for this segment included the receipt of contingent milestones of $0.9 million from Shire, which the Company earned in early 2005, partially offset by a reduction of deferred revenue 65 amortization. The contingent milestones were earned based on market driven conditions related directly to product sales. Depreciation and amortization expense in this segment in 2005 decreased as compared to 2004 since the Company had fully amortized product rights related to the SpectroPharm line in January 2005. SG&A expenses increased $571,000 for the year ended 2005 compared with 2004 due to incremental spending on corporate business development activities, regulatory compliance costs related to the Sarbanes-Oxley Act of 2002 and the impact of foreign exchange in the translation of Canadian denominated costs to U.S. reporting dollars. Aside from the impact of foreign currency, none of the factors noted increased SG&A expenses by more than $200,000 individually. As a result of the strengthening of the Canadian dollar versus the U.S. dollar since early 2004, approximately $438,000 of the SG&A expenses for 2005 were related solely to foreign currency translation. Operating income from this segment decreased compared to 2004 due to the factors described above. LIQUIDITY AND CAPITAL RESOURCES (in thousands of U.S. dollars) (U.S. GAAP)
(1) Excluding cash and cash equivalents, restricted cash, current portion of deferred revenues and customer deposits.
(2) Each whole warrant entitled the holder to acquire one common share at a price of CDN$8.50, subject to certain adjustments, any time prior to April 24, 2006. All warrants expired unexercised on April 24, 2006. Cash and cash equivalents as of December 31, 2006 totalled $21.4 million as compared with $12.4 million as of December 31, 2005 and $5.9 million as at December 31, 2004. The increase is attributable to the increasing cash earnings of the Company and proceeds from the exercise of stock options offset by capital expenditures and funds used to buy back the Company’s shares under the 2006 Issuer Bid. In management’s opinion, the Company has sufficient funds to meet its present working capital requirements. The Company follows a policy of investing its surplus cash resources in high quality, liquid, short-term commercial paper and government treasury bills and money market mutual funds that invest in high quality short-term securities. All investments as of December 31, 2006, 2005 and 2004 had less than three months maturity. As at December 31, 2006 there were no restrictions on the flow of these funds nor have any of these funds been committed in any way. For the year ended December 31, 2006, net operating cash flows were $16.4 million compared to $9.7 million for 2005 and $5.1 million for 2004. The year-over-year increases in net operating cash flows have been driven by increased volumes in the Company’s two core businesses partially offset by a higher investment in working capital. 66 Non-financial working capital, comprising accounts receivable, inventories, prepaid expenses, current deferred income tax assets, accounts payable and accrued liabilities, as at December 31, 2006 increased compared to December 31, 2005 and December 31, 2004 due mainly to increased receivable levels related to volume growth and timing of collection of receivables. Capital expenditures for the year ended December 31, 2006 are mainly attributable to expenditures to improve operating efficiencies in production areas, increase manufacturing capacity and infrastructure upgrades, namely to the Company’s information technology and SAP platforms. Infrastructure upgrade expenditures from existing programs are expected to continue into the first half of 2007. Capital expenditures for 2004 and 2005 were mainly to due to the installation and validation of the Company’s second lyophilization unit. All third party debt was repaid at the end of 2004 (see Bank Financing). Proceeds from the issuance of treasury common shares by the Company attributable to the exercise of options generated $1.9 million for the year ended December 31, 2006 compared with $1.6 million for 2005 and 2004. The following table summarizes the Company’s major contractual cash obligations as of December 31, 2006:
All contractual obligations related to 2006 and 2005 were fully paid as of December 31, 2006 and December 31, 2005 respectively. In addition to the above, the Company may be obligated to make certain royalty payments based on related product sales and milestone payments based on the achievement of certain specified events. The amount, timing and likelihood of these royalty payments are not determinable as they mainly relate to products being developed and not yet approved by the applicable regulatory authorities. Bank Financing The Company has the following credit facilities available, expiring June 2007: — CDN$15 million or U.S.$equivalent operating facility payable within 364 days upon drawing upon the facility. The operating facility can be extended by one year upon agreement with the lender. As at December 31, 2006, no amount was drawn under this facility. — CDN$10 million or U.S.$equivalent term facility, repayable in full at the end of the term. As at December 31, 2006, 2005 and 2004 no amount was drawn under this facility. As of December 31, 2006, a letter of credit was issued to the Company’s payroll provider in the amount of $621,000 which expires on March 25, 2007. Interest under the credit facilities (both term and operating) is based on the bank’s prime lending rate provided that the Company meets certain ratios, which as at December 31, 2006 were met. Amounts drawn under both credit facilities would be secured by specific assets of DRAXIS Specialty Pharmaceuticals Inc., and shares and guarantees of certain other subsidiaries. The Company was in compliance with all lending covenants as at December 31, 2006, 2005 and 2004. 67 Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the Company’s financial condition, changes in revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. Research and Developments, Patents and Licenses In accordance with SFAS No.2 Accounting for Research and Development Costs, research and development costs are expensed in the period in which they are incurred. Acquired research and development having no alternative future use is written off at the time of acquisition. The cost of intangibles that are purchased from others for a particular research and development project that have no alternative future use is written off at the time of acquisition. In the last three fiscal years ended December 31, 2004, December 31, 2005 and December 31, 2006, the Company has spent $1,948,000, 2,103,000 and 2,372,000 respectively on Research and Development expenses. SELECTED ANNUAL INFORMATION (in thousands of U.S. dollars, except share related data) (U.S. GAAP)
68 SUMMARY OF QUARTERLY RESULTS (in thousands of U.S. dollars, except share related data) (U.S. GAAP)
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