Elan Corporation (ELN)

Financial Review

exceptional items. Exceptional items include gains on the disposal of businesses, tangible and intangible asset impairments, purchase of royalty rights, severance and relocation costs, losses from litigation or regulatory actions. These items have been treated consistently from period to period. We believe that the disclosure of exceptional items is meaningful because it provides additional information.

Contingencies Relating to Actual or Potential Administrative Proceedings

We are currently involved in certain legal and administrative proceedings, relating to securities matters, patent matters, antitrust matters and other matters, as described in Note 26 to the Consolidated Financial Statements. We assess the likelihood of any adverse outcomes to contingencies, including legal matters, as well as potential ranges of probable losses. We record provisions for such contingencies when it is probable that a liability will be incurred and the amount of the loss can be reasonably estimated. If an unfavourable outcome is probable, but the amount of the loss cannot be reasonably estimated, we estimate the range of probable loss and provide for the most probable loss within the range. If no amount within the range is deemed more probable, we provide for the minimum amount within the range. If neither a range of loss or a minimum amount of loss is estimatable, then appropriate disclosure is given, but no provision is recorded. As at 31 December 2004, we had provided for $63.4 million (which includes $55.0 million in relation to settlement of the SEC investigation and shareholder class actions), representing our estimate of the costs for the current resolution of these matters. We developed these estimates in consultation with outside counsel handling our defense in these matters using the current facts and circumstances known to us. The factors that we consider in developing our legal contingency provision include the merits and jurisdiction of the litigation, the nature and number of other similar current and past litigation cases, the nature of the product and current assessment of the science subject to the litigation, and the likelihood of settlement and current state of settlement discussions, if any. We believe that the legal contingency provision that we have established is appropriate based on current factors and circumstances. However, it is possible that other people applying reasonable judgement to the same facts and circumstances could develop a different liability amount. The nature of these matters is highly uncertain and subject to change. As a result, the amount of our liability for certain of these matters could exceed or be less than the amount of our current estimates, depending on the outcome of these matters.

Revenue—Discounts, Sales Returns, Rebates and Charge-backs

Estimated sales returns, pursuant to rights of return granted to our customers, are reflected as a reduction of revenue in the same period that the related sales are recorded. The sales returns provisions are based on actual experience, although in certain situations, for example, a new product launch or at patent expiry, further judgement may be required. Additionally, revenue is also recorded net of provision, made at the time of sale, for estimated cash discounts, rebates and charge-backs. These amounts are included in other current liabilities (rebates) or deducted from trade debtors (other discounts). Discounts, sales returns, rebates and charge-backs that require the use of judgement in the establishment of the accrual include Medicaid, managed care, long-term care, hospital and various other government programmes. We enter into contracts with managed care organisations to provide access to our products. Based on a managed care organisation’s market share performance and utilisation of our products, the organisation receives rebates from us. In addition, we are bound by certain laws and regulations to provide products at a discounted rate to Medicaid recipients. Medicaid rebates are paid to each state in the United States based on claims filed by pharmacies that provide our products to Medicaid recipients at the reduced rate. Charge-backs are reimbursements to wholesalers for sales to third parties at reduced prices. Cash discounts are provided to customers that pay their invoice within a certain time period. Discounts, sales returns, rebates and charge-backs are primarily based upon historical rebate and discount payments made to our customer segment groups. These amounts are calculated based upon a percentage of sales for each of our products as defined by the statutory rates and the contracts with our various customer groups. The nature of estimating discounts, sales returns, rebates and charge-backs is complex and subject to change. However, we believe that we have used reasonable judgements in assessing our estimates.

For additional information regarding our significant accounting policies, please refer to Note 1 to the Consolidated Financial Statements.