Elan Corporation (ELN)

25   Pharma Marketing

In June 2000, we disposed of royalty rights on certain products and development projects to Pharma Marketing. Pharma Marketing completed a private placement of its common shares to a group of institutional investors, resulting in gross proceeds of $275.0 million. We held no investment in Pharma Marketing and had no representative on its board of directors. Concurrent with the private placement, we entered into a Program Agreement with Pharma Marketing. The Program Agreement, which substantially regulated the relationship, was a risk-sharing arrangement. Under the terms of the Program Agreement, Pharma Marketing acquired certain royalty rights to each of the following products for the designated indications (including any other product that contained the active ingredient included in such product for any other designation): (i) Frova, for the treatment of migraines; (ii) Myobloc, for the treatment of cervical dystonia; (iii) Prialt, for the treatment of acute pain and severe chronic pain; (iv) Zanaflex, for the treatment of spasticity and painful spasms; and (v) Zonegran, for the treatment of epilepsy. Pharma Marketing agreed to make payments to us in amounts equal to expenditures incurred by us in connection with the commercialisation and development of these products, subject to certain limitations. These payments were made on a quarterly basis based on the actual costs incurred by us. We did not receive a margin on these payments.

We received no revenue from Pharma Marketing in 2004 or 2003. Pursuant to the Program Agreement, Pharma Marketing utilised all of its available funding by mid-2002. We will not receive any future revenue from Pharma Marketing. In 2003, the royalty rate on net sales of all designated products was 27.7% on the first $122.9 million of net sales and 52.5% for net sales above $122.9 million. We paid aggregate royalties of $43.3 million in 2003, recorded as a cost of sales.

In December 2001, the Program Agreement was amended such that we re-acquired the royalty rights to Myobloc and disposed of the royalty rights of Sonata to Pharma Marketing. The amendment was transacted at estimated fair value. The board of directors and shareholders of Pharma Marketing approved this amendment. The estimated difference in relative fair value between the royalty rights of Sonata and the royalty rights of Myobloc was $60.0 million. We paid this amount to Pharma Marketing in cash and capitalised it as an intangible asset.

Under the original agreements, we could have, at our option at any time prior to 30 June 2003, acquired the royalty rights by initiating an auction process. This date was extended to 3 January 2005 under the settlement with Pharma Marketing and its subsidiary, Pharma Operating Ltd. (“Pharma Operating”), described below. In addition, the holders of Pharma Marketing common shares were entitled to initiate the auction process earlier upon the occurrence of certain events. Pursuant to the auction process, the parties were to negotiate in good faith to agree on a purchase price, subject to our right to re-acquire the royalty rights at a maximum purchase price. The maximum purchase price was approximately $413.0 million at 31 December 2002 and increased by approximately 25% annually (less royalty payments). The purchase price was reduced under the settlement with Pharma Marketing and Pharma Operating described below.

In January 2003, Pharma Operating filed a lawsuit in the Supreme Court of the State of New York against us and certain of our subsidiaries in connection with the risk-sharing arrangement between the parties. The lawsuit sought, among other things, a court determination that Pharma Operating’s approval would be required in the event we sell our interest in Sonata to a third party. On 30 January 2003, we settled the lawsuit and, under the terms of the settlement agreement, Pharma Operating dismissed the litigation between the parties without prejudice. Pursuant to the settlement agreement, effective upon the sale of Sonata to King in June 2003: (1) we paid Pharma Operating $196.4 million in cash (representing $225.0 million less royalty payments on all related products paid or due to Pharma Operating from 1 January 2003 through 12 June 2003) to acquire Pharma Operating’s royalty rights with respect to Sonata and Prialt; and (2) our maximum purchase price for the remaining products in the arrangement, Zonegran, Frova and Zanaflex, was reduced to $110.0 million, which increased at a rate of 15% per annum from 12 June 2003 (less royalty payments made for periods after 12 June 2003). The parties also agreed to extend our purchase option termination date to 3 January 2005 from the original termination date of 30 June 2003.

In connection with the settlement agreement, we agreed that we would cause certain subsidiaries in the United States, Ireland, the United Kingdom, Germany, France, Spain and Italy to pledge their accounts receivable from commercial sales of pharmaceutical products and services to Pharma Operating as collateral to secure our obligations in relation to royalty payments under the Pharma Marketing arrangement and the settlement agreement. We also agreed that, following the closing of a sale of Sonata, we would grant Pharma Operating additional collateral to the extent that the aggregate value of the collateral package, which was to be tested on a quarterly basis, was less than the maximum purchase price for the royalty rights on Zonegran, Frova and Zanaflex. On 6 March 2003, Elan Pharmaceuticals, Inc. (“EPI”) and Pharma Operating entered