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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 20-F  £
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF
1934 OR  R
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 OR  £
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___to ___ Commission file number 0-22286 TARO PHARMACEUTICAL INDUSTRIES LTD. (Exact name of Registrant as specified in its charter)
 N/A
(Translation of Registrants name into English) Israel
(Jurisdiction of incorporation or organization) Italy House, Euro Park, Yakum 60972, Israel
(Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class
None
    
    Name of each exchange on which registered
None
 Securities registered or to be registered pursuant to Section 12(g) of the Act: Ordinary Shares, NIS 0.0001 nominal (par) value per share
(Title of Class) Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
(Title of Class) Indicate the number of outstanding shares of each of the issuers classes of capital or common
stock as of the close of the period covered by the annual report: 29,170,405 Ordinary Shares, NIS 0.0001 nominal (par) value per share 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. R Yes            No £ Indicate by check mark which financial statement item the registrant has elected to follow. £ Item 17 R Item 18




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INTRODUCTION We develop, manufacture and market prescription and over-the-counter, or OTC, pharmaceutical
products, as well as active pharmaceutical ingredients, or APIs, primarily in the United States,
Canada and Israel. We were incorporated in 1959 under the laws of the State of Israel. In 1961, we
completed the initial public offering of our ordinary shares in the United States. Our ordinary
shares are currently traded on the Nasdaq National Market under the symbol TARO. Except for the historical information contained in this annual report, the statements
contained herein are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to our business, financial condition and results of
operations. Actual results could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including all the risks discussed in Item 3D  Key
Information: Risk Factors and elsewhere in this annual report. We urge you to consider that
statements which use the terms believe, expect, plan, intend, estimate, anticipate,
should, will, may", hopeand similar expressions are intended to identify forward-looking
statements. These statements reflect our current views with respect to future events and are based
on assumptions and are subject to risks and uncertainties. Except as required by applicable law,
including the securities laws of the United States, we do not intend to update or revise any
forward-looking statements, whether as a result of new information, future events or otherwise. Our consolidated financial statements appearing in this annual report are prepared in U.S.
dollars and in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. All
references in this annual report to dollars, or $, are to U.S. dollars and all references in
this annual report to NIS are to New Israeli Shekels. The published representative exchange rate
between the NIS and the dollar for May 31, 2005 was NIS 4.42 per $1.00. The published
representative exchange rate between the Canadian dollar and the dollar for May 31, 2005 was $1.25
Canadian dollar per $1.00. As used in this annual report, the terms we, us, our and the Company mean Taro
Pharmaceutical Industries Ltd. and its subsidiaries, unless otherwise indicated. 2




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TABLE OF CONTENTS PagePART IITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
    
    
    5ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
    
    
    5ITEM 3. KEY INFORMATION
    
    
    5A. SELECTED FINANCIAL DATA
    
    
    5B. CAPITALIZATION AND INDEBTEDNESS
    
    
    7C. REASONS FOR THE OFFER AND USE OF PROCEEDS
    
    
    7D. RISK FACTORS
    
    
    7ITEM 4. INFORMATION ON THE COMPANY
    
    
    25A. HISTORY AND DEVELOPMENT OF THE COMPANY
    
    
    25B. BUSINESS OVERVIEW
    
    
    27C. ORGANIZATIONAL STRUCTURE
    
    
    38D. PROPERTY, PLANT AND EQUIPMENT
    
    
    38ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    39A. OPERATING RESULTS
    
    
    39B. LIQUIDITY AND CAPITAL RESOURCES
    
    
    49C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES
    
    
    51D. TREND INFORMATION
    
    
    54E. OFF-BALANCE SHEET ARRANGEMENTS
    
    
    54F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
    
    
    54ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    55A. DIRECTORS AND SENIOR MANAGEMENT
    
    
    55B. COMPENSATION
    
    
    58C. BOARD PRACTICES
    
    
    59D. EMPLOYEES
    
    
    63E. SHARE OWNERSHIP
    
    
    65ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    70A. MAJOR SHAREHOLDERS
    
    
    70B. RELATED PARTY TRANSACTIONS
    
    
    72C. INTERESTS OF EXPERTS AND COUNSEL
    
    
    72ITEM 8. FINANCIAL INFORMATION
    
    
    72A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
    
    
    72B. SIGNIFICANT CHANGES
    
    
    73ITEM 9. THE OFFER AND LISTING
    
    
    73A. OFFER AND LISTING DETAILS
    
    
    73B. PLAN OF DISTRIBUTION
    
    
    74C. MARKETS
    
    
    74D. SELLING SHAREHOLDERS
    
    
    74E. DILUTION
    
    
    74F. EXPENSES OF THE ISSUE
    
    
    74ITEM 10. ADDITIONAL INFORMATION
    
    
    74A. SHARE CAPITAL
    
    
    74B. MEMORANDUM AND ARTICLES OF ASSOCIATION
    
    
    74C. MATERIAL CONTRACTS
    
    
    80D. EXCHANGE CONTROLS
    
    
    80E. TAXATION AND GOVERNMENT PROGRAMS
    
    
    81F. DIVIDENDS AND PAYING AGENTS
    
    
    93G. STATEMENT BY EXPERTS
    
    
    93H. DOCUMENTS ON DISPLAY
    
    
    93I. SUBSIDIARY INFORMATION
    
    
    93ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    94ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    94PART IIITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    94ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS
    
    
    94ITEM 15. CONTROLS AND PROCEDURES
    
    
    95
 3




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PageITEM 16. [RESERVED]
    
    
    95A. AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    95B. CODE OF ETHICS
    
    
    95C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    95D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
    
    
    96E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATED PURCHASERS
    
    
    96PART IIIITEM 17. FINANCIAL STATEMENTS
    
    
    96ITEM 18. FINANCIAL STATEMENTS
    
    
    96ITEM 19. EXHIBITS
    
    
    97EX-1.2: ARTICLES OF ASSOCIATIONEX-12.1: CERTIFICATION OF THE SENIOR VICE PRESIDENT & GENERAL MANAGEREX-12.2: CERTIFICATION OF THE CHIEF FINANCIAL OFFICEREX-13: CERTIFICATION OF SENIOR VICE PRESIDENT & GENERAL MANAGER AND CHIEF FINANCIAL OFFICEREX-15.A.1: CONSENT OF KOST, FORER ET AL
 4




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PART I 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS Not applicable. 
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. 
 ITEM 3. KEY INFORMATION 
 A. SELECTED FINANCIAL DATA We have derived the following selected consolidated financial data as of December 31, 2004 and
2003 and for each of the years ended December 31, 2004, 2003 and 2002 from our consolidated
financial statements set forth elsewhere in this annual report that have been prepared in
accordance with U.S. GAAP. We have derived the consolidated selected financial data as of December
31, 2002, 2001 and 2000 and for each of the years ended December 31, 2001 and 2000 from our audited
consolidated financial statements not included in this annual report. In July 2001, we completed a
split of our ordinary shares, NIS 0.0001 nominal (par) value per share, by distributing as a
dividend, one ordinary share for every ordinary share then outstanding and one ordinary share for
every ten founders shares then outstanding. All ordinary share and per share numbers contained in
this annual report have been adjusted to give effect to this stock split. 5




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You should read the selected consolidated financial data together with Item 5 - Operating and
Financial Review and Prospects and our consolidated financial statements included elsewhere in
this annual report. Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands of U.S. dollars except per ordinary share data)Statement of Income Data:Sales
    
    $
    284,130
    
    
    $
    315,458
    
    
    $
    211,581
    
    
    $
    149,230
    
    
    $
    103,797Cost of sales
    
    
    119,404
    
    
    
    102,454
    
    
    
    79,468
    
    
    
    54,736
    
    
    
    41,206Gross profit
    
    
    164,726
    
    
    
    213,004
    
    
    
    132,113
    
    
    
    94,494
    
    
    
    62,591Operating expenses:Research and development, net
    
    
    41,943
    
    
    
    40,601
    
    
    
    26,373
    
    
    
    19,633
    
    
    
    14,593Selling, General and Administrative
    
    
    123,299
    
    
    
    97,718
    
    
    
    52,481
    
    
    
    42,086
    
    
    
    31,902Total operating expenses
    
    
    165,242
    
    
    
    138,319
    
    
    
    78,854
    
    
    
    61,719
    
    
    
    46,495Operating income
    
    
    (516
    )
    
    
    74,685
    
    
    
    53,259
    
    
    
    32,775
    
    
    
    16,096Financial expenses, net
    
    
    6,417
    
    
    
    1,722
    
    
    
    162
    
    
    
    2,594
    
    
    
    3,855Other income (loss), net
    
    
    
    
    
    
    (7
    )
    
    
    78
    
    
    
    272
    
    
    
    344Income before taxes on income
    
    
    (6,933
    )
    
    
    72,956
    
    
    
    53,175
    
    
    
    30,453
    
    
    
    12,585Taxes on income
    
    
    (16,991
    )
    
    
    11,475
    
    
    
    8,406
    
    
    
    4,378
    
    
    
    2,53810,058
    
    
    
    61,481
    
    
    
    44,769
    
    
    
    26,075
    
    
    
    10,047Minority interest in (earnings) loss
of a subsidiary
    
    
    1,017
    
    
    
    (326
    )
    
    
    (214
    )
    
    
    (81
    )
    
    
    (20
    )Net income
    
    $
    11,075
    
    
    $
    61,155
    
    
    $
    44,555
    
    
    $
    25,994
    
    
    $
    10,027Earnings per ordinary share:Basic
    
    $
    0.38
    
    
    $
    2.12
    
    
    $
    1.55
    
    
    $
    1.11
    
    
    $
    0.47Diluted
    
    $
    0.37
    
    
    $
    2.06
    
    
    $
    1.52
    
    
    $
    0.99
    
    
    $
    0.42Number of ordinary shares used in
computing earnings per ordinary share
(in thousands):Basic
    
    
    29,058
    
    
    
    28,873
    
    
    
    28,665
    
    
    
    23,370
    
    
    
    21,420Diluted
    
    
    29,657
    
    
    
    29,674
    
    
    
    29,408
    
    
    
    26,302
    
    
    
    23,864
 As of December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In thousands of U.S. dollars)Consolidated Balance Sheet Data:Working capital
    
    $
    201,585
    
    
    $
    279,955
    
    
    $
    198,871
    
    
    $
    196,711
    
    
    $
    43,588Property, plant and equipment, net
    
    
    241,966
    
    
    
    182,306
    
    
    
    93,358
    
    
    
    54,024
    
    
    
    41,827Total assets
    
    
    696,847
    
    
    
    616,523
    
    
    
    379,845
    
    
    
    307,762
    
    
    
    120,446Short-term debt, including current
maturities
    
    
    81,905
    
    
    
    43,544
    
    
    
    10,272
    
    
    
    8,231
    
    
    
    8,491Long-term debt
    
    
    187,346
    
    
    
    156,937
    
    
    
    47,127
    
    
    
    49,285
    
    
    
    38,250Minority interest
    
    
    694
    
    
    
    1,711
    
    
    
    1,159
    
    
    
    776
    
    
    
    168Shareholders equity
    
    
    368,120
    
    
    
    347,400
    
    
    
    269,137
    
    
    
    218,364
    
    
    
    50,214
 6




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B. CAPITALIZATION AND INDEBTEDNESS Not applicable. 
 C. REASONS FOR THE OFFER AND USE OF PROCEEDS Not applicable. 
 D. RISK FACTORS Our business, operating results and financial condition may be seriously harmed due to any of
the following risks, among others. If we do not successfully address the risks to which we are
subject, we may experience a material adverse effect on our business, results of operations and
financial condition and our share price may decline. We cannot assure you that we will successfully
address any of these risks. Risks Relating to Our Industry The pharmaceutical industry in which we operate is intensely competitive. We are particularly
subject to the risks of competition. For example, the competition we encounter may have a negative
impact upon the prices we may charge for our products, the market share of our products and our
revenues and profitability. The pharmaceutical industry in which we operate is intensely competitive. The competition
which we encounter has an effect on our product prices, market share, revenues and profitability.
Depending upon how we respond to this competition, its effect may be materially adverse to us. We
compete with:  
    
    the original manufacturers of the brand-name equivalents of our generic products;  
    
    other drug manufacturers (including brand-name companies that also manufacture generic drugs); and  
    
    manufacturers of new drugs that may compete with our generic drugs and proprietary products. Most of the products that we sell are either generic drugs or drugs in respect of which
patents have expired. Most of these products do not benefit from patent protection and are
therefore more subject to the risk of competition than patented products. In addition, because many
of our competitors have substantially greater financial, production, and research and development
resources, substantially larger sales and marketing organizations, and substantially greater name
recognition than we have, we are particularly subject to the risks inherent in competing with them.
For example, many of our competitors may be able to develop products and processes competitive
with, or superior to, our own. Furthermore, we may not be able to differentiate our products from
those of our competitors, successfully develop or introduce new products that are less costly or
offer better performance than those of our competitors or offer purchasers of our products payment
and other commercial terms as favorable as those offered by our competitors. 7




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Brand-name companies frequently take actions to prevent or discourage the use of generic drug
products such as ours. Brand-name companies have increasingly taken actions, including the use of state and federal
legislative and regulatory mechanisms, to prevent, delay or discourage the use of generic
equivalents to their products, including generic products that we manufacture or market. If these
efforts to delay or prevent generic competition are successful, our ability to sell our generic
versions of those brand-name products may be limited or prevented. This could have a material
adverse effect on our future results of operations. These efforts have included, among others:  
    
    filing new patents or extensions of existing patents on brand-name products whose original patent protection is about to
expire, which could extend patent protection for the product and delay launch of generic equivalents;  
    
    developing patented controlled-release products or other product improvements;  
    
    developing and marketing branded products as over-the-counter products;  
    
    pursuing pediatric exclusivity for brand-name products;  
    
    submitting citizen petitions to request that the Commissioner of the United States Food and Drug Administration, or the
FDA, take administrative action with respect to an abbreviated new drug application, or ANDA approval;  
    
    attaching special patent extension amendments to unrelated federal legislation;  
    
    engaging in state-by-state initiatives to enact legislation that restricts the substitution of some brand-name drugs with
generic drugs; and  
    
    introducing authorized generics to the marketplace. Generally, no additional regulatory approvals are required for brand-name manufacturers to
sell directly or through a third party to the generic market. Brand-name products that are licensed
to third parties and are marketed under their generic names at discounted prices are known as
authorized generics. This facilitates the sale by brand-name manufacturers of generic equivalents
of their own brand-name products. Because many brand-name companies are substantially larger than
we are and have substantially greater resources than we have, we are particularly subject to the
risks of their undertaking to prevent or discourage the use of those of our products that compete
with theirs. Moreover, the introduction of authorized generics may make competition in the
generic market more intense. It may also reduce the likelihood that a generic company like ours
that obtains the first ANDA approval for a particular product, will be the first-to-market and/or
the only generic alternative offered to the market and thus may diminish the economic benefit
associated with this position. New developments by others could make our products or technologies non-competitive or obsolete. The markets in which we compete and intend to compete are undergoing, and are expected to
continue to undergo, rapid and significant technological change. We expect competition to 8




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intensify as technological advances are made. Our competitors may succeed in developing
products and technologies that are more effective or less costly than any that we are developing,
or that would render our products obsolete and noncompetitive. For example, AstraZeneca
Pharmaceuticals has filed a New Drug Application for a novel oral direct thrombin inhibitor,
Exanta® (ximelagatran). If approved by regulatory authorities, the launch of Exanta® may have an
adverse effect on our sales of Coumadin® in Israel and warfarin sodium tablets in the United States
and Canada. A reduction in the sales and profitability of warfarin sodium tablets may have an
adverse effect on the results of our operations and financial condition. We anticipate that we will face increased competition in the future as new companies enter the
market and advanced technologies emerge. Smaller or early-stage companies may also prove to be
significant competitors, particularly through collaborative arrangements with large and established
companies. Many of our competitors have significantly greater research and development, financial,
sales and marketing, manufacturing, and other resources than we have. As a result, they may be able
to devote greater resources to the development, manufacture, marketing or sale of their products,
initiate or withstand substantial price competition, or more readily take advantage of acquisitions
or other opportunities. Our ability to market products successfully depends, in part, upon the acceptance of the products
not only by consumers, but also by independent third parties. Our ability to market generic or proprietary pharmaceutical products successfully depends, in
part, on the acceptance of the products by independent third parties (including physicians,
pharmacies, government formularies, managed care providers, insurance companies, and retailers) as
well as patients. In addition, unanticipated side effects or unfavorable publicity concerning any
of our products, or any brand-name product of which our generic product is the equivalent, could
have an adverse effect on our ability to achieve acceptance by prescribing physicians, managed care
providers, pharmacies and other retailers, customers and patients. Our ongoing profitability depends upon our ability to introduce new generic or innovative products
on a timely basis. Our ongoing profitability depends, to a significant extent, upon our ability to introduce, on
a timely basis, new generic or innovative products for which we either are the first to market (or
among the first to market) or can otherwise gain significant market share. Our ability to achieve
any of these objectives is dependent upon, among other things, the timing of regulatory approval of
these products and the number and timing of regulatory approvals of competing products. Inasmuch as
this timing is not within our control, we may not be able to develop and introduce new generic and
innovative products on a timely basis, if at all. Our revenues and profits from individual generic pharmaceutical products are likely to decline as
our competitors introduce their own generic equivalents. Revenues and gross profit derived from generic pharmaceutical products tend to follow a
pattern based on regulatory and competitive factors unique to the generic pharmaceutical industry.
As the patents for a brand-name product and the related exclusivity periods expire, the first
generic manufacturer to receive regulatory approval for a generic equivalent of the product is
often able to capture a substantial share of the market. However, as other generic manufacturers
receive regulatory approvals for competing products, or brand-name 9




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manufacturers introduce authorized generics, that market share and the price of that product
will decline. We are subject to extensive government regulation that increases our costs and could prevent us
from marketing or selling our products. We are subject to extensive regulation by the United States, Canada, Israel and other
jurisdictions. These jurisdictions regulate the approval, testing, manufacture, labeling, marketing
and sale of pharmaceutical products. For example, approval by the FDA is generally required before
any new drug or the generic equivalent to any previously approved drug may be marketed in the
United States. In order to receive approval from the FDA for each new drug product we wish to
market, we must demonstrate, through rigorous clinical trials, that the new drug product is safe
and effective for its intended use and that our manufacturing processes for that product candidate
complies with current good manufacturing practices, or cGMPs. We cannot provide an assurance that
the FDA will, in a timely manner, or ever, approve our applications for new drug products. The FDA
may require substantial additional clinical testing or find our drug product does not satisfy the
standards for approval. In addition, in order to obtain approval for our product candidates that
are generic versions of brand-name drugs, we must demonstrate to the FDA that each generic product
candidate is bioequivalent to a drug previously approved by the FDA through the new drug approval
process, known as an innovator drug. Bioequivalency may be demonstrated by comparing the generic
product to the innovator drug product in dosage form, strength, route of administration, quality,
performance characteristics and intended use. If the FDA determines that an ANDA for a generic drug
product is not adequate to support approval, it could deny our application or request additional
information, including clinical trials, which could delay approval of the product and impair our
ability to compete with other versions of the generic drug product. If our product candidates receive FDA approval, the labeling claims and marketing statements
that we can make for our new and generic products are limited by statues and regulations and, with
respect to our generic drugs, by the labeling claims made in brand-name packaging. In addition, if
the FDA and/or a foreign regulatory authority approves any of our products, the labeling,
packaging, adverse event reporting, storage, advertising and promotion for the product will be
subject to extensive and ongoing regulatory requirements. As a manufacturer of pharmaceutical
products distributed in the U.S., we must also comply with cGMPs, which include requirements
related to production processes, quality control and assurance, and recordkeeping. Products that we
manufacture and distribute in foreign jurisdictions may be regulated under comparable laws and
regulations in those jurisdictions. Our manufacturing facilities and procedures and those of our
suppliers are subject to periodic inspection by the FDA and foreign regulatory agencies. Any
violations of cGMPs or other applicable standards identified during such inspections may result in
enforcement actions, including delaying or preventing new product approvals, a delay or suspension
in manufacturing operations, consent decrees, or civil or criminal penalties. Further, discovery of
previously unknown problems with a product or manufacturer may result in restrictions or sanctions
with respect to the product, including withdrawal of the product from the market. In addition, because we market a controlled substance in the United States and other
controlled substances in Canada and Israel, we must meet the requirements of the United States
Controlled Substances Act and its equivalents in Canada and Israel, as well as the regulations
promulgated thereunder in each country. These regulations include stringent requirements for 10




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manufacturing controls, importation, receipt and handling procedures and security to prevent
diversion of, or unauthorized access to, the controlled substances in each stage of the production
and distribution process. The U.S. Drug Enforcement Administration, or DEA, and comparable
regulatory authorities in Israel and Canada may periodically inspect our facilities for compliance
with the United States Controlled Substances Act and its equivalents in Israel and Canada. Any
failure to comply with these laws and regulations could lead to a variety of sanctions, including
the revocation, or a denial of renewal, of our DEA registration (or Israeli or Canadian
equivalent), injunctions, or civil or criminal penalties. Furthermore, most of the products that we manufacture and distribute are manufactured outside
the United States and must be shipped into the United States. The FDA and the DEA, in conjunction
with the U.S. Customs Service, can exercise greater legal authority over goods that we seek to
import into the United States than they can over products that are manufactured in the United
States. Although we devote significant time, effort and expense to addressing the extensive government
regulations applicable to our business and obtaining regulatory approvals, we remain subject to the
risk of being unable to obtain necessary approvals on a timely basis, if at all. Delays in
receiving regulatory approvals could adversely affect our ability to market our products. Product approvals by the FDA and by comparable foreign regulatory authorities may be withdrawn
if compliance with regulatory standards is not maintained or if problems relating to the products
are experienced after initial approval. In addition, if we fail to comply with governmental
regulations we may be subject to fines, unanticipated compliance expenditures, interruptions of our
production and/or sale, prohibition of importation, seizures and recalls of our products, criminal
prosecution and debarment of us and our employees from the generic drug approval process. Reimbursement policies of third parties, cost containment measures and healthcare reform could
adversely affect the demand for our products and limit our ability to sell our products. Our ability to market our products depends, in part, on reimbursement levels for them and
related treatment established by healthcare providers (including government authorities), private
health insurers and other organizations, including health maintenance organizations and managed
care organizations. Reimbursement may not be available for some of our products and, even if
granted, may not be maintained. Limits placed on reimbursement could make it more difficult for
people to buy our products and reduce, or possibly eliminate, the demand for our products. In the
event that governmental authorities enact additional legislation or adopt regulations which affect
third party coverage and reimbursement, demand for our products may be reduced with a consequent
adverse effect, which may be material, on our sales and profitability. In addition, the purchase of
our products could be significantly influenced by the following factors, among others:  
    
    trends in managed healthcare in the United States;  
    
    developments in health maintenance organizations, managed care organizations and similar enterprises; 11




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
    
    legislative proposals to reform healthcare and government insurance programs; and  
    
    price controls and reimbursement policies. These factors could result in lower prices and/or a reduced demand for our products. We are susceptible to product liability claims that may not be covered by insurance and could
require us to pay substantial sums. We face the risk of loss resulting from, and adverse publicity associated with, product
liability lawsuits, whether or not such claims are valid. We may not be able to avoid such claims.
In addition, our product liability insurance may not be adequate to cover such claims and we may
not be able to obtain adequate insurance coverage in the future at acceptable costs. A successful
product liability claim that exceeds our policy limits could require us to pay substantial sums. The manufacture and storage of pharmaceutical products are subject to inherent risk. Because chemical ingredients are used in the manufacture of pharmaceutical products and due to
the nature of the manufacturing process itself, there is a risk of incurring liability for damages
caused by or during the storage or manufacture of both the chemical ingredients and the finished
pharmaceutical products. Although we have never incurred any material liability for damages of that
nature, we may be subject to liability in the future. In addition, while we believe our insurance
coverage is adequate, it is possible that a successful claim would exceed our coverage, requiring
us to pay a substantial sum. The manufacture and storage of pharmaceutical and chemical products are subject to environmental
regulation and risk. Because of the chemical ingredients of pharmaceutical products and the nature of their
manufacturing process, the pharmaceutical industry is subject to extensive environmental regulation
and the risk of incurring liability for damages or the costs of remedying environmental problems.
Although we have never incurred any such liability in any material amount, we may be subject to
liability in the future. We may also be required to increase expenditures to remedy environmental
problems and comply with applicable regulations. If we fail to comply with environmental
regulations to use, discharge or dispose of hazardous materials appropriately or otherwise to
comply with the conditions attached to our operating licenses, the licenses could be revoked and we
could be subject to criminal sanctions and substantial liability. We could also be required to
suspend or modify our manufacturing operations. Testing required for the regulatory approval of our products is sometimes conducted by independent
third parties. Any failure by any of these third parties to perform this testing properly may have
an adverse effect upon our ability to obtain regulatory approvals. Our applications for the regulatory approval of our products incorporate the results of
testing and other information that are sometimes provided by independent third parties (including,
for example, manufacturers of raw materials, testing laboratories, contract research organizations
or independent research facilities). The likelihood that the products being tested will receive
regulatory approval is, to some extent, dependent upon the quality of the work performed by 12




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these third parties, the quality of the third parties facilities and the accuracy of the
information provided by these third parties. We have little or no control over any of these
factors. Risks Relating to Our Company Three wholesale customers account for a very substantial portion of our consolidated sales. During 2003 and 2004, AmerisourceBergen Corporation, McKesson Corporation and Cardinal Health,
Inc., collectively accounted for approximately 46% and 39%, respectively, of our consolidated
sales. We have no long-term agreements with these wholesalers and they may therefore reduce or
cease their purchases from us at any time. Any cessation or reduction of their purchases from us
would likely have a material adverse effect on the results of our operations and our financial
condition. Furthermore, changes in their buying patterns or in their policies and practices in
relation to their working capital and inventory management may result in a reduction of, or a
change in the timing of, their purchases of our products. For example, we believe that the decrease
in our sales to each of these customers during 2004, as compared to 2003, was, to a significant
extent, attributable to changes in their buying patterns and inventory management practices. We
have no ability to obtain advance knowledge of such changes. We base our manufacturing schedules,
inventories and internal sales projections principally on historical data. To the extent that
actual orders from these wholesalers differ substantially from our internal projections, we may
either find ourselves with excess inventory or in an out of stock position. In 2004, orders
received from these three wholesalers were substantially below our internal projections, resulting
in an increase in inventory and an adverse effect on our operating results. Hence, factors beyond
our control relative to these customers have had in the recent past, and may have from time to time
in the future, a material adverse effect upon our operating results, which has, in the recent past,
resulted, and may from time to time in the future result, in substantial volatility of the market
prices of our securities. We derive most of our revenues and profits from a small group of product lines. During 2004, seven product lines accounted for 48% of our consolidated sales. In 2003 and
2002, seven product lines accounted for 54% and 53% of consolidated sales, respectively. In 2004,
one product line accounted for approximately 10% of our consolidated sales. A significant decline
in revenues or profitability of any one of these product lines may adversely affect the results of
our operations and financial condition. The nature of our business requires us to estimate future charges against wholesaler accounts
receivable. If these estimates are not accurate, the results of our operations and financial
condition could be adversely affected. Sales to third parties, including government institutions, hospitals, hospital buying groups,
pharmacy buying groups, pharmacy chains and others generally are made through wholesalers. We sell
our goods to wholesalers, and the wholesalers subsequently resell the goods to third parties at
times and in quantities ordered by the third parties. Typically, we have a contract price with a
third party to which a wholesaler resells our goods that may be equal to or less than the price at
which we sold the goods to the wholesaler. In such a case, at the time the third party purchases
from the wholesaler, the wholesaler charges us back for any shortfall. At the time of any
individual sale by us to a wholesaler, we do not know under which contracts the wholesaler will
resell goods to third parties. Therefore, we estimate the amount of chargebacks and other 13




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credits that may be associated with these sales and we reduce our revenue accounts
accordingly. From time to time, the amount of such chargebacks and other credits reported by a
wholesaler may be different from our estimates. Discrepancies of this nature may result in a
reduction in the value of our accounts receivable and a related charge to our net income. The
reconciliation of our accounts with wholesalers may, from time to time, delay, or otherwise impact
upon, the collection of our accounts receivable or result in a decrease in their value and in a
related charge to our net income. Our inventories of finished goods have expiration dates after which they cannot be sold. Industry standards require that pharmaceutical products be made available to customers from
existing stock levels rather than on a made-to-order basis. Therefore, in order to accommodate
market demand adequately, we strive to maintain sufficiently high levels of inventories. However,
inventories prepared for sales that are not realized as or when anticipated may approach their
expiration dates and have to be written off. These write-offs, if any, could have an adverse affect
on the results of our operations and financial condition. Our future success depends on our ability to develop, manufacture and sell new products. Our future success is largely dependent upon our ability to develop, manufacture and market
new commercially viable pharmaceutical products and generic equivalents of proprietary
pharmaceutical products whose patents and other exclusivity periods have expired. Delays in the
development, manufacture and marketing of new products will negatively impact the results of our
operations. Each of the steps in the development, marketing and manufacture of our products
involves significant time and expense. We are, therefore, subject to the risks, among others, that:  
    
    any products under development, if and when fully developed and tested, will not perform in accordance with our
expectations;  
    
    any generic product under development will, when tested, not be bioequivalent to its brand-name counterpart;  
    
    necessary regulatory approvals will not be obtained in a timely manner, if at all;  
    
    any new product cannot be successfully and profitably produced and marketed;  
    
    other companies may launch their version of generic products, either prior to or following the launch of our newly approved
generic version of the same product; or  
    
    brand-name companies may launch their products, either themselves or through third parties, in the form of authorized
generic products which can reduce sales, prices and profitability of our newly approved generic products. If we are unable to obtain raw materials, our operations could be seriously impaired. We currently obtain some raw materials for our products from either a single supplier or a
limited number of suppliers. Although we have not experienced significant difficulty in obtaining
raw materials to date, material supply interruptions may occur in the future and we may have to
obtain substitute materials or products. While we do have long-term supply 14




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agreements for some raw materials, for most raw materials we do not have any long-term supply
agreements and we are therefore subject to the risk that our suppliers of raw materials may not
continue to supply us with raw materials on satisfactory terms or at all. Furthermore, obtaining the regulatory approvals required for adding alternative suppliers of
raw materials for finished products we manufacture may be a lengthy process. We strive to maintain
adequate inventories of single source raw materials in order to ensure that any delays in receiving
regulatory approvals will not have a material adverse effect upon our business. However, we may not
be successful in doing so and, as a consequence, we may be unable to sell some products pending
approval of one or more alternate sources of raw materials. Any significant interruption in our
supply stream could have a material adverse effect on our operations. We are increasing our efforts to develop new proprietary pharmaceutical products, but these efforts
may not be successful. Our principal business in North America has traditionally been the development, manufacture
and marketing of generic equivalents of pharmaceutical products first introduced by other
companies. However, we have greatly increased our efforts to develop new proprietary products,
including T-2000 and T2001 (our patented non-sedating barbiturate compounds) and products utilizing
NonSpil (our patented spill-resistant liquid drug delivery system). Expanding our focus beyond generic products and broadening our product pipeline to include new
proprietary products may require additional internal expertise or external collaboration in areas
in which we currently do not have substantial resources and personnel. We may have to enter into
collaborative arrangements with others that may require us to relinquish rights to some of our
technologies or products that we would otherwise pursue independently. We may not be able to
acquire the necessary expertise or enter into collaborative agreements on acceptable terms, if at
all, to develop and market new proprietary products. In addition, although a newly developed product may be successfully manufactured in a
laboratory setting, difficulties may be encountered in scaling up for manufacture in
commercially-sized batches. For this reason and others, only a small minority of all new
proprietary research and development programs ultimately results in commercially successful drugs.
A program (including any program of ours) cannot be deemed successful until it actually produces a
drug that is commercially marketed for a significant period of time. In order to obtain regulatory approvals for the commercial sale of our new proprietary
products, we are required to complete extensive clinical trials in humans to demonstrate the safety
and efficacy of the products to the satisfaction of FDA and regulatory authorities abroad.
Conducting clinical trials is a lengthy, time-consuming and expensive process, and the results of
such trials are inherently uncertain. We have limited experience in conducting clinical trials in
these new product areas. A clinical trial may fail for a number of reasons, including:  
    
    failure to enroll a sufficient number of patients meeting eligibility criteria;  
    
    failure of the new product to demonstrate safety and/or efficacy; 15




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
    
    the development of serious (including life threatening) adverse events (including, for example, side effects caused by or
connected with exposure to the new product); or  
    
    the failure of clinical investigators, trial monitors and other consultants or trial subjects to comply with the trial plan
or protocol. The results from early clinical trials may not be predictive of results obtained in later
clinical trials. Clinical trials may not demonstrate the safety and efficacy of a product
sufficient to obtain the necessary regulatory approvals, or to support a commercially viable
product. Any failure of a clinical trial for a product in which we have invested significant time
or other resources could have a material adverse effect on our results of operations and financial
condition. Even if launched commercially, our proprietary products may face competition from existing or
new products of other companies. These other companies may have greater resources, market access,
and consumer recognition than we have. Thus, even if launched commercially, there can be no
assurance that our proprietary products will be successful or profitable. In addition, advertising
and marketing expenses associated with the launch of a proprietary product may adversely affect the
results of our operations and our financial condition. We may not be able to successfully identify, consummate and integrate recent and/or future
acquisitions. We have in the past pursued, and may in the future pursue, acquisitions of product lines
and/or companies and seek to integrate them into our operations. Acquisitions of additional product
lines and companies involve risks that could adversely affect our future revenues and results of
operations. For example:  
    
    we may not be able to identify suitable acquisition targets or acquire
companies on favorable terms;  
    
    we compete with other companies that may have stronger financial
positions to acquire product lines and companies. We believe that this
competition will increase and may result in decreased availability or
increased prices for suitable acquisition targets;  
    
    we may not be able to obtain the necessary financing, on favorable
terms or at all, to finance any of our potential acquisitions;  
    
    we may not be able to obtain the necessary regulatory approvals,
including the approval of antitrust regulatory bodies, in any of the
countries in which we may seek to consummate potential acquisitions;  
    
    we may ultimately fail to complete an acquisition after we announce
that we plan to acquire a product line or a company;  
    
    we may fail to integrate our acquisitions successfully in accordance
with our business strategy; 16




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
    
    we may choose to acquire a business that is not profitable, either at
the time of acquisition or thereafter;  
    
    acquisitions may require significant management resources and divert
attention away from our daily operations, result in the loss of key
customers and personnel, and expose us to unanticipated liabilities;  
    
    we may not be able to retain the skilled employees and experienced
management that may be necessary to operate businesses we acquire, and
if we cannot retain such personnel, we may not be able to locate and
hire new skilled employees and experienced management to replace them;
or  
    
    we may purchase a company that has contingent liabilities that
include, among others, known or unknown patent or product liability
claims. In the event that we grant licenses to third parties to market or distribute any of our products,
the level of sales of such products and of the manufacturing or license fees that we receive as a
result thereof will depend to a very substantial extent upon the efforts of our licensees. We may, from time to time, grant licenses to unaffiliated third parties, which may or may not
be exclusive, to market or distribute certain of our products. For example, in March, 2005, we
granted exclusive licenses to market and distribute our proprietary Kerasal® and ElixSure® lines of
products in North America to an unaffiliated third party. To the extent that our revenues from the
granting of such licenses (whether in respect of these two product lines or any other products) are
dependent upon the sale of the underlying products (for example, if we receive fees for
manufacturing the products or royalties based upon the sale of the products), to a very substantial
extent such revenues will depend upon the extent, quality and results of the efforts of our
licensees. Our ability to have an impact upon these factors is limited and there can be no
assurance that the revenue that we realize from licensing any product will be sufficient to enable
us to recover our investment in the development of the product. We depend on our ability to protect our intellectual property and proprietary rights, but we may
not be able to maintain the confidentiality, or assure the protection, of these assets. Our success depends, in large part, on our ability to protect our current and future
technologies and products and to defend our intellectual property rights. If we fail to protect our
intellectual property adequately, competitors may manufacture and market products similar to ours.
Numerous patents covering our technologies have been issued to us, and we have filed, and expect to
continue to file, patent applications seeking to protect newly developed technologies and products
in various countries, including the United States. Some patent applications in the United States
are maintained in secrecy until the patent is issued. Because the publication of discoveries tends
to follow their actual discovery by many months, we may not be the first to invent, or file patent
applications on any of our discoveries. Patents may not be issued with respect to any of our patent
applications and existing or future patents issued to or licensed by us may not provide competitive
advantages for our products. Patents that are issued may be challenged, invalidated or circumvented
by our competitors. Furthermore, our patent rights may not prevent our competitors from developing,
using or commercializing products that are similar or functionally equivalent to our products.
Where trade secrets are our sole protection, we may 17




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not be able to prevent third parties from marketing generic equivalents to our products,
reducing prices in the marketplace and reducing our profitability. We also rely on trade secrets, non-patented proprietary expertise and continuing technological
innovation that we seek to protect, in part, by entering into confidentiality agreements with
licensees, suppliers, employees and consultants. These agreements may be breached and there may not
be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of
intellectual property or the applicability of confidentiality agreements. Moreover, our trade
secrets and proprietary technology may otherwise become known or be independently developed by our
competitors. If patents are not issued with respect to products arising from research, we may not
be able to maintain the confidentiality of information relating to these products. Third parties may claim that we infringe on their proprietary rights and may prevent us from
manufacturing and selling certain of our products. There has been substantial litigation in the pharmaceutical industry with respect to the
manufacture, use and sale of new products. These lawsuits relate to the validity and infringement
of patents or proprietary rights of third parties. We may be required to commence or defend against
charges relating to the infringement of patent or proprietary rights. Any such litigation could:  
    
    require us to incur substantial expenses, even if we are insured or successful in the litigation;  
    
    require us to divert significant time and effort of our technical and management personnel;  
    
    result in the loss of our rights to develop or make certain products; and  
    
    require us to pay substantial monetary damages or royalties in order to license proprietary rights from third parties. Although patent and intellectual property disputes within the pharmaceutical industry have
often been settled through licensing or similar arrangements, costs associated with these
arrangements may be substantial and could include the long-term payment of royalties. These
arrangements may be investigated by U.S. regulatory agencies and, if improper, may be invalidated.
Furthermore, the required licenses may not be made available to us on acceptable terms.
Accordingly, an adverse determination in a judicial or administrative proceeding or a failure to
obtain necessary licenses could prevent us from manufacturing and selling some of our products or
increase our costs to market these products. From time to time, we seek to market products before the patents for them expire. In order to
do so in the United States, we must challenge the patent under the procedures set forth in the
Hatch-Waxman Act of 1984. (In the United States, in order to obtain a final approval for a generic
product prior to expiration of certain of the innovators patents, we must, under the terms of the
Drug Price Competition and Patent Term Restoration Act of 1984 (Hatch-Waxman Act), as amended by
the Medicare Prescription Drug Improvement and Modernization Act of 2003, notify the patent holder
as well as the owner of a New Drug Application that we believe that the patents listed in the
Approved Drug Products with Therapeutic Equivalence Evaluations (Orange Book) for the new drug
are either invalid or not infringed by our product.) To the 18




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extent that we engage in patent challenge procedures, we are involved and expect to be
involved in patent litigation regarding the validity or infringement of the originators patent.
Patent challenges are complex, costly and can take a significant amount of time to complete. In addition, when seeking regulatory approval for some of our products, we are required to
certify to regulatory authorities, including the FDA, that such products do not infringe upon third
party patent rights. Filing a certification against a patent gives the patent holder the right to
bring a patent infringement lawsuit against us. Any lawsuit would delay regulatory approval by the
FDA until the earlier of the resolution of such claim or 30 months from the patent holders receipt
of notice of certification. A claim of infringement and the resulting delay could result in
substantial expenses and even prevent us from manufacturing and selling certain of our products. In addition, it is not required that pharmaceutical patents be listed with the Food and Drug
Administration or other regulatory authorities. For example, patents relating to antibiotics might
not be listed in the Orange Book. Any launch of a pharmaceutical product by us that infringes a
patent, whether listed or not, may involve us in litigation; in certain circumstances, litigation
may result in significant damages which could have a material adverse effect on the results of our
operations or financial condition. Our launch of a product prior to a final court decision or the expiration of a patent held by
a third party may result in substantial damages to us. Depending upon the circumstances, a court
may award the patent holder damages equal to three times the patent holders loss of income. If we
are found to infringe a patent held by a third party and become subject to significant damages,
these damages could have a material adverse effect on the results of our operations and financial
condition. Volatility of the market price of our ordinary shares could adversely affect us and our
shareholders. The market price of our ordinary shares may be volatile, has recently been subject to
substantial fluctuation and may, in the future, continue to be subject to wide fluctuations, for
the following reasons, among others:  
    
    actual or anticipated variations in our quarterly operating results or those of our competitors;  
    
    announcements by us or our competitors of new and enhanced products;  
    
    market conditions or trends in the pharmaceutical industry;  
    
    developments or disputes concerning proprietary rights;  
    
    introduction of technologies or product enhancements by others that reduce the need for our products;  
    
    the inaccuracy of, or changes, in financial estimates by securities analysts;  
    
    general economic and political conditions;  
    
    departures of key personnel; 19




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
    
    changes in the market valuations of our competitors;  
    
    regulatory considerations; and  
    
    the other risk factors listed in this section. Three of our directors, and members of their immediate families, currently control 45.6% of the
voting power in our company. Dr. Barrie Levitt, Dr. Daniel Moros, Tal Levitt and members of their immediate families
currently control, through their beneficial ownership of outstanding ordinary shares and founders
shares, approximately 45.6% of the voting power in our company. Dr. Levitt and Dr. Moros are
cousins and Ms. Levitt is Dr. Levitts daughter. By reason of their shareholdings, the Levitt and
Moros families should be able to control the outcome of most actions that require majority
shareholder approval, including the election of directors, the approval of mergers, sales of
substantially all of our assets and other extraordinary transactions that require shareholder
approval. 50% of the voting power in our subsidiary, Taro U.S.A., is held by a corporation which is
controlled by the Chairman and Vice Chairman of Taros Board of Directors and their families. The share capital of Taro U.S.A. is divided into two classes. Taro owns 96.9% of the shares
that have economic rights and 50% of the shares that have voting rights in Taro U.S.A. Taro
Development Corporation, or TDC, owns 3.1% of the shares that have economic rights and 50% of the
shares that have voting rights in Taro U.S.A. Dr. Levitt, Dr. Moros and their families are able to
vote the majority of the outstanding voting shares of TDC and thereby control TDC. Although TDC has
agreed to vote all of its shares in Taro U.S.A. for the election to its board of directors of such
persons as we may designate, TDC may terminate the agreement upon one year written notice. In the
event that TDC were to cease voting its shares in Taro U.S.A. for our designees or otherwise in
accordance with our preference, TDC could prevent us from electing a majority of the board of
directors of Taro U.S.A., effectively block actions that require approval of a majority of the
voting power in Taro U.S.A. and potentially preclude us from consolidating Taro U.S.A. into our
financial statements. Taro U.S.A. accounted for approximately 90% and 87%, of our consolidated
sales during 2003 and 2004, respectively. No citizen or resident of the United States who acquired or acquires any of our ordinary shares at
any time after October 21, 1999 is permitted to exercise more than 9.9% of the voting power in our
company, with respect to such ordinary shares, regardless of how many shares the shareholder owns. In order to reduce our risk of being classified as a Controlled Foreign Corporation under
the United States Internal Revenue Code of 1986, as amended, or the Code, we amended our Articles
of Association in 1999 to provide that no owner of any of our ordinary shares is entitled to any
voting right of any nature whatsoever with respect to such ordinary shares if (a) the ownership or
voting power of such ordinary shares was acquired, either directly or indirectly, by the owner
after October 21, 1999 and (b) the ownership would result in our being classified as a Controlled
Foreign Corporation. This provision has the practical effect of prohibiting each 20




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citizen or resident of the United States who acquired or acquires our ordinary shares after
October 21, 1999 from exercising more than 9.9% of the voting power in our company, with respect to
such ordinary shares, regardless of how many shares the shareholder owns. The provision may
therefore discourage U.S. persons from seeking to acquire, or from accumulating, 15% or more of our
ordinary shares (which, due to the voting power of the founders shares, would represent 10% or
more of the voting power of our company). We face risks related to foreign currency exchange rates. Because some of our revenue, operating expenses, assets and liabilities are denominated in
foreign currencies, we are subject to foreign exchange risks that could adversely affect our
operations and reported results. To the extent that we incur expenses in one currency but earn
revenue in another, any change in the values of those foreign currencies relative to the U.S.
dollar could cause our profits to decrease or our products to be less competitive against those of
our competitors. To the extent that our foreign currency holdings and other assets denominated in a
foreign currency are greater or less than our liabilities denominated in a foreign currency, we
have foreign exchange exposure. Our business requires us to move goods across international borders. Any events that interfere
with, or increase the costs of, the transfer of goods across international borders could have a
material adverse effect on our business. We transport most of our goods across international borders, primarily those of the United
States, Canada and Israel. Since September 11, 2001, there has been more intense scrutiny of goods
that are transported across international borders. As a result, we may face delays, and increases
in costs due to such delays, in delivering goods to our customers. Any events that interfere with,
or increase the costs of the transfer of goods across international borders could have a material
adverse effect on our business. Risks Relating to Our Location in Israel Conditions in Israel affect our operations and may limit our ability to produce and sell our
products. We are incorporated under Israeli law and our principal offices and a significant component of
our manufacturing and research and development facilities are located in Israel. Political,
economic and military conditions in Israel directly affect our operations, and we could be
adversely affected by hostilities involving Israel, the interruption or curtailment of trade
between Israel and its trading partners or a significant downturn in the economic or financial
condition of Israel. Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, as well as incidents of civil
unrest. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian
Authority, Israel frequently has been subject to civil unrest and terrorist activity, with varying
levels of severity. Furthermore, certain parties with whom we do business periodically have
declined to travel to Israel, forcing us to make alternative arrangements where necessary, and the
United States Department of State has issued an advisory regarding travel to Israel, impeding the
ability of travelers to attain travel insurance. As a result, the FDA has at various times
curtailed or prohibited its inspectors from traveling to Israel to inspect the facilities of
Israeli companies, which, should it occur with respect to our company, could result in the FDA
withholding 21




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approval for new products we intend to produce at those facilities. Also, although it has not
yet occurred, the political and security situation in Israel may result in certain parties with
whom we have contracts claiming that they are not obligated to perform their commitments pursuant
to force majeure provisions of those contracts. In addition, since a significant component of our manufacturing and research and development
facilities are located in Israel, we could experience disruption of our manufacturing and research
and development due to terrorist attacks. If terrorist acts were to result in substantial damage to
our facilities, our business activities would be disrupted since, with respect to some of our
products, we would need to obtain prior FDA approval for a change in manufacturing site. Our
business interruption insurance may not adequately compensate us for losses that may occur and any
losses or damages sustained by us could have a material adverse effect on our business. Some neighboring countries, as well as certain companies and organizations, continue to
participate in a boycott of Israeli firms and others doing business with Israel or with Israeli
companies. We are also precluded from marketing our products to certain of these countries due to
U.S. and Israeli regulatory restrictions. Because none of our revenue is currently derived from
sales to these countries, we believe that the boycott has not had a material adverse effect on our
current operations. However, continuation or extension of the boycott and the implementation of
additional restrictive laws, policies or practices directed towards Israel or Israeli businesses
could have an adverse impact on the expansion of our business. Finally, many male Israeli citizens, including our employees, are subject to compulsory annual
military service through middle age. Additionally, these employees are subject to being called to
active duty at any time under emergency circumstances. While we believe that we have operated
relatively efficiently given these requirements, we cannot predict the effect on our business
operations if the conflict with the Palestinians continues to escalate or intensify. Our operations
could be disrupted by the absence for a significant period of one or more of our executive officers
or key employees or a significant number of our other employees due to obligatory military service
requirement. Any disruption in our operations would harm our business. We may be adversely affected if the rate of inflation in Israel exceeds the rate of devaluation of
the New Israeli Shekel, or NIS, against the U.S. dollar. A substantial portion of our expenses, primarily labor and occupancy expenses in Israel, is
incurred in NIS. As a result, the cost of our operations in Israel, as measured in U.S. dollars, is
subject to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the
NIS in relation to the U.S. dollar or that the timing of any devaluation will lag behind inflation
in Israel. If the U.S. dollar cost of our operations in Israel increases, our U.S. dollar-measured
results of operations will be adversely affected. Our operations may be affected by negative economic conditions in Israel. Israel has experienced periods of recession in economic activity in recent years, resulting in
low growth rates and growing unemployment. Our operations could be adversely affected if the
economic conditions in Israel deteriorate. In addition, due to significant economic measures
proposed by the Israeli government, there have been several general strikes and work stoppages in
2003 and 2004, affecting all banks, airports and ports. These strikes have had an adverse effect 22




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on the Israeli economy and on business, including our ability to deliver products to our
customers or to receive raw materials from our suppliers in a timely manner. From time to time,
the Israeli trade unions threaten strikes or work-stoppages, which may, if carried out, have a
material adverse effect on the Israeli economy and us. Government price control policies can materially impede our ability to set prices for our products. All pharmaceutical products sold in Israel are subject to price controls. Permitted price
increases are enacted by the Israeli government as part of a formal review process. The inability
to control the prices of our products may adversely affect our operations. We currently benefit from government programs and tax benefits, both or either of which may be
discontinued or reduced. We currently receive grants and substantial tax benefits under government of Israel programs,
including the Approved Enterprise program and programs of the Office of the Chief Scientist of
the Ministry of Commerce and Industry of the State of Israel. In order to maintain our eligibility
for these programs and benefits, we must continue to meet specified conditions, including making
specified investments in fixed assets from our equity and paying royalties with respect to grants
received. In addition, some of these programs restrict our ability to manufacture particular
products and transfer particular technology outside of Israel. If we fail to comply with these
conditions in the future, the benefits received could be canceled and we could be required to
refund payments previously received under these programs or pay increased payments and/or taxes. In
recent years, the government of Israel has reduced the benefits available under these programs, and
these programs and tax benefits may be discontinued or curtailed in the future. Various proposals
have been put forth for new legislation to amend the benefits available under these programs. We
are not able to predict whether or when this new legislation will be enacted, nor can we predict
the nature and scope of benefits that may be available under any new laws. If the government of
Israel ends these programs and tax benefits, our business, financial condition and results of
operations could be materially adversely affected. Provisions of Israeli law may delay, prevent or make more difficult a merger or acquisition. This
could prevent a change of control and depress the market price of Taros ordinary shares. Provisions of Israeli corporate and tax law may have the effect of delaying, preventing or
making more difficult a merger or acquisition. The Israeli Companies Law, or the Companies Law,
generally requires that a merger be approved by a companys board of directors and by a shareholder
vote at a shareholders meeting that has been called on at least 21 days advance notice by each of
the merger parties. Under our Articles of Association, the required shareholder vote is a
supermajority of at least 75% of the shares voting in person or by proxy on the matter. Any
creditor of a merger party may seek a court order blocking a merger if there is a reasonable
concern that the surviving company will not be able to satisfy all of the obligations of any party
to the merger. Moreover, a merger may not be completed until at least 70 days have passed from the
time that the merger proposal has been filed with the Israeli Registrar of Companies. 23




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##### Table of Contents



Other potential means of acquiring a public Israeli company such as ours might involve
additional obstacles. In addition, a body of case law has not yet developed with respect to the
Companies Law. Until this happens, uncertainties will exist regarding its interpretation. Finally, Israeli tax law treats some acquisitions, such as stock-for-stock exchanges between
an Israeli company and a foreign company, less favorably than do U.S. tax laws. The provisions of
Israeli corporate and tax law and the uncertainties surrounding such laws may have the effect of
delaying, preventing or making more difficult a merger or acquisition. This could prevent a change
of control of Taro and depress the market price of Taros ordinary shares which otherwise might
rise as a result of such a change of control. It may be difficult to effect service of process and enforce judgments against our directors and
officers. We are incorporated in Israel. A majority of our executive officers and directors are
nonresidents of the United States and a substantial portion of our assets and the assets of such
persons are located outside the United States. Therefore, it may be difficult to enforce a judgment
obtained in the United States against us or any of those persons or to effect service of process
upon those persons. It may also be difficult to enforce civil liabilities under U.S. federal
securities laws in original actions instituted in Israel. Risks Relating to Our Location in Canada Government price control policies can materially impede our ability to set prices for our products. The Canadian Government Patented Medicine Prices Review Board, or PMPRB, monitors and controls
prices of patented drug products marketed in Canada by persons holding, or licensed under, one or
more patents. The PMPRB will approve an introductory price (based on a comparative analysis) and
will require that the price not be increased each year thereafter by more than the annual increase
of the Canadian Consumer Price Index. Consequently, the existence of one or more patents relating
to a drug product, while providing some level of proprietary protection for the product, also
triggers a governmental price control regime that significantly affects the Canadian pharmaceutical
industrys ability to set pricing. The inability to control the prices of our products may
adversely affect our operations. Sales of our products in Canada depend, in part, upon their being eligible for reimbursement from
drug benefit formularies. In each province of Canada there is a drug benefit formulary. A formulary lists the drugs for
which a provincial government will reimburse qualifying persons and the prices at which the
government will reimburse such persons. There is not complete uniformity among provinces. However,
provincial governments generally will reimburse the lowest available price of the generic
equivalents of any drug listed on the formulary list of the province. The formularies can also
provide for drug substitution, even for patients who do not qualify for government reimbursement.
The effect of these provincial formulary regimes is to encourage the sale of lower-priced versions
of pharmaceutical products. The potential lack of reimbursement represents a significant threat to
our business. Additionally, the substitution effect may adversely affect our ability to profitably
market our products. 24




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##### Table of Contents



We may be adversely affected if the rate of inflation in Canada exceeds the rate of devaluation of
the Canadian dollar against the U.S. dollar. A substantial portion of our expenses, primarily labor and occupancy expenses in Canada, is
incurred in Canadian dollars. As a result, the cost of our operations in Canada, as measured in
U.S. dollars, is subject to the risk that the rate of inflation in Canada will exceed the rate of
devaluation of the Canadian dollar in relation to the U.S. dollar or that the timing of any
devaluation will lag behind inflation in Canada. If the U.S. dollar cost of our operations in
Canada increases, our U.S. dollar-measured results of operations will be adversely affected. During
the year-ended December 31, 2004, the value of the Canadian dollar has increased 6.9% with respect
to the U.S. dollar. This increase in the value of the Canadian dollar has had the effect of
increasing the cost of our goods manufactured in Canada. 
 ITEM 4. INFORMATION ON THE COMPANY 
 A. HISTORY AND DEVELOPMENT OF THE COMPANY The legal and commercial name of our company is Taro Pharmaceutical Industries Ltd. We were
incorporated under the laws of the State of Israel in 1959 under the name Taro-Vit Chemical
Industries Ltd. In 1984, we changed our name to Taro Vit Industries Ltd. and in 1994 we changed our
name to Taro Pharmaceutical Industries Ltd. In 1961, we completed the initial public offering of our ordinary shares, which are currently
traded on the Nasdaq National Market under the symbol TARO. In that year, we also acquired 97% of
the outstanding stock of an Israeli corporation, then known as Taro Pharmaceutical Industries Ltd.,
or TPIL. In 1981, we sold 37% of our interest in TPIL. In 1993, after acquiring all of the
outstanding shares of TPIL, we merged TPIL into our company. In July 2001, we completed a split of
our ordinary shares by distributing a dividend of one ordinary share for each ordinary share then
outstanding and one ordinary share for every ten founders shares then outstanding. In October
2001, we sold 3,950,000 of our ordinary shares, and selling shareholders sold 1,800,000 of our
ordinary shares, in a public offering. In May 2002, a newly-created subsidiary of Taro U.S.A. purchased substantially all of the
assets of Thames Pharmacal Company, Inc., or Thames, a manufacturer of prescription and OTC
pharmaceuticals. The purchase price was approximately $6.4 million, all of which was paid in cash.
The assets acquired included the right to all of Thames generic prescription and OTC products, as
well as Thames laboratories and manufacturing operations. We also added to our operations all of
Thames approximately 60 employees and acquired the leases for its facilities, which include
laboratories, manufacturing and warehousing operations, located in Ronkonkoma, New York. As of
December 31, 2004, manufacturing operations at this site have been transferred to Canada. On January 14, 2003, Taro Pharmaceuticals North America Inc., or TNA, entered into a license
and option agreement with Medicis Pharmaceutical Corporation, or Medicis. According to the
agreement, TNA, on June 1, 2004, exercised its option and purchased from Medicis four branded
prescription product lines for sale in the United States and Puerto Rico for an aggregate purchase
price of $23.8 million. Approximately $11.7 million was for the licensing period and was payable
over five consecutive quarters. The balance of $12.1 million was due upon the 25




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##### Table of Contents



exercise of the purchase option. Two of these products are used in dermatology and the other
two are used in pediatrics. On March 21, 2003, our Irish subsidiary, Taro Pharmaceuticals Ireland Ltd., acquired, for 5.55
million Euros, a multi-purpose pharmaceutical manufacturing and research facility in Ireland. The
facility was purchased out of liquidation proceedings under the Official Liquidator appointed by
the High Court of Ireland. The facility consists of 124,000 square feet of manufacturing,
laboratory, office and warehouse space located on a 14-acre campus in central Ireland. The
facility, which had been operating until the end of 2002, has been licensed and approved by the
Irish Medicines Board to manufacture and distribute pharmaceutical products in Ireland and the
European Union. In December 2003, our Canadian subsidiary expanded its distribution capacity with the purchase
of a 108,797 square foot distribution facility located on 6.7 acres in Brampton, Ontario in close
proximity to our existing facilities. In January 2004, Taro U.S.A. expanded its distribution capacity with the purchase of a 315,000
square foot distribution center on 25 acres of land in South Brunswick, New Jersey. Taro U.S.A.
acquired the facility for approximately $18 million. In conjunction with the purchase, the U.S.
subsidiary receives certain financial incentives from the New Jersey Economic Development
Authority. In July 2004, Taro U.S.A. entered into a license and option agreement with Medicis for four
products including the Lustra® product line. These products are used for the treatment of
dyschromia or discoloration of the skin. In March 2005, the Company divested the ElixSure® and Kerasal® brands in North America.
However, the Company will continue to manufacture and supply these products from its Canadian
plant. Our principal executive offices are located at Yakum Business Park, Yakum 60972, Israel. Our
telephone number at that address is +972-9-971-1800. Our registered office is located at 14
Hakitor Street, Haifa Bay 26110, Israel. Our telephone number at that address is +972-4-847-5700. Capital Expenditures During 2004, 2003 and 2002, our capital expenditures were approximately $72.3 million, $94.4
million and $43.2 million, respectively. The focus of our capital expenditure program has been the
expansion and upgrade of our manufacturing facilities and information technology systems in order
to enable us to increase operational efficiencies, remain in compliance with cGMP, accommodate
increasing demand for our products, and maintain a competitive position in the marketplace. The major projects undertaken during the past three years, as part of our capital expenditure
program, include:  
    
    the expansion of our production and distribution facilities in Canada and Israel; 26




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##### Table of Contents




    
    the construction of new research, development and manufacturing facilities in Canada and Israel;  
    
    the acquisition of additional production and packaging equipment;  
    
    the upgrade of our information technology systems;  
    
    acquisition of additional land in Haifa Bay, Israel for expansion of our facilities;  
    
    acquisition of a facility (previously rented by us) in Canada;  
    
    acquisition of Thames;  
    
    acquisition of a 124,000 square feet building in Hawthome, N.Y. for the research laboratory and administrative offices of
Taro U.S.A.;  
    
    acquisition of a multi-purpose pharmaceutical manufacturing and research facility in Ireland;  
    
    acquisition of a distribution center facility in New Jersey;  
    
    acquisition of a distribution facility in Ontario, Canada; and  
    
    acquisition of product rights to Topicort®, Ovide®, Primsol®, A/T/S®, and Lustra® in the United States. We have not launched A/T/S® and the rights to Primsol® were sold in March, 2005. In addition, during the above period, in anticipation of an increase in sales and the overall
growth of our operations, we purchased, leased or contracted to purchase additional properties and
ordered new equipment for construction of new multi-purpose pharmaceutical and chemical plants in
Haifa Bay, Israel. (For a detailed presentation of our property, plant and equipment, please see
Note 5 to our consolidated financial statements included elsewhere in this report.) 
 B. BUSINESS OVERVIEW We are a multinational, science-based pharmaceutical company. We develop, manufacture and
market prescription and OTC pharmaceutical products, as well as active pharmaceutical ingredients,
or APIs, primarily in the United States, Canada and Israel. Our primary areas of focus include
topical creams and ointments, liquids, capsules and tablets, mainly in the dermatological,
cardiovascular and central nervous system therapeutic categories. We operate principally through
three entities: Taro Pharmaceutical Industries Ltd., or Taro Israel, and two of its subsidiaries,
Taro Pharmaceuticals Inc., or Taro Canada, and Taro U.S.A. The principal activities and primary
product lines of these subsidiaries may be summarized as follows: 27




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##### Table of Contents



Entity
    
    Principal Activities
    
    Primary Product LinesTaro Israel
    
    
    
    Manufactures more than 65 finished dosage form
pharmaceutical products for sale in Israel and
for export
    
    
    
    Dermatology: Prescription and OTC semi-solid
products (creams, ointments and gels) and liquids
    
    Produces, for its own use and for sale to third
parties, APIs used in the manufacture of
finished dosage form pharmaceutical products
    
    
    
    Cardiology and Neurology: Prescription oral dosage
products
    
    Markets both proprietary and generic products
in the local Israeli market
    
    
    
    Oral Analgesics: Prescription and OTC
    
    Performs research and development independently
and through Taro Research Institute Ltd., a
wholly-owned subsidiary
    
    
    
    OTC Nasal Sprays and Nutritional Supplements
Oral, Opthalmic and OTC preparationsTaro Canada
    
    
    
    Manufactures more than 45 finished dosage form
pharmaceutical products for sale in Canada and
for export
    
    
    
    Dermatology: Prescription and OTC semi-solid
products (creams, ointments and gels) and liquids
    
    Markets both proprietary and generic products
in the local Canadian market
    
    
    
    Cardiology and Neurology: Prescription oral dosage
products
    
    Independently performs research and development
and through Taro Research Institute Ltd.Taro U.S.A.
    
    
    
    Markets and distributes both proprietary and
generic products in the local U.S. market
    
    
    
    Dermatology: Prescription and OTC semi-solid
products (creams, ointments and gels) and liquids
    
    Performs research and development
    
    
    
    Cardiology and Neurology: Prescription oral dosage
products
    
    Other prescription and OTC products
 Warfarin sodium tablets are sold as Coumadin® by us in Israel under the brand-name, and as
generic warfarin sodium tablets in the United States, Canada, the United Kingdom, and elsewhere.
This product accounted for 10% of our sales in 2004. As of June 20, 2005, 25 of our ANDAs and one NDA are being reviewed by the FDA. In addition,
there are several products for which either development or internal regulatory work is in process.
The applications pending before the FDA are at various stages in the review process, and there can
be no assurance that we will be able to successfully complete any remaining testing or that, upon
completion of such testing, approvals for any of the applications currently under review at the FDA
will be granted. In addition, there can be no assurance that the FDA will not grant approvals for
competing products submitted by our competitors, prior to or simultaneous with the granting of
approval to us. The Generic Pharmaceutical Industry Generic pharmaceuticals are the chemical and therapeutic equivalents of brand-name drugs and
are typically marketed after the patents for brand-name drugs have expired. Generic pharmaceuticals
generally must undergo clinical testing that demonstrates that they are 28




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bioequivalent to their branded equivalents and are manufactured to the same standards. Proving
bioequivalence generally requires data demonstrating that the generic formulation results in a
product whose rate and extent of absorption are within an acceptable range of the results achieved
by the brand-name reference drug. In some instances, bioequivalence can be established by
demonstrating that the therapeutic effect of the generic formula falls within an acceptable range
of the therapeutic effects achieved by the brand-name reference drug. Generic pharmaceutical products must meet the same quality standards as branded pharmaceutical
products although they are sold at prices that are substantially lower than those of their branded
counterparts. As a result, generic pharmaceuticals represent a much larger percentage of total drug
prescriptions dispensed than their corresponding percentage of total sales. This discount tends to
increase (and margins tend to decrease) as the number of generic competitors increases for a given
product. Because of this pricing dynamic, companies that are among the first to develop and market
a generic pharmaceutical tend to earn higher profits than companies that subsequently enter the
market for that product. Furthermore, products that are difficult to develop or are intended for
niche markets generally attract fewer generic competitors and therefore may offer higher profit
margins than those products that attract a larger number of competitors. However, profit is
influenced by many factors other than the number of competitors for a given drug or the size of the
market. Depending on the actions of each of our competitors, price discounts can be just as
significant for a specific product with only a few competitors or a small market, as for a product
with many competitors or a large market. In recent years, the market for generic pharmaceuticals has grown dramatically. We believe
that this growth has been driven by the following factors, among others:  
    
    efforts by governments, employers, third-party payors and consumers to control healthcare costs;  
    
    increased acceptance of generic products by physicians, pharmacists and consumers; and  
    
    the increasing number of pharmaceutical products whose patents have expired and are therefore subject to competition from,
and substitution by, generic equivalents. 29




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##### Table of Contents



Products We currently market more than 180 pharmaceutical products in over 20 countries. The following
table represents some of our key product groups and the major markets in which they are sold: U.S. Brand
    
    Therapeutic
    
    Major
    
    Rx/Product Groups
    
    Dosage Form
    
    Name*
    
    Category
    
    Markets
    
    OTCAmiodarone HCI
    
    tablets
    
    Cordarone ®
    
    Cardiovascular
    
    U.S.
    
    RxAmmonium Lactate
    
    cream, lotion
    
    Lac-Hydrin ®
    
    Moisturizer
    
    U.S.
    
    Rx/Canada
    
    OTCBethamethasone
    
    cream, gel
    
    Diprolene ®
    
    Topical
    
    U.S.
    
    RxDipropionate
    
    
    
    
    
    Corticosteroid(augmented)Carbamazepine
    
    tablets, controlled
    
    Tegretol ®
    
    Anticonvulsant
    
    U.S.
    
    Rxrelease tablets,
    
    
    
    
    
    Canadachewable tablets,
    
    
    
    
    
    Israeloral suspensioncream, ointmentClobetasol Propionate
    
    gel, topical solution,
    
    Temovate ®
    
    Topical
    
    U.S.
    
    Rxemollient cream
    
    
    
    CorticosteroidClorazepate
    
    tablets
    
    Tranxene ®
    
    Antianxiety
    
    U.S.
    
    RxDipotassiumClotrimazole
    
    cream, topical
    
    Lotrimin ®/
    
    Antifungal
    
    U.S.
    
    Rx/solution, vaginal
    
    Gyne-Lotrimin ®
    
    
    
    Canada
    
    OTCcreamClotrimazole and
    
    cream, lotion
    
    Lotrisone ®
    
    Antifungal
    
    Israel
    
    RxBetametasone
    
    
    
    
    
    
    
    U.S.DipropionateDesonide
    
    cream, ointment
    
    Tridesilon ®
    
    Topical
    
    U.S.
    
    RxCorticosteroidDesoximetasone
    
    cream, ointment, gel
    
    Topicort ® **
    
    Topical
    
    U.S.
    
    RxCorticosteroid
    
    CanadaIsraelDiflorasone Diacetate
    
    cream, ointment
    
    Psorcon ®
    
    Topical
    
    U.S.
    
    RxCorticosteroidEconazole Nitrate
    
    cream
    
    Spectazole ®
    
    Antifungal
    
    U.S.
    
    RxEnalapril
    
    tablets
    
    Vasotec ®
    
    Cardiovascular
    
    U.S.
    
    RxEnalapril and
    
    tablets
    
    Vaseretic ®
    
    Cardiovascular
    
    U.S.
    
    RxHydrochlorothiazideEtodolac
    
    tablets, capsules
    
    Lodine ®
    
    Analgesic
    
    U.S.
    
    RxCanadaIsraelEtodolac
    
    extended release
    
    Lodine® XL
    
    Analgesic
    
    U.S.
    
    Rxtablets
    
    
    
    
    
    IsraelFluconazole
    
    tablets
    
    Diflucan ®
    
    Antifungal
    
    U.S.
    
    RxFluocinonide
    
    cream, ointment,
    
    Lidex ®
    
    Topical
    
    U.S.
    
    Rxgel, topical
    
    
    
    Corticosteroid
    
    Canadasolution, emollientcreamFluorouracil
    
    solution
    
    Efudex ®
    
    Topical
    
    U.S.
    
    RxHalobetasol
    
    ointment
    
    Ultravate ®
    
    Topical
    
    U.S.
    
    RxPropionate
    
    
    
    
    
    Corticosteroid
 30




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##### Table of Contents



U.S. Brand
    
    Therapeutic
    
    Major
    
    Rx/Product Groups
    
    Dosage Form
    
    Name*
    
    Category
    
    Markets
    
    OTCHydrocortisone
    
    cream, ointment
    
    Westcort ®
    
    Topical
    
    U.S.
    
    RxValerate
    
    
    
    
    
    CorticosteroidHydrocortisone
    
    cream, ointment
    
    Cortizone ®
    
    First Aid
    
    U.S.
    
    OTCCanadaIsraelKetoconazole
    
    tablets, cream
    
    Nizoral ®
    
    Antifungal
    
    U.S.
    
    RxMalathion
    
    lotion
    
    Ovide ® **
    
    Pediculicide
    
    U.S.
    
    RxMiconazole Nitrate
    
    vaginal cream, cream
    
    Monistat® 3
    
    Antifungal
    
    U.S.
    
    OTCMonistat® 7Micatin®Mometasone Furoate
    
    cream, ointment
    
    Elocon ®
    
    Topical
    
    U.S.Corticosteroid
    
    
    
    RxNystatin
    
    oral suspension,
    
    Mycostatin ®
    
    Antifungal
    
    U.S.
    
    Rxvaginal cream
    
    
    
    
    
    CanadaIsraelSalicyclic Acid and
    
    ointment
    
    Kerasal ® ***
    
    Exfoliating
    
    U.S.
    
    OTCUrea
    
    
    
    
    
    Moisturizer
    
    CanadaTerconazole
    
    vaginal cream
    
    Terazol ®
    
    Antifungal
    
    U.S.
    
    RxTriamcinolone
    
    cream, ointment,
    
    Kenalog ®
    
    Topical
    
    U.S.
    
    RxAcetonide
    
    dental paste
    
    
    
    Corticosteroid
    
    CanadaIsraelWarfarin Sodium
    
    tablets
    
    Coumadin ®
    
    Anticoagulant
    
    U.S.
    
    RxCanadaIsrael
 
 *
    
    Presented in this column are the brand-names under which the products are most commonly
prescribed in the United States. Except as noted below, we do not own any of the specific
names. In some cases, we manufacture and sell the generic equivalent of the product sold by
the third party owner of such name. Thus, for example, we sell our product Warfarin Sodium
under that name in the United States. Warfarin is the generic equivalent of Coumadin, a
product sold under that name in the United States by the third party owner of the U.S. rights
to that name and by us in Israel, where we own the right to use that name.**
    
    Taro brands***
    
    Brand rights for North America were sold on March 3, 2005. Topical corticosteroids are used in the treatment of some dermatologic conditions
(including psoriasis, eczema and various types of skin rashes). Antifungals are used in the
treatment of some infections (including athletes foot, ringworm and vaginal yeast infections).
Anticonvulsants are used in the treatment of various seizure disorders (including epilepsy).
Cardiovascular products are used in the treatment of heart disease. There are several categories of
cardiovascular drugs, including anticoagulants, antihypertensive and antiarrhythmics.
Anticoagulants are blood thinners used in the treatment of heart disease and stroke associated with
heart disease. Sales and Marketing In the United States, Israel and Canada, our sales are primarily generated by our own
dedicated sales force. In other countries, we sell through agents and other distributors. Our sales
force is supported by our medical representatives, customer service, and marketing employees. 31




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##### Table of Contents



The following is a breakdown of our sales by geographic region, including the percentage of
our total consolidated sales for each period: 2004
    
    
    2003
    
    
    2002In
    
    
    % of our
    
    
    In
    
    
    % of our
    
    
    In
    
    
    % of ourthousands
    
    
    total sales
    
    
    thousands
    
    
    total sales
    
    
    thousands
    
    
    total salesU.S.A.
    
    $
    247,765
    
    
    
    87
    %
    
    $
    283,197
    
    
    
    90
    %
    
    $
    183,857
    
    
    
    87
    %Canada
    
    
    18,353
    
    
    
    6
    %
    
    
    15,603
    
    
    
    5
    %
    
    
    12,819
    
    
    
    6
    %Israel
    
    
    14,587
    
    
    
    5
    %
    
    
    13,468
    
    
    
    4
    %
    
    
    11,809
    
    
    
    5
    %Other
    
    
    3,425
    
    
    
    2
    %
    
    
    3,190
    
    
    
    1
    %
    
    
    3,096
    
    
    
    2
    %Total
    
    $
    284,130
    
    
    
    100
    %
    
    $
    315,458
    
    
    
    100
    %
    
    $
    211,581
    
    
    
    100
    %
 In 2004, sales in the United States accounted for approximately 87% of our total consolidated
sales. In addition to marketing prescription drugs, Taro U.S.A. markets its generic OTC products
primarily as store brands under its customers labels to wholesalers, drug chains, food chains and
mass merchandisers. During 2004, we sold to approximately 250 customers in the United States. The
following table represents sales to our three largest wholesale customers as a percent of
consolidated sales during the last three years: Customer
    
    2004

    
    2003

    
    2002AmerisourceBergen Corporation
    
    
    16
    %
    
    
    20
    %
    
    
    22
    %McKesson Corporation
    
    
    15
    %
    
    
    17

    %
    
    
    12
    %Cardinal Health, Inc.
    
    
    8
    %
    
    
    9
    %
    
    
    9
    %
 The following table sets forth the contributions to sales by each type of customer of Taro
U.S.A. in 2004: Percentage ofCustomer
Type
    
    Consolidated SalesDrug wholesalers
    
    
    43%Drug store chains
    
    
    17%Mass merchandisers food and retail chains
    
    
    15%Generic drug distributors
    
    
    7%Managed care organizations
    
    
    5%
 In 2004, sales in Israel accounted for approximately 5% of our total consolidated sales. The
marketing, sales and distribution of prescription pharmaceuticals and OTC products in Israel is
closely monitored by the Israeli government. The market for these products is dominated by
institutions that are similar to health maintenance organizations in the United States, as well as
private pharmacies. Most of our marketing efforts in Israel focus on selling directly to these
groups. In 2004, sales to other international markets accounted for approximately 1% of our
consolidated sales. All pharmaceutical products sold in Israel are subject to price controls. Permitted price
increases are enacted by the Israeli government as part of a formal review process. In addition,
recently enacted parallel import regulations are expected to further increase pressure within the
industry to lower prices on prescription products. There are no restrictions on the import of
pharmaceuticals, provided that they comply with registration requirements of the Israeli Ministry
of Health. 32




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##### Table of Contents



In Israel, the pharmaceutical market generally is divided into two market segments: (i) the
private market, which includes drug store chains, private pharmacies and wholesalers; and (ii) the
institutional market, which includes Kupat Holim Clalit or Kupat Holim (the largest health
maintenance organization in Israel), the Israel Ministry of Health and other health insurance
groups. The following table sets forth the contributions to sales by each type of customer of Taro
Israel and other international markets in 2004: Percentage ofCustomer
Type
    
    Consolidated SalesInstitutional market
    
    
    4%Private market
    
    
    2%Other international markets
    
    
    1%
 In 2004, sales in Canada accounted for approximately 6% of our total consolidated sales. Taro
Canada has approximately 600 customers, which consist primarily of independent pharmacies. The following table sets forth the contributions to sales by each type of customer of Taro
Canada in 2004: Percentage ofCustomer
Type
    
    Consolidated SalesDrug wholesalers
    
    
    4%Drug chains, independent pharmacies and others
    
    
    2%
 We have expanded the production capacity of our Israeli and Canadian operations to meet
anticipated demand for our products. In addition, we utilize contract manufacturing for certain
products to satisfy customer demand in a timely manner. As a result, in each of 2002, 2003 and
2004, backorders generally represented less than one percent (1%) of our consolidated sales. Competition and Pricing The pharmaceutical industry is intensely competitive. We compete with the original
manufacturers of the brand-name equivalents of our generic products, other generic drug
manufacturers (including brand-name companies that also manufacture generic drugs or license their
products to other generic drug manufacturers), and manufacturers of new drugs that may compete with
our generic drugs. Many of our competitors have greater financial, production and research and
development resources, substantially larger sales and marketing organizations, and substantially
greater name recognition than we have. Historically, brand-name drug companies have attempted to prevent generic drug manufacturers
from producing certain products and to prevent competing generic drug products from being accepted
as equivalent to their brand-name products. We expect such efforts to continue in the future. Also,
some brand-name competitors, in an attempt to participate in the generic drug sales of their
branded products, have introduced generic equivalents of their own branded products, both prior and
subsequent to the expiration of their patents or FDA exclusivity periods for such drugs. These
competitors have also introduced generic equivalents of brand-name drug products other than their
own. 33




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In the United States, we compete with such brand-name manufacturers as Novartis,
Schering-Plough, Medicis Pharmaceutical, GlaxoSmithKline and Bristol-Myers Squibb, as well as with
generic companies such as Alpharma, Altana, Barr Laboratories, Perrigo, Mylan Laboratories, QLT,
Sandoz Pharmaceuticals, Teva Pharmaceuticals U.S.A. and Warrick Pharmaceuticals. These companies
have more resources, market and name recognition and better access to customers than we have.
Therefore, there can be no assurance of the success of any of our products. We compete in the Canadian market with Hoffmann-La Roche, Schering Canada, Novartis,
GlaxoSmithKline, Bayer and Bristol-Myers Squibb Canada, as well as with other manufacturers of
generic products, such as Apotex, Novopharm (Teva), Ratiopharm, Genpharm and Pharmascience. Pricing in Canada is established in part by competitive factors and in part by Canadian
formulary price lists published by the Canadian provinces. In Israel, we compete with Teva Pharmaceuticals Industries, Ltd., Agis Industries (1983) Ltd.,
Dexxon Ltd. and Rafa Laboratories Ltd., among others. In addition, many leading multinational
companies, including Bayer, Eli Lilly, Merck and Pfizer, market their products in Israel. In Israel, the government establishes the prices for pharmaceutical products as part of a
formal review process. In addition, recently enacted parallel import regulations are expected to
further increase pressure within the industry to lower prices. There are no restrictions on the
import of pharmaceuticals provided that they comply with registration requirements of the Israeli
Ministry of Health. Manufacturing and Raw Materials We currently manufacture finished pharmaceutical products at our government approved
facilities in Canada and Israel and active pharmaceutical ingredients at our facilities in Israel.
We have expanded our research and development and warehousing facilities. For the manufacture of our finished dosage form pharmaceutical products, we use pharmaceutical
chemicals that we either produce ourselves or purchase from chemical manufacturers in the open
market globally. Substantially all of such chemicals are obtainable from a number of sources,
subject to regulatory approval. However, we purchase certain raw materials from single source
suppliers. The decision to purchase APIs is a function of our sales
forecast and prevailing prices in the market. When appropriate
purchasing opportunities arise, the Company may acquire certain APIs
in excess of its ordinary requirements or rate of growth. Obtaining the regulatory approvals required to add alternative suppliers of such raw
materials for products sold in the United States or Canada may be a lengthy process. We strive to
maintain adequate inventories of single source raw materials in order to ensure that any delays in
receiving such regulatory approvals will not have a material adverse effect on our business.
However, we may become unable to sell certain products in the United States or Canada pending
approval of one or more alternate sources of raw materials. We synthesize the active pharmaceutical ingredients used in some of our key products,
including our warfarin sodium tablets, our carbamazepine products, our etodolac tablets, and our
clorazepate dipotassium tablets. We plan to continue the strategic selection of active
pharmaceutical ingredients for synthesis in order to maximize the advantages from this scientific
and manufacturing capability. 34




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Industry Practices Relating to Working Capital Items Certain customary industry selling practices affect our supply of working capital, including,
but not limited to, providing favorable payment terms to customers and discounting selling prices
through the issuance of free products as well as other incentives within a specified time frame if
a customer purchases more than a specified threshold of a product. These incentives are provided
principally with the intention of maintaining or expanding our distribution to the detriment of
competing products. Industry practice requires that pharmaceutical products be made available to customers from
existing stock rather than on a made-to-order basis. Therefore, in order to accommodate market
demand adequately, we strive to maintain a sufficient level of inventory. In 2004, we initiated an
inventory reduction program as a result of a change in market conditions for our products. This
program necessitated a decrease in production output and a reduction in manufacturing personnel. Government Regulation We are subject to extensive pharmaceutical industry regulation in the United States, Canada,
Israel and other jurisdictions, and may be subject to future legislative and other regulatory
developments concerning our products and the healthcare field generally. Any failure by us to
comply with applicable policies and regulations of any of the numerous authorities that regulate
our industry could have a material adverse effect on our results of operations. In the United States, Canada, Israel and other jurisdictions, the manufacture and sale of
pharmaceutical products are regulated in a similar manner. Legal requirements generally prohibit
the handling, manufacture, marketing and importation of any pharmaceutical product unless it is
properly registered in accordance with applicable law. In addition, approval is required before any
new drug or a generic equivalent to a previously approved drug can be marketed. Furthermore, each
country requires approval of manufacturing facilities, including adherence to good manufacturing
practices during the production and storage of pharmaceutical products. As a result, we have had
periodic inspections of our facilities and records. For example, Taro Canada was inspected by the
FDA in 1995, 1996, 1998, 2001 and 2005. Our facilities in Haifa Bay, Israel were inspected by the
FDA in 1996, 1997, 1999 and 2002, and by the Irish Medicines Board in 2005. Regulatory authorities in each country also have extensive enforcement powers over the
activities of pharmaceutical manufacturers, including the power to seize, force the recall of and
prohibit the sale or import of non-complying products and to halt the operations of and criminally
prosecute and fine non-complying manufacturers. These regulatory authorities also have the power to
revoke approvals previously granted and remove from the market previously approved drug products. In the United States, Canada, Israel and other jurisdictions, we, as well as other
manufacturers of drugs, are dependent on obtaining timely approvals for products. The approval
process in each country has become more rigorous and costly in recent years. There can be no
assurance that approvals will be granted in a timely manner or at all. In the United States,
Canada, Israel and other jurisdictions, the procedure for drug product approvals, if such approval
is ultimately 35




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granted, generally takes longer than one year. Inability or delay in obtaining approvals for
our products could adversely affect our product introduction plans and our results of operations. In the United States, any drug that is not generally recognized as safe and effective by
qualified experts for its intended use is deemed to be a new drug which requires FDA approval.
Approval is obtained, either by the submission of an ANDA or an NDA. If the new drug is a new
dosage form, a strength not previously approved, a new indication or an indication for which the
ANDA procedure is not available, an NDA is required. We generally receive approval for generic products by submitting an ANDA to the FDA. When
processing an ANDA, the FDA waives the requirement of conducting complete clinical studies,
although it may require bioavailability and/or bioequivalence studies. Bioavailability is
generally determined by the rate and extent of absorption and levels of concentration of a drug
product in the blood stream needed to produce a therapeutic effect. Bioequivalence compares the
bioavailability of one drug product with another and, when established, indicates that the rate of
absorption and levels of concentration of a generic drug in the body or on the skin are
substantially equivalent to the previously approved brand-name reference drug. An ANDA may be
submitted for a drug on the basis that it is bioequivalent to a previously listed drug, contains
the same active ingredient, has the same route of administration, dosage form, and strength as the
listed drug, and otherwise complies with legal and regulatory requirements. There can be no
assurance that approval for ANDAs can be obtained in a timely manner, or at all. ANDA approvals are
granted after the review by the FDA of detailed information submitted as part of the ANDA regarding
the pharmaceutical ingredients, drug production methods, quality control, labeling, and
demonstration that the product is therapeutically equivalent or bioequivalent to the brand-name
reference drug. Demonstrating bioequivalence generally requires data demonstrating that the generic
formula results in a product whose rate and extent of absorption are within an acceptable range of
the results achieved by the brand-name reference drug. In some instances, bioequivalence can be
established by demonstrating that the therapeutic effect of the generic formula falls within an
acceptable range of the therapeutic effects achieved by the brand-name reference drug. Approval of
an ANDA, if granted, generally takes more than one year from the submission of the application. Products resulting from our proprietary drug program may require us to submit an NDA to the
FDA. When processing an NDA, the FDA generally requires, in addition to the ANDA requirements
(except for bioequivalence), complete pharmacological and toxicological studies in animals and
humans to establish the safety and efficacy of the drug. However, the clinical studies required
prior to the NDA submission are both costly and time consuming, and often take five to seven years
or longer, depending, among other factors, on the nature of the chemical ingredients involved and
the indication for which the approval is sought. Approval of an NDA, if granted, generally takes at
least one year from the submission of the application to the FDA. Among the requirements for drug approval by the FDA is that manufacturing procedures and
operations conform to cGMP as defined in the U.S. Code of Federal Regulations. The cGMP regulations
must be followed at all times during the manufacture of pharmaceutical products. In complying with
the standards set forth in the cGMP regulations, a manufacturer must expend time, money and effort
in the areas of production and quality control to ensure full compliance. If the FDA believes a company is not in compliance with cGMP, certain sanctions may be
imposed, including: (i) withholding new drug approvals as well as approvals for supplemental 36




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changes to existing applications; (ii) preventing the receipt of necessary licenses to export
products; (iii) preventing the importation of certain products into the United States; (iv)
classifying the company as an unacceptable supplier and thereby disqualifying the company from
selling products to federal agencies and (v) pursuing a consent decree or court action that limits
company operations or imposes monetary fines. We believe that we are currently in substantial
compliance with cGMP. In addition, because we market a controlled substance in the United States and other
controlled substances in Israel, we must meet the requirements of the United States Controlled
Substances Act and its equivalents in Canada and Israel, as well as the regulations promulgated
thereunder in each country. These regulations include stringent requirements for manufacturing
controls, receipt and handling procedures and security to prevent diversion of, or the unauthorized
access to, the controlled substances in each stage of the production and distribution process. In May 1992, the Generic Drug Enforcement Act of 1992, or the Generic Act, was enacted. The
Generic Act, a result of legislative hearings and investigations into the generic drug approval
process, allows the FDA to impose debarment and other penalties on individuals and companies that
commit certain illegal acts relating to the generic drug approval process. In some situations, the
Generic Act requires the FDA not to accept or review for a period of time, ANDAs from a company or
an individual that has committed certain violations. It also provides for temporary denial of
approval of applications during the investigation of certain violations that could lead to
debarment and also, in more limited circumstances, provides for the suspension of the marketing of
approved drugs by the affected company. Lastly, the Generic Act allows for civil penalties and withdrawal of previously approved
applications. To our knowledge, neither we nor any of our employees has ever been subject to
debarment. The review process in Canada and Israel is substantively similar to the review process in the
United States. Environmental Compliance We believe that we are currently in compliance with all applicable environmental laws and
regulations in Canada, the United States and Ireland. In Israel, in light of the continued
expansion of our Haifa Bay facility and an enhanced general enforcement program instituted by the
Israeli Ministry of the Environment, we have taken steps to improve our waste water treatment
facility and plan to further upgrade our facility in accordance with a plan submitted to the
Ministry. The cost of this program is not anticipated to have a material adverse effect on our
business or operations. However, environmental laws and regulations may become more stringent and
therefore require us to commit substantial additional resources which are beyond our current plan. 37




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C. ORGANIZATIONAL STRUCTURE The legal and commercial name of our company is Taro Pharmaceutical Industries Ltd. We were
incorporated under the laws of the State of Israel in 1959 under the name Taro-Vit Chemical
Industries Ltd. In 1984, we changed our name to Taro Vit Industries Ltd., and in 1994, we changed
our name to Taro Pharmaceutical Industries Ltd. The following is a list of our significant subsidiaries and their countries of incorporation
as of December 31, 2004: Name of Subsidiary
    
    Country of IncorporationTaro Research Institute Ltd.
    
    IsraelTaro Pharmaceuticals U.S.A., Inc.
    
    United StatesTaro Pharmaceuticals Inc.
    
    CanadaTaro Pharmaceuticals North America, Inc.
    
    Cayman IslandsTaro Pharmaceuticals Europe B.V.
    
    The NetherlandsTaro Pharmaceuticals Ireland Ltd.
    
    Ireland
 See Note 2c to our consolidated financial statements included elsewhere in this annual report for
information regarding the ownership of Taro U.S.A. Taro owns, directly or indirectly, 100% of the
ownership and voting interests in the other subsidiaries listed above. 
 D. PROPERTY, PLANT AND EQUIPMENT The following is a list of our principal facilities as of December 31, 2004: SquareLocation
    
    Footage
    
    Main Use
    
    Own/LeaseHaifa Bay, Israel
    
    
    325,000
    
    
    Pharmaceutical manufacturing,
production laboratories, offices,
warehousing, chemical production
(including tank farm and chemical
finishing plant), and research
facility
    
    OwnHaifa Bay, Israel
    
    
    10,000
    
    
    Warehouse, maintenance
    
    LeaseYakum, Israel
    
    
    15,000
    
    
    Administrative offices
    
    LeaseBrampton, Canada
    
    
    250,800
    
    
    Pharmaceutical manufacturing,
production laboratories,
laboratories, administration,
distribution and warehousing
    
    OwnBrampton, Canada
    
    
    75,400
    
    
    Administration and warehousing
    
    LeaseHawthorne, New York
    
    
    124,000
    
    
    Research laboratory and
administrative offices
    
    OwnHawthorne, New York
    
    
    102,000
    
    
    Administrative offices and
warehousing
    
    LeaseSouth Brunswick, New Jersey
    
    
    315,000
    
    
    Distribution facility
    
    OwnRoscrea, Ireland
    
    
    124,000
    
    
    Pharmaceutical manufacturing,
research laboratories and
warehousing
    
    Own
 38




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Our plant, research and office facilities in Haifa Bay, Israel are located in a complex of
buildings with an aggregate area of approximately 325,000 square feet. We lease much of the land
underlying these facilities from the Israel Land Authority pursuant to long-term ground leases that
expire between 2009 and 2049. We have the option to renew each lease for an additional 49 years. We
also lease approximately 10,000 square feet of adjacent space in Haifa Bay. The lease for this
property commenced in January 2001, with an option to purchase this property at the termination of
the lease. For additional information, please refer to Note 5 to our consolidated financial
statements included elsewhere in this annual report. Since December 2000, we have purchased approximately 600,000 square feet of land adjacent to
the Haifa Bay plant for expansion of our manufacturing and warehouse facilities. We lease
approximately 15,000 square feet of space in a facility located in Yakum, Israel, which is used for
administrative and marketing offices. In February 2002, Taro Canada purchased 74,000 square feet of space that it had leased since
March 1997 adjacent to the 68,000 square foot main manufacturing facility which it owns in
Brampton, Canada. In September 2000, Taro Canada leased an additional 75,400 square feet of office
and warehouse space, adjacent to the other two facilities, for a period of five years, with renewal
options, which can extend the lease period for an additional twenty years. In December 2003, Taro
Canada purchased a 108,797 square foot building in close proximity to its existing facilities for
$3.6 million. This building is used for warehousing and distribution. In August 2002, Taro U.S.A. purchased a 32% interest in a 124,000 square foot building in
Hawthorne, NY, in which it located its U.S. research operations for approximately $4.4 million. In February 2005, Taro U.S.A. exercised its option to purchase the remaining 68% interest in
this building and, in May 2005, Taro U.S.A. consolidated its administrative offices and research
laboratory to this location. In January 2004, Taro U.S.A. purchased a 315,000 square foot distribution facility in South
Brunswick, New Jersey for approximately $18 million. In addition, Taro U.S.A. leases approximately 102,000 square feet of office and warehouse
space in Hawthorne, New York pursuant to two leases that expire in July 2007. In May 2004, we
consolidated the warehouse and distribution operations of Taro U.S.A. into our South Brunswick, New
Jersey facility. 
 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 
 A. OPERATING RESULTS The following discussion should be read in conjunction with our consolidated financial
statements and related notes for the three years ended December 31, 2004, which are included
elsewhere in this annual report. OVERVIEW We are a multinational, science-based pharmaceutical company. We develop, manufacture and
market prescription and OTC pharmaceutical products, as well as active pharmaceutical ingredients,
primarily in Israel, Canada and the United States. Our primary areas of focus include 39




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topical creams and ointments, liquids, capsules and tablets. We operate principally through
three entities: Taro Israel and two of its subsidiaries, Taro Canada and Taro U.S.A. The following is a breakdown of our sales by geographic region, including the percentage of
our total consolidated sales for each period: 2004
    
    2003
    
    2002In
    
    % of our
    
    In
    
    % of our
    
    In
    
    % of ourthousands
    
    total sales
    
    thousands
    
    total sales
    
    thousands
    
    total salesU.S.A.
    
    $
    247,765
    
    
    
    87
    %
    
    $
    283,197
    
    
    
    90
    %
    
    $
    183,857
    
    
    
    87
    %Canada
    
    
    18,353
    
    
    
    6
    %
    
    
    15,603
    
    
    
    5
    %
    
    
    12,819
    
    
    
    6
    %Israel
    
    
    14,587
    
    
    
    5
    %
    
    
    13,468
    
    
    
    4
    %
    
    
    11,809
    
    
    
    5
    %Other
    
    
    3,425
    
    
    
    2
    %
    
    
    3,190
    
    
    
    1
    %
    
    
    3,096
    
    
    
    2
    %Total
    
    $
    284,130
    
    
    
    100
    %
    
    $
    315,458
    
    
    
    100
    %
    
    $
    211,581
    
    
    
    100
    %
 Operating income varies among the different geographic areas in which we conduct our business.
The variation in operating income reflects the different activities in and contributions to our
business by each geographic area. Operating income is allotted to each geographic area in
accordance with the ownership of intellectual property, the performance of manufacturing activities
and the distribution and sale of product to third parties. The ownership of intellectual property,
manufacturing facilities and know-how is primarily located in Canada and Israel, while distribution
occurs mainly in the United States. Each of these geographic areas is compensated according to the
economic value of its activity. Therefore, Taro Israel and Taro Canada, which bear more risk in
terms of actually deploying substantial assets to develop and manufacture products, earn a greater
share of the profit derived from such products. Taro U.S.A. distributes to third parties the
products developed, manufactured or owned by the other geographic areas of the group. Inter-area
sales are based on arms-length transactions and prices usually charged among third parties with
similar economic circumstances and profile. Inter-area transactions and balances have been
eliminated in consolidation. Profits from inter-area sales not yet realized outside the Company
have been eliminated in consolidation. We generate most of our revenues from the sales of prescription and OTC pharmaceutical
products. Portions of our OTC products are sold as private label products primarily to chain drug
stores, food stores, drug wholesalers, drug distributors and mass merchandisers in the United
States. During the past three years, three major drug wholesalers in the United States accounted
for the following proportion of our total consolidated sales (in millions of dollars): 2004
    
    2003
    
    2002Customer
    
    Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    PercentAmerisourceBergen
Corporation
    
    $
    44.5
    
    
    
    16
    %
    
    $
    62.7
    
    
    
    20
    %
    
    $
    46.5
    
    
    
    22
    %McKesson Corporation
    
    $
    43.2
    
    
    
    15
    %
    
    $
    53.0
    
    
    
    17
    %
    
    $
    25.4
    
    
    
    12
    %Cardinal Health, Inc.
    
    $
    23.8
    
    
    
    8
    %
    
    $
    28.4
    
    
    
    9
    %
    
    $
    19.0
    
    
    
    9
    %Total
    
    $
    111.5
    
    
    
    39
    %
    
    $
    144.1
    
    
    
    46
    %
    
    $
    90.9
    
    
    
    43
    %
 We also sell active pharmaceutical ingredients to unaffiliated customers around the world.
Sales of active pharmaceutical ingredients to third parties have historically represented less than
1% of consolidated revenues. Our primary reason for manufacturing active pharmaceutical ingredients
is to support our pharmaceutical manufacturing operations. 40




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Due to increased competition from other generic pharmaceutical manufacturers as they gain
regulatory approvals to manufacture generic products, selling prices and related profit margins
tend to decrease as products mature. Thus, our future operating results are dependent on, among
other factors, our ability to introduce new products. In addition, our operating results are
dependent on the impact of pricing pressures on existing products. These pricing pressures are
inherent in the generic pharmaceutical industry. In 2004, seven product lines accounted for 48% of our consolidated sales. One oral product,
warfarin sodium, contributed approximately 10% and 9% to our consolidated sales in 2004 and 2003,
respectively. In 2003 and 2002, seven product lines accounted for 54% and 53% of consolidated
sales, respectively. As evidenced by this years sales, our sales of these and other product lines are subject to
market conditions and other factors. We are therefore unable to predict the extent, if any, to
which the relative contribution to our total revenues of these seven product lines as well as other
product lines may increase or decrease in the future. Cost of goods sold consists of direct costs and allocated costs. Direct costs consist of raw
materials, packaging materials and direct labor identified with a specific product. Allocated costs
are costs not associated with a specific product. Since the allocation of various elements of
overhead to individual products or product lines is to some extent arbitrary, it is not practical
to determine the specific amount or percentage of our profits that may be attributed to any
individual product or product line. Certain customary industry selling practices affect our supply of working capital, for
example, industry practice requires that pharmaceutical products be made available to customers on
demand from existing stock levels rather than on a made-to-order basis. Therefore, in order to
accommodate market demand, we try to maintain adequate levels of inventories. Increased demand for
existing products and preparation for new product launches, the exact timing of which cannot be
determined accurately, have generally resulted in higher levels of inventory. However, anticipated
growth in sales of any individual product or of all products may not materialize. Consequently,
inventories prepared for these sales may become obsolete and have to be written off. Another industry practice that impacts upon our working capital is the provision of favorable
payment terms to customers and the discounting of selling prices through the issuance of free
products as well as other incentives within a specified time frame if a customer purchases more
than a specified threshold of product. Such incentives are provided primarily with the intention of
maintaining and expanding our distribution to the detriment of competing products. Another such industry practice causes us to provide some of our customers with limited rights to
return products, receive rebates, assert chargebacks and take other deductions with respect to
sales that we make to them. See Critical Accounting Policies  Allowance for sales deductions and
product returns. The exercise of these rights by customers to which we have granted them has an
impact, which may be substantial, upon our accounts receivable from those customers. In addition,
because we operate in a highly competitive environment, our days sales in accounts 41




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receivable may, from time to time, exceed company terms. This issue, if any, is one of timing,
not collectibility. Thus, for example, in our press release dated February 17, 2004, we
acknowledged that we had higher than expected trade accounts receivable due to a payment timing
issue with a major customer. This customer mailed us a payment on December 30, 2003, in the amount
of $12.5 million. The payment arrived on January 5, 2004. Similarly, disputes concerning chargebacks and other sales deductions are common and occur in
the ordinary course of business. For example, in 2003 we increased the price for certain of our
products to the trade, including to certain wholesale customers. When these wholesale customers
sold merchandise to third parties acquired under their old cost, they submitted to us chargebacks
based on their new cost. In error, they withheld the difference between their new and old costs.
The amount withheld initially totaled $20 million. During the second half of 2004, $9 million of
such amount was paid to us. The revenue for the merchandise was recognized appropriately by us at
the old (lower) price and we believe that our recognition of revenue was appropriate. Moreover, on
the basis of active discussions to resolve the remainder of the disputed deductions, we believe
that the remainder of the amounts withheld will be collected. After adjustment for these two events, our days sales outstanding, or DSOs, at year end 2003
and at the end of the first quarter of 2004 would have been 125 and 126, as compared to 139 and
148, before such adjustment. For December 31, 2000, 2001, 2002, 2003 and 2004, our DSOs as
adjusted for the events described above, were 137, 100, 119, 125 and 144 days, respectively, or an
average of 125 days. Sales during the first half of 2004 were substantially lower than sales during the second half
of the year. The DSO is computed by dividing the adjusted accounts receivable at the end of the
year, including the reserve established for the acquired Medicis products, by the average daily
sales during the year. Using this formula, the lower sales in the first half of the year increases
the DSOs when calculated on an annual basis. Accounts receivable at year end, however, are
principally the result of sales made during the second half of the year. When average daily sales
for the second half of the year are used in the same formula, the results are DSOs of 130 days,
which is consistent with the Companys historical trends. In light of the level of accounts receivable, we continuously monitor our aged receivables and
our customers creditworthiness. In addition, we maintain accounts receivable insurance to protect
us from possible payment defaults by our customers. We also engage in active and intensive
collection efforts as necessary. The decision to purchase APIs is a function of our sales forecast and prevailing prices in the
market. When appropriate purchasing opportunities arise, the Company may acquire certain APIs in
excess of its ordinary requirements or rate of growth. CRITICAL ACCOUNTING POLICIES Our significant accounting policies are described in Note 2 to our consolidated financial
statements, which we have prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We
evaluate, on an ongoing basis, our estimates, including those related to bad debts, income taxes
and contingencies. We base our estimates on currently available information, our historical 42




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experience and various other assumptions that we believe to be reasonable under the
circumstances. The results of these assumptions are the basis for determining the carrying values
of assets and liabilities that are not readily apparent from other sources. Since the factors
underlying these assumptions are subject to change over time, the estimates on which they are based
are subject to change accordingly. The following is a summary of certain policies that have a critical impact upon our financial
statements and, we believe, are most important to keep in mind in assessing our financial condition
and operating results; Revenue Recognition.In accordance with Staff Accounting Bulletin 104 and SFAS 48, we recognize
revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is
determinable, payment is reasonably assured and product returns can be reasonably estimated. We
ship products to our customers only in response to, and to the extent of, the orders that they
submit to us. Allowance for sales deductions and product returns.When we recognize and record revenue from the
sale of our pharmaceutical products, we simultaneously record an estimate of various future costs
related to the sale. This has the effect of reducing the amount of reported product sales. These
costs include our estimates of product returns, rebates, chargebacks and other sales deductions.
Chargebacks result from price arrangements we have with end-user customers establishing contract
prices which are typically lower than the wholesalers acquisition costs or invoice prices. When
these customers buy our products from their wholesaler of choice, the wholesaler issues a credit
memo (chargeback) to us for the difference between the invoice price and the end-user contract
price. In addition, it is customary in the generic industry to grant customers shelf-stock
adjustments based on customers existing levels of inventory and the decrease in the market price
of the related product. When market prices for our products decline, we may therefore elect to
provide shelf-stock adjustments and thereby allow our customers with existing inventories to
compete at the lower product price. We use these shelf-stock adjustments to support our market
position and to promote customer loyalty. Also, consistent with industry practice, we maintain a
return policy in some markets that allows our customers to return products within a specified
period before, and subsequent to, the products expiration dates. We base our estimates for sales
deductions on a variety of factors, including actual experience of products returned, rebate
agreements for each product and estimated sales by our wholesale customers to third parties who
have contracts with us. Although these estimates are based upon extensive and substantial
historical data that we use to arrive at these estimates, actual experience associated with any of
these items may, in the future, differ materially from our estimates. We review the factors that
influence our estimates periodically. If actual product returns, credits and other sales
deductions differ from our established reserves, we adjust our estimates and reserves. If
conditions in future periods deviate from their historical pattern, a revision of our estimates may
be required. Such revision may affect our reported revenues and results of operations. The
following table summarizes the activities for sales deductions: 43




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##### Table of Contents



Returns andPrice
    
    
    
    Doubtful
    
    
    
    TotalAdjustments
    
    
    
    Accounts
    
    
    
    AllowancesBalance at December 31, 2002
    
    
    $
    51,910
    
    
    
    $
    112
    
    
    
    $
    52,022Sales provisions made in the current period
    
    
    
    271,226
    
    
    
    
    52
    
    
    
    
    271,278Deductions allowed to customers
    
    
    
    (278,084
    )
    
    
    
    
    
    
    
    
    (278,084
    )Decrease due to write-offs of
uncollectible accounts
    
    
    
    
    
    
    
    
    (23
    )
    
    
    
    (23
    )Balance at December 31, 2003
    
    
    
    45,052
    
    
    
    
    141
    
    
    
    
    45,193Sales provisions made in the current
period*
    
    
    
    364,239
    
    
    
    
    83
    
    
    
    
    364,322Deductions allowed to customers
    
    
    
    (342,661
    )
    
    
    
    
    
    
    
    
    (342,661
    )Decrease due to write-offs of
uncollectible accounts
    
    
    
    
    
    
    
    
    (34
    )
    
    
    
    (34
    )Balance at December 31, 2004
    
    
    $
    66,630
    
    
    
    $
    190
    
    
    
    $
    66,820
 
 *
    
    See Note 1.f to our financial statements included elsewhere in this report. Our estimates reflect the inherent risks and uncertainties in our industry, which include
future changes in: the number of sales contracts to new and existing customers, the price
environment for our products, the number of new products introduced to the marketplace, and the
number of competing products. Based on such factors, our estimates of the balance for sales
provision decreased from $52.0 million at December 31, 2002
to $45.2 million at December 31, 2003
reflecting our assessment of market conditions during the period. As a result of the factors cited
above, the reserve established for returns and other deductions for
the acquired Medicis products and changes in market conditions for our products, we increased our sales provision resulting
in a balance of $66.8 million at December 31, 2004. Product Rights.Our rights in licensed or acquired products are stated at cost, less accumulated
amortization. Product rights are amortized using the straight-line method over their estimated
useful lives ranging from five to twenty years. We determine amortization periods for product
rights based on our assessment of various factors impacting estimated useful lives and cash flows
of the acquired products. These factors include a products position in its life cycle, the
existence of like products in the marketplace, various other competitive and regulatory issues, and
contractual terms. Significant changes to any of these factors may result in a reduction in a
product rights useful life and an acceleration of related amortization expense, which could cause
our operating income, net income and earnings per share to decline.
For further discussion on Long-lived assets, see Note 2.k to our
financial statements included elsewhere in this report. Deferred Taxes.As of December 31, 2004, deferred tax assets totaled approximately $37.8 million,
including $32.8 million in the United States. Of this amount, approximately $28.2 million results
from the remaining portion of U.S. loss carryovers that were created in 2001 due to the exercise of
stock options and the future benefit from 2004 U.S. operating losses. The remaining deferred tax
assets result from miscellaneous temporary differences, most of which represent items that have
been accrued for financial statement purposes but not yet deducted for tax purposes. We estimate that, based on the cost reduction measures implemented during the second half of the
year, the tax asset will be realized in coming years. However, in the event that it appears that
the amount of these deferred tax assets is greater than the amount that we will more than likely 44




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realize, we will reduce the amount at which we carry the deferred tax assets accordingly. Any
such reduction would result in a charge to income, in the amount of the reduction, for the period
in which the reduction was made. For additional analysis of tax issues, please refer to Note 14 of
our consolidated financial statements included elsewhere in this annual report. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, selected items from our
consolidated statement of income as a percentage of total sales: Year ended December 31,2004
    
    
    2003
    
    
    2002Statement of Income Data:Sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of sales
    
    
    42
    
    
    
    32
    
    
    
    38Gross Profit
    
    
    58
    
    
    
    68
    
    
    
    62Operation expenses:Research and development, net
    
    
    15
    
    
    
    13
    
    
    
    12Selling, marketing, general and
administrative
    
    
    43
    
    
    
    31
    
    
    
    25Total operating expenses
    
    
    58
    
    
    
    44
    
    
    
    37Operating income
    
    
    (0.2
    )
    
    
    24
    
    
    
    25Financial expenses, net
    
    
    2.3
    
    
    
    1
    
    
    
    Other income, net
    
    
    0
    
    
    
    
    
    
    
    Income before taxes on income
    
    
    (2
    )
    
    
    23
    
    
    
    25Taxes on income
    
    
    (6
    )
    
    
    4
    
    
    
    4Minority interest in earnings of a subsidiary
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    4
    %
    
    
    19
    %
    
    
    21
    %
 YEAR ENDED DECEMBER 31, 2004 COMPARED WITH YEAR ENDED DECEMBER 31, 2003 Sales.During 2004, our sales decreased by $31.3 million, or 10%, from the amount of sales we
reported in 2003. This decrease in sales in 2004 was primarily attributable to reduced purchases by
our three major wholesale customers, as we believe these customers reduced the level of inventory
they customarily kept on hand in prior periods. These wholesalers purchased $111.5
million during 2004 and $144.1 million during 2003. Sales in the United States during 2004
decreased by $35.4 million, or 12.5% of sales reported in 2003. Sales in Canada increased by $2.8
million, or 18% above 2003 sales while sales in Israel and other international markets increased by
$1.4 million, or 8%, from 2003. During 2004, products that we introduced in the United States
included phenytoin oral suspension 125 mg/mL clindamycin phosphate topical solution 1%;
hydrocortisone butyrate topical solution, 0.1%; terconazole vaginal cream, 0.8%; ammonium lactate
lotion, 12%; clotrimazole and betamethasone dipropionate lotion; alclometasone dipropionate
ointment, 0.05%; fluconazole tablets in 50, 100, 150, and 200 mg tablets, betamethasone
dipropionate ointment augmented, 0.05%; mometasone furoate ointment, 0.1% and cream, 0.1%; and
loratadine syrup 5 mg/5 ml. In the United States, we also introduced our ElixSure® brand ibuprofen
oral suspension 100mg/5ml; and Kerasal® Lotion, and we entered into an agreement with Medicis
pursuant to which Medicis licenses to us dermatologic products, including Lustra® and Lustra-AF®,
which are used for the treatment of dyschromia or discoloration of the skin. 45




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Cost of Sales.Cost of sales increased by 17% in 2004, as a result of several factors, including
the appreciation of the Canadian dollar, increasing the cost of goods manufactured abroad, as well
as a lower level of capacity utilization of our manufacturing facilities, which resulted in a
higher level of overhead costs per unit. Gross Profit.Gross profit was $213.0 million in 2003 and $164.7 million in 2004. This decrease
reflects the impact of reduced sales and increased cost of goods for the reasons mentioned above. Research and Development.Net R&D expenses increased by $1.2 million, or 3%, in 2004. R&D expenses
equaled 15% and 13% of sales in 2004 and 2003, respectively. The increase in R&D expenses during
2004 was the result of our continued commitment to research and development. Approximately 80% of
the R&D investment was focused on our generic pipeline and the remaining 20% was focused on our
proprietary pipeline, which includes products that use our NonSpilTM drug delivery
system, Kerasal® lotion, an extension to our Kerasal® line of footcare products, and our new class
of non-sedating barbiturate compounds. (See Item 4  Information on the Company  History and
Development of the Company for information on the licensing of the rights of Kerasal® and
ElixSure®). Selling, General and Administrative.In 2004, SG&A increased $25.6 million, or 26%, from the amount
we recorded in 2003. Our SG&A expenses as a percentage of sales increased from 31% in 2003 to 43%
in 2004. Selling and marketing expenses increased by $16.4 million, or 31%, primarily due to
increased advertising and promotion of our proprietary OTC product lines, Kerasal® and ElixSure®,
as well as the full effect of building and supporting our TaroPharma detail force of approximately
60 representatives who call on physicians. Administrative expenses increased by $9.0 million, or
20%. (See Item 4  Information on the Company  History and Development of the Company for
information on the licensing of the rights of Kerasal® and ElixSure®). Operating Results.Operating income decreased by $75.2 million in 2004. The decrease reflects the
decrease in revenues and higher level of product cost, as well as the impact of our marketing and
promotional activities to support our proprietary product line and the increased level of R&D
investment. The variation in operating income among our geographic areas compensates for the use
of their intellectual property and manufacturing facilities to produce our products. Israel and
Canada, which bear more risk in terms of deploying more assets to develop and manufacture products,
earn a greater share of the profit derived from such products. The USA subsidiary primarily
distributes products developed, manufactured or owned by the other subsidiaries. Financial Expenses.Financial expenses result from interest expense and income, and the impact of
currency fluctuations. Net financial expenses increased $4.7 million, or 273%, in 2004. The
increase is primarily the result of the full impact of our increased level of borrowing in 2003.
This increase in interest expenses was partially offset by interest income that we earned on our
cash balances, capitalization of interest expenses related to plant and equipment under
construction and hedges against currency fluctuations. Taxes.Due to the pre-tax loss in 2004, our tax benefit was $17.0 million, as compared with a tax
expense of $11.5 million in 2003. Our effective tax rate was 16% on pre-tax income in 2003 (See our
discussion on Deferred Taxes under Critical Accounting Policies). 46




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##### Table of Contents



Net Income.Our net income decreased by $50.1 million from $61.2 million in 2003 to $11.1 million
in 2004, by reason of the factors noted above. YEAR ENDED DECEMBER 31, 2003 COMPARED WITH YEAR ENDED DECEMBER 31, 2002 Sales.During 2003, our sales increased $103.9 million, or 49%, from the amount of sales we
reported in 2002. Of this increase, $27.7 million, or 27%, was attributable to the sale of products
that we introduced in 2003. The balance of this increase was attributable to increased sales of
products which were sold in both 2002 and 2003, including clotrimazole and betamethasone
dipropionate cream, our generic version of Lotrisone®, which we began to sell in May 2001. Sales in
the United States during 2003 increased $99.3 million, or 54%, from the amount we reported in 2002.
Sales in Canada increased by $2.8 million, or 22%, and sales in Israel and other international
markets increased $1.8 million, or 12%, from 2002. The products introduced during the year in the
United States included betamethasone dipropionate (augmented) cream, ammonium lactate cream and
etodolac XR tablets in three strengths, 400, 500 and 600 mg. In the United States, we also
introduced our ElixSure® line of products and the four branded products we acquired earlier this
year from Medicis. Our sales in 2003 grew by a greater percentage than our cost of sales primarily because of the
following factors:  
    
    Our sales of newly introduced products, which we sell at higher margins than our
existing products, were responsible for most of the increase in our gross profit
percentage, which grew from 62.4% to 67.5%.
    
    During 2003, we experienced a more favorable competitive environment for generic
products than in 2002. Such an environment includes, for example, an environment in which
our products are the initial generic entrants into the market (and, occasionally, remain
the sole generic versions of the product); an environment in which we are able to compete
particularly well (for example, because of operational efficiencies or less expensive
access to raw materials); and/or an environment in which there is, for any number of
reasons (including, for example, a market perception more favorable to our products than to
those of our competitors) a particularly great demand for our products.
    
    Over the past several years, we have invested in a number of capital projects designed
to increase our production efficiency. As demand for our products increased in 2003, we
benefited from economies of scale which decreased our per unit cost of production. Cost of Sales.Cost of sales increased by 29% in 2003, as a result of the 49% increase in sales
described above. Gross Profit.Gross profit margin increased from 62% in 2002 to 68% in 2003. The increase reflects
a higher level of branded product sales and a more favorable competitive environment for generic
products. Research and Development.Net R&D expenses increased $14.2 million, or 54% in 2003. R&D expenses
equaled 13% and 12% of sales in 2003 and 2002, respectively. The increase in R&D 47




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##### Table of Contents



expenses during 2003 was the result of expanding our research facilities, recruiting additional
scientists, and pursuing more projects. Selling, General and Administrative.In 2003, SG&A increased $45.2 million, or 86%, from the amount
we recorded in 2002. Our SG&A expenses as a percentage of sales increased from 25% in 2002 to 31%
in 2003. Selling and marketing expenses increased $32.4 million, or 162%, primarily due to the
recruitment of representatives who call on physicians and promotional campaigns, including media
advertising, aimed at supporting our branded initiatives in the United States. General and
administrative expenses increased $12.8 million, or 39%, primarily due to investments in personnel,
facilities and infrastructure necessary to accommodate continued growth and expansion in the United
States and other markets. Operating Results.Operating income increased $21.4 million, or 40%, in 2003. The increase was
primarily the result of increased sales and improved gross profit margins. The variation in
operating income among our geographic areas compensates for the use of their intellectual property
and manufacturing facilities to produce our products. Israel and Canada, which bear more risk in
terms of deploying more assets to develop and manufacture products, earn a greater share of the
profit derived from such products. The USA subsidiary primarily distributes products developed,
manufactured or owned by the other subsidiaries. Financial Expenses.Net financial expenses increased $1.5 million, or 962%, in 2003. The increase
is primarily the result of a higher level of interest expenses as we increased our level of
borrowing during the second half of 2003. The increase in interest expenses was partially offset by
interest income that we earned on our cash balances and from hedges against currency fluctuations. Taxes on Income.Due to a higher level of pre-tax income, our tax expense increased $3.1 million,
or 36%, in 2003. Our effective tax rate was 16% in both 2002 and 2003. Net Income.Our net income increased $16.6 million from $44.6 million in 2002 to $61.2 million in
2003, an increase of 37%, based on the factors cited above. The years 2002-2003 represented a period of rapid growth for the Company. It is typical during
such a period for a company to experience an increase in accounts receivable and inventories. In
light of the growing demand for our products that we experienced during this period, we decided to
increase our inventories in order to assure uninterrupted supply of our products to our customers.
This was the main reason for our lower level of cash generated from operating activities during
2003. IMPACT OF INFLATION, DEVALUATION (APPRECIATION) AND EXCHANGE RATES ON RESULTS OF OPERATIONS,
LIABILITIES AND ASSETS We conduct manufacturing, marketing and research and development operations primarily in
Israel, Canada and the United States. As a result, we are subject to risks associated with
fluctuations in the rates of inflation and foreign exchange in each of these countries. The following table sets forth the annual rate of inflation, the devaluation (appreciation)
rate of the NIS and the Canadian dollar against the U.S. dollar and the exchange rates between the
U.S. dollar and each of the NIS and the Canadian dollar at the end of the year indicated: 48




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##### Table of Contents



Rate of Devaluation(Appreciation)
    
    
    Rate of Exchange ofRate of Inflation
    
    
    Against U.S. Dollar
    
    
    U.S. DollarYear
    
    Israel(1)
    
    
    Canada(2)
    
    
    Israel(1)
    
    
    Canada(3)
    
    
    Israel(1)
    
    
    Canada(3)2000
    
    
    0.0%
    
    
    
    3.2%
    
    
    
    (2.7%
    )
    
    
    3.9%
    
    
    
    4.04
    
    
    
    1.502001
    
    
    1.4%
    
    
    
    0.7%
    
    
    
    9.3%
    
    
    
    6.2%
    
    
    
    4.42
    
    
    
    1.592002
    
    
    6.5%
    
    
    
    3.9%
    
    
    
    7.2%
    
    
    
    (1.2%
    )
    
    
    4.74
    
    
    
    1.582003
    
    
    (1.9%
    )
    
    
    2.0%
    
    
    
    (7.6%
    )
    
    
    (17.8%
    )
    
    
    4.38
    
    
    
    1.292004
    
    
    1.2%
    
    
    
    2.1%
    
    
    
    (1.6%
    )
    
    
    (6.9%
    )
    
    
    4.31
    
    
    
    1.20
 
 Sources:       (1)
  Bank of Israel.       (2)   Statistics Canada.      (3)   Bank of Canada. 
 B. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY Cash and cash equivalents decreased by $60.5 million to $98.6 million at December 31, 2004.
This decrease funded our working capital requirements, capital investments, and product acquisition
programs. Trade accounts receivable increased by 3.4% to $124.7 million at December 31, 2004.
Inventory levels increased by 2% to $86.6 million, reflecting our policy of maintaining sufficient
finished goods required to meet customer demand. Shareholders equity increased from $347.4 million
at December 31, 2003 to $368.1 at December 31, 2004, principally due to retained earnings and
foreign currency fluctuations. 
 Cash used in operating activities for the year ended December 31, 2004 was $1.8 million as
compared to cash provided by operating activities of $5.2 million in the prior year. The decrease
in cash from operations is the result of increases in trade receivables and inventory, which were
partially offset by higher amortization and depreciation, our net income and other working capital
items. 
 Our long-term debt outstanding as of December 31, 2004 was approximately $204.3 million,
including current maturities of $16.9 million, and was comprised of the following:  
    
    bonds payable of $129.1 million;
    
    obligations of $36.6 million under bank agreements; and
    
    mortgage payable and other obligations of $38.6 million. Our loans from institutional investors and bond obligations consist of the following, in
thousands: Amount
    
    Linkage
    
    Rate
    
    Maturity$13,753
    
    Israel CPI(a)
    
    8.25%
    
    2005-2010$49,275
    
    Israel CPI(a)
    
    5.80%
    
    2005-2014$  2,950
    
    Dollar
    
    Libor + 2.25%
    
    2005-2014$  1,773
    
    Dollar
    
    Libor + 2-3%
    
    2005-2010$44,500
    
    Dollar
    
    6%
    
    2005-2010$15,500
    
    Dollar
    
    Libor + 2.25%
    
    2005-2010
 
 (a)
    
    We have a contract to hedge our exposure to CPI fluctuations in Israel. 49




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Covenants in some of our loan agreements stipulate that our debt to equity ratio may not
exceed 2:1 and that our current ratio may not be lower than 1:1. In addition, the loan agreements
that the Company entered into during 2003 require that, prior to incurring additional debt in
Israel, the Companys interest coverage ratio be greater than 2:1 to be measured on April 1 of each
year of the loan, commencing on April 1, 2005. The interest coverage ratio is defined as earnings
before interest, taxes, depreciation, and amortization, or EBITDA, divided by net interest expenses
plus the current principal repayment. In the first quarter of 2005, the loan agreements entered into by the Company in May 2003 and
November 2003 were amended to defer measurement of the interest coverage ratio until April 1, 2006.
In addition, the Company undertook, with two of the institutional investors who had made loans to
the Company of approximately $6.5 million, to perform a review of the Companys compliance with the
interest coverage ratio on August 15, 2005, with respect to the 12-month period ending June 30,
2005. These covenants, as amended, may restrict the Companys
ability to incur additional debt in Israel. We anticipate that our cash balances and operating cash flow, together with available
borrowings under our credit facilities and cash balances, will be sufficient to meet all of our
working capital, capital expenditure and interest requirements for both the short-term and the
foreseeable future. For information with respect to commitments for future capital expenditures,
please see Note 5(d) to our consolidated financial statements included elsewhere in this annual
report. CAPITAL EXPENDITURES We invested $72.3 million in capital equipment and facilities in the year ended December 31,
2004 and $94.4 million during the year ended December 31, 2003. These investments are principally
related to our pharmaceutical and chemical manufacturing facilities, expanding and upgrading our
research and development laboratories in Israel, Canada, Ireland, and the United States, and
maintaining compliance with cGMPs. In addition to facility-related investments, we acquired certain
manufacturing and packaging equipment to increase production capacity. We also continued to upgrade
our information systems infrastructure, to enable more efficient production scheduling and enhanced
inventory analysis. See Note 5 to our consolidated financial statements included elsewhere in this
annual report. Tax Matters Tax Loss Carryforward and Effective Tax Rates As of December 31, 2004, on an unconsolidated basis, we had available tax loss carryforwards
of $1.3 million in Israel, $6.8 million in the United Kingdom, $6.8 million in Ireland and $74.8
million in the United States. The loss carryforward in the United States principally resulted from
the exercise by employees of stock options during 2001 and the operating results in 2004. In 2004,
we recorded a tax benefit. Our consolidated effective tax rate was 16% in both 2003 and 2002. 50




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##### Table of Contents



Approved Enterprise Status in Israel Israeli companies are generally subject to tax at the rate of 35% (declining to 34% in 2005,
32% in 2006, and 30% in 2007) of taxable income. However, our facilities in Israel have received
Approved Enterprise status from the Israel Investment Center, which entitles us to receive
specified tax benefits. We have received three approvals granting us a package of benefits, subject
to compliance with applicable requirements. Under the first approval, our undistributed income
derived from one Approved Enterprise will be exempt from corporate tax for a period of four years
from 2001, and we will be eligible for a reduced tax rate of between 10% and 25% for two additional
years. Under the second approval, our undistributed income derived from another Approved Enterprise
was exempt from corporate tax for a period of two years from 2001 and we will be eligible for a
reduced tax rate of 10% to 25% for eight additional years. Under the third approval (benefit period
starting 2003), our undistributed income will be exempt from corporate tax for a period of two
years following implementation of the plan. We will be eligible for a reduced tax rate of between
10% and 25% for thirteen additional years thereafter. Under the fourth approval (benefit period
most likely to be implemented during 2005), our undistributed income, derived from this approval,
will be exempt from corporate tax for a period of two years following implementation and we will be
eligible for a reduced tax rate of 10% to 25% for eight additional years thereafter. All of these
programs are subject to time limits imposed by the Law for Encouragement of Capital Investments,
1959 and based upon the level of foreign ownership in our company in each tax year. To retain the
most favorable rates we must maintain a foreign shareholders level of at least 90%. Currently, we
exceed this level. As a result of these programs, a substantial portion of the profits derived from
products manufactured in Israel may benefit from a reduced Israeli tax rate. 
 C. RESEARCH AND DEVELOPMENT, PATENTS, TRADEMARKS AND LICENSES Most of our sales are derived from products that are the result of our own research and
development. We believe that our research and development activities have been a principal
contributor to our achievements to date and that our future performance will depend, to a
significant extent, upon the results of these activities. In 1991, we formed the Taro Research Institute for the purpose of consolidating our
pharmaceutical and chemical research activities. The Institute coordinates all of our research and
development activities on a global basis. Recruiting talented scientists is essential to the success of our research and development
programs. Approximately 20% of our employees work in our worldwide research and development
programs. More than 90 of our scientists hold either M.D. or Ph.D. degrees. We currently conduct research and development in three principal areas:  
    
    generic pharmaceuticals, where our programs have resulted in our
developing and introducing a wide range of pharmaceutical products
(including tablets, capsules, injectables, suspensions, solutions,
creams and ointments) that are equivalent to numerous brand-name
products whose patents and FDA exclusivity periods have expired;  
    
    proprietary pharmaceuticals and delivery systems, in which we are
developing T-2000 and products utilizing the NonSpil delivery system;
and 51




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##### Table of Contents




    
    organic and steroid chemistry, where our programs have enabled us to
synthesize the active ingredients used in many of our products. Generic Pharmaceuticals In 2004, we received several product approvals in Canada, Israel and the United States. The
following table sets forth the approvals received in the United States from the FDA from January 1,
2004 through June 20, 2005: Brand Name*FINAL NDA APPROVALIbuprofen Oral Suspension
    
    ElixSure®FINAL ANDA APPROVALSAlclometasone dipropionate ointment, 0.05%
    
    Aclovate®Ammonium lactate lotion, 12%
    
    Lac-Hydrin®Betamethasone dipropionate ointment (augmented) 0.05%
    
    Diprolene®Ciclopirox olamine cream, 0.77%
    
    Loprox®Ciprofloxacin tablets 100, 250, 500, 750 mg
    
    Cipro®Clindamycin phosphate topical solution
    
    Cleocin®Clotrimazole and betamethasone dipropionate lotion
    
    Lotrisone®Fluconazole tablets 50, 100, 150 and 200 mg
    
    Diflucan®Halobetasol ointment, 0.05%
    
    Ultravate®Hydrocortisone butyrate ointment, 0.1%
    
    Locoid®Hydrocortisone butyrate solution, 0.1%
    
    Locoid®Loratadine syrup, 5 mg / 5 mL
    
    Claritin®Miconazole nitrate vaginal cream, 4%
    
    Monistat®Mometasone furoate cream, 0.1%
    
    Elocon®Mometasone furoate ointment, 0.1%
    
    Elocon®Phenytoin oral suspension, 125 mg / 5 mL
    
    Dilantin®Terconazole vaginal cream, 0.4%
    
    Terazol®Terconazole vaginal cream, 0.8%
    
    Terazol®Fluticasone propionate ointment, 0.005%
    
    Cutivate®TENTATIVE ANDA APPROVALSGabapentin oral solution, 250 mg / 5 mL
    
    Neurontin®Mometasone furoate topical solution, 0.1% (lotion)
    
    Elocon®
 
 *
    
    The above trademarks are the property of their respective owners. As of June 20, 2005, we had 25 of our ANDAs, including two tentative approvals, and one
NDA under review by the FDA. In addition, there are multiple products for which either
developmental or internal regulatory work is in process. The applications pending before the FDA
are at various stages in the review process, and there can be no assurance that we will be able to
successfully complete any remaining testing or that, upon completion of such testing, approvals for
any of the applications currently under review at the FDA will be granted. In addition, there can
be no assurance that the FDA will not grant approvals for competing products submitted by our
competitors. Proprietary Technologies T-2000 52




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##### Table of Contents



We are currently preparing for Phase III studies in Canada for T-2000, our non-sedating
barbiturate compound developed by us. These trials will be directed toward the treatment of
essential tremor. However it is important to note that there can be no assurance of the successful
completion of Phase III testing, the approval by any regulatory authority of the drug, or the
commercial success of the drug if and when approved. NonSpil We also continue to work on our NonSpil liquid drug delivery system, which allows liquid
medications to pour, but not spill, thereby increasing the accuracy of dosage and ease of use.
NonSpil development activities include improving product formulations, refining taste and texture,
scaling up from laboratory sized manufacturing to commercial sized manufacturing. In the second half of 2003, the Company started marketing ElixSure® in the U.S. ElixSure® is a
line of childrens OTC medication using the NonspilTM vehicle. On March 3, 2005, the
Company divested the ElixSure® product line in North America. However, the Company will continue
to develop prescription products using the NonspilTM delivery system. In addition, the
Company will continue to manufacture and supply ElixSure® products from its Canadian plant. Patents, Trademarks and Licenses We have filed and received patents in the United States for a variety of products and
processes, including:  
    
    a class of anticonvulsant, tranquilizer and muscle relaxant drugs;  
    
    a class of antiarrhythmic drugs;  
    
    novel oral delivery for pharmaceutical and related products; and  
    
    the synthesis and formulation of certain of our products. We do not believe that any single patent or license is of material importance to us in relation to
our current commercial activities. We have registered trademarks in the United States and in Canada. Moreover, we have recently
acquired the rights to use the A/T/S®, Kerasal®, Ovide®, Primsol®, Lustra®, and Topicort®
trademarks in the United States. Taro U.S.A. typically does not use trademarks in the sale and
marketing of its generic products. On March 3, 2005, the Company divested the Kerasal® and Primsol®
trademarks. From time to time, we seek to develop products for sale in various countries prior to patent
expiration. In the United States, in order to obtain a final approval for a generic product prior
to expiration of certain of the innovators patents, we must, under the terms of the Drug Price
Competition and Patent Term Restoration Act of 1984 (Hatch-Waxman Act), as amended by the
Medicare Prescription Drug Improvement and Modernization Act of 2003, notify the patent holder as
well as the owner of a NDA, that we believe that the patents listed in the Approved Drug Products
with Therapeutic Equivalence Evaluations (Orange Book) for the new drug are 53




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either invalid or not infringed by our product. To the extent that we seek to utilize this
mechanism to obtain approval to sell products, we are involved and expect to be involved in patent
litigation regarding the validity, enforceability or infringement of patents listed in the Orange
Book, as well as other patents, for a particular product for which we have sought approval. We may
also be involved in patent litigation with third parties to the extent that claims are made that
our finished product, an ingredient in our product, or our manufacturing process, may infringe the
innovators or third partys process patents. We may also become involved in patent litigation in
other countries where we conduct business, including Israel, and Canada and various countries in
Europe. 
 D. TREND INFORMATION Please see Item 4-Information on the Company and Item 5-Operating and Financial Review and
Prospect for trend information. 
 E. OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any material off-balance sheet arrangements. 
 F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS The following table describes the payment schedules of our contractual obligations as of
December 31, 2004, in millions: Payments due by period (in millions)Less than
    
    
    1-3
    
    
    3-5
    
    
    Over 5Type of Contractual Obligation
    
    Total
    
    
    1 year
    
    
    years
    
    
    years
    
    
    yearsOperating lease obligations
    
    $
    5.9
    
    
    $
    1.6
    
    
    $
    2.9
    
    
    $
    1.2
    
    
    $
    0.2Purchase obligations
    
    
    11.5
    
    
    
    11.5
    
    
    
    
    
    
    
    
    
    
    
    Long-term debt obligations
    
    
    204.3
    
    
    
    16.9
    
    
    
    65.9
    
    
    
    53.9
    
    
    
    67.6Total
    
    $
    221.7
    
    
    $
    30.0
    
    
    $
    68.8
    
    
    $
    55.1
    
    
    $
    67.8
 54




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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 
 A. DIRECTORS AND SENIOR MANAGEMENT The following table lists our current directors and executive officers as of June 15, 2005: Name
    
    Age
    
    PositionBarrie Levitt, M.D.
    
    
    69
    
    
    Director and Chairman of the Board of DirectorsDaniel Moros, M.D.
    
    
    57
    
    
    Director and Vice Chairman of the Board of DirectorsMyron Strober, C.P.A.
    
    
    75
    
    
    Director and Chairman of the Audit CommitteeHeather Douglas, Esq.
    
    
    50
    
    
    DirectorMicha Friedman, Ph.D.
    
    
    64
    
    
    DirectorEric Johnston, Esq.
    
    
    60
    
    
    DirectorGad Keren, M.D.
    
    
    53
    
    
    DirectorTal Levitt, Esq.
    
    
    35
    
    
    DirectorBen Zion Hod, C.P.A.
    
    
    51
    
    
    Director (1)Haim Fainaro, C.P.A.
    
    
    62
    
    
    Director (1)Samuel Rubinstein
    
    
    65
    
    
    Senior Vice President and General ManagerKevin Connelly, C.P.A.
    
    
    44
    
    
    Senior Vice President, Chief Financial OfficerAvraham Yacobi, Ph.D.
    
    
    59
    
    
    Senior Vice President, Research and DevelopmentZahava Rafalowicz
    
    
    58
    
    
    Group Vice President, Sales and Marketing and Deputy General Manager, IsraelMariana Bacalu
    
    
    55
    
    
    Vice President, Pharmaceutical ProductionHannah Bayer, C.P.A.
    
    
    55
    
    
    Vice President, Chief Accounting OfficerMarc Coles, Esq.
    
    
    48
    
    
    Vice President, General CounselPuah Dekel
    
    
    45
    
    
    Vice President, Administration, IsraelYohanan Dichter
    
    
    58
    
    
    Vice President, Quality AssuranceRoman Kaplan, Ph.D.
    
    
    59
    
    
    Vice President, Technical Operations, PharmaceuticalsIftach Katz
    
    
    41
    
    
    Vice President, Technical Services, IsraelAlon Korb
    
    
    46
    
    
    Vice President, Engineering and Projects, IsraelSigalit Portnoy, Ph.D.
    
    
    41
    
    
    Vice President, Haifa OperationsTzvi Tal
    
    
    55
    
    
    Vice President, Information Technology, Israel
 
 (1)
    
    Statutory independent director elected in accordance with the Israeli Companies Law. Certain Familial Relationships Tal Levitt is the daughter, and Dr. Daniel Moros is a first cousin, of Dr. Barrie Levitt. Business Experience Barrie Levitt, M.D.became Chairman of our board of directors in 1991. Dr. Levitt has been a
director since 1963. Dr. Levitt, a pharmacologist (basic as well as clinical), has been involved in
pharmacologic research and clinical cardiology since 1963. From 1974 to 1977, he was Professor of
Medicine and Pharmacology and Director of Cardiology and Clinical Pharmacology at New York Medical
College. From 1977 to 1985, he was Clinical Professor of Medicine and Visiting Professor of
Pharmacology at the Albert Einstein College of Medicine in New York. From 1982 to 2000, he was
Chairman of the Committee on Clinical Investigations at that institution. Dr. Levitt is a Fellow of
the American College of Cardiology and of the American College of Clinical Pharmacology. He is a
member of the American Society for Pharmacology and Experimental Therapeutics. In addition, Dr.
Levitt served as a consultant to the FDA from 1971 through March 1991, when he resigned in order to
increase his involvement in our company. Daniel Moros, M.D.was elected to our board of directors in 1988 and is currently Vice
Chairman. He is instrumental in overseeing our clinical research program, including the design 55




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and conduct of clinical trials. Dr. Moros has been Associate Professor of Neurology at the
Mount Sinai School of Medicine of the City University of New York since 1991, and currently is
Associate Clinical Professor at such institution. Myron Strober, C.P.A. was elected to our board of directors in 2002 and serves as the chairman
of our audit committee. A Certified Public Accountant in the United States, Mr. Strober was an
audit partner of Ernst & Young, New York, from 1969 to 1990. Since his retirement in 1990, Mr.
Strober has been actively involved as a financial consultant to a number of organizations. He was a
financial consultant to our company from 1993 to 2002 and served on our advisory board. Heather Douglas, Esq.was elected to our board of directors in 1998. Ms. Douglas is a partner
with the Canadian law firm of Borden Ladner Gervais LLP. Micha Friedman, Ph.D.was elected to our board of directors in 2002 and is currently a
Professor in the Department of Pharmacy at the Hebrew University of Jerusalem in Israel. He has
served as Dean of the School of Pharmacy of the Hebrew University and has published numerous
articles both in Israel and internationally. He is also a member of many professional
pharmaceutical societies. Eric Johnston, Esq.was elected to our board of directors in 1984. Mr. Johnston is currently
an attorney in Ottawa and consultant to the Canadian law firm of Perley-Robertson, Hill and
McDougall LLP. From 1974 to 1998, Mr. Johnston served as a Deputy Regional Solicitor of The
Regional Municipality of Ottawa-Carleton, Ontario, Canada and from 1998 to 2001 as Regional
Solicitor and Counsel. Gad Keren, M.D.served on our board of directors from 1991 to 2000 and was reelected in 2001.
Dr. Keren is currently Chairman of the Cardiology Department at the Tel Aviv Medical Center, where
he was named Professor of Cardiology in 1995, and he has been secretary of the Israel Cardiology
Society since 1991. Dr. Keren was a research fellow at the National Institute of Health in 1989 and
1990. Dr. Keren also acts as a research consultant to the Taro Research Institute (Institute). Tal Levitt, Esq.was elected to our board of directors in 1998. Ms. Levitt joined our company
in 1995 as Associate Counsel and currently serves as Senior Vice President, Corporate Affairs and
Treasurer of Taro U.S.A. She previously worked as a corporate attorney at the New York law firm of
Jenkens Gilchrist Parker and Chapin, LLP from 1994 to 1995. Ben Zion Hod, C.P.A.was elected to our board of directors in 2003 as a statutory independent
director. Mr. Hod is a certified public accountant in Israel and for the past 11 years, has served
as company comptroller for Zim Integrated Shipping Services Ltd.. Prior to joining Zim, Mr. Hod was
a senior manager at Kesselman & Kesselman, a member of PricewaterhouseCoopers International Ltd.
Mr. Hod previously served as a public director of the Company from 1993 to 1998. Haim Fainaro, C.P.A.was elected to our board of directors in 2003 as a statutory independent
director. He is a certified public accountant in Israel, managing a private accounting practice in
Tel Aviv since 1969. Mr. Fainaro has previously served as the Companys internal auditor in Israel
and as public director from 1988 to 1993. 56




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Samuel Rubinsteinjoined our company in 1990 and currently serves as Senior Vice President and
General Manager. From 1986 to 1989, Mr. Rubinstein served as President of Laminated Plastics, Inc.,
a joint venture of two Israeli corporations operating in the United States. From 1974 until 1986,
Mr. Rubinstein managed several different Israeli companies. Kevin Connelly, C.P.A.joined our company in 1993 and has served as our Senior Vice President
and Chief Financial Officer since 1994. A Certified Public Accountant in the United States, Mr.
Connelly has a background in financial management. From 1990 to 1993, he served as a Vice President
and Controller of BT-Financial Services and Information Systems, a subsidiary of Bankers Trust Co.
Prior to 1990, he held the position of Vice President and Divisional Controller with First American
Bank of New York. Avraham Yacobi, Ph.D.joined our company in 1994 as President of the Institute and was
appointed our Senior Vice President, Research and Development in 1998. Dr. Yacobi directs our
pharmaceutical, scientific and regulatory initiatives. Prior to joining our company, he was the
Director of Pharmacodynamics Research for the Medical Research Division of American Cyanamid
Company from 1982 to 1994. From 1976 to 1982, Dr. Yacobi served as Section Head of Clinical
Pharmacology and Drug Metabolism of American Critical Care. He has extensive experience in drug
development, with over 120 publications in the field. Zahava Rafalowiczjoined our company in 1997 as Marketing Manager of our Israeli operations.
Ms. Rafalowicz presently serves as Group Vice President, Sales and Marketing, and Deputy General
Manager in Israel. She is responsible for our Israeli and European sales and marketing operations
and planning. Prior to joining us, Ms. Rafalowicz was the Deputy Managing Director of the
Pharmaceutical Division of Teva Pharmaceutical Industries Ltd. She also spent several years at IMS
Health Global Services, or IMS, where she established IMS in the Eastern European Bloc. Mariana Bacalujoined our company in 1984 as Senior Analyst in the Quality Control Laboratory.
As Vice President, Pharmaceutical Production, she is currently responsible for pharmaceutical
production at the Haifa Bay facility. Prior to joining us, Ms. Bacalu served as a production
manager for Polymer Industry in Romania. Hannah Bayer, C.P.A.joined our company in 2001 as Vice President and Chief Accounting
Officer. Ms. Bayer is a Certified Public Accountant in Israel. From 1999 to 2000, she served as
Chief Financial Officer of Omrix Biopharmaceuticals, Ltd. From 1990 to 1999, Ms. Bayer held several
financial positions in Teva Pharmaceutical Industries Ltd. Marc Coles, Esq.joined our company in 1992 as in-house legal counsel in Israel and currently
serves as our General Counsel responsible for legal affairs in Israel. Before joining our company,
Mr. Coles was the Director of Regulatory Affairs for Biodan Medical Systems, Rehovot, Israel. Puah Dekeljoined our company in 1987 in our Human Resources Department. She served as the
Director of Human Resources for the company from 1990 until 2003. Mrs. Dekel currently serves as
Vice President, Administration, Israel. Prior to joining the company, she worked in the field of
human resources for various companies, including Bank Leumi. 57




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Yohanan Dichterjoined our company in 1986 in the research department and since 1988 has
served as the Vice President, Pharmacist in Charge of the Haifa Bay pharmaceutical manufacturing
plant. He is responsible for the review and release of all pharmaceutical products manufactured or
sold in Israel. Prior to joining us, Mr. Dichter served in the Medical Corps of the Israel Defense
Forces, Kupat Holim Clalit (Israels largest healthcare fund) and worked in a private pharmacy. Roman Kaplan, Ph.D.joined our company in 1991 and currently serves as Vice President,
Technical Operations, Pharmaceuticals. He is responsible for process and product formulation
improvements. Dr. Kaplan served from 1982 to 1987 as project manager of the biochemical laboratory
of Abic Chemical and Pharmaceutical Industries and from 1987 to 1991 as head of its solid dosage
forms development group. Iftach Katzjoined our company in 1995 and is now the head of the Companys Pharmaceutical
Technical Services Group in Israel. Mr. Katz has over 17 years of experience in the industry and
has held several key positions in the areas of product improvement and production. Alon Korbjoined our company in 2002 and is currently serving as Vice President, Engineering
and Projects in Israel. Prior to joining our company, Mr. Korb was the Facilities Manager for Tower
Semiconductor Ltd. in Israel, responsible for engineering, maintenance and the management of
large-scale projects. He has extensive experience in engineering, industrial plant operations and
project management. Sigalit Portnoy, Ph.D.joined our company in 1997 as Head of Sterile Production. Thereafter,
she was promoted to the position of Pharmaceutical Production Manager and subsequently as Vice
President, Training and Planning. Dr. Portnoy is presently the Site Manager, Operations, Haifa,
Israel. From 1990 to 1997, she taught at the Technion Institute, Israel. Tzvi Taljoined our company in 1996 and currently serves as our Vice President, Information
Technology in Israel. He is responsible for all information technology programs at our facilities
in Israel. From 1977 to 1996, Mr. Tal was Head of Information Technology for the Vargus Group and
Plant Manager for Egmo Industries. 
 B. COMPENSATION Our directors, other than the statutory independent directors, are paid $6,000 per year for
their service as directors. Directors who are not executive officers are also paid $500 for each
meeting of our board of directors that they attend. Because of the increased responsibilities
imposed by the Sarbanes-Oxley Act, the Chairman of our Audit Committee receives additional
compensation of $6,000 per year. Our statutory independent directors, as defined under Israeli law,
may not be compensated in connection with their services as statutory independent directors in
excess of the amounts set forth in the Israeli Companies Law and regulations promulgated
thereunder. Each of our statutory independent directors receives $390 as a participation fee for
each board meeting that he attends and $6,400 as an annual fee. 58




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Cash Compensation of Executive Officers We paid an aggregate of $5,482,947 to all of our directors and officers (24 persons) for
services rendered to us in all capacities during the year ended December 31, 2004. This amount does
not include certain additional benefits which, as to all directors and officers as a group,
aggregated approximately $100,000. 
 C. BOARD PRACTICES We are subject to the provisions of the Israeli Companies Law, which became effective on
February 1, 2000. Board of Directors According to the Companies Law and our Articles of Association, the management of our business
is vested in our board of directors. The board of directors may exercise all powers and may take
all actions that are not specifically granted to our shareholders. As part of its powers, our board
of directors may cause us to borrow or secure payments of any sum or sums of money for our
purposes, at times and upon conditions as it thinks fit, including the grant of security interests
on all or any part of our property. Our board of directors currently consists of ten directors. The following members of our
board of directors have been determined to be independent within the meaning of applicable Nasdaq
regulations: Myron Strober, C.P.A., Heather Douglas, Esq., Micha Friedman, Ph.D., Eric Johnston,
Esq., Gad Keren, M.D., Ben Zion Hod, C.P.A. and Haim Fainaro, C.P.A. The board of directors
includes two statutory independent directors, Ben Zion Hod, C.P.A. and Haim Fainaro, C.P.A.,
mandated under Israeli law and subject to additional criteria to help ensure their independence.
See  Statutory Independent Directors below. According to our Articles of Association (as amended in 2002), our board of directors may
neither consist of fewer than five directors nor more than 25 directors. The Companies Law, as
amended, requires the board of directors of a public company to determine the number of directors
who shall possess accounting and financial expertise. This requirement is subject to and will only
enter into effect upon promulgation of regulations by the Israeli Minister of Justice. Such
regulations have not yet been published. The board of directors must make such determination by no
later than 90 days following publication of such regulations. Our directors, other than our statutory independent directors, are elected at annual general
meetings of our shareholders, which are required to be held at least once during every calendar
year and not more than fifteen months after the last preceding meeting. Directors may also be
appointed, whether to fill vacancies or as additional members of the board of directors, by a
resolution passed at an extraordinary general meeting of our shareholders. Likewise, in the event
of a vacancy, the board of directors is empowered to appoint a director to fill such vacancy until
the next annual general meeting of shareholders. A director holds office until the next annual
general meeting, unless he or she resigns or is earlier removed from office by an ordinary
resolution passed at an extraordinary general meeting of our shareholders. 59




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Statutory Independent Directors Qualifications of Statutory Independent Directors Under the Companies Law, companies incorporated under the laws of Israel whose shares are
listed for trading on a stock exchange or have been offered to the public by a prospectus and are
held by the public, in or outside of Israel, are required to elect two statutory independent
directors. The Companies Law provides that a person may not be elected as a statutory independent
director if the person or the persons relative, partner, employer or any entity under the persons
control has, as of the date of the persons election to serve as a statutory independent director,
or had, during the two years preceding that date, any affiliation with:  
    
    our company;  
    
    any entity controlling our company; or  
    
    any entity controlled by our company or under common control with our company. The term affiliation includes an employment relationship, a business or professional relationship
maintained on a regular basis, control of the company, and service as an office holder. The Companies Law defines the term office holder as a director, general manager, chief
business manager, deputy general manager, vice general manager, any other person assuming the
responsibilities of any of the forgoing positions without regard to such persons title, or any
manager that reports directly to the general manager. The Companies Law further provides that no
person can serve as a statutory independent director if the persons other positions or other
business creates, or may create, a conflict of interest with the persons responsibilities as a
statutory independent director or may otherwise interfere with the persons ability to serve as a
statutory independent director. Until the lapse of two years from termination of office, a company
may not engage a statutory independent director to serve as an office holder and cannot employ or
receive services from that person, either directly or indirectly, including through a corporation
controlled by that person. A person shall be qualified to serve as a statutory independent director only if he or she
possesses accounting and financial expertise or professional qualifications. At least one statutory
independent director must posses accounting and financial expertise. The conditions and criteria
for possessing accounting and financial expertise or professional qualifications are subject to
promulgation of regulations by the Israeli Minister of Justice in consultation with the Israeli
Securities Authority, which have not yet been published; moreover, these criteria do not apply to
external directors appointed before the recent amendment to the Companies Law but will
apply to their reappointment for an additional term. Election of Statutory Independent Directors Statutory independent directors generally are elected by a majority vote at a shareholders
meeting, provided that either:  
    
    the majority includes at least one third of the shares of
non-controlling shareholders (as defined in the Companies Law) or
their representatives voted at the meeting in favor of the election;
or 60




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
    
    the total number of shares voted against the election of the statutory
independent director by the non-controlling shareholders does not
exceed one percent of the aggregate voting rights in the company. The initial term of a statutory independent director is three years and may be extended for
three additional years. Statutory independent directors may be removed from office only by the same
percentage of shareholders as is required for their election or by a court, if the statutory
independent directors cease to meet the statutory qualifications for their appointment or if they
violate their duty of loyalty to the company. Each committee of a companys board of directors is
required to include at least one statutory independent director, except for the audit committee
which is required to include all the statutory independent directors. Our statutory independent directors, Ben Zion Hod and Haim Fainaro, were elected by our
shareholders in 2003, pursuant to the provisions of the Israeli Companies Law for initial three
year terms, which will end on July 31, 2006 and August 28, 2006, respectively. Alternate Directors Pursuant to our Articles of Association and the Israeli Companies Law, any director may
appoint, by written notice to us, any person who is not serving as a director, or as an alternate
director, to serve as an alternate director and may also remove such alternate director. An
alternate director possesses all the rights and obligations of the appointing director except that
the alternate, in his capacity as such, has no standing at any meeting if the appointing director
is present. Unless the appointing director limits the time or scope of the appointment, it shall be
effective for all purposes until the appointing director ceases to be a director or terminates the
appointment. The appointment of an alternate director does not diminish the responsibility of the
appointing director as a director. Committees Subject to the provisions of the Israeli Companies Law, our board of directors may delegate
its powers to certain committees comprised of board members. Pursuant to the Companies Law, any
committee of the board of directors that is authorized to perform any function of the board, must
include at least one statutory independent director. Our board of directors has formed Audit,
Executive, Finance, Compensation and Stock Option committees. Audit Committee Under the Israeli Companies Law, our board of directors is required to appoint an audit
committee, comprised of at least three directors including both statutory independent directors,
but excluding:  
    
    the chairman of the board of directors; and  
    
    a controlling shareholder or a relative of a controlling shareholder
and any director employed by our company or who provides services to
us on a regular basis. As of June 15, 2005, our audit committee consisted of the following directors: Myron Strober,
Chairman, Eric Johnston, Heather Douglas, Ben Zion Hod, and Haim Fainaro, all of 61




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whom have been determined to be independent as defined by the applicable Nasdaq rules and
those of the SEC. The role of the audit committee is, among other things, to examine flaws in our business
management, in consultation with the  and the independent accountants and to
propose remedial measures to the board. The audit committee is responsible for making proposals to
the board with respect to the compensation of our executive officers. Thus, the determination, or
recommendation for determination, of the compensation of our executive officers is made by a
majority of our independent directors (as defined by the applicable Nasdaq rules). Audit Committee Report The audit committee has reviewed and discussed with management the Companys audited
consolidated financial statements as of and for the year ended December 31, 2004. The audit committee has also discussed with Kost, Forer, Gabbay & Kasierer, a member of Ernst
& Young Global, the matters required to be discussed by the Statement on Auditing Standards No. 61,
Communication with Audit Committees, as amended, issued by the Auditing Standards Board of the
American Institute of Certified Public Accountants. Based on the reviews and discussions referred to above, the audit committee has recommended to
the board of directors of the Company that the audited consolidated financial statements referred
to above be included in this Form 20-F for the year ended December 31, 2004. Approval of Interested Party Transactions The approval of the audit committee is required to effect specified actions and transactions
with office holders, controlling shareholders and entities in which they have a personal interest.
An audit committee may not approve an action or a transaction with the Companys controlling
shareholders or with its office holders unless at the time of approval the two statutory
independent directors are serving as members of the audit committee and at least one of our
statutory independent directors serving as members of our audit committee was present at the
meeting in which such approval was granted. A controlling shareholder is defined in the Companies
Law for this purpose as a person with the ability to direct the actions of a company, or a person
who holds 25% or more of the voting rights in a public company if no other shareholder owns more
than 50% of the voting rights in the company, provided that two or more persons holding voting
rights in the company who each have a personal interest in the approval of the same transaction
shall be deemed to be one holder. Audit committee approval is also required to approve the grant of an exemption from the
responsibility for a breach of the duty of care towards the company, or for the provision of
insurance or an undertaking to indemnify any office holder who is not a director of the company. In
addition, among other things the audit committee must approve contracts between the company and any
of its directors relating to the service or employment of a director. 62




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Internal Auditor Under the Companies Law, the board of directors is required to appoint an internal auditor
proposed by the audit committee. The internal auditor may not be an interested party, an office
holder, or a relative of any of the foregoing, nor may the internal auditor be our independent
accountant or its representative. The Companies Law defines the term interested party to include
a person who holds 5% or more of our outstanding share capital or voting rights, a person who has
the right to appoint one or more directors or the general manager, or any person who serves as a
director or as the general manager. The role of the internal auditor is to examine, among other
things, whether our actions comply with the law and orderly business procedure. Mr. Elisha Saar,
C.P.A., an independent public accountant, currently serves as our internal auditor. The internal
auditor has the right to demand that the chairman of the audit committee convene an audit committee
meeting and the internal auditor may participate in all audit committee meetings. In addition,
there are two employees whose sole responsibilities are to perform internal audit functions. Compensation Committee The compensation committee is responsible for making proposals to the board with respect to
the compensation of employees other than executive officers. However, the determination, or
recommendation for determination, of the compensation of our executive officers is made by the
audit committee which is a majority of our independent directors (as defined by the applicable Nasdaq
rules). As of June 15, 2005, our compensation committee consisted of the following directors: Tal
Levitt, Esq., Chair, Myron Strober, C.P.A., Eric Johnston, Esq., and Ben Zion Hod, C.P.A. 
 D. EMPLOYEES The following table sets forth the number of our employees as of December 31, 2004: Israel
    
    
    Canada
    
    
    U.S.A.
    
    
    Ireland
    
    
    Other
    
    
    TotalSales and Marketing
    
    
    35
    
    
    
    39
    
    
    
    165
    
    
    
    1
    
    
    
    2
    
    
    
    218Administration
    
    
    48
    
    
    
    33
    
    
    
    127
    
    
    
    8
    
    
    
    3
    
    
    
    243Research and Development
    
    
    139
    
    
    
    76
    
    
    
    36
    
    
    
    12
    
    
    
    1
    
    
    
    264Production and Quality Control
    
    
    376
    
    
    
    214
    
    
    
    0
    
    
    
    32
    
    
    
    
    
    
    
    622Total
    
    
    598
    
    
    
    362
    
    
    
    328
    
    
    
    53
    
    
    
    6
    
    
    
    1,347
 As part of the Companys efforts to control costs during 2004, our work force was reduced by
approximately 10%. In general, our relationship with our employees is satisfactory. We have no collective
bargaining agreements with any of our employees. However, certain provisions of the collective
bargaining agreements between the Histadrut (General Federation of Labor in Israel) and the Israeli
Coordination Bureau of Economic Organizations (including the Industrialists Association) apply to
all of our employees in Israel by order of the Israeli Ministry of Labor. These provisions concern
principally the length of the workday, minimum daily wages for professional workers, insurance for
work-related accidents, procedures for dismissing employees, determination of severance pay, and
other conditions of employment. We generally provide our employees with benefits and working
conditions beyond the required minimums. 63




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Israeli law generally requires severance pay upon the retirement or death of an employee or
termination of employment without cause. We currently fund our ongoing severance obligations by
contributing on behalf of our senior employees to a fund known as the Managers Insurance. This
fund provides a combination of savings plan, life insurance and severance pay benefits to our
employees, and each employee receives a lump sum payment upon retirement and severance pay, if the
employee is legally entitled to it, upon termination of employment. We decide whether each employee
is entitled to participate in the plan, and each employee who agrees to participate contributes an
amount equal to 5% of his or her salary and we contribute an additional sum of between 13.3% and
15.8% of the employees salary. In addition, Israeli employees and employers are required to pay
predetermined sums to the National Insurance Institute (an agency similar to the United States
Social Security Administration), which include payments for national health insurance. The payments
to the National Insurance Institute are approximately 14.5% of an employees wages (up to a
specified amount), of which the employee contributes approximately 66% and we contribute
approximately 34%. 64




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E. SHARE OWNERSHIP The following table sets forth certain information regarding the ownership of our ordinary
shares by our directors and officers as of May 31, 2005. The percentage of ownership is based on
29,530,535 ordinary shares outstanding as of May 31, 2005. Ordinary shares subject to options
currently exercisable, or exercisable within 60 days of May 31, 2005, are deemed outstanding for
computing the percentage ownership of the person holding such options, but are not deemed
outstanding for computing the percentage ownership of any other person. Percentage ofNumber of
    
    Outstanding OrdinaryName
    
    Ordinary Shares
    
    SharesBarrie Levitt, M.D. (1)
    
    1,206,232
    
    4.1%Daniel Moros, M.D. (2)
    
    820,851
    
    2.8%Tal Levitt, Esq.
    
    569,514
    
    1.9%Myron Strober, C.P.A.
    
    *
    
    *Heather Douglas, Esq.
    
    *
    
    *Micha Friedman, Ph.D
    
    *
    
    *Eric Johnston, Esq
    
    *
    
    *Gad Keren, M.D.
    
    *
    
    *Ben Zion Hod, C.P.A.
    
    *
    
    *Haim Fainaro, C.P.A.
    
    *
    
    *Samuel Rubinstein
    
    *
    
    *Kevin Connelly, C.P.A.
    
    *
    
    *Avraham Yacobi, Ph.D
    
    *
    
    *Zahava Rafalowicz
    
    *
    
    *Mariana Bacalu
    
    *
    
    *Hannah Bayer, C.P.A.
    
    *
    
    *Marc Coles, Esq.
    
    *
    
    *Yohanan Dichter
    
    *
    
    *Roman Kaplan, Ph.D
    
    *
    
    *Iftach Katz
    
    *
    
    *Sigalit Portnoy, Ph.D
    
    *
    
    *Alon Korb
    
    *
    
    *Tzvi Tal
    
    *
    
    *Puah Dekel
    
    *
    
    *Total for all directors and
officers (24 persons) listed
above, as a group
    
    2,893,521
    
    9.8%
 
 (1)
    
    Of the ordinary shares beneficially owned by Dr. Levitt, (1) 319,066 ordinary shares are
owned individually by Dr. Levitt, (2) 585,780 ordinary shares are held by Dr. Levitt as trustee for
trusts established by Dr. Levitt, (3) 12,934 ordinary shares are owned by Dr. Levitt and his wife
as joint tenants, (4) 780 ordinary shares are owned by Morley and Company, Inc., or Morley, which
is controlled by Dr. Levitt, (5) 198,032 ordinary shares are owned by Orenova Corporation, which is
wholly-owned by Dr. Levitt and members of his immediate family, (6) 24,200 ordinary shares, which
are not currently outstanding, are subject to incentive options granted to Dr. Levitt that are
presently exercisable, (7) 65,440 ordinary shares are owned by Taro Research Foundation, Inc., or
the Research Foundation, a charitable foundation established by Dr. Levitt. In addition, Dr. Levitt
has the right to appoint a majority of the Board of Directors of Morley and Company, Inc. which
owns all 2,600 of our outstanding founders shares, whose holders are entitled to exercise
one-third of the total voting power in our company regardless of the number of ordinary shares then
outstanding. 65




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In 2001, the Research Foundation was created by means of a gift of 65,440 shares from the Levitt
Family. The members of the Foundation are: Dr. Barrie Levitt, Dr. Daniel Moros, Tal Levitt, Dr.
Jacob Levitt, and Taro U.S.A.,and its trustees are: Dr. Barrie Levitt and Dr. Daniel Moros. The purpose of the Foundation is to
make charitable contributions to health related educational and research institutions.(2)
    
    Of the ordinary shares owned by Dr. Moros, (1) 353,217 ordinary shares are owned individually
by Dr. Moros, (2) 190,960 ordinary shares are held by Dr. Moros as co-trustee of the Nathan Moros
Trust, (3) 253,574 ordinary shares are held by Dr. Moros as trustee for trusts established by
Isabel Moros, and (4) 23,100 ordinary shares, which are not currently outstanding, are subject to
incentive options granted to Dr. Moros that are presently exercisable.*
    
    Less than 1% As of May 31, 2005, the directors and executive officers listed above, as a group, held
options to purchase 611,650 of our ordinary shares at a weighted average exercise price of $21.53,
such options expiring between June 2005 and January 2015. Stock Option Plans From time to time, we have granted options to purchase our ordinary shares. As of May 31,
2005, there were 1,472,278 options outstanding to acquire our ordinary shares. Compensation Pursuant to Plans 1991 Stock Incentive Plan Our 1991 Stock Incentive Plan was unanimously adopted by our board of directors on November
19, 1991 and approved by our shareholders on April 10, 1992. The purpose of the 1991 Stock
Incentive Plan is to attract, retain and provide incentives to key employees, including directors
and officers who are key employees, and to consultants and directors who are not our employees by
enabling them to participate in our long-term growth. Dr. Levitt and Dr. Moros were not eligible to
participate in the 1991 Stock Incentive Plan. The 1991 Stock Incentive Plan permits the grant of options and stock appreciation rights, or
SARs. Options may either be incentive stock options, or ISOs, or nonqualified stock options, or
NQSOs. The total number of our ordinary shares with respect to which options and SARs may be
granted under the 1991 Plan may not exceed 1,000,000, subject to appropriate adjustment in the
event of stock dividends, stock splits and similar transactions. All key employees of, and consultants to us, and our directors, including officers and
directors who are key employees, other than the Optionees, and members of our stock option
committee, as defined in the 1991 Stock Incentive Plan, were eligible to participate in the 1991
Stock Incentive Plan. However, ISOs may only be granted to employees, including officers and
directors who are also employees. Under the plan, directors, excluding Identified Public Directors
who are not employees of our company or Outside Directors, both as defined in the 1991 Stock
Incentive Plan, are granted, on the date that such individual is initially elected a director, a
one-time nonqualified option to purchase 4,000 ordinary shares, or the Initial Outside Director
Award. The 1991 Stock Incentive Plan is administered by our board of directors (as required by the
Companies Law) and by a Plan Committee, composed of not less than two members, each of 66




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whom must be
disinterested persons as defined by the Securities and Exchange Commission (as required by U.S.
law). Within the limits of the 1991 Stock Incentive Plan, the board of
directors and Plan Committee are authorized to determine, among other things, to whom and the
time or times at which options and SARs are to be granted, the types of options and SARs to be
granted, the number of shares which will be subject to any option or SAR, the term of each option
and SAR, the exercise price of each option and base price of each SAR, and the time or times and
conditions under which options and SARs may be exercised. The board of directors and the Plan
Committee may, with the consent of the holder of the option or SAR, cancel or modify an option or
SAR or grant an option or SAR in substitution for any canceled option or SAR, provided that any
substituted option or SAR and any modified option or SAR is permitted to be granted on such date
under the terms of the 1991 Stock Incentive Plan and the Code. In such case, the board of directors
and the Plan Committee may give credit toward any required vesting period for the substituted
option or SAR for the period during which the employee held the canceled option or SAR. The exercise price of an option or base price of a SAR granted under the 1991 Stock Incentive
Plan, other than the Initial Outside Director Award, shall be determined by the board of directors
and the Plan Committee, but may not be less than 100% of the fair market value of the ordinary
shares on the date of grant or 110% of such fair market value in the case of an ISO granted to an
optionee who owns or is deemed to own stock possessing more than 10% of the combined voting power
of all classes of our stock. The exercise price of an Initial Outside Director Award shall equal
the fair market value of the ordinary shares subject to such option on the date of grant. Upon exercise of a SAR, subject to applicable law, the holder is entitled to receive an
amount, in cash, ordinary shares or a combination of the two, as determined by the board of
directors and the Plan Committee, equal to the excess of the fair market value of the shares with
respect to which the SAR is, exercised calculated as of the exercise date, over the base price. The term of each option and SAR other than an Initial Outside Director Award will be for such
period, and such option or SAR may be exercised at such times during such period and on such terms
and conditions, as the board of directors and the Plan Committee may determine, consistent with the
terms of the 1991 Stock Incentive Plan. The term of an Initial Outside Director Award will be five
years. Each Initial Outside Director Award will become exercisable in each of the four years
commencing one year after the date of grant to the extent of one-fourth of the number of our
ordinary shares originally subject to the option granted therein. Ordinary shares not purchased
pursuant to an Initial Outside Director Award in any one exercise period may be purchased in any
subsequent exercise period prior to the termination of the award. The term of any option or SAR may
not exceed ten years, or five years with respect to ISOs granted to optionees who own or are deemed
to own stock representing more than 10% of the combined voting power of all classes of our shares. There is no limit on the number of shares for which options or SARs may be granted or awarded
to any eligible employee, consultant or director. However, the aggregate fair market value
(determined as of the date of grant) of ordinary shares with respect to which ISOs granted to any
employee may be first exercisable in any calendar year under all of our incentive stock option
plans may not exceed $100,000. To the extent such limit is exceeded, the excess will be treated as
a separate NQSO. 67




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As of June 16, 2005, 158,623 ordinary shares were subject to outstanding options. Of such
options, 62,000 (at an average exercise price of $2.87 per share) were held by executive officers;
50,000 (at an average exercise price of $2.96 per share) were held by directors who are not
executive officers; and 46,623 (at an average exercise price of $2.86 per share) were held by
other persons. None of such options was an SAR. 1999 Stock Incentive Plan Our 1999 Stock Incentive Plan was unanimously adopted by our board of directors on March 10,
1999, and was approved at the annual meeting of shareholders held on July 29, 1999. An amendment
that had been previously adopted by our board of directors was approved at the annual meeting of
shareholders held on August 5, 2004. The purpose of the 1999 Stock Incentive Plan is to attract,
retain and provide incentives to key employees (including directors and officers who are key
employees) and to consultants and directors who are not our employees by enabling them to
participate in our long-term growth. The total number of ordinary shares with respect to which
options and SARs may be granted under the 1999 Plan may not exceed 2,100,000 subject to appropriate
adjustment in the event of stock dividends, stock splits and similar transactions. The 1999 Stock Incentive Plan permits the grant of options and SARs. Options may either be
ISOs or NQSOs. SARs may be granted either alone or in tandem with ISOs or NQSOs, and may be granted
before, simultaneously with or subsequent to the grant of an option. Any option granted in tandem
with a SAR would no longer be exercisable to the extent the SAR is exercised and the exercise of
the related option would cancel the SAR to the extent of such exercise. All key employees and directors of, and consultants to us, (as defined in the 1999 Stock
Incentive Plan), are eligible to participate in the 1999 Stock Incentive Plan. However, ISOs may
only be granted to employees (including officers and directors who are also employees). Each
Outside Director, including statutory independent directors, shall be granted, on the date
initially elected a director, a one-time nonqualified option to purchase the Initial Outside
Director Award. The 1999 Stock Incentive Plan is administered by our board of directors (as required by the
Companies Law), and, by a committee of our board of directors, which shall contain at least the
minimum number of and type of directors (the Administrators) that may be required in order for
options granted under the Plan to be entitled to benefits under Section 162(m) of the Code. Within
the limits of the 1999 Stock Incentive Plan, the Administrators are authorized to determine, among
other things, to whom and the time or times at which, options and SARs are to be granted, the types
of options and SARs to be granted, the number of shares which will be subject to any option or SAR,
the term of each option and SAR, the exercise price of each option and base price of each SAR, and
the time or times and conditions under which options and SARs may be exercised. The Administrators
may (with the consent of the holder of the option or SAR) cancel or modify an option or SAR, or
grant an option and/or SAR in substitution for any canceled option or SAR, provided that any
substituted option or SAR and any modified option or SAR is permitted to be granted on such date
under the terms of the 1999 Stock Incentive Plan and the Code. In such case, the Administrators may
give credit toward any required vesting period for the substituted option or SAR for the period
during which the employee held the canceled option or SAR. The exercise price of an option or base price of a SAR granted under the 1999 Stock Incentive
Plan shall be determined by the Administrators, but may not be less than 100% of the fair market 68




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value of the ordinary shares on the date of grant (110% of such fair market value in the case of an
ISO granted to an optionee who owns or is deemed to own stock possessing more than 10% of the
combined voting power of all classes of our stock). The exercise price of an Initial Outside
Director Award shall equal the fair market value of the ordinary shares subject to such option
on the date of grant. Upon exercise of a SAR, the holder is entitled to receive an amount in cash, ordinary shares
or a combination of the two, as determined by the Administrators, equal to the excess of the fair
market value of the shares with respect to which the SAR is exercised (calculated as of the
exercise date) over the base price. The term of each option and SAR, subject to applicable law, other than an Initial Outside
Director Award will be for such period, and such option or SAR may be exercised at such times
during such period and on such terms and conditions, as the Administrators may determine,
consistent with the terms of the 1999 Stock Incentive Plan. The term of an Initial Outside Director
Award will be five years. Each Initial Outside Director Award will become exercisable in each of
the four years commencing one year after the date of grant to the extent of one-fourth of the
number of ordinary shares originally subject to the option granted therein. Ordinary shares not purchased pursuant to an Initial Outside Director Award in any one
exercise period may be purchased in any subsequent exercise period prior to the termination of the
award. The term of any ISO may not exceed ten years (five years with respect to ISOs granted to
optionees who own or are deemed to own stock representing more than 10% of the combined voting
power of all classes of our shares). The maximum number of shares for which options may be granted or awarded in any calendar year
to any eligible employee is 1,000,000. There is no limit on the number of shares for which options
may be granted or awarded to any consultant or director, or for which SARs may be granted or
awarded to any eligible employee, consultant or director. However, the aggregate fair market value
(determined as of the date of grant) of ordinary shares in respect of which ISOs granted to any
employee may be first exercisable in any calendar year under all incentive stock option plans of
our company may not exceed $100,000. To the extent such limit is exceeded, the excess will be
treated as a separate NQSO. As of June 16, 2005, 1,313,655 ordinary shares were subject to outstanding options. Of such
options, 423,650 (at an average exercise price of $33.23 per share) were held by executive
officers; 76,000 (at an average exercise price of $32.73 per share) were held by directors who are
not executive officers; and 814,005 (at an average exercise rice of $33.14 per share) were held by
other persons. None of such options was an SAR. 2000 Employee Stock Purchase Plan Our 2000 Employee Stock Purchase Plan was adopted by our board of directors on May 3, 2000,
and was approved at an extraordinary general meeting of shareholders held on May 2, 2001. The
purpose of the 2000 Employee Stock Purchase Plan is to provide our employees and those of certain
of our subsidiaries designated by our board of directors with an opportunity to purchase our
ordinary shares. Dr. Levitt, Ms. Levitt and Dr. Moros are not eligible to participate in the 2000
Employee Stock Purchase Plan. 69




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The 2000 Employee Stock Purchase Plan is administered by our board of directors (as required
by the Companies Law) and by a committee named by our board of directors, which, subject to
applicable law, has the power to adopt, amend and rescind any rules deemed desirable
and appropriate for the administration of the 2000 Employee Stock Purchase Plan and not
inconsistent with the 2000 Employee Stock Purchase Plan, to construe and interpret the 2000
Employee Stock Purchase Plan, and to make all other determinations necessary or advisable for the
2000 Employee Stock Purchase Plan. The composition of the committee shall be in accordance with the
requirements to obtain or retain any available exemption from the operation of Section 16(b) of the
Securities and Exchange Act of 1934 pursuant to Rule 16b-3 promulgated thereunder. Under the terms of the 2000 Employee Stock Purchase Plan, participating employees accrue funds
in an account through payroll deductions during six-month offering periods. The funds in this
account are applied at the end of such offering periods to purchase our ordinary shares at a 15%
discount from the closing price of the ordinary shares on (i) the first business day of the
offering period or (ii) the last business day of the offering period, whichever closing price shall
be less. The maximum number of shares issuable under the 2000 Employee Stock Purchase Plan is 500,000
ordinary shares, subject to adjustment. To be eligible to participate in the 2000 Employee Stock
Purchase Plan, an individual must be employed by us or one of our subsidiaries designated by the
board of directors on the first day of the applicable plan period. Notwithstanding the foregoing,
anyone who is both a highly compensated employee within the meaning of the Code and is designated
by the board of directors as ineligible to participate in the 2000 Employee Stock Purchase Plan
shall not be entitled to participate in the 2000 Employee Stock Purchase Plan. In addition, no employee will be granted a right under the 2000 Employee Stock Purchase Plan
if (i) immediately after the grant, such employee would own stock and/or hold outstanding options
to purchase stock constituting 5% or more of the total combined voting power or value of our stock
or any of our subsidiaries or (ii) such grant would result in such employees rights to purchase
stock under all of our employee stock purchase plans or of our subsidiaries to accrue at a rate
that exceeds $25,000 of the fair market value of such stock (determined as of the last business day
of the preceding semi-annual period) for each calendar year. As of December 31, 2004, approximately 125,438 ordinary shares have been purchased through the
2000 Employee Stock Purchase Plan at a weighted average purchase price of $21.06. 
 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 
 A. MAJOR SHAREHOLDERS The following table sets forth certain information as of June 15, 2005, with respect to the
ownership of our ordinary shares by all persons who are known to us to beneficially own more than
5% of our outstanding ordinary shares, and by all of our directors and officers as a group. Except
as indicated, each such shareholder has sole voting and investment power with respect to the
ordinary shares beneficially owned by such shareholder. Beneficial ownership is determined in
accordance with rules of the United States Securities and Exchange Commission and generally 70




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includes voting and investment power with respect to our ordinary shares. Percentage ownership is
based on 29,530,535 ordinary shares outstanding as of May 31, 2005. Ordinary Shares
    
    
    Percent of OrdinaryName
    
    Beneficially Owned
    
    
    Shares OutstandingNeuberger Berman, Inc./Neuberger Berman, LLC(1)
    
    
    3,073,632
    
    
    
    10.4
    %Taro Development Corporation(2)
    
    
    2,332,937
    
    
    
    7.9
    %T. Rowe Price Associates, Inc. (3)
    
    
    1,983,100
    
    
    
    6.7
    %Franklin Resources, Inc. (4)
    
    
    1,817,305
    
    
    
    6.2
    %Brookside Capital Partners Fund, L.P. (5)
    
    
    1,610,810
    
    
    
    5.5
    %
 
 (1)
    
    Based on information contained in a Schedule 13F filed on February 8, 2005 by Neuberger
Berman, LLC.(2)
    
    Dr. Levitt, Dr. Moros, and their families may be deemed to control all of the ordinary
shares owned by TDC by virtue of their ownership of more than 50% of the shares of TDC.(3)
    
    Based on information contained in a Schedule 13G, filed on February 14, 2005 by T. Rowe
Price Associates, Inc.(4)
    
    Based on information contained in a Schedule 13G, filed on February 14, 2005 by Franklin
Resources, Inc.(5)
    
    Based on information contained in a Schedule 13G, filed on April 12, 2005 by Brookside
Capital Partners Fund, L.P. Founders Shares At the formation of our company in 1959, two classes of shares were created, founders shares
and ordinary shares. One third of the voting power of all of our voting shares is allocated to the
founders shares. Morley and Company, which is controlled by Dr. Levitt, owns all of the 2,600
outstanding founders shares. Holders of Morleys class A shares are entitled to elect one director
of Morley and holders of Morleys class B shares are entitled to elect two directors of Morley. As the holder of all of Morleys class B Shares, Dr. Levitt may cause the election of two of
the three directors and, therefore, may be deemed to control the voting and disposition of the
founders shares. Voting Power As of May 31, 2005, Dr. Levitt, Dr. Moros, Tal Levitt and members of their respective
immediate families, in the aggregate, control 45.6% of the voting power in our company by reason of
their (i) beneficial ownership, other than through TDC, of an aggregate of 10.5% of our ordinary
shares, (ii) their majority ownership of TDC, which owns 7.9% of our ordinary shares, and (iii) Dr.
Levitts control of Morley, which, through its ownership of the founders shares, has one-third of
the voting power of our shares. 71




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As of May 31, 2005 29,530,535 of our ordinary shares were outstanding. They were held of
record by 347 persons. 
 B. RELATED PARTY TRANSACTIONS Not applicable. 
 C. INTERESTS OF EXPERTS AND COUNSEL Not applicable. 
 ITEM 8. FINANCIAL INFORMATION 
 A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION The Financial Statements required by this item are found at the end of this annual report,
beginning on page F-1. Other Financial Information We manufacture pharmaceutical products in our facilities in Israel and Canada. A substantial
amount of these products are exported, both to our affiliates and non-affiliates. For a breakdown
of our sales by geographic market for the past three years, see Item 4  Information on the
Company-Business Overview-Sales and Marketing. Legal Proceedings From time to time, we are a party to routine litigation incidental to our business, none of
which, individually or in the aggregate, is expected to have a material adverse effect on our
financial position. Prior to 2004, a claim in the approximate amount of $550,000 was filed by a
customer. Based upon a legal opinion and our insurance coverage, we believe that the ultimate
resolution of this matter will not result in a material adverse effect on our financial position. On August 2, 2004, a purported securities class action complaint was filed against us and
certain of our current and former officers and directors in the United States District Court for
the Southern District of New York. The complaint alleges that the defendants made statements during
the period February 20, 2003 through July 29, 2004 in press releases, our 2003 Annual Report and
during conference calls with analysts which were materially false and misleading and which
artificially inflated the price of our ordinary shares. The complaint alleges claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934. Nine additional purported securities class
action complaints were subsequently filed in the United States District Court for the Southern
District of New York, all containing similar allegations. On October 5, 2004, a motion to
consolidate the ten actions, appoint lead plaintiffs and for approval of selection of lead counsel
was filed. The motion is still pending. We and the individual defendants intend to vigorously
defend against the claims in these actions. On August 17, 2004, two shareholders derivative actions were filed in the United States
District Court for the Southern District of New York against certain of our current and former
officers and directors alleging that defendants breached their fiduciary duties based on the same 72




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alleged course of conduct identified in the securities actions described above. On October 27,
2004, the two actions were consolidated. Subsequently, plaintiffs counsel agreed to voluntarily
dismiss the lawsuit, in its entirety, without prejudice. On November 24, 2004, a stipulation and
proposed order dismissing the litigation, in its entirety, without prejudice, was submitted to the
court for approval and was approved. As described in our Annual Report on Form 20-F for the year ended December 31, 2003, on
November 14, 2003, Godecke Aktiengesellschaft, Pfizer and Warner-Lambert, responding to our filing
of an abbreviated new drug application requesting approval for gabapentin capsules prior to the
expiration of certain listed patents, filed a complaint against us and our U.S. subsidiary, Taro
Pharmaceuticals U.S.A., Inc., in the district court in New Jersey alleging that under the
provisions of the Hatch-Waxman Act that our ANDA infringed certain Warner-Lambert patents. By
mutual consent between the parties, the case was dismissed without prejudice by the court in August
2004. Dividend Policy We have never paid cash dividends and we do not anticipate paying any cash dividends in the
foreseeable future. We currently intend to retain our earnings to finance the development of our
business, but such policy may change depending upon, among other things, our earnings, financial
condition and capital requirements. 
 B. SIGNIFICANT CHANGES Not applicable. 
 ITEM 9. THE OFFER AND LISTING 
 A. OFFER AND LISTING DETAILS The following table sets forth the high and low closing sale prices of our ordinary shares as
quoted on the Nasdaq National Market during the last five years: High
    
    
    Low2000
    
    $
    17.47
    
    
    $
    3.662001
    
    $
    48.50
    
    
    $
    13.442002
    
    $
    39.26
    
    
    $
    21.602003
    
    $
    72.11
    
    
    $
    30.142004
    
    $
    66.53
    
    
    $
    18.99
 The following table sets forth the high and low closing sale prices of our ordinary shares as
quoted on the Nasdaq National Market during each fiscal quarter of the last two years and any
subsequent period: High
    
    
    LowFirst Quarter 2003
    
    $
    38.92
    
    
    $
    30.14Second Quarter 2003
    
    $
    57.77
    
    
    $
    39.43Third Quarter 2003
    
    $
    58.71
    
    
    $
    48.85Fourth Quarter 2003
    
    $
    72.11
    
    
    $
    57.34First Quarter 2004
    
    $
    66.53
    
    
    $
    57.40
 73




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High
    
    
    LowSecond Quarter 2004
    
    $
    63.61
    
    
    $
    39.91Third Quarter 2004
    
    $
    43.48
    
    
    $
    18.99Fourth Quarter 2004
    
    $
    35.42
    
    
    $
    21.12First Quarter 2005
    
    $
    34.11
    
    
    $
    26.54
 The following table sets forth the high and low closing sale prices of our ordinary shares as
quoted on the Nasdaq National Market during the last six months: High
    
    
    LowDecember 2004
    
    $
    35.42
    
    
    $
    30.90January 2005
    
    $
    34.11
    
    
    $
    30.04February 2005
    
    $
    30.23
    
    
    $
    26.54March 2005
    
    $
    32.01
    
    
    $
    28.60April 2005
    
    $
    31.85
    
    
    $
    27.89May 2005
    
    $
    34.59
    
    
    $
    29.98
 
 B. PLAN OF DISTRIBUTION Not applicable. 
 C. MARKETS Our ordinary shares have been traded in the over the counter market in the United States since
1961. Our ordinary shares were first registered for trading on NASDAQ in 1982. Our ordinary shares
have been quoted on the Nasdaq National Market since 1993 under the symbol TARO. In May 2001, the
Chicago Option Exchange started to quote options on our ordinary shares under the symbol QTT.
There is no non-United States trading market for our ordinary shares. 
 D. SELLING SHAREHOLDERS Not applicable. 
 E. DILUTION Not applicable. 
 F. EXPENSES OF THE ISSUE Not applicable. 
 ITEM 10. ADDITIONAL INFORMATION 
 A. SHARE CAPITAL Not applicable. 
 B. MEMORANDUM AND ARTICLES OF ASSOCIATION Our registration number at the Israeli Registrar of Companies is 52-002290-6. 74




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Objects and Purposes Our Articles of Association provides that our main objects and purposes include any business
connected with the developing, manufacturing, processing, supplying, marketing and distributing
of prescription, over-the-counter medical and other health care products. These products
include active pharmaceutical ingredients and final dosage form products. In February 2000, the Companys Ordinance (New Version  1983) was replaced with the Companies
Law, which was most recently amended in March 2005. Since our Articles of Association were adopted
before the enactment of the Companies Law, they are not always consistent with the provisions of
the new law. In all instances in which the Companies Law changes or amends provisions in the
Companies Ordinance, and as a result our Articles of Association are not consistent with the
Companies Law, the provisions of the Companies Law apply unless specifically stated otherwise in
the Companies Law. Similarly, in all places where our Articles of Association refer to a section of
the Companies Ordinance that has been replaced by the Companies Law, the Articles of Association
are understood to refer to the relevant section of the Companies Law. Approval of Specified Related Party Transactions Under Israeli Law Fiduciary Duties of Office Holders The Companies Law imposes fiduciary duties that office holders owe to a company. An office
holders fiduciary duties consist of a duty of care and a duty of loyalty. The duty of care
requires an office holder to act with the level of care that a reasonable office holder in the same
position would have acted under the same circumstances. The duty of care includes a duty to use
reasonable means to obtain information on the advisability of a given action brought for the office
holders approval or performed by the office holder by virtue of his or her position and all other
important information pertaining to these actions. The duty of loyalty generally requires an office holder to act in good faith and for the good
of the company. Specifically, an office holder must avoid any conflict of interest between the
office holders position in a company and his or her other positions or personal affairs. In
addition, an office holder must avoid competing against the company or exploiting any business
opportunity of a company to receive a personal gain for himself, herself or others. An office
holder must also disclose to a company any information or documents relating to that companys
affairs that the office holder has received due to his or her position in the company. Under the Companies Law, all arrangements as to compensation of public companies directors
require the approval of the audit committee, the board of directors and shareholder approval, in
that order. Disclosure of Personal Interest of an Office Holder The Companies Law requires that an office holder promptly disclose to the company any personal
interest that he or she may have, and all related material information known to him or her, in
connection with any existing or proposed transaction by the company. A personal interest of an
office holder includes an interest of a company in which the office holder is, directly or
indirectly, a 5% or greater shareholder, holder of 5% or more of the voting power, director or 75




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general manager or in which he or she has the right to appoint at least one director or the general
manager. In the case of an extraordinary transaction, the office holders duty to disclose applies
also to a personal interest of the office holders spouse, siblings, parents, grandparents,
descendants, spouses descendants and the spouses of any of these people. An extraordinary
transaction is a transaction executed other than in the ordinary course of business, other
than according to prevailing market terms, or that is likely to have a material impact on the
companys profitability, assets or liabilities. Under the Companies Law, once the office holder complies with the above disclosure
requirement, the board of directors may approve the transaction between the company and an office
holder or a third party in which an office holder has a personal interest, unless the companys
articles of association provide otherwise. A transaction that is adverse to the companys interest
may not be approved. If the transaction is an extraordinary transaction, then it also must be
approved by the companys audit committee and board of directors, and, under certain circumstances,
by the shareholders of the company, in that order. A director who has a personal interest in a matter that is considered at a meeting of the
board of directors or a committee of the board may not be present at this meeting or vote on this
matter, unless a majority of the members of the board of directors or such committee, as the case
may be, has a personal interest in the matter. If a majority of members of the board of directors
have a personal interest therein, shareholder approval is also required. Disclosure of Personal Interests of a Controlling Shareholder Under the Companies Law, the disclosure requirements that apply to an office holder also apply
to a controlling shareholder of a public company. A controlling shareholder is a shareholder who
has the ability to direct the activities of a company, including a shareholder that owns 25% or
more of the voting rights if no other shareholder owns more than 50% of the voting rights, but
excluding a shareholder whose power derives solely from his or her position on the board of
directors or any other position with the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and the engagement of a
controlling shareholder as an office holder or employee, require the approval of the audit
committee, the board of directors and the shareholders of the company, in that order. The
shareholder approval must be by a majority of the shares voted on the matter, provided that either:  
    
    such majority includes at least one-third of the voting rights of shareholders who have
no personal interest in the transaction and who vote on the matter vote in favor thereof;
or
    
    the shareholders who have no personal interest in the transaction who vote against the
transaction do not represent more than one percent of the voting rights in the company. Shareholders generally have the right to examine documents in the companys possession
pertaining to any matter that requires shareholder approval. 76




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Voting, Rights Attached to Shares, Shareholders Meetings and Resolutions Under the Companies Law, we are required to hold an annual meeting of shareholders at least
once every calendar year and not more than fifteen months after the previous annual meeting. In
addition, special meetings may be conducted as required by certain events and circumstances. Our share capital is divided into founders shares and ordinary shares. Holders of paid-up
ordinary shares are entitled to participate equally in the payment of dividends and other
distributions and, in the event of liquidation, in all distributions after the discharge of
liabilities to creditors. In addition, ordinary shares entitle their holders to two-thirds of the
voting power of our company. The founders shares entitle their holders to one-third of the voting
power of our company. Dividends on our ordinary shares may be paid only out of profits and other surplus, as defined
in the Companies Law, as of the end of the most recent fiscal year or as accrued over a period of
two years, whichever is higher. Our board of directors is authorized to declare interim dividends,
whereas our shareholders are authorized to declare final dividends in accordance with our board of
directors recommendation, provided that there is no reasonable concern that the dividend will
prevent us from satisfying our existing and foreseeable obligations as they become due. Under the Companies Law and our Articles of Association, an ordinary resolution of the
shareholders (for example, with respect to the appointment of auditors) requires the affirmative
vote of a majority of the voting power voting in person or by proxy, whereas a special resolution
(for example, a resolution amending the Articles of Association or authorizing changes in
capitalization or in the rights attached to a class of shares) requires the affirmative vote of at
least 75% of the voting power voting in person or by proxy. Rights pertaining to a particular class
of shares require the vote of 75% of such class of shares in order to change said rights in
addition to the approval of 75% of the voting power of the shareholders voting in person or by
proxy on such resolution. The quorum required for a meeting of shareholders consists of at least
three shareholders present in person or by proxy who hold or represent between them at least
one-third of the outstanding voting power unless otherwise required by applicable rules. A meeting
adjourned for lack of a quorum generally is adjourned to the same day in the following week at the
same time and place or any time and place as the board of directors may designate. At such
reconvened meeting the required quorum consists of any two members present in person or by proxy. Restriction on Voting In order to reduce our risk of being classified as a Controlled Foreign Corporation under
the Code, we amended our Articles of Association in 1999 to provide that no owner of any of our
ordinary shares is entitled to any voting right of any nature whatsoever with respect to such
ordinary shares if (a) the ownership or voting power of such ordinary shares was acquired, either
directly or indirectly, by the owner after October 21, 1999 and (b) the ownership would result in
our being classified as a Controlled Foreign Corporation. This provision has the practical effect
of prohibiting each citizen or resident of the United States who acquired or acquires our ordinary
shares after October 21, 1999 from exercising more than 9.9% of the voting power in our company,
with respect to such ordinary shares, regardless of how many shares the shareholder owns. The
provision may therefore discourage U.S. persons from seeking to acquire, or from accumulating, 15%
or more of our ordinary shares (which, due to the voting power of the founders shares, would
represent 10% or more of the voting power of our company). 77




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Duties of Shareholders Under the Companies Law, each and every shareholder has a duty to act in good faith and in an
acceptable manner in exercising his, her or its rights and fulfilling his, her, or its obligations
towards us and other shareholders and to refrain from abusing his, her or its power, such as
in voting in the general meeting of shareholders on the following matters:  
    
    any amendment to the articles of association;  
    
    an increase of our authorized share capital;  
    
    a merger; or  
    
    approval of certain actions and transactions that require shareholder approval. In addition, each and every shareholder has the general duty to refrain from depriving other
shareholders of their rights. Furthermore, any controlling shareholder, any shareholder who knows that such shareholder
possesses the power to determine the outcome of a shareholder vote and any shareholder that,
pursuant to the provisions of the articles of association, has the power to appoint or to prevent
the appointment of an office holder in the company or any other power in regard to the company is
under a duty to act in fairness towards us. The Companies Law does not describe the substance of
this duty of fairness. These various shareholder duties may restrict the ability of a shareholder
to act in what the shareholder perceives to be his, her or its own best interests. Mergers and Acquisitions under Israeli Law The Companies Law includes provisions that allow a merger transaction, in general, and
requires that each company that is a party to a merger have the transaction approved by its board
of directors and a vote of the majority of the voting power of its shares at a shareholders
meeting called on at least 21 days prior notice. For purposes of the shareholder vote, unless a
court rules otherwise, the merger will not be deemed approved if a majority of the voting power
held by parties other than the other party to the merger, or by any person or entity holding 25% or
more of the voting power or the right to appoint 25% or more of the directors of the other party or
any person or entity affiliated or related to such person or entity, vote against the merger. Upon
the request of a creditor of either party of the proposed merger, the court may delay or prevent
the merger if it concludes that there exists a reasonable concern that as a result of the merger
the surviving company will be unable to satisfy the obligations of any of the parties to the
merger. In addition, a merger may not be completed unless at least 30 days have passed from the
time that the shareholders of each company has approved the merger and 50 days have passed from the
time that a proposal of the merger has been filed with the Israeli Registrar of Companies. In general, the Companies Law also provides that an acquisition of shares of a public company
must be made by means of a tender offer if as a result of the acquisition the purchaser would
become a 25% shareholder of the company and there is no existing 25% or greater shareholder in the
company. If there is no existing 45% or greater shareholder in the company, the Companies Law
provides that an acquisition of shares of a public company must be made by means of a tender offer
if as a result of the acquisition the purchaser would become a 45% 78




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shareholder of the company. If
following any acquisition of shares, the acquirer will hold 90% or more of the companys voting
power, the acquisition may not be made other than through a tender offer to acquire all of the
shares of such class. If more than 95% of the outstanding shares are tendered in the tender offer,
all the shares that the acquirer offered to purchase will be
transferred to it. However, the remaining minority shareholders may seek to alter the
consideration by court order. Recent promulgated regulations provide an exemption to the above
tender offer requirement, in the event that the acquisition of the control of the company, in any
degree, is subject to limitations of applicable non-Israeli law. Finally, Israeli tax law treats stock-for-stock acquisitions between an Israeli company and a
foreign company less favorably than does U.S. tax law. For example, unless the stock-for stock
transaction is considered a tax-deferred merger, Israeli tax law subjects a shareholder who
exchanges his ordinary shares for shares in another corporation to taxation on half the
shareholders shares two years following the exchange and on the balance four years thereafter even
if the shareholder has not yet sold the new shares. Indemnification and Insurance of Office Holders Insurance of Office Holders Subject to the provisions of the Companies Law, our Articles of Association provide that we
may enter into an insurance contract that would provide coverage for any monetary liability
incurred by any of our office holders with respect to an act performed in the capacity of an office
holder for:  
    
    a breach of the office holders duty of care to us or to another person;
    
    a breach of the office holders duty of loyalty to us, provided that the office holder
acted in good faith and had reasonable cause to assume that his or her act would not harm
us; or
    
    a financial liability imposed upon him or her in favor of another person. We have obtained liability insurance covering our officers and directors. Indemnification of Office Holders Subject to the provisions of the Companies Law, our Articles of Association provide that we
may indemnify any of our office holders against the following obligations and expenses imposed on
the office holder with respect to an act performed in the capacity of an office holder:  
    
    a financial obligation imposed on him or her in favor of another person by a court
judgment, including a compromise judgment or an arbitrators award approved by the court;
and
    
    reasonable litigation expenses, including attorneys fees, expended by the office holder
or charged to him or her by a court in connection with proceedings we institute against him
or her or that are instituted on our behalf or by another person or a criminal charge from 79




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which he or she is acquitted, or a criminal charge in which he or she is convicted of an
offense that does not require proof of criminal intent. Limitations on Exculpation, Insurance and Indemnification The Companies Law provides that a company may not exculpate or indemnify an office holder, or
enter into an insurance contract that would provide coverage for any monetary liability incurred as
a result of any of the following:  
    
    a breach by the office holder of his or her duty of loyalty unless, with respect to
indemnification and insurance coverage, the office holder acted in good faith and had a
reasonable basis to believe that the act would not prejudice the company;
    
    a breach by the office holder of his or her duty of care which was committed if the
breach was intentionally or recklessly, except when it was commited only by negligence;
    
    any act or omission done with the intent to derive an illegal personal benefit; or
    
    any fine levied against the office holder. In addition, under the Companies Law, exculpation, indemnification, and procurement of
insurance coverage for our office holders, must be approved by our audit committee and our board of
directors and if the beneficiary is a director, by our shareholders, in that order. 
 C. MATERIAL CONTRACTS During the two years preceding the date of this annual report, we did not enter into any
material contracts, other than contracts entered into in the ordinary course of business. 
 D. EXCHANGE CONTROLS Israeli law and regulations do not impose any material foreign exchange restrictions on
non-Israeli holders of our ordinary shares. In May 1998, a new general permit was issued under the
Israeli Currency Control Law, 1978, which removed most of the restrictions that previously existed
under the law, and enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies. Dividends, if any, paid to our ordinary shareholders, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of our
ordinary shares to an Israeli resident, may be paid in non-Israeli currency or, if paid in Israeli
currency, may be converted into freely repatriable dollars at the rate of exchange prevailing at
the time of conversion. 
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E. TAXATION AND GOVERNMENT PROGRAMS General The following is a summary of the current tax structure applicable to companies in Israel with
reference to its effect on us. The following also contains a discussion of material Israeli and
United States tax consequences to our shareholders and Israeli government programs benefiting us.
We cannot assure you that the tax authorities will accept the views expressed in the discussion in
question. The discussion is not intended, and should not be construed, as legal or professional tax
advice and is not exhaustive of all possible tax considerations. Holders of our ordinary shares should consult their own tax advisors as to the United States,
Israeli or other tax consequences of the purchase, ownership and disposition of ordinary shares,
including, in particular, the effect of any foreign, state or local taxes. Israeli Tax Considerations and Government Programs General Corporate Tax Structure Israeli companies were subject in 2004 to company tax at the rate of 35% (the rate has been
reduced to 34% in 2005, and will be further reduced to 32% in 2006 and to 30% in 2007) of taxable
income. However, the effective tax rate payable by a company that derives income from an Approved
Enterprise, as discussed below, may be considerably less. Tax Benefits under the Law for the Encouragement of Capital Investments, 1959 The Law for the Encouragement of Capital Investments, 1959, commonly referred to as the
Investment Law, provides that a proposed capital investment in eligible facilities may, upon
application to the Investment Center of the Ministry of Industry, Trade and Labor of the State of
Israel, be designated as an Approved Enterprise. Each certificate of approval for an Approved
Enterprise relates to a specific investment program delineated both by its financial scope,
including its capital sources, and by its physical characteristics, for example, the equipment to
be purchased and utilized under the program. The tax benefits derived from any certificate of
approval relate only to taxable income attributable to the specific Approved Enterprise. If a
company has more than one approval or only a portion of its capital investments is approved, its
effective tax rate is the result of a weighted average of the applicable rates. A recent amendment to the Investment Law, which came into effect as of April 1, 2005 (the
Amendment) has significantly changed the provisions of the Investment Law. The Amendment limits
the scope of enterprises which may be approved by the Investment Center by setting criteria for the
approval of a facility as an Approved Enterprise, such as provisions generally requiring that at
least 25% of the Approved Enterprises income will be derived from export. Additionally, as
explained below, the Amendment enacted major changes in the manner in which tax benefits are
awarded under the Investment Law so that companies no longer require Investment Center approval
(and Approved Enterprise status) in order to qualify for tax benefits. However, the Investment Law
provides that terms and benefits included in any certificate of approval already granted will
remain subject to the provisions of the law as they were on the date of such approval. Therefore
the tax benefits granted to our Approved Enterprises under the Investment Law will generally not be
subject to the provisions of the Amendment (which are described below). 81




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Tax Benefits Before the Amendment In general, taxable income of a company derived from an Approved Enterprise was subject to
company tax at the maximum rate of 25% rather than the regular rates stated above (this will also
apply to Approved Enterprises approved after the Amendment, as explained below). The 25% company
tax rate will apply for a period of time termed the benefit period. The benefit period is a
period of seven years commencing with the year in which the Approved Enterprise first
of production or 14 years from the year of receipt of approval, whichever is earlier.
Under certain circumstances (as further detailed below), the benefit period may extend to a maximum
of ten years from the commencement of the benefit period. In the event that a company is operating
under more than one approval or that only part of its capital investments are approved (a Mixed
Enterprise), its effective Company Tax rate is the result of a weighted combination of the various
applicable rates. A company which qualifies as a Foreign Investors Company is entitled to an extended benefit
period and further reductions in the tax rate normally applicable to Approved Enterprises. Subject
to certain conditions, a Foreign Investors Company is a company which has more than 25% of its
combined shareholders investment in share capital (in terms of rights to profits, voting and the
appointment of directors) and in long term shareholders loans, as defined in the Investment Law,
made by persons who are not residents of Israel. The percentage owned by nonresidents of Israel for
any tax year will be determined by the lowest percentage of any of the above rights held by
nonresidents during that year. Such a company will pay Company Tax at reduced rates for an extended
ten-year (rather than the otherwise applicable seven-year) period as detailed below: Company
    
    Benefit periodLevel of Foreign Investment
    
    Tax Rate
    
    (years)Over 0% but less than 25%
    
    25%
    
    7Over 25% but less than 49%
    
    25%
    
    1049% or more but less than 74%
    
    20%
    
    1074% or more but less than 90%
    
    15%
    
    1090% or more
    
    10%
    
    10
 There can be no assurance that the above-mentioned shareholding proportion will be reached for
each subsequent year. Prior to the Amendment, a company owning an Approved Enterprise approved
after April 1, 1986 (or prior thereto provided no government grants or loans had previously been
granted regarding such enterprise) was able to elect to forego certain Government grants extended
to Approved Enterprises in return for an alternative route of tax benefits (the Alternative
Route). Under the Alternative Route, a companys undistributed income derived from an Approved
Enterprise is exempt from Company Tax for a period of between two and ten years from the first year
of taxable income, depending on the geographic location of the Approved Enterprise within Israel,
and such company is eligible for the reduced tax rates under the Investment Law for the remainder
of the benefit period as mentioned above. 82




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The entitlement to the above benefits is condition upon the fulfillment of the conditions
stipulated by the law, regulations published thereunder and the instruments of approval for the
specific investments in the Approved Enterprise. In the event of failure to comply with these
conditions, the benefits may be canceled the amount of the benefits, in whole or in part, may
be required to be refunded with the addition of linkage differences, interest and penalties. A company that has elected the Alternative Route prior to the Amendment and that subsequently
pays a dividend out of income derived from the Approved Enterprise(s) during the tax exemption
period will be subject to Company Tax in the year the dividend is distributed in respect of the
amount distributed (including the Company Tax thereon), at the rate that would have been applicable
had the company not elected the Alternative Route (10%-25%, depending on the level of foreign
investment in the company, as explained above). In addition, the dividend recipient is taxed at the
reduced rate applicable to dividends from Approved Enterprises (15%), if the dividend is
distributed during the tax exemption period or within a specified period thereafter. (In the event,
however, that the company qualifies as a Foreign Investors Company, there is no such time
limitation). This tax must be withheld by the company at source, regardless of whether the dividend
is converted into foreign currency. We currently intend to reinvest any income derived from our
Approved Enterprise programs and not to distribute the income as dividends. Subject to certain provisions concerning income subject to the Alternative Route, all
dividends are considered to be attributable to the entire enterprise and the effective tax rate is
the result of a weighted combination of the various applicable tax rates. The Investment Law also provides that an Approved Enterprise is entitled to accelerated
depreciation on its property and equipment that are included in an approved investment program. The benefits available to an Approved Enterprise are conditioned upon terms stipulated in the
Investment Law and the regulations thereunder and the criteria set forth in the applicable
certificate of approval. In the event that we do not fulfill these conditions in whole or in part,
the benefits can be cancelled and we may be required to refund the amount of the benefits with the
addition of linkage differences and interest. Our facilities in Israel have received Approved Enterprise status which entitles us to receive
certain tax benefits. We have received four approvals granting us a package of benefits, subject to
compliance with applicable requirements. Under the first approval, our undistributed income derived
from one Approved Enterprise will be exempt from corporate tax for a period of four years from
2001, and we will be eligible for a reduced tax rate of between 10% and 25% for an additional two
years. Under the second approval, our undistributed income derived from another Approved Enterprise
was exempt from corporate tax for a period of two years from 2001 and we will be eligible for a
reduced tax rate of 10% to 25% for an additional eight years. Under the third approval (benefit
period starting 2003), our undistributed income will be exempt from corporate tax for a period of
two years following implementation of the plan. We will be eligible for a reduced tax rate of
between 10% and 25% for an additional thirteen years thereafter. All of these programs are subject
to time limits imposed by the Law for Encouragement of Capital Investments, 1959 and based upon the
level of foreign ownership in our company in each tax 83




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year. To retain the most favorable rates we
must maintain a foreign shareholders level of at least 90%. Currently, we exceed this level. Under
the fourth approval (benefit period most likely to be implemented during 2005), our undistributed
income, derived from this approval, will be exempt
from corporate tax for a period of two years following implementation and we will be eligible
for a reduced tax rate of 10% to 25% for eight additional years thereafter. As a result of these
programs, a substantial portion of the profits derived from products manufactured in Israel may
benefit from a reduced Israeli tax rate. Tax Benefits under the Amendment As a result of the Amendment, it is no longer necessary for a company to acquire Approved
Enterprise status in order to receive the tax benefits previously available under the Alternative
Route, and therefore such companies need not apply to the Investment Center for this purpose (the
Investment Center will continue to grant Approved Enterprise status to companies seeking
Governmental grants). Rather, a company may claim the tax benefits offered by the Investment Law
directly in its tax returns, provided that its facilities meet the criteria for tax benefits set
out by the Amendment (a Benefited Enterprise). Companies are also granted a right to approach the
Israeli Tax Authority for a pre-ruling regarding their eligibility for benefits under the
Amendment. The Amendment includes provisions attempting to ensure that a company will not enjoy
both Government grants and tax benefits for the same investment program. Tax benefits are available under the Amendment to production facilities (or other eligible
facilities), which are generally required to derive more than 25% of their business income from
export. In order to receive the tax benefits, the Amendment states that the company must make an
investment in the Benefited Enterprise exceeding a minimum amount specified in the Law. Such
investment may be made over a period of no more than three years ending at the end of the year in
which the company requested to have the tax benefits apply to the Benefited Enterprise (the Year
of Election). Where the company requests to have the tax benefits apply to an expansion of
existing facilities, then only the expansion will be considered a Benefited Enterprise and the
companys effective tax rate will be the result of a weighted combination of the applicable rates.
In the case of an expansion of existing facilities, the minimum investment required in order to
qualify as a Benefited Enterprise is determined as a certain percentage of the companys production
assets before the expansion. The tax benefits available under the Amendment to qualifying income of a Benefited Enterprise
are determined by the geographic location of the Benefited Enterprise. The Investment Law divides
the country into three zones  A, B and C, so that a Benefited Enterprise operating in Zone A
(which generally includes areas remote from the center of Israel) will receive the greatest
benefits and Benefited Enterprises in Zone C the least. The Amendment provides that a company
producing income from a Benefited Enterprise in Zone A may elect either that (i) the undistributed
income derived from the Benefited Enterprise will be fully tax exempt for the entire benefit period
(see below) (tax exemption), in which case the ordinary provisions concerning the taxation of the
company and shareholder for distribution of dividends will apply (see below); or (ii) that the
income from its Benefited Enterprise will be subject to corporate tax at a rate of a 11.5%, in
which case dividends paid out of such income to a foreign resident will be taxed at a rate of 4%
and the company will not be subject to additional tax upon 84




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dividend distribution. Further benefits
are available to very large investments by multinational companies. Benefited Enterprises located in Zones B and C will be exempt from tax for six and two years,
respectively, and subject to tax at a rate of 10%-25% for the remainder of the benefit period,
depending on the extent of foreign investment in the Company, as explained above. Dividends paid out of income derived by a Benefited Enterprise (or out of dividends received
from a company whose income is derived from a Benefited Enterprise) are generally subject to
withholding tax at the rate of 15% (deductible at source). The reduced rate of 15% is limited to
dividends and distributions out of income derived during the benefits period and actually paid at
any time up to 12 years thereafter. A company qualifying for tax benefits under the Amendment which
pays a dividend out of income derived by its Benefited Enterprise during the tax exemption period
will be subject to tax in respect of the gross amount of the dividend at the otherwise applicable
rate of 25%, (or lower in the case of a qualified Foreign Investors Company which is at least
49% owned by non-Israeli residents). The dividend recipient would be subject to tax at the rate of
15% on the amount received which tax would be deducted at source. The period for which tax benefits are available under the Amendment is also determined by the
geographical location of the Benefited Enterprise. The benefit period for Benefited Enterprises in
Zone A will end on the earlier of (i) a period of ten years from the tax year in which the company
first derived taxable income from the Benefited Enterprise (the Commencement Year); or (ii)
twelve years (or in certain cases fourteen years) from the first day of the Year of Election. The
benefit period for Benefited Enterprises in Zones B and C will extend until the earlier of (i)
seven years from the Commencement Year or (ii) 12 years from the first day of the Year of Election.
This period may be extended for Benefited Enterprises owned by a Foreign Investors Companyduring
all or part of the benefits period. Additionally, the Amendment sets a minimal amount of foreign investment required for a company
to be regarded a Foreign Investors Company. There can be no assurance that we will attain approval for additional tax benefits under the
Amendment, or receive approval for Approved Enterprises in the future. Grants under the Law for the Encouragement of Industrial Research and Development, 1984 Under the Law for the Encouragement of Industrial Research and Development, 1984, commonly
referred to as the Research Law, research and development programs that meet specified criteria and
are approved by a governmental committee of the Office of the Chief Scientist are eligible for
grants of up to 50% of the projects expenditures, as determined by the research committee, in
exchange for the payment of royalties from the sale of products developed under the program.
Regulations under the Research Law generally provide for the payment of royalties to the Chief
Scientist of 3-5% on sales of products and services derived from a technology developed using these
grants until 100% of the dollar-linked grant is repaid. Our obligation to pay these royalties is
contingent on our actual sale of such products and services. In the absence of such sales, no
payment is required. Effective for grants received from the Chief Scientist under programs approved
after January 1, 1999, the outstanding balance of 85




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the grants will be subject to interest at a rate
equal to the 12 month LIBOR applicable to dollar deposits that is published on the first business
day of each calendar year. Following the full repayment of the grant, there is no further liability
for royalties. The terms of the Israeli government participation also require that the manufacture of
products developed with government grants be performed in Israel. However, under the regulations of
the Research Law, if any of the manufacturing is performed outside of Israel, assuming we receive
approval from the Chief Scientist for the foreign manufacturing, we may be required to pay
increased royalties. The increase in royalties depends upon the extent of the manufacturing volume
that is performed outside of Israel as follows: Royalties to the ChiefExtent of manufacturing
    
    Scientistvolume outside of Israel
    
    as a percentage of grantless than 50%
    
    120%between 50% and 90%
    
    150%90% and more
    
    300%
 A recent amendment to the Research Law has provided that the restriction on manufacturing
outside of Israel shall not apply to the extent that plans to so manufacture were declared when
applying for funding. In general, the technology developed with Chief Scientist grants may not be transferred to
Israeli third parties without the prior approval of a governmental committee under the Research Law
and may not be transferred to non-Israeli third parties. A recent amendment to the Research Law has
stressed, that it is not just transfer of know-how that is prohibited, but also transfer of any
rights in such know-how. This approval, however, is not required for the export of any final
products developed using the grants. Approval of the transfer of technology may be granted in
specific circumstances only if the recipient abides by the provisions of the Research Law and
related regulations, including the restrictions on the transfer of know-how and the obligation to
pay royalties in an amount that may be increased. We cannot assure you that any consent, if
requested, will be granted, or if granted, will be on reasonable commercial terms. Effective for grants received from the Chief Scientist under programs approved after January
1, 1999, the outstanding balance of the grants will be subject to interest at a rate equal to the
12 month LIBOR applicable to dollar deposits that is published on the first business day of each
calendar year. The Israeli authorities have indicated that the government may reduce or abolish grants from
the Chief Scientist in the future. Even if these grants are maintained, we cannot assure you that
we will receive Chief Scientist grants in the future. In addition, each application to the Chief
Scientist is reviewed separately, and grants are based on the program approved by the research
committee. Generally, expenditures supported under other incentive programs of the State of Israel
are not eligible for grants from the Chief Scientist. We cannot assure you that applications to the
Chief Scientist will be approved and, until approved, the amounts of any grants are not
determinable. 86




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Tax Benefits and Grants for Research and Development Israeli tax law allows, under specific conditions, a tax deduction in the year incurred for
expenditures, including depreciation, relating to scientific research and development projects, if:  
    
    the expenditures are approved by the relevant Israeli government ministry, determined by
the field of research;
    
    the research and development is for the promotion or development of the company; and
    
    the research and development is carried out by or on behalf of the company seeking the
deduction. Expenditures not so approved are deductible over a three-year period. However, expenditures
made out of proceeds made available to a company through government grants are not deductible
according to Israeli law. Taxation of Non-Resident Holders of Shares Non-residents of Israel are subject to income tax on income accrued or derived from sources in
Israel. These sources of income include passive income, including dividends, royalties and
interest, as well as nonpassive income from services provided in Israel. Israeli tax at a rate of
25% is generally withheld at source from dividends paid to non-residents; the applicable rate for
dividends paid out of the profits of an Approved Enterprise is 15%. These rates are subject to the
provisions of any applicable tax treaty. Under the US-Israel Tax Treaty, Israeli withholding tax on dividends paid to a US treaty
resident may not in general exceed 25%, or 15% in the case of dividends paid out of the profits of
an Approved Enterprise. Where the recipient is a US corporation owning 10% or more of the voting
stock of the paying corporation and the dividend is not paid from the profits of an Approved
Enterprise, the Israeli tax withheld may not exceed 12.5%, subject to certain conditions. Capital Gains Tax on Sales of Our Ordinary Shares Israeli Capital Gains Tax Until the end of the year 2002, capital gains from the sale of our securities were generally
exempt from Israeli Capital Gains Tax because we qualified as an Industrial Company. However,
there can be no assurance that the Israeli tax authorities will not contest our status as an
Industrial Company, possibly on a retroactive basis. This exemption did not apply to a
shareholder whose taxable income is determined pursuant to the Israeli Income Tax Law (Inflationary
Adjustments), 1985, or to a person whose gains from selling or otherwise disposing of our
securities are deemed to be business income. As a result of the recent tax reform legislation in Israel, gains from the sale of our
ordinary shares accrued from and after January 1, 2003 will in general be liable to capital gains
tax of up to 15%. This will be the case so long as our securities remain listed for trading on a
designated foreign stock market such as the NASDAQ. However, according to the tax reform
legislation and regulations promulgated thereunder, non-residents of Israel will generally be
exempt from any 87




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capital gains tax from the sale of our securities so long as the gains are not
derived through a permanent establishment that the non-resident maintains in Israel, and so long as
our securities remain listed for trading as described above. These provisions dealing with capital
gains are not applicable to a person whose gains from selling or otherwise disposing of our securities are
deemed to be business income or whose taxable income is determined pursuant to the Israeli Income
Tax Law (Inflation Adjustments), 1985; the latter law would not normally be applicable to non-
resident shareholders who have no business activity in Israel. The tax basis of shares acquired
prior to January 1, 2003 will be determined in accordance with the average closing share price in
the three trading days preceding January 1, 2003. However, a request may be made to the tax
authorities to consider the actual adjusted cost of the shares as the tax basis if it is higher
than such average price. In any event, under the US-Israel Tax Treaty, a US treaty resident who is eligible for the
benefits of the treaty may only be liable to Israeli capital gains tax on the sale of our ordinary
shares if that US treaty resident holds 10% or more of the voting power in our company at any time
during the twelve month period preceding such sale. United States Federal Income Tax Considerations Subject to the limitations described in the next paragraph, the following discussion describes
the material United States federal income tax consequences to a holder of our ordinary shares,
referred to for purposes of this discussion as a U.S. Holder, that is:  
    
    a citizen or resident of the United States;  
    
    a corporation created or organized in the United States or under the
laws of the United States or of any political subdivision thereof;  
    
    an estate, the income of which is includable in gross income for
United States federal income tax purposes regardless of its source; or  
    
    a trust, if a court within the United States is able to exercise
primary supervision over the administration of the trust and one or
more U.S. persons have the authority to control all substantial
decisions of the trust or if the trust has validly elected to be
treated as a U.S. person under applicable Treasury regulations. In addition, certain material aspects of United States federal income tax relevant to a holder
other than a U.S. Holder, referred to as a Non-U.S. Holder, are discussed below. This summary is for general information purposes only. It does not purport to be a
comprehensive description of all of the tax considerations that may be relevant to each persons
decision to own our ordinary shares. This discussion is based on current provisions of the Code, current and proposed Treasury
regulations promulgated thereunder, and administrative and judicial decisions as of the date
hereof, all of which are subject to change, possibly on a retroactive basis. This discussion does
not address all aspects of United States federal income taxation that may be relevant to any
particular shareholder based on such shareholders individual circumstances. In particular, this
discussion considers only U.S. Holders that will own ordinary shares as capital assets and does 88




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not
address the potential application of the alternative minimum tax or United States federal income
tax consequences to U.S. Holders that are subject to special treatment, including U.S. Holders
that:  
    
    are broker-dealers or insurance companies;  
    
    have elected mark-to-market accounting;  
    
    are tax-exempt organizations;  
    
    are financial institutions or financial services entities;  
    
    hold ordinary shares as part of a straddle, hedge or conversion transaction with other investments;  
    
    own directly, indirectly or by attribution at least 10% of our voting power;  
    
    have a functional currency that is not the U.S. dollar; or  
    
    acquire ordinary shares as compensation. In addition, this discussion does not address any aspect of state, local or non-United States
tax laws. Additionally, the discussion does not consider the tax treatment of persons who hold ordinary
shares through a partnership or other pass-through entity or the possible application of United
States federal gift or estate tax. Material aspects of United States federal income tax relevant to
a Non-U.S. Holder are also discussed below. Each holder of ordinary shares is advised to consult such persons own tax advisor with
respect to the specific tax consequences to such person of purchasing, holding or disposing of our
ordinary shares. Taxation of Ordinary Shares Taxation of Dividends Paid On Ordinary Shares Subject to the discussion below under Tax Consequences if We Are a Passive Foreign Investment
Company, a U.S. Holder will be required to include in gross income as ordinary income the amount
of any distribution paid on ordinary shares, including any Israeli taxes withheld from the amount
paid, on the date the distribution is received to the extent the distribution is paid out of our
current or accumulated earnings and profits as determined for United States federal income tax
purposes. Distributions in excess of such earnings and profits will be applied against and will
reduce the U.S. Holders basis in the ordinary shares and, to the extent in excess of such basis,
will be treated as gain from the sale or exchange of ordinary shares. U.S. Holders will have the option of claiming the amount of any Israeli income taxes withheld
on a dividend distribution either as a deduction from gross income or as a dollar-for-dollar credit 89




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against their United States federal income tax liability. Individuals who do not claim itemized
deductions, but instead utilize the standard deduction, may not claim a deduction for the amount of
the Israeli income taxes withheld, but such amount may be claimed as a credit against the
individuals United States federal income tax liability. The amount of foreign income taxes
that may be claimed as a credit in any year is subject to complex limitations and restrictions,
which must be determined on an individual basis by each shareholder. The limitations set out in the
Code include, among others, rules which limit foreign tax credits allowable with respect to
specific classes of income to the United States federal income taxes otherwise payable with respect
to each such class of income. Distributions of current or accumulated earnings and profits will be
foreign source passive income for United States foreign tax credit purposes; however, special rules
will apply if we are a United States-owned foreign corporation, which we may be. In that case
distributions of current or accumulated earnings and profits will be treated as U.S. source and
foreign source income in proportion to our earnings and profits in the year of the distribution
allocable to U.S. and foreign sources. We will be treated as a United States-owned foreign
corporation as long as stock representing 50% or more of the voting power or value of our shares
is owned, directly or indirectly, by United States persons. U.S. Holders who are entitled to the
benefits of the Tax Treaty may elect to credit Israeli withholding taxes allocable to the portion
of our distributions treated as from U.S. sources under these rules against their United States
federal income tax liability on such portion. Generally, the total amount of allowable foreign tax credits in any year cannot exceed regular
U.S. tax liability for the year attributable to foreign source taxable income. A U.S. Holder will
be denied a foreign tax credit with respect to Israeli income tax withheld from dividends received
on the ordinary shares to the extent such U.S. Holder has not held the ordinary shares for at least
16 days of the 30-day period beginning on the date which is 15 days before the ex-dividend date or
to the extent such U.S. Holder is under an obligation to make related payments with respect to
positions in substantially similar or related property. Any days during which a U.S. Holder has
substantially diminished its risk of loss on the ordinary shares are not counted toward meeting the
16 day holding period required by the statute. Taxation of the Disposition of Ordinary Shares Upon the sale or exchange of ordinary shares, a U.S. Holder will recognize a capital gain or
loss in an amount equal to the difference between such U.S. Holders basis in the ordinary shares,
which is usually the cost of such shares in U.S. dollars, and the amount realized on the
disposition in U.S. dollars. Capital gain from the sale or exchange of ordinary shares held more
than one year is a long-term capital gain, and is presently eligible for a maximum 20% rate of
taxation for individuals and other non-corporate taxpayers. Gains and losses recognized by a U.S.
Holder on a sale or exchange of ordinary shares normally will be treated as United States source
income or loss for United States foreign tax credit purposes. The deductibility of a capital loss
recognized on the sale or exchange of ordinary shares is subject to limitations. In certain instances, a U.S. Holder who is subject to tax in Israel on the sale of our shares
and who is entitled to the benefits of the Tax Treaty may treat such gain as Israeli source income
and thus could, subject to other U.S. foreign tax credit limitations, credit the Israeli tax on
such sale against their U.S. federal income on the gain from that sale. 90




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Tax Consequences if We Are a Passive Foreign Investment Company We will be a passive foreign investment company, or PFIC, if 75% or more of our gross income
in a taxable year, including the pro rata share of the gross income of any company, U.S. or
foreign, in which we are considered to own, directly or indirectly, 25% or more of the shares
by value, is passive income. Alternatively, we will be considered to be a PFIC if at least 50%
of our assets in a taxable year, averaged quarterly over the year and ordinarily determined based
on fair market value and including the pro rata share of the assets of any company in which we are
considered to own, directly or indirectly, 25% or more of the shares by value, are held for the
production of, or produce, passive income. Passive income includes amounts derived by reason of the
temporary investment of funds raised in our public offerings. If we were a PFIC, and a U.S. Holder
did not make an election to treat us as a qualified electing fund (as described below):  
    
    Excess distributions by us to a U.S. Holder would be taxed in a
special way. Excess distributions are amounts received by a U.S.
Holder with respect to our stock in any taxable year that exceed 125%
of the average distributions received by such U.S. Holder from us in
the lesser of either the three previous years or such U.S. Holders
holding period for ordinary shares before the present taxable year.
Excess distributions must be allocated ratably to each day that a U.S.
Holder has held our stock. A U.S. Holder must include amounts
allocated to the current taxable year in its gross income as ordinary
income for that year. A U.S. Holder must pay tax on amounts allocated
to each prior taxable year (other than the year prior to the first
year in which we were a PFIC) at the highest rate in effect for that
year on ordinary income and the tax is subject to an interest charge
at the rate applicable to deficiencies for income tax.  
    
    The entire amount of gain that was realized by a U.S. Holder upon the
sale or other disposition of ordinary shares will also be treated as
an excess distribution and will be subject to tax as described above.  
    
    A U.S. Holders tax basis in shares of our stock that were acquired
from a decedent would not receive a step-up to fair market value as of
the date of the decedents death but would instead be equal to the
decedents basis, if lower. The special PFIC rules described above will not apply to a U.S. Holder if the U.S. Holder
makes an election to treat us as a qualified electing fund, or QEF, in the first taxable year in
which the U.S. Holder owns ordinary shares and if we comply with certain reporting requirements.
Instead, a shareholder of a qualified electing fund is required for each taxable year to include in
income a pro rata share of the ordinary earnings of the qualified electing fund as ordinary income
and a pro rata share of the net capital gain of the qualified electing fund as long-term capital
gain, subject to a separate election to defer payment of taxes, which deferral is subject to an
interest charge. We have agreed to supply U.S. Holders with the information needed to report income
and gain pursuant to a QEF election in the event we are classified as a PFIC. The QEF election is
made on a shareholder-by-shareholder basis and can be revoked only with the consent of the Internal
Revenue Service, or IRS. A shareholder makes a QEF election by attaching a completed IRS Form 8621,
including the PFIC annual information statement, to a timely filed United States federal income tax
return or, if no federal income tax return is required to be filed, by filing such form with the
IRS Service Center in Philadelphia, Pennsylvania. Even if a QEF election is not made, a shareholder
in a PFIC who is a U.S. person must file a completed IRS Form 8621 every year. 91




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A U.S. Holder of PFIC stock which is publicly traded could elect to mark the stock to market
annually, recognizing as ordinary income or loss each year an amount equal to the difference as of
the close of the taxable year between the holders fair market value of the PFIC stock and the
adjusted basis in the PFIC stock. Losses would be allowed only to the extent of net
mark-to-market gain previously included by the U.S. Holder under the election for prior taxable
years. If the mark-to-market election were made, then the rules set forth above would not apply for
periods covered by the election. We do not believe that we are a PFIC. However, the tests for determining PFIC status are
applied annually and it is difficult to make accurate predictions of future income and assets,
which are relevant to this determination. Accordingly, there can be no assurance that we will not
become a PFIC. If we determine that we have become a PFIC, we will notify our U.S. Holders and
provide them with the information necessary to comply with the QEF rules. U.S. Holders who hold
ordinary shares during a period when we are a PFIC will be subject to the foregoing rules, even if
we cease to be a PFIC, subject to certain exceptions for U.S. Holders who made a QEF election. U.S.
Holders are urged to consult their tax advisors about the PFIC rules, including the consequences to
them of making a mark-to-market or QEF election with respect to our ordinary shares in the event
that we qualify as a PFIC. Similarly, U.S. Holders of our shares would be subject to adverse tax consequences if we or
any of our foreign corporate subsidiaries were classified as a foreign personal holding company.
However, we do not currently believe that we or any of such subsidiaries currently is, or is likely
in the future to be so classified. Tax Consequences for Non-U.S. Holders of Ordinary Shares Except as described in Information Reporting and Back-up Withholding below, a Non-U.S.
Holder of ordinary shares will not be subject to U.S. federal income or withholding tax on the
payment of dividends on, and the proceeds from the disposition of, ordinary shares, unless:  
    
    such item is effectively connected with the conduct by the Non-U.S.
Holder of a trade or business in the United States and, in the case of
a resident of a country which has a treaty with the United States,
such item is attributable to a permanent establishment or, in the case
of an individual, a fixed place of business, in the United States;  
    
    the Non-U.S. Holder is an individual who holds the ordinary shares as
a capital asset and is present in the United States for 183 days or
more in the taxable year of the disposition and certain other
conditions are met; or  
    
    the Non-U.S. Holder is subject to tax pursuant to the provisions of
United States tax law applicable to U.S. expatriates. Information Reporting and Back-up Withholding U.S. Holders generally are subject to information reporting requirements with respect to
dividends paid in the United States on ordinary shares. U.S. Holders are also generally subject to
back-up withholding on dividends paid in the United States on ordinary shares unless the U.S.
Holder provides IRS Form W-9 or otherwise establishes an exemption. U.S. Holders are subject to
information reporting and back-up withholding (currently 30%) on proceeds paid from the 92




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disposition
of ordinary shares unless the U.S. Holder provides IRS Form W-9 or otherwise establishes an
exemption. Non-U.S. Holders generally are not subject to information reporting or back-up withholding
with respect to dividends paid on, or upon the disposition of, ordinary shares, provided that such
non-U.S. Holder provides a taxpayer identification number, certifies to its foreign status, or
otherwise establishes an exemption. The amount of any back-up withholding may be allowed as a credit against a U.S. or Non-U.S.
Holders United States federal income tax liability and may entitle such holder to a refund,
provided that certain required information is furnished to the IRS. 
 F. DIVIDENDS AND PAYING AGENTS Not applicable. 
 G. STATEMENT BY EXPERTS Not applicable. 
 H. DOCUMENTS ON DISPLAY We are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligation with respect to such
requirements by filing reports with the Securities and Exchange Commission. You may read and copy
any document we file with the Securities and Exchange Commission without charge at the Securities
and Exchange Commissions public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such material may be obtained by mail from the Public Reference Branch of the Securities
and Exchange Commission at such address, at prescribed rates. Please call the Securities and
Exchange Commission at l-800-SEC-0330 for further information on the public reference room. As a
foreign private issuer, all documents which were filed after November 4, 2002 on the Securities and
Exchange Commissions EDGAR system will be available for retrieval on its website at www.sec.gov.
You may read and copy any reports, statements or other information that we file with the Securities
and Exchange Commission at its facilities listed above. These Securities and Exchange Commission
filings are also available to the public from commercial document retrieval services. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing
the furnishing and content of proxy statements, and our officers, directors and principal
shareholders are exempt from the reporting and short-swing profit recovery provisions contained in
Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file
periodic reports and financial statements with the Securities and Exchange Commission as frequently
or as promptly as United States companies whose securities are registered under the Exchange Act. A
copy of each report submitted in accordance with applicable United States law is available for
public review at our principal executive offices. 
 I. SUBSIDIARY INFORMATION Not applicable. 93




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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk for changes in interest rates and foreign currency rates relates
mainly to our long-term debt incurred to purchase fixed assets. Our interest expenses are sensitive
to LIBOR and CPI, as most of our long-term debt bears a LIBOR or CPI-linked interest rate. As of
December 31, 2004, $204.3 million of our outstanding debt bears an average interest rate of 4.8%.
Of the $204.3 million, only $46.3 million is exposed to interest rate fluctuation. Consequently,
each 0.25% increase in interest rates will reduce pretax income by approximately $116,000. Our functional currency and that of Taro U.S.A. is the U.S. dollar. The functional currency of
our European and Canadian subsidiaries is the local currency in their respective countries. In 2004, 87% of our revenues were generated in U.S. dollars. However, the remainder of our
sales was denominated in the local currencies of the countries in which they occurred. As a result,
our reported profits and cash flows are exposed to changing exchange rates. If the U.S. dollar
weakens relative to the foreign currencies, the earnings generated in these foreign currencies
will, in effect, increase when converted into U.S. dollars, and vice versa. Therefore, from time to
time we attempt to manage exposures that arise in the normal course of business related to
fluctuations in foreign currency exchange rates by entering into offsetting positions through the
use of foreign exchange forward contracts. Due to the relative low level of non-U.S. dollar
revenues, the effects of currency fluctuations on consolidated net revenues and operating income
were not significant in 2004. In addition, the Company entered into hedge transactions designed to reduce its exposure to
NIS denominated loans and risk associated with interest rates for these loans. Under current conditions, we do not believe that our exposure to market risks will have a
material impact on future earnings. For additional information on hedging against NIS-based loans, please see Note 19 of our
consolidated financial statements, included elsewhere in this annual report. 
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not Applicable. 
 PART II 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES Not Applicable. 
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS Not applicable. 94




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ITEM 15. CONTROLS AND PROCEDURES  a.
    
    An evaluation was performed under the supervision and with the participation of our
management, including our general manager and chief financial officer, of the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period
covered by this annual report. Based on that evaluation, our general manager and chief
financial officer have concluded that our disclosure controls and procedures are effective as
of December 31, 2004.  b.
    
    There was no change in our internal control over financial reporting (as defined in rules
13(a)-15(f) and 15(d)-15(f) under the Exchange Act) that occurred during the period covered by
this annual report that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting. 
 ITEM 16. [RESERVED] 
 A. AUDIT COMMITTEE FINANCIAL EXPERT Our Board of directors has determined that Mr. Myron Strober, C.P.A., the chairman of our
audit committee, is an audit committee financial expert, as defined by applicable SEC regulations,
and is independent in accordance with applicable SEC and Nasdaq regulations. 
 B. CODE OF ETHICS We have adopted a code of business conduct applicable to our executive officers, directors and
all other employees. A copy of the code may be obtained, without charge, upon a written request
addressed to the Companys Corporate Affairs Department, Taro Pharmaceutical Industries Ltd., c/o
Taro Pharmaceuticals U.S.A., Inc., 3 Skyline Drive, Hawthorne, NY 10532. Any waivers of this code
for executive officers or directors will be disclosed through the filing of a Form 6-K. Our board
of directors has also approved a whistleblower policy which functions in coordination with our code
of business conduct and provides an anonymous means for employees and others to communicate with
various bodies within the Company, including the audit committee of our Board of directors. 
 C. PRINCIPAL ACCOUNTANT FEES AND SERVICES Policy on Pre-Approval of Audit and Non-Audit Services of Independent Auditors Our board of directors audit committee is responsible for the oversight of our independent
auditors work. The audit committees policy is to pre-approve all audit and non-audit services
provided by Kost, Forer, Gabby & Kasierer (KFG&K). These services may include audit services,
audit-related services, tax services and other services, as further described below. The audit
committee sets forth the basis for its pre-approval in detail, listing the particular services or
categories of services that are pre-approved, and setting forth a specific budget for such
services. Additional services may be pre-approved by the audit committee on an individual basis.
Once services have been pre-approved, KFG&K and our management then report to the audit 95




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committee
on a periodic basis regarding the extent of services actually provided in accordance with the
applicable pre-approval, and regarding the fees for the services performed. Principal Accountant Fees and Services: 2004
    
    
    2003In million dollarsAudit Fees
    
    $
    0.83
    
    
    $
    0.56Audit-Related Fees
    
    
    
    
    
    
    Tax Fees
    
    
    0.45
    
    
    
    0.50All Other Fees
    
    
    
    
    
    
    Total
    
    $
    1.28
    
    
    $
    1.06
 The audit fees for the years ended December 31, 2004 and 2003, respectively, represent fees
for professional services rendered for the audits of our annual consolidated financial statements,
statutory or regulatory audits of us and our subsidiaries, consents and assistance with review of
documents filed with the SEC. Tax fees represents fees for professional services related to tax compliance, including the
preparation of tax returns and claims for refund, and tax planning and tax advice, including
assistance with tax audits and appeals, advice related to mergers and acquisitions, tax services
for employee benefit plans and assistance with respect to requests for rulings from tax
authorities. 
 D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES The Company has and utilizes exemptions from NASDAQ corporate governance rule 4350 subsections
(f) Quorum; (g) Solicitation of Proxy; (i) Shareholder Approval. These issues are governed by the
Companies Law. 
 E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS Not applicable. 
 PART III 
 ITEM 17. FINANCIAL STATEMENTS We have responded to Item 18 in lieu of this item. 
 ITEM 18. FINANCIAL STATEMENTS The Financial Statements required by this item are found at the end of this annual report,
beginning on page F-1. 96




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Financial Statement Schedule II  Valuation and Qualifying Accounts (S-1) 
 ITEM 19. EXHIBITS The exhibits filed with or incorporated into this annual report are listed on the index of
exhibits below. Exhibit No.
    
    Description1.1
    
    Memorandum of Association of Taro Pharmaceutical Industries
Ltd. (1)1.2
    
    Articles of Association of Taro Pharmaceutical Industries
Ltd., as amended2.1
    
    Form of ordinary share certificate (1)4.1
    
    Taro Vit Industries Limited 1991 Stock Incentive Plan (2)4.2
    
    Taro Pharmaceutical Industries Ltd. 2000 Employee Stock
Purchase Plan (3)4.3
    
    Taro Pharmaceutical Industries 1999 Stock Incentive Plan (4)8
    
    List of Subsidiaries (See Organizational Structure in
Item 4.C of this Form 20-F)12.1
    
    Certification of the Senior Vice President & General
Manager pursuant to Section 302 of the Sarbanes-Oxley Act
of 200212.2
    
    Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 200213
    
    Certification of the Senior Vice President & General
Manager and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200215(a).1
    
    Consent of Kost, Forer, Gabbay & Kasierer15(a).2
    
    Debenture and Loan Agreement dated December 19, 2000 (5)15(a).3
    
    Loan agreements dated May 20, 2003 and November 27, 2003 (6)
 
 (1)
    
    Previously filed as an exhibit to our Registration Statement on Form F-1 (No. 333-63464), as
amended, and incorporated herein by reference.(2)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 33-80802) and
incorporated herein by reference.(3)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 333-12388) and
incorporated herein by reference.(4)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 333-13840) and
incorporated herein by reference.(5)
    
    Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended
December 31, 2000 and incorporated herein by reference. 97




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(6)
    
    Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended
December 31, 2003 and incorporated herein by reference. 98




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SIGNATURE The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F
and that it has duly caused and authorized the undersigned to sign this annual report on its
behalf. TARO PHARMACEUTICAL INDUSTRIES LTD.By:
    
    /s/ Kevin ConnellyKevin Connelly,Dated:
June 29, 2005
    
    
    
    Senior Vice President and Chief Financial Officer
 99




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TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2004 IN U.S. DOLLARS PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Balance Sheets
    
    
    F-3  F-4Consolidated Statements of Income
    
    
    F-5Statements of Changes in Shareholders Equity
    
    
    F-6Consolidated Statements of Cash Flows
    
    
    F-7  F-8Notes to Consolidated Financial Statements
    
    
    F-9  F-48
 F-1




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(ERNST & YOUNG LOGO) 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders of TARO PHARMACEUTICAL INDUSTRIES LTD. We have audited the accompanying consolidated balance sheets of Taro Pharmaceutical Industries
Ltd. (the Company) and its subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in shareholders equity and cash flows for each of the
three years in the period ended December 31, 2004. Our audit also included the accompanying
financial statement schedule. These financial statements and schedule are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial statements
and schedule based on our audits. We conducted our audits in accordance with the Standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. We were not engaged to perform an audit of the Companys internal control over
financial reporting. Our audit included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but not for
the purpose of expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above, present fairly, in
all material respects, the consolidated financial position of the Company and its subsidiaries as
of December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2004, in conformity with US generally
accepted accounting principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein. Tel-Aviv, Israel
    
    KOST FORER GABBAY & KASIERERFebruary 23, 2005
    
    A Member of Ernst & Young Global
 F-2




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TARO PHARMACEUTICAL INDUSTRIES LTD. 
 CONSOLIDATED BALANCE SHEETS  U.S. dollars in thousands
 December 31,2004
    
    
    2003ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    98,630
    
    
    $
    159,121Restricted short-term bank deposits
    
    
    6,598
    
    
    
    2,518Accounts receivable:Trade (Note 3a)
    
    
    124,674
    
    
    
    120,522Other receivables and prepaid expenses (Note 3b)
    
    
    16,621
    
    
    
    17,046Inventories (Note 4)
    
    
    86,591
    
    
    
    84,486TOTAL CURRENT ASSETS
    
    
    333,114
    
    
    
    383,693LONG-TERM INVESTMENTS (Note 7)
    
    
    19,984
    
    
    
    2,888PROPERTY, PLANT AND EQUIPMENT, NET (Note 5)
    
    
    241,966
    
    
    
    182,306GOODWILL
    
    
    7,222
    
    
    
    7,199OTHER INTANGIBLE ASSETS AND DEFERRED CHARGES, NET
(Note 6)
    
    
    63,174
    
    
    
    30,187DEFERRED INCOME TAXES (Note 14)
    
    
    31,387
    
    
    
    10,250TOTAL ASSETS
    
    $
    696,847
    
    
    $
    616,523
 The accompanying notes are an integral part of the consolidated financial statements. F-3




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TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED BALANCE SHEETS  U.S. dollars in thousands (except share data)
 December 31,2004
    
    
    2003LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term bank credit and short-term loans (Note 8)
    
    $
    64,961
    
    
    $
    19,124Current maturities of long-term debt (Note 10)
    
    
    16,944
    
    
    
    24,420Accounts payable:Trade
    
    
    17,845
    
    
    
    26,148Other and accrued expenses (Note 9)
    
    
    27,220
    
    
    
    31,083Income taxes payable
    
    
    4,559
    
    
    
    2,963TOTAL CURRENT LIABILITIES
    
    
    131,529
    
    
    
    103,738LONG-TERM LIABILITIES:Long-term debt, net of current maturities (Note 10)
    
    
    187,346
    
    
    
    156,937Deferred income taxes (Note 14)
    
    
    6,716
    
    
    
    4,880Accrued severance pay
    
    
    2,442
    
    
    
    1,857TOTAL LONG-TERM LIABILITIES
    
    
    196,504
    
    
    
    163,674COMMITMENTS AND CONTINGENCIES (Note 12)MINORITY INTEREST
    
    
    694
    
    
    
    1,711SHAREHOLDERS EQUITY (Note 13):share capital:Ordinary Shares of NIS 0.0001 par value:Authorized at December 31, 2004
and 2003: 200,000,000 shares;
Issued at December 31, 2004
and 2003: 29,435,805 and 29,234,618 shares,
respectively; Outstanding at December 31, 2004 and
2003: 29,170,405 and 28,969,218, respectively
    
    
    679
    
    
    
    679Founders shares of NIS 0.00001 par value:Authorized, issued and outstanding at December 31,
2004 and 2003: 2,600 shares
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    184,562
    
    
    
    182,699Accumulated other comprehensive income
    
    
    13,477
    
    
    
    5,695Treasury stock
    
    
    (1,348
    )
    
    
    (1,348
    )Retained earnings
    
    
    170,749
    
    
    
    159,674TOTAL SHAREHOLDERS EQUITY
    
    
    368,120
    
    
    
    347,400TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    696,847
    
    
    $
    616,523
 The accompanying notes are an integral part of the consolidated financial statements. F-4




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TARO PHARMACEUTICAL INDUSTRIES LTD. 
 CONSOLIDATED STATEMENTS OF INCOME  U.S. dollars in thousands (except per share data)
 Year ended December 31,2004
    
    
    2003
    
    
    2002Sales (Notes 15a and 16)
    
    $
    284,130
    
    
    $
    315,458
    
    
    $
    211,581Cost of sales
    
    
    119,404
    
    
    
    102,454
    
    
    
    79,468Gross profit
    
    
    164,726
    
    
    
    213,004
    
    
    
    132,113Operating expenses:Research and development, net (Note 15b)
    
    
    41,943
    
    
    
    40,601
    
    
    
    26,373Selling, marketing, general and
administrative (Note 15c)
    
    
    123,299
    
    
    
    97,718
    
    
    
    52,481165,242
    
    
    
    138,319
    
    
    
    78,854Operating income (loss)
    
    
    (516
    )
    
    
    74,685
    
    
    
    53,259Financial expenses, net (Note 15d)
    
    
    (6,417
    )
    
    
    (1,722
    )
    
    
    (162
    )(6,933
    )
    
    
    72,963
    
    
    
    53,097Other income (loss), net
    
    
    
    
    
    
    (7
    )
    
    
    78Income (loss) before income taxes
    
    
    (6,933
    )
    
    
    72,956
    
    
    
    53,175Income taxes (tax benefit) (Note 14)
    
    
    (16,991
    )
    
    
    11,475
    
    
    
    8,40610,058
    
    
    
    61,481
    
    
    
    44,769Minority
interest in losses (earnings) of a
subsidiary
    
    
    1,017
    
    
    
    (326
    )
    
    
    (214
    )Net income
    
    $
    11,075
    
    
    $
    61,155
    
    
    $
    44,555Basic
net earnings per Ordinary share (Note 13f)
    
    $
    0.38
    
    
    $
    2.12
    
    
    $
    1.55Diluted net
earnings per Ordinary share (Note 13f)
    
    $
    0.37
    
    
    $
    2.06
    
    
    $
    1.52
 The accompanying notes are an integral part of the consolidated financial statements. F-5




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TARO PHARMACEUTICAL INDUSTRIES LTD.
 
 STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY  U.S. dollars in thousands
 Accumulatedother
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    TotalShare
    
    
    Additional
    
    
    comprehensive
    
    
    Treasury
    
    
    Retained
    
    
    comprehensive
    
    
    shareholderscapital
    
    
    paid-in capital
    
    
    income (loss)
    
    
    stock
    
    
    earnings
    
    
    income
    
    
    equityBalance at January 1, 2002
    
    $
    680
    
    
    $
    167,599
    
    
    $
    (2,591
    )
    
    $
    (1,288
    )
    
    $
    53,964
    
    
    $
    
    
    
    $
    218,364Tax benefit related to exercise of stock options
    
    
    
    
    
    
    5,195
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,195Exercise of options and issuance of shares of ESPP
    
    
    *
    )
    
    
    651
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    651Compensation in respect of options granted to non-employees
    
    
    
    
    
    
    139
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    139Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,555
    
    
    
    44,555
    
    
    
    44,555Comprehensive incomeForeign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    236
    
    
    
    
    
    
    
    
    
    
    
    236
    
    
    
    236Unrealized loss on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,788Balance at December 31, 2002
    
    
    680
    
    
    
    173,584
    
    
    
    (2,358
    )
    
    
    (1,288
    )
    
    
    98,519
    
    
    
    
    
    
    
    269,137Tax benefit related to exercise of stock options
    
    
    
    
    
    
    6,995
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,995Exercise of options and issuance of shares of ESPP
    
    
    *
    )
    
    
    2,110
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,110Compensation in respect of options granted to non-employees
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Purchase of treasury stock
    
    
    *
    )
    
    
    
    
    
    
    
    
    
    
    (60
    )
    
    
    
    
    
    
    
    
    
    
    (60
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,155
    
    
    
    61,155
    
    
    
    61,155Comprehensive incomeForeign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    9,501
    
    
    
    
    
    
    
    
    
    
    
    9,501
    
    
    
    9,501Unrealized loss from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    (1,448
    )
    
    
    
    
    
    
    
    
    
    
    (1,448
    )
    
    
    (1,448
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,208Balance at December 31, 2003
    
    
    680
    
    
    
    182,699
    
    
    
    5,695
    
    
    
    (1,348
    )
    
    
    159,674
    
    
    
    
    
    
    
    347,400Exercise of options and issuance of shares of ESPP
    
    
    *
    )
    
    
    1,863
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,863Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,075
    
    
    
    11,075
    
    
    
    11,075Comprehensive incomeForeign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    6,076
    
    
    
    
    
    
    
    
    
    
    
    6,076
    
    
    
    6,076Unrealized gain from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    1,681
    
    
    
    
    
    
    
    
    
    
    
    1,681
    
    
    
    1,681Unrealized gain from available for sale marketable securities
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    25Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,857Balance at December 31, 2004
    
    $
    680
    
    
    $
    184,562
    
    
    $
    13,477
    
    
    $
    (1,348
    )
    
    $
    170,749
    
    
    
    
    
    
    $
    368,120Accumulated unrealized gains on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    $
    71Accumulated foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    13,173Accumulated unrealized gain from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    233$
    13,477
 
 *) Represents an amount lower than $1.  F-6




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TARO PHARMACEUTICAL INDUSTRIES LTD. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  U.S. dollars in thousands
 Year ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    11,075
    
    
    $
    61,155
    
    
    $
    44,555Adjustments required to reconcile net income to net
cash provided by (used in) operating activities:Minority interest in earnings (losses) of a subsidiary
    
    
    (1,017
    )
    
    
    326
    
    
    
    214Depreciation and amortization
    
    
    19,622
    
    
    
    14,405
    
    
    
    8,263Compensation in respect of options granted to
non-employees
    
    
    
    
    
    
    10
    
    
    
    139Accrued severance pay, net
    
    
    177
    
    
    
    27
    
    
    
    55Capital gain (loss) on sale of property, plant and
equipment
    
    
    (5
    )
    
    
    9
    
    
    
    Currency fluctuation of long-term debt
    
    
    (190
    )
    
    
    212
    
    
    
    (327
    )Deferred income taxes, net
    
    
    (18,822
    )
    
    
    2,004
    
    
    
    (1,110
    )Tax benefit from exercise of options
    
    
    
    
    
    
    7,219
    
    
    
    5,364Increase in
trade receivables (Note 1.f)
    
    
    (3,804
    )
    
    
    (50,992
    )
    
    
    (26,853
    )Increase in other accounts receivable and prepaid
expenses
    
    
    (27
    )
    
    
    (1,209
    )
    
    
    (4,250
    )Decrease (increase) in inventories
    
    
    776
    
    
    
    (37,638
    )
    
    
    (11,717
    )Increase (decrease) in trade payables
    
    
    (8,783
    )
    
    
    (340
    )
    
    
    11,090Increase (decrease) in other accounts payable and
accrued expenses
    
    
    (2,408
    )
    
    
    10,132
    
    
    
    3,142Increase (decrease) in income taxes payable
    
    
    1,596
    
    
    
    (63
    )
    
    
    1,077Net cash provided (used in) by operating activities
    
    
    (1,810
    )
    
    
    5,257
    
    
    
    29,642Cash flows from investing activities:Purchase of property, plant and equipment
    
    
    (72,270
    )
    
    
    (94,421
    )
    
    
    (43,246
    )Acquisition of Thames Pharmacal Company, Inc. (a)
    
    
    
    
    
    
    
    
    
    
    (6,436
    )Purchase of product rights
    
    
    (37,326
    )
    
    
    (10,375
    )
    
    
    (377
    )Long-term and other deposits
    
    
    (14,196
    )
    
    
    (64
    )
    
    
    (130
    )Investment in restricted short-term bank deposits
    
    
    (4,080
    )
    
    
    (50
    )
    
    
    (52
    )Proceeds from sale of property, plant and equipment
    
    
    
    
    
    
    24
    
    
    
    371Net cash used in investing activities
    
    
    (127,872
    )
    
    
    (104,886
    )
    
    
    (49,870
    )
 The accompanying notes are an integral part of the consolidated financial statements. F-7




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TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS  U.S. dollars in thousands
 Year ended December 31,2004
    
    
    2003
    
    
    2002Cash flows from financing activities:Proceeds from exercise of options and issuance of
shares of ESPP
    
    
    1,863
    
    
    
    2,110
    
    
    
    651Proceeds from long-term debt
    
    
    41,496
    
    
    
    116,346
    
    
    
    7,183Purchase of treasury stock
    
    
    
    
    
    
    (60
    )
    
    
    Repayment of long-term debt
    
    
    (19,696
    )
    
    
    (8,616
    )
    
    
    (6,006
    )Short-term bank credit and short-term loans, net
    
    
    45,504
    
    
    
    17,873
    
    
    
    (1,636
    )Net cash provided by financing activities
    
    
    69,167
    
    
    
    127,653
    
    
    
    192Effect of exchange rate changes on cash and cash
equivalents
    
    
    24
    
    
    
    380
    
    
    
    21Increase (decrease) in cash and cash equivalents
    
    
    (60,491
    )
    
    
    28,404
    
    
    
    (20,015
    )Cash and cash equivalents at the beginning of the year
    
    
    159,121
    
    
    
    130,717
    
    
    
    150,732Cash and cash equivalents at the end of the year
    
    $
    98,630
    
    
    $
    159,121
    
    
    $
    130,717Supplemental disclosure of cash flow transaction:Cash paid during the year for:Interest
    
    $
    9,417
    
    
    $
    3,102
    
    
    $
    2,696Income taxes
    
    $
    894
    
    
    $
    5,593
    
    
    $
    3,270(a) Acquisition of Thames Pharmacal Company, Inc.:Estimated fair value of assets acquired and
liabilities assumed at the date of acquisition:Working capital deficiency, net (excluding cash)
    
    
    
    
    
    
    
    
    
    $
    1,788Property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    (220
    )Intangible assets
    
    
    
    
    
    
    
    
    
    
    (4,697
    )Goodwill
    
    
    
    
    
    
    
    
    
    
    (3,307
    )$
    (6,436
    )(b) Non-cash investing and financing transactions:Purchase of property, plant and equipment on credit
    
    $
    2,948
    
    
    $
    5,415
    
    
    $
    5,870Investment in intangible assets on credit
    
    $
    12,750
    
    
    $
    14,100
    
    
    $
    
 The accompanying notes are an integral part of the consolidated financial statements. F-8




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##### Table of Contents



Notes to consolidated financial statements   NOTE 1:-
    
    GENERAL
  a.
    
    Taro Pharmaceutical Industries Ltd. (the Company) is an Israeli
corporation, which operates in Israel and through Israeli, North American, and
European subsidiaries (the Group). The principal business activities of the Group
are the production, research, development and marketing of pharmaceutical products.
The Companys Ordinary shares are listed for trade on the NASDAQ National Market in
the United States.All of the industrial pharmaceutical activities of the Group in Israel are
performed by the Company. The activities of the Group in North America are
performed by Taro Pharmaceuticals Inc., Taro Pharmaceuticals North America, Inc.
and Taro Pharmaceuticals U.S.A., Inc. Taro Research Institute Ltd. provides
research and development services to the Group. Taro International Ltd., Taro
Pharmaceuticals Ireland Ltd. and Taro Pharmaceuticals (U.K.) Ltd. are engaged in
the pharmaceutical activities of the Group outside North America.The Group manufactures generic and proprietary drug products in its facilities
located in Israel, Canada and the U.S.A., and manufactures bulk active
pharmaceutical ingredients in its facilities located in Israel. The majority of
the Groups sales are in North America.In North America, the Company sells and distributes its products principally to
drug industry wholesalers, drug store chains and mass merchandisers. In Israel,
the Group sells and distributes its products principally to healthcare institutions
and private pharmacies.In the generic pharmaceutical industry, selling prices and related profit margins
tend to decrease as products mature due to increased competition from other generic
pharmaceutical manufacturers as they gain approval from the U.S. Food & Drug
Administration, the Canadian Therapeutic Products Directorate and the Israeli and
other Ministries of Health (Government Agencies) to manufacture equivalent
products. The Groups future operating results are dependent on, among other
things, its ability to introduce new products and maintain its approvals to market
existing drugs.While non-compliance with Government Agencies regulations can result in refusal to
allow entry, seizure, fines or injunctive actions to prevent the sale of products,
no such actions against the Group or its products have ever occurred. The Group
believes that it is in material compliance with all Government Agencies
regulations.One customer accounted for 16%, 20%, and 22% of the Groups revenues for the years
ended December 31, 2004, 2003 and 2002, respectively (see also Note 15a). F-9




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Notes to consolidated
financial statements (continued)    Some raw materials and certain products are currently obtained from single domestic
or foreign suppliers. Although the Group has not experienced material difficulties
to date, future supply interruptions could require additional regulatory approvals
and may result in the Groups inability to market affected products pending
approvals. Any significant and prolonged interruption of supply could have a
material adverse effect on the Groups results of operations and financial
position.b.
    
    On May 7, 2002, the Company through its subsidiaries purchased substantially
all of the assets and assumed all liabilities of Thames Pharmacal, Inc.. Thames was a
privately-held New York manufacturer of prescription and over-the-counter
pharmaceutical products. The acquisition was made in order to broaden the Companys
portfolio of products. The aggregate purchase price of $6,436 was paid in cash. The
Company accounted for this acquisition by the purchase method. The results of Thames
operations have been included in the consolidated financial statements since the
acquisition date.The following table summarizes the estimated fair value of assets acquired and
liabilities assumed at the acquisition date: Current assets
    
    $
    3,024Current liabilities
    
    
    (4,812
    )Property, plant and equipment
    
    
    220Intangible assets
    
    
    4,697Goodwill
    
    
    3,307$
    6,436
  The intangible assets acquired include product rights with a weighted average
useful life of 11 years. No in-process research and development was identified.Pro forma information in accordance with Statement of Financial Accounting Standard
No. 141, Business Combinations, has not been provided since the sales and net
income for 2002 were not material in relation to total consolidated sales and net
income.c.
    
    On January 14, 2003, Taro Pharmaceuticals North America, Inc. entered into a
license and option agreement with Medicis Pharmaceutical Corporation. According to
the agreement, during 2004, TNA exercised its option and purchased from Medicis four
branded prescription product lines for sale in the United States and Puerto Rico for
an aggregate purchase price of $23,800. The main products purchased were Topicort and
Ovide. These product lines are used primarily in dermatology and pediatrics. The
purchase price was allocated to the product lines. Such product lines have a weighted
average useful life of 15 years. F-10




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##### Table of Contents



Notes to consolidated
financial statements (continued)    d.
    
    On March 21, 2003, the Companys Irish subsidiary, Taro Pharmaceuticals Ireland
Ltd., acquired, for an amount equal to $5,900, a multi-purpose pharmaceutical
manufacturing and research facility in Ireland. The facility was purchased in
connection with liquidation proceedings from the Official Liquidator appointed by
the High Court of Ireland. Based on a valuation analysis, $2,350 was allocated to
land, $1,950 was allocated to buildings with an average useful life of 30 years and
$1,600 was allocated to infrastructure, machinery and equipment with an average
useful life of eight years.e.
    
    On January 8, 2004, the Companys U.S. subsidiary expanded its distribution
capacity with the purchase of a modern, 315,000 square foot distribution center on 25
acres of land in South Brunswick, New Jersey. Taro acquired the facility for
approximately $18,433. This facility is subject to depreciation on a straight line
basis over a period of 40 years.f.
    
    In July 2004, Taro U.S.A. entered into a license agreement with Medicis for
four product lines including the Lustra® product line and two development stage
products in the United States, Canada and Puerto Rico. The aggregate purchase price
will be $35,565. These products are used for the treatment of skin disorders. The
products have a weighted average useful life of 14 years. As part of the agreement,
the Company received $20,000 from Medicis with which the Company established a
reserve, reducing accounts receivable and including it in cash flows
from operating activities. This reserve is to be utilized for returns and
other deductions related to the products. NOTE 2:-       SIGNIFICANT ACCOUNTING POLICIES  The consolidated financial statements are prepared according to accounting
principles generally accepted in the United States (U.S. GAAP).a.
    
    Use of estimates:The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.b.
    
    Financial statements in U.S. dollars:A majority of the revenues of the Company and certain of its subsidiaries is
generated in U.S. dollars (dollars). In addition, a substantial portion of the
costs of the Company and certain of its subsidiaries is incurred in dollars. The
Companys management believes that the dollar is the primary currency of the
economic environment in which the Company and F-11




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##### Table of Contents



Notes to consolidated financial statements (continued)    certain of its subsidiaries operate. Thus, the functional and reporting currency
of the Company and certain of its subsidiaries is the dollar.Accordingly, amounts in currencies other than U.S dollars have been
translated as follows: Monetary balances  at the exchange rate in effect on the balance sheet date. Revenues and costs  at the exchange rates in effect as of the date of
recognition of the transactions.  All transaction gains and losses resulting from the remeasurement mentioned above
are reflected in the statement of income as financial income or expenses, as
appropriate.The dollar has been determined to be the functional currency for the Company and
all subsidiaries except the Canadian, Irish and the U.K. subsidiaries, for which
their respective local currencies are their functional currencies. The financial
statements of the Canadian, Irish and the U.K. subsidiaries have been translated
into dollars. All balance sheet accounts have been translated using the exchange
rates in effect at the balance sheet date. Amounts recorded in the statements of
income have been translated using the average exchange rate for the year. The
resulting translation adjustments are reported as a component of shareholders
equity, under Accumulated other comprehensive income (loss).c.
    
    Principles of consolidation:The consolidated financial statements include the accounts of the Company and its
subsidiaries. Inter-company transactions and balances have been eliminated in
consolidation. Profits from inter-company sales not yet realized outside the Group
have been eliminated in consolidation. The Company holds 50% of the shares
conferring voting rights, and 96.9% of the shares conferring rights to profits, of
Taro Pharmaceuticals U.S.A. Inc. (the U.S. subsidiary); the remaining shares
(conferring 50% of the voting rights and 3.1% of the rights to profits) are held by
Taro Development Corporation (a shareholder of the Company). According to an
agreement between TDC and the Company, the shareholder will appoint directors in
the U.S. subsidiary as instructed by the Company. TDC may terminate the agreement
upon one year written notice.d.
    
    Cash equivalents:Cash equivalents are short-term highly liquid investments that are readily
convertible to cash with maturities of three months or less at the date acquired. F-12




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##### Table of Contents



Notes to consolidated financial statements (continued)    e.
    
    Restricted short-term bank deposits:Restricted cash is primarily invested in certificates of deposit, which mature
within one year and which are used as collateral for the Companys short-term bank
loans. Such restricted short-term bank deposits are recorded at cost, including
accrued interest.f.
    
    Allowance for doubtful accounts:The allowance for doubtful accounts is calculated primarily with respect to
specific debts which, in the opinion of the Companys management, are doubtful of
collection, and with respect to a fixed general allowance which, in the opinion of
the Companys management, is sufficient to cover anticipated uncollectible
balances.g.
    
    Inventories:Inventories are stated at the lower of cost or market value. Inventory reserves
are provided to cover risks arising from slow-moving items or obsolescence. Cost
is determined as follows:Raw and packaging materials - average cost basis.Finished goods and work in progress - average production costs including materials,
labor and direct and indirect manufacturing expenses.Purchased products for commercial purposes  average cost basis.The amounts of inventory obsolescence were $7,156, $5,209, and $2,930 for the years
ended December 31, 2004, 2003 and 2002, respectively.h.
    
    Property, plant and equipment:  1.
    
    Property, plant and equipment are stated at cost net of
accumulated depreciation.2.
    
    Interest and payroll expenses incurred during the
construction period of property, plant and equipment are capitalized to the
cost of such assets. F-13




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##### Table of Contents



Notes to consolidated
financial statements (continued)    3.
    
    Depreciation is calculated by the straight-line method over the
estimated useful lives of the assets, from the date the asset is ready for
its intended use, at the following annual rates: %Buildings
    
    2.5 - 4Installations, machinery and equipment
    
    5 - 10 (mainly 10)Motor vehicles
    
    15 - 20Furniture, fixtures, office equipment and EDP equipment
    
    6 - 33 (mainly 20)
  Leasehold improvements are depreciated by the straight-line method over
the term of the lease (5-10 years).4.
    
    The Group accounts for costs of computer software developed
or obtained for internal use in accordance with Statement of Position No.
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. SOP No. 98-1 requires the capitalization of certain costs
incurred in connection with developing or obtaining internal use software
during the application development stage. During the years 2004 and 2003, the
Group capitalized $924 and $958 of software costs, respectively. Capitalized
software costs are amortized by the straight-line method over their estimated
useful life of three years.  i.
    
    Goodwill:Effective January 1, 2002, the Company adopted the full provisions of Statement of
Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets (SFAS
142). Under SFAS 142 goodwill is no longer amortized but instead is tested for
impairment at least annually (or more frequently if impairment indicators arise).SFAS 142 prescribes a two phase process for impairment testing of goodwill. The
first phase screens for impairment; while the second phase (if necessary) measures
impairment.In the first phase of impairment testing, goodwill attributable to a reporting unit
is tested for impairment by comparing the fair value of the reporting unit with its
carrying value. The second phase of the goodwill impairment test compares the
implied fair value of the reporting units goodwill with the carrying amount of
that goodwill. If the carrying amount of the reporting units goodwill exceeds the
implied fair value of that goodwill, an impairment loss is recognized in an amount
equal to that excess. F-14




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##### Table of Contents



Notes to consolidated financial statements (continued)    Fair value of the reporting unit is determined using market capitalization. The
Company performs its annual impairment tests during the fourth fiscal quarter of
each year. As of December 31, 2004, no impairment loss has been identified.Changes in goodwill during the year resulted from translation adjustment related to
goodwill recorded in the Canadian subsidiary.j.
    
    Other intangible assets and deferred charges:Product rights are amortized on a straight-line basis over their estimated useful
lives. Such product rights are amortized over eight and 20 years.Acquired intangible assets are amortized over their useful life using a method of
amortization that reflects the pattern in which the economic benefits of the
intangible assets are consumed or otherwise used up, in accordance with SFAS 142.
These assets are amortized over a weighted average amortization period of 15 years.Debt issuance costs in respect of long-term loans from institutional investors and
bonds are deferred and amortized under the effective interest method over the term
of the loans from institutional investors and bonds.k.
    
    Impairment of long-lived assets:The Groups long-lived assets are reviewed for impairment in accordance with
Statement of Financial Accounting Standards No. 144 Accounting for the Impairment
or Disposal of Long-lived Assets, whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. An
impairment exists when the carrying amount of the asset exceeds the aggregate
future undiscounted cash flows expected to be generated by the asset. The
impairment to be recognized is measured by the amount by which the carrying amount
of the assets exceeds the fair value of the assets. As of December 31, 2004, no
impairment losses have been identified.l.
    
    Revenue recognition:Revenues from product sales are recognized when delivery has occurred, persuasive
evidence of an arrangement exists, the vendors fee is fixed or determinable and
collection is probable. The Group maintains a provision for product returns and
sales allowances in accordance with Statement of Financial Accounting Standard No.
48, Revenue Recognition When Right of Return Exists. Provision for returns and
other sale allowances are determined on the basis of past experience and are
deducted from revenues. F-15




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##### Table of Contents



Notes to consolidated financial statements (continued)    Allowance for sales deductions and product returns: When the Company recognizes
and records revenue from the sale of its pharmaceutical products, the Company
simultaneously records an estimate of various future costs related to the sale.
This has the effect of reducing the amount of reported product sales. These costs
include the Companys estimates of product returns, rebates, chargebacks and other
sales deductions. Chargebacks result from price arrangements the Company has with
end-user customers establishing contract prices which are typically lower than the
wholesalers acquisition costs or invoice prices. When these customers buy the
Companys products from their wholesaler of choice, the wholesaler issues a credit
memo (chargeback) to the Company for the difference between the invoice price and
the end-user contract price.m.
    
    Research and development:Research and development expenses, net of related grants received, are
charged to expenses as incurred.n.
    
    Royalty-bearing grants:Royalty-bearing grants from the government of Israel through the Office of the
Chief Scientist for funding approved research and development projects are
recognized at the time the Company is entitled to such grants, on the basis of the
related costs incurred. Such grants are included as deductions from research and
development costs.o.
    
    Advertising expenses:The Group expenses advertising costs as incurred. Advertising expenses were
approximately $30,955, $22,309, and $4,075 for the years ended December 31, 2004,
2003 and 2002, respectively.p.
    
    Income taxes:Income taxes are accounted for in accordance with Statement of Financial Accounting
Standard No. 109 Accounting for Income Taxes (SFAS 109). SFAS 109 prescribes
the use of the liability method, whereby deferred tax asset and liability account
balances are determined for temporary differences between the financial reporting
and tax bases of assets and liabilities, and for carryforward losses. Deferred
taxes are measured using the enacted tax rates and laws that will be in effect when
the differences are expected to reverse. The Group provides a valuation allowance,
if necessary, to reduce deferred tax assets to their estimated realizable value. F-16




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##### Table of Contents



Notes to consolidated financial statements (continued)    q.
    
    Basic and diluted net earnings per share:Basic earnings per share are calculated based on the weighted average number of
Ordinary shares outstanding during each year. Diluted net earnings per share are
calculated based on the weighted average number of Ordinary shares outstanding
during each year, plus dilutive potential Ordinary Shares considered outstanding
during the year, in accordance with Statement of Financial Accounting Standard No.
128, Earnings per Share.The total weighted average number of options excluded from the calculations of
diluted net earnings per share, as a result of their anti-dilutive effect, was
396,145, 49,000, and 164,050 for the years ended December 31, 2004, 2003 and 2002,
respectively.r.
    
    Accounting for stock-based compensation:The Company has elected to follow Accounting Principles Board Statement No. 25,
Accounting for Stock Options Issued to Employees (APB 25) and Financial
Accounting Standards Board (the FASB) Interpretation No. 44 Accounting for
Certain Transactions Involving Stock Compensation (FIN 44) in accounting for its
employees stock options plans. According to APB 25, compensation expense is
measured under the intrinsic value method, whereby compensation expense is equal to
the excess, if any, of the quoted market price of the stock over the exercise price
at the grant date of the award.The Company adopted the disclosure provisions of Financial Accounting Standards
Board Statement No. 148, Accounting for Stock-Based
Compensation - Transition and
Disclosure, which amended certain provisions of Statement of Financial Accounting
Standard No. 123, Accounting for Stock-Based Compensation (SFAS 123). The
Company continues to apply the provisions of APB 25 in accounting for stock-based
compensation.Pro-forma information regarding the Companys net income and net earnings per share
is required by SFAS 123 and has been determined as if the Company had accounted for
its employee stock options under the fair value method prescribed by SFAS 123.The fair value for options granted in 2004, 2003 and 2002 is amortized over their
vesting period on a straight line basis and estimated at the date of grant using a
Black-Scholes options pricing model with the following weighted average
assumptions: F-17




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##### Table of Contents



Notes to consolidated financial statements (continued)     2004
    
    
    2003
    
    
    2002Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected volatility
    
    
    55.8
    %
    
    
    52.0
    %
    
    
    52.3
    %Risk-free interest
    
    
    3.50
    %
    
    
    3.00
    %
    
    
    1.75
    %Expected life of up to
    
    5 years
    
    5 years
    
    5 years
  In 2004, the fair value for the options granted under the Companys ESPP plan is
amortized over their vesting period on a straight line basis and estimated at the
date of the grant using a Black-Scholes options pricing model with the following
weighted assumptions: 0% dividend yield, 31.6% volatility, 3.5% risk free interest
rate and expected life of up to eight months.The following table illustrates the effect on net income (loss) and net earnings
(loss) per share, assuming that the Company had applied the fair value recognition
provision of SFAS 123 on its stock-based employee compensation: Year ended December 31,2004
    
    
    2003
    
    
    2002Net income - as reported
    
    $
    11,075
    
    
    $
    61,155
    
    
    $
    44,555Less - total stock-based
compensation expenses determined
under fair value method for all
awards
    
    
    3,811
    
    
    
    1,474
    
    
    
    1,026Net income - pro-forma
    
    $
    7,263
    
    
    $
    59,681
    
    
    $
    43,529Earnings per share:Basic - as reported
    
    $
    0.38
    
    
    $
    2.12
    
    
    $
    1.55Basic - pro forma
    
    $
    0.25
    
    
    $
    2.07
    
    
    $
    1.52Diluted - as reported
    
    $
    0.37
    
    
    $
    2.06
    
    
    $
    1.52Diluted  pro forma
    
    $
    0.24
    
    
    $
    2.01
    
    
    $
    1.48
 F-18




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##### Table of Contents



Notes to consolidated
financial statements (continued)    The Company applies SFAS No. 123 and Emerging Issue Task Force No. 96-18
Accounting for Equity Instruments That are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling Goods or Services with respect to
options issued to non-employees. SFAS No. 123 requires the use of option valuation
models to measure the fair value of the options granted.s.
    
    Concentrations of credit risk:Financial instruments that potentially subject the Group to concentrations of
credit risk consist principally of cash and cash equivalents, restricted short-term
bank deposits and trade receivables. Cash and cash equivalents and restricted
short-term bank deposits are invested in major banks in Israel, the United States,
Canada and the Cayman Islands. Such deposits in the United States may be in excess
of insured limits and are not insured in other jurisdictions. Management believes
that the financial institutions that hold the Groups cash and cash equivalent and
restricted short-term bank deposits are financially sound and that minimal credit
risk therefore exists with respect to these financial instruments.The Groups trade receivables are mainly derived from sales to customers in the
United States, Canada, Europe and Israel. The Group has adopted credit policies
and standards intended to accommodate industry growth and inherent risk.
Management believes that credit risks are moderated by obtaining credit insurance
providing certain protection in the event of customers default and by the
diversity of the Groups customer base and geographic sales areas. The Group
performs ongoing credit evaluations of its customers financial condition and
requires collateral when deemed necessary.t.
    
    Fair value of financial instruments:The carrying amounts of cash and cash equivalents, restricted short-term bank
deposits, trade and other receivables and trade and other payables approximate
their fair value, due to the short-term maturities of these instruments.The carrying amount of long term bank deposits approximate their fair value since
such deposits bear market interest rates.The carrying amounts of the Groups borrowing arrangements under its short-term and
long-term debt agreements approximate their fair value since the loans bear
interest at rates that approximate the Groups incremental borrowing rates for
similar types of borrowing arrangements.The fair value of currency swap contracts is determined by discounting to the
present all future cash flows of the currencies to be exchanged at F-19




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##### Table of Contents



Notes to consolidated financial statements (continued)    interest rates prevailing in the market for the period the currency exchanges are
due and expressing the results in U.S. dollars at the current spot foreign currency
exchange rate.u.
    
    Accounting for derivatives:FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS No. 133), requires companies to recognize all of their
derivative instruments as either assets or liabilities in the statement of
financial position at fair value. The accounting for changes (i.e., gains or
losses) in the fair value of a derivative instrument depends on whether the
instrument has been designated and qualifies as part of a hedging relationship and
on the type of hedging relationship. For derivative instruments that are
designated and qualify as hedging instruments, a company must designate the hedging
instrument, as a fair value hedge, cash flow hedge or a hedge of a net investment
in a foreign operation. The designation is based upon the nature of the exposure
being hedged.For a derivative instrument that is designated and qualifies as a fair value hedge
(i.e., an instrument that hedges the exposure to changes in the fair value of an
asset or a liability or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument as well as the
offsetting loss or gain on the hedged item are recognized in the same line item
associated with the hedged item in current earnings. For a derivative instrument
that is designated and qualifies as a cash flow hedge (i.e., an instrument that
hedges the exposure to variability in expected future cash flows that is
attributable to a particular risk), the effective portion of the gain or loss on
the derivative instrument is reported as a component of other comprehensive income
and reclassified into earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged transaction
affects earnings.For derivative instruments not designated as hedging instruments, the gain or loss
is recognized in financial income/expense in current earnings during the period of
change.v.
    
    Impact of recently issued accounting standards:On November 2004, the FASB issued Statement of Financial Accounting Standard No.
151, Inventory Costs, an Amendment of ARB 43, Chapter 4. SFAS 151 amends
Accounting Research Bulletin No. 43, Chapter 4, to clarify that abnormal amounts of
idle facility expense, freight handling costs and wasted materials (spoilage)
should be recognized as current-period charges. In addition, SFAS 151 requires that
allocation of fixed production overheads to the costs of conversion be based on
normal F-20




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##### Table of Contents



Notes to consolidated financial statements (continued)    capacity of the production facilities. SFAS 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The Company does not
expect that the adoption of SFAS 151 will have a material effect on its financial
position or results of operations.In December 2004, the FASB issued Financial Accounting Standards No. 153,
Exchanges of Nonmonetary Assets  An Amendment of Accounting Principles Board
Opinion No. 29 (SFAS 153). SFAS 153 amends Accounting Principles Board Opinion No.
29, Accounting for Nonmonetary Transactions (APB 29). The amendments made by
SFAS 153 eliminate the APB 29 exception for nonmonetary exchanges of similar
productive assets and replace it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. As applicable to the
Company, the provisions in SFAS 153 are effective for nonmonetary asset exchanges
occurring as from the third quarter of 2005 and the provisions of this statement
will also be applied prospectively. The Company does not expect the
adoption of SFAS
153 to have a material effect on the Companys financial statements or its results
of operations.On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004),
Share-Based Payment (Statement 123(R)), which is a revision of FASB Statement
No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally,
the approach in Statement 123(R) is similar to the approach described in Statement
123. However, Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative.Statement 123(R) must be adopted no later than January 1, 2006. Early adoption will
be permitted in periods in which financial statements have not yet been issued. The
Company expects to adopt Statement 123(R) on the first interim period beginning
after January 1, 2006.Statement 123(R) permits public companies to adopt its requirements using one of
two methods:a) A modified prospective method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of Statement 123(R)
for all share-based payments granted after the effective date and (b) based on the
requirements of Statement 123 for all awards granted to employees prior to the
effective date of Statement 123(R) that remain unvested on the effective date. F-21




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Notes to consolidated financial statements (continued)    b) A modified retrospective method which includes the requirements of the
modified prospective method described above, but also permits entities to restate
based on the amounts previously recognized under Statement 123 for purposes of pro
forma disclosures either (a) all prior periods presented or (b) prior interim
periods of the year of adoption.The Company is still in the process of evaluating which of the two methods
described above it will use prospectively.As permitted by Statement 123, the Company currently accounts for share-based
payments to employees using Opinion 25s intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options. Accordingly,
the adoption of Statement 123(R)s fair value method will have a significant impact
on the Companys results of operations, although it will have no impact on the
Companys overall financial position. The impact of adoption of Statement 123(R)
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. However, had the Company adopted Statement 123(R)
in prior periods, the impact of that standard would have approximated the impact of
Statement 123 as described in the disclosure of pro forma income and earnings per
share in Note 2r above.Statement 123(R) also requires that the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather than
as an operating cash flow as required under current literature. This requirement
will reduce net operating cash flows and increase net financing cash flows in
periods after the effective date. While the Company cannot estimate what those
amounts will be in the future (because they depend on, among other things, when
employees exercise stock options), the amount of operating cash flows recognized in
prior periods for such excess tax deductions were $0, $7,219, and $5,364 in 2004,
2003 and 2002, respectively.NOTE 3:-     ACCOUNTS RECEIVABLEa.
    
    Trade: December 31,2004
    
    
    2003Open accounts
    
    $
    123,296
    *)
    
    $
    119,547Notes and checks receivable
    
    
    1,568
    
    
    
    1,116124,864
    
    
    
    120,663Less - allowance for doubtful accounts
    
    
    190
    
    
    
    141$
    124,674
    
    
    $
    120,522
 F-22




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##### Table of Contents



Notes to consolidated financial statements (continued)   
 *) Includes a balance of $11,000 from an original amount of $20,000 withheld by
customers in connection with customary deduction procedures. The Company believes
these amounts were withheld in error and is conducting active discussions to
collect them. Approximately $9,000 of the $20,000 was collected as of December 31,
2004.  See Note 1.f.As for pledges, see Note 11.b.
    
    Other receivables and prepaid expenses: December 31,2004
    
    
    2003Employees
    
    $
    98
    
    
    $
    262Office of the Chief Scientist
    
    
    807
    
    
    
    670Government authorities
    
    
    3,911
    
    
    
    4,344Derivative instruments (Note 19)
    
    
    1,050
    
    
    
    1,313Deferred income taxes (Note 14)
    
    
    4,647
    
    
    
    5,487Prepaid expenses
    
    
    5,413
    
    
    
    3,917Other
    
    
    695
    
    
    
    1,053$
    16,621
    
    
    $
    17,046
 NOTE 4:-
    
    INVENTORIES
 December 31,2004
    
    
    2003Raw and packaging materials
    
    $
    31,467
    
    
    $
    32,665Finished goods
    
    
    48,321
    
    
    
    42,650Work in progress
    
    
    5,483
    
    
    
    7,587Purchased products for commercial activities
    
    
    1,320
    
    
    
    1,584$
    86,591
    
    
    $
    84,486
  As for pledges, see Note 11. F-23




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##### Table of Contents



Notes to consolidated financial statements (continued)     NOTE 5:-
    
    PROPERTY, PLANT AND EQUIPMENT
  a.
    
    Composition of assets grouped by major classifications are as follows: December 31,2004
    
    
    2003Cost:Land
    
    $
    15,580
    
    
    $
    12,491Leasehold land (1)
    
    
    13,421
    
    
    
    12,539Buildings (1)
    
    
    119,460
    
    
    
    73,712Leasehold improvements
    
    
    3,009
    
    
    
    3,401Installation, machinery and equipment
    
    
    120,722
    
    
    
    100,948EDP equipment
    
    
    29,124
    
    
    
    23,248Motor vehicles
    
    
    341
    
    
    
    342Furniture, fixtures and office equipment
    
    
    7,906
    
    
    
    6,212Advances for property and equipment
    
    
    2,788
    
    
    
    2,023312,351
    
    
    
    234,916Accumulated depreciation:Buildings (1)
    
    
    7,219
    
    
    
    5,375Leasehold improvements
    
    
    2,191
    
    
    
    1,566Installation, machinery and equipment
    
    
    39,667
    
    
    
    29,663EDP equipment
    
    
    17,953
    
    
    
    13,392Motor vehicles
    
    
    212
    
    
    
    163Furniture, fixtures and office equipment
    
    
    3,143
    
    
    
    2,451$
    70,385
    
    
    
    52,610Depreciated cost
    
    $
    241,966
    
    
    $
    182,306
  Depreciation expenses were $16,515, $12,206 and $7,875, for the years ended
December 31, 2004, 2003 and 2002, respectively.(1) Certain buildings (the depreciated balance of which as of December 31, 2004 was
$48,273) were constructed on land leased from the Israel Land Administration
pursuant to four leases. These leases expire between 2009 and 2049. The Company
has the option to renew each lease for an additional term of 49 years.b.
    
    Cost of property, plant and equipment includes capitalized interest expenses,
payroll and related expenses and other expenses incurred in order to bring the assets
to their intended use, in the amount of $17,967 and $8,211 as of December 31, 2004 and
2003, respectively. Capitalized expenses were $9,756, $4,989 and $1,258 for the years
ended December 31, 2004, 2003 and 2002, respectively. F-24




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##### Table of Contents



Notes to consolidated financial statements (continued)    c.
    
    Cost of EDP equipment includes capitalized development costs of computer
software developed for internal use in the amount of $3,384 and $2,460 as of December
31, 2004 and 2003, respectively.d.
    
    As of December 31, 2004, the Company has outstanding contractual commitments
to expand its buildings and to purchase equipment in the amount of $11,506.e.
    
    As of December 31, 2004, $53,771 of the Companys plant and equipment was
under various stages of construction and validation, and therefore was not subject to
depreciation.f.
    
    As for pledges  see Note 11. NOTE 6:-
    
    OTHER INTANGIBLE ASSETS AND DEFERRED CHARGES
  a.
    
    Composition: December 31,2004
    
    
    2003Cost:Product rights
    
    $
    68,167
    
    
    $
    32,049Deferred charges in respect of loans from
institutional investors and bonds
    
    
    1,327
    
    
    
    1,32769,494
    
    
    
    33,376Accumulated amortization:Product rights
    
    
    5,609
    
    
    
    2,667Deferred charges in respect of loans from
institutional investors and bonds
    
    
    711
    
    
    
    5226,320
    
    
    
    3,189Amortized cost
    
    $
    63,174
    
    
    $
    30,187
  See Note 1.f.b.
    
    Amortization expenses were $3,107, $2,199, and $388, for the years ended
December 31, 2004, 2003 and 2002, respectively.c.
    
    As of December 31, 2004, the estimated amortization expenses of intangible
assets for 2005 to 2009 is as follows: 2005 - $4,014; 2006 - $4,953; 2007 - $4,953;
2008 - $5,232; and 2009  $4,833. The weighted average amortization period for these
assets is 15 years. F-25




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 NOTE 7:- LONG-TERM INVESTMENTS December 31,2004
    
    
    2003Severance pay fund (1)
    
    $
    1,897
    
    
    $
    1,489Derivative
instruments (2)
    
    
    3,536
    
    
    
    1,044Long-term deposit (3)
    
    
    14,398
    
    
    
    185Other
    
    
    153
    
    
    
    170$
    19,984
    
    
    $
    2,888
 
 (1)
    
    Under Israeli law, the Company and its Israeli subsidiaries are required to
make severance or pension payments to dismissed employees and to employees terminating
employment under certain other circumstances. Deposits are made with a pension fund
to secure pension and severance rights for the majority of the employees in Israel who
have joined the pension fund. The deposits, together with a one-time payment made to
that fund, relieve the Company and its Israeli subsidiaries of their severance pay
liability to those employees whose employment started after June 1, 1979. Accordingly,
neither the deposit nor the related severance pay liability for such employees have
been recorded.The severance pay liability for the period through May 31, 1979 is covered by the
balance sheet accrual. The balance sheet accrual also covers the severance pay
liability to employees of the Company who have not joined the pension fund. The
Company has made deposits with recognized severance pay funds with respect to this
accrual.The Company may only withdraw the amounts funded for the purpose of disbursement of
severance pay.The Companys non-Israeli subsidiaries maintain a retirement savings plan covering
substantially all of their employees. The subsidiaries matching contribution to
the plan was approximately $1,283, $882, and $477 for the years 2004, 2003 and
2002, respectively. December 31,2004
    
    
    2003
    
    
    2002Pension, retirement
savings and
severance expenses
    
    $
    4,239
    
    
    $
    3,060
    
    
    $
    2,138
  (2)
    
    As for derivative instruments, see Note 19.(3)
    
    Long-term deposits consist of an interest bearing two year bank deposit at a
weighted average rate of 2.19%, in the amount of $14,000 as collateral for loans to
purchase fixed assets. F-26




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 NOTE 8:- SHORT-TERM BANK CREDIT AND SHORT-TERM LOANS Classified by currency, linkage terms and interest rates, the credit and loans are as
follows: Weighted average
    
    
    Amountinterest rateDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003%Short-term bank credit and loans:In, or linked to, U.S. dollars
    
    
    3.93
    
    
    
    2.94
    
    
    $
    53,262
    
    
    $
    14,605In NIS
    
    
    5.23
    
    
    
    6.70
    
    
    
    6,410
    
    
    
    5In Canadian dollars
    
    
    5.00
    
    
    
    5.25
    
    
    
    4,564
    
    
    
    4,372Other
    
    
    6.00
    
    
    
    2.18
    
    
    
    725
    
    
    
    142$
    64,961
    
    
    $
    19,124Total authorized credit lines
approximate
    
    
    
    
    
    
    
    
    
    $
    65,000
    
    
    $
    28,500Unutilized credit lines approximate
    
    
    
    
    
    
    
    
    
    $
    39
    
    
    $
    9,006Weighted average interest rates at the
end of the year for all loans
    
    
    4.16
    
    
    
    3.46
 As for collateral  see Notes 7(3) and 11. NOTE 9:- ACCOUNTS PAYABLE  OTHER AND ACCRUED EXPENSES December 31,2004
    
    
    2003Employees and payroll accruals (including
accrual for vacation pay)
    
    $
    9,477
    
    
    $
    14,599Interest payable
    
    
    2,313
    
    
    
    2,148
    *)Suppliers of property, plant and equipment
    
    
    2,948
    
    
    
    4,683Accrued expenses and other
    
    
    12,482
    
    
    
    9,653
    *)$
    27,220
    
    
    $
    31,083
 
 *)
    
    Reclassified NOTE 10:- LONG-TERM DEBT  a.
    
    Composed as follows: F-27




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 December 31,2004
    
    
    2003Loans from institutional investors and bonds
    
    $
    129,068
    
    
    $
    130,432Banks
    
    
    36,599
    
    
    
    29,672Mortgage
    
    
    23,711
    
    
    
    4,571Obligations to other vendors
    
    
    12,750
    
    
    
    14,100Other
    
    
    2,162
    
    
    
    2,582204,290
    
    
    
    181,357Less  current maturities
    
    
    16,944
    
    
    
    24,420$
    187,346
    
    
    $
    156,937
  1.
    
    The Company has undertaken to comply with financial covenants in respect of its
bank debt. The covenants stipulate that our debt to equity ratio may
not exceed 2:1, and that our current ratio may not be lower than 1:1. During December 2004, the Company requested and received from its
Israeli banks, a one year waiver for certain financial covenants. Accordingly,
these financial covenants will be measured based on the Companys December 31, 2005
financial statements. Another financial covenant was amended by the bank and the
Company expects to meet the amended financial covenant in the coming year. As of
December 31, 2004, the Company was in compliance with all other bank debt
covenants.2.
    
    The loan agreements that the Company signed during 2003 require that,
prior to incurring additional debt in Israel, the Companys interest coverage ratio be
greater than 2:1, to be measured on April 1 of each year of the loan, commencing on
April 1, 2005. In the first quarter of 2005, the loan agreements were amended to
defer measurement of the interest coverage ratio until April 1, 2006. In addition,
the Company undertook, with two of the institutional investors who had made loans
to the Company of approximately $6,500, to perform a review of the Companys
compliance with the interest coverage ratio on August 15, 2005, with respect to the
12-month period ending June 30, 2005. These covenants, as
amended, may restrict the Companys ability to incur additional
debt in Israel. Under certain restrictive debt covenants,
any dividend distribution requires the prior approval of certain banks.b.
    
    Classified by currency, linkage terms and interest rates, the total amount of
the liabilities (before deduction of current maturities) is as follows: Interest rate
    
    
    AmountDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003%In, or linked to, U.S. dollar
    
    
    4.16
    
    
    
    4.58
    
    
    $
    117,071
    
    
    $
    107,604In Euro
    
    
    
    
    
    
    
    
    
    
    1,609
    
    
    
    In Canadian dollars
    
    
    4.56
    
    
    
    5.29
    
    
    
    23,710
    
    
    
    9,891In Israeli currency  linked to
CPI*
    
    
    6.37
    
    
    
    6.41
    
    
    
    61,900
    
    
    
    63,862$
    204,290
    
    
    $
    181,357
 F-28




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 
 (*)
    
    After giving effect to the hedging instrument, this debt is linked to the
U.S. dollar and bears interest at a weighted average rate of 6.37%, as of December
31, 2004.  As for hedging foreign currency and interest rate risk of the portion linked to the
Israeli CPI, see Note 19.Loans in the amount of $46,300 are subject to variable
interest rates primarily linked to the LIBOR and the Canadian
Bankers Rate. As of December 31, 2004, the balance of the Companys outstanding debt is subject
to fixed interest rate.c.
    
    The liabilities mature as follows: December31, 20042005
    
    $
    16,9442006
    
    
    34,9302007
    
    
    30,9522008
    
    
    28,7412009
    
    
    25,156Thereafter
    
    
    67,567$
    204,290
  For collateral, see Notes 7(3) and 11. NOTE 11:- LIABILITIES COLLATERALIZED BY PLEDGES  a.
    
    Balance of liabilities collateralized by pledges is as follows: December31, 2004Short-term bank credit and short-term loans *)
    
    $
    64,691Long-term debt (including current maturities) **)
    
    $
    189,931
 
 *)
    
    Including a short-term loan of $2,300 received by the U.S.
subsidiary, collateralized by a short-term bank deposit of the North American
subsidiary in an equal amount. F-29




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except share and per share data)
 
 **)
    
    Including long-term loans of $14,000 received by the U.S. subsidiary,
collateralized by long-term bank deposits of the Company in an equal amount.  b.
    
    The above mentioned liabilities are collateralized by:  1.
    
    A mortgage which includes a first priority charge on all
property, plant and equipment of the Canadian subsidiary, specifically
including land, buildings, production machinery, furniture and fixtures, and a
floating charge covering all assets of the Canadian subsidiary.2.
    
    Pledges on assets of the Company and its Israeli
subsidiaries, including a first priority floating charge on all assets. NOTE 12:- COMMITMENTS AND CONTINGENCIES  a.
    
    Companies of the Group have leased offices, warehouse space, production
facilities and equipment, under operating leases for periods through 2010. The
minimum annual rental payments, under non-cancelable lease agreements, are as follows: December31, 20042005
    
    $
    1,5752006
    
    
    1,1842007
    
    
    9312008
    
    
    8162009 and Thereafter
    
    
    1,396$
    5,902




| |    |  | Total rent expenses were $3,977, $3,366, and $1,967 for the years ended December
31, 2004, 2003 and 2002, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b. |  | Royalty commitments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |    |  | One of the subsidiaries is committed to pay royalties at the rate of 3%-5%
to the government of Israel through the Office of the Chief Scientist (OCS) on
proceeds from sales of products in which the government participates in the
research and development by way of grants. The obligation to pay these royalties
is contingent on actual sales of the products and, in the absence of such sales, no
payment is required. The commitment is on a product by product basis, is in an
amount not
exceeding the total of the grants received by the subsidiary, including

F-30



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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
  interest
accrued thereon, and is linked to the dollar. Commencing 1999, grants are subject
to interest at a rate of Dollar LIBOR. As of December 31, 2004, the aggregate
contingent liability to the OCS amounted to $9,251.Royalty payments to the OCS were $431, $506 and $1,376 for the years ended December
31, 2004, 2003 and 2002, respectively.c.
    
    A claim in the amount of approximately $550 was filed by a customer against
the Company. Based on a legal opinion and insurance coverage, management believes
that the final outcome of the lawsuit will not have a material adverse effect on the
accompanying financial statements and, accordingly, no provision was made for this
claim.d.
    
    During 2004, purported securities class action complaints were filed against
the Company and certain of its current and former officers and directors in the United
States District Court for the Southern District of New York. The Company intends to
rigorously defend against the claims in these actions and believes that it will not
incur any material charge as a result of these actions. NOTE 13:- SHAREHOLDERS EQUITY  a.
    
    Pertinent rights and privileges of Ordinary shares:  1.
    
    100% of the rights to profits are allocated to the Ordinary
shares.2.
    
    Two-thirds of the voting power of the Companys shares are
allocated to the Ordinary shares.3.
    
    100% of the dissolution rights are allocated to the Ordinary
shares.  b.
    
    Founders Shares:One-third of the voting power of all of the Companys shares is allocated to the
Founders shares.c.
    
    Stock option plans:  1.
    
    The Companys 1991 Stock Incentive Plan (1991 plan) and 1999 Stock
Incentive Plan (1999 plan) provide for the issuance of incentive stock
options, non-qualified stock options, and stock appreciation rights to key
employees and associates of the Group.The options are granted for
at least 100% of the fair market value on the date of grant and the
aggregate amount of the options granted may not exceed 2,100,000. As of
December 31, 2004,
none of the options granted include stock appreciation rights. The F-31




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
  options are granted to employees and associates, have a four to five-year
graded vesting term and generally expire ten years after the date of the
grant. Each option entitles its holder the right to purchase one Ordinary
share of NIS 0.0001 par value (subject to adjustments). As of December
31, 2004, an aggregate of 635,775 options in respect of the 1999 plan are
still available for future grants. Any options that are canceled or
forfeited before expiration become available for future grants.2.
    
    A summary of the Companys stock option activity (except
options to associates) and related information for the three years ended
December 31, 2004 is as follows: WeightedaverageNumber of
    
    
    Exercise
    
    
    exerciseoptions
    
    
    price
    
    
    price$
    
    
    $Outstanding at January 1, 2002
    
    
    1,076,597
    
    
    
    
    
    
    
    9.67Exercised
    
    
    (91,834
    )
    
    
    2.17 - 11.91
    
    
    
    3.77Canceled and forfeited
    
    
    (21,674
    )
    
    
    2.44 - 38.58
    
    
    
    19.87Granted
    
    
    266,500
    
    
    
    24.10 - 38.98
    
    
    
    32.02Outstanding at December 31, 2002
    
    
    1,229,589
    
    
    
    
    
    
    
    14.72Exercised
    
    
    (192,167
    )
    
    
    2.38- 39.03
    
    
    
    7.28Canceled and forfeited
    
    
    (46,300
    )
    
    
    2.49 - 46.28
    
    
    
    22.29Granted
    
    
    295,750
    
    
    
    30.30 - 71.15
    
    
    
    45.59Outstanding at December 31, 2003
    
    
    1,286,872
    
    
    
    
    
    
    
    23.10Exercised
    
    
    (155,045
    )
    
    
    2.08 - 46.95
    
    
    
    7.34Canceled and forfeited
    
    
    (180,250
    )
    
    
    2.49 - 71.15
    
    
    
    39.30Granted
    
    
    527,500
    
    
    
    20.24 - 66.42
    
    
    
    34.68Outstanding at December 31, 2004
    
    
    1,479,077
    
    
    
    2.38-69.26
    
    
    
    26.83
 The number of options exercisable as of December 31, 2004, 2003 and 2002
are 468,293 466,561, and 436,160, respectively. The weighted average
exercise prices for the options exercisable as of December 31, 2004, 2003 and
2002 are $12.79, $7.94, and $4.82, respectively. The stock options outstanding and exercisable as of December 31, 2004 have
been classified into ranges of exercise prices as follows: F-32




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 Options outstanding
    
    
    Options exercisableWeightedOutstanding
    
    
    average
    
    
    Weighted
    
    
    Exercisable
    
    
    WeightedRange of
    
    as of
    
    
    remaining
    
    
    average
    
    
    as of
    
    
    averageexercise
    
    December 31,
    
    
    contractual
    
    
    exercise
    
    
    December 31,
    
    
    exerciseprice
    
    2004
    
    
    life
    
    
    price
    
    
    2004
    
    
    price$
    
    
    
    
    
    years
    
    
    $
    
    
    
    
    
    
    $2.38 - 6.82
    
    
    237,572
    
    
    
    4.19
    
    
    
    3.60
    
    
    
    237,572
    
    
    
    3.606.83 - 13.18
    
    
    217,900
    
    
    
    5.95
    
    
    
    12.37
    
    
    
    117,710
    
    
    
    12.2813.19 - 20.75
    
    
    86,400
    
    
    
    8.31
    
    
    
    18.26
    
    
    
    15,010
    
    
    
    14.9120.76 - 33.98
    
    
    546,400
    
    
    
    8.64
    
    
    
    28.04
    
    
    
    47,510
    
    
    
    30.1733.99 - 42.46
    
    
    128,555
    
    
    
    7.25
    
    
    
    37.12
    
    
    
    38,991
    
    
    
    37.2342.47 - 69.26
    
    
    262,250
    
    
    
    8.92
    
    
    
    55.12
    
    
    
    11,500
    
    
    
    50.161,479,077
    
    
    
    7.44
    
    
    
    26.83
    
    
    
    468,293
    
    
    
    12.79
  3.
    
    The weighted average fair values for options granted were: Year ended December 31,2004
    
    
    2003
    
    
    2002Weighted average fair value on
the date of grant
    
    $
    17.68
    
    
    $
    22.33
    
    
    $
    14.85
  Options to employees were issued with an exercise price equal to fair
market value. No compensation expenses were recognized in 2004, 2003 or
2002. 4.
    
    a)
    
    A summary of the Companys stock option activity in respect of associates and related information for the three years ended December 31, 2004 is as follows:
 WeightedaverageNumber of
    
    
    Exercise
    
    
    exerciseoptions
    
    
    price
    
    
    price$
    
    
    $Outstanding at January 1, 2002
    
    
    32,500
    
    
    
    
    
    
    
    9.58Exercised
    
    
    (12,500
    )
    
    
    2.63  6.19
    
    
    
    3.82Outstanding at December 31, 2002
    
    
    20,000
    
    
    
    2.75  36.38
    
    
    
    10.82Exercised
    
    
    (4,500
    )
    
    
    2.63  6.19
    
    
    
    5.16Cancelled and forfeited
    
    
    (2,000
    )
    
    
    32.61  32.61
    
    
    
    32.61Outstanding at December 31, 2003
    
    
    13,500
    
    
    
    2.75  36.38
    
    
    
    10.82Exercised
    
    
    (2,500
    )
    
    
    6.19
    
    
    
    6.19Outstanding at December 31, 2004
    
    
    11,000
    
    
    
    2.756.13
    
    
    
    4.27
 The number of options exercisable as of December 31, 2004, 2003 and
2002 were 11,000, 11,375, and 14,750, respectively. F-33




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
 The stock options outstanding and exercisable as of December 31, 2004 have
been classified into ranges of exercise prices as follows: Options outstanding
    
    
    Options exercisableWeightedOutstanding
    
    
    average
    
    
    Weighted
    
    
    Exercisable
    
    
    WeightedRange of
    
    as of
    
    
    remaining
    
    
    average
    
    
    as of
    
    
    averageexercise
    
    December 31,
    
    
    contractual
    
    
    exercise
    
    
    December 31,
    
    
    exerciseprice
    
    2004
    
    
    life
    
    
    price
    
    
    2004
    
    
    price$
    
    
    
    
    
    years
    
    
    $
    
    
    
    
    
    
    $2.75  6.13
    
    11,000
    
    
    4.81
    
    
    4.27
    
    
    11,000
    
    
    4.27
 b)
    
    The Company accounts for its options granted to associates under the fair value method as prescribed in SFAS No. 123 and EITF 96-18. These options vest primarily over 4-5 years.The fair value of these options was estimated using the Black-Scholes Option Pricing Model.Compensation expenses of approximately $0, $10 and $139 amortized over the vesting period were recognized in the years ended December 31, 2004, 2003 and 2002, respectively.
  5.
    
    In 2004, 2003 and 2002, 157,545, 196,667, and 104,334 options
were exercised to purchase 157,545, 196,667, and 104,334 Ordinary shares,
respectively. The amount of consideration received therefrom in 2004, 2003
and 2002, was $1,013, $1,422, and $393, respectively.  e.
    
    Dividends:The Company may declare and pay dividends out of its retained earnings (as for
restrictions on dividend distribution see Notes 10 and 14c).f.
    
    Net earnings per share: Year ended December 31, 2004
    
    
    Year ended December 31, 2003
    
    
    Year ended December 31, 2002Per
    
    
    Net
    
    
    
    
    
    
    Per
    
    
    
    
    
    
    
    
    
    
    PerNet income
    
    
    Shares
    
    
    Share
    
    
    income
    
    
    Shares
    
    
    Share
    
    
    Net income
    
    
    Shares
    
    
    Share(numerator)
    
    
    (denominator)
    
    
    Amount
    
    
    (numerator)
    
    
    (denominator)
    
    
    Amount
    
    
    (numerator)
    
    
    (denominator)
    
    
    AmountBasic EPS:Net income available
to holders of
Ordinary shares
    
    $
    11,075
    
    
    
    29,057,564
    
    
    $
    0.38
    
    
    $
    61,155
    
    
    
    28,872,839
    
    
    $
    2.12
    
    
    $
    44,555
    
    
    
    28,664,887
    
    
    $
    1.55Effect of dilutive
securities:Stock options
    
    
    

    
    
    
    599,922
    
    
    
    (0.01
    )
    
    
    
    
    
    
    801,309
    
    
    
    (0.06
    )
    
    
    
    
    
    
    743,307
    
    
    
    (0.03
    )Diluted EPS:Income available to
holders of Ordinary
Shares plus
assumed exercises
    
    $
    11,075
    
    
    
    29,657,486
    
    
    $
    0.37
    
    
    $
    61,155
    
    
    
    29,674,148
    
    
    $
    2.06
    
    
    $
    44,555
    
    
    
    29,408,194
    
    
    $
    1.52
   F-34




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except
share and per share data)
  g.
    
    Stock repurchase:In prior years, the Group acquired 265,400 Ordinary shares of the Company in the
aggregate amount of $1,348, which represent less than 1% of the total outstanding
Ordinary shares.h.
    
    2000 Employee Stock Purchase Plan:In May 2000, the Companys Board of Directors approved and implemented the 2000
Employee Stock Purchase Plan (the Plan). The Plan was approved at an
Extraordinary General Meeting of Shareholders held on May 2, 2001. The purpose of
the Plan is to provide employees of the Company and those of its subsidiaries
designated by the Board with an opportunity to purchase Ordinary shares. The
maximum number of shares issuable under the Plan is 500,000 Ordinary shares,
subject to adjustment.Under the terms of the Plan, participating employees accrue funds in an account
through payroll deductions during six month offering periods. The funds in this
account are applied at the end of such offering periods to purchase Ordinary shares
at a 15% discount from the closing price of the Ordinary Shares on (i) the first
business day of the offering period or (ii) the last business day of the offering
period, whichever closing price is lower. As of December 31, 2004,participating
employees purchased an aggregate of 129,379 Ordinary Shares at a weighted average
exercise price of $26.54.The amounts of consideration received therefrom in 2004, 2003 and 2002 were $850,
$688 and $258, respectively. NOTE 14:- INCOME TAXES  a.
    
    Measurement of taxable income under the Income Tax (Inflationary Adjustments)
Law, 1985:Results for tax purposes in Israel are measured in terms of earnings in New Israeli
Shekels (NIS) after certain adjustments for increases in Israels CPI. As
explained in Note 2b, the financial statements are measured in dollars. The
difference between the annual change in the Israeli CPI and in the NIS/dollar
exchange rate causes a further difference between taxable income and the income
before taxes shown in the financial statements. In accordance with paragraph 9(f)
of SFAS 109, the Company has not provided deferred income taxes on the differences
resulting from changes in exchange rates and indexing for tax purposes through
December 31, 2002. The Company and its Israeli subsidiaries are taxed under this
law.As of January 1, 2003, for tax purposes the Companys earnings are measured
in terms of dollars. F-35




---



##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except share and per share data)
  b.
    
    Tax rates applicable to the income of the Israeli companies in the group:Until December 31, 2003, the regular tax rate applicable to income of companies
(which are not entitled to benefits due to approved enterprise status, as
described below) was 36%. In June 2004, an amendment to the Income Tax Ordinance
(No. 140 and Temporary Provision), 2004 was approved by the Israeli parliament,
which determines, among other things, that the corporate tax rate is to be
gradually reduced to the following tax rates: 2004  35%, 2005  34%, 2006  32%
and 2007 and thereafter  30%. Since the Company benefits from lower tax rates of
the Approved Enterprise status, such changes do not have, or are not expected to
have, a material effect on its financial results.c.
    
    Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969:The Company is an industrial company as defined by this law and, as such, is
entitled to certain income tax benefits, mainly accelerated depreciation in respect
of machinery and equipment (as prescribed by regulations published under the
Inflationary Adjustments Law) and the right to claim public issuance expenses,
amortization of patents and other intangible property rights as deductions for tax
purposes.d.
    
    Tax benefits under the Law for the Encouragement of Capital Investments, 1959
(the Law):The Companys production facilities in Israel have been granted an Approved
Enterprise status under the Law. The main benefits arising from such status are
tax exempt income for a period of 2-4 years and reduction in tax rates on income
derived from Approved Enterprises for the remaining benefit period. The Company is
also a foreign investors company, as defined by the Law and, as such, is
entitled to a 10 or 15 year period of benefits, based on the level of investment,
and to a reduction in tax rates to 10%  25% (based on the percentage of foreign
ownership in each tax year) and to accelerated depreciation in respect of machinery
and equipment.The period of tax benefits, described above, is subject to a limit of 12 years
from commencement of production or 14 years from the date of receiving the
Approved Enterprise status, whichever occurs earlier.The Company has four Approved Enterprise plans. Under the first approval, the
undistributed income derived from one Approved Enterprise will be exempt
from corporate tax for a period of four years from 2001, and the Company will be
eligible for a reduced tax rate of between 10% to 25% for an additional two years.
Under the second approval, the F-36




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except share and per share data)
  undistributed income derived from another Approved Enterprise was exempt from
corporate tax for a period of two years from 2001 and the Company will be eligible
for a reduced tax rate of 10% to 25% (based on the percentage of foreign ownership
in each tax year) for an additional eight years. Under the third approval
(benefit period starting 2003), the undistributed income will be exempt from
corporate tax for a period of two years following implementation of the plan. The
Company will be eligible for a reduced tax rate of between 10% to 25% (based on
the percentage of foreign ownership in each tax year) for an additional 13 years
thereafter. Under the fourth approval (benefit period most likely be implemented
during 2005), the undistributed income will be exempt from corporate tax for a
period of two years following implementation of the plan and the Company will be
eligible for a reduced tax rate of between 10% to 25% (based on the percentage of
foreign ownership in each tax year) for an additional eight years thereafter.The entitlement to these benefits is conditional upon the Company fulfilling the
requirements of the Law, regulations published thereunder and the instruments of
approval for the specific investments in Approved Enterprises. In the event of
failure to comply with these requirements, the benefits may be canceled and the
Company may be required to refund the amount of the benefits, in whole or in part,
including interest. As of December 31, 2004, management believes that the Company
is meeting all of the aforementioned requirements.The tax-exempt income attributable to the Approved Enterprises can not be
distributed to shareholders without subjecting the Company to taxes. As of
December 31, 2004, retained earnings included approximately $92,331 of tax-exempt
profits earned by the Companys Approved Enterprises. The Company has decided not
to declare dividends out of such tax-exempt income. Accordingly, no deferred
income taxes have been provided on income attributable to the Companys Approved
Enterprises.If the retained tax-exempt income is distributed, it will be taxed at the
corporate tax rate applicable to such profits as if the Company had not chosen the
alternative tax benefits (currently 10%), and an income tax liability would be
incurred of approximately $9,233 as of December 31, 2004.Income not eligible for Approved Enterprise benefits mentioned above is taxed at
the regular rate of 35%.e.
    
    On July 24, 2002, Amendment 132 to the Israeli Income Tax Ordinance (the
Amendment) was approved by the Israeli Parliament and came into effect on January 1,
2003. The principal objectives of the Amendment F-37




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##### Table of Contents



Notes to consolidated financial statements(continued)U.S. dollars in thousands (except share and per share data)
  were to broaden the categories of taxable income and to reduce the tax rates
imposed on employees income.The material consequences of the Amendment applicable to the Company include, among
other things, imposing a tax on all income of Israeli residents, individuals and
corporations, regardless of the territorial source of income, certain modifications
in the qualified taxation tracks of employee stock options and the introduction of
the controlled foreign corporation concept according to which an Israeli company
may become subject to Israeli taxes on certain income of a non-Israeli subsidiary,
if the subsidiarys primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). An Israeli company that is
subject to Israeli taxes on the income of its non-Israeli subsidiaries will receive
a credit for income taxes paid by the subsidiary in its country of residence. Since
the Company benefits from lower tax rates of an Approved Enterprise, such credits
are immaterial to its results of operations. F-38




---



##### Table of Contents



Notes to consolidated financial statements(continued) 
   f.
    
    Income before income taxes comprises the following: Year ended December 31,2004
    
    
    2003
    
    
    2002Domestic (Israel)
    
    $
    32,802
    
    
    $
    40,666
    
    
    $
    28,095Foreign (North America, the Cayman
Islands, Ireland and the U.K.)
    
    
    (39,735
    )
    
    
    32,290
    
    
    
    25,080$
    (6,933
    )
    
    $
    72,956
    
    
    $
    53,175
  g.
    
    The provision for income taxes comprises the following: Year ended December 31,2004
    
    
    2003
    
    
    2002Current taxes
    
    $
    1,831
    
    
    $
    2,252
    
    
    $
    4,152Deferred income taxes
    
    
    (18,822
    )
    
    
    9,223
    
    
    
    4,254$
    (16,991
    )
    
    $
    11,475
    
    
    $
    8,406Domestic
    
    $
    1,743
    
    
    $
    2,556
    
    
    $
    373Foreign
    
    
    (18,734
    )
    
    
    8,919
    
    
    
    8,033$
    (16,991
    )
    
    $
    11,475
    
    
    $
    8,406
 F-39




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##### Table of Contents



Notes to consolidated financial statements(continued) 
   h.
    
    Reconciliation of the theoretical tax expenses to the actual tax expenses:A reconciliation of the theoretical tax expense, assuming all income is taxed at
the statutory rate applicable to income of the Group and the actual tax expense is
as follows: Year ended December 31,2004
    
    
    2003
    
    
    2002Income before income taxes
    
    $
    (6,933
    )
    
    $
    72,956
    
    
    $
    53,175Statutory tax rate
    
    
    35
    %
    
    
    36
    %
    
    
    36
    %Theoretical tax expenses
    
    $
    (2,427
    )
    
    $
    26,264
    
    
    $
    19,143Deferred tax in respect of
losses for which valuation
allowance was provided
    
    
    586
    
    
    
    465
    
    
    
    193Approved Enterprise benefit
(1)
    
    
    (8,768
    )
    
    
    (11,704
    )
    
    
    (8,864
    )Effect of different tax rates
in other countries
    
    
    (3,242
    )
    
    
    (1,024
    )
    
    
    (993
    )Non-deductible expenses
    
    
    110
    
    
    
    150
    
    
    
    150Canadian tax benefits in
respect of research and
development expenses
    
    
    (2,900
    )
    
    
    (2,556
    )
    
    
    (1,078
    )Other
    
    
    (350
    )
    
    
    (120
    )
    
    
    (145
    )Income taxes in the
statements of income
    
    $
    (16,991
    )
    
    $
    11,475
    
    
    $
    8,406
 
 (1)
    
    Earnings per share
amounts of the tax benefit
resulting from the income
exemption: Basic
    
    $
    0.30
    
    
    $
    0.41
    
    
    $
    0.31Diluted
    
    $
    0.30
    
    
    $
    0.39
    
    
    $
    0.30
 F-40




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##### Table of Contents



Notes to consolidated financial statements(continued) 
   i.
    
    Current taxes are calculated at the following rates: 2004
    
    
    2003
    
    
    2002On Israeli operations (not including Approved
Enterprise)
    
    
    35
    %
    
    
    36
    %
    
    
    36
    %On U.S. operations *)
    
    
    38.7
    %
    
    
    38.7
    %
    
    
    40.6
    %On Canadian operations *)
    
    
    33.8
    %
    
    
    33.8
    %
    
    
    33.8
    %On U.K. operations *)
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %On Ireland operations *)
    
    
    10
    %
    
    
    10
    %
    
    
    10
    %
 
 *)
    
    The U.S., U.K. and Canadian subsidiaries are taxed on the
basis of the tax laws prevailing in their countries of residence. The
Canadian subsidiary qualifies for research and development tax credits,
thereby reducing its effective tax rate.  j.
    
    Deferred income taxes:Deferred income taxes reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes and of carryforward losses. December 31,2004
    
    
    2003Deferred tax assets:Net operating losses carryforward
    
    $
    35,653
    
    
    $
    14,714Inventory
    
    
    1,742
    
    
    
    1,836Research and development expenses
    
    
    1,203
    
    
    
    72Pre-paid tax on inter-company interest expenses
    
    
    2,843
    
    
    
    644Allowance for sale returns
    
    
    1,333
    
    
    
    811Other, net
    
    
    2,068
    
    
    
    2,784Total deferred tax assets
    
    
    44,842
    
    
    
    20,861Valuation allowance for deferred tax assets
    
    
    (7,010
    )
    
    
    (5,124
    )Net deferred tax assets
    
    
    37,832
    
    
    
    15,737Deferred tax liabilities:Property, plant, and equipment
    
    
    (5,882
    )
    
    
    (3,196
    )Other, net
    
    
    (2,632
    )
    
    
    (1,684
    )Total deferred tax liabilities
    
    
    (8,514
    )
    
    
    (4,880
    )Net deferred tax assets
    
    $
    29,318
    
    
    $
    10,857Domestic
    
    $
    2,894
    
    
    $
    1,794Foreign
    
    
    26,424
    
    
    
    9,063$
    29,318
    
    
    $
    10,857
 F-41




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##### Table of Contents



Notes to consolidated financial statements(continued) 
  The deferred income taxes are presented in the balance sheet as follows: December 31,2004
    
    
    2003Among current assets (other accounts receivable
and prepaid expenses)
    
    $
    4,647
    
    
    $
    5,487Long-term deferred income tax assets
    
    
    31,387
    
    
    
    10,250Among long-term liabilities
    
    
    (6,716
    )
    
    
    (4,880
    )$
    29,318
    
    
    $
    10,857
  k.
    
    Carryforward tax losses:  1.
    
    The Company:As of December 31, 2004, the Company had no carryforward tax losses.2.
    
    Israeli subsidiaries:As of December 31, 2004, the Israeli subsidiaries have carryforward tax
losses in the amount of $978, linked to the Israeli CPI and which may be
carried forward and offset against taxable income for an indefinite period
in the future.3.
    
    Canadian subsidiary:As of December 31, 2004, this subsidiary has no carryforward tax losses.4.
    
    U.K. subsidiary:As of December 31, 2004, this subsidiary has carryforward tax losses in
the amount of $6,835, which may be carried forward and offset against
taxable income for an indefinite period in the future.5.
    
    Irish subsidiary: F-42




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##### Table of Contents



Notes to consolidated financial statements(continued) 
   As of December 31, 2004, this subsidiary has carryforward tax losses of
$6,755. In order for this subsidiary to obtain a full benefit from these
losses, it must commence commercial operations within three years after
incurring these losses.6.
    
    U.S. subsidiary:As of December 31, 2004, this subsidiary has carryforward tax losses in
the amount of $86,339, resulting from 2004 U.S. operating losses and the
exercise of stock options in 2001 by selling shareholders in a public
offering of the Companys shares. These losses can be carried forward
against taxable income for 20 years from the year in which the losses were
incurred, resulting in expiration dates of 2021 and 2024.  l.
    
    During 2002, 84.4% of the shares conferring rights to profits of the U.S.
subsidiary were transferred, in the form of dividend, to the Company from Taro
Pharmaceuticals North America Inc. pursuant to section 104 (c) of the Israeli Income
Tax Ordinance. According to a tax ruling received from the Israeli Income Tax
Commission, in the event that the U.S. subsidiary pays a dividend to its shareholders,
a portion equal to the ratio of $5,200 out of total retained earnings, at the
distribution date, will not be entitled to tax benefits under the tax treaty between
Israel and the United States.The Companys Board of Directors has determined that its U.S. subsidiary will not
pay any dividend as long as such payment will result in any tax expenses for the
Company. F-43




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##### Table of Contents



Notes to consolidated financial statements(continued) 
    NOTE 15:- SELECTED STATEMENTS OF INCOME DATA Year ended December 31,2004
    
    
    2003
    
    
    2002a.
    
    Sales by location of customers (1) (2) (3):Israel
    
    $
    14,587
    
    
    $
    13,468
    
    
    $
    11,809Canada
    
    
    18,353
    
    
    
    15,603
    
    
    
    12,819U.S.A.
    
    
    247,765
    
    
    
    283,197
    
    
    
    183,857Other
    
    
    3,425
    
    
    
    3,190
    
    
    
    3,096$
    284,130
    
    
    $
    315,458
    
    
    $
    211,581(1) Including commercial activities
    
    $
    4,654
    
    
    $
    3,983
    
    
    $
    1,529(2) Including sales to customer A
    
    $
    45,460
    
    
    $
    62,693
    
    
    $
    46,548Including sales to customer B
    
    $
    43,188
    
    
    $
    52,997
    
    
    $
    25,389(3) Sales to customer A as a percentage of total sales
    
    
    16
    %
    
    
    20
    %
    
    
    22
    %Sales to customer B as a percentage of total sales
    
    
    15
    %
    
    
    17
    %
    
    
    12
    %b.
    
    Research and development expenses, net:Total expenses
    
    $
    43,343
    
    
    $
    42,479
    
    
    $
    27,500Less - grants and participations
    
    
    1,400
    
    
    
    1,878
    
    
    
    1,127$
    41,943
    
    
    $
    40,601
    
    
    $
    26,373c.
    
    Selling, marketing, general and administrative expenses:Selling and marketing
    
    $
    37,918
    
    
    $
    30,149
    
    
    $
    15,947Advertising
    
    
    30,955
    
    
    
    22,309
    
    
    
    4,075General and administrative *)
    
    
    54,426
    
    
    
    45,260
    
    
    
    32,459$
    123,299
    
    
    $
    97,718
    
    
    $
    52,481*) Including allowance for doubtful accounts
    
    $
    83
    
    
    $
    52
    
    
    $
    d.
    
    Financial expenses, net *):Interest and exchange differences on long-term liabilities
    
    $
    6,622
    
    
    $
    2,720
    
    
    $
    2,944Income in respect of deposits
    
    
    (1,770
    )
    
    
    (1,469
    )
    
    
    (2,351
    )Expenses in respect of short-term credit
    
    
    1,883
    
    
    
    1,245
    
    
    
    506Foreign currency translation losses (gains)
    
    
    (318
    )
    
    
    (774
    )
    
    
    (937
    )$
    6,417
    
    
    $
    1,722
    
    
    $
    162*) Net of interest capitalized in cost of property, plant
and equipment
    
    $
    2,569
    
    
    $
    1,180
    
    
    $
    479
 F-44




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##### Table of Contents



Notes to consolidated financial statements(continued) 
  NOTE 16:- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Unrealizedloss onavailable-for-
    
    
    
    UnrealizedForeign currency
    
    
    
    sale
    
    
    
    gain fromtranslation
    
    
    
    marketable
    
    
    
    hedgingadjustments
    
    
    
    securities
    
    
    
    derivatives
    
    
    
    TotalBalance at January 1, 2003
    
    
    
    (2,404
    )
    
    
    
    46
    
    
    
    
    
    
    
    
    
    (2,358
    )Foreign currency translation adjustments
    
    
    
    9,501
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,501Unrealized loss from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,448
    )
    
    
    
    (1,448
    )Balance at December 31, 2003
    
    
    
    7,097
    
    
    
    
    46
    
    
    
    
    (1,448
    )
    
    
    
    5,695Foreign currency translation adjustments
    
    
    
    6,076
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,076Unrealized gain from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,681
    
    
    
    
    1,681Unrealized gain from available for sale
marketable securities
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    
    25Balance at December 31, 2004
    
    
    
    13,173
    
    
    
    
    71
    
    
    
    
    233
    
    
    
    
    13,477
 NOTE 17:- SEGMENT INFORMATION Geographic Area Information The Group operates in one industry segment. The following geographic data is presented in
accordance with Statement of Financial Accounting Standard No. 131, Disclosure About Segments of
an Enterprise and Related Information. SFAS 131, paragraph 38, Information about Geographic
Areas is as follows: Israel
    
    

Canada*)
    
    

U.S.A.
    
    

Other
    
    

ConsolidatedYear ended December 31, 2004
and as of December 31, 2004:Sales to
unaffiliated customers **)
    
    $
    14,587
    
    
    $
    18,353
    
    
    $
    247,765
    
    
    $
    3,425
    
    
    $
    284,130Long-lived assets
    
    $
    131,993
    
    
    $
    51,642
    
    
    $
    39,070
    
    
    $
    26,483
    
    
    $
    249,188Year ended December 31, 2003
and as of December 31, 2003:Sales to
unaffiliated customers**)
    
    $
    13,468
    
    
    $
    15,603
    
    
    $
    283,197
    
    
    $
    3,190
    
    
    $
    315,458Long-lived assets
    
    $
    108,684
    
    
    $
    46,148
    
    
    $
    20,009
    
    
    $
    14,664
    
    
    $
    189,505Year ended December 31, 2002
and as of December 31, 2002:Sales to
unaffiliated customers**)
    
    $
    11,809
    
    
    $
    12,819
    
    
    $
    183,857
    
    
    $
    3,096
    
    
    $
    211,581Long-lived assets
    
    $
    67,344
    
    
    $
    22,515
    
    
    $
    10,040
    
    
    $
    609
    
    
    $
    100,508
 
 *)
    
    Includes operations in both Canada and Cayman Islands.**)
    
    Based on customers location. F-45




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##### Table of Contents



Notes to consolidated financial statements(continued) 
  The Groups primary product lines in Israel are prescription and over-the-counter
pharmaceutical products in multiple strengths, including capsules, creams and ointments, liquids, sterile products and tablets. Its primary product lines in Canada and the United
States are prescription dermatological cream, ointment, lotion and gel products; oral dosage form
prescription products; and over-the-counter products. Management believes that it was
impracticable to provide revenue by products or therapeutic category for the years ended December
31, 2004, 2003 and 2002. NOTE 18:- TRANSACTIONS WITH RELATED PARTIES Transactions with related parties: Year ended December 31,2004
    
    
    2003
    
    
    2002Compensation to related parties *):Wages and salaries
    
    $
    1,050
    
    
    $
    2,131
    
    
    $
    1,669Management fees
    
    
    1,063
    
    
    
    1,382
    
    
    
    1,060Directors fees
    
    
    97
    
    
    
    103
    
    
    
    74$
    2,210
    
    
    $
    3,616
    
    
    $
    2,803*) Compensation was paid to related parties, as
follows:Related parties employed by the Group
    
    $
    1,062
    
    
    $
    2,150
    
    
    $
    1,689Related parties not employed as
above - directors (including
companies held by these directors)
    
    $
    1,148
    
    
    $
    1,466
    
    
    $
    1,114Number of individuals to whom the
compensation relates (includes all
directors)
    
    
    10
    
    
    
    11
    
    
    
    11
 NOTE 19:- DERIVATIVE FINANCIAL INSTRUMENTS The Companys overall risk management strategy includes entering into hedge transactions and
derivative instruments. The objectives for this strategy are: (1) to minimize the impact of
foreign currency fluctuations, mainly NIS, and interest rates fluctuations on the Companys
financial performance; and (2) to protect the Companys cash flows from adverse movement in foreign
exchange and interest rates. The Company does not obtain financial instruments for speculative
trading purposes. Moreover, management believes that the financial institution associated with
these investments is financially sound and, accordingly, minimal credit risk exists with respect to
these derivative instruments. F-46




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##### Table of Contents



Notes to consolidated financial statements(continued) 
  The Companys derivative instruments are recorded at fair value and are included as part of assets
and liabilities as of December 31, 2004 as follows: As recorded
    
    
    Fair valueOther receivable and prepaid expenses
    
    $
    1,050
    
    
    $
    1,050Long-term investment
    
    $
    3,536
    
    
    $
    3,536
 Foreign currency and interest rate risk: a. Fair value hedge: During 1999-2000 the Company entered into debenture agreements to borrow in Israel, NIS 89.4
million, for a ten-year term and at an annual interest rate of 8.25%, payable semi-annually. During the same period, the Company entered into a ten-year cross-currency interest rate swap in
which it receives a semi-annual fixed payment in NIS at an annual rate of 8.25% on the notional
amount of NIS 89.4 million linked to Israeli Consumer Price Index (CPI), and makes a payment of
LIBOR plus 2.8% on $21,600. There will be a final exchange of principal at the maturity dates
specified in the contract based on the comparison of NIS 89.4 million, linked to the CPI, to the
$21,600. The Company designated the cross-currency interest rate swap as a fair value hedge of the
changes in the fair value of the loan due to both interest rate and foreign exchange risk. At inception, the hedge relationship is expected to be highly effective because the notional amount
of the cross-currency interest rate swap coincides with that of the debenture agreement, and all
cash flows and reset dates coincide between the debt and the swap. Accordingly, no portion of the
change in fair value of the cross-currency interest rate swap is considered to be ineffective.
Hedge ineffectiveness, if any, is included in current period earnings, and was insignificant in all
reported periods. In accordance with fair value
hedge accounting under SFAS 133, the change in the fair value of the
debentures attributable to changes in the NIS interest rates is calculated and then this adjusted
value is remeasured at spot rates through earnings (in accordance
with SFAS 52). The change in the
fair value of the cross-currency interest rate swap is also recorded in earnings. The fair value of the afformentioned hedge amounted to $1,800 as of December 31, 2004. b. Cash flow hedge: In 2003, the Company entered into loan agreements to borrow, in Israel, NIS 210 million for an
eleven-year term at an annual interest rate of 5.8%, payable semi-annually. At the same time the Company entered into a five-year currency swap in which it will receive an NIS
amount equal to 5.8% of the outstanding NIS balance, linked to the CPI, F-47




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##### Table of Contents



Notes to consolidated financial statements(continued) 
  and pay USD at a fixed rate of 5.9% on USD $47,000. There will be a final exchange of principal on
maturity of the contract based on a comparison of NIS 210 million, linked to the CPI, to $47,000.
Interest payments on the debt and the swap are payable semi-annually. The Company designated the
cross-currency swap as a cash flow hedge of the exposure to changes in
functional-currency-equivalent cash flows on the debt. The cash flow hedge is expected to be highly effective because the notional amount of the
cross-currency swap coincides with that of the debenture agreement, and the five-year interest
rates and cash flow dates coincide between the debt and the swap. The Company assessed whether the
derivative continued to be highly effective in offsetting changes in cash flows from the hedged
item. No portion of the change in cash flows of the cross-currency swap is considered to be
ineffective. Hedge ineffectiveness, if any, is included in current period earnings, and was
insignificant in all reported periods. Changes in the fair value of a derivative that is designated
as a cash flow hedge and is highly effective are recorded in accumulated other comprehensive income
until the underlying transaction affects earnings and are then reclassified to earnings in the same
account as the hedged transaction. In 2004, the Company recorded in accumulated other comprehensive
income an unrealized gain in the amount of $1,600. The fair value of the cash flow hedge amounted to $2,800 as of December 31, 2004. NOTE 20:- SUBSEQUENT EVENTS (UNAUDITED)  1.
    
    In February 2005, the Company completed the
acquisition of 3 Skyline Drive, the 124,000 square foot building in which
the Company had initially acquired a 32% interest in 2002.2.
    
    In March 2005, the Company divested the ElixSure® and
Kerasal® brands in North America. However, the Company will continue to
manufacture and supply these products from its Canadian plant.3.
    
    In March 2005, the Company divested the Kerasal® and
Primsol® trademarks. End of consolidated financial statements F-48




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. SCHEDULE II: - VALUATION AND QUALIFYING ACCOUNTS Allowance for Inventory Obsolescence Additions Balance at
    
    
    
    Charged to
    
    
    
    Deductions beginning of
    
    
    
    costs and
    
    
    
    Write-offs of
    
    
    
    Balance at end ofYear
    
    
    period
    
    
    
    expenses
    
    
    
    Inventory
    
    
    
    period2004
    
    
    $
    3,591
    
    
    
    $
    8,132
    
    
    
    $
    6,221
    
    
    
    $
    5,5022003
    
    
    
    1,461
    
    
    
    
    5,574
    
    
    
    
    3,444
    
    
    
    
    3,5912002
    
    
    
    966
    
    
    
    
    2,930
    
    
    
    
    2,435
    
    
    
    
    1,461
 Allowance for Doubtful Accounts Additions Balance at
    
    
    
    Charged tobeginning of
    
    
    
    costs and
    
    
    
    Deductions 
    
    
    
    Balance at end ofYear
    
    
    period
    
    
    
    expenses
    
    
    
    Bad-Debt
    
    
    
    period2004
    
    
    $
    141
    
    
    
    $
    83
    
    
    
    $
    34
    
    
    
    $
    1902003
    
    
    
    112
    
    
    
    
    52
    
    
    
    
    23
    
    
    
    
    1412002
    
    
    
    108
    
    
    
    
    8
    
    
    
    
    4
    
    
    
    

    112
 S-1




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description1.1
    
    Memorandum of Association of Taro Pharmaceutical Industries Ltd. (1)1.2
    
    Articles of Association of Taro Pharmaceutical Industries Ltd., as amended2.1
    
    Form of ordinary share certificate (1)4.1
    
    Taro Vit Industries Limited 1991 Stock Incentive Plan (2)4.2
    
    Taro Pharmaceutical Industries Ltd. 2000 Employee Stock Purchase Plan (3)4.3
    
    Taro Pharmaceutical Industries 1999 Stock Incentive Plan (4)8
    
    List of Subsidiaries (See Organizational Structure in Item 4.C of this Form 20-F)12.1
    
    Certification of the Senior Vice President & General Manager pursuant to Section 302 of the
Sarbanes-Oxley Act of 200212.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 200213
    
    Certification of the Senior Vice President & General Manager and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200215(a).1
    
    Consent of Kost, Forer, Gabbay & Kasierer15(a).2
    
    Debenture and Loan Agreement dated December 19, 2000 (5)15(a).3
    
    Loan agreements Dated May 20, 2003 and November 27, 2003 (6)
 
  (1)

Previously filed as an exhibit to our Registration Statement on Form F-1 (No. 333-63464), as amended, and incorporated herein by reference.(2)

Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 33-80802) and incorporated herein by reference.(3)

Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 333-12388) and incorporated herein by reference.(4)

Previously filed as an exhibit to our Registration Statement on Form S-8 (No. 333-13840) and incorporated herein by reference.(5)

Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2000 and incorporated herein by reference.(6)

Previously filed as an exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2003 and incorporated herein by reference.