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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 20-F o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
 OR x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003
 OR o
    
    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)
 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
    
    Name of each exchange on which registeredNone
    
    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: 28,969,218 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. x Yes o No Indicate by check mark which financial statement item the registrant has
elected to follow. o Item 17 x 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. 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. Our
ordinary shares are currently traded on the Nasdaq National Market under the
symbol TARO. In July 2001, we completed a split of our ordinary shares by distributing
a dividend of 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 dividend. 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 3  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
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 March 31, 2004 was NIS 4.53 per $1.00.
The published representative exchange rate between the Canadian dollar and the
dollar for March 31, 2004 was $1.31 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.




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TABLE OF CONTENTS PagePART I
    
    1ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
    
    1ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
    
    1ITEM 3. KEY INFORMATION
    
    1A. SELECTED FINANCIAL DATA
    
    1B. CAPITALIZATION AND INDEBTEDNESS
    
    3C. REASONS FOR THE OFFER AND USE OF PROCEEDS
    
    3D. RISK FACTORS
    
    3ITEM 4. INFORMATION ON THE COMPANY
    
    20A. HISTORY AND DEVELOPMENT OF THE COMPANY
    
    20B. BUSINESS OVERVIEW
    
    22C. ORGANIZATIONAL STRUCTURE
    
    35D. PROPERTY, PLANTS AND EQUIPMENT
    
    36ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    39A. OPERATING RESULTS
    
    39B. LIQUIDITY AND CAPITAL RESOURCES
    
    46C. RESEARCH AND DEVELOPMENT, PATENTS, TRADE MARKS AND LICENSES
    
    49D. TREND INFORMATION
    
    52ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    52A. DIRECTORS AND SENIOR MANAGEMENT
    
    52B. COMPENSATION
    
    58C. BOARD PRACTICES
    
    58D. EMPLOYEES
    
    62E. SHARE OWNERSHIP
    
    63ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    69A. MAJOR SHAREHOLDERS
    
    69
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TABLE OF CONTENTS
(Continued) PageB. RELATED PARTY TRANSACTIONS
    
    71C. INTERESTS OF EXPERTS AND COUNSEL
    
    71ITEM 8. FINANCIAL INFORMATION
    
    71A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
    
    71B. SIGNIFICANT CHANGES
    
    73ITEM 9. THE OFFER AND LISTING
    
    73A. OFFER AND LISTING DETAILS
    
    73B. PLAN OF DISTRIBUTION
    
    73C. 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
    
    80F. DIVIDENDS AND PAYING AGENTS
    
    91G. STATEMENT BY EXPERTS
    
    91H. DOCUMENTS ON DISPLAY
    
    91I.   SUBSIDIARY INFORMATION
    
    92ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    92ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    93PART II
    
    93ITEM 13. DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES
    
    93
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TABLE OF CONTENTS
(Continued) PageITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
    
    93ITEM 15. CONTROLS AND PROCEDURES
    
    93ITEM 16. [RESERVED]
    
    93A. AUDIT COMMITTEE FINANCIAL EXPERT
    
    93B. CODE OF ETHICS
    
    93C. PRINCIPAL ACCOUNTANT FEES & SERVICES
    
    94PART III
    
    95ITEM 17. FINANCIAL STATEMENTS
    
    95ITEM 18. FINANCIAL STATEMENTS
    
    95ITEM 19. EXHIBITS
    
    95CONSENT OF KOST, FORER, GABBAY & KASIERERLOAN AGREEMENTSCERTIFICATIONCERTIFICATION
  iii




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##### Table of Contents



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, 2003 and 2002 and for each of the years ended December 31, 2003,
2002 and 2001 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, 2001,
2000 and 1999 and for each of the years ended December 31, 2000 and 1999 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. 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. 1




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Year Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(In thousands of U.S. dollars except perordinary share data)Statement of Income Data:Sales
    
    $
    315,458
    
    
    $
    211,581
    
    
    $
    149,230
    
    
    $
    103,797
    
    
    $
    83,785Cost of sales
    
    
    102,454
    
    
    
    79,468
    
    
    
    54,736
    
    
    
    41,206
    
    
    
    35,314Gross profit
    
    
    213,004
    
    
    
    132,113
    
    
    
    94,494
    
    
    
    62,591
    
    
    
    48,471Operating expenses:Research and development,
net
    
    
    40,601
    
    
    
    26,373
    
    
    
    19,633
    
    
    
    14,593
    
    
    
    11,728Selling, general and
Administrative
    
    
    97,718
    
    
    
    52,481
    
    
    
    42,086
    
    
    
    31,902
    
    
    
    25,933Total operating expenses
    
    
    138,319
    
    
    
    78,854
    
    
    
    61,719
    
    
    
    46,495
    
    
    
    37,661Operating income
    
    
    74,685
    
    
    
    53,259
    
    
    
    32,775
    
    
    
    16,096
    
    
    
    10,810Financial expenses, net
    
    
    1,722
    
    
    
    162
    
    
    
    2,594
    
    
    
    3,855
    
    
    
    3,869Other income (loss), net
    
    
    (7
    )
    
    
    78
    
    
    
    272
    
    
    
    344
    
    
    
    94Income before taxes on income
    
    
    72,956
    
    
    
    53,175
    
    
    
    30,453
    
    
    
    12,585
    
    
    
    7,035Taxes on income
    
    
    11,475
    
    
    
    8,406
    
    
    
    4,378
    
    
    
    2,538
    
    
    
    1,47161,481
    
    
    
    44,769
    
    
    
    26,075
    
    
    
    10,047
    
    
    
    5,564Minority interest in earnings of
a subsidiary
    
    
    (326
    )
    
    
    (214
    )
    
    
    (81
    )
    
    
    (20
    )
    
    
    (25
    )Net income
    
    $
    61,155
    
    
    $
    44,555
    
    
    $
    25,994
    
    
    $
    10,027
    
    
    $
    5,539Earnings per ordinary share:Basic
    
    $
    2.12
    
    
    $
    1.55
    
    
    $
    1.11
    
    
    $
    0.47
    
    
    $
    0.27Diluted
    
    $
    2.06
    
    
    $
    1.52
    
    
    $
    0.99
    
    
    $
    0.42
    
    
    $
    0.25Number of ordinary shares used in
computing earnings per ordinary
share:Basic
    
    
    28,873
    
    
    
    28,665
    
    
    
    23,370
    
    
    
    21,420
    
    
    
    20,151Diluted
    
    
    29,674
    
    
    
    29,408
    
    
    
    26,302
    
    
    
    23,864
    
    
    
    21,525
 As of December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(In thousands of U.S. dollars)Consolidated Balance Sheet Data:Working capital
    
    $
    279,955
    
    
    $
    198,871
    
    
    $
    196,711
    
    
    $
    43,588
    
    
    $
    25,964Property, plant and equipment, net
    
    
    182,306
    
    
    
    93,358
    
    
    
    54,024
    
    
    
    41,827
    
    
    
    34,624Total assets
    
    
    616,523
    
    
    
    379,845
    
    
    
    307,762
    
    
    
    120,446
    
    
    
    90,957Short-term debt, including current
maturities
    
    
    43,544
    
    
    
    10,272
    
    
    
    8,231
    
    
    
    8,491
    
    
    
    11,396Long-term debt
    
    
    156,937
    
    
    
    47,127
    
    
    
    49,285
    
    
    
    38,250
    
    
    
    23,328Minority interest
    
    
    1,711
    
    
    
    1,159
    
    
    
    776
    
    
    
    168
    
    
    
    148Shareholders equity
    
    
    347,400
    
    
    
    269,137
    
    
    
    218,364
    
    
    
    50,214
    
    
    
    40,552
 2




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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 could 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 could 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. None of these products benefits 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, 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 3




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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. Brand-name companies frequently take actions to prevent or discourage the use
of generic drug products such as ours. Brand-name companies frequently take actions to prevent or discourage the
use of generic equivalents to their products, including generic products that
we manufacture or market. Because most of the products that we sell are generic
versions of brand-name drugs, we are particularly subject to the risk that the
manufacturers and sellers of the brand-name equivalents of our products may
take the following actions, among others:  
    
    filing new patents on products whose original patent
protection is about to expire;
    
    developing patented controlled-release products or other
product improvements;
    
    developing and marketing branded products as over-the-counter
products;
    
    increasing marketing initiatives, regulatory activities and
litigation relating to our products or proposed products; 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 name at discounted prices are known as authorized generics.
This facilitates the sale by brand-name manufacturers of generic equivalents of
their 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 may obtain the first ANDA approval for a particular product, be
the first-to-market and/or the only generic alternative offered to the market
and thus 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 intensify as technological advances are made. New
developments by others may render our products or technologies non-competitive
or obsolete. For example, AstraZeneca Pharmaceuticals have filed New Drug
Applications 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 4




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Coumadin® in Israel and warfarin in the United States and Canada. A reduction
in the sales and profitability of warfarin may have an adverse effect on the
results of our operations and financial condition. 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 and
other retailers) as well as patients. In addition, unanticipated side effects
or unfavorable publicity concerning any of our products 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 manufacturers introduce authorized generics, that market share and
the price of that product will decline. For example, in May 2001, we began to
market the first generic equivalent of Schering-Ploughs Lotrisone® cream to be
sold to the public in the United States. Competitors have introduced their own
generic equivalents of Lotrisone® cream and additional competitors can be
expected to enter the market. The introduction of additional generic
equivalents or price reductions of existing generic products may have an
adverse effect on revenues from our products, including our generic equivalent
of Lotrisone® cream. 5




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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 United States Food and Drug Administration, or
FDA, is generally required before any new drug or the generic equivalent to any
previously approved drug may be marketed in the United States. The process for
obtaining FDA and other approvals is lengthy, costly and subject to the risk,
among others, that approval will not be obtained. In addition, the labeling
claims and marketing statements that we can make are limited by regulations
and, in most cases, by the labeling claims made in brand-name packaging. 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 Israel and Canada, as well as the regulations promulgated thereunder in each
country. These regulations include stringent requirements for manufacturing
controls, importation, receipt and handling procedures and security to prevent
diversion of, or unauthorized access to, the controlled substances in each
stage of the production and distribution process. 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 U.S. Drug Enforcement Administration, 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. 6




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Our ability to market our products depends, in part, on reimbursement
levels for them and related treatment established by healthcare providers
(including government authorities), private health insurers and other
organizations, including health maintenance organizations and managed care
organizations. Reimbursement may not be available for some of our products and,
even if granted, may not be maintained. Limits placed on reimbursement could
make it more difficult for people to buy our products and reduce, or possibly
eliminate, the demand for our products. In the event that governmental
authorities enact additional legislation or adopt regulations which affect
third party coverage and reimbursement, demand for our products may be reduced
with a consequent adverse effect, which may be material, on our sales and
profitability. In addition, the purchase of our products could be significantly
influenced by the following factors, among others:  
    
    trends in managed healthcare in the United States;
    
    developments in health maintenance organizations, managed
care organizations and similar enterprises;
    
    legislative proposals to reform healthcare and government
insurance programs; and
    
    price controls and reimbursement policies relating to new and
expensive medicines. These factors could result in lower prices and 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
refinement 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. 7




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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 of the products being tested to receive
regulatory approval is, to some extent, dependent upon the quality of the work
performed by these third parties, the quality of the third parties facilities
and the accuracy of the information provided by third parties. We have little
or no control over any of these factors. Risks Relating to Our Company We derive most of our revenues and profits from a small group of product lines. In 2003, 2002 and 2001, seven product lines accounted for 54%, 53% and 57%
of our consolidated sales, respectively. In 2003, 2002 and 2001, one product
line accounted for approximately 11%, 16% and 19% of our consolidated sales,
respectively. 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. In 2003, three U.S. major wholesale customers accounted for approximately 46%
of our consolidated sales. Any substantial decline in our sales to these
customers, for any reason, would have an adverse effect on our revenues and
profitability. In 2003, AmerisourceBergen Corporation, McKesson Corporation and Cardinal
Health, Inc., collectively accounted for approximately 46% of our consolidated
sales. We have no long-term agreement with these wholesalers and thus they may
reduce or cease 8




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their purchases from us at any time in the future. Furthermore, any change
in their buying pattern or changes in their policies and practices in relation
to their working capital and inventory management may result in a reduction of
purchases of our products. Any cessation or reduction of purchases from us
would likely have a material adverse effect on 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 sell to third parties at times and in quantities needed by the
third parties. Typically, we have a contract price with a third party that may
be different from the price at which we sold to the wholesaler. At the time the
third party purchases from the wholesaler, the wholesaler charges us back for
any price differential. At the time of any individual sale to a wholesaler, we
do not know under which contracts the wholesaler will sell goods to third
parties. Therefore, at the time of each sale, we make a reasonable estimate of
chargebacks and other credits associated with the sale and we reduce our
revenue accounts accordingly. From time to time, the transactions reported by
a wholesaler are different from our estimates. Actual transactions that differ
materially from our estimates may result in a reduction in the value of our
accounts receivable. The ultimate reconciliation of our accounts with those of
the wholesalers may delay the collection of our accounts receivable. Our inventories are dated and may become obsolete. 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. The growth of our sales in
the past few years has resulted in higher levels of inventory in anticipation
of additional business for new products and from new customers, the exact
timing of which cannot be accurately determined. However, anticipated growth
in sales of any individual product or of all products may not materialize. In
this circumstance, inventories prepared for these anticipated sales may become
obsolete 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. 9




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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 our results of 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 presently 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 of these new products cannot be successfully and
profitably produced and marketed; or
    
    brand name companies can 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 for some raw materials we do have
long-term supply agreements, 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 commercially successful. Our principal business in North America has traditionally been the
development, manufacture and marketing of generic equivalents of pharmaceutical
products first 10




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introduced by other companies. However, we have recently increased our
efforts to develop new proprietary products, including T-2000 and T2001 (our
patented non-sedating barbiturate compounds) and the Elixsure® line of products
utilizing NonSpil (our patented spill-resistant liquid drug delivery system.) Expanding our focus beyond generic products and broadening our pipeline to
include proprietary product candidates 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 product candidates 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 proprietary product candidates. 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
proprietary product candidates, we are required to complete extensive clinical
trials in humans to demonstrate the safety and efficacy of the products. 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 product candidate to demonstrate safety and efficacy;
    
    the development of serious (including life threatening)
adverse events (including, for example, side effects caused by or
connected with exposure to the product candidate); or
    
    the failure of clinical investigators, trial monitors and
other consultants or trial subjects to comply with the trial plan or
protocol. 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 11




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the launch of a proprietary product may adversely affect the results of
our operations and financial condition. We may not be able to successfully identify, consummate and integrate
recent and/or future acquisitions. We plan to pursue additional acquisitions of product lines and/or
companies and seek to integrate them into our operations. The recent and
future 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 to 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 successfully our acquisitions in
accordance with our business strategy;
    
    we may choose to acquire a business that is not profitable at
the time of acquisition;
    
    potential 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 the
businesses we may 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. 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 12




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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. 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 expense, 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 13




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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 Waxman-Hatch Act of 1984. To the extent
that we engage in patent challenge procedures, we are involved and expect to be
involved in patent litigation regarding the validity or infringement of the
originators patent. Patent challenges are complex, costly and can take a
significant 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. 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 their loss of income. If we are found to infringe a patent
held by a third party and become subject to such treble 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, and could 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;
    
    changes in financial estimates by securities analysts;
    
    general economic and political conditions;
    
    departures of key personnel;
    
    changes in the market valuations of our competitors;
    
    regulatory considerations; and 14




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
    
    the other risk factors listed in this section. Four of our directors, and members of their immediate families, currently
control 49.5% of the voting power in our company. Dr. Barrie Levitt, Aaron 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
49.5% of the voting power in our company. Dr. Levitt and Mr. Levitt are
brothers. Dr. Moros is their cousin 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 appointment of management, the
entering into of mergers, sales of substantially all of our assets and other
extraordinary transactions. The companys board of directors has the
authority, subject to the terms and limitations of our debt agreements, to
issue additional shares, implement share repurchase programs, declare interim
dividends and make other decisions about our shares. For information
concerning a prospective change in the shareholdings of the persons
referred to in this paragraph, please see Note (3) to the table
set forth under the heading E. SHARE OWNERSHIP in
ITEM 6 below. 50% of the voting power in our subsidiary Taro Pharmaceuticals U.S.A., Inc., or
Taro U.S.A., is held by a corporation which is jointly controlled by the
Chairman of our Board of Directors and by our President. The share capital of Taro U.S.A. is divided into two classes. We own 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 and Mr. Levitt are able to vote an aggregate of
54.7% 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% of our consolidated sales in 2003. For information
concerning a prospective change in the ownership of TDC, please see Note (3) to the table
set forth under the heading E. SHARE OWNERSHIP in
ITEM 6 below. 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 15




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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). 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 and
receivables 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 the terrorist attacks
that occurred in the United States on 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 16




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neighbors and a state of hostility, varying in degree and intensity, has
led to security and economic problems for Israel. Since October 2000, there
has been a marked increase in hostilities between Israel and the Palestinians,
which has continued with varying levels of severity and which has adversely
affected the peace process and negatively influenced Israels relationship with
several Arab countries and international organizations. Furthermore, certain
parties with whom we do business have declined to travel to Israel during this
period, 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 of the State Departments advisory, the FDA has at various times
curtailed or prohibited its inspectors from traveling to Israel to inspect the
facilities of Israeli companies, which, should it occur with respect to our
company, could result in the FDA withholding approval for new products we
intend to produce at those facilities. 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 incurred 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, all male adult citizens and permanent residents of Israel under
the age of 50 generally are obligated to perform up to 45 days of military
reserve duty annually. Additionally, these residents are subject to being
called to active duty at any time under emergency circumstances. Certain of
our employees are currently obligated to perform annual reserve duty.
Recently, there has been a significant call-up of military reservists, and it
is possible that there will be additional call-ups in the future. While we
believe that we have operated relatively efficiently given these requirements,
both since we began operations and during the period of the increase in
hostilities with the Palestinians since October 2000, 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 17




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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. 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 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 or 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 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. 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 a merger or acquisition of
us difficult, which could prevent a change of control and depress the market
price of our ordinary shares. Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making a merger or acquisition of us more difficult.
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 18




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has been called on at least 21 days advance notice. 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. 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 a merger or acquisition of us more difficult. This could prevent a
change of control of us and depress the market price of our ordinary shares
which otherwise might rise as a result of such a change of control. It may be difficult to effect service of process and enforce judgments against
directors, officers and experts named in this annual report. We are incorporated in Israel. A majority of our executive officers and
directors and some of the experts named in this annual report 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. 19




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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. 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. 
 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, we purchased substantially all of the assets of Thames
Pharmacal Company, Inc., or Thames, a manufacturer of prescription and OTC
pharmaceuticals, through a newly-created subsidiary of Taro U.S.A. The
purchase price was approximately $6.4 million, all of which was paid in cash.
The assets acquired included 20




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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. 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 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 paid in cash, 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 was 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 the existing
facilities. In January 2004, our U.S. subsidiary 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. The U.S. subsidiary acquired the facility
for approximately $18 million. In conjunction with the purchase, we expect that
the U.S. subsidiary will receive some financial incentives from the New Jersey
Economic Development Authority. Our registered office in Israel is located at 14 Hakitor Street, Haifa
Bay, Israel, 26100. Our principal executive offices are located at Italy
House, Euro Park, Yakum 60972, Israel, and our telephone number there is
972-9-971-1800. Capital Expenditures During the past three years, our capital expenditures amounted to
approximately $156.9 million. 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 current Good 21




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Manufacturing Practices, or 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; the construction of new research and development and plant operations
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 32% interest in a 123,713 square feet building adjacent to the
offices of Taro U.S.A. for the construction of research laboratory and
administrative offices; acquisition of a multi-purpose pharmaceutical manufacturing and research
facility in Ireland; acquisition of a distribution center facility in New Jersey; and acquisition of a distribution facility in Ontario, Canada. In addition, in anticipation of an increase in sales and the overall
growth of our operations, we have purchased, leased or contracted to purchase
additional properties and ordered new equipment for our 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 22




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##### Table of Contents



Taro Canada, and Taro U.S.A. The principal activities and primary product
lines of these subsidiaries may be summarized as follows: Entity
    
    Principal Activities
    
    Primary Product LinesTaro Israel
    
    
    
    Manufactures more than 60
finished dosage form pharmaceutical
products for sale in Israel and for
export
    
    
    
    Dermatology: Prescription and
OTC semi-solid products (creams,
ointments, 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
Oral Analgesics: Prescription
and OTC
    
    Markets both proprietary and
generic products in the local Israeli
market
    
    
    
    OTC Nasal Sprays and Nutritional
Supplements
    
    Performs research and development
independently and through Taro
Research Institute Ltd., a Taro
subsidiary
    
    
    
    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, gels and liquids)
    
    Markets both proprietary and
generic products in the local Canadian market
    
    
    
    Cardiology and Neurology:
Prescription oral dosage products
    
    Performs research and development
independently and through Taro
Research InstituteTaro U.S.A.
    
    
    
    Manufactures more than 10
finished dosage form pharmaceutical
products for sale in the United
States and for export
    
    
    
    Dermatology: Prescription and
OTC semi-solid products (creams,
ointments, gels and liquids)
    
    Markets both proprietary and generic products in the local U.S.
market
    
    
    
    Cardiology and Neurology:
Prescription oral dosage products
    
    Performs research and development
independently and through Taro
Research Institute
    
    
    
    OTC products
 In May 2001, we received approval from the FDA to market the first generic
equivalent of Schering-Ploughs Lotrisone® cream, which we began to sell at the
end of that month. According to industry sources, within a few weeks we had
become the 23




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leading supplier of the generic equivalent of Lotrisone® cream in the
United States, a position which we maintained throughout the remainder of 2001,
2002 and 2003. Our generic equivalent of Lotrisone® cream was our largest
selling product and comprised approximately 11%, 16% and 19% of our
consolidated sales in 2003, 2002 and 2001, respectively. As of April 29, 2004 31 of our ANDAs and one NDA are being reviewed by the
FDA. In addition, there are multiple 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 granting 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 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. 24




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##### Table of Contents



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. Products Currently, we
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: 25




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##### Table of Contents



U.S. Brand
    
    Therapeutic
    
    Major
    
    Rx/Product Groups
    
    Dosage Form
    
    Name
    
    Category
    
    Markets
    
    OTCAmiodarone HCI
    
    tablets
    
    Cordarone®
    
    Cardiovascular
    
    U.S.
    
    RxAmmonium Lactate
    
    cream
    
    Lac-Hydrin®
    
    Moisturizer
    
    U.S.
Canada
    
    Rx/
OTCBethamethasone
Dipropionate
(augmented)
    
    cream, gel
    
    Diprolene®
    
    Topical
Corticosteroid
    
    U.S.
    
    RxCarbamazepine
    
    tablets, controlled release
tablets, chewable tablets,
oral suspension
    
    Tegretol®
    
    Anticonvulsant
    
    U.S.
Canada
Israel
    
    RxClobetasol
Propionate
    
    cream, ointment, gel,
topical solution,
emollient cream
    
    Temovate®
    
    Topical
Corticosteroid
    
    U.S.
    
    RxClorazepate
Dipotassium
    
    tablets
    
    Tranxene®
    
    Antianxiety
    
    U.S.
    
    RxClotrimazole
    
    cream, topical solution,
vaginal cream
    
    Lotrimin®,
Gyne-Lotrimin®
    
    Antifungal
    
    U.S.
Canada
Israel
    
    Rx/
OTCClotrimazole and
Betametazone
Dipropionate
    
    cream
    
    Lotrisone®
    
    Antifungal
    
    U.S.
    
    RxDesonide
    
    cream, ointment
    
    Tridesilon®
    
    Topical
Corticosteroid
    
    U.S.
    
    RxDesoximetasone
    
    cream, ointment, gel
    
    Topicort®
    
    Topical
Corticosteroid
    
    U.S.
Canada
Israel
    
    RxDiflorasone
Diacetate
    
    cream, ointment
    
    Psorcon®
    
    Topical
Corticosteroid
    
    U.S.
    
    RxEconazole Nitrate
    
    C
    
    Spectazole®
    
    Antifungal
    
    U.S.
    
    RxreamEnalapril/Enalapril
Hydrochlorothiazide
    
    tablets
    
    Vasotec®/Vaseretic®
    
    Cardiovascular
    
    U.S.
    
    RxEtodolac
    
    tablets, capsules
    
    Lodine®
    
    Analgesic
    
    U.S.
Canada
Israel
    
    RxEtodolac XL
    
    extended release tablets,
capsules
    
    Lodine XL®
    
    Analgesic
    
    U.S.
Israel
    
    RxFluocinonide
    
    cream, ointment, gel,
topical solution,
emollient cream
    
    Lidex®
    
    Topical
Corticosteroid
    
    U.S.
Canada
Israel
    
    RxFluorouracil
    
    solution
    
    Efuex®
    
    Topical
    
    U.S.
    
    Rx
 26




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##### Table of Contents



U.S. Brand
    
    Therapeutic
    
    Major
    
    Rx/Product Groups
    
    Dosage Form
    
    Name
    
    Category
    
    Markets
    
    OTCHydrocortisone
Valerate
    
    cream, ointment
    
    Westcort®
    
    Topical
Corticosteroid
    
    U.S.
    
    RxHydrocortisone
    
    cream, ointment
    
    Cortizone®
    
    First Aid
    
    U.S.
Canada
Israel
    
    OTCKetoconazole
    
    tablets, cream
    
    Nizoral®
    
    Antifungal
    
    U.S.
    
    RxMalathion
    
    lotion
    
    Ovide®
    
    Pediculicide
    
    U.S.
    
    RxNystatin
    
    cream, ointment, oral
suspension, vaginal cream
    
    Mycostatin®
    
    Antifungal
    
    U.S.
Canada
Israel
    
    Rx/
OTCSalicyclic Acid and
Urea
    
    ointment
    
    Kersal®
    
    Exfoliating
Moisturizer
    
    U.S.
Canada
    
    OTCTriamcinolone
Acetonide
    
    cream, ointment, dental
paste, dental paste with
lidocane
    
    Kenalog®
    
    Topical
Corticosteroid
    
    U.S.
Canada
Israel
    
    RxWarfarin Sodium
    
    tablets
    
    Coumadin®
    
    Anticoagulant
    
    U.S.
Canada
Israel
    
    Rx
 27




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##### Table of Contents



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 customer service
and marketing employees. The following is a breakdown of our sales by geographic region, including
the percentage of our total consolidated sales for each period: 2003
    
    2002
    
    2001In
    
    % of our
    
    In
    
    % of our
    
    In
    
    % of ourthousands
    
    total sales
    
    thousands
    
    total sales
    
    thousands
    
    total salesU.S.A.
    
    $
    283,197
    
    
    
    90
    %
    
    $
    183,857
    
    
    
    87
    %
    
    $
    123,762
    
    
    
    83
    %Canada
    
    
    15,603
    
    
    
    5
    %
    
    
    12,819
    
    
    
    6
    %
    
    
    8,968
    
    
    
    6
    %Israel
    
    
    13,468
    
    
    
    4
    %
    
    
    11,809
    
    
    
    5
    %
    
    
    13,690
    
    
    
    9
    %Other
    
    
    3,190
    
    
    
    1
    %
    
    
    3,096
    
    
    
    2
    %
    
    
    2,810
    
    
    
    2
    %Total
    
    $
    315,458
    
    
    
    100
    %
    
    $
    211,581
    
    
    
    100
    %
    
    $
    149,230
    
    
    
    100
    %
 In 2003, sales in the United States accounted for approximately 90% of our
total consolidated sales. In addition to marketing prescription drugs, Taro
U.S.A. markets its OTC products primarily as store brands under its customers
labels to wholesalers, drug chains, food chains and mass merchandisers. During
2003, 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: 28




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##### Table of Contents



Customer
    
    2003
    
    2002
    
    2001AmerisourceBergen Corporation
    
    
    20
    %
    
    
    22
    %
    
    
    13
    %McKesson Corporation
    
    
    17
    %
    
    
    12
    %
    
    
    15
    %Cardinal Health, Inc.
    
    
    9
    %
    
    
    9
    %
    
    
    9
    %
 The following table sets forth the contributions to sales by each type of
customer of Taro U.S.A. in 2003: Percentage ofCustomer Type
    
    Consolidated SalesDrug wholesalers
    
    
    52
    %Drug store chains
    
    
    15
    %Mass merchandisers food and retail chains
    
    
    11
    %Generic drug distributors
    
    
    8
    %Managed care organizations
    
    
    4
    %
 In 2003, sales in Israel accounted for approximately 4% 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 organization in the United States, as well as
private pharmacies. Most of our marketing efforts in Israel focus on selling
directly to these groups. In 2003, 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. In Israel, the pharmaceutical market is divided into two market segments:
(i) the private market, which includes drug store chains, private pharmacies
and wholesalers; and 29




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##### Table of Contents



(ii) the institutional market, which includes Kupat Holim Klalit or Kupat
Holim (the largest health fund 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 2003: Percentage ofCustomer Type
    
    Consolidated SalesInstitutional market
    
    
    3
    %Private market
    
    
    1
    %Other international markets
    
    
    1
    %
 In 2003, sales in Canada accounted for approximately 5% of our total
consolidated sales. Taro Canada has approximately 4,000 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 2003: Percentage ofCustomer Type
    
    Consolidated SalesDrug wholesalers
    
    
    4
    %Drug chains, independent pharmacies and others
    
    
    1
    %
 As a result of our sales growth during the past five years, especially in
North America, we have expanded the production capacity of our Israel, U.S. and
Canadian operations. In addition, we utilize contract manufacturing for
certain products to satisfy customer demand in a timely manner. In 2001, 2002
and 2003, our production capacity increased significantly as a result of our
investment in facilities, capital equipment and an increase in the number of
our manufacturing personnel. As a result, in each of 2001, 2002 and 2003,
backorders generally represented less than one percent (1%) of our annualized
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), 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. 30




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##### Table of Contents



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. 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, Atrix, Barr Laboratories, Clay Park Labs, Geneva Pharmaceuticals, Mylan
Laboratories, Teva Pharmaceuticals U.S.A. and Warrick Pharmaceuticals. In the
market for proprietary drugs, our ElixSure® products compete with products of
Johnson & Johnson, Novartis and Wyeth among others. 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, including but not limited to our ElixSure® products. We compete in the Canadian market with Hoffmann-La Roche, Schering Canada,
Novartis, GlaxoSmithKline, Medicis Canada, Bayer and Bristol-Myers Squibb
Canada, as well as with other manufacturers of generic products, such as
Apotex, Novopharm Limited (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 Pharmaceutical Industries Ltd., Agis
Industries (1983) Ltd., Dexon and Rafa, 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 the United States, Canada and Israel and
active pharmaceutical ingredients at our facilities in Israel. Due to the
continued growth of sales of our products, we have been expanding these
facilities, our related research and development and warehousing facilities and
we are continuing to do so. For the manufacture of our finished dosage form pharmaceutical products,
we use pharmaceutical chemicals that we either produce ourselves or purchase
from chemical 31




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##### Table of Contents



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. 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 ingredient used in some of our key
products, including our warfarin sodium tablets, our carbamazepine products 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 capability. 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 at the expense of competing products. 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. The growth of our sales in
the past few years has resulted in higher levels of inventory in anticipation
of additional business for new products and from new customers, the exact
timing of which cannot be accurately determined. 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 32




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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 and 2001 and our facilities in Haifa Bay, Israel were
inspected by the FDA in 1996, 1997, 1999 and 2002. Regulatory authorities in each country also have extensive enforcement
powers over the activities of pharmaceutical manufacturers, including the power
to seize, force the recall of and prohibit the sale or import of non-complying
products and, to halt the operations of and criminally prosecute and fine
non-complying manufacturers. These regulatory authorities also have the power
to revoke approvals previously granted and remove from the market previously
approved drug products. In the United States, Canada, Israel and other jurisdictions, we, as well
as other manufacturers of drugs, are dependent on obtaining timely approvals
for products. The approval process in each country has become more rigorous and
costly in recent years. There can be no assurance that approvals will be
granted in a timely manner or at all. In the United States, Canada, Israel and
other jurisdictions, the procedure for drug product approvals, if such approval
is ultimately granted, generally takes longer than one year. 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 33




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##### Table of Contents



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 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 Canada and Israel, we must meet the
requirements of the United States Controlled Substances Act and its equivalents
in Israel and Canada, 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 34




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##### Table of Contents



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 resources which are beyond our current plan. 
 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 principal subsidiaries and countries of
incorporation: 35




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##### Table of Contents



Name of Subsidiary
    
    Country of IncorporationTaro Research Institute Ltd.
    
    IsraelTaro International Ltd.
    
    IsraelTaro Pharmaceuticals U.S.A., Inc.
    
    United StatesTaro Pharmaceuticals Inc.
    
    CanadaTaro Pharmaceuticals North America, Inc.
    
    Cayman IslandsTaro Pharmaceuticals (UK) Ltd.
    
    United KingdomTaro Pharmaceuticals Europe B.V.
    
    The NetherlandsTaro Hungary Kft.
    
    HungaryTaro Pharmaceuticals Canada, Ltd.
    
    CanadaTaro Pharmaceutical Laboratories, Inc.
    
    United StatesTaro Pharmaceuticals Ireland Ltd.
    
    IrelandTaro Pharmaceuticals India Pvt. Ltd.
    
    India
 See Note 2c to our consolidated financial statements included elsewhere in this
annual report for information regarding the ownership of our subsidiaries. 
 D. PROPERTY, PLANTS AND EQUIPMENT The following is a list of our facilities as of April 1, 2004: 36




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##### Table of Contents



SquareLocation
    
    Footage
    
    Main Use
    
    Own/LeaseHaifa Bay, Israel
    
    
    190,000
    
    
    Pharmaceutical manufacturing,
production laboratories,
offices and warehousing
    
    OwnHaifa Bay, Israel
    
    
    77,000
    
    
    Chemical production, including
tank farm and chemical
finishing plant
    
    OwnHaifa Bay, Israel
    
    
    40,000
    
    
    Research facility
    
    OwnHaifa Bay, Israel
    
    
    5,000
    
    
    Warehouse
    
    LeaseHaifa Bay, Israel
    
    
    10,000
    
    
    Warehouse, maintenance
    
    LeaseYakum, Israel
    
    
    15,000
    
    
    Administrative offices
    
    LeaseBrampton, Canada
    
    
    68,000
    
    
    Pharmaceutical manufacturing
and production laboratories
    
    OwnBrampton, Canada
    
    
    74,000
    
    
    Laboratories and administration
    
    OwnBrampton, Canada
    
    
    108,797
    
    
    Distribution & Warehousing
    
    OwnBrampton, Canada
    
    
    75,400
    
    
    Administration and warehousing
    
    LeaseHawthorne, New York
    
    
    42,000
    
    
    Administrative offices
    
    LeaseHawthorne, New York
    
    
    90,000
    
    
    Warehousing
    
    LeaseHawthorne, New York
    
    
    37,000
    
    
    Research laboratory and
administrative offices
    
    OwnSouth Brunswick, New Jersey
    
    
    315,000
    
    
    Distribution facility
    
    OwnHertford, United Kingdom
    
    
    1,250
    
    
    Administrative offices
    
    Lease
 37




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##### Table of Contents



SquareLocation
    
    Footage
    
    Main Use
    
    Own/LeaseRonkonkoma, New York
    
    
    50,000
    
    
    Pharmaceutical manufacturing,
production laboratories and
warehousing
    
    LeaseBudapest, Hungary
    
    
    1,250
    
    
    Administrative offices
    
    LeaseRoscrea, Ireland
    
    
    124,000
    
    
    Pharmaceutical manufacturing,
research laboratories and
warehousing
    
    OwnMumbai, India
    
    
    9,000
    
    
    Pharmaceutical research
laboratories and
administrative offices
    
    Lease
 Our plant, research and office facilities in Haifa Bay, Israel are located
in a complex of buildings with an aggregate area of approximately 322,000
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 15,000 square feet of adjacent space in
Haifa Bay pursuant to two separate leases. The first is for ten years, which
commenced in January 2001, with an option to purchase this property at the
termination of the lease. The second was for an initial term of five years,
commencing in September 1997, and has subsequently been renewed for two
additional one-year terms. For additional information, please refer to Note 6
to our consolidated financial statements included elsewhere in this annual
report. Since December 2000, we have purchased approximately 570,000 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
we had leased since March 1997 adjacent to the main 68,000 square foot
manufacturing facility, which we own, 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 for $3.6 million a 108,797
square foot building in close proximity to its existing facilities. This
building is used for warehousing and distribution. In August 2002, Taro U.S.A. purchased a 32% interest in a 123,713 square
foot building in which it located its U.S. research operations for
approximately $4.4 million. The U.S. subsidiary has two options exercisable at
two different times to purchase the remainder of the building, approximately
86,000 square feet, for an additional amount of $9.3 million. 38




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##### Table of Contents



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 130,000 square feet of
office and warehouse space in Hawthorne, New York pursuant to two leases. One
lease, for approximately 100,000 square feet, expires in July 2007 and the
other lease, for approximately 30,000 square feet expired on April 30, 2004 and
was not renewed. 
 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, 2003, 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 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. 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: 2003
    
    2002
    
    2001Customer
    
    Amount
    
    Percent
    
    Amount
    
    Percent
    
    Amount
    
    PercentAmerisourceBergen
Corporation
    
    $
    62.7
    
    
    
    20
    %
    
    $
    46.5
    
    
    
    22
    %
    
    $
    19.4
    
    
    
    13
    %McKesson Corporation
    
    $
    53.0
    
    
    
    17
    %
    
    $
    25.4
    
    
    
    12
    %
    
    $
    22.3
    
    
    
    15
    %Cardinal Health,
Inc.
    
    $
    28.4
    
    
    
    9
    %
    
    $
    19.0
    
    
    
    9
    %
    
    $
    13.4
    
    
    
    9
    %
 We also sell active pharmaceutical ingredients to unaffiliated customers
around the world. Sales of active pharmaceutical ingredients to third parties
have historically represented 39




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##### Table of Contents



less than 1% of consolidated revenues. Our primary reason for manufacturing
active pharmaceutical ingredients is to support our pharmaceutical
manufacturing operations. 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, the
operating results are dependent on the impact of pricing pressures on existing
products. These pricing pressures are inherent in the generic pharmaceutical
industry. In 2003 and 2002, sales of seven product lines contributed approximately
54% and 53% of our consolidated sales, respectively. These seven product lines
include four topical product families and three oral product families.
Clotrimazole and betamethasone dipropionate cream, our generic equivalent of
Lotrisone® cream, which we introduced into the market in May 2001, contributed
approximately 10% and 16% to our consolidated sales during 2003 and 2002,
respectively. 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, including our
generic equivalent of Lotrisone® cream. 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 at the expense of competing products. For example, the payment terms that we typically provide to our U.S.
customers vary from 30 to more than 90 days, with the longer terms typically
allowed to customers purchasing higher volumes of a product. Similarly, the
cash discounts that we offer may range from two to more than ten percent, with
the higher discounts offered in connection with larger sales. 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 40




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##### Table of Contents



launches, the exact timing of which cannot be determined accurately, has
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. 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 judgements that
affect the reported amounts of assets, liabilities, revenues and expenses. We
evaluate, on an ongoing basis, our estimates, including those related to bad
debts, income taxes and contingencies. We base our estimates on currently
available information, our historical experience and various other assumptions
that we believe to be reasonable under the circumstances. The results of these
assumptions are the basis for determining the carrying values of assets and
liabilities that are not readily apparent from other sources. Since the factors
underlying these assumptions are subject to change over time, the estimates on
which they are based are subject to change accordingly. The following is a summary of certain policies that have a critical impact
upon our financial statements and, we believe, are most important to keep in
mind in assessing our financial condition and operating results: Revenue Recognition.Revenue is recognized when delivery to our customers
has occurred. 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 allowances. In addition, we may record
allowances for shelf-stock adjustments when appropriate. We base our estimates
for these sales allowances on a variety of factors, including actual return
experience of products returned, rebate agreements for each product and
estimated sales by our wholesale customers to other third parties who have
contracts with us. Actual experience associated with any of these items may
differ materially from our estimates. We conduct a review of the factors that
influence our estimates periodically. When we find that actual product returns,
credits and other allowances differ from our established reserves we make the
necessary adjustments. 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 market price of the related product. When market
prices for our product decline, we may elect to provide shelf-stock adjustments
and thereby allow customers with existing inventories to compete at the lower
product price. These shelf-stock adjustments are intended to support our market
position and to promote customers loyalty. Functional and Reporting Currency.A majority of our revenues is
generated, and a substantial portion of our expenses is incurred, in U.S.
dollars. Hence, the U.S. dollar is our functional and reporting currency.
Monetary accounts that are maintained in other currencies are re-measured into
dollars in accordance with Statement No. 52 of the Financial Accounting
Standards Board. 41




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##### Table of Contents



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
generated by 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 acceleration of related amortization expense which could cause
our operating income, net income and earnings per share to decline. Deferred Taxes. In 2001, we conducted a public offering of our ordinary
shares. In connection with the offering, we recorded, as of December 31, 2003,
approximately $9.5 million of deferred tax assets due to the exercise of stock
options by the selling shareholders. In the event that it appears that the
amount of these deferred tax assets is, at any time, greater than the amount
that we are likely to 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 31,2003
    
    2002
    
    2001Statement of Income Data:Sales
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Cost of sales
    
    
    32
    
    
    
    38
    
    
    
    37Gross profit
    
    
    68
    
    
    
    62
    
    
    
    63Operating expenses:Research and development, net
    
    
    13
    
    
    
    12
    
    
    
    13Selling, marketing, general and
administrative
    
    
    31
    
    
    
    25
    
    
    
    28Total operating expenses
    
    
    44
    
    
    
    37
    
    
    
    41Operating income
    
    
    24
    
    
    
    25
    
    
    
    22Financial expenses, net
    
    
    1
    
    
    
    
    
    
    
    2Other income, net
    
    
    
    
    
    
    
    
    
    
    Income before taxes on income
    
    
    23
    
    
    
    25
    
    
    
    20Taxes on income
    
    
    4
    
    
    
    4
    
    
    
    3
 42




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##### Table of Contents



Year ended December 31,2003
    
    2002
    
    2001Minority interest in earnings of a
subsidiary
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    19
    %
    
    
    21
    %
    
    
    17
    %
 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 bethametasone 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 in the year from Medicis
Pharmaceutical Corporation. 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
favorable competitive environment for the 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 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 medical representatives 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. 43




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##### Table of Contents



Operating Income.Operating income increased $21.4 million, or 40% in
2003. The increase was primarily the result of increased sales and improved
gross profit margins. Financial Expenses.Financial expenses consist of interest expense and
income, and the impact of currency fluctuations. 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 2003. The increase in interest expenses was partially offset by interest
income that we earned on our cash balances and from foreign currency hedging
transactions. 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. Year Ended December 31, 2002 compared with Year Ended December 31, 2001 Sales.During 2002, sales increased $62.0 million, or 42%, from the amount
we recorded in 2001. Of this increase, $7.6 million, or 4%, was attributable to
the sale of products that we introduced in 2002. The balance of the increase
was attributable to increased sales of products that were sold in both 2001 and
2002, including clotrimazole and betamethasone dipropionate cream, our generic
version of Lotrisone®, which we began to sell in May 2001. Sales in the United
States increased $60.1 million, or 49%, in 2002. Sales in Canada increased by
$3.8 million, or 44%, in 2002. Sales in Israel and other international markets
decreased $1.6 million, or 10%, in 2002. The products introduced during the
year in the United States were amcinonide cream, ketoconazole cream and
econazole nitrate cream. Cost of Sales.Cost of sales increased $24.8 million, or 45% in 2002, as a
result of the 42% increase in sales described above. Gross Profit.Gross profit increased $37.6 million, or 40% in 2002 but
gross profit margins declined from 63% in 2001 to 62% in 2002. The decrease
reflects a higher level of OTC product sales and a competitive environment for
some products, which was partially offset by an increased volume of sales for
other products. Research and Development.Net R&D expenses increased $6.8 million, or 35%
in 2002. R&D expenses equaled 12% and 13% of sales in 2002 and 2001,
respectively. The increase in R&D expenses during 2002 was the result of
expanding our research facilities, recruiting additional scientists and
pursuing more projects. Selling, General and Administrative.SG&A increased $10.4 million, or 25%
in 2002. Our SG&A expenses as a percentage of sales declined from 28% in 2001
to 25% in 2002. Selling and marketing expenses increased $0.8 million, or 4% in
2002. General and administrative expenses increased $9.7 million, or 43% in
2002, primarily due to investments 44




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in personnel, facilities and infrastructure necessary to accommodate continued
growth and expansion in both the United States and international markets. Operating Income.Operating income increased $20.5 million, or 62% in
2002. The increase was primarily the result of increased sales and improved
SG&A margin. Financial Expenses.Net financial expenses decreased $2.4 million, or 92%
in 2002 primarily as a result of interest income realized from the high cash
balance maintained during 2002. This income nearly offset most of the Companys
cost of borrowing. Taxes on Income.Due to a higher level of pre-tax income, our tax expense
increased $4.0 million, or 91% in 2002, with our effective tax rate increasing
from 14% in 2001 to 16% in 2002. Net Income.Our net income increased $18.6 million from $26.0 million in
2001 to $44.6 million in 2002, an increase of 71%, based on the factors cited
above. Impact of Inflation, Devaluation, (Appreciation) and Exchange Rates on Results
of Operations, Liabilities and Assets We conduct manufacturing, marketing and research and development
operations primarily in Israel, Canada and the United States. As a result, we
are subject to risks associated with fluctuations in the rates of inflation and
foreign exchange in each of these countries. The following table sets forth the annual rate of inflation, the
devaluation (appreciation) rate of the NIS and the Canadian dollar against the
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: 45




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##### Table of Contents



Rate of DevaluationRate of
    
    (Appreciation)
    
    Rate of ExchangeInflation
    
    Against U.S. Dollar
    
    of U.S. DollarYear
    
    Israel (1)
    
    Canada (2)
    
    Israel (1)
    
    Canada (3)
    
    Israel (1)
    
    Canada (3)1999
    
    
    1.3
    %
    
    
    2.6
    %
    
    
    (0.2
    %)
    
    
    (5.9
    %)
    
    
    4.15
    
    
    
    1.442000
    
    
    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
    
    
    
    1.30
 Sources: (1) Bank of Israel. (2) Statistics Canada. (3) Bank of Canada. 
 B. LIQUIDITY AND CAPITAL RESOURCES Liquidity Cash and cash equivalents increased by $28.4 million to $159.1 million at
December 31, 2003. During 2003, we completed two private placements of bonds to
institutional investors in Israel in the aggregate amount of $110 million,
primarily to fund our capital expansion programs. Our increase in sales caused
trade accounts receivable to increase by 75%, to $120.5 million at December 31,
2003. Inventory levels increased 99% from December 31, 2002 to December 31,
2003, primarily due to strategic API acquisitions and to support increased
level of sales. Shareholders equity increased from $269.1 million at December
31, 2002 to $347.4 million at December 31, 2003, principally due to net income
contribution to retained earnings and tax benefits related to the exercise of
stock options. We generated cash from operations amounting to $5.2 million for the year
ended December 31, 2003 as compared to $29.6 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, higher net income and other working capital items. Our long-term debt outstanding as of December 31, 2003 was approximately
$181.4 million, including current maturities of $24.4 million, and was
comprised of the following:  
    
    bonds payable of $130.4 million;  
    
    obligations of $29.7 million under a bank credit agreement; and 46




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
    
    mortgage payable, capital leases and other obligations of $21.3 million. Our bond obligations consist of the following, in millions: Amount
    
    Linkage
    
    Rate
    
    Maturity$15.8
    
    Israel CPI
    
    8.25%
    
    2004-2010$48.0
    
    Israel CPI
    
    5.8%
    
    2004-2014$2.1
    
    Dollar
    
    Libor + 2-3%
    
    2004-2010$64.5
    
    Dollar
    
    6%
    
    2004-2010
 We have a contract to hedge our exposure to CPI fluctuations in Israel.
Under the bond agreements, our debt to equity ratio may not be greater than 2:1
and our current ratio may not be lower than 1:1. In addition the bonds that we
issued during the year require that we maintain an interest coverage ratio of
2:1. The interest coverage ratio is defined as earnings before interest, taxes,
depreciation and amortization expenses, or EBITDA, divided by net interest
expenses plus the current principal repayment. We are currently in compliance
with these covenants. We anticipate that our 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. As for 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 $94.4 million in capital equipment and facilities during the
year ended December 31, 2003 and $43.2 million during the year ended December
31, 2002. These investments are principally related to expanding and upgrading
our research and development laboratories and our pharmaceutical and chemical
manufacturing facilities in Israel, Canada, Ireland and the United States and
maintaining compliance with cGMPs, while increasing manufacturing capacity. 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 for
an analysis of property, plant and equipment activity in 2003. Tax Matters Tax Loss Carryforward and Effective Tax Rates As of December 31, 2003, on an unconsolidated basis, we had an available
tax loss carryforward of $1.3 million in Israel, $3.9 million in the United
Kingdom and $37.5 million in the United States. The loss carryforward in the
United States principally resulted from the 47




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exercise by employees of stock options during 2001. Our consolidated effective
tax rates were 16%, 16% and 14% in 2003, 2002 and 2001, respectively. Approved Enterprise Status in Israel Israeli companies are generally subject to tax at the rate of 36% 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% to 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% to 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 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. Additionally, in October 2003, we
submitted an application for a fourth approval for capital investments that
will be implemented by the end of 2005. 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 obtained to purchase fixed
assets. Our interest expenses are sensitive to the LIBOR and CPI, as most of
our long-term debt bears a LIBOR or CPI-linked interest rate. As of December
31, 2003, $181.4 million of our outstanding debt bears an average interest rate
of 5.3%. Consequently, each 0.25% increase in interest rates will reduce pretax
income by approximately $0.5 million. Our functional currency and that of our U.S. subsidiary is the U.S.
dollar. The functional currency of our European and Canadian subsidiaries, is
the local currency in their respective countries. In 2003, over 90% of our revenues were generated in U.S. dollars. However,
the remainder of our sales were denominated in the local currencies of the
countries in which they occurred. As such, 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 48




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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 2003. OFF-BALANCE SHEET ARRANGEMENTS The Company does not have any material off-balance sheet arrangements. CONTRACTUAL OBLIGATIONS As of December 31, 2003, we have contractual obligations in connection
with the construction and installation of new pharmaceutical facilities in the
amount of $17.2 million. In addition we have contractual obligations under
several operating leases in relation to facilities and equipment which we lease
from third parties. The following table describes the payment schedules of our contractual
obligations, in millions: Payments due by periodLessthan 1
    
    1-3
    
    3-5
    
    Over 5Contractual Obligation
    
    Total
    
    year
    
    years
    
    years
    
    yearsOperating lease
obligation
    
    $
    16.5
    
    
    $
    4.7
    
    
    $
    7.6
    
    
    $
    2.9
    
    
    $
    1.3Purchase obligations
    
    $
    17.2
    
    
    $
    17.2
    
    
    
    
    
    
    
    
    
    
    
    
 
 C. RESEARCH AND DEVELOPMENT, PATENTS, TRADE MARKS 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 Ltd., or the 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 49




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research and development programs.
More than 80 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  
    
    organic and steroid chemistry, where our programs have enabled us to
synthesize the active ingredients used in many of our products. Generic Pharmaceuticals In 2003, we received multiple product approvals in Canada, Israel and the
United States. The following table sets forth the approvals in the United
States by the FDA during 2003 and through April 29, 2004: Generic Name
    
    Brand NameAmiodarone tablets, 300mg
    
    Pacerone®Ammonium lactate cream, 12%
    
    Lac-Hydrin®Betamethasone dipropionate cream (augmented) 0.05%
    
    Diprolene®Betamethasone dipropionate gel (augmented) 0.05%
    
    Diprolene®Clindamycin phosphate topical solution, 1%3
    
    Cleocin T®Etodolac extended release tablets, 400, 500 and 600 mg
    
    Lodine® XLFluconazole tablets 50, 100, 150 and 200 mg1
    
    Diflucan®Fluorouracil topical solution, 2% and 5%
    
    Efudex®Hydrocortisone butyrate topical solution, 0.1%3
    
    Locoid®Ibuprofen oral suspension, 100mg/5mL2,3
    
    ElixSure® IBPhenytoin oral suspension USP, 125 mg/5mL3
    
    Dilantin-125®Terconazole vaginal cream, 0.8%3
    
    Terazol®
  (1)
    
    Tentative approval (2) NDA approval (3) Approval received in 2004 As of April 29, 2004, 33 of our ANDAs and one NDA were being reviewed 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. 50




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Proprietary Technologies T-2000 We are currently conducting Phase II studies on T-2000, our non-sedating
barbiturate compound. This product is currently intended for the treatment of
epilepsy and essential tremor, but may have other indications. It is intended
to be a long-acting, non-sedating barbiturate compound that permits increased
patient compliance and reduced side effects. T-2000 must complete Phase II testing, successfully undergo Phase III
studies and obtain regulatory approval in order to reach the market. There can
be no assurance of the successful completion of Phase II or Phase III testing,
the approval by the FDA of the drug or the commercial success of the drug. 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 and preparing the marketing program for this new
delivery system. While there can be no assurance of regulatory approvals or
commercial success, we hope to introduce more NonSpil formulations in
commercial markets where they can contribute to both pediatric and geriatric
healthcare. In 2003, we launched the ElixSure® line of childrens medicines for
fever/pain, cough and congestion. ElixSure is the first line of products to
use our NonSpil liquid drug delivery system. The commercial success of the
ElixSure® line will depend upon consumer acceptance of this new delivery
system. Furthermore, competition from other products for the same clinical
indications may prevent successful commercialization of these products. Thus,
there can be no assurance of the success of the ElixSure® product line. Patents, Trademarks and Licenses We have filed and received patents in the United States in a variety of
areas including for:  
    
    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 some of our products. 51




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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® 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. We do not believe that any
single patent or license is of material importance to us in relation to our
current commercial activities. From time to time, we seek to develop products for sale prior to patent
expiration in various countries. 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 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 patent(s) 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
jurisdictions where we conduct business, including Israel, Canada and Europe. On November 14, 2003, Godecke Aktiengesellschaft, Pfizer and
Warner-Lambert (collectively, Warner Lambert), responding to our filing of an
ANDA 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. (collectively, Taro) in the district court
in New Jersey alleging that, under the provisions of the Hatch-Waxman Act,
Taros ANDA infringed certain Warner-Lambert patents. 
 D. TREND INFORMATION Please see Item 4 Information on the Company and Item 5 Operating and
Financial Review and Prospect for trend information. 
 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 
 A. DIRECTORS AND SENIOR MANAGEMENT The following table lists our current directors and executive officers as
of April 1, 2004: 52




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Name
    
    Age
    
    PositionBarrie Levitt, M.D.
    
    
    68
    
    
    Chairman of the Board of DirectorsAaron Levitt
    
    
    65
    
    
    Director and PresidentDaniel Moros, M.D.
    
    
    56
    
    
    Director and Vice ChairmanMyron Strober, C.P.A.
    
    
    74
    
    
    Director and Chairman of the Audit CommitteeHeather Douglas, Esq.
    
    
    49
    
    
    DirectorMicha Friedman, Ph.D.
    
    
    63
    
    
    DirectorEric Johnston, Esq.
    
    
    59
    
    
    DirectorGad Keren, M.D.
    
    
    52
    
    
    DirectorTal Levitt, Esq.
    
    
    34
    
    
    DirectorBen Zion Hod, C.P.A.
    
    
    49
    
    
    Director1Haim Fainaro, C.P.A.
    
    
    61
    
    
    Director1Samuel Rubinstein
    
    
    64
    
    
    Senior Vice President & General ManagerKevin Connelly, C.P.A.
    
    
    43
    
    
    Senior Vice President, Chief Financial OfficerAvraham Yacobi, Ph.D.
    
    
    58
    
    
    Senior Vice President, Research and DevelopmentZahava Rafalowicz
    
    
    57
    
    
    Group Vice President, Sales and Marketing and Deputy General Manager, IsraelMariana Bacalu
    
    
    54
    
    
    Vice President, Pharmaceutical Production
 53




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Name
    
    Age
    
    PositionHannah Bayer, C.P.A.
    
    
    54
    
    
    Vice President, Chief Accounting OfficerIlan Ben Cnaan
    
    
    56
    
    
    Vice President, Operations, IsraelMarc Coles, Esq.
    
    
    47
    
    
    Vice President, General CounselPuah Dekel
    
    
    44
    
    
    Vice President, Administration, IsraelYohanan Dichter
    
    
    57
    
    
    Vice President, Pharmacist in ChargeRoman Kaplan, Ph.D.
    
    
    58
    
    
    Vice President, Technical Operations, PharmaceuticalsIftach Katz
    
    
    40
    
    
    Vice President, Technical Services, IsraelAlon Korb
    
    
    45
    
    
    Vice President, Engineering and Projects, IsraelSigalit Portnoy, Ph.D.
    
    
    40
    
    
    Vice President, Training and PlanningSabar Sasson, Ph.D.
    
    
    62
    
    
    Vice President, Strategic Planning, ChemicalsTzvi Tal
    
    
    54
    
    
    Vice President, Information Technology, Israel
 (1)Statutory independent director elected in accordance with the Israeli
Companies Law Certain Familial Relationships Dr. Levitt and Aaron Levitt are brothers. Tal Levitt is the daughter of
Dr. Levitt and niece of Aaron Levitt. Dr. Moros is a first cousin of each of
Dr. Levitt and Aaron 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 54




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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 for the FDA from 1971 through March 1991, when he
resigned in order to increase his involvement in our company. Aaron Levittwas elected to our board of directors in 1981 and became
President of our company in 1982. Mr. Levitt joined our company in 1980 as
Director of Marketing for our Israel operations after serving as regional sales
manager for the Coty Division of Pfizer Inc. from 1970 to 1976 and later as
regional sales manager for the Ultima Division of Revlon Group Inc. from 1976
to 1979. He has been on a paid leave of absence from his employment
by Taro U.S.A. since February 2004. 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 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 published numerous articles both in Israel and
internationally and is 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 with the Canadian law firm of
Perley-Robertson, Hill and McDougall LLP. From 1974 to 2000, Mr. Johnston
served as a Deputy Regional Solicitor of The Regional Municipality of
Ottawa-Carleton, Ontario, Canada. 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. 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. Ms. Levitt is
responsible for corporate communications, including investor and media
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affairs. She previously worked as a
corporate attorney at the New York law firm of Jenkens Gilchrist Parker &
Chapin, LLP from 1994 to 1995. Ben Zion Hod, C.P.A.was elected to our board of directors in 2003 as an
independent director. Mr. Hod is a certified public accountant in Israel and
for the past 11
years, has served as company comptroller for Zim Israel Navigation
Company. 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.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 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. 56




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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., including chief accountant
and manager of global business reporting. Ilan Ben Cnaanjoined our company in 1999 and currently serves as Vice
President, Operations, Israel. He is responsible for our chemical manufacturing
operations in Israel. From 1979 to 1999, Mr. Ben Cnaan served as a pilot plant
manager, production manager and
operations manager for Teva Pharmaceutical Industries Ltd. in both the
chemical and veterinary divisions. 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 of Administration. Prior
to joining the company, she worked in the field of human resources for various
companies, including Bank Leumi. 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. 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 57




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presently serves as Vice President, Training and
Planning. From 1990 to 1997, she taught at the Technion Institute, Israel. Sabar Sasson, Ph.D.joined our company in 1991 and currently serves as
Vice President, Strategic Planning, Chemicals. He is responsible for scientific
strategy with respect to our chemical synthesis program. From 1976 to 1991, Dr.
Sasson served as manager of chemical process development for Abic Chemical and
Pharmaceutical Industries. 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 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 will receive additional compensation of
$6,000 per year. Our independent directors, as defined under Israeli law, may
not be compensated in connection with their services as independent directors
in excess of the amounts set forth in the Companies Law and regulations
promulgated thereunder. Each of our independent directors receives $390 as a
participation fee for each board meeting that they attend and $6,400 as an
annual fee. Cash Compensation of Executive Officers We paid an aggregate of $7,512,808 to all our directors and officers (26
persons) for services rendered to us in all capacities during the year ended
December 31, 2003. 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. 58




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Our board of directors currently consists of eleven directors (including
our two independent directors). 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. Our directors, other than our independent directors, are elected at annual
general meetings of our shareholders to hold office until the next annual
general meeting of shareholders, which is 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. A director holds office until the next annual general meeting,
unless he is earlier removed from office by an ordinary resolution passed at an
extraordinary general meeting of our shareholders. Independent Directors Qualifications of 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 independent directors. The Companies Law provides
that a person may not be elected as an 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 an 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 an 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 an independent director or may otherwise interfere with the
persons ability to serve as an independent director. Until the lapse of two
years from termination of office, a company may not engage an 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. 59




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Election of Independent Directors Independent directors generally are to be elected by a majority vote at a
shareholders meeting, provided that either:  
    
    the majority include 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  
    
    the total number of shares voted against the election of the
independent director by the non-controlling shareholders, does not
exceed one percent of the aggregate voting rights in the company. The initial term of an independent director is three years and may be
extended for three additional years. 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 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 independent director, except for the audit
committee which is required to include all the independent directors. Our independent directors, Ben Zion Hod and Haim Fainaro, were elected by
our shareholders in 2003, pursuant to the provisions of the Companies Law for
an initial three year term, which will end on July 31, 2006 and August 28,
2006, respectively. Alternate Directors Pursuant to our Articles of Association and the Companies Law, any
director may appoint, by written notice to us, any person (other than a
director, an alternate director and a person who is not qualified to serve as a
director) to serve as an alternate director and may remove such alternate
director. An alternate director possesses all the rights and obligations of the
director who appointed him 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 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 exercise any function of the board must include at least one
independent director. Our board of directors has formed Audit, Executive,
Finance, Compensation and Stock Option committees. Audit Committee 60




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Under the Companies Law, our board of directors is required to appoint an
audit committee, comprised of at least three directors including both
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 December 31, 2003, our audit committee consisted of the following
directors: Mr. Myron Strober, C.P.A., Chairman, Mr. Eric Johnston, Esq., Ms.
Heather Douglas, Esq., Ben Zion Hod, C.P.A. and Haim Fainaro, C.P.A., none of
whom are our employees. The role of the audit committee is, among other things, to examine flaws
in our business management, in consultation with the internal auditor and the
independent accountants and to propose remedial measures to the board. 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, 2003. 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, 2003. 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 controlling shareholders or with its
office holders unless at the time of approval the two independent directors are
serving as members of the audit committee and at least one of our 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. 61




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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, the audit
committee must approve contracts between the company and any of its directors
relating to the service or employment of a director. 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. 
 D. EMPLOYEES The following table sets forth the number of our employees as of December
31, 2003: Israel
    
    Canada
    
    U.S.A.
    
    Ireland
    
    Other
    
    TotalSales and Marketing
    
    
    35
    
    
    
    39
    
    
    
    168
    
    
    
    1
    
    
    
    3
    
    
    
    246Administration
    
    
    51
    
    
    
    36
    
    
    
    137
    
    
    
    9
    
    
    
    6
    
    
    
    239Research and Development
    
    
    135
    
    
    
    81
    
    
    
    36
    
    
    
    14
    
    
    
    
    
    
    
    266Production and Quality
Control
    
    
    363
    
    
    
    253
    
    
    
    53
    
    
    
    26
    
    
    
    
    
    
    
    695Total
    
    
    584
    
    
    
    409
    
    
    
    394
    
    
    
    50
    
    
    
    9
    
    
    
    1,446
 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. 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 62




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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%. 
 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 17, 2004. The
percentage of outstanding shares is based on 29,298,577 ordinary shares
outstanding as of May 17, 2004. Ordinary shares subject to options currently
exercisable, or exercisable within 60 days of May 17, 2004, 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. Number of
    
    Percentage ofName
    
    Ordinary Shares
    
    Outstanding Ordinary SharesBarrie
Levitt, M.D. (1)(3)
    
    
    1,947,084
    
    
    
    6.6
    %Aaron Levitt (2)(3)
    
    
    1,038,179
    
    
    
    3.5
    %Daniel
Moros, M.D. (4)
    
    
    929,051
    
    
    
    3.2
    %Tal Levitt, Esq.
    
    
    567,014
    
    
    
    1.9
    %Myron Strober, C.P.A.
    
    
    *
    
    
    
    *Heather Douglas, Esq.
    
    
    *
    
    
    
    *Micha Friedman, Ph.D.
    
    
    *
    
    
    
    *Eric Johnston, Esq.
    
    
    *
    
    
    
    *Gad Keren, M.D.
    
    
    *
    
    
    
    *Samuel Rubinstein
    
    
    *
    
    
    
    *Kevin Connelly, C.P.A.
    
    
    *
    
    
    
    *Avraham Yacobi, Ph.D.
    
    
    *
    
    
    
    *Zahava Rafalowicz
    
    
    *
    
    
    
    *Mariana Bacalu
    
    
    *
    
    
    
    *Hannah Bayer, C.P.A.
    
    
    *
    
    
    
    *Ilan Ben Cnaan
    
    
    *
    
    
    
    *Marc Coles, Esq.
    
    
    *
    
    
    
    *Yohanan Dichter
    
    
    *
    
    
    
    *Roman Kaplan, Ph.D.
    
    
    *
    
    
    
    *Iftach Katz
    
    
    *
    
    
    
    *Zalmin Lempert
    
    
    *
    
    
    
    *
 63




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Number of
    
    Percentage ofName
    
    Ordinary Shares
    
    Outstanding Ordinary SharesSigalit Portnoy, Ph.D.
    
    
    *
    
    
    
    *Sabar Sasson, Ph.D.
    
    
    *
    
    
    
    *Zvi Tal
    
    
    *
    
    
    
    *Ben Zion Hod,
C.P.A.Haim Fainaro, C.P.A.Total for all directors and
officers (28 persons) listed
above, as a group
    
    
    3,928,661
    
    
    
    13.3
    %
  (1) Of the ordinary shares beneficially owned by Dr. Levitt, (1) 297,066
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) 35,200 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
controlled by Dr. Levitt and Aaron Levitt, and (8) 751,852 ordinary shares are
owned by the R and J Levitt Corporation, or the R&J Corporation, which is owned
50% by Dr. Levitt and members of his immediate family and 50% by Aaron Levitt
and members of his immediate family. In addition, Dr. Levitt is the beneficial
owner of 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. (2) Of the ordinary shares beneficially owned by Aaron Levitt, (1) 22,600
ordinary shares are individually owned by Mr. Levitt, (2) 175,412 ordinary
shares are owned by Mr. Levitt and his wife as joint tenants, (3) 17,600
ordinary shares, which are not currently outstanding, are subject to incentive
options granted to Mr. Levitt that are presently exercisable, (4) 5,275 are
owned by his wife, (5) 65,440 ordinary shares are owned by the Research
Foundation, which is controlled by Mr. Levitt and Dr. Levitt, and (6) 751,852
ordinary shares are owned by the R&J Corporation, which is owned 50% by Mr.
Levitt and members of his immediate family and 50% by Dr. Levitt and members of
his immediate family. (3) Aaron
Levitt, together with his wife and two sons, has commenced litigation
in the Supreme Court of the State of New York against Barrie Levitt,
Tal Levitt, Daniel Moros, TDC and R&J Corporation, seeking, among
other relief, to cause the ordinary shares of our company held by TDC
and R&J Corporation to be distributed by those corporations to
their respective shareholders. An agreement-in-principle to settle
the litigation has been reached by the parties to the litigation. The
agreement-in-principle contemplates that Aaron Levitt and members of
his family would exchange a portion of the outstanding shares of TDC
which they currently own for all of the outstanding shares of R&J
Corporation which they do not currently own. In addition, the
agreement-in-principle contemplates that TDC would sell approximately
510,000 of the ordinary shares of our company that it currently owns
and pay the net after-tax proceeds of the sales to Aaron Levitt and
members of his family in exchange for the balance of their
shareholdings in TDC. The sales are to be conducted by TDC at such
time or times, prior to July 31, 2005, as Aaron Levitt may
direct and in accordance with Rule 144 under the Securities Act
of 1933. Upon consummation of the transactions contemplated by the
agreement-in-principle, (i) Aaron Levitt and members of his
family would cease to own any shares of TDC and would become the sole
shareholders of R&J Corporation and (ii) the shareholdings
of TDC in our company would be reduced by approximately
510,000 shares. The agreement-in-principle does not impose any
restrictions upon the sale by R&J Corporation of its shares in
our company, except for a requirement that any such sale be made in
compliance with applicable law. It is anticipated that the
agreement-in-principle will be executed and delivered by each of the
parties to the pending litigation, and the resulting changes in the
ownership of TDC and R&J Corporation contemplated thereby will
take place, during the summer of 2004. There is, however, no
assurance that the agreement-in-principle will become a binding
agreement or that the transactions contemplated thereby will be
consummated. We are unable to predict what might happen in the event
that the litigation referred to above is not settled or is settled
upon terms other than those contemplated by the
agreement-in-principle. (4) Of the ordinary shares owned by Dr. Moros, (1) 353,217 ordinary shares
are owned individually by Dr. Moros, (2) 229,960 ordinary shares are held by
Dr. Moros as co-trustee of the Nathan Moros
Trust, (3) 337,074 ordinary shares are held by Dr. Moros as trustee for
trusts established by Isabel Moros, and (4) 17,600 ordinary shares, which are
not currently outstanding, are subject to incentive options granted to Dr.
Moros that are presently exercisable. Each of Dr. Moross two minor daughters
owns 100 ordinary shares.  *
    
    Less than 1% As of April 1, 2004, the directors and executive officers listed above, as
a group, held options to purchase 630,700 of our ordinary shares at a weighted
average exercise price of $21.53, expiring between July 2005 and January 2014. Stock Option Plans 64




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General.From time to time, we have granted options to purchase our
ordinary shares. As of December 31, 2003, there were outstanding 1,300,372
options 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, Mr. 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 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. 65




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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. As of April 1, 2004, 251,869 ordinary shares were subject to outstanding
options. Of such options, 126,250 (at an average exercise price of $2.74 per
share) were held by executive officers; 52,000 (at an average exercise price of
$3.40 per share) were held by directors who are not executive officers; and
73,619 (at an average exercise price of $3.34 per share) were held by other
persons. None of such options were SARs. 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 held on
July 29, 1999. 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 66




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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,
excluding Identified Public Directors, as defined in the 1999 Stock Incentive
Plan, 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 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 67




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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 April 1, 2004, 1,124,057 ordinary shares were subject to outstanding
options. Of such options, 355,250 (at an average exercise price of $26.95 per
share) were held by executive officers; 97,200 (at an average exercise price of
$35.85 per share) were held by directors who are not executive officers; and
671,607 (at an average exercise price of $32.96 per share) were held by other
persons. None of such options were SARs. 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, Mr. Levitt, Ms. Levitt and Dr. Moros
are not eligible to participate in the 2000 Employee Stock Purchase Plan. 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 68




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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, 2003, approximately 88,000 ordinary shares had been
purchased through the 2000 Employee Stock Purchase Plan at a weighted average
exercise price of $29.70. 
 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 
 A. MAJOR SHAREHOLDERS The following table sets forth certain information, as of May 17, 2004,
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 includes voting and
investment power with respect to our ordinary shares. Ordinary shares subject
to options currently exercisable, or exercisable within 60 days of May 17,
2004, are deemed outstanding for computing the percentage ownership of the 69




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person holding such options, but are not deemed outstanding for computing the
percentage ownership of any other person. For information concerning prospective changes in the ownership of TDC and The R&J Corporation
and the shareholding of these two companies in our Company, please
see Note (3) to the table set forth under the heading E.
SHARE OWNERSHIP in ITEM 6 above. Ordinary Shares
    
    Percent of OrdinaryName
    
    Beneficially Owned
    
    Shares OutstandingBarrie Levitt, M.D. (1)(4)
    
    
    1,947,084
    
    
    
    6.6
    %Aaron Levitt (2)(4)
    
    
    1,038,179
    
    
    
    3.5
    %Daniel Moros, M.D. (3)
    
    
    929,051
    
    
    
    3.2
    %Taro Development Corporation (4)
    
    
    2,921,896
    
    
    
    10.0
    %
  (1) Of the ordinary shares beneficially owned by Dr. Levitt, (1) 297,066
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) 35,200 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
controlled by Dr. Levitt and Aaron Levitt, and (8) 751,852 ordinary shares are
owned by the R and J Levitt Corporation, or the R&J Corporation, which is owned
50% by Dr. Levitt and members of his immediate family and 50% by Aaron Levitt
and members of his immediate family. In addition, Dr. Levitt is the beneficial
owner of 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. (2) Of the ordinary shares beneficially owned by Aaron Levitt, (1) 22,600
ordinary shares are individually owned by Mr. Levitt, (2) 175,412 ordinary
shares are owned by Mr. Levitt and his wife as joint tenants, (3) 17,600
ordinary shares, which are not currently outstanding, are subject to incentive
options granted to Mr. Levitt that are presently exercisable, (4) 5,275 are
owned by his wife, (5) 65,440 ordinary shares are owned by the Research
Foundation, which is controlled by Mr. Levitt and Dr. Levitt, and (6) 751,852
ordinary shares are owned by the R&J Corporation, which is owned 50% by Mr.
Levitt and members of his immediate family and 50% by Dr. Levitt and members of
his immediate family. (3) Of the ordinary shares owned by Dr. Moros, (1) 353,217 ordinary shares
are owned individually by Dr. Moros, (2) 229,960 ordinary shares are held by
Dr. Moros as co-trustee of the Nathan Moros Trust, (3) 337,074 ordinary shares
are held by Dr. Moros as trustee for trusts established by Isabel Moros, and
(4) 17,600 ordinary shares, which are not currently outstanding, are subject to
incentive options granted to Dr. Moros that are presently exercisable. Each of
Dr. Moross two minor daughters owns 100 ordinary shares. (4) As a result of the TDC Shareholders Agreement and the familial
relationship of Dr. Levitt and Aaron Levitt, Dr. Levitt and Aaron Levitt may be
deemed to share beneficial ownership of the ordinary shares owned by TDC by
virtue of their ownership in TDC. 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 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. 70




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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 17, 2004, Dr. Levitt, Aaron Levitt, Dr. Moros, Tal Levitt and
members of their respective immediate families, in the aggregate, control 49.5%
of the voting power in our company by reason of their (i) direct ownership of
an aggregate of 14.2% of our ordinary shares, (ii) their majority ownership of
TDC, which owns 10.0% 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. As of April 1, 2004, 29,010,977 of our ordinary shares were outstanding.
They were held of record by 363 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 products and chemicals in our facilities in Israel and
Canada. A substantial amount of these products and chemicals 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 We are not currently a party to any material litigation. We are, from
time to time, 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. A claim for compensation in the approximate
amount of $550,000 was filed by a customer in a previous year. Based on 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. 71




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As mentioned above in Item 5, section C, 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 Taros ANDA infringed certain Warner-Lambert patents. We confirm that a private legal action involving Taro Development
Corporation and R&J Levitt Corporation is currently pending. Both corporations
are shareholders in our company, but neither our company nor any of our
subsidiaries is a party to the litigation or underlying dispute. Thus, neither
the litigation nor the dispute is expected to have any material effect on our
company or any of our subsidiaries. Dividend Policy We may declare a dividend in U.S. dollars out of our retained earnings.
Under the most restrictive debt covenants, any dividend distribution and any
cash dividend distribution requires prior approval of certain banks. We have never paid cash dividends on either our ordinary shares or the
Founders shares 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. 72




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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
    
    Low1999
    
    $
    9.50
    
    
    $
    2.442000
    
    $
    17.47
    
    
    $
    3.662001
    
    $
    48.50
    
    
    $
    13.442002
    
    $
    39.26
    
    
    $
    21.602003
    
    $
    72.11
    
    
    $
    30.14
 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 2002
    
    $
    38.34
    
    
    $
    28.35Second Quarter 2002
    
    $
    30.46
    
    
    $
    21.60Third Quarter 2002
    
    $
    34.90
    
    
    $
    22.56Fourth Quarter 2002
    
    $
    39.26
    
    
    $
    32.13First 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
 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 2003
    
    $
    72.11
    
    
    $
    64.09January 2004
    
    $
    65.13
    
    
    $
    60.45February 2004
    
    $
    66.53
    
    
    $
    60.80March 2004
    
    $
    64.90
    
    
    $
    57.40April 2004
    
    $
    63.61
    
    
    $
    43.25May 2004
    
    $
    45.32
    
    
    $
    39.91
 
 B. PLAN OF DISTRIBUTION Not applicable. 73




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C. MARKETS Our ordinary shares have been traded in the over-the-counter market in the
United States since 1961. 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. Objects and Purposes Our Memorandum of Association provides that our main objects and purposes
include any business connected with the developing, manufacturing, processing,
supplying, marketing and distributing of prescription, 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. Since our Articles were approved 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
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 refer to a section of the Companies Ordinance
that has been replaced by the Companies Law, the Articles are understood to
refer to the relevant section of the Companies Law. Approval of Specified Related Party Transactions Under Israeli Law 74




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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 his approval or performed by him by virtue of his 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 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 a 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 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 the audit committee may not be present at
this meeting or vote on this 75




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matter, unless a majority of the members of the board of directors or the
audit 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 shares 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. 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. 76




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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 shares 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 shares 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. 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 shares 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.) 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 or her rights and
fulfilling his or her obligations towards us and other shareholders and to
refrain from abusing his 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. 77




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Furthermore, any controlling shareholder, any shareholder who knows that
it 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 its own best
interests. Mergers and Acquisitions under Israeli Law The Companies Law includes provisions that allow a merger transaction 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 who holds 25% or more of the shares or the right to appoint 25% or more
of the directors of the other party, 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 70 days have passed from the time that a proposal
of the merger has been filed with the Israeli Registrar of Companies. 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 50% 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%
shareholder of the Company. This rule does not apply if someone else is
already a majority shareholder in the company. If following any acquisition of
shares, the acquirer will hold 90% or more of the companys shares, 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. 78




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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 shall 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 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 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 if the breach was
intentional or reckless; any act or omission done with the intent to derive an illegal personal benefit;
or 79




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any fine levied against the office holder. In addition, under the Companies Law, exculpation of, indemnification of,
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. 
 C. MATERIAL CONTRACTS For a summary of our material contracts, see Item 4-Information on the
Company-Property, Plants and Equipment and Note 21(a) of our consolidated
financial statements included elsewhere in this annual report. 
 D. EXCHANGE CONTROLS Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
general permit was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under the law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies. Dividends, if any, paid to our ordinary shareholders, and any amounts
payable upon our dissolution, liquidation or winding up, as well as the
proceeds of any sale in Israel of our ordinary shares to an Israeli resident,
may be paid in non-Israeli currency or, if paid in Israeli currency, may be
converted into freely repatriable dollars at the rate of exchange prevailing at
the time of conversion. 
 E. TAXATION 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 80




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Israeli companies are subject to company tax at the rate of 36% of taxable
income. According to a proposed amendment to Israeli tax law, the company tax
rate may be reduced in the near future to 35%, and may be additionally reduced
in subsequent tax years. 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 and Trade 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. Taxable income of a company derived from an approved enterprise is subject
to company tax at the maximum rate of 25%, rather than 36%, for the benefit
period. This period is ordinarily seven years, or ten years if the company
qualifies as a foreign investors company as described below, commencing with
the year in which the approved enterprise first generates taxable income.
However, this period is limited to 12 years from commencement of production or
14 years from the date of approval, whichever is earlier. A company owning an approved enterprise may elect to receive an
alternative package of benefits. Under the alternative package of benefits, a
companys undistributed income derived from an approved enterprise will be
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 the company will be eligible for a
reduced tax rate for the remainder of the benefits period. A company that has an approved enterprise program is eligible for further
tax benefits if it qualifies as a foreign investors company. A foreign
investors company is a company more than 25% of whose share capital
representing more than 25% of the rights to profits, voting power and to
nominate directors and more than 25% of the combined share and loan capital is
owned by non-Israeli residents. A company that qualifies as a foreign
investors company and has an approved enterprise program is eligible for tax
benefits for a ten year benefit period. If the level of foreign investment
exceeds 49%, the tax rate is 20%; if the level of foreign investment exceeds
74%, the tax rate is 15%; and if the level of foreign investment exceeds 90%,
the tax rate is 10%. A company that has elected the alternative package of benefits and that
subsequently pays a dividend out of income derived from the approved enterprise
during the tax exemption period will be subject to tax on the amount
distributed, including the amount of company tax 81




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thereon. The tax rate will be the rate that would have been applicable had
the company not elected the alternative package of benefits. This rate is
generally 10%-25%, depending on the percentage of the companys shares held by
foreign shareholders. The dividend recipient is taxed at the reduced rate applicable to
dividends from approved enterprises, which is 15% if the dividend is
distributed (a) during the tax exemption period or within 12 years after the
period or (b) if by a foreign investors company, at any time. The company must
withhold this tax at the source, regardless of whether the dividend is
converted into foreign currency. Subject to applicable provisions concerning income under the alternative
package of benefits, all incomes are considered to be attributable to the
entire enterprise and their effective tax rate is the result of a weighted
average of the various applicable tax rates. Under the Investment Law, a
company that has elected the alternative package of benefits is not obliged to
declare a dividend on exempt retained profits, and may generally decide from which years profits to declare dividends. We currently intend to reinvest
any income derived from our approved enterprise programs and not to distribute
the income as dividends. The Investment Center bases its decision whether or not to approve an
application on the criteria in the Investment Law and regulations, the then
prevailing policy of the Investment Center and the specific objectives and
financial criteria of the applicant. Therefore, we cannot assure you that any
of our applications will be approved. In addition, the benefits available to an
approved enterprise are conditional upon the fulfillment of conditions
stipulated in the Investment Law and its regulations and the criteria in the
specific certificate of approval, as described above. If a company does not
meet these conditions, it would be required to refund the amount of tax
benefits, with the addition of the consumer price index linkage adjustment and
interest. Moreover, it has recently been announced that significant changes in the
Investment Law, including the tax benefits therein, can be expected in the near
future. Nonetheless, 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,
any future changes in the Investment Law are likely to apply only to
applications approved after such changes are legislated. Our facilities in Israel have received Approved Enterprise status from the
Israel Investment Center, which entitles us to receive certain 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% to 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% to 25% for an additional thirteen years 82




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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. Additionally, in October 2003, we submitted
an application for a fourth approval for capital investments that will be
implemented by the end of 2005. The above benefits are conditioned upon the fulfillment of conditions
stipulated by the Investment Law, regulations promulgated thereunder and the
instruments of approval for the specified investments in approved enterprises.
If we fail to comply with these conditions, our benefits may be cancelled and
we may be required to refund the amount of the benefits, in whole or in part. 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 expenditure, 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. 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: Extent of manufacturing
    
    Royalties to the Chief Scientistvolume outside of Israel
    
    as a percentage of grantless than 50%
    
    
    120
    %between 50% and 90%
    
    
    150
    %more than 90%
    
    
    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. 83




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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 at all. 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 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. 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. 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. Special Provisions Relating to Taxation under Inflationary Conditions The Income Tax Law (Inflationary Adjustments), 1985, generally referred to
as the Inflationary Adjustments Law, represents an attempt to overcome the
problems presented to a 84




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traditional tax system by an economy undergoing rapid inflation. The
Inflationary Adjustments Law is highly complex. Its features which are material
to us can be described as follows: There is a special tax adjustment for the preservation of equity as
follows:  
    
    Where a companys equity, as calculated under the
Inflationary Adjustments Law, exceeds the depreciated cost of fixed
assets, a deduction from taxable income is permitted equal to the
excess multiplied by the applicable annual rate of inflation. The
maximum deduction permitted in any single tax year is 70% of taxable
income, with the unused portion permitted to be carried forward.
    
    Where a companys depreciated cost of fixed assets exceeds
its equity, then the excess multiplied by the applicable annual rate
of inflation is added to taxable income.
    
    Subject to specified limitations, depreciation deductions on
fixed assets and losses carried forward are adjusted for inflation
based on the increase in the consumer price index. The Inflationary Adjustments Law also includes provisions concerning
taxation on gains of companies from the sale of traded securities. However, the
Inflationary Adjustments Law does not generally apply to non-resident companies
which do not regularly carry out business in Israel. 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 121⁄2%, 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 85




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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 January 1, 2003 and on 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 be exempt from
any 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 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. Non-residents of Israel who purchase our ordinary shares with Israeli
currency or other foreign currency are able to receive dividends thereon, and
any amounts payable upon the dissolution, liquidation or winding up of our affairs, less any
applicable taxes, as well as the proceeds of any sale of our ordinary shares,
in freely repatriable U.S. dollars (or other currencies) at the rate of the
exchange prevailing at the time of conversion, pursuant to the general permit
issued by the Controller of Foreign Currency at the Bank of Israel under the
Israeli Currency Control Law, 1978, provided that Israeli income tax has been
withheld with respect to such amounts. 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 86




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
    
    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 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 87




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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 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 88




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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 generally 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. 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 shorter 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. 89




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
    
    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. 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 90




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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 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 91




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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. 
 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 obtained 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-based interest rate. As of December 31,
2003, $181.4 million of our outstanding debt bears an average interest rate of
5.3%. Consequently, each 0.25% increase in interest rates will reduce pretax
income by approximately $0.4 million. The Companys functional currency and that of its U.S. subsidiary is the
U.S. dollar, with the exception of its European and Canadian subsidiaries,
where the functional currency is the local currency in their respective
countries. In 2003, over 90% of the Company revenues were generated in U.S. dollars.
However, the remainder of our sales were denominated in the local currencies of
the countries in which 92




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##### Table of Contents



they occurred. As such, 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 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 low level of non-U.S. dollar revenues, the effects of
currency fluctuation on consolidated net revenues and operating income were not
significant. Under current conditions, we do not believe that our exposure to market
risks will have a material impact on future earnings. 
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not Applicable. 
 PART II 
 ITEM 13. DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES Not Applicable. 
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS Not applicable. 
 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-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934, as amended). Based on that
evaluation, which was completed within 90 days of the filing date of
this annual report, our general manager and chief financial officer
concluded that our disclosure controls and procedures were effective.b.
    
    There have been no significant changes in our disclosure controls
or in other factors that would likely significantly affect disclosure
controls subsequent to the date of the evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses. 
 ITEM 16. [RESERVED] 
 A. AUDIT COMMITTEE FINANCIAL EXPERT 93




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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. 
 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
is available to all of our employees upon request from our human resources department, and to
investors by contacting our corporate affairs department and to others
through our legal department. Any waivers of this code for executive
officers or directors will be disclosed through the filing of a Form 6-K.
As referred to above, our Board of directors has 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 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: 2003
    
    2002In million dollarsAudit Fees
    
    $
    0.43
    
    
    $
    0.41Audit-Related Fees
    
    $
    0.13
    
    
    $
    0.23Tax Fees
    
    $
    0.50
    
    
    $
    0.53All Other Fees
    
    
    
    
    
    
    Total
    
    $
    1.06
    
    
    $
    1.17
 94




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##### Table of Contents



The audit fees for the years ended December 31, 2003 and 2002,
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. The audit-related fees represent fees for assurance and due diligence
related to mergers and acquisitions, accounting consultations and audits in
connection with acquisitions, employee benefit plan audits, review of
consolidated quarterly financial statements, internal control reviews,
attestation services that are not required by statute or regulation and
consultations concerning financial accounting and reporting standards. 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. All other fees represent fees for services not otherwise included in the
categories above. 
 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. 
 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
amended (2)2.1
    
    Form of ordinary share certificate (1)4.1
    
    Taro Vit Industries Limited 1984 Stock Option Plan (3)4.2
    
    Taro Vit Industries Limited 1991 Stock Incentive Plan (3)
 95




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##### Table of Contents



Exhibit No.
    
    Description4.3
    
    Taro Pharmaceutical Industries Ltd. 2000 Employee Stock Purchase
Plan (4)4.4
    
    Taro Pharmaceutical Industries 1999 Stock Incentive Plan (5)10.1
    
    Consent of Kost, Forer, Gabbay & Kasierer10.2
    
    Debenture and Loan Agreement dated December 19, 2000 (6)10.3
    
    Loan agreements Dated May 20, 2003 and November 27, 2003
   (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 F-3
(No. 33-11806) and incorporated herein by reference.(3)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 33-80802) and incorporated herein by reference.(4)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 333-12388) and incorporated herein by reference.(5)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 333-13840) 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, 2000. 96




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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,Senior Vice President


and Chief Financial Officer Dated: May 28, 2004 97




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CERTIFICATIONS I, Samuel Rubinstein, certify that: 1. I have reviewed this annual report on Form 20-F of Taro Pharmaceutical
Industries Ltd.; 2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; 3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report; 4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the Evaluation Date); and c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date; 5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the
equivalent function): a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and 6. The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. By:
    /s/ Samuel RubinsteinSamuel RubinsteinDate:  May 28, 2004
    
    Senior Vice President & General Manager 98




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##### Table of Contents



CERTIFICATIONS I, Kevin Connelly, certify that: 1. I have reviewed this annual report on Form 20-F of Taro Pharmaceutical
Industries Ltd.; 2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; 3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report; 4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the Evaluation Date); and c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date; 5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing the
equivalent function): a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and 6. The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. By:
    /s/ Kevin ConnellyKevin ConnellyDate: May 28, 2004
    
    Senior Vice President and Chief Financial Officer 99




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TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2003 IN U.S. DOLLARS PageReport of Independent Accountants
    
    
    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  F40
 100




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2003 IN U.S. DOLLARS TABLE OF CONTENTS PageReport of Independent Auditors
    
    
    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-40
 F-1




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##### Table of Contents



(ERNST & YOUNG LOGO) REPORT OF INDEPENDENT AUDITORS 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, 2003 and 2002, 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, 2003. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our 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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
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, 2003 and 2002, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States. Tel-Aviv, Israel
    
    KOST FORER GABBAY & KASIERERFebruary 16, 2004
    
    A Member of Ernst & Young Global
 F-2




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED BALANCE SHEETS U.S. dollars in thousands December 31,2003
    
    2002ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    159,121
    
    
    $
    130,717Restricted short-term bank deposits
    
    
    2,518
    
    
    
    2,468Accounts receivable:Trade (Note 3a)
    
    
    120,522
    
    
    
    69,038Other receivables and prepaid expenses (Note 3b)
    
    
    17,046
    
    
    
    12,453Inventories (Note 4)
    
    
    84,486
    
    
    
    42,439TOTAL CURRENT ASSETS
    
    
    383,693
    
    
    
    257,115LONG-TERM INVESTMENTS (Note 7)
    
    
    2,888
    
    
    
    1,348PROPERTY, PLANT AND EQUIPMENT, NET (Note 5)
    
    
    182,306
    
    
    
    93,358OTHER INTANGIBLE ASSETS AND DEFERRED CHARGES, NET
(Note 6)
    
    
    30,187
    
    
    
    7,676GOODWILL
    
    
    7,199
    
    
    
    7,150DEFERRED INCOME TAXES (Note 14)
    
    
    10,250
    
    
    
    13,198TOTAL ASSETS
    
    $
    616,523
    
    
    $
    379,845
 The accompanying notes are an integral part of the consolidated financial
statements. F-3




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED BALANCE SHEETS U.S. dollars in thousands December 31,2003
    
    2002LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Short-term bank credit and short-term loans (Note 8)
    
    $
    19,124
    
    
    $
    2,310Current maturities of long-term debt (Note 10)
    
    
    24,420
    
    
    
    7,962Accounts payable:Trade
    
    
    26,148
    
    
    
    25,216Other and accrued expenses (Note 9)
    
    
    31,083
    
    
    
    20,199Income taxes payable
    
    
    2,963
    
    
    
    2,557TOTAL CURRENT LIABILITIES
    
    
    103,738
    
    
    
    58,244LONG-TERM LIABILITIES:Long-term debt, net of current maturities (Note 10)
    
    
    156,937
    
    
    
    47,127Deferred income taxes (Note 14)
    
    
    4,880
    
    
    
    2,780Accrued severance pay
    
    
    1,857
    
    
    
    1,398TOTAL LONG-TERM LIABILITIES
    
    
    163,674
    
    
    
    51,305COMMITMENTS AND CONTINGENCIES (Note 12)MINORITY INTEREST
    
    
    1,711
    
    
    
    1,159SHAREHOLDERS EQUITY (Note 13):Share capital:Ordinary Shares of NIS 0.0001 par value:Authorized at December 31, 2003 and 2002: 200,000,000 shares; Issued at December 31,
2003 and 2002: 29,234,618 and 29,008,589
shares, respectively; Outstanding at December
31, 2003 and 2002: 28,969,218 and 28,744,289,
respectively
    
    
    679
    
    
    
    679Founders shares of NIS 0.00001 par value:Authorized, issued and outstanding at December
31, 2003 and 2002: 2,600 shares
    
    
    1
    
    
    
    1Additional paid-in capital
    
    
    182,699
    
    
    
    173,584Accumulated other comprehensive income (loss)
    
    
    5,695
    
    
    
    (2,358
    )Treasury stock
    
    
    (1,348
    )
    
    
    (1,288
    )Retained earnings
    
    
    159,674
    
    
    
    98,519TOTAL SHAREHOLDERS EQUITY
    
    
    347,400
    
    
    
    269,137TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    616,523
    
    
    $
    379,845
 The accompanying notes are an integral part of the consolidated financial
statements. F-4




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED STATEMENTS OF INCOME U.S. dollars in thousands (except per share data) Year ended December 31,2003
    
    2002
    
    2001Sales (Notes 15a and16)
    
    $
    315,458
    
    
    $
    211,581
    
    
    $
    149,230Cost of sales
    
    
    102,454
    
    
    
    79,468
    
    
    
    54,736Gross profit
    
    
    213,004
    
    
    
    132,113
    
    
    
    94,494Operating expenses:Research and development, net (Note 15b)
    
    
    40,601
    
    
    
    26,373
    
    
    
    19,633Selling, marketing, general and
administrative (Note 15c)
    
    
    97,718
    
    
    
    52,481
    
    
    
    42,086138,319
    
    
    
    78,854
    
    
    
    61,719Operating income
    
    
    74,685
    
    
    
    53,259
    
    
    
    32,775Financial expenses, net (Note 15d)
    
    
    (1,722
    )
    
    
    (162
    )
    
    
    (2,594
    )72,963
    
    
    
    53,097
    
    
    
    30,181Other income (loss), net
    
    
    (7
    )
    
    
    78
    
    
    
    272Income before income taxes
    
    
    72,956
    
    
    
    53,175
    
    
    
    30,453Income taxes (Note 14)
    
    
    11,475
    
    
    
    8,406
    
    
    
    4,37861,481
    
    
    
    44,769
    
    
    
    26,075Minority interest in earnings of a subsidiary
    
    
    (326
    )
    
    
    (214
    )
    
    
    (81
    )Net income
    
    $
    61,155
    
    
    $
    44,555
    
    
    $
    25,994Basic earnings per Ordinary share (Note 13g)
    
    $
    2.12
    
    
    $
    1.55
    
    
    $
    1.11Diluted earnings per Ordinary share (Note 13g)
    
    $
    2.06
    
    
    $
    1.52
    
    
    $
    0.99
 The accompanying notes are an integral part of the consolidated financial
statements. F-5




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY U.S. dollars in thousands AccumulatedAdditional
    
    other
    
    
    
    
    
    
    
    
    
    TotalShare
    
    paid-in
    
    comprehensive
    
    Treasury
    
    Retained
    
    shareholderscapital
    
    capital
    
    income (loss)
    
    stock
    
    earnings
    
    equityBalance at January 1, 2001
    
    $
    680
    
    
    $
    23,961
    
    
    $
    (1,381
    )
    
    $
    (1,016
    )
    
    $
    27,970
    
    
    $
    50,214Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,994
    
    
    
    25,994Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    (1,204
    )
    
    
    
    
    
    
    
    
    
    
    (1,204
    )Unrealized loss on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (6
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,784Tax benefit related to exercise of stock options
    
    
    
    
    
    
    16,045
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,045Exercise of options
    
    
    *
    )
    
    
    989
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    989Stock split effected as a stock dividend (100%)
    
    
    *
    )
    
    
    *
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of shares, net
    
    
    *
    )
    
    
    126,574
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    126,574Amortization of compensation in respect of options granted to
non-employees
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30Purchase of treasury stock
    
    
    *
    )
    
    
    
    
    
    
    
    
    
    
    (272
    )
    
    
    
    
    
    
    (272
    )Balance at December 31, 2001
    
    
    680
    
    
    
    167,599
    
    
    
    (2,591
    )
    
    
    (1,288
    )
    
    
    53,964
    
    
    
    218,364Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,555
    
    
    
    44,555Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    236
    
    
    
    
    
    
    
    
    
    
    
    236Unrealized loss on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (3
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,788Tax benefit related to exercise of stock options
    
    
    
    
    
    
    5,195
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,195Exercise of options and issuance of shares of E
    
    
    *
    )
    
    
    651
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    651Amortization of compensation in respect of options granted to
non-employees
    
    
    
    
    
    
    139
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    139Purchase of treasury stock
    
    
    *
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance at December 31, 2002
    
    
    680
    
    
    
    173,584
    
    
    
    (2,358
    )
    
    
    (1,288
    )
    
    
    98,519
    
    
    
    269,137Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,155
    
    
    
    61,155Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    9,501
    
    
    
    
    
    
    
    
    
    
    
    9,501Unrealized loss from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    (1,448
    )
    
    
    
    
    
    
    
    
    
    
    (1,448
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,208Tax benefit related to exercise of stock options
    
    
    
    
    
    
    6,995
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,995Exercise of options and issuance of shares
    
    
    *
    )
    
    
    2,110
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,110Amortization of compensation in respect of options granted to
non-employees
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Purchase of treasury stock
    
    
    *
    )
    
    
    
    
    
    
    
    
    
    
    (60
    )
    
    
    
    
    
    
    (60
    )Balance at December 31, 2003
    
    $
    680
    
    
    $
    182,699
    
    
    $
    5,695
    
    
    $
    (1,348
    )
    
    $
    159,674
    
    
    $
    347,400Accumulated unrealized gains on available-for-sale marketable securities
    
    
    
    
    
    
    
    
    
    $
    46Accumulated foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    7,097Accumulated unrealized loss from hedging derivatives
    
    
    
    
    
    
    
    
    
    
    (1,448
    )$
    5,695
 *)      Represents an amount lower than $1. The accompanying notes are an integral part of the consolidated financial
statements. F-6




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands Year ended December 31,2003
    
    2002
    
    2001Cash flows from operating activities:Net income
    
    $
    61,155
    
    
    $
    44,555
    
    
    $
    25,994Adjustments required to reconcile net income to
net cash provided by operating activities:Minority interest in earnings of a subsidiary
    
    
    326
    
    
    
    214
    
    
    
    81Depreciation and amortization
    
    
    14,405
    
    
    
    8,263
    
    
    
    6,728Amortization of compensation in respect of
options granted to non-employees
    
    
    10
    
    
    
    139
    
    
    
    30Accrued severance pay, net
    
    
    27
    
    
    
    55
    
    
    
    35Capital gain (loss) on sale of property, plant
and equipment
    
    
    9
    
    
    
    
    
    
    
    (19
    )Currency fluctuation of long-term debt
    
    
    212
    
    
    
    (327
    )
    
    
    (622
    )Deferred income taxes, net
    
    
    9,223
    
    
    
    4,254
    
    
    
    2,117Increase in trade receivables
    
    
    (50,992
    )
    
    
    (26,853
    )
    
    
    (2,560
    )Increase in other accounts receivable and prepaid
expenses
    
    
    (1,209
    )
    
    
    (4,250
    )
    
    
    (1,410
    )Increase in inventories
    
    
    (37,638
    )
    
    
    (11,717
    )
    
    
    (10,454
    )Increase (decrease) in trade payables
    
    
    (340
    )
    
    
    11,090
    
    
    
    4,125Increase in other accounts payable and accrued
expenses
    
    
    10,132
    
    
    
    3,142
    
    
    
    2,662Increase (decrease) in income taxes payable
    
    
    (63
    )
    
    
    1,077
    
    
    
    687Net cash provided by operating activities
    
    
    5,257
    
    
    
    29,642
    
    
    
    27,394Cash flows from investing activities:Purchase of property, plant and equipment
    
    
    (94,421
    )
    
    
    (43,246
    )
    
    
    (19,258
    )Acquisition of Thames Pharmacal Company, Inc. (a)
    
    
    
    
    
    
    (6,436
    )
    
    
    Investments in other intangible assets
    
    
    (10,375
    )
    
    
    (377
    )
    
    
    (1,391
    )Long-term and other deposits
    
    
    (64
    )
    
    
    (130
    )
    
    
    10Investment in restricted short-term bank deposits
    
    
    (50
    )
    
    
    (52
    )
    
    
    (185
    )Proceeds from sale of property, plant and
equipment
    
    
    24
    
    
    
    371
    
    
    
    26Net cash used in investing activities
    
    
    (104,886
    )
    
    
    (49,870
    )
    
    
    (20,798
    )
 The accompanying notes are an integral part of the consolidated financial
statements. F-7




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. dollars in thousands Year ended December 31,2003
    
    2002
    
    2001Cash flows from financing activities:Proceeds from exercise of options and issuance of shares of ESPP
    
    
    2,110
    
    
    
    651
    
    
    
    989Proceeds from issuance of shares, net
    
    
    
    
    
    
    
    
    
    
    126,574Proceeds from long-term debt
    
    
    116,346
    
    
    
    7,183
    
    
    
    15,750Purchase of treasury stock
    
    
    (60
    )
    
    
    
    
    
    
    (272
    )Repayment of long-term debt
    
    
    (8,616
    )
    
    
    (6,006
    )
    
    
    (6,102
    )Short-term bank credit and short-term loans, net
    
    
    17,873
    
    
    
    (1,636
    )
    
    
    51Net cash provided by financing activities
    
    
    127,653
    
    
    
    192
    
    
    
    136,990Effect of exchange rate changes on cash and cash equivalents
    
    
    380
    
    
    
    21
    
    
    
    (99
    )Increase (decrease) in cash and cash equivalents
    
    
    28,404
    
    
    
    (20,015
    )
    
    
    143,487Cash and cash equivalents at the beginning of the year
    
    
    130,717
    
    
    
    150,732
    
    
    
    7,245Cash and cash equivalents at the end of the year
    
    $
    159,121
    
    
    $
    130,717
    
    
    $
    150,732Supplemental disclosure of cash flow transaction:Cash paid during the year for:Interest
    
    $
    3,102
    
    
    $
    2,696
    
    
    $
    3,557Income taxes
    
    $
    5,593
    
    
    $
    3,270
    
    
    $
    1,568(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)
    
    
    
    
    
    $
    (1,788
    )Property, plant and equipment
    
    
    
    
    
    
    220Intangible assets
    
    
    
    
    
    
    4,697Goodwill
    
    
    
    
    
    
    3,307$
    6,436(b) Non-cash investing and financing transactions:Purchase of property, plant and equipment
    
    $
    5,415
    
    
    $
    5,870
    
    
    $
    1,867Investment in other intangible assets
    
    $
    14,100
    
    
    $
    
    
    
    $
    Tax benefit related to exercise of stock options
    
    $
    6,995
    
    
    $
    5,195
    
    
    $
    16,045
 The accompanying notes are an integral part of the consolidated financial
statements. F-8




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##### Table of Contents



TARO PHARMACEUTICAL INDUSTRIES LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share data) 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, 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 20%, 22% and 15% of the Groups
revenues for the years ended December 31, 2003, 2002 and 2001,
respectively (see also Note 15a).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. F-9




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##### Table of Contents



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). 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 and 2001 were not
material in relation to total consolidated sales and net income.c.
    
    On January 14, 2003, Taro Pharmaceuticals North
America, Inc. (TNA) entered into a license and option agreement
with Medicis Pharmaceutical Corporation (Medicis). According to
the agreement, TNA 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
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.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. F-10




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##### Table of Contents



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 certain of its
subsidiaries operate. Thus, the functional and reporting currency
of the Company and certain of its subsidiaries is the dollar.Accordingly, monetary accounts maintained in currencies other than
the dollar are remeasured into dollars in accordance with
Statement of Financial Accounting Standard No. 52 Foreign
Currency Translation. All transaction gains and losses resulting
from remeasurement of monetary balance sheet items 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 the shareholder and the Company, the
shareholder will appoint directors in the U.S. subsidiary as
instructed by the Company. F-11




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##### Table of Contents



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.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  at cost.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.3.
    
    Depreciation is calculated by the straight-line
method over the estimated useful lives of the assets, 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). SOP F-12




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##### Table of Contents



No. 98-1 requires the capitalization of certain costs
incurred in connection with developing or obtaining internal
use software. During the years 2003 and 2002, the Group
capitalized $958 and $777 of software costs, respectively.
Capitalized software costs are amortized by the straight-line
method over their estimated useful life of three years.  i.
    
    Goodwill:Goodwill represents the excess of the costs over the fair value of
net assets of businesses acquired. Goodwill that arose from
acquisitions prior to July 1, 2001, was amortized until December
31, 2001, on a straight-line basis over 40 years. Under Statement
of Financial Accounting Standard No.142, Goodwill and Other
Intangible Assets (SFAS No. 142) goodwill acquired in a
business combination on or after July 1, 2001 and all goodwill
after December 31, 2001, is not amortized.SFAS No. 142 requires goodwill to be tested for impairment on
adoption and at least annually thereafter or between annual tests
in certain circumstances, and written down when impaired, rather
than being amortized as previous accounting standards required.
Goodwill attributable to each of the reporting units is tested for
impairment by comparing the fair value of each reporting unit with
its carrying value. Fair values of the reporting units were
determined using expected future discounted cash flows. The
Company performed the impairment tests during the fourth fiscal
quarter. According to those tests, no impairment exists as of
December 31, 2003.Pro forma information in accordance with SFAS No. 142 has not been
provided, since the goodwill amortization expenses for 2001 were
not material.Changes in goodwill during the year resulting from translation
adjustment related to goodwill recorded in the Canadian
subsidiary.j.
    
    Other intangible assets and deferred charges:Product rights subject to amortization arising from acquisitions
prior to July 1, 2001 continue to be amortized on a straight-line
basis over their useful life. Such product rights are amortized
over eight and 20 years.Intangible assets acquired in a business combination on or after
July 1, 2001, should be 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 No. 142. Related
product rights are amortized over a weighted average life of 15
years.Debt issuance costs in respect of long-term bonds are deferred and
amortized under the effective interest method over the term of the
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.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of the assets to the future
undiscounted cash flows expected to be generated by the assets. If
such assets are considered to be F-13




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impaired, 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, 2003, no impairment losses
have been identified.l.
    
    Revenue recognition:Revenues from product sales are recognized when delivery has
occurred, persuasive evidence of an agreement exists, the vendors
fee is fixed or determinable and collection is probable. The Group
maintains a provision for product returns, 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.m.
    
    Sales incentives and trade promotional allowances:The Company has adopted Emerging Issues Task Force (EITF) No.
01-09 Accounting for Consideration Given by a Vendor to a
Customer or Reseller of the Vendors Products effective December
31, 2001. All sales incentives and trade promotional allowances
generated during prior periods, including selling, marketing,
general and administrative expenses were reclassified as
deductions from sales and accordingly, sales were reduced by $904
in 2001.n.
    
    Research and development:Research and development expenses, net of related grants received,
are charged to expenses as incurred.o.
    
    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 and included as a deduction from research and development
costs.p.
    
    Advertising expenses:The Group expenses advertising costs as incurred. Advertising
expenses were approximately $22,309, $4,075 and $4,038 for the
years ended December 31, 2003, 2002 and 2001, respectively.q.
    
    Income taxes:The Group accounts for income taxes in accordance with Statement
of Financial Accounting Standard No. 109 Accounting for Income
Taxes (SFAS No. 109). SFAS No. 109prescribes the use of the liability method, whereby deferred tax
asset and liability account balances are determined based on the
differences between the financial reporting and tax bases of
assets and liabilities and 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.r.
    
    Basic and diluted net earnings per share: F-14




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##### Table of Contents



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.
Options which have anti-dilutive effect are immaterial.The total weighted average number of shares related to the
outstanding options excluded from the calculations of diluted net
earnings per share, as a result of anti-diluted effect, was
49,000, 164,050 and 11,725 for the years ended December 31, 2003,
2002 and 2001, respectively.s.
    
    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 No. 25) and FASB Interpretation No. 44
Accounting for Certain Transactions Involving Stock Compensation
(FIN No. 44) in accounting for its employees stock options
plans. Under APB No. 25, when the exercise price of an employee
stock option is equivalent to or above the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.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
No. 123) to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of
accounting for stock-based employee compensation, effective as of
the beginning of the fiscal year. The Company continues to apply
the provisions of APB No. 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 No. 123 and has been
determined as if the Company had accounted for its employee stock
options under the fair value method prescribed by SFAS No. 123.The fair value for options granted in 2003, 2002 and 2001 is
amortized over their vesting period and estimated at the date of
grant using a Black-Scholes options pricing model with the
following weighted average assumptions: 2003
    
    2002
    
    2001Dividend yield
    
    0%
    
    0%
    
    0%Expected volatility
    
    52%
    
    52.3%
    
    54.6%Risk-free interest
    
    1.00%
    
    1.75%
    
    2.75%Expected life of up to
    
    5 years
    
    5 years
    
    7 years
  Pro forma information under SFAS No. 123, is as follows: F-15




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##### Table of Contents



Year ended December 31,2003
    
    2002
    
    2001Net income  as reported
    
    $
    61,155
    
    
    $
    44,555
    
    
    $
    25,994Less  total stock-based compensation
expenses determined under fair value
method for all awards, net of related
tax effect
    
    
    1,414
    
    
    
    1,026
    
    
    
    543Net income  pro-forma
    
    $
    59,741
    
    
    $
    43,529
    
    
    $
    25,451Earnings per share:Basic  as reported
    
    $
    2.12
    
    
    $
    1.55
    
    
    $
    1.11Basic  pro forma
    
    $
    2.07
    
    
    $
    1.52
    
    
    $
    1.09Diluted  as reported
    
    $
    2.06
    
    
    $
    1.52
    
    
    $
    0.99Diluted  pro forma
    
    $
    2.01
    
    
    $
    1.48
    
    
    $
    0.97
  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 when performance is completed.t.
    
    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, marketable
securities 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 accordingly, minimal credit risk 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, 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.u.
    
    Fair value of financial instruments:The following methods and assumptions were used by the Group in
estimating their fair value disclosures for financial instruments: F-16




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##### Table of Contents



The carrying amounts of cash and cash equivalents, restricted
short-term bank deposits, trade receivables and trade payables,
approximate their fair value due to the short-term maturities of
these instruments.The carrying and fair values for marketable securities are based
on quoted market prices.The carrying amounts of the Groups borrowing arrangements under
its short-term and long-term debt agreements approximate their
fair value based on the Groups incremental borrowing rates for
similar types of borrowing arrangements.v.
    
    Accounting for derivatives:Financial Accounting Standards Board Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities
(SFAS No. 133), requires companies to recognize all of theirs
derivative instruments as either assets or liabilities in the
statement of financial position at fair value. The accounting for
changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and qualifies
as part of a hedging relationship and further, on the type of
hedging relationship. For those derivative instruments that are
designated and qualify as hedging instruments, a company must
designate the hedging instrument, based upon the exposure being
hedged, as a fair value hedge, cash flow hedge or a hedge of a net
investment in a foreign operation.For derivative instruments that are designated and qualify as a
fair value hedge (i.e., hedging 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 attributable to the hedged risk are
recognized in the same line item associated with the hedged item
in current earnings during the period of the change in fair
values. For derivative instruments that are designated and qualify
as a cash flow hedge (i.e., hedging 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.The cumulative effect of the adoption of SFAS No. 133 was a
decrease in income before taxes of $194 for the year ended
December 31, 2001. This amount is included in financial expenses,
net, and not as an accumulated effect of an accounting change, due
to immateriality. The adoption did not have a material effect on
other comprehensive income.w.
    
    Impact of recently issued accounting standards:In May 2003, the EITF reached a consensus on Issue 00-21,
addressing how to account for arrangements that involve the
delivery or performance of multiple products, services, and/or
rights to use assets. Revenue arrangements with multiple
deliverables are divided into separate units of accounting if the
deliverables in the arrangement meet the following criteria: (1)
the delivered item has value to the customer on a standalone
basis; (2) there is objective and reliable evidence of the fair
value of undelivered items; and (3) delivery of any undelivered
item is probable. Arrangement consideration should be allocated
among the separate units of accounting based on their relative
fair values, with the amount allocated to the delivered item
being limited to the amount that is not contingent on the
delivery of
additional items or on compliance with other specified
performance conditions. The final F-17




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##### Table of Contents



consensus will be applicable to
agreements entered into in fiscal periods beginning after June
15, 2003 with early adoption permitted. The provisions of this
consensus are not expected to have a significant effect on the
Companys financial position or operating results.In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149, Amendment of SFAS No. 133 on Derivative
Instruments and Hedging Activities (SFAS No. 149). SFAS No.
149 amends and clarifies the accounting for derivative
instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities under SFAS No. 133.
SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The Company does not expect the
adoption of SFAS No. 149 to have a material impact on its results
of operations or financial position.In December 2003, the SEC issued Staff Accounting Bulletin No.
104, Revenue Recognition, (SAB No. 104) which revises or
rescinds certain sections of SAB No. 101, Revenue Recognition,
in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC
rules and regulations. The changes noted in SAB No. 104 did not
have a material effect on the Companys consolidated results of
operations, consolidated financial position or consolidated cash
flows. F-18




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##### Table of Contents



NOTE 3:- ACCOUNTS RECEIVABLE  a.
    
    Trade: December 31,2003
    
    2002Open accounts
    
    $
    119,716
    
    
    $
    67,753Notes and checks receivable
    
    
    1,116
    
    
    
    1,311120,832
    
    
    
    69,064Less  allowance for doubtful accounts
    
    
    310
    
    
    
    26$
    120,522
    
    
    $
    69,038
  As for pledges, see Note 11.b.
    
    Other and prepaid expenses: Employees
    
    $
    262
    
    
    $
    175Office of the Chief Scientist
    
    
    670
    
    
    
    345Government authorities
    
    
    4,344
    
    
    
    5,233Derivative instruments (Note 18)
    
    
    1,313
    
    
    
    653Deferred income taxes (Note 14)
    
    
    5,487
    
    
    
    2,707Prepaid expenses
    
    
    3,917
    
    
    
    2,025Other
    
    
    1,053
    
    
    
    1,315$
    17,046
    
    
    $
    12,453
 NOTE 4:- INVENTORIES December 31,2003
    
    2002Raw and packaging materials
    
    $
    32,665
    
    
    $
    17,240Finished goods
    
    
    42,650
    
    
    
    19,865Work in progress
    
    
    7,587
    
    
    
    3,810Purchased products for commercial activities
    
    
    1,584
    
    
    
    1,524$
    84,486
    
    
    $
    42,439
  As for pledges, see Note 11. F-19




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##### Table of Contents



NOTE 5:- PROPERTY, PLANT AND EQUIPMENT  a.
    
    Composition of assets grouped by major classifications
are as follows: December 31,2003
    
    2002Cost:Land
    
    $
    12,491
    
    
    $
    3,028Leasehold land (1)
    
    
    12,539
    
    
    
    9,217Buildings (1)
    
    
    73,712
    
    
    
    36,457Leasehold improvements
    
    
    3,401
    
    
    
    2,657Installation, machinery and equipment
    
    
    100,948
    
    
    
    56,465EDP equipment
    
    
    23,248
    
    
    
    15,490Motor vehicles
    
    
    342
    
    
    
    290Furniture, fixtures and office equipment
    
    
    6,212
    
    
    
    3,965Advance for property and equipment
    
    
    2,023
    
    
    
    4,693234,916
    
    
    
    132,262Accumulated depreciation:Buildings (1)
    
    
    5,375
    
    
    
    3,652Leasehold improvements
    
    
    1,566
    
    
    
    1,151Installation, machinery and equipment
    
    
    29,663
    
    
    
    22,013EDP equipment
    
    
    13,392
    
    
    
    9,816Motor vehicles
    
    
    163
    
    
    
    164Furniture, fixtures and office equipment
    
    
    2,451
    
    
    
    2,10852,610
    
    
    
    38,904Depreciated cost
    
    $
    182,306
    
    
    $
    93,358
  Depreciation expenses were $12,181, $7,875 and $6,402, for the
years ended December 31, 2003, 2002 and 2001, respectively.(1) Certain buildings (the depreciated balance of which as of
December 31, 2003 was $35,877) 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 until the assets are ready for their
intended use, in the amount of $8,211 and $3,222 as of December
31, 2003 and 2002, respectively.c.
    
    Cost of EDP equipment includes, costs of computer
software developed for internal use in the amount of $2,460 and
$1,502 as of December 31, 2003 and 2002, respectively.d.
    
    As of December 31, 2003, the Company has outstanding
contractual commitments to expand its buildings and to purchase
equipment in the amount of $17,153. NOTE 6:- OTHER INTANGIBLE ASSETS AND DEFERRED CHARGES  a.
    
    Composition: F-20




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##### Table of Contents



December 31,2003
    
    2002Original amount:Product rights
    
    $
    32,049
    
    
    $
    7,872Deferred charges in respect of bonds
    
    
    1,327
    
    
    
    79433,376
    
    
    
    8,666Accumulated amortization:Product rights
    
    
    2,667
    
    
    
    616Deferred charges in respect of bonds
    
    
    522
    
    
    
    3743,189
    
    
    
    990Amortized cost
    
    $
    30,187
    
    
    $
    7,676
  b.
    
    Amortization expenses were $2,199, $388 and $326, for
the years ended December 31, 2003, 2002 and 2001, respectively.  c.
    
    As of December 31, 2003, the estimated amortization
expenses of intangible assets for 2004 to 2008 is as follows:
2004  $2,512; 2005  $2,461; 2006  $2,446; 2007  $2,432 and
2008  $2,725. NOTE 7:- LONG-TERM INVESTMENTS December 31,2003
    
    2002Severance pay fund (1)
    
    $
    1,489
    
    
    $
    1,057Derivative instrument (2)
    
    
    1,044
    
    
    
    Long-term deposit
    
    
    355
    
    
    
    291$
    2,888
    
    
    $
    1,348
  (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. As of December 31, 2003, the Company
has no related severance pay liability for such employees. The
severance pay liability for several senior employees is covered
by insurance policies.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 employeesof 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. F-21




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##### Table of Contents



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
$882, $477 and $378 for the years 2003, 2002 and 2001,
respectively. Year ended December 31,2003
    
    2002
    
    2001Pension, retirement savings and
severance expenses
    
    $
    3,060
    
    
    $
    2,138
    
    
    $
    1,930
  (2)
    
    As for derivative instruments, see Note 18. 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: Interest rate
    
    AmountDecember 31,
    
    December 31,2003
    
    2002
    
    2003
    
    2002%Short-term bank credits and loans:In, or linked to, U.S. dollars
    
    
    2.94
    
    
    
    2.72
    
    
    $
    14,605
    
    
    $
    2,310In other currency
    
    
    5.15
    
    
    
    
    
    
    
    4,519
    
    
    
    $
    19,124
    
    
    $
    2,310Total authorized credit lines
approximate
    
    
    
    
    
    
    
    
    
    $
    28,500
    
    
    $
    28,500Unutilized credit lines approximate
    
    
    
    
    
    
    
    
    
    $
    9,006
    
    
    $
    26,190Weighted average interest rates at
the end of the year
    
    
    3.45
    
    
    
    2.72
 F-22




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##### Table of Contents



NOTE 9:- ACCOUNTS PAYABLE  OTHER AND ACCRUED EXPENSES December 31,2003
    
    2002Employees and payroll accruals (including accrual
for vacation pay)
    
    $
    14,599
    
    
    $
    11,876Interest payable
    
    
    1,117
    
    
    
    494Suppliers of property, plant and equipment
    
    
    4,683
    
    
    
    5,130Accrued expenses and other
    
    
    10,684
    
    
    
    2,699$
    31,083
    
    
    $
    20,199
 NOTE 10:- LONG-TERM DEBT  a.
    
    Composed as follows: Bonds
    
    $
    130,432
    
    
    $
    20,724Banks
    
    
    29,672
    
    
    
    29,620Other
    
    
    21,253
    
    
    
    4,745181,357
    
    
    
    55,089Less  current maturities
    
    
    24,420
    
    
    
    7,962$
    156,937
    
    
    $
    47,127
  The Company has undertaken to maintain certain financial ratios in
respect of its long-term debt. As of December 31, 2003, the
Company was in compliance with these ratios. 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 31,2003
    
    2002
    
    2003
    
    2002%In, or linked to, U.S. dollar
    
    
    4.58
    
    
    
    3.08
    
    
    $
    107,604
    
    
    $
    31,882In Canadian dollars
    
    
    5.29
    
    
    
    5.41
    
    
    
    9,891
    
    
    
    4,905In Israeli currency  linked to CPI
    
    
    6.41
    
    
    
    8.25
    
    
    
    63,862
    
    
    
    18,302$
    181,357
    
    
    $
    55,089
  As for hedging foreign currency and interest rate risk of the
portion linked to the Israeli CPI, see Note 18. F-23




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##### Table of Contents



c.
    
    The liabilities mature as follows: December31, 20032004 (current maturity)
    
    $
    24,4202005
    
    
    10,4782006
    
    
    21,7782007
    
    
    20,2912008
    
    
    25,950Thereafter
    
    
    78,440$
    181,357
 NOTE 11:- LIABILITIES COLLATERALIZED BY PLEDGES  a.
    
    Balance of liabilities collateralized by pledges is as
follows: December31, 2003Short-term bank credit and short-term loans *)
    
    $
    19,124Long-term debt (including current maturities)
    
    $
    164,091
  *)
    
    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.  b.
    
    The abovementioned 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 mortgage on
Companys rights to land and buildings and a first priority
floating charge on all property, plant and equipment. F-24




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##### Table of Contents



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: 2004
    
    $
    4,6962005
    
    
    4,0662006
    
    
    3,5792007
    
    
    1,874Thereafter
    
    
    2,295$
    16,510
  Total rent expenses were $3,366, $1,967 and $1,985 for the years
ended December 31, 2003, 2002 and 2001, 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 and is linked to the dollar.
Commencing 1999, grants are subject to interest at a rate of
Dollar Libor. As of December 31, 2003, the aggregate contingent
liability to the OCS amounted to $8,243.c.
    
    A claim in a prior year for compensation 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. 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. F-25




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##### Table of Contents



c.
    
    Public offering:On October 5, 2001, the Company completed a public offering of
3,950,000 Ordinary shares, at $34.30 per share. The public
offering included an additional 1,800,000 Ordinary Shares sold by
certain shareholders of the Company.d.
    
    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. As
of December 31, 2003, none of the options granted include
stock appreciation rights. The options are granted to
employees and associates, have a four to five-year 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, 2003, an aggregate of
983,100 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, 2003 is as
follows: F-26




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##### Table of Contents



WeightedaverageNumber of
    
    Exercise
    
    exerciseoptions
    
    price
    
    price$
    
    $Outstanding at January 1, 2001
    
    
    4,265,698
    
    
    
    
    
    
    
    3.40Exercised
    
    
    (3,427,851
    )
    
    
    1.44 - 8.97
    
    
    
    3.39Canceled and forfeited
    
    
    (44,150
    )
    
    
    2.38 - 22.61
    
    
    
    2.82Granted
    
    
    282,900
    
    
    
    12.91 - 42.46
    
    
    
    21.32Outstanding at December 31,
2001
    
    
    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
    
    
    
    
    
    
    
    23.10
  The number of options exercisable in 2003, 2002 and 2001 are
466,561, 436,160 and 392,099, respectively. The weighted
average exercise price for the options exercisable in 2003,
2002 and 2001 are $7.94, $ 4.82, and $4.41, respectively.The stock options outstanding and exercisable as of December
31, 2003 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
    
    2003
    
    life
    
    price
    
    2003
    
    price$
    
    
    
    
    
    years
    
    $
    
    
    
    
    
    $2.08 - 6.82
    
    
    346,322
    
    
    
    5.08
    
    
    
    3.51
    
    
    
    318,990
    
    
    
    3.406.83 - 13.18
    
    
    282,750
    
    
    
    6.95
    
    
    
    12.31
    
    
    
    96,198
    
    
    
    12.1413.19 - 20.75
    
    
    41,000
    
    
    
    7.04
    
    
    
    15.15
    
    
    
    13,950
    
    
    
    15.2820.76 - 33.98
    
    
    306,700
    
    
    
    8.30
    
    
    
    31.55
    
    
    
    15,528
    
    
    
    27.7033.99 - 42.46
    
    
    146,600
    
    
    
    8.31
    
    
    
    37.05
    
    
    
    21,895
    
    
    
    37.0242.47 - 71.20
    
    
    163,500
    
    
    
    9.65
    
    
    
    56.90
    
    
    
    
    
    
    
    1,286,872
    
    
    
    7.27
    
    
    
    23.10
    
    
    
    466,561
    
    
    
    7.94
 F-27




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##### Table of Contents



3.
    
    The weighted average fair values for options
granted were: Year ended December 31,2003
    
    2002
    
    2001Weighted average fair value on the
date of grant
    
    $
    22.33
    
    
    $
    14.85
    
    
    $
    11.21
  Options to employees were issued at fair market value. No
compensation expenses were recognized in 2003, 2002 or 2001.4.
    
    a) A summary of the Companys stock option
activity in respect of associates and related information for
the three years ended December 31, 2003 is as follows: WeightedAverageNumber of
    
    Exercise
    
    exerciseoptions
    
    price
    
    price$
    
    $Outstanding at January 1, 2001
    
    
    42,500
    
    
    
    
    
    
    
    4.17Exercised
    
    
    (16,500
    )
    
    
    1.88 - 6.19
    
    
    
    3.62Granted
    
    
    6,500
    
    
    
    12.91 - 36.38
    
    
    
    24.58Outstanding at December 31, 2001
    
    
    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
    
    
    
    5.16Canceled
    
    
    (2,000
    )
    
    
    32.61 - 32.61
    
    
    
    32.61Outstanding at December 31, 2003
    
    
    13,500
    
    
    
    2.75 - 36.38
    
    
    $
    10.82
  The number of options exercisable in 2003, 2002 and 2001
were 11,375, 14,750 and 21,025, respectively.The stock options outstanding and exercisable as of
December 31, 2003 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
    
    2003
    
    life
    
    price
    
    2003
    
    price$
    
    
    
    years
    
    $
    
    
    
    $2.08 - 6.19
    
    
    13,500
    
    
    
    5.85
    
    
    
    4.62
    
    
    
    11,375
    
    
    
    4.42
 F-28




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##### Table of Contents



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 with the following
weighted-average assumptions for 2003, 2002 and 2001:
risk-free interest rates of 3.00%, 3.50% and 2.75%,
respectively; dividend yield of 0% for each year;
expected volatility of 52.0%, 52.3% and 58.7%,
respectively; and contractual life of five years for
options granted in 2003 and 2002 and seven years for
options granted in 2001.Compensation expenses of approximately $10, $139 and $30
amortized over the vesting period were recognized in the
years ended December 31, 2003, 2002 and 2001,
respectively.  5.
    
    In 2003, 2002 and 2001, 196,667, 104,334 and
3,444,351 options were exercised to purchase 196,667, 104,334
and 3,444,351 Ordinary shares, respectively. The amount of
consideration received therefrom in 2003, 2002 and 2001, was
$1,422, $651 and $989, respectively.  e.
    
    Dividends:The Company may declare and pay dividends in dollars 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, 2003
    
    Year ended December 31, 2002
    
    Year ended December 31, 2001Net
    
    
    
    
    
    Per
    
    Net
    
    
    
    
    
    Per
    
    Net
    
    
    
    
    
    Perincome
    
    Shares
    
    Share
    
    income
    
    Shares
    
    share
    
    income
    
    Shares
    
    share(numerator)
    
    (denominator)
    
    Amount
    
    (numerator)
    
    (denominator)
    
    amount
    
    (numerator)
    
    (denominator)
    
    amountBasic EPS:Net income
available to
holders of Ordinary
shares
    
    $
    61,155
    
    
    
    28,872,839
    
    
    $
    2.12
    
    
    $
    44,555
    
    
    
    28,664,887
    
    
    $
    1.55
    
    
    $
    25,994
    
    
    
    23,370,224
    
    
    $
    1.11Effect of dilutive
securities:Stock options
    
    
    
    
    
    
    801,309
    
    
    
    (0.06
    )
    
    
    
    
    
    
    743,307
    
    
    
    (0.03
    )
    
    
    
    
    
    
    2,931,705
    
    
    
    (0.12
    )Diluted EPS:Income available to
holders of Ordinary
Shares plus assumed
exercises
    
    $
    61,155
    
    
    
    29,674,148
    
    
    $
    2.06
    
    
    $
    44,555
    
    
    
    29,408,194
    
    
    $
    1.52
    
    
    $
    25,994
    
    
    
    26,301,929
    
    
    $
    0.99
  g.
    
    Stock repurchase:The Group acquired Ordinary Shares of the Company in the amount of
$60, and $272 in 2003 and 2001, respectively, which in the
aggregate represent less than 2% 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 F-29




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##### Table of Contents



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, 2003, participating employees purchased an aggregate
of 87,682 Ordinary Shares at a weighted average exercise price of
$29.70.The amount of consideration received therefrom in
2003 was $688. NOTE 14:- INCOME TAXES  a.
    
    Measurement of taxable income under the Income Tax
(Inflationary Adjustments) Law, 1985:Results for tax purposes were 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 No. 109, the Company has not provided
deferred income taxes on the difference between the functional
currency and the tax bases of assets and liabilities. 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.b.
    
    Tax benefits under the Law for the Encouragement of
Industry (Taxes), 1969:The Company is an industrial company as defined by this law and,
as such, is entitled to certain income tax benefits, mainly
accelerated depreciation in respect of machinery and equipment (as
prescribed by regulations published under the Inflationary
Adjustments Law) and the right to claim public issuance expenses,
amortization of patents and other intangible property rights as
deductions for tax purposes.c.
    
    Tax benefits under the Law for the Encouragement of
Capital Investments, 1959 (the Law):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. The Company is also a foreign investors company,
as defined by the Law and, as such, isentitled 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 the earlier of 12
years from commencement of production or 14 years from the date
of receiving the Approved Enterprise status. F-30




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##### Table of Contents



The Company has three 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 it 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 two
years. Under the second approval, the undistributed income
derived from another Approved Enterprise will be exempt from
corporate tax for a period of four years from 2001, and it 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. 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 and it 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 thirteen 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, 2003,
management believes that the Company is meeting all of the
aforementioned requirements.The tax-exempt income attributable to the Approved Enterprises
can be distributed to shareholders without subjecting the Company
to taxes only upon the complete liquidation of the Company. As of
December 31, 2003, retained earnings included approximately
$86,216 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 in a manner
other than in the complete liquidation of the Company, 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 $8,622 as of December 31, 2003.Income not eligible for Approved Enterprise benefits mentioned
above is taxed at the regular rate of 36%.d.
    
    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 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 andcorporations, 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. F-31




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##### Table of Contents



e.
    
    Income before income taxes comprises the following: Year ended December 31,2003
    
    2002
    
    2001Domestic (Israel)
    
    $
    40,666
    
    
    $
    28,095
    
    
    $
    16,491Foreign (North America, the Cayman
Islands and the U.K.)
    
    
    32,290
    
    
    
    25,080
    
    
    
    13,962$
    72,956
    
    
    $
    53,175
    
    
    $
    30,453
  f.
    
    The provision for income taxes comprises the following: Year ended December 31,2003
    
    2002
    
    2001Current taxes
    
    $
    2,206
    
    
    $
    4,148
    
    
    $
    2,261Deferred income taxes
    
    
    9,269
    
    
    
    4,258
    
    
    
    2,117$
    11,475
    
    
    $
    8,406
    
    
    $
    4,378Domestic
    
    $
    2,556
    
    
    $
    373
    
    
    $
    (91
    )Foreign
    
    
    8,919
    
    
    
    8,033
    
    
    
    4,469$
    11,475
    
    
    $
    8,406
    
    
    $
    4,378
  g.
    
    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 31,2003
    
    2002
    
    2001Income before income taxes
    
    $
    72,956
    
    
    $
    53,175
    
    
    $
    30,453Statutory tax rate
    
    
    36
    %
    
    
    36
    %
    
    
    36
    %Theoretical tax expenses
    
    $
    26,264
    
    
    $
    19,143
    
    
    $
    10,963Deferred tax on losses for which
valuation allowance was provided
    
    
    465
    
    
    
    193
    
    
    
    405
 F-32




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##### Table of Contents



Year ended December 31,2003
    
    2002
    
    2001Approved Enterprise benefit (1)
    
    
    (11,704
    )
    
    
    (8,864
    )
    
    
    (5,590
    )Effect of different tax rates in
other countries
    
    
    (1,024
    )
    
    
    (993
    )
    
    
    (561
    )Non-deductible expenses
    
    
    150
    
    
    
    150
    
    
    
    53Canadian tax benefits in respect of
research and development expenses
    
    
    (2,556
    )
    
    
    (1,078
    )
    
    
    (815
    )Other
    
    
    (120
    )
    
    
    (145
    )
    
    
    (77
    )Income taxes in the statements of
income
    
    $
    11,475
    
    
    $
    8,406
    
    
    $
    4,378(1) Earnings per share amounts of
the tax benefit resulting from the
income exemption:Basic
    
    $
    0.41
    
    
    $
    0.31
    
    
    $
    0.24Diluted
    
    $
    0.39
    
    
    $
    0.30
    
    
    $
    0.21
  h.
    
    Current taxes are calculated at the following rates: 2003
    
    2002
    
    2001On Israeli operations (not including Approved
Enterprise)
    
    
    36
    %
    
    
    36
    %
    
    
    36
    %On U.S. operations *)
    
    
    40.6
    %
    
    
    40.6
    %
    
    
    40.6
    %On Canadian operations *)
    
    
    33.8
    %
    
    
    33.8
    %
    
    
    33.8
    %On U.K. operations *)
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %
  *
    
    ) 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.  i.
    
    Deferred income taxes:Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income
tax purposes. December 31,2003
    
    2002Deferred tax assets:Net operating losses carryforward
    
    $
    14,714
    
    
    $
    25,656Other, net
    
    
    6,147
    
    
    
    2,173Total deferred tax assets
    
    
    20,861
    
    
    
    27,829
 F-33




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##### Table of Contents



December 31,2003
    
    2002Valuation allowance for deferred tax assets *)
    
    
    (5,124
    )
    
    
    (11,924
    )Net deferred tax assets
    
    
    15,737
    
    
    
    15,905Deferred tax liabilities:Tax over book depreciation
    
    
    (3,196
    )
    
    
    (1,539
    )Other, net
    
    
    (1,684
    )
    
    
    (1,241
    )Total deferred tax liabilities
    
    
    (4,880
    )
    
    
    (2,780
    )Net deferred tax assets
    
    $
    10,857
    
    
    $
    13,125Domestic
    
    $
    1,794
    
    
    $
    396Foreign
    
    
    9,063
    
    
    
    12,729$
    10,857
    
    
    $
    13,125
  *)
    
    This allowance consisting of (i) $3,651 related
to the carryforward tax losses of the U.S. subsidiary, (ii)
$1,385 to the U.K., and (iii) $87 to the Hungarian
subsidiarys operations.  The deferred income taxes are presented in the
balance sheet as follows: December 31,2003
    
    2002Among current assets (other accounts receivable
and prepaid expenses)
    
    $
    5,487
    
    
    $
    2,707Long-term deferred income taxes
    
    
    10,250
    
    
    
    13,198Among long-term liabilities
    
    
    (4,880
    )
    
    
    (2,780
    )$
    10,857
    
    
    $
    13,125
  j.
    
    Carryforward tax losses:  1.
    
    The Company:As of December 31, 2003, the Company had no carryforward tax
losses.2.
    
    Israeli subsidiaries:As of December 31, 2003, the Israeli subsidiaries have
carryforward tax losses in the amount of $1,329, linked to
the Israelis 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, 2003, this subsidiary has no carryforward
tax losses.4.
    
    U.K. subsidiary:As of December 31, 2003, this subsidiary has carryforward tax
losses in the amount of $3,893, which may be carried forward
and offset against taxable income for an indefinite period in
the future. F-34




---



##### Table of Contents



5.
    
    U.S. subsidiary:As of December 31, 2003, this subsidiary has carryforward tax
losses in the amount of $37,478 from the options exercised by
certain shareholders whick can be carried forward and offset
against taxable income for 20 years, expiring in 2021.  k.
    
    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 of $5,200 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-35




---



##### Table of Contents



NOTE 15:- SELECTED STATEMENTS OF INCOME DATA Year ended December 31,2003
    
    2002
    
    2001a.
    
    
    Sales by destination (1) (2) (3):Israel
    
    $
    13,468
    
    
    $
    11,809
    
    
    $
    13,690Canada
    
    
    15,603
    
    
    
    12,819
    
    
    
    8,968U.S.A.
    
    
    283,197
    
    
    
    183,857
    
    
    
    123,762U.K.
    
    
    1,878
    
    
    
    1,449
    
    
    
    870Other
    
    
    1,312
    
    
    
    1,647
    
    
    
    1,940$
    315,458
    
    
    $
    211,581
    
    
    $
    149,230(1) Including commercial
activities
    
    $
    3,983
    
    
    $
    1,529
    
    
    $
    1,353(2) Including sales to customer A
    
    $
    62,693
    
    
    $
    46,548
    
    
    $
    19,399Including sales to customer B
    
    $
    52,997
    
    
    $
    25,389
    
    
    $
    22,382(3) Sales to customer A as a
percentage of total sales
    
    
    20
    %
    
    
    22
    %
    
    
    13
    %Sales to customer B as a
percentage of total sales
    
    
    17
    %
    
    
    12
    %
    
    
    15
    %b.
    
    
    Research and development
expenses, net:Total expenses
    
    $
    42,479
    
    
    $
    27,500
    
    
    $
    20,740Less  grants and participations
    
    
    1,878
    
    
    
    1,127
    
    
    
    1,107$
    40,601
    
    
    $
    26,373
    
    
    $
    19,633c.
    
    
    Selling, marketing, general and
administrative expenses:Selling and marketing
    
    $
    30,149
    
    
    $
    15,947
    
    
    $
    15,249Advertising
    
    
    22,309
    
    
    
    4,075
    
    
    
    4,038General and administrative *)
    
    
    45,260
    
    
    
    32,459
    
    
    
    22,799$
    97,718
    
    
    $
    52,481
    
    
    $
    42,086*) Including allowance for
doubtful accounts
    
    $
    284
    
    
    $
    
    
    
    $
    101d.
    
    
    Financial expenses, net *):Interest and linkage differences
on long-term liabilities
    
    $
    2,720
    
    
    $
    2,944
    
    
    $
    2,078Income in respect of deposits
    
    
    (1,469
    )
    
    
    (2,351
    )
    
    
    (794
    )Expenses in respect of short-term
credit
    
    
    1,245
    
    
    
    506
    
    
    
    1,070Foreign currency translation
losses (gains)
    
    
    (774
    )
    
    
    (937
    )
    
    
    240$
    1,722
    
    
    $
    162
    
    
    $
    2,594*) Net of interest capitalized in
cost of property, plant and
equipment
    
    $
    1,180
    
    
    $
    479
    
    
    $
    
 F-36




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##### Table of Contents



NOTE 16:- SEGMENT INFORMATION  The Group operates in one industry segment. The Company has three main
reportable geographic areas. The data is presented in accordance with
Statement of Financial Accounting Standard No. 131, Disclosure About
Segments of an Enterprise and Related Information. Information by
geographic area is as follows: Israel *)
    
    Canada **)
    
    U.S.A.
    
    Elimination
    
    ConsolidatedYear ended December 31, 2003:Sales to unaffiliated customers
    
    $
    16,658
    
    
    $
    15,603
    
    
    $
    283,197
    
    
    $
    
    
    
    $
    315,458Inter-area sales to affiliates
    
    
    109,838
    
    
    
    79,262
    
    
    
    
    
    
    
    (189,100
    )
    
    
    Total sales
    
    $
    126,496
    
    
    $
    94,865
    
    
    $
    283,197
    
    
    $
    (189,100
    )
    
    $
    315,458Operating income
    
    $
    51,053
    
    
    $
    13,843
    
    
    $
    18,390
    
    
    $
    (8,601
    )
    
    $
    74,685Financial income (expenses), net
    
    $
    (1,594
    )
    
    $
    1,234
    
    
    $
    (1,362
    )
    
    $
    
    
    
    
    (1,722
    )Other income (loss), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )Income before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    72,956Income taxes
    
    $
    3,948
    
    
    $
    1,565
    
    
    $
    7,291
    
    
    $
    (1,329
    )
    
    
    11,475Minority interest in earnings
of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    326Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    61,155Depreciation and amortization
    
    $
    6,804
    
    
    $
    4,555
    
    
    $
    3,018
    
    
    $
    
    
    
    $
    14,377Long-lived assets
    
    $
    123,631
    
    
    $
    45,865
    
    
    $
    20,009
    
    
    $
    
    
    
    $
    189,505Capital expenditures
    
    $
    61,119
    
    
    $
    20,391
    
    
    $
    12,911
    
    
    $
    
    
    
    $
    94,421
  *)
    
    Includes operations in Europe and other markets.**)
    
    Includes operations in both Canada and Cayman Islands. F-37




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##### Table of Contents



Israel *)
    
    Canada **)
    
    U.S.A.
    
    Elimination
    
    ConsolidatedYear ended December 31, 2002:Sales to unaffiliated customers
    
    $
    14,905
    
    
    $
    12,819
    
    
    $
    183,857
    
    
    $
    
    
    
    $
    211,581Inter-area sales to affiliates
    
    
    74,044
    
    
    
    56,148
    
    
    
    
    
    
    
    (130,192
    )
    
    
    Total sales
    
    $
    88,949
    
    
    $
    68,967
    
    
    $
    183,857
    
    
    $
    (130,192
    )
    
    $
    211,581Operating income
    
    $
    35,099
    
    
    $
    13,908
    
    
    $
    12,742
    
    
    $
    (8,490
    )
    
    $
    53,259Financial income (expenses), net
    
    $
    870
    
    
    $
    31
    
    
    $
    (1,063
    )
    
    $
    
    
    
    
    (162
    )Other income (loss), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    78Income before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,175Income taxes
    
    $
    595
    
    
    $
    3,245
    
    
    $
    4,788
    
    
    $
    (222
    )
    
    
    8,406Minority interest in earnings
of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    214Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    44,555Depreciation and amortization
    
    $
    4,647
    
    
    $
    1,493
    
    
    $
    2,123
    
    
    $
    
    
    
    $
    8,263Long-lived assets
    
    $
    67,504
    
    
    $
    22,964
    
    
    $
    10,040
    
    
    $
    
    
    
    $
    100,508Capital expenditures
    
    $
    25,061
    
    
    $
    10,859
    
    
    $
    7,326
    
    
    $
    
    
    
    $
    43,246
 Israel *)
    
    Canada **)
    
    U.S.A.
    
    Elimination
    
    ConsolidatedYear ended December 31, 2001:Sales to unaffiliated customers
    
    $
    16,500
    
    
    $
    8,968
    
    
    $
    123,762
    
    
    $
    
    
    
    $
    149,230Inter-area sales to affiliates
    
    
    45,730
    
    
    
    42,082
    
    
    
    
    
    
    
    (87,812
    )
    
    
    Total sales
    
    $
    62,230
    
    
    $
    51,050
    
    
    $
    123,762
    
    
    $
    (87,812
    )
    
    $
    149,230Operating income
    
    $
    21,361
    
    
    $
    10,938
    
    
    $
    4,254
    
    
    $
    (3,778
    )
    
    $
    32,775Financial income (expenses), net
    
    $
    (2,304
    )
    
    $
    51
    
    
    $
    (341
    )
    
    $
    
    
    
    
    (2,594
    )Other income (loss), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    272Income before income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,453Income taxes
    
    $
    94
    
    
    $
    2,792
    
    
    $
    1,777
    
    
    $
    (285
    )
    
    
    4,378Minority interest in earnings of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    25,994Depreciation and amortization
    
    $
    4,048
    
    
    $
    1,200
    
    
    $
    1,480
    
    
    $
    
    
    
    $
    6,728Long-lived assets
    
    $
    43,991
    
    
    $
    9,995
    
    
    $
    3,877
    
    
    $
    
    
    
    $
    57,863
  *)
    
    Includes operations in Europe and other markets.**)
    
    Includes operations in both Canada and Cayman Islands.  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. F-38




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##### Table of Contents



NOTE 17:- TRANSACTIONS WITH RELATED PARTIES Transactions with related parties: Year ended December 31,2003
    
    2002
    
    2001Compensation to related parties *):Wages and salaries
    
    $
    2,131
    
    
    $
    1,669
    
    
    $
    1,184Management fees
    
    
    1,382
    
    
    
    1,060
    
    
    
    808Directors fees
    
    
    103
    
    
    
    74
    
    
    
    88$
    3,616
    
    
    $
    2,803
    
    
    $
    2,080*) Compensation was paid to related parties,
as follows:Related parties employed by the Group
    
    $
    2,150
    
    
    $
    1,689
    
    
    $
    1,201Related parties not employed as
above  directors (including
companies held by these directors)
    
    $
    1,466
    
    
    $
    1,114
    
    
    $
    879Number of individuals to whom the
compensation relates (includes all
directors)
    
    
    11
    
    
    
    11
    
    
    
    10
 NOTE 18:- DERIVATIVE FINANCIAL INSTRUMENTS  The Companys primary objective for holding derivative financial
instruments is to manage foreign currency and interest rate risks. The
Companys derivative instruments are recorded at fair value and are
included as parts of assets and liabilities as of December 31, 2003 as
follows: As recorded
    
    Fair valueOther and prepaid expenses
    
    $
    1,313
    
    
    $
    1,313Long-term investment
    
    $
    1,044
    
    
    $
    1,044Other accounts payable and accrued liabilities
    
    $
    63
    
    
    $
    63Long-term debt
    
    $
    2,060
    
    
    $
    2,060
  Foreign currency and interest rate risk:The Company transacts business in various foreign currencies,
primarily NIS. In 2000, the Company entered into a cross currency swap
to hedge the NIS denominated fixed rate bonds. This swap has been
designed as a fair value hedge of the changes in fair value of the
bonds, due to both interest rate risk and foreign exchange risk. In
2003, the Company entered into an additional cross currency swap to
hedge the NIS denominated fixed rate bonds. This swap has been
designed as a cash flow hedge of a fixed rate due to the foreign
exchange risk. F-39




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##### Table of Contents



There is no material ineffectiveness related to these hedges.
Management believes that the financial institution associated with the
aforementioned investments is financially sound and, accordingly,
minimal credit risk exists with respect to these derivative
instruments.
As of December 31, 2003, the notional amount of the swap is $62,700. NOTE 19:- SUBSEQUENT EVENTS (UNAUDITED)  On January 8, 2004, the Companys U.S. subsidiary 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. The U.S. subs acquired the facility for approximately $18,000.
In conjunction with the purchase, the U.S. subsidiary expects to
receive certain financial incentives from the New Jersey Economic
Development Authority. END OF CONSOLIDATED FINANCIAL STATEMENTS F-40




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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
amended (2)2.1
    
    Form of ordinary share certificate (1)4.1
    
    Taro Vit Industries Limited 1984 Stock Option Plan (3)4.2
    
    Taro Vit Industries Limited 1991 Stock Incentive Plan (3)4.3
    
    Taro Pharmaceutical Industries Ltd. 2000 Employee Stock Purchase
Plan (4)4.4
    
    Taro Pharmaceutical Industries 1999 Stock Incentive Plan (5)10.1
    
    Consent of Kost, Forer, Gabbay & Kasierer10.2
    
    Debenture and Loan Agreement dated December 19, 2000 (6)10.3
    
    Loan agreements Dated May 20, 2003 and November 27, 2003
   (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 F-3
(No. 33-11806) and incorporated herein by reference.(3)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 33-80802) and incorporated herein by reference.(4)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 333-12388) and incorporated herein by reference.(5)
    
    Previously filed as an exhibit to our Registration Statement on Form S-8
(No. 333-13840) 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, 2000. 101