SkyePharma 2006 Annual Report

making good drugs better SkyePharma PLC Annual Report 2006 SkyePharma PLC Annual Report 2006 Our Mission SkyePharma’s mission is to become one of the world’s leading speciality pharmaceutical companies, powered through excellence in drug delivery. We strive to improve patient clinical outcome by using our multiple delivery technologies to create enhanced versions of existing pharmaceutical products. Corporate Highlights — Company restructuring successfully completed by new management team — Sale of Injectable Business completed in March 2007: — Eliminates related operating losses and need to invest — Potential upside from development of DepoBupivacaine™ at no cost/risk to the Group — Major financial restructuring: — Raised £35m new finance facility from Christofferson Robb & Co. (‘CRC’) in December 2006 — Paul Capital Refinancing agreed in March 2007. Exceptional Credit £20.1m in 2006 — Equity placing raised £14.8m (net) in March 2007 — Total debt less cash at year end £111.7m (2005: £109.8m) including convertible bonds — Good progress with Flutiform™: — Licensed for US to Kos (now Abbott), for Europe to Mundipharma — Phase III clinical trials progressing to plan with Food and Drug Administraton (‘FDA’) filing expected around end of 2007 — Revenue: — Revenue from continuing operations down 15% to £43.0m (2005: £50.8m) — Cash received from license signing and milestone fees up 24% at £30.0m (2005: £24.1m) — Royalty revenue totalled £18.1m (2005: £19.6m), reflecting continuing sales of existing products Contents :IFC Our Mission :IFC Corporate Highlights :01 Financial Highlights :02 Chairman’s Statement :05 Operating and Financial Review :15 Corporate Social Responsibility :16 Products :18 Directors and Advisers :20 Report of the Directors :23 Corporate Governance :29 Statement of Directors’ Responsibilities :30 Remuneration Report :47 Independent Auditors’ Report :48 Consolidated Income Statement :49 Consolidated Balance Sheet :50 Company Balance Sheet :51 Consolidated Statement of Recognised Income and Expense :51 Company Statement of Recognised Income and Expense :52 Consolidated Cash Flow Statement :53 Notes to the Consolidated Cash Flow Statement :54 Company Cash Flow Statement :55 Notes to the Financial Statements :92 Non-Audited Financial Information Extracted from the January 2007 Circular :96 Notice of Annual General Meeting 01 SkyePharma PLC Annual Report 2006 Highlights Financial Highlights 2006 £m Continuing operations Revenue from continuing operations Research and development expenditure Operating loss from continuing operations before exceptionals Loss before tax from continuing operations after exceptionals Discontinued operations Revenue from discontinued operations Operating loss from discontinued operations (before exceptionals) Loss before tax from discontinued operations after exceptionals Net debt Total debt less cash including convertible bonds† 43.0 (22.9) (13.9) (17.9) 6.3 (16.1) (59.0) 111.7 2005* £m 50.8 (14.3) (1.0) (20.3) 10.5 (15.9) (30.3) 109.8 * The income statement for 2005 has been restated to show the discontinued operations separately from the continuing operations. † Total debt less cash including convertible bonds includes convertible bonds at face value. Revenue (£m) Continuing Operations 2004 2005 2006 I 0.0 10.0 Research and Development (£m) Discontinued Operations 56.1 50.8 43.0 6.3 10.5 19.1 Oral and Inhalation 2004 2005 2006 14.3 22.9 15.4 I 20.0 I 30.0 I 40.0 I 50.0 I 60.0 I 70.0 I 80.0 0.0 I 5.0 I 10.0 I 15.0 I 20.0 I 25.0 Net Cash and Facilities (£m) Net Cash Dec 2005 June 2006 Dec 2006 0.0 Cash Flow (£m) Facilities -8.7 Operational Cash Flow -3.4 Capex 1.3 34.3 21.8 10.6 1.3 -6.9 Investment Disposals 35.6 Debt repaid -5.3 Total: -£23.4m Interest -0.4 I 10.0 I 20.0 I 30.0 I 40.0 I 50.0 Other I -10.0 I -8.0 I -6.0 I -4.0 I -2.0 0.0 I 2.0 I 4.0 Net cash and facilities comprises cash, less overdrafts, plus the balance of undrawn facilities. The cash inflow from continuing operations was £1.0 million whilst the discontinued operations had a cash outflow of £24.4 million. Brand names appearing in italics throughout Report are trademarks owned by and/or licensed to SkyePharma or associated companies. SkyePharma PLC Annual Report 2006 02 Chairman’s Statement “We have achieved all of the objectives set early in 2006 as well as completing a major financial restructuring.” 2006 was a year of significant transition that established a new direction for SkyePharma. The new management team with Frank Condella as CEO, Ken Cunningham as COO and Peter Grant as Finance Director delivered on all of the objectives set early in the year, and transformed the financial position of the Group. Dr Jerry Karabelas credit of £20.1 million arose from the reduction in estimated future payments to Paul Capital as detailed in Note 24. The Injectable Business lost £22.0 million in the year (2005: £14.0 million) which is reported as a result from Discontinued Operations. The net result after exceptional charges, finance charges and tax was a loss of £77.7 million (2005: £50.9 million). Achievements Under the leadership of the new management, we have achieved all of the objectives set early in 2006 as well as completing a major financial restructuring which has significantly strengthened the Group’s working capital position. We achieved our objective of licensing Flutiform™, our key combination asthma product for the United States and Europe. We announced Kos Pharmaceuticals Inc. as our US partner in May 2006 and Mundipharma International Corporation Limited as our partner for Europe in September. Kos was subsequently acquired by Abbott Laboratories, which is now our partner for the important US territory. We have not yet concluded agreements for Canada and Japan but are aiming to do so in 2007. Consolidated results The continuing business (being the Group excluding the Injectable Business which was sold in March 2007) achieved revenues of £43.0 million in the year, 15% below the £50.8 million reported in 2005. This was primarily due to the deferral of recognition of up-front milestone payments received in 2006 for the US and European marketing and distribution rights for Flutiform™. Cash received from milestones totalled £30.0 million (2005: £24.1 million). The continuing business incurred an operating loss, before exceptional items, of £13.9 million (2005: loss of £1.0 million) after investing £19.0 million (2005: £8.7 million) in the continued development of Flutiform™. After net finance costs and share of losses in associated companies, the continuing business incurred a loss before exceptional items and tax of £25.0 million (2005: £15.2 million). Phase III trials for Flutiform™ started in February 2006, as planned, and all studies are progressing well. Flutiform™ Exceptional items totalled £29.9 million (net). Exceptional charges arose from the development represents our largest impairment of assets (including £37.0 expense and use of cash. This will million from the write down of the carrying continue until the New Drug Application value of the Injectable Business, which (‘NDA’) is filed in the US, which is expected was sold on 23 March 2007) and other to be around the end of 2007. Flutiform™ one-off charges as detailed in Note 5 to European development is also continuing the financial statements. An exceptional with filing expected in 2008. 03 Chairman’s Statement SkyePharma PLC Annual Report 2006 Foradil® Certihaler™, which is licensed to Novartis worldwide, was approved in December in the United States by the FDA. This was a major achievement for our development team and the device. We continue to work with Novartis regarding the potential commercialisation of this product and we also see the device as having potential in other products. Our oral pipeline was expanded with one new partnered project, a controlled release version of nisoldipine (Sular®), with Sciele Pharma, our US partner for Triglide™. We are currently working to partner two other early stage products: a sleep disorder product and a product to treat acute pain and inflammation. Given the size of these indications, and the potential costs associated with conducting clinical trials for these programmes, we have decided the best course of action would be to find partners for these programmes to share in the potential costs of development. This will enable us to focus our financial resources on completing the Flutiform™ development whilst creating future value from our innovative ideas, skills and technology. In early January 2007, we reached agreement with Blue Acquisition Corp. to divest our Injectable Business. This is a stand-alone operation in San Diego with its own management team and manufacturing facilities for marketed products (DepoCyt® and DepoDur™). Its major pipeline product is DepoBupivacaine™, which represents a significant commercial opportunity. Consideration for the sale included an upfront payment and other potential payments dependent on the successful commercialisation of DepoBupivacaine™. The disposal of the Injectable Business both releases cash and relieves the Group of a significant cash burn due to operating losses and the potential costs of future product development and related capital expenditure. We reduced corporate overhead costs by closing our New York office and significantly reducing the size of our London Office. We intend to continue to keep costs firmly under control and anticipate a substantial reduction in expenditure on research and development once the Flutiform™ trials are completed. Financing Ahead of the sale of the Injectable Business, we arranged a royalty and asset based financing facility from Christofferson Robb & Co. (‘CRC’) for approximately £35 million. Upon completion of the sale in March 2007, we also completed a refinancing of the Paul Capital facility and an equity placing for £14.8 million (net of costs). This financial restructuring together with the consideration received for the Injectable Business has greatly improved our cash position and will result in a substantial reduction of the cost of the Paul Capital finance charges in 2007 compared with 2006. In 2007 we will commence work on refinancing the £89.6 million convertible bonds so that the earliest redemption dates are extended in order to more closely match the liquidity profile of the Group. Board The stronger financial position of the Group provides the opportunity to work on attracting new talent and reshaping the composition of the non-executive membership of the Board. During 2006, we established a process whereby we consult with major investors on the selection of new Directors as well as overall business strategy. Following a review of the fee structure, from 1 April 2007 the Chairman and Non-Executive Directors have agreed to lower compensation amounting in aggregate to a reduction in total fees of nearly one-third. The Remuneration Committee in consultation with the Executive Directors, and with their full support, has not awarded them any bonuses in respect of 2006 or base salary increase in respect of 2007. Although overall non-financial objectives and the major financial restructuring were achieved during 2006 or shortly thereafter, it was agreed by the Executive Directors that the Company’s share price performance during 2006 did not warrant any such bonuses or increase. Long-term incentive plans As announced on 18 April 2007, having taken advice and consulted with principal shareholders, the Board has called an extraordinary general meeting on 4 May 2007 to seek approval for a long-term incentive plan to provide incentives to Executive Directors and senior managers. The previous plans expired in June 2006 and the Remuneration Committee concluded that it would be appropriate to implement a replacement plan as soon as possible to provide the Executive team with the appropriate incentives in alignment with the interests of the Company’s shareholders. Strategy and objectives SkyePharma’s strategy is to become a leading speciality pharmaceutical SkyePharma PLC Annual Report 2006 04 Chairman’s Statement company by using its proprietary technologies and competitive capabilities, particularly in the areas of inhaled and controlled-oral drug delivery, to produce new formulations of known molecules that meet market needs. Our near-term objectives are as follows: — Work with partners to maximize royalty streams of existing and near-term launch products: — Marketed products include Paxil CR™, Xatral® OD (Uroxatral®), Solaraze® and Triglide™; — Near-term launch products include Requip® XL 24-hour™, Lodotra™, zileuton CR, Foradil® Certihaler™ and nisoldipine CR; — Successfully complete development of Flutiform™ and gain approvals for asthma in the US and European markets. Work with partners to gain additional indications of COPD and paediatrics; — Finalize marketing partners for Flutiform™ for Canada and Japan; — Enter into new partner-financed development programmes that increase the number of products in our pipeline; — — Reduce unfunded third-party expenditure on clinical trials significantly after the successful filings of Flutiform™ in US and Europe; Use FlutiformTM earnings to further strengthen the balance sheet and provide new opportunities for future growth. Outlook In 2007, since new products are planned to be launched towards the end of the year, revenues are unlikely to show a significant increase compared with 2006. We expect that there will be some reduction in sales, general and administration costs compared with 2006, but these savings are likely to be more than offset by the planned costs of completing the Phase III clinical trials for Flutiform™ during 2007. In 2008, as the research and development costs scale back to a more normal level and pipeline products come to market, our objective is to move into operating profit (before finance costs). We have set a target to become profitable (after tax) in 2009. Our goal remains to deliver long-term value for shareholders. We thank all of our shareholders, employees and many business partners for their support during the past year. Dr Jerry Karabelas Non-Executive Chairman 25 April 2007 05 SkyePharma PLC Annual Report 2006 Operating and Financial Review “Both Abbott and Mundipharma share our belief in the high potential of Flutiform™.” Review of Products INHALATION PRODUCTS the specific expertise Kos has in inhalation therapies. Frank Condella FlutiformTM HFA-MDI Flutiform™ HFA-MDI is a fixed-dose combination of formoterol and the inhaled steroid fluticasone in a metered dose inhaler (‘MDI’). The product uniquely incorporates the fastest onset long-acting beta-agonist (formoterol) with the most commonly prescribed steroid (fluticasone) in combination with an environmentally friendly aerosol propellant (‘HFA’) and is being developed for asthma and chronic obstructive pulmonary disease (‘COPD’). Flutiform™ commenced Phase III trials in February 2006, on target, and is on track for a target US filing date around the end of 2007, with a target approval in the first half of 2009. The European filing is targeted for around the end of 2008 with launch expected in 2010. Abbott has exclusive rights to market Flutiform™, once approved, in the US and a right of first negotiation for Canada. SkyePharma could receive up to $165 million (£89 million) in milestone payments, of which $25 million (£13.5 million) were paid upfront, up to $80 million (£43.2 million) are payable up to and including approval and up to $60 million (£32.4 million) are sales related. In addition the Group will earn royalties starting in the mid teens on net sales by Abbott. We are managing and funding the trials needed for approval of Flutiform™ in adult asthma while, if it chooses to do so, Abbott is responsible for managing and funding the trials needed for all other indications, including COPD and paediatrics. Abbott is also responsible for all marketing and post-approval studies. The US represents the largest market opportunity for Flutiform™. Sales In May 2006 we announced that we had entered into an agreement with Kos of combination products containing a Pharmaceuticals, Inc. to market steroid and a long-acting beta-agonist are Flutiform™ in the US and in September we forecast to exceed $10 billion by 2009, which is when we expect Flutiform™ to announced an agreement with Mundipharma International Corporation be launched. Limited to develop Flutiform™ for Europe and other territories outside the Americas Mundipharma has exclusive rights in and Japan. Europe and other territories outside the Americas and Japan. The agreement provides for up to €82 million (£58.6 In December 2006 Abbott Laboratories million) in milestone payments, of which acquired Kos, stating that Flutiform™ will €15 million (£10.7 million) was paid provide an expanded presence for Abbott upfront to the Group, up to €27 million in the $10 billion asthma market. The (£19.3 million) payments are earmarked Directors believe that prospects for to cover specific development costs and Flutiform™ are enhanced by Abbott’s up to €40 million (£28.6 million) are sales acquisition of Kos as Abbott brings related. In addition, the Group will earn additional size and marketing strength in the primary care area which complements royalties, escalating upwards from SkyePharma PLC Annual Report 2006 06 Operating and Financial Review a low teens percentage of net sales. Mundipharma will have access to data from the trials we are conducting for FDA approval, which will be used as the basis for obtaining European approval. Mundipharma will also conduct an additional clinical study needed for regulatory approval in Europe and also the studies needed to extend the indication to paediatric patients and to a higher dose strength. The costs of these studies will be recouped from future royalty and milestone payments to SkyePharma. As stated above, the Flutiform™ project continues to operate substantially to the original timescales. We are in the process of seeking licensees for Canada and Japan. Solaraze® Solaraze® (diclofenac), our topical gel Under the agreement with Abbott and treatment for actinic keratosis, an early Mundipharma, SkyePharma will supply form of skin cancer, is marketed in the US Flutiform™, which will be sourced from We continue to work with Novartis by Bradley Pharmaceuticals. Sales in 2006 a third party manufacturer. regarding the potential commercialisation were up by 50% on the prior year to $22 of this product, following which we would million. Sales in Europe and certain other Both Abbott and Mundipharma share earn a mid single digit royalty on net sales territories by Shire plc were $13.2 million, our belief in the high potential of as well as manufacturing and supplying up by 6% from $12.5 million in 2005. Flutiform™ as a superior product the product. Both partners are actively involved in concept, differentiated from competing campaigns to raise awareness of the combination asthma products. risks posed by this common condition. We see the SkyeHaler™ multi-dose dry Solaraze® has been approved and Pulmicort® HFA-MDI powder inhaler device (used for Foradil® Certihaler™) as having potential in other This new HFA-MDI containing marketed in the United States and Europe products, including combination products. for several years and received approval for AstraZeneca’s inhaled corticosteroid Pulmicort® (budesonide) which was registration by the Australian Government developed for territories outside of the US, ORAL AND TOPICAL PRODUCTS Department of Health and Ageing was filed for marketing authorisation in Therapeutic Goods Administration (‘TGA’) June 2005 on a country-by-country basis on 28 November 2006. SkyePharma’s Paxil CRTM in Europe for the treatment of asthma in marketing partner in Australia, Shire plc, Paxil CRTM is an improved formulation of adults and children. The HFA-MDI will aims to launch Solaraze® after selection of the anti-depressant Paxil® developed by replace the currently available MDI SkyePharma with GlaxoSmithKline using a distributor and final approval of product formulation of Pulmicort® which uses SkyePharma’s Geomatrix™ technology. information and reimbursement. the environmentally unfriendly Sales of Paxil CR™ in 2006 were up by 38% SkyePharma receives a low teens royalty on relevant net sales. chlorofluorocarbons (‘CFC’s) as the on the prior year to $318 million. The propellant. SkyePharma developed this majority of these sales were in the US on new formulation, which employs its which we earned a royalty of 4%. However, TriglideTM proprietary formulation technology, and this growth was largely a result of shortTriglide™ (fenofibrate), an oral treatment also conducted the clinical development term supply disruption of Paxil CR™ for elevated blood lipid disorders, is programme for AstraZeneca. The product during 2005. Royalty income was, marketed in the United States by Sciele has been approved in 11 countries, however, down compared with 2005 as Pharma, Inc. and was launched in July including Germany, Spain and Switzerland. during the supply disruption we were paid 2005. In December 2006, TriglideTM AstraZeneca is now managing the launch royalties based on higher budgeted sales captured 2.5% of new prescriptions for process and has already launched of Paxil CR™ as required by contract. The fenofibrate and 1.8% of total prescriptions. Pulmicort® HFA-MDI in Finland, Latvia and first US generic competitor for Paxil CR™ TriglideTM growth was due primarily to Denmark. SkyePharma earns a mid teens could enter the market in the second half greater focus by Sciele’s sales force on key of 2007 and this could impact sales of royalty on AstraZeneca’s net sales of targeted physicians and increased Paxil CR™. Pulmicort® HFA-MDI. managed care access and was one of the key drivers in Sciele’s strong revenue Xatral® OD growth. SkyePharma receives 25% of Foradil® Certihaler™ Sciele’s net sales, out of which we pay for The Foradil® Certihaler™ is the multi-dose Xatral® OD (Uroxatral® in the United dry powder inhaler version of Novartis’s States) is our once-daily version of Sanofi- manufacturing. long-acting beta-2-agonist Foradil® (formoterol fumarate). Global sales of Foradil® (in other devices) were $331m in 2006. For Foradil® Certihaler™ we developed not only the multi-dose drypowder inhaler device but also the formulation technologies designed to ensure dose consistency regardless of storage conditions. After launch in two European markets in late 2005, the product was voluntarily withdrawn by Novartis early in 2006 because a small number of patients received an incorrect dose after mishandling the device. During 2006 SkyePharma and Novartis successfully made modifications to the inhaler to prevent the identified problem from recurring and submitted these to the FDA. In December 2006 the FDA approved the modified Foradil® Certihaler™ for the treatment of asthma. Foradil® Certihaler™ is approved in 30 countries outside of the United States. Aventis’ Xatral® (alfuzosin), a treatment for the urinary symptoms of benign prostatic hypertrophy. Xatral® OD has been on the market outside the US since April 2000 and older multidose versions of Xatral® have now largely been withdrawn. European sales have started to be affected by generic competition after the expiry of a key European patent in May 2006, and the impact increased in the second half of 2006. However, this impact was offset by strong growth in the US. In 2006, reported sales of all forms of Xatral® were €353 million, up by 7.3% (on a comparable basis) on the prior year. Included in this were US sales of Uroxatral®. SkyePharma earns low single digit royalties on net sales of Xatral® OD (Uroxatral®). 07 Operating and Financial Review SkyePharma PLC Annual Report 2006 We continue to seek additional applications of our technologies and skills through a combination of in-house innovation and external collaboration. Our LodotraTM research and development activities are Lodotra™, developed for Nitec, is a novel focused on developing new formulations of modified-release formulation of known molecules and applying our prednisone, a widely used antiproprietary technology to provide a clinical inflammatory drug for treating the pain advantage and life-cycle extension. By and stiffness caused by rheumatoid using our multiple technologies, proven arthritis. With our GeoclockTM delivery skills, regulatory and manufacturing system the drug can be taken at bedtime expertise, we have a proven track record but released in the early hours of the morning, the optimum time. Nitec filed the of building a product pipeline for product in Europe in September 2006 and commercialisation through out-licensing to co-development and marketing launch is expected in 2007. In Phase III partners. We do not intend to finance studies Lodotra™ patients showed further major clinical trial programmes significantly reduced morning stiffness before Flutiform™ is launched. compared with the group using standard immediate-release prednisone. Merck KGaA will market the product in Germany Financial Review and Austria. Nitec is currently in Continuing business and discontinued negotiations with potential licensees for operations other markets. SkyePharma will The Injectable Business, which was sold manufacture the product at its plant in Lyon and receive a mid-single digit royalty on 23 March 2007, is included as a discontinued operation for the reasons set on net sales. out in Note 12. Accordingly the consolidated income statement shows the Nisoldipine CR In May 2006 we entered into an agreement net results of the Injectable Business separately (described as loss from with Sciele Pharma (our US licensee for Triglide™) to develop an improved version discontinued operations) and all other lines (including revenue, gross profit and of Sciele’s leading product Sular®, operating loss) are for the continuing (nisoldipine CR), a calcium channel business. The comparatives in the blocker antihypertensive. New consolidated income statement have been prescriptions of Sular® increased 24.6% and total prescriptions increased 20.0% in restated accordingly and, except where otherwise stated, all commentary in the the fourth quarter of 2006 compared with Chairman’s Statement and the Operating the fourth quarter of 2005. One of the key Zileuton CR factors driving Sular® prescription growth and Financial Review relates to the We have developed a controlled-release continuing business. was the successful leveraging of Sciele’s formulation of the oral asthma drug zileuton for Critical Therapeutics. Zileuton improved managed care position by their is a highly potent anti-inflammatory drug. primary care sales force. Nisoldipine CR is Revenue expected to be filed in the first half of 2007 Revenues for 2006, at £43.0 million, were The current immediate-release 15% below the £50.8 million reported in with launch in 2008. SkyePharma will formulation of zileuton (marketed as 2005. This was primarily due to the ZYFLO®) is approved for asthma in the US manufacture the product at its plant in and has a four times daily dosing regimen. Lyon, France, and receive a low mid single deferral of recognition of upfront digit royalty on net sales of nisoldipine CR milestone payments received in 2006 for The controlled-release formulation of the US and European marketing and and SkyePharma will also receive a total zileuton (zileuton CR), taken twice daily, distribution rights for Flutiform™. Cash utilises our Geomatrix™ technology, and is of up to $5 million (£2.5 million) in currently awaiting FDA approval in the US. milestone payments. $1 million (£0.5 received from milestones totalled £30.0 million) has been paid at signing and up Pending regulatory approval, Critical million (2005: £24.1 million) whilst to $4 million (£2 million) will be paid Therapeutics expects to launch the deferred revenues from milestones product in the second half of 2007. We will up to approval in the US, which is increased from £10.6 million at expected in 2008. manufacture the product at our plant in 31 December 2005 to £18.2 million at Lyon, France and receive a high–mid 31 December 2006 (see deferred income single digit royalty on net sales of zileuton Research and development section below). In addition to the above late stage oral CR. In March 2007, Critical Therapeutics pipeline products, we are also working on Revenues recognised from license signing announced the signing of a definitive covarious other earlier stage projects promotion agreement with Dey, L.P., part and milestone fees amounted to £12.7 addressing such areas as sleep disorders million in 2006 compared with £16.4 of the Merck KGaA group of companies, that strengthens the resource available for and pain/inflammation. million in 2005, primarily due to deferral marketing zileuton CR in the US respiratory care market. Requip® XL 24-hour™ Requip® XL 24-hourTM (ropinirole) for Parkinson’s disease was developed in partnership with GlaxoSmithKline. A recent study showed that adding Requip® XL 24-hourTM ropinirole prolonged release tablets to Parkinson’s disease patients’ existing levodopa therapy significantly reduced the “off” time by an average of more than two hours per day when compared with baseline prior to treatment, thus allowing patients to continue their daily activities for a longer period of time. In addition, the 24 hour dosing regime should significantly aid compliance. It was filed for approval at the end of 2005 in Europe, and regulatory approval was received in France in April 2007. It also has approval in Canada, Slovakia, Slovenia, Latvia and Estonia and GlaxoSmithKline plans to gain further marketing authorizations in other member states of the European Union. The US NDA was submitted in February 2007, and the US FDA accepted the submission for filing in April 2007. SkyePharma will earn low–mid single digit royalties on net sales of Requip® XL 24-hourTM formulation only. GlaxoSmithKline’s sales of Requip®, the immediate release form for Parkinson’s disease and restless legs syndrome in 2006 were at £268 million, up by 74% (at constant exchange rates) on the prior year. Parkinson’s disease makes up about 40% of current Requip® sales in the United States. SkyePharma PLC Annual Report 2006 08 Operating and Financial Review of proportionally more revenue from payments received in 2006. Upfront payments are generally deferred and recognised over the period of development up to the completion of the development phase, such as filing or approval. To the extent that they relate to reduced royalty rates they may be spread over the period of that reduction in rates. Consequently, whilst the Group received £13.5 million ($25.0 million) in May 2006 from Kos for the US marketing rights to Flutiform™, only £5.7 million was recognised as revenue in 2006 and the balance is expected to be recognised over the period up to filing. In addition, SkyePharma received £10.2 million (€15.0 million) from Mundipharma for the European marketing rights to Flutiform™, but only £1.2 million was recognised as revenue in 2006, and a large part of the balance was deferred to be released post-launch to offset a temporary royalty reduction, being SkyePharma’s contribution to Mundipharma's costs for developing the higher dose strength version. Contract research and development costs recharged decreased £2.0 million to £1.6 million, compared with £3.6 million in 2005, mainly due to a fall in the revenue from Novartis in respect of the QAB 149 project and the focus of available resources on the Flutiform™ development. Royalty income was £18.1 million (2005: £19.6 million), a reduction of 8%. During the early part of 2005 the Group received royalties based on GlaxoSmithKline’s (GSK’s) budgeted sales of Paxil CR™ whilst the product was temporarily off the market as a result of GSK’s suspension of production at its Cidra plant in Puerto Rico. The decrease in 2006 was due to a 24% fall in Paxil CR™ royalty income; although the product returned to the market in June 2005, continuing supply constraints meant that sales did not fully recover to the pre-withdrawal level. This was partly offset in 2006 by an increase in royalty income from TriglideTM and Solaraze®. Excluding Paxil CRTM, royalties for the balance of SkyePharma’s other products grew by 7% (at constant exchange rates) in 2006 compared with 2005. Manufacturing and distribution revenue decreased by £0.6 million to £10.6 million, compared with £11.2 million in 2005, mainly due to the aforementioned fall in the revenue from Novartis in respect of QAB 149. Manufacturing and distribution revenues included a substantial contribution towards maintaining manufacturing capacities internally and externally for the Foradil® CertihalerTM. Deferred income During 2006, there was a net increase in deferred income of £7.6 million as milestone payments in respect of Flutiform™ licences were deferred as described above. The movement in deferred income was as follows: 31 December 2005 £m Contract development and licensing revenue * Includes exchange adjustments. Recognised/ 31 December Received* Transferred 2006 £m £m £m 30.0 (22.4) 18.2 10.6 Cost of sales Cost of sales comprises: the direct costs of contract manufacturing; direct costs of licensing arrangements; expenditure on research and development conducted for third parties including the costs of directly funded clinical trials incurred on behalf of our collaborative partners and royalties payable. Cost of sales decreased by £2.6 million to £18.0 million in 2006, and gross profit decreased 17% to £25.0 million compared with £30.2 million in 2005, being in line with the fall in revenue. Selling and administration expenses Selling, marketing and distribution expenses mainly comprise Triglide™ marketing contribution costs, and decreased slightly to £3.0 million in 2006, compared with £3.1 million in 2005. Other administration expenses before exceptionals for the continuing business were £12.3 million in 2006, compared with £12.0 million in 2005. Research and development expenses SkyePharma’s own research and development expenses in the year increased by £8.6 million to £22.9 million, mainly due to the development expenditure incurred on the start of the Flutiform™ Phase III clinical trials. Expenditure on Flutiform™ in 2006 was £19.0 million (2005: £8.7 million). As announced on 27 December 2006, further costs forecast to be incurred from that date in respect of the development required for US approval (excluding saleable launch stock) total $60 million (£30.5 million), comprising $47 million (£23.9 million) of revenue expenditure plus $13 million (£6.6 million) of capital expenditure. In addition, a total of $10 million (£5.1 million) of expenditure incurred on Flutiform™ up to 31 December 2006 remained unpaid at that date, so that the total forecast cash requirement for Flutiform™ at the end of 2006 totalled $70 million (£35.6 million). Additional trials will be conducted in Europe for paediatrics and to compare Flutiform™ with an existing marketed product. These will be paid for by Mundipharma up to €12 million (£8.6 million) will be deducted from a milestone of that amount due to the Group at the end of the trials. Other income The other income before exceptionals of £0.8 million is mainly due to the profit on disposal of the Group’s holding in Vectura Group plc and certain Vital Living Inc securities. The exceptional income of £0.7 million is the profit on disposal of SkyePharma Canada Inc. Following the reorganisation of research and development operations and other business functions completed in 2004, SkyePharma Canada Inc was sold in July 2006 for £1.0 million (CDN$2.0 million). Further development work is being carried The sale did not include any product or out for Europe on a higher strength version technology rights. of FlutiformTM funded by Mundipharma and Finance costs and income partially reimbursed by SkyePharma by The finance costs of £14.1 million (2005: reductions in royalties and sales related £16.2 million) mainly comprise notional milestones for a limited period of time. 09 Operating and Financial Review SkyePharma PLC Annual Report 2006 interest on the Paul Capital funding liabilities as well as the interest of £6.3 million payable on the convertible bonds. The finance income of £23.1 million in 2006 includes £1.9 million of foreign exchange gains (2005: loss of £3.3 million included in finance costs) relating to the Paul Capital funding liabilities which are denominated in US dollars and £20.1 million in respect of a decrease in the estimated future payments to Paul Capital (2005: £1.8 million). Income tax expenses The Group’s income tax expense was £0.8 million, relating to provisions for irrecoverable withholding taxes. The Group has substantial tax losses, subject to expiry dates, available for offset against future profits. £0.5 million related to the EGM held in March 2006. Further details are provided in Note 5 to the financial statements. The exceptional credit of £0.7 million in Other income relates to a profit on the disposal of SkyePharma Canada Inc., and the exceptional credit of £20.1 million in Finance income arose from the reduction in estimated future payments to Paul Capital as described in Note 24. Results The operating loss before exceptional items was £13.9 million, compared with £1.0 million in 2005. This was principally due to the reduction in revenue and the increased R&D costs for Flutiform™ Phase III clinical trials (up £10.3 million on 2005). The operating loss after exceptionals increased by £20.8 million to £26.9 million, mainly due to the fall in revenue, increased R&D costs and higher exceptional charges. The loss for the year after exceptionals from continuing and discontinued operations increased by £26.8 million to £77.7 million, primarily due to the £46.6 million total impairment charges partly offset by the decrease in the estimated future payments to Paul Capital. The £46.6 million impairment charge comprises the £9.6 million relating to the continuing operations described above and £37.0 million relating to discontinued operations regarding the impairment of the Injectable Business goodwill. Earnings per share The loss per share from continuing operations amounted to 2.5 pence (2005: 3.3 pence). The pre-exceptional loss per share from continuing operations amounted to 3.4 pence (2005: 2.5 pence). As at 31 December 2006 there were 753,764,146 ordinary 10 pence shares and 12,000,000 deferred 10 pence “B” shares in issue. Exceptional items The deferred “B” shares have negligible The exceptional charge of £13.7 million in The loss for the year after exceptionals participation rights in the Company. from continuing operations decreased by administration expenses comprises: Following the equity placing in March 2007 £1.9 million to £18.7 million, £8.8 million relating to the impairment of the number of ordinary 10 pence shares notwithstanding the fall in revenue and the was increased by a further 61,224,490 to intangible assets following a review of higher costs as a result of the Flutiform™ 814,988,636. their value to the continuing business; £0.6 million in respect of impairment of clinical trials, due primarily to the investments in non-group companies; decrease in the estimated future In addition, there were outstanding as at £0.2 million in respect of write down of payments to Paul Capital as described in 31 December 2006 a number of warrants, fixed assets; corporate restructuring costs Note 24. options, conversion rights and employee of £2.1 million; £1.5 million in respect of share schemes as follows: provisions for legal claims; and Description Warrants (D&E) Warrants (F) Deferred consideration (Krypton) Paul Capital Employee share option schemes Employee share schemes* Convertible bonds 2024 Convertible bonds 2025 Total at 31 December 2006 Total at 31 December 2005 Number of ordinary 10p shares 5,000,000 300,000 37,500,000 38,320,049 22,411,165 10,908,727 73,263,158 34,482,759 222,185,858 233,372,997 Exercise price 73.75p 120.0p 229.0p increasing at 10% per annum — Expiry conditions December 2008 September 2007 None Extinguished on March 2007 refinancing 43.0p to 89.3p Various dates 2007 to 2013 Nil 95.0p 58.0p Various performance and service conditions May 2024 June 2025 * Employee share schemes include the deferred share bonus plan, long-term incentive plans, international share purchase plan. SkyePharma PLC Annual Report 2006 10 Operating and Financial Review As set out in the Chairman’s Statement, approval is being sought at an extraordinary general meeting on 4 May 2007 for a long-term incentive plan to provide incentives to Executive Directors and senior managers to replace the previous scheme which expired in 2006. The maximum dilution of the proposed initial grant is estimated at 2.63%, based on achievement of all conditions over 3 years. The total limits on dilution for employee share plans (10% over 10 years, including 5% for discretionary executive schemes) will continue to apply. More details of the convertible bonds, are set out in Note 24 to the financial statements. As at 25 April 2007, the Company’s closing mid-market share price was 22.5 pence and the number of ordinary shares in issue at that date was 814,988,636. Cash flows In 2006 there was a net cash outflow from operating activities of £8.7 million, compared with £7.6 million in 2005. During the year the Group spent £2.0 million on property, plant and equipment. In addition, expenditure on intangible assets was £1.4 million and mainly related to the purchase of licences to intellectual property in the area of pulmonary delivery. The proceeds on The Group balance sheet as at 31 December 2006 shows total shareholders’ equity of £48.4 million deficit (2005: £24.3 million positive). The Borrowings of £6.9 million were repaid in reduction in net equity has arisen mainly the year, primarily comprising Paul due to the £77.7 million loss from Capital’s share of the Group’s royalty continuing and discontinued operations income. In addition, the Group paid (of which £29.9 million relates to £6.3 million of interest during 2006, mainly exceptional items). relating to the convertible bonds. Interest received on cash deposits amounted to As set out in Note 1(v) the comparative £1.0 million. figures for 2005 have been restated to correct a prior period error by including a Subsequent to 31 December 2006, in provision for deferred tax, as required by March 2007, the Company disposed of its IAS 12 (“Income Taxes”), of £7.6 million at interest in GeneMedix for £1.2 million cash 31 December 2005 on the temporary proceeds and disposed of the Injectable difference between the face value of the Business for upfront consideration of convertible bonds and the value at which $20.0 million (£10.2 million) realising they are included in liabilities in the approximately £2.1 million after allowing balance sheet. This adjustment should for $2 million (£1.0 million) paid into have been made on the transition to IFRS escrow and attributable costs. and should have been included in the 2005 financial statements. The restatement has Balance sheet no material effect on the consolidated As noted above, the Injectable Business income statement or consolidated cash has been treated as held for sale and a flow statement for the year ended Discontinued Operation, and therefore the 31 December 2005. This liability will total assets and liabilities of the Injectable unwind as the temporary difference Business have been shown separately and reverses to maturity of the convertible excluded from the individual line items of bonds and there is no tax payable on the balance sheet. The prior period has redemption of the bonds at par. not been restated and the assets and liabilities are included in the individual line items. disposal of the holding in Vectura Group plc and certain Vital Living Inc securities were £1.3 million. Borrowings and liquidity The Group’s total net debt and convertible debt comprises: 2006 £m Convertible bonds at face value (see note below) Paul Capital funding liabilities (included at net present value) Property mortgage Bank borrowings Finance lease liabilities Bank overdraft Total debt (including convertible debt included in equity) Less cash and cash equivalents Net debt (including convertible debt included in equity) 89.6 24.3 6.2 2.0 0.2 1.3 123.6 (11.9) 111.7 2005 £m 89.6 44.6 6.9 2.9 0.1 — 144.1 (34.3) 109.8 Note: The above table includes the convertible bonds at face value of £89.6 million. The convertible bonds are included in the balance sheet partly in non-current liabilities (2006: £64.1 million, 2005: £63.6 million) and partly in other reserves in shareholders’ equity (2006 and 2005: £28.5 million). The financial liability accrues over time to the face value, whereas the equity component remains fixed at the value at inception until the bonds are realised. In addition to the above, the Group had committed but unutilised facilities totalling approximately £35.0 million in respect of the CRC Financing (noted below) and, in March 2007, completed an equity placing which raised £14.8 million (net of costs) and the disposal of the Injectable Business realising a net £2.1 million as described under “Cash flows” above. 11 Operating and Financial Review SkyePharma PLC Annual Report 2006 Convertible bonds The convertible bonds comprise £69.6 million 6% convertible bonds due May 2024 and £20.0 million 8% convertible bonds due June 2025 outstanding as at 31 December 2006. Of the total convertible bonds, £64.1 million is included in liabilities and £28.5 million in equity in the consolidated balance sheet. The £69.6 million May 2024 bonds may be converted into ordinary shares at 95 pence per share, and may be called for repayment by the bond holders at par in May 2009, May 2011, May 2014 or May 2019. The £20.0 million June 2025 bonds may be converted into ordinary shares at 58 pence per share, and may be called for repayment by the bond holders at par in June 2010, June 2012, June 2015 or June 2020. The Board intends to seek to refinance these bonds well before May 2009 in order to ensure that the earliest redemption dates are extended to match more closely the Group’s expected cash inflows. Paul Capital Finance As at 31 December 2006, the Paul Capital royalty-sharing finance was included in the balance sheet at the net present value of anticipated payments under the agreements in force as at that date using the underlying contracts’ effective interest rates at inception of 24.5% and 29.8% respectively. Applying these rates to the latest forecasts of relevant royalties, the net present value of the liability as at 31 December 2006 amounted to $47.6 million (£24.3 million) (2005: $76.6 million (£44.6 million)). The reduction in liability due to the decrease in the estimated future payments to Paul Capital during the course of the year amounted to $37.2 million (£20.1 million) and is credited to the profit and loss account under finance income as an exceptional item. The amount included in finance charges in 2006 in respect of the notional interest relating to the Paul Capital finance amounted to $12.8 million (£6.9 million) (2005: $12.0 million (£6.6 million)). reach certain thresholds. The note is repayable in accordance with an amortisation schedule through to 2015. The Injectable Business has been sold on the basis that it retains responsibility to Paul Capital for its existing obligations to share royalties received in respect of DepoCyt® and DepoDur™ and, to the extent that payments are made in respect of these, the continuing Group’s liability will be reduced accordingly. Security under the Paul Capital refinancing is provided by receivables for the products which were part of the previous two royalty sharing arrangements with Paul Capital, the main products of which are: Solaraze®, Xatral® OD, Foradil® CertihalerTM, Pulmicort® HFA, Paxil CRTM and TriglideTM. There is also a covenant (negative pledge), not to grant further securities over FlutiformTM intellectual property, and the In March 2007, in conjunction with the requirement for prior consent from Paul disposal of the Injectable Business, the Capital for certain transactions that could Group completed a fundamental affect Paul Capital’s security and risk. The restructuring of its arrangements with loan will be repaid early up to $10.0 Paul Capital from the sharing of royalties from a number of specified products into a million out of 50% of any FlutiformTM fixed amortisable note (“Note”) of US$92.5 milestones received after 1 January 2009 (or on FDA approval if earlier) and 50% of million (£47.3 million) with up to an the proceeds of any disposal of Solaraze®, additional $12.5 million (£6.4 million) Xatral® OD, Foradil® CertihalerTM, payable if worldwide sales of DepoDur™ Pulmicort® HFA, Paxil CRTM and Triglide™. (a product of the Injectable Business) The amortisation schedule determines the minimum amounts payable under the Note which will be accounted for as payments of principal and interest as follows: Notional interest $m 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total 6.6 6.1 5.6 5.1 4.2 3.2 2.1 0.8 — 33.7 Repayment of principal $m 4.1 4.6 5.1 7.9 8.8 9.8 10.9 7.6 — 58.8 Total $m 10.7 10.7 10.7 13.0 13.0 13.0 13.0 8.4 — 92.5 The above table excludes (i) the additional payments due if sales of DepoDur™ reach certain thresholds and (ii) any reductions for future salesrelated payments by the Injectable Business for DepoDurTM and DepoCyt®. SkyePharma PLC Annual Report 2006 12 Operating and Financial Review In March 2007, once the detailed terms of the Paul Capital Refinancing were settled, Half of the committed principal on each further discussions took place with CRC loan was drawn down in January 2007 and and the terms of the CRC Financing were the balance must be drawn down by amended in a number of respects: (i) from December 2007. In the event that the 22 March 2007, the interest charged on the cumulative milestone and royalties first €7.5 million of the facility will be at received from these products are in excess the rate of euro three month LIBOR plus of the minimum amortisation schedule 10.85%; (ii) the loan will be prepaid up to and interest due, the balance will be $10.0 million out of 50% of any FlutiformTM milestones received after 1 January 2009 applied to the prepayment of principal (or on FDA approval if earlier); (iii) without penalty. The three products are additional security will be provided of an licensed for marketing to the Therabel assignment or charge over receipts in CRC Finance Group, Nitec and GlaxoSmithKline In December 2006 SkyePharma respectively. The loan facility is secured by respect of two additional products (nisoldipine CR and zileuton CR); and (iv) a announced an agreement with a specialist the assignment or charge over certain lending entity domiciled in Ireland and assets including the receipts in respect of number of additional covenants and consents are incorporated in line with the advised by Christofferson Robb for a 10 Coruno®, Lodotra™, and Requip® XL 24year secured amortising loan facility of hour™. There is also a covenant (negative Paul Capital refinancing. The security does approximately £35.0 million. The facility pledge) not to grant further securities over not include Flutiform™. comprises initial commitments of US$35.0 the Group’s assets, including Flutiform™ million and €26.5 million repayable over intellectual property, and the requirement The restructured Paul Capital financing will be accounted for as a new facility in 2007 and included in the balance sheet from March 2007 onwards at the net present value (discounted at an annual discount rate of 11.2%, being management’s estimate of a fair market cost) of the anticipated amortisation payments less management’s forecast of the future sales related payments of the Injectable Business in respect of DepoDur™ and DepoCyt®. As at 25 April 2007, the net present value of this liability, after paying a first instalment of $2.7 million (£1.4 million) amounted to $44.3 million (£22.1 million) compared with the value of $47.6 million (£24.3 million) included under the original arrangements in the 31 December 2006 balance sheet. 10 years based on a minimum amortisation schedule. This schedule is based on expected receipts from milestone and royalties in respect of Coruno®, Lodotra™ and Requip® XL 24hourTM. Interest is generally charged on a quarterly basis at the respective US dollar and euro three month LIBOR rates plus a 5.85% margin. for prior consent from Christofferson Robb for certain transactions that could affect Christofferson Robb’s security and risk. There are provisions for the facility to be increased by a further $15.0 million subject to due diligence and progress with a specific product development. The amortisation schedule determines the minimum amounts payable under the CRC Financing as follows (using exchange rates ruling as at 31 December 2006): Interest $m 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total 6.2 7.8 7.5 6.7 5.7 4.6 3.5 2.6 1.6 0.4 46.6 Repayment of principal $m — 0.5 4.9 8.1 10.5 10.7 9.4 8.9 8.7 8.3 70.0 Total $m 6.2 8.3 12.4 14.8 16.2 15.3 12.9 11.5 10.3 8.7 116.6 The above table shows the minimum amortisation schedule assuming the cumulative milestones and royalties from Coruno®, Lodotra™, and Requip® XL 24-hourTM are not in excess of these (otherwise the principal would be paid off earlier without penalty). The interest estimate for 2007 is based on an anticipated draw down schedule. Approximately half of the facility is denominated in US dollar and half in euro. The amounts above are translated into US dollar using the euro exchange rates applicable at 31 December 2006. 13 Operating and Financial Review SkyePharma PLC Annual Report 2006 Other borrowings and cash Bank and other borrowings amounted to £8.4 million at 31 December 2006 (2005: £9.9 million), consisting principally of a £6.2 million property mortgage secured on the assets of Jago (2005: £6.9 million). At 31 December 2006 SkyePharma had net cash of £10.6 million, comprising cash and cash equivalents of £11.9 million net of a bank overdraft of £1.3 million, compared with £34.3 million net cash at 31 December 2005. 31 December 2006 again includes an emphasis of matter paragraph, on this occasion, to draw attention to the disclosures made in Note 1 to the financial statements indicating the existence of material uncertainties which relate to 2009. The auditors’ opinion is not qualified in this respect, and the Directors have reasonable expectations that the risks concerned can be managed to a successful outcome. the exchange differences on which are taken to reserves. Use has been made of currency options and forward currency contracts to minimise the currency exposure on operational transactions. Injectable Business In January 2007, SkyePharma announced that it had sold the Injectable Business subject to shareholders’ approval and certain other conditions to Blue Acquisition Corp for an initial cash consideration of $20 million (less costs $2 million paid into escrow, a working capital adjustment and certain liabilities) and up to $62 million of contingent milestone payments and a percentage of sales for certain future products for a defined period of time. The Injectable Business is also retaining responsibility for certain royalty-based payments which, when made, will reduce SkyePharma’s debt to Paul Capital. In February 2007, shareholders approved the proposed sale of the Injectable Business to Blue Acquisition Corp at an EGM. The disposal completed in March 2007. Foreign exchange risks All of the Group’s continuing operations Going concern basis are based overseas in Continental Europe Following the financial restructuring and licence royalty payments are typically completed in March 2007, the Directors denominated in various currencies, with have a reasonable expectation that the sales-related payments based on Group has adequate resources to continue underlying sales in local currencies. This in operational existence for the gives rise to direct and indirect exposures foreseeable future. The auditors’ report on to changes in foreign exchange rates the financial statements for the year notably the Swiss Franc, euro and US ended 31 December 2005 and the auditors’ dollar. To minimise the impact of any independent review conclusion on the fluctuations, the Group’s policy has 30 June 2006 interim report each historically been to maintain natural contained an emphasis of matter hedges by relating the structure of paragraph relating to assumptions borrowings to the underlying trading justifying the use of the going concern cash flows that generate them. Where basis. The auditors’ report on the subsidiaries are funded centrally, this is financial statements for the year ended achieved by the use of long-term loans, The results before exceptional items of the Injectable Business are as follows: 2006 Pre-Exceptional £m Revenue Cost of sales Gross (loss)/profit Selling, marketing and distribution expenses Administration expenses Amortisation of other intangibles Other administration expenses Research and development expenses Operating loss Finance costs Finance income Loss for the year from discontinued operations 6.3 (8.5) (2.2) (0.1) (0.7) (4.4) (5.1) (8.7) (16.1) (5.9) — (22.0) 2005 Pre-Exceptional £m 10.5 (8.6) 1.9 (2.7) (0.7) (2.7) (3.4) (11.7) (15.9) (6.1) 8.0 (14.0) Note: The results of the Injectable Business for the year ended 31 December 2005 are different from those of the Injectable Segment published in the January 2007 circular and prior years’ segmental analyses which included an allocation of corporate costs. SkyePharma PLC Annual Report 2006 14 Operating and Financial Review The operating losses of the Injectable Business in 2007 up to the date of sale are estimated at £3.6 million. The realisable value of the Injectable Business has been arrived at based on the upfront consideration. No account has been taken of the potential deferred payments in respect of DepoBupivacaine™ and other product sales as it will be some years before these would be realised. As noted above, the consolidated income statement shows the net results of the Injectable Business separately (described as Discontinued Operations). Forward looking statements The foregoing discussions contain certain forward looking statements and are made in reliance on the safe harbour provisions of the US Private Securities Litigation Act of 1995. Although SkyePharma believes that the expectations reflected in these forward looking statements are reasonable, it can give no assurance that these expectations will materialise. Because the expectations are subject to risks and uncertainties, actual results may vary significantly from those expressed or implied by the forward looking statements based upon a number of factors, which are described in SkyePharma’s 20-F and other documents on file with the SEC. Factors that could cause differences between actual results and those implied by the forward looking statements contained in this Annual Report include, without limitation, risks related to the development of new products, risks related to obtaining and maintaining regulatory approval for existing, new or expanded indications of existing and new products, risks related to SkyePharma’s ability to manufacture products on a large scale or at all, risks related to SkyePharma’s and its marketing partners’ ability to market products on a large scale to maintain or expand market share in the face of changes in customer requirements, competition and technological change, risks related to regulatory compliance, the risk of product liability claims, risks related to the ownership and use of intellectual property. SkyePharma undertakes no obligation to revise or update any such forward looking statement to reflect events or circumstances after the date of this Annual Report. Key Performance Indicators We consider the following Key Performance Indicators (KPIs) to be the most relevant to our continuing business: Key performance indicators for continuing business Number of approved and marketable products at year end Revenue excluding milestones Signing and milestone payments received Research and development expenditure Manufacturing output £m £m £m Units (millions) 2002 8 12.1 58.6 11.9 53.1 2003 8 26.7 26.6 17.9 65.1 2004 9 33.8 26.6 15.4 120.1 2005 10 34.4 24.1 14.3 103.2 2006 9* 30.3 30.0 22.9 98.2 * As at 25 April 2007, Requip®XL 24-hour™ has approval in a number of countries in Europe and in Canada bringing the current number of approved and marketable products to 10. The above figures exclude the Injectable Business which is included in discontinued operations. 15 SkyePharma PLC Annual Report 2006 Corporate Social Responsibility procedures, including a Code of Ethics for Senior Officers and a Complaints and Whistleblowing Procedure. A Code of We also recognise that a safe, secure and Business Conduct and Ethics has been introduced throughout the Company that healthy working environment contributes to productivity and improved performance. complies with or exceeds the requirements of the published US SEC/Nasdaq Code of Business Conduct The Group is committed to a policy of and Ethics. promoting employees’ awareness of its activities, encouraging employees’ participation in the growth of the Group and The Environment As a Company we are committed to welcoming staff input at all levels. It is protecting the environment in which we recognised that by far the most important conduct our activities. Our formal form of involvement and information Environmental Policy aims to foster a regarding the progress, performance and positive attitude towards the environment plans of the Group takes place during and to raise the awareness of employees informal daily discussions between to responsible environmental practices at management and other employees. all sites operated by the Company. We Consultations occur to allow employee ensure compliance with all relevant opinions to be heard when making legislation and regulatory requirements decisions affecting their interests. and where practical and economically Communication also takes place via the viable we develop standards in excess of intranet and the periodic publication — Employment Issues such requirements. Although we are only “SkyeNews”. SkyePharma is committed to a policy of a small-scale manufacturer, we aim to set equal opportunities in its employment practices. We believe that the contribution Employee remuneration is determined on a high standard through continuous improvement in our environmental an annual basis by the Remuneration an employee can make should not be performance. We now undertake routine Committee and Executive Committee as affected by factors such as gender, age, monitoring of various measures of our appropriate. The Group attracts and marital status, disability, sexuality, race, environmental performance at our main retains employees of high calibre by colour, religion, ethnic or national origin R&D and manufacturing sites in or any other conditions not relevant to the offering remuneration that is in line with Switzerland and France. that offered by industry competitors and performance of the job. Our formal Equal local practice in the countries in which it Opportunities Policy is posted on the operates. All employees are encouraged to The Community Company’s website. We aim to be a ‘good neighbour’ wherever participate in the Company’s share we have business units and to be active purchase scheme. It is Group policy to offer the same participants in the community. While we opportunity to disabled people as to all do not believe that we have a mandate others in matters of recruitment and career Ethical Issues from shareholders for the Company to advancement, provided they have the ability We aim to demonstrate and promote the make charitable donations, we do to perform the tasks required, with training highest standards of honest and ethical encourage our employees to support conduct throughout our Company. We where appropriate, and to institute charitable causes of their choosing. have established formal policies and retraining where practical in cases where SkyePharma’s mission is to become one of the world’s leading speciality pharmaceutical companies, powered through excellence in drug delivery. We strive to improve patient clinical outcomes by using our multiple delivery technologies to create enhanced versions of existing pharmaceutical products. We believe that this in itself is a worthwhile enterprise. Furthermore, the pharmaceutical industry as a whole is intensively regulated to ensure that all medicinal products are both safe and effective and manufactured to the highest standards. We also recognise that our business will prosper for the long term only if we act in a responsible manner and we are conscious of growing interest among investors and other stakeholders in the compliance of companies with ethical, social and environmental issues. disability has occurred during employment with the Group. SkyePharma PLC Annual Report 2006 16 Products Approved products as at 25 April 2007 Licensee/partner Oral GlaxoSmithKline Sanofi-Aventis Roche Therabel ratiopharm Sciele Pharma GlaxoSmithKline Inhalation Novartis AstraZeneca Topical Bradley/Shire Product name Generic name of active Primary indication Paxil CR™ Xatral® OD/Uroxatral® Madopar DR® Coruno® diclofenac-ratiopharm-uno Triglide™ Requip® XL 24-hour™ paroxetine alfuzosin levodopa/benserazide molsidomine diclofenac fenofibrate ropinirole Depression BPH (urinary symptoms)‡ Parkinson’s disease Angina Pain/inflammation Lipid disorders Parkinson’s disease Foradil® Certihaler™† Pulmicort® HFA formoterol budesonide Asthma Asthma Solaraze® diclofenac Actinic keratosis Development pipeline as at 25 April 2007 Licensee/partner Oral GlaxoSmithKline Critical Therapeutics Nitec Sciele Pharma SkyePharma SkyePharma Inhalation Abbott/Mundipharma SkyePharma Product name Generic name of active Primary indication Requip® XL 24-hour™ zileuton CR Lodotra™ nisoldipine CR SKP-1032 SKP-1041 ropinirole zileuton prednisone nisoldipine undisclosed undisclosed Parkinson’s disease Asthma Rheumatoid arthritis Hypertension Pain/inflammation Sleep disorders Flutiform™ formoterol HFA formoterol/fluticasone formoterol Asthma/COPD§ Asthma/COPD§ In addition, there are a number of early stage and internal development projects. ‡ Benign prostatic hypertrophy. Filing based on Phase I Data § Chronic obstructive pulmonary disease. † Currently not marketed. * 17 Products SkyePharma PLC Annual Report 2006 Feasibility In vitro (laboratory) feasibility study to determine whether, under laboratory conditions, the formulation of the product candidate can be achieved. Phase I First stage of human clinical testing for toxicity in healthy human volunteers. Phase II Additional in vivo testing may be performed (also called pre-pivotal trials) involving a small patient population to evaluate the optimal clinical dose. Phase III Trials in an expanded patient population, typically at dispersed sites. Also called pivotal trials. Filed SkyePharma or its partners file for regulatory approval in the jurisdictions in which it is intended that the product will be marketed. For example, in the US, this will require filing with the Food and Drug Administration and in the European community with the European Medicines Agency. Feasibility Phase I Phase II Phase III Filed * SkyePharma PLC Annual Report 2006 18 Directors and Advisers Dr Jerry Karabelas (aged 54) Chairman Appointed as a Non-Executive Director in November 2000 and as Chairman in February 2006. Dr Karabelas has more than 24 years’ experience in the pharmaceutical industry and is a partner at Care Capital LLC and Chairman of Human Genome Sciences, Vanda Pharmaceuticals, Inc., Inotek Pharmaceuticals Corporation and NitroMed Inc. He is also a non-executive director of Minster Pharmaceuticals plc and Renovo Group plc, as well as a member of the scientific advisory board of Epigenesis Pharmaceuticals LLC and CardioKine Inc. He was previously the CEO of Novartis Pharma AG and a nonexecutive director at Acura Pharmaceuticals Inc., Anadys Pharmaceuticals Inc., Fox Chase Cancer Centre, Halsey Pharmaceuticals, International Partnership for Microbicides, Layton Biosciences and the University of the Sciences in Philadelphia. Prior to this he spent a significant part of his career working for SmithKline Beecham plc. Frank Condella (aged 52) Chief Executive Officer Appointed to the Board in April 2006, Mr Condella was previously president of European operations for IVAX, CEO of Faulding Pharmaceutical Co., vicepresident of the specialty care products business for Roche, and vice-president and general manager of the Lederle unit of American Home Products. He holds a BS in Pharmacy and an MBA from Northeastern University in Boston, Massachusetts. Dr Ken Cunningham (aged 54) Chief Operating Officer Appointed to the Board in May 2006. Dr Cunningham is a non-executive director of Xention Ltd. He was previously CEO of Arakis Ltd, vice-president European affairs for Alza Corporation and vicepresident clinical development for Sequus Inc. Prior to this he held a variety of clinical development and commercial strategy positions in GlaxoWellcome plc and Warner-Lambert. Dr Cunningham qualified from St Mary’s Medical School, London University. Peter Grant (aged 51) Finance Director Appointed in November 2006. Mr Grant is a non-executive director of ShipServ, Inc. He was previously interim CEO of Voice Commerce Group, group finance director of Eurodis Electron PLC, chief financial officer of WorldPay plc, and group finance director, then group chief executive of Molins PLC. Prior to that he held various senior commercial, financial and general management roles in the General Electric Company plc group of companies. Mr Grant is a Chartered Accountant with an MA (Hons) in Mathematics from Oxford University. R Stephen Harris (aged 64) Non-Executive Director‡†* Appointed in November 1995. Mr Harris is non-executive chairman of Proteome Sciences plc, Sinclair Pharma plc and Conve plc and non-executive director of Advanced Medical Solutions Group plc and Premier Research PLC. He was previously a director of GeneMedix plc and Prophilian plc. Prior to this he worked for ICI Pharmaceuticals plc, Merck & Co. Inc., Eli Lilly and Company, Boots PLC, Reckitt & Colman PLC, Gensia Inc. and Medeva plc. He holds a Bachelor of Pharmacy degree from the University of London and is a fellow of the Royal Pharmaceutical Society. Mr Harris, having served more than nine years as a Non-Executive Director, will offer himself for re-election at the Annual General Meeting in accordance with the recommendations of the 2003 Combined Code on Corporate Governance. Please refer to page 20 where the Board explains why it recommends Mr Harris’s continued presence on the Board. 19 Directors and Advisers SkyePharma PLC Annual Report 2006 Dr David Ebsworth (aged 52)†‡* Non-Executive Director Appointed in April 2002. Dr Ebsworth is non-executive chairman of Atani Ltd, A&D Pharma Holdings NV, Curacyte AG, Wilex AG and Xention Ltd. He is also nonexecutive director of Intercell AG, CuraGen Corporation and Renovo Group plc. He was previously non-executive director of Schein Pharmaceuticals, Inc. (now known as Watson Pharmaceuticals, Inc.) and chief executive officer of Oxford GlycoSciences PLC, president and general manager of the Pharmaceutical Business Group for Bayer AG in Leverkusen, Germany, and has also worked for Bayer AG in a series of global positions in Canada, Europe and the United States. Alan Bray (aged 62)*†‡ Senior Independent Director Appointed in September 2004. Mr Bray is a chartered accountant having retired as a senior partner from Deloitte & Touche LLP’s financial services practice in May 2004. Mr Bray has worked with retail and investment banks, insurance companies and asset management firms and was seconded for a time to the Department of Trade and Industry. He was responsible for Deloitte & Touche LLP’s risk management policies and procedures in its financial services practice and was a serving member on a DTI Supervisory Board and Audit Committee. John Murphy (aged 53) Company Secretary Appointed in September 2006. Mr Murphy is a lawyer with extensive experience in legal and company secretarial roles in listed pharmaceutical and biotechnology companies including Medeva PLC, Celltech Group PLC and Pharmagene PLC (now Asterand PLC). Mr Murphy is a graduate (BSc) of Bristol University. Key: * Audit Committee † Remuneration Committee ‡ Nomination & Governance Committee Additional information regarding Directors’ roles and membership of Board Committees is set out in the Corporate Governance Report on pages 23 to 28. Registered Head Office Solicitors Bankers 105 Piccadilly London W1J 7NJ Telephone: 020 7491 1777 Fax: 020 7491 3338 Registered No: 107582 Company Secretary: John Murphy Auditors UK Fasken Martineau Stringer Saul LLP 17 Hanover Square London W1S 1HU US Sullivan & Cromwell 1 New Fetter Lane London EC4A 1AN Corporate Broker and Financial Adviser National Westminster Bank plc Bishopsgate Business Centre PO Box 34 15 Bishopsgate London EC2P 2AP Registrars Ernst & Young LLP 1 More London Place London SE1 2AF Credit Suisse First Boston 20 Columbus Courtyard London E14 4DA Capita Registrars Northern House Woodsome Park Fenay Bridge Huddersfield West Yorkshire HD8 0LA Depository The Bank of New York 101 Barclay Street New York NY 10286 USA SkyePharma PLC Annual Report 2006 20 Report of the Directors (including Business Review) Dr Argeris (Jerry) Karabelas Frank Condella Alan Bray * † ‡ Principal activities The principal activities of the Group during Dr Kenneth Cunningham the year continued to be the research and Dr David Ebsworth * † ‡ Peter Grant development, manufacture and sale of Stephen Harris * † ‡ prescription pharmaceutical products. Company Secretary: John Murphy * Audit Committee Business review † Remuneration Committee A review of the business and future developments of the Group is presented in ‡ Nomination Committee the Chairman’s Statement on pages 2 to 4 In January 2006 Ian Gowrie-Smith stepped and Operating and Financial Review on down as Chairman and in February 2006 pages 5 to 14. retired from the Board. Dr Jerry Karabelas was appointed Chairman in February 2006. Principal risks and uncertainties In March 2006 Frank Condella joined the The principal risks and uncertainties Company as Chief Executive Officer and applying to the Group are outlined in the Corporate Governance report on page 27. was appointed to the Board in April 2006. In April 2006 Dr Ken Cunningham joined the Company as Chief Operating Officer Risk management The Group’s policy on risk management is and was appointed to the Board in May 2006. Michael Ashton, Sir Michael Beavis outlined in the Corporate Governance and Dr Keith Mansford retired as Directors report on page 26. at the conclusion of our Annual General Meeting in June 2006 (though Michael Results and dividends Ashton remained as an employee of the The Group made a loss for the year to 31 December 2006 of £77.7 million (2005: Company until November 2006). In November 2006 Donald Nicholson £50.9 million). The Directors do not resigned from the Board and Peter Grant propose to pay a dividend. joined the Company and was appointed to the Board as Finance Director. Research and development The Group incurred research and development costs of £22.9 million (2005: Stephen Harris, having served more than nine years as a Non-Executive Director, will £14.3 million) during the year which have offer himself for re-election at the Annual been written off to the profit and loss General Meeting in accordance with the account in accordance with the Group’s recommendations of Section A.7.2 of the accounting policy. Further details of Combined Code. In the opinion of the Board research and development activities are Stephen Harris has been been key in the contained in the Operating and Financial development of the Company and continues Review on pages 5 to 14. to provide a worthwhile contribution to its future growth. Through his contributions to Payment of creditors The Group’s policy is to pay its suppliers in debates and questioning of issues at the accordance with the terms and conditions Board and Committee meetings together with his active Chairmanship of the agreed with suppliers, subject to those terms and conditions being fulfilled by the Nomination and Governance Committee Mr supplier. As at 31 December 2006 creditor Harris continues to demonstrate to the Board real independence of thought and days outstanding in respect of the approach. During the year under review Mr Company amounted to 25 days (2005: Harris has spent a considerable amount of 26 days). additional time on recruitment and succession planning matters for which he has received no additional fees. Mr Harris holds a number of non-executive and other positions and the fees he earns from the Company do not constitute a material part of his annual income. Accordingly, the Board considers Mr Harris to fulfil the requirements of an independent nonexecutive director. The Directors present their report on the affairs of the Group, together with the consolidated financial statements and auditors’ report for the year ended 31 December 2006. Directors and their interests The membership of the Board on 25 April 2007 was as follows: The Directors retiring by rotation at the Annual General Meeting are Dr Jerry Karabelas and Alan Bray who, being eligible, offer themselves for re-election. Peter Grant, having been appointed since the last Annual General Meeting, offers himself for election. Directors’ interests Details of Directors’ interests in the share capital of the Company together with details of the share incentives granted to them are disclosed in the Remuneration Report on pages 30 to 46. As at the date of this report, the Directors of the Company had an interest, beneficially and non-beneficially, in an aggregate of 1,520,042 Ordinary Shares, representing 0.187% of the Company’s total voting rights. Directors’ and officers’ liability insurance During the period under review, the Company and the Group maintained insurance policies for its Directors and officers in respect of liabilities which could arise in the discharge of their duties. Substantial shareholdings The Company has been notified of the following interests which represented 3% or more of the Company’s total voting rights as at 25 April 2007: HBM BioVentures (Cayman) Ltd Aviva plc and subsidiaries UBS Investment Bank Lehman Brothers International (Europe) Dr J Gonella Kowa Company Limited Legal & General Group plc 11.13% 10.31% 4.83% 4.61% 4.59% 3.68% 3.39% Authority to make market purchases of Ordinary Shares No purchases of own shares were made in the period under review. As at 31 December 2006 authority given by the shareholders at the 2006 Annual General Meeting for the Company to make market purchases of up to £7,537,641 nominal value of its Ordinary Shares at a price of not more than 105% of the current market price was still in force. Employees and disabled persons A full review of all policies relating to employees is given in the Corporate Social Responsibility review on page 15. Health, safety and environment The Group is committed to maintaining high standards of health and safety, both for their employees and the communities 21 Report of the Directors (including Business Review) SkyePharma PLC Annual Report 2006 shareholders must then specify if they wish to receive communications in paper form (hard copy). To enable the Company to benefit from this opportunity to provide for electronic communication as the Key performance indicators default method of communication, the The Directors have identified certain Key Company is proposing resolution 6 to Resolution 5 — Re-election of the Performance Indicators (“KPIs”) as being authorise the use of its website as a Directors important to the Group. These are means of communicating with Shareholders should be aware that in listed in the Operating and Financial shareholders who do not request addition to the Directors retiring by Review on page 14. documentation in paper form (hard copy). rotation, namely Dr Jerry Karabelas and If approved by shareholders, the new Alan Bray, Stephen Harris, having served Charitable and political donations regime will require the Company to more than nine years as a Non-Executive No contributions were made to charities consult with its shareholders individually Director, offers himself for re-election in (2005: £Nil). No contributions were made as to whether they wish to receive accordance with the recommendations of to political organisations (2005: £Nil). information through the Company’s Section A.7.2 of the Combined Code. website. This consultation will take place Furthermore, Peter Grant having been Close company provisions during the coming year. If a shareholder appointed since the Company’s last AGM The Company is not a ‘close’ company agrees, then future communications with offers himself for election in accordance within the meaning of the Income and that shareholder will be by electronic with the Company’s Articles Corporation Taxes Act 1988, and there means. Notwithstanding any prior request of Association. have been no changes since the end of or deemed consent to receive the year. communications electronically, a In accordance with best practice your attention is also drawn to the biographical shareholder may at any time tell the Annual General Meeting Company that he or she wishes to receive information set out in the Directors & The Annual General Meeting of the all or specific information in paper form Company will take place at the Institute of Advisers section on pages 18 and 19, and to the Corporate Governance Statement on (hard copy). In addition, the Company has Physics, 76 Portland Place, London, pages 23 to 28, which includes information to notify shareholders who receive W1B 1NT at 10.30 am on Friday information in electronic form when on the background and experience of 29 June 2007. Stephen Harris and the basis on which the certain key information is available on the Company’s website. This notification will, Company regards his continued Ordinary Business typically, be sent around the time of the contribution to be of great value to the Resolution 1 — Receipt of the 2006 Company’s annual general meeting. The Company. Report and Accounts overall effect of resolution 6 will be to The Directors are required to lay before allow the Company to increase its use of the Annual General Meeting the accounts In addition to the ordinary business of electronic communications with the Annual General Meeting, certain of the Company for the year ended shareholders. However, as indicated, 31 December 2006, the Directors’ Report, additional resolutions will be proposed, above, the rights of those shareholders details of which are set out below: the Remuneration Report and the who wish to receive documents in paper Auditors’ Report on the accounts and the form (hard copy) will be fully protected. Resolution 6 — Electronic auditable part of the Remuneration Communication Report. The Company sees a positive benefit in the In May 2002, the Company amended its increase of electronic communications Resolution 2 — Approval of the Directors’ Articles of Association to take advantage and associated production expenses. of the Electronic Communications Act Remuneration Report Shareholders will be asked to approve the 2000, which allowed companies to Resolution 7 — Increase of the communicate with their shareholders Directors’ Remuneration Report (as set Authorised Share Capital using electronic means, provided that out on pages 30 to 46); however, the Directors’ remuneration is not conditional individual shareholders gave their specific This resolution increases the authorised share capital of the Company from consent. This regime has been enhanced on this resolution being passed. £111,400,000 to £120,000,000 by the and revised through Schedule 5 of the Companies Act 2006 (“Schedule 5”), which creation of an additional 86,000,000 new Resolution 3 — Appointment of the Ordinary Shares of 10 pence each having came into force earlier this year, and by auditors A resolution to appoint Ernst & Young LLP amendments to the Disclosure Rules and the same rights in all respects as the existing Ordinary Shares in the capital of Transparency Rules of the Financial as auditors to the Company will be the Company. This increase is proposed, Services Authority made in December proposed at the AGM. During the year following the placing of 61,224,490 shares PricewaterhouseCoopers LLP resigned as 2006. in March 2007, to provide the Company auditors having been reappointed by with an appropriate level of authorised but shareholders at the AGM held on 26 June The new regime has the aim of moving unissued share capital. from a “paper first” to a “web first” 2006. Ernst & Young LLP were appointed system. Previously, shareholders had to as auditors by the Board upon the advice ask for information to be communicated to Resolution 8 — Authority to allot relevant of the Audit Committee and are now securities them electronically. The new regime seeking appointment by shareholders. This resolution gives authority to allot makes it possible for electronic shares (or grant rights over shares) up to a communication to become the default nominal amount of £27,139,121. This figure method of communication, so within which the Group operates. Further details are provided in the Corporate Social Responsibility review on page 15. Resolution 4 — Remuneration of the auditors This resolution proposes that the Directors be authorised to determine the level of the Auditors’ Remuneration. SkyePharma PLC Annual Report 2006 22 Report of the Directors (including Business Review) Resolution 10 — Authority to make market purchases The Company is seeking power to make market purchases of its Ordinary Shares. It is common practice for listed companies Special Business to have such authority and the Directors Resolution 9 — Disapplication of preconsider that it is prudent for the emption rights Company to seek such authority at the This resolution will permit directors to Annual General Meeting. The proposed allot, in the period to the Annual General authority is for a maximum nominal Meeting in 2008, shares (or grant rights amount of £8,149,880 which represents over shares) for cash, for example in a not more than 10% of the Company’s rights issue, or to persons who are not issued Ordinary Share Capital as at already shareholders, provided that any issue for cash would not exceed a nominal 25 April 2007 and will expire at the end of the next Annual General Meeting. The amount of £4,074,940 representing 5% of maximum price which may be paid for an the issued Ordinary Share Capital as at 25 April 2007. This amount is in addition to Ordinary Share is 105% of the average of the middle market quotations for the five the shares (or rights over shares) which may be required to be issued under existing business days preceding the purchase and the minimum price that may be paid for an contractual commitments as set out in Ordinary Share is its nominal value of 10p. Resolution 8 above. represents approximately one-third of the Company’s issued Ordinary Share Capital as at 25 April 2007. This authority is in substitution for but without prejudice to authorities previously given relating to the shares required to be set aside to satisfy the Company’s existing contractual commitments including: contingent consideration by way of shares and other securities which may fall due to be issued to the vendors of Krypton Limited; shares which may fall to be allotted under the Company’s share schemes for employees; and shares which may fall due to be allotted to holders of the 6% Convertible Bonds due 2024 and to holders of the 8% Convertible Bonds due 2025 issued by SkyePharma (Jersey) Limited. The authority will expire at the conclusion of the Annual General Meeting to be held in 2008 and replaces a similar authority granted on 28 June 2006, which expires at the end of the forthcoming Annual General Meeting. The Association of British Insurers (“ABI”) recommends that a company should not issue shares for cash (without first offering them to existing shareholders) in any one year in excess of 5% of the issued ordinary share capital or in excess of 7.5% in any rolling period of three years. It is the Company’s intention to comply with these guidelines or to the extent that an issue is contemplated in excess of any such guidelines, to consult with and seek the approval of its substantial shareholders. It is also proposed that the power should also extend to the sale of any Ordinary Shares purchased by the Company and held in treasury and that any such Ordinary Shares shall be included in the 5% limit referred to above. The Directors intend to use this authority only when they consider it to be in the best interests of the shareholders taking into account prevailing market conditions and the financial position of the Company and where the effect would be expected to result in an increase in earnings per share. In addition, it would be possible for the Company to hold any Ordinary Shares purchased by it in treasury instead of cancelling them. Such Ordinary Shares may be sold by the Company for cash or alternatively transferred for the purposes of an employees’ share scheme. If the Company were able to purchase Ordinary Shares in accordance with this authority, the Directors would consider the possibility of holding them in treasury. The Directors have no present intention of exercising the authority conferred by this resolution. By order of the Board John Murphy General Counsel and Company Secretary 25 April 2007 23 SkyePharma PLC Annual Report 2006 Corporate Governance This section contains the Company’s reporting disclosures on corporate governance required by the 2003 Combined Code on Corporate Governance of the Financial Reporting Council (“the Code”) including the required statement of compliance. Comment is also made on the Company’s compliance with applicable US laws and regulations. Governance and Policy The Board is committed to ensuring that high standards of corporate governance are maintained by SkyePharma. We believe that visibly high standards result in increased shareholder value and satisfaction. The Board considers that during 2006 the Company complied with all relevant principles and provisions of the Code. The Board and its processes Board Membership The Board currently comprises three Executive and four Non-Executive Directors, whose biographical details are listed under ‘Directors and Advisers’ on pages 18 and 19. Against a background of shareholder unrest, the Board underwent considerable changes during 2006. In January 2006 Ian Gowrie-Smith stepped down as Chairman and in February 2006 retired from the Board. Dr Jerry Karabelas was appointed Chairman in February 2006. In March 2006 Frank Condella joined the Company as Chief Executive Officer and was appointed to the Board in April 2006. In April 2006 Dr Ken Cunningham joined the Company as Chief Operating Officer and was appointed to the Board in May 2006. Michael Ashton, Sir Michael Beavis and Dr Keith Mansford retired as Directors at the conclusion of the Annual General Meeting in June 2006 (though Michael Ashton remained as an employee of the Company until November 2006). In November 2006 Donald Nicholson resigned from the Board and Peter Grant joined the Company and was appointed to the Board as Finance Director. The Board has been and continues to be engaged in a process of identifying two new Non-Executive Directors. the Annual General Meeting are Dr Jerry Karabelas and Alan Bray who, being eligible, offer themselves for re-election. Steve Harris, having served more than nine years as a Non-Executive Director, will offer himself for re-election at the Annual General Meeting in accordance with the recommendations of the Code. Peter Grant, having been appointed during the year, will offer himself for election at the Annual General Meeting. Board Balance and Independence Dr Jerry Karabelas was considered to be independent at the time of his appointment as Chairman. The Board considers that all the other Non-Executive Directors are independent in both judgement and character and that they carry out their duties in an independent manner and provide constructive challenge to decisions. This is due to their ability to: — corporate governance and internal control and is accountable for all its activities. The Board reviews the operational performance of the Group on a regular basis and also exercises a number of reserved powers including: — — — — — — — — — — rigorously analyse management reports; robustly defend their own points of view; and critically evaluate the pharmaceutical industry and the Company itself. — responsibility for setting the strategic direction of the Group; approving the key operating plan and annual budget; appointment and dismissal of any Board member, senior manager or Company Secretary; approving substantial (i.e. over £0.5m) investments; authorisation of financing, treasury and risk management policies; approving the annual and interim reports; approving and monitoring compliance with the Company’s Codes of Ethics and Conduct, including whistleblowing procedures; ensuring that the Company has adequate internal control systems; and establishing committees of the Board (namely, the Audit, Remuneration and Nomination & Governance Committees), approving their terms of reference, reviewing their performance and ratifying their decisions. Board Meetings The Board meets formally at least eight times a year and ad hoc as required. In 2006, in addition to the eight pre-scheduled formal Board meetings which were held, there were 20 additional meetings held in order to discuss matters such as the EGM, the financing initiatives undertaken late in 2006/7 and the disposal of the Injectable Business. Attendance levels of scheduled In 2006, Dr David Ebsworth received additional fees for consultancy services in meetings are shown in the table below. Directors are fully briefed following any relation to the disposal of SkyePharma meetings which they are unable to attend. Inc. as outlined in the Remuneration Report on pages 30 to 47. It is the opinion The Directors intend that the Board meets of the Board that the sum involved was not abroad each year to enable Directors to visit non-UK sites. Last year one meeting material and that Dr Ebsworth remains took place in San Diego. independent. Dr Jerry Karabelas and Dr Ebsworth both sit on the board of Renovo Each formal Board meeting considers, Group plc, and Dr Ebsworth and Dr as a matter of course, the operational Cunningham both sit on the board of Xention Limited. In respect of both Renovo performance of the Company against its and Xention the Directors concerned have strategic plan and annual budget; reports from the Chairs of the Nomination & confirmed that their appointments were Governance, Remuneration and Audit made following appropriate independent The Executive and Non-Executive Committees (if applicable); important selection processes. The Board believes Directors are subject to retirement by forthcoming events and reports on investor rotation and re-election by shareholders in that these positions do not compromise relations and Health & Safety. Additionally, accordance with the Articles of Association the independence of the Non-Executive Directors are required to confirm their Directors involved. whereby one-third of the Directors retire interests in the Company, any potential by rotation each year. In accordance with conflicts of interest arising from the The Role of the Board the Code all Directors are re-elected proposed business of the meeting and any The Board of SkyePharma PLC is within intervals of no more than three changes in their other appointments. years. The Directors retiring by rotation at responsible for the Group’s system of The Code indicates that independence may be compromised after nine consecutive years’ service with a company. As explained above, Steve Harris has served for more than nine years. The Board believes, however, that he has been key in the development of the Company and he continues to make a valuable contribution to its future growth. SkyePharma PLC Annual Report 2006 24 Corporate Governance Attendance at formal pre-scheduled Board and Committee meetings is set out in the table below: Nomination & Governance Committee meetings4 1/2 Board meetings1 Chairman Dr Jerry Karabelas Executive Directors Frank Condella Dr Ken Cunningham Peter Grant Senior Independent Director Alan Bray Non-Executive Directors R Stephen Harris Dr David Ebsworth Directors leaving during year Michael Ashton Sir Michael Beavis Ian Gowrie-Smith Dr Keith Mansford Donald Nicholson 1 2 Audit Committee meetings2 — Remuneration Committee meetings3 — 8/8 6/6 5/5 1/1 — — — — — — — — — 8/8 6/6 (Chair) 2/2 5/5 7/8 8/8 1/1 5/6 7/7 7/7 (Chair) 5/5 (Chair) 5/5 4/4 4/4 1/1 4/4 7/7 — 3/ 3 — — — — 3/3 (Ex-Chair) — 3/3 — — 2/2 — — 3 4 The Company Secretary also attended all Board meetings. At the invitation of the Chairman of the Audit Committee, the Chief Executive Officer, Finance Director, Company Secretary and external auditors were also invited to attend the Committee meetings. At the invitation of the Chairman of the Remuneration Committee, the Chief Executive Officer and Company Secretary were also invited to attend the Committee meetings except when their remuneration was discussed. At the invitation of the Chairman of the Nomination & Governance Committee, the Company Secretary was also invited to attend meetings of the Committee. Note: The maximum number of Board and/or Committee meetings that could be attended by each Director varies as Directors joined and departed at various times during the year. Certain key senior management members are invited to give presentations at Board and Committee meetings where appropriate. The Non-Executive Directors meet independently of management on a regular basis. In 2006, they met formally eight times and informally on an ad hoc basis as required. The members of the Audit Committee also met with the external auditors independently of management on three occasions. Insurance and Indemnification The Company maintains Directors’ and officers’ insurance cover, up to a limit of £15 million, in respect of any legal actions taken against the Directors in connection with their duties. Additionally, the Company indemnifies Directors for claims made against them in connection with their duties, except those resulting from their wilful negligence. Role of Chairman and Chief Executive The roles of Chairman and Chief Executive are distinct and are held by different people to ensure a clear division of The Board has access to the advice and services of the Company Secretary and are responsibility. The Chairman is responsible for running the Board able in the course of their duties, if including ensuring the timely flow of necessary, to take independent information to Board members and professional advice at the Company’s overseeing its development, whilst the expense within preset limits with prior written approval. Committees have access Chief Executive is responsible for the dayto such resources as are required to fulfil to-day running of the Company and reporting upon this to the Board. their duties. Role of Senior Independent Director The Senior Independent Director, Alan Bray, is available to shareholders if they request a meeting, or have concerns which contact through the normal channels has failed to resolve or where such contact is inappropriate. He also provides a communication channel between the Chairman and the Non-Executive Directors. In addition, he chairs the Audit Committee and also leads the annual performance review of the Chairman. 25 Corporate Governance SkyePharma PLC Annual Report 2006 Role of the Non-Executive Directors The role of the Non-Executive Directors is to bring independent judgement to Board deliberations and decisions and to supervise the corporate governance of the Group. The Non-Executive Directors are all experienced and influential individuals whose blend of skills and business experience contributes to the proper functioning of the Board and its Committees, ensuring that matters are fully debated and that no individual or group dominates the Board’s decisionmaking processes. Induction and Development New Directors receive formal induction training, including site visits and meetings with the Company’s advisers, brokers, auditors and major shareholders, and ongoing training is provided as appropriate. This training is customised for each Director and varies depending upon their skills, experience and background. Directors also receive regular updates on changes and developments in the business, legislative and regulatory environments. Directors are able to identify and suggest any further training requirements which they feel are needed during their annual performance reviews with the Chairman. Board Committees There are three main Committees, all of which operate within written terms of reference. The terms of reference are available on the Company website (www.skyepharma.com) and upon request from the Company Secretary. Details of Committee membership can be found in the table on page 24 which shows attendance at Board and Committee meetings in 2006. No Director may participate in Board and Committee discussions at meetings where he has or may have a conflict of interest. Audit Committee The Audit Committee currently consists of three Non-Executive Directors: Alan Bray, Dr David Ebsworth and Steve Harris, all of whom the Board has determined to be independent. The Committee is chaired by Alan Bray, a chartered accountant who as a retired senior partner of Deloitte & Touche LLP, has recent and relevant financial experience as recommended in the Code and meets the requirements of section 407 of the Sarbanes-Oxley Act 2002 (“Sarbanes-Oxley”) that defines a “financial expert”. Their work during the year included replacing PricewaterhouseCoopers LLP who resigned as auditors. After a tender process, Ernst & Young LLP were selected as auditors. Policy on Non-Audit Services The guidelines set out in the Company’s policy on engaging the external auditors to provide non-audit services include ascertaining that: — — — the skills and experience of the external auditors make them a suitable supplier of the non-audit services; adequate safeguards are in place so that the objectivity and independence of the audit are not compromised; and the fee levels relative to the annual audit fee are within the limits set by the Committee. Remuneration Committee The Remuneration Committee currently consists of Dr David Ebsworth, who chairs the Committee, Alan Bray and Steve Harris, all of whom have been determined by the Board to be independent. The Chief Executive Officer may be invited to attend Remuneration Committee meetings, other than when his own remuneration is discussed. No Director is involved in deciding his own remuneration. The scope and authority of the Committee and the means by which the Company applies the principles of the Code in respect of remuneration policy are set out in the Remuneration Report which is presented on pages 30 to 46. The Committee is advised by Halliwell Consulting, an independent executive remuneration and share schemes consultancy, which provides no other services to the Company. Their work during the year included considering the structure of pay and incentive arrangements for new Directors. The external auditors, Chief Executive Officer and Finance Director are normally invited to attend meetings and, at least once per annum, the Committee and Board Evaluation external auditors meet with no Executives The Board conducts an annual formal evaluation of its own performance and that present. of its committees and of individual The Committee’s terms of reference Directors. This is conducted via an include: anonymous questionnaire devised in accordance with the Higgs Report. Feedback on collective performance is — reviewing the interim and full year collated and presented to the Board and results; actions to improve are agreed and — approving the Interim and Annual implemented. In addition to the review Report and Accounts and Form 20-F carried out through questionnaires, the prior to their submission to the Board; Board focused specifically on its — considering any material matters membership and roles during the lead-up affecting the Company; to and following the EGM held in March — any matters raised by or relating to, 2006. This resulted in the changes to including the appointment or removal Chairman and Executive positions of, the external auditors; described earlier on page 23 which have — responsibility for approving non-audit been well documented in the course of the work to be undertaken by the year. The outcome of the evaluation Company’s auditors. This process, process continues to be used in the search which involves obtaining written for new Non-Executive Directors referred approval from the Audit Committee, to above. ensures that auditor objectivity and independence is safeguarded; and Directors are invited to focus specifically — responsibility for the Company’s on areas requiring priority action and to complaints and whistleblowing policy, give honest and constructive comments so which allows staff to raise concerns that the Board can review its performance about possible improprieties. in a thorough and thoughtful manner. SkyePharma PLC Annual Report 2006 26 Corporate Governance Nomination & Governance Committee The Nomination & Governance Committee currently consists of Steve Harris, who chairs the Committee, Alan Bray and Dr David Ebsworth. The Committee’s terms of reference include: — Reappointment Non-Executive Directors are appointed for an initial term of three years from the annual general meeting following their joining the Board. All Directors must stand for reappointment every three years or every year if over the age of 70 or if they have served on the Board for more than nine years. The terms and conditions of appointment of each Director will be available for inspection at the AGM and at the Company’s registered office. Policy on Other Appointments The Board believes that Non-Executive Directors should be able to accept other appointments where no conflict of interest arises and provided that the NonExecutive Director is able to maintain his time commitments to the Company. These other appointments enable Non-Executive Directors to accrue further skills and experience from which the Company benefits. This policy is reviewed annually. — — — — regularly reviewing the Board’s structure, size and composition; identifying and nominating candidates to join the Board for the approval of the Board; ensuring plans are put in place for succession of the Executive Directors; making recommendations upon the reappointment of the Directors upon retirement whether by virtue of rotation, age or length of service; and assisting the Board in its oversight of the Company’s corporate governance practices and procedures. Financial results and key operational and financial performance indicators are reported regularly throughout the year and variances from plans and budgets are investigated and reported. The Group has a system of high level financial control procedures which are supplemented by detailed procedures at each operating entity. Compliance with these procedures is monitored by the Audit Committee. With the divestment of the Injectable Business, SkyePharma took the opportunity to review its policy in relation to its internal audit function and it was decided that, in common with many other companies of its size and reduced complexity, an internal audit function was no longer required. Appropriate assistance with internal audit will be obtained on a consultancy basis as required. No system can provide an absolute assurance against material misstatement or loss. Their work during the year included considering and recommending the appointments of Dr Jerry Karabelas as Chairman, Frank Condella as Chief Executive Officer, Dr Ken Cunningham as Chief Operating Officer and Peter Grant as Finance Director. An extensive search for suitable candidates was undertaken, including discussions with a specialist recruitment consultancy firm. The firm drew up a shortlist of candidates who met the criteria set out by the Committee. Candidates were then interviewed by the Nomination & Governance Committee prior to their recommendation to the Board. The Nomination & Governance Committee is pleased to be able to recommend Dr Jerry Karabelas, Alan Bray, Stephen Harris and Peter Grant for re-election to the Board of SkyePharma PLC. The Committee has been and continues to be engaged in a process of identifying two new Non-Executive Directors. Principal Risks The pharmaceuticals development Details of any other appointments held by business is inherently risky as new products can fail at any stage in their each Non-Executive Director are listed under ‘Directors and Advisers’ on pages 18 development. It may be that there are difficulties in finding new compounds to and 19. Directors’ commitments are develop; it may be that initially promising reviewed at each Board meeting. developments fail to reach the clinical trial stage; or that they do not complete clinical Internal control framework trials; if they complete clinical trials, then Internal Accountability and Risk regulatory approval may not be achieved; Management or the product may not succeed in the The Board believes that the Company marketplace due to strong competition maintains a sound system of internal from other products, including generics, control with a view to safeguarding or other factors. Shareholders and shareholders’ investment and the Company’s assets. The Board reviews the prospective investors should be aware that investment in the Company involves a high effectiveness of the system at least degree of risk. annually, covering all material controls including financial, operational and compliance controls and risk management systems, and reports to shareholders that it has done so. SkyePharma operates, and attaches importance to, clear principles and procedures designed to achieve the accountability and control appropriate to a science-based business operating internationally in a highly regulated business sector. SkyePharma has established an organisational structure with clearly drawn lines of accountability and delegation of authority. 27 Corporate Governance SkyePharma PLC Annual Report 2006 We consider the following risks to be the main ones faced by our business: Regulation – In the near term the Group’s fortunes are linked to the successful development and launch of Flutiform™. Flutiform™ may be delayed in or not successfully complete the development process, achieve regulatory approval or succeed in the market if approved – Other products for which the Company obtains regulatory approval may not succeed in the market, thereby adversely affecting anticipated revenues – Extensive government regulation may cause increased costs and delays in developing and marketing products – Healthcare reforms may adversely affect the market for the Company’s products – Failure by the Company to keep its manufacturing facilities in compliance with required standards could result in delays in manufacturing, and/or additional costs and/or loss of business – The Company may incur substantial costs relating to its use of hazardous materials – Failure to comply, or the costs of complying with environmental, health and safety regulations could affect the Company’s business Financial – The Company may not be able to refinance its convertible bonds more closely to match its forecast cash flows which may lead to additional or alternative funding requirements which may not be easily available – Various covenants and consent requirements in favour of principal lenders may restrict operational flexibility and obtaining consents/waivers may lead to additional costs or reductions in facilities – Whilst the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the forseeable future, its working capital requirements cannot be predicted with certainty and any additional requirements may not be easily fulfilled – The Company may not achieve and sustain profitability in the timescale envisaged due to a number of factors which include that the revenues of the Company tend to fluctuate – Exchange rate fluctuations may adversely affect the Company’s results of operations and financial position Commercial/ Operational – Competition and technological change may render the Company’s products and/or technologies uncompetitive or obsolete – The Company’s business may give rise to product liability or other claims not covered by insurance or indemnification and/or the Group may be unable to secure adequate insurance at reasonable cost – The Company’s revenues may be reduced and/or costs increased as a result of healthcare cost reimbursement containment measures – The Company is dependent on its various technologies on which further successful development is uncertain – Failure by the Company’s collaborative partners to fulfil and/or maintain their obligations to the Company to provide funding, obtain regulatory approvals and conduct marketing activities could adversely affect the Company’s business – Failure to obtain and maintain patents and other proprietary rights to protect the Company’s assets may adversely affect the Company’s business and competitive position – Failure by the Company to fulfil its obligations to its collaborative partners in respect of manufacturing or to enter into additional or maintain its existing manufacturing arrangements could adversely affect the Company’s business – The Group cannot guarantee that its collaborators will devote sufficient resources to collaborations with the Group or that the Group’s drug candidates can be developed and commercialised without these collaborators – The Group is dependent on single sources of supply for certain of its products and components – The Company may expend significant time and resources relating to existing and potential legal proceedings and the eventual outcome of such proceedings may differ materially from management’s current estimates and beliefs – If the Company is unable to retain key personnel or attract new personnel of the appropriate calibre, this could have an adverse effect on the Company’s business SkyePharma PLC Annual Report 2006 28 Corporate Governance Ethics All Group employees are required to adhere to specified codes of conduct, policies and procedures, including, but not limited to: — — — The Board takes steps to ensure that the views of major shareholders are considered. This is achieved through feedback from meetings with significant shareholders and feedback from the Company’s brokers. US law and regulation A number of provisions of US law and regulation apply to the Company because the shares are listed on NASDAQ. NASDAQ rules In general, the rules permit the Company to follow UK corporate governance practice instead of those applied in the USA, provided that the Company explains any significant variations. There are no significant variations to report. New rules that came into effect in 2005 require the Company to file annual and interim written affirmations concerning the Audit Committee and the Company’s statement on significant differences in corporate governance. Sarbanes-Oxley Act of 2002 Sarbanes-Oxley established new standards for corporate accountability for companies listed in the USA. For accounting periods ending on or after 15 July 2006 (the applicable implementation date for foreign registrants) the Company’s Form 20-F is required to contain a report stating the responsibility of management for establishing and maintaining adequate internal control over financial reporting and assessing the effectiveness of the Company’s internal control over financial reporting. — — Code of Business Conduct and Ethics Code of Ethics for Senior Officers Complaints and Whistleblowing Procedure Equal Opportunities Policy Environmental Policy. A Disclosure Committee was established in 2003 to evaluate the effectiveness of the Group and divisional disclosure controls and procedures; the Committee met once in 2006. Additionally in 2006 and 2007, work continued to document and test the internal controls structure and procedures to comply with Section 404 of Sarbanes-Oxley. The Sarbanes-Oxley Steering Committee has met regularly and reports formally to the Audit Committee. Additionally, the Chairman of the Audit Committee is available on an informal basis to discuss any matters arising between meetings. Copies of the above are available on our website (www.skyepharma.com). These policies are all reviewed annually. Relations with Shareholders It is the objective of SkyePharma’s management to ensure a timely, open, comprehensive and consistent flow of information to investors and the financial community. By this means we aim to help investors to understand the Company’s activities and strategic objectives and thereby facilitate the Company’s access to capital markets. All new information disseminated to institutional investors and analysts by print, email or fax is simultaneously made available on our website (www.skyepharma.com) so that private investors have equal access. We also webcast or provide transcripts on our website of our regular meetings and teleconferences with analysts and investors, and wherever possible, our presentations at investor conferences. The Company is committed to maintaining good relations with its shareholders through the provision of financial updates, interim and annual reports, press releases, presentations at conferences, through its website www.skyepharma.com and through meeting with shareholders at general meetings. Meetings with individual shareholders are also arranged with Executive Directors and/or the Chairman and/or Senior Independent Director, as appropriate. Alan Bray Chairman of the Audit Committee 25 April 2007 29 SkyePharma PLC Annual Report 2006 Statement of Directors’ Responsibilities Statement of Directors’ Responsibility in relation to the Accounts The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable United Kingdom law and those International Financial Reporting Standards (‘IFRS’) as adopted by the European Union. The Directors are required to prepare, for each financial year, financial statements which present fairly the financial position of the Company and of the Group and the financial performance and cash flows of the Company and the Group for that period. In preparing those statements, the Directors are required to: — The financial statements for the year ended 31 December 2006 are included in the Annual Report 2006, which is published by the Company in hard copy printed form and available to download on the Company’s website on the Internet. The Directors are responsible for the maintenance and integrity of the Annual Report on the website in accordance with UK legislation governing the preparation and dissemination of financial statements. This may differ from legislation in other jurisdictions. Access to the website is available from outside the UK, where comparable legislation may be different. Disclosure of information to auditors The Directors, in office at the date of this Report, have each confirmed that: — The Combined Code The Board considers that the Company applies the principles of the Combined Code on Corporate Governance of the Financial Reporting Council, as described under ‘Corporate Governance’ on pages 23 to 28 and has complied with its provisions. As required by the Listing Rules of the Financial Services Authority, the auditors have considered the Directors’ statement of compliance in relation to those points of the Combined Code which are specified for their review. Annual Report The Annual Report for the year ended 31 December 2006, comprising the Report of the Directors, the Remuneration Report, the Financial statements and additional information for investors, has been approved by the Board of Directors. select suitable accounting policies and then apply them consistently; present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; — so far as they are aware, there is no relevant audit information of which the Company’s auditors are unaware; and the Directors have taken all the steps that ought to have been taken as Directors in order to make themselves aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. — Dr Jerry Karabelas Non-Executive Chairman 25 April 2007 provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events Directors’ remuneration and conditions on the entity’s financial The Remuneration Report on pages 30 to position and financial performance; and 46 sets out the remuneration policies operated by the Company and disclosures on Directors’ remuneration and other — state that the Company has complied disclosable information relating to with IFRSs, subject to any material Directors and officers and their interests. departures disclosed and explained in the financial statements. Internal control The Directors are responsible for keeping The Board, through the Audit Committee, proper accounting records which disclose has reviewed the assessment of risks and the internal control framework that with reasonable accuracy at any time the SkyePharma operates and has considered financial position of the Company and of the Group and enable them to ensure that the effectiveness of the system of internal control in operation in the Group for the the financial statements comply with the year covered by this Report and up to the Companies Act 1985 and Article 4 of the IAS Regulation. They are also responsible date of its approval by the Board of Directors. for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. — SkyePharma PLC Annual Report 2006 30 Remuneration Report Introduction This report has been prepared in accordance with The Directors’ Remuneration Report Regulations 2002 (the “Regulations”). The report also meets the relevant requirements of the Listing Rules of the Financial Services Authority and describes how the Board has applied the Principles and complied with the provisions of the revised Combined Code (the “Code”) on Corporate Governance relating to directors’ remuneration. As required by the Regulations, an advisory resolution to approve the report will be proposed at the Annual General Meeting of the Company at which the financial statements will be approved. The auditors are required to report on the ‘auditable’ part of this report and to state whether, in their opinion, that part of the report has been properly prepared in accordance with the Companies Act 1985 (as amended by the Regulations). The report is therefore divided into separate sections for audited and unaudited information. Part 2 of the Regulations — Unaudited Information Remuneration Committee The Directors who were members of the committee during the year are shown in the Corporate Governance report on pages 23 to 28. The following also served on the Remuneration Committee during the financial year: Name Sir Michael Beavis Dr Keith Mansford Position Chairman Member Date of Resignation from Committee 28 June 2006 28 June 2006 The responsibility for the establishment of a remuneration policy and its cost is a matter for the full Board, on the advice of the Remuneration Committee. The recommendations of the Remuneration Committee have been approved without amendment by the Board for submission to shareholders. The Remuneration Committee is responsible for developing policy on remuneration for Executive Directors and senior management and for determining specific remuneration packages for each of the Executive Directors. The Remuneration Committee members have no personal financial interest other than as shareholders in matters to be decided, no potential conflicts of interests arising from cross-directorships and no day-to-day involvement in running the business. During the period under review, the Remuneration Committee sought the assistance of the Chief Executive on matters relating to Directors’ performance and remuneration. The Chief Executive and the Company Secretary, attend meetings by invitation except when their individual remuneration arrangements are discussed. No Director takes part in discussions relating to their own remuneration and benefits. The Remuneration Committee appointed and received wholly independent advice on executive compensation and associated share scheme administration from Halliwell Consulting. No other services were provided to the Company by Halliwell Consulting during the year. The Executive Directors do not hold any executive outside appointments, nor do they retain any earnings, in respect of any non-executive appointments on behalf of the Company. The Remuneration Committee is formally constituted with written terms of reference with the full remit of the Committee role described. A copy of the terms of reference is available to shareholders on request by writing to the Company Secretary whose contact details are set out on page 19 of the Annual Report and on the Company’s website, www.skyepharma.com. Philosophy behind Remuneration Committee’s Approach The underlying philosophy behind the Committee’s policy is to encourage, reward and retain the Executives and the Remuneration Committee believes that shareholders’ interests are best served by remuneration packages which have a large emphasis on performance related pay. Emphasis on performance should encourage Executives to focus on delivering the business strategy and by providing meaningful incentives to Executives ensure that the appropriate balance between fixed and performance related pay is maintained. Remuneration Policy 2006 Overview For 2006 the Remuneration Committee’s policy was to set the main elements of the remuneration package at the following quartiles in comparison to the Company’s Comparator Groups: Base Salary Between Median and Upper Quartile Annual Bonus potential Upper Quartile Share Incentives Lower Quartile Total Compensation Lower Quartile–Median The objective of the remuneration policy is to provide remuneration packages that will: — — — — motivate and encourage superior performance; allow the Company to retain the talent needed to execute its business strategy; enable the Company to be competitive when recruiting appropriate skilled and experienced newcomers; and align rewards with the interests of shareholders. 31 Remuneration Report SkyePharma PLC Annual Report 2006 2006 Comparator Groups The Remuneration Committee used the following Comparators during 2006 prior to the selection of a new Comparator Group set out in the Shareholders’ Circular dated 18 April 2007. Element Salary Benchmark FTSE Mid 250 & Comparator Group Comparator Group Reason The relative lack of UK members in the Comparator Group and the different salary policies adopted by the US members. The Remuneration Committee felt that there was sufficient commonality between the practice of the UK and US members of the Comparator Group to safeguard the Company’s and shareholders’ interests when benchmarking. The Remuneration Committee benchmarked short-term remuneration available against the Comparator Group to ensure that taking into account the FTSE Mid 250 when benchmarking salary did not result in any ratcheting up of compensation levels. US company pension practice is not comparable to UK practice and therefore the relative lack of UK companies in the Comparator Group meant that it was not viable as a benchmark. The Remuneration Committee benchmarked total compensation against the Comparator Group to ensure that taking into account the FTSE Mid 250 when benchmarking salary and pension did not result in any ratcheting up of compensation levels. Bonus Total Short-Term Remuneration Available Comparator Group Pension FTSE Mid 250 Total Compensation Comparator Group The constituents of the Comparator Group were: Acambis Plc Alizyme Plc Alkermes Inc Andrx Corporation Inc Astra Zeneca Plc CAT Group Plc Cephalon Inc Elan Corporation Plc Emisphere Technologies Inc Enzon Pharmaceuticals Inc Nektar Therapeutics Inc Noven Pharmaceuticals Inc QLT Inc Sepracor Inc Shire Pharmaceuticals Group Plc Changes to the Board The Company disclosed in its 2005 Remuneration Committee Report the substantial changes to membership of the Board. The following table repeats this information and also sets out further changes amongst the Executive team subsequent to the publishing of the 2005 Annual Report & Accounts: Standard Company Package n/a n/a Yes Yes Yes Yes Yes Relevant Date 2 February 2006 13 February 2006 1 March 2006 24 April 2006 28 June 2006* 14 November 2006 14 November 2006 Joining/Departing/ Change Change Departing Joining Joining Departing Departing Joining Name & Position Dr Jerry Karabelas (new Chairman) Ian Gowrie-Smith (former Chairman) Frank Condella (new CEO) Dr Ken Cunningham (COO) Michael Ashton (former CEO) Donald Nicholson (former FD) Peter Grant (new FD) Salary/ Fees p.a. £70,000 £140,000 £450,000 £250,000 £466,000 £250,000 £210,000 Special Arrangements No No (see note 2) Yes (see note 1) Yes (see note 1) No (see note 4) No (see note 3) Yes (see notes 1&5) * Mr Ashton ceased employment on 30 November 2006. SkyePharma PLC Annual Report 2006 32 Remuneration Report Notes 1. Overview of Operation of Co-Investment Agreements On appointment, the new Executive Directors were offered the opportunity to participate in the following one-off incentive arrangement. All Executives took advantage of this opportunity by purchasing shares. The main terms of the arrangement were: — the ability to purchase a maximum of one-third of their annual salary in shares of the Company out of their own personal resources; — the Company will provide a maximum of two matching shares for every share purchased: — 50% of these matching shares will be capable of release to the relevant Executive on the first anniversary of their grant, i.e. a 1:1 match if: — he retains the shares he purchased for this period; — remains employed by the Company; — the balance of these matching shares will be capable of release to the relevant Executive on the second anniversary of their grant, i.e. a 2:1 match if: — he retains the shares he purchased for this period; and — remains employed by the Company. Standard Terms 1. If a variation of the issued share capital of the Company occurs the number of Matching Shares subject to the Award and the terms and conditions applying to the Award shall be adjusted in such manner and with effect from such date as the Committee may determine to be appropriate and as the advisers of the Company shall have confirmed in writing to be, in their opinion, fair and reasonable. 2. No benefit from this arrangement is pensionable. Copies of these Agreements will be available on the same basis as the Executive Directors’ service agreements. Basis for Introducing the Arrangement The Remuneration Committee took the following factors into account in determining this arrangement: — A desire to encourage the new Executives to build up a meaningful interest in the shares of the Company in order to assist them in satisfying the Company’s shareholding target — It is a standard element of compensation packages offered by the Company’s US competitors to provide significant sign-on grants to new executives of options and restricted shares awards which are not subject to any co-investment requirement or corporate performance conditions. This is not considered best practice in the UK. Therefore, the Remuneration Committee was required to offer some incentive in order to be competitive taking into account the employment potential for all candidates in the US — The Remuneration Committee felt that the requirement to make a meaningful investment at their own cost in the Company’s shares demonstrated an immediate commitment by the Executives to the Company and is consistent with the objective of aligning Executives’ and shareholders’ interests; and comparatively the maximum value of the one-off award of matching shares of 66% of salary is modest. Date when Matching Shares are Eligible for 1st Release 27 February 2007 Date when Matching Shares are Eligible for 2nd Release 27 February 2008 Name Frank Condella Effective Date of Agreement 27 February 2006 Shares Purchased 350,000 (at a price per share of £0.408929) 179,300 (at a price per share of £0.445) 100,000 (at a price per share of £0.24) Matching Shares Awarded 700,000 Dr Ken Cunningham 1 March 2006 358,600 1 March 2007 1 March 2008 Peter Grant* 26 January 2007 200,000 26 January 2008 26 January 2009 33 Remuneration Report SkyePharma PLC Annual Report 2006 It should be noted that no Matching Shares are eligible for release prior to the dates set out in the table above. Once these dates have been reached, the actual date of release will be determined by the Remuneration Committee in its discretion. * It should be noted that the grant of Matching Shares occurred after 31 December 2006. The entitlement to take part in the Co-Investment Programme was part of the contractual offer made to Peter Grant on joining the Company. However, the first opportunity to take advantage of the Programme for Peter Grant occurred in January 2007 due to his possession of pricesensitive information up to this point prohibiting his acquisition of shares and the award of Matching Shares to him by the Company. 2. Ian Gowrie-Smith On stepping down from the Board Ian Gowrie-Smith was paid his fees for the period ending on the date of the 2006 Annual General Meeting. The Remuneration Committee felt this was appropriate as it had been agreed with Ian Gowrie-Smith that he would step down at the 2006 Annual General Meeting. Ian Gowrie-Smith agreed to step down earlier at the request of the Board and in the best interests of the Company and therefore the Remuneration Committee felt it was equitable to pay the fees for the original agreed period. 3. Donald Nicholson The Company provided the following termination package to Donald Nicholson. Termination of Contract Payment £60,000 Payment in consideration of the Executive waiving all statutory and further legal rights against the Company Pension Contribution £46,375 Value of 12 months’ contractual pension contributions Salary £265,000 Salary equivalent to the contractual notice of 12 months Bonus £0 No bonus is payable under the Plan to any Executives of the Company in respect of 2006. Benefits £14,000 Value of 12 months’ contractual benefits In addition, the Company agreed to pay £15,000 for outplacement services and £5,000 for legal services. The following sets out the treatment of deferred shares, long-term incentives and share option schemes in respect of Donald Nicholson following his resignation: SkyePharma PLC Deferred Share Bonus Plan Number of Matching Shares Capable of Release on Cessation 64,411 56,262 18,403 Shares Released on Cessation 64,411 0 0 Date of Grant 5 May 2004 2 February 2005 2 February 2006 Reason for Release/Lapse Time Based under rules of the Plan Non-satisfaction of Performance Conditions Non-satisfaction of Performance Conditions SkyePharma PLC 2004 Long-Term Incentive Plan Number of Shares Capable of Release on Cessation 344,602 232,691 129,166 Shares Released on Cessation 0 0 0 Date of Grant 5 May 2004 3 June 2005 24 April 2006 Reason for Release/Lapse Non-satisfaction of Performance Conditions Non-satisfaction of Performance Conditions Non-satisfaction of Performance Conditions SkyePharma PLC Annual Report 2006 34 Remuneration Report SkyePharma PLC European and North American Executive Share Option Scheme (31 March 1998 Grant) SkyePharma PLC 1999 Share Option Scheme (all other Grants) End of Exercise Period 13 November 2007 13 November 2007 13 November 2007 13 November 2007 13 November 2007 Date of Grant 31 March 1998 19 April 1999 25 May 1999 12 June 2001 12 April 2002 Number of Shares 89,614 179,872 1,064,830 465,301 483,274 Exercise Price £0.89 £0.67 £0.54 £0.77 £0.69 Reason for Exercise Period post-Cessation The rules of the Schemes provide the following on cessation of employment as a “good leaver”: — no performance conditions apply to the vesting of options (there is no Remuneration Committee discretion, the rules providing an automatic waiver); — a participant shall have the longer of 12 months from the date of cessation or 42 months from the date of grant unless the Committee determines to extend this period. In the case of Donald Nicholson, the Remuneration Committee felt it appropriate to provide the maximum permissible exercise period under the rules of 66 months from the date of grant. The Committee exercised its discretion to treat Donald Nicholson as a good leaver under the Schemes with the maximum post-cessation exercise period to reflect his long service to the Company. 4. Michael Ashton Michael Ashton’s twelve month notice period started on 30 November 2005. The Board decided that Michael Ashton should conduct specific projects for the Company during his notice period (including but not limited to assistance in the disposal of SkyePharma Inc.) and therefore Michael Ashton remained an employee of the Company throughout his notice period. Michael Ashton was provided with his current compensation package during his notice period (except that he was not granted an award under the LTIP). Michael Ashton received no compensation on his cessation of employment although he has been treated as a good leaver under the relevant share plans due to his retirement. The following table summaries the payments and benefits in respect of the 2006 financial year: Salary £427,167 Bonus £0 No bonus was payable under the Plan Benefits £26,341 Benefits provided until 30 November 2006 Living Allowance £19,968 Pension Contribution 74,754 Pension Contribution until 30 November 2006 In addition, the Company agreed to pay £5,000 for legal services, £5,000 for accountants fees and £15,000 for removal expenses. The following sets out the treatment of deferred shares, long-term incentives and share option schemes in respect of Michael Ashton on his retirement: SkyePharma PLC Deferred Share Bonus Plan Number of Matching Shares Capable of Release on Cessation 88,558 61,772 34,329 Shares Released on Cessation 88,558 0 0 Date of Grant 5 May 2004 2 February 2005 2 February 2006 Reason for Release/Lapse Time Based under the rules of the Plan Non-satisfaction of Performance Conditions Non-satisfaction of Performance Conditions 35 Remuneration Report SkyePharma PLC Annual Report 2006 SkyePharma PLC 2004 Long-Term Incentive Plan Number of Shares Capable of Release on Cessation 625,817 422,723 Shares Released on Cessation 0 0 Date of Grant 5 May 2004 3 June 2005 Reason for Release/Lapse Non-satisfaction of Performance Conditions Non-satisfaction of Performance Conditions SkyePharma PLC European and North American Executive Share Option Scheme (31 March 1998 Grant) SkyePharma PLC 1999 Share Option Scheme (all other Grants) End of Exercise Period 30 November 2007 30 November 2007 30 November 2007 30 November 2007 30 November 2007 Date of Grant 31 March 1998 19 April 1999 25 May 1999 12 June 2001 12 April 2002 Number of Shares 665,763 907,841 2,129,659 904,752 939,701 Exercise Price £0.89 £0.67 £0.54 £0.77 £0.69 Reason for Exercise Period post-Cessation The rules of the Schemes provide the following on cessation of employment as a “good leaver” (i.e. retirement): — no performance conditions apply to the vesting of options (there is no Remuneration Committee discretion, the rules providing an automatic waiver); — a participant shall have the longer of 12 months from the date of cessation or 42 months from the date of grant unless the Committee determines to extend this period. In the case of Michael Ashton, the Remuneration Committee felt it appropriate to provide the maximum permissible exercise period under the rules of 66 months from the date of grant. The Committee exercised its discretion in this manner to reflect the long service of Michael Ashton with the Company. 5. Peter Grant It should be noted that Peter Grant has not received any award of matching shares under the SkyePharma PLC Deferred Share Bonus Plan or award under the SkyePharma PLC 2004 Long-Term Incentive Plan due to the lapse of shareholder approval for these Plans in June 2006. Termination of Existing Discretionary Share Plans The following Plans terminated on 6 June 2006 due to the lapse of their shareholder approval: — SkyePharma PLC Deferred Share Bonus Plan (the “DSB”); and — SkyePharma PLC 2004 Long-Term Incentive Plan (the “LTIP”). The substantial changes occurring during 2006 to both the Board and the Company resulted in the Remuneration Committee freezing the existing packages provided to Executive Directors until a new Remuneration Policy could be put before shareholders. Note In this section of the Report where figures are given for an Executive who has only served part of the year but is a continuing employee of the Company, these figures have been annualised to allow an easy comparison amongst their colleagues on the Board and their peers in the Pharmaceutical and Biotechnology sector of the FTSE All Share Index. SkyePharma PLC Annual Report 2006 36 Remuneration Report Fixed vs. Variable Performance Based Compensation for 2006 The chart below demonstrates the potential fixed vs. variable compensation that the Executive Directors could have received under the standard 2006 Remuneration Policy (on an annual basis): Balance Between Fixed and Performance Based Compensation (Variable Compensation) F Condella K Cunningham P Grant I 0% 20% 36% 34% 50% 64% 66% 50% Fixed Compensation: — Salary — Benefits — Pension Contribution I Performance Based (Variable) Compensation: — Maximum Bonus Available — Fair Market Value of LTIP — Fair Market Value of Matching Share Award I 40% I 60% I 80% 100% It should be noted: 1. The Matching Share award under the Co-Investment Agreement is a one-off arrangement. 2. Peter Grant did not receive an LTIP grant during 2006 as the shareholder approval had lapsed prior to his appointment. In addition, the performance compensation includes the value of the Matching Share award made after the year end on 26 January 2007. The entitlement to take part in the Co-Investment Programme was part of the contractual offer made to Peter Grant on joining the Company. However, the first opportunity to take advantage of the Programme for Peter Grant occurred in January 2007 due to his possession of price-sensitive information up to this point prohibiting his acquisition of shares and the award of Matching Shares to him by the Company. Elements of Executive Directors’ Remuneration Basic Salary Policy 2006: Between the Median and the Upper Quartile The Remuneration Committee in consultation with and with the full support of the Executive Directors has not awarded any salary increases to the Executive Directors in respect of 2007. Although overall non-financial objectives and the major financial restructuring were achieved during 2006 or shortly thereafter, it was agreed by the Executive Directors that the Company’s share price performance during 2006 did not warrant any increase. Further, the Remuneration Committee believes that the current salary levels are competitive against the historic comparators used by the Company and does not want to make any changes until the whole new Remuneration Policy has been considered by shareholders. It is not proposed to change the basic principles used by the Remuneration Committee to determine the salaries of the Executive Directors under the new Remuneration Policy. The factors that will be taken into account are: — the levels of base salary for similar positions with comparable status, responsibility and skills, in organisations of broadly similar size and complexity, in particular the policy position compared to comparable companies (a proposed new Comparator Group is set out in the EGM Circular); — the performance of the individual Executive Director; — the individual Executive Director’s experience and responsibilities; and — pay and conditions throughout the Company. Annual Performance Related Bonus Policy 2006: Upper Quartile Bonus payments are not pensionable. Although overall non-financial objectives and the major financial restructuring were achieved during the year or shortly thereafter, the Remuneration Committee in consultation with and with the full support of the Executive Directors has concluded that, in view of the share price performance of the Group, the Executive Directors should not be awarded any bonuses in respect of 2006. The new Remuneration Policy on bonuses and the proposed performance conditions have been set out in the Circular to Shareholders dated 18 April 2007. The Committee will continue under the new Policy with the central principle of reviewing the annual bonus performance targets at the beginning of each financial year to ensure that they are appropriate to the current market conditions and position of the Company in order to ensure that they continue to remain challenging. 37 Remuneration Report SkyePharma PLC Annual Report 2006 Summary of Main Terms of Historic Share Plans The following table summarises the main terms and conditions of the Company’s historic share plans and the grants made under them: Reference for Performance Condition DSB 1 DBS 2 Name of the Plan SkyePharma PLC Deferred Share Bonus Plan (“DSB”) Main Terms 50% of annual bonus was deferred in shares and this was matched on a 1:1 basis (based on the pre-tax amount of salary used to purchase the bonus shares). Matching shares would be released in three years time subject to: — continued employment by the participant; — retention of the executive shares; and — the satisfaction of performance conditions from 1 January 2005. Conditional awards of shares which would be released three years after the date of grant provided that: — the participant was still employed by the Company; and — the performance condition had been satisfied. Market value options were granted which could be exercised three years from the date of grant provided that: — the participant was still employed by the Company; and — the performance condition had been satisfied. Grant Made 5 May 2004 2 February 2005 2 February 2006 Performance Condition None Median comparative total shareholder return1 performance against the relevant Comparator Group before any matching shares can be released. In addition, the Company is required to be in profit at the end of the performance period. Maximum Grant 50% of salary p.a. SkyePharma PLC 2004 Long-Term Incentive Plan (“2004 LTIP”) 5 May 2004 3 June 2005 24 April 2006 Maximum Grant 100% of salary p.a. SkyePharma Executive Share Option Scheme, the European and North American Scheme and the SkyePharma PLC 1999 Share Option scheme (“Option Schemes”) Comparative TSR.1 30% of the award is released for median performance with full release for upper quartile performance compared with the relevant Comparator Group. LTIP 1 31 March 1998 19 April 1999 Options granted may be exercised only if, over a period of three consecutive years, the shareholder return of the Company exceeds the growth in the FTSE All Share Index over the same period. Options granted may be exercised only if, over a period of five consecutive years, the shareholder return of the Company lies within the top quartile growth of the FTSE 250 Share Index over the same period. Options granted vest after three years on a scale between 0% and 100% depending on the Company’s performance relative to the performance of a Comparator Group of companies. Option 1 25 May 1999 Option 3 Maximum Grant 200% of salary p.a. Performance Conditions do not apply if participant cessation of employment is as a result of being a “good leaver”. 12 June 2001 12 April 2002 7 April 2003 Option 2 1 Total Shareholder Return (“TSR”) is a measure showing the return on investing in one share of the Company over the performance period (the return is the value of the capital gain and reinvested dividends). It is normally used comparatively and the company which achieves the best return is ranked number one. SkyePharma PLC Annual Report 2006 38 Remuneration Report Share Incentives Policy 2006: Lower Quartile Awards were made to F Condella and K Cunningham under the 2004 LTIP during 2006; however, the shareholder approval for the Plan lapsed prior to P Grant joining the Company resulting in no grant being made to him. The following table summarises the grants made to the Executive Directors during the year: SkyePharma PLC 2004 Long-Term Incentive Plan Details of Awards are on page 45 1 Maximum Annual Grant Face Value1 as % of Salary 100% Performance Condition LTIP 1 F Condella (% of Salary & Fair Market Value) 100% £320,921 K Cunningham (% of Salary & Fair Market Value) 100% £178,289 Face Value for awards under the LTIP is the aggregate market value of the shares subject to the award at the date of grant. The expiry of shareholder approval for the 2004 LTIP and the Committee’s desire to review the total Remuneration Policy of the Company taking into account the changes to the Executive team and the Board has resulted in the design of a new long-term incentive plan. The Shareholders’ Circular dated 18 April 2007 contains full details of the proposed new 2007 Long-Term Incentive Plan. Dilution In accordance with the ABI guidelines the Company can issue a maximum of 10% of its issued share capital in a rolling ten year period to employees under all its share plans. In addition, of this 10% the Company can only issue 5% to satisfy awards under discretionary or executive plans. The Company operates all its share plans within these guidelines. Pension Policy 2006: Median The Company makes contributions into individual personal pension schemes for the Executives at a defined percentage of salary, excluding bonus and other forms of remuneration. The Executive Directors do not participate in any Company sponsored pension plans and are expected to make their own pension arrangements: Frank Condella (CEO) £78,750 17.5% Dr Ken Cunningham (COO) £43,750 17.5% Peter Grant (FD) £36,750 17.5% Contribution Annual Contribution % of Salary There has been no compensation provided to the Executive Directors for loss of tax relief resulting from the change in pension legislation on “A” Day. Further, the overall cost to the Company of Executive pension provisions remains broadly the same as before the change in legislation. Benefits in Kind Policy 2006: Market Practice The Company provides normal benefits in kind for executives of this level in a company of this size, such as company cars or car allowance and healthcare. Total Compensation Policy 2006: Lower Quartile to Median The following table shows the value of each of the main elements of the remuneration package provided to the Executive Directors during the year ended 31 December 2006 (annualised). It should be noted that the Fair Market Value (FMV) of LTIP awards are not the value that will be received by the Executives but represents the accounting cost to the Company of providing these share incentives under IFRS 2 and, therefore, represents the ‘cash value’ of those grants at the date of grant. The FMV calculation is based on a series of assumptions and may not equate to the actual value received by the Executive Directors on release. In addition, no benefit under the LTIP will be provided unless the attached performance conditions are satisfied and will also depend on the share price on release. Fair Market Value LTIP & Match Value £607,171 Total Compensation Pension Value Actual & Contribution Fair Market Value £78,750 £1,190,219 Name Frank Condella(1) Chief Executive Officer Dr Ken Cunningham(1) Chief Operating Officer Peter Grant(1)(2) Finance Director Salary £450,000 Bonus Paid £0 Benefits £54,298 Total Annual Payments £504,298 £250,000 £0 £10,534 £260,534 £337,866 £43,750 £642,150 £210,000 £0 £12,227 £222,227 £48,000 £36,750 £306,977 39 Remuneration Report SkyePharma PLC Annual Report 2006 Notes: (1) Although overall non-financial objectives and the major financial restructuring were achieved during the year or shortly thereafter, the Remuneration Committee in consultation with and with the full support of the Executive Directors has concluded that, in view of the share price performance of the Group, the Executive Directors should not be awarded any bonuses in respect of 2006. (2) It should be noted that the grant of Matching Shares to Peter Grant occurred after 31 December 2006. The entitlement to take part in the Co-Investment Programme was part of the contractual offer made to Peter Grant on joining the Company. However, the first opportunity to take advantage of the Programme for Peter Grant occurred in January 2007 due to his possession of price-sensitive information up to this point prohibiting his acquisition of shares and the award of Matching Shares to him by the Company. Other Remuneration Matters All Employee Share Arrangements The following table summarises the main features of the Company’s all employee share arrangement and its current status: % of Employees Participating 20% Name ISPP3 Status Operated during year ended 31 December 2006 and will be operated for year ending 31 December 2007. Eligibility All employees of the Company including the Executive Directors. Main Features In the UK the Plan provides employees with the opportunity of purchasing £1,500 of shares a year out of pre-tax salary and providing additional matching shares on a 1:1 ratio. These matching shares will be normally released three years after they have been awarded provided that the associated shares purchased by the employee have been retained and provided the employee is still employed by a Group Company at this time. Equivalent Plans have been introduced in Switzerland, France and the US. 3 SkyePharma PLC International Purchase Plan (“ISPP”). Executive Directors’ Contracts All Executive Directors’ contracts are for a fixed period of one year from date of appointment, and will continue thereafter unless terminated by at least 12 months’ written notice. This arrangement is in line with best corporate practice for listed companies. In the event of the termination of an Executive’s contract, salary and benefits will be payable during the notice period. However, all Executive Directors will be expected to mitigate their loss in accordance with general legal principles in the event of their cessation of employment. The Remuneration Committee will apply phasing of payments of notice on cessation in line with the combined ABI and NAPF guidelines, subject to existing contractual constraints. The Remuneration Committee will ensure that there have been no unjustified payments for failure on an Executive Director’s termination of employment. There are no special provisions in the contracts of employment extending notice periods on a change of control, liquidation of the Company or cessation of employment. Name Frank Condella Dr Ken Cunningham Peter Grant Company Notice Period 12 months 12 months 12 months Effective Date of Contract 1 March 2006 24 April 2006 14 November 2006 Unexpired term of contract (months) Rolling Contract* Rolling Contract* Rolling Contract* * Contract will continue until terminated on notice by either the Company or the Executive Director. SkyePharma PLC Annual Report 2006 40 Remuneration Report Non-Executive Directors Policy 2006: Median The fees paid to the Non-Executive Directors are determined by the Board. Non-Executive Directors are remunerated at a basic rate, plus a fixed amount for membership of Board Committees, adjusted for the acceptance of additional and specific responsibilities. Some of the fees may be payable in the form of shares on the request of the Non-Executive Directors. NonExecutive Directors do not participate in the Company’s share schemes, nor do they receive pension contributions or a bonus. Following a review of the fee structure, from 1 April 2007 the Chairman and Non-Executive Directors have agreed to lower compensation amounting in aggregate to a reduction in total fees of nearly one-third, as set out in the table below, effective 1 April 2007: Annual fees effective 1 April 2007 Basic Fee Rate (£) £43,000 £33,000 £33,000 £36,000 Committee Fees (£) Total 2007 (£) £43,000 £41,000 £41,000 £47,000 £172,000 Total 2006 Rate (£) £70,000 £60,500 £58,000 £61,500 £250,000 Name Dr Jerry Karabelas Dr David Ebsworth Steve Harris Alan Bray (SID) TOTAL £8,000 £8,000 £11,000 In addition to the amounts above, in 2006 Dr D Ebsworth was paid a sum of £7,000 for providing additional assistance on the disposal of SkyePharma Inc. Remuneration Policy 2007 The Remuneration Committee reviews on an annual basis whether the policy remains appropriate for the relevant financial year. Factors taken into account by the Remuneration Committee include: — — — — market conditions affecting the Company; the recruitment market in the Company’s Sector; changing market practice; changing views of institutional shareholders and their representative bodies. In 2007 the following factors were also expressly considered by the Remuneration Committee: — the appointment of a completely new team of Executive Directors to implement a new strategy for the Company; — the change in market capitalisation of the Company and the disposal of SkyePharma Inc.; and — the expiry of shareholder approval for the Company’s historic discretionary share plans: — SkyePharma PLC Deferred Share Bonus Plan; and — SkyePharma PLC 2004 Long-Term Incentive Plan. The Remuneration Committee, therefore, determined to design a completely new Remuneration Policy for Executive Directors including a new Long-Term Incentive Plan. The details of the new Policy are contained in the Notice of EGM and Circular sent to Shareholders on 18 April 2007. In summary, the Committee intends to make the following changes from its historic policy: — the selection of a new Comparator Group to reflect the current size and nature of the Company following the disposal of SkyePharma Inc.; — the design of a new annual bonus plan to replace the existing SkyePharma PLC Deferred Share Bonus Plan; and — the design of new LTIP to replace the SkyePharma PLC 2004 Long-Term Incentive Plan. 41 Remuneration Report SkyePharma PLC Annual Report 2006 Total Shareholder Return Performance Graph The graph below shows the Company’s performance, measured by total shareholder return (“TSR”), compared to the constituents of the FTSE Pharmaceutical and Biotechnology Index over the past 5 years: Total Shareholder Return from 31 December 2001 (%) SkyePharma PLC FTSE Pharmaceutical and Biotechnology Sector 40 20 0 -20 -40 -60 I 2001 I 2002 I 2003 I 2004 I 2005 I 2006 The Remuneration Committee considers the FTSE Pharmaceutical and Biotechnology Index a relevant index for total shareholder return comparison disclosure required under the Directors’ Remuneration Report Regulations 2002 as the index members represent the broad range of UK quoted pharmaceutical companies. SkyePharma PLC Annual Report 2006 42 Remuneration Report Part 3 of the Regulations — Audited Information References to Original Performance Condition in this section of the Report refer to the detailed explanation of these conditions contained on page 37. Directors’ Remuneration The table below sets out details of the Directors’ emoluments for the years ended 31 December 2006 and 31 December 2005. 2006 £’000 Directors Notes Fees & Salary 375 171 27 233 251 69 68 58 62 23 32 27 — Benefits Bonuses 22 7 2 25 9 — — — — — — — — — — — — — — — — — — — — — Termination Payments — — — — 385 — — — — 47 — — — Total 397 178 29 258 645 69 68 58 62 70 32 27 — 1,893 Fees & Salary — — — 440 250 51 53 51 54 140 58 49 25 Benefits — — — 48 10 — — — — — — — — 2005 £’000 Bonuses — — — 110 63 — — — — — — — — Total — — — 598 323 51 53 51 54 140 58 49 25 1,402 Executive Directors (1) F Condella Dr K Cunningham (1) P Grant (1) Former Executive Directors M Ashton (2) D Nicholson (3) Non-Executive Directors Dr A N Karabelas Dr D R Ebsworth (4) R S Harris A Bray Former Non-Executive Directors I R Gowrie-Smith (5) Sir Michael Beavis (6) Dr K R Mansford (6) T Yamamoto (7) Total £’000 Notes: (1) F Condella was appointed on 1 March 2006, Dr K Cunningham was appointed on 24 April 2006, P Grant was appointed on 14 November 2006. (2) M Ashton retired on 30 November 2006. The payments in the table above relate only to the period to 28 June 2006 when M Ashton was a Director. Of the £233,000 paid in this period, £52,000 was paid as a salary sacrifice into M Ashton’s pension. (3) D Nicholson resigned on 14 November 2006. Termination payments of £385,375 were paid. (4) In 2006 Dr D Ebsworth was paid a sum of £7,000 for providing additional assistance on the disposal of SkyePharma Inc. (5) I R Gowrie-Smith was an Executive Director to 23 June 2004 and then served as a Non-Executive Director until standing down on 13 February 2006. On stepping down from the Board I R Gowrie-Smith was paid his fees for the period ending on the date of the 2006 AGM (£47,000). The Remuneration Committee felt that this was appropriate as it had been agreed with I R GowrieSmith that he would step down at the 2006 AGM. I R Gowrie-Smith agreed to step down earlier at the request of the Board and in the best interests of the Company and therefore the Remuneration Committee felt it was equitable to pay the fees for the original agreed period. (6) Sir Michael Beavis and Dr K R Mansford did not stand for re-election in 2006 and retired on 28 June 2006. (7) T Yamamoto resigned on 18 July 2005. Pensions Contributions made to defined contribution pension schemes on behalf of the Executive Directors are set out below. Directors Executive Directors F Condella Dr K Cunningham P Grant Former Executive Directors M Ashton D Nicholson(1) Contributions made in 2006 Contributions made in 2005 £’000 £’000 66 30 5 41 44 — — — 77 44 Notes: (1) In addition, the value of 12 months’ contractual pension contributions (£46,000) was paid as part of D Nicholson’s termination package. Total Directors’ emoluments, excluding pension contributions, amounted to £1,893,575 (2005: £1,402,122). 43 Remuneration Report SkyePharma PLC Annual Report 2006 Directors’ Interests The following tables set out the interests of Directors (including the interests of their immediate families and persons connected with the Directors) as at 31 December 2006 and 31 December 2005. All interests are beneficial unless otherwise stated below. Interests in Ordinary Shares include shares acquired by the Executive Directors, other than Matching Shares not yet released, under the Deferred Share Bonus Plan and Share Purchase Plan. 31 December 2006 Ordinary Convertible Shares Bonds 403,218 179,300 — — — 257,299 206,667 133,000 170,000 — — — — — — — — — — — — — — — 31 December 2005 Ordinary Convertible Shares Bonds — — — 687,674 753,531 157,299 6,667 108,000 120,000 7,452,744 372,356 81,531 9,739,802 — — — — — — — — — 20,000 — — 20,000 Directors Executive Directors F Condella Dr K Cunningham P Grant Former Executive Directors M Ashton D Nicholson R S Harris Dr A N Karabelas Dr D R Ebsworth A Bray Former Non-Executive Directors I R Gowrie-Smith Sir Michael Beavis Dr K R Mansford Notes (1) (2) (3) (4) (5) (6) (7) Notes: (1) Including Partnership Shares held under the Share Purchase Plan (see below). (2) 350,000 of the Ordinary Shares beneficially owned by F Condella are registered in the name of Barfield Nominees Limited and 50,000 in the name of NY Nominees Limited. (3) The Ordinary Shares beneficially owned by Dr Cunningham are registered in the name of Barfield Nominees Limited. (4) P Grant purchased 100,000 Ordinary Shares in 2007 and these are registered in the name of Barfield Nominees Limited. (5) 100,000 of the Ordinary Shares are registered in the name of S M Harris. (6) 94,000 of the Ordinary Shares beneficially owned by Dr Ebsworth are registered in the name of HSBC Global Custody Nominee (UK) Limited and 34,600 in the name of Vidacos Nominees Limited and 67,000 are held in the name of DWP Bank. (7) The Ordinary Shares beneficially owned by A Bray are registered in the name of Strand Nominees Limited. All interests are beneficial unless otherwise stated in the notes to the table. Save as disclosed in this section, no interest exists which the Company is required pursuant to Section 325 of the Act to enter in the register maintained pursuant to that Section. Holdings under the SkyePharma PLC Deferred Share Bonus Plan and the SkyePharma PLC Share Purchase Plan: The following table sets out details of Matching Shares held under the DSB: Original 31 December Performance Lapsed 2006 Condition — — 14,713 101,563 125,000 — 12,086 94,927 71,022 — — — — — — — — — DSB 1 DSB 1 DSB 2 DSB 2 DSB 2 DSB 1 DSB 2 DSB 2 DSB 2 Directors Former Non-Executive Director I Gowrie-Smith Former Executive Directors M Ashton Notes (1) (1) (2) (3) (1) (4) (3) 1 January 2006 133,250 207,748 103,271 101,563 106,841 76,497 94,927 — Granted in the Year — — — — 125,000 — — — 71,022 Released 133,250 207,748 88,558 D Nicholson 106,841 64,411 — — SkyePharma PLC Annual Report 2006 44 Remuneration Report Notes: (1) These Matching Shares were released to the above individuals on 31 January 2006 and relate to an award granted on 31 January 2003 in respect of the bonus earned for the financial year ended 31 December 2002. In relation to I Gowrie-Smith these awards were granted to him in his capacity as Executive Chairman. The share price on 31 January 2006 was 44.5 pence. The total value of Ordinary Shares acquired on this date was £59,296 for I Gowrie-Smith, £92,448 for M Ashton and £47,544 for D Nicholson. (2) These Matching Shares were released to M Ashton on his retirement on 30 November 2006. The share price on 30 November 2006 was 22.75 pence. The total value of Ordinary Shares acquired on this date was £20,147. All other Matching Shares lapsed as the relevant performance conditions were not achieved on the date of retirement. (3) The Matching Shares were awarded on 2 February 2006 at a share price of 44.0 pence. Under the terms of the DSB M Ashton acquired 73,750 Executive Shares and D Nicholson acquired 41,903 Executive Shares on the same date. (4) These Matching Shares were released to D Nicholson on the cessation of his employment on 14 November 2006. The share price on 14 November 2006 was 21.75 pence. The total value of Ordinary Shares acquired on this date was £14,009. All other Matching Shares lapsed as the relevant performance conditions were not achieved on the date of cessation of employment. The following table sets out details of Matching Shares held under the Share Purchase Plan as at 31 December 2006: 1 January 2006 — 10,337 10,337 31 December 2006 3,218 — — Director Executive Directors F Condella Former Executive Directors M Ashton D Nicholson Notes (1) (1) (2) (1) (3) Granted 3,218 4,457 3,896 Released — 14,794 14,233 Lapsed — — — Notes: (1) Matching Shares awarded under the Share Purchase Plan were awarded on a monthly basis (the range over the year was between 22.25 pence and 59.5 pence in conjunction with the monthly share purchases). On the date of award of Matching Shares an equivalent number of Partnership Shares was acquired by the individuals. (2) These Matching Shares were released to M Ashton on his retirement on 30 November 2006. The share price on 30 November 2006 was 22.75 pence. The total value of Ordinary Shares acquired on this date was £3,366. (3) These Matching Shares were released to D Nicholson on the cessation of his employment on 14 November 2006. The share price on 14 November 2006 was 21.75 pence. The total value of Ordinary Shares acquired on this date was £3,096. The following table sets out details of Matching Shares held under the Share Purchase Plan granted after 31 December 2006: Director Executive Directors F Condella P Grant Granted 2,013 1,545 Notes: Matching Shares awarded under the Share Purchase Plan were awarded on a monthly basis (the range over the year was between 22 pence and 27 pence in conjunction with the monthly share purchases). On the date of award of the Matching Shares the above individuals acquired the equivalent number of Partnership Shares. 45 Remuneration Report SkyePharma PLC Annual Report 2006 Options Date from which options Original can be Performance exercised Expiry date Condition Directors I R Gowrie-Smith M Ashton 1 January 2006 2,016,306 665,763 907,841 904,752 939,701 1,774,349 555,604 89,614 179,872 465,301 483,274 985,750 Granted — — — — — — — — — — — — Lapsed 31 December 2006 Exercise price 2,016,306 — — — — 1,774,349 555,604 — — — — 985,750 665,763 907,841 904,752 939,701 89.27p 66.71p 77.37p 69.40p 31-03-01 19-04-02 12-06-04 12-04-05 30-11-07 30-11-07 30-11-07 30-11-07 Option 1 Option 1 Option 2 Option 2 D Nicholson 89,614 179,872 465,301 483,274 89.27p 66.71p 77.37p 69.40p 31-03-01 19-04-02 12-06-04 12-04-05 13-11-07 13-11-07 13-11-07 13-11-07 Option 1 Option 1 Option 2 Option 2 Super Options over shares of 10p each Date from which options Original Exercise can be Performance price exercised Expiry date Condition 54.40p 54.40p 25-05-04 25-05-04 30-11-07 13-11-07 Option 3 Option 3 Directors M Ashton D Nicholson 1 January 2006 2,129,659 1,064,830 Granted — — Lapsed — — 31 December 2006 2,129,659 1,064,830 No options were granted to or exercised by any Director during the year. Options granted were for nil consideration. LTIP Awards Value of shares conditionally awarded Percentage of salary at date of £’000 Grant Number 420 440 235 250 265 450 250 100% 100% 100% 100% 100% 100% 100% 729,787 850,100 409,262 483,011 697,368 1,184,210 657,894 Executive Directors M Ashton D Nicholson Notes (1) (1) (1) (1) (1) Date of grant 05-05-04 03-06-05 05-05-04 03-06-05 24-04-06 24-04-06 24-04-06 Share price at date of grant 57.52p 51.76p 57.52p 51.76p 38p 38p 38p Original Date of Performance lapse Condition 30-11-06 30-11-06 13-11-06 13-11-06 13-11-06 24-04-09 24-04-09 LTIP 1 LTIP 1 LTIP 1 LTIP 1 LTIP 1 LTIP 1 LTIP 1 F Condella Dr K Cunningham Notes: (1) These LTIP Awards lapsed due to the relevant performance conditions not being satisfied on the date of cessation of employment. SkyePharma PLC Annual Report 2006 46 Remuneration Report Co-Investment Agreements Date when Matching Shares are Eligible for 1st Release 27 February 2007 Date when Matching Shares are Eligible for 2nd Release 27 February 2008 Name F Condella Notes Shares Purchased 350,000 (at a price per share of £0.408929) 179,300 (at a price per share of £0.445) Matching Shares Awarded 700,000 Dr K Cunningham 358,600 1 March 2007 1 March 2008 P Grant (1) 100,000 (at a price per share of £0.24) 200,000 26 January 2008 26 January 2009 Notes: (1) It should be noted that the grant of Matching Shares to P Grant occurred after 31 December 2006. The entitlement to take part in the Co-Investment Programme was part of the contractual offer made to P Grant on joining the Company. However, the first opportunity to take advantage of the Programme for P Grant occurred in January 2007 due to his possession of price-sensitive information up to this point prohibiting his acquisition of shares and the award of Matching Shares to him by the Company. Holdings by Trustees The SkyePharma PLC Share Purchase Plan Trust supports the purchases of shares for the UK element of the SkyePharma PLC International Share Purchase Plan. The General Employee Benefit Trust supports purchases of shares for the Option Schemes, the DSB (including the LTIP Schedule) and the international elements of the Share Purchase Plan. The following table illustrates the holdings as at 31 December 2006: SkyePharma PLC Share SkyePharma PLC General Purchase Plan Trust Employee Benefit Trust 91,870 91,870 183,740 2,515,780 2,520,707 5,036,487 Directors Nominee/Non-Beneficial Interest Unallocated or Conditional Grants Total Notes: (1) The Trustees of the SkyePharma PLC Share Purchase Plan Trust are F Condella and P Grant. They have no beneficial interests in the shares held within the Trust except relating to their own participation in the SkyePharma PLC International Share Purchase Plan. (2) The Trustees of the SkyePharma PLC General Employee Benefit Trust are Northern Trust Fiduciary Services (Guernsey) Limited. As a result of transactions since 31 December 2006, the holdings in the Trusts as at 1 April 2007 are as follows: SkyePharma PLC Share SkyePharma PLC General Purchase Plan Trust Employee Benefit Trust 74,185 74,185 148,369 2,488,511 2,430,711 4,919,222 Directors Nominee/Non-Beneficial Interest Unallocated or Conditional Grants Total As at 31 December 2006, none of the Directors had any interests in shares of any other Group company. The market value of Ordinary Shares at 31 December 2006 was 27.5 pence. The market value of Ordinary Shares during 2006 ranged from the lowest closing mid-price of 21 pence to the highest closing mid-price of 49.5 pence. Dr David Ebsworth Chairman of the Remuneration Committee 25 April 2007 47 SkyePharma PLC Annual Report 2006 Independent Auditors’ Report to the Members of SkyePharma PLC We have audited the Group and Parent Company financial statements (the “financial statements”) of SkyePharma PLC for the year ended December 2006 which comprise the Group Income Statement, the Group and Parent Company Balance Sheets, the Group and Parent Company Cash Flow Statements, the Group and Parent Company Statement of Recognised Income and Expenses and the related notes 1 to 34. These financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the Directors’ Remuneration Report that is described as having been audited. This report is made solely to the Company’s members, as a body, in accordance with Section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of Directors and auditors The Directors’ responsibilities for preparing the Annual Report, the Directors’ Remuneration Report and the financial statements in accordance with applicable United Kingdom law and International Financial Reporting Standards (IFRSs) as adopted by the European Union are set out in the Statement of Directors’ Responsibilities. Our responsibility is to audit the financial statements and the part of the Directors’ Remuneration Report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements and the part of the Directors’ Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985 and, as regards the Group financial information, Article 4 of the IAS Regulation. We also report to you whether in our opinion the information given in the Report of the Directors is consistent with the financial statements. The information given in the Report of the Directors includes that specific information presented in the Chairman’s Statement and Operating and Financial Review that is crossreferred from the Business Review section of the Report of the Directors. In addition we report to you if, in our opinion, the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions are not disclosed. We review whether the Corporate Governance Statement reflects the company’s compliance with the nine provisions of the 2003 Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the group’s corporate governance procedures or its risk and control procedures. We read other information contained in the Annual Report and consider whether it is consistent with the audited financial statements. The other information comprises only the Report of the Directors, the unaudited part of the Directors’ Remuneration Report, the Chairman’s Statement, the Operating and Financial Review and the Corporate Governance Statement. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information. Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Directors’ Remuneration Report to be audited. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Group’s and Company’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the part of the Directors’ Remuneration Report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements and the part of the Directors’ Remuneration Report to be audited. Opinion In our opinion: — the Group financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2006 and of its loss for the year then ended; — the Parent Company financial statements give a true and fair view, in accordance with IFRSs as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of the Parent Company’s affairs as at 31 December 2006; — the financial statements and the part of the Directors’ Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation; and — the information given in the Report of the Directors is consistent with the financial statements. Emphasis of Matter — Going concern In forming our opinion we have considered the adequacy of disclosures made in note 1 to the financial statements which indicates the existence of material uncertainties which relate to 2009 and which could affect the Group’s ability to continue as a going concern if not resolved in a timely manner. In view of the significance of this, we consider that it should be brought to your attention, but our opinion is not qualified in this respect. The financial statements do not reflect any adjustments which would be required to be made if they were to be prepared on a basis other than the going concern basis. Ernst & Young LLP Registered Auditor London 25 April 2007 SkyePharma PLC Annual Report 2006 48 Consolidated Income Statement for the year ended 31 December 2006 Notes Continuing operations Revenue 4 Cost of sales Gross profit Selling, marketing and distribution expenses Administration expenses Amortisation of intangibles Other administration expenses Research and development expenses Other income/(expense) 8 Operating loss Finance costs 9 Finance income 9 Share of loss in associate 16 Loss before income tax Income tax expense 10 Loss for the year from continuing operations Loss for the year from discontinued operations 12 Loss for the year from continuing and discontinued operations Basic and diluted earnings per share 11 Continuing operations Continuing and discontinued operations See Notes to the Financial Statements. Year to 31 December 2006 Year to 31 December 2005 (restated) Exceptional Exceptional Pre(Notes 5 Pre(Notes 5 Exceptional and 12) Total exceptional and 12) Total £m £m £m £m £m £m 43.0 — 43.0 50.8 — 50.8 (18.0) — (18.0) (20.6) — (20.6) 25.0 — 25.0 30.2 — 30.2 (3.0) — (3.0) (3.1) — (3.1) (1.5) (12.3) (13.8) (22.9) 0.8 (13.9) (14.1) 3.0 — (25.0) (0.8) (25.8) (22.0) (47.8) (3.4)p (6.4)p (8.8) (4.9) (13.7) — 0.7 (13.0) — 20.1 — 7.1 — 7.1 (37.0) (29.9) 0.9p (4.0)p (10.3) (17.2) (27.5) (22.9) 1.5 (26.9) (14.1) 23.1 — (17.9) (0.8) (18.7) (59.0) (77.7) (2.5)p (10.4)p (1.4) (12.0) (13.4) (14.3) (0.4) (1.0) (16.2) 2.8 (0.8) (15.2) (0.3) (15.5) (14.0) (29.5) (2.5)p (4.7)p — (5.1) (5.1) — — (5.1) — — — (5.1) — (5.1) (16.3) (21.4) (0.8)p (3.4)p (1.4) (17.1) (18.5) (14.3) (0.4) (6.1) (16.2) 2.8 (0.8) (20.3) (0.3) (20.6) (30.3) (50.9) (3.3)p (8.1)p 49 SkyePharma PLC Annual Report 2006 Consolidated Balance Sheet as at 31 December 2006 Notes ASSETS Non-current assets Goodwill Other intangible assets Property, plant and equipment Investments in associates Available-for-sale financial assets Current assets Inventories Trade and other receivables Financial assets at fair value through profit or loss Cash and cash equivalents Non-current assets classified as held for sale Total assets LIABILITIES Current liabilities Trade and other payables Other borrowings Deferred income Non-current liabilities Convertible bonds Other borrowings Deferred income Other non-current liabilities Provisions: Deferred tax liabilities Pensions Liabilities directly associated with non-current assets classified as held for sale Total liabilities Net (liabilities)/assets SHAREHOLDERS’ EQUITY Share capital Share premium Translation reserve Fair value reserve Retained losses Other reserves Total shareholders’ equity Approved by the Board of Directors on 25 April 2007 and signed on its behalf by: 31 December 2006 £m (Restated) 31 December 2005 £m 13 14 15 16 17 29.2 8.7 25.1 — 0.1 63.1 0.5 14.5 0.6 11.9 27.5 17.1 107.7 68.7 26.8 37.1 0.2 1.6 134.4 3.6 14.2 0.4 34.3 52.5 — 186.9 19 20 21 22 12 23 24 (23.4) (8.6) (10.8) (42.8) (64.1) (25.4) (7.4) (0.2) (7.6) (1.9) (106.6) (6.7) (156.1) (48.4) (21.0) (3.4) (7.7) (32.1) (63.6) (51.1) (2.9) (3.4) (7.6) (1.9) (130.5) — (162.6) 24.3 24 24 25 12 27 29 29 29 29 30 76.6 345.6 1.8 (0.2) (501.5) 29.3 (48.4) 76.6 345.6 (1.2) 0.2 (426.2) 29.3 24.3 F Condella Chief Executive Officer P Grant Finance Director See Notes to the Financial Statements. SkyePharma PLC Annual Report 2006 50 Company Balance Sheet as at 31 December 2006 Notes ASSETS Non-current assets Property, plant and equipment Investments in associates Available-for-sale financial assets Shares in and loans to Group undertakings Current assets Trade and other receivables Cash and cash equivalents Total assets LIABILITIES Current liabilities Trade and other payables Other borrowings Non-current liabilities Other borrowings Provisions Total liabilities Net assets SHAREHOLDERS’ EQUITY Share capital Share premium Fair value reserve Retained losses Other reserves Total shareholders’ equity Approved by the Board of Directors on 25 April 2007 and signed on its behalf by: 31 December 2006 £m 31 December 2005 £m 15 16 17 18 0.1 — 0.1 291.1 291.3 2.6 10.4 13.0 304.3 0.1 0.2 1.3 339.8 341.4 5.7 31.6 37.3 378.7 20 22 23 24 (134.4) (0.6) (135.0) — — — (135.0) 169.3 (91.5) (0.8) (92.3) (0.6) — (0.6) (92.9) 285.8 24 25 27 29 29 29 30 76.6 345.6 (0.2) (262.1) 9.4 169.3 76.6 345.6 0.2 (146.0) 9.4 285.8 F Condella Chief Executive Officer P Grant Finance Director See Notes to the Financial Statements. 51 SkyePharma PLC Annual Report 2006 Consolidated Statement of Recognised Income and Expense for the year ended 31 December 2006 Net currency translation effect Available for sale financial assets Fair value movement taken to equity Transfer to the income statement on disposal Actuarial losses on defined benefit plans Net profits/(losses) recognised directly in equity Loss for the year from continuing operations Loss for the year from discontinued operations Total recognised income and expense for the year Effect of restatement for prior period error (Note 1(v)) Reduction in shareholder’s equity Year to 31 December 2006 £m 2.9 (0.2) (0.2) (0.1) 2.4 (18.7) (59.0) (75.3) — (Restated) Year to 31 December 2005 £m (0.3) 0.2 — — (0.1) (16.4) (34.5) (51.0) (7.6) Company Statement of Recognised Income and Expense for the year ended 31 December 2006 Year to 31 December 2006 £m Available for sale financial assets Fair value movement taken to equity Transfer to the income statement on disposal Net (losses)/profits recognised directly in equity Loss for the year Total recognised income and expense for the year See Notes to the Financial Statements. (0.2) (0.2) (0.4) (117.6) (118.0) Year to 31 December 2005 £m 0.2 — 0.2 (98.3) (98.1) SkyePharma PLC Annual Report 2006 52 Consolidated Cash Flow Statement for the year ended 31 December 2006 Continuing operations Cash flow from operating activities Cash used in operations Income tax paid Net cash used in operating activities Cash flows from investing activities Purchases of property, plant and equipment Purchases of intangible assets Proceeds from disposal of available for sale investments Purchase of shares in associates Purchase of own shares Net cash used in investing activities Cash flows from financing activities Repayments of borrowings Interest paid Interest received Gross proceeds from rights issue Expenses of rights issue Proceeds from issue of ordinary share capital Proceeds from issue of convertible bonds due June 2025 Expenses of issue of convertible bonds due June 2025 Repayment of convertible bonds due June 2005 Net cash (used in)/generated from financing activities Effect of exchange rate changes Net (decrease)/increase in cash and cash equivalents less bank overdraft Net cash and cash equivalents less bank overdraft at beginning of the year Net (decrease)/increase in cash and cash equivalents less bank overdraft Less cash and cash equivalents included in discontinued operations Net cash and cash equivalents less bank overdraft at end of the year Analysis of net cash: Cash and cash equivalents Bank overdraft Net cash and cash equivalents See Notes to the Financial Statements. Note (a) Year to 31 December 2006 £m (8.7) (0.3) (9.0) (Restated) Year to 31 December 2005 £m (7.6) (0.3) (7.9) (2.0) (1.4) 1.3 — — (2.1) (2.6) (2.3) 1.6 (0.2) (0.4) (3.9) (6.9) (6.3) 1.0 — — — — — — (12.2) (0.1) (23.4) 34.3 (23.4) (0.3) 10.6 22 24 11.9 (1.3) 10.6 (7.4) (6.7) 0.8 37.7 (2.9) 0.1 20.0 (1.2) (9.8) 30.6 0.2 19.0 15.3 19.0 — 34.3 34.3 — 34.3 53 SkyePharma PLC Annual Report 2006 Notes to the Consolidated Cash Flow Statement (a) Cash flow from operating activities Year to 31 December 2006 £m (18.7) (59.0) (77.7) 0.8 5.5 2.2 46.6 0.2 18.2 (23.1) — (0.6) 2.5 0.2 (25.2) (Restated) Year to 31 December 2005 £m (16.4) (34.5) (50.9) 0.3 6.2 2.1 19.4 (0.3) 22.3 (10.0) 0.8 (0.3) 2.4 0.8 (7.2) Loss for the year from continuing operations Loss for the year from discontinued operations Loss for the year from continuing and discontinued operations Adjustments for: Tax Depreciation Amortisation Impairments Fair value loss/(gain) on derivative financial instruments Finance costs Finance income Share of loss in associate Profit on disposal of available for sale financial assets Share based payments charge Other non-cash charges Operating cash flows before movements in working capital Changes in working capital Decrease/(increase) in inventories (Increase)/decrease in trade and other receivables Increase in trade and other payables Increase/(decrease) in deferred income Decrease in provisions Cash used in operations 2.1 (2.4) 6.5 10.3 — (8.7) (2.1) 4.2 1.2 (3.4) (0.3) (7.6) SkyePharma PLC Annual Report 2006 54 Company Cash Flow Statement for the year ended 31 December 2006 Note Cash flows from operating activities Cash used in operations Cash flows from investing activities Purchases of property, plant and equipment Purchases of shares in associates Proceeds from disposal of available for sale investments Net cash generated from investing activities Cash flows from financing activities Repayments of borrowings Interest paid Interest received Gross proceeds from rights issue Expenses of rights issue Proceeds from issue of ordinary share capital Repayment of convertible bonds due June 2005 Net cash generated from financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at beginning of the year Cash and cash equivalents at end of the year (a) Cash flow from operating activities (a) Year to 31 December 2006 £m (31.3) Year to 31 December 2005 £m (13.3) (0.1) — 1.1 1.0 (0.1) (0.2) 1.6 1.3 (0.9) (7.2) 17.2 — — — — 9.1 (21.2) 31.6 10.4 (0.5) (6.4) 14.1 37.7 (2.9) 0.1 (9.8) 32.3 20.3 11.3 31.6 Loss for the year Adjustments for: Tax Impairments Provision — Shares in Group undertakings Provision — Loans to Group undertakings Provision — Amounts owed to subsidiary undertakings Fair value loss/(gain) on derivative financial instruments Interest expense Interest income Profit on disposal of available for sale financial assets Share based payments charge Other non-cash charges Operating cash flows before movements in working capital Changes in working capital Decrease in trade and other receivables Decrease in trade and other payables Cash used in operations See Notes to the Financial Statements. Year to 31 December 2006 £m (117.6) 0.5 0.2 31.4 90.3 (3.7) 0.2 7.2 (17.2) (0.3) 1.5 0.2 (7.3) Year to 31 December 2005 £m (98.3) — 19.1 — 80.0 — (0.3) 5.8 (14.2) (0.3) 1.3 (0.4) (7.3) 3.0 (27.0) (31.3) 1.0 (7.0) (13.3) 55 SkyePharma PLC Annual Report 2006 Notes to the Financial Statements 1 Accounting policies General information SkyePharma PLC (the “Company”) and its subsidiaries (together the “Group”) is a speciality pharmaceutical Group which uses its multiple drug delivery technologies to create a product pipeline for out-licensing to marketing partners. The Company is incorporated and domiciled in United Kingdom, with its registered office at 105 Piccadilly, London W1J 7NJ. The principal accounting policies adopted in the preparation of these consolidated financial statements are set out below. (a) Basis of preparation The financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) adopted by the European Union and the interpretations issued by the International Financial Reporting Interpretations Committee (“IFRIC”) and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS. All IFRSs issued by the International Accounting Standards Board (“IASB”) that were effective at the time of preparing the financial statements and adopted by the European Commission for use inside the EU were applied by SkyePharma. The financial statements have been prepared under the historical cost convention, as modified by the revaluation of financial assets and financial liabilities. Going concern As set out in Note 24, the Group has in issue £69.6 million bonds which may be converted into Ordinary Shares at 95 pence per share, and may be called for repayment by the bond holders at par during May 2009 and £20.0 million bonds which may be converted into Ordinary Shares at 58 pence per share, and may be called for repayment by the bond holders at par during the following year. The Directors intend to seek to refinance these bonds well before May 2009 in order to ensure that the earliest repayment dates are extended to match more closely the Group’s expected cash inflows. The ability to refinance the convertible bonds in a timely and cost-effective manner will depend upon market conditions as well as continued progress with the Group’s business, especially the development of Flutiform™. Although the application of drug delivery technologies to known molecules is lower risk than drug development, there can be no absolute certainty that Flutiform™ will successfully complete development and be launched in the United States in 2009. Nevertheless, the Directors have a reasonable expectation that these risks can be managed to a successful outcome. Accordingly, following the financial restructuring completed in March 2007, and having made an assessment of the working capital requirements for the next twelve months, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future and have, therefore, prepared the financial information contained herein on a going concern basis. The financial statements do not reflect any adjustments that would be required to be made if they were to be prepared on a basis other than the going concern basis. Use of estimates The preparation of the financial statements, in conformity with generally accepted accounting principles, requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on management’s best knowledge of the amount, event or actions, actual results may ultimately differ from those estimates. The areas involving higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 3, Critical accounting estimates and judgements. Company income statement In accordance with the provisions of section 230 of the Companies Act 1985, no separate income statement has been presented for the Company. The results for the Company are also presented under IFRS. (b) Consolidation The underlying financial statements comprise a consolidation of the accounts of the Company and all its subsidiaries and includes the Group’s share of the results and net assets of its associates. The accounts of the Group’s subsidiaries and associates are made up to 31 December. Subsidiaries Subsidiaries are all entities over which the Group has control. Control is achieved where the Company has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date on which control ceases. The results of subsidiaries acquired or disposed of during the year are included in the consolidated income statement from the effective date of acquisition or up to the effective date of disposal, as appropriate. The Group uses the purchase method to account for the acquisition of subsidiaries. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the Group’s share of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement. SkyePharma PLC Annual Report 2006 56 Notes to the Financial Statements 1 Accounting policies continued Inter-company transactions, balances and unrealised gains on transactions between Group companies are eliminated. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Subsidiaries’ accounting policies have been changed where necessary to ensure consistency with the policies adopted by the Group. Associates Associates are all entities over which the Group has the power to exercise significant influence but not control generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in associates are accounted for by the equity method of accounting and are initially recognised at cost. The Group’s investment in associates includes goodwill identified on acquisition. The Group’s share of its associates’ post-acquisition profits or losses is recognised in the income statement, and its share of post-acquisition movements in reserves is recognised in reserves. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in an associate or joint venture equals or exceeds its interest or participation, including any other unsecured long-term receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate or joint venture. Unrealised gains on transactions between the Group and its associates are eliminated to the extent of the Group’s interest in the associates. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Where Associates’ differ from those of the Group adjustments are made, where material, to report the Group’s share of results on a basis which is consistent with the policies adopted by the Group. (c) Foreign currency translation Functional and presentation currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (‘the functional currency’). The consolidated financial statements are presented in pound sterling, which is the Company’s functional and presentation currency. Transactions and balances Foreign currency transactions by Group companies are translated in the functional currency at the exchange rate prevailing at the date of the transaction. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement, except when it relates to items recognised directly in equity, e.g. for financial assets classified as available for sale, the exchange component of that gain or loss will be recognised directly in equity. Group companies The results and financial position of all the Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of the balance sheet; (ii) income and expenses for each income statement are translated at average exchange rates; and (iii) all resulting exchange differences are recognised as a separate component of equity. On consolidation, exchange differences arising from the translation of the net investment in foreign entities, are taken to shareholders’ equity. Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate. On disposal of a foreign entity, accumulated exchange differences are recognised in the income statement in the same period in which the gain or loss on disposal is recognised. (d) Segment reporting The Group’s primary segment for IFRS segment reporting is the business segment. A business segment is a group of assets and operations engaged in providing products or services that are subject to risks and returns that are different from those of other business segments. Geographical regions are the secondary reporting segments. A geographic segment is engaged in providing products or services within a particular economic environment that are subject to risks and return that are different from those of components operating in other economic environments. Segment reporting reflects the internal management reporting structure and the way the business is managed. (e) Revenue recognition Revenue comprises the fair value for the sale of goods and services, net of sales taxes, rebates and discounts and after eliminating sales within the Group. Revenue is recognised as follows: 57 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 1 Accounting policies continued License signing and milestone fees License signing and milestone fees represent amounts earned from licensing agreements, including upfront payments, milestone payments and technology access fees. Revenues are recognised where they are non-refundable, the Group’s obligations related to the revenues have been discharged and their collection is reasonably assured. Refundable contract revenue is treated as deferred until such time that it is no longer refundable. In general, upfront payments are deferred and amortised on a systematic basis over the period of development to filing. Milestone payments related to scientific or technical achievements are recognised as income when the milestone is accomplished. Contract research and development costs recharged Contract research and development recharged represents amounts earned for services rendered under development contracts. Revenues are recognised in the period when they are earned. Royalty income Royalty income is recognised on an accruals basis and represents income earned as a percentage of product sales in accordance with the substance of the relevant agreement. Manufacturing and distribution Manufacturing and distribution revenues principally comprise contract manufacturing fees invoiced to third parties and income from product sales. Revenues are recognised upon transfer to the customer of significant risks and rewards, usually upon dispatch of goods shipped where the sales price is agreed and collectability is reasonably assured. Interest income Interest income is recognised on a time-proportion basis using the effective interest method. (f) Intangible assets Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary at the date of acquisition. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Goodwill is allocated to cash generating units for the purpose of impairment testing. Each of those cash generating units represents the Group’s investment in each country of operation. Intellectual property Intellectual property comprises acquired patents, trade marks, know-how and other similarly identified rights. These are recorded at their fair value at acquisition date and are amortised on a straight-line basis over their estimated useful economic lives from the time they are available for use. The period over which the Group expects to derive economic benefits does not exceed 20 years. Research and development Research expenditure is charged to the income statement in the period in which it is incurred. Development expenditure is capitalised when the criteria for recognising as an asset are met — when it is probable that the project will be a success, considering its commercial and technological feasibility and costs can be measured reliably. Regulatory and other uncertainties generally mean that such criteria are not met. Where development costs are capitalised they are amortised over their useful economic lives from product launch. Prior to product launch the asset is tested annually for impairment. Computer software Costs that are directly associated with the purchase and implementation of identifiable and unique software products by the Group are recognised as intangible assets. Expenditure that enhances and extends the benefits of computer software programs beyond their original specifications and lives are recognised as capital improvements and added to the original cost of the software. Direct costs include the employee costs of software development and an appropriate portion of relevant overheads. Software costs are amortised over their useful economic lives, generally a period of 3 to 5 years. (g) Property, plant and equipment Property, plant and equipment are stated at the cost of purchase or construction less provision for depreciation and impairment. The cost of property, plant and equipment includes acquisition costs and labour and overhead costs arising directly from the construction or acquisition of an item of property, plant and equipment. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance expenditures are charged to the income statement during the financial period in which they are incurred. Depreciation is not provided on freehold land or projects under construction. On other property, plant and equipment, depreciation is provided on the difference between the cost of an item and its estimated residual value, in equal annual instalments over the estimated useful lives of the assets as follows: Freehold buildings Laboratory equipment and machines Office and other equipment Motor vehicles Short leasehold property Assets in the course of construction are depreciated when they have been brought into operational use. 2%–5% 10%–33% 10%–33% 20% period of the lease SkyePharma PLC Annual Report 2006 58 Notes to the Financial Statements 1 Accounting policies continued The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. An asset’s carrying amount is written down immediately to its recoverable amount if the asset’s carrying amount is greater than its estimated recoverable amount. Gains and losses on disposals are determined by comparing the disposal proceeds with the carrying amount and are included in the income statement. (h) Impairment of assets Assets that have an indefinite useful life are not subject to amortisation and are tested annually for impairment. Assets that are subject to amortisation or depreciation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. Any impairment loss is charged to the income statement in the year concerned. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash in flows (cash-generating units). The expected cash flows generated by the assets are discounted using asset specific discount rates which reflect the risks associated with the groups of assets. These risks vary with the nature and the location of the cash generating units. (i) Investments The Group classifies its investments according to the purpose for which the investments were acquired. Management determines the classification of investments at initial recognition and re-evaluates the designation at every reporting date. The Group has the following categories of investments: Available-for-sale financial assets Available-for-sale financial assets are non-derivatives that are not acquired to generate profit from short-term fluctuations in price. They are included in non-current assets unless management intends to dispose of the asset within 12 months of the balance sheet date. Available-for-sale investments are initially recorded at cost, being the fair value of consideration given, plus transaction costs. Subsequently, available-for-sale investments comprising marketable equity securities that are traded in active markets are carried at their fair value as of each balance sheet date. Unrealised gains and losses arising from changes in the fair value of non-monetary securities classified as available-for-sale investments are recognised in equity. When available-for-sale investments are sold or impaired, the accumulated fair value adjustments in equity are recycled into the income statement as gains and losses from investment securities. The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss — measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised is removed from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement. Financial assets at fair value through profit or loss The Group classifies investments in this category if acquired principally for the purpose of selling in the short term or if so designated by management on inception as held for trading. Financial assets at fair value through profit or loss are initially recorded, and subsequently carried, at fair value. Realised and unrealised gains and losses arising from changes in the fair value of assets held in this category are included in the income statement in the period in which they arise. Financial assets at fair value through profit or loss are classified as current assets if they are either held for trading or are expected to be realised within 12 months of the balance sheet date. (j) Inventories Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first in first out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and an appropriate proportion of related production overheads, based on the normal level of utilisation of production capacity. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. Provision is made for obsolete, slow-moving or defective items where appropriate. (k) Trade receivables Trade receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable. They are included in current assets, except for maturities greater than 12 months after the balance sheet date. These are classified as non-current assets. Trade receivables are recognised initially at fair value less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. (l) Cash and cash equivalents Cash and cash equivalents are highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Cash and cash equivalents are carried in the balance sheet at cost. For the purposes of the cash flow statement, cash and cash equivalents comprise cash at bank and in hand, short-term deposits, marketable securities and overdrafts. Bank overdrafts are included within borrowings in current liabilities on the balance sheet. 59 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 1 Accounting policies continued (m) Assets held for sale and discontinued operations Assets classified as held for sale are measured at the lower of carrying value and fair value less costs to sell. Non-current assets and disposal groups are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and expected to be completed within one year from classification and the asset is available for immediate sale in its present condition. Disposal groups are classified as discontinued operations where they represent a major line of business or geographical area of operations. The income statement for the comparative period is restated to show the discontinued operations separate from the continuing operations. (n) Borrowings Borrowings are recognised initially at fair value, net of transaction costs incurred. Borrowings are subsequently stated at amortised cost, any difference between proceeds (net of transaction costs) and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method. Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date. (o) Convertible bonds On issue the debt and equity components of a convertible bond are separated and recorded at fair value net of issue costs. The fair value of the liability portion is determined by applying a market interest rate for an equivalent non-convertible bond to the forecast cash flows under the convertible bond agreement. This amount is recorded as a liability on an amortised cost basis until extinguished on conversion or maturity of the bonds. The remainder of the proceeds of the bond is allocated to the conversion option which is recognised and included in shareholders’ equity, net of income tax effects. The value of the conversion option is not changed in subsequent periods. Where the bonds include early repayment options for the bond holders and early repayment will be at par the embedded option is considered as clearly and closely related and therefore not separated from the host contract. (p) Paul Capital funding liabilities The Group entered into two transactions with Paul Capital Royalty Acquisition Fund (‘Paul Capital’) in 2000 and 2002. Under these transactions Paul Capital provided a total of US$60 million in return for the sale of a portion of the potential future royalty and revenue streams on a selection of the Group’s products. The proceeds received from Paul Capital meet the definition of financial liabilities under IAS 39, Financial Instruments: Recognition and Measurement, and are treated as financial liabilities accordingly. Royalties paid to Paul Capital are treated as repayment of the liabilities and notional interest is charged on the liabilities using the effective interest rate at inception of each agreement. The estimated payments to Paul Capital are discounted using each contract’s original effective interest rate. Any change in the estimated future payments to Paul Capital is recognised as income or expense in the income statement. (q) Derecognition of financial assets and liabilities A financial asset or liability is generally derecognised when the contract that gives rise to it is settled, sold, cancelled or expires. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, such that the difference in the respective carrying amounts together with any costs or fees incurred are recognised in profit or loss. (r) Derivative financial instruments The Group uses derivative financial instruments to manage its exposure to fluctuations in interest and foreign exchange rates. Specifically, the Group uses interest rate swaps, forward currency contracts and currency options. Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured at their fair value. The Group designates certain derivatives as either: — — hedges of the fair value of recognised assets or liabilities (fair value hedge); or hedges of highly probable forecast transactions (cash flow hedges). For relationships where hedge accounting is applied the Group documents at the inception of the transaction the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions and reviews this documentation on an ongoing basis. Fair value hedge Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Cash flow hedge The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in equity. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts deferred in equity are recycled in the income statement in the periods when the hedged item will affect profit or loss. Derivatives that do not qualify for hedge accounting Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognised immediately in the income statement. SkyePharma PLC Annual Report 2006 60 Notes to the Financial Statements 1 Accounting policies continued (s) Leases Lease agreements which transfer to the Group substantially all the risks and rewards of ownership of an asset are classified as finance leases. Finance leases are capitalised at the inception of the lease at the lower of the fair value of the leased property, plant and equipment or the present value of minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are included in other long-term payables. These payments are split between capital and interest elements using the annuity method. The interest element of the lease rental is included in the income statement. Assets held under finance leases are depreciated on a basis consistent with similar owned assets or the lease term if shorter. All other leases are classified as operating leases. Payments made under operating leases, net of lease incentives or premiums received, are charged to the income statement on a straight-line basis over the period of the lease. (t) Employee benefits Pension obligations The Group operates various defined contribution plans for its employees in the UK and US. The Group’s contributions to these plans are charged to the income statement in the period to which they relate, and the assets are held in separate trustee administered funds. The Group has no further payment obligations once the contributions have been paid. The Group operates unfunded defined benefit schemes in respect of its employees in Switzerland and France. The liability recognised in the balance sheet in respect of the defined benefit pension plans is the present value of the defined benefit obligations at the balance sheet date less the fair value of plan assets, together with adjustments for unrecognised actuarial gains or losses and past service costs. Defined benefit obligations for the schemes are calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligations are determined by discounting the estimated future cash outflows using interest rates of high quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability. Service costs are included in staff costs and charged to income statement over the remaining average expected service lives of employees. The Group recognises actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions directly in equity, in the period they have occurred, in accordance to the alternative treatment allowed by the amendment to IAS 19, Employee benefits — Actuarial gains and losses, group plans and disclosures. Share-based compensation Incentives in the form of shares are provided to employees under share option, share purchase and long-term incentive plans. The fair value of the employee services received in exchange for the grant of the options and rewards is recognised as an expense. The total amount to be expensed over the vesting period is determined by reference to the fair value of the options granted, which excludes the impact of any non-market vesting conditions (for example, profitability and sales growth targets). Non-market vesting conditions are included in estimates about the number of options that are expected to become exercisable. The Group provides finance to an employee share ownership trust to purchase Company shares on the open market to meet the Group’s obligation to provide shares when employees exercise their options or awards. The costs of running the employee share ownership trust are charged to the income statement as they accrue. Shares held by the employee share ownership trust are deducted from shareholders’ equity. At each balance sheet date, the entity revises its estimates of the number of options that are expected to become exercisable. It recognises the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity over the remaining vesting period. (u) Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, if it is probable that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Restructuring charges are provided in the period in which management has committed to a plan and it is probable that an obligation has been incurred that can be reliably estimated. Provisions are not recognised for future operating losses. (v) Taxation and prior period error Current tax is the expected tax payable on the taxable income for the year using the tax rates and laws that have been enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidate financial statements. Deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilised. Deferred income tax is determined using tax rates that have been enacted or substantially enacted by the balance sheet date. Deferred tax assets and liabilities are not discounted. The comparative figures for 2005 have been restated for a prior period error to include a provision for deferred tax, as required by IAS 12, of £7.6 million at 31 December 2005 on the temporary difference between the face value of the convertible bonds and the value at which they are included in liabilities in the balance sheet. This adjustment should have been made on the transition to IFRS and should have been included in the consolidated 2005 financial statements. The prior period comparative figures in the consolidated balance sheet have been restated as follows: — — — — A provision for deferred taxation of £7.6 million has been included as at 31 December 2005; Other Reserves brought forward at 1 January 2005 have been reduced by £6.9 million; Other Reserves carried forward at 31 December 2005 have been reduced by £8.5 million; and Retained losses brought forward at 1 January 2005 and carried forward at 31 December 2005 have been reduced by £0.9 million. 61 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 1 Accounting policies continued The restatement has no material effect on the consolidated income statement or consolidated cash flow statement for the year ended 31 December 2005. (w) Deferred consideration Provisions for deferred consideration comprise the fair value of contingent consideration arising from acquisitions and are included in the cost of business combinations at the acquisition date if the adjustment is probable and can be reliably measured. Provisions are reviewed annually by the Directors, and changes to the estimated fair value of the contingent consideration are recorded as an adjustment to goodwill or the underlying asset value. (x) Future changes to the accounting policies At the date of authorisation of these financial statements, the following standards and interpretations, relevant to the Group, which have not been applied in these financial statements, were in issue but not yet effective: IFRS 7, Financial instruments: Disclosures; and the related amendment to IAS 1 on capital disclosures; IFRIC 8, Scope of IFRS 2; and IFRIC 9, Reassessment of Embedded Derivatives. The Directors anticipate that the adoption of these standards and interpretations in future periods will have no material impact on the financial statements of the Group, except for additional disclosures on financial instruments when the relevant standards come into effect for periods commencing on or after 1 January 2007. 2 Financial risk management Financial risk factors The Group holds financial instruments to finance its operations and to manage the currency risk that arises from these operations. It is the Group’s policy that no speculative trading in financial instruments shall be undertaken. The Group finances its operations through a combination of equity, convertible bonds, bank loans and other borrowings. The main risks arising from the Group’s financial instruments are liquidity risk, foreign currency risk, interest rate risk, credit risk and price risk. Liquidity risk The Group’s policy is to maintain continuity of funding through a mixture of long-term debt and bank loans, raised to cover specific projects, and through the issue of shares to collaborative partners, where necessary, to finance development contracts. Short-term flexibility is provided through the use of overdrafts. Foreign currency risk The Group’s principal operations are based overseas in Continental Europe and North America and revenues are derived from sales in various countries, giving rise to exposures to changes in foreign exchange rates notably the Swiss franc, euro and US dollar. To minimise the impact of any fluctuations, the Group’s policy has historically been to maintain natural hedges by relating the structure of borrowings to the trading cash flows that generate them. Where subsidiaries are funded centrally, this is achieved by the use of long-term loans, the exchange differences on which are taken to reserves. Where it has not been possible to use natural hedges, currency options, accrual forward options and forward currency contracts are used. The Group has used these financial instruments during the year to minimise the currency exposure on operational transactions. Interest rate risk The Group borrows at fixed and floating rates of interest as deemed appropriate for its circumstances. Where necessary the Group uses interest rate swaps to achieve the desired interest rate profile. Credit risk The Group is exposed to credit related losses in the event of non-performance by third parties to financial instruments. The Group does not expect any third parties to fail to meet their obligations given the policy of selecting only parties with high credit ratings and minimising its exposure to any one institution. Price risk The Group is exposed to equity securities price risk because of investments which have been classified on the consolidated balance sheet to be valued at fair value with movements charged through profit or loss. Fair value estimation The fair value of financial instruments traded in active markets (such as trading and available-for-sale securities) is based on quoted market prices at the balance sheet date. The quoted market price used for financial assets held by the Group is the current bid price. Quoted market prices or dealer quotes for similar instruments are used for other financial instruments. The fair value of forward foreign exchange contracts is determined using forward exchange market rates at the balance sheet date. The nominal value less estimated credit adjustments of trade receivables and payables are assumed to approximate their fair values. The fair value of the liabilities for the disclosure purposes is estimated by discounting the future cash flows at the current market interest rates that is available to the Group for similar financial instruments. SkyePharma PLC Annual Report 2006 62 Notes to the Financial Statements 3 Critical accounting estimates and judgements The preparation of the Consolidated Financial Statements requires the Group to make estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Group bases its estimates and judgements on historical experience and on various other assumptions that it considers to be reasonable. Actual results may differ from these estimates under different assumptions or conditions. Revenue recognition The Group’s revenue comprises revenues from contract development and licensing, royalties and manufacturing and distribution. The Group enters a wide variety of collaborative arrangements with its partners from which it may earn all, or some of, these revenue streams. The application of the Group’s revenue recognition policy set out in note 1(e) to its complex collaboration agreements requires significant estimates and judgement. In particular, in arrangements with multiple deliverables, there may be significant judgement in separating the different revenue generating activities. Paul Capital funding liabilities The proceeds received from Paul Capital are treated as financial liabilities under IAS 39 and are recorded within borrowings at the net present value of royalties expected to be paid to Paul Capital. Therefore in order to be able to record the funding liabilities significant estimation of certain of the Group’s future cash flows is required. Royalty cash flows are periodically reassessed to determine the estimated funding liabilities. In addition, such cash flows are subject to foreign exchange movements. Refer to Note 9, Finance costs and income and Note 24, Borrowings. Impairment of goodwill The Group tests annually whether goodwill has suffered any impairment, in accordance with the accounting policy stated earlier in this note. The recoverable amounts of cash-generating units have been determined based on value-in-use calculations. These calculations require the use of estimates. The estimates used in goodwill impairment testing as at 31 December 2006 and 2005 are presented in Note 13, Goodwill. Impairment of other intangible assets and property, plant and equipment The Group tests annually whether other intangible assets and property, plant and equipment have suffered any impairment, in accordance with the accounting policy stated in note 1(f). These calculations require the use of estimates. Deferred consideration Provisions for deferred consideration payable by the Group comprise the fair value of contingent consideration arising from acquisitions. The eventual outcome is subject to the Group’s future performance and certain contractual terms. Provisions are reviewed annually by the Directors, who make significant judgements as to the estimated fair value of the contingent consideration. Based on these judgements, changes to the estimated fair value of the consideration are recorded. No deferred consideration has been recorded in the financial statements. Refer to Note 27, Share capital. Contingent liabilities Provisions for contingent liabilities are dependent upon estimates and assessments of whether the criteria for recognition have been met, including estimates by the Directors as to the probable outcome and the amount of the potential cost of resolution. Any estimate for such an accrual would be developed in consultation with external legal advisers handling the Group’s defence in these matters and would be based upon an analysis of potential outcomes. Refer to note 32, Contingencies. Pensions The Group recognises actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions directly in equity, in the period they have occurred, in accordance to the alternative treatment allowed by the amendment to IAS 19, Employee benefits — Actuarial gains and losses, group plans and disclosures. The costs are assessed in accordance with advice received from independent actuaries. These assumptions include inflation rate, rate of increase in salaries, discount rate and expected return on plan assets and are disclosed in Note 26, Retirement benefit obligations. The selection of different assumptions could affect the future results of the Group. Share based compensation Incentives in the form of shares are provided to employees under share option, share purchase and long-term incentive plans. The fair value of the employee services received in exchange for the grant of the options and rewards is recognised as an expense. The expense is based upon a number of assumptions disclosed in Note 27, Share capital. The selection of different assumptions could affect the future results of the Group. Amortisation lives Other intangible assets are recorded at their fair value at acquisition date and are amortised on a straight-line basis over their estimated useful economic lives from the time they are available for use. Any change in the estimated useful economic lives could affect the future results of the Group. Taxation Current tax is the expected tax payable on the taxable income for the year using the tax rates and laws that have been enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. The Group has open tax submissions with a number of revenue authorities and, on the basis of external professional advice, continues to believe that it has made adequate provision for any liabilities that may arise from these open assessments. The ultimate liability for any issues arising may vary from the amounts provided, and is dependent upon negotiations with the relevant tax authorities. 63 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 4 Segment information Primary reporting format — business segments The Group is a speciality pharmaceutical company, using its multiple drug delivery technologies to create a product pipeline for out-licensing to marketing partners. Based on the risks and returns of the various segments, the Directors consider that the Group’s primary reporting format is by business segment with geographical reporting being the secondary format. The continuing operations business segment consists of the Oral and Inhalation business. The discontinued operations business segment consists of the Injectable business. Business segment data includes an allocation of corporate costs to this segment on an appropriate basis. There are no material inter-segment transfers. The geographic segments of UK, Europe, North America and Rest of the World reflect the Group’s most significant regional markets. Revenue is shown by business segment, revenue stream and location of customer. Other geographic information is provided by location of operation. Revenue by business segment: Year ended 31 December 2006 £m 43.0 6.3 49.3 12.7 1.6 18.1 10.6 43.0 6.3 49.3 (Restated) Year ended 31 December 2005 £m 50.8 10.5 61.3 16.4 3.6 19.6 11.2 50.8 10.5 61.3 Continuing operations Discontinued operations Total revenue from continuing and discontinued operations Revenue earned can be analysed as: License signing and milestone fees Contract research and development costs recharged Royalties Manufacturing and distribution Continuing operations Discontinued operations Total revenue from continuing and discontinued operations Manufacturing and distribution revenues included a substantial contribution towards maintaining manufacturing capacities internally and externally for the Foradil® Certihaler™. Operating loss by business segment: Year ended 31 December 2006 £m Continuing operations Operating loss pre-exceptional items Exceptional items Operating loss Share of loss in associate Net interest Tax Loss after tax from continuing operations Loss after tax from discontinued operations Loss after tax from continuing and discontinued operations Total assets by business segment: Year ended 31 December 2006 £m 78.0 — 78.0 — 0.1 0.6 11.9 17.1 107.7 (Restated) Year ended 31 December 2005 £m 93.3 57.1 150.4 0.2 1.6 0.4 34.3 — 186.9 (13.9) (13.0) (26.9) — 9.0 (0.8) (18.7) (59.0) (77.7) (Restated) Year ended 31 December 2005 £m (1.0) (5.1) (6.1) (0.8) (13.4) (0.3) (20.6) (30.3) (50.9) Continuing operations Discontinued operations Total operating assets Investments in associates Available-for-sale financial assets Financial assets at fair value through profit or loss Cash and cash equivalents Discontinued operations Total assets SkyePharma PLC Annual Report 2006 64 Notes to the Financial Statements 4 Segment information continued Total liabilities by business segment: Year ended 31 December 2006 £m (75.6) — (75.6) (3.6) (64.1) (6.1) (6.7) (156.1) (Restated) Year ended 31 December 2005 £m (49.0) (40.1) (89.1) (2.7) (63.6) (7.2) — (162.6) Continuing operations Discontinued operations Total operating liabilities Short-term borrowings: other Long-term borrowings: convertible bonds Long-term borrowings: other Discontinued operations Total liabilities Property, plant and equipment and intangible assets by business segment: Year ended 31 December 2006 £m Additions Continuing operations Discontinued operations Depreciation and amortisation Continuing operations Discontinued operations 1.8 1.5 3.3 (6.2) (1.5) (7.7) (Restated) Year ended 31 December 2005 £m 3.3 1.8 5.1 (6.4) (1.9) (8.3) Investments in associates by business segment: Year ended 31 December 2006 £m — (Restated) Year ended 31 December 2005 £m 0.2 Discontinued operations Secondary reporting format — geographic Revenue by location of customer: UK Rest of Europe North America Rest of World Continuing operations Discontinued operations Total revenue from continuing and discontinued operations Year ended 31 December 2006 £m 10.0 19.5 12.8 0.7 43.0 6.3 49.3 (Restated) Year ended 31 December 2005 £m 22.8 22.8 4.1 1.1 50.8 10.5 61.3 65 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 4 Segment information continued Total assets by location of operation: Year ended 31 December 2006 £m 11.6 79.0 — 17.1 107.7 (Restated) Year ended 31 December 2005 £m 37.7 56.9 92.3 — 186.9 UK Rest of Europe North America Discontinued operations Total assets Property, plant and equipment and intangible asset additions by location of operation: Rest of Europe Discontinued operations Year ended 31 December 2006 £m 1.8 1.5 3.3 (Restated) Year ended 31 December 2005 £m 3.3 1.8 5.1 5 Exceptional items Year ended 31 December 2006 £m (8.8) (0.8) (2.1) (1.5) (0.5) — (13.7) 0.7 20.1 7.1 (Restated) Year ended 31 December 2005 £m — (3.1) — — — (2.0) (5.1) — — (5.1) Continuing operations Amortisation of intangibles Impairments Corporate restructuring Legal claims EGM costs Aborted transaction costs Other administration expenses Profit on disposal of subsidiary undertaking Exceptional Paul Capital change in estimated future payments Total exceptional items Of the exceptional items for 2006, £8.8 million relates to impairments of intangibles as follows: £0.9 million in respect of goodwill in SkyePharma AB related to certain products which are no longer considered to be cash generating; £7.9 million in respect of intellectual property comprising nano technology acquired from Medac and certain topical products acquired from Bioglan. A further £4.9 million relates to Other administration expenses as follows: impairments of £0.8 million comprising £0.2 million related to Astralis in view of the continuing losses and financial position of Astralis; £0.4 million is to write down the investment in Vital Living to reflect the illiquidity of the shares in that company; and £0.2 million relates to Land and Buildings. Changes in the composition of the Board and staff reductions during the year resulted in termination payments, recruitment costs and other charges of £2.1 million reported above under corporate restructuring. Provisions of £1.5 million for legal claims reflect potential costs of settlement and or legal defence of historic claims. EGM costs relate to the EGM which was requisitioned by certain shareholders and held in March 2006. In addition £0.7 million, which is included in Other income, relates to a profit on disposal of SkyePharma Canada Inc. Following the reorganisation of research and development operations and other business functions completed in 2004, SkyePharma Canada Inc was sold in July 2006 for £1.0 million (Cdn$2.0 million). The disposal did not give rise to a taxation charge and did not include any product or technology rights. The £20.1 million exceptional credit arises from the change in estimated future payments to Paul Capital as explained in Note 24 (Borrowings). Of the exceptional items for 2005 of £5.1 million, £3.1 million relates to the impairment of the investments in Vital Living and Micap and £2.0 million relates to legal and professional fees for an aborted strategic transaction. SkyePharma PLC Annual Report 2006 66 Notes to the Financial Statements 6 Operating expenses Year ended 31 December 2006 £m 18.0 3.0 4.7 1.5 22.9 7.6 57.7 9.6 2.1 1.5 0.5 — 71.4 (Restated) Year ended 31 December 2005 £m 20.6 3.1 5.0 1.4 14.3 7.4 51.8 3.1 — — — 2.0 56.9 Continuing operations Cost of sales Selling, marketing and distribution expenses Depreciation Amortisation Research and development expenses Other operating expenses Operating expenses before exceptional items Impairments Corporate restructuring Legal claims EGM costs Aborted transaction costs Total operating expenses after exceptional items Services provided by the Group’s auditor and network firms In August 2006 SkyePharma announced that the Group’s auditors PricewaterhouseCoopers LLP had resigned. Ernst & Young LLP were subsequently appointed the Group’s new auditors in August 2006. It is the Group’s policy to employ the auditors on assignments additional to their statutory audit duties where their expertise and experience with the Group are important, principally tax advice and due diligence reporting on acquisitions, or where they are awarded assignments on a competitive basis. During the year the Group (including its overseas subsidiaries) obtained the following services from the Group’s auditors at costs detailed below: (Restated) Year ended Year ended 31 December 31 December 2006 2005 £m £m Audit services statutory audit (Ernst & Young LLP) 0.6 — statutory audit (PricewaterhouseCoopers LLP) — 0.4 audit-related regulatory reporting (Ernst & Young LLP) 0.1 — audit-related regulatory reporting (PricewaterhouseCoopers LLP) 0.1 0.2 Further assurance services (Ernst & Young LLP) 0.3 — Further assurance services (PricewaterhouseCoopers LLP) — 1.2 Tax advisory services (Ernst & Young LLP) 0.1 — Tax advisory services (PricewaterhouseCoopers LLP) 0.3 0.2 1.5 2.0 Included in the analysis above are audit fees paid to Ernst & Young LLP in the UK of £0.5 million (2005: £0.2 million paid to PricewaterhouseCoopers LLP), of which £15,000 was paid to Ernst & Young LLP in respect of the Parent Company (2005: £15,000 paid to PricewaterhouseCoopers LLP). Also included above are fees paid to PricewaterhouseCoopers LLP of £0.1 million in respect of non-audit services in the UK (2005: £1.3 million paid to PricewaterhouseCoopers LLP). 67 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 7 Staff costs Year ended 31 December 2006 £m 11.9 1.9 2.1 0.6 0.7 0.7 17.9 (Restated) Year ended 31 December 2005 £m 12.8 1.2 1.8 0.2 0.5 0.8 17.3 Continuing operations Wages and salaries Equity settled share based payments Social security costs Pensions defined benefit plans defined contribution plans Other benefits The average number of people, including Executive Directors, employed by the continuing Group during the period was 317 persons (2005: 328 persons) and by the Company was 16 persons (2005: 18 persons). The Group’s key management for disclosure of remuneration comprises only Directors, and Directors’ remuneration for the year is shown in the audited part of the Remuneration Report. 8 Other income and expenses Year ended 31 December 2006 £m 0.2 0.6 0.8 0.7 1.5 (Restated) Year ended 31 December 2005 £m (0.7) 0.3 (0.4) — (0.4) Continuing operations Gain/(loss) on financial assets at fair value through profit or loss Profit on disposal of available-for-sale financial assets Pre-exceptional Other income and expenses Profit on disposal of subsidiary undertaking Total Other income and expenses 9 Finance costs and income Continuing operations Interest and similar expense: Interest: bank borrowings Paul Capital arrangements interest on convertible bonds Total interest expense Foreign exchange on Paul Capital arrangements Foreign exchange on inter company balances Total interest and similar expense Interest and similar income: Paul Capital change in estimated future payments Foreign exchange on Paul Capital arrangements Other interest income Total interest and similar income pre-exceptional Exceptional credit arising from change in the estimated future payments to Paul Capital (see Note 24) Total interest and similar income Year ended 31 December 2006 £m (Restated) Year ended 31 December 2005 £m (0.5) (6.9) (6.3) (13.7) — (0.4) (14.1) — 1.9 1.1 3.0 20.1 23.1 (0.5) (6.6) (5.8) (12.9) (3.3) — (16.2) 1.8 — 1.0 2.8 — 2.8 SkyePharma PLC Annual Report 2006 68 Notes to the Financial Statements 10 Income tax Continuing operations Discontinued operations Total (Restated) (Restated) (Restated) 31 December 31 December 31 December 31 December 31 December 31 December 2006 2005 2006 2005 2006 2005 £m £m £m £m £m £m (0.8) (0.3) — — (0.8) (0.3) — — — — — — (0.8) (0.3) — — (0.8) (0.3) Current income tax Deferred income tax The tax on the Group’s losses before tax differs from the theoretical amount that would arise using the standard rate of corporation tax in the UK. The differences are explained below: (Restated) 31 December 31 December 2006 2005 £m £m Accounting profit before tax: Continuing operations (17.9) (20.3) Discontinued operations (59.0) (30.3) (76.9) (50.6) Tax credit at the UK corporation tax rate of 30% (2005: 30%) 23.0 15.2 Effects of: Adjustments in respect of foreign tax rates (2.7) (2.2) Expenses not deductible for tax purposes (7.6) (1.5) Tax losses and other items for which no deferred tax asset was recognised (13.4) (11.9) Tax losses utilised 0.2 0.5 Withholding taxes (0.3) (0.4) Effective tax (0.8) (0.3) As at 31 December 2006, the Group including discontinued operations has estimated total losses of approximately £328.1 million (31 December 2005: £280.0 million) and total tax credits and temporary differences of £34.9 million (31 December 2005: £59.8 million). Of these, losses and total tax credits and temporary differences relating to the discontinued business, i.e. the Injectable Business in the US, are approximately £121.5 million and £24.5 million respectively. These losses will not be available going forward as a result of the sale of the Injectable Business. The expiry profile of the tax losses of the continuing business is estimated as follows: Indefinite carry forward £m 2.0 — 2.0 Expiry 2007 £m Tax losses: Corporate/Federal Cantonal/State 20.2 7.1 27.3 Expiry 2008 £m 23.7 2.9 26.6 Expiry 2009 £m 7.4 0.4 7.8 Expiry 2010 £m 8.8 2.8 11.6 Expiry 2011 £m 14.8 25.0 39.8 Expiry Thereafter £m 67.2 24.3 91.5 Total £m 144.1 62.5 206.6 Most of the tax losses relate to Switzerland. The Swiss tax losses expire in the years set out above but expire on the 1st of January of each respective year. No deferred tax asset has been recognised, given the uncertainty of the recoverability of the Group’s tax losses carried forward. 69 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 11 Earnings per share Year ended 31 December 2006 £m (25.8) 7.1 (18.7) (47.8) (29.9) (77.7) Number m 748.8 (3.4)p 0.9p (2.5)p (6.4)p (4.0)p (10.4)p (Restated) Year ended 31 December 2005 £m (15.5) (5.1) (20.6) (29.5) (21.4) (50.9) Number m 624.9 (2.5)p (0.8)p (3.3)p (4.7)p (3.4)p (8.1)p Continuing operations Attributable loss before exceptional items Exceptional items Basic and diluted attributable loss Continuing and discontinued operations Attributable loss before exceptional items Exceptional items Basic and diluted attributable loss Basic and diluted weighted average number of shares in issue Continuing operations Loss per Ordinary Share before exceptional items Exceptional items Basic and diluted loss per Ordinary Share Continuing and discontinued operations Loss per Ordinary Share before exceptional items Exceptional items Basic and diluted loss per Ordinary Share There is no difference between basic and diluted loss per share since in a loss-making year all potential shares from convertible bonds, stock options, warrants and contingent issuance of shares are anti-dilutive. Shares held by the SkyePharma PLC General Employee Benefit Trust have been excluded from the weighted average number of shares. EPS information for Discontinued Operations is presented in Note 12. SkyePharma PLC Annual Report 2006 70 Notes to the Financial Statements 12 Assets held for sale and discontinued operations The injectable business is that part of the Group’s business focused on the formulation, development and manufacturing of controlled release injectable products, utilising two proprietary drug delivery platforms: DepoFoam and Biosphere, together with the related assets and liabilities. In January 2007, SkyePharma announced that it had sold the injectable business subject to shareholders’ approval and certain other conditions to Blue Acquisition Corp (“Blue”). In February 2007, shareholders approved the proposed sale of the injectable business to Blue Acquisition Corp at an EGM. The disposal was completed on 23 March 2007. The consideration for the disposal is broken down as follows: 1. i. ii. iii. 2. i. ii. iii. iv. v. Cash payments by Blue of US$20 million to SkyePharma: of US$18 million (£9.2 million) at completion; of US$2 million (£1.0 million) into an escrow account; and an adjustment to the payments set forth above based upon the net asset value of the business at completion in relation to a specified target amount of the net asset value. Milestone payments, by Blue to SkyePharma, of: US$10 million (£5.1 million) upon the first commercial sale in the US of DepoBupivacaine™; US$4 million (£2.0 million) upon the first commercial sale of DepoBupivacaine™ in a major country of the EU; US$8 million (£4.1 million) if worldwide annual net sales of DepoBupivacaine™ reach US$100 million (£51 million); US$8 million (£4.1 million) if worldwide annual net sales of DepoBupivacaine™ reach US$250 million (£128 million); US$32 million (£16.3 million) if worldwide annual net sales of DepoBupivacaine™ reach US$500 million (£255 million). 3. Ongoing payments for the period of protection by existing patents, subject to certain conditions, to SkyePharma, of: i. 3% of worldwide net sales of DepoBupivacaine™; and ii. 3% of worldwide net sales of Biologics (not to exceed 20% of the royalty income of Blue). In addition, the injectable business is retaining responsibility for certain royalty-related payments due to Paul Capital and currently recorded as debt in the balance sheet of the injectable business. The injectable business has been classified as held for sale because the Group was committed to sell the injectable business since the outcome of the strategic review in February 2006; an active plan to locate a buyer was initiated following the strategic review; the injectable business was actively marketed at a fair price, and the sale was expected to be completed within one year from classification. In addition, the injectable business has been classified as a discontinued operation because it represents a major line of business and geographical area of operations. The income statement for the comparative period has been restated to show the discontinued operation separate from the continuing operations. The injectable segment is the injectable business together with an allocation of corporate and other Group costs, assets and liabilities. (a) Results of discontinued operations Year to 31 December 2006 Year to 31 December 2005 Pre- Exceptional Pre- Exceptional exceptional (Note 12b) Total exceptional (Note 12b) Total £m £m £m £m £m £m Revenue 6.3 — 6.3 10.5 — 10.5 Cost of sales (8.5) — (8.5) (8.6) — (8.6) Gross (loss)/profit (2.2) — (2.2) 1.9 — 1.9 Selling, marketing and distribution expenses (0.1) — (0.1) (2.7) — (2.7) Administration expenses Amortisation of other intangibles (0.7) — (0.7) (0.7) — (0.7) Other administration expenses (4.4) (37.0) (41.4) (2.7) (16.3) (19.0) (5.1) (37.0) (42.1) (3.4) (16.3) (19.7) Research and development expenses (8.7) — (8.7) (11.7) — (11.7) Operating loss (16.1) (37.0) (53.1) (15.9) (16.3) (32.2) Finance costs (5.9) — (5.9) (6.1) — (6.1) Finance income — — — 8.0 — 8.0 Loss for the year from discontinued operations (22.0) (37.0) (59.0) (14.0) (16.3) (30.3) 71 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 12 Assets held for sale and discontinued operations continued (b) Exceptional items Year ended 31 December 2006 £m (37.0) (Restated) Year ended 31 December 2005 £m (16.3) Discontinued operations Impairments The exceptional item for 2006 of £37.0 million relates to the impairment of the injectable business goodwill. Following the completion of the disposal in March 2007 the impairment of the discontinued operation is based on the net realisable value of £2.1 million, allowing for the subsequent sale proceeds, and attributable costs as set out in Note 13 (Goodwill). The exceptional item for 2005 of £16.3 million relates to the impairment of the investment in Astralis. (c) Operating expenses Year ended 31 December 2006 £m 8.5 0.1 0.8 0.7 8.7 3.6 22.4 37.0 59.4 (Restated) Year ended 31 December 2005 £m 8.6 2.7 1.2 0.7 11.7 1.5 26.4 16.3 42.7 Discontinued operations Cost of sales Selling, marketing and distribution expenses Depreciation Amortisation Research and development expenses Other operating expenses Operating expenses before exceptional items Impairments Total operating expenses (d) Staff costs Discontinued operations Wages and salaries Equity settled share based payments Social security costs Defined contribution pension plans Year ended 31 December 2006 £m 6.5 0.6 1.1 0.2 8.4 (Restated) Year ended 31 December 2005 £m 6.8 0.8 1.1 0.2 8.9 The average number of people employed by the injectable business segment during the period was 138 persons (2005: 129 persons). SkyePharma PLC Annual Report 2006 72 Notes to the Financial Statements 12 Assets held for sale and discontinued operations continued (e) Assets and liabilities classified as held for sale 31 December 2006 £m ASSETS Non-current assets Goodwill Other intangible assets Property, plant and equipment Current assets Inventories Trade and other receivables Cash and cash equivalents Total assets LIABILITIES Current liabilities Trade and other payables Deferred income Non-current liabilities Deferred income Other non-current liabilities Total liabilities Net assets 1.6 7.4 5.8 14.8 0.9 1.1 0.3 2.3 17.1 (2.3) (0.6) (2.9) (0.9) (2.9) (3.8) (6.7) 10.4 IFRS requires that the total assets and liabilities of discontinued operations are each shown separately and excluded from the individual line items of the Balance Sheet. However, no restatement of the prior period is required and the assets and liabilities are included in the individual line items. Hence only amounts in respect of 2006 are shown above. (f) Cash flow from discontinued operations included in the Consolidated Cash Flow Statement Year ended 31 December 2006 £m Cash flow from operating activities (21.4) Cash flows from investing activities (1.1) Cash flows from financing activities (1.8) (24.3) (g) Earnings per share Year to 31 December 2006 £m (22.0) (37.0) (59.0) Number m 748.8 (2.9)p (4.9)p (7.8)p (Restated) Year to 31 December 2005 £m (14.0) (16.3) (30.3) Number m 624.9 (2.2)p (2.6)p (4.8)p Year ended 31 December 2005 £m (11.5) (2.0) (1.3) (14.8) Discontinued operations Attributable loss before exceptional items Exceptional items Basic and diluted attributable loss Basic and diluted weighted average number of shares in issue Discontinued operations Loss per Ordinary Share before exceptional items Exceptional items Basic and diluted loss per Ordinary Share 73 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 13 Goodwill Group Cost At 1 January 2005 and 1 January 2006 Transfer to discontinued operations At 31 December 2006 Accumulated amortisation At 1 January 2005 and 1 January 2006 Impairment Transfer to discontinued operations At 31 December 2006 Net book value At 31 December 2005 At 31 December 2006 Total £m 82.7 (49.0) 33.7 14.0 0.9 (10.4) 4.5 68.7 29.2 Goodwill arose on the acquisition of SkyePharma Inc (£35.6 million), SkyePharma Canada (£29.2 million) and SkyePharma AB (£3.9 million) and has been allocated to the following business segments/cash-generating units: (Restated) As at 31 December 2005 £m 38.6 — — 38.6 As at 31 December 2006 £m Injectable Beginning of the year Impairment Transfer to discontinued operations End of the year Oral and inhalation Beginning of the year Impairment End of the year 38.6 (37.0) (1.6) — 30.1 (0.9) 29.2 29.2 30.1 — 30.1 68.7 Goodwill is not amortised but is tested annually for impairment or more frequently if there are indications that goodwill might be impaired. Fair value less costs to sell and value in use calculations are generally utilised to calculate the recoverable amount. Value in use is calculated as the net present value of the projected risk-adjusted cash flows of the cash generating unit to which goodwill is allocated. The cash flow projections are based on the most recent business plans approved by management which, generally, cover a period of 10 years, and are adjusted where necessary to take account of longer patent lives. The discount rate applied varies from 10% to 15% depending on the risk profile of the asset being valued. The key assumptions for the value in use calculations are those regarding the launch dates of products, their growth rates, the discount rates used and the period over which the cash flows are projected. The assumptions made reflect past experience, market research and expectations of future market trends. Goodwill was tested for impairment at both 31 December 2005 and 2006. At 31 December 2006, the Group incurred a total impairment loss of £37.9 million. Of the £37.9 million, £37.0 million relates to the impairment of the injectable business goodwill. Following the completion of the disposal in March 2007 the impairment of the discontinued operation is based on the net realisable value of £2.1 million, allowing for the subsequent sale proceeds, and attributable costs. The remaining £0.9 million was the result of impairing the goodwill in SkyePharma AB related to certain products which are no longer considered to be cash generating. No impairment was identified at 31 December 2005. SkyePharma PLC Annual Report 2006 74 Notes to the Financial Statements 14 Other intangible assets Intellectual property £m 39.0 0.2 1.8 41.0 (3.2) 1.2 — (12.7) 26.3 12.5 (0.1) 2.0 14.4 (2.2) 1.4 — 7.9 (3.8) 17.7 26.6 8.6 Software costs £m 0.9 — 0.1 1.0 — — (0.2) (0.2) 0.6 0.7 — 0.1 0.8 — 0.1 (0.2) — (0.2) 0.5 0.2 0.1 Development costs £m 0.6 0.4 — 1.0 (0.1) — — — 0.9 0.6 0.4 — 1.0 (0.1) — — — — 0.9 — — Total £m 40.5 0.6 1.9 43.0 (3.3) 1.2 (0.2) (12.9) 27.8 13.8 0.3 2.1 16.2 (2.3) 1.5 (0.2) 7.9 (4.0) 19.1 26.8 8.7 Group Cost At 1 January 2005 Exchange Additions At 1 January 2006 Exchange Additions Disposals Transfer to discontinued operations At 31 December 2006 Accumulated amortisation At 1 January 2005 Exchange Amortisation charge At 1 January 2006 Exchange Amortisation charge Disposals Impairment Transfer to discontinued operations At 31 December 2006 Net book value At 31 December 2005 At 31 December 2006 There are no intangible assets with indefinite useful lives. All amortisation charges in the year have been charged through administrative expenses. Intellectual property acquired during 2006 mainly relates to the purchase of licences to intellectual property in the area of pulmonary delivery. In 2006, as a result of external and internal events within the Group, the intellectual property was tested for impairment consistent with the value in use method set out in Note 13, Goodwill. At 31 December 2006, the Group incurred a total impairment loss of £7.9 million. This related to the nano technology acquired from Medac and intellectual property related to certain topical products acquired from Bioglan. Included within intellectual property is £3.0 million of assets which are not yet in use. These assets have not been amortised but have been tested for impairment consistent with the method set out for goodwill in Note 13, Goodwill. No impairment was identified. 75 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 15 Property, plant and equipment Laboratory equipment Assets and under machines construction £m £m 40.3 (0.6) 1.4 0.1 (0.1) 41.1 (1.4) 0.2 0.2 (1.5) — (6.4) 32.2 22.1 (0.2) 3.8 — 25.7 (0.9) 3.0 (1.5) — (4.2) 22.1 15.4 10.1 0.9 0.1 1.4 (0.1) (0.1) 2.2 — 0.2 (0.2) — — (2.1) 0.1 — — — — — — — — — — — 2.2 0.1 Office and other equipment £m 3.0 — 0.2 — (0.2) 3.0 — — — (0.8) — (0.8) 1.4 2.5 — 0.3 (0.3) 2.5 — 0.2 (0.8) — (0.7) 1.2 0.5 0.2 Group Cost At 1 January 2005 Exchange Additions Transfers Disposals At 1 January 2006 Exchange Additions Transfers Disposals Impairment Transfer to discontinued operations At 31 December 2006 Depreciation At 1 January 2005 Exchange Provided in the year Disposals At 1 January 2006 Exchange Provided in the year Disposals Impairment Transfer to discontinued operations At 31 December 2006 Net book value At 31 December 2005 At 31 December 2006 Land and buildings £m 32.9 (0.7) 0.2 — (0.1) 32.3 (1.0) 0.1 — — (0.7) (4.5) 26.2 11.8 (0.4) 2.1 (0.1) 13.4 (0.3) 1.5 — (0.5) (2.5) 11.6 18.9 14.6 Motor vehicles £m 0.3 — — — (0.1) 0.2 — 0.1 — (0.1) — — 0.2 0.1 — — — 0.1 — — — — — 0.1 0.1 0.1 Total £m 77.4 (1.2) 3.2 — (0.6) 78.8 (2.4) 0.6 — (2.4) (0.7) (13.8) 60.1 36.5 (0.6) 6.2 (0.4) 41.7 (1.2) 4.7 (2.3) (0.5) (7.4) 35.0 37.1 25.1 All depreciation charges in the year have been charged through administrative expenses. Included in land and buildings is an amount of £4.7 million (2005: £4.9 million) in respect of land which is not depreciated. At 31 December 2006, the carrying amount of the Group’s motor vehicles includes an amount of £0.1 million (2005: £0.1 million) in respect of assets held under finance leases and hire purchase arrangements. At 31 December 2006, the net book value of the tangible assets pledged as collateral in the framework of various borrowing agreements (disclosed in Note 24 (Borrowings)) was £10.4 million (2005: £11.8 million). The Group did not identify any tangible assets temporarily idle as at the balance sheet date. Land and Office and buildings other equipment Total Company £m £m £m Cost At 1 January 2005 0.1 0.3 0.4 Additions 0.1 — 0.1 Disposals (0.1) — (0.1) At 1 January 2006 0.1 0.3 0.4 Disposals — (0.1) (0.1) At 31 December 2006 0.1 0.2 0.3 Depreciation At 1 January 2005 0.1 0.2 0.3 Provided in the year — 0.1 0.1 Disposals (0.1) — (0.1) At 1 January 2006 — 0.3 0.3 Disposals — (0.1) (0.1) At 31 December 2006 — 0.2 0.2 Net book value At 31 December 2005 0.1 — 0.1 At 31 December 2006 0.1 — 0.1 SkyePharma PLC Annual Report 2006 76 Notes to the Financial Statements 16 Investments in associates As at 31 December 2006 £m 0.2 — — (0.2) — As at 31 December 2005 £m 14.3 3.0 (0.8) (16.3) 0.2 Group Beginning of the year Additions Share of loss Impairment End of the year The investment in Astralis Limited was recorded at £Nil at 31 December 2006 in view of the continuing losses and financial position of Astralis (2005: £0.2 million). Based on its quoted share price the investment in Astralis had a market value of £0.4 million at 31 December 2006 (2005: £0.4 million). As at 31 December 2006 £m 0.2 — (0.2) — As at 31 December 2005 £m 14.3 3.0 (17.1) 0.2 Company Beginning of the year Additions Impairment End of the year The investment in Astralis Limited was recorded at £Nil at 31 December 2006 in view of the continuing losses and financial position of Astralis (2005: £0.2 million). 17 Available for sale financial assets As at 31 December 2006 £m 1.6 — 0.1 (0.8) (0.4) (0.4) 0.1 As at 31 December 2006 £m 1.3 — (0.8) (0.4) 0.1 As at 31 December 2005 £m 5.2 0.1 0.1 (1.8) (2.6) 0.6 1.6 As at 31 December 2005 £m 3.6 0.1 (1.8) (0.6) 1.3 Group Beginning of the year Exchange Additions Disposal Impairments Revaluation (deficit)/surplus transfer End of the year Company Beginning of the year Additions Disposal Revaluation (deficit)/surplus transfer End of the year 77 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 17 Available for sale financial assets continued Group and Company Available for sale financial assets comprise the following unlisted securities: Vital Living Inc Vital Living is a US nutriceuticals company traded on the OTC Bulletin Board. During the year SkyePharma sold its interests in Vital Living’s 12% senior secured convertible notes due 2008 and series D preferred shares to VTLV LLC (a company formed by Vital Living management) for £0.2 million (US$0.4 million) cash. In addition, the Group received an additional 12.5 million common shares of Vital Living, in consideration for the termination by SkyePharma of an outstanding £0.4 million (US$0.75 million) debt owed by Vital Living to SkyePharma. As a result of these transactions, as at 31 December 2006 the total SkyePharma holding was 29,493,599 common shares and warrants expiring 2008 exercisable for 4 million common shares at an exercise price of US$0.25, representing approximately 21.3% of the common shares. The investment in Vital Living was recorded at £Nil at 31 December 2006 (2005: £0.4 million). Micap plc Micap is a UK science-based technology company traded on the Alternative Investment Market. As at 31 December 2006 the total SkyePharma holding was 5,238,334 ordinary shares and 1,830,000 convertible shares, representing approximately 3.7% of the ordinary shares. The investment in Micap was recorded at £0.1 million at 31 December 2006 (2005: £0.2 million). Vectura Group plc Vectura is a UK emerging pharmaceutical company traded on the Alternative Investment Market. During the year SkyePharma sold its 1.2 million ordinary shares in Vectura for £1.1 million and as at 31 December 2006 SkyePharma no longer held any ordinary shares. Cade Struktur Corp Cade Struktur is a Canadian company and was formerly a drug delivery company engaged in research and development and worldwide commercialisation of pharmaceutical formulations. The current business is the development, financing and completion of industrial and infrastructure projects in Europe. The shares were originally acquired consequent upon the acquisition of the assets of Hyal Pharmaceutical Corp. As at 31 December 2006, the total SkyePharma holding was 869,086 shares, representing approximately 10.1% of the ordinary shares. SkyePharma has not attributed a fair value to these shares and they have been recorded at £Nil (2005: £Nil). 18 Shares in and loans to Group undertakings Shares in Group undertakings £m 163.5 — — 163.5 — (31.4) 132.1 Loans to Group undertakings £m 237.3 19.0 (80.0) 176.3 73.0 (90.3) 159.0 Company At 1 January 2005 Additions Provision At 1 January 2006 Additions Provision At 31 December 2006 Total £m 400.8 19.0 (80.0) 339.8 73.0 (121.7) 291.1 Of the provision in respect of recoverability of shares in and loans to Group undertakings for 2006; £111.8 million relates to the impairment of the injectable business, following the completion of the disposal in March 2007, based on the net realisable value of £2.1 million, allowing for the subsequent sale proceeds and attributable costs; £7.5 million relates to Krypton Limited, a dormant subsidiary; and £2.4 million relates to Skyepharma Production SAS to bring the investment to net asset value. Principal subsidiaries are detailed in Note 35 (Principal subsidiaries). SkyePharma PLC Annual Report 2006 78 Notes to the Financial Statements 19 Inventories As at 31 December 2006 £m 0.6 0.2 0.4 1.2 (0.7) 0.5 As at 31 December 2005 £m 2.1 1.0 1.0 4.1 (0.5) 3.6 Group Raw materials and consumables Work in progress Finished goods Less inventory provisions The cost of inventories recognised as an expense are included in cost of sales as disclosed in Note 6 (Operating expenses). 20 Trade and other receivables Group As at 31 December 2006 £m 1.7 (0.1) 1.6 — 2.9 0.6 9.4 14.5 Group As at 31 December 2005 £m 2.4 (0.1) 2.3 — 2.2 0.6 9.1 14.2 Company As at 31 December 2006 £m — — — 1.6 1.0 — — 2.6 Company As at 31 December 2005 £m — — — 5.2 0.5 — — 5.7 Trade receivables Less provision for impairment Net trade receivables Amounts owed by subsidiary undertakings Other debtors Interest receivable Prepayments and accrued income 21 Financial assets at fair value through profit and loss As at 31 December 2006 £m 0.4 0.2 0.6 As at 31 December 2005 £m 1.1 (0.7) 0.4 Group Beginning of the year Revaluation to fair value End of the year Financial assets at fair value through profit or loss comprise GeneMedix plc 5% convertible loan notes due at par in June 2007. The notes were convertible at any time, at SkyePharma’s option, into between approximately 8.3 million and 11.2 million GeneMedix ordinary shares. There were no restrictions or a lock-up period on conversion of the notes. GeneMedix could elect to redeem in cash some or all of the notes on conversion. The notes were designated as at fair value through profit or loss on initial recognition. During 2006, an agreement was reached with GeneMedix, as part of its financial restructuring, to enable the repurchase of all of the convertible loan notes and accrued interest for £1.2 million. In March 2007 GeneMedix repurchased all of the convertible loan notes and settled all of the accrued interest thereon for £1.2 million cash. 22 Cash and cash equivalents Group As at 31 December 2006 £m 11.9 — 11.9 Group As at 31 December 2005 £m 26.8 7.5 34.3 Company As at 31 December 2006 £m 10.4 — 10.4 Company As at 31 December 2005 £m 24.1 7.5 31.6 Cash at bank and in hand Short-term deposits 79 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 23 Trade and other payables Group As at 31 December 2006 £m 9.0 — 1.1 13.3 23.4 Group As at 31 December 2005 £m 6.8 — 2.0 12.2 21.0 Company As at 31 December 2006 £m 0.2 132.3 0.2 1.7 134.4 Company As at 31 December 2005 £m 0.6 89.7 0.1 1.1 91.5 Trade payables Amounts owed to subsidiary undertakings Other taxation and social security costs Accruals 24 Borrowings Group As at 31 December 2006 £m Current Bank overdraft Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Total current borrowings Non-current Convertible bonds due May 2024 Convertible bonds due June 2025 Convertible bonds Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Other non-current borrowings Total non-current borrowings Total borrowings 1.3 2.0 0.2 5.0 0.1 8.6 51.2 12.9 64.1 — 6.0 19.3 0.1 25.4 89.5 98.1 Group As at 31 December 2005 £m — 2.3 0.3 0.7 0.1 3.4 50.8 12.8 63.6 0.6 6.6 43.9 — 51.1 114.7 118.1 Company As at 31 December 2006 £m — 0.6 — — — 0.6 — — — — — — — — — 0.6 Company As at 31 December 2005 £m — 0.8 — — — 0.8 — — — 0.6 — — — 0.6 0.6 1.4 Bank overdraft At 31 December 2006 the Group had an overdraft of £1.3 million (SwFr 3 million) (2005: £Nil) with the Basellandschaftliche Kantonalbank secured on the assets of SkyePharma AG. Bank borrowings At 31 December 2006 bank borrowings include two amounts due to the Basellandschaftliche Kantonalbank of £0.8 million (SwFr 2 million) and £0.6 million (SwFr 1.5 million) (2005: £0.9 million (SwFr 2 million) and £0.7 million (SwFr 1.5 million)). Both loans can be terminated with six weeks’ notice by either party and bear interest at 6.5% and 6.0% respectively. Both loans are secured on the assets of SkyePharma AG and the £0.6 million (SwFr 1.5 million) loan is guaranteed by SkyePharma PLC supported by a bank guarantee. The Group had a loan as at 31 December 2006 with GE Capital Corp of £0.6 million (US$1.1 million) (2005: £1.4 million (US$2.4 million)). The loan was secured by certain assets of SkyePharma Inc, SkyePharma US Inc and SkyePharma PLC. The loan bore interest at 8.0% and was repayable by instalments until September 2007. In February 2007 SkyePharma settled the loan in full. SkyePharma PLC Annual Report 2006 80 Notes to the Financial Statements 24 Borrowings continued Convertible bonds The Group has £69.6 million 6% convertible bonds due May 2024 at a conversion price of 95 pence and £20 million 8% convertible bonds due June 2025 at a conversion price of 58 pence. The conversion price of the £20 million convertible bonds due June 2025 was reset from 77 pence to 58 pence in June 2006 in accordance with the reset mechanism. The £69.6 million May 2024 bonds may be called for repayment by the bond holders at par in May 2009, May 2011, May 2014 or May 2019 and the £20.0 million June 2025 bonds may be called for repayment by the bond holders at par in June 2010, June 2012, June 2015 or June 2020. The convertible bonds are included in the balance sheet partly in non-current liabilities (2006: £64.1 million, 2005: £63.6 million) and partly in other reserves in shareholders’ equity (2006 and 2005: £28.5 million). The total face value of the convertible bonds is £89.6 million. The financial liability accrues over time to the face value, whereas the equity component remains fixed at the value at inception until the bonds are realised. Property mortgage At 31 December 2006, the Group had a property mortgage facility with the Basellandschaftliche Kantonalbank of £6.2 million (SwFr 14.9 million) (2005: £6.9 million (SwFr 15.5 million)). The mortgage is in two tranches, both secured by the assets of SkyePharma AG. The first tranche of £2.4 million (SwFr 5.8 million) bears interest at 3.875% and is repayable by instalments over 15 years semi-annually. The second tranche of £3.8 million (SwFr 9.1 million) bears interest at 3.875% and is repayable by instalments over 46 years semi-annually. Paul Capital funding liabilities The Group entered into two transactions with Paul Capital in 2000 and 2002. Under these transactions Paul Capital provided a total of US$60 million in return for the sale of a portion of the potential future royalty and revenue streams on a selection of the Group’s products. Whilst the contractual arrangements with Paul Capital are royalty agreements under which royalties are payable on revenues earned and payments received, the proceeds received from Paul Capital meet the definition of financial liabilities under IAS 39, and are treated as financial liabilities accordingly. Royalties paid to Paul Capital are treated as repayment of the liabilities and notional interest is charged on the liabilities using the effective interest rate at inception of each agreement. The estimated payments to Paul Capital are discounted using each contract’s original effective interest rates of 24.5% and 29.8%. Any change in the estimated future payments to Paul Capital is recognised as income or expense in the income statement. Refer to Note 9 (Finance costs and income). Subsequent to the year end the Group has completed a restructuring of the Paul Capital debt from an arrangement sharing royalties from a number of specified products into a fixed amortisable note of £47.3 million (US$92.5 million). The note will be increased by up to an additional £6.4million (US$12.5 million) if worldwide sales of DepoDur™ (a product of the injectable business) reach certain thresholds, and the Group’s obligations in that regard will be reduced by its share of royalty receipts on certain products included in the injectable business sold subsequent to the year end, as explained in Note 12. The note is repayable in accordance with an amortisation schedule through to 2015. The Company has guaranteed to the lender the obligations of the Group in respect of this facility. As at 25 April 2007, the net present value of this liability, after paying a first instalment of $2.7 million (£1.4 million) amounted to $44.3 million (£22.1 million) compared with the value of $47.6 million (£24.3 million) included under the original arrangements in the 31 December 2006 Balance Sheet. The restructuring of the Paul Capital debt is on substantially different terms from those applying to the royalty sharing arrangement and therefore will be treated in 2007 as a new financial liability arising on extinguishment of an original financial liability. The calculation of the Paul Capital funding liability at 31 December 2006 reflects relevant evidence from the restructuring only in so far as it affects estimated future payments due under the royalty sharing arrangement, and the reduction in liability accounts for the £20.1 million exceptional gain referred to in Note 9. Finance lease liabilities Obligations under hire purchase and finance leases are secured upon the assets to which they relate and as at 31 December 2006 £Nil (2005: £Nil) is guaranteed by SkyePharma PLC. 81 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 24 Borrowings continued Maturity analysis of non-current borrowings 1 to 2 Years 2008 £m — 0.3 4.5 0.1 4.9 2 to 3 Years 2009 £m 51.2 0.3 4.3 — 55.8 As at 31 December 2006 3 to 4 Years 4 to 5 Years Over 5 Years 2010 2011 From 2012 £m £m £m 12.9 — — 0.3 0.3 4.8 3.7 2.9 3.9 — — — 16.9 3.2 8.7 As at 31 December 2005 3 to 4 Years 4 to 5 Years Over 5 Years 2009 2010 From 2011 £m £m £m 50.8 12.8 — — — — 0.3 0.3 5.4 10.4 4.2 16.9 61.5 17.3 22.3 Convertible bonds Property mortgage Paul Capital funding liabilities Finance lease liabilities Non-current borrowings Total £m 64.1 6.0 19.3 0.1 89.5 Convertible bonds Bank borrowings Property mortgage Paul Capital funding liabilities Non-current borrowings Currency analysis of borrowings 1 to 2 Years 2007 £m — 0.6 0.3 4.9 5.8 2 to 3 Years 2008 £m — — 0.3 7.5 7.8 Total £m 63.6 0.6 6.6 43.9 114.7 Convertible bonds Bank overdraft Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Total borrowings Sterling £m 64.1 — — — — — 64.1 As at 31 December 2006 US$ Swiss francs £m £m — — — 1.3 0.5 1.5 — 6.2 24.3 — — 0.2 24.8 9.2 As at 31 December 2005 US$ Swiss francs £m £m — — 1.4 1.5 — 6.9 44.6 — — 0.1 46.0 8.4 Total £m 64.1 1.3 2.0 6.2 24.3 0.2 98.1 Convertible bonds Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Total borrowings Interest rate analysis Sterling £m 63.6 — — — — 63.6 Total £m 63.6 2.9 6.9 44.6 0.1 118.1 Convertible bonds Bank overdraft Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Sterling % 8.9/9.5/13.3 — — — — — As at 31 December 2006 US$ Swiss francs % % — — — 6.25/6.5 8.0 6.5/6.0 — 3.9 24.5/29.8 — — 5.0 SkyePharma PLC Annual Report 2006 82 Notes to the Financial Statements 24 Borrowings continued Interest rate analysis Sterling % 8.9/9.5/13.3 — — — — As at 31 December 2005 US$ Swiss francs % % — — 8.0 6.5/6.0 — 2.8 24.5/29.8 — — 5.0 Convertible bonds Bank borrowings Property mortgage Paul Capital funding liabilities Finance lease liabilities Fair values At 31 December 2006, the carrying amount of non-current liabilities, compared with the fair value was as follows: Carrying Amount £m 64.1 6.0 19.3 0.1 89.5 Fair Value £m 79.2 6.0 19.3 0.1 104.6 Convertible bonds Property mortgage Paul Capital funding liabilities Finance lease liabilities At 31 December 2005, the carrying amount of non-current liabilities, compared with the fair value was as follows: Carrying Amount £m 63.6 0.6 6.6 43.9 114.7 Fair Value £m 83.5 0.6 6.6 43.9 134.6 Convertible bonds Bank borrowings Property mortgage Paul Capital funding liabilities At 31 December 2006 and 2005 the carrying value of financial assets and all other financial liabilities is equal to fair value. Undrawn facility In December 2006 SkyePharma announced an agreement with a specialist lending entity domiciled in Ireland and advised by Christofferson Robb for a 10 year secured amortising loan facility of approximately £35.0 million. The facility comprises initial commitments of US$35.0 million and €26.5 million repayable over 10 years based on a minimum amortisation schedule. This schedule is based on expected receipts from milestone and royalties in respect of Coruno®, Lodotra™ and Requip® XL 24-hour™. Interest is generally charged on a quarterly basis at the respective US and euro three month LIBOR rates plus a 5.85% margin. Half of the committed principal on each loan was drawn down in January 2007 and the balance must be drawn down by December 2007. In the event that the cumulative milestone and royalties received from these products are in excess of the minimum amortisation schedule and interest due, the balance will be applied to the prepayment of principal without penalty. The loan facility is secured by the assignment or charge over certain assets including the receipts in respect of Coruno®, Lodotra™, and Requip® XL 24-hour™. The three products are licensed for marketing to the Therabel Group, Nitec and GlaxoSmithKline respectively. There is also a covenant (negative pledge), not to grant further securities over the Group’s assets, including Flutiform™ intellectual property, and the requirement for prior consent from Christofferson Robb for certain transactions that could affect Christofferson Robb’s security and risk. There are provisions for the facility to be increased by a further US$15.0 million subject to due diligence and progress with a specific product development. In March 2007, the terms of the CRC Financing were amended in a number of respects: (i) from 22 March 2007, the interest charged on the first €7.5 million of the facility will be at the rate of euro three month LIBOR plus 10.85%; (ii) the loan will be prepaid up to $10.0 million out of 50% of any Flutiform™ milestones received after 1 January 2009 (or on FDA approval if earlier); (iii) additional security will be provided by an assignment or charge over receipts in respect of two additional products (nisoldipine CR and zileuton CR); and (iv) a number of additional covenants and consents are incorporated in line with the Paul Capital refinancing. The security does not include Flutiform™. The Company has guaranteed to the lender the obligations of the Group in respect of this facility. 83 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 25 Provisions Deferred tax Group As at 31 December 2006 £m 7.6 — — 7.6 (Restated) Group As at 31 December 2005 £m 6.0 1.8 (0.2) 7.6 Company As at 31 December 2006 £m — — — — (Restated) Company As at 31 December 2005 £m 0.2 — (0.2) — Beginning of the year Issue of convertible bonds Repayment of convertible bonds End of the year As required by IAS 12 (“Income Taxes”), provision for deferred tax relates to the temporary differences between the face value of the convertible bonds and the value at which they are included in liabilities in the balance sheet. Pensions As at 31 December 2006 £m 1.9 (0.1) 0.1 — 1.9 As at 31 December 2005 £m 1.7 — 0.3 (0.1) 1.9 Group Beginning of the year Exchange Actuarial losses Charge of the year End of the year The provision relates to the Group’s retirement commitments under its defined benefit schemes in respect of its employees in Switzerland and France. 26 Retirement benefit obligations Defined contribution plans The Group operates various defined contribution plans for its employees in the UK and US. The Group’s contributions to these plans are charged to the income statement in the period to which they relate, and the assets are held in separate trustee administered funds. The income statement charge related to defined contributions plans is disclosed in Note 7, Staff costs and Note 12, Assets held for sale and discontinued operations. Defined benefit plan The Group operates defined benefit schemes in respect of its employees in Switzerland and France. The liabilities of the defined benefit schemes operated by the Group are presented below: As at 31 December 2006 £m Balance sheet obligations for: Defined benefit pension benefits The amounts recognised in the balance sheet are determined as follows: As at 31 December 2006 £m 6.6 (5.6) 1.0 0.9 1.9 As at 31 December 2005 £m 6.4 (5.3) 1.1 1.8 2.9 1.9 As at 31 December 2005 £m 1.9 Present value of funded obligations Fair value of plan assets Present value of unfunded obligations Liability on the balance sheet SkyePharma PLC Annual Report 2006 84 Notes to the Financial Statements 26 Retirement benefit obligations continued The amounts recognised in the income statement are as follows: Year ended 31 December 2006 £m 0.6 0.2 (0.2) (0.3) 0.3 Year ended 31 December 2005 £m 0.3 0.3 (0.2) — 0.4 Current service cost Interest cost Expected losses on assets Employee contributions Total included in staff cost The actuarial return on plan assets was £0.4 million (2005: £0.2 million). The movement in the defined benefit obligation over the year is as follows: Beginning of the year Exchange Current service cost Benefits paid Interest on pension scheme liabilities Expected losses on assets Actuarial losses recognised in equity End of the year The movement in the fair value of the plan assets over the year is as follows: Year ended 31 December 2006 £m 7.2 (0.3) 0.6 (0.7) 0.3 — 0.4 7.5 Year ended 31 December 2005 £m 7.0 (0.1) 0.3 (0.3) 0.3 (0.2) 0.2 7.2 Beginning of the year Exchange Current service cost Interest on pension scheme liabilities Benefits paid Actuarial gains recognised in equity End of the year Year ended 31 December 2006 £m 5.3 0.7 — — (0.6) 0.2 5.6 Year ended 31 December 2005 £m 5.3 (0.1) 0.3 0.3 (0.7) 0.2 5.3 At 31 December 2005 and 2006 actuarial valuations were performed by professionally qualified actuaries on the present value of the accrued liabilities calculated under the projected unit method. The principal assumptions made by the actuaries were: 2006 % per annum 1.9 2.3 3.6 1.7 2005 % per annum 1.9 2.3 3.7 2.0 Inflation rate Rate of increase in salaries Discount rate Expected return on plan assets Assumptions regarding future mortality experience are set based on advice in accordance with published statistics and experience in Switzerland and France. 2006 Years Male 17.4 Female 21.3 As at 31 December 2006 £m 0.1 0.4 2005 Years 17.3 20.8 Actuarial losses recognised in equity Cumulative actuarial losses recognised in equity As at 31 December 2005 £m — 0.3 85 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 26 Retirement benefit obligations continued Plan assets are comprised as follows: As at 31 December 2006 £m 4.3 1.3 5.6 As at 31 December 2005 £m 4.7 0.6 5.3 Equity Other Expected contributions to post-employment benefit plans for the year ending 31 December 2007 are £0.5 million (2006: £0.6 million). 27 Share capital 31 December 2006 Number of shares 1,102,000,000 31 December 2005 Number of shares 1,102,000,000 31 December 2006 £m 110.2 31 December 2005 £m 110.2 Total nominal value £m 63.4 12.6 0.6 — 76.6 Group and Company Authorised Ordinary Shares of 10p each Ordinary Shares of 10p each Number 622,398,743 125,627,357 5,482,238 255,808 753,764,146 At 1 January 2005 Rights issue Acquisition of shares in Astralis Exercise of share options At 31 December 2005 and 2006 Deferred ‘B’ Nominal value Shares of 10p each £m Number 62.2 12,000,000 12.6 — 0.6 — 75.4 — — 12,000,000 Nominal value £m 1.2 — — — 1.2 In March 2007 SkyePharma issued 61.2 million new Ordinary Shares at a price of 24.5 pence per share raising £14.8 million net of expenses. The shares were placed with several institutions including HBM BioVentures (Cayman) Limited which owned over 10% of the issued share capital at the time of placing. Deferred ‘B’ shares In July 2000, 12 million deferred ‘A’ and 12 million deferred ‘B’ shares were issued to Dr Gonella, the vendor of Jago, under a settlement agreement that established the full and final settlement of the deferred consideration payable on the acquisition of Jago. The holders of deferred ‘A’ and ‘B’ shares have no rights to participate in the profits of the Company, no voting rights and on a winding-up or other return of capital only receive the nominal value of their shares if the holders of Ordinary Shares in the capital of the Company have received the sum of £1 million per Ordinary Share. Under the terms of the settlement agreement, following the US launch and first commercial sale of Paxil CR by GlaxoSmithKline in 2002, the 12 million deferred ‘A’ shares were automatically converted into 12 million Ordinary Shares. The 12 million deferred ‘B’ shares would have automatically converted into 12 million Ordinary Shares upon the Company’s receipt of a royalty statement under the current licence agreement stating that reported sales of Paxil CR had exceeded US$1,000 million during any calendar period prior to 1 January 2006 or exceeded US$337 million between 1 January 2006 and 3 May 2006. Neither of these conditions was met and therefore the deferred ‘B’ shares will not be converted into Ordinary Shares. The deferred ‘B’ shares were transferred to the Company Secretary for no consideration for him to hold as custodian. Warrants The Company has the following warrants outstanding: (a) ‘D’ and ‘E’ warrants The ‘D’ and ‘E’ warrants were issued in March 2002 as part of the consideration for the agreement with Paul Capital to fund new product development. The ‘D’ and ‘E’ warrants entitle the holders to subscribe for a total of 5 million Ordinary Shares at any time during the period to 31 December 2008 at an exercise price of 73.75 pence per Ordinary Share. A value of £0.3 million, deemed to be the fair value of the ‘D’ and ‘E’ warrants, has been recorded in Other Reserves. (b) ‘F’ warrants The ‘F’ warrants were issued in December 2003 as part of the £2.7 million (US$5 million) loan with GE Capital Corp. The ‘F’ warrants entitle the holders to subscribe for a total of 0.3 million Ordinary Shares at any time until the repayment date of the loan at an exercise price of £1.20 per Ordinary Share. A value of £39,000, deemed to be the fair value of the ‘F’ warrants, has been recorded in Other Reserves. SkyePharma PLC Annual Report 2006 86 Notes to the Financial Statements 27 Share capital continued Potential Issues of ordinary shares (a) Employee share schemes The Group encourages employee participation in its shares through ownership and continues to operate various incentive schemes whereby Directors and employees are able to acquire shares, and potential shares, in the Company. Further details are provided in Note 29, Share based payments. (b) Deferred consideration on acquisition of Krypton The deferred consideration on the acquisition of Krypton provides that a maximum of 37.5 million Ordinary Shares would be issued contingent on a change in control of the Company at a share price of not less than 80 pence compounded at an annual rate of 10% (£2.29 as at 31 December 2006), or satisfaction of various conditions and hurdles which lapsed on 31 December 2003. No provision for deferred consideration has been recognised as at 31 December 2006. (c) Paul Capital Royalty Acquisition Fund In March 2002 the Group announced a second transaction with Paul Capital Royalty Acquisition Fund under which SkyePharma would issue Ordinary Shares up to a value of US$7.5 million if royalties and milestones received by SkyePharma in respect of those products included in the transaction were not in excess of minimum annual payments required to be made to Paul Capital. During 2006 the royalties received by SkyePharma were substantially in excess of the minimum payments required to be made to Paul Capital; consequently, the Company has not recognised a provision. In March 2007 the Group restructured its arrangements with Paul Capital and this obligation was extinguished. 28 Share based payments The Group operates various share based compensation plans as follows: Option schemes Options granted to UK and European employees are only exercisable between the third and tenth anniversary of the date of grant, and are subject to the Company’s Code of Business Conduct and Ethics for dealing in Shares, and the Model Code. Options granted to US employees prior to 2001 vest at 25% per annum from the date of grant and there were no performance criteria. UK and European options granted prior to 2001 may only be exercised if the growth in the Company’s share price over a consecutive three-year period exceeds the growth over the same period in the FTSE All Share Index. This criteria was satisfied for the first time in March 2000. Employees with options that are within their exercise period are now able to exercise those options within any one-year period from the date the performance condition is satisfied. Super Options are exercisable after five years and are subject to higher performance conditions in accordance with those recommended by the Association of British Insurers. Following changes to the option plans approved at the Annual General Meeting in June 2001, options granted to Directors and senior employees since that date are subject to performance conditions linked to the total shareholder return of a comparator group of companies, and are not subject to retesting. Options granted to other US employees continue to vest at 25% per annum with no performance criteria, and other European employees who are not Directors or senior employees can exercise their options after three years and are not subject to performance conditions. The Group’s option plans are detailed further in the Remuneration Report. It is the intention of the Group that no further options grants will be made under any of the option plans. The following table summarises the activity in share options for the year to 31 December 2006: Share options 37,497,544 1,492,028 13,594,351 22,411,165 22,327,714 Option price 43.0p–89.3p 44.6p–87.6p 44.6p–87.6p 43.0p–89.3p 43.0p–89.3p Beginning of the year Forfeited Cancelled or expired End of the year Exercisable The weighted average exercise price as at 31 December 2006 was 64.5 pence. The market value of Ordinary Shares as at 31 December 2006 was 27.5 pence. The market value of Ordinary Shares during 2006 ranged from the lowest closing mid-price of 21.0 pence to the highest closing mid-price of 49.5 pence per share. No options were granted 2005 or 2006. 87 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 28 Share based payments continued At 31 December 2006 the following Ordinary Shares were under option to employees or former employees of the Group: Option price for each Ordinary Share of 10p 63.8p 49.0p 89.3p 43.0p 66.7p 54.4p 54.6p 87.6p 78.4p 77.4p 53.4p 69.4p 75.4p 49.6p 44.6p 59.5p Number of options over Ordinary Shares of 10p 529,100 129,254 829,615 570,128 2,272,318 5,022,720 115,310 271,698 913,530 3,571,902 668,533 4,572,267 447,637 522,921 1,827,348 146,884 22,411,165 Normal expiry date 7 April 2007 28 January 2008 31 March 2008 5 October 2008 19 April 2009 25 May 2009 7 September 2009 6 June 2010 3 November 2010 12 June 2011 31 October 2011 12 April 2012 24 May 2012 25 September 2012 7 April 2013 26 September 2013 The weighted remaining contractual life as at 31 December 2006 was 3.8 years. As stated above, no options were granted to employees in 2005 or 2006. For those options granted in prior years which impact the income statement, fair values were determined using an option pricing model based on Black-Scholes but adjusted to model the particular features of the options. The fair value of these options is consistent with the values previously disclosed for SEC filing purposes. The total expense relating to share based payments, which are all equity settled transactions, is disclosed in Note 7 (Staff costs). Deferred Share Bonus Plan (“DSB”) Under the rules of this plan, Directors and senior employees receive conditional rights to acquire Ordinary Shares in the Company, at the prevailing market rates at the time of grant. Eligible employees are awarded rights to acquire a maximum number of shares at the beginning of a three year period, a proportion of which they will be entitled to receive at the end of that period depending on the extent to which the performance conditions set by the Remuneration Committee at the time the allocation is made are satisfied. If the performance conditions are not satisfied the share award will lapse. Awards are either linked to the deferral of annual bonus (DSB Matching Share Awards) or stand-alone share awards (LTIP Awards). Further information on awards and performance conditions is detailed in the Remuneration Report. DSB Matching Share Awards 2,253,299 533,348 (116,161) (484,735) (1,034,168) 1,151,583 Beginning of the year Granted Forfeited Cancelled or expired Released End of the year LTIP Awards 7,442,929 5,041,900 (192,659) (4,281,928) — 8,010,242 For the purposes of IFRS 2 the fair values of LTIP Awards and DSB Matching Shares Awards with market-based performance conditions have been determined using a Monte Carlo Simulation model. The Monte Carlo Simulation model takes into account the comparative total shareholder return performance element attaching to these share awards. The following table sets out the assumptions used in determining the fair value of these share awards: SkyePharma PLC Annual Report 2006 88 Notes to the Financial Statements 28 Share based payments continued DSB Matching LTIP Awards Share Awards Monte Carlo Simulation This model takes into account the market based performance conditions (comparative TSR) attaching to the LTIP and DSB Matching Share Awards 24 April 2006 2 February 2006 0.38 0.40 Nil Nil n/a n/a 44.84% 45.17% 5.23% 5.04% 3 years 3 years 0.27 0.32 Model Rationale Date of Grant Share Price on Grant (£) Exercise Price Expected Dividend Yield Expected Volatility Risk Free Interest Rate Expected Life Fair Value (£) The excepted volatility is calculated as the historic volatility of the Company share return over the three years prior to each grant date. In determining the charge to the income statement, the Company has assumed that the number of share awards that will ultimately vest is reduced by 5% per annum. The total expense relating to share based payments, which are all equity settled transactions, is disclosed in Note 7 (Staff costs). International Share Purchase Plan (“ISPP”) All employees are eligible to participate in the ISPP whereby employees buy shares in the Company. These shares are called Partnership Shares and are held in trust on behalf of the employee. For every Partnership Share bought by the employee the Company will give the employee one share free of charge (Matching Shares). The employees have to take their shares out of the plan on leaving the Company and will not be entitled to the Matching Shares if they leave within three years of buying the Partnership Shares. In addition, the Company can also award employees rights to acquire up to a maximum of £3,000 of shares (Free Shares). There are no vesting conditions attaching to the Free Shares other than being continuously employed by a Group company on the third anniversary of the date of grant. Matching Shares 430,835 265,441 (38,064) (40,433) (140,022) 477,757 Free Shares 25,279 — — (1,785) — 23,494 Beginning of the year Granted Forfeited Cancelled or expired Released End of the year For the purposes of IFRS 2 the fair value of these Matching Shares and Free Shares is determined as the market value of the shares at the date of grant. In determining the charge to the income statement, the Company has assumed that the number of share awards that will ultimately vest is reduced by 10% per annum. One-off Arrangement In addition to the above plans, there was a one-off share-based arrangement put in place for the Executive Directors on their recruitment. Under the provisions of this special arrangement the Executive Directors were granted conditional rights to acquire Ordinary Shares (Matching Shares) at the beginning of a two-year holding period linked to the number of shares purchased with their own resources. There are no vesting conditions attached to these Matching Shares. Further information on these awards is detailed in the Remuneration Report. Matching Shares — 1,058,600 1,058,600 Beginning of the year Granted End of the year For the purposes of IFRS 2 the fair value of these Matching Shares is determined as the market value of the shares at the date of grant. The total expense relating to share based payments, which are all equity settled transactions, is disclosed in Note 7 (Staff costs). 89 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 29 Reserves Share premium £m 321.0 25.1 (2.9) 2.3 0.1 — — — — — — — 345.6 — — — — — — 345.6 Translation reserve £m (0.9) — — — — (0.3) — — — — — — (1.2) 2.9 0.1 — — — — 1.8 Share premium £m 321.0 25.1 (2.9) 2.3 0.1 — — — — — — 345.6 — — — 345.6 Fair value reserve £m (0.5) — — — — — 0.5 0.2 — — — — 0.2 — — (0.4) — — — (0.2) Fair value reserve £m (0.5) — — — — 0.5 0.2 — — — — 0.2 (0.4) — — (0.2) (Restated) Retained losses £m (378.0) — — — — — — — (50.9) 2.4 (0.4) 0.7 (426.2) — — — (77.7) 2.5 (0.1) (501.5) Retained losses £m (49.3) — — — — — — (98.3) 1.3 (0.4) 0.7 (146.0) — (117.6) 1.5 (262.1) Group At 1 January 2005 Rights issue Expenses of rights issue Acquisition of shares in Astralis Exercise of share options Exchange Impairments Revaluation surplus transfer Loss for the year Share based payments charge Purchase of own shares Repayment of convertible bonds due June 2005 At 1 January 2006 Exchange Transfer on disposal of subsidiary undertaking Revaluation surplus transfer Loss for the year Share based payments charge Pension actuarial losses At 31 December 2006 Company At 1 January 2005 Rights issue Expenses of rights issue Acquisition of shares in Astralis Exercise of share options Impairments Revaluation surplus transfer Loss for the year Share based payments charge Purchase of own shares Repayment of convertible bonds due June 2005 At 1 January 2006 Revaluation surplus transfer Loss for the year Share based payments charge At 31 December 2006 As permitted by Section 230 of the Companies Act 1985, the Income Statement of the Company is not presented. The loss of the Company for the year ended 31 December 2006 was £117.6 million (2005: £98.3 million). SkyePharma PLC Annual Report 2006 90 Notes to the Financial Statements 30 Other reserves Merger reserve £m 9.0 — — 9.0 Warrants reserve £m 0.4 — — 0.4 (Restated) Equity of convertible bonds £m 16.1 4.3 (0.5) 19.9 Group At 1 January 2005 Issue of convertible bonds due June 2025 Repayment of convertible bonds due June 2005 At 31 December 2005 and 2006 Total £m 25.5 4.3 (0.5) 29.3 The equity of convertible bonds at 1 January 2005 included gross equity of £23.0 million less related deferred tax of £6.9 million. The issue of convertible bonds due June 2025 of £4.3 million is stated net of a related deferred tax debit of £1.8 million. The repayment of convertible bonds due June 2005 of £0.5 million is stated net of a related deferred tax credit of £0.2 million. The equity of convertible bonds at 31 December 2005 and 2006 included gross equity of £28.4 million less related deferred tax of £8.5 million. The merger reserve relates to the acquisition of Krypton Limited during 1996. The warrant reserve relates to the ‘D’, ‘E’ and ‘F’ warrants described in note 28 (Share capital). The equity element of the convertible bonds reserve relates to the convertible bonds due May 2024 and June 2025. Merger reserve £m 9.0 — 9.0 Warrants reserve £m 0.4 — 0.4 Equity of convertible bonds £m 0.5 (0.5) — Company At 1 January 2005 Repayment of convertible bonds due June 2005 At 31 December 2005 and 2006 Total £m 9.9 (0.5) 9.4 The equity of convertible bonds due at 1 January 2005 included gross equity of £0.7 million less related deferred tax of £0.2 million. Both elements reversed during 2005 on repayment of those bonds. 31 Commitments Group As at 31 December 2006 £m Commitments under operating leases Operating leases on land and buildings: In one year or less In two to five years In five years or more Other operating leases: In one year or less Group As at 31 December 2005 £m Company As at 31 December 2006 £m Company As at 31 December 2005 £m 2.5 10.7 9.4 22.6 0.1 0.1 2.3 10.4 14.6 27.3 0.1 0.1 0.5 1.6 — 2.1 — — 0.3 0.3 1.3 1.9 — — In addition, the Group has committed to undertake certain clinical trials on behalf of its partners under development and licensing agreements. The Group is committed to make certain payments to third parties contingent upon future events such as the approval and launch of products. 32 Contingencies At 31 December 2006 the Company had provided guarantees on various bank borrowings of its subsidiaries as set out in Note 24 (Borrowings). In common with most business enterprises, Group companies are subject to a number of claims from third parties, the outcome of which cannot at present be determined but which are not considered to be material in the context of these financial statements. Provisions have been made in these financial statements for any liabilities which are expected to materialise from such claims. 91 Notes to the Financial Statements SkyePharma PLC Annual Report 2006 33 Related Parties Group Directors’ transactions At the end of December 1998, Ian Gowrie-Smith (through a family-owned trust) acquired a 51% interest in 10 East 63rd Street Inc., the company which owns 10 East 63rd Street, a property in New York. In December 2002 Mr. Gowrie-Smith acquired a further 49% interest. SkyePharma PLC has been in occupation of approximately half of that property since January 1997, subject to tenancy agreements based upon independent valuation. In August 2003 the Company took occupation of the entire building under an eight-year tenancy agreement, at which time the annual rent was increased from US$420,000 per annum to US$720,000 per annum until August 2008, and US$942,500 per annum from August 2008 to August 2011. The Company sought legal advice in relation to its obligations under the lease and as a consequence notice of termination of the lease was served on 28 February 2007. The service of this notice has been challenged and discussions regarding this are taking place. Company The Company has issued share options to employees of subsidiary undertakings and in accordance with IFRS 2 has made a charge of £1.5 million (2005: £1.3 million). The Company has charged £1.2 million (2005: £1.6 million) to subsidiary undertakings and the Company was charged £0.4 million (2005: £0.5 million) by subsidiary undertakings for corporate services provided. The Company has intercompany loans and accounts with its subsidiary undertakings and details can be found in Notes 17, Shares in and loans to Group undertakings; 19 (Trade and other receivables); and 22 (Trade and other payables). Interest is charged on intercompany loans and accounts at 0.5% above one month LIBOR or 1.0% above three month LIBOR and totalled £9.3 million for the year (2005: £7.5 million). The Group’s key management for disclosure of remuneration comprises only Directors, and Directors’ remuneration for the year is shown in the audited part of the Remuneration Report. There are no material balances held with associates at the year ended 31 December 2006 or 2005. 34 Principal subsidiaries Subsidiary undertakings Country of incorporation France Jersey Switzerland Switzerland Switzerland Switzerland US US % held of nominal value and voting rights 100% 100% 100% 100% 100% 100% 100% 100% Company SkyePharma Production SAS(1) SkyePharma (Jersey) Limited(1) Jago Holding AG Jagotec AG SkyePharma AG SkyePharma Holding AG(1) SkyePharma Holding Inc.(1) SkyePharma Inc.(2) Principal activities Manufacturing of pharmaceuticals Issue of bonds Holding company Exploitation of intellectual property Research and development Holding company Holding company Development of pharmaceuticals (1) Directly held by the Company. (2) SkyePharma Inc. disposed of in March 2007. The above table only includes principal subsidiaries. Associates Country of incorporation US % held of nominal value and voting rights 40% Company Astralis Limited Principal activities Research and development SkyePharma PLC Annual Report 2006 92 Non-Audited Financial Information Extracted from the January 2007 Circular This information is included as required by the UK Listing Rule 9.2.18 as unaudited financial information which was included in the Circular to shareholders dated 15 January 2007 Financial Information on the Injectable Division 1. Nature of Financial Information This contains the financial information for the Injectable Division as previously published. The Injectable Division is the Injectable segment of the Group, and comprises the Injectable Business together with an allocation of corporate and other Group costs, assets and liabilities. The following financial information in respect of the Injectable Division has been extracted without material adjustment from the consolidation schedules which support the consolidated audited financial statements of the Group for the years ended 31 December 2003, 2004 and 2005 and the consolidated unaudited financial statements of the Group for the six months ended 30 June 2006. The Group adopted IFRS for the first time in its reporting for the year ended 31 December 2005. This involved the restatement of comparative amounts for the year ended 31 December 2004. Therefore, the income statement for the year ended 31 December 2003 included in paragraph 2 is presented under UK GAAP and the income statements for the years ended 31 December 2004 and 2005 and the six months ended 30 June 2006 are presented under IFRS. The balance sheet information as at 31 December 2005 and 30 June 2006 is presented under IFRS. The financial information for each period has been prepared using the accounting policies set out in the consolidated audited financial statements of the Group for the years ended 31 December 2003, 2004 and 2005 and the consolidated unaudited financial statements of the Group for the six months ended 30 June 2006. The financial information contained in paragraphs 2 and 3 is unaudited and does not constitute statutory financial statements within the meeting of Section 240 of the Act. The audited statutory financial statements of the Group for the years ended 31 December 2003, 2004 and 2005 have been delivered to the Registrar of Companies. These consolidated financial statements have been audited by PricewaterhouseCoopers LLP of 1 Embankment Place, London WC2N 6RH. The auditors have issued unqualified reports in respect of these consolidated financial statements which contained no statement under Section 237 (2) or Section 237 (3) of the Act. 2. Statements of operating losses for the years ended 31 December 2003, 2004 and 2005 and the six months ended 30 June 2006 The statements of operating losses of the Injectable Division for the years ended 31 December 2003, 2004 and 2005 and the six months ended 30 June 2006 have been prepared on the basis set out above and in the notes below. 12 months to 31 December 2003 £m 11.7 (6.2) 5.5 (1.7) (0.6) (6.8) (7.4) (15.6) 0.8 (18.4) 12 months to 31 December 2004 £m 25.6 (6.7) 18.9 (0.7) (0.7) (7.2) (7.9) (11.7) — (1.4) 12 months to 31 December 2005 £m 10.5 (7.9) 2.6 (3.5) (0.7) (5.5) (6.2) (11.7) 0.2 (18.6) 6 months to 30 June 2006 £m 3.9 (4.8) (0.9) (0.2) (0.4) (5.4) (5.8) (5.0) 0.2 (11.7) Revenue Cost of sales Gross profit/(loss) Selling, marketing and distribution expenses Administration expenses Amortisation of other intangibles Other administration expenses Research and development expenses Other income Operating loss of the Injectable Division Notes: (1) The statement of operating losses for the year ended 31 December 2003 has been extracted without material adjustment from the consolidation schedules which support the consolidated financial statements which have been prepared in accordance with UK GAAP, and the statements of operating losses for the years ended 31 December 2004 and 2005 and the six months ended 30 June 2006 are extracted without material adjustment from the consolidation schedules which support the consolidated financial statements which have been prepared in accordance with IFRS. (2) It is not possible to provide a meaningful allocation of non-operating finance costs, finance income and income tax expense, and therefore the above results of the Injectable Division only reflect the operating results. (3) The operating loss of the Injectable Division for the six months ended 30 June 2006 includes £2.8 million relating to corporate and other Group cost allocations. 93 Non-Audited Financial Information Extracted from the January 2007 Circular SkyePharma PLC Annual Report 2006 3. Statement of net assets as at 31 December 2005 and 30 June 2006 The statements of net assets of the Injectable Division as at 31 December 2005 and 30 June 2006 have been prepared on the basis set out above and in the note below. 31 December 30 June 2005 2006 £m £m ASSETS Non-current assets Goodwill 35.6 35.6 Other intangible assets 12.1 11.2 Property, plant and equipment 6.5 6.4 54.2 53.2 Current assets Inventories 1.4 1.1 Trade and other receivables 1.5 1.1 2.9 2.2 Total assets 57.1 55.4 LIABILITIES Current liabilities Trade and other payables (8.3) (6.2) Other borrowings (3.3) (3.9) Deferred income (6.6) (0.7) (18.2) (10.8) Non-current liabilities Other borrowings (17.0) (14.9) Deferred income (1.5) (1.1) Other non-current liabilities (3.4) (3.2) (21.9) (19.2) Total liabilities (40.1) (30.0) Net assets 17.0 25.4 Note: (1) The statements of net assets as at 31 December 2005 and 30 June 2006 are extracted without material adjustment from the consolidation schedules which support the consolidated financial statements which have been prepared in accordance with IFRS. SkyePharma PLC Annual Report 2006 94 Non-Audited Financial Information Extracted from the January 2007 Circular Pro Forma Financial Information for the Continuing Group 1. Pro forma financial information The pro forma financial information set out below has been prepared to illustrate the effect of the Placing and Disposal on the unaudited consolidated net assets of the Group if it had occurred on 30 June 2006. The pro forma financial information is for illustrative purposes only and because of its nature, it addresses a hypothetical situation and does not, therefore, represent the actual financial position. The pro forma financial information has been prepared on the basis set out in the notes below and in accordance with paragraph 20.2 of Annexe I and Annexe II of Appendix 3 to the Prospectus Rules. The pro forma financial information has been prepared using the accounting policies set out in the consolidated unaudited financial statements of the Group for the six months ended 30 June 2006 as prepared under IFRS. 2. Pro forma net assets as at 30 June 2006 Adjustments Group as at 30 June 2006 £m ASSETS Non-current assets Goodwill Other intangible assets Property, plant and equipment Available-for-sale financial assets Current assets Inventories Trade and other receivables Financial assets at fair value through profit or loss Cash and cash equivalents Total assets LIABILITIES Current liabilities Trade and other payables Other borrowings Deferred income Non-current liabilities Convertible bonds Other borrowings Deferred income Other non-current liabilities Provisions Total liabilities Net assets/liabilities Injectable Division as at 30 June 2006 £m Placing and Disposal Adjustments £m Pro forma Continuing Group as at 30 June 2006 £m 68.7 26.3 34.9 0.4 130.3 2.3 14.8 0.3 22.8 40.2 170.5 (35.6) (11.2) (6.4) — (53.2) (1.1) (1.1) — — (2.2) (55.4) — — — — — — 2.2(3)(i) — 21.6(3)(ii) 23.8 23.8 33.1 15.1 28.5 0.4 77.1 1.2 15.9 0.3 44.4 61.8 138.9 (26.9) (4.3) (12.0) (43.2) (63.9) (48.0) (2.4) (3.3) (1.6) (119.2) (162.4) 8.1 6.2 3.9 0.7 10.8 — 14.9 1.1 3.2 — 19.2 30.0 (25.4) (1.4)(3)(iii) (3.9)(3)(iv) — (5.3) — (14.9)(3)(iv) — — — (14.9) (20.2) 3.6 (22.1) (4.3) (11.3) (37.7) (63.9) (48.0) (1.3) (0.1) (1.6) (114.9) (152.6) (13.7) 95 Non-Audited Financial Information Extracted from the January 2007 Circular SkyePharma PLC Annual Report 2006 2. Pro forma net assets as at 30 June 2006 continued (1) The consolidated net assets of the Group as at 30 June 2006 in the first column have been extracted without material adjustment from the unaudited financial statements of the Group for the six months ended 30 June 2006. (2) The net assets of the Injectable Division as at 30 June 2006 in the second column have been extracted without material adjustment from the Financial Information of the Injectable Division. (3) The Placing and Disposal adjustments in the third column reflect the effects of the Placing and Disposal as if they had taken place on 30 June 2006. These amounts have been calculated using the rate as at 30 June 2006 of US$1.8496 to the pound sterling. The adjustments are as follows: i. The £2.2 million included within trade and other receivables comprises £1.1 million (US$2.0 million) of consideration on the Disposal which will be held in escrow and £1.1 million relating to DepoCyt® and DepoDur™ receivables which would have been retained by the Continuing Group under the terms of the Disposal had it taken place at 30 June 2006. The £21.6 million included within cash and cash equivalents comprises the £14.8 million net proceeds from the Placing and £9.7 million (US$18.0 million) of consideration on the Disposal which will be settled in cash less £2.9 million associated costs. The contingent consideration on the Disposal of milestone and ongoing payments has not been included as the receipt of these payments is uncertain since they depend on the development and successful launch and level of sales of future products. ii. iii. The £1.4 million included within trade and other payables comprises £0.5 million (US$1.0 million) in respect of certain specific disputed and aged potential liabilities, £0.5 million (US$1.0 million) in respect of certain transitional services and £0.4 million (US$0.8 million) in respect of employees since these liabilities would have been retained by the Continuing Group. iv. The £3.9 million recorded within other current borrowings and £14.9 million within other non-current borrowings relate to Paul Capital funding liabilities, which would have been retained by the Continuing Group. No adjustment has been made for any potential payments after the date of the Disposal by the Injectable Business to Paul Capital which, if made, would reduce the Continuing Group’s liability to Paul Capital. (4) No account has been taken of the trading results of the Continuing Group or the Injectable Division since 30 June 2006, nor any other event or transaction since that date. SkyePharma PLC Annual Report 2006 96 Notice of Annual General Meeting Notice is hereby given that the 2007 Annual General Meeting of SkyePharma PLC (the “Company”) will be held at the Institute of Physics, 76 Portland Place, London, W1B 1NT at 10.30 am on Friday 29 June 2007 for the following purposes: Resolutions To consider and, if thought fit, to pass the following resolutions, of which numbers 1 to 8 will be proposed as ordinary resolutions and resolutions 9 and 10 as special resolutions. 1 2 3 4 5 To receive the Annual Report and Accounts for the year ended 31 December 2006. By separate advisory resolution to approve the Directors’ Remuneration Report contained in the Annual Report and Accounts for the year ended 31 December 2006. To appoint Ernst & Young LLP as auditors of the Company to hold office until the conclusion of the next general meeting at which the accounts are laid before the Company. To authorise the Directors to determine the remuneration of the auditors. By separate resolutions: 5.1 To re-elect as a Director Dr Jerry Karabelas, who retires by rotation in accordance with the Articles of Association of the Company; 5.2 To re-elect as a Director Alan Bray, who retires by rotation in accordance with the Articles of Association of the Company; 5.3 To re-elect as a Director Stephen Harris, who has served as a Non-Executive Director for over nine years, in accordance with the recommendations of Section A.7.2 of the Combined Code; 5.4 To elect as a Director Peter Grant, who was appointed following the last Annual General Meeting of the Company, in accordance with the Articles of Association of the Company. 6 To authorise the Company generally and unconditionally to use electronic communications with its shareholders and in particular to authorise the Company to send or supply documents or information to its shareholders by making them available on a website. That the authorised share capital of the Company be increased from £111,400,000 to £120,000,000 by the creation of an additional 86,000,000 new Ordinary Shares of 10 pence each having the same rights in all respects as the existing Ordinary Shares of 10 pence each in the capital of the Company. That the Directors be and they are hereby generally and unconditionally authorised pursuant to section 80 of the Companies Act 1985 (the “Act”) to allot relevant securities (within the meaning of section 80) up to an aggregate nominal amount of £27,139,121, which represents approximately one-third of the Company’s issued ordinary share capital as at 25 April 2007 for a period expiring (unless previously renewed, varied or revoked by the Company in general meeting) at the conclusion of the next following annual general meeting of the Company after the date on which this resolution is passed and to make an offer or agreement which would or might require relevant securities to be allotted after the expiry of this authority and the Directors may allot relevant securities pursuant to that offer or agreement as if this authority had not expired. This authority shall be in substitution for any other authority to allot relevant securities but without prejudice to the continuing authority of the Directors to allot relevant securities in pursuance of an offer or agreement made before the expiry of the authority pursuant to which such offer or agreement was made. 7 8 97 Notice of Annual General Meeting SkyePharma PLC Annual Report 2006 9 That, subject to the passing of Resolution 8 set out in this Notice, the Directors be empowered to allot for cash equity securities (as defined for the purposes of Section 89 of the Act) pursuant to the general authority conferred on them under section 80 of the Act in accordance with Resolution 8 above and to sell or make offers or agreements to sell equity securities which immediately before the sale are held by the Company as treasury shares (as defined by Section 162A of the Act) in each case, as if section 89 (1) of the Act did not apply to the allotment but this power shall be limited: 9.1 to the allotment of equity securities, whether by way of rights issue, open offer or other pro rata offers or issues, to holders of Ordinary Shares and to holders of other securities in the Company that by their terms are entitled to participate in such rights issue, open offer or other pro rata offers or issues in such a manner that the number of equity securities allotted to them is in proportion (as nearly as may be) to their respective holdings of such securities or in accordance with the rights attached thereto. The Directors may deal as they see fit with fractional entitlements, overseas shareholders and with the legal or practical problems or requirements of any regulatory body or stock exchange, in any territory; 9.2 to the allotment of equity securities pursuant to the terms of any share scheme for employees approved by the Company in general meeting; 9.3 (otherwise than pursuant to sub-paragraphs 9.1 and 9.2 above) to the allotment or sale of equity securities up to an aggregate nominal amount of £4,074,940, representing 5% of the Company’s issued ordinary share capital as at 25 April 2007; This power shall be in substitution for all such powers previously given but without prejudice to the continuing power of Directors to allot equity securities pursuant to an offer or agreement made by the Company before the date this resolution is passed and unless previously renewed, varied or revoked by the Company in general meeting shall expire at the conclusion of the next following annual general meeting of the Company after the date on which this resolution is passed save that the Company may before such expiry make an offer or agreement which would or might require equity securities to be allotted after such expiry and the Directors may allot equity securities in pursuance of such offer or agreement as if the power conferred hereby had not expired. 10 That the Company be generally and unconditionally authorised to make market purchases (as defined by section 163 of the Act) of its Ordinary Shares provided that: 10.1 the Company shall not purchase Ordinary Shares with an aggregate nominal value of more than £8,149,880; 10.2 the Company shall not pay less than 10p for each Ordinary Share; 10.3 the Company shall not pay more for each Ordinary Share than 105 per cent of the average of the middle market price of an Ordinary Share as derived from the UK Listing Authority Daily Official List for the five business days immediately preceding the date on which the Company agrees to buy the Ordinary Shares concerned; 10.4 this authority shall continue in force until the conclusion of the next following annual general meeting of the Company; and 10.5 the Company may agree before the authority terminates under sub-paragraph 10.4 above to purchase Ordinary Shares where the purchase contract will or may be executed (either wholly or in part) after the authority terminates and the Company may complete such purchase contract notwithstanding that the authority has terminated. By Order of the Board Registered Office: 105 Piccadilly London W1J 7NJ 25 April 2007 John Murphy General Counsel and Company Secretary SkyePharma PLC Annual Report 2006 98 Notice of Annual General Meeting NOTES: 1 2 A Form of Proxy is enclosed for your use. A member of the Company entitled to attend and vote at the meeting may appoint one or more proxies to attend and, on a poll, vote on his/her behalf. A proxy need not be a member of the Company. The form of proxy may be returned to the Registrars, Capita Registrars, Proxy Processing Centre, Telford Road, Bicester, OX26 4LD in hard copy form by post or courier, or by hand to The Registry, 34 Beckenham Road, Beckenham, Kent, BR3 4TU; or electronically at the Registrar’s website at www.capitaregistrars.com by following the instructions on the website. CREST members should use the CREST electronic proxy appointment service and should refer to note 3 below. In each case, the proxy appointment must be received not less than 48 hours before the time for the holding of the meeting or adjourned meeting together (except in the case of appointments made electronically) with any authority (or a notarially certified copy of such authority) under which it is signed. CREST members who wish to appoint a proxy or proxies through the CREST electronic proxy appointment service may do so for the meeting and any adjournment(s) thereof by using the procedures described in the CREST Manual. CREST Personal Members or other CREST sponsored members, and those CREST members who have appointed a voting service provider(s), should refer to their CREST sponsor or voting service provider(s), who will be able to take the appropriate action on their behalf. In order for a proxy appointment or instruction made using the CREST service to be valid, the appropriate CREST message (a “CREST Proxy Instruction”) must be properly authenticated in accordance with CRESTCo’s specifications and must contain the information required for such instructions, as described in the CREST Manual. The message, regardless of whether it constitutes the appointment of a proxy or an amendment to the instruction given to a previously appointed proxy must, in order to be valid, be transmitted so as to be received by the Company’s agent (ID RA10) by the latest time(s) for receipt of proxy appointments specified in the notice of meeting. For this purpose, the time of receipt will be taken to be the time (as determined by the timestamp applied to the message by the CREST Applications Host) from which the Company’s agent is able to retrieve the message by enquiry to CREST in the manner prescribed by CREST. After this time any change of instructions to proxies appointed through CREST should be communicated to the appointee through other means. CREST members and, where applicable, their CREST sponsors or voting service providers should note that CRESTCo does not make available special procedures in CREST for any particular messages. Normal system timings and limitations will therefore apply in relation to the input of CREST Proxy Instructions. It is the responsibility of the CREST member concerned to take (or, if the CREST member is a CREST personal member or sponsored member or has appointed a voting service provider(s), to procure that his CREST sponsor or voting service provider(s) take(s)) such action as shall be necessary to ensure that a message is transmitted by means of the CREST system by any particular time. In this connection, CREST members and, where applicable, their CREST sponsors or voting service providers are referred, in particular, to those sections of the CREST Manual concerning practical limitations of the CREST system and timings. The Company may treat as invalid a CREST Proxy Instruction in the circumstances set out in Regulation 35(5)(a) of the Uncertificated Securities Regulations 2001. 4 5 Completion of a Form of Proxy will not preclude a member from attending and voting in person at the meeting should he/she so wish. The following will be available for inspection at the registered office of the Company during usual business hours on any weekday (Saturdays and Bank Holidays excepted) from the date of this notice up to and including the date of the meeting and at the place of the meeting for fifteen minutes prior to and during the meeting: 5.1 the register of Directors’ interests kept by the Company under section 325 of the Act; 5.2 Directors’ service contracts and letters of engagement; 5.3 the Memorandum and Articles of Association of the Company; and 5.4 the audited consolidated accounts of the Company and its subsidiaries for the years ended 31 December 2005 and 2006. 6 Pursuant to Regulation 41 of the Uncertificated Securities Regulations 2001, only those members of the Company registered in the register of members 48 hours before the time of the meeting shall be entitled to attend or vote at the above meeting in respect of the number of shares registered in their name at that time. Subsequent changes to entries on the register of members will be disregarded in determining the rights of any person to attend or vote at the meeting. 3 99 SkyePharma PLC Annual Report 2006 Shareholder Notes SkyePharma PLC Annual Report 2006 100 Shareholder Notes SkyePharma PLC Registered Head Office 105 Piccadilly London W1J 7NJ Telephone: 020 7491 1777 Fax: 020 7491 3338 Registered No: 107582 SkyePharma PLC Annual Report 2006