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Outstanding.

2009 Annual Report

1


Outstanding

performance.

14 … 70 … 3 … 13 …

Over the last 14 years at Paladin, we have

acquired or in-licensed a diverse portfolio

of products to serve the Canadian specialty

pharmaceutical market. Our pipeline consists

of more than 70 commercial products, with

3 products awaiting regulatory approval and

another 13 products in clinical development.

14 … 33 … 32 … 35 …

Our revenue growth acceleration includes:

• 14 consecutive years of record revenues

• Revenues for 2009 of $109.7 million, up 33%

versus 2008

• Strong revenue growth which includes a 5 year

revenue Compound Annual Growth Rate (CAGR)

of 32%

• Healthy and robust business of 7 consecutive

years of record EBITDA 1 ; 2009 EBITDA 1 of

$39.2 million, up 35% versus 2008

Financial highlights

For the years ended December 31 (in thousands of Canadian dollars except share and per share amounts).

Revenues

Net Income

(Loss)

Earnings

Cash &

Share (Basic) EBITDA 1 Securities

(Loss) Per

Marketable

Shareholders'

Equity

Shares

Issued and

Outstanding

2009 109,693 37,738 2.23 39,183 105,369 194,802 18,563,250

2008 82,744 13,798 0.93 28,941 21,342 95,348 14,921,446

2007 62,941 9,033 0.60 19,913 36,216 82,000 14,902,784

2006 48,357 5,806 0.39 15,420 36,074 73,741 14,980,131

2005 33,689 3,254 0.22 9,230 42,319 66,250 14,732,368

2004 27,871 3,239 0.22 7,571 42,124 63,192 14,858,469

2003 23,788 (4,172) (0.28) 4,457 44,547 59,332 14,799,588

2002 23,277 5,162 0.37 8,301 45,612 63,178 14,780,205

2001 17,497 1,485 0.12 4,982 22,448 37,836 12,539,247

2000 12,381 2,797 0.24 2,860 24,339 35,769 12,394,038

1999 10,915 2,016 0.22 2,873 9,886 13,830 9,466,338

1


“There are many easy ways to make a mark, to

stand out: Be the loudest, the biggest, the most

provocative. We prefer to take the harder approach,

and stand out thoughtfully. Attract notice for our

credibility, our management team and board of

directors, our employees, our products and our

collective, consistent performance.”

– Jonathan Ross Goodman, BA, LLB, MBA

President and Chief Executive Officer

Paladin Labs Inc.

Revenues EBITDA 1

96 97 98 99 00 01 02 03 04 05 06 07 08 09 96 97 98 99 00 01 02 03 04 05 06 07 08 09

1 EBITDA — Non-GAAP Financial Measures

The term EBITDA (earnings before interest, taxes, depreciation and amortization) does not have any standardized meaning under Canadian GAAP and therefore

may not be comparable to similar measures presented by other companies. The Company defines EBITDA as earnings before interest expense, taxes, amortization,

foreign exchange gains (losses) and unusual items; such as write-downs and gains (losses) on intellectual property and investments. EBITDA is calculated and

presented consistently from period to period and agrees, on a consolidated basis, with the amount disclosed as “Earnings before under-noted items” on the

consolidated statements of income. The Company believes EBITDA to be an important measurement that allows it to assess the operating performance of

its ongoing business on a consistent basis without the impact of amortization expenses. The Company excludes amortization expenses because their level

depends substantially on non‐operating factors such as the historical cost of intangible and capital assets. The Company’s method for calculating EBITDA may

differ from that used by other issuers and, accordingly, this measure may not be comparable to EBITDA used by other issuers.


“Part of Paladin’s mission is to make a difference in the lives of Canadians; Twinject® is

a great example of such a product. I’ve had the privilege to work on Twinject®, the only

epinephrine auto-injector that has a built-in back-up dose for patients suffering from

severe allergies (anaphylaxis). A letter that I recently received from a parent expresses how

everyday we make a difference in the lives of patients: ‘The life of my precious daughter

was saved when we had to use her Twinject® after she ate candy that contained traces of

nuts. We can’t imagine what could have happened if we did not have Twinject® with us.

Thank you.’”

– Jad Isber, B.Eng, MBA

Product Manager, Paladin Labs Inc.

3


Standing up

for patients.

At Paladin, we have established a track record

of profitable growth by bringing new specialty

pharmaceutical brand products into the Canadian

market to improve the lives of patients. Our

successful sales and marketing capabilities

have made us the partner of choice for both

international and domestic commercial-stage

companies that are searching for an established

partner to penetrate the Canadian market.

Our ability to identify complementary products that

support our existing portfolio has enabled us to

leverage our sales and marketing resources while

maintaining a lean organization focused on our key

therapeutic areas.

With an experienced and dynamic management

team and the financial strength coming from

14 years of continuous growth, we possess all

the necessary elements to fuel continued sales

growth with an innovative and expanding product

portfolio to serve Canadians.

Bringing Twinpack to

Canadian patients:

Providing multiple

options to those

at risk of anaphylaxis

In June 2009, we launched Twinject® Twinpack, which includes two Twinject® epinephrine autoinjectors,

and gives patients multiple options and greater convenience in the face of anaphylaxis. Twinject®

Twinpack is a life-saving device that addressed the unmet needs of anaphylactic patients by having

two auto-injectors instead of one. Understandably, the threat of anaphylaxis is an extremely anxious

condition for patients and their families. With Twinpack, we include a Twinject® demonstrator that

not only allows but encourages patients to practice in non-emergent situations to ensure that if, or when,

the time comes, users feel confident to use the device properly and gain from it the maximum benefits.

In-licensing Abstral®

for the Canadian market:

A novel formulation

for cancer pain relief

During 2009, we prepared the new drug submission for Abstral®, a sublingual fentanyl. Abstral® is a

great example of our ability to in-license an innovative product that complements our existing pipeline;

in this case our pain portfolio which includes Tridural®, Metadol® and Pennsaid®. We in-licensed

Abstral® from ProStrakan Group plc in late 2008. It is a novel, rapidly-disintegrating, under the tongue

formulation of fentanyl, which is a well-established opioid used for the management of episodes of

breakthrough pain experienced by cancer patients who are already receiving opioid analgesics for

chronic pain. In early 2010, we received notification from Health Canada that our submission had been

accepted for a priority review which provides a 180-day review cycle.

3


“During his lifetime, 1 in 6 men will develop prostate cancer, the most common cancer to

affect Canadian men. Different medical interventions and therapies can greatly improve

prognosis. Amongst the therapeutic options available, hormonal therapy, more specifically

LHRH agonists like Trelstar, can be used at varying stages of the disease. Needless to say,

the introduction 4 years ago of Trelstar on the Canadian market contributes to provide

quality care for our patients.”

– Dr. Neil E Fleshner, FRCSC, MD, MPH

Head of Division of Urology

University Health Network, Princess Margaret Hospital

4


Standing out with

our products.

We possess a broad portfolio of more than

70 commercial products that address patient

needs across five core therapeutic fields

which include urology, endocrinology, pain

management, allergy and women’s health.

We continue to explore the category para meters

in search of the right product for the right

indication at the right price.

Our strategy is to leverage our strong sales and

marketing capabilities to enhance the performance of

existing and newly acquired pharmaceutical products.

Our sales and marketing team provides targeted

promotion for our inno vative products in these five

core therapeutic fields. By focusing on specialty

pharmaceuticals we are able to aggressively capitalize

on market opportunities that may be under-served by

large pharmaceutical companies.

Our product acquisition process screens and

selects candidates based on a defined set of

criteria that includes product differentiation

from existing com mercial pharmaceuticals and

the potential to complement our existing pipeline.

A new way to treat pain.

Tridural® is indicated for moderately severe pain. Some of the benefits include: Initial rapid release,

rapid titration, efficacious analgesia sustained for 24 hours and favourable safety profile.

A better way to manage prostate cancer.

Trelstar®, injectable luteinizing hormone-releasing agonist (LHRH), bolster both our urology and women’s

health franchises as they are indicated for the palliative treatment of prostate cancer and endometriosis.

Improving access to emergency contraceptive pills for Canadian women.

PLAN B® is a safe and effective emergency contraceptive and is now available over-the-counter.

Most Canadian women have access to emergency contraception without having to talk to a doctor

or physician.

5


“The Tridural partnership with Paladin has been successful on many levels. We are thrilled

with the leading market position Tridural has achieved. In addition it is a pleasure to work

with the Paladin team.”

– Mary Anne Heino

President

Labopharm USA

6


Standing with

our partners.

As we continue to execute our strategy of acquiring

mature and under-promoted products from large

pharmaceutical companies, we have positioned

ourselves as the partner of choice in the Canadian

market. We are aligned with numerous companies

in the licensing of innovative pharmaceuticals and

the development of near-term, low risk/low expense

products internally for both the Canadian and/or

global markets.

Recent Partnerships:

• Agreement with Mission Pharmacal Company

to market and sell Urocit-K ® 540 mg in Canada

• Agreement with Sylphar N.V. to market an oral

dissolving teeth whitening filmstrip in Europe

• Acquired from Wyeth the commercial rights

in Canada to a bundle of existing products

including Anacin ® and Anbesol ®

• Strategic partnership with Isotechnika Pharma Inc.

for the commercialization of voclosporin in Canada,

Mexico, Central and South America, Israel and

South Africa

• Amended the agreement with Pfizer to sell,

market and distribute Estring ® in Canada

• Preparing to file a new drug submission in

collaboration with Stallergenes for Oralair, a

group of sublingual desensitization tablets for

the treatment of allergies (2010)

Growing the pipeline

through partners

We successfully amended our Canadian Estring® agreement with Pfizer. The amended agreement

provides us with all commercial responsibilities for the selling, marketing and distribution of Estring®,

a valuable treatment alternative for symptoms associated with urogenital estrogen deficiency in

Canada. It effectively complements our existing women’s health franchise that includes Plan B®

and Seasonale®.

We acquired a bundle of currently marketed products, which include Anacin® (acetylsalicylic acid) and

Anbesol® (benzocaine), from Wyeth. These products expand and complement our growing pain portfolio

that includes both prescription and over-the-counter (OTC) solutions for Canadian patients. Expanding

our existing base of OTC brands allows us to leverage our existing distribution activities and provide

additional critical mass and strategic options for further developing our Canadian OTC presence.

7


Understanding

the Canadian market.

We’re pleased to report that we begin 2010 with energy, optimism and momentum from last year’s performance. Without question,

2009 was a year of unprecedented economic obstacles. Still, we maintained and acted on our vision, and closed the year with

success, satisfaction and determination to stay our course. We have not wavered from our mission of focused innovation, and

thoughtful growth to bring smarter, more effective health options to Canadians. Consequently, for the fourteenth consecutive

year, we have exceeded our targets and surpassed our $100 million-revenue goal.

Outstanding performance

During this volatile time in our industry, our diverse and highly profitable product portfolio combined with our healthy balance sheet,

differentiate us among our competition, and embolden us to execute a positive growth strategy.

This year, growth stemmed from both promoted brands, and new acquisitions which translated into increased revenue of

$109.7 million (compared to $82.7 million in 2008). The earnings before interest, taxes, depreciation, amortization and unusual

items (EBITDA) reached a record $39.2 million, representing an increase of 35% from the 2008 EBITDA of $28.9 million.

In May, we issued common shares, generating $57.4 million, and further strengthening our financial position. This flow of capital

helped fund both the Isotechnika Inc. transaction and the final payment related to the acquisition of Dexedrine®.

At year’s end, our balance sheet was solid, and included $105.4 million in cash and marketable securities.

Standing out with our products

At our onset, Paladin had a unique business vision which, fourteen years later, is manifested in a diverse product portfolio:

Over 70 products in our pipeline, 3 products awaiting regulatory approval and 13 products in Phase I, II, and III. We continue to

explore the category parameters in search of the right product for the right indication at the right price.

Some highlights from this year:

• January 2009: Mission Pharmacal Company grants Paladin exclusive Canadian rights to market and

sell Urocit-K® (540 mg strength), indicated for the treatment of calcium and uric acid kidney stones.

According to the Canadian Urological Association, approximately one in ten Canadians will develop

kidney stones. Further data suggests that 50% of stone formers will develop a second stone within

10 years and 75% will develop a second stone within 20 years.

• June 2009: Paladin acquires a bundle of products – Anacin® (acetylsalicylic acid) and Anbesol®

(benzocaine) – currently marketed in Canada by Wyeth. Canadian net sales of these products in 2008

were approximately $4 million. These products have strong brand recognition and tie-in strategically with

Paladin’s goal of building a broad and robust pain portfolio that includes both Rx and OTC solutions.

8


• June 2009: We launched Twinject® Twinpack, which includes two Twinject® epinephrine autoinjectors,

and gives patients multiple options and greater convenience in the face of anaphylaxis. For the

1.3 million Canadians at risk of anaphylaxis, we believe we are providing a real solution: Studies reveal that

fewer than 30% of patients carry their epinephrine auto-injectors with them at all times. The Twinpack

also includes a Twinject® demonstrator that encourages practice in non-emergent situations so when

the time comes, users (patients, family members) feel confident to use the device properly and gain from

it the maximum benefits.

• February 2010: Paladin receives priority review status from Health Canada for Abstral® sublingual fentanyl,

a well-established opioid used by cancer patients in the management of breakthrough pain. A complement

to our growing pain portfolio (Tridural®, Metadol® and Pennsaid®), Abstral® is poised to fulfill an unmet

need in the cancer care market.

Standing with our partners

As we proceed in acquiring mature and under-promoted products from large pharmaceutical companies, we have positioned

ourselves as the partner of choice in the Canadian market. To that end, we are aligned with numerous companies in the licensing

of innovative pharmaceuticals and the development of near-term, low risk/low expense products internally for both the Canadian

and/or global markets.

• June 2009: Paladin enters into an agreement with Sylphar N.V. to market an oral dissolving teeth whitening

filmstrip in Europe. We are responsible for the development, manufacturing and packaging of the product

and are, effectively, leading the category’s movement (development, marketing, innovation) in Europe.

• June 2009: Paladin enters into a strategic partnership with Isotechnika Pharma Inc. for the commercialization

and development of voclosporin, Isotechnika’s next-generation calcineurin inhibitor, in Canada, Mexico,

Central and South America, Israel and South Africa.

• October 2009: Paladin and Pfizer amend the Canadian Estring® agreement which gives Paladin all

commercial responsibilities for the selling, marketing and distribution of Estring® in Canada. Estring® offers

women a valuable treatment alternative for symptoms associated with urogenital estrogen deficiency.

9


Standing with our community

As Paladin grows, so does our commitment to the community.

This year, our major involvement was in the Ride to Conquer Cancer, a two-day cycling event from Montreal to Quebec City (over

240 kms). Team Paladin, a collective of 78 cyclists, raised over $330,000 making it the largest team in terms of number of riders

and dollars raised. Overall, the event raised over $5 million for cancer research and improvements to patient care across Quebec, and

benefited the Segal Cancer Centre at the Jewish General Hospital, the CHUQ, the CHRTR and the CSSS de Gatineau.

This past January, in conjunction with Health Partners International of Canada, a not-for-profit relief and development organization,

Paladin donated much-needed medication to the survivors of Haiti’s devastating earthquake.

Other community-based organizations we support: Centraide, the McGill University Hospital Centre Foundation and the centre

hospitalier de l’universite de Montreal.

Stand out in a crowd: the future

In July 2009, Paladin Biosciences division and specifically, the Chimigen® Platform, received a contribution from the National

Research Council of Canada Industrial Research Assistance Program. The contribution will go towards a 14-month project that will

focus on the development of bio-nanoparticle-based siRNA therapeutic vaccines using Chimigen® Vaccine Platform for Hepatitis B

(HBV) and Hepatitis C (HCV) infections.

In October 2009, our Paladin Biosciences division and Dr. Rajan George, its Chief Technology Officer, received a prestigious grant,

‘Grand Challenges Explorations’, from the Bill & Melinda Gates Foundation. The $100,000 grant will support an innovative global

health research project conducted by Dr. George entitled “Dendritic cell receptor-targeted malaria vaccines”.

For upcoming year 2010, we’re working with our partner, Stallergenes, to file a new drug submission for Oralair Grasses with Health

Canada. The Oralair pipeline includes 3 different sublingual desensitization tablets for the treatment of allergic rhinitis: Oralair

Grasses for grass sensitive patients, Oralair Mites for dust mite sensitive patients and Oralair Birch for birch sensitive patients.

A significant addition to our allergy franchise, Oralair is a strategic companion to our Twinject® product. We’re confident that Oralair

will offer patients a safer and more convenient allergy treatment than the current injectable immunotherapies.

10


In closing

There are many easy ways to make a mark, to stand out: Be the loudest, the biggest, the most

provocative. We prefer to take the harder approach, and stand out thoughtfully. Attract notice

for our credibility, our management team and board of directors, our employees, our products

and our collective, consistent performance.

We consider ourselves pioneers who have forged a unique business path, and continue to mine

it for its opportunities. The past fourteen years have witnessed great success, but our team is

simply not hard-wired to rest on its laurels; rather, we’re motivated by them.

Moving into 2010, we continue on our mission to identify potential new deals to

accelerate our growth. It is — and has been — an effective strategy that has

given our shareholders the long-term advantages of owning a part of our

dynamic company. We strive to exceed our shareholders’ expectations

as we — thoughtfully — stand out with our products, stand up for our

patients, stand with our partners and stand out in the crowd.

Jonathan Ross Goodman BA, LLB, MBA

President & CEO

11


Standing together with

our community.

In 2009, we played a major role in the Ride to

Conquer Cancer, a two-day charity cycling event

from Montreal to Quebec City — a distance of

nearly 300 kms. Team Paladin’s 78 cyclists raised

over $330,000, making it the largest team both in

terms of number of riders and in dollars raised.

Overall, the event raised $5.7 million for cancer

research and improvements to patient care

across Québec, and benefited the Segal Cancer

Centre at the Jewish General Hospital, the Centre

hospitalier universitaire de Québec (CHUQ),

the Centre hospitalier régional de Trois-Rivières

(CHRTR) and the Centre de santé et de services

sociaux de Gatineau (CSSS).

In 2010, Paladin will once again participate in the

Ride to Conquer cancer, with a new goal to attract

even more riders and raise more funds than last

year for this worthy cause. Paladin invites all of

our employees, friends, family and shareholders

to get on their bikes and join us for another

successful Ride to Conquer Cancer — we can

make a difference!

12


Table of Contents

01 Financial Highlights

08 Letter to Shareholders

14 Financial Review

61 Our Management Team

62 Board of Directors

63 Licensing Advisory Board

65 Corporate Information

Paladin Labs Inc. is a specialty pharmaceutical company focused on developing, acquiring, in-licensing, marketing and distributing

innovative pharmaceutical products. Headquartered in Montreal, Paladin is a publicly traded company listed on the Toronto Stock

Exchange under the symbol PLB.

Forward-looking statements

This Annual Report contains forward-looking statements and predictions. These forward-looking statements, by their nature,

necessarily involve risks and uncertainties that could cause actual results to differ materially from those contemplated by the

forward-looking statements. The Company considers the assumptions on which these forward-looking statements are based to

be reasonable at the time they were prepared, but cautions that these assumptions regarding the future events, many of which are

beyond the control of the Company and its subsidiaries, may ultimately prove to be incorrect. Factors and risks, which could cause

actual results to differ materially from current expectations, are discussed in the annual report as well as in the Company’s Annual

Information Form for the year ended December 31, 2009. The Company disclaims any intention or obligation to update or revise any

forward-looking statements whether a result of new information, future events, or except as required by law. For additional information

on risks and uncertainties relating to these forward-looking statements, investors should consult the Company’s ongoing quarterly

filings, annual report and Annual Information Form and other filings found on SEDAR at www.sedar.com.

13


Selected Financial Information

(In thousands of Canadian dollars except per share amounts)

The following table includes selected consolidated financial data, prepared in accordance with Canadian Generally Accepted Accounting

Principles (“GAAP”), for each year from 2007 to 2009. All amounts in this Management Discussion and Analysis (“MD&A”) are in

thousands of Canadian dollars, except where otherwise noted. We discuss the factors that caused our results to vary over the past

two years throughout this MD&A.

Income Statement Data

For the years ended December 31

2009 2008 2007

$ % $ % $ %

Revenues 109,693 100 82,744 100 62,941 100

Gross profit 80,000 73 62,594 76 48,652 77

EBITDA 1 39,183 36 29,021 35 19,913 32

Income before income taxes and extraordinary gain 14,608 13 16,037 19 7,958 13

Net income before extraordinary gain 8,321 8 9,726 12 4,159 7

Net income 37,738 34 13,798 17 9,033 14

Earnings per common share before extraordinary gain

Basic 0.49 0.66 0.28

Diluted 0.48 0.65 0.27

Earnings per common share

Basic 2.23 0.93 0.60

Diluted 2.16 0.92 0.59

Balance Sheet Data

As at December 31

2009 2008 2007

$ $ $

Cash, short and long-term marketable securities 105,369 21,342 36,216

Current assets 145,299 61,870 56,995

Total assets 235,395 132,140 98,905

Long-term liabilities 5,750 341 1,875

Shareholders’ equity 194,802 95,348 82,000

The Company has not paid dividends on its Common Shares and does not anticipate declaring any dividends in the near future.

1 EBITDA — Non-GAAP Financial Measures

The term EBITDA (earnings before interest, taxes, depreciation and amortization) does not have any standardized meaning under Canadian GAAP and therefore may

not be comparable to similar measures presented by other companies. The Company defines EBITDA as earnings before interest expense, taxes, amortization, foreign

exchange gains (losses) and unusual items; such as write-downs and gains (losses) on intellectual property and investments. EBITDA is calculated and presented

consistently from period to period and agrees, on a consolidated basis, with the amount disclosed as “Earnings before under-noted items” on the consolidated

statements of income. The Company believes EBITDA to be an important measurement that allows it to assess the operating performance of its ongoing business

on a consistent basis without the impact of amortization expenses. The Company excludes amortization expenses because their level depends substantially on

non‐operating factors such as the historical cost of intangible and capital assets. The Company’s method for calculating EBITDA may differ from that used by other

issuers and, accordingly, this measure may not be comparable to EBITDA used by other issuers.

14 — Paladin Annual Report 2009


Management’s Discussion

and Analysis

(All numbers are in thousands of Canadian dollars except share and per share amounts)

This management’s discussion and analysis provides our overview of the Company’s operations, performance and financial condition

for 2009, and compares the 2009 results to those of 2008 prepared in accordance with Canadian GAAP. It is intended to complement

and supplement financial information included in the interim and annual consolidated financial statements, related notes, other

financial information found elsewhere in our annual report and in our annual information form or other documents filed on SEDAR

at www.sedar.com. As a result, it should be read in conjunction with such financial information. This management’s discussion and

analysis is current as at March 16, 2010 and as at this date 18,639,091 shares and 1,469,776 options were issued and outstanding.

Reference to “Paladin” or the “Company” includes Paladin Labs Inc. and all its subsidiaries including the acquisition of Isotechnika

Inc. (“Isotechnika”) as of June 18, 2009, and ViRexx Medical Corp. (“ViRexx”) as of December 23, 2008, the effective dates of

acquisition, further described in more detail in Note 13 of the annual audited consolidated financial statements.

Overview & Corporate Highlights

Paladin is a specialty pharmaceutical company focused on developing, acquiring, in-licensing, marketing, and distributing innovative

pharmaceutical products.

In 2009, Paladin continued to make significant progress in acquiring the rights to innovative products, advancing the regulatory

status and market access of its product pipeline, and expanding sales of key promoted products, more specifically, Paladin:

• Entered into a distribution agreement with Mission Pharmacal Company granting Paladin the exclusive

Canadian rights to market and sell Urocit-K ® , indicated for the treatment of calcium and uric acid

kidney stones

• Received approval from the Toronto Stock Exchange (“TSX”) on February 27, 2009 to make a normal

course issuer bid to purchase up to 811,548 common shares

• Filed a new drug submission for Trelstar® 22.5 mg (triptorelin pamoate for injectable suspension). Trelstar ®

22.5 mg is a 6-month slow release, injectable, luteinizing hormone-releasing hormone (LHRH) agonist

indicated for the palliative treatment of advanced prostate cancer

• Entered into an agreement with Sylphar N.V. to develop and market an oral dissolving teeth whitening

film strip in Europe

• Launched Twinject® Twinpack, in a package that includes two Twinject ® epinephrine auto-injectors

• Closed a bought deal offering of 3,450,000 common shares issued at a price of $17.00 per common

share for total gross proceeds of approximately $58.7 million

• Acquired all the outstanding shares of Isotechnika Inc., Isodiagnostika Inc. (together “Isotechnika”) and

19% of the outstanding shares of Isotechnika Pharma Inc. (“IsoPharma”) (TSX: ISA). Entered into a

partnership for the commercialization of voclosporin including committed research and development

funding of $4.35 million to IsoPharma over the next 12 months to further the development of voclosporin.

Isotechnika is a biopharmaceutical company focused on the discovery and development of novel

immunosuppressive therapeutics and the commercialization of diagnostic products

• Entered into an agreement with Wyeth to acquire a bundle of products currently marketed in Canada by

Wyeth that includes Anacin ® (acetylsalicylic acid) and Anbesol ® (benzocaine)

• Received through its Biosciences division a contribution from the National Research Council of Canada

Industrial Research Assistance Program (NRC-IRAP) for its Chimigen ® Platform

• Sold the T-ACT technology platform to IMBiotechnologies Ltd. (“IMBio”), a private biotechnology

company based in Edmonton, Canada

• Received approval for GlucaGen® (recombinant glucagon for injection) from the Biologics and Genetic

Therapies Directorate of Health Canada. GlucaGen ® is indicated for the treatment of severe hypoglycemia

in diabetic patients being treated with insulin, and is the market leader in Europe

Management’s Discussion & Analysis —15


• Sold the AIT® technology platform to Quest PharmaTech (TSX VENTURE: QPT)(“Quest”), an Edmontonbased

biotechnology company

• Reached an agreement with Pfizer Canada Inc. to amend the terms of an existing contract and take over

all commercial responsibilities for the selling, marketing and distribution of Estring ® in Canada

• Received through its Biosciences division a US$100 Grand Challenges Explorations grant for innovative

global health research from the Bill & Melinda Gates Foundation

Subsequent to the year ended December 31, 2009:

• Filed a new drug submission for Abstral® sublingual fentanyl, which has been accepted for priority review

by Health Canada

• Amended its existing agreements with IsoPharma (TSX: ISA) that will give Paladin the full share of future

net profits of the Isodiagnostika line of diagnostic products

• Entered into a distribution agreement with Protherics Inc., a wholly owned subsidiary of BTG plc (LSE: BGC),

under which Paladin receives the exclusive Canadian rights to market and sell DigiFab (Digoxin Immune

Fab (Ovine)). DigiFab is under review with Health Canada and is expected to be indicated for the

treatment of patients with life-threatening or potentially life-threatening digoxin toxicity or overdose

• Received approval from the Toronto Stock Exchange (“TSX”) on March 1, 2010 to make a normal course

issuer bid to purchase up to 1,102,000 common shares

• Made a strategic investment in SpePharm Holding B.V., a rapidly-growing, specialty pharmaceutical

company focused on acquiring, registering and marketing high medical value specialty medicines

throughout Europe

• Entered into a strategic investment to acquire an initial 34.99% ownership interest in Pharmaplan (Pty)

Ltd., a privately-owned specialty pharmaceutical company based in Johannesburg, South Africa

2009 Financial Highlights

• Revenues reached $109,693, an increase of 33% over the prior year

• Net income was $37,738, an increase of 174% over the prior year

• Net income before the extraordinary gain was $8,321, a decrease of 14% over the prior year

1

• EBITDA was $39,183, a 35% increase over the prior year

• Cash flows from operations reached $46,558, an 85% increase over the prior year

Paladin’s revenues reached $109,693 for the year ended December 31, 2009 compared to $ 82,744 for last year. For the year ended

December 31, 2009, the Company’s net income was $37,738 or $2.16 per share on a fully diluted basis compared to $13,798 or

$0.92 per share on a fully diluted basis last year.

As at December 31, 2009, the Company’s total assets were $235,395 and shareholders’ equity was $194,802 compared to

$132,140 and $95,348, respectively as at December 31, 2008. The Company’s cash, short- and long-term marketable securities

amounted to $105,369 as at December 31, 2009 compared to $21,342 as at December 31, 2008.

Paladin’s revenues are principally derived from sales of pharmaceutical products to large pharmaceutical wholesalers and large chain

pharmacies.

The Company’s expenses have been comprised primarily of cost of goods sold (including royalty payments to those companies

from whom Paladin licenses its products), selling, marketing, administrative expenses and research and development expenses.

In addition, a substantial portion of the Company’s expenses are related to amortization of the pharmaceutical product licenses and

rights the Company acquires.

Paladin’s annual and quarterly operating results are primarily affected by the level of acceptance of Paladin’s products by physicians

and their patients, and the timing and number of product launches. The level of patient and physician acceptance of Paladin’s

products, the acceptance of provincial government reimbursement on such products, market access, as well as the availability of

similar therapies, impact Paladin’s revenues by driving the level and timing of prescriptions for its products. Each new product launch

requires significant promotional investment during the first three to five years from launch.

16 — Paladin Annual Report 2009


Critical Accounting Estimates

Paladin’s consolidated financial statements are prepared in accordance with Canadian GAAP, applied on a consistent basis. Paladin’s

critical accounting estimates include revenue recognition, inventory valuation, the recording of research and development expenses

and related tax credits, the useful lives and fair value of pharmaceutical product licenses and rights, stock-based compensation

expense, income taxes and the determination of fair value of financial instruments.

Revenue recognition

Revenue is recognized when the product is shipped to the Company’s customers, provided the Company has not retained any

significant risks of ownership or future obligations with respect to the product. Revenue from product sales is recognized net of sales

discounts, credits and allowances. Revenue related to service arrangements, where the Company earns a distribution fee on net sales

or earns co-promotion revenue, is recognized when the service is provided and is recorded on a net basis. Revenue related to royalty

arrangements with partners, where the Company earns a royalty fee based on certain pre-determined terms relating to the net sales

of products, is recognized as such terms are met alongside the recording of partner product revenues. In certain circumstances,

returns or exchange of products are allowed under the Company’s policy and provisions are maintained accordingly. Management

is required to estimate the level of sales which may be returned, and record a related reserve at the time of sale. These amounts

are deducted from gross sales to determine net revenues. These estimates take into consideration historical returns of products

and product specific conditions, including market trends and historical purchasing patterns. Management periodically reviews the

reserves established for returns and adjusts them based on actual experience.

In certain situations, such as initial product launches for which the Company has limited comparable information or where the

market or client acceptance has not been clearly established, the Company may determine that it has not met the requirements for

recognition of revenue, such as the ability to reasonably determine provisions for product returns. As a result, the Company will defer

the recognition of revenue for these product sales until such criteria are met.

Inventory valuation

Inventory is valued at the lower of cost, determined on a first-in, first-out basis, and net realizable value. The cost of finished goods

and work-in-progress includes direct costs and an allocation of overhead. Net realizable value is determined to be the selling price in

the ordinary course of business less applicable selling expenses. A reserve for inventory is maintained and revised regularly, consisting

of all or a portion of the inventory which has reached its expiration or is close to expiration and is not expected to be sold, based on the

specific facts and circumstances. In order to determine whether the inventory is properly stated at the lower of cost or net realizable

value, management regularly reviews the amount of inventory on hand, the remaining shelf life and estimates the time required to sell

such inventory taking into account current and expected market conditions and competition.

Research and development expense and related tax credits

Research costs are charged to income in the year of expenditure and generally include milestone payments for products currently

under development. Milestones and other license payments paid prior to regulatory approval of the product are generally expensed

when the event requiring payment of the milestone occurs. Development costs are charged against income in the year of expenditure

unless a development project meets the criteria under generally accepted accounting principles for deferral and amortization. The

Company has not deferred any such internal development costs to date. Research and development expenses are recorded net

of government assistance, including investment tax credits, which are based on estimates of amounts expected to be recovered.

Investment tax credits from acquired companies are established as part of the purchase equation and recognized as investment

tax credits recoverable. Management is required to assess whether it is more likely than not that the investment tax credits will be

realized and, based on all available evidence, determine if an adjustment is required on all or a portion of the recognized investment

tax credits. Factors considered in the assessment of the likelihood of realization and value of the investment tax credits recoverable

include the Company’s forecast of the amount and timing of future net income before taxes on an annual basis, available tax

planning strategies that could be implemented to realize the investment tax credits recoverable, and the remaining period available

to use the investment tax credits recoverable. These amounts are subject to audit by the taxation authorities and could be reduced

by a material amount in the future.

Pharmaceutical product licenses and rights

Intellectual property acquired is recorded at cost, less accumulated amortization, and consists primarily of process know-how covered

by certain patented and non-patented information. Milestones and other license payments determined to have a high likelihood

of attainment, subsequent to the regulatory approval of the product, are capitalized upon the Company’s periodic review and

assessment of the product’s expected performance. Pharmaceutical product licenses, rights and intellectual property are amortized

Management’s Discussion & Analysis —17


on a straight-line basis over the lesser of the term of the agreement, the life of the patent or the expected useful life of the product.

The factors that drive the actual economic useful life of a pharmaceutical product are inherently uncertain, and include patent

protection, physician loyalty and prescribing patterns, competition by products prescribed for similar indications, introductions of

competing products, the impact of promotional efforts, adverse patient reactions to products or similar products and many other

issues. The terms generally range from 2 to 10 years. Management periodically reviews the useful lives and recoverability of the

carrying values based on projected future results and whenever events or changes in circumstances indicate that an asset may be

impaired. Management must make estimates of the future cash flows related to the intellectual property. Such estimates may result

in changes to the expected useful life of the intellectual property or impairment. Any impairment in the carrying value results in a

write-down of the pharmaceutical product license and right and intellectual property which is charged to income during the year.

Stock-based compensation expense

The Company has stock-based compensation plans and applies the fair value method of accounting for such plans. A charge

for stock-based compensation has been recorded as an expense and is reflected in the net income of fiscal 2009 and 2008.

The calculation of stock-based compensation is dependent on estimates to determine the fair value. The fair value of the option is

calculated using the Black-Scholes option-pricing model, which requires making assumptions, including the volatility of the market

price of the Company’s common shares and the expected life of the option.

Future income tax assets

The Company has future income tax assets from various sources and uses judgment when estimating income taxes and future income

tax assets and liabilities. This process involves estimating actual current tax exposure, as well as assessing temporary differences

that result from the difference in treatment for accounting and tax purposes and the availability of loss carry-forwards. The temporary

differences and tax-loss carry-forwards result in future income tax assets and liabilities which are included in the Company’s consolidated

balance sheets. Management is required to assess whether it is more likely than not that future income tax assets will be realized and,

based on all available evidence, determine if an adjustment is required on all or a portion of the recognized future income tax assets.

Factors considered in the assessment of the likelihood and value of the realizable future income tax assets include the Company’s

forecast of the amount and timing of future net income before taxes on an annual basis, available tax planning strategies that could be

implemented to realize the net future income tax assets, and the remaining period of loss carry-forwards.

Fair value of financial instruments

When a financial instrument is initially recognized, its fair value is the amount of the consideration for which a financial instrument

would be exchanged in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act.

The best evidence of the fair value of a financial instrument at initial recognition is the transaction price, i.e., the fair value of

the consideration given or received. When financial instruments are subsequently re-measured, quoted market prices in an active

market are the best evidence of fair value and, when they are available, the Company uses them to measure financial instruments.

A financial instrument is considered to be quoted in an active market when quoted prices are readily and regularly available from an

exchange and those prices reflect actual and regularly occurring market transactions on an arm’s length basis. The fair value of a

financial asset traded in an active market generally reflects the bid price and, that of a financial liability traded in an active market, the

asking price. Establishing fair value is a critical accounting estimate and has an impact on available-for-sale financial assets other

than equity instruments that are not traded in an active market and are therefore presented at cost, and the fair value of derivative

financial instruments in the consolidated balance sheets. This estimate also has an impact on interest income and other income

in the consolidated statements of income. Furthermore, this estimate also has an impact on other comprehensive income in the

consolidated statements of comprehensive income.

Available-for-sale financial assets are measured periodically to determine whether there is objective evidence of impairment and this

determination requires judgment and estimates. Management examines the fair value of available-for-sale financial assets on an

ongoing basis in order to determine whether there has been an other-than-temporary decline in fair value. The examination involves

analyzing the facts specific to each investment and assessing expected future returns. The factors the Company considers when

determining whether there is objective evidence of impairment include the duration and materiality of the impairment in relation to

its cost or amortized cost, the financial condition and prospects of the issuer as well as the Company’s ability and intent to hold the

investment until it fully recovers its fair value. Any change in the evaluation of one or more of these factors used to identify availablefor-sale

financial assets that have experienced an other than temporary decline in value resulting from objective evidence of impairment

and the estimate of fair value could have an impact on the amount of losses that are recognized. This critical accounting estimate has

an impact on available-for-sale financial assets in the consolidated balance sheets as well as on other comprehensive income in the

consolidated statements of comprehensive income and other income in the consolidated statements of income.

18 — Paladin Annual Report 2009


Recently Adopted Accounting Standards

Effective January 1, 2009, the Company adopted the following recently introduced Canadian Institute of Chartered Accountants

(“CICA”) Handbook Sections:

Section 3064, Goodwill and Intangible Assets, which reinforces the approach under which assets are recorded only if they meet the

definition and the recognition criteria of an asset.

Amended Section 3862, Financial Instruments — Disclosures, which includes additional disclosure requirements about fair value

measurement for financial instruments and liquidity risk disclosures.

The Company refers the reader to Note 3 of the annual audited consolidated financial statements for the year ended

December 31, 2009, for further details regarding the adoption of these standards.

Future Accounting Changes

The CICA has issued the following new Handbook sections:

Section 1582, Business Combinations. This section establishes the standards for the accounting of business combinations, and

states that all assets and liabilities of an acquired business will be recorded at fair value. Obligations for contingent considerations

and contingencies will also be recorded at fair value at the acquisition date. The standard also states that acquisition-related costs

will be expensed as incurred and that restructuring charges will be expensed in the periods after the acquisition date. The Company

will early adopt this standard as of January 1, 2010. The initial application of this standard is not expected to have a significant effect

on the Company’s consolidated financial statements.

Section 1601, Consolidated Financial Statements. This section establishes the standards for preparing consolidated financial

statements. The Company will early adopt this standard as of January 1, 2010. The initial application of this standard is not

expected to have a significant effect on the Company’s consolidated financial statements.

Section 1602, Non-controlling Interests, which establishes standards for the accounting of non-controlling interests of a subsidiary

in the preparation of consolidated financial statements subsequent to a business combination. The Company will early adopt this

standard as of January 1, 2010. The initial application of this standard is not expected to have a significant effect on the Company’s

consolidated financial statements.

IFRS Changeover Plan

In February 2008, the Canadian Accounting Standards Board (“AcSB”) confirmed that the use of International Financial Reporting

Standards (“IFRS”) would be required for Canadian publicly accountable enterprises for interim and annual financial statements effective

for fiscal years beginning on or after January 1, 2011. The Company will implement these standards on January 1, 2011. The AcSB

also stated that, during the transition period, companies will be required to provide comparative figures in accordance with IFRS. For

the year ended December 31, 2010, the Company will be providing readers a reconciliation of current CICA GAAP to IFRS accounting

standards. It is important to note that under IFRS there is significantly more disclosure required. Further, while IFRS uses a conceptual

framework similar to Canadian GAAP, there are significant differences in accounting policy that must be addressed.

The Company’s IFRS changeover plan is progressing according to expectations. The Company continues to monitor standards to be

issued by the International Accounting Standards Board (“IASB”) but it is difficult to predict the IFRS that will be in effect at the end

of the Company’s first IFRS reporting period as the IASB work plan anticipates the completion of several projects in calendar years

2010 and 2011. The Company will provide updates as further progress is achieved and conclusions are reached.

IFRS 1 “First time adoption of international financial reporting standards” requires that first-time adopters select accounting policies

that comply with each IFRS effective at the end of its first IFRS reporting period, December 31, 2011 for the Company, and apply

those policies to all periods presented in its first IFRS financial statements. IFRS 1 also provides certain optional exemptions to the

full retrospective application. The following are the Company’s conclusions with respect to the key IFRS 1 optional exemptions:

• Business combinations — the Company will apply the new standard only to business combinations that

have occurred after the transition date, without restatement of prior business combinations.

• Property, plant and equipment and pharmaceutical product licenses and rights — the Company will use

the historical cost method for capital assets and pharmaceutical product licenses and rights.

• Share-based payments — the Company will not restate any of its existing stock options which have been

fully vested before January 1, 2010.

Management’s Discussion & Analysis —19


Based on the Company’s assessment of current IFRS, the Company has not identified any significant balance sheet items that would

be materially impacted by the application of IFRS standards. Continued progress is necessary before we can increase the specificity

of the disclosure of the impacts of IFRS.

Pursuant to the Canadian Securities Administrators Staff Notice 52-320, Disclosure of Expected Changes in Accounting Policies

Relating to Changeover to IFRS, the Company is presenting below the progress towards the completion to our changeover plan.

Accounting

policies and

financial

statement

preparation

Information

technology and

data systems

Internal control

over financial

reporting (ICFR)

Disclosure

controls and

procedures

(DC&P)

Training and

communication

Business

activities

Key Activities Milestones /Deadlines Progress to Date

Identify relevant differences between

IFRS and the Company’s accounting

policies and practices and design and

implement solutions;

Evaluate and select one-time

and ongoing accounting policy

alternatives;

Benchmark findings with peer

companies;

Prepare financial statements and

related note disclosures to comply

with IFRS;

Quantify the effects of changeover

to IFRS;

Identify and address IFRS differences

that require changes to financial

systems;

Evaluate and select methods to

address need for dual record-keeping

during 2010 (i.e. IFRS and Canadian

GAAP) for comparatives, budget and

planning purposes in 2011;

Revise existing internal control

processes and procedures to address

significant changes to existing

accounting policies and practices,

including the need for dual recordkeeping

in 2010;

Design and implement internal

controls with respect to one-time

changeover adjustments and related

communications;

For changes to accounting policies

and practices identified, assess

the DC&P design and effective

implementation;

Provide training to employees and

management;

Communicate progress of changeover

plan to internal and external

stakeholders;

Identify impact of changeover on

contractual arrangements, including

customer and supplier agreements

and employee compensation plans;

Make any required changes to

arrangements and plans;

Assessment and quantification of the

significant effects of the changeover

to be completed by approximately the

first quarter of 2010;

Final selection of accounting policy

alternatives by the changeover date;

Changes to significant systems

and dual record-keeping process

completed in time for the first quarter

of 2010;

Changes completed by the

first quarter of 2010. Conduct

management evaluation of new or

revised controls throughout 2010;

Update the Chief Executive Officer/

Chief Financial Officer certification

process by fourth quarter of 2010;

See ICFR deadlines above;

Timely training provided to align

with work under changeover — to be

completed during 2010;

Communicate effects of changeover

for 2011 financial planning process,

by the third quarter of 2010;

Changes to be completed by third

quarter of 2010;

Preliminary identification of

IFRS differences completed by

management and reviewed by thirdparty

experts underway;

Evaluation and selection of accounting

policy alternatives is ongoing;

Third-party experts are assisting in

the transition;

Analysis, subject to the impact of the

proposed IFRS standards, is underway;

Impact quantification is underway;

No IFRS differences with significant

system impacts have been identified

to date;

Dual record-keeping solution design

is underway;

Monitoring design of solutions to

address IFRS differences to permit

concurrent design or revision and

implementation of necessary internal

controls;

MD&A disclosures have begun;

Selected training for employees

directly engaged in the changeover

and general awareness to broader

group of finance employees;

Periodic internal and external

communications about our progress

are ongoing;

No potential impact identified to date;

20 — Paladin Annual Report 2009


Results of Operations

Year ended December 31, 2009 compared to year ended December 31, 2008.

Revenues

Revenues increased $26,949 or 33% to $109,693 for the year ended December 31, 2009 from $82,744 for the year ended

December 31, 2008. Revenues generated as a result of the acquisition of Dexedrine ® , effective December 24, 2008, contributed

$14,771 for the year ended December 31, 2009 compared to $nil for the same period ended December 31, 2008. Revenues from

other products acquired during 2009 contributed $2,618 to the year ended December 31, 2009. Furthermore, in accordance with

the Company’s revenue recognition policy, a revenue deferral of $1,776 was recorded in 2009 (2008 — $1,693).

The increase in revenues for the year ended December 31, 2009 is also attributable to the sales growth of certain significant

promoted products, including Tridural ® , Twinject ® , Plan B ® , Metadol ® , Testim ® and Trelstar ® which combined, increased by 20%

compared to the year ended December 31, 2008.

Product revenues highlights for the Company’s most significant promoted products using IMS Canada sales data 2 for the year ended

December 31, 2009 compared to the year ended December 31, 2008 are as follows:

Promoted Products Sales per IMS Canada in 2009 % change vs. 2008

Tridural ® 9,673 111%

Trelstar ® 3,147 119%

Testim ® 2,261 57%

Metadol ® 7,900 17%

Plan B ® 8,679 10%

Twinject ® 5,957 nil%

Total 37,617 34%

$

Gross profit

Total gross profit increased $17,406 or 28% to $80,000 for the year ended December 31, 2009 from $62,594 for the same

comparative period last year. Gross profit, as a percentage of revenues, decreased 3% to 73% for the year ended December 31, 2009

from 76% for the same period last year. The decrease in gross profit as a percentage of revenues is mainly the result of lower margins

from the BioEnvelop ® business and the effect of reduced margins on the Company’s product mix as a result of growth in certain

promoted products.

Selling and marketing expense

Selling and marketing expense increased $3,984 or 18% to $26,001 for the year ended December 31, 2009 from $22,017 for the

same comparative period last year. Selling and marketing expense, as percentage of revenues, decreased to 24% for the year ended

December 31, 2009 compared to 27% for the year ended December 31, 2008. The decrease in selling and marketing expenses as a

percentage of revenues is primarily the result of the Company’s growth in non-promoted product revenue, including the acquisition

of Dexedrine ® , shifting selling and marketing expense as a percentage of revenues downward for the year ended December 31, 2009.

Furthermore, during 2008, the Company was in the first year of promotional market launch activities for Tridural ® and Seasonale ® ,

requiring significant marketing and promotional expense outlays. The promotional activities driving selling and marketing costs

primarily relate to Paladin’s continued promotional activities for Tridural ® , Trelstar ® , Twinject ® , Plan B ® , Metadol ® and Testim ® .

General and administrative expense

General and administrative expense increased $590 or 8% to $8,419 for the year ended December 31, 2009 from $7,829 for

the year ended December 31, 2008. General and administrative expense, as percentage of revenues, decreased 1% to 8% for

the year ended December 31, 2009 from 9% for the same comparative period last year. The increase in the amount of general

and administrative expense is primarily the result of an increased headcount, an increase in stock-based compensation expense

and business development activities supporting the Company’s growth, however, represents an overall decrease in percentage of

revenues as a result of scale growth in non-promoted products.

2 The Company has chosen not to disclose detailed product by product revenue information for competitive reasons. However, it does include detailed IMS Canada

sales data, essentially end-user pharmacy purchase volume data, to allow the reader to better understand revenue changes from period to period on certain significant

products. It is important that readers of this sales data note that IMS Canada sales data may not necessarily correspond to the Company’s recording of revenue in

accordance with GAAP.

Management’s Discussion & Analysis —21


Research and development expense

Research and development expense increased $1,702 or 31% to $7,229 for the year ended December 31, 2009 from $5,527

for the same comparative period last year. Research and development expense, as percentage of revenues, remained steady at

7% for the year ended December 31, 2009 and 2008, respectively. The increase in the amount of research and development expense

for the year ended December 31, 2009 primarily relates to the recently initiated and on-going research and development efforts

at IsoPharma and Paladin Biosciences, as further described in Note 13 to the annual audited consolidated financial statements,

and research activities related to BioEnvelop ® and Impavido ® advancements. In addition to the above, the research activities driving

research and development expense include managing development projects with licensors and preparing new drug submissions

to strengthen the Company’s pipeline as well as to search and explore potential product opportunities for internal development.

Interest income

Interest income decreased $888 or 52% to $832 for the year ended December 31, 2009 from $1,720 for the year ended

December 31, 2008. This decrease is primarily the result of significantly reduced interest rates, the effective termination of accretive

interest income on the allocated loan portion of a secured convertible term note investment in a portfolio company sold during 2009

and accretive interest expense on the balance of sale payable pursuant to the Dexedrine ® transaction. These decreases have been

partially offset by significantly higher average daily cash and marketable securities balances over the year ended December 31, 2009,

mainly as a result of the Company’s share offering, compared to the same comparative period last year. The Company earned an

effective rate of return of 0.9% and held an average cash and marketable securities balance in the amount of $69,238 for the year

ended December 31, 2009, compared to 4.1% and $31,323, respectively, for the year ended December 31, 2008.

Amortization of pharmaceutical product licenses and rights

Amortization expense increased by $12,465 or 99% to $25,063 for the year ended December 31, 2009 from $12,598 for the same

comparative period last year. The increase in amortization expense is the result of the amortization related to the Company’s recently

acquired pharmaceutical product licenses and rights, principally: Dexedrine ® , Antizol ® , Impavido ® , Anacin ® , Anbesol ® and Auralgan ® ,

partially offset by a reduction in amortization expense for certain pharmaceutical product licenses and rights having reached full

amortization during the year.

Unrealized net loss on derivative financial instruments

During 2009, the Company sold the derivative financial instruments it held in a certain portfolio company and realized gains disclosed

below under “Net (Gain) Loss on Investments”. During 2008, in accordance with Section 3855, the Company used the Black-Scholes

option pricing model to re-measure the fair value of a conversion option on a secured convertible term note investment in a portfolio

company recording an unrealized loss on the conversion option in the amount of $558 and an unrealized gain on warrants in a

portfolio company in the amount of $26.

Net (gain) loss on investments

During the year ended December 31, 2009, the Company disposed of shares held in a portfolio company for proceeds of $1,340,

representing a gain of $215. The Company also exercised its right to convert a convertible term note in this same portfolio investment

into common shares, subsequently selling such shares in the public market for proceeds of $3,168 and realizing a gain of $1,344.

Furthermore, the Company also exercised its right to convert warrants in the portfolio investment discussed above into common shares

and subsequently disposed such shares for proceeds of $304, representing a gain of $147. During the same period, the Company

as part of its on-going assessment of investment carrying values determined its investment Glide Pharmaceuticals Technologies

Limited, a private company, to be permanently impaired and recorded a write-down in the amount of $801 (see Note 10 to the annual

audited consolidated financial statements).

Further, during the year ended December 31, 2009, Endo Pharmaceuticals Inc. (“Endo”) acquired Indevus Pharmaceuticals Inc.

(“Indevus”) for US$4.50 per Indevus share in cash and up to an additional US$3.00 per share in cash upon achievement of certain

regulatory and sales milestones. The Company received proceeds in the amount of $2,167 (US$1,720) for the investment it held

in 382,253 common shares of Indevus, resulting in a realized loss on disposal in the amount of $414. Furthermore, the Company

recorded a $416 contingent right receivable in relation to the potential achievement of certain regulatory and sales milestones,

determined to represent its fair value upon receipt and measured based upon the average incremental Indevus common stock trading

price over the $4.50 cash payment received over a 31-day trading period on NASDAQ. During the quarter ended December 31, 2009,

the Company as part of its on-going assessment of investment carrying values determined its contingent right receivable to be

permanently impaired and recorded a write-down in the amount of $416.

22 — Paladin Annual Report 2009


During the year ended December 31, 2008, the Company redeemed a secured convertible term note in a portfolio company with a

carrying value of $291 for proceeds equal to the face value of $500 resulting in a gain on disposal of $209. During the same period,

the Company as part of its on-going assessment of investment carrying values determined the investment in Verus Pharmaceuticals

Inc. to be permanently impaired and recorded a write-down in the amount of $394, resulting in a net loss on investments in the

amount of $185 for the year ended December 31, 2008.

Foreign exchange loss (gain)

During the year ended December 31, 2009, the Company recorded a foreign exchange loss of $266 on the Company’s foreign

operating results, mainly as a result of the strengthening of the Canadian dollar relative to the US dollar and Euro.

During the year ended December 31, 2008, the Company recorded a foreign exchange gain of $80 on the Company’s foreign

operating results, mainly as a result of the strengthening of the US dollar and Euro relative to the Canadian dollar.

Other income

During the year ended December 31, 2009, the Company out-licensed certain pharmaceutical product licenses and rights for

proceeds of $666, including the receipt of common shares in a portfolio company, having a fair value of $60, representing a net

gain of $666.

During the year ended December 31, 2008, the Company out-licensed a product for $200 and recorded a $200 gain in other income

on the transaction and in a separate transaction, received common shares in a portfolio company having a fair value of $125 in

exchange for out-licensing the exclusive rights to a novel topical pain formulation. In addition, during this same period, the Company

received $75 as a termination payment for certain costs disbursed as part of a previously licensed pharmaceutical product and paid

$70 to settle a disputed client relationship.

Income tax expense

Income tax expense decreased only slightly by $24 or nil% to $6,287 for the year ended December 31, 2009 from $6,311 for the

year ended December 31, 2008. For the year ended December 31, 2009, the effective tax rate was 43% compared to 39% for

the year ended December 31, 2008. The increase in effective rates in the current year is principally due to increases in permanent

differences in comparison to the previous year, mainly: amortization of eligible capital property and stock-based compensation

expense.

The Company has the following tax pools detailed below which may be applied against taxable income:

Non-capital tax losses

Available Recognized Expires in

2009 2008 2009 2008

$ $ $ $

Federal 65,258 30,140 30,166 22,193 2013–2028

Provincial 65,258 21,078 30,166 14,099 2013–2028

Scientific Research and Experimental

Development expenditures

Federal 89,232 20,902 69,098 9,905 N/A

Provincial 85,820 11,805 66,534 7,145 N/A

Investment tax credits

Federal 23,187 2,565 15,679 43 2016–2029

The amount of tax benefit claimed in the current and prior years is subject to audit by the taxation authorities and could be reduced

by a material amount in the future.

Subsequent to December 31, 2009, in connection with the Company’s previously disclosed tax contingency, the Company received

notices of re-assessment from the Canada Revenue Agency (“CRA”) reversing its original position on the use of certain non-capital

losses acquired as part of the Dimethaid Health Care Ltd. (subsequently renamed Squire Pharmaceuticals Inc., “Squire”) acquisition

from Nuvo Research Inc. (“Nuvo”). While the Company has not received a notice from the Ontario Minister of Finance (“OMF”),

the OMF has agreed to be bound by the decision of the CRA appeals process.

Management’s Discussion & Analysis —23


As previously disclosed, on various dates during fiscal 2008 and 2009, the Company had received notices of re-assessment from the

CRA relating to the taxation years ending August 16, 2005, July 31, 2006, July 31, 2007 and December 31, 2008, and from the OMF

for the taxation year ended August 16, 2005, containing adjustments relating to the use of certain non-capital losses. The notices of

assessment and re-assessment, if they had stood as a result of the CRA’s position, amounted to a total tax liability exposure to the

federal and relevant provincial governments of approximately $11,625 including interest and penalties. The Company filed a Notice

of Objection through the CRA appeals process on October 23, 2008 and August 13, 2009. Furthermore, the Company, under the

terms of the Share Purchase Agreement (“SPA”) for Squire with Nuvo, holds indemnities with respect to the status of the Squire tax

accounts and certain tax asset values the Company as well as all costs relating to reassessment including advisory fees, interest and

penalties, as applicable. In addition, Nuvo had issued additional security over the indemnity obligations by entitling the Company to

the benefit of security over certain assets and product revenue streams of Nuvo and certain of its subsidiaries.

In connection with the appeals process, during the years ended December 31, 2009 and 2008, the Company had posted a deposit

of $3,752 to the CRA and $500 to the OMF, representing up to one half of the tax and interest assessed. In addition, during the year

ended December 31, 2009, the Company issued from its $2,000 revolving unsecured credit facility, a bank guarantee in the amount

of $720 to the OMF. As a result of the Company’s success in the appeal process, an amount of $3,936 was received from the CRA on

January 20, 2010, representing a refund for the full amount of the deposit above, along with accrued interest in the amount of $184.

In addition, the bank guarantee previously issued to the OMF expired February 1, 2010 without being drawn-down by the OMF.

Net income before extraordinary gain

Net income before extraordinary gain decreased $1,405 to $8,321 for the year ended December 31, 2009 compared to net income

before extraordinary gain of $9,726 for the same comparative period last year.

Extraordinary gain (net of $nil taxes)

On June 18, 2009, the Company acquired all the issued and outstanding shares of Isotechnika (TSX: ISA) in accordance with a

court supervised Plan of Arrangement. As part of the transaction, the Company paid $7,594 in cash and Isotechnika entered into a

collaborative research and development agreement with IsoPharma in exchange for supporting research and development services

for the commercialization of voclosporin, Isotechnika’s next-generation calcineurin inhibitor, in Canada, Mexico, Central and South

America, Israel and South Africa (“Paladin-acquired territories”). The total purchase price of $10,689 was allocated to the fair value

of the net assets acquired in the amount of $47,204, representing negative goodwill in the amount of the excess of $36,515.

The Company, as per applicable accounting standards, eliminated the value previously assigned to certain prescribed assets in the

amount of $7,098 against the excess of the amounts assigned to assets acquired and undiscounted liabilities assumed over the cost

of the purchase above. The remaining excess is presented as an extraordinary gain in the amount of $29,417.

On December 23, 2008, the Company acquired all the issued and outstanding shares of ViRexx (TSX: VIR) (AMEX: REX) in accordance

with an Order for Reorganization led by ViRexx’s appointed Trustee, whereby the Company paid $1,446 in cash. In addition, the

Company agreed to a contractual right of payment of an amount up to $2,500 in the aggregate to former ViRexx shareholders,

if certain conditions are met, including the Company receiving at least $4,000 in connection with certain ViRexx assets, prior to

December 31, 2009. The Company had not received funds with respect to this contractual right, which would generate a contractual

amount payable as at December 31, 2009. The total purchase price of $1,446 was allocated to the fair value of the net assets

acquired in the amount of $7,951, representing negative goodwill in the amount of the excess of $6,505. The Company, as per

applicable accounting standards, eliminated the value previously assigned to certain prescribed assets in the amount of $2,433

against the excess of the amounts assigned to assets acquired and liabilities assumed over the cost of the purchase above.

The remaining excess is presented as an extraordinary gain in the amount of $4,072.

For additional information regarding the acquisitions described above, please refer to Note 13 of the annual audited consolidated

financial statements.

Net income

Due to the factors set forth above, net income was $37,738 or $2.16 per share on a fully diluted basis for the year ended

December 31, 2009 compared to $13,798 or $0.92 per share on a fully diluted basis for the year ended December 31, 2008.

24 — Paladin Annual Report 2009


Liquidity and Capital Resources

The Company believes that its existing cash, cash equivalents and marketable securities, as well as cash generated from operations

are sufficient to finance its current operations, working capital requirements and future product acquisitions. At present, the Company

is actively pursuing acquisitions that may require the use of substantial capital resources. There are no present agreements or

commitments with respect to such acquisitions except as disclosed in the “Subsequent Events” section below.

The Company has entered into a one-year $2,000 revolving unsecured credit facility with one of the Company’s bankers effective

August 10, 2009. The credit facility may be used for general corporate purposes including financing acquisitions.

The table below sets forth a summary of cash flow activity and should be read in conjunction with our consolidated statements of

cash flows.

2009 2008

$ $

Cash flows from operating activities 46,558 25,152

Cash flows used in investing activities (77,314) (25,828)

Cash flows from (used) in financing activities 57,337 (752)

Increase (decrease) in cash position 26,581 (1,428)

Cash and cash equivalents, beginning of year 4,646 6,074

Cash and cash equivalents, end of year 31,227 4,646

Short- and long-term marketable securities, end of year 74,142 16,696

Cash, cash equivalents and marketable securities, end of year 105,369 21,342

Paladin’s cash, cash equivalents and marketable securities increased $84,027 to $105,369 as at December 31, 2009 from $21,342

for the same comparative period last year. This increase is primarily a result of the Company’s cash inflows from financing activities

whereby the Company issued 3,450,000 common shares in the form of a bought deal share offering at a price of $17.00 per

common share, generating total net proceeds of $55,871, further described in Note 11 to the annual audited consolidated financial

statements. Furthermore, the Company has generated $46,558 from operations and $6,979 from disposal of investments in

portfolio companies. These cash inflows were offset by $57,397 net additions of marketable securities from funds generated as

a result of the Company’s share offering, by $11,021 for the repayment of a portion of the balance of sale payable, by $8,273 for

additions to pharmaceutical product licenses and rights and by $7,594 for the acquisition of Isotechnika Inc. Working capital, which

is defined as current assets less current liabilities, increased $85,037 to $110,456 as at December 31, 2009 from $25,419 for the

same comparative period last year. This increase in working capital is primarily due to the Company’s share offering, generating net

proceeds of $55,871, and cash flow from operations.

No dividend was declared or paid by Paladin on its common shares during the current financial year. In addition, the Company does

not expect to pay dividends in the near future.

Cash flows from operating activities increased $21,406 or 85% to $46,558 for the year ended December 31, 2009 from $25,152

for the same comparative period last year. Cash flows from operating activities represent the cash flows from net earnings, excluding

revenues and expenses not affecting cash, principally amortization, future income taxes, stock-based compensation expense, gains

(losses) on investments, derivative instruments and pharmaceutical licenses, accreted interest and extraordinary gains.

Cash flows used in investing activities increased $51,486 to $77,314 for the year ended December 31, 2009 compared to $25,828

for the year ended December 31, 2008. During the year ended December 31, 2009, the Company’s investment activities primarily

consisted of the following: an investment of $57,397 towards the acquisition of short- and long-term marketable securities net

of cash flows generated by maturing marketable securities, $11,021 in repayment of a balance of sale payable relating to the

Dexedrine ® acquisition, $8,273 for the acquisition of pharmaceutical product licenses and rights, $7,594 for the business acquisition

of Isotechnika further described in Note 13 to the annual audited consolidated financial statements and $429 towards acquisition

of property, plant and equipment. These investment activities were partially offset by proceeds from disposal of investments in

portfolio companies in the amount of $6,979 and proceeds from disposal of pharmaceutical licenses in the amount of $551. During

the year ended December 31, 2008, the Company invested $34,562 towards the acquisition of pharmaceutical product licenses and

rights, $3,000 as an investment in a portfolio company, $1,446 towards the acquisition of ViRexx, further described in Note 13 to

the annual audited consolidated financial statements, $531 in repayment of a balance of sale payable, and $510 for the acquisition

of property, plant and equipment. These investments were partially offset by net cash flows generated by maturing marketable

securities in the amount of $13,521, proceeds from the disposal of an investment in a portfolio company in the amount of $500

and proceeds from the disposal of a pharmaceutical license in the amount of $200.

Management’s Discussion & Analysis —25


Cash flows from financing activities increased $58,089 to $57,337 for the year ended December 31, 2009 compared to cash

flows used in financing activities in the amount of $752 for the same comparative period last year. During the year ended

December 31, 2009, the Company issued 3,450,000 common shares in the form of a bought deal share offering at a price of

$17.00 per common share for total gross proceeds to the Company in the amount of $58,650. In conjunction with the offering the

Company incurred share issue costs of approximately $2,779 for total net proceeds amounting to $55,871. In addition, an amount

of $1,538 was generated from stock option exercises and the issuance of common shares under the stock purchase plan for cash,

offset by $72 used by the Company to repurchase 4,500 of its own common shares under the terms of the normal course issuer

bid approved by the Toronto Stock Exchange (“TSX”) in 2009. During the year ended December 31, 2008, $2,269 was used by

the Company to repurchase 226,725 of its own common shares under the terms of the normal course issuer bid approved by the

Toronto Stock Exchange (“TSX”) in 2008, offset by $1,517 received from the exercise of common stock options and the issuance

of common shares under the stock purchase plan for cash.

On March 1, 2010, Paladin announced that it had received regulatory approval from the TSX to carry out a normal course issuer bid

effective March 3, 2010. Paladin has been authorized to purchase up to 1,102,000 of its common shares, or approximately 10% of

its public float of 11,020,019 common shares, in the twelve-month period following the bid’s effective date.

On February 27, 2009, Paladin announced that it had received regulatory approval from the TSX to carry out a normal course issuer

bid effective March 3, 2009. Paladin has been authorized to purchase up to 811,548 of its common shares, or approximately 10% of

its public float of 8,115,483 common shares, in the twelve-month period following the bid’s effective date. As at February 24, 2010,

Paladin had repurchased 4,500 at an average price of $16.00 per common share and 18,583,187 common shares remain issued

and outstanding.

2009 — Acquisition of Isotechnika Inc.

On June 18, 2009, the Company acquired all the issued and outstanding shares of Isotechnika (TSX: ISA) in accordance with a

court supervised Plan of Arrangement. As part of the transaction the Company paid $7,594 in cash and Isotechnika entered into a

collaborative research and development agreement with IsoPharma in exchange for supporting research and development services

for the commercialization of voclosporin, Isotechnika’s next-generation calcineurin inhibitor, in Canada, Mexico, Central and South

America, Israel and South Africa (“Paladin-acquired territories”). The research and development services extend for a period of

seven years and included an amount of $4,350 payable by the Company to IsoPharma over the next 12 months and expensed as

incurred over this same 12 month period. Furthermore, the Research and Development Agreement in conjunction with the Company’s

Licence Agreement for voclosporin in the Paladin acquired territories, contains certain other voclosporin research, development and

commercialization payment arrangements including possible licensing and royalty revenue payments over the remaining period. During

the year ended December 31, 2009, the Company has expensed $1,975 with respect to these research and development services.

As part of the acquisition, the Company also received the international rights to a portfolio of products under development and a

commercialized diagnostic product portfolio. The Company had also assumed an obligation to pay out certain future contractually

pre-defined amounts relating to the commercialization of the diagnostic product portfolio over a period of seven years, estimated to

amount to approximately $5,950 at the time of acquisition (the “contingent balance of sale payable”). This estimated amount was

determined based upon the historical sales of the products, current expenditure levels and market conditions and was payable over

a seven-year period pursuant to its Research and Development Agreement and represented management’s best estimate of this

liability at the time of acquisition. It was considered reasonably possible that changes in future conditions could require a material

change in the recognized amount. As at December 31, 2009, the Company had applied $500 and disbursed $274 with respect to

this balance of sale payable.

On December 31, 2009, the Company entered into an Amended Agreement with IsoPharma to settle the contingent balance of

sale payable for a total amount of $1,991, of which $1,650 is payable February 28, 2010 and the remainder in the amount of

$341, representing the discounted present value, is payable on January 31, 2011 if certain conditions are met. Isotechnika is

an international biopharmaceutical company dedicated to the discovery, development and commercialization of novel immunosuppressive

therapeutics for the treatment of autoimmune diseases and for use in the prevention of organ rejection in transplantation.

In addition to the Company’s drug pipeline, Isotechnika also has commercialized diagnostic products. Isotechnika was subsequently

wound up into the Company on October 1, 2009. Furthermore, as part of the purchase price, the Company received 24,921,312

common shares, representing a 19 percent interest in IsoPharma as at the date of acquisition, with an approximate value of $4,348

using the weighted average trading price of the common shares on the TSX for the 20 trading days pre and post acquisition.

26 — Paladin Annual Report 2009


The results of Isotechnika’s operations have been included in the Company’s results since June 18, 2009, the effective date of

acquisition. The Company accounts for its investment in IsoPharma using the equity method of accounting. As per applicable

accounting standards, the Company eliminated the value assigned to its investment in common shares of IsoPharma against the

excess (“negative goodwill’) of the amounts assigned to assets acquired and undiscounted liabilities assumed over the cost of

the total purchase price. As a result, the Company’s investment in IsoPharma has a carrying value of $nil effective June 18, 2009.

Since the Company’s acquisition, IsoPharma has incurred net losses from operations. As the Company is not committed to make

further capital contributions to IsoPharma, the Company has not recorded its share of IsoPharma’s net loss since acquisition as per

applicable accounting standards. The Company refers the reader to Note 13 of the annual audited consolidated financial statements,

for further details regarding the acquisition.

2008 — Acquisition of ViRexx Medical Corp.

On December 23, 2008, the Company acquired all the issued and outstanding shares of ViRexx (TSX: VIR) (AMEX: REX) in accordance

with an Order for Reorganization led by ViRexx’s appointed Trustee, whereby the Company paid $1,446 in cash. In addition,

the Company agreed to a contractual right of payment of an amount up to $2,500 in the aggregate to former ViRexx shareholders,

if certain conditions are met, including the Company receiving at least $4,000 in connection with certain ViRexx assets prior to

December 31, 2009. The Company had not received funds with respect to this contractual right, which would generate a contractual

amount payable as at December 31, 2009. The Company also incurred transaction costs in the amount of $196, included in the cash

payment above, in connection with the acquisition. ViRexx is a Canadian-based biotech company focused on developing innovativetargeted

therapeutic products and was subsequently wound up into the Company on December 23, 2008.

The results of ViRexx operations have been included in the Company’s results since December 23, 2008, the date of acquisition.

The Company refers the reader to Note 13 of the annual audited consolidated financial statements, for further details regarding

the acquisition.

Related Party Transactions

Joddes Limited (“Joddes”), a private Canadian corporation, together with its affiliates own in aggregate approximately 38% of the

outstanding shares of the Company, and one director of the Company, the Company’s President and CEO, is related to this group.

The Company engages a wholly-owned subsidiary of Joddes to provide logistics services including: customer service, ware housing,

shipping, invoicing, collection services and certain manufacturing and selling services on behalf of the Company. The Company

also engages this affiliate to perform certain research and development services on a contractual pay-for-use basis. In addition, the

Company leases its office facilities from another wholly-owned subsidiary of Joddes. This lease is for a period of 10 years, ending

in 2013 and includes minimum annual payments for a total remaining committed amount of $706 as at December 31, 2009 and is

included in the purchase and service based commitments in Note 18.

The Company has also entered into contractual royalty agreements with a wholly-owned subsidiary of Joddes for certain legacy and

over-the-counter products. The terms of these arrangements vary, whereby the Company may earn a royalty fee based on certain

established terms relating to the net sales of the respective products such as through a percentage of net sales, certain guaranteed

minimum annual payments, or as a percentage of a defined product contribution.

Effective November 1, 2006, the Company acquired the Canadian distribution rights to Metadol ® from a wholly-owned subsidiary

of Joddes for cash consideration of $15,000. Under the terms of the agreement, the Company can purchase the Canadian license

for Metadol ® on the fourth anniversary of the agreement for $1 and can receive a reimbursement of up to $3,750 subject to

certain acquisition related conditions. As at December 31, 2009, the Company has not received or earned any reimbursement. The

acquisition of the Canadian distribution rights to Metadol ® was not in the normal course of operations and was recorded at an agreed

upon exchange amount in accordance with the requirements of accounting standard CICA 3840.

The Company owns a 19% interest in the common shares of IsoPharma and considers this investment a related party. The Company,

in conjunction with the business combination discussed in Note 13 to the annual audited consolidated financial statements,

settled with IsoPharma on December 31, 2009 the balance of sale contingently payable over a seven-year period for an amount

of $1,991, of which $1,650 is payable on February 28, 2010 and $341, representing the discounted present value, is payable on

January 31, 2011 if certain conditions are met. This transaction was not in the normal course of operations and was recorded at an

agreed upon exchange amount in accordance with the requirements of accounting standard CICA 3840. Furthermore, the Company

is committed to research and development services payments with IsoPharma, as further discussed in Note 13 to the annual

audited consolidated financial statements, in the amount of $2,375 as at December 31, 2009 that are included in the contractual

obligations and commitments paragraph below.

Management’s Discussion & Analysis —27


All transactions with related parties, except for the Metadol ® and IsoPharma transactions described above, are carried out in the

normal course of operations, and are recorded at an agreed upon exchange amount. The accounts payable to related parties are on

normal commercial terms and conditions and are non-interest bearing.

The table below reflects all transactions and services with related parties carried in the normal course of operations, which include

those referred to in the agreements described above, as well as revenues from a wholly-owned subsidiary of Joddes:

2009 2008

$ $

Revenues 3,962 3,672

Purchases 8,549 13,314

Selling and marketing 5,893 4,441

Research and development 2,484 449

General and administrative 570 389

Quarterly Information (unaudited)

(In thousands of Canadian dollars except per share information)

Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1

F2009 F2009 F2009 F2009 F2008 F2008 F2008 F2008

Revenues 29,279 28,374 26,255 25,815 23,051 22,191 20,668 16,834

EBITDA 1 9,661 10,161 8,410 10,955 7,415 9,189 6,997 5,419

Earnings before

income taxes 2,501 4,212 3,051 4,844 3,512 5,975 4,067 2,483

Net income before

extraordinary gain 934 2,564 1,771 3,052 2,044 3,617 2,588 1,477

Net income 4,392 2,564 27,730 3,052 6,116 3,617 2,588 1,477

Earnings per share before

extraordinary gain $0.05 $0.14 $0.11 $0.20 $0.14 $0.24 $0.17 $0.10

Earnings per share $0.24 $0.13 $1.77 $0.20 $0.41 $0.24 $0.17 $0.10

Diluted earnings per

share before

extraordinary gain $0.05 $0.14 $0.11 $0.20 $0.14 $0.24 $0.17 $0.10

Diluted earnings per share $0.23 $0.13 $1.71 $0.20 $0.41 $0.24 $0.17 $0.10

Paladin’s annual and quarterly operating results are primarily affected by the level of acceptance of Paladin’s products by physicians

and their patients, and the timing and number of product launches. The level of patient and physician acceptance of Paladin’s

products, the acceptance of provincial government reimbursement on such products, market access, as well as the availability of

similar therapies, impact Paladin’s revenues by driving the level and timing of prescriptions for its products. Each new product launch

requires significant promotional investment during the first three to five years from launch.

Fourth Quarter Analysis

For the three-month period ended December 31, 2009, Paladin recorded revenues of $29,279 compared to $23,051 in

the fourth quarter of 2008, a 27% year over year increase. Revenues generated as a result of the acquisition of Dexedrine ® ,

effective December 24, 2008, contributed $2,994 for the quarter ended December 31, 2009 compared to $nil for the same

period ended December 31, 2008. Revenues from other products acquired during 2009 contributed $1,666 to the quarter

ended December 31, 2009. The increase in revenues for the quarter ended December 31, 2009 is also attributable to the sales

growth of certain significant promoted products, including Tridural ® , Twinject ® , Plan B ® , Metadol ® , Testim ® and Trelstar ® , which

combined increased by 28% compared to the quarter ended December 31, 2008.

28 — Paladin Annual Report 2009


Product revenues highlights for the Company’s most significant promoted products using IMS Canada sales data 2 for the quarter

ended December 31, 2009 compared to the quarter ended December 31, 2008 are as follows:

Three-month period ended December 31

Promoted Products Sales per IMS Canada in 2009 % change vs. 2008

Tridural ® 2,813 52%

Trelstar ® 963 149%

Testim ® 728 67%

Metadol ® 2,104 12%

Plan B ® 2,187 3%

Twinject ® 1,457 49%

Total 10,252 34%

$

For the three-month period ended December 31, 2009, Paladin recorded a gross profit of $20,985 compared with $17,740 for

the three-month period ended December 31, 2008. The gross profit, as a percentage of revenues, decreased 5% to 72% for the

year ended December 31, 2009 from 77% for the same period last year. The decrease in gross profit as a percentage of revenues

is mainly the effect of reduced margins on the Company’s product mix as a result of growth in certain promoted products and the

result of lower margins from the BioEnvelop ® business.

Selling and marketing expense increased $1,678 or 31% to $7,150 for the quarter ended December 31, 2009 from $5,472 for the

same quarter ended last year. Selling and marketing expense, as percentage of revenues, remained steady at 24% for the quarter

ended December 31, 2009 and 2008, respectively. The promotional activities driving selling and marketing costs primarily relate to

Paladin’s continued promotional activities for Tridural ® , Trelstar ® , Twinject ® , Plan B ® , Metadol ® and Testim ® .

General and administrative expenses decreased $465 or 18% to $2,184 for the quarter ended December 31, 2009 from $2,649 for

the same quarter ended last year. As a percentage of revenues, general and administrative expenses decreased to 7% from 11% for

the quarter ended December 31, 2009 compared to the same quarter ended last year. The decrease in general and administrative

expenses is the result of reduced business development expenses along with streamlining efforts in the fourth quarter of 2009 when

compared to the same quarter in 2008.

Research and development expense decreased $218 to $2,360 for the quarter ended December 31, 2009 from $2,578 for the

same quarter ended last year. The decrease for the quarter ended December 31, 2009 primarily relates to a milestone payment for

a certain product not having yet achieved regulatory approval recorded in the same quarter ended last year, offset by the recently

initiated and on-going research and development efforts at IsoPharma and ViRexx as further described in Note 13 to the annual

audited consolidated financial statements.

Interest income decreased $40 to $370 for the quarter ended December 31, 2009 from $410 for the same quarter ended last year.

The decrease for the quarter ended December 31, 2009 is primarily the result of significantly reduced interest rates, the effective

termination of accretive interest income on the allocated loan portion of a secured convertible term note investment in a portfolio

company sold during the quarter ended June 30, 2009 and accretive interest expense on the balance of sale payable pursuant to

the Dexedrine ® transaction. These decreases have been partially offset by significantly higher average daily cash and marketable

securities balances over the three-month period ended December 31, 2009, mainly as a result of the Company’s share offering,

compared to the same period comparative quarter last year.

Amortization expense increased $3,243 to $6,610 for the quarter ended December 31, 2009 from $3,367 for the same quarter

ended last year. The increase in amortization expense is the result of the amortization related to the Company’s recently acquired

pharmaceutical product licenses and rights, principally: Dexedrine ® , Anacin ® , Anbesol ® and Auragel ® , partially offset by a reduction in

amortization expense for certain pharmaceutical product licenses and rights having reached full amortization during the year.

Income tax expense increased $99 to $1,567 for the quarter ended December 31, 2009 from $1,468 for the same quarter ended

last year. For the quarter ended December 31, 2009, the effective tax rate was 63% compared to 42% for the quarter ended

December 31, 2008. The increase in effective rates in the current quarter is principally due to increases in permanent differences in

comparison to the previous quarter, mainly; amortization of eligible capital property and stock-based compensation expense.

Net income before extraordinary gain was $934 or $0.05 per fully diluted share in the fourth quarter of 2009 compared to $2,044

or $0.14 per fully diluted share in the fourth quarter of 2008.

2 The Company has chosen not to disclose detailed product by product revenue information for competitive reasons. However, it does include detailed IMS Canada

sales data, essentially end-user pharmacy purchase volume data, to allow the reader to better understand revenue changes from period to period on certain significant

products. It is important that readers of this sales data note that IMS Canada sales data may not necessarily correspond to the Company’s recording of revenue in

accordance with GAAP.

Management’s Discussion & Analysis —29


On December 31, 2009, the Company entered into an Amended Agreement with IsoPharma to settle the contingent balance of

sale payable for a total amount of $1,991, of which $1,650 is payable February 28, 2010 and the remainder in the amount of

$341, representing the discounted present value, is payable on January 31, 2011 if certain conditions are met. This settlement

resulted in an adjustment to the extraordinary gain in the amount of $3,458 which has been recorded in accordance with

related party accounting standards (see Notes 13 and 14 to the annual audited consolidated financial statements for additional

information). The Company had originally recorded an extraordinary gain in the amount of $25,959 upon the acquisition of

Isotechnika, which in conjunction with the settlement above, results in an aggregate extraordinary gain of $29,417 for the year

ended December 31, 2009.

Due to the factors set forth above, net income was $4,392 or $0.23 per fully diluted share in the fourth quarter of 2009 compared

to $6,116 or $0.41 per fully diluted share in the fourth quarter of 2008.

In relation to the results described above, the cash impact for the quarter ended December 31, 2009 was as follows: cash flows

from operating activities were $21,044, cash flows used in investing activities amounted to $10,754 and cash flows from financing

activities were $412, for a total net cash-inflow of $10,702 for the three-month period ended December 31, 2009.

Segmented Information

The Company operates in a single business segment focused on the in-licensing, acquiring, marketing, distributing and developing

pharmaceutical products in Canada and internationally. In addition, the Company earns interest income from the investment of its

excess cash. The Company carries out business in Canada, Barbados, the United States, Europe, Australia and New Zealand, and

substantially all of the Company’s tangible assets are located in Canada.

Revenues by geographic region are detailed as follows:

2009 2008

$ $

Canada 105,543 79,691

International 4,150 3,053

109,693 82,744

Revenues have been allocated to geographic regions based on the country of residence of the related customer.

Pharmaceutical product licenses and rights by geographic region are detailed as follows:

2009 2008

$ $

Canada 32,577 44,180

International 9,966 13,972

42,543 58,152

Proposed Transactions

The Company does not currently anticipate any material asset or business acquisition or disposal transaction other than those

disclosed in the “Subsequent Events” section below.

Off Balance Sheet Arrangements

The Company’s off balance sheet arrangements consist of contractual obligations and agreements for development, sales, marketing

and distribution rights to innovative drug products for the Canadian market. The effect of terminating these arrangements under

normal operating circumstances consists of an effective transition of the remaining responsibilities and obligations to the licensor

under agreed upon time frames and conditions. Please refer to this section below or Note 18 of the Company’s annual audited

consolidated financial statements for additional details. Other than these contractual obligations and commitments, the Company

does not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on the

Company’s financial condition, changes in revenues or expenses, results of operations, liquidity, capital expenditures, or capital

resources that are material to investors.

The Company does not issue guarantees contemplated by the applicable CICA Guidelines.

30 — Paladin Annual Report 2009


Financial Instruments

The Company’s Investment Policy regulates the investment activities relating to cash resources. An Investment Committee

composed of representatives from management and the Board of Directors monitors compliance with said policy. The Company

invests in strategic investments in the form of equity or strictly in liquid, high-grade investment securities with varying terms to

maturity, selected with regard to the expected timing of investments and expenditures for continuing operations and prevailing

interest rates.

Concentration of Credit Risk and Major Customers

The Company’s cash and cash equivalents, short- and long-term investments are held through various institutions. Marketable

securities are mainly investments in liquid, high-grade investment securities. They are subject to minimal risk of changes in value

and generally have an original maturity from three months to eighteen months from the date of purchase. Marketable securities are

substantially all invested with large Canadian financial institutions, with a minor proportion of securities invested in one large U.S.

financial institution.

The Company is exposed to credit risk from its customers and continually monitors its customers’ credit. It establishes the provision

for doubtful accounts based upon the credit risk applicable to each customer. For the year ended December 31, 2009, two customers,

a major wholesale distributor and a major retail chain, represented 29% and 15% of the Company’s sales, respectively (2008 — two

customers, a major wholesale distributor and a major retail chain represented 33% and 15% of the Company’s sales, respectively).

As at December 31, 2009, two customers, a major wholesale distributor and a major retail chain represented 10% and 14% of

trade accounts receivable, respectively (2008 — two customers, a major wholesale distributor and a major retail chain represented

40% and 11% of trade accounts receivable, respectively). These above concentrations on the Company’s customers are considered

normal for the Company and its industry. For a more detailed analysis and disclosure of credit risk please refer to Note 19 to the

annual audited consolidated financial statements.

Liquidity Risk

The Company generates sufficient cash from operating activities to fund its operations and fulfill its obligations as they become

due. The Company has sufficient funds available through its cash, cash equivalents and marketable securities, should its cash

requirements exceed cash generated from operations to cover all financial liability obligations. As at December 31, 2009, there

were no restrictions on the flow of these funds nor have any of these funds been committed in any way, except as set out in the

“Contractual Obligations and Commitments” section below and the income tax section above.

All financial liabilities are short term in nature except for the long-term portion of the balance of sale payable, which is payable to

the extent of future product sales and profitability (see Note 13 to the annual audited consolidated financial statements).

Foreign Exchange Risk

The Company principally operates within Canada, however, a portion of the Company’s revenues, expenses, and current assets

and liabilities are incurred in United States dollars (“US$”) and EURO. This results in financial risk due to fluctuations in the value

of the US dollar and EURO relative to the Canadian dollar (“C$”). The Company does not use derivative financial instruments

to reduce its foreign exchange exposure. Fluctuations in foreign exchange rates could cause unanticipated fluctuations in the

Company’s operating results, financial position or cash flows. Based on the net exposure described in Note 19 to the annual audited

consolidated financial statements as at December 31, 2009, and assuming that all other variables remain constant, a ten-point

increase or decrease in the CAD/USD and/or CAD/EURO exchange rate would have an aggregate effect of $419 (2008 — $212)

on net earnings. For a more detailed analysis and disclosure of the foreign exchange risk please refer to Note 19 to the annual

audited consolidated financial statements.

Management’s Discussion & Analysis —31


Interest Rate Risk

The Company is exposed to interest rate fluctuations on its cash, cash equivalents and marketable securities. Details regarding

maturity dates and effective interest rates are described in Notes 4 and 7 to the annual audited consolidated financial statements.

The Company does not believe that the results of operations or cash flows would be materially affected to any significant degree by

a sudden change in market interest rates relative to interest rates on the investments, owing to the relative short-term nature of the

marketable securities.

Payment of Dividends

The Company has not paid dividends on its Common Shares and does not anticipate declaring any dividends in the near future.

Paladin’s current policy is to retain earnings to finance the acquisition and development of new products and to reinvest in the

Company. Any future determination to pay dividends is at the discretion of the Company’s Board of Directors and will depend on the

Company’s financial condition, results of operations, capital requirements and other such factors as the Board of Directors of the

Company deems relevant.

Product Pricing Regulation on Certain Patented Drug Products

Certain patented drug products within the Company’s portfolio of products are subject to product pricing regulation by the

Patented Medicine Prices Review Board (“PMPRB”). The PMPRB’s objective is to ensure that prices of patented products in Canada

are not excessive. For new patented products, the price in Canada is limited to either the cost of existing drugs sold in Canada or

the median of prices for the same drug sold in other specified industrial countries. For existing patented products, prices cannot

increase by more than the Consumer Price Index. The PMPRB monitors compliance through a review of the average transaction

price of each patented drug product as reported by the Company over a recurring six-month reporting period.

Disclosure Controls and Procedures

The Company’s Chief Executive Officer and its Chief Financial Officer are responsible for establishing and maintaining the Company’s

disclosure controls and procedures. They are assisted in this responsibility by the other Officers of the Company. This group requires

that it be fully appraised of any material information affecting the Company so that it may evaluate and discuss this information and

determine the appropriateness and timing of public release.

The Chief Executive Officer and the Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls

and procedures as at December 31, 2009, have concluded that the Company’s disclosure controls and procedures are adequate and

effective to ensure that material information relating to the Company and its subsidiaries would have been known to them.

Internal Control over Financial Reporting

Internal control over financial reporting (“ICFRs”) are designed to provide reasonable assurance regarding the reliability of the Company’s

financial reporting and compliance with GAAP in its financial statements. The Company’s Chief Executive Officer and Chief Financial

Officer, together with other members of management, have designed and evaluated the ICFRs to provide reasonable assurance

regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with

GAAP. This design evaluation included documentation activities, management inquiries and other reviews as deemed appropriate

by management in consideration of the size and the nature of the Company’s business. As at December 31, 2009, management

assessed the effectiveness of the Company’s ICFRs and, based on that assessment, concluded that the Company’s ICFRs was

effective and that there were no material weaknesses in our ICFRs. No changes have occurred during the most recent interim period

that have materially affected, or are reasonably likely to materially affect, the Company’s ICFRs.

Risk Factors

For a more detailed discussion of the risk factors that could materially affect the results of operations and the financial condition of

the Company, please refer to the Company’s Annual Information Form.

32 — Paladin Annual Report 2009


Contractual Obligations and Commitments

In the normal course of business, Paladin secures development, sales, marketing and distribution rights to innovative drug products

and has entered into various agreements, which include contractual obligations extending beyond the current year. The Company is

committed to making minimum purchases of inventory, and minimum expenditures for regulatory, selling and marketing services in

the amount of $21,219, including €4,062, to retain exclusive distribution agreements for certain products. These commitments end

in 2015 and annual commitments are as follows:

Contractual Obligations

(In thousands of Canadian dollars)

Total

Less than

1 year

Purchase and service based commitments 21,219 11,425 7,690 2,104 —

In addition, under certain agreements, Paladin may have to pay additional consideration should the Company achieve certain sales

volumes or if certain milestones are met, such as regulatory approval in Canada. The Company may have to pay up to $17,871

including US$11,561, €1,000 and GBP£500 over a maximum period of 15 years if it achieves certain product, regulatory or sales

milestones on specific products in the future. The Company has the following commitments related to product license, trademark

and distribution agreements:

Commitments

(In thousands of Canadian dollars)

Total

Less than

1 year

Milestone based commitments 11,302 3,389 3,922 526 3,465

Revenues based commitments 6,569 526 1,577 525 3,941

As further described below under the “Subsequent Events” section, the Company has entered into strategic investments and

has committed to consideration in the estimated total amount of $4,460 over the following years: $2,250 in 2012 and $2,210

in 2013.

Subsequent Events

On March 3, 2010, the Company invested 4 million Euros in SpePharm Holding B.V. (“SpePharm”) in the form of a secured interestbearing

convertible debenture. SpePharm, a Dutch company with its registered office in Amsterdam, is a specialty pharmaceutical

company focused on acquiring, registering and marketing high medical value specialty medicines throughout Europe. As part of

the investment, the Company also received certain strategic collaborative rights including the exclusive license to a pharmaceutical

product in certain territories. Under the current financing terms, the conversion of the Company’s convertible debenture into equity

would provide Paladin with an approximate 10% ownership interest in SpePharm.

On March 16, 2010, the Company entered into a strategic investment to acquire an initial 34.99% ownership interest in Pharmaplan

(Pty) Ltd. (“Pharmaplan”), a privately-owned specialty pharmaceutical company based in Johannesburg, South Africa. The Company

paid an amount of approximately $18,800 in cash including a non-interest bearing loan in the amount of approximately $2,900.

In addition, the Company has committed to additional future consideration by annually increasing its ownership position by 5% over

the next 3 years to 49.99%, with such additional consideration based upon Pharmaplan’s future financial results.

1–3

years

1–3

years

4–5

years

4–5

years

After 5

years

After 5

years

Management’s Discussion & Analysis —33


Management Report

The accompanying consolidated financial statements of Paladin Labs Inc. and all of the information in this Annual Report are the

responsibility of management and have been approved by the Board of Directors.

The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles. The

most significant of these accounting principles are described in Note 2 to the consolidated financial statements. The consolidated

financial statements include some amounts that are based on estimates and judgments. Management has determined such amounts

on a reasonable basis in order to ensure that the consolidated financial statements are presented fairly in all material respects. The

Company’s accounting procedures and related systems of internal control are designed to provide reasonable assurance that its

assets are safeguarded and its financial records are reliable. The financial information elsewhere in this Annual Report is consistent

with the information presented in the consolidated financial statements.

The Board of Directors has appointed an Audit Committee consisting of three outside directors. The committee meets periodically

during the year to review with management and the external auditors any significant accounting, internal control and auditing

matters. They review and finalize the annual consolidated financial statements of the Company along with the external auditors’

report prior to the submission of the consolidated financial statements to the Board of Directors for final approval.

The Company’s external auditors, Ernst & Young LLP, Chartered Accountants, conduct an independent audit on behalf of the

shareholders, in accordance with Canadian generally accepted auditing standards, and express their opinion on the consolidated

financial statements. Their report outlines the scope of their audit and their opinion on the consolidated financial statements of the

Company. The external auditors have full access to management and the Audit Committee of the Board.

Montreal, Canada,

February 5, 2010

(except for note 26 which is as of March 16, 2010)

(signed) Jonathan Ross Goodman

Jonathan Ross Goodman, BA, LLB, MBA

President & CEO

(signed) Samira Sakhia

Samira Sakhia, CA, MBA

Chief Financial Officer

Auditors’ Report

To the Shareholders of Paladin Labs Inc.

We have audited the consolidated balance sheets of Paladin Labs Inc. as at December 31, 2009 and 2008 and the consolidated

statements of income, cash flows, comprehensive income, accumulated other comprehensive income (loss) and retained earnings

for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to

express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan

and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatements. An audit

includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also

includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall

financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company

as at December 31, 2009 and 2008 and the results of its operations and its cash flows for the years then ended in accordance with

Canadian generally accepted accounting principles.

Chartered Accountants

Montreal, Canada

February 5, 2010

(except for note 26 which is as of March 16, 2010)

1 CA auditor permit no. 16652

34 — Paladin Annual Report 2009


Consolidated Balance Sheets

As at December 31

[In thousands of Canadian dollars]

2009 2008

$ $

ASSETS

Current

Cash and cash equivalents 31,227 4,646

Marketable securities [note 4] 73,274 14,753

Accounts receivable [note 19] 14,167 17,889

Inventories [note 5] 12,361 8,643

Other current assets [note 6] 2,668 2,567

Income taxes receivable [note 16] 4,630 4,209

Investment tax credits recoverable 776 43

Future income tax assets [note 16] 6,196 9,120

Total current assets 145,299 61,870

Long-term marketable securities [note 7] 868 1,943

Property, plant and equipment [note 8] 691 594

Pharmaceutical product licenses and rights [note 9] 42,543 58,152

Investments [note 10] 62 4,792

Investment tax credits recoverable [note 16] 14,903 —

Future income tax assets [note 16] 31,029 4,789

Total assets 235,395 132,140

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current

Accounts payable and accrued liabilities 22,934 16,464

Accounts payable to related parties [note 14] 1,122 1,384

Deferred revenues 1,776 1,693

Income taxes payable 7,109 6,391

Balance of sale payable [notes 9, 13 and 14] 1,650 10,429

Future income tax liabilities [note 16] 252 90

Total current liabilities 34,843 36,451

Balance of sale payable [notes 9, 13 and 14] 1,743 —

Future income tax liabilities [note 16] 4,007 341

Total liabilities 40,593 36,792

Shareholders’ equity

Capital stock [note 11] 119,652 60,664

Other paid-in capital [note 12] 4,408 3,155

Accumulated other comprehensive income (loss) 98 (1,420)

Retained earnings 70,644 32,949

Total shareholders’ equity 194,802 95,348

Total liabilities and shareholders’ equity 235,395 132,140

Commitments [note 18]

See accompanying notes

On behalf of the Board

(signed) Jonathan Ross Goodman

Jonathan Ross Goodman, Director

(signed) Mark Beaudet

Mark Beaudet, Director

Consolidated Financial Statements —35


Consolidated Statements of Income

Years ended December 31

[In thousands of Canadian dollars except share and per share amounts]

2009 2008

$ $

Revenues [notes 14 and 19] 109,693 82,744

Cost of sales [note 14] 29,693 20,150

Gross profit 80,000 62,594

Expenses (income)

Selling and marketing [note 14] 26,001 22,017

General and administrative 8,419 7,829

Research and development [notes 14, 15 and 16] 7,229 5,527

Interest income (832) (1,720)

Earnings before under-noted items 39,183 28,941

Amortization of pharmaceutical product licenses, rights and deferred charges [note 9] 25,063 12,598

Unrealized net loss on derivative financial instruments [note 10] — 531

Net (gain) loss on investments [note 10] (88) 185

Foreign exchange loss (gain) 266 (80)

Other income [note 10] (666) (330)

Income before income taxes and extraordinary gain 14,608 16,037

Provision for income taxes [note 16]

Current 807 4,977

Future 5,480 1,334

6,287 6,311

Net income before extraordinary gain 8,321 9,726

Extraordinary gain (net of $nil taxes) [note 13] 29,417 4,072

Net income for the year 37,738 13,798

Earnings per share before extraordinary gain

Basic 0.49 0.66

Diluted 0.48 0.65

Earnings per share

Basic 2.23 0.93

Diluted 2.16 0.92

Weighted average number of shares outstanding [note 17]

Basic 16,933,229 14,846,306

Diluted 17,432,898 15,071,283

See accompanying notes

36 — Paladin Annual Report 2009


Consolidated Statements of Cash Flows

Years ended December 31

[In thousands of Canadian dollars]

2009 2008

$ $

Operating activities

Net income for the year 37,738 13,798

Add items not affecting cash

Extraordinary gain [note 13] (29,417) (4,072)

Amortization 25,555 12,814

Future income taxes 5,480 1,334

Stock-based compensation expense [note 11] 2,022 1,400

Unrealized net loss on derivative financial instruments [note 10] — 531

Net accreted interest expense (income) [note 10] 127 (273)

Net (gain) loss on investments [note 10] (88) 185

Gain on disposal of pharmaceutical product licenses and rights [note 10] (666) (200)

40,751 25,517

Net change in non-cash balances relating to operations [note 20] 5,807 (365)

Cash flows from operating activities 46,558 25,152

Investing activities

Repayment of balance of sale payable (11,021) (531)

Additions to pharmaceutical product licenses and rights [note 9] (8,273) (34,562)

Business acquisitions [note 13] (7,594) (1,446)

Acquisition of property, plant and equipment [note 8] (429) (510)

Investment in portfolio companies [note 10] (130) (3,000)

Purchases of short-term marketable securities (81,473) (37,082)

Maturities of marketable securities 37,847 52,576

Purchases of long-term marketable securities (13,771) (1,973)

Proceeds from disposal of investments [note 10] 6,979 500

Proceeds from disposal of pharmaceutical licenses 551 200

Cash flows used in investing activities (77,314) (25,828)

Financing activities

Common shares issued for cash, net of issue costs 57,409 1,517

Repurchase of shares [note 11] (72) (2,269)

Cash flows from (used) in financing activities 57,337 (752)

Net change in cash and cash equivalents during the year 26,581 (1,428)

Cash and cash equivalents, beginning of year 4,646 6,074

Cash and cash equivalents, end of year 31,227 4,646

Supplemental cash flow information

Interest paid [note 16] 15 582

Income taxes paid [note 16] 635 3,771

See accompanying notes

Consolidated Financial Statements —37


Consolidated Statements of Comprehensive Income,

Accumulated Other Comprehensive Income (Loss)

and Retained Earnings

Years ended December 31

[In thousands of Canadian dollars]

2009 2008

$ $

Net income for the year 37,738 13,798

Other comprehensive income (loss):

Change in fair value of available-for-sale financial instruments [net of $(116) taxes [2008 — $205] 251 (958)

Reclassification adjustment for gain (losses) on available-for-sale financial instruments included

in net income in the year [net of $(196) taxes [2008— $30]] 1,267 (138)

1,518 (1,096)

Comprehensive income for the year 39,256 12,702

Accumulated other comprehensive loss, beginning of year (1,420) (324)

Other comprehensive income (loss) for the year 1,518 (1,096)

Accumulated other comprehensive income (loss), end of year 98 (1,420)

Retained earnings, beginning of year 32,949 20,508

Net income for the year 37,738 13,798

Excess of purchase price over stated capital of common shares cancelled [note 11] (43) (1,357)

Retained earnings, end of year 70,644 32,949

See accompanying notes

38 — Paladin Annual Report 2009


Notes to Consolidated Financial Statements

December 31, 2009

[In thousands of Canadian dollars except share and per share amounts]

1. Governing Statute and Nature of Operations

Paladin Labs Inc. is a specialty pharmaceutical public company continued under the Canada Business Corporations Act, focused on

developing, acquiring, in-licensing, marketing and distributing innovative pharmaceutical products. Paladin Labs Inc., together with

its subsidiaries, is hereinafter referred to as the “Company”.

2. Basis of Presentation and Significant Accounting Policies

Basis of presentation

The consolidated financial statements of the Company have been prepared by management in accordance with Canadian generally

accepted accounting principles [“GAAP”].

Basis of consolidation

The consolidated financial statements include the accounts of the Company and all its subsidiaries, including the acquisition of

Isotechnika Inc. as of June 18, 2009 and ViRexx Medical Corp. as of December 23, 2008, the effective dates of these acquisitions

[described in more detail in Note 13]. Any intercompany transactions and balances have been eliminated upon consolidation.

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that

affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial

statements and the reported amounts of revenues and expenses during the reporting periods. Paladin’s critical accounting estimates

include revenue recognition, inventory valuation, the recording of research and development expenses and related tax credits, the

useful lives and fair value of intangible assets, stock-based compensation expense, income taxes and the determination of fair value

of financial instruments. Actual results could differ from those estimates, and such differences could be material.

Cash and cash equivalents

Cash consists of bank deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known

amounts of cash and which are subject to an insignificant risk of change in value, and consist primarily of banker’s acceptances with

initial maturities of three months or less.

Marketable securities

Marketable securities are classified as “Available-for-sale” and are initially measured at fair value with any resulting subsequent

changes in the fair value being charged or credited to other comprehensive income and when ultimately sold, to net income. Fair

values for marketable securities are obtained using quoted active market prices for such securities.

Inventory

Inventory is valued at the lower of cost, determined on a first-in, first-out basis, and net realizable value. The cost of finished goods

and work-in-progress includes direct costs and an allocation of overhead. Net realizable value is determined to be the selling price

in the ordinary course of business less applicable selling expenses.

Notes to Consolidated Financial Statements —39


2. Basis of Presentation and Significant Accounting Policies [cont’d]

Property, plant and equipment

Property, plant and equipment is recorded at cost. Amortization is provided on a basis and at a rate assigned to amortize the cost of

the assets over their estimated useful life as follows:

Computer equipment and software Straight-line 3 years

Furniture and fixtures Straight-line 2–5 years

Machinery and equipment Straight-line 2–5 years

Pharmaceutical product licenses and rights

In the normal course of business, the Company secures development, sales, marketing and distribution rights to innovative drug

products. Intellectual property acquired is recorded at cost and consists primarily of process know-how covered by certain patented

and non-patented information. Milestones and other license payments determined to have a high likelihood of attainment,

subsequent to the regulatory approval of the product, are capitalized upon the Company’s periodic review and assessment of the

product’s expected performance. Pharmaceutical product licenses and rights are amortized on a straight-line basis over the lesser

of the term of the agreement, the life of the patent or the expected useful life of the product. The terms generally range from

2 to 10 years. The Company periodically reviews the useful lives and the carrying values of its intangible assets. As a result, the

useful life of pharmaceutical product licenses and rights may be reduced. In addition, the Company reviews its intangible assets

for impairment annually and whenever events or changes in circumstances indicate that the carrying value of the intangible asset

may not be recoverable. When the carrying value is less than its net recoverable value as determined on an undiscounted cash flow

basis, an impairment loss is recognized. The impairment loss is recognized to the extent that its fair value, generally measured on a

discounted cash flow basis over the life of the asset, is below the asset’s carrying value.

Investments

Investments consist of strategic investments in portfolio companies. The investments classified as available-for-sale are

carried at fair value with changes in the fair value being charged or credited to other comprehensive income. In compliance with

Section 3855, investments in private companies are carried at cost unless evidence of an other than temporary impairment

exists, in which case they are written down to their net recoverable amount with a charge to income during the year. Indicators

of impairment include: a sustained decline in the quoted market price of a marketable investment; a significant deterioration in

the earnings performance, credit rating, or business prospects of the investee; and a significant adverse change in the regulatory,

economic, or technological environment of the investee. Factors that the Company considers in determining whether a decline is

other-than-temporary include: the financial condition and near-term prospects of the investee; the duration and extent to which

the fair value of an investment is below its cost basis; and the Company’s ability and intent to hold the investment until a recovery

in fair value occurs. Fair values for investments in other companies classified as available-for-sale are obtained using quoted

prices in active markets for public companies, if such are available.

Investments classified as loans and receivables are recorded at cost with subsequent measurements recorded at amortized cost

using the effective interest method, unless evidence of an other than temporary impairment exists, in which case they are written

down to their net recoverable amount with a charge to income during the year.

Derivative financial instruments are carried at fair value with changes in the fair value being charged or credited to the statement

of income during the year. Fair value for conversion options within convertible term notes and common share purchase warrants are

obtained using the Black-Scholes option pricing valuation model.

The Company accounts for its investment in Isotechnika Pharma Inc. [“IsoPharma”] using the equity method of accounting.

On June 18, 2009, in conjunction with the business combination further described in Note 13, the Company, as per applicable

accounting standards, eliminated the value assigned to its investment in common shares of IsoPharma against the excess

[“negative goodwill”] of the amounts assigned to assets acquired and undiscounted liabilities assumed over the cost of the total

purchase price. As a result, the Company’s investment in IsoPharma has a carrying value of $nil effective June 18, 2009. Since

the Company’s acquisition, IsoPharma has incurred net losses from operations. As the Company is not committed to make further

capital contributions to IsoPharma, the Company has not recorded its share of IsoPharma’s net loss since acquisition as per

applicable accounting standards.

40 — Paladin Annual Report 2009


2. Basis of Presentation and Significant Accounting Policies [cont’d]

Financial instruments

All financial assets and liabilities are classified based on their inherent characteristics, management’s intended use, or the choice

of category in certain circumstances. When they are initially recognized, all financial assets are classified as held for trading, heldto-maturity,

available-for-sale or loans and receivables, while financial liabilities are classified as held for trading or other financial

liabilities. Upon initial recognition, all financial assets and liabilities, including derivative financial instruments, are recorded at fair

value in the consolidated balance sheet. In subsequent periods, they are measured at fair value, except for financial assets held-tomaturity,

loans and receivables and financial liabilities not held for trading purposes which are measured at cost or amortized cost

calculated using the effective interest method.

The Company generally designates portfolio investments in securities as available-for-sale. These securities are initially recorded

at their fair value on the date of acquisition, plus additional related transaction costs. Investments in publicly-traded securities are

adjusted to fair value at each balance sheet date using quoted active market prices for such securities. The corresponding unrealized

gains and losses are recorded in the consolidated statement of comprehensive income and are reclassified in the consolidated

statement of income when realized or when management assesses a decline in fair value to be other than temporary. Investments

in privately-held securities are recorded at cost as their fair value cannot be measured reliably.

The Company also has financial assets designated as loans and receivables, and derivatives. The derivatives are initially recorded

at their fair value on the date of acquisition, plus additional related transaction costs. The changes in value are recorded to the

consolidated statement of income for the relevant year.

The loans and receivables are recorded at cost, which upon their initial measurement is equal to their fair value. Subsequent

measurements are recorded at amortized cost using the effective interest method.

All financial liabilities are classified as other financial liabilities. They are initially measured at their fair value. Subsequent measurements

are recorded at amortized cost using the effective interest rate method.

The Company categorizes its financial assets and liabilities measured at fair value into one of three different levels depending on the

observability of the inputs used in their measurement:

• Level 1: This level includes assets and liabilities measured at fair value based on unadjusted quoted prices

for identical assets and liabilities in active markets that are accessible at the measurement date.

• Level 2: This level includes valuations determined using directly or indirectly observable inputs other than

quoted prices included within Level 1. The instruments in this category are valued using models or other

industry standard valuation techniques derived from observable market inputs.

• Level 3: This level includes valuations based on inputs which are less observable, unavailable or where the

observable data does not support a significant portion of the instruments’ fair value.

Revenue recognition

Revenue is recognized when the product is shipped to the Company’s customers, provided the Company has not retained any

significant risks of ownership or future obligations with respect to the product. Revenue from product sales is recognized net of

sales discounts, credits and allowances. Revenue related to service arrangements, where the Company earns a distribution fee on

net sales or earns co-promotion revenue, is recognized when the service is provided and is recorded on a net basis. Revenue related

to royalty arrangements with partners, where the Company earns a royalty fee based on certain pre-determined terms relating to

the net sales of products, is recognized as such terms are met alongside the recording of partner product revenues. In certain

circumstances, returns or exchange of products are allowed under the Company’s policy and provisions are maintained accordingly.

Sales are recorded net of these provisions. In certain situations, such as initial product launches for which the Company has limited

comparable information or where the market or client acceptance has not been clearly established, the Company may determine that

it has not met the requirements for recognition of revenue, such as the ability to reasonably determine provisions for product returns,

as a result the Company will defer the recognition of revenue for these product sales until such criteria are met.

Government assistance

Amounts received or receivable resulting from government assistance programs, including grants and investment tax credits for

research and development, are reflected as reductions to the cost of the assets or expenses to which they relate at the time the

eligible expenditures are incurred, provided that it is more likely than not that benefits will be realized.

Notes to Consolidated Financial Statements —41


2. Basis of Presentation and Significant Accounting Policies [cont’d]

Research and development

Research costs are charged to income in the year of expenditure. Milestones and other license payments paid prior to regulatory

approval of the product are generally expensed when the event requiring payment of the milestone occurs. Development costs are

charged against income in the year of expenditure unless a development cost meets the criteria under generally accepted accounting

principles for deferral and amortization. The Company has not deferred any such costs to date.

Interest income

Interest income is recognized as it accrues to the Company.

Income taxes

The Company provides for income taxes using the liability method. Under this method, future income tax assets and liabilities are

determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using

substantively enacted tax rates and laws that are expected to be in effect in the period in which the future tax assets or liabilities

are expected to be realized or settled. Future income tax assets are recognized to the extent that it is more likely than not that they

will be realized.

Stock-based compensation plans

The Company has stock-based compensation plans, which are described in Note 11 and applies the fair value method of accounting

for all stock-based awards. Any consideration paid by employees upon exercise of stock options or purchase of stock is credited

to share capital. If stock or stock options are repurchased from employees, the excess of the consideration paid over the carrying

amount of the stock or stock options cancelled is charged to retained earnings.

Share buy-back plans

The Company from time to time initiates a share buy-back plan, which is described in Note 11. The common shares are repurchased

by the Company and later cancelled. The difference between the amounts paid for the common shares and the weighted average

common share value is recorded to contributed surplus or retained earnings according to applicable accounting standards.

Share issue costs

Share issue costs incurred by the Company are recorded as a reduction of capital stock.

Earnings per share

Basic earnings per share are calculated using the weighted average number of shares outstanding during the year. Diluted earnings

per share are calculated using the treasury stock method, giving effect to the exercise of all dilutive instruments. The treasury stock

method assumes that any proceeds that could be obtained upon the exercise of options would be used to purchase common shares

at the average market price during the year.

Foreign currency translation

Transactions arising in foreign currencies are translated into Canadian dollars at the exchange rate prevailing at the transaction

dates. At the balance sheet date, monetary assets and liabilities denominated in foreign currencies are translated at the year-end

rates of exchange. Exchange gains and losses, except those related to available-for-sale securities, arising from the translation of

foreign currency items are included in the determination of net income.

The Company has foreign subsidiaries which are considered to be integrated foreign entities and are accounted for in accordance

with the temporal method. Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at

the year-end exchange rates, non-monetary assets and liabilities are translated at the historical exchange rates, and revenue and

expense items are translated into Canadian dollars at rates of exchange in effect at the related transaction dates. Exchange gains

and losses arising from these transactions are included in income during the year in which they occurred.

42 — Paladin Annual Report 2009


3. Changes in Accounting Policies

Recently adopted accounting standards

In January 2009, the CICA issued the Section 3064, Goodwill and Intangible Assets. This new accounting standard reinforces the

approach under which assets are recorded only if they meet the definition and the recognition criteria of an asset. It also clarifies the

application of the concept of matching costs with revenues. These changes, including the related disclosure requirements, did not

have a significant effect on the Company’s consolidated financial statements.

In June 2009, the CICA amended Section 3862, Financial Instruments — Disclosures, to include additional disclosure requirements

about fair value measurement for financial instruments and liquidity risk disclosures. These amendments require a three level

hierarchy that reflects the significance of the inputs used in making the fair value measurements. Fair value of assets and liabilities

included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Assets and

liabilities in Level 2 include valuations using inputs other than the quoted prices for which all significant inputs are based on

observable market data, either directly or indirectly. Level 3 valuations are based in inputs that are not based on observable market

data. The amended Section relates to disclosure only and the Company reflected such additional disclosures under Note 19.

Accounting standards pending adoption

In January 2009, the CICA issued Handbook Section 1582, Business Combinations. This section establishes the standards for

accounting of business combinations, and states that all assets and liabilities of an acquired business will be recorded at fair value.

Obligations for contingent considerations and contingencies will also be recorded at fair value at the acquisition date. The standard

also states that acquisition-related costs will be expensed as incurred and that restructuring charges will be expensed in the periods

after the acquisition date. Furthermore, the Company, will early adopt this standard as of January 1, 2010. The initial application of

this standard is not expected to have a significant effect on the Company’s consolidated financial statements.

In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial Statements. This section establishes the standards

for preparing consolidated financial statements. The Company will early adopt this standard as of January 1, 2010. The initial application

of this standard is not expected to have a significant effect on the Company’s consolidated financial statements.

In January 2009, the CICA issued Handbook Section 1602, Non-controlling Interests, which establishes standards for the accounting

of non-controlling interests of a subsidiary in the preparation of consolidated financial statements subsequent to a business

combination. The Company will early adopt this standard as of January 1, 2010. The initial application of this standard is not

expected to have a significant effect on the Company’s consolidated financial statements.

4. Marketable Securities

2009 2008

$ $

Corporate bonds, earning effective interest at rates ranging from 0.39% to 4.20% [4.42% to 4.64% in 2008]

and maturing on various dates from January 2010 to December 2010 22,519 5,196

Government bonds, earning effective interest at rates ranging from 0.51% to 1.16% and maturing on various dates

from March 2010 to October 2010 19,289 —

Commercial paper, earning effective interest at rates ranging from 0.22% to 1.25% [1.30% to 3.53% in 2008]

and maturing on various dates from January 2010 to September 2010 13,766 2,807

Guaranteed investment certificates, earning effective interest at rates ranging from 0.90% to 1.30%

[1.30% to 2.89% in 2008] and maturing on various dates from January 2010 to November 2010 12,700 6,750

Discount note, earning effective interest at 0.55% and maturing in December 2010 5,000 —

73,274 14,753

The above marketable securities balances are classified available-for-sale and are invested within four large Canadian and one large

US financial institutions [2008 — two large Canadian financial institutions], comprised of thirteen investments in corporate bonds

[five in 2008], seven investments in bonds guaranteed by the Canadian and provincial governments [nil in 2008], seven investments

in commercial paper [three in 2008], five guaranteed investment certificate investments [three in 2008] and one investment in

discount notes [nil in 2008].

Notes to Consolidated Financial Statements —43


5. Inventories

2009 2008

$ $

Raw materials 871 473

Work in progress 378 401

Finished goods 12,531 8,951

Provision for obsolescence (1,419) (1,182)

12,361 8,643

During the year ended December 31, 2009, inventories in the amount of $27,656 [2008 — $17,986] were recognized as cost of

sales, including provisions for write-downs to net realizable value of $237 [2008 — $549].

6. Other Current Assets

2009 2008

$ $

Deferred costs [i] 874 1,259

Other receivables [ii] 633 389

Deposits 515 419

Interest receivable 386 158

Prepaid expenses 203 306

Investment tax credits receivable 57 36

[i] Deferred costs consist of deferred product costs associated with deferred revenues and prepaid royalty payments.

[ii] Other receivables consist primarily of commodity taxes receivable.

7. Long-Term Marketable Securities

2,668 2,567

2009 2008

$ $

Discount note, earning effective interest at 2.36% and maturing in March 2011 868 —

Corporate bonds, earning effective interest at rates ranging from 3.93% to 4.15% and maturing

on various dates from January 2010 to December 2010 — 1,943

868 1,943

The above long-term marketable securities balances are classified available-for-sale and are invested within a large Canadian financial

institution [2008 — one large Canadian financial institution], comprised of one investment in discount notes [two investments in

corporate bonds in 2008].

8. Property, Plant and Equipment

Cost

Accumulated

amortization

Net carrying

value

2009 2008

Cost

Accumulated

amortization

Net carrying

value

$ $ $ $ $ $

Machinery and equipment 687 (384) 303 534 (99) 435

Furniture and fixtures 347 (112) 235 33 (9) 24

Computer equipment and software 352 (199) 153 358 (223) 135

1,386 (695) 691 925 (331) 594

During 2009, the Company recorded additions of $589 [2008 — $510], disposed of $128 [2008 — $148] and recorded amortization

expense of $492 [2008 — $216] related to capital assets. Included in the additions is an accrual to related parties of $159

[2008 — $nil]

44 — Paladin Annual Report 2009


9. Pharmaceutical Product Licenses and Rights

Cost

Accumulated

amortization

Net carrying

value

2009 2008

Cost

Accumulated

amortization

Net carrying

value

$ $ $ $ $ $

Pharmaceutical product licenses and rights 105,987 (63,444) 42,543 96,190 (38,038) 58,152

During 2009, the Company recorded additions of $9,854 [2008 — $44,929], disposed of $57 [2008 — $nil] and recorded amortization

expense of $25,063 [2008 — $11,143] related to pharmaceutical product licenses and rights. Included in the above additions is a

balance of sale payable of $1,402 [2008 — $10,429].

10. Investments

Carrying

value

2009 2008

Fair market

value

Carrying

value

Fair market

value

$ $ $ $

Investment in common shares of Isotechnika Pharma Inc. [“IsoPharma”],

a public company listed on the Toronto Stock Exchange [see note [i] below] — 4,237 — —

Investment in common shares of Quest Pharmatech, Inc. [“Quest”], a public

company listed on the Toronto Stock Exchange [see note [ii] below] 60 60 — —

Investment in common shares of BioSante Pharmaceuticals, Inc. [“BioSante”],

a public company in the United States 2 2 2 2

Investment in common shares of Indevus Pharmaceuticals, Inc. [“Indevus”],

a public company in the United States [see note [iii] below] — — 1,463 1,463

Investment in common shares of Glide Pharmaceutical Technologies, Limited

[“Glide”], a private company in the United Kingdom [see note [iv] below] — — 801 801 2

Investment in 8% Secured Convertible Term Notes in Nuvo Research Inc. [“Nuvo”],

a public company listed on the Toronto Stock Exchange [see note [v] below]

Loans and receivables allocated amount — — 1,067 1,419

Embedded derivative — — 568 568

Investment in common shares of Nuvo [see note [vi] below] — — 865 865

Investment in warrants of Nuvo [see note [vi] below] — — 26 26

62 4,299 4,792 5,144

[i] The Company accounts for its 19% interest in common shares of IsoPharma using the equity method of accounting. IsoPharma

is an international biopharmaceutical company dedicated to the discovery, development and commercialization of novel

immunosuppressive therapeutics for the treatment of autoimmune diseases and for use in the prevention of organ rejection in

transplantation. On June 18, 2009, in conjunction with the business combination further described in Note 13, the Company, as

per applicable accounting standards, eliminated the value assigned to its investment in common shares of IsoPharma against

the excess [“negative goodwill’] of the amounts assigned to assets acquired and undiscounted liabilities assumed over the

cost of the total purchase price. As a result, the Company’s investment in IsoPharma has a carrying value of $nil effective

June 18, 2009. Since the Company’s acquisition, IsoPharma has incurred net losses from operations. As the Company is not

committed to make further capital contributions to IsoPharma, the Company has not recorded its share of IsoPharma’s net loss

since acquisition as per applicable accounting standards.

[ii] On September 30, 2009, as part of the Company’s sale of the AIT ® technology platform to Quest, the Company received

1,500,000 common shares in Quest, and can receive up to 3,500,000 additional common shares upon the realization of

certain future technology and product-related milestones. The Company has recorded a gain of $60, representing the quoted

fair value of the 1,500,000 common shares upon closing and the remaining 3,500,000 common shares to be received will

only be recorded when the milestones will be achieved. The common shares are classified as available-for-sale.

2 In compliance with Section 3855, the Company’s investment in Glide, was originally carried at cost as there is no quoted market prices in an active market for such equity

instrument and subsequently determined to be permanently impaired (see note (ii)). Fair value has not been disclosed because fair value cannot be measured reliably.

Notes to Consolidated Financial Statements —45


10. Investments [cont’d]

[iii] On February 19, 2009, Endo Pharmaceuticals Inc. [“Endo”] acquired Indevus for US$4.50 per Indevus share in cash and up to

an additional US$3.00 per share in cash upon achievement of certain future regulatory and sales milestones with respect to

two Indevus product candidates in development. The Company received proceeds in the amount of $2,167 [US$1,720] for

the investment it held in 382,253 common shares of Indevus, resulting in a realized loss on disposal in the amount of $414.

Furthermore, the Company recorded a $416 contingent right to cash in relation to the achievement of the milestones above,

determined to represent the fair value upon receipt and measured based upon the average incremental Indevus common stock

trading price over the US$4.50 cash payment received over a 31-day trading period on the NASDAQ Stock Exchange. During the

quarter ended December 31, 2009, the Company, as part of its on-going assessment of investment carrying values, determined

the contingent right receivable to be permanently impaired and recorded a write-down in the amount of $416.

[iv] On August 8, 2007, the Company purchased 84,679 Class B common shares in Glide at a per share price of $9.46 [GBP 4.36] for

a total amount of $801 [GBP 369] representing a nominal ownership in Glide on a fully diluted basis. During the quarter ended

June 30, 2009, the Company, as part of its on-going assessment of investment carrying values, determined its investment in

Glide to be permanently impaired and recorded a write-down in the amount of $801.

[v] On December 22, 2006, the Company purchased a $500 Secured Convertible Term Note [“Note 1”] from Nuvo bearing 8%

interest calculated and payable semi-annually at Nuvo’s option, in cash or common stock, using the weighted average trading

price of the common shares on the Toronto Stock Exchange [“TSX”] for the 10 trading days immediately prior to the payment

date. The Note 1 is convertible at the Company’s option into 833,333 common shares of Nuvo based on a conversion price of

$0.60, representing the weighted average trading price of the common shares on the TSX for the 10 trading days immediately

prior to the Note 1 purchase.

On July 7, 2008, the Company redeemed Note 1 for proceeds equal to the face value of $500, resulting in a gain on the early

redemption of $209 and simultaneously purchased a $2,000 Secured Convertible Term Note [“Note 2”] from Nuvo bearing

8% interest calculated and payable semi-annually at Nuvo’s option, in cash or common stock, using the weighted average

trading price of the common shares on the TSX for the 5 trading days immediately prior to the payment date. The Note 2

is convertible at the Company’s option into 14,492,753 common shares of Nuvo based on a conversion price of $0.1380,

representing the weighted average trading price of the common shares on the TSX for the 5 trading days immediately prior

to the Note 2 purchase.

According to financial instruments accounting standards, Notes 1 and 2 were initially recognized at their respective fair value

through the bifurcation of the conversion option being classified and subsequently re-measured as a derivative asset. The fair

value of the conversion options were obtained using the Black-Scholes option pricing model, using the following assumptions,

as at December 31, 2008: volatility factor: 104%, risk-free interest rate: 1.09% and time to expiry: 1.5 years. The allocated loan

portion of these same secured convertible term notes were classified as “Loans and Receivables” and recorded at fair value upon

initial measurement and subsequently recorded at amortized cost using the effective interest rate method. The effective interest

rate for Notes 1 and 2, previous to conversion, was 43.29% per year and 44.08% per year respectively.

During the year ended December 31, 2009, the Company exercised its right to convert the full value of Note 2 into common

shares subsequently selling such shares in the public market for proceeds of $3,168 and realizing a gain of $1,000.

Prior to the redemption of Note 1 and the conversion of Note 2, the Company had recorded an unrealized gain on the derivative

financial instruments described above in the amount of $344 [2008 — $558 loss] and recorded accreted interest income on the

allocated loan portion of the above secured convertible term notes in the amount of $189 [2008 — $252] for the year ended

December 31, 2009.

[vi] On May 29, 2008, the Company invested $1,000 in exchange for 7,692,307 common shares in Nuvo at a per share price of

$0.13 and was granted 769,230 two-year common share purchase warrants. These warrants entitled the Company to acquire

one Nuvo common share at a per share price of $0.169, representing the weighted average trading price of the common shares

on the TSX for the 5 trading days immediately prior to the date of the grant. On this same date, the Company also out-licensed

the right to commercialize a topical pain innovation in exchange for 961,538 common shares in Nuvo at a per share price

of $0.13 for a total consideration of $125 which was recorded in “Other Income” on the consolidated statement of income.

The common shares were classified as available-for-sale and the warrants were classified as derivatives.

During the year ended December 31, 2009, the Company disposed of the 8,653,845 common shares held in Nuvo for proceeds

of $1,340, representing a gain of $215. In addition, the Company also exercised its right to convert the 769,230 common share

purchase warrants into common shares and subsequently disposed of such shares for net proceeds of $304, representing a gain

of $133.

46 — Paladin Annual Report 2009


10. Investments [cont’d]

Prior to the disposition of the Nuvo common shares and common share purchase warrants, the Company had recorded an

unrealized gain on Nuvo common shares pursuant to applicable accounting regulations in the amount of $260 [2008 — $260

loss], and an unrealized gain on Nuvo common share purchase warrants in the amount of $15 [2008 — $26] during the year

ended December 31, 2009.

11. Capital Stock

Authorized

100,000,000 common shares without nominal or par value.

Issued and outstanding

Number of

shares

2009 2008

Amount

$

Number of

shares

Amount

$

Balance, beginning of year 14,921,446 60,664 14,902,784 59,797

Issued during the year:

Issued upon common share offering 3 3,450,000 56,680 — —

Exercise of stock options 184,453 2,144 234,906 1,668

Employee share purchase plan 11,851 193 10,481 111

Purchase of shares for cancellation (4,500) (29) (226,725) (912)

Balance, end of year 18,563,250 119,652 14,921,446 60,664

Stock Option Plan

The Company has a Stock Option Plan [“Plan”] in place for the benefit of key employees, directors, officers and consultants of

the Company to purchase an aggregate maximum of 3,000,000 common shares. Options issued to employees under the plan

expire seven years from the grant date and generally vest equally over four years. Certain options to employees under the Plan

vest in accordance with certain pre-established performance criteria and are recorded in accordance with management’s regular

assessments of the likelihood of the pre-established performance criteria’s attainment. Options issued to the Board of Directors

under the Plan expire seven years from the grant date, vest immediately upon grant and are expensed in the year they are granted.

In addition, stock options issued to non-employees vest immediately and are expensed in the year they are granted.

Stock-based compensation is accounted for using the fair value method using the Black-Scholes option-pricing model. The attributed

exercise price for option grants cannot be less than the closing price per common share on the date of the grant per Company policy.

As at December 31, 2009, 709,979 [2008 — 1,073,002] common share options remain available under the Plan.

The changes to the number of stock options granted by the Company and their weighted average exercise price are as follows:

2009 2008

Weighted

average

exercise

price

Weighted

average

exercise price

# $ # $

Balance, beginning of year 1,067,948 9.03 1,002,844 7.73

Granted 443,500 13.41 366,935 10.88

Exercised (184,453) 7.46 (234,906) 6.04

Forfeited (80,477) 11.84 (66,925) 10.10

Balance, end of year 1,246,518 10.65 1,067,948 9.03

Options exercisable, end of year 533,767 8.84 391,746 6.73

3 On June 11, 2009, the Company issued 3,450,000 common shares including an amount of 450,000 comprising of the underwriters’ over-allotment option in the

form of a bought deal share offering at a price of $17.00 per common share for total gross proceeds to the Company in the amount of $58,650. In conjunction with

the offering, the Company incurred share issue costs of approximately $1,970, net of taxes, and recorded these as a reduction of capital stock.

Notes to Consolidated Financial Statements —47


11. Capital Stock [cont’d]

Additional information concerning stock options outstanding as at December 31, 2009 is as follows:

Exercise price Options outstanding Options exercisable

Number

Weighted

average

months

to expiry

Weighted

average

exercise price

$ Number

Weighted

average

exercise price

$

$4.19–$6.07 153,433 16 4.60 153,433 4.60

$6.60–$8.10 100,700 38 6.85 79,123 6.88

$9.90–$11.06 486,898 57 10.86 215,898 10.96

$11.10–$12.19 411,237 72 11.98 60,313 11.36

$16.55–$19.26 94,250 80 17.62 25,000 16.55

1,246,518 533,767

The Company recorded stock option compensation expense with a corresponding credit to other paid-in capital and determined the

fair value of stock options under the Black-Scholes option pricing model using the following assumptions:

2009 2008

Stock-based compensation expense $2,022 $1,382

Weighted average fair value of options $6.17 $5.73

Weighted average risk-free interest rate 2.48% 3.32%

Dividend yield Nil Nil

Weighted average volatility factor 42% 47%

Weighted average expected life 7 years 7 years

Stock Purchase Plan

The Company has a Stock Purchase Plan [“Purchase Plan”] allowing permanent employees to purchase up to 200,000 common

shares at fair market value from treasury. During 2009, 11,851 [10,481 in 2008] shares were issued from treasury at fair market

value under the Purchase Plan. As at December 31, 2009, 124,972 [2008 — 136,823] common shares reserved for stock purchase

arrangements remain available under the Purchase Plan.

Under the Purchase Plan, the Company will contribute 25% of employees’ contributions to a maximum of 6% of the employees’

salary in the form of common shares if the employee remains employed by the Company and has held the original shares for two

years from the original purchase date. The Company’s contribution in common shares is calculated using the lesser of the original

common share value at the original purchase date and the date of the Company’s contribution. During 2009, the Company issued

1,641 shares [1,391 in 2008] representing its 25% contribution and recorded a corresponding expense of $30 [$18 in 2008].

Share buyback

On February 27, 2009, the Company received regulatory approval from the TSX to carry out a normal course issuer bid effective

March 3, 2009. The Company has been authorized to purchase up to 811,548 of its common shares, or approximately 10% of its

public float of 8,115,483 common shares as at February 18, 2009, in the twelve-month period following the bid’s effective date.

The Company has an automatic share purchase plan with a broker in order to facilitate repurchases of its common shares

under its normal course issuer bid. The Company’s broker may repurchase shares under the normal course issuer bid at any

time including, without limitation, when the Company would ordinarily not be permitted to due to regulatory restrictions or

self-imposed blackout periods.

During the year ended December 31, 2009, under the terms of a normal course issuer bid approved in 2009, the Company repurchased

and cancelled 4,500 shares at an average price of $16.00 for a cash consideration of $72 resulting in an excess of purchase price

over stated capital of common shares $43 which was charged to retained earnings.

During the year ended December 31, 2008, under the terms of a normal course issuer bid approved in 2008, the Company repurchased

and cancelled 226,725 shares at an average price of $10.01 for a cash consideration of $2,269 resulting in an excess of purchase

price over stated capital of common shares $1,357 which was charged to retained earnings.

48 — Paladin Annual Report 2009


12. Other Paid-In Capital

The changes to other paid-in capital are as follows:

2009 2008

$ $

Balance, beginning of year 3,155 2,019

Amount related to stock-based compensation 2,022 1,382

Transfer to capital stock upon exercise of stock options (769) (246)

Balance, end of year 4,408 3,155

13. Business Acquisitions

2009 — Isotechnika Inc. acquisition

On June 18, 2009, the Company acquired all the issued and outstanding shares of Isotechnika Inc. [“Isotechnika”][TSX: ISA] in

accordance with a court supervised Plan of Arrangement. As part of the transaction, the Company paid $7,594 in cash and Isotechnika

entered into a collaborative research and development agreement with Isotechnika Pharma Inc. [“IsoPharma”] in exchange for

supporting research and development services for the commercialization of voclosporin, Isotechnika’s next-generation calcineurin

inhibitor, in Canada, Mexico, Central and South America, Israel and South Africa [“Paladin-acquired territories”]. The research and

development services extend for a period of seven years and included an amount of $4,350 payable by the Company to IsoPharma

over the next 12 months and expensed as incurred over this same 12 month period. Furthermore, the Research and Development

Agreement in conjunction with the Company’s Licence Agreement for voclosporin in the Paladin acquired territories, contains certain

other voclosporin research, development and commercialization payment arrangements including possible licensing and royalty

revenue payments over the remaining period. During the year ended December 31, 2009, the Company has expensed $1,975 with

respect to these research and development services.

As part of the acquisition, the Company also received the international rights to a portfolio of products under development and a

commercialized diagnostic product portfolio. The Company had also assumed an obligation to pay out certain future contractually

pre-defined amounts relating to the commercialization of the diagnostic product portfolio over a period of seven years, estimated to

amount to approximately $5,950 at the time of acquisition [the “contingent balance of sale payable”]. This estimated amount was

determined based upon the historical sales of the products, current expenditure levels and market conditions and was payable over

a seven-year period pursuant to its Research and Development Agreement and represented management’s best estimate of this

liability at the time of acquisition. It was considered reasonably possible that changes in future conditions could require a material

change in the recognized amount. As at December 31, 2009, the Company had applied $500 and disbursed $274 with respect to

this balance of sale payable.

On December 31, 2009, the Company entered into an Amended Agreement with IsoPharma to settle the contingent balance of

sale payable for a total amount of $1,991, of which $1,650 is payable February 28, 2010 and the remainder in the amount of

$341, representing the discounted present value, is payable on January 31, 2011 if certain conditions are met. This settlement

resulted in an adjustment to the extraordinary gain in the amount of $3,458 which has been recorded in accordance with related

party accounting standards [see Note 14 for additional information]. The Company had originally recorded an extraordinary gain in

the amount of $25,959 upon the acquisition of Isotechnika which in conjunction with the settlement above results in an aggregate

extraordinary gain of $29,417 for the year ended December 31, 2009.

Isotechnika is an international biopharmaceutical company dedicated to the discovery, development and commercialization of novel

immunosuppressive therapeutics for the treatment of autoimmune diseases and for use in the prevention of organ rejection in

transplantation. In addition to the Company’s drug pipeline, Isotechnika also has commercialized diagnostic products. Isotechnika

was subsequently wound up into the Company on October 1, 2009.

Furthermore, as part of the purchase price, the Company received 24,921,312 common shares, representing a 19% interest in

IsoPharma as at the date of acquisition, with an approximate value of $4,348 using the weighted average trading price of the

common shares on the TSX for the 20 trading days pre and post acquisition. In connection with the acquisition, the Company had

incurred transaction costs in the amount of $530 included in the purchase price below.

Notes to Consolidated Financial Statements —49


13. Business Acquisitions [cont’d]

The acquisition was accounted for using the purchase method. The results of Isotechnika’s operations have been included in the

Company’s results since June 18, 2009, the effective date of acquisition. The total purchase price of $10,689 was allocated to

the fair value of the net assets acquired in the amount of $47,204, representing negative goodwill in the amount of the excess

of $36,515. The Company, as per applicable accounting standards, eliminated the value previously assigned to certain prescribed

assets in the amount of $7,098 against the excess of the amounts assigned to assets acquired and undiscounted liabilities

assumed over the cost of the purchase above. The remaining excess is presented as an extraordinary gain in the amount of

$29,417. The purchase price was preliminarily allocated as follows:

Purchase price allocation $

Cash 1,565

Current assets 627

Future income tax assets 39,440

Current liabilities (1,526)

Consideration represented by:

40,106

Cash paid 7,594

Balance of sale payable 2,565

Acquisition costs 530

10,689

Extraordinary gain [net of $nil taxes] 29,417

The Company is in the process of finalizing the purchase price allocation which will be completed during 2010.

2008 — ViRexx Medical Corp. acquisition

On December 23, 2008, the Company acquired all the issued and outstanding shares of ViRexx Medical Corp. [“ViRexx”][TSX: VIR]

[AMEX: REX] in accordance with an Order for Reorganization led by ViRexx’s appointed Trustee, whereby the Company paid $1,446

in cash. In addition, the Company agreed to a contractual right of payment of an amount up to $2,500 in the aggregate to former

ViRexx shareholders, if certain conditions are met, including the Company receiving at least $4,000 in connection with certain ViRexx

assets, prior to December 31, 2009. The Company had not received funds with respect to this contractual right which would generate

a contractual amount payable as at December 31, 2009. The Company also incurred transaction costs in the amount of $196,

included in the cash payment above, in connection with the acquisition. ViRexx is a Canadian-based biotech company focused on

developing innovative-targeted therapeutic products and was subsequently wound up into the Company on December 23, 2008.

The acquisition was accounted for using the purchase method. The results of ViRexx’s operations have been included in the

Company’s results since December 23, 2008, the date of acquisition. The Company, using information currently available has

estimated the fair value of the contingent consideration described above to be $nil. The total purchase price of $1,446 was allocated

to the fair value of the net assets acquired in the amount of $7,951, representing negative goodwill in the amount of the excess of

$6,505. The Company, as per applicable accounting standards, eliminated the value previously assigned to certain prescribed assets

in the amount of $2,433 against the excess of the amounts assigned to assets acquired and liabilities assumed over the cost of

the purchase above. The remaining excess is presented as an extraordinary gain in the amount of $4,072. The purchase price was

allocated as follows:

Purchase price allocation $

Cash 27

Future income tax assets 6,056

Current liabilities (565)

Consideration represented by:

Cash paid 1,446

Extraordinary gain [net of $nil taxes] 4,072

5,518

50 — Paladin Annual Report 2009


14. Related Party Transactions

Joddes Limited [“Joddes”], a private Canadian corporation, together with its affiliates, owns in aggregate approximately 38% of the

outstanding shares of the Company, and one director of the Company, the Company’s President and CEO, is related to this group.

The Company engages a wholly-owned subsidiary of Joddes to provide logistics services including: customer service, warehousing,

shipping, invoicing, collection services and certain manufacturing and selling services on behalf of the Company. The Company

also engages this affiliate to perform certain research and development services on a contractual pay-for-use basis. In addition, the

Company leases its office facilities from another wholly-owned subsidiary of Joddes. This lease is for a period of 10 years, ending

in 2013 and includes minimum annual payments for a total remaining committed amount of $706 as at December 31, 2009 and is

included in the purchase and service based commitments in Note 18.

The Company has also entered into contractual royalty agreements with a wholly-owned subsidiary of Joddes for certain legacy and

over-the-counter products. The terms of these arrangements vary whereby the Company may earn a royalty fee based on certain

established terms relating to the net sales of the respective products such as through a percentage of net sales, certain guaranteed

minimum annual payments, or as a percentage of a defined product contribution.

Effective November 1, 2006, the Company acquired the Canadian distribution rights to Metadol ® from a wholly-owned subsidiary

of Joddes for cash consideration of $15,000. Under the terms of the agreement, the Company can purchase the Canadian license

for Metadol ® on the fourth anniversary of the agreement for $1 and can receive a reimbursement of up to $3,750 subject to

certain acquisition related conditions. As at December 31, 2009, the Company has not received or earned any reimbursement. The

acquisition of the Canadian distribution rights to Metadol ® was not in the normal course of operations and was recorded at an agreed

upon exchange amount in accordance with the requirements of accounting standard CICA 3840.

The Company owns a 19% interest in the common shares of IsoPharma and considers this investment a related party. The Company,

in conjunction with the business combination discussed in Note 13, settled with IsoPharma on December 31, 2009 the balance of

sale contingently payable over a seven-year period for an amount of $1,991, of which $1,650 is payable on February 28, 2010 and

$341, representing the discounted present value, is payable on January 31, 2011 if certain conditions are met. This transaction was

not in the normal course of operations and was recorded at an agreed upon exchange amount in accordance with the requirements

of accounting standard CICA 3840. Furthermore, the Company is committed to research and development service payments with

IsoPharma, as further discussed in Note 13, in the amount of $2,375 as at December 31, 2009 that are included in the purchase

and service based commitments in Note 18.

All transactions with related parties, except for the Metadol ® and IsoPharma transactions described above, are carried out in the

normal course of operations, and are recorded at an agreed upon exchange amount. The accounts payable to related parties are on

normal commercial terms and conditions and are non-interest bearing.

The table below reflects all transactions and services with related parties carried in the normal course of operations, which include

those referred to in the agreements described above, as well as revenues from a wholly-owned subsidiary of Joddes:

2009 2008

$ $

Revenues 3,962 3,672

Purchases 8,549 13,314

Selling and marketing 5,893 4,441

Research and development 2,484 449

General and administrative 570 389

Notes to Consolidated Financial Statements —51


15. Research and Development and Government Assistance

The Company incurred research and development expenditures, which are eligible for investment tax credits. The investment tax

credits recorded are based on management’s estimates of amounts expected to be recovered and are subject to audit by the

taxation authorities.

The amounts can be summarized as follows:

2009 2008

$ $

Research and development expenditures 7,984 5,532

Government assistance (209) —

Investment tax credits (546) (5)

7,229 5,527

16. Income Taxes

The Company’s income tax provision consists of the following:

2009 2008

$ $

Canadian statutory rates 30.90% 30.90%

Provision at Canadian statutory rates based on pre-tax income before extraordinary gain 4,514 4,955

Increase (decrease) resulting from:

Non-deductible expenses 1,603 718

Impact of foreign tax rate differential 273 290

Impact of change in tax rates — 142

Other (103) 206

6,287 6,311

Major components of the income tax provision are as follow:

2009 2008

$ $

Current income tax expense 807 4,977

Future income tax expense relating to origination and reversal of temporary differences 5,495 1,114

Future income tax expense resulting from income tax rate changes, net — 142

Future income tax recovery resulting from recognition of previously unrecognized temporary differences (15) 78

Income tax provision 6,287 6,311

Future income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for

financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s future tax

assets and liabilities are as follows:

2009 2008

$ $

Future income tax assets

Current

Scientific Research and Experimental Development expenditures not claimed for tax purposes 3,925 2,075

Loss carryforwards 2,081 8,180

Share issuance costs 376 —

Tax basis of current assets in excess of carrying value 2,168 1,148

8,550 11,403

Less: valuation allowance 2,354 2,283

Total current income tax assets 6,196 9,120

52 — Paladin Annual Report 2009


16. Income Taxes [cont’d]

2009 2008

$ $

Long-term

Tax basis of intangible and other assets in excess of carrying value 6,949 3,938

Scientific Research and Experimental Development expenditures not claimed for tax purposes 20,362 3,215

Loss carryforwards 17,267 —

Share issuance costs 687 —

Tax basis of investments in excess of carrying amounts 256 308

45,521 7,461

Less: valuation allowance 14,492 2,672

Total long-term income tax assets 31,029 4,789

Total future income tax assets 37,225 13,909

2009 2008

$ $

Future income tax liabilities

Deferred charges — current 19 90

Investment tax credits — current 233 —

Total current income tax liabilities 252 90

Carrying value of intangible assets in excess of tax basis — long-term — 341

Investment tax credits — long-term 4,007 —

Total long-term income tax liabilities 4,007 341

Total future income tax liabilities 4,259 431

Net future income tax assets 32,966 13,478

As at December 31, 2009 and 2008, the Company has the following tax pools detailed below which may be applied against taxable

income of future years:

Non-capital tax losses

Available

Recognized

2009 2008 2009 2008

$ $ $ $

Federal 65,258 30,140 30,166 22,193

Provincial 65,258 21,078 30,166 14,099

Scientific Research and Experimental Development expenditures

Federal 89,232 20,902 69,098 9,905

Provincial 85,820 11,805 66,534 7,145

Investment tax credits

Federal 23,187 2,565 15,679 43

Notes to Consolidated Financial Statements —53


16. Income Taxes [cont’d]

Expires in

Investments

tax credits

Non-capital tax losses

Federal

Québec

$ $ $

2013 — 6,950 6,950

2014 — 2,342 2,342

2017 111 — —

2018 633 — —

2019 1,323 — —

2020 532 — —

2021 1,974 — —

2022 2,902 — —

2023 2,509 — —

2024 2,930 — —

2025 3,783 3,235 3,235

2026 2,352 15,063 15,063

2027 1,935 8,758 8,758

2028 1,606 28,910 28,910

2029 597 — —

23,187 65,258 65,258

The amount of tax benefit claimed in the current and prior years is subject to audit by the taxation authorities and could be reduced

by a material amount in the future.

Subsequent to December 31, 2009, in connection with the Company’s previously disclosed tax contingency, the Company received

notices of re-assessment from the Canada Revenue Agency [“CRA”] reversing its original position on the use of certain non-capital

losses acquired as part of the Dimethaid Health Care Ltd. [subsequently renamed Squire Pharmaceuticals Inc., “Squire”] acquisition

from Nuvo Research Inc. [“Nuvo”]. While the Company has not received a notice from the Ontario Minister of Finance [“OMF”],

the OMF has agreed to be bound by the decision of the CRA appeals process.

As previously disclosed, on various dates during fiscal 2008 and 2009 the Company had received notices of re-assessment from the

CRA relating to the taxation years ending August 16, 2005, July 31, 2006, July 31, 2007 and December 31, 2008 and from the OMF

for the taxation year ended August 16, 2005, containing adjustments relating to the use of certain non-capital losses. The notices of

assessment and re-assessment, if they had stood as a result of the CRA’s position, amounted to a total tax liability exposure to the

federal and relevant provincial governments of approximately $11,625 including interest and penalties. The Company filed a Notice

of Objection through the CRA appeals process on October 23, 2008 and August 13, 2009. Furthermore, the Company, under the

terms of the Share Purchase Agreement [“SPA”] for Squire with Nuvo, holds indemnities with respect to the status of the Squire tax

accounts and certain tax asset values the Company as well as all costs relating to reassessment including advisory fees, interest and

penalties, as applicable. In addition, Nuvo had issued additional security over the indemnity obligations by entitling the Company to

the benefit of security over certain assets and product revenue streams of Nuvo and certain of its subsidiaries.

In connection with the appeals process, during the years ended December 31, 2009 and 2008, the Company had posted a deposit

of $3,752 to the CRA and $500 to the OMF, representing up to one-half of the tax and interest assessed. In addition, during the year

ended December 31, 2009, the Company issued from its $2,000 revolving unsecured credit facility, a bank guarantee in the amount

of $720 to the OMF. As a result of the Company’s success in the appeal process, an amount of $3,936 was received from the CRA on

January 20, 2010, representing a refund for the full amount of the deposit above, along with accrued interest in the amount of $184.

In addition, the bank guarantee previously issued to the OMF expired February 1, 2010 without being drawn-down by the OMF.

54 — Paladin Annual Report 2009


17. Earnings Per Share

The following summarizes the reconciliation of the basic weighted average number of shares outstanding and the diluted weighted

average number of shares outstanding used in the diluted earnings per share calculations:

2009 2008

# #

Basic weighted average number of shares outstanding 16,933,229 14,846,306

Dilutive effect of stock options 499,669 224,977

Diluted weighted average number of shares outstanding 17,432,898 15,071,283

There was no significant adjustment to net income for purposes of calculating diluted earnings per share.

18. Commitments

In the normal course of business, the Company secures development, sales, marketing and distribution rights to innovative drug

products and has entered into various agreements which include contractual obligations extending beyond the current year.

These obligations are classified into three major categories: revenue based, milestone based, and purchase and services based

commitments.

Revenue based commitments

Most pharmaceutical product license agreements require that the Company make royalty payments ranging from 10% to 20% of

sales, or generally require payments for products at rates ranging from 20% to 40% of the net selling price and in certain cases

require revenue sharing at various rates over and above a pre-established net sales threshold.

In addition, the Company may have to pay up to $6,569 [US$6,250] if it achieves specific sales volumes on specific products in the

future, over a maximum of ten years.

Milestone based commitments

The Company has also committed to fund certain research and development expenditures of third parties upon milestone attainment

in the amount of $3,974, including €1,000, over the next five years. In addition, certain additional payments may be required under

these agreements if milestones are met, such as regulatory approval in Canada. Based on the outcome of these milestones, the

Company may have to pay up to $7,328, including US$5,311 and GBP£500, over a maximum period of fifteen years.

Purchase and service based commitments

The Company is committed to making minimum purchases of inventory, and minimum expenditures for regulatory, selling and

marketing services in the amount of $21,219, including €4,062, to retain exclusive distribution agreements for certain products.

These commitments end in 2015 and annual commitments are as follows:

2010 11,425

2011 5,162

2012 1,270

2013 1,259

2014 1,088

2015 1,015

$

Notes to Consolidated Financial Statements —55


19. Financial Instruments

The Company’s Investment Policy regulates the investment activities relating to cash resources. An Investment Committee

composed of representatives from management and the Board of Directors monitors compliance with said policy. The Company

invests in strategic investments in the form of equity or strictly in liquid, high-grade investment securities with varying terms to

maturity, selected with regard to the expected timing of investments and expenditures for continuing operations and prevailing

interest rates.

Loans and

receivables

Other

financial

liabilities

Derivatives

Carrying

value

Fair value

$ $ $ $ $ $

2009

Financial Assets

Cash and cash equivalents 31,227 31,227 31,227

Marketable securities 73,274 73,274 73,274

Accounts receivable 14,167 14,167 14,167

Other current assets 901 901 901

Long-term marketable securities 868 868 868

Investments 62 62 4,299

Total Financial Assets 105,431 15,068 — — 120,499 124,736

Financial Liabilities

Accounts payable and accrued liabilities 22,934 22,934 22,934

Accounts payable to related parties 1,122 1,122 1,122

Balance of sale payable 1,650 1,650 1,650

Long-term balance of sale payable 1,743 1,743 1,743

Total Financial Liabilities — — 27,449 — 27,449 27,449

2008

Financial Assets

Availablefor-sale

Availablefor-sale

Loans and

receivables

Other

financial

liabilities Derivatives Carrying value Fair value

$ $ $ $ $ $

Cash and cash equivalents 4,646 4,646 4,646

Marketable securities 14,753 14,753 14,753

Accounts receivable 17,889 17,889 17,889

Other current assets 158 158 158

Long-term marketable securities 1,943 1,943 1,943

Investments 3,131 1,067 594 4,792 4 5,144

Total Financial Assets 24,473 19,114 — 594 44,181 44,533

Financial Liabilities

Accounts payable and accrued liabilities 16,464 16,464 16,464

Accounts payable to related parties 1,384 1,384 1,384

Balance of sale payable 10,429 10,429 10,429

Total Financial Liabilities — — 28,277 — 28,277 28,277

4 In accordance with Section 3855, certain investments in private companies included in the balance above are carried at cost as there are no quoted market prices in

an active market for such equity instruments. Fair value has not been disclosed because fair value cannot be measured reliably.

56 — Paladin Annual Report 2009


19. Financial Instruments [cont’d]

[a] Fair values

Financial assets and liabilities

The carrying amounts of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued liabilities,

accounts payable to related parties and the short-term portion of the balance of sale payable are a reasonable estimate of their fair

values because of the short maturity of these instruments. The effective rate of return on marketable securities approximated 1.07%

during the year ended December 31, 2009 [2008 – 3.09%].

The long-term portion of the balance of sale payable has been recorded at its discounted value, using a discount rate of 2.50%

[2008 – 3.75%], and approximates its market value.

Cash, cash equivalents, marketable securities and investments were measured using level 1 in the fair value hierarchy. The balance

of sale payable was measured using level 2 in the fair value hierarchy.

[b] Risks arising from financial instruments

Concentration of credit risk and major customers

The Company’s cash and cash equivalents, short-term and long-term marketable securities are held through various institutions.

Marketable securities are mainly investments in liquid, high-grade investment securities. They are subject to minimal risk of changes

in value and generally have an original maturity from three months to eighteen months from the date of purchase. Marketable

securities are substantially all invested with large Canadian financial institutions, with a minor proportion of securities invested in

one large U.S. financial institution.

The Company is exposed to credit risk from its customers and continually monitors its customers’ credit. It establishes the provision

for doubtful accounts based upon the credit risk applicable to each customer. For the year ended December 31, 2009, two customers,

a major wholesale distributor and a major retail chain represented 29% and 15% of the Company’s sales, respectively [2008 — two

customers, a major wholesale distributor and a major retail chain represented 33% and 15% of the Company’s sales, respectively].

As at December 31, 2009, two customers, a major wholesale distributor and a major retail chain represented 10% and 14% of

trade accounts receivable, respectively [2008 — two customers, a major wholesale distributor and a major retail chain represented

40% and 11% of trade accounts receivable, respectively]. These above concentrations on the Company’s customers are considered

normal for the Company and its industry.

The following table provides further details on the Company’s accounts receivable balances:

2009 2008

$ $

Accounts receivables 19,188 21,869

Allowance for product returns (4,918) (3,783)

Allowance for doubtful accounts (103) (197)

Total accounts receivable 14,167 17,889

The following table provides the change in the allowance for doubtful accounts and product returns for trade accounts receivable:

2009 2008

$ $

Balance, beginning of the year 3,980 3,196

Change in allowance for product returns 1,135 650

Change in allowance for doubtful accounts (94) 134

Balance, end of year 5,021 3,980

Notes to Consolidated Financial Statements —57


19. Financial Instruments [cont’d]

The following table provides further details on trade accounts receivable past due but not provisioned:

2009 2008

$ $

Trade accounts receivables not past due 13,212 15,132

Trade accounts receivables past due and not provisioned

Under 30 days 4,402 4,573

31 to 60 days 1,269 1,967

Over 60 days 202 —

Allowance for product returns (4,918) (3,783)

Total accounts receivable, net of allowance for doubtful accounts and product returns 14,167 17,889

Liquidity risk

The Company generates sufficient cash from operating activities to fund its operations and fulfill its obligations as they become

due. The Company has sufficient funds available through its cash, cash equivalents and marketable securities to cover all financial

liability obligations should its cash requirements exceed cash generated from operations. As at December 31, 2009, there were no

restrictions on the flow of these funds nor have any of these funds been committed in any way, except as set out in Note 18.

All financial liabilities are short term in nature except for the long-term portion of the balance of sale payable, which is payable to

the extent of future product sales.

Foreign exchange risk

The Company principally operates within Canada, however, a portion of the Company’s revenues, expenses, and current assets and

liabilities, are denominated in United States dollars [“US$”] and EURO. This results in financial risk due to fluctuations in the value of

the US dollar and EURO relative to the Canadian dollar [“C$”]. The Company does not use derivative financial instruments to reduce

its foreign exchange exposure. Fluctuations in foreign exchange rates could cause unanticipated fluctuations in the Company’s

operating results, financial position or cash flows. The significant balances in foreign currencies as at December 31, 2009 and 2008

are as follows:

2009 2008

US dollars EURO US dollars EURO

$ € $ €

Cash and cash equivalents 1,845 581 960 —

Accounts receivable 138 1,499 754 1,268

Accounts payable and accrued liabilities (660) (206) (560) (300)

Based on the aforementioned net exposure as at December 31, 2009, and assuming that all other variables remain constant, a tenpoint

increase or decrease in the C$/US$ and C$/EURO exchange rate would have an aggregate effect of $419 [2008 — $212] on

net income.

Interest rate risk

The Company is subject to interest rate risk on its cash and cash equivalents and marketable securities. Details regarding maturity

dates and effective interest rates are described in Notes 4 and 7. The Company does not believe that the results of operations or cash

flows would be materially affected to any significant degree by a sudden change in market interest rates relative to interest rates on

the investments, owing to the relative short-term nature of the marketable securities.

58 — Paladin Annual Report 2009


20. Supplemental Disclosure for Consolidated Statements of Cash Flows

Effect on cash flows of net change in non-cash balances related to operations are as follows:

2009 2008

$ $

Accounts receivable 4,024 (5,969)

Other current assets (4,761) (5,474)

Other long-term assets (1,481) 716

Accounts payable and accrued liabilities 4,317 4,652

Other current liabilities 1,223 5,668

Other long-term liabilities 2,485 42

5,807 (365)

21. Management of Capital

The Company’s objectives when managing capital are:

• to safeguard the Company’s ability to continue as a going concern in order to provide returns for

shareholders; and

• to maintain a flexible capital structure which optimizes the cost of capital at acceptable risk.

In the management of capital, the Company includes shareholders’ equity alone in the definition of capital. The Company manages

the capital structure and makes adjustments to it in the light of changes in economic conditions and the risk characteristics of

the underlying assets. To maintain or adjust the capital structure, the Company may attempt to issue new shares, issue new debt,

acquire or dispose of assets or adjust the amount of cash and cash equivalents, short-term and long-term marketable securities

and investment balances.

The Company expects that its current capital resources will be sufficient to carry on its operations for the foreseeable future and is

not subject to any capital requirements imposed by a regulator or third parties.

22. Credit Facility

The Company has entered into a one-year $2,000 revolving unsecured credit facility with one of the Company’s bankers effective

August 10, 2009. The credit facility may be used for general corporate purposes including financing acquisitions.

Notes to Consolidated Financial Statements —59


23. Segmented Information

The Company operates in a single business segment focused on the in-licensing, acquiring, marketing, distributing and developing

pharmaceutical products in Canada and internationally. In addition, the Company earns interest income from the investment of its

excess cash. The Company carries out business in Canada, Barbados, the United States, Europe, Australia and New Zealand, and

substantially all of the Company’s tangible assets are located in Canada.

Revenues by geographic region are detailed as follows:

2009 2008

$ $

Canada 105,543 79,691

International 4,150 3,053

109,693 82,744

Revenues have been allocated to geographic regions based on the country of residence of the related customer.

Pharmaceutical product licenses and rights by geographic region are detailed as follows:

2009 2008

$ $

Canada 32,577 44,180

International 9,966 13,972

42,543 58,152

24. Product Pricing Regulation on Certain Patented Drug Products

Certain patented drug products within the Company’s portfolio of products are subject to product pricing regulation by the Patented

Medicine Prices Review Board [“PMPRB”]. The PMPRB’s objective is to ensure that prices of patented products in Canada are not

excessive. For new patented products, the price in Canada is limited to either the cost of existing drugs sold in Canada or the median

of prices for the same drug sold in other specified industrial countries. For existing patented products, prices cannot increase by

more than the Consumer Price Index. The PMPRB monitors compliance through a review of the average transaction price of each

patented drug product as reported by the Company over a recurring six-month reporting period.

25. Comparative Figures

Certain of the comparative figures have been reclassified to conform to the presentation adopted in the current year.

26. Subsequent Events

On March 3, 2010, the Company invested 4 million Euros in SpePharm Holding B.V. (“SpePharm”) in the form of a secured interestbearing

convertible debenture. SpePharm, a Dutch company with its registered office in Amsterdam, is a specialty pharmaceutical

company focused on acquiring, registering and marketing high medical value specialty medicines throughout Europe. As part of

the investment, the Company also received certain strategic collaborative rights including the exclusive license to a pharmaceutical

product in certain territories. Under the current financing terms, the conversion of the Company’s convertible debenture into equity

would provide Paladin with an approximate 10% ownership interest in SpePharm.

On March 16, 2010, the Company entered into a strategic investment to acquire an initial 34.99% ownership interest in Pharmaplan

(Pty) Ltd. (“Pharmaplan”), a privately-owned specialty pharmaceutical company based in Johannesburg, South Africa. The Company

paid an amount of approximately $18,800 in cash including a non-interest bearing loan in the amount of approximately $2,900.

In addition, the Company has committed to additional future consideration by annually increasing its ownership position by 5% over

the next 3 years to 49.99%, with such additional consideration based upon Pharmaplan’s future financial results.

60 — Paladin Annual Report 2009


Our Management Team

Jonathan Ross Goodman

President & CEO

Prior to co-founding Paladin Labs Inc., Mr. Goodman was a

consultant with Bain & Corporation and also worked in brand

management for Procter & Gamble. Mr. Goodman holds a BA

with Great Distinction from McGill University and the London

School of Economics with 1st Class Honours. Additionally,

Mr. Goodman holds an LLB and an MBA from McGill University.

Mr. Goodman is a member of the Bars of New York and

Massachusetts, in an Accredited Pharmaceutical Manufacturing

Representative and is a seasonal lecturer in pharmaceutical

entrepreneurship at McGill University. Mr. Goodman is a past

recipient of the Globe and Mail’s Top 40 Under 40 award and

was named Quebec Entrepreneur of the Year in the Life Sciences

by Ernst & Young in 2003. Mr. Goodman co-founded Paladin

Labs Inc. and has been President, Chief Executive Officer and a

director of Paladin since 1995.

Mark Beaudet

Vice President, Marketing & Sales

Since 1996, Mr. Beaudet has been a co-founder, Director and

Vice President of Sales and Marketing for Paladin Labs. Under

Mr. Beaudet’s direction, the Paladin Sales and Marketing team

has led over 30 major product launches and grown sales revenues

on average more than 25% in each of the last 10 years. Prior to

his work with Paladin, Mr. Beaudet held marketing management

positions at Procter & Gamble Canada and Pizza Hut Canada.

Samira Sakhia

Chief Financial Officer

Prior to joining Paladin, Ms. Sakhia held several leadership

positions at Discreet Logic Inc., including Controller of North

American Operations, Manager of International Financial Reporting

(Montreal, Quebec), and European Financial Manager (London,

England). Prior to working at Discreet Logic, Ms. Sakhia worked

as an auditor at Arthur Andersen & Co. Ms. Sakhia has received

a BComm in Finance and Accounting, and a MBA in Strategy and

Marketing, all from McGill University. In addition, Ms. Sakhia is a

Canadian-designated Chartered Accountant.

Mark Nawacki

Vice President Business & Corporate Development

Mr. Nawacki held several leadership positions with Pharmacia

Corporation, including all Canadian business development

activities. Before Pharmacia, Mr. Nawacki worked for the

Pillsbury Company in brand financial management, and prior to

this worked with Arthur Andersen’s Canadian practice providing

financial advisory services. Mr. Nawacki holds a BA in International

Relations and Russian and East European Studies and an MBA

both from the University of Toronto and is a Canadian-designated

Chartered Accountant.

Patrice Larose

Vice President, Scientific Affairs

Prior to joining Paladin, Dr. Larose was Vice President, Regulatory

Affairs, Drug Safety and Medical Services at Schering Canada

Inc. Before Schering, Dr. Larose was Assistant Director of

Medical Affairs at Ayerst Laboratories. Dr. Larose received a PhD

in Pharmaceutical Sciences from the University of Montreal. He

is a member of the Quebec Order of Pharmacists, the Canadian

Pharmacists Association, the Canadian Association of Professionals

in Regulatory Affairs, the Drug Information Association and the

Regulatory Affairs Professional Society.

Michael Freeman

Vice President, Government Affairs

Mr. Freeman joined Paladin in 2000 as Group Product

Director, Urology. He was promoted to Director of Marketing

in November 2003. In November 2005, he assumed the newly

created role of Vice President Government Affairs. Before joining

Paladin, Mr. Freeman held the position of Group Product Director

at Johnson & Johnson Consumer (Canada), and was responsible

for the Wound Care and Dental franchises. Mr. Freeman holds an

MBA degree from Queen’s University, as well as an LLB from the

University of Western Ontario. Prior to pursuing his MBA studies,

Mr. Freeman practiced law in Ottawa.

Joseph Walewicz

Vice President, Special Projects

Mr. Walewicz joined Paladin in 2009 as the Vice President,

Special Projects and also as the Chief Operating Office of Paladin

Biosciences. Prior to joining Paladin, Mr. Walewicz was an equity

analyst for nearly 12 years, most recently as Executive Director,

Institutional Equity Research at CIBC World Markets. Previously,

Mr. Walewicz was a Vice President and Senior Health Care

Analyst at Orion Securities and a Vice President, Equity Research

at BMO Nesbitt Burns. Mr. Walewicz holds a BA in Economics

and a BSc in Biochemistry from Queens University, an MBA from

McGill University and is a CFA Charterholder.

Paladin Annual Report 2009 —61


Board of Directors

Ted Wise †

Chairman (Since 1995)

Mr. Wise is a co-founder, previous President and then

Vice‐Chairman of Pharmascience Inc. Mr. Wise, a pharmacist

by profession, has more than forty years of experience in the

pharmaceutical industry, having worked for Ayerst Laboratories,

Winley-Morris Ltd. and ICN Canada.

Jonathan Ross Goodman

Director (Since 1995)

Prior to co-founding Paladin Labs Inc., Mr. Goodman was a

consultant with Bain & Corporation and also worked in brand

management for Procter & Gamble. Mr. Goodman holds a BA with

Great Distinction from McGill University and the London School

of Economics with 1st Class Honours. Additionally, Mr. Goodman

holds an LLB and an MBA from McGill University. Mr. Goodman

is a member of the Bars of New York and Massachusetts, in

an Accredited Pharmaceutical Manufacturing Representative

and is a seasonal lecturer in pharmaceutical entrepreneurship at

McGill University. Mr. Goodman is a past recipient of the Globe

and Mail’s Top 40 Under 40 award and was named Quebec

Entrepreneur of the Year in the Life Sciences by Ernst & Young

in 2003. Mr. Goodman co-founded Paladin Labs Inc. and has

been President, Chief Executive Officer and a director of Paladin

since 1995.

Mark Beaudet

Director (Since 1996)

Since 1996, Mr. Beaudet has been a co-founder, Director and

Vice President of Sales and Marketing for Paladin Labs. Under

Mr. Beaudet’s direction, the Paladin Sales and Marketing team

has led over 30 major product launches and grown sales revenues

on average more than 25% in each of the last 10 years. Prior to

his work with Paladin, Mr. Beaudet held marketing management

positions at Procter & Gamble Canada and Pizza Hut Canada.

Gerald McDole *†

Director (Since 2004)

Mr. McDole was President and CEO of AstraZeneca Canada

Inc. until his retirement in December 2003. He is the former

Chairman of the Advanced Coronary Treatment Foundation and a

former director of the Institute of Health Economics in Edmonton

and the Canadian Stroke Network. He is past President of the

Canadian Foundation for Pharmacy.

Joel Raby *

Director (Since 2007)

Mr. Raby is President of Joel Raby Asset Management investment

counsel and manages his family’s investment office. He is the

former Senior Vice President of Burgundy Asset Management

and is the founder and former President of Magna Vista Capital

Management Inc. He was a senior partner of Jarislowsky,

Fraser & Company in addition to holding positions in portfolio

management and investment analysis at the CN pension fund

and Jones Heward & Company.

James C. Gale

Director (since 2008)

Mr. Gale is the founding partner of Signet Healthcare Partners.

Prior to founding Signet Healthcare Partners, Mr. Gale was

head of principal investment activities and head of investment

banking for Gruntal & Co., LLC. Before joining Gruntal,

he originated and managed private equity investments for

the Home Insurance Co., Gruntal’s parent. Earlier in his career,

Mr. Gale was a senior investment banker at E.F. Hutton & Co.

Mr. Gale received his Masters of Business Administration from

the University of Chicago.

Robert Lande *

Director (Since 1995)

Mr. Lande is the Chief Financial Officer of Forex Capital Markets

LLC (FXCM), a foreign exchange broker serving retail and

institutional clients. Formerly, Mr. Lande was Managing Partner

of Riveredge Capital Partners LLC, a New York-based investment

firm. Prior to Riveredge Capital, Mr. Lande worked 17 years

within the BCE/Bell Canada group where his last position was

Chief Financial Officer of Telecom Américas Ltd., a joint venture

between Bell Canada International, SBC Communications and

the Telmex group. A Chartered Financial Analyst, Mr. Lande

holds an MBA from Concordia University and a BA in Economics

from McGill University in Montreal.

* Member of the Audit Committee

† Member of the Compensation Committee

62 — Paladin Annual Report 2009


Licensing Advisory Board (Lab)

Dr. Neil Fleshner MD, MPH, FRCSC

Head of the Division of Urology at the University Health Network in

Toronto (incorporating Princess Margaret Hospital) and Associate

Professor at the University of Toronto

Dr. Robert L. Reid MD

Professor, Department of Obstetrics and Gynecology and Chief,

Division of Reproductive Endocrinology at Queen’s University in

Kingston, Ontario

Dr. Peter Thomson BSc (Pharm), PharmD

Clinical Pharmacist for Internal Medicine at Health Sciences

Centre in Winnipeg Manitoba and Clinical Assistant Professor

with the Faculty of Pharmacy at the University of Manitoba

Dr. Luc Valiquette MD, FRCSC

Full Clinical Professor in the Department of Surgery at the

Université de Montreal and Chief of Urology Department at

the CHUM

Paladin Annual Report 2009 —63


Corporate Information

Paladin Labs Inc.

6111 Royalmount Avenue, Suite 102

Montreal, Quebec

H4P 2T4

T: 514-340-1112

F: 514-344-4675

Email: info@paladinlabs.com

www.paladinlabs.com

Stock Exchange Listing

Toronto Stock Exchange

Trading Symbol: PLB

Shares Outstanding

18,563,250 Common Shares

(at December 31, 2009)

Fiscal 2009 Trading Summary

High: $20.50

Low: $10.00

Close: $19.75

Average daily volume: 32,731

Transfer Agent

Computershare Investor Services Inc.

1-800-564-6253

Auditors

Ernst & Young LLP

Annual General Meeting

May 4, 2010 @ 5:00 PM

This annual report is also available

on the Internet at www.paladinlabs.com

Design and production by Equicom, a TMX Group company.


Paladin Labs Inc.

6111 Royalmount Avenue, Suite 102

Montreal, QC H4P 2T4

t: 514-340-1112

f: 514-344-4675

66 www.paladinlabs.com

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