ACTELION LTD AND SUBSIDIARIES

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Statements of Operations for the years ended December 31, 2005 and 2004

Consolidated Balance Sheets as of December 31, 2005 and 2004

Consolidated Statements of Cash Flows for the years ended December 31, 2005 and 2004

Consolidated Statement of Changes in Shareholders’ Equity for the years ended
December 31, 2005 and 2004

Report of group auditors

Notes to the consolidated financial statements

Note 1. Description of business and summary of significant accounting policies

Actelion Ltd (“Actelion” or the “Group”), a biopharmaceutical company headquartered in Allschwil, Switzerland, discovers, develops and commercializes innovative low molecular weight drugs for high unmet medical needs.

Basis of accounting

The Group’s consolidated financial statements have been prepared under accounting principles generally accepted in the United States of America (“US GAAP”) and are presented in Swiss francs (“CHF”). All periods presented are accounted for under US GAAP.

Use of estimates

The preparation of financial statements in conformity with US GAAP requires management to make judgments, assumptions and estimates that affect the amounts and disclosures reported in the financial statements and accompanying notes. On an on-going basis, management evaluates its estimates, including those related to revenue recognition for contract revenue, stock based compensation, purchase accounting and impairment. The Group bases its estimates on historical experience and on various other market-specific assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

Principles of consolidation

The consolidated financial statements include the accounts of the Group and its wholly-owned subsidiaries as well as affiliated companies in which the Group has a controlling financial interest and exercises control over their operations. All material intercompany transactions and balances have been eliminated in consolidation. Investments in affiliated companies which are 50% or less owned and where the Group exercises significant influence over operations are accounted for using the equity method.

Consistent with our policy for purchases or sales of equity by an investee, at the time a less than wholly-owned consolidated subsidiary sells its stock to unrelated parties at a price different than its book value, the Group’s net investment in that subsidiary changes. The Group records the resulting increase or decrease in its net investment as a gain or loss to the Group’s additional paid-in-capital.

Segment information

Statement of Financial Accounting Standards (“SFAS”) No. 131, ‘‘Disclosures about Segments of an Enterprise and Related Information’’, establishes standards for reporting information on operating segments in interim and annual financial statements. The Group’s chief operating decision-makers review the profit and loss of the Group on an aggregate basis and manage the operations of the Group as a single operating segment. Accordingly, the Group operates in one segment.

Revenue recognition

Product sales

The Group recognizes revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectibility is reasonably assured. Allowances are established for estimated uncollectible amounts, product returns and discounts. Generally, the Group ships products to its customers fully insured with shipping terms of DDU destination point.

Contract revenue

Contract revenue includes license fees and milestone payments associated with collaborations with third parties. The Group recognizes revenue from collaborative agreements when the services are performed and collectibility is reasonably assured, revenue from non-refundable, upfront license fees and performance milestones where the Group has continuing involvement is recognized over the estimated performance or agreement period, depending on the terms of the agreement. The recognition of revenue is prospectively changed for subsequent changes in the development or agreement period. Revenue associated with performance milestones where the Group has no continuing involvement or service obligation is recognized upon achievement of the milestone. Payments received in excess of amounts earned are classified as deferred revenue until earned.

Shipping and handling costs

The Group recognizes expenses relating to shipping and handling costs in cost of goods sold.

Research and development

Research and development expense consists primarily of compensation and other expenses related to research and development personnel; costs associated with pre-clinical testing and clinical trials of the Group’s product candidates, including the costs of manufacturing the product candidates; expenses for research and services rendered under co-development agreements; and facilities expenses. All research and development costs are charged to expense when incurred.

Payments made to acquire research and development assets, including those payments made under licensing agreements, that are deemed to have an alternative future use or are related to proven products are capitalized as intangible assets; otherwise, they are expensed as research and development costs.  For further information on payments made under the Group’s licensing agreements refer to Note 5, “Licensing agreements”.

Advertising costs

The Group expenses the costs of advertising, including promotional expenses, as incurred. Advertising expenses were CHF 71.9 million in 2005 and CHF 46.3 million in 2004.

Patents and trademarks

Costs associated with the filing and registration of patents and trademarks are expensed in the period in which they occur.

Taxes

The Group accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rules and laws that will be in effect when differences are expected to reverse. The Group performs periodic evaluations of recorded tax assets and liabilities and maintains a valuation allowance if deemed necessary. Significant estimates are required in determining income tax expense and benefits. Various internal and external factors may have favorable or unfavorable effects on the future effective tax rate, which would directly impact the Group’s financial position or results of operations. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, future levels of capital expenditures, and changes in overall levels of pretax earnings.

Earnings per share

Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and diluted common equivalent shares outstanding during the period using the treasury stock method for options, unless amounts are anti-dilutive.

Dividends

The Group may declare dividends upon the recommendation of the board of directors and the approval of shareholders at their annual general meeting.  Under Swiss corporate law, the Group’s right to pay dividends may be limited in specific circumstances.  The Group has not paid any cash dividends since inception and does not anticipate a dividend in the near to medium term.

Cash and cash equivalents

The Group considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Additionally, the Group includes all amounts held in money market funds as cash equivalents.

Short term deposits - Reclassification

The Group uses highly liquid low risk instruments with original maturities greater than 90 days. These short-term deposits with maturities greater than 90 days have been separated from cash and cash equivalents and are reported in a separate line in the consolidated balance sheet.  On the consolidated cash flow statement cash and cash equivalents was reclassified at the beginning and the end of the period to purchase of short-term deposits and withdrawal of short-term deposits. The respective impact on the consolidated cash flow from investing activities for the period ended December 31, 2004 and on cash and cash equivalents as of December 31, 2004 was CHF (104) million.

Marketable securities

The Group categorizes marketable securities as either “available-for-sale” or “held-to-maturity.”  Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity. Held-to-maturity securities are carried at amortized cost. Dividends and interest income are accrued as earned. Realized gains and losses are determined on an average cost basis. The Group reviews marketable securities for impairment whenever circumstances and situations change, such that there is an indication that the carrying amounts may not be recovered. Securities with unrealized losses for more than six months are presumed to be impaired, absent compelling evidence to the contrary. In addition, securities with unrealized losses for less than six months may be deemed impaired in certain circumstances.

Derivative instruments

A significant portion of the Group’s operations is denominated in foreign currencies, principally in US dollars and Euros. The inherent exposure may adversely impact the Group’s net income and net assets. The Group uses derivatives to partially offset market exposure to fluctuations in foreign currencies. The Group records all derivatives on the balance sheet at fair value. The Group’s derivative instruments, while providing effective economic hedges under the Group’s policies, do not qualify for hedge accounting as defined by SFAS No.133, "Accounting for Derivative Instruments and Hedging Activities". Changes in the fair value of any derivative instruments are recognized immediately in other financial income (expense) in the consolidated statements of operations. See Note 10, "Investments" for further information on the Group’s accounting for derivatives.
 
The Group does not regularly enter into agreements containing embedded derivatives. However, when such agreements are executed, an assessment is made of any embedded derivative based on the criteria outlined in SFAS No. 133 to determine if the derivative is required to be bifurcated and accounted for separately. See Note 10, “Investments” for further information on the Group’s accounting for these embedded derivatives.

Accounts receivable

The Group maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Group’s customers were to deteriorate, resulting in an impairment of their ability to make payments, an increase to the allowance might be required, which could affect future earnings.

Inventories

Inventories are stated at the lower of cost or market value with cost determined by the first-in first-out (FIFO) method. Inventories consist of intermediaries and finished products. If inventory costs exceed the expected market value due to obsolescence or unmarketability, a reserve is recorded for the difference between the cost and the market value.

Property, plant and equipment

Property, plant and equipment is recorded at historical cost less accumulated depreciation.

Depreciation expense is recorded utilizing the straight-line method over the estimated useful life of the asset. Assets are written down to their estimated residual value. Leasehold improvements and assets acquired under capital leases are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Assets acquired under capital leases in which title transfers to the Group at the end of the agreement are amortized over the useful life of the asset. Expenditures for maintenance and repairs are charged to expense as incurred.

The depreciation periods, in years, are as follows:

The carrying values of the Group’s long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the asset may not be recoverable. Specific potential indicators of impairment include:

• a significant decrease in the fair value of an asset;
• a significant change in the extent or manner in which an asset is used or a significant physical change in an asset;
• a significant adverse change in legal factors or in the business climate that affects the value of an asset;
• an adverse action or assessment by the U.S. Food and Drug Administration or another regulator;
• an accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset; and
• operating or cash flow losses combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an income-producing asset.

Should there be indication of impairment, an assessment will be made by comparing the estimated future cash flows expected to result from the use of the asset and its eventual disposition to the carrying amount of the asset. In estimating these future cash flows, assets are grouped at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the sum of the expected future cash flows (undiscounted and without interest changes) is less than the carrying amount of the asset, an impairment loss, measured as the excess of the carrying value of the asset over its fair value, will be recognized. The cash flow estimates used in such calculations are based on management's best estimates, using appropriate and customary assumptions and projections at the time.

Goodwill and intangible assets

Goodwill represents the excess of purchase price over the fair value of net assets acquired in a business combination. Pursuant to SFAS 142, "Goodwill and Other Intangibles", goodwill is not amortized and is regularly reviewed for impairment.

Intangible assets consist primarily of acquired existing licenses and internal use software, which is amortized on a straight-line basis over the economic lives of the respective assets, estimated at 11 and 3 years, respectively.

Stock-based compensation

On July 1, 2005, the Group adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share Based Payment – Revised 2004”, using the modified prospective transition method. Under this method, stock-based employee compensation cost is recognized in net income using the fair-value based method for all new awards granted after July 1, 2005. Additionally, compensation costs for unvested stock options and awards that were outstanding at July 1, 2005, are recognized in net income over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under the pro-forma disclosures under SFAS 123. Prior to the adoption of SFAS 123(R), the Group accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.

The Group’s unearned stock compensation balance of CHF (1.4) million as of June 30, 2005, which was accounted for under APB 25, was reclassified into the Group’s additional paid-in-capital upon the adoption of SFAS 123(R).

Fair values of awards granted under the stock option plans until December 2004 were estimated at grant or purchase dates using a Black-Scholes option pricing model. Fair value of awards granted after December 2004 were estimated by use of a Binomial Lattice option pricing model.

Comprehensive income (loss)

Comprehensive income (loss) is comprised of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities and currency translation adjustments. Comprehensive income (loss) for the years ended December 31, 2005 and 2004 has been reflected in the consolidated statement of changes in shareholders' equity.

Foreign currency exposure

Income, expense and cash flows of foreign subsidiaries are translated into the Group’s reporting currency at quarterly average exchange rates and the corresponding balance sheets translated at the period-end exchange rate. Exchange differences arising from the translation of the net investment in foreign subsidiaries and long-term internal financing are recorded, net of tax, in “currency translation adjustment” in shareholders’ equity.

Foreign currency transactions are accounted for at the exchange rates prevailing at the date of the transactions. Gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognized in the subsidiary’s statement of operations in the corresponding period.

Interest rate risk

Interest rate risk arises from movements in interest rates, which could have adverse effects on the Group’s net income or financial position. Changes in interest rates cause variations in interest income and expenses on interest-bearing assets and liabilities. In addition, they can affect the market value of certain financial assets, liabilities and instruments.

Recent accounting pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. Further, SFAS 151 requires that allocation of fixed and production facilities overheads to conversion costs should be based on normal capacity of the production facilities. The provisions in SFAS 151 are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Group does not expect that the adoption of SFAS 151 will have a significant effect on our financial position and results of operations.

In December 2004, the FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets” (“SFAS 153”). The provisions of this Statement are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The provisions of this Statement should be applied prospectively. The provisions of this statement also eliminate the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, and replace it with an exception for exchanges that do not have commercial substance. The Group does not expect that the adoption of SFAS 153 will have a significant effect on our financial position and results of operations.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). This statement clarifies the meaning of the term "conditional asset retirement" as used in Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” and clarifies when an entity has sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 requires the accelerated recognition of certain asset retirement obligations when a fair value of such obligation can be estimated. FIN 47 became effective for Actelion in the fourth quarter of 2005. This standard did not have a significant effect on the Group’s financial position and results of operations.

In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements — an amendment of APB Opinion No. 28” (“SFAS 154”).  SFAS 154 changes the requirements of the accounting for and reporting of a change in accounting principle and also provides guidance on the accounting for and reporting of error corrections. Prior to SFAS 154, most voluntary changes in accounting principle were recognized by including in net income of the period of change the cumulative effect of changing to the new accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, and to changes required by an accounting pronouncement in the instance that the pronouncement does not include specific transition provisions, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS 154 will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Group will apply the provisions of the standard as they relate to the Group going forward.

Note 2. Segment and geographic information

The Group operates in one segment, which is the business of discovering, developing and commercializing drugs for human health care. The chief operating decision makers review the profit and loss of the Group on an aggregated basis and manage the operations of the Group as a single operating segment. The Group currently derives product revenue from sales of Tracleer® for the treatment of pulmonary arterial hypertension and Zavesca® for the treatment of type I Gaucher's disease. Contract revenue is derived from collaboration and service agreements with third parties. Product revenue attributable to individual countries is based on location of the customer.

The Group’s geographic information is as follows:

Note 3. Axovan

On October 31, 2003, the Group acquired Axovan Ltd (“Axovan”), a privately-held biopharmaceutical company in Switzerland focused on the research and development of new compounds. The Group acquired all of the remaining common stock of Axovan for CHF 53 million. The Group acquired Axovan to gain access to Axovan’s licenses and to expand the Group’s research capacities.  

The acquisition was recorded as a business combination and, accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of the acquisition. Since the fair value of assets acquired and liabilities assumed exceeded the fair value of the consideration paid the Group then recorded a liability for contingent consideration for the difference.

The Group agreed to pay additional amounts to the shareholders of Axovan upon achievement of future product development milestones. In December 2004, a milestone payment of CHF 32.5 million became payable to former Axovan shareholders upon initiation of a Phase IIb/III clinical trial. This milestone was paid in January 2005 and allocated to contingent consideration with the exceeding amount allocated to goodwill. The total additional value of remaining milestone payments could total CHF 146 million. The Group considers all milestone payments to be performance-related measures and as such, treats them as goodwill.

Note 4. Sale of Hesperion

On February 9, 2004 the sale of Hesperion to Cerep SA was successfully completed at a total sales price of CHF 16.1 million. Of the total sales price, the Group received CHF 11.1 million for its 69% ownership in Hesperion, resulting in a gain of CHF 9.6 million. The financial statements as of and for the year ended December 31, 2004 reflects Hesperion as a discontinued operation.

Note 5. Licensing agreements

On March 19, 1998, the Group entered into a license agreement with F. Hoffman-La Roche (“Roche”) for tezosentan. Under this agreement, Roche granted the Group an exclusive worldwide right to manufacture and sell any product with tezosentan as its active ingredient. The license covers any human therapeutic use of tezosentan except acute renal failure and subarachnoid hemorrhage. The Group may also grant sub-licenses to third parties. The agreement called for the Group to make an initial payment to Roche as well as payments upon the achievement of certain milestones. The Group will make milestone payments upon the filing and approval of new drug applications in the United States and the European Union. If the Group is successful in obtaining regulatory approval for Veletri, the Group will pay a royalty to Roche based on a percentage of net sales of products with tezosentan as the active ingredient. No payments were made under this agreement during 2005 and 2004.

On November 4, 1998 the Group entered into a license agreement with Roche for bosentan, the active ingredient in the Group’s product, Tracleer®. The license grants the Group the exclusive worldwide rights to develop, manufacture, sell any pharmaceutical product with bosentan as its active ingredient for any human therapeutic use, and grant sub-licenses to third parties. The agreement called for the Group to make an initial payment to Roche as well as payments upon the achievement of certain milestones. All payments made to Roche prior to receiving regulatory approval were expensed as acquired in-process research and development costs. Payments made to Roche subsequent to receiving regulatory approval were capitalized and are being amortized over the life of the agreement. As of December 31, 2005 and 2004, payments of CHF 9 million are included in intangible assets and are amortized over 11 years. The agreement also calls for the Group to pay a royalty to Roche based on a percentage of net sales of products with bosentan as the active ingredient.

On November 22, 2002 the Group entered into a license agreement with Oxford GlycoSciences (“OGS”) for miglustat, the active ingredient of Zavesca®. OGS has since been acquired by Celltech Group plc which was subsequently acquired by UCB SA. In 1998, OGS in-licensed miglustat from G.D. Searle & Co. Under the Group’s license agreement with OGS, the Group had been granted exclusive marketing rights to sell Zavesca® in all countries except Israel and the adjacent West Bank and Gaza Strip territories. For the period from January 1, 2003 through November 17, 2005, the Group paid Celltech a royalty on net sales of Zavesca®.

On November 17, 2005, the Group replaced the existing license agreement and assumed full responsibility for manufacturing and supply chain, patent-related activities, clinical and pre-clinical activities of Zavesca®. In addition, the Group will ensure the drug supply to Teva, the license holder of Zavesca® in Israel, and was assigned all UCB rights and obligations under the Searle Licence. Actelion committed to an upfront payment to UCB, which was capitalized as an intangible asset, in exchange for a single-digit royalty rate on future Zavesca® sales in glycosphingolipid (GSL) storage disorders.

In conjunction with the acquisition of Axovan on October 31, 2003 the Group gained access to the license granted from Roche for clazosentan. In June 2004, the Group incurred a CHF 5 million in-process research and development charge in form of a milestone payment to Roche relating to this agreement. No such payments were made in 2005.

Note 6. Collaborative agreements

In July 1999, the Group entered into an agreement with a subsidiary of Johnson and Johnson (“J&J”). For the first three years of the agreement, J&J paid the Group for certain research and development costs incurred under the agreement. In October 2003, the agreement was amended to the effect that the Group would be the best place to continue development of the compounds covered by the collaboration. The Group therefore, has now sole rights for the ongoing development and potential commercialization of these compounds. If successful, the Group will pay J&J a single-digit royalty on sales generated from these compounds.

In February 2000, the Group entered into an agreement with Genentech Inc. (“Genentech”) for the co-exclusive, royalty-bearing right and license to research, develop, manufacture and sell tezosentan in the United States. Genentech may elect to co-promote the drug for certain indications in the United States or receive a royalty on net sales of tezosentan in the United States. Upon signing the contract the Group received an upfront payment, which is being recognized over the life of the agreement. For each of the years ended December 31, 2005 and 2004 the Group recognized revenue of CHF 1.5 million related to this agreement.

In December 2000, the Group entered into an agreement with Genentech for the co-exclusive, royalty-bearing right and license to research, develop, manufacture and sell bosentan, the active ingredient in Tracleer®, in the United States. Genentech receives a royalty on net sales of bosentan in the United States.  Upon signing the contract the Group received an upfront payment, a portion of which was refundable if the Group did not complete Phase III trials for bosentan for use in the treatment of chronic heart failure. The non-refundable portion of the upfront payment is being recognized over the agreement period, which began in December 2000.  In December 2001, the Group received FDA approval for bosentan in the United States for the treatment of pulmonary arterial hypertension and began paying Genentech a royalty on net sales.  In January 2002, the Group completed Phase III trials for bosentan for the use in the treatment of chronic heart failure and received neutral results. Upon completion of Phase III trials and receipt of the neutral results, the Group began recognizing the refundable portion of the upfront payment over the remaining agreement period. For each of the years ended December 31, 2005 and 2004 the Group recognized revenue of CHF 4.9 million related to this agreement.

In December 2003, the Group and Merck & Co., Inc. (“Merck”), formed an exclusive worldwide alliance to discover, develop and market new classes of renin inhibitors. This alliance enables the Group and Merck to combine their discovery, development and marketing capabilities with the goal to efficiently provide innovative and better medicines to patients suffering from cardio-renal diseases. Development funding will be initially shared by both parties, with Merck fully responsible to fund pivotal Phase III and outcome studies. Merck will lead and fund commercialization, the Group retains a worldwide option to co-promote any product resulting from this alliance as a paid-for sales force. Merck made upfront payments of USD 25 million following completion of technology transfer to Merck and, in March 2005, further USD 5 million on the selection of the first compound for full pre-clinical development. In addition, the Group will be eligible to receive additional payments of up to USD 242 million for the successful commercialization of the first collaboration product. The Group will also be eligible to receive certain milestone payments for the successful commercialization of additional products. Merck will pay the Group substantial royalties on the sale of all products resulting from this alliance. For the years ended December 31, 2005 and 2004, the Group recognized revenue of CHF 9.3 million and CHF 9.9 million, respectively, under this agreement.

Note 7. Income taxes

The following table sets forth the income before taxes:

The following table sets forth the current and deferred income tax expense:

Taxes payable and accrued as of December 31, 2005 amounted to CHF 9.1 million (2004: CHF 6.6 million). Significant components of the Group’s deferred tax assets as of December 31, 2005 and 2004 are shown below. A valuation allowance of CHF 21.6 million (2004: CHF 27.7 million) has been recognized for certain Group companies based on their historical cumulative operating losses.

The gross value of unused tax loss carry forwards with their expiry dates is as follows:

Reconciliation between the effective income tax expense and the Swiss statutory tax rate, which is 25%:

Note 8. Earnings per share

Earnings per basic and diluted share are based on weighted average common shares. and exclude anti-dilutive shares relating to employee stock options of 2,414,936 and 601,324 for the year ended December 31, 2005, and December 31, 2004, respectively. The following table sets forth the basic and diluted earnings per share calculation:

Note 9. Cash and cash equivalents

Cash and cash equivalents consisted of the following at December 31:

Note 10. Investments

Marketable Securities

In June 2005, management decided to buy investments of CHF 10.0 million with embedded derivative instruments. In accordance with US GAAP, the derivative instruments are required to be bifurcated and accounted for separately. The host instruments are categorized as available-for-sale securities, which are carried at fair value with unrealized gains and losses recorded in other comprehensive income. The fair values of the host contracts and the components of unrealized gains and losses recorded in other comprehensive income are shown in the table below.

No realized gains and losses on available-for sale securities were recorded in the income statement in 2005.

Financial Instruments

The following tables show the contract or underlying principal amounts and fair values of derivative financial instruments at December 31, 2005 and 2004. Contract or underlying principal amounts indicate the volume of business outstanding at the balance sheet date and do not represent amounts at risk. The fair values are determined by the markets or standard pricing models at December 31, 2005 and 2004, respectively.

Changes in the fair value of these derivatives are recognized in earnings, as they do not meet the definition of a hedge.

Note 11. Trade and other receivables

Trade and other receivables consisted of the following at December 31:

Note 12. Inventories

Inventories consisted of the following at December 31:

Note 13. Goodwill and other intangible assets

Changes in the net carrying amount of goodwill in 2005 are as follows:

The other intangible assets consisted of the following at December 31:

Amortization expense of other intangible assets is as follows:

The expected future annual amortization expense of other intangible assets is as follows:

Note 14. Property, plant and equipment

Property, plant and equipment consisted of the following at December 31:

Depreciation expense was CHF 10.6 million in 2005 and CHF 8.2 million in 2004.

Note 15. Accrued expenses

Accrued expenses consisted of the following at December 31:

In October 2003, the Group issued CHF 143.8 million in convertible bonds. The bonds are convertible into shares of the Group up to October 1, 2008. The bonds carry a zero coupon with a yield to maturity at the time of issuance of 4.75%. Except in the case of redemption after a substantial majority of the bonds have been converted or repurchased, or in the event that the Group becomes required to pay additional tax amounts, the Group may not call the bonds before October 15, 2006. The conversion price of the bonds is CHF 153.40 per share. If all bonds are converted into shares at this conversion price, the Group would issue an additional 937,093 shares, if not converted, the Group would pay a redemption price of 126.12% of the principal amount of the bonds. The fair value of the convertible bond at December 31, 2005 is 116.76% of the principal amount (CHF 167.8 million). Debt issuance costs amounted to CHF 3.2 million and were recorded in other non current assets.

At December 31, 2005 the aggregate amount of indebtedness of CHF 181,298 thousand is maturing on October 1, 2008.

Note 17. Lease commitments

Capital Leases

The following assets acquired under capital leases are included in property, plant and equipment:

The Group records interest expense relating to capital leases on a straight-line basis, which is not materially different from interest expense calculated using the imputed interest method.

Operating Leases

The Group has several operating leases for its office and research and development facilities and equipment around the world, including the Group’s most significant facilities in Switzerland, the United States and Japan. The leases expire between 2006 and 2020, most of them with options to extend for 1 to 5 years. The aggregate of the minimum annual operating lease payments are expensed on a straight-line basis over the term of the related lease. The amount by which straight-line rent expense differs from actual lease payments is recognized as either prepaid rent or deferred rent liability and is reduced in later years.

Future minimum payments under non-cancelable operating and capital leases at December 31, 2005 are as follows:

Rent expense under operating leases was CHF 15.7 million and CHF 12.7 million for the years ended December 31, 2005 and 2004, respectively.

In October 2003, the Group signed a lease agreement for a new building to be constructed within 2.5 years, being complete and fully functional in Q1 2006. The agreement contains a committed lease period of 15 years with an option to extend for another 10 years or an option to buy the building at market rates after the first lease period of 10 years has ended. Future payments under this lease agreement amount to a yearly lease expense of an estimated CHF 6.8 million, which are included in the table above.

Note 18. Retirement plans

The Group has entered into a term agreement with a third party insurance company to minimize the risk associated with a pension obligation. For accounting purposes this insurance contract represents the sole asset of the plan. This investment strategy was adopted as a means to reduce the uncertainty and volatility of the plan's assets for the Group. Fair value of plan assets is the estimated cash surrender value at the respective balance sheet date.

The Group maintains a pension plan covering all of its employees in Switzerland including its executive officers. In addition to retirement benefits, the plan provides benefits on death or long-term disability of its employees. The Group and its employees pay retirement contributions, which are defined as a percentage of the employees’ covered salaries, to a collective pension fund operated by an insurance company. Interest is credited to the employees’ accounts at the minimum rate provided in the plan, payment of which is guaranteed by an insurance contract, which represents the plan’s primary asset. Future benefit payments are managed by the insurance company. Net periodic benefit costs for the Group's defined benefit retirement plans for 2005 and 2004 include the following components:

The following tables provide the weighted-average assumptions used to develop net periodic benefit cost and the actuarial present value of projected benefit obligations:

The following tables set forth the change in benefit obligations and change in plan assets at December 31, 2005 and 2004 for the Group's defined benefit plans:

Amounts recognized in the Group’s balance sheet consist of the following:

The asset represents the difference between the cash surrender value of the insurance policy and the actuarially determined projected benefit obligation.
The accumulated benefit obligation, project benefit obligation and the plan assets at fair value consisted of the following:

Certain of the Group’s subsidiaries sponsor defined contribution plans. Total contribution expense to these plans in 2005 and 2004 was CHF 3,738,590 and CHF 2,734,751, respectively. The contribution payable at December 31, 2005 and 2004, was CHF 882,069 and CHF 435,807, respectively.

Note 19. Shareholders’ equity

Authorized capital

The Annual General Meeting of April 14, 2005 authorized an increase in share capital to be used for strategic purposes. The Board of Directors is authorized to increase until April 14, 2007 the share capital to an amount of not more than CHF 27.5 million by issuance of not more than 11 million fully paid-in registered shares with a nominal value of CHF 2.50 per share.

Conditional capital

Since inception, the Group has created conditional capital for the establishment of stock option plans and convertible bonds as well as for the potential issuance of shares in relation with certain credit facilities. At December 31, 2005, the Group has conditional capital of CHF 19.7 million.

Movements in conditional capital are as follows:

Treasury shares

At December 31, 2005 the Group held 6,197 treasury shares, which were acquired at an average price of CHF 75.41. During 2005, members of the Board of Directors received 5,353 shares out of the Group’s treasury stock.

Note 20. Stock-based compensation

Share-based payment arrangements

The Group has two share-based payment plans for employees and Members of the Board, which are described below. Total compensation costs recognized in the financial statements with respect to these plans are CHF 13.6 million and CHF 4.5 million for the years ending December 31, 2005 and December 31, 2004, respectively. Total related tax benefits of CHF 1.5 million were recognized for the year ending December 31, 2005, no tax benefits were recorded in 2004.

Fair values of awards granted under the stock option plans until December 2004 were estimated at grant or purchase dates using a Black-Scholes option pricing model. Fair value of awards granted after December 2004 were estimated by use of a Binomial Lattice option pricing model. The following assumptions have been applied:

Standard Share Option Plan

The Group issues standard stock options to employees and consultants, which generally vest over a four-year period with 25% of the options becoming exercisable each year. Options granted to members of the board out of the Group’s Directors’ Share Option Plan are immediately vested. One option is entitled to one share. Options generally expire ten years after the plan issuance date.

In 2005, the shareholders approved an increase in the total number of authorized shares by 1,000,000 to be used in connection with employee stock option plans. At December 31, 2005, there were 1,322,701 shares available for grant of future stock options.

The following table summarizes activities under the standard share option plan for the years ended December 31: