SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
Consolidated Financial Statements for the
Years Ended December 31, 1998, 1997 and 1996, and
Independent Auditors' Report
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Somerset Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Somerset
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Somerset Pharmaceuticals, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Pittsburgh, Pennsylvania
January 29, 1999
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- - --------------------------------------------------------------------------------
ASSETS 1998 1997
CURRENT ASSETS:
Cash and cash equivalents $ 18,672,000 $ 32,141,000
Investment securities 41,412,000 15,963,000
Accounts receivable (net of
allowance for doubtful accounts
of $206,000 and $250,000, respectively) 6,085,000 3,526,000
Inventories 2,350,000 1,077,000
Prepaid expenses and other current assets 2,410,000 1,266,000
----------- -----------
Total current assets 70,929,000 53,973,000
PROPERTY AND EQUIPMENT - Net 514,000 752,000
INTANGIBLE ASSETS - Net 868,000 1,066,000
OTHER ASSETS 658,000 1,648,000
------------ ------------
$ 72,969,000 $ 57,439,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
CURRENT LIABILITIES:
Accounts payable $ 1,281,000 $ 516,000
Royalty payable 799,000 1,172,000
Medicaid payable 578,000 687,000
Other accrued expenses 587,000 853,000
Accrued research and development 2,924,000 4,394,000
Income taxes payable 8,280,000 5,099,000
Accrued sales returns 800,000 906,000
Accrued compensation 740,000 600,000
Amounts due to related parties 595,000 1,433,000
----------- ----------
Total current liabilities 16,584,000 15,660,000
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 13,719
shares authorized, 11,297 shares issued - -
Retained earnings 56,837,000 42,231,000
Less treasury stock, 644 shares at cost (452,000) (452,000)
------------ ------------
Total stockholders' equity 56,385,000 41,779,000
------------ ------------
$ 72,969,000 $ 57,439,000
============ ============
See notes to consolidated financial statements.
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SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- - --------------------------------------------------------------------------------
1998 1997 1996
NET SALES $ 43,557,000 $ 66,956,000 $ 101,512,000
------------ ------------ -------------
COSTS AND EXPENSES:
Cost of sales 4,623,000 6,622,000 12,672,000
Marketing 4,587,000 5,757,000 6,263,000
Research and development 7,269,000 13,073,000 20,118,000
Administrative 6,449,000 7,338,000 9,574,000
------------ ------------ ------------
22,928,000 32,790,000 48,627,000
------------ ------------ ------------
20,629,000 34,166,000 52,885,000
OTHER INCOME - Net 3,612,000 2,735,000 1,732,000
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 24,241,000 36,901,000 54,617,000
PROVISION FOR INCOME TAXES 9,635,000 12,924,000 18,815,000
------------ ------------ ------------
NET INCOME $ 14,606,000 $ 23,977,000 $ 35,802,000
============ ============ ============
See notes to consolidated financial statements.
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SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- - ----------------------------------------------------------------------------------------------------------
Common Stock Treasury Stock Retained Stockholders'
----------------------- --------------------------------------------------
Shares Amount Shares Amount Earnings Equity
BALANCE, DECEMBER 31, 1995 11,297 $ - 644 $ (452,000) $ 34,452,000 $ 34,000,000
------ ---------- ----- ---------- ------------ ------------
Net income - - - - 35,802,000 35,802,000
Dividends - - - - (36,000,000) (36,000,000)
------ ---------- ----- ---------- ------------ ------------
BALANCE, DECEMBER 31, 1996 11,297 - 644 (452,000) 34,254,000 33,802,000
Net income - - - - 23,977,000 23,977,000
Dividends - - - - (16,000,000) (16,000,000)
------ ---------- ----- ---------- ------------ ------------
BALANCE, DECEMBER 31, 1997 11,297 - 644 (452,000) 42,231,000 41,779,000
Net income - - - - 14,606,000 14,606,000
------ ---------- ----- ---------- ------------ ------------
BALANCE, DECEMBER 31, 1998 11,297 $ - 644 $ (452,000) $ 56,837,000 $ 56,385,000
====== ========== ===== ========== ============ ============
See notes to consolidated financial statements.
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SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- - ----------------------------------------------------------------------------------------------------
1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 14,606,000 $ 23,977,000 $ 35,802,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 429,000 952,000 1,048,000
Deferred tax expense (benefit) 232,000 (8,000) (736,000)
Loss on sale of property and equipment 5,000 422,000 -
Deferred revenue - - (63,000)
Changes in operating assets and liabilities:
Accounts receivable (2,559,000) 2,646,000 7,703,000
Inventories (1,273,000) 627,000 4,847,000
Prepaid expenses and other current assets (1,144,000) 2,415,000 (1,438,000)
Accounts payable 765,000 (135,000) (861,000)
Royalty payable (373,000) (454,000) (3,050,000)
Medicaid payable (109,000) - -
Accrued research and development (1,470,000) (184,000) 2,657,000
Other accrued expenses (232,000) (1,521,000) 2,084,000
Income taxes payable 3,181,000 (933,000) 1,642,000
Amounts due to related parties (838,000) (188,000) (454,000)
----------- ----------- -----------
Net cash provided by operating activities 11,220,000 27,616,000 49,181,000
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in investment securities (25,449,000) (14,955,000) (828,000)
Purchases of property and equipment (12,000) (42,000) (251,000)
Proceeds from sale of property and equipment 14,000 2,000,000 -
Decrease in other assets 758,000 45,000 60,000
----------- ----------- -----------
Net cash used in investing activities (24,689,000) (12,952,000) (1,019,000)
----------- ----------- -----------
-5- (Continued)
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- - ------------------------------------------------------------------------------
1998 1997 1996
CASH FLOWS FROM FINANCING ACTIVITIES -
Dividends paid on common stock $ - $ (16,000,000) $(36,000,000)
------------ ------------- ------------
Cash used in financing activities - (16,000,000) (36,000,000)
------------ ------------- ------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (13,469,000) (1,336,000) 12,162,000
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 32,141,000 33,477,000 21,315,000
------------ ------------- ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 18,672,000 $ 32,141,000 $ 33,477,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION -
Cash paid during the year for
income taxes $ 7,762,000 $ 12,092,000 $ 20,409,000
============ ============ ============
See notes to consolidated financial statements.
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SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. PRINCIPLES OF CONSOLIDATION AND OPERATIONS
The consolidated financial statements include the accounts of Somerset
Pharmaceuticals, Inc. (the "Company") and its wholly owned subsidiaries,
Somerset Pharmaceuticals Holding Company and Somerset Caribe, Inc. The
Company is jointly owned by Mylan Laboratories, Inc. and Watson
Pharmaceuticals, Inc. ("Watson"), with each owning 50% of the outstanding
common stock of the Company. All significant intercompany accounts and
transactions have been eliminated in consolidation. The Company, incorporated
in February 1986, is engaged in the development, testing and marketing of
drugs to be used in the treatment of various human disorders. Currently, the
Company manufactures (at its facility in Puerto Rico), markets and sells
Eldepryl, which is used as a treatment for Parkinson's Disease. The Company
had exclusivity relating to the chemical compound Eldepryl for use as a
treatment for late stage Parkinson's Disease through June of 1996. In May
1996, the Company received approval from the Food and Drug Administration for
Eldepryl capsules and withdrew the tablet form from the marketplace.
Competitors entered the marketplace with a generic version of the tablet in
August 1996. The loss of exclusivity and the introduction of competitive
products has had and could continue to have a material impact on the
Company's future operating results.
The Company is party to an exclusive 14-year agreement (through November 22,
2003) with Chinoin Pharmaceutical Company ("Chinoin") of Budapest, Hungary
under which Eldepryl and other new potential drugs resulting from Chinoin
research are made available for licensing by the Company. The license
agreement required the Company to pay royalties equal to 7% of net sales of
Eldepryl including sub-license revenues. During 1996, the license agreement
was amended to reduce the Eldepryl royalties to 3.5% of net sales subsequent
to May 31, 1996. The Company incurred royalty expense of approximately
$1,730,000, $2,716,000, and $5,917,000 for the years ended December 31, 1998,
1997 and 1996, respectively. The license agreement also requires the Company
to purchase the main raw material used in the manufacture of Eldepryl from
Chinoin through June 1999.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Cash and Cash Equivalents - The Company generally considers debt
instruments purchased with a maturity of three months or less and
investments in money market accounts to be cash equivalents.
b. Investment Securities - The Company accounts for investment securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
At December 31, 1998 and 1997, the investment securities were
available-for-sale, and there were no material unrealized gains or losses.
Proceeds from sales and maturities of investments were $116,712,000 and
$44,973,000, in 1998 and 1997, respectively. In 1998 there were $1,356,000
of realized gains and $23,400 of realized losses. There were no material
realized gains or losses in 1997. There were no sales or maturities of
investments in 1996. The gain or loss on sale is based on the specific
identification method.
c. Inventories - Inventories are stated at the lower-of-cost or market, with
cost determined on a first-in, first-out basis.
-7-
d. Property and Equipment - Property and equipment are stated at cost.
Depreciation is provided over the estimated useful lives of the assets by
the straight-line method. Estimated useful lives are five to seven years.
e. Intangible Assets - Intangible assets are amortized on a straight-line
basis over 14 years.
f. Research and Development - Research and development costs are expensed as
incurred.
g. Concentration of Credit Risk - The Company's product is sold throughout
the United States principally to distributors and wholesalers in the
pharmaceutical industry. The Company performs ongoing credit evaluation of
its customers' financial condition and generally requires no collateral
from its customers.
h. Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of income and
expenses during the reporting period. Actual results could differ from
those estimates.
3. INVENTORIES
Inventories consist of the following at December 31, 1998 and 1997:
1998 1997
Raw material $ 1,853,000 $ 461,000
Work in process - 1,000
Finished goods 497,000 615,000
----------- -----------
Total $ 2,350,000 $ 1,077,000
=========== ===========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 1998 and
1997:
1998 1997
Machinery and equipment $ 1,216,000 $ 1,263,000
Furniture and fixtures 90,000 97,000
----------- -----------
1,306,000 1,360,000
Less accumulated depreciation 792,000 608,000
----------- -----------
Property and equipment - net $ 514,000 $ 752,000
=========== ===========
-8-
5. SUB-LICENSE OF RIGHTS
On February 9, 1988, the Company granted a sub-license to its exclusive right
and license to use its technology to Draxis Health Inc. (formerly Deprenyl
Research Limited) to commercialize certain drugs in Canada for 15 years. The
Company receives a royalty of 11% of Draxis Health Inc.'s net sales over the
license period.
Royalty income, net of related royalty expense payable to Chinoin, included
in other income for the years ended December 31, 1998, 1997 and 1996 was
approximately $97,000, $261,000 and $175,000, respectively.
6. INTANGIBLE ASSETS
Intangible assets primarily represent the cost of a modification to the terms
of the Chinoin Agreement, less accumulated amortization of $1,832,000, and
$1,639,000 at December 31, 1998 and 1997, respectively.
7. CO-PROMOTIONAL AGREEMENT
In 1990, the Company entered into an agreement with Sandoz Pharmaceuticals
Corporation ("Sandoz") to co-promote the product Eldepryl. The agreement
required Sandoz, among other things, to expend, at a minimum, a predetermined
amount for advertising during each year of the agreement. In December 1994,
the Company amended its co-promotional agreement with Sandoz. The amended
agreement eliminated certain residual period payments to Sandoz, shortened
the term to March 31, 1996, eliminated certain sales force detail
requirements and required certain payments to be made to the Company if a
predetermined level of sales was not achieved.
The Company had previously entered into an agreement with CoCensys, Inc.
("CoCensys") for the promotion of Elderpryl. The agreement was effective
January 1, 1996 and had an initial term of two years. Under the terms of the
original agreement, the Company would have compensated CoCensys, based on a
predetermined formula that considered both the number of new prescriptions
written and the net sales dollars achieved in each quarter. During 1996 and
1997, the agreement was modified with respect to term, new prescriptions and
detail calls. During 1997, CoCensys was acquired by Watson. The Company paid
Watson $4.7 million for the promotion and marketing of Elderpryl during 1998.
During 1997 and 1996, the Company expensed $3,800,000 and $1,230,000,
respectively, pursuant to these agreements with CoCensys. Additionally,
certain co-promotional fees paid by Sandoz at the commencement of the 1990
agreement were recognized ratably by the Company during the term of the
agreement (six years, expiring on March 31, 1996), and certain costs
associated with the procurement, negotiating and execution of the agreement
by the owners of the Company were incurred by the Company in approximately
the same amount.
8. OTHER INCOME
In November 1994, the Company prevailed in litigation it brought against
foreign defendants who were selling and marketing chemical compounds similar
to Eldepryl without FDA approval. In late 1997, a final judgment was rendered
by the United States Federal District Court. In November 1997, the Company
received and recorded as other income approximately $1,225,000 for settlement
of the litigation and reimbursement of related costs.
-9-
During November 1997, the Company sold its research and development facility
and related equipment with a net book value of approximately $3,422,000 for
$3,000,000. The resulting loss of $422,000 is recorded as a reduction in
other income. The Company financed in the form of a note $1,000,000 of the
sales price. The note receivable is collateralized by the facility and will
be collected in 60 monthly installments bearing interest at 8%. Current and
non-current portions are included with prepaid expenses and other current
assets and other assets, respectively, in the consolidated balance sheet at
December 31, 1997. In September 1998, the total outstanding portion of this
note receivable was received in full.
9. INCOME TAXES
The income tax provision consists of the following for the years ended
December 31, 1998, 1997 and 1996:
1998 1997 1996
Current tax expense:
Federal $ 7,800,000 $10,283,000 $15,257,000
State 1,603,000 2,549,000 4,194,000
Foreign - 100,000 100,000
----------- ----------- -----------
9,403,000 12,932,000 19,551,000
----------- ----------- -----------
Deferred tax expense (benefit):
Federal 211,000 (7,000) (669,000)
State 21,000 (1,000) (67,000)
----------- ----------- -----------
232,000 (8,000) (736,000)
----------- ----------- -----------
Total provision for income taxes $ 9,635,000 $12,924,000 $18,815,000
=========== =========== ===========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The tax
effects of significant items comprising the Company's deferred taxes (which
are included in "Other Assets" in the consolidated balance sheet) at December
31, 1998 and 1997 are as follows:
1998 1997
Deferred tax assets:
Chargeback and rebate allowances $ 510,000 $ 593,000
Deferred compensation 229,000 223,000
Inventory valuation allowance - 243,000
Other 100,000 95,000
--------- ---------
839,000 1,154,000
Deferred tax liabilities - different methods of accounting
between financial and income tax reporting for depreciation
and amortization 243,000 326,000
--------- ---------
Net deferred tax assets $ 596,000 $ 828,000
========= =========
-10-
The statutory federal income tax rate is reconciled to the effective tax rate
as follows for the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996
Tax at statutory rate 35.0 % 35.0 % 35.0 %
State income tax (net of federal benefit) 3.6 3.8 3.6
Tax credits (6.2) (7.9) (9.5)
Tollgate tax 3.1 3.4 4.0
Other 4.2 0.7 1.3
---- ---- ----
Effective tax rate 39.7 % 35.0 % 34.4 %
==== ==== ====
Tax credits result principally from operations in Puerto Rico.
See Note 13.
10.RELATED PARTY TRANSACTIONS
The Company incurs expenses for ongoing management services and over a
six-year period (which ended March 31, 1996) for specific services related to
the procurement, negotiation and execution of the original co-promotion
agreement by one of the owners of the Company. The Company also has other
transactions with one or both of its owners as detailed below for the years
ended December 31, 1998, 1997 and 1996:
1998 1997 1996
Management fees $ 2,167,000 $ 3,348,000 $ 5,076,000
Marketing and advertising 4,714,000 775,000 -
Research and development 232,000 90,000 1,250,000
Inventory handling and distribution fees 524,000 465,000 519,000
Rent - equipment and facilities 14,000 640,000 1,217,000
11.SIGNIFICANT CUSTOMERS
The Company had sales to certain customers which individually exceeded 10% of
sales. In 1998 sales to three major customers were $8,983,000, $8,013,000 and
$6,953,000, respectively. In 1997 sales to five major customers were
$15,878,000, $13,498,000, $11,427,000, $8,658,000 and $7,746,000,
respectively. In 1996 sales to three major customers were $23,200,000,
$21,259,000 and $18,692,000, respectively.
12.EMPLOYEE BENEFIT PLANS
Effective January 1, 1998, the Company created a new defined contribution
profit sharing plan covering substantially all employees. Contributions are
made at the discretion of the Board of Directors. The defined contribution
profit sharing plan in effect prior to 1998 was terminated as of December 31,
1997. Additionally, during 1994, the Company initiated a deferred
compensation plan for certain key employees which was terminated during 1997.
During 1998, 1997 and 1996, the Company recorded expense of $120,000, $-0-
and $954,000, respectively, under these plans.
-11-
13.CONTINGENCIES
IRS
In connection with an examination of the Company's Federal tax returns for
the three years ended December 31, 1995, representatives of the Internal
Revenue Service, in June 1997, issued to the Company a report that contains
proposed adjustments to the Company's use of tax credits under Internal
Revenue Code section 936.
Under the proposed adjustments, the Company could be subject to approximately
$14 million of additional income tax and interest charges that have not been
accrued at December 31, 1998.
Management believes that the Company has met all of the requirements to
qualify for the tax credits available under Internal Revenue Code section
936, and intends to vigorously defend its position on this matter.
FoxMeyer
The Company has been named as a defendant in a complaint filed by the trustee
to the bankruptcy estates of FoxMeyer Corporation and its related entities in
the U.S. Bankruptcy Court for the District of Delaware. The complaint alleges
that the Company received preferential payments of approximately $3.4 million
from the bankruptcy estates and seeks reimbursement from the Company of such
amounts. The Company has filed an answer to the complaint denying the
allegations.
In the opinion of management, the outcome of these proceedings should not
have a material adverse effect on the Company's financial position or results
of operations.
* * * * * *
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