SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
Consolidated Financial Statements for the
Years Ended December 31, 1999, 1998 and 1997, and
Independent Auditors' Report
<PAGE>
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, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999. 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, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999 in conformity with generally accepted accounting principles.
February 4, 2000
-2-
<PAGE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
------------------------------------------------------------------------------
ASSETS 1999 1998
CURRENT ASSETS:
Cash and cash equivalents $ 18,914,000 $ 18,672,000
Investment securities 40,230,000 41,412,000
Accounts receivable (net of allowance for doubtful
accounts of $206,000 and $250,000, respectively) 2,846,000 6,085,000
Inventories 1,972,000 2,350,000
Prepaid expenses and other current assets 1,549,000 2,410,000
Total current assets 65,511,000 70,929,000
PROPERTY AND EQUIPMENT - Net 436,000 514,000
INTANGIBLE ASSETS - Net 675,000 868,000
OTHER ASSETS 398,000 658,000
------------ ------------
$ 67,020,000 $ 72,969,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
CURRENT LIABILITIES:
Accounts payable $ 49,000 $ 1,281,000
Royalty payable 385,000 799,000
Medicaid payable 225,000 578,000
Other accrued expenses 464,000 587,000
Accrued research and development 5,369,000 2,924,000
Income taxes payable 6,602,000 8,280,000
Accrued sales returns 733,000 800,000
Accrued compensation 105,000 740,000
Amounts due to related parties 527,000 595,000
Total current liabilities 14,459,000 16,584,000
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 13,719
shares authorized, 11,297 shares issued - -
Retained earnings 53,013,000 56,837,000
Less treasury stock, 644 shares at cost (452,000) (452,000)
Total stockholders' equity 52,561,000 56,385,000
---------- ----------
$ 67,020,000 $ 72,969,000
========== ==========
See notes to consolidated financial statements.
<PAGE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
NET SALES $ 18,403,000 $ 43,557,000 $ 66,956,000
------------- ------------- ------------
COSTS AND EXPENSES:
Cost of sales 2,177,000 4,623,000 6,622,000
Marketing 2,180,000 4,587,000 5,757,000
Research and development 17,588,000 7,269,000 13,073,000
Administrative 5,203,000 6,449,000 7,338,000
---------- ---------- ---------
27,148,000 22,928,000 32,790,000
----------- ----------- ----------
(8,745,000) 20,629,000 34,166,000
OTHER INCOME - Net 3,526,000 3,612,000 2,735,000
---------- ---------- ---------
(LOSS) INCOME BEFORE INCOME TAXES (5,219,000) 24,241,000 36,901,000
PROVISION FOR INCOME TAXES (1,395,000) 9,635,000 12,924,000
------------ ---------- ----------
NET (LOSS) INCOME $ (3,824,000) $ 14,606,000 $ 23,977,000
============== ============= ============
See notes to consolidated financial statements.
</TABLE>
<PAGE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Common Stock Treasury Stock Retained Stockholders'
-------------------------- ---------------------------
Shares Amount Shares Amount Earnings Equity
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
Net loss ............... -- -- -- -- (3,824,000) (3,824,000)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1999 11,297 $ -- 644 $ (452,000) $ 53,013,000 $ 52,561,000
============ ============ ============ ============ ============ ============
See notes to consolidated financial statements.
</TABLE>
<PAGE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (3,824,000) $ 14,606,000 $ 23,977,000
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation and amortization 335,000 429,000 952,000
Deferred tax expense (benefit) 260,000 232,000 (8,000)
(Gain) loss on sale of property and equipment (1,000) 5,000 422,000
Changes in operating assets and liabilities:
Accounts receivable 3,239,000 (2,559,000) 2,646,000
Inventories 378,000 (1,273,000) 627,000
Prepaid expenses and other current assets 861,000 (1,144,000) 2,415,000
Accounts payable (1,232,000) 765,000 (135,000)
Royalty payable (414,000) (373,000) (454,000)
Medicaid payable (353,000) (109,000) -
Accrued research and development 2,445,000 (1,470,000) (184,000)
Other accrued expenses and related parties (893,000) (1,070,000) (1,709,000)
Income taxes payable (1,678,000) 3,181,000 (933,000)
------------ ---------- ---------
Net cash (used in) provided by operating activities (877,000) 11,220,000 27,616,000
---------- ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in investment securities 1,182,000 (25,449,000) (14,955,000)
Purchases of property and equipment (67,000) (12,000) (42,000)
Proceeds from sale of property and equipment 4,000 14,000 2,000,000
Decrease in other assets - 758,000 45,000
-- -------- ------
Net cash provided by (used in) investing activities 1,119,000 (24,689,000) (12,952,000)
---------- ------------- ------------
(Continued)
</TABLE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<S> <C> <C> <C>
1999 1998 1997
CASH FLOWS FROM FINANCING ACTIVITIES -
Dividends paid on common stock $ -- $ -- $ (16,000,000)
------------- ----------- ------------
Cash used in financing activities -- -- (16,000,000)
------------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 242,000 (13,469,000) (1,336,000)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 18,672,000 32,141,000 33,477,000
----------- ----------- ----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 18,914,000 $ 18,672,000 $ 32,141,000
============= ============= ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION -
Cash paid during the year for income taxes $ 2,152,500 $ 7,762,000 $ 12,092,000
============ ============ ============
See notes to consolidated financial statements.
</TABLE>
<PAGE>
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
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 requires the Company to pay royalties equal to 3.5% of
net sales of Eldepryl including sub-license revenues. The Company incurred
royalty expense of approximately $794,000, $1,730,000, and $2,716,000 for
the years ended December 31, 1999, 1998 and 1997, respectively. The
license agreement also required the Company to purchase the main raw
material used in the manufacture of Eldepryl from Chinoin through June of
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, 1999 and 1998, the
investment securities were available-for-sale, and there were no
material unrealized gains or losses. Proceeds from sales and
maturities of investments were $151,619,000 and $116,712,000, in
1999 and 1998, respectively. In 1999 there were $1,686,000 of
realized gains and $-0- of realized losses. There were $1,356,000 of
realized gains and $23,400 of realized losses in 1998. The gain or
loss on sale of investments 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.
<PAGE>
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.
i. New Accounting Pronouncements - In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
and for hedging activities. The provisions of this statement are
effective for all fiscal quarters of all fiscal years beginning after
June 15, 2000. Management is in the process of evaluating the impact
of this statement on the consolidated financial statements.
3. INVENTORIES
Inventories consist of the following at December 31, 1999 and 1998:
1999 1998
Raw materials $ 1,175,000 $ 1,853,000
Work in process 35,000 -
Finished goods 762,000 497,000
-------- -------
Total $ 1,972,000 $ 2,350,000
============ ===========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 1999 and
1998:
1999 1998
Machinery and equipment $ 1,124,000 $ 1,216,000
Furniture and fixtures 62,000 90,000
------- ------
1,186,000 1,306,000
Less accumulated depreciation 750,000 792,000
-------- -------
Property and equipment - net $ 436,000 $ 514,000
========== =========
<PAGE>
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, 1999, 1998 and
1997 was approximately $51,000, $97,000 and $261,000, respectively.
6. INTANGIBLE ASSETS
Intangible assets primarily represent the cost of a modification to the
terms of the Chinoin Agreement, less accumulated amortization of
$2,025,000, and $1,832,000 at December 31, 1999 and 1998, respectively.
7. CO-PROMOTIONAL AGREEMENT
The Company entered into an agreement with CoCensys, Inc. ("CoCensys") for
the promotion of Elderpryl in 1996. The agreement 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 $2,050,000
and $4,700,000 for the promotion and marketing of Elderpryl during 1999
and 1998, respectively. During 1997 the Company paid $3,800,000 pursuant
to these agreements with CoCensys. The marketing agreement with Watson was
terminated June 30, 1999.
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.
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 was recorded as
a reduction in other income in 1997.
<PAGE>
9. INCOME TAXES
The income tax provision consists of the following for the years ended
December 31, 1999, 1998 and 1997:
1999 1998 1997
Current (benefit) tax expense:
Federal $ (1,651,000) $ 7,800,000 $ 10,283,000
State (4,000) 1,603,000 2,549,000
Foreign -- -- 100,000
(1,655,000) 9,403,000 12,932,000
Deferred tax expense (benefit):
Federal 247,000 211,000 (7,000)
State 13,000 21,000 (1,000)
260,000 232,000 (8,000)
Total provision for income taxes $ (1,395,000) $ 9,635,000 $ 12,924,000
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, 1999 and 1998 are as follows:
<TABLE>
<S> <C> <C>
1999 1998
Deferred tax assets:
Chargeback and rebate allowances $ 391,000 $ 510,000
Deferred compensation 105,000 229,000
Other 124,000 100,000
-------- -------
620,000 839,000
Deferred tax liabilities - different methods of accounting
between financial and income tax reporting for depreciation
and amortization 284,000 243,000
-------- -------
Net deferred tax assets $ 336,000 $ 596,000
=========== =========
</TABLE>
<PAGE>
The statutory federal income tax rate is reconciled to the effective tax
rate as follows for the years ended December 31, 1999, 1998 and 1997:
1999 1998 1997
Tax at statutory rate (35.0)% 35.0 % 35.0 %
State income tax (net of federal benefit) -- 3.6 3.8
Tax credit reductions (credits) 10.6 (6.2) (7.9)
Tollgate tax -- 3.1 3.4
Other (2.3) 4.2 0.7
Effective tax rate (26.7)% 39.7 % 35.0 %
Tax credits result principally from operations in Puerto Rico. See Note 13.
10. RELATED PARTY TRANSACTIONS
The Company had certain transactions with one or both of its owners as
detailed below for the years ended December 31, 1999, 1998 and 1997:
1999 1998 1997
Management fees $ 929,000 $2,167,000 $3,348,000
Marketing and advertising 2,050,000 4,714,000 775,000
Research and development 821,000 232,000 90,000
Inventory handling and distribution fees 283,000 524,000 465,000
Rent - equipment and facilities 54,000 14,000 640,000
11. SIGNIFICANT CUSTOMERS
The Company had sales to certain customers which individually exceeded 10%
of sales. In 1999 sales to four major customers were $4,256,000,
$2,351,000, $2,308,500 and $2,242,000, respectively. 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.
12. EMPLOYEE BENEFIT PLANS
Effective January 1, 1998, the Company created a 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 1999, 1998 and 1997, the Company recorded expense of
$120,000, $120,000 and $-0-, respectively, under these plans.
<PAGE>
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
the Internal Revenue Code section 936.
Under the proposed adjustments, the Company could be subject to
approximately $34 million of additional income tax and interest charges
that have not been accrued at December 31, 1999. The increase of $20
million of potential additional income tax over the prior year is
primarily attributable to losses incurred in the current year and the
anticipation of losses in the near future which would not allow the
Company to utilize Puerto Rican tax credits.
In September of 1999, the Company's case was transferred from the
appellate level back to the agent level for further development of the
facts. Management believes that the Company has met all 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
In 1998, the Company was named as a defendant in a compliant 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
compliant alleged 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 filed an
answer to the complaint denying the allegations.
In 1999, a settlement agreement was reached with the Trustee. There was no
material effect to the Company as a result of this settlement.
* * * * * *
