On March 7, 2002, we announced that we had entered into an agreement
with Eli Lilly and Company dated February 18, 2002 to acquire,
through our wholly owned subsidiary, NeoSan Pharmaceuticals Inc., the U.S.
rights and related intangibles associated with the Darvon and Darvocet branded
product lines for up to $211.4 million, payable at closing. The completion of
this transaction is subject to regulatory review of our recent filing with
respect to the acquisition under the Hart-Scott-Rodino Antitrust Improvements
Act of 1976, as well as our obtaining permanent debt financing.
The Darvon and Darvocet products are prescribed for the treatment of
mild to moderate pain. The acquired products include Darvon (propoxyphene
hydrochloride), Darvocet-N (propoxyphene napsylate and acetaminophen) and
Darvon-N (propoxyphene napsylate). We are acquiring the Darvon and Darvocet
brands because we believe they have high customer recognition in the pain
management therapeutic class, an area where we currently have products under
development. Our goal is to increase the value of these brands by actively
marketing and promoting them and repositioning them through the development of
line extensions. We believe that these brands will respond positively to the
marketing and promotional support that we intend to provide. Specifically, we
intend to enhance the value of the Darvon and Darvocet brands by:
- actively promoting the Darvon and Darvocet brands with our sales
force;
- increasing our sales force from 20 to 50 people;
- creating incentives for this sales force to generate new
prescriptions for Darvon and Darvocet;
- working with respected physicians at leading pain clinics to develop
pain-management guidelines that specify the use of the Darvon and
Darvocet products;
- targeting our brand promotion towards high-prescribing physicians;
and
- developing, marketing and promoting improved products and line
extensions with improved product, delivery, and therapeutic
characteristics and potential regulatory and patent exclusivity.
These product lines have been sold in the U.S. for over 25 years, with
the initial marketing of Darvon beginning in 1957. Darvon lost its patent
exclusivity in 1973 and Darvon-N and Darvocet-N in 1985. The first generic
version of Darvon was introduced in 1973, and by 1985 numerous generic products
were being marketed for substitution for Darvon and Darvocet. We believe that
Eli Lilly ceased actively promoting these brands in approximately 1993.
Product Market.
Darvon and Darvocet compete primarily in the pain management market,
especially with products indicated for the management of mild to moderate pain.
According to Scott-Levin data, the size of the U.S. pain management market has
grown to approximately $16 billion in 2001, from $6.4 billion in 1995. The
Darvon and Darvocet products compete with a large number of other branded and
generic products generally used to treat mild to moderate pain, including Ultram
and other non-steroidal anti- inflammatory drugs, or NSAIDs, such as ibuprofen.
We believe these products comprise approximately 50% of the total U.S. pain
management market.
Each of the Darvon and Darvocet products currently faces competition
from generic products, and two of the world's largest manufacturers of generic
products, Teva Pharmaceutical Industries Ltd. and Mylan Laboratories Inc.,
manufacture generic substitutes to the Darvon and Darvocet products. These
generic substitutes are sold at significantly lower prices than Darvon or
Darvocet, due to the significantly lower costs associated with them. While
precise data on generic substitution is not available, we believe a vast
majority of the prescriptions written for Darvon and Darvocet are filled with
generic propoxyphene products.
Product Line Strategy.
This acquisition will provide us with a significant position in the
pain management therapeutic class, which is one of our targeted therapeutic
classes. Our goal is to increase the value of these brands by actively marketing
and promoting them and repositioning them through the development of line
extensions.
Specifically, we seek to enhance the value of Darvon and Darvocet by
increasing the size of our contract sales force from approximately 20 to 50
people and creating sales incentives with respect to these products.
Additionally, we intend to individually target high-prescribing physicians in an
effort to boost sales of Darvon and Darvocet. We also plan to work with
respected physicians at leading pain clinics to develop pain-management
guidelines that specify the use of our Darvon and Darvocet products. These
clinics provide guidelines to primary-care physicians for the proper management
and selection of products to treat pain.
We plan to develop improved products and line extensions with improved
product, delivery, and therapeutic characteristics and potential regulatory and
patent exclusivity. For example, we are considering the development of a liquid
form of Darvocet, a formulation of these products that could be taken twice a
day, and some products that would combine propoxyphene, the active ingredient in
Darvon and Darvocet, with a non-steroidal anti-inflammatory drug.
Acquisition Terms.
We will pay a purchase price of $211.4 million in cash for the rights
in the U.S. to these products and Eli Lilly's existing inventory of these
products. This amount will be reduced in the event that net sales by Eli Lilly
of Darvon and Darvocet products from February 1, 2002 until the day before
closing are greater than target net sales for that period calculated at a
monthly rate of $4.167 million. If actual net sales during that period exceed
the target, then the purchase price will be reduced by 90% of the excess amount.
The purchase price will further be reduced by up to $18 million if net sales of
the Darvon and Darvocet products during a 12-month measurement period are less
than targeted levels. The measurement period will be any 12 months, as selected
by Eli Lilly, ending on any calendar month end from December 31, 2002 until the
month end following the first anniversary of the closing -- that is, March 31,
2003 if the acquisition is completed in March 2002. If net sales are less than
$50 million during the 12-month measurement period, the purchase price will be
reduced incrementally by $0.9 million for each $250,000 that actual sales are
below $50 million. The maximum amount of this post-closing reduction is $18
million. The amount of this reduction is to be paid by Eli Lilly to us following
confirmation of the amount of net sales during the measurement period. In
addition, we have agreed to pay Eli Lilly royalties upon sales of our future
developed improvements to the Darvon and Darvocet products or other products
containing the active ingredient propoxyphene and any other pharmaceutical
products sold under the name Darvon, Darvocet or certain other defined
trademarks. We will pay a royalty on sales of each of these future products
during each calendar quarter for a ten-year period beginning upon the product's
commercial introduction, provided that the total net sales of all of these
future products, combined with the total net sales of the current Darvon and
Darvocet products, exceed $15.8 million in the applicable calendar quarter. We
will not owe any royalties on the sales of the Darvon and Darvocet products
themselves that we acquire from Eli Lilly.
Supply of Product.
Under a manufacturing agreement that we have entered into with Eli
Lilly at the time we signed the acquisition agreement, Eli Lilly has agreed upon
closing to supply a specified percentage of our requirements from and after
closing for the 12 Darvon and Darvocet product presentations (form and dosage)
currently being sold by Eli Lilly. The supply agreement will extend through
December 31, 2004. Upon the satisfaction of certain conditions, we may extend
the agreement for an additional six months, during which Eli Lilly will use
commercially reasonable efforts to supply NeoSan with a full calendar year's
supply of products during the extension period, subject to certain maximum and
minimum quantities. Under this agreement, we have agreed to order the
manufacture of certain minimum amounts of Darvon and Darvocet products and
certain minimum percentages of our requirements: 60% of our requirements in the
first year, 50% in the second year, and 40% in the third year. Also under this
agreement, the supply obligation of Eli Lilly is subject to a maximum amount of
the Darvon and Darvocet products over the life of the contract. We anticipate
that this maximum supply obligation of Eli Lilly is sufficient to cover all of
our supply needs through the end of 2005. We will purchase these products
manufactured by Eli Lilly for a fixed unit cost, subject to a percentage
increase on each January 1 (beginning on January 1, 2003) plus any increase in
Eli Lilly's cost of raw materials during that year. However, the purchase price
for these products will be no less than Eli Lilly's standard cost of
manufacturing, which includes raw materials, direct labor, and plant overhead
attributable to the Darvon and Darvocet products. Prior to expiration of this
agreement, we intend to have FDA approval permitting the transfer of the
manufacturing of these products to our manufacturing facilities, one or more
third-party manufacturing facilities, or a combination of these facilities. This
approval, however, could require much more time and it is possible that we never
receive it.
Historical Revenues.
The Darvon and Darvocet product lines had net sales of $62.9 million in
2001, compared to $56.5 million in 2000 and $49.5 million in 1999. Average
monthly net sales of Darvon and Darvocet were $4.1 million in 1999, $4.7 million
in 2000 and $5.2 million in 2001. However, net sales of these products were $3.4
million in January 2002, $3.9 million in December 2001 and $3.1 million in
November 2001. We believe that the levels of net sales in 1999 and 2000 are more
indicative of future sales levels than the elevated sales levels in 2001 or the
reduced sales levels during the three months ended January 31, 2002. Although we
have focused on the longer-term trends in evaluating the acquisition of these
product lines, this decrease in monthly sales may not be temporary and sales
levels may never return to the range existing in 1999 and 2000. If sales
continue at these recent levels, annual product sales of Darvon and Darvocet
will be less than $42 million, or 33.9% less than the amount shown in our pro
forma financial statements appearing elsewhere in this report. Any prolonged
decrease in sales of these products or the failure to return to the sales levels
existing in 1999 and 2000 will have a material adverse effect on our business,
results of operations and financial condition.
Acquisition Financing.
We are currently seeking senior secured and senior subordinated debt
financing of an aggregate of $350 million to fund the acquisition of these
product lines, to repay indebtedness outstanding under our existing loan
agreement, to terminate our tax retention operating lease and purchase the
underlying properties, and pay related fees and expenses. Our obligation to
complete the acquisition of these product lines is contingent on obtaining this
financing.
Our proposed senior secured credit facilities consist of a $75.0
million five-year revolving credit facility and a $100 million five-year term
loan facility. As proposed, the term loan facility will amortize over the full
five-year term, with amortization of $5.0 million, $15.0 million, $20.0 million,
$25.0 million and $35.0 million, respectively, in years one through five of the
facility. The revolving credit facility is not tied to a borrowing base. Our
proposed senior credit facilities provide for variable interest rates based on
LIBOR or base rate, at our option. Such facilities will be guaranteed by all of
our domestic subsidiaries and secured by a security interest on substantially
all of our domestic assets, all of the stock of our domestic subsidiaries and
65% of the stock of our material foreign subsidiaries directly owned by us or
one of our domestic subsidiaries. The proposed senior credit facilities will
require the payment of certain commitment fees based on the unused portion of
the revolving credit facility. Under the terms of the credit agreement for the
proposed senior credit facilities, we will be required to comply with various
covenants including, but not limited to, those pertaining to maintenance of
certain financial ratios and incurrence of additional indebtedness. The proposed
senior credit facilities may be optionally prepaid at any time without a
premium.
Our proposed issuance of senior subordinated debt will consist of $175
million of senior subordinated notes due 2010. The notes will have a fixed
interest rate to be established prior to the closing of the acquisition of
Darvon and Darvocet. The notes will be guaranteed on a subordinated basis by all
of our existing domestic subsidiaries and all of our future domestic
subsidiaries of which we and/or our subsidiaries own 80% or more of the equity
interests. The notes will not be secured. For the first three years, up to 35%
of the notes will be redeemable with the proceeds of qualified sales of equity
at a premium redemption price. On or after the fourth anniversary of the
issuance of these notes, all or any portion of the notes will be redeemable at a
premium redemption price. Under the terms of the proposed indenture for the
notes, we would be required to comply with various covenants including, but not
limited to, a covenant relating to incurrence of additional indebtedness.
Additional Information.
The financial statements for the Darvon and Darvocet product lines
included in this report do not include the full financial statements required by
Rule 3-05 of Regulation S-X. The Darvon and Darvocet product lines did not
represent a stand-alone entity prior to our acquisition. No separate, audited
financial statements of the Darvon and Darvocet product lines had been prepared
prior to our acquisition, and Eli Lilly did not maintain the distinct and
separate accounts necessary to present full financial statements for the
respective product line. As a result, it is impracticable for us to provide full
audited financial statements for the Darvon and Darvocet product lines,
including balance sheets and statements of cash flows, or other information
regarding operating, investing and financing cash flows.
This report contains certain forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including the statements
pertaining to whether we will obtain permanent financing and complete the
acquisition of the Darvon and Darvocet product lines. These statements involve
risks and uncertainties pertaining to our ability to successfully obtain
permanent financing and complete the acquisition, including adverse changes in
the markets for senior secured loans and senior subordinated notes that are
beyond our control, obtaining anticipated ratings for our proposed senior credit
facility and senior subordinated notes from appropriate rating agencies, and
other factors that may be beyond our control. In addition, our acquisition
agreement with Eli Lilly provides that Eli Lilly may terminate the agreement if
we do not complete the acquisition of the Darvon and Darvocet product lines by
March 15, 2002. We believe there is substantial risk that we will not be able to
arrange necessary permanent financing prior to March 15, 2002 to permit us to
complete the acquisition by that date.
We undertake no obligation to update the forward-looking statements we
have included in this report, other than to report the completion of the
acquisition of the Darvon and Darvocet product lines if we complete the
transaction.
2
Item 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
DARVON(R)/DARVOCET(R) PRODUCT LINE OF ELI LILLY AND COMPANY
Report of Independent Auditors...................................................... F-1
Special Purpose Statements of Product Contribution For Years
Ended December 31, 1999, 2000, and 2001............................................. F-2
Notes to Special Purpose Statements of Product Contribution......................... F-3
(b) Pro Forma Financial Information
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
FOR ACQUISITION OF THE DARVON AND DARVOCET PRODUCT LINES
aaiPharma Inc. Unaudited Pro Forma Consolidated Balance Sheet
at December 31, 2001............................................................ F-5
Notes to Unaudited Pro Forma Consolidated Balance Sheet......................... F-6
aaiPharma Inc. Unaudited Pro Forma Consolidated Statement of
Operations for the Year Ended December 31, 2001................................. F-7
Notes to Unaudited Pro Forma Consolidated Statements of Operations.............. F-8
FOR ACQUISITION OF THE M.V.I., AQUASOL, BRETHINE, DARVON AND DARVOCET PRODUCT LINES
Unaudited Pro Forma Consolidated Financial Statements........................... F-9
aaiPharma Inc. Unaudited Pro Forma Consolidated Balance Sheet
at December 31, 2001............................................................ F-10
Notes to Unaudited Pro Forma Consolidated Balance Sheet......................... F-11
aaiPharma Inc. Unaudited Pro Forma Consolidated Statement of
Operations for the Year Ended December 31, 2001................................ F-12
Notes to Unaudited Pro Forma Consolidated Statements of
Operations..................................................................... F-13
3
(c) Exhibits
Exhibit 23.1 Consent of Ernst & Young LLP
4
REPORT OF INDEPENDENT AUDITORS
Chief Accounting Officer
Eli Lilly and Company
Indianapolis, Indiana
We have audited the accompanying special-purpose statements of product
contribution for the Darvon(R)/Darvocet(R) Product Line of Eli Lilly and Company
for the years ended December 31, 2001, 2000, and 1999. The statements of product
contribution are the responsibility of the Company's management. Our
responsibility is to express an opinion on these special purpose statements
based on our audits.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the statements of product
contribution are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the statement
of product contribution. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the statement of product contribution. We
believe that our audits provide a reasonable basis for our opinion.
The operations covered by the statements of product contribution referred to
above have no separate legal status or existence. The accompanying statements
were prepared as described in Note 1 to present the direct revenues and standard
cost of sales of the Darvon(R)/Darvocet(R) Product Line and are not intended to
be a complete presentation of Darvon(R)/Darvocet(R) Product Line results.
Furthermore, the amounts in the accompanying statements are not necessarily
indicative of the costs and expenses that would have resulted if the
Darvon(R)/Darvocet(R) Product Line had been operated as a separate entity.
In our opinion, the statements referred to above present fairly, in all material
respects, the product contribution for the Darvon(R)/Darvocet(R) Product Line of
Eli Lilly and Company for the years ended December 31, 2001, 2000, and 1999 in
conformity with accounting principles generally accepted in the United States
and the basis of presentation described in Note 1.
/s/ Ernst & Young LLP
Indianapolis, Indiana
January 28, 2002
F-1
Darvon(R)/Darvocet(R) Product Line
of Eli Lilly and Company
Special Purpose Statements of Product Contribution
Years Ended December 31, 2001, 2000, and 1999
(Dollars in thousands)
Year Ended Year ended Year ended
December 31, December 31, December 31,
2001 2000 1999
------------ ------------ ------------
Net Sales $62,902 $56,541 $49,452
Standard Cost of Sales 4,757 3,828 3,267
------- ------- -------
Net Product Contribution $58,145 $52,713 $46,185
======= ======= =======
SEE ACCOMPANYING NOTES TO THE SPECIAL PURPOSE STATEMENTS OF PRODUCT
CONTRIBUTION.
F-2
Darvon(R)/Darvocet(R)Product Line of Eli Lilly and Company
Notes to Special Purpose Statements of Product Contribution
Years Ended December 31, 2001, 2000, and 1999
(Dollars in Thousands)
1. BASIS OF PRESENTATION
The Darvon(R)/Darvocet(R) Product Line (the "Product") includes all formulations
of the analgesics Darvon(R)/Darvocet(R) that are sold under the Eli Lilly and
Company (the "Company") brand names. The special purpose financial statements
include sales of the Product in the United States and Puerto Rico.
Historically, financial statements were not prepared for the Product. These
statements have been developed from the historical accounting records of the
Company and represent the direct revenues and standard costs of sale of the
Product. Manufacturing capacity variances are not included in standard cost of
sales, as discussed in Note 2. Further, no marketing or selling costs are
included in the financial statements as the Company did not promote the Product
during the periods presented.
All of the estimates in the financial statements, as described in Note 2, are
based on assumptions that Company management believes are reasonable. However,
these estimates are not necessarily indicative of the net sales and costs that
would have resulted if the Product had been operated as a separate entity.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue from sales of products is recognized at the time title of goods passes
to the buyer and the buyer assumes the risks and rewards of ownership. This is
generally at the time products are shipped to the customer. Provisions for
discounts and rebates to customers are established in the same period the
related sales are recorded.
NET SALES
Net sales include certain sales deductions. Sales deductions include deductions
specifically attributable to the Product and deductions allocated to the Product
by management. The types of deductions included in the calculation of net sales
are as follows:
SALES REBATES - Medicaid rebates and wholesaler chargebacks are charged
to the Product monthly based on actual historical rebate payments.
Actual chargebacks are allocated to the Product monthly, based on
actual sales.
CASH DISCOUNTS - Cash discounts are allocated to the Product based upon
the percentage of actual Product gross sales less chargebacks and
wholesaler returns to total Company gross sales less chargebacks and
wholesaler returns.
SALES RETURNS - Sales returns are directly attributable to identifiable
products based on actual sales returns.
F-3
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STANDARD COST OF SALES
Standard cost of sales includes raw materials, direct labor, and plant overhead.
Certain overhead costs are specifically identifiable to specific brands, and the
remaining costs are allocated based on the Product's percentage of total
production for the production facility. Manufacturing capacity variances are not
allocated to individual product lines and, thus are not included in cost of
sales.
Depreciation of plant facilities is computed using the straight-line method
based on estimated useful lives of the assets. Generally, the lives of the
buildings range from twelve to fifty years, and five to eighteen years for
machinery and equipment.
USE OF ESTIMATES
The preparation of the special purpose financial statements of
Darvon(R)/Darvocet(R) Product Contribution in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts of gross profit for the years ended December 31,
2001, 2000 and 1999. Actual results could differ from those estimates.
3. SIGNIFICANT CUSTOMERS
The Product is distributed through wholesalers that serve physicians and other
health care professionals, pharmacies and hospitals. The Company sold Product to
three significant wholesalers in 2001. Sales to these three wholesalers in the
aggregate are estimated to have been 85% to 95% of total Product sales in 2001,
2000, and 1999. These three wholesalers are estimated to have each accounted for
between 20% and 40% of total Product sales in each of these three years. Certain
of these wholesalers have acquired some of their competitors during the three
years presented. This sales data has been adjusted to include the
pre-acquisition sales to any companies acquired by these three wholesalers
during the periods presented.
F-4
aaiPharma Inc.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
December 31, 2001
(In Thousands)
aaiPharma
Actual Adjustments Pro Forma
--------- ----------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 6,371 $ -- $ 6,371
Accounts receivable, net 26,594 -- 26,594
Work-in-progress 10,464 -- 10,464
Inventories 9,057 1,400(1) 10,457
Prepaid and other current assets 5,972 1,155(2) 7,127
--------- --------- ---------
Total current assets 58,458 2,555 61,013
Property and equipment, net 37,035 14,145(3) 51,180
Goodwill and other intangibles, net 88,504 210,000(4) 298,504
Other assets 12,289 5,102(2) 17,391
--------- --------- ---------
Total assets $ 196,286 $ 231,802 $ 428,088
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of new senior credit facilities $ -- $ 5,000(5) $ 5,000
Accounts payable 15,444 -- 15,444
Customer advances 13,349 -- 13,349
Accrued wages and benefits 3,879 -- 3,879
Other accrued liabilities 5,293 (2,257)(6) 3,036
--------- --------- ---------
Total current liabilities 37,965 2,743 40,708
Long-term debt, less current portion 78,878 (78,000)(7) 878
New senior credit facilities -- 136,280(8) 136,280
New senior subordinated notes -- 175,000(9) 175,000
Other liabilities 224 -- 224
Redeemable warrants 2,855 -- 2,855
Stockholders equity:
Common stock 18 -- 18
Paid-in capital 75,233 75,233
Retained earnings (accumulated deficit) 3,278 (4,221)(10) (1,219)
Accumulated other comprehensive losses (2,165) -- (2,165)
--------- --------- ---------
Total stockholders equity 76,364 (4,221) 72,143
--------- --------- ---------
Total liabilities and stockholders equity $ 196,286 $ 231,802 $ 428,088
========= ========= =========
See Notes to Unaudited Pro Forma Consolidated Balance Sheet
F-5
aaiPharma Inc.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
(1) Reflects the inventory acquired as part of the Darvon and Darvocet
product line acquisitions.
(2) Reflects the current and long-term portion of total financing fees of
$12.7 million for the acquisition of the Darvon and Darvocet product
lines, less the write-off of the unamortized deferred financing costs
related to the existing senior credit facilities of $7.0 million, net
of a tax benefit of $0.6 million.
(3) Reflects an adjustment to record the assets purchased under our
terminated synthetic lease.
(4) Reflects the goodwill and intangible assets acquired with the Darvon
and Darvocet product lines.
(5) Reflects an adjustment to record the current maturities of our new
senior credit facilities.
(6) Reflects an adjustment to record the income tax benefit related to the
write-off of deferred financing costs from our existing senior credit
facilities.
(7) Reflects an adjustment to record repayment of amounts outstanding under
our existing credit facilities.
(8) Reflects an adjustment to record the long-term portion of proceeds from
the new senior credit facilities.
(9) Reflects an adjustment to record the issuance of the new senior
subordinated notes.
(10) Reflects an adjustment to record the write-off of deferred financing
costs related to our existing senior credit facilities, net of tax.
F-6
aaiPharma Inc.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
For the Year Ended December 31, 2001
(In Thousands)
Darvon
aaiPharma Darvon Acquisition
Actual Actual(a) Adjustments Pro Forma
--------- --------- ----------- ---------
Net revenues $ 141,073 $ 62,902 $ -- $ 203,975
--------- --------- --------- ---------
Operating costs and expenses:
Direct costs 70,372 4,757 1,044(1) 76,173
Selling 13,974 -- 6,061(2) 20,035
General and administrative 30,524 -- 9,897(3) 40,421
Direct pharmaceutical start-up costs 2,123 -- -- 2,123
Research and development 10,851 -- 1,000(4) 11,851
--------- --------- --------- ---------
127,844 4,757 18,002 150,603
--------- --------- --------- ---------
Income from operations 13,229 58,145 (18,002) 53,372
Other income (expense):
Interest, net (3,646) -- (28,160)(5) (31,806)
Other (444) -- -- (444)
--------- --------- --------- ---------
(4,090) -- (28,160) (32,250)
--------- --------- --------- ---------
Income before income taxes 9,139 58,145 (46,162) 21,122
Provision for income taxes 3,199 -- 4,793(6) 7,992
--------- --------- --------- ---------
Net income $ 5,940 $ 58,145 $ (50,955) $ 13,130
========= ========= ========= =========
EBITDA $ 20,984 $ 58,145 $ (9,602) $ 69,527
========= ========= ========= =========
(a) Represents the historical results for the Darvon product line for the
full year period ended December 31, 2001.
See Notes to Unaudited Pro Forma Consolidated Statement of Operations
F-7
aaiPharma Inc.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(1) Assumes a gross margin of 91% to reflect costs pursuant to
contractually determined manufacturing agreements.
(2) Assumes adjustments to selling expense to reflect the anticipated
infrastructure necessary to provide support for the acquired product
line.
(3) Assumes adjustments to general and administrative expenses to reflect
additional overhead costs to support the acquired product line.
(4) Estimated research and development spending to develop line extensions
for the Darvon and Darvocet acquired products.
(5) Assumes an increase in interest expense based on the additional
indebtedness incurred based on the actual interest rates for the
assumed period of borrowing.
(6) Assumes a marginal tax rate of 40% on the incremental pro forma income
before income taxes.
F-8
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma consolidated financial statements are
based on our historical consolidated financial statements included in our Annual
Report on Form 10-K for the year ended December 31, 2001, adjusted to give pro
forma effect to the following acquisition and financing transactions:
- the acquisition of the M.V.I. and Aquasol branded product lines from
AstraZeneca AB on August 17, 2001;
- the acquisition of the Brethine branded product line from Novartis
Pharmaceuticals Corporation on December 13, 2001;
- the proposed acquisition of the Darvon and Darvocet branded product lines
and related inventories;
- the receipt of $169.0 million of net proceeds from the sale of $175
million senior subordinated notes;
- the receipt of $141.3 million of borrowings under our new senior credit
facilities;
- the repayment of all amounts outstanding under our existing senior credit
facilities; and
- our purchase of the assets currently leased under our tax retention
operating lease.
The unaudited pro forma consolidated balance sheet as of December 31, 2001
gives effect to our proposed acquisition of the Darvon and Darvocet branded
product lines, as if this acquisition and the related financing transactions had
occurred on December 31, 2001. The unaudited pro forma consolidated statement of
operations for the year ended December 31, 2001 gives effect to each of the
acquisition transactions and financing transactions as if each had occurred on
January 1, 2001. Adjustments have been made to these unaudited pro forma
consolidated financial statements. These adjustments are based upon information
available to us and certain assumptions that we believe are reasonable. These
unaudited pro forma consolidated financial statements do not purport to
represent what our results of operations or financial condition would actually
have been if the transactions in fact occurred on such dates, nor do they
purport to project our results of operations or financial condition for any
future period or date. The information set forth below should be read together
with the other information contained in our Annual Report on Form 10-K for the
year ended December 31, 2001.
The M.V.I., Aquasol, and Brethine acquisitions were accounted for under the
purchase method of accounting and the proposed acquisition of Darvon and
Darvocet has been reflected in the unaudited pro forma adjustments as if the
transaction was accounted for under the purchase method. A preliminary
allocation of the purchase price of the Darvon and Darvocet product lines was
based upon the estimated fair value of assets acquired and liabilities assumed
in accordance with Statements of Financial Accounting Standards, or SFAS, Nos.
141 and 142. Under the initial allocation, we will amortize $210 million of the
$211.4 million purchase price over 25 years. The remaining $1.4 million will be
allocated to product inventory that we will acquire. After further evaluation,
we may change this initial allocation of the $210 million or the estimated lives
of the intangible assets. If so, we may not amortize the entire $210 million. In
that case, our amortization expense will be reduced and our net income
increased.
The following pro forma financial information is based upon the historical
financial information set forth in the product line financial statements for
each of these products and on estimated costs to be incurred by us for selling,
general and administrative and research and development expenses. While we
believe that our assumptions are reasonable, our actual costs may not be the
same.
On a pro forma basis as if we had acquired the M.V.I., Aquasol, Brethine,
Darvon and Darvocet product lines on January 1, 2001, these product lines would
have represented 49% of our total net revenues and 92% of net revenues from
product sales in 2001 and Darvon and Darvocet would have represented 26% of
total net revenues and 48% of net revenues from product sales in 2001. Net sales
of Darvon and Darvocet in the three months ended January 31, 2002 decreased
significantly compared to average monthly net sales in 2001, 2000 and 1999.
If sales continue at these recent levels, annual product sales of Darvon and
Darvocet will be less than $42 million, or 33.9% less than the amount shown in
our unaudited pro forma consolidated financial statements.
Additionally, we will probably move manufacturing of our products to new
sites. This will involve costs and require FDA approval of the new manufacturing
facility. We may not receive FDA approval for a long time, if at all. Neither
our pro forma financial statements, which use the prices in our supply
contracts, nor the product line financial statements, which use the seller's
estimated actual direct manufacturing costs, include or estimate the possibility
of these higher costs. Therefore, the unaudited pro forma consolidated financial
statements do not represent what our results of operations would actually have
been if the events described therein had in fact occurred on the date indicated
or project our results of operations for any future period. For all of these
reasons, investors should not place undue reliance on the pro forma financial
data contained in this report.
F-9
AAIPHARMA INC.
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 2001
(IN THOUSANDS)
AAIPHARMA PRO
ACTUAL ADJUSTMENTS FORMA
--------- ----------- --------
ASSETS
Current assets:
Cash and cash equivalents............................... $ 6,371 $ -- $ 6,371
Accounts receivable, net................................ 26,594 -- 26,594
Work-in-progress........................................ 10,464 -- 10,464
Inventories............................................. 9,057 1,400(1) 10,457
Prepaid and other current assets........................ 5,972 1,155(2) 7,127
-------- -------- --------
Total current assets............................ 58,458 2,555 61,013
Property and equipment, net............................... 37,035 14,145(3) 51,180
Goodwill and other intangibles, net....................... 88,504 210,000(4) 298,504
Other assets.............................................. 12,289 5,102(5) 17,391
-------- -------- --------
Total assets......................................... $196,286 $231,802 $428,088
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of new senior credit facilities...... $ -- $ 5,000(6) $ 5,000
Accounts payable........................................ 15,444 -- 15,444
Customer advances....................................... 13,349 -- 13,349
Accrued wages and benefits.............................. 3,879 -- 3,879
Other accrued liabilities............................... 5,293 (2,257)(7) 3,036
-------- -------- --------
Total current liabilities....................... 37,965 2,743 40,708
Long-term debt, less current portion...................... 78,878 (78,000)(8) 878
New senior credit facilities.............................. -- 136,280(9) 136,280
New senior subordinated notes............................. -- 175,000(10) 175,000
Other liabilities......................................... 224 -- 224
Redeemable warrants....................................... 2,855 -- 2,855
Stockholders' equity:
Common stock............................................ 18 -- 18
Paid-in capital......................................... 75,233 -- 75,233
Retained earnings (accumulated deficit)................. 3,278 (4,221)(11) (943)
Accumulated other comprehensive losses.................. (2,165) -- (2,165)
-------- -------- --------
Total stockholders' equity........................... 76,364 (4,221) 72,143
-------- -------- --------
Total liabilities and stockholders' equity........... $196,286 $231,802 $428,088
======== ======== ========
See accompanying notes to unaudited pro forma consolidated balance sheet.
F-10
AAIPHARMA INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(1) To reflect an adjustment to record inventories acquired in
the acquisition of the Darvon and Darvocet product lines.... $ 1,400
========
(2) To reflect adjustments:
To record the current portion of deferred financing costs
related to the issuance of our new senior subordinated
notes and our new senior credit facilities............. $ 2,097
To eliminate the current portion of unamortized deferred
financing costs related to our existing credit
facilities............................................. (1,499)
To record the income tax benefit related to the write-off
of deferred financing costs from our existing credit
facilities............................................. 557
--------
$ 1,155
========
(3) To reflect an adjustment to record the assets purchased
under our terminated tax retention operating lease.......... $ 14,145
========
(4) To reflect an adjustment to record the intangible assets
associated with the acquisition of the Darvon and Darvocet
product lines from Eli Lilly; this amount may be reduced if
revenues from these products do not meet certain levels
after the acquisition is completed.......................... $210,000
========
(5) To reflect adjustments:
To record the noncurrent portion of deferred financing
costs related to the issuance of our new senior
subordinated notes and our new senior credit
facilities............................................. $ 10,638
To eliminate the noncurrent portion of unamortized
deferred financing costs related to our existing senior
credit facilities...................................... (5,536)
--------
$ 5,102
========
(6) To reflect an adjustment to record the current maturities of
borrowings under our new senior credit facilities........... $ 5,000
========
(7) To reflect an adjustment to record the income tax benefit
related to the write-off of deferred financing costs from
our existing senior credit facilities....................... $ (2,257)
========
(8) To reflect an adjustment to record repayment of amounts
outstanding under our existing credit facilities............ $(78,000)
========
(9) To reflect an adjustment to record the long-term portion of
borrowings under our new senior credit facilities........... $136,280
========
(10) To reflect an adjustment to record the issuance of our new
senior subordinated notes................................... $175,000
========
(11) To reflect an adjustment to record the write-off of deferred
financing costs related to our existing senior credit
facilities, net of tax at an effective rate of 40%.......... $ (4,221)
========
F-11
AAIPHARMA INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001
(IN THOUSANDS)
PRO FORMA
FOR THE DARVON AND DARVON AND
COMPLETED DARVOCET DARVOCET
AAIPHARMA PRODUCT LINE PRODUCT LINE ACQUISITION
ACTUAL ACQUISITIONS(1) ACTUAL(2) ADJUSTMENTS PRO FORMA
--------- --------------- ------------ ----------- ---------
Product sales................... $ 27,448 $ 67,195 $62,902 $ -- $130,097
Product development............. 20,426 20,426 -- -- 20,426
Research revenues:
Non-clinical.................. 64,262 64,262 -- -- 64,262
Clinical...................... 28,937 28,937 -- -- 28,937
-------- -------- ------- -------- --------
93,199 93,199 -- -- 93,199
-------- -------- ------- -------- --------
Net revenues.................... 141,073 180,820 62,902 -- 243,722
-------- -------- ------- -------- --------
Operating costs and expenses:
Direct costs.................. 70,372 83,469 4,757 1,044(3) 89,270
Selling....................... 13,974 18,373 -- 6,061(4) 24,434
General and administrative.... 30,524 32,763 -- 9,897(5) 42,660
Research and development...... 10,851 12,501 -- 1,000(6) 13,501
Direct pharmaceutical start-up
costs...................... 2,123 2,123 -- -- 2,123
-------- -------- ------- -------- --------
127,844 149,229 4,757 18,002 171,988
-------- -------- ------- -------- --------
Income (loss) from operations... 13,229 31,591 58,145 (18,002) 71,734
Other income (expense):
Interest, net................. (3,646) (8,278) -- (23,528)(7) (31,806)
Other......................... (444) (444) -- -- (444)
-------- -------- ------- -------- --------
(4,090) (8,722) -- (23,528) (32,250)
-------- -------- ------- -------- --------
Income (loss) before income
taxes......................... 9,139 22,869 58,145 (41,530) 39,484
Provision for income taxes...... 3,199 8,691 -- 6,646(8) 15,337
-------- -------- ------- -------- --------
Net income (loss)............... $ 5,940 $ 14,178 $58,145 $(48,176) $ 24,147
======== ======== ======= ======== ========
EBITDA(9)....................... $ 20,984 $ 39,841 $58,145 $ (9,602) $ 88,384
======== ======== ======= ======== ========
See accompanying notes to unaudited pro forma consolidated statement of
operations.
F-12
AAIPHARMA INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)
(1) The following table presents our unaudited pro forma consolidated statement
of operations for the product line acquisitions we completed in 2001.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
COMPLETED PRODUCT LINE ACQUISITIONS
YEAR ENDED DECEMBER 31, 2001
(IN THOUSANDS)
PRO FORMA
FOR OUR
M.V.I. COMPLETED
AND PRODUCT
AAIPHARMA AQUASOL BRETHINE PRO FORMA LINE
ACTUAL ACTUAL(A) ACTUAL(B) ADJUSTMENTS ACQUISITIONS
--------- --------- --------- ----------- ------------
Product sales........................... $ 27,448 $24,559 $15,188 $ -- $67,195
Product development..................... 20,426 -- -- -- 20,426
Research revenues:
Non-clinical.......................... 64,262 -- -- -- 64,262
Clinical.............................. 28,937 -- -- -- 28,937
-------- ------- ------- -------- -------
93,199 -- -- -- 93,199
-------- ------- ------- -------- -------
Net revenues............................ 141,073 24,559 15,188 -- 180,820
-------- ------- ------- -------- -------
Operating costs and expenses:
Direct costs.......................... 70,372 13,373 3,749 (4,025)(c) 83,469
Selling............................... 13,974 1,170 -- 3,229(d) 18,373
General and administrative............ 30,524 460 -- 1,779(e) 32,763
Research and development.............. 10,851 -- -- 1,650(f) 12,501
Direct pharmaceutical start-up
costs.............................. 2,123 -- -- -- 2,123
-------- ------- ------- -------- -------
127,844 15,003 3,749 2,633 149,229
-------- ------- ------- -------- -------
Income (loss) from operations........... 13,229 9,556 11,439 (2,633) 31,591
Other income (expense):
Interest, net......................... (3,646) -- -- (4,632)(g) (8,278)
Other................................. (444) -- -- -- (444)
-------- ------- ------- -------- -------
(4,090) -- -- (4,632) (8,722)
-------- ------- ------- -------- -------
Income (loss) before income taxes....... 9,139 9,556 11,439 (7,265) 22,869
Provision for income taxes.............. 3,199 -- -- 5,492(h) 8,691
-------- ------- ------- -------- -------
Net income (loss)....................... $ 5,940 $ 9,556 $11,439 $(12,757) $14,178
======== ======= ======= ======== =======
EBITDA(i)............................... $ 20,984 $ 9,556 $11,439 $ (2,138) $39,841
======== ======= ======= ======== =======
F-13
(a) Represents the historical statement of revenues and direct expenses
for the M.V.I. and Aquasol product lines for the period prior to
the acquisition on August 17, 2001.
(b) Represents the historical statement of product contribution for the
Brethine product line for the period prior to the acquisition on
December 13, 2001.
(c) Direct costs for each product line have been adjusted to reflect
estimated costs that would have been incurred by us as follows:
Adjustment to M.V.I. and Aquasol cost of goods sold to reflect
estimated reduction in costs due to contractually determined
prices under our supply agreements:
Estimated cost of goods under supply agreements............. $10,362
Cost of goods sold as reported by AstraZeneca............... 13,373
-------
Pro forma decrease in direct costs.......................... (3,011)
-------
Adjustment to Brethine cost of goods sold to reflect estimated
reduction in costs due to contractually determined prices under
our supply agreements and the elimination of royalties incurred
by Novartis and not incurred by us subsequent to acquisition:
Estimated cost of goods under supply agreements............. 2,735
Cost of sales as reported by Novartis....................... 2,928
-------
(193)
Less royalty expense reported by Novartis................... (821)
-------
Pro forma decrease in direct costs.......................... (1,014)
-------
Total direct cost adjustment for our product line
acquisitions completed in 2001.............................. $(4,025)
=======
(d) We calculated the estimated selling expenses for each of the
product lines based on the estimated costs to be incurred by
NeoSan's direct sales force, and compared those amounts to the
selling expenses reported in the historical financial information
for the respective product lines as follows:
Adjustment to M.V.I. and Aquasol selling expense to reflect estimated
costs that would be representative of the selling activities of
our NeoSan business unit:
Estimated selling expense under NeoSan...................... $ 3,998
Selling and other expenses plus drug development expenses
reported by AstraZeneca..................................... 1,170
-------
Pro forma increase in selling expense....................... 2,828
-------
Adjustment to Brethine selling expense to reflect estimated costs that
would be representative of the selling activities of our NeoSan
business unit:
Estimated selling expense under NeoSan...................... 401
Selling expenses reported by Novartis....................... --
-------
Pro forma increase in selling expense....................... 401
-------
Total selling expense adjustment for our product line
acquisitions completed in 2001.............................. $ 3,229
=======
(e) Adjustment to M.V.I. and Aquasol general and administrative expense
to reflect estimated costs that would be representative of our
NeoSan business unit. We have determined that the specifically
identifiable intangible assets obtained through the M.V.I. and
Aquasol product line acquisition have indefinite lives and
therefore are not amortized:
Estimated general and administrative expense under NeoSan... $ 1,440
Amortization expense reported by AstraZeneca................ 460
-------
Pro forma increase in general and administrative expense.... 980
-------
F-14
Adjustment to Brethine general and administrative expense to
reflect estimated costs that would be representative of our
NeoSan business unit:
Estimated general and administrative expense under NeoSan... 304
General and administrative expense reported by Novartis..... --
-------
Pro forma increase in general and administrative expense.... 304
-------
Adjustment to reflect amortization of $9.9 million of
specifically identifiable intangible assets obtained through
the Brethine product line acquisition. This amount reflects
amortization over 20 years. ................................ 495
-------
Total general and administrative expense adjustment for our
product line acquisitions completed in 2001................. $ 1,779
=======
(f) Estimated research and development spending to develop
line extensions for our acquired products:
M.V.I. and Aquasol.......................................... $ 1,200
Brethine.................................................... 450
-------
Total research and development expense adjustment for our
product line acquisitions completed in 2001................. $ 1,650
=======
(g) Adjustment to reflect the additional net interest expense under the
pro forma debt incurred for the acquisition of the M.V.I., Aquasol
and Brethine product lines reflecting a full year of interest and
debt cost under our existing senior credit facilities:
Existing senior credit facilities........................... $ 6,779
Amortization of financing fees related to the above item.... 1,499
-------
Pro forma interest expense, net for our product line
acquisitions completed in 2001.............................. 8,278
Less: Actual interest for 2001.............................. (3,646)
-------
Total interest expense, net adjustment for our product line
acquisitions completed in 2001.............................. $ 4,632
=======
(h) Adjustment to reflect a 40% effective tax rate applied to the
incremental pro forma income (loss) before income taxes. A
reconciliation of the statutory tax rate to the assumed pro forma
tax rate is provided as follows:
Federal statutory rate...................................... 35%
State taxes, net of federal benefit......................... 4%
Other....................................................... 1%
-------
Total....................................................... 40%
=======
(i) We define EBITDA as the sum of income (loss) from operations and
depreciation and amortization. We included this measurement because
we believe that some investors will find it to be useful in
measuring our ability to meet debt service, capital expenditure and
working capital requirements. EBITDA is not a measurement of
financial performance under generally accepted accounting
principles and should not be considered an alternative to, or more
meaningful than, income (loss) from operations or other traditional
indicators of operating performance and net cash provided by (used
in) operating activities determined in accordance with generally
accepted accounting principles. In addition, companies define
EBITDA differently, and the EBITDA for our company may not be
comparable to that of other companies.
(2) Represents the historical statement of product contribution
for the Darvon and Darvocet product lines for the period
presented.
(3) Adjustment to the Darvon and Darvocet cost of goods sold to
reflect estimated higher costs due to contractually
determined prices under our supply agreements:
Estimated cost of goods under supply agreements............. $ 5,801
Standard cost of sales as reported by Eli Lilly............. 4,757
-------
Pro forma increase in direct costs.......................... $ 1,044
=======
F-15
(4) Adjustment to Darvon and Darvocet selling expense to reflect
estimated costs that would be representative of the selling
activities of our NeoSan business unit:
Estimated selling expense under NeoSan...................... $ 6,061
Selling expense reported by Eli Lilly....................... --
-------
Pro forma increase in selling expense....................... $ 6,061
=======
(5) Adjustment to Darvon and Darvocet general and administrative
expense to reflect estimated costs that would be
representative of our NeoSan business unit, including
assumed amortization of $210.0 million in intangible assets
over 25 years:
Estimated general and administrative expense under NeoSan... $ 1,497
General and administrative expense reported by Eli Lilly.... --
-------
1,497
Amortization of intangible assets acquired.................. 8,400
-------
Pro forma increase in general and administrative expense.... $ 9,897
=======
(6) Estimated research and development spending to develop line
extensions for our Darvon
and Darvocet acquired products. ............................ $ 1,000
=======
(7) Adjustment to reflect the additional net interest expense
under the pro forma debt incurred under our new senior
subordinated notes and the additional borrowings under our
new senior credit facilities at the rates indicated below,
assuming the repayment of our existing senior credit
facilities, as if these financings were completed on January
1, 2001:
Repayment of our existing senior credit facilities:
Interest incurred on our existing senior credit
facilities.................................................. $(6,779)
Amortization of financing fees associated with our existing
senior credit facilities.................................... (1,499)
-------
(8,278)
-------
Additional borrowings:
New senior term loan of $100 million at LIBOR plus 4.25% per
annum....................................................... 7,970
Outstanding portion of new senior revolver of $41.3 million
at LIBOR plus 3.75% per annum............................... 3,084
New senior subordinated notes of $175 million at 10.5% per
annum....................................................... 18,375
Amortization of financing fees related to the above items... 2,097
Other debt related interest costs........................... 280
-------
31,806
-------
Pro forma increase in interest expense...................... $23,528
=======
If the variable interest rates used above increase or
decrease by 50 basis points, the annualized effect of that
change would be to increase or decrease interest expense by
$0.7 million.
Does not give effect to our planned repurchase, prior to the
completion of the offering of the notes, of outstanding
redeemable warrants for approximately $3.7 million, based on
an assumed purchase price per share of $32.50. Had we
borrowed $3.7 million under the new senior revolver to fund
the purchase of these warrants on January 1, 2001, our pro
forma net interest expense would have increased by
approximately $0.3 million in 2001.
(8) Adjustment to reflect a 40% effective tax rate applied to
the incremental pro forma income (loss) before income taxes.
A reconciliation of the statutory tax rate to the assumed
pro forma tax rate is provided as follows:
Federal statutory rate...................................... 35%
State taxes, net of federal benefit......................... 4%
Other....................................................... 1%
-------
Total....................................................... 40%
=======
F-16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: March 11, 2002
aaiPharma Inc.
By: /s/ William L. Ginna, Jr.
-------------------------------------
William L. Ginna, Jr.
Executive Vice President and
Chief Financial Officer
II-1
EXHIBIT INDEX
Exhibit Description
------- -----------
Exhibit 23.1 Consent of Ernst & Young LLP
II-2
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 333-78453, 333-50877, 333-74515, 333-67114 and 333-50841) and the
Registration Statement (Form S-3 No. 333-05535) and in the related Prospectus of
our report dated January 28, 2002, with respect to the special-purpose
statements of product contribution for the Darvon/Darvocet Product Line of Eli
Lilly and Company for the years ended December 31, 2001, 2000, and 1999 included
in the aaiPharma Inc.'s Current Report on Form 8-K dated March 11, 2002.
/s/ Ernst & Young LLP
Indianapolis, Indiana
March 8, 2002
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