Eli Lilly 2004 Annual Report Download - page 36

FINANCIALS
34
Note 3: Acquisitions and Collaboration
Applied Molecular Evolution, Inc. Acquisition
On February 12, 2004, we acquired all the outstanding common stock of Applied Molecular Evolution, Inc. (AME) in
a tax-free merger. Under the terms of the merger agreement, each outstanding share of AME common stock was
exchanged for our common stock or a combination of cash and our stock valued at $18. The aggregate purchase
price of approximately $442.8 million consisted of issuance of 4.2 million shares of our common stock valued at
$314.8 million, issuance of 0.7 million replacement options to purchase shares of our common stock in exchange
for the remaining outstanding AME options valued at $37.6 million, cash of $85.4 million for AME common stock
and options for certain AME employees, and transaction costs of $5.0 million. The fair value of our common stock
was derived using a per-share value of $74.14, which was our average closing stock price for February 11 and 12,
2004. The fair value for the options granted was derived using a Black-Scholes valuation method using assump-
tions consistent with those we used in valuing employee options. Replacement options to purchase our common
stock granted as part of this acquisition have terms equivalent to the AME options being replaced.
In addition to acquiring the rights to two compounds currently under development, we expect the acquisition of
AME’s protein optimization technology to create synergies that will accelerate our ability to discover and optimize
biotherapeutic drugs for cancer, critical care, diabetes, and obesity, areas in which proteins are of great therapeu-
tic benefi t.
In accordance with SFAS 141, Business Combinations, the acquisition has been accounted for as a purchase
business combination. Under the purchase method of accounting, the assets acquired and liabilities assumed from
AME at the date of acquisition are recorded at their respective fair values as of the acquisition date in our consoli-
dated fi nancial statements. The excess of the purchase price over the fair value of the acquired net assets has been
recorded as goodwill in the amount of $9.6 million. Goodwill resulting from this acquisition has been fully allocated
to the pharmaceutical products segment. No portion of this goodwill is expected to be deductible for tax purposes.
AME’s results of operations are included in our consolidated fi nancial statements from the date of acquisition.
As of the date of acquisition, we determined the following estimated fair values for the assets purchased and
liabilities assumed. The determination of estimated fair value requires management to make signifi cant estimates
and assumptions. We hired independent third parties to assist in the valuation of assets that were diffi cult to value.
Estimated Fair Value at February 12, 2004
Cash and short-term investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 38.7
Acquired in-process research and development. . . . . . . . . . . . . . . . . 362.3
Platform technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17.9
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.6
Other assets and liabilities—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14.3
Total estimated purchase price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 442.8
The acquired in-process research and development (IPR&D) represents compounds currently under develop-
ment that have not yet achieved regulatory approval for marketing. The estimated fair value of these intangible
assets was derived using a valuation from an independent third party. AME’s two lead compounds for the treat-
ment of non-Hodgkin’s lymphoma and rheumatoid arthritis represent approximately 80 percent of the estimated
fair value of the IPR&D. In accordance with FIN 4, Applicability of FASB Statement No. 2 to Business Combinations
Accounted for by the Purchase Method, these IPR&D intangible assets have been written off by a charge to income
immediately subsequent to the acquisition because the compounds do not have any alternative future use. This
charge is not deductible for tax purposes. The ongoing activity with respect to each of these compounds under
development is not material to our research and development expenses.
There are several methods that can be used to determine the estimated fair value of the acquired IPR&D. We
utilized the “income method,” which applies a probability weighting to the estimated future net cash fl ows that
are derived from projected sales revenues and estimated costs. These projections are based on factors such as
relevant market size, patent protection, historical pricing of similar products, and expected industry trends. The
estimated future net cash fl ows are then discounted to the present value using an appropriate discount rate. This
analysis is performed for each project independently. The discount rate we used in valuing the acquired IPR&D
projects was 18.75 percent.
Product Acquisition
In October 2004, we entered into an agreement with Merck KGaA (Merck) to acquire Merck’s compound for a