Eli Lilly 2006 Annual Report Download - page 39

FINANCIALS
37
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. AME’s results of
operations subsequent to the acquisition are included in our consolidated fi nancial statements.
We hired independent third parties to assist in the valuation of assets that were diffi cult to value. Of the $442.8
million purchase price, $362.3 million was attributable to acquired IPR&D. The IPR&D represents compounds that
were under development at that time and that had not yet achieved regulatory approval for marketing. AME’s two
lead compounds for the treatment of non-Hodgkin’s lymphoma and rheumatoid arthritis represented approxi-
mately 80 percent of the estimated fair value of the IPR&D. These IPR&D intangible assets were written off by a
charge to income immediately subsequent to the acquisition because the compounds did not have any alternative
future use. This charge was 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 were 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 were then discounted to the present value using an appropriate discount rate. This
analysis was performed for each project independently. The discount rate we used in valuing the acquired IPR&D
projects was 18.75 percent.
Product Acquisitions
In January 2007, we entered into an agreement with OSI Pharmaceuticals, Inc. to acquire the rights to its com-
pound for the potential treatment of Type 2 diabetes. At the inception of this agreement, this compound was in the
development stage (Phase I clinical trials) and had no alternative future uses. As with many development phase
compounds, launch of the product, if approved, was not expected in the near term. Our charge for acquired IPR&D
related to this arrangement was $25.0 million and will be included as expense in the fi rst quarter of 2007.
In 2004, we incurred an IPR&D charge of $29.9 million related to a development stage compound acquired
from Merck KGaA for a potential treatment for insomnia. This compound did not have any alternative future use.
Note 4: Asset Impairments, Restructuring, and Other Special Charges
The components of the charges included in asset impairments, restructuring, and other special charges in our
consolidated statements of income are described below.
Asset Impairments and Related Restructuring and Other Charges
In the fourth quarter of 2006, management approved plans to close two research and development facilities and
one production facility outside the U.S. Management also made the decision to stop construction of a planned
insulin manufacturing plant in the U.S. in an effort to increase productivity in research and development opera-
tions and to reduce excess manufacturing capacity. These decisions, as well as other strategic changes, resulted
in non-cash charges of $308.8 million for the write-down of certain impaired assets, substantially all of which have
no future use, and other charges of $141.5 million, primarily related to severance and contract termination pay-
ments. The impairment charges are necessary to adjust the carrying value of the assets to fair value. In addition,
in early 2007 the Board approved other related actions to offer voluntary severance to up to 250 employees at one
of our plants in the U.S. Severance and other costs related to all of these actions will result in estimated additional
charges of approximately $125 million (pretax) in the fi rst quarter of 2007. We expect to complete these restructur-
ing activities by December 31, 2007.
In December 2005, management approved, as part of our ongoing efforts to increase productivity and reduce
our cost structure, decisions that resulted in non-cash charges of $154.6 million for the write-down of certain im-
paired assets, and other charges of $17.3 million, primarily related to contract termination payments. The impaired
assets, which have no future use, include manufacturing buildings and equipment no longer needed to supply pro-
jected capacity requirements, as well as obsolete research and development equipment. The impairment charges
are necessary to adjust the carrying value of the assets to fair value.
During 2004, management approved actions designed to increase productivity, to address current challenges