CASE # 4 ASSIGNMENT: PRO FORMA You are a professional accountant who has been employed to offer advice to a small start up biotech company with the following details given by the client in the first meeting. The pre-IPO company called NewBio Corporation (NewBio) has been operating for the last four years but has not had the chance to form an accounting department and has been working on a cash only basis since inception. The company has now decided to offer itself for sale given the difficult market for raising additional financing to fund continued research and development. The company has been researching potential treatments for various fungal diseases and has collected approximately $45M over the last 4 years from equity financings. The company has no debt other than a convertible note for $5M used for building a research facility for its employees. The company has no financial statements although has provided the following details of how money was spent over the last 4 years. $23M on researching and developing patents for the treatment of certain fungal diseases $12M on salary and related expenses $5M on capital equipment (all purchased) $1M rent and facility costs $4M on sundry research expenses $1M Other expenses including legal defense fees for various patents The research activities have led to 10 new patents that are in the process of being filed and there is a good probability that they will be issued for NewBio. $5M on corporate and administration expenses $2M on corporate officer expenses $1M travel and such related expenses $1M Legal $1M Corporate and business development $10M on acquiring intellectual property rights from 16 external patents. The cost of the patents was as follows Patent # Cost Used in Research 100-45 $1M Yes actively used 100-46 to 100-51 $7M Yes actively used Random others $2M No potential product protection The company is likely to need to spend considerable amounts of money on the protection and maintenance of its current and future IP portfolio. These costs are estimated to run in excess of $3M each year for the next 10 years. The company currently licenses certain technologies but cross licenses its technologies so there is minimal cost although upon commercialization of both Xp1 and Xp2 and any future products, there will be royalties of 1.5% payable annually, in arrears, on recognized revenues for each of these products off set by technology license revenues. These technology licenses are owned by the company although it is unclear what costs were associated with their development as they were part of the original work that was the genesis of the company. Off setting license technology income is estimated at $250,000 in 2012. A state of the art research facility was custom built with the proceeds of a $5M senior note, which is convertible to equity upon any liquidation event. Interest is accruing at 6% annually payable upon the commercialization of Xp2. The holder of the note is the Chairman of the Board of Directors who also owns 7% of the total outstanding shares of the company. The founder also owns key intellectual property that is used by the company with an annual payment of $250,000 with royalties due of 0.25% payable annually in advance on projected revenues of Xp1. Other operating expenses are likely to increase substantially over the coming years although the client expects this growth to be from the run rate of the last 4 years. Any remaining funds collected are cash and liquid investments, earning negligible interest income. Net operating losses have not been calculated but no revenues have been generated in the last 4 years. There are current 12 shareholders with the angel investor owning 45% of the outstanding shares. Other shareholders are officers, employees and the founders. The first of two products (Xp1 and Xp2) are likely (85% probability) to hit the market in the next 2 years and are to relieve sick patients of certain diseases. These patent protected products are approved, new and are likely to generate revenues as below. Xp1 2014 projected revenues of $40M (67% margin). Growth rate of 12% annually Xp2 2013 projected revenues of $25M (81% margin). Growth rate of 32% annually Other products are further downstream and not likely to have any significant financial impact for the next 3 years after which there is a 25% probability that the pre-commercialized products will generate in excess of $150M in an annual revenues based on very promising clinical trials. Should the company wish to pursue these products through to final development and commercialization there would be an estimated $424M in additional development and commercialization costs through to gaining final market approval. The company is unsure how to fund these additional costs or how to evaluate the potential value or accounting treatment for such future development efforts. Assignment 1. Since NewBio doesnt have an accounting department, you have been hired to create pro forma financial statements (only balance sheet and income statement spreadsheet is acceptable or can embed a spreadsheet into a word document). 1. Your client wants to know what assumptions you are using to calculate any amounts that NewBio doesnt have data for. Also include assumptions and explanations for any accounting adjustments. Hints: Item 1 requires that you create a balance sheet and income statement. So you'll need to draw on your undergrad accounting classes and think back to how you would use the facts in the case to calculate revenue, expenses etc. for multiple years. I have no preference on a template as long as it's easy to follow. I attached a link here. http://office.microsoft.com/en-us/templates/pro-forma-income-statement-TC101877359.aspx Item 2 you'll probably want to consider what accounting entries you'll need depending on whether you select a cash basis or accrual basis methodology. State to the client what assumptions you'll be making in your calcs