the shifting pharmaceutical industry landscape
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The shifting pharmaceutical
industry landscapeAccounting and regulatory
trends affecting reporting for 2012 and planning for 2013
January 2013
2
Introduction 1
Regulatory environment: key developments and trends
• SECstaffcomments• Lessonsfromrestatements• FASBandIASBjointprojects• PCAOBupdates• FASBupdates
2
Peer review: how seven companies handled disclosures 1.Revenuerecognitionandcollaborationagreements
2.IPR&Dassetsandintellectualproperty
3.Performance
4.Riskandmitigation
5.Accountingpolicies,judgmentsandestimates
6.Leasecommitments
7.Financialstatementcloseprocess
8
Accounting landscape: a sea of change
• Focuson2013• Changeiscoming:reportingstandards• Revenuerecognition• Financialinstruments• Leases• Dodd-FrankandOTCderivatives
29
Appendix: reconciliation between earnings and adjusted earnings
35
Contents
DisclaimerThis publication has been carefully prepared but necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decisions.
3The shifting pharmaceutical industry landscapeThe shifting pharmaceutical industry landscape
For further information, please contact:
TimGordonFinancialAccountingAdvisoryServices(FAAS)LifeSciencesLeader+12127736938tim.gordon@ey.com
GlenT.GiovannettiGlobalLifeSciencesLeader+16175851998glen.giovannetti@ey.com
ScottBrunsGlobalLifeSciencesAssuranceLeader+13176817229scott.bruns@ey.com
Cash on prescription 4
Aspartofourongoingcommitmenttoproviderelevantinsighttothepharmaceuticalindustry,wehavepreparedthisstudyofnewandloomingshiftsandtrendsinfinancialreporting.
Ouranalysisisbasedonthe2011financialreportingseasonandhighlightsaccountingandregulatoryhottopicstoconsiderasyouprepareforthe2012year-endcloseandplanfor2013andbeyond.Wehavefocusedonareasinwhichregulatorsandexternalstakeholdershaveexpressedinterestandprovidedcomment.
Ourreportisdividedintothreesections.
Thefirstsectiondiscussesdevelopmentsaffectingtheregulatoryenvironment.WeexaminerecentSecuritiesandExchangeCommission(SEC)staffcomments,offerlessonsfrommistakesthatledtofinancialrestatementsandprovideupdatesaboutongoinginitiativesfromthreeindustryregulatorybodies–theFinancialAccountingStandardsBoard(FASB),theInternationalAccountingStandardsBoard(IASB)andthePublicCompanyAccountingOversightBoard(PCAOB).
ThesecondsectionbenchmarksthedisclosurepracticesofsevenUS-basedpharmaceuticalcompanies.Fiveofthecompanies–Bristol-MyersSquibb(BMS),EliLilly,Johnson&Johnson(J&J),MerckandPfizer–primarilysellbrandedproducts.Theothertwo–TevaandWatson–primarilysellgenericproducts.Thecomparisonofwhatthesevencompaniesdisclosedandhowandwheretheymadetheirdisclosuresintheirfinancialstatements,highlightsmajorthemesfortheindustry.
Thethirdandfinalsectionofourreportsurveystheaccountinglandscapeandthelargenumberofmajorchangesthatareloomingfortheindustry.Thechangesarecertaintoaffectthestrategicprioritiesofallmajorplayersinthesector.
Bywayofprovidinggeneralcontextforthereport’sfindingsandsuggestedactions,weofferthefollowingobservations:
• Jointprojectwatch–Thestandard-settingactivitiesoftheFASBandtheIASBcontinuetomoveforward.Aspartofanumberofjointprojects,theBoardsarereviewingtheirsecondexposuredraftonrevenuerecognitionandarepreparingtoissueaseconddraftonleasesinearly2013.Otherongoingjointprojectsinvolvefinancialinstruments,insurancecontracts,consolidationandinvestmentcompanies.Duringthereviewperiod,theBoardsmaketentativedecisionsthatmaybedifferentfromearlieronesandfromthoseintheexposuredrafts.Indeed,atthispoint,theBoards’decisionsareallsubjecttochange.WeencourageyoutoactivelyfollowtheBoards’progressandtorespondtorequestsforcomment.But,whatevertheultimateshapeofthechangesturnsouttobe,atleastsomeofthechangeswillbefar-reaching.Forthatreason,manycompanieshavealreadyestablishedcross-functionalteams–drawingfromoperational,finance,accountingandinformationtechnology(IT)resources—toorganizeappropriateresponses.
• Regulatoryfocus–TheSECremainsfocusedonexpandeddisclosuresrelatingtorevenuerecognition,collaborationagreements,in-processresearchanddevelopment(IPR&D)assets,materialpatents,andresearchanddevelopmentactivities.
• Learningfromrestatements–Errorsinaccountingforincometaxes,revenuerecognitionandthepreparationofthestatementofcashflowsweretheleadingcausesofrestatementsofannualfilingsin2011inallindustries.1Understandingtheissuesthatgaverisetorestatementscanhelplifesciencescompaniesastheyperforminternalriskassessmentsandevaluatetheircontrolenvironments.Askingquestionsaboutthemorefrequentrestatementissuesalsocouldbehelpfultomanagementandauditcommitteemembers.
• Reducingcostsanddrivingefficiency–Companiescontinuetolookforwaystocutcostsanddriveefficiencieswhilebalancingriskassociatedwithregulatorycomplianceandstatutoryreporting.Giventheincreasingcomplexityandexpenseofriskmanagementandcompliance,thehunthasintensifiedtofindwaystoimproveandtransformthereportingprocesses.
Introduction
1
1Statistics were derived from our review of restatements of US public companies that are audited by the four largest accounting firms, as disclosed in annual financial statements filed during the year ended 31 December 2011.
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Regulatory environment: key developments and trends
ThischapterfocusesonimportantshiftsintheUSpharmaceuticalindustry’sregulatorylandscape.
First,weexaminethepastyear’sSECstaffcommentstohighlightnewandcontinuingagencyconcerns.Someofthecommentsbrokenewground,whileothersservedasusefulsummariesofexistingpolicy.
WethenreviewrestatementsofannualfilingsbyUSpubliccompaniestorevealcommonmistakesandtosuggestwaystoimproveinternalcontrols.Finally,weprovideanoverviewofrecentactionsandproposedchangesunderconsiderationbytheFASB,theIASBandthePCAOB.
SEC staff comments Inrecentyears,marketuncertaintyhasputincreasedpressureoncompaniestoimprovethetransparencyoftheirfinancialreporting.Eachyear,Ernst&YoungtrackstheSECstaffcommentsoftheSEConpubliccompanyfilingstoprovideinsightsintotheagency’sconcernsandareasoffocus.Althougheachcompany’sfactsandcircumstancesaredifferent,theeconomicconditionsand
financialreportingchallengesbusinessesfaceareoftensimilar,particularlyinthepharmaceuticalindustry.ThissectionhighlightskeyareasofSECconcern.AmorecomprehensiveanalysisisincludedinourSEC Comments and Trendspublicationlocatedatwww.ey.com/us/accountinglink.
Initscommentsrelatedtothepharmaceuticalindustry,theSECstaffhasfocusedonfivemainareas:revenuerecognition,collaborationagreements,acquiredIPR&Dassets,materialpatents,andresearchanddevelopment.WhatfollowsarehighlightsandanalysisofrecentcommentlettersthattheSEChasprovidedinthesefiveareas,aswellasupdatesandsummariesofSECpositionsinotherareasofconcern.
Revenue recognition
Revenue deductions as they relate to new product offerings
Initscommentletters,theSECstaffhaschallengedregistrantsabouttheprocesstheyusetomakereasonableestimateswhenrecognizingrevenueforthesaleofanew,noveloruniqueproducts.
Registrantsinthepharmaceuticalindustrycommonlyoffercustomersrightsofreturnorproviderebates,chargebacksorotherincentives.Registrantsmustdeterminewhethersellingpricesarefixedordeterminableinordertorecognizerevenueupon
deliveryofproductstocustomers.Inorderforfeestobefixedordeterminable,registrantsmustbeabletoreasonablyestimaterebates,chargebacksandotherincentives,aswellastheamountoffutureproductreturns.
Aspartofitsreviewprocess,theSECstaffmaypointtoinformationinForm10-Kand10-Qfilingsotherthanthefinancialstatementsandfootnotes,recentpressreleases,marketingmaterialsorrecentmanagementpresentationsthatindicateaproductisnew,noveloruniqueinsomeaspect.TheSECstaffmayrequestthatregistrantsexplainhowtheydeterminedtheirestimatesofproductreturns,rebates,chargebacksandotherincentivesintheabsenceofhistoricalinformationrelatedtoanewproduct.Baseduponadditionalinformationreceived,theSECstaffmayrequestthatregistrantsexpanddisclosuresofmanagementdiscussionandanalysis(MD&A)andcriticalaccountingestimatesintheirfuturefilings.
Disclosures relating to estimating revenue deductions
TheSECstaffcontinuestopressformorerobustdisclosureswhenestimatingrevenuedeductions.
Theconcerninthisareaistiedtothebroadrangeofjudgmentsandassumptionsusedinestimatingthesedeductions(forproductreturns,rebatesandchargebacks)andtheoftenmaterialimpactthatthesedeductionshaveonthefinancialstatements.
TheexpandeddisclosuresrequestedbytheSECincludemoreinformationaboutthenatureandamountofeachdeduction.Thedisclosuresencompassarollforwardofinformation,additionalmaterialaboutthequalitativefactorsthatmanagementconsiderswhenitestimateseachdeduction,quantitativeinformationtosupportqualitativefactorsthatareconsideredwhenmakinganestimateandunderlyingbusinessreasonsformaterialperiod-to-periodfluctuationsforeachtypeofreductionofgrossrevenue.Section1.1,onpages8and9,providesadetailedpeercomparisonrelatedtodisclosuresofrevenuedeductions.
Milestone method of revenue recognition
Ifamilestonemethodofrevenuerecognitionpolicyiselected,registrantsmustprovideadditionaldisclosuresaboutresearchanddevelopmentcomponentsofthatarrangement.Thesedisclosureswouldincludeadescriptionoftheoverallarrangement,adescriptionofeachmilestoneandrelatedcontingentconsideration,adeterminationofwhethereachmilestoneisconsideredsubstantive,thefactorstheentityconsideredindeterminingwhethermilestonesaresubstantiveandtheamountofconsiderationrecognizedduringtheperiodofthosemilestones.
3The shifting pharmaceutical industry landscape
TheSECstaffhasissuedcommentsregardingtheadequacyofdisclosuresforeacharrangementandmilestone.Manyregistrantsaggregateinformationwhentheyhavemultiplearrangementsandmilestones,whereastheSECstaffbelievesthatdisclosureonanindividuallevelofeacharrangementandmilestoneismoreappropriate.However,incertaincases,theSEChasnotobjectedtoaggregatedisclosurewhentheregistranthasassertedthatindividualmilestonesarenotmaterialandthatinformationonmilestoneswouldbemoreusefultotheusersofthefinancialstatementsonanaggregatebasis.
Multiple-element arrangements
TheSECstafffrequentlyrequestsregistrantstoexpandtheirdisclosuresaroundmultiple-elementarrangements.Companiesareaskedtoprovidebothquantitativeandqualitativeinformationregardingsignificantjudgmentsmade(andchangesinthosejudgments)regardingtheapplicationoftheSEC’sguidanceinthisarea,aswellasthespecificrequirementsofAccountingStandardsCodification(ASC)605-25-50-2.Additionally,withrespecttoidentifyingseparatedeliverableswithinamultiple-elementarrangement,theSECstaffoftenrequestsregistrantstoprovideexplanationsorfurtheranalysisaboutspecificitemswithinatransactionandwhetherthoseitemsareconsidereddeliverablesthatshouldbeaccountedforseparately.Suchitemsincludetransferofalicensetoaproductcandidate,R&Dservices,manufacturingandsupplyagreements,andparticipationinjointsteeringanddevelopmentcommittees.
Example from SEC comment letters: identifying multiple-element arrangementsInyourevaluationofdeliverables,howdidyouconsidertheobligationsofeachofyourcommittees(i.e.,jointsteeringcommitteeandjointdevelopmentcommittee)?Aretheseobligationsconsideredadeliverable?Whyorwhynot?
TheSECstaffmayalsorequestanevaluationofstand-alonevalueforeachdeliverable:
Example from SEC comment letters: separation criteriaYouindicateyoubelievethelicenseofProductXandtherelatedresearchanddevelopmentservicestobeseparatedunitsofaccounting.Pleaseprovideusyouranalysisdemonstratinghoweachunitofaccountinghadstand-alonevaluebasedontherequirementsofASC605-25-25-5a(i.e.,soldseparatelybyanyvendor,orthecustomercouldreselltheunitofaccountingonastand-alonebasis).
Concentrations of business with European government entities
GiventheongoingsovereigndebtcrisisinEurope,moreemphasishasbeenplacedontheconcentrationofcreditriskrelatedto
accounts-receivablebalancesduefromcustomersinGreece,Italy,Portugal,SpainandothercountriesintheEurozone.
TheSECstaffisaskingregistrantstoprovidemoredetaileddisclosuresabouttheamountofproductsalesbycountryandaccountsreceivableoutstandingbycountry,withaseparatelistforamountsduedirectlyfromthegovernmentorfundedbythegovernment.Inaddition,companiesmustdiscloseamountsduefromprivateparties,theamountofpast-dueaccountsreceivablebycountryandthenumberofdayspastdue.TheSECstaffhasalsorequesteddisclosureoftheamountofallowancefordoubtfulaccountsbycountry,andtheevidencethattheallowanceadequatelyaddressesthecollectibilityofcurrentandpastduereceivablesfromthesecustomers.
Section4.6onpage20providesadetailedpeercomparisonrelatedtothedisclosureofrelationshipswithcustomersintheEurozone.
TheSECstaffhasrequestedmoredetaileddisclosuresaboutreceivablesfromcountriesexperiencingeconomicchallenges:
Example from SEC comment letters: accounts receivables from European entitiesPleaseprovideusproposeddisclosuretobeincludedinfutureperiodicreportsthatbreaksouttheamountoftradereceivablesfromproductsales,andtheamountofproductsalesbycountryinItalyandSpain(andGreeceandPortugal,ifany),andalsodisclosetheamountsthatarepastduefromeachofthesecountriesseparately.Disclosetheportionineachofthesecountriesthatisduedirectlyfromthegovernmentorfundedbythegovernment.
Collaboration arrangements
Collaboration arrangement disclosures
TheSECstaffhasrequestedregistrantstoexpandtheirdisclosuresrelatedtocollaborationarrangements.TheSECstaffhasspecifiedalonglistofitemssubjecttodisclosure:identificationoftheotherpartyinthearrangement;theproductsbeingdeveloped;amountspaidorreceivedtodateunderthearrangement;aggregatepotentialmilestonepaymentstobemadeorreceivedandtheeventstriggeringthemilestones;theexistenceofroyaltyprovisions,ratesandanysalesthresholdsrelatedtotherates;andtheexistenceofannualmaintenancefees,includingdurationandterminationprovisionsandpaymentstheregistrantmayberequiredtomakeintheeventoftermination.
RegistrantswithpaymentobligationsundercollaborationarrangementsmustalsolistanypotentialpaymentsinthecontractualobligationstableintheMD&Asectiontotheextentthatapaymentisreasonablypossible.
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Disclosuresshouldclearlydescribetheregistrant’saccountingpolicywithrespecttoalloftheaboveitems,aswellastheincomestatementpresentationandamountsattributabletocollaborationarrangementsforeachapplicableperiod.
Section1.2onpage10providesadetailedpeercomparisonrelatedtocollaborationarrangementdisclosures.
Acquired IPR&D assets
Disclosures related to acquired IPR&D assets
TheSECstaffcontinuestoissuecommentlettersrequestingadditionalinformationregardingacquiredIPR&Dassets.
Specifically,theSECstaffhasrequestedthatregistrantscontinuetoprovidethedisclosurescitedintheAmericanInstituteofCPAs’(AICPA)TechnicalPracticeAid,Assets Acquired in a Business Combination to Be Used in Research and Development Activities: A Focus on Software, Electronic Devices, and Pharmaceutical Industries.TheAICPAdraftpracticeaidfocusesonincreasedqualitativeandquantitativedisclosuresinthenotestothefinancialstatementsandondisclosuresofforward-lookinginformationwithintheMD&A.Bycontrast,thepracticeaiddoesnotrefertothenotestothefinancialstatementstoprotectacompanyfromalegalperspectiveunderthePrivateSecuritiesLitigationReformActof1995,whichdoesnotextendtofinancial-statementdisclosures.
TheSECsuggeststhatregistrantsprovidethefollowinginformationaboutacquiredIPR&D:adiscussionofthespecificnatureandfairvalueofeachsignificantacquiredproject;thecompleteness,complexityanduniquenessoftheprojectsontheiracquisitiondates;thenature,timingandestimatedcostsoftheeffortsnecessarytocompletetheprojectsandtheanticipatedcompletiondates;therisksanduncertaintiesassociatedwithcompletingdevelopment;andthemethodusedtovaluetheprojects,includingsignificantvaluationassumptions.RegistrantsmaybeaskedtoprovideadditionalinformationexplaininghowIPR&Dassetswereidentified,orwhy,baseduponotherinformationdisclosed,noIPR&Dassets,oralimitednumberofIPR&Dassetswererecorded.
Seesection2.1onpages11-12forfurtherinformationandadetailedpeercomparisonrelatedtoacquiredIPR&Dassetdisclosures.
Material patents
Disclosures related to material patents
TheSECstafffrequentlyrequestsregistrantstoprovideexpandeddisclosureaboutmaterialpatents.Thedisclosurerequest
generallyincludesadiscussionoftheproductsortechnologiesthatrelatetothepatent,thejurisdictioninwhichthepatentisgranted,theexpirationdate,identificationofpatentssubjecttolegalproceedingsandastatementsayingwhetherthepatentsareownedorleased.Additionally,theSECstaffmayrequestregistrantswithmultiplepatentstodiscloseinformationforeachpatentortoidentifyindividualpatentsthathavebeenaggregatedfordisclosurepurposesbasedonsimilarcharacteristics.
Seesection2.2onpage12forfurtherinformationandadetailedpeercomparisonofdisclosuresrelatedtomaterialpatents.
Research and development
Research and development expenses
MostregistrantsinthepharmaceuticalindustryincursignificantexpensesforR&Dactivitiestodevelopalimitednumberofnewdrugsincorrelationtothenumberofcompoundsdeveloped.Accordingly,theSECstaffcontinuestorequestregistrantstoprovidedisclosuresforoverallR&Dexpenses,notjustthoserelatedtonewproducts.Specifically,theSECstafffocusesonthestatusofmajorR&Dprojectsandtherelatedcostsincurredtodate,aswellastheestimatedcompletiondates,completioncostsandcapitalrequirements.TheSECstaffmayalsorequestdisclosuresdescribingtheextenttowhichaproject’ssuccessdependsonpartiesotherthantheregistrant,adiscussionoftheproject’sphasesandadescriptionofthenatureoftheproductsinthepipeline.TheSECstaffmayalsorequireregistrantswhodonottrackR&Dcostsbyprojecttodisclosethatfactandexplainwhythatisthecase.Suchregistrantsmustalsoprovidequantitativeorqualitativedisclosuresthatdescribetheamountofresourcesbeingusedoneachprojectorgroupofprojects.
Regulatory environment: key developments and trends
Example from SEC comment letters: research and development expensesInordertogainabetterunderstandingoftheeffectsandexpectedeffectsofyourresearchanddevelopmentactivitiesonresultsofoperationsandfinancialposition,pleaseprovideus,aspracticable,thefollowingadditionalinformationforsignificantproductsinresearchanddevelopment:
• Thecostsincurredduringeachperiodpresented.Ifyoudonotmaintainanyresearchanddevelopmentcostsbyproject,provideusotherquantitativeorqualitativedisclosurethatindicatestheamountofthecompany’sresourcesbeingusedontheproject.
• Thenatureofeffortsandstepsnecessarytocompletetheproduct.
• Therisksanduncertaintiesassociatedwithcompletingdevelopment,andtheextentandnatureofadditionalresourcesthatneedtobeobtainedifcurrentliquidityisnotexpectedtobesufficienttocompletetheproduct.
5The shifting pharmaceutical industry landscape
Seesection2.3onpages13-14forfurtherinformationandadetailedpeercomparisonrelatingtoresearchanddevelopmentexpenses.
Other areas of consideration
Trends in the adoption of the new fair-value disclosures
WeanalyzedhowasampleofpubliccompaniesinitiallyadoptedthenewdisclosuresrequiredbyAccountingStandardsUpdate(ASU)2011-04intheir31March2012quarterlyfilings.DuetotherecentadoptionofthisASU,wenotedvariationsinpracticeastohowcompanieshadappliedtheirdisclosurerequirementsofthisstandard.Forexample,wenotedvariationsinthetypesofquantitativeinformationcompaniesdisclosedaboutsignificantunobservableinputsintheirLevel3measurements(e.g.,therangeofinputsusedandtheweighted-averageinputsforanassetclass)andinthelevelofdisaggregationofthatinformation.Thedisclosuresweremoreconsistentinotherareas,includinghowcompaniesaddressedpricinginformationfromthird-partyvendors(e.g.,pricingservices,brokers).Additionally,wenotedthatpharmaceuticalcompaniesgenerallyreportedalimitednumberofitemsincreasedatfairvalueonarecurringornonrecurringbasis,usingLevel3inputs(e.g.,impairmentoflong-livedassets,contingentconsiderationliabilities,financialinstrumentswithcharacteristicsofbothdebtandequity).
ThesenewdisclosuresmayevolveovertimeascompaniesrefinetheinformationtheyprovidebasedonleadingpracticesandfeedbackfromtheSECstaff.
Compensation committees and their use of advisers
TheSECfinalizedarulethatwillrequirenationalsecuritiesexchangestoadoptminimumlistingstandardsrelatedtocompensationcommitteesandtheiruseofadvisers.Underthesestandards,amemberofalistedcompany’scompensationcommitteemustbean“independent”memberoftheboardofdirectors,asdefinedbytheexchange.Listingstandardsmustrequirethatcompensationcommitteeshavetheauthoritytoretainadvisersandberesponsiblefortheirappointment,paymentandoversight.
2009 US GAAP XBRL taxonomy phased out
Edgarnolongeracceptsextensiblebusinessreportinglanguage(XBRL)exhibitsusingthe2009USgenerallyacceptedaccountingprinciples(GAAP)XBRLtaxonomy.Registrantsmaycontinuetousethe2011USGAAPXBRLtaxonomy,buttheSECstaffstronglyencouragescompaniestoadoptthelatestversionofthetaxonomy
fortheirXBRLexhibits(i.e.,the2012taxonomyreleasedinMarch2012).DetailsaboutthetaxonomiescanbefoundontheFASBandSECwebsites.
Accounting for and disclosure of loss contingencies
TheSECstafffrequentlychallengesregistrantsforfailingtomakerequiredfootnotedisclosureswhenlossesareconsideredreasonablypossibleorforfailingtodisclosetherangeofreasonablypossiblelosses,includingthereasonablepossibilityofalossinexcessoftheamountaccrued.TheSECstaffmaylooktoverifythataregistranthasconsideredanddisclosedanestimateoftheamountorrangeofreasonablypossiblelossesor,ifapplicable,astatementthattheamountoflosscannotbeestimated.Ifaregistrantstatesanestimateoflosscannotbemade,theSECstaffmaylookforredflagsthatmightindicateotherwise,suchastheregistrant’shistorywithsimilarlegalmattersandtheageofanypreviouslitigation.
TheSECstaffmayalsochallengetheadequacyofhistoricaldisclosureswhenlosscontingenciesaresubsequentlysettled.Inparticular,theSECstaffreviewsprior-perioddisclosuresandmayinquirewhetherpastdisclosureswereappropriateandwhetheranaccrualshouldhavebeenrecognizedinapriorperiod.
Lessons from restatementsUnderstandingtheissuesthatgaverisetorestatementsoffinancialstatementscanassistcompaniesastheyperforminternalriskreassessmentsandevaluatetheircontrolenvironments.Errorsinaccountingforincometaxes,revenuerecognitionandthepresentationofthestatementofcashflowscontinuedtobeleadingcausesofannualrestatementsduring2011.
Top 3 topics – 2011 No. Top 3 topics – 2010 No.
Incometaxes 18 20% Revenuerecognition 21 17%
Revenuerecognition 9 10% Incometaxes 15 12%
Statementofcashflows 5 6% Derivatives 9 7%
Income taxes
Errorsinaccountingforincometaxesoccur,inpart,becauseofthedetailedrecordkeepingrequiredtoappropriatelytrackthetaxbasesofallassetsandliabilities(i.e.,atax-basisbalancesheet).Inessence,thisresultsinanentitykeepingasecondsetofbooksonataxbasis.Moreover,trackingatax-basisbalancesheetrequiresanunderstandingofthetaxlaw,oftenformultipletaxingjurisdictions.Furthercomplicatingmatters,theaccountingmodelforincometaxesunderASC740iscomplex.
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Whilethespecificcausesofrecentincometaxaccountingrestatementsvary,asignificantportionofincometaxaccountingrestatementsfellintothefollowingcategories:
• Inappropriateevaluationoftherealizabilityofdeferredtaxassets
• Incorrectidentificationorcalculationofthetaxbasis,resultingininappropriatemeasurementofdeferredtaxassetsandliabilities
• Incometaxaccountingerrorsassociatedwithintercompanytransactions
Revenue recognitionRevenuerecognitionguidanceconsistsofmorethan200piecesofliterature.Insomecases,theguidanceisgeneral,andinothersitisprescriptive.Muchoftheguidanceisspecifictocertaintransactionsorindustries.Thesefactors,combinedwithothercomplexities,makeinappropriaterevenuerecognitiononeofthemostfrequentcausesofrestatements.
Thespecificreasonsforrevenue-relatedrestatementsvary.Theyincludecalculationerrors,fraud,failuretounderstandcontractualtermsandmisapplicationofaccountingliterature.Onerecentrevenuerecognitionrestatementtrendisineffectivemonitoringofaccountingestimatesrelatedtorevenuerecognition.
Revenuerecognitionrequirestheuseofaccountingestimatesandongoingmonitoring,suchascomparingestimatesandassumptionstoactualresults.Revenuerecognitionestimatesincludedetermining:
• Productreturns
• Thestand-alonesellingpriceforseparateunitsofaccounting
• Thepatternofperformanceofacontractedservice(i.e.,determiningtheextenttowhichtheearningsprocesshasbeencompleted,includingusingtheproportionalperformancemethod)
• Theprogresstowardcompletionofcontracts,applyingthepercentage-of-completionmethod
Theseestimatesshouldbereassessedonaregularbasistodeterminewhethertheunderlyingassumptionscontinuetobeappropriate.Iftheactualresultsdonotsupporttheassumptionsusedtodeveloptheaccountingestimate,acompanyshouldevaluatewhetheranyrequiredchangereflectsachangeinestimateoranerror.
Examplesofanerrorinclude:
• Inappropriatelyapplyingassumptionsthatarenotconsistentwiththebestavailableinformation(e.g.,historicalresults)
• Notchangingtheunderlyingassumptionsinatimelymannerwhenfactsandcircumstanceschange
• Inappropriatedesignoroperatingeffectivenessofinternalcontrolsovertheseestimationprocesses
Statement of cash flows
Restatementsrelatedtothestatementofcashflowstypicallystemfromaninappropriateclassificationofcashinflowsandoutflowsbetweenoperating,investingandfinancingactivities(e.g.,inappropriateclassificationofchangesinrestrictedcashandderivative-relatedactivity).
Accountingguidanceinthisareaisexplicitwithrespecttotheproperclassificationofcertainitems;otheritemsrequiretheuseofjudgment.Forexample,whentheclassificationisnotexplicitlyaddressed,itwilloftenbebasedonthenatureoftheactivityandthepredominantsourceoftherelatedcashflow.
Other topics
Suchtopicsastheaccountingfortransactionsinvolvingfinancialinstrumentswithcharacteristicsofbothdebtandequityandfinancialstatementclassificationwerealsosignificantcontributorstorestatementsduring2011.Othertopicsfluctuateinfrequencyduetovariousfactors,includingnewaccountingpronouncements,changesinthenatureorvolumeoftransactions,andthefocusofregulators.Someexamplesfrom2011restatementsinclude:
• Businesscombinationsandtransactionsinvolvingfinancialinstrumentswithcharacteristicsofbothdebtandequity—Fortransactionsinvolvingbusinesscombinations,somecompaniesinappropriatelyaccountedforcontingentconsiderationorfailedtoidentifyintangibleassets.Inrestatementsinvolvingtransactionsinvolvingfinancialinstrumentswithcharacteristicsofbothdebtandequity,certainwarrantinstrumentswereinappropriatelytreatedasacomponentofequityinsteadofasaderivativeliability.
• Financialstatementclassification—Frequenterrorsinthisareaincludedinappropriateclassificationofincomestatementactivity(i.e.,betweenoperatingexpenses,selling,generalandadministrativeexpenses,andotherexpenses)andincorrectbalancesheetpresentationofcurrentandlong-termassetsandliabilities.
• Accountsreceivableallowances—Companiesincreasinglymadeerrorsrelatedtotheallowancefordoubtfulaccounts,includingerrorsresultingfromtheuseofaninappropriatereservemethodology(e.g.,aggregatingreceivablesthataredissimilarin
Regulatory environment: key developments and trends
7The shifting pharmaceutical industry landscape
nature)orfromtheuseofflawedorincompletefacts.Athoroughanalysisofallfactors,includinghistoricalresults,shouldbeconsideredwhenmakingjudgmentsinthisarea.
• Leases—Companiesmisappliedtheleasingguidance.Examplesincludeincorrectlyclassifyingleases(i.e.,operatingversuscapitalleasesforlessees)andinappropriatelyaccountingforsaleandleasebacktransactionsandbuild-to-suitleasetransactions.Awidevarietyofleases,coupledwiththecomplexityoftheaccountingmodel,makeleaseaccountingarecurringcauseofrestatements.
FASB and IASB joint projects
Continued redeliberations on revenue recognition
TheBoardsarereviewingmorethan40topics,includingwhetherconsiderationreceivedforthesaleofalicenseshouldberecognizedovertimeorataspecificpoint.TheBoardsdiscussedpossiblerefinementstotheimplementationguidanceonlicensesandrightstouseandaskedtheirstafftoperformadditionalanalysistohelpthemreachafinaldecision.Lifesciencescompaniesshouldmonitorthereviewtodetermineifanyrefinementstoaccountingforlicensesorrightstouseaffecttreatmentofthesetransactions.
TheBoardsalsotentativelydecidedtoremovetheproposedrequirementtomeasureandrecognizelossesononerousperformanceobligationsincustomercontracts.Instead,theytentativelydecidedtolookintoexistingguidance,eventhoughthiswouldmeanthatcurrentdifferencesbetweenUSGAAPandInternationalFinancialReportingStandards(IFRS)inthisareawouldremain.
Whilemuchislefttodiscuss,theBoardsstillplantoissueafinalstandardinthefirsthalfof2013.
PCAOB updates
Auditor independence
ThePCAOBheldanotherroundtableonauditorindependenceandmandatoryfirmrotationandbrieflyreopenedthecommentperiod.Thefeedbackwasconsistentwithotheroutreachefforts—participantsgenerallysupportedimprovingauditqualityandenhancingauditorindependencebutweregenerallyagainstmandatoryrotationoftheirauditfirms.ThePCAOBwillcontinuegatheringfeedbackthroughmoreoutreachinitiatives,whichwilllikelyextendthisprojectinto2013.
PCAOB inspection process
Inresponsetofeedbackfrompubliccompanyauditcommittees,thePCAOBissuedareleasetohelpthecommitteesunderstandmoreaboutitsinspectionsofregisteredpublicaccountingfirms.Amongotherthings,thereleaseincludedanumberofquestionsrelatedtotheinspectionprocessthatthePCAOBencouragedthecommitteestoasktheirauditors.
FASB updates
Improvements to disclosure requirements
TheFASBsoughtcommentonadiscussionpaperaboutaframeworkforimprovingtheeffectivenessofdisclosuresinnotestofinancialstatements.ThepaperisnotaproposalbutratherameanstogatherstakeholderinputtohelptheBoarddevelopaproposal.TheFASB’sgoalistoimprovetheeffectivenessofdisclosuresbyclearlycommunicatingtheinformationthatisimportanttotheusersofacompany’sfinancialstatements.Toachievethisgoal,theFASBbelievesitmustdevelopaframeworkthatpromotesconsistentdecisionsaboutdisclosurerequirementsandhelpscompaniesdeterminewhichdisclosuresarerelevanttotheirsituation.
Thepaperaskedforinputonanumberofissues,including:
• AdecisionprocessthatcouldhelptheFASBestablishdisclosurerequirements
• Awaytomakedisclosurerequirementsflexiblesothateachcompanycouldtailoritsdisclosurestomeettheneedsoftheusersofitsfinancialstatements
• Ajudgmentframeworktohelpcompaniestailortheirdisclosures
• Asetoforganizationandformattingtechniquesthatwouldmakeinformationeasiertofindandunderstand
• Aframeworkforevaluatingdisclosurerequirementsforfinancialstatementscoveringinterimperiods
End of project on loss contingencies
TheFASBdecidedtodiscontinueitsprojectonlosscontingencies,aneffortthatwouldhavesignificantlyexpandedquantitativeandqualitativelosscontingencydisclosurerequirements.Invotingtodiscontinuetheproject,someBoardmembersstatedthatanyissuerelatingtolosscontingencydisclosureswasacompliancematter,notastandard-settingmatter.WeexpecttheSECstafftocontinuetochallengeregistrants’disclosuresinthisarea.
8
Inordertomakeinvestmentdecisions,itisimportantforusersoffinancialstatementstoobtainkeyinformationrelevanttoacompany,thusallowinginvestorstomakereliablecomparisonsamongcompetitors.Studieshaveshownacorrelationbetweenthetransparencyandconsistencyofacompany’sfinancialreportinganditsshare-priceperformance.
Tohelpyouprepareyour2012annualreport,wehavereviewedandcomparedaselectionofsignificant2011financialstatementsofsevenleadingcompaniesinthepharmaceuticalindustry.Fiveofthecompanies—BMS,EliLilly,J&J,MerckandPfizer—primarilysellbrandedproducts.Theothertwo—TevaandWatson—areprimarilygenericcompanies.AllsevencompaniesreporttheirfinancialresultsonthebasisofUSGAAP.
Inthefollowingsection,weprovidecommentsoncertaininformationintheirfinancialstatementsfromayearagothatmayhaverelevancetoyourupcomingfinancialstatementdisclosureconsiderations,particularlywithregardtodisclosuresthatwilllikelybethefocusofattentionforinvestorsandtheSEC.
Ourcomparisonencompassessevenfocusareas:
1.Revenuerecognitionandcollaborationarrangements
2.IPR&Dassetsandintellectualproperty
3.Performance
4.Riskandmitigation
5.Accountingpolicies,judgmentsandestimates
6.Leasecommitments
7.Financialstatementcloseprocess
Aseachofthesurveyedcompaniesinformationintheirfinancialstatementsisbasedontheirspecificfacts,circumstancesanddeterminationofmateriality,youshouldconsultwithErnst&YoungLLPorotherprofessionaladvisorsfamiliarwithyourparticularfactualsituationforadvicebeforemakinganydecisionsaboutyourspecificdisclosures.
1. Revenue recognition and collaboration arrangements
1.1 Revenue deductions
Refertotheregulatoryenvironmentsectiononpage2foradescriptionofSECreportingobservationsaboutrevenuedeductionsandrelateddisclosures.
AllcompaniessurveyedprovideddisclosuresonrevenuedeductioninMD&Aandinthenotestothefinancialstatements.
Noneofthecompaniesprovidedquantitativeinformationrelatedtothequalitativefactorsthatmanagementconsideredwhenitestimatedeachrevenuededuction.
ThecompaniesgenerallyprovidedqualitativeinformationinthenotestothefinancialstatementsandquantitativeinformationinMD&A.InadditiontothequantitativeinformationinMD&A,BMSincludedinthenotestothefinancialstatementsthereductionstotradereceivablesandalistingofaccruedrebatesandreturnliabilitiesatyear-end.
Allcompaniesprovideddetailedqualitativeinformationaroundtheirrevenuededuction.However,thelevelofquantitativeinformationwasgenerallylimitedwithonlyBMS,J&JandTevapresentingrollforwardinformationforeachrevenuededuction.J&Jwastheonlycompanythatpresentedrevenuedeductionsandrollforwardinformationbybusinesssegment.
PfizerdisclosedaggregaterevenuedeductionsforMedicaidandrelatedstaterebateprograms,Medicarerebates,performance-basedcontractrebatesandchargebacks.However,theamountsrelatedtosalesreturnsandsalesincentiveswerenotpresented.
BMSdisclosedtheamountsofrevenuedeductionatadetailedlevel,includingthefollowingbreakout:
• Chargebacksrelatedtogovernmentprograms
• Cashdiscount
• Managedhealthcarerebatesandothercontractdiscounts
• Medicaidrebates
• Salesreturn
• Otheradjustments
J&Jdisclosed,atahighlevel,theamountofrevenuedeductions,splitbetweenthefollowingcategories:
• Rebates
• Salesreturns
• Promotions
Tevadisclosed,inarollforwardformat,thefollowingrevenuedeductions:
• Reservesincludedinaccountsreceivable,net
• Chargebacks
• Returns
• Rebatesandothersalesreservesandallowances
Peer review: how seven companies handled disclosures
9The shifting pharmaceutical industry landscape
SEC disclosure requirements BMS Eli Lilly J&J Merck Pfizer Teva Watson
Nature of each revenue deduction, along with information about the key terms of material arrangements or agreements that influence the estimate of each deduction as of each balance sheet date
Amount of each revenue deduction (1) (2) (3) (4)
Rollforward information for each revenue deduction, including the beginning and ending accrual balances, the current provision related to sales made in the current and prior periods (presented separately) and the actual returns or credits in the current period related to sales made in the current and prior periods (presented separately)
(5) (2) (3) ND
Qualitative factors that management considers when it estimates each revenue deduction (e.g., a description of how management evaluates factors such as):
Levels of inventory in distribution channels ND ND(6)
Estimated remaining product shelf lives
Shipments of product made as a result of incentives or in excess of the customer’s ordinary demand ND ND ND ND ND
Introduction of new or generic competitive products
Quantitative information related to qualitative factors a registrant considers when it estimates each revenue deduction, e.g., a discussion accompanied by detailed quantitative information by product, including the total amount of product in sales dollars that could potentially be returned as of the most recent balance sheet date, disaggregated by expiration period, if any
ND ND(9) ND ND ND ND ND
The effects that could result from using other reasonably likely assumptions in estimating each revenue deduction (e.g., a range of reasonably likely estimates or other types of sensitivity analyses)
ND (7) ND(8) ND ND ND ND
The underlying business reasons for material period-to-period fluctuations for each type of reduction of gross revenue, including the effect that changes in estimates have on revenues and obligations
ND(9) ND(8) ND ND
ND - Not disclosed(1) Amounts provided for the total amount of sales returns, rebate and discount, including Medicaid. (2) Amounts of each revenue deduction disclosed for each business segment.(3) Amounts and rollforward information disclosed for indirect customer discount accrual (chargebacks and rebates).(4) Amounts disclosed for Medicaid and related state program rebates, Medicare rebates, performance-based contract rebates and chargebacks. Other revenue deduction amounts were not included.(5) Rollforward table provided for the total revenue deductions related to the US market.(6) Narrative disclosures provided including a broad estimate.(7) Sensitivity analysis for sales returns, Medicaid and Medicare rebates.(8) Disclosures provided related to the fact that any changes are not anticipated to be material.(9) Adjustments for estimated revenue deductions disclosed as less than 0.3% of net sales for all years presented.
EliLillywastheonlycompanytoincludehigh-levelcommentsontheeffectsthatcouldresultfromusingotherreasonablylikelyassumptionsinestimatingrevenuedeductions.BMS,Pfizerand
Tevaweretheonlycompaniesthatpresentedananalysisofmaterialperiod-to-periodfluctuationsforrevenuedeductions.
10
Peer review: how seven companies handled disclosures
SEC requirements BMS Eli Lilly J&J Merck Pfizer Teva Watson
Does the entity have collaboration arrangements? YES(1) YES(2) YES(3) YES(4) YES(5) YES(5) YES(6)
Nature of collaboration arrangements disclosed:LicensingCo-developmentCo-commercializationCo-manufacturingCo-marketingCo-promotionCo-distribution
—
——
—————
—
—
———
————
The table below shows which companies provide enhanced disclosures:
The identity of the other party in the arrangement ND (5) (5)
The products being developed, as applicable ND (5) (5)
Any amounts paid or received to date under the arrangement (including up-front licensing fees and milestone payments) ND ND(7) (5) ND
Under each arrangement, aggregate potential milestone payments to be made or received and the triggering events for the milestones ND ND(8) (5) ND
The existence of royalty provisions, royalty rates (or ranges within defined percentages if tiered) and any sales thresholds related to rates ND ND ND(9) ND
Duration and termination provisions, including payments the registrant may be required to make in the event of termination ND (5) ND(9) ND
Disclosure by entity
ND - Not disclosed(1) Collaboration arrangements with seven significant partners.(2) Collaboration arrangements with six significant partners. (3) Disclosed only the accounting policies used for collaboration arrangements.(4) Collaboration arrangements with two significant partners. Joint ventures with five significant partners. (5) Did not include a separate section for collaboration arrangements, which were disclosed in many places in MD&A or in notes to the financial statements.(6) Collaboration arrangement with one significant partner.(7) Disclosed in aggregate in the notes to the financial statements. (8) Disclosures in the notes to the financial statements of total amounts received and paid during the fiscal year.(9) Disclosed for major collaboration agreements.
Inthenotestothefinancialstatements,BMS,EliLillyandMerckincludedaspecificfootnoteprovidingextendeddisclosuresrelatedtotheirrespectivecollaborationarrangements.Tevaprovidedonlylimitedinformationinthenotestothefinancialstatementsaboutitscollaborationarrangements.BMSandMerckalsoincludedaspecificsectionrelatedtocollaborationarrangementsinMD&A.
J&Jdisclosedtheaccountingpoliciesrelatedtoitscollaborationarrangements.However,nodetaileddisclosuresrelatedtothesearrangementswerepresentedinthenotestothefinancialstatementsorinMD&A.EliLillytooktheapproachofdisclosingitscollaborationarrangementsinthenotestothefinancialstatementsorganizedbydrugandnotbycollaborationpartner.
1.2 Collaboration arrangements
Refertotheregulatoryenvironmentsectiononpages3-4foradescriptionofSECreportingobservationsaboutcollaborationarrangementsandrelateddisclosures.
ThetablebelowhighlightsthespecificitemstheSECstaffhasidentifiedrelatedtocollaborationarrangementsthatregistrantsshouldconsiderdisclosing.
11The shifting pharmaceutical industry landscape
2. IPR&D assets and intellectual property
2.1 Disclosures related to acquired IPR&D assets Refertotheregulatoryenvironmentsectiononpage4foradescriptionofSECreportingobservationsaboutacquiredIPR&Dassetsandrelateddisclosures.
ThesuggestedfinancialstatementandMD&Adisclosuresareasfollows:
SEC requirements BMS Eli Lilly J&J Merck Pfizer Teva Watson
Amount of IPR&D on the balance sheet (US$ millions) 645 475 1,849 2,671 1,197 2,178 1,197
Specific nature and fair value of each significant IPR&D project acquired ND(3)
Completeness, complexity and uniqueness of the projects at the acquisition date ND(3)
Nature, timing and estimated costs of the efforts necessary to complete the projects and the anticipated completion dates ND ND(4) ND ND ND ND
Risks and uncertainties associated with completing development on schedule and consequences if it is not completed on time ND ND ND
Valuation method used for IPR&D projects (1) (1) (3)
Significant valuation assumptions, such as:• Periodinwhichmaterialnetcashinflowsfromsignificantprojectsare
expectedtobegin• Materialanticipatedchangesfromhistoricalpricing,marginsand
expenselevels• Therisk-adjusteddiscountrateappliedtotheproject’scashflows
ND(2) ND(2) ND(2) ND(2) ND ND(2) ND(2)
ND - Not disclosed(1) Included in the critical accounting policies section and notes to the financial statements.(2) Disclosures of valuation assumptions, including the methodology, the consideration of a probability of success factors and the discount rate used.(3) Included in the acquisition section of the notes to the financial statements.(4) Disclosed ongoing expenses related to these projects was not material to current or future research and development expense.
BMSandEliLillyprovidedanunderstandingofthemethodusedtodeterminefairvalueofIPR&Datthedateofacquisition.TheyalsoprovidedassumptionsutilizedinthevaluationoftheindefinitelivedintangibleassetsacquiredinMD&Aandinthenotestothefinancialstatements.Additionally,BMSprovidedlimitedinformationabouttheacquiredassetwithregardtothepastfewyears,includingthecurrentphaseatacquisition,andreferencedthenotestothefinancialstatementsforfurtherinformation.ThosenotesprovidedareconciliationofidentifiedIPR&Dassets,encompassingIPR&DforeachacquisitionandadescriptionofthechangeinIPR&Dyearoveryear,includingtransfersandimpairmentstakenin2011.
J&JprovidedabriefdescriptionofIPR&DinMD&Aanddetaileddisclosuresinthenotestothefinancialstatements.J&JdisclosedinformationrelatedtoIPR&Dintheacquisitionandbusinesscombinationfootnotes,aswellasintheintangiblesandgoodwillfootnotes.J&JalsodisclosedamaterialincreasetoIPR&DofUS$1millionin2011,aswellastransfersandimpairmentsrecorded
in2011toprovidecontextforthechangeintheaccountyearoveryear.J&JdidnotprovideareconciliationoftheassetsacquiredinthepurchasebutrathertookaccountofonlytheendingIPR&Dbalance.
Ofallsevencompanies,MerckprovidedthemostdetailregardingIPR&D.InaseparatepartofMD&A,Merckdiscussed,amongotherthings,acquiredIPR&D,impairmentsrecordedtoIPR&D,fairvaluemeasurementsandtheassumptionsitused.Additionally,MerckidentifiedIPR&DasacriticalaccountingpolicyintheMD&Asectionandnotestothefinancialstatements.MercksupplementedtheMD&AinformationwithanunderstandingofthechangeyearoveryearinIPR&Dwithinthenotestothefinancialstatements.
Pfizerprovidedinformationonparwith,butlessthan,thatdisclosedbyBMS,EliLilly,MerckandJ&J.PfizerlimiteditsdisclosurestothenatureandfairvalueofIPR&Drecognizedinabusinesscombination.Pfizerwassilent,however,onthevaluationassumptionsandtimingofeffortsnecessarytocompleteprojectsandtheiranticipatedcompletiondates.
12
Peer review: how seven companies handled disclosures
disclosuresrelatedtotherisksanduncertaintiesassociatedwithspecificdevelopmentprojectswerenotprovidedbyanyofthesevencompanies.
QualitativedescriptionsabouttheprojectsbeingdevelopedunderIPR&Dassetsweregenerallyincludedinthefinancialstatementfootnotes.However,informationontheunderlyingvaluationassumptionsanddetailedinformationonthenature,timingandestimatedcostsoftheeffortsnecessarytocompletetheprojectsweregenerallyabsentfromdisclosures,exceptforthosefromJ&JandMerck.
Draft AICPA Practice Aid for disclosures around IPR&D
Refertotheregulatoryenvironmentsectiononpage4foradescriptionofthedraftAICPAPracticeAiddisclosurerequirementsforacquiredIPR&Dassets.
2.2 Disclosures related to material patents
Refertotheregulatoryenvironmentsectiononpage4foradescriptionofSECreportingobservationsaboutmaterialpatentsandrelateddisclosures.
Registrantsareaskedtoprovidethefollowingadditionaldisclosuresformaterialpatents:
• AllcompaniesprovidedextensivedisclosuresrelatedtopatentsinMD&A,andtheyallincludedaspecificsectiononpatentsandintellectualproperty.Eachcompanyprovidedadditionalinformationrelatedtopatentswhenmakingdisclosuresinotherareas,includingproductsandrisksanduncertainties.
• Allcompaniesalsoreferredtothenotestothefinancialstatementsfordisclosuresrelatedtopatentlitigation.Furthermore,J&JincludedaclearscheduleofallpatentlitigationintheUSandasreferencedinitsAbbreviatedNewDrugApplicationfilings,andEliLillyincludedadetailedpatentlitigationdiscussionwithinitsMD&A.
Seeadditionaldetailbelowinsection4.4,protectionofpatentsandproductsales.
SEC requirements BMS Eli Lilly J&J Merck Pfizer Teva Watson
Discussion of the products or technologies that relate to the patent
Jurisdiction in which patent is granted (1)
Expiration date
Patents subject to legal proceedings
Whether patents are owned or licensed
(1) Provided only for the US market.
TevaprovidedverylimitedinformationinMD&AaboutacquiredIPR&D,limitingthediscussiontothedeterminationofIPR&Dimpairment.However,detailswereprovidedinthenotestothefinancialstatements,whichincludedareconciliationofallassetsinvolvedinamaterialacquisition,includingIPR&D,andthemethodologyandassumptionsusedtodeterminefairvaluefortheIPR&Dasoftheacquisitiondate.TevadisclosedatotalincreasetoIPR&Din2011ofmorethanUS$2million,aswellasimpairmentsrecordedandtransferstoR&Dtoprovideanunderstandingofthechangeyearoveryear.BecauseTevaisfocusedprimarilyongenericbrands—incontrasttoBMS,EliLilly,J&J,MerckandPfizer,whichfocusprimarilyonbrandedproducts—itisexpectedthatTeva’sIPR&Dactivitywouldgenerallybesmallerthanthatofitscounterparts.
Inadditiontotheabove,therisksanduncertaintiesassociatedwithIPR&DwereoftendisclosedonagenericbasisinMD&A.Detailed
13The shifting pharmaceutical industry landscape
2.3 Dynamic pipeline of new products Refertotheregulatoryenvironmentsectiononpages4-5foradescriptionofSECreportingobservationsrelatedtoresearchanddevelopmentexpenses.
Registrantsareaskedtoprovidethefollowingdisclosuresforeachnewproduct:
SEC requirements BMS Eli Lilly J&J Merck Pfizer Teva Watson
The nature, objective and current status of each R&D project and the extent to which its success depends on parties other than the registrant (1) (1) (1)
Discussion of phases (1) (1) ND(1)
Description of the nature of products in the pipeline (1) (1) (1)
ND - Not disclosed (1) SEC comment letter received.
Research and development activities
AllcompanieshadaspecificsectionwithintheirMD&ArelatedtoresearchanddevelopmentasrequiredbytheSEC.Eachcompanydisclosedtheirresearchanddevelopmentactivities,thedifficultiesanduncertaintiesrelatedtothedevelopmentofnewdrugs,theglobalamountofresearchanddevelopmentexpensesincurredoverthelastthreeyears,andthetherapeuticcategoriesthattheytargeted.Inaddition,J&Jincludedatableoftheresearchanddevelopmentexpenses(excludingIPR&D)bybusinesssegment.
Mostcompaniesincludedlengthyqualitativedescriptionsoftheirmainprojectsandlistsofregulatoryapprovalsobtainedorfiled.However,theydidnotincludeanyquantitativeanalysisorprojections.J&Jdidnotdiscloseitsmainprojectsorfilingsmadeduringthefiscalyearintheannualreport,butitdidmakethisinformationavailableinaseparatedocumentpostedonitswebsite.
Pipeline of new products
EliLillyprovidedasummaryofthenumberofprogramsineachphaseoftheR&Dpipeline,adescriptionofkeyproductsinthepipelineanddetailsontheprogressofeachdrug(includingmilestonesreachedandattrition).Significantlate-stagedevelopmentwithinpipelineswerefurtherexplainedinMD&A.
BMS’discussionofproductandpipelinedevelopmentswaslimitedtosignificantdevelopmentsinlatestage(PhaseIIIclinicaltrials)programs.Itdidnotprovideinformationofproductsinotherphases(i.e.,PhaseIandPhaseIIclinicaltrials).Itdidprovideadescriptionofdrugsinthepipelineandsignificantdevelopmentsregardingapprovals,studyresultsandpublicationsoftestsresults.
Merckdidnotpresentthedefinitionofthevariousdevelopmentphasesinawaythatwaseasilyextractable,asitwasembeddedin
thecompany’sR&Ddiscussion.However,MerckdidhighlightthedifferencesbetweenPhaseI,IIandIIIclinicaltrialsforcompounddiscoveryandvaccinestoenableanassessmentoftheprogressofthekeyproductsdescribedwithinitsR&Dpipeline.Merckalsoprovidedadescriptionofdrugsinthepipelineandsignificantdevelopmentsregardingapprovals,studyresultsandpublicationsofsignificanttestresults.
J&JprovidedabriefdiscussionthathighlightedcertainkeyproductsitsR&DpipelinebutdidnotsaywhethertheproductswereinPhaseI,IIorIIIclinicaltrials.However,J&Jdidhighlightthedistinctionbetweennewproducts,leadingproductpipelinesandtargetedacquisitionsinitsannualreport.
TevaprovidedabriefdiscussionthathighlightedcertainkeyproductsinitsR&DpipelinebutofferedonlylimiteddisclosureonthecompositionofitsR&D,includingdistinguishingtheR&Dspendbyphase.Further,Tevadidnotdisclosetheexpectedfinancialimpactonitsfutureoperations,financialpositionorliquidityofthefollowing:themonthandyeareachprojectenteredintothecurrentphaseofdevelopmentandidentificationofsignificantpatentsassociatedwiththeprojectandtheirexpirationdatesand/orotherinformation,asapplicable,thatwouldprovideinsightintotheavailableperiodofexclusivityforthesetobedevelopedproducts.TevareceivedanSECcommentletterinquiringabouttheaforementionedconsiderationsandrespondedthatitwouldupdateitsdisclosures.
WatsonprovidedadetailedunderstandingofR&Dspendingwithregardstokeyproductsanddistinguishedbetweenbrandedandgeneric,aswellasonacountry-by-countrybasis.However,limiteddisclosurewasprovidedonthecompositionofR&D,includingdistinguishingtheR&Dspendbyphaseofclinicaldevelopment.
14
Peer review: how seven companies handled disclosures
SEC comments
SeveralofthecompaniesinthissurveyreceivedcommentsduringthepasttwoyearsrelatingtotheirR&Ddisclosures.TheSEC’scommentsweregenerallyfocusedonthefollowingareas:
1.R&Dspendingbyproject,bysegmentandbystageofdevelopment
2.FoodandDrugAdministration(FDA)approvalandpatentsassociatedwithprojectsinPhaseIIIclinicaltrials
3.ThenumberofnewdrugsinPhaseIIIclinicaltrialsandhowmanycompoundsweresubmittedforregulatoryreview
4.Theperiodoftimeittooktocompleteaclinicaltrial
5.TheimpactofR&Dprojectsonthecompany’sfutureoperationsandliquidity
3. Performance
3.1 Non-GAAP financial measures
Non-GAAPfinancialmeasures(oradjustedearnings)provideanalternativeviewofanentity’sfinancialperformance.Adjustedearningsmeasuresareusedbymanagementtoenhanceinvestors’understandingofacompany’sperformancebyadjustingfornonrecurringeventsoritemsthatdonotreflectacompany’snormaloperations.
Mostofthesurveyedcompaniesprovideddetailedexplanationsoftheadjustedearnings,akeyperformanceindicatorinthepharmaceuticalindustry.
BMSbrieflyoutlinedthepurposebehindeachlineitemincludedintheadjustedearningsreconciliation.
EliLillydiscussedadjustedearningsmainlyonanearnings-per-share(EPS)basisandprovidedonlyadjustedrevenuefigures.EliLilly’sdiscussionofnon-GAAPfinancialmeasureswasmostlyconfinedtotheproxystatementsectionofitsannualreport,whereitalsodescribedhowmanagementcompensationwasdetermined.
J&Jprovidedadetailedbreakdownofadjustmentsthroughtheuseofinformationheadingsforeachadjustment,butitdidnotincludeinformationregardingthenatureoftheadjustments,nordiditreferenceotherpartsofthefinancialstatementstoobtainmoreinformation.Overall,adjustedearningsdidnotappeartobeasignificantemphasisofJ&Jcomparedwiththeothercompanies,nordidJ&Jexcludethepurchaseaccountingadjustmentandresultingamortizationofintangibles,whichappearstobegeneralpracticeformanyUScompanies.
Merckexplainedthepurposeforusinganadjustedearningsamountforinternalpurposes,anditidentifiedtheareasinwhichadjustedincomeisevaluatedinternally.
Pfizerprovidedthemostcontextformanagement’suseofadjustedincomemeasuresforinternalpurposes,suchastheassessmentofseniormanagementcompensation,thepreparationofannualbudgetsandtheanalysisofoperatingresults.
Tevaprovidedanunderstandingoftheuseandimportanceofnon-GAAPfinancialmeasuresforinternalpurposesandofferedadetailedbreakdownoftheadjustmentstoreportedGAAPmeasures.Additionally,Tevaprovidedafullnon-GAAPincomestatement.During2011,TevadidreceiveanSECcommentletter,notingthatdisclosureofafullnon-GAAPincomestatementmayattachundueprominencetothenon-GAAPinformation.
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Description of adjusted earnings Non-GAAP
earnings
(1) (2) Non-GAAP
income
Adjusted income
Non-GAAP
financial measures
Non-GAAP
earnings
Adjusted earnings presented (non-GAAP financial measures)
Breakdown of calculation of adjusted income
Explanation of the purpose of the adjusted earnings figure ND
Explanation for significant adjustments highlighted
Adjusted earnings disclosed in the MD&A section ND ND
(1) Eli Lilly provided only adjusted revenues and EPS in its proxy statement. No adjusted earnings were provided. (2) J&J provided a reconciliation of non-GAAP adjusted revenues and EPS on its website (referenced in its proxy statement).
15The shifting pharmaceutical industry landscape
3,709 4,348
9,672
6,392
10,009
2,759 456
212
(33)
4,195
5,425
8,208
1,679
(2,000)
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Adjustments included to get to adjusted earnings
US GAAP earnings
US$ millions
Adjustments to US GAAP earnings
Watsonprovidedanexplanationoftheinternalpurposesforusinganadjustedearningsmeasureandtheareasinwhichadjustedincomeisevaluatedinternally.Watsonalsoprovidedadetailedreconciliationofthenon-GAAPadjustments.
3.2 Reported earnings to adjusted earnings
PfizerandMerckemployedthemostsignificantnon-GAAPadjustmentswhencalculatingadjustedearnings.Theseadjustmentsgenerallyrelatedtopurchaseaccountingandcostsfrommaterialacquisitionsmadeduringtheyear.
Merckalsotookrestructuringcostsintoaccounttoadjustitsearnings,asdidTeva.BMSandEliLillyadjustedearningsmainlyforrestructuringcostsbutalsoincludedeliminationofassetimpairments.J&Jconsideredonlylitigationchargestoarriveatadjustedearnings.
Forfurtherinformation,pleaserefertotheappendix,onpage35.
Adjustments to US GAAP earnings
16
Principal business risks and uncertainties BMS Eli Lilly J&J Merck Pfizer Teva Watson
Descriptions of key risks
Industry specific risks
Intense competition around branded products
Costly and highly uncertain nature of research and development
Competition from lower-priced generic products
Loss or expiration of intellectual property in the near future ND ND ND
Unexpected developments related to safety or efficiency of products ND
Pipeline productivity and competition — ability to continuously develop or replace products
Pricing and access pressures
Current and future product liability claims ND
Regulatory environment:
Potential exposure to government price controls ND ND
Ability to obtain and maintain approval for products
Potential noncompliance issues and scrutiny from FDA and other regulators
Adverse effect from changes in laws and regulations
High dependency of revenues, cash flows and earnings on protections given by patents ND
Negative events in animal health industry ND ND ND ND ND
General risks
Manufacturing and supply-chain difficulties
Reliance on third-party and outsourcing arrangements
Prolonged economic downturn ND
Financial distress and bankruptcies experienced by significant customers ND ND ND ND
Economic factors, including inflation and fluctuating interest rates and currency values
Political and economic instability caused by terrorist attacks ND ND ND ND
Interruptions of computer systems, impairing ability to conduct business ND
Vulnerability of key company products, and their significant profits and cash flows, to adverse market events ND ND
Effect of complex and evolving tax laws, which may result in additional liabilities ND ND ND
Failure to realize the anticipated benefits of strategic initiatives and acquisitions ND
Peer review: how seven companies handled disclosures
4. Risk and mitigation
4.1 Principal business risks and uncertaintiesOurreviewincludeshowclearlytheissue,impactandmitigationofrisksanduncertaintieshavebeendisclosed.
Thefollowingcharthighlightssimilaritiesanddifferencesinthelevelofdisclosure:
17The shifting pharmaceutical industry landscape
Thechartbelowsummarizesthedisclosurepracticesofthesevencompaniesinourreview,anditshowsthatregulatoryandpricingpressureswerekeyriskfactors.RegulatoryissuesincluderisksaroundpatentprotectionandobtainingandmaintainingFDAapprovals.Otherrisksinthisareaincludelitigationtiedtopatentissuesandproductliabilityclaims.Everycompanyidentifiedrisksrelatingtoregulatoryissuesandpricingpressure,underscoringtheirimportancetomanypharmaceuticalcompanies.
Thesecondmostsignificantcategoryisrelatedtorisksaroundsupplychains,technologyandmanufacturing.Thiscategory
includedriskssuchasdealingwithoutsourcingcompaniesandotherthirdpartiesinthemanufacturingprocessthatcouldslowdownproductionoraffectquality.Companieswerealsohighlyconcernedaboutthedisruptionsthatcouldresultfromattacksontheirinformationtechnologysystems.
Oneoftheareasthatdrewtheleastconcernwasrelatedtointernationaloperations.BecauseoftheEuropeansovereigndebtcrisis,thisareaofriskmaybecomemoresignificantbecausemanypharmaceuticalcompanieshaveextensiveoperationsinforeigncountries,whichcouldexposethemtomorerisk.
Principal business risks and uncertainties BMS Eli Lilly J&J Merck Pfizer Teva Watson
Potential impact of climate change on design, manufacturing and marketing of products ND ND ND ND ND ND
Adverse impact of new or revised accounting standards ND ND ND ND
Risk associated with significant international operations ND
Number of risks and uncertainties disclosed 21 22 21 24 24 17 20
Out of which are industry specific 12 13 10 14 13 11 12
12 13
10
14 13 11
12
9 9
11
10 11
6
8
0
5
10
15
20
25
BMS Eli Lilly J&J Merck Pfizer Teva Watson
General risks
Industry specific risks
Disclosed risk factors
18
Peer review: how seven companies handled disclosures
4.2 Cost reduction, government regulations and pricing constraintsTheregulatoryenvironmentisoneofthekeyrisksidentifiedbyallthecompaniessurveyed.Reflectingthatlevelofconcern,wewouldexpecttheSECstafftorequestregistrantstoprovidemoreinformationabouttheserisksandtheirpotentialimpact.
Initsdiscussionofthebusinessenvironment,BMSprovidedextensivedisclosuresaboutgovernmentregulationsandpriceconstraints.OfparticularconcernwerethecostsincurredasaresultofFDA-imposedrequirementscoveringthetesting,safety,effectiveness,manufacturing,labeling,marketing,advertisingandpost-marketingsurveillanceofitsproducts.Similarly,BMSincurredextensivecostsforactivitiesoutsidetheUSbasedonrequirementsissuedbytheEuropeanMedicinesAgency,thecounterparttotheFDAintheEuropeanUnion(EU).Inaddition,BMSincludedaspecifickeyriskthatindicatesitfacesincreasedpricingpressureandotherrestrictionsintheUSandabroadfrommanagedcareorganizations,institutionalpurchasersandgovernmentagencies,aswellasprogramsthatcouldnegativelyaffectsalesandprofitmargins.WithinthebusinessenvironmentsectionoftheMD&A,BMSalsomentionsvariouspricingconstraintsstemmingfromgovernmentregulation.
EliLillydisclosedakeyriskrelatedtotheimpactofincreasinggovernmentpricecontrolsandotherhealthcarecost-containmentmeasures.Additionally,EliLillymentionedtheimpactofhealthcarereform,includingtheestimateddollarimpacttothefinancialstatementsandtheeffectofthisregulationwithinMD&A.
J&Jmentioned,bothinthebusinesssectionandinthe
identificationofriskfactors,theincreasingpressureonpricescausedbyregulation.However,therewaslimitedinformationabouthowthistrendwouldaffectsales,pricingandotherareasofthebusiness.
Merckidentifiedariskduetoincreasedregulationfromthegovernmentandasecondrisk,frompricingpressures,thatcitedgovernmentasakeyriskfactor.InthehealthcareenvironmentportionoftheMD&Asection,Merckalsocitedpricingpressuresbutlinkedthemtoglobaleffortstowardhealthcarecostcontainment,healthcarereformintheUSandotherregulatoryefforts.
Pfizeridentifiedkeyrisksrelatingtopricingpressuresfromhealthcarereformandhealthcarelegislation.ItalsocitedgovernmentregulationandmanagedcaretrendsandthepotentialimpactoftheserisksinboththeUSandabroad.Additionally,MD&Areferencedthe2011financialreport,whichincludedfurtherdiscussionofthesetopicsinitsfinancialreviewanalysis.
Tevaidentifiedakeyriskindicatingthatitsrevenuesandprofitsfromgenericproductstypicallydeclinedasaresultofcompetitionfromotherpharmaceuticalcompaniesandofincreasedgovernmentpricingpressures.Tevaalsodiscussedotherrisksrelatingtohealthcarereformandgovernmentregulation,inadditiontoprovidingextensivedisclosuresabouttheimpactofregulationbothwithintheUSandinternationally.
Watsondidnotidentifyspecificrisksfrompricingpressurestiedtoregulations.However,Watsondidprovidesomediscussionontheimpactofregulationonitsbusiness.
19The shifting pharmaceutical industry landscape
4.3 Mitigation of risks Asdiscussedabove,allofthesurveyedcompanieshighlightedtheseprincipalrisks,amongothers:theintensecompetitionaroundbrandedproducts,expiringpatentson“blockbuster”drugsandgenericscompetition.Becausetheseriskscanhavesuchamaterialimpactonthefinancialstandingofanentity,itisimportanttounderstandthestrategiesthatcompanieshaveinplacetomitigatetheserisks.Thesestrategiesneedtobeviewedincombinationwitheachcompany’stimelineforexpiringpatentsanditsproductpipeline.Thecloseracompany’sproductsaretoexpiring,themorelikelyitistoseeadiscussionofanIPR&Dpipeline,indicatingthatthecompanyisplanningtohavenewproductsinthefuturetoprotectagainstthelossinsalesfromexpiringpatentsandgenericcompetition.
BMSandEliLillyofferedcomparabledisclosuresinthesensethattheybothacknowledgedtherisksrelatingtoexpiringpatents,buttheydidnotprovideinformationaboutcost-reductionplanstomitigatethoserisks.Incontrast,MerckandPfizernotonlyprovideddetailsaboutspecificexpiringpatentsbutalsodiscussedcost-reductionplans.
TevaandWatsonprovidedlessdisclosureinthisarea,primarilybecausethemostsignificantportionoftheirbusinessisdrivenbygenericproductsales,andtheriskposedbypatentexpirationisthereforelesssignificant.J&J’sdisclosuresappeartobemoreconsistentwiththoseofthegenericcompanies,eventhoughitderivesasignificantportionofitsbusinessfrombrandedproducts.
Analysis of risks and mitigation plans BMS Eli Lilly J&J Merck Pfizer Teva Watson
Disclosure of:
Discussion of general risk of patent expiring (1) (1)
List of expiring patents ND ND(3) ND
Discussion of cost-reduction plan ND ND ND ND(4) (2)
(1) Limited disclosures of general risks of patent expiring.(2) Brief mention of cost-reduction strategies.(3) Date of patent expiration included for the major products in the branded product discussion.(4) Discussion on restructuring plan.
4.4 Protection of patents and product salesWithinthebusinessdiscussionofitsannualreport,BMSidentifiedkeyproductsthatcontributedasignificantportionofitstotalnetsalesandlistedthedatesonwhichpatentsforthoseproductsareduetoexpire.Inthefootnotes,BMSdiscussedpendinglitigationrelatingtosomeofitsexpiringpatents.Acompletelistingofproductsduetoexpirewasnotdisclosed.
EliLillydiscussedexpirationdatesonpatentsinvarioussections,includingtheoverallintellectualpropertyreviewanditsdiscussionsrelatingtoriskandfinancialcondition.Withinthekeyrisksection,EliLillyidentifiedproductsthatrepresentedasignificantportionofitstotalrevenueanddisclosedtheyearoftheexpectedlossofUSexclusivity.Noinformationonriskmitigationstrategywaspresented.
J&Jdiscussedafewpatentscomingupforexpirationandnewpatentdevelopments,butonlytotheextentthatlitigationwasassociatedwiththosepatents.Thisinformationwasprovidedinthenotestothefinancialstatements.Therefore,nospecificsectionintheannualreportsummarizedthelistofexpiringpatentsforJ&J’smajorproducts,andcost-reductionplanswerenotdiscussed.
Merckincludedalistofitsmajorproductsandtheirexpectedpatentexpirationdatesinthebusinessoverviewsection.GeneralinsightswereprovidedaboutthepossibleimpactofexpiringpatentsonMerck.ThekeyfocuswasonthepatentexpiringforMerck’slargest-sellingproduct,Singulair.Nospecificplanswerediscussedtomitigatetheriskfromexpiringpatents,andthepotentialeffectonsaleswasnotquantified.
Initsdiscussionofkeyrisks,Merckalsomentionedtheriskofpatentsbeinginvalidatedorcircumvented.Inthissection,Merckdidprovideinformationaboutkeyproductswithpatentsthatwouldsoonexpire,includingthepotentialimpactonsales.Inaddition,Merckdiscusseditscost-reductionplans,whichincludedamergerrestructuringplanthatwasinitiatedin2011.ThelatterplanwasdesignedtoproducesavingsthroughoptimizationofthecoststructurethatresultedfromMerck’smergerwithSchering-Plough.
Pfizerdisclosedtheproductsforwhichpatentswouldsoonexpire,providinginformationregardingtheriskofgenericcompetitionandidentifyingwhichexpirationswouldhaveasignificantimpactonrevenues.Initsstrategydiscussion,Pfizerdisclosedhowthe
20
Peer review: how seven companies handled disclosures
companycontinuedtoaggressivelydefendpatentrightsandtosupporteffortstostrengthenthoserightsonaworldwidebasis.TherevenueofeachmajorproductwasprovidedintheformofachartinMD&A;thechartincludedproductswithexpiringpatents.Inaddition,Pfizerdescribedthecost-reductionstrategyitinitiatedpriorto2011,followingitsacquisitionin2009ofWyeth.Asnotedabove,Merckalsoincludeddisclosuresrelatedtorestructuringprogramsinitiatedtooptimizeitscoststructureandincreaseefficiency.Theothercompaniesdescribedmoregeneralriskaroundexpiringpatentsbutprovidednospecificinformationabouttheirpositiontomitigatethatrisk.
TevaandWatsonofferedsomegeneraldiscussionsabouttheimpactofpatentexpirations.Butbecausethesecompaniesarefocusedonthegenericmarket,thediscussionwasneitherextensivenorspecific.Totalrevenuefrompatentedproductsforthesecompanieswas34%and9%,respectively.Bothcompanies,however,identifygenericcompetitionasariskthatmayaffectfuturesales.
4.5 Expiring products, R&D, new patents, and new drug approvals
Toprotectagainstdiminishingrevenues,companiesmusthavesufficientR&Dandnewproductsintheirpipeline.Theyshouldalsodiscloseenoughinformationforinvestorstodeterminetheirfuturerevenueprospectsbasedonpotentialproductsinthepipeline.
BMSprovidedaseparatediscussiononproductandpipelinedevelopmentsthatdisclosedallrecentsignificanteventsandidentifiedthoseproductsinlater-stagedevelopment.Foreachproduct,atimelineofthedevelopmentswithinthelastyearwasprovided,aswellasrelevantcommunicationswiththeFDAandotherregulators.
EliLillyincluded,inMD&A,adiscussionofitslate-stagepipeline,whichfeaturedsubheadingsspecifyingwhereeachproductwasinthedevelopmentprocess(i.e.,PhaseIIIclinicaltrialorsubmittedforregulatoryreview)anddescribeditstherapeuticpurpose.However,expectedcompletiondateswerenotprovided.
J&Jdidnotspecificallydiscloseinformationaboutnewproductsinthepipelineornewdrugsseekingapproval.Butinitsopeningaddresstoshareholders,itmentionedafewkeyproductsthatwerebeingdevelopedandthetreatmentstheywereexpectedtoprovide.However,therewasnoadditionaldisclosuresprovidedabouttheseproductsphaseofdevelopment,thetimingofthemovetothenextphaseofdevelopmentortheexpecteddateofcompletion.
Merckincludedadiscussionofitspipelineintheoverviewofthebusinesssectionofitsannualreport,specificallyintheR&Dportion.Thisdiscussionincludedanoveralldescriptionofthepipelineprocess,thedefinitionofthephasesandadescriptionofcurrentindicationsforproductsthatwereundergoingregulatoryrevieworwereinPhaseIIIdevelopment.Inaddition,MerckprovidedachartthatidentifiedproductsinPhasesIIandIIIdevelopmentorthatwereunderregulatoryreview;however,nodescriptionsoftheseproductswereincludedinitsdisclosures.
PfizerprovidedaseparatesectioninitsMD&Aforproductdevelopmenttogetherwithachart,whichoutlinedrecentapprovals,pendingapplications,whateachproductwouldtreatandthetargeteddateforregulatoryapprovalorsubmission.Pfizeralsoprovidedachartfordrugsinlate-stagedevelopmentthatincludedadescriptionoftheindicationforeachproduct.AnotherchartlisteddrugsforwhichPfizerwasseekingregulatoryapprovalintheEUandJapan.Thischartdescribedthestageintheapprovalprocess,datesapprovedanddatesfiled.
Initsinformationonthecompanysection,Tevadiscussedbothbrandedandgenericproductsinitspipeline.Achartshoweddrugsinallstagesofdevelopment(i.e.,PhasesI,IIandIIIclinicaltrials),aswellasproductsthathadbeensubmittedtotheFDA.Inaddition,Tevaprovidedadescriptionofeachoftheproducts,includingindicationsandatimelineforthenextstepsinitsdevelopment(e.g.,thedateitwouldbeginPhaseIIIclinicaltrials,thedateitwouldbesubmittedtotheFDA).
Watsondidnotincludeanextensivediscussionorprovideachartofpipelineproducts.However,inseveralplaces,Watsonbrieflymentionedsomeproductsthatareinitsdevelopmentpipeline.
Analysis of patents and new drug approvals BMS Eli Lilly J&J Merck Pfizer Teva Watson
Disclosure of:
Current phase of development ND ND
Target date ND ND ND
21The shifting pharmaceutical industry landscape
4.6 Eurozone
Refertotheregulatoryenvironmentsectiononpage3foradescriptionofSECreportingobservationsregardingconcentrationsofbusinesswithEuropeangovernmententities.
Inlimitedcircumstances,wehaveseensomelifesciencescompaniesindicatethattheyhavegonetoacashbasisofrevenuerecognitionforsalesintoEuropeancountries.However,wedidnotseethatapproachtakenbyanyofthesevencompanieswesurveyedforthisstudy.AsthesituationintheEurozonecontinuedtoevolve,first-andsecond-quarterfilingsfor2012werereviewedtodeterminewhetherthesurveyedcompaniesmadesignificantchangesintheirdisclosures.Nonewerenoted,exceptinthecasesofJ&JandMerck,whichindicatedthattheycollectedasignificantportionofreceivablesinEuropeinthesecondquarter.
DisclosuresaroundconcentrationsofcreditriskinEuropehavebecomeincreasinglymoresignificantastheeconomicconditionswithintheEurozonehavedeteriorated.WiththeexceptionofTeva,allofthesurveyedcompaniesincludeddisclosuresrelatingtorisksofreceivableswithintheEurozone.Specifically,J&J,MerckandPfizerdisclosedtheamountofreceivableswithinthecountries
ofGreece,Italy,PortugalandSpain.Further,MerckandPfizerdisclosedtheamountofreceivablesoutstandinginexcessofoneyear.
Manycompaniesdidnotadjusttheirallowanceforthesereceivables,butsomehavetakenalternatestepstoensurethatthereceivableswouldbecollected.Thesestepsincludedfactoringspecificreceivables,amoveadoptedbyBMSandMerck,andrestructuringreceivablesintosovereigndebtofthedebtornation,asteptakenbyPfizer.Inlimitedinstances,BMSdeferredaportionofitsrevenueforsalesintotheEurozone.
Basedonourreviewoffirst-andsecond-quarterfilingsin2012,wenotedthatJ&JandMerckbothcollectedasignificantportionoftheoutstandingreceivablesfromcertainEurozonecountriesthatwerepreviouslydisclosedintheannualfiling.However,disclosuresdidnotseemtohaveincreasedduringthesubsequentreportingperiod.AstheEurozonesituationplaysout,companieswillneedtoensurethatappropriateconcentrationsofEurozonecreditrisksand/orchangestoaccountingpoliciesareappropriatelydisclosed.
Analysis of concentration of credit risk in Europe BMS Eli Lilly J&J Merck Pfizer Teva Watson
Disclosure of:
Risk due to receivables in Europe ND
Total exposure due to receivables in Europe ND ND (2) (2) (1) ND ND
Receivables in excess of one year in Europe ND ND ND (2) ND ND
(1) Disclosure includes an aggregate amount for all receivables in Greece, Ireland, Italy, Portugal and Spain. (2) Disclosed as aggregate amounts for Greece, Italy, Portugal and Spain.
22
Peer review: how seven companies handled disclosures
5. Accounting policies, judgments and estimates
5.1 Significant judgments and estimatesCriticalaccountingestimatesaredefinedasthosethataremostimportanttofinancialstatementpresentationandrequiredifficult,subjectiveandcomplexjudgments.TheSECstaffhasconsistentlycommentedthatregistrants’disclosuresaboutcriticalaccountingestimatesareoftentoogeneralandshouldnot
merelyrepeatinformationalreadyincludedinthenotestothefinancialstatements.
Thecompanieswereviewedidentifiedmanyofthesametypesofsignificantjudgmentsandestimates,indicatingthattheseareasaregenerallysignificanttothepharmaceuticalindustry.
Significant judgments or estimates BMS Eli Lilly J&J Merck Pfizer Teva Watson
Deductions from revenues — rebates, chargebacks, sales returns and allowances
Income taxes payable
Legal contingencies/product liabilities/environmental liabilities ND
Impairment of long-lived assets ND
Post-employment benefit costs ND ND
Stock-based compensation ND ND
Valuation and impairment of intangible assets/goodwill/IPR&D
Restructuring charges and accruals ND ND ND ND
Financial instruments ND ND ND
Allowance for doubtful accounts ND ND ND ND ND
Impairment of marketable securities and investment in other companies ND ND ND ND
Inventories produced in preparation for product launches ND ND ND ND ND ND
Total 11 6 8 11 8 7 5
TheSECexpectsregistrantstoprovideanalysisoftheuncertaintiesinvolvedinmakingsignificantaccountingestimatesasofthefinancialreportingdateandtodothesameforthevariabilitythatisreasonablylikelytoresultuntiltheuncertaintyisresolved.Specifically,theSECindicatesthattheMD&Adisclosureshould
addresswhytheaccountingestimateorassumptionbearstheriskofchange.Thetablebelowindicateswhichcompaniesprovidethisinformationandconfirmsthattheirapproachtodisclosingthisinformationisgenerallysimilar:
Analysis of estimates/assumptions BMS Eli Lilly J&J Merck Pfizer Teva Watson
How the registrant arrived at the estimate/assumption
Historical accuracy of the estimate/assumption ND (2) ND ND (4) ND ND
How much the estimate/assumption has changed historically ND ND ND ND ND ND ND
If estimate/assumption is reasonably likely to change in the future
Disclosed sensitivity analysis relating to the estimate/assumption (1) (6) ND (3) (5) ND ND
(1) BMS disclosed sensitivity relating to its pension plan estimates within MD&A and interest rate risk within the market risk section of its annual report.(2) Eli Lilly disclosed adjustments to its estimates for returns, rebates and discounts compared with actual results were less than 0.3% of net sales for each period presented.(3) Merck disclosed sensitivity relating to the pension plan actuarial assumptions interest rate and US dollars within MD&A.(4) Pfizer disclosed adjustments of estimates for sales deductions had not been material and had generally been less than 1% of biopharmaceutical net sales on a
quarterly basis.(5) Pfizer disclosed sensitivity relating to the pension plan actuarial assumptions within MD&A.(6) Eli Lilly disclosed sensitivity related to sale returns, Medicaid and Medicare rebates and pension plan actuarial assumptions in the footnotes.
23The shifting pharmaceutical industry landscape
Allofthecompaniesdisclosedtheirsignificantestimateswithinthefootnotestothefinancialstatements—notablyinthefootnoteforaccountingpolicies,butalsointhoseforincometaxandforcommitmentsandcontingencies,amongothers—and/orwithinMD&A.Overall,disclosurewaslimitedtoanexplanationthatthesignificantaccountincludedanelementofestimation.Themethodofestimationwasnotexplicitlydetailedineachcasewithinthedisclosures.Theestimatesdisclosedbyallofthebrandedcompanies(BMS,EliLilly,J&J,MerckandPfizer)werefairlyconsistent,whereasthosedisclosedbytheprimarilygenericcompanieswerelessso.
Thedisclosuresdidnotincludeasignificantamountofdetailastohowaccuratetheestimate/assumptionhadbeeninthepast,orhowmuchtheestimatehadchangedhistorically.Thisomissionwasconsistentacrossboththebrandedandgenericcompanies.
5.2 Segment disclosures
TheSECstafffrequentlychallengesregistrants’conclusionsonidentifyingandaggregatingoperatingsegmentsinconnectionwithASC280.Theareasofconcernincludeentity-widedisclosureswithrespecttoproductsandservices,revenuesattributabletoindividualforeigncountries,andrevenuesfrommajorcustomersandanyperceivedinconsistenciesbetweenthemannerinwhichthebusinesssegmentisdescribedinotherpublicinformationandintheregistrant’ssegmentfootnote.
Segmentdisclosuresshouldbeconsistentwitharegistrant’sinternalmanagementreportingstructuretoenableinvestorstoviewthecompanythesamewaythatmanagementdoes.Registrantsshouldchallengeanyconclusionstheyreachaboutoperatingsegmentdeterminationsthatarenotconsistentwiththebasicorganizationalstructureofthatoperation.
Thefollowingtablecomparesthesegmentsidentifiedbythereviewedcompanies:
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Primary business segments
Biopharmaceuticals Human pharmaceutical
products(3)
Consumer pharmaceuticals,
medical devices and diagnostics
Pharmaceuticals, All other
Biopharmaceutical diversified
Pharmaceuticals Global generics,global brands,
distribution
Key product revenue disclosures (2) (2) ND
Revenues attributable by geography (2)
Revenue from major customer (1) (1) ND ND (1) (1) (1)
Earnings measure used for segment reporting
Adjusted earnings(non-GAAP measure)
Revenue as disclosed in the income
statement and income before income taxes
(GAAP measure)
Revenue as disclosed in the income
statement (GAAP measure)
Adjusted earnings(non-GAAP measure)
Revenue as disclosed in the income
statement (GAAP measure)
Net revenue as disclosed in the
income statement (GAAP measure)
Net revenue as disclosed in the
income statement (GAAP measure)
(1) Disclosed as a percentage of gross sales.(2) Disclosed within the MD&A section.(3) Disclosed animal health segment was not material.
24
Peer review: how seven companies handled disclosures
BMSusedaseparatefootnotetodisclosebusinesssegmentinformation.Itvieweditsbusinessasasingleoperatingsegment,whichincludedthediscovery,development,licensing,manufacturing,marketing,distributionandsaleofinnovativemedicines.Thefootnotewentontoprovidenetsalesbygeographyandbykeyproductinatabularformat.Additionally,BMSprovidedareconciliationofsegmentincometoearningsfromcontinuingoperationsbeforeincometaxesasitappearedontheconsolidatedstatementofearnings.
SimilarlytoBMS,EliLillyvieweditsbusinessasoneoperatingsegment,humanpharmaceuticalproducts.Itdisclosedthatitalsooperatedanimmaterialanimalhealthbusinessbutdidnotprovideanyfurtherinformationwithregardtothisbusinesssegmentlikelyduetoimmateriality.EliLillypresenteditssegmentinformationinaseparatestatementafterthestatementofcashflows.Thisstatementprovidedtabularinformationonrevenuebygeographicareaandbyspecialty(e.g.,neuroscience,endocrinology,oncology,cardiovascular,animalhealthandotherpharmaceuticals).
J&Jidentifiedthreesegmentsanddisclosedafootnotewithsalestiedtosegmentandgeography.Italsodisclosedtotalsalesbygeography,anditprovidedoperatingprofits,identifiableassets,additionstopropertyplantandequipment,anddepreciationandamortizationbybusinesssegment.Inaddition,itprovided,withinMD&A,thebalancesofaccruedgrosstonetrebates,aswellasreservesfordoubtfulaccountsandcashdiscountsbysegment.
Merckdisclosedwithinitsfootnotesthatithadfouroperatingsegments—pharmaceuticals,animalhealth,consumercareandalliances.Merckdisclosedonlyonereportablesegment:pharmaceuticals.WithinMD&A,Merckprovideddetailsofthepharmaceuticalsegmentbyspecialty(e.g.,cardiovascular,diabetesandobesity,infectiousdisease).Thisdisclosureincludeddetailsonspecificproductswithineachspecialty,suchasproductsalesyearoveryearandreasonsforassociatedfluctuations.Fortheothernon-reportablesegments,Merckprovidedminimaladditionalinformation.Withinthebusinessoverviewsection,Merckalsoprovidedatabulardisclosureofsalesbymajorproductswithinitspharmaceuticalsegment.
Pfizeridentifiedfiveoperatingsegments:primarycare,specialtycareandoncology;establishedproductsandemergingmarkets;animalhealth;consumerhealthcare;andnutrition.Pfizerprovidedafootnotethatcontainedadescriptionofeachsegment,includingatabulardisclosureofrevenues,R&Dexpenses,earnings,anddepreciationandamortizationbysegment.Additionally,itdisclosedrevenuebygeography.WhilePfizerdidnotdiscloserevenuebysignificantcustomer,Pfizerstatedthatthreecustomers
madeup32%ofitssalesand13%ofaccountsreceivable.Pfizerdidnotdiscloserevenuebykeybiopharmaceuticalproducts.
Tevaidentifiedonesegment,pharmaceuticals,underthenotionof“OneTeva.”Itprovideddisclosureswithinthefootnotesofrevenuebygeographyandnetrevenuesbyproductline.
Watsonlistedthreebusinesssegments:globalgenerics,globalbrandsanddistribution.Withinthebusinessoverviewsection,Watsonprovidedadescriptionofeachofthesegments,includinginformationonstrategyandproductportfolio.WithinMD&A,Watsondiscussedtheresultsofoperationsbysegment.Inthesegmentfootnote,Watsonprovidedatabulardisclosure,bysegment,ofproductsales,operatingexpenses,costofsales,R&D,andsellingandmarketingexpenses.Watsonalsodisclosedrevenuebygeography,butthebreakdownwaslimitedtotheUnitedStatesandinternational.
25The shifting pharmaceutical industry landscape
5.3 Impairment of goodwillWeakeconomicconditionsaffectentities’valuationsoftherecoverabilityofgoodwill.Asaresult,theSECstaffhascontinuedtochallengedisclosuresaboutreportingunitsthatmaybeatriskofgoodwillimpairmentandhasrequestedsupplementalinformationaboutaregistrant’simpairmenttestingpolicy.Registrantsshouldalsoconsiderenhancingtheirdisclosuresaboutthepossiblefutureimpairmentofgoodwillforanyreportingunitwithanestimatedfairvaluethatisnotsubstantiallyinexcessofitscarryingvalue(i.e.,thereportingunitispotentiallyatriskoffailingafuturestep1impairmenttestunderASC350,particularlywhentheregistrant’soperatingresults,orthatoftherelevantsegment,havedeclinedsignificantly).Withregardtogoodwillimpairmenttesting,thelevelofdisclosurewasgenerallyconsistentamongallofthereviewedcompanies.
During2011,theFASBissuedASU2011-08,whichgavecompaniestheoptiontofirstperformaqualitativeassessmenttodeterminewhetheritwasmorelikelythannot(alikelihoodofmorethan50%)thatthefairvalueofareportingunitwaslessthanitscarryingamount.Ifacompanyconcludedthatthiswasthecase,itmustthenperformthetwo-stepimpairmenttestdetailedinASC350.Thisrevisedguidancewaseffectiveforfiscalyearsbeginningafter15December2011.However,earlyadoptionwaspermitted.
Allofthecompanieswereconsistentintheirdisclosuresregardingthetestingofimpairment.Asnotedabove,in2011,companieswereallowedto“earlyadopt”guidancethatallowsanentitytofirstassessqualitativefactorstodeterminewhetheritismorelikelythannotthatthefairvalueofareportingunitislessthanitscarryingvalueand,ifso,tothenperformthetwo-stepimpairment
test.MerckandTevaweretheonlyentitiesthatadoptedthisguidance.BMSperformeditsimpairmenttestingduringthefirstquarterandsubsequentlymonitoredforpotentialimpairment.BMSalsodisclosedthatthefairvaluesofitsreportingunitsweresubstantiallyinexcessoftheirrelatedcarryingvalues.
EliLillydidnotdisclosethetimingoftestingbutratherdisclosedthatgoodwillisreviewedforimpairmentatleastannually,aswellaswhencertainindicatorsofimpairmentarepresent.Noimpairmentwasidentifiedin2011.
J&Jperformeditsgoodwillimpairmenttestinginthefourthquarter,andnoimpairmentwasidentifiedin2011.
Merckperformeditsgoodwillimpairmentanalysison1October2011andnoimpairmentwasidentified.
Pfizerdidnotdisclosewhenitstestingwasperformedbutdiddisclosethatittestedgoodwillforimpairmentannually,aswellaswhenindicatorsofimpairmentexist.Italsoexplainedhowitarrivedatthefairvalueofeachofitsreportingunits,aswellashowitdeterminedfutureimpairmentrisks.Noimpairmentwasidentified.
Tevatestsforimpairmentattheendofeachyearorwhenevereventsorcircumstancespresentanindicationofimpairment.Noimpairmentwasidentifiedduring2011.
Watsonitperformsitsgoodwillimpairmenttestinginthesecondquarterofeachyearandwheneventsoccurthatcouldpotentiallyreducethefairvalueofareportingunitbelowitscarryingvalue.Noimpairmentwasidentifiedin2011.
5.4 IPR&D impairment
BMS Eli Lilly J&J Merck Pfizer Teva Watson
IPR&D impairment expense is included in the following line items in the income statement:
R&D expenses Other — net, expense No IPR&D impairment was disclosed in 2011
R&D expenses Included in “Other deductions“ line item
on the face of the income statement,
but amount disclosed separately in the
notes to the financial statements
Included in legal settlements, acquisition,
restructuring and other expenses, and
impairment
Included in loss on asset sales and impairments, net
Method used to obtain the fair value
Present value of each research project’s
projected cash flows using an income
approach
Income approach based on estimated
risks and project probability
Not stated Income approach based on each asset’s probability-adjusted future net cash flows
Income approach, specifically the
multi-period excess earnings method
Variation of the income approach
known as the multi-period excess earnings approach
Income approach based on forecast
future net cash flows adjusted to present
value
Aspresentedinthetableabove,therearedifferencesinpracticeastohowthecompaniesreviewedpresentIPR&Dimpairmentintheincomestatement,aswellasthelevelofdisclosurerelatedtothemethodologiesusedfordeterminingimpairmentand/oritscauses.
BMSprovidedadescriptionofthemethodologyusedtoobtainfairvalueoftheIPR&Dbutdidnotprovideanyspecificinformationaboutinputsorriskfactors.Additionally,IPR&Dimpairmentsweredisclosedintotalforall“otherintangible”assets(i.e.,impairmentattributablespecificallytoIPR&D).
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Peer review: how seven companies handled disclosures
EliLillydisclosedadescriptionofthemethodologyusedtodeterminethefairvalueofitsIPR&D,includingsomeofthefactorsconsideredinmakingprojections.
J&JdidnotdisclosedetailsofitsmethodologyindeterminingfairvalueofitsIPR&Dandnotedthatnoimpairmentswererecordedduring2011.
MerckdisclosedtheamountofIPR&Dimpairmentlossfortheyearandadescriptionofthetriggereventsthatproducedthemajorityoftheimpairmentloss(i.e.,abandonedpipelineprogramsanddelaysinthelaunchtimingorchangesinthecash-flowassumptionsforcertaincompounds).MerckalsoprovidedabriefexplanationofhowitdeterminedthefairvalueoftheintangibleassetsrelatedtoIPR&D.
Pfizerdiscloseditsimpairmentmethodologyindetail(fairvaluecalculationandrelatedassumptionsanddiscountrate)andhighlightedtheriskfactorsinherenttoitsIPR&D.Pfizeralsopresentedtheamountofimpairmentlossandthereasonforsuchaloss.
TevadisclosedageneraldescriptionofthemethodologyitusedwhenperformingitsIPR&Dimpairmentanalysisbutdidnotprovidedetailsaboutspecificinputs.Additionally,detailsregardingthefactorsleadingtoanimpairmentchargetakenin2011werenotdisclosed,norwastheamountofanyimpairmentchargespecificallyidentifiedasbeingrelatedtoIPR&D.
Watsondisclosedadescriptionofitsimpairmentmethodology,includingsignificantassumptionsandkeyriskfactors.Inaddition,WatsondisclosedthediscountrateusedinderivingthepresentvalueassociatedtoitsIPR&Dassets.Watson’simpairmentchargewasincludedintheincomestatementaspartofitslossonassetssalesandimpairment,net.
Considerations for annual impairment testing of IPR&D assets
CompaniesnowhavetheoptionunderASU2012-02toperformaqualitativeimpairmentassessmentfortheirindefinite-livedintangibleassets.Forpharmaceuticalcompanies,carefulconsiderationwillbenecessarytodeterminewhethertheassessmentwillallowthemtoskiptheannualfairvaluecalculationforIPR&Dassets.Initsbasisforconclusions,theFASBacknowledgedthatapplyingtheproposaltoIPR&Dassetsmightbedifficulttoapplybecauseofsignificantuncertaintiesinherentinthefairvalueoftheseassets,suchastheprobabilityofregulatoryapproval.However,theFASBultimatelydecidednottoexcludeIPR&DassetsfromthescopeofASU2012-02becausethe
assessmentisoptional,andtheremightbecircumstanceswheretheuseofthequalitativeassessmentcouldbeappropriate.
Thequalitativeassessmentforindefinite-livedintangibleassetsissimilartothescreencompaniescanusetodeterminewhethertheymustperformthetwo-stepgoodwillimpairmenttest.Toperformaqualitativeassessmentonanindefinite-livedintangibleasset,pharmaceuticalcompaniesshouldidentifyandevaluatechangesineconomic,industryandcompany-specificeventsandcircumstancesthatcouldaffectthesignificantinputs(e.g.,projectedcashflows,discountratesandmarketmultiples)usedindeterminingthefairvalueofthatassetbeingevaluatedforimpairment.Developingclearandconcisedocumentationwillhelpsupportanassertionthatthefairvalueofanindefinite-livedintangibleassetisnotlessthanitscarryingvalue.ASU2012-02iseffectiveforannualandinterimimpairmenttestsperformedforfiscalyearsbeginningafter15September2012.Earlyadoptionisalsopermitted.
5.5 US health care reform
On30March2010,PresidentObamasignedtheUSHealthCareandEducationReconciliationActof2010(theReconciliationBill)intolaw.TheReconciliationBillamendedthepreviouslyenactedPatientProtectionandAffordableCareAct(PPACA).Amongmanyotherthings,thePPACA,asamended,imposesanannualfeebeginningin2011oncertainentitiessellingbrandedprescriptiondrugs.Thefee(PharmaFee),whichisnotdeductible,ispayabletotheFederalGovernmentbasedonanallocationofacompany’smarketshareofbrandedproductsalesmadeinthepreviousyeartocertainUSgovernmentpayerprograms(Medicare,Medicaid,etc).
Thedisclosurespresentedinthefinancialstatementsofthecompaniesoperatingprimarilyinthebrandedspace(BMS,EliLilly,J&J,MerckandPfizer)wereconsistent,exceptfortheimpactonEPS,whichwasdisclosedonlybyBMSandEliLilly.TherewaslittleornodisclosureregardingtheimpactofUShealthcarereforminthefinancialstatementsofTevaandWatson,whichprimarilyoperateinthegenericspace.As2011wasthefirstyearinwhichthePharmaFeewasrequiredtobepaid,wewouldanticipatethatdisclosuremayincreaseslightlyinthecomingyearsduetoitsgrowingmateriality.
27The shifting pharmaceutical industry landscape
Disclosures relating to the Pharma Fee BMS Eli Lilly J&J Merck Pfizer Teva Watson
Disclosure of:
Impact of 2011 Pharma Fee on financial results ND ND
Where the Pharma Fee is recorded within the statement of operations ND ND
Impact of US health care reform on EPS ND ND ND ND ND
6. Lease commitments
Registrantsinthepharmaceuticalindustrythathavesignificantleasecommitmentsarerequiredtopresenttheirfuturenon-cancelableleasecommitmentsforthenextfiveyears.TheSECstaffmayalsoaskregistrantstoprovideadditionalinformationabouttheuseandtypesofleasecommitments.
Allofthereviewedcompaniesincludedlease-relateddisclosuresinthefootnotestothefinancialstatementsandintheMD&Asection.
Thequalityoftherelateddiscussiondifferedwithrespecttothenatureandextentofdisclosureforeachtypeoflease.
Withinthenotestofinancialstatements,allofthecompaniesdisclosedthecollectiveleasecommitmentsoverthesucceedingfiveyearsandthereafterfornon-cancelableoperatingleases.
Thefollowingtableshowsannualleaseexpensesandfutureminimumrentalcommitmentsundernon-cancelableoperatingleases:
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Lease expense 2011 (US$ million) US$136 US$353 US$313 US$411 US$382 US$115 US$32
2012 136 112 188 215 187 114 22
2013 122155 (1)
162 157 166 87 18
2014 113 131 119 144 63 16
2015 96100 (2)
104 98 105 37 16
2016 93 82 68 83 28 15
After 162 148 65 115 723 70 91
Total future commitment US$722 US$515 US$732 US$772 US$1,408 US$399 US$178
(1) Between one and three years (2) Between three and five years
Merck,TevaandWatsonaretheonlycompaniesofthesevenwereviewedthatdonotdisclosetheiroperatingleasesintableforminthefootnotesandinsteadchoosetopresenttheinformationinanarrativeformat.
EliLilly,MerckandJ&Jincludedasentenceinthefootnotestofinancialstatementsthattheircapitalleasesarenotsignificantand,therefore,werenotbepresentedseparately.However,EliLilly,initsMD&A,separatelysplitoutfuturecommitmentsunderoperatingandcapitalleases.
BMSdisclosedthatitsubleasescertainpropertiesbutthatitssubleaserentalincomewasimmaterial.BMS,Pfizer,TevaandWatsonhadenhanceddisclosuresunderItem2Properties.Thelevelofdisclosurevaried,withBMS,TevaandWatsonpresentingintabularformandPfizerusingaparagraphformat.
28
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Year-end 31 Dec 11 31 Dec 11 31 Dec 11 31 Dec 11 31 Dec 11 31 Dec 11 31 Dec 11
Press release 26 Jan 12 31 Jan 12 24 Jan 12 2 Feb 12 31 Jan 12 15 Feb 12 14 Feb 12
Days from year-end to press release 26 31 24 33 31 46 45
SEC filing 17 Feb 12 24 Feb 12 23 Feb 12 28 Feb 12 28 Feb 12 17 Feb 12 16 Feb 12
Days from year-end to publish annual report 48 55 54 59 59 48 47
Days between publishing press release and annual report 22 24 30 26 28 2 2
Inreviewingtheaboveinformation,wenotethatBMS,EliLilly,J&J,MerckandPfizerwerefairlyconsistentintheirapproach,choosingtoprovideinvestorswithfinancialinformationintheformofapressreleasewellbeforethereleaseoftheirannualreport.Incomparison,TevaandWatsonreleasedpreliminaryinformationjusttwodaysbeforetheirannualreportwentpublic.TheSECdoesnotspecifyanappropriatetimeperiodbetweenpreliminaryandfinalresults—thedecisionisateachcompany’sdiscretion.Indeed,wefoundnocorrelationbetweenthedifferencesinthetimeittook
togetfrompreliminarytofinalresultsandthereceiptofanySECcommentsbyanyofthecompanies.
Tofurthercomparepracticesinthisarea,welookedatthereportingtimeframeforthe2010annualreportsandfoundthatthereviewedcompanieswerefairlyconsistentwiththetimelinetheyusedforthe2011reports.TheonlysignificantchangesweredecreasesintimebetweenthepressreleaseandSECfilingforbothTevaandWatson,whichcutthesevendaystheyneededfor2010tojusttwothefollowingyear.
7. Financial statement close process
Inrecentyears,wehaveobservedincreasingpressurefrominvestorsoncompaniestoreportfinancialresultsmorequicklyandinmoredetail.CompoundingthispressureareXBRLreportingrequirementsandthetimeittakestogetfinancialstatementsandfootnotesintoXBRLformat.Thispresentsanumberofchallenges
forcompaniesastheytrytomaintainthequalityoftheirfinancialreportingwhilemeetinginvestordemands.Wehavecomparedthenumberofdaysittookthecompaniesinourreviewtopublishapreliminaryannouncementabouttheir2011resultsandthentomakethatyear’sannualreportavailabletothepublic.
26
31
24
33
21
45
46
32
48
55
54
59
59
47
48
53
0 10 20 30 40 50 60
BMS
Eli Lilly
J&J
Merck
Pfizer
Watson
Teva
Average
Press release
SEC filing
(# of days)
Peer review: how seven companies handled disclosures
29The shifting pharmaceutical industry landscape
Inthischapter,weprovideanoverviewoftheaccountinglandscapeandtheseachangethatisquicklyapproaching.Weexaminethedevelopmentsthatwillshape2013,thepotentialimpactoftheIASB/FASBjointstandard-settingprojects,shiftsinrevenuerecognition,financialinstruments,leasesand,finally,theDodd-FrankWallStreetReformandConsumerProtectionAct’s(Dodd-FrankAct)regulatoryregimefortheover-the-counterderivativesmarket.
Focus on 2013Ascompaniesbegintofocusonadoptingnewaccountingpronouncements,reducingtheirreportingtimelineandcomplyingwithchangingregulations,attentionmustalsobepaidtocostreductionandsimplificationefforts.Asalways,theimplementationofnewpoliciesandrulestypicallybringswithitexpandeddisclosuresandcostpressuresassociatedwithtrackingmoreinformation.Tokeepcostsdown,companieshavecontinuedtolookforwaystoimproveandtransformstatutoryreporting,rationalizelegalentitiesandtightenaccountingpolicygovernance.
Findingefficienciesinstatutoryreportinghasbeenafocusofmanypharmaceuticalcompaniesforsometime,asthenumberofstatutoryreportingrequirementshasgrowninmarketsaroundtheworld.Specificallybecausethetimeandeffortescalaterapidlybasedonthenumberofcountriesinwhichanorganizationoperates.Managingglobalstatutorycomplianceandreportingcanabsorbdisproportionateamountsoftime,effortandmoneyforwhatmanyorganizationsconsidertobeanon-corefinanceprocess.
Significantefficienciesmaybegainedbyusingaglobalgovernancemodelforstatutoryreportingandastandardizedprocess.Inadditiontocuttingcosts,operationalizedstatutoryreportingmitigatesrisksbymaximizingvisibilityintosubsidiaryfinancialstatementsandincreasestransparency.Suchchangesincreaseaccessandconnectivitytolocalindividualspreparingstatutoryreports,improvetheirunderstandingofchanginglocalstatutoryrequirementsandthustheirabilitytocomply,reducerisksoferrors,betteridentifydifferencesbetweenstatutoryandgroupreporting,and,finally,enhancecontrolstoensurethatreportsandreturnshavebeenfiledinatimelyfashion.
Companieshavealsobeenlookingtoachievereportingefficienciesandreducecoststhroughtherationalizationoflegalentities.Legalentitiescostmoneyandresourcestoholdandmanage.Companiesmaybeabletoimprovelong-termbusinessperformancebyaggressivelyreducingthenumberoflegalentitiesandcombiningtheiroperationsefficientlywithothergroupmembers.Besides
helpingtoreduceoravoidcosts,thisapproachalsoincreasesoperationalsynergiesandstreamlinesgovernance.
Change is coming: reporting standards TheIASBandFASBhaveundertakenasetofveryambitiousjointprojectstoimproveIFRSandUSGAAP,aswellastoachievesubstantiveconvergenceonanumberofaccountingstandards.Beginningin2010,theIASBandtheFASBissuedavarietyofproposednewstandardsforpubliccomment,withsomefinalstandardsoncertaintopicsbeingfinalizedin2011.Nofinalstandardshavebeenissuedin2012.
Thenewstandardsthatawaitfinalapprovalwillsignificantlychangeaccountinginseveralcriticalareas,includingfinancialinstruments,leasesandrevenuerecognition.ThesejointprojectswillresultinchangesforbothIFRSandUSGAAPreporters,regardlessofwhetherfullconvergenceisachievedorwhethertheSECultimatelymandatestheuseofIFRSforUS-listedcompanies.
Companiesareaccustomedtoaccountingchanges.Newstandardsandamendmentsaretheordinarycourseofbusinessinanyfinancialreportingframework.However,theextentofchangeanticipatedintheneartermisextraordinary.Inadditiontothesignificantnumberofaccountingstandardsthatareundergoingrevision,fundamentalshiftsintheaccountingofroutinetransactionsarealsoonthehorizon.
Accounting landscape: a sea of change
30
Accounting landscape: a sea of change
Impact on your business
Together,theseaccountingchangeswillaffectthefollowingfiveleadingstrategicprioritiesformostbusinesses:
• Top-linegrowth—Timingofrevenuerecognitionmaychange.Standardcustomercontractsmayneedtobereconsidered.Anearlyunderstandingofhowrevenuewillberecognizedunderthenewstandardswillbecriticalinbeingabletoproperlycommunicateearningsforecaststoinvestors.
• Focusonmanagingcosts—Systemsandbusinessprocessesmayneedtoberevisedorimplementedtocapturenewdatapoints.Earlyassessmentcanleadtoefficienciesandhelpavoidcostlyredesignandre-work.
• Robustnessofforecastingandstrategicplanning—Changestofinancialmeasuresmayaffectbudgets,debtcovenants,incentivesandperformancetargets.Earlyidentificationoftheseareaswillhelpfacilitatetimelyaction.
• Transparencyinreportingandinvestorrelations—Financialresultsandperformancemetricsmaychange.Proactivecommunicationtoinvestors,analystsandotherkeystakeholderswillhelppreventmarketmisperceptionsandpresentaclearpictureofacompany’sfinancialposition.
• Strengtheninginternalcontrolandriskmanagement—Significantexecutionriskexistswhenimplementingorganization-widechangesinanevolvingregulatoryenvironment.Assessingexposuresandassigningresponsibilitiesearlyonwillhelpmitigatethatrisk.
What companies should do to prepare for the changes
Changesofthismagnitudewilltaketimetounderstandandimplement.Thislevelofchangewillnotonlyrequiretheattentionofaccountingandfinancepersonnel,butalsothecommitmentofinternalresourcesacrossanorganizationaswellastimelyandcandidcommunicationwithexternalstakeholders.Companieswillfaceanumberofcriticalchallengesasaresultofthesechanges.Appropriateplanningandpreparationwillbecriticalinsuccessfullyimplementingandexecutingonthesechanges.
ForaprojectinwhichtheIASBandFASBhaveissuedanexposuredraftbuthavenotyetbeguntheirredeliberationprocess,companiesshouldbe:
• ConsideringimplicationsthattheBoards’currentthinkingontheprojectwouldhaveonaccountingforneworproposedcontracts/transactionswithinthescopeoftheproject
Foraprojectthatisfurtheralonginthedeliberationprocess,companiesshouldbe:
• Evaluatingtheeffectofnewstandardsonfinancialstatements,systemsandoperations,whicharelikelytobesignificant,andcoordinatingwithtax,ITandoperationspersonnel
• Evaluatingtheneedtorevisecommercialcontracttermsfortransactionsthatwillbeaccountedforunderthenewstandard
• Assessingtheexpertiseoffinancialreporting,accountingandinformationsystemspersonnelanddeterminingwhetheroutsideassistanceisrequired
31The shifting pharmaceutical industry landscape
AsBoardprojectsarecompleted,companiesshouldevaluatetheirimpactanddraftappropriatecommunicationstointernalandexternalstakeholderssuchastheauditcommitteeandinvestors.
Revenue recognitionTherevisedrevenuerecognitionproposalissuedbytheFASBandtheIASBcouldresultinsignificantchangesforpharmaceuticalentities.
Inparticular,theproposedchangestotheaccountingforvariableconsiderationcouldaffectthetimingofrevenuerecognitionforpharmaceuticalentitiesthatreceivemilestonepaymentsundertermsoftheircontractswithcustomers.Inaddition,complexarrangementswithmultiplepromisedgoodsandservices(e.g.,alicenseofaproductcandidatecombinedwithresearchanddevelopmentservices,oramedicaldevicecombinedwithinstallationservicesandamaintenanceagreement)wouldrequirecarefulconsiderationtodeterminewhethertheyshouldbeaccountedforseparately.Also,theproposaldoesnotaddresswhethercertaincollaborativearrangementsbetweenlifesciencesentitieswouldrepresentacontractwithacustomerandthusfallwithinitsscope.
Basedonthecurrentrevenuerecognitionexposuredraft,thefollowingarefrequentlyaskedquestionsbypeercompaniesintheindustry:
Variable consideration
• Whenestimatingthetransactionpriceforgrosstonettransactions(rebates,chargebacks,etc.)willeithertheexpectedvalueapproachorthemostlikelyamountapproachberequired?
• Isonemethodpreferredoveranother?Willthecompanyberequiredtoperformboth?
Consideration paid to a customer
• Willtheproposedstandardchangecurrentpracticerelatedtoclassificationoffeespaidtowholesalersforsalesinformation(fee-for-servicearrangements)?
• Howwillslottingfeesbeclassifiedundertheexposuredraft?
Targeted savings
• Howwouldacompanyaccountforrevenuearrangementswithtargetedsavingsundertheproposedmodel?WouldthisbeachangefromthecurrentUSGAAP?
Collectibility
• HowdoesdeterminationofcollectibilityaffectrevenuerecognitiononDayOne?Forexample,undertheproposedmodel,wouldalegallyenforceablecontractforwhichaperformanceobligationhasbeensatisfiedbeprecludedfromrevenuerecognitionsolelybecauseofconcernsaboutcollectibility?
• Willanetrevenuelineberequired?Ifnot,isanetrevenuelinepreferable?
Vaccine stockpiling
• WouldcurrentSECguidanceonvaccinerevenuerecognitionstillapplyandthuscontinuetorequireuniqueaccountingpolicydisclosure?
Other matters
• Wouldcollaborationarrangementsbeconsideredacontractwithacustomer?Ifnot,whatguidancewouldbeconsideredindetermininghowtoaccountforrecognitionandmeasurementcomponentsofcollaborationarrangements?Couldacompanyanalogizetotheproposedmodel?
• WouldacompanybeabletodeterminethatitisreasonablyassuredtobeentitledtoamountsthatarecontingentuponFDAorotherregulatoryapproval?
Financial instrumentsAspartofthejointprojectsbetweentheFASBandtheIASB,theFASBissued,inMay2010,itsfinancialinstrumentsExposureDraft,whichcoversclassificationandmeasurement,impairmentandhedging.TheIASBissuedIFRS9onclassificationandmeasurementoffinancialassetsandfinancialliabilities,aswellasseparateExposureDraftsonimpairmentandhedging.
Sincethen,theFASBandtheIASBhavedeliberatedagainontheirrespectiveproposedmodels.Onclassificationandmeasurement,theFASBtentativelyagreedtomorecloselyalignitsmodelwiththeIFRS9approach.Onimpairment,theFASBdevelopedasinglemeasurementmodelthatdifferssignificantlyfromthejointlydeliberatedthree-bucketmodel.Onhedging,theFASBdoesnotexpecttobeginredeliberationsuntilitcompletesworkonclassificationandmeasurementandimpairment.TheIASBhasfinishedredeliberationsandexpectstoissuefinalguidanceinDecember2012(exceptformacro-hedging).
32
Accounting landscape: a sea of change
Classification and measurement
Themajorchangestotheclassificationandmeasurementoffinancialinstrumentsareasfollows:
• ►Financialassetswouldbeclassifiedandmeasuredinoneofthreecategoriesbasedontheinstrument’scashflowcharacteristicsandanentity’sbusinessmodelformanaginginstruments
• ►Theinvestmentsinequitysecuritiesgenerallywouldbemeasuredatfairvaluethroughnetincome
• ►Apracticabilityexceptionwouldbeavailableforinvestmentsinnon-marketablesecurities
• ►Mostfinancialliabilitieswouldbemeasuredatamortizedcost
• ►Embeddedderivativeswouldnotbebifurcatedforfinancialassets.Nochangeisexpectedtotheexistingbifurcationandseparationrequirementsforfinancialliabilities
TheFASBexpectstoissueanewExposureDraftinthefirstquarterof2013.
Impairment model
TheFASBoutreachidentifiedconcernsabouttheoperabilityofajointlydevelopedthree-bucketapproachanddecidedtodevelopaCurrentExpectedCreditLossmodel.Thismodelwouldbeappliedtofinancialassetsmeasuredatamortizedcostorfairvaluethroughothercomprehensiveincomeandwouldreflectmanagement’scurrentestimateofcontractualcashflowsitdoesnotexpecttocollect.Thecurrentproposaldoesnotsetupanyinitialrecognitionthresholdandstatesthattheestimateisnotlimitedtolossesexpectedoveraspecifiedperiod.
TheFASBexpectstoissueanewExposureDraftshortly.
Companiesareencouragedtotrackthesecomingchanges,astheywillsignificantlychangetheaccountingforfinancialinstruments.
LeasesAspartoftheirjointprojects,theFASBandtheIASBissuedajointExposureDraftin2010.Itsobjectiveistorespondtosomeofthecriticismsofthecurrentleaseaccountingmodelbyrecordingleasecontractsonthebalancesheet.Thisexposuredraftaddressestheperspectiveoflesseesandlessors.Astheexposuredraftintroducedsignificantchangestotheproposedmodel,theBoardsdecidedtore-expose.AsecondExposureDraftisexpectedinthefirstquarterof2012.
Asaconsequence,theBoardsreintroducedleaseclassificationintotheproposal.Lesseesandlessorswoulddistinguish
betweentwotypesofleasesbasedprimarilyonthenatureoftheunderlyingassetbeingleased.Certainconditionswouldovercomepresumptiveclassification.Thisclassificationwouldbeusedtodeterminethemethodofrecognizingleaserevenueandexpense.
Lesseeswouldrecognizearight-of-useassetandaleaseliabilityforthefollowingtypesofleases:
• ►Leasesofproperty(i.e.,land,buildingorpartofabuilding)–generallyrecognizestraight-lineleaseexpense
• Leasesofassetsotherthanproperty(e.g.,equipment)–generallyrecognizeamortizationexpenseandinterestexpenseseparatelyinapatternusuallyresultinginacceleratedexpenserecognition
Lessorswouldgenerallyapplyoperatingleaseaccountingfortheleasesofpropertywhilerecognizingaleasereceivable,aresidualassetandDayOneprofit(ifany)forleasesofassetsotherthanproperty.Incomerelatedtointerestonthereceivableandaccretionofresidualassetswouldberecognizedovertheleaseterm.
Thecomingchangeswouldrequiredfullretrospectiveormodifiedretrospectiveadoptionattheeffectivedate.Grandfatheringleaseswouldnotbeallowed.Companiesareencouragedtostartperforminganinventoryoftheirleaseagreementsandcollectingthedatathatwouldbeneededforafullretrospectiveadoptionapproach.
Indefinite-lived intangible asset impairment assessments
TheFASBissuedfinalguidanceaddinganoptionalqualitativeassessmentfordeterminingwhetheranindefinite-livedintangibleassetisimpaired.TheguidanceinASU2012-02issimilartolastyear’sgoodwillguidance(ASU2011-08,explainedonpage25insection5.3Impairmentofgoodwill),whichallowscompaniestoperformaqualitativeassessmenttotestgoodwillforimpairment.
Untilnow,companieshavehadtocalculatethefairvalueoftheirindefinite-livedintangibleassetsannually.Ifthecarryingamountofanindefinite-livedintangibleassetexceedsitsfairvalue,animpairmentchargemustberecorded.
TheguidanceintheASUgivescompaniestheoptiontofirstperformaqualitativeassessmenttodeterminewhetheritismorelikelythannot(alikelihoodofmorethan50%)thatanindefinite-livedintangibleassetisimpaired.Ifacompanydeterminesthatitismorelikelythannotthatthefairvalueofsuchanassetexceedsitscarryingamount,itwouldnotneedtocalculatethefairvalueoftheassetinthatyear.However,ifacompanyconcludesotherwise,
33The shifting pharmaceutical industry landscape
For further information, please contact:
TimGordonFinancialAccountingAdvisoryServices(FAAS)LifeSciencesLeader+12127736938tim.gordon@ey.com
GlenT.GiovannettiGlobalLifeSciencesLeader+16175851998glen.giovannetti@ey.com
itmustcalculatethefairvalueoftheasset,comparethatvaluewithitscarryingamountandrecordanimpairmentcharge,ifany.
Theguidanceiseffectiveforannualandinterimimpairmenttestsperformedforfiscalyearsbeginningafter15September2012.Earlyadoptionispermitted.
Dodd-Frank and OTC derivatives On21July2010,theDodd-FrankActwasenacted,imposingthemostsignificantfinancialregulationintheUSsincetheGreatDepression.Asaresult,TitleVIIoftheDodd-FrankActwasintroducedastheregulatoryregimefortheover-the-counter(OTC)derivativesmarket,resultinginthefollowingchanges:
• RegulatoryoversightoftheOTCderivativesmarketbytheCommodityFuturesTradingCommission
• Mandatedclearing,exchangetradingandtradereporting
• Increasedmarginandcapitalrequirements
• End-userexceptiontoclearingrequirementsavailable,subjecttolimitations
Dodd-FrankappliestoallcompaniesthatuseOTCswaps,evenifonlyusedforhedging.Examplesofswapsincludeinterest-rateswaps,currencyswapsandcross-currencyswaps.UndertherulesprescribedbytheDodd-FrankAct,anappropriatecommitteeoftheboardofdirectors(orequivalentbody)mustreviewandapprovethedecisiontoenterintoswapsthatareexemptfromtherequirements.
Basedonparticularrulesanddefinitionsbeingfinalizedrecently,initialcompliancewithTitleVIIrangesfromOctober2012(positionlimits)toApril2013andbeyond.AlthoughtheendusersdonotneedtobeincompliancewithallofTitleVIIuntilApril2013,manyoftheircounterparties(financialinstitutions,etc.)willberequestinginformationandrepresentationsfromthemfortheirearliercompliance,startinginOctober2012.
Conflict minerals – final rule
TheSECapprovedafinalrulerequiringissuerstodisclosetheiruseofconflictmineralsintheirproductsandwhetherthosemineralsoriginatedfromtheDemocraticRepublicoftheCongoandneighboringcountries(collectively,coveredcountries).
TherulewasmandatedbySection1502oftheDodd-FrankActinresponsetohumanitarianconcernsthattradeinconflictmineralsisfinancingarmedgroupsintheregion.
Thefinalrulerequiresissuerstodisclosetheiruseof“conflictminerals”andwhetherthosemineralsoriginatedfromtheDemocraticRepublicoftheCongoandneighboringcountries.TheSECnarrowedthescopeoftheruleinresponsetoconcernsthatcompliancewithitsinitialproposalwouldhavebeentoocostly.
Therulewillrequireadditionalreportingby6,000ormorecompaniesthatmakeorsellmobilephones,computers,digitalcameras,jetenginecomponents,jewelryandotherproducts.Companieshaveuntil31May2014topreparetheirinitialdisclosures,buttheymaydisclosethattheirproductsare“conflictundeterminable”forthefirsttwoyears.
ScottBrunsGlobalLifeSciencesAssuranceLeader+13176817229scott.bruns@ey.com
34
Appendix
35The shifting pharmaceutical industry landscape
Appendix: reconciliation between earnings and adjusted earnings
BMS Eli Lilly J&J Merck Pfizer Teva Watson
Net earnings, reported (US$ million) US$3,709
(A)
US$9,672 US$6,392 US$10,009 US$2,759 US$261
Purchase accounting adjustments 0 0 5,939 5,032 0 0
Acquisition-related costs 0 477 0 860
901 (B)
22
Restructuring costs 116 536 1,911 3,135 0
Litigation charges 0 1,466 0 828 3
Other significant adjustments 329 1,716 242 (1,647) 1,243 318
Tax reserves and other tax charges (233) 0 (2,667) 0 (465) 0
Net earnings, adjusted US$3,921 US$13,867 US$11,817 US$18,217 US$4,438 US$604
(A) Eli Lilly reported only adjusted EPS.(B) Teva disclosed legal settlements and acquisition, restructuring, impairment and other expenses in one line item, totaling $901 million.
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