Revenue Recognition under Collaborative Arrangements for Biotechnology

Companies

Shelly Mui-Lipnik

Tom Hess

Steven Love

Doug McCorkleMarch 17, 2009

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BIO AdvocacyBIO Advocacy

BIO world's largest biotechnology trade association Represents over 1,200 members globally

Large & Predominately small companies Members in healthcare, agricultural, industrial and environmental

sector Emerging Companies Section ≈ 650 companies

Capital formation advocacy: tax, financial services, accounting Tax: R&D/AMT in Lieu of bonus depreciation, Accelerated use of

NOLs in lieu of tax benefits Financial Services: SOX, Short Selling Accounting: Revenue recognition of collaborations, IFRS

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BIO Advocates on Revenue Recognition

ECS members highlight revenue recognition problems with JSCs Slowed approval of S-1s Questions regarding annual/quarterly filings JSCs included in collaborations Affymax and Curis examples

Current rules do not accurately reflect the underlying economics of collaborations Lack of clarity results in hodgepodge of general guidelines Financial statements become less reliable for investors Lack of clear guidance increases chances for restatements Shakes investor confidence & increases costs

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Collaborative Arrangements

BIO seeks clarity on accounting guidance on collaborations Collaborations are increasingly popular financing mechanism Long lead times, increasingly expensive and capital intensive nature to

bring a product to market Ongoing economic crisis resulting in credit crunch

BIO commissioned Glass-Lewis to perform independent study Focus on revenue recognition of collaborations in biotech industry Outlines state of current accounting, key findings, recommendations to

FASB/SEC, recommendations to biotechs

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BIO Revenue Recognition Study

Study Sample: 25 companies, small to mid- size public companies, no product

to market, average # ees (180), average market cap (480M) Common Collaborations: Up-front payments (54), Milestones

(47), Royalties/profit-sharing (47), JSC (38)Key findings:

Varying accounting methods are used for similar collaborations resulting in wide variations in timing of revenue recognition

Majority of companies defer and amortize revenue ranging from 18 months to more than 18 years

Revenue recognition related restatements shake investor confidence, neg. impact stock price, potential shareholder class-action suits, increase cost to capital, delay filings (public offerings)

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Affymax Collaboration

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Date: February 2006 for Japan license and June 2006 for worldwide license (combined is the “Arrangement”)

License: Hematide, a peptide-based erythropoiesis-stimulating agent (ESA) used to treat anemia

Milestones: up to $475 million

Development and commercialization:

United States:

Co-develop and co-commercialize in the renal (dialysis and pre-dialysis) and oncology indications

External development costs (no internal) shared 70% Takeda / 30% Affymax

Equal share of profits and losses during commercialization

Ex-United States:

Takeda responsible for all development and commercialization activities and costs

Affymax to receive royalties from Takeda on Hematide net sales

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Affymax/Takeda Collaboration

All development period obligations deemed to be a single unit of accounting

Obligations: license, development activities, active pharmaceutical ingredient (API) manufacturing and joint steering committee (JSC) participation

JSC obligation deemed to be significant and indefinite – as a result, the term of the entire single unit of accounting was indefinite

Revenue was recognized using the ‘zero profit proportional performance model’ (ZPPPM)

Input based measure used - direct costs deemed most appropriate

Representative of value delivered to Takeda

Closely reflected level of Affymax’s effort under the Arrangement

Revenue recognized equal to direct costs incurred…but not in excess of cash received or receivable

Overall Arrangement required to be profitable

ZPPPM required until earlier of (i) meeting the criteria for separate recognition of each element under EITF 00-21 or (ii) fulfillment of all obligations under the Arrangement

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Accounting for Collaboration

Amendment effective 1/1/08 provided Affymax the ability to opt-out of the obligation to participate in the JSC at any time beginning January 1, 2011

Amendment modified the JSC obligation such that the obligation is no longer indefinite

All other development period obligations are estimated to end prior to January 1, 2011

As a result, the performance of the development period is deemed to occur from inception of the Arrangement to January 1, 2011 (~4.5 years)

Development period revenue is being recognized ratably over the performance period using the Contingency-Adjusted Performance Model (CAPM)

The impact of any change in the development period estimate would be recorded as a change in estimate

Two contingent obligations potentially remain: API manufacturing for the commercial product and co-promotion activities

Excluded from the development period obligations as both are contingent on actions outside Affymax’s control (e.g., FDA approval of the new drug application)

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Impact of Amendment

Regeneron Collaboration

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Regeneron Collaboration Agreements

sanofi-aventis

Bayer HealthCare

sanofi-aventis

Upfront/milestone payments $130MM $95MM $85MM

Development costs paid by partner *

100% ~50% ~100%**

Profit split – Regeneron share

US 50% 100% 50%

Japan ~35% royalty 50% 35-45%

ROW 50% 50% 35-45%

Milestones remaining

Regulatory $400MM $90MM –

Sales – $135MM $250MM

* 50% repayment from profits ** plus $475MM of research funding over 5 years

Oncology Eye Disease Antibodies

Global collaboration to discover, develop, and commercialize therapeutic human antibodies

Sanofi-aventis funds $475 million of discovery research over five years through 2012

Sanofi-aventis funds ~ 100% of development costs for collaboration antibodies

Sanofi-Aventis Antibody Collaboration

Adolor Collaboration

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Date: December 2007

Focus: Delta opioid agonists for pain

Milestones: $232.5MM

Back End

United States

Profits/Losses shared 60% to Pfizer and 40% to Adolor

- US development expenses (external) to be shared in same proportion

Rest of World

Adolor to receive royalties on Pfizer net sales

Provisions for adding compounds and indications

Development Collaboration

Adolor: IND filings and clinical program through Phase 2a

Pfizer: Subsequent worldwide development and regulatory approvals

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Adolor/Pfizer Collaboration

Recent Benchmark Example Pain Compounds in Phase IIa

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Adolor/Pfizer Targacept/GSK Glenmark/Lilly

Transaction Date December 4, 2007 July 27, 2007 October 30, 2007

Pain Target Delta Opoid Receptor Neuronal Nicotinic

Receptor

Transient Receptor Potential

Vanilloid Sub-family 1 (TRPV1)

Lead Compound ADL5859 TC-2696 GRC 6211

Upfront Payment $30 Million +

$1.9 Million reimbursement for Phase

2a studies

$20 Million

Plus $15 Million

in Equity

$45 Million

Milestones

-Development

-Regulatory

-Commercial

Total

Not Disclosed

Not Disclosed

Not Disclosed____

$232.5 MM

Not Disclosed

Not Disclosed

Not Disclosed

$1.5 B

Not Disclosed

Not Disclosed

Not Disclosed

$215 MM

Back End US – 40/60 Profit Split

ROW Royalties

Undisclosed Double Digit

Royalty

~15% Royalty in the Territory

Territory Worldwide Worldwide North America, Europe, and

Japan

Cost Sharing 40/60 US

100% Pfizer in ROW

Targacept to fund through Phase

2 POC. Then 100% GSK if they

opt to take the compound

100% Lilly in Territory - no

mention of access to Lilly trial

data

Co-promote Option Yes – US Specialty Yes – US Specialty for first two

compounds

Yes – US

Adolor had the “option” to attend all JSC meetings!

Adolor is not obligated to attend- collaboration meetings.

Allows for recognition of the up front payment.

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Deal Structure for Revenue Recognition

Accounting for Upfront Payments

Collaboration signed December 2007 Two compounds in the clinic as of the collaboration date. Adolor is responsible for the development of each

compound through Phase II a and then Pfizer assumes all responsibilty.

Adolor’s project management projects that compound I & II will be completed in February 2010 (26 months).

Amortize the upfront over 26 months. Adjust if Phase II takes more/less time.

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Best Practices: What Biotechs Can Do

Determining the Accounting for the Collaborative Arrangement Ensure that Accounting/Financial Reporting review draft agreements

and/or term sheets and have adequate opportunity to propose changes

Do your homework• Research technical guidance• Research collaboration accounting by other companies• Consult with outside experts for guidance/feedback• Draft proposed accounting for internal and external auditor review

Involve external auditors early in the process• Obtain preliminary feedback on proposed accounting• Obtain suggested changes to draft agreement to alleviate issues

Consider SEC Consultation

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Best Practices: What Biotechs Can Do

Suggestions to Alleviate Collaboration RevenueRecognition Issues

Define an end date to the collaboration (if feasible) Use opt-out (or opt-in) clauses, where appropriate

• Joint Committees, especially Joint Steering Committee (JSC)• Development in future indications or of future drug candidates• Commercialization activities

Consider whether biotech’s collaborative obligations are deemed substantive. If not, document why.• JSC (if no opt-out provision)• Manufacturing preclinical and/or early stage clinical supplies • Co-marketing activities

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Best Practices: What Biotechs Can Do

Suggestions to Alleviate Collaboration Revenue Recognition Issues (continued) Provide biotech with rights to participate in collaboration activities

(not obligations)• Manufacturing clinical and/or commercial supplies• Co-promotion/co-marketing activities

Evaluate the nature of each milestone payment - is it substantive?• Proximity to up-front payment• Biotech’s activities/effort to achieve milestone (relative to payment

amount) • Note: Monitor EITF Issue No. 08-9, Milestone Method of Revenue

Recognition Monitor EITF Issue No. 08-1, Revenue Arrangements with Multiple

Deliverables• Anticipated to be effective for new or materially modified arrangements

in fiscal years beginning on or after 12/15/09. (Earlier application would be permissable as of the beginning of a FY.)

• Would supersede EITF 00-21

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Best Practices: What Biotechs Can Do

External Communications regarding New Collaborative Arrangements Involve Investors Relations from both parties up front Prepare financial projections – Cash impact and financial statement

impact Plan adequate time for collaborator review and comments

• Initial Press Release• Wording in SEC Filings – 10-K; 10-Q; Annual Report to Shareholders

Reach out to the analysts, as appropriate.

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BIO Study: Recommendations for FASB & SEC

JSC participation should only be considered a deliverable if a company is incentivized to participate or is at a detriment for non-participation

Provide additional guidance for recognizing revenue when contracts include multiple deliverables

Revenue accounting should better reflect the economics of a collaboration

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Advocacy

BIO working with SEC & FASB to address revenue recognition Met with SEC on revenue recognition of JSCs (Fall 2007) Working through FASB’s comment process

Accounting for multiple arrangements EITFs 08-1, 08-9

Consolidation variable interest entities-->require all biotech’s losses to be reflected on pharmaceutical company’s financial statement FIN 46(R)

Monitoring IFRS impact on revenue recognition BIO & CFO/Tax VP committee meeting with FASB on 3/23/09

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Discussion & Questions

Thomas P. Hess, Senior Vice President/Chief Financial Officer

Yaupon Therapeutics, Inc.

(484) 253-2292

thess@yaupontherapeutics.com

Steven Love, Vice President/Chief Accounting Officer

Affymax, Inc.

(650) 812-8747

slove@affymax.com

Douglas McCorkle, Vice President/Controller

Regeneron Pharmaceuticals, Inc.

(914) 345-7776

douglas.mccorkle@regeneron.com

Shelly Mui-Lipnik, Director of Capital Formation & Financial Services Policy

Biotechnology Industry Organization (BIO)

(202) 312-9262

smui-lipnik@bio.org

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