Life Sciences. Collaboration arrangement accounting. March 18, 2015

Transcription

1 Life Sciences Collaboration arrangement accounting March 18, 2015

2 Disclaimer Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US. This presentation is 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP and its member firms expressly disclaim any liability in connection with use of this presentation or its contents by any third party. The views expressed by panelists are not necessarily those of Ernst & Young LLP. Page 2 Ernst & Young LLP

3 Agenda Market overview discussion Illustrative example of accounting model Page 3

4 Market overview Page 4

5 Market overview (continued) Significant M&A: more than $300b in the life sciences industry Big pharma portfolio rationalization continues; more expected in 2015 Medtech companies continue to consolidate Specialty pharma pursues scale via inversions Shareholder activists push M&A agenda Strong Capital Markets Nearly US$7 billion of life sciences IPO s in Q 2015 would mark the 8 th consecutive quarter of significant activity Biotechs raised US $13.8 billion in follow-ons in Outlook Revenue growth gaps increase urgency within big pharma Will biotechs use M&A to maintain high growth trajectories? Twin forces of focus and scale drive bolt-on acquisitions Emerging markets an area of focus Page 5

6 Market overview (continued) $83b $16b $34b $74b $117b 2014 life sciences M&A: more than $300b Big pharma Big biotech Specialty Pharma Generics Medtech Tech LifeScience Tools Source: EY, Datamonitor, Company Reports, 2014 data are for January November Page 6

7 Market overview (continued) Target Category Acquirer Value Allergan Specialty Actavis $66.0b Covidien PLC Medtech Medtronic Inc 47.9 Forest Labs Specialty Actavis 23.3 Sigma-Aldrich Medtech (tools) Merck KGaA 17.0 GSK-Oncology Big pharma Novartis AG 16.0 Merck Consumer Big pharma Bayer AG 14.2 Biomet Inc Medtech Zimmer Holdings 13.4 Care Fusion Medtech Becton Dickenson 12.2 Intermune Biotech Roche 8.3 Novartis-Vaccines Big pharma GlaxoSmithKline 7.1 Novartis-Animal H Big pharma Eli Lilly & Co 5.4 Abbott Est Products Big pharma EP Mylan 5.3 Questcor Pharma Specialty Mallinckrodt PLC 5.2 OCD (JNJ) Medtech The Carlyle Group 4.0 Idenix Pharma Biotech Merck & Co Inc 3.7 CFR Pharmaceutical Generics Abbott Laboratories 3.3 Divestiture New inversion Old inversion Medtech Growth Source: Company reports, Datamonitor and EY GTH Page 7

8 Market overview (continued) Focus on pipeline execution and new product launches Combo therapies are a focus Emerging battlegrounds: Immuno-oncology (CART-T, PD-1), HCV, PCSK-9 Biosimilars arrive: generics (offense); biotechs (defense) New collaborations show widening definition of innovation Novartis/Qualcomm Ventures Illumina/Lockheed Martin Optimism that innovation will continue to be rewarded More predictable regulatory climate New FDA channels fuel approval of 41 novel drugs in 2014 But development-stage programs in payers crosshairs Page 8

9 Collaboration arrangements Page 9

10 Collaboration arrangements (continued) Joint operating activity often focused on development or exploitation of intellectual property Each participant is active in the activity, performing development, providing a sales force and being part of the steering committee Participants are exposed to risks and rewards based on success or failure of the arrangement Page 10

11 Authoritative Guidance What ASC 808, Collaborative Arrangements ASC , Revenue Recognition - Principal Agent Considerations ASC , Research and Development- Overall, and , Research and Development Arrangements When Staff Accounting Bulletin Topic 13 (SAB 101) ASC , Revenue Recognition - Multiple Element Arrangements ASC , Revenue Recognition - Milestone Method Where ASC , Revenue Recognition - Principal Agent Considerations ASC , Revenue Recognition - Customer Payments and Incentives Concepts Statement No. 6 Page 11

12 Risk sharing arrangements Risk sharing payments Company 1 Company 2 Development Phase Commercial Approval Commercial Phase Up-front payments from collaborators Milestone payments from collaborators Reimbursement payments Substantive milestones Supply arrangements Manufacturing arrangements Co-marketing arrangements Profit split arrangements Milestone payments received by Company 1 upon commercial approval Milestone payments received upon meeting certain sales thresholds End customer sales in certain geographies Page 12

13 Illustrative example Biotech enters into R&D collaboration arrangement with Pharma under which: Biotech licenses certain rights to Pharma Biotech provides R&D services on a best-efforts basis (anticipated period of six years) Biotech will manufacture product, assuming successful development Biotech s compensation under arrangement is as follows: $10 million up-front license fee Three $5 million milestone payments $250,000 / year / 4 FTEs performing R&D activities for 6 years Cost plus 30% for manufacturing efforts No payments are refundable, even if FDA approval not obtained Page 13

14 Illustrative example (continued) 1. Identify the deliverables License R&D Services Manufacturing 2. Determine units of accounting Assume for this example that the delivered item(s) have stand alone value and are separable Assume the delivery of the license, R&D services, and manufacturing is in that order Page 14

15 Illustrative example (continued) 3. Allocation of arrangement consideration Manufacturing is considered a contingent deliverable at the onset of the arrangement Estimated selling price % of relative selling price Allocated discount Allocated arrangement consideration Contractually stated amounts License $ 16, % $ (4,800) $ 11,700 $10,000 R&D services (1) 6, % (1,700) 4,300 6,000 $ 22,500 $ (6,500) $ 16,000 $16,000 (1) $6M is R&D services calculated by $250,000 FTE rate by 4 FTE s x 6 years Page 15

16 Illustrative example (continued) 4. Recognition License: recognized upon delivery of license However, amount recognizable is limited to the amount that isn t contingent upon receipt of future services, so limited to $10m Remaining $1.7m recognized on proportional basis as R&D services are provided R&D services: recognized as services are provided Milestone payments: depends on whether or not Biotech has elected to apply the milestone method If applying milestone method, each milestone payment is recognized in its entirety in the period the related milestone is achieved Must be allocated to the units of accounting for income statement classification purposes; no specific guidance on this, but generally believe most appropriate method is to allocate based on relativeselling-price percentages previously determined Page 16

17 Illustrative example (continued) 4. Recognition (continued) If Biotech doesn t apply milestone method, update the allocable arrangement consideration in its relative-selling-price allocation Estimated selling price % of relative selling price Allocated discount Allocated arrangement consideration License $ 16, % $ (1,100) $ 15,400 R&D services 6, % (400) 5,600 $ 22,500 $ (1,500) $ 21,000 To the extent units of accounting have been completed, allocated revenue would be immediately recognized If units of accounting are partially completed, amount of revenue recognition dependent upon Biotech s policy (diversity in practice exists); straight-line and cumulative catch-up both acceptable methods Page 17

18 Valuation considerations Best Estimate of Selling Price Objective the estimate of selling price should be consistent with the objective of determining VSOE of selling price (i.e., the price at which the entity would sell that item on a standalone basis) Not an ASC 820 fair value measurement Entity should use the most objective and reliable inputs available, including entity-specific factors and market conditions Contractual prices should not be presumed to represent the selling price of products or services Cannot presume that upfront license fee represents BESP for license Estimating selling prices for certain deliverables may be complex and require significant judgment Licenses more complex (discount rates, allocation) R&D or contract manufacturing services less complex (mark-up) Page 18

19 Valuation considerations (continued) Best Estimate of Selling Price When estimating BESP of a license, market and company specific factors such as the following should be considered: Rights received by licensee (e.g., worldwide vs. a territory, specific indication vs. any indication) Stage of development and estimated development timeline Expected market size for the product candidate Expected life of the product candidate if commercialized The efficacy of the product candidate compared with others, if any Consideration received for similar products in other deals, if any Companies should consider all factors contemplated in negotiating the arrangement with the customer (e.g., DCF or other cash flows/revenue models) If robust analysis does not exist, will need to prepare analysis If lack necessary experience, 3rd party assistance may be needed Page 19

20 Disclosure considerations The SEC staff has requested that registrants consider disclosing the following specific items related to collaboration arrangements: Information about the nature and purpose of the collaboration arrangement The accounting policy for separating and allocating amounts received or paid under the arrangement and the accounting policy for recognizing those amounts A discussion of the material terms of the arrangement (e.g., rights and obligations, performance, cancellation, termination or refund provisions) The income statement presentation and amounts attributable to collaboration arrangements for each applicable period Page 20

21 Disclosure considerations (continued) The identity of the other party in the arrangement The products being developed, as applicable Any amounts paid or received to date under the arrangement (including up-front licensing fees and milestone payments) Under each arrangement, aggregate potential milestone payments to be made or received and the triggering events underlying the milestones for each arrangement The existence of royalty provisions, rates (or ranges within defined percentages if tiered) and any sales thresholds related to royalty rates Annual maintenance fees Duration and termination provisions, including payments the registrant may be required to make in the event of termination Page 21

22 Questions? Page 22

23 Ernst & Young LLP contacts Peter Hornecker Partner, Financial Accounting Advisory Services (212) Michelle Mittelsteadt Partner, Transaction Advisory Services (617) William Roberts Senior Manager, Financial Accounting Advisory Services (732) Page 23

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