An Overview of Risk and Disclosure in the Global Pharmaceutical and Life Sciences Industry

Transcription

1 An Overview of Risk and Disclosure in the Global Pharmaceutical and Life Sciences Industry April 2012 kpmg.com KPMG INTERNATIONAL

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3 Contents Executive summary 2 Reported risk factors 4 Financial statement disclosures 13 Legal proceedings analysis 19 About KPMG s Pharmaceutical & Life Sciences Practice 25

4 2 An Overview of Risk and Disclosure An overview of risk and disclosure Executive summary This is a summary report of risk and disclosure by the major pharmaceutical and life sciences companies. The pharmaceutical industry is now experiencing the longexpected and much-discussed patent cliff. During the period, patent protection covering US$120 billion in sales is expected to be lost 1. This is impacting individual company and market growth rates, exacerbated by economic crises, European austerity measures, pricing pressures and continuing healthcare reform in the US. Emerging markets that have been engines of both growth and shifts in global market dynamics have not been immune to some negative trends, particularly price reductions, although the extraordinary volume growth opportunity acts as a strong counterbalance. To a greater or lesser extent, these factors are disclosed as risks by the industry, together with many other well-known and some newly emerging factors. Key findings are: US companies and foreign companies filing with the US Securities and Exchange Commission (SEC) disclose broadly twice as many risks as non-us filers. Overall, there was a 13 percent increase in the aggregate total number of risks disclosed by the sample of companies we reviewed. Pricing, patent-related risks and generic competition dominate disclosure tables. Political instability, natural disasters and the risk posed by use of information technology show the greatest increase in disclosure. US healthcare reform, European economic risk, and emerging market risk are new risks disclosed by more than 15 percent of filers for the first time. Six companies with more than 30 percent of sales from the European Union (EU) did not disclose specific EU risk. Emerging market risk was disclosed by less than a quarter of the companies. Disclosure of R&D pipelines remains relatively limited, influenced by the problems and lack of success of recent years, and competitive pressures. Only one company estimates its return on R&D spending. We observed no meaningful trend in disclosure related to M&A activity. Contingent legal liabilities are dominated by product liabilities ahead of sales and marketing and patent litigation liabilities. In our recent report on the industry, 2 we identified rising legal, political, personnel and scientific risk, combined with a loss of trust as one of five key challenges for the industry. We see companies taking steps to reduce legal risk. It is perhaps too early to see a decline but the absence of significant increase in contingent legal liabilities relating to sales and marketing practice is a positive sign. Political risk is understood and disclosed, at least partially, for US and EU markets. For emerging markets it is much less well-disclosed. Emerging markets also carry significant personnel risk driven by a shortage of staff qualified for employment in the life sciences industry. We do not see the issue of scientific risk yet being embraced: companies disclosure is, in general, limited, and the governance of R&D merits a higher profile. The pharmaceutical companies behaviors that have created the perception that they put their commercial goals above the interests of governments, payors, prescribers and patients are at the heart of the loss of trust of these stakeholders. We sense that the beginning of the cultural change that is essential to rebuilding trust is underway. However, comparison of the profile given to corporate social responsibility in the annual reports of US and European companies, which is modest at best, with that of their Japanese counterparts, which is expansive, is interesting to note. The industry is faced with some real opportunities to counterbalance these risks. The most important of these is innovation. True innovation is still valued highly, particularly in the US and in Japan. Delivery of innovative products is rewarded by commensurate returns even in the face of the multiple reforms in both these markets, although it is harder to say the same is true, in general, of Europe. Many of the opportunities for innovation are in more specialist markets. In-house research and development may not be capable of delivering the requisite innovation that should result in more collaboration and also more mergers and acquisitions (M&A), especially involving small 1 IMS Institute for Healthcare Informatics: The Global Use of Medicines: Outlook Through 2015, May Future Pharma: Five Strategies to Accelerate the Transformation of the Pharmaceutical Industry by 2020, KPMG 2011, p.16

5 An Overview of Risk and Disclosure 3 and medium-sized companies. More collaboration will mean more royalty payments and a potential long-term increase in the cost of sales. It is also possible that collaborating companies will focus more on selling, marketing and branding and other activities characteristic of consumer markets. Large-scale M&A is expected to be more challenging as most of the large companies are already the product of a significant acquisition and are working toward rationalizing excess capacity and resources. In any case, M&A and alliances should involve careful examination of the risks of fully developing the compound and bringing it to market as part of effective due diligence on behalf of the acquirer. We observed no meaningful trend in disclosure related to M&A, although two of the smaller companies noted that provisions in agreements with thirdparties might discourage a third party from acquiring them. This is a good illustration of the growing risks associated with alliances, and also, in these cases, that there is a risk of M&A not occurring. At the same time, the negative impact of product profit sharing and royalties on margins means greater efficiency must be driven through the industry, particularly the manufacturing and R&D processes. This is underway at most major companies, but the speed of implementation could be questioned. We do not see the issue of scientific risk yet being embraced: companies disclosure is, in general, limited and the governance of R&D merits a higher profile.

6 4 An Overview of Risk and Disclosure Reported risk factors This report highlights the significant business risk factors disclosed by leading pharmaceutical and other life sciences companies in their 2011 annual reports and financial statements. These risk factors serve to alert shareholders or potential shareholders to those factors that could materially alter a company s performance and financial circumstances. We have reviewed the most recent relevant filing of the 34 largest pharmaceutical and other life sciences companies and considered their quantitative and qualitative disclosures.

7 An Overview of Risk and Disclosure 5 Pharmaceutical and life sciences companies We reviewed 34 companies as illustrated below: US filers publicly traded US companies that file Form 10-K with the SEC Foreign US filers non-us public companies that file Form 20-F with the SEC Non-US filers public and private foreign companies that do not file with the SEC. Composition of company universe Foreign US filers disclosures seem to be more comprehensive than US filers but the approach to disclosure in Form 20-F seems more free-form than traditional risk factor disclosure as Item 1A in a 10-K filing. 38% 44% US Filers (15) Foreign US Filers (6) Non-US Filers (13) 18% Source: KPMG analysis of company findings, April Average number of disclosures Broadly, US filers and foreign US filers disclose more risks than non-us filers, whether assessed on risks disclosed by more than 15 percent of all companies or on total number of risks disclosed. Foreign US filers disclosures seem to be more comprehensive than US filers but the approach to disclosure in Form 20-F seems more free-form than traditional risk factor disclosure as Item 1A in a 10-K filing. US filers disclosed on average 28 risks, foreign US filers on average 31 risks and non-us filers on average 15 risks. Average total number of disclosures* US Filers 18% Foreign US Filers Non-US Filers *Including all disclosures Source: KPMG analysis of 2011 company filings, April 2012.

8 6 An Overview of Risk and Disclosure Risk frequency 2011 marked the beginning of a four-year period during which patent protection for products with US$120bn in sales is being lost. 3 Risks related to intellectual property protection and generic competition appear most frequently. Patent life also drives the need for R&D organizations to deliver sufficient products with potential to replace the revenue being lost to generic competition in the face of increasingly stringent regulatory requirements, which may result in failure. The worldwide pressure on pharmaceutical pricing in the face of tough economic conditions features frequently. Risks related to intellectual property protection and generic competition appear most frequently. 3 IMS Institute for Healthcare Informatics: The Global Use of Medicines: Outlook Through 2015 May 2011

9 An Overview of Risk and Disclosure 7 Frequency of risk disclosure Industry/generic competition 100% Protection and expiration of intellectual property rights Pharmaceutical pricing: Competition, price controls and reimbursement reductions Regulatory requirements R&D efforts may not be successful Interest rates/currency exposure/inflation Legal proceedings including adverse outcome of litigation and government investigations Patent litigation Manufacturing processes/product supply/raw materials Global, political and economic conditions Unsuccessful strategic alliances/business combinations Product liability Environmental/health and safety liabilities Taxation Reliance on IT Reliance on third party manufacturing/providers or marketing suppliers Disruption from natural disasters 94% 91% 91% 91% 88% 88% 82% 79% 79% 74% 71% 68% 68% 65% 62% 62% Delay in product launches US healthcare reform legislation Political instability 50% 53% 53% Human resources/key personnel European economic exposure 44% 44% Reliance on key products Impairments/credit risk and bad debts 35% 38% Product safety issues Concentration of sales to key customers, e.g. wholesalers Failure or adverse impact of productivity initiatives/failure to implement business strategy New or revised accounting standards Emerging market risk Business restrictions due to high debt ratios Liquidity risks/insufficient cash International business risks Anti-bribery and corruption legislation Counterfeit products Competition from biosimilars 29% 26% 24% 24% 24% 21% 21% 18% 15% 15% 15% 0% 20% 40% 60% 80% 100% New risks reported by more than15 percent of companies Source: KPMG analysis of 2011 company filings, April 2012.

10 8 An Overview of Risk and Disclosure Changes in risk frequency Overall there was a 13 percent increase in the aggregate total number of risks disclosed by the companies we reviewed in the 2011 filings vs. the 2010 filings (573 vs. 506). Against a background of political unrest in North Africa and the Middle East over the past year, it is perhaps not surprising that the largest increase in risk frequency was for political instability. Similarly, the East Japan earthquake was no doubt a factor in a more than 100 percent increase in disclosure of risk from exposure to natural disaster. The rapid growth in the use of and reliance on information technology raises a number of new risks. One company disclosed that social media/mobile technologies could result in liabilities or security breaches. Overall there was a more than 50 percent increase in disclosure of IT-related risk. The rapid growth in the use and reliance on information technology raises a number of new risks. Social media risk While social media adoption provides the pharmaceutical and life sciences industry great opportunities, there are also clear risks for companies that use these channels, including threats to the control of confidential information or intellectual property, increased levels of reputational risk (that develop at viral speed), and the potential for regulatory infractions. If a social media solution provider updates or changes its functionality policies, for instance, companies can be left with less control over community commentary, resulting in a reduced ability to maintain compliance in this rapidly expanding marketing area. In many cases, the success or failure of a social media program lies in its ability to create a dialogue with the audience being addressed through any selected channel, whether it be a product informational page on Facebook, a Twitter stream dedicated to product launch, or instructional training materials released through YouTube. In all of these examples, the sponsoring organization must remain vigilant about the content and tone of the messaging being generated by the audience in response to the organization s intended message. Consumers are more frequently turning to these channels to comment on the effectiveness of a product, and this could very likely develop into a mechanism for reporting adverse events. Therefore, the sponsoring organization must remain involved in the ongoing dialogue through carefully developed monitoring programs and moderation of comments being publicly captured in these social media applications. Source: David Blumberg and John Hair, KPMG LLP-US. Reproduced with permission from Life Sciences Law & Industry Report, 5LSLR 981, 10/07/2011. Copyright 2011 by The Bureau of National Affairs, Inc. ( )

11 An Overview of Risk and Disclosure 9 There was a 30 percent increase in the disclosure of legal proceedings including adverse outcome of litigation and government investigations. The greatest reduction in risk frequency was 27 percent reduction in the failure of productivity initiatives. Most companies have been restructuring for several years and may well have a better perspective on delivery than in the past. Change in risk frequency Political instability 240% Disruption from natural disasters 133% Reliance on IT Human resources/key personnel 50% 57% Taxation Legal proceedings including adverse outcome of litigation and government investigations Patent litigation Reliance on third party manufacturing/providers or marketing suppliers New or revised accounting standards Industry/generic competition Environmental/health and safety liabilities Unsuccessful strategic alliances/business combinations Reliance on key products Manufacturing processes/product supply/raw materials Protection and expiration of intellectual property rights Regulatory requirements R&D efforts may not be successful Pharmaceutical pricing: competition, price controls and reimbursement Concentration of sales to key customers, e.g. wholesalers Liquidity risks insufficient cash Interest rates/currency exposure/inflation 35% 30% 27% 24% 14% 13% 10% 9% 8% 8% 7% 6% 3% 3% 0% 0% 0% Product liability Global, political and economic conditions Impairments/credit risk and bad debts Business restrictions due to high debt ratios -3% -4% -10% -13% Failure or adverse impact of productivity -27% initiatives/failure to implement business strategy -50% 0% 50% 100% 150% 200% 250% Source: KPMG analysis of 2011 company filings, April 2012.

12 10 An Overview of Risk and Disclosure Analysis of newly disclosed risks We identified eight risks reported by more than 15 percent of companies for the first time: US healthcare reform legislation, i.e. the Patient Protection and Affordable Care Act of 2010 European economic risk Emerging market risk Product safety International business risk Anti-bribery and corruption legislation Counterfeit products Competition from biosimilars The Eurozone crisis may also influence exchange rates and the translation of overseas sales into the reporting currency. US Patient Protection and Affordable Care Act of 2010 Eighty-seven percent of US filers and 83 percent of Foreign US Filers specifically identified the impact of the US Patient Protection and Affordable Care Act of 2010 as a risk to their businesses, although the language varied from the exact wording of the Act to US healthcare reform in 2010, increased rebates, mandated contribution taxes, and other contributions to close the Medicare Part D coverage gap were all cited. European economic risk The Eurozone crisis and severe economic difficulties experienced in some Southern European countries such as Spain, Portugal, Italy and Greece in the past year, have raised the profile of potential financial impact on many companies. This includes the extended time taken to collect trade receivables, sovereign debt issues that could increase collection risk given the high proportion of sales in these countries to publicly-owned customers, and the impact of austerity measures introduced to reduce government spending on pharmaceutical reimbursement prices. The Eurozone crisis may also influence exchange rates and the translation of overseas sales into the reporting currency. Wholesalers and third-party manufacturers based in the EU may also be affected by the economic downturn with particular impact on the larger pharmaceutical and life sciences companies. The effects of the EU economic crisis extend to its influence on consumer spending. While self-evident for those life science companies with diversified business models including over-the-counter (OTC) medicines or other consumer products, the increasing use of patient co-pays by governments means a cut in consumer spending has an impact on pharmaceutical sales and is a growing risk. Three companies specifically identified consumer spending as a risk to their business.

13 34% 33% 32% 31% An Overview of Risk and Disclosure 11 Given that fewer than 50 percent of filers disclosed European economic risk, we investigated the relationship between percentage of sales from the EU and disclosure. We were surprised that six companies with more than 30 percent of revenue from the EU chose not to highlight this risk in an explicit manner. 4 Passing reference to tough economic conditions in a business description section was deemed a retrospective comment and not a risk factor disclosure for shareholders or potential shareholders. Some companies with approximately 20 percent of revenue from the EU chose to disclose the risk: this seems prudent to us give the continuing uncertainty in these markets. We were surprised that six companies with more than 30 percent of revenues from the EU chose not to highlight this risk in an explicit manner. Disclosure of European economic risk vs. percentage of sales in the EU 50% 49% 40% 40% 37% 37% 40% Percentage of sales from EU 30% 20% 10% 32% 32% 31% 30% 29% 29% 29% 27% 25% 22% 22% 26% 25% 20% 20% 17% 12% 9% 6% 2% 0% Companies that disclose EU risk Companies that do not disclose EU risk Source: KPMG analysis of 2011 company filings, April We have had to make judgments about where non-us filers disclose risks; we concluded that if these were not included with other risks to the business or under risk factors in management s review of the year, then this was not an explicit disclosure.

14 12% 11% 11% 11% 10% 10% 9% 9% 12 An Overview of Risk and Disclosure Emerging market risk Slightly less than a quarter of filing companies disclosed risks associated with strong growth from emerging markets. These risks included: The strong, often double-digit growth rates experienced in recent years may not continue. Some developing countries have reduced (or threatened to reduce) the duration of patent protection to facilitate early generic competition. Companies may not be able to realize the expected benefits of significant investments in emerging growth markets. There may be a relatively limited number of people with the skills and training suitable for employment in life science enterprises. Companies may be required to rely on third-party agents, which may put them at risk of liability. Many emerging countries have currencies that fluctuate substantially and should these currencies devalue without it being possible to offset the devaluations with price increases, products may become less profitable. Many companies do not explicitly disclose emerging market sales and, when they do, the definition of emerging markets can vary from company to company. We compared the number of companies that disclose emerging market risk with the percentage of sales from non-us and non-european sources. This includes Japan, but again, not all companies disclose Japanese sales (where it is disclosed, the range of sales from Japan is 6 to 19 percent). As illustrated below, there is a substantial proportion of companies with significant sales outside the traditional Western markets and Japan that do not disclose emerging market risk. We see this as a potentially important area for review. Many companies do not explicitly disclose emerging market sales and, when they do, the definition of emerging markets can vary from company to company. Disclosure of emerging market risk vs. percentage of ex-us, ex-eu sales 50% 43% 42% 40% 30% 20% 33% 30% 26% 24% 22% 18% 36% 31% 27% 26% 25% 23% 21% 21% 26% 10% 4% 8% 8% 6% 6% 5% 3% 3% 0% Companies that disclose Emerging Market risk Companies that do not disclose Emerging Market risk 0% Source: KPMG analysis of 2011 company filings, April 2012.

15 An Overview of Risk and Disclosure 13 Financial statement disclosures The top five critical accounting policies are the same as we reported in 2010, when we reviewed 12 major US and European pharmaceutical companies. This year the order has changed, reflecting a broader population of companies reviewed. Critical accounting policies and frequency of disclosure are shown below. Only six policies were disclosed as critical by more than 50 percent of the companies. Critical accounting policies percentage reported Income/deferred/contingent taxes Revenue recognition Intangible assets/impairment Pension/retirement benefits Contingent liabilities and litigation Property, plant and equipment/impairments Inventory valuation Goodwill R&D costs Consolidation Acquisitions/business combinations Financial instruments Foreign currency translation Cash, cash equivalents and investments Share-based compensation Leases New accounting standards Use of estimates Earnings per share Allowance for doubtful accounts 18% 15% 15% 12% 38% 35% 35% 35% 32% 29% 29% 47% 44% 44% 61% 61% 61% 76% 76% 91% 0% 20% 40% 60% 80% 100% Risks reported by more than 15 percent of companies for the first time Source: KPMG analysis of 2011 company filings, April 2012.

16 14 An Overview of Risk and Disclosure Taxes were the most-disclosed critical accounting policy, disclosed by 90 percent of these companies. This is consistent with their global supply chains and movements of intellectual property across borders. Additionally, many of the companies have effective tax rates below or well below expected statutory rates. Recently, tax authorities have been very focused on the amount of profit recorded in and outside of their country. These factors clearly highlight the critical nature of the judgments utilized to record the appropriate tax provision and reserves. The next most-disclosed critical policies were revenue recognition and intangible asset impairments. Gross revenue for most pharmaceutical companies is not very subjective. The critical nature of revenue recognition is judgment regarding gross to net adjustments for rebates, governmental fees and returns (particularly as patent expiration nears). We believe gross revenue recognition will become more challenging in the future as pricing moves away from a fixed price to more outcomes-based pricing that we are starting to see in Europe and in a more limited way with US managed care organizations. Intangible asset impairment is critical particularly with respect to in-process research and development (IPRD) which results from acquisitions and is recorded on the balance sheet and not subject to amortization until approved, meaning it is subject to annual impairment testing. Assessing impairment in developmental technology can be extremely subjective especially for early technology that may be several years away from an approval date. Assessing impairment in developmental technology can be extremely subjective especially for early technology that may be several years away from an approval date.

17 An Overview of Risk and Disclosure 15 Given the highly regulated nature of the industry, contingent liabilities and litigation have a high degree of uncertainty and are highly judgmental with respect to outcomes. A high degree of judgment is necessary in assessing when to accrue, how much to accrue, and when and what should be disclosed. We noted that less than 15 percent of the companies disclosed allowance for doubtful receivables as critical. We found this surprising given the various European government debt issues for a number of European countries. Topics discussed separately in Management s Discussion and Analysis (MD&A), Operating and Financial Review (OFR) or Equivalent A high degree of judgment is necessary in assessing when to accrue, how much to accrue, and when and what should be disclosed. There is a wide variation in how companies choose to disclose certain topics pertaining to their business. This is partly because non-us filers have a more freeform approach to business description within their annual reports. For example, strategy was only a specific MD&A/OFR topic in slightly more than half of the cases; this is perhaps surprisingly low given the seismic shift in the business environment combined with economic uncertainties. Topics discussed separately in Management s Discussion and Analysis (MD&A), Operating and Financial Review (OFR) or equivalent 100% 100% 80% 82% 79% 71% 71% 65% 60% 40% 56% 53% 50% 47% 41% 29% 20% 15% 0% Overall performance Performance by region Performance by key product Performance by business segment Business environment Product pipeline/r&d Strategy Finance risks Product portfolio Future perspectives, outlook Business risks Corporate social responsibility/ global citizenship Performance by therapeutic area Source: KPMG analysis of 2011 company filings, April 2012.

18 16 An Overview of Risk and Disclosure Surprisingly, given the challenging business climate only 70 percent of the companies discussed the business environment and just 65 percent discussed product pipeline/r&d. With the complex business environment and patent cliff pressures, greater disclosure here may aid an investor in understanding how a company is responding to these challenges. We note even fewer companies (45 percent) discussed their future prospects and outlook. R&D pipeline disclosures The approach to disclosure on R&D pipelines varied widely. Some companies have moved away from any discussion of early stage compounds, which makes sense given that early stage R&D has always had more failure than success, and that in the wake of a relatively disappointing decade for pharmaceutical R&D, the external world has become skeptical of early promise turning into actual revenue dollars. It seems that some of the industry is dealing with the rising risk in R&D by choosing to disclose less detail about their pipelines. For instance the mechanism of action of pipeline compounds is not readily revealed by a number of major companies, including some US companies. Many investors would find this information useful in assessing the relative attractiveness and competitive positioning of a pipeline. This selective or restrictive approach to disclosure, driven by concerns about competitive information, should be seen in the context of R&D being the lifeblood of the industry and accounting for as much as a quarter of annual costs. 5 More than 80 percent of companies disclose the most recent pipeline information in a formal link on their website. Those that do not disclose pipeline information are some generic companies and foreign US filers. Some companies have moved away from any discussion of early stage compounds, which makes sense given that early stage R&D has always had more failure than success. 5 Based on estimated 16 percent R&D/sales and 32 percent operating margins: See Future Pharma, KPMG 2011, p8.

19 An Overview of Risk and Disclosure 17 R&D review Stage of development P1 P2 P3 Filed Name/ Code Therapy area Tabular disclosures Indication Mechanism Expected filing date Discontinued projects Formulation Partner Pipeline on website Abbott Allergan Amgen Baxter Biogen Idec BMS 1 N/A N/A N/A N/A Celgene Eli Lilly Forest Lab Gilead J&J 2 Merck & Co Mylan Pfizer 3 Watson AstraZeneca GSK Novartis Novo Nordisk Sanofi Teva Astellas Bayer BI Chugal CSL Daiichi Sankyo Eisai Merck KGaA Mitsubishi Tanabe Otsuka Roche Takeda UCB SA Count Percentage 94% 68% 76% 82% 76% 82% 88% 82% 53% 21% 21% 26% 32% 82% 1 BMS disclosed the number of compounds in the respective development stages as defined by the company: Exploratory Development; Full Development; Marketed Product Development. 2 Johnson & Johnson did not provide detailed pipeline data in addition to the narrative in the annual report. Phase 3 compound/device and filed compounds/devices were sourced from the pharmaceutical/medical devices and diagnostics pipeline link on the company s website. 3 Pfizer includes no specific compound discussion in its 10-K filing, giving only headline numbers of compounds. The pipeline on the company s website does not include a discussion of the pipeline. Source: KPMG analysis of 2011 company filings, April 2012.

20 18 An Overview of Risk and Disclosure Disclosure of discontinued projects remains rare, with less than a quarter of companies making this explicit. In a very highly scrutinized industry, success and failure will be readily apparent to interested investors or shareholders; it should enhance the reputation of companies to disclose failures. Disclosure of the estimated return on R&D spending remains unique to GlaxoSmithKline. There is an opportunity for other companies to be more transparent with their R&D spend and help shareholders and potential investors understand why the strategies being pursued will improve returns. We have illustrated previously that returns on R&D have been falling steadily for the past two decades. 6 As evident below, average industry returns on R&D have been falling since 1999 while R&D spend continues to grow. Returns on R&D compared to R&D spending 50,000 15% Annual US industry R&D spend 40,000 30,000 20,000 10,000 12% 9% Illustrative post-tax return on R&D expenditure 0 6% Source: Future Pharma, KPMG Future Pharma KPMG 2011, p13 and 14

21 An Overview of Risk and Disclosure 19 Legal proceedings analysis Pharmaceutical companies are frequently involved in a number of legal proceedings and the disclosures regarding the resulting contingent liabilities vary from company to company. The majority of legal proceedings involve actions by US state or federal government, or US patent disputes. Disclosure by US filers and foreign filers is, therefore, typically substantially more lengthy than that of foreign filers. We include seven Japanese companies, which have much lower levels of exposure to the US market, in the foreign filers group. Categories of contingent legal liabilities 14% 18% 42% Product liability Sales and marketing 26% Other Patents Source: KPMG analysis of 2011 company filings, April There were two noteworthy agreements reached with the US government over sales and marketing practices in late In November 2011 GlaxoSmithKline agreed in principle to a US$3 billion settlement with the US government to conclude its most significant ongoing Federal investigations, two of which were related to sales and marketing practices: the investigation begun by the US Attorney s office of Colorado in 2004 and the Department of Justice s investigation of the development and marketing of Avandia. In December 2011 Merck agreed to pay US$950 million to settle criminal and civil charges with the US Department of Justice related to research, marketing and selling activities with respect to Vioxx.

22 20 An Overview of Risk and Disclosure Rising legal risk In spite of extensive risk management input to board audit committees, there has been a rise in the number of settlements for violations of a variety of laws as exemplified by data from the US over the past 20 years with a very rapid rise since Since 2005, the annual value of the settlements has exceeded US$1billion reaching US$4.4 billion in The industry needs to reverse these trends to begin to win back confidence and trust from consumers and governments alike. This is no small task. Source: Future Pharma, KPMG 2011 Number of Pharmaceutical industry settlements with US state and federal governments Source: KPMG analysis of 2011 company filings, April 2012.

23 An Overview of Risk and Disclosure 21 Summary of significant contingent legal liabilities from 2011 disclosures (or 2010 where 2011 was unavailable as of 31 March 2012) Company USD $m Status Brief description Abbott 1,845 Pending HUMIRA patent infringement with Centocor (part of Johnson & Johnson) Abbott 1,630 Pending Depakote marketing Department of Justice (DOJ) investigation Amgen 780 Pending Federal investigation of sales and marketing practices for erythropoietin stimulating agents (ESAs) AstraZeneca 135 Pending Seroquel product liability litigation and state attorney general investigation of sales and marketing practices Baxter 300 Pending Contaminated heparin Bayer 125 In Appeal GM contaminated rice Bayer 750 Pending GM contaminated rice Bayer 133 Pending GM contaminated rice Eli Lilly 245 Settled Zyprexa product liability ($230m 2009 $15m 2008) Forest 313 Settled Celexa, Lexapro and Levothroid GSK 4,435 Pending Manufacturing, Paxil and Avandia product liability claims Johnson & Johnson 593 In Appeal CYPHER stent patent infringement Johnson & Johnson 330 In Appeal RISPERDAL promotion Johnson & Johnson N/A RISPERDAL promotion - criminal settlement - media suggest more than $1bn Merck 950 Pending DOJ investigation of Vioxx marketing Novartis 1,059 Pending Environment landfill Novartis 66 Settled Average wholesaling pricing settlement Novartis 150 Settled Average wholesaling pricing settlement Novartis 53 Pending Average wholesaling pricing settlement Novartis 78 Pending Average wholesaling pricing settlement Novartis 30 Pending Average wholesaling pricing settlement Novartis 25 Pending Average wholesaling pricing settlement Novartis 99 Pending Wage and hour law violation for failure to pay overtime Novartis 422 Settled Trileptal marketing Otsuka 311 Pending Payment to Bristol-Myers Squibb if Abilify generics launched Pfizer 790 Pending Hormone Replacement Therapy litigation Sanofi 985 Pending Product liability risks Sanofi 2,267 In Appeal Environmental liabilities Teva 270 Pending Design, manufacture and sales of large vials of propofol Source: KPMG analysis of 2011 company filings, April 2012.

24 22 An Overview of Risk and Disclosure Risk factor raw data Risk Factor Abbott Allergan Amgen Inc. Baxter Biogen Idec Bristol Myers Squibb Celgene US Filers Eli Lilly Forest Lab Gilead Johnson & Johnson Industry/Generic competition Protection and expiration of intellectual property rights Pharmaceutical pricing: Competition, price controls and reimbursement reductions Regulatory requirements R&D efforts may not be successful Interest rates/currency exposure/inflation Legal proceedings including adverse outcome of litigation and government investigations Patent litigation Manufacturing processes/product supply/raw materials Global, political and economic conditions Unsuccessful strategic alliances/business combinations Product liability Environmental/Health and safety liabilities Taxation Reliance on IT Reliance on third party manufacturing/providers or marketing suppliers Disruption from natural disasters Delay in product launches Political instability Human resources/key personnel European economic exposure* Reliance on key products US healthcare reform legislations* Impairements/Credit risk and bad debts Product safety issues* Concentration of sales to key customers, e.g. wholesalers Initiatives/Failure to implement business strategy New or revised accounting standards Emerging market risk* Business restrictions due to high debt ratios Liquid risks/insufficient cash International business risks* Anti-bribery and corruption legislations* Counterfeit products* Competition from biosimilars* Total number of risks Source: KPMG analysis of 2011 company filings, April Merck & Co. Mylan Pfizer Watson Pharma Astra Zeneca

25 An Overview of Risk and Disclosure 23 Foreign US Filers Glaxo Novartis SmithKline AG plc. Novo Nordisk Sanofi Bayer AG Boehringer Ingelheim CSL Merck KGaA Roche UCB SA Non-US Filers Astellas Pharma Teva Pharmaceuticals Chugai Pharmaceuticals Daiichi Sankyo Eisal Mitsubishi Tanabe Otsuka Holding Co. Takeda Pharmaceuticals Count

26 24 An Overview of Risk and Disclosure We would like to thank Kevin Wilson, Managing Director of Jovin Healthcare, for his invaluable contribution to this project, and we look forward to your feedback on this report. Ed Giniat Global Leader Pharmaceuticals US Leader Healthcare & Pharmaceuticals Chris Stirling European Leader Chemicals & Pharmaceuticals Norbert Meyring Asia Pacific Leader Chemicals & Pharmaceuticals

27 An Overview of Risk and Disclosure 25 About KPMG s Pharmaceuticals & Life Sciences Practice KPMG offers a broad range of audit, tax and advisory services to pharmaceuticals and other life sciences clients, ranging in size from biotechnology start-ups to multinational pharmaceutical companies. As a global leader in serving this evolving industry, KPMG is committed to helping our member firm clients stay abreast of emerging market trends, regulatory and legislative changes, leading practices and effective approaches to managing their business. KPMG is a global network of professional firms providing audit, tax and advisory services. We have 145,000 outstanding professionals working together to deliver value in 153 countries worldwide. Through its member firms, KPMG has invested extensively in developing a highly experienced pharmaceuticals and other life sciences team. KPMG s understanding of the industry is both current and forward looking, thanks to member firms global experience, knowledge sharing, industry training, and the involvement of professionals with direct experience in the pharmaceutical industry. Through its member firms, KPMG has invested extensively in developing a highly experienced pharmaceuticals and other life sciences team.

28 For more information, contact Ed Giniat Global Leader Pharmaceuticals US Leader Healthcare & Pharmaceuticals T: E: Chris Stirling European Leader Chemicals & Pharmaceuticals T: E: Norbert Meyring Asia Pacific Leader Chemicals & Pharmaceuticals T: E: David Blumberg Global and US Advisory Sector Leader Pharmaceuticals T: E: Frank Mattei Global and US Tax Leader Chemicals & Pharmaceuticals T: E: Melissa Stahl Global Executive & Knowledge Manager Pharmaceuticals T: E: Adrienne Rivlin European Executive Chemicals & Pharmaceuticals T: E: adrienne.rivlin@kpmg.co.uk Candice Zhang Asia Pacific Executive Chemicals & Pharmaceuticals T: E: candice.zhang@kpmg.com Mark Drozdowski US Audit Sector Leader Pharmaceuticals T: E: mdrozdowski@kpmg.com kpmg.com The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG International Cooperative ( KPMG International ), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: An Overview of Risk and Disclosure in the Global Pharmaceutical and Life Science Industry Publication number: Publication date: April 2012