fmv in healthcare transactions: compliance with anti-kickback and self-referral laws live webcast

Speaker Firms and Organization:

Stout Risius Ross, Inc.John W. VanSanten, MAI, MRICS

Managing Director

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Presented By:

October 15, 2014

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Partner Firms:

Duff & PhelpsRick Schwartz

Managing Director

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Partner Firms:

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Duff & Phelps is the premier global valuation and corporate finance advisor with expertise in complex valuation, dispute consulting, M&A and

restructuring. The firm's more than 1,000 employees serve a diverse range of clients from offices in North America, Europe and Asia. For more

information, visit www.duffandphelps.com.

M&A advisory, capital raising and restructuring services in the United States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill Partners is a Division of Duff & Phelps Securities, LLC. M&A

advisory and capital raising services in the United Kingdom and Germany are provided by Duff & Phelps Securities Ltd., which is authorized and

regulated by the Financial Conduct Authority.

Stout Risius Ross (SRR) is a premier global financial advisory firm specializing in Investment Banking, Valuation & Financial Opinions, and Dispute Advisory & Forensic Services. We serve a range of clients from

Fortune 500 corporations to privately held companies in numerous industries around the world. SRR has significant expertise providing financial advisory

services to companies in the Healthcare sector. Our professionals have extensive experience regarding the economic and financial issues faced by

the spectrum of Healthcare entities. For more information, visit www.SRR.com.

http://theknowledgegroup.org/%22https:/mail.ex1.secureserver.net/owa/redir.aspx?C=67b05ded3e204a41a36f9c94d3ec8633&URL=http://www.SRR.com/%22

Brief Speaker Bios:

Rick Schwartz

Rick Schwartz is a managing director in Duff & Phelps' Valuation Advisory practice. Duff & Phelps is a global valuation and corporate finance advisor with expertise in M&A, complex valuation, dispute consulting and restructuring. More than 1,000 employees serve more than 4,600 clients annually from offices throughout North America, Europe and Asia.

Rick is a member of the firm's Integrated Healthcare group, and has more than 25 years of experience in the pharmaceuticals, biotech, medical devices, and other industries. Rick's expertise includes valuation and analysis to guide compliance with healthcare anti-kickback and pricing regulations, support for M&A deal-making, decisions on intellectual property and R&D licensing/partnering, and assessment of damages for litigation. Rick received his Ph.D. and M.S. in engineering-economic systems from Stanford University and his B.S. in civil engineering and B.A. in government from Cornell University.

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John W. VanSanten, MAI, MRICS

John W. VanSanten is a Managing Director for the real estate practice within the Valuation & Financial Opinions Group of Stout Risius Ross. He has more than 22 years of extensive experience in real estate valuations of all types of commercial and special use properties, with a particular emphasis on healthcare properties. He has prepared and reviewed valuation and feasibility studies for litigation support, conventional financing, synthetic lease transactions, bond financing, ad valorem, condemnation, estate, purchase accounting, financial reporting, federal tax disputes, fair rental studies, and insurance purposes. John has extensive experience in the valuation of healthcare properties for Stark & Anti-Kickback Compliance.

► For more information about the speakers, you can visit: http://theknowledgegroup.org/event_name/fmv-in-healthcare-transactions-compliance-with-anti-kickback-and-self-referral-laws-live-webcast-2/

http://theknowledgegroup.org/event_name/fmv-in-healthcare-transactions-compliance-with-anti-kickback-and-self-referral-laws-live-webcast-2/

http://theknowledgegroup.org/event_name/fmv-in-healthcare-transactions-compliance-with-anti-kickback-and-self-referral-laws-live-webcast-2/

In a two hour live webcast, a panel of thought leaders and practitioners assembled by The Knowledge Group will discuss the significant and latest issues regarding the use of fair market value for compliance with the Anti-Kickback and Self-Referral Laws.

In a two-hour live webcast, the speakers will discuss:

• Overview on Fair Market Value • The Anti-Kickback and Self-Referral Law • Payments Covered by the Anti-Kickback Statute • Do’s and Don’ts on Self-Referral Law (Paying for Referrals is a Crime) • Complying with Federal Anti-Kickback and Self-Referral Law • Up-to-the-Minute Regulatory Updates

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Featured Speakers:

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Rick SchwartzManaging DirectorDuff & Phelps

John W. VanSanten, MAI, MRICSManaging DirectorStout Risius Ross, Inc.

Introduction

Rick Schwartz is a managing director in Duff & Phelps' Valuation Advisory practice. Duff & Phelps is a global valuation and

corporate finance advisor with expertise in M&A, complex valuation, dispute consulting and restructuring. More than 1,000

employees serve more than 4,600 clients annually from offices throughout North America, Europe and Asia.

Rick is a member of the firm's Integrated Healthcare group, and has more than 25 years of experience in the

pharmaceuticals, biotech, medical devices, and other industries. Rick's expertise includes valuation and analysis to guide

compliance with healthcare anti-kickback and pricing regulations, support for M&A deal-making, decisions on intellectual

property and R&D licensing/partnering, and assessment of damages for litigation. Rick received his Ph.D. and M.S. in

engineering-economic systems from Stanford University and his B.S. in civil engineering and B.A. in government from

Cornell University.

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Introduction

John W. VanSanten is a Managing Director for the real estate practice within the Valuation & Financial Opinions Group of

Stout Risius Ross. He has more than 22 years of extensive experience in real estate valuations of all types of commercial

and special use properties, with a particular emphasis on healthcare properties. He has prepared and reviewed valuation

and feasibility studies for litigation support, conventional financing, synthetic lease transactions, bond financing, ad

valorem, condemnation, estate, purchase accounting, financial reporting, federal tax disputes, fair rental studies, and

insurance purposes. John has extensive experience in the valuation of healthcare properties for Stark & Anti-Kickback

Compliance.

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Agenda

• Introduction

• Payments to Healthcare Providers

• Real Estate Transactions

• Payments for Healthcare Data

• Discussion

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The current environment…

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Scrutiny under anti-kickback, fraud and abuse, and pricing statutes continues to be applied by regulatory agencies.

– Annual OIG judgments and settlements now exceed $2B/year. – Focus: Transactions involving healthcare providers that could be construed as an inducement to

refer or prescribe, or to improperly price healthcare services.– A key protection is to ensure that these transactions reflect Fair Market Value (FMV) for the

services or asset involved.

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FMV is relevant to the spectrum of healthcare transactions.Examples

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Marketing, Advisory, &Educational Services

Data Related Services

Distribution Services

Property & Equipment Transactions

Advisory boards, research services, product reviews

Utilization data/analyses

Basic distribution services

Lease Transactions

Meetings, speaker events, CME programs

Sales/marketing data Contract

administration Real Estate

Purchase/Sale

Market research studies, health provider surveys

Outcomes data/health economics analyses

Specialty pharmacy distribution services

Medical Equipment purchase/lease

Sales calls to physicians

Customized research studies

Enhanced services such as product pedigree control

Communications to patients, physicians, and pharmacies

Customized analytic tools

Reimbursement training to provider staff

Product flyers, displays, shipping inserts

Clinical education, decision support tools

Managed care contracting support

What do FMV and Commercially Reasonable Mean?

The Stark Regulations define "fair market value" as:

[T]he value in arm's-length transactions, consistent with the general market value. "General market value" means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Usually, the fair market price is ... the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, ... [and] has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals.

A "commercially reasonable" arrangement is one that "would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician ... of similar scope and specialty, even if there were no potential [service] referrals" pursuant to the arrangement. 69 Fed.Reg. at 16,093.

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Three valuation approaches are typically considered

• Market Approach – “What is everyone else paying?”– Comparable products, services, or assets– Transaction-based

• Cost Approach – “How much was spent or would have to be spent?”– Historical spend to develop the product or service– Future cost to reproduce or replace the product or service

• Income Approach – “How much value will the product or service generate in the future?”– Discounted Cash Flow Analysis– Royalty savings (or relief from royalty)

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Market Approach – “What is everyone else paying?”

• Objective data from publicly reported transactions involving comparable products or services• Value based on arm’s-length prices in actual transactions

– Compensation, licensing transactions, acquisitions• Selecting and applying comparables requires expertise and judgment

– Adjustments can be made to make the “comparables” more comparable

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Search and SelectComparables

Adjust forDifferences

Apply to Value Product or Service

Understand the subject product, service, or asset

Search for comparable products and service transactions

Select performance metrics on which to base any adjustments

Identify performance metrics for the comparable products or services

Conclude on the relationship between the performance metric and the price

Apply adjustment based on the performance metric of the product or service

Conclude on fair market value, typically a range

Cost Approach – “How much was spent or would need to be spent?”

• Value is the cost to replace or re-create the product or service

• Theory: Acquirer avoids these costs by gaining use of the asset from others

• Approach 1: Historical spend – Calculate historical accumulation of development costs, amortize over volume to obtain a per-unit

cost

• Approach 2: Future cost to reproduce or replace– A prudent buyer would pay no more for the product or service than the amount it would cost to

reproduce or replace it

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Income Approach – “How much value will the asset generate in the future?”

• Value equals the present value of the expected (probability-weighted) future income stream

• Method 1: Discounted Cash Flow Analysis– Revenue projections– Cost benchmarks– Probability-weighted, if appropriate– Expected cash flows– Discounted at a rate of return commensurate with the risks

• Method 2: Royalty Savings Analysis (“Relief from Royalty”)– If we did not own the asset, how much would we pay to license it?– Estimate the royalty by using: transaction data, return on assets– Sum of after-tax royalty savings, discounted at risk-adjusted rate of return, provides indication of

value

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Each approach has challenges; best practice is to use multiple methods

• Market Approach – Challenges– Finding comparable products or services– Obtaining pricing for these comparables – Incomplete, biased, or unreliable pricing data– Adjustment for unique aspects of the product or service; takes experience & judgment

• Cost Approach – Challenges– Difficult to accumulate all historical costs or replacement costs– Value of asset does not necessarily equal to its cost

» Fails to consider anticipated future benefits to the buyer» May not reflect what a willing buyer and seller would transact for

• Income Approach – Challenges – Value is sensitive to projections and discount rates– Focuses on value to buyer – to be avoided for FMV purposes– Relief from royalty may be appropriate in some cases, and is tied to market transaction data

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Agenda

• Introduction




• Discussion

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Payments to physicians and other health care professionals (“HCP”) create a number of issues for buyers.

1. What is an appropriate payment to HCPs who serve as presenters, trainers, researchers, consultants, board advisors, etc.?

2. How should the payment depend on characteristics of the HCP (specialty, reputation, experience, geographic location, etc.)?

3. How should the fee depend on the demands of the activity (distance away, preparation required, complexity, level of responsibility, etc.)?

4. How should the fee depend on the time commitment (single vs. multiple events, lunch meeting vs. full day, etc.)?

5. How should the fee be set when the contract involves several different types of activities?

6. What is an appropriate limit, if any, on the cumulative payments by one company to any one HCP in a given year?

7. What is an appropriate limit, if any, on the aggregate payments by any one payor (e.g., drug brand) to all HCPs over a given timeframe?

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Informal approaches and ad-hoc arrangements expose both parties to risk.

Some key concerns:– The buyer may be viewed as paying more than fair market value:

» Fees based on history and negotiation may viewed as being inconsistent with an “arms length agreement” standard

» Fees that differ on an individual basis for what appear to be the same service may be viewed as providing an inappropriate incentive to some individuals

– Informal approaches result in extra time and effort to negotiate with each HCP, since there is lack of data/analysis to support an offer made by the sponsor or to refute an offer received from an HCP.

– Ad-hoc arrangements make it difficult for the sponsor to provide assurance and defensibility to an HCP that its payments are appropriate either for a specific assignment or cumulatively for a given year.

– Further, the buyer may be viewed as spending too much in total, or paying too many HCPs in total, on programs for a given brand or therapeutic area.

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We recommend that multiple approaches be used when possible.

– Analyze comparables» Fees paid by third-party providers of HCP programs» Salary and compensation data for HCPs

– Adjust where appropriate, for: » Relative performance, e.g., ability to draw a larger audience or better-targeted participants» Characteristics of the HCP, e.g., regional differences, years of experience, specialty» Characteristics of the program, e.g., preparation time, local vs. distant, time commitment

– Key challenges:» Data for comparables is often not granular enough given the unique characteristics of the

services or HCPs » Adjustments for characteristics of the HCP or for unique aspects of the program need to have a

credible basis.

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Case Study: Demand-Adjusted Compensation Approach

A manufacturer and distributer of medical devices serves a highly specialized segment of surgeons. The company sought to contract with selected surgeons to provide marketing, training, and product development services.• Approach

– Identify appropriate ranges from compensation data for key characteristics (experience, region, specialty)

– Measure the demand that different activities place upon the surgeon. » Demand captures the effort, knowledge, skills, risk, and responsibility a given activity entails that

would justify higher or lower compensation relative to another activity. » Activities include ordinary job duties fulfilled on a day to day basis (which are reflected in the

compensation data) and specialized activities of the type that the manufacture is contracting for.– Estimated FMV range for each activity is the compensation range adjusted to reflect the demand of

each activity

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Mock Survey QuestionOn a scale from 1 (least demanding) to 9 (most demanding), how would rate:

1. An hour of your time performing surgery?

2. An hour of your time on product development?

Paperwork

Training

Product Dev.

Surgery

Average Demand of Activity

Least MostDemand of Activity

Case Study: Conjoint-Based (Willingness-to-be-paid) Approach

A clinic network sought an indication of FMV for the services that its clinicians provide to pharmaceutical manufacturers. The results would support negotiations and compliance, as well as providing a tool to help price services beyond those envisioned by the original survey.• Approach:

– Define activities and characteristics of the activities (time commitment, location, etc.)– Gather healthcare providers’ responses to a series of tradeoff questions– Based on analysis of the choices, infer each HCP’s willingness to participate in each activity at each

of several different compensation levels– Based on the aggregated response, estimate the percentage of an HCP segment that is willing to

perform a specified activity at a specified price

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Mock Survey QuestionWhich of the following activities are you most likely to choose.

Activity A Activity B

Train product sales representatives via a 1 hour conference call.

Compensation: $100

Participate in a 4 hour online advisory panel.

Compensation: $600

0%

40%

80%

Activity requiring travelActivity not requiring travel

Compensation ($/hr)E

st.

Pa

rtic

ipa

tio

n

Ra

te

Which method is more appropriate?

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Demand-Adjusted Compensation Approach

Conjoint-Based (Willingness-to-be-paid) Approach

Advantages

Simple to design and field More robust, uses realistic choice questions

Fewer participants required Flexible definition for activities

Straightforward analysis Broad range of parameters

Transparent methodology Allows for development of complex pricing models

FMV is not directly tied to comp data

Disadvantages

Limited activities and parameters Requires more time to setup and field survey

Limited ability to adapt results to new activities Recruitment more difficult and involves higher incentives

Anchored to compensation data Complex analysis (measuring utilities)

Agenda

• Introduction




• Discussion

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Valuation Triage:

Stark/Anti-Kickback Valuation Issues within the Healthcare Industry - Real Estate Transaction Implications

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Introduction

Topics Covered – Fair Market Value – Real Estate Transaction Implications

Lease Transactions Key Factors of Lease Transactions Unique Situations in Lease Transactions Purchase/Sale Transactions

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Fair Market Value

Fair Market Value is a significant part of compliance for both Stark & Anti-Kickback laws. All transactions must be consistent with Fair Market Value Fair Market Value should always be obtained from an independent third-party valuation expert.

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Real Estate Transaction Implications

In real estate transactions between hospitals and physicians, the hospital must be careful to comply with Stark and Anti-Kickback regulations. Two most common real estate transactions:

– Lease Transaction– Purchase Transaction

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Lease Transactions – Determining Fair Market Rent

Comparable Lease Transactions – Based on the principal of substitution. – Comparable leases can include actual leases and asking rents.– Application of this method must consider several key factors:

Expense basis Location Age/Physical Condition Size Usable vs. Rentable Tenant Improvement Allowance Lease Term Rent Escalations

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Lease Transactions – Expense Basis

The expense basis must be the same for each comparable lease transaction, or appropriate adjustments must be applied. The expense basis is typically one of the following: Net Gross Modified Gross

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Lease Transactions – Location

Location is a critical factor for healthcare properties, particularly proximity to the hospital.

On-campus medical space often commands a higher market rent.

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Lease Transactions – Size & Age/Condition

Newer facilities, in superior physical condition, will command higher rents. This is especially true in healthcare, due to changing technologies and space requirements.

Larger spaces will typically rent for a lower value per square foot than smaller spaces.

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Lease Transactions – Usable vs. Rentable

Usable vs. rentable area is a key factor that is often misunderstood by both landlords and tenants. Usable Area Rentable Area Common Area Factor (CAF)

– CAF = (Rentable Area/Usable Area)

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Lease Transactions – Tenant Improvements

Depending on the market and terms of the lease agreement landlords may include a tenant improvement allowance (TIs). For Example:– A 10-year lease with a base rent of $15/SF, which includes a $25/SF tenant improvement

allowance. Adjustments must be made when comparing this lease transaction to other transactions. For Example:

– A 10-year lease with a base rent of $20/SF, which includes a $50/SF tenant improvement allowance.

Excess TI’s will typically be amortized over the term of the lease at a market rate of interest.

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Lease Transactions – Lease Term

Shorter term leases often rent at higher rates than long-term leases. Landlords are often willing to accept a slightly lower rent in exchange for a longer lease term. The difference can be attributed to the higher costs associated with short-term leases.

– More frequent transaction costs, potential downtime between leases, and general disruption of tenants moving in and out.

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Lease Transactions – Rent Escalations

Leases typically have some type of escalation clause based on a specific dollar amount or percentage rate.

Difference in rent escalations must be accounted for when comparing lease transactions.

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Unique Situations in Lease Transactions

Ground Leases Timeshares for Medical Space Specialized Medical Space

– Ambulatory Surgery Centers (ASC’s)– Imaging Centers – Dialysis Centers

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Ground Leases– Extended period of time. – Comparable ground lease

transactions are often unavailable. – Market rent is driven by underlying

land value.

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Timeshares for medical space are used by physicians that may have a need for space on a part-time basis.

Pro rata share of the market rent.

Adjustments are made for the cost of administrative support and/or furnishings.

Adjustments and conclusions are often dependent on standard practices within the given market.

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Specialized Space– Ambulatory Surgery Centers (ASCs),

Imaging Centers, etc. – Comparable lease transactions are scarce. – Return on Cost Analysis

Total Cost (land and building) x Capitalization Rate

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Example of Return on Cost Analysis: – If the total cost of an ASC (land and building) is $350/SF, and an appropriate capitalization rate is

8.5%, the estimated net rent for the ASC equals $29.75/SF ($350 X 8.5% = $29.75).

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Purchase/Sale Transaction – Determining Fair Market Value

For a purchase/sale transaction, market value is typically estimated by applying some or all of the three traditional approaches to value. Cost Approach Sales Comparison Approach Income Capitalization Approach

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Cost Approach

The cost approach starts with an estimate of the replacement or reproduction cost new of the building improvements.

Deductions are made to arrive at depreciated cost.

Land value is added to the value of improvements.

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Sales Comparison Approach

Based on the principle of substitution. Appropriate adjustments are applied for key

factors:– Location– Age– Size– Amenities– Economic Characteristics

Price per square foot is a typical unit of comparison.

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Income Capitalization Approach

Based on the premise that the value of a property is driven by anticipated cash flows. Gross Income

– Contractual Rent– Market Rent

Deductions– Vacancy– Collection Loss– Operating Expenses

Capitalization Rate (return on and of the investment)

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Applicability of Valuation Methods

Income Capitalization Approach– Multi-tenant properties that are leased to third-party tenants.

Sales Comparison Approach – Owner/user or single tenant buildings.

Cost Approach – New construction where minimal depreciation is present. – High-cost special purpose properties

(i.e. Ambulatory Surgery Centers).

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Conclusion

Whether it is a lease or a purchase/sale agreement, real estate transactions in the healthcare industry have unique complexities that make them different from “normal” real estate transactions.

Regulatory compliance requirements make it imperative to obtain a market value opinion from a professional who understands the healthcare industry.

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Agenda

• Introduction




• Discussion

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Establishing Fair Market Value for data is particularly challenging

• Often the data is unique, or cannot be obtained through another source• In applying the Market Approach:

– What products are comparable?– How do we obtain pricing information for these products? – How do we adjust for unique aspects of product we are valuing?

• In applying the Cost Approach:– How do we capture historical or replacement costs?– How do we allocate these costs on a per-unit (per dataset) basis?

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To establish FMV for data, best practice is to apply multiple approaches

Rigorous, independent, objective analysis

Multiple approaches and data sources; not just a pricing survey.

FMV is not the price of the lowest-priced alternative!

Both cost and performance are considered.

Transparent, defensible results.

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Cost• Actual cost• Cost build-up• Comparable product

Performance• Response rate• Quality of data• Ability to meet

customer need• Etc.

Cost• Actual cost• Cost build-up• Comparable product

Performance• Response rate• Quality of data• Ability to meet

customer need• Etc.

Fair MarketValue

Both provider-side and buyer-side research can support a robust valuation

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Identify target buyers

Design interview to measure customer value and willingness-to-pay for product alternatives

Conduct survey, analyze data, integrate with supplier data

Buyer-Side Research (as needed)

Identify the relevant set of competing suppliers

Research competitor offerings and pricing

Research data to support performance based adjustments (e.g., response rates)

Provider-SideResearch

Identify products addressed, including:

Product currently purchased

Potential new products/providers

Identify potential data sources including internal costs

Formulation

Recommend appropriate FMV ranges for products addressed

Guidance/training to support compliance strategies

Analysis &Recommendation

LUCENT TECHNOLOGIES INC. Exhibit IIESTIMATION OF THE FAIR VALUE OF INTELLECTUAL PROPERTY Section BAS OF SEPTEMBER 30, 2002 Page 3d of 3DOLLARS IN MILLIONSFAIR VALUE OF TECHNOLOGY-IN-USE (INS)RETURN ON ASSETS: COMPARABLE COMPANY ANALYSIS

CISCO SYSTEMS, INC.

Assumptions

Net Working Capital ("NWC") Rate of Return (1) 4.75% 6.75% 9.50% 8.00%Net Property, Plant & Equipment ("PP&E") Rate of Return (2) 6.75% 8.75% 11.50% 10.00%Remaining Useful Life (Years) 3.0 2.0 2.0 2.0 Research & Development ("R&D") Addback to Operating Profit (3) 75.0% 75.0% 75.0% 75.0%

Historical Balance Sheet Information Fiscal Year Ended7/27/2002 7/28/2001 7/29/2000 7/31/1999

NWC 7,350.0$ 723.9$ 2,032.5$ 365.7$

PP&E 4,102.0$ 2,591.0$ 1,426.0$ 825.0$

Historical Income Statement Information Fiscal Year Ended7/27/2002 7/28/2001 7/29/2000 7/31/1999

Revenue 18,915.0$ 22,293.0$ 18,928.0$ 12,173.0$ Cost of Revenue (5,644.0) (10,040.0) (6,174.0) (3,831.0)

R&D (3,448.0) (3,922.0) (2,704.0) (1,663.0) Depreciation and Amortization ("D&A") (1,957.0) (2,236.0) (863.0) (489.0)

Other Operating Expenses (4,882.0) (6,074.0) (4,579.0) (2,846.0) Operating Profit 2,984.0$ 21.0$ 4,608.0$ 3,344.0$

Adjusted Operating Profit (before D&A, non-recurring, and 75% of R&D) 7,527.0$ 5,198.5$ 7,499.0$ 5,080.3$ as a percent of Revenue 39.8% 23.3% 39.6% 41.7%

Return on Assets Analysis Fiscal Year Ended7/27/2002 7/28/2001 7/29/2000 7/31/1999

Pre-tax Return on NWC 349.0$ 49.0$ 193.0$ 29.0$ Pre-tax Return on PP&E 1,555.9 1,467.9 838.2 475.4

Pre-tax Return on NWC and PP&E 1,904.9$ 1,516.9$ 1,031.2$ 504.4$ as a percent of Revenue 10.1% 6.8% 5.4% 4.1%

Adjusted Operating Profit 7,527.0$ 5,198.5$ 7,499.0$ 5,080.3$ Less: Pre-tax Return on NWC and PP&E (1,904.9) (1,516.9) (1,031.2) (504.4)

Equals: Excess Adjusted Operating Profit 5,622.1$ 3,681.6$ 6,467.8$ 4,575.9$ as a percent of Revenue 29.7% 16.5% 34.2% 37.6%

Portion of Excess Adjusted Operating Profit Attributed to Technology-In-Use @ 44.0% 2,474.0$ 1,620.0$ 2,846.0$ 2,013.0$ as a percent of Revenue (Indicated Royalty Rate) 13.1% 7.3% 15.0% 16.5%

Average Indicated Royalty Rate (Historical) (4) 13.0%

Average Indicated Royalty Rate (Historical) 13.0%Divided by: Average Adjusted Operating Profit (as a Percent of Revenue) 36.1% Average Indicated Royalty Rate as a Percent of Adjusted Operating Profit 35.9%Multiplied by: Projected Adjusted Operating Profit (fiscal year 2003) (5) 52.5%

Implied Royalty Rate (Projected) 18.9%

Definitions & FootnotesLTM = Last Twelve Months(1) Prime rate as per Bloomberg.(2) Equals prime rate plus 200 basis points as per Bloomberg.


CISCO SYSTEMS, INC.

Assumptions



NWC 7,350.0$ 723.9$ 2,032.5$ 365.7$

PP&E 4,102.0$ 2,591.0$ 1,426.0$ 825.0$


Revenue 18,915.0$ 22,293.0$ 18,928.0$ 12,173.0$ Cost of Revenue (5,644.0) (10,040.0) (6,174.0) (3,831.0) R&D (3,448.0) (3,922.0) (2,704.0) (1,663.0) Depreciation and Amortization ("D&A") (1,957.0) (2,236.0) (863.0) (489.0)














CISCO SYSTEMS, INC.

Assumptions



NWC 7,350.0$ 723.9$ 2,032.5$ 365.7$

PP&E 4,102.0$ 2,591.0$ 1,426.0$ 825.0$


Revenue 18,915.0$ 22,293.0$ 18,928.0$ 12,173.0$ Cost of Revenue (5,644.0) (10,040.0) (6,174.0) (3,831.0) R&D (3,448.0) (3,922.0) (2,704.0) (1,663.0) Depreciation and Amortization ("D&A") (1,957.0) (2,236.0) (863.0) (489.0)













Case Study: Integrated Surveys of Buyers and Sellers

Situation

The seller is the data services arm of a leading pharmacy benefits manager.

The buyer is a manufacturer considering a contract for ongoing data services to support sales and marketing of a newly launched drug. The seller’s data service is uniquely equipped to meet the buyer’s need.

Is the proposed price at fair market value? How should it change if we change some of the contract terms (e.g., frequency of updates, inclusion of customized reports)?

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Approach:

Research sellers to determine competing products and prices

Research buyers to measure importance they place on type of data, size of dataset, frequency of updates, and other product differentiators

Integrate the two to determine the fair market value of the proposed service.

Result:

Insight into why the seller’s service commands a higher price

Defensible contract price based on independent Fair Market Value analysis

Buyer’s Compliance organization is happy

Swift conclusion to contract negotiations

Case Study: Integrated Surveys of Buyers and Sellers

Price

A B C

Competing Data Products

Competing Data Products

A B C

Fulfillment of Customer Need

Data Products/Services Under Consideration

Product#1

Fair Market Value

Product#2

Product#3

Case Study: Buyer Survey

Situation

The seller is a specialty drug distributor with unique access to valuable market data.

The buyer is the distributor’s customer, a pharmaceutical manufacturers.

Given the uniqueness of the seller’s data, it is difficult to find comparable data products as a basis for pricing.

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Approach:

Buyer survey: measure willingness to pay for a specified data product.

Integrate results from multiple buyers to estimate the market’s price sensitivity.

The concluded FMV range is based on the % of buyers willing to pay a given price for a specified product. Result:

Pricing tailored to a given product, based on market information, and consistent with FMV standard.

Example:• “Low” Price: $A• “Moderate” Price: $B• “High” Price: $C

0%

20%

40%

60%

80%

100%

Price

Es

tim

ate

d %

Will

ing

ne

ss

to

Pa

y

0% 10% 20% 30% 40% 50% 60% 70% 80%

Average of All Buyers' Estimated % Willingness-to-Pay for Product A

(# of Resp. = n)

Estimated % Willingness to Pay

Pri

ce

Agenda

• Introduction




• Discussion

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59


A credible FMV analysis captures the unique aspects of a given product, service, provider, and transaction.

By documenting the unique aspects and tying the concluded FMV to solid data, the benefits are:

• Reduced risk:– A rigorous basis for concluding on pricing that, in some instances, may be significantly higher or

lower than “average”.

• Support for price negotiations between buyer and seller:– Transparency in the basis for the concluded price range gives both parties a realistic understanding

of the Fair Market Value.

• Streamlined procurement process:– A flexible approach can address many

different transactions of a given type, avoiding the need to re-do the FMV analysiseach time a new contract is being considered.

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