risks overview in pharma sector

An Overview of Risk and Disclosure in the

Global Pharmaceutical and Life Sciences

Industry

April 2012

kpmg.com

KPMG INTERNATIONAL

© 2012 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. All rights reserved.

Contents

Executive summary 2

Reported risk factors 4

Financial statement disclosures 13

Legal proceedings analysis 19

About KPMG’s Pharmaceutical & Life Sciences Practice 25


An overview of risk and disclosure

Executive summaryThis is a summary report of risk and disclosure by the major pharmaceutical and life sciences companies. The pharmaceutical industry is now experiencing the long-expected and much-discussed patent cliff. During the 2011-14 period, patent protection covering US$120 billion in sales is expected to be lost1. 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:

• UScompaniesandforeigncompaniesfiling with the US Securities and Exchange Commission (SEC) disclose broadly twice as many risks as non-US filers.

• Overall,therewasa13percentincrease in the aggregate total number of risks disclosed by the sample of companies we reviewed.

• Pricing,patent-relatedrisksandgeneric competition dominate disclosure tables.

• Politicalinstability,naturaldisastersand the risk posed by use of information technology show the greatest increase in disclosure.

• UShealthcarereform,Europeaneconomic risk, and emerging market risk are new risks disclosed by more than 15 percent of filers for the first time.

• Sixcompanieswithmorethan30 percentofsalesfromtheEuropean Union (EU) did not disclose specific EU risk.

• Emergingmarketriskwasdisclosedby less than a quarter of the companies.

• DisclosureofR&Dpipelinesremainsrelatively limited, influenced by the problems and lack of success of recent years, and competitive pressures. Only one company estimatesitsreturnonR&Dspending.

• WeobservednomeaningfultrendindisclosurerelatedtoM&Aactivity.

• Contingentlegalliabilitiesaredominated 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. Weseecompaniestakingstepstoreduce 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 lifesciencesindustry.Wedonotseethe issue of scientific risk yet being embraced: companies’ disclosure is, in general, limited, and the governanceofR&Dmeritsahigherprofile.

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. Wesensethatthebeginningofthecultural 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),especiallyinvolvingsmall

1 IMS Institute for Healthcare Informatics: The Global Use of Medicines: Outlook Through 2015, May 20112 Future Pharma: Five Strategies to Accelerate the Transformation of the Pharmaceutical Industry by 2020, KPMG 2011, p.16

2 | An Overview of Risk and Disclosure


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.

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-scaleM&Aisexpectedtobemore challenging as most of the large companies are already the product of a significant acquisition and are working toward rationalizing excess capacity and resources.

Inanycase,M&Aandalliancesshould involve careful examination of the risks of fully developing the compound and bringing it to market as part of effective due diligence on behalfoftheacquirer.Weobservedno meaningful trend in disclosure relatedtoM&A,althoughtwoofthe smaller companies noted that provisions in agreements with third-parties 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&Anotoccurring.

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&Dprocesses.Thisisunderwayat most major companies, but the speed of implementation could be questioned.

An Overview of Risk and Disclosure | 3


Reportedrisk 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. Wehavereviewedthemostrecentrelevantfilingofthe34largestpharmaceutical and other life sciences companies and considered their quantitative and qualitative disclosures.



Pharmaceutical and life sciences companies

Wereviewed34companiesasillustratedbelow:

• USfilers–publiclytradedUScompaniesthatfileForm10-KwiththeSEC

• ForeignUSfilers–non-USpubliccompaniesthatfileForm20-FwiththeSEC

• Non-USfilers–publicandprivateforeigncompaniesthatdonotfilewiththeSEC.

Composition of company universe

38%44%

18%

US Filers (15)

Foreign US Filers (6)

Non-US Filers (13)

Source: KPMG analysis of company findings, April 2012.

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 31risksandnon-USfilersonaverage15risks.

Average total number of disclosures*

18%

US Filers

*Including all disclosures

0

5

10

15

20

25

30

35

Non-US FilersForeign US Filers

28

31

15

Source: KPMG analysis of 2011 company filings, April 2012.

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.



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 alsodrivestheneedforR&Dorganizationstodeliversufficientproductswithpotential 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.

3 IMS Institute for Healthcare Informatics: The Global Use of Medicines: Outlook Through 2015 May 2011

Risks related to intellectual property protection and generic competition appear most frequently.



US healthcare reform legislation

0% 20% 40% 60% 80% 100%

Competition from biosimilars

Counterfeit products

Anti-bribery and corruption legislation

International business risks

Liquidity risks/insufficient cash

Business restrictions due to high debt ratios

Emerging market risk

New or revised accounting standards

Failure or adverse impact of productivity initiatives/failureto implement business strategy

Concentration of sales to key customers, e.g. wholesalers

Product safety issues

Impairments/credit risk and bad debts

Reliance on key products

European economic exposure

Human resources/key personnel

Political instability

Delay in product launches

Disruption from natural disasters

Reliance on third party manufacturing/providers ormarketing suppliers

Reliance on IT

Taxation

Environmental/health and safety liabilities

Product liability

Unsuccessful strategic alliances/business combinations

Global, political and economic conditions

Manufacturing processes/product supply/raw materials

Patent litigation

Legal proceedings including adverse outcome of litigation andgovernment investigations

Interest rates/currency exposure/inflation

R&D efforts may not be successful

Regulatory requirements

Pharmaceutical pricing: Competition, price controls andreimbursement reductions

Protection and expiration of intellectual property rights

Industry/generic competition 100%

94%

91%

91%

91%

88%

88%

82%

79%

79%

74%

71%

68%

68%

65%

62%

62%

53%

53%

50%

44%

44%

38%

35%

29%

26%

24%

24%

24%

21%

21%

18%

15%

15%

15%

New risks reported by more than15 percent of companies

Frequency of risk disclosure




Changes in risk frequency

Overalltherewasa13percentincreaseintheaggregatetotalnumberofrisksdisclosed by the companies we reviewed in the 2011 filings vs. the 2010 filings (573vs.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.

“Whilesocialmediaadoptionprovidesthepharmaceuticalandlifesciencesindustry 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&IndustryReport,5LSLR981,10/07/2011.Copyright©2011byTheBureauofNationalAffairs,Inc.(800-372-1033)http://www.bna.com

The rapid growth in the use and reliance on information technology raises a number of new risks.

Social media risk



Therewasa30percentincreaseinthedisclosureoflegalproceedingsincludingadverse 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



Reliance on IT

Human resources/key personnel

Taxation

Legal proceedings including adverse outcome of litigation and government investigations

Patent litigation

Reliance on third party manufacturing/providers or marketing suppliers


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

Product liability


Impairments/credit risk and bad debts

Business restrictions due to high debt ratios

Failure or adverse impact of productivity initiatives/failure to implement business strategy

-50% 0% 50% 100% 150% 200% 250%

240%

133%

57%

50%

35%

30%

27%

24%

14%

13%

10%

9%

8%

8%

7%

6%

3%

3%

0%

0%

0%

-3%

-4%

-10%

-13%

-27%




Analysis of newly disclosed risks

Weidentifiedeightrisksreportedbymorethan15percentofcompaniesfor the first time:

• UShealthcarereformlegislation,i.e.thePatientProtectionandAffordable Care Act of 2010

• Europeaneconomicrisk

• Emergingmarketrisk

• Productsafety

• Internationalbusinessrisk

• Anti-briberyandcorruptionlegislation

• Counterfeitproducts

• Competitionfrombiosimilars

US Patient Protection and Affordable Care Act of 2010

Eighty-sevenpercentofUSfilersand83percentofForeignUSFilersspecificallyidentified 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 ofoverseassalesintothereportingcurrency.Wholesalersandthird-partymanufacturers 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. Whileself-evidentforthoselifesciencecompanieswithdiversifiedbusinessmodels 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.

The Eurozone crisis may also influence exchange rates and the translation of overseas sales into the reporting currency.



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.Weweresurprisedthatsixcompanieswithmorethan30percentofrevenue 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.

Companies that disclose EU risk

Perc

enta

ge o

f sal

es fr

om E

U

Companies that do not disclose EU risk

40%

Disclosure of European economic risk vs. percentage of sales in the EU


37% 37%

32% 32% 31% 30% 29% 29%27%

25%

29%

22% 22%

49%

40%

34% 33% 32% 31%

26% 25%

20% 20%

17%

12%

9%

6%

2%

0%

10%

20%

30%

40%

50%

4 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.



Emerging market risk

Slightly less than a quarter of filing companies disclosed risks associated with strong growth from emerging markets. These risks included:

• Thestrong,oftendouble-digitgrowthratesexperiencedinrecentyearsmaynotcontinue.

• Somedevelopingcountrieshavereduced(orthreatenedtoreduce)thedurationof patent protection to facilitate early generic competition.

• Companiesmaynotbeabletorealizetheexpectedbenefitsofsignificantinvestments in emerging growth markets.

• Theremaybearelativelylimitednumberofpeoplewiththeskillsandtrainingsuitable for employment in life science enterprises.

• Companiesmayberequiredtorelyonthird-partyagents,whichmayputthematrisk of liability.

• Manyemergingcountrieshavecurrenciesthatfluctuatesubstantiallyandshouldthese 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. Wecomparedthenumberofcompaniesthatdiscloseemergingmarketriskwiththe 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, therangeofsalesfromJapanis6to19percent).Asillustratedbelow,thereisasubstantial proportion of companies with significant sales outside the traditional WesternmarketsandJapanthatdonotdiscloseemergingmarketrisk.Weseethisas a potentially important area for review.

Companies that disclose Emerging Market risk Companies that do not disclose Emerging Market risk

43%

33%

30%

26%24%

22%

18%

4%

42%

36%

31%

27% 26% 25%23%

21% 21%

26%

12% 11% 11% 11% 10% 10% 9% 9% 8% 8%6% 6%

5% 3% 3%

0%0%

10%

20%

30%

40%

50%

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


Financialstatement 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.

91%

76%

76%

61%

61%

61%

47%

44%

44%

38%

35%

35%

35%

32%

29%

29%

18%

15%

15%

12%

0% 20% 40% 60% 80% 100%

Allowance for doubtful accounts

Earnings per share

Use of estimates

New accounting standards

Leases

Share-based compensation

Cash, cash equivalents and investments

Foreign currency translation

Financial instruments

Acquisitions/business combinations

Consolidation

R&D costs

Goodwill

Inventory valuation

Property, plant and equipment/impairments

Contingent liabilities and litigation

Pension/retirement benefits

Intangible assets/impairment

Revenue recognition

Income/deferred/contingent taxes

Risks reported by more than 15 percent of companies for the first time

Critical accounting policies – percentage reported




Taxeswerethemost-disclosedcriticalaccountingpolicy,disclosedby90percentofthese 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 aspatentexpirationnears).Webelievegrossrevenuerecognitionwillbecomemore 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.



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.

Wenotedthatlessthan15percentofthecompaniesdisclosedallowancefordoubtfulreceivablesascritical.WefoundthissurprisinggiventhevariousEuropeangovernment 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

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 free-form approach to business description within their annual reports. For example, strategywasonlyaspecificMD&A/OFRtopicinslightlymorethanhalfofthecases; this is perhaps surprisingly low given the seismic shift in the business environment combined with economic uncertainties.

0%

20%

40%

60%

80%

100%100%

82%79%

71% 71%65%

56%53%

50%47%

41%

29%

15%

Busi

ness

env

ironm

ent

Over

all p

erfo

rman

ce

Perfo

rman

ce b

y re

gion

Perfo

rman

ce b

y bu

sine

ssse

gmen

t

Prod

uct p

ipel

ine/

R&D

Stra

tegy

Prod

uct p

ortfo

lio

Busi

ness

risk

s

Perfo

rman

ce b

yth

erap

eutic

are

a

Fina

nce

risks

Futu

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ersp

ectiv

es, o

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Corp

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cial

resp

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bilit

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Perfo

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oduc

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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.



Surprisingly, given the challenging business climate only 70 percent of the companiesdiscussedthebusinessenvironmentandjust65percentdiscussedproductpipeline/R&D.Withthecomplexbusinessenvironmentandpatentcliffpressures, greater disclosure here may aid an investor in understanding how a companyisrespondingtothesechallenges.Wenoteevenfewercompanies(45percent) discussed their future prospects and outlook.

R&D pipeline disclosures

TheapproachtodisclosureonR&Dpipelinesvariedwidely.Somecompanieshave moved away from any discussion of early stage compounds, which makes sensegiventhatearlystageR&Dhasalwayshadmorefailurethansuccess,andthatinthewakeofarelativelydisappointingdecadeforpharmaceuticalR&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 inR&Dbychoosingtodiscloselessdetailabouttheirpipelines.Forinstancethemechanism 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 byconcernsaboutcompetitiveinformation,shouldbeseeninthecontextofR&Dbeing 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.



R&D review

Tabular disclosuresPipeline on

websiteStage of development Name/

CodeTherapy

areaIndication Mechanism

Expected filing date

Discontinued projects

Formulation PartnerP1 P2 P3 Filed

Abbott

Allergan

Amgen

Baxter

Biogen Idec

BMS1 N/A N/A N/A N/A

Celgene

Eli Lilly

Forest Lab

Gilead

J&J2

Merck & Co

Mylan

Pfizer3

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 32 23 26 28 26 28 30 28 18 7 7 9 11 28

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.


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.

0

10,000

20,000

30,000

40,000

50,000

1999 20102009200820072006200520042003200220012000

Ann

ual U

S in

dust

ry R

&D

spe

nd

Illus

trat

ive

post

-tax

ret

urn

on R

&D

exp

endi

ture

0 6%

9%

12%

15%

Returns on R&D compared to R&D spending

Source: Future Pharma, KPMG 2011.

6 Future Pharma KPMG 2011, p13 and 14



Legal proceedingsanalysis

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 thatofforeignfilers.WeincludesevenJapanesecompanies,whichhavemuchlower levels of exposure to the US market, in the foreign filers group.

18%

26%

42%

Product liability

Sales and marketing

Other

Patents

14%

Categories of contingent legal liabilities




There were two noteworthy agreements reached with the US government over sales and marketing practices in late 2011. In November 2011 GlaxoSmithKline agreedinprincipletoaUS$3billionsettlementwiththeUSgovernmenttoconcludeits 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 andmarketingofAvandia.InDecember2011MerckagreedtopayUS$950millionto settle criminal and civil charges with the US Department of Justice related to research, marketing and selling activities with respect to Vioxx.

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 risesince2003.Since2005,theannualvalueofthesettlementshasexceededUS$1billionreachingUS$4.4billionin2009.

40

35

30

25

20

15

10

5

01

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

1 10

2 31 1

3 2 2 2

98 8

10

14

27

38

32

Number of Pharmaceutical industry settlements with US state and federal governments 1991–2010


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



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 HUMIRApatentinfringementwithCentocor(partofJohnson&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 Zyprexaproductliability($230m2009$15m2008)

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 99 Pending Wageandhourlawviolationforfailuretopayovertime

Novartis 422 Settled Trileptal marketing

Otsuka 311 Pending Payment to Bristol-Myers Squibb if Abilify generics launched 2012-2015

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




Risk factor raw data

Risk Factor

US Filers Foreign US Filers Non-US Filers

CountAbbott Allergan Amgen

Inc. Baxter Biogen Idec

Bristol Myers Squibb

Celgene Eli Lilly

Forest Lab Gilead

Johnson &

Johnson

Merck & Co. Mylan Pfizer Watson

PharmaAstra

Zeneca

Glaxo SmithKline

plc.

Novartis AG

Novo Nordisk Sanofi

Teva Pharma-ceuticals

Bayer AG

Boehringer Ingelheim CSL Merck

KGaA Roche UCB SA

Astellas Pharma

Chugai Pharma-ceuticals

Daiichi Sankyo Eisal Mitsubishi

Tanabe

Otsuka Holding

Co.

Takeda Pharma-ceuticals

Industry/Generic competition 34Protection and expiration of intellectual property rights 32

Pharmaceutical pricing: Competition, price controls and reimbursement reductions

31

Regulatory requirements 31R&D efforts may not be successful 31

Interest rates/Currency exposure/Inflation 30


30

Patent litigation 28Manufacturing processes/Prod-uct supply/Raw materials 27

Global, political and economic conditions 27

Unsuccessful strategic alliances/Business combinations

25

Product liability 24Environmental/Health and safety liabilities 23

Taxation 23Reliance on IT 22Reliance on third party manufacturing/Providers or marketing suppliers

21

Disruption from natural disasters 21

Delay in product launches 18Political instability 17Human resources/Key personnel 15European economic exposure* 15Reliance on key products 13US healthcare reform legislations* 13

Impairements/Credit risk and bad debts 12

Product safety issues* 10Concentration of sales to key customers, e.g. wholesalers 9

Initiatives/Failure to implement business strategy 8

New or revised accounting standards 8

Emerging market risk* 8Business restrictions due to high debt ratios 7

Liquid risks/insufficient cash 7International business risks* 6Anti-bribery and corruption legislations* 5

Counterfeit products* 5Competition from biosimilars* 5Total number of risks 25 21 21 24 27 23 25 15 13 25 18 28 32 28 26 26 29 27 24 28 27 16 7 13 16 18 14 10 11 15 19 15 17 10 34




Risk factor raw data

Risk Factor

US Filers Foreign US FilersGlaxo Novartis SmithKline AGplc.

Novo Nordisk Sanofi

Teva Pharma-ceuticals

Bayer AG

Boehringer Ingelheim CSL Merck

KGaA Roche UCB SA

Non-US FilersChugai Astellas Pharma-Pharma ceuticals

Daiichi Sankyo Eisal Mitsubishi

Tanabe

Otsuka Holding

Co.

Takeda Pharma-ceuticals

Count

34

32

31

31

31

30

30

28

27

27

25

24

23

23

22

21

21

18

17

15

15

13

13

12

10

9

8

8

8

7

7

6

5

5

529 27 24 28 27 16 7 13 16 18 14 10 11 15 19 15 17 10 34

Abbott Allergan Amgen Inc. Baxter Biogen

Idec

Bristol Myers Squibb

Celgene Eli Lilly

Forest Lab Gilead

Johnson &

Johnson

Merck & Co. Mylan Pfizer Watson

PharmaAstra

Zeneca

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


Patent litigation Manufacturing processes/Prod-uct supply/Raw materials


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


Delay in product launches


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


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 25 21 21 24 27 23 25 15 13 25 18 28 32 28 26 26



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 GlobalLeader–Pharmaceuticals USLeader–Healthcare&Pharmaceuticals

Chris Stirling EuropeanLeader– Chemicals&Pharmaceuticals

Norbert Meyring AsiaPacificLeader –Chemicals&Pharmaceuticals



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.Wehave145,000outstandingprofessionalsworkingtogethertodelivervaluein153countriesworldwide.Throughitsmemberfirms,KPMGhasinvestedextensively 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.



For more information, contact

Ed GiniatGlobal Leader – PharmaceuticalsUS Leader – Healthcare & PharmaceuticalsT:+13126652073E: [email protected]

Chris StirlingEuropean Leader – Chemicals & PharmaceuticalsT:+442073181512E: [email protected]

Norbert MeyringAsia Pacific Leader – Chemicals & PharmaceuticalsT:+862122122707E: [email protected]

David BlumbergGlobal and US Advisory Sector Leader – PharmaceuticalsT:+12672563270E: [email protected]

Mark DrozdowskiUS Audit Sector Leader – PharmaceuticalsT:+19739126640E: [email protected]

Frank MatteiGlobal and US Tax Leader – Chemicals & PharmaceuticalsT:+12672561910E: [email protected]

Melissa StahlGlobal Executive & Knowledge Manager – PharmaceuticalsT:+16095245608E: [email protected]

Adrienne RivlinEuropean Executive – Chemicals & PharmaceuticalsT:+442076941992E: [email protected]

Candice ZhangAsia Pacific Executive – Chemicals & PharmaceuticalsT:+862122124085E: [email protected]

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.

© 2012 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

Publicationnumber:120437

Publication date: April 2012

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