The new revenue recognition standard for life sciences companies

1. The new revenue recognition standard for life sciences companies Hosted by EY Global Life Sciences 15 June 2015

2. Page 2 Scott Bruns Ernst & Young LLP Partner, Global Life Sciences Assurance Leader Today’s moderator The new revenue recognition standard for life sciences companies

3. Page 3 Today’s presenters Derek Kosti International Controller for Pfizer’s Worldwide Biopharmaceuticals Business Tim Gordon EY Global Life Sciences Financial Accounting Advisory Services Leader Frederik Schmachtenberg EY Global Life Sciences Assurance Resident The information contained herein is a summary in nature. Viewers should consult their own professional advisors to address their individual circumstances and concerns. The new revenue recognition standard for life sciences companies

4. Page 4 Agenda ► The 5-step model ► Applying the 5-step model: life sciences industry- specific examples ► Implementation considerations The new revenue recognition standard for life sciences companies

5. Page 5 ► Core principle: recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Applying the new standard: the 5-step model Step 1: Identify the contract(s) with a customer Step 2: Identify the performance obligations in the contract Step 3: Determine the transaction price Step 4: Allocate the transaction price to the performance obligations Step 5: Recognize revenue when (or as) each performance obligation is satisfied The new revenue recognition standard for life sciences companies

7. Page 7 Example 1: ► Biotech out-licenses the rights to an investigational compound in phase II and will perform R&D services to Pharma ► Biotech receives an upfront nonrefundable payment of $50 million, and R&D services are billed at an agreed upon FTE rate ► Assume for this example, that the license and the R&D services are capable of being distinct (e.g., the R&D services provided by Biotech are not considered complex and could be performed by others in the market) ► Question: Are the license and the R&D services distinct in the context of the contract (i.e., separate performance obligations)? Distinct within the context of a contract (Part of Step 2: identify performance obligations) The new revenue recognition standard for life sciences companies

8. Page 8 Distinct within the context of a contract (Part of Step 2: identify performance obligations) Distinct within the context of a contract Both Boards Clarify when a promised good or service is “separately identifiable” from other promises in a contract (i.e., distinct within the context of the contract) FASB (May 2015 Exposure Draft) Three-part change: 1. Refine the principle for determining distinct within the context of the contract (i.e., whether the multiple promised goods or services work together to deliver a combined output) 2. Align this principle with the standard’s three indicators for determining when a good or service is not separately identifiable: (1) the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer; (2) one or more of the goods or services significantly modifies or customizes one of the other goods or services; (3) goods or services are highly interdependent or highly interrelated 3. Add examples IASB (tentative decisions) Add examples The new revenue recognition standard for life sciences companies

9. Page 9 Example 2: ► Pharma sells a product to a public hospital in a country that is in financial difficulties in connection with the sovereign debt crisis ► Pharma has a history of delays in receipt of payment for sales due to poor economic conditions ► On average, Pharma has days sales outstanding of 500 days and typically receives $0.70 per dollar of the initial sales price ► Further assume that Pharma deems collection probable for $0.70 per dollar of the initial sales price and the other criteria in Step 1 (as part of assessing the attributes of a contract) have been met ► Question: What should be considered when evaluating whether revenue would be recognized under: (1) Current US GAAP and IFRS? (2) ASC 606/IFRS 15? Variable consideration – price concessions (Part of Step 3: determine the transaction price) The new revenue recognition standard for life sciences companies

10. Page 10 Example 2 (continued): Variable consideration – price concessions (Part of Step 3: determine the transaction price) Current US GAAP and IFRS ASC 606/IFRS 15 • Pharma would need to determine whether collectibility is reasonably assured (US GAAP)/if it is probable that the economic benefits will flow to the entity (IFRS) • If those criteria are not met, Pharma would need to defer revenue recognition until payments from the customer are received, assuming the other basic revenue recognition criteria have been met • If Pharma is aware of potential collectibility issues at the onset of the contract, but is still willing to enter into the contract, the arrangement may include implied price concessions. Under the new standard implied price concessions are considered variable consideration and should be reflected in the estimated transaction price. • Once determined, the transaction price is allocated to the performance obligations and recognized as revenue as control of the product transfers to the customer The new revenue recognition standard for life sciences companies

11. Page 11 Example 3: ► Biotech out-licenses the rights to an investigational compound in phase II and will perform R&D services for Pharma ► Biotech receives an upfront nonrefundable payment of $50 million, and R&D services are billed at an agreed upon FTE rate ► Assume for this example that the license and R&D services are distinct ► Question: How should the amount of the transaction price allocated to the license be recognized? Nature of promise in granting a license of Intellectual Property (IP) (Part of Step 5: recognize revenue) The new revenue recognition standard for life sciences companies

12. Page 12 Nature of promise in granting a license of IP (Part of Step 5: recognize revenue) * Unless the functionality of the IP is expected to substantively change as a result of activities performed by the entity that do not transfer a good or service and the customer is contractually or practically required to use the updated IP The nature of an entity’s promise in granting a license of IP Both Boards (May 2015 FASB ED; IASB tentative decisions) • Activities performed by the licensor that affect the “utility” of the IP  revenue recognized over time • Utility = the IP’s ability to provide benefit or value • If IP has significant standalone functionality, licensor’s activities will not significantly affect a substantial portion of the utility of the IP  revenue recognized at a point in time FASB (May 2015 ED) IP will be classified into one of two categories: • Functional (revenue recognition at a point in time*): IP would have standalone functionality (e.g., drug formulas, biological compounds) • Symbolic (revenue recognition over time): IP would not have standalone functionality (e.g., brands, trade names, logos) IASB (tentative decisions) • Only minor wording changes to expand on the principles in the new standard • Will not include a requirement to classify licenses of IP as either functional or symbolic The Boards agreed that both of their approaches generally would result in consistent answers. The new revenue recognition standard for life sciences companies

13. Page 13 Example 4: ► Biotech out-licenses the rights to an investigational compound in phase II and will perform R&D services for Pharma ► Biotech receives an upfront nonrefundable payment of $50 million, and a quarterly payment for R&D services that are billed at an “at market” FTE rate. Biotech is eligible to receive a 5% royalty on all sales of a commercialized product. ► Assume for this example, that the license and R&D services are distinct and that the stand-alone selling price of the license is the $50 million upfront payment plus the 5% royalty rate ► Question: ► When should the 5% royalties revenue be recognized? Sales- and usage-based royalties exception (Part of Step 5: recognize revenue) The new revenue recognition standard for life sciences companies

14. Page 14 Sales- and usage-based royalties / other license issues (Part of Step 5: recognize revenue) Sales- and usage-based royalties Both Boards (May 2015 FASB ED; IASB tentative decisions) • The sales-based royalty exception would be applied to the overall royalty stream when the predominant item to which the royalty relates is the license of IP • A sales-based royalty would not be partially in the scope of the sales-based royalty constraint guidance and partially in the scope of the general variable consideration constraint guidance Other license issues FASB (May 2015 ED) • An entity would need to consider the licenses guidance when determining the pattern of revenue recognition for a combined performance obligation that includes a license • Restrictions of time, geographical region or use do not define whether a performance obligation is satisfied at a point in time or over time or affect how many goods or services are promised in the contract IASB (tentative decisions) • No changes • Existing guidance is sufficient The new revenue recognition standard for life sciences companies

16. Page 16 ‘We don’t think there will be significant changes so why should we do anything?’ ► Detail ► Documentation ► Disclosure Impact and challenges of the new standard The new revenue recognition standard for life sciences companies

17. Page 17 Customers Impact and challenges of the new standard Patient Physician Hospital GPO Pharmacists Wholesalers Specialty distributors Supermarkets Government agency Competitors Contract type/terms Licenses Direct to consumer Return rights Variable consideration Rebates Outcome based Cost sharing Milestones CRO agreements GeographyProducts Products Portfolio of products The new revenue recognition standard for life sciences companies

18. Page 18 Performing a diagnostic will enable you to: ► Identify relevant revenue streams and “unique” contracts ► Understand high-level financial and existing in-progress project effects ► Decide on a transition method ► Prepare a detailed planning budget to understand the level of resources required ► Navigate stakeholder questions regarding changes and effects Action planning and next steps Why start a diagnostic now? The new revenue recognition standard for life sciences companies

19. Page 19 Practical challenges and questions How to start the assessment process? ► Team – internal/external, central/decentralized, expertise needed? ► Education sessions – how broad? ► Use of questionnaire/ surveys – how deep? What operational changes are we expecting to see? ► Changes to current contracts? ► More people outside of finance that need to be technically trained? ► System changes? Challenges during the process? ► What market coverage is appropriate? ► How many contracts should be reviewed? ► How much documentation is enough? ► Use of tools? The new revenue recognition standard for life sciences companies

20. Page 20 Action planning and next steps Before 31 December 2015 Must: ► Read the standard and understand the accounting implications ► Communicate results internally and with other stakeholders ► Understand what the industry is doing Should: ► Appoint a project lead and cross functional team ► Educate the accounting and commercial teams ► Identify revenue streams and survey pilot markets ► Decide on a preferred transition method ► Consider the tax and systems implications Could: ► Identify the financial effects ► Understand the disclosure requirements ► Develop a data collection plan ► Revise accounting and procedural policies The new revenue recognition standard for life sciences companies

21. Page 21 EY resources ► EY Revenue Recognition Readiness tool ► Recent IFRS EY publications (visit ey.com/IFRS) ► Applying IFRS: A closer look at the new revenue recognition standard (June 2014) ► Applying IFRS in Life Sciences: The new revenue recognition standard – life sciences (November 2014) ► Applying IFRS: Joint Transition Resource Group for Revenue Recognition items of general agreement (May 2015) ► Recent US GAAP EY publications (visit ey.com/accountinglink) ► Technical Line, A closer look at the new revenue recognition standard (June 2014) ► Technical Line, The new revenue recognition standard — life sciences (August 2014) ► Joint Transition Resource Group for Revenue Recognition items of general agreement (April 2015) ► To the Point, FASB proposes first round of amendments to its’ new revenue recognition standard (May 2015) The new revenue recognition standard for life sciences companies

22. Page 22 Scott Bruns, Global Life Sciences Assurance Leader scott.bruns@ey.com +1 317 681 7229 Tim Gordon, EY Global Life Sciences FAAS Leader tim.gordon@ey.com +1 212 773 6938 Frederik Schmachtenberg, EY Global Life Sciences Assurance Resident frederik.schmachtenberg@ey.com +1 312 879 5026 EY contact information The new revenue recognition standard for life sciences companies

23. Page 23 Disclaimer ► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. ► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances. ► The views expressed by the presenters are not necessarily those of Ernst & Young LLP. ► This presentation is © 2015 Ernst & Young LLP. All Rights Reserved. EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms, of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.