Rx Marketplace Quarterly - Q3 2020

The latest accounting and reporting developments in the pharma & life sciences industry

Get the latest accounting and reporting developments in the pharma & life sciences industry, including updates on COVID-19, SEC comment letter trends, and more.

Spotlight: Industry update

PwC Health Research Institute (HRI): Q3 Spotlight

The COVID-19 pandemic has reshaped US healthcare. Virtual care has skyrocketed as people are largely avoiding in-person visits and procedures. Many providers are experiencing a liquidity crisis as patient volumes plummeted in early March and have seen only a partial rebound since May. Pharma and Life Science (PLS) companies have experienced delays in clinical trials and have had to take some of them virtual. What could this mean for you?

Controlling costs when revenues are down is top of mind for companies that have seen a detrimental impact from COVID-19. Medical cost trends in the midst of the pandemic have been challenging to predict. With this uncertainty, HRI has developed three scenarios to help companies understand 2021 medical cost trends, including potential inflators or deflators for payers, employers, providers, and PLS companies.

Changes in the health plan market are also expected. HRI evaluated how the pandemic has affected health plan enrollment and why health insurers should focus on retaining members and recruiting new ones through diversified product portfolios, which may mean changes to future payer mix and impacts to corresponding estimates.

Understanding how these changes could impact your gross to net estimates, including the Medicaid and managed reserves, will be important to managing your business. A change in payer mix could be created by a shift in coverage from employer sponsored plans to government plans. This change could ultimately result in a need to reassess inputs used in developing periodic estimates of gross-to-net reserves, as previous benchmarks may no longer be the most appropriate. In addition, customer liquidity challenges may increase the duration of receivables outstanding and lead to an increase in collection risk.

The COVID-19 pandemic has upended clinical trials for pharmaceutical and life sciences companies. What should companies be thinking about now?

The shift in how some clinical trials are conducted has caused companies to rethink the traditional study delivery model. Changes include incorporating virtual elements, such as remote monitoring and, in some cases, a decentralized approach where fewer visits are required at the traditional trial sites and more can be done locally.

HRI investigated how PLS companies are adapting to the change, whether this change will be temporary, and what the opportunities these changes create for other stakeholders, including Contract Research Organization (CRO), private equity firms, and digital tech companies. As noted in the study, “the ability to deliver trials through virtual and decentralized models will be a necessary business continuity strategy because if this happens again, we can’t have trials grinding to a halt.”

PLS companies should consider how the impact of both changes in trial design and duration may affect their existing revenue recognition models and/or R&D accruals. As the role of your CRO changes, companies will need to ensure that increased costs associated with changes in patient monitoring, study design, or increased duration have been properly reflected in relevant accruals and corresponding revenue recognition estimates.

Further, PLS companies will need to evaluate their current approach to clinical trials to ensure they are appropriately adapting operations and related financial reporting internal controls in a rapidly changing environment.

In the Market

US IPO market rebounds while PLS Sector remains hot

While much of the business world has been disrupted by the COVID-19 pandemic and sudden downturn, IPO activity in the first half of 2020 was down only slightly from the same period last year. After IPO issuances came to a near-halt in late Q1 and early Q2, the window opened wide in June, when much-needed liquidity infused the markets and led to the strongest month for IPOs in 13 years.

During the initial shock of COVID-19, the IPO markets effectively closed for most sectors, although some biotech companies and special purpose acquisition companies (SPACs) made their debut. Overall, US IPOs were dominated by issuances from the PLS sector and SPACs in the first half of the year. Although PLS IPO volume was flat compared to the first half of 2019, with biotech comprising more than 80% of all PLS volume, PLS proceeds increased approximately 148%, primarily driven by the Royalty Pharma plc IPO.

PLS IPOs (Year to date)

  Q2 2020 Q2 2019
Volume 31 31
Value $8.9 billion $3.6 billion

Thought leadership

First Half of 2020 US Capital Markets Watch

Mergers and acquisitions (M&A): Activity down, outlook promising

As expected, deals activity has significantly slowed in the first half of 2020 due to a combination of economic, regulatory, political, and macro-economic factors.

While most of the sector is not facing the same issues retail and travel sectors are experiencing, the PLS sector has faced its own set of challenges during the first half of 2020. Rapidly evolving supply chains, concerns around the availability of capital, and regulatory/political uncertainty have all contributed to potential buyers exhibiting caution before deploying resources towards M&A. As companies continue to evaluate their competitive position in the face of these new challenges, we expect many industry participants will look to M&A in the second half of the year to best maximize their limited resources. This may come in the form of divestitures, private equity investments, or partnerships and alliances.

PLS venture funding and M&A (Year to date)

  Q2 2020 Q2 2019
Venture funding volume 432 357
Venture funding value $12.4 billion $8.8 billion
M&A volume 99 119
M&A value $35.0 billion $272.9 billion

Thought leadership

Regulatory update

Updated SEC comment letter trends

Comment letter trends within the Health Industries sector have remained relatively consistent, with the majority of comments relating to revenue recognition, non-GAAP measures, and MD&A. Our analysis of SEC comment letters identifies the top ten topics included in comment letters to Health Industries companies, details key themes, and includes examples of comments within the sector for each topic. While not a comment letter trend yet, the SEC remains focused on registrants’ disclosures related to COVID -19, and it’s not unreasonable to expect that focus to continue.

Amended rule for pro forma financial information reflecting acquisitions and dispositions

The life sciences industry remains one of the most active deal sectors in the economy. As industry participants consider deals, they are beginning to evaluate early application of the SEC’s amended disclosure requirements about acquired and disposed businesses. One aspect of the amended rules that registrants are interested in is the revised pro forma financial information requirement, although voluntary compliance prior to the January 1, 2021 effective date would mean adopting all aspects of the amended rules.

Rules 11-02(a)(6) and (7) address the types of adjustments that can be made when preparing pro forma financial information. The existing rules require that the adjustments be directly attributable to the transaction, factually supportable, and, with respect to the income statement, expected to have a continuing impact. As detailed in our In depth, the amended rules replace these criteria with three new categories of adjustments: transaction accounting adjustments, autonomous entity adjustments, and management’s adjustments, each with certain presentation requirements. Notably, the new transaction accounting adjustments would reflect only the application of required accounting to the acquisition, disposition, or other transaction as required by US GAAP or IFRS, as applicable. As a result of the amendments, there will be differences in the types of pro forma adjustments that can be made.

A common example is the pro forma treatment of transaction costs. Under the current rules, transaction costs, which result directly from the transaction but do not have a continuing impact, are not included in the pro forma condensed income statement. In addition, transaction costs included in the acquirer’s or acquiree’s historical income statements are eliminated. However, transaction costs are reflected in retained earnings on the pro forma condensed balance sheet and disclosed in the footnotes to the pro forma financial information.

Under the amended rules, transaction costs would be included in the pro forma condensed income statement, which results in consistent treatment in the balance sheet and income statement and aligns the pro forma treatment with the accounting under US GAAP or IFRS, as applicable. The new rules further include a requirement to disclose revenues, expenses, gains and losses, and related tax effects that will not recur in the income of the registrant beyond 12 months after the transaction in the accompanying explanatory notes.

COVID-19 disclosure and non-GAAP considerations

The SEC’s Division of Corporation Finance released CF Disclosure Guidance Topic 9 and Topic 9A in March 2020 and June 2020, respectively. This guidance includes the Division of Corporation Finance’s views regarding disclosure of the impact of COVID-19. Due to the ongoing impact of COVID-19, the guidance will likely continue to be relevant as companies evaluate disclosures during the third quarter and beyond. As an example, the release suggests that management should include disclosures that reflect how management and the Board of Directors are assessing COVID-19 operational issues, which may be reflected in communications that management has with the Board.

Additionally, the releases provide questions for companies to consider as they evaluate COVID-19-related effects and disclosure obligations, and encourages proactively addressing financial reporting matters earlier than usual (including prompt engagement with specialists, as necessary). Topic 9 further includes considerations around non-GAAP financial measures and reminds registrants of their obligations under Item 10 of Regulation S-K and Regulation G.

To assist in evaluating disclosures of non-GAAP measures, PwC’s In depth “FAQ on accounting for COVID-19 and market volatility,” contains the following FAQs related to non-GAAP measures:

  • What guidance has the SEC staff issued on non-GAAP financial measures relating to COVID-19?
  • How should a company identify the adjustments that are attributable to COVID-19?
  • What are some items to consider when preparing and presenting a non-GAAP financial measure that has adjustments relating to COVID-19?
  • How can a company communicate the effects of COVID-19 if an adjustment is not included in the non-GAAP presentation?

For a discussion of observations on how companies are addressing the impact of the virus, including the use of non-GAAP measures in their reports, listen to PwC’s podcast Non-GAAP disclosures and COVID-19: What you need to know.

SEC adopts rule amendments to modernize disclosures under Regulation S-K

On August 26, the SEC adopted amendments to modernize the Regulation S-K requirements related to the description of business (Item 101), legal proceeding (Item 103), and risk factor (Item 105) disclosures, which are required in many SEC filings, including Form 10-K and registration statements. The amendments, which will be effective 30 days after publication in the federal register, are part of the SEC’s overall project to improve disclosure effectiveness and follow a principles-based, registrant-specific approach to disclosure.

Key changes include:

  • Requiring a description of the company’s human capital resources, including any human capital measures/objectives that the company focuses on in managing its business (e.g., those that address the development, attraction and retention of personnel);
  • Permitting a company to provide (in a filing other than an initial registration statement) an update of the general development of its business if it incorporates by reference a full discussion from a single previously-filed registration statement or report;
  • Increasing the quantitative threshold for disclosing certain governmental environmental proceedings;
  • Allowing legal proceedings disclosures to be hyperlinked or cross-referenced to other sections in the document; and
  • Requiring a risk factor summary when the risk factor section is longer than 15 pages.

Accounting and financial reporting

Accounting for tax positions

Periods of change may not just mean uncertainty in economic climates but also in tax positions

Accounting for uncertain tax positions requires considerable judgment. Our “Uncertain tax positions: The basics” podcast provides insight to help you navigate these judgments. Hear PwC discuss the key concepts in accounting for uncertain tax positions, from the recognition of a tax position to the reassessment of positions at each reporting period. This podcast can provide PLS companies with insights to help ensure positions (e.g., reserves for transfer pricing adjustments) reflect the latest facts and circumstances.

Principal or agent? Your revenue questions answered

PLS companies often have product distribution arrangements involving multiple parties, making it challenging to determine who may be a principal and who is an agent in the ultimate transaction with the end consumer. In this podcast, Heather Horn is joined by PwC partner Angela Fergason to discuss the accounting factors for determining principal or agent, including how to first think about transfer of control, and how to consider the three additional indicators outlined in the revenue standard.

PwC’s recently issued and updated accounting and reporting guides

Accounting for business combinations and preparing carve-out financial statements is complex but PwC’s recently issued and updated guides can help you navigate these challenging areas

While M&A activity in the PLS industry may be down, PwC research has shown that companies that make deals in a recession can see higher shareholder returns than industry peers. Business combination accounting and preparing carve-out financial statements are at the forefront of challenges a company may face when dealing with M&A activity. To assist in addressing those challenges, we are excited to announce updates to the Business combinations and noncontrolling interests guide (BCG), and the addition of our new accounting and reporting guide, Carve-out financial statements (CO).

The recent updates to our BCG include the addition of a decision tree (Figure BCG 1-1) for evaluating whether an acquired set is a business or a group of assets subsequent to adoption of ASU 2017-01.

PwC’s new CO guide addresses the requirements, methodologies, and practical considerations when preparing carve-out financial statements. Examples in each chapter provide illustrations to help PLS companies address common questions. The CO guide also provides insights on the related presentation and disclosure matters.

Want to learn more about what to consider when acquiring an asset or a business? PwC’s Acquiring an asset or a business? It matters in deal models provides insights that can help.

PwC’s considerations related to IRC Section 163(j)

If you pay interest, consider using PwC’s practical considerations related to the final and proposed IRC Section 163(j) regulations to ensure impacts are properly evaluated

The US Department of the Treasury recently finalized 2018 proposed regulations and released new 2020 proposed regulations on how the Internal Revenue Code Section 163(j) interest deduction limitation applies to partnerships, corporations, US shareholders of controlled foreign corporations, and foreign persons with effectively connected income. It also includes a definition of interest. PwC’s Tax Insight, Practical considerations from the final and proposed Section 163(j) regulations, explores these limitation rules as amended by the Tax Cuts and Jobs Act and the CARES Act. PLS companies will want to be familiar with these regulations in order to properly reflect the associated impacts.

Transparency intelligence helps companies manage reputational risk

In a world of comprehensive transparency, global tax authorities are using publicly available information to respond to perceived political pressure in requiring multinational enterprises to pay their “fair share” of taxes.

Tax authorities are increasingly using publicly available information generated by new technologies and 24/7 media to question the support for corporate tax positions. In addition, tax authorities are compiling company information across multiple industries and jurisdictional borders to challenge tax positions, make adjustments, and impose penalties. This means that companies should be researching and analyzing what information is publicly available about their own operating structures and tax positions. See PwC’s Insight, Transparency intelligence helps manage reputational risk, on how PLS companies should consider the development of a well-coordinated communication strategy around sharing tax-related information with governments, regulators, investors, and the public.

For a deeper discussion on items included in this edition of Rx Marketplace Quarterly, please contact: Josh Herron

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Josh Herron

US Pharmaceutical & Life Sciences Assurance Leader, PwC US

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