Organon & Co. (OGN) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Organon makes statements in this Annual Report on Form 10-K, and Organon may from time to time make other written reports and oral statements, regarding its outlook or expectations for financial, business or strategic matters regarding or affecting Organon that are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, all of which are based on management's current expectations and are subject to risks and uncertainties which change over time and may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as "anticipates," "expects," "plans," "will," "estimates," "forecasts," "projects" and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. Such forward-looking statements include, but are not limited to, statements relating to Organon’s growth and acquisition strategies, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from Organon's forward-looking statements. These factors may be based on inaccurate assumptions and are subject to a broad variety of other risks and uncertainties. No forward-looking statement can be guaranteed and actual future results may vary materially. The factors described in Part I. Item 1A. Risk Factors of this report

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or otherwise described in Organon's filings with the SEC, provide examples of risks, uncertainties and events that may cause Organon's actual results to differ materially from the expectations expressed in its forward-looking statements, including, but not limited to:

•expanded brand and class competition in the markets in which Organon operates;

•difficulties with performance of third parties Organon relies on for its business growth;

•the failure of any supplier to provide substances, materials, or services as agreed;

•the increased cost of supply, manufacturing, packaging, and operations;

•difficulties developing and sustaining relationships with commercial counterparties;

•competition from generic products as Organon's products lose patent protection;

•expiration of current patents or loss of patent protection for Organon's products;

•difficulties and uncertainties inherent in the implementation of Organon's acquisition strategy or failure to recognize the benefits of such acquisitions;

•pricing pressures globally, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general;

•the impact of the global COVID-19 pandemic and any future pandemic, epidemic, or similar public health threat on Organon's business, operations and financial performance;

•changes in government laws and regulations in the United States and other jurisdictions, including laws and regulations governing the research, development, approval, clearance, manufacturing, supply, distribution, and/or marketing of Organon's products and related intellectual property, environmental regulations, and the enforcement thereof affecting Organon's business;

•efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales;

•delays or failures to demonstrate adequate efficacy and safety of Organon's product candidates in pre-clinical and clinical trials, which may prevent or delay the development, approval, clearance, or commercialization of Organon's product candidates;

•difficulties in operating as an independent company;

•costs and temporary business interruptions related to the separation;

•future actions of third-parties, including significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and forgoing health care insurance coverage;

•legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental claims and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products;

•lost market opportunity resulting from delays and uncertainties in clinical trials and the approval or clearance process of the U.S. FDA and other regulatory authorities;

•cyberattacks on, or other failures, accidents, or security breaches of, Organon's or third-party providers' information technology systems, which could disrupt Organon's operations;

•increased focus on privacy issues in countries around the world, including the United States, the European Union, and China, and a more difficult legislative and regulatory landscape for privacy and data protection that continues to evolve with the potential to directly affect Organon's business, including recently enacted laws in a majority of states in the United States requiring security breach notification;

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•changes in tax laws including changes related to the taxation of foreign earnings;

•loss of key employees or inability to identify and recruit new employees;

•changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to Organon; and

•economic factors over which Organon has no control, including changes in inflation, interest rates and foreign currency exchange rates.

It is not possible to predict or identify all such factors. Consequently, one should not consider the above list or any other such list to be a complete statement of all potential risks or uncertainties. Further, any forward-looking statement speaks only as of the date on which it is made, and Organon undertakes no obligation to update or revise any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as otherwise may be required by law.

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General

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist the reader in understanding the Company’s financial condition and results of operations. The following discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements included in Part II, Item 8 of this 2021 Form 10-K to enhance the understanding of our results of operations, financial condition and cash flows.

Organon & Co. (“Organon”) is a global healthcare company formed through a spinoff from Merck & Co., Inc. (“Merck”) to focus on improving the health of women throughout their lives. Organon develops and delivers innovative health solutions through a portfolio of prescription therapies within women's health, biosimilars and established brands (the "Organon Products"). Organon has a portfolio of more than 60 medicines and products across a range of therapeutic areas. The Company sells these products through various channels including drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. The Company operates six manufacturing facilities, which are located in Belgium, Brazil, Indonesia, Mexico, the Netherlands and the United Kingdom ("UK"). Unless otherwise indicated, trademarks appearing in italics are trademarks of the Organon group of companies.

Separation from Merck

On June 2, 2021, Organon and Merck entered into a Separation and Distribution Agreement (the "Separation and Distribution Agreement"). Pursuant to the Separation and Distribution Agreement, Merck agreed to spin off the Organon Products into Organon, a new, publicly traded company (the "Separation"). The Separation from Merck was completed on June 2, 2021, in which Organon's Common Stock was distributed to all holders of outstanding shares of Merck Common Stock as of the close of business on May 17, 2021 (the "Record Date"). For each share of Merck Common Stock held, such holder received one tenth of one share of Common Stock, and holders received cash in lieu of any fractional share of Common Stock they otherwise would have been entitled to receive in connection with the Distribution. Organon is now a standalone publicly traded company, and on June 3, 2021, regular-way trading of the Common Stock commenced on the New York Stock Exchange ("NYSE") under the symbol "OGN." Until the Separation on June 2, 2021, Organon’s historical combined financial statements were prepared on a standalone basis and were derived from Merck’s consolidated financial statements and accounting records.

For the period subsequent to June 2, 2021, as a standalone publicly traded company, Organon presents its financial statements on a consolidated basis. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

The Separation was completed pursuant to the Separation and Distribution Agreement and other agreements with Merck related to the Separation, including, but not limited to, a tax matters agreement, an employee matters agreement and a transition services agreement (see Part II, Item 8. Note 19 for additional details).

Key Trends Affecting Our Results of Operations

•Generic Competition: The majority of our established brands products are beyond market exclusivity. However, these products continue to represent a significant value opportunity arising from long-term sustainable revenue streams and well-established supply chains that together generate significant operating profit relative to low promotional and development expenses.

•Sustained Shift Towards Long-Acting Reversible Contraceptives: Although daily contraceptive pills remain the largest market segment, the Long-Acting Reversible Contraceptives ("LARC") market segment, which includes Nexplanon® (etonogestrel implant) (sold as Implanon NXT™ in some countries outside the US), has experienced significant growth in the years leading up to 2019 due to a sustained shift from daily oral contraception to LARC. This was driven by payors, providers and patients looking for options beyond commonly used daily contraceptive pills. The COVID-19 pandemic negatively affected the LARC segment during 2021 and 2020 due to clinic closures and the postponement of non-essential medical procedures during country lockdowns. However, LARC segment growth quickly rebounded during months when clinic restrictions were removed and the sustained shift to LARC is expected to continue with fundamental drivers unchanged.

•Increased Access to Fertility Solutions: We believe governments and payors are implementing favorable policies across major markets that, in turn, drive growth in the market for women’s health therapies. For example, in the United States, there has been an increase in fertility insurance mandates and employer coverage, albeit subject to certain exemptions.

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•Emergence of Biosimilars: Biologics continue to experience strong growth trends. However, given the high cost of many of these biologics treatments, biosimilars are a more affordable alternative and represent a significant opportunity for patients, providers, and payors once a biologics product loses patent protection. Moreover, a significant number of biologics are expected to lose exclusivity over the next decade, representing a large opportunity for more biosimilar approvals.

•Increased Competitive Pressures: The markets in which we conduct our business and the pharmaceutical industry in general are highly competitive and highly regulated. Our competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus and generic drug manufacturers.

Recent Developments

Business Development

In February 2022, Organon acquired the product rights from Bayer AG to Marvelon® (ethinylestradiol, desogestrel) and Mercilon® (ethinylestradiol, desogestrel), combined oral hormonal daily contraceptive pills, in the People’s Republic of China, including Hong Kong and Macau, and has entered into an agreement to acquire the rights to these products in Vietnam. Marvelon and Mercilon are already owned, manufactured, and marketed by Organon as prescription oral contraceptives in 20 other markets. The transaction to acquire the rights to these products in Vietnam will close in the first half of 2022 and is subject to customary closing conditions, including regulatory approval.

In December 2021, Organon completed its acquisition of Forendo Pharma, a clinical-stage drug development company focused on novel treatments in women’s health. Forendo is pioneering the science of intracrinology, addressing disease through a novel, tissue-specific approach. Its lead clinical compound is an investigational, potentially first-in-class oral 17β-hydroxysteroid dehydrogenase type 1 (HSD17B1) inhibitor in early development for endometriosis, being evaluated for its potential effect on endometriotic lesions. Total consideration includes a $75 million upfront payment, the assumption of approximately $10 million of Forendo debt, payments upon the achievement of certain development and regulatory milestones of up to $270 million and commercial milestones payments of up to $600 million, which together could amount to total consideration of $955 million. Contingent consideration will be paid by Organon upon achievement and the liability recorded once it is deemed probable of occurrence. The transaction was accounted for in 2021 as an asset acquisition, as substantially all of the value was concentrated in a single identifiable asset. During the year ended December 31, 2021, the Company recorded $79 million, which consisted of the $75 million upfront payment, the assumption of debt of $10 million and other net assets, as Research and Development expense. The Company also incurred $5 million of transaction related expenses reflected in Selling, General and Administrative expenses.

In July 2021, Organon and ObsEva entered into a license agreement whereby Organon licensed the global development, manufacturing and commercial rights to ebopiprant (OBE022) from ObsEva. Ebopiprant is an investigational, orally active, selective prostaglandin F2α (PGF2α) receptor antagonist being evaluated as a potential treatment for preterm labor by reducing inflammation and uterine contractions. Under the terms of the license agreement, Organon gained exclusive worldwide rights to develop and commercialize ebopiprant. ObsEva is entitled to receive tiered double-digit royalties on commercial sales, up to $90 million in development and regulatory milestone payments, and up to $385 million sales-based milestone payments that will be paid by Organon upon achievement of the contractual milestone and the liability recorded once it is deemed probable of occurrence. Upon execution of the agreement, Organon made a $25 million upfront payment, which was recorded as Research and development expense during 2021.

In June 2021, Organon completed its acquisition of Alydia Health, a commercial-stage medical device company. Alydia’s device, the Jada system, is intended to provide control and treatment of abnormal postpartum uterine bleeding or hemorrhage when conservative management is warranted. The transaction consideration included a $219 million upfront payment. Additionally, there is a $25 million sales based contingent milestone payment that will be paid by Organon upon achievement and the liability recorded once it is deemed probable of occurrence. The transaction was accounted for as an asset acquisition as substantially all of the value was concentrated in a single identifiable asset. This resulted in an intangible of $247 million attributed to the Jada system device. This asset is subject to amortization on a straight-line basis over its expected useful life of 11 years. In addition to the intangible asset, Organon also recorded other net liabilities of $7 million, a deferred tax liability of $44 million related to the intangible asset, and compensation expense of $23 million, which was recorded in Selling General and Administrative Expenses. Of the $23 million of compensation expense, $19 million was related to accelerated vesting of Alydia stock-based compensation awards.

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Debt

In April 2021, in connection with the Separation, Organon Finance 1 LLC (“Organon Finance 1”), a subsidiary of Merck, issued €1.25 billion aggregate principal amount of 2.875% senior secured notes due 2028, $2.1 billion aggregate principal amount of 4.125% senior secured notes due 2028 and $2.0 billion aggregate principal amount of 5.125% senior unsecured notes due 2031 (collectively, “the Notes”). Interest payments are due semiannually on October 30 and April 30. As part of the Separation, on June 2, 2021, Organon and a wholly-owned Dutch subsidiary of Organon (the “Dutch Co-Issuer”) assumed the obligations under the Notes as co-issuers, Organon Finance 1 was released as an obligor under the Notes, and certain subsidiaries of Organon agreed to guarantee the Notes. Each series of Notes was issued pursuant to an indenture dated April 22, 2021, between Organon and U.S. Bank National Association. Organon and the Dutch Co-Issuer assumed the obligations under the Notes pursuant to a first supplemental indenture to the relevant indenture, and the guarantors agreed to guarantee the Notes pursuant to a second supplemental indenture to the relevant indenture.

Also upon Separation on June 2, 2021, Organon entered into a credit agreement providing for a Term Loan B Facility, consisting of (i) a U.S. Dollar denominated senior secured “tranche B” term loan in the amount of $3.0 billion due 2028 (ii) a euro denominated senior secured “tranche B” term loan in the amount of €750 million due 2028; and a Revolving Credit Facility (“Revolving Credit Facility”), in an aggregate principal amount of up to $1 billion, with a five-year term that matures in 2026.

Borrowings made under the Revolving Credit Facility initially bear interest (i) in U.S. Dollars at 2.00% in excess of an Adjusted London Interbank Offered Rate (“Adjusted LIBOR”) (subject to a floor of 0.00%) or 1.00% in excess of an alternate base rate (“ABR”), at our option and (ii) in euros, at 2.00% in excess of an adjusted Euro Interbank Offer Rate (“Adjusted EURIBOR”). The Term Loan B Facility bears interest (i) denominated in U.S. Dollars, at 3.00% in excess of Adjusted LIBOR (subject to a floor of 0.50%) or 2.00% in excess of ABR, at our option and (ii) denominated in euros, at 3.00% in excess of Adjusted EURIBOR (subject to a floor of 0.00%). The interest rate on revolving loans under the Revolving Credit Facility is subject to a step-down based on meeting a leverage ratio target and is subject to a commitment fee which applies to the unused portion of the revolving facility, initially equal to 0.50% and subject to a step-down to 0.375% based on meeting a leverage ratio target. The Revolving Credit Facility is also subject to customary financial covenants.

Organon used the net proceeds from the Notes offering, together with available cash on its balance sheet and borrowings under senior secured credit facilities, to distribute $9.0 billion to Merck and to pay fees and expenses related to the Separation. On December 23, 2021, the Company made a discretionary prepayment of $100 million on the U.S. Dollar denominated term loan. As of December 31, 2021, Organon is in compliance with all financial covenants and no default or event of default has occurred.

Net Investment Hedge

In each quarter subsequent to the Separation, €1.75 billion in the aggregate of both the euro-denominated term loan (€750 million) and the 2.875% euro-denominated secured notes (€1.25 billion) has been designated and is effective as an economic hedge of the net investment in a foreign operation. As a result, $162 million of foreign currency gains due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustments in Other Comprehensive Income for the year ended December 31, 2021, respectively.

COVID-19 Update

Organon remains focused on protecting the safety of its employees and supporting Organon’s communities in response to the COVID-19 pandemic. COVID-19-related disruptions, including patients’ inability to access health care providers, prioritization of COVID-19 patients, as well as social distancing measures have negatively affected our results.

The negative impact of the COVID-19 pandemic to Organon sales was approximately $400 million in each of the years 2021 and 2020. Our product portfolio is comprised of physician prescribed products, mainly in established brands, which have been affected by social distancing measures and fewer medical visits. Additionally, our portfolio in Women's Health includes products that are physician administered, which have been affected by limited access to physicians and healthcare centers. These impacts, as well as the prioritization of COVID-19 patients at health care providers, resulted in reduced administration of many products within established brands, particularly for respiratory and cardiovascular products and women's health product Nexplanon/Implanon NXT, throughout 2020 and 2021.

We believe that global health systems and patients continue to adapt to the evolving impacts of the COVID-19 pandemic, and although we experienced recoveries during 2021, ongoing negative impacts persisted during most of 2021 principally affecting products within established brands and women’s health, primarily Nexplanon/Implanon NXT.

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Operating expenses in 2021 were higher compared to 2020 primarily due to lower promotional and selling costs incurred in 2020 attributable to the COVID-19 pandemic as well as incremental costs associated with establishing Organon as a standalone company.

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Operating Results

Sales Overview

U.S. plus international may not equal total due to rounding.

Worldwide sales were $6.3 billion in 2021, a decrease of 3% compared with 2020. The sales decline is primarily due to ongoing generic competition for products within the established brands business, particularly for cardiovascular products Zetia and Vytorin (ezetimibe and simvastatin), an expiration of a distribution agreement in December 2020 for Rosuzet in Korea, lower sales of respiratory products including Singulair (montelukast) and Dulera (mometasone furoate and formoterol fumarate dihydrate), generic competition for women’s health product NuvaRing (etonogestrel/ethinyl estradiol vaginal ring) and the generic etonogestrel/ethinyl estradiol vaginal ring, as well as the negative impact of volume-based procurement ("VBP") in China. In addition, the COVID-19 pandemic continued to negatively affect sales in 2021 across several markets. The overall sales decline was offset by higher sales of women's health products Nexplanon/Implanon NXT, Follistim AQ (follitropin beta injection) and ganirelix acetate injection due to higher demand, and higher sales of biosimilars resulting from the continued uptake of Renflexis and Ontruzant in the United States as well as the favorable impact of foreign exchange.

Worldwide sales were $6.5 billion in 2020, a decline of 16% compared with 2019, primarily due to generic competition for women’s health product NuvaRing, and ongoing generic competition for products within the established brands business, particularly for respiratory products Singulair and Nasonex, and cardiovascular products Zetia and Vytorin. As described above, the COVID-19 pandemic negatively affected sales in 2020, contributing to declines in established brands, particularly respiratory and cardiovascular products, as well as declines in women’s health products, particularly Nexplanon, Follistim AQ and Orgalutran. The sales decline was partially offset by revenue resulting from an arrangement for the sale of generic etonogestrel/ethinyl estradiol vaginal ring, higher sales of biosimilars resulting from the continued uptake of Renflexis in existing markets and the launch of Ontruzant into new markets, as well as higher sales of cardiovascular product Atozet.

The loss of exclusivity ("LOE") negatively impacted sales by approximately $300 million for 2021 compared to 2020 based on the decrease in volume period over period. Additionally, the VBP in China continues to unfavorably affect a number of our products with an impact to sales of approximately $170 million for 2021 compared to 2020 based on the decrease in volume period over period.

Organon’s operations include a portfolio of products. Highlights of the sales of Organon’s products for 2021, 2020 and 2019 are provided below. See Note 18 “Product and Geographic Information” to the Consolidated Financial Statements for further details on sales of our products.

Women’s Health

Contraception

Worldwide sales of Nexplanon/Implanon NXT, a single-rod subdermal contraceptive implant, increased 13% in 2021 primarily due to favorable impact from pricing and increased demand in the United States, favorable impact from the timing of tenders in Latin America, and higher demand and recovery from the COVID-19 pandemic in the international markets.

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Worldwide sales of Nexplanon/Implanon NXT declined 14% in 2020 primarily due to lower demand in the United States and in the EU resulting from the COVID-19 pandemic.

Worldwide sales of NuvaRing, a vaginal contraceptive product, declined 19% in 2021 primarily due to ongoing generic competition in the United States and the EU. We expect a continued decline in NuvaRing sales as a result of generic competition. Worldwide sales of NuvaRing sales declined 73% in 2020 due to generic competition in the United States resulting from patent expiration in the United States. In addition to sales of branded NuvaRing, we have an agreement with a generic manufacturer that authorizes the sale of generic etonogestrel/ethinyl estradiol vaginal ring in the United States. Under the terms of the agreement, we are reimbursed on a cost-plus basis by the generic manufacturer for supplying finished goods and receive a share of the net profits recorded by the generic manufacturer. Under the terms of the agreement, our share in the profits declines over time as new participants enter the market. Revenues from this arrangement were $73 million, $148 million and $2 million for 2021, 2020 and 2019, respectively. Revenues for 2021 primarily reflect our share of the profits. Revenues for 2020 and 2019 reflect supply sales of the generic product to the manufacturer. The decline in revenue for 2021 is due to the entry of a new market participant. Given the nature of this arrangement, we expect revenue under this arrangement to continue to decline significantly in 2022.

Fertility

Worldwide sales of Follistim AQ (marketed in most countries outside the United States as Puregon), a fertility treatment, increased 23% in 2021, primarily due to continuous volume growth in the United States, as well as recovery from the COVID-19 pandemic in the United States and China. Worldwide sales of Follistim AQ declined 20% in 2020 largely due to lower global demand resulting from the COVID-19 pandemic.

Worldwide sales of ganirelix acetate injection (marketed in certain countries outside the United States as Orgalutran), a fertility treatment, increased 37% in 2021 primarily due to favorable pricing in the United States, volume growth in Europe and Canada, and China, as well as recovery from the COVID-19 pandemic in China. Worldwide sales of ganirelix acetate injection declined 28% in 2020 primarily due to lower pricing in the United States, as well as lower demand in international markets attributable both to the COVID-19 pandemic and generic competition.

Biosimilars

The following biosimilar products are part of a development and commercialization agreement between Organon and Samsung Bioepis entered into in 2013. See Note 4 to the Consolidated Financial Statements. Our commercialization territories under the agreement vary by product as noted below.

Renflexis is a biosimilar to Remicade (infliximab) (a trademark of Janssen Biotech, Inc.) for the treatment of certain inflammatory diseases. Sales growth in 2021 and 2020 was driven primarily by continued demand growth in the United States since launch in 2017 as well as growth in Canada. We have commercialization rights to Renflexis in countries outside the EU, Korea, China, Turkey and Russia.

Ontruzant (trastuzumab-dttb) is a biosimilar to Herceptin (trastuzumab) (a trademark of Genentech, Inc.) for the treatment of HER2-overexpressing breast cancer and HER2-overexpressing metastatic gastric or gastroesophageal junction adenocarcinoma. For 2021, sales reflect uptake since the July 2020 launch in the United States partially offset by a decrease in the EU reflecting increasing competitive pressures and tenders lost. We have commercialization rights to Ontruzant in countries outside of Korea and China. Sales growth in 2020 was driven by the launch in Brazil.

Brenzys (etanercept) is a biosimilar to Enbrel (etanercept) (a trademark of Immunex Corporation) for the treatment of certain inflammatory diseases. Sales in 2021 decreased 15% primarily due to lower demand in Brazil. We have commercialization rights to Brenzys in countries outside of the United States, the E.U., Korea, China and Japan. Sales in 2020 were relatively flat compared to 2019.

Recent Launches

Aybintio is a biosimilar to Avastin (bevacizumab) (a trademark of Genentech, Inc.) for the treatment of metastatic carcinoma of the colon or rectum, metastatic non-squamous, non-small cell lung cancer, metastatic renal cell carcinoma,

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metastatic cervical cancer, epithelial ovarian, fallopian tube, or primary peritoneal cancer and metastatic breast cancer. We recorded sales of $36 million during 2021, with minimal sales during 2020 due to the approval of Aybintio in the EU in August 2020 and its launch in September 2020. We currently have no plan for the timing of any launch of Aybintio in the United States nor do we know when such timing would be determined. We have experienced increased competition, including pricing pressure, which is expected to impact our sales in 2022 and forward. We have commercialization rights to Aybintio in the United States, Canada, Germany, Italy, France, the UK and Spain.

Hadlima (adalimumab-bwwd) is a biosimilar to Humira (adalimumab) (a trademark of AbbVie Technology Ltd.) for the treatment of certain inflammatory diseases. We have worldwide commercialization rights to Hadlima in countries outside of the EU, Korea, China, Turkey and Russia. Samsung Bioepis reached a global settlement with AbbVie permitting us to launch Hadlima in the United States in June 2023 and outside of the United States starting in 2021. Hadlima is currently approved in the United States, Australia, Canada, and Israel. Hadlima was launched in Australia and Canada in February 2021. Following these launches, we recorded sales of $13 million during 2021, with no comparable sales during 2020.

Established Brands

Established brands represents a broad portfolio of well-known brands, which generally are beyond market exclusivity, including leading brands in cardiovascular, respiratory, dermatology and non-opioid pain management, for which generic competition varies by market.

Cardiovascular

Combined global sales of Zetia (marketed in most countries outside of the United States as Ezetrol) and Vytorin (marketed outside of the United States as Inegy), medicines for lowering LDL cholesterol, decreased 18% and 24% in 2021 and 2020, respectively, primarily driven by lower sales of Ezetrol in Japan, as well as lower sales of Ezetrol and Inegy in the EU. The patent that provided market exclusivity for Ezetrol in Japan expired in September 2019 and generic competition began in June 2020. The EU patents for Ezetrol and Inegy expired in April 2018 and April 2019, respectively. Accordingly, we are experiencing sales declines in these markets as a result of generic competition and expect the declines to continue. Higher demand for Ezetrol in China during 2021, resulting from expanded access, partially offset the sales decline.

Sales of Atozet (ezetimibe and atorvastatin calcium) (marketed outside of the United States), a medicine for lowering LDL cholesterol, remained relatively flat 2021, primarily due to increased competition in Germany, partially offset by demand increase in France and the Asia Pacific region. Sales of Atozet grew 16% in 2020 primarily due to higher demand in most markets, particularly in the EU, Japan and other countries in the Asia Pacific region.

Sales of Rosuzet (ezetimibe and rosuvastatin calcium) (marketed outside of the United States), a medicine for lowering LDL cholesterol, declined 48% in 2021 due to the expiration of a distribution agreement in Korea in December 2020, partially offset by higher demand and favorable pricing in Japan. Sales of Rosuzet grew 8% in 2020 primarily due to higher demand in Korea and Japan.

Combined global sales of Cozaar (losartan potassium) and Hyzaar (losartan potassium and hydrochlorothiazide) (a combination of Cozaar and hydrochlorothiazide that is marketed in Japan as Preminent), a medicine for the treatment of hypertension, declined 7% in 2021 primarily due to continued generic competition in Japan and the Asia Pacific region, market decline in China, lower demand in the United States, and lower sales in Canada as sales in 2020 were higher due to competitor supply shortages. Combined global sales of Cozaar and Hyzaar declined 13% in 2020 primarily due to lower demand in China, Japan and the EU.

Worldwide sales of Zocor (simvastatin), a statin for modifying cholesterol, decreased 16% in 2021, primarily due to lower volumes in China due to the VBP impact. Worldwide sales of Zocor declined 31% in 2020 primarily due to lower demand in China.

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Respiratory

Worldwide sales of Singulair, a once-a-day oral medicine for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis, decreased 11% in 2021 primarily attributable to the impact of VBP in China, lower volume in Japan, Europe and Canada due to generic competition, and the impact of the COVID-19 pandemic in the Middle East region. The sales decline was partially offset by the market recovery from the COVID-19 pandemic in China. Worldwide sales of Singulair declined 34% in 2020 primarily due to lower demand in China and Japan attributable in part to the COVID-19 pandemic.

Global sales of Nasonex, an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, decreased 6% in 2021 primarily driven by generic competition in Japan, lower demand impacted by the COVID-19 pandemic across several markets in the United States, Latin America, and Europe, partially offset by higher demand in China. Global sales of Nasonex declined 26% in 2020 primarily due to continued generic competition in Japan, as well as lower demand in several other international markets resulting from the COVID-19 pandemic, partially offset by higher demand in China.

Global sales of Dulera, a combination medicine for the treatment of asthma, decreased 15% in 2021, largely due to significant buy-in during 2020 related to the COVID-19 pandemic. Global sales of Dulera increased 2% in 2020 due to higher demand in Canada.

Non-Opioid Pain, Bone and Dermatology

Sales of Arcoxia (etoricoxib) (marketed outside of the United States) for the treatment of arthritis and pain decreased 5% in 2021 primarily due to the impact of VBP in China and lower demand in the Asia Pacific region attributable to the COVID-19 pandemic. Sales of Arcoxia declined 11% in 2020 primarily due to lower demand in the Asia Pacific region related to the COVID-19 pandemic, partially offset by higher demand in the EU.

Other

Worldwide sales of Proscar for the treatment of symptomatic benign prostate enlargement declined 33% in 2021 primarily due to lower performance reflecting the impact of VBP in China. Worldwide sales of Proscar declined 13% in 2020 primarily due to lower demand in China.

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Costs, Expenses and Other

* Calculation not meaningful.

Cost of Sales

Cost of sales includes expenses for the amortization of intangible assets which totaled $103 million in 2021, $86 million in 2020 and $284 million in 2019. Cost of sales increased 12% in 2021 primarily due to an increase in manufacturing and freight costs, as well as certain costs related to tolling arrangements with Merck which were not in place in 2020. During 2021, the Company recognized $24 million in Cost of sales pertaining to estimated unavoidable losses associated with a long-term vendor supply contract conveyed as part of the Separation. Due to increased competition during 2021, which resulted in the loss of contract tenders in certain markets and pricing pressure, the Company recorded an impairment charge of $7 million related to a product right for a biosimilar product. Cost of sales decreased 7% in 2020, primarily attributable to the decline in amortization expense for the intangible assets of Nasonex, Clarinex and Atozet, which were fully amortized at the end of 2019.

Gross margin was 62.2%, 67.6% and 70.8% in 2021, 2020 and 2019, respectively. The gross margin decline in 2021 compared to 2020 reflects stand up costs, certain costs related to tolling arrangements with Merck, which have lower gross margin percentages compared to product sales, higher amortization expense, as well as the $24 million charge associated with the long-term vendor supply contract conveyed to Organon and the $7 million of impairment charge related to a biosimilar product. The gross margin decline in 2020 compared with 2019 reflects pricing pressure and product mix, partially offset by lower amortization of intangible assets as noted above.

Selling, General and Administrative

Selling, general and administrative expenses increased 23% in 2021 due to costs incurred to establish Organon as a standalone entity, higher employee related costs, and higher selling and promotional costs. Selling, general and administrative expenses declined 6% in 2020 primarily due to lower selling and promotional costs, reflecting lower travel and meeting expenses due in part to the impact of the COVID-19 pandemic. These declines were partially offset by costs incurred to establish Organon as a standalone entity.

Research and Development

Research and development expenses more than doubled in 2021 primarily due to the $79 million charge for the acquisition of Forendo Pharma, the $25 million upfront payment related to the license agreement with ObsEva, higher expenses related to clinical development, and higher employee related costs incurred to establish Organon as a standalone entity. Research and development expenses declined 5% in 2020 primarily due to lower costs from post-marketing research activities, partially offset by higher spending associated with Organon development programs.

Restructuring Costs

Certain of our operations have been affected by restructuring plans initiated by Merck. The decline in restructuring costs for 2021 and 2020 is due to lower allocated costs from Merck. Currently, Organon does not have an established restructuring program. See Note 6 to the Consolidated Financial Statements.

Other (Income) Expense, Net

For 2021, the increase in other (income) expense is primarily due to $258 million of interest expense related to the issuance of the debt instruments, offset by lower allocated foreign exchange hedging losses as compared to 2020. The decrease in other (income) expenses for 2020 was primarily due to lower allocated foreign exchange hedging losses as compared to 2019.

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Taxes on Income

The effective income tax rates for 2021, 2020 and 2019 were 11.7%, 18.0% and 10.6%, respectively. The decrease in effective interest rates for 2021 reflect the beneficial impact of foreign earnings, the $75 million tax benefit relating to a portion of the non-U.S. step-up of tax basis associated with Organon's Separation from Merck, as well as the income tax benefit recognized in connection with the conclusion of the Internal Revenue Service (IRS) examination of Merck’s 2015-2016 U.S. federal income tax returns. As a result of the examination conclusion, we reflected an allocation from Merck of $18 million in the Consolidated Financial Statements representing our portion of the payment made to the IRS. Our portion of reserves for unrecognized tax benefits for the years under examination exceeded the allocated adjustments relating to this examination period and therefore for the year ended December 31, 2021, we have reflected a $29 million net tax benefit. This net benefit reflects reductions in reserves for unrecognized tax benefits and other related liabilities for tax positions relating to the years that were under examination.

Income/Loss from Discontinued Operations

The historical results of certain Merck non-U.S. legal entities that were contributed to Organon in connection with the Separation included operations related to other Merck products that were retained by Merck. The Merck Retained Products business of the Transferred Entities were contributed by Organon to Merck and its affiliates. Accordingly, the historical results of operations of the Merck Retained Products have been reflected as discontinued operations in the Consolidated Financial Statements for all periods presented.

There was no income or loss from discontinued operations, net of taxes for 2021. Loss from discontinued operations, net of taxes, for 2020 and 2019 was $96 million and $88 million, respectively.

Analysis of Liquidity and Capital Resources

Liquidity and Capital Resources

Up to the date of Separation on June 2, 2021, Organon participated in Merck’s centralized treasury model, which included its cash pooling and other intercompany financing arrangements. We have historically generated, and expect to continue to generate, positive cash flow from operations.

In April 2021, in connection with the Separation, Organon Finance 1, previously a subsidiary of Merck, issued €1.25 billion aggregate principal amount of 2.875% senior secured notes due 2028, $2.1 billion aggregate principal amount of 4.125% senior secured notes due 2028 and $2.0 billion aggregate principal amount of 5.125% senior unsecured notes due 2031. The notes were assumed by Organon and the Dutch Co-Issuer. In addition, on June 2, 2021, we entered into a credit agreement providing for a $3.0 billion U.S. dollar-denominated senior secured term loan due 2028 and a euro denominated senior secured term loan in the amount of €750 million due 2028. We also entered into a secured, unsubordinated five-year revolving credit facility that provides for the availability of $1.0 billion of borrowings. As of December 31, 2021, there are no borrowings outstanding under our Revolving Credit Facility. We distributed $9.0 billion of the $9.5 billion proceeds to Merck in accordance with the terms of the Separation.

After the distribution to Merck of $9.0 billion in net debt proceeds and settlement of certain balances with Merck and its affiliates, we began operations as an independent company with approximately $900 million of cash and cash equivalents, which included approximately $400 million of funds received from Merck for the purchase of inventory from Merck upon exit of certain Interim Operating Model agreements. This purchase was completed at the end of 2021. On December 23, 2021, the Company made a discretionary prepayment of $100 million on the U.S. dollar denominated term loan. At December 31, 2021, we had cash and cash equivalents of $737 million. We expect to continue to fund our ongoing operating, investing and financing requirements mainly through cash flows from operations, available liquidity through cash on hand, available capacity under our Revolving Credit Facility and access to capital markets.

Working capital of continuing operations was $1.2 billion at December 31, 2021 and $348 million at December 31, 2020. The increase in working capital of continuing operations was primarily driven by cash funding by Merck in connection with the Separation and an increase in accounts receivable, partially offset by increases in employee benefits and payroll accruals and interest payable.

Cash provided by operating activities was $2.2 billion in 2021, $2.3 billion in 2020 and $3.0 billion in 2019. Cash provided by operating activities in 2021 was unfavorably impacted by the decline in net income and an increase in accounts receivable and inventory partially offset by an increase in trade accounts payable, including amounts due to Merck, and accrued and other current liabilities. Cash provided by operating activities in 2020 was primarily impacted by the decline in net income.

Cash used in investing activities was $481 million in 2021, $250 million in 2020, and $88 million in 2019. Cash used in investing activities in 2021 primarily reflects the asset acquisition of Forendo and Alydia Health and the licensing agreement with ObsEva. Cash used in investing activities in 2020, reflects an increase in capital expenditures.

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Cash used in financing activities was $977 million in 2021, $2.0 billion in 2020 and 2.9 billion in 2019. The change in cash used in financing activities in 2021 reflects the proceeds from the issuance of long term debt, the payment of related debt issuance costs and related principal payment, payment of dividends, and the settlement of the transactions with Merck in connection with the Separation (see Note 19 to the Consolidated Financial Statements). The change in cash used in financing activities in 2020 reflects transactions with Merck.

Our ability to fund our operations and anticipated capital needs is reliant upon the generation of cash from operations, supplemented as necessary by periodic utilization of our Revolving Credit Facility. Our principal uses of cash in the future will be primarily to fund our operations, working capital needs, capital expenditures, repayment of borrowings, payment of dividends and strategic business development transactions.

Capital expenditures were $192 million in 2021, $255 million in 2020 and $92 million in 2019. Capital expenditures in 2021 and 2020 reflect investment in new capital projects focused primarily on establishing Organon as an independent Company. We estimate that we will continue to invest in new capital projects from 2022 to 2023, for ongoing projects to stand up Organon, principally related to investments in information technology.

In February 2022, the armed conflict between Ukraine and Russia escalated, which may adversely impact Organon’s business. Specifically, trade sanctions, travel bans and asset or financial freezes announced by the United States, European Union and other countries against Russian entities and designated individual restrictions have impacted and may continue to impact many global businesses in direct and indirect ways (including, but not limited to, product shipping delays, supply shortages, delays in regulatory approvals and audits, currency exchange rates and exchange controls). Such actions may negatively impact the financial institutions, vendors, manufacturers, suppliers, partners and other third parties with whom Organon conducts business. Organon will continue to monitor the impacts of the conflict, which may negatively impact Organon’s operations, financial position or cash flows. For the year ended December 31, 2021, Organon’s combined revenues of Ukraine and Russia were approximately 2% of total revenues.

Our contractual obligations as of December 31, 2021, which require material cash requirements in the future, consist of purchase obligations and lease obligations. Purchase obligations are enforceable and legally binding obligations for purchases of goods and services which include inventory purchase commitments. Lease obligations exclude reasonably certain lease renewals that have not yet been executed. As of December 31, 2021, total payments due for purchase obligations and lease obligations are $1.5 billion and $251 million, respectively, and extend through 2030. Contractual obligations due within the next twelve months are $349 million related to purchase commitments and $53 million related to lease obligations. In addition, Organon is responsible for settlement of certain tax matters, of which the Company expects to pay approximately $20 million within the next year.

During 2021, Organon paid cash dividends of $0.56 per share. In February 2022, the Board of Directors declared a quarterly dividend of $0.28 per share on Organon’s stock that was paid on March 17, 2022 to stockholders of record at the close of business on February 28, 2022.

We believe that our financing arrangements, future cash from operations, and access to capital markets will provide adequate resources to fund our future cash flow needs.

Critical Accounting Estimates

The audited annual consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on management’s best estimates and judgments. A discussion of accounting estimates considered critical because of the potential for a significant impact on the financial statements due to the inherent uncertainty in such estimates are disclosed below. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates.

Revenue Recognition

Our accounting policy for revenue recognition has a substantial impact on reported results and relies on certain estimates. Revenue is recognized following a five-step model: (i) identify the customer contract; (ii) identify the contract’s performance obligation; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligation; and (v) recognize revenue when or as a performance obligation is satisfied. Revenue is reduced for gross-to-net sales adjustments discussed below, all of which involve significant estimates and judgment after considering applicable laws and regulations and definitive contractual agreements with private sector and public sector benefit providers. These types of variable consideration are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. Estimates are assessed each period and adjusted as required to revise information or actual experience.

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In the United States, revenue is reduced by sales discounts issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebate amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D customers). Additionally, sales are generally made with a limited right of return under certain conditions.

The provision for aggregate customer discounts in the United States covers chargebacks and rebates. We determine the provision for chargebacks based on expected sell-through levels by our wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. We use historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued.

We continually monitor our provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2021, 2020, or 2019.

Summarized information about changes in the aggregate customer discount accrual related to sales in the United States is as follows:

(1) Includes 2021 payments made by Merck on behalf of Organon for the period prior to the Separation date.

Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in accounts receivable and accrued and other current liabilities were $54 million and $275 million, respectively at December 31, 2021, $41 million and $302 million, respectively, at December 31, 2020 and were $52 million and $313 million, respectively, at December 31, 2019.

Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the government’s total unbudgeted spending and our specific payback obligation. Rebates may also be required based on specific product sales thresholds. We apply an estimated factor against our actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale.

We maintain a returns policy that allows our customers in the United States to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, we consider factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis.

See Note 3 to the Consolidated Financial Statements for additional details on our revenue recognition policy.

Contingencies and Environmental Liabilities

We are involved in various claims and legal proceedings of a nature considered normal to our business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 12 to the Consolidated Financial Statements). We record accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated.

Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable.

We believe that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on us. Expenditures for remediation and environmental liabilities were $4 million in 2021, and are estimated at $19 million in the aggregate for the years 2022 through 2026. In management’s opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $24 million at both

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December 31, 2021 and 2020. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $16 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on our financial condition, results of operations or liquidity for any year.

Impairments of Long-Lived Assets

We assess changes in economic, regulatory and legal conditions and make assumptions regarding estimated future cash flows in evaluating the value of our property, plant and equipment, goodwill and other intangible assets. The judgments made in evaluating impairment of long-lived intangibles can materially affect our results of operations.

We periodically evaluate whether current facts or circumstances indicate that the carrying values of our long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the asset’s fair value and its carrying value. If quoted market prices are not available, we estimate fair value using a discounted value of estimated future cash flows approach.

Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is evaluated for impairment as of October 1 each year, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that fair value is less than carrying value. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, and overall financial performance. If we conclude it is more likely than not that fair value is less than carrying value, a quantitative fair value test is performed. If carrying value is greater than fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). We completed the annual goodwill impairment test as of October 1, 2021 and concluded that no impairment to goodwill was necessary as the fair value of the reporting unit was significantly in excess of the carrying value.

Other acquired intangible assets are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, we will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Potential risks leading to impairment could include loss of exclusivity occurring earlier than expected, competition, pricing reductions, and other macroeconomic changes. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows.

Taxes on Income

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. We evaluate tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, we recognize the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, we do not recognize any portion of the benefit in the financial statements. We recognize interest and penalties associated with uncertain tax positions as a component of Taxes on income in the combined statement of income.

Prior to the Separation, we did not maintain an income taxes payable to or from account as it is deemed to be settled with the tax paying entities in the respective jurisdictions. These settlements are reflected as changes in accumulated deficit in the consolidated balance sheet. However, our consolidated balance sheet reflects balances with taxing authorities and the one-time transition tax resulting from the Tax Cuts and Jobs Act enacted in 2017, as well as for unrecognized income tax benefits along with related interest and penalties.

Prior to the Separation, income tax expense and deferred tax balances in the consolidated financial statements were calculated on a separate tax return basis. We relied on certain assumptions, one of them that as a standalone basis we would not benefit from certain tax incentives that historically benefited Merck. We believe the assumptions supporting the allocation and presentation of income taxes on a separate return basis were reasonable.

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Inventory Valuation

Inventories consist of currently marketed products and are valued at the lower of cost or net realizable value. Inventories are assessed regularly for impairment and valuation reserves are established when necessary based on a number of factors including, but not limited to, product obsolescence and changes in estimates of future product demand and expiry. The determination of events and the assumptions utilized in our quantification of valuation reserves may require judgement. No material adjustments have been required to our inventory reserve estimates for the periods presented. Adverse changes in assumptions utilized in our inventory reserve calculations could result in an increase to our inventory valuation reserves and higher cost of sales.

Acquisitions

Business combinations are evaluated in order to determine whether transactions should be accounted for as acquisitions of assets or businesses. The Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the Company accounts for the transaction as an asset acquisition. In an asset acquisition, acquired IPR&D with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable of being achieved.

To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. Businesses acquired are consolidated upon obtaining control. The fair value of assets acquired and liabilities assumed are recognized at the date of acquisition. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Any excess of the purchase price over the estimated fair values of the net assets acquired is recognized as goodwill. Business acquisition costs are expensed when incurred.

The fair values of intangible assets are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management.

Pension

Our pension plans are calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. These significant assumptions are reviewed annually and are disclosed in Note 14 of the Consolidated Financial Statements.

For our pension plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due.

The expected rate of return for the pension plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Company’s plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate.

Share-Based Compensation

We expense all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The fair value of certain share-based awards is determined using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options.

Recently Issued Accounting Standards

For a discussion of recently issued accounting standards, see Note 3 to the Consolidated Financial Statements.

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