AstraZeneca Annual Report and Form 20-F Information 2008

Industry/Economic Environment Risks

Expiration of patents or marketing exclusivity

Pharmaceutical products or diagnostic or medical devices are normally only protected from competition from copying during the period of patent protection or marketing exclusivity. Following patent protection or marketing exclusivity expiry the product is generally open to competition from generic copies. Products under patent protection or having marketing exclusivity generally generate significantly higher revenues than those not protected by patents or marketing exclusivity.

Patent litigation and early loss of patents, marketing exclusivity or trademarks

Generic drug manufacturers are seeking to market generic versions of many of our more important products, prior to the expiration of our patents and marketing exclusivity periods. For example, we are currently facing challenges from multiple generic manufacturers to certain of our patents for Nexium, Seroquel and Crestor, some of our best-selling products in the US, our largest market. If such challenges are successful and generic products are launched, or launched ‘at risk’ on the expectation that challenges to our intellectual property will be successful, this may have a materially adverse effect on our financial condition and results of operations. US sales for Nexium in 2008 were $3,101m, for Seroquel were $3,015m and for Crestor were $1,678m. The more significant patent litigation relating to our products is described in Note 25 to the Financial Statements. In addition, the research-based pharmaceutical industry may exert intellectual property rights against other research-based companies and there continues to be examples of this. In the case of litigation both with generic manufacturers and other research-based companies, we expect that the greatest challenges will be focused on the most valuable products. Although we vigorously defend our intellectual property rights we cannot be certain we will be successful.

There is the risk that we may be found to infringe the patents of others, and managing such disputes can be costly. We may be liable for damages or royalties, have to obtain costly licences or stop manufacturing, using or selling our products. This risk may be greater in respect of biologics and vaccines where intellectual property protection is sometimes not so clear. In the event of such risks arising we may mitigate them through, for example, acquiring licences or making modifications to cease the infringement and permit commercialisation of our products.

Any of our currently patented products may be the subject of intellectual property litigation or other disputes involving patent offices, anti-trust authorities, other government or law enforcement agencies. Despite our efforts to establish and defend robust patent protection, we may not succeed in such litigation or disputes or be able to mitigate the risk through, for example: obtaining a licence to any third party patent on commercially reasonable terms; successfully developing non-infringing alternatives on a timely basis; or licensing alternative non-infringing technology, if any exists, on commercially reasonable terms. If we were not successful during the patent protection or data exclusivity periods in maintaining exclusive rights to market one or more of our major products, particularly in the US where we have our highest revenue and margins, our revenue and margins would be significantly adversely affected.

In addition to the challenges to our patented products from manufacturers of generic or other patented pharmaceutical products, there is a risk that some countries, particularly some of those in the developing world, may seek to impose limitations on the availability of patent protection for pharmaceutical products, or on the extent to which such protection may be obtained and/or enforced, within their jurisdictions. As a result, generic manufacturers in these countries may be increasingly and more easily able to introduce competing products to the market earlier than they would have been able to, had the patent protection been available.

Combined with patent protection and other types of marketing exclusivity, products protected by a valid trademark usually generate higher revenues than those without a trademark. We believe that we have robust trademark protection for our products but cannot be certain that we would be able to defend any challenge successfully.

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Expiration or earlier loss of patents covering competing products

The expiration or earlier loss of patents covering others’ branded products may lead to the availability of generic products earlier than anticipated, which could have a materially adverse effect on our financial condition and results of operations. For example, the loss/expiry of patent rights covering major products in the US, such as Lipitor^™ or Advair Diskus^™ after 2012 may adversely affect growth of our still patented products in that market.

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Failure to obtain patent protection

Our policy is to protect our investment in R&D by applying for appropriate intellectual property protection in respect of our inventions and innovations; this is a key business priority. Our ability to obtain patents and other proprietary rights in relation to our products is, therefore, an important element of our ability to create long-term value for the business.

Many of the different countries in which we operate are developing their patent laws for pharmaceuticals and there is more uncertainty regarding the patent protection available now and in the future than in countries with well developed intellectual property regimes. Limitations on the availability of patent protection in certain developing countries could have an adverse effect on the pricing and sales of our products and, consequently, could adversely affect our revenues from them. More information about protecting our intellectual property is contained in the Intellectual Property section.

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Impact of fluctuations in exchange rates

As a global business, currency fluctuations can significantly affect our results of operations, which are accounted for in US dollars. Approximately 47% of our 2008 sales were in North America (US and Canada) with a significant proportion of that figure being in respect of US sales, which is expected to remain our largest single market. Sales in certain other countries are also in US dollars, or in currencies whose exchange rates are linked to the US dollar. Major components of our cost base are, however, located in Europe, where an aggregate of approximately 51% of our employees are based. Movements in the exchange rates used to translate foreign currencies into US dollars may, therefore, have a materially adverse effect on our financial condition and results of operations.

Certain of our subsidiaries import and export goods and services in currencies other than their own working currency. The results of such subsidiaries could, therefore, be affected by currency fluctuations arising between the transaction dates and the settlement dates for those transactions. We hedge these exposures through financial instruments. The fair value of financial instruments used to hedge these exposures, principally forward foreign exchange contracts, at 31 December 2008 was $95 million.

We have policies that seek to mitigate the effect of exchange rate fluctuations on the value of foreign currency cash flows and in turn their effects on the results of the Group, but we do not seek to remove all such risks. Further information is contained in Note 15 Financial Risk Management Policies. In general, a unilateral strengthening of the US dollar adversely affects our reported results whereas a weakening of the US dollar is generally favourable.

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Debt-funding arrangements

We incurred substantial debt in connection with the acquisition of MedImmune, Inc.. Our debt could affect our business flexibility and requires us to devote cash resources to service interest and principal payments. Our current debt level could limit our ability to engage in additional transactions or incur additional indebtedness and could potentially affect our investment grade credit rating. Further information is contained in Financial Risk Management Policies.

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Bad debts

The Group sells to a large number of customers, across many countries, ranging from government backed agencies and large private wholesalers to privately owned pharmacies. An economic slowdown may impact the ability of some of these customers to continue to trade, which in turn may result in losses from writing these debts off. Although risk management processes are in place to manage this risk, and provisions are established for debts that may not be recoverable we cannot be certain that there will not be further losses above those already provided for. Further information is contained in the Financial Review.

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Adverse impact of a sustained economic downturn

A variety of significant risks may arise from a sustained global economic downturn including those referred to here. Additional pressure from governments and other healthcare payers on medicine prices and volume of sales in response to recessionary pressures on budgets may cause a slowdown or decline in growth in some markets. In addition, suppliers of some of the key goods and services we rely upon may cease to trade. The consequence of this may be significant delays and/or difficulties obtaining goods and services on commercially acceptable terms or even at all. We seek to mitigate these risks as described in the Supply and Manufacturing section.

Moreover, the high fixed costs of operating a global research-based pharmaceuticals business and the long and uncertain development cycles for our products mean that we are highly dependant on being able to access a sustainable flow of liquid funds. In a sustained and/or severe economic downturn financial institutions who hold our cash and other short-term deposits may cease to trade and there can be no guarantee that depositors/investors will be able to access their assets without a protracted, expensive and uncertain process, if at all. Although we have adopted conservative cash management and treasury policies to mitigate this risk (further information of which is contained in Financial Risk Management Policies) we cannot be certain that these will be completely effective should a number of major financial institutions cease to trade. Additionally, if we need access to external sources of financing to sustain and/or grow our business, such as may be available via the debt or capital financial markets, this may not be available on commercially acceptable terms, or at all, in the event of a severe and/or sustained economic downturn.

A particular risk relates to the Group’s pension obligations, the single largest of which is the UK Pension Fund. The obligations are backed by assets invested across the broad investment market. Sustained falls in these assets will put a strain on funding resulting in requirements for additional cash, which may restrict our ability to grow the business in line with our strategic objectives. Similarly, if the liabilities rise, for example due to continued, sustained improvements in longevity, or falls in the corporate bond spreads that drive discount rates for accounting valuations, there will be a strain on funding. The likely increase in the IAS19 accounting deficit generated by any of these may cause the ratings agencies to review our credit rating, with the potential to impact our ability to raise debt to fund further externalisation.

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Owning and operating a biologics and vaccines business

As we continue to expand our biologics capabilities, the risks related to owning and operating a biological products business are becoming more important to the Group. Some of the more significant of these risks are described below.

• We may have limited access to and/or supply of biological materials, such as cells or animal products or by-products. In addition, government regulations in multiple jurisdictions could result in restricted access to, use or transport of such materials. Loss of access to sufficient sources of such materials, or tighter restrictions on the use of such materials may interrupt or prevent our research activities as planned and/or increase our costs.
• The development, manufacturing and marketing of biological products are often subject to more complex and stringent regulations than those applicable to other pharmaceutical products. As a result, the production and release schedules for biological products may be more significantly affected by the regulatory process than for other products. In addition, various legislative and regulatory authorities are considering whether an abbreviated approval process is appropriate for biosimilars or follow-on biological products (similar versions of existing biological products). It is uncertain as to when, or if, any such process may be adopted or how such a process would relate to intellectual property rights in connection with marketed or pipeline biological products, but any such process could have a material effect on the future commercial prospects for patented biological products.
• Manufacturing biological products, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Manufacturing biological products requires facilities specifically designed and validated for this purpose, with sophisticated quality assurance and quality control procedures. Slight deviations in any part of the manufacturing process may result in lot failure, product recalls or spoilage, for example due to contamination.
• The methods of distributing and marketing biological products could have a material impact on the revenue we are able to generate from the sales of products such as Synagis and FluMist. The commercialisation of biologic products is often more complex than for traditional pharmaceutical products. This is primarily due to differences in mode of administration, technical aspects of the product, and the rapidly changing distribution and reimbursement environments. The tools available to the commercial team can be more limited and time-consuming in that the target physicians who prescribe biologics are often hospital-based specialists who treat patients with rare diseases. Biologics sales forces are usually smaller, more targeted and typically are required to make a more detailed, data-driven sales call. Patient education and awareness also requires a more personalised approach in that broad-based awareness campaigns, such as direct-to-consumer advertising in the US, is often not an efficient means by which to reach a smaller target population.

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Competition, price controls and price reductions

Some of our most valuable products compete directly with other products marketed either by major R&D based prescription pharmaceutical companies or by generic pharmaceutical manufacturers. These competitors may invest greater resources to the marketing of their products than we do depending on the relative priority of these competitor products within their company’s portfolio. Generic versions of products are often sold at lower prices because they do not have to recoup the significant cost of R&D investment, nor do they generally invest the same amounts in education services for healthcare professionals. Industry consolidation has resulted in a small number of very large companies, some of which have acquired generic businesses. This trend, if it continued, could adversely affect our competitive position, whilst consolidation among our customers may increase price pressures. Some of our patented products, including Nexium, Crestor, Seroquel and Symbicort are subject to price pressure from competition from generic products in the same product class.

In most of our key markets there is continued economic, regulatory and political pressure to limit or reduce the cost of pharmaceutical products. A summary of the principal aspects of price regulation and how price pressures are affecting our business in our most important markets is set out in the Geographical Review.

In the US realised prices are being depressed through limited lists, or formularies, that may force manufacturers either to reduce prices or be excluded from the list, and as a consequence lose sales revenue from patients covered by that formulary. In addition, private health insurance companies and employers that self-insure increasingly require co-payments from beneficiaries, particularly for branded pharmaceuticals and biotechnology products, among other reasons, to encourage beneficiaries to use generic products. The increased use of strict formularies by institutional customers in response to the current cost-containment environment and increasingly restrictive reimbursement policies could result in a materially adverse effect on our financial condition and results of operations.

In the EU, efforts by the European Commission to reduce inconsistencies and improve standards and best practice in the disparate national regulatory systems have met with little immediate success. The industry is, therefore, exposed to greater application of reference pricing mechanisms and ad hoc national cost-containment measures on prices and the consequent cross-border movement of products. The importation of pharmaceutical products from countries where prices are low due to government price controls or other market dynamics, to countries where prices for those products are higher, may increase. The accession of additional countries from Central and Eastern Europe to the EU as well as economic changes within EU countries may result in significant increases in the parallel trading of pharmaceutical products. In the US, new legislation is possible that may allow the commercial importation of drugs into the US from selected countries. The adoption of such legislation could result in an increase in volume of cross-border product movements which could result in a materially adverse effect on our financial condition and results of operations.

We expect that pressures on pricing will continue and may increase. Because of these pressures, there can be no certainty that we will be able to charge prices for a product that, in a particular country or in the aggregate, enable us to earn an adequate return on our investment in that product.

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Taxation

The integrated nature of our worldwide operations can produce conflicting claims from revenue authorities as to the profits to be taxed in individual territories. The resolution of these disputes can result in a reallocation of profits between jurisdictions and an increase or decrease in related tax costs, and has the potential to affect our cash flows and earnings per share. Claims, regardless of their merits or their outcome, are costly, divert management attention, and may adversely affect our reputation.

The majority of the jurisdictions in which we operate have double tax treaties with other foreign jurisdictions, which enable us to ensure that our revenues and capital gains do not incur a double tax charge. If any of these double tax treaties should be withdrawn or amended, especially in a territory where a member of the Group is involved in a taxation dispute with a tax authority in relation to cross-border transactions, such withdrawal or amendment could have a materially adverse effect on our financial condition and results of operations, as could a negative outcome of a tax dispute or failure of tax authorities to agree through competent authority proceedings. See Financial Risk Management Policies for further details of risk mitigation. The Group is currently managing a number of tax disputes detailed in Note 25 to the Financial Statements.

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Substantial product liability claims

Given the widespread impact that prescription drugs may have on the health of large patient populations, pharmaceutical, biopharmaceutical and medical device companies have, historically, been subject to large product liability damages claims, settlements and awards for injuries allegedly caused by the use of their products. Product liability claims, regardless of their merits or their outcome, are costly, divert management attention, and may adversely affect our reputation and demand for our products. Adverse publicity relating to the safety of a product or of other competing products may increase the risk of product liability claims. Litigation, particularly in the US, is inherently unpredictable and verdicts and/or unexpectedly high awards of damages can result. Substantial product liability claims that result in court decisions against us or in the settlement of proceedings could have a materially adverse effect on our financial condition and results of operations, particularly where such circumstances are not covered by insurance. We are currently subject to extensive product liability litigation in relation to Seroquel, and further details about this and all material legal proceedings in which we are involved are set out in Note 25 to the Financial Statements. Information about our approach to patient safety is set out in the Medicines section.

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Performance of new products

Although we carry out numerous and extensive clinical trials on all our products before they are launched, for a new product it can be difficult, for a period following its launch, to establish from available data a complete assessment of its eventual efficacy and/or safety in broader clinical use on the market. Due to the relatively short time that a product has been tested and the relatively small number of patients who have taken the product, the available data may be immature. Simple extrapolation of the data may not be accurate and could lead to a misleading interpretation of a new product’s likely future commercial performance.

The successful launch of a new pharmaceutical product involves a substantial investment in sales and marketing costs, launch stocks and other items. The commercial success of our new medicines is of particular importance to us in order to replace sales lost as and when patent protection ceases in established markets. If a new product does not succeed as anticipated or its rate of sales growth is slower than anticipated, there is a risk that the costs incurred in launching it could have a materially adverse effect on our financial condition and results of operations. In addition, for launch of products that are seasonal in nature, delays for regulatory approval or manufacturing difficulties can have the effect of delaying launch to the next season and significantly reduce the value of costs spent in preparing for the launch for that season.

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Environmental/occupational/health and safety liabilities

We have environmental liabilities at some currently or formerly owned, leased and third party sites, as described in more detail in Note 25 to the Financial Statements. These liabilities are carefully managed by designated technical, legal and business personnel and there is no reason for us to believe that associated current and expected expenditure and/or risks are likely to have a materially adverse effect on our financial condition and results of operations as a general matter, although they could, to the extent that they exceed applicable provisions, have a materially adverse effect on our financial condition and results of operations for the relevant period. In addition, a change in circumstances (including a change in applicable laws or regulations) may result in such an effect.

Nonetheless, a significant non-compliance or incident for which we were responsible could result in us being liable to pay compensation, fines or remediation costs. In some circumstances, such liability could have a materially adverse effect on our financial condition, reputation and results of operations. In addition, our financial provisions for any obligations that we may have relating to environmental liabilities may be insufficient if the assumptions underlying the provisions – including our assumptions regarding the portion of waste at a site for which we are responsible – prove incorrect, or if we are held responsible for additional contamination.

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Developing our business in emerging markets

The development of our business in emerging markets may be a critical factor in determining our future ability to sustain or increase the level of our global product revenues. Challenges that arise in relation to the development of the business in emerging markets include, but are not limited to, more volatile economic conditions, competition from companies that are already present in the market, the need to identify correctly and leverage appropriate opportunities for sales and marketing, poor protection of intellectual property, inadequate protection against crime (including counterfeiting, corruption and fraud) (further details of which can be found below), inadvertent breaches of local law/regulation and not being able to recruit sufficient personnel with appropriate skills and experience. The failure to exploit potential opportunities appropriately in emerging markets may have a materially adverse effect on our financial condition and results of operations. Information on the risks associated with the failure to obtain patent protection can be found above.

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Product counterfeiting

Counterfeit medicines may contain harmful substances, the wrong dose of the active pharmaceutical ingredient (API) or no API at all. Counterfeit medicines are a danger to patients in all parts of the world; the International Medical Products Anti-Counterfeiting Taskforce (IMPACT) of the World Health Organization (WHO) estimates that approximately 10% to 30% of medicines in emerging economies are counterfeit, with parts of Latin America, Asia and Africa having a greater percentage than that. By contrast, in developed countries with effective regulatory systems, counterfeits represent less than 1% of the market.

Public loss of confidence in the integrity of pharmaceutical products as a result of counterfeiting could adversely affect our reputation and financial performance. In addition, undue or misplaced concern about the issue might induce some patients to stop taking their medicines, with consequential risks to their health.

We use a range of measures against counterfeit medicines, and continue to develop our capabilities in this area. These include introducing technologies that make it more difficult for counterfeiters to copy our products; conducting market surveillance and monitoring the supply chain to identify potential counterfeiting operations; and responding rapidly to any reports of counterfeit AstraZeneca medicines, working with regulators, healthcare professionals, distributors, law enforcement agencies and other organisations to protect patient interests. We also participate in a variety of anti-counterfeiting forums in the public and private sector, including the WHO’s IMPACT working group and the Pharmaceutical Security Institute.

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