Organon & Co. (OGN) FY 2023 MD&A

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

We make statements in this Annual Report on Form 10-K, and we may from time to time make other written reports and oral statements, regarding our outlook or expectations for financial, business or strategic matters regarding or affecting us 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," "believes," "would," "potentially," "intends," "seeks," 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 our 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 our 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 or otherwise described in our filings with the SEC, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations expressed in our forward-looking statements, including, but not limited to:

•expanded brand and class competition in the markets in which we operate;

•difficulties with performance of third parties we rely on for our 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 our products lose patent protection;

•any failure by us to obtain an additional period of market exclusivity in the United States for Nexplanon subsequent to the expiration of certain key patents in 2027;

•difficulties and uncertainties inherent in the implementation of our 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 higher selling and promotional costs;

•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 our products and related intellectual property, environmental regulations, and the enforcement thereof affecting our business;

•efficacy, safety or other quality concerns with respect to our 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 our product candidates in pre-clinical and clinical trials, which may prevent or delay the development, approval, clearance, or commercialization of our product candidates;

•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, our or third-party providers' information technology systems, which could disrupt our operations;

•increased focus on privacy issues in countries around the world, including the United States, the EU, 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 our business, including recently enacted laws in a majority of states in the United States requiring security breach notification;

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

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•the impact of any future pandemic, epidemic, or similar public health threat on our business, operations and financial performance;

•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 us; and

•economic factors over which we have no control, including changes in inflation, interest rates, recessionary pressures, 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 we undertake 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.

General

The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist the reader in understanding our financial condition and results of operations for the years ended December 31, 2023 and 2022 and should be read in conjunction with our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K to enhance the understanding of our results of operations, financial condition and cash flows. Additionally, this section should be read in connection with Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC and available on the SEC's website at www.sec.gov, which includes a discussion regarding our financial condition and results of operations for the years ended December 31, 2022 and 2021.

We are a global health care company with a focus on improving the health of women throughout their lives. We develop and deliver innovative health solutions through a portfolio of prescription therapies and medical devices within women's health, biosimilars and established brands. We have a portfolio of more than 60 medicines and products across a range of therapeutic areas. We sell 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. We operate six manufacturing facilities, which are located in Belgium, Brazil, Indonesia, Mexico, the Netherlands and the United Kingdom. Unless otherwise indicated, trademarks appearing in italics throughout this document are trademarks of, or are used under license by our companies.

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 valuable 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. In addition, Nexplanon may be eligible for an additional three years of market exclusivity in the United States subsequent to the expiration of certain key patents in 2027, although there can be no assurance that such an additional term will be granted.

•Historical Shift Towards Long-Acting Reversible Contraceptives: Daily contraceptive pills are by far the largest contraception market segment, with almost half of all women choosing a hormonal contraceptive electing this particular method. However, the Long-Acting Reversible Contraceptives ("LARC") market segment, which includes Nexplanon, has experienced significant growth in the decade from 2010 through to 2019, driven by a significant shift away 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 2020 and 2021 due to clinic closures and the postponement of non-essential medical procedures during country lockdowns. The LARC segment began to rebound in 2021 and 2022, during months when clinic restrictions were removed. The LARC market is expected to continue to be an important and large segment of the overall contraception market as payors, providers and patients consider the benefits of long acting and highly effective options including Nexplanon.

•Increased Access to Fertility Solutions: With the global trend toward declining birthrates, governments and payors are implementing favorable policies across major markets that, in turn, improve access to care and drives growth for infertility therapies.

•Growing Acceptance of Biosimilars: Biologics continue to experience strong growth trends. 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

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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

Eli Lilly ("Lilly")

In December 2023, we announced an agreement with Lilly to become the sole distributor and promoter of the migraine medicines Emgality and Rayvow in Europe. Lilly will remain the marketing authorization holder and will manufacture the products for sale. Under the terms of the agreement, we paid an upfront payment of $50 million, upon closing of the transaction in January 2024, and will pay sales-based milestone payments. The upfront payment and certain sales-based milestone payments, which were deemed probable of being achieved, are recognized as an intangible asset in the first quarter of 2024.

Claria Medical, Inc. ("Claria")

In January 2023, we made a strategic investment in Claria, a privately-held company developing an investigational medical device being studied for use during minimally invasive laparoscopic hysterectomy. Under the terms of the agreement, we paid $8 million upfront and have the option to acquire Claria for an additional $47 million, payable if and when the option is exercised. The $8 million was expensed as Acquired in-process research and development and milestones in our Condensed Consolidated Statement of Income for the year ended December 31, 2023.

COVID-19 Update

COVID-19 related disruptions, including patients' inability to access health care providers, negatively affected our results during 2022 and the first half of 2023, specifically, in China. The China economy has had a slower recovery from COVID-19 and this, coupled with healthcare budget deficits, has created cost containment measures post-COVID that have primarily impacted our retail business, and to a lesser extent has impacted the hospital side.

Operating Results

Sales Overview

Worldwide sales were $6.3 billion for the year ended December 31, 2023, an increase of 1% compared with 2022. Worldwide sales were negatively impacted by approximately 2%, or $117 million, due to unfavorable foreign exchange. Excluding foreign exchange, sales increases primarily reflect the performance of; Atozet due to increased demand in various international markets; Renflexis driven primarily by continued patient growth in the United States and Canada; Follistim AQ due to a one-time buy-in as a result of the exit of the IOM in the United States, increased patient demand in the United States and volume recovery in China related to the COVID-19 negative impact during the first half of the year; Ontruzant driven by the timing of tenders and increased demand; Jada due to continued uptake in the United States following the launch; and Marvelon and Mercilon, resulting from the transaction with Bayer Healthcare where we gained rights in China during the second quarter of 2022 and in Vietnam during the third quarter of 2022. This performance was offset by: decreased sales of Zetia and Vytorin driven by the negative impact of VBP in China; the impact of the Diprospan regulatory inspection finding at the Heist manufacturing location

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that impacted the manufacturing of selected injectable steroid brands in the first quarter of 2023 (the "Market Action"); and decreased sales of Cozaar and Hyzaar (a combination of losartan potassium and hydrochlorothiazide that is marketed in Japan as Preminent™), primarily due to ongoing generic competition.

The loss of exclusivity negatively impacted sales of certain of our products by approximately $18 million during the year ended December 31, 2023, compared to the year ended December 31, 2022, due to the decrease in volume period over period, which mainly impacted NuvaRing in the United States. VBP in China had a $95 million negative impact on our sales during the year ended December 31, 2023, compared to the year ended December 31, 2022. We expect VBP to impact our established brands product portfolio for the next several quarters.

Our operations include a portfolio of products. Highlights of the sales of our products for the year ended December 31, 2023 and 2022 are provided below. See Note 6 "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, a single-rod subdermal contraceptive implant, declined 1% for the year ended December 31, 2023, compared to 2022, primarily due to the impact of foreign exchange, unfavorable discount rates, the result of distributor purchasing patterns associated with the timing of the increase in Nexplanon list price in the United States and the impact of the limited participation of a tender in Mexico. This was partially offset by price increases.

Worldwide sales of NuvaRing, a vaginal contraceptive product, declined 12% for the year ended December 31, 2023, compared to 2022, due to ongoing generic competition in the United States. We expect a continued decline in NuvaRing sales as a result of generic competition.

Worldwide sales of Marvelon and Mercilon, combined oral hormonal daily contraceptive pills not approved or marketed in the United States but available in certain countries outside the United States, increased 22% for the year ended December 31, 2023, compared to 2022, as a result of the transaction with Bayer Healthcare where we gained rights in China during the second quarter of 2022 and in Vietnam during the third quarter of 2022.

Fertility

Worldwide sales of Follistim AQ, a fertility treatment, increased 14% for the year ended December 31, 2023, compared to 2022, due to a one-time buy-in as a result of the exit of the IOM in the United States, increased patient demand in the United States and volume recovery in China related to the COVID-19 negative impact during the first half of the year. This was partially offset by the negative impact of unfavorable discount rates in the United States.

Worldwide sales of ganirelix acetate injection, a fertility treatment, declined 10% for the year ended December 31, 2023, compared to 2022, primarily due to unfavorable discount rates in the United States and increased generic competition in Europe.

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Other Women's Health

Worldwide sales of Jada, a device intended to provide control and treatment of abnormal postpartum uterine bleeding or hemorrhage when conservative management is warranted, increased 113% for the year ended December 31, 2023, compared to 2022. The sales increase is due to continued uptake in the United States following the Jada launch in early 2022.

Biosimilars

Renflexis is a biosimilar to Remicade (infliximab) for the treatment of certain inflammatory diseases. Sales increased 23% for the year ended December 31, 2023, compared to 2022, driven primarily by continued demand growth in the United States and Canada. We have commercialization rights to Renflexis in countries outside Europe, Korea, China, Turkey, and Russia.

Ontruzant is a biosimilar to Herceptin (trastuzumab) for the treatment of HER2-overexpressing breast cancer and HER2-overexpressing metastatic gastric or gastroesophageal junction adenocarcinoma. Sales for the year ended December 31, 2023, compared to 2022, increased 28% driven by the timing of tenders in Brazil and increased demand partially offset by the competitive pressures in Europe. We have commercialization rights to Ontruzant in countries outside of Korea and China.

Brenzys is a biosimilar to Enbrel (etanercept) for the treatment of certain inflammatory diseases. Sales in the year ended December 31, 2023, compared to 2022, remained substantially consistent. We have commercialization rights to Brenzys in countries outside of the United States, Europe, Korea, China, and Japan.

Hadlima is a biosimilar to Humira (adalimumab) for the treatment of certain inflammatory diseases. We have commercialization rights to Hadlima in countries outside of the EU, Korea, China, Turkey, and Russia. We recorded sales of $44 million during the year ended December 31, 2023, reflecting an increase from modest sales during 2022 in markets outside of the United States and the launch in the United States in July 2023. Hadlima is currently approved in the United States, Australia, Canada, and Israel.

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 and Vytorin, medicines for lowering LDL cholesterol, declined 11% for the year ended December 31, 2023, compared to 2022, primarily driven by the negative impact of VBP in China.

Sales of Atozet, a medicine for lowering LDL cholesterol, increased 14% for the year ended December 31, 2023, compared to 2022, primarily due to increased demand in various international markets.

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Combined global sales of Cozaar and Hyzaar, medicines for the treatment of hypertension, declined 13% for the year ended December 31, 2023, compared to 2022, primarily due to ongoing generic competition.

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, declined 2% for the year ended December 31, 2023, compared to 2022, due to the impact of foreign exchange partially offset by increased demand due to higher incidences of respiratory conditions across many international markets during the fourth quarter of 2023 compared to 2022.

Global sales of Nasonex, an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, increased 6% for the year ended December 31, 2023, compared to 2022, due to increased demand across several markets partially offset by a $10 million milestone related to a regulatory approval received during the first quarter of 2022.

Global sales of Dulera, a combination medicine for the treatment of asthma, increased 8% for the year ended December 31, 2023, compared to 2022, primarily due to the favorable impact from price and increased demand in the United States.

Non-Opioid Pain, Bone and Dermatology

Sales of Arcoxia, a medicine for the treatment of arthritis and pain, increased 7% for the year ended December 31, 2023, compared to 2022, primarily due to customers buying patterns and higher demand in various international markets.

Sales of Diprospan, a corticosteroid approved for treatment of a wide range of inflammatory conditions, declined 25% for the year ended December 31, 2023, compared to 2022, due to manufacturing issues resulting from the Market Action. In the first quarter of 2023, we resolved the regulatory inspection findings. Sales have not yet recovered. We expect the sales recovery to continue over the next twelve months.

Other

Worldwide sales of Proscar, a medicine for the treatment of symptomatic benign prostate enlargement, for the year ended December 31, 2023, compared to 2022 were substantially consistent.

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Costs, Expenses and Other

* Calculation not meaningful.

Cost of Sales

Cost of sales increased 10% for the year ended December 31, 2023, compared to 2022, primarily due to foreign exchange translation, higher employee-related and material and distribution related costs, which increased as a result of inflationary pressures, and product mix. During the year ended December 31, 2022, we recorded a $36 million inventory charge relating to the Market Action and an impairment charge of $9 million related to a product right for a biosimilar product. Cost of sales includes amortization of intangible assets which totaled $116 million in 2023, $116 million in 2022 and $103 million in 2021.

Selling, General and Administrative

Selling, general and administrative expenses increased 11% for the year ended December 31, 2023, compared to 2022, due to higher employee-related costs, costs incurred in connection with the separation from Merck, which includes the implementation of the enterprise resource planning system, and the $80 million charge related to the Microspherix legal matter as discussed in Note 20. "Contingencies" to the Consolidated Financial Statements. This was partially offset by lower promotional expenses.

Research and Development

Research and development expenses increased 12% for the year ended December 31, 2023, compared to 2022, primarily due to higher costs associated with our acquisitions of clinical stage assets, increased clinical study activity and higher employee-related costs.

Acquired In-Process Research and Development and Milestones

For the year ended December 31, 2023, acquired in-process research and development and milestones of $8 million related to the Claria transaction. For the year ended December 31, 2022 acquired in-process research and development and milestones represents the upfront and development milestones related to our research collaboration and license agreement with Cirqle and our agreement with Henlius for the license of certain biosimilar candidates.

Restructuring Costs

For the year ended December 31, 2023, we incurred $62 million of headcount-related restructuring expense, of which $58 million is due to activities initiated in the fourth quarter related to the ongoing optimization of our internal operations.

Interest Expense

Interest expense increased 25% for the year ended December 31, 2023, compared to 2022, due to increased interest rates, and debt fees and discounts expensed as part of the prepayment on the U.S. Dollar-denominated term loan and the impact of exchange rates.

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Exchange Losses

For the year ended December 31, 2023, the change in exchange losses was driven by foreign currency exchange translation losses and the impact of the portion of Euro-denominated debt not designated as a net investment hedge in the prior year period.

Other Expense, net

For the year ended December 31, 2023, other expense, net, remained relatively consistent with the prior year.

Taxes on Income

The effective income tax rates were (52.2)% and 18.3% for the year ended December 31, 2023 and 2022, respectively. These effective income tax rates reflect the beneficial impact of foreign earnings, offset by the impact of U.S. inclusions under the Global Intangible Low-Taxed Income regime and a partial valuation allowance recorded against non-deductible U.S. interest expense. In the fourth quarter of 2023, we recorded a $476 million tax benefit comprised of a gross benefit of $686 million, net of a $210 million valuation allowance, resulting from the termination of a Swiss tax arrangement. Our valuation allowance was determined based on expected future income and the terms of the remaining tax arrangement.

On August 16, 2022, the United States enacted the Inflation Reduction Act of 2022. Provisions of the bill that relate to tax include the minimum tax on book income, a 1% excise tax on stock buybacks and certain tax incentives to promote clean energy. There are no impacts of the legislation to the 2023 results. We will continue to assess future impacts of this legislation.

Liquidity and Capital Resources

As of December 31, 2023, we had cash and cash equivalents of $693 million. We have historically generated and expect to continue to generate positive cash flow from operations. 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. 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.

Working capital was $1.6 billion and $1.4 billion as of December 31, 2023 and December 31, 2022, respectively. The increase in working capital was primarily driven by an increase in inventory and the timing of collection of receivables.

Net cash provided by operating activities was $799 million for the year ended December 31, 2023 compared to $858 million for the same period in the prior year. The decrease in cash provided by operating activities was primarily attributable to the changes in working capital balances, offset by an increase in net income.

Net cash used in investing activities was $260 million for the year ended December 31, 2023 compared to $420 million for the same period in the prior year, primarily reflecting lower investment in business development transactions in the year ended December 31, 2023 compared to the prior year, partially offset by an increase in capital expenditures.

Net cash used in financing activities was $569 million for the year ended December 31, 2023 compared to $433 million for the same period in the prior year. The increase in cash used in financing activities was driven by the $250 million voluntary prepayment on the U.S. Dollar-denominated term loan in 2023 compared to the $100 million voluntary prepayment in 2022.

Capital expenditures were $251 million and $196 million for the years ended December 31, 2023 and 2022, respectively. Capital expenditures in 2023 and 2022 reflect investments in new capital projects focused primarily on establishing us as an independent Company. We estimate that we will continue to invest in new capital projects in 2024, for ongoing projects to stand up Organon, principally related to investments in information technology.

As part of our post-spinoff plan, we have approved an initiative to further optimize our manufacturing and supply network. As part of this initiative, we will continue to separate our supply chain through planned exits from supply agreements from Merck through 2031. This will enable us to redefine our appropriate sourcing strategy, and move to fit-for-purpose supply chains, while focusing on delivering efficiencies. We anticipate we will incur costs associated with this separation, including but not limited to accelerated depreciation, exit premiums and fees, technology transfer costs, stability and qualification batch costs, one-time resourcing costs, regulatory and filing costs, capital investment, and inventory stock bridges.

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For the year ended December 31, 2023 and 2022, our combined revenues from Ukraine, Russia and Israel were approximately 2% of total revenues. While we will continue to monitor the impacts of the Ukraine-Russia war and the Hamas-Israel war, as of December 31, 2023, our assets in Ukraine, Russia and Israel are not material.

Contractual Obligations

Our contractual obligations as of December 31, 2023, which require material cash requirements in the future, consist of contractual milestones, purchase obligations, lease obligations and the settlement of certain tax matters.

Contractual milestones are potential payments based upon the achievement of specified milestones associated with business development transactions. Such milestone payments will only be payable in the event that our collaborative partners achieve contractually defined success-based milestones such as the advancement of the specified research and development programs or the receipt of regulatory approval for the specified compounds or products and/or we reach a sales threshold of the specified compounds or products. The timing of the payments of the contractual milestones cannot be estimated and the likelihood of achieving the milestones cannot be determined. As of December 31, 2023, total potential payments due for contractual milestones are $1.9 billion. Potential amounts due within the next twelve months are $98 million.

Purchase obligations are enforceable and legally binding obligations for purchases of goods and services which include inventory purchase commitments. As of December 31, 2023, total payments due for purchase obligations are $1.2 billion and extend through 2031. Amounts due within the next twelve months are $376 million.

Long-term debt consists of both fixed and variable-rate instruments. As of December 31, 2023, total payments due for debt obligations are $8.8 billion and extend through 2031. Amounts due within the next twelve months are $9 million.

Lease obligations exclude reasonably certain lease renewals that have not yet been executed. As of December 31, 2023, total payments due for lease obligations are $189 million and extend through 2041. Amounts due within the next twelve months are $52 million.

During the 2024 fiscal year, we anticipate paying higher cash taxes than the 2023 fiscal year. In addition, we are responsible for settlement of certain tax matters, of which we expect to pay approximately $56 million within the next year.

During 2023, we paid cash dividends of $1.12 per share. On February 15, 2024, our Board of Directors declared a quarterly dividend of $0.28 for each issued and outstanding share of our common stock. The dividend is payable on March 14, 2024, to stockholders of record at the close of business on February 26, 2024.

Critical Accounting Estimates

The audited annual consolidated financial statements are prepared in conformity with U.S. 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.

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

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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, 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 2023, 2022, or 2021.

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 us 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 $87 million and $417 million, respectively, at December 31, 2023, $78 million and $307 million, respectively, at December 31, 2022 and $54 million and $275 million, respectively, at December 31, 2021. The increase in accrued rebates in 2023 is attributable to a wholesaler buy-in in conjunction with the exit of the IOM with Merck for the Follistim product.

Outside of the United States, variable consideration in the form of discounts and rebates is 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 certain countries 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.

See Note 3 "Summary of Accounting Policies" to the Consolidated Financial Statements included in this report 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 20 "Contingencies" to the Consolidated Financial Statements included in this report. We record accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated.

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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 $2 million in 2023, and are estimated at $15 million in the aggregate for the years 2024 through 2028. Liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $19 million and $20 million at December 31, 2023 and 2022, respectively. 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, we do not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $24 million in the aggregate. We also do 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 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 qualitative goodwill impairment test as of October 1, 2023 and concluded that there was no impairment to goodwill as the fair value of the reporting unit was significantly in excess of the carrying value.

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. We did not have impairment charges as of December 31, 2023. We recorded impairment charges of $9 million and $7 million as of December 31, 2022 and 2021 respectively. See Note 13 "Intangibles" to the Consolidated Financial Statements included in this report for additional details on Intangibles.

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 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 consolidated statement of income.

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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 on 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.

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 judgment. 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. We make certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If we determine 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), we account 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 we deem reasonable.

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 15 "Pension and Other Postretirement Benefit Plans" to the Consolidated Financial Statements.

For our pension plans, the discount rate is evaluated on measurement dates 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, we consider long-term compound annualized returns of historical market data, current market conditions and actual returns on our plan assets. Using this reference information, we develop 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.

Stock-Based Compensation

We expense all stock-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 stock-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

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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 "Summary of Accounting Policies" to the Consolidated Financial Statements included in this report.