Financial Instruments and Fair Value Measures | 3 Months Ended |
Mar. 31, 2014 |
Financial Instruments and Fair Value Measures | ' |
Financial Instruments and Fair Value Measures | ' |
Note 6 Financial Instruments and Fair Value Measures |
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Risk Management Policy |
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The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative instruments to reduce its exposure to foreign currency exchange rates. The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company periodically enters into interest rate swaps, based on judgment, to manage interest costs in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company’s outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. |
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Financial Instruments |
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Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $2.7 billion and $1.5 billion at March 31, 2014 and December 31, 2013, respectively, are designated as cash flow hedges and are recorded at fair value. Accumulated gains and losses as of March 31, 2014 will be included in cost of products sold at the time the products are sold, generally not exceeding twelve months. |
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The company enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. The contracts are marked-to-market, and resulting gains or losses are reflected in income and are generally offset by losses or gains on the foreign currency exposure being managed. At March 31, 2014 and December 31, 2013, AbbVie held notional amounts of $6.3 billion and $5.3 billion, respectively, of such foreign currency forward exchange contracts. |
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AbbVie is a party to interest rate hedge contracts, designated as fair value hedges, totaling $8.0 billion at both March 31, 2014 and December 31, 2013. The effect of the hedge is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie recorded the contracts at fair value and adjusted the carrying amount of the fixed-rate debt by an offsetting amount. |
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The following table summarizes the amounts and location of AbbVie’s derivative instruments as of March 31, 2014. |
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| | Derivatives in asset position | | | Derivatives in liability position | | |
(in millions) | | Fair value | | Balance sheet caption | | | Fair value | | Balance sheet caption | | |
Interest rate swaps designated as fair value hedges | | $— | | n/a | | | $346 | | Long-term liabilities | | |
Foreign currency forward exchange contracts — | | | | | | | | | | | |
Hedging instruments | | 17 | | Prepaid expenses and other | | | 36 | | Accounts payable and accrued liabilities | | |
Others not designated as hedges | | 25 | | Prepaid expenses and other | | | 35 | | Accounts payable and accrued liabilities | | |
Total | | $42 | | | | | $417 | | | | |
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The following table summarizes the amounts and location of AbbVie’s derivative instruments as of December 31, 2013. |
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| | Derivatives in asset position | | | Derivatives in liability position | | |
(in millions) | | Fair value | | Balance sheet caption | | | Fair value | | Balance sheet caption | | |
Interest rate swaps designated as fair value hedges | | $— | | n/a | | | $432 | | Long-term liabilities | | |
Foreign currency forward exchange contracts — | | | | | | | | | | | |
Hedging instruments | | — | | Prepaid expenses and other | | | 61 | | Accounts payable and accrued liabilities | | |
Others not designated as hedges | | 17 | | Prepaid expenses and other | | | 12 | | Accounts payable and accrued liabilities | | |
Total | | $17 | | | | | $505 | | | | |
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While certain derivatives are subject to netting arrangements with the company’s counterparties, the company does not offset derivative assets and liabilities within the condensed consolidated balance sheets. |
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The following table summarizes the activity for derivative instruments and the amounts and location of income (expense) and gain (loss) reclassified into income and for certain other derivative instruments for the three months ended March 31, 2014 and 2013, respectively. The amount of hedge ineffectiveness was not significant for the three months ended March 31, 2014 or 2013. |
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| | (Loss) gain | | Income (expense) | | | |
recognized in other | and gain (loss) |
comprehensive | reclassified into or |
(loss) income | recorded in net income |
(in millions) | | 2014 | | 2013 | | 2014 | | 2013 | | Income statement caption | |
Foreign currency forward exchange contracts — | | | | | | | | | | | |
Designated as cash flow hedges | | $21 | | $9 | | ($12) | | $— | | Cost of products sold | |
Not designated as hedges | | n/a | | n/a | | -1 | | -9 | | Net foreign exchange loss | |
Interest rate swaps designated as fair value hedges | | n/a | | n/a | | 86 | | -40 | | Interest expense, net | |
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The gain/(loss) related to fair value hedges is recognized in net interest expense and directly offsets the (loss)/gain on the underlying hedged item, the fixed-rate debt, resulting in no net impact to net interest expense for the three months ended March 31, 2014 and 2013. |
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Fair Value Measures |
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The fair value hierarchy under the accounting standard for fair value measurements consists of the following three levels. |
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· Level 1 – Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; |
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· Level 2 – Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuations in which all significant inputs are observable in the market; and |
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· Level 3 – Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company’s management about the assumptions market participants would use in pricing the asset or liability. |
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The following table summarizes the bases used to measure certain assets and liabilities that are carried at fair value on a recurring basis in the condensed consolidated balance sheet as of March 31, 2014. |
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| | | | Basis of fair value measurement | | | |
(in millions) | | Balance at | | Quoted prices in | | Significant other | | Significant | | | |
March 31, 2014 | active markets for | observable inputs | unobservable inputs | | |
| identical assets | (Level 2) | (Level 3) | | |
| (Level 1) | | | | |
Assets | | | | | | | | | | | |
Cash and equivalents | | $8,140 | | $618 | | $7,522 | | $— | | | |
Time deposits | | 960 | | — | | 960 | | — | | | |
Equity securities | | 12 | | 12 | | — | | — | | | |
Foreign currency contracts | | 42 | | — | | 42 | | — | | | |
Total assets | | $9,154 | | $630 | | $8,524 | | $— | | | |
Liabilities | | | | | | | | | | | |
Interest rate hedges | | $346 | | $— | | $346 | | $— | | | |
Foreign currency contracts | | 71 | | — | | 71 | | — | | | |
Contingent consideration | | 27 | | — | | — | | 27 | | | |
Total liabilities | | $444 | | $— | | $417 | | $27 | | | |
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The following table summarizes the bases used to measure certain assets and liabilities that are carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2013. |
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| | | | Basis of fair value measurement | | | |
(in millions) | | Balance at | | Quoted prices in | | Significant other | | Significant | | | |
December 31, 2013 | active markets for | observable inputs | unobservable inputs | | |
| identical assets | (Level 2) | (Level 3) | | |
| (Level 1) | | | | |
Assets | | | | | | | | | | | |
Cash and equivalents | | $9,595 | | $684 | | $8,911 | | $— | | | |
Time deposits | | 300 | | — | | 300 | | — | | | |
Equity securities | | 10 | | 10 | | — | | — | | | |
Foreign currency contracts | | 17 | | — | | 17 | | — | | | |
Total assets | | $9,922 | | $694 | | $9,228 | | $— | | | |
Liabilities | | | | | | | | | | | |
Interest rate hedges | | $432 | | $— | | $432 | | $— | | | |
Foreign currency contracts | | 73 | | — | | 73 | | — | | | |
Contingent consideration | | 165 | | — | | — | | 165 | | | |
Total liabilities | | $670 | | $— | | $505 | | $165 | | | |
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The fair values for time deposits included in cash and equivalents and short-term investments are determined based on a discounted cash flow analysis reflecting quoted market rates for the same or similar instruments. The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. Available-for-sale equity securities consists of investments for which the fair value is determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company are valued using publicized spot curves for interest rate hedges and publicized forward curves for foreign currency contracts. The contingent consideration is valued using a discounted cash flow technique that reflects management’s expectations about probability of payment. |
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Cumulative unrealized holding gains on available-for-sale equity securities totaled $2 million at both March 31, 2014 and December 31, 2013, respectively. |
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There have been no transfers of assets or liabilities between the fair value measurement levels. The following table is a reconciliation of the fair value measurements that use significant unobservable inputs (Level 3), which consist of contingent payments related to acquisitions and investments. |
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(in millions) | | | | | | | | | | | |
Fair value as of December 31, 2013 | | $165 | | | | | | | | | |
Payments | | (137 | ) | | | | | | | | |
Change in fair value recognized in net foreign exchange loss | | (1 | ) | | | | | | | | |
Fair value as of March 31, 2014 | | $27 | | | | | | | | | |
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In connection with the acquisition of Solvay’s U.S. pharmaceuticals business in 2010, the achievement of a certain sales milestone resulted in a payment of approximately $137 million in the first quarter of 2014 for which a liability was previously established. |
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In addition to the financial instruments that the company is required to recognize at fair value on the condensed consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. The carrying values and fair values of certain financial instruments as of March 31, 2014 and December 31, 2013 are shown in the table below. |
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| | Book values | | Approximate fair values | | | |
(in millions) | | March 31, | | December 31, | | March 31, | | December 31, | | | |
2014 | 2013 | 2014 | 2013 | | |
Assets | | | | | | | | | | | |
Investments | | $107 | | $108 | | $144 | | $129 | | | |
Liabilities | | | | | | | | | | | |
Short-term borrowings | | 2 | | 413 | | 2 | | 413 | | | |
Current portion of long-term debt and lease obligations | | 18 | | 18 | | 18 | | 18 | | | |
Long-term debt and lease obligations, excluding fair value hedges | | 14,732 | | 14,724 | | 14,696 | | 14,493 | | | |
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The following table summarizes the bases used to measure the approximate fair values of the financial instruments as of March 31, 2014. |
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| | | | | Basis of fair value measurement | | |
(in millions) | | Fair value at | | | Quoted prices in active | | Significant | | Significant | | |
March 31, 2014 | markets for identical | other observable | unobservable | |
| assets | inputs | inputs | |
| (Level 1) | (Level 2) | (Level 3) | |
Assets | | | | | | | | | | | |
Investments | | $144 | | | $54 | | $31 | | $59 | | |
Total assets | | $144 | | | $54 | | $31 | | $59 | | |
Liabilities | | | | | | | | | | | |
Short-term borrowings | | $2 | | | $— | | $2 | | $— | | |
Current portion of long-term debt and lease obligations | | 18 | | | — | | 18 | | — | | |
Long-term debt and lease obligations, excluding fair value hedges | | 14,696 | | | 14,609 | | 87 | | — | | |
Total liabilities | | $14,716 | | | $14,609 | | $107 | | $— | | |
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The following table summarizes the bases used to measure the approximate fair values of the financial instruments as of December 31, 2013. |
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| | | | | Basis of fair value measurement | | |
(in millions) | | Fair value at | | | Quoted prices in active | | Significant | | Significant | | |
December 31, | markets for identical | other observable | unobservable | |
2013 | assets | inputs | inputs | |
| (Level 1) | (Level 2) | (Level 3) | |
Assets | | | | | | | | | | | |
Investments | | $129 | | | $39 | | $30 | | $60 | | |
Total assets | | $129 | | | $39 | | $30 | | $60 | | |
Liabilities | | | | | | | | | | | |
Short-term borrowings | | $413 | | | $— | | $413 | | $— | | |
Current portion of long-term debt and lease obligations | | 18 | | | — | | 18 | | — | | |
Long-term debt and lease obligations, excluding fair value hedges | | 14,493 | | | 14,413 | | 80 | | — | | |
Total liabilities | | $14,924 | | | $14,413 | | $511 | | $— | | |
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Investments consist of cost method investments and held-to-maturity debt securities. Cost method investments include certain investments for which the fair value is determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. To determine the fair value of other cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement. The fair value of held-to-maturity debt securities was estimated based upon the quoted market prices for the same or similar debt instruments. The fair values of short-term and current borrowings approximate the carrying values due to the short maturities of these instruments. |
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The fair value of long-term debt, excluding fair value hedges, was determined by using the published market price for the debt instruments, without consideration of transaction costs, which represents a Level 1 basis of fair value measurement. The counterparties to financial instruments consist of select major international financial institutions. |
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Concentrations of Risk |
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The company invests excess cash in time deposits, money market funds and U.S. Treasury securities and diversifies the concentration of cash among different financial institutions. The company monitors concentrations of credit risk associated with deposits with financial institutions. Credit exposure limits have been established to limit a concentration with any single issuer or institution. |
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Three U.S. wholesalers accounted for 34 percent and 38 percent of total net accounts receivable as of March 31, 2014 and December 31, 2013, respectively, and substantially all of AbbVie’s U.S. sales are to these three wholesalers. In addition, net governmental receivables outstanding in Greece, Portugal, Italy and Spain totaled $566 million at March 31, 2014 and $781 million at December 31, 2013. |
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HUMIRA is AbbVie’s single largest product and accounted for approximately 58 percent and 52 percent of AbbVie’s total net sales in the first three months ended March 31, 2014 and 2013, respectively. |
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Short-Term Borrowings |
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At December 31, 2013, short-term borrowings included $400 million of commercial paper borrowings. No commercial paper balances were outstanding as of March 31, 2014. The weighted-average interest rate on the commercial paper was 0.2% for the three months ended March 31, 2014. No borrowings were outstanding under the $2.0 billion unsecured bank credit facility as of March 31, 2014. |