QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File No. 0-19731
GILEAD SCIENCES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
94-3047598
(State or Other Jurisdiction of
Incorporation or Organization)
(IRS Employer
Identification No.)
333 Lakeside Drive, Foster City, California
94404
(Address of principal executive offices)
(Zip Code)
650-574-3000
Registrant’s Telephone Number, Including Area Code
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
Number of shares outstanding of the issuer’s common stock, par value $0.001 per share, as of July 20, 2012: 756,568,507
We own or have rights to various trademarks, copyrights and trade names used in our business, including the following: GILEAD®, GILEAD SCIENCES®, TRUVADA®, VIREAD®, HEPSERA®, AMBISOME®, EMTRIVA®, COMPLERA®, EVIPLERA®, VISTIDE®, LETAIRIS®, VOLIBRIS®, RANEXA®, CAYSTON® and RAPISCAN®. ATRIPLA® is a registered trademark belonging to Bristol-Myers Squibb & Gilead Sciences, LLC. LEXISCAN® is a registered trademark belonging to Astellas U.S. LLC. MACUGEN® is a registered trademark belonging to Valeant Pharmaceuticals International, Inc. SUSTIVA® is a registered trademark of Bristol-Myers Squibb Pharma Company. TAMIFLU® is a registered trademark belonging to Hoffmann-La Roche Inc. This report also includes other trademarks, service marks and trade names of other companies.
PART I.
FINANCIAL INFORMATION
ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
June 30, 2012
December 31, 2011
(unaudited)
Assets
Current assets:
Cash and cash equivalents
$
1,625,500
$
9,883,777
Short-term marketable securities
82,044
16,491
Accounts receivable, net
1,702,818
1,951,167
Inventories
1,603,401
1,389,983
Deferred tax assets
213,448
208,155
Prepaid taxes
306,256
246,444
Prepaid expenses
83,732
95,922
Other current assets
226,903
126,846
Total current assets
5,844,102
13,918,785
Property, plant and equipment, net
811,799
774,406
Noncurrent portion of prepaid royalties
164,263
174,584
Noncurrent deferred tax assets
116,263
144,015
Long-term marketable securities
564,130
63,704
Intangible assets, net
11,751,191
1,062,864
Goodwill
1,078,919
1,004,102
Other noncurrent assets
171,283
160,674
Total assets
$
20,501,950
$
17,303,134
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
$
1,367,353
$
1,206,052
Accrued government rebates
771,827
547,473
Accrued compensation and employee benefits
144,834
173,316
Income taxes payable
11,847
40,583
Other accrued liabilities
624,337
471,129
Deferred revenues
93,660
74,665
Current portion of long-term debt and other obligations, net
1,972,816
1,572
Total current liabilities
4,986,674
2,514,790
Long-term deferred revenues
23,662
31,870
Long-term debt, net
7,126,377
7,605,734
Long-term income taxes payable
126,655
135,655
Other long-term obligations
155,195
147,736
Commitments and contingencies (Note 10)
Stockholders’ equity:
Preferred stock, par value $0.001 per share; 5,000 shares authorized; none outstanding
—
—
Common stock, par value $0.001 per share; 2,800,000 shares authorized; 756,153 and 753,106 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively
756
753
Additional paid-in capital
5,213,910
4,903,143
Accumulated other comprehensive income
124,377
58,200
Retained earnings
2,663,077
1,776,760
Total Gilead stockholders’ equity
8,002,120
6,738,856
Noncontrolling interest
81,267
128,493
Total stockholders’ equity
8,083,387
6,867,349
Total liabilities and stockholders’ equity
$
20,501,950
$
17,303,134
See accompanying notes.
2
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Revenues:
Product sales
$
2,321,240
$
2,039,588
$
4,529,582
$
3,903,166
Royalty revenues
81,106
94,321
152,211
152,986
Contract and other revenues
2,840
3,344
5,842
7,195
Total revenues
2,405,186
2,137,253
4,687,635
4,063,347
Costs and expenses:
Cost of goods sold
617,345
533,863
1,198,276
1,007,974
Research and development
396,244
282,403
854,455
536,849
Selling, general and administrative
332,505
304,269
775,626
599,837
Total costs and expenses
1,346,094
1,120,535
2,828,357
2,144,660
Income from operations
1,059,092
1,016,718
1,859,278
1,918,687
Interest expense
(88,418
)
(46,107
)
(185,688
)
(87,323
)
Other income (expense), net
(1,075
)
11,978
(35,160
)
25,810
Income before provision for income taxes
969,599
982,589
1,638,430
1,857,174
Provision for income taxes
263,525
240,130
494,825
467,412
Net income
706,074
742,459
1,143,605
1,389,762
Net loss attributable to noncontrolling interest
5,490
3,768
9,915
7,606
Net income attributable to Gilead
$
711,564
$
746,227
$
1,153,520
$
1,397,368
Net income per share attributable to Gilead common stockholders—basic
$
0.94
$
0.95
$
1.52
$
1.77
Shares used in per share calculation—basic
756,951
784,807
756,619
790,430
Net income per share attributable to Gilead common stockholders—diluted
$
0.91
$
0.93
$
1.48
$
1.73
Shares used in per share calculation—diluted
780,506
800,800
779,246
806,462
See accompanying notes.
3
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Net income
$
706,074
$
742,459
$
1,143,605
$
1,389,762
Other comprehensive income:
Net foreign currency translation gain (loss)
(2,642
)
(4,358
)
2,256
2,836
Available-for-sale securities:
Net unrealized gain (loss), net of tax impact of $(79) and $(5,945) for the three months ended June 30, 2012 and 2011, and $188 and $(6,254) for the six months ended June 30, 2012 and 2011, respectively
134
2,346
(329
)
723
Reclassifications to net income, net of tax impact of $(29) and $(1,774) for the three months ended June 30, 2012 and 2011, and $(547) and $(2,611) for the six months ended June 30, 2012 and 2011, respectively
(50
)
(3,068
)
30,549
(4,565
)
Net change
84
(722
)
30,220
(3,842
)
Cash flow hedges:
Net unrealized gain (loss), net of tax impact of $(4,074) and $2,609 for the three months ended June 30, 2012 and 2011, and $(2,318) and $101 for the six months ended June 30, 2012 and 2011, respectively
107,855
(46,857
)
58,993
(174,194
)
Reclassification to net income, net of tax impact of $(548) and $1,105 for the three months ended June 30, 2012 and 2011, and $(994) and $6 for the six months ended June 30, 2012 and 2011, respectively
(14,511
)
19,840
(25,292
)
11,010
Net change
93,344
(27,017
)
33,701
(163,184
)
Other comprehensive income (loss)
90,786
(32,097
)
66,177
(164,190
)
Comprehensive income
796,860
710,362
1,209,782
1,225,572
Comprehensive loss attributable to noncontrolling interest
5,490
3,768
9,915
7,606
Comprehensive income attributable to Gilead
$
802,350
$
714,130
$
1,219,697
$
1,233,178
See accompanying notes.
4
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended
June 30,
2012
2011
Operating Activities:
Net income
$
1,143,605
$
1,389,762
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense
39,937
36,030
Amortization expense
93,642
119,776
Stock-based compensation expense
97,134
99,595
Excess tax benefits from stock-based compensation
(35,439
)
(20,298
)
Tax benefits from employee stock plans
30,804
17,796
Deferred income taxes
21,966
40,008
Other
1,064
6,150
Changes in operating assets and liabilities:
Accounts receivable, net
180,167
(221,966
)
Inventories
(213,190
)
(114,644
)
Prepaid expenses and other assets
(32,329
)
10,884
Accounts payable
230,614
295,648
Income taxes payable
(102,093
)
51,585
Accrued liabilities
276,944
98,541
Deferred revenues
10,794
(45,070
)
Net cash provided by operating activities
1,743,620
1,763,797
Investing Activities:
Purchases of marketable securities
(607,078
)
(2,714,090
)
Proceeds from sales of marketable securities
63,274
2,225,064
Proceeds from maturities of marketable securities
2,951
348,968
Acquisitions, net of cash acquired
(10,751,636
)
(588,608
)
Purchases of other investments
(25,000
)
—
Capital expenditures
(60,591
)
(41,505
)
Net cash used in investing activities
(11,378,080
)
(770,171
)
Financing Activities:
Proceeds from issuances of senior notes, net of issuance costs
—
987,370
Proceeds from issuances of common stock
201,791
115,912
Proceeds from credit facilities, net of issuance costs
1,146,844
—
Proceeds from term loan, net of issuance costs
997,889
—
Repayments of term loan
(700,000
)
—
Repurchases of common stock
(261,791
)
(1,272,862
)
Repayments of convertible senior notes
—
(649,987
)
Repayments of other long-term obligations
(2,151
)
(1,567
)
Excess tax benefits from stock-based compensation
35,439
20,298
Distributions to noncontrolling interest
(37,310
)
(86,016
)
Net cash provided by (used in) financing activities
1,380,711
(886,852
)
Effect of exchange rate changes on cash
(4,528
)
(108,874
)
Net change in cash and cash equivalents
(8,258,277
)
(2,100
)
Cash and cash equivalents at beginning of period
9,883,777
907,879
Cash and cash equivalents at end of period
$
1,625,500
$
905,779
See accompanying notes.
5
GILEAD SCIENCES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. The financial statements include all adjustments (consisting only of normal recurring adjustments) that the management of Gilead Sciences, Inc. (Gilead, we or us) believes are necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year or for any subsequent interim period.
The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, we evaluate our estimates, including critical accounting policies or estimates related to revenue recognition, intangible assets, allowance for doubtful accounts, prepaid royalties, clinical trial accruals, our tax provision and stock-based compensation. We base our estimates on historical experience and on various other market specific and other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.
The accompanying Condensed Consolidated Financial Statements include the accounts of Gilead, our wholly-owned subsidiaries and our joint ventures with Bristol-Myers Squibb Company (BMS), for which we are the primary beneficiary. We record a noncontrolling interest in our Condensed Consolidated Financial Statements to reflect BMS’s interest in the joint ventures. All intercompany transactions have been eliminated. The Condensed Consolidated Financial Statements include the results of companies acquired by us from the date of each acquisition for the applicable reporting periods.
The accompanying Condensed Consolidated Financial Statements and related financial information should be read in conjunction with the audited Consolidated Financial Statements and the related notes thereto for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC). Certain amounts within our Condensed Consolidated Financial Statements have been reclassified to conform to the current presentation.
Net Income Per Share Attributable to Gilead Common Stockholders
Basic net income per share attributable to Gilead common stockholders is calculated based on the weighted-average number of shares of our common stock outstanding during the period. Diluted net income per share attributable to Gilead common stockholders is calculated based on the weighted-average number of shares of our common stock outstanding and other dilutive securities outstanding during the period. The potential dilutive shares of our common stock resulting from the assumed exercise of outstanding stock options, performance shares and the assumed exercise of warrants relating to the convertible senior notes due in May 2013 (May 2013 Notes), May 2014 (May 2014 Notes) and May 2016 (May 2016 Notes) (collectively, the Convertible Notes) are determined under the treasury stock method.
Because the principal amount of the Convertible Notes will be settled in cash, only the conversion spread relating to the Convertible Notes is included in our calculation of diluted net income per share attributable to Gilead common stockholders. Our common stock resulting from the assumed settlement of the conversion spread of the Convertible Notes has a dilutive effect when the average market price of our common stock during the period exceeds the conversion prices of $38.10, $45.08 and $45.41 for the May 2013 Notes, May 2014 Notes and May 2016 Notes, respectively.
In 2011, our convertible senior notes due in May 2011 (May 2011 Notes) matured and the related warrants expired. As a result, we have only considered their impact for the period they were outstanding on our net income per share calculations. Our common stock resulting from the assumed settlement of the conversion spread of the May 2011 Notes had a dilutive effect when the average market price of our common stock during the period exceeded the conversion price of $38.75. During the three and six months ended June 30, 2011, the average market price of our common stock exceeded the conversion price of the May 2011 Notes and the dilutive effect is included in the accompanying table. Warrants related to the May 2011 Notes had a dilutive effect when the average market price of our common stock during the period exceeded the warrants’ exercise price of $50.80. The average market price of our common stock during the three and six months ended June 30, 2011 did not exceed the exercise price of the warrants related to the May 2011 Notes; therefore, these warrants did not have a dilutive effect on our net income per share for those periods.
6
During the three and six months ended June 30, 2012, the average market price of our common stock exceeded the conversion prices of the May 2013 Notes, May 2014 Notes and May 2016 Notes and the dilutive effects are included in the accompanying table. During the three and six months ended June 30, 2011, the average market price of our common stock exceeded the conversion price of the May 2013 Notes and the dilutive effect is included in the accompanying table. During the three and six months ended June 30, 2011, the average market price of our common stock did not exceed the conversion prices of the May 2014 Notes and May 2016 Notes and therefore, these notes did not have a dilutive effect on our net income per share for those periods.
Warrants relating to the May 2013 Notes, May 2014 Notes and May 2016 Notes have a dilutive effect when the average market price of our common stock during the period exceeds the warrants’ exercise prices of $53.90, $56.76 and $60.10, respectively. The average market prices of our common stock during each of the three and six months ended June 30, 2012 and 2011 did not exceed the warrants’ exercise prices relating to any of the Convertible Notes; therefore, these warrants did not have a dilutive effect on our net income per share for those periods.
Stock options to purchase approximately 9.2 million weighted-average shares of our common stock were outstanding during both the three and six months ended June 30, 2012, but were not included in the computation of diluted net income per share attributable to Gilead common stockholders because their effect was antidilutive. Stock options to purchase approximately 21.6 million and 21.8 million weighted-average shares of our common stock were outstanding during the three and six months ended June 30, 2011, respectively, but were not included in the computation of diluted net income per share attributable to Gilead common stockholders because their effect was antidilutive.
The following table is a reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share attributable to Gilead common stockholders (in thousands):
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Numerator:
Net income attributable to Gilead
$
711,564
$
746,227
$
1,153,520
$
1,397,368
Denominator:
Weighted-average shares of common stock outstanding used in the calculation of basic net income per share attributable to Gilead common stockholders
756,951
784,807
756,619
790,430
Effect of dilutive securities:
Stock options and equivalents
14,386
14,461
14,882
14,817
Conversion spread related to the May 2011 Notes
—
432
—
402
Conversion spread related to the May 2013 Notes
4,029
1,100
3,735
813
Conversion spread related to the May 2014 Notes
2,672
—
2,107
—
Conversion spread related to the May 2016 Notes
2,468
—
1,903
—
Weighted-average shares of common stock outstanding used in the calculation of diluted net income per share attributable to Gilead common stockholders
780,506
800,800
779,246
806,462
Concentrations of Risk
We are subject to credit risk from our portfolio of cash equivalents and marketable securities. Under our investment policy, we limit amounts invested in such securities by credit rating, maturity, industry group, investment type and issuer, except for securities issued by the U.S. government. We are not exposed to any significant concentrations of credit risk from these financial instruments. The goals of our investment policy, in order of priority, are as follows: safety and preservation of principal and diversification of risk; liquidity of investments sufficient to meet cash flow requirements; and a competitive after-tax rate of return.
We are also subject to credit risk from our accounts receivable related to our product sales. The majority of our trade accounts receivable arises from product sales in the United States and Europe.
7
As of June 30, 2012, our accounts receivable in Southern Europe, specifically Greece, Italy, Portugal and Spain, totaled approximately $791.8 million, of which $291.4 million were greater than 120 days past due and $114.6 million were greater than 365 days past due. To date, we have not experienced significant losses with respect to the collection of our accounts receivable. We believe that our allowance for doubtful accounts was adequate at June 30, 2012.
In June 2012, we received payment on $460.6 million in past due accounts receivable from customers based in Spain. Included in this amount were proceeds from a one-time factoring arrangement where we sold receivables with a carrying value of $319.8 million, net of the allowance for doubtful accounts. We received proceeds of $349.7 million and recorded a gain of $29.9 million, resulting primarily from the reversal of the related allowance for doubtful accounts. This gain was recorded as an offset to selling, general and administrative (SG&A) expenses in our Condensed Consolidated Statement of Income. As of June 30, 2012, we had no continuing involvement with the transferred receivables, which were derecognized at the time of the sale.
Recent Accounting Pronouncements
During the three months ended June 30, 2012, there were no new accounting pronouncements issued that are expected to significantly impact our consolidated financial statements or results of operations.
2.
FAIR VALUE MEASUREMENTS
We determine the fair value of financial and non-financial assets and liabilities using the fair value hierarchy, which establishes three levels of inputs that may be used to measure fair value, as follows:
•
Level 1 inputs which include quoted prices in active markets for identical assets or liabilities;
•
Level 2 inputs which include observable inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability. For our marketable securities, we review trading activity and pricing as of the measurement date. When sufficient quoted pricing for identical securities is not available, we use market pricing and other observable market inputs for similar securities obtained from various third-party data providers. These inputs either represent quoted prices for similar assets in active markets or have been derived from observable market data; and
•
Level 3 inputs which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
Our financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable, foreign currency exchange forward and option contracts, accounts payable, and short-term and long-term debt. Cash and cash equivalents, marketable securities and foreign currency exchange contracts that hedge accounts receivable and forecasted product sales are reported at their respective fair values on our Condensed Consolidated Balance Sheets. The carrying value and fair value of the Convertible Notes were $2.96 billion and $4.06 billion, respectively, as of June 30, 2012. The carrying value and fair value of the Convertible Notes were $2.92 billion and $3.53 billion, respectively, as of December 31, 2011.
In March 2011, we issued senior unsecured notes due in April 2021 (April 2021 Notes) in a registered offering for an aggregate principal amount of $1.00 billion. The carrying value and fair value of the April 2021 Notes were $992.5 million and $1.11 billion, respectively, as of June 30, 2012. The carrying value and fair value of the April 2021 Notes were $992.1 million and $1.06 billion, respectively, as of December 31, 2011. In December 2011, we issued senior unsecured notes due in December 2014 (December 2014 Notes), December 2016 (December 2016 Notes), December 2021 (December 2021 Notes) and December 2041 (December 2041 Notes) in a registered offering for an aggregate principal amount of $3.70 billion. The carrying value and fair value of these notes were $3.69 billion and $4.09 billion, respectively, as of June 30, 2012. The carrying value and fair value of these notes were $3.69 billion and $3.93 billion, respectively, as of December 31, 2011. The fair values of the Convertible Notes and senior unsecured notes were determined using Level 2 inputs based on their quoted market values.
The remaining financial instruments are reported on our Condensed Consolidated Balance Sheets at amounts that approximate current fair values.
8
The following table summarizes, for assets or liabilities recorded at fair value, the respective fair value and the classification by level of input within the fair value hierarchy defined above (in thousands):
June 30, 2012
December 31, 2011
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
Total
Assets:
Debt securities:
U.S. treasury securities
$
168,679
$
—
$
—
$
168,679
$
—
$
—
$
—
$
—
Money market funds
1,252,482
—
—
1,252,482
7,455,982
—
—
7,455,982
Certificates of deposit
—
—
—
—
—
1,139,982
—
1,139,982
U.S. government agencies and FDIC guaranteed securities
—
203,568
—
203,568
—
—
—
—
Non-U.S. government securities
—
—
—
—
—
—
24,741
24,741
Municipal debt securities
—
8,074
—
8,074
—
—
—
—
Corporate debt securities
—
193,886
—
193,886
—
404,989
—
404,989
Residential mortgage and asset-backed securities
—
33,295
—
33,295
—
—
—
—
Student loan-backed securities
—
—
43,872
43,872
—
—
46,952
46,952
Total debt securities
1,421,161
438,823
43,872
1,903,856
7,455,982
1,544,971
71,693
9,072,646
Equity securities
—
—
—
—
8,503
—
—
8,503
Derivatives
—
134,464
—
134,464
—
100,475
—
100,475
$
1,421,161
$
573,287
$
43,872
$
2,038,320
$
7,464,485
$
1,645,446
$
71,693
$
9,181,624
Liabilities:
Contingent consideration
$
—
$
—
$
140,897
$
140,897
$
—
$
—
$
135,591
$
135,591
Derivatives
—
4,090
—
4,090
—
5,710
—
5,710
$
—
$
4,090
$
140,897
$
144,987
$
—
$
5,710
$
135,591
$
141,301
Level 2 Inputs
We estimate the fair values of our government related debt, corporate debt, residential mortgage and asset-backed securities by taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income- and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities; prepayment/default projections based on historical data; and other observable inputs.
9
Substantially all of our foreign currency derivatives contracts have maturities primarily over an 18 month time horizon and all are with counterparties that have a minimum credit rating of A- or equivalent by Standard & Poor's, Moody's Investors Service, Inc. or Fitch, Inc. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that utilizes an income-based industry standard valuation model for which all significant inputs are observable, either directly or indirectly. These inputs include foreign currency rates, London Interbank Offered Rates (LIBOR), and swap rates. These inputs, where applicable, are at commonly quoted intervals.
Level 3 Inputs
Assets measured at fair value using Level 3 inputs at June 30, 2012 were comprised of auction rate securities within our available-for-sale investment portfolio. The following table provides a rollforward of assets measured using Level 3 inputs (in thousands):
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Balance, beginning of period
$
48,168
$
116,823
$
71,693
$
80,365
Total realized and unrealized gains (losses) included in:
Other income (expense), net
83
1,625
(40,013
)
2,871
Other comprehensive income, net
1,155
(7,854
)
34,249
(5,694
)
Sales of marketable securities
(5,534
)
(6,450
)
(22,057
)
(27,280
)
Transfers into Level 3
—
1
—
53,883
Balance, end of period
$
43,872
$
104,145
$
43,872
$
104,145
Our policy is to recognize transfers into or out of Level 3 classification as of the actual date of the event or change in circumstances that caused the transfer. The underlying assets of our auction rate securities consist of student loans. Although auction rate securities would typically be measured using Level 2 inputs, the failure of auctions and the lack of market activity and liquidity experienced since the beginning of 2008 required that these securities be measured using Level 3 inputs. The fair value of our auction rate securities was determined using a discounted cash flow model that considered projected cash flows for the issuing trusts, underlying collateral and expected yields. Projected cash flows were estimated based on the underlying loan principal, bonds outstanding and payout formulas. The weighted-average life over which the cash flows were projected considered the collateral composition of the securities and related historical and projected prepayments. The underlying student loans have a weighted-average expected life of two to six years. The discount rates used in our discounted cash flow model were based on market conditions for comparable or similar term asset-backed and other fixed income securities, adjusted for an illiquidity discount. This resulted in an annual discount rate of 1.97%. Our auction rate securities reset every seven to 14 days with maturity dates ranging from 2025 through 2040 and have annual interest rates ranging from 0.28% to 0.98%. As of June 30, 2012, our auction rate securities continued to earn interest. Although there continued to be failed auctions as well as lack of market activity and liquidity, we believe we had no other-than-temporary impairments on these securities as of June 30, 2012. We have the ability to hold these securities until the recovery of their amortized cost basis.
In 2010, the Greek government agreed to settle the majority of its aged outstanding accounts receivable with zero-coupon bonds, which were expected to trade at a discount to face value. We estimated the fair value of the Greek zero-coupon bonds using Level 3 inputs due to the then current lack of market activity and liquidity. The discount rates used in our fair value model for these bonds were based on credit default swap rates. In March 2012, the Greek government restructured its sovereign debt which impacted all holders of Greek bonds. As a result, we recorded a $40.1 million loss related to the debt restructuring as part of other income (expense), net on our Condensed Consolidated Statement of Income and exchanged the Greek government-issued bonds for new securities, which we liquidated during the first quarter of 2012.
As of June 30, 2012 and December 31, 2011, our auction rate securities were recorded in long-term marketable securities on our Condensed Consolidated Balance Sheets. As of December 31, 2011, our Greek government-issued bonds were recorded in short-term and long-term marketable securities on our Condensed Consolidated Balance Sheets.
10
The following table provides a rollforward of our contingent consideration liabilities (in thousands):
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Balance, beginning of period
$
138,328
$
11,100
$
135,591
$
11,100
Additions
—
116,008
—
116,008
Changes in valuation
2,569
(418
)
5,306
(418
)
Balance, end of period
$
140,897
$
126,690
$
140,897
$
126,690
The estimated fair value of the contingent consideration liabilities for our acquisitions was based on the present value of the total earnout amount giving consideration to significant inputs such as the probability of technical and regulatory success, the discount rate used and the timeline to achieve each of the milestone events. Significant increases in the probability of success in isolation would result in a significantly higher fair value measurement while significant decreases in the probability of success in isolation would result in a significantly lower fair value measurement. Similarly, significant increases in the discount rate or timeline in isolation would result in a significantly lower fair value measurement while significant decreases in the discount rate or timeline in isolation would result in a significantly higher fair value measurement. We evaluate changes in each of the assumptions used to calculate fair values of our contingent consideration liabilities at the end of each period.
11
3.
AVAILABLE-FOR-SALE SECURITIES
The following table is a summary of available-for-sale debt and equity securities included in cash and cash equivalents or marketable securities in our Condensed Consolidated Balance Sheets. During the first quarter of 2012, we liquidated a portion of our investment portfolio to partially fund the acquisition of Pharmasset, Inc. (Pharmasset) which was completed in January 2012. Estimated fair values of available-for-sale securities are generally based on prices obtained from commercial pricing services (in thousands):
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
June 30, 2012
Debt securities:
U.S. treasury securities
$
168,598
$
89
$
(8
)
$
168,679
Money market funds
1,252,482
—
—
1,252,482
Certificates of deposit
—
—
—
—
U.S. government agencies securities
203,583
98
(113
)
203,568
Non-U.S. government securities
—
—
—
—
Municipal debt securities
8,089
—
(15
)
8,074
Corporate debt securities
193,944
142
(200
)
193,886
Residential mortgage-backed and asset-backed securities
33,303
18
(26
)
33,295
Student loan-backed securities
46,050
—
(2,178
)
43,872
Total debt securities
1,906,049
347
(2,540
)
1,903,856
Equity securities
—
—
—
—
Total
$
1,906,049
$
347
$
(2,540
)
$
1,903,856
December 31, 2011
Debt securities:
U.S. treasury securities
$
—
$
—
$
—
$
—
Money market funds
7,455,982
—
—
$
7,455,982
Certificates of deposit
1,140,000
—
(18
)
1,139,982
U.S. government agencies securities
—
—
—
—
Non-U.S. government securities
55,246
—
(30,505
)
24,741
Municipal debt securities
—
—
—
—
Corporate debt securities
404,994
—
(5
)
404,989
Residential mortgage-backed and asset-backed securities
—
—
—
—
Student loan-backed securities
51,500
—
(4,548
)
46,952
Total debt securities
9,107,722
—
(35,076
)
9,072,646
Equity securities
1,451
7,052
—
8,503
Total
$
9,109,173
$
7,052
$
(35,076
)
$
9,081,149
The following table summarizes the classification of the available-for-sale debt and equity securities on our Condensed Consolidated Balance Sheets (in thousands):
June 30, 2012
December 31, 2011
Cash and cash equivalents
$
1,258,457
$
9,000,954
Short-term marketable securities
81,269
16,491
Long-term marketable securities
564,130
63,704
Total
$
1,903,856
$
9,081,149
12
The following table summarizes our portfolio of available-for-sale debt securities by contractual maturity (in thousands):
June 30, 2012
Amortized Cost
Fair Value
Less than one year
$
1,329,324
$
1,329,311
Greater than one year but less than five years
521,927
521,921
Greater than five years but less than ten years
8,748
8,752
Greater than ten years
46,050
43,872
Total
$
1,906,049
$
1,903,856
The following table summarizes the gross realized gains and losses related to sales of marketable securities (in thousands):
Three Months Ended
Six Months Ended
June 30,
June 30,
2012
2011
2012
2011
Gross realized gains on sales
$
84
$
5,257
$
10,099
$
8,954
Gross realized losses on sales
$
(5
)
$
(415
)
$
(40,101
)
$
(1,777
)
The cost of securities sold was determined based on the specific identification method.
The following table summarizes our available-for-sale debt securities that were in a continuous unrealized loss position, but were not deemed to be other-than-temporarily impaired (in thousands):
Less Than 12 Months
12 Months or Greater
Total
Gross
Unrealized
Losses
Estimated
Fair Value
Gross
Unrealized
Losses
Estimated
Fair Value
Gross
Unrealized
Losses
Estimated
Fair Value
June 30, 2012
Debt securities:
U.S. treasury securities
$
(8
)
$
67,658
$
—
$
—
$
(8
)
$
67,658
Certificates of deposit
—
—
—
—
—
—
U.S. government agencies securities
(113
)
127,056
—
—
(113
)
127,056
Non-U.S. government securities
—
—
—
—
—
—
Municipal debt securities
(15
)
8,074
—
—
(15
)
8,074
Corporate debt securities
(200
)
124,410
—
—
(200
)
124,410
Residential mortgage-backed and asset-backed securities
(26
)
19,516
—
—
(26
)
19,516
Student loan-backed securities
—
—
(2,178
)
43,872
(2,178
)
43,872
Total
$
(362
)
$
346,714
$
(2,178
)
$
43,872
$
(2,540
)
$
390,586
December 31, 2011
Debt securities:
U.S. treasury securities
$
—
$
—
$
—
$
—
$
—
$
—
Certificates of deposit
(18
)
1,019,982
—
—
(18
)
1,019,982
U.S. government agencies securities
—
—
—
—
—
—
Non-U.S. government securities
(30,505
)
24,741
—
—
(30,505
)
24,741
Municipal debt securities
—
—
—
—
—
—
Corporate debt securities
(5
)
224,989
—
—
(5
)
224,989
Residential mortgage-backed and asset-backed securities
—
—
—
—
—
—
Student loan-backed securities
—
—
(4,548
)
46,952
(4,548
)
46,952
Total
$
(30,528
)
$
1,269,712
$
(4,548
)
$
46,952
$
(35,076
)
$
1,316,664
13
As of June 30, 2012 and December 31, 2011, we held a total of 144 and 42 securities, respectively, that were in an unrealized loss position.
4.
DERIVATIVE FINANCIAL INSTRUMENTS
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and various foreign currencies, the most significant of which is the Euro. In order to manage this risk, we hedge a portion of our foreign currency exposures related to outstanding monetary assets and liabilities as well as forecasted product sales using foreign currency exchange forward and option contracts. In general, the market risk related to these contracts is offset by corresponding gains and losses on the hedged transactions. The credit risk associated with these contracts is driven by changes in interest and currency exchange rates and, as a result, varies over time. We work only with major banks and closely monitor current market conditions, which limits the risk that counterparties to our contracts may be unable to perform. We also limit our risk of loss by entering into contracts that permit net settlement at maturity. Therefore, our overall risk of loss in the event of a counterparty default is limited to the amount of any unrecognized gains on outstanding contracts (i.e., those contracts that have a positive fair value) at the date of default. We do not enter into derivative contracts for trading purposes, nor do we hedge our net investment in any of our foreign subsidiaries.
We hedge our exposure to foreign currency exchange rate fluctuations for certain monetary assets and liabilities of our foreign subsidiaries that are denominated in a non-functional currency. The derivative instruments we use to hedge this exposure are not designated as hedges, and as a result, changes in their fair value are recorded in other income (expense), net on our Condensed Consolidated Statements of Income.
We hedge our exposure to foreign currency exchange rate fluctuations for forecasted product sales that are denominated in a non-functional currency. The derivative instruments we use to hedge this exposure are designated as cash flow hedges and have maturity dates of 18 months or less. Upon executing a hedging contract and quarterly thereafter, we assess prospective hedge effectiveness using a regression analysis which calculates the change in cash flow as a result of the hedge instrument. On a monthly basis, we assess retrospective hedge effectiveness using a dollar offset approach. We exclude time value from our effectiveness testing and recognize changes in the time value of the hedge in other income (expense), net. The effective component of our hedge is recorded as an unrealized gain or loss on the hedging instrument in accumulated other comprehensive income (OCI) within stockholders’ equity. When the hedged forecasted transaction occurs, the hedge is de-designated and the unrealized gains or losses are reclassified into product sales. The majority of gains and losses related to the hedged forecasted transactions reported in accumulated OCI at June 30, 2012 will be reclassified to product sales within 12 months.
We had notional amounts on foreign currency exchange contracts outstanding of $3.32 billion and $4.03 billion at June 30, 2012 and December 31, 2011, respectively.
14
The following table summarizes information about the fair values of derivative instruments on our Condensed Consolidated Balance Sheets (in thousands):
