10-Q 1 gild2012093010-q.htm 10-Q GILD 2012.09.30 10-Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
 
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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 October 26, 2012757,648,151
 




GILEAD SCIENCES, INC.
INDEX
PART I.
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
PART II.
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
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®, STRIBILDTM, 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.

2



PART I.
FINANCIAL INFORMATION
ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
 
 
September 30,
2012
 
December 31,
2011
 
 
(unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,550,710

 
$
9,883,777

Short-term marketable securities
 
144,775

 
16,491

Accounts receivable, net
 
1,766,091

 
1,951,167

Inventories
 
1,617,369

 
1,389,983

Deferred tax assets
 
222,572

 
208,155

Prepaid taxes
 
334,013

 
246,444

Prepaid expenses
 
100,674

 
95,922

Other current assets
 
144,175

 
126,846

Total current assets
 
5,880,379

 
13,918,785

Property, plant and equipment, net
 
856,184

 
774,406

Noncurrent portion of prepaid royalties
 
176,430

 
174,584

Noncurrent deferred tax assets
 
110,331

 
144,015

Long-term marketable securities
 
955,603

 
63,704

Intangible assets, net
 
11,735,354

 
1,062,864

Goodwill
 
1,078,919

 
1,004,102

Other noncurrent assets
 
170,629

 
160,674

Total assets
 
$
20,963,829

 
$
17,303,134

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
1,319,670

 
$
1,206,052

Accrued government rebates
 
805,088

 
547,473

Accrued compensation and employee benefits
 
182,756

 
173,316

Income taxes payable
 
17,087

 
40,583

Other accrued liabilities
 
647,604

 
471,129

Deferred revenues
 
99,048

 
74,665

Current portion of long-term debt and other obligations, net
 
1,730,895

 
1,572

Total current liabilities
 
4,802,148

 
2,514,790

Long-term deferred revenues
 
20,836

 
31,870

Long-term debt, net
 
7,040,382

 
7,605,734

Long-term income taxes payable
 
128,655

 
135,655

Other long-term obligations
 
221,646

 
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; 757,933 and 753,106 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
 
758

 
753

Additional paid-in capital
 
5,435,242

 
4,903,143

Accumulated other comprehensive income
 
28,249

 
58,200

Retained earnings
 
3,139,393

 
1,776,760

Total Gilead stockholders’ equity
 
8,603,642

 
6,738,856

Noncontrolling interest
 
146,520

 
128,493

Total stockholders’ equity
 
8,750,162

 
6,867,349

Total liabilities and stockholders’ equity
 
$
20,963,829

 
$
17,303,134

See accompanying notes.

3



GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
 
Product sales
 
$
2,357,978

 
$
2,065,859

 
$
6,887,560

 
$
5,969,025

Royalty revenues
 
63,915

 
51,629

 
216,126

 
204,615

Contract and other revenues
 
4,704

 
4,172

 
10,546

 
11,367

Total revenues
 
2,426,597

 
2,121,660

 
7,114,232

 
6,185,007

Costs and expenses:
 
 
 
 
 
 
 
 
Cost of goods sold
 
597,269

 
531,989

 
1,795,545

 
1,539,963

Research and development
 
465,831

 
290,066

 
1,320,286

 
826,915

Selling, general and administrative
 
319,583

 
295,927

 
1,095,209

 
895,764

Total costs and expenses
 
1,382,683

 
1,117,982

 
4,211,040

 
3,262,642

Income from operations
 
1,043,914

 
1,003,678

 
2,903,192

 
2,922,365

Interest expense
 
(89,322
)
 
(43,097
)
 
(275,010
)
 
(130,420
)
Other income (expense), net
 
(3,505
)
 
14,406

 
(38,665
)
 
40,216

Income before provision for income taxes
 
951,087

 
974,987

 
2,589,517

 
2,832,161

Provision for income taxes
 
280,052

 
237,449

 
774,877

 
704,861

Net income
 
671,035

 
737,538

 
1,814,640

 
2,127,300

Net loss attributable to noncontrolling interest
 
4,470

 
3,586

 
14,385

 
11,192

Net income attributable to Gilead
 
$
675,505

 
$
741,124

 
$
1,829,025

 
$
2,138,492

Net income per share attributable to Gilead common stockholders—basic
 
$
0.89

 
$
0.97

 
$
2.42

 
$
2.72

Shares used in per share calculation—basic
 
757,385

 
767,033

 
757,032

 
787,272

Net income per share attributable to Gilead common stockholders—diluted
 
$
0.85

 
$
0.95

 
$
2.33

 
$
2.66

Shares used in per share calculation—diluted
 
792,304

 
781,312

 
783,824

 
802,762














See accompanying notes.

4



GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Net income
 
$
671,035

 
$
737,538

 
$
1,814,640

 
$
2,127,300

Other comprehensive income:
 
 
 
 
 
 
 
 
Net foreign currency translation gain (loss)
 
5,090

 
(3,958
)
 
7,346

 
(1,122
)
Available-for-sale securities:
 
 
 
 
 
 
 
 
Net unrealized gain (loss), net of tax impact of $(848) and $3,681 for the three months ended September 30, 2012 and 2011, and $(660) and $(2,634) for the nine months ended September 30, 2012 and 2011, respectively
 
1,476

 
(24,786
)
 
1,146

 
(24,124
)
Reclassifications to net income, net of tax impact of $1,396 and $(1,531) for the three months ended September 30, 2012 and 2011, and $849 and $(4,203) for the nine months ended September 30, 2012 and 2011, respectively
 
2,429

 
(2,656
)
 
32,979

 
(7,160
)
Net change
 
3,905

 
(27,442
)
 
34,125

 
(31,284
)
Cash flow hedges:
 
 
 
 
 
 
 
 
Net unrealized gain (loss), net of tax impact of $3,180 and $(5,031) for the three months ended September 30, 2012 and 2011, and $460 and $3,366 for the nine months ended September 30, 2012 and 2011, respectively
 
(67,674
)
 
107,044

 
(9,084
)
 
(66,481
)
Reclassification to net income, net of tax impact of $(1,760) and $1,978 for the three months ended September 30, 2012 and 2011, and $(3,156) and $2,655 for the nine months ended September 30, 2012 and 2011, respectively
 
(37,449
)
 
42,094

 
(62,338
)
 
52,433

Net change
 
(105,123
)
 
149,138

 
(71,422
)
 
(14,048
)
Other comprehensive income (loss)
 
(96,128
)
 
117,738

 
(29,951
)
 
(46,454
)
Comprehensive income
 
574,907

 
855,276

 
1,784,689

 
2,080,846

Comprehensive loss attributable to noncontrolling interest
 
4,470

 
3,586

 
14,385

 
11,192

Comprehensive income attributable to Gilead
 
$
579,377

 
$
858,862

 
$
1,799,074

 
$
2,092,038











See accompanying notes.

5



GILEAD SCIENCES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
 
Nine Months Ended
 
September 30,
 
2012
 
2011
Operating Activities:
 
 
 
Net income
$
1,814,640

 
$
2,127,300

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation expense
60,488

 
53,232

Amortization expense
144,087

 
175,575

Stock-based compensation expense
151,598

 
145,775

Excess tax benefits from stock-based compensation
(64,955
)
 
(30,255
)
Tax benefits from employee stock plans
61,401

 
26,574

Deferred income taxes
21,374

 
43,415

Other
(2,037
)
 
47,159

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
160,831

 
(221,393
)
Inventories
(224,742
)
 
(136,684
)
Prepaid expenses and other assets
(109,550
)
 
13,373

Accounts payable
146,458

 
257,805

Income taxes payable
(75,674
)
 
85,177

Accrued liabilities
397,831

 
106,492

Deferred revenues
7,238

 
(32,642
)
Net cash provided by operating activities
2,488,988

 
2,660,903

Investing Activities:
 
 
 
Purchases of marketable securities
(1,148,751
)
 
(4,161,322
)
Proceeds from sales of marketable securities
130,463

 
3,498,720

Proceeds from maturities of marketable securities
25,975

 
506,513

Acquisitions, net of cash acquired
(10,751,636
)
 
(588,608
)
Purchases of other investments
(25,000
)
 

Capital expenditures
(127,175
)
 
(105,794
)
Net cash used in investing activities
(11,896,124
)
 
(850,491
)
Financing Activities:
 
 
 
Proceeds from issuances of senior notes, net of issuance costs

 
987,370

Proceeds from issuances of common stock
350,264

 
158,234

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
(1,000,000
)
 

Repayments of credit facility
(50,000
)
 

Repurchases of common stock
(467,000
)
 
(2,156,830
)
Repayments of convertible senior notes

 
(649,987
)
Repayments of other long-term obligations
(2,167
)
 
(1,619
)
Excess tax benefits from stock-based compensation
64,955

 
30,255

Contributions from (distributions to) noncontrolling interest
32,412

 
(130,474
)
Net cash provided by (used in) financing activities
1,073,197

 
(1,763,051
)
Effect of exchange rate changes on cash
872

 
(45,881
)
Net change in cash and cash equivalents
(8,333,067
)
 
1,480

Cash and cash equivalents at beginning of period
9,883,777

 
907,879

Cash and cash equivalents at end of period
$
1,550,710

 
$
909,359

See accompanying notes.

6



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 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.
Significant Accounting Policies, Estimates and Judgments
The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and 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, contingent consideration liabilities, stock-based compensation and our tax provision. We base our estimates on historical experience and various 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.
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.

7



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 nine months ended September 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 nine months ended September 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 that period.
During the three and nine months ended September 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; therefore, the dilutive effects are included in the accompanying table. During the three and nine months ended September 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 nine months ended September 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. During the three months ended September 30, 2012, the average market price of our common stock exceeded the warrants’ exercise prices relating to the May 2013 Notes and May 2014 Notes and the dilutive effects are included in the accompanying table. During the three months ended September 30, 2012, the average market price of our common stock did not exceed the warrants’ exercise price relating to the May 2016 Notes and therefore, these warrants did not have a dilutive effect on our net income per share for that period. The average market prices of our common stock during the nine months ended September 30, 2012 and the three and nine months ended September 30, 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 2.1 million and 5.7 million weighted-average shares of our common stock were outstanding during the three and nine months ended September 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 21.0 million and 21.4 million weighted-average shares of our common stock were outstanding during the three and nine months ended September 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.

8



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
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Numerator:
 
 
 
 
 
 
 
 
Net income attributable to Gilead
 
$
675,505

 
$
741,124

 
$
1,829,025

 
$
2,138,492

Denominator:
 
 
 
 
 
 
 
 
Weighted-average shares of common stock outstanding used in the calculation of basic net income per share attributable to Gilead common stockholders
 
757,385

 
767,033

 
757,032

 
787,272

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Stock options and equivalents
 
16,239

 
13,548

 
15,463

 
14,452

Conversion spread related to the May 2011 Notes
 

 

 

 
253

Conversion spread related to the May 2013 Notes
 
5,723

 
731

 
4,475

 
785

Conversion spread related to the May 2014 Notes
 
5,930

 

 
3,529

 

Conversion spread related to the May 2016 Notes
 
5,726

 

 
3,325

 

         Warrants related to the Convertible Notes
 
1,301

 

 

 

Weighted-average shares of common stock outstanding used in the calculation of diluted net income per share attributable to Gilead common stockholders
 
792,304

 
781,312

 
783,824

 
802,762

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.
During the second quarter of 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 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. Subsequent to this transaction, we have had no continuing involvement with the transferred receivables, which were derecognized at the time of the sale.
As of September 30, 2012, our accounts receivable in Southern Europe, specifically Greece, Italy, Portugal and Spain, totaled approximately $826.8 million, of which $314.9 million were greater than 120 days past due and $84.8 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 September 30, 2012.
Recent Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board (FASB) issued new accounting guidance intended to simplify the testing of indefinite-lived intangible assets for impairment. Entities will be allowed the option to first perform a qualitative assessment on impairment for indefinite-lived intangible assets to determine whether a quantitative assessment is necessary. This guidance is effective for impairment tests performed in the interim and annual periods for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on our Consolidated Financial Statements.

9



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 $2.99 billion and $4.98 billion, respectively, as of September 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.
During the first quarter of 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 $992.7 million and $1.14 billion, respectively, as of September 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 $4.21 billion, respectively, as of September 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.

10



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):
 
 
September 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
 
$
308,309

 
$

 
$

 
$
308,309

 
$

 
$

 
$

 
$

Money market funds
 
1,110,384

 

 

 
1,110,384

 
7,455,982

 

 

 
7,455,982

Certificates of deposit
 

 

 

 

 

 
1,139,982

 

 
1,139,982

U.S. government agencies and FDIC guaranteed securities
 

 
353,596

 

 
353,596

 

 

 

 

Non-U.S. government securities
 

 

 

 

 

 

 
24,741

 
24,741

Municipal debt securities
 

 
8,106

 

 
8,106

 

 

 

 

Corporate debt securities
 

 
334,886

 

 
334,886

 

 
404,989

 

 
404,989

Residential mortgage and asset-backed securities
 

 
95,481

 

 
95,481

 

 

 

 

Student loan-backed securities
 

 

 

 

 

 

 
46,952

 
46,952

Total debt securities
 
1,418,693

 
792,069

 

 
2,210,762

 
7,455,982

 
1,544,971

 
71,693

 
9,072,646

Equity securities
 

 

 

 

 
8,503

 

 

 
8,503

Derivatives
 

 
57,298

 

 
57,298

 

 
100,475

 

 
100,475

 
 
$
1,418,693

 
$
849,367

 
$

 
$
2,268,060

 
$
7,464,485


$
1,645,446


$
71,693


$
9,181,624

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
 
$

 
$

 
$
199,707

 
$
199,707

 
$

 
$

 
$
135,591

 
$
135,591

Derivatives
 

 
34,135

 

 
34,135

 

 
5,710

 

 
5,710

 
 
$

 
$
34,135

 
$
199,707

 
$
233,842

 
$

 
$
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.

11



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 were comprised of auction rate securities and Greek bonds within our available-for-sale investment portfolio. 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 following table provides a rollforward of the fair value of our assets measured using Level 3 inputs (in thousands):  
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Fair value, beginning of period
 
$
43,872

 
$
104,145

 
$
71,693

 
$
80,365

Total realized and unrealized gains (losses) included in:
 
 
 
 
 
 
 
 
Other income (expense), net
 

 
1,707

 
(40,096
)
 
4,578

Other comprehensive income, net
 
(1,618
)
 
(22,681
)
 
32,630

 
(28,375
)
Sales of marketable securities
 
(42,254
)
 
(1,350
)
 
(64,227
)
 
(28,630
)
Transfers into Level 3
 

 

 

 
53,883

Fair value, end of period
 
$

 
$
81,821

 
$

 
$
81,821

Auction Rate Securities
The underlying assets of the auction rate securities consisted of student loans. Although auction rate securities are typically 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 the 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.
During the third quarter of 2012, we sold our remaining portfolio of auction rate securities. As a result of the sale, we received total proceeds of $37.3 million and resulted in a $3.8 million loss which was recognized in other income (expense), net on our Condensed Consolidated Statement of Income.
As of December 31, 2011, our auction rate securities were recorded in long-term marketable securities on our Condensed Consolidated Balance Sheets.
Greek Government Bonds
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. During the first quarter of 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 bonds for new securities, which we liquidated during the first quarter of 2012.
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.

12



Contingent Consideration Liabilities
In connection with certain acquisitions, we may be required to pay future consideration that is contingent upon the achievement of specified development, regulatory approval or sales-based milestone events. We estimate the fair value of the contingent consideration liabilities on the acquisition date and each reporting period thereafter using a probability-weighted income approach, which reflects the probability and timing of future payments. This fair value measurement is based on significant Level 3 inputs such as the anticipated timelines and probability of achieving development, regulatory approval or sales-based milestone events and projected revenues. The resulting probability-weighted cash flows are discounted using credit-risk adjusted interest rates.
Each reporting period thereafter, we revalue these obligations by performing a review of the assumptions listed above and record increases or decreases in the fair value of these contingent consideration obligations in research and development expense within our Condensed Consolidated Statements of Income until such time that the related product candidate reaches commercialization. In the absence of any significant changes in key assumptions, the quarterly determination of fair values of these contingent consideration obligations would primarily reflect the passage of time.
Significant judgment is employed in determining Level 3 inputs and fair value measurements as of the acquisition date and for each subsequent period. Updates to assumptions could have a significant impact on our results of operations in any given period and actual results may differ from estimates. For example: significant increases in the probability of achieving a milestone or projected revenues would result in a significantly higher fair value measurement while significant decreases in the estimated probability of achieving a milestone or projected revenues would result in a significantly lower fair value measurement. Significant increases in the discount rate or in the anticipated timelines would result in a significantly lower fair value measurement while significant decreases in the discount rate or anticipated timelines would result in a significantly higher fair value measurement.
The potential contingent consideration payments resulting from development or regulatory approval based milestones related to our CGI Pharmaceuticals, Inc. and Calistoga Pharmaceuticals, Inc. (Calistoga) acquisitions range from no payment if none of the milestones are achieved, to an estimated maximum of $254 million (undiscounted), of which we had accrued $157.7 million as of September 30, 2012 and $120.2 million as of September 30, 2011. Potential future payments resulting from the acquisition of Arresto Biosciences, Inc. (Arresto) relate to royalty obligations on future sales once specified sales-based milestones are achieved.
The following table provides a rollforward of our contingent consideration liabilities, which are recorded as part of other long-term obligations in our Condensed Consolidated Balance Sheets (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Balance, beginning of period
 
$
140,897

 
$
126,690

 
$
135,591

 
$
11,100

Additions from new acquisitions
 

 

 

 
116,008

Net changes in valuation
 
58,810

 
1,615

 
64,116

 
1,197

Balance, end of period
 
$
199,707

 
$
128,305

 
$
199,707

 
$
128,305


13



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):
 
 
September 30, 2012
 
December 31, 2011
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury securities
 
$
307,961

 
$
368

 
$
(20
)
 
$
308,309

 
$

 
$

 
$

 
$

Money market funds
 
1,110,384

 

 

 
1,110,384

 
7,455,982

 

 

 
7,455,982

Certificates of deposit
 

 

 

 

 
1,140,000

 

 
(18
)
 
1,139,982

U.S. government agencies securities
 
353,152

 
474

 
(30
)
 
353,596

 

 

 

 

Non-U.S. government securities
 

 

 

 

 
55,246

 

 
(30,505
)
 
24,741

Municipal debt securities
 
8,075

 
31

 

 
8,106

 

 

 

 

Corporate debt securities
 
333,491

 
1,429

 
(34
)
 
334,886

 
404,994

 

 
(5
)
 
404,989

Residential mortgage-backed and asset-backed securities
 
95,465

 
175

 
(159
)
 
95,481

 

 

 

 

Student loan-backed securities
 

 

 

 

 
51,500

 

 
(4,548
)
 
46,952

Total debt securities
 
2,208,528

 
2,477

 
(243
)
 
2,210,762

 
9,107,722

 

 
(35,076
)
 
9,072,646

Equity securities
 

 

 

 

 
1,451

 
7,052

 

 
8,503

Total
 
$
2,208,528

 
$
2,477

 
$
(243
)
 
$
2,210,762

 
$
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):
 
 
September 30,
2012
 
December 31,
2011
Cash and cash equivalents
 
$
1,110,384

 
$
9,000,954

Short-term marketable securities
 
144,775

 
16,491

Long-term marketable securities
 
955,603

 
63,704

Total
 
$
2,210,762

 
$
9,081,149

The following table summarizes our portfolio of available-for-sale debt securities by contractual maturity (in thousands):
 
 
September 30, 2012
 
 
Amortized Cost
 
Fair Value
Less than one year
 
$
1,245,135

 
$
1,245,165

Greater than one year but less than five years
 
927,079

 
929,196

Greater than five years but less than ten years
 
17,151

 
17,229

Greater than ten years
 
19,163

 
19,172

Total
 
$
2,208,528

 
$
2,210,762


14



The following table summarizes the gross realized gains and losses related to sales of marketable securities (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Gross realized gains on sales
 
$
25

 
$
4,830

 
$
10,124

 
$
13,784

Gross realized losses on sales
 
$
(3,850
)
 
$
(644
)
 
$
(43,951
)
 
$
(2,421
)
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
September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. treasury securities
 
$
(20
)
 
$
67,983

 
$

 
$

 
$
(20
)
 
$
67,983

Certificates of deposit
 

 

 

 

 

 

U.S. government agencies securities
 
(30
)
 
41,856

 

 

 
(30
)
 
41,856

Non-U.S. government securities
 

 

 

 

 

 

Corporate debt securities
 
(34
)
 
42,456

 

 

 
(34
)
 
42,456

Residential mortgage-backed and asset-backed securities
 
(159
)
 
43,211

 

 

 
(159
)
 
43,211

Student loan-backed securities
 

 

 

 

 

 

Total
 
$
(243
)
 
$
195,506

 
$

 
$

 
$
(243
)
 
$
195,506

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

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

As of September 30, 2012 and December 31, 2011, we held a total of 39 and 42 securities, respectively, that were in an unrealized loss position.

15



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 September 30, 2012 will be reclassified to product sales within 12 months.
We had notional amounts on foreign currency exchange contracts outstanding of $3.27 billion and $4.03 billion at September 30, 2012 and December 31, 2011, respectively.
The following table summarizes information about the fair values of derivative instruments on our Condensed Consolidated Balance Sheets (in thousands):
 
 
September 30, 2012
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Classification
 
Fair Value
 
Classification
 
Fair Value
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other current assets
 
$
56,602

 
Other accrued liabilities
 
$
25,787

Foreign currency exchange contracts
 
Other noncurrent assets
 
608

 
Other long-term obligations
 
8,317

Total derivatives designated as hedges
 
 
 
57,210

 
 
 
34,104

Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other current assets
 
85

 
Other accrued liabilities
 
31

Total derivatives not designated as hedges
 
 
 
85

 
 
 
31

Total derivatives
 
 
 
$
57,295

 
 
 
$
34,135

 

16



 
 
December 31, 2011
 
 
Asset Derivatives
 
Liability Derivatives
 
 
Classification
 
Fair Value
 
Classification
 
Fair Value
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other current assets
 
$
77,066

 
Other accrued liabilities
 
$
5,052

Foreign currency exchange contracts
 
Other noncurrent assets
 
23,169

 
Other long-term obligations
 
620

Total derivatives designated as hedges
 
 
 
100,235

 
 
 
5,672

Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
 
Other current assets
 
240

 
Other accrued liabilities
 
38

Total derivatives not designated as hedges
 
 
 
240

 
 
 
38

Total derivatives
 
 
 
$
100,475

 
 
 
$
5,710

The following table summarizes the effect of our foreign currency exchange contracts on our Condensed Consolidated Statements of Income (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Derivatives designated as hedges:
 
 
 
 
 
 
 
 
Net gains (losses) recognized in OCI (effective portion)
 
$
(70,855
)
 
$
107,871

 
$
(7,730
)
 
$
(66,236
)
Net gains (losses) reclassified from accumulated OCI into product sales (effective portion)
 
$
39,209

 
$
(44,072
)
 
$
65,494

 
$
(55,088
)
Net gains (losses) recognized in other income (expense), net (ineffective portion and amounts excluded from effectiveness testing)
 
$
(1,688
)
 
$
(7,759
)
 
$
(8,444
)
 
$
(10,825
)
Derivatives not designated as hedges:
 
 
 
 
 
 
 
 
Net gains (losses) recognized in other income (expense), net
 
$
(31,973
)
 
$
86,781

 
$
34,445

 
$
(33,409
)
There were no material amounts recorded in other income (expense), net, for the three or nine months ended September 30, 2012 and 2011 as a result of the discontinuance of cash flow hedges.
5.
ACQUISITION OF PHARMASSET, INC.
On January 17, 2012, we completed the acquisition of Pharmasset, a publicly-held clinical-stage pharmaceutical company committed to discovering, developing and commercializing novel drugs to treat viral infections. Pharmasset's primary focus was the development of oral therapeutics for the treatment of HCV infection. Pharmasset's lead compound, now known as GS-7977, is a nucleotide analog which, as of January 2012, was being evaluated in Phase 2 and Phase 3 clinical studies for the treatment of HCV infection across genotypes. We believe the acquisition of Pharmasset provides us with an opportunity to complement our existing HCV portfolio and helps advance our effort to develop all-oral regimens for the treatment of HCV.
We acquired all of the outstanding shares of common stock of Pharmasset for $137 per share in cash through a tender offer and subsequent merger under the terms of an agreement and plan of merger entered into in November 2011. The aggregate cash payment to acquire all of the outstanding shares of common stock was $11.1 billion. We financed the transaction with approximately $5.2 billion in cash on hand, $3.7 billion in senior unsecured notes issued in December 2011 and $2.2 billion in bank debt issued in January 2012.
The Pharmasset acquisition was accounted for as a business combination. The results of operations of Pharmasset have been included in our Condensed Consolidated Statement of Income since January 13, 2012, the date on which we acquired approximately 88% of the outstanding shares of common stock of Pharmasset, cash consideration was transferred, and as a result, we obtained effective control of Pharmasset. The acquisition was completed on January 17, 2012, at which time Pharmasset became a wholly-owned subsidiary of Gilead and was integrated into our operations. As we do not track earnings results by product candidate or therapeutic area, we do not maintain separate earnings results for the acquired Pharmasset business.

17



The following table summarizes the components of the cash paid to acquire Pharmasset (in thousands):
Total consideration transferred
 
$
10,858,372

Stock-based compensation expense
 
193,937

Total cash paid
 
$
11,052,309

The $11.1 billion cash payment consisted of a $10.38 billion cash payment to the outstanding common stockholders as well as a $668.3 million cash payment to option holders under the Pharmasset stock option plans. The $10.38 billion cash payment to the outstanding common stockholders and $474.3 million of the cash payment to the option holders under the Pharmasset stock option plans were accounted for as consideration transferred. The remaining $193.9 million of cash payment was accounted for as stock-based compensation expense resulting from the accelerated vesting of Pharmasset employee options immediately prior to the acquisition.
The following table summarizes the acquisition date fair values of assets acquired and liabilities assumed, and the consideration transferred (in thousands):
Intangible assets - in-process research and development
 
$
10,720,000

Cash and cash equivalents
 
106,737

Other assets acquired (liabilities assumed), net
 
(43,182
)
Total identifiable net assets
 
10,783,555

Goodwill
 
74,817

Total consideration transferred
 
$
10,858,372

In-Process Research and Development (IPR&D)
The estimated fair value of the acquired IPR&D related to GS-7977 was $10.72 billion, which was determined using a probability-weighted income approach that discounts expected future cash flows to present value. The estimated net cash flows were discounted using a discount rate of 12%, which is based on the estimated weighted-average cost of capital for companies with profiles similar to that of Pharmasset. This rate is comparable to the estimated internal rate of return for the acquisition and represents the rate that market participants would use to value the intangible asset. The projected cash flows from GS-7977 were based on key assumptions such as: the time and resources needed to complete its development considering its stage of development on the acquisition date, the probability of obtaining approval from the U.S. Food and Drug Administration (FDA) and other regulatory agencies, estimates of revenues and operating profits, the life of the potential commercialized product and other associated risks related to the viability of and potential alternative treatments in future target markets. Intangible assets related to IPR&D projects are considered to be indefinite-lived assets until the completion or abandonment of the associated research and development (R&D) efforts.
Goodwill
The $74.8 million of goodwill represents the excess of the consideration transferred over the fair values of assets acquired and liabilities assumed and is attributable to the synergies expected from combining our R&D operations with Pharmasset's. None of the goodwill is expected to be deductible for income tax purposes.
Stock-Based Compensation Expense
The stock-based compensation expense recognized for the accelerated vesting of employee options immediately prior to the acquisition was reported in our Condensed Consolidated Statement of Income as follows (in thousands):
 
 
Nine Months Ended
 
 
September 30, 2012
Research and development expense
 
$
100,149

Selling, general and administrative expense
 
93,788

Total stock-based compensation expense
 
$
193,937


18



Other Costs
Other costs incurred in connection with the acquisition include (in thousands):
 
 
Nine Months Ended
 
Three Months Ended
 
 
September 30, 2012
 
December 31, 2011
Transaction costs (e.g. investment advisory, legal and accounting fees)
 
$
10,463

 
$
28,461

Bridge financing costs
 
7,333

 
23,817

Restructuring costs
 
14,929

 

Total other costs
 
$
32,725

 
$
52,278

The following table summarizes these costs by the line item in the Condensed Consolidated Statement of Income in which these costs were recognized (in thousands).
 
 
Nine Months Ended
 
Three Months Ended
 
 
September 30, 2012
 
December 31, 2011
Research and development expense
 
$
7,710

 
$

Selling, general and administrative expense
 
17,682

 
28,461

Interest expense
 
7,333

 
23,817

Total other costs
 
$
32,725

 
$
52,278

Pro Forma Information
The following unaudited pro forma information presents the combined results of operations of Gilead and Pharmasset as if the acquisition of Pharmasset had been completed on January 1, 2011, with adjustments to give effect to pro forma events that are directly attributable to the acquisition. The unaudited pro forma results do not reflect any operating efficiencies or potential cost savings which may result from the consolidation of the operations of Gilead and Pharmasset. Accordingly, these unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what the actual results of operations of the combined company would have been if the acquisition had occurred at the beginning of the period presented, nor are they indicative of future results of operations (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Total revenues
 
$
2,426,597

 
$
2,121,660

 
$
7,114,232

 
$
6,185,007

Net income attributable to Gilead
 
$
680,483

 
$
677,662

 
$
1,983,004

 
$
1,756,056

The unaudited pro forma consolidated results include non-recurring pro forma adjustments that assume the acquisition occurred on January 1, 2011. Stock-based compensation expenses of $193.9 million incurred during the nine months ended September 30, 2012 were included in the net income attributable to Gilead for the nine months ended September 30, 2011. Other costs of $17.8 million incurred during the nine months ended September 30, 2012 were included in the net income attributable to Gilead for the nine months ended September 30, 2011. Of the $17.8 million, $0.3 million was incurred during the three months ended September 30, 2012. Other costs of $52.3 million incurred during the three months ended December 31, 2011 were included in net income attributable to Gilead for the nine months ended September 30, 2011.
6.
INVENTORIES
Inventories are summarized as follows (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Raw materials
 
$
826,651

 
$
697,621

Work in process
 
378,988

 
466,499

Finished goods
 
411,730

 
225,863

Total
 
$
1,617,369

 
$
1,389,983

As of September 30, 2012 and December 31, 2011, we held $1.18 billion and $995.7 million of efavirenz in inventory, respectively, which was purchased from BMS at BMS’s estimated net selling price of efavirenz.

19



7.
INTANGIBLE ASSETS AND GOODWILL
The following table summarizes the carrying amount of our intangible assets and goodwill (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Indefinite-lived intangible assets
 
$
10,986,200

 
$
266,200

Finite-lived intangible assets
 
749,154

 
796,664

Total intangible assets
 
11,735,354

 
1,062,864

Goodwill
 
1,078,919

 
1,004,102

Total intangible assets and goodwill
 
$
12,814,273

 
$
2,066,966

Indefinite-Lived Intangible Assets
In January 2012, we acquired $10.72 billion of purchased IPR&D as part of our acquisition of Pharmasset that we have classified as indefinite-lived intangible assets (See Note 5).
As of December 31, 2011, we had indefinite-lived intangible assets of $266.2 million, which consisted of $117.0 million and $149.2 million of purchased IPR&D from our acquisitions of Arresto and Calistoga, respectively.
Finite-Lived Intangible Assets
The following table summarizes our finite-lived intangible assets (in thousands):
 
 
September 30, 2012
 
December 31, 2011
 
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Gross Carrying
Amount
 
Accumulated
Amortization
Intangible asset - Ranexa
 
$
688,400

 
$
124,114

 
$
688,400

 
$
97,099

Intangible asset - Lexiscan
 
262,800

 
89,030

 
262,800

 
69,723

Other
 
24,995

 
13,897

 
24,995

 
12,709

Total
 
$
976,195

 
$
227,041

 
$
976,195

 
$
179,531

Amortization expense related to intangible assets was included in cost of goods sold in our Condensed Consolidated Statements of Income and totaled $15.8 million and $47.5 million for the three and nine months ended September 30, 2012, respectively, and $17.4 million and $52.2 million for the three and nine months ended September 30, 2011, respectively.
As of September 30, 2012, the estimated future amortization expense associated with our intangible assets for the remaining three months of 2012 and each of the five succeeding fiscal years are as follows (in thousands):
Fiscal Year
 
Amount
2012 (remaining three months)
 
$
15,836

2013
 
64,283

2014
 
66,735

2015
 
73,261

2016
 
100,048

2017
 
132,786

Total
 
$
452,949

Goodwill
The following table summarizes the changes in the carrying amount of goodwill (in thousands):
Balance at December 31, 2011
 
$
1,004,102

Goodwill resulting from the acquisition of Pharmasset
 
74,817

Balance at September 30, 2012
 
$
1,078,919


20



8.
COLLABORATIVE ARRANGEMENTS
From time to time, as a result of entering into strategic collaborations, we may hold investments in non-public companies. We review our interests in investee companies for consolidation and/or appropriate disclosure based on applicable guidance. For variable interest entities (VIEs), we may be required to consolidate an entity if the contractual terms of the arrangement essentially provide us with control over the entity, even if we do not have a majority voting interest. We assess whether we are the primary beneficiary of a VIE based on our power to direct the activities of the VIE that most significantly impact the VIE's economic performance and our obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. As of September 30, 2012, we determined that certain of our investee companies are VIEs; however, other than with respect to our joint ventures with BMS, we do not control and are not the primary beneficiary with respect to such investees; therefore, we do not consolidate these investees.
Bristol-Myers Squibb Company
North America
In 2004, we entered into a collaboration arrangement with BMS in the United States to develop and commercialize a single tablet regimen containing our Truvada and BMS's Sustiva (efavirenz), which we sell as Atripla. The collaboration is structured as a joint venture and operates as a limited liability company named Bristol-Myers Squibb & Gilead Sciences, LLC, which we consolidate. The ownership interests of the joint venture and thus the sharing of product revenue and costs reflect the respective economic interests of BMS and Gilead and are based on the proportions of the net selling price of Atripla attributable to efavirenz and Truvada. Since the net selling price for Truvada may change over time relative to the net selling price of efavirenz, both BMS's and our respective economic interests in the joint venture may vary annually.
We and BMS share marketing and sales efforts. Since the second quarter of 2011, except for a limited number of activities that will be jointly managed, the parties no longer coordinate detailing and promotional activities in the United States, and the parties have begun to reduce their joint promotional efforts in Canada, as we launch Complera and Stribild. The parties will continue to collaborate on activities such as manufacturing, regulatory, compliance and pharmacovigilance. We are responsible for accounting, financial reporting, tax reporting, manufacturing and product distribution for the joint venture. Both parties provide their respective bulk active pharmaceutical ingredients to the joint venture at their approximate market values. In 2006, we and BMS amended the joint venture's collaboration agreement to allow the joint venture to sell Atripla into Canada. As of September 30, 2012 and December 31, 2011, the joint venture held efavirenz active pharmaceutical ingredient which it purchased from BMS at BMS's estimated net selling price of efavirenz in the U.S. market. These amounts are included in inventories on our Condensed Consolidated Balance Sheets. As of September 30, 2012, total assets held by the joint venture were $1.85 billion and consisted primarily of cash and cash equivalents of $210.3 million, accounts receivable of $228.4 million and inventories of $1.40 billion; total liabilities were $1.46 billion and consisted primarily of accounts payable of $570.9 million and other accrued expenses of $327.2 million. As of December 31, 2011, total assets held by the joint venture were $1.62 billion and consisted primarily of cash and cash equivalents of $156.9 million, accounts receivable of $235.6 million and inventories of $1.19 billion; total liabilities were $1.27 billion and consisted primarily of accounts payable of $561.1 million and other accrued expenses of $232.9 million. These asset and liability amounts do not reflect the impact of intercompany eliminations that are included in our Condensed Consolidated Balance Sheets. Although we consolidate the joint venture, the legal structure of the joint venture limits the recourse that its creditors will have over our general credit or assets.
Europe
In 2007, Gilead Sciences Limited, a wholly-owned subsidiary in Ireland, and BMS entered into a collaboration arrangement to commercialize and distribute Atripla in the European Union, Iceland, Liechtenstein, Norway and Switzerland (collectively, the European Territory). The parties formed a limited liability company, which we consolidate, to manufacture Atripla for distribution in the European Territory using efavirenz that it purchases from BMS at BMS's estimated net selling price of efavirenz in the European Territory. We are responsible for product distribution, inventory management and warehousing. Through our local subsidiaries, we have primary responsibility for order fulfillment, collection of receivables, customer relations and handling of sales returns in all the territories where we and BMS promote Atripla. Revenue and cost sharing is based on the relative ratio of the respective net selling prices of the components of Atripla, Truvada and efavirenz.
Starting in the first quarter of 2012, except for a limited number of activities that will be jointly managed, the parties no longer coordinate detailing and promotional activities in the region. We are also responsible for accounting, financial reporting and tax reporting for the collaboration. As of September 30, 2012 and December 31, 2011, efavirenz purchased from BMS at BMS's estimated net selling price of efavirenz in the European Territory is included in inventories on our Condensed Consolidated Balance Sheets.

21



The parties also formed a limited liability company to hold the marketing authorization for Atripla in Europe. We have primary responsibility for regulatory activities. In the major market countries, both parties have agreed to continue to use commercially reasonable efforts to independently promote Atripla.
9.LONG-TERM OBLIGATIONS
Financing Arrangements
The following table summarizes the carrying amount of our borrowings under various financing arrangements (in thousands):
 
 
 
 
 
 
Carrying Value as of
Type of Borrowing
 
Description
Issue Date
Due Date
Interest Rate
September 30,
2012
 
December 31,
2011
Convertible Senior
 
May 2013 Notes
April 2006
May 2013
0.625%
$
630,838

 
$
607,036

Convertible Senior
 
May 2014 Notes
July 2010
May 2014
1.00%
1,202,938

 
1,181,525

Convertible Senior
 
May 2016 Notes
July 2010
May 2016
1.625%
1,151,236

 
1,132,293

Senior Unsecured
 
April 2021 Notes

March 2011
April 2021
4.50%
992,709

 
992,066

Senior Unsecured
 
December 2014 Notes

December 2011
December 2014
2.40%
749,315

 
749,078

Senior Unsecured
 
December 2016 Notes

December 2011
December 2016
3.05%
699,037

 
698,864

Senior Unsecured
 
December 2021 Notes
December 2011
December 2021
4.40%
1,247,356

 
1,247,138

Senior Unsecured
 
December 2041 Notes

December 2011
December 2041
5.65%
997,791

 
997,734

Term Loan Facility
 
Term Loan
January 2012
January 2015
Variable

 

Credit Facility
 
Short-Term Revolver
January 2012
January 2013
Variable
350,000

 

Credit Facility
 
Five-Year Revolver
January 2012
January 2017