Financial Instruments and Fair Value Measures

12 Months Ended

Dec. 31, 2019

Financial Instruments and Fair Value Measures

Risk Management Policy

The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required.

Financial Instruments

Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $957 million at December 31, 2019 and $1.4 billion at December 31, 2018, are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months. Accumulated gains and losses as of December 31, 2019 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement.

In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the proposed acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a gain of $383 million recognized in other comprehensive income (loss). This gain will be reclassified to interest expense, net over the lives of the related debt.

In the fourth quarter of 2019, the company entered into interest rate swap contracts with notional amounts totaling $2.3 billion at December 31, 2019. The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. The contracts were designated as cash flow hedges and are recorded at fair value. Realized and unrealized gains or losses are included in AOCI and will be reclassified to interest expense, net over the lives of the floating-rate debt.

The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $7.1 billion at December 31, 2019 and $8.6 billion at December 31, 2018.

The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had €3.6 billion aggregate principal amount of senior Euro notes designated as net investment hedges at December 31, 2019 and December 31, 2018. In the third quarter of 2019, the company issued €1.4 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company elected to de-designate hedge accounting for €1.4 billion aggregate principal amount of existing senior Euro notes which were subsequently repaid in October 2019. In addition, in 2019, the company entered into foreign currency forward exchange contracts and designated the instruments as net investment hedges. These contracts had notional amounts totaling €971 million, £204 million and CHF62 million at December 31, 2019. The company uses the spot method of assessing hedge effectiveness for derivative

instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument.

AbbVie is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $10.8 billion at December 31, 2019 and December 31, 2018. The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount.

No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges.

The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets:



	Fair value - Derivatives in asset position					Fair value - Derivatives in liability position
as of December 31 (in millions)	Balance sheet caption	2019		2018		Balance sheet caption	2019		2018
Foreign currency forward exchange contracts
Designated as cash flow hedges	Prepaid expenses and other	$	3	$	113	Accounts payable and accrued liabilities	$	14	$	—
Designated as net investment hedges	Prepaid expenses and other	—		—		Accounts payable and accrued liabilities	24		—
Not designated as hedges	Prepaid expenses and other	19		19		Accounts payable and accrued liabilities	18		26
Interest rate swap contracts
Designated as cash flow hedges	Other assets	3		—		Other long-term liabilities	—		—
Designated as fair value hedges	Prepaid expenses and other	—		—		Accounts payable and accrued liabilities	2		—
Designated as fair value hedges	Other assets	28		—		Other long-term liabilities	74		466
Total derivatives		$	53	$	132		$	132	$	492

While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets.

The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss):



years ended in December 31 (in millions)	2019			2018		2017
Foreign currency forward exchange contracts
Designated as cash flow hedges	$	(5	)	$	175	$	(250	)
Designated as net investment hedges	33			—		—
Interest rate swap contracts designated as cash flow hedges	4			—		—
Treasury rate lock agreements designated as cash flow hedges	383			—		—

Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax losses of $10 million into cost of products sold for foreign currency cash flow hedges, pre-tax gains of $7 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months.

Related to AbbVie’s non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax gains of $90 million in 2019, pre-tax gains of $178 million in 2018 and pre-tax losses of $537 million in 2017.

The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI.



years ended December 31 (in millions)	Statement of earnings caption	2019			2018			2017
Foreign currency forward exchange contracts
Designated as cash flow hedges	Cost of products sold	$	167		$	(161	)	$	118
Designated as net investment hedges	Interest expense, net	27			—			—
Not designated as hedges	Net foreign exchange loss	(70		)	83			(96		)
Treasury rate lock agreements designated as cash flow hedges	Interest expense, net	3			—			—
Interest rate swap contracts
Designated as cash flow hedges	Interest expense, net	1			—			—
Designated as fair value hedges	Interest expense, net	418			(71		)	(63		)
Debt designated as hedged item in fair value hedges	Interest expense, net	(418		)	71			63

Fair Value Measures

The fair value hierarchy consists of the following three levels:


•	Level 1—Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access;


•	Level 2—Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and


•	Level 3—Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability.

The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2019:



			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)
Assets
Cash and equivalents	$	39,924	$	1,542	$	38,382	$	—
Debt securities	3		—		3		—
Equity securities	24		24		—		—
Interest rate swap contracts	31		—		31		—
Foreign currency contracts	22		—		22		—
Total assets	$	40,004	$	1,566	$	38,438	$	—
Liabilities
Interest rate swap contracts	$	76	$	—	$	76	$	—
Foreign currency contracts	56		—		56		—
Contingent consideration	7,340		—		—		7,340
Total liabilities	$	7,472	$	—	$	132	$	7,340

The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2018:



			Basis of fair value measurement
(in millions)	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)
Assets
Cash and equivalents	$	7,289	$	1,209	$	6,080	$	—
Time deposits	568		—		568		—
Debt securities	1,536		—		1,536		—
Equity securities	4		4		—		—
Foreign currency contracts	132		—		132		—
Total assets	$	9,529	$	1,213	$	8,316	$	—
Liabilities
Interest rate swap contracts	$	466	$	—	$	466	$	—
Foreign currency contracts	26		—		26		—
Contingent consideration	4,483		—		—		4,483
Total liabilities	$	4,975	$	—	$	492	$	4,483

The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2019, a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $280 million. Additionally, at December 31, 2019, a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $150 million.

There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs:



years ended December 31 (in millions)	2019			2018			2017
Beginning balance	$	4,483		$	4,534		$	4,213
Change in fair value recognized in net earnings	3,091			49			626
Payments	(234		)	(100		)	(305		)
Ending balance	$	7,340		$	4,483		$	4,534

The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the second quarter of 2019, the company recorded a $2.3 billion increase in the SKYRIZI contingent consideration liability due to higher probabilities of success, higher estimated future sales and declining interest rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T research and development program. During the fourth quarter of 2018, the company recorded a $428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval.

Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2019 are shown in the table below:



					Basis of fair value measurement
(in millions)	Book value		Approximate fair values		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)
Liabilities
Current portion of long-term debt and finance lease obligations, excluding fair value hedges	$	3,755	$	3,760	$	3,753	$	7	$	—
Long-term debt and finance lease obligations, excluding fair value hedges	63,021		66,651		66,631		20		—
Total liabilities	$	66,776	$	70,411	$	70,384	$	27	$	—

The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2018 are shown in the table below:



					Basis of fair value measurement
(in millions)	Book value		Approximate fair values		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable Inputs (Level 3)
Liabilities
Short-term borrowings	$	3,699	$	3,693	$	—	$	3,693	$	—
Current portion of long-term debt and finance lease obligations, excluding fair value hedges	1,609		1,617		1,609		8		—
Long-term debt and finance lease obligations, excluding fair value hedges	35,468		34,052		34,024		28		—
Total liabilities	$	40,776	$	39,362	$	35,633	$	3,729	$	—

AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $66 million as of December 31, 2019 and $84 million as of December 31, 2018. No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2019.

Available-for-sale Securities

Substantially all of the company’s investments in debt securities were classified as available-for-sale with changes in fair value recognized in other comprehensive income. In the third quarter of 2019, the company sold substantially all of its investments in debt securities. There were no debt securities classified as short-term as of December 31, 2019 and $204 million as of December 31, 2018. Long-term debt securities mature primarily within five years. Estimated fair values of available-for-sale debt securities were based on prices obtained from commercial pricing services.

The following table summarizes available-for-sale securities by type as of December 31, 2018:



	Amortized cost		Gross unrealized					Fair value
(in millions)	Amortized cost		Gains		Losses			Fair value
Asset backed securities	$	423	$	—	$	(2	)	$	421
Corporate debt securities	1,042		1		(9		)	1,034
Other debt securities	81		—		—			81
Total	$	1,546	$	1	$	(11	)	$	1,536

AbbVie had no other-than-temporary impairments as of December 31, 2019. Net realized gains and losses were insignificant in 2019 and 2018. Net realized gains were $90 million in 2017.

Concentrations of Risk

The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits.

Of total net accounts receivable, three U.S. wholesalers accounted for 68% as of December 31, 2019 and 63% as of December 31, 2018, and substantially all of AbbVie's net revenues in the United States were to these three wholesalers.

HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 58% of AbbVie's total net revenues in 2019, 61% in 2018 and 65% in 2017.