10-Q 1 a2018063010q.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
 
[x]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
 
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 Number 001-34912
CELGENE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
22-2711928
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
86 Morris Avenue, Summit, NJ
 
07901
(Address of principal executive offices)
 
(Zip Code)
 
 
(908) 673-9000
 
 
 
 
(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
X
 
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
X
 
No
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
X
 
Accelerated filer
 
 
 
 
 
 
Non-accelerated filer (Do not check if a smaller reporting company)
 
 
Smaller reporting company
 
 
 
 
 
 
Emerging growth company
 
 
 
 
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes
 
 
No
X
 
 
As of July 23, 2018, 703,363,010 shares of Common Stock, par value $.01 per share, were outstanding.





CELGENE CORPORATION
 
FORM 10-Q TABLE OF CONTENTS
 
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
Consolidated Statements of Income - Three-Month and Six-Month Periods Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Comprehensive Income - Three-Month and Six-Month Periods Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Balance Sheets - As of June 30, 2018 and December 31, 2017
 
 
 
 
Consolidated Statements of Cash Flows - Six-Month Periods Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



PART I – FINANCIAL INFORMATION
 
Item 1. Financial Statements (Unaudited)
 
CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in millions, except per share amounts)
 
 
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenue:
 
 
 
 
 
 
 
 
Net product sales
 
$
3,808

 
$
3,259

 
$
7,339

 
$
6,211

Other revenue
 
6

 
12

 
13

 
22

Total revenue
 
3,814

 
3,271

 
7,352

 
6,233

Expenses:
 
 

 
 

 
 

 
 

Cost of goods sold (excluding amortization of acquired intangible assets)
 
126

 
111

 
261

 
224

Research and development
 
1,251

 
835

 
3,454

 
1,830

Selling, general and administrative
 
790

 
939

 
1,654

 
1,559

Amortization of acquired intangible assets
 
127

 
88

 
214

 
170

Acquisition related charges (income) and restructuring, net
 
34

 
(13
)
 
65

 
26

Total costs and expenses
 
2,328

 
1,960

 
5,648

 
3,809

Operating income
 
1,486

 
1,311

 
1,704

 
2,424

Other income and (expense):
 
 

 
 

 
 

 
 

Interest and investment income, net
 
9

 
24

 
22

 
39

Interest (expense)
 
(192
)
 
(126
)
 
(358
)
 
(253
)
Other income (expense), net
 
4

 
(31
)
 
969

 
(18
)
Income before income taxes
 
1,307

 
1,178

 
2,337

 
2,192

Income tax provision
 
262

 
77

 
446

 
159

Net income
 
$
1,045

 
$
1,101

 
$
1,891

 
$
2,033

Net income per common share:
 
 

 
 

 
 

 
 

Basic
 
$
1.46

 
$
1.41

 
$
2.58

 
$
2.61

Diluted
 
$
1.43

 
$
1.36

 
$
2.52

 
$
2.51

Weighted average shares:
 
 

 
 

 
 

 
 

Basic
 
716.1

 
780.4

 
732.1

 
779.7

Diluted
 
732.6

 
811.7

 
750.6

 
811.5

 
See accompanying Notes to Unaudited Consolidated Financial Statements

3


CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in millions)

 
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
1,045

 
$
1,101

 
$
1,891

 
$
2,033

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(28
)
 
31

 
(12
)
 
41

 
 
 
 
 
 
 
 
 
Net unrealized gains (losses) related to cash flow hedges:
 
 
 
 
 
 
 
 
Unrealized holding gains (losses)
 
226

 
(198
)
 
127

 
(266
)
Tax benefit
 

 
7

 
1

 
7

Unrealized holding gains (losses), net of tax
 
226

 
(191
)
 
128

 
(259
)
 
 
 
 
 
 
 
 
 
Reclassification adjustment for losses (gains) included in net income
 
13

 
(79
)
 
40

 
(163
)
Tax (benefit)
 
(1
)
 
(1
)
 
(1
)
 
(2
)
Reclassification adjustment for losses (gains) included in net income, net of tax
 
12

 
(80
)
 
39

 
(165
)
 
 
 
 
 
 
 
 
 
Excluded component related to cash flow hedges:
 
 
 
 
 
 
 
 
Amortization of excluded component (gains)
 
(7
)
 
(3
)
 
(15
)
 
(5
)
Reclassification of realized excluded component losses to net income
 
6

 

 
17

 

Net reclassification adjustment included in net income
 
(1
)
 
(3
)
 
2

 
(5
)
 
 
 
 
 
 
 
 
 
Net unrealized gains (losses) on available-for-sale debt / marketable securities (see Note 1):
 
 
 
 
 
 
 
 
Unrealized holding gains (losses)
 

 
2

 
(9
)
 
229

Tax (expense) benefit
 

 
(1
)
 
2

 
(81
)
Unrealized holding gains (losses), net of tax
 

 
1

 
(7
)
 
148

 
 
 
 
 
 
 
 
 
Reclassification adjustment for losses included in net income
 

 
34

 
18

 
34

Tax (benefit)
 

 
(13
)
 
(4
)
 
(13
)
Reclassification adjustment for losses included in net income, net of tax
 

 
21

 
14

 
21

Total other comprehensive income (loss)
 
209

 
(221
)
 
164

 
(219
)
Comprehensive income
 
$
1,254

 
$
880

 
$
2,055

 
$
1,814


See accompanying Notes to Unaudited Consolidated Financial Statements

4



CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions, except per share amounts)
 
 
June 30,
2018
 
December 31,
2017
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
1,503

 
$
7,013

Debt securities available-for-sale
79

 
3,219

Equity investments with readily determinable fair values
1,828

 
1,810

Accounts receivable, net of allowances of $37 and $36 as of June 30, 2018 and December 31, 2017, respectively
2,064

 
1,921

Inventory
555

 
541

Other current assets
824

 
388

Total current assets
6,853

 
14,892

Property, plant and equipment, net
1,292

 
1,070

Intangible assets, net
16,470

 
8,436

Goodwill
8,004

 
4,866

Other non-current assets
825

 
877

Total assets
$
33,444

 
$
30,141

Liabilities and Stockholders’ Equity
 

 
 

Current liabilities:
 

 
 

Short-term borrowings and current portion of long-term debt
$
1,497

 
$

Accounts payable
294

 
305

Accrued expenses and other current liabilities
2,615

 
2,523

Income taxes payable
32

 
84

Current portion of deferred revenue
64

 
75

Total current liabilities
4,502

 
2,987

Deferred revenue, net of current portion
63

 
34

Income taxes payable
2,368

 
2,490

Deferred income tax liabilities
2,771

 
1,327

Other non-current liabilities
556

 
544

Long-term debt, net of discount
19,754

 
15,838

Total liabilities
30,014

 
23,220

Commitments and Contingencies (See Note 15)


 


Stockholders’ Equity:
 

 
 

Preferred stock, $.01 par value per share, 5.0 million shares authorized; none outstanding as of June 30, 2018 and December 31, 2017

 

Common stock, $.01 par value per share, 1,150.0 million shares authorized; issued 977.5 million and 971.7 million shares as of June 30, 2018 and December 31, 2017, respectively
10

 
10

Common stock in treasury, at cost; 274.9 million and 212.4 million shares as of June 30, 2018 and December 31, 2017, respectively
(25,700
)
 
(20,243
)
Additional paid-in capital
13,835

 
13,806

Retained earnings
15,404

 
13,061

Accumulated other comprehensive (loss) income
(119
)
 
287

Total stockholders’ equity
3,430

 
6,921

Total liabilities and stockholders’ equity
$
33,444

 
$
30,141

 
See accompanying Notes to Unaudited Consolidated Financial Statements

5



CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in millions)
 
Six-Month Periods Ended June 30,
 
2018
 
2017
Cash flows from operating activities:
 

 
 

Net income
$
1,891

 
$
2,033

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation
79

 
66

Amortization
217

 
174

Impairment charges
27

 
50

Deferred income taxes
(43
)
 
(186
)
Change in value of contingent consideration and success payments
(23
)
 
26

Net loss on sales of debt securities available-for-sale
18

 

Net (gain) on equity investments with and without a readily determinable fair value
(954
)
 
(15
)
Share-based compensation expense
492

 
323

Share-based employee benefit plan expense
20

 
22

Derivative instruments
8

 
60

Other, net
(10
)
 
(46
)
Change in current assets and liabilities, excluding the effect of acquisitions and disposals:
 

 
 

Accounts receivable
(157
)
 
(75
)
Inventory
(14
)
 
(32
)
Other operating assets
(323
)
 
(184
)
Accounts payable and other operating liabilities
(144
)
 
219

Income tax payable
(178
)
 
33

Payment of contingent consideration
(22
)
 

Deferred revenue
20

 
1

Net cash provided by operating activities
904

 
2,469

Cash flows from investing activities:
 

 
 

Proceeds from sales of debt securities available-for-sale
3,240

 
2,057

Purchases of debt securities available-for-sale
(110
)
 
(3,411
)
Capital expenditures
(168
)
 
(132
)
Proceeds from sales of equity investment securities
55

 
27

Purchases of equity investment securities
(155
)
 
(156
)
Payments for acquisition of business, net of cash acquired

(8,648
)
 

Net cash (used in) investing activities
(5,786
)
 
(1,615
)
Cash flows from financing activities:
 

 
 

Payment for treasury shares
(6,096
)
 
(811
)
Proceeds from short-term borrowing
4,929

 

Principal repayments on short-term borrowing
(3,934
)
 

Proceeds from issuance of long-term debt
4,452

 

Payment of contingent consideration
(40
)
 

Net proceeds from share-based compensation arrangements
46

 
387

Net cash (used in) financing activities
(643
)
 
(424
)
Effect of currency rate changes on cash and cash equivalents
15

 
60

Net (decrease) increase in cash and cash equivalents
(5,510
)
 
490

Cash and cash equivalents at beginning of period
7,013

 
6,170

Cash and cash equivalents at end of period
$
1,503

 
$
6,660


 See accompanying Notes to Unaudited Consolidated Financial Statements

6



CELGENE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(Dollars in millions)
 
 
Six-Month Periods Ended June 30,
 
2018
 
2017
Supplemental schedule of non-cash investing and financing activity:
 

 
 

Change in net unrealized loss (gain) on debt securities available-for-sale/marketable securities available-for-sale

$
9

 
$
(229
)
Supplemental disclosure of cash flow information:
 

 
 

Interest paid
300

 
262

Income taxes paid
786

 
333

  
See accompanying Notes to Unaudited Consolidated Financial Statements

7



CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(In all accompanying tables, amounts of dollars expressed in millions,
except per share amounts, unless otherwise indicated)
 
1. Nature of Business, Basis of Presentation and New Accounting Standards

Celgene Corporation, together with its subsidiaries (collectively “we,” “our,” “us,” “Celgene” or the “Company”), is an integrated global biopharmaceutical company engaged primarily in the discovery, development and commercialization of innovative therapies for the treatment of cancer and inflammatory diseases through next-generation solutions in protein homeostasis, immuno-oncology, epigenetics, immunology and neuro-inflammation. Celgene Corporation was incorporated in the State of Delaware in 1986.

Our commercial stage products include REVLIMID®, POMALYST®/IMNOVID®, OTEZLA®, ABRAXANE®, VIDAZA®, azacitidine for injection (generic version of VIDAZA®), THALOMID® (sold as THALOMID® or Thalidomide Celgene® outside of the U.S.) and IDHIFA®. In addition, we earn revenue from other product sales and licensing arrangements.

The consolidated financial statements include the accounts of Celgene Corporation and its subsidiaries. Investments in limited partnerships and interests where we have an equity interest of 50% or less and do not otherwise have a controlling financial interest are accounted for by one of three methods: the equity method, as an investment without a readily determinable fair value or as an investment with a readily determinable fair value.

We operate in a single segment engaged in the discovery, development, manufacturing, marketing, distribution and sale of innovative therapies for the treatment of cancer and inflammatory diseases. Consistent with our operational structure, our Chief Executive Officer (CEO), as the chief operating decision maker, manages and allocates resources at the global corporate level. Our global research and development organization is responsible for discovery of new drug candidates and supports development and registration efforts for potential future products. Our global supply chain organization is responsible for the manufacturing and supply of products. Regional/therapeutic area commercial organizations market, distribute and sell our products. The business is also supported by global corporate staff functions. Managing and allocating resources at the global corporate level enables our CEO to assess both the overall level of resources available and how to best deploy these resources across functions, therapeutic areas, regional commercial organizations and research and development projects in line with our overarching long-term corporate-wide strategic goals, rather than on a product or franchise basis. Consistent with this decision-making process, our CEO uses consolidated, single-segment financial information for purposes of evaluating performance, allocating resources, setting incentive compensation targets, as well as forecasting future period financial results.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates. We are subject to certain risks and uncertainties related to, among other things, product development, regulatory approval, market acceptance, scope of patent and proprietary rights, competition, outcome of legal and governmental proceedings, credit risk, technological change and product liability.
 
Interim results may not be indicative of the results that may be expected for the full year. In the opinion of management, these unaudited consolidated financial statements include all normal and recurring adjustments considered necessary for a fair presentation of these interim unaudited consolidated financial statements.


8

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Certain prior year amounts have been reclassified to conform to the current year's presentation. During the first quarter of 2018, we adopted Accounting Standards Update No. 2016-01, “Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (ASU 2016-01). As such, we have recast our previously reported marketable securities available-for-sale of $5,029 million on our Consolidated Balance Sheet as of December 31, 2017 to conform to the current year presentation as shown in the table below. There were no changes to total current assets or total assets as a result of this reclassification.
 
December 31, 2017
 
As Reported
 
As Revised
Marketable securities available-for-sale
$
5,029

 
N/A

Debt securities available-for-sale
N/A

 
$
3,219

Equity investments with readily determinable fair values
N/A

 
1,810


In addition, as a result of adopting ASU 2016-01, we have also recast certain activity within our previously reported Consolidated Statement of Cash Flows for the six-month period ended June 30, 2017 to conform to the current year presentation as shown in the table below. There were no changes to Net cash provided by operating activities, Net cash (used in) investing activities and Net cash (used in) financing activities as a result of this reclassification.
 
Six-Month Period Ended
 
June 30, 2017
 
As Reported
 
As Revised
Purchases of marketable securities available-for-sale
$
(3,482
)
 
N/A

Purchases of investment securities
(85
)
 
N/A

Purchases of debt securities available-for-sale
N/A

 
$
(3,411
)
Purchases of equity investment securities
N/A

 
(156
)
Proceeds from sales of marketable securities available-for-sale
2,070

 
N/A

Proceeds from sales of investment securities
14

 
N/A

Proceeds from sales of debt securities available-for-sale
N/A

 
2,057

Proceeds from sales of equity investment securities
N/A

 
27


In addition, in August 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2017-12, "Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities" (ASU 2017-12), which we adopted on August 31, 2017, with an initial application date as of January 1, 2017. As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Annual Report on Form 10-K), during the nine-month period ended September 30, 2017, the Company recorded pre-tax income of $48 million and $37 million for the three- and six-month periods ended June 30, 2017, respectively, as a result of applying the new guidance. As such, we have recast the financial statements for the three- and six-month periods ended June 30, 2017 to reflect the adoption of ASU 2017-12 as follows:
 
Three-Month Period Ended
 
Six-Month Period Ended
 
June 30, 2017
 
June 30, 2017
 
As Reported
 
As Revised
 
As Reported
 
As Revised
Net product sales
$
3,256

 
$
3,259

 
$
6,206

 
$
6,211

Other (expense) income, net
(76
)
 
(31
)
 
(50
)
 
(18
)
Income tax provision
69

 
77

 
153

 
159

Net income
1,061

 
1,101

 
2,002

 
2,033

Diluted net income per common share
$
1.31

 
$
1.36

 
$
2.47

 
$
2.51

Our significant accounting policies are described in Note 1 of Notes to Consolidated Financial Statements included in our 2017 Annual Report on Form 10-K. Such significant accounting policies are applicable for periods prior to the adoption of the following new accounting standards.


9

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


New accounting standards which have been adopted

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (ASU 2014-09) and has subsequently issued a number of amendments to ASU 2014-09. The new standard, as amended, provides a single comprehensive model to be used in the accounting for revenue arising from contracts with customers and supersedes previous revenue recognition guidance, including industry-specific guidance. The standard’s stated core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle, ASU 2014-09 includes provisions within a five step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. See Note 2 for revenue recognition disclosures.

The new standard was effective for us on January 1, 2018 and we elected to adopt it using a modified retrospective transition method, which required a cumulative effect adjustment to opening retained earnings as of January 1, 2018. The implementation of ASU 2014-09 using the modified retrospective transition method did not have a material quantitative impact on our consolidated financial statements as the timing of revenue recognition did not significantly change. We also elected the following practical expedients, which were available to us as a result of utilizing the modified retrospective transition method:

We applied the provisions of the standard only to contracts that were not completed as of January 1, 2018; and
We did not retrospectively restate contracts for contract modifications executed before the beginning of the earliest period presented.

In accordance with the transition provisions of ASU 2014-09, we recorded a cumulative effect adjustment of $4 million to increase Retained earnings (net of a $1 million tax effect). In limited instances, the new standard permits us to recognize revenue earlier than under the previous revenue recognition guidance. Historically, we deferred certain revenue where the transaction price pursuant to the underlying customer arrangement was not fixed or determinable. Under the new standard, such customer arrangements are accounted for as variable consideration, which results in revenue being recognized earlier provided we can reliably estimate the ultimate price expected to be realized from the customer. In addition, ASU 2014-09 requires companies who elect to adopt the standard using the modified retrospective transition method to disclose within the footnotes the effects of applying the provisions of the previous standards to current year financial statements. Revenue and net income for the three- and six-month periods ended June 30, 2018, do not differ materially from amounts that would have resulted from application of the previous standards.

In January 2016 and February 2018, the FASB issued ASU 2016-01 and Accounting Standards Update No. 2018-03, "Technical Corrections and Improvements to Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities" (ASU-2018-03), respectively. ASU 2016-01 changes accounting for equity investments, financial liabilities under the fair value option, and presentation and disclosure requirements for financial instruments. ASU 2016-01 does not apply to equity investments in consolidated subsidiaries or those accounted for under the equity method of accounting. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. Equity investments with readily determinable fair values will be measured at fair value with changes in fair value recognized in net income. We have elected to measure all of our equity investments without readily determinable fair values at cost adjusted for changes in observable prices minus impairment or at net asset value (NAV), as a practical expedient, if available. Changes in measurement of equity investments without readily determinable fair values will be recognized in net income. The guidance related to equity investments without readily determinable fair values, in which the practical expedient has not been elected, will be applied prospectively to equity investments that exist as of the date of adoption. For equity investments without a readily determinable fair value in which the NAV per share practical expedient is elected, ASU 2018-03 clarified that the transition should not be performed prospectively, but rather as a cumulative effect adjustment to opening retained earnings as of the beginning of the fiscal year of adoption. Equity investments without readily determinable fair values are recorded within Other non-current assets on the Consolidated Balance Sheets. We have not elected the fair value option for financial liabilities with instrument-specific credit risk. Companies must assess valuation allowances for deferred tax assets related to available-for-sale debt securities in combination with their other deferred tax assets. ASU 2016-01 was effective for us on January 1, 2018 which required a cumulative effect adjustment to opening retained earnings to be recorded for equity investments with readily determinable fair values and equity investments without readily determinable fair values in which the NAV per share practical expedient was elected. As of the adoption date, we held publicly traded equity investments with a fair value of approximately $1.8 billion in a net unrealized gain position of $875 million, and having an associated deferred tax liability of $188 million. We recorded a cumulative effect adjustment of $687 million to decrease Accumulated other comprehensive income (AOCI) with a corresponding

10

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


increase to Retained earnings for the amount of unrealized gains or losses, net of tax as of the beginning of fiscal year 2018. In addition, we held an equity investment without a readily determinable fair value in which we elected the NAV per share practical expedient. As such, on January 1, 2018, we recorded an additional cumulative effect adjustment of $59 million to increase Equity investments without readily determinable fair values as the NAV was in excess of our cost basis as of the adoption date with a corresponding increase to Retained earnings of $44 million, net of the tax effect of $15 million. As a result of the implementation of ASU 2016-01, effective on January 1, 2018 unrealized gains and losses in equity investments with readily determinable fair values and equity investments without readily determinable fair values for which observable price changes for identical or similar (e.g. dividend rights, voting rights, etc.) investments occur are recorded on the Consolidated Statement of Income within Other income (expense), net. We recorded a net loss of $6 million and net gain of $953 million in Other income (expense), net for the three- and six-month periods ended June 30, 2018, respectively, as a result of adopting this standard. The implementation of ASU 2016-01 is expected to increase volatility in our net income as the volatility previously recorded in Other comprehensive income (OCI) related to changes in the fair market value of available-for-sale equity investments will now be reflected in net income effective with the adoption date.

In February 2018, the FASB issued Accounting Standards Update No. 2018-02, "Income Statement-Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" (ASU 2018-02). The new standard is effective on January 1, 2019 with early adoption permitted. The guidance permits a reclassification from AOCI to Retained earnings for stranded tax effects resulting from U.S. tax reform legislation enacted in December 2017 (2017 Tax Act). We elected to early adopt ASU 2018-02 on January 1, 2018. We use a specific identification approach to release the income tax effects in AOCI. We have recast our previously reported Marketable securities available-for-sale on our Consolidated Balance Sheet as of December 31, 2017 to conform to the current year presentation as outlined earlier in this Note 1. As a result of adopting this standard, we recorded a cumulative effect adjustment to increase AOCI by $117 million with a corresponding decrease to Retained earnings. We recorded the impacts of adopting ASU 2018-02 prior to recording the impacts of adopting ASU 2016-01 and included state income tax related effects in the amounts reclassified to Retained earnings.

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" (ASU 2016-15). ASU 2016-15 clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows where diversity in practice exists. ASU 2016-15 was effective for us in our first quarter of fiscal 2018 and did not result in any changes to the presentation of our Consolidated Statement of Cash Flows upon adoption.

In October 2016, the FASB issued Accounting Standards Update No. 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory” (ASU 2016-16). ASU 2016-16 requires the income tax consequences of intra-entity transfers of assets other than inventory to be recognized as current period income tax expense or benefit and removes the requirement to defer and amortize the consolidated tax consequences of intra-entity transfers. The new standard was effective for us on January 1, 2018. As of the adoption date, we had net prepaid tax assets of $166 million related to intra-entity transfers of assets other than inventory which was recorded in Other non-current assets. Using the modified retrospective approach, we recorded a cumulative effect adjustment of $166 million to decrease Retained earnings with a corresponding decrease in prepaid tax assets as of the beginning of fiscal year 2018.

In January 2017, the FASB issued Accounting Standards Update No. 2017-01, “Business Combinations” (ASU 2017-01). ASU 2017-01 provides guidance for evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance provides a screen to determine when an integrated set of assets and activities (a “set”) does not qualify to be a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in an identifiable asset or a group of similar identifiable assets, the set is not a business. If the screen is not met, the guidance requires a set to be considered a business to include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs and removes the evaluation as to whether a market participant could replace the missing elements. The new standard was effective for us on January 1, 2018 and was adopted on a prospective basis. In the first quarter of 2018, we acquired Impact Biomedicines Inc. (Impact) and Juno Therapeutics Inc. (Juno) which were accounted for as an asset acquisition and a business combination, respectively. See Note 3 for further information on the acquisitions of Impact and Juno. We anticipate that the adoption of this standard will result in more acquisitions being accounted for as asset acquisitions.


11

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The following table presents a summary of cumulative effect adjustments to Retained earnings due to the adoption of new accounting standards on January 1, 2018 as noted above:
 
 
Cumulative Effect Adjustments to Retained Earnings on January 1, 2018 Increase / (Decrease)
Cumulative effect adjustment to Retained earnings due to the adoption of the following new accounting standards:
 
 
ASU 2014-09
$
4

 
ASU 2016-01
687

 
ASU 2018-03
44

 
ASU 2018-02
(117
)
 
ASU 2016-16
(166
)
 
Net cumulative effect adjustments to Retained earnings on January 1, 2018 due to the adoption of new accounting standards
$
452


New accounting standards which have not yet been adopted

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, "Leases" (ASU 2016-02). ASU 2016-02 provides accounting guidance for both lessee and lessor accounting models. Among other things, lessees will recognize a right-of-use asset and a lease liability for leases with a duration of greater than one year. For income statement purposes, ASU 2016-02 will require leases to be classified as either an operating or finance lease. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The new standard will be effective for us on January 1, 2019 and will be adopted using a modified retrospective approach which will require application of the new guidance at the beginning of the earliest comparative period presented. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures. We expect the implementation of this standard to have an impact on our consolidated financial statements and related disclosures as we had aggregate future minimum lease payments of approximately $235 million as of December 31, 2017 under our portfolio of non-cancelable leased office and research facilities. In addition, Juno had $106 million of aggregate future minimum lease payments as of December 31, 2017. We anticipate recognition of additional assets and corresponding liabilities related to these leases on our consolidated balance sheet.

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, "Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments" (ASU 2016-13). ASU 2016-13 requires that expected credit losses relating to financial assets measured on an amortized cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU 2016-13 limits the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective for us on January 1, 2020. Early adoption will be available on January 1, 2019. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

2. Revenue
 
Subsequent to January 1, 2018 we account for revenue in accordance with ASU 2014-09, which we adopted using the modified retrospective method. See Note 1 for further discussion of the adoption, including the impact on our consolidated financial statements. The majority of our revenue is derived from product sales. Our commercial stage products include REVLIMID®, POMALYST®/IMNOVID®, OTEZLA®, ABRAXANE®, IDHIFA®, VIDAZA®, azacitidine for injection (generic version of VIDAZA®) and THALOMID® (sold as THALOMID® or Thalidomide Celgene® outside of the U.S.). In addition, we recognize revenue from other product sales and royalties based on licensees’ sales of our products or products using our technologies. We do not consider royalty revenue to be a material source of our consolidated revenue. As such, the following disclosure only relates to revenue associated with net product sales.


12

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the current revenue standard. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.

At contract inception, we assess the goods promised in our contracts with customers and identify a performance obligation for each promise to transfer to the customer a good that is distinct. When identifying our performance obligations, we consider all goods promised in the contract regardless of whether explicitly stated in the customer contract or implied by customary business practices. Generally, our contracts with customers require us to transfer an individual distinct product, which would represent a single performance obligation. In limited situations, our contracts with customers will require us to transfer two or more distinct products, which would represent multiple performance obligations for each distinct product. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation on a relative standalone selling price basis. In determining our standalone selling prices for our products, we utilize observable prices for our goods sold separately in similar circumstances and to customers in the same geographical region or market. Our performance obligations with respect to our product sales are satisfied at a point in time, which transfer control upon delivery of product to our customers. We consider control to have transferred upon delivery because the customer has legal title to the asset, we have transferred physical possession of the asset, the customer has significant risks and rewards of ownership of the asset, and in most instances we have a present right to payment at that time. The aggregate dollar value of unfulfilled orders as of June 30, 2018 was not material.

Distribution

REVLIMID®, POMALYST® and THALOMID® are distributed in the United States primarily through contracted pharmacies under the REVLIMID Risk Evaluation and Mitigation Strategy (REMS), POMALYST REMS® and THALOMID REMS® programs, respectively. These are proprietary risk-management distribution programs tailored specifically to provide for the safe and appropriate distribution and use of REVLIMID®, POMALYST® and THALOMID®. Internationally, REVLIMID®, THALOMID®/Thalidomide Celgene® and IMNOVID® are distributed under mandatory risk-management distribution programs tailored to meet local authorities’ specifications to provide for the product’s safe and appropriate distribution and use. These programs may vary by country and, depending upon the country and the design of the risk-management program, the product may be sold through hospitals or retail pharmacies. OTEZLA®, ABRAXANE®, ISTODAX®, IDHIFA® and VIDAZA® are distributed through the more traditional pharmaceutical industry supply chain and are not subject to the same risk-management distribution programs as REVLIMID®, POMALYST®/IMNOVID® and THALOMID®/Thalidomide Celgene®.

Significant Payment Terms

Our contracts with our customers state the terms of the sale including the description, quantity, and price for each product purchased as well as the payment and shipping terms. Our contractual payment terms vary by jurisdiction. In the United States, our contractual payment terms are typically due in no more than 30 days. Sales made outside the United States typically have payment terms that are greater than 60 days, thereby extending collection periods beyond those in the United States. The period between when we transfer control of the promised goods to a customer and when we receive payment from such customer is expected to be one year or less. Any exceptions to this are either not material or we collect interest from the customer for the time period between the invoice due date and the payment date. As such, we do not adjust the invoice amount for the effects of a significant financing component as the impact is not material to our consolidated financial statements.
  
Contract Balances

When the timing of our delivery of product is different from the timing of payments made by the customers, we recognize either a contract asset (performance precedes the contractual due date) or a contract liability (customer payment precedes performance). There were no significant changes in our contract asset or liability balances during the three- or six-month periods ended June 30, 2018 other than from transactions in the ordinary course of operating activities as described above.

Contract Assets

In limited situations, certain customer contractual payment terms require us to bill in arrears; thus, we satisfy some or all of our performance obligations before we are contractually entitled to bill the customer. In these situations, billing occurs subsequent to revenue recognition, which results in a contract asset. We reflect these contract assets as Other current assets on the Consolidated Balance Sheet. For example, certain of our contractual arrangements do not permit us to bill until the product is sold through to the end-customer. As of June 30, 2018, such contract assets were $25 million. For the three- and six-month periods ended June 30, 2018, we recognized revenue included in such contract assets of $5 million and $28 million, respectively.

13

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Contract Liabilities

In other limited situations, certain customer contractual payment terms allow us to bill in advance; thus, we receive customer cash payment before satisfying some or all of its performance obligations. In these situations, billing occurs in advance of revenue recognition, which results in contract liabilities. We reflect these contract liabilities as Deferred revenue on our Consolidated Balance Sheet. For example, certain of our contractual arrangements provide the customer with free product after the customer has purchased a contractual minimum amount of product. We concluded the free product represents a future performance obligation in the form of a contractual material right. As such, we defer a portion of the transaction price as a contract liability upon each sale of product until the contractual minimum volume is achieved. As we satisfy our remaining performance obligations we release a portion of the deferred revenue balance. Revenue recognized for the three- and six-month periods ended June 30, 2018 that was reflected in the deferred revenue balance at the beginning of the year was $82 million and $98 million, respectively. As of June 30, 2018, such contract liabilities were $127 million.

Gross to Net Sales Adjustments

We record gross to net sales accruals for government rebates, chargebacks, distributor service fees, other rebates and administrative fees, sales returns and allowances, and sales discounts. Provisions for discounts, early payments, rebates, sales returns, distributor service fees and chargebacks under terms customary in the industry are provided for in the same period the related sales are recorded. We record estimated reductions to revenue for volume-based discounts and rebates at the time of the initial sale based upon the sales terms, historical experience and trend analysis. We estimate these accruals using an expected value approach based primarily upon our historical rebate and discount payments made and the provisions included in current customer contracts and government regulations.

Government Rebates, including Medicaid and Medicare Rebates

Government rebate accruals are based on estimated payments due to governmental agencies for purchases made by third parties under various governmental programs. In the U.S., we participate in state government Medicaid programs and other Federal and state government programs, which require rebates to participating government entities. U.S. Medicaid rebate accruals are generally based on historical payment data and estimates of future Medicaid beneficiary utilization applied to the Medicaid unit rebate formula established by the Center for Medicaid and Medicare Services. The Medicaid rebate percentage was increased and extended to Medicaid Managed Care Organizations in March 2010. The accrual of the rebates associated with Medicaid Managed Care Organizations is calculated based on estimated historical patient data related to Medicaid Managed Care Organizations. We also analyze actual billings received from the states to further support the accrual rates. Manufacturers of pharmaceutical products are responsible for 50% of the patient’s cost of branded prescription drugs related to the Medicare Part D Coverage Gap. In order to estimate the cost to us of this coverage gap responsibility, we analyze data for eligible Medicare Part D patients against data for eligible Medicare Part D patients treated with our products as well as the historical invoices. This expense is recognized throughout the year as costs are incurred. In certain international markets government-sponsored programs require rebates to be paid based on program specific rules and, accordingly, the rebate accruals are determined primarily on estimated eligible sales.

Chargebacks, Distributor Service Fees, Other Rebates and Administrative Fees

Chargeback accruals are based on the differentials between product acquisition prices paid by wholesalers and lower government contract pricing paid by eligible customers covered under federally qualified programs. Distributor service fee accruals are based on contractual fees to be paid to the wholesale distributor for services provided. TRICARE is a health care program of the U.S. Department of Defense Military Health System that provides civilian health benefits for military personnel, military retirees and their dependents. TRICARE rebate accruals are included in chargeback accruals and are based on estimated Department of Defense eligible sales multiplied by the TRICARE rebate formula.

Rebates or administrative fees are offered to certain wholesale customers, group purchasing organizations and end-user customers, consistent with pharmaceutical industry practices. Settlement of rebates and administrative fees may generally occur from one to 15 months from the date of sale. We record a provision for rebates at the time of sale based on contracted rates and historical redemption rates. Assumptions used to establish the provision include level of wholesaler inventories, contract sales volumes and average contract pricing. We regularly review the information related to these estimates and adjust the provision accordingly.



14

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Returns, Refunds and Warranties

We base our sales returns allowance on estimated on-hand retail/hospital inventories, measured end-customer demand as reported by third-party sources, actual returns history and other factors, such as the trend experience for lots where product is still being returned or inventory centralization and rationalization initiatives conducted by major pharmacy chains, as applicable. If the historical data we use to calculate these estimates do not properly reflect future returns, then a change in the allowance would be made in the period in which such a determination is made and revenues in that period could be materially affected. Under this methodology, we track actual returns by individual production lots. Returns on closed lots, that is, lots no longer eligible for return credits, are analyzed to determine historical returns experience. Returns on open lots, that is, lots still eligible for return credits, are monitored and compared with historical return trend rates. Any changes from the historical trend rates are considered in determining the current sales return allowance. We do not provide warranties on our products to our customers unless the product is defective as manufactured or damaged in transit within a reasonable period of time after receipt of the product by the customer.

Sales Discounts

Sales discounts are based on payment terms extended to customers, which are generally offered as an incentive for prompt payment. We record our best estimate of sales discounts to which customers are likely to be entitled based on both historical information and current trends.

The reconciliation of gross product sales to net product sales by each significant category of gross-to-net adjustments was as follows:
 
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Gross Product Sales
 
$
4,530

 
$
3,808

 
$
8,777

 
$
7,243

Gross-to-Net Adjustments:
 
 
 
 
 
 
 
 
Government Rebates
 
(269
)
 
(216
)
 
(560
)
 
(434
)
Chargebacks and Distributor Services Fees
 
(390
)
 
(282
)
 
(757
)
 
(508
)
Sales Discounts
 
(59
)
 
(48
)
 
(115
)
 
(90
)
Sales Returns and Allowances
 
(4
)
 
(3
)
 
(6
)
 

Total Gross-to-Net Adjustments
 
(722
)
 
(549
)
 
(1,438
)
 
(1,032
)
Net Product Sales
 
$
3,808

 
$
3,259

 
$
7,339

 
$
6,211



15

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Total revenues from external customers by our franchises (Hematology / Oncology and Inflammation & Immunology), product and geography for the three- and six-month periods ended June 30, 2018 and June 30, 2017 were as follows:
 
 
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
 
 
 
2018
 
2017
 
2018
 
2017
Hematology / Oncology:
 
 
 
 
 
 
 
 
 
REVLIMID®
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
1,586

 
$
1,358

 
$
3,073

 
$
2,592

 
International
 
867

 
676

 
1,614

 
1,326

 
Worldwide
 
2,453

 
2,034

 
4,687

 
3,918

POMALYST®/IMNOVID®
 
 
 
 
 
 
 
 
 
 
U.S.
 
341

 
241

 
641

 
457

 
International
 
166

 
150

 
319

 
298

 
Worldwide
 
507

 
391

 
960

 
755

ABRAXANE®
 
 
 
 
 
 
 
 
 
 
U.S.
 
152

 
161

 
311

 
303

 
International
 
91

 
93

 
194

 
187

 
Worldwide
 
243

 
254

 
505

 
490

VIDAZA®
 
 
 
 
 
 
 
 
 
 
U.S.
 
3

 
2

 
5

 
4

 
International
 
159

 
154

 
314

 
310

 
Worldwide
 
162

 
156

 
319

 
314

All Other
 
 
 
 
 
 
 
 
 
 
U.S.
 
52

 
47

 
107

 
95

 
International
 
16

 
19

 
33

 
39

 
Worldwide
 
68

 
66

 
140

 
134

Total Hematology / Oncology:
 
 
 
 
 
 
 
 
 
 
U.S.
 
2,134

 
1,809

 
4,137

 
3,451

 
International
 
1,299

 
1,092

 
2,474

 
2,160

 
Worldwide
 
$
3,433

 
$
2,901

 
$
6,611

 
$
5,611

 
 
 
 
 
 
 
 
 
 
Inflammation & Immunology:
 
 
 
 
 
 
 
 
 
OTEZLA®
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
291

 
$
306

 
$
567

 
$
505

 
International
 
84

 
52

 
161

 
95

 
Worldwide
 
$
375

 
$
358

 
$
728

 
$
600

 
 
 
 
 
 
 
 
 
 
Total net product sales
 
 
 
 
 
 
 
 
 
 
U.S.
 
$
2,425

 
$
2,115

 
$
4,704

 
$
3,956

 
International
 
1,383

 
1,144

 
2,635

 
2,255

 
Worldwide
 
$
3,808

 
$
3,259

 
$
7,339

 
$
6,211

 
 
 
 
 
 
 
 
 
 
Other revenue
 
 
6

 
12

 
13

 
22

 
 
 
 
 
 
 
 
 
 
Total revenue
 
 
$
3,814


$
3,271

 
$
7,352


$
6,233


3. Acquisitions

Acquisitions in Fiscal 2018:

Impact Biomedicines, Inc. (Impact): On February 12, 2018, we acquired all of the outstanding shares of Impact, a privately held biotechnology company which was developing fedratinib, a highly selective JAK2 kinase inhibitor, for myelofibrosis.

The consideration included an initial payment of approximately $1.1 billion. In addition, the sellers of Impact are eligible to receive contingent consideration based upon regulatory approvals of up to $1.4 billion and contingent consideration of up to $4.5 billion based upon the achievement of sales in any four consecutive calendar quarters between $1.0 billion and $5.0 billion. The acquisition of Impact was concentrated in one single identifiable asset and thus, for accounting purposes, we have concluded that the acquired assets do not meet the accounting definition of a business. The initial payment was allocated primarily to fedratinib, resulting in a $1.1 billion research and development asset acquisition expense and the balance of approximately $7 million was allocated to the remaining net assets acquired.

16

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Juno Therapeutics, Inc. (Juno): On March 6, 2018 (Acquisition Date), we acquired all of the outstanding shares of Juno, resulting in Juno becoming our wholly-owned subsidiary. Juno is developing CAR (chimeric antigen receptor) T and TCR (T cell receptor) therapeutics with a broad, novel portfolio evaluating multiple targets and cancer indications. The acquisition added a novel scientific platform and scalable manufacturing capabilities including JCAR017 and JCARH125, both directed CAR T therapeutics currently in programs for relapsed and/or refractory diffuse large B-cell lymphoma and relapsed/refractory multiple myeloma, respectively.

Total consideration for the acquisition was approximately $10.4 billion, consisting of $9.1 billion for common stock outstanding, $966 million for the fair value of our investment in Juno and $367 million for the portion of equity compensation attributable to the pre-combination service period. In addition, the fair value of the awards attributed to post-combination service period was $666 million, which will be recognized as compensation expense over the requisite service period in the post-combination financial statements of Celgene. We recognized $150 million and $400 million of post combination share-based compensation for the three- and six-month periods ended June 30, 2018, respectively.

The acquisition has been accounted for as a business combination using the acquisition method of accounting which requires that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date and requires the fair value of acquired in-process research and development (IPR&D) to be classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. A preliminary purchase price allocation has been performed and the recorded amounts for intangible assets, goodwill and current and deferred tax assets and liabilities are subject to change pending finalization of valuation efforts and review of tax matters. During the second quarter of 2018, the Company recorded certain measurement period adjustments that were not material. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the acquisition date.

The total consideration for the acquisition of Juno was $10.4 billion, which consisted of the following:
 
Total Consideration
Cash paid for outstanding common stock at $87.00 per share
$
9,101

Celgene investment in Juno at $87.00 per share (1)
966

Cash for equity compensation attributable to pre-combination service (2)
367

Total consideration
$
10,434


(1) The Company recognized a gain of $458 million as a result of remeasuring to fair value the equity interest in Juno held by us before the business combination, which was recorded in Other income (expense), net within the Consolidated Statement of Income during the first quarter of 2018. See Note 1 for further information on the adoption of ASU 2016-01.

(2) All equity compensation attributable to pre-combination service was paid during the first quarter of 2018.


17

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The preliminary purchase price allocation resulted in the following amounts being allocated to the assets acquired and liabilities assumed at the Acquisition Date based upon their respective preliminary fair values summarized below:
 
Amounts Recognized as of the Acquisition Date (Provisional)
Working capital (1)
$
437

In-process research and development (IPR&D)
6,980

Technology platform intangible asset
1,260

Property, plant and equipment, net
144

Other non-current assets
46

Deferred tax liabilities, net
(1,530
)
Other non-current liabilities
(41
)
Total identifiable net assets
7,296

Goodwill
3,138

Total net assets acquired
$
10,434


(1)  Includes cash and cash equivalents, debt securities available-for-sale, accounts receivable, other current assets, accounts payable, accrued expenses and other current liabilities (including accrued litigation). See Note 16 for litigation matters related to Juno.

The fair value assigned to acquired IPR&D was based on the present value of expected after-tax cash flows attributable to JCAR017, which is in a pivotal phase II trial and JCARH125. The present value of expected after-tax cash flows attributable to JCAR017 and JCARH125 assigned to IPR&D was determined by estimating the after-tax costs to complete development of JCAR017 and JCARH125 into commercially viable products, estimating future revenue and ongoing expenses to produce, support and sell JCAR017 and JCARH125, on an after-tax basis, and discounting the resulting net cash flows to present value. The revenue and costs projections used were reduced based on the probability that products at similar stages of development will become commercially viable products. The rate utilized to discount the net cash flows to their present value reflects the risk associated with the intangible asset and is benchmarked to the cost of equity. Acquired IPR&D will be accounted for as indefinite-lived intangible assets until regulatory approvals for JCAR017 and JCARH125 in a major market or discontinuation of development.

The excess of purchase price over the fair value amounts assigned to identifiable assets acquired and liabilities assumed represents the goodwill amount resulting from the acquisition. The goodwill recorded as part of the acquisition is primarily attributable to the broadening of our product portfolio and research capabilities in the hematology and oncology therapeutic area, the assembled workforce and the deferred tax consequences of the IPR&D asset recorded for financial statement purposes. We do not expect any portion of this goodwill to be deductible for tax purposes. The goodwill attributable to the acquisition has been recorded as a non-current asset in our Consolidated Balance Sheets and is not amortized, but is subject to review for impairment annually.


18

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Juno actual results for the three-months ended June 30, 2018 and from the Acquisition Date through June 30, 2018, which are included in the Consolidated Statement of Income are as follows:
Classification in the Consolidated Statements of Income
Three-Months Ended June 30, 2018
 
Acquisition Date Through June 30, 2018
Other revenue
$
1

 
$
1

Research and development (1)
225

 
385

Selling, general and administrative (1)
79

 
210

Amortization of acquired intangible assets
21

 
28

Acquisition related charges (income) and restructuring, net (2)
27

 
49

Interest and investment income, net
3

 
3

Other income (expense), net
15

 
11

Income tax provision (benefit), net
(63
)
 
(83
)
Total
$
(270
)
 
$
(574
)

(1) Includes share-based compensation expense related to the post-combination service period of $100 million and $50 million, which was recorded in Research and development and Selling, general and administrative expenses, respectively, for the three-months ended June 30, 2018. Also includes share-based compensation expense related to the post-combination service period of $233 million and $167 million, which was recorded in Research and development and Selling, general and administrative expenses, respectively, for the period from the acquisition date through June 30, 2018.
(2) Consists of acquisition related compensation expense, transaction costs and the change in fair value of contingent consideration and success payment liabilities. In addition, Celgene incurred incremental acquisition costs related to Juno of nil and $41 million for the three- and six-month periods ended June 30, 2018 respectively.

Pro Forma Financial Information:

The following table provides unaudited pro forma financial information for the six-month period ended June 30, 2018 and the three- and six-month periods ended June 30, 2017 as if the acquisition of Juno had occurred on January 1, 2017.
 
 
Six-Month Periods Ended June 30,
 
Three-Month Period Ended June 30, 2017
 
 
2018
 
2017
 
Total revenue
 
$
7,362

 
$
6,234

 
$
3,272

Net income
 
1,805

 
1,495

 
994

 
 
 
 
 
 
 
Net income per common share: basic
 
$
2.47

 
$
1.92

 
$
1.27

Net income per common share: diluted
 
$
2.40

 
$
1.84

 
$
1.22


The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of Celgene and Juno. The supplemental pro forma financial information reflects primarily the following pro forma adjustments:

Elimination of research related cost sharing transactions between Celgene and Juno;
The pro forma financial information assumes that the acquisition related transaction fees and costs, including post combination share-based compensation related to the acquisition, were removed from the three- and six-month periods ended June 30, 2018 and were assumed to have been incurred during the first quarter of 2017;
The pro forma financial information assumes that the gain recognized as a result of remeasuring to fair value the equity interest we held in Juno prior to the business combination was removed from the six-month period ended June 30, 2018 and was assumed to have been recognized during the first quarter of 2017;
Additional interest expense and amortization of debt issuance costs for a portion of the $4.5 billion of debt that was issued in February 2018 to partially finance the acquisition;

19

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Additional amortization expense on the acquired technology platform asset; and
Statutory tax rates were applied, as appropriate, to each pro forma adjustment based on the jurisdiction in which the adjustment occurred.

The unaudited pro forma results do not reflect any operating efficiencies or potential cost savings that may result from the combined operations of Celgene and Juno. Accordingly, these unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the acquisition occurred at the beginning of the period presented, nor are they intended to represent or be indicative of future results of operations.

Acquisitions in Fiscal 2017:

Delinia, Inc. (Delinia): On February 3, 2017, we acquired all of the outstanding shares of Delinia, a privately held biotechnology company focused on developing novel therapeutics for the treatment of autoimmune diseases. The transaction expands our Inflammation and Immunology pipeline primarily through the acquisition of Delinia’s lead program, DEL-106, as well as related second generation programs. DEL-106 is a novel IL-2 mutein Fc fusion protein designed to preferentially upregulate regulatory T cells (Tregs), immune cells that are critical to maintaining natural self-tolerance and immune system homeostasis.

The consideration included an initial payment of $302 million. In addition, the sellers of Delinia are eligible to receive up to $475 million in contingent development, regulatory and commercial milestones. The acquisition did not include any significant processes and thus, for accounting purposes, we have concluded that the acquired assets did not meet the definition of a business. The initial payment was allocated primarily to the DEL-106 program, resulting in a $300 million research and development asset acquisition expense and approximately $2 million of net assets acquired.

Other acquisitions: In addition, during the first quarter of 2017, we acquired all of the outstanding shares of a privately held biotechnology company for total initial consideration of $26 million. The sellers are also eligible to receive up to $210 million in contingent development and regulatory approval milestones. The acquisition did not include any significant processes and thus, for accounting purposes, we have concluded that the acquired assets did not meet the definition of a business. The consideration transferred resulted in a $25 million research and development asset acquisition expense and $1 million of net assets acquired. 

4. Earnings Per Share
 
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
(Amounts in millions, except per share)
2018
 
2017
 
2018
 
2017
Net income
$
1,045

 
$
1,101

 
$
1,891

 
$
2,033

Weighted-average shares:
 
 
 
 
 
 
 
Basic
716.1

 
780.4

 
732.1

 
779.7

Effect of dilutive securities:
 
 
 
 
 
 
 
Options, restricted stock units, performance-based restricted stock units and other
16.5

 
31.3

 
18.5

 
31.8

Diluted
732.6

 
811.7

 
750.6

 
811.5

Net income per share:
 
 
 
 
 
 
 
Basic
$
1.46

 
$
1.41

 
$
2.58

 
$
2.61

Diluted
$
1.43

 
$
1.36

 
$
2.52

 
$
2.51

 
The total number of potential shares of common stock excluded from the diluted earnings per share computation because their inclusion would have been anti-dilutive was 45.6 million and 21.4 million shares for the three-month periods ended June 30, 2018 and 2017, respectively, and 41.3 million and 22.0 million shares for the six-month periods ended June 30, 2018 and 2017, respectively.

Share Repurchase Program: In February and May 2018, our Board of Directors approved increases of $5.0 billion and $3.0 billion, respectively to our authorized share repurchase program, bringing the total amount authorized since April 2009 to $28.5 billion of our common stock. As part of the existing Board authorized share repurchase program, in May 2018, we entered into an Accelerated Share Repurchase (ASR) agreement with a bank to repurchase an aggregate of $2.0 billion of our common stock. As part of the ASR agreement, we received an initial delivery of approximately 18.0 million shares, which is included in Common

20

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


stock in treasury in the accompanying Consolidated Balance Sheet as of June 30, 2018, at a cost of approximately $1.4 billion.  The initial delivery reduced our outstanding shares used to determine our weighted average shares outstanding for purposes of calculating basic and diluted earnings per share.  The remaining $600 million was included in Additional paid-in capital in the accompanying Consolidated Balance Sheet as of June 30, 2018. The total number of shares that will ultimately be repurchased under the ASR agreement will be determined upon final settlement, which we anticipate will be in the third quarter of 2018 and will be based on a discount to the volume-weighted average price of our common stock during the ASR period. We have evaluated the ASR agreement for its potential dilution of earnings per share and determined that the additional shares to be received upon final settlement would have had an anti-dilutive effect and as a result, these shares were not included in our weighted average diluted earnings per share calculation.
 
As part of the management of our share repurchase program, we may, from time to time, sell put options on our common stock with strike prices that we believe represent an attractive price to purchase our shares. If the trading price of our shares exceeds the strike price of the put option at the time the option expires, we will have economically reduced the cost of our share repurchase program by the amount of the premium we received from the sale of the put option. If the trading price of our stock is below the strike price of the put option at the time the option expires, we would purchase the shares covered by the option at the strike price of the put option. During the three- and six-month periods ended June 30, 2018 and 2017, there were no gains or losses from the sale of put options. As of June 30, 2018 and December 31, 2017, we had no outstanding put options.

We have purchased 32.8 million and 61.8 million shares of common stock under the share repurchase program from all sources at a total cost of $2.7 billion and $5.4 billion during the three- and six-month periods ended June 30, 2018, respectively. As of June 30, 2018, we had a remaining share repurchase authorization of $2.8 billion.


5. Accumulated Other Comprehensive Income (Loss)

During the third quarter of 2017, we adopted ASU 2017-12 on a modified retrospective basis. As a result of applying the new guidance during the nine-month period ended September 30, 2017, we recorded a cumulative effect adjustment of $30 million to decrease AOCI as of the beginning of fiscal year 2017 and adjustments to pre-tax income of $48 million and $37 million, respectively for the three- and six-month periods ended June 30, 2017 with corresponding decreases to AOCI. As such, certain disclosures for the three- and six-month periods ended June 30, 2017 below have been recast to conform to the disclosure requirements related to the adoption of ASU 2017-12. See Note 1 for additional information related to the adoption of ASU 2017-12.

The components of other comprehensive income (loss) consist of changes in pension liability, changes in net unrealized gains (losses) on debt securities available-for-sale and equity investments with readily determinable fair values in 2017 and debt securities available-for-sale in 2018, net unrealized gains (losses) related to cash flow hedges, the amortization of the excluded component related to cash flow hedges and changes in foreign currency translation adjustments.


21

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The accumulated balances related to each component of other comprehensive income (loss), net of tax, are summarized as follows:
 
Pension
Liability
Adjustment
 
Net Unrealized
Gains (Losses) On
Available-for-Sale Debt Securities / Marketable Securities (1)
 
Net Unrealized
Gains (Losses)
Related to Cash Flow Hedges
 
Amortization of Excluded Component Related to Cash Flow Hedges (See Note 1)
 
Foreign
Currency
Translation
Adjustments
 

Accumulated
Other
Comprehensive
Income (Loss)
Balance as of December 31, 2017
$
(22
)
 
$
562

 
$
(206
)
 
$
(15
)
 
$
(32
)
 
$
287

Cumulative effect adjustment for the adoption of ASU 2016-01 and ASU 2018-02 (See Note 1)

 
(566
)
 
(4
)
 

 

 
(570
)
Other comprehensive (loss) income before reclassifications, net of tax

 
(7
)
 
128

 
(15
)
 
(12
)
 
94

Reclassified losses (gains) from accumulated other comprehensive income (loss), net of tax

 
14

 
39

 
17

 

 
70

Net current-period other comprehensive income (loss), net of tax

 
7


167

 
2


(12
)

164

Balance as of June 30, 2018
$
(22
)
 
$
3


$
(43
)
 
$
(13
)

$
(44
)

$
(119
)
 
 
 
 
 
 
 


 
 
 


Balance as of December 31, 2016
$
(38
)
 
$
144

 
$
415

 
$

 
$
(102
)
 
$
419

Cumulative effect adjustment for the adoption of ASU 2017-12

 

 
(12
)
 
(18
)
 

 
(30
)
Other comprehensive income (loss) before reclassifications, net of tax

 
148

 
(259
)
 
(5
)
 
41

 
(75
)
Reclassified losses (gains) from accumulated other comprehensive income (loss), net of tax

 
21

 
(165
)
 

 

 
(144
)
Net current-period other comprehensive income (loss), net of tax

 
169


(424
)
 
(5
)

41

 
(219
)
Balance as of June 30, 2017
$
(38
)
 
$
313


$
(21
)
 
$
(23
)

$
(61
)
 
$
170


(1) Balances as of December 31, 2017 are prior to the adoption of ASU 2016-01 and, as such, include equity securities with readily determinable fair values. Upon adoption of ASU 2016-01, we recorded a cumulative effect adjustment for our net unrealized gains related to our equity securities with readily determinable fair values as of January 1, 2018. Therefore, the unrealized gains (losses) position as of June 30, 2018 solely relate to debt securities available-for-sale. See Note 1 for further information related to the adoption of ASU 2016-01.


22

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


 
 
 
 
Gains (Losses) Reclassified Out of Accumulated
Other Comprehensive Income
Accumulated Other Comprehensive Income (Loss) Components
 
Classification in the
Consolidated Statements of Income
 
Three-Month Periods Ended June 30,
 
Six-Month Periods Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
(Losses) gains related to cash-flow hedges:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Net product sales
 
$
(12
)
 
$
81

 
$
(38
)
 
$
167

Treasury rate lock agreements
 
Interest (expense)
 
(1
)
 
(2
)
 
(2
)
 
(3
)
Interest rate swap agreements
 
Interest (expense)
 

 

 

 
(1
)
 
 
Income tax provision - (expense) benefit
 
1

 
1

 
1

 
2

 
 
 
 
 
 
 
 
 
 
 
Excluded component related to cash-flow hedges:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Net product sales
 
1

 
3

 
(2
)
 
5

 
 
 
 
 
 
 
 
 
 
 
(Losses) gains on available-for-sale debt securities / marketable securities (1):
 
 
 
 
 
 
 
 
Realized (loss) gain on sales of debt securities / marketable securities
 
Interest and investment income, net
 

 
(34
)
 
(18
)
 
(34
)
 
 
Income tax provision - (expense) benefit
 

 
13

 
4

 
13

Total reclassification, net of tax
 
 
 
$
(11
)
 
$
62

 
$
(55
)
 
$
149


(1) (Losses) gains reclassified out of Accumulated other comprehensive income prior to December 31, 2017 are prior to the adoption of ASU 2016-01 and, as such, include equity securities with readily determinable fair values. Upon adoption of ASU 2016-01, we recorded a cumulative effect adjustment for our net unrealized gains related to our equity securities with readily determinable fair values as of January 1, 2018. Therefore, unrealized gains (losses) for the three- and six-month periods ended June 30, 2018 solely relate to debt securities available-for-sale. See Note 1 for further information related to the adoption of ASU 2016-01.

6. Financial Instruments and Fair Value Measurement

The tables below present information about assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017 and the valuation techniques we utilized to determine such fair value.
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Our level 1 assets consist of debt securities available-for-sale and equity investments with readily determinable fair values. Our level 1 liability relates to our publicly traded contingent value rights (CVRs). See Note 18 of Notes to Consolidated Financial Statements included in our 2017 Annual Report on Form 10-K for a description of the CVRs.
Level 2 inputs utilize observable quoted prices for similar assets and liabilities in active markets and observable quoted prices for identical or similar assets in markets that are not very active. From time to time, our level 2 assets consist of U.S. Treasury securities, U.S. government-sponsored agency securities, U.S. government-sponsored agency mortgage-backed securities (MBS), global corporate debt securities, asset backed securities, ultra short income fund investments, time deposits and repurchase agreements with original maturities of greater than three months, foreign currency forward contracts, purchased foreign currency options and interest rate swap contracts. Our level 2 liabilities relate to written foreign currency options, foreign currency forward contracts and interest rate swap contracts.
Level 3 inputs utilize unobservable inputs and include valuations of assets or liabilities for which there is little, if any, market activity. We do not have any level 3 assets. Our level 3 liabilities consist of contingent consideration related to undeveloped product rights and technology platforms resulting from the acquisitions of Gloucester Pharmaceuticals, Inc. (Gloucester), Nogra Pharma Limited (Nogra), Avila Therapeutics, Inc. (Avila) and Quanticel Pharmaceuticals, Inc. (Quanticel). In addition, in connection with our acquisition of Juno in the first quarter of 2018, we assumed Juno's contingent consideration and success payment liabilities.

Our contingent consideration obligations are recorded at their estimated fair values and we revalue these obligations each reporting period until the related contingencies are resolved. The fair value measurements are estimated using probability-weighted discounted cash flow approaches that are based on significant unobservable inputs related to product candidates acquired in business

23

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


combinations and are reviewed quarterly. These inputs include, as applicable, estimated probabilities and timing of achieving specified development and regulatory milestones, estimated annual sales and the discount rate used to calculate the present value of estimated future payments. Significant changes which increase or decrease the probabilities of achieving the related development and regulatory events, shorten or lengthen the time required to achieve such events, or increase or decrease estimated annual sales would result in corresponding increases or decreases in the fair values of these obligations. The fair value of our contingent consideration as of June 30, 2018 and December 31, 2017 was calculated using the following significant unobservable inputs:
Inputs
Ranges (weighted average) utilized as of:
June 30, 2018
December 31, 2017
Discount rate
2.5% to 4.0% (3.2%)
2.7% to 12.0% (3.5%)
Probability of payment
0% to 68% (4.6%)
0% to 20% (4%)
Projected year of payment for development and regulatory milestones
2020 to 2029 (2023)
2020 to 2029 (2024)
Projected year of payment for sales-based milestones and other amounts calculated as a percentage of annual sales
N/A
2024 to 2030 (2028)

The maximum remaining potential payments related to the contingent consideration from the acquisitions of Gloucester, Avila, Quanticel and those assumed in our acquisition of Juno are estimated to be approximately $120 million, $475 million, $214 million and $296 million, respectively, and $1.8 billion plus other amounts calculated as a percentage of annual sales pursuant to the license agreement with Nogra.

Success payment obligations assumed through our acquisition of Juno are also recorded at their estimated fair values and are revalued quarterly. Changes in the fair value of contingent consideration and success payment obligations are recognized in Acquisition related charges (income) and restructuring, net in the Consolidated Statements of Income.

Effective January 1, 2018, we adopted ASU 2016-01. Among other provisions, the new standard required modifications to existing presentation and disclosure requirements on a prospective basis. Certain disclosures as of December 31, 2017 below conform to the disclosure requirements of ASU 2016-01. See Note 1 for additional information related to the adoption of ASU 2016-01.

The following tables present the Company's hierarchy for its assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017:

 
 
 
Fair Value Measurements
as of June 30, 2018
 
Balance as of
June 30, 2018
 
Quoted Price in
Active Markets for
Identical Assets
(Level 1)
 
Significant
Other Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Debt securities available-for-sale
$
79

 
$

 
$
79

 
$

Equity investments with readily determinable fair values
1,828

 
1,828

 

 

Forward currency contracts
27

 

 
27

 

Purchased currency options

33

 

 
33

 

Total assets
$
1,967

 
$
1,828

 
$
139

 
$

Liabilities:
 

 
 

 
 

 
 

Contingent value rights
$
(18
)
 
$
(18
)
 
$

 
$

Interest rate swaps
(27
)
 

 
(27
)
 

Written currency options
(81
)
 

 
(81
)
 

Other acquisition related contingent consideration and success payments
(193
)
 

 

 
(193
)
Total liabilities
$
(319
)
 
$
(18
)
 
$
(108
)
 
$
(193
)



24

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)





 
 
 
Fair Value Measurements
as of December 31, 2017
 
Balance as of December 31, 2017
 
Quoted Price in
Active Markets for
Identical Assets
(Level 1)
 
Significant
Other Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 

 
 

 
 

 
 

Debt securities available-for-sale
$
3,219

 
$

 
$
3,219

 
$

Equity investments with readily determinable fair values
1,810

 
1,810

 

 

Purchased currency options
36

 

 
36

 

Total assets
$
5,065

 
$
1,810

 
$
3,255

 
$

Liabilities:
 

 
 

 
 

 
 

Contingent value rights
$
(42
)
 
$
(42
)
 
$

 
$

Forward currency contracts
(42
)
 

 
(42
)
 

Interest rate swaps
(7
)
 

 
(7
)
 

Written currency options
(172
)
 

 
(172
)
 

Other acquisition related contingent consideration
(80
)
 

 

 
(80
)
Total liabilities
$
(343
)
 
$
(42
)
 
$
(221
)
 
$
(80
)

As of result of the implementation of ASU 2016-01 and ASU 2018-03, effective on January 1, 2018, we measure equity investments without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer or at NAV, as a practical expedient, if available. We record upward adjustments, downward adjustments and impairments of equity investments without readily determinable fair values within Other income (expense), net on the Consolidated Statement of Income. The following table represents a roll-forward of equity investments without readily determinable fair values:

 
Six-Month Period Ended June 30, 2018
Balance as of December 31, 2017
$
513

Cumulative effect adjustment for the adoption of ASU 2018-03 (See Note 1)
59

Purchases
46

Upward adjustments
32

Sales
(23
)
Downward adjustments
(1
)
Impairments
(1
)
Transfer to readily determinable fair value
(20
)
Balance as of June 30, 2018
$
605


For equity investments with and without readily determinable fair values held as of June 30, 2018, we recorded a net unrealized loss of $11 million and a net unrealized gain of $435 million within Other income (expense), net on the Consolidated Statement of Income for the three- and six-month periods ended June 30, 2018, respectively.


25

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


There were no security transfers between levels 1, 2 and 3 during the three-month periods ended June 30, 2018 and 2017. The following table represents a roll-forward of the fair value of level 3 instruments: 
 
 
Three-Month Period Ended June 30, 2018
Liabilities:
 
 
Balance as of March 31, 2018
 
$
(201
)
Amounts acquired from Juno, including measurement period adjustments
 
6

Settlements, including transfers to Accrued expenses and other current liabilities
 
2

  Balance as of June 30, 2018
 
$
(193
)

 
 
Three-Month Period Ended June 30, 2017
Liabilities:
 
 
Balance as of March 31, 2017
 
$
(1,527
)
Net change in fair value
 
20

Settlements, including transfers to Accrued expenses and other current liabilities
 
19

  Balance as of June 30, 2017
 
$
(1,488
)

There were no security transfers between levels 1, 2 and 3 during the six-month periods ended June 30, 2018 and 2017. The following table represents a roll-forward of the fair value of level 3 instruments: 

 
 
Six-Month Period Ended June 30, 2018
Liabilities:
 
 
Balance as of December 31, 2017
 
$
(80
)
Amounts acquired from Juno, including measurement period adjustments
 
(116
)
Net change in fair value
 
1

Settlements, including transfers to Accrued expenses and other current liabilities
 
2

  Balance as of June 30, 2018
 
$
(193
)

 
 
Six-Month Period Ended June 30, 2017
Liabilities:
 
 
Balance as of December 31, 2016
 
$
(1,490
)
Net change in fair value
 
(17
)
Settlements, including transfers to Accrued expenses and other current liabilities
 
19

  Balance as of June 30, 2017
 
$
(1,488
)

As previously reported in our 2017 Annual Report on Form 10-K, we reduced our contingent consideration liabilities related to Nogra by $1,397 million due to the discontinuance of the GED-0301 phase III REVOLVE (CD-002) trial in Crohn's disease and the SUSTAIN (CD-004) extension trial in the fourth quarter of 2017.

7. Derivative Instruments and Hedging Activities
During the third quarter of 2017, we adopted ASU 2017-12 on a modified retrospective basis. We recorded pre-tax income of $48 million and $37 million for the three- and six-month period ended June 30, 2017 as a result of applying the new guidance during the nine-month period ended September 30, 2017. As such, certain disclosures for the three- and six-month periods ended June 30, 2017 below have been recast to conform to the disclosure requirements related to the adoption of ASU 2017-12. See Note 1 for additional information related to the adoption of ASU 2017-12.


26

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Our revenue and earnings, cash flows and fair values of assets and liabilities can be impacted by fluctuations in foreign exchange rates and interest rates. We actively manage the impact of foreign exchange rate and interest rate movements through operational means and through the use of various financial instruments, including derivative instruments such as foreign currency option contracts, foreign currency forward contracts, treasury rate lock agreements and interest rate swap contracts. In instances where these financial instruments are accounted for as cash flow hedges or fair value hedges we may from time to time terminate the hedging relationship. If a hedging relationship is terminated, we generally either settle the instrument or enter into an offsetting instrument.

Foreign Currency Risk Management

We maintain a foreign exchange exposure management program to mitigate the impact of volatility in foreign exchange rates on future foreign currency cash flows, translation of foreign earnings and changes in the fair value of assets and liabilities denominated in foreign currencies.

Through our revenue hedging program, we endeavor to reduce the impact of possible unfavorable changes in foreign exchange rates on our future U.S. Dollar cash flows that are derived from foreign currency denominated sales. To achieve this objective, we hedge a portion of our forecasted foreign currency denominated sales that are expected to occur in the foreseeable future, typically within the next three years, with a maximum of five years. We manage our anticipated transaction exposure principally with foreign currency forward contracts, a combination of foreign currency put and call options, and occasionally purchased foreign currency put options.
 
Foreign Currency Forward Contracts: We use foreign currency forward contracts to hedge specific forecasted transactions denominated in foreign currencies, manage exchange rate volatility in the translation of foreign earnings, and reduce exposures to foreign currency fluctuations of certain assets and liabilities denominated in foreign currencies.

We manage a portfolio of foreign currency forward contracts to protect against changes in anticipated foreign currency cash flows resulting from changes in foreign currency exchange rates, primarily associated with non-functional currency denominated revenues and expenses of foreign subsidiaries. The foreign currency forward hedging contracts outstanding as of June 30, 2018 and December 31, 2017 had settlement dates within 36 months and 20 months, respectively. The spot rate components of these foreign currency forward contracts are designated as cash flow hedges and any unrealized gains or losses are reported in OCI and reclassified to the Consolidated Statement of Income in the same periods during which the underlying hedged transactions affect earnings. If a hedging relationship is terminated with respect to a foreign currency forward contract, accumulated gains or losses associated with the contract remain in OCI until the hedged forecasted transaction occurs and are reclassified to operations in the same periods during which the underlying hedged transactions affect earnings. We recognize in earnings the initial value of the forward point components on a straight-line basis over the life of the derivative instrument within the same line item in the Consolidated Statements of Income that is used to present the earnings effect of the hedged item.

Foreign currency forward contracts entered into to hedge forecasted revenue and expenses were as follows as of June 30, 2018 and December 31, 2017:
 
 
Notional Amount
Foreign Currency
 
June 30, 2018
 
December 31, 2017
Australian Dollar
 
$
46

 
$
61

British Pound
 
134

 
97

Canadian Dollar
 
190

 
227

Euro
 
962

 
954

Japanese Yen
 
508

 
356

Total
 
$
1,840

 
$
1,695

 
 We consider the impact of our own and the counterparties’ credit risk on the fair value of the contracts as well as the ability of each party to execute its obligations under the contract on an ongoing basis. As of June 30, 2018, credit risk did not materially change the fair value of our foreign currency forward contracts.
 
We also manage a portfolio of foreign currency contracts to reduce exposures to foreign currency fluctuations of certain recognized assets and liabilities denominated in foreign currencies and, from time to time, we enter into foreign currency contracts to manage exposure related to translation of foreign earnings. These foreign currency forward contracts have not been designated as hedges

27

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


and, accordingly, any changes in their fair value are recognized on the Consolidated Statements of Income in Other income (expense), net in the current period. The aggregate notional amount of the foreign currency forward non-designated hedging contracts outstanding as of June 30, 2018 and December 31, 2017 were $748 million and $885 million, respectively.

Foreign Currency Option Contracts: From time to time, we may hedge a portion of our future foreign currency exposure by utilizing a strategy that involves both a purchased local currency put option and a written local currency call option that are accounted for as hedges of future sales denominated in that local currency. Specifically, we sell (or write) a local currency call option and purchase a local currency put option with the same expiration dates and local currency notional amounts but with different strike prices. This combination of transactions is generally referred to as a “collar.” The expiration dates and notional amounts correspond to the amount and timing of forecasted foreign currency sales. The foreign currency option contracts outstanding as of June 30, 2018 and December 31, 2017 had settlement dates within 30 months and 36 months, respectively. If the U.S. Dollar weakens relative to the currency of the hedged anticipated sales, the purchased put option value reduces to zero and we benefit from the increase in the U.S. Dollar equivalent value of our anticipated foreign currency cash flows; however, this benefit would be capped at the strike level of the written call, which forms the upper end of the collar. The premium collected from the sale of the call option is equal to the premium paid for the purchased put option, resulting in a net zero cost for each collar.

Outstanding foreign currency option contracts entered into to hedge forecasted revenue were as follows as of June 30, 2018 and December 31, 2017:
 
Notional Amount (1)
 
June 30, 2018
 
December 31, 2017
Foreign currency option contracts designated as hedging activity:
 
 
 
Purchased Put
$
2,756

 
$
3,319

Written Call
3,131

 
3,739

(1) U.S. Dollar notional amounts are calculated as the hedged local currency amount multiplied by the strike value of the foreign currency option. The local currency notional amounts of our purchased put and written call that are designated as hedging activities are equal to each other.
We also have entered into foreign currency put option contracts to hedge forecasted revenue which were not part of a collar strategy. Such put option contracts had a notional amount of $129 million and $258 million as of June 30, 2018 and December 31, 2017, respectively, and settlement dates within 6 months and 12 months, respectively.
Interest Rate Risk Management
Forward Starting Interest Rate Swaps and Treasury Rate Locks: In anticipation of issuing fixed-rate debt, we may use forward starting interest rate swaps (forward starting swaps) or treasury rate lock agreements (treasury rate locks) that are designated as cash flow hedges to hedge against changes in interest rates that could impact expected future issuances of debt. To the extent these hedges of cash flows related to anticipated debt are effective, any realized or unrealized gains or losses on the forward starting swaps or treasury rate locks are reported in OCI and are recognized in income over the life of the anticipated fixed-rate notes. As of June 30, 2018 and December 31, 2017, we did not have any outstanding forward starting swaps or treasury rate locks.

Interest Rate Swap Contracts: From time to time we hedge the fair value of certain debt obligations through the use of interest rate swap contracts. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in benchmark interest rates. Gains or losses resulting from changes in fair value of the underlying debt attributable to the hedged benchmark interest rate risk are recorded on the Consolidated Statement of Income within Interest (expense) with an associated offset to the carrying value of the notes recorded on the Consolidated Balance Sheet. Since the specific terms and notional amount of the swap are intended to match those of the debt being hedged all changes in fair value of the swap are recorded on the Consolidated Statement of Income within Interest (expense) with an associated offset to the derivative asset or liability on the Consolidated Balance Sheet. Consequently, there is no net impact recorded in income. Any net interest payments made or received on interest rate swap contracts are recognized as interest expense on the Consolidated Statements of Income. If a hedging relationship is terminated for an interest rate swap contract, accumulated gains or losses associated with the contract are measured and recorded as a reduction or increase of current and future interest expense associated with the previously hedged debt obligations.


28

CELGENE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The following table summarizes the notional amounts of our outstanding interest rate swap contracts as of June 30, 2018 and December 31, 2017: 
 
Notional Amount
 
June 30, 2018
 
December 31, 2017
Interest rate swap contracts entered into as fair value hedges of the following fixed-rate senior notes:
 
 
 
3.875% senior notes due 2025
$
200

 
$
200

3.450% senior notes due 2027