Derivative Financial Instruments

3 Months Ended

Mar. 31, 2015

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Financial Instruments

DERIVATIVE FINANCIAL INSTRUMENTS

We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and various foreign currencies, the most significant of which is the Euro. In order to manage this risk, we hedge a portion of our foreign currency exposures related to outstanding monetary assets and liabilities as well as forecasted product sales using foreign currency exchange forward or option contracts. In general, the market risk related to these contracts is offset by corresponding gains and losses on the hedged transactions. The credit risk associated with these contracts is driven by changes in interest and currency exchange rates and, as a result, varies over time. By working only with major banks and closely monitoring current market conditions, we seek to limit the risk that counterparties to these contracts may be unable to perform. We also seek to limit our risk of loss by entering into contracts that permit net settlement at maturity. Therefore, our overall risk of loss in the event of a counterparty default is limited to the amount of any unrecognized gains on outstanding contracts (i.e. those contracts that have a positive fair value) at the date of default. We do not enter into derivative contracts for trading purposes.

We hedge our exposure to foreign currency exchange rate fluctuations for certain monetary assets and liabilities of our foreign subsidiaries that are denominated in a non-functional currency. The derivative instruments we use to hedge this exposure are not designated as hedges, and as a result, changes in their fair value are recorded in other income (expense), net on our Condensed Consolidated Statements of Income.

We hedge our exposure to foreign currency exchange rate fluctuations for forecasted product sales that are denominated in a non-functional currency. The derivative instruments we use to hedge this exposure are designated as cash flow hedges and have maturity dates of 18 months or less. Upon executing a hedging contract and quarterly thereafter, we assess prospective hedge effectiveness using regression analysis which calculates the change in cash flow as a result of the hedge instrument. On a monthly basis, we assess retrospective hedge effectiveness using a dollar offset approach. We exclude time value from our effectiveness testing and recognize changes in the time value of the hedge in other income (expense), net. The effective component of our hedge is recorded as an unrealized gain or loss on the hedging instrument in accumulated other comprehensive income (OCI) within stockholders' equity. When the hedged forecasted transaction occurs, the hedge is de-designated and the unrealized gains or losses are reclassified into product sales. The majority of gains and losses related to the hedged forecasted transactions reported in accumulated OCI at March 31, 2015 will be reclassified to product sales within 12 months.

The cash flow effects of our derivative contracts for the three months ended March 31, 2015 and 2014 are included within net cash provided by operating activities in the Condensed Consolidated Statements of Cash Flows.

We had notional amounts on foreign currency exchange contracts outstanding of $6.8 billion at March 31, 2015 and $6.4 billion at December 31, 2014.

While all of our derivative contracts allow us the right to offset assets or liabilities, we have presented amounts on a gross basis. Under the International Swap Dealers Association, Inc. master agreements with the respective counterparties of the foreign currency exchange contracts, subject to applicable requirements, we are allowed to net settle transactions of the same currency with a single net amount payable by one party to the other. The following table summarizes the classification and fair values of derivative instruments on our Condensed Consolidated Balance Sheets (in millions):

	March 31, 2015
	Asset Derivatives			Liability Derivatives
	Classification	Fair Value		Classification	Fair Value
Derivatives designated as hedges:
Foreign currency exchange contracts	Other current assets	$	567	Other accrued liabilities	$	6
Foreign currency exchange contracts	Other long-term assets	40		Other long-term obligations	3
Total derivatives		$	607		$	9

	December 31, 2014
	Asset Derivatives			Liability Derivatives
	Classification	Fair Value		Classification	Fair Value
Derivatives designated as hedges:
Foreign currency exchange contracts	Other current assets	$	314	Other accrued liabilities	$	—
Foreign currency exchange contracts	Other long-term assets	35		Other long-term obligations	—
Total derivatives		$	349		$	—

The following table summarizes the effect of our foreign currency exchange contracts on our Condensed Consolidated Financial Statements (in millions):

	Three Months Ended
	March 31,
	2015		2014
Derivatives designated as hedges:
Gains recognized in accumulated OCI (effective portion)	$	389	$	3
Gains (losses) reclassified from accumulated OCI into product sales (effective portion)	$	145	$	(21	)
Gains recognized in other income (expense), net (ineffective portion and amounts excluded from effectiveness testing)	$	1	$	—
Derivatives not designated as hedges:
Gains recognized in other income (expense), net	$	108	$	1

From time to time, we may discontinue cash flow hedges and as a result, record related amounts in other income (expense), net on our Condensed Consolidated Statements of Income. There were no material amounts recorded in other income (expense), net for the three months ended March 31, 2015 and 2014 as a result of the discontinuance of cash flow hedges.

As of March 31, 2015 and December 31, 2014, we held one type of financial instrument, derivative contracts related to foreign currency exchange contracts. The following table summarizes the potential effect of offsetting derivatives by type of financial instrument on our Condensed Consolidated Balance Sheets (in millions):

As of March 31, 2015
Offsetting of Derivative Assets/Liabilities
									Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
Description	Gross Amounts of Recognized Assets/Liabilities			Gross Amounts Offset in the Condensed Consolidated Balance Sheet		Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet			Derivative Financial Instruments			Cash Collateral Received/Pledged		Net Amount (Legal Offset)
Derivative assets	$	607		$	—	$	607		$	(9	)	$	—	$	598
Derivative liabilities	(9		)	—		(9		)	9			—		—

As of December 31, 2014
Offsetting of Derivative Assets/Liabilities
							Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
Description	Gross Amounts of Recognized Assets/Liabilities		Gross Amounts Offset in the Condensed Consolidated Balance Sheet		Amounts of Assets/Liabilities Presented in the Condensed Consolidated Balance Sheet		Derivative Financial Instruments		Cash Collateral Received/Pledged		Net Amount (Legal Offset)
Derivative assets	$	349	$	—	$	349	$	—	$	—	$	349
Derivative liabilities	—		—		—		—		—		—