Fair value measurement

9 Months Ended

Sep. 30, 2022

To estimate the fair value of our financial assets and liabilities, we use valuation approaches within a hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about inputs that market participants would use in pricing an asset or liability and are developed based on the best information available in the circumstances. The fair value hierarchy is divided into three levels based on the sources of inputs as follows:


Level 1	—	Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access
Level 2	—	Valuations for which all significant inputs are observable either directly or indirectly—other than Level 1 inputs
Level 3	—	Valuations based on inputs that are unobservable and significant to the overall fair value measurement

The availability of observable inputs can vary among different types of financial assets and liabilities. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, inputs used for measuring fair value may fall into different levels of the fair value hierarchy. In such cases, for financial statement disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is categorized is based on the lowest level of input used that is significant to the overall fair value measurement.

The fair values of each major class of the Company’s financial assets and liabilities measured at fair value on a recurring basis were as follows (in millions):


	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Fair value measurement as of September 30, 2022, using:							Total
Assets:
Available-for-sale securities:
U.S. Treasury notes	$	—	$	—	$	—	$	—
U.S. Treasury bills	1,976		—		—		1,976









Money market mutual funds	8,945		—		—		8,945
Other short-term interest-bearing securities	—		—		—		—
Other investments	—		135		—		135
Equity securities	385		—		382		767
Derivatives:
Foreign currency contracts	—		639		—		639
Cross-currency swap contracts	—		6		—		6
Interest rate swap contracts	—		—		—		—

Total assets	$	11,306	$	780	$	382	$	12,468

Liabilities:
Derivatives:
Foreign currency contracts	$	—	$	22	$	—	$	22
Cross-currency swap contracts	—		754		—		754
Interest rate swap contracts	—		810		—		810
Contingent consideration obligations	—		—		302		302
Total liabilities	$	—	$	1,586	$	302	$	1,888


	Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)

Fair value measurement as of December 31, 2021, using:							Total
Assets:
Available-for-sale securities:
U.S. Treasury notes	$	47	$	—	$	—	$	47
U.S. Treasury bills	1,400		—		—		1,400









Money market mutual funds	5,856		—		—		5,856
Other short-term interest-bearing securities	—		1		—		1
Other investments	—		—		—		—
Equity securities	611		—		220		831
Derivatives:
Foreign currency contracts	—		183		—		183
Cross-currency swap contracts	—		66		—		66
Interest rate swap contracts	—		16		—		16
Total assets	$	7,914	$	266	$	220	$	8,400

Liabilities:
Derivatives:
Foreign currency contracts	$	—	$	39	$	—	$	39
Cross-currency swap contracts	—		339		—		339
Interest rate swap contracts	—		156		—		156
Contingent consideration obligations	—		—		342		342
Total liabilities	$	—	$	534	$	342	$	876

Interest-bearing and equity securities

The fair values of our U.S. Treasury securities, money market mutual funds and equity investments in publicly traded securities are based on quoted market prices in active markets, with no valuation adjustment. Other investments consist of interest-bearing deposits that are valued at amortized cost, which approximates fair value given their near term maturity. The fair value of equity securities without readily determinable fair values are initially valued at the transaction price and subsequently valued based on a combination of observable price transactions, when available, market performance and publicly available market information for similar companies that have actively traded equity securities.

Derivatives

All of our foreign currency forward derivative contracts have maturities of three years or less, and all are with counterparties that have minimum credit ratings of A– or equivalent by S&P, Moody’s or Fitch. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that uses an income-based industry-standard valuation model for which all significant inputs are observable either directly or indirectly. These inputs include foreign currency exchange rates, LIBOR, swap rates and obligor credit default swap rates. In addition, inputs for our foreign currency option contracts include implied volatility measures. These inputs, when applicable, are at commonly quoted intervals. See Note 12, Derivative instruments.

Our cross-currency swap contracts are with counterparties that have minimum credit ratings of A– or equivalent by S&P, Moody’s or Fitch. We estimate the fair values of these contracts by taking into consideration valuations obtained from a third-party valuation service that uses an income-based industry-standard valuation model for which all significant inputs are observable either directly or indirectly. These inputs include foreign currency exchange rates, LIBOR, swap rates, obligor credit default swap rates and cross-currency-basis swap spreads. See Note 12, Derivative instruments.

Our interest rate swap contracts are with counterparties that have minimum credit ratings of A– or equivalent by S&P, Moody’s or Fitch. We estimate the fair values of these contracts by using an income-based industry-standard valuation model for which all significant inputs are observable either directly or indirectly. These inputs include LIBOR, swap rates and obligor credit default swap rates. See Note 12, Derivative instruments.

Contingent consideration obligations

As a result of our business acquisitions, we have incurred contingent consideration obligations as discussed below. The contingent consideration obligations are recorded at their fair values by using probability-adjusted discounted cash flows, and we revalue these obligations each reporting period until the related contingencies have been resolved. The fair value measurements of these obligations are based on significant unobservable inputs related to licensing rights and product candidates acquired in business combinations, and they are reviewed quarterly by management in our R&D and commercial sales organizations. The inputs include, as applicable, estimated probabilities and the timing of achieving specified development, regulatory and commercial milestones as well as estimated annual sales. Significant changes that increase or decrease the probabilities of achieving the related development, regulatory and commercial events or that shorten or lengthen the time required to achieve such events or that increase or decrease estimated annual sales would result in corresponding increases or decreases in the fair values of the obligations, as applicable. Changes in the fair values of contingent consideration obligations are recognized in Other operating expenses in the Condensed Consolidated Statements of Income.

Changes in the carrying amounts of contingent consideration obligations were as follows (in millions):


	Three months ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021
Beginning balance	$	310	$	48	$	342	$	33

Payments	(2)		(2)		(5)		(5)
Net changes in valuations	(6)		(11)		(35)		7
Ending balance	$	302	$	35	$	302	$	35

As of September 30, 2022 and December 31, 2021, our contingent consideration obligations are primarily the result of our acquisition of Teneobio in October 2021, which obligates us to pay the former shareholders up to $1.6 billion upon achieving separate development and regulatory milestones with regard to various R&D programs. See Note 2, Acquisitions and divestitures.

Summary of the fair values of other financial instruments

Cash equivalents

The fair values of cash equivalents approximate their carrying values due to the short-term nature of such financial instruments.

Borrowings

We estimated the fair values of our borrowings by using Level 2 inputs. As of September 30, 2022 and December 31, 2021, the aggregate fair values of our borrowings were $34.2 billion and $37.9 billion, respectively, and the carrying values were $38.7 billion and $33.3 billion, respectively.

Investment in BeiGene, Ltd.

We estimated the fair value of our investment in BeiGene by using Level 1 inputs. As of September 30, 2022 and December 31, 2021, the fair values were $2.6 billion and $5.1 billion, and the carrying values were $2.3 billion and $2.8 billion, respectively.

During the three and nine months ended September 30, 2022 and 2021, there were no transfers of assets or liabilities between fair value measurement levels, and there were no material remeasurements to the fair values of assets and liabilities that are not measured at fair value on a recurring basis, except with respect to the impairment of net assets in connection with the nonstrategic Gensenta divestiture. See Note 2, Acquisitions and divestitures.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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