Notes to Consolidated Financial Statements
Note 7 — Litigation and Environmental Matters
Abbott has been identified as a potentially responsible party for investigation and cleanup costs at a number of locations in the United States and Puerto Rico under federal and state remediation laws and is investigating potential contamination at a number of company-owned locations. Abbott has recorded an estimated cleanup cost for each site for which management believes Abbott has a probable loss exposure. No individual site cleanup exposure is expected to exceed $4 million, and the aggregate cleanup exposure is not expected to exceed $15 million.
There are a number of patent disputes with third parties who claim Abbott’s products infringe their patents. In April 2007, New York University (NYU) and Centocor, Inc. filed a lawsuit in the Eastern District of Texas asserting that HUMIRA infringes a patent co-owned by NYU and Centocor and exclusively licensed to Centocor. In June 2009, a jury found that Abbott had willfully infringed the patent and awarded NYU and Centocor approximately $1.67 billion in past compensatory damages. In December 2009, the district court issued a final judgment and awarded the plaintiffs an additional $175 million in prejudgment interest. On February 23, 2011, the Federal Circuit reversed the district court’s final judgment and found Centocor’s patent invalid. On April 25, 2011 Centocor petitioned the Federal Circuit to rehear and reconsider the decision. In June 2011 the Federal Circuit denied Centocor’s request to reconsider. In November 2011, Centocor, now known as Janssen Biotech, Inc., petitioned the United States Supreme Court to review the Federal Circuit’s decision. Abbott is confident in the merits of its case and, as a result, no reserves have been recorded in this case.
The United States Department of Justice, through the United States Attorney for the Western District of Virginia, is investigating Abbott’s sales and marketing activities for Depakote. The government is seeking to determine whether any of these activities violated civil and/or criminal laws, including the Federal False Claims Act, the Food and Drug Cosmetic Act, and the anti-Kickback Statute in connection with Medicare and/or Medicaid reimbursement to third parties. In addition, eight state Attorneys General Offices (Florida, Illinois, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina and Texas) have formed a committee on behalf of themselves and other State Attorneys General to investigate Abbott’s sales and marketing activities for Depakote to determine whether any of these activities violated various state laws, including state consumer fraud/protection statutes. Discussions to resolve potential civil and criminal claims arising from this matter have advanced to a point where Abbott believes a loss is probable and estimable and therefore, Abbott recorded a charge of $1.5 billion in 2011. If the discussions are successfully concluded, Abbott expects the discussions to result in resolution of the Depakote-related federal claims, as well as similar state Medicaid-related claims, but not state consumer fraud/protection claims. However, the discussions are ongoing, and until concluded, there can be no certainty about definitive resolution.
Within the next year, legal proceedings may occur that may result in a change in the estimated reserves recorded by Abbott. For its legal proceedings and environmental exposures Abbott estimates the range of possible loss to be from approximately $1.59 billion to $1.63 billion, which includes the $1.5 billion charge discussed above. The recorded reserve balance at December 31, 2011 for these proceedings and exposures was approximately $1.6 billion. These reserves represent management’s best estimate of probable loss, as defined by FASB ASC No. 450, “Contingencies.”
While it is not feasible to predict the outcome of all such proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on Abbott’s financial position, cash flows, or results of operations except for the federal government investigation discussed in the third paragraph of this footnote, the resolution of which is expected to be material to cash flows in a given year.
In 2009, Abbott and Medtronic, Inc. reached a settlement resolving all outstanding intellectual property litigation between the two parties. Under the terms of the settlement, Medtronic paid Abbott $400 million. The settlement also includes a mutual agreement not to pursue additional litigation on current and future vascular products, subject to specific conditions and time limits. In connection with the settlement, Abbott recognized a gain of $287 million which is included in Other (income) expense, net. The remaining amounts were recognized as royalty income as earned.
Note 8 — Incentive Stock Program
The 2009 Incentive Stock Program authorizes the granting of nonqualified stock options, replacement stock options, restricted stock awards, restricted stock units, performance awards, foreign benefits and other share-based awards. Stock options, replacement stock options and restricted stock awards and units comprise the majority of benefits that have been granted and are currently outstanding under this program and a prior program. In 2011, Abbott granted 1,757,339 stock options, 852,819 replacement stock options, 1,180,159 restricted stock awards and 6,793,336 restricted stock units under this program. The purchase price of shares under option must be at least equal to the fair market value of the common stock on the date of grant, and the maximum term of an option is 10 years. Options vest equally over three years except for replacement options, which vest in six months. Options granted before January 1, 2005 included a replacement feature. Except for options outstanding that have a replacement feature, options granted after December 31, 2004 do not include a replacement feature. When an employee tenders mature shares to Abbott upon exercise of a stock option, a replacement stock option may be granted equal to the amount of shares tendered. Replacement options are granted at the then current market price for a term that expires on the date of the underlying option grant. Upon a change in control of Abbott, all outstanding stock options become fully exercisable, and all terms and conditions of all restricted stock awards and units are deemed satisfied. Restricted stock awards generally vest between 3 and 5 years and for restricted stock awards that vest over 5 years, no more than one-third of the award vests in any one year upon Abbott reaching a minimum return on equity target. Restricted stock units vest over three years and upon vesting, the recipient receives one share of Abbott stock for each vested restricted stock unit. The aggregate fair market value of restricted stock awards and units is recognized as expense over the service period. Restricted stock awards and settlement of vested restricted stock units are issued out of treasury shares. Abbott generally issues new shares for exercises of stock options. Abbott does not have a policy of purchasing its shares relating to its share-based programs. At December 31, 2011, approximately 180 million shares were reserved for future grants. Subsequent to year-end, the reserve was reduced by approximately 25 million shares for stock options and restricted stock awards and units granted by the Board of Directors.
The number of restricted stock awards and units outstanding and the weighted-average grant-date fair value at December 31, 2010 and December 31, 2011 was 12,449,413 and $54.02 and 14,698,595 and $50.29, respectively. The number of restricted stock awards and units, and the weighted-average grant-date fair value, that were granted, vested and lapsed during 2011 were 7,973,495 and $46.85, 4,998,410 and $53.94 and 725,903 and $51.18, respectively. The fair market value of restricted stock awards and units vested in 2011, 2010 and 2009 was $237 million, $203 million and $81 million, respectively.
Options Outstanding |
Exercisable Options |
||||||
Shares |
Weighted Average Exercise Price |
Weighted Average Remaining Life (Years) |
Shares |
Weighted Average Exercise Price |
Weighted Average Remaining Life (Years) |
||
December 31, 2010 |
109,921,688 |
$50.46 |
4.9 |
100,739,252 |
$50.06 |
4.6 |
|
Granted |
2,610,158 |
48.43 |
|||||
Exercised |
(20,872,261) |
48.36 |
|||||
Lapsed |
(6,220,306) |
55.96 |
|||||
December 31, 2011 |
85,439,279 |
$50.52 |
4.7 |
81,734,460 |
$50.51 |
4.5 |
|
The aggregate intrinsic value of options outstanding and exercisable at December 31, 2011 was $529 million and $508 million, respectively. The total intrinsic value of options exercised in 2011, 2010 and 2009 was $94 million, $77 million and $129 million, respectively. The total unrecognized compensation cost related to all share-based compensation plans at December 31, 2011 amounted to approximately $242 million which is expected to be recognized over the next three years.
Total non-cash compensation expense charged against income in 2011, 2010 and 2009 for share-based plans totaled approximately $383 million, $385 million and $365 million, respectively, and the tax benefit recognized was approximately $116 million, $119 million and $118 million, respectively. Compensation cost capitalized as part of inventory is not significant.
The fair value of an option granted in 2011, 2010 and 2009 was $6.23, $9.24 and $9.28, respectively. The fair value of an option grant was estimated using the Black-Scholes option-pricing model with the following assumptions:
2011 |
2010 |
2009 |
|
Risk-free interest rate |
2.7% |
2.9% |
2.7% |
Average life of options (years) |
6.0 |
6.0 |
6.0 |
Volatility |
21.0% |
22.0% |
22.0% |
Dividend yield |
4.1% |
3.2% |
3.0% |
The risk-free interest rate is based on the rates available at the time of the grant for zero-coupon U.S. government issues with a remaining term equal to the option’s expected life. The average life of an option is based on both historical and projected exercise and lapsing data. Expected volatility is based on implied volatilities from traded options on Abbott’s stock and historical volatility of Abbott’s stock over the expected life of the option. Dividend yield is based on the option’s exercise price and annual dividend rate at the time of grant.
