Financial Review: Part 1
Abbott’s revenues are derived primarily from the sale of a broad line of health care products under short-term receivable arrangements. Patent protection and licenses, technological and performance features, and inclusion of Abbott’s products under a contract or by a pharmacy benefit manager most impact which products are sold; price controls, competition and rebates most impact the net selling prices of products; and foreign currency translation impacts the measurement of net sales and costs. Abbott’s primary products are prescription pharmaceuticals, nutritional products, diagnostic testing products and vascular products. Sales in international markets are approximately 60 percent of consolidated net sales.
In 2011, Abbott announced a plan to separate into two publicly traded companies, one in diversified medical products and the other in research-based pharmaceuticals. To accomplish the separation, Abbott plans to create a new company for its research-based pharmaceuticals business which will include Abbott’s Proprietary Pharmaceutical Products segment. The transaction is expected to take the form of a tax-free distribution to Abbott shareholders of the stock of the newly created research-based pharmaceutical company and is expected to be completed by the end of 2012. Subsequent to the separation, the historical results of the research-based pharmaceuticals business will be presented as discontinued operations.
Continued robust growth of HUMIRA in a broad range of indications, the acquisitions of Solvay’s pharmaceuticals business (Solvay Pharmaceuticals) and Piramal Healthcare Limited’s Healthcare Solutions business, continued growth and market penetration by the Xience drug eluting stent franchise, the loss of patent protection for some pharmaceutical products, an ongoing government investigation of Abbott’s sales and marketing activities related to Depakote, and the challenging economic environment in many countries around the world have impacted Abbott’s sales, costs and financial position over the last three years.
Pharmaceutical research and development is focused on therapeutic areas that include immunology, oncology, neuroscience, pain management, hepatitis C (HCV), chronic kidney disease and women’s health. During the last three years, Abbott acquired the rights to various in-process pharmaceutical research and development projects including the development of second-generation oral antioxidant inflammation modulators and a product for the treatment of chronic kidney disease.
In 2003, Abbott began the worldwide launch of HUMIRA for rheumatoid arthritis, followed by launches for five additional indications, which increased HUMIRA’s worldwide sales to $7.9 billion in 2011 compared to $6.5 billion in 2010, and $5.5 billion in 2009. Abbott forecasts low double-digit growth for worldwide HUMIRA sales in 2012. Abbott is studying additional indications for HUMIRA. Substantial research and development and selling support has been and continues to be dedicated to maximizing the worldwide potential of HUMIRA. Abbott expects generic competition for TriCor to begin in the second half of 2012. Austerity measures implemented by several European countries reduced healthcare spending and affected pharmaceutical pricing in 2010 and 2011. The 2010 healthcare reform legislation in the U.S. resulted in rebate changes beginning in 2010 and the payment of an annual fee beginning in 2011, which negatively affected Abbott’s pharmaceutical business. The impact of the austerity measures and the U.S. healthcare reform legislation is expected to continue.
In February 2010, Abbott acquired Solvay Pharmaceuticals which provided Abbott with a large and complementary portfolio of pharmaceutical products and expanded Abbott’s presence in key global emerging markets. The acquisition added approximately $3.1 billion to Abbott’s 2010 total sales, primarily outside the U.S. In September 2010, Abbott completed the acquisition of Piramal’s Healthcare Solutions business, propelling Abbott to market leadership in the Indian pharmaceutical market and further accelerating the company’s growth in emerging markets. In 2011 and 2010, Abbott recorded approximately $345 million and $710 million, respectively, of expense related to the integration of the Solvay business and a restructuring plan announced in September 2010 to streamline operations, improve efficiencies and reduce costs primarily in certain Solvay sites and functions. The restructuring plan is further described below. In 2011, Abbott recorded a litigation charge of $1.5 billion related to ongoing settlement discussions in the U.S. government’s investigation related to Depakote.
In Abbott’s worldwide nutritional products business, favorable economic development in emerging markets and an aging population in developed markets have provided significant opportunities to leverage strong nutritional brands and introduce innovative products.
In the fourth quarter of 2008, Abbott’s Xience V product became the market-leading drug eluting stent in the U.S. In June 2009, Xience PRIME, Abbott’s next generation drug eluting stent, received CE Mark approval and was launched in Europe in August 2009. Abbott received approval to market Xience V in Japan in January 2010 and Xience V became the market-leading drug eluting stent in Japan in the second quarter of 2010. With the U.S. launches of Xience nano and Xience PRIME in May and November 2011, respectively, and continued strong performance in Japan, China, and other international markets, Xience, which includes Xience V, PRIME and nano, ended 2011 as the market-leading drug eluting stent globally. At the same time the third party distributor of the Promus product began transitioning away from the product and that distribution agreement will end in 2012.
In 2010, the U.S. government passed health care reform legislation which included an increase in Medicaid rebate rates and the extension of the rebate to drugs provided through Medicaid managed care organizations beginning in 2010. The legislation also imposed annual fees which pharmaceutical manufacturers began paying in 2011 and medical device companies will begin paying in 2013, as well as additional rebates related to the Medicare Part D “donut hole” beginning in 2011. In addition to a 2010 one-time charge of approximately $60 million to reduce deferred tax assets associated with retiree health care liabilities related to the Medicare Part D retiree drug subsidy, the legislation’s negative impact on Abbott’s performance grew from more than $200 million in 2010 to approximately $400 million in 2011 and is expected to remain at approximately $400 million in 2012.
Abbott’s short- and long-term debt totaled $15.4 billion at December 31, 2011, largely incurred to finance acquisitions. Operating cash flows in excess of capital expenditures and cash dividends have partially funded acquisitions over the last three years. At December 31, 2011, Abbott’s long-term debt rating was AA by Standard and Poor’s Corporation and A1 by Moody’s Investors Service.
In 2012, Abbott will focus on several key initiatives. In the proprietary pharmaceutical business, Abbott will continue maximizing the market potential for HUMIRA and other products, including AndroGel, as well as continuing to build its global presence. Pharmaceutical research and development efforts will continue to focus a significant portion of expenditures on compounds for immunology, oncology, neuroscience, pain management, HCV, chronic kidney disease and women’s health. Current research and development projects are described in the Research and Development Programs section.
In the established pharmaceutical business which includes international sales of branded generic products, Abbott will continue to focus on obtaining additional product approvals across numerous countries and expanding its presence in emerging markets. In the vascular business, Abbott will continue to focus on marketing products in the Xience franchise, obtaining regulatory review of the MitraClip device in the U.S., and increasing international MitraClip sales as well as further clinical development of ABSORB, its bioresorbable vascular scaffold (BVS) device and a further roll-out of ABSORB in CE Mark countries. In Abbott’s other segments, Abbott will focus on developing or acquiring differentiated technologies in higher growth segments of those markets.
Critical Accounting Policies
Sales Rebates – Approximately 54 percent of Abbott’s consolidated gross revenues are subject to various forms of rebates and allowances that Abbott records as reductions of revenues at the time of sale. Most of these rebates and allowances are in the Proprietary Pharmaceutical Products segment and the Nutritional Products segment. Abbott provides rebates to pharmacy benefit management companies, state agencies that administer the federal Medicaid program, insurance companies that administer Medicare drug plans, state agencies that administer the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC), wholesalers, group purchasing organizations, and other government agencies and private entities. Rebate amounts are usually based upon the volume of purchases using contractual or statutory prices for a product. Factors used in the rebate calculations include the identification of which products have been sold subject to a rebate, which customer or government agency price terms apply, and the estimated lag time between sale and payment of a rebate. Using historical trends, adjusted for current changes, Abbott estimates the amount of the rebate that will be paid, and records the liability as a reduction of gross sales when Abbott records its sale of the product. Settlement of the rebate generally occurs from two to 24 months after sale. Abbott regularly analyzes the historical rebate trends and makes adjustments to reserves for changes in trends and terms of rebate programs. Rebates and chargebacks charged against gross sales in 2011, 2010 and 2009 amounted to approximately $5.5 billion, $4.9 billion and $4.4 billion, respectively, or 22.2 percent, 23.1 percent and 23.8 percent, respectively, based on gross sales of approximately $24.8 billion, $21.1 billion and $18.4 billion, respectively, subject to rebate. A one-percentage point increase in the percentage of rebates to related gross sales would decrease net sales by approximately $248 million in 2011. Abbott considers a one-percentage point increase to be a reasonably likely increase in the percentage of rebates to related gross sales. Other allowances charged against gross sales were approximately $409 million, $415 million and $414 million for cash discounts in 2011, 2010 and 2009, respectively, and $490 million, $537 million and $456 million for returns in 2011, 2010 and 2009, respectively. Cash discounts are known within 15 to 30 days of sale, and therefore can be reliably estimated. Returns can be reliably estimated because Abbott’s historical returns are low, and because sales returns terms and other sales terms have remained relatively unchanged for several periods.
Management analyzes the adequacy of ending rebate accrual balances each quarter. In the domestic nutritional business, management uses both internal and external data available to estimate the level of inventory in the distribution channel. Management has access to several large customers’ inventory management data, and for other customers, utilizes data from a third party that measures time on the retail shelf. These sources allow management to make reliable estimates of inventory in the distribution channel. Except for a transition period before or after a change in the supplier for the WIC business in a state, inventory in the distribution channel does not vary substantially. Management also estimates the states’ processing lag time based on claims data. In addition, internal processing time is a factor in estimating the accrual. In the WIC business, the state where the sale is made, which is the determining factor for the applicable price, is reliably determinable. Estimates are required for the amount of WIC sales within each state where Abbott has the WIC business. External data sources utilized for that estimate are participant data from the U.S. Department of Agriculture (USDA), which administers the WIC program, participant data from some of the states, and internally administered market research. The USDA has been making its data available for many years. Internal data includes historical redemption rates and pricing data. At December 31, 2011, Abbott had the exclusive WIC business in 23 states.
In the domestic proprietary pharmaceutical business, the most significant charges against gross sales are for Medicaid and Medicare Rebates, Pharmacy Benefit Manager Rebates and Wholesaler Chargebacks. In order to evaluate the adequacy of the ending accrual balances, management uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time. External data sources used to estimate the inventory in the distribution channel include inventory levels periodically reported by wholesalers and third party market data purchased by Abbott. Management estimates the processing lag time based on periodic sampling of claims data. To estimate the price rebate percentage, systems and calculations are used to track sales by product by customer and to estimate the contractual or statutory price. Abbott’s systems and calculations have developed over time as rebates have become more significant, and Abbott believes they are reliable.
The following table is an analysis of the four largest rebate accruals, which comprise approximately 68 percent of the consolidated rebate provisions charged against revenues in 2011. Remaining rebate provisions charged against gross sales are not significant in the determination of operating earnings.
Domestic Proprietary Pharmaceutical Products |
||||
(dollars in millions) |
Domestic Nutritionals WIC Rebates |
Medicaid and Medicare Rebates |
Pharmacy Benefit Manager Rebates |
Wholesaler Chargebacks |
Balance at January 1, 2009 |
$162 |
$295 |
$228 |
$146 |
Provisions |
747 |
563 |
505 |
1,134 |
Payments |
(756) |
(506) |
(494) |
(1,120) |
Balance at December 31, 2009 |
153 |
352 |
239 |
160 |
Provisions |
616 |
899 |
841 |
1,162 |
Payments |
(640) |
(617) |
(670) |
(1,163) |
Balance at December 31, 2010 |
129 |
634 |
410 |
159 |
Provisions |
575 |
985 |
831 |
1,361 |
Payments |
(568) |
(899) |
(735) |
(1,349) |
Balance at December 31, 2011 |
$136 |
$720 |
$506 |
$171 |
Historically, adjustments to prior years’ rebate accruals have not been material to net income. Abbott employs various techniques to verify the accuracy of claims submitted to it, and where possible, works with the organizations submitting claims to gain insight into changes that might affect the rebate amounts. For Medicaid, Medicare and other government agency programs, the calculation of a rebate involves interpretations of relevant regulations, which are subject to challenge or change in interpretation.
