Eli Lilly 2012 Annual Report Download - page 46

34
Our primary interest rate risk exposure results from changes in short-term U.S. dollar interest rates. In an
effort to manage interest rate exposures, we strive to achieve an acceptable balance between fixed and
floating rate debt positions and may enter into interest rate derivatives to help maintain that balance. Based
on our overall interest rate exposure at December 31, 2012 and 2011, including derivatives and other interest
rate risk-sensitive instruments, a hypothetical 10 percent change in interest rates applied to the fair value of
the instruments as of December 31, 2012 and 2011, respectively, would not have a material impact on
earnings, cash flows, or fair values of interest rate risk-sensitive instruments over a one-year period.
Our foreign currency risk exposure results from fluctuating currency exchange rates, primarily the U.S. dollar
against the euro and the Japanese yen, and the British pound against the euro. We face transactional currency
exposures that arise when we enter into transactions, generally on an intercompany basis, denominated in
currencies other than the local currency. We also face currency exposure that arises from translating the
results of our global operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of
the period. We may enter into foreign currency forward contracts to reduce the effect of fluctuating currency
exchange rates (principally the euro, the British pound, and the Japanese yen). Our policy outlines the
minimum and maximum hedge coverage of such exposures. Gains and losses on these derivative positions
offset, in part, the impact of currency fluctuations on the existing assets, liabilities, commitments, and
anticipated revenues. Considering our derivative financial instruments outstanding at December 31, 2012 and
2011, a hypothetical 10 percent change in exchange rates (primarily against the U.S. dollar) as of
December 31, 2012 and 2011, respectively, would not have a material impact on earnings, cash flows, or fair
values of foreign currency rate risk-sensitive instruments over a one-year period. These calculations do not
reflect the impact of the exchange gains or losses on the underlying positions that would be offset, in part, by
the results of the derivative instruments.
Off-Balance Sheet Arrangements and Contractual Obligations
We have no off-balance sheet arrangements that have a material current effect or that are reasonably likely to
have a material future effect on our financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures, or capital resources. We acquire and collaborate on
assets still in development and enter into research and development arrangements with third parties that
often require milestone and royalty payments to the third party contingent upon the occurrence of certain
future events linked to the success of the asset in development. Milestone payments may be required
contingent upon the successful achievement of an important point in the development life cycle of the
pharmaceutical product (e.g., approval of the product for marketing by the appropriate regulatory agency or
upon the achievement of certain sales levels). If required by the arrangement, we may make royalty payments
based upon a percentage of the sales of the pharmaceutical product in the event that regulatory approval for
marketing is obtained. Because of the contingent nature of these payments, they are not included in the table
of contractual obligations below.
Individually, these arrangements are not material in any one annual reporting period. However, if milestones
for multiple products covered by these arrangements would happen to be reached in the same reporting
period, the aggregate charge to expense could be material to the results of operations in that period. These
arrangements often give us the discretion to unilaterally terminate development of the product, which would
allow us to avoid making the contingent payments; however, we are unlikely to cease development if the
compound successfully achieves milestone objectives. We also note that, from a business perspective, we
view these payments as positive because they signify that the product is successfully moving through
development and is now generating or is more likely to generate cash flows from sales of products.