Eli Lilly 2015 Annual Report Download - page 76

F64
FINANCIAL REPORT
Investments in companies over which we have significant influence but not a controlling interest are
accounted for using the equity method with our share of earnings or losses reported in other–net, (income)
expense. We own no investments that are considered to be trading securities.
Our derivative activities are initiated within the guidelines of documented corporate risk-management policies
and offset losses and gains on the assets, liabilities, and transactions being hedged. Management reviews
the correlation and effectiveness of our derivatives on a quarterly basis.
For derivative contracts that are designated and qualify as fair value hedges, the derivative instrument is
marked to market with gains and losses recognized currently in income to offset the respective losses and
gains recognized on the underlying exposure. For derivative contracts that are designated and qualify as cash
flow hedges, the effective portion of gains and losses on these contracts is reported as a component of
accumulated other comprehensive loss and reclassified into earnings in the same period the hedged
transaction affects earnings. Hedge ineffectiveness is immediately recognized in earnings. Derivative
contracts that are not designated as hedging instruments are recorded at fair value with the gain or loss
recognized in current earnings during the period of change.
We may enter into foreign currency forward or option contracts to reduce the effect of fluctuating currency
exchange rates (principally the euro, the British pound, and the Japanese yen). Foreign currency derivatives
used for hedging are put in place using the same or like currencies and duration as the underlying exposures.
Forward and option contracts are principally used to manage exposures arising from subsidiary trade and
loan payables and receivables denominated in foreign currencies. These contracts are recorded at fair value
with the gain or loss recognized in other–net, (income) expense. We may enter into foreign currency forward
and option contracts and currency swaps as fair value hedges of firm commitments. Forward contracts
generally have maturities not exceeding 12 months. At December 31, 2015, we had outstanding foreign
currency forward commitments to purchase 1.17 billion U.S. dollars and sell 1.06 billion euro; commitments to
purchase 1.85 billion euro and sell 2.04 billion U.S. dollars; commitments to purchase 187.7 million British
pounds and sell 258.4 million euro; commitments to purchase 288.3 million U.S. dollars and sell 190.6 million
British pounds, and commitments to purchase 561.7 million U.S. dollars and sell 67.78 billion Japanese yen,
which will all settle within 30 days.
Foreign currency exchange risk is also managed through the use of foreign currency debt. Our euro-
denominated notes issued in June 2015 and discussed in Note 10, which had a carrying amount of $2.27
billion as of December 31, 2015, have been designated as, and are effective as, economic hedges of net
investments in certain of our euro-denominated foreign operations. Accordingly, foreign currency translation
gains or losses due to spot rate fluctuations on the euro-denominated notes are included as a component of
other comprehensive income (loss). During the year ended December 31, 2015, we recorded a pretax foreign
currency translation gain of $5.6 million from the euro-denominated notes.
In the normal course of business, our operations are exposed to fluctuations in interest rates which can vary
the costs of financing, investing, and operating. We address a portion of these risks through a controlled
program of risk management that includes the use of derivative financial instruments. The objective of
controlling these risks is to limit the impact of fluctuations in interest rates on earnings. 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 and
investment positions and may enter into interest rate swaps or collars to help maintain that balance.
Interest rate swaps or collars that convert our fixed-rate debt to a floating rate are designated as fair value
hedges of the underlying instruments. Interest rate swaps or collars that convert floating-rate debt to a fixed
rate are designated as cash flow hedges. Interest expense on the debt is adjusted to include the payments
made or received under the swap agreements. Cash proceeds from or payments to counterparties resulting
from the termination of interest rate swaps are classified as operating activities in our consolidated statement
of cash flows. At December 31, 2015, substantially all of our total long-term debt is at a fixed rate. We have
converted approximately 40 percent of our long-term fixed-rate notes to floating rates through the use of
interest rate swaps.
We may enter into forward contracts and designate them as cash flow hedges to limit the potential volatility of
earnings and cash flow associated with forecasted sales of available-for-sale securities.