Abbott Laboratories - 10-Q quarterly report FY2016 Q3

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to                  

Commission File No. 1-2189

ABBOTT LABORATORIES

100 Abbott Park Road

Abbott Park, Illinois 60064-6400

Telephone:  (224) 667-6100

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of l934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of September 30, 2016, Abbott Laboratories had 1,472,309,523 common shares without par value outstanding.

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Abbott Laboratories

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Abbott Laboratories and Subsidiaries

Condensed Consolidated Statement of Earnings

(Unaudited)

(dollars in millions except per share data; shares in thousands)

The accompanying notes to the condensed consolidated financial statements are an integral part of this statement.

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Abbott Laboratories and Subsidiaries

Condensed Consolidated Statement of Comprehensive Income

(Unaudited)

(dollars in millions)

The accompanying notes to the condensed consolidated financial statements are an integral part of this statement.

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Abbott Laboratories and Subsidiaries

Condensed Consolidated Balance Sheet

(Unaudited)

(dollars in millions)

The accompanying notes to the condensed consolidated financial statements are an integral part of this statement.

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Abbott Laboratories and Subsidiaries

Condensed Consolidated Statement of Cash Flows

(Unaudited)

(dollars in millions)

The accompanying notes to the condensed consolidated financial statements are an integral part of this statement.

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Abbott Laboratories and Subsidiaries

Notes to the Condensed Consolidated Financial Statements

September 30, 2016

(Unaudited)

Note 1 — Basis of Presentation

The accompanying unaudited, condensed consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission and, therefore, do not include all information and footnote disclosures normally included in audited financial statements.  However, in the opinion of management, all adjustments (which include only normal adjustments) necessary to present fairly the results of operations, financial position and cash flows have been made.  It is suggested that these statements be read in conjunction with the financial statements included in Abbott’s Annual Report on Form 10-K for the year ended December 31, 2015.  The consolidated financial statements include the accounts of the parent company and subsidiaries, after elimination of intercompany transactions.

Note 2 — Discontinued Operations

On February 27, 2015, Abbott completed the sale of its developed markets branded generics pharmaceuticals business to Mylan Inc. (Mylan) for 110 million shares (or approximately 22%) of a newly formed entity (Mylan N.V.) that combined Mylan’s existing business and Abbott’s developed markets branded generics pharmaceuticals business.  Mylan N.V. is publicly traded.  Historically, this business was included in Abbott’s Established Pharmaceutical Products segment.  Abbott retained its branded generics pharmaceuticals business in emerging markets.  At the date of closing, the 110 million Mylan N.V. shares that Abbott received were valued at $5.77 billion and Abbott recorded an after-tax gain on the sale of the business of approximately $1.6 billion.  The shareholder agreement with Mylan N.V. includes voting and other restrictions that prevent Abbott from exercising significant influence over the operating and financial policies of Mylan N.V.

At the close of this transaction, Abbott and Mylan entered into a transition services agreement pursuant to which Abbott and Mylan are providing various back office support services to each other on an interim transitional basis.  Transition services may be provided for up to 2 years.  Charges by Abbott under this transition services agreement are recorded as a reduction of the costs to provide the respective service in the applicable expense category in the Condensed Consolidated Statement of Earnings.  This transition support does not constitute significant continuing involvement in Mylan’s operations. Abbott also entered into manufacturing supply agreements with Mylan related to certain products, with the supply term ranging from 3 to 10 years and requiring a 2 year notice prior to termination.  The cash flows associated with these transition services and manufacturing supply agreements are not expected to be significant, and therefore, these cash flows are not direct cash flows of the disposed component under Accounting Standards Codification 205.

In April 2015, Abbott sold 40.25 million of the 110 million ordinary shares of Mylan N.V. received in the sale of the developed markets branded generics pharmaceuticals business to Mylan.  In the second quarter of 2015, Abbott recorded a pretax gain of $207 million on $2.29 billion in net proceeds from the sale of these shares. The gain was recognized in the Other (income) expense line of the Condensed Consolidated Statement of Earnings.  As a result of this sale, Abbott’s ownership interest in Mylan N.V. decreased to approximately 14%.

On February 10, 2015, Abbott completed the sale of its animal health business to Zoetis Inc.  Abbott received cash proceeds of $230 million and reported an after-tax gain on the sale of approximately $130 million in the first quarter of 2015. In the first quarter of 2016, Abbott received an additional $25 million of proceeds related to the expiration of a holdback agreement associated with the sale of this business and reported an after-tax gain on the sale of discontinued operations of $16 million.

As a result of the disposition of the above businesses, the operating results of these businesses up to the date of sale are reported as part of discontinued operations on the Earnings from Discontinued Operations, net of tax line in the Condensed Consolidated Statement of Earnings. The cash flows associated with the developed markets branded generics pharmaceuticals and animal health businesses up to the date of disposition are included in Abbott’s Condensed Consolidated Statement of Cash Flows.

On January 1, 2013, Abbott completed the separation of AbbVie Inc. (AbbVie), which was formed to hold Abbott’s research-based proprietary pharmaceuticals business. For a small portion of AbbVie’s operations, the legal transfer of AbbVie’s assets (net of liabilities) did not occur with the separation of AbbVie on January 1, 2013 due to the time required to transfer marketing authorizations and other regulatory requirements in each of these countries.  Under the terms of the separation agreement with Abbott, AbbVie is subject to the risks and entitled to the benefits generated by these operations and assets.  The majority of these operations were transferred to AbbVie in 2013 and 2014.  These assets and liabilities have been presented as held for disposition in the

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Condensed Consolidated Balance Sheet. Abbott has recorded a prepaid asset of $306 million for its obligation to transfer these net liabilities held for disposition to AbbVie.

Abbott has retained all liabilities for all U.S. federal and foreign income taxes on income prior to the separation, as well as certain non-income related taxes attributable to AbbVie’s business prior to the separation. AbbVie generally will be liable for all other taxes attributable to its business. Net earnings from discontinued operations in the first nine months of 2016 and 2015 reflect the recognition of $282 million of tax benefit and $10 million of tax expense, respectively, as a result of the resolution of various tax positions related to AbbVie’s operations for years prior to the separation.

The following table summarizes the components of discontinued operations:

The sale of the developed markets branded generics pharmaceuticals and animal health businesses in the first nine months of 2015 resulted in the recognition of a pretax gain of $2.837 billion, tax expense of $1.085 billion and an after-tax gain of $1.752 billion.

Note 3 — Assets and Liabilities Held for Disposition

In September 2016, Abbott announced that it will sell Abbott Medical Optics (AMO), its vision care business, to Johnson & Johnson for $4.325 billion in cash. The decision to sell AMO reflects Abbott’s proactive shaping of its portfolio in line with its strategic priorities. The transaction is expected to close in the first quarter of 2017 and is subject to customary closing conditions, including regulatory approvals. The operating results of AMO do not qualify for reporting as discontinued operations. For the three months ended September 30, 2016 and 2015, AMO’s earnings (loss) before taxes were $2 million and $(2) million, respectively. For the first nine months ended September 30, 2016 and 2015, AMO’s earnings (loss) before taxes were $(42) million and $54 million, respectively. As a result of the planned sale of AMO, the assets and liabilities of this business meet the criteria to qualify as being held for disposition at September 30, 2016.

The assets and liabilities held for disposition as of September 30, 2016 relate to the AMO and AbbVie businesses. The assets and liabilities held for disposition as of December 31, 2015 relate to the AbbVie business.

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The following is a summary of the assets and liabilities held for disposition:

Note 4 — Supplemental Financial Information

Shares of unvested restricted stock that contain non-forfeitable rights to dividends are treated as participating securities and are included in the computation of earnings per share under the two-class method.  Under the two-class method, net earnings are allocated between common shares and participating securities. Earnings (loss) from Continuing Operations allocated to common shares for the three months ended September 30, 2016 and 2015 were $(357) million and $593 million, respectively, and for the nine months ended September 30, 2016 and 2015 were $297 million and $1.902 billion, respectively.  Net earnings (loss) allocated to common shares for the three months ended September 30, 2016 and 2015 were $(329) million and $577 million, respectively, and for the nine months ended September 30, 2016 and 2015 were $600 million and $3.638 billion, respectively.

On September 30, 2016, Abbott recorded expense of $947 million to adjust its holding of Mylan N.V. ordinary shares due to a decline in the fair value of the securities which is considered by Abbott to be other than temporary. The adjustment reflects Mylan N.V.’s share price as of September 30, 2016 and is included in the Other expense (income), net line of the Condensed Consolidated Statement of Earnings.

In the first nine months of 2015, Other (income) expense, net primarily relates to a $207 million gain on the sale of a portion of Abbott’s position in Mylan N.V. stock and $79 million of income resulting from a decrease in the fair value of contingent consideration related to a business acquisition.  In the first nine months of 2015, Abbott sold 40.25 million of the 110 million ordinary shares of Mylan N.V. received in the sale of the developed markets branded generics pharmaceuticals business to Mylan.  Abbott received $2.29 billion in net proceeds from the sale of these shares.  As a result of this sale, Abbott’s ownership interest in Mylan N.V. decreased from approximately 22% to approximately 14%.

Other, net in Net cash from operating activities in the Condensed Consolidated Statement of Cash Flows for the first nine months of 2016 and 2015 includes the effects of contributions to defined benefit plans of $540 million and $551 million, respectively, and to the post-employment medical and dental benefit plans of $9 million and $24 million, respectively. The first nine months of 2016 also includes the non-cash impact of approximately $539 million of net tax benefits primarily associated with the resolution of various tax positions from prior years, as well as cash taxes paid of approximately $140 million related to the disposition of businesses. The first nine months of 2015 includes the non-cash impact of approximately $1.1 billion of tax expense associated with the gain on the sale of businesses. The foreign currency loss related to Venezuela in the first nine months of 2016 reduced Abbott’s cash by approximately $410 million and is shown on the Effect of exchange rate changes on cash and cash equivalents line within the Condensed Consolidated Statement of Cash Flows.

Since January 2010, Venezuela has been designated as a highly inflationary economy under U.S. GAAP.  In 2014 and 2015, the government of Venezuela operated multiple mechanisms to exchange bolivars into U.S. dollars. These mechanisms included the CENCOEX, SICAD, and SIMADI rates, which stood at 6.3, 13.5, and approximately 200, respectively, at December 31, 2015. In 2015, Abbott continued to use the CENCOEX rate of 6.3 Venezuelan bolivars to the U.S. dollar to report the results, financial

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position, and cash flows related to its operations in Venezuela since Abbott continued to qualify for this exchange rate to pay for the import of various products into Venezuela.

On February 17, 2016, the Venezuelan government announced that the three-tier exchange rate system would be reduced to two rates renamed the DIPRO and DICOM rates.  The DIPRO rate is the official rate for food and medicine imports and was adjusted from 6.3 to 10 bolivars per U.S. dollar.  The DICOM rate is a floating market rate published daily by the Venezuelan central bank, which at the end of the first quarter of 2016 was approximately 263 bolivars per U.S. dollar.  As a result of decreasing government approvals to convert bolivars to U.S. dollars to pay for intercompany accounts, as well as the accelerating deterioration of economic conditions in the country, Abbott concluded that it was appropriate to move to the DICOM rate at the end of the first quarter of 2016.  As a result, Abbott recorded a foreign currency loss of $481 million in the first nine months of 2016 to revalue its net monetary assets in Venezuela.  Abbott is continuing to use the DICOM rate to report the results of operations and to remeasure net monetary assets for Venezuela at the end of each quarter.  As of September 30, 2016, Abbott’s Venezuelan operations represented approximately 0.1% of Abbott’s consolidated assets and any additional foreign currency losses related to Venezuela are not expected to be material.

The components of long-term investments as of September 30, 2016 and December 31, 2015 are as follows:

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Note 5 — Changes in Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss), net of income taxes, are as follows:

Reclassified amounts for foreign currency translation are recorded in the Condensed Consolidated Statement of Earnings as Net foreign exchange loss (gain); gains (losses) on marketable equity securities as Other (income) expense, net and cash flow hedges as Cost of products sold.  Net actuarial losses and prior service cost are included as a component of net periodic benefit plan costs; see Note 12 for additional details.

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Note 6 — Business Acquisitions

In August 2015, Abbott completed the acquisition of the equity of Tendyne Holdings, Inc. (Tendyne) that Abbott did not already own for approximately $225 million in cash plus additional payments up to $150 million to be made upon completion of certain regulatory milestones. The acquisition of Tendyne, which is focused on developing minimally invasive mitral valve replacement therapies, allows Abbott to broaden its foundation in the treatment of mitral valve disease. The final allocation of the fair value of the acquisition resulted in non-deductible acquired in-process research and development of approximately $220 million, which is accounted for as an indefinite-lived intangible asset until regulatory approval or discontinuation, non-deductible goodwill of approximately $142 million, deferred tax assets and other net assets of approximately $18 million, deferred tax liabilities of approximately $85 million, and contingent consideration of approximately $70 million. The goodwill is identifiable to the Vascular Products segment. Had this acquisition taken place as of the beginning of the comparable prior annual reporting period, consolidated net sales and earnings would not have been significantly different from reported amounts.

On January 30, 2016, Abbott entered into a definitive agreement to acquire Alere Inc. (Alere). With annual sales of approximately $2.5 billion, Alere is a global leader in point of care diagnostics.  The acquisition, which is expected to significantly advance Abbott’s global diagnostics presence and leadership, is subject to the approval of Alere shareholders and the satisfaction of customary closing conditions, including applicable regulatory approvals. On May 2, 2016, Abbott and Alere received a request for additional information from the United States Federal Trade Commission (FTC) relating to Abbott’s potential acquisition of Alere. The effect of this request, which was issued under the Hart-Scott Rodino (HSR) Antitrust Improvements Act of 1976, as amended, is to extend the waiting period imposed by the HSR Act until 30 days after Abbott and Alere have substantially complied with this request, unless the period is extended voluntarily by the parties or terminated sooner by the FTC.

On August 25, 2016, Alere filed a lawsuit against Abbott alleging that Abbott had breached its obligations under the agreement in connection with obtaining regulatory approvals. Abbott denies Alere’s allegations in the case. Abbott has complied with all of its obligations under the agreement.

On October 21, 2016, Alere shareholders approved the acquisition.

Under the terms of the agreement, Abbott will pay $56 per common share at a total expected equity value of $5.8 billion. Alere’s net debt, currently $2.5 billion, will be assumed or refinanced by Abbott.  In February 2016, Abbott obtained a commitment for a 364-day senior unsecured bridge term loan facility for an amount not to exceed $9 billion in conjunction with its pending acquisition of Alere.  While Abbott plans to use cash on hand at the time of the acquisition from anticipated long-term borrowings to acquire Alere, the bridge facility will provide back-up financing.

On April 27, 2016, Abbott entered into a definitive agreement to acquire St. Jude Medical, Inc. (St. Jude Medical).  With 2015 sales of approximately $5.5 billion, St. Jude Medical is a global medical device manufacturer.  The acquisition, which is expected to significantly advance Abbott’s global cardiovascular device presence and leadership, is subject to the approval of St. Jude Medical shareholders and the satisfaction of customary closing conditions, including applicable regulatory approvals. On July 11, 2016, Abbott and St. Jude Medical received a request for additional information from the FTC relating to Abbott’s potential acquisition of St. Jude Medical. The effect of this request, which was issued under the HSR Act, is to extend the waiting period imposed by the HSR Act until 30 days after Abbott and St. Jude Medical have substantially complied with this request, unless the period is extended voluntarily by the parties or terminated sooner by the FTC. On October 18, 2016, Abbott and St. Jude Medical announced an agreement to sell certain products to Terumo Corporation (Terumo). The transaction with Terumo reflects a purchase price of approximately $1.12 billion and is subject to the successful completion of Abbott’s acquisition of St. Jude Medical and antitrust regulatory approvals.

On October 26, 2016, St. Jude Medical shareholders approved the acquisition.

Under the terms of the agreement, for each share of stock, St. Jude Medical shareholders will receive $46.75 in cash and 0.8708 of a share of Abbott common stock.  At an Abbott stock price of $40.74, which reflects the closing price on October 20, 2016, this represents a value of approximately $82 per common share at a total expected equity value of approximately $24 billion. St. Jude Medical’s net debt of approximately $5.4 billion will be assumed or refinanced by Abbott.  In April 2016, Abbott obtained a commitment for a 364-day senior unsecured bridge term loan facility for an amount not to exceed $17.2 billion in conjunction with its pending acquisition of St. Jude Medical.  While Abbott plans to fund the cash portion of this transaction with anticipated medium and long-term borrowings, the bridge facility will provide back-up financing.

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Note 7 — Goodwill and Intangible Assets

The total amount of goodwill reported was $7.812 billion at September 30, 2016 and $9.638 billion at December 31, 2015. The amount at September 30, 2016 excludes goodwill included in non-current assets held for disposition. In the third quarter of 2016, approximately $2.0 billion of goodwill was moved to Non-current assets held for disposition due to the pending sale of AMO. In the first nine months of 2016, foreign currency translation adjustments increased goodwill by approximately $126 million. There were no purchase price allocation adjustments associated with recent acquisitions made during the nine months of 2016. The amount of goodwill related to reportable segments at September 30, 2016 was $3.0 billion for the Established Pharmaceutical Products segment, $286 million for the Nutritional Products segment, $451 million for the Diagnostic Products segment, and $3.1 billion for the Vascular Products segment.  There was no reduction of goodwill relating to impairments.

The gross amount of amortizable intangible assets, primarily product rights and technology was $10.5 billion as of September 30, 2016 and $10.8 billion as of December 31, 2015, and accumulated amortization was $6.1 billion as of September 30, 2016 and $5.7 billion as of December 31, 2015. The September 30, 2016 amounts exclude the intangibles included in Non-current assets held for disposition. In the third quarter of 2016, approximately $533 million of net intangible assets related to AMO was moved to Non-current assets held for disposition due to the pending sale of this business. Foreign currency translation adjustments increased intangible assets by $72 million in the first nine months of 2016.  Indefinite-lived intangible assets, which relate to in-process research and development acquired in a business combination, were approximately $325 million and $419 million as of September 30, 2016 and December 31, 2015, respectively. In the first nine months of 2016, Abbott recorded an impairment of a $59 million in-process research and development project related to a non-reportable segment. Abbott’s estimated annual amortization expense for intangible assets is approximately $560 million in 2016, $490 million in 2017, $450 million in 2018, $420 million in 2019 and $410 million in 2020. Amortizable intangible assets are amortized over 2 to 20 years (weighted average 13 years).

Note 8 — Restructuring Plans

In 2016, 2015 and 2014, Abbott management approved plans to streamline operations in order to reduce costs and improve efficiencies in various Abbott businesses including the nutritional, established pharmaceuticals and vascular businesses. In the first nine months of 2016, charges of approximately $23 million were recognized, of which approximately $7 million is recognized as Cost of products sold and approximately $16 million as Selling, general and administrative expense. Additional charges of approximately $2 million were recorded primarily for accelerated depreciation.  The following summarizes the activity for the first nine months of 2016 related to these restructuring actions and the status of the related accrual as of September 30, 2016:

From 2013 to 2015, Abbott management approved various plans to reduce costs and improve efficiencies across various functional areas. In the first nine months of 2016, charges of approximately $12 million were recognized as Selling, general and administrative expense. In 2013, Abbott management also approved plans to streamline certain manufacturing operations in order to reduce costs and improve efficiencies in Abbott’s established pharmaceuticals business. In 2012, Abbott management approved plans to streamline various commercial operations in order to reduce costs and improve efficiencies in Abbott’s core diagnostics, established pharmaceuticals and nutritionals businesses. The following summarizes the activity for the first nine months of 2016 related to these restructuring actions and the status of the related accrual as of September 30, 2016:

In 2013 and prior years, Abbott management approved plans to streamline global manufacturing operations, reduce overall costs and improve efficiencies in its worldwide pharmaceutical, vascular and core diagnostics businesses as well as selected domestic and international commercial and research and development operations.  The following summarizes the activity for the first nine months of 2016 related to these restructuring actions and the status of the related accrual as of September 30, 2016:

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Note 9 — Incentive Stock Programs

In the first nine months of 2016, Abbott granted 7,699,301 stock options, 776,510 restricted stock awards and 7,467,430 restricted stock units under its incentive stock programs.  At September 30, 2016, approximately 57 million shares were reserved for future grants.  Information regarding the number of stock options outstanding and exercisable at September 30, 2016 is as follows:

The total unrecognized share-based compensation cost at September 30, 2016 amounted to approximately $237 million which is expected to be recognized over the next three years.

Note 10 — Financial Instruments, Derivatives and Fair Value Measures

Certain Abbott foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany purchases by those subsidiaries whose functional currencies are not the U.S. dollar.  These contracts, with gross notional amounts totaling $2.9 billion at September 30, 2016 and $2.4 billion at December 31, 2015 are designated as cash flow hedges of the variability of the cash flows due to changes in foreign exchange rates and are recorded at fair value.  Accumulated gains and losses as of September 30, 2016 will be included in Cost of products sold at the time the products are sold, generally through the next twelve to eighteen months.  The amount of hedge ineffectiveness was not significant in 2016 and 2015.

Abbott enters into foreign currency forward exchange contracts to manage currency exposures for foreign currency denominated third-party trade payables and receivables, and for intercompany loans and trade accounts payable where the receivable or payable is denominated in a currency other than the functional currency of the entity.  For intercompany loans, the contracts require Abbott to sell or buy foreign currencies, primarily European currencies including the British pound, in exchange for primarily U.S. dollars and other European currencies.  For intercompany and trade payables and receivables, the currency exposures are primarily the U.S. dollar and European currencies.  At September 30, 2016 and December 31, 2015, Abbott held the gross notional amount of $15.5 billion and $14.0 billion, respectively, of such foreign currency forward exchange contracts.

Abbott has designated foreign denominated short-term debt as a hedge of the net investment in a foreign subsidiary of approximately $522 million and approximately $439 million as of September 30, 2016 and December 31, 2015, respectively.  Accordingly, changes in the reported value of this debt due to changes in exchange rates are recorded in Accumulated other comprehensive income (loss), net of tax.

Abbott is a party to interest rate hedge contracts totaling approximately $4.0 billion at September 30, 2016 and December 31, 2015 to manage its exposure to changes in the fair value of fixed-rate debt.   These contracts are designated as fair value hedges of the variability of the fair value of fixed-rate debt due to changes in the long-term benchmark interest rates.  The effect of the hedge is to change a fixed-rate interest obligation to a variable rate for that portion of the debt.  Abbott records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount.  The amount of hedge ineffectiveness was not significant in 2016 and 2015.

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The following table summarizes the amounts and location of certain derivative financial instruments as of September 30, 2016 and December 31, 2015:

The following table summarizes the activity for foreign currency forward exchange contracts designated as cash flow hedges, debt designated as a hedge of net investment in a foreign subsidiary and certain other derivative financial instruments, as well as the amounts and location of income (expense) and gain (loss) reclassified into income for the three months and nine months ended September 30, 2016 and 2015.  The amount of hedge ineffectiveness was not significant in 2016 and 2015 for these hedges.

Losses of $5 million and $9 million were recognized in the three months ended September 30, 2016 and 2015, respectively, related to foreign currency forward exchange contracts not designated as a hedge. Gains of $16 million and $92 million were recognized in the nine months ended September 30, 2016 and 2015, respectively, related to foreign currency forward exchange contracts not designated as a hedge. These amounts are reported in the Condensed Consolidated Statement of Earnings on the Net foreign exchange loss (gain) line.

The interest rate swaps are designated as fair value hedges of the variability of the fair value of fixed-rate debt due to changes in the long-term benchmark interest rates.  The hedged debt is marked to market, offsetting the effect of marking the interest rate swaps to market.

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The carrying values and fair values of certain financial instruments as of September 30, 2016 and December 31, 2015 are shown in the following table. The carrying values of all other financial instruments approximate their estimated fair values.  The counterparties to financial instruments consist of select major international financial institutions.  Abbott does not expect any losses from nonperformance by these counterparties.

The fair value of the debt was determined based on significant other observable inputs, including current interest rates.

The following table summarizes the bases used to measure certain assets and liabilities at fair value on a recurring basis in the   balance sheet:

Equity securities are principally comprised of Mylan N.V. ordinary shares.  The fair value of the Mylan equity securities was determined based on the value of the publicly-traded ordinary shares. The fair value of debt was determined based on the face value of the debt adjusted for the fair value of the interest rate swaps, which is based on a discounted cash flow analysis. The fair value of foreign currency forward exchange contracts is determined using a market approach, which utilizes values for comparable derivative instruments.  The fair value of the contingent consideration was determined based on an independent appraisal adjusted for the time value of money and other changes in fair value primarily resulting from changes in regulatory timelines.

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Note 11 — 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 $10 million.

Abbott is involved in various claims and legal proceedings, and Abbott estimates the range of possible loss for its legal proceedings and environmental exposures to be from approximately $40 million to $45 million. The recorded accrual balance at September 30, 2016 for these proceedings and exposures was approximately $45 million. This accrual represents management’s best estimate of probable loss, as defined by FASB ASC No. 450, “Contingencies.” Within the next year, legal proceedings may occur that may result in a change in the estimated loss accrued by Abbott. 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.

Note 12 — Post-Employment Benefits

Retirement plans consist of defined benefit, defined contribution, and medical and dental plans.  Net cost recognized in continuing operations for the three months and nine months ended September 30 for Abbott’s major defined benefit plans and post-employment medical and dental benefit plans is as follows:

Abbott funds its domestic defined benefit plans according to IRS funding limitations.  International pension plans are funded according to similar regulations.  In the first nine months of 2016 and 2015, $540 million and $551 million, respectively, were contributed to defined benefit plans and $9 million and $24 million, respectively, were contributed to the post-employment medical and dental benefit plans.

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Note 13 — Taxes on Earnings

Taxes on earnings from continuing operations reflect the estimated annual effective rates and include charges for interest and penalties.  In the first nine months of 2016, taxes on earnings from continuing operations includes the impact of a net tax benefit of approximately $250 million as a result of the resolution of various tax positions from prior years, partially offset by the unfavorable impact of non-deductible foreign exchange losses related to Venezuela and the adjustment of the Mylan N.V. equity investment as well as the recognition of deferred taxes associated with the pending sale of AMO.  Earnings from discontinued operations, net of tax, in the first nine months of 2016 reflects the recognition of $289 million of net tax benefits primarily as a result of the resolution of various tax positions related to prior years. The conclusion of these tax matters decreased the gross amount of unrecognized tax benefits by approximately $546 million. In the first nine months of 2015, taxes on earnings from continuing operations include a tax cost of $71 million related to the disposal of shares of Mylan N.V. stock.  Taxes on earnings from continuing operations in the first nine months of 2015 were not affected by any adjustments as the result of the resolution of various tax positions pertaining to prior years. 2015 tax expense related to discontinued operations includes $667 million of tax expense on certain funds earned outside the U.S. in 2015 that were not designated as permanently reinvested overseas. Earnings from discontinued operations, net of tax, in the first nine months of 2015 also reflects the recognition of $10 million of net tax expense primarily as a result of the resolution of various tax positions related to AbbVie’s operations for years prior to the separation. The conclusion of these tax matters decreased the gross amount of unrecognized tax benefits by approximately $16 million.

Tax authorities in various jurisdictions regularly review Abbott’s income tax filings.  Abbott believes that it is reasonably possible that the recorded amount of gross unrecognized tax benefits may decrease by $100 million to $200 million, including cash adjustments, within the next twelve months as a result of concluding various domestic and international tax matters. In the U.S., Abbott’s federal income tax returns through 2013 are settled except for one issue.

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Note 14 — Segment Information

Abbott’s principal business is the discovery, development, manufacture and sale of a broad line of health care products.  Abbott’s products are generally sold directly to retailers, wholesalers, hospitals, health care facilities, laboratories, physicians’ offices and government agencies throughout the world.  Abbott’s reportable segments are as follows:

Established Pharmaceutical Products — International sales of a broad line of branded generic pharmaceutical products.

Nutritional Products — Worldwide sales of a broad line of adult and pediatric nutritional products.

Diagnostic Products — Worldwide sales of diagnostic systems and tests for blood banks, hospitals, commercial laboratories and alternate-care testing sites.  For segment reporting purposes, the Core Laboratories Diagnostics, Molecular Diagnostics, Point of Care and Ibis diagnostic divisions are aggregated and reported as the Diagnostic Products segment.

Vascular Products — Worldwide sales of coronary, endovascular, structural heart, vessel closure and other medical device products. For segment reporting purposes, the Vascular and Electrophysiology Products divisions are aggregated and reported as the Vascular Products segment.

Non-reportable segments include the Diabetes Care and Medical Optics segments.

Abbott’s underlying accounting records are maintained on a legal entity basis for government and public reporting requirements.  Segment disclosures are on a performance basis consistent with internal management reporting.  Intersegment transfers of inventory are recorded at standard cost and are not a measure of segment operating earnings.  The cost of some corporate functions and the cost of certain employee benefits are charged to segments at predetermined rates that approximate cost.  Remaining costs, if any, are not allocated to segments.  In addition, intangible asset amortization is not allocated to operating segments, and intangible assets and goodwill are not included in the measure of each segment’s assets.

The following segment information has been prepared in accordance with the internal accounting policies of Abbott, as described above, and is not presented in accordance with generally accepted accounting principles applied to the consolidated financial statements.

(a)         Net interest expense for the quarter and the nine months ended September 30, 2016 includes amortization expense associated with bridge facility fees.

(b)         Approximately 50 percent of the annual net cost of share-based awards will typically be recognized in the first quarter due to the timing of the granting of share-based awards.

(c)          Other, net for the nine months ended September 30, 2016, includes the $947 million adjustment of the Mylan equity investment and $481 million of foreign currency loss related to operations in Venezuela. Other, net for the nine months ended September 30, 2015, includes a gain on the sale of a portion of Abbott’s position in Mylan stock and a decrease in the fair value of contingent consideration related to a business acquisition.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Review - Results of Operations

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 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 nutritional products, branded generic pharmaceuticals, diagnostic testing products and vascular products.

The following table details sales by reportable segment for the three months and nine months ended September 30.  Percent changes are versus the prior year and are based on unrounded numbers.