Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition
(Tables present dollars in millions, except per-share data)
General
Management's discussion and analysis of results of operations and financial condition is intended to assist the reader in understanding and assessing significant changes and trends related to our company's results of operations and financial position. This discussion and analysis should be read in conjunction with Item 8, "Financial Statements and Supplementary Data." Certain statements in this Item 7 constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements" and Item 1A, "Risk Factors," may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements.
EXECUTIVE OVERVIEW
This section provides an overview of our financial results, late-stage pipeline developments, and other matters affecting our company and the pharmaceutical industry.
Financial Results
The following table summarizes our key operating results:
Year Ended December 31 Percent Change
2022 2021
Revenue $ 28,541.4 $ 28,318.4 1
Gross margin 21,911.6 21,005.6 4
Gross margin as a percent of revenue 76.8 % 74.2 %
Research and development $ 7,190.8 $ 6,930.7 4
Marketing, selling, and administrative 6,440.4 6,431.6 —
Acquired in-process research and development (IPR&D) and development milestones 908.5 970.1 (6)
Asset impairment, restructuring, and other special charges 244.6 316.1 (23)
Other—net, (income) expense 320.9 201.6 59
Net income 6,244.8 5,581.7 12
Earnings per share - diluted 6.90 6.12 13
Revenue increased in 2022 driven by increased volume, largely offset by lower realized prices and the unfavorable impact of foreign exchange rates. Research and development expenses increased in 2022, driven primarily by higher development expenses for late-stage assets, partially offset by lower development expenses for COVID-19 antibodies and the favorable impact of foreign exchange rates. Marketing, selling, and administrative expenses in 2022 remained relatively flat compared to 2021 as increased costs associated with launches of new products and indications were offset by the favorable impact of foreign exchange rates.
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The following highlighted items affect comparisons of our 2022 and 2021 financial results:
2022
Acquired IPR&D and Development Milestones (Note 3 to the consolidated financial statements)
• We recognized $908.5 million of acquired IPR&D and development milestones that included the buy-out of substantially all future obligations that were contingent upon the occurrence of certain events linked to the success of our mutant-selective PI3kα inhibitor and a purchase of a Priority Review Voucher.
Asset Impairment, Restructuring, and Other Special Charges (Note 5 to the consolidated financial statements)
• We recognized charges of $244.6 million primarily related to an intangible asset impairment for GBA1 Gene Therapy (PR001) due to changes in estimated launch timing.
Other-Net, (Income) Expense (Note 18 to the consolidated financial statements)
• We recognized $410.7 million of net investment losses on equity securities.
2021
Cost of Sales (See Note 6 to the consolidated financial statements)
• We recognized a net inventory impairment charge related to our COVID-19 antibodies of $339.7 million. As part of our response to the COVID-19 pandemic, and at the request of the United States (U.S.) and international governments, we invested in large-scale manufacturing of COVID-19 antibodies at risk, in order to ensure rapid access to patients around the world. As the COVID-19 pandemic evolved during 2021, we incurred a net inventory impairment charge primarily due to the combination of changes to demand from U.S. and international governments, including changes to our agreement with the U.S. government, and near-term expiry dates of COVID-19 antibodies.
Acquired IPR&D and Development Milestones (Note 3 to the consolidated financial statements)
• We recognized $970.1 million of acquired IPR&D and development milestones that included charges resulting from business development transactions with Foghorn Therapeutics Inc. (Foghorn), Rigel Pharmaceuticals, Inc. (Rigel), and Precision Biosciences, Inc. (Precision).
Asset Impairment, Restructuring, and Other Special Charges (Note 5 to the consolidated financial statements)
• We recognized charges of $316.1 million primarily related to an impairment of a contract-based intangible asset from our acquisition of Loxo Oncology, Inc. (Loxo), an intangible asset impairment resulting from the sale of the rights to Qbrexza ® , as well as acquisition and integration costs associated with the acquisition of Prevail Therapeutics Inc. (Prevail).
Other-Net, (Income) Expense (Note 18 to the consolidated financial statements)
• We recognized a debt extinguishment loss of $405.2 million related to the repurchase of debt.
• We recognized $176.9 million of net investment gains on equity securities.
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Late-Stage Pipeline
Our long-term success depends on our ability to continually discover or acquire, develop, and commercialize innovative new medicines. We currently have approximately 45 new medicine candidates in clinical development or under regulatory review, and a larger number of projects in the discovery phase.
The following certain new molecular entities (NMEs) are currently in Phase II or Phase III clinical trials or have been submitted for regulatory review or have received regulatory approval in the U.S., Europe, or Japan. The following table reflects the status of certain NMEs, including certain other developments, up to the time of the filing of this Annual Report on Form 10-K:
Compound Indication Status Developments
Diabetes
Basal Insulin-Fc Type 1 and 2 diabetes Phase III Phase III trials initiated in 2022 and 2023.
ANGPTL3 siRNA Cardiovascular disease Phase II Phase II trial initiated in 2022.
LP(a) Inhibitor Cardiovascular disease Phase II Phase II trial initiated in 2022.
LP(a) siRNA Cardiovascular disease Phase II Phase II trial initiated in 2022.
Orforglipron Obesity Phase II Phase II trials were recently completed.
Type 2 diabetes
Retatrutide Obesity Phase II Phase II trials were recently completed.
Type 2 diabetes
Immunology
Lebrikizumab (1)
Atopic dermatitis Submitted Submitted in the U.S. and Europe in 2022. Phase III trials are ongoing.
Mirikizumab Ulcerative colitis Submitted Submitted in the U.S., Europe, and Japan in 2022.
Crohn's Disease Phase III Phase III trials are ongoing.
BTLA MAB Agonist Systemic lupus erythematosus Phase II Phase II trial initiated in 2022.
CXCR1/2 Ligands Monoclonal Antibody Hidradenitis suppurativa Phase II Phase II trial is ongoing.
Peresolimab Rheumatoid arthritis Phase II Phase II trial is ongoing.
Rezpegaldesleukin Systemic lupus erythematosus Phase II Phase II trial is ongoing.
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Compound Indication Status Developments
Neuroscience
Donanemab Early Alzheimer's disease Complete Response Letter Granted U.S. Food and Drug Administration (FDA) Breakthrough Therapy designation (2) . Submitted in the U.S. in 2022 under the accelerated approval pathway. In January 2023, the FDA issued a complete response letter for the accelerated approval submission. Phase III trials are ongoing.
Preclinical Alzheimer's disease Phase III Phase III trial is ongoing.
Remternetug Early Alzheimer's disease Phase III Phase III trial initiated in 2022.
Solanezumab Preclinical Alzheimer's disease Phase III Phase III trial is ongoing.
GBA1 Gene Therapy (PR001) Parkinson's disease Phase II Granted FDA Fast Track designation (3) . Phase II trial is ongoing.
GRN Gene Therapy (PR006) Frontotemporal dementia Phase II Granted FDA Fast Track designation (3) . Phase II trial is ongoing.
O-GlcNAcase Inh Alzheimer's disease Phase II Phase II trial is ongoing.
P2X7 Inhibitor Pain Phase II Phase II trials initiated in 2022.
SSTR4 Agonist Pain Phase II Phase II trials are ongoing.
TRPA1 Antagonist Pain Phase II Phase II trials are ongoing.
Oncology
Pirtobrutinib
(Jaypirca TM )
Mantle cell lymphoma Approved (4)
FDA granted accelerated approval (4) in the U.S. in January 2023. Phase III trial is ongoing.
Chronic lymphocytic leukemia Phase III Phase III trials are ongoing.
B-cell malignancies Phase II Phase II trial is ongoing.
Selpercatinib (Retevmo ® )
Lung cancer Approved (4)
Phase III trials are ongoing.
Thyroid cancer Approved (4)
Phase III trial is ongoing.
Imlunestrant Adjuvant Breast Cancer Phase III Phase III trial initiated in 2022.
ER+HER2- metastatic breast cancer Phase III Phase III trial is ongoing.
(1) In collaboration with Almirall, S.A. in Europe.
(2) Breakthrough Therapy designation is designed to expedite the development and review of potential medicines that are intended to treat a serious condition where preliminary clinical evidence indicates that the treatment may demonstrate substantial improvement over available therapy on a clinically significant endpoint.
(3) Fast Track designation is designed to facilitate the development and expedite the review of medicines to treat serious conditions and fill an unmet medical need.
(4) Continued approval may be contingent on verification and description of clinical benefit in confirmatory Phase III trials.
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Our pipeline also contains several new indication line extension (NILEX) products. The following certain NILEX products for use in the indication described are currently in Phase II or Phase III clinical trials or have been submitted for regulatory review or have received regulatory approval in the U.S., Europe, or Japan. The following table reflects the status of certain NILEX products, including certain other developments, up to the time of the filing of this Annual Report on Form 10-K:
Compound Indication Status Developments
Diabetes
Empagliflozin (Jardiance ® ) (1)
Chronic kidney disease Submitted Granted FDA Fast Track designation (2) . Submitted in the U.S. and Europe in January 2023.
Tirzepatide (Mounjaro ® )
Obesity Submission initiated Granted FDA Fast Track designation (2) in 2022. Initiated a rolling submission in the U.S. in 2022. Phase III trials are ongoing.
Heart failure with preserved ejection fraction Phase III Phase III trials are ongoing.
Obstructive sleep apnea Phase III Phase III trial initiated in 2022. Granted FDA Fast Track designation (2) in 2022.
Nonalcoholic steatohepatitis Phase II Phase II trial is ongoing.
Oncology
Abemaciclib (Verzenio ® )
Prostate cancer
Phase III Phase III trials are ongoing.
(1) In collaboration with Boehringer Ingelheim.
(2) Fast Track designation is designed to facilitate the development and expedite the review of medicines to treat serious conditions and fill an unmet medical need.
There are many difficulties and uncertainties inherent in pharmaceutical research and development and the introduction of new products, as well as a high rate of failure inherent in new drug discovery and development. To bring a drug from the discovery phase to market can take over a decade and often costs in excess of $2 billion. Failure can occur at any point in the process, including in later stages after substantial investment. As a result, most funds invested in research programs will not generate financial returns. New product candidates that appear promising in development may fail to reach the market or may have only limited commercial success because of efficacy or safety concerns, inability to obtain or maintain necessary regulatory approvals or payer reimbursement or coverage, the application of pricing controls, limited scope of approved uses, label changes, changes in the relevant treatment standards or the availability of new or better competitive products, difficulty or excessive costs to manufacture, or infringement of the patents or intellectual property rights of others. Regulatory agencies establish high hurdles for the efficacy and safety of new products and indications. Delays, uncertainties, unpredictabilities, and inconsistencies in drug approval processes across markets and agencies can result in delays in product launches and lost market opportunity. In addition, it can be very difficult to predict revenue growth rates of or variability in demand for new products and indications.
We manage research and development spending across our portfolio of potential new medicines. A delay in, or termination of, any one project will not necessarily cause a significant change in our total research and development spending. Due to the risks and uncertainties involved in the research and development process, we cannot reliably estimate the nature, timing, and costs of the efforts necessary to complete the development of our research and development projects, nor can we reliably estimate the future potential revenue that will be generated from any successful research and development project. Each project represents only a portion of the overall pipeline, and none is individually material to our consolidated research and development expense. While we do accumulate certain research and development costs on a project level for internal reporting purposes, we must make significant cost estimations and allocations, some of which rely on data that are neither reproducible nor validated through accepted control mechanisms. Therefore, we do not have sufficiently reliable data to report on total research and development costs by project, by preclinical versus clinical spend, or by therapeutic category.
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Other Matters
Patent Matters
We depend on patents or other forms of intellectual property protection for most of our revenue, cash flows, and earnings.
Following the expiration of patent exclusivity for Alimta ® in Europe and Japan in June 2021, we have faced generic competition that has rapidly and severely eroded revenue from prior levels, and we expect such competition will continue to erode revenues from current levels in these markets. In addition, as a result of the entry of multiple generics in the U.S. following the expiration of patent and pediatric exclusivity in the first half of 2022, we began facing, and expect to continue to face, generic competition that has rapidly and severely eroded revenue from prior levels, and we expect will continue to erode revenue from current levels. This decline in revenue will continue to impact period-over-period financial results comparisons, particularly during the first half of 2023. See Note 16 to the consolidated financial statements for a description of legal proceedings currently pending regarding certain of our patents.
Our compound patents for Humalog ® (insulin lispro) have expired in the U.S. and major international markets, and we have also introduced lower-priced versions of Humalog as part of our insulin access and affordability solutions. A competitor has a similar version of insulin lispro in the U.S. and in certain European markets. Due to the impact of competition and pricing pressure in the U.S. and certain international markets, we expect that lower revenue for Humalog due to realized price decline will continue over time.
Trends Affecting Pharmaceutical Pricing, Reimbursement, and Access
Reforms, including those that may stem from periods of economic downturn or uncertainty, or as a result of high inflation, emergence or escalation of, and responses to, war or unrest (including the Russia-Ukraine war), or government budgeting priorities (including as exacerbated by the COVID-19 pandemic), may continue to result in added pressure on pricing and reimbursement for our products.
Global concern over access to and affordability of pharmaceutical products continues to drive regulatory and legislative debate and action, as well as worldwide cost containment efforts by governmental authorities. Such measures include the use of mandated discounts, price reporting requirements, mandated reference prices, restrictive formularies, changes to available intellectual property protections, as well as other efforts. In August 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (IRA). Among other measures, the IRA will require the U.S. Department of Health and Human Services to effectively set prices for certain single-source drugs and biologics reimbursed under Medicare Part B and Part D. Generally, these government prices apply nine (medicines approved under a New Drug Application) or thirteen (medicines approved under a Biologics License Application) years following initial FDA approval and will be capped at a statutory ceiling price that is likely to represent a significant discount from average prices to wholesalers and direct purchasers. It is too soon to tell how the U.S. government will set these prices as the law specifies a ceiling price, but not a minimum or floor price. One or more of our significant products may be selected, which would have the effect of accelerating revenue erosion prior to patent expiry. The effect of reducing prices and reimbursement for certain of our products would significantly impact our business and consolidated results of operations. The establishment of payment limits or other restrictions by drug affordability review boards and other state level actors would similarly impact us.
Other IRA provisions provide for rebate obligations on drug manufacturers that increase prices of Medicare Part B and Part D medicines at a rate greater than the rate of inflation and Part D benefit redesign that includes replacing the Part D coverage gap discount program with a new manufacturer discounting program. Manufacturers that fail to comply with the IRA may be subject to various penalties, including civil monetary penalties, which could be significant.
The IRA takes effect progressively starting in 2023, with the first government-set prices effective in 2026. The IRA may meaningfully influence our business strategies and those of our competitors. In particular, the nine-year timeline to set prices for medicines approved under a new drug application may reduce the attractiveness of investment in small molecule innovation. The implications to us of a competitor's product being selected for price setting are also uncertain. Provisions of the IRA may be subject to legal challenges or other reformation, and the full impact of the IRA on our business and the pharmaceutical industry remains uncertain.
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Additional policies, regulations, legislation, or enforcement, including those proposed and/or pursued by the U.S. Congress, the current U.S. presidential administration, and regulatory authorities worldwide, could adversely impact our business and consolidated results of operations.
Consolidation and integration of private payors and pharmacy benefit managers in the U.S. has also significantly impacted the market for pharmaceuticals by increasing payor leverage in negotiating manufacturer price or rebate concessions and pharmacy reimbursement rates. Furthermore, restrictive or unfavorable pricing, coverage, or reimbursement determinations for our medicines or product candidates by governments, regulatory agencies, courts, or private payers, such as the Centers for Medicare & Medicaid Services' national coverage determination for monoclonal antibodies for the treatment of Alzheimer's Disease, may adversely impact our business and consolidated results of operations. We expect that these actions may intensify and could particularly affect certain products, such as insulin, as governments manage and emerge from the COVID-19 pandemic, which could adversely affect our business. In addition, we are engaged in litigation and investigations related to our 340B program and access to insulin that, if resolved adversely to us, could negatively impact our business and consolidated results of operations. It is not currently possible to predict the overall potential adverse impact to us or the general pharmaceutical industry of continued cost containment efforts worldwide.
In addition, regulatory issues concerning compliance with current Good Manufacturing Practices, quality assurance, evolving standards, and increased scrutiny around excipients and potential impurities such as nitrosamines, and similar regulations and standards (and comparable foreign regulations and standards) for our products can lead to regulatory and legal actions, product recalls and seizures, fines and penalties, interruption of production leading to product shortages, import bans or denials of import certifications, delays or denials in new product approvals or line extensions or supplemental approvals of current products pending resolution of the issues, and reputational harm, any of which would adversely affect our business. Moreover, increased focus on business combinations across industries and jurisdictions can lead to impediments to the completion of business combinations.
See Item 1, "Business—Regulations and Private Payer Actions Affecting Pharmaceutical Pricing, Reimbursement, and Access" and Note 16 to the consolidated financial statements for additional information.
Product Supply
We have faced challenges, and expect to continue to face challenges, meeting strong demand for our incretin products, including due to the limited and fluctuating availability of competitor therapies. In the U.S., given very strong uptake of Mounjaro following its launch in the U.S. for type 2 diabetes in the second quarter of 2022, and as demand for Trulicity ® has remained strong, we have experienced intermittent delays in fulfilling certain U.S. orders for these products. Outside the U.S., we have implemented certain actions to minimize the impact on existing Trulicity patients, but we expect to continue to experience intermittent disruptions in our supply of Trulicity in international markets.
We anticipate tight supplies of our incretin products will persist until additional manufacturing capacity is operationalized. We expect additional internal and contracted manufacturing capacity will become fully operational around the world in the next several years, with significant expansion in 2023, as part of our ongoing efforts to meet the significant demand for our incretin medicines.
Tax Matters
We are subject to income taxes and various other taxes in the U.S. and in many foreign jurisdictions; therefore, changes in both domestic and international tax laws or regulations have affected and may affect our effective tax rate, results of operations, and cash flows. In 2017, the U.S. enacted the Tax Cuts and Jobs Act (the 2017 Tax Act), which contained a provision that requires capitalization and amortization of research and development expenses for tax purposes starting in 2022. Previously, these expenses could be deducted in the year incurred. The implementation of this provision increased our cash payments of income taxes by approximately $1.20 billion in 2022. While the implementation of this provision will continue to increase our cash payments of income taxes, the increase will moderately decrease from 2022 levels over the five-year amortization period.
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The U.S. and countries around the world are actively proposing and enacting tax law changes. Further, actions taken with respect to tax-related matters by associations such as the Organisation for Economic Co-operation and Development and the European Commission could influence tax laws in countries in which we operate. Tax authorities in the U.S. and other jurisdictions in which we do business routinely examine our tax returns and are intensifying their scrutiny and examinations of profit allocations among jurisdictions. Changes to existing U.S. and foreign tax laws and increased scrutiny by tax authorities in the U.S. and other jurisdictions could adversely impact our future consolidated results of operations and cash flows.
Foreign Currency Exchange Rates and Other Impacts
As a global company, we face foreign currency risk exposure from fluctuating currency exchange rates, primarily the U.S. dollar against the euro, Japanese yen, and Chinese yuan. While we seek to manage a portion of these exposures through hedging and other risk management techniques, significant fluctuations in currency rates can have a material impact, either positive or negative, on our consolidated results of operations in any given period. During the year ended December 31, 2022, revenue was unfavorably impacted by 3 percent due to foreign exchange rates. While there is uncertainty in the future movements in foreign exchange rates, fluctuations in these rates have, and we currently expect in the near-term future will, adversely impact our consolidated results of operations and cash flows.
In addition, cost inflation, the strain on global transportation, logistics, and labor markets (including as exacerbated by the COVID-19 pandemic and the emergence or escalation of, and responses to, war or unrest, including the Russia-Ukraine war), global economic downturns or uncertainty, and an increase in overall demand in our industry for certain products and materials have had, and may continue to have, a number of impacts on our business, including increased costs and disruptions in the supply of our medicines.
Acquisitions
We invest in external research and technologies that we believe complement and strengthen our own efforts. These investments can take many forms, including acquisitions, collaborations, investments, and licensing arrangements. We view our business development activity as a way to enhance our pipeline and strengthen our business.
See Note 3 to the consolidated financial statements for further discussion regarding our recent acquisitions.
COVID-19 Pandemic
As the COVID-19 pandemic evolves, we remain focused on protecting the health, safety, and well-being of our employees; supporting the medical system and our communities; and affordability of and access to our medicines. At the outset of the COVID-19 pandemic, we also focused on researching, developing, and supplying COVID-19 therapies, although we do not currently expect significant further revenue attributable to treatments for COVID-19.
The COVID-19 pandemic has adversely impacted and may continue to adversely impact our business and operations across markets to varying and fluctuating degrees, including as a result of cost inflation and strain on the global transportation, manufacturing, and labor markets, fewer in-person interactions among patients and healthcare providers and our employees with healthcare professionals in certain markets, pricing pressures, rebates, clawbacks, and other changes in reimbursement policies resulting from the financial strain of the COVID-19 pandemic on government-funded healthcare systems, and risks related to our COVID-19 therapies. The degree to which the COVID-19 pandemic could continue to affect us will depend on developments that are highly uncertain and beyond our knowledge or control. For additional information, see Item 1A, "Risk Factors—Risk Related to Our Business—Public health outbreaks, epidemics, or pandemics, such as the COVID-19 pandemic, have adversely impacted and may in the future adversely impact our business and operations."
See Item 1A, "Risk Factors" for additional information on risk factors that could impact our business and operations.
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RESULTS OF OPERATIONS
Operating Results—2022
Revenue
The following table summarizes our revenue activity by region:
Year Ended December 31,
2022 2021 Percent Change
U.S. $ 18,190.0 $ 16,811.0 8
Outside U.S. 10,351.3 11,507.4 (10)
Revenue $ 28,541.4 $ 28,318.4 1
Numbers may not add due to rounding.
The following are components of the change in revenue compared with the prior year:
2022 vs. 2021
U.S. Outside U.S. Consolidated
Volume 11 % 9 % 10 %
Price (3) % (10) % (6) %
Foreign exchange rates — % (8) % (3) %
Percent change 8 % (10) % 1 %
Numbers may not add due to rounding.
In the U.S. the increase in volume in 2022 was primarily driven by Trulicity, Verzenio, Jardiance, Mounjaro, and Taltz ® , partially offset by decreased volume for Alimta, following the entry of multiple generics in the first half of 2022. In the U.S. the decrease in realized prices was primarily driven by Humalog, due to a list price reduction of insulin lispro injection and unfavorable segment mix, and Trulicity and Basaglar ® , due to unfavorable segment mix and higher contracted rebates. In addition, the decrease in realized prices of Humalog was partially offset by changes to estimates for rebates and discounts in 2021.
Outside the U.S. the increase in volume in 2022 was primarily driven by Verzenio, Trulicity, Jardiance, Tyvyt ® , and Taltz, partially offset by a decrease in volume due to generic competition for Alimta and Cymbalta ® and decreased utilization of COVID-19 antibodies. The decrease in realized prices outside the U.S. was primarily driven by the impact of government pricing in China from National Reimbursement Drug List (NRDL) formulary for certain products, particularly Tyvyt and Verzenio, and volume-based procurement (VBP) for Humalog.
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The following table summarizes our revenue activity in 2022 compared with 2021:
Year Ended December 31,
2022 2021 Percent Change
Product U.S. Outside U.S. Total Total
Trulicity $ 5,688.8 $ 1,750.9 $ 7,439.7 $ 6,471.9 15
Verzenio 1,653.2 830.3 2,483.5 1,349.9 84
Taltz 1,724.6 757.4 2,482.0 2,212.8 12
Jardiance (1)
1,194.5 871.5 2,066.0 1,490.8 39
Humalog (2)
1,191.9 868.7 2,060.6 2,453.0 (16)
COVID-19 antibodies (3)
2,008.9 14.7 2,023.5 2,239.3 (10)
Humulin ®
730.2 289.2 1,019.4 1,222.6 (17)
Cyramza ®
351.4 620.0 971.4 1,033.0 (6)
Alimta 543.7 384.0 927.7 2,061.4 (55)
Olumiant ®(4)
148.2 682.3 830.5 1,115.1 (26)
Basaglar 470.7 289.7 760.4 892.5 (15)
Emgality ®
462.8 188.1 650.9 577.2 13
Forteo ®
367.3 245.8 613.1 801.9 (24)
Cialis ®
35.2 552.1 587.3 718.4 (18)
Erbitux ®
500.1 66.4 566.5 548.3 3
Mounjaro 366.6 115.9 482.5 — NM
Zyprexa ®
30.4 306.5 336.9 430.3 (22)
Tyvyt — 293.3 293.3 418.1 (30)
Cymbalta 33.7 249.6 283.3 581.5 (51)
Other products 687.8 974.9 1,662.9 1,700.4 (2)
Revenue $ 18,190.0 $ 10,351.3 $ 28,541.4 $ 28,318.4 1
Numbers may not add due to rounding.
NM - Not meaningful
(1) Jardiance revenue includes Glyxambi ® , Synjardy ® , and Trijardy ® XR.
(2) Humalog revenue includes insulin lispro.
(3) COVID-19 antibodies include sales for bamlanivimab administered alone, for bamlanivimab and etesevimab administered together, and for bebtelovimab and were made pursuant to Emergency Use Authorizations (EUAs) or similar regulatory authorizations.
(4) Olumiant revenue includes sales for baricitinib that were made pursuant to EUA or similar regulatory authorizations.
Revenue of Trulicity increased 16 percent in the U.S., driven by increased demand, partially offset by lower realized prices due to unfavorable segment mix and higher contracted rebates. Revenue outside the U.S. increased 12 percent, driven by increased volume, partially offset by the unfavorable impact of foreign exchange rates and, to a lesser extent, lower realized prices. We experienced intermittent delays in fulfilling certain U.S. Trulicity orders during the second half of 2022. Actions to manage strong demand across our incretin portfolio, including measures to minimize existing patient impact in international markets, also affected volume in 2022.
Revenue of Verzenio increased 98 percent in the U.S., primarily driven by increased demand. Revenue outside the U.S. increased 61 percent, driven by increased demand, partially offset by lower realized prices primarily due to the impact of the NRDL formulary in China and the unfavorable impact of foreign exchange rates.
Revenue of Taltz increased 12 percent in the U.S., driven by increased demand, partially offset by lower realized prices. Revenue outside the U.S. increased 13 percent, driven by increased volume, partially offset by the unfavorable impact of foreign exchange rates and lower realized prices.
Revenue of Jardiance increased 48 percent in the U.S., primarily driven by increased demand. Revenue outside the U.S. increased 28 percent, primarily driven by increased demand, partially offset by the unfavorable impact of foreign exchange rates. See Note 4 to the consolidated financial statements for information regarding our collaboration with Boehringer Ingelheim involving Jardiance.
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Revenue of Humalog decreased 10 percent in the U.S., primarily driven by lower realized prices due to a list price reduction of insulin lispro injection and unfavorable segment mix, partially offset by changes to estimates for rebates and discounts in 2021. Revenue outside the U.S. decreased 23 percent, primarily driven by lower realized prices due to the impact of VBP in China and the unfavorable impact of foreign exchange rates. Due to the impact of competition and pricing pressure in the U.S. and certain international markets, we expect that lower revenue for Humalog due to realized price decline will continue over time. See "—Executive Overview—Other Matters—Patent Matters" for additional information.
Revenue of COVID-19 antibodies was $2.01 billion in the U.S. during the year ended December 31, 2022, primarily due to bebtelovimab supplied to the U.S. government. COVID-19 antibodies are not currently authorized for emergency use in the U.S. We do not currently expect significant further revenue attributable to the treatment of COVID-19.
Revenue of Alimta decreased 56 percent in the U.S., primarily driven by decreased demand due to the entry of multiple generics in the first half of 2022. Revenue outside the U.S. decreased 54 percent, primarily driven by decreased demand due to generic competition. Following the expiration of patent exclusivity for Alimta in Europe and Japan in June 2021, we have faced generic competition that has rapidly and severely eroded revenue from prior levels, and we expect such competition will continue to erode revenues from current levels in these markets. In addition, as a result of the entry of multiple generics in the U.S. following the expiration of patent and pediatric exclusivity in the first half of 2022, we began facing, and expect to continue to face, generic competition that has rapidly and severely eroded revenue from prior levels, and we expect will continue to erode revenue from current levels. See "—Executive Overview—Other Matters—Patent Matters" for additional information.
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Gross Margin, Costs, and Expenses
Gross margin as a percent of revenue was 76.8 percent in 2022, an increase of 2.6 percentage points compared with 2021, primarily driven by a net inventory impairment charge related to our COVID-19 antibodies recognized in 2021 and the unfavorable effect of foreign exchange rates on international inventories sold in 2021. Additionally, in 2022, favorable product mix, including the impact of lower sales of COVID-19 antibodies and Olumiant for the treatment of COVID-19, were offset by lower realized prices and increased expenses due to inflation and logistics costs.
Research and development expenses increased 4 percent to $7.19 billion in 2022, driven primarily by higher development expenses for late-stage assets, partially offset by lower development expenses for COVID-19 antibodies and the favorable impact of foreign exchange rates.
Marketing, selling, and administrative expenses remained relatively flat at $6.44 billion in 2022, as increased costs associated with launches of new products and indications were offset by the favorable impact of foreign exchange rates.
We have undertaken compensatory actions to improve retention and address wage inflation, which will increase compensation costs and impact our consolidated results of operations.
We recognized acquired IPR&D and development milestones of $908.5 million in 2022 that included the buy-out of substantially all future obligations that were contingent upon the occurrence of certain events linked to the success of our mutant-selective PI3kα inhibitor and a purchase of a Priority Review Voucher. We recognized acquired IPR&D and development milestones of $970.1 million in 2021 that included charges resulting from business development transactions with Foghorn, Rigel, and Precision. See Note 3 to the consolidated financial statements for additional information.
We recognized asset impairment, restructuring, and other special charges of $244.6 million in 2022, primarily related to an intangible asset impairment for GBA1 Gene Therapy (PR001) due to changes in estimated launch timing. We recognized asset impairment, restructuring, and other special charges of $316.1 million in 2021, primarily related to an impairment of a contract-based intangible asset from our acquisition of Loxo, an intangible asset impairment resulting from the sale of the rights to Qbrexza, as well as acquisition and integration costs associated with the acquisition of Prevail.
Other—net, (income) expense was expense of $320.9 million in 2022, primarily driven by net investment losses on equity securities. Other—net, (income) expense was expense of $201.6 million in 2021, primarily driven by a debt extinguishment loss of $405.2 million related to the repurchase of debt, partially offset by net investment gains on equity securities.
Our effective tax rate was 8.3 percent in 2022, reflecting the favorable tax impact of the implementation of a provision in the 2017 Tax Act that requires capitalization and amortization of research and development expenses for tax purposes starting in 2022, partially offset by the tax impact of the mix of earnings in higher tax jurisdictions. Our effective tax rate was 9.3 percent in 2021, reflecting the favorable tax impacts of acquired IPR&D and development milestone charges, net investment gains on equity securities, and a net discrete tax benefit.
Operating Results—2021
For a discussion of our results of operations pertaining to 2021 and 2020 see Item 7, "Management's Discussion and Analysis of Results of Operations and Financial Condition" in our Annual Report on Form 10-K for the year ended December 31, 2021.
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FINANCIAL CONDITION AND LIQUIDITY
We believe our available cash and cash equivalents, together with our ability to generate operating cash flow and our access to short-term and long-term borrowings, are sufficient to fund our existing and planned capital requirements, which include:
• working capital requirements, including related to employee payroll, clinical trials, manufacturing materials, and taxes;
• capital expenditures;
• share repurchases and dividends;
• repayment of outstanding short-term and long-term borrowings;
• contributions to our defined benefit pension and retiree health benefit plans;
• milestone and royalty payments; and
• potential business development activities, including acquisitions, collaborations, investments, and licensing arrangements.
Our management continuously evaluates our liquidity and capital resources, including our access to external capital, to ensure we can adequately and efficiently finance our capital requirements. As of December 31, 2022, our material cash requirements primarily related to purchases of goods and services to produce our products and conduct our operations, capital expenditures, dividends, repayment of outstanding borrowings, milestone and royalty payments, the remaining obligations for the one-time repatriation transition tax (also known as the 'Toll Tax') from the 2017 Tax Act, leases, unfunded commitments to invest in venture capital funds, and retirement benefits (see Notes 11, 4, 14, 10, 7, and 15 to the consolidated financial statements). We anticipate our cash requirements related to ordinary course purchases of goods and services will be consistent with our past levels relative to revenues.
In 2022, we committed to invest over several years more than $2 billion in two new facilities in Lebanon, Indiana to manufacture existing and future products, more than $1 billion in a new facility in Concord, North Carolina to manufacture parenteral (injectable) products and devices, and more than 400 million euro in a new facility in Limerick, Ireland to expand our manufacturing network for biologic active ingredients. In early 2023, we committed to invest an additional $450 million to expand manufacturing capacity at Research Triangle Park facility in Durham, North Carolina for additional parenteral filling, device assembly, and packaging capacity. These investments, and other capital investments that support our operations, will result in higher capital expenditures for the next several years.
The 2017 Tax Act contained a provision that requires us to capitalize and amortize research and development expenses for tax purposes starting in 2022, whereas previously we could fully deduct these expenses in the year incurred. The implementation of this provision increased our cash payments of income taxes by approximately $1.20 billion in 2022. While the implementation of this provision will continue to increase our cash payments of income taxes, the increase will moderately decrease from 2022 levels over the five-year amortization period. See "—Executive Overview—Other Matters—Tax Matters" for additional information.
Cash and cash equivalents decreased to $2.07 billion as of December 31, 2022, compared with $3.82 billion at December 31, 2021. Net cash provided by operating activities was $7.08 billion in 2022, compared with $7.26 billion in 2021. Refer to the consolidated statements of cash flows for additional information on the significant sources and uses of cash for the years ended December 31, 2022 and 2021.
In addition to our cash and cash equivalents, we held total investments of $3.05 billion and $3.30 billion as of December 31, 2022 and 2021, respectively. See Note 7 to the consolidated financial statements for additional information.
In December 2022, we acquired all shares of Akouos, Inc. (Akouos) for a purchase price that included $12.50 per share in cash (or an aggregate of $327.2 million, net of cash acquired) plus one non-tradable contingent value right (CVR) per share. The CVR entitles Akouos shareholders up to an additional $3.00 per share in cash (or an aggregate of approximately $122 million) payable, subject to certain terms and conditions, upon the achievement of certain specified milestones. This acquisition was funded through cash on hand. See Note 3 to the consolidated financial statements for additional information.
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As of December 31, 2022, total debt was $16.24 billion, a decrease of $646.1 million compared with $16.88 billion at December 31, 2021. See Note 11 to the consolidated financial statements for additional information.
As of December 31, 2022, we had a total of $7.33 billion of unused committed bank credit facilities, $7.00 billion of which is available to support our commercial paper program. See Note 11 to the consolidated financial statements for additional information. We believe that amounts accessible through existing commercial paper markets should be adequate to fund short-term borrowing needs.
Dividends of $3.92 per share and $3.40 per share were paid in 2022 and 2021, respectively. The quarterly dividend was increased to $1.13 per share effective for the dividend to be paid in the first quarter of 2023, resulting in an indicated annual rate for 2023 of $4.52 per share.
Capital expenditures were $1.85 billion during 2022, compared to $1.31 billion in 2021.
In 2022, we repurchased $1.50 billion of shares under our $5.00 billion share repurchase program authorized in May 2021. As of December 31, 2022, we had $3.25 billion remaining under this program. See Note 13 to the consolidated financial statements for additional information.
See "—Executive Overview—Other Matters—Patent Matters" for information regarding recent losses of patent protection.
Both domestically and abroad, we continue to monitor the potential impacts of the economic environment; the creditworthiness of our wholesalers and other customers, including foreign government-backed agencies and suppliers; the uncertain impact of healthcare legislation; and various international government funding levels.
In the normal course of business, our operations are exposed to fluctuations in interest rates, currency values, and fair values of equity securities. These fluctuations impact the costs of financing, investing, and operating. We seek to address a portion of these risks through a controlled program of risk management that includes the use of derivative financial instruments. The objective of this risk management program is to limit the impact on earnings of fluctuations in interest and currency exchange rates. All derivative activities are for purposes other than trading.
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. As of December 31, 2022, substantially all of our total long-term debt carries interest at a fixed rate. We have converted approximately 10 percent of our long-term fixed-rate notes to floating rates through the use of interest rate swaps. Based on our overall interest rate exposure at December 31, 2022 and 2021, 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, 2022 and 2021, 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, Japanese yen, and Chinese yuan. We face foreign currency exchange exposures when we enter into transactions arising from subsidiary trade and loan payables and receivables denominated in foreign currencies. 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 or option derivative contracts to reduce the effect of fluctuating currency exchange rates (primarily the euro, the Japanese yen, and Chinese yuan). Our corporate risk-management policy outlines the minimum and maximum hedge coverage of such exposures. Gains and losses on these derivative contracts offset, in part, the impact of currency fluctuations on the existing assets and liabilities. We periodically analyze the fair values of the outstanding foreign currency derivative contracts to determine their sensitivity to changes in foreign exchange rates. A hypothetical 10 percent change in exchange rates (primarily against the U.S. dollar) applied to the fair values of our outstanding foreign currency derivative contracts as of December 31, 2022 and 2021, would not have a material impact on earnings, cash flows, or financial position over a one-year period. This sensitivity analysis does not consider the impact that hypothetical changes in exchange rates would have on the underlying foreign currency denominated transactions.
Our fair value risk exposure relates primarily to our public equity investments and to equity investments that do not have readily determinable fair values. As of December 31, 2022 and 2021, our carrying values of these investments were $1.16 billion and $1.83 billion, respectively. A hypothetical 20 percent change in fair value of the equity instruments would have impacted other-net, (income) expense by $232.4 million and $365.6 million as of December 31, 2022 and 2021, respectively.
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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 potential products 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 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 product in the event that regulatory approval for marketing is obtained.
Individually, these arrangements are generally not material in any one annual reporting period. However, if milestones for multiple products covered by these arrangements were reached in the same reporting period, the aggregate expense or aggregate milestone payments made could be material to our results of operations or cash flows, respectively, in that period. See Note 4 to the consolidated financial statements for additional information. 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 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.
As we expand our manufacturing capacity in order to meet existing and expected demand of our incretin products, we have entered, and expect to continue to enter, into various agreements for contract manufacturing and for supply of materials. The executed agreements could, under certain circumstances, require us to pay up to approximately $4.5 billion if we do not purchase specified amounts of goods or services over the durations of the agreements, which generally range from 2 to 8 years.
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APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
In preparing our financial statements in accordance with accounting principles generally accepted in the U.S., we must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. Some of those judgments can be subjective and complex, and consequently actual results could differ from those estimates. For any given individual estimate or assumption we make, it is possible that other people applying reasonable judgment to the same facts and circumstances could develop different estimates. We believe that, given current facts and circumstances, it is unlikely that applying any such other reasonable judgment would cause a material adverse effect on our consolidated results of operations, financial position, or liquidity for the periods presented in this report. Our most critical accounting estimates have been discussed with our audit committee and are described below.
Revenue Recognition and Sales Return, Rebate, and Discount Accruals
Background and Uncertainties
We recognize revenue primarily from two different types of contracts, product sales to customers (net product revenue) and collaborations and other arrangements. For product sales to customers, provisions for returns, rebates and discounts are established in the same period the related product sales are recognized. To determine the appropriate transaction price for our product sales at the time we recognize a sale to a direct customer, we estimate any rebates or discounts that ultimately will be due to the direct customer and other customers in the distribution chain under the terms of our contracts. Significant judgments are required in making these estimates. The largest of our sales rebate and discount amounts include rebates associated with sales covered by managed care, Medicare, Medicaid, and chargeback programs, as well as reductions in revenue related to our patient assistance programs, in the U.S. In determining the appropriate accrual amount, we consider our historical rebate payments for these programs, as well as patient assistance program costs, by product as a percentage of our historical sales as well as any significant changes in sales trends (e.g., patent expiries and product launches), an evaluation of the current contracts for these programs, the percentage of our products that are sold via these programs, and our product pricing.
Refer to Note 2 to the consolidated financial statements for further information on revenue recognition and sales return, rebate, and discount accruals.
Revenue recognized from collaborations and other arrangements will include our share of profits from the collaboration, as well as royalties, upfront and milestone payments we receive under these types of contracts.
Financial Statement Impact
We believe that our accruals for sales returns, rebates, and discounts are reasonable and appropriate based on current facts and circumstances. Our rebate and discount liabilities are included in sales rebates and discounts on our consolidated balance sheet. Our sales return liability is included in other current liabilities and other noncurrent liabilities on our consolidated balance sheet. As of December 31, 2022, a 5 percent change in our consolidated sales return, rebate, and discount liability would result in a change in revenue of approximately $464 million.
The portion of our consolidated sales return, rebate, and discount liability resulting from sales of our products in the U.S. was approximately 90 percent as of December 31, 2022 and 2021.
The following represents a roll-forward of our most significant U.S. sales return, rebate, and discount liability balances, including managed care, Medicare, Medicaid, chargeback, and patient assistance programs:
(Dollars in millions) 2022 2021
Sales return, rebate, and discount liabilities, beginning of year $ 6,161.6 $ 5,400.0
Reduction of net sales (1)
28,398.4 20,106.3
Cash payments (26,345.9) (19,344.7)
Sales return, rebate, and discount liabilities, end of year $ 8,214.1 $ 6,161.6
(1) Adjustments of the estimates for these returns, rebates, and discounts to actual results were less than 1 percent of consolidated revenue for each of the years presented.
Increase in reduction of net sales in 2022 was primarily driven by our incretin products due to increase in our patient assistance programs and in volume of rebates for managed care, Medicare and Medicaid programs.
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Litigation Liabilities and Other Contingencies
Background and Uncertainties
Litigation liabilities and other contingencies are, by their nature, uncertain and based upon complex judgments and probabilities. The factors we consider in developing our litigation liability reserves and other contingent liability amounts include the merits and jurisdiction of the litigation, the nature and the number of other similar current and past matters, the nature of the product and the current assessment of the science subject to the litigation, as applicable, and the likelihood of settlement and current state of settlement discussions, if any. In addition, we accrue for certain liability claims incurred, but not filed, to the extent we can formulate a reasonable estimate of their costs based primarily on historical claims experience and data regarding product usage.
We also consider the insurance coverage we have to diminish the exposure for periods covered by insurance. In assessing our insurance coverage, we consider the policy coverage limits and exclusions, the potential for denial of coverage by the insurance company, the financial condition of the insurers, and the possibility of and length of time for collection. Due to a very restrictive market for litigation liability insurance, we are self-insured for litigation liability losses for all our currently marketed products. In addition to insurance coverage, we consider any third-party indemnification to which we are entitled or under which we are obligated. With respect to our third-party indemnification rights, these considerations include the nature of the indemnification, the financial condition of the indemnifying party, and the possibility of and length of time for collection.
The litigation accruals and environmental liabilities and the related estimated insurance recoverables have been reflected on a gross basis as liabilities and assets, respectively, on our consolidated balance sheets.
Acquisitions
Background and Uncertainties
To determine whether acquisitions or licensing transactions should be accounted for as a business combination or as an asset acquisition, we make certain judgments, which include assessing whether the acquired set of activities and assets would meet the definition of a business under the relevant accounting rules.
If the acquired set of activities and assets meets the definition of a business, assets acquired and liabilities assumed are required to be recorded at their respective fair values on our consolidated balance sheet as of the acquisition date. The excess of the purchase price over the fair value of the acquired net assets, where applicable, is recorded as goodwill. If the acquired set of activities and assets does not meet the definition of a business, the transaction is recorded as an acquisition of assets and, therefore, any acquired IPR&D that does not have an alternative future use is charged to acquired IPR&D and development milestones on our consolidated statement of operations at the acquisition date, and goodwill is not recorded. See Note 3 to the consolidated financial statements for additional information.
The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as estimated asset lives, can materially affect our consolidated results of operations. The fair values of intangible assets, including acquired IPR&D, are determined using information available near the acquisition date based on estimates and assumptions that are deemed reasonable by management. Significant estimates and assumptions include, but are not limited to, probability of technical success, revenue projections, and discount rate. Depending on the facts and circumstances, we may deem it necessary to engage an independent valuation expert to assist in valuing significant assets and liabilities.
The fair values of identifiable intangible assets are primarily determined using an "income method," as described in Note 8 to the consolidated financial statements.
The fair value of any contingent consideration liability that results from a business combination is primarily determined using a discounted cash flow analysis, as described in Note 7 to the consolidated financial statements. Estimating the fair value of contingent consideration requires the use of significant estimates and judgments, including, but not limited to, probability of technical success and the discount rate.
Financial Statement Impact
As of December 31, 2022, a 5 percent change in the contingent consideration liabilities would result in a change in income before income taxes of $5.5 million.
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Impairment of Indefinite-Lived and Long-Lived Assets
Background and Uncertainties
We review the carrying value of long-lived assets (both intangible and tangible) for potential impairment on a periodic basis and whenever events or changes in circumstances indicate the carrying value of an asset (or asset group) may not be recoverable. We identify impairment by comparing the projected undiscounted cash flows to be generated by the asset (or asset group) to its carrying value. If an impairment is identified, a loss is recorded equal to the excess of the asset's net book value over its fair value, and the cost basis is adjusted.
Goodwill and indefinite-lived intangible assets are reviewed for impairment at least annually, or more frequently if impairment indicators are present, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If we conclude it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the intangible asset to its carrying value is performed to determine the amount of any impairment.
Several methods may be used to determine the estimated fair value of acquired IPR&D, all of which require multiple assumptions. We utilize the "income method," as described in Note 8 to the consolidated financial statements.
For acquired IPR&D assets, the risk of failure has been factored into the fair value measure and there can be no certainty that these assets ultimately will yield a successful product, as discussed previously in "—Executive Overview—Late-Stage Pipeline." The nature of the pharmaceutical business is high-risk and requires that we invest in a large number of projects to maintain a successful portfolio of approved products. As such, it is likely that some acquired IPR&D assets will become impaired in the future.
Estimates of future cash flows, based on what we believe to be reasonable and supportable assumptions and projections, require management's judgment. Actual results could vary materially from these estimates.
Retirement Benefits Assumptions
Background and Uncertainties
Defined benefit pension plan and retiree health benefit plan costs include assumptions for the discount rate, expected return on plan assets, and retirement age. These assumptions have a significant effect on the amounts reported. In addition to the analysis below, see Note 15 to the consolidated financial statements for additional information regarding our retirement benefits.
Annually, we evaluate the discount rate and the expected return on plan assets in our defined benefit pension and retiree health benefit plans. We use an actuarially determined, plan-specific yield curve of high quality, fixed income debt instruments to determine the discount rates. In evaluating the expected return on plan assets, we consider many factors, with a primary analysis of current and projected market conditions, asset returns and asset allocations (approximately 70 percent of which are growth investments), and the views of leading financial advisers and economists. We may also review our historical assumptions compared with actual results, as well as the discount rates and expected return on plan assets of other companies, where applicable. In evaluating our expected retirement age assumption, we consider the retirement ages of our past employees eligible for pension and medical benefits together with our expectations of future retirement ages.
Annually, we determine the fair value of the plan assets in our defined benefit pension and retiree health benefit plans. Approximately 50 percent of our plan assets are in hedge funds and private equity-like investment funds (collectively, alternative assets). We value these alternative investments using significant unobservable inputs or using the net asset value reported by the counterparty, adjusted as necessary. Inputs include underlying net asset values, discounted cash flows valuations, comparable market valuations, and adjustments for currency, credit, liquidity and other risks.
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Financial Statement Impact
If the 2022 discount rate for the U.S. defined benefit pension and retiree health benefit plans (U.S. plans) were to change by a quarter percentage point, income before income taxes would change by $23.8 million. If the 2022 expected return on plan assets for U.S. plans were to change by a quarter percentage point, income before income taxes would change by $33.5 million. If our assumption regarding the 2022 expected age of future retirees for U.S. plans were adjusted by one year, our income before income taxes would be affected by $46.3 million. The U.S. plans, including Puerto Rico, represent approximately 85 percent of each of the total projected benefit obligation and total plan assets at December 31, 2022.
Adjustments to the fair value of plan assets are not recognized in pension and retiree health benefit expense in the year that the adjustments occur. Such changes are deferred, along with other actuarial gains and losses, and are amortized into expense over the expected remaining service life of employees.
Income Taxes
Background and Uncertainties
We file tax returns based upon our interpretation of tax laws and regulations, and we record estimates in our financial statements based upon these interpretations at the applicable tax rates in the jurisdictions in which we operate. Our tax returns are routinely subject to examination by taxing authorities, which could result in future tax, interest, and penalty assessments. Inherent uncertainties also exist in estimates of many tax positions due to the complexity of tax laws. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate resolution. The amount of unrecognized tax benefits is adjusted for changes in facts and circumstances such as changes to existing tax law, the issuance of regulations by taxing authorities, new information obtained during a tax examination, or resolution of a tax examination. We believe our estimates for uncertain tax positions are both appropriate and sufficient to pay assessments that may result from examinations of our tax returns. We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense.
We have recorded valuation allowances against certain of our deferred tax assets, primarily those that have been generated from net operating losses, tax credits, and other tax carryforwards and carrybacks in certain taxing jurisdictions. In evaluating whether we would more likely than not recover these deferred tax assets, we have not assumed future taxable income in the jurisdictions associated with these carryforwards where history does not support such an assumption. Implementation of tax planning strategies to recover these deferred tax assets or to generate future taxable income in these jurisdictions could lead to the reversal of all or a portion of these valuation allowances and a reduction of income tax expense.
Financial Statement Impact
As of December 31, 2022, a 5 percent change in the amount of uncertain tax positions and the valuation allowance would result in a change in net income of $85.0 million and $38.8 million, respectively.
LEGAL AND REGULATORY MATTERS
Information relating to certain legal proceedings can be found in Note 16 to the consolidated financial statements and is incorporated here by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
You can find quantitative and qualitative disclosures about market risk (e.g. , interest rate risk) at Item 7, "Management's Discussion and Analysis - Financial Condition and Liquidity." That information is incorporated by reference herein.
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