Pfizer 2005 Annual Report Download - page 33

32 2005 Financial Report
Financial Review
Pfizer Inc and Subsidiary Companies
This report includes discussion of certain clinical studies relating
to various in-line products and/or product candidates. These
studies typically are part of a larger body of clinical data relating
to such products or product candidates, and the discussion herein
should be considered in the context of the larger body of data.
Financial Risk Management
The overall objective of our financial risk management program
is to seek a reduction in the potential negative earnings effects
from changes in foreign exchange and interest rates arising in our
business activities. We manage these financial exposures through
operational means and by using various financial instruments.
These practices may change as economic conditions change.
Foreign Exchange Risk—A significant portion of our revenues and
earnings are exposed to changes in foreign exchange rates. We
seek to manage our foreign exchange risk in part through
operational means, including managing same currency revenues
in relation to same currency costs, and same currency assets in
relation to same currency liabilities.
Foreign exchange risk is also managed through the use of foreign
currency forward-exchange contracts. These contracts are used to
offset the potential earnings effects from mostly intercompany
short-term foreign currency assets and liabilities that arise from
operations. We also use foreign currency forward-exchange
contracts and foreign currency swaps to hedge the potential
earnings effects from short and long-term foreign currency
investments and loans and intercompany loans.
Foreign currency put options are sometimes purchased to reduce
a portion of the potential negative effects on earnings related to
certain of our significant anticipated intercompany inventory
purchases for up to two years. In early 2003, these purchased
options hedged Japanese yen versus the U.S. dollar.
In addition, under certain market conditions, we protect against
possible declines in the reported net assets of our Japanese yen
and certain euro functional currency subsidiaries.
Our financial instrument holdings at year-end were analyzed to
determine their sensitivity to foreign exchange rate changes.
The fair values of these instruments were determined as follows:
•foreign currency forward-exchange contracts and currency
swaps-net present values
•foreign receivables, payables, debt and loans-changes in
exchange rates
In this sensitivity analysis, we assumed that the change in one
currency’s rate relative to the U.S. dollar would not have an
effect on other currencies’ rates relative to the U.S. dollar. All other
factors were held constant.
If there were an adverse change in foreign exchange rates of 10%,
the expected effect on net income related to our financial
instruments would be immaterial. For additional details, see Notes
to Consolidated Financial Statements—Note 9D, Financial
Instruments:Derivative Financial Instruments and Hedging Activities.
Interest Rate Risk—Our U.S. dollar interest-bearing investments,
loans and borrowings are subject to interest rate risk. We are also
subject to interest rate risk on euro investments and short-term
currency swaps, and on Japanese yen short and long-term
borrowings and short-term currency swaps. We invest and borrow
primarily on a short-term or variable-rate basis. From time to
time, depending on market conditions, we will fix interest rates
either through entering into fixed rate investments and
borrowings or through the use of derivative financial instruments
such as interest rate swaps.
Our financial instrument holdings at year-end were analyzed to
determine their sensitivity to interest rate changes. The fair values
of these instruments were determined by net present values.
In this sensitivity analysis, we used the same change in interest rate
for all maturities. All other factors were held constant.
If there were an adverse change in interest rates of 10%, the
expected effect on net income related to our financial instruments
would be immaterial.
Legal Proceedings and Contingencies
We and certain of our subsidiaries are involved in various patent,
product liability, consumer, commercial, securities, environmental
and tax litigations and claims; government investigations; and
other legal proceedings that arise from time to time in the
ordinary course of our business. We do not believe any of them
will have a material adverse effect on our financial position.
We record accruals for such contingencies to the extent that we
conclude their occurrence is probable and the related damages
are estimable. If a range of liability is probable and estimable and
some amount within the range appears to be a better estimate
than any other amount within the range, we accrue that amount.
If a range of liability is probable and estimable and no amount
within the range appears to be a better estimate than any other
amount within the range, we accrue the minimum of such
probable range. Many claims involve highly complex issues relating
to causation, label warnings, scientific evidence, actual damages
and other matters. Often these issues are subject to substantial
uncertainties and, therefore, the probability of loss and an
estimation of damages are difficult to ascertain. Consequently, we
cannot reasonably estimate the maximum potential exposure or
the range of possible loss in excess of amounts accrued for these
contingencies. These assessments can involve a series of complex
judgments about future events and can rely heavily on estimates
and assumptions (see Notes to Consolidated Financial
Statements—Note 1B, Significant Accounting Policies:Estimates
and Assumptions). Our assessments are based on estimates and
assumptions that have been deemed reasonable by management.
Litigation is inherently unpredictable, and excessive verdicts do
occur. Although we believe we have substantial defenses in these
matters, we could in the future incur judgments or enter into
settlements of claims that could have a material adverse effect on
our results of operations in any particular period.
Patent claims include challenges to the coverage and/or validity
of our patents on various products or processes. Although we
believe we have substantial defenses to these challenges with
respect to all our material patents, there can be no assurance as
to the outcome of these matters, and a loss in any of these cases
could result in a loss of patent protection for the drug at issue,
which could lead to a significant loss of sales of that drug and
could materially affect future results of operations.