Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, our audited Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements and other disclosures included in this Annual Report on Form 10-K (including the disclosures under Part I, Item 1A, “Risk Factors”). Our Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles and are presented in U.S. dollars.

Management Overview

Gilead Sciences, Inc. (Gilead, we, our or us), incorporated in Delaware on June 22, 1987, is a research-based biopharmaceutical company that discovers, develops and commercializes innovative medicines in areas of unmet medical need. With each new discovery and investigational drug candidate, we strive to transform and simplify care for people with life-threatening illnesses around the world. We have operations in more than 35 countries worldwide, with headquarters in Foster City, California. Gilead’s primary areas of focus include HIV/AIDS, liver diseases, hematology/oncology and inflammation/respiratory diseases. We seek to add to our existing portfolio of products through our internal discovery and clinical development programs, product acquisition, in-licensing and strategic collaborations.

Our portfolio of marketed products includes AmBisome®, Atripla®, Biktarvy®, Cayston®, Complera®/Eviplera®, Descovy®, Emtriva®, Epclusa®, Genvoya®, Harvoni®, Hepsera®, Letairis®, Odefsey®, Ranexa®, Sovaldi®, Stribild®, Truvada®, Tybost®, Vemlidy®, Viread®, Vosevi®, Yescarta® and Zydelig®. We also sell and distribute certain products through our corporate partners under collaborative agreements.

2018 Business Highlights

2018 was marked by operational excellence and transition as we positioned ourselves for the future growth of our business. We continued to develop and deliver innovative medicines to help people with life-threatening illnesses around the world. Highlights of our 2018 performance include:

•

HIV: We achieved record sales of our HIV products in 2018, with HIV product revenues increasing by 19% in the United States and 12% worldwide compared to 2017. This growth was driven by the successful launch of Biktarvy and the continued strong uptake of our single tablet regimens containing tenofovir alafenamide (TAF) for the treatment of HIV infection as well as Truvada for a pre-exposure prophylaxis (PrEP) indication for HIV prevention. Biktarvy, a once-daily single tablet regimen containing bictegravir, emtricitabine (FTC) and TAF for the treatment of HIV infection in adults, was approved by the U.S. Food and Drug Administration (FDA) in February and by the European Commission in June.

•

Liver Diseases: Our revenues from our chronic hepatitis C virus (HCV) products became more predictable in 2018. Because we wanted to introduce a lower-priced alternative to our HCV products without significant disruption to the healthcare system and our business, we authorized the launch of generic versions of Epclusa and Harvoni in the United States starting in January 2019 through our separate subsidiary, Asegua Therapeutics LLC (Asegua). We also continued to advance our clinical trials for the treatment of chronic hepatitis B virus (HBV) and nonalcoholic steatohepatitis (NASH), including completing enrollment of Phase 3 clinical trials of NASH.

•

Cell Therapy and Immuno-Oncology: We advanced our pipeline of cancer therapies and positioned ourselves as a leader in cell therapy. Yescarta was approved by the European Commission in August for the treatment of relapsed or refractory diffuse large B-cell lymphoma (DLBCL) and primary mediastinal large B-cell lymphoma (PMBCL) after two or more lines of systemic therapy. We certified additional centers in the United States and Europe to provide treatment for Yescarta. In order to advance and accelerate research and development efforts in cell therapy and immuno-oncology, during the year, we entered into key strategic collaborations with the National Cancer Institute, Pfizer, Inc. (Pfizer), Sangamo Therapeutics, Inc. (Sangamo), Gadeta B.V. (Gadeta), HiFiBiO Therapeutics (HiFiBiO), Tango Therapeutics (Tango) and Agenus Inc. (Agenus).

•

Inflammation: We continued to advance our pipeline of novel investigational agents for inflammatory diseases, including announcing positive data on filgotinib in ongoing Phase 2 and 3 clinical trials. We also entered into a strategic collaboration with Verily Life Sciences LLC, an Alphabet company (Verily), using Verily’s Immunoscape platform to identify and better understand the immunological basis of inflammatory diseases.

During the year, we continued to invest in and advance our research and development pipeline across our therapeutic areas. At the end of 2018, our research and development pipeline included 119 active clinical studies, of which 41 were Phase 3 clinical trials. Additionally, we completed 26 collaborations, partnerships and strategic investments in 2018, which reflects our commitment to enabling our access to new technologies and drug candidates with the potential to evolve care for people with life-threatening illnesses. Our investments in research and development reflect our commitment to expanding our pipeline across a range of diseases to address areas of significant unmet medical need and positioning ourselves for the long-term growth of our business.

Recent key announcements include:

HIV and Liver Diseases Programs

•	FDA and European Commission granted marketing authorization for Biktarvy for the treatment of HIV-1 infection.

•	FDA approved Truvada - in combination with safer sex practices - to reduce the risk of sexually acquired HIV-1 in at-risk adolescents.

•	China National Drug Administration (CDA, succeeded by China National Medical Products Administration (NMPA)) approved Genvoya in China for the treatment of HIV-1 infection.

•	NMPA approved Descovy in China for the treatment of HIV-1 infection in adults and adolescents.

•	We entered into an agreement with Japan Tobacco Inc. (Japan Tobacco) to expand our rights to develop and commercialize elvitegravir to include Japan and to acquire from Japan Tobacco the rights to market and distribute certain products in our HIV portfolio in Japan effective January 1, 2019.

•	We entered into a research collaboration and license agreement with Hookipa Biotech AG (Hookipa) that grants us exclusive rights to Hookipa’s TheraT® and Vaxwave® arenavirus vector-based immunization technologies for chronic HBV infection and HIV infection.

•	We announced plans to launch authorized generic versions of Epclusa and Harvoni in the United States through our separate subsidiary, Asegua.

•	NMPA approved Harvoni in China for the treatment of chronic HCV infection with genotype 1-6 in adults and adolescents aged 12 to 18 years.

•	CDA approved Epclusa in China for the treatment of adults with genotype 1-6 chronic HCV infection. The CDA also approved Epclusa in combination with ribavirin for adults with chronic HCV infection and decompensated cirrhosis.

•	NMPA approved Vemlidy in China for the treatment of chronic HBV infection in adults and adolescents.

•	We entered into a strategic collaboration with Precision BioSciences (Precision) to develop therapies targeting the in vivo elimination of chronic HBV infection with Precision’s proprietary genome editing platform, ARCUS.

•

We announced that STELLAR-4, a Phase 3, randomized, double-blind, placebo-controlled study evaluating the safety and efficacy of selonsertib, an investigational, once-daily, oral inhibitor of apoptosis signal-regulating kinase 1 (ASK1), in patients with compensated cirrhosis (F4) due to NASH, did not meet the pre-specified week 48 primary endpoint of a ≥ 1-stage histologic improvement in fibrosis without worsening of NASH.

Oncology and Cell Therapy Programs

•	We entered into an immuno-oncology partnership with Agenus focused on the development and commercialization of up to five novel immuno-oncology therapies.

•	We entered into a global strategic collaboration with Tango to discover, develop and commercialize a pipeline of targeted immuno-oncology treatments for patients with cancer.

•	European Commission granted marketing authorization for Yescarta as a treatment for adult patients with relapsed or refractory DLBCL and PMBCL after two or more lines of systemic therapy.

•	We announced new worldwide facilities to advance manufacturing of cell therapies for people with cancer.

•	We entered into a research collaboration with Gadeta to advance gamma delta T cell receptor technology for solid tumors. This collaboration adds an additional new platform to our current capabilities in research and cell manufacturing.

•	We entered into a research collaboration and license agreement with HiFiBiO to develop technology supporting the discovery of neoantigen-reactive T cell receptors for the potential treatment of various cancers, including solid tumors.

•	We entered into a license agreement with Trianni, Inc. (Trianni) that grants us the use of the Trianni transgenic human monoclonal antibody discovery platform to support our drug discovery efforts.

•	We announced a new cooperative research and development agreement with the National Cancer Institute to develop adoptive cell therapies targeting patient-specific tumor neoantigens.

•	We entered into a worldwide collaboration with Sangamo using Sangamo’s zinc finger nuclease technology platform for the development of next-generation ex vivo cell therapies in oncology.

•	We entered into a clinical trial collaboration with Pfizer to evaluate the safety and efficacy of the investigational combination of Yescarta and Pfizer’s utomilumab, a fully humanized 4-1BB agonist monoclonal antibody, in patients with refractory large B-cell lymphoma.

Inflammation Programs

•	We entered into a strategic collaboration with Scholar Rock Holding Corporation to discover and develop highly specific inhibitors of transforming growth factor beta activation for the treatment of fibrotic diseases.

•	We entered into a scientific collaboration with Verily, using Verily’s Immunoscape platform to identify and better understand the immunological basis of three common and serious inflammatory diseases: rheumatoid arthritis, inflammatory bowel disease and lupus-related diseases.

Transition

•

Following 28 years of service, John F. Milligan, Ph.D., stepped down from his role as President and Chief Executive Officer (CEO) effective December 31, 2018. Our Board announced the selection of Daniel O’Day to be our new Chairman and CEO effective March 1, 2019. Mr. O’Day brings more than 30 years of executive management, creative leadership and operational excellence. Most recently, Mr. O’Day served as the CEO of Roche Pharmaceuticals, the pharma division of Roche Group. We had other leadership transitions throughout the year resulting from planned successions and normal industry turnover.

2018 Financial Highlights

Total revenues decreased to $22.1 billion and total product sales decreased to $21.7 billion in 2018, compared to $26.1 billion and $25.7 billion in 2017, respectively, primarily due to lower sales of our HCV products, partially offset by higher sales of our HIV products. In the United States, product sales were $16.2 billion in 2018, compared to $18.1 billion in 2017. In Europe, product sales were $3.7 billion in 2018, compared to $5.0 billion in 2017. Product sales in other international locations were $1.8 billion in 2018, compared to $2.6 billion in 2017.

Cost of goods sold increased to $4.9 billion in 2018, compared to $4.4 billion in 2017, primarily due to reserves for excess raw material inventory, and higher amortization related to intangible assets acquired in connection with our acquisition of Kite Pharma, Inc. (Kite). In 2018, inventory reserves of $440 million were recorded for excess raw materials primarily due to a sustained decrease in demand for Harvoni as a result of a shift in the market from Harvoni to Epclusa.

Research and development (R&D) expenses increased to $5.0 billion in 2018, compared to $3.7 billion in 2017, primarily due to an $820 million impairment charge related to in-process R&D (IPR&D) for the KITE-585 program (an anti-BCMA being evaluated for the treatment of multiple myeloma), an increase in up-front collaboration expenses to further enhance our pipeline, a full year of investments to support the growth of our business following the acquisition of Kite and higher stock-based compensation expenses associated with the acquisition of Kite.

Selling, general and administrative (SG&A) expenses increased to $4.1 billion for 2018, compared to $3.9 billion in 2017, primarily due to a full year of investments to support the growth of our business following the acquisition of Kite, partially offset by lower acquisition-related costs associated with the acquisition of Kite and lower branded prescription drug (BPD) fees.

Net income attributable to Gilead was $5.5 billion or $4.17 per diluted share in 2018, compared to $4.6 billion or $3.51 per diluted share in 2017. The increase was primarily due to a $5.5 billion charge to income tax expense related to the enactment of the Tax Cuts and Jobs Act (Tax Reform) recorded in 2017 and higher HIV product sales in 2018, partially offset by lower HCV product sales and higher operating expenses associated with advancement of our pipeline and investments to support the growth of our business following the acquisition of Kite in 2018.

As of December 31, 2018, we had $31.5 billion of cash, cash equivalents and marketable debt securities compared to $36.7 billion as of December 31, 2017. During 2018, we generated $8.4 billion in operating cash flow, repaid $6.3 billion of principal amount of debt, paid cash dividends of $3.0 billion and repurchased a total of 40 million shares for $2.9 billion through open market transactions.

Outlook 2019

In 2019, we expect to continue to maintain our strong focus on operational excellence and financial discipline. From an R&D perspective, we expect to continue to invest in new and ongoing clinical studies that support both our existing products and product candidates. We expect data read-outs in 2019 including selonsertib or STELLAR-3 for the treatment of NASH, filgotinib for the treatment of rheumatoid arthritis, and Descovy for PrEP indication. In order to further augment our product pipeline, we continue to pursue opportunities for collaborations, partnerships and strategic investments that fit into our long term strategic plan.

From a commercial perspective, we expect to continue to promote Biktarvy and other HIV regimens containing TAF. In addition, we believe Truvada for PrEP will continue to be an integral part of our growth in HIV in the United States as communities continue to embrace the public health benefits of prevention. In HCV, we expect a decline in product sales as a result of lower patient starts across all markets and competitive factors, although at a lower rate than in 2018. We believe the launch of authorized generic versions of Epclusa and Harvoni in the United States through our separate subsidiary, Asegua, will increase access to the medications for patients at lower prices. In cell therapy, we expect to continue to promote Yescarta in the United States and support its launch in Europe.

We will continue to help promote patient access to our products around the world, including through our Gilead Access Program, under which more than 11 million people receive our HIV medicines in low- and middle-income countries.

Our progress on all of these initiatives is subject to a number of uncertainties, including, but not limited to, the possibility of unfavorable results from new and ongoing clinical trials (for example, we recently announced that STELLAR-4, a Phase 3 study evaluating the safety and efficacy of selonsertib in patients with compensated cirrhosis due to NASH, did not meet the pre-specified week 48 primary endpoint); the continuation of an uncertain global macroeconomic environment; additional pricing pressures from payers and competitors; slower than anticipated growth in our HIV products; an increase in discounts, chargebacks and rebates due to ongoing contracts and future negotiations with commercial and government payers; market share and price erosion caused by the introduction of generic versions of products containing tenofovir disoproxil fumarate (TDF) outside the United States and Viread, Letairis and Ranexa in the United States; inaccuracies in our HCV patient start estimates; potential amendments to the Affordable Care Act or other government action that could have the effect of lowering prices; a larger-than-anticipated shift in payer mix to more highly discounted payer segment; and volatility in foreign currency exchange rates.

2018 Results of Operations

Total Revenues

The following table summarizes the period-over-period changes in our product sales and royalty, contract and other revenues:

(In millions, except percentages)		2018				Change			2017				Change			2016
Revenues:
Product sales		$	21,677			(16	)%		$	25,662			(14	)%		$	29,953
Royalty, contract and other revenues		450				1	%		445				2	%		437
Total revenues		$	22,127			(15	)%		$	26,107			(14	)%		$	30,390

On January 1, 2018, we adopted Accounting Standards Update No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. As such, results for 2018 are presented under Topic 606, while the information for prior periods has not been adjusted and continues to be reported in accordance with our historical accounting under Topic 605 “Revenue Recognition” (Topic 605). The impact as a result of applying Topic 606 in place of Topic 605 was not material for the year ended December 31, 2018. See Note 1, Organization and Summary of Significant Accounting Policies, and Note 2, Revenues, of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for further information.

Product Sales

2018 Compared to 2017

Total product sales decreased by 16% to $21.7 billion in 2018, compared to $25.7 billion in 2017, primarily due to lower sales of our HCV products, partially offset by increased sales of our HIV products.

HIV product sales increased by 12% to $14.6 billion in 2018, compared to $13.0 billion in 2017, primarily due to the launch of Biktarvy in 2018 and the continued uptake of Descovy, Genvoya and Odefsey.

HCV product sales decreased by 60% to $3.7 billion in 2018, compared to $9.1 billion in 2017, primarily due to lower average net selling price and lower sales volume across all major markets as a result of increased competition and lower patient starts.

Yescarta generated $264 million in sales in 2018, compared to $7 million in sales in 2017.

Other product sales, which include products from our HBV, cardiovascular, oncology and other categories inclusive of Vemlidy, Viread, Letairis, Ranexa, Zydelig and AmBisome, decreased by 12% to $3.1 billion in 2018, compared to $3.5 billion in 2017. Sales of Viread, which is primarily used for the treatment of chronic HBV infection, decreased due to the availability of generic versions of the product. Letairis is expected to face generic competition in the United States because the U.S. patent for ambrisentan, the active pharmaceutical ingredient in Letairis, expired in July 2018. Ranexa is also expected to face generic competition in the United States. We expect a decline in our Letairis and Ranexa sales in the United States after the generic entries.

Of our total product sales, 25% were generated outside the United States in 2018. We faced exposure to movements in foreign currency exchange rates, primarily in the Euro. We used foreign currency exchange contracts to hedge a percentage of our foreign currency exposure. Foreign currency exchange, net of hedges, had a favorable impact on our product sales of $94 million in 2018, compared to 2017.

We record product sales net of estimated mandatory and supplemental discounts to government payers, in addition to discounts to private payers, including rebates, chargebacks, cash discounts for prompt payment, distributor fees and other related costs. These deductions are generally referred to as gross-to-net deductions, which totaled $16.5 billion, or 43% of gross product sales in 2018, compared to $17.2 billion, or 40% of gross products sales in 2017. Of the $16.5 billion in 2018, $14.8 billion or 39% of

gross product sales was related to government and other rebates and chargebacks, and $1.7 billion was related to cash discounts for prompt payment, distributor fees and other related costs.

Product sales in the United States decreased by 11% to $16.2 billion in 2018, compared to $18.1 billion in 2017. The decrease was primarily due to lower sales of our HCV products, partially offset by higher sales of our HIV products. The decrease in sales of our HCV products was primarily due to lower average net selling price and lower sales volume as a result of increased competition. The increase in the sales of our HIV products was primarily due to the launch of Biktarvy in 2018, the continued uptake of Descovy, Genvoya and Odefsey, the increased usage of Truvada for PrEP and higher average net selling price, partially offset by the decreases in sales volume of Atripla, Complera and Stribild.

Product sales in Europe decreased by 26% to $3.7 billion in 2018, compared to $5.0 billion in 2017. The decrease was primarily due to lower sales of our HCV products and the availability of generic versions of Truvada, Atripla and Viread. The decrease in sales of our HCV products was primarily due to lower sales volume and average net selling price as a result of increased competition. The decrease was partially offset by our launch of Biktarvy in 2018 and the continued uptake of Descovy, Genvoya and Odefsey. Foreign currency exchange, net of hedges, had a favorable impact on our product sales in Europe of $68 million in 2018, compared to 2017.

Product sales in other international locations decreased by 30% to $1.8 billion in 2018, compared to $2.6 billion in 2017, primarily due to lower sales of our HCV products in Japan. Sales of our HCV products in Japan decreased to $167 million for 2018, compared to $692 million in 2017, primarily due to lower market share as a result of increased competition.

2017 Compared to 2016

Total product sales decreased by 14% to $25.7 billion in 2017, compared to $30.0 billion in 2016, primarily due to lower sales of our HCV products, partially offset by increased sales of our HIV products.

HIV product sales increased by 11% to $13.0 billion in 2017, compared to $11.7 billion in 2016, primarily driven by the continued uptake of Descovy, Genvoya and Odefsey, partially offset by decreases in sales of Truvada, Atripla, Complera and Stribild.

HCV product sales decreased by 38% to $9.1 billion in 2017, compared to $14.8 billion in 2016, primarily due to declines across all major markets as a result of increased competition and lower total market patient starts.

Other product sales, which include products from our HBV, cardiovascular, oncology and other categories inclusive of Vemlidy, Viread, Letairis, Ranexa, Zydelig and AmBisome, increased by 2% to $3.5 billion in 2017, compared to $3.4 billion in 2016.

Of our total product sales, 29% were generated outside the United States in 2017. We faced exposure to movements in foreign currency exchange rates, primarily in the Euro. We used foreign currency exchange contracts to hedge a percentage of our foreign currency exposure. Foreign currency exchange, net of hedges, had an unfavorable impact on our product sales of $117 million in 2017, compared to 2016.

Our gross-to-net deductions totaled $17.2 billion, or 40% of gross product sales in 2017, compared to $20.3 billion, or 40% of gross products sales in 2016. Of the $17.2 billion in 2017, $15.5 billion or 36% of gross product sales was related to government and other rebates and chargebacks, and $1.7 billion was related to cash discounts for prompt payment, distributor fees and other related costs.

Product sales in the United States decreased by 6% to $18.1 billion in 2017, compared to $19.3 billion in 2016. The declines in sales of our HCV products was partially offset by the increase in sales of our HIV products. The declines in sales of our HCV products was primarily due to lower Harvoni and Sovaldi sales volume as a result of increased competition and lower total market patient starts. Additionally, increases in Epclusa and Vosevi sales volume were partially offset by lower average net selling price for Epclusa as pricing of all regimens has gravitated towards the 8-week regimen price. The increase in the sales of our HIV products was primarily due to the continued uptake of Descovy, Genvoya and Odefsey and higher average net selling prices, partially offset by decreases of Truvada, Atripla, Complera and Stribild and the prior year favorable impact of a revision to our rebate reserves of $332 million, primarily related to Truvada, Atripla, Complera and Stribild.

Product sales in Europe decreased by 18% to $5.0 billion in 2017, compared to $6.1 billion in 2016, primarily due to lower Harvoni and Sovaldi sales volume, partially offset by higher Epclusa sales volume. Foreign currency exchange, net of hedges, had an unfavorable impact on our product sales in Europe of $89 million in 2017 compared to 2016.

Product sales in other international locations decreased by 45% to $2.6 billion in 2017, compared to $4.6 billion in 2016, primarily due to lower sales in Japan. Sales of our HCV products in Japan decreased to $692 million in 2017, compared to $2.5 billion in 2016, primarily due to lower sales volume as a result of lower total market patient starts and increased competition.

The following table summarizes the period-over-period changes in our product sales:

(In millions, except percentages)		2018				Change			2017				Change			2016
Atripla		$	1,206			(33	)%		$	1,806			(31	)%		$	2,605
Biktarvy		1,184				*			—				*			—
Complera/Eviplera		653				(32	)%		966				(34	)%		1,457
Descovy		1,581				30	%		1,218				*			298
Genvoya		4,624				26	%		3,674				*			1,484
Odefsey		1,598				44	%		1,106				*			329
Stribild		644				(39	)%		1,053				(45	)%		1,914
Truvada		2,997				(4	)%		3,134				(12	)%		3,566
Other HIV(1)		61				5	%		58				23	%		47
Revenue share - Symtuza(2)		79				*			—				*			—
Total HIV		14,627				12	%		13,015				11	%		11,700
AmBisome		420				15	%		366				3	%		356
Epclusa		1,966				(44	)%		3,510				100	%		1,752
Harvoni		1,222				(72	)%		4,370				(52	)%		9,081
Letairis		943				6	%		887				8	%		819
Ranexa		758				6	%		717				6	%		677
Vemlidy		321				*			122				*			3
Viread		307				(71	)%		1,046				(12	)%		1,186
Vosevi		396				35	%		293				*			—
Yescarta		264				*			7				*			—
Zydelig		133				(11	)%		149				(11	)%		168
Other(3)		320				(73	)%		1,180				(72	)%		4,211
Total product sales		$	21,677			(16	)%		$	25,662			(14	)%		$	29,953
_______________________

Notes:

• Percentage not meaningful

(1) Includes Emtriva and Tybost

(2) Represents our revenue from cobicistat (C), FTC and TAF in Symtuza® (darunavir/C/FTC/TAF), a fixed dose combination product commercialized by Janssen

(3) Includes Cayston, Hepsera and Sovaldi

The following is additional discussion of our results on certain products:

•	Descovy (FTC/TAF)-based products - Biktarvy, Descovy, Genvoya and Odefsey

Product sales of our Descovy (FTC/TAF)-based products were $9.0 billion, $6.0 billion and $2.1 billion, and were 41%, 23% and 7% of our total product sales in 2018, 2017 and 2016, respectively.

In 2018, sales of our Descovy (FTC/TAF)-based products were $7.2 billion in the United States and $1.5 billion in Europe, compared to $5.0 billion in the United States and $892 million in Europe in 2017 and $1.8 billion in the United States and $256 million in Europe in 2016.

The increase in 2018 compared to 2017 in all major markets was primarily driven by higher sales volume reflecting our launch of Biktarvy in 2018 and the continued uptake of Genvoya, Odefsey and Descovy.

The increase in 2017 compared to 2016 in all major markets was primarily driven by higher sales volume as patients shifted away from Truvada (FTC/TDF)-based regimens.

•	Truvada (FTC/TDF)-based products - Atripla, Complera/Eviplera, Stribild and Truvada

Product sales of our Truvada (FTC/TDF)-based products were $5.5 billion, $7.0 billion and $9.5 billion, and were 25%, 27% and 32% of our total product sales in 2018, 2017 and 2016, respectively.

In 2018, sales of our Truvada (FTC/TDF)-based products were $4.4 billion in the United States and $815 million in Europe, compared to $4.8 billion in the United States and $1.7 billion in Europe in 2017 and $6.6 billion in the United States and $2.3 billion in Europe in 2016.

In the United States, the decrease in 2018 compared to 2017 was primarily due to lower sales volume as a result of patients switching to newer regimens containing TAF, partially offset by the increased usage of Truvada for PrEP and higher average net selling price of certain of our Truvada (FTC/TDF)-based products. In Europe, the decrease in 2018 compared to 2017 was primarily due to lower sales volume as a result of the availability of generic versions of Truvada and Atripla and patients switching to newer regimens containing TAF.

In the United States, the decrease in 2017 compared to 2016 was primarily due to lower sales volume as a result of patients switching to newer regimens containing TAF, partially offset by the increased usage of Truvada for PrEP. In Europe, the decreases in 2017 compared to 2016 was primarily due to lower sales volume as a result of the availability of generic versions of Truvada in several countries and patients switching to newer regimens containing TAF.

•	HCV products - Epclusa, Harvoni, Sovaldi and Vosevi

HCV product sales were $3.7 billion, $9.1 billion and $14.8 billion, and were 17%, 36% and 50% of our total product sales in 2018, 2017 and 2016, respectively.

In 2018, sales of our HCV products were $2.0 billion in the United States, $896 million in Europe and $767 million in other international locations. In 2017, sales of our HCV products were $5.9 billion in the United States, $1.9 billion in Europe and $1.4 billion in other international locations. In 2016, sales of our HCV products were $8.4 billion in the United States, $2.8 billion in Europe and $3.6 billion in other international locations.

The decrease in 2018 compared to 2017 in all major markets was primarily due to lower sales volume and lower average net selling price as a result of increased competition and lower total market patient starts. Harvoni and Sovaldi product sales also decreased as a result of a shift in the market from Harvoni and Sovaldi to Epclusa.

The decrease in 2017 compared to 2016 in all major markets was primarily due to lower sales volume and lower average net selling price as a result of increased competition and lower total market patient starts. Harvoni and Sovaldi product sales also decreased as a result of a shift in the market from Harvoni and Sovaldi to Epclusa. Epclusa product sales increased in 2017 compared to 2016 primarily due to a full year of sales. Epclusa was approved by FDA and European Commission in June and July 2016, respectively.

Cost of Goods Sold and Product Gross Margin

The following table summarizes the period-over-period changes in our product sales, cost of goods sold and product gross margin:

(In millions, except percentages)		2018				Change			2017				Change			2016
Total product sales		$	21,677			(16	)%		$	25,662			(14	)%		$	29,953
Cost of goods sold		$	4,853			11	%		$	4,371			3	%		$	4,261
Product gross margin		78		%					83		%					86		%

Our cost of goods sold for 2018 increased by $482 million or 11%, compared to 2017, primarily due to higher inventory reserves. In 2018, we recorded inventory reserves of $572 million, of which $440 million was related to excess raw materials primarily due to a sustained decrease in demand for Harvoni as a result of a shift in the market from Harvoni to Epclusa. Inventory reserves recorded for the years ended December 31, 2017 and 2016 were not material. Cost of goods sold also increased due to a full year of amortization expense related to intangible assets acquired in connection with our acquisition of Kite in October 2017. The increases were partially offset by lower costs of efavirenz, a component of Atripla, as a result of the termination of a collaboration arrangement with Bristol-Myers Squibb Company on December 31, 2017.

The decrease in our product gross margin in 2018 compared to 2017 was primarily due to the factors impacting cost of goods sold noted above and changes in product mix.

The decrease in our product gross margin in 2017 compared to 2016 was primarily due to changes in product mix, as our HCV product sales decreased as a percentage of total product sales.

Research and Development Expenses

The following table summarizes the period-over-period changes in R&D expenses:

(In millions, except percentages)		2018				Change			2017				Change			2016
R&D expenses		$	5,018			34	%		$	3,734			(27	)%		$	5,098

R&D expenses consist primarily of clinical studies performed by contract research organizations, materials and supplies, licenses and fees, up-front and milestone payments under collaboration agreements, personnel costs, including salaries, benefits and stock-based compensation and overhead allocations consisting of various support and facilities-related costs.

We do not track total R&D expenses by product candidate, therapeutic area or development phase. However, we manage our R&D expenses by identifying the R&D activities we anticipate will be performed during a given period and then prioritizing efforts based on scientific data, probability of successful development, market potential, available human and capital resources and other considerations. We continually review our R&D pipeline and the status of development and, as necessary, reallocate resources among the R&D portfolio that we believe will best support the future growth of our business.

The following table provides a breakout of R&D expenses by major cost type (in millions):

		2018				2017				2016
Clinical studies and outside services		$	1,665			$	1,881			$	2,446
Personnel, infrastructure and other expenses		1,876				1,399				1,271
IPR&D impairment charges		820				—				432
Up-front collaboration expenses		278				—				373
Acquired IPR&D		—				222				400
Stock-based compensation expenses		379				232				176
Total		$	5,018			$	3,734			$	5,098

In 2018, R&D expenses increased by $1.3 billion or 34%, compared to 2017, primarily due to an $820 million impairment charge related to the IPR&D for the KITE-585 program due to its discontinuance, an increase in up-front collaboration expenses and higher personnel and facilities-related costs to support the growth of our business following the acquisition of Kite, partially offset by higher acquired IPR&D expense in 2017 as a result of our purchase of Cell Design Labs, Inc.

In 2017, R&D expenses decreased by $1.4 billion or 27%, compared to 2016, primarily due to the 2016 impacts of business development activities resulting in up-front collaboration expense related to our license and collaboration agreement with Galapagos NV and acquired IPR&D expense related to our purchase of Nimbus Apollo, Inc., IPR&D impairment charges and ongoing milestone payments, partially offset by acquired IPR&D expense related to our purchase of Cell Design Labs, Inc. in 2017.

Selling, General and Administrative Expenses

The following table summarizes the period-over-period changes in SG&A expenses:

(In millions, except percentages)		2018				Change			2017				Change			2016
SG&A expenses		$	4,056			5	%		$	3,878			14	%		$	3,398

SG&A expenses relate to sales and marketing, finance, human resources, legal and other administrative activities. Expenses consist primarily of personnel costs, facilities and overhead costs, outside marketing, advertising and legal expenses and other general and administrative costs. SG&A expenses also include the BPD fee. In the United States, we, along with other pharmaceutical manufacturers of branded drug products, are required to pay a portion of the BPD fee, which is estimated based on select government sales during the prior year as a percentage of total industry government sales and is trued-up upon receipt of invoices from the Internal Revenue Service.

In 2018, SG&A expenses increased by $178 million or 5%, compared to 2017, primarily due to a full year of expense to support the growth of our business following the acquisition of Kite, partially offset by lower acquisition-related costs associated with the acquisition of Kite and lower BPD fees.

In 2017, SG&A expenses increased by $480 million or 14%, compared to 2016, primarily due to costs associated with our acquisition of Kite, which primarily consist of stock-based compensation and transaction costs, as well as higher BPD fee expenses resulting from a favorable adjustment of $191 million in the first quarter of 2016.

BPD fee expenses were $229 million, $385 million and $270 million in 2018, 2017 and 2016, respectively. BPD fee expenses are not tax-deductible.

Other Income (Expense), Net

Other income (expense), net, was $676 million, $523 million and $428 million in 2018, 2017 and 2016, respectively. The increase in 2018 compared to 2017 was primarily due to unrealized gains from changes in the fair value of our marketable equity securities. Starting in January 2018, we recorded unrealized gains (losses) from changes in the fair value of our marketable equity securities in Other income (expense), net, on our Consolidated Statements of Income as a result of the adoption of Accounting Standards Update No. 2016-01 “Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities”. See Note 1, Organization and Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for further information.

The increase in other income (expense), net, in 2017 compared to 2016 was primarily due to our cash, cash equivalents and marketable securities earning a higher yield and higher cash balances.

Provision for Income Taxes

Provision for income taxes was $2.3 billion in 2018 compared to $8.9 billion in 2017. The 2018 effective tax rate decreased to 30.0% from the 2017 effective tax rate of 65.7%, primarily due to a $5.5 billion net tax charge in 2017 and a reduction to the U.S. corporate tax rate in 2018 as a result of the enactment of Tax Reform in December 2017. In addition, the 2018 effective tax rate was further decreased due to a $202 million tax benefit recorded in 2018 related to settlement of tax examinations, offset by a $588 million deferred tax charge in 2018 resulting from a transfer of acquired intangible assets between wholly owned subsidiaries, changes to the geographic mix of earnings and the tax on Global Intangible Low-Taxed Income (enacted as part of Tax Reform). We are continuing to evaluate certain changes to our legal entity structure in response to guidelines and requirements in various international tax jurisdictions where we conduct business. These changes may take multiple reporting periods to implement and may result in certain material, but non-recurring, adjustments to our deferred tax assets and/or liabilities, which will cause an offsetting increase or decrease to our tax provision. Estimates of these adjustments cannot be reasonably determined at this time and are dependent on the changes actually implemented.

Our provision for income taxes was $8.9 billion in 2017 compared to $3.6 billion in 2016. The 2017 effective tax rate increased to 65.7% from the 2016 effective tax rate of 21.1%, primarily due to the enactment of Tax Reform in December 2017. Changes to the geographic mix of earnings also contributed to the increase in the 2017 effective tax rate.

See Note 18, Income Taxes of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional details on Tax Reform.

Liquidity and Capital Resources

The following table summarizes our cash, cash equivalents, and marketable debt securities and working capital (in millions):

			December 31,
			2018				2017
Cash, cash equivalents and marketable debt securities			$	31,512			$	36,694
Working capital			$	25,231			$	20,188

Cash, Cash Equivalents and Marketable debt Securities

Cash, cash equivalents and marketable debt securities decreased by $5.2 billion, or 14%, compared to December 31, 2017. During 2018, we generated $8.4 billion in operating cash flow, repaid $1.8 billion principal amount of senior unsecured notes at maturity, repaid $4.5 billion of term loans borrowed in connection with our acquisition of Kite, paid cash dividends of $3.0 billion and utilized $2.9 billion on stock repurchases.

Working Capital

Working capital increased by $5.0 billion, or 25%, compared to December 31, 2017, primarily driven by an increase in cash and cash equivalents resulting from a shift in the average remaining term to maturity of our marketable debt securities portfolio to reduce interest rate risk.

Cash Flows

The following table summarizes our cash flow activities (in millions):

			2018				2017				2016
Cash provided by (used in):
Operating activities			$	8,400			$	11,898			$	17,047
Investing activities			$	14,355			$	(16,069	)		$	(11,985	)
Financing activities			$	(12,318	)		$	3,393			$	(9,725	)

Cash Provided by Operating Activities

Cash provided by operating activities represents the cash receipts and disbursements related to all of our activities other than investing and financing activities. Operating cash flow is derived by adjusting our net income for non-cash items and changes in operating assets and liabilities. Cash provided by operating activities decreased by $3.5 billion to $8.4 billion in 2018 compared to 2017, primarily due to lower cash receipts as a result of lower product sales and higher tax payments. The tax payments made

in 2018 included a $500 million payment related to the first annual installment of the Tax Reform transition tax, a $771 million deemed early payment of the Tax Reform transition tax and a $514 million settlement of a tax examination.

Cash provided by operating activities decreased by $5.1 billion to $11.9 billion in 2017 compared to 2016, primarily due to lower cash receipts as a result of lower product sales and higher tax payments.

Cash Provided by (Used in) Investing Activities

Cash provided by (used in) investing activities primarily consists of purchases, sales and maturities of our marketable debt securities, capital expenditures, acquisitions (net of cash acquired) and other investments.

Cash provided by investing activities was $14.4 billion in 2018 compared to cash used in investing activities of $16.1 billion in 2017. The change in cash provided by (used in) investing activities was primarily due to higher proceeds from maturities of our marketable debt securities and lower purchases of marketable debt securities, partially offset by lower proceeds from sales of our marketable debt securities. In addition, $10.4 billion cash was used to acquire Kite in 2017, whereas no cash was used for acquisitions in 2018.

Cash used in investing activities increased by $4.1 billion to $16.1 billion in 2017 compared to 2016, primarily due to our acquisition of Kite, partially offset by higher proceeds from maturities and sales of marketable debt securities and lower purchases of marketable debt securities.

Cash Provided by (Used in) Financing Activities

Cash used in financing activities was $12.3 billion in 2018, compared to cash provided by financing activities of $3.4 billion in 2017. The change in cash provided by (used in) financing activities was primarily due to higher repayment of debt and repurchases of our common stock in 2018. In addition, we had $9.0 billion net proceeds from debt issuances to partially fund our acquisition of Kite in 2017, whereas no debt was issued in 2018.

Cash provided by financing activities was $3.4 billion in 2017, compared to cash used in financing activities of $9.7 billion in 2016, primarily due to lower repurchases of our common stock and higher proceeds from the issuances of debt.

Debt and Credit Facilities

Long-Term Obligations

The summary of our borrowings under various financing arrangements is included in Note 12, Debt and Credit Facilities of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K.

Senior Unsecured Notes

In 2018, we repaid at maturity $1.0 billion principal amount of senior unsecured notes that were issued in September 2015 and $750 million of principal amount of senior unsecured notes that were issued in September 2017.

In 2017, in connection with our acquisition of Kite, we issued $3.0 billion aggregate principal amount of senior unsecured notes consisting of $750 million principal amount of floating rate notes due September 2018, $750 million principal amount of floating rate notes due March 2019, and $500 million principal amount of floating rate notes due September 2019 (collectively, the Floating Rate Notes) and $1.0 billion principal amount of 1.85% senior notes due September 2019 (the Fixed Rate Notes, and collectively with the Floating Rate Notes, the 2017 Notes). The Floating Rate Notes bear interest rates equal to three month London Interbank Offered Rates (LIBOR), plus 0.17% with respect to the Floating Rate Notes due September 2018, 0.22% with respect to the Floating Rate Notes due March 2019 and 0.25% with respect to the Floating Rate Notes due September 2019. The Fixed Rate Notes pay interest semiannually and the Floating Rate Notes pay interest quarterly.

We are required to comply with certain covenants under our notes indentures and as of December 31, 2018, we were not in violation of any covenants.

Term Loan Facilities

In September 2017, we entered into a $6.0 billion aggregate principal amount term loan facility credit agreement consisting of a $1.0 billion principal amount 364-day senior unsecured term loan facility, a $2.5 billion principal amount three-year senior unsecured term loan facility and a $2.5 billion principal amount five-year senior unsecured term loan facility (collectively, the Term Loan Facilities). In October 2017, we drew $6.0 billion aggregate principal amount on the Term Loan Facilities and used the proceeds to finance our acquisition of Kite, of which $1.5 billion was repaid in 2017 and the remaining $4.5 billion was repaid in 2018. The term loan facility credit agreement was terminated in 2018.

Credit Facilities

In 2016, we entered into a $2.5 billion five-year revolving credit facility maturing in May 2021 (the Five-Year Revolving Credit Agreement). The revolving credit facility can be used for working capital requirements and for general corporate purposes, including, without limitation, acquisitions. We are required to comply with certain covenants under the Five-Year Revolving Credit Agreement and as of December 31, 2018, we were not in violation of any covenants, and no amounts were outstanding under the Five-Year Revolving Credit Agreement.

Capital Return Program

The details of our Stock Repurchase Programs and Dividends are included in Note 14, Stockholders’ Equity of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information.

Stock Repurchase Programs

In the first quarter of 2016, our Board of Directors authorized a $12.0 billion stock repurchase program (2016 Program), under which repurchases may be made in the open market or in privately negotiated transactions. We started repurchases under the 2016 Program in April 2016.

Repurchases under the 2016 Program were 40 million and 13 million shares of our common stock for $2.9 billion and $954 million in 2018 and 2017, respectively. As of December 31, 2018, the remaining authorized repurchase amount under the 2016 Program was $5.1 billion.

Dividends

We declared and paid quarterly cash dividends for an aggregate amount of $3.0 billion or $2.28 per common share and $2.7 billion or $2.08 per common share in 2018 and 2017, respectively.

On February 4, 2019, we announced that our Board of Directors declared a quarterly cash dividend increase of 11% from $0.57 to $0.63 per share of our common stock, with a payment date of March 28, 2019 to all stockholders of record as of the close of business on March 15, 2019. Future dividends are subject to declaration by the Board of Directors.

Capital Resources

We believe our existing capital resources, supplemented by cash flows generated from our operations, will be adequate to satisfy our capital needs for the foreseeable future. Our future capital requirements will depend on many factors, including but not limited to the following:

•	the commercial performance of our current and future products;

•	the progress and scope of our R&D efforts, including preclinical studies and clinical trials;

•	the cost, timing and outcome of regulatory reviews;

•	the expansion of our sales and marketing capabilities;

•	the possibility of acquiring additional manufacturing capabilities or office facilities;

•	the possibility of acquiring other companies or new products;

•	debt service requirements;

•	the establishment of additional collaborative relationships with other companies; and

•	costs associated with the defense, settlement and adverse results of government investigations and litigation

We may in the future require additional funding, which could be in the form of proceeds from equity or debt financings. If such funding is required, we cannot guarantee that it will be available to us on favorable terms, if at all.

Critical Accounting Policies, Estimates and Judgments

The discussion and analysis of our financial condition and results of operations is based on our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate and base our estimates on historical experience and on various other market specific and other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.

We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.

Revenue Recognition

Adoption of ASC Topic 606, “Revenue from Contracts with Customers”

On January 1, 2018, we adopted Topic 606 using the modified retrospective method whereby results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historical accounting under Topic 605. Under Topic 606, an entity recognizes revenue when it transfers control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We recorded the cumulative effect of applying the new revenue standard as a net increase of $190 million to the opening balance of retained earnings. The impact as a result of applying Topic 606 in place of Topic 605 was not material for the year ended December 31, 2018.

Product Sales

We recognize revenue from product sales when control of the product transfers, generally upon shipment or delivery, to the customer, or in certain cases, upon the corresponding sales by our customer to a third party. We record product sales net of estimated mandatory and supplemental discounts to government and private payers, in addition to discounts to private payers, and other related charges. These are generally accounted for as variable consideration estimated in the same period the related sales occur. Government and other rebates and chargebacks represent the majority of our variable consideration and require complex and significant judgment by management. Estimates are assessed each period and updated to reflect current information.

Government and Other Rebates and Chargebacks

Government and other rebates and chargebacks include amounts paid to payers and healthcare providers in the United States, including Medicaid rebates, AIDS Drug Assistance Program rebates and chargebacks, Veterans Administration and Public Health Service chargebacks and other rebates, as well as foreign government rebates. Rebates and chargebacks are based on contractual arrangements or statutory requirements which may vary by product, by payer and individual payer plans.

For qualified programs that can purchase our products through wholesalers or other distributors at a lower contractual price, the wholesalers or distributors charge back to us the difference between their acquisition cost and the lower contractual price.

Our allowances for government and other rebates and chargebacks are estimated based on products sold, historical payer mix, pertinent third-party industry information, estimated patient population, known market events or trends, channel inventory data and/or other market data. We also consider new information regarding changes in programs’ regulations and guidelines that would impact the amount of the actual rebates and/or our expectations regarding future payer mix for these programs. We believe the methodology that we use to estimate our government and other rebates and chargebacks is reasonable and appropriate given the current facts and circumstances. However, actual results may differ significantly from our estimates. Historically, our actual government rebates and chargebacks claimed for prior periods have varied by less than 5% from our estimates.

Government and other chargebacks that are payable to our direct customers are classified as reductions of Accounts receivable on our Consolidated Balance Sheets and totaled $492 million and $340 million at December 31, 2018 and 2017, respectively. Government and other rebates that are invoiced directly to us are recorded in Accrued government and other rebates on our Consolidated Balance Sheets and totaled $3.9 billion and $4.7 billion at December 31, 2018 and 2017, respectively. The following table summarizes the consolidated activities and ending balances in our government and other rebates and chargebacks accounts (in millions):

Accrued government and other rebates and chargebacks:		Balance at Beginning of Year				Decrease/(Increase) to Product Sales				Payments				Balance at End of Year
Year ended December 31, 2018:
Activity related to 2018 sales		$	—			$	14,784			$	(10,953	)		$	3,831
Activity related to sales prior to 2018		5,044				41				(4,496		)		589
Total		$	5,044			$	14,825			$	(15,449	)		$	4,420
Year ended December 31, 2017:
Activity related to 2017 sales		$	—			$	15,809			$	(11,170	)		$	4,639
Activity related to sales prior to 2017		5,657				(264		)		(4,988		)		405
Total		$	5,657			$	15,545			$	(16,158	)		$	5,044

Legal Contingencies

We are a party to various legal actions. The most significant of these are described in Note 13, Commitments and Contingencies - Legal Proceedings of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. It is not possible to determine the outcome of these matters. We recognize accruals for such actions to the extent that we conclude that a loss is both probable and reasonably estimable. We accrue for the best estimate of a loss within a range; however, if no estimate in the range is better than any other, then we accrue the minimum amount in the range. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss.

Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of the inherent uncertainty and unpredictability related to these matters, accruals are based on what we believe to be the best information available at the time of our assessment, including the legal facts and circumstances of the case, status of the proceedings, applicable law and the views of legal counsel. Upon the final resolution of such matters, it is possible that there may be a loss in excess of the amount recorded, and such amounts could have a material adverse effect on our results of operations, cash flows or financial position. We periodically reassess these matters when additional information becomes available and adjust our estimates and assumptions when facts and circumstances indicate the need for any changes.

We did not recognize any accruals in our Consolidated Balance Sheets for such matters as of December 31, 2018 and 2017 as we did not believe losses were probable.

Valuation of Intangible Assets

The identifiable intangible assets are measured at their respective fair values as of the acquisition date and may be subject to revision within the measurement period, which may be up to one year from the acquisition date. The models used in valuing these intangible assets require the use of significant estimates and assumptions including but not limited to:

•	estimates of revenues and operating profits related to the products or product candidates;

•	the probability of success for unapproved product candidates considering their stages of development;

•	the time and resources needed to complete the development and approval of product candidates;

•	the life of the potential commercialized products and associated risks, including the inherent difficulties and uncertainties in developing a product candidate such as obtaining FDA and other regulatory approvals; and

•	risks related to the viability of and potential alternative treatments in any future target markets.

We believe the fair values used to record intangible assets acquired in connection with a business combination using information known and knowable and are based upon reasonable estimates and assumptions given the facts and circumstances as of the related valuation dates.

Intangible assets related to IPR&D projects are considered to be indefinite-lived until the completion or abandonment of the associated R&D efforts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed finite-lived and would then be amortized based on their respective estimated useful lives at that point in time. During the period the assets are considered indefinite-lived, they are not amortized but are tested for impairment on an annual basis as well as between annual tests if we become aware of any events or changes that would indicate that it is more likely than not that the fair values of the IPR&D projects are below their respective carrying amounts. The fair value of our indefinite-lived intangible assets is dependent on assumptions such as the expected timing or probability of achieving the specified milestones, changes in projected revenues or changes in discount rates. Significant judgment is employed in determining these assumptions and changes to our assumptions could have a significant impact on our results of operations in any given period.

Intangible assets with finite useful lives are amortized over their estimated useful lives primarily on a straight-line basis. Intangible assets with finite useful lives are reviewed for impairment when facts or circumstances suggest that the carrying value of these assets may not be recoverable.

On October 3, 2017, in connection with our Kite acquisition, we acquired intangible assets primarily related to IPR&D for axicabtagene ciloleucel, KITE-585 (an anti-BCMA, being evaluated for the treatment of multiple myeloma) and KTE-X19 (being evaluated for the treatment of adult and pediatric acute lymphoblastic leukemia), which had an estimated aggregate fair value of $9.0 billion. On October 18, 2017, FDA approved axicabtagene ciloleucel, now known commercially as Yescarta, making it the first CAR T cell therapy for the treatment of adult patients with relapsed or refractory large B-cell lymphoma after two or more lines of systemic therapy, which includes diffuse large B-cell lymphoma, transformed follicular lymphoma and primary mediastinal B-cell lymphoma. Upon approval, we reclassified $6.2 billion of the purchased IPR&D as a finite-lived intangible asset. We are amortizing this asset over an estimated useful life of 18 years using the straight-line method.

During the fourth quarter of 2018, we concluded that the efficacy profile of the KITE-585 program did not justify further efforts based on the totality of the clinical data gathered and made a decision to discontinue the KITE-585 program. As a result,

the estimated fair value of the IPR&D relating to the KITE-585 program was written down to zero and we recorded an impairment charge of $820 million within Research and development expenses on our Consolidated Statements of Income included in Item 8 of this Annual Report on Form 10-K.

Provision for Income Taxes

We estimate our income tax provision, including deferred tax assets and liabilities, based on significant management judgment. We evaluate the realization of all or a portion of our deferred tax assets on a quarterly basis. We record a valuation allowance to reduce our deferred tax assets to the amounts that are more likely than not to be realized. We consider future taxable income, ongoing tax planning strategies and our historical financial performance in assessing the need for a valuation allowance. If we expect to realize deferred tax assets for which we have previously recorded a valuation allowance, we will reduce the valuation allowance in the period in which such determination is first made. The valuation allowance was $331 million and $162 million at December 31, 2018 and 2017, respectively. The increase of our valuation allowance in 2018 was primarily related to certain Kite tax attributes and certain foreign jurisdictions, which do not have sufficient history of profit to realize the benefit of the losses on a more-likely-than-not basis.

We are subject to income taxes in the United States and various foreign jurisdictions including Ireland. Due to economic and political conditions, various countries are actively considering and have made changes to existing tax laws (for example, the United States enacted significant tax reform, and certain provisions of the new law will continue to significantly affect us). We cannot predict the form or timing of potential legislative changes that could have a material adverse impact on our results of operations. In addition, significant judgment is required in determining our worldwide provision for income taxes.

We record liabilities related to uncertain tax positions in accordance with the guidance that clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. An adverse resolution of one or more of these uncertain tax positions in any period could have a material impact on the results of operations for that period.

Of the total unrecognized tax benefits, $1.3 billion and $1.8 billion at December 31, 2018 and 2017, if recognized, would reduce our effective tax rate in the period of recognition. As of December 31, 2018, we believe that it is reasonably possible that our unrecognized tax benefits will decrease by approximately $100 million in the next 12 months due to potential settlements with taxing authorities.

We file federal, state and foreign income tax returns in the United States and in many foreign jurisdictions. For federal income tax purposes, the statute of limitations is open for 2013 and onwards and 2010 and onwards for California income tax purposes. For certain acquired entities, the statute of limitations is open for all years from inception due to our utilization of their net operating losses and credits carried over from prior years.

Our income tax returns are subject to audit by federal, state and foreign tax authorities. We are currently under examination by the IRS for the tax years from 2013 to 2015 and by various state and foreign jurisdictions. There are differing interpretations of tax laws and regulations, and as a result, significant disputes may arise with these tax authorities involving issues of the timing and amount of deductions and allocations of income among various tax jurisdictions. We periodically evaluate our exposures associated with our tax filing positions.

See Note 18, Income Taxes of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Contractual Obligations

Our contractual obligations consist of debt obligations, operating leases, capital commitments, purchase obligations for active pharmaceutical ingredients and inventory-related items and clinical trials contracts. The following table summarizes our significant enforceable and legally binding obligations, future commitments and obligations related to all contracts that we are likely to continue regardless of the fact that certain of these obligations may be cancelable as of December 31, 2018 (in millions):

		Payments due by Period
Contractual Obligations		Total				Less than one year				1-3 years				3-5 years				More than 5 years
Debt (1)		$	41,876			$	3,753			$	6,582			$	3,801			$	27,740
Operating lease obligations		574				89				144				112				229
Capital commitments (2)		336				336				—				—				—
Purchase obligations (3)		1,629				1,280				214				72				63
Clinical trials (5)		1,678				930				505				207				36
Transition Tax Payable (6)		4,639				—				621				1,359				2,659
Total (4)(7)		$	50,732			$	6,388			$	8,066			$	5,551			$	30,727
_______________________

Notes:

(1)

Debt consists of senior unsecured notes and includes principal and interest payments. Interest payments for our fixed rate senior unsecured notes are incurred and calculated based on terms of the related notes. Interest payments for our variable rate debt are calculated based on the interest rates on the last reset date in 2018 for each debt instrument. See Note 12, Debt and Credit Facilities of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information.

(2)	Amounts include capital project commitments primarily relating to construction of new buildings.

(3)

Amounts include purchase commitments primarily relating to active pharmaceutical ingredients with minimum purchase requirements and certain inventory-related items. These amounts also include a $365 million accrued payment to Japan Tobacco, Inc. as a result of a collaboration arrangement. See Note 11, Collaborative Arrangements of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information.

(4)

In addition to the above, we have committed to make potential future milestone payments to third parties as part of licensing, collaboration and development arrangements. Payments under these agreements generally become due and payable only upon achievement of certain developmental, regulatory and/or commercial milestones. Because the achievement of these milestones is neither probable nor reasonably estimable, such contingencies have not been recorded on our Consolidated Balance Sheets and have not been included in the table above.

(5)

At December 31, 2018, we had several clinical studies in various clinical trial phases. Our most significant clinical trial expenditures are to contract research organizations (CROs). Although all of our material contracts with CROs are cancelable, we historically have not canceled such contracts. These amounts reflect commitments based on existing contracts and do not reflect any future modifications to, or terminations of, existing contracts or anticipated or potential new contracts.

(6)

In connection with Tax Reform, as of December 31, 2017, we recorded a federal income tax payable for transition tax on the mandatory deemed repatriation of foreign earnings that will be payable over an eight-year period. The amounts included in the table above represent the remaining federal income tax payable after applying the first year’s installment payment and early payments of future installments. See Note 18, Income Taxes of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional details on Tax Reform.

(7)

As of December 31, 2018, our long-term income taxes payable includes unrecognized tax benefits, interest and penalties totaling $1.3 billion. Due to the high degree of uncertainty on the timing of future cash settlement and other events that could extinguish these unrecognized tax benefits, we are unable to estimate the period of cash settlement and therefore we have excluded these unrecognized tax benefits from the table above.

Recent Accounting Pronouncements

The information required by this item is included in Note 1, Organization and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.