UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004March 31, 2005
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-4448
BAXTER INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Delaware | 36-0781620 | |
(State incorporation or organization) | (I.R.S. Employer Identification No.) | |
One Baxter Parkway, Deerfield, Illinois | 60015-4633 | |
(Address of principal executive offices) | (Zip Code) |
847-948-2000(847) 948-2000
(Registrant’s telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yesx No¨
The number of shares of the registrant’s Common Stock, par value $1.00 per share,
outstanding as of October 31, 2004April 29, 2005 was 616,448,448620,729,469 shares.
BAXTER INTERNATIONAL INC.
FORM 10-Q
For the quarterly period ended September 30, 2004March 31, 2005
Page Number | ||||
| FINANCIAL INFORMATION | |||
Item 1. | Financial Statements | |||
2 | ||||
3 | ||||
4 | ||||
5 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||
Item 3. | ||||
Item 4. | ||||
| OTHER INFORMATION | |||
Item 1. | 31 | |||
Item 2. | 38 | |||
Item 5. | Other Information | 39 | ||
Item 6. | ||||
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
Baxter International Inc. and Subsidiaries
Condensed Consolidated Statements of Income (unaudited)
(in millions, except per share data)
Three months ended September 30, | Nine months ended September 30, | Three months ended March 31, | ||||||||||||||
2004 | 2003 | 2004 | 2003 | 2005 | 2004 | |||||||||||
Net sales | $2,320 | $2,216 | $6,908 | $6,373 | $2,383 | $2,209 | ||||||||||
Cost and expenses | ||||||||||||||||
Costs and expenses | ||||||||||||||||
Cost of goods sold | 1,357 | 1,247 | 4,113 | 3,555 | 1,414 | 1,316 | ||||||||||
Marketing and administrative expenses | 462 | 440 | 1,460 | 1,320 | 483 | 466 | ||||||||||
Research and development expenses | 124 | 137 | 389 | 412 | 133 | 136 | ||||||||||
Restructuring charges | — | — | 543 | 337 | ||||||||||||
Net interest expense | 20 | 25 | 66 | 71 | 31 | 21 | ||||||||||
Other expense, net | 11 | 6 | 74 | 46 | 24 | 21 | ||||||||||
Total costs and expenses | 1,974 | 1,855 | 6,645 | 5,741 | 2,085 | 1,960 | ||||||||||
Income from continuing operations before income taxes and cumulative effect of accounting changes | 346 | 361 | 263 | 632 | ||||||||||||
Income tax expense (benefit) | 87 | 86 | (14 | ) | 96 | |||||||||||
Income from continuing operations before income taxes | 298 | 249 | ||||||||||||||
Income tax expense | 74 | 62 | ||||||||||||||
Income before cumulative effect of accounting changes | 259 | 275 | 277 | 536 | ||||||||||||
Income from continuing operations | 224 | 187 | ||||||||||||||
Discontinued operations | 17 | (5 | ) | 5 | (17 | ) | 2 | (11 | ) | |||||||
Income from continuing operations before cumulative effect of accounting changes | 276 | 270 | 282 | 519 | ||||||||||||
Cumulative effect of accounting changes, net of income tax benefit of $5 | — | (17 | ) | — | (17 | ) | ||||||||||
Net income | $ 276 | $ 253 | $ 282 | $ 502 | $ 226 | $ 176 | ||||||||||
Earnings per basic common share | ||||||||||||||||
Continuing operations | $ 0.42 | $ 0.47 | $ 0.45 | $ 0.90 | $ 0.36 | $ 0.31 | ||||||||||
Discontinued operations | 0.03 | (0.01 | ) | 0.01 | (0.02 | ) | 0.01 | (0.02 | ) | |||||||
Cumulative effect of accounting changes | — | (0.03 | ) | — | (0.03 | ) | ||||||||||
Net income | $ 0.45 | $ 0.43 | $ 0.46 | $ 0.85 | $ 0.37 | $ 0.29 | ||||||||||
Earnings per diluted common share | ||||||||||||||||
Continuing operations | $ 0.42 | $ 0.46 | $ 0.45 | $ 0.89 | $ 0.36 | $ 0.30 | ||||||||||
Discontinued operations | 0.03 | (0.01 | ) | 0.01 | (0.03 | ) | — | (0.02 | ) | |||||||
Cumulative effect of accounting changes | — | (0.03 | ) | — | (0.03 | ) | ||||||||||
Net income | $ 0.45 | $ 0.42 | $ 0.46 | $ 0.83 | $ 0.36 | $ 0.28 | ||||||||||
Weighted average number of common shares outstanding | ||||||||||||||||
Basic | 615 | 589 | 613 | 595 | 619 | 612 | ||||||||||
Diluted | 619 | 592 | 617 | 604 | 623 | 616 | ||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (unaudited)
(in millions, except shares)
September 30, 2004 | December 31, 2003 | March 31, 2005 | December 31, 2004 | |||||||||||||
Current assets | Cash and equivalents | $ 822 | $ 925 | Cash and equivalents | $ 1,106 | $ 1,109 | ||||||||||
Accounts and other current receivables | 2,108 | 1,914 | Accounts and other current receivables | 1,982 | 2,091 | |||||||||||
Inventories | 2,106 | 2,104 | Inventories | 2,105 | 2,135 | |||||||||||
Short-term deferred income taxes | 405 | 140 | Short-term deferred income taxes | 249 | 297 | |||||||||||
Prepaid expenses and other | 282 | 277 | Prepaid expenses and other | 339 | 387 | |||||||||||
Total current assets | 5,723 | 5,360 | Total current assets | 5,781 | 6,019 | |||||||||||
Property, plant | At cost | 7,840 | 7,791 | |||||||||||||
and equipment | Accumulated depreciation and amortization | (3,494 | ) | (3,199 | ) | |||||||||||
Property, plant and equipment | At cost | 7,994 | 7,991 | |||||||||||||
Accumulated depreciation and amortization | (3,684 | ) | (3,622 | ) | ||||||||||||
Net property, plant and equipment | 4,346 | 4,592 | Net property, plant and equipment | 4,310 | 4,369 | |||||||||||
Other assets | Goodwill | 1,640 | 1,648 | Goodwill | 1,617 | 1,648 | ||||||||||
Other intangible assets | 572 | 611 | Other intangible assets | 536 | 547 | |||||||||||
Other | 1,488 | 1,498 | Other | 1,564 | 1,564 | |||||||||||
Total other assets | 3,700 | 3,757 | Total other assets | 3,717 | 3,759 | |||||||||||
Total assets | $13,769 | $13,709 | $13,808 | $14,147 | ||||||||||||
Current liabilities | Short-term debt | $ 178 | $ 153 | Short-term debt | $ 550 | $ 207 | ||||||||||
Accounts payable and accrued liabilities | 2,800 | 3,107 | Current maturities of long-term debt and lease obligations | 1,027 | 154 | |||||||||||
Income taxes payable | 648 | 538 | Accounts payable and accrued liabilities | 2,701 | 3,531 | |||||||||||
Income taxes payable | 417 | 394 | ||||||||||||||
Total current liabilities | 3,626 | 3,798 | ||||||||||||||
Total current liabilities | 4,695 | 4,286 | ||||||||||||||
Long-term debt and lease obligations | Long-term debt and lease obligations | 4,411 | 4,421 | Long-term debt and lease obligations | 3,022 | 3,933 | ||||||||||
Other long-term liabilities | Other long-term liabilities | 2,046 | 2,216 | Other long-term liabilities | 2,081 | 2,223 | ||||||||||
Commitments and contingencies | Commitments and contingencies | Commitments and contingencies | ||||||||||||||
Stockholders’ equity | Common stock, $1 par value, authorized 2,000,000,000 shares, 648,417,007 issued in 2004 and 648,574,109 in 2003 | 648 | 649 | Common stock, $1 par value, authorized 2,000,000,000 shares, issued 648,414,492 shares in 2005 and 2004 | 648 | 648 | ||||||||||
Common stock in treasury, at cost, 32,539,304 shares in 2004 and 37,273,424 shares in 2003 | (1,613 | ) | (1,863 | ) | Common stock in treasury, at cost, 28,414,340 shares in 2005 and 30,489,183 shares in 2004 | (1,405 | ) | (1,511 | ) | |||||||
Additional contributed capital | 3,630 | 3,773 | Additional contributed capital | 3,549 | 3,597 | |||||||||||
Retained earnings | 2,427 | 2,145 | Retained earnings | 2,485 | 2,259 | |||||||||||
Accumulated other comprehensive loss | (1,406 | ) | (1,430 | ) | Accumulated other comprehensive loss | (1,267 | ) | (1,288 | ) | |||||||
Total stockholders’ equity | 3,686 | 3,274 | Total stockholders’ equity | 4,010 | 3,705 | |||||||||||
Total liabilities and stockholders’ equity | Total liabilities and stockholders’ equity | $13,808 | $14,147 | |||||||||||||
Total liabilities and stockholders’ equity | $13,769 | $13,709 | ||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (unaudited)
(in millions)
(brackets denote cash outflows)
Nine months ended September 30, | ||||||||||
2004 | 2003 | |||||||||
Cash flows from | Income from continuing operations | $ | 277 | $ | 536 | |||||
operations | Adjustments | |||||||||
Depreciation and amortization | 445 | 400 | ||||||||
Deferred income taxes | (238 | ) | (135 | ) | ||||||
Restructuring charges | 543 | 337 | ||||||||
Other | 151 | 34 | ||||||||
Changes in balance sheet items | ||||||||||
Accounts receivable | (155 | ) | 16 | |||||||
Inventories | (44 | ) | (233 | ) | ||||||
Accounts payable and accrued liabilities | (175 | ) | (160 | ) | ||||||
Restructuring payments | (136 | ) | (38 | ) | ||||||
Contributions to pension trusts | (95 | ) | (11 | ) | ||||||
Other | (44 | ) | (76 | ) | ||||||
Cash flows from continuing operations | 529 | 670 | ||||||||
Cash flows from discontinued operations | 17 | 5 | ||||||||
Cash flows from operations | 546 | 675 | ||||||||
Cash flows from | Capital expenditures | (363 | ) | (564 | ) | |||||
investing activities | Acquisitions (net of cash received) and investments in and advances to affiliates | (20 | ) | (106 | ) | |||||
Divestitures and other | 31 | — | ||||||||
Cash flows from investing activities | (352 | ) | (670 | ) | ||||||
Cash flows from | Issuances of debt | 519 | 654 | |||||||
financing activities | Redemptions of financing obligations | (596 | ) | (1,001 | ) | |||||
Increase in debt with maturities of three months or less, net | 64 | 335 | ||||||||
Common stock cash dividends | (361 | ) | (346 | ) | ||||||
Proceeds from stock issued under employee benefit plans | 108 | 60 | ||||||||
Issuance of stock | — | 644 | ||||||||
Purchases of treasury stock | (18 | ) | (714 | ) | ||||||
Cash flows from financing activities | (284 | ) | (368 | ) | ||||||
Effect of currency exchange rate changes on cash and equivalents | (13 | ) | 24 | |||||||
Decrease in cash and equivalents | (103 | ) | (339 | ) | ||||||
Cash and equivalents at beginning of period | 925 | 1,169 | ||||||||
Cash and equivalents at end of period | $ | 822 | $ | 830 | ||||||
Three months ended March 31, | ||||||||
(brackets denote cash outflows) | 2005 | 2004 | ||||||
Cash flows from operations | Income from continuing operations | $ 224 | $187 | |||||
Adjustments | ||||||||
Depreciation and amortization | 147 | 149 | ||||||
Deferred income taxes | 23 | 10 | ||||||
Other | 18 | 23 | ||||||
Changes in balance sheet items | ||||||||
Accounts and other current receivables | 44 | (96 | ) | |||||
Inventories | 19 | (66 | ) | |||||
Accounts payable and accrued liabilities | (245 | ) | (252 | ) | ||||
Restructuring payments | (43 | ) | (37 | ) | ||||
Other | 84 | 29 | ||||||
Cash flows from continuing operations | 271 | (53 | ) | |||||
Cash flows from discontinued operations | 1 | (1 | ) | |||||
Cash flows from operations | 272 | (54 | ) | |||||
Cash flows from investing activities | Capital expenditures | (65 | ) | (90 | ) | |||
Acquisitions (net of cash received) and investments in and advances to affiliates | — | (14 | ) | |||||
Divestitures and other | 49 | 26 | ||||||
Cash flows from investing activities | (16 | ) | (78 | ) | ||||
Cash flows from financing activities | Issuances of debt | 20 | 87 | |||||
Payments of obligations | (349 | ) | (33 | ) | ||||
Increase in debt with maturities of three months or less, net | 357 | 137 | ||||||
Common stock cash dividends | (359 | ) | (361 | ) | ||||
Proceeds from stock issued under employee benefit plans | 53 | 31 | ||||||
Purchases of treasury stock | — | (11 | ) | |||||
Cash flows from financing activities | (278 | ) | (150 | ) | ||||
Effect of currency exchange rate changes on cash and equivalents | 19 | 3 | ||||||
Decrease in cash and equivalents | (3 | ) | (279 | ) | ||||
Cash and equivalents at beginning of period | 1,109 | 925 | ||||||
Cash and equivalents at end of period | $1,106 | $646 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited interim condensed consolidated financial statements of Baxter International Inc. and its subsidiaries (the company or Baxter) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the company’s Form 10-K/A for the year ended December 31, 2003.2004 Annual Report to Stockholders (2004 Annual Report).
In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the interim periods. All such adjustments, unless otherwise noted herein, are of a normal, recurring nature (refer to Note 2 for certain special charges recorded during the second quarter of 2004).nature. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year.
Certain reclassifications have been made to conform the 20032004 financial statements and notes to the 20042005 presentation.
Stock compensation plans
The company has a number of stock-based employee compensation plans, including stock option, stock purchase, restricted stock and restricted stock unit plans. The company appliesmeasures stock-based compensation expense using the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for these plans. In accordance with this intrinsic value method of accounting. Generally, no compensation expense is recognized for the company’s fixed stock options that have an exercise price equal to or greater than the market price on the date of grant, and employee stock option and purchase subscriptions.plans. Expense is recognized relating to restricted stock and restricted stock unit grants and certain modifications to stock options.
Under the fair value method, expense would be recognized for the company’s employee stock option and purchase plans. The following table illustrates the effect onshows net income and earnings per share (EPS) ifhad the company had applied the fair value recognition provisionsmethod of Statement of Financial Accounting Standards (SFAS) No. 123, “Accountingaccounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123,” to all stock-based employee compensation.
Three months ended Nine months ended (in millions, except per share data) 2004 2003 2004 2003 Net income, as reported Add: Stock-based employee compensation expense included in reported net income, net of tax Deduct: Total stock-based employee compensation expense determined under the fair value method, net of tax Pro forma net income Earnings per basic share As reported Pro forma Earnings per diluted share As reported Pro forma
September 30,
September 30, $276 $253 $282 $502 1 1 13 1 (19) (35) (79) (120) $258 $219 $216 $383 $0.45 $0.43 $0.46 $0.85 $0.42 $0.38 $0.35 $0.65 $0.45 $0.42 $0.46 $0.83 $0.42 $0.37 $0.35 $0.64
Three months ended March 31, | ||||
(in millions, except per share data) | 2005 | 2004 | ||
Net income, as reported | $ 226 | $ 176 | ||
Add: Stock-based employee compensation expense included in reported net income, net of tax | — | — | ||
Deduct: Total stock-based employee compensation expense determined under the fair value method, net of tax | 12 | 28 | ||
Pro forma net income | $ 214 | $ 148 | ||
Earnings per basic share | ||||
As reported | $0.37 | $0.29 | ||
Pro forma | $0.35 | $0.25 | ||
Earnings per diluted share | ||||
As reported | $0.36 | $0.28 | ||
Pro forma | $0.34 | $0.23 | ||
Changes inNew accounting principlesstandard
In December 2004, the Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), was adopted July 1, 2003. Refer to the company’s 2003 Form 10-K/A for further information. In December 2003 the FASB revised and reissued FIN 46 (FIN 46-R)FASB No. 123, “Share-Based Payment” (FASB No. 123-R), which requires companies to expense the value of employee stock options and similar awards. The standard was to become effective July 1, 2005. In April 2005, the SEC amended Regulation S-X to provide a six-month adoption deferral period for public companies. Therefore, FASB No. 123-R will not become effective until January 1, 2006. The new rules provide for one of two transition elections, either prospective application or restatement (back to January 1, 1995). The company plans to adopt FASB No. 123-R on January 1, 2006 and has not yet decided which transition option the company will use. Management is in the process of analyzing the provisions of FIN 46-R were required to be adopted no later than March 31, 2004. Baxter adopted FIN 46-R on March 31, 2004,FASB No. 123-R and adoption ofassessing the revised standard did not have a material impact on the company’s future consolidated financial statements. The pro forma effect of expensing employee stock options and similar awards under existing rules is presented above.
2. SUPPLEMENTAL FINANCIAL INFORMATION
Net pension and other postemployment benefits expense
The following is a summary of net expense relating to the company’s pension and other postemployment benefit (OPEB) plans.
Three months ended March 31, | ||||||
(in millions) | 2005 | 2004 | ||||
Pension benefits | ||||||
Service cost | $21 | $20 | ||||
Interest cost | 41 | 39 | ||||
Expected return on plan assets | (43 | ) | (48 | ) | ||
Amortization of net loss, prior service cost and transition obligation | 21 | 16 | ||||
Net pension plan expense | $40 | $27 | ||||
OPEB | ||||||
Service cost | $ 2 | $ 2 | ||||
Interest cost | 8 | 8 | ||||
Amortization of net loss and prior service cost | 3 | 2 | ||||
Net OPEB plan expense | $13 | $12 | ||||
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the Act) was signed into law. The Act introduces a prescription drug benefit under Medicare (Part D) as well as a federal subsidy to sponsors of retiree health-care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare (Part D). The final regulations for determining whether plans are actuarially equivalent to Medicare (Part D) were issued in January 2005. Based on these final regulations, management expects the company’s OPEB plan to be actuarially equivalent to Medicare (Part D), and that the company will be eligible for the federal subsidy. In accordance with GAAP, the estimated reduction in the accumulated OPEB obligation due to the federal subsidy will be reflected as an actuarial gain. The actuarial
gain will be amortized, reducing OPEB plan expense in the future. The effect on the company’s consolidated financial statements is not expected to be material.
Net interest expense
Net interest expense consisted of the following.
Three months ended September 30, | Nine months ended September 30, | Three months ended March 31, | ||||||||||||
(in millions) | 2004 | 2003 | 2004 | 2003 | 2005 | 2004 | ||||||||
Interest expense | $ 29 | $33 | $ 87 | $94 | $41 | $28 | ||||||||
Interest income | (9) | (7) | (21) | (21) | (10 | ) | (7 | ) | ||||||
Net interest expense | $ 20 | $26 | $ 66 | $73 | $31 | $21 | ||||||||
Continuing operations | $ 20 | $25 | $ 66 | $71 | ||||||||||
Discontinued operations | $— | $ 1 | $— | $ 2 | ||||||||||
Other income and expense, net
Other income and expense typicallyprincipally includes amounts relating to fluctuations in currencyforeign exchange, rates, minority interests, income and losses relating to equity method investments, and divestiture gains and asset impairment charges.
The increase in other expense for the three months ended September 30, 2004 principally related to foreign currency fluctuations. The increase in other expense for the nine months ended September 30, 2004 principally related to foreign currency fluctuations and lower equity method income. Equity method income was lower in 2004 because Baxter divested its equity method investment in Acambis, Inc. in late 2003.
In addition, asset impairment charges totaled $18 million and $13 million for the nine-month periods ended September 30, 2004 and 2003, respectively. The charges related to investments whose declines in value were deemed to be other than temporary, with the investments written down to estimated fair value, as determined by reference to quoted market values, where available (see below for more information regarding the second quarter 2004 special charge). Other expense for the year-to-date period ended September 30, 2004 also included a charge relating to the application of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), to the company’s guarantee of the Shared Investment Plan loans, as further discussed in Note 9. Included in other expense in the year-to-date period ended September 30, 2003 were $11 million in costs associated with the redemption of the company’s convertible bonds.losses.
Comprehensive income
Total comprehensive income was $352 million and $306$247 million for the three and nine months ended September 30, 2004, respectively,March 31, 2005 and $257 million and $539$191 million for the three and nine months ended September 30, 2003, respectively.March 31, 2004. The increase in comprehensive income during the quarter was2005 principally related to favorable currency translation adjustments and higher net income. The decrease in comprehensive income during the year-to-date period was principally related to unfavorable currency translation adjustments and lowerincreased net income partially offset by changesand favorable movements in the value of the company’s net investment and foreignhedges, partially offset by unfavorable currency cash flow hedges.translation adjustments.
Earnings per share
The numerator for both basic and diluted EPS is net earnings available to common shareholders.income. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The dilutive effect of outstanding employee stock options, employee stock purchase subscriptions and the purchase contracts in the company’s equity unitsother common stock equivalents is reflected in the denominator for diluted EPS by application ofusing the treasury stock method under SFAS No. 128, “Earnings per Share.” Prior to the adoption of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” on July 1, 2003, the dilutive effect of equity forward agreements was reflected in the denominator for diluted EPS by application of the reverse treasury stock method. Refer to the 2003 Form 10-K/A for additional information regarding the company’s equity units (which did not have a dilutive effect in either 2004 or 2003), as well as the equity forward agreements (which were terminated during the third quarter of 2003). The following is a reconciliation of thebasic shares (denominator) of the basic andto diluted per-share computations.shares.
(in millions) Basic shares Effect of dilutive securities Employee stock options Equity forward agreements Employee stock purchase plans Diluted shares Three months ended
September 30, Nine months ended
September 30, 2004 2003 2004 2003 615 589 613 595 3 1 3 1 — — — 7 1 2 1 1 619 592 617 604
Three months ended March 31, | ||||
(in millions) | 2005 | 2004 | ||
Basic shares | 619 | 612 | ||
Effect of dilutive securities | ||||
Employee stock options | 4 | 2 | ||
Employee stock purchase and other plans | — | 2 | ||
Diluted shares | 623 | 616 | ||
Inventories
Inventories consisted of the following.
(in millions) | September 30, 2004 | December 31, 2003 | March 31, 2005 | December 31, 2004 | ||||
Raw materials | $ 460 | $ 568 | $ 447 | $ 456 | ||||
Work in process | 813 | 731 | 690 | 754 | ||||
Finished products | 833 | 805 | 968 | 925 | ||||
Total inventories | $2,106 | $2,104 | $2,105 | $2,135 | ||||
Goodwill
Goodwill was $871$895 million, $602$578 million and $167$144 million for the Medication Delivery, BioScience and Renal segments, respectively, at September 30, 2004.March 31, 2005. Goodwill was $872$895 million, $605$583 million and $171$170 million for the Medication Delivery, BioScience and Renal segments, respectively, at December 31, 2003.2004. The change in the goodwill balance for each segment principally related to foreign currency fluctuations and a divestiture in currency exchange rates.
Other intangible assets
The following is a summary of the company’s intangible assets subject to amortization at September 30, 2004March 31, 2005 and December 31, 2003.2004. Intangible assets with indefinite useful lives are not material to the company.material.
(in millions, except amortization period data) | Developed technology, including patents | Manufacturing, distribution and other contracts | Other | Total | Developed technology, including patents | Manufacturing, distribution and other contracts | Other | Total | ||||||||
September 30, 2004 | ||||||||||||||||
March 31, 2005 | ||||||||||||||||
Gross intangible assets | $804 | $46 | $72 | $922 | $803 | $31 | $80 | $914 | ||||||||
Accumulated amortization | 308 | 28 | 21 | 357 | 343 | 15 | 27 | 385 | ||||||||
Net intangible assets | $496 | $18 | $51 | $565 | $460 | $16 | $53 | $529 | ||||||||
Weighted-average amortization period (in years) | 15 | 8 | 20 | 15 | 15 | 8 | 20 | 15 | ||||||||
December 31, 2003 | ||||||||||||||||
December 31, 2004 | ||||||||||||||||
Gross intangible assets | $802 | $39 | $74 | $915 | $804 | $28 | $80 | $912 | ||||||||
Accumulated amortization | 279 | 14 | 18 | 311 | 333 | 14 | 25 | 372 | ||||||||
Net intangible assets | $523 | $25 | $56 | $604 | $471 | $14 | $55 | $540 | ||||||||
Weighted-average amortization period (in years) | 15 | 9 | 20 | 15 | 14 | 8 | 20 | 15 | ||||||||
The amortization expense for these intangible assets was $16 million and $11$14 million for the three months ended September 30, 2004March 31, 2005 and 2003, respectively, and $48 million and $38$16 million for the ninethree months ended September 30, 2004 and 2003, respectively.March 31, 2004. At September 30, 2004,March 31, 2005, the anticipated annual amortization expense for these intangible assets is $67 million, $60 million, $56 million, $45$54 million, $46 million, $41 million, $40 million and $39 million in 2004, 2005, 2006, 2007, 2008, 2009 and 2009,2010, respectively.
Product warranties
The following is a summary of activity in the product warranty liability.
As of and for the September 30, | As of and for the nine months ended September 30, | As of and for the three months ended March 31, | ||||||||||||||||
(in millions) | 2004 | 2003 | 2004 | 2003 | 2005 | 2004 | ||||||||||||
Beginning of period | $52 | $52 | $53 | $53 | $57 | $53 | ||||||||||||
New warranties and adjustments to existing warranties | 6 | 7 | 16 | 20 | 7 | 3 | ||||||||||||
Payments in cash or in kind | (6 | ) | (8 | ) | (17 | ) | (22 | ) | (7 | ) | (6 | ) | ||||||
End of period | $52 | $51 | $52 | $51 | $57 | $50 | ||||||||||||
Second quarter 2004 special charges
Financial results for the nine-month period ended September 30, 2004 include several special charges recorded during the second quarter, in addition to the restructuring charge discussed in Note 4. These special charges, as summarized below, reduced pre-tax income from continuing
operations by $115 million, and reduced net income for the nine months ended September 30, 2004 by $20 million or $0.03 per diluted share. By line item, cost of goods sold increased $45 million, marketing and administrative expenses increased $55 million, other expense, net increased $15 million, and income tax expense decreased $95 million.
Accounts and other receivable reservesSecuritization arrangements
The company establishedcompany’s securitization arrangements resulted in net cash outflows of $52 million for the three months ended March 31, 2005 and $43 million for the three months ended March 31, 2004. A summary of the activity is as follows.
As of and for the three months ended | ||||||
(in millions) | 2005 | 2004 | ||||
Sold receivables at beginning of period | $594 | $742 | ||||
Proceeds from sales of receivables | 356 | 375 | ||||
Cash collections (remitted to the owners of the receivables) | (408 | ) | (418 | ) | ||
Foreign exchange | (3 | ) | 5 | |||
Sold receivables at end of period | $539 | $704 | ||||
The American Jobs Creation Act of 2004
In October 2004, the American Jobs Creation Act of 2004 (the Jobs Creation Act) was enacted. The Act includes numerous provisions, including the creation of a reserve duetemporary incentive for United States multinationals to repatriate accumulated income earned abroad. The temporary tax deduction of 85% of certain repatriated foreign earnings is subject to a number of limitations. Detailed final guidance necessary to implement the Jobs Creation Act has not yet been issued by the Internal Revenue Service. Management is analyzing the provisions of the Jobs Creation Act and has not yet determined the effects, if any, on the company’s plans or its consolidated financial statements. Management expects to complete its evaluation by the end of the third quarter of 2005. Refer to the uncertain collectibility of a loan from Cerus Corporation (Cerus). This reserve was determined based on Cerus’ current financial position. Also, based on the lengthening age of accounts receivables and more current market data in certain markets, the company increased the allowance for doubtful accounts. In addition, certain Shared Investment Plan participants defaulted on their loans, which were due and payable in May 2004 requiring the company to make payments to the bank under its guarantee arrangement. Refer to Note 9Annual Report for further information regarding the Shared Investment Plan. While the company has not forgiven any of these loans and is pursuing repayment of the defaulted amounts, a reserve was recorded for potential losses, representing the amount that the company paid to the bank under the loan guarantee as a result of the defaulted loans. These adjustments, which were recorded in marketing and administrative expenses, totaled $55 million.information.
3. RESTRUCTURING INITIATIVES
Inventories2004 Restructuring Charge
Based upon second quarter 2004 restructuring decisions in the Bioscience segment, which will reduce inventory production in an effort to focus on more profitable sales in the plasma market, the company expects that future sales in this market will be less than previously expected. As a result, the company increased inventory reserves (a charge to cost of goods sold) by $28 million.
Hedges
As discussed in the 2003 Form 10-K/A, the company uses forwards to hedge the risk to earnings relating to anticipated intercompany sales denominated in foreign currencies (cash flow hedges). Based on a second quarter 2004 analysis, intercompany sales from the United States to Europe (denominated in Euros) are expected to be lower than originally projected. In particular, due to the strong European sales launch of ADVATE (Antihemophilic Factor (Recombinant), Plasma/Albumin-Free Method) rAHF-PFM, the company’s advanced recombinant therapy (which is manufactured in Europe), the second quarter 2004 forecasts of intercompany sales of Recombinate Antihemophilic Factor (rAHF) from the United States into Europe had been reduced. Because it was probable that these originally forecasted sales would no longer occur, the related deferred hedge loss was recorded as a $17 million charge to cost of goods sold.
Pathogen Inactivation program assets
As a result of lower than expected sales from the company’s Pathogen Inactivation programs, strategic decisions announced inDuring the second quarter of 2004, by Cerus, along with an assessment of future market potential for these products, the company performed an impairment review of its fixed assets in this program and recorded a $15 million impairment charge, which was classified as other expense.
Income taxes
The income tax benefit relating to the above-mentioned charges totaled $40 million. In addition, as a result of the completion of tax audits in the second quarter of 2004, $55 million of reserves for matters previously under review were reversed into income in the quarter.
3. DISCONTINUED OPERATIONS
During the fourth quarter of 2002, the company recorded a $294$543 million pre-taxrestructuring charge ($229 million on an after-tax basis) principally associated with management’s decision to divest the majority of the services businesses included in the Renal segment. Refer to the 2003 Form 10-K/A for further information.
During 2003, the company sold RMS Lifeline, Inc. and RMS Disease Management, Inc. and the Medication Delivery segment’s offsite pharmacy admixture products and services business, and closed or had under contract the majority of transactions in connection with the divestiture of the Renal Therapy Services centers. Management expects the divestiture plan to be completed during 2004.
Net revenues relating to the discontinued businesses were $2 million and $42 million for the three months ended September 30, 2004 and 2003, respectively, and $22 million and $142 million for the nine months ended September 30, 2004 and 2003, respectively. During 2004, discontinued operations generated income of $17 million and $5 million for the three- and nine-month periods ended September 30, respectively (net of tax benefits of $24 million and $28 million, respectively). The income was principally related to tax and other adjustments, as the company completes divestitures. During 2003, discontinued operations generated losses of $5 million and $17 million for the three- and nine-month periods ended September 30, respectively (net of tax benefits of $3 million and $6 million, respectively).
Included in the pre-tax charge was $269 million pertaining to asset impairments, principally relating to goodwill and property and equipment. Also included in the charge was $25 million for cash costs, principally relating to severance and other employee-related costs associated with the elimination of approximately 75 positions, as well as legal and contractual commitment costs. Approximately $2 million of the reserve for cash costs was utilized during 2004. The remaining reserve is insignificant and is expected to be substantially utilized in 2004.
4. RESTRUCTURING INITIATIVES
Second quarter 2004 restructuring charge
In January 2004, management announced plans (which were finalized during the second quarter of 2004) to implement restructuring initiatives (in addition to the actions initiated in 2003, as discussed below). Management undertook these actions in order to reduce the company’s overall cost structure and to drive sustainable improvements in financial performance. The charge was primarily for severance and costs associated with the closing of facilities (including the closure of additional plasma collection centers) and the exiting of contracts.
These actions include the elimination of over 4,000 positions, or 8% of the global workforce, as management reorganizes and streamlines the company. Approximately 50% of the positions being eliminated are in the United States. Approximately three quartersthree-quarters of the estimated savings impact general and administrative expenses, with the remainder primarily impacting
cost of sales. The eliminations impact all three of the company’s segments, along with the corporate headquarters and functions. Baxter is also further reducing plasma production and closing additional plasma collection centers. In addition, the company is exiting certain other facilities and activities. As a result, management recorded a restructuring charge in the second quarter of 2004 totaling $543 million ($394 million, or $0.64 per diluted share, on an after-tax basis), principally for severance and costs associated with the closing of facilities and the exiting of contracts.
Included in the 2004 pre-tax charge was $196 million relating to asset impairments, almost all of which was to write down property, plant and equipment (PP&E), based on market data for the assets. Also included in the 2004 pre-tax charge was $347 million for cash costs, principally pertaining to severance and other employee-related costs. Approximately one thirdthree-quarters of the targeted positions have been eliminated as of September 30, 2004.March 31, 2005.
Second quarter 2003 restructuring chargeRestructuring Charge
During the second quarter of 2003, the company recorded a $337 million restructuring charge ($202 million, or $0.33 per diluted share, on an after-tax basis) principally associated with management’s decision to close certain facilities and reduce headcount on a global basis. Management decided to takeundertook these actions in order to position the company more competitively and to enhance profitability. The company has closed 26 plasma collection centers across the United States, as well asand a plasma fractionation facility located in Rochester, Michigan.facility. In addition, the company has consolidated and integrated several facilities, including facilities in Maryland; Frankfurt, Germany; Issoire, France; and Mirandola, Italy.facilities. Management discontinued Baxter’s recombinant hemoglobin protein program because it did not meet expected clinical milestones. Also included in the charge were costs related to other reductions in the company’s workforce.
Included in the 2003 pre-tax charge was $128 million relating to asset impairments, principally to write down PP&E, and goodwill and other intangible assets. The impairment loss relating to the PP&E was based on market data for the assets. The impairment loss relating to goodwill and other intangible assets was based on management’s assessment of the value of the related businesses. Also included in the 2003 pre-tax charge was $209 million for cash costs, principally pertaining to severance and other employee-related costs associated with the elimination of approximately 3,200 positions worldwide. Virtually all of the targeted positions have been eliminated as of September 30, 2004,March 31, 2005, and the program is substantially complete, except for remaining severance and other cash payments to be made in the future.
Restructuring reservesReserves
The following summarizes activity in the company’s restructuring reserves for cash costs for the nine-month period ended September 30, 2004.through March 31, 2005.
(in millions) | Employee- related costs | Contractual and other costs | Total | Employee- related costs | Contractual and other costs | Total | ||||||||||||
2003 Restructuring Charge | ||||||||||||||||||
Charge | $160 | $ 49 | $209 | |||||||||||||||
Utilization | (63 | ) | (6 | ) | (69 | ) | ||||||||||||
Reserve at December 31, 2003 | $ 97 | $ 43 | $140 | 97 | 43 | 140 | ||||||||||||
Utilization | (25 | ) | (12 | ) | (37 | ) | (74 | ) | (17 | ) | (91 | ) | ||||||
Reserve at March 31, 2004 | $ 72 | $ 31 | $103 | |||||||||||||||
Reserve at December 31, 2004 | 23 | 26 | 49 | |||||||||||||||
Utilization | (19 | ) | (1 | ) | (20 | ) | (5 | ) | (1 | ) | (6 | ) | ||||||
Reserve at June 30, 2004 | $ 53 | $ 30 | $ 83 | |||||||||||||||
Utilization | (23 | ) | (3 | ) | (26 | ) | ||||||||||||
Reserve at September 30, 2004 | $ 30 | $ 27 | $ 57 | |||||||||||||||
Reserve at March 31, 2005 | $ 18 | $ 25 | $ 43 | |||||||||||||||
2004 Restructuring Charge | ||||||||||||||||||
Charge | $212 | $135 | $347 | $212 | $135 | $347 | ||||||||||||
Utilization | (4 | ) | — | (4 | ) | (60 | ) | (32 | ) | (92 | ) | |||||||
Reserve at June 30, 2004 | $208 | $135 | $343 | |||||||||||||||
Reserve at December 31, 2004 | 152 | 103 | 255 | |||||||||||||||
Utilization | (29 | ) | (18 | ) | (47 | ) | (26 | ) | (11 | ) | (37 | ) | ||||||
Reserve at September 30, 2004 | $179 | $117 | $296 | |||||||||||||||
Reserve at March 31, 2005 | $126 | $ 92 | $218 | |||||||||||||||
With respect to the 2003 restructuring charge, the majority of the severance and other costs areremaining reserve is expected to be paid in 2004.utilized during 2005. With respect to the 2004 restructuring charge, approximately $50$150 million of the reserve is expected to be paidutilized during full-year 2005, with the remainder of 2004, approximately $150 million in 2005, and the remainderto be utilized in 2006.
5. SECURITIZATIONS
Where economical, the company has entered into agreements with various financial institutions in which undivided interest in certain pools of receivables are sold. Refer to the 2003 Form 10-K/A for further information regarding these arrangements. There have been no material changes in the company’s accounting policies with respect to its securitization arrangements. The key assumptions used in measuring the fair values of the retained interests are substantially unchanged from those disclosed in the 2003 Form 10-K/A.
Baxter’s securitization arrangements resulted in net cash outflows of $84 million and $274 million for the three and nine months ended September 30, 2004, respectively, and generated net cash inflows of $10 million and net cash outflows of $44 million for the three and nine months ended September 30, 2003, respectively.
A summary of the activity for these securitization arrangements is as follows.
(in millions) | Three months ended September 30, | Nine months ended September 30, | ||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||
Sold receivables at beginning of period | $ 547 | $ 644 | $ | 742 | $ | 721 | ||||||||
Proceeds from sales of receivables | 307 | 458 | �� | 1,000 | 1,334 | |||||||||
Cash collections (remitted to the owners of the receivables) | (391 | ) | (448 | ) | (1,274 | ) | (1,378 | ) | ||||||
Effect of currency exchange rate changes | (1 | ) | 7 | (6 | ) | (16 | ) | |||||||
Sold receivables at end of period | $ 462 | $ 661 | $ | 462 | $ | 661 | ||||||||
6. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
Net pension and other postretirement benefits cost
The following is a summary of net expense relating to the company’s pension and other postretirement benefit plans.
(in millions) | Three months ended September 30, | Nine months ended September 30, | ||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||
Pension benefits | ||||||||||||
Service cost | $ 19 | $ 18 | $ 59 | $ 51 | ||||||||
Interest cost | 38 | 38 | 114 | 104 | ||||||||
Expected return on assets | (47 | ) | (48 | ) | (141 | ) | (134 | ) | ||||
Amortization of net loss, prior service cost and transition obligation | 16 | 6 | 47 | 18 | ||||||||
Net periodic pension benefit cost | $ 26 | $ 14 | $ 79 | $ 39 | ||||||||
Other benefits | ||||||||||||
Service cost | $ 3 | $ 2 | $ 7 | $ 6 | ||||||||
Interest cost | 7 | 7 | 22 | 21 | ||||||||
Amortization of net loss and prior service cost | 2 | 2 | 7 | 4 | ||||||||
Net periodic other benefit cost | $ 12 | $ 11 | $ 36 | $ 31 | ||||||||
Medicare Prescription Drug, Improvement and Modernization Act
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the Act) was signed into law. The Act introduces a prescription drug benefit under Medicare (Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare (Part D). Detailed final regulations necessary to implement the Act have not yet been issued. The effects of the Act are not recognized in the company’s net expense and benefit obligation as management is not yet able to determine whether the company’s benefits are actuarially equivalent to Medicare (Part D). However, based on preliminary analyses, management has determined that any impact of the Act on the company’s consolidated financial statements will not be material.
7.4. LEGAL PROCEEDINGS COMMITMENTS AND CONTINGENCIES
Refer to “Part II –- Item 1. Legal Proceedings” below.
8.5. SEGMENT INFORMATION
The company operates in three segments, each of which areis a strategic businessesbusiness that areis managed separately because each business develops, manufactures and sells distinct products and services. The segments and a description of their businessesproducts and services are as follows:
Medication Delivery, which provides a range of intravenous solutions and specialty products that are used in combination for fluid replenishment, general anesthesia, nutrition therapy, pain management, antibiotic therapy and antibiotic therapy;chemotherapy;BioScience, which develops biopharmaceuticals, biosurgery products, vaccines and blood collection, processing and storage products and technologies for transfusion therapies; andRenal, which develops products and provides services to treat end-stage kidney disease.
Certain items are maintained at the corporate headquarterslevel (Corporate) and are not allocated to the segments. They primarily include most of the company’s debt and cash and equivalents and related net interest expense, corporate headquarters costs, certain non-strategic investments and related income and expense, certain nonrecurring gains and losses, certain special charges (such as in-process research and development, restructuring and restructuring)certain asset impairments), deferred income taxes, certain foreign currency fluctuations, certain employee benefit costs, the majority of the foreign currency and interest rate hedging activities, and certain litigation liabilities and related insurance receivables.
Financial information for the company’s segments for the quarter and year-to-date periodquarters ended September 30March 31 is as follows.
(in millions) | Three months ended September 30, | Nine months ended September 30, | ||||||||||||||||||
Three months ended March 31, | ||||||||||||||||||||
(in millions) | 2004 | 2003 | 2004 | 2003 | 2005 | 2004 | ||||||||||||||
Medication Delivery | $ 986 | $ 945 | $ | 2,918 | $ | 2,730 | $ 978 | $ 926 | ||||||||||||
BioScience | 849 | 820 | 2,552 | 2,333 | 902 | 810 | ||||||||||||||
Renal | 485 | 451 | 1,438 | 1,310 | 503 | 473 | ||||||||||||||
Total | $2,320 | $2,216 | $ | 6,908 | $ | 6,373 | $2,383 | $2,209 | ||||||||||||
Pre-tax income from continuing operations | ||||||||||||||||||||
Medication Delivery | $ 191 | $ 184 | $ | 524 | $ | 480 | $ 157 | $ 151 | ||||||||||||
BioScience | 181 | 161 | 440 | 460 | 204 | 122 | ||||||||||||||
Renal | 87 | 81 | 259 | 226 | 97 | 80 | ||||||||||||||
Other | (113 | ) | (65 | ) | (960 | ) | (534 | ) | (160 | ) | (104 | ) | ||||||||
Total | $ 346 | $ 361 | $ | 263 | $ | 632 | $ 298 | $ 249 | ||||||||||||
The following is a reconciliation of segment pre-tax income to income from continuing operations before income taxesto the totals per the consolidated income statements.
(in millions) | Three months ended September 30, | Nine months ended September 30, | ||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||
Total pre-tax income from segments | $459 | $426 | $ | 1,223 | $ | 1,166 | ||||||||
Unallocated amounts | ||||||||||||||
Interest expense, net | (20 | ) | (25 | ) | (66 | ) | (71 | ) | ||||||
Restructuring charge | — | — | (543 | ) | (337 | ) | ||||||||
Certain currency exchange rate fluctuations and hedging activities | (21 | ) | (16 | ) | (91 | ) | (49 | ) | ||||||
Other corporate items | (72 | ) | (24 | ) | (260 | ) | (77 | ) | ||||||
Income from continuing operations before income taxes and cumulative effect of accounting changes | $346 | $361 | $ | 263 | $ | 632 | ||||||||
Three months ended March 31, | ||||||
(in millions) | 2005 | 2004 | ||||
Total pre-tax income from segments | $458 | $353 | ||||
Unallocated amounts | ||||||
Net interest expense | (31 | ) | (21 | ) | ||
Foreign exchange fluctuations and hedging activities | (24 | ) | (34 | ) | ||
Other Corporate items | (105 | ) | (49 | ) | ||
Income from continuing operations before income taxes | $298 | $249 | ||||
9. SHARED INVESTMENT PLAN
As discussed in the 2003 Form 10-K/A, in order to align management and shareholder interests, in 1999 the company sold 6.1 million shares of the company’s stock to 142 of Baxter’s senior managers for $198 million in cash. The participants used five-year full-recourse personal bank loans to purchase the stock at the May 3, 1999 closing price (adjusted for the company’s stock split) of $31.81. Baxter guaranteed repayment to the banks in the event a participant in the plan defaulted on his or her obligations, which were due on May 6, 2004. The plan also included certain risk-sharing provisions, which terminated on May 6, 2004. The company was entitled to 50% of any gain relating to stock sold on or before May 3, 2002. For stock sold after May 3, 2002 and through May 6, 2004, the company shared 50% in any loss incurred by the participants relating to a stock price decline.
In May 2003, management announced that, in order to continue to align management and shareholder interests and to balance both the short- and long-term needs of Baxter, the board of directors authorized the company to provide a new three-year guarantee at the May 6, 2004 loan due date for the non-executive officer employees who remain in the plan, should they elect to extend their loans. As noted above, as of May 6, 2004, the 50% risk-sharing provision included in the original plan terminated. The amount under the company’s loan guarantee at September 30, 2004 relating to the 70 eligible employees who have extended their loans was $95 million. In accordance with FIN 45 (which was effective for guarantees issued or modified after December 31, 2002), the company has recorded a $5 million liability for the fair value of these guarantees. As with the guarantee issued in 1999, the company may take actions relating to participants and their assets to obtain full reimbursement for any amounts the company pays to the banks pursuant to the loan guarantee.
With respect to the participants who were either not eligible or did not elect to extend their loans on the May 6, 2004 due date, the majority paid their principal and interest obligations in full. However, seven participants did not pay their principal and interest obligations in full on the due date. While the company has not forgiven any of these loans, a reserve of $10 million, which represented the amount that the company paid to the banks under the loan guarantee, was recorded during the second quarter of 2004 for potential losses (as discussed in Note 2 above).
The company collected monies during the third quarter from certain of the participants, and the reserve balance totaled $8 million at September 30, 2004. The company is pursuing repayment of the remaining defaulted loan balance in order to obtain full reimbursement for amounts the company paid to the bank pursuant to the loan guarantee.
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Refer to the company’s Form 10-K/A for the year ended December 31, 20032004 Annual Report for management’s discussion and analysis of the financial condition and results of operations of Baxter International Inc. and its subsidiaries (thethe company or Baxter) for the year ended December 31, 2003.2004. The following is management’s discussion and analysis of the financial condition and results of operations of the company for the quarter and year-to-date period ended September 30, 2004.March 31, 2005.
RESULTS OF CONTINUING OPERATIONS
NET SALES
Three months ended September 30, | Percent increase | Nine months ended September 30, | Percent increase | Three months ended March 31, | Percent change | |||||||||||||
(in millions) | 2004 | 2003 | 2004 | 2003 | 2005 | 2004 | ||||||||||||
International | $1,218 | $1,149 | 6% | $3,693 | $3,353 | 10% | ||||||||||||
United States | 1,102 | 1,067 | 3% | 3,215 | 3,020 | 6% | ||||||||||||
Medication Delivery | $ 978 | $ 926 | 6% | |||||||||||||||
BioScience | 902 | 810 | 11% | |||||||||||||||
Renal | 503 | 473 | 6% | |||||||||||||||
Total net sales | $2,320 | $2,216 | 5% | $6,908 | $6,373 | 8% | $2,383 | $2,209 | 8% | |||||||||
Three months ended March 31, | Percent change | |||||
(in millions) | 2005 | 2004 | ||||
International | $1,339 | $1,190 | 13% | |||
United States | 1,044 | 1,019 | 2% | |||
Total net sales | $2,383 | $2,209 | 8% | |||
CurrencyForeign exchange rate fluctuations benefited sales growth by 3 points and 4 points duringin the three and nine months ended September 30, 2004, respectively,first quarter of 2005 principally because the United States Dollar weakened since the prior year periods relative to the Euro. TheseEuro and the Japanese Yen. Foreign currency fluctuations favorably impacted sales growth for all three segments. Refer to Note 8 for a summary of net sales by segment.
Medication Delivery
TheNet sales for the Medication Delivery segment generated 4% and 7% sales growth forincreased 6% during the three- and nine-month periodsthree months ended September 30, 2004, respectivelyMarch 31, 2005 (including 2 and 3 percentage points relating to the favorable impact of foreign currency fluctuations for the quarter and year-to-date period, respectively)exchange).
IncreasedThe following is a summary of sales by significant product line.
Three months ended March 31, | Percent change | ||||||
(in millions) | 2005 | 2004 | |||||
IV Therapies | $296 | $282 | 5% | ||||
Drug Delivery | 204 | 188 | 9% | ||||
Infusion Systems | 230 | 188 | 22% | ||||
Anesthesia | 231 | 242 | (5% | ) | |||
Other | 17 | 26 | (35% | ) | |||
Total net sales | $978 | $926 | 6% | ||||
IV Therapies
This product line principally consists of intravenous solutions and nutritional products. Because approximately two-thirds of IV Therapies’ sales are generated outside the United States, sales growth in this product line particularly benefited from the weakened United States Dollar in the first quarter of 2005. Sales growth, which was primarily due to increased volume, was strong in international markets, partially offset by lower sales of nutritional products used with automated compounding equipment in the United States.
Drug Delivery
This product line primarily consists of drugs and contract services, principally for pharmaceutical and biotechnology customers. Sales growth in this product line for the first quarter of 2005 was principally driven by $9 million of sales under an existing order from the United States Government related to its biodefense program. In addition, increased sales of certain generic and branded pre-mixed drugs as well as increased contract services revenues, contributed 1 point and 2 points ofto sales growth forin the first quarter and year-to-date period, respectively. of 2005, with the growth driven by increases in volume, partially offset by lower pricing.
Infusion Systems
Sales of intravenous therapies, which principally include intravenous solutions and nutritional products, were flat for the quarter and contributed 2 points to the segment’s growth rate for the year-to-date period. Sales of anesthesia and critical care products were flat for the quarter and contributed 1 point to the segment’s growth rate for the nine-month period, with pricing stable for both periods, and volume impacted by domestic wholesaler inventory reduction actions. Sales of electronic infusion pumps and related tubing sets contributed 3 pointsduring the first quarter of 2005 was primarily driven by higher sales of devices, and 2 pointswas particularly strong due to the growth rate fortiming of customers’ purchases. Device volume was strong in both the United States and international markets, partially offset by reduced pricing related to certain renegotiated group purchasing organization contracts in the United States.
Anesthesia
Sales of anesthesia products declined during the first quarter and year-to-date periods, respectively,of 2005, with devicethe reduced sales the primary contributors. Increased device volume primarily driven by wholesaler stocking actions in the United States during the fourth quarter andof 2004. The wholesaler actions impacted sales of certain proprietary products, such as SUPRANE (Desflurane, USP), an inhaled anesthetic agent. As discussed in the United States2004 Annual Report, management continues to believe additional competitors may enter the market in 2005 with a generic propofol, which could unfavorably impact market share and Canadapricing for this product.
Other
This category primarily includes other hospital-distributed products. The decline in sales during the year-to-date period,first quarter of 2005 was partially offset by reduced pricing. The growth in volume in the United States in 2004 was partially due to the timing of group purchasing organization (GPO) contract awards, as certain customers delayed capital purchases in the prior year in anticipation of a new contract award. The reduced pricing, which is expected to impact growth for the remainder of
2004, is primarily due to the renegotiated long-term contracts withcontinued exit of certain GPOs, principally Premier Purchasing Partners L. P. (Premier). The most significant renegotiated Premier contract became effective in February 2004. Management believes that over time,lower-margin distribution businesses outside the impact of reduced pricing will be substantially offset by increased sales volumes and product mix upgrades.United States.
BioScience
Sales inNet sales for the BioScience segment increased 4% and 9% for11% during the three- and nine-month periodsthree months ended September 30, 2004, respectivelyMarch 31, 2005 (including 4 and 53 percentage points duerelating to the favorable impact of foreign currency fluctuations for the quarter and year-to-date period, respectively)exchange).
The following is a summary of sales by significant product line.
Three months ended March 31, | Percent change | ||||||
(in millions) | 2005 | 2004 | |||||
Recombinants | $344 | $292 | 18% | ||||
Plasma Proteins | 259 | 238 | 9% | ||||
Antibody Therapy | 89 | 80 | 11% | ||||
Transfusion Therapies | 133 | 140 | (5% | ) | |||
Other | 77 | 60 | 28% | ||||
Total net sales | $902 | $810 | 11% | ||||
Recombinants
The primary driver of sales growth in the segment’s growth rate forBioScience segment during the first quarter and year-to-date periodof 2005 was increased sales volume of recombinant Factor VIII products. Factor VIII products contributing 6 points and 7 points of growthare used in the three- and nine-month periods, respectively. Growthtreatment of hemophilia A, which is a bleeding disorder caused by a deficiency in salesblood clotting Factor VIII. Sales growth for the first quarter of recombinant products in both the quarter and year-to-date period2005 was principallyprimarily fueled by the continued launch of the advanced recombinant therapy, ADVATE (Antihemophilic Factor (Recombinant), Plasma/Albumin-Free Method) rAHF-PFM, which received regulatory approval in the United States in July 2003 and in Europe in March 2004. Partially offsettingADVATE is the growthfirst and only Factor VIII product made without any added human or animal proteins in the cell culture, purification or final formulation process, thereby eliminating the risk of infections caused by viruses that could potentially be contained in these proteins. Increased sales volume relating to the ADVATE launch in the year-to-date periodfirst quarter of 2005 was the impact of reductions in wholesaler inventory levels of recombinant productspartially offset by reduced pricing in the United States which managementas compared to the prior year quarter. Management expects sales volumes of ADVATE will continue for the remainder of the year. Management expects an increased sales contribution from ADVATE during the remainder of 2004to grow in 2005 as the launch of this new product continues.continues, and as pricing remains stable.
SalesPlasma Proteins
The growth in sales of plasma-based products (excluding anti-bodyantibody therapies) increased slightly during the first quarter and contributed 2 points to the segment’s growth rate in the year-to-date period. The increase in the quarter was due solely to foreign currency fluctuations. The growth in the year-to-date periodof 2005 was primarily due to increased sales volume of FEIBA, an anti-inhibitor coagulant complex, along with increased sales volume of the company’s plasma-based sealant, TISSEEL, and the timing of certain tenders outside the United States. Overall, pricing of this product,was stable to slightly increasing. This growth was partially offset by reduced pricing in other product lines. Increasedlower sales of FEIBA were partially offset by the impact of competitive pressures across certain product lines, as well as a continuing shift in the market from plasma-basedplasma to recombinant hemophilia products. As discussed further below,third parties as a result of these competitive pressures,management’s decision to exit certain lower-margin contracts. During the first quarter of 2005, and effective in the third quarter of 2005, the company closed 26 plasma collection centers and the American Red Cross terminated their contract manufacturing agreement and replaced it with a plasma fractionation plant during 2003, andprocurement agreement. For the second half of 2005, this new arrangement is reducing plasma production and closing additional centers during 2004,expected to improveresult in lower revenues for the profitability ofPlasma Proteins product line as compared to the business.prior arrangement (this impact is expected to be offset by increased sales in the Antibody Therapy product line, as further discussed below).
Antibody Therapy
Higher sales of anti-body therapies, including IGIV (immune globulin intravenous) forIVIG (intravenous immunoglobulin), which is used in the treatment of immune deficiencies, contributed 1 point and 2 points tofueled sales growth during the growth rate for thefirst quarter and year-to-date period, respectively, principallyof 2005, primarily due to improved pricing in the United States and,as well as increased sales volume. Sales volume is expected to grow in the year-to-date period, highersecond half of the year as a result of the recently executed plasma procurement agreement with the American Red Cross which, as discussed above, is effective in the third quarter of 2005. Sales are also expected to increase during the remainder of 2005 as a result of the company recently assuming the exclusive rights to market and distribute Cangene Corporation’s WinRho® SDF [Rho(D) Immune Globulin Intravenous (Human)] product availabilityin the United States. WinRho SDF is used to treat a critical bleeding disorder. In addition, a liquid formulation of IVIG, which received regulatory approval in the United States in April 2005 and is expected to be launched in the fourth quarter of 2005, is expected to fuel sales growth in the future, partly due to cycle time reduction initiatives.more favorable pricing and higher yields generated from the liquid formulation process.
Partially offsetting the growth in these product lines was the impact of lower salesTransfusion Therapies
Sales of transfusion therapies products, which are products and vaccinessystems for use in both the collection and preparation of blood and blood components, continued to be unfavorably impacted by consolidation in the plasma industry during the first quarter of 2005. Sales growth in the future is expected to be fueled by continued penetration in the United States of ALYX, the new system for the automated collection of red blood cells and year-to-date period. The lower salesplasma.
Other
Other BioScience products primarily consist of vaccines principally relatedand non-plasma-based sealant products. Sales of vaccines increased during the first quarter of 2005 as a result of the timing of government tenders, particularly relating to smallpox and Neis-Vac-CNeisVac-C (for the prevention of meningitis C) vaccines. Sales of vaccines. The company’s non-plasma-based sealants are impacted by the timing of government tenders,relatively new products, and there were no significant tenders filledsales increased during the first nine monthsquarter of 2004. Management expects that2005 as the segment’s growth for the remainder of the year will continuecompany continues to be impacted by lower sales of plasma and transfusion therapies products due to consolidation in the plasma industry.
Renal
Sales from continuing operations inNet sales for the Renal segment increased 8% and 10% for6% during the three- and nine-month periodsthree months ended September 30, 2004, respectivelyMarch 31, 2005 (including 4 and 6 percentage points respectively, duerelating to the favorable impact of foreign currency fluctuations)exchange). Increased
The following is a summary of sales of productsby significant product line.
Three months ended March 31, | Percent change | ||||||
(in millions) | 2005 | 2004 | |||||
PD Therapy | $374 | $345 | 8% | ||||
HD Therapy | 126 | 124 | 2% | ||||
Other | 3 | 4 | (25% | ) | |||
Total net sales | $503 | $473 | 6% | ||||
PD Therapy
Peritoneal dialysis, or PD Therapy, is a dialysis treatment method for end-stage renal disease. PD Therapy, which is used primarily at home, uses the peritoneal dialysis contributed 5 points and 7 pointsmembrane, or abdominal lining, as a natural filter to remove waste from the segment’s growth rate for the quarter and year-to-date periods, respectively.bloodstream. In addition to the favorable impact of foreign currency fluctuations,exchange, the sales growth in both periods was primarily driven by an increased number of peritoneal dialysis patients, principally in Europe, JapanAsia, Latin America and Asia.Japan. Changes in the pricing of the segment’s peritoneal dialysisPD Therapy products were not a significant factor. Increased penetration of PD Therapy products for peritoneal dialysis continues to be strongeststrong in emerging markets, where many people with end-stage renal disease are currently under-treated. The remaining 3 points
HD Therapy
Hemodialysis, or HD Therapy, is another form of end-stage renal disease dialysis therapy, which is generally performed in a hospital or outpatient center. HD Therapy works by removing wastes and fluid from the blood by using a machine and a filter, also known as a dialyzer. This product line includes sales of products as well as revenues from the Renal Therapy Services (RTS) businesses outside the United States. Sales growth for both the first quarter andof 2005 was driven by the nine-month period ended September 30, 2004, respectively, was primarily relatedRTS businesses. RTS revenues from continuing operations are expected to increased salesdecline in 2005 due to planned divestitures. As discussed below, the company divested its RTS business in Taiwan at the end of hemodialysis hardware and related products.the first quarter of 2005.
GROSS MARGIN AND EXPENSE RATIOS
Three months ended March 31, Gross margin Marketing and administrative expensesThe following table shows key ratios of certain income statement items as a percent of sales. 2005 2004 Change 40.7% 40.4% 0.3 pts 20.3% 21.1% (0.8 pts )
Gross Margin
Three months ended September 30, | Change | Nine months ended September 30, | Change | |||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||
Gross margin | 41.5% | 43.7% | (2.2 pts | ) | 40.5% | 44.2% | (3.7 pts | ) | ||||||
Marketing and administrative expenses | 19.9% | 19.9% | — pts | 21.1% | 20.7% | 0.4 pts |
The declineimprovement in gross margin in both the first quarter of 2005 was principally driven by increased sales of higher-margin recombinant products and year-to-date period was impacted by changes in product mix. Incost savings related to the BioScience segment, the gross margin declined in the year-to-date period principally because increased margins in certain product lines, such as recombinants,company’s restructuring initiatives (as further discussed below). These increases were partially offset by lower sales of other high-margin products. Inan unfavorable mix in the Medication Delivery segment, the above-mentioned pricing pressures associated with the renegotiated contracts with Premier contributed to Baxter’s margin decline in both the quarter and year-to-date period. In the Renal segment, the margin declined in both the quarter and nine-month periodwhich was partially due to an unfavorable mix oflower sales of peritoneal and hemodialysis products. In addition, while 2004 sales benefited from the effect of foreign currency fluctuations, principally relating to the strengthened Euro, the gross margin was unfavorably impacted by the company’s foreign currency hedging activities, especially in the year-to-date period ended September 30, 2004. Increased inventory reserves and foreign currency hedge adjustments totaling $45 million (included in the second quarter 2004 special charges, which are discussed in Note 2) accounted for almost 1 point of the decline during the year-to-date period.Anesthesia product line. In addition, costs associated with the company’s employee pension and other postretirementpostemployment benefit (OPEB) plans have increased sinceas compared to the prior year periodsquarter (as further discussed below). These factors, which unfavorably impacted the company’s gross margin, were partially offset by cost savings relating to the company’s 2003
Marketing and 2004 restructuring programs (as further discussed below).Administrative Expenses
Marketing and administrative expenses as a percent of sales decreased as a result of cost savings relating to the company’s restructuring initiatives and other actions designed to reduce the company’s expense base. These cost reductions were flat forpartially offset by the quarter andimpact of increased during the year-to-date period. Increased receivable reserves totaling $55 million (discussed in Note 2) increased the expense ratio by approximately 1 point in the year-to-date period. Expenses also increased because of foreign currency fluctuations, employee pension and other postretirement benefitOPEB plan costs, and the impact of reduced costs in the prior year
due to a change in the employee vacation policy. Offsetting these increases were the benefits of the company’s restructuring programs. See further discussion below regarding the restructuring initiatives.costs.
Employee Benefit Plan Expenses associated with the company’s pension
Pension and other postretirement benefit plansOPEB plan expenses increased $13 million and $45$14 million during the thirdfirst quarter and first nine months of 2004, respectively,2005, as detailed in Note 6, principally2, partially offsetting the above-mentioned improvements to the company’s gross margin and expense ratios. The increased pension and OPEB plan expenses were due to a reductionchanges in the discount rate and theexpected return on assets assumptions, as well as increased amortization of unrecognized losses. Refer to the 2003 Form 10-K/A2004 Annual Report for further information. Expenses associated with Baxter’s pension and other postretirement benefit plans are expected to further increase in 2005, by approximately $40 million, primarily due to changes in pension assumptions. The 2005 assumptions for the domestic plans, which represent over three-quarters of the company’s total pension assets and obligation, will be reduced from 6.00% to 5.75% (discount rate) and from 10% to 8.5% (expected return on assets). The discount rate assumption change is due to reductions in market interest rates used to determine the appropriate pension discount rate. The change in the expected return on assets assumption is a result of anticipated changes in the company’s pension trust asset allocation.
RESEARCH AND DEVELOPMENT
Three months ended March 31, | Percent change | ||||||||||||||||||||
(in millions) | Three months ended September 30, | Percent decrease | Nine months ended September 30, | Percent decrease | 2005 | 2004 | |||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||||||
Research and development (R&D) | $124 | $137 | (9% | ) | $389 | $412 | (6% | ) | $133 | $136 | (2% | ) | |||||||||
As a percent of sales | 5.3% | 6.2% | 5.6% | 6.5% | |||||||||||||||||
as a percent of sales | 5.6% | 6.2% |
R&D expenses declined in both the thirdfirst quarter and first nine months of 2004,2005, with increased spending on certain projects across the three segments more than offset by restructuring-related cost savings. Management expects that full-year 2005 R&D expenses will increase over the cost savings generated by the restructuring initiatives and the termination of certain programs (suchprior year as the recombinant hemoglobin protein project, which was terminatedcompany invests in the second quarter of 2003). Management expects a similar decline invarious R&D spending duringprojects across the fourth quarter of 2004.three segments.
RESTRUCTURING INITIATIVES
Second quarter 2004 restructuring charge
In January 2004, management announced plans (which were finalized duringDuring the second quarter of 2004)2004, the company recorded a $543 million restructuring charge principally associated with management’s decision to implement restructuring initiatives (in addition to the actions initiated in 2003, as discussed below). Management undertook these actions in order to reduce the company’s overall cost structure and to drive sustainable improvements in financial performance. The charge is primarily for severance and costs associated with the closing of facilities (including the closure of additional plasma collection centers) and the exiting of contracts.
These actions include the elimination of over 4,000 positions, or 8% of the global workforce, as management reorganizes and streamlines the company. Approximately 50% of the positions being eliminated are in the United States. Approximately three quartersthree-quarters of the estimated savings impact general and administrative expenses, with the remainder primarily impacting
cost of sales. The eliminations impact all three of the company’s segments, along with the corporate headquarters and functions. Baxter is also further reducing plasma production and closing additional plasma collection centers. In addition, the company is exiting certain other
facilities and activities. As a result, management recorded a restructuring charge in the second quarter of 2004 totaling $543 million ($394 million, or $0.64 per diluted share, on an after-tax basis), principally for severance and costs associated with the closing of facilities and the exiting of contracts. Refer to Note 4 for additional information.
During the three- and nine-month period ended September 30, 2004, $47first quarter of 2005, $37 million and $51 million, respectively, of the reserve for cash costs was utilized. Approximately $50$150 million of the reserve is expected to be paidutilized during full-year 2005, with the remainder of 2004, approximately $150 million in 2005, and the remainderto be utilized in 2006. The cash expenditures are being funded with cash generated from operations. Approximately one thirdthree-quarters of the targeted positions have been eliminated as of September 30, 2004, and management expects that approximately half of the targeted positions will be eliminated by the end of the year.March 31, 2005. The program is proceeding on plan. Refer to Note 3 for additional information.
Management estimatescontinues to estimate that these additional initiatives will yield savings of approximately $0.05 per diluted share in the second half of 2004, and anticipates that the initiatives will yield savings of approximately $0.20 to $0.25 per diluted share infor full-year 2005 an(assuming a constant diluted share count), or incremental savings of $0.15 to $0.20 per diluted share as compared to full-year 2004. Savings for the first quarter of 2005 were consistent with management’s original estimates. Once fully implemented in 2006, management anticipates total annual savings will be approximately $0.30 to $0.35 per diluted share.share (assuming a constant diluted share count), or incremental savings of $0.10 as compared to full-year 2005.
Second quarter 2003 restructuring charge
During the second quarter of 2003, the company recorded a $337 million restructuring charge ($202 million, or $0.33 per diluted share, on an after-tax basis) principally associated with management’s decision to close certain facilities and reduce headcount on a global basis. Management decided to take these actionsAs discussed in order to position the company more competitively and to enhance the company’s profitability. Refer to Note 4 for additional information.
During the three- and nine-month period ended September 30, 2004, $26 million and $83 million, respectively, of the reserve for cash costs was utilized. Virtually all of the targeted positions have been eliminated as of September 30, 2004, and the3, this program is substantially complete.complete, and management does not expect incremental cost savings in 2005. The majority of theremaining reserve principally relates to severance and other costs are expectedcash payments to be paid bymade in the end of 2004. The cash expendituresfuture, and these payments are being funded with cash generated from operations.
Management expects that the actions initiated in 2003 will generate incremental annual savings of approximately $0.15 to $0.20 per diluted share when fully implemented. Management estimates that the cost savings in the three- and nine-month periods ended September 30, 2004 were approximately $0.04 and $0.12 per diluted share, respectively, and expects that the full year 2004 savings will total approximately $0.15 per diluted share. As mentioned above, these benefits are offset by increased employee benefit costs.
NET INTEREST EXPENSE
Net interest expense decreased $5increased $10 million for both the first quarter and year-to-date period ended September 30, 2004,of 2005 principally due to a lower averagehigher interest rates and the execution of the net debt level, partially offset by lower capitalized interest,investment hedge mirror strategy, as the company completed certain projects and placed assets into service.further discussed below.
OTHER EXPENSE, NET
Other income and expense, typically includesnet increased slightly for the three months ended March 31, 2005. Other expense, net in both periods principally consisted of amounts relating to fluctuations in currencyforeign exchange, rates, minority interests, income and losses relating to equity method investments, and divestiture gains and asset impairment charges.
The increase in other expense for the three months ended September 30, 2004 principally related to foreign currency fluctuations. The increase in other expense for the nine months ended September 30, 2004 principally related to foreign currency fluctuations and lower equity method income. Equity method income was lower in 2004 because Baxter divested its equity method investment in Acambis, Inc. in late 2003. Refer to Note 2 for further information.losses.
PRE-TAX INCOME
Refer to Note 85 to the condensed consolidated financial statements for a summary of financial results by segment. Certain items are maintained at the company’s corporate headquarters and are not allocated to the segments. They primarily include certain foreign currency fluctuations, the majority of the foreign currency and interest rate hedging activities, net interest expense, income and expense related to certain non-strategic investments, corporate headquarters costs, certain employee benefit plan costs, certain nonrecurring gains and losses and certain special charges (such as in-process research and development, restructuring and restructuring)certain asset impairments). Included in Note 5 is a table that reconciles financial results for the segments to the consolidated company’s results. The following is a summary of significant factors impacting the segments’ financial results.
Medication Delivery
Pre-tax income increased 4% and 9% for the three and nine months ended September 30, 2004, respectively.first quarter of 2005. The growth in pre-tax income was primarily the result of sales growth, (especially in the year-to-date period), the close management of costs, therestructuring-related benefits, of the restructuring initiatives, and changes in currencyforeign exchange rates (as noted above, the majority of foreign currency hedging activities for all segments are recorded at the corporate level, and are not included in segment results). As noted above, theseThese factors were partially offset by the impact of reduced pricingan unfavorable sales mix, which was partially due to lower sales in the renegotiated long-term contracts with GPOs, principally Premier. Earnings growth is expected to continue to be impacted by the reduced pricing in these contracts during the remainder of 2004.Anesthesia product line.
BioScience
Pre-tax income increased 12% and decreased 4%67% for the three and nine months ended September 30, 2004, respectively.first quarter of 2005. The increase in pre-tax income for the quarter was primarily due to lower R&D spending asstrong sales growth, a result of the recent prioritization initiatives (including the termination of the recombinant hemoglobin protein project in 2003),higher gross margin, the close management of costs, restructuring-related benefits and foreign exchange, partially offset by increased R&D spending. As discussed above, the benefits of the recent restructuring initiatives, and changes in currency exchange rates. While many of these factors also impacted the year-to-date period, pre-tax income for the nine months ended September 30, 2004 declined primarilyimproved gross margin was due to increased inventory reserves and an asset impairment charge (recorded as special charges in the second quarter of 2004, as discussed in Note 2) and lowera favorable sales mix, with strong sales of higher-margin recombinant products, as well as improved pricing in certain high-margin products. In addition, both prior year periods, particularly the year-to-date period, include income from the company’s investment in Acambis, Inc. As noted above, this investment was divested in late 2003.product lines.
Renal
Pre-tax income increased 7% and 15%21% for the three and nine months ended September 30, 2004, respectively.first quarter of 2005. The increase in pre-tax income was primarily due to solid sales growth, particularly in the year-to-date period, changes in currency exchange rates, the close management of costs, restructuring-related benefits and the benefits of the recent restructuring initiatives, partially offset by an unfavorable change in mix, particularly during the quarter.
INCOME TAXES
As discussed in Note 2, as a result of the completion ofThe effective income tax audits in the second quarter of 2004, $55 million of reserves for matters previously under review were reversed into income during the second quarter of 2004. In addition, the effective tax ratesrate relating to continuing operations was 25% for both the three- and nine-month periodsfirst quarter of both 2004 and 2003 were impacted by the restructuring charges2005 and the special charges discussed in Notes 4 and 2, respectively, which were tax-effected at different (generally higher) rates, depending on the particular tax jurisdictions. There were no other significant changes to the company’s effective income tax rate.first quarter of 2004.
The American Jobs Creation Act of 2004
In October 2004, the American Jobs Creation Act of 2004 (the Jobs Creation Act) was enacted. The Act includes numerous provisions, including the creation of a temporary incentive for U.S.United States multinationals to repatriate accumulated income earned abroad. The temporary tax deduction of 85% of certain repatriated foreign earnings is subject to a number of limitations. Detailed final guidance necessary to implement the Jobs Creation Act has not yet been issued by the Internal Revenue Service. Management is analyzing the provisions of the Jobs Creation Act and has not yet determined the effects, if any, on the company’s plans or its consolidated financial statements. Management expects to complete its evaluation by the end of the third quarter of 2005. Refer to the 2004 Annual Report for further information.
INCOME AND EARNINGS PER DILUTED SHARE FROM CONTINUING OPERATIONS
Income from continuing operations before the cumulative effect of accounting changes was $259$224 million, and $275 millionor $0.36 per diluted share, for the three months ended September 30, 2004 and 2003, respectively, and $277March 31, 2005 increased 20% from the $187 million, and $536 million for the nine months ended September 30, 2004 and 2003, respectively. Income from continuing operationsor $0.30 per diluted share, was $0.42 and $0.46reported in the three months ended September 30, 2004 and 2003, respectively, and $0.45 and $0.89 for the nine months ended September 30, 2004 and 2003, respectively.prior year quarter. The significant factors and events causingcontributing to the declines from 2003 to 2004growth are discussed above.
DISCONTINUED OPERATIONS
DuringRefer to the 2004 discontinuedAnnual Report regarding the 2002 decision to divest the majority of the Renal segment’s services businesses. Discontinued operations generated income of $17$2 million in the first quarter of 2005 and $5a loss of $11 million forin the three- and nine-month periods ended September 30, respectively (netfirst quarter of tax benefits of $24 million and $28 million, respectively).2004. The income was principally related to tax and other adjustments, as the company completes divestitures. During 2003, discontinued operations generated losses of $5 million and $17 million for the three- and nine-month periods ended September 30, respectively (net of tax benefits of $3 million and $6 million, respectively). Refer to Note 3 for further discussion of the discontinued operations. Management expects the divestiture plan willis substantially complete, and is expected to be fully completed by the end of 2004.during 2005.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with generally accepted accounting principles (GAAP) requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of the company’s significant accounting policies is included in Note 1 to the company’s consolidated financial statements for the year ended December 31, 2003, which are2004, included in the 2003 Form 10-K/A.2004 Annual Report. Certain of the company’s accounting policies are considered critical, as these policies are the most important to the depiction of the company’s financial statements and require significant, difficult or complex judgments by management, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’s Discussion and Analysis section of the 2003 Form 10-K/A.2004 Annual Report. There have been no
significant changes in the application of the critical accounting policies since December 31, 2003.2004.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
Cash flows from continuing operations
The company reported cashContinuing operations Cash flows from continuing operations increased in the first quarter of $529 million for the nine months ended September 30, 2004, a decrease of $141 million from2005 as compared to the prior year.year quarter. The decreaseincrease in cash flows was principallyprimarily due to improved cash flows relating to inventories, receivables, accounts payable and accrued liabilities, and the settlement of certain mirror cross- currency swaps, partially offset by increased payments related to the restructuring programs and higher contributions to the company’s primary pension trusts,trust relating to the United States and reduced accounts receivables securitization cash flows, partially offset by improved inventory management.Puerto Rico pension plans.
Accounts Receivable
The decrease in cashCash flows relating to accounts receivable was primarily dueincreased as management continues to $87 million inincrease its focus on working capital efficiency. With this increased focus, the company improved its accounts receivable collections. Days sales outstanding improved from 61.4 days at March 31, 2004 to 59.2 days at March 31, 2005. Proceeds from factoring of receivables increased during the quarter, partially offset by reduced cash flows from the company’s securitization and factoring activities, with $230 millionarrangements (as detailed in reduced cash flows from securitization arrangements, partially offset by $143 million of increased cash flows relating to factoring activities. In addition, days sales outstanding increased from 62.4 days at September 30, 2003 to 63.9 days at September 30, 2004.Note 2).
Inventories
The following is a summary of inventories at September 30, 2004March 31, 2005 and December 31, 2003,2004, as well as inventory turns for the first nine monthsquarter of 20042005 and 2003,2004, by segment.
Inventories | Inventory Turns | |||||||||||||||
September 30, 2004 | December 31, 2003 | Nine months ended September 30, | Inventories | Inventory turns for the three months ended March 31, | ||||||||||||
(in millions, except inventory turn data) | 2004 | 2003 | March 31, 2005 | December 31, 2004 | 2005 | 2004 | ||||||||||
BioScience | $1,271 | $1,378 | 1.51 | 1.39 | $1,280 | $1,332 | 1.54 | 1.42 | ||||||||
Medication Delivery | 620 | 528 | 3.70 | 3.64 | 595 | 587 | 3.91 | 3.62 | ||||||||
Renal | 215 | 198 | 4.13 | 3.95 | 230 | 216 | 3.89 | 4.00 | ||||||||
Total | $2,106 | $2,104 | 2.48 | 2.31 | $2,105 | $2,135 | 2.57 | 2.34 | ||||||||
Inventory balances were relatively flat
Inventories decreased $30 million from December 31, 20032004 to September 30, 2004.March 31, 2005. The reduction in BioScience inventories principallydecline was primarily related to the planned reduction in plasma inventories. Inventory turns are impacted by seasonality and the timing of facility shutdowns for planned maintenance in certain of the company’s businesses, and are generally highest in the fourth quarter of the year, and lower earlier in the year, for these businesses. Inventory turns increased in total and for all of the businesses as management continues to focus on working capital efficiency.
Liabilities, Including Restructuring Payments and Contributions to the Pension TrustsOther
As noted above,Cash flows relating to liabilities increased in the most significant reasons forfirst quarter of 2005 as compared to the declineprior year quarter, as management focuses on the company’s working capital efficiency. Contributing to the increase in cash flows from continuing operations was a $58 million cash inflow related to the settlement of certain mirror cross-currency swaps during the nine-month periodfirst quarter of 2005. Refer to the net investment hedges section below for further information regarding these swaps. Partially offsetting these cash inflows were increased payments associated with restructuring programs, andwith cash payments increasing $6 million, from $37 million in 2004 to $43 million in 2005. The company also made $46 million of increased contributions to its primary pension trust in the company’s pension trusts. Restructuring payments
increased $98United States, from $54 million from $38in the first quarter of 2004 to $100 million to $136 million. Contributions to Baxter’s pension trusts increased $84 million, from $11 million to $95 million.in the first quarter of 2005.
Cash flows from discontinuedDiscontinued operations
Cash flows relating to discontinuedDiscontinued operations increased $12generated a net cash inflow of $1 million duringin the first nine monthsquarter of 2004, from $52005, and a net cash outflow of $1 million in 2003 to $17 million in 2004, with the increased cash flows primarily relating to divestiture proceeds.prior year quarter. As discussed in Note 3 and above, the company has divested the majority of the discontinued operations and plans to complete the divestiture plan in 2004.2005.
Cash flows from investing activities
Capital Expenditures
Capital expenditures decreased $25 million for the ninethree months ended September 30, 2004 by $201 million,March 31, 2005, from $564$90 million in 20032004 to $363$65 million in 2004.2005, partially due to the timing of expenditures. As discussed in the 2003 Form 10-K/A,2004 Annual Report, management is reducing its level of investmentsexpects to spend approximately $550 million to $600 million in capital expenditures in 2004 as certain significant long-term projects are completed and as management more aggressively manages capital spending. Management currently anticipates that the company’s capital expenditures will not exceed $650 million in 2004. Construction in progress decreased 9% from December 31, 2003 to September 30, 2004, as major projects were completed and the company placed assets into service.for full-year 2005.
Acquisitions and Investments In and Advances to Affiliates
NetThere were no net cash outflows relating to acquisitions andor investments in and advances to affiliates decreased by $86 million during the first ninethree months of 2005. There were $14 million of payments in the first quarter of 2004, from $106 million in 2003 to $20 million in 2004. The current period included outflows relatingwhich primarily related to the 2003 acquisition of certain assets of Alpha Therapeutic Corporation, which are included in the BioScience segment. The 2003 outflows included the funding of a $50 million loan to Cerus Corporation, a minority investment holding (which is included in the BioScience segment), a $24 million additional purchase price payment relating to the December 2002 acquisition of ESI Lederle (which is included in the Medication Delivery segment), an $11 million common stock investment in Acambis, Inc., which was divested later in 2003, and an $11 million payment for an icodextrin manufacturing facility in England (which is included in the Renal segment).
Divestitures and Other
Net cash flows relating to divestitures and other totaled $31$49 million infor the first nine monthsquarter of 2005 and $26 million for the first quarter of 2004. The 2005 total principally related to the collection of a loan from Cerus Corporation, a company in which Baxter owns approximately 1% of the common stock, and the cash proceeds relating to the divestiture of the Renal segment’s RTS business in Taiwan. The 2004 andtotal principally related to the sale of a building and the return of collateral.
Cash flows from financing activities
Debt Issuances, Net of Redemptions and Other Payments of Financing Obligations
DebtNet cash inflows relating to debt issuances, net of redemptions and other payments of financing obligations, were relatively flat fordecreased $163 million in the first nine monthsquarter, from $191 million of net cash inflows in 2004 as compared to the prior year period.$28 million in 2005. Included in the year-to-datenet total for 2005 was $312 million in cash outflows was a $40 million payment to exit oneassociated with the settlement of certain of the company’s cross-currency swap agreements. Refer to further discussion below.
Other Financing Activities
Common stock cash dividends increased in 2004 by $15 million duewere substantially unchanged as compared to a higher level of common shares outstanding.the prior year quarter. Cash received for stock issued under employee benefit plans increased by $48$22 million, principallyfrom $31 million in the first quarter of 2004 to $53 million in the first quarter of 2005, primarily due to a higher level of employee stock option exercises and purchases under the company’s employee stock purchase plans. There were no common stock
issuances in 2004. In September 2003, the company issued 22 million shares of common stock and received net proceeds of $644 million. The net proceeds were used to settle equity forward agreements, to fund the company’s acquisition of certain assets of Alpha Therapeutic Corporation, and for other general corporate purposes.coupled with a higher average exercise price. Stock repurchases decreased from 20032004 to 2004.2005. In the first nine monthsquarter of 2004 the company paid $18$11 million to repurchase stock from Shared Investment Plan (SIP) participants. Refer to Note 9the 2004 Annual Report for further information regarding the Shared Investment Plan. InSIP and these repurchases. There were no repurchases during the first nine monthsquarter of 2003 the company purchased 15 million shares of common stock for $714 million from counterparty financial institutions in conjunction with the settlement of equity forward agreements. Refer to the 2003 Form 10-K/A for further information.2005.
CREDIT FACILITIES, ACCESS TO CAPITAL, AND COMMITMENTS AND CONTINGENCIES
Refer to the 2003 Form 10-K/A2004 Annual Report for further discussion of the company’s credit facilities, access to capital, and commitments and contingencies.
Credit facilities
The company had $822 million$1.1 billion of cash and equivalents at September 30, 2004.March 31, 2005. The company also maintains twothree revolving credit facilities, which totaled $1.44approximately $2.1 billion at September 30, 2004.March 31, 2005. One of the facilities totals $640 million and matures in October 2007, and the otheranother facility totals $800 million and matures in September 2009.2009, and the third facility, which is denominated in Euros and was entered into in January 2005, totals approximately $650 million and matures in January 2008. The facilities enable the company to borrow funds on an unsecured basis at variable interest rates. The company has never drawn on these facilities. Management believes these credit facilities are adequate to support ongoing operational requirements. The credit facilities contain certain covenants, including a maximum net-debt-to-capital ratio and a minimum interest coverage ratio. At September 30, 2004, as in prior periods,March 31, 2005, the company was in compliance with all financial covenants. The company’s net-debt-to-capital ratio, as defined below, of 38.8%34.9% at September 30, 2004March 31, 2005 was well below the credit facilities’ net-debt-to-capital covenant. Similarly, the company’s actual interest coverage ratio of 7.84.5 to 1 in the thirdfirst quarter of 20042005 was well in excess of the minimum interest coverage ratio covenant. The net-debt-to-capital ratio, which is calculated in accordance with the company’s primary credit agreements, and is not a measure defined by GAAP, is calculated as net debt (short-term and long-term debt and lease obligations, less cash and equivalents) divided by capital (the total of net debt and stockholders’ equity). The net-debt-to-capital ratio at September 30, 2004March 31, 2005 and the corresponding covenant in the company’s credit agreements give 70% equity credit to the company’s equity units. Refer to the 2003 Form 10-K/A2004 Annual Report for a description of the equity units, which were issued in December 2002.units. The minimum interest coverage ratio is a four-quarter rolling calculation of the total of income from continuing operations before income taxes plus interest expense (before interest income), divided by interest expense (before interest income). Baxter also maintains certain other short-term credit arrangements.
Access to capital
The companyManagement intends to fund its short-term and long-term obligations as they mature through cash on hand, future cash flows from operations, by issuing additional debt, or by issuing common stock. As of September 30, 2004,March 31, 2005, the company can issue up tohas approximately $399 million of securities, includingshelf registration statement capacity available for the issuance of debt, common stock andor other securities, under an effective registration statement filed with the Securities and Exchange Commission.
The company’s ability to generate cash flows from operations, issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms could be adversely affected in the event there is a material decline in the demand for the company’s products, deterioration in the company’s key financial ratios or credit ratings, or other significantly unfavorable changes in conditions. Management believes it has sufficient financial flexibility in the future to issue debt, enter into other financing arrangements, and attract long-term capital on acceptable terms as may be needed to support the company’s growth objectives.
Short-term debt and current maturities of long-term debt and lease obligations
The increase in short-term debt from December 31, 2004 to March 31, 2005 principally related to increased commercial paper ($0 at December 31, 2004 to $357 million at March 31, 2005). The increase in current maturities of long-term debt and lease obligations from December 31, 2004 to March 31, 2005 principally related to the reclassification of $873 million of notes due in the first quarter of 2006 from long-term to short-term.
Credit ratings
The company’s credit ratings at September 30, 2004March 31, 2005 were Baa1 by Moody’s, A- by Standard & Poor’s and BBB+ by Fitch on senior debt, and P2 by Moody’s, A2 by Standard & Poor’s and F2 by Fitch on short-term debt. The outlooks were negative by Moody’s and Standard & Poor’s and stable by Fitch. The company’s credit ratings and outlooks have been downgraded during 2004. Refer to the 2003 Form 10-K/A for a summary of the company’s ratings and outlooks at December 31, 2003.as follows.
Standard & Poor’s | Fitch | Moody’s | ||||
Ratings | ||||||
Senior debt | A- | BBB+ | Baa1 | |||
Short-term debt | A2 | F2 | P2 | |||
Outlook | Negative | Stable | Negative |
The rating agency downgrades in 2004 and any
Any future downgrades of Baxter’s credit ratings may unfavorably impact the financing costs associated withrelated to the company’s credit arrangements and future debt issuances. Management believes that the actual and anticipated impact of the recent downgrades and changes in outlook is not material. Management believes that the impact of reasonably possible future changes in credit ratings or outlook would also not be material.
Any future credit rating downgrades or changes in outlook would not affect the company’s ability to draw on its credit facilities, and would not result in an acceleration of the scheduled maturities of any of the company’s outstanding debt.
Certain specified rating agency downgrades, if they occur in the future, wouldcould require the company to post additional collateral pursuant tofor, or immediately settle certain of its arrangements. These arrangements principally pertainNo collateral was required to the company’s foreign currency and interest rate derivatives, which Baxter uses for hedging purposes. For risk-management purposes, certain of the company’s counterparty financial institutions require that collateral be posted under specified circumstances. The terms of the arrangements vary, but generally, the level of collateral postings is dependent upon the mark-to-market liability (if any) with the financial institution and the company’s credit ratings. It is not possible to know with certainty what each of these variables will beat March 31, 2005. In addition, in the future. However, if Baxter’s credit ratingevent of certain specified downgrades (Baa3 or BBB-, depending on its senior unsecured debt declined to Baa2 or BBB (i.e., a one-rating or two-rating downgrade, depending upon the rating agency), the amountcompany would no longer be able to securitize new receivables under certain of collateral thatits securitization arrangements. However, any downgrade of credit ratings would currently be required (holdingnot impact previously securitized receivables. Refer to the mark-to-market liability balance of outstanding derivative instruments constant) would total less than $100 million.2004 Annual Report for further information.
Net investment hedges
As further discussed in the company’s 2003 Form 10-K/A,2004 Annual Report, the company has historically used cross-currency swaps to hedge the net assets of certain of its foreign operations. Theseoperations using a combination of foreign currency denominated debt and cross-currency swaps. The swaps have served as effective hedges for accounting purposes and have reduced volatility in the company’s stockholders’ equity balance and net-debt-to-capital ratio (as any increase or decrease in the fair value of the swaps relating to changes in spot currency exchange rates is offset by the change in value of the hedged net assets of the foreign operations relating to changes in spot currency exchange rates).
Because the United States Dollar has weakened relative to the hedged currency, the hedged net assets have increased in value over time, while the cross-currency swaps have decreased in value over time. At September 30, 2004,March 31, 2005, as presented in the following table, the company had a pre-tax net liability in its consolidated balance sheet of $956$893 million relating to these cross-currency swap agreements (before consideration of deferred tax benefits).agreements. Of this total, $125 million was short-term, and $768 million was long-term.
Management hasThe company reevaluated its net investment hedge strategy in the fourth quarter of 2004 and has decided to reduce the use of these instruments as a risk-management tool as the current portfolio matures. At this time, management does not intend to extend the current maturity dates of the instruments.tool. Management intends to settle the swaps that mature in 2005 as they mature,using cash flows from cash flow from operations. Management anticipates that the remaining swaps will be settled as they mature, or possibly sooner, depending on the level of the company’s future cash flows.
In addition, in order to reduce financial risk and uncertainty through the maturity (or cash settlement) dates of the cross-currency swaps, the company is executinghas executed offsetting or mirror cross-currency swaps. At March 31, 2005, mirror swaps were executed relating to approximately 50%54% of the existingcurrent notional amount of the portfolio. TheseAs of the date of execution, these mirror swaps will effectively fixfixed the net amount that the company will ultimately pay to settle the cross-currency swap agreements subject to this strategy. After execution, as the market value of the fixed portion of the original portfolio decreases, the market value of the mirror swaps increases by an approximately offsetting amount, and vice versa. The mirror swaps will be settled when the offsetting existing swaps are settled. Of the pre-tax liability of $956 million at September 30, 2004 relating to the cross-currency swaps, the company has fixed $296 millionThe following is a summary, by entering into mirror swaps as of October 31, 2004. The maturity by yeardate, of the $956 millionmark-to-market liability position of the original cross-currency swaps portfolio, as well as the portion that is fixed via October 2004 executions ofoffsetting mirror swaps isnet asset position, and the net mark-to-market position as follows:of March 31, 2005 (in millions).
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Maturity date | Swaps liability | Mirror swaps net asset | Net liability position | ||||
2005 | $159 | $(34 | ) | $125 | |||
2007 | 39 | (1 | ) | 38 | |||
2008 | 292 | 5 | 297 | ||||
2009 | 433 | 433 | |||||
Total | $923 | $(30 | ) | $893 | |||
ForApproximately $460 million of the total swaps net liability of $893 million as of March 31, 2005 has been fixed by the mirror swaps.
As discussed in the 2004 Annual Report and above, for the mirrored swaps, the company will no longer realizerealizes the favorable interest rate differential between the two currencies, and this will resultresults in increased net interest expense in the future.expense. The amount of increased net interest expense will vary based on floating interest rates and foreign exchange rates, and the timing of the company’s settlements. Based
As discussed above, during the first quarter of 2005, the company settled certain cross-currency swaps agreements (and related mirror swaps, as applicable), and made net payments totaling $254 million. In accordance with Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on interest rates at September 30, 2004,Derivative Instruments and Hedging Activities,” when the increaseoriginal cross-currency swaps are settled, the cash flows are reported within the financing section of the consolidated statement of cash flows. When the mirror swaps are settled, the cash flows are reported in the operating section of the consolidated statement of cash flows. Of the $254 million in net interest expense is estimated to be approximately $15settlement payments, $312 million on an annual basis.of cash outflows were included in the financing section and $58 million of cash inflows were included in the operating section.
Legal contingenciesLEGAL CONTINGENCIES
SeeRefer to Note 4 and “Part II –- Item 1. Legal Proceedings” for a discussion of the company’s legal contingencies. Upon resolution of any of these uncertainties, the company may incur charges in excess of presently established reserves. While such a future charge could have a material adverse impact on the company’s net income or cash flows in the period in which it is recorded or paid, based on the adviseadvice of counsel, management believes that any outcome of these actions, individually or in the aggregate, will not have a material adverse effect on the company’s consolidated financial position.
NEW ACCOUNTING STANDARD
In December 2004, the Financial Accounting Standards Board revised and reissued FASB No. 123, “Share-Based Payment” (FASB No. 123-R), which requires companies to expense the value of employee stock options and similar awards. The standard was to become effective July 1, 2005. In April 2005, the Securities and Exchange Commission amended Regulation S-X to provide a six-month adoption deferral period for public companies. Therefore, FASB No. 123-R will not become effective until January 1, 2006. The new rules provide for one of two transition elections, either prospective application or restatement (back to January 1, 1995). The company plans to adopt FASB No. 123-R on January 1, 2006 and has not yet decided which transition option the company will use. Management is in the process of analyzing the provisions of FASB No. 123-R and assessing the impact on the company’s future consolidated financial statements. The pro forma effect of expensing employee stock options and similar awards under existing rules is presented in Note 1.
FORWARD-LOOKING INFORMATION
The matters discussed in this report that are not historical facts include forward-looking statements. These statements are based on the company’s current expectations and involve numerous risks and uncertainties. Some of these risks and uncertainties are factors that affect all international businesses, while some are specific to the company and the health-care arenas in which it operates. Many factors could affect the company’s actual results, causing results to differ, and possibly differ materially, from those expressed in any such forward-looking statements. These factors include, but are not limited to:
Additionally, as discussed in Part II – Item 1. Legal Proceedings, upon the resolution of certain legal matters, the company may incur charges in excess of presently established reserves. Any such charge could have a material adverse effect on the company’s results of operations or cash flows in the period in which it is recorded.
Currency fluctuations are also a significant variable for global companies, especially fluctuations in local currencies where hedging opportunities are not economic or not available. If the United States Dollar strengthens significantly against foreign currencies, the company’s ability to
realize projected growth rates in its sales and net earnings outside the United States, as reported in United States Dollars, could be negatively impacted.
Management believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its knowledge of the company’s business and operations, but there can be no assurance that the actual results or performance of the company will conform to any future results or performance expressed or implied by such forward-looking statements and undue reliance should not be placed upon them. Actual results could differ materially from such statements. Please refer to the company’s Annual Report on Form 10-K, and Quarterly Reports in Form 10-Q and other documents filed by the company with the Securities and Exchange Commission, which are available on the company’s website, for more details concerning important factors that could cause actual results to differ materially. The company does not undertakedisclaims any obligationcurrent intention to update any forward-looking statements as a result of new information, future events, changed assumptions or otherwise, and all forward-looking statements speak only as of the time when made.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Currency Riskrisk
For a more complete discussion, refer to the caption “Financial Instrument Market Risk” in the company’s 2003 Form 10-K/A.2004 Annual Report. As part of its risk-management program, the company performs sensitivity analyses to assess potential changes in the fair value of its foreign exchange financial instruments relating to hypothetical and reasonably possible near-term movements in currencyforeign exchange rates.
A sensitivity analysis of changes in the fair value of foreign exchange forward and option contracts outstanding at September 30, 2004,March 31, 2005, while not predictive in nature, indicated that if the United States Dollar uniformly fluctuated unfavorably by 10% against all currencies, on a net-of-tax basis, the net liability balance (net of tax) of $54$48 million with respect to those contracts would increase by approximately $85$69 million.
With respect to the company’s cross-currency swap agreements (including the outstanding mirror swaps) discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, if the United States Dollar uniformly fluctuated unfavorablyweakened by 10%, on a net-of-tax basis, the net liability balance (net of tax) of $597$563 million with respect to those contracts outstanding at March 31, 2005 would increase by approximately $265$93 million. Any increase or decrease in the fair value of cross-currency swap agreements designated as hedges of the net assets of foreign operations relating to changes in spot currency exchange rates is completely offset by the change in the value of the designated hedged net assets. Referassets relating to Management’s Discussion and Analysis of Financial Condition and Results of Operationschanges in this Form 10-Q for further discussionspot currency exchange rates. With respect to the portion of the company’s cross-currency swap agreements.portfolio that is no longer designated as a net investment hedge, but is fixed via the mirror swaps, as the fair value of this fixed portion of the portfolio decreases, the fair value of the mirror swaps increases by an approximately offsetting amount, and vice versa.
The sensitivity analysis model calculatesrecalculates the fair value of the foreign currency forward, option and cross-currency swap contracts outstanding at September 30, 2004March 31, 2005 by replacing the actual exchange rates at September 30, 2004March 31, 2005 with exchange rates that are 10% unfavorable to the actual exchange rates for each applicable currency. All other factors are held constant. These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the underlying hedged transactions and balances.
Interest rate and other risks
For a complete discussion, refer to the caption “Financial Instrument Market Risk” in the company’s 2003 Form 10-K/A.2004 Annual Report. There have been no significant changes from the information discussed therein.
Item 4. | Controls and Procedures |
Disclosure Controls and Procedures
The company carried out an evaluation, under the supervision and with the participation of the company’s Disclosure Committee and the company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the quarterly period covered by this report. The company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported on a timely basis.basis and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective.effective as of March 31, 2005.
ThereChanges in Internal Control over Financial Reporting
As reported in the company’s Form 10-K for the year ended December 31, 2004, as of December 31, 2004, the company reported a material weakness relating to controls over the accounting for income taxes. During the first quarter of 2005, the company performed enhanced reconciliation procedures to address the issues reported in the Form 10-K. In the first quarter of 2005, the company relocated its United States’ transaction processing activities (including cash disbursements, cash application and fixed asset processing) and general accounting activities from Northern Illinois to a new Baxter facility in Costa Rica. Also, during the first quarter of 2005, the company began to outsource the transaction processing activities of one European country and certain previously centralized activities (expense report processing, accounts payable, accounts receivable, fixed asset and intercompany accounting). Management has taken appropriate steps to mitigate the risk associated with these transitions, including auditing of certain key controls, oversight of current control activities by managers directly responsible for the control activities prior to the changes and monitoring of key performance indicators.
Other than the actions mentioned above, there has been no change in Baxter’s internal control over financial reporting that occurred during the quarter ended September 30, 2004March 31, 2005 that has materially affected, or is reasonably likely to materially affect, Baxter’s internal control over financial reporting, except for the aggregate effect of the changes to internal controls discussed below.
As previously reported, the company restated its previously issued financial results for the years 2001 through 2003, and for the first quarter of 2004. This restatement was primarily the result of the inappropriate application of accounting principles for revenue recognition and inadequate provisions for bad debts in Brazil during this period.
Management previously concluded that the following weaknesses in the company’s internal control over financial reporting collectively constituted a material weakness:
During the third quarter of 2004, the company took several actions that it believes has remediated this material weakness. These actions include:
The Company intends to continue its remediation efforts throughout the fourth quarter of 2004.reporting.
Review by Independent Registered Public Accounting Firm
Reviews of the interim condensed consolidated financial information included in this Quarterly Report on Form 10-Q for the three and nine months ended September 30,March 31, 2005 and 2004 and 2003 have been performed by PricewaterhouseCoopers LLP, the company’s independent registered public accounting firm. Their report on the interim condensed consolidated financial information follows. This report is not considered a report within the meaning of Sections 7 and 11 of the Securities Act of 1933 and therefore, the independent accountants’ liability under Section 11 does not extend to it.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Baxter International Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Baxter International Inc. and its subsidiaries as of September 30, 2004,March 31, 2005, and the related condensed consolidated statements of income for each of the three-month and nine-month periods ended September 30,March 31, 2005 and 2004 and 2003 and the condensed consolidated statements of cash flows for the nine-monththree-month periods ended September 30, 2004March 31, 2005 and 2003.2004. These interim financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 20032004, and the related consolidated statements of income, cash flows and stockholders’ equity and comprehensive income for the year then ended, (not presented herein),management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004; and in our report dated February 20, 2004, except for Note 1A which is as of August 9, 2004,March 14, 2005, we expressed (i) an unqualified opinion on those consolidated financial statements.statements, (ii) an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting, and (iii) an adverse opinion on the effectiveness of the Company’s internal control over financial reporting. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003,2004, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopersLLPPricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Chicago, Illinois
November 4, 2004May 3, 2005
PART II. OTHER INFORMATION
Baxter International Inc. and Subsidiaries
Item 1. | Legal Proceedings |
Baxter International Inc. (Baxter International) and certain of its subsidiaries are named as defendants in a number of lawsuits, claims and proceedings. The most significant of these are reported in the company’s Form 10-K/A for the year ended December 31, 2003 and below, and material developments for the quarter ended September 30, 2004 are described below. These cases and claims raise difficult and complex factual and legal issues and are subject to many uncertainties and complexities, including, but not limited to, the facts and circumstances of each particular case and claim, the jurisdiction in which each suit is brought, and differences in applicable law. Baxter has established reserves in accordance with generally accepted accounting principles for certain of the matters discussed below. For these matters, there is a possibility that resolution of the matters could result in an additional loss in excess of presently established reserves. Also, there is a possibility that resolution of certain of the company’s legal contingencies for which there is no reserve could result in a loss. Management is not able to estimate the amount of such loss or additional loss (or range of loss or additional loss). However, management believes that, while such a future charge could have a material adverse impact on the company’s net income and net cash flows in the period in which it is recorded or paid, no such charge would have a material adverse effect on Baxter’s consolidated financial position.
Mammary Implant LitigationProduct Liability
As previously reported in the company’s 2003 Form 10-K/A, Mammary Implant Litigation
Baxter, International, together with certain of its subsidiaries, is currently a defendant in various courts in a number of lawsuits seeking damages for injuries of various types allegedly caused by silicone mammary implants previously manufactured by the Heyer-Schulte division of American Hospital Supply Corporation (AHSC). AHSC, which was acquired by Baxter in 1985, divested its Heyer-Schulte division in 1984. It is not known how many of these claims and lawsuits involve products manufactured and sold by Heyer-Schulte, as opposed to other manufacturers. In December 1998, a panel of independent medical experts appointed by a federal judge announced its findings that reported medical studies contained no clear evidence of a connection between silicone mammary implants and traditional or atypical systemic diseases. In June 1999, a similar conclusion was announced by a committee of independent medical experts from the Institute of Medicine, an arm of the National Academy of Sciences. The majority of the claims and lawsuits against the company have been resolved. Certain of the proceedings are ongoing, as described below.
As of September 30, 2004,March 31, 2005, Baxter International, together with certain of its subsidiaries, was named as a defendant or co-defendant in 7137 lawsuits relating to mammary implants, brought by approximately 159100 plaintiffs, of which 12989 are implant plaintiffs and the remainder are consortium or second generation plaintiffs. Of those plaintiffs, eleventwo currently are included in the Lindsey class action Revised Settlement described below, which accounts for approximately tenone of the pending lawsuits against the company. Additionally, 6136 plaintiffs have opted out of the Revised Settlement (representing approximately 4823 pending lawsuits), and the status of the remaining plaintiffs with pending lawsuits is unknown. Some of the opt-out plaintiffs filed their cases naming multiple defendants and without product identification; thus, the company believes that not all of the opt-out plaintiffs will have viable claims against the company. As of September 30, 2004,March 31, 2005, 26 of the opt-out plaintiffs had confirmed Heyer-Schulte mammary implant product identification.
identification. Furthermore, during the thirdfirst quarter of 2004,2005, Baxter obtained dismissals, or agreements for dismissals, with respect to one plaintiff.54 plaintiffs.
In addition to the individual suits against the company, a class action on behalf of all women with silicone mammary implants was filed on March 23, 1994 and is pending in the United States District Court (U.S.D.C.) for the Northern District of Alabama involving most manufacturers of such implants, including Baxter as successor to AHSC (Lindsey, et al., v. Dow Corning, et al.,U.S.D.C., N. Dist. Ala., CV 94-P-11558-S). The class action was certified for settlement purposes only by the court on September 1, 1994, and the settlement terms were subsequently revised and approved on December 22, 1995 (the Revised Settlement). All appeals directly challenging the Revised Settlement have been dismissed. In addition to the Lindsey class action, the company also has been named in three other purported class actions in various state and provincial courts, only one of which is certified.
On March 31, 2000, the United States Department of Justice filed an action in the federal district court in Birmingham, Alabama against Baxter and other manufacturers of breast implants, as well as the escrow agent for the revised settlementRevised Settlement fund, seeking reimbursement under various federal statutes for medical care provided to various women with mammary implants. On September 26, 2001, the district courtDistrict Court granted the motion of all defendants, including Baxter, to dismiss the action. The federal government appealed the dismissal and on September 15, 2003 the Eleventh Circuit Court of Appeals reversed the order of dismissal and remanded the case to the district court.District Court. The defendants, including Baxter, filed a petition for a writ of certiorari in the United States Supreme Court, which petition was denied in June 2004. In October 2004, the district courtDistrict Court approved a settlement betweenamong all defendants, including Baxter, and the Department of Justice.
Baxter believes that a substantial portion of its liability and defense costs for mammary implant litigation will be covered by insurance, subject to self-insurance retentions, exclusions, conditions, coverage gaps, policy limits and insurer insolvency.
Plasma-Based Therapies Litigation
As previously reported in the company’s 2003 Form 10-K/A, Baxter currently is a defendant in a number of claims and lawsuits brought by individuals who have hemophilia, and their families, all seeking damages for injuries allegedly caused by anti-hemophilic factor concentrates VIII or IX derived from human blood plasma (factor concentrates) processed by the company from the late 1970s to the mid-1980s. The typical case or claim alleges that the individual was infected with the HIV virus by factor concentrates, which contained the HIV virus. None of these cases involves factor concentrates currently processed by the company.
As of September 30, 2004,March 31, 2005, Baxter was named as a defendant in 2548 lawsuits most of which are to be consolidated in the U.S.D.C. for the Northern District of Illinois and has received notice of 149163 claims in the United States, France, Ireland, Italy, Japan, Spain and Spain. The U.S.D.C. forArgentina. Among the Northern District of Illinois has approved a settlement of U.S. federal court factor concentrate cases. As of September 30, 2004, approximately 6,246 claimant groups had been found eligible to participate in the settlement. Approximately 6,244 of the claimant groups had received payments as of September 30, 2004. In addition,lawsuits, the company and other manufacturers have been named as defendants in two32 lawsuits, eight of which are purported class actions, pending inor expected to be transferred to the U.S.D.C. for the Northern District of Illinois on behalf of claimants, who are primarily non-U.S. residents, seeking unspecified damages for HIV and/or Hepatitis C infections.infections from their use of plasma-based factor concentrates. In March 2005, the District Court denied Plaintiff’s motion to certify classes alleged. A Baxter subsidiary is currently participating in a foundation that would make payments to Italian applicants who have hemophilia and are HIV positive. At least 370
applications are pending before the foundation. The U.S.D.C. for the Northern District of Illinois has approved a settlement of U.S. federal court HIV factor concentrate cases. As of December 31, 2004, all 6,246 claimant groups eligible to participate in the settlement have been paid.
In addition, Immuno International AG (Immuno), acquired by Baxter in 1996, has unsettled claims and lawsuits for damages for injuries allegedly caused by its plasma-based therapies. The typical claim alleges that the individual with hemophilia was infected with HIV and/or Hepatitis C by factor concentrates. Immuno’s successor is a participant in a foundation that would make payments to Italian applicants who are HIV positive. At least 370 applications are pending before that foundation. Additionally, Immuno faces multiple claims stemming from its vaccines and other biologically derived therapies. A portion of the liability and defense costs related to these
claims will be covered by insurance, subject to exclusions, conditions, policy limits and other factors. Pursuant to the stock purchase agreement between the company and Immuno, as revised in April 1999, approximately 26 million Swiss Francs, which is the equivalent of approximately $20$22 million based on the exchange rate as of September 30, 2004,March 31, 2005, of the purchase price is being withheld to cover these contingent liabilities.
As previously reported in the company’s 2003 Form 10-K/A, Baxter is currently named in a number of claims and lawsuits brought by individuals who infused the company’s GammagardGAMMAGARD IVIG (intravenous immuno-globulin)immunoglobulin), all of whom are seeking damages for Hepatitis C infections allegedly caused by infusing GammagardGAMMAGARD IVIG. As of September 30, 2004,March 31, 2005, Baxter was a defendant in tennine lawsuits and has received notice of fivefour claims in the United States, France, Denmark, Italy, Germany and Spain. One class action in the United States has been certified. In September 2000, the U.S.D.C. for the Central District of California approved a settlement of the class action that would provide financial compensation for U.S. individuals who used GammagardGAMMAGARD IVIG between January 1993 and February 1994.
The company believes that a substantial portion of the liability and defense costs related to its plasma-based therapies litigation will be covered by insurance, subject to self-insurance retentions, exclusions, conditions, coverage gaps, policy limits and insurer insolvency.
OtherAlthane Dialyzers Litigation
In July 2003, Baxter International receivedhas been a request from the Midwest Regional Officedefendant in a number of the Securities and Exchange Commission for the voluntary production of documents and information concerning revisions to the company’s growth and earnings forecasts for 2003. The company has also been requested to voluntarily provide information as to the events in connection with the restatement of its financial statements, previously announced on July 22, 2004. The company is cooperating fully with the SEC.
In August 2002, six purported class action lawsuits were filed in the U.S.D.C. for the Northern District of Illinois naming Baxter International and its then Chief Executive Officer and then Chief Financial Officer as defendants. These lawsuits, which were consolidated and sought recovery of unspecified damages, alleged that the defendants violated the federal securities laws by making misleading statements that allegedly caused Baxter International common stock to trade at inflated levels. In December 2002, plaintiffs filed their consolidated amended class action complaint which named nine additional Baxter officers as defendants. In July 2003, the U.S.D.C. for the Northern District of Illinois dismissed in its entirety the consolidated amended class action complaint. In July 2004, the Seventh Circuit Court of Appeals reversed the order of dismissal and remanded the case to the District Court. In September 2004, the Seventh Circuit Court of Appeals denied motions by Baxter for rehearing, rehearing en banc and to stay the order to remand the case pending a petition for a writ of certiorari to the U.S. Supreme Court.
In July 2004, a purported class action lawsuit was filed in the U.S.D.C. for the Northern District of Illinois, in connection with the previously disclosed restatement, naming Baxter International and its current Chief Executive Officer and Chief Financial Officer and their predecessors as defendants. The lawsuit, which seeks recovery of unspecified damages, alleges that the defendants violated the federal securities laws by making false and misleading statements regarding the company’s financial results, which allegedly caused Baxter International common stock to trade at inflated levels during the period between April 2001 and July 2004. Three similar purported class action lawsuits were filed in the third quarter of 2004 in the U.S.D.C. for the Northern District of Illinois against the same defendants. Thesecivil cases are in the process of being consolidated before a single judge.
In October 2004, a sole plaintiff filed a purported class action in the U.S.D.C. for the Northern District of Illinois against Baxter International and its current Chief Executive Officer and Chief
Financial Officer and their predecessors for alleged violations of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Plaintiff alleges that these defendants, along with the Administrative and Investment Committees of the company’s Incentive Investment Plan and Puerto Rico Savings and Investment Plan, which are the company’s 401(k) plans, breached their fiduciary duties to the plans’ participants by offering Baxter International common stock as an investment option in each of these plans during the period of January 2001 to October 2004. Plaintiff alleges that Baxter International common stock traded at artificially inflated prices during this period and seeks unspecified damages and declaratory and equitable relief.
In August and September 2004, three plaintiffs filed separate derivative lawsuits in the Circuit Court of Cook County, Illinois against the company’s Chief Executive Officer and Chief Financial Officer and certain other current and former officers and directors of the company. These actions, which plaintiffs purport to bring on the company’s behalf, seekseeking unspecified damages for alleged breachesinjury from exposure to Baxter’s Althane series of fiduciary dutydialyzers, which were withdrawn from the market in connection2001. All of these suits have been resolved, although the possibility of additional suits being filed cannot be excluded. Currently, there are a number of claims from Croatian citizens and one from the Spanish Ministry of Health, although suits have not been filed. The company previously reached settlements with a number of families of patients who died or were injured in Spain, Croatia and the United States allegedly after undergoing hemodialysis on an Althane dialyzer. The U.S. government is investigating the matter and Baxter received a subpoena in December 2002 to provide documents. Baxter is fully cooperating with the company’s disclosuresDepartment of Justice.
Vaccines Litigation
As of March 31, 2005, Baxter and certain of its financial results between April 2001subsidiaries have been served as defendants, along with others, in 143 lawsuits filed in various state and July 2004.U.S. federal courts, four of which are purported class actions, seeking damages, injunctive relief and medical monitoring for claimants alleged to have contracted autism or other attention deficit disorders as a result of
exposure to vaccines for childhood diseases containing the preservative, Thimerosal. These vaccines were formerly manufactured and sold by North American Vaccine, Inc., which was acquired by Baxter in June 2000, as well as other companies. As of December 31, 2004, ten suits have been dismissed based on the application of the National Vaccine Injury Compensation Act. Additional Thimerosal cases may be filed in the future against Baxter and companies that marketed Thimerosal-containing products.
In October 2004, a solitary plaintiff filed a purported class action against Baxter International inOther
As of September 30, 1996, the Circuit Court of Cook County, Illinois alleging a breach of federal securities law through Baxter International’s secondary offering of common stock in September 2003. The plaintiff alleges that the offering price of these shares was artificially inflated by virtuedate of the financial statements thatspin-off of Allegiance Corporation (Allegiance) from Baxter, Allegiance assumed the defense of litigation involving claims related to Allegiance’s businesses, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves. Allegiance, which merged with Cardinal Health in 1999, has not been named in most of this litigation but will be defending and indemnifying Baxter pursuant to certain contractual obligations for all expenses and potential liabilities associated with claims pertaining to latex gloves. As of March 31, 2005, the company filed prior to and concurrent with the offering, which the company later amendedhas been served as a defendant in connection with the restatement, and seeks unspecified damages.17 lawsuits.
The company believes that it may be subject to additional class action litigation and regulatory proceedings in connection with the events preceding the restatement announced in the third quarter of 2004.Pricing
As of March 31, 2005, Baxter International and certain of its subsidiaries are defendants in one civil lawsuit seeking unspecified damages on behalf of a person who allegedly was injured as a result of exposure to Baxter’s Althane series dialyzers, as well as a separate civil lawsuit seeking unspecified damages brought by the former distributor of Althane series dialyzers in Croatia. The company has reached settlements with a number of the families of patients who died in Spain, Sweden, Croatia and the United States after undergoing hemodialysis on Baxter Althane series dialyzers. The U.S. Government is investigating the matter and Baxter has received a subpoena to provide documents. Other lawsuits and claims may be filed in the United States and elsewhere.
As of September 30, 2004, Baxter International and certain of its subsidiaries have beenwere named as defendants, along with others, in seventeenmore than 30 lawsuits brought in various state and U.S. federal courts which allege that Baxter and other defendants reported artificially inflated average wholesale prices for Medicare and Medicaid eligible drugs. These cases have been brought by private parties on behalf of various purported classes of purchasers of Medicare and Medicaid eligible drugs, as well as by state attorneys general. As further explained below, all but fivenine of these cases have beenwere consolidated and are currently pending in the U.S.D.C. for the District of Massachusetts for pretrial case management under Multi District Litigation rules. Claimants seek unspecified damages and declaratory and injunctive relief under various state and/or federal statutes. In May 2003,After the U.S.D.C. for the Districtpartial dismissal of Massachusetts granted in part defendants’ motion to dismiss the consolidated amended complaint.complaint, Plaintiffs filed an amended master consolidated class action complaint andthat the defendants, including Baxter, moved to dismiss the complaint.dismiss. In February 2004, the court granted in part and denied in part defendants’ motion to dismiss. The lawsuits against Baxter include fiveeight lawsuits brought by
state attorneys general, which allege that prices for Medicare and Medicaid eligible drugs were artificially inflated and seek unspecified damages, injunctive relief, civil penalties, disgorgement, forfeiture and restitution. Specifically, in January 2002, the Attorney General of Nevada filed a civil suit in the Second Judicial District Court of Washoe County, Nevada. In February 2002, the Attorney General of Montana filed a civil suit in the First Judicial District Court of Lewis and Clark County, Montana. In June 2003, the U.S.D.C. for the District of Massachusetts remanded the Nevada case to Washoe County, Nevada and denied plaintiffs’ motion to remand the Montana case. In January 2004, the District Court remanded another case filed in state court to the Superior Court of Maricopa County, Arizona. In March 2004, the Attorney General of Pennsylvania filed a civil suit in the Commonwealth Court of Pennsylvania. That action was dismissed in February 2005. In March 2005, the Attorney General of Pennsylvania filed an amended complaint. In May 2004, the Attorney General of Texas filed a civil suit in the District Court of Travis County, Texas. In June 2004, the Attorney General of Wisconsin filed a civil suit in the Circuit Court of Dane County, Wisconsin. In November 2004, the Attorney General of Kentucky filed a civil suit in the Circuit Court of Franklin County, Kentucky. During the first quarter of 2005, Baxter has been named as a defendant in 13 additional cases, nine of which have been served upon the company. Additionally, during April 2005 Baxter has been named as a defendant in six cases,
none of which has yet been served. In January 2005, the Attorney General of Alabama filed a civil suit in the Circuit Court of Montgomery County, Alabama. In February 2005, the Attorney General of Illinois filed a civil suit in the Circuit Court of Cook County, Illinois. Various state and federal agencies are conducting civil investigations into the marketing and pricing practices of Baxter and others with respect to Medicare and Medicaid reimbursement. These investigations may result in additional cases being filed by various state attorneys general.
AsSecurities Laws and Other
In July 2003, Baxter received a request from the Midwest Regional Office of the Securities and Exchange Commission (SEC) for the voluntary production of documents and information concerning revisions to the company’s growth and earnings forecasts for 2003 and the establishment of certain reserves. The company was also requested in late July 2004 to voluntarily provide information as to the events in connection with the restatement of its consolidated financial statements, previously announced on July 22, 2004. The company is cooperating fully with the SEC.
In August 2002, six purported class action lawsuits were filed in the U.S.D.C. for the Northern District of Illinois naming Baxter and its then Chief Executive Officer and then Chief Financial Officer as defendants. These lawsuits, which were consolidated and sought recovery of unspecified damages, alleged that the defendants violated the federal securities laws by making misleading statements that allegedly caused Baxter common stock to trade at inflated levels. In December 2002, plaintiffs filed their consolidated amended class action complaint which named nine additional Baxter officers as defendants. In July 2003, the U.S.D.C. for the Northern District of Illinois dismissed in its entirety the consolidated amended class action complaint. In July 2004, the Seventh Circuit Court of Appeals reversed the order of dismissal and remanded the case to the District Court. In September 30,2004, the Seventh Circuit Court of Appeals denied motions by Baxter for rehearing, rehearing en banc and to stay the order to remand the case pending a petition for a writ of certiorari to the U.S. Supreme Court. In December 2004, Baxter International and certainfiled its petition for a writ of certiorari in the U.S. Supreme Court. Plaintiffs filed a revised consolidated amended complaint in the District Court in November 2004. Baxter filed its subsidiaries have been served as defendants, along with others,motion to dismiss the complaint in 142 lawsuits filedDecember 2004. The District Court denied Baxter’s motion to dismiss in various state andFebruary 2005. In March 2005, the U.S. federal courts, one of which isSupreme Court denied Baxter’s petition for certiorari.
In July 2004, a purported class action seeking damages, injunctive relief and medical monitoring for claimants alleged to have contracted autism or other attention deficit disorders as a result of exposure to vaccines for childhood diseases containing Thimerosal. These vaccines were formerly manufactured and sold by North American Vaccine, Inc., whichlawsuit was acquired by Baxter in June 2000, as well as others. As of September 30, 2004, seven suits have been dismissed based on the application of the National Vaccine Injury Compensation Act, five of which are pending on appeal. Additional Thimerosal cases may be filed in the futureU.S.D.C. for the Northern District of Illinois, in connection with the previously disclosed restatement, naming Baxter and its current Chief Executive Officer and Chief Financial Officer and their predecessors as defendants. The lawsuit, which seeks recovery of unspecified damages, alleges that the defendants violated the federal securities laws by making false and misleading statements regarding the company’s financial results, which allegedly caused Baxter common stock to trade at inflated levels during the period between April 2001 and July 2004. Three similar purported class action lawsuits were filed in the third quarter of 2004 in the U.S.D.C. for the Northern District of Illinois against the same defendants. These cases have been consolidated before a single judge. In October 2004, a solitary plaintiff filed a purported class action against Baxter in the Circuit Court of Cook County, Illinois alleging a breach of federal securities law through Baxter International’s secondary offering of common stock in September 2003. The plaintiff alleges that the offering price of these shares was artificially inflated by virtue of the financial statements that the company filed prior to and concurrent with the offering, which the company later amended in connection with the restatement, and seeks unspecified damages.
Baxter has removed this case to the U.S.D.C. for the Northern District of Illinois and it has also been consolidated with the other federal cases. In January 2005, plaintiffs filed a consolidated amended complaint in the District Court. In February 2005, Baxter filed its motion to dismiss.
The company believes that it may be subject to additional class action litigation and regulatory proceedings in connection with the events preceding the restatement announced in the third quarter of 2004.
In October 2004, a sole plaintiff filed a purported class action in the U.S.D.C. for the Northern District of Illinois against Baxter and companiesits current Chief Executive Officer and Chief Financial Officer and their predecessors for alleged violations of the Employee Retirement Income Security Act of 1974, as amended. Plaintiff alleges that marketed Thimerosal-containing products.these defendants, along with the Administrative and Investment Committees of the company’s Incentive Investment Plan and Puerto Rico Savings and Investment Plan (the Plans), which are the company’s 401(k) plans, breached their fiduciary duties to the Plans’ participants by offering Baxter common stock as an investment option in each of the Plans during the period of January 2001 to October 2004. Plaintiff alleges that Baxter common stock traded at artificially inflated prices during this period and seeks unspecified damages and declaratory and equitable relief. The plaintiff seeks to represent a class of the Plans’ participants who elected to acquire Baxter common stock through the Plans between January 2001 and the present.
AsIn August and September 2004, three plaintiffs filed separate derivative complaints in the Circuit Court of September 30, 1996,Cook County, Illinois against the datecompany’s Chief Executive Officer and Chief Financial Officer and certain other current and former officers and directors of the spin-offcompany. These actions, which plaintiffs purport to bring on the company’s behalf, seek unspecified damages for alleged breaches of Allegiancefiduciary duty in connection with the company’s disclosures of its financial results between April 2001 and July 2004. These three cases have been consolidated before one judge in the state court.
During the first quarter of 2005, Baxter and Haemonetics Corporation (Allegiance)(Haemonetics) have been engaged in a binding arbitration proceeding brought by Haemonetics. Haemonetics has alleged that Baxter breached supply contracts assigned to it in connection with Baxter’s acquisition of assets from Alpha Corporation in 2003. Baxter Allegiance assumedhas denied the defenseallegations. The matter has been submitted for decision by the arbitration panel in the second quarter of litigation involving claims related to Allegiance’s businesses, including certain claims2005.
In April 2003, A. Nattermann & Cie GmbH and Aventis Behring L.L.C. filed a patent infringement lawsuit in the U.S.D.C. for the District of Delaware naming Baxter Healthcare Corporation as the defendant. In November 2003, plaintiffs dismissed the lawsuit without prejudice. The complaint, which sought injunctive relief, alleged personal injuries as a resultthat Baxter’s planned manufacture and sale of exposure to natural rubber latex gloves. AllegianceADVATE would infringe United States Patent No. 5,565,427. A reexamination of the patent is pending before the United States Patent and Trademark Office.
Baxter has not been named a potentially responsible party (PRP) for environmental clean-up at a number of sites. Under the United States Superfund statute and many state laws, generators of hazardous waste that is sent to a disposal or recycling site are liable for clean-up of the site if contaminants from that property later leak into the environment. The laws generally provide that a PRP may be held jointly and severally liable for the costs of investigating and remediating the site. Baxter’s estimated exposure for the eight sites where Baxter is contributing to cleanup costs is approximately $2 million, which has been accrued (and not discounted) in most of this litigation but will be defending and indemnifying Baxter pursuant to certain contractual obligations for all expenses and potential liabilities associated with claims pertaining to latex gloves. As of September 30, 2004, the company was named as a defendant in 30 lawsuits.company’s financial statements.
In addition to the cases discussed above, Baxter is a defendant in a number of other claims, investigations and lawsuits. Based on the advice of counsel, management does not believe that, individually or in the aggregate, these other claims, investigations and lawsuits will have a material adverse effect on the company’s results of operations, cash flows or consolidated financial position.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
On March 28, 2005, the company issued 35,063 shares of its common stock to BioSurgical Liquidating Trust (BioSurgical) to satisfy its contractual obligations under an amended asset purchase agreement with BioSurgical to pay regulatory clearance payments and accrued contingent payments based on sales related to the technology acquired under the original agreement. The company may issue additional shares of common stock if additional consideration becomes payable by the company pursuant to the contingent payment provisions of the amended agreement. The company is contractually obligated to maintain an effective registration statement for the resale of such shares. The shares of common stock were issued in a transaction not involving a public offering and the issuance was deemed to be exempt from registration in reliance on Section 4(2) of the Securities Act of 1933. The recipient of the shares in such transaction represented its intention to acquire the shares for investment only and not with a view to distribution thereof and appropriate legends were affixed to the share certificates issued in the transaction. No underwriters were involved in the issuance of the shares.
Item 5. | Other Information |
Subsequent to the filing of the company’s annual meeting proxy statement on March 21, 2005, the company discovered that certain amounts reported for named executive officer James E. Utts were incorrectly reported in the proxy statement. The additional amounts relate to Mr. Utts’s international assignment as Corporate Vice President—President, Europe and relocation to Zurich, Switzerland. Mr. Utts received a cost of living adjustment of $15,636 in 2004, which is to be reported as salary. The aggregate incremental cost for Mr. Utt’s perquisites and personal benefits in 2004 was $79,504, $69,104 of which was attributable to relocation costs and expatriate support. Mr. Utts also received $22,389 in 2004 as reimbursement for the payment of taxes, $21,062 of which related to host country taxes.
On March 29, 2005, the company received a warning letter from the Food and Drug Administration (FDA) as a result of a manufacturing facility audit conducted in October 2004 at the company’s Tampa facility. The warning letter identified issues with the adequacy of the company’s documentation in response to FDA observations, primarily citing hemodialysis equipment, from an inspection of the Tampa facility. Before receiving the warning letter, Baxter was already working to address every issue the warning letter raised, and some of the issues have already been fully resolved to the FDA’s satisfaction, as indicated in the FDA letter. The company is in the process of addressing other issues that require more systemic change and will continue to collaborate closely with the FDA to make sure all concerns are appropriately resolved.
Item 6. | Exhibits |
Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index hereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
BAXTER INTERNATIONAL INC. | ||||||||
(Registrant) | ||||||||
Date: | By: | /s/ JOHN J. GREISCH | ||||||
John J. Greisch | ||||||||
Corporate Vice President and Chief Financial Officer
|
EXHIBIT INDEXEXHIBITS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
Number | Description of Exhibit | |
15 | Letter Re Unaudited Interim Financial Information | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934 | |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350 | |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350 |
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