UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 20162017
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period fromto
Commission file number 1-4448
BAXTER INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Delaware | 36-0781620 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
One Baxter Parkway, Deerfield, Illinois | 60015 | |
(Address of principal executive offices) | (Zip Code) |
224-948-2000 | ||||
(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. Yes x☒ No ¨☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x☒ No ¨☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”filer,” “smaller reporting company,” and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |||
Non-accelerated filer | ☐ | (Do not check if a smaller reporting company) | Smaller reporting company | ☐ | ||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨☐ No x☒
The number of shares of the registrant’s Common Stock, par value $1.00 per share, outstanding as of October 31, 201627, 2017 was 543,919,936544,831,923 shares.
FORM 10-Q
For the quarterly period ended September 30, 20162017
TABLE OF CONTENTS
Page Number | ||||||||
PARTI. | 2 | |||||||
Item 1. | 2 | |||||||
2 | ||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 26 | ||||||
Item 3. | 39 | |||||||
Item 4. | 40 | |||||||
41 | ||||||||
42 | ||||||||
| ||||||||
PART II. | 43 | |||||||
Item 1. | 43 | |||||||
Item 2. | 43 | |||||||
Item 6. | 44 | |||||||
45 |
Baxter International Inc.
Condensed Consolidated Statements of Income (unaudited)
(in millions, except per share data)
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| |||||||||||||||||
Net sales | $2,558 | $2,487 | $7,518 | $7,365 |
| $ | 2,707 |
|
| $ | 2,558 |
|
| $ | 7,787 |
|
| $ | 7,518 |
| ||||||||||||
Cost of sales | 1,487 | 1,453 | 4,510 | 4,291 |
|
| 1,579 |
|
|
| 1,487 |
|
|
| 4,487 |
|
|
| 4,510 |
| ||||||||||||
Gross margin | 1,071 | 1,034 | 3,008 | 3,074 |
|
| 1,128 |
|
|
| 1,071 |
|
|
| 3,300 |
|
|
| 3,008 |
| ||||||||||||
Marketing and administrative expenses | 726 | 794 | 2,076 | 2,361 |
|
| 685 |
|
|
| 726 |
|
|
| 1,890 |
|
|
| 2,076 |
| ||||||||||||
Research and development expenses | 159 | 148 | 490 | 442 |
|
| 151 |
|
|
| 159 |
|
|
| 435 |
|
|
| 490 |
| ||||||||||||
Operating income | 186 | 92 | 442 | 271 |
|
| 292 |
|
|
| 186 |
|
|
| 975 |
|
|
| 442 |
| ||||||||||||
Net interest expense | 14 | 34 | 53 | 94 |
|
| 14 |
|
|
| 14 |
|
|
| 41 |
|
|
| 53 |
| ||||||||||||
Other expense (income), net | 44 | 91 | (4,286 | ) | (46 | ) | ||||||||||||||||||||||||||
Income (loss) from continuing operations before income taxes | 128 | (33 | ) | 4,675 | 223 | |||||||||||||||||||||||||||
Other (income) expense, net |
|
| (12 | ) |
|
| 44 |
|
|
| 10 |
|
|
| (4,286 | ) | ||||||||||||||||
Income from continuing operations before income taxes |
|
| 290 |
|
|
| 128 |
|
|
| 924 |
|
|
| 4,675 |
| ||||||||||||||||
Income tax expense (benefit) | 1 | (35 | ) | (51 | ) | 13 |
|
| 42 |
|
|
| 1 |
|
|
| 139 |
|
|
| (51 | ) | ||||||||||
Income from continuing operations | 127 | 2 | 4,726 | 210 |
|
| 248 |
|
|
| 127 |
|
|
| 785 |
|
|
| 4,726 |
| ||||||||||||
Income (loss) from discontinued operations, net of tax | 3 | (1 | ) | (4 | ) | 553 |
|
| 3 |
|
|
| 3 |
|
|
| 3 |
|
|
| (4 | ) | ||||||||||
Net income | $ 130 | $ 1 | $4,722 | $ 763 |
| $ | 251 |
|
| $ | 130 |
|
| $ | 788 |
|
| $ | 4,722 |
| ||||||||||||
Income from continuing operations per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Basic | $ 0.23 | $ 0.00 | $ 8.64 | $ 0.39 |
| $ | 0.46 |
|
| $ | 0.23 |
|
| $ | 1.45 |
|
| $ | 8.64 |
| ||||||||||||
Diluted | $ 0.23 | $ 0.00 | $ 8.56 | $ 0.38 |
| $ | 0.45 |
|
| $ | 0.23 |
|
| $ | 1.42 |
|
| $ | 8.56 |
| ||||||||||||
Income (loss) from discontinued operations per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Basic | $ 0.01 | $ 0.00 | $ (0.01 | ) | $ 1.01 |
| $ | — |
|
| $ | 0.01 |
|
| $ | — |
|
| $ | (0.01 | ) | |||||||||||
Diluted | $ 0.01 | $ 0.00 | $ (0.01 | ) | $ 1.01 |
| $ | — |
|
| $ | 0.01 |
|
| $ | — |
|
| $ | (0.01 | ) | |||||||||||
Net income per common share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Basic | $ 0.24 | $ 0.00 | $ 8.63 | $ 1.40 |
| $ | 0.46 |
|
| $ | 0.24 |
|
| $ | 1.45 |
|
| $ | 8.63 |
| ||||||||||||
Diluted | $ 0.24 | $ 0.00 | $ 8.55 | $ 1.39 |
| $ | 0.45 |
|
| $ | 0.24 |
|
| $ | 1.42 |
|
| $ | 8.55 |
| ||||||||||||
Weighted-average number of common shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Basic | 544 | 546 | 547 | 544 |
|
| 545 |
|
|
| 544 |
|
|
| 543 |
|
|
| 547 |
| ||||||||||||
Diluted | 551 | 549 | 552 | 548 |
|
| 557 |
|
|
| 551 |
|
|
| 554 |
|
|
| 552 |
| ||||||||||||
Cash dividends declared per common share | $ 0.13 | $0.115 | $0.375 | $1.155 |
| $ | 0.160 |
|
| $ | 0.130 |
|
| $ | 0.450 |
|
| $ | 0.375 |
| ||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc.
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(in millions)
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| |||||||||||||||||
Net income | $ | 130 | $ | 1 | $ | 4,722 | $ | 763 |
| $ | 251 |
|
| $ | 130 |
|
| $ | 788 |
|
| $ | 4,722 |
| ||||||||
Other comprehensive income (loss), net of tax: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Currency translation adjustments, net of tax benefit of ($2) and ($10) for the three months ended September 30, 2016 and 2015, respectively, and ($12) and ($78) for the nine months ended September 30, 2016 and 2015, respectively | 10 | (271 | ) | (16 | ) | (985 | ) | |||||||||||||||||||||||||
Pension and other employee benefits, net of tax expense of $11 and $16 for the three months ended September 30, 2016 and 2015, respectively, and $32 and $150 for the nine months ended September 30, 2016 and 2015, respectively | 21 | 31 | 61 | 212 | ||||||||||||||||||||||||||||
Hedging activities, net of tax (benefit) expense of zero and ($1) for the three months ended September 30, 2016 and 2015, respectively, and $(5) and $9 for the nine months ended September 30, 2016 and 2015, respectively | 1 | (2 | ) | (10 | ) | 16 | ||||||||||||||||||||||||||
Available-for-sale securities, net of tax expense of zero and $2 for the three months ended September 30, 2016 and 2015, respectively, and zero and $6 for the nine months ended September 30, 2016 and 2015 | — | 3,418 | (4,431 | ) | 3,440 | |||||||||||||||||||||||||||
Currency translation adjustments, net of tax expense (benefit) of $21 and ($2) for the three months ended September 30, 2017 and 2016, respectively, and $69 and ($12) for the nine months ended September 30, 2017 and 2016, respectively |
|
| 181 |
|
|
| 10 |
|
|
| 530 |
|
|
| (16 | ) | ||||||||||||||||
Pension and other employee benefits, net of tax expense of $6 and $11 for the three months ended September 30, 2017 and 2016, respectively, and $26 and $32 for the nine months ended September 30, 2017 and 2016, respectively |
|
| 6 |
|
|
| 21 |
|
|
| 44 |
|
|
| 61 |
| ||||||||||||||||
Hedging activities, net of tax benefit of ($2) and zero for the three months ended September 30, 2017 and 2016, respectively, and ($7) and ($5) for the nine months ended September 30, 2017 and 2016, respectively |
|
| (6 | ) |
|
| 1 |
|
|
| (16 | ) |
|
| (10 | ) | ||||||||||||||||
Available-for-sale securities, net of tax expense of zero for the three months ended September 30, 2017 and 2016, and $1 and zero for the nine months ended September 30, 2017 and 2016, respectively |
|
| 1 |
|
|
| — |
|
|
| 4 |
|
|
| (4,431 | ) | ||||||||||||||||
Total other comprehensive income (loss), net of tax | 32 | 3,176 | (4,396 | ) | 2,683 |
|
| 182 |
|
|
| 32 |
|
|
| 562 |
|
|
| (4,396 | ) | |||||||||||
Comprehensive income | $ | 162 | $ | 3,177 | $ | 326 | $ | 3,446 |
| $ | 433 |
|
| $ | 162 |
|
| $ | 1,350 |
|
| $ | 326 |
| ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc.
Condensed Consolidated Balance Sheets (unaudited)
(in millions, except shares)
September 30, | December 31, |
|
|
| September 30, |
|
| December 31, |
| |||||||||||
2016 | 2015 |
|
|
| 2017 |
|
| 2016 |
| |||||||||||
Current assets | Cash and equivalents | $ 2,597 | $ 2,213 |
| Cash and equivalents |
| $ | 3,517 |
|
| $ | 2,801 |
| |||||||
Accounts and other current receivables, net | 1,739 | 1,731 | ||||||||||||||||||
Inventories | 1,568 | 1,604 |
| Accounts and other current receivables, net |
|
| 1,748 |
|
|
| 1,691 |
| ||||||||
Prepaid expenses and other | 634 | 855 |
| Inventories |
|
| 1,550 |
|
|
| 1,430 |
| ||||||||
Investment in Baxalta common stock | — | 5,148 |
| Prepaid expenses and other |
|
| 633 |
|
|
| 602 |
| ||||||||
Current assets held for disposition | 51 | 245 |
| Current assets held for disposition |
|
| — |
|
|
| 50 |
| ||||||||
Total current assets | 6,589 | 11,796 |
| Total current assets |
|
| 7,448 |
|
|
| 6,574 |
| ||||||||
Property, plant and equipment, net | Property, plant and equipment, net | 4,327 | 4,386 | Property, plant and equipment, net |
|
| 4,488 |
|
|
| 4,289 |
| ||||||||
Other assets | Goodwill | 2,679 | 2,687 |
| Goodwill |
|
| 3,117 |
|
|
| 2,595 |
| |||||||
Other intangible assets, net | 1,180 | 1,349 |
| Other intangible assets, net |
|
| 1,371 |
|
|
| 1,111 |
| ||||||||
Other | 1,020 | 744 |
| Other |
|
| 1,117 |
|
|
| 977 |
| ||||||||
Total other assets | 4,879 | 4,780 |
| Total other assets |
|
| 5,605 |
|
|
| 4,683 |
| ||||||||
Total assets | $ 15,795 | $ 20,962 |
|
|
| $ | 17,541 |
|
| $ | 15,546 |
| ||||||||
Current liabilities | Short-term debt | $ — | $ 1,775 |
| Current maturities of long-term debt and lease obligations |
| $ | 3 |
|
| $ | 3 |
| |||||||
Current maturities of long-term debt and lease obligations | 6 | 810 | ||||||||||||||||||
Accounts payable and accrued liabilities | 2,499 | 2,666 |
| Accounts payable and accrued liabilities |
|
| 2,572 |
|
|
| 2,612 |
| ||||||||
Current income taxes payable | 98 | 453 |
| Current income taxes payable |
|
| 87 |
|
|
| 126 |
| ||||||||
Current liabilities held for disposition | 3 | 46 |
| Current liabilities held for disposition |
|
| — |
|
|
| 3 |
| ||||||||
Total current liabilities | 2,606 | 5,750 |
| Total current liabilities |
|
| 2,662 |
|
|
| 2,744 |
| ||||||||
Long-term debt and lease obligations | Long-term debt and lease obligations | 2,834 | 3,922 | Long-term debt and lease obligations |
|
| 3,495 |
|
|
| 2,779 |
| ||||||||
Other long-term liabilities | Other long-term liabilities | 1,691 | 2,425 | Other long-term liabilities |
|
| 1,925 |
|
|
| 1,743 |
| ||||||||
Equity | Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2016 and 2015 | 683 | 683 |
| Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2017 and 2016 |
|
| 683 |
|
|
| 683 |
| |||||||
Common stock in treasury, at cost, 139,581,579 shares in 2016 and 135,839,938 shares in 2015 | (7,813 | ) | (7,646 | ) |
| Common stock in treasury, at cost, 138,870,075 shares in 2017 and 143,890,064 shares in 2016 |
|
| (7,756 | ) |
|
| (7,995 | ) | ||||||
Additional contributed capital | 5,930 | 5,902 |
| Additional contributed capital |
|
| 5,918 |
|
|
| 5,958 |
| ||||||||
Retained earnings | 14,049 | 9,683 |
| Retained earnings |
|
| 14,615 |
|
|
| 14,200 |
| ||||||||
Accumulated other comprehensive (loss) income | (4,172 | ) | 224 |
| Accumulated other comprehensive (loss) income |
|
| (3,994 | ) |
|
| (4,556 | ) | |||||||
Total Baxter shareholders’ equity | 8,677 | 8,846 |
| Total Baxter shareholders’ equity |
|
| 9,466 |
|
|
| 8,290 |
| ||||||||
Noncontrolling interests | (13 | ) | 19 |
| Noncontrolling interests |
|
| (7 | ) |
|
| (10 | ) | |||||||
Total equity | 8,664 | 8,865 |
| Total equity |
|
| 9,459 |
|
|
| 8,280 |
| ||||||||
Total liabilities and equity | Total liabilities and equity | $ 15,795 | $ 20,962 | Total liabilities and equity |
| $ | 17,541 |
|
| $ | 15,546 |
| ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
(in millions)
Nine months ended |
|
|
| Nine months ended |
| |||||||||||||||
September 30, |
|
|
| September 30, |
| |||||||||||||||
2016 | 2015 |
|
|
| 2017 |
|
| 2016 |
| |||||||||||
Cash flows from operations | Net income | $4,722 | $ 763 |
| Net income |
| $ | 788 |
|
| $ | 4,722 |
| |||||||
Adjustments to reconcile income from continuing operations to net cash from operating activities: | ||||||||||||||||||||
Loss (income) from discontinued operations, net of tax | 4 | (553 | ) | |||||||||||||||||
Depreciation and amortization | 599 | 593 |
| Adjustments to reconcile income from continuing operations to net cash from operating activities: |
|
|
|
|
|
|
|
| ||||||||
Deferred income taxes | (298 | ) | 63 |
| Loss (income) from discontinued operations, net of tax |
|
| (3 | ) |
|
| 4 |
| |||||||
Stock compensation | 84 | 96 |
| Depreciation and amortization |
|
| 562 |
|
|
| 599 |
| ||||||||
Realized excess tax benefits from stock issued under employee benefit plans | (36 | ) | (6 | ) |
| Deferred income taxes |
|
| (30 | ) |
|
| (298 | ) | ||||||
Net periodic pension benefit and OPEB costs | 90 | 170 |
| Stock compensation |
|
| 77 |
|
|
| 84 |
| ||||||||
Business optimization items | 237 | 102 |
| Net periodic pension benefit and OPEB costs |
|
| 93 |
|
|
| 90 |
| ||||||||
Net realized gains on Baxalta common stock | (4,387 | ) | — |
| Net realized gains on the Baxalta Retained Share transactions |
|
| — |
|
|
| (4,387 | ) | |||||||
Other | 236 | (8 | ) |
| Other |
|
| 69 |
|
|
| 437 |
| |||||||
Changes in balance sheet items |
| Changes in balance sheet items |
|
|
|
|
|
|
|
| ||||||||||
Accounts and other current receivables, net | 22 | 5 |
| Accounts and other current receivables, net |
|
| 32 |
|
|
| 22 |
| ||||||||
Inventories | (11 | ) | (205 | ) |
| Inventories |
|
| — |
|
|
| (11 | ) | ||||||
Accounts payable and accrued liabilities | (326 | ) | 14 |
| Accounts payable and accrued liabilities |
|
| (36 | ) |
|
| (326 | ) | |||||||
Business optimization and infusion pump payments | (119 | ) | (61 | ) |
| Business optimization and infusion pump payments |
|
| (116 | ) |
|
| (119 | ) | ||||||
Other | 121 | (216 | ) |
| Other |
|
| (93 | ) |
|
| 121 |
| |||||||
Cash flows from operations – continuing operations | 938 | 757 |
| Cash flows from operations – continuing operations |
|
| 1,343 |
|
|
| 938 |
| ||||||||
Cash flows from operations – discontinued operations | 3 | 290 |
| Cash flows from operations – discontinued operations |
|
| (20 | ) |
|
| 3 |
| ||||||||
Cash flows from operations | 941 | 1,047 |
| Cash flows from operations |
|
| 1,323 |
|
|
| 941 |
| ||||||||
Cash flows from investing activities | Capital expenditures | (519 | ) | (658 | ) |
| Capital expenditures |
|
| (410 | ) |
|
| (519 | ) | |||||
Acquisitions and investments, net of cash acquired | (47 | ) | (27 | ) |
| Acquisitions and investments, net of cash acquired |
|
| (680 | ) |
|
| (47 | ) | ||||||
Divestitures and other investing activities | 17 | 56 |
| Divestitures and other investing activities, net |
|
| 2 |
|
|
| 17 |
| ||||||||
Cash flows from investing activities – continuing operations | (549 | ) | (629 | ) |
| Cash flows from investing activities – continuing operations |
|
| (1,088 | ) |
|
| (549 | ) | ||||||
Cash flows from investing activities – discontinued operations | 13 | (946 | ) |
| Cash flows from investing activities – discontinued operations |
|
| — |
|
|
| 13 |
| |||||||
Cash flows from investing activities | (536 | ) | (1,575 | ) |
| Cash flows from investing activities |
|
| (1,088 | ) |
|
| (536 | ) | ||||||
Cash flows from financing activities | Issuances of debt | 1,641 | 6,868 |
| Issuances of debt |
|
| 633 |
|
|
| 1,641 |
| |||||||
Payments of obligations | (1,383 | ) | (3,723 | ) |
| Payments of obligations |
|
| — |
|
|
| (1,383 | ) | ||||||
Debt extinguishment costs | (16 | ) | (114 | ) |
| Debt extinguishment costs |
|
| — |
|
|
| (16 | ) | ||||||
Decrease in debt with original maturities of three months or less, net | (300 | ) | (450 | ) |
| Increase (decrease) in debt with original maturities of three months or less, net |
|
| — |
|
|
| (300 | ) | ||||||
Transfer of cash and equivalents to Baxalta | — | (2,122 | ) |
| Cash dividends on common stock |
|
| (228 | ) |
|
| (197 | ) | |||||||
Cash dividends on common stock | (197 | ) | (847 | ) |
| Proceeds from stock issued under employee benefit plans |
|
| 298 |
|
|
| 251 |
| ||||||
Proceeds and realized excess tax benefits from stock issued under employee benefit plans | 286 | 174 |
| Purchases of treasury stock |
|
| (275 | ) |
|
| (45 | ) | ||||||||
Purchase of treasury stock | (45 | ) | — |
| Other |
|
| (37 | ) |
|
| 5 |
| |||||||
Other | (30 | ) | (39 | ) |
| Cash flows from financing activities |
|
| 391 |
|
|
| (44 | ) | ||||||
Cash flows from financing activities | (44 | ) | (253 | ) | ||||||||||||||||
Effect of foreign exchange rate changes on cash and equivalents | Effect of foreign exchange rate changes on cash and equivalents | 23 | (174 | ) | Effect of foreign exchange rate changes on cash and equivalents |
|
| 90 |
|
|
| 23 |
| |||||||
Increase (decrease) in cash and equivalents | 384 | (955 | ) | |||||||||||||||||
Increase in cash and equivalents | Increase in cash and equivalents |
|
| 716 |
|
|
| 384 |
| |||||||||||
Cash and equivalents at beginning of period | Cash and equivalents at beginning of period | 2,213 | 2,925 | Cash and equivalents at beginning of period |
|
| 2,801 |
|
|
| 2,213 |
| ||||||||
Cash and equivalents at end of period | Cash and equivalents at end of period | $ 2,597 | $ 1,970 | Cash and equivalents at end of period |
| $ | 3,517 |
|
| $ | 2,597 |
| ||||||||
Supplemental Schedule of Non-Cash Investing and Financing Activities | Supplemental Schedule of Non-Cash Investing and Financing Activities |
| Supplemental Schedule of Non-Cash Investing and Financing Activities |
|
|
|
|
|
|
|
| |||||||||
Net proceeds on Retained Share transactions | $ 4,387 | $ — | ||||||||||||||||||
Payment of obligations in exchange for Retained Shares | 3,646 | — | ||||||||||||||||||
Exchange of Baxter shares with Retained Shares | 611 | — | ||||||||||||||||||
Other Supplemental Information | ||||||||||||||||||||
Income taxes paid | $ 453 | $ 357 | ||||||||||||||||||
Net proceeds on the Baxalta Retained Share transactions | Net proceeds on the Baxalta Retained Share transactions |
| $ | — |
|
| $ | 4,387 |
| |||||||||||
Payment of obligations in exchange for Baxalta Retained Shares | Payment of obligations in exchange for Baxalta Retained Shares |
| $ | — |
|
| $ | 3,646 |
| |||||||||||
Exchange of Baxter shares with Baxalta Retained Shares | Exchange of Baxter shares with Baxalta Retained Shares |
| $ | — |
|
| $ | 611 |
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
Baxter International Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
1. BASIS OF PRESENTATION
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 (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States have been condensed or omitted. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the company’s Annual Report on Form 10-K for the year ended December 31, 2015 (20152016 (2016 Annual Report).
In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair statement of the interim periods. All such adjustments, unless otherwise noted herein, are of a normal, recurring 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 prior period condensed consolidated statements to the current period presentation.
SeparationAccounting for Venezuelan Operations
Currency restrictions enacted in Venezuela require Baxter to obtain approval from the Venezuelan government to exchange Venezuelan bolivars for U.S. dollars and require such exchange to be made at the official exchange rate established by the government. In the first quarter of Baxalta Incorporated
On July 1, 2015, Baxter completed2016, the distributionVenezuelan government moved from the three-tier exchange rate system to a two-tiered exchange rate system and the official rate for food and medicine imports was adjusted from 6.3 to 10 bolivars per U.S. dollar. Due to a recent decline in transactions settled at the official rate or the secondary rate and limitations on the company’s ability to repatriate funds generated by its Venezuela operations, the company concluded in the second quarter of approximately 80.5% of2017 that it no longer met the outstanding common stock of Baxalta Incorporated (Baxalta) to Baxter shareholders (the Distribution). The Distribution was made to Baxter’s shareholders of record as ofaccounting criteria for control over its business in Venezuela and the close of businesscompany deconsolidated its Venezuelan operations on June 17, 2015 (Record Date), who received one share of Baxalta common stock for each Baxter common share held as of the Record Date.30, 2017. As a result of deconsolidating the Distribution, Baxalta became an independent publicVenezuelan operations, the company trading under the symbol “BXLT” on the New York Stock Exchange. On June 3, 2016,recorded a wholly-owned subsidiarypre-tax charge of Shire plc (Shire) merged with and into Baxalta, with Baxalta as the surviving company$33 million in other (income) expense, net in the merger (Merger).second quarter of 2017. This charge included the write-off of the company’s investment in its Venezuelan operations, related unrealized translation adjustments and elimination of intercompany amounts. Beginning in the third quarter of 2017, the company no longer included the results of its Venezuelan business in its consolidated financial statements.
References
Hurricane Maria
In September 2017, Hurricane Maria caused damage to certain of the company's assets in this reportPuerto Rico and disrupted operations. Insurance, less applicable deductibles and subject to Baxalta priorany coverage exclusions, covers the repair or replacement of the company's assets that suffered loss or damage, and the company is working closely with its insurance carriers and claims adjusters to ascertain the full amount of insurance proceeds due to the Merger closing date refers to Baxaltacompany as a stand-alone public company. References in this report to Baxalta subsequent to the Merger closing date refer to Baxalta as a subsidiary of Shire.
As a result of the separation,damages and the loss the company suffered. The company's insurance policies also provide coverage for interruption to its business, including lost profits, and reimbursement for other expenses and costs that have been incurred relating to the damages and losses suffered. In the third quarter of 2017, the Company recorded $21 million of pre-tax charges related to damages caused by the hurricane, including $11 million related to the impairment of damaged inventory and fixed assets as well as $10 million of idle facility and other costs. These amounts were recorded as a component of cost of sales in the condensed consolidated statements of income condensed consolidated balance sheets, condensed consolidated statementsfor the three and nine month periods ended September 30, 2017. At this time, the full amount of cash flowcombined property damage and related financial information reflect Baxalta’s operations, assetsbusiness interruption costs and liabilities,recoveries cannot be estimated, and cash flowsaccordingly, no additional amounts, including amounts for anticipated insurance recoveries, have been recorded as discontinued operations for all periods presented. Refer to Note 2 for additional information regarding the separation of Baxalta.September 30, 2017.
New accounting standards
Recently issued accounting standards not yet adopted
In March 2016,August 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09,2017-12, Targeted Improvements to Employee Share-Based Payment Accounting for Hedging Activities, which amends ASC Topic 718,815, Derivatives and Hedging. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the hedge accounting requirements, and improve the disclosures of hedging arrangements. The effective date for this ASU is January 1, 2019, with early adoption permitted. The company is evaluating the potential effects on the consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which amends ASC 715, Compensation – Stock Compensation.Retirement Benefits, to require employers that present a measure of operating income in their statements of earnings to include only the service cost component of net periodic postretirement benefit cost in operating expenses. The updated guidance requires all tax effects related to share-based paymentservice cost component of net periodic postretirement benefit cost should be recorded in income tax expensepresented in the consolidated statement of income. Current guidance requires that tax effects of deductions in excess of share-basedsame operating expense line items as other employee compensation costs (windfall
tax benefits) be recorded in additional paid-in capital,arising from services rendered during the period. The other components of net benefit cost, including interest costs, expected return on assets, amortization of prior service cost/credit, and tax deficiencies (shortfalls) be recorded in additional paid-in capital to the extent of previously recognized windfall tax benefits, with the remainder recorded in income tax expense. The new guidance also requires all tax-related cash flows resulting from share-based paymentssettlement and curtailment effects, are to be reported asincluded separately and outside of any subtotal of operating activities inincome. The company intends to adopt the consolidated statement of cash flows, rather than the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. The guidance isstandard effective for the company beginning January 1, 2017. The2018. This guidance will impact the presentation of the company’s consolidated statements of income with no impact on net income. Upon adoption of the standard is dependent on the timing and value of award exercises and vesting. The company has evaluated the impact of this standard on its consolidated financial statementsJanuary 1, 2018, operating income for the three and nine month periodsmonths ended September 30, 2016, and determined that net income and operating cash flow for the periods would have each increased by approximately $92017, will be recast to increase $8 million and $36$25 million, respectively, if the company had adopted the new standard January 1, 2016.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees are required to recognize lease assets and liabilities on the balance sheet for leases classified as operating leases under current GAAP. This ASU is effective for the company beginning January 1, 2019. The company is currently evaluating the impact of this standard on its consolidated financial statements.with a corresponding increase in other (income) expense, net.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. ASU No. 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU No. 2014-09 will be effective for the company beginning on January 1, 2018. The standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The company has completed an assessment of the new standard and is currently evaluatingexecuting its detailed implementation plan and developing processes for gathering information for required disclosures. Based on the work performed to date, the company does not expect the adoption of the new standard to have a material impact of adoptingon the standard on its consolidated financial statements. The company expects to adopt the standard using the modified retrospective method.
Recently adopted accounting pronouncements
As of January 1, 2016,2017, the company adopted on a prospective basis ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs,2016-09, Improvements to Employee Share-Based Payment Accounting, which amendedamends ASC 835-30, Interest - Imputation of Interest. ThisTopic 718, Compensation – Stock Compensation. The updated guidance requires that debt issuance costsall tax effects related to a recognized debt liabilityshare-based payments to be presented as a direct deduction from the carrying amount of the related debt liability. As a result of the adoption, the company reclassified debt issuance costs of $13 million from other assets to long-term debtrecorded in income tax expense in the Company’s consolidated balance sheet asstatement of December 31, 2015.income. Previous guidance required that tax effects of deductions in excess of share-based compensation costs (windfall tax benefits) be recorded in additional paid-in capital, and tax deficiencies be recorded in additional paid-in capital to the extent of previously recognized windfall tax benefits, with the remainder recorded in income tax expense. The adoption of thisnew guidance did not impactalso requires the company’s consolidated statements of earnings, comprehensive income, shareholders’ equity, or cash flows.
As of January 1, 2016, the company adopted ASU No. 2015-05, Intangibles–Goodwill and Other–Internal-Use Software (Subtopic 350-40), Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This guidance requires software licenses within cloud computing arrangementsflows resulting from windfall tax benefits to be classifiedreported as intangible assets. The adoptionoperating activities in the consolidated statement of ASU No. 2015-05 did not have a material impact on Baxter’s financial position or results of operations.
As of July 1, 2016,cash flows, rather than the company adopted ASU No. 2016-15, Statement of Cash Flows (Topic 230). The guidance requires that the cash payments for debt prepayment or debt extinguishment costs be classifiedprevious requirement to present windfall tax benefits as cash outflows foran inflow from financing activities and an outflow from operating activities. As a result of the adoption, net income and operating cash flow for the three and nine months ended September 30, 2017, increased by approximately $18 million and $48 million, respectively. The prior periods have not been restated and therefore, windfall tax benefits of $8 million and $35 million, respectively, for the three and nine months ended September 30, 2016, were not included in net income and were included as an inflow from financing activities and an outflow from operating activities in the third quartercondensed consolidated statement of 2016 the company has reclassified certain debt prepayments and debt extinguishment costs from operating to financing activities which resulted in a decrease in financing cash flows of $16 million and $124 million for the first nine months of 2016 and 2015, respectively. The adoption of this guidance did not impact the company’s consolidated statements of earnings, consolidated balance sheet, comprehensive income, or shareholders’ equity.flows.
2. SEPARATION OF BAXALTA INCORPORATED
On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta Incorporated (Baxalta) to Baxter shareholders (the Distribution). After giving effect to the Distribution, the company retained 19.5% of the outstanding common stock, or 131,902,719 shares of Baxalta (Retained Shares). Effective January 27, 2016, Baxter completed a debt-for-equity exchange through the transferThe Distribution was made to Baxter’s shareholders of 37,573,040 Retained Shares in exchange for the extinguishmentrecord as of the $1.45 billion aggregate principal amountclose of indebtedness outstandingbusiness on June 17, 2015 (Record Date), who received one share of Baxalta common stock for each Baxter common share held as of the Record Date. As a result of the Distribution, Baxalta became an independent public company trading under the company’s prior U.S. dollar denominated revolving credit facility, which was terminated in connectionsymbol “BXLT” on the New York Stock Exchange.
On June 3, 2016, Baxalta became a wholly-owned subsidiary of Shire plc (Shire) through a merger of a wholly-owned Shire subsidiary with the closing of this exchange. On March 16, 2016, the company completed a debt-for-equity exchange, in which Baxter exchanged 63,823,582 Retained Shares for the extinguishment of $2.2 billion in aggregate principal amount of Baxter indebtedness. On May 6, 2016 the company contributed 17,145,570 Retained Shares to Baxter’s U.S. pension fund. On May 26, 2016 the company completed an equity-for-equity exchange by exchanging 13,360,527 Retained Shares for 11,526,638 shares of Baxter. The company held no shares ofand into Baxalta, with Baxalta as the surviving subsidiary (the Merger). References in this report to Baxalta prior to the Merger closing date refer to Baxalta as a stand-alone public company. References in this report to Baxalta subsequent to the Merger closing date refer to Baxalta as a subsidiary of September 30, 2016. See Note 8 for additional details regarding these transactions.Shire.
For a portion of Baxalta’s operations, the legal transfer of Baxalta’s assets and liabilities did not occur with the separation of Baxalta on July 1, 2015 due to the time required to transfer marketing authorizations and other regulatory requirements in certain countries. Under the terms of the International Commercial Operations Agreement (ICOA), Baxalta is subject to the risks and entitled to the benefits generated by these operations and assets until legal transfer; therefore, the net economic benefit and any cash collected by these entities by Baxter are transferred to Baxalta. As of September 30, 2017, all countries have been separated.
Following is a summary of the operating results of Baxalta, which have been reflected as discontinued operations for the three and nine months ended September 30, 20162017 and 2015.2016. The assets and liabilities have been classified as held for disposition as of September 30, 2016 and December 31, 2015.
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Major classes of line items constituting income from discontinued operations before income taxes | ||||||||||||||||
Net sales | $ | 24 | $ | 63 | $ | 144 | $ | 2,853 | ||||||||
Cost of sales | (20 | ) | (63 | ) | (135 | ) | (1,172 | ) | ||||||||
Marketing and administrative expenses | — | (1 | ) | (20 | ) | (547 | ) | |||||||||
Research and development expenses | — | — | — | (393 | ) | |||||||||||
Other income and expense items that are not major | — | — | — | 7 | ||||||||||||
Total income (loss) from discontinued operations before income taxes | 4 | (1 | ) | (11 | ) | 748 | ||||||||||
Gain on disposal of discontinued operations | — | — | 17 | — | ||||||||||||
Income tax expense | 1 | — | 10 | 195 | ||||||||||||
Total income (loss) from discontinued operations | $ | 3 | $ | (1 | ) | $ | (4 | ) | $ | 553 | ||||||
September 30, | December 31, | |||||||
(in millions) | 2016 | 2015 | ||||||
Carrying amounts of major classes of assets included as part of discontinued operations | ||||||||
Accounts and other current receivables, net | $ 48 | $ 228 | ||||||
Inventories | — | 8 | ||||||
Property, plant, and equipment, net | 1 | 2 | ||||||
Other | 2 | 7 | ||||||
Total assets of the disposal group | $ 51 | $ 245 | ||||||
Carrying amounts of major classes of liabilities included as part of discontinued operations | ||||||||
Accounts payable and accrued liabilities | $ 3 | $ 46 | ||||||
Total liabilities of the disposal group | $ 3 | $ 46 | ||||||
As2016. All assets and liabilities have been transferred as of September 30, 2016 and2017.
|
| Three months ended September 30, |
|
| Nine months ended September 30, |
| ||||||||||
(in millions) |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||
Major classes of line items constituting income from discontinued operations before income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
| $ | 1 |
|
| $ | 24 |
|
| $ | 7 |
|
| $ | 144 |
|
Cost of sales |
|
| — |
|
|
| (20 | ) |
|
| (5 | ) |
|
| (135 | ) |
Marketing and administrative expenses |
|
| — |
|
|
| — |
|
|
| (1 | ) |
|
| (20 | ) |
Income (loss) from discontinued operations before income taxes |
|
| 1 |
|
|
| 4 |
|
|
| 1 |
|
|
| (11 | ) |
Gain on disposal of discontinued operations |
|
| 2 |
|
|
| — |
|
|
| 2 |
|
|
| 17 |
|
Income tax expense |
|
| — |
|
|
| 1 |
|
|
| — |
|
|
| 10 |
|
Income (loss) from discontinued operations, net of tax |
| $ | 3 |
|
| $ | 3 |
|
| $ | 3 |
|
| $ | (4 | ) |
|
| December 31, |
| |
(in millions) |
| 2016 |
| |
Carrying amounts of major classes of assets included as part of discontinued operations |
|
|
|
|
Accounts and other current receivables, net |
| $ | 48 |
|
Property, plant, and equipment, net |
|
| 1 |
|
Other |
|
| 1 |
|
Total assets of the disposal group |
| $ | 50 |
|
|
|
|
|
|
Carrying amounts of major classes of liabilities included as part of discontinued operations |
|
|
|
|
Accounts payable and accrued liabilities |
| $ | 3 |
|
Total liabilities of the disposal group |
| $ | 3 |
|
As of December 31, 2015,2016, Baxter has recorded a net liability of $44$47 million and $190 million, respectively, for its obligation to transfer these net assets to Baxalta. In the first nine months of 2016, the company transferred $156 million of net assets to Baxalta resulting in a gain of $17 million, which is recorded within income from discontinued operations, net of tax. It is expected that the majority of the remaining operations will be transferred to Baxalta during the fourth quarter of 2016.
Baxter and Baxalta entered into several agreements in connection with the July 1, 2015 separation, including a transition services agreement (TSA), separation and distribution agreement, manufacturing and supply agreements (MSA), tax matters agreement, an employee matters agreement, a long-term services agreement, and a shareholder’s and registration rights agreement.
Pursuant to the TSA, Baxter and Baxalta and their respective subsidiaries are providing to each other, on an interim, transitional basis, various services. Services being provided by Baxter include, among others, finance, information technology, human resources, quality supply chain and certain other administrative services. The services generally commenced on the Distribution date and are expected to terminate within 24 months (or 36 months in the case of certain information technology services) of the Distribution date. Billings by Baxter under the TSA are recorded as a reduction of the costs to provide the respective service in the applicable expense category, primarily in marketing and administrative expenses, in the condensed consolidated statements of income. In the three and nine months ended September 30, 2017, the company recognized approximately $11 million and $47 million, respectively, as a reduction to marketing and administrative expenses related to the TSA. In the three and nine months ended September 30, 2016, the company recognized approximately $26 million and $79 million, respectively, as a reduction into marketing and administrative expenses related to the TSA.
Pursuant to the MSA, Baxalta or Baxter, as the case may be, manufactures, labels, and packages products for the other party. The terms of the agreements range in initial duration from five to ten10 years. In the three and nine months ended September 30, 2017, Baxter recognized approximately $6 million and $18 million, respectively, in sales to Baxalta. In the three and nine months ended September 30, 2016, Baxter recognized approximately $6 million and $31 million, respectively, in sales to Baxalta. In addition, in the three and nine months ended September 30, 2017, Baxter recognized $6$35 million and $30$133 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. In the three and nine months ended September 30, 2016, Baxter recognized $47 million and $139 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. The cash flows associated with these agreements are included in cash flows from operations — continuing operations.
Cash outflows of $20 million and inflows of $3 million were reported in cash flows from operations – discontinued operations for the periodnine-month periods ending September 30, 2016.2017 and 2016, respectively. These relate to non-assignable tenders whereby Baxter
remains the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled by Baxterpost local separation on Baxalta’s behalf after the local separation.behalf.
3. SUPPLEMENTAL FINANCIAL INFORMATION
Net interest expense
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||||
Three months ended September 30, | Nine months ended September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Interest expense, net of capitalized interest | $ 20 | $ 38 | $ 69 | $ 109 |
| $ | 22 |
|
| $ | 20 |
|
| $ | 62 |
|
| $ | 69 |
| ||||||||||||
Interest income | (6 | ) | (4 | ) | (16 | ) | (15 | ) |
|
| (8 | ) |
|
| (6 | ) |
|
| (21 | ) |
|
| (16 | ) | ||||||||
Net interest expense | $ 14 | $ 34 | $ 53 | $ 94 |
| $ | 14 |
|
| $ | 14 |
|
| $ | 41 |
|
| $ | 53 |
| ||||||||||||
Other (income) expense, (income), net
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Foreign exchange | $ — | $ (22 | ) | $ (12 | ) | $ (92 | ) |
| $ | (12 | ) |
| $ | — |
|
| $ | (27 | ) |
| $ | (12 | ) | |||||||||
Net loss on debt extinguishment | 52 | 130 | 153 | 130 |
|
| — |
|
|
| 52 |
|
|
| — |
|
|
| 153 |
| ||||||||||||
Net realized gains on Retained Shares transactions | — | — | (4,387 | ) | — | |||||||||||||||||||||||||||
Other | (8 | ) | (17 | ) | (40 | ) | (84 | ) | ||||||||||||||||||||||||
Other expense (income), net | $ 44 | $ 91 | $ (4,286) | $ (46 | ) | |||||||||||||||||||||||||||
Net realized gains on Baxalta Retained Shares transactions |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (4,387 | ) | ||||||||||||||||
Venezuela deconsolidation |
|
| — |
|
|
| — |
|
|
| 33 |
|
|
| — |
| ||||||||||||||||
All other |
|
| — |
|
|
| (8 | ) |
|
| 4 |
|
|
| (40 | ) | ||||||||||||||||
Other (income) expense, net |
| $ | (12 | ) |
| $ | 44 |
|
| $ | 10 |
|
| $ | (4,286 | ) |
Inventories
September 30, | December 31, |
| September 30, |
|
| December 31, |
| |||||||||
(in millions) | 2016 | 2015 |
| 2017 |
|
| 2016 |
| ||||||||
Raw materials | $ 346 | $ 374 |
| $ | 351 |
|
| $ | 319 |
| ||||||
Work in process | 148 | 142 |
|
| 135 |
|
|
| 122 |
| ||||||
Finished goods | 1,074 | 1,088 |
|
| 1,064 |
|
|
| 989 |
| ||||||
Inventories | $ 1,568 | $ 1,604 |
| $ | 1,550 |
|
| $ | 1,430 |
| ||||||
Property, plant and equipment, net
September 30, | December 31, |
| September 30, |
|
| December 31, |
| |||||||||
(in millions) | 2016 | 2015 |
| 2017 |
|
| 2016 |
| ||||||||
Property, plant and equipment, at cost | $ 9,258 | $ 8,990 |
| $ | 9,954 |
|
| $ | 9,162 |
| ||||||
Accumulated depreciation | (4,931 | ) | (4,604 | ) |
|
| (5,466 | ) |
|
| (4,873 | ) | ||||
Property, plant and equipment, net | $ 4,327 | $ 4,386 |
| $ | 4,488 |
|
| $ | 4,289 |
| ||||||
4. EARNINGS PER SHARE
The numerator for both basic and diluted earnings per share (EPS) is either net income, income from continuing operations, or income from discontinued operations. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The dilutive effect of outstanding stock options, restricted stock units (RSUs) and performance share units (PSUs) is reflected in the denominator for diluted EPS using the treasury stock method.
The following table is a reconciliation of basic shares to diluted shares.
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Basic shares | 544 | 546 | 547 | 544 |
|
| 545 |
|
|
| 544 |
|
|
| 543 |
|
|
| 547 |
| ||||||||||||
Effect of dilutive securities | 7 | 3 | 5 | 4 |
|
| 12 |
|
|
| 7 |
|
|
| 11 |
|
|
| 5 |
| ||||||||||||
Diluted shares | 551 | 549 | 552 | 548 |
|
| 557 |
|
|
| 551 |
|
|
| 554 |
|
|
| 552 |
| ||||||||||||
The effect of dilutive securities included unexercised stock options, unvested RSUs and contingently issuable shares related to granted PSUs. The computation of diluted EPS excluded 0.1 million and 2.8 million of equity awards for the third quarter and nine months ended September 30, 2017, respectively, and 0.3 million and 10 million of equity awards for the third quarter and nine months ended September 30, 2016, respectively, and 18 million and 16 million equity awards for the third quarter and nine months ended September 30, 2015, because their inclusion would have had an anti-dilutive effect on diluted EPS. Refer to Note 9 for additional information regarding items impacting basic shares.
Stock repurchases
In July 2012, the Board of Directors authorized the repurchase of up to $2.0$2 billion of the company’s common stock. The board of directors increased this authority by an additional $1.5 billion in November 2016. During the first three quarters of 2017, the company repurchased 4.7 million shares for $275 million in cash. The company has $1.4 billion remaining available under the authorization as of September 30, 2017.
5. ACQUISITIONS AND OTHER ARRANGEMENTS
Claris Injectables Limited
On July 27, 2017, Baxter acquired 100 percent of Claris Injectables Limited (Claris), a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of approximately $629 million, net of cash acquired. Through the acquisition, Baxter added capabilities in production of essential generic injectable medicines, such as anesthesia and analgesics, renal, anti-infectives and critical care in a variety of presentations including bags, vials and ampoules. The following table summarizes the fair value of the assets acquired and liabilities assumed as of the acquisition date for the company’s acquisition of Claris:
(in millions) |
|
|
|
|
Assets acquired and liabilities assumed |
|
|
|
|
Cash |
| $ | 11 |
|
Accounts and other current receivables |
|
| 16 |
|
Inventories |
|
| 30 |
|
Prepaid expenses and other |
|
| 16 |
|
Property, plant and equipment |
|
| 132 |
|
Goodwill |
|
| 310 |
|
Other intangible assets |
|
| 235 |
|
Other |
|
| 20 |
|
Accounts payable and accrued liabilities |
|
| (22 | ) |
Other long-term liabilities |
|
| (108 | ) |
Total assets acquired and liabilities assumed |
| $ | 640 |
|
The valuation of total assets acquired and liabilities assumed are preliminary and measurement period adjustments may be recorded in the future as the company finalizes its fair value estimates. The results of operations of Claris have been included in the company’s condensed consolidated statement of income since the date the business was acquired and were not material. Acquisition and integration costs associated with the Claris acquisition were $15 million and $20 million in the three and nine months ended September 30, 2017, respectively, and were primarily included within marketing and administrative expenses on the condensed consolidated statements of income.
Baxter allocated $235 million of the total consideration to acquired intangible assets with the residual consideration of $310 million recorded as goodwill. The acquired intangible assets include $115 million of developed technology with a weighted-average useful life of 8 years and $120 million of in-process research and development with an indefinite useful life. For the in-process research and development, additional R&D will be required prior to technological feasibility. The goodwill, which is not deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits to Baxter in the injectables market, and is included in the Hospital Products segment.
The fair value of intangible assets was determined using the income approach. The income approach is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life, discounted to present value. The discount rates used to measure the developed technology and in-process research and development intangible assets were 12% and 13%, respectively. The company considers the fair value of each of the acquired intangible assets to be Level 3 assets due to the significant estimates and assumptions used by management in establishing the estimated fair values. Refer to Note 10 within the 2016 Annual Report for additional information regarding fair value measurements.
Celerity Pharmaceuticals, LLC
In the third quarter of 2016, the company repurchased approximately 0.9 million shares pursuant to this authority and has $0.4 billion remaining available under this authorization as of September 30, 2016.
In the second quarter of 2016, the company executed an equity-for-equity exchange of Retained Shares for 11.5 million outstanding Baxter shares. Refer to Note 8 for additional information regarding Retained Share transactions.
5. ACQUISITIONS AND OTHER ARRANGEMENTS
In the first quarter of 2016,2017, Baxter paid approximately $23$10 million to acquire the rights to vancomycin injection in 0.9% Sodium Chloride (Normal Saline) in 500 mg, 750 mg and 1 gram presentationsClindamycin Dextrose from Celerity Pharmaceuticals, LLC (Celerity). Baxter capitalized the purchase price as an intangible asset and is amortizing the asset over the estimated economic life of 12 years.
In the second quarter of 2017, Baxter paid approximately $10 million to acquire the rights to Clindamycin Saline from Celerity. Baxter capitalized the purchase price as an intangible asset and is amortizing the asset over the estimated economic life of 12 years.
In the first quarter of 2016, Baxter paid approximately $23 million to acquire the rights to Vancomycin injection in 0.9% Sodium Chloride (Normal Saline) in 500mg, 750mg, and 1 gram presentations from Celerity. Baxter capitalized the purchase price as an intangible asset and is amortizing the asset over the estimated economic life of 12 years. Refer to Note 5 within the 20152016 Annual Report for additional information regarding the company’s agreement with Celerity.
Wound Care Technologies, Inc.
In April 2017, Baxter paid approximately $8 million to acquire Wound Care Technologies, Inc., a medical technology company that develops and markets external tissue expansion devices for the wound care market. The purchase price allocation resulted in an amortizable intangible asset of $8 million that will be amortized over its estimated economic life of 8 years.
6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill
The following is a reconciliation of goodwill by business segment.
(in millions) | Renal | Hospital Products | Total |
| Renal |
|
| Hospital Products |
|
| Total |
| ||||||||||||
Balance as of December 31, 2015 | $ | 408 | $2,279 | $ | 2,687 | |||||||||||||||||||
Balance as of December 31, 2016 |
| $ | 397 |
|
| $ | 2,198 |
|
| $ | 2,595 |
| ||||||||||||
Additions | 5 | — | 5 |
|
| 5 |
|
|
| 312 |
|
|
| 317 |
| |||||||||
Currency translation adjustments | (2 | ) | (11 | ) | (13 | ) |
|
| 31 |
|
|
| 174 |
|
|
| 205 |
| ||||||
Balance as of September 30, 2016 | $ | 411 | $2,268 | $ | 2,679 | |||||||||||||||||||
Balance as of September 30, 2017 |
| $ | 433 |
|
| $ | 2,684 |
|
| $ | 3,117 |
|
As of September 30, 2016,2017, there were no accumulated goodwill impairment losses.
Other intangible assets, net
The following is a summary of the company’s other intangible assets.
(in millions) | Developed technology, including patents | Other amortized intangible assets | Indefinite-lived intangible assets | Total |
| Developed technology, including patents |
|
| Other amortized intangible assets |
|
| Indefinite-lived intangible assets |
|
| Total |
| ||||||||||||||||
September 30, 2016 | ||||||||||||||||||||||||||||||||
September 30, 2017 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Gross other intangible assets | $1,753 | $ 401 | $58 | $2,212 |
| $ | 1,979 |
|
| $ | 432 |
|
| $ | 152 |
|
| $ | 2,563 |
| ||||||||||||
Accumulated amortization | (866 | ) | (166 | ) | — | (1,032 | ) |
|
| (977 | ) |
|
| (215 | ) |
|
| — |
|
|
| (1,192 | ) | |||||||||
Other intangible assets, net | $ 887 | $ 235 | $58 | $1,180 |
| $ | 1,002 |
|
| $ | 217 |
|
| $ | 152 |
|
| $ | 1,371 |
| ||||||||||||
December 31, 2015 | ||||||||||||||||||||||||||||||||
December 31, 2016 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Gross other intangible assets | $1,742 | $ 393 | $86 | $2,221 |
| $ | 1,690 |
|
| $ | 384 |
|
| $ | 57 |
|
| $ | 2,131 |
| ||||||||||||
Accumulated amortization | (729 | ) | (143 | ) | — | (872 | ) |
|
| (855 | ) |
|
| (165 | ) |
|
| — |
|
|
| (1,020 | ) | |||||||||
Other intangible assets, net | $1,013 | $ 250 | $86 | $1,349 |
| $ | 835 |
|
| $ | 219 |
|
| $ | 57 |
|
| $ | 1,111 |
| ||||||||||||
Intangible asset amortization expense was $42$38 million and $40$42 million in the three months ended September 30, 2017 and 2016, respectively, and 2015, respectively,$112 million and $124 million and $120 million forin the nine months ended September 30, 2017 and 2016, and 2015, respectively.
In the third quarter of 2016, the company recorded an impairment charge of $27 million related to an indefinite-lived intangible asset (acquired IPR&D) in the company’s Renal segment and its in-center hemodialysis program. The assets of the business were written down to estimated fair value and recorded in research and development expenses.
In the second quarter of 2016, the company recorded an impairment charge of $51 million, of which $41 million related to a developed technology asset, relating to the company’s Hospital Products segment synthetic bone repair products business which was acquired from ApaTech Limited in 2010. The assets of the business were written down to estimated fair value and recorded in cost of sales.
The decrease in other intangible assets, net during the first nine months of 2016 was primarily driven by amortization expense and the impairments noted above, partially offset by the acquisition of vancomycin detailed in Note 5 and currency translation adjustments (CTA).
7. INFUSION PUMP AND BUSINESS OPTIMIZATION CHARGES
Infusion pump chargesPump Charges
In the first quarter of 2016, theThe company refined its estimates for remediation activities relatedhas undertaken a field corrective action with respect to the SIGMA SPECTRUM infusion pump. Remediation primarily includes inspection and repair charges as well as a temporary replacement pump recall and decreasedin a limited number of cases. In the reserve by $12 million. For the three and nine months ended September 30, 2016,third quarter of 2017, the company recorded utilizationa charge of the SIGMA SPECTRUM reserve$22 million related primarily to cash costs associated with remediation efforts and none of zero and $24 million, respectively. The balancethese charges have been utilized as of September 30, 2016 was $4 million for the SIGMA SPECTRUM infusion pump recall. Refer to the 2015 Annual Report for further information about the company’s infusion pump recall activities.2017.
Business optimization chargesOptimization Charges
Beginning in the second half of 2015, the company initiated actions to transform its cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through September 30, 2017, the company has incurred cumulative pretax costs of $526 million related to these actions. The costs consisted primarily of employee termination, implementation costs and accelerated depreciation. The company records charges from its business optimization initiativesexpects to incur additional pretax costs of approximately $285 million and capital expenditures of $90 million through the completion of these initiatives. The company expects to complete these activities by the end of 2018. The costs will primarily related to optimizinginclude employee termination costs, implementation costs, and accelerated depreciation. Of the company’s overalltotal estimated cost, structure on a global basis, as the company streamlines its operations, rationalizes its manufacturing facilities, enhances its general and administrative infrastructure and realigns certain research and development (R&D) activities.expects that approximately 5 percent of the charges will be non-cash.
During the three and nine months ended September 30, 20162017 and 2015,2016, the company recorded the following charges related to business optimization programs.
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Restructuring charges, net | $130 | $ 92 | $237 | $102 |
| $ | 31 |
|
| $ | 130 |
|
| $ | 50 |
|
| $ | 237 |
| ||||||||||||
Costs to implement business optimization programs | 25 | — | 44 | — |
|
| 21 |
|
|
| 25 |
|
|
| 58 |
|
|
| 44 |
| ||||||||||||
Gambro integration costs | 5 | 12 | 19 | 50 |
|
| — |
|
|
| 5 |
|
|
| — |
|
|
| 19 |
| ||||||||||||
Accelerated depreciation | 11 | — | 25 | — |
|
| — |
|
|
| 11 |
|
|
| 8 |
|
|
| 25 |
| ||||||||||||
Total business optimization charges | $171 | $104 | $325 | $152 |
| $ | 52 |
|
| $ | 171 |
|
| $ | 116 |
|
| $ | 325 |
| ||||||||||||
Included in the restructuringFor segment reporting, business optimization charges forare unallocated expenses.
During the three months ended September 30, 2016 were net employee termination costs of $101 million which primarily consisted of a global workforce reduction program and $27 million related to the impairment of acquired IPR&D as described in Note 6. The restructuring charges for the nine months ended September 30, 2016 also include $54 million for costs associated with the discontinuance of the VIVIA home hemodialysis development program. These costs consisted of contract termination costs of $21 million, asset impairments of $31 million,2017 and other exit costs of $2 million.
For the three and nine month periods ended September 30, 2016, and 2015, the company recorded the following components of restructuring costs:charges.
Three months ended |
| Three months ended |
| |||||||||||||||||||||||||||||
September 30, 2016 |
| September 30, 2017 |
| |||||||||||||||||||||||||||||
(in millions) | COGS | SGA | R&D | Total |
| COGS |
|
| SGA |
|
| R&D |
|
| Total |
| ||||||||||||||||
Employee termination costs | $21 | $84 | $ 1 | $106 |
| $ | 7 |
|
| $ | 24 |
|
| $ | — |
|
| $ | 31 |
| ||||||||||||
Asset impairments | 6 | — | 27 | 33 | ||||||||||||||||||||||||||||
Reserve adjustments | ||||||||||||||||||||||||||||||||
Employee termination costs | — | (3 | ) | (2 | ) | (5 | ) | |||||||||||||||||||||||||
Contract termination costs | (3 | ) | — | (1 | ) | (4 | ) | |||||||||||||||||||||||||
Total restructuring charges | $24 | $81 | $25 | $130 |
| $ | 7 |
|
| $ | 24 |
|
| $ | — |
|
| $ | 31 |
| ||||||||||||
Three months ended | ||||||||||||||||||||||||||||||||
September 30, 2015 | ||||||||||||||||||||||||||||||||
(in millions) | COGS | SGA | R&D | Total | ||||||||||||||||||||||||||||
Employee termination costs | $ 7 | $56 | $11 | $ 74 | ||||||||||||||||||||||||||||
Asset impairments | 31 | — | — | 31 | ||||||||||||||||||||||||||||
Reserve adjustments | (6) | (4) | (3) | (13) | ||||||||||||||||||||||||||||
Total restructuring charges | $32 | $52 | $ 8 | $ 92 | ||||||||||||||||||||||||||||
Nine months ended | ||||||||||||||||
September 30, 2016 | ||||||||||||||||
(in millions) | COGS | SGA | R&D | Total | ||||||||||||
Employee termination costs | $51 | $ 94 | $13 | $158 | ||||||||||||
Contract termination costs | 8 | 2 | 13 | 23 | ||||||||||||
Asset impairments | 28 | — | 40 | 68 | ||||||||||||
Other exit costs | 2 | — | — | 2 | ||||||||||||
Reserve adjustments | ||||||||||||||||
Employee termination costs | (1 | ) | (11 | ) | (2 | ) | (14 | ) | ||||||||
Total restructuring charges | $88 | $ 85 | $64 | $237 | ||||||||||||
Nine months ended | ||||||||||||||||
September 30, 2015 | ||||||||||||||||
(in millions) | COGS | SGA | R&D | Total | ||||||||||||
Employee termination costs | $ 11 | $ 72 | $12 | $ 95 | ||||||||||||
Asset related costs | 3 | 1 | — | 4 | ||||||||||||
Asset impairment | 33 | — | 2 | 35 | ||||||||||||
Reserve adjustments | (19) | (10) | (3) | (32) | ||||||||||||
Total restructuring charges | $ 28 | $ 63 | $11 | $102 | ||||||||||||
|
| Three months ended |
| |||||||||||||
|
| September 30, 2016 |
| |||||||||||||
(in millions) |
| COGS |
|
| SGA |
|
| R&D |
|
| Total |
| ||||
Employee termination costs |
| $ | 21 |
|
| $ | 84 |
|
| $ | 1 |
|
| $ | 106 |
|
Asset impairments |
|
| 6 |
|
| — |
|
|
| 27 |
|
|
| 33 |
| |
Reserve adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee termination costs |
| — |
|
|
| (3 | ) |
|
| (2 | ) |
|
| (5 | ) | |
Contract termination costs |
|
| (3 | ) |
| — |
|
|
| (1 | ) |
|
| (4 | ) | |
Total restructuring charges |
| $ | 24 |
|
| $ | 81 |
|
| $ | 25 |
|
| $ | 130 |
|
|
| Nine months ended |
| |||||||||||||
|
| September 30, 2017 |
| |||||||||||||
(in millions) |
| COGS |
|
| SGA |
|
| R&D |
|
| Total |
| ||||
Employee termination costs |
| $ | 21 |
|
| $ | 33 |
|
| $ | — |
|
| $ | 54 |
|
Contract termination costs |
|
| — |
|
|
| 5 |
|
|
| — |
|
|
| 5 |
|
Asset impairments |
|
| 5 |
|
|
| — |
|
|
| — |
|
|
| 5 |
|
Reserve adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee termination costs |
|
| (7 | ) |
|
| (5 | ) |
|
| (2 | ) |
|
| (14 | ) |
Total restructuring charges |
| $ | 19 |
|
| $ | 33 |
|
| $ | (2 | ) |
| $ | 50 |
|
|
| Nine months ended |
| |||||||||||||
|
| September 30, 2016 |
| |||||||||||||
(in millions) |
| COGS |
|
| SGA |
|
| R&D |
|
| Total |
| ||||
Employee termination costs |
| $ | 52 |
|
| $ | 94 |
|
| $ | 13 |
|
| $ | 159 |
|
Contract termination costs |
|
| 9 |
|
|
| 2 |
|
|
| 13 |
|
|
| 24 |
|
Asset impairments |
|
| 28 |
|
|
| — |
|
|
| 40 |
|
|
| 68 |
|
Reserve adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee termination costs |
|
| (1 | ) |
|
| (11 | ) |
|
| (2 | ) |
|
| (14 | ) |
Total restructuring charges |
| $ | 88 |
|
| $ | 85 |
|
| $ | 64 |
|
| $ | 237 |
|
Costs to implement business optimization programs for the three and nine months ended September 30, 2017, were $21 million and $58 million respectively, and consisted primarily of external consulting and transition costs as well as employee salary and related costs. These costs were included within cost of sales and marketing and administrative expense.
Costs to implement business optimization programs for the three and nine months ended September 30, 2016, were $25 million and $44 million, respectively. These costs consistedrespectively, and were related primarily ofto external consulting and employee salary and related costs. TheThese costs were included within marketing and administrative and R&D expense.
Costs related to the integration of Gambro AB (Gambro) were included within marketing and administrative expense for all referenced periods.
For the three and nine months ended September 30, 2017, the company recognized accelerated depreciation, primarily associated with facilities to be closed, of zero and $8 million, respectively. The costs were recorded within cost of sales, marketing and administrative and R&D expense.
For the three and nine months ended September 30, 2016, the company recognized $11 million and $25 million, respectively, of accelerated depreciation, primarily associated with facilities to be closed of $11 million and $25 million, respectively.closed. The costs were recorded in cost of sales for all referenced periods.
The following table summarizes cash activity in the reserves related to the company’s restructuringbusiness optimization initiatives.
(in millions) |
|
|
|
| ||||
Reserves as of December 31, 2015 | $ | 116 | ||||||
Reserves as of December 31, 2016 |
| $ | 164 |
| ||||
Charges | 183 |
|
| 59 |
| |||
Reserve adjustments | (14 | ) |
|
| (14 | ) | ||
Utilization | (98 | ) |
|
| (114 | ) | ||
CTA | 9 |
|
| 24 |
| |||
Reserves as of September 30, 2016 | $ | 196 | ||||||
Reserves as of September 30, 2017 |
| $ | 119 |
|
Reserve adjustments primarily relate to employee termination cost reserves established in prior periods.
TheApproximately 80% of the company’s restructuring reserves of $196 million as of September 30, 2016 consisted of $171 million of2017 relate to employee termination costs, andwith the remaining reserves relatedattributable to contract termination costs. The reserves are expected to be substantially utilized by the end of 2017.2018.
8. DEBT, FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS
Debt Issuance
In August 2016,May 2017, Baxter issued €600 million of senior notes with a total aggregate principal amount of $1.6 billion, comprised of $400 million at a fixed coupon rate of 1.70%1.30% due in August 2021, $750 million atMay 2025. The company has designated this debt as a fixed coupon ratenon-derivative net investment hedge of 2.60% due in August 2026, and $450 million at a fixed coupon rate of 3.50% due in August 2046.its European operations for accounting purposes.
Debt Redemptions
In September 2016, Baxter redeemed an aggregate of approximately $1 billion in principal amount of its 1.850% Senior Notes due 2017, 1.850% Senior Notes due 2018, 5.375% Senior Notes due 2018, 4.500% Senior Notes due 2019, 4.250% Senior Notes due 2020, and 3.200% Senior Notes due 2023. Baxter paid approximately $1 billion, including accrued and unpaid interest and tender premium, to redeem such notes. As a result of the debt redemptions, the company recognized a loss on extinguishment of debt in the third quarter of 2016 of approximately $52 million, which is included in other (income) expense, (income), net.
Debt-for-equity exchanges
On January 27, 2016, Baxter exchanged Baxalta Retained Shares for the extinguishment of $1.45 billion aggregate principal amount outstanding under its $1.8 billion U.S. dollar-denominated revolving credit facility. This exchange extinguished the indebtedness under the facility, which was terminated in connection with such debt-for-equity exchange. There were no material prepayment penalties or breakage costs associated with the termination of the facility. Baxter recognized a net realized gain of $1.25 billion related to the Baxalta Retained Shares exchanged, which was included in other income,(income) expense, net for the nine monthsperiod ended September 30, 2016.
On March 16, 2016, the company exchanged Baxalta Retained Shares for the extinguishment of approximately $2.2 billion in aggregate principal amount of its 0.950% Notes due May 2016, 5.900% Notes due August 2016, 1.850% Notes due January 2017, 5.375% Notes due May 2018, 1.850% Notes due June 2018, 4.500% Notes due August 2019, and 4.250% Notes due February 2020 purchased by certain third party purchasers in the previously announced debt tender offers. As a result, the company recognized a net loss on extinguishment of debt totaling $101 million and a net realized gain of $2.0 billion on the Baxalta Retained Shares exchanged, which are included in other income,(income) expense, net for the nine monthsperiod ended September 30, 2016.
Debt Maturities
In the second quarter of 2016, the company repaid the $190 million outstanding balance of its 0.95% senior unsecured notes that matured in June 2016. In the third quarter of 2016, the company repaid the $130 million outstanding balance of its 5.9% senior unsecured notes that matured in September 2016.
Commercial paper
During the first nine months of 2016, the company issued and redeemed commercial paper, of which zero was outstanding as of September 30, 2016. There was a balance of $300 million outstanding at December 31, 2015 with a weighted-average interest rate of 0.6%. This commercial paper is classified as short-term debt.
Securitization arrangement
The following is a summary of the activity relating to the company’s securitization arrangement in Japan.
Three months ended September 30, | Nine months ended September 30, |
| Three months ended September 30, |
|
| Nine months ended September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Sold receivables at beginning of period | $ 62 | $ 106 | $ 81 | $ 104 |
| $ | 63 |
|
| $ | 62 |
|
| $ | 68 |
|
| $ | 81 |
| ||||||||||||
Proceeds from sales of receivables | 75 | 81 | 272 | 311 |
|
| 69 |
|
|
| 75 |
|
|
| 198 |
|
|
| 272 |
| ||||||||||||
Cash collections (remitted to the owners of the receivables) | (71 | ) | (59 | ) | (299 | ) | (284 | ) |
|
| (66 | ) |
|
| (71 | ) |
|
| (203 | ) |
|
| (299 | ) | ||||||||
Effect of currency exchange rate changes | 2 | 4 | 14 | 1 |
|
| — |
|
|
| 2 |
|
|
| 3 |
|
|
| 14 |
| ||||||||||||
Sold receivables at end of period | $ 68 | $ 132 | $ 68 | $ 132 |
| $ | 66 |
|
| $ | 68 |
|
| $ | 66 |
|
| $ | 68 |
| ||||||||||||
The impacts on the condensed consolidated statements of income relating to the sale of receivables were immaterial for each period. Refer to the 20152016 Annual Report for further information regarding the company’s securitization arrangement.agreements.
Concentrations of credit risk
The company invests excess cash in certificates of deposit or money market funds and diversifies the concentration of cash among different financial institutions. With respect to financial instruments, where appropriate, the company has diversified its selection of counterparties, and has arranged collateralization and master-netting agreements to minimize the risk of loss.
The company continues to do business with foreign governments in certain countries including Greece, Spain, Portugal and Italy that have experienced a deterioration in credit and economic conditions. As of September 30, 2016,2017, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $181$151 million.
Global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses. Governmental actions and customer-specific factors may also require the company to re-evaluate the collectability of its receivables and the company could potentially incur additional credit losses. These conditions may also impact the stability of the Euro.
Derivatives and hedging activities
The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs.
The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Swedish Krona, Mexican Peso and New Zealand Dollar. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and equity volatility resulting from foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.
The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company’s policy is to manage interest costs using a mix of fixed- and floating-rate debt that the company believes is appropriate.
To manage this mix in a cost-efficient manner, the company periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount.
The company does not hold any instruments for trading purposes and none of the company’s outstanding derivative instruments contain credit-risk-related contingent features.
All derivative instruments are recognized as either assets or liabilities at fair value in the condensed consolidated balance sheets and are classified as short-term or long-term based on the scheduled maturity of the instrument. Based upon the exposure being hedged, the company designates its hedging instruments as cash flow, or fair value, or net investment hedges.
Cash Flow Hedges
The company may use options, including collars and purchased options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions and recognized assets and liabilities.
For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is accumulated in accumulated other comprehensive income (AOCI) and then recognized in earnings consistent with the underlying hedged item. Option premiums or net premiums paid are initially recorded as assets and reclassified to other comprehensive income (OCI) over the life of the option, and then recognized in earnings consistent with the underlying hedged item. Cash flow hedges are classified in net sales, cost of sales, and net interest expense, and other (income) expense, net, and primarily relate to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt, respectively.
The notional amounts of foreign exchange contracts were $438$667 million and $378$561 million as of September 30, 20162017 and December 31, 2015,2016, respectively. There were no outstanding interest rate contracts designated as cash flow hedges as of September 30, 20162017 and December 31, 2015.2016. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions as of September 30, 20162017 is 15 months.
Fair Value Hedges
The company uses interest rate swaps to convert a portion of its fixed-rate debt into variable-rate debt. These instruments hedge the company’s earnings from changes in the fair value of debt due to fluctuations in the designated benchmark interest rate. For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized immediately to earnings, and offsets the loss or gain on the underlying hedged item. Fair value hedges are classified in net interest expense, as they hedge the interest rate risk associated with certain of the company’s fixed-rate debt.
The total notional amount of interest rate contracts designated as fair value hedges was $200 million and $1.3 billion as of September 30, 20162017 and December 31, 2015, respectively.2016.
Net Investment Hedges
In May 2017, the company issued €600 million of senior notes due May 2025. The decrease is duecompany has designated this debt as a hedge of a portion of its net investment in its European operations and, as a result, mark to swaps terminatedspot rate adjustments of the outstanding debt balances have been and will be recorded as a component of AOCI. As of September 30, 2017, the company had an accumulated pre-tax unrealized translation loss in conjunction withAOCI of $70 million related to the previously mentioned debt-for-equity exchanges and debt redemptions.Euro-denominated senior notes.
Dedesignations
If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If the company removes the cash flow hedge designation because the hedged forecasted transactions are no longer probable of occurring, any gains or losses are immediately reclassified from AOCI to earnings. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the loss or income recognition of the underlying hedged items.
There were no hedge dedesignations in the first nine months of 20162017 or 20152016 resulting from changes in the company’s assessment of the probability that the hedged forecasted transactions would occur.
If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item. There were no fair value hedges terminated during the first nine months of 2017. In March 2016, the company terminated a total notional value of $765 million of interest rate contracts in connection with the March debt tender offers, resulting in a $34 million reduction to the debt extinguishment loss. In September 2016, the company terminated a total notional value of $335 million of interest rate contracts in connection with the September debt redemptions, resulting in a $14 million reduction to the debt extinguishment loss. The company terminated a total notional value of $1.65 billion of interest rate contracts in connection with debt tender offers, which resulted in a $33 million reduction to the debt extinguishment loss, during the first nine months of 2015.
Undesignated Derivative Instruments
The company uses forward contracts to hedge earnings from the effects of foreign exchange relating to certain of the company’s intercompany and third-party receivables and payables denominated in a foreign currency. These derivative instruments are generally not formally designated as hedges, and the change in fair value, which substantially offsets the change in book value of the hedged items, is recorded directly to other (income) expense, (income), net. The terms of these instruments generally do not exceed one month.
The total notional amount of undesignated derivative instruments was $914$807 million as of September 30, 20162017 and $580$822 million as of December 31, 2015.2016.
Gains and Losses on Derivative InstrumentsHedging Activities
The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments for the three months ended September 30, 20162017 and 2015.2016.
Gain (loss) recognized in OCI | Location of gain (loss) in income statement | Gain (loss) reclassified from AOCI into income |
| Gain (loss) recognized in OCI |
|
| Location of gain (loss) |
| Gain (loss) reclassified from AOCI into income |
| ||||||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| in income statement |
| 2017 |
|
| 2016 |
| ||||||||||||||||||||
Cash flow hedges |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Interest rate contracts | $— | $— | Other expense (income), net | $ 5 | $— |
| $ | — |
|
| $ | — |
|
| Other (income) expense, net |
| $ | — |
|
| $ | 5 |
| |||||||||||||||
Foreign exchange contracts | 3 | 1 | Cost of sales | (2 | ) | 5 |
|
| (11 | ) |
|
| 3 |
|
| Cost of sales |
|
| (3 | ) |
|
| (2 | ) | ||||||||||||||
Net investment hedge |
|
| (39 | ) |
|
| — |
|
| Other (income) expense, net |
|
| — |
|
|
| — |
| ||||||||||||||||||||
Total | $ 3 | $ 1 | $ 3 | $ 5 |
| $ | (50 | ) |
| $ | 3 |
|
|
|
| $ | (3 | ) |
| $ | 3 |
| ||||||||||||||||
Gain (loss) recognized in income |
|
|
| Gain (loss) recognized in income |
| |||||||||||||||||
(in millions) | Location of gain (loss) in income statement | 2016 | 2015 |
| Location of gain (loss) in income statement |
| 2017 |
|
| 2016 |
| |||||||||||
Fair value hedges |
|
|
|
|
|
|
|
|
|
| ||||||||||||
Interest rate contracts | Net interest expense | $(7 | ) | $(11 | ) |
| Net interest expense |
| $ | (1 | ) |
| $ | (7 | ) | |||||||
Undesignated derivative instruments |
|
|
|
|
|
|
|
|
|
| ||||||||||||
Foreign exchange contracts | Other expense (income), net | $ 9 | $ 12 |
| Other (income) expense, net |
| $ | (3 | ) |
| $ | 9 |
|
The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments for the nine months ended September 30, 20162017 and 2015.2016.
Gain (loss) recognized in OCI | Location of gain (loss) in income statement | Gain (loss) reclassified from AOCI into income |
| Gain (loss) recognized in OCI |
|
| Location of gain (loss) |
| Gain (loss) reclassified from AOCI into income |
| ||||||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| in income statement |
| 2017 |
|
| 2016 |
| ||||||||||||||||||||
Cash flow hedges |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Interest rate contracts | $ — | $— | Other expense (income), net | $ 9 | $— |
| $ | (3 | ) |
| $ | — |
|
| Other (income) expense, net |
| $ | — |
|
| $ | 9 |
| |||||||||||||||
Foreign exchange contracts | — | (1 | ) | Net sales | — | — |
|
| (24 | ) |
|
| (8 | ) |
| Cost of sales |
|
| (4 | ) |
|
| (3 | ) | ||||||||||||||
Foreign exchange contracts | (8 | ) | 4 | Cost of sales | (3 | ) | 45 | |||||||||||||||||||||||||||||||
Net investment hedge |
|
| (70 | ) |
|
| — |
|
| Other (income) expense, net |
|
| — |
|
|
| — |
| ||||||||||||||||||||
Total | $ (8 | ) | $ 3 | $ 6 | $45 |
| $ | (97 | ) |
| $ | (8 | ) |
|
|
| $ | (4 | ) |
| $ | 6 |
| |||||||||||||||
Gain (loss) recognized in income |
|
|
| Gain (loss) recognized in income |
| |||||||||||||||||
(in millions) | Location of gain (loss) in income statement | 2016 | 2015 |
| Location of gain (loss) in income statement |
| 2017 |
|
| 2016 |
| |||||||||||
Fair value hedges |
|
|
|
|
|
|
|
|
|
| ||||||||||||
Interest rate contracts | Net interest expense | $ 19 | $(24) |
| Net interest expense |
| $ | (1 | ) |
| $ | 19 |
| |||||||||
Undesignated derivative instruments |
|
|
|
|
|
|
|
|
|
| ||||||||||||
Foreign exchange contracts | Other expense (income), net | $ 4 | $(13) |
| Other (income) expense, net |
| $ | (7 | ) |
| $ | 4 |
|
For the company’s fair value hedges, an equal and offsetting gain of $7$1 million and loss of $19 million werewas recognized in net interest expense in the third quarter and first nine months of 2016,2017, respectively, and an equal and offsetting gainsgain of $11$7 million and $24loss of $19 million werewas recognized in net interest expense in the third quarter and first nine months of 2015,2016, respectively, as adjustments to the underlying hedged item, fixed-rate debt. Ineffectiveness related to the company’s cash flow and fair value hedges for the nine months ended September 30, 2016 wasall periods presented were not material.
As of September 30, 2016, $32017, $10 million of deferred, net after-tax losses on derivative instruments included in AOCI are expected to be recognized in earnings during the next 12 months, coinciding with when the hedged items are expected to impact earnings.
Fair Values of Derivative Instruments
The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet as of September 30, 2016.2017.
Derivatives in asset positions | Derivatives in liability positions |
| Derivatives in asset positions |
|
| Derivatives in liability positions |
| |||||||||||||||||||||
(in millions) | Balance sheet location | Fair value | Balance sheet location | Fair value |
| Balance sheet location |
| Fair value |
|
| Balance sheet location |
| Fair value |
| ||||||||||||||
Derivative instruments designated as hedges |
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Interest rate contracts | Other long-term assets | $ 16 | Other long-term liabilities | $ — |
| Other long-term assets |
| $ | 6 |
|
| Other long- term liabilities |
| $ | — |
| ||||||||||||
Foreign exchange contracts | Prepaid expenses and other | 13 |
| Accounts payable and accrued liabilities |
| 2 |
| Prepaid expenses and other |
|
| 11 |
|
| Accounts payable and accrued liabilities |
|
| 4 |
| ||||||||||
Foreign exchange contracts | Other long-term assets | 1 | Other long-term liabilities | — |
| Other long-term assets |
|
| 2 |
|
| Other long- term liabilities |
|
| — |
| ||||||||||||
Total derivative instruments designated as hedges | $ 30 | $ 2 |
|
|
| $ | 19 |
|
|
|
| $ | 4 |
| ||||||||||||||
Undesignated derivative instruments |
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Foreign exchange contracts | Prepaid expenses and other | $ — |
| Accounts payable and accrued liabilities |
| $ 1 |
| Prepaid expenses and other |
| $ | — |
|
| Accounts payable and accrued liabilities |
| $ | 1 |
| ||||||||||
Total derivative instruments | $ 30 | $ 3 |
|
|
| $ | 19 |
|
|
|
| $ | 5 |
| ||||||||||||||
The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet as of December 31, 2015.2016.
Derivatives in asset positions | Derivatives in liability positions |
| Derivatives in asset positions |
|
| Derivatives in liability positions |
| |||||||||||||||||||||
(in millions) | Balance sheet location | Fair value | Balance sheet location | Fair value |
| Balance sheet location |
| Fair value |
|
| Balance sheet location |
| Fair value |
| ||||||||||||||
Derivative instruments designated as hedges |
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Interest rate contracts | Other long-term assets | $ 46 | Other long-term liabilities | $ — |
| Other long-term assets |
| $ | 7 |
|
| Other long- term liabilities |
| $ | — |
| ||||||||||||
Foreign exchange contracts | | Prepaid expenses and other | | 9 | | Accounts payable and accrued liabilities | | 1 |
| Prepaid expenses and other |
|
| 22 |
|
| Accounts payable and accrued liabilities |
|
| 1 |
| ||||||||
Total derivative instruments designated as hedges | $ 55 | $ 1 |
|
|
| $ | 29 |
|
|
|
| $ | 1 |
| ||||||||||||||
Undesignated derivative instruments |
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Foreign exchange contracts | | Prepaid expenses and other | | $ 1 | | Accounts payable and accrued liabilities | | $ 1 |
| Prepaid expenses and other |
| $ | 1 |
|
| Accounts payable and accrued liabilities |
| $ | 2 |
| ||||||||
Total derivative instruments | $ 56 | $ 2 |
|
|
| $ | 30 |
|
|
|
| $ | 3 |
| ||||||||||||||
While the company’s derivatives are all subject to master-nettingmaster netting arrangements, the company presents its assets and liabilities related to derivative instruments on a gross basis within the condensed consolidated balance sheets. Additionally, the company is not required to post collateral for any of its outstanding derivatives.
The following table provides information on the company’s derivative positions as if they were presented on a net basis, allowing for the right of offset by counterparty.
September 30, 2016 | December 31, 2015 |
| September 30, 2017 |
|
| December 31, 2016 |
| |||||||||||||||||||||||||
(in millions) | Asset | Liability | Asset | Liability |
| Asset |
|
| Liability |
|
| Asset |
|
| Liability |
| ||||||||||||||||
Gross amounts recognized in the consolidated balance sheet | $30 | $ 3 | $56 | $ 2 |
| $ | 19 |
|
| $ | 5 |
|
| $ | 30 |
|
| $ | 3 |
| ||||||||||||
Gross amount subject to offset in master-netting arrangements not offset in the consolidated balance sheet | (3 | ) | (3 | ) | (2 | ) | (2 | ) | ||||||||||||||||||||||||
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet |
|
| (5 | ) |
|
| (5 | ) |
|
| (3 | ) |
|
| (3 | ) | ||||||||||||||||
Total | $27 | $— | $54 | $— |
| $ | 14 |
|
| $ | — |
|
| $ | 27 |
|
| $ | — |
| ||||||||||||
Fair value measurements
The following tables summarize the basisbases used to measure financial assets and liabilities that are carried at fair value on a recurring basis in the condensed consolidated balance sheets.
Basis of fair value measurement |
|
|
|
|
| Basis of fair value measurement |
| |||||||||||||||||||||||||
(in millions) | Balance as of September 30, 2016 | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable (Level 3) |
| Balance as of September 30, 2017 |
|
| Quoted prices in active markets for identical assets (Level 1) |
|
| Significant other observable inputs (Level 2) |
|
| Significant unobservable inputs (Level 3) |
| ||||||||||||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Foreign currency hedges | $ 14 | $— | $ 14 | $— |
| $ | 13 |
|
| $ | — |
|
| $ | 13 |
|
| $ | — |
| ||||||||||||
Interest rate hedges | 16 | — | 16 | — |
|
| 6 |
|
|
| — |
|
|
| 6 |
|
|
| — |
| ||||||||||||
Available-for-sale securities | 10 | 10 | — | — |
|
| 11 |
|
|
| 11 |
|
|
| — |
|
|
| — |
| ||||||||||||
Total assets | $ 40 | $10 | $ 30 | $— |
| $ | 30 |
|
| $ | 11 |
|
| $ | 19 |
|
| $ | — |
| ||||||||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Foreign currency hedges | $ 3 | $— | $ 3 | $— |
| $ | 5 |
|
| $ | — |
|
| $ | 5 |
|
| $ | — |
| ||||||||||||
Contingent payments related to acquisitions | 19 | — | — | 19 |
|
| 10 |
|
|
| — |
|
|
| — |
|
|
| 10 |
| ||||||||||||
Total liabilities | $ 22 | $— | $ 3 | $19 |
| $ | 15 |
|
| $ | — |
|
| $ | 5 |
|
| $ | 10 |
| ||||||||||||
Basis of fair value measurement | ||||||||||||||||||||||||||||||||
(in millions) | Balance as of December 31, 2015 | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable (Level 3) | ||||||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||
Foreign currency hedges | $ 10 | $— | $ 10 | $— | ||||||||||||||||||||||||||||
Interest rate hedges | 46 | — | 46 | — | ||||||||||||||||||||||||||||
Available-for-sale securities | 5,162 | 14 | 5,148 | — | ||||||||||||||||||||||||||||
Total assets | $5,218 | $14 | $5,204 | $— | ||||||||||||||||||||||||||||
Liabilities | ||||||||||||||||||||||||||||||||
Foreign currency hedges | $ 2 | $— | $ 2 | $— | ||||||||||||||||||||||||||||
Contingent payments related to acquisitions | 20 | — | — | 20 | ||||||||||||||||||||||||||||
Total liabilities | $ 22 | $— | $ 2 | $20 | ||||||||||||||||||||||||||||
|
|
|
|
|
| Basis of fair value measurement |
| |||||||||
(in millions) |
| Balance as of December 31, 2016 |
|
| Quoted prices in active markets for identical assets (Level 1) |
|
| Significant other observable inputs (Level 2) |
|
| Significant unobservable inputs (Level 3) |
| ||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency hedges |
| $ | 23 |
|
| $ | — |
|
| $ | 23 |
|
| $ | — |
|
Interest rate hedges |
|
| 7 |
|
|
| — |
|
|
| 7 |
|
|
| — |
|
Available-for-sale securities |
|
| 9 |
|
|
| 9 |
|
|
| — |
|
|
| — |
|
Total assets |
| $ | 39 |
|
| $ | 9 |
|
| $ | 30 |
|
| $ | — |
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency hedges |
| $ | 3 |
|
| $ | — |
|
| $ | 3 |
|
| $ | — |
|
Contingent payments related to acquisitions |
|
| 19 |
|
|
| — |
|
|
| — |
|
|
| 19 |
|
Total liabilities |
| $ | 22 |
|
| $ | — |
|
| $ | 3 |
|
| $ | 19 |
|
As of September 30, 2016,2017, cash and equivalents of $2.6$3.5 billion included money market funds of approximately $785 million,$1 billion, and as of December 31, 2015,2016, cash and equivalents of $2.2$2.8 billion included money market funds of approximately $500 million.$1 billion. Money market funds would be considered Level 2 in the fair value hierarchy.
For assets that are measured using quoted prices in active markets, the fair value is the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The investment in the Retained Shares of $5.1 billion as of December 31, 2015 was categorized as a Level 2 security as these securities were not registered as of that date. The value of this investment was based on Baxalta’s common stock price as of December 31, 2015, which represents an identical equity instrument registered under the Securities Act of 1933, as amended. The majority of the derivatives entered into by the company are valued using internal valuation techniques as no quoted market prices exist for such instruments. The principal techniques used to value these instruments are discounted cash flow and Black-Scholes models. The key inputs are considered observable and vary depending on the type of derivative, and include contractual terms, interest rate yield curves, foreign exchange rates and volatility.
Contingent payments related to acquisitions consist of commercial milestone payments and sales-based payments, and are valued using discounted cash flow techniques. The fair value of commercial milestone payments reflects management’s expectations of probability of payment, and increaseincreases as the probability of payment increases or expectation of timing of payments is accelerated. The fair value of sales-based payments is based upon probability-weighted future revenue estimates, and increases as revenue estimates increase, probability weighting of higher revenue scenarios increase or expectation of timing of payment is accelerated. ChangesThe change in the fair value of contingent payments related to Baxter’s acquisitions, which use significant unobservable inputs (Level 3) in the fair value measurement, were immaterial during the nine monthsprimarily driven by payments of 2016. The company made minor sales-based paymentsapproximately $8 million in the first nine months of 2016.2017.
The following table provides information relating to the company’s investments in available-for-sale equity securities.
(in millions) | Amortized cost | Unrealized gains | Unrealized losses | Fair value | ||||||||||||
September 30, 2016 | $ 13 | $ 1 | $ 4 | $ 10 | ||||||||||||
December 31, 2015 | $732 | $4,430 | $— | $5,162 |
(in millions) |
| Amortized cost |
|
| Unrealized gains |
|
| Unrealized losses |
|
| Fair value |
| ||||
September 30, 2017 |
| $ | 9 |
|
| $ | 3 |
|
| $ | 1 |
|
| $ | 11 |
|
December 31, 2016 |
| $ | 13 |
|
| $ | — |
|
| $ | 4 |
|
| $ | 9 |
|
In the first quarter of 2017, the company recorded a $4 million other-than-temporary impairment charge within other (income) expense, net based on the duration of losses related to one of the company’s investments. In the first nine months of 2016, the company recorded net $4.4 billion of net realized gains within other income,(income) expense, net related to exchanges of available-for-sale equity securities, which represented gains from the Retained SharesShare transactions. On May 6, 2016, Baxter made a voluntary non-cash contribution of 17,145,570 Retained Shares to the company’s U.S. pension fund. The company recorded $611 million of realized gains within other income, net related to the contribution of Retained Shares. On May 26, 2016, Baxter completed an exchange of 13,360,527 Retained Shares for 11,526,638 outstanding shares of Baxter common stock. The company recorded $537 million of realized gains within other income, net related to the exchange of the Retained Shares. The company held no shares of Baxalta as of September 30, 2016. Refer to the debt-for-equity exchange section above for discussion related to the first quarter 2016 Retained Shares transactions. In the first nine months of 2015 the company recorded $38 million of income in other expense (income), net related to sales of available-for-sale equity securities and equity method investments, which primarily represented gains from the sale of certain investments as well as distributions from funds that sold portfolio companies.
Book Values and Fair Values of Financial Instruments
In addition to the financial instruments that the company is required to recognize at fair value in the condensed consolidated balance sheets, the company has certain financial instruments that are recognized at historical cost or some basis other than fair value. For these financial instruments, the following table provides the values recognized in the condensed consolidated balance sheets and the approximate fair values as of September 30, 20162017 and December 31, 2015.2016.
Book values | Approximate fair values |
| Book values |
|
| Approximate fair values |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Investments | $ 33 | $ 21 | $ 32 | $ 21 |
| $ | 42 |
|
| $ | 31 |
|
| $ | 42 |
|
| $ | 31 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Short-term debt | $ — | $1,775 | $ — | $1,775 | ||||||||||||||||||||||||||||
Current maturities of long-term debt and lease obligations | 6 | 810 | 6 | 818 |
| $ | 3 |
|
| $ | 3 |
|
| $ | 3 |
|
| $ | 3 |
| ||||||||||||
Long-term debt and lease obligations | 2,834 | 3,922 | 2,960 | 4,077 |
|
| 3,495 |
|
|
| 2,779 |
|
|
| 3,568 |
|
|
| 2,756 |
|
The following tables summarize the basisbases used to measure the approximate fair value of the financial instruments as of September 30, 20162017 and December 31, 2015.2016.
Basis of fair value measurement |
|
|
|
|
| Basis of fair value measurement |
| |||||||||||||||||||||||||
(in millions) | Balance as of September 30, 2016 | Quoted prices in active markets for identical assets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) |
| Balance as of September 30, 2017 |
|
| Quoted prices in active markets for identical assets (Level 1) |
|
| Significant other observable inputs (Level 2) |
|
| Significant unobservable inputs (Level 3) |
| ||||||||||||||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Investments | $ 32 | $— | $ 2 | $30 |
| $ | 42 |
|
| $ | — |
|
| $ | — |
|
| $ | 42 |
| ||||||||||||
Total assets | $ 32 | $— | $ 2 | $30 |
| $ | 42 |
|
| $ | — |
|
| $ | — |
|
| $ | 42 |
| ||||||||||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Short-term debt | $ — | $— | $ — | $— | ||||||||||||||||||||||||||||
Current maturities of long-term debt and lease obligations | 6 | — | 6 | — |
| $ | 3 |
|
|
|
|
|
| $ | 3 |
|
|
|
|
| ||||||||||||
Long-term debt and lease obligations | 2,960 | — | 2,960 | — |
|
| 3,568 |
|
|
|
|
|
|
| 3,568 |
|
|
|
|
| ||||||||||||
Total liabilities | $2,966 | $— | $2,966 | $— |
| $ | 3,571 |
|
| $ | — |
|
| $ | 3,571 |
|
| $ | — |
| ||||||||||||
|
|
|
|
|
| Basis of fair value measurement |
| |||||||||
(in millions) |
| Balance as of December 31, 2016 |
|
| Quoted prices in active markets for identical assets (Level 1) |
|
| Significant other observable inputs (Level 2) |
|
| Significant unobservable inputs (Level 3) |
| ||||
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments |
| $ | 31 |
|
| $ | — |
|
| $ | — |
|
| $ | 31 |
|
Total assets |
| $ | 31 |
|
| $ | — |
|
| $ | — |
|
| $ | 31 |
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current maturities of long-term debt and lease obligations |
| $ | 3 |
|
| $ | — |
|
| $ | 3 |
|
| $ | — |
|
Long-term debt and lease obligations |
|
| 2,756 |
|
|
| — |
|
|
| 2,756 |
|
|
| — |
|
Total liabilities |
| $ | 2,759 |
|
| $ | — |
|
| $ | 2,759 |
|
| $ | — |
|
Balance as of December 31, 2015 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Investments Total assets Liabilities Short-term debt Current maturities of long-term debt and lease obligations Long-term debt and lease obligations Total liabilities Basis of fair value measurement (in millions) $ 21 $— $ 2 $19 $ 21 $— $ 2 $19 $1,775 $— $1,775 $— 818 — 818 — 4,077 — 4,077 — $6,670 $— $6,670 $—
Investments in 20162017 and 20152016 included certain cost method investments and held-to-maturity debt securities.
The fair value of held-to-maturity debt securities is calculated using a discounted cash flow model that incorporates observable inputs, including interest rate yields, which represents a Level 2 basis of fair value measurement.investments.
In determining the fair value of cost method investments, the company takes into consideration recent transactions, as well as the financial information of the investee, which represents a Level 3 basis of fair value measurement.
The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instrument. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with the
company’s credit risk. The carrying values of the other financial instruments approximate their fair values due to the short-term maturities of most of these assets and liabilities.
9. STOCK COMPENSATION
Stock compensation expense totaled $31 million and $30 million for bothin the three months ended September 30,third quarter of 2017 and 2016, respectively, and 2015, and $84$77 million and $96$84 million for the nine months ended September 30, 2017 and 2016, and 2015, respectively. OverApproximately 70% of stock compensation expense is classified in marketing and administrative expenses with the remainder classified in cost of sales and R&D expenses.
In March 2016,2017, the company awarded its annual stock compensation grants which consisted of 6.45.4 million stock options, 1.00.7 million RSUs and 0.30.6 million PSUs.
10. RETIREMENT AND OTHER BENEFIT PROGRAMS
The following is a summary of net periodic benefit cost relating to the company’s pension and other postemployment benefit (OPEB) plans.
Three months ended | Nine months ended |
| Three months ended |
|
| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Pension benefits |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Service cost | $ | 23 | $ | 27 | $ | 70 | $ | 75 |
| $ | 23 |
|
| $ | 23 |
|
| $ | 68 |
|
| $ | 70 |
| ||||||||
Interest cost | 46 | 50 | 138 | 149 |
|
| 46 |
|
|
| 46 |
|
|
| 136 |
|
|
| 138 |
| ||||||||||||
Expected return on plan assets | (76 | ) | (66 | ) | (227 | ) | (192 | ) |
|
| (75 | ) |
|
| (76 | ) |
|
| (220 | ) |
|
| (227 | ) | ||||||||
Amortization of net losses and other deferred amounts | 38 | 44 | 113 | 130 |
|
| 42 |
|
|
| 38 |
|
|
| 123 |
|
|
| 113 |
| ||||||||||||
Net periodic pension benefit cost | $ | 31 | $ | 55 | $ | 94 | $ | 162 |
| $ | 36 |
|
| $ | 31 |
|
| $ | 107 |
|
| $ | 94 |
| ||||||||
OPEB |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Service cost | $ | 1 | $ | 1 | $ | 3 | $ | 2 |
| $ | — |
|
| $ | 1 |
|
| $ | — |
|
| $ | 3 |
| ||||||||
Interest cost | 4 | 3 | 8 | 13 |
|
| 2 |
|
|
| 4 |
|
|
| 6 |
|
|
| 8 |
| ||||||||||||
Amortization of net loss and prior service credit | (7 | ) | (4 | ) | (15 | ) | (7 | ) |
|
| (7 | ) |
|
| (7 | ) |
|
| (20 | ) |
|
| (15 | ) | ||||||||
Net periodic OPEB cost | $ | (2 | ) | $ | — | $ | (4 | ) | $ | 8 |
| $ | (5 | ) |
| $ | (2 | ) |
| $ | (14 | ) |
| $ | (4 | ) | ||||||
In the second quarter of 2016, the company made a $706 million voluntary, non-cash contribution to the qualified U.S. pension plan using Retained Shares. Refer to Note 8 for additional information regarding Retained Share transactions.
11. ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income includes all changes in shareholders��shareholders’ equity that do not arise from transactions with shareholders, and consists of net income, CTA, pension and other employee benefits, unrealized gains and losses on cash flow hedges and unrealized gains and losses on available-for-sale equity securities. The following table is a net-of-tax summary of the changes in AOCI by component for the nine months ended September 30, 20162017 and 2015.2016.
(in millions) | CTA | Pension and other employee benefits | Hedging activities | Available- for-sale securities | Total |
| CTA |
|
| Pension and other employee benefits |
|
| Hedging activities |
|
| Available- for-sale securities |
|
| Total |
| ||||||||||||||||||||
Gains (losses) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Balance as of December 31, 2015 | $ | (3,191 | ) | $ (1,064 | ) | $ | 7 | $ | 4,472 | $ | 224 | |||||||||||||||||||||||||||||
Balance as of December 31, 2016 |
| $ | (3,438 | ) |
| $ | (1,161 | ) |
| $ | 3 |
|
| $ | 40 |
|
| $ | (4,556 | ) | ||||||||||||||||||||
Other comprehensive income before reclassifications | (16 | ) | (6 | ) | (6 | ) | 105 | 77 |
|
| 501 |
|
|
| (25 | ) |
|
| (19 | ) |
|
| 1 |
|
|
| 458 |
| ||||||||||||
Amounts reclassified from AOCI (a) | — | 67 | (4 | ) | (4,536 | ) | (4,473 | ) |
|
| 29 |
|
|
| 69 |
|
|
| 3 |
|
|
| 3 |
|
|
| 104 |
| ||||||||||||
Net other comprehensive (loss) income | (16 | ) | 61 | (10 | ) | (4,431 | ) | (4,396 | ) | |||||||||||||||||||||||||||||||
Balance as of September 30, 2016 | $ | (3,207 | ) | $ (1,003 | ) | $ | (3 | ) | $ | 41 | $ | (4,172 | ) | |||||||||||||||||||||||||||
(in millions) | CTA | Pension and other employee benefits | Hedging activities | Available- for-sale- securities | Total | |||||||||||||||||||||||||||||||||||
Gains (losses) | ||||||||||||||||||||||||||||||||||||||||
Balance as of December 31, 2014 | $ | (2,323 | ) | $ (1,427 | ) | $ | 34 | $ | 66 | $ | (3,650 | ) | ||||||||||||||||||||||||||||
Other comprehensive income before reclassifications | (985 | ) | 118 | 55 | 3,446 | 2,634 | ||||||||||||||||||||||||||||||||||
Amounts reclassified from AOCI (a) | — | 94 | (39 | ) | (6 | ) | 49 | |||||||||||||||||||||||||||||||||
Net other comprehensive (loss) income | (985 | ) | 212 | 16 | 3,440 | 2,683 | ||||||||||||||||||||||||||||||||||
Distribution of Baxalta | 226 | 198 | (42 | ) | (32 | ) | 350 | |||||||||||||||||||||||||||||||||
Balance as of September 30, 2015 | $ | (3,082 | ) | $ (1,017 | ) | $ | 8 | $ | 3,474 | $ | (617 | ) | ||||||||||||||||||||||||||||
Net other comprehensive income (loss) |
|
| 530 |
|
|
| 44 |
|
|
| (16 | ) |
|
| 4 |
|
|
| 562 |
| ||||||||||||||||||||
Balance as of September 30, 2017 |
| $ | (2,908 | ) |
| $ | (1,117 | ) |
| $ | (13 | ) |
| $ | 44 |
|
| $ | (3,994 | ) |
(in millions) |
| CTA |
|
| Pension and other employee benefits |
|
| Hedging activities |
|
| Available- for-sale- securities |
|
| Total |
| |||||
Gains (losses) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2015 |
| $ | (3,191 | ) |
| $ | (1,064 | ) |
| $ | 7 |
|
| $ | 4,472 |
|
| $ | 224 |
|
Other comprehensive income before reclassifications |
|
| (16 | ) |
|
| (6 | ) |
|
| (6 | ) |
|
| 105 |
|
|
| 77 |
|
Amounts reclassified from AOCI (a) |
|
| — |
|
|
| 67 |
|
|
| (4 | ) |
|
| (4,536 | ) |
|
| (4,473 | ) |
Net other comprehensive income (loss) |
|
| (16 | ) |
|
| 61 |
|
|
| (10 | ) |
|
| (4,431 | ) |
|
| (4,396 | ) |
Balance as of September 30, 2016 |
| $ | (3,207 | ) |
| $ | (1,003 | ) |
| $ | (3 | ) |
| $ | 41 |
|
| $ | (4,172 | ) |
(a) | See table below for details about these reclassifications. |
The following is a summary of the amounts reclassified from AOCI to net income during the three months and nine months ended September 30, 20162017 and 2015.2016.
|
| Amounts reclassified from AOCI (a) |
|
|
| |||||||||||||||
(in millions) |
| Three months ended September 30, 2017 |
|
| Nine months ended September 30, 2017 |
|
| Location of impact in income statement | ||||||||||||
Translation adjustments |
|
|
|
|
|
|
|
|
|
| ||||||||||
Loss on Venezuela deconsolidation |
| $ | — |
|
| $ | (29 | ) |
| Other (income) expense, net | ||||||||||
|
| — |
|
|
| (29 | ) |
| Total before tax | |||||||||||
Amounts reclassified from AOCI (a) |
|
| — |
|
|
| — |
|
| Income tax expense (benefit) | ||||||||||
(in millions) | Three months ended September 30, 2016 | Nine months ended September 30, 2016 | Location of impact in income statement | |||||||||||||||||
|
| $ | — |
|
| $ | (29 | ) |
| Net of tax | ||||||||||
Amortization of pension and other employee benefits items |
|
|
|
|
|
|
|
|
|
| ||||||||||
Actuarial losses and other (b) | $ | (31 | ) | $ | (98 | ) |
| $ | (35 | ) |
| $ | (103 | ) |
|
| ||||
(31 | ) | (98 | ) | Total before tax |
|
| (35 | ) |
|
| (103 | ) |
| Total before tax | ||||||
11 | 31 | Tax benefit |
|
| 12 |
|
|
| 34 |
|
| Income tax expense (benefit) | ||||||||
$ | (20 | ) | $ | (67 | ) | Net of tax |
| $ | (23 | ) |
| $ | (69 | ) |
| Net of tax | ||||
Gains on hedging activities | ||||||||||||||||||||
Interest rate contracts | $ | 5 | $ | 9 | Other income, net | |||||||||||||||
Losses on hedging activities |
|
|
|
|
|
|
|
|
|
| ||||||||||
Foreign exchange contracts | (2 | ) | (3 | ) | Cost of sales |
| $ | (3 | ) |
| $ | (4 | ) |
| Cost of sales | |||||
3 | 6 | Total before tax |
|
| (3 | ) |
|
| (4 | ) |
| Total before tax | ||||||||
(1 | ) | (2 | ) | Tax expense |
|
| 1 |
|
|
| 1 |
|
| Income tax expense (benefit) | ||||||
$ | 2 | $ | 4 | Net of tax |
| $ | (2 | ) |
| $ | (3 | ) |
| Net of tax | ||||||
Available-for-sale-securities |
|
|
|
|
|
|
|
|
|
| ||||||||||
Gains on sale of equity securities | $ | — | $ | 4,536 | Other income, net | |||||||||||||||
— | 4,536 | Total before tax | ||||||||||||||||||
Other-than-temporary impairment of equity securities |
| $ | — |
|
| $ | (4 | ) |
| Other (income) expense, net | ||||||||||
— | — | Tax benefit |
|
| — |
|
|
| (4 | ) |
| Total before tax | ||||||||
$ | — | $ | 4,536 | Net of tax |
|
| — |
|
|
| 1 |
|
| Income tax expense (benefit) | ||||||
|
| — |
|
|
| (3 | ) |
| Net of tax | |||||||||||
Total reclassification for the period | $ | (18 | ) | $ | 4,473 | Total net of tax |
| $ | (25 | ) |
| $ | (104 | ) |
| Total net of tax | ||||
Amounts reclassified from AOCI (a) |
| Amounts reclassified from AOCI (a) |
|
|
| |||||||||||||||
(in millions) | Three months ended September 30, 2015 | Nine months ended 30, 2015 | Location of impact in income statement |
| Three months ended September 30, 2016 |
|
| Nine months ended September 30, 2016 |
|
| Location of impact in income statement | |||||||||
Amortization of pension and other employee benefits items |
|
|
|
|
|
|
|
|
|
| ||||||||||
Actuarial losses and other (b) | $ | (40 | ) | $ | (139 | ) |
| $ | (31 | ) |
| $ | (98 | ) |
|
| ||||
(40 | ) | (139 | ) | Total before tax |
|
| (31 | ) |
|
| (98 | ) |
| Total before tax | ||||||
13 | 45 | Tax benefit |
|
| 11 |
|
|
| 31 |
|
| Income tax expense (benefit) | ||||||||
$ | (27 | ) | $ | (94 | ) | Net of tax |
| $ | (20 | ) |
| $ | (67 | ) |
| Net of tax | ||||
Gains (losses) on hedging activities |
|
|
|
|
|
|
|
|
|
| ||||||||||
Interest rate contracts |
| $ | 5 |
|
| $ | 9 |
|
| Other (income) expense, net | ||||||||||
Foreign exchange contracts | $ | 5 | $ | 60 | Cost of sales |
|
| (2 | ) |
|
| (3 | ) |
| Cost of sales | |||||
5 | 60 | Total before tax |
|
| 3 |
|
|
| 6 |
|
| Total before tax | ||||||||
(1 | ) | (21 | ) | Tax expense |
|
| (1 | ) |
|
| (2 | ) |
| Income tax expense (benefit) | ||||||
$ | 4 | $ | 39 | Net of tax |
| $ | 2 |
|
| $ | 4 |
|
| Net of tax | ||||||
Other | ||||||||||||||||||||
Gain on sale of available-for-sale equity securities | $ | 7 | $ | 22 | Other expense (income), net | |||||||||||||||
Other-than-temporary impairment of available-for-sale equity securities | — | (9 | ) | Other expense (income), net | ||||||||||||||||
7 | 13 | Total before tax | ||||||||||||||||||
Available-for-sale-securities |
|
|
|
|
|
|
|
|
|
| ||||||||||
Gains on sale of equity securities |
| $ | — |
|
| $ | 4,536 |
|
| Other (income) expense, net | ||||||||||
(3 | ) | (7 | ) | Tax expense |
|
| — |
|
|
| 4,536 |
|
| Total before tax | ||||||
$ | 4 | $ | 6 | Net of tax |
|
| — |
|
|
| — |
|
| Income tax expense (benefit) | ||||||
|
| — |
|
|
| 4,536 |
|
| Net of tax | |||||||||||
Total reclassification for the period | $ | (19 | ) | $ | (49 | ) | Total net of tax |
| $ | (18 | ) |
| $ | 4,473 |
|
| Total net of tax | |||
(a) | Amounts in parentheses indicate reductions to net income. |
(b) | These AOCI components are included in the computation of net periodic benefit cost disclosed in Note 10. |
Refer to Note 8 for additional information regarding hedging activity and Note 10 for additional information regarding the amortization of pension and other employee benefits items.
12. INCOME TAXES
Effective tax rate
The company’s effective income tax rate for continuing operations was 0.8%14.5% and 106.1%0.8% in the three months ended September 30,third quarters of 2017 and 2016, and 2015, respectively, and 15.0% and (1.1%) and 5.8% in the nine months ended September 30, 20162017 and 2015,2016, respectively. The company’s effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.
The effective income tax rate for continuing operations during the three months ended September 30, 2017 increased from the three months ended September 30, 2016, decreased due to the inclusion in 2016 of restructuring and other charges incurred in higher tax rate jurisdictions as well as the favorable impact of discrete items including the partial settlement of an on-going income tax matter related to the company’s Turkish operations and the settlement of a transfer pricing audit related to the company’s Italian operations. Partially offsettingWindfall benefits realized from stock option exercises and vesting of RSUs and PSUs associated with the foregoing items werecompany’s stock compensation programs partially offset the increase from the prior period as such benefits are now reflected as a tax charges related tobenefit as a result of the settlementcompany’s adoption of state income tax audit matters. ASU 2016-09 in 2017.
The effective income tax rate for continuing operations in the third quarter of 2015 was primarily the result of charges associated with the company’s spin-off of Baxalta, such as debt tender premium costs associated with debt refinancing, which received tax benefits at rates significantly higher than the rate of tax without such charges. The resulting tax benefits were greater than the resulting net loss for the period.
In addition to the foregoing factors, the income tax rate forincreased during the nine months ended September 30, 2016 benefited by several factors including tax-free net realized gains during2017 due to the first and second quarter associated with the exchanges of Baxalta retained shares for the company’s debt and the company’s sharesitems noted above as well as the absence in the current year of the tax-free net realized gains associated with the Baxalta Retained Share transactions, which included debt-for-equity exchanges, the contribution of Baxalta retained sharesRetained Shares to the company’s U.S. pension plan. Additionally,plan and the exchange of Baxalta Retained Shares for shares of the company, as well as benefits attributable to closing an IRS and German income tax audit that were all reflected during the nine months ended September 30, 2016. The effective income tax rate for this periodcontinuing operations during the nine months ended September 30, 2017 was favorably impacted by approximately 5.2 percentage points due to tax windfall benefits realized from partially settling an IRS (2008-2013) income tax auditstock option exercises and settling a German (2008-2011) income tax audit.
Duringvesting of RSUs and PSUs associated with the first quarter of 2016, Baxter paid approximately $303 million to partially settle a US Federal income tax audit for the period 2008-2013. Additionally, the company settled a German income tax audit for the period 2008-2011. As a result, the company reduced its gross unrecognized tax benefits by $85 million. Pursuant to the tax matters agreement with Baxalta, Baxalta paid the company approximately $34 million related to its tax indemnity obligations in respect of its portion of the settled gross unrecognized tax benefits. See Note 2 for additional details regarding the separation of Baxalta.company’s stock compensation programs.
13. LEGAL PROCEEDINGS
Baxter is involved in product liability, patent, commercial, and other legal matters that arise in the normal course of the company’s business. The company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is recorded. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. As of September 30, 2016,2017, the company’s total recorded reserves with respect to legal matters were $50$15 million and the totalthere were no related receivables were $10 million.receivables.
Baxter has established reserves for certain of the matters discussed below. The company is not able to estimate the amount or range of any loss for certain contingencies for which there is no reserve or additional loss for matters already reserved. While the liability of the company in connection with the claims cannot be estimated and although the resolution thereof in any reporting period of one or more of these matters could have a significant impact on the company’s results of operations and cash flows for that period, the outcome of these legal proceedings is not expected to have a material adverse effect on the company’s consolidated financial position. While the company believes that it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may incur material judgments or enter into material settlements of claims.
In addition to the matters described below, the company remains subject to the risk of future administrative and legal actions. With respect to governmental and regulatory matters, these actions may lead to product recalls, injunctions, and other restrictions on the company’s operations and monetary sanctions, including significant civil or criminal penalties. With respect to intellectual property, the company may be exposed to significant litigation concerning the scope of the company’s and others’ rights. Such litigation could result in a loss of patent protection or the ability to market products, which could lead to a significant loss of sales, or otherwise materially affect future results of operations.
General litigation
On July 31, 2015, Davita Healthcare Partners, Inc. filed suit against Baxter Healthcare Corporation in the District Court of the State of Colorado regarding an ongoing commercial dispute relating to the provision of peritoneal dialysis products. The company denies the claims and is vigorously defending itself against the suit. A bench trial concluded in third quarter 2016 and the parties arewere awaiting the court’s decision. In October, 2017, the parties jointly requested a stay in the matter while they work to resolve the matter. The court has granted the stay.
In November 2016, a purported antitrust class action complaint seeking monetary and injunctive relief from the company was filed in the United States District Court for the Northern District of Illinois. The complaint alleges a conspiracy among manufacturers of IV solutions to restrict output and affect pricing in connection with a shortage of such solutions. Similar parallel actions subsequently were filed. In January 2017, a single consolidated complaint covering these matters was filed in the Northern District of Illinois. The company filed a motion to dismiss the consolidated complaint in February 2017.
In April 2017, the company became aware of a criminal investigation by the U.S. Department of Justice, Antitrust Division and a federal grand jury in the United States District Court for the Eastern District of Pennsylvania. The company and an employee received subpoenas seeking production of documents and testimony regarding the manufacturing, selling, pricing and shortages of IV solutions and containers (including saline solutions and certain other injectable medicines sold by the company) and communications with competitors regarding the same. The company is cooperating with the investigation. As previously disclosed, the New York Attorney General has requested that Baxter provide information regarding business practices in the IV saline industry. The company is cooperating with the New York Attorney General.
Other
In the fourth quarter of 2012,December 2016, the company received twoa civil investigative demandsdemand from the Commercial Litigation Branch of the United States AttorneyDepartment of Justice primarily relating to contingent discount arrangements for, the Western District of North Carolina for information regarding its quality and manufacturing practices and procedures and related potential violationother promotion of, the Food Drugcompany’s TISSEEL and Cosmetic Act associated with operations at its North Cove facility.ARTIS products. The company is fully cooperating within this investigation.matter.
14.
14 SEGMENT INFORMATION
Baxter’s two segments are strategic businesses that are managed separately because each business develops, manufactures and markets distinct products and services. The segments and a description of their products and services are as follows:
TheRenal business provides products and services to treat end-stage renal disease, or irreversible kidney failure, along with other renal therapies. The Renal business offers a comprehensive portfolio to meet the needs of patients across the treatment continuum, including technologies and therapies for peritoneal dialysis (PD), hemodialysis (HD), continuous renal replacement therapy (CRRT) and additional dialysis services.
TheHospital Products business manufactures intravenous (IV) solutions and administration sets, premixed drugs and drug-reconstitution systems, oncology injectable drugs, IV nutrition products, infusion pumps, inhalation anesthetics, and biosurgery products. The business also provides products and services related to pharmacy compounding, drug formulation and packaging technologies.
The company uses income from continuing operations before net interest expense, income tax expense, depreciation and amortization expense (Segment EBITDA), on a segment basis to make resource allocation decisions and assess the ongoing performance of the company’s business segments. Intersegment sales are eliminated in consolidation.
Certain items are maintained at Corporate and are not allocated to a segment. They primarily include most of the company’s debt and cash and equivalents and related net interest expense, foreign exchange fluctuations (principally relating to intercompany receivables, payables and loans denominated in a foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, stock compensation expense, nonstrategic investments and related income and expense, certain employee benefit plan costs as well as certain nonrecurring gains, losses, and other charges (such as business optimization, integration and separation-related costs, and asset impairment)impairments). Financial information for the company’s segments is as follows.
Three months ended | Nine months ended |
| Three months ended |
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| Nine months ended |
| |||||||||||||||||||||||||
September 30, | September 30, |
| September 30, |
|
| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Net sales |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Renal | $ | 977 | $ | 943 | $ | 2,840 | $ | 2,805 |
| $ | 1,010 |
|
| $ | 977 |
|
| $ | 2,874 |
|
| $ | 2,840 |
| ||||||||
Hospital Products | 1,581 | 1,544 | 4,678 | 4,560 |
|
| 1,697 |
|
|
| 1,581 |
|
|
| 4,913 |
|
|
| 4,678 |
| ||||||||||||
Total net sales | $ | 2,558 | $ | 2,487 | $ | 7,518 | $ | 7,365 |
| $ | 2,707 |
|
| $ | 2,558 |
|
| $ | 7,787 |
|
| $ | 7,518 |
| ||||||||
EBITDA |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Renal | $ | 214 | $ | 182 | $ | 494 | $ | 422 |
| $ | 226 |
|
| $ | 214 |
|
| $ | 649 |
|
| $ | 494 |
| ||||||||
Hospital Products | 588 | 515 | 1,673 | 1,462 |
|
| 653 |
|
|
| 588 |
|
|
| 1,821 |
|
|
| 1,673 |
| ||||||||||||
Total segment EBITDA | $ | 802 | $ | 697 | $ | 2,167 | $ | 1,884 |
| $ | 879 |
|
| $ | 802 |
|
| $ | 2,470 |
|
| $ | 2,167 |
| ||||||||
Total assets Renal Hospital Products Other Total assets September 30, December 31, (in millions) 2016 2015 $ 4,586 $ 4,609 6,602 6,632 4,607 9,721 $ 15,795 $ 20,962
The following is a reconciliation of segment EBITDA to income from continuing operations before income taxes per the condensed consolidated statements of income.
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| September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Total segment EBITDA | $ | 802 | $ | 697 | $ | 2,167 | $ | 1,884 |
| $ | 879 |
|
| $ | 802 |
|
| $ | 2,470 |
|
| $ | 2,167 |
| ||||||||
Reconciling items |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Depreciation and amortization | (204 | ) | (216 | ) | (599 | ) | (593 | ) |
|
| (184 | ) |
|
| (204 | ) |
|
| (562 | ) |
|
| (599 | ) | ||||||||
Stock compensation | (30 | ) | (30 | ) | (84 | ) | (96 | ) |
|
| (31 | ) |
|
| (30 | ) |
|
| (77 | ) |
|
| (84 | ) | ||||||||
Net interest expense | (14 | ) | (34 | ) | (53 | ) | (94 | ) |
|
| (14 | ) |
|
| (14 | ) |
|
| (41 | ) |
|
| (53 | ) | ||||||||
Restructuring charges, net | (130 | ) | (92 | ) | (237 | ) | (102 | ) |
|
| (31 | ) |
|
| (130 | ) |
|
| (50 | ) |
|
| (237 | ) | ||||||||
Certain foreign currency fluctuations and hedging activities | 3 | 44 | 27 | 118 | ||||||||||||||||||||||||||||
Net realized gains on Retained Shares transactions | — | — | 4,387 | — | ||||||||||||||||||||||||||||
Venezuela deconsolidation |
|
| — |
|
|
| — |
|
|
| (33 | ) |
|
| — |
| ||||||||||||||||
Net realized gains on Baxalta Retained Shares transactions |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 4,387 |
| ||||||||||||||||
Net loss on debt extinguishment | (52 | ) | (130 | ) | (153 | ) | (130 | ) |
|
| — |
|
|
| (52 | ) |
|
| — |
|
|
| (153 | ) | ||||||||
Other Corporate items | (247 | ) | (272 | ) | (780 | ) | (764 | ) |
|
| (329 | ) |
|
| (244 | ) |
|
| (783 | ) |
|
| (753 | ) | ||||||||
Income from continuing operations before income taxes | $ | 128 | $ | (33 | ) | $ | 4,675 | $ | 223 |
| $ | 290 |
|
| $ | 128 |
|
| $ | 924 |
|
| $ | 4,675 |
| |||||||
Refer to the company’s Annual Report on Form 10-K for the year ended December 31, 2015 (20152016 (2016 Annual Report) for management’s discussion and analysis of the financial condition and results of operations of the company. The following is management’s discussion and analysis of the financial condition and results of operations of the company for the three and nine months ended September 30, 2016.2017.
Separation of Baxalta Incorporated
On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of its biopharmaceuticals business, Baxalta Incorporated (Baxalta), to Baxter shareholders (the Distribution). As a result of the separation, the operating results of Baxalta have been reflected as discontinued operations. Refer to Note 2 for additional information regarding the separation of Baxalta. Unless otherwise stated, financial results herein reflect continuing operations.
RESULTS OF OPERATIONS
Baxter’s income from continuing operations for the three and nine months ended September 30, 20162017 totaled $248 million, or $0.45 per diluted share, and $785 million, or $1.42 per diluted share, compared to $127 million, or $0.23 per diluted share, and $4.7 billion, or $8.56 per diluted share. This compares to $2 million, or $0.00 per diluted share, and $210 million, or $0.38 per diluted share for the three and nine months ended September 30, 2015.2016. Income from continuing operations for the three and nine months ended September 30, 2017 included special items which decreased income from continuing operations by $108 million and $237 million, respectively, or $0.19 and $0.42 per diluted share, respectively, as further discussed below. Income from continuing operations for the three months ended September 30, 2016 included special items which reduced income from continuing operations by $184 million, or $0.33 per diluted share. Special items increased income from continuing operations by $4 billion, or $7.17 per diluted share, for the nine months ended September 30, 2016. Income from continuing operations for the three and nine months ended September 30, 2015 included special items which reduced income from continuing operations by $223 million, or $0.41 per diluted share, and $309 million, or $0.57 per diluted share, respectively.
Special Items
The following table provides a summary of the company’s special items and the related impact by line item on the company’s results of continuing operations for the three and nine months ended September 30, 20162017 and 2015.2016.
Three months ended September 30, | Nine months ended September 30, |
| Three months ended September 30, |
|
| Nine months ended September 30, |
| |||||||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Gross Margin |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Intangible asset amortization expense | $(42 | ) | $(40 | ) | $(124 | ) | $(120 | ) |
| $ | (38 | ) |
| $ | (42 | ) |
| $ | (112 | ) |
| $ | (124 | ) | ||||||||
Business optimization items1 | (35 | ) | (32 | ) | (113 | ) | (28 | ) |
|
| (12 | ) |
|
| (35 | ) |
|
| (42 | ) |
|
| (113 | ) | ||||||||
Product-related items2 | — | 18 | 12 | 18 |
|
| (21 | ) |
|
| — |
|
|
| (17 | ) |
|
| 12 |
| ||||||||||||
Separation-related costs 4 |
|
| — |
|
|
| (1 | ) |
|
| (1 | ) |
|
| (1 | ) | ||||||||||||||||
Claris acquisition and integration expenses 8 |
|
| (4 | ) |
|
|
|
|
|
| (4 | ) |
|
|
|
| ||||||||||||||||
Hurricane Maria costs 10 |
|
| (21 | ) |
|
|
|
|
|
| (21 | ) |
|
|
|
| ||||||||||||||||
Intangible asset impairment3 | — | — | (51 | ) | — |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (51 | ) | |||||||||||
Baxalta separation-related costs4 | (1 | ) | (1 | ) | (1 | ) | (1 | ) | ||||||||||||||||||||||||
Total Special Items | $(78 | ) | $(55 | ) | $(277 | ) | $(131 | ) |
| $ | (96 | ) |
| $ | (78 | ) |
| $ | (197 | ) |
| $ | (277 | ) | ||||||||
Impact on Gross Margin Ratio | (3.0 pts | ) | (2.2 pts | ) | (3.7 pts | ) | (1.8 pts | ) |
| (3.5 pts) |
|
| (3.0 pts) |
|
| (2.5 pts) |
|
| (3.7 pts) |
| ||||||||||||
Marketing and Administrative Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Business optimization items1 | $106 | $64 | $137 | $113 |
| $ | 39 |
|
| $ | 106 |
|
| $ | 74 |
|
| $ | 137 |
| ||||||||||||
Baxalta separation-related costs4 | 9 | 60 | 45 | 88 | ||||||||||||||||||||||||||||
Separation-related costs 4 |
|
| 2 |
|
|
| 9 |
|
|
| 16 |
|
|
| 45 |
| ||||||||||||||||
Claris acquisition and integration expenses 8 |
|
| 11 |
|
|
| — |
|
|
| 16 |
|
|
| — |
| ||||||||||||||||
Historical reserve adjustments 5 |
|
| — |
|
|
| — |
|
|
| (12 | ) |
|
| — |
| ||||||||||||||||
Total Special Items | $115 | $124 | $182 | $201 |
| $ | 52 |
|
| $ | 115 |
|
| $ | 94 |
|
| $ | 182 |
| ||||||||||||
Impact on Marketing and Administrative Expense Ratio | 4.5 pts | 5.0 pts | 2.4 pts | 2.8 pts |
| 1.9 pts |
|
| 4.5 pts |
|
| 1.2 pts |
|
| 2.4 pts |
| ||||||||||||||||
Research and Development Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Business optimization items1 | $30 | $8 | $75 | $11 |
| $ | 1 |
|
| $ | 30 |
|
| $ | — |
|
| $ | 75 |
| ||||||||||||
Total Special Items | $30 | $8 | $75 | $11 |
| $ | 1 |
|
| $ | 30 |
|
| $ | — |
|
| $ | 75 |
| ||||||||||||
Other Expense (Income), Net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Net realized gains on Retained Shares transactions5 | $— | $— | $(4,391 | ) | $— | |||||||||||||||||||||||||||
Loss on debt extinguishment6 | 48 | 130 | 149 | 130 |
| $ | — |
|
| $ | 48 |
|
| $ | — |
|
| $ | 149 |
| ||||||||||||
Litigation settlement | — | — | — | (52 | ) | |||||||||||||||||||||||||||
Net realized gains on Baxalta Retained Share transactions 7 |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (4,391 | ) | ||||||||||||||||
Venezuela deconsolidation 9 |
|
| — |
|
|
| — |
|
|
| 33 |
|
|
| — |
| ||||||||||||||||
Total Special Items | $48 | $130 | $(4,242 | ) | $78 |
| $ | — |
|
| $ | 48 |
|
| $ | 33 |
|
| $ | (4,242 | ) | |||||||||||
Income Tax Benefit | ||||||||||||||||||||||||||||||||
Impact of special items7 | $(87 | ) | $(94 | ) | $(252 | ) | $(112 | ) | ||||||||||||||||||||||||
Income Tax Expense (Benefit) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||
Impact of special items |
| $ | (41 | ) |
| $ | (87 | ) |
| $ | (87 | ) |
| $ | (252 | ) | ||||||||||||||||
Total Special Items | $(87 | ) | $(94 | ) | $(252 | ) | $(112 | ) |
| $ | (41 | ) |
| $ | (87 | ) |
| $ | (87 | ) |
| $ | (252 | ) | ||||||||
Impact on Effective Tax Rate | 21.3 pts | (85.3 pts | ) | 21.9 pts | 13.6 pts |
| 4.4 pts |
|
| 21.3 pts |
|
| 3.1 pts |
|
| 21.9 pts |
|
Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance and is similar to how management internally assesses performance. Additional special items are identified above because they are highly variable, difficult to predict and of a size that may substantially impact the company’s reported operations for a period. Management believes that providing the separate impact of the above items on the company’s results in accordance with GAAP in the United States may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another. This information should be considered in addition to, and not as a substitute for, information prepared in accordance with GAAP.
1 | The company's results in the third quarter of 2017 included a charge of $52 million related to business optimization initiatives. This included a charge of $31 million related to restructuring activities and $21 million of costs to implement business optimization programs which primarily included external consulting and project employee costs. The $31 million of restructuring charges were comprised of employee termination costs. |
The company’s results in the first nine months of 2017 included a net charge of $116 million related to business optimization initiatives. This included a net charge of $50 million related to restructuring activities, $58 million of costs to implement business optimization programs which primarily included external consulting and project employee costs, and $8 million of accelerated depreciation associated with facilities to be closed. The $50 million of net restructuring charges included $40 million of employee termination costs, $5 million of contract termination costs, and $5 million of asset impairment charges primarily related to facility closures. |
The company’s results in the third quarter of 2016 included a net charge of $171 million related to business optimization initiatives. This included a net charge of $130 million related to restructuring activities, $25 million of costs to implement business optimization programs which included external consulting and employee salary and related costs, $11 million of accelerated depreciation associated with facilities to be closed, and $5 million of Gambro integration costs. The $130 million of |
The company’s results in the first nine months of 2016 included a net charge of $325 million related to business optimization initiatives. This included a net charge of $237 million related to restructuring activities, $44 million of costs to implement business optimization programs which included external consulting and employee salary and related costs, $25 million of accelerated depreciation associated with facilities to be closed, and $19 million of Gambro integration costs. The $237 million of net restructuring charges included net $144 million of employee termination costs, $54 million of costs related to the discontinuance of the VIVIA home hemodialysis development program, a $27 million of intangible asset impairment charge related to acquired in-process R&D, and net $12 million of other exit costs.
The company’s results in the third quarter 2015 included a net charge of $104 million related to business optimization initiatives. This included a net charge of $92 million related to restructuring activities and Gambro integration charges of $12 million. The $92 million of net restructuring charges included net $61 million of employee termination costs, a $13 million intangible asset impairment, and $18 million of asset and other exit costs.
The company’s results in the first nine months of 2015 included a net charge of $152 million primarily related to business optimization charges. This included a net charge of $102 million related to restructuring activities and Gambro integration charges of $50 million. The $102 million of net restructuring charges included net $71 million of employee termination costs, a $13 million intangible asset impairment, and $18 million of asset and other exit costs.
The company’s results in the first nine months of 2016 included a net charge of $325 million related to business optimization initiatives. This included a net charge of $237 million related to restructuring activities, $44 million of costs to implement business optimization programs which included external consulting and employee salary and related costs, $25 million of accelerated depreciation associated with facilities to be closed, and $19 million of Gambro integration costs. The $237 million of restructuring activities included $144 million of employee termination costs, $54 million of costs related to the discontinuance of the VIVIA home hemodialysis development program, $27 million of intangible asset impairment charges related to acquired in-process R&D, and $12 million of other exit costs. |
2 | The company’s results in the third quarter and first nine months of 2017 included a net charge of $21 million and $17 million, respectively, related to SIGMA SPECTRUM infusion pump inspection and remediation activities, partially offset by a benefit related to an adjustment to historical product reserves. The company’s results in the first nine months of 2016 included a benefit of $12 million related to an adjustment to the SIGMA SPECTRUM infusion pump reserves. |
The company’s results in the third quarter and first nine months of 2015 included a net benefit of $18 million primarily related to adjustments to the COLLEAGUE and SIGMA SPECTRUM infusion pump reserves.
3 | The company’s results in the first nine months of 2016 included |
4 | The |
The company’s results in the third quarter and first nine months of 2015 included costs incurred related to the Baxalta separation totaling $61 million and $89 million, respectively.
5 | The |
6 | The company’s results in the third quarter of 2016 included a net debt extinguishment loss of $48 million primarily related to certain debt redemptions. The company’s results in |
The company’s results in the third quarter and first nine months of 2015 included a loss of $130 million primarily related to the July 2015 debt tender offers.
7 | The company’s results in the first nine months of 2016 included net realized gains of $4.4 billion related to the |
8 | The company’s results in the third quarter and first nine months of 2017 include acquisition and integration costs of $15 million and $20 million, respectively, related to the company’s acquisition of Claris Injectables Limited (Claris). |
9 | The company’s results in 2017 included a |
10 | The company’s results in 2017 included a charge of $21 million related to the impact of Hurricane Maria on the company’s |
NET SALES
Three months ended September 30, | Percent change | Nine months ended September 30, | Percent change |
| Three months ended September 30, |
|
| Percent change |
| |||||||||||||||||||||||||||||||||||||||||||||||||||
(in millions) | 2016 | 2015 | At actual currency rates | At constant currency rates | 2016 | 2015 | At actual currency rates | At constant currency rates |
| 2017 |
|
| 2016 |
|
| At actual currency rates |
|
| At constant currency rates |
|
| U.S. Cyclophosphamide |
|
| Claris |
|
| Strategic Product Exits |
| |||||||||||||||||||||||||||||||
Renal | $ 977 | $ 943 | 4% | 6% | $2,840 | $2,805 | 1% | 5% |
| $ | 1,010 |
|
| $ | 977 |
|
|
| 3 | % |
|
| 3 | % |
|
| 0 | % |
|
| 0 | % |
|
| (3 | )% | ||||||||||||||||||||||||
Hospital Products | 1,581 | 1,544 | 2% | 3% | 4,678 | 4,560 | 3% | 5% |
|
| 1,697 |
|
|
| 1,581 |
|
|
| 7 | % |
|
| 7 | % |
|
| 0 | % |
|
| 2 | % |
|
| (1 | )% | ||||||||||||||||||||||||
Total net sales | $2,558 | $2,487 | 3% | 4% | $7,518 | $7,365 | 2% | 5% |
| $ | 2,707 |
|
| $ | 2,558 |
|
|
| 6 | % |
|
| 6 | % |
|
| 0 | % |
|
| 1 | % |
|
| (1 | )% | ||||||||||||||||||||||||
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
September 30, | Percent change | September 30, | Percent change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(in millions) | 2016 | 2015 | At actual currency rates | At constant currency rates | 2016 | 2015 | At actual currency rates | At constant currency rates | ||||||||||||||||||||||||||||||||||||||||||||||||||||
International | $1,491 | $1,482 | 1% | 3% | $4,376 | $4,427 | (1)% | 3% | ||||||||||||||||||||||||||||||||||||||||||||||||||||
United States | 1,067 | 1,005 | 6% | 6% | 3,142 | 2,938 | 7% | 7% | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Total net sales | $2,558 | $2,487 | 3% | 4% | $7,518 | $7,365 | 2% | 5% | ||||||||||||||||||||||||||||||||||||||||||||||||||||
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(in millions) |
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| 2016 |
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| At actual currency rates |
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| At constant currency rates |
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| U.S. Cyclophosphamide |
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| Claris |
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| Strategic Product Exits |
| |||||||
International |
| $ | 1,559 |
|
| $ | 1,491 |
|
|
| 5 | % |
|
| 4 | % |
|
| 0 | % |
|
| 1 | % |
|
| (3 | )% |
United States |
|
| 1,148 |
|
|
| 1,067 |
|
|
| 8 | % |
|
| 8 | % |
|
| 0 | % |
|
| 1 | % |
|
| 0 | % |
Total net sales |
| $ | 2,707 |
|
| $ | 2,558 |
|
|
| 6 | % |
|
| 6 | % |
|
| 0 | % |
|
| 1 | % |
|
| (1 | )% |
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| Nine months ended September 30, |
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(in millions) |
| 2017 |
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| 2016 |
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| At actual currency rates |
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| At constant currency rates |
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| U.S. Cyclophosphamide |
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| Claris |
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| Strategic Product Exits |
| |||||||
Renal |
| $ | 2,874 |
|
| $ | 2,840 |
|
|
| 1 | % |
|
| 2 | % |
|
| 0 | % |
|
| 0 | % |
|
| (2 | )% |
Hospital Products |
|
| 4,913 |
|
|
| 4,678 |
|
|
| 5 | % |
|
| 5 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% |
Total net sales |
| $ | 7,787 |
|
| $ | 7,518 |
|
|
| 4 | % |
|
| 4 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% |
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(in millions) |
| 2017 |
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| 2016 |
|
| At actual currency rates |
|
| At constant currency rates |
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| U.S. Cyclophosphamide |
|
| Claris |
|
| Strategic Product Exits |
| |||||||
International |
| $ | 4,405 |
|
| $ | 4,376 |
|
|
| 1 | % |
|
| 2 | % |
|
| 0 | % |
|
| 0 | % |
|
| (2 | )% |
United States |
|
| 3,382 |
|
|
| 3,142 |
|
|
| 8 | % |
|
| 8 | % |
|
| (1 | )% |
|
| 1 | % |
|
| 0 | % |
Total net sales |
| $ | 7,787 |
|
| $ | 7,518 |
|
|
| 4 | % |
|
| 4 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% |
Foreign currency unfavorably impacteddid not have an impact on consolidated net sales by one percentage point and three percentage points during the third quarter and first nine months of 2016, respectively. Duringor the first nine months of 2016, foreign currency was principally impacted by the strengthening of the U.S dollar relative2017 compared to the Mexican Peso, Colombian Peso, British Pound, Australian Dollar, as well as certain other currencies.prior periods.
The comparisons presented at constant currency rates reflect comparative local currency sales at the prior period’s foreign exchange rates. This measure provides information on the change in net sales assuming that foreign currency exchange rates have not changed between the prior and the current period. The company believes that the non-GAAP measure of change in net sales at constant currency rates, when used in conjunction with the GAAP measure of change in net sales at actual currency rates, may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another.
During 2016, the company made a strategic decision to exit select products in certain markets including Venezuela, India and Turkey. Overall, these items had a negative impact to the company’s net sales growth rate of 1 percentage point during the third quarter and first nine months of 2017, respectively. The company is also presenting the impact of generic competition for U.S. cyclophosphamide to enhance comparability between periods and better identify operating trends.
On July 27, 2017, Baxter completed the acquisition of Claris, a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of $629 million, net of cash acquired. In the three and nine months ended September 30, 2017, consolidated Baxter results include $27 million of net sales related to the Claris acquisition.
In September 2017, the company’s three Puerto Rico manufacturing sites sustained minimal structural damage from the impact of Hurricane Maria and limited production activities resumed soon thereafter. Given the temporary disruptions to the company’s manufacturing facilities as a result of the storm, the company expects net sales in the fourth quarter of 2017 to be negatively impacted by approximately $70 million. The company does not expect any material impact to net sales in 2018 or thereafter.
Franchise Net Sales Reporting
The Renal segment includes sales of the company’s peritoneal dialysis (PD), hemodialysis (HD) and continuous renal replacement therapies.therapies (CRRT) and additional dialysis services.
The Hospital Products segment includes four commercial franchises: Fluid Systems, Integrated Pharmacy Solutions, Surgical Care and Other.
The following is a summary of net sales by commercial franchise.franchise on a reported and constant currency basis along with the impact of significant non-operational items.
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(in millions) | 2016 | 2015 | At actual currency rates | At constant currency rates | 2016 | 2015 | At actual currency rates | At constant currency rates |
| 2017 |
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| 2016 |
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| At actual currency rates |
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| At constant currency rates |
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| U.S. Cyclo- phosphamide |
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| Claris |
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| Strategic Product Exits |
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Total Renal net sales | $ | 977 | $ | 943 | 4% | 6% | $ | 2,840 | $ | 2,805 | 1% | 5% |
| $ | 1,010 |
|
| $ | 977 |
|
|
| 3 | % |
|
| 3 | % |
|
| 0 | % |
|
| 0 | % |
|
| (3 | )% | ||||||||||||||||||||
Fluid Systems | $ | 576 | $ | 526 | 10% | 11% | $ | 1,686 | $ | 1,537 | 10% | 12% |
| $ | 610 |
|
| $ | 576 |
|
|
| 6 | % |
|
| 6 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% | ||||||||||||||||||||
Integrated Pharmacy Solutions | 563 | 590 | (5%) | (4%) | 1,682 | 1,702 | (1%) | 1% |
|
| 627 |
|
|
| 563 |
|
|
| 11 | % |
|
| 11 | % |
|
| (2 | )% |
|
| 5 | % |
|
| 0 | % | ||||||||||||||||||||||||
Surgical Care | 320 | 322 | (1%) | 0% | 972 | 977 | (1%) | 1% |
|
| 338 |
|
|
| 320 |
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|
| 6 | % |
|
| 5 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% | ||||||||||||||||||||||||
Other | 122 | 106 | 15% | 15% | 338 | 344 | (2%) | (1%) |
|
| 122 |
|
|
| 122 |
|
|
| — |
|
|
| (2 | )% |
|
| 0 | % |
|
| 0 | % |
|
| 0 | % | ||||||||||||||||||||||||
Total Hospital Products net sales | $ | 1,581 | $ | 1,544 | 2% | 3% | $ | 4,678 | $ | 4,560 | 3% | 5% |
| $ | 1,697 |
|
| $ | 1,581 |
|
|
| 7 | % |
|
| 7 | % |
|
| 0 | % |
|
| 2 | % |
|
| (1 | )% | ||||||||||||||||||||
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(in millions) |
| 2017 |
|
| 2016 |
|
| At actual currency rates |
|
| At constant currency rates |
|
| U.S. Cyclo- phosphamide |
|
| Claris |
|
| Strategic Product Exits |
| |||||||
Total Renal net sales |
| $ | 2,874 |
|
| $ | 2,840 |
|
|
| 1 | % |
|
| 2 | % |
|
| 0 | % |
|
| 0 | % |
|
| (2 | )% |
Fluid Systems |
| $ | 1,802 |
|
| $ | 1,686 |
|
|
| 7 | % |
|
| 7 | % |
|
| 0 | % |
|
| 0 | % |
|
| (2 | )% |
Integrated Pharmacy Solutions |
|
| 1,747 |
|
|
| 1,682 |
|
|
| 4 | % |
|
| 5 | % |
|
| (1 | )% |
|
| 1 | % |
|
| 0 | % |
Surgical Care |
|
| 1,024 |
|
|
| 972 |
|
|
| 5 | % |
|
| 6 | % |
|
| 0 | % |
|
| 0 | % |
|
| 0 | % |
Other |
|
| 340 |
|
|
| 338 |
|
|
| 1 | % |
|
| 1 | % |
|
| 0 | % |
|
| 0 | % |
|
| 0 | % |
Total Hospital Products net sales |
| $ | 4,913 |
|
| $ | 4,678 |
|
|
| 5 | % |
|
| 5 | % |
|
| 0 | % |
|
| 0 | % |
|
| (1 | )% |
Net sales in the Renal segment increased 4% and 1% during the third quarter and first nine months of 2016, respectively. These amounts include an unfavorable foreign currency impact of two percentage points2017 increased 3% and four percentage points in the third quarter and first nine months of 2016, respectively. Excluding the impact of foreign currency, sales increased 6% and 5% during the third quarter and first nine months of 2016, respectively. This growth was driven by continued global growth of patients, new product launches, and improved pricing in the United States in our PD business. PD growth contributed approximately four and two percentage points to the growth rate during the third quarter and first nine months of 2016, respectively. In addition, global growth of the company’s continuous renal replacement therapy to treat acute kidney injury contributed one and two percentage points to the growth rate during the third quarter and first nine months of 2016, respectively.
Net sales in the Hospital Products segment increased 2% and 3% during the third quarter and first nine months of 2016, respectively. These amounts include an unfavorable foreign currency impact of one percentage point and two percentage points in the third quarter and first nine months of 2016,1%, respectively. Excluding the impact of foreign currency, sales increased 3% and 5%2% in the third quarter and first nine months of 2017, respectively, driven by continued growth of PD patients and adoption of the company’s new Automated Peritoneal Dialysis Cyclers (APD) AMIA in the U.S. and HomeChoice CLARIA in international markets. Increased sales globally of the company’s CRRT products also contributed to growth in the third quarter and first nine months of 2017. Sales growth in the first nine months of 2017 was partially offset by lower sales of HD products internationally, driven by reduced volumes and increased pricing pressures. Certain international strategic market exits negatively impacted the Renal segment’s net sales by 3% and 2% during the third quarter and first nine months of 2016, respectively.2017, respectively, and are expected to negatively impact full year Renal segment net sales by approximately $50 million as compared to 2016.
Net sales in the Hospital Products segment increased 7% and 5%, respectively, during the third quarter and first nine months of 2017 compared to the prior period on both a reported basis and constant currency basis. Certain international strategic market exits negatively impacted the Hospital Products segment net sales by 1% during the third quarter and first nine months of 2017 and are expected to negatively impact full year 2017 net sales by approximately $50 million as compared to 2016. The company’s acquisition of Claris contributed $27 million of net sales during the third quarter and first nine months of 2017. The principal drivers impacting net sales were the following:
In the Integrated Pharmacy Solutions franchise, sales increased 11% in the third quarter and 12%5% in the first nine months of 2017 on a constant currency basis driven by improved volumes for the company’s nutritional therapies, increased sales of pre-mixed injectable drugs (as a result of recent product launches), the acquisition of Claris and a one-time benefit from an early contract settlement. These increases were offset by decreased U.S. sales of cyclophosphamide, a generic oncology drug, due to the entry of competitors into the market. U.S. sales of cyclophosphamide declined from $163 million in the first nine months of 2016 to $143 million in the first nine months of 2017. The company expects U.S. sales of cyclophosphamide to continue to decline due to the entrance of additional competitors.
In the Surgical Care franchise, sales increased 5% in the third quarter and 6% in the first nine months of 2017 on a constant currency basis driven by favorableimproved volumes and pricing in the U.S. for the company’s portfolio of anesthetic and critical care products and positive demand for inhaled anesthetics internationally. The increase was principally due to pricing for BREVIBLOC, a fast-acting IV solutionsbeta blocker, during the third quarter and first nine months of 2017 as well as volume for Transderm Scop during the first nine months. The increased salesTransderm Scop volume was the result of a temporary supply disruption during the first half of the SIGMA SPECTRUM pump and theyear related sets in the United States.to an alternative product.
Gross Margin and Expense Ratios
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(as a percentage of net sales) | 2016 | 2015 | Change | 2016 | 2015 | Change |
| 2017 |
|
| 2016 |
|
| Change |
| 2017 |
|
| 2016 |
|
| Change | ||||||||||||||||||||||
Gross margin | 41.9% | 41.6% | 0.3 pts | 40.0% | 41.7% | (1.7) pts |
|
| 41.7 | % |
|
| 41.9 | % |
| (0.2 pts) |
|
| 42.4 | % |
|
| 40.0 | % |
| 2.4 pts | ||||||||||||||||||
Marketing and administrative expenses | 28.4% | 31.9% | (3.5) pts | 27.6% | 32.1% | (4.5) pts |
|
| 25.3 | % |
|
| 28.4 | % |
| (3.1 pts) |
|
| 24.3 | % |
|
| 27.6 | % |
| (3.3 pts) |
Gross Margin
The special items identified above had an unfavorable impact of approximately 3.03.5 and 3.72.5 percentage points on the gross margin ratio in the third quarter and first nine months of 2016,2017, respectively. The unfavorable impact was 2.23.0 and 1.83.7 percentage points in the third quarter and first nine months of 2015,2016, respectively. Refer to the Special Items caption above for additional detail.
Excluding the impact of the special items, the gross margin ratio increased 1.1%due to select price increases, favorable manufacturing performance and 0.2% ina benefit from the third quarter and first nine months of 2016, respectively. The gross margin ratio was impacted by a positive sales mix, improved pricing in select areas ofcompany’s business transformation initiatives aimed at simplifying the portfolio favorable manufacturing variances in the quarter,to drive efficiency and reduced sales of U.S. cyclophosphamide.reduce costs.
Marketing and Administrative Expenses
The special items identified above had an unfavorable impact of approximately 4.51.9 and 2.41.2 percentage points on the marketing and administrative expense ratio in the third quarter and first nine months of 2016,2017, respectively. The unfavorable impact was 5.04.5 and 2.82.4 percentage points in the third quarter and first nine months of 2015.2016. Refer to the Special Items caption above for additional detail.
Excluding the impact of the special items, the marketing and administrative expenses ratio in the third quarter and first nine months of 20162017 declined by approximately $13 million and $43 million, respectively, as a result of reduced pension expense, as well as benefits fromdue to the company’s actions taken by the company to rebase its cost structure and continued focus on expense management. In addition,These savings were partially offset by decreased benefits to the marketing and administrative expenses ratio from lower transition service income as the agreement with Baxalta for these services continues to wind down.
Research and Development
|
| Three months ended September 30, |
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| Percent |
|
| Nine months ended September 30, |
|
| Percent |
| ||||||||||||
(in millions) |
| 2017 |
|
| 2016 |
|
| change |
|
| 2017 |
|
| 2016 |
|
| change |
| ||||||
Research and development expenses |
| $ | 151 |
|
| $ | 159 |
|
|
| (5 | )% |
| $ | 435 |
|
| $ | 490 |
|
|
| (11 | )% |
As a percentage of net sales |
|
| 5.6 | % |
|
| 6.2 | % |
|
|
|
|
|
| 5.6 | % |
|
| 6.5 | % |
|
|
|
|
The special items identified above had an unfavorable impact of approximately 1.2 and 1.0 percentage points in the third quarter and first nine months of 20162016. Refer to the company recognized $26 millionSpecial Items caption above for additional detail.
Excluding the impact of the special items, the research and $79 million, respectively, as a reduction to expense under the transition services agreement with Baxalta as compared to $29 million and $45 milliondevelopment expenses ratio increased in the third quarter and first nine months of 2015, respectively.
Research and Development
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September 30, | Percent change | September 30, | Percent change | |||||||||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 | ||||||||||||||||||||
Research and development expenses | $159 | $148 | 7% | $490 | $442 | 11% | ||||||||||||||||||
As a percentage of net sales | 6.2% | 6.0% | 6.5% | 6.0% |
Research and development expenses increased by 7% and 11% during the third quarter and first nine months of 2016, respectively,2017 as a result of the special items identified above. Excluding the impact of the special items, research and development expenses decreased 8% and 4% and during the third quarter and first nine months of 2016, respectively, primarily due to the optimization of the R&D infrastructure, the exit of certain R&D programs, and the impact of foreign currency.company’s increased investment in new product development.
Business Optimization Items
TheBeginning in the second half of 2015, the company initiated actions to transform its costs structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through September 30, 2017, the company has implemented certain restructuring initiatives in an effortincurred pretax costs of $526 million related to optimize the company’s overall cost structure on a global basis, as it streamlines its operations, rationalizes its manufacturing facilities, enhances its general and administrative infrastructure, and re-aligns certain R&D activities.
Through the nine months ended September 30, 2016, the company recorded gross restructuring chargesthese actions. The costs consisted primarily of $251 million primarily relating to a global workforce reduction initiative, the impairment of an acquired IPR&D intangible asset, and the discontinuation of the VIVIA home hemodialysis development program. Of the $251 million total restructuring charges, the company recorded gross employee termination costs, implementation costs, and accelerated depreciation. The company expects to incur additional pretax costs of $106approximately $285 million and capital expenditures of $90 million related to these initiatives by the end of 2018. These costs will primarily include employee termination costs, implementation costs, and accelerated depreciation. The company expects that approximately 5 percent of the remaining charges will be non-cash. These actions in the third quarter of 2016 which relates to global workforce reductions. These actionsaggregate are expected to provide future annual pretax savings of $0.12 per diluted share whenapproximately $950 million. The savings from these actions will impact cost of sales, marketing and administrative expenses, and research and development expenses. Approximately 85 percent of the program is fully implementedexpected annual pretax savings are expected to be realized by the end of 2017. 2018, with the remainder by the end of 2020.
Refer to Note 7 withinin Item 1 for additional information regarding the company’s business optimization initiatives.
Net Interest Expense
Net interest expense was $14 million and $41 million in the third quarter and first nine months of 2017, respectively, and $14 million and $53 million in the third quarter and first nine months of 2016, respectively, and $34 million and $94 million in the third quarter and first nine months of 2015, respectively. The decrease in the first nine months of 20162017 was primarily driven by lower outstanding debt as a result of the first quarter 2016 debt-for-equity exchanges which extinguished $3.65 billion of debt as well as reduced coupon rates resulting fromrelated to the Q3third quarter 2016 debt issuance, partially offset by lower interest capitalized interest compared to the same period last year.on assets under construction. See Note 8 within Item 1 for additional details about the debt extinguishments.
Other (Income) Expense, (Income), Net
Other (income) expense, (income), net was income of $12 million and expense of $10 million in the third quarter and first nine months of 2017, respectively, and expense of $44 million and income of expense and $4.3 billion of income in the third quarter and first nine months of 2016, respectively,respectively. Special items during the periods presented included the $4.4 billion net realized gain on the Baxalta Retained Shares transactions in
the first nine months of 2016, the $101 million debt extinguishment loss in the first quarter of 2016, the $48 million debt extinguishment loss in the third quarter of 2016, and $91the $33 million loss on the deconsolidation of the company’s Venezuelan subsidiary in the second quarter of 2017. Excluding the impact of special items, other (income) expense, and $46 millionnet had higher income in the third quarter of 2017 and lower income in the first nine months of 2015, respectively.
The2017 as compared to 2016. Higher income in the third quarter and first nine months of 2016 included net realized gains2017 was the result of $0 and $4.4 billion, respectively, on the Retained Shares transactions, dividend income of $0 and $16 million, respectively, from the Retained Shares, and $0 million and $12 million, respectively, of income related to foreign currency fluctuations principally relatingrelated to intercompany receivables, payables and monetary assets denominated in a foreign currency. TheseLower income items were partially offset by net debt extinguishment losses of $52 million and $153 million infor the third quarter and first nine months of 2016, respectively. See Note 8 within Item 1 for additional details regarding2017 was attributable to the debt extinguishment losses andabsence of dividends on the Retained Shares transactions.
The third quarterreceived from Baxalta in 2016 and first nine months of 2015 included a $130 million loss on extinguishment of debt. This loss was more than offsetrecognized investment impairment losses in the first nine months by $52 million of income related to a litigation settlement in which Baxter was the beneficiary, $38 million of income related to the sales of available-for-sale securities, and $92 million of income related to foreign currency fluctuations, principally relating to intercompany receivables, payables and monetary assets denominated in a foreign currency.2017.
Segment EBITDA
The company uses income from continuing operations before net interest expense, income tax expense, depreciation and amortization expense (Segment EBITDA), on a segment basis to make resource allocation decisions and assess the ongoing performance of the company’s business segments. Refer to Note 14 within Item 1 for a summary of financial results by segment. The following is a summary of significant factors impacting the segments’ financial results.
Renal
Segment EBITDA was $226 million and $649 million in the third quarter and first nine months of 2017, respectively, and $214 million and $494 million in the third quarter and first nine months of 2016, respectively,respectively. The increase in 2017 was driven by lower research and $182development costs as the company realigned allocations of research and development costs based on project spend attributable to segments, higher gross margins due to product mix and lower marketing and administrative expenses as the Renal segment benefited from the company’s business optimization programs and continued focus on reducing discretionary spending. This growth was partially offset by unfavorable foreign currency.
Hospital Products
Segment EBITDA was $653 million and $422 million$1.821 billion in the third quarter and first nine months of 2015, respectively. The increase in 2016 was primarily driven by increased sales2017, respectively, and lower marketing and administrative expenses as cost savings were realized form the company’s business optimization programs and continued focus on expense management. This was partially offset by unfavorable foreign currency, incremental manufacturing and quality costs, and higher allocated research and development costs.
Hospital Products
Segment EBITDA was $588 million and $1.673 billion in the third quarter and first nine months of 2016, respectively, and $515 million and $1.462 billion in the third quarter and first nine months of 2015, respectively. This increase was driven by increasedhigher net sales, and lower marketing and administrative expenses as cost savings were realized from the company’s business optimization programs and continued focus on expense management.reducing discretionary spending. This growth was partially offset by higher research and development costs as the company realigned allocations of research and development costs based on project spend attributable to segments and unfavorable foreign currency fluctuations.currency.
Corporate and other
Certain income and expense amounts are not allocated to a segment. These amounts are detailed in the table in Note 14 within Item 1 and primarily include net interest expense, foreign exchange fluctuations (principally relating to intercompany receivables, payables and loans denominated in a foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, stock compensation expense, non-strategic investments and related income and expense, certain employee benefit plan costs as well as certain nonrecurring gains and losses and other charges (such as business optimization, integration and separation-related costs and asset impairment)impairments).
Income Taxes
The company’s effective income tax rate for continuing operations was 0.8%14.5% and 106.1%0.8% in the third quarter and 15.0% and (1.1%) and 5.8% for the first nine months of 20162017 and 2015,2016, respectively. The company’s effective income tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes, and foreign taxes that are different than the U.S. federal statutory rate. In addition, the effective tax rate can be impacted each period by discrete factors and events.
The effective income tax rate for continuing operations during the three months ended September 30, 2017 increased from the three months ended September 30, 2016, decreased due to the inclusion in 2016 of restructuring and other charges incurred in higher tax rate jurisdictions as well as the favorable impact of discrete items including the partial settlement of an on-going income tax matter related to the company’s Turkish operations and the settlement of a transfer pricing audit related to the company’s Italian operations. Partially offsettingWindfall benefits realized from stock option exercises and vesting of RSUs and PSUs associated with the foregoing items werecompany’s stock compensation programs partially offset the increase from the prior period as such benefits are now reflected as a tax charges related tobenefit as a result of the settlementcompany’s adoption of state income tax audit matters. ASU 2016-09 in 2017.
The effective income tax rate for continuing operations in the third quarter of 2015 was primarily the result of charges associated with the company’s spin-off of Baxalta, such as debt tender premium costs associated with debt refinancing, which received tax benefits at rates significantly higher than the rate of tax without such charges. The resulting tax benefits were greater than the resulting net loss for the period.
In addition to the foregoing factors, the income tax rate forincreased during the nine months ended September 30, 2016 benefited by several factors including tax-free net realized gains during2017 due to the first and second quarter associated with the exchanges of Baxalta retained shares for the company’s debt and the company’s sharesitems noted above as well as the absence in the current year of the tax-free net realized gains associated with the Baxalta Retained Share
transactions, which included debt-for-equity exchanges, the contribution of Baxalta retained sharesRetained Shares to the company’s U.S. pension plan. Additionally,plan and the income tax rateexchange of Baxalta Retained Shares for this period was favorably impacted by taxshares of the company, as well as benefits from partially settlingattributable to closing an IRS (2008-2013)and German income tax audit and settling a German (2008-2011)that were all reflected during the nine months ended September 30, 2016. The effective income tax audit.
The company anticipates that the effective tax rate for continuing operations forduring the full-year 2016 will benine months ended September 30, 2017 was favorably impacted by approximately 20.5%, excluding the impact5.2 percentage points due to tax windfall benefits realized from stock option exercises and vesting of audit developmentsRSUs and other discrete items. Changes inPSUs associated with the company’s mix of earnings may also impact the effective tax rate and as profit improvement initiatives are implemented at different times and across different operations, the earnings mix could shift with an impact on the effective tax rate.stock compensation programs.
Income from Continuing Operations and Earnings per Diluted Share
Income from continuing operations was $127$248 million and $2$127 million for the three months ended September 30, 20162017 and 2015,2016, respectively, and $785 million and $4.7 billion and $210 million for the nine months ended September 30, 20162017 and 2015,2016, respectively. Income from continuing operations per diluted share was $0.23$0.45 and $0.00$0.23 for the three months ended September 30, 20162017 and 2015,2016, respectively, and $8.56$1.42 and $0.38$8.56 for the nine months ended September 30, 20162017 and 2015,2016, respectively. The significant factors and events contributing to thesethe changes are discussed above.
Income (Loss)(loss) from Discontinued Operations
The following table is a summary of the operating results of Baxalta, which have been reflected as discontinued
Discontinued operations were insignificant for the quarters ended September 30, 2016 and 2015.
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(in millions) | 2016 | 2015 | 2016 | 2015 | ||||||||||||
Net sales | $24 | $63 | $144 | $2,853 | ||||||||||||
Income (loss) from discontinued operations before income taxes | 4 | (1 | ) | (11) | 748 | |||||||||||
Gain on disposal of discontinued operations | — | — | 17 | — | ||||||||||||
Income tax expense | 1 | — | 10 | 195 | ||||||||||||
Income (loss) from discontinued operations, net of tax | $ 3 | $ (1 | ) | $ (4) | $ 553 | |||||||||||
both periods presented. Refer to Note 2 within Item 1 for additional information regarding the separation of Baxalta.
LIQUIDITY AND CAPITAL RESOURCES
The following table is a summary of the statement of cash flowsflow for the nine monthsmonth periods ended September 30, 20162017 and 2015.2016.
Nine months ended | Nine months ended |
| |||||||||||||
September 30, | September 30, |
| |||||||||||||
(in millions) | 2016 | 2015 | 2017 |
|
| 2016 |
| ||||||||
Cash flows from operations – continuing operations | $ 938 | $ 757 | |||||||||||||
Cash flows from investing activities – continuing operations | (549 | ) | (629 | ) | |||||||||||
Cash flows from operations - continuing operations | $ | 1,343 |
|
| $ | 938 |
| ||||||||
Cash flows from investing activities - continuing operations |
| (1,088 | ) |
|
| (549 | ) | ||||||||
Cash flows from financing activities | $ (44 | ) | $ (253 | ) |
| 391 |
|
|
| (44 | ) |
Cash Flows from Operations — Continuing Operations
Operating cash flows from continuing operations increased during the first nine months of 20162017 as compared to the prior year period. The increase was driven by the factors discussed below.
Net Income
Net income, as adjusted for certain non-cash items, such as depreciation and amortization, net periodic pension benefit and OPEB costs, stock compensation, deferred income taxes and other items increased in the nine months ended September 30, 2017 compared to 2016. Additionally, non-cash items in the nine months ended September 30, 2016 included net realized gains of $4.4 billion related to the debt-for-equity exchanges of Baxalta Retained Shares for certain company indebtedness and for the equity-for-equity exchange.
Accounts Receivable
Cash flows relating toinflows from accounts receivable were $32 million in the first nine months of 2017 compared to an inflow of $22 million during the first nine months of 2016 compared to an inflow of $5 million in the prior year period and daysyear. Days sales outstanding decreasedin the current year were comparable to 55.0 days at September 30, 2016 from 60.3 at September 30, 2015. This decrease was primarily driven by timing of collections in certain international markets.the prior year.
Inventories
Cash outflows relating to inventories declineddecreased in the first nine months of 20162017 as compared to the prior yearprior-year period. The following is a summary of inventories as of September 30, 20162017 and December 31, 2015,2016, as well as annualized inventory turns for the first nine months of 20162017 and 2015,2016, by segment.
Inventories | Annualized inventory turns for the nine months ended September 30, |
| Inventories |
|
| Annualized inventory turns for the Nine |
| |||||||||||||||||||||||||
September 30, | December 31, |
| September 30, |
|
| December 31, |
|
| months ended September 30, |
| ||||||||||||||||||||||
(in millions, except inventory turn data) | 2016 | 2015 | 2016 | 2015 |
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
| ||||||||||||||||
Renal | $ 614 | $ 605 | 3.58 | 3.61 |
| $ | 635 |
|
| $ | 544 |
|
|
| 3.77 |
|
|
| 3.58 |
| ||||||||||||
Hospital Products | 954 | 955 | 3.61 | 3.14 |
|
| 915 |
|
|
| 885 |
|
|
| 3.97 |
|
|
| 3.61 |
| ||||||||||||
Other | — | 44 | n/a | n/a |
|
| — |
|
|
| 1 |
|
| n/a |
|
| n/a |
| ||||||||||||||
Total company | $1,568 | $1,604 | 3.60 | 3.32 |
| $ | 1,550 |
|
| $ | 1,430 |
|
|
| 3.89 |
|
|
| 3.60 |
| ||||||||||||
Segment inventory levels remained consistent during the first nine months of 2016. The increase in inventory turnsinventories was driven primarily by timing of 0.28 from September 30, 2015 to September 30, 2016 related to business optimization chargespurchases and intangible asset impairments.longer sourcing lead times for certain products within the Renal segment portfolio, coupled with the acquisition of Claris in the Hospital Products segment.
Other
The changes in accounts payable and accrued liabilities waswere a $36 million outflow in the first nine months of 2017 compared to a $326 million outflow in the first nine months of 2016 compared to a $14 million inflow in the first nine months of 2015.2016. The change waschanges were primarily driven by an increase ina first quarter 2016 non-recurring $303 million tax payments primarily duesettlement payment to partially settle a U.S. Federal income tax settlementaudit as well as the timing of payments to suppliers. See Note 12 within Item 1 for additional details regarding the tax settlement.supplier payments.
Payments related to the execution of the SIGMA SPECTRUM infusion pump recall as well as the company’s business optimization initiatives increased from $61$98 million in the first nine months of 20152016 to $119$114 million in the first nine months of 2016.2017. The company made payments of $21 million in the first nine months of 2016 related to the execution of the COLLEAGUE infusion pump and SIGMA SPECTRUM infusion pump recalls. Refer to Note 7 within Item 1 for further information regarding the SIGMA SPECTRUM infusion pump recalls as well as thecompany’s business optimization initiatives.
Changes in other balance sheet items were inflowsinclude an outflow of $121$93 million and outflowsan inflow of $216$121 million in the first nine months of 20162017 and 2015,2016, respectively, primarily driven by changesthe collection of a tax receivable in prepaid expenses. During the first nine monthssecond quarter of 2016, the company received a U.S. federal income tax refund of $218 million as a result of carrying back to prior tax years the company’s 2015 U.S. tax loss which arose, in significant part, from the funding of the company’s defined benefit pension plan with a portion of the Baxalta retained stake.2016.
Cash Flows from Investing Activities — Continuing Operations
Capital Expenditures
Capital expenditures were $519$410 million and $658$519 million in the first nine months of 20162017 and 2015,2016, respectively. The company’s capital expenditures in 2016 consisted of2017 were driven by targeted investments in projects to support production of PD and IV solutions as well as expansion activities for dialyzers. The declinesolutions.
Acquisitions and Investments
Cash outflows relating to acquisitions and investments of $680 million in capital expenditures is duethe first nine months of 2017 were primarily driven by the $629 million acquisition of Claris, the acquisition of the rights to a reduction in spending related to ongoing projectsClindamycin Saline and Clindamycin Dextrose from Celerity and the completionacquisition of certain expansion activities.
Acquisitions and Investments
Wound Care Technologies, Inc. Cash outflows relating to acquisitions and investments of $47 million in the first nine months of 2016 were driven primarily by the acquisition of the rights to vancomycinVancomycin from Celerity. Cash outflows relating to acquisitions and investments of $27 million in the first nine months of 2015 were driven primarily by the acquisition of the rights to cefazolin injection in GALAXY Container (2 g/100 mL).
Divestitures and Other Investing Activities
Cash inflows from divestitures and other investing activities in the first nine months of2017 and 2016 and 2015 were $17 million and $56 million, respectively. The decrease was primarily due to the sales of certain investments in the first nine months of 2015.not significant.
Cash Flows from Financing Activities
Debt Issuances, Net of Payments of Obligations
Net cash inflows related to debt and other financing obligations totaled $633 million for the first nine months of 2017 primarily related to the issuance of €600 million of senior notes at a fixed coupon rate of 1.30% due in May 2025.
Net cash outflows related to debt and other financing obligations totaled $58 million for the first nine months of 2016 primarily related to a $190 million repayment of the company’s 0.95% senior unsecured notes that matured in June 2016, a $130 million repayment of the company’s 5.9% senior unsecured notes that matured in September 2016, and the redemption of approximately $1 billion in
aggregate principal amount of senior notes in September 2016, as well as other short-term obligations. The company also had $300 million of net repayments related to its commercial paper program. This was partially offset by issuances of debt totaling $1.6 billion of senior notes in August 2016. See Note 8 within Item 1 for additional details regarding the debt transactions in the first nine months of 2016.
Cash inflows related to issuances of debt totaled $6.9 billion for the first nine months of 2015 primarily related to the Baxalta senior
notes and borrowings under the company’s revolving credit facilities. The company purchased an aggregate of approximately $2.7 billion in principal amount of its notes through two debt tender offers that closed in July 2015. Additionally, the company repaid $600 million of 4.625% senior unsecured notes that matured in March 2015 as well as the borrowings under the company’s Euro-denominated revolving credit facility. The company also had $450 million of net repayments related to its commercial paper program.
Other Financing Activities
Cash dividend payments totaled $197$228 million and $847$197 million in the first nine months of 20162017 and 2015,2016, respectively. The decreaseincrease in cash dividend payments was primarily due to a decreasean increase in the quarterly dividend rate of approximately 75%from $0.115 to $0.13 per share as announcedfor quarterly dividends declared between May 2016 and May 2017. In addition, the company increased the quarterly dividend rate from $0.13 to $0.16 per share for quarterly dividends declared beginning in July 2016.
May 2017. Proceeds and realized excess tax benefits from stock issued under employee benefit plans increased from $174$251 million in the first nine months of 20152016 to $286$298 million in the first nine months of 2016,2017, primarily due to increased option exercises in the first nine months of 2016.2017.
In the first nine months of 2016, the company executed an equity-for-equity exchange of Retained Shares for 11.5 million outstanding Baxter shares. As authorized by the Board of Directors, the company repurchases its stock depending upon the company’s cash flows, net debt level and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock. In the third quarterThe Board of 2016, theDirectors increased this authority by an additional $1.5 billion in November 2016. The company repurchasedpaid $275 million in cash to repurchase approximately 0.94.7 million shares pursuant to this authority in the first nine months of 2017 and had $0.4$1.4 billion remaining available under this authorization as of September 30, 2016. The company did not repurchase stock in2017. In the first nine months of 2015.2016, the company paid $45 million in cash to repurchase shares. In the first nine months of 2016, the company executed an equity-for-equity exchange of Baxalta Retained Shares for 11.5 million outstanding Baxter shares.
Credit Facilities, Access to Capital and Credit Ratings
Credit Facilities
As of September 30, 2016,2017, the company’s U.S. dollar-denominated revolving credit facility and Euro-denominated senior revolving credit facility had a maximum capacity of $1.5 billion and approximately $200€200 million, Euro, respectively. As of September 30, 2016,2017, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting either of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment.
Access to Capital
The company intends to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations or by issuing additional debt. The company had $2.6$3.5 billion of cash and equivalents as of September 30, 2016,2017, with adequate cash available to meet operating requirements in each jurisdiction in which the company operates. The company invests its excess cash in certificates of deposit and money market funds, and diversifies the concentration of cash among different financial institutions.
The company’s ability to generate cash flows from operations, issue debt or enter into other financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company’s products or in the solvency of its
customers or suppliers, deterioration in the company’s key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company’s growth objectives.
The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, which have experienced a deterioration in credit and economic conditions. As of September 30, 2016,2017, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $181$151 million.
While these economic conditions have not significantly impacted the company’s ability to collect receivables, global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses.
Credit Ratings
The company’s credit ratings at September 30, 20162017 were as follows:follows.
Standard & Poor’s | Fitch | Moody’s | ||||||||||
Ratings | ||||||||||||
Senior debt | A- | BBB+ | Baa2 | |||||||||
Short-term debt | A2 | F2 | P2 | |||||||||
Outlook | Stable | Stable | Stable |
CONTRACTUAL OBLIGATIONS
The table below summarizes Baxter’s contractual obligations as of September 30, 2016 related to long-term debt and interest expense in the following periods to give effect to the company’s debt redemptions and debt offerings.
(in millions) | Total | Less than one year | One to three years | Three to five years | More than five years | |||||||||||||||
Long-term debt and capital lease obligations, including current maturities | $2,840 | $ 6 | $ 6 | $736 | $2,092 | |||||||||||||||
Interest on short- and long-term debt and capital lease obligations1 | 1,530 | 85 | 170 | 167 | 1,108 | |||||||||||||||
Contractual obligations | $4,370 | $91 | $176 | $903 | $3,200 | |||||||||||||||
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with 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 in the 20152016 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, 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 of Financial Condition and Results of Operations section in the 20152016 Annual Report. There have been no significant changes in the company’s application of its critical accounting policies during the first nine months of 2016.2017.
LEGAL CONTINGENCIES
Refer to Note 13 within Item 1 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 liabilities. While the liability of the company in connection with certain claims cannot be estimated with any certainty, and although the resolution in any reporting period of one or more of these
matters could have a significant impact on the company’s results of operations and cash flows for that period, the outcome of these legal proceedings is not expected to have a material adverse effect on the company’s consolidated financial position. While the company believes that it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may in the future incur material judgments or enter into material settlements of claims.
CERTAIN REGULATORY MATTERS
The U.S. Food and Drug Administration (FDA) commenced an inspection of Claris’ facilities in Ahmedabad, India on July 27, 2017, immediately prior to the closing of the Claris acquisition. FDA completed the inspection on August 4, 2017, at which time FDA issued a related Form-483 (Claris 483). The Claris 483 includes a number of observations across a variety of areas. The company submitted its timely response to the Claris 483 and is in the process of implementing corrective and preventive actions, which have included product recalls that are financially immaterial to the company, to address FDA’s observations and other items identified in connection with integrating Claris into the company’s quality systems.
In January 2014, the company received a Warning Letter from FDA primarily directed to quality systems for the company’s Round Lake, Illinois, facility, particularly in that facility’s capacity as a specification developer for certain of the company’s medical devices. This Warning Letter was lifted in February 2017.
The company received a separate Warning Letter in December 2013 that included observations related to the company’s ambulatory infuser business in Irvine, California, which previously had been subject to agency action. This Warning Letter was lifted in May 2017.
In June 2013, the company received a Warning Letter from FDA regarding operations and processes at its North Cove, North Carolina and Jayuya, Puerto Rico facilities andfacilities. The company attended Regulatory Meetings with the FDA in November 2015 attended(concerning the Jayuya facility). The company also requested and participated in a Regulatory Meeting with FDA concerning the Jayuya facility.regarding both facilities in July 2017. The Warning Letter addresses observations related to Current Good Manufacturing Practice (CGMP) violations at the two facilities.
In June 2010, the company received a Warning Letter from FDA in connection with an inspection of its McGaw Park, Illinois facility, which previously supported the Renal franchise. The company’s Round Lake facility now provides the related capacity for the Renal franchise. The Warning Letter pertains to the processes by which the company analyzes and addresses product complaints through corrective and preventative action, and reports relevant information to FDA. This Warning Letter was lifted in February 2017.
On October 9, 2014, the company had a Regulatory Meeting with FDA to discuss the Warning Letters described above. At the meeting, the company agreed to work closely with FDA to provide regular updates on its progress to meet all requirements and resolve all matters identified in the Warning Letters described above.
Please see Item 1A of the 20152016 Annual Report and Item 1 of Part II of this quarterly report for additional discussion of regulatory matters and how they may impact the company.
FORWARD-LOOKING INFORMATION
This quarterly report includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, litigation-related matters including outcomes, future regulatory filings and the company’s R&D pipeline, strategic objectives, credit exposure to foreign governments, potential developments with respect to credit ratings, investment of foreign earnings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, discount rates and rates of return, the company’s exposure to financial market volatility and foreign currency and interest rate risks, potential tax liability associated the impactseparation of the recent separation of thecompany’s biopharmaceuticals and medical products businesses (including the 2016 disposition of the company’s Retained Shares in Baxalta), the impact of competition, future sales growth, business development activities (including the recent acquisition of Claris Injectables in July 2017), business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of the company’s facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts.
These forward-looking statements are based on certain assumptions and analyses made in light of the company’s experience and perception of historical trends, current conditions, and expected future developments as well as other factors that the company believes are appropriate in the circumstances. While these statements represent the company’s current judgment on what the future may hold, and the company believes these judgments are reasonable, these statements are not guarantees of any events or financial results. Whether actual future results and developments will conform to expectations and predictions is subject to a number of risks and uncertainties, including the following factors, many of which are beyond our control:
Actual results may differ materially from those projected in the forward-looking statements. The company does not undertake to update its forward-looking statements.
Currency Risk
The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assetsrevenues generated outside of the United States denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, ColumbianColombian Peso, Brazilian Real, Swedish Krona, Mexican Peso and New Zealand Dollar. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative financial instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and shareholders’stockholders’ equity volatility relating to foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.
The company may use options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions denominated in foreign currencies and recognized assets and liabilities. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions as of September 30, 20162017 is 15 months. The company also enters into derivative instruments to hedge certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.
In advance of the U.K. European Union membership referendum, the company increased the coverage level of its British Pound and Euro exposures by adding to its derivative positions to hedge those underlying exposures over the next 18 months. As a result, we do not expect to be significantly impacted by future potential currency volatility in the near term caused by the U.K.’s proposed exit from the European Union due to the size and composition of the company’s U.K. operations and the derivative strategy and positions we currently have in place.
As part of its risk-management program, the company performs a sensitivity analysisanalyses to assess potential changes in the fair value of its foreign exchange instruments relating to hypothetical and reasonably possible near-term movements in foreign exchange rates.
A sensitivity analysis of changes in the fair value of foreign exchange option and forward contracts outstanding at September 30, 2016,2017, while not predictive in nature, indicated that if the U.S. Dollar uniformly weakened by 10% against all currencies, on a net-of-tax basis, the net asset balance of $7$5 million with respect to those contracts would decrease by $27$23 million, resulting in a net liability.liability position.
The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at September 30, 20162017 by replacing the actual exchange rates at September 30, 20162017 with exchange rates that are 10% weaker to the actual exchange rates for each applicable currency. All other factors are held constant. The sensitivity analysis disregards 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 analysis also disregards the offsetting change in value of the underlying hedged transactions and balances.
Interest Rate and Other Risks
Refer to the caption “Interest Rate and Other Risks” in the “Financial Instrument Market Risk” section of the 20152016 Annual Report. There were no significant changes during the quarter ended September 30, 2016.2017.
Evaluation of Disclosure Controls and Procedures
Baxter carried out an evaluation, under the supervision and with the participation of its Disclosure Committee and management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of Baxter’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of September 30, 2016.2017. Based on that evaluation the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures were effective as of September 30, 2016.2017.
Changes in Internal Control over Financial Reporting
ThereIn the third quarter of 2017, related to its overall business optimization initiatives, the company began implementation of a business transformation project within the finance, human resources, purchasing and information technology functions which will further centralize and standardize business processes and systems across the company. The company is transitioning some processes to its shared services centers while others are moving to outsourced providers. This multi-year initiative will be conducted in phases and include modifications to the design and operation of controls over financial reporting.
With the exception of the above, there have been no changes in Baxter’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 20162017 that have materially affected, or are reasonably likely to materially affect, Baxter’s internal control over financial reporting.
Review by Independent RegisteredRegistered Public Accounting Firm
A review 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, 20162017 and 20152016 has been performed by PricewaterhouseCoopers LLP, the company’s independent registered public accounting firm. Its 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 RegisteredRegistered Public Accounting Firm
To the Board of Directors and Shareholders of Baxter International Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of Baxter International Inc. and its subsidiaries as of September 30, 2016,2017, and the related condensed consolidated statements of income for the three month and nine month periods ended September 30, 2016 and 2015, the condensed consolidated statements of comprehensive income for the three monththree-month and nine monthnine-month periods ended September 30, 20162017 and 20152016 and the condensed consolidated statements of cash flows for the nine monthnine-month periods ended September 30, 20162017 and 2015.2016. These interim financial statements are the responsibility of the company’sCompany’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 (United States), 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 previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2015,2016, and the related consolidated statements of income, of comprehensive income, of cash flows and of changes in equity for the year then ended (not presented herein), and in our report dated February 26, 2016,23, 2017, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet information as of December 31, 2015,2016 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.derived.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
November 7, 2016
The information in Part I, Item 1, Note 13 is incorporated herein by reference.
The following table includes information about the company’s common stock repurchases during the three-month period ended September 30, 2017.
Issuer Purchases of Equity Securities |
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|
|
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|
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|
|
|
Period |
| Total number of shares purchased (1) |
|
| Average price paid per share |
|
| Total number of shares purchased as part of publicly announced program(1) |
|
| Approximate dollar value of shares that may yet be purchased under the program(1) |
| ||||
July 1, 2017 through July 31, 2017 |
| — |
|
| $ | — |
|
| — |
|
|
|
|
| ||
August 1, 2017 through August 31, 2017 |
|
| 2,082,000 |
|
| $ | 61.05 |
|
|
| 2,082,000 |
|
|
|
|
|
September 1, 2017 through September 30, 2017 |
|
| 834,700 |
|
| $ | 62.78 |
|
|
| 834,700 |
|
|
|
|
|
Total |
|
| 2,916,700 |
|
| $ | 61.54 |
|
|
| 2,916,700 |
|
| $ | 1,408,670,768 |
|
(1)In July 2012, the company announced that its board of directors authorized the company to repurchase up to $2.0 billion of its common stock on the open market or in private transactions. The board of directors increased this authority by an additional $1.5 billion in November 2016. During the third quarter of 2017, the company repurchased 2.9 million shares for $180 million under this program. $1.4 billion remained available as of September 30, 2017. This program does not have an expiration date.
Exhibit Index:
Exhibit Number | Description | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document |
* | Filed herewith. |
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 hereunto duly authorized.
BAXTER INTERNATIONAL INC. | ||||||
(Registrant) | ||||||
Date: November | By: | /s/ James K. Saccaro | ||||
James K. Saccaro | ||||||
Executive Vice President and Chief Financial Officer | ||||||
(duly authorized officer and principal financial officer) |
4645