Baxter International is a US company operating worldwide in the pharmaceutical and medical technology sectors. The company produces drugs for anesthesiology and intensive care medicine, vaccines and medical devices.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2015
For the transition period from to
Commission file number 1-4448
BAXTER INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Delaware
36-0781620
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One Baxter Parkway, Deerfield, Illinois
60015
224-948-2000
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. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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 July 31, 2015 was 545,538,967 shares.
TABLE OF CONTENTS
PART I.
Item 1.
Condensed Consolidated Statements of Income
Condensed Consolidated Statements of Comprehensive Income
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Cash Flows
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
PART II.
Item 6.
Signature
Baxter International Inc.
Condensed Consolidated Statements of Income (unaudited)
(in millions, except per share data)
Net sales
Cost of sales
Gross margin
Marketing and administrative expenses
Research and development expenses
Net interest expense
Other (income) expense, net
Income from continuing operations before income taxes
Income tax expense
Income from continuing operations
(Loss) income from discontinued operations, net of tax
Net income
Income from continuing operations per common share
Basic
Diluted
Income from discontinued operations per common share
Net income per common share
Weighted-average number of common shares outstanding
Cash dividends declared per common share
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Condensed Consolidated Statements of Comprehensive Income (unaudited)
(in millions)
Other comprehensive income (loss), net of tax:
Currency translation adjustments, net of tax expense (benefit) of $41 and ($12) for the three months ended June 30, 2015 and 2014, respectively, and ($68) and ($8) for the six months ended June 30, 2015 and 2014, respectively
Pension and other employee benefits, net of tax expense of $103 and $14 for the three months ended June 30, 2015 and 2014, respectively, and $134 and $23 for the six months ended June 30, 2015 and 2014, respectively
Hedging activities, net of tax expense (benefit) of $17 and $4 for the three months ended June 30, 2015 and 2014, respectively, and $10 and ($2) for the six months ended June 30, 2015 and 2014, respectively
Other, net of tax (benefit) expense of ($2) and ($5) for the three months ended June 30, 2015 and 2014, respectively, and $7 and ($2) for the six months ended June 30, 2015 and 2014, respectively
Total other comprehensive income (loss), net of tax
Comprehensive income
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Condensed Consolidated Balance Sheets (unaudited)
(in millions, except shares)
Current assets
Cash and equivalents
Accounts and other current receivables, net
Inventories
Prepaid expenses and other
Total current assets
Property, plant and equipment, net
Other assets
Goodwill
Other intangible assets, net
Other
Total other assets
Total assets
Current liabilities
Short-term debt
Current maturities of long-term debt and lease obligations
Accounts payable and accrued liabilities
Total current liabilities
Long-term debt and lease obligations
Other long-term liabilities
Commitments and contingencies
Equity
Common stock, $1 par value, authorized 2,000,000,000 shares, issued 683,494,944 shares in 2015 and 2014
Common stock in treasury, at cost, 138,295,306 shares in 2015 and 141,116,857 shares in 2014
Additional contributed capital
Retained earnings
Accumulated other comprehensive loss
Total Baxter shareholders’ equity
Noncontrolling interests
Total equity
Total liabilities and equity
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Condensed Consolidated Statements of Cash Flows (unaudited)
Cash flows from operations
Adjustments
Depreciation and amortization
Deferred income taxes
Stock compensation
Net periodic pension benefit and OPEB costs
Infusion pump and other product-related charges
Changes in balance sheet items
Business optimization and infusion pump payments
Cash flows from investing activities
Capital expenditures
Acquisitions and investments, net of cash acquired
Divestitures and other investing activities
Cash flows from financing activities
Issuances of debt
Payments of obligations
(Decrease) increase in debt with original maturities of three months or less, net
Cash dividends on common stock
Proceeds and realized excess tax benefits from stock issued under employee benefit plans
Purchases of treasury stock
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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, 2014 (2014 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 financial statements to the current period presentation.
Prior to 2015, the company’s biosurgery products and services were reported in the BioScience segment. As a result of the planned spin-off of the biopharmaceuticals business, Baxalta Incorporated (Baxalta), the company realigned its biosurgery products and services to the Medical Products segment. Effective January 1, 2015, the company changed its segment presentation to reflect this new structure, and recast all prior periods presented to conform to the new presentation.
Spin-off of Baxalta Incorporated
On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta to Baxter shareholders (the Distribution). The Distribution was made to Baxter’s shareholders of record as of the close of business 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. The Distribution was intended to take the form of a tax-free distribution for federal income tax purposes in the United States. As a result of the Distribution, Baxalta is now an independent public company trading under the symbol “BXLT” on the New York Stock Exchange. In the aggregate, 544,521,483 shares of Baxalta common stock were distributed to Baxter’s shareholders of record in the Distribution. After giving effect to the Distribution, Baxter holds 131,902,719 shares of Baxalta’s common stock. The company will account for this investment as an available-for-sale equity security. The value of the company’s investment in Baxalta as of July 1, 2015 was approximately $4.3 billion, calculated using a stock price of $32.54 per share, which represents the mid-point price for Baxalta’s common stock on July 1, 2015.
The unaudited interim condensed consolidated financial statements for the quarterly and six month periods ended June 30, 2015 include the results of Baxalta. The spin-off of Baxalta has therefore not yet been reflected in our historical results and will be presented as a discontinued operation starting in the third quarter of 2015. Discontinued operations will reflect the revenues and expenses directly associated with the results of operations of Baxalta for all periods presented.
In conjunction with the spin-off, the company entered into certain agreements with Baxalta, including the Employee Matters Agreement, which made certain adjustments to the company’s outstanding equity awards. Refer to Exhibit 99.1 of Baxter’s Current Report on Form 8-K filed on July 7, 2015 for additional information.
Vaccines discontinued operations
In December 2014, the company completed the divestiture of its commercial vaccines business. During the first quarter of 2015, the company recorded an after-tax gain of $9 million as a result of a purchase price adjustment. The company has also entered into a separate agreement for the sale of the remainder of the Vaccines franchise. As a result of the divestitures, the operations and cash flows of the Vaccines franchise have been eliminated from the ongoing operations of the company.
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Following is a summary of the operating results of the Vaccines franchise, which have been reflected as discontinued operations for the three and six months ended June 30, 2015 and 2014.
(Loss) income before income taxes
Income tax (benefit) expense
Net (loss) income
New accounting standards
In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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, which provides guidance to customers about how to account for cloud computing arrangements when such arrangements include software licenses. ASU No. 2015-05 will be effective for the company beginning on January 1, 2016. Early adoption is permitted. The standard may be applied retrospectively or prospectively. The company is currently evaluating the impact of adopting the standard on its consolidated financial statements.
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. In July 2015, the FASB voted to approve a one-year deferral of the original effective date of January 1, 2017; therefore, ASU No. 2014-09 will be effective for the company beginning on January 1, 2018. Early adoption is permitted as of the original effective date. 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 is currently evaluating the impact of adopting the standard on its consolidated financial statements.
2. SUPPLEMENTAL FINANCIAL INFORMATION
Interest expense, net of capitalized interest
Interest income
Raw materials
Work in process
Finished goods
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Property, plant and equipment, at cost
Accumulated depreciation
Property, plant and equipment (PP&E), net
3. 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 is a reconciliation of basic shares to diluted shares.
Basic shares
Effect of dilutive securities
Diluted shares
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 21 million and 16 million equity awards for the second quarter and the six months ended June 30, 2015, respectively, and 11 million and 9 million equity awards for the second quarter and the six months ended June 30, 2014, because their inclusion would have had an anti-dilutive effect on diluted EPS. Refer to Note 8 and Note 10 for additional information regarding items impacting basic shares, including the company’s stock repurchase program.
4. ACQUISITIONS AND COLLABORATIONS
Acquisitions
In March 2015, Baxter acquired all of the outstanding shares of SuppreMol GmbH (SuppreMol), a privately held biopharmaceutical company based in Germany. Through the acquisition, Baxter acquired SuppreMol’s early-stage pipeline of treatment options for autoimmune and allergic diseases, as well as its operations in Munich, Germany. The acquired investigational treatments will complement and build upon Baxter’s immunology portfolio and offer an opportunity to expand into new areas with significant market potential and unmet medical needs in autoimmune diseases.
The following table summarizes the fair value of the consideration transferred and the recognized amounts of the assets acquired and liabilities assumed as of the acquisition date.
Consideration transferred
Cash, net of cash acquired
Fair value of consideration transferred
Assets acquired and liabilities assumed
Deferred tax asset
In-process research and development (IPR&D)
Other assets, net
Deferred tax liability
Total identifiable net assets
Total assets acquired and liabilities assumed
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While the valuation of the assets acquired and liabilities assumed is substantially complete, measurement period adjustments may be recorded in the future as the company finalizes its fair value estimates. Pro forma financial information has not been provided because the pro forma impact of the acquisition was not material to the company’s condensed consolidated financial statements.
Baxter allocated $179 million of the consideration to acquired IPR&D, which is being accounted for as an indefinite-lived intangible asset. The acquired IPR&D relates to SuppreMol’s SM-101, an investigational immunoregulatory treatment, which had completed Phase IIa studies at the time of the acquisition. This project is expected to be completed in approximately 5 years. The value of the IPR&D was calculated using cash flow projections adjusted for the inherent technical, regulatory, commercial and obsolescence risks in such activities, discounted at a rate of 20%. Additional research and development will be required prior to regulatory approval, and as of the acquisition date, incremental research and development costs were projected to be in excess of $400 million. The goodwill, which is not deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits of the acquisition to Baxter’s immunology portfolio and is included in the BioScience segment.
Collaborations
SFJ Pharmaceuticals Group
In June 2015, the company entered into an agreement with SFJ Pharmaceuticals Group (SFJ) relating to adalimumab (BAX 923) (formerly known as M923/BAX 2923) whereby SFJ will fund up to $200 million of specified development costs related to the company’s BAX 923 program in exchange for payments in the event the product obtains regulatory approval in the United States or Europe. The terms of the agreement include funding limitations of up to $50 million for incurred costs through Phase I development and cumulative spending caps in six month intervals through December 31, 2017. The contingent success payments, which total approximately 5.5 times the incurred development costs, are payable in annual installments over an approximate eight-year period following the dates of regulatory approval. The development funding from SFJ is being recognized as an offset to R&D expenses as incurred because there is substantive and genuine transfer of risk to SFJ. The R&D expense offset for the second quarter of 2015 totaled $9 million.
CTI BioPharma Corp.
In June 2015, the company entered into an amendment of its agreement with CTI BioPharma Corp. (CTI BioPharma). Pursuant to the amendment, the company paid $32 million to CTI BioPharma relating to two contingent milestone payments included in the original agreement. The company obtained additional rights relating to manufacturing and supply, and CTI BioPharma committed to spend a specified amount on the development of pacritinib through February 2016, with failure to do so resulting in payments to the company equal to the deficiency.
Milestone payments to collaboration partners
Baxter recognized R&D charges of $87 million for the second quarter and first half of 2015 related to milestone payments pursuant to the company’s collaboration arrangements. In the second quarter and first half of 2014, Baxter also recognized R&D charges of $35 million and $60 million, respectively, related to milestone payments pursuant to one of the company’s collaboration arrangements.
Refer to the 2014 Annual Report for further discussion of the company’s collaboration arrangements.
5. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
The following is a reconciliation of goodwill by business segment.
Balance as of December 31, 2014
Additions
Currency translation and other adjustments
Balance as of June 30, 2015
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The balance as of December 31, 2014 has been recast to reflect the realignment of the company’s biosurgery products and services from the BioScience segment to the Medical Products segment.
The addition in the first six months of 2015 related to the acquisition of SuppreMol and the overall decrease in goodwill was driven by currency translation adjustments (CTA).
As of June 30, 2015, there were no accumulated goodwill impairment losses.
The following is a summary of the company’s other intangible assets.
Developed technology,
including patents
Other amortized
intangible assets
Indefinite-lived
Total
June 30, 2015
Gross other intangible assets
Accumulated amortization
December 31, 2014
Intangible asset amortization expense was $48 million and $47 million in the three months ended June 30, 2015 and 2014, respectively, and $96 million and $90 million for the six months ended June 30, 2015 and 2014, respectively.
The increase in other intangible assets, net from the IPR&D acquired in the acquisition of SuppreMol during the first quarter of 2015 was offset by the decrease from amortization expense and CTA.
6. INFUSION PUMP AND BUSINESS OPTIMIZATION CHARGES
Infusion pump charges
There were no significant updates related to the company’s infusion pump recall activities during the first half of 2015. Refer to the 2014 Annual Report for further information about the company’s infusion pump recall activities.
Business optimization charges
The company records charges from its business optimization initiatives primarily related to costs associated with optimizing the company’s overall cost structure on a global basis, as the company streamlined its international operations, rationalized its manufacturing facilities, enhanced its general and administrative infrastructure and realigned certain R&D activities. Refer to the 2014 Annual Report for further information about these charges.
Cash expenses
Non-cash expenses
Reserve adjustments
Total business optimization items
Discontinued operations
Business optimization items in continuing operations
The 2015 and 2014 charges primarily included severance and employee-related costs. The company also recorded adjustments to its previous estimates in both 2015 and 2014.
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The business optimization items are recorded as follows in the consolidated statements of income:
The following table summarizes cash activity in the reserves related to the company’s business optimization initiatives.
Reserves as of December 31, 2014
Charges
Utilization
CTA
Reserves as of June 30, 2015
The reserves are expected to be substantially utilized by the end of 2016. The company believes the remaining reserves to be adequate; however, additional adjustments may be recorded in the future as the programs are completed.
7. DEBT, FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS
Securitization arrangement
The following is a summary of the activity relating to the company’s securitization arrangement in Japan.
Sold receivables at beginning of period
Proceeds from sales of receivables
Cash collections (remitted to the owners of the receivables)
Effect of currency exchange rate changes
Sold receivables at end of period
The net losses relating to the sales of receivables were immaterial for each period. Refer to the 2014 Annual Report for further information regarding the company’s securitization agreements.
Significant debt issuances
In June 2015, the company’s wholly-owned subsidiary Baxalta issued senior notes with a total aggregate principal amount of $5.0 billion. Approximately $4.0 billion of the related net proceeds were distributed to Baxter in connection with the spin-off. The general terms of the notes, which remain obligations of Baxalta subsequent to the spin-off, are as follows:
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In connection with this issuance, the company recognized a debt discount of $51 million and deferred issue costs totaling $9 million. After giving effect to the spin-off, Baxter has no obligations as it relates to the Baxalta senior notes.
Credit facilities and commercial paper
In the first half of 2015, the company borrowed $1.5 billion which was outstanding as of June 30, 2015, under its $1.8 billion U.S. dollar-denominated revolving credit facility at a weighted average interest rate of 1.37%. This facility matures in December 2015. As of December 31, 2014 there were no borrowings under any of the company’s credit facilities.
Effective July 1, 2015, the company terminated its $1.5 billion U.S. dollar-denominated revolving credit facility and €300 million Euro-denominated revolving credit facility and entered into credit agreements providing for a senior U.S. dollar-denominated revolving credit facility in an aggregate principal amount of up to $1.5 billion maturing in 2020, as well as a Euro-denominated senior revolving credit facility in an aggregate principal amount of up to €200 million maturing in 2020. The facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net leverage ratio and maximum interest coverage ratio.
During the first six months of 2015, the company issued and redeemed commercial paper, of which zero was outstanding as of June 30, 2015. There was a balance of $875 million outstanding at December 31, 2014 with a weighted-average interest rate of 0.46%.
Debt tender offers
On July 6, 2015 and July 21, 2015 the company purchased an aggregate of approximately $2.7 billion in principal amount of its 5.900% Notes due September 2016, 6.625% Debentures due February 2028, 6.250% Notes due December 2037, 3.650% Notes due August 2042, 4.500% Notes due June 2043, 3.200% Notes due June 2023, and 2.400% Notes due August 2022 in the settlement of previously announced debt tender offers. Baxter paid approximately $2.9 billion, including accrued and unpaid interest and tender premium, to purchase such notes. As a result of the debt tender offers, the company will recognize a loss on extinguishment of debt in the third quarter of 2015 of approximately $130 million, net of gains from the unwinding of interest rate swaps related to the debt.
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 June 30, 2015, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $327 million, of which $48 million related to Greece.
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 collectibility 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, Japanese Yen, British Pound, Australian Dollar, Canadian Dollar, Brazilian Real, Colombian Peso, and Swedish Krona. 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.
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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 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. In prior periods, the company entered into $1.8 billion of forward-starting interest rate swaps to hedge the risk to earnings associated with movements in benchmark interest rates relating to the anticipated issuance of the Baxalta senior notes. During the six months ended June 30, 2015, in conjunction with the above debt issuance, the company terminated the swaps, which resulted in a $36.7 million net gain that is deferred in accumulated other comprehensive income (AOCI) that is being amortized as a decrease to net interest expense over the terms of the underlying debt.
For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is accumulated in 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 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 $1.2 billion and $917 million as of June 30, 2015 and December 31, 2014, respectively. There were no outstanding interest rate contracts designated as cash flow hedges as of June 30, 2015. The notional amount of interest rate contracts were $550 million as of December 31, 2014. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions as of June 30, 2015 is 18 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 $3.9 billion and $2.9 billion as of June 30, 2015 and December 31, 2014, respectively. The increase is due to swaps executed in conjunction with the debt issuance described above.
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 six months of 2015 or 2014 resulting from changes in the company’s assessment of the probability that the hedged forecasted transactions would occur.
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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 half of 2015 and 2014.
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, net. The terms of these instruments generally do not exceed one month.
The total notional amount of undesignated derivative instruments was $681 million as of June 30, 2015 and $434 million as of December 31, 2014.
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Gains and Losses on Derivative Instruments
The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments for the three months ended June 30, 2015 and 2014.
Location of gain (loss)
in income statement
Cash flow hedges
Interest rate contracts
Foreign exchange contracts
Fair value hedges
Undesignated derivative instruments
The following tables summarize the income statement locations and gains and losses on the company’s derivative instruments for the six months ended June 30, 2015 and 2014.
For the company’s fair value hedges, equal and offsetting gains of $72 million and $25 million were recognized in net interest expense in the second quarter and first half of 2015, respectively, and equal and offsetting losses of $17 million and $31 million were recognized in net interest expense in the second quarter and first half of 2014, 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 six months ended June 30, 2015 was not material.
As of June 30, 2015, $26 million of deferred, net after-tax gains 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.
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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 June 30, 2015.
Derivative instruments designated as hedges
Total derivative instruments designated as hedges
Total derivative instruments
The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet as of December 31, 2014.
While the company’s derivatives are all subject to master 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.
Gross amounts recognized in the consolidated balance sheet
Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet
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Fair value measurements
The following tables summarize the bases used to measure financial assets and liabilities that are carried at fair value on a recurring basis in the condensed consolidated balance sheets.
Balance as of
Quoted prices inactive markets foridentical assets
(Level 1)
Significant otherobservable inputs
(Level 2)
Significantunobservable
inputs
(Level 3)
Assets
Foreign currency hedges
Interest rate hedges
Available-for-sale securities
Equity securities
Foreign government debt securities
Liabilities
Contingent payments related to acquisitions
Total liabilities
As of June 30, 2015, cash and equivalents of $6.7 billion included money market funds of approximately $2.0 billion, and as of December 31, 2014, cash and equivalents of $2.9 billion included money market funds of approximately $989 million. 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 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. The fair values of foreign government debt securities are obtained from pricing services or broker/dealers who use proprietary pricing applications, which include observable market information for like or same securities.
Contingent payments related to acquisitions consist of development, regulatory, and commercial milestone payments, in addition to sales-based payments, and are valued using discounted cash flow techniques. The fair value of development, regulatory, and commercial milestone payments reflects management’s expectations of probability of payment, and increases or decreases as the
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probability of payment or expectation of timing of payments changes. As of June 30, 2015, management’s expected weighted-average probability of payment for development and commercial milestone payments was approximately 26%. The fair value of sales-based payments is based upon probability-weighted future revenue estimates and increases or decreases as revenue estimates or expectation of timing of payments changes.
At June 30, 2015, the company held available-for-sale equity securities that had an amortized cost basis and fair value of $61 million and $117 million, respectively. The company had net unrealized gains of $56 million, comprised of unrealized losses of $2 million, which the company believes to be temporary in nature, and unrealized gains of $58 million. In the first half of 2015, the company recorded $9 million in other-than-temporary impairment charges based on the duration of losses related to two of the company’s investments. At December 31, 2014, the amortized cost basis and fair value of the available-for-sale equity securities was $79 million and $105 million, respectively. The company had net unrealized gains of $26 million, comprised of unrealized losses of $9 million, which the company believed to be temporary in nature, and unrealized gains of $35 million.
Changes in the fair value of contingent payments related to acquisitions, which use significant unobservable inputs (Level 3) in the fair value measurement, were immaterial during the first half of 2015.
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 June 30, 2015 and December 31, 2014.
Investments
Long-term litigation liabilities
The following tables summarize the bases used to measure the approximate fair value of the financial instruments as of June 30, 2015 and December 31, 2014.
Fair value as of
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The estimated fair values of long-term litigation liabilities were computed by discounting the expected cash flows based on currently available information, which in many cases does not include final orders or settlement agreements. The discount factors used in the calculations reflect the non-performance risk of the company.
Investments in 2015 and 2014 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.
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.
In connection with the company’s initiative to invest in early-stage products and therapies, the company increased its unfunded commitments as a limited partner in multiple investment companies to $78 million as of June 30, 2015 from $38 million as of December 31, 2014.
In the first half of 2015 and 2014, the company recorded $25 million and $44 million, respectively, of income in other (income) expense, 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.
8. STOCK COMPENSATION
Stock compensation expense totaled $48 million and $41 million for the three months ended June 30, 2015 and 2014, respectively, and $87 million and $72 million for the six months ended June 30, 2015 and 2014, respectively.
In March 2015, the company awarded its annual stock compensation grants, which consisted of 8.8 million stock options and 1.3 million RSUs.
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Stock Options
The weighted-average Black-Scholes assumptions used in estimating the fair value of stock options granted during the period, along with the weighted-average grant-date fair values, were as follows.
Expected volatility
Expected life (in years)
Risk-free interest rate
Dividend yield
Fair value per stock option
The total intrinsic value of stock options exercised was $15 million and $34 million during the three months ended June 30, 2015 and 2014, respectively, and $29 million and $79 million during the six months ended June 30, 2015 and 2014, respectively.
As of June 30, 2015, the unrecognized compensation cost related to all unvested stock options of $106 million is expected to be recognized as expense over a weighted-average period of 1.9 years.
Restricted Stock Units
As of June 30, 2015, the unrecognized compensation cost related to all unvested RSUs of $140 million is expected to be recognized as expense over a weighted-average period of 1.9 years.
Performance Share Units
As of June 30, 2015, the unrecognized compensation cost related to all granted unvested PSUs of $13 million is expected to be recognized as expense over a weighted-average period of 1.0 years.
Baxter International Inc. 2015 Incentive Plan
In May 2015, shareholders approved the Baxter International Inc. 2015 Incentive Plan which provides for 35 million additional shares of common stock available for issuance with respect to awards for eligible participants.
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9. 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.
Pension benefits
Service cost
Interest cost
Expected return on plan assets
Amortization of net losses and other deferred amounts
Net periodic pension benefit cost
OPEB
Amortization of net loss and prior service credit
Net periodic OPEB cost
In the second quarter of 2015, in connection with the transfer of liabilities and assets from a combined Baxter pension or OPEB plan to a newly created Baxalta pension or OPEB plan, the company remeasured pension and OPEB liabilities and assets for several of its plans. The remeasurement resulted in a reduction to pension and OPEB obligations of $203 million, with an offset to AOCI. The significant weighted-average assumptions used at the measurement date were as follows.
Pension
benefits
Discount rate
U.S. plans
International plans
Rate of compensation increase
Annual rate of increase in the per-capita cost
Rate decreased to
by the year ended
The company also adjusted its assumptions for future company actions related to postemployment medical benefits for retirees who are age 65 and older and receive a subsidy to be utilized on a medical insurance exchange.
Baxter contributed a discretionary amount of $100 million in the second quarter of 2015 to its U.S. qualified pension plan.
10. SHAREHOLDERS’ EQUITY
Stock repurchases
In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock. During the first half of 2015, the company did not repurchase any shares and has $0.5 billion remaining available under the authorization as of June 30, 2015.
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Accumulated other comprehensive income
Comprehensive income includes all changes in 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 unrestricted available-for-sale marketable equity securities. The following is a net-of-tax summary of the changes in AOCI by component for the six months ended June 30, 2015 and 2014.
Gains (losses)
Other comprehensive income before reclassifications
Amounts reclassified from AOCI (a)
Net other comprehensive (loss) income
Balance as of December 31, 2013
Balance as of June 30, 2014
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The following is a summary of the amounts reclassified from AOCI to net income during the three and six months ended June 30, 2015 and 2014.
Three months ended
Six months ended
Amortization of pension and other employee benefits items
Actuarial losses and other
Gains (losses) on hedging activities
Gain on sale of available-for-sale equity securities
Other-than-temporary impairment of available-for-sale equity securities
Total reclassification for the period
June 30, 2014
Refer to Note 7 for additional information regarding hedging activity and Note 9 for additional information regarding the amortization of pension and other employee benefits items.
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11. INCOME TAXES
Effective tax rate
The company’s effective income tax rate for continuing operations was 28.2% and 22.3% in the three months ended June 30, 2015 and 2014, respectively, and 24.2% and 22.3% in the six months ended June 30, 2015 and 2014, 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 increased during the three and six months ended June 30, 2015 compared to the prior year periods primarily as a result of a valuation allowance increase related to a foreign affiliate as well as certain tax audit developments, including tax costs associated with internal restructurings related to the company’s spin-off of Baxalta.
As a result of the spin-off of Baxalta on July 1, 2015, Baxter is re-evaluating its assertions relating to prior earnings outside the United States that were previously deemed indefinitely reinvested. The company expects to amend certain assertions and, as a consequence, may record a significant tax charge in the third quarter of 2015.
12. 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 June 30, 2015, the company’s total recorded reserves with respect to legal matters were $110 million and the total related receivables were $49 million.
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 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
Baxter was a defendant in a number of suits alleging that certain of the company’s current and former executive officers and its board of directors failed to adequately oversee the operations of the company and issued materially false and misleading statements regarding the company’s plasma-based therapies business, the company’s remediation of its COLLEAGUE infusion pumps, its heparin product, and other quality matters. A consolidated derivative suit filed in the U.S.D.C. for the Northern District of Illinois was settled with the plaintiffs in February 2015, and as a result the two other derivative actions previously filed in state courts, one in Lake County, Illinois and one in the Delaware Chancery Court, were dismissed. The company also has agreed to settle within its insurance limits a consolidated alleged class action pending in the U.S.D.C. for the Northern District of Illinois against the company and certain of its executive officers. Subject to court approval of the settlement, all claims and related, consolidated cases will be favorably resolved.
On July 31, 2015, Davita Healthcare Partners, Inc. filed suit against Baxter Healthcare Corporation in the District Court of the State of Colorado for a breach of contract claim regarding an ongoing commercial dispute relating to the provision of peritoneal dialysis products. The company intends to vigorously defend against the suit.
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In May 2014, the company received a formal demand for information from the United States Attorney for the Western District of Pennsylvania for information related to alleged “off-label” sales of its pulmonary treatments. The Department of Justice informed the company on February 27, 2015 that its investigation is closed.
In the fourth quarter of 2012, the company received two investigative demands from the United States Attorney for the Western District of North Carolina for information regarding its quality and manufacturing practices and procedures at its North Cove facility. The company is fully cooperating with this investigation.
13. SEGMENT INFORMATION
Baxter’s two segments, BioScience and Medical Products, are strategic businesses that are managed separately because each business develops, manufactures and markets distinct products and services. Prior to 2015, the company’s biosurgery products and services were reported in the BioScience segment. In preparation of the planned spin-off of Baxalta, the company realigned its biosurgery products and services to the Medical Products segment. Effective January 1, 2015, the company changed its segment presentation to reflect this new structure, and recast all prior periods presented to conform to the new presentation.
The segments and a description of their products and services are as follows:
The BioScience business processes recombinant and plasma-based proteins to treat hemophilia and other bleeding disorders; plasma-based therapies to treat immune deficiencies, alpha-1 antitrypsin deficiency, burns and shock, and other chronic and acute blood-related conditions. Additionally, the BioScience business is investing in new disease areas, including oncology, as well as emerging technology platforms, including gene therapy and biosimilars.
The Medical Products business manufactures intravenous (IV) solutions and administration sets, premixed drugs and drug-reconstitution systems, pre-filled vials and syringes for 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. In addition, the Medical Products business provides products and services to treat end-stage renal disease, or irreversible kidney failure, along with other renal therapies, which business was enhanced through the 2013 acquisition of Gambro AB. The Medical Products business now offers a comprehensive portfolio to meet the needs of patients across the treatment continuum, including technologies and therapies for peritoneal dialysis, in-center hemodialysis (HD), home HD, continuous renal replacement therapy and additional dialysis services.
The operating results of the Vaccines franchise, previously reported within the BioScience segment, have been reflected as discontinued operations for the three and six months ended June 30, 2015 and 2014. Refer to Note 1 for additional information regarding the presentation of the Vaccines franchise.
The company uses more than one measurement and multiple views of data to measure segment performance and to allocate resources to the segments. However, the dominant measurements are consistent with the company’s condensed consolidated financial statements and, accordingly, are reported on the same basis in this report. The company evaluates the performance of its segments and allocates resources to them primarily based on pre-tax income along with cash flows and overall economic returns. Intersegment sales are eliminated in consolidation.
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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 and asset impairment). With respect to depreciation and amortization and expenditures for long-lived assets, the difference between the segment totals and the consolidated totals principally relate to assets maintained at Corporate. Financial information for the company’s segments is as follows.
BioScience
Medical Products
Total net sales
Pre-tax income from continuing operations
Total pre-tax income from continuing operations segments
The following is a reconciliation of segment pre-tax income from continuing operations to income before income taxes from continuing operations per the condensed consolidated statements of income.
Total pre-tax income from continuing operations from segments
Unallocated amounts
Business optimization items
Certain foreign currency fluctuations and hedging activities
Other Corporate items
14. SUBSEQUENT EVENTS
Refer to Notes 1, 7, and 11 for additional information regarding the spin-off of Baxalta as well as other events that occurred after June 30, 2015.
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Refer to the company’s Annual Report on Form 10-K for the year ended December 31, 2014 (2014 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 six months ended June 30, 2015.
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). The Distribution was made to Baxter’s shareholders of record as of the close of business 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.
The spin-off of Baxalta has not yet been reflected in our historical results and will be presented as a discontinued operation starting in the third quarter of 2015. Discontinued operations will reflect the revenues and expenses directly associated with the results of operations of Baxalta for all periods presented. Refer to Note 1 for additional information regarding the spin-off of Baxalta. Unless otherwise stated, financial results herein include the results of Baxalta.
Vaccines Discontinued Operations
The operating results of the Vaccines franchise have been reflected as discontinued operations for the three and six months ended June 30, 2015 and 2014. Refer to Note 1 for additional information regarding the presentation of the Vaccines franchise. Unless otherwise stated, financial results herein reflect continuing operations.
Change in Segments
As a result of the planned spin-off of Baxalta, the company realigned its biosurgery products and services to the Medical Products segment. Effective January 1, 2015, the company changed its segment presentation to reflect this new structure, and recast all prior periods presented to conform to the new presentation.
RESULTS OF OPERATIONS
Baxter’s income from continuing operations for the three and six months ended June 30, 2015 totaled $336 million, or $0.61 per diluted share, and $756 million, or $1.38 per diluted share, compared to $468 million, or $0.85 per diluted share, and $975 million, or $1.78 per diluted share for the three and six months ended June 30, 2014. Income from continuing operations for the three and six months ended June 30, 2015 included special items which reduced income from continuing operations by $214 million and $343 million, respectively, or $0.39 and $0.63 per diluted share, respectively, as further discussed below. Income from continuing operations for the three and six months ended June 30, 2014 included special items which reduced income from continuing operations by $172 million and $260 million, respectively, or $0.31 and $0.47 per diluted share, as further discussed below.
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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 six months ended June 30, 2015 and 2014.
Gross Margin
Intangible asset amortization expense
Business optimization items 1
Separation-related costs 2
Product-related items 3
Total Special Items
Impact on Gross Margin Ratio
Marketing and Administrative Expenses
Gambro integration items 4
Reserve items and adjustments 5
Impact on Marketing and Administrative Expense Ratio
Research and Development Expenses
Business development items 6
Net Interest Expense
Other (Income) Expense, Net
Income Tax Expense
Impact of special items
Impact on Effective Tax Rate
Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance, particularly in terms of cash returns, and is similar to how management internally assesses performance. Upfront and milestone payments related to collaborations that have been expensed as research and development (R&D) are uncertain and often result in a different payment and expense recognition pattern than internal R&D activities and therefore are typically treated as special items. 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 generally accepted accounting principles (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.
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NET SALES
International
United States
Foreign currency unfavorably impacted net sales by 9 percentage points and 7 percentage points during the second quarter and first half of 2015, respectively, primarily due to the strengthening of the U.S. Dollar relative to the Euro as well as certain other currencies.
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.
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Franchise Net Sales Reporting
Effective January 1, 2015, Baxter modified its commercial franchise structure for reporting net sales within each segment. Prior period net sales have been recast to reflect the new commercial franchise structure. Refer to the segment net sales discussions below for a description of each commercial franchise.
The BioScience segment includes four commercial franchises: Hemophilia, Immunoglobulin Therapies, Inhibitor Therapies and BioTherapeutics.
The following is a summary of net sales by franchise in the BioScience segment.
Hemophilia
Immunoglobulin Therapies
Inhibitor Therapies
BioTherapeutics
Total BioScience net sales
Net sales in the BioScience segment decreased 2% during the second quarter of 2015 and remained flat during the first half of 2015 (with an unfavorable foreign currency impact of nine percentage points and eight percentage points in the second quarter and first half of 2015, respectively). Excluding the impact of foreign currency, the principal drivers impacting net sales were the following:
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The Medical Products segment includes five commercial franchises: Renal, Fluid Systems, Integrated Pharmacy Solutions, Surgical Care and Other.
The following is a summary of net sales by franchise in the Medical Products segment.
Renal
Fluid Systems
Integrated Pharmacy Solutions
Surgical Care
Total Medical Products net sales
Net sales in the Medical Products segment decreased 9% and 7% during the second quarter and first half of 2015, respectively (with an unfavorable foreign currency impact of nine percentage points and eight percentage points in the second quarter and first half of 2015, respectively). Excluding the impact of foreign currency, the principal drivers impacting net sales were the following:
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Gross Margin and Expense Ratios
The special items identified above had an unfavorable impact of approximately 1.4 and 1.2 percentage points on the gross margin percentage in the second quarter and first half of 2015, respectively. The unfavorable impact was 2.9 and 2.1 percentage points in the second quarter and first half of 2014, respectively. Refer to the Special Items caption above for additional detail.
Offsetting the unfavorable impact of the special items, gross margin was favorably impacted by sales growth for select higher margin products in the BioScience segment as well as foreign currency in the second quarter of 2015. In the first half of 2015, these favorable impacts were more than offset by decreased sales of the high margin product cyclophosphamide within the Medical Products segment, higher manufacturing costs for plasma-derived products, and increased investments to enhance manufacturing operations, quality systems and processes.
The special items identified above had an unfavorable impact of approximately 3.8 and 3.6 percentage points on the marketing and administrative expense ratio in the second quarter and first half of 2015, respectively. The unfavorable impact was 0.9 and 0.7 percentage points in the second quarter and first half of 2014, respectively. Refer to the Special Items caption above for additional detail.
In addition to the unfavorable impact of the special items, the marketing and administrative expenses ratio in both periods increased primarily as a result of increased spending on marketing and promotional programs to support new product launches, certain costs incurred to establish the regional commercial organizations for Baxalta, bad debt expense in emerging markets, and increased pension expense. Partially offsetting the these was the company’s continued focus on controlling discretionary spending.
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Research and Development
As a percentage of net sales
R&D expenses increased by 20% during the second quarter of 2015 mainly due to the special items identified above. R&D expenses increased by 9% during the first half of 2015 as a result of the company’s continued investment in both the Medical Products and BioScience segments.
Business Optimization Items
The company has implemented certain business optimization initiatives in an effort to streamline its international operations, rationalize its manufacturing facilities, enhance its general and administrative infrastructure and realign certain R&D activities. The company estimates that business optimization activities from 2011 through 2014 have resulted in cumulative savings of approximately $0.37 per diluted share as of June 30, 2015. The company expects additional savings of approximately $0.06 per diluted share as the programs are fully implemented through 2016. In the first half of 2015, the company recorded gross business optimization charges of $32 million primarily related to severance and employee-related costs. The company expects additional savings from the 2015 charges of approximately $0.02 per diluted share as the programs are fully implemented through 2016. The savings from these actions will impact cost of sales, marketing and administrative expenses and R&D expenses, and benefit both the BioScience and Medical Products segments. Refer to Note 6 for additional information regarding the company’s business optimization initiatives.
Net interest expense was $34 million and $64 million in the second quarter and first half of 2015, respectively, and $42 million and $85 million in the second quarter and first half of 2014, respectively. The decrease in both periods was driven by the maturity of $600 million of 4.625% senior unsecured notes in March 2015, increased capitalized interest, and the company’s interest rate swap hedging activities. The decrease in both periods was partially offset by interest expense related to the Baxalta senior notes issued in June 2015, the company’s $1.8 billion U.S. dollar-denominated revolving credit facility, and increased interest expense related to the company’s commercial paper program.
Other (income) expense, net was $67 million and $141 million of income in the second quarter and first half of 2015, respectively. Other (income) expense, net was $15 million of expense and $9 million of income in the second quarter and first half of 2014, respectively.
In the second quarter and first half of 2015, other (income) expense, net included $52 million of income related to a litigation settlement in which Baxter was the beneficiary as well as $25 million of income related to equity method investments and sales of available-for-sale equity securities. Also included was expense of $12 million in the second quarter of 2015 and income of $77 million in the first half of 2015 related to foreign currency fluctuations, principally relating to intercompany receivables, payables and monetary assets denominated in a foreign currency.
In the second quarter of 2014, other (income) expense, net included a $44 million loss related to an increase in the estimated fair value of contingent payment liabilities for certain milestones associated with the prior acquisition of OBIZUR and related assets from Inspiration BioPharmaceuticals, Inc. and Ipsen Pharma S.A.S., partially offset by a $14 million gain on a third-party recovery of previous litigation reserves. The first half of 2014 also included income of $44 million related to equity method investments, which primarily represented gains from the sale of certain investments as well as distributions from funds that sold portfolio companies.
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Pre-Tax Income from Continuing Operations
Refer to Note 13 for a summary of financial results by segment. The following is a summary of significant factors impacting the segments’ financial results.
Pre-tax income from continuing operations decreased 11% and 10% in the second quarter and first half of 2015, respectively. Pre-tax income from continuing operations in the second quarter and first half of 2015 included R&D charges of $87 million related to certain milestone payments associated with the company’s collaboration arrangements. Pre-tax income in both periods of 2014 included R&D charges of $35 million and $60 million, respectively, related to certain milestone payments associated with the company’s collaboration arrangements. Additionally, a net loss of $44 million was recorded in the second quarter of 2014 due to an increase in the estimated fair value of contingent payment liabilities for certain milestones associated with the prior acquisition of OBIZUR and related assets.
Excluding the impact of the above items, pre-tax income from continuing operations decreased 8% and 11% in the second quarter and first half of 2015, respectively. Pre-tax income from continuing operations in both periods decreased as a result of increased spending on marketing and promotional programs to support new product launches, higher manufacturing costs for plasma-derived products, and additional R&D investments.
Pre-tax income from continuing operations increased 4% in the second quarter of 2015 and decreased 9% in the first half of 2015. Pre-tax income from continuing operations in both periods of 2015 included Gambro integration costs of $20 million and $38 million, respectively. Pre-tax income from continuing operations in both periods of 2014 included Gambro integration costs of $29 million and $63 million, respectively. Additionally, total charges of $93 million were recorded in the second quarter of 2014 primarily related to product remediation efforts for the SIGMA SPECTRUM infusion pump.
Excluding the impact of the above items, pre-tax income from continuing operations decreased 22% in both the second quarter and first half of 2015. Pre-tax income from continuing operations in both periods decreased as a result of decreased sales of the high margin product cyclophosphamide, increased investments to enhance manufacturing operations, quality systems and processes, and additional R&D investments.
Corporate and other
Certain income and expense amounts are not allocated to a segment. These amounts are detailed in the table in Note 13 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 and asset impairment).
Income Taxes
The company anticipates that the effective tax rate for continuing operations for the full-year 2015 will be approximately 21.5%, excluding the impact of audit developments and other special items.
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Income from Continuing Operations and Earnings per Diluted Share
Income from continuing operations was $336 million and $468 million for the three months ended June 30, 2015 and 2014, respectively, and $756 million and $975 million for the six months ended June 30, 2015 and 2014, respectively. Income from continuing operations per diluted share was $0.61 and $0.85 for the three months ended June 30, 2015 and 2014, respectively, and $1.38 and $1.78 for the six months ended June 30, 2015 and 2014, respectively. The significant factors and events contributing to the changes are discussed above. Additionally, income from continuing operations per diluted share for the three and six months ended June 30, 2014 was positively impacted by the company’s stock repurchase program, including the repurchase of 2.7 million and 6.4 million shares during such periods. Refer to Note 10 for further information regarding the company’s stock repurchases.
LIQUIDITY AND CAPITAL RESOURCES
The company’s cash flows reflect both continuing and discontinued operations.
Cash Flows from Operations
Cash flows from operations decreased during the first half of 2015 as compared to the prior year period, totaling $792 million in 2015 and $1.2 billion in 2014. The decrease was driven by lower net income as well as the factors discussed below.
Accounts Receivable
Cash inflows relating to accounts receivable decreased during the first half of 2015 as compared to the prior year period and days sales outstanding increased from 56.7 days as of June 30, 2014 to 60.6 days as of June 30, 2015. The decrease in cash inflows and corresponding increase in days sales outstanding was driven by longer collection periods in the United States and certain international markets as well as the timing of significant collections in the first quarter of 2014.
Cash outflows relating to inventories increased in 2015 as compared to the prior year. The following is a summary of inventories as of June 30, 2015 and December 31, 2014, as well as annualized inventory turns for the first half of 2015 and 2014, by segment.
Total company
The increase in inventories and the associated decrease in inventory turns during the first half of 2015 was driven by plasma protein and recombinant inventory build in the BioScience segment as well as certain inventories across the Medical Products segment to support future growth.
The changes in accounts payable and accrued liabilities were $34 million in the first half of 2015 compared to $261 million in the first half of 2014. The changes were primarily driven by the timing of payments to suppliers as well as higher litigation-related payments in the first half of 2014.
Payments related to the execution of the COLLEAGUE infusion pump and SIGMA SPECTRUM infusion pump recalls as well as the company’s business optimization initiatives decreased from $83 million in the first half of 2014 to $45 million in the first half of 2015. Refer to Note 6 for further information regarding the COLLEAGUE infusion pump and SIGMA SPECTRUM infusion pump recalls as well as the business optimization initiatives.
Changes in other balance sheet items were $168 million and $38 million in the first half of 2015 and 2014, respectively. The change in the first half of 2015 was driven by prepaid expenses as well as the discretionary contribution to the company’s U.S. qualified pension plan.
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Cash Flows from Investing Activities
Capital Expenditures
Capital expenditures increased by $177 million in the first half of 2015, from $844 million in 2014 to $1.0 billion in 2015. The company’s capital expenditures in 2015 were driven by additional investments in construction of a state-of-the-art manufacturing facility in Covington, Georgia to support growth of its plasma-based treatments, with commercial production scheduled to begin in 2018. The company also invested in projects to support production of PD and IV solutions as well as expansion plans to meet the growing global demand for dialyzers. Capital expenditures related to the company’s planned spin-off of Baxalta, primarily in the area of information technologies, also contributed to the increase compared to the first half of 2014.
Acquisitions and Investments
Cash outflows relating to acquisitions and investments of $341 million in the first half of 2015 were driven primarily by the acquisition of SuppreMol GmbH, milestone payments associated with the company’s collaboration arrangements, and other business development activities.
Cash outflows relating to acquisitions and investments of $176 million in the first half of 2014 were driven primarily by the acquisitions of Chatham Therapeutics, LLC and AesRx, LLC, milestone payments associated with one of the company’s collaboration arrangements, and other business development activities.
Divestitures and Other Investing Activities
Cash flows from divestitures and other investing activities were not significant in the first half of 2015. Cash inflows from divestitures and other investing activities included $70 million from the sale of certain investments in the first half of 2014 as well as $32 million of net proceeds from the divestiture of Baxter’s legacy CRRT business.
Cash Flows from Financing Activities
Debt Issuances, Net of Payments of Obligations
Cash inflows related to issuances of debt totaled $6.7 billion for the first half of 2015 primarily related to the $5.0 billion of Baxalta senior notes and $1.7 billion of borrowings under the company’s revolving credit facilities. 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 repaid $875 million related to its commercial paper program.
Net cash outflows related to debt and other financing obligations totaled $342 million for the first half of 2014 primarily related to the repayment of the company’s $350 million of 4.0% senior unsecured notes that matured in March 2014 as well as other short-term obligations, offset by the issuance of $150 million of commercial paper in June 2014.
Other Financing Activities
Cash dividend payments totaled $564 million and $531 million in the first half of 2015 and 2014, respectively. The increase in cash dividend payments was primarily due to an increase in the quarterly dividend rate of approximately 6% to $0.52 per share, as announced in May 2014. In May 2015, the Board of Directors declared a quarterly dividend of $0.52 per share, which was paid on July 1, 2015 to shareholders of record as of June 1, 2015.
Proceeds and realized excess tax benefits from stock issued under employee benefit plans decreased by $130 million, from $249 million in the first half of 2014 to $119 million in the first half of 2015, primarily due to decreases in stock option exercises and the weighted-average exercise price of the stock options that were exercised.
The company did not repurchase stock in the first half of 2015 compared to $450 million of repurchases in the first half of 2014. 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 and $0.5 billion remained available as of June 30, 2015.
Credit Facilities, Access to Capital and Credit Ratings
Credit Facilities
As of June 30, 2015, the company’s U.S. dollar-denominated revolving credit facilities had a maximum capacity of $3.3 billion and were scheduled to mature in December 2015. The company also maintained a Euro-denominated revolving credit facility with a
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maximum capacity of approximately $339 million as of June 30, 2015, which was set to mature in December 2015. These facilities enabled the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net-debt-to-capital ratio. As of June 30, 2015, the company was in compliance with the financial covenants in these agreements. In the first half of 2015, the company borrowed $1.5 billion which was outstanding as of June 30, 2015, under its $1.8 billion U.S. dollar-denominated revolving credit facility at a weighted average interest rate of 1.37%. 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.
Effective July 1, 2015, the company terminated its $1.5 billion U.S. dollar-denominated revolving credit facility and €300 million Euro-denominated revolving credit facility and entered into credit agreements providing for a senior U.S. dollar-denominated revolving credit facility in an aggregate principal amount of up to $1.5 billion maturing in 2020, as well as a Euro-denominated senior revolving credit facility in an aggregate principal amount of up to €200 million maturing in 2020. The company may, at its option, seek to increase the aggregate commitment under the new U.S. facility by up to an additional $750 million. The facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net leverage ratio and maximum interest coverage ratio.
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 $6.7 billion of cash and equivalents as of June 30, 2015, with adequate cash available to meet operating requirements in each jurisdiction in which the company operates. Giving effect to the cash expected to be distributed to Baxalta as part of the distribution and the cash utilized in the July 2015 debt tender offers, cash and equivalents as of June 30, 2015 would have been $1.8 billion. 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, that have experienced a deterioration in credit and economic conditions. As of June 30, 2015, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $327 million, of which $48 million related to Greece. This represents a $36 million decrease from December 31, 2014, primarily as a result of collections in Spain and Italy.
While the economic downturn has 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.
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Credit Ratings
The company’s credit ratings at June 30, 2015 were as follows.
Ratings
Senior debt
Outlook
In May 2015, Moody’s downgraded Baxter’s senior debt from A3 to Baa2. Fitch also downgraded Baxter’s senior debt from A to BBB+ as well as Baxter’s short-term debt from F1 to F2. The downgrades reflect the impact of the Baxalta spin-off as detailed in Note 1.
CONTRACTUAL OBLIGATIONS
There have been no significant changes to the company’s contractual obligations during the first six months of 2015, except for the issuance of $5.0 billion senior notes, which remain obligations of Baxalta subsequent to the spin-off. The table below summarizes Baxter’s contractual obligations as of June 30, 2015 related to short- and long-term debt and interest expense in the following periods.
One to
three years
Three to
five years
More than
Short- and long-term debt and capital lease obligations, including current maturities
Interest on short- and long-term debt and capital lease obligations 1
Total 2
The table below summarizes Baxter’s contractual obligations as of June 30, 2015 related to short- and long-term debt and interest expense in the following periods to give effect to the above mentioned debt tender offers as well as the release of Baxter’s obligations relating to the Baxalta senior notes. The balances below do not reflect the transfer of any capital leases to Baxalta.
Interest on short- and long-term debt and capital lease obligations
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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 2014 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 2014 Annual Report. There have been no significant changes in the company’s application of its critical accounting policies during the first six months of 2015.
LEGAL CONTINGENCIES
Refer to Note 12 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
In July 2014, the company received a Warning Letter from FDA primarily relating to processes implemented to ensure the absence of particulate matter or leaks associated with products manufactured at the company’s Aibonito, Puerto Rico, plant. The company is working with FDA to resolve this matter, as well as each of the other Warning Letters listed below.
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. The letter also included observations related to the company’s ambulatory infusor business in Irvine, California, which previously had been subject to agency action.
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. 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 Renal franchise’s McGaw Park, Illinois facility. The Warning Letter pertains to the processes by which the company analyzes and addresses product complaints through corrective and preventative actions, and reports relevant information to FDA.
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 2014 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.
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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, the impact of the recent separation of the biopharmaceuticals and medical products businesses, the impact of competition, future sales growth, business development activities, business optimization initiatives, future capital and R&D expenditures, manufacturing expansion, the sufficiency of the company’s facilities and financial flexibility, the adequacy of credit facilities, future debt issuances, 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 our experience and perception of historical trends, current conditions, and expected future developments as well as other factors that we believe are appropriate in the circumstances. While these statements represent our current judgment on what the future may hold, and we believe 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:
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Actual results may differ materially from those projected in the forward-looking statements. The company does not undertake to update its forward-looking statements.
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Currency Risk
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, Japanese Yen, British Pound, Australian Dollar, Canadian Dollar, Brazilian Real, Colombian Peso, and Swedish Krona. 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’ 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 June 30, 2015 is 18 months. The company also enters into derivative instruments to hedge certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.
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. Since January 1, 2010, Venezuela has been designated as a highly inflationary economy under GAAP and as a result, the functional currency of the company’s subsidiary in Venezuela is the U.S. Dollar. The devaluation of the Venezuelan Bolivar and designation of Venezuela as highly inflationary did not have a material impact on the financial results of the company. As of June 30, 2015, the company’s subsidiary in Venezuela had net assets of $27 million denominated in the Venezuelan Bolivar. In the first half of 2015, net sales in Venezuela represented less than 1% of Baxter’s total net sales.
As part of its risk-management program, the company performs a sensitivity analysis 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 June 30, 2015, 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 $16 million would decrease by $53 million, resulting in a net liability.
The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at June 30, 2015 by replacing the actual exchange rates at June 30, 2015 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 2014 Annual Report. There were no significant changes during the quarter ended June 30, 2015.
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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 June 30, 2015. 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 June 30, 2015.
Changes in Internal Control over Financial Reporting
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 June 30, 2015 that have materially affected, or are reasonably likely to materially affect, Baxter’s internal control over financial reporting.
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Review by Independent Registered 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 six months ended June 30, 2015 and 2014 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.
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Report of Independent Registered 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 June 30, 2015, and the related condensed consolidated statements of income for the three- and six month periods ended June 30, 2015 and 2014, the condensed consolidated statements of comprehensive income for the three- and six month periods ended June 30, 2015 and 2014 and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2015 and 2014. These interim financial statements are the responsibility of the company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (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, 2014, and the related consolidated statements of income, of comprehensive income, of cash flows and of changes in equity for the year then ended, and in our report dated February 26, 2015, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2014, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
August 7, 2015
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PART II. OTHER INFORMATION
On February 25, 2015, Baxter received a notice of a violation from the Ventura County Air Pollution Control District as a result of it self-reporting certain violations of environmental regulations at its manufacturing facility located in Thousand Oaks, California, to that agency promptly after discovery on October 16, 2014, as required by local regulations. Pursuant to that notice, the company paid penalties in the amount of $103,000 to the agency, which released the company of any further claims or liabilities for such violations.
The information in Part I, Item 1, Note 12 is incorporated herein by reference.
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Exhibit Index:
Exhibit
Number
Description
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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.
Date: August 7, 2015
/s/ James K. Saccaro
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