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BAXTER INTERNATIONAL INC - Quarter Report: 2019 June (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-4448

 

BAXTER INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

36-0781620

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

One Baxter Parkway, Deerfield, Illinois

 

60015

(Address of principal executive offices)

 

(Zip Code)

 

 

 

224-948-2000

 

 

 

 

(Registrant’s telephone number, including area code)

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, $1.00 par value

 

BAX (NYSE)

 

New York Stock Exchange

 

 

 

 

Chicago Stock Exchange

0.4% Global Notes due 2024

 

BAX 24

 

New York Stock Exchange

1.3% Global Notes due 2025

 

BAX 25

 

New York Stock Exchange

1.3% Global Notes due 2029

 

BAX 29

 

New York Stock Exchange

 

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      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  

 

 

Accelerated filer  

Non-accelerated filer  

 

 

Smaller reporting company  

Emerging growth company  

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.       

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The number of shares of the registrant’s Common Stock, par value $1.00 per share, outstanding as of July 25, 2019 was 510,555,869 shares.

 

 


 

BAXTER INTERNATIONAL INC.

FORM 10-Q

For the quarterly period ended June 30, 2019

TABLE OF CONTENTS

 

 

 

 

 

Page Number

PART I.

 

FINANCIAL INFORMATION

  

2

Item 1.

 

Financial Statements (unaudited)

  

2

 

 

Condensed Consolidated Balance Sheets

  

2

 

 

Condensed Consolidated Statements of Income

  

3

 

 

Condensed Consolidated Statements of Comprehensive Income

  

4

 

 

Condensed Consolidated Statements of Changes in Equity

 

5

 

 

Condensed Consolidated Statements of Cash Flows

  

7

 

 

Notes to Condensed Consolidated Financial Statements

  

8

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

29

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

  

41

Item 4.

 

Controls and Procedures

 

42

Review by Independent Registered Public Accounting Firm

 

43

Report of Independent Registered Public Accounting Firm

 

44

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

45

Item 1.

 

Legal Proceedings

 

45

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

45

Item 6.

 

Exhibits

 

46

Signature

 

47

 

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Baxter International Inc.

Condensed Consolidated Balance Sheets (unaudited)

(in millions, except shares)

 

 

 

 

 

June 30,

 

 

December 31,

 

 

 

 

 

2019

 

 

2018

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

2,925

 

 

$

1,832

 

Accounts and other current receivables, net

 

 

1,885

 

 

 

1,812

 

Inventories

 

 

1,757

 

 

 

1,653

 

Prepaid expenses and other

 

 

651

 

 

 

622

 

Total current assets

 

 

7,218

 

 

 

5,919

 

Property, plant and equipment, net

 

 

4,541

 

 

 

4,542

 

Goodwill

 

 

2,938

 

 

 

2,958

 

Other intangible assets, net

 

 

1,364

 

 

 

1,398

 

Operating lease right-of-use assets

 

 

588

 

 

 

 

Other non-current assets

 

 

895

 

 

 

824

 

Total assets

 

 

 

$

17,544

 

 

$

15,641

 

Current liabilities:

 

 

 

 

 

 

 

 

Short-term debt

 

$

2

 

 

$

2

 

Current maturities of long-term debt and finance lease obligations

 

 

2

 

 

 

2

 

Accounts payable and accrued liabilities

 

 

2,593

 

 

 

2,832

 

Total current liabilities

 

 

2,597

 

 

 

2,836

 

Long-term debt and finance lease obligations

 

 

5,157

 

 

 

3,473

 

Operating lease liabilities

 

 

490

 

 

 

 

Other non-current liabilities

 

 

1,464

 

 

 

1,516

 

Total liabilities

 

 

9,708

 

 

 

7,825

 

Equity:

 

 

 

 

 

 

 

 

Common stock, $1 par value, authorized 2,000,000,000

   shares, issued 683,494,944 shares in 2019 and 2018

 

 

683

 

 

 

683

 

Common stock in treasury, at cost, 173,275,586 shares

   in 2019 and 170,495,859 shares in 2018

 

 

(10,322

)

 

 

(9,989

)

Additional contributed capital

 

 

5,906

 

 

 

5,898

 

Retained earnings

 

 

16,184

 

 

 

15,626

 

Accumulated other comprehensive (loss) income

 

 

(4,639

)

 

 

(4,424

)

Total Baxter stockholders’ equity

 

 

7,812

 

 

 

7,794

 

Noncontrolling interests

 

 

24

 

 

 

22

 

Total equity

 

 

7,836

 

 

 

7,816

 

Total liabilities and equity

 

$

17,544

 

 

$

15,641

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

2

 


 

Baxter International Inc.

Condensed Consolidated Statements of Income (unaudited)

(in millions, except per share data)

 

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Net sales

 

$

2,840

 

 

$

2,842

 

 

$

5,472

 

 

$

5,519

 

Cost of sales

 

 

1,681

 

 

 

1,603

 

 

 

3,233

 

 

 

3,166

 

Gross margin

 

 

1,159

 

 

 

1,239

 

 

 

2,239

 

 

 

2,353

 

Selling, general and administrative expenses

 

 

642

 

 

 

681

 

 

 

1,242

 

 

 

1,303

 

Research and development expenses

 

 

166

 

 

 

174

 

 

 

295

 

 

 

314

 

Other operating income, net

 

 

(4

)

 

 

 

 

 

(37

)

 

 

(80

)

Operating income

 

 

355

 

 

 

384

 

 

 

739

 

 

 

816

 

Interest expense, net

 

 

20

 

 

 

11

 

 

 

38

 

 

 

23

 

Other income, net

 

 

(28

)

 

 

(31

)

 

 

(53

)

 

 

(49

)

Income before income taxes

 

 

363

 

 

 

404

 

 

 

754

 

 

 

842

 

Income tax expense

 

 

20

 

 

 

61

 

 

 

64

 

 

 

110

 

Net income

 

$

343

 

 

$

343

 

 

$

690

 

 

$

732

 

Net income per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.67

 

 

$

0.64

 

 

$

1.35

 

 

$

1.36

 

Diluted

 

$

0.66

 

 

$

0.63

 

 

$

1.33

 

 

$

1.33

 

Weighted-average number of common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

510

 

 

 

535

 

 

 

511

 

 

 

537

 

Diluted

 

 

519

 

 

 

547

 

 

 

520

 

 

 

549

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 


 

Baxter International Inc.

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(in millions)

 

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Net income

 

$

343

 

 

$

343

 

 

$

690

 

 

$

732

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustments, net of tax (benefit) expense of ($4) and ($24) for the three months ended June 30, 2019 and 2018, respectively, and $2 and ($31) for the six months ended June 30, 2019 and 2018, respectively

 

 

(78

)

 

 

(363

)

 

 

(48

)

 

 

(282

)

Pension and other postretirement benefits, net of tax expense of $3 and $4 for the three months ended June 30, 2019 and 2018, respectively, and $6 and $17 for the six months ended June 30, 2019 and 2018, respectively

 

 

13

 

 

 

29

 

 

 

21

 

 

 

81

 

Hedging activities, net of tax (benefit) expense of ($3) and $2 for the three months ended June 30, 2019 and 2018, respectively, and ($8) and $3 for the six months ended June 30, 2019 and 2018, respectively

 

 

(12

)

 

 

11

 

 

 

(27

)

 

 

6

 

Total other comprehensive (loss) income, net of tax

 

 

(77

)

 

 

(323

)

 

 

(54

)

 

 

(195

)

Comprehensive income

 

$

266

 

 

$

20

 

 

$

636

 

 

$

537

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 


4

 


 

Baxter International Inc.

Condensed Consolidated Statements of Changes in Equity (unaudited)

(in millions)

 

 

 

 

For the three and six months ended June 30, 2019

 

 

 

Baxter International Inc. stockholders' equity

 

 

 

 

 

 

 

 

 

 

 

Common stock shares

 

 

Common stock

 

 

Common stock shares in treasury

 

 

Common stock in treasury

 

 

Additional contributed capital

 

 

Retained earnings

 

 

Accumulated other comprehensive income (loss)

 

 

Total Baxter stockholders' equity

 

 

Noncontrolling interests

 

 

Total equity

 

Balance as of January 1, 2019

 

683

 

 

$

683

 

 

 

170

 

 

$

(9,989

)

 

$

5,898

 

 

$

15,626

 

 

$

(4,424

)

 

$

7,794

 

 

$

22

 

 

$

7,816

 

Adoption of new accounting standards

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

161

 

 

 

(161

)

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

347

 

 

 

 

 

 

347

 

 

 

 

 

 

347

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

23

 

 

 

23

 

 

 

 

 

 

23

 

Purchases of treasury stock

 

 

 

 

 

 

 

 

8

 

 

 

(586

)

 

 

 

 

 

 

 

 

 

 

 

(586

)

 

 

 

 

 

(586

)

Stock issued under employee benefit plans and other

 

 

 

 

 

 

 

 

(5

)

 

 

291

 

 

 

(59

)

 

 

(66

)

 

 

 

 

 

166

 

 

 

 

 

 

166

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(98

)

 

 

 

 

 

(98

)

 

 

 

 

 

(98

)

Change in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

1

 

Balance as of March 31, 2019

 

683

 

 

$

683

 

 

173

 

 

$

(10,284

)

 

$

5,839

 

 

$

15,970

 

 

$

(4,562

)

 

$

7,646

 

 

$

23

 

 

$

7,669

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

343

 

 

 

 

 

 

343

 

 

 

 

 

 

343

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(77

)

 

 

(77

)

 

 

 

 

 

(77

)

Purchases of treasury stock

 

 

 

 

 

 

 

 

2

 

 

 

(157

)

 

 

46

 

 

 

 

 

 

 

 

 

(111

)

 

 

 

 

 

(111

)

Stock issued under employee benefit plans and other

 

 

 

 

 

 

 

 

(2

)

 

 

119

 

 

 

21

 

 

 

(17

)

 

 

 

 

 

123

 

 

 

 

 

 

123

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(112

)

 

 

 

 

 

(112

)

 

 

 

 

 

(112

)

Change in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

1

 

Balance as of June 30, 2019

 

 

683

 

 

$

683

 

 

 

173

 

 

$

(10,322

)

 

$

5,906

 

 

$

16,184

 

 

$

(4,639

)

 

$

7,812

 

 

$

24

 

 

$

7,836

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

 


 

Baxter International Inc.

Condensed Consolidated Statements of Changes in Equity (unaudited)

(in millions)

 

 

 

 

For the three and six months ended June 30, 2018

 

 

 

Baxter International Inc. stockholders' equity

 

 

 

 

 

 

 

 

 

 

 

Common stock shares

 

 

Common stock

 

 

Common stock shares in treasury

 

 

Common stock in treasury

 

 

Additional contributed capital

 

 

Retained earnings

 

 

Accumulated other comprehensive income (loss)

 

 

Total Baxter stockholders' equity

 

 

Noncontrolling interests

 

 

Total equity

 

Balance as of January 1, 2018

 

683

 

 

$

683

 

 

 

142

 

 

$

(7,981

)

 

$

5,940

 

 

$

14,483

 

 

$

(4,001

)

 

$

9,124

 

 

$

(8

)

 

$

9,116

 

Adoption of new accounting standards

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(16

)

 

 

(3

)

 

 

(19

)

 

 

 

 

 

(19

)

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

389

 

 

 

 

 

 

389

 

 

 

 

 

 

389

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

128

 

 

 

128

 

 

 

 

 

 

128

 

Purchases of treasury stock

 

 

 

 

 

 

 

 

8

 

 

 

(522

)

 

 

 

 

 

 

 

 

 

 

 

(522

)

 

 

 

 

 

(522

)

Stock issued under employee benefit plans and other

 

 

 

 

 

 

 

 

(3

)

 

 

149

 

 

 

(28

)

 

 

(36

)

 

 

 

 

 

85

 

 

 

 

 

 

85

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(86

)

 

 

 

 

 

(86

)

 

 

 

 

 

(86

)

Change in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2

 

 

 

2

 

Balance as of March 31, 2018

 

683

 

 

$

683

 

 

147

 

 

$

(8,354

)

 

$

5,912

 

 

$

14,734

 

 

$

(3,876

)

 

$

9,099

 

 

$

(6

)

 

$

9,093

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

343

 

 

 

 

 

 

343

 

 

 

 

 

 

343

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(323

)

 

 

(323

)

 

 

 

 

 

(323

)

Purchases of treasury stock

 

 

 

 

 

 

 

 

3

 

 

 

(259

)

 

 

 

 

 

 

 

 

 

 

 

(259

)

 

 

 

 

 

(259

)

Stock issued under employee benefit plans and other

 

 

 

 

 

 

 

 

(2

)

 

 

128

 

 

 

4

 

 

 

(9

)

 

 

 

 

 

123

 

 

 

 

 

 

123

 

Dividends declared on common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(102

)

 

 

 

 

 

(102

)

 

 

 

 

 

(102

)

Change in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6

)

 

 

(6

)

Balance as of June 30, 2018

 

 

683

 

 

$

683

 

 

 

148

 

 

$

(8,485

)

 

$

5,916

 

 

$

14,966

 

 

$

(4,199

)

 

$

8,881

 

 

$

(12

)

 

$

8,869

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6

 


 

Baxter International Inc.

Condensed Consolidated Statements of Cash Flows (unaudited)

(in millions)

 

 

 

 

 

Six months ended

 

 

 

 

 

June 30,

 

 

 

 

 

2019

 

 

2018

 

Cash flows from operations

 

 

 

 

 

 

 

 

Net income

 

 

 

$

690

 

 

$

732

 

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

393

 

 

 

387

 

Deferred income taxes

 

 

(55

)

 

 

(51

)

Stock compensation

 

 

57

 

 

 

54

 

Net periodic pension benefit and other postretirement costs

 

 

7

 

 

 

21

 

Restructuring charges

 

 

77

 

 

 

33

 

Intangible asset impairment

 

 

31

 

 

 

 

Other

 

 

21

 

 

 

7

 

Changes in balance sheet items:

 

 

 

 

 

 

 

 

Accounts and other current receivables, net

 

 

(60

)

 

 

43

 

Inventories

 

 

(91

)

 

 

(134

)

Accounts payable and accrued liabilities

 

 

(308

)

 

 

(109

)

Restructuring payments

 

 

(60

)

 

 

(47

)

Other

 

 

(85

)

 

 

(84

)

Cash flows from operations – continuing operations

 

 

617

 

 

 

852

 

Cash flows from operations – discontinued operations

 

 

(6

)

 

 

 

Cash flows from operations

 

 

611

 

 

 

852

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures

 

 

(352

)

 

 

(311

)

Acquisitions and investments

 

 

(111

)

 

 

(228

)

Other investing activities, net

 

 

1

 

 

 

 

Cash flows from investing activities

 

 

(462

)

 

 

(539

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Issuances of debt

 

 

1,661

 

 

 

 

Cash dividends on common stock

 

 

(198

)

 

 

(173

)

Proceeds from stock issued under employee benefit plans

 

 

262

 

 

 

170

 

Purchases of treasury stock

 

 

(720

)

 

 

(781

)

Other financing activities, net

 

 

(37

)

 

 

(24

)

Cash flows from financing activities

 

 

968

 

 

 

(808

)

Effect of foreign exchange rate changes on cash and cash equivalents

 

 

(24

)

 

 

(42

)

Increase (decrease) in cash and cash equivalents

 

 

1,093

 

 

 

(537

)

Cash and cash equivalents at beginning of period

 

 

1,832

 

 

 

3,394

 

Cash and cash equivalents at end of period

 

$

2,925

 

 

$

2,857

 

 

 

 

 

 

 

 

 

 

 

 

Non-cash investing and financing activities

 

 

 

 

 

 

 

 

Decrease in liabilities for capital expenditures

 

$

47

 

 

$

20

 

Decrease in liability for treasury stock purchases

 

$

23

 

 

$

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

7

 


 

Baxter International Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

1. BASIS OF PRESENTATION

The unaudited interim condensed consolidated financial statements of Baxter International Inc. and its subsidiaries (we or our) 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 our Annual Report on Form 10-K for the year ended December 31, 2018 (2018 Annual Report).

In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. All such adjustments, unless otherwise noted herein, are of a normal, recurring nature. The results of operations for the current interim period are not necessarily indicative of the results of operations to be expected for the full year.

Certain reclassifications have been made to conform the prior period condensed consolidated statements to the current period presentation.  

New Accounting Standards

Recently adopted accounting pronouncements

As of January 1, 2019, we adopted Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).  Under this guidance, lessees are required to recognize a right-of-use asset and a lease liability on the balance sheet for all operating leases, other than those that meet the definition of a short-term lease.  We adopted Topic 842 using the modified retrospective method.  We elected the following practical expedients when assessing the transition impact: i) not to reassess whether any expired or existing contracts as of the adoption date are or contain leases; ii) not to reassess the lease classification for any expired or existing leases as of the adoption date; and iii) not to reassess initial direct costs for any existing leases as of the adoption date. The adjustment to record operating lease right-of-use assets and operating lease liabilities was $502 million as of January 1, 2019. The impact to the condensed consolidated statements of income was not material and there was no net impact to the condensed consolidated statements of cash flows.

As of January 1, 2019, we adopted ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities.  The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships, simplify the hedge accounting requirements, and improve the disclosures of hedging arrangements.  The adoption of this standard did not have a material impact on our condensed consolidated financial statements.

As of January 1, 2019, we adopted ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (AOCI).  As a result of the enactment of the U.S. Tax Cuts and Jobs Act of 2017 (the 2017 Tax Act), this guidance provides for a reclassification of certain tax effects from AOCI to retained earnings.  The impact of the adoption of this standard was a $161 million increase to retained earnings.

2. ACQUISITIONS AND OTHER ARRANGEMENTS

In the first quarter of 2019, we acquired the U.S. rights to multiple products for an aggregate purchase price of $94 million. The purchase prices were capitalized as developed-technology intangible assets and are being amortized over a weighted-average useful life of 10 years. Net sales related to these products in the first half of 2019 were not material.

In July 2019, we acquired the U.S. rights to an additional product for $62 million. The purchase price will be capitalized as a developed-technology intangible asset in the quarter ending September 30, 2019 and will be amortized over its estimated useful life of 12 years.

8

 


 

3. SUPPLEMENTAL FINANCIAL INFORMATION

 

Interest Expense, Net

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Interest expense, net of capitalized interest

 

$

28

 

 

$

24

 

 

$

53

 

 

$

46

 

Interest income

 

 

(8

)

 

 

(13

)

 

 

(15

)

 

 

(23

)

Interest expense, net

 

$

20

 

 

$

11

 

 

$

38

 

 

$

23

 

 

Other Income, Net

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Foreign exchange gains, net

 

$

(17

)

 

$

(18

)

 

$

(22

)

 

$

(33

)

Pension and other postretirement benefits

 

 

(15

)

 

 

(14

)

 

 

(31

)

 

 

(26

)

Other

 

 

4

 

 

 

1

 

 

 

 

 

 

10

 

Other income, net

 

$

(28

)

 

$

(31

)

 

$

(53

)

 

$

(49

)

 

Inventories

 

 

 

June 30,

 

 

December 31,

 

(in millions)

 

2019

 

 

2018

 

Raw materials

 

$

397

 

 

$

363

 

Work in process

 

 

197

 

 

 

203

 

Finished goods

 

 

1,163

 

 

 

1,087

 

Inventories

 

$

1,757

 

 

$

1,653

 

 

Property, Plant and Equipment, Net

 

 

 

June 30,

 

 

December 31,

 

(in millions)

 

2019

 

 

2018

 

Property, plant and equipment, at cost

 

$

10,593

 

 

$

10,327

 

Accumulated depreciation

 

 

(6,052

)

 

 

(5,785

)

Property, plant and equipment, net

 

$

4,541

 

 

$

4,542

 

 

4. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following is a reconciliation of goodwill by business segment.

 

(in millions)

 

Americas

 

 

EMEA

 

 

APAC

 

 

Total

 

Balance as of December 31, 2018

 

$

2,351

 

 

$

387

 

 

$

220

 

 

$

2,958

 

Adjustments

 

 

 

 

 

(4

)

 

 

 

 

 

(4

)

Currency translation adjustments

 

 

(13

)

 

 

(2

)

 

 

(1

)

 

 

(16

)

Balance as of June 30, 2019

 

$

2,338

 

 

$

381

 

 

$

219

 

 

$

2,938

 

 

As of June 30, 2019, there were no reductions in goodwill relating to impairment losses.

9

 


 

Other intangible assets, net

The following is a summary of our other intangible assets.

 

(in millions)

 

Developed technology,

including patents

 

 

Other amortized

intangible assets

 

 

Indefinite-lived

intangible assets

 

 

Total

 

June 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross other intangible assets

 

$

2,164

 

 

$

450

 

 

$

188

 

 

$

2,802

 

Accumulated amortization

 

 

(1,171

)

 

 

(267

)

 

 

 

 

 

(1,438

)

Other intangible assets, net

 

$

993

 

 

$

183

 

 

$

188

 

 

$

1,364

 

December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross other intangible assets

 

$

2,115

 

 

$

451

 

 

$

188

 

 

$

2,754

 

Accumulated amortization

 

 

(1,106

)

 

 

(250

)

 

 

 

 

 

(1,356

)

Other intangible assets, net

 

$

1,009

 

 

$

201

 

 

$

188

 

 

$

1,398

 

 

Intangible asset amortization expense was $45 million and $44 million for the three months ended June 30, 2019 and 2018, respectively, and $88 million and $85 million for the six months ended June 30, 2019 and 2018, respectively.

 

For the three and six months ended June 30, 2019, we recognized a $31 million impairment charge related to a developed-technology intangible asset due to a decline in market expectations for the related product. The fair value of the intangible asset was measured using a discounted cash flow approach and the charge is classified within cost of sales in the accompanying condensed consolidated statements of income. We consider the fair value of the asset to be a Level 3 measurement due to the significant estimates and assumptions we used in establishing the estimated fair value.

5. FINANCING ARRANGEMENTS

Debt Issuance

In May 2019, we issued €750 million of 0.4% senior notes due in May 2024 and €750 million of 1.3% senior notes due in May 2029.  We have designated these debt instruments as net investment hedges of our European operations. Refer to Note 15 for additional information.

Short-term Debt

In the second quarter of 2019, we repaid $795 million of commercial paper and other short-term borrowings that were outstanding as of March 31, 2019. No commercial paper was outstanding as of June 30, 2019 or December 31, 2018.

6. LEASES

Lessee Activity

We have entered into operating and finance leases primarily for office, manufacturing and research and development (R&D) facilities, vehicles and equipment. Our leases have remaining terms from one to 25 years and some of those leases include options that provide us with the ability to extend the lease term for periods ranging from one to 12 years. Such options are included in the lease term when it is reasonably certain that the option will be exercised.

Certain lease contracts include other services, such as operations and maintenance. For all asset classes, we have elected to apply a practical expedient to account for other services within lease contracts as components of the lease. We also have elected to apply a practical expedient for short-term leases whereby we do not recognize a lease liability and right-of-use asset for leases with a term of less than 12 months.

We classify our leases as operating or finance at the lease commencement date. Finance leases are generally those leases for which we will pay substantially all of the underlying asset’s fair value or will use the asset for all or a major part of its economic life, including circumstances in which we will ultimately own the asset. All other leases are operating leases. For finance leases, we recognize interest expense using the effective interest method and we recognize

10

 


 

amortization expense on the right-of-use asset over the shorter of the lease term or the useful life of the asset. For operating leases, we recognize lease cost on a straight-line basis over the term of the lease.

Lease liabilities and right-of-use assets are recognized at the lease commencement date based on the present value of minimum lease payments over the lease term. We determine the present value of payments under a lease based on our incremental borrowing rate as of the lease commencement date. The incremental borrowing rate is equal to the rate of interest that we would have to pay to borrow on a collateralized basis over a similar term in an amount equal to the lease payments in a similar economic environment. For operating leases that commenced prior to our adoption of Topic 842, we measured the lease liabilities and right-of-use assets using our incremental borrowing rate as of January 1, 2019.

There were no material lease transactions that we entered into but have not yet commenced as of June 30, 2019.

 

The components of lease cost for the three and six months ended June 30, 2019 were:

 

(in millions)

 

Three months ended

June 30, 2019

 

 

Six months ended

June 30, 2019

 

Operating lease cost

 

$

29

 

 

$

60

 

Finance lease cost

 

 

 

 

 

 

 

 

Amortization of right-of-use assets

 

 

1

 

 

 

2

 

Interest on lease liabilities

 

 

 

 

 

1

 

Variable lease cost

 

 

21

 

 

 

43

 

Lease cost

 

$

51

 

 

$

106

 

The following table contains supplemental cash flow information related to leases for the six months ended June 30, 2019:

 

(in millions)

 

Six months ended

June 30, 2019

 

Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

 

Operating cash flows from operating leases

 

$

60

 

Operating cash flows from finance leases

 

 

3

 

Financing cash flows from finance leases

 

 

1

 

 

 

 

 

 

Right-of-use operating lease assets obtained in exchange for lease obligations

 

 

140

 

Supplemental balance sheet information related to leases as of June 30, 2019 includes:

 

(in millions)

 

June 30, 2019

 

Operating leases

 

 

 

 

Operating lease right-of-use assets

 

$

588

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

98

 

Operating lease liabilities

 

 

490

 

Total operating lease liabilities

 

$

588

 

 

 

 

 

 

Finance leases

 

 

 

 

Property, plant and equipment, at cost

 

$

81

 

Accumulated depreciation

 

 

(27

)

Property, plant and equipment, net

 

$

54

 

 

 

 

 

 

Current maturities of long-term debt and finance lease obligations

 

$

1

 

Long-term debt and finance lease obligations

 

 

58

 

Total finance lease liabilities

 

$

59

 

11

 


 

Lease term and discount rates as of June 30, 2019 were:

 

 

June 30, 2019

 

Weighted-average remaining lease term (years)

 

 

 

 

Operating leases

 

 

10

 

Finance leases

 

 

15

 

Weighted-average discount rate

 

 

 

 

Operating leases

 

 

2.8

%

Finance leases

 

 

10.3

%

Maturities of operating and finance lease liabilities as of June 30, 2019 were:

 

(in millions)

 

Finance Leases

 

 

Operating Leases

 

2019

 

$

4

 

 

$

59

 

2020

 

 

8

 

 

 

99

 

2021

 

 

8

 

 

 

83

 

2022

 

 

8

 

 

 

70

 

2023

 

 

6

 

 

 

59

 

Thereafter

 

 

82

 

 

 

297

 

Total minimum lease payments

 

 

116

 

 

 

667

 

Less: imputed interest

 

 

(57

)

 

 

(79

)

Present value of lease liabilities

 

$

59

 

 

$

588

 

Future minimum lease payments as of December 31, 2018, as disclosed in our 2018 Annual Report, were:

 

(in millions)

 

Capital Leases

 

 

Operating Leases

 

2019

 

$

8

 

 

$

122

 

2020

 

 

7

 

 

 

93

 

2021

 

 

7

 

 

 

86

 

2022

 

 

8

 

 

 

71

 

2023

 

 

6

 

 

 

64

 

Thereafter

 

 

88

 

 

 

210

 

Total minimum lease payments

 

 

124

 

 

$

646

 

Less: imputed interest

 

 

(62

)

 

 

 

 

Present value of lease liabilities

 

$

62

 

 

 

 

 

Lessor Activity

We lease medical equipment, such as renal dialysis equipment and infusion pumps, to customers primarily in conjunction with arrangements to provide consumable medical products such as dialysis therapies, intravenous (IV) fluids and inhaled anesthetics. Certain of our equipment leases are classified as sales-type leases and the remainder are operating leases. The terms of the related contracts, including the proportion of fixed versus variable payments and any options to shorten or extend the lease term, vary by customer. We allocate revenue between equipment leases and medical products based on their standalone selling prices.  

The components of lease revenue for the three and six months ended June 30, 2019 were:

 

(in millions)

 

Three months ended

June 30, 2019

 

 

Six months ended

June 30, 2019

 

Sales-type lease revenue

 

$

5

 

 

$

11

 

Operating lease revenue

 

 

15

 

 

 

30

 

Variable lease revenue

 

 

21

 

 

 

42

 

Total lease revenue

 

$

41

 

 

$

83

 

12

 


 

The components of our net investment in sales-type leases as of June 30, 2019 were:

 

(in millions)

 

June 30, 2019

 

Minimum lease payments

 

$

86

 

Unguaranteed residual values

 

 

11

 

Net investment in leases

 

$

97

 

 

Our net investment in sales-type leases is classified as follows in the accompanying condensed consolidated balance sheets:

 

(in millions)

 

June 30, 2019

 

Accounts and other current receivables, net

 

$

36

 

Other non-current assets

 

 

61

 

Total

 

$

97

 

Maturities of sales-type and operating leases as of June 30, 2019 were:

 

(in millions)

 

Sales-type Leases

 

 

Operating Leases

 

2019

 

$

17

 

 

$

24

 

2020

 

 

30

 

 

 

48

 

2021

 

 

24

 

 

 

48

 

2022

 

 

15

 

 

 

30

 

2023

 

 

8

 

 

 

16

 

Thereafter

 

 

2

 

 

 

7

 

Total minimum lease payments

 

 

96

 

 

$

173

 

Less: imputed interest

 

 

(10

)

 

 

 

 

Present value of minimum lease payments

 

$

86

 

 

 

 

 

 

7. COMMITMENTS AND CONTINGENCIES

We are involved in product liability, patent, commercial, and other legal matters that arise in the normal course of our business. We record 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 accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. As of June 30, 2019 and December 31, 2018, our total recorded reserves, including the environmental matters discussed below, with respect to legal matters were $49 million and $43 million, respectively, and there were no related receivables.

We have established reserves for certain of the matters discussed below. We are 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 our liability in connection with these claims cannot be estimated and the resolution thereof in any reporting period could have a significant impact on our 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 our consolidated financial position. While we believe that we have valid defenses in the matters set forth below, litigation is inherently uncertain, excessive verdicts do occur, and we may incur material judgments or enter into material settlements of claims.

In addition to the matters described below, we remain 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 our operations and monetary sanctions, including significant civil or criminal penalties. With respect to intellectual property, we may be exposed to significant litigation concerning the scope of our 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.

13

 


 

Environmental

We are involved as a potentially responsible party (PRP) for environmental clean-up costs at six Superfund sites. Under the U.S. Superfund statute and many state laws, generators of hazardous waste sent to a disposal or recycling site are liable for site cleanup if contaminants from that property later leak into the environment. The laws generally provide that a PRP may be held jointly and severally liable for the costs of investigating and remediating the site. Separate from the Superfund cases noted above, we are involved in an ongoing voluntary environmental remediation associated with historic operations at our Irvine, California, United States facility. As of June 30, 2019 and December 31, 2018, our environmental reserves, which are measured on an undiscounted basis, were $20 million and $19 million, respectively.  After considering these reserves, management is of the opinion that the outcome of these matters will not have a material adverse effect on our financial position or results of operations.

General Litigation

In November 2016, a purported antitrust class action complaint seeking monetary and injunctive relief was filed in the United States District Court for the Northern District of Illinois. The complaint alleges a conspiracy among manufacturers of IV solutions to restrict output and affect pricing in connection with a shortage of such solutions. Similar parallel actions subsequently were filed. In January 2017, a single consolidated complaint covering these matters was filed in the Northern District of Illinois. We filed a motion to dismiss the consolidated complaint in February 2017.  The court granted our motion to dismiss the consolidated complaint without prejudice in July 2018. The plaintiffs filed an amended complaint on September 6, 2018.  We filed a motion to dismiss the amended complaint on November 9, 2018.

In April 2017, we became aware of a criminal investigation by the U.S. Department of Justice (DOJ), Antitrust Division and a federal grand jury in the United States District Court for the Eastern District of Pennsylvania. We and an employee received subpoenas seeking production of documents and testimony regarding the manufacturing, selling, pricing and shortages of IV solutions and containers (including saline solutions and certain other injectable medicines sold by us) and communications with competitors regarding the same. On November 30, 2018, the DOJ notified us that it had closed the investigation. The New York Attorney General has also requested that we provide information regarding business practices in the IV saline industry. We are cooperating with the New York Attorney General.  

Other

As previously disclosed, in 2008 we recalled our heparin sodium injection products in the United States.  Following the recall, more than 1,000 lawsuits alleging that plaintiffs suffered various reactions to a heparin contaminant, in some cases resulting in fatalities, were filed. In January 2019, the last of these cases was settled. In the first half of 2019, following the resolution of an insurance dispute, we received cash proceeds of $35 million for our allocation of the insurance proceeds under a settlement and cost-sharing agreement related to the defense of the heparin product liability cases. We recognized a $33 million gain in connection with the resolution of the dispute with the insurer that is classified within other operating income, net on the condensed consolidated statement of income for the six months ended June 30, 2019.

In September 2017, Hurricane Maria caused damage to certain of our assets in Puerto Rico and disrupted operations.  As previously disclosed, we realized $42 million of insurance recoveries in 2018 related to the damages and losses from that hurricane. In July 2019, an additional $40 million of claims were approved by our insurers and will be recognized in the quarter ending September 30, 2019.

In December 2016, we received a civil investigative demand from the Commercial Litigation Branch of the U.S. DOJ primarily relating to contingent discount arrangements for, and other promotion of, our TISSEEL and ARTISS products. In April 2018, the DOJ filed a notice of its decision not to intervene and an underlying qui tam complaint (U.S. ex rel. Andrew Capp v. Baxter) was unsealed in the United States District Court for the District of Columbia. The attorney for the relator/plaintiff voluntarily dismissed the qui tam complaint on June 16, 2018. The complaint which is now fully resolved, related to contingent discount arrangements for, and other promotion of, our TISSEEL, ARTISS and VERITAS products.

8. STOCKHOLDERS’ EQUITY

Cash Dividends

Cash dividends declared per common share for the three and six months ended June 30, 2019 were $0.22 and $0.41, respectively.  Cash dividends declared per common share for the three and six months ended June 30, 2018 were $0.19 and $0.35, respectively.

14

 


 

Stock Repurchase Programs

In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of our common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018 and by an additional $2.0 billion in November 2018. During the first half of 2019, we repurchased 9.5 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise. During the first half of 2018, we repurchased 11.5 million shares pursuant to Rule 10b5-1 plans. We had $1.4 billion remaining available under the authorization as of June 30, 2019.

In December 2018, we entered into a $300 million accelerated share repurchase agreement (ASR Agreement) with an investment bank. We funded the ASR Agreement with available cash. The ASR Agreement was executed pursuant to the 2012 Repurchase Authorization described above. Under the ASR Agreement, we received 3.6 million shares upon execution.  Based on the volume-weighted average price of our common stock during the term of the ASR Agreement, we received an additional 0.6 million shares from the investment bank at settlement on May 7, 2019.

9. ACCUMULATED OTHER COMPREHENSIVE INCOME

Comprehensive income includes all changes in stockholders’ equity that do not arise from transactions with shareholders, and consists of net income, currency translation adjustments (CTA), pension and other postretirement employee benefit (OPEB) plans, unrealized gains and losses on cash flow hedges and prior to 2018, unrealized gains and losses on available-for-sale equity securities.  As a result of changes in accounting guidance related to available-for-sale equity securities, the unrealized gains and losses associated with these assets are no longer recognized in AOCI beginning January 1, 2018. The following table is a net-of-tax summary of the changes in AOCI by component for the six months ended June 30, 2019 and 2018.

 

(in millions)

 

CTA

 

 

Pension and

OPEB plans

 

 

Hedging

activities

 

 

Total

 

Gains (losses)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2018

 

$

(3,474

)

 

$

(949

)

 

$

(1

)

 

$

(4,424

)

Adoption of new accounting standard

 

 

9

 

 

 

(169

)

 

 

(1

)

 

 

(161

)

Other comprehensive income before reclassifications

 

 

(48

)

 

 

8

 

 

 

(26

)

 

 

(66

)

Amounts reclassified from AOCI (a)

 

 

 

 

 

13

 

 

 

(1

)

 

 

12

 

Net other comprehensive income (loss)

 

 

(48

)

 

 

21

 

 

 

(27

)

 

 

(54

)

Balance as of June 30, 2019

 

$

(3,513

)

 

$

(1,097

)

 

$

(29

)

 

$

(4,639

)

 

(in millions)

 

CTA

 

 

Pension and

OPEB plans

 

 

Hedging

activities

 

 

Available-

for-sale-

equity securities

 

 

Total

 

Gains (losses)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2017

 

$

(3,013

)

 

$

(981

)

 

$

(10

)

 

$

3

 

 

$

(4,001

)

Adoption of new accounting standard

 

 

 

 

 

 

 

 

 

 

 

(3

)

 

 

(3

)

Other comprehensive income before reclassifications

 

 

(282

)

 

 

51

 

 

 

(1

)

 

 

 

 

 

(232

)

Amounts reclassified from AOCI (a)

 

 

 

 

 

30

 

 

 

7

 

 

 

 

 

 

37

 

Net other comprehensive income (loss)

 

 

(282

)

 

 

81

 

 

 

6

 

 

 

 

 

 

(195

)

Balance as of June 30, 2018

 

$

(3,295

)

 

$

(900

)

 

$

(4

)

 

$

 

 

$

(4,199

)

(a)

See table below for details about these reclassifications.

15

 


 

The following is a summary of the amounts reclassified from AOCI to net income during the three and six months ended June 30, 2019 and 2018.

 

 

 

Amounts reclassified from AOCI (a)

 

 

 

(in millions)

 

Three months ended

June 30, 2019

 

 

Six months ended

June 30, 2019

 

 

Location of impact in income statement

Amortization of pension and OPEB items

 

 

 

 

 

 

 

 

 

 

Amortization of net losses and prior service costs or credits

 

$

(7

)

 

$

(15

)

 

Other income, net

 

 

 

(7

)

 

 

(15

)

 

Total before tax

 

 

 

1

 

 

 

2

 

 

Income tax expense

 

 

$

(6

)

 

$

(13

)

 

Net of tax

Gains on hedging activities

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

1

 

 

$

1

 

 

Cost of sales

 

 

 

1

 

 

 

1

 

 

Total before tax

 

 

 

 

 

 

 

 

Income tax expense

 

 

$

1

 

 

$

1

 

 

Net of tax

Total reclassifications for the period

 

$

(5

)

 

$

(12

)

 

Total net of tax

 

 

 

Amounts reclassified from AOCI (a)

 

 

 

(in millions)

 

Three months ended

June 30, 2018

 

 

Six months ended

June 30, 2018

 

 

Location of impact in income statement

Amortization of pension and OPEB items

 

 

 

 

 

 

 

 

 

 

Amortization of net losses and prior service costs or credits

 

$

(18

)

 

$

(36

)

 

Other income, net

 

 

 

(18

)

 

 

(36

)

 

Total before tax

 

 

 

3

 

 

 

6

 

 

Income tax expense

 

 

$

(15

)

 

$

(30

)

 

Net of tax

Losses on hedging activities

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

(6

)

 

$

(10

)

 

Cost of sales

 

 

 

(6

)

 

 

(10

)

 

Total before tax

 

 

 

2

 

 

 

3

 

 

Income tax expense

 

 

$

(4

)

 

$

(7

)

 

Net of tax

Total reclassifications for the period

 

$

(19

)

 

$

(37

)

 

Total net of tax

(a)

Amounts in parentheses indicate reductions to net income. 

Refer to Note 12 for additional information regarding the amortization of pension and OPEB items and Note 15 for additional information regarding hedging activity.

10. REVENUES

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the contract. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Some of our contracts have multiple performance obligations. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. Our global payment terms are typically between 30-90 days.

16

 


 

The majority of our performance obligations are satisfied at a point in time. This includes sales of our broad portfolio of essential healthcare products across our geographic segments including acute and chronic dialysis therapies; sterile IV solutions; infusion systems and devices; parenteral nutrition therapies; inhaled anesthetics; generic injectable pharmaceuticals; and surgical hemostat and sealant products. For a majority of these sales, our performance obligation is satisfied upon delivery to the customer. Shipping and handling activities are considered to be fulfillment activities and are not considered to be a separate performance obligation.

To a lesser extent, in all of our segments, we enter into other types of contracts including contract manufacturing arrangements, equipment leases, and certain subscription software and licensing arrangements. We recognize revenue for these arrangements over time or at a point in time depending on our evaluation of when the customer obtains control of the promised goods or services. Revenue is recognized over time when we are creating or enhancing an asset that the customer controls as the asset is created or enhanced or our performance does not create an asset with an alternative use and we have an enforceable right to payment for performance completed.

On June 30, 2019, we had $8.9 billion of transaction price allocated to remaining performance obligations related to executed contracts with an original duration of one year or more, which are primarily included in the Americas segment. Some contracts in the United States included in this amount contain index-dependent price increases, which are not known at this time. We expect to recognize approximately 10% of this amount as revenue over the remainder of 2019, 20% in each year between 2020 and 2022, 10% in each of 2023 and 2024, and the remaining balance thereafter.

Significant Judgments

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for reserves related to rebates, product returns, sales discounts and wholesaler chargebacks. These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are included in accounts and other current receivables, net and accounts payable and accrued liabilities on the condensed consolidated balance sheets. Management's estimates take into consideration historical experience, current contractual and statutory requirements, specific known market events and trends, industry data, and forecasted customer buying and payment patterns. Overall, these reserves reflect our best estimates of the amount of consideration to which we are entitled based on the terms of the contract using the expected value method. The amount of variable consideration included in the net sales price is limited to the amount that is probable not to result in a significant reversal in the amount of the cumulative revenue recognized in a future period. Revenue recognized during the three and six months ended June 30, 2019 and 2018 related to performance obligations satisfied in prior periods was not material.

Contract Balances

The timing of revenue recognition, billings and cash collections results in the recognition of trade accounts receivable, unbilled receivables, contract assets and customer advances and deposits (contract liabilities) on our condensed consolidated balance sheets. Net trade accounts receivable were $1.8 billion and $1.7 billion as of June 30, 2019 and December 31, 2018, respectively.

For contract manufacturing arrangements, revenue is primarily recognized throughout the production cycle, which typically lasts up to 90 days, resulting in the recognition of contract assets until the related services are completed and the customers are billed. Additionally, for arrangements containing a performance obligation to deliver software that can be used with medical devices, we recognize revenue upon delivery of the software, which results in the recognition of contract assets when customers are billed over time, generally over one to five years. For certain bundled contracts, total contract revenue is allocated between equipment and consumable medical products. In conjunction with these arrangements, a contract asset is created, which represents the difference between the amount of equipment revenue recognized upon sale and the amount of consideration received from the customer. The contract asset is reclassified as accounts receivable as consumable medical products are provided and billed, generally over one to seven years. Our contract asset balances totaled $89 million as of June 30, 2019, of which $37 million related to contract manufacturing services, $40 million related to software sales and $12 million related to bundled equipment and consumable medical products contracts. Our contract asset balances totaled $80 million as of December 31, 2018, of which $33 million related to contract manufacturing services and $47 million related to software sales. Contract assets are presented within accounts and other receivables, net ($57 million and $50 million as of June 30, 2019 and December 31, 2018, respectively) and other non-current assets ($32 million and $30 million as of June 30, 2019 and December 31, 2018, respectively) in the accompanying condensed consolidated balance sheets. Contract liabilities as of June 30, 2019 and December 31, 2018 were not significant.

17

 


 

Disaggregation of Net Sales

The following tables disaggregate our net sales from contracts with customers by Global Business Unit (GBU) between the U.S. and international:

 

 

Three months ended June 30,

 

 

 

2019

 

 

2018

 

(in millions)

 

U.S.

 

 

International

 

 

Total

 

 

U.S.

 

 

International

 

 

Total

 

Renal Care 1

 

$

196

 

 

$

714

 

 

$

910

 

 

$

204

 

 

$

727

 

 

$

931

 

Medication Delivery 2

 

 

441

 

 

 

248

 

 

 

689

 

 

 

426

 

 

 

255

 

 

 

681

 

Pharmaceuticals 3

 

 

235

 

 

 

304

 

 

 

539

 

 

 

262

 

 

 

275

 

 

 

537

 

Clinical Nutrition 4

 

 

79

 

 

 

136

 

 

 

215

 

 

 

80

 

 

 

141

 

 

 

221

 

Advanced Surgery 5

 

 

143

 

 

 

89

 

 

 

232

 

 

 

118

 

 

 

86

 

 

 

204

 

Acute Therapies 6

 

 

44

 

 

 

89

 

 

 

133

 

 

 

42

 

 

 

87

 

 

 

129

 

Other 7

 

 

55

 

 

 

67

 

 

 

122

 

 

 

78

 

 

 

61

 

 

 

139

 

Total Baxter

 

$

1,193

 

 

$

1,647

 

 

$

2,840

 

 

$

1,210

 

 

$

1,632

 

 

$

2,842

 

 

 

 

Six months ended June 30,

 

 

 

2019

 

 

2018

 

(in millions)

 

U.S.

 

 

International

 

 

Total

 

 

U.S.

 

 

International

 

 

Total

 

Renal Care 1

 

$

388

 

 

$

1,373

 

 

$

1,761

 

 

$

400

 

 

$

1,399

 

 

$

1,799

 

Medication Delivery 2

 

 

847

 

 

 

476

 

 

 

1,323

 

 

 

862

 

 

 

495

 

 

 

1,357

 

Pharmaceuticals 3

 

 

467

 

 

 

581

 

 

 

1,048

 

 

 

505

 

 

 

528

 

 

 

1,033

 

Clinical Nutrition 4

 

 

156

 

 

 

264

 

 

 

420

 

 

 

163

 

 

 

281

 

 

 

444

 

Advanced Surgery 5

 

 

263

 

 

 

167

 

 

 

430

 

 

 

217

 

 

 

169

 

 

 

386

 

Acute Therapies 6

 

 

92

 

 

 

169

 

 

 

261

 

 

 

88

 

 

 

170

 

 

 

258

 

Other 7

 

 

100

 

 

 

129

 

 

 

229

 

 

 

122

 

 

 

120

 

 

 

242

 

Total Baxter

 

$

2,313

 

 

$

3,159

 

 

$

5,472

 

 

$

2,357

 

 

$

3,162

 

 

$

5,519

 

 

1

Renal Care includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services.

 

2

Medication Delivery includes sales of our IV therapies, infusion pumps, administration sets and drug reconstitution devices.

 

3

Pharmaceuticals includes sales of our premixed and oncology drug platforms, inhaled anesthesia and critical care products and pharmacy compounding services.

 

4

Clinical Nutrition includes sales of our parenteral nutrition (PN) therapies and related products.

 

5

Advanced Surgery includes sales of our biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.

 

6

Acute Therapies includes sales of our continuous renal replacement therapies (CRRT) and other organ support therapies focused in the intensive care unit (ICU).

 

7

Other primarily includes sales of contract manufacturing services from our pharmaceutical partnering business.

11. BUSINESS OPTIMIZATION CHARGES

Beginning in the second half of 2015, we have undertaken actions to transform our cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through June 30, 2019, we have incurred cumulative pre-tax costs of $899 million related to these actions. The costs consisted primarily of employee termination, implementation costs and accelerated depreciation. We currently expect to incur additional pre-tax costs of approximately $70 million through the completion of these initiatives under our current program. These costs will primarily include employee termination costs, implementation costs, and accelerated depreciation.  

18

 


 

During the three and six months ended June 30, 2019 and 2018, we recorded the following charges related to business optimization programs.

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Restructuring charges

 

$

52

 

 

$

21

 

 

$

77

 

 

$

33

 

Costs to implement business optimization programs

 

 

12

 

 

 

25

 

 

 

22

 

 

 

50

 

Accelerated depreciation

 

 

1

 

 

 

1

 

 

 

4

 

 

 

2

 

Total business optimization charges

 

$

65

 

 

$

47

 

 

$

103

 

 

$

85

 

 

For segment reporting, business optimization charges are unallocated expenses.

Costs to implement business optimization programs for the three and six months ended June 30, 2019 and 2018, respectively, consisted primarily of external consulting and transition costs, including employee compensation and related costs. The costs were generally included within cost of sales, selling, general and administrative (SG&A) expense and R&D expense.

For the three and six months ended June 30, 2019 and 2018, respectively, we recognized accelerated depreciation, primarily associated with facilities to be closed. The costs were recorded within cost of sales and SG&A expense.

During the three and six months ended June 30, 2019 and 2018, we recorded the following restructuring charges.

 

 

 

 

 

 

Three months ended June 30, 2019

 

(in millions)

 

COGS

 

 

SG&A

 

 

R&D

 

 

Total

 

Employee termination costs

 

$

6

 

 

$

26

 

 

$

17

 

 

$

49

 

Contract termination and other costs

 

 

1

 

 

 

 

 

 

 

 

 

1

 

Asset impairments

 

 

1

 

 

 

 

 

 

1

 

 

 

2

 

Total restructuring charges

 

$

8

 

 

$

26

 

 

$

18

 

 

$

52

 

 

 

 

 

 

 

 

Three months ended June 30, 2018

 

(in millions)

 

COGS

 

 

SG&A

 

 

R&D

 

 

Total

 

Employee termination costs

 

$

3

 

 

$

8

 

 

$

7

 

 

$

18

 

Contract termination costs

 

 

 

 

 

2

 

 

 

 

 

 

2

 

Asset impairments

 

 

 

 

 

1

 

 

 

 

 

 

1

 

Total restructuring charges

 

$

3

 

 

$

11

 

 

$

7

 

 

$

21

 

 

 

 

 

 

 

 

Six months ended June 30, 2019

 

(in millions)

 

COGS

 

 

SG&A

 

 

R&D

 

 

Total

 

Employee termination costs

 

$

6

 

 

$

25

 

 

$

26

 

 

$

57

 

Contract termination and other costs

 

 

8

 

 

 

 

 

 

 

 

 

8

 

Asset impairments

 

 

10

 

 

 

1

 

 

 

1

 

 

 

12

 

Total restructuring charges

 

$

24

 

 

$

26

 

 

$

27

 

 

$

77

 

 

 

 

 

 

 

 

Six months ended June 30, 2018

 

(in millions)

 

COGS

 

 

SG&A

 

 

R&D

 

 

Total

 

Employee termination costs

 

$

4

 

 

$

14

 

 

$

10

 

 

$

28

 

Contract termination costs

 

 

 

 

 

2

 

 

 

 

 

 

2

 

Asset impairments

 

 

1

 

 

 

2

 

 

 

 

 

 

3

 

Total restructuring charges

 

$

5

 

 

$

18

 

 

$

10

 

 

$

33

 

 

19

 


 

The following table summarizes activity in the reserves related to our restructuring initiatives.

 

(in millions)

 

 

 

 

Reserve as of December 31, 2018

 

$

101

 

Charges

 

 

78

 

Reserve adjustments

 

 

(13

)

Utilization

 

 

(60

)

Currency translation

 

 

2

 

Reserve as of June 30, 2019

 

$

108

 

 

Reserve adjustments primarily related to employee termination cost reserves established in prior periods.

Substantially all of our restructuring reserves as of June 30, 2019 relate to employee termination costs, with the remaining reserves attributable to contract termination costs. The reserves are expected to be substantially utilized by the end of 2020.

12. PENSION AND OTHER POSTRETIREMENT BENEFIT PROGRAMS

The following is a summary of net periodic benefit cost relating to our pension and OPEB plans.

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Pension benefits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

19

 

 

$

25

 

 

$

38

 

 

$

47

 

Interest cost

 

 

43

 

 

 

45

 

 

 

90

 

 

 

91

 

Expected return on plan assets

 

 

(67

)

 

 

(79

)

 

 

(140

)

 

 

(157

)

Amortization of net losses and prior service costs

 

 

14

 

 

 

24

 

 

 

29

 

 

 

48

 

Net periodic pension benefit cost

 

$

9

 

 

$

15

 

 

$

17

 

 

$

29

 

OPEB

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest cost

 

$

2

 

 

$

2

 

 

$

4

 

 

$

4

 

Amortization of net loss and prior service credit

 

 

(7

)

 

 

(6

)

 

 

(14

)

 

 

(12

)

Net periodic OPEB cost

 

$

(5

)

 

$

(4

)

 

$

(10

)

 

$

(8

)

 

13. INCOME TAXES

Our effective income tax rate was 5.5% and 15.1% for the three months ended June 30, 2019 and 2018, respectively, and 8.5% and 13.1% for the six months ended June 30, 2019 and 2018, respectively. Our effective income tax rate can differ from the 21% U.S. Federal statutory rate due to a number of factors, including foreign rate differences, tax incentives, increases or decreases in valuation allowances and liabilities for uncertain tax positions and excess tax benefits on stock compensation awards.

For the three and six months ended June 30, 2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to a tax benefit from the resolution of an uncertain tax position (UTP) as a result of a favorable ruling from the related taxing authority and excess tax benefits on stock compensation awards.  For the three months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily driven by excess tax benefits on stock compensation awards, partially offset by the revaluation of Swedish net deferred tax assets due to legislation reducing the Swedish income tax rate. For the six months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to nontaxable income from the settlement of certain claims with the seller of the acquired operations of Claris Injectables Limited, excess tax benefits on stock compensation awards, an adjustment of provisional amounts related to U.S. tax reform, a reduction of a liability for a UTP as a result of a settlement with the related taxing authority and the reversal of a valuation allowance as a result of continued profit improvements.  Partially offsetting the foregoing benefits was interest on the reserve for UTPs, the revaluation of Swedish net deferred tax assets and transfer pricing-related income tax accruals.

20

 


 

14. EARNINGS PER SHARE

The numerator for both basic and diluted earnings per share (EPS) is net income. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The dilutive effect of outstanding stock options, restricted stock units (RSUs) and performance share units (PSUs) is reflected in the denominator for diluted EPS using the treasury stock method.

The following table is a reconciliation of basic shares to diluted shares.

 

Three months ended

 

 

Six months ended

 

 

June 30,

 

 

June 30,

 

(in millions)

2019

 

 

2018

 

 

2019

 

 

2018

 

Basic shares

 

510

 

 

 

535

 

 

 

511

 

 

 

537

 

Effect of dilutive securities

 

9

 

 

 

12

 

 

 

9

 

 

 

12

 

Diluted shares

 

519

 

 

 

547

 

 

 

520

 

 

 

549

 

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 4 million equity awards each for the three and six months ended June 30, 2019, respectively, and 4 million and 3 million equity awards for the three and six months ended June 30, 2018, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS.

15. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. Our hedging policy attempts to manage these risks to an acceptable level based on our judgment of the appropriate trade-off between risk, opportunity and costs.

We are primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Mexican Peso and Swedish Krona. We manage our foreign currency exposures on a consolidated basis, which allows us to net exposures and take advantage of any natural offsets. In addition, we use derivative and nonderivative instruments to further reduce the net exposure to foreign exchange risk. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and equity volatility resulting from changes in foreign exchange rates. Financial market and currency volatility may limit our ability to cost-effectively hedge these exposures.

We are also exposed to the risk that our earnings and cash flows could be adversely impacted by fluctuations in interest rates. Our policy is to manage interest costs using a mix of fixed- and floating-rate debt that we believe is appropriate.

To manage this mix in a cost-efficient manner, we periodically enter into interest rate swaps in which we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount.

We do not hold any instruments for trading purposes and none of our 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. We designate certain of our hedging instruments as cash flow, fair value, or net investment hedges.

Cash Flow Hedges

We 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. We periodically use treasury rate locks to hedge the risk to earnings associated with movements in interest rates relating to anticipated issuances of debt.

21

 


 

For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is recorded 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 interest expense, net, and are primarily related 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 designated as cash flow hedges were $629 million and $775 million as of June 30, 2019 and December 31, 2018, respectively. The total notional amounts of interest rate contracts designated as cash flow hedges were $300 million and $150 million as of June 30, 2019 and December 31, 2018, respectively. The maximum term over which we have cash flow hedge contracts in place related to forecasted transactions at June 30, 2019 is 18 months for foreign exchange contracts and 30 years for interest rate contracts.

Fair Value Hedges

We periodically use interest rate swaps to convert a portion of our fixed-rate debt into variable-rate debt. These instruments hedge our 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 interest expense, net, as they hedge the interest rate risk associated with certain of our fixed-rate debt.

There were no outstanding interest rate swap contracts designated as fair value hedges as of June 30, 2019 and December 31, 2018.

Net Investment Hedges

In May 2017, we issued €600 million of senior notes due May 2025. In May 2019, we issued €750 million of senior notes due May 2024 and €750 million of senior notes due May 2029. We have designated these debt obligations as hedges of our net investment in our European operations and, as a result, mark to spot rate adjustments of the outstanding debt balances have been and will be recorded as a component of AOCI. As of June 30, 2019, we had an accumulated pre-tax unrealized translation loss in AOCI of $69 million related to the Euro-denominated senior notes.

In May 2019, we entered into forward contracts designated as net investment hedges to reduce exposure to changes in currency rates on €1.2 billion of our net investment in our European operations.  Those hedges were entered into in advance of the issuance of our senior notes mentioned above, were settled in the second quarter of 2019 and resulted in an insignificant loss.

Dedesignations

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, we discontinue hedge accounting prospectively. If we remove 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 2019 or 2018 resulting from changes in our assessment of the probability that the hedged forecasted transactions would occur.

If we terminate 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 six months of 2019 and 2018.

If we terminate a net investment hedge, any gain or loss recognized in AOCI is not reclassified to earnings until we sell, liquidate, or deconsolidate the foreign investments that were being hedged. In the second quarter of 2019, we dedesignated €1.2 billion of forward contracts designated as a net investment hedge of our European operations.

22

 


 

Undesignated Derivative Instruments

We use forward contracts to hedge earnings from the effects of foreign exchange relating to certain of our intercompany and third-party receivables and payables denominated in a foreign currency. These derivative instruments are generally not formally designated as hedges and the terms of these instruments generally do not exceed one month. 

The total notional amount of undesignated derivative instruments was $494 million as of June 30, 2019 and $485 million as of December 31, 2018.

Gains and Losses on Derivative Instruments

The following tables summarize the income statement locations and gains and losses on our derivative instruments for the three months ended June 30, 2019 and 2018.

 

 

 

Gain (loss) recognized in OCI

 

 

Location of gain (loss)

 

Gain (loss) reclassified from AOCI

into income

 

(in millions)

 

2019

 

 

2018

 

 

in income statement

 

2019

 

 

2018

 

Cash flow hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

$

(23

)

 

$

 

 

Interest expense, net

 

$

 

 

$

 

Foreign exchange contracts

 

 

9

 

 

 

7

 

 

Cost of sales

 

 

1

 

 

 

(6

)

Net investment hedges

 

 

(36

)

 

 

38

 

 

Other income, net

 

 

 

 

 

 

Total

 

$

(50

)

 

$

45

 

 

 

 

$

1

 

 

$

(6

)

 

 

 

 

 

Gain (loss) recognized in income

 

(in millions)

 

Location of gain (loss) in income statement

 

2019

 

 

2018

 

Undesignated derivative instruments

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Other income, net

 

$

3

 

 

$

6

 

 

The following tables summarize the income statement locations and gains and losses on our derivative instruments for the six months ended June 30, 2019 and 2018.

 

 

 

Gain (loss) recognized in OCI

 

 

Location of gain (loss)

 

Gain (loss) reclassified from AOCI

into income

 

(in millions)

 

2019

 

 

2018

 

 

in income statement

 

2019

 

 

2018

 

Cash flow hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

$

(34

)

 

$

 

 

Interest expense, net

 

$

 

 

$

 

Foreign exchange contracts

 

 

 

 

 

(2

)

 

Cost of sales

 

 

1

 

 

 

(10

)

Net investment hedges

 

 

(22

)

 

 

17

 

 

Other income, net

 

 

 

 

 

 

Total

 

$

(56

)

 

$

15

 

 

 

 

$

1

 

 

$

(10

)

 

 

 

 

 

 

Gain (loss) recognized in income

 

(in millions)

 

Location of gain (loss) in income statement

 

2019

 

 

2018

 

Fair value hedges

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Interest expense, net

 

$

 

 

$

(4

)

Undesignated derivative instruments

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Other income, net

 

$

(6

)

 

$

(11

)

 

For our fair value hedges, an equal and offsetting gain of $4 million was recognized in interest expense, net as an adjustment to the underlying hedged item, fixed-rate debt, in the second quarter and first half of 2018.

As of June 30, 2019, $13 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.

23

 


 

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, 2019.

 

 

 

Derivatives in asset positions

 

 

Derivatives in liability positions

 

(in millions)

 

Balance sheet location

 

Fair value

 

 

Balance sheet location

 

Fair value

 

Derivative instruments designated as hedges

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other non-current assets

 

$

 

 

Other non-current liabilities

 

 

$

37

 

Foreign exchange contracts

 

Prepaid expenses and other

 

 

20

 

 

Accounts payable

and accrued liabilities

 

 

1

 

Foreign exchange contracts

 

Other non-current assets

 

 

1

 

 

Other non-current liabilities

 

 

 

Total derivative instruments designated as hedges

 

 

 

 

21

 

 

 

 

 

38

 

Undesignated derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Prepaid expenses and other

 

 

 

 

Accounts payable

and accrued liabilities

 

 

 

Total derivative instruments

 

 

 

$

21

 

 

 

 

$

38

 

 

The following table summarizes the classification and fair values of derivative instruments reported in the condensed consolidated balance sheet as of December 31, 2018.

 

 

 

Derivatives in asset positions

 

 

Derivatives in liability positions

 

(in millions)

 

Balance sheet location

 

Fair value

 

 

Balance sheet location

 

Fair value

 

Derivative instruments designated as hedges

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Other non-current assets

 

$

 

 

Other non-current liabilities

 

$

3

 

Foreign exchange contracts

 

Prepaid expenses and other

 

 

22

 

 

Accounts payable

and accrued liabilities

 

 

1

 

Foreign exchange contracts

 

Other non-current assets

 

 

1

 

 

Other non-current liabilities

 

 

 

Total derivative instruments designated as hedges

 

 

 

 

23

 

 

 

 

 

4

 

Undesignated derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Prepaid expenses and other

 

 

 

 

Accounts payable

and accrued liabilities

 

 

1

 

Total derivative instruments

 

 

 

$

23

 

 

 

 

$

5

 

 

While some of our derivatives are subject to master netting arrangements, we present our assets and liabilities related to derivative instruments on a gross basis within the condensed consolidated balance sheets. Additionally, we are not required to post collateral for any of our outstanding derivatives.

24

 


 

The following table provides information on our derivative positions as if they were presented on a net basis, allowing for the right of offset by counterparty.

 

 

June 30, 2019

 

 

December 31, 2018

 

(in millions)

 

Asset

 

 

Liability

 

 

Asset

 

 

Liability

 

Gross amounts recognized in the consolidated balance sheet

 

$

21

 

 

$

38

 

 

$

23

 

 

$

5

 

Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet

 

 

(1

)

 

 

(1

)

 

 

(5

)

 

 

(5

)

Total

 

$

20

 

 

$

37

 

 

$

18

 

 

$

 

The following table presents the amounts recorded on the condensed consolidated balance sheet related to fair value hedges:

 

 

Carrying amount of hedged item

 

 

Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged item (a)

 

(in millions)

 

Balance as of

June 30, 2019

 

 

Balance as of

December 31, 2018

 

 

Balance as of

June 30, 2019

 

 

Balance as of

December 31, 2018

 

Long-term debt

 

$

103

 

 

$

103

 

 

$

6

 

 

$

7

 

(a) These fair value hedges were terminated prior to December 31, 2018.

16. FAIR VALUE MEASUREMENTS

The following tables summarize our financial instruments that are measured at fair value on a recurring basis.

 

 

 

 

 

 

 

Basis of fair value measurement

 

(in millions)

 

Balance as of

June 30, 2019

 

 

Quoted prices in

active markets for

identical assets

(Level 1)

 

 

Significant other

observable inputs

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

21

 

 

$

 

 

$

21

 

 

$

 

Marketable equity securities

 

 

4

 

 

 

4

 

 

 

 

 

 

 

Total

 

$

25

 

 

$

4

 

 

$

21

 

 

$

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

1

 

 

$

 

 

$

1

 

 

$

 

Interest rate contracts

 

 

37

 

 

 

 

 

 

37

 

 

 

 

Contingent payments related to acquisitions

 

 

27

 

 

 

 

 

 

 

 

 

27

 

Total

 

$

65

 

 

$

 

 

$

38

 

 

$

27

 

25

 


 

 

 

 

 

 

 

 

Basis of fair value measurement

 

(in millions)

 

Balance as of

December 31, 2018

 

 

Quoted prices in

active markets for

identical assets

(Level 1)

 

 

Significant other

observable inputs

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

23

 

 

$

 

 

$

23

 

 

$

 

Marketable equity securities

 

 

3

 

 

 

3

 

 

 

 

 

 

 

Total

 

$

26

 

 

$

3

 

 

$

23

 

 

$

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

$

2

 

 

$

 

 

$

2

 

 

$

 

Interest rate contracts

 

 

3

 

 

 

 

 

 

3

 

 

 

 

Contingent payments related to acquisitions

 

 

32

 

 

 

 

 

 

 

 

 

32

 

Total

 

$

37

 

 

$

 

 

$

5

 

 

$

32

 

 

As of June 30, 2019 and December 31, 2018, cash and cash equivalents of $2.9 billion and $1.8 billion, respectively, included money market funds of approximately $1.5 billion and $169 million, respectively, which are 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 us 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, which are considered observable and vary depending on the type of derivative, include contractual terms, interest rate yield curves, foreign exchange rates and volatility.

Contingent payments related to acquisitions, which consist of milestone payments and sales-based payments, are valued using discounted cash flow techniques. The fair value of milestone payments reflects management’s expectations of probability of payment, and increases as the probability of payment increases or the expected timing of payments is accelerated. The fair value of sales-based payments is based upon probability-weighted future revenue estimates, and increases as revenue estimates increase, probability weighting of higher revenue scenarios increases or the expected timing of payment is accelerated. The following table is a reconciliation of the fair value measurements that use significant unobservable inputs (Level 3), which consist of contingent payments related to acquisitions.

 

 

 

Three months ended

June 30,

 

 

Six months ended

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Fair value at beginning of period

 

$

31

 

 

$

23

 

 

$

32

 

 

$

9

 

Additions

 

 

 

 

 

 

 

 

 

 

 

14

 

Change in fair value recognized in earnings

 

 

(4

)

 

 

 

 

 

(4

)

 

 

 

Payments

 

 

 

 

 

 

 

 

(1

)

 

 

 

Fair value at end of period

 

$

27

 

 

$

23

 

 

$

27

 

 

$

23

 

Equity investments not measured at fair value are comprised of other equity investments without readily determinable fair values and were $39 million at June 30, 2019 and $41 million at December 31, 2018. These amounts are included in Other non-current assets.

26

 


 

Fair Values of Financial Instruments Not Measured at Fair Value

In addition to the financial instruments that we are required to recognize at fair value in the condensed consolidated balance sheets, we have certain financial instruments that are recognized at amortized 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 estimated fair values as of June 30, 2019 and December 31, 2018.

 

 

 

Book values

 

 

Fair values(a)

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term debt

 

$

2

 

 

$

2

 

 

$

2

 

 

$

2

 

Current maturities of long-term debt and finance lease obligations

 

 

2

 

 

 

2

 

 

 

2

 

 

 

2

 

Long-term debt and finance lease obligations

 

 

5,157

 

 

 

3,473

 

 

 

5,440

 

 

 

3,460

 

(a)

These fair value amounts are classified as Level 2 within the fair value hierarchy as they are estimated based on observable inputs.

The carrying value of short-term debt approximates its fair value due to the short-term maturities of the obligations. The estimated fair values of current and long-term debt were computed by multiplying price by the notional amount of the respective debt instruments. Price is calculated using the stated terms of the respective debt instrument and yield curves commensurate with our credit risk. The carrying values of other financial instruments approximate their fair values due to the short-term maturities of most of those assets and liabilities.

17. SEGMENT INFORMATION

We manage our business based on three geographical segments: Americas (North and South America), EMEA (Europe, Middle East and Africa) and APAC (Asia Pacific). Our segments provide a broad portfolio of essential healthcare products, including acute and chronic dialysis therapies; sterile IV solutions; infusion systems and devices; parenteral nutrition therapies; inhaled anesthetics; generic injectable pharmaceuticals; and surgical hemostat and sealant products.

We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of our business segments. Intersegment sales are eliminated in consolidation.

Certain items are maintained at Corporate and are not allocated to a segment. They primarily include the majority of the foreign currency hedging activities, corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation expense, certain employee benefit plan costs as well as certain gains, losses, and other charges (such as business optimization, acquisition and integration costs, intangible asset amortization and asset impairments). Our chief operating decision maker does not receive any asset information by operating segment and, accordingly, we do not report asset information by operating segment.

Financial information for our segments is as follows.

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

1,520

 

 

$

1,525

 

 

$

2,928

 

 

$

2,967

 

EMEA

 

 

744

 

 

 

758

 

 

 

1,449

 

 

 

1,482

 

APAC

 

 

576

 

 

 

559

 

 

 

1,095

 

 

 

1,070

 

Total net sales

 

$

2,840

 

 

$

2,842

 

 

$

5,472

 

 

$

5,519

 

Operating Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

584

 

 

$

619

 

 

$

1,121

 

 

$

1,185

 

EMEA

 

 

162

 

 

 

162

 

 

 

307

 

 

 

313

 

APAC

 

 

137

 

 

 

131

 

 

 

258

 

 

 

248

 

Total segment operating income

 

$

883

 

 

$

912

 

 

$

1,686

 

 

$

1,746

 

 

27

 


 

The following is a reconciliation of segment operating income to income before income taxes per the condensed consolidated statements of income.

 

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Total segment operating income

 

$

883

 

 

$

912

 

 

$

1,686

 

 

$

1,746

 

Corporate and other

 

 

(528

)

 

 

(528

)

 

 

(947

)

 

 

(930

)

Total operating income

 

 

355

 

 

 

384

 

 

 

739

 

 

 

816

 

Net interest expense

 

 

20

 

 

 

11

 

 

 

38

 

 

 

23

 

Other income, net

 

 

(28

)

 

 

(31

)

 

 

(53

)

 

 

(49

)

Income before income taxes

 

$

363

 

 

$

404

 

 

$

754

 

 

$

842

 

 

Refer to Note 10 for additional information on Net Sales by GBU.

 

28

 


 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Refer to our Annual Report on Form 10-K for the year ended December 31, 2018 (2018 Annual Report) for management’s discussion and analysis of our financial condition and results of operations. The following is management’s discussion and analysis of our financial condition and results of operations for the three and six months ended June 30, 2019 and 2018.

RESULTS OF OPERATIONS

Our net income for the three and six months ended June 30, 2019 totaled $343 million, or $0.66 per diluted share, and $690 million, or $1.33 per diluted share, compared to $343 million, or $0.63 per diluted share, and $732 million, or $1.33 per diluted share, for the three and six months ended June 30, 2018. Net income for the three and six months ended June 30, 2019 included special items which decreased net income by $121 million and $173 million, respectively, or $0.23 and $0.33 per diluted share, respectively, as further discussed below. Net income for the three and six months ended June 30, 2018 included special items which decreased net income by $78 million and $77 million, respectively, or $0.14 per diluted share, as further discussed below.

29

 


 

Special Items

The following table provides a summary of our special items and the related impact by line item on our results for the three and six months ended June 30, 2019 and 2018.

 

 

 

Three months ended June 30,

 

 

Six months ended June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Gross Margin

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intangible asset amortization expense

 

$

(45

)

 

$

(44

)

 

$

(88

)

 

$

(85

)

Intangible asset impairment 1

 

 

(31

)

 

 

 

 

 

(31

)

 

 

 

Business optimization items 2

 

 

(10

)

 

 

(3

)

 

 

(29

)

 

 

(9

)

Acquisition and integration expenses 3

 

 

(12

)

 

 

(6

)

 

 

(17

)

 

 

(9

)

Litigation 4

 

 

 

 

 

 

 

 

 

 

 

(8

)

European medical devices regulation 5

 

 

(6

)

 

 

 

 

 

(10

)

 

 

 

Total Special Items

 

$

(104

)

 

$

(53

)

 

$

(175

)

 

$

(111

)

Impact on Gross Margin Ratio

 

(3.7 pts)

 

 

(1.9 pts)

 

 

(3.2 pts)

 

 

(2.0 pts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, General and Administrative (SG&A) Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Business optimization items 2

 

$

32

 

 

$

34

 

 

$

40

 

 

$

63

 

Acquisition and integration expenses 3

 

 

 

 

 

6

 

 

 

5

 

 

 

10

 

Litigation 4

 

 

 

 

 

 

 

 

 

 

 

2

 

Total Special Items

 

$

32

 

 

$

40

 

 

$

45

 

 

$

75

 

Impact on SG&A Ratio

 

1.1 pts

 

 

1.4 pts

 

 

0.8 pts

 

 

1.3 pts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and Development (R&D) Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Business optimization items 2

 

$

23

 

 

$

10

 

 

$

34

 

 

$

13

 

Acquisition and integration expenses 3

 

 

2

 

 

 

 

 

 

6

 

 

 

 

Total Special Items

 

$

25

 

 

$

10

 

 

$

40

 

 

$

13

 

Impact on R&D Ratio

 

0.8 pts

 

 

0.3 pts

 

 

0.7 pts

 

 

0.2 pts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Operating Income, net

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition and integration expenses 3

 

$

(4

)

 

$

 

 

$

(4

)

 

$

 

Insurance recovery from legacy product-related matter 6

 

 

 

 

 

 

 

 

(33

)

 

 

 

Claris settlement 7

 

 

 

 

 

 

 

 

 

 

 

(80

)

Total Special Items

 

$

(4

)

 

$

 

 

$

(37

)

 

$

(80

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income Tax Expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tax effects of special items and impact of U.S. Tax Reform 8

 

$

(36

)

 

$

(25

)

 

$

(50

)

 

$

(42

)

Total Special Items

 

$

(36

)

 

$

(25

)

 

$

(50

)

 

$

(42

)

Impact on Effective Tax Rate

 

(5.3 pts)

 

 

(1.9 pts)

 

 

(3.2 pts)

 

 

(2.7 pts)

 

 

Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance and is consistent with how management and our Board of Directors assess performance. Additional special items are identified above because they are highly variable, difficult to predict and of a size that may substantially impact our reported results of operations for the period. Management believes that providing the separate impact of those items may provide a more complete understanding and facilitate a fuller analysis of our results of operations, particularly in evaluating performance from one period to another.

1

Our results in 2019 included a $31 million asset impairment related to a developed-technology intangible asset.  

30

 


 

2

In 2019 and 2018, our results were impacted by costs associated with our execution of programs to optimize our organization and cost structure on a global basis. These actions included streamlining our international operations, rationalizing our manufacturing facilities, reducing our general and administrative infrastructure, re-aligning certain R&D activities and cancelling certain R&D programs. Our results in 2019 included business optimization charges of $65 million in the second quarter and $103 million in the first half.  Our results in 2018 included business optimization charges of $47 million in the second quarter and $85 million in the first half.  Refer to Note 11 within Item 1 for more information.  

3

Our results in 2019 included $10 million in the second quarter and $24 million in the first half of acquisition and integration expenses. This included integration expenses related to our acquisitions of Claris Injectables Limited (Claris) and the RECOTHROM and PREVELEAK products in prior periods, as well as the 2019 acquisitions of in-process R&D assets, partially offset by a benefit related to the change in the estimated fair value of contingent consideration liabilities. Our results in 2018 included $12 million in the second quarter and $19 million in the first half of acquisition and integration expenses related to our acquisitions of Claris and the RECOTHROM and PREVELEAK products.

4

Our results in the first half of 2018 included a charge of $10 million related to certain product litigation.

5

Our results in 2019 included costs of $6 million in the second quarter and $10 million in the first half related to updating our quality systems and product labeling to comply with the new medical device reporting regulation and other requirements of the European Union’s regulations for medical devices that will become effective in 2020.

6

Our results in the first half of 2019 included a benefit of $33 million for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter.

7

Our results in the first half of 2018 included a benefit of $80 million for the settlement of certain claims related to the acquired operations of Claris.

8

Reflected in this item is the income tax impact of the special items identified in this table.  Additionally, our results in the first half of 2018 included a tax benefit of $8 million related to updates to the estimated impact of U.S. Federal tax reform previously made in 2017. The tax effect of each adjustment is based on the jurisdiction in which the adjustment is incurred and the tax laws in effect for each such jurisdiction.

NET SALES

 

 

Three months ended

 

 

 

 

 

 

June 30,

 

 

Percent change

 

(in millions)

 

2019

 

 

2018

 

 

At actual currency rates

 

 

At constant currency rates

 

 

U.S. cyclophosphamide(1)

 

United States

 

$

1,193

 

 

$

1,210

 

 

 

(1

)%

 

 

(1

)%

 

 

(1

)%

International

 

 

1,647

 

 

 

1,632

 

 

 

  1

%

 

 

8

%

 

 

0

%

Total net sales

 

$

2,840

 

 

$

2,842

 

 

 

(0

)%

 

 

4

%

 

 

0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30,

 

 

Percent change

 

(in millions)

 

2019

 

 

2018

 

 

At actual

currency rates

 

 

At constant currency rates

 

 

U.S. cyclophosphamide(1)

 

United States

 

$

2,313

 

 

$

2,357

 

 

 

           (2

)%

 

 

(2

)%

 

 

(1

)%

International

 

 

3,159

 

 

 

3,162

 

 

(0

)%

 

 

7

%

 

 

0

%

Total net sales

 

$

5,472

 

 

$

5,519

 

 

 

(1

)%

 

 

3

%

 

 

0

%

(1)

The amounts reflect the impact of U.S. cyclophosphamide net sales on constant currency sales growth for the current period.

Foreign currency unfavorably impacted net sales by 4 percentage points during the second quarter and first half of 2019, respectively, compared to the prior period principally due to the strengthening of the U.S. Dollar relative to the Euro, Australian Dollar, British Pound, Chinese Yuan, Colombian Peso and Brazilian Real.  

31

 


 

The comparisons presented at constant currency rates reflect 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 had not changed between the prior and the current period. We believe 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 and facilitate a fuller analysis of our results of operations, particularly in evaluating performance from one period to another.

We have disclosed the impact of generic competition for U.S. cyclophosphamide on our net sales to enhance comparability between periods and better identify operating trends.  

Global Business Unit Net Sales Reporting

Our global business units (GBUs) include the following:

 

Renal Care includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services.

 

Medication Delivery includes sales of our intravenous (IV) therapies, infusion pumps, administration sets and drug reconstitution devices.

 

Pharmaceuticals includes sales of our premixed and oncology drug platforms, inhaled anesthesia and critical care products and pharmacy compounding services.

 

Clinical Nutrition includes sales of our parenteral nutrition (PN) therapies and related products.

 

Advanced Surgery includes sales of our biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention.

 

Acute Therapies includes sales of our continuous renal replacement therapies (CRRT) and other organ support therapies focused in the intensive care unit (ICU).

 

Other primarily includes sales of contract manufacturing services from our pharmaceutical partnering business.

 

The following is a summary of net sales by GBU.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

June 30,

 

 

Percent change

 

(in millions)

 

2019

 

 

2018

 

 

At actual

currency rates

 

 

At constant

currency rates

 

 

U.S. cyclophosphamide(1)

 

Renal Care

 

$

910

 

 

$

931

 

 

 

(2

)%

 

 

3

%

 

 

0

%

Medication Delivery

 

 

689

 

 

 

681

 

 

 

1

%

 

 

4

%

 

 

0

%

Pharmaceuticals

 

 

539

 

 

 

537

 

 

 

0

%

 

 

4

%

 

 

(2

)%

Clinical Nutrition

 

 

215

 

 

 

221

 

 

 

(3

)%

 

 

2

%

 

 

0

%

Advanced Surgery

 

 

232

 

 

 

204

 

 

 

14

%

 

 

17

%

 

 

0

%

Acute Therapies

 

 

133

 

 

 

129

 

 

 

3

%

 

 

8

%

 

 

0

%

Other

 

 

122

 

 

 

139

 

 

 

(12

)%

 

 

(9

)%

 

 

0

%

Total Baxter

 

$

2,840

 

 

$

2,842

 

 

(0

)%

 

 

4

%

 

 

0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended

June 30,

 

 

Percent change

 

(in millions)

 

2019

 

 

2018

 

 

At actual

currency rates

 

 

At constant

currency rates

 

 

U.S. cyclophosphamide(1)

 

Renal Care

 

$

1,761

 

 

$

1,799

 

 

 

(2

)%

 

 

3

%

 

 

0

%

Medication Delivery

 

 

1,323

 

 

 

1,357

 

 

 

(3

)%

 

   (0

)%

 

 

0

%

Pharmaceuticals

 

 

1,048

 

 

 

1,033

 

 

 

1

%

 

 

5

%

 

 

(2

)%

Clinical Nutrition

 

 

420

 

 

 

444

 

 

 

(5

)%

 

 

(1

)%

 

 

0

%

Advanced Surgery

 

 

430

 

 

 

386

 

 

 

11

%

 

 

15

%

 

 

0

%

Acute Therapies

 

 

261

 

 

 

258

 

 

 

1

%

 

 

6

%

 

 

0

%

Other

 

 

229

 

 

 

242

 

 

 

(5

)%

 

 

(2

)%

 

 

0

%

Total Baxter

 

$

5,472

 

 

$

5,519

 

 

 

(1

)%

 

 

3

%

 

 

0

%

 

(1)

The amounts reflect the impact of U.S. cyclophosphamide net sales on constant currency sales growth for the current period.

32

 


 

On a constant currency basis, Renal Care net sales increased during the second quarter and first half of 2019, driven by global patient growth in PD partially offset by lower U.S. in-center HD sales.

 

On a constant currency basis, Medication Delivery net sales increased during the second quarter and were flat during the first half of 2019.  The increase in the second quarter of 2019 was attributable to increased sales of our Spectrum IQ Infusion System in the U.S. and EVO IQ Infusion System internationally and related IV access administration sets.  The increase in the second quarter was offset by a decline in the first quarter compared to the prior year due to higher sales in 2018 of our large volume parenterals (LVPs) as customer demand increased due to industry-wide supply challenges.    

 

On a constant currency basis, Pharmaceuticals net sales increased during the second quarter and first half of 2019. The increase in 2019 was due to growth in international pharmacy compounding sales and increased sales of our generic injectables. Partially offsetting those increases were reduced sales of U.S. cyclophosphamide and BREVIBLOC due to increased generic competition.

 

On a constant currency basis, Clinical Nutrition net sales increased during the second quarter and decreased during the first half of 2019. The increase in the second quarter was due to the launch of new products. The decrease in the first half of 2019 was due to lower U.S. sales of our PN therapies and related products.

 

On a constant currency basis, Advanced Surgery net sales increased during the second quarter and first half of 2019, primarily driven by higher sales as a result of a temporary supply disruption of a competitor.

 

On a constant currency basis, Acute Therapies net sales increased during the second quarter and first half of 2019 due to higher global demand for our CRRT systems to treat acute kidney injuries, including the launch of PrisMax in several countries across Europe and Asia.

 

On a constant currency basis, Other net sales decreased during the second quarter and first half of 2019 in comparison to strong sales performance in the prior year.

Gross Margin and Expense Ratios

 

 

 

Three months ended June 30,

 

 

 

2019

 

 

% of net sales

 

 

2018

 

 

% of net sales

 

 

$ change

 

 

% change

 

Gross margin

 

$

1,159

 

 

 

40.8

%

 

$

1,239

 

 

 

43.6

%

 

$

(80

)

 

 

(6.5

)%

SG&A

 

$

642

 

 

 

22.6

%

 

$

681

 

 

 

24.0

%

 

$

(39

)

 

 

(5.7

)%

R&D

 

$

166

 

 

 

5.8

%

 

$

174

 

 

 

6.1

%

 

$

(8

)

 

 

(4.6

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30,

 

 

 

2019

 

 

% of net sales

 

 

2018

 

 

% of net sales

 

 

$ change

 

 

% change

 

Gross margin

 

$

2,239

 

 

 

40.9

%

 

$

2,353

 

 

 

42.6

%

 

$

(114

)

 

 

(4.8

)%

SG&A

 

$

1,242

 

 

 

22.7

%

 

$

1,303

 

 

 

23.6

%

 

$

(61

)

 

 

(4.7

)%

R&D

 

$

295

 

 

 

5.4

%

 

$

314

 

 

 

5.7

%

 

$

(19

)

 

 

(6.1

)%

Gross Margin

The special items identified above had an unfavorable impact of approximately 3.7 and 3.2 percentage points on the gross margin ratio in the second quarter and first half of 2019, respectively.  The unfavorable impact was 1.9 and 2.0 percentage points in the second quarter and first half of 2018, respectively. Refer to the Special Items caption above for additional detail.

Excluding the impact of the special items, the gross margin ratio decreased in the second quarter and first half of 2019 compared to the prior year due to an unfavorable product mix as well as inventory write-downs and incremental costs relating to improvements at a dialyzer facility in the U.S. that experienced manufacturing issues during the second quarter of 2019.

33

 


 

SG&A

The special items identified above had an unfavorable impact of approximately 1.1 and 0.8 percentage points on the SG&A expenses ratio in the second quarter and first half of 2019, respectively. The unfavorable impact was 1.4 and 1.3 percentage points in the second quarter and first half of 2018, respectively. Refer to the Special Items caption above for additional detail.

Excluding the impact of the special items, the SG&A expenses ratio decreased in the second quarter and first half of 2019 primarily due to favorable foreign currency translation and actions we took to restructure our cost position and focus on expense management, partially offset by the absence of transition service income that we earned following our spinoff of Baxalta Incorporated (Baxalta), as the agreement for those services terminated as of July 1, 2018.

R&D

The special items identified above had an unfavorable impact of approximately 0.8 and 0.7 percentage points on the R&D expenses ratio in the second quarter and first half of 2019, respectively. The unfavorable impact was 0.3 and 0.2 percentage points in the second quarter and first half of 2018, respectively. Refer to the Special Items caption above for additional detail.

 

Excluding the impact of the special items, R&D expenses decreased in the second quarter and first half of 2019 as a result of the timing of project-related expenditures compared to the prior year, actions we took to restructure our cost position and focus on expense management, and favorable foreign currency translation.

Business Optimization Items

Beginning in the second half of 2015, we have undertaken actions to transform our cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing our manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through June 30, 2019, we have incurred cumulative pre-tax costs of $899 million related to these actions. The costs consisted primarily of employee termination costs, implementation costs, and accelerated depreciation. We currently expect to incur additional pre-tax costs of approximately $70 million related to these initiatives, primarily related to employee termination costs and implementation costs. The reductions in our cost base from these actions in the aggregate are expected to provide cumulative annual pre-tax savings of approximately $1.2 billion once the remaining actions are complete. The savings from these actions will impact cost of sales, SG&A expenses, and R&D expenses. Approximately 90 percent of the expected annual pre-tax savings are expected to be realized by the end of 2019, with the remainder by the end of 2023.

Other Operating Income, Net

Other operating income, net was $4 million and $37 million in the second quarter and first half of 2019, respectively, and $80 million in the first half of 2018.  In the second quarter of 2019, we recognized a benefit of $4 million related to the change in the estimated fair value of contingent consideration liabilities. In the first half of 2019, we recognized a $33 million gain when our share of the proceeds under a cost-sharing agreement became realizable following the resolution of a dispute with an insurer related to a legacy product-related matter. In the prior period, we settled certain claims with the seller related to the acquired operations of Claris, which resulted in a gain of $80 million.

Interest Expense, Net

Interest expense, net was $20 million and $38 million in the second quarter and first half of 2019, respectively, and $11 million and $23 million in the second quarter and first half of 2018, respectively. The increase in the second quarter and first half of 2019 was primarily driven by higher average debt outstanding and lower interest income as a result of lower average cash and cash equivalents balances.  

34

 


 

Other Income, Net

Other income, net was $28 million and $53 million in the second quarter and first half of 2019, respectively, and $31 million and $49 million in the second quarter and first half of 2018, respectively. The decrease in the second quarter of 2019 compared to the prior year was primarily due to fair value declines in marketable equity securities in the current year. The increase in the first half of 2019 compared to the prior year was primarily due to the impairment of an investment in the prior-year period and higher pension benefits in the current-year period, partially offset by lower foreign exchange gains in the current-year period.    

Income Taxes

Our effective income tax rate was 5.5% and 15.1% in the second quarter and 8.5% and 13.1% for the first half of 2019 and 2018, respectively. Our effective income tax rate can differ from the 21% U.S. Federal statutory rate due to a number of factors, including foreign rate differences, tax incentives, increases or decreases in valuation allowances and liabilities for uncertain tax positions and excess tax benefits on stock compensation awards. For the three and six months ended June 30, 2019, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to a tax benefit from the resolution of an uncertain tax position (UTP) as a result of a favorable ruling from the related taxing authority and excess tax benefits on stock compensation awards.  For the three months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily driven by excess tax benefits on stock compensation awards, partially offset by the revaluation of Swedish net deferred tax assets due to legislation reducing the Swedish income tax rate. For the six months ended June 30, 2018, the difference between our effective income tax rate and the U.S. Federal statutory rate was primarily attributable to nontaxable income from the settlement of certain claims with the seller of the acquired operations of Claris, excess tax benefits on stock compensation awards, an adjustment of provisional amounts related to U.S. tax reform, a reduction of a liability for a UTP as a result of a settlement with the related taxing authority and the reversal of a valuation allowance as a result of continued profit improvements.  Partially offsetting the foregoing benefits was interest on the reserve for UTPs, the revaluation of Swedish net deferred tax assets and transfer pricing-related income tax accruals.

Segment Results

We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of our segments. The following is a summary of significant factors impacting our reportable segments’ financial results.

 

 

 

Net sales

 

 

Operating income (loss)

 

 

 

Three months ended

 

 

Six months ended

 

 

Three months ended

 

 

Six months ended

 

 

 

June 30,

 

 

June 30,

 

 

June 30,

 

 

June 30,

 

(in millions)

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Americas

 

$

1,520

 

 

$

1,525

 

 

$

2,928

 

 

$

2,967

 

 

$

584

 

 

$

619

 

 

$

1,121

 

 

$

1,185

 

EMEA

 

 

744

 

 

 

758

 

 

 

1,449

 

 

 

1,482

 

 

 

162

 

 

 

162

 

 

 

307

 

 

 

313

 

APAC

 

 

576

 

 

 

559

 

 

 

1,095

 

 

 

1,070

 

 

 

137

 

 

 

131

 

 

 

258

 

 

 

248

 

Corporate and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(528

)

 

 

(528

)

 

 

(947

)

 

 

(930

)

Total

 

$

2,840

 

 

$

2,842

 

 

$

5,472

 

 

$

5,519

 

 

$

355

 

 

$

384

 

 

$

739

 

 

$

816

 

Americas

Segment operating income was $584 million and $1,121 million, respectively, in the second quarter and first half of 2019 and $619 million and $1,185 million, respectively, in the second quarter and first half of 2018. The decrease in the second quarter of 2019 was primarily driven by lower sales and gross margin in Pharmaceuticals.  Lower sales and gross margin in Medication Delivery and Clinical Nutrition in the first quarter of 2019 contributed to the decrease in the first half of 2019. Partially offsetting the decreases in the second quarter and first half of 2019 was favorable performance in Advanced Surgery primarily due to a temporary supply disruption of a competitor.

EMEA

Segment operating income was $162 million and $307 million, respectively, in the second quarter and first half of 2019 and $162 million and $313 million, respectively, in the second quarter and first half of 2018. The decrease in the first half of 2019 was primarily driven by unfavorable foreign exchange rates partially offset by increased sales and gross margin in Renal Care and Pharmaceuticals.

35

 


 

APAC

Segment operating income was $137 million and $258 million, respectively, in the second quarter and first half of 2019 and $131 million and $248 million, respectively, in the second quarter and first half of 2018. Results in 2019 were driven by higher sales and gross margin, primarily from China and Australia, in Renal Care and Pharmaceuticals.

Corporate and Other

Certain items are maintained at Corporate and are not allocated to a segment. They primarily include certain foreign currency hedging activities, corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation expense, certain employee benefit plan costs as well as certain gains, losses, and other charges (such as business optimization, acquisition and integration costs, intangible asset amortization and asset impairments). The operating loss in the second quarter of 2019 was consistent with the prior-year period as higher business optimization charges and an impairment of a developed-technology intangible asset were offset by lower SG&A and R&D expenses.  The operating loss in the first half of 2019 increased over the prior-year period due to an impairment of a developed-technology intangible asset, higher business optimization charges and the benefit from the Claris settlement in the prior year, partially offset by a benefit for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter in the current year and lower SG&A and R&D expenses.

LIQUIDITY AND CAPITAL RESOURCES

The following table is a summary of the statement of cash flows for the six-month periods ended June 30, 2019 and 2018.

 

 

Six months ended

 

 

June 30,

 

(in millions)

2019

 

 

2018

 

Cash flows from operations - continuing operations

$

617

 

 

$

852

 

Cash flows from investing activities

 

(462

)

 

 

(539

)

Cash flows from financing activities

 

968

 

 

 

(808

)

 

Cash Flows from Operations — Continuing Operations

In the first half of 2019, cash provided by operating activities was $617 million, as compared to cash provided by operating activities of $852 million in the first half of 2018, a decrease of $235 million. The decrease was primarily due to the Claris settlement received in 2018 and the timing of customer and vendor payments, partially offset by an insurance recovery received in 2019 from a legacy product-related matter.

Cash Flows from Investing Activities

In the first half of 2019, cash used for investing activities included payments for acquisitions of $111 million, primarily related to the U.S. rights to multiple products we acquired, and capital expenditures of $352 million. In the first half of 2018, cash used for investing activities included payments for acquisitions of $228 million, primarily related to RECOTHROM and PREVELEAK and two molecules from Celerity Pharmaceuticals, LLC, and capital expenditures of $311 million.

Cash Flows from Financing Activities

In the first half of 2019, cash generated from financing activities included the net proceeds from the issuance of 750 million of senior notes due in 2024 and 750 million of senior notes due in 2029 along with stock issued under employee benefit plans of $262 million, partially offset by payments for stock repurchases of $720 million and dividend payments of $198 million. In the first half of 2018, cash used for financing activities included payments for stock repurchases of $781 million and dividend payments of $173 million, partially offset by the proceeds from stock issued under employee benefit plans of $170 million.

36

 


 

As authorized by the Board of Directors, we repurchase our stock depending upon our cash flows, net debt levels and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of our common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018 and by an additional $2.0 billion in November 2018. We paid $720 million in cash to repurchase approximately 9.5 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise in the first half of 2019 and had $1.4 billion remaining available under this authorization as of June 30, 2019.

In December 2018, we entered into a $300 million accelerated share repurchase agreement (ASR Agreement) with an investment bank. We funded the ASR Agreement with available cash. Under the ASR Agreement, we received 3.6 million shares upon execution. Based on the volume-weighted average price of our common stock during the term of the ASR Agreement, we received an additional 0.6 million shares from the investment bank at settlement on May 7, 2019.

Credit Facilities and Access to Capital and Credit Ratings

Credit Facilities

As of June 30, 2019, our U.S. dollar-denominated revolving credit facility and Euro-denominated senior revolving credit facility had a maximum capacity of $1.5 billion and approximately €200 million, respectively. There were no amounts outstanding under our credit facilities at June 30, 2019 or December 31, 2018, respectively. As of June 30, 2019, we were in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting either of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment.

Access to Capital and Credit Ratings

We intend 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. We had $2.9 billion of cash and cash equivalents as of June 30, 2019, with adequate cash available to meet operating requirements in each jurisdiction in which we operate. We invest our excess cash in money market funds and diversify the concentration of cash among different financial institutions.

Our 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 our products or in the solvency of our customers or suppliers, deterioration in our key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, we believe we have sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support our growth objectives. Between February and July 2019, Standard & Poor’s, Fitch, and Moody’s reaffirmed our investment grade credit ratings that we disclosed in our 2018 Annual Report.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements in our 2018 Annual Report. Certain of our accounting policies are considered critical, as these policies are the most important to the depiction of our 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 our 2018 Annual Report. There have been no significant changes in the application of our critical accounting policies during the first half of 2019.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASU) 2016-13, Financial Instruments - Credit Losses, which requires the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The standard is effective for our financial statements beginning in 2020. We are currently evaluating the impact of the adoption of this ASU, but it is not expected to have a material effect on our condensed consolidated financial statements.

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In August 2018, the FASB issued ASC 2018-15, Intangibles-Goodwill and Other-Internal-Use Software, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.  The standard is effective for our financial statements beginning in 2020. We are currently evaluating the impact of the adoption of this ASU, but it is not expected to have a material effect on our condensed consolidated financial statements.

LEGAL CONTINGENCIES

Refer to Note 7 within Item 1 for a discussion of our legal contingencies. Upon resolution of any of these uncertainties, we may incur charges in excess of presently established liabilities. While our liability 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 our 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 our consolidated financial position. While we believe that we have valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and we may in the future incur material judgments or enter into material settlements of claims.

CERTAIN REGULATORY MATTERS

The U.S. Food and Drug Administration (FDA) commenced an inspection of Claris’ facilities in Ahmedabad, India in July 2017, immediately prior to the closing of the Claris acquisition. FDA completed the inspection, at which time FDA issued a related Form-483 (Claris 483). In July 2018, FDA issued a Warning Letter based on observations identified in the 2017 inspection (Claris Warning Letter).1 The Claris Warning Letter includes a number of observations across a variety of areas. We submitted our response to the Claris Warning Letter in August 2018 and we are continuing to implement corrective and preventive actions, which have included product recalls that are financially immaterial to us, to address FDA’s observations as set forth in the Claris 483 or the Claris Warning Letter and other items identified in connection with integrating Claris into our quality systems. We had a Regulatory Meeting with FDA on November 6, 2018 and we continue to cooperate with FDA in connection with the resolution of these matters.

On May 6, 2019, we received a Show Cause Notice under the Drugs & Cosmetics Act, 1940 and Rules thereunder (Show Cause Notice) from the Commissioner of the Food & Drugs Control Administration in the Gujarat State in Gandhinagar, India (Commissioner).  The Show Cause Notice was issued regarding an April 9, 2019 inspection of our Claris facilities in Ahmedabad, India by the Commissioner.  The Show Cause Notice contains a number of observations of alleged Good Manufacturing Practice related issues across a variety of areas, some of which overlap with the areas covered in the Claris 483 or the Claris Warning Letter.  We responded to the Show Cause Notice and are cooperating with the regulatory authorities.

In June 2013, we received a Warning Letter from FDA regarding operations and processes at our North Cove, North Carolina and Jayuya, Puerto Rico facilities. We attended Regulatory Meetings with FDA regarding one or both of these facilities in October 2014, November 2015, July 2017, April 2018 and October 2018. The Warning Letter addresses observations related to Current Good Manufacturing Practice violations at the two facilities.

As previously disclosed, 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. In January 2017, the parties resolved the matter by entering into a deferred prosecution agreement and a civil settlement whereby the company agreed to pay approximately $18 million and implement certain enhanced compliance measures.  In July 2019, the deferred prosecution agreement expired and, based on Baxter’s fulfillment of the terms of the agreement, the court dismissed the criminal information previously filed in the case with prejudice.

 

1 Available online at https://www.fda.gov/ICECI/EnforcementActions/WarningLetters/ucm613538.htm

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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 our R&D pipeline (including estimates regarding our ability to obtain approval for distribution in the U.S. of new products manufactured at our Baxter Ahmedabad facility), strategic objectives, sales from new product offerings, 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, our exposure to financial market volatility and foreign currency and interest rate risks, potential tax liability associated with the separation of our biopharmaceuticals and medical products businesses (including the 2016 disposition of our formerly retained shares in Baxalta (Retained Shares)), the impact of competition, future sales growth, business development activities (including the recent acquisitions of Claris Injectables and two surgical products from Mallinckrodt plc), the effects of product recalls or production disruptions, business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of our facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts.

These forward-looking statements are based on certain assumptions and analyses made in light of 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:

 

failure to achieve our long-term financial improvement goals;

 

demand for and market acceptance risks for and competitive pressures related to new and existing products (including challenges with our ability to predict these pressures and the resulting impact on customer inventory levels), and the impact of those products on quality and patient safety concerns;

 

product development risks, including satisfactory clinical performance, the ability to manufacture at appropriate scale, and the general unpredictability associated with the product development cycle;

 

our ability to finance and develop new products or enhancements on commercially acceptable terms or at all;

 

our ability to identify business development and growth opportunities to successfully execute on business development strategies;

 

product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, warning letters (including the Claris Warning Letter), import bans, sanctions, seizures, litigation, or declining sales;

 

the continuity, availability and pricing of acceptable raw materials and component supply, and the related continuity of our manufacturing and distribution;

 

inability to create additional production capacity in a timely manner or the occurrence of other manufacturing or supply difficulties (including as a result of natural disaster or otherwise);

 

breaches or failures of our information technology systems or products, including by cyber-attack, unauthorized access or theft;

 

future actions of (or failures to act or delays in acting by) FDA, the European Medicines Agency or any other regulatory body or government authority (including the DOJ or the Attorney General of any State) that could delay, limit or suspend product development, manufacturing or sale or result in seizures, recalls, injunctions, monetary sanctions or criminal or civil liabilities;

 

proposed regulatory changes of the U.S. Department of Health and Human Services in kidney health policy (AAKHI) and reimbursement, which may substantially change the U.S. end stage renal disease market and demand for our peritoneal dialysis products, necessitating significant multi-year capital expenditures which are difficult to estimate in advance;

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failures with respect to our quality, compliance or ethics programs;

 

future actions of third parties, including third-party payers, the impact of healthcare reform and the implementation, suspension, repeal, replacement, amendment, modification and other similar actions undertaken by the United States or foreign governments, including with respect to pricing, reimbursement, taxation and rebate policies; legislation, regulation and other governmental pressures in the United States or globally, including the cost of compliance and potential penalties for purported noncompliance thereof, all of which may affect pricing, reimbursement, taxation and rebate policies of government agencies and private payers or other elements of our business, including new or amended laws, rules and regulations (such as the California Consumer Privacy Act of 2018 and the European Union’s General Data Protection Regulation which became effective in May 2018 for example);

 

the impact of competitive products and pricing, including generic competition, drug reimportation and disruptive technologies;

 

global regulatory, trade and tax policies;

 

the ability to protect or enforce our owned or in-licensed patent or other proprietary rights (including trademarks, copyrights, trade secrets and know-how) or patents of third parties preventing or restricting our manufacture, sale or use of affected products or technology;

 

the impact of any goodwill impairments on our operating results;

 

any failure by Baxalta or Shire plc to satisfy its obligation under the separation agreements, including the tax matters agreement, or that certain letter agreement entered into with Shire plc and Baxalta;

 

the impact of global economic conditions (including potential trade wars) on us and our customers and suppliers, including foreign governments in countries in which we operate;

 

fluctuations in foreign exchange and interest rates;

 

any changes in law concerning the taxation of income (whether with respect to current or future tax reform), including income earned outside the United States;

 

actions by tax authorities in connection with ongoing tax audits;

 

loss of key employees or inability to identify and recruit new employees;

 

the outcome of pending or future litigation;

 

the adequacy of our cash flows from operations to meet our ongoing cash obligations and fund our investment program; and

 

other factors identified elsewhere in this report and other filings with the Securities and Exchange Commission, including those factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, all of which are available on our website.

Actual results may differ materially from those projected in the forward-looking statements. We do not undertake to update our forward-looking statements.

 

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Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Currency Risk

We are primarily exposed to foreign exchange risk with respect to revenues generated outside of the United States denominated in the Euro, British Pound, Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar, Japanese Yen, Colombian Peso, Brazilian Real, Mexican Peso and Swedish Krona. We manage our foreign currency exposures on a consolidated basis, which allows us to net exposures and take advantage of any natural offsets. In addition, we use 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 stockholders’ equity volatility relating to foreign exchange. Financial market and currency volatility may limit our ability to cost-effectively hedge these exposures.

We 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 we have cash flow hedge contracts in place related to foreign exchange risk on forecasted transactions as of June 30, 2019 is 18 months. We also enter into derivative instruments to hedge foreign exchange risk on certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.

As part of our risk-management program, we perform sensitivity analyses to assess potential changes in the fair value of our 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 as of June 30, 2019, 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 $15 million with respect to those contracts would decrease by $26 million, resulting in a net liability position.

The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at June 30, 2019 by replacing the actual exchange rates at June 30, 2019 with exchange rates that are 10% weaker compared to the actual exchange rates for each applicable currency. All other factors are held constant. These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the underlying hedged transactions and balances.

Our operations in Argentina are reported using highly inflationary accounting effective July 1, 2018. Changes in the value of the Argentine Peso applied to our peso-denominated net monetary asset positions are recorded in income at the time of the change. As of June 30, 2019, our net monetary assets denominated in Argentine Pesos are not significant.

Interest Rate and Other Risks

Refer to the caption “Interest Rate and Other Risks” in the “Financial Instrument Market Risk” section of the 2018 Annual Report. There were no significant changes during the quarter ended June 30, 2019.

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Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our Disclosure Committee and management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our 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, 2019. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2019.

Changes in Internal Control over Financial Reporting

 

We are currently implementing an upgrade to our enterprise resource planning (ERP) software. In connection with the ERP upgrade, we are updating the processes that constitute our internal control over financial reporting, as necessary. This normal course of business ERP upgrade is being implemented to remain current with the latest release of the software.

In 2017, related to our overall business optimization initiatives, we began implementation of a business transformation project within the finance, human resources, purchasing and information technology functions which will further centralize and standardize business processes and systems across the company.  We are transitioning some processes to our shared services centers while others have moved to outsourced providers.  This multi-year initiative is being conducted in phases and includes modifications to the design and operation of controls over financial reporting.

With the exception of the above, there have been no changes in our 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, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  

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Review by Independent Registered Public Accounting Firm

A review of the interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2019 and 2018 has been performed by PricewaterhouseCoopers LLP, our 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 Stockholders of Baxter International Inc.

 

Results of Review of Interim Financial Statements

 

We have reviewed the condensed consolidated balance sheet of Baxter International Inc. and its subsidiaries (the “Company”) as of June 30, 2019, and the related condensed consolidated statements of income, comprehensive income and changes in equity for the three-month and six-month periods ended June 30, 2019 and 2018 and the related condensed consolidated statements of cash flows for the six-month periods ended June 30, 2019 and 2018, including the related notes, appearing under Part I, Item 1 of this Quarterly Report on Form 10-Q (collectively referred to as the “interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the interim financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2018 and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for the year then ended (not presented herein), and in our report dated February 21, 2019, which included a paragraph describing a change in the manner of accounting for certain pension and postretirement net periodic benefit costs in the 2018 financial statements, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the condensed consolidated balance sheet as of December 31, 2018, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

Basis for Review Results

 

These interim financial statements are the responsibility of the Company’s management. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. 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 PCAOB, 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.

 

 

 

/s/ PricewaterhouseCoopers LLP

Chicago, Illinois

July 30, 2019

 

 

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PART II. OTHER INFORMATION

Item 1.

The information in Part I, Item 1, Note 7 is incorporated herein by reference.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

The following table includes information about our common stock repurchases during the three-month period ended June 30, 2019.

Issuer Purchases of Equity Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Period

 

Total number of shares purchased (1)

 

 

Average price paid per share

 

 

Total number of shares purchased as part of publicly announced program(1)

 

 

Approximate dollar value of shares that may yet be purchased under the program(1)

 

April 1, 2019 through April 30, 2019

 

 

749,300

 

 

$

80.68

 

 

 

749,300

 

 

 

 

 

May 1, 2019 through May 31, 2019 (2)

 

 

1,254,787

 

 

$

76.59

 

 

 

1,254,787

 

 

 

 

 

June 1, 2019 through June 30, 2019

 

 

 

 

$

 

 

 

 

 

 

 

 

Total

 

 

2,004,087

 

 

$

78.12

 

 

 

2,004,087

 

 

$

1,447,516,465

 

 

(1)

In July 2012, we announced that our Board of Directors authorized us to repurchase up to $2.0 billion of our common stock on the open market or in private transactions. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018 and by an additional $2.0 billion in November 2018. During the second quarter of 2019, we repurchased 1.4 million shares under this authority pursuant to Rule 10b5-1 plans and otherwise. We had $1.4 billion remaining under this program (as amended and after giving effect to stock repurchases) as of June 30, 2019. This program does not have an expiration date.

 

(2)

In December 2018, we entered into a $300 million accelerated share repurchase agreement (ASR Agreement) with an investment bank. We funded the ASR Agreement with available cash. The ASR Agreement was executed pursuant to the 2012 Repurchase Authorization described above. Under the ASR Agreement, we received 3.6 million shares upon execution.  Based on the volume-weighted average price of our common stock during the term of the ASR Agreement, we received an additional 0.6 million shares from the investment bank at settlement on May 7, 2019.

 

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Item 6.

Exhibits

Exhibit Index:

 

Exhibit

Number

 

Description

 

 

 

4.2

 

Twelfth Supplemental Indenture, dated as of May 15, 2019, between Baxter International Inc. (the “Company”) and The Bank of New York Mellon Trust Company, N.A., as Trustee (including form of 0.400% Senior Note due 2024 and form of 1.300% Senior Note due 2029) (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K, filed May 15, 2019).

 

15*

 

Letter Re Unaudited Interim Financial Information

 

 

 

31.1*

 

Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

31.2*

 

Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

32.1*

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2*

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS*

 

XBRL Instance Document

 

 

 

101.SCH*

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL*

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.LAB*

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE*

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

101.DEF*

 

XBRL Taxonomy Extension Definition Linkbase Document

 

*

Filed herewith.

 

 

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

 

 

 

 

 

 

BAXTER INTERNATIONAL INC.

 

 

 

 

 

 

(Registrant)

 

 

 

 

Date: July 30, 2019

 

 

 

By:

 

/s/ James K. Saccaro

 

 

 

 

 

 

James K. Saccaro

 

 

 

 

 

 

Executive Vice President and Chief Financial Officer

 

 

 

 

 

 

(duly authorized officer and principal financial officer)

 

 

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