10-K 1 d848964d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

 

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

For the fiscal year ended December 31, 2014

OR

 

  ¨ 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

 

LOGO

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)

Registrant’s telephone number, including area code 224.948.2000

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

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common stock, $1.00 par value  

New York Stock Exchange

Chicago Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  þ    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  þ

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  þ    No  ¨

Indicate by check mark whether registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)    Yes  þ    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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

Large accelerated filer  þ

   Accelerated filer  ¨

Non-accelerated filer  ¨

   Smaller reporting company  ¨

(Do not check if a smaller reporting company)

  

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

The aggregate market value of the voting common equity held by non-affiliates of the registrant as of June 30, 2014 (the last business day of the registrant’s most recently completed second fiscal quarter), based on the per share closing sale price of $72.30 on that date and the assumption for the purpose of this computation only that all of the registrant’s directors and executive officers are affiliates, was approximately $39 billion. There is no non-voting common equity held by non-affiliates of the registrant. The number of shares of the registrant’s common stock, $1.00 par value, outstanding as of January 31, 2015 was 542,581,466.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive 2015 proxy statement for use in connection with its Annual Meeting of Shareholders to be held on May 5, 2015 are incorporated by reference into Part III of this report.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page
Number
 

Item 1.

   Business      1   

Item 1A.

   Risk Factors      6   

Item 1B.

   Unresolved Staff Comments      14   

Item 2.

   Properties      14   

Item 3.

   Legal Proceedings      16   

Item 4.

   Mine Safety Disclosures      16   

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      17   

Item 6.

   Selected Financial Data      19   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      21   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      49   

Item 8.

   Financial Statements and Supplementary Data      50   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      108   

Item 9A.

   Controls and Procedures      108   

Item 9B.

   Other Information      108   

Item 10.

   Directors, Executive Officers and Corporate Governance      109   

Item 11.

   Executive Compensation      109   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      109   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      109   

Item 14.

   Principal Accountant Fees and Services      109   

Item 15.

   Exhibits and Financial Statement Schedules      110   


Table of Contents

PART I

Item 1.    Business.

Company Overview

Baxter International Inc., through its subsidiaries, develops, manufactures and markets products that save and sustain the lives of people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. As a global, diversified healthcare company, Baxter applies a unique combination of expertise in medical devices, pharmaceuticals and biotechnology to create products that advance patient care worldwide. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices, clinical and medical research laboratories, and by patients at home under physician supervision. Baxter manufactures products in 29 countries and sells them in more than 100 countries.

Baxter International Inc. was incorporated under Delaware law in 1931. As used in this report, “Baxter International” means Baxter International Inc. and “Baxter,” the “company” or the “Company” means Baxter International and its consolidated subsidiaries.

Business Segments and Products

The company operates in two segments: BioScience and Medical Products.

The BioScience business processes recombinant and plasma-based proteins to treat hemophilia and other bleeding disorders; plasma-based therapies to treat immune deficiencies, alpha-1 antitrypsin deficiency, burns and shock, and other chronic and acute blood-related conditions; and biosurgery products. Additionally, the BioScience business is investing in new disease areas, including oncology, as well as emerging technology platforms, including gene therapy and biosimilars.

The Medical Products business manufactures intravenous (IV) solutions and administration sets, premixed drugs and drug-reconstitution systems, pre-filled vials and syringes for injectable drugs, IV nutrition products, infusion pumps, and inhalation anesthetics. The business also provides products and services related to pharmacy compounding, drug formulation and packaging technologies. In addition, the Medical Products business provides products and services to treat end-stage renal disease, or irreversible kidney failures, along with other renal therapies, which business was enhanced through the 2013 acquisition of Gambro AB (Gambro). The Medical Products business now offers a comprehensive portfolio to meet the needs of patients across the treatment continuum, including technologies and therapies for peritoneal dialysis (PD), in-center hemodialysis (HD), home HD (HHD), continuous renal replacement therapy (CRRT) and additional dialysis services.

For financial information about Baxter’s segments and principal product categories, see Note 17 in Item 8 of this Annual Report on Form 10-K.

Sales and Distribution

The company has its own direct sales force and also makes sales to and through independent distributors, drug wholesalers acting as sales agents and specialty pharmacy or other alternate site providers. In the United States, third parties such as Cardinal Health, Inc. warehouse and ship a significant portion of the company’s products through their distribution centers. These centers are generally stocked with adequate inventories to facilitate prompt customer service. Sales and distribution methods include frequent contact by sales and customer service representatives, automated communications via various electronic purchasing systems, circulation of catalogs and merchandising bulletins, direct-mail campaigns, trade publication presence and advertising.

International sales are made and products are distributed on a direct basis or through independent distributors or sales agents in more than 100 countries.

 

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International Operations

The majority of the company’s revenues are generated outside of the United States and geographic expansion remains a core component of the company’s strategy. Baxter’s international presence includes operations in Europe (including Eastern and Central Europe), the Middle East, Africa, Asia-Pacific, Latin America and Canada. The company is subject to certain risks inherent in conducting business outside the United States. For more information on these risks, see the information under the captions “We are subject to risks associated with doing business globally” and “Changes in foreign currency exchange rates and interest rates could have a material adverse effect on our operating results and liquidity” in Item 1A of this Annual Report on Form 10-K.

For financial information about foreign and domestic operations and geographic information, see Note 17 in Item 8 of this Annual Report on Form 10-K. For more information regarding foreign currency exchange risk, refer to the discussion under the caption entitled “Financial Instrument Market Risk” in Item 7 of this Annual Report on Form 10-K.

Contractual Arrangements

Substantial portions of the company’s products are sold through contracts with customers, both within and outside the United States. Some of these contracts have terms of more than one year and place limits on the company’s ability to increase prices. In the case of hospitals, governments and other facilities, these contracts may specify minimum quantities of a particular product or categories of products to be purchased by the customer.

In keeping with the increased emphasis on cost-effectiveness in healthcare delivery, many hospitals and other customers of medical products in the United States have joined group purchasing organizations (GPOs), or formed integrated delivery networks (IDNs), to enhance purchasing power. GPOs and IDNs negotiate pricing arrangements with manufacturers and distributors, and the negotiated prices are made available to members. Baxter has purchasing agreements with several of the major GPOs in the United States. GPOs may have agreements with more than one supplier for certain products. Accordingly, in these cases, Baxter faces competition from other suppliers even where a customer is a member of a GPO under contract with Baxter. Purchasing power is similarly consolidated in many other countries. For example, public contracting authorities act as the purchasing entities for the hospitals and other customers of medical products in their region and many hospitals and other customers have joined joint procurement entities and buying consortia. The result is that demand for healthcare products is increasingly concentrated across the company’s markets globally.

Raw Materials

Raw materials essential to Baxter’s business are purchased from numerous suppliers worldwide in the ordinary course of business. Although most of these materials are generally available, Baxter at times may experience shortages of supply. In an effort to manage risk associated with raw materials supply, Baxter works closely with its suppliers to help ensure availability and continuity of supply while maintaining high quality and reliability. The company also seeks to develop new and alternative sources of supply where beneficial to its overall raw materials procurement strategy. In order to produce plasma-based therapies, the company also collects plasma at numerous collection facilities in the United States and Europe. For more information on plasma collection, refer to the discussion under the caption “The nature of producing plasma-based therapies may prevent us from timely responding to market forces and effectively managing our production capacity” in Item 1A of this Annual Report on Form 10-K.

The company also utilizes long-term supply contracts with some suppliers to help maintain continuity of supply and manage the risk of price increases. Baxter is not always able to recover cost increases for raw materials through customer pricing due to contractual limits and market forces.

 

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Competition and Healthcare Cost Containment

Baxter’s BioScience and Medical Products businesses enjoy leading positions based on a number of competitive advantages. The BioScience business benefits from continued innovation in its products and therapies, consistency of its supply of products, and strong customer relationships. The Medical Products business benefits from the breadth and depth of its product offering, as well as strong relationships with customers, including hospitals and clinics, group purchasing organizations, pharmaceutical and biotechnology companies, and patients, many who self-administer the home-based therapies supplied by Baxter. Baxter as a whole benefits from efficiencies and cost advantages resulting from shared manufacturing facilities and the technological advantages of its products.

Although no single company competes with Baxter in all of its businesses, Baxter faces substantial competition in each of its segments from international and domestic healthcare and pharmaceutical companies of all sizes. BioScience continues to face competitors from pharmaceutical, biotechnology and other companies. Medical Products faces competition from medical device manufacturers and pharmaceutical companies. In addition, global and regional competitors continue to expand their manufacturing capacity and sales and marketing channels. Competition is primarily focused on cost-effectiveness, price, service, product performance, and technological innovation. There has been increasing consolidation in the company’s customer base and by its competitors, which continues to result in pricing and market pressures.

Global efforts toward healthcare cost containment continue to exert pressure on product pricing. Governments around the world use various mechanisms to control healthcare expenditures, such as price controls, the formation of public contracting authorities, product formularies (lists of recommended or approved products), and competitive tenders which require the submission of a bid to sell products. Sales of Baxter’s products are dependent, in part, on the availability of reimbursement by government agencies and healthcare programs, as well as insurance companies and other private payors. In the United States, the federal and many state governments have adopted or proposed initiatives relating to Medicaid and other health programs that may limit reimbursement or increase rebates that Baxter and other providers are required to pay to the state. In addition to government regulation, managed care organizations in the United States, which include medical insurance companies, medical plan administrators, health-maintenance organizations, hospital and physician alliances and pharmacy benefit managers, continue to put pressure on the price and usage of healthcare products. Managed care organizations seek to contain healthcare expenditures, and their purchasing strength has been increasing due to their consolidation into fewer, larger organizations and a growing number of enrolled patients. Baxter faces similar issues outside of the United States. In Europe and Latin America, for example, the government provides healthcare at low cost to patients, and controls its expenditures by purchasing products through public tenders, collective purchasing, regulating prices, setting reference prices in public tenders or limiting reimbursement or patient access to certain products.

Intellectual Property

Patents and other proprietary rights are essential to Baxter’s business. Baxter relies on patents, trademarks, copyrights, trade secrets, know-how and confidentiality agreements to develop, maintain and strengthen its competitive position. Baxter owns a number of patents and trademarks throughout the world and has entered into license arrangements relating to various third-party patents and technologies. Products manufactured by Baxter are sold primarily under its own trademarks and trade names. Some products distributed by the company are sold under the company’s trade names, while others are sold under trade names owned by its suppliers or partners. Trade secret protection of unpatented confidential and proprietary information is also important to Baxter. The company maintains certain details about its processes, products and technology as trade secrets and generally requires employees, consultants, parties to collaboration agreements and other business partners to enter into confidentiality agreements. These agreements may be breached and Baxter may not have adequate remedies for any breach. In addition, Baxter’s trade secrets may otherwise become known or be independently discovered by

 

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competitors. To the extent that Baxter’s employees, consultants, parties to collaboration agreements and other business partners use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions.

Baxter’s policy is to protect its products and technology through patents and trademarks on a worldwide basis. This protection is sought in a manner that balances the cost of such protection against obtaining the greatest value for the company. Baxter also recognizes the need to promote the enforcement of its patents and trademarks and takes commercially reasonable steps to enforce its patents and trademarks around the world against potential infringers, including judicial or administrative action where appropriate.

Baxter operates in an industry susceptible to significant patent litigation. At any given time, the company is involved as either a plaintiff or defendant in a number of patent infringement and other intellectual property-related actions. Such litigation can result in significant royalty or other payments or result in injunctions that can prevent the sale of products. For more information on patent and other litigation, see Note 16 in Item 8 of this Annual Report on Form 10-K.

Research and Development

Baxter’s investment in research and development (R&D) is essential to its future growth and its ability to remain competitive in each of its business segments. Accordingly, Baxter continues to focus its investment on R&D programs to enhance future growth through clinical differentiation. Expenditures for Baxter’s R&D activities were $1.4 billion in 2014, $1.2 billion in 2013 and $1.1 billion in 2012. These expenditures include costs associated with R&D activities performed at the company’s R&D centers located around the world, which include facilities in Austria, Belgium, Sweden, Italy, Germany, China, Japan and the United States, as well as in-licensing, milestone and reimbursement payments made to partners for R&D work performed at non-Baxter locations. Included in Baxter’s R&D activities in 2014 were upfront and milestone payments of $217 million related to collaboration arrangements and $83 million related to business optimization charges.

The company’s research efforts emphasize self-manufactured product development, and portions of that research relate to multiple product categories. Baxter supplements its own R&D efforts by acquiring various technologies and entering into development and other collaboration agreements with third parties. In July 2011, Baxter established Baxter Ventures, a strategic initiative to invest in early-stage companies developing products and therapies to accelerate innovation and growth for the company. Through December 31, 2014, Baxter Ventures’ portfolio has included investments in such therapeutic areas as immunology, hematology and renal. In addition, Baxter’s BioScience business has been actively engaged in investigating new potential biosimilar and oncology treatments, primarily through business collaborations.

For more information on the company’s R&D activities, refer to the discussion under the caption entitled “Strategic Objectives” in Item 7 of this Annual Report on Form 10-K.

Quality Management

Baxter’s success depends upon the quality of its products. Quality management plays an essential role in determining and meeting customer requirements, preventing defects, facilitating continuous improvement of the company’s processes, products and services, and assuring the safety and efficacy of the company’s products. Baxter has one quality system deployed globally that enables the design, development, manufacturing, packaging, sterilization, handling, distribution and labeling of the company’s products to ensure they conform to customer requirements. In order to continually improve the effectiveness and efficiency of the quality system, various measurements, monitoring and analysis methods such as management reviews and internal, external and vendor audits are employed at local and central levels.

 

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Each product that Baxter markets is required to meet specific quality standards, both in packaging and in product integrity and quality. If either of those is determined to be compromised at any time, Baxter takes corrective and preventive actions designed to ensure compliance with regulatory requirements and to meet customer expectations. For more information on corrective actions taken by Baxter, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K.

Government Regulation

The operations of Baxter and many of the products manufactured or sold by the company are subject to extensive regulation by numerous government agencies, both within and outside the United States. The Food and Drug Administration (FDA) in the United States, the European Medicines Agency (EMA) in Europe, the China Food and Drug Administration (CFDA) in China and other government agencies inside and outside of the United States, administer requirements covering the testing, safety, effectiveness, manufacturing, labeling, promotion and advertising, distribution and post-market surveillance of Baxter’s products. The company must obtain specific approval from FDA and non-U.S. regulatory authorities before it can market and sell most of its products in a particular country. Even after the company obtains regulatory approval to market a product, the product and the company’s manufacturing processes and quality systems are subject to continued review by FDA and other regulatory authorities globally. State agencies in the United States also regulate the facilities, operations, employees, products and services of the company within their respective states. The company and its facilities are subject to periodic inspections and possible administrative and legal actions by FDA and other regulatory agencies inside and outside the United States. Such actions may include warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses. As situations require, the company takes steps to ensure safety and efficacy of its products, such as removing products found not to meet applicable requirements from the market and improving the effectiveness of quality systems. For more information on compliance actions taken by the company, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K.

The company is also subject to various laws inside and outside the United States concerning our relationships with healthcare professionals and government officials, price reporting and regulation, the promotion, sales and marketing of our products and services, the importation and exportation of our products, the operation of our facilities and distribution of our products. In the United States, the company is subject to the oversight of FDA, Office of the Inspector General within the Department of Health and Human Services (OIG), the Center for Medicare/Medicaid Services (CMS), the Department of Justice (DOJ), Environmental Protection Agency, Department of Defense and Customs and Border Protection in addition to others. The company supplies products and services to healthcare providers that are reimbursed by federally funded programs such as Medicare. As a result, the company’s activities are subject to regulation by CMS and enforcement by OIG and DOJ. In each jurisdiction outside the United States, the company’s activities are subject to regulation by government agencies including the EMA in Europe, CFDA in China and other agencies in other jurisdictions. Many of the agencies enforcing these laws have increased their enforcement activities with respect to healthcare companies in recent years. These actions appear to be part of a general trend toward increased enforcement activity globally.

Environmental policies of the company require compliance with all applicable environmental regulations and contemplate, among other things, appropriate capital expenditures for environmental protection.

Employees

As of December 31, 2014, Baxter employed approximately 66,000 people.

 

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Available Information

Baxter makes available free of charge on its website at www.baxter.com its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), as soon as reasonably practicable after electronically filing or furnishing such material to the Securities and Exchange Commission. In addition, Baxter’s Corporate Governance Guidelines, Code of Conduct, and the charters for the committees of Baxter’s Board of Directors are available on Baxter’s website at www.baxter.com under “Corporate Governance.” All the foregoing materials will be made available to shareholders in print upon request by writing to: Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015. Information contained on Baxter’s website shall not be deemed incorporated into, or to be a part of, this Annual Report on Form 10-K.

 

Item 1A. Risk Factors.

In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors. If any of the events described below occurs, our business, financial condition and results of operations and future growth prospects could suffer.

If we are unable to successfully introduce new products or fail to keep pace with advances in technology, our business, financial condition and results of operations could be adversely affected.

We need to successfully introduce new products to achieve our strategic business objectives. Product development requires substantial investment and there is inherent risk in the research and development process. A successful product development process depends on many factors, including our ability to properly anticipate and satisfy customer needs, adapt to new technologies, obtain regulatory approvals on a timely basis, demonstrate satisfactory clinical results, manufacture products in an economical and timely manner and differentiate our products from those of our competitors. If we cannot successfully introduce new products or adapt to changing technologies, our products may become obsolete and our revenue and profitability could suffer.

Issues with product quality could have an adverse effect upon our business, subject us to regulatory actions and cause a loss of customer confidence in us or our products.

Our success depends upon the quality of our products. Quality management plays an essential role in determining and meeting customer requirements, preventing defects, improving the company’s products and services and assuring the safety and efficacy of our products. Our future success depends on our ability to maintain and continuously improve our quality management program. While we have one quality system deployed globally that covers the lifecycle of our products, quality and safety issues may occur with respect to any of our products. A quality or safety issue may result in adverse inspection reports, warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, costly litigation, refusal of a government to grant approvals and licenses, restrictions on operations or withdrawal of existing approvals and licenses. An inability to address a quality or safety issue in an effective and timely manner may also cause negative publicity, a loss of customer confidence in us or our current or future products, which may result in the loss of sales and difficulty in successfully launching new products. Additionally, Baxter has made and continues to make significant investments in assets, including inventory and property, plant and equipment, which relate to potential new products or modifications to existing products. Product quality or safety issues may restrict the company from being able to realize the expected returns from these investments, potentially resulting in asset impairments in the future.

Unaffiliated third party suppliers provide a number of goods and services to our R&D, clinical and manufacturing organizations. Third party suppliers are required to comply with our quality standards. Failure of a third party supplier to provide compliant raw materials or supplies could result in delays, service interruptions or

 

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other quality related issues that may negatively impact our business results. In addition, some of the raw materials employed in our production processes are derived from human and animal origins, requiring robust controls to eliminate the potential for introduction of pathogenic agents or other contaminants.

For more information on regulatory matters currently affecting us, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K.

We are subject to a number of existing laws and regulations, non-compliance with which could adversely affect our business, financial condition and results of operations, and we are susceptible to a changing regulatory environment.

As a participant in the healthcare industry, our operations and products, and those of our customers, are regulated by numerous government agencies, both inside and outside the United States. The impact of this on us is direct to the extent we are subject to these laws and regulations, and indirect in that in a number of situations, even though we may not be directly regulated by specific healthcare laws and regulations, our products must be capable of being used by our customers in a manner that complies with those laws and regulations.

The manufacture, distribution, marketing and use of our products are subject to extensive regulation and scrutiny by FDA and other regulatory authorities globally. Any new product must undergo lengthy and rigorous testing and other extensive, costly and time-consuming procedures mandated by FDA and foreign regulatory authorities. Changes to current products may be subject to vigorous review, including additional 510(k) and other regulatory submissions, and approvals are not certain. Our facilities must be approved and licensed prior to production and remain subject to inspection from time to time thereafter. Failure to comply with the requirements of FDA or other regulatory authorities, including a failed inspection or a failure in our adverse event reporting system, could result in adverse inspection reports, warning letters, product recalls or seizures, monetary sanctions, injunctions to halt the manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses. Any of these actions could cause a loss of customer confidence in us and our products, which could adversely affect our sales. The requirements of regulatory authorities, including interpretative guidance, are subject to change and compliance with additional or changing requirements or interpretative guidance may subject the company to further review, result in product launch delays or otherwise increase our costs. For information on current regulatory issues affecting us, please refer to the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K. In connection with these issues, there can be no assurance that additional costs or civil and criminal penalties will not be incurred, that additional regulatory actions with respect to the company will not occur, that the company will not face civil claims for damages from purchasers or users, that substantial additional charges or significant asset impairments may not be required, that sales of other products may not be adversely affected, or that additional regulation will not be introduced that may adversely affect the company’s operations and consolidated financial statements.

The sales, marketing and pricing of products and relationships that pharmaceutical and medical device companies have with healthcare providers are under increased scrutiny by federal, state and foreign government agencies. Compliance with the Anti-Kickback Statute, False Claims Act, Food, Drug and Cosmetic Act (including as these laws relate to off-label promotion of products) and other healthcare related laws, as well as competition, data and patient privacy and export and import laws, is under increased focus by the agencies charged with overseeing such activities, including FDA, OIG, DOJ and the Federal Trade Commission. The DOJ and the Securities and Exchange Commission have also increased their focus on the enforcement of the U.S. Foreign Corrupt Practices Act (FCPA), particularly as it relates to the conduct of pharmaceutical companies. The FCPA and similar anti-bribery laws generally prohibit companies and their employees, contractors or agents from making improper payments to government officials for the purpose of obtaining or retaining business. Healthcare professionals in many countries are employed by the government and consequently may be considered government officials. Foreign governments have also increased their scrutiny of pharmaceutical and medical device companies’ sales and marketing activities and relationships with healthcare providers and

 

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competitive practices generally. The laws and standards governing the promotion, sale and reimbursement of our products and those governing our relationships with healthcare providers and governments, including the Sunshine Act enacted under the Patient Protection and Affordable Care Act, can be complicated, are subject to frequent change and may be violated unknowingly. We have compliance programs in place, including policies, training and various forms of monitoring, designed to address these risks. Nonetheless, these programs and policies may not always protect us from conduct by individual employees that violate these laws. Violations or allegations of violations of these laws may result in large civil and criminal penalties, debarment from participating in government programs, diversion of management time, attention and resources and may otherwise have an adverse effect on our business, financial condition and results of operations. For more information related to the company’s ongoing government investigations, please refer to Note 16 in Item 8 of this Annual Report on Form 10-K.

The laws and regulations discussed above are broad in scope and subject to evolving interpretations, which could require us to incur substantial cost associated with compliance or to alter one or more of our sales and marketing practices and may subject us to enforcement actions which could adversely affect our business, financial condition and results of operations.

If reimbursement or other payment for our current or future products is reduced or modified in the United States or abroad, including through the implementation of government-sponsored healthcare reform or other similar actions, cost containment measures, or changes to policies with respect to pricing, taxation or rebates, then our business could suffer.

Sales of our products depend, in part, on the extent to which the costs of our products are paid by both public and private payors. These payors include Medicare, Medicaid, and private health care insurers in the United States and foreign governments and third-party payors outside the United States. Public and private payors are increasingly challenging the prices charged for medical products and services. We may continue to experience continued downward pricing pressures from any or all of these payors which could result in an adverse effect on our business, financial condition and operational results.

Global efforts toward healthcare cost containment continue to exert pressure on product pricing. Governments around the world use various mechanisms to control healthcare expenditures such as price controls, the formation of public contracting authorities, product formularies (lists of recommended or approved products), and competitive tenders which require the submission of a bid to sell products. Sales of our products are dependent, in part, on the availability of reimbursement by government agencies and healthcare programs, as well as insurance companies and other private payors. In much of Europe, Latin America, Asia and Australia, for example, the government provides healthcare at low cost to patients, and controls its expenditures by purchasing products through public tenders, collective purchasing, regulating prices, setting reference prices in public tenders or limiting reimbursement or patient access to certain products. Additionally, austerity measures or other reforms by foreign governments may limit, reduce or eliminate payments for our products and adversely affect both pricing flexibility and demand for our products.

For example, in the United States the Patient Protection and Affordable Care Act (PPACA), which was signed into law in March 2010, includes several provisions which impact our businesses in the United States, including increased Medicaid rebates and an expansion of the 340B Drug Pricing Program which provides certain qualified entities, such as hospitals serving disadvantaged populations, with discounts on the purchase of drugs for outpatient use and an excise tax on the sale of certain drugs. We may also experience downward pricing pressure as the PPACA reduces Medicare and Medicaid payments to hospitals and other providers. While it is intended to expand health insurance coverage and increase access to medical care generally, the long-term impact of the PPACA on our business and the demand for our products is uncertain.

As a result of these and other measures, including future measures or reforms that cannot be predicted, reimbursement may not be available or sufficient to allow us to sell our products on a competitive basis.

 

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Legislation and regulations affecting reimbursement for our products may change at any time and in ways that may be adverse to us. We cannot predict the impact of these pressures and initiatives, or any negative effects of any additional regulations that may affect our business.

There is substantial competition in the product markets in which we operate and in the development of alliances with research, academic and governmental institutions.

Although no single company competes with us in all of our businesses, we face substantial competition in both of our segments from international and domestic healthcare and pharmaceutical companies of all sizes. Competition is primarily focused on cost-effectiveness, price, service, product performance, and technological innovation.

Competition may increase further as additional companies begin to enter our markets or modify their existing products to compete directly with ours. If our competitors respond more quickly to new or emerging technologies and changes in customer requirements, our products may be rendered obsolete or non-competitive. If our competitors develop more effective or affordable products, or achieve earlier patent protection or product commercialization than we do, our operations will likely be negatively affected. If we are forced to reduce our prices due to increased competition, our business could become less profitable. The company’s sales could be adversely affected if any of its contracts with GPOs, IDNs or other customers are terminated due to increased competition or otherwise.

We also face competition for marketing, distribution and collaborative development agreements, for establishing relationships with academic and research institutions, and for licenses to intellectual property. In addition, academic institutions, government agencies and other public and private research organizations may also conduct research, seek patent protection and establish collaborative arrangements for discovery, research, clinical development and marketing of products similar to ours. These companies and institutions compete with us in recruiting and retaining qualified scientific and management personnel as well as in acquiring technologies complementary to our programs. If we are unable to successfully compete with these companies and institutions, our business may suffer.

If our business development activities are unsuccessful, our business could suffer and our financial performance could be adversely affected.

As part of our long-term strategy, we are engaged in business development activities including evaluating acquisitions, joint development opportunities, technology licensing arrangements and other opportunities. These activities may result in substantial investment of the company’s resources. Our success developing products or expanding into new markets from such activities will depend on a number of factors, including our ability to find suitable opportunities for acquisition, investment or alliance; whether we are able to complete an acquisition, investment or alliance on terms that are satisfactory to us; the strength of the other company’s underlying technology, products and ability to execute its business strategies; any intellectual property and litigation related to these products or technology; and our ability to successfully integrate the acquired company, business, product, technology or research into our existing operations, including the ability to adequately fund acquired in-process research and development projects and to maintain adequate controls over the combined operations. Certain of these activities are subject to antitrust and competition laws, which laws could impact our ability to pursue strategic transactions and could result in mandated divestitures in the context of proposed acquisitions. If we are unsuccessful in our business development activities, we may be unable to meet our financial targets and our financial performance could be adversely affected.

For more information on recent business development activities, see Note 5 in Item 8 of this Annual Report on Form 10-K.

 

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The nature of producing plasma-based therapies may prevent us from timely responding to market forces and effectively managing our production capacity.

The production of plasma-based therapies is a lengthy and complex process, and we source our plasma both externally and internally through BioLife Plasma Services L.P. (BioLife), our wholly-owned subsidiary. Efforts to increase the collection of plasma or the production of plasma-based therapies may include the construction and regulatory approval of additional plasma collection facilities and plasma fractionation facilities. We are in the process of building a state-of-the-art manufacturing facility near Covington, Georgia to support growth of our plasma-based treatments, with commercial production scheduled to begin in 2018. The development of such facilities involves a lengthy regulatory process and is highly capital intensive. In addition, access to,transport and use of plasma may be subject to restrictions by governmental agencies both inside and outside the United States. As a result, our ability to match our collection and production of plasma-based therapies to market demand is imprecise and may result in a failure to meet market demand for our plasma-based therapies or, alternatively, an oversupply of inventory. Failure to meet market demand for our plasma-based therapies may result in customers transitioning to available competitive products resulting in a loss of market share or customer confidence. In the event of an oversupply, we may be forced to lower the prices we charge for some of our plasma-based therapies, close collection and processing facilities, record asset impairment charges or take other action which may adversely affect our business, financial condition and results of operations.

If we are unable to obtain sufficient components or raw materials on a timely basis or if we experience other manufacturing or supply difficulties, our business may be adversely affected.

The manufacture of our products requires the timely delivery of sufficient amounts of quality components and materials. We manufacture our products in more than 50 manufacturing facilities around the world. We acquire our components and materials from many suppliers in various countries. We work closely with our suppliers to ensure the continuity of supply but we cannot guarantee these efforts will always be successful. Further, while efforts are made to diversify our sources of components and materials, in certain instances we acquire components and materials from a sole supplier. For most of our components and materials for which a sole supplier is used, we believe that alternative sources of supply exist and have made a strategic determination to use a sole supplier. In very limited instances, however, we do rely upon sole supplier relationships for which no alternatives have currently been identified. Although we do carry strategic inventory and maintain insurance to mitigate the potential risk related to any related supply disruption, there can be no assurance that such measures will be effective. Due to the regulatory environment in which we operate, we may be unable to quickly establish additional or replacement sources for some components or materials. A reduction or interruption in supply, and an inability to develop alternative sources for such supply, could adversely affect our ability to manufacture our products in a timely or cost-effective manner, and our ability to make product sales.

Many of our products are difficult to manufacture. This is due to the complex nature of manufacturing pharmaceuticals, including biologics, and devices, as well as the strict regulatory regime governing our manufacturing operations. Variations in the manufacturing process may result in production failures which could lead to launch delays, product shortage, unanticipated costs, lost revenues and damage to our reputation. A failure to identify and address manufacturing problems prior to the release of products to our customers may also result in a quality or safety issue of the type discussed above.

Several of our products are manufactured at a single manufacturing facility or stored at a single storage site. Loss or damage to a manufacturing facility or storage site due to a natural disaster or otherwise could adversely affect our ability to manufacture sufficient quantities of key products or otherwise deliver products to meet customer demand or contractual requirements which may result in a loss of revenue and other adverse business consequences. Because of the time required to approve and license a manufacturing facility a third party manufacturer may not be available on a timely basis to replace production capacity in the event we lose manufacturing capacity or products are otherwise unavailable due to natural disaster, regulatory action or otherwise.

 

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The proposed spin-off of Baxter’s biopharmaceutical business may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the intended results.

In March 2014, Baxter announced plans to create two separate, independent global healthcare companies — one focused on developing and marketing innovative biopharmaceuticals and the other on life-saving medical products — through a tax-free distribution to Baxter shareholders of publicly traded stock in the new biopharmaceuticals company. The transaction is expected to be completed by mid-year 2015. Unanticipated developments could delay, prevent or otherwise adversely affect this proposed spin-off, including but not limited to disruptions in general market conditions or potential problems or delays in obtaining various regulatory, tax and works council approvals or clearances. In addition, consummation of the proposed spin-off will require final approval from our Board of Directors. Therefore, we cannot assure that we will be able to complete the spin-off on the terms or on the timeline that we announced, if at all.

We will incur significant expenses in connection with the spin-off. In addition, completion of the proposed spin-off will require significant amounts of management’s time and effort which may divert management’s attention from other aspects of our business operations. Further, if the spin-off is completed, it may not achieve the intended results. The spin-off will also require modifications to the company’s systems and processes used to operate our business and accurately maintain the company’s books and records. We may experience delays, increased costs and other difficulties related to these modifications which could adversely affect our business operations, results of operations or financial condition.

If we are unable to protect our patents or other proprietary rights, or if we infringe the patents or other proprietary rights of others, our competitiveness and business prospects may be materially damaged.

Patent and other proprietary rights are essential to our business. Our success depends to a significant degree on our ability to obtain and enforce patents and licenses to patent rights, both in the United States and in other countries. We cannot guarantee that pending patent applications will result in issued patents, that patents issued or licensed will not be challenged or circumvented by competitors, that our patents will not be found to be invalid or that the intellectual property rights of others will not prevent the company from selling certain products or including key features in the company’s products.

The patent position of a healthcare company is often uncertain and involves complex legal and factual questions. Significant litigation concerning patents and products is pervasive in our industry. Patent claims include challenges to the coverage and validity of our patents on products or processes as well as allegations that our products infringe patents held by competitors or other third parties. A loss in any of these types of cases 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. We also rely on trademarks, copyrights, trade secrets and know-how to develop, maintain and strengthen our competitive positions. Third parties may know, discover or independently develop equivalent proprietary information or techniques, or they may gain access to our trade secrets or disclose our trade secrets to the public.

Although our employees, consultants, parties to collaboration agreements and other business partners are generally subject to confidentiality or similar agreements to protect our confidential and proprietary information, these agreements may be breached, and we may not have adequate remedies for any breach. To the extent that our employees, consultants, parties to collaboration agreements and other business partners use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

Furthermore, our intellectual property, other proprietary technology and other sensitive company data is potentially vulnerable to loss, damage or misappropriation from system malfunction, computer viruses, unauthorized access to our data or misappropriation or misuse thereof by those with permitted access and other events. While we have invested to protect our intellectual property and other data, and continue to work

 

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diligently in this area, there can be no assurance that our precautionary measures will prevent breakdowns, breaches, cyber incidents or other events. Such events could have a material adverse effect on our reputation, business, financial condition or results of operations.

Misappropriation or other loss of our intellectual property from any of the foregoing would have an adverse effect on our competitive position and may cause us to incur substantial litigation costs.

We are subject to risks associated with doing business globally.

Our operations are subject to risks inherent in conducting business globally and under the laws, regulations and customs of various jurisdictions and geographies. These risks include changes in exchange controls and other governmental actions, loss of business in government and public tenders that are held annually in many cases, increasingly complex labor environments, availability of raw materials, changes in taxation, export control restrictions, changes in or violations of U.S. or local laws, including the FCPA and the United Kingdom Bribery Act, dependence on a few government entities as customers, pricing restrictions, economic and political instability (including instability as it relates to the Euro and currencies in certain emerging market countries), disputes between countries, diminished or insufficient protection of intellectual property, and disruption or destruction of operations in a significant geographic region regardless of cause, including war, terrorism, riot, civil insurrection or social unrest. Failure to comply with, or material changes to, the laws and regulations that affect our global operations could have an adverse effect on our business, financial condition or results of operations.

Changes in foreign currency exchange rates and interest rates could have a material adverse effect on our operating results and liquidity.

We generate the majority of our revenue outside the United States. As a result, our financial results may be adversely affected by fluctuations in foreign currency exchange rates. We cannot predict with any certainty changes in foreign currency exchange rates or our ability to mitigate these risks. We may experience additional volatility as a result of inflationary pressures and other macroeconomic factors in certain emerging market countries. We are also exposed to changes in interest rates, and our ability to access the money markets and capital markets could be impeded if adverse liquidity market conditions occur. A discussion of the financial impact of foreign exchange rate and interest rate fluctuations, and the ways and extent to which we attempt to mitigate such impact is contained under the caption “Financial Instrument Market Risk” in Item 7 of this Annual Report on Form 10-K.

Changes in tax laws or exposure to additional income tax liabilities may have a negative impact on our operating results.

Tax policy reform continues to be a topic of discussion in the United States. A significant change to the tax system in the United States, including changes to the taxation of international income, could have an adverse effect upon our results of operations. Because we operate in multiple income tax jurisdictions both inside and outside the United States, we are subject to tax audits in various jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, we may not accurately predict the outcome of these audits, and as a result the actual outcome of these audits may have an adverse impact on our financial results. For more information on ongoing audits, see Note 15 in Item 8 of this Annual Report on Form 10-K.

We are increasingly dependent on information technology systems, and our systems and infrastructure face certain risks, including from cyber security breaches and data leakage.

We increasingly rely upon technology systems and infrastructure. Our technology systems are potentially vulnerable to breakdown or other interruption by fire, power loss, system malfunction, unauthorized access and

 

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other events. Likewise, data privacy breaches by employees and others with both permitted and unauthorized access to our systems may pose a risk that sensitive data may be exposed to unauthorized persons or to the public, or may be permanently lost. The increasing use and evolution of technology, including cloud-based computing, creates additional opportunities for the unintentional dissemination of information, intentional destruction of confidential information stored in our systems or in non-encrypted portable media or storage devices. We could also experience a business interruption, information theft of confidential information, or reputational damage from industrial espionage attacks, malware or other cyber incidents, which may compromise our system infrastructure or lead to data leakage, either internally or at our third-party providers or other business partners. While we have invested heavily in the protection of data and information technology and in related training, there can be no assurance that our efforts will prevent significant breakdowns, breaches in our systems or other cyber incidents that could have a material adverse effect upon our reputation, business, operations or financial condition. In addition, significant implementation issues may arise as we continue to consolidate and outsource certain computer operations and application support activities.

If we fail to attract and retain key employees our business may suffer.

Our ability to compete effectively depends on our ability to attract and retain key employees, including people in senior management, sales, marketing and research positions. Competition for top talent in healthcare can be intense. Our ability to recruit and retain such talent will depend on a number of factors, including hiring practices of our competitors, compensation and benefits, work location, work environment and industry economic conditions. If we cannot effectively recruit and retain qualified employees, our business could suffer.

We are subject to a number of pending lawsuits.

We are a defendant in a number of pending lawsuits. In addition, we may be named as a defendant in future patent, product liability or other lawsuits. These current and future matters may result in a loss of patent protection, reduced revenue, significant liabilities and diversion of our management’s time, attention and resources. Given the uncertain nature of litigation generally, we are not able in all cases to estimate the amount or range of loss that could result from an unfavorable outcome in these current matters. In view of these uncertainties, the outcome of these matters may result in charges in excess of any established reserves, and, to the extent available, liability insurance. We also continue to be self-insured with respect to product liability claims. The absence of third-party insurance coverage for current or future claims increases our potential exposure to unanticipated claims and adverse decisions. Protracted litigation, including any adverse outcomes, may have an adverse impact on the business, operations or financial condition of the company. Even claims without merit could subject us to adverse publicity and require us to incur significant legal fees. See Note 16 in Item 8 of this Annual Report on Form 10-K for more information regarding current lawsuits.

Current or worsening economic conditions may adversely affect our business and financial condition.

The company’s ability to generate cash flows from operations could be affected if there is a material decline in the demand for the company’s products, in the solvency of its customers or suppliers, or deterioration in the company’s key financial ratios or credit ratings. Current or worsening economic conditions may adversely affect the ability of our customers (including governments) to pay for our products and services, and the amount spent on healthcare generally. This could result in a decrease in the demand for our products and services, declining cash flows, longer sales cycles, slower adoption of new technologies and increased price competition. These conditions may also adversely affect certain of our suppliers, which could cause a disruption in our ability to produce our products. We continue to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, that have experienced a deterioration in credit and economic conditions. As of December 31, 2014, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $363 million. While global economic conditions have not significantly impacted the company’s ability to collect receivables, liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses. These conditions may also impact the stability of the

 

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Euro. For more information on accounts receivable and credit matters with respect to certain of these countries, refer to the discussion under the caption entitled “Credit Facilities, Access to Capital and Credit Ratings” in Item 7 of this Annual Report on Form 10-K.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties.

The company’s corporate offices are owned and located at One Baxter Parkway, Deerfield, Illinois 60015.

Baxter owns or has long-term leases on all of its manufacturing facilities. The company maintains 17 manufacturing facilities in the United States and its territories, including three in Puerto Rico. The company also manufactures in Australia, Austria, Belgium, Brazil, Canada, China, Colombia, Costa Rica, the Czech Republic, Dominican Republic, France, Germany, India, Ireland, Italy, Japan, Malta, Mexico, the Philippines, Poland, Saudi Arabia, Singapore, Spain, Sweden, Switzerland, Tunisia, Turkey and the United Kingdom. The company’s principal manufacturing facilities by segment are listed below:

 

Business

  

Location

  

Owned/Leased

BioScience

     
   Orth, Austria    Owned
   Vienna, Austria    Owned
   Lessines, Belgium    Owned
   Bohumil, Czech Republic    Owned(5)
   Pisa, Italy    Owned
   Rieti, Italy    Owned
   Woodlands, Singapore    Owned/Leased(3)
   Neuchatel, Switzerland    Owned
   Elstree, United Kingdom    Leased
   Hayward, California    Leased
   Los Angeles, California    Owned
   Thousand Oaks, California    Owned
   St. Paul, Minnesota    Leased
   Milford, Massachusetts    Leased

Medical Products

     
   Toongabbie, Australia    Owned
   Lessines, Belgium    Owned
   Sao Paulo, Brazil    Owned
   Alliston, Canada    Owned
   Guangzhou, China    Owned
   Suzhou, China    Owned
   Shanghai, China    Owned(1)
   Cali, Colombia    Owned
   Cartago, Costa Rica    Owned
   Prerov, Czech Republic    Leased
   Haina, Dominican Republic    Leased
   Meyzieu, France    Owned
   Hechingen, Germany    Leased
   Joka, Germany    Owned
   Rostock, Germany    Leased

 

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Business

  

Location

  

Owned/Leased

Medical Products

   Halle, Germany    Owned
   Castlebar, Ireland    Owned
   Swinford, Ireland    Owned
   Medolla, Italy    Owned
   Poggio Rusco, Italy    Leased(2)
   Sondalo, Italy    Owned
   Grosotto, Italy    Owned
   Miyazaki, Japaxn    Owned
   Cuernavaca, Mexico    Owned
   PESA, Mexico    Owned/Leased
   Tijuana, Mexico    Owned
   Guayama, Puerto Rico    Owned
   Jayuya, Puerto Rico    Leased
   Aibonito, Puerto Rico    Leased
   Woodlands, Singapore    Owned/Leased(3)
   Sabinanigo, Spain    Owned
   Lund, Sweden    Leased
   San Vittore, Switzerland    Owned
   Liverpool, United Kingdom    Owned
   Thetford, United Kingdom    Owned
   Opelika, Alabama    Owned
   Mountain Home, Arkansas    Owned
   Englewood, Colorado    Leased
   Round Lake, Illinois    Owned
   Bloomington, Indiana    Owned/Leased(4)
   Brooklyn Park, Minnesota    Leased
   Cleveland, Mississippi    Leased
   Medina, New York    Leased
   North Cove, North Carolina    Owned

 

(1) There are two plants located in Shanghai, China.

 

(2) This plant is a temporary Baxter Renal Gambro location.

 

(3) Baxter owns the facility at Woodlands, Singapore, and leases the property upon which it rests. This facility is shared between the Medical Products and BioScience businesses.

 

(4) The Bloomington, Indiana location includes both owned and leased facilities.

 

(5) Baxter entered into an agreement for the sale of this facility in December 2014.

The company also owns or operates shared distribution facilities throughout the world. In the United States and Puerto Rico, there are 8 shared distribution facilities with the principal facilities located in Memphis, Tennessee; Catano, Puerto Rico; North Cove, North Carolina; and Round Lake, Illinois. Internationally, we have more than 100 shared distribution facilities located in Argentina, Australia, Austria, Belgium, Brazil, Brunei, Canada, Chile, China, Colombia, Costa Rica, the Czech Republic, Ecuador, France, Germany, Greece, Guatemala, Hong Kong, India, Indonesia, Ireland, Italy, Japan, Korea, Malaysia, Mexico, New Zealand, Panama, the Philippines, Poland, Portugal, Russia, Singapore, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, the United Arab Emirates, the United Kingdom, Venezuela and Vietnam.

The company continually evaluates its plants and production lines and believes that its current facilities plus any planned expansions are generally sufficient to meet its expected needs and expected near-term growth. Expansion projects and facility closings will be undertaken as necessary in response to market needs.

 

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Item 3. Legal Proceedings.

Incorporated by reference to Note 16 in Item 8 of this Annual Report on Form 10-K.

 

Item 4. Mine Safety Disclosures.

Not Applicable.

Executive Officers of the Registrant

Robert L. Parkinson, Jr., age 64, is Chairman and Chief Executive Officer of Baxter, having served in that capacity since April 2004. Prior to joining Baxter, Mr. Parkinson was Dean of Loyola University Chicago School of Business Administration and Graduate School of Business from 2002 to 2004. He retired from Abbott Laboratories in 2001 following a 25-year career, having served in a variety of domestic and international management and leadership positions, including as President and Chief Operating Officer. Mr. Parkinson also serves on the Board of Directors of Chicago-based Northwestern Medical Group and as Chairman of the Loyola University Chicago Board of Trustees.

Ludwig N. Hantson, Ph.D., age 52, is Corporate Vice President and President, BioScience, having served in that capacity since October 2010. Dr. Hantson joined Baxter in May 2010 as Corporate Vice President and President, International. From 2001 to May 2010, Dr. Hantson held various positions at Novartis Pharmaceuticals Corporation, the most recent of which was Chief Executive Officer, Pharma North America. Prior to Novartis, Dr. Hantson spent 13 years with Johnson & Johnson in roles of increasing responsibility in marketing and clinical research and development.

Robert J. Hombach, age 49, is Corporate Vice President and Chief Financial Officer, having served in that capacity since July 2010. From February 2007 to March 2011, Mr. Hombach served as Treasurer and from December 2004 to February 2007, he was Vice President of Finance, Europe. Prior to that, Mr. Hombach served in a number of finance positions of increasing responsibility in the planning, manufacturing, operations and treasury areas at Baxter.

Jeanne K. Mason, Ph.D., age 59, is Corporate Vice President, Human Resources. Prior to joining Baxter in May 2006, Dr. Mason was with General Electric from 1988, holding various leadership positions, the most recent of which was with GE Insurance Solutions, a primary insurance and reinsurance business, where she was responsible for global human resource functions.

David P. Scharf, age 47, is Corporate Vice President and General Counsel, having served in this capacity since August 2009. Mr. Scharf has also served as Corporate Secretary from September 2013. Mr. Scharf joined Baxter in July 2005 and served in progressive leadership roles within the legal department. Prior to joining Baxter, Mr. Scharf was with Guidant Corporation from 2002, in roles of increasing responsibility.

All executive officers hold office until the next annual election of officers and until their respective successors are elected and qualified.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The following table includes information about the company’s common stock repurchases during the three-month period ended December 31, 2014.

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
Programs(1)
   Approximate Dollar
Value of Shares
that may yet be
Purchased Under the
Program(1)
 

 

 

October 1, 2014 through
October 31, 2014

   420,000    $69.23    420,000   

November 1, 2014 through
November 30, 2014

   298,800    $70.02    298,800   

December 1, 2014 through
December 31, 2014

      $     —      

 

 

Total

   718,800    $69.56    718,800    $ 470,589,813   

 

 

 

(1) In July 2012, the company announced that its Board of Directors authorized the company to repurchase up to $2.0 billion of its common stock on the open market or in private transactions. During the fourth quarter of 2014, the company repurchased 0.7 million shares for $50 million under this program. The remaining authorization under this program totaled approximately $0.5 billion at December 31, 2014. This program does not have an expiration date.

Additional information required by this item is incorporated by reference to Note 18 in Item 8 of this Annual Report on Form 10-K.

 

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Performance Graph

The following graph compares the change in Baxter’s cumulative total shareholder return (including reinvested dividends) on Baxter’s common stock with the Standard & Poor’s 500 Composite Index and the Standard & Poor’s 500 Health Care Index over the past five years.

 

LOGO

 

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Item 6. Selected Financial Data.

 

as of or for the years ended December 31    20141,6      20132,6      20123,6      20114,6      20105,6  

 

 

Operating Results

  

Net sales

   $ 16,671         14,967         13,936         13,638         12,562   

(in millions)

  

Income from continuing operations

   $ 1,946         2,012         2,283         2,208         1,420   
  

Income from discontinued operations, net of tax

   $ 551         0         43         16         0   
  

Net income7

   $ 2,497         2,012         2,326         2,224         1,420   
  

Depreciation and amortization

   $ 1,002         815         704         662         677   
  

Research and development expenses

   $ 1,421        1,165         1,081         890         857  

 

 

Balance Sheet and

  

Capital expenditures

   $ 1,898         1,525         1,161         960         963   
Cash Flow Information   

Total assets

   $ 25,917         25,224         20,390         19,073         17,489   

(in millions)

  

Long-term debt and lease obligations

   $ 7,606        8,126         5,580         4,749         4,363  

 

 
Common Stock Information   

Weighted-average number of common shares outstanding

              
  

Basic

     542         543         551         569         590   
  

Diluted

     547         549         556         573         594   
  

Income from continuing operations per common share

              
  

Basic

   $ 3.59         3.70         4.14         3.88         2.41   
  

Diluted

   $ 3.56         3.66         4.11         3.85         2.39   
  

Income from discontinued operations per common share

              
  

Basic

   $ 1.02         0.00         0.08         0.03         0.00   
  

Diluted

   $ 1.00         0.00         0.07         0.03         0.00   
  

Net income per common share

              
  

Basic

   $ 4.61         3.70         4.22         3.91         2.41   
  

Diluted

   $ 4.56         3.66         4.18         3.88         2.39   
  

Cash dividends declared per common share

   $ 2.050         1.920         1.570         1.265         1.180   
  

Year-end market price per common share

   $ 73.29        69.55         66.66         49.48         50.62  

 

 

Other Information

  

Total shareholder return8

     8.4%         7.3%         38.3%         0.0%         (11.6%
  

Common shareholders of record at year-end

     34,742        36,718         42,067         43,534         43,715  

 

 

 

1 

Income from continuing operations included charges totaling $83 million for business optimization, $93 million for SIGMA Spectrum Infusion Pump product remediation efforts, $144 million related to the acquisition and integration of Gambro, $167 million for the planned separation of Baxter’s biopharmaceutical and medical products businesses, $217 million in upfront and milestone payments associated with the company’s collaboration arrangements, $45 million for an other-than-temporary impairment loss related to Baxter’s holdings in the common stock of one of its collaboration partners, $124 million related to an increase in the estimated fair value of acquisition-related contingent payment liabilities, and $29 million to account for an additional year of the Branded Prescription Drug Fee in accordance with final regulations issued by the Internal Revenue Service. Also included were benefits of $64 million for business optimization reserves that are no longer probable of being utilized, $25 million for an adjustment to the COLLEAGUE infusion pump reserves, and $9 million related to third-party recoveries and reversals of prior tax and legal reserves.

 

2 

Income from continuing operations included charges totaling $200 million for business optimization, $17 million primarily related to remediation efforts associated with modifications to the SIGMA Spectrum Infusion Pump in conjunction with re-filing for 510(k) clearance, $255 million related to the acquisition and integration of Gambro and losses from the derivative instruments used to hedge the anticipated foreign currency cash outflows, $103 million primarily related to upfront and milestone payments associated with the company’s collaboration arrangements, $89 million related to tax and legal reserves associated with VAT matters in Turkey and existing class-action and other related litigation. Also included was a benefit of $20 million for business optimization reserves that are no longer probable of being utilized.

 

3 

Income from continuing operations included charges totaling $150 million for business optimization, $128 million primarily related to upfront and milestone payments associated with the company’s collaboration arrangements, and $170 million primarily related to pension settlement charges and other pension-related

 

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  items. Also included were benefits of $23 million primarily related to an adjustment to the COLLEAGUE infusion pump reserve when the company substantially completed its recall activities in the United States and $91 million for gains related to a decrease in the estimated fair value of acquisition-related contingent payment liabilities.

 

4 

Income from continuing operations included charges totaling $180 million for business optimization, $79 million related to litigation and certain historical rebate and discount adjustments, and $103 million primarily related to the write-down of Greek government bonds and a contribution to the Baxter International Foundation.

 

5 

Income from continuing operations included charges totaling $256 million for business optimization, $112 million for an impairment associated with the company’s divestiture of its U.S. multi-source generic injectables business, $62 million related to litigation, $39 million to write off a deferred tax asset, $34 million primarily related to an upfront payment associated with one of the company’s collaboration arrangements, $28 million to write down accounts receivable in Greece, and $588 million related to the recall of COLLEAGUE infusion pumps. The COLLEAGUE charge reduced net sales by $213 million.

 

6 

Refer to the notes to the consolidated financial statements for information regarding other charges and income items.

 

7 

Excludes net income attributable to noncontrolling interests of $32 million and $7 million in 2011 and 2010, respectively.

 

8 

Represents the total of appreciation (decline) in market price plus cash dividends declared on common shares.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following commentary should be read in conjunction with the consolidated financial statements and accompanying notes.

EXECUTIVE OVERVIEW

Description of the Company and Business Segments

Baxter International Inc., through its subsidiaries, develops, manufactures and markets products that save and sustain the lives of people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. As a global, diversified healthcare company, Baxter applies a unique combination of expertise in medical devices, pharmaceuticals and biotechnology to create products that advance patient care worldwide. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices, clinical and medical research laboratories, and by patients at home under physician supervision.

The company operates in two segments: BioScience and Medical Products.

The BioScience business processes recombinant and plasma-based proteins to treat hemophilia and other bleeding disorders; plasma-based therapies to treat immune deficiencies, alpha-1 antitrypsin deficiency, burns and shock, and other chronic and acute blood-related conditions; and biosurgery products. Additionally, the BioScience business is investing in new disease areas, including oncology, as well as emerging technology platforms, including gene therapy and biosimilars.

The Medical Products business manufactures intravenous (IV) solutions and administration sets, premixed drugs and drug-reconstitution systems, pre-filled vials and syringes for injectable drugs, IV nutrition products, infusion pumps, and inhalation anesthetics. The business also provides products and services related to pharmacy compounding, drug formulation and packaging technologies. In addition, the Medical Products business provides products and services to treat end-stage renal disease, or irreversible kidney failure, along with other renal therapies, which business was enhanced through the 2013 acquisition of Gambro AB (Gambro). The Medical Products business now offers a comprehensive portfolio to meet the needs of patients across the treatment continuum, including technologies and therapies for peritoneal dialysis (PD), in-center hemodialysis (HD), home HD (HHD), continuous renal replacement therapy (CRRT) and additional dialysis services.

Baxter has approximately 66,000 employees and conducts business in over 100 countries. The company generates approximately 60% of its revenues outside the United States, and maintains over 50 manufacturing facilities and over 100 distribution facilities in the United States, Europe, Asia-Pacific, Latin America and Canada.

Planned Spin-Off of Biopharmaceuticals Business

In March 2014, Baxter announced plans to create two separate, independent global healthcare companies – one focused on developing and marketing innovative biopharmaceuticals and the other on life-saving medical products. The transaction is intended to take the form of a tax-free distribution in the United States to Baxter shareholders of more than 80% of the publicly traded stock in the new biopharmaceuticals company. The transaction is expected to be completed by mid-year 2015, subject to market, regulatory and certain other conditions, including final approval by the Baxter Board of Directors, receipt of a favorable opinion and/or rulings in the United States with respect to the tax-free nature of the transaction, and the effectiveness of a Form 10 registration statement that has been filed with the SEC. Upon separation, the historical results of the biopharmaceuticals business will be presented as discontinued operations.

Vaccines Discontinued Operations

In December 2014, the company completed the divestiture of the commercial vaccines business and entered into a separate agreement for the sale of the remainder of the Vaccines franchise, which is expected to be completed

 

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in the first quarter of 2015. As a result of the divestitures, the operating results of the Vaccines franchise have been reflected as discontinued operations for 2014, 2013, and 2012. Refer to Note 2 for additional information regarding the presentation of the Vaccines franchise. Unless otherwise stated, financial results herein reflect continuing operations only.

Financial Results

Baxter’s 2014 results reflect the company’s success in meeting its financial objectives while navigating a challenging and complex macroeconomic environment. Baxter has continued to improve operational and commercial execution, while deriving significant benefits from bringing products and therapies to various markets more effectively. Further, the company has made investments to further advance the product pipeline and position Baxter for future growth and success. The company generated significant cash flows in 2014 while maintaining a disciplined capital allocation strategy of returning value to shareholders through both share repurchases and increased dividends.

Baxter’s global net sales totaled $16.7 billion in 2014, an increase of 11% over 2013, including an unfavorable foreign currency impact of two percentage points. The acquisition of Gambro resulted in net sales totaling $1.6 billion in 2014 compared to $513 million in 2013, from the September 6, 2013 acquisition date; the acquisition contributed seven percentage points towards total Baxter net sales growth. International sales totaled $9.7 billion in 2014, an increase of 13% compared to 2013, including an unfavorable foreign currency impact of three percentage points. Sales in the United States totaled $7.0 billion in 2014, an increase of 9% over 2013.

Baxter’s income from continuing operations for 2014 totaled $1.9 billion, or $3.56 per diluted share, compared to $2.0 billion, or $3.66 per diluted share, in the prior year. Income from continuing operations in 2014 included special items which resulted in a net reduction to income from continuing operations by $737 million, or $1.34 per diluted share. Income from continuing operations in 2013 included special items which resulted in a net reduction to income from continuing operations by $565 million, or $1.03 per diluted share. The company’s special items are discussed further in the Results of Operations section below.

Baxter’s financial results included research and development (R&D) expenses totaling $1.4 billion in 2014, which reflects the acceleration of R&D spending to advance late-stage development programs and product approvals in both developed and emerging markets, while also focusing on enhancing the company’s early-stage and exploratory R&D. During the year, Baxter continued to transform the new product pipeline into a robust portfolio of products and therapies that improve the quality of care and address key high-potential areas of unmet medical need. Additionally, R&D expenses in 2014 included upfront and milestone payments of $217 million related to the company’s various collaboration arrangements.

The company’s financial position remains strong, with cash flows from operations totaling $3.2 billion in 2014. The company has continued to execute on its disciplined capital allocation framework, which is designed to optimize shareholder value creation through targeted capital investments, share repurchases and dividends, as well as acquisitions and other business development initiatives as discussed in Strategic Objectives below.

Capital investments totaled $1.9 billion in 2014 as the company continues to invest across its businesses to support future growth, including additional investments in support of new and existing product capacity expansions in the BioScience and Medical Products segments. The company’s investments in capital expenditures in 2014 were focused on projects that improve production efficiency and enhance manufacturing capabilities to support its strategy of geographic expansion with select investments in growing markets.

The company also continued to return value to its shareholders in the form of share repurchases and dividends. During 2014, the company repurchased eight million shares of common stock for $550 million, and paid cash dividends to its shareholders totaling $1.1 billion.

 

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Strategic Objectives

Baxter continues to focus on several key objectives to successfully execute its long-term strategy to achieve sustainable growth and deliver shareholder value. Baxter’s diversified and broad portfolio of products that treat life-threatening acute or chronic conditions and its global presence are core components of the company’s strategy to achieve these objectives. The company continues to focus on four key strategic growth vectors: advancing the core portfolio globally, driving innovation through the R&D pipeline, enhancing growth through acquisitions and collaborations, and developing unique public-private partnerships.

Advancing the Core Portfolio Globally

Baxter is well-positioned in the market, despite challenging global economic conditions, due to the breadth and diversity of the company’s portfolio in both BioScience and Medical Products. In the BioScience business, the company’s products treat bleeding disorders and a range of immune disorders. The Medical Products business offers innovative products for treatment of end-stage renal disease and other therapies and technologies supporting the work of hospital pharmacies and serving the needs of patients in acute care settings.

While Baxter is a leader in several of the markets noted above, there is significant potential to expand across the company’s core portfolio by improving access to Baxter’s products and therapies globally.

Baxter remains committed to meeting patient demands by enhancing its manufacturing capabilities in both the BioScience and Medical Products businesses. In the BioScience business, the company made progress in the construction of a state-of-the-art manufacturing facility in Covington, Georgia, which is expected to begin commercial production in 2018. In the Medical Products business, the company is expanding its capacity in several key markets and product areas. These include investments in Asia and at the North Cove, North Carolina, facility to support production of PD and IV solutions. Additionally, the company is executing expansion plans at the Opelika, Alabama, facility to meet the growing global demand for dialyzers.

Driving Innovation through the R&D Pipeline

R&D innovation and scientific productivity continue to be key strategic priorities for Baxter. Key developments in 2014 included the following:

Product Approvals and Launches

 

   

United States Food and Drug Administration (FDA) approval and launch of BAXJECT III, a new reconstitution system for ADVATE [Antihemophilic Factor (Recombinant)], which reduces the number of steps in the reconstitution process for hemophilia A patients and caregivers. The company has also received approval in Europe with a planned launch in 2015.

 

   

FDA approval and launch of HYQVIA [Immune Globulin Infusion 10% (Human) with Recombinant Human Hyaluronidase]. HYQVIA is the first FDA approved subcutaneous treatment for adult patients with primary immunodeficiency with a dosing regimen requiring only one infusion up to once per month and one injection site per infusion to deliver a full therapeutic dose of immune globulin.

 

   

FDA approval and launch of OBIZUR [Antihemophilic Factor (Recombinant), Porcine Sequence] for the treatment of bleeding episodes in adults with acquired hemophilia A, a very rare and potentially life-threatening acute bleeding disorder.

 

   

FDA approval extending the use of RIXUBIS [Coagulation Factor IX (Recombinant)] to children with hemophilia B, for routine prophylactic treatment, control and prevention of bleeding episodes, and perioperative management. The company also received regulatory approvals in several markets outside the United States including Australia, Brazil, Canada, Europe, and Japan for either adults (over the age of 12) or both pediatric and adult patients.

 

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FDA approval of FLEXBUMIN 5%, expanding the FLEXBUMIN product portfolio, which is the first and only preparation of human albumin to be packaged in a flexible plastic container, to include both 5% in a 250 mL solution and 25% in 50 and 100 mL solutions.

 

   

European CE marking of myPKFiT, a web-based individualized dosing device for prophylactic treatment of hemophilia A with ADVATE. The device allows physicians to calculate personalized ADVATE treatment regimens based on patient information and individual pharmacokinetic profiles.

 

   

Regulatory approval for ADVATE in Turkey and Russia.

 

   

FDA 510(k) clearance for the next-generation SIGMA Spectrum Infusion Pump, which increases capacity of the master drug library and enables a hospital to maintain a customized in-house library of facility-defined dosing parameters for infusions, minimizing the likelihood of drug error during care.

Other Developments

 

   

Submission of biologics license applications (BLA) to FDA for the approval of BAX 855, an investigational, extended half-life recombinant factor VIII (rFVIII) treatment for hemophilia A based on ADVATE [Antihemophilic Factor (Recombinant)], and BAX111, the first highly-purified recombinant von Willebrand Factor (rVWF), as a treatment for patients with von Willebrand disease, the most common type of inherited bleeding disorder.

 

   

European regulatory approval of a new manufacturing facility in Singapore for the production of recombinant proteins, including ADVATE.

 

   

Announcement of plans to form a new global innovation and R&D center in Cambridge, Massachusetts, which positions the company to accelerate innovation by building on its pipeline in core areas of expertise, strengthen and build upon R&D collaborations with partners in new and emerging biotechnology areas, and optimize R&D productivity while enhancing patient care globally.

Enhancing Growth through Acquisitions and Collaborations

Baxter has accelerated its pace of acquisitions and collaborations in recent years. Key developments in 2014 included the following:

 

   

The acquisition of all the outstanding membership interests in Chatham Therapeutics, LLC (Chatham Therapeutics), obtaining Chatham Therapeutics’ gene therapy programs related to the development and commercialization of treatments for hemophilia.

 

   

The acquisition of all the outstanding membership interests in AesRx, LLC (AesRx), obtaining AesRx’s program related to the development and commercialization of treatments for sickle cell disease.

 

   

The acquisition of all of the outstanding shares in IC Net International Ltd, a leader in surveillance and case management software used in hospitals, which enhances Baxter’s unique expertise in hospital pharmacy operations.

 

   

The execution of an exclusive collaboration agreement with Merrimack Pharmaceuticals, Inc. (Merrimack) relating to the development and commercialization of MM-398 (nanoliposomal irinotecan injection), also known as “nal-IRI”, across all markets with the exception of the United States and Taiwan.

 

   

The execution of an exclusive distribution agreement with Rockwell Medical, Inc. (RMI) for its leading HD concentrates in the United States and other select markets, which enhances Baxter’s comprehensive range of therapeutic options across home, in-center and hospital settings for patients with end-stage renal disease.

 

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Baxter has also benefitted from the continued integration of Gambro following the 2013 acquisition. The combination of Gambro’s dialysis products and therapies and Baxter’s own global leadership in home-based PD therapy provides patients and providers a comprehensive renal portfolio and global array of cross-therapeutic options.

During 2014, Baxter continued to make equity investments in companies developing high-potential technologies through Baxter Ventures, a strategic initiative established in 2011 to invest in early-stage companies developing products and therapies to accelerate innovation and growth for the company.

The company expects to continue to further supplement its internal R&D activities and pursue accelerated growth with its investment in other business development opportunities, including acquisitions, collaborations and alliances, that complement our current businesses, enhance our portfolio, and leverage our core strengths.

Public-Private Partnerships

In addition to the company’s business development activities, Baxter is focused on pursuing innovation through unique business models and the development of public-private partnerships. During 2014, Baxter made advances in its existing public-private partnership with Hemobrás to provide hemophilia patients in Brazil greater access to rFVIII therapy for the treatment of hemophilia A. Baxter is Brazil’s exclusive provider of rFVIII and will facilitate a technology transfer to support local manufacturing capacity and technical expertise.

In 2014, Baxter entered into an arrangement with Singapore’s Changi General Hospital to form a new Centre of Excellence in Compounding Sciences to drive process and clinical innovations to meet increasing needs for compounded sterile products while improving quality, efficiency and supporting the ongoing shifting of care delivery from the hospital to the community setting and the patient’s home.

Baxter is also making progress on a new facility in Amata City, Rayong province, Thailand. The plant will support growing demand for PD therapy in response to Thailand’s PD First policy. The new plant is expected to be fully operational in 2016.

Responsible Corporate Citizen

The company strives for continued growth and profitability, while furthering its focus on acting as a responsible corporate citizen. At Baxter, sustainability means creating lasting social, environmental and economic value by addressing the needs of the company’s wide-ranging stakeholder base. Baxter’s comprehensive sustainability program is focused on areas where the company is uniquely positioned to make a positive impact. Priorities include providing employees a safe, healthy and inclusive workplace, fostering a culture that drives integrity, strengthening access to healthcare, enhancing math and science education, and driving environmental performance across the product life cycle including development, manufacturing and transport. Baxter and the Baxter International Foundation provide financial support and product donations in support of critical needs, from assisting underserved communities to providing emergency relief for countries experiencing natural disasters.

Throughout 2014 the company continued to implement a range of water conservation strategies and facility-based energy saving initiatives. In the area of product stewardship and life cycle management, Baxter is pursuing efforts such as sustainable design and reduced packaging. Baxter is also responding to the challenges of climate change through innovative greenhouse gas emissions-reduction programs, such as shifting to less carbon-intensive energy sources in manufacturing and transport.

Risk Factors

The company’s ability to sustain long-term growth and successfully execute the strategies discussed above depends in part on the company’s ability to manage within an increasingly competitive and regulated environment and to address the other risk factors described in Item 1A of this Annual Report on Form 10-K.

 

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RESULTS OF OPERATIONS

Special Items

The following table provides a summary of the company’s special items and the related impact by line item on the company’s results of continuing operations for 2014, 2013, and 2012.

 

years ended December 31 (in millions)    2014     2013     2012  

Gross Margin

      

Intangible asset amortization expense

   $ (184   $ (129   $ (101

Business optimization items

     8        (52     (62

Product-related items

     (64     (17     23   

Gambro acquisition and integration items

            (63       

Separation-related costs

     (2              

Business development items

                   (6

Total Special Items

   $ (242   $ (261   $ (146

 

 

Impact on Gross Margin Ratio

     (1.5 pts     (1.8 pts     (1.0 pts

 

 

Marketing and Administrative Expenses

      

Reserve items and adjustments

   $ (10   $ 124      $   

Branded Prescription Drug Fee

     29                 

Business optimization items

     2        81        60   

Product-related items

     4                 

Gambro acquisition and integration items

     119        115          

Separation-related costs

     150                 

Business development items

                   9   

Pension-related items

                   170   

 

 

Total Special Items

   $ 294      $ 320      $ 239   

 

 

Impact on Marketing and Administrative Expense Ratio

     1.8 pts        2.1 pts        1.7 pts   

 

 

Research and Development Expenses

      

Business development items

   $ 217      $ 103      $ 113   

Business optimization items

     25        47        28   

Separation-related costs

     15                 

 

 

Total Special Items

   $ 257      $ 150      $ 141   

 

 

Other Expense (Income), Net

      

Gambro acquisition and integration items

   $ 25      $ 77      $   

Reserve items and adjustments

     125        (35     (91

Business development items

     45                 

 

 

Total Special Items

   $ 195      $ 42      $ (91

 

 

Income Tax Expense

      

Impact of special items

   $ (251   $ (208   $ (122

 

 

Total Special Items

   $ (251   $ (208   $ (122

 

 

Impact on Effective Tax Rate

     (1.5 pts     (1.4 pts     (2.4 pts

Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance, particularly in terms of cash returns, and is similar to how management internally assesses performance. Upfront and milestone payments related to collaborations that have been expensed as R&D are uncertain and often result in a different payment and expense recognition pattern than internal R&D activities and therefore are typically treated as special items. Additional special items are identified above because they are highly variable, difficult to predict, and of a size that may substantially impact the company’s

 

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reported operations for a period. Management believes that providing the separate impact of the above items on the company’s GAAP results may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another.

In 2014, 2013 and 2012, the company’s results were impacted by costs associated with the company’s execution of certain strategies to optimize its organizational and overall cost structure on a global basis. These actions included streamlining the company’s international operations, rationalizing its manufacturing facilities, improving its general and administrative infrastructure, re-aligning certain R&D activities and cancelling certain R&D programs. The company recorded business optimization charges of $83 million, $200 million, and $150 million in 2014, 2013, and 2012, respectively. The 2014 and 2013 business optimization charges were partially offset by adjustments of $64 million and $20 million, respectively, for reserves that are no longer probable of being utilized. Refer to Note 7 for further information regarding these charges and related reserves.

In 2014, the company recorded a charge of $93 million for SIGMA Spectrum Infusion Pump product remediation efforts, partially offset by a benefit of $25 million for an adjustment to the COLLEAGUE infusion pump reserves. In 2013, the company’s results included total charges of $17 million, primarily related to remediation efforts associated with modifications to the SIGMA Spectrum Infusion Pump in conjunction with re-filing for 510(k) clearance. In 2012, the company recognized a net benefit of $23 million primarily related to an adjustment to the COLLEAGUE infusion pump reserve when the company substantially completed its recall activities in the United States. Refer to Note 7 for further information regarding these charges and related reserves.

In 2014, the company recorded total charges of $144 million primarily related to the integration of Gambro. In 2013, the company’s results included total charges of $255 million primarily related to the acquisition and integration of Gambro and losses from the derivative instruments used to hedge the anticipated foreign currency cash outflows for the planned acquisition of Gambro. Refer to Note 5 for further information regarding the acquisition of Gambro.

In 2014, the company recorded separation-related costs of $167 million for the planned separation of Baxter’s biopharmaceutical and medical products businesses.

In 2014, the company recorded total charges of $262 million resulting from $217 million in upfront and milestone payments associated with the company’s collaboration arrangements as well as a $45 million other-than-temporary impairment loss related to Baxter’s holdings in the common stock of one of its collaboration partners. The company’s results in 2013 and 2012 included total charges of $103 million and $128 million, respectively, primarily related to upfront and milestone payments associated with the company’s collaboration arrangements. Refer to Note 5 for further information regarding the company’s collaboration arrangements.

In 2014, the company’s results included a net expense of $115 million primarily related to a $124 million increase in the estimated fair value of acquisition-related contingent payment liabilities, partially offset by $9 million in third-party recoveries and reversals of prior tax and legal reserves. In 2013, the company’s results included a net expense of $89 million related to tax and legal reserves associated with tax and VAT matters in Turkey and existing class-action and other related litigation. In 2012, the company recorded gains of $91 million related to a decrease in the estimated fair value of acquisition-related contingent payment liabilities. Refer to Note 10 for further information regarding the change in estimated fair value of contingent payment liabilities.

In 2014, the company recorded a charge of $29 million in marketing and administrative expenses to account for an additional year of the Branded Prescription Drug Fee in accordance with final regulations issued by the Internal Revenue Service.

 

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In 2012, the company recorded total charges of $170 million in marketing and administrative expenses primarily related to pension settlement charges and other pension-related items. Refer to Note 13 for further information regarding the pension settlement charges.

Net Sales

            Percent change  
                           At actual
currency rates
     At constant
currency rates
 
years ended December 31 (in millions)    2014      2013      2012      2014      2013      2014      2013  

 

 

BioScience

   $ 6,699       $ 6,272       $ 5,983         7%         5%         8%         5%   

Medical Products

     9,972         8,695         7,953         15%         9%         16%         10%   

 

 

Total net sales

   $ 16,671       $ 14,967       $ 13,936         11%         7%         13%         8%   

 

 
            Percent change  
                           At actual
currency rates
     At constant
currency rates
 
years ended December 31 (in millions)    2014      2013      2012      2014      2013      2014      2013  

 

 

United States

   $ 7,015       $ 6,444       $ 6,043         9%         7%         9%         7%   

International

     9,656         8,523         7,893         13%         8%         16%         9%   

 

 

Total net sales

   $ 16,671       $ 14,967       $ 13,936         11%         7%         13%         8%   

 

 

Net sales during the year ended December 31, 2014 included $1.6 billion in Gambro sales compared to $513 million in 2013, from the September 6, 2013 acquisition date, which favorably impacted total sales growth by seven percentage points at actual currency rates and eight percentage points on a constant currency basis. During the year ended December 31, 2013, Gambro sales favorably impacted total sales growth by four percentage points at both actual currency rates and on a constant currency basis. Refer to Note 5 for further information regarding the Gambro acquisition.

Foreign currency unfavorably impacted net sales by two percentage points during the year ended December 31, 2014 compared to the prior year principally due to the strengthening of the U.S. Dollar relative to the Euro, Japanese Yen, Swedish Krona and certain other currencies. Foreign currency unfavorably impacted net sales by one percentage point during the year ended December 31, 2013 principally due to the strengthening of the U.S. Dollar relative to the Japanese Yen and certain other currencies.

The comparisons presented at constant currency rates reflect comparative local currency sales at the prior year’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. The company believes that the non-GAAP measure of change in net sales at constant currency rates, when used in conjunction with the GAAP measure of change in net sales at actual currency rates, may provide a more complete understanding of the company’s operations and can facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another.

Franchise Net Sales Reporting

BioScience

The BioScience segment includes three commercial franchises: Hemophilia, BioTherapeutics and BioSurgery.

 

   

Hemophilia includes sales of recombinant and plasma-derived hemophilia products (primarily factor VIII and factor IX).

 

   

BioTherapeutics includes sales of the company’s plasma-based therapies to treat alpha-1 antitrypsin deficiency, burns and shock, and other chronic and acute blood-related conditions.

 

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BioSurgery consists of biological products and medical devices used in surgical procedures for hemostasis, tissue sealing, adhesion prevention, as well as hard and soft tissue repair and microsurgery products.

The following is a summary of net sales by franchise in the BioScience segment.

 

            Percent change  
                           At actual
currency rates
     At constant
currency rates
 
years ended December 31 (in millions)    2014      2013      2012      2014      2013      2014      2013  

 

 

Hemophilia

   $ 3,728       $ 3,437       $ 3,241         8%         6%         10%         7%   

BioTherapeutics

     2,224         2,118         2,069         5%         2%         6%         2%   

BioSurgery

     747         717         673         4%         7%         4%         6%   

 

 

Total BioScience net sales

   $ 6,699       $ 6,272       $ 5,983         7%         5%         8%         5%   

 

 

Net sales in the BioScience segment increased 7% and 5% in 2014 and 2013, respectively (with an unfavorable foreign currency impact of one percentage point in 2014 and no significant foreign currency impact in 2013). Excluding the impact of foreign currency, the principal drivers impacting net sales were the following:

 

   

In the Hemophilia franchise, sales growth in 2014 was driven by strong global demand for the company’s leading recombinant factor VIII therapy, ADVATE, which contributed approximately seven percentage points. The company’s sales also benefitted from the expanded prophylaxis indication and strong global demand for its plasma-based inhibitor bypass therapy, FEIBA, which contributed approximately three percentage points in 2014, as well as the launch of new products, such as RIXUBIS, a recombinant factor IX therapy for the treatment of hemophilia B patients. We expect growth in the Hemophilia franchise to moderate in 2015 as we expect increased competition from new entrants including a competitor that launched an extended half-life recombinant FVIII therapy in the United States during the third quarter of 2014. The company submitted a BLA for BAX 855, the company’s own investigational extended half-life factor VIII treatment for hemophilia A, to FDA in the fourth quarter of 2014 following positive topline results from the phase III clinical trial. In addition, the company expects long-term growth in the Hemophilia franchise, driven by strong underlying global demand, further penetration in markets outside the United States, new multi-year tenders, and new product launches including OBIZUR for acquired hemophilia A. Sales growth in 2013 was driven by strong global demand for ADVATE, which contributed approximately six percentage points, in addition to increased sales of FEIBA and shipments to Brazil as part of Baxter’s ongoing partnership with Hemobrás.

 

   

In the BioTherapeutics franchise, sales growth in 2014 was driven by strong global demand for the company’s albumin therapies as well as immune globulin therapies including GAMMAGARD LIQUID [Immune Globulin Intravenous (Human)]. Immune globulin sales were favorably impacted by the fourth quarter introduction of HYQVIA, a subcutaneous immune globulin treatment for adult patients with primary immunodeficiency, in the United States. Sales growth in 2013 was driven by immunoglobulin therapies resulting from improved product availability and accelerated demand for GAMMAGARD LIQUID, albumin and Alpha-1 treatments. Sales growth was partially offset in 2013 by lower international sales as a result of an exit from certain markets due to previous supply constraints.

 

   

In the BioSurgery franchise, sales growth in 2014 and 2013 was driven primarily by global demand for the company’s surgical sealants TISSEEL and FLOSEAL. Sales growth in 2013 was also favorably impacted by the acquisition of Synovis Life Technologies, Inc. (Synovis).

 

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Medical Products

The Medical Products segment includes four commercial franchises: Fluid Systems, Renal, Specialty Pharmaceuticals, and BioPharma Solutions.

 

   

Fluid Systems principally includes IV solutions, infusion pumps, administration sets and premixed and the oncology drug cyclophosphamide.

 

   

Renal consists of therapies to treat end-stage renal disease, including PD, HD, and HHD and therapies to treat acute kidney injuries, including CRRT. The Renal franchise includes the results of Gambro since the acquisition date of September 6, 2013. Refer to Note 5 for additional information.

 

   

Specialty Pharmaceuticals principally includes nutrition and anesthesia products.

 

   

BioPharma Solutions principally includes sales from the pharmaceutical partnering business and pharmacy compounding services.

The following is a summary of net sales by franchise in the Medical Products segment.

 

            Percent change  
                           At actual
currency rates
    At constant
currency rates
 
years ended December 31 (in millions)    2014      2013      2012      2014      2013     2014      2013  

 

 

Fluid Systems

   $ 3,222       $ 3,106       $ 2,937         4%         6%        4%         6%   

Renal

     4,172         3,089         2,527         35%         22%        38%         24%   

Specialty Pharmaceuticals

     1,574         1,508         1,475         4%         2%        5%         2%   

BioPharma Solutions

     1,004         992         1,014         1%         (2%     2%         (2%

 

 

Total Medical Products net sales

   $ 9,972       $ 8,695       $ 7,953         15%         9%        16%         10%   

 

 

Net sales in the Medical Products segment increased 15% and 9% in 2014 and 2013, respectively (with an unfavorable foreign currency impact of one percentage point in both 2014 and 2013). Excluding the impact of foreign currency, the principal drivers impacting net sales were the following:

 

   

In the Fluid Systems franchise, sales growth in 2014 was driven by increased sales and favorable pricing of cyclophosphamide (a generic oncology drug) in the United States, which contributed approximately three percentage points, as well as price improvements and strong U.S. demand for the company’s IV solutions. A generic competitor for cyclophosphamide entered the U.S. market during the fourth quarter of 2014 and the company expects additional competitors in the coming months, which is anticipated to substantially impact pricing and demand for Baxter’s product. U.S. sales for cyclophosphamide in 2014 totaled approximately $450 million. Sales growth in 2013 was primarily driven by increased sales of cyclophosphamide, which contributed approximately six percentage points, as well as strong demand for IV solutions. Sales growth in both 2014 and 2013 was partially offset by an expected decline in SIGMA Spectrum Infusion Pump sales due to suspension of sales to new accounts commencing with the receipt of an FDA Warning Letter in April 2013.

 

   

In the Renal franchise, Gambro revenues totaled $1.6 billion in 2014 compared to $513 million from the September 6, 2013 acquisition date through December 31, 2013. Excluding the impact of Gambro, sales remained flat at actual currency rates and increased 2% on a constant currency basis. Sales growth in 2014 was driven by a higher number of PD patients in the United States and emerging markets, which contributed approximately four percentage points to sales growth. This growth was partially offset by the divestiture of Baxter’s legacy CRRT business in the first quarter of 2014. Excluding the impact of Gambro, sales in 2013 increased 2% at actual currency rates and 4% on a constant currency basis driven by growth in the number of PD patients in the United States and emerging markets, which contributed approximately four percentage points. This growth was partially offset by lower HD sales.

 

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In the Specialty Pharmaceuticals franchise, sales growth in 2014 was driven by increased international sales of anesthetics products as well as strong U.S. demand for nutritional therapies. Sales growth in 2013 was driven by strong global sales of anesthetics, which was partially offset by lower sales of nutrition products due to supplier shortages of distributed vitamins and lipids.

 

   

In the BioPharma Solutions franchise, sales growth in 2014 was driven by higher pharmacy compounding revenues. Sales declined in 2013 as a result of delayed shipments from the company’s Bloomington, Indiana facility, which was partially offset by an improvement in sales during the fourth quarter of 2013 as a result of the timing of orders and shipments as supply constraints were alleviated.

Gross Margin and Expense Ratios

                                  Change  
years ended December 31 (as a percent of net sales)      2014        2013        2012        2014        2013  

 

 

Gross margin

       48.9%           49.9%           51.2%           (1.0pts        (1.3 pts

Marketing and administrative expenses

       24.2%           24.3%           23.6%           (0.1pts        0.7 pts   

 

 

Gross Margin

The special items identified above had an unfavorable impact of 1.5, 1.8 and 1.0 percentage points on the gross margin percentage in 2014, 2013, and 2012, respectively. Refer to the Special Items caption above for additional detail.

In addition to the impact of the special items, the gross margin percentage was unfavorably impacted by 1.1 percentage points in 2014 as a result of the integration of the lower margin Gambro business. Other unfavorable impacts include foreign currency, expedited freight for PD solutions, and manufacturing inefficiencies resulting from lower production volumes as the company continues to make investments to enhance its operations, quality systems and processes. The unfavorable impacts from these factors were partially offset by improved product mix within the BioScience segment, lower pension expense and benefits from the company’s business optimization initiatives.

In addition to the impact of the special items, the gross margin percentage was unfavorably impacted by 0.5 percentage points in 2013 as a result of the integration of the lower margin Gambro business. Other unfavorable impacts include foreign currency, increased pension expense, government austerity measures and the realization of additional costs associated with modifications and the ramp-up of production at the company’s Los Angeles fractionation facilities. The unfavorable impacts from these factors were offset by improved product mix and price improvements.

Marketing and Administrative Expenses

The special items identified above had an unfavorable impact of 1.8, 2.1 and 1.7 percentage points on the marketing and administrative expenses ratio in 2014, 2013, and 2012, respectively. Refer to the Special Items caption above for additional detail.

In addition to the impact of the special items, the marketing and administrative expenses ratio in 2014 was unfavorably impacted as a result of inclusion of Gambro’s operations, the company’s select investments to support new product launches in the BioScience segment, and incremental freight and logistical expenses to support the strong demand for IV solutions. Offsetting the unfavorable impacts in 2014 were savings from the company’s continued focus on controlling discretionary spending, lower pension expense and benefits from the company’s business optimization initiatives.

In addition to the impact of the special items, the marketing and administrative expenses ratio in 2013 was unfavorably impacted as a result of inclusion of Gambro’s operations, increased pension expense, and select

 

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investments and spending on marketing and promotional programs for new product launches and to enhance the company’s global presence in international markets, partially offset by the company’s focus on controlling discretionary spending.

Pension Plan Expense

Fluctuations in pension plan expense impacted the company’s gross margin and expense ratios. Pension plan expense decreased $88 million in 2014 primarily due to a decrease in amortization of actuarial losses.

Pension plan expense decreased in 2013 as 2012 expense included a charge of $168 million primarily related to the settlement of certain U.S. pension obligations. Excluding the impact of the 2012 settlement charge, pension plan expense increased $70 million in 2013 due to lower interest rates used to discount the plans’ projected benefit obligations and an increase in amortization of actuarial losses.

Business Optimization Items

The company has implemented certain business optimization initiatives in an effort to streamline its international operations, rationalize its manufacturing facilities, enhance its general and administrative infrastructure and re-align certain R&D activities. The company estimates that business optimization activities from 2011 through 2013 have resulted in cumulative savings of approximately $0.30 per diluted share as of December 31, 2014. The company expects additional savings of approximately $0.09 per diluted share as the programs are fully implemented through 2016. The savings from these actions will impact cost of sales, marketing and administrative expenses and R&D expenses, and benefit both the BioScience and Medical Products segments. Refer to Note 7 for additional information regarding the company’s business optimization initiatives.

In 2014, the company recorded charges of $83 million and expects savings of approximately $0.05 per diluted share as the programs are fully implemented through 2016.

Research and Development

 

                                  Percent change  
years ended December 31 (in millions)      2014        2013        2012        2014        2013  

 

 

Research and development expenses

       $1,421           $1,165           $1,081           22%           8%   

as a percent of net sales

       8.5%           7.8%           7.8%             

 

 

R&D expenses increased in both 2014 and 2013. The increase in both periods was driven by contributions in the Medical Products segment from the acquisition of Gambro and additional investments in renal therapies as well as new investments in the BioScience segment to advance programs across the R&D pipeline, particularly in the areas of hematology, oncology and immunology. Additionally, R&D expenses related to upfront and milestone payments associated with the company’s collaboration arrangements increased to $217 million in 2014 from $103 million in 2013. Refer to the discussion under Strategic Objectives above for additional detail.

Net Interest Expense

Net interest expense increased by $17 million in 2014 and $41 million in 2013. The increase in 2014 was principally driven by an increase in debt from the issuance of $3.5 billion of senior unsecured notes in June 2013, which was partially offset by the maturity of $350 million of 4.0% senior unsecured notes in March 2014, and the company’s interest rate swap hedging activities. The increase in 2013 was principally driven by an increase in debt from the issuance of $1.0 billion of senior unsecured notes in August 2012 and the above mentioned $3.5 billion of senior unsecured notes in June 2013. Refer to Note 3 for a summary of the components of net interest expense for 2014, 2013 and 2012.

 

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Other Expense (Income), Net

Other expense (income), net was expense of $123 million in 2014, income of $9 million in 2013 and income of $155 million in 2012. Refer to the Special Items caption above for additional detail.

In addition to the impact of the special items, during 2014 the company recorded $84 million of income related to equity method investments, which primarily represented gains from the sale of certain investments as well as distributions from funds that sold portfolio companies.

Also included in other expense (income), net were amounts related to foreign currency fluctuations, principally relating to intercompany receivables, payables and loans denominated in a foreign currency.

Pre-Tax Income from Continuing Operations

Refer to Note 17 for a summary of financial results by segment. The following is a summary of significant factors impacting the segments’ financial results.

BioScience

Pre-tax income from continuing operations decreased 12% in 2014 and increased 3% in 2013. Included in pre-tax income from continuing operations during 2014 were charges of $217 million related to certain upfront and milestone payments associated with the company’s collaboration arrangements, $26 million related to the Branded Prescription Drug Fee, $45 million related to an other-than-temporary impairment loss associated with Baxter’s holdings in the common stock of one of its collaboration partners, and a $124 million loss related to an increase in the estimated fair value of acquisition-related contingent payment liabilities. Included in pre-tax income from continuing operations during 2013 were charges of $78 million related to upfront and milestone payments associated with the company’s collaboration arrangements. Included in pre-tax income from continuing operations during 2012 were charges of $123 million related to certain upfront and milestone payments associated with the company’s collaboration arrangements and a gain of $38 million related to a decrease in the estimated fair value of acquisition-related contingent payment liabilities.

Excluding the impact of the above items, pre-tax income from continuing operations increased 2% in 2014 primarily due to sales growth of higher margin products, and was partially offset by increased spending on marketing and promotional programs as well as R&D investments and the impact of foreign currency.

Excluding the impact of the above items, pre-tax income from continuing operations increased 3% in 2013 primarily due to sales growth of higher margin products, partially offset by increased spending on marketing and promotional programs.

Medical Products

Pre-tax income decreased 6% in 2014 and 12% in 2013. Included in pre-tax income from continuing operations during 2014 were charges of $93 million primarily related to product remediation efforts associated with the SIGMA Spectrum Infusion Pump and Gambro acquisition and integration costs of $120 million. Additionally, a benefit of $25 million was recorded for an adjustment to the COLLEAGUE infusion pump reserves as the company refined its expectations based on the progress of remediation activities in Canada. Included in pre-tax income from continuing operations during 2013 were charges of $16 million primarily related to remediation efforts associated with modifications to the SIGMA Spectrum Infusion Pump in conjunction with re-filing for 510(k) clearance, $25 million related to an upfront payment associated with one of the company’s collaboration arrangements, and Gambro acquisition and integration-related costs of $192 million. Included in pre-tax income from continuing operations during 2012 was a gain of $53 million related to a decrease in the estimated fair value of acquisition-related contingent payment liabilities as well as a benefit of $23 million related to an adjustment to the COLLEAGUE infusion pump reserves when the company substantially completed its recall activities in the United States.

 

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Excluding the impact of the above items, pre-tax income from continuing operations decreased 8% in 2014. The decrease was driven by product mix, expedited freight for PD solutions, and manufacturing inefficiencies resulting from lower production volumes as the company continues to make investments to enhance quality systems and processes. The decrease was partially offset by improved performance in the Fluid Systems and Specialty Pharmaceuticals franchises

Excluding the impact of the above items, pre-tax income in 2013 increased by 7% primarily due to a favorable impact of sales growth of higher margin products and the favorable impact from foreign currency.

Corporate and other

Certain income and expense amounts are not allocated to a segment. These amounts are detailed in the table in Note 17 and primarily include net interest expense, foreign exchange fluctuations (principally relating to intercompany receivables, payables and loans denominated in foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, stock compensation expense, non-strategic investments and related income and expense, certain employee benefit plan costs as well as certain nonrecurring gains, losses, and other charges (such as business optimization and asset impairments).

Income Taxes

Effective Income Tax Rate

The effective income tax rate for continuing operations was 20.2% in 2014, 21.0% in 2013, and 19.6% in 2012. The company anticipates that the effective income tax rate for continuing operations, calculated in accordance with GAAP, will be approximately 21.5% in 2015, excluding any impact from additional audit developments or other special items.

The company’s effective tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes and foreign taxes that are different than the U.S. federal statutory rate. The average foreign effective tax rate on international pre-tax income for continuing operations was 16.4%, 17.2% and 14.2% for the years ended December 31, 2014, 2013 and 2012, respectively. The company’s average foreign effective tax rate was lower than the U.S. federal statutory rate as a result of the impact of tax incentives in Puerto Rico, Switzerland and certain other tax jurisdictions outside of the United States, as well as foreign earnings in tax jurisdictions with lower statutory rates than the United States. In addition, as discussed further below, the company’s effective income tax rate can be impacted in each year by discrete factors or events. Refer to Note 15 for further information regarding the company’s income taxes.

Factors impacting the company’s effective tax rate in 2014 included a non-deductible charge to account for an additional year of the Branded Prescription Drug Fee in accordance with final regulations issued in the third quarter by the Internal Revenue Service. Partially offsetting this increase in the effective tax rate was an increase in income earned in foreign jurisdictions with rates of tax lower than the U.S. rate. Additionally, the company favorably settled certain contingent tax matters.

Factors impacting the company’s effective tax rate in 2013 included the favorable settlement of the company’s bilateral Advance Pricing Agreement proceedings between the U.S. government and the government of Switzerland relating to intellectual property, product, and service transfer pricing arrangements, which was offset by other contingent tax matters principally related to transfer pricing. Additionally, the effective tax rate was unfavorably impacted by increases in valuation allowances relating to the tax benefit from losses that the company does not believe that it is more likely than not to realize and interest expense related to the company’s unrecognized tax benefits. Partially offsetting these unfavorable items were $16 million of U.S. R&D credits. Additionally, the company’s effective tax rate was impacted by a change in the earnings mix from lower tax to higher tax rate jurisdictions compared to the prior year.

Factors impacting the company’s effective tax rate in 2012 were gains totaling $91 million relating to the reduction of certain contingent payment liabilities related to prior acquisitions, for which there were no tax

 

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charges. Also impacting the effective tax rate was a cost of sales reduction of $37 million for an adjustment to the COLLEAGUE infusion pump reserves when the company substantially completed the recall in the United States in 2012, for which there was no tax charge. These items were offset by a change in the earnings mix from lower tax to higher tax rate jurisdictions compared to the prior year.

As described in Note 15, management intends to reinvest past earnings in several jurisdictions outside of the United States indefinitely. The company will continue to evaluate its global financial structure and U.S. cash needs as part of its planned separation into two independent, global healthcare companies.

Income from Continuing Operations and Earnings per Diluted Share

Income from continuing operations was $1.9 billion in 2014, $2.0 billion in 2013, and $2.3 billion in 2012. Income from continuing operations per diluted share was $3.56 in 2014, $3.66 in 2013, and $4.11 in 2012. The significant factors and events causing the net changes from 2013 to 2014 and from 2012 to 2013 are discussed above. Additionally, income from continuing operations per diluted share was positively impacted by the repurchase of eight million shares in 2014, 13 million shares in 2013, and 25 million shares in 2012. Refer to Note 12 for further information regarding the company’s stock repurchases.

Income from Discontinued Operations, Net of Tax

Income from discontinued operations, net of tax was $551 million in 2014, $0 million in 2013, and $43 million in 2012. The increase in 2014 was driven primarily by the $417 million gain recognized on the sale of the commercial vaccines business. The decrease in 2013 was driven primarily by $90 million in business optimization charges.

LIQUIDITY AND CAPITAL RESOURCES

The company’s cash flows reflect both continuing and discontinued operations.

Cash Flows from Operations

Cash flows from operations totaled $3.2 billion in 2014, $3.2 billion in 2013, and $3.1 billion in 2012. Cash flows remained flat in 2014 as compared to 2013 and increased in 2013 as compared to 2012 due to the factors discussed below.

Accounts Receivable

Cash flows relating to accounts receivable decreased in 2014 and increased in 2013. Days sales outstanding were 52.0 days, 55.9 days, and 53.3 days for 2014, 2013, and 2012, respectively. Days sales outstanding in 2014 and 2013 included an unfavorable impact of 1.9 days and 3.4 days, respectively, from the acquisition of Gambro. Excluding the impact of Gambro, days sales outstanding declined to 50.1 days in 2014 reflecting an improvement in collection periods in both the United States and certain international markets as well as the favorable impact of foreign currency. Similarly, excluding the impact of Gambro, days sales outstanding declined to 52.5 days in 2013 reflecting improvement in collection periods in both the United States and certain international markets.

Inventories

Cash outflows for inventories increased in both 2014 and 2013. The following is a summary of inventories at December 31, 2014 and 2013, as well as inventory turns by segment for 2014, 2013 and 2012. Inventory turns for the year are calculated as the annualized fourth quarter cost of sales divided by the year-end inventory balance.

 

     Inventories      Inventory turns  
(in millions, except inventory turn data)    2014      2013      2014      2013      2012  

 

 

BioScience

   $ 2,147       $ 2,078         1.41         1.49         1.48   

Medical Products

     1,412         1,421         3.96         4.36         4.25   

 

 

Total company

   $ 3,559       $ 3,499         2.42         2.66         2.52   

 

 

 

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The increase in inventories in 2014 and associated decrease in inventory turns was due to higher levels of plasma protein related inventories in the BioScience segment to support increased demand and future growth and the impact from new products, including RIXUBIS, OBIZUR and HYQVIA. The decrease in inventory turns was also driven by higher cost of sales in 2013 compared to 2014 associated with Gambro purchase accounting adjustments and business optimization charges.

Inventory turns for the total company increased during 2013 compared to 2012 primarily due to strong sales and inventory management efforts. Inventory turns in 2013 also included the favorable impacts from the above-mentioned Gambro purchase accounting adjustments and business optimization charges.

Other

The changes in accounts payable and accrued liabilities were $115 million in 2014, $361 million in 2013, and $40 million in 2012. The changes were primarily driven by the timing of payments to suppliers and the impact of litigation-related payments.

Payments related to the execution of the COLLEAGUE infusion pump recall and the company’s business optimization initiatives were $161 million in 2014, $125 million in 2013, and $283 million in 2012. Refer to Note 7 for further information regarding the COLLEAGUE infusion pump recall and the business optimization initiatives.

Changes in other balance sheet items were $54 million in 2014, $135 million in 2013, and $193 million in 2012. The changes during 2014 and 2013 were primarily driven by prepaid expenses and hedging activity. Cash contributions to the company’s pension plans totaled $74 million, $67 million, and $78 million in 2014, 2013, and 2012, respectively.

Cash Flows from Investing Activities

Capital Expenditures

Capital expenditures totaled $1.9 billion in 2014, $1.5 billion in 2013, and $1.2 billion in 2012. The increase in capital expenditures in 2014 was primarily driven by product capacity expansions at certain manufacturing facilities, including the Covington, Georgia facility. The company also invested in projects that enhance the company’s cost structure and manufacturing capabilities, support the company’s strategy of geographic expansion with select investments in growing markets and support an ongoing strategic focus on R&D with the expansion of facilities, pilot manufacturing sites and laboratories.

Acquisitions and Investments

Net cash outflows related to acquisitions and investments were $409 million in 2014, $3.9 billion in 2013, and $515 million in 2012.

The cash outflows in 2014 included $85 million for the acquisitions of Chatham Therapeutics and AesRx as well as $217 million primarily related to upfront and milestone payments associated with the company’s collaboration arrangements with Merrimack, Coherus Biosciences, Inc. (Coherus), CTI BioPharma Corp. (CTI BioPharma, formerly named Cell Therapeutics, Inc.) and Momenta Pharmaceuticals, Inc. (Momenta).

The cash outflows in 2013 included $3.6 billion for the acquisition of Gambro (net of cash acquired of $88 million) and $51 million for the acquisition of the investigational hemophilia compound OBIZUR and related assets from Inspiration BioPharmaceuticals, Inc. and Ipsen Pharma S.A.S. Also included were upfront and milestone payments of $130 million associated with the company’s collaboration arrangements with Coherus, CTI BioPharma, and JW Holdings Corporation.

The cash outflows in 2012 included $304 million for the acquisition of Synovis, $19 million for the acquisition of Laboratoire Fasonut, and $50 million for an investment in the preferred stock of Onconova Therapeutics, Inc. (Onconova). Also included were upfront payments of $113 million primarily associated with the company’s collaboration arrangements with Onconova and Momenta.

 

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Refer to Note 5 for further information about these acquisitions and collaborations.

Divestitures and Other Investing Activities

Net cash inflows relating to divestitures and other investing activities were $765 million in 2014, $14 million in 2013, and $107 million in 2012. Cash inflows in 2014 primarily related to proceeds of $639 million from the sale of the company’s commercial vaccines business as well as the sale of certain investments.

Cash inflows in 2013 primarily related to various sales of certain investments and other assets.

Cash inflows in 2012 primarily related to proceeds of $59 million from the sale and maturity of available-for-sale securities (including the sale of Greek government bonds) and $19 million from the sale of common stock of Enobia Pharma Corporation.

Cash Flows from Financing Activities

Debt Issuances, Net of Payments of Obligations

Net cash outflows related to debt and other financing obligations totaled $113 million in 2014 driven by approximately $1.0 billion in repayments, which included $500 million of floating rate senior unsecured notes that matured in December 2014 as well as $350 million of 4.0% senior unsecured notes that matured in March 2014. The company issued and redeemed commercial paper throughout the year, and there was $875 million outstanding at December 31, 2014.

In June 2013, the company issued $3.5 billion of senior unsecured notes with various maturities. Approximately $3.0 billion of the net proceeds of these debt issuances was used to finance the acquisition of Gambro in 2013 and the remainder was used for general corporate purposes, including the repayment of commercial paper. This issuance was partially offset by the repayment of $300 million of 1.8% senior unsecured notes that matured in March 2013 and payment of assumed Gambro debt of $221 million after completion of the acquisition in September 2013. Refer to Note 8 for additional information regarding the debt issuance and Note 5 regarding the Gambro acquisition.

In August 2012, the company issued $1.0 billion of senior unsecured notes, with $700 million maturing in August 2022 and bearing a 2.40% coupon rate, and $300 million maturing in August 2042 and bearing a 3.65% coupon rate. The net proceeds of the debt issuance were used for general corporate purposes, which includes capital expenditures associated with previously announced plans to expand capacity to support longer-term growth of the company’s plasma-based treatments, including with respect to the Covington, Georgia facility.

The company’s debt instruments discussed above are unsecured and contain certain covenants, including restrictions relating to the company’s creation of secured debt.

Other Financing Activities

Cash dividend payments totaled $1.1 billion in 2014, $1.0 billion in 2013, and $804 million in 2012. The increase in cash dividend payments was primarily due to increases in the quarterly dividend rate of approximately 6%, 9% and 34% as announced in May 2014, May 2013 and July 2012.

Proceeds and realized excess tax benefits from stock issued under employee benefit plans totaled $369 million, $508 million, and $512 million in 2014, 2013, and 2012, respectively. Realized excess tax benefits, which were $24 million in 2014, $34 million in 2013, and $24 million in 2012, are presented in the consolidated statements of cash flows as an outflow in the operating section and an inflow in the financing section.

As authorized by the Board of Directors, the company repurchases its stock depending on the company’s cash flows, net debt level and market conditions. The company repurchased eight million shares for $550 million in

 

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2014, 13 million shares for $913 million in 2013, and 25 million shares for $1.5 billion in 2012. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock and $0.5 billion remained available as of December 31, 2014.

Credit Facilities, Access to Capital and Credit Ratings

Credit Facilities

The company’s primary revolving credit facility has a maximum capacity of $1.5 billion and matures in December 2015. In 2014, the company entered into an additional revolving credit facility with a maximum capacity of $1.8 billion which also matures in December 2015 and contains similar covenants as the primary revolving credit facility. The company also maintains a Euro-denominated revolving credit facility with a maximum capacity of approximately $375 million as of December 31, 2014 and matures in December 2015. As of December 31, 2014 there were no borrowings outstanding under any of these revolving credit facilities. As of December 31, 2013, there was approximately $124 million outstanding under the Euro-denominated facility and there were no outstanding borrowings under the primary revolving credit facility. The company’s facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net-debt-to-capital ratio. At December 31, 2014, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting any of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment.

The company also maintains other credit arrangements, as described in Note 8.

Access to Capital

The company intends to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations or by issuing additional debt. The company had $2.9 billion of cash and equivalents at December 31, 2014, with adequate cash available to meet operating requirements in each jurisdiction in which the company operates. The divestiture of the Vaccines franchise is not expected to have a significant impact on the company’s liquidity. The company invests its excess cash in certificates of deposit and money market funds, and diversifies the concentration of cash among different financial institutions.

The company’s ability to generate cash flows from operations, issue debt or enter into other financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company’s products or in the solvency of its customers or suppliers, deterioration in the company’s key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company’s growth objectives.

The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, that have experienced a deterioration in credit and economic conditions. As of December 31, 2014 and 2013, the company’s net accounts receivable from the public sector in Greece, Spain, Portugal and Italy totaled $363 million and $561 million, respectively. The decrease in net accounts receivable reflects strong collections in both Spain and Portugal. While global economic conditions have not significantly impacted the company’s ability to collect receivables, liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses.

 

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Credit Ratings

The company’s credit ratings at December 31, 2014 were as follows:

 

      Standard & Poor’s    Fitch    Moody’s

Ratings

        

Senior debt

   A-    A    A3

Short-term debt

   A2    F1    P2

Outlook

   Negative    Negative    Negative

 

In March 2014, Standard & Poor’s lowered its ratings on Baxter’s senior debt to A- and short-term debt to A2 from A and A1, respectively, at December 31, 2013. The change in the credit ratings and outlook is due to the uncertainty around the planned spin-off of Baxter’s biopharmaceuticals business as detailed above.

If Baxter’s credit ratings or outlooks were to be further downgraded, the company’s financing costs related to its credit arrangements and any future debt issuances could be unfavorably impacted. However, any future credit rating downgrade or change in outlook would not affect the company’s ability to draw on its credit facilities, and would not result in an acceleration of the scheduled maturities of any of the company’s outstanding debt, unless, with respect to certain debt instruments, preceded by a change in control of the company.

Contractual Obligations

As of December 31, 2014, the company had contractual obligations, excluding accounts payable and accrued liabilities (other than the current portion of unrecognized tax benefits), payable or maturing in the following periods.

 

(in millions)    Total      Less than
one year
    

One to

three years

    

Three to

five years

    

More than

five years

 

 

 

Short-term debt

   $ 913       $ 913         $     —       $         $     —   

Long-term debt and capital lease obligations, including current maturities

     8,469         786         1,786         1,800         4,097   

Interest on short- and long-term debt and
capital lease obligations
1

     2,239         209         328         233         1,469   

Operating leases

     1,047         222         350         243         232   

Other long-term liabilities2

     1,119                 229         74         816   

Purchase obligations3

     1,864         906         709         193         56   

Unrecognized tax benefits4

     20         20                           

 

 

Contractual obligations5

   $ 15,671       $ 3,056         $3,402       $ 2,543         $6,670   

 

 

 

1 

Interest payments on debt and capital lease obligations are calculated for future periods using interest rates in effect at the end of 2014. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates, foreign currency fluctuations or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2014. Refer to Note 8 and Note 9 for further discussion regarding the company’s debt instruments and related interest rate agreements outstanding at December 31, 2014.

 

2 

The primary components of other long-term liabilities in the company’s consolidated balance sheet are liabilities relating to pension and other postemployment benefit plans, litigation, foreign currency hedges, and certain income tax-related liabilities. The company projected the timing of the future cash payments based on contractual maturity dates (where applicable) and estimates of the timing of payments (for liabilities with no contractual maturity dates). The actual timing of payments could differ from the estimates.

The company contributed $74 million, $67 million, and $78 million to its defined benefit pension plans in 2014, 2013, and 2012, respectively. Most of the company’s plans are funded. The timing of funding in the

 

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future is uncertain and is dependent on future movements in interest rates and investment returns, changes in laws and regulations, and other variables. Therefore, the table above excludes pension plan cash outflows. The pension plan balance included in other long-term liabilities (and excluded from the table above) totaled $2.2 billion at December 31, 2014.

 

3 

Includes the company’s significant contractual unconditional purchase obligations. For cancelable agreements, any penalty due upon cancellation is included. These commitments do not exceed the company’s projected requirements and are in the normal course of business. Examples include firm commitments for raw material purchases, utility agreements and service contracts.

 

4 

Due to the uncertainty related to the timing of the reversal of uncertain tax positions, the long-term liability relating to uncertain tax positions of $195 million at December 31, 2014 has been excluded from the table above.

 

5 

Excludes contingent liabilities, including contingent milestone payments of $2.6 billion associated with joint development and commercialization arrangements and contingent milestone payments of $2.6 billion associated with acquisitions, as well as the company’s unfunded commitment at December 31, 2014 of $38 million as a limited partner in multiple investment companies. These amounts have been excluded from the contractual obligations above due to uncertainty regarding the timing and amount of future payments. Refer to Note 5, Note 10 and Note 11 for additional information regarding these commitments.

Off-Balance Sheet Arrangements

Baxter periodically enters into off-balance sheet arrangements. Certain contingencies arise in the normal course of business, and are not recorded in the consolidated balance sheet in accordance with GAAP (such as contingent joint development and commercialization arrangement payments). Also, upon resolution of uncertainties, the company may incur charges in excess of presently established liabilities for certain matters (such as contractual indemnifications). For a discussion of the company’s significant off-balance sheet arrangements, refer to Note 10 for information regarding receivable securitizations, Note 11 regarding joint development and commercialization arrangements and indemnifications and Note 16 regarding legal contingencies.

FINANCIAL INSTRUMENT MARKET RISK

The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs. Refer to Note 9 and Note 10 for further information regarding the company’s financial instruments and hedging strategies.

Currency Risk

The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets denominated in the Euro, Japanese Yen, British Pound, Australian Dollar, Canadian Dollar, Brazilian Real, Colombian Peso, and Swedish Krona. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative financial instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and shareholders’ equity volatility relating to foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.

The company may use options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions denominated in foreign currencies and recognized assets and liabilities. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions at December 31, 2014 is 12 months. The company also enters into derivative instruments to hedge certain intercompany and third-party receivables and payables and debt denominated in foreign currencies.

 

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Currency restrictions enacted in Venezuela require Baxter to obtain approval from the Venezuelan government to exchange Venezuelan Bolivars for U.S. Dollars and require such exchange to be made at the official exchange rate established by the government. Since January 1, 2010, Venezuela has been designated as a highly inflationary economy under GAAP and as a result, the functional currency of the company’s subsidiary in Venezuela is the U.S. Dollar. Effective February 8, 2013, the Venezuelan government devalued the official exchange rate from 4.3 to 6.3, which resulted in a charge of $11 million during 2013. As of December 31, 2014, the company’s subsidiary in Venezuela had net assets of $26 million denominated in the Venezuelan Bolivar. In 2014, net sales in Venezuela represented less than 1% of Baxter’s total net sales.

As part of its risk-management program, the company performs sensitivity analyses to assess potential changes in the fair value of its foreign exchange instruments relating to hypothetical and reasonably possible near-term movements in foreign exchange rates.

A sensitivity analysis of changes in the fair value of foreign exchange option and forward contracts outstanding at December 31, 2014, 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 $12 million with respect to those contracts would decrease by $72 million, resulting in a net liability position. A similar analysis performed with respect to option and forward contracts outstanding at December 31, 2013 indicated that, on a net-of-tax basis, the net asset balance of $18 million would decrease by $71 million.

The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at December 31, 2014 by replacing the actual exchange rates at December 31, 2014 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.

Interest Rate and Other Risks

The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company’s policy is to manage interest costs using a mix of fixed- and floating-rate debt that the company believes is appropriate. To manage this mix in a cost-efficient manner, the company periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. The company also periodically uses forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with fluctuations in interest rates relating to anticipated issuances of term debt.

As part of its risk management program, the company performs sensitivity analyses to assess potential gains and losses in earnings relating to hypothetical movements in interest rates. A 21 basis-point increase in interest rates (approximately 10% of the company’s weighted-average interest rate during 2014) affecting the company’s financial instruments, including debt obligations and related derivatives, would have an immaterial effect on the company’s 2014, 2013 and 2012 earnings and on the fair value of the company’s fixed-rate debt as of the end of each fiscal year.

As discussed in Note 10, the fair values of the company’s long-term litigation liabilities were computed by discounting the expected cash flows based on currently available information. A 10% movement in the assumed discount rate would have an immaterial effect on the fair values of those liabilities.

With respect to the company’s investments in affiliates, the company believes any reasonably possible near-term losses in earnings, cash flows and fair values would not be material to the company’s consolidated financial position.

 

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CHANGES IN ACCOUNTING STANDARDS

Refer to Note 1 for information on changes in accounting standards.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with GAAP requires the company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of the company’s significant accounting policies is included in Note 1. Certain of the company’s accounting policies are considered critical because these policies are the most important to the depiction of the company’s financial statements and require significant, difficult or complex judgments by the company, often requiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from the company’s estimates could have an unfavorable effect on the company’s results of operations and financial position. There have been no significant changes in the company’s application of its critical accounting policies during 2014. The company’s critical accounting policies have been reviewed with the Audit Committee of the Board of Directors. The following is a summary of accounting policies that the company considers critical to the consolidated financial statements.

Revenue Recognition and Related Provisions and Allowances

The company’s policy is to recognize revenues from product sales and services when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectibility is reasonably assured. For product sales, revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for the majority of the company’s revenue arrangements are FOB destination. The company sometimes enters into arrangements in which it commits to delivering multiple products or services to its customers. In these cases, total arrangement consideration is allocated to the deliverables based on their relative selling prices. Then the allocated consideration is recognized as revenue in accordance with the principles described above. Selling prices are determined by applying a selling price hierarchy. Selling prices are determined using vendor specific objective evidence (VSOE), if it exists. Otherwise, selling prices are determined using third party evidence (TPE). If neither VSOE nor TPE is available, the company uses its best estimate of selling prices.

Provisions for rebates, chargebacks to wholesalers and distributors, returns, and discounts (collectively, “sales deductions”) are provided for at the time the related sales are recorded, and are reflected as a reduction of sales. The sales deductions are based primarily on estimates of the amounts earned or that will be claimed on such sales.

The company periodically and systematically evaluates the collectibility of accounts receivable and determines the appropriate reserve for doubtful accounts. In determining the amount of the reserve, the company considers historical credit losses, the past-due status of receivables, payment history and other customer-specific information, and any other relevant factors or considerations.

The company also provides for the estimated costs that may be incurred under its warranty programs when the cost is both probable and reasonably estimable, which is at the time the related revenue is recognized. The cost is determined based on actual company experience for the same or similar products as well as other relevant information. Estimates of future costs under the company’s warranty programs could change based on developments in the future. The company is not able to estimate the probability or amount of any future developments that could impact the reserves, but believes presently established reserves are adequate.

Pension and Other Postemployment Benefit (OPEB) Plans

The company provides pension and other postemployment benefits to certain of its employees. These employee benefit expenses are reported in the same line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and net periodic benefit cost for the plans

 

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is calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate. The significant assumptions include the following:

 

   

interest rates used to discount pension and OPEB plan liabilities;

 

   

the long-term rate of return on pension plan assets;

 

   

rates of increases in employee compensation (used in estimating liabilities);

 

   

anticipated future healthcare costs (used in estimating the OPEB plan liability); and

 

   

other assumptions involving demographic factors such as retirement, mortality and turnover (used in estimating liabilities).

Selecting assumptions involves an analysis of both short-term and long-term historical trends and known economic and market conditions at the time of the valuation (also called the measurement date). The use of different assumptions would result in different measures of the funded status and net cost. Actual results in the future could differ from expected results. The company is not able to estimate the probability of actual results differing from expected results, but believes its assumptions are appropriate.

The company’s key assumptions are listed in Note 13. The most critical assumptions relate to the plans covering U.S. and Puerto Rico employees, because these plans are the most significant to the company’s consolidated financial statements.

Discount Rate Assumption

For the U.S. and Puerto Rico plans, at the December 31, 2014 measurement date, the company used a discount rate of 4.00% and 3.95% to measure its benefit obligations for the pension plans and OPEB plan, respectively. These discount rates will be used in calculating the net periodic benefit cost for these plans for 2015. The company used a broad population of approximately 350 Aa-rated corporate bonds as of December 31, 2014 to determine the discount rate assumption. All bonds were denominated in U.S. Dollars, with a minimum amount outstanding of $50 million. This population of bonds was narrowed from a broader universe of over 700 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top 10th percentile and bottom 40th percentile to adjust for any pricing anomalies and to represent the bonds Baxter would most likely select if it were to actually annuitize its pension and OPEB plan liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve.

For plans in Canada, Japan, the United Kingdom and the Eurozone, the company uses a method essentially the same as that described for the U.S. and Puerto Rico plans. For the company’s other international plans, the discount rate is generally determined by reviewing country- and region-specific government and corporate bond interest rates.

To understand the impact of changes in discount rates on pension and OPEB plan cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase in the discount rate, global pre-tax pension and OPEB plan cost would decrease by approximately $44 million, and for each 50 basis point decrease in the discount rate, global pre-tax pension and OPEB plan cost would increase by approximately $54 million.

Return on Plan Assets Assumption

In measuring net periodic cost for 2014, the company used a long-term expected rate of return of 7.50% for the pension plans covering U.S. and Puerto Rico employees. For measuring the net periodic benefit cost for these plans for 2015, this assumption will decrease to 7.25%. This assumption is not applicable to the company’s OPEB plan because it is not funded.

 

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The company establishes the long-term asset return assumption based on a review of historical compound average asset returns, both company-specific and relating to the broad market (based on the company’s asset allocation), as well as an analysis of current market and economic information and future expectations. The current asset return assumption is supported by historical market experience for both the company’s actual and targeted asset allocation. In calculating net pension cost, the expected return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. The difference between this expected return and the actual return on plan assets is a component of the total net unrecognized gain or loss and is subject to amortization in the future.

To understand the impact of changes in the expected asset return assumption on net cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan cost would decrease (increase) by approximately $19 million.

Other Assumptions

For the U.S. and Puerto Rico plans, at the December 31, 2014 measurement date, the company used the RP 2014 combined mortality table adjusted to reflect past experience. For all other pension plans, the company utilized country- and region-specific mortality tables to calculate the plans’ benefit obligations. The company periodically analyzes and updates its assumptions concerning demographic factors such as retirement, mortality and turnover, considering historical experience as well as anticipated future trends.

The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future company actions. Refer to Note 13 for information regarding the sensitivity of the OPEB plan obligation and the total of the service and interest cost components of OPEB plan cost to potential changes in future healthcare costs.

Legal Contingencies

The company is involved in product liability, patent, commercial, regulatory and other legal proceedings that arise in the normal course of business. Refer to Note 16 for further information. The company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. The company has established reserves for certain of its legal matters. The company is not able to estimate the amount or range of any loss for certain of the legal contingencies for which there is no reserve or additional loss for matters already reserved. At December 31, 2014, total legal liabilities were $72 million.

The company’s loss estimates are generally developed in consultation with outside counsel and are based on analyses of potential outcomes. With respect to the recording of any insurance recoveries, after completing the assessment and accounting for the company’s legal contingencies, the company separately and independently analyzes its insurance coverage and records any insurance recoveries that are probable of occurring at the gross amount that is expected to be collected. In performing the assessment, the company reviews available information, including historical company-specific and market collection experience for similar claims, current facts and circumstances pertaining to the particular insurance claim, the financial viability of the applicable insurance company or companies, and other relevant information.

While the liability of the company in connection with certain claims cannot be estimated and although the resolution in any reporting period of one or more of these matters could have a significant impact on the company’s results of operations and cash flows for that period, the outcome of these legal proceedings is not expected to have a material adverse effect on the company’s consolidated financial position. While the company believes it has valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and the company may in the future incur material judgments or enter into material settlements of claims.

 

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Deferred Tax Asset Valuation Allowances and Reserves for Uncertain Tax Positions

The company maintains valuation allowances unless it is more likely than not that all or a portion of the deferred tax asset will be realized. Changes in valuation allowances are included in the company’s tax provision in the period of change. In determining whether a valuation allowance is warranted, the company evaluates factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The realizability assessments made at a given balance sheet date are subject to change in the future, particularly if earnings of a subsidiary are significantly higher or lower than expected, or if the company takes operational or tax planning actions that could impact the future taxable earnings of a subsidiary.

In the normal course of business, the company is audited by federal, state and foreign tax authorities, and is periodically challenged regarding the amount of taxes due. These challenges relate to the timing and amount of deductions and the allocation of income among various tax jurisdictions. The company believes its tax positions comply with applicable tax law and the company intends to defend its positions. In evaluating the exposure associated with various tax filing positions, the company records reserves for uncertain tax positions in accordance with GAAP, based on the technical support for the positions, the company’s past audit experience with similar situations, and potential interest and penalties related to the matters. The company’s results of operations and effective tax rate in a given period could be impacted if, upon final resolution with taxing authorities, the company prevailed in positions for which reserves have been established, or was required to pay amounts in excess of established reserves.

Valuation of Intangible Assets, Including IPR&D

The company acquires intangible assets and records them at fair value. Valuations are generally completed for business acquisitions using a discounted cash flow analysis, incorporating the stage of completion and consideration of market participant assumptions. The most significant estimates and assumptions inherent in a discounted cash flow analysis include the amount and timing of projected future cash flows, the discount rate used to measure the risks inherent in the future cash flows, the assessment of the asset’s life cycle, and the competitive and other trends impacting the asset, including consideration of technical, legal, regulatory, economic and other factors. Each of these factors and assumptions can significantly affect the value of the intangible asset.

Acquired in-process R&D (IPR&D) is the value assigned to acquired technology or products under development which have not received regulatory approval and have no alternative future use.

Acquired IPR&D included in a business combination is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred. Upon receipt of regulatory approval of the related technology or product, the indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

R&D acquired in transactions that are not business combinations is expensed immediately. For such transactions, payments made to third parties on or after regulatory approval are capitalized and amortized over the remaining useful life of the related asset, and are classified as intangible assets.

Due to the inherent uncertainty associated with R&D projects, there is no assurance that actual results will not differ materially from the underlying assumptions used to prepare discounted cash flow analyses, nor that the R&D project will result in a successful commercial product.

Impairment of Assets

Goodwill and other indefinite-lived intangible assets are subject to impairment reviews annually, and whenever indicators of impairment exist. The company assesses goodwill for impairment based on its reporting units,

 

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which are the same as its operating segments, BioScience and Medical Products. As of December 31, 2014, the date of the company’s annual impairment review, the fair values of the company’s reporting units were in excess of their carrying values. The company performs a qualitative assessment of other indefinite-lived intangible assets, including IPR&D, at least annually. If the intangible asset is determined to be more likely than not impaired as a result of the assessment, the company completes a quantitative impairment test. Intangible assets with definite lives and other long-lived assets (such as fixed assets) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Refer to Note 1 for further information. The company’s impairment reviews are based on an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings, and other assumptions and estimates. The estimates and assumptions used are consistent with the company’s business plans and a market participant’s views of the company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair values of the assets, and potentially result in different impacts to the company’s results of operations. Actual results may differ from the company’s estimates.

Stock-Based Compensation Plans

Stock-based compensation cost is estimated at the grant date based on the fair value of the award, and the cost is recognized as expense ratably over the substantive vesting period. Determining the appropriate fair value model to use requires judgment. Determining the assumptions that enter into the model is highly subjective and also requires judgment. The company’s stock compensation costs primarily relate to awards of stock options, restricted stock units (RSUs), and performance share units (PSUs). The company uses the Black-Scholes model for estimating the fair value of stock options, and significant assumptions include long-term projections regarding stock price volatility, employee exercise, post-vesting termination and pre-vesting forfeiture behaviors, interest rates and dividend yields. The company’s expected volatility assumption is based on a weighted-average of the historical volatility of Baxter’s stock and the implied volatility from traded options on Baxter’s stock, with historical volatility more heavily weighted. The expected life assumption is primarily based on the vesting terms of the stock option, historical employee exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield reflects historical experience as well as future expectations over the expected life of the option.

The fair value of RSUs is equal to the quoted price of the company’s common stock on the date of grant.

As part of an overall periodic evaluation of the company’s stock compensation programs, the company changed the vesting condition for 50% of the PSUs granted to senior management beginning with its 2013 annual equity awards. The vesting condition for these PSUs is based on return on invested capital (ROIC), with annual performance targets set at the beginning of the year for each tranche of the award during the three-year service period. The holder of the ROIC PSUs is entitled to receive a number of shares of common stock equal to a percentage, ranging from 0% to 200%, of the ROIC PSUs granted, depending on the actual results compared to the annual performance targets. Compensation cost for the ROIC PSUs is measured based on the fair value of the awards on the date that the specific vesting terms for each tranche of the award are established. The fair value of the awards is determined based on the quoted price of the company’s stock on the grant date for each tranche of the award. The compensation cost for ROIC PSUs is adjusted at each reporting date to reflect the estimated probability of achieving the vesting condition. The probability of achieving the vesting condition has not materially changed during the year ended December 31, 2014. The remaining 50% of the PSUs continued to include conditions for vesting based on Baxter stock performance relative to the company’s peer group. The company uses a Monte Carlo model for estimating the fair value of these PSUs. A Monte Carlo model uses stock price volatility and other variables to estimate the probability of satisfying the market conditions and the resulting fair value of the award. Refer to Note 12 for additional information.

 

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CERTAIN REGULATORY MATTERS

In July 2014, the company received a Warning Letter from FDA primarily relating to processes implemented to ensure the absence of particulate matter or leaks associated with products manufactured at the company’s Aibonito, Puerto Rico, plant. The company is working with FDA to resolve this matter, as well as each of the other Warning Letters listed below.

In January 2014, the company received a Warning Letter from FDA primarily directed to quality systems for the company’s Round Lake, Illinois, facility, particularly in that facility’s capacity as a specification developer for certain of the company’s medical devices. The letter also included observations related to the company’s ambulatory infusor business in Irvine, California, which previously had been subject to agency action.

In June 2013, the company received a Warning Letter from FDA regarding operations and processes at its North Cove, North Carolina and Jayuya, Puerto Rico facilities. The Warning Letter addresses observations related to Current Good Manufacturing Practice (CGMP) violations at the two facilities.

In June 2010, the company received a Warning Letter from FDA in connection with an inspection of its Renal franchise’s McGaw Park, Illinois facility. The Warning Letter pertains to the processes by which the company analyzes and addresses product complaints through corrective and preventative actions, and reports relevant information to FDA.

On October 9, 2014, the company had a Regulatory Meeting with FDA to discuss the Warning Letters described above. At the meeting, the company agreed to work closely with FDA to provide regular updates on its progress to meet all requirements and resolve all matters identified in the Warning Letters described above.

Please see Item 1A of this Annual Report on Form 10-K for additional discussion of regulatory matters and how they may impact the company.

FORWARD-LOOKING INFORMATION

This annual report includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, litigation-related matters including outcomes, future regulatory filings and the company’s R&D pipeline, strategic objectives, credit exposure to foreign governments, potential developments with respect to credit ratings, investment of foreign earnings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, discount rates and rates of return, the company’s exposure to financial market volatility and foreign currency and interest rate risks, the planned separation of the biopharmaceuticals and medical products businesses, the impact of competition, future sales growth, business development activities, business optimization initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of the company’s facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts.

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

 

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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:

 

   

demand for and market acceptance risks for and competitive pressures related to new and existing products;

 

   

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

 

   

product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, sanctions, seizures, litigation, or declining sales;

 

   

future actions of FDA, EMA or any other regulatory body or government authority that could delay, limit or suspend product development, manufacturing or sale or result in seizures, recalls, injunctions, monetary sanctions or criminal or civil liabilities;

 

   

failures with respect to the company’s compliance programs;

 

   

future actions of third parties, including third-party payors, as healthcare reform and other similar measures are implemented in the United States and globally;

 

   

the impact of U.S. healthcare reform and other similar actions undertaken by foreign governments with respect to pricing, reimbursement, taxation and rebate policies;

 

   

additional legislation, regulation and other governmental pressures in the United States or globally, which may affect pricing, reimbursement, taxation and rebate policies of government agencies and private payers or other elements of the company’s business;

 

   

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

 

   

global regulatory, trade and tax policies;

 

   

the company’s ability to identify business development and growth opportunities and to successfully execute on business development strategies;

 

   

the company’s ability to realize the anticipated benefits from its joint product development and commercialization arrangements, governmental collaborations and other business development activities;

 

   

fluctuations in supply and demand and the pricing of plasma-based therapies;

 

   

the availability and pricing of acceptable raw materials and component supply;

 

   

inability to create additional production capacity in a timely manner or the occurrence of other manufacturing or supply difficulties;

 

   

the company’s ability to successfully separate its biopharmaceuticals and medical products businesses on the terms or timeline currently contemplated, if at all, and achieve the intended results;

 

   

the ability to protect or enforce the company’s 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 the company’s manufacture, sale or use of affected products or technology;

 

   

the impact of global economic conditions on the company and its customers and suppliers, including foreign governments in certain countries in which the company operates;

 

   

fluctuations in foreign exchange and interest rates;

 

   

any changes in law concerning the taxation of income, including income earned outside the United States;

 

   

actions by tax authorities in connection with ongoing tax audits;

 

   

breaches or failures of the company’s information technology systems;

 

   

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

 

   

the outcome of pending or future litigation;

 

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the adequacy of the company’s cash flows from operations to meet its ongoing cash obligations and fund its investment program; and

 

   

other factors identified elsewhere in this Annual Report on Form 10-K including those factors described in Item 1A and other filings with the Securities and Exchange Commission, all of which are available on the company’s website.

Actual results may differ materially from those projected in the forward-looking statements. The company does not undertake to update its forward-looking statements.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Incorporated by reference to the section entitled “Financial Instrument Market Risk” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Annual Report on Form 10-K.

 

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Item 8. Financial Statements and Supplementary Data.

CONSOLIDATED BALANCE SHEETS

 

as of December 31 (in millions, except share information)    2014     2013  

 

 

Current assets

  

Cash and equivalents

   $ 2,925      $ 2,733   
  

Accounts and other current receivables, net

     2,803        2,911   
  

Inventories

     3,559        3,499   
  

Short-term deferred income taxes

     501        504   
  

Prepaid expenses and other

     563        548   
  

 

 
  

Total current assets

     10,351        10,195   

 

 

Property, plant and equipment, net

     8,698        7,832   

 

 

Other assets

  

Goodwill

     3,874        4,205   
  

Other intangible assets, net

     2,079        2,294   
  

Other

     915        698   
  

 

 
  

Total other assets

     6,868        7,197   

 

 
  

Total assets

   $ 25,917      $ 25,224   

 

 

Current liabilities

  

Short-term debt

   $ 913      $ 181   
  

Current maturities of long-term debt and lease obligations

     786        859   
  

Accounts payable and accrued liabilities

     4,343        4,208   
  

 

 
  

Total current liabilities

     6,042        5,248   

 

 

Long-term debt and lease obligations

     7,606        8,126   

 

 

Other long-term liabilities

     4,113        3,364   

 

 

Commitments and contingencies

    

 

 

Equity

  

Common stock, $1 par value, authorized
2,000,000,000 shares, issued
683,494,944 shares in 2014 and 2013

     683        683   
  

Common stock in treasury, at cost,
141,116,857 shares in 2014 and 140,456,989 shares in 2013

     (7,993     (7,914
  

Additional contributed capital

     5,853        5,818   
  

Retained earnings

     13,227        11,852   
  

Accumulated other comprehensive loss

     (3,650     (1,976
  

 

 
  

Total Baxter International Inc. (Baxter)
shareholders’ equity

     8,120        8,463   
  

 

 
  

Noncontrolling interests

     36        23   
  

 

 
  

Total equity

     8,156        8,486   

 

 
  

Total liabilities and equity

   $ 25,917      $ 25,224   

 

 

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

 

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CONSOLIDATED STATEMENTS OF INCOME

 

years ended December 31 (in millions, except per share data)    2014      2013     2012  

 

 

Net sales

   $ 16,671       $ 14,967      $ 13,936   

Cost of sales

     8,514         7,495        6,802   

 

 

Gross margin

     8,157         7,472        7,134   

 

 

Marketing and administrative expenses

     4,029         3,642        3,283   

Research and development expenses

     1,421         1,165        1,081   

Net interest expense

     145         128        87   

Other expense (income), net

     123         (9     (155

 

 

Income from continuing operations before income taxes

     2,439         2,546        2,838   

Income tax expense

     493         534        555   

 

 

Income from continuing operations

     1,946         2,012        2,283   

Income from discontinued operations, net of tax

     551         0        43   

 

 

Net income

   $ 2,497       $ 2,012      $ 2,326   

 

 

Income from continuing operations per common share

       

Basic

   $ 3.59       $ 3.70      $ 4.14   

 

 

Diluted

   $ 3.56       $ 3.66      $ 4.11   

 

 

Income from discontinued operations per common share

       

Basic

   $ 1.02       $ 0.00      $ 0.08   

 

 

Diluted

   $ 1.00       $ 0.00      $ 0.07   

 

 

Net income per common share

       

Basic

   $ 4.61       $ 3.70      $ 4.22   

 

 

Diluted

   $ 4.56       $ 3.66      $ 4.18   

 

 

Weighted-average number of common shares outstanding

       

Basic

     542         543        551   

 

 

Diluted

     547         549        556   

 

 

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

 

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

years ended December 31 (in millions)    2014     2013     2012  

 

 

Net income

   $ 2,497      $ 2,012      $ 2,326   

Other comprehensive (loss) income, net of tax:

      

Currency translation adjustments, net of tax (benefit) expense of ($132) in 2014, $41 in 2013 and $22 in 2012

     (1,332     236        (98

Pension and other employee benefits, net of tax (benefit) expense of ($193) in 2014, $309 in 2013 and ($1) in 2012

     (400     592        (111

Hedging activities, net of tax expense (benefit) of $14 in 2014, $7 in 2013 and ($6) in 2012

     24        15        (7

Other, net of tax (benefit) of ($2) in 2014, ($3) in 2013 and ($2) in 2012

     34        (9     (3

 

 

Total other comprehensive (loss) income, net of tax

     (1,674     834        (219

 

 

Comprehensive income

   $ 823      $ 2,846      $ 2,107   

 

 

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

 

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CONSOLIDATED STATEMENTS OF CASH FLOWS

 

years ended December 31 (in millions) (brackets denote cash outflows)   2014     2013     2012  

 

 

Cash flows from

  

Net income

  $ 2,497      $ 2,012      $ 2,326   

operations

  

Adjustments

     
  

Depreciation and amortization

    1,005        823        712   
  

Deferred income taxes

    (78     (224     (17
  

Stock compensation

    159        150        130   
  

Realized excess tax benefits from stock issued under employee benefit plans

    (24     (34     (24
  

Business optimization charges

    27        282        150   
  

Net periodic pension benefit and OPEB costs

    275        381        477   
  

Gain on sale of discontinued operations

    (466              
  

Infusion pump and other product-related charges

    93        17          
  

Losses (gains) related to contingent payment liabilities

    122        (17     (108
  

Other

    269        54        66   
  

Changes in balance sheet items

     
  

Accounts and other current receivables, net

    (125     (36     (41
  

Inventories

    (439     (311     (129
  

Accounts payable and accrued liabilities

    115        361        40   
  

Business optimization and infusion pump payments

    (161     (125     (283
  

Other

    (54     (135     (193
  

 

 
  

Cash flows from operations

    3,215        3,198        3,106   

 

 
Cash flows from investing activities   

Capital expenditures (including additions to the pool of equipment placed with or leased to customers of $151 in 2014, $148 in 2013 and $150 in 2012)

    (1,898     (1,525     (1,161
  

Acquisitions and investments, net of cash acquired

    (409     (3,851     (515
  

Divestitures and other investing activities

    765        14        107   
  

 

 
  

Cash flows from investing activities

    (1,542     (5,362     (1,569

 

 

Cash flows from

  

Issuances of debt

    41        3,636        1,037   

financing activities

  

Payments of obligations

    (1,029     (540     (22
  

Increase (decrease) in debt with original maturities of three months or less, net

    875               (250
  

Cash dividends on common stock

    (1,095     (1,023     (804
  

Proceeds and realized excess tax benefits from stock issued under employee benefit plans

    369        508        512   
  

Purchases of treasury stock

    (550     (913     (1,480
  

Other

    (13     (23     (108
  

 

 
  

Cash flows from financing activities

    (1,402     1,645        (1,115

 

 

Effect of foreign exchange rate changes on cash and equivalents

    (79     (18     (57

 

 

Increase (decrease) in cash and equivalents

    192        (537     365   

 

 

Cash and equivalents at beginning of year

    2,733        3,270        2,905   

 

 

Cash and equivalents at end of year

  $ 2,925      $ 2,733      $ 3,270   

 

 

Other supplemental information

     

Interest paid, net of portion capitalized

  $ 208      $ 200      $ 135   

Income taxes paid

  $ 726      $ 648      $ 415   

 

 

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

 

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CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

     2014     2013     2012  
as of and for the years ended December 31 (in millions)    Shares     Amount     Shares     Amount     Shares     Amount  

 

 

Common stock

            

Balance, beginning and end of year

     683      $ 683        683      $ 683        683      $ 683   

 

 

Common stock in treasury

            

Beginning of year

     140        (7,914     137        (7,592     123        (6,719

Purchases of common stock

     8        (550     13        (913     25        (1,480

Stock issued under employee benefit plans and other

     (7     471        (10     591        (11     607   

 

 

End of year

     141        (7,993     140        (7,914     137        (7,592

 

 

Additional contributed capital

            

Beginning of year

       5,818          5,769          5,783   

Stock issued under employee benefit plans and other

       35          45          17   

Exercise of SIGMA purchase option

                4          (31

 

 

End of year

       5,853          5,818          5,769   

 

 

Retained earnings

            

Beginning of year

       11,852          10,888          9,429   

Net income

       2,497          2,012          2,326   

Dividends declared on common stock

       (1,116       (1,048       (866

Stock issued under employee benefit plans

       (6                (1

 

 

End of year

       13,227          11,852          10,888   

 

 

Accumulated other comprehensive loss

            

Beginning of year

       (1,976       (2,810       (2,591

Other comprehensive (loss) income

       (1,674       834          (219

 

 

End of year

       (3,650       (1,976       (2,810

 

 

Total Baxter shareholders’ equity

     $ 8,120        $ 8,463        $ 6,938   

 

 

Noncontrolling interests

            

Beginning of year

     $ 23        $ 40        $ 243   

Elimination of SIGMA noncontrolling ownership interest

                         (159

Change in noncontrolling interests

       13          (17       (44

 

 

End of year

     $ 36        $ 23        $ 40   

 

 

Total equity

     $ 8,156        $ 8,486        $ 6,978   

 

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

 

Nature of Operations

Baxter International Inc. (Baxter or the company), through its subsidiaries, develops, manufactures and markets products that save and sustain the lives of people with hemophilia, immune disorders, cancer, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. As a global, diversified healthcare company, Baxter applies a unique combination of expertise in medical devices, pharmaceuticals and biotechnology to create products that advance patient care worldwide. The company operates in two segments, BioScience and Medical Products, which are described in Note 17.

In March 2014, Baxter announced plans to create two separate, independent global healthcare companies – one focused on lifesaving medical products and the other on developing and marketing innovative biopharmaceuticals. The transition is intended to take the form of a tax-free distribution to Baxter shareholders of more than 80% of the publicly traded stock in the new biopharmaceuticals company. The transaction is expected to be completed by mid-year 2015, subject to market, regulatory and certain other conditions, including final approval by the Baxter Board of Directors, receipt of a favorable opinion and/or rulings with respect to the tax-free nature of the transaction in the United States, and the effectiveness of the Form 10 registration statement filed with the United States Securities and Exchange Commission. Upon separation, the historical results of the biopharmaceuticals business will be presented as discontinued operations.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles (GAAP) requires the company to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates.

Basis of Presentation

The consolidated financial statements include the accounts of Baxter and its majority-owned subsidiaries, any other subsidiaries that Baxter controls, and variable interest entities (VIEs) in which Baxter is the primary beneficiary, after elimination of intercompany transactions. During 2012, the company exercised its option to purchase the remaining equity of Sigma International General Medical Apparatus, LLC (SIGMA), which Baxter previously consolidated as the primary beneficiary of a VIE. The company has not subsequently entered into any new arrangements in which it determined that it was the primary beneficiary of a VIE, and there were no VIEs consolidated by the company as of December 31, 2013 and 2014. Refer to Note 3 for additional information about the SIGMA option exercise.

On September 6, 2013, Baxter acquired Indap Holding AB, the holding company for Gambro AB (Gambro), a privately held dialysis product company based in Lund, Sweden, for cash consideration of $3.7 billion. Beginning September 6, 2013, Baxter’s financial statements include the assets, liabilities, and operating results of Gambro. Refer to Note 5 for additional information about the Gambro acquisition.

In the third quarter of 2014, the company committed to a plan to divest its Vaccines franchise. Refer to Note 2 for a summary of the operating results of the Vaccines franchise reflected as discontinued operations.

Revision of 2013 Tax Balances

The company identified and corrected prior period errors in the presentation of its current and deferred income tax assets and liabilities as of December 31, 2013 in the consolidated balance sheet with no impact to total equity.

 

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The company assessed the impact of these errors and concluded that these errors were not material to previously issued financial statements. The company has revised its previously reported consolidated balance sheet as of December 31, 2013 as reflected below.

 

as of December 31, 2013 (in millions)    As Reported      Adjustments     As Revised  

Short-term deferred income taxes

     $   393         $ 111        $   504   

Prepaid expense and other

     468         80        548   

Other assets

     1,534         (836     698   

Accounts payable and accrued liabilities

     4,866         (658     4,208   

Other long-term liabilities

     3,351         13        3,364   

Revenue Recognition

The company recognizes revenues from product sales and services when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectibility is reasonably assured. For product sales, revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for the majority of the company’s revenue arrangements are FOB destination. The recognition of revenue is delayed if there are significant post-delivery obligations, such as training, installation or other services. Provisions for discounts, rebates to customers, chargebacks to wholesalers and returns are provided for at the time the related sales are recorded, and are reflected as a reduction to gross sales to arrive at net sales.

The company sometimes enters into arrangements in which it commits to delivering multiple products or services to its customers. In these cases, total arrangement consideration is allocated to the deliverables based on their relative selling prices. Then the allocated consideration is recognized as revenue in accordance with the principles described above. Selling prices are determined by applying a selling price hierarchy. Selling prices are determined using vendor specific objective evidence (VSOE), if it exists. Otherwise, selling prices are determined using third party evidence (TPE). If neither VSOE nor TPE is available, the company uses its best estimate of selling prices.

Accounts Receivable and Allowance for Doubtful Accounts

In the normal course of business, the company provides credit to its customers, performs credit evaluations of these customers and maintains reserves for potential credit losses. In determining the amount of the allowance for doubtful accounts, the company considers, among other items, historical credit losses, the past-due status of receivables, payment histories and other customer-specific information. Receivables are written off when the company determines they are uncollectible. The allowance for doubtful accounts was $139 million at December 31, 2014 and $169 million at December 31, 2013.

Product Warranties

The company provides for the estimated costs relating to product warranties at the time the related revenue is recognized. The cost is determined based on actual company experience for the same or similar products, as well as other relevant information. Product warranty liabilities are adjusted based on changes in estimates.

Cash and Equivalents

Cash and equivalents include cash, certificates of deposit and money market funds with an original maturity of three months or less.

 

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Inventories

 

as of December 31 (in millions)    2014      2013  

Raw materials

   $ 910       $ 920   

Work in process

     1,126         1,136   

Finished goods

     1,523         1,443   

Inventories

   $ 3,559       $ 3,499   

 

 

Inventories are stated at the lower of cost (first-in, first-out method) or market value. Market value for raw materials is based on replacement costs, and market value for work in process and finished goods is based on net realizable value. The company reviews inventories on hand at least quarterly and records provisions for estimated excess, slow-moving and obsolete inventory, as well as inventory with a carrying value in excess of net realizable value.

Property, Plant and Equipment, Net

 

as of December 31 (in millions)    2014     2013  

Land

   $ 225      $ 220   

Buildings and leasehold improvements

     2,673        2,670   

Machinery and equipment

     7,687        7,360   

Equipment with customers

     1,353        1,361   

Construction in progress

     2,870        2,184   

 

 

Total property, plant and equipment, at cost

     14,808        13,795   

Accumulated depreciation

     (6,110     (5,963

 

 

Property, plant and equipment (PP&E), net

   $ 8,698      $ 7,832   

 

 

Depreciation expense is calculated using the straight-line method over the estimated useful lives of the related assets, which range from 20 to 50 years for buildings and improvements and from three to 15 years for machinery and equipment. Leasehold improvements are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. Baxter capitalizes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use as part of machinery and equipment. Capitalized software costs are amortized on a straight-line basis over the estimated useful lives of the software, and are included in depreciation expense. Straight-line and accelerated methods of depreciation are used for income tax purposes. Depreciation expense was $809 million in 2014, $674 million in 2013 and $590 million in 2012.

Acquisitions

Results of operations of acquired companies are included in the company’s results of operations as of the respective acquisition dates. The purchase price of each acquisition is allocated to the net assets acquired based on estimates of their fair values at the date of the acquisition. Any purchase price in excess of these net assets is recorded as goodwill. The allocation of purchase price in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date.

Contingent consideration is recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent payments are recognized in earnings. Contingent payments related to acquisitions consist of development, regulatory, and commercial milestone payments, in addition to sales-based payments, and are valued using discounted cash flow techniques. The fair value of development, regulatory, and commercial milestone payments reflects management’s expectations of probability of payment, and increases or

 

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decreases as the probability of payment or expectation of timing of payments changes. The fair value of sales-based payments is based upon probability-weighted future revenue estimates and increases or decreases as revenue estimates or expectation of timing of payments changes.

Research and Development

Research and development (R&D) costs, including R&D acquired in transactions that are not business combinations, are expensed as incurred. Pre-regulatory approval contingent milestone obligations to counterparties in collaborative arrangements are expensed when the milestone is achieved. Payments made to counterparties on or after regulatory approval are capitalized and amortized over the remaining useful life of the related product. Amounts capitalized for such payments are included in other intangible assets, net of accumulated amortization.

Acquired in-process R&D (IPR&D) is the value assigned to technology or products under development acquired in a business combination which have not received regulatory approval and have no alternative future use. Acquired IPR&D is capitalized as an indefinite-lived intangible asset. Development costs incurred after the acquisition are expensed as incurred. Upon receipt of regulatory approval of the related technology or product, the indefinite-lived intangible asset is accounted for as a finite-lived intangible asset and generally amortized on a straight-line basis over the estimated economic life of the related technology or product, subject to annual impairment reviews as discussed below. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

Collaborative Arrangements

The company enters into collaborative arrangements in the normal course of business. These collaborative arrangements take a number of forms and structures, and are designed to enhance and expedite long-term sales and profitability growth. These arrangements generally provide that Baxter obtain commercialization rights to a product under development. The agreements often require Baxter to make upfront payments and include additional contingent milestone payments relating to the achievement of specified development, regulatory and commercial milestones, as well as make royalty payments. Baxter may also be responsible for other on-going costs associated with the arrangements, including R&D cost reimbursements to the counterparty.

Royalty payments are expensed as cost of sales when they become due and payable. Any purchases of inventory from the partner during the development stage are expensed as R&D, while such purchases during the commercialization phase are capitalized as inventory and recognized as cost of sales when the related finished products are sold.

Business Optimization Charges

The company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. Employee termination costs are primarily recorded when actions are probable and estimable. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Refer to the discussion below regarding the accounting for asset impairment charges.

Goodwill

Goodwill is not amortized, but is subject to an impairment review annually and whenever indicators of impairment exist. Goodwill would be impaired if the carrying amount of a reporting unit exceeded the fair value of that reporting unit, calculated as the present value of estimated cash flows discounted using a risk-free market rate adjusted for a market participant’s view of similar companies and perceived risks in the cash flows. The implied fair value of goodwill is then determined by subtracting the fair value of all identifiable net assets other than goodwill from the fair value of the reporting unit, with an impairment charge recorded for the excess, if any, of carrying amount of goodwill over the implied fair value.

 

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Intangible Assets Not Subject to Amortization

Indefinite-lived intangible assets, such as IPR&D acquired in business combinations and certain trademarks with indefinite lives, are subject to an impairment review annually and whenever indicators of impairment exist. Indefinite-lived intangible assets are impaired if the carrying amount of the asset exceeded the fair value of the asset.

Other Long-Lived Assets

The company reviews the carrying amounts of long-lived assets, other than goodwill and intangible assets not subject to amortization, for potential impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating recoverability, the company groups assets and liabilities at the lowest level such that the identifiable cash flows relating to the group are largely independent of the cash flows of other assets and liabilities. The company then compares the carrying amounts of the assets or asset groups with the related estimated undiscounted future cash flows. In the event impairment exists, an impairment charge is recorded as the amount by which the carrying amount of the asset or asset group exceeds the fair value.

Shipping and Handling Costs

Shipping costs, which are costs incurred to physically move product from Baxter’s premises to the customer’s premises, are classified as marketing and administrative expenses. Handling costs, which are costs incurred to store, move and prepare products for shipment, are classified as cost of sales. Approximately $340 million in 2014, $293 million in 2013 and $265 million in 2012 of shipping costs were classified in marketing and administrative expenses.

Income Taxes

Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The company maintains valuation allowances unless it is more likely than not that the deferred tax asset will be realized. With respect to uncertain tax positions, the company determines whether the position is more likely than not to be sustained upon examination, based on the technical merits of the position. Any tax position that meets the more likely than not recognition threshold is measured and recognized in the consolidated financial statements at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The liability relating to uncertain tax positions is classified as current in the consolidated balance sheets to the extent the company anticipates making a payment within one year. Interest and penalties associated with income taxes are classified in the income tax expense line in the consolidated statements of income.

Foreign Currency Translation

Currency translation adjustments (CTA) related to foreign operations are included in other comprehensive income (OCI). For foreign operations in highly inflationary economies, translation gains and losses are included in other expense (income), net, and were not material in 2014, 2013 and 2012.

Derivatives and Hedging Activities

All derivative instruments are recognized as either assets or liabilities at fair value in the consolidated balance sheets and are classified as short-term or long-term based on the scheduled maturity of the instrument. Based upon the exposure being hedged, the company designates its hedging instruments as cash flow or fair value hedges.

For each derivative instrument that is designated and effective as a cash flow hedge, the gain or loss on the derivative is accumulated in accumulated other comprehensive income (AOCI) and then recognized in earnings consistent with the underlying hedged item. Option premiums or net premiums paid are initially recorded as assets and reclassified to OCI over the life of the option, and then recognized in earnings consistent with the

 

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underlying hedged item. Cash flow hedges are classified in net sales, cost of sales, and net interest expense, and primarily related to forecasted third-party sales denominated in foreign currencies, forecasted intercompany sales denominated in foreign currencies and anticipated issuances of debt, respectively.

For each derivative instrument that is designated and effective as a fair value hedge, the gain or loss on the derivative is recognized immediately to earnings, and offsets the loss or gain on the underlying hedged item. Fair value hedges are classified in net interest expense, as they hedge the interest rate risk associated with certain of the company’s fixed-rate debt.

For derivative instruments that are not designated as hedges, the change in fair value is recorded directly to other expense (income), net.

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If the company removes the cash flow hedge designation because the hedged forecasted transactions are no longer probable of occurring, any gains or losses are immediately reclassified from AOCI to earnings. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the income or loss recognition of the underlying hedged items. If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item.

Derivatives, including those that are not designated as a hedge, are principally classified in the operating section of the consolidated statements of cash flows in the same category as the related consolidated balance sheet account.

Refer to Note 9 for further information regarding the company’s derivative and hedging activities.

New Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. ASU No. 2014-09 will be effective for the company beginning on January 1, 2017. Early adoption is not permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The company is currently evaluating the impact of adopting the new revenue standard on its consolidated financial statements.

NOTE 2

DISCONTINUED OPERATIONS

 

 

In July 2014, the company entered into an agreement with Pfizer Inc. to sell its commercial vaccines business, including NeisVac-C, a vaccine which helps protect against meningitis caused by group C meningococcal meningitis, and FSME-IMMUN, which helps protect against tick-borne encephalitis (TBE), an infection of the brain transmitted by the bite of ticks infected with the TBE-virus, and committed to a plan to divest the remainder of its Vaccines franchise, which includes certain R&D programs. The company completed the divestiture of the commercial vaccines business in December 2014 and received cash proceeds of $639 million and recorded an after-tax gain of $417 million. The company entered into a separate agreement for the sale of the remainder of the Vaccines franchise in December 2014, which is expected to be completed in the first quarter of 2015. As a result of the divestitures, the operations and cash flows of the Vaccines franchise will be eliminated from the ongoing operations of the company.

 

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Following is a summary of the operating results of the Vaccines franchise, which have been reflected as discontinued operations for the years ended December 31, 2014, 2013 and 2012.

 

years ended December 31 (in millions)    2014      2013      2012  

Net sales

   $ 301       $ 292       $ 254   

Income before income taxes

     616         3         51   

Income tax expense

     65         3         8   

 

 

Net income

   $ 551       $ 0       $ 43   

 

 

NOTE 3

SUPPLEMENTAL FINANCIAL INFORMATION

 

 

Other Long-Term Assets

 

as of December 31 (in millions)    2014      2013  

Deferred income taxes

   $ 273       $ 41   

Other long-term receivables

     127         216   

Other

     515         441   

 

 

Other long-term assets

   $ 915       $ 698   

 

 

Accounts Payable and Accrued Liabilities

 

as of December 31 (in millions)    2014      2013  

Accounts payable, principally trade

   $ 1,264       $ 1,103   

Income taxes payable

     336         382   

Deferred income taxes

     9         21   

Common stock dividends payable

     282         266   

Employee compensation and withholdings

     716         667   

Property, payroll and certain other taxes

     261         237   

Infusion pump reserves

     22         64   

Business optimization reserves

     118         199   

Accrued rebates

     374         346   

Other

     961         923   

 

 

Accounts payable and accrued liabilities

   $ 4,343       $ 4,208   

 

 

Other Long-Term Liabilities

 

as of December 31 (in millions)    2014      2013  

Pension and other employee benefits

   $ 2,748       $ 2,049   

Litigation reserves

     53         72   

Infusion pump reserves

             19   

Business optimization reserves

     51         89   

Contingent payment liabilities

     569         340   

Other

     692         795   

 

 

Other long-term liabilities

   $ 4,113       $ 3,364   

 

 

 

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Net Interest Expense

 

years ended December 31 (in millions)    2014     2013     2012  

Interest costs

   $ 237      $ 225      $ 165   

Interest costs capitalized

     (70     (70     (52

 

 

Interest expense

     167        155        113   

Interest income

     (22     (27     (26

 

 

Net interest expense

   $ 145      $ 128      $ 87   

 

 

Certain of the above 2013 balance sheet amounts were revised in connection with the income tax assets and liabilities adjustments described in Note 1.

Exercise of SIGMA Option

In April 2012, the company exercised its option to purchase the remaining equity of SIGMA for a cash payment of $90 million. Since the 2009 acquisition of a 40% stake in SIGMA, the company has consolidated the financial statements of SIGMA, with the equity owned by existing SIGMA equity holders reported as noncontrolling interests. As a result, the exercise of the option was treated as an equity transaction and no additional assets were recognized by Baxter related to the additional ownership interest acquired. On the date of exercise, the carrying value of the noncontrolling interest was eliminated to reflect Baxter’s change in ownership interest in SIGMA’s equity and the carrying value of the call option was also eliminated. The exercise of the SIGMA purchase option had no direct impact on the company’s results of operations, and the payment was classified as a financing activity on the consolidated statements of cash flows. Effective as of the date of the option exercise, 100% of SIGMA’s pre-tax income has been reflected in the company’s results of operations and, as a result, the company no longer reports noncontrolling interest related to SIGMA.

NOTE 4

EARNINGS PER SHARE

 

 

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

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

 

years ended December 31 (in millions)    2014      2013      2012  

Basic shares

     542         543         551   

Effect of dilutive securities

     5         6         5   

 

 

Diluted shares

     547         549         556   

 

 

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 9 million, 5 million, and 16 million equity awards in 2014, 2013 and 2012, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS. Refer to Note 12 for additional information regarding items impacting basic shares.

 

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NOTE 5

ACQUISITIONS AND COLLABORATIONS

 

 

Gambro AB Acquisition

On September 6, 2013, Baxter acquired 100 percent of the voting equity interests in Indap Holding AB, the holding company for Gambro, a privately held dialysis product company based in Lund, Sweden. Gambro is a global medical technology company focused on developing, manufacturing and supplying dialysis products and therapies for patients with acute or chronic kidney disease. The transaction provides Baxter with a broad and complementary dialysis product portfolio, while further advancing the company’s geographic footprint in the dialysis business. In addition, the company has augmented its pipeline with Gambro’s next-generation monitors, dialyzers, devices and dialysis solutions.

The total cash consideration for the acquisition, as reduced by assumed debt of $221 million, was $3.7 billion. During 2014, the company finalized its valuation of the acquisition date assets acquired and liabilities assumed. The measurement period adjustments in 2014 include a $14 million increase to property, plant and equipment and $4 million of working capital adjustments. The adjustments resulted in a corresponding decrease in goodwill of $10 million and a decrease to the fair value of consideration transferred of $4 million. These adjustments did not have a material impact on Baxter’s results of operations during 2014.

The following table summarizes the final fair value of the consideration transferred and the amounts recognized for assets acquired and liabilities assumed as of the acquisition date.

 

(in millions)        

Consideration transferred

  

Cash

   $ 3,700   

 

 

Fair value of consideration transferred

   $ 3,700   

 

 

Assets acquired and liabilities assumed

  

Cash

   $ 88   

Accounts receivable

     488   

Inventories

     368   

Prepaid expenses and other

     54   

Property, plant, and equipment

     740   

Other intangible assets

     1,290   

Other assets

     11   

Current-maturities of long-term debt and lease obligations

     (2

Accounts payable and accrued liabilities

     (345

Long-term debt and lease obligations

     (261

Other long-term liabilities (including pension obligations of $209)

     (341

 

 

Total identifiable net assets

     2,090   

Goodwill

     1,610   

 

 

Total assets acquired and liabilities assumed

   $ 3,700   

 

 

The results of operations, assets and liabilities of Gambro are included in the Medical Products segment, together with the related goodwill. Goodwill includes expected synergies, as well as an expanded dialysis product portfolio and global footprint for the company’s Medical Products business, particularly the Renal franchise. The goodwill is not deductible for tax purposes. Other intangible assets included developed technology of $916 million, trademarks of $206 million, and indefinite-lived IPR&D of $168 million. Other intangible assets, excluding IPR&D, are being amortized on a straight-line basis over a weighted-average estimated useful life of approximately 15 years. The acquired IPR&D related to next generation monitors, dialyzers, fluids, and other technologies used in both chronic and acute therapies. The projects ranged in levels of completion and were

 

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expected to be completed over a five year period. The value of the IPR&D was calculated using cash flow projections adjusted for the inherent technical, regulatory, commercial and obsolescence risk in such activities, discounted at a rate of 12%. As of the acquisition date, additional research and development costs totaling approximately $85 million were projected to be required in order for the projects to obtain regulatory approval. Certain projects were completed during 2014, and there has been no material change in management’s projections since the acquisition date.

Long-term debt and lease obligations included $221 million of Gambro’s pre-existing Euro-denominated debt assumed by Baxter on the date of closing, which was subsequently paid off in September 2013. The debt settlement has been classified as a financing activity in the consolidated statements of cash flows.

The company incurred acquisition-related costs of $101 million during 2013, which were recorded in marketing and administrative expenses.

Actual and pro forma impact of acquisition

The following table presents information for Gambro that has been included in Baxter’s consolidated statements of income from the acquisition date through December 31, 2013.

 

(in millions)    Gambro’s operations
included in Baxter’s results
 

Net sales

     $513   

Net loss

     $ (45

 

 

 

 

The net loss included the impact of fair value adjustments to acquisition-date inventory that was sold in 2013 (approximately $62 million on a pre-tax basis).

The following table presents supplemental pro forma information for the years ended December 31, 2013 and 2012 as if the acquisition of Gambro had occurred on January 1, 2012.

 

     Unaudited Pro Forma Consolidated Results  
     Years ended December 31,  
(in millions, except per share information)          2013            2012  

Net sales

     $15,996         $15,513   

Income from continuing operations

     2,138         1,978   

Basic EPS from continuing operations

     $    3.94         $    3.59   

Diluted EPS from continuing operations

     $    3.89         $    3.56   

 

 

The unaudited pro forma consolidated results were prepared using the acquisition method of accounting and are based on the historical information of Baxter and Gambro. The unaudited pro forma consolidated results are not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2012. In addition, the unaudited pro forma consolidated results are not projections of future results of operations of the combined company nor do they reflect the expected realization of any cost savings or synergies associated with the acquisition.

The unaudited pro forma consolidated results reflect primarily the following pro forma pre-tax adjustments:

 

   

Conversion of Gambro’s historical results of operations from International Financial Reporting Standards (IFRS) to GAAP.

 

   

Elimination of Gambro’s historical intangible asset amortization expense and property, plant and equipment depreciation expense.

 

   

Addition of amortization expense related to the fair value of identifiable intangible assets acquired.

 

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Addition of depreciation expense related to the fair value of property, plant and equipment acquired.

 

   

Elimination of a $62 million charge related to the fair value adjustment of acquisition-date inventory from the year ended December 31, 2013.

 

   

Addition of a $62 million charge related to the fair value adjustment of acquisition-date inventory to the year ended December 31, 2012.

 

   

Elimination of Gambro’s historical interest expense and addition of interest expense associated with debt that was issued in 2013 to partially finance the acquisition.

 

   

Elimination of $244 million of acquisition, integration and currency-related charges from the year ended December 31, 2013 and addition of these costs to the year ended December 31, 2012. These costs were directly attributable to the acquisition and non-recurring in nature, and included acquisition and integration related charges incurred by Baxter, in addition to post-acquisition restructuring costs and losses from foreign currency hedging activity related to the acquisition.

Other Acquisitions

The following table summarizes the fair value of consideration transferred and the assets acquired and liabilities assumed as of the acquisition date for the company’s other significant acquisitions in 2014, 2013 and 2012.

 

     2014        2013      2012  
(in millions)    Chatham      AesRx        Inspiration/Ipsen      Synovis  

Consideration transferred

             

Cash, net of cash acquired

     $  70         $15           $  51         $304   

Contingent payments

     77         65           269           

 

 

Fair value of consideration transferred

     $147         $80           $320         $304   

 

 

Assets acquired and liabilities assumed

             

Other intangible assets

     $  74         $78           $288         $115   

Other assets, net

                       25         25   

 

 

Total identifiable net assets

     $  74         $78           $313         $140   

Goodwill

     73         2           7         164   

 

 

Total assets acquired and liabilities assumed

     $147         $80           $320         $304   

 

 

Pro forma financial information has not been included because these acquisitions, individually and in the aggregate, did not have a material impact on the company’s financial position or results of operations for the years ended December 31, 2014, 2013 and 2012. Additional information regarding the above acquisitions has been provided below.

Chatham Therapeutics, LLC

In May 2012, Baxter entered into an exclusive global license agreement with Chatham Therapeutics, LLC (Chatham Therapeutics) to develop and commercialize potential treatments for hemophilia B utilizing Chatham Therapeutics’ gene therapy technology. Baxter recognized an R&D charge of $30 million related to an upfront payment.

In April 2014, Baxter acquired all of the outstanding membership interests in Chatham Therapeutics, obtaining all gene therapy programs related to the development and commercialization of treatments for hemophilia.

Baxter made an initial payment of $70 million, and may make additional payments of up to $560 million in payments related to the achievement of development, regulatory and first commercial sale milestones, in addition to sales milestones of up to $780 million. The estimated fair value of the contingent payment liabilities at the

 

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acquisition date was $77 million, which was recorded in other long-term liabilities, and was calculated based on the probability of achieving the specified milestones and the discounting of expected future cash flows. As of December 31, 2014, there were no significant changes to these contingent payment liabilities.

Baxter allocated $74 million of the total consideration to acquired IPR&D, which is being accounted for as an indefinite-lived intangible asset, with the residual consideration of $73 million recorded as goodwill. The acquired IPR&D primarily related to Chatham Therapeutics’ hemophilia A (FVIII) program, which was in preclinical stage at the time of the acquisition and is expected to be completed in approximately 10 years. The value of the IPR&D was calculated using cash flow projections adjusted for the inherent technical, regulatory, commercial and obsolescence risks in such activities, discounted at a rate of 12%. Additional R&D will be required prior to obtaining regulatory approval and, as of the acquisition date, incremental R&D costs were projected to be in excess of $130 million. The goodwill, which may be deductible for tax purposes depending on the ultimate resolution of the contingent payment liabilities, includes the value of potential future technologies as well as the overall strategic benefits of the acquisition to Baxter in the hemophilia market and is included in the BioScience segment.

AesRx, LLC

In June 2014, Baxter acquired all of the outstanding membership interests in AesRx, LLC (AesRx), obtaining AesRx’s program related to the development and commercialization of treatments for sickle cell disease.

Baxter made an initial payment of $15 million, and may make additional payments of up to $278 million related to the achievement of development and regulatory milestones, in addition to sales milestones of up to $550 million. The estimated fair value of the contingent payment liabilities at the acquisition date was $65 million, which was recorded in other long-term liabilities, and was calculated based on the probability of achieving the specified milestones and the discounting of expected future cash flows. As of December 31, 2014, there were no significant changes to these contingent payment liabilities.

Baxter allocated $78 million of the total consideration to acquired IPR&D, which is being accounted for as indefinite-lived intangible assets, with the residual consideration of $2 million recorded as goodwill. The acquired IPR&D related to AesRx’s sickle cell disease program, which was in Phase II clinical trials at the time of the acquisition, and was expected to be completed in approximately five years. The value of IPR&D was calculated using cash flow projections adjusted for the inherent technical, regulatory, commercial and obsolescence risks in such activities, discounted at a rate of 15.5%. Additional R&D will be required prior to obtaining regulatory approval and, as of the acquisition date, incremental R&D costs were projected to be in excess of $40 million.

Inspiration / Ipsen

In March 2013, Baxter acquired the investigational hemophilia compound OBIZUR and related assets from Inspiration BioPharmaceuticals, Inc. (Inspiration), and certain other OBIZUR related assets, including manufacturing operations, were acquired from Ipsen Pharma S.A.S. (Ipsen) in conjunction with Inspiration’s bankruptcy proceedings. Ipsen was Inspiration’s senior secured creditor and had been providing Inspiration with debtor-in-possession financing to fund Inspiration’s operations and the sales process. Additionally, Ipsen was the owner of certain assets acquired by Baxter in the transaction.

OBIZUR is a recombinant porcine factor VIII that was approved in the United States in 2014 for the treatment of patients with acquired hemophilia A, and is being investigated for the treatment of congenital hemophilia A patients with inhibitors.

In March 2013, Baxter made an upfront payment of $51 million for OBIZUR and the related assets, and, as of the acquisition date, may make future payments of up to $135 million related to the achievement of regulatory and sales milestones. Additionally, Baxter may make sales-based payments. The estimated fair value of contingent

 

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payment liabilities at the acquisition date was $269 million, which was recorded in other long-term liabilities, and was calculated based on the probability of achieving the specified milestones and sales-based payments and the discounting of expected future cash flows. As of December 31, 2014, the estimated fair value of the contingent payments was $386 million. Refer to Note 10 for additional information regarding the Inspiration / Ipsen contingent payment liability.

Goodwill of $7 million principally includes the value associated with the assembled workforce at the acquired manufacturing facility. The goodwill is deductible for tax purposes. Other intangible assets of $288 million related to acquired IPR&D activities, and the total was accounted for as an indefinite-lived intangible asset at the acquisition date.

The results of operations, assets and liabilities from the Inspiration / Ipsen acquisition are included in the BioScience segment, together with the related goodwill.

Synovis Life Technologies, Inc.

In February 2012, the company acquired Synovis Life Technologies, Inc. (Synovis), a publicly-traded company which developed, manufactured and marketed biological and mechanical products for soft tissue repair used in a variety of surgical procedures.

Goodwill of $164 million includes expected synergies and other benefits the company believes will result from the acquisition, including an expanded product portfolio and the impact of a larger sales force to support surgeons across a range of procedures. The goodwill is not deductible for tax purposes. Other intangible assets of $115 million related to developed technology and are being amortized on a straight-line basis over an estimated average useful life of 12 years.

The results of operations, assets and liabilities of Synovis are included in the BioScience segment, together with the related goodwill.

Collaborations

Merrimack Pharmaceuticals, Inc.

In September 2014, Baxter entered into a license and collaboration agreement with Merrimack Pharmaceuticals, Inc. (Merrimack) relating to the development and commercialization of MM-398 (nanoliposomal irinotecan injection), also known as “nal-IRI.” The arrangement includes all potential indications for MM-398 across all markets with the exception of the United States and Taiwan. The first indication being pursued is for the treatment of patients with metastatic pancreatic cancer who were previously treated with gemcitabine-based therapy. In 2014, Baxter recognized an R&D charge of $100 million related to an upfront payment. Upon entering into the agreement, Baxter had the potential to make future payments of up to $870 million related to the achievement of development, regulatory, and commercial milestones, in addition to royalty payments.

CTI BioPharma Corp.

In November 2013, Baxter acquired approximately 16 million shares of CTI BioPharma Corp. (CTI BioPharma), which was formerly named Cell Therapeutics, Inc., common stock for $27 million. Baxter also entered into an exclusive worldwide licensing agreement with CTI BioPharma, to develop and commercialize pacritinib, a novel investigational JAK2/FLT3 inhibitor with activity against genetic mutations linked to myelofibrosis, leukemia and certain solid tumors. Pacritinib is currently in Phase III development for patients with myelofibrosis, a chronic malignant bone marrow disorder. Under the terms of the agreement, Baxter gained commercialization rights for all indications of pacritinib outside the United States and Baxter and CTI BioPharma will jointly commercialize pacritinib in the United States. CTI BioPharma is responsible for the funding of the majority of development activities as well as the manufacture of the product. In 2013, Baxter recognized an R&D charge of $33 million related to an upfront payment. Upon entering into the agreement, Baxter had the potential to make future payments of up to $302 million related to the achievement of development, regulatory, and commercial milestones, in addition to future royalty payments.

 

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Coherus Biosciences, Inc.

In August 2013, Baxter entered into an exclusive license agreement with Coherus Biosciences, Inc. (Coherus) to develop and commercialize a biosimilar to ENBREL® (etanercept) for Europe, Canada, Brazil and certain other markets. Baxter also has the right of first refusal to certain other biosimilars in the collaboration. Under the terms of the agreement, Coherus is responsible for the development plan, preparation of regulatory filings, and manufacture of the product, subject to certain cost reimbursement by Baxter. In 2013, Baxter recognized R&D charges of $30 million related to its decision to continue to pursue development of etanercept. Upon entering into the agreement, Baxter had the potential to make future payments of up to $169 million relating to the achievement of development and regulatory milestones, in addition to future royalty payments.

JW Holdings Corporation

In July 2013, Baxter entered into a collaboration agreement with JW Holdings Corporation (JW Holdings) for parenteral nutritional products containing a novel formulation of omega 3 lipids. Baxter has exclusive rights to co-develop and distribute the products globally, with the exception of Korea. In 2013, Baxter recognized an R&D charge of $25 million related to an upfront payment. Upon entering into the agreement, Baxter had the potential to make future payments of up to $11 million relating to the achievement of regulatory milestones, in addition to future royalty payments.

Onconova Therapeutics, Inc.

In July 2012, Baxter acquired approximately three million shares of preferred stock in Onconova Therapeutics, Inc. (Onconova) for $50 million. Refer to Note 10 for additional information regarding this investment. In September 2012, Baxter entered into an exclusive license agreement with Onconova for rigosertib, a novel targeted anti-cancer compound for the treatment of a group of rare hematologic malignancies called myelodysplastic syndromes and pancreatic cancer. Baxter gained commercialization rights for the compound in Europe. Onconova is responsible for the funding of the R&D as well as the manufacture of the product. In 2012, Baxter recognized an R&D charge of $50 million related to an upfront payment. Upon entering into the agreement, Baxter had the potential to make future payments of up to $783 million related to the achievement of development, regulatory, and commercial milestones, in addition to future royalty payments.

Momenta Pharmaceuticals, Inc.

In February 2012, the company entered into an exclusive license agreement with Momenta Pharmaceuticals, Inc. (Momenta) to develop and commercialize biosimilars. The arrangement includes specified funding by Baxter, as well as other responsibilities, relating to development and commercialization activities. In 2012, Baxter recognized an R&D charge of $33 million related to an upfront payment. Upon entering into the agreement, Baxter had the potential to make future payments of up to $202 million related to the exercise of options to develop additional products and the achievement of technical, development and regulatory milestones for these products, in addition to future royalty payments and potential profit-sharing payments.

Unfunded Contingent Payments

At December 31, 2014, the company’s unfunded contingent milestone payments associated with all of its collaborative arrangements totaled $2.6 billion. This total excludes any contingent royalty and profit-sharing payments. Based on the company’s projections, any contingent payments made in the future will be more than offset over time by the estimated net future cash flows relating to the rights acquired for those payments.

Payments to Collaboration Partners

Payments to collaboration partners classified in R&D expenses were $270 million, $129 million, and $138 million in 2014, 2013, and 2012, respectively. These payments were comprised of upfront payments of $100 million, $88 million and $108 million in 2014, 2013 and 2012, respectively, and milestone payments of $118 million, $17 million and $6 million in 2014, 2013 and 2012, respectively. The remainder related to R&D cost reimbursements. Payments to collaboration partners classified in cost of sales were not significant in 2014, 2013 and 2012.

 

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NOTE 6

GOODWILL AND OTHER INTANGIBLE ASSETS, NET

 

 

Goodwill

The following is a summary of the activity in goodwill by segment.

 

(in millions)    BioScience    

Medical

Products

    Total  

 

 

December 31, 2012

     $   975      $ 1,527      $ 2,502   

Additions

     7        1,622        1,629   

Currency translation and other adjustments

     9        65        74   

 

 

December 31, 2013

     991        3,214        4,205   

Additions

     75        4        79   

Currency translation and other adjustments

     (39     (371     (410

 

 

December 31, 2014

     $1,027      $ 2,847      $ 3,874   

 

 

Goodwill additions in 2014 and 2013 were primarily related to the acquisitions of Chatham Therapeutics in the BioScience segment and Gambro in the Medical Products segment, respectively.

As of December 31, 2014, there were no accumulated goodwill impairment losses.

Other Intangible Assets, Net

The following is a summary of the company’s other intangible assets.

 

(in millions)   

Developed technology,

including patents

   

Other amortized

intangible assets

   

Indefinite-lived

intangible assets

     Total  

 

 

December 31, 2014

         

Gross other intangible assets

     $2,278        $ 443        $272         $2,993   

Accumulated amortization

     (769     (145             (914

 

 

Other intangible assets, net

     $1,509        $ 298        $272         $2,079   

 

 

December 31, 2013

         

Gross other intangible assets

     $2,144        $ 494        $465         $3,103   

Accumulated amortization

     (665     (144             (809

 

 

Other intangible assets, net

     $1,479        $ 350        $465         $2,294   

 

 

Intangible asset amortization expense was $185 million in 2014, $129 million in 2013 and $101 million in 2012. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2014 is $193 million in 2015, $189 million in 2016, $173 million in 2017, $168 million in 2018 and $155 million in 2019.

The decrease in indefinite-lived intangible assets and corresponding increase in developed technology was primarily driven by the acquired IPR&D from the Inspiration / Ipsen acquisition obtaining regulatory approval. These intangible assets are being amortized on a straight-line basis over an estimated useful life of approximately 15 years. The decrease in indefinite-lived intangible assets was partially offset by additions related to the acquisitions of Chatham Therapeutics and AesRx. The overall decrease in intangible assets was also driven by currency translation.

 

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NOTE 7

INFUSION PUMP AND BUSINESS OPTIMIZATION CHARGES

 

 

Infusion Pump Charges

The company is undertaking a field corrective action with respect to the SIGMA Spectrum Infusion Pump, which is predominantly sold in the United States. The United States Food and Drug Administration (FDA) categorized the action as a Class 1 recall during the second quarter of 2014 and the company recorded a charge of $93 million related primarily to cash costs associated with remediation efforts. Remediation is expected to include software-related corrections and a replacement pump in a limited number of cases. The company expects to complete remediation by mid-2016. The company utilized $4 million of the cash reserves in the fourth quarter of 2014 and, as of December 31, 2014, the company believes the remaining reserves to be adequate; however, it is possible that substantial additional cash and non-cash charges may be required in future periods based on new information or changes in estimates.

From 2005 through 2011, the company recorded total charges and adjustments of $925 million related to COLLEAGUE and SYNDEO infusion pumps, including $716 million of cash costs and $209 million principally related to asset impairments.

During 2012, the company recorded an adjustment of $37 million in cost of sales to reduce the COLLEAGUE infusion pump reserves as the company substantially completed its recall activities in the United States. The company also refined the original expectations for cash and non-cash activities based on expected usage of the reserves and recorded a $63 million adjustment to increase reserves for cash costs with a corresponding decrease to non-cash reserves, which had no impact on the results of operations. The net impact of these adjustments was an increase in cash reserves of $26 million during 2012. During 2013, the company further refined its expectations for cash and non-cash activities related to COLLEAGUE based on expected usage of the reserves and recorded a $17 million adjustment to decrease reserves for cash costs with a corresponding increase to non-cash reserves, which had no impact on the results of operations. During 2014, the company further refined its expectations and recorded an adjustment of $25 million in cost of sales to reduce the COLLEAGUE infusion pump reserves based on the progress of remediation activities in Canada.

The following table summarizes cash activity in the company’s COLLEAGUE and SYNDEO infusion pump reserves through December 31, 2014.

 

(in millions)       

 

 

Charges and adjustments in 2005 through 2011

   $ 716   

Utilization in 2005 through 2011

     (440

 

 

Reserves at December 31, 2011

     276   

Reserve adjustments

     26   

Utilization

     (175

 

 

Reserves at December 31, 2012

     127   

Reserve adjustments

     (17

Utilization

     (27

 

 

Reserves at December 31, 2013

     83   

Reserve adjustments

     (25

Utilization

     (36

 

 

Reserves at December 31, 2014

   $ 22   

 

 

The reserve for remediation activities in the United States has been substantially utilized, with remaining reserves related to remediation activities outside of the United States continuing to be utilized through 2015.

 

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As of December 31, 2014, the company believes the remaining infusion pump reserves for COLLEAGUE and SYNDEO to be adequate; however, additional adjustments may be recorded in the future as the programs are completed.

Business Optimization Charges

From 2009 through 2011, the company recorded total charges of $528 million (of which $13 million are classified as discontinued operations) primarily related to costs associated with optimizing the company’s overall cost structure on a global basis, as the company streamlined its international operations, rationalized its manufacturing facilities, enhanced its general and administrative infrastructure and re-aligned certain R&D activities. The total charges included cash costs of $409 million, principally pertaining to severance and other employee-related costs, and $119 million of asset impairments relating to fixed assets, inventory and other assets associated with discontinued products and projects.

The company’s total charges in 2014, 2013, and 2012 are presented below.

 

years ended December 31 (in millions)    2014     2013     2012  

 

 

Cash expenses

     $87      $ 182      $ 98   

Non-cash expenses

     4        132        52   

Reserve adjustments

     (64     (20       

 

 

Total business optimization expenses

     27        294        150   

 

 

Discontinued operations

     (8     (101       

 

 

Business optimization expenses in continuing operations

     $19      $ 193      $ 150   

 

 

The 2014 charges primarily included severance and other employee-related costs associated with the formation of a new R&D center in Cambridge, Massachusetts as well as Gambro post-acquisition restructuring activities. The 2013 charges included severance, other employee-related costs, and asset impairments associated with the discontinuation of certain R&D programs related to the Vaccines franchise, in addition to Gambro post-acquisition restructuring activities. In 2014 and 2013, the company refined its expectations and recorded adjustments to previous business optimization reserves that are no longer probable of being utilized. The 2012 charges included severance, other employee-related costs, and asset impairments primarily in Europe and the United States.

The business optimization charges are recorded as follows in the consolidated statements of income:

 

   

2014: ($8 million) in cost of sales, $2 million in marketing and administrative expenses, and $25 million in R&D expenses (with an additional $8 million recorded in discontinued operations)

 

   

2013: $52 million in cost of sales, $95 million in marketing and administrative expenses, and $46 million in R&D expenses (with an additional $101 million recorded in discontinued operations)

 

   

2012: $62 million in cost of sales, $60 million in marketing and administrative expenses, and $28 million in R&D expenses

 

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The following table summarizes cash activity in the reserves related to the company’s business optimization initiatives.

 

(in millions)       

 

 

Charges and adjustments in 2009 through 2011

   $ 409   

Utilization in 2009 through 2011

     (183

CTA

     (1

 

 

Reserve at December 31, 2011

     225   

2012 charges

     98   

Utilization in 2012

     (99

CTA

     (4

 

 

Reserve at December 31, 2012

     220   

2013 charges

     182   

Reserve adjustments

     (20

Utilization in 2013

     (98

CTA

     4   

 

 

Reserve at December 31, 2013

     288   

2014 charges

     87   

Reserve adjustments

     (62

Utilization in 2014

     (125

CTA

     (19

 

 

Reserve at December 31, 2014

   $ 169   

 

 

The reserves are expected to be substantially utilized by the end of 2016. The company believes the remaining reserves to be adequate; however, additional adjustments may be recorded in the future as the programs are completed.

 

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NOTE 8

DEBT, CREDIT FACILITIES AND LEASE COMMITMENTS

 

 

Debt Outstanding

At December 31, 2014 and 2013, the company had the following debt outstanding.

 

as of December 31 (in millions)        2014     2013  

 

 

Commercial paper

       $   875      $   

Other short-term debt

       38        181   

 

 

Short-term debt

       $   913      $ 181   

 

 
as of December 31 (in millions)   Effective interest
rate in 20141
   20142     20132  

 

 

4.0% notes due 2014

  4.1%             351   

Floating rate notes due 2014

  0.6%             500   

Variable-rate loan due 2015

  0.8%      171        194   

4.625% notes due 2015

  4.7%      604        625   

5.9% notes due 2016

  6.0%      614        622   

0.95% notes due 2016

  1.1%      500        500   

1.85% notes due 2017

  2.0%      500        500   

Variable-rate loan due 2017

  1.0%      120        136   

5.375% notes due 2018

  5.5%      500        499   

1.85% notes due 2018

  2.0%      750        750   

4.5% notes due 2019

  4.6%      535        534   

4.25% notes due 2020

  4.4%      299        299   

2.40% notes due 2022

  2.5%      723        684   

3.2% notes due 2023

  3.3%      1,275        1,246   

6.625% debentures due 2028

  6.7%      132        133   

6.25% notes due 2037

  6.3%      499        499   

3.65% notes due 2042

  3.7%      298        298   

4.5% notes due 2043

  4.5%      500        500   

Other

       372        115   

 

 

Total debt and capital lease obligations

       8,392        8,985   

Current portion

       (786     (859

 

 

Long-term portion

       $7,606      $ 8,126   

 

 

 

1 

Excludes the effect of any related interest rate swaps.

2 

Book values include any discounts, premiums and adjustments related to hedging instruments.

Significant Debt Issuances

In June 2013, the company issued $500 million of floating rate senior notes maturing in December 2014, $500 million of senior notes bearing a coupon rate of 0.95% and maturing in June 2016, $750 million of senior notes bearing a coupon rate of 1.85% and maturing in June 2018, $1.25 billion of senior notes bearing a coupon rate of 3.2% and maturing in June 2023, and $500 million of senior notes bearing a coupon rate of 4.5% and maturing in June 2043. Approximately $3.0 billion of the net proceeds from the June 2013 debt issuances was used to finance the acquisition of Gambro in 2013 and the remainder was used for general corporate purposes, including the repayment of commercial paper.

Commercial Paper

During 2014, the company issued and redeemed commercial paper, and there was $875 million outstanding at December 31, 2014 with a weighted-average interest rate of 0.456%. There was no commercial paper outstanding at December 31, 2013.

 

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Credit Facilities

The company’s primary revolving credit facility has a maximum capacity of $1.5 billion and matures in December 2015. In 2014, the company entered into an additional revolving credit facility with a maximum capacity of $1.8 billion which also matures in December 2015 and contains similar covenants as the primary revolving credit facility. The company also maintains a Euro-denominated revolving credit facility with a maximum capacity of approximately $375 million as of December 31, 2014 and matures in December 2015. As of December 31, 2014 there were no borrowings outstanding under any of these revolving credit facilities. As of December 31, 2013, there was approximately $124 million outstanding under the Euro-denominated facility and there were no outstanding borrowings under the primary revolving credit facility. The company’s facilities enable the company to borrow funds on an unsecured basis at variable interest rates, and contain various covenants, including a maximum net-debt-to-capital ratio. At December 31, 2014, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting any of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment.

The company also maintains other credit arrangements, which totaled $329 million at December 31, 2014 and $587 million at December 31, 2013. Borrowings outstanding under these facilities totaled $38 million at December 31, 2014 and $181million at December 31, 2013.

Leases

The company leases certain facilities and equipment under capital and operating leases expiring at various dates. The leases generally provide for the company to pay taxes, maintenance, insurance and certain other operating costs of the leased property. Most of the operating leases contain renewal options. Operating lease rent expense was $250 million in 2014, $214 million in 2013 and $202 million in 2012.

Future Minimum Lease Payments and Debt Maturities

 

as of and for the years ended December 31 (in millions)    Operating
leases
   Debt maturities
and capital
leases
 

2015

   $   222      $   786   

2016

   187      1,142   

2017

   163      644   

2018

   130      1,275   

2019

   113      525   

Thereafter

   232      4,097   

 

 

Total obligations and commitments

   1,047      8,469   

Interest on capital leases, discounts and premiums, and adjustments relating to hedging instruments

        (77

 

 

Total debt and lease obligations

   $1,047      $8,392   
   

NOTE 9

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

 

 

Foreign Currency and Interest Rate Risk Management

The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs.

 

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The company is primarily exposed to foreign exchange risk with respect to recognized assets and liabilities, forecasted transactions and net assets denominated in the Euro, Japanese Yen, British Pound, Australian Dollar, Canadian Dollar, Brazilian Real, Colombian Peso and Swedish Krona. The company manages its foreign currency exposures on a consolidated basis, which allows the company to net exposures and take advantage of any natural offsets. In addition, the company uses derivative and nonderivative instruments to further reduce the net exposure to foreign exchange. Gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and equity volatility resulting from foreign exchange. Financial market and currency volatility may limit the company’s ability to cost-effectively hedge these exposures.

The company is also exposed to the risk that its earnings and cash flows could be adversely impacted by fluctuations in interest rates. The company’s policy is to manage interest costs using a mix of fixed- and floating-rate debt that the company believes is appropriate. To manage this mix in a cost-efficient manner, the company periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount.

The company does not hold any instruments for trading purposes and none of the company’s outstanding derivative instruments contain credit-risk-related contingent features.

Cash Flow Hedges

The company may use options, including collars and purchased options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions and recognized assets and liabilities. The company periodically uses forward-starting interest rate swaps and treasury rate locks to hedge the risk to earnings associated with movements in interest rates relating to anticipated issuances of debt. Certain other firm commitments and forecasted transactions are also periodically hedged. Cash flow hedges primarily related to forecasted intercompany sales denominated in foreign currencies, and anticipated issuances of debt.

The notional amounts of foreign exchange contracts were $917 million and $2.1 billion as of December 31, 2014 and 2013, respectively. As of December 31, 2014, $550 million of interest rate contracts designated as cash flow hedges were outstanding. The company did not have any interest rate contracts designated as cash flow hedges outstanding at December 31, 2013. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions at December 31, 2014 is 12 months.

Fair Value Hedges

The company uses interest rate swaps to convert a portion of its fixed-rate debt into variable-rate debt. These instruments hedge the company’s earnings from changes in the fair value of debt due to fluctuations in the designated benchmark interest rate.

The total notional amount of interest rate contracts designated as fair value hedges was $2.9 billion and $1.2 billion as of December 31, 2014 and 2013, respectively.

Dedesignations

If it is determined that a derivative or nonderivative hedging instrument is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If the company removes the cash flow hedge designation because the hedged forecasted transactions are no longer probable of occurring, any gains or losses are immediately reclassified from AOCI to earnings. Gains or losses relating to terminations of effective cash flow hedges in which the forecasted transactions are still probable of occurring are deferred and recognized consistent with the loss or income recognition of the underlying hedged items.

There were no hedge dedesignations in 2014 resulting from changes in the company’s assessment of the probability that the hedged forecasted transactions would occur. In 2013, the company had $1 billion of interest

 

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rate contracts designated as cash flow hedges that matured or were terminated, resulting in a net gain of $5 million that was deferred in AOCI. In the second quarter of 2013, the company determined that certain forecasted transactions associated with these contracts were no longer probable of occurring and therefore dedesignated the hedge relationship, which, together with ineffectiveness, resulted in the immediate reclassification of a net gain of $11 million from AOCI to net interest expense. The remaining deferred net loss of $6 million from the matured or terminated interest rate contracts is being amortized to net interest expense against the related accrued interest payments.

If the company terminates a fair value hedge, an amount equal to the cumulative fair value adjustment to the hedged items at the date of termination is amortized to earnings over the remaining term of the hedged item. There were no fair value hedges terminated during 2014 and 2013.

Undesignated Derivative Instruments

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

The total notional amount of undesignated derivative instruments was $434 million as of December 31, 2014 and $381 million as of December 31, 2013. In the fourth quarter of 2012 and the first quarter of 2013, the company entered into option contracts with a total notional amount of $3.7 billion to hedge anticipated foreign currency cash outflows associated with the planned acquisition of Gambro. These contracts matured in June 2013, and in the second quarter of 2013, the company entered into undesignated forward contracts with a total notional amount of $1.5 billion also to hedge anticipated foreign currency cash outflows associated with the planned acquisition of Gambro, which matured in 2013.

The company recorded losses of $23 million in 2013 associated with the Gambro-related option and forward contracts.

Gains and Losses on Derivative Instruments

The following tables summarize the gains and losses on the company’s derivative instruments for the years ended December 31, 2014 and 2013.

 

     Gain (loss)
recognized in OCI
     Location of gain (loss) in
income statement
     Gain (loss)
reclassified from
AOCI into income
 
(in millions)        2014         2013             2014         2013  

 

 

Cash flow hedges

            

Interest rate contracts

     $ (1     $26         Net interest expense         $ (1     $10   

Foreign exchange contracts

     1        1         Net sales         1        (1

Foreign exchange contracts

     51        36         Cost of sales         13        32   

 

 

Total

     $51        $63            $13        $41   

 

 

 

     

Location of gain (loss) in

income statement

     Gain (loss)
recognized in income
 
(in millions)           2014          2013  

 

 

Fair value hedges

        

Interest rate contracts

     Net interest expense         $68         $(46

 

 

Undesignated derivative instruments

        

Foreign exchange contracts

     Other expense (income), net         $49         $ 11   

 

 

 

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For the company’s fair value hedges, equal and offsetting losses of $68 million and gains of $46 million were recognized in net interest expense in 2014 and 2013, respectively, as adjustments to the underlying hedged items, fixed-rate debt. Ineffectiveness related to the company’s cash flow and fair value hedges for the year ended December 31, 2014 was not material.

The following table summarizes net-of-tax activity in AOCI, a component of shareholders’ equity, related to the company’s cash flow hedges.

 

as of and for the years ended December 31 (in millions)    2014     2013     2012  

 

 

Accumulated other comprehensive income (loss) balance at beginning of year

   $ 10      $ (5   $ 2   

Gain (loss) in fair value of derivatives during the year

     32        41        (7

Amount reclassified to earnings during the year

     (8     (26       

 

 

Accumulated other comprehensive income (loss) balance at end of year

   $ 34      $ 10      $ (5

 

 

As of December 31, 2014, $28 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, coinc