10-Q 1 bax-10q_20180930.htm 10-Q bax-10q_20180930.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2018

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

For the transition period from                      to                     

Commission file number 1-4448

 

BAXTER INTERNATIONAL INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

36-0781620

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

One Baxter Parkway, Deerfield, Illinois

 

60015

(Address of principal executive offices)

 

(Zip Code)

 

 

 

224-948-2000

 

 

 

 

(Registrant’s telephone number, including area code)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

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

Large accelerated filer  

 

 

Accelerated filer  

Non-accelerated filer  

 

 

Smaller reporting company  

Emerging growth company  

 

 

 

 

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

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

The number of shares of the registrant’s Common Stock, par value $1.00 per share, outstanding as of October 31, 2018 was 532,140,998 shares.

 

 


BAXTER INTERNATIONAL INC.

FORM 10-Q

For the quarterly period ended September 30, 2018

TABLE OF CONTENTS

 

 

 

 

 

Page Number

PART I.

 

FINANCIAL INFORMATION

  

2

Item 1.

 

Financial Statements (unaudited)

  

2

 

 

Condensed Consolidated Statements of Income

  

2

 

 

Condensed Consolidated Statements of Comprehensive Income

  

3

 

 

Condensed Consolidated Balance Sheets

  

4

 

 

Condensed Consolidated Statements of Cash Flows

  

5

 

 

Notes to Condensed Consolidated Financial Statements

  

6

Item 2.

 

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

  

28

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

  

42

Item 4.

 

Controls and Procedures

 

43

Review by Independent Registered Public Accounting Firm

 

44

Report of Independent Registered Public Accounting Firm

 

45

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

46

Item 1.

 

Legal Proceedings

 

46

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

46

Item 6.

 

Exhibits

 

47

Signature

 

48

 

 

 

 

 


 

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Baxter International Inc.

Condensed Consolidated Statements of Income (unaudited)

(in millions, except per share data)

 

 

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net sales

 

$

2,767

 

 

$

2,707

 

 

$

8,286

 

 

$

7,787

 

Cost of sales

 

 

1,531

 

 

 

1,577

 

 

 

4,697

 

 

 

4,481

 

Gross margin

 

 

1,236

 

 

 

1,130

 

 

 

3,589

 

 

 

3,306

 

Marketing and administrative expenses

 

 

685

 

 

 

680

 

 

 

1,988

 

 

 

1,874

 

Research and development expenses

 

 

166

 

 

 

150

 

 

 

480

 

 

 

432

 

Claris settlement

 

 

 

 

 

 

 

 

(80

)

 

 

 

Operating income

 

 

385

 

 

 

300

 

 

 

1,201

 

 

 

1,000

 

Net interest expense

 

 

11

 

 

 

14

 

 

 

34

 

 

 

41

 

Other (income) expense, net

 

 

(32

)

 

 

(4

)

 

 

(81

)

 

 

35

 

Income from continuing operations before income taxes

 

 

406

 

 

 

290

 

 

 

1,248

 

 

 

924

 

Income tax (benefit) expense

 

 

(138

)

 

 

42

 

 

 

(28

)

 

 

139

 

Income from continuing operations

 

 

544

 

 

 

248

 

 

 

1,276

 

 

 

785

 

Income from discontinued operations, net of tax

 

 

 

 

 

3

 

 

 

 

 

 

3

 

Net income

 

$

544

 

 

$

251

 

 

$

1,276

 

 

$

788

 

Income from continuing operations per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.02

 

 

$

0.46

 

 

$

2.38

 

 

$

1.45

 

Diluted

 

$

1.00

 

 

$

0.45

 

 

$

2.33

 

 

$

1.42

 

Income from discontinued operations per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

 

 

$

 

 

$

 

 

$

 

Diluted

 

$

 

 

$

 

 

$

 

 

$

 

Net income per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.02

 

 

$

0.46

 

 

$

2.38

 

 

$

1.45

 

Diluted

 

$

1.00

 

 

$

0.45

 

 

$

2.33

 

 

$

1.42

 

Weighted-average number of common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

534

 

 

 

545

 

 

 

536

 

 

 

543

 

Diluted

 

 

546

 

 

 

557

 

 

 

548

 

 

 

554

 

 

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

2

 


 

Baxter International Inc.

Condensed Consolidated Statements of Comprehensive Income (unaudited)

(in millions)

 

 

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net income

 

$

544

 

 

$

251

 

 

$

1,276

 

 

$

788

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency translation adjustments, net of tax (benefit) expense of $5 and $21 for the three months ended September 30, 2018 and 2017, respectively, and ($26) and $69 for the nine months ended September 30, 2018 and 2017, respectively

 

 

(50

)

 

 

181

 

 

 

(332

)

 

 

530

 

Pension and other employee benefits, net of tax expense of $9 and $6 for the three months ended September 30, 2018 and 2017, respectively, and $26 and $26 for the nine months ended September 30, 2018 and 2017, respectively

 

 

8

 

 

 

6

 

 

 

89

 

 

 

44

 

Hedging activities, net of tax expense (benefit) of $1 and ($2) for the three months ended September 30, 2018 and 2017, respectively, and $4 and ($7) for the nine months ended September 30, 2018 and 2017, respectively

 

 

2

 

 

 

(6

)

 

 

8

 

 

 

(16

)

Available-for-sale securities, net of tax expense of zero for the three months ended September 30, 2018 and 2017, and zero and $1 for the nine months ended September 30, 2018 and 2017, respectively

 

 

 

 

 

1

 

 

 

 

 

 

4

 

Total other comprehensive (loss) income, net of tax

 

 

(40

)

 

 

182

 

 

 

(235

)

 

 

562

 

Comprehensive income

 

$

504

 

 

$

433

 

 

$

1,041

 

 

$

1,350

 

 

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

3

 


 

Baxter International Inc.

Condensed Consolidated Balance Sheets (unaudited)

(in millions, except shares)

 

 

 

 

September 30,

 

 

December 31,

 

 

 

 

 

2018

 

 

2017

 

Current assets

 

Cash and equivalents

 

$

2,860

 

 

$

3,394

 

 

 

Accounts and other current receivables, net

 

 

1,826

 

 

 

1,793

 

 

 

Inventories

 

 

1,718

 

 

 

1,475

 

 

 

Prepaid expenses and other

 

 

624

 

 

 

601

 

 

 

Total current assets

 

 

7,028

 

 

 

7,263

 

Property, plant and equipment, net

 

 

4,520

 

 

 

4,588

 

Other assets

 

Goodwill

 

 

2,980

 

 

 

3,099

 

 

 

Other intangible assets, net

 

 

1,402

 

 

 

1,374

 

 

 

Other

 

 

917

 

 

 

787

 

 

 

Total other assets

 

 

5,299

 

 

 

5,260

 

Total assets

 

 

 

$

16,847

 

 

$

17,111

 

Current liabilities

 

Current maturities of long-term debt and lease obligations

 

$

3

 

 

$

3

 

 

 

Accounts payable and accrued liabilities

 

 

2,592

 

 

 

2,733

 

 

 

Current income taxes payable

 

 

109

 

 

 

85

 

 

 

Total current liabilities

 

 

2,704

 

 

 

2,821

 

Long-term debt and lease obligations

 

 

3,485

 

 

 

3,509

 

Other long-term liabilities

 

 

1,545

 

 

 

1,665

 

Equity

 

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

   shares, issued 683,494,944 shares in 2018 and 2017

 

 

683

 

 

 

683

 

 

 

Common stock in treasury, at cost, 150,213,621 shares

   in 2018 and 142,017,600 shares in 2017

 

 

(8,639

)

 

 

(7,981

)

 

 

Additional contributed capital

 

 

5,931

 

 

 

5,940

 

 

 

Retained earnings

 

 

15,394

 

 

 

14,483

 

 

 

Accumulated other comprehensive (loss) income

 

 

(4,239

)

 

 

(4,001

)

 

 

Total Baxter shareholders’ equity

 

 

9,130

 

 

 

9,124

 

 

 

Noncontrolling interests

 

 

(17

)

 

 

(8

)

 

 

Total equity

 

 

9,113

 

 

 

9,116

 

Total liabilities and equity

 

$

16,847

 

 

$

17,111

 

 

 

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

4

 


 

Baxter International Inc.

Condensed Consolidated Statements of Cash Flows (unaudited)

(in millions)

 

 

 

 

 

Nine months ended

 

 

 

 

 

September 30,

 

 

 

 

 

2018

 

 

2017

 

Cash flows from operations

 

Net income

 

$

1,276

 

 

$

788

 

 

 

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

 

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net of tax

 

 

 

 

 

(3

)

 

 

Depreciation and amortization

 

 

594

 

 

 

562

 

 

 

Deferred income taxes

 

 

(284

)

 

 

(30

)

 

 

Stock compensation

 

 

87

 

 

 

77

 

 

 

Net periodic pension benefit and OPEB costs

 

 

31

 

 

 

93

 

 

 

Other

 

 

108

 

 

 

69

 

 

 

Changes in balance sheet items

 

 

 

 

 

 

 

 

 

 

Accounts and other current receivables, net

 

 

(16

)

 

 

32

 

 

 

Inventories

 

 

(236

)

 

 

 

 

 

Accounts payable and accrued liabilities

 

 

(51

)

 

 

(36

)

 

 

Business optimization items

 

 

(72

)

 

 

(114

)

 

 

Other

 

 

(96

)

 

 

(95

)

 

 

Cash flows from operations – continuing operations

 

 

1,341

 

 

 

1,343

 

 

 

Cash flows from operations – discontinued operations

 

 

 

 

 

(20

)

 

 

Cash flows from operations

 

 

1,341

 

 

 

1,323

 

Cash flows from investing activities

 

Capital expenditures

 

 

(468

)

 

 

(410

)

 

 

Acquisitions and investments, net of cash acquired

 

 

(255

)

 

 

(680

)

 

 

Divestitures and other investing activities, net

 

 

8

 

 

 

2

 

 

 

Cash flows from investing activities

 

 

(715

)

 

 

(1,088

)

Cash flows from financing activities

 

Issuance of debt

 

 

 

 

 

633

 

 

 

Payments of obligations

 

 

(2

)

 

 

 

 

 

Cash dividends on common stock

 

 

(274

)

 

 

(228

)

 

 

Proceeds from stock issued under employee benefit plans

 

 

232

 

 

 

298

 

 

 

Purchases of treasury stock

 

 

(1,028

)

 

 

(275

)

 

 

Other

 

 

(23

)

 

 

(37

)

 

 

Cash flows from financing activities

 

 

(1,095

)

 

 

391

 

Effect of foreign exchange rate changes on cash and equivalents

 

 

(65

)

 

 

90

 

(Decrease) increase in cash and equivalents

 

 

(534

)

 

 

716

 

Cash and equivalents at beginning of period

 

 

3,394

 

 

 

2,801

 

Cash and equivalents at end of period

 

$

2,860

 

 

$

3,517

 

 

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

5

 


 

Baxter International Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

1. BASIS OF PRESENTATION

The unaudited interim condensed consolidated financial statements of Baxter International Inc. and its subsidiaries (the company or Baxter) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States have been condensed or omitted. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the company’s Current Report on Form 8-K filed with the SEC on August 23, 2018 (2017 Annual Report), which revised and superseded the corresponding sections of the Annual Report on Form 10-K for the year ended December 31, 2017.

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

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

Accounting for Venezuelan Operations

Effective as of the end of the second quarter of 2017, the company no longer met the accounting criteria for control over its business in Venezuela and therefore deconsolidated its Venezuelan operations.  As a result of deconsolidating the Venezuelan operations, the company recorded a pre-tax charge of $33 million in other (income) expense, net in the second quarter of 2017.

Hurricane Maria

In September 2017, Hurricane Maria caused damage to certain of the company’s assets in Puerto Rico and disrupted operations. Insurance, less applicable deductibles and subject to any coverage exclusions, covers the repair or replacement of the company’s assets that suffered loss or damage, and also provides coverage for interruption to its business, including lost profits, and reimbursement for other expenses and costs that have been incurred relating to the damages and losses suffered. In the third quarter of 2017, the company recorded $21 million of pre-tax charges related to damages caused by the hurricane, including $11 million related to the impairment of damaged inventory and fixed assets as well as $10 million of idle facility and other costs. These amounts were recorded as a component of cost of sales in the condensed consolidated statements of income for the three and nine month periods ended September 30, 2017. In the third quarter of 2018, the company recognized $23 million of insurance recoveries related to the previously mentioned asset impairments and idle facility and other costs suffered as a result of the hurricane. This benefit was recorded as a reduction of cost of sales in the condensed consolidated statements of income for the three and nine month periods ended September 30, 2018. At this time, any additional insurance recoveries are not realizable, and accordingly, no additional amounts have been recorded as of September 30, 2018.  

New accounting standards

Recently adopted accounting pronouncements

As of January 1, 2018, the company adopted Accounting Standards Update (ASU) No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which amends ASC 715, Compensation – Retirement Benefits, to require employers that present a measure of operating income in their statements of earnings to include only the service cost component of net periodic postretirement benefit cost in operating expenses. The service cost component of net periodic postretirement benefit cost should be presented in the same operating expense line items as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest costs, expected return on assets, amortization of prior service cost/credit and actuarial gains/losses, and settlement and curtailment effects, are to be included separately and outside of any subtotal of operating income. This guidance impacted the presentation of the company’s condensed consolidated statements of income with no significant impact on net income. The company elected to apply the practical expedient which allows it to reclassify amounts disclosed previously in the retirement and other benefits footnote as the basis for applying retrospective presentation for prior comparative periods. The retrospective impact of adoption for the three and nine months ended September 30, 2017 is shown in the following table.

  

6

 


 

 

 

Three months ended September 30, 2017

 

 

Nine months ended September 30, 2017

 

 

 

As Previously Reported

 

 

Reclassification

 

 

As Reclassified

 

 

As Previously Reported

 

 

Reclassification

 

 

As Reclassified

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

1,579

 

 

$

(2

)

 

$

1,577

 

 

$

4,487

 

 

$

(6

)

 

$

4,481

 

Gross margin

 

 

1,128

 

 

 

2

 

 

 

1,130

 

 

 

3,300

 

 

 

6

 

 

 

3,306

 

Marketing and administrative expenses

 

 

685

 

 

 

(5

)

 

 

680

 

 

 

1,890

 

 

 

(16

)

 

 

1,874

 

Research and development expenses

 

 

151

 

 

 

(1

)

 

 

150

 

 

 

435

 

 

 

(3

)

 

 

432

 

Operating income

 

 

292

 

 

 

8

 

 

 

300

 

 

 

975

 

 

 

25

 

 

 

1,000

 

Other (income) expense, net

 

 

(12

)

 

 

8

 

 

 

(4

)

 

 

10

 

 

 

25

 

 

 

35

 

 

As of January 1, 2018, the company adopted ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory. ASU No. 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. Entities are required to adopt using a modified retrospective approach with a cumulative adjustment to opening retained earnings in the year of adoption for previously unrecognized income tax expense. The company recorded a net negative retained earnings adjustment of approximately $66 million upon adoption of the standard on January 1, 2018 related to the unrecognized income tax effects of asset transfers that occurred prior to adoption. Net income increased $4 million and $11 million, respectively, for the three and nine months ended September 30, 2018 as a result of the adoption of the standard.

As of January 1, 2018, the company adopted ASU No. 2016-01, Financial Instruments: Recognition and Measurement of Financial Assets and Liabilities. The new standard amends certain aspects of accounting and disclosure requirements of financial instruments, including the requirement that equity investments with readily determinable fair values be measured at fair value with changes in fair value recognized in the results of operations. The adoption of this standard did not have a material impact on the company’s condensed consolidated financial statements.

As of January 1, 2018, the company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the existing accounting standards for revenue recognition. ASU No. 2014-09 is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are transferred to customers. The company adopted the standard using the modified retrospective method. The primary impact of the new standard relates to the company’s contract manufacturing operations and software arrangements. Certain contract manufacturing arrangements require revenue recognition over-time in situations in which the company produces products that have no alternative use and the company has an enforceable right to payment for performance completed to date, inclusive of a reasonable profit margin. This results in an acceleration of revenue recognition for certain contractual arrangements as compared to recognition under prior accounting literature. The new guidance also impacts the company’s arrangements subject to previous software revenue recognition guidance, as the company is required to recognize as revenue a significant portion of the contract consideration upon delivery of the software compared to the previous practice of recognizing the contract consideration ratably over time for certain arrangements. The company adopted Topic 606 using the modified retrospective method. The adjustment upon adoption increased the company’s opening balance of retained earnings by approximately $48 million, net of tax, on January 1, 2018. The impact to net sales as a result of the adoption was an increase of $4 million and $8 million, respectively, for the three and nine months ended September 30, 2018.  The impact to cost of sales was an increase of $1 million and $5 million, respectively, for the three and nine months ended September 30, 2018. Refer to Note 2 for further information regarding the company’s revenues.

 

Recently issued accounting standards not yet adopted

 

In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, Leases.  In July 2018, the FASB issued an update to the leasing guidance to allow an additional transition option which would allow companies to adopt the standard as of the beginning of the year of adoption as opposed to the earliest comparative period presented.  Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability on the balance sheet for all leases, other than those that meet the definition of a short-term lease. This ASU is effective for the company beginning January 1, 2019 and the company expects the adoption to materially increase assets and liabilities on the condensed consolidated balance sheet related to those leases classified as operating and not recognized on the condensed consolidated balance sheets under current GAAP.  The company does not anticipate any material change on the condensed consolidated balance sheets related to capital leases under current GAAP or to the condensed consolidated statement of income.  Under the new standard, lessor accounting will be largely unchanged from current GAAP, however disclosures will be expanded.

7

 


 

2. REVENUES

Revenue is recognized when obligations under the terms of a contract with a customer are satisfied; generally this occurs with the transfer of control of the company’s products or services. The company’s global payment terms are typically between 30-90 days. Revenue is measured as the amount of consideration the company expects to receive in exchange for transferring goods or providing services. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the contract. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Some of the company’s contracts have multiple performance obligations. For contracts with multiple performance obligations, the company allocates the contract’s transaction price to each performance obligation using its best estimate of the standalone selling price of each distinct good or service in the contract.

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

To a lesser extent, in all the company’s segments, the company enters into other types of contracts including contract manufacturing arrangements, equipment leases, and certain subscription software and licensing arrangements. The company recognizes revenue for these arrangements over time or at a point in time depending on its evaluation of when the customer obtains control of the promised goods or service. Revenue is recognized over time when the company is creating or enhancing an asset that the customer controls as the asset is created or enhanced or the company’s performance does not create an asset with an alternative use and the company has an enforceable right to payment for performance completed.

On September 30, 2018, the company had $7.9 billion of transaction price allocated to remaining performance obligations related to executed contracts with an original duration of one year or more which are primarily included in the Americas segment. Some contracts in the United States included in this amount may contain index-dependent price increases, which are not known at this time. The company expects to recognize approximately 5% of this amount as revenue in 2018, 20% each in 2019, 2020, 2021, and 2022, and the remaining balance thereafter.

Significant Judgments

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

 

The company’s contracts with customers sometimes include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Judgment is also required to determine the stand-alone selling price for each distinct performance obligation and whether there is a discount to be allocated based on the relative stand-alone selling price of the various products and services.

Contract Balances

The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the condensed consolidated balance sheet. Net trade accounts receivable at September 30, 2018 and January 1, 2018 were $1.8 billion and $1.7 billion, respectively. Generally, for certain contract manufacturing and software arrangements, revenue recognition occurs prior to billing, resulting in contract assets. These assets are reported on the condensed consolidated balance sheet on an individual basis at the end of each reporting period. The contract asset balances at September 30, 2018 and January 1, 2018 were $81 million and $73 million, respectively.  The contract assets as of September 30, 2018 are presented within accounts and other current receivables, net ($54 million) and other ($27 million) on the condensed consolidated balance sheet.  The company had contract assets of $36 million and $31 million as of September 30, 2018 and

8

 


 

January 1, 2018, respectively, related to certain contract manufacturing arrangements for which revenue is recognized throughout the production cycle which typically lasts up to 90 days.  The company had contract assets of $45 million and $42 million as of September 30, 2018 and January 1, 2018, respectively, related to certain software arrangements for which revenue is recognized upon delivery to the customer, however the customer is billed over time, generally between one and five years. The company had no contract liabilities as of September 30, 2018 and January 1, 2018, respectively.

 

Practical Expedients

The company applies a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include the company’s internal sales force compensation programs as the company has determined annual compensation is commensurate with annual sales activities. The company does not disclose the value of transaction price allocated to unsatisfied performance obligations for contracts with an original expected length of one year or less. The company has elected to use the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component if it is expected, at contract inception, that the period between when the company transfers a promised good or service to a customer, and when the customer pays for that good or service, will be one year or less. Additionally, all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected from a customer are excluded from revenue.

3. SEPARATION OF BAXALTA INCORPORATED

On July 1, 2015, Baxter completed the distribution of approximately 80.5% of the outstanding common stock of Baxalta Incorporated (Baxalta) to Baxter shareholders (the Distribution). Baxter and Baxalta entered into several agreements in connection with the July 1, 2015 separation, including a transition services agreement (TSA), separation and distribution agreement, manufacturing and supply agreements (MSA), tax matters agreement, an employee matters agreement, a long-term services agreement, and a shareholder’s and registration rights agreement.  

Pursuant to the TSA, Baxter and Baxalta and their respective subsidiaries were providing to each other, on an interim, transitional basis, various services. Services provided by Baxter included, among others, finance, information technology, human resources, quality supply chain and certain other administrative services. The services generally commenced on the Distribution date and terminated as of July 1, 2018. Billings by Baxter under the TSA were recorded as a reduction of the costs to provide the respective service in the applicable expense category, primarily in marketing and administrative expenses, in the condensed consolidated statements of income. In the nine months ended September 30, 2018, the company recognized approximately $9 million as a reduction to marketing and administrative expenses related to the TSA. In the three and nine months ended September 30, 2017, the company recognized approximately $11 million and $47 million, respectively, as a reduction to marketing and administrative expenses related to the TSA.

Pursuant to the MSA, Baxalta or Baxter, as the case may be, manufactures, labels, and packages products for the other party. The terms of the agreements range in initial duration from five to 10 years. In the three and nine months ended September 30, 2018, Baxter recognized approximately $8 million and $21 million in sales to Baxalta. In the three and nine months ended September 30, 2017, Baxter recognized approximately $6 million and $18 million, respectively, in sales to Baxalta. In addition, in the three and nine months ended September 30, 2018, Baxter recognized $38 million and $111 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. In the three and nine months ended September 30, 2017, Baxter recognized $35 million and $133 million, respectively, in cost of sales related to purchases from Baxalta pursuant to the MSA. The cash flows associated with these agreements are included in cash flows from operations — continuing operations.

Cash outflows of $20 million were reported in cash flows from operations — discontinued operations for the nine-month period ending September 30, 2017. These related to non-assignable tenders whereby Baxter was the seller of Baxalta products, transactions related to importation services Baxter provides in certain countries, in addition to trade payables settled post local separation on Baxalta’s behalf.

9

 


 

4. SUPPLEMENTAL FINANCIAL INFORMATION

 

Net interest expense

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30,

 

 

September 30,

 

(in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Interest expense, net of capitalized interest

 

$

24

 

 

$

22

 

 

$

70

 

 

$

62

 

Interest income

 

 

(13

)

 

 

(8

)

 

 

(36

)

 

 

(21

)

Net interest expense

 

$

11

 

 

$

14

 

 

$

34

 

 

$

41

 

 

Other (income) expense, net

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30,

 

 

September 30,

 

(in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Foreign exchange

 

$

(20

)

 

$

(12

)

 

$

(53

)

 

$

(27

)

Venezuela deconsolidation

 

 

-

 

 

 

-

 

 

 

-

 

 

 

33

 

Pension and other postemployment benefit plans

 

 

(13

)

 

 

8

 

 

 

(39

)

 

 

25

 

All other

 

 

1

 

 

 

-

 

 

 

11

 

 

 

4

 

Other (income) expense, net

 

$

(32

)

 

$

(4

)

 

$

(81

)

 

$

35

 

 

Inventories

 

 

 

September 30,

 

 

December 31,

 

(in millions)

 

2018

 

 

2017

 

Raw materials

 

$

373

 

 

$

347

 

Work in process

 

 

224

 

 

 

116

 

Finished goods

 

 

1,121

 

 

 

1,012

 

Inventories

 

$

1,718

 

 

$

1,475

 

 

Property, plant and equipment, net

 

 

 

September 30,

 

 

December 31,

 

(in millions)

 

2018

 

 

2017

 

Property, plant and equipment, at cost

 

$

10,323

 

 

$

10,148

 

Accumulated depreciation

 

 

(5,803

)

 

 

(5,560

)

Property, plant and equipment, net

 

$

4,520

 

 

$

4,588

 

 

In the first quarter of 2018, the estimated useful life of the company’s enterprise resource planning (ERP) software was extended from 2020 on a prospective basis based on the company’s commitment to upgrade, enhance and support its existing systems through 2028. This change in estimate resulted in a reduction of depreciation expense of $6 million and increase in net income of $5 million, or $0.01 per diluted share, for the three months ended September 30, 2018 and a reduction of depreciation expense of $18 million and increase in net income of $15 million, or $0.03 per diluted share, for the nine months ended September 30, 2018. 

5. 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.

10

 


 

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

 

Three months ended

 

 

Nine months ended

 

 

September 30,

 

 

September 30,

 

(in millions)

2018

 

 

2017

 

 

2018

 

 

2017

 

Basic shares

 

534

 

 

 

545

 

 

 

536

 

 

 

543

 

Effect of dilutive securities

 

12

 

 

 

12

 

 

 

12

 

 

 

11

 

Diluted shares

 

546

 

 

 

557

 

 

 

548

 

 

 

554

 

 

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 3.3 million and 3.1 million equity awards for the three and nine months ended September 30, 2018, respectively, and 0.1 million and 2.8 million equity awards for the three and nine months ended September 30, 2017, respectively, because their inclusion would have had an anti-dilutive effect on diluted EPS.

Stock repurchases

In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of the company’s common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018. During the first three quarters of 2018, the company repurchased 14.9 million shares pursuant to one or more Rule 10b5-1 plans for $1.0 billion in cash. During the first three quarters of 2017, the company repurchased 4.7 million shares for $275 million in cash. The company had $1.6 billion remaining available under the authorization (as amended and after giving effect to stock repurchases) as of September 30, 2018.

Dividends declared

Cash dividends declared per common share for the three and nine months ended September 30, 2018 were $0.19 and $0.54, respectively.  Cash dividends declared per common share for the three and nine months ended September 30, 2017 were $0.16 and $0.45, respectively.

6. ACQUISITIONS AND OTHER ARRANGEMENTS

Claris Injectables Limited

On July 27, 2017, Baxter acquired 100 percent of Claris Injectables Limited (Claris), a wholly owned subsidiary of Claris Lifesciences Limited, for total cash consideration of approximately $629 million, net of cash acquired. Through the acquisition, Baxter added capabilities in production of essential generic injectable medicines, such as anesthesia and analgesics, renal, anti-infectives and critical care in a variety of presentations including bags, vials and ampoules. In the third quarter of 2018, the company finalized its valuation of the acquisition date assets acquired and liabilities assumed. The measurement period adjustments in 2018 include a $2 million reduction in property, plant and equipment, a $1 million increase in accounts payable and accrued liabilities and a $2 million increase in other long-term liabilities. These adjustments resulted in a corresponding increase to goodwill of $5 million. These adjustments did not have a material impact on the company’s results of operations in 2018. The following table summarizes the fair value of the assets acquired and liabilities assumed as of the acquisition date for the company’s acquisition of Claris:

 

(in millions)

 

 

 

 

Assets acquired and liabilities assumed

 

 

 

 

Cash

 

$

11

 

Accounts and other current receivables

 

 

16

 

Inventories

 

 

30

 

Prepaid expenses and other

 

 

16

 

Property, plant and equipment

 

 

130

 

Goodwill

 

 

296

 

Other intangible assets

 

 

280

 

Other

 

 

20

 

Accounts payable and accrued liabilities

 

 

(23

)

Other long-term liabilities

 

 

(136

)

Total assets acquired and liabilities assumed

 

$

640

 

11

 


 

The results of operations of Claris have been included in the company’s condensed consolidated statement of income since the date the business was acquired. The Claris acquisition contributed $38 million and $107 million, respectively, of net sales for the three and nine months ended September 30, 2018, and $27 million of net sales for the three and nine months ended September 30, 2017. Acquisition and integration costs associated with the Claris acquisition were $5 million and $19 million, respectively, for the three and nine months ended September 30, 2018, and $15 million and $20 million, respectively, for the three and nine months ended September 30, 2017, and were primarily included within marketing and administrative expenses and cost of sales on the condensed consolidated statements of income.

Baxter allocated $280 million of the total consideration to acquired intangible assets. The acquired intangible assets include $140 million of developed technology with a weighted-average useful life of eight years and $140 million of in-process research and development (IPR&D) with an indefinite useful life. For the IPR&D, additional R&D will be required to assess technological feasibility.

The fair value of intangible assets was determined using the income approach. The income approach is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life, discounted to present value. The discount rates used to measure the developed technology and IPR&D intangible assets were 12% and 13%, respectively. The company considers the fair value of each of the acquired intangible assets to be Level 3 assets due to the significant estimates and assumptions used by management in establishing the estimated fair values. Refer to Note 10 within the 2017 Annual Report for additional information regarding fair value measurements.

The goodwill, which is not deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits provided to Baxter in the injectables market, and is included primarily in the Americas segment.

In the first quarter of 2018, Baxter and Claris Lifesciences Limited settled certain claims related to the acquired operations and terminated a development agreement with Dorizoe Lifesciences Limited. As a result, Baxter received $73 million in February 2018 and was released from an accrued liability to Claris Lifesciences Limited of $7 million. The total of $80 million is reflected as a benefit in the 2018 condensed consolidated statements of income.

RECOTHROM and PREVELEAK

On March 16, 2018, Baxter acquired two hemostat and sealant products from Mallinckrodt plc: RECOTHROM Thrombin topical (Recombinant), the first and only stand-alone recombinant thrombin, and PREVELEAK Surgical Sealant, which is used in vascular reconstruction. The company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. The purchase price included an upfront payment of approximately $148 million in the first quarter of 2018 and a $15 million post-closing payment in the third quarter of 2018. The company made additional measurement period adjustments, in the third quarter of 2018, which included finalizing the post-closing settlement and adjusting its acquisition-date estimate of the fair value of contingent consideration, acquired inventory and intangible assets. These adjustments resulted in a $10 million increase in the total consideration transferred, a $19 million increase to acquired inventory, a $2 million decrease in other intangible assets and a $7 million decrease in goodwill.  The measurement period adjustments did not have a material impact on the company’s results of operations.

In addition, the purchase price included new and assumed contingent payments in the future related to inventory and technology transfer milestones and net revenue royalty payments with an estimated fair value of $21 million as of the acquisition date.  The maximum aggregate amount payable for the inventory and technology transfer and net revenue royalties was $7 million, $15 million and $143 million, respectively. The fair value of the potential contingent consideration payments was estimated by applying a probability-weighted expected payment model for the inventory and technology transfer payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs. Refer to Note 10 within the 2017 annual report for additional information regarding fair value measurements.

    

The following table summarizes total consideration:

(in millions)

 

 

 

 

Cash

 

$

163

 

Contingent consideration

 

 

21

 

Total consideration

 

$

184

 

 

12

 


 

The following table summarizes the fair value of the assets acquired as of the acquisition date.

 

(in millions)

 

 

 

 

Assets acquired

 

 

 

 

Accounts receivable

 

$

2

 

Inventory

 

 

80

 

Goodwill

 

 

2

 

Other intangible assets

 

 

100

 

Total assets acquired

 

$

184

 

The valuation of the assets acquired are preliminary and measurement period adjustments may be recorded in the future as the company finalizes its fair value estimates. The results of operations of the acquired business have been included in the company’s condensed consolidated statements of income since the date the business was acquired. The RECOTHROM and PREVELEAK acquisitions contributed $14 million and $31 million, respectively, of net sales for the three and nine months ended September 30, 2018.  Acquisition and integration costs associated with the acquisition were $6 million and $11 million, respectively, for the three and nine months ended September 30, 2018.

Baxter allocated $100 million of the total consideration to the RECOTHROM and PREVELEAK developed product rights with a weighted-average useful life of 10 years. The fair value of the intangible assets was determined using the income approach. The discount rates used to measure the RECOTHROM and PREVELEAK intangible assets were 12.5% and 13%, respectively. The company considers the fair value of the intangible assets to be Level 3 assets due to the significant estimates and assumptions used by management in establishing the estimated fair values. Refer to Note 10 within the 2017 annual report for additional information regarding fair value measurements.

The goodwill, which is deductible for tax purposes, includes the value of potential future technologies as well as the overall strategic benefits provided to Baxter’s surgical portfolio of hemostats and sealants, and is included in the Americas segment.

Other

Total consideration transferred for other acquisitions totaled $24 million in 2018 and primarily resulted in the recognition of intangible assets.  These acquisitions did not materially affect the company’s results of operations.

Celerity Pharmaceuticals, LLC

In the first quarter of 2018, Baxter paid approximately $37 million and $35 million, respectively, to acquire the rights to Bivalirudin and Dexmedetomidine from Celerity Pharmaceuticals, LLC (Celerity). The payment for Dexmedetomidine was based on tentative approval from the U.S. Food and Drug Administration (FDA).  Full approval from the FDA was received in the third quarter of 2018. Baxter capitalized the purchase price of both products and is amortizing the assets over their estimated economic lives of 12 years. Refer to Note 5 within the 2017 Annual Report for additional information regarding the company’s agreement with Celerity.

In the third quarter of 2017, Baxter paid approximately $10 million to acquire the rights to Clindamycin Dextrose from Celerity. In the second quarter of 2017, Baxter paid approximately $10 million to acquire the rights to Clindamycin Saline from Celerity. Baxter capitalized the purchase price of both products as intangible assets and is amortizing them asset over their estimated economic lives of 12 years.

7. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following is a reconciliation of goodwill by business segment.

 

(in millions)

 

Americas

 

 

EMEA

 

 

APAC

 

 

Total

 

Balance as of December 31, 2017

 

$

2,474

 

 

$

392

 

 

$

233

 

 

$

3,099

 

Additions

 

 

9

 

 

 

 

 

 

 

 

 

9

 

Currency translation adjustments

 

 

(102

)

 

 

(16

)

 

 

(10

)

 

 

(128

)

Balance as of September 30, 2018

 

$

2,381

 

 

$

376

 

 

$

223

 

 

$

2,980

 

 

As of September 30, 2018, there were no accumulated goodwill impairment losses.

13

 


 

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

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross other intangible assets

 

$

2,123

 

 

$

420

 

 

$

188

 

 

$

2,731

 

Accumulated amortization

 

 

(1,084

)

 

 

(245

)

 

 

 

 

 

 

(1,329

)

Other intangible assets, net

 

$

1,039

 

 

$

175

 

 

$

188

 

 

$

1,402

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross other intangible assets

 

$

2,002

 

 

$

435

 

 

$

172

 

 

$

2,609

 

Accumulated amortization

 

 

(1,010

)

 

 

(225

)

 

 

 

 

 

(1,235

)

Other intangible assets, net

 

$

992

 

 

$

210

 

 

$

172

 

 

$

1,374

 

 

Intangible asset amortization expense was $42 million and $38 million in the three months ended September 30, 2018 and 2017, respectively, and $127 million and $112 million in the nine months ended September 30, 2018 and 2017, respectively.

8. INFUSION PUMP CHARGES

In 2017, the company recorded a charge of $22 million related to a second field corrective action with respect to the SIGMA Spectrum Infusion Pump, which is predominantly sold in the United States. Remediation primarily includes inspection and repair charges as well as a temporary replacement pump in a limited number of cases. The charge includes estimated cash costs associated with remediation efforts and the remaining liability was $4 million as of September 30, 2018.

9. BUSINESS OPTIMIZATION CHARGES

Beginning in the second half of 2015, the company initiated actions to transform its cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing the manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through September 30, 2018, the company has incurred cumulative pretax costs of $751 million related to these actions. The costs consisted primarily of employee termination, implementation costs and accelerated depreciation. The company expects to incur additional pretax costs of approximately $130 million and capital expenditures of $50 million through the completion of these initiatives. The costs will primarily include employee termination costs, implementation costs, and accelerated depreciation.  

During the three and nine months ended September 30, 2018 and 2017, the company recorded the following charges related to business optimization programs.

 

 

 

Three months ended

 

 

Nine months ended

 

 

 

September 30,

 

 

September 30,

 

(in millions)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Restructuring charges, net

 

$

63

 

 

$

31

 

 

$

96

 

 

$