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BAX > SEC Filings for BAX > Form 10-K on 21-Feb-2014All Recent SEC Filings




Annual Report

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.


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; biosurgery products; and select vaccines.

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 was enhanced in 2013 through the 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 hemodialysis (HHD), continuous renal replacement therapy (CRRT) and additional dialysis services.

Baxter has approximately 61,000 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.

Financial Results

Baxter's 2013 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 leveraging existing opportunities to bring 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 2013 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 $15.3 billion in 2013, an increase of 8% over 2012, with no significant foreign currency impact. The acquisition of Gambro in September 2013 resulted in additional net sales of $513 million, which contributed four percentage points towards total Baxter net sales growth. International sales totaled $8.8 billion, an increase of 8% compared to 2012, including an unfavorable foreign currency impact of one percentage point. Sales in the United States totaled $6.5 billion in 2013, an increase of 7% over 2012.

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Baxter's net income for 2013 totaled $2.0 billion, or $3.66 per diluted share, compared to $2.3 billion, or $4.18 per diluted share, in the prior year. Net income in 2013 included special items which reduced income before income taxes by $744 million and net income by $555 million, or $1.01 per diluted share, as further discussed in the Results of Operations section below. Net income in 2012 included special items which reduced income before income taxes by $334 million and net income by $190 million, or $0.35 per diluted share, as further discussed in the Results of Operations section below.

Baxter's financial results included R&D expenses totaling $1.2 billion in 2013, which reflects the acceleration of R&D spending to drive late-stage development programs through 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, included in R&D expenses in 2013 were upfront and milestone payments of $103 million related to the company's various collaboration arrangements and $73 million related to business optimization charges.

The company's financial position remains strong, with cash flows from operations totaling $3.2 billion in 2013. The company has continued to execute on its disciplined capital allocation framework, which was 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 $1.5 billion in 2013 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 segment. The company's investments in capital expenditures in 2013 were focused on projects that improve the company's cost structure and manufacturing capabilities and 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 2013, the company repurchased 13 million shares of common stock for $913 million, and paid cash dividends to its shareholders totaling $1.0 billion.

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 healthcare model, its 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 with 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, which will serve as a solid foundation for future growth. 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 ensuring the cost effectiveness and improved access to Baxter's products and therapies globally.

Baxter remains committed to meeting patient demands by enhancing its plasma manufacturing footprint. The company completed planned modifications at an existing Los Angeles, California plasma fractionation facility

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during 2013 and continues to invest in a new manufacturing facility in Covington, Georgia. The investments in the facilities in Los Angeles and Covington position Baxter well to meet the growing demand for immunoglobulin and other plasma-based therapies in both the short- and long-term.

Driving Innovation through the R&D Pipeline

R&D innovation and scientific productivity continue to be key strategic priorities for Baxter. Key developments in 2013 included the following:

Product Approvals and Launches

• Approval by the United States Food and Drug Administration (FDA) for Baxter's FEIBA [Anti-Inhibitor Coagulant Complex], the first and only FDA-approved treatment for routine prophylaxis to prevent or reduce the frequency of bleeding episodes in patients with hemophilia A or B who have developed inhibitors.

• FDA approval for RIXUBIS [Coagulation Factor IX (Recombinant)] for routine prophylactic treatment, control of bleeding episodes, and perioperative management in adults with hemophilia B.

• Marketing authorization received by the European Commission for the use of HyQvia (solution for subcutaneous use) as replacement therapy for adult patients with primary and secondary immunodeficiencies.

• Completion of CE marking in Europe for the VIVIA HD system, designed to deliver more frequent, extended duration, short daily or nocturnal home HD therapy, known as High Dose HD therapy.

• Launch of HEMOPATCH Sealing Hemostat, a novel collagen-based hemostatic device, following CE mark approval in Europe.

• FDA clearance and Health Canada approval for ONE-LINK Needle-Free IV Connectors featuring bonded and standard bore extension sets for use with low pressure power injectors.

Other Developments

• Authorization by the European Medicines Agency for an update to the Summary of Product Characteristics for Baxter's ADVATE [Antihemophilic Factor (Recombinant) Plasma/Albumin Free Method, (in the European Union, ADVATE, octocog alfa)] to include findings of the Phase IV prophylaxis study.

• Submission of a biologics license application (BLA) to FDA for the approval of OBI-1, a recombinant antihemophilic porcine sequence factor VIII, for use by patients with acquired hemophilia A.

• Completion of enrollment in Phase III clinical trial of BAX 855, an investigational extended half-life, recombinant factor VIII (rFVIII) treatment for hemophilia A. The ongoing trial is aimed at assessing the efficacy of the compound in reducing annual bleed rates in both prophylaxis and on-demand treatment schedules, and will also evaluate its safety and pharmacokinetic profile.

• Initiation of global Phase III study of BAX 817, a recombinant factor VIIa to treat severe bleeding in hemophilia A or B patients with inhibitors to factor VIII or factor IX.

Enhancing Growth with Acquisitions and Collaborations

Acquisition of Gambro

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

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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.

The acquisition of Gambro enhances Baxter's global leadership in renal therapies and provides a number of longer-term opportunities and significant cost synergies.

Other Acquisitions and Collaboration Arrangements

Baxter has accelerated its pace of acquisitions and collaborations in recent years. Key developments in 2013 included the following:

• The acquisition of the investigational hemophilia compound OBI-1 and related assets from Inspiration BioPharmaceuticals, Inc. (Inspiration), as well as certain other OBI-1 related assets, including manufacturing operations, from Ipsen Pharma S.A.S. (Ipsen) in conjunction with Inspiration's bankruptcy proceedings.

• The execution of a global licensing agreement with Cell Therapeutics, Inc. (Cell Therapeutics) to develop and commercialize pacritinib, a novel investigational JAK2/FLT3 inhibitor with activity against genetic mutations linked to myelofibrosis, leukemia and certain solid tumors.

• The execution of an exclusive collaboration agreement with Coherus Biosciences, Inc. (Coherus) to develop and commercialize a biosimilar to etanercept for Europe, Canada, Brazil and certain other markets. Baxter may select additional products in the collaboration.

• The execution of an exclusive collaboration agreement with JW Holdings Corporation (JW Holdings) for parenteral nutrition products containing a novel formulation of omega 3 lipids, which provides Baxter with exclusive rights to co-develop and distribute the products globally (with the exception of Korea).

During 2013, Baxter accelerated its 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 by fully capitalizing on Baxter's diversified healthcare model 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 2013, Baxter made advances in its existing public-private partnerships primarily through the exclusive 20-year partnership with Hemobrαs to provide hemophilia patients in Brazil greater access to rFVIII therapy for the treatment of hemophilia A. Baxter recently became Brazil's exclusive provider of rFVIII and will facilitate a technology transfer to support local manufacturing capacity and technical expertise. During 2013, Baxter commenced shipments of recombinant factor VIII therapy for treatment of hemophilia. Baxter expects peak annual sales related to this partnership to reach $200 million by 2017.

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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 a 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. 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.

Baxter's priorities also include sound environmental stewardship. Throughout 2013 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 and modes of product 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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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 operations for 2013,
2012, and 2011.

years ended December 31 (in millions)                   2013              2012              2011
Gross Margin
Gambro acquisition and integration items          $      (62 )      $        -        $        -
Currency-related items                                    (1 )               -                 -
Product-related items                                    (17 )               -                 -
Business optimization charges (including
certain asset impairments)                              (125 )             (62 )             (95 )
COLLEAGUE infusion pump items                              -                23                 -
Business development charges                               -                (6 )               -
Total Special Items                               $     (205 )      $      (45 )      $      (95 )

Impact on Gross Margin Ratio                        (1.3 pts )        (0.3 pts )        (0.7 pts )

Marketing and Administrative Expenses
Gambro acquisition and integration items          $      115        $        -        $        -
Tax and legal reserves                                   124                 -                 -
Business optimization charges (including
certain asset impairments)                                82                60                97
Business development charges                               -                 9                 -
Pension-related items                                      -               170                 -
AWP litigation and historical rebate and
discount items                                             -                 -                79
Asset impairment and other charges                         -                 -                41

Total Special Items                               $      321        $      239        $      217

Impact on Marketing and Administrative
Expense Ratio                                        2.1 pts           1.7 pts           1.6 pts

Research and Development Expenses
Business optimization charges (including
certain asset impairments)                        $       73        $       28        $        -
Business development charges                             103               113                 -

Total Special Items                               $      176        $      141        $        -

Other (Income) Expense, Net
Gambro acquisition and integration items          $       15        $        -        $        -
Currency-related items                                    62                 -                 -
Tax and legal reserves                                   (35 )               -                 -
Gains on the reduction of contingent payment
liabilities                                                -               (91 )               -
Asset impairment and other charges                         -                 -                62

Total Special Items                               $       42        $      (91 )      $       62

Income Tax Expense
Impact of special items                           $     (189 )      $     (144 )      $     (127 )

Total Special Items                               $     (189 )      $     (144 )      $     (127 )

Impact on Effective Tax Rate                        (0.9 pts )        (2.4 pts )        (1.7 pts )

Special items are identified above because they are highly variable, difficult to predict, and of a size that may substantially impact the company's reported operations for a period. Management believes that providing the separate impact of the above items on the company's 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. Upfront and milestone payments related to

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collaborative arrangements 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 excluded as special items.

In 2013, the company recorded pre-tax charges of $192 million associated with the acquisition and integration of Gambro and business development charges of $103 million related to upfront and milestone payments for collaboration agreements. Additionally, Baxter recorded pre-tax currency-related charges totaling $63 million in 2013 principally related to derivative instruments used to hedge the anticipated foreign currency cash outflows for the Gambro acquisition and the Venezuelan currency devaluation announced by the government of Venezuela in February 2013. In 2013, the company also recorded pre-tax 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.

Marketing and administrative expenses in 2013 included charges totaling $124 million related to tax and legal reserves associated with VAT matters in Turkey and existing class-action and other related litigation, including litigation fees. Income tax expense in 2013 included a net benefit of $6 million related to uncertain tax positions in Switzerland and Turkey. Other (income) expense, net in 2013 included the offsetting impact of $35 million in noncontrolling interest for the VAT and tax items above associated with the company's non-wholly owned joint venture in Turkey.

In 2013, 2012 and 2011, the company's results were impacted by costs associated with the company's execution of certain strategies to optimize its organizational structure, as the company implemented actions to optimize its 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 pre-tax business optimization charges of $280 million, $150 million, and $192 million in 2013, 2012, and 2011, respectively, which impacted cost of sales, marketing and administrative expenses and, in 2012 and 2013, R&D expenses. The 2013 business optimization charge also included a benefit of $20 million related to an adjustment to a business optimization reserve recorded in a prior period. Refer to Note 6 for further information regarding these charges.

In 2012, the company recognized a net benefit of $23 million in cost of sales 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 6 for further information regarding the COLLEAGUE infusion pump charge and related reserve adjustment.

In 2012, the company also recorded pre-tax charges of $170 million primarily related to pension settlement charges and other pension-related items, and business development charges of $128 million principally related to upfront payments for collaboration agreements. Also included in 2012 results were gains of $91 million related to the reduction of certain contingent payment liabilities. Refer to Note 12 for further information regarding the pension settlement charges, Note 4 for further information regarding the business development charges, and Note 9 for further information regarding the gains from reductions of contingent payment liabilities.

In 2011, the company also recorded pre-tax charges of $79 million related to the resolution of litigation pertaining to average wholesale prices (AWP) and certain historical rebate and discount adjustments, $62 million in asset impairments primarily related to the write-down of Greek government bonds, and $41 million principally related to a contribution to the Baxter International Foundation.

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Net Sales

                                                                                              Percent change
                                                                                    At actual               At constant
                                                                                 currency rates            currency rates
years ended December 31 (in millions)       2013         2012         2011        2013        2012          2013        2012

BioScience                              $  6,564     $  6,237     $  6,053          5%          3%            6%          6%
Medical Products                           8,695        7,953        7,840          9%          1%           10%          4%

Total net sales                         $ 15,259     $ 14,190     $ 13,893          8%          2%            8%          5%

                                                                                              Percent change
                                                                                    At actual               At constant
                                                                                 currency rates            currency rates
years ended December 31 (in millions)       2013         2012         2011        2013        2012          2013        2012

United States                           $  6,451     $  6,056     $  5,709          7%          6%            7%          6%
International                              8,808        8,134        8,184          8%         (1% )          9%          4%

Total net sales                         $ 15,259     $ 14,190     $ 13,893          8%          2%            8%          5%

Foreign currency did not have a significant impact on net sales in 2013 as the weakening of the U.S. Dollar relative to the Euro was offset by the strengthening of the U.S. Dollar relative to the Japanese Yen and certain other currencies. Foreign currency unfavorably impacted net sales by 3 percentage points in 2012 principally due to the strengthening of the U.S. Dollar relative to the Euro. Excluding the impact of foreign currency, total net sales growth was 8% and 5% in 2013 and 2012, respectively, primarily driven by improved sales volumes (demand).

In 2013, the acquisition of Gambro in September 2013 contributed 4 percentage points towards sales growth. In 2012, the acquisitions of Synovis and Baxa contributed 2 percentage points towards sales growth. Additionally, included in net sales in the Medical Products segment were sales of $58 million in 2011 related to the U.S. multi-source generic injectables business, which was . . .

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