10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF --- THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 ________ 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 (I.R.S. Employer incorporation or organization) Identification No.) One Baxter Parkway, Deerfield, Illinois 60015-4633 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (847) 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 X No --- --- The number of shares of the registrant's Common Stock, par value $1.00 per share, outstanding as of April 25, 2002 was 601,093,841 shares. BAXTER INTERNATIONAL INC. FORM 10-Q For the quarterly period ended March 31, 2002 TABLE OF CONTENTS
Page Number ----------- Part I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Statements of Income ............. 2 Condensed Consolidated Balance Sheets ................... 3 Condensed Consolidated Statements of Cash Flows ......... 4 Notes to Condensed Consolidated Financial Statements .... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................ 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Review by Independent Accountants .................................. 17 Report of Independent Accountants .................................. 18 Part II. OTHER INFORMATION Item 1. Legal Proceedings ......................................... 19 Item 6. Exhibits and Reports on Form 8-K .......................... 22 Signature .......................................................... 23 Exhibits ........................................................... 24
PART I. FINANCIAL INFORMATION Item 1. Financial Statements Baxter International Inc. and Subsidiaries Condensed Consolidated Statements of Income (unaudited) (in millions, except per share data)
Three months ended March 31, 2002 2001 ------------------ Net sales $1,950 $1,757 Costs and expenses Cost of goods sold 1,064 986 Marketing and administrative expenses 400 343 Research and development expenses 115 103 Goodwill amortization -- 12 Interest, net 16 19 Other expense 13 7 -------------------------------------------------------------------------------- Total costs and expenses 1,608 1,470 -------------------------------------------------------------------------------- Income before income taxes and cumulative effect of accounting change 342 287 Income tax expense 89 73 -------------------------------------------------------------------------------- Income before cumulative effect of accounting change 253 214 Cumulative effect of accounting change, net of income tax benefit of $32 -- (52) -------------------------------------------------------------------------------- Net income $253 $162 ================================================================================ Earnings per basic common share Before cumulative effect of accounting change $.42 $.36 Cumulative effect of accounting change -- (.09) -------------------------------------------------------------------------------- Net income $.42 $.27 ================================================================================ Earnings per diluted common share Before cumulative effect of accounting change $.41 $.35 Cumulative effect of accounting change -- (.08) -------------------------------------------------------------------------------- Net income $.41 $.27 ================================================================================ Weighted average number of common shares outstanding Basic 600 590 ================================================================================ Diluted 622 606 ================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements. 2 Baxter International Inc. and Subsidiaries Condensed Consolidated Balance Sheets (in millions, except shares)
--------------------------------------------------------------------------------------------------------------------- March 31, December 31, 2002 2001 (unaudited) ------------------------------------- Current assets Cash and equivalents $522 $582 Accounts receivable 1,619 1,493 Notes and other current receivables 122 129 Inventories 1,462 1,341 Short-term deferred income taxes 40 82 Prepaid expenses 396 350 --------------------------------------------------------------------------------------------------- Total current assets 4,161 3,977 --------------------------------------------------------------------------------------------------------------------- Property, At cost 5,788 5,732 plant and Accumulated depreciation and amortization (2,462) (2,426) equipment --------------------------------------------------------------------------------------------------- Net property, plant and equipment 3,326 3,306 --------------------------------------------------------------------------------------------------------------------- Other assets Goodwill and other intangibles 1,695 1,698 Insurance receivables 82 93 Other 1,353 1,269 --------------------------------------------------------------------------------------------------- Total other assets 3,130 3,060 --------------------------------------------------------------------------------------------------------------------- Total assets $10,617 $10,343 ===================================================================================================================== Current Short-term debt $490 $149 liabilities Current maturities of long-term debt and lease obligations 52 52 Accounts payable and accrued liabilities 2,004 2,432 Income taxes payable 626 661 --------------------------------------------------------------------------------------------------- Total current liabilities 3,172 3,294 --------------------------------------------------------------------------------------------------------------------- Long-term debt and lease obligations 2,677 2,486 --------------------------------------------------------------------------------------------------------------------- Long-term deferred income taxes 201 218 --------------------------------------------------------------------------------------------------------------------- Long-term litigation liabilities 131 140 --------------------------------------------------------------------------------------------------------------------- Other long-term liabilities 496 448 --------------------------------------------------------------------------------------------------------------------- Commitments and contingencies --------------------------------------------------------------------------------------------------------------------- Stockholders' Common stock, $1 par value, authorized 1,000,000,000 equity shares, issued 608,817,449 shares in 2002 and 608,817,449 shares in 2001 609 609 Common stock in treasury, at cost, 7,943,249 shares in 2002 and 9,924,459 shares in 2001 (271) (328) Additional contributed capital 2,813 2,815 Retained earnings 1,346 1,093 Accumulated other comprehensive loss (557) (432) --------------------------------------------------------------------------------------------------- Total stockholders' equity 3,940 3,757 --------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $10,617 $10,343 =====================================================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 Baxter International Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows (unaudited) (in millions)
--------------------------------------------------------------------------------------------------------------------- Three months ended March 31, (brackets denote cash outflows) 2002 2001 ---------------------------- Cash flows Income before cumulative effect of non-cash from accounting change $253 $214 operations Adjustments Depreciation and amortization 105 108 Deferred income taxes 34 80 Other (16) 15 Changes in balance sheet items Accounts receivable (181) (11) Inventories (128) (100) Accounts payable and other accrued liabilities (124) (256) Net litigation payable and other (43) (83) --------------------------------------------------------------------------------------------------- Cash flows from operations (100) (33) --------------------------------------------------------------------------------------------------------------------- Cash flows Capital expenditures (139) (131) from investing Acquisitions (net of cash received) activities and investments in affiliates (49) (49) Divestitures and other asset dispositions -- 19 --------------------------------------------------------------------------------------------------- Cash flows from investing activities (188) (161) --------------------------------------------------------------------------------------------------------------------- Cash flows Issuances of debt and lease obligations 53 767 from financing Redemptions of debt and lease obligations (285) (168) activities Increase in debt with maturities of three months or less, net 749 32 Common stock cash dividends (348) (340) Stock issued under employee benefit plans 91 64 Purchases of treasury stock (35) -- --------------------------------------------------------------------------------------------------- Cash flows from financing activities 225 355 --------------------------------------------------------------------------------------------------------------------- Effect of currency exchange rate changes on cash and equivalents 3 (17) --------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and equivalents (60) 144 Cash and equivalents at beginning of period 582 579 --------------------------------------------------------------------------------------------------------------------- Cash and equivalents at end of period $522 $723 =====================================================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Baxter International Inc. and Subsidiaries Notes to Condensed Consolidated Financial Statements (unaudited) 1. FINANCIAL INFORMATION 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. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP) have been condensed or omitted. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the company's 2001 Annual Report to Stockholders. In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation 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. Comprehensive income Total comprehensive income was $128 million and $340 million for the three months ended March 31, 2002 and 2001, respectively. The decline in comprehensive income in the quarter was principally related to unfavorable foreign currency fluctuations, partially offset by increased net income. Allowance for doubtful accounts In the normal course of business, the company provides credit to customers in the health-care industry, performs credit evaluations of these customers and maintains reserves for potential credit losses. In determining the amount of the allowance for doubtful accounts, management 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 past due status of a receivable is based on its contractual terms. Receivables are written off when management determines they are uncollectible. Credit losses, when realized, have been within the range of management's allowance for doubtful accounts. 2. CHANGE IN ACCOUNTING PRINCIPLE IN 2001 Effective at the beginning of 2001, the company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," and its amendments. In accordance with the transition provisions of SFAS No. 133, upon adoption the company recorded a cumulative effect after-tax reduction to earnings of $52 million and a cumulative effect after-tax increase to other comprehensive income of $8 million. 5 3. INVENTORIES Inventories consisted of the following.
------------------------------------------------------------------------------- March 31, December 31, (in millions) 2002 2001 ------------------------------------------------------------------------------- Raw materials $387 $353 Work in process 287 244 Finished products 788 744 ------------------------------------------------------------------------------- Total inventories $1,462 $1,341 ===============================================================================
4. INTEREST, NET Net interest expense consisted of the following.
------------------------------------------------------------------------------- Three months ended March 31, (in millions) 2002 2001 ------------------------------------------------------------------------------- Interest expense $18 $28 Interest income (2) (9) ------------------------------------------------------------------------------- Interest expense, net $16 $19 ===============================================================================
5. STOCK SPLIT On February 27, 2001, Baxter's board of directors approved a two-for-one stock split of the company's common shares. On May 1, 2001, the split was approved by the company's shareholders. On May 30, 2001, shareholders of record on May 9, 2001 received one additional share of Baxter common stock for each share held on May 9, 2001. All share and per share data in the condensed consolidated financial statements and notes have been adjusted and restated to reflect the stock split. 6. EARNINGS PER SHARE The numerator for both basic and diluted earnings per share (EPS) is net earnings available to common shareholders. The denominator for basic EPS is the weighted-average number of common shares outstanding during the period. The following is a reconciliation of the shares (denominator) of the basic and diluted per-share computations.
------------------------------------------------------------------------------- Three months ended March 31, (in millions) 2002 2001 ------------------------------------------------------------------------------- Basic EPS shares 600 590 ------------------------------------------------------------------------------- Effect of dilutive securities Employee stock options 21 15 Employee stock purchase plans and equity forward agreements 1 1 ------------------------------------------------------------------------------- Diluted EPS shares 622 606 ===============================================================================
6 7. ACQUISITIONS AND INTANGIBLE ASSETS Adoption of new accounting standards SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," were issued in July 2001. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. The amortization provisions of SFAS No. 142, including nonamortization of goodwill, apply to goodwill and intangible assets acquired after June 30, 2001. With the adoption of SFAS No. 142 in its entirety on January 1, 2002, all of the company's goodwill is no longer being amortized, but is subject to periodic impairment reviews, beginning on January 1, 2002. In performing the reviews, potential impairment is to be identified by comparing the fair value of a reporting unit with its carrying amount, and if the fair value is less than the carrying amount, an impairment loss is recorded as the excess of the carrying amount of the goodwill over its implied fair value. The implied fair value is determined by allocating the fair value of the entire unit to all of its assets and liabilities, with any excess of fair value over the amount allocated representing the implied fair value of that unit's goodwill. The company's reporting units are the same as its reportable operating segments, and are referred to as Medication Delivery, BioScience and Renal. While the company is still in the process of performing the initial goodwill impairment review by reporting unit as of January 1, 2002, it is management's preliminary assessment that a goodwill impairment charge will not be recorded as of the date of adoption. Goodwill The carrying amount of goodwill as of March 31, 2002 was $646 million, $488 million and $210 million for Medication Delivery, BioScience and Renal, respectively. The change in goodwill during the three months ended March 31, 2002 was not significant. There was no impairment of goodwill during the quarter. Other intangible assets Intangible assets other than goodwill are separated into two categories. Intangible assets with finite useful lives are recorded on the condensed consolidated balance sheet and amortized over the estimated useful life of the asset. Intangible assets with indefinite useful lives are recorded on the condensed consolidated balance sheet, are not amortized, and are subject to periodic impairment tests. The amount of intangible assets with indefinite lives is immaterial. The following is a summary of the company's intangible assets subject to amortization at March 31, 2002.
---------------------------------------------------------------------------------------------- As of March 31, 2002 --------------------------------------------- Weighted- Average Accumulated Amortization ($ in millions) Gross Amortization Net Period ---------------------------------------------------------------------------------------------- Amortized intangible assets Developed technology, including patents $492 $212 $280 14 Manufacturing, distribution and other contracts 33 7 26 12 Other 43 6 37 18 ---------------------------------------------------------------------------------------------- Total amortized intangible assets $568 $225 $343 14 ==============================================================================================
The amortization expense for these intangible assets was $8 million for the three months ended March 31, 2002. The anticipated annual amortization expense for these intangible assets is 7 $32 million, $33 million, $31 million, $28 million, $27 million and $24 million in 2002, 2003, 2004, 2005, 2006 and 2007, respectively. Earnings and per share earnings in 2001 excluding amortization Net-of-tax amortization expense relating to goodwill and indefinite-lived assets was $10 million, or $.02 per basic and diluted common share for the three months ended March 31, 2001. Adjusted for this amortization expense, income before cumulative effect of accounting change, net income, net income per basic common share and net income per diluted common share were $224 million, $172 million, $.29 and $.29, respectively, for the three months ended March 31, 2001. Acquisitions Acquisitions during the three months ended March 31, 2002 and 2001 were accounted for under the purchase method. 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. The excess of the purchase price over the fair values of the tangible assets and identifiable intangible assets acquired and liabilities assumed is allocated to goodwill. The allocation of purchase price in certain cases may be subject to revision based on the final determination of fair values. Fusion Medical Technologies, Inc. In February 2002, the company entered into an agreement to acquire Fusion Medical Technologies, Inc. (Fusion), subject to shareholder and regulatory approvals. The acquisition of Fusion, a business that develops and commercializes proprietary products used to control bleeding during surgery, supports the company's strategic initiative to expand and enhance the portfolio of innovative therapeutic solutions for biosurgery and tissue regeneration. The acquisition of Fusion, which will be included in the BioScience segment, is expected to close during the second quarter of 2002. Pro forma information The following pro forma information presents a summary of the company's consolidated results of operations as if acquisitions during the first quarter of 2002 and the first quarter of 2001 had taken place as of the beginning of the current and preceding fiscal year, giving effect to purchase accounting adjustments. No adjustments were made for charges for in-process research and development and acquisition-related costs.
------------------------------------------------------------------------------- Three months ended March 31, (in millions, except per share data) 2002 2001 ------------------------------------------------------------------------------- Net sales $1,950 $1,836 Income before cumulative effect of accounting change $253 $211 Net income $253 $159 Net income per diluted common share $0.41 $0.26 -------------------------------------------------------------------------------
These pro forma results of operations have been presented for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisitions occurred on the date indicated, or which may result in the future. The pro forma earnings above relating to acquisitions completed after June 30, 2001 do not include amortization of goodwill. 8. LEGAL PROCEEDINGS, COMMITMENTS AND CONTINGENCIES Refer to "Part II - Item 1. Legal Proceedings" below. 8 9. SEGMENT INFORMATION The company operates in three segments, each of which are strategic businesses that are managed separately because each business develops, manufactures and sells distinct products and services. The segments and a description of their businesses are as follows: Medication Delivery: medication delivery products and therapies, including intravenous infusion pumps and solutions, anesthesia-delivery devices and pharmaceutical agents, and oncology therapies; BioScience: biopharmaceuticals and blood-collection, separation and storage products and technologies; and Renal: products and services to treat end-stage kidney disease. Certain items are maintained at corporate headquarters (Corporate) and are not allocated to the segments. They primarily include most of the company's debt and cash and equivalents and related net interest expense, corporate headquarters costs, certain non-strategic investments and related income and expense, deferred income taxes, the majority of hedging activities, and certain litigation liabilities and related insurance receivables. Financial information for the company's segments for the quarter ended March 31 is as follows.
Medication (in millions) Delivery BioScience Renal Other Total ------------------------------------------------------------------------------------------------------------------- For the three months ended March 31, 2002 Net sales $739 $746 $465 -- $1,950 Pretax income 120 171 56 ($5) 342 2001 Net sales $669 $631 $457 -- $1,757 Pretax income 102 113 66 $6 287 -------------------------------------------------------------------------------------------------------------------
The following are reconciliations of total segment amounts to amounts per the condensed consolidated income statements.
Three months ended March 31, ------------------ (in millions) 2002 2001 ------------------------------------------------------------------------------------------------------------------- Pretax income Total pretax income from segments $347 $281 Unallocated amounts Interest expense, net (16) (19) Other Corporate items 11 25 ------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of accounting change $342 $287 -------------------------------------------------------------------------------------------------------------------
9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Baxter International Inc.'s (the company or Baxter) 2001 Annual Report to Stockholders (Annual Report) contains management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2001. In the Annual Report, management outlined its key financial objectives for 2002. The table below reflects these objectives and the company's results through March 31, 2002.
-------------------------------------------------------------------------------------- RESULTS THROUGH FULL YEAR 2002 OBJECTIVES MARCH 31, 2002 -------------------------------------------------------------------------------------- .. Accelerate sales growth to the low- . Net sales for the quarter ended March 31, teens. 2002 increased 11 percent. Excluding the effects of changes in currency exchange rates, net sales increased 14 percent. -------------------------------------------------------------------------------------- .. Grow earnings per share in the . Diluted earnings per share increased 17 mid-teens. percent for the first quarter of the year, excluding the first quarter 2001 cumulative effect of a change in accounting principle. -------------------------------------------------------------------------------------- .. Generate at least $500 million in . The company had operational cash outflow operational cash flow, after of $217 million during the quarter ended investing more than $1.3 billion in March 31, 2002. The company typically capital expenditures and research generates the majority of its annual cash and development. flow during the second half of the year. The total of capital expenditures and research and development expenses for the quarter ended March 31, 2002 was $254 million. --------------------------------------------------------------------------------------
10 RESULTS OF OPERATIONS NET SALES
------------------------------------------------------------------------ Three months ended March 31, Percent (in millions) 2002 2001 increase ------------------------------------------------------------------------ International $991 $902 10% United States 959 855 12% ------------------------------------------------------------------------ Total net sales $1,950 $1,757 11% ========================================================================
Excluding the effect of fluctuations in currency exchange rates, which impacted sales growth unfavorably for all three segments, total net sales growth was 14 percent for the quarter ended March 31, 2002. The United States dollar strengthened principally relative to the Euro and the Japanese Yen. Refer to Note 9 to the condensed consolidated financial statements for a summary of net sales by segment. Medication Delivery The Medication Delivery segment generated 10 percent sales growth during the three months ended March 31, 2002. Excluding the impact of fluctuations in currency exchange rates, sales growth was 12 percent for the quarter, with the strongest sales growth in the international market. Of the constant-currency sales growth, seven points of growth were generated by the October 2001 acquisition of a subsidiary of Degussa AG, ASTA Medica Onkologie GmbH & CoKG (ASTA), which develops, produces and markets oncology products worldwide, and the August 2001 acquisition of Cook Pharmaceutical Solutions, formerly a unit of Cook Group Incorporated (Cook), which provides contract filling of syringes and vials. The drug delivery business, excluding the impact of the acquisition of Cook, contributed two points of sales growth, primarily driven by increased sales of frozen premixed products. The remaining sales growth for the quarter was principally driven by increased sales of specialty products, particularly outside the United States. BioScience Sales in the BioScience segment increased 18 percent for the three months ended March 31, 2002. Excluding the impact of fluctuations in currency exchange rates, sales growth was 21 percent for the quarter, with sales in both the domestic and international markets contributing strongly to the growth rate. The constant-currency sales growth was driven by increased sales of recombinant products, particularly Recombinate Antihemophilic Factor (rAHF) (Recombinate), with such growth principally a result of increased capacity, improved pricing, and continued strong demand for this product, as well as strong sales of vaccines. Sales of plasma-derived products for hemophilia and other conditions and sales of products that provide for leukoreduction, which is the removal of white blood cells from blood products used for transfusion, also contributed strongly to the segment's growth rate for the quarter. Renal The Renal segment generated sales growth of two percent during the three months ended March 31, 2002. Excluding the impact of fluctuations in currency exchange rates, sales growth was seven percent for the quarter. Of the constant-currency sales growth, approximately five points of growth were due to increased penetration of products for peritoneal dialysis. The penetration continues to be strongest in emerging markets such as Latin America and Asia, where many people with end-stage renal disease are currently under-treated. The remaining growth in the Renal segment was driven principally by the segment's Renal Therapy Services business, which operates dialysis clinics in partnership with local physicians in international markets, and the Renal Management Strategies business, which is a renal-disease 11 management organization, with revenues from these businesses increasing approximately $6 million in the first quarter of 2002 as compared to the prior year quarter. The following tables show key ratios of certain income statement items as a percent of sales. GROSS MARGIN AND EXPENSE RATIOS
-------------------------------------------------------------------------- Three months ended March 31, 2002 2001 Increase -------------------------------------------------------------------------- Gross profit margin 45.4% 43.9% 1.5 pts Marketing and administrative expenses 20.5% 19.5% 1.0 pt ----------------------------------------------------------------------------
The improvement in the gross profit margin during the quarter was primarily due to a change in the products and services mix in all three segments, and particularly as a result of increased sales of higher-margin products in the BioScience segment. Marketing and administrative expenses increased as a percent of sales in the current quarter as compared to the prior year quarter. The company has been increasing its investments in sales and marketing programs in conjunction with the launch of new products, and to continue to drive overall sales growth. Management is also making other investments, including enhancing the technological infrastructure of the company and attracting and retaining a highly talented workforce. To offset these investments, management is aggressively managing expenses and leveraging recent acquisitions. Management expects the expense ratio to decline during the remainder of the year. RESEARCH AND DEVELOPMENT
-------------------------------------------------------------------------- Three months ended March 31, Percent (in millions) 2002 2001 increase -------------------------------------------------------------------------- Research and development expenses $115 $103 12% As a percent of sales 5.9% 5.9% --------------------------------------------------------------------------
The increase in research and development (R&D) expenses for the quarter was due to increased spending in all three segments. Contributing to the growth rate was the Medication Delivery segment's October 2001 acquisition of ASTA, as well as increased spending relating to the development of a next-generation recombinant clotting factor for hemophilia, a next-generation oxygen-therapeutics program, initiatives in the wound management and plasma-based products area, as well as other R&D projects across the three segments. Management expects to significantly increase its growth rate in R&D spending during the remainder of the year. GOODWILL AMORTIZATION In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002, goodwill is no longer amortized, but is subject to periodic impairment reviews. Management expects to significantly increase R&D spending, offsetting the reduced expense due to the elimination of goodwill amortization. 12 INTEREST, NET AND OTHER EXPENSE Net interest expense decreased for the three months ended March 31, 2002 as compared to the prior year period principally due to the May 2001 issuance of convertible debt, which bears a lower interest rate than the debt balances repaid with the proceeds from the issuance. Other expense in both the current and prior year quarter primarily consisted of amounts relating to minority interests and fluctuations in currency exchange rates. PRETAX INCOME Refer to Note 9 to the condensed consolidated financial statements for a summary of financial results by segment. Certain items are maintained at the company's corporate headquarters and are not allocated to the segments. They primarily include the majority of the hedging activities, certain foreign currency fluctuations, net interest expense, income and expense related to certain non-strategic investments, corporate headquarters costs, and certain nonrecurring gains and losses. The following is a summary of the significant factors impacting the segments' financial results. Medication Delivery Pretax income increased 18 percent for the three months ended March 31, 2002. The growth in pretax income was primarily the result of solid sales growth, the close management of costs, the leveraging of expenses in conjunction with recent acquisitions, and decreased pump service costs, partially offset by the unfavorable impact of fluctuations in currency exchange rates and increased R&D spending, which was primarily related to the acquisition of ASTA. BioScience Pretax income increased 51 percent for the three months ended March 31, 2002. The growth in pretax income was primarily a result of strong sales growth, an improved gross margin due to a change in product mix, and the leveraging of expenses. Partially offsetting these increases was the unfavorable impact of fluctuations in currency exchange rates, as well as increased R&D investments in the business. Renal Pretax income decreased 15 percent for the three months ended March 31, 2002. The decrease in pretax income during the quarter was principally due to the unfavorable impact of fluctuations in currency exchange rates and increased R&D spending, partially offset by an improved sales mix and the close management of expenses. INCOME TAXES The effective income tax rate for the three months ended March 31, 2002 was substantially unchanged as compared to the prior year quarter. Management does not expect a significant change in the effective tax rate during the remainder of the year. CHANGES IN ACCOUNTING PRINCIPLES Refer to Note 7 to the condensed consolidated financial statements regarding the company's adoption in 2002 of Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and its amendments at the beginning of 2001. In accordance with the transition provisions of SFAS No. 133, upon adoption the company recorded a cumulative effect reduction to earnings of approximately $52 million (net of tax benefit of approximately $32 million), and a cumulative effect increase to other comprehensive income of approximately $8 million (net of tax of approximately $5 million). 13 LIQUIDITY AND CAPITAL RESOURCES Cash flows from operations per the company's condensed consolidated statements of cash flows decreased for the three months ended March 31, 2002. The effect of increased earnings in 2002, improved cash flows relating to accounts payable and accrued liabilities, and decreased net cash payments relating to the company's litigation was more than offset by the effect of increases in accounts receivable and inventories, as the company continues to grow its businesses. Cash flows from investing activities decreased for the three months ended March 31, 2002. Capital expenditures increased modestly during the three months ended March 31, 2002 as compared to the prior year quarter as the company increased its investments in various capital projects across the three segments. The increased investments principally pertained to the BioScience segment, as the company is in the process of increasing manufacturing capacity for vaccines, and plasma-based and recombinant products. The company plans to increase its level of capital expenditures during the remainder of the year. Net cash outflows relating to acquisitions remained constant during the first three months of 2002 as compared to the prior year period. Approximately $24 million of the 2002 total related to the Medication Delivery segment's January 2002 acquisition of Autros Healthcare Solutions Inc., a developer of automated patient information and medication management systems designed to reduce medication errors, with the remainder pertaining to individually insignificant acquisitions. Approximately $11 million of the 2001 total related to acquisitions of dialysis centers in international markets, with the remainder pertaining to individually insignificant acquisitions. In February 2001, the company acquired Sera-Tec Biologicals, L.P., which owned and operated 80 plasma centers in 28 states, and a central testing laboratory. The purchase price of this acquisition, which is included in the BioScience segment, was paid with Baxter International Inc. common stock. The cash flows relating to divestitures and other asset dispositions in 2001 principally related to the sale and leaseback of certain assets. Cash flows from financing activities decreased for the three months ended March 31, 2002. Debt issuances, net of redemptions and other payments of debt, decreased in the current quarter as compared to the prior year quarter. Cash outflows relating to common stock dividends increased for the three-month period due to an increase in the number of shares outstanding. Cash received for stock issued under employee benefit plans increased due to a higher level of stock option exercises coupled with a higher average exercise price. In conjunction with the early termination of an equity forward agreement, the company purchased one million shares of common stock for $35 million during the first quarter of 2002. The company's net-debt-to-capital ratio was 40.6 percent and 35.9 percent at March 31, 2002 and December 31, 2001, respectively. Management assesses the company's liquidity in terms of its overall ability to mobilize cash to support ongoing business levels and to fund its growth. Management uses an internal performance measure called operational cash flow that evaluates each operating business and geographic region on all aspects of cash flow under its direct control. Operational cash flow, as defined, reflects all litigation payments and related insurance recoveries except for those payments and recoveries relating to mammary implants, which the company never manufactured or sold. The following table reconciles cash flow provided by operations, as determined by generally accepted accounting principles (GAAP), to operational cash flow, which is not a measure defined by GAAP. 14
--------------------------------------------------------------------------------------- Three months ended March 31, (in millions) 2002 2001 --------------------------------------------------------------------------------------- Cash flows from operations per the company's condensed consolidated statements of cash flows ($100) ($33) Capital expenditures (139) (131) Net interest after tax 12 11 Other, including mammary implant litigation 10 42 --------------------------------------------------------------------------------------- Operational cash flow ($217) ($111) =======================================================================================
As authorized by the board of directors, the company repurchases its stock to optimize its capital structure depending upon its operational cash flows, net debt level and current market conditions. In July 2001, the board of directors authorized the repurchase of $500 million of common stock. The company began repurchasing under this program in the third quarter of 2001, and, as discussed above, repurchased one million shares of common stock during the first quarter of 2002. Stock repurchases totaled $111 million under this program at March 31, 2002. On February 27, 2001, Baxter's board of directors approved a two-for-one stock split of the company's common shares. On May 1, 2001, the split was approved by the company's shareholders. On May 30, 2001, shareholders of record on May 9, 2001 received one additional share of Baxter common stock for each share held on May 9, 2001. All share and per share data in the condensed consolidated financial statements and notes have been adjusted and restated to reflect the stock split. The company intends to fund its short-term and long-term obligations as they mature through cash flow from operations, by issuing additional debt, by entering into other financing arrangements or by issuing common stock. In April 2002, the company issued $500 million of term debt, maturing in May 2007, and bearing a 5.25% coupon rate. The net proceeds will be used for working capital, to repay certain existing debt, for capital expenditures and for general corporate purposes. The company believes it has lines of credit adequate to support ongoing operational requirements. Beyond that, the company believes it has sufficient financial flexibility to attract long-term capital on acceptable terms as may be needed to support its growth objectives. The company's ability to generate cash flows from operations could be adversely affected in the event there is a material decline in the demand for the company's products, deterioration in the company's key financial ratios or credit ratings, or other significantly unfavorable change in conditions. With respect to the company's credit arrangements and debt outstanding at March 31, 2002, while a deterioration in the company's credit rating could unfavorably impact the financing costs associated with the credit arrangements, such a downgrade would not affect the company's ability to draw on the credit arrangements, and would not result in an acceleration of the scheduled maturities of the outstanding debt. See "Part II - Item 1. Legal Proceedings" for a discussion of the company's legal contingencies and related insurance coverage with respect to cases and claims relating to the company's plasma-based therapies and mammary implants manufactured by the Heyer-Schulte division of American Hospital Supply Corporation, as well as other matters. Upon resolution of any of these matters, the company may incur charges in excess of presently established reserves. While such future charges could have a material adverse impact on the company's net income or cash flows in the period in which they are recorded or paid, management believes that the outcomes of these actions, individually or in the aggregate, will not have a material adverse effect on the company's consolidated financial position. FORWARD-LOOKING INFORMATION The matters discussed above that are not historical facts include forward-looking statements. These statements are based on the company's current expectations and involve numerous 15 risks and uncertainties. Some of these risks and uncertainties are factors that affect all international businesses, while some are specific to the company and the health-care arenas in which it operates. Many factors could affect the company's actual results, causing results to differ, and possibly differ materially, from those expressed in any such forward-looking statements. These factors include, but are not limited to, interest rates; technological advances in the medical field; economic conditions; demand and market acceptance risks for new and existing products, technologies and health-care services; the impact of competitive products and pricing; manufacturing capacity; new plant start-ups; global regulatory, trade and tax policies; regulatory, legal or other developments relating to the company's Series A, AF and AX dialyzers; continued price competition; product development risks, including technological difficulties; ability to enforce patents; actions of regulatory bodies and other government authorities; reimbursement policies of government agencies; commercialization factors; results of product testing; and other factors described in this report or in the company's other filings with the Securities and Exchange Commission. Additionally, as discussed in "Legal Proceedings" below, upon the resolution of certain legal matters, the company may incur charges in excess of presently established reserves. Any such charge could have a material adverse effect on the company's results of operations or cash flows in the period in which it is recorded. Currency fluctuations are also a significant variable for global companies, especially fluctuations in local currencies where hedging opportunities are unreasonably expensive or unavailable. If the United States dollar strengthens against most foreign currencies, the company's growth rates in its sales and net earnings could be negatively impacted. Management believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its knowledge of the company's business and operations, but there can be no assurance that the actual results or performance of the company will conform to any future results or performance expressed or implied by such forward-looking statements. 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk For a complete discussion, refer to the caption "Financial Instrument Market Risk" in the company's 2001 Annual Report to Stockholders on Form 10-K. As part of its risk-management program, the company performs sensitivity analyses to assess potential changes in fair value relating to hypothetical movements in currency exchange rates. A sensitivity analysis of changes in the fair value of foreign exchange option and forward contracts outstanding at March 31, 2002, the total of which did not change significantly from that at December 31, 2001, indicated that, if the U.S. Dollar uniformly fluctuated unfavorably by 10 percent against all currencies, the fair value of those contracts would decrease by approximately $139 million. With respect to the company's cross-currency swap agreements used to hedge net investments in foreign affiliates, if the U.S. Dollar uniformly weakened by 10 percent, the fair value of the contracts would decrease by approximately $249 million as of March 31, 2002. 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. Review by Independent Accountants Reviews of the interim condensed consolidated financial information included in this Quarterly Report on Form 10-Q for the three months ended March 31, 2002 and 2001 have been performed by PricewaterhouseCoopers LLP, the company's independent accountants. Their report on the interim condensed consolidated financial information follows. This report is not considered a report within the meaning of Sections 7 and 11 of the Securities Act of 1933 and therefore, the independent accountants' liability under Section 11 does not extend to it. 17 Report of Independent Accountants To the Board of Directors and Stockholders of Baxter International Inc.: We have reviewed the accompanying condensed consolidated balance sheet of Baxter International Inc. and its subsidiaries as of March 31, 2002, and the related condensed consolidated statements of income for the three-month periods ended March 31, 2002 and 2001 and the condensed consolidated statements of cash flows for the three-month periods ended March 31, 2002 and 2001. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 2001 and the related consolidated statements of income, cash flows and stockholders' equity for the year then ended (not presented herein), and in our report dated February 14, 2002 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2001, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. PricewaterhouseCoopers LLP Chicago, Illinois April 30, 2002 18 PART II. OTHER INFORMATION Baxter International Inc. and Subsidiaries Item 1. Legal Proceedings Baxter International Inc. (Baxter or the company) and certain of its subsidiaries are named as defendants in a number of lawsuits, claims and proceedings, including product liability claims involving products now or formerly manufactured or sold by the company or by companies that were acquired by the company. The most significant of these are reported in the company's Annual Report on Form 10-K for the year ended December 31, 2001, and material developments in such matters for the quarter ended March 31, 2002 are described below. Upon resolution of any such matters, Baxter may incur charges in excess of presently established reserves. While such a future charge could have a material adverse impact on the company's net income and net cash flows in the period in which it is recorded or paid, management believes that no such charge would have a material adverse effect on Baxter's consolidated financial position. Mammary implant litigation As previously reported in the company's Annual Report on Form 10-K, the company, together with certain of its subsidiaries, is currently a defendant in various courts in a number of lawsuits brought by individuals, all seeking damages for injuries of various types allegedly caused by silicone mammary implants formerly manufactured by the Heyer-Schulte division of American Hospital Supply Corporation (AHSC). AHSC, which was acquired by the company in 1985, divested its Heyer-Schulte division in 1984. It is not known how many of these claims and lawsuits involve products manufactured and sold by Heyer-Schulte, as opposed to other manufacturers. In December 1998, a panel of independent medical experts appointed by a federal judge announced its findings that reported medical studies contained no clear evidence of a connection between silicone mammary implants and traditional or atypical systemic diseases. In June 1999, a similar conclusion was announced by a committee of independent medical experts from the Institute of Medicine, an arm of the National Academy of Sciences. As of March 31, 2002, Baxter, together with certain of its subsidiaries, was named as a defendant or co-defendant in 231 lawsuits and one claim relating to mammary implants, brought by approximately 480 plaintiffs, of which 385 are implant plaintiffs and the remainder are consortium or second generation plaintiffs. Of those plaintiffs, 12 currently are included in the Lindsey class action Revised Settlement described below, which accounts for approximately 11 of the pending lawsuits against the company. Additionally, 283 plaintiffs have opted out of the Revised Settlement (representing approximately 176 pending lawsuits), and the status of the remaining plaintiffs with pending lawsuits is unknown. Some of the opt-out plaintiffs filed their cases naming multiple defendants and without product identification; thus, not all of the opt-out plaintiffs will have viable claims against the company. As of March 31, 2002, 147 of the opt-out plaintiffs had confirmed Heyer-Schulte mammary implant product identification. Furthermore, during the first quarter of 2002, Baxter obtained dismissals, or agreements for dismissals, with respect to 112 plaintiffs. In addition to the individual suits against the company, a class action on behalf of all women with silicone mammary implants is pending in the United States District Court (U.S.D.C.) for the Northern District of Alabama involving most manufacturers of such implants, including Baxter, as successor to AHSC (Lindsey, et al., v. Dow Corning, et al., U.S.D.C., N. Dist. Ala., CV 94-P-11558-S). The class action was certified for settlement purposes only by the court on September 1, 1994, and the settlement terms were subsequently revised and approved on December 22, 1995 (the Revised Settlement). All appeals directly challenging the Revised Settlement have been dismissed. 19 In addition to the Lindsey class action, the company also has been named in three other purported class actions in various state and provincial courts, only one of which is certified. On March 31, 2000, the United States Department of Justice filed an action in the federal district court in Birmingham, Alabama against Baxter and other manufacturers of breast implants, as well as the escrow agent for the revised settlement fund, seeking reimbursement under various federal statutes for medical care provided to various women with mammary implants. On September 26, 2001 the district court granted the motion of all defendants, including Baxter, to dismiss the action. The federal government has appealed the dismissal. Plasma-based therapies litigation As previously reported in the company's Annual Report on Form 10-K, Baxter currently is a defendant in a number of claims and lawsuits brought by individuals who have hemophilia, all seeking damages for injuries allegedly caused by anti-hemophilic factor concentrates VIII or IX derived from human blood plasma (factor concentrates) processed by the company from the late 1970s to the mid-1980s. The typical case or claim alleges that the individual was infected with the HIV virus by factor concentrates, which contained the HIV virus. None of these cases involves factor concentrates currently processed by the company. As of March 31, 2002, Baxter was named in 37 lawsuits and 91 claims in the United States, France, Ireland, Italy, Japan and Taiwan. The U.S.D.C. for the Northern District of Illinois has approved a settlement of all U.S. federal court factor concentrates cases. As of March 31, 2002, approximately 6,500 claimant groups had been found eligible to participate in the settlement, and approximately 350 claimants had opted out of the settlement. Approximately 6,236 of the claimant groups had received payments as of March 31, 2002. In Japan, Baxter is a defendant, along with the Japanese government and four other co-defendants, in factor concentrates cases in Osaka, Tokyo, Nagoya, Tohoku, Fukuoka, Sapporo and Kumamoto. As of March 31, 2002, the cases involved 1,351 plaintiffs, of whom 1,340 have settled their claims. In addition, Immuno International AG (Immuno), a company acquired by Baxter in fiscal year 1997, has unsettled claims for damages for injuries allegedly caused by its plasma-based therapies. The typical claim alleges that the individual with hemophilia was infected with HIV by factor concentrates containing the HIV virus. Additionally, Immuno faces multiple claims stemming from its vaccines and other biologically derived therapies. A portion of the liability and defense costs related to these claims will be covered by insurance, subject to exclusions, conditions, policy limits and other factors. Pursuant to the stock purchase agreement between the company and Immuno, as revised in April 1999 in consideration for payment by the company of 29 million Swiss Francs to Immuno as additional purchase price, approximately 26 million Swiss Francs of the purchase price is being withheld to cover these contingent liabilities. As previously reported in the company's Annual Report on Form 10-K, Baxter is currently a defendant in a number of claims and lawsuits brought by individuals who infused the company's Gammagard(R) IVIG (intravenous immuno-globulin), all of whom are seeking damages for Hepatitis C infections allegedly caused by infusing Gammagard(R) IVIG. As of March 31, 2002, Baxter was a defendant in 17 lawsuits and 26 claims in the United States, Denmark, France, Germany, Italy, Spain and the United Kingdom. One class action in the United States has been certified. In September 2000, the U.S.D.C. for the Central District of California approved a settlement of the class action that would provide financial compensation for U.S. individuals who used Gammagard(R) IVIG between January 1993 and February 1994. 20 Other As of March 31, 2002, Baxter International Inc. and certain of its subsidiaries were named as defendants in three civil lawsuits, one of which is a purported class action, seeking damages on behalf of persons who allegedly died or were injured as a result of exposure to Baxter's A, AF and AX series dialyzers. One of these cases, which is pending in the Superior Court of San Bernardino County, California, was filed during the first quarter of 2002. The company has reached settlements with a number of the families of patients who died in Spain and Croatia after undergoing hemodialysis on Baxter Althane series dialyzers. Government criminal investigations concerning the patient deaths are pending in Spain and Croatia. Other lawsuits and claims may be filed in the United States and elsewhere. Baxter International Inc. and certain of its subsidiaries have been named as defendants, along with others, in six lawsuits brought in U.S. federal courts on behalf of various classes of purchasers of Medicare and Medicaid eligible drugs alleged to have been injured by Baxter and other defendants as a result of pricing practices for such drugs, which are alleged to be artificially inflated. One of these cases was filed during the first quarter of 2002 in the U.S.D.C. for the Western District of Louisiana and another was filed in April 2002 in the U.S.D.C. for the Eastern District of Pennsylvania. All six of these U.S. federal court cases have been transferred to the U.S.D.C. for the District of Massachusetts for consolidated pretrial case management under Multi District Litigation rules. Claimants seek damages and declaratory and injunctive relief under various state and/or federal statutes. In addition, in January 2002, the Attorney General of Nevada filed a civil suit in the Second Judicial District Court of Washoe County, Nevada. In February 2002, the Attorney General of Montana filed a civil suit in the First Judicial District Court of Lewis and Clark County, Montana. These lawsuits in Nevada and Montana, which each name a subsidiary of Baxter International as a defendant and seek damages, injunctive relief, civil penalties, disgorgement, forfeiture and restitution, allege that prices for Medicare and Medicaid eligible drugs were artificially inflated in violation of various state laws. Various state and federal agencies are conducting civil investigations into the marketing and pricing practices of Baxter and others with respect to Medicare and Medicaid reimbursement. As of September 30, 1996, the date of the spin-off of Allegiance Corporation (Allegiance) from Baxter, Allegiance assumed the defense of litigation involving claims related to Allegiance's businesses, including certain claims of alleged personal injuries as a result of exposure to natural rubber latex gloves. Allegiance has not been named in most of this litigation but will be defending and indemnifying Baxter pursuant to certain contractual obligations for all expenses and potential liabilities associated with claims pertaining to latex gloves. As of March 31, 2002, the company was named as a defendant in 494 lawsuits, including the following purported class action: Swartz v. Baxter Healthcare Corporation, et al. Court of Common Pleas, Jefferson County, PA, 656-1997 C.D. In connection with the spin-off of its cardiovascular business, Baxter obtained a ruling from the Internal Revenue Service to the effect that the distribution should qualify as a tax-free spin-off in the United States. In many countries throughout the world, Baxter has not sought similar rulings from the local tax authorities and has taken the position that the spin-off was a tax-free event to Baxter. In the event that this position was successfully challenged by one or more countries' taxing authorities, Baxter would be liable for any resulting liability. Baxter believes that it has established adequate reserves to cover the expected tax liabilities. There can be no assurance, however, that Baxter will not incur losses in excess of such reserves. 21 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index hereto. (b) Reports on Form 8-K None. 22 Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BAXTER INTERNATIONAL INC. ----------------------------------- (Registrant) Date: May 3, 2002 By: /s/ Brian P. Anderson ------------------------------- Brian P. Anderson Senior Vice President and Chief Financial Officer (Chief Accounting Officer) 23 EXHIBITS FILED WITH SECURITIES AND EXCHANGE COMMISSION -------------------------------------------------------------------------------- Number Description of Exhibit ------ ---------------------- 10.3 Baxter International Inc. and Subsidiaries Supplemental Pension Plan, as amended and restated effective January 1, 2002 10.9 Baxter International Inc. and Subsidiaries Deferred Compensation Plan, as amended and restated effective January 1, 2002 12 Computation of Ratio of Earnings to Fixed Charges 15 Letter Re Unaudited Interim Financial Information 24