UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 10-K

 

 

Commission file number 1-4448

 

 

Baxter International Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Registrant’s telephone number, including area code 847.948.2000
Securities registered pursuant to Section 12(b) of the Act:

 

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

The aggregate market value of the voting common equity held by non-affiliates of the registrant as of June 30, 2010 (the last business day of the registrant’s most recently completed second fiscal quarter), based on the per share closing sale price of $40.64 on that date and the assumption for the purpose of this computation only that all of the registrant’s directors and executive officers are affiliates, was approximately $24 billion. There is no non-voting common equity held by non-affiliates of the registrant.

 

The number of shares of the registrant’s common stock, $1.00 par value, outstanding as of January 31, 2011 was 579,426,016.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive 2011 proxy statement for use in connection with its Annual Meeting of Shareholders to be held on May 3, 2011 are incorporated by reference into Part III of this report.

 

 

TABLE OF CONTENTS

 

 

PART I

 

 

Company Overview

 

Baxter International Inc., through its subsidiaries, develops, manufactures and markets products that save and sustain the lives of people with hemophilia, immune disorders, infectious diseases, kidney disease, trauma, and other chronic and acute medical conditions. As a global, diversified healthcare company, Baxter applies a unique combination of expertise in medical devices, pharmaceuticals and biotechnology to create products that advance patient care worldwide. These products are used by hospitals, kidney dialysis centers, nursing homes, rehabilitation centers, doctors’ offices, clinical and medical research laboratories, and by patients at home under physician supervision. Baxter manufactures products in 27 countries and sells them in more than 100 countries.

 

Baxter International Inc. was incorporated under Delaware law in 1931. As used in this report, except as otherwise indicated in information incorporated by reference, “Baxter International” means Baxter International Inc. and “Baxter,” the “company” or the “Company” means Baxter International and its consolidated subsidiaries.

 

Business Segments and Products

 

The BioScience, Medication Delivery and Renal segments comprise Baxter’s continuing operations.

 

BioScience.  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; products for regenerative medicine, such as biosurgery products; and select vaccines.

 

Medication Delivery.  The Medication Delivery 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 October 2010, the company announced an agreement providing for the divestiture of its U.S. generic injectables business to Hikma Pharmaceuticals PLC. For more information on this divestiture, see Note 3 in Item 8 of this Annual Report on Form 10-K.

 

Renal.  The Renal business provides products to treat end-stage renal disease, or irreversible kidney failure. The business manufactures solutions and other products for peritoneal dialysis (PD), a home-based therapy, and also distributes products for hemodialysis, which is generally conducted in a hospital or clinic.

 

In October 2010, the company announced the combination of its Medication Delivery and Renal businesses into a single global business unit, Medical Products.

 

For financial information about Baxter’s segments and principal product categories, see Note 12 in Item 8 of this Annual Report on Form 10-K.

 

Sales and Distribution

 

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

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

 

International Operations

 

Baxter products are manufactured and sold worldwide. Approximately 60% of the company’s revenues are generated outside of the United States and geographic expansion remains a core component of the company’s strategy. Baxter’s international presence includes operations in Europe, Asia-Pacific, Latin America and Canada. The company is subject to certain risks inherent in conducting business outside the United States. For more information on these risks, see the information under the captions “We are subject to risks associated with doing business globally” and “We are subject to foreign currency risk” in Item 1A of this Annual Report on Form 10-K all of which information is incorporated herein by reference.

 

For financial information about foreign and domestic operations and geographic information, see Note 12 in Item 8 of this Annual Report on Form 10-K. For more information regarding foreign currency exchange risk, refer to the discussion under the caption entitled “Financial Instrument Market Risk” in Item 7 of this Annual Report on Form 10-K.

 

Contractual Arrangements

 

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

 

In keeping with the increased emphasis on cost-effectiveness in healthcare delivery, many hospitals and other customers of medical products in the United States and in other countries have joined group purchasing organizations (GPOs), or formed integrated delivery networks (IDNs), to enhance purchasing power. GPOs and IDNs negotiate pricing arrangements with manufacturers and distributors, and the negotiated prices are made available to members. Baxter has purchasing agreements with several of the major GPOs in the United States. GPOs may have agreements with more than one supplier for certain products. Accordingly, in these cases, Baxter faces competition from other suppliers even where a customer is a member of a GPO under contract with Baxter.

 

Raw Materials

 

Raw materials essential to Baxter’s business are purchased from numerous suppliers worldwide in the ordinary course of business. Although most of these materials are generally available, certain raw materials used in producing some of the company’s products are available only from one or a limited number of suppliers, and Baxter at times may experience shortages of supply. In an effort to manage risk associated with raw materials supply, Baxter works closely with its suppliers to help ensure availability and continuity of supply while maintaining high quality and reliability. The company also seeks to develop new and alternative sources of supply where beneficial to its overall raw materials procurement strategy.

 

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

 

Competition and Healthcare Cost Containment

 

Baxter’s BioScience, Medication Delivery and Renal businesses enjoy leading positions based on a number of competitive advantages. The BioScience business benefits from continued innovation in its products and therapies, consistency of its supply of products, and strong customer relationships. The Medication Delivery business benefits from the breadth and depth of its product offering, as well as strong relationships with customers, including hospitals, customer purchasing groups and pharmaceutical and biotechnology companies. The Renal business benefits from its position as one of the world’s leading manufacturers of PD products, as

well as its strong relationships with customers and patients, including the many patients who self-administer the home-based therapy supplied by Baxter. Baxter as a whole benefits from efficiencies and cost advantages resulting from shared manufacturing facilities and the technological advantages of its products.

 

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

 

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

 

Intellectual Property

 

Patents and other proprietary rights are essential to Baxter’s business. Baxter relies on patents, trademarks, copyrights, trade secrets, know-how and confidentiality agreements to develop, maintain and strengthen its competitive position. Baxter owns a number of patents and trademarks throughout the world and has entered into license arrangements relating to various third-party patents and technologies. Products manufactured by Baxter are sold primarily under its own trademarks and trade names. Some products distributed by the company are sold under the company’s trade names, while others are sold under trade names owned by its suppliers. Trade secret protection of unpatented confidential and proprietary information is also important to Baxter. The company maintains certain details about its processes, products and technology as trade secrets and generally requires employees, consultants, parties to collaboration agreements and other business partners to enter into confidentiality agreements.

 

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

 

Baxter operates in an industry susceptible to significant patent litigation. At any given time, the company is involved as either a plaintiff or defendant in a number of patent infringement and other intellectual property-related actions. Such litigation can result in significant royalty or other payments or result in injunctions that

can prevent the sale of products. For more information on patent and other litigation, see Note 11 in Item 8 of this Annual Report on Form 10-K.

 

Research and Development

 

Baxter’s investment in research and development (R&D) is essential to its future growth and its ability to remain competitive in each of its business segments. Accordingly, Baxter continues to focus its investment in R&D programs to enhance future growth through clinical differentiation. Expenditures for Baxter’s R&D activities were $915 million in 2010, $917 million in 2009 and $868 million in 2008. These expenditures include costs associated with R&D activities performed at the company’s R&D centers located around the world, which include facilities in Austria, Belgium, Japan and the United States, as well as in-licensing, milestone and reimbursement payments made to partners for R&D work performed at non-Baxter locations.

 

Principal areas of strategic focus for R&D include recombinant and plasma-based therapeutics, vaccines, initiatives in regenerative medicine, kidney dialysis, formulation of small molecule drugs, enhanced packaging systems for medication delivery, and parenteral nutrition. The company’s research efforts emphasize self-manufactured product development, and portions of that research relate to multiple product categories. Baxter supplements its own R&D efforts by acquiring various technologies and entering into development and other collaboration agreements with third parties. For more information on the company’s R&D activities, refer to the discussion under the caption entitled “Research and Development” contained in Item 7 of this Annual Report on Form 10-K.

 

Quality Management

 

Baxter’s success depends upon the quality of its products. Quality management plays an essential role in determining and meeting customer requirements, preventing defects, improving the company’s products and services and maintaining the integrity of the data that supports the safety and efficacy of the company’s products. Baxter has a network of quality systems throughout the company’s business units and facilities that relate to the design, development, manufacturing, packaging, sterilization, handling, distribution and labeling of the company’s products. To assess and facilitate compliance with applicable requirements, the company regularly reviews its quality systems to determine their effectiveness and identify areas for improvement. Baxter also performs assessments of its suppliers of raw materials, components and finished goods. In addition, the company conducts quality management reviews designed to inform management of key issues that may affect the quality of products and services.

 

From time to time, the company may determine that products manufactured or marketed by the company do not meet company specifications, published standards, such as those issued by the International Organization for Standardization, or regulatory requirements. When a quality issue is identified, Baxter investigates the issue and takes appropriate corrective action, such as notice to the customer of revised labeling, correction of the product at the customer location, withdrawal of the product from the market and other actions. For more information on corrective actions taken by Baxter, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K.

 

Government Regulation

 

The operations of Baxter and many of the products manufactured or sold by the company are subject to extensive regulation by numerous government agencies, both within and outside the United States. In March 2010, the Patient Protection and Affordable Care Act was enacted in the United States. While this legislation provides for a number of changes in how companies are compensated for providing healthcare products and services, many of these changes will be implemented by regulations which have yet to be established. For more information on the expected impact of healthcare reform on the company, refer to the information under the caption “The implementation of healthcare reform in the United States may adversely affect our business” in Item 1A of this Annual Report on Form 10-K.

In the United States, the federal agencies that regulate the company’s facilities, operations, employees, products (their manufacture, sale, import and export) and services include: the U.S. Food and Drug Administration (FDA), the Drug Enforcement Agency, the Environmental Protection Agency, the Occupational Health & Safety Administration, the Department of Agriculture, the U.S. Department of Justice, the Department of Labor, the Department of Defense, Customs and Border Protection, the Department of Commerce, the Department of Treasury and others. Because Baxter supplies products and services to healthcare providers that are reimbursed by federally funded programs such as Medicare, its activities are also subject to regulation by the Center for Medicare/Medicaid Services and enforcement by the Office of the Inspector General within the Department of Health and Human Services (OIG). State agencies in the United States also regulate the facilities, operations, employees, products and services of the company within their respective states. Outside the United States, the company’s products and operations are subject to extensive regulation by government agencies, including the European Medicines Agency (EMA) in the European Union. International government agencies also regulate public health, product registration, pricing, manufacturing, environmental conditions, labor, exports, imports and other aspects of the company’s global operations.

 

The FDA in the United States, the EMA in Europe, and other government agencies inside and outside of the United States, administer requirements covering the testing, safety, effectiveness, manufacturing, labeling, promotion and advertising, distribution and post-market surveillance of Baxter’s products. The company must obtain specific approval from the FDA and non-U.S. regulatory authorities before it can market and sell most of its products in a particular country. Even after the company obtains regulatory approval to market a product, the product and the company’s manufacturing processes are subject to continued review by the FDA and other regulatory authorities worldwide.

 

The company is subject to possible administrative and legal actions by the FDA and other regulatory agencies inside and outside the United States. Such actions may include warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses. From time to time, the company takes steps to ensure safety and efficacy of its products, such as removing products from the market found not to meet applicable requirements and improving the effectiveness of quality systems. For more information on compliance actions taken by the company, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K.

 

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

 

Employees

 

As of December 31, 2010, Baxter employed approximately 48,000 people.

 

Available Information

 

Baxter makes available free of charge on its website at www.baxter.com its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), as soon as reasonably practicable after electronically filing or furnishing such material to the Securities and Exchange Commission.

 

In addition, Baxter’s Corporate Governance Guidelines, Code of Conduct, and the charters for the required committees of Baxter’s board of directors are available on Baxter’s website at www.baxter.com under “Corporate Governance” and in print upon request by writing to: Corporate Secretary, Baxter International Inc., One Baxter Parkway, Deerfield, Illinois 60015. Information contained on Baxter’s website shall not be deemed incorporated into, or to be a part of, this Annual Report on Form 10-K.

 

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

 

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

 

The successful and timely implementation of our business model depends on our ability to adapt to changing technologies and introduce new products. As our competitors will continue to introduce competitive products, the development and acquisition of innovative products and technologies that improve efficacy, safety, patients’ and clinicians’ ease of use and cost-effectiveness are important to our success. The success of new product offerings will depend on many factors, including our ability to properly anticipate and satisfy customer needs, obtain regulatory approvals on a timely basis, develop and manufacture products in an economic and timely manner, obtain or maintain advantageous positions with respect to intellectual property, and differentiate our products from those of our competitors. Failure by us to introduce planned products or other new products or to introduce products on schedule could have an adverse effect on our business, financial condition and results of operations.

 

The development and acquisition of innovative products and technologies that improve efficacy, safety, patients’ and clinicians’ ease of use and cost-effectiveness involve significant technical and business risks. If we cannot adapt to changing technologies or anticipate changes in our current and potential customers’ requirements our products may become obsolete, and our business could suffer. Our success will depend, in part, on our ability to continue to enhance our existing products, develop new technology that addresses the increasingly sophisticated and varied needs of our prospective customers, license or acquire leading technologies and respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis.

 

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

 

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

 

The manufacture, distribution, marketing and use of our products are subject to extensive regulation and increasing scrutiny by the FDA and other regulatory authorities both inside and outside the United States. Any new product must undergo lengthy and rigorous testing and other extensive, costly and time-consuming procedures mandated by the FDA and foreign regulatory authorities. Our facilities must be approved and licensed prior to production and remain subject to inspection from time to time thereafter. Failure to comply with the requirements of the FDA or other regulatory authorities, including a failed inspection or a failure in our adverse event reporting system, could result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt the manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses. Any of these actions could cause a loss of customer confidence in us and our products, which could adversely affect our sales.

 

We continue to address a number of regulatory issues as discussed further under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K. In connection with these issues, there can be no assurance that additional costs or civil and criminal penalties will not be incurred, that additional regulatory actions with respect to the company will not occur, that the company will not face civil claims for

damages from purchasers or users, that substantial additional charges or significant asset impairments may not be required, that sales of other products may not be adversely affected, or that additional regulation will not be introduced that may adversely affect the company’s operations and consolidated financial statements.

 

The sales and marketing of our products and our relationships with healthcare providers are under increasing scrutiny by federal, state and foreign government agencies. The FDA, the OIG, the U.S. Department of Justice (DOJ) and the Federal Trade Commission have each increased their enforcement efforts (including joint efforts) with respect to the Anti-Kickback Statute, False Claims Act, off-label promotion of products, other healthcare related laws, antitrust and other competition laws. The DOJ also has increased its focus on the enforcement of the U.S. Foreign Corrupt Practices Act (FCPA), particularly as it relates to the conduct of pharmaceutical companies. The FCPA prohibits certain individuals and entities, including the company, from promising, offering, or giving anything of value to foreign officials with the intent of influencing the foreign official for the purpose of helping the company obtain or retain business or gain an improper advantage. Outside of the United States, our business involves significant interaction with foreign officials. The FCPA also imposes recordkeeping and internal controls requirements on the company. Foreign governments have also increased their scrutiny of pharmaceutical companies’ sales and marketing activities and relationships with healthcare providers. The laws and standards governing the promotion, sale and reimbursement of our products and those governing our relationships with healthcare providers and governments can be complicated, are subject to frequent change and may be violated unknowingly. We have compliance programs in place, including policies, training and various forms of monitoring, designed to address these risks. Nonetheless, these programs and policies may not always protect us from conduct by our employees that violate these laws. Violations, or allegations of violations, of these laws may result in large civil and criminal penalties, debarment from participating in government programs, diversion of management time, attention and resources and may otherwise have an adverse effect on our business, financial condition and results of operations. Refer to Note 11 in Item 8 of this Annual Report on Form 10-K for a discussion of the requests that the company received in 2010 from certain federal government agencies.

 

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

 

Our success depends upon the quality of our products. Quality management plays an essential role in determining and meeting customer requirements, preventing defects, improving the company’s products and services and maintaining the integrity of the data that supports the safety and efficacy of our products. Our future operating results will depend on our ability to implement and improve our quality management program, and effectively train and manage our employee base with respect to quality management. While we have a network of quality systems throughout our business units and facilities that relate to the design, development, manufacturing, packaging, sterilization, handling, distribution and labeling of our products, quality and safety issues may occur with respect to any of our products. In addition, some of the raw materials employed in our production processes are derived from human and animal origins. Though great care is taken to assure the safety of these raw materials, the nature of their origin elevates the potential for the introduction of pathogenic agents or other contaminants.

 

A quality or safety issue could have an adverse effect on our business, financial condition and results of operations and may result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals and licenses, restrictions on operations or withdrawal of existing approvals and licenses. An inability to address a quality or safety issue in an effective and timely manner may also cause negative publicity, a loss of customer confidence in us or our current or future products, which may result in the loss of sales and difficulty in successfully launching new products. In addition, we may be named as a defendant in product liability or other lawsuits, which could result in costly litigation, reduced sales, significant liabilities and diversion of our management’s time, attention and resources. We continue to be self-insured with respect to product liability claims. The absence of third-party insurance coverage for such claims increases our potential exposure to unanticipated claims and adverse decisions. Even claims without merit could subject us to adverse publicity and require us to incur significant legal fees.

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

 

Implementation of the FDA order to recall our COLLEAGUE infusion pumps in the United States may adversely affect our business.

 

Pursuant to the Consent Decree entered into by the company in June 2006, the FDA issued a final order in July 2010 regarding the recall of the company’s COLLEAGUE infusion pumps currently in use in the United States. The company is executing the recall over the two years following the final order by offering its customers an option to replace their COLLEAGUE infusion pumps or receive monetary consideration. Under the replacement option, the company’s customers may receive the Sigma International General Medical Apparatus, LLC (SIGMA) Spectrum infusion pumps in exchange for their COLLEAGUE infusion pumps. For more information on the COLLEAGUE recall, refer to the discussion under the caption entitled “Certain Regulatory Matters” in Item 7 of this Annual Report on Form 10-K. The company cannot be certain that SIGMA will have sufficient production capacity to meet the demand for SIGMA Spectrum infusion pumps. Customers choosing a refund or for whom sufficient replacement pumps are unavailable are likely to move to a competitive infusion pump platform. Many of the company’s COLLEAGUE customers also purchase a variety of the company’s other Medication Delivery products. If a significant number of COLLEAGUE customers move to a competitive pump platform, our business may suffer and sales of other products in the company’s Medication Delivery product portfolio may be adversely affected. In addition, it is possible that substantial additional cash and non-cash charges, including significant asset impairments related to the COLLEAGUE infusion pumps and related businesses, may be required in future periods based on new information, changes in estimates, the implementation of the recall in the United States, and other actions the company may be required to undertake in markets outside the United States.

 

The implementation of healthcare reform in the United States may adversely affect our business.

 

The Patient Protection and Affordable Care Act (Act), which was signed into law in March 2010, includes several provisions which impact the company’s businesses in the United States, including increased Medicaid rebates and an expansion of the 340B Drug Pricing Program which provides certain qualified entities, such as hospitals serving disadvantaged populations, with discounts on the purchase of drugs for outpatient use and an excise tax on the sale of certain drugs and medical devices. The company will also be required to pay a tax on the sales of its pharmaceutical products to the government beginning in 2011 and a 2.3% tax on certain of its medical devices beginning in 2013. The impact of the increased Medicaid rebates and the expanded 340B Drug Pricing Program is largely expected to impact the company’s Bioscience business, while the additional taxes are expected to impact each of the company’s business segments. We may also experience downward pricing pressure as the Act reduces Medicare and Medicaid payments to hospitals. While it is intended to expand health insurance coverage and increase access to medical care generally, additional regulations need to be established to implement many of the Act’s provisions. As a result, the full impact of the Act is uncertain.

 

If reimbursement for our current or future products is reduced or modified, our business could suffer.

 

Sales of our products depend, in part, on the extent to which the costs of our products are paid by health maintenance, managed care, pharmacy benefit and similar healthcare management organizations, or reimbursed by government health administration authorities, private health coverage insurers and other third-party payors. These healthcare management organizations and third-party payors are increasingly challenging the prices charged for medical products and services. Additionally, as discussed above, the containment of healthcare costs has become a priority of federal and state governments, and the prices of drugs and other healthcare products have been targeted in this effort. We also face challenges, including austerity measures being taken by governments, in certain foreign markets where the pricing and profitability of our products generally are subject to government controls. Government controls in foreign markets also impact our ability to collect accounts receivable in a timely manner. Accordingly, our current and potential products may not be considered cost effective, and reimbursement to the consumer may not be available or sufficient to allow us to

sell our products on a competitive basis. Legislation and regulations affecting reimbursement for our products may change at any time and in ways that are difficult to predict and these changes may be adverse to us. Further reductions in Medicare, Medicaid or other third-party payor reimbursements could have a negative effect on our operating results.

 

Consolidation in the healthcare industry could adversely affect our business, financial condition and results of operations.

 

There has been consolidation in our customer base, and by our competitors, which has resulted in pricing and sales pressures. As these consolidations occur, competition to provide products like ours will become more intense, and the importance of establishing relationships with key industry participants including GPOs, IDNs and other customers will become greater. Customers will continue to work and organize to negotiate price reductions for our products and services. To the extent we are forced to reduce our prices, our business will become less profitable unless we are able to achieve corresponding reductions in costs. The company’s sales could be adversely affected if any of its contracts with its GPOs, IDNs or other customers are terminated in part or in their entirety, or members decide to purchase from another supplier.

 

We face substantial competition and many of our competitors have significantly greater financial and other resources.

 

Although no single company competes with us in all of our businesses, we face substantial competition in each of our segments from international and domestic healthcare and pharmaceutical companies of all sizes. Competition is primarily focused on cost-effectiveness, price, service, product performance, and technological innovation. Some competitors, principally large pharmaceutical companies, have greater financial, R&D and marketing resources than us. Competition may increase further as additional companies begin to enter our markets or modify their existing products to compete directly with ours. Greater financial, R&D and marketing resources may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements that may render our products obsolete or non-competitive. If our competitors develop more effective or affordable products, or achieve earlier patent protection or product commercialization than we do, our operations will likely be negatively affected.

 

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

 

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

 

The production of plasma-based products is a lengthy and complex process. Efforts to increase the collection of plasma may include the construction and regulatory approval of additional plasma collection facilities, which can be a lengthy regulatory and capital intensive process. As a result, our ability to match our collection and production of plasma-based products to market demand is imprecise and may result in a failure to meet the market demand of our plasma-based products or potentially an oversupply of inventory. Failure to meet market demand for our plasma-based products may result in customers transitioning to available competitive products resulting in a loss of segment share. In the event of an oversupply we may be forced to lower the prices we charge for some of our plasma-based products, close collection and processing facilities, record asset impairment charges or take other action which may adversely affect our business, financial condition and results of operations.

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

 

The manufacture of our products requires the timely delivery of sufficient amounts of quality components and materials. We manufacture our products in over 50 manufacturing facilities around the world. We acquire our components and materials from many suppliers in various countries. While efforts are made to diversify our sources of components and materials, in certain instances we acquire components and materials from a sole supplier. We work closely with our suppliers to ensure the continuity of supply but we cannot guarantee these efforts will continue to be successful. In addition, due to the regulatory environment in which we operate, we may be unable to quickly establish additional or replacement sources for some components or materials. A reduction or interruption in supply, and an inability to develop alternative sources for such supply, could adversely affect our ability to manufacture our products in a timely or cost-effective manner, and our ability to make product sales.

 

Many of our products are difficult to manufacture. This is due to the complex nature of manufacturing pharmaceuticals, including biologics, and devices as well as the strict regulatory regime governing our manufacturing operations. Variations in the manufacturing process may result in production failures which could lead to launch delays, product shortage, unanticipated costs, lost revenues and damage to our reputation. A failure to identify and address manufacturing problems prior to the release of products to our customers may also result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals or licenses.

 

Some of our manufacturing facilities are located in areas that are subject to hurricanes, earthquakes or other natural disasters. Loss or damage to a manufacturing facility could adversely affect our ability to manufacture sufficient quantities of key products to meet customer demand or contractual requirements which may result in a loss of revenue and other adverse business consequences. Because of the time required to approve and license a manufacturing facility a third party manufacturer may not be available on a timely basis to replace production capacity in the event we lose manufacturing capacity due to natural disaster, regulatory action or otherwise.

 

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

 

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

 

The patent position of a healthcare company is often uncertain and involves complex legal and factual questions. Significant litigation concerning patents and products is pervasive in our industry. Patent claims include challenges to the coverage and validity of our patents on products or processes as well as allegations that our products infringe patents held by competitors or other third parties. A loss in any of these types of cases could result in a loss of patent protection or the ability to market products, which could lead to a significant loss of sales, or otherwise materially affect future results of operations.

 

We also rely on trademarks, copyrights, trade secrets and know-how to develop, maintain and strengthen our competitive positions. While we protect our proprietary rights to the extent possible, we cannot guarantee that third parties will not know, discover or independently develop equivalent proprietary information or techniques, or that they will not gain access to our trade secrets or disclose our trade secrets to the public. Therefore, we cannot guarantee that we can maintain and protect unpatented proprietary information and trade secrets. Misappropriation or other loss of our intellectual property would have an adverse effect on our competitive position and may cause us to incur substantial litigation costs.

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

 

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

 

If we are unsuccessful in identifying growth opportunities or exiting low margin businesses or discontinuing low profit products, our business, financial condition and results could be adversely affected.

 

Successful execution of our business strategy depends, in part, on improving the profit margins we earn with respect to our current and future products. A failure to identify and take advantage of opportunities that allow us to increase our profit margins or a failure by us to exit low profit margin businesses or discontinue low profit margin products, may result in us failing to meet our financial targets and may otherwise have an adverse effect on our business, financial condition and results of operations.

 

We are subject to risks associated with doing business globally.

 

Our operations, both inside and outside the United States, are subject to risks inherent in conducting business globally and under the laws, regulations and customs of various jurisdictions and geographies. These risks include fluctuations in currency exchange rates, changes in exchange controls, loss of business in government and public tenders that are held annually in many cases, nationalization, increasingly complex labor environments, expropriation and other governmental actions, availability of raw materials, changes in taxation, including legislative changes in United States and international taxation of income earned outside of the United States, importation limitations, export control restrictions, changes in or violations of U.S. or local laws, including the FCPA, dependence on a few government entities as customers, pricing restrictions, economic and political instability, disputes between countries, diminished or insufficient protection of intellectual property, disruption or destruction of operations in a significant geographic region — due to the location of manufacturing facilities, distribution facilities or customers — regardless of cause, including war, terrorism, riot, civil insurrection or social unrest, or natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. Failure to comply with the laws and regulations that affect our global operations could have an adverse effect on our business, financial condition or results of operations.

 

We are subject to foreign currency exchange risk.

 

In 2010, we generated approximately 60% of our revenue outside the United States. We anticipate that revenue from outside the United States will continue to be significant. As a result, our financial results may continue to be adversely affected by fluctuations in foreign currency exchange rates. Market volatility and currency fluctuations may also reduce the benefits from our natural hedges and limit our ability to cost-effectively hedge against our foreign currency exposure. Governments may impose currency restrictions restricting our ability to manage our foreign currency exposure. We cannot predict with any certainty changes in foreign currency exchange rates or the degree to which we can mitigate these risks. A discussion of the financial impact of foreign exchange rate fluctuations, and the ways and extent to which we attempt to mitigate such impact, including the impact of restrictions on currency exchange imposed by the Venezuelan government, is contained under the heading “Financial Instrument Market Risk” in Item 7 of this Annual Report on Form 10-K.

We may experience difficulties implementing our new global enterprise resource planning system.

 

We are engaged in a multi-year implementation of a new global enterprise resource planning system (ERP). The ERP is designed to accurately maintain the company’s books and records and provide information to the company’s management team important to the operation of the business. The company’s ERP has required, and will continue to require, the investment of significant human and financial resources. We may not be able to successfully implement the ERP without experiencing delays, increased costs and other difficulties. Any significant disruption or deficiency in the design and implementation of the ERP could adversely affect our ability to process orders, ship product, send invoices and track payments, fulfill contractual obligations or otherwise operate our business.

 

We are subject to a number of pending lawsuits.

 

We are a defendant in a number of pending lawsuits, including with respect to patent and product liability matters, and could be subject to additional lawsuits in the future. See Note 11 in Item 8 of this Annual Report on Form 10-K for more information regarding these lawsuits. Given the uncertain nature of litigation generally, we are not able in all cases to estimate the amount or range of loss that could result from an unfavorable outcome of the litigation to which we are a party. In view of these uncertainties, we cannot assure that the outcome of these matters will not result in charges in excess of any established reserves, and, to the extent available, liability insurance. Protracted litigation, including any adverse outcomes, may have an adverse impact on the business, operations or financial condition of the company.

 

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

 

The company’s ability to generate cash flows from operations could be affected if there is a material decline in the demand for the company’s products, in the solvency of its customers or suppliers, or deterioration in the company’s key financial ratios or credit ratings. Current or worsening economic conditions may adversely affect our business and the business of our customers, including their ability to pay for our products and services, and the amount spent on healthcare generally. This could result in a decrease in the demand for our products and services, declining cash flows, longer sales cycles, slower adoption of new technologies and increased price competition. These conditions may also adversely affect certain of our suppliers, which could cause a disruption in our ability to produce our products.

 

 

None.

 

 

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

 

Baxter owns or has long-term leases on all of its manufacturing facilities. The company maintains 14 manufacturing facilities in the United States and its territories, including three in Puerto Rico. The company also manufactures in Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Costa Rica, the Czech Republic, Germany, India, Ireland, Italy, Japan, Malta, Mexico, the Philippines, Poland, Saudi Arabia, Singapore, Spain, Switzerland, Tunisia, Turkey and the United Kingdom. The majority of these facilities are shared by more than one of the company’s business segments. The company’s principal manufacturing facilities by segment are listed below:

 

 

 

The company also owns or operates shared distribution facilities throughout the world. In the United States and Puerto Rico, there are 12 shared distribution facilities with the principal facilities located in Memphis, Tennessee; Catano, Puerto Rico; North Cove, North Carolina; and Round Lake, Illinois. Internationally, we have more than 100 shared distribution facilities located in Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Costa Rica, the Czech Republic, Ecuador, France, Germany, Greece, Guatemala, Hong Kong, India, Ireland, Italy, Japan, Korea, Mexico, New Zealand, Panama, Peru, the Philippines, Poland, Portugal, Russia, Singapore, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, the United Arab Emirates, the United Kingdom and Venezuela.

 

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

 

 

Incorporated by reference to Note 11 in Item 8 of this Annual Report on Form 10-K.

 

 

Executive Officers of the Registrant

 

Robert L. Parkinson, Jr., age 60, is Chairman and Chief Executive Officer of Baxter, having served in that capacity since April 2004. Prior to joining Baxter, Mr. Parkinson was Dean of Loyola University Chicago School of Business Administration and Graduate School of Business from 2002 to 2004. He retired from Abbott Laboratories in 2001 following a 25-year career, having served in a variety of domestic and international management and leadership positions, including as President and Chief Operating Officer. Mr. Parkinson also serves on the Board of Directors of Chicago-based Northwestern Memorial HealthCare as well as Loyola University Chicago Board of Trustees.

 

Phillip L. Batchelor, age 49, is Corporate Vice President, Quality, having served in that capacity since April 2010. From April 2005 to April 2010, Mr. Batchelor served as Vice President for BioScience Global Operations. Prior to that, Mr. Batchelor served in a variety of positions in quality management and manufacturing.

 

Michael J. Baughman, age 46, is Corporate Vice President and Controller, having served in that capacity since May 2006. Mr. Baughman joined Baxter in 2003 as Vice President of Corporate Audit and was appointed Controller in March 2005. Before joining Baxter, Mr. Baughman spent 16 years at PricewaterhouseCoopers LLP, in roles of increasing responsibility, which included audit partner and partner in the firm’s mergers and acquisitions practice.

 

Robert M. Davis, age 44, is Corporate Vice President and President, Medical Products, having served in that capacity since October 2010. From May 2006 to July 2010, Mr. Davis served as Corporate Vice President and Chief Financial Officer and from July to October 2010, he was Corporate Vice President and President, Renal. Prior to joining Baxter as Treasurer in 2004, Mr. Davis was with Eli Lilly and Company from 1990.

 

J. Michael Gatling, age 61, is Corporate Vice President, Manufacturing, having served in that capacity since December 1996. Mr. Gatling is also responsible for the supply chain and environment, health and safety functions.

 

Ludwig N. Hantson, Ph.D., age 48, is Corporate Vice President and President, BioScience, having served in that capacity since October 2010. Dr. Hantson joined Baxter in May 2010 as Corporate Vice President and President, International. From 2001 to May 2010, Dr. Hantson held various positions at Novartis

Pharmaceuticals Corporation, the most recent of which was Chief Executive Officer, Pharma North America. Prior to Novartis, Dr. Hantson spent 13 years with Johnson & Johnson in roles of increasing responsibility in marketing and clinical research and development.

 

Robert J. Hombach, age 45, is Corporate Vice President, Chief Financial Officer and Treasurer, having served in that capacity since July 2010. From February 2007 to July 2010, Mr. Hombach served as Corporate Vice President and Treasurer and from December 2004 to February 2007, he was Vice President of Finance, Europe. Prior to that, Mr. Hombach served in a number of finance positions with increasing responsibility in the planning, manufacturing, operations and treasury areas.

 

Jeanne K. Mason, Ph.D., age 55, is Corporate Vice President, Human Resources. Prior to joining Baxter in May 2006, Dr. Mason was with General Electric from 1988, holding various leadership positions, the most recent of which was with GE Insurance Solutions, a primary insurance and reinsurance business, where she was responsible for global human resource functions.

 

Norbert G. Riedel, Ph.D., age 53, is Corporate Vice President and Chief Scientific Officer, having served in that capacity since May 2001. From 1998 to 2001, he served as President of the recombinant business unit of BioScience. Prior to joining Baxter, Dr. Riedel was head of worldwide biotechnology and worldwide core research functions at Hoechst Marion Roussel, now Sanofi-Aventis.

 

David P. Scharf, age 43, is Corporate Vice President and General Counsel, having served in that capacity since August 2009. Mr. Scharf joined Baxter in July 2005 and served in a number of positions, including Deputy General Counsel and Corporate Secretary. Prior to joining Baxter, Mr. Scharf was with Guidant Corporation from 2002, in roles of increasing responsibility.

 

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

PART II

 

 

The following table includes information about the company’s common stock repurchases during the three-month period ended December 31, 2010.

 

Issuer Purchases of Equity Securities

 

 

 

Additional information required by this item is incorporated by reference to Note 13 in Item 8 of this Annual Report on Form 10-K.

 

 

 

 

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

 

EXECUTIVE OVERVIEW

 

Description of the Company and Business Segments

Baxter International Inc. (Baxter or the company), 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. The company operates in three segments. BioScience 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; products for regenerative medicine, such as biosurgery products; and select vaccines. Medication Delivery 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, as well as provides products and services related to pharmacy compounding, drug formulation and packaging technologies. In October 2010, the company entered into an agreement to divest its U.S. generic injectables business. Refer to Note 3 for further information regarding this divestiture. Renal provides products to treat end-stage renal disease, or irreversible kidney failure. The business manufactures solutions and other products for peritoneal dialysis (PD), a home-based therapy, and also distributes products for hemodialysis (HD), which is generally conducted in a hospital or clinic. In October 2010, the company announced the formation of a new Medical Products business, combining the company’s Medication Delivery and Renal businesses into a single global business unit.

 

Baxter has approximately 48,000 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 faced a number of significant challenges in 2010, including the impact of the global economic environment, healthcare reform in the United States and abroad, and dynamics in the plasma proteins market. While these challenges negatively impacted the company’s sales growth and profitability, Baxter delivered solid financial results and executed on key commercial, operational and organizational strategies in 2010.

 

Baxter’s global net sales totaled $12.8 billion in 2010, an increase of 2% over 2009, including a favorable foreign currency impact of 1 percentage point. International sales totaled $7.6 billion, an increase of 5% over 2009, including a favorable foreign currency impact of 2 percentage points.

 

Baxter’s net income for 2010 totaled $1.4 billion, or $2.39 per diluted share, compared to $2.2 billion, or $3.59 per diluted share, in the prior year. Net income in 2010 included after-tax asset impairment, business optimization, litigation-related, in-process research and development (IPR&D) and other charges which reduced net sales by $213 million and net income by $946 million, or $1.59 per diluted share. Net income in 2009 included after-tax impairment, business optimization and other charges which reduced net income by $125 million, or $0.21 per diluted share. On an adjusted basis, excluding these special charges in both years, Baxter’s net income in 2010 was $2.4 billion, which represents an increase of 2% from $2.3 billion in 2009, while earnings per diluted share of $3.98 increased 5% from $3.80 in 2009. Adjusted net income and adjusted earnings per share, each excluding special items, are non-GAAP (generally accepted accounting principles) financial measures. The company believes that these non-GAAP measures may provide a more complete understanding of the company’s operations and may facilitate a fuller analysis of the company’s results of operations, particularly in evaluating performance from one period to another.

Significant items impacting the company’s results in 2010 included a $588 million pre-tax charge associated with the recall of the company’s COLLEAGUE infusion pumps from the U.S. market and other actions the company is undertaking outside of the United States, with $213 million recorded as a reduction of net sales and $375 million in cost of sales. This charge primarily reflected the costs associated with the execution of the final order issued in July 2010 by the U.S. Food and Drug Administration (FDA), which allows Baxter to offer replacement infusion pumps or monetary consideration to owners of COLLEAGUE pumps. Under the replacement option, customers may receive Spectrum infusion pumps manufactured by Sigma International General Medical Apparatus, LLC (SIGMA), a company in which Baxter has an equity stake. Net income in 2009 also included a $27 million pre-tax charge primarily related to planned retirement costs associated with the SYNDEO PCA Syringe Pump.

 

Also impacting the company’s results were costs associated with the company’s execution of certain strategies to optimize its business portfolio and organizational structure, including the following.

 

 

The company also recorded pre-tax charges in 2010 of $62 million related to litigation, $34 million related to IPR&D, $28 million to write down accounts receivable in Greece, and $39 million to write off a deferred tax asset as a result of a change in the tax treatment of reimbursements under the Medicare Part D retiree prescription drug subsidy program. In 2009, the company recorded a pre-tax impairment charge of $54 million associated with the discontinuation of the company’s SOLOMIX drug delivery system in development.

 

Baxter’s financial results included research and development (R&D) expenses totaling $915 million in 2010. This significant investment in R&D reflects the company’s efforts to enhance future growth through clinical differentiation, including the broadening of its hemophilia portfolio with continued innovation; exploration of alternative routes of administration of GAMMAGARD LIQUID (marketed as KIOVIG in most markets outside the United States), the liquid formulation of the company’s antibody replacement therapy, IGIV (immune globulin intravenous); and the development of home HD therapy. During the year, the company advanced a number of Phase III clinical trials and numerous earlier stage clinical trials of therapies that have the potential to impact the treatment and delivery of care for chronic diseases like Alzheimer’s disease, hemophilia, end-stage renal disease and immune deficiencies.

 

The company’s financial position remains strong, with cash flows from operations totaling $3.0 billion in 2010, a record level for the company, driven by strong working capital management. The company has continued to execute on its disciplined capital allocation framework, which was designed to optimize shareholder value creation through targeted investments in working capital and capital investments, share repurchases and dividends, and acquisitions and other business development initiatives to accelerate the company’s growth.

 

Capital investments totaled $963 million in 2010 as the company continues to invest in capacity across its businesses to support future growth. In addition, these investments were focused on projects that enhance the company’s cost structure and manufacturing capabilities, particularly as they relate to the company’s nutritional, anesthesia and PD products, as well as plasma and recombinant manufacturing platforms. A significant portion of the company’s investment in capital expenditures supports the company’s strategy of geographic expansion with select investments in growing markets. In addition, the company continues to invest to support the company’s ongoing strategic focus on R&D with the expansion of research facilities, manufacturing sites and laboratories.

The company also continued to return value to its shareholders in the form of share repurchases and dividends. During 2010, the company repurchased 30 million shares of common stock for $1.5 billion, and paid cash dividends to its shareholders totaling $688 million. Since 2007, the company has consistently raised the quarterly dividend rate, with increases of 20% in 2008, 12% in 2009 and 7% in 2010.

 

The company’s strong financial position also enabled several business development initiatives in 2010, including the following:

 

 

Strategic Objectives

Baxter is focusing 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. R&D innovation and scientific productivity will continue to be a key strategic priority. In 2011, the company will continue to invest in its R&D pipeline while enhancing the prioritization and management of R&D projects, ensuring that R&D expenditures match business growth strategies and leveraging the company’s core strengths to expand into new therapeutic areas.

 

In 2011, Baxter launched a global, multi-year business transformation initiative, with the goal of strengthening the company’s focus on disciplined innovation, commercial effectiveness, operational excellence, organizational effectiveness and accelerated growth. As part of this initiative, the company will seek opportunities to maximize its deployment of sales and marketing resources, and re-engineer certain global systems and processes, including quality, regulatory and financial systems, as the company reinvigorates its commitment to continuous improvement. The company also plans to pursue accelerated growth by fully capitalizing on Baxter’s diversified healthcare model in its business development opportunities, including acquisitions, collaborations and alliances. Through continued innovation, investment and collaboration, Baxter seeks to advance new therapies, improve the safety and cost-effectiveness of treatments and expand access to care.

 

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.

RESULTS OF OPERATIONS

 

Net Sales

 

Foreign currency favorably impacted net sales by 1 percentage point in 2010, as the impact of the strengthening of the U.S. Dollar relative to the Euro was more than offset by the weakening of the U.S. Dollar relative to other currencies, including the Australian Dollar, the Canadian Dollar and the Japanese Yen. Foreign currency unfavorably impacted net sales by 5 percentage points in 2009 due to the strengthening of the U.S. Dollar relative to other currencies, including the Euro and the British Pound.

 

Total net sales growth in 2010 was unfavorably impacted by 2 percentage points due to the COLLEAGUE infusion pump charge, which reduced net sales in the Medication Delivery segment by $213 million. Refer to Note 5 for further information regarding this charge. In addition, healthcare reform unfavorably impacted sales growth in 2010 by approximately 0.5 percentage points. Healthcare reform legislation enacted in the United States in the first quarter of 2010 increased Medicaid rebates and expanded the 340B Drug Pricing Program, primarily impacting the Recombinants, Plasma Proteins and Antibody Therapy product categories in the BioScience segment. Similar reform actions undertaken by governments outside the United States also unfavorably impacted sales growth.

 

BioScience  The following is a summary of sales by product category in the BioScience segment.

 

 

Net sales in the BioScience segment increased 1% and 5% in 2010 and 2009, respectively (with no impact from foreign currency in 2010 and an unfavorable foreign currency impact of 5 percentage points in 2009). Sales growth in the BioScience segment in both years was driven by increased demand across a majority of the product categories. The principal drivers were the following:

 

 

 

Medication Delivery  The following is a summary of sales by product category in the Medication Delivery segment.

 

 

Net sales in the Medication Delivery segment increased 3% and 2% in 2010 and 2009, respectively (with a favorable foreign currency impact of 2 percentage points in 2010 and an unfavorable foreign currency impact of 5 percentage points in 2009). The principal drivers were the following:

 

 

 

Renal  The following is a summary of sales by product category in the Renal segment.

 

 

Net sales in the Renal segment increased 5% in 2010 and decreased 2% in 2009 (with a favorable foreign currency impact of 3 percentage points in 2010 and an unfavorable foreign currency impact of 6 percentage points in 2009). The principal drivers were the following:

 

 

Transition Services to Fenwal Inc.  Net sales in this category represent revenues associated with manufacturing, distribution and other services provided by the company to Fenwal Inc. (Fenwal) subsequent to the divestiture of the Transfusion Therapies (TT) business in February 2007. Revenues declined in 2010 and 2009 as Baxter provided less transition services to Fenwal. See Note 3 for additional information regarding the TT business divestiture.

 

Gross Margin and Expense Ratios

 

 

Gross Margin

Gross margin declined in 2010 and increased in 2009. Included in the company’s gross margin percentages were the unfavorable impact of infusion pump charges and costs totaling $588 million (of which $375 million was recorded to cost of sales), $27 million and $125 million in 2010, 2009 and 2008, respectively, and the 2010 and 2009 business optimization charges, of which $132 million and $30 million were recorded in cost of sales in 2010 and 2009, respectively. These charges unfavorably impacted the gross margin by 4.7, 0.5 and 1.1 percentage points in 2010, 2009 and 2008, respectively. Refer to Note 5 for additional information on these charges and costs.

 

Also unfavorably impacting the gross margin percentage in 2010 were lower prices for certain plasma protein (including Antibody Therapy) products, cost inefficiencies driven by lower volume throughput for plasma-based therapies and vaccines, lower sales of high margin vaccines, increased inventory reserves and healthcare

reform in the United States and abroad. These items were partially offset by improved sales mix across other product lines, as well as a benefit from foreign currency.

 

The increase in gross margin in 2009 was principally driven by improvements in sales mix across all three segments, manufacturing cost and yield improvements, as well as improved pricing for select products. Contributing to the gross margin improvement was the continued customer conversion to ADVATE therapy; increased demand and improved pricing for GAMMAGARD LIQUID therapy and certain other plasma protein and nutritional products; and increased demand for IV solutions, global injectables and anesthesia products. Partially offsetting the gross margin improvement was the unfavorable impact of lower FSME-IMMUN vaccine revenues.

 

Marketing and Administrative Expenses

The marketing and administrative expense ratio increased in 2010 and declined in 2009. The increase in the marketing and administrative expense ratio in 2010 was driven by the $588 million COLLEAGUE infusion pump charge (of which $213 million was recorded to sales), the $257 million business optimization charge (of which $125 million was recorded in marketing and administrative expenses), and a $28 million charge to write down accounts receivable in Greece. These charges unfavorably impacted the marketing and administrative expense ratio by 1.5 percentage points in 2010.

 

The ratio in both years was favorably impacted by leverage from higher sales and the company’s continued focus on controlling discretionary spending, partially offset by increased spending relating to certain sales and promotional programs. Also impacting the marketing and administrative expense ratio in 2009 was the unfavorable impact of foreign currency and the $79 million business optimization charge (of which $49 million was recorded in marketing and administrative expenses), which increased the marketing and administrative expense ratio by 0.3 percentage points in 2009.

 

Refer to Note 1 for further information regarding the Greece receivable charge and Note 5 for further information about the COLLEAGUE infusion pump charge and the 2010 and 2009 business optimization charges.

 

Pension Plan Costs

Fluctuations in pension plan costs impacted the company’s gross margin and expense ratios. Pension plan costs increased $15 million in 2010 and $18 million in 2009, as detailed in Note 9. The $15 million increase in 2010 was principally due to lower interest rates used to discount the plans’ projected benefit obligations and an increase in loss amortization, partially offset by the impact of $350 million of cash contributions made to the pension plan in the United States in 2010. The $18 million increase in 2009 was principally due to an increase in loss amortization related to asset performance and demographic experience, partially offset by the impact of the company’s contributions to its pension plans and higher interest rates used to discount the plans’ projected benefit obligations as compared to the prior year.

 

Costs of the company’s pension plans are expected to increase from $170 million in 2010 to approximately $220 million in 2011, principally due to lower interest rates used to discount the plans’ projected benefit obligations, a decrease in the expected return on plan assets assumption, and an increase in loss amortization, partially offset by the impact of $150 million of discretionary cash contributions made to the pension plan in the United States in January 2011. Refer to Note 9 for further information on the funding of pension plans. For the domestic plans, the discount rate will decrease to 5.45% from 6.05% and the expected return on plan assets will decrease to 8.25% from 8.5% for 2011.

 

Research and Development

 

R&D expenses decreased slightly in 2010 and increased in 2009. The reduction in R&D expenses in 2010 was due to the completion of clinical work on late-stage programs, lower milestone payments to partners and efforts to reposition projects to gain organizational efficiencies. The company continues to invest in all key R&D programs across the product pipeline. The increase in 2009 reflected the company’s continued focus on innovation and investments across its business portfolio to advance and expand its product pipeline. Foreign currency had an unfavorable impact on R&D expense growth in 2010 and a favorable impact in 2009.

 

R&D expenses in 2010 included IPR&D charges totaling $34 million, principally related to the licensing and acquisition of the hemophilia-related intellectual property and other assets of Archemix. Refer to Note 4 for more information regarding this transaction. R&D expenses in 2008 included IPR&D charges totaling $19 million, principally related to an in-licensing agreement with Innocoll Pharmaceuticals Ltd. (Innocoll).

 

The company’s investments in R&D reflect its efforts to enhance future growth through clinical differentiation, including broadening the hemophilia portfolio with continued innovation, exploring alternative routes of administration of GAMMAGARD LIQUID, and developing a home hemodialysis system. Key developments in 2010 included the following R&D milestones, product approvals and product launches:

 

 

Net Interest Expense

Net interest expense decreased $11 million in 2010, principally due to an increase in interest income. Net interest expense increased $22 million in 2009, principally due to the impact of lower interest rates on interest income. Also contributing to the increase in net interest expense in 2009 was the impact of a higher average net debt balance due to the February 2009 issuance of $350 million of senior unsecured notes due in 2014 and

the August 2009 issuance of $500 million of senior unsecured notes due in 2019. Refer to Note 2 for a summary of the components of net interest expense for the three years ended December 31, 2010.

 

Other Expense, Net

Other expense, net was $159 million in 2010, $45 million in 2009 and $26 million in 2008. Refer to Note 2 for a table that details the components of other expense, net for the three years ended December 31, 2010. Other expense, net in each year included amounts relating to equity method investments and foreign currency fluctuations, principally relating to intercompany receivables, payables and loans denominated in a foreign currency.

 

Included in other expense, net in 2010 was an impairment charge of $112 million associated with the company’s agreement to divest its U.S. generic injectables business and a charge of $62 million associated with litigation related to the company’s 2008 recall of its heparin sodium injection products in the United States. In 2009, other expense, net included a charge of $54 million associated with the discontinuation of the company’s SOLOMIX drug delivery system in development. In 2008, other expense, net included a charge of $31 million associated with the discontinuation of the company’s CLEARSHOT pre-filled syringe program. Refer to Note 2 for further information on the litigation-related, SOLOMIX and CLEARSHOT charges.

 

Pre-Tax Income

Refer to Note 12 for a summary of financial results by segment. The following is a summary of significant factors impacting the segments’ financial results.

 

BioScience  Pre-tax income decreased 2% in 2010 and increased 5% in 2009. Sales growth for select higher-margin products in 2010 was more than offset by pricing pressures for certain plasma protein (including Antibody Therapy) products, manufacturing cost inefficiencies for plasma-based therapies and vaccines, the impact of healthcare reform and increased inventory reserves. Also contributing to the decline in pre-tax income was an expansion of certain sales resources and increased spending on new marketing and promotional programs.

 

The primary drivers of the increase in pre-tax income in 2009 were continued gross margin expansion driven by strong sales of higher-margin products, fueled principally by the continued customer adoption of ADVATE therapy and increased demand and improved pricing for GAMMAGARD LIQUID therapy and certain other plasma protein products, as well as continued manufacturing improvements. Partially offsetting the growth in 2009 was increased R&D spending, the unfavorable impact of lower FSME-IMMUN vaccine sales and the unfavorable impact of foreign currency.

 

Medication Delivery  Pre-tax income decreased 59% in 2010 and increased 28% in 2009. The decrease in 2010 was due to a $588 million COLLEAGUE infusion pump charge, an impairment charge of $112 million associated with the company’s agreement to divest its U.S. generic injectables business and a charge of $62 million associated with litigation related to the company’s 2008 recall of its heparin sodium injection products in the United States. Partially offsetting the negative impact of these charges were sales growth across multiple product categories, gross margin improvements, a reduction in R&D spending due to optimization efforts and the favorable impact of foreign currency.

 

Included in pre-tax income in 2009 and 2008 were $27 million and $125 million, respectively, of charges and other costs relating to the COLLEAGUE and SYNDEO infusion pumps. Also included in pre-tax income was a $54 million charge in 2009 related to the discontinuation of the company’s SOLOMIX drug delivery system in development and a $31 million charge in 2008 related to the discontinuation of the CLEARSHOT pre-filled syringe program. Aside from the impact of these items, pre-tax earnings in 2009 benefited from gross margin improvements resulting from favorable product mix, principally from increased sales of IV solutions, global injectables, anesthesia and nutritional products. Foreign currency had an unfavorable impact on growth in 2009.

 

Refer to Note 3 for further information on the U.S. generic injectables business impairment charge, Note 5 for further information on the infusion pump charges and Note 2 for further information on the litigation-related charge.

Renal  Pre-tax income increased 15% in 2010 and decreased 4% in 2009. The increase in 2010 was primarily due to continued growth of PD Therapy patients, partially offset by an inventory impairment charge due to manufacturing issues with certain PD solutions at the company’s Castlebar, Ireland facility. R&D spending in the Renal segment increased in both years, driven by costs associated with the development of a home hemodialysis system.

 

Other  Certain income and expense amounts are not allocated to a segment. These amounts are detailed in the table in Note 12 and include net interest expense, certain foreign exchange fluctuations (principally relating to intercompany receivables, payables and loans denominated in a foreign currency) and the majority of the foreign currency hedging activities, corporate headquarters costs, stock compensation expense, income and expense related to certain non-strategic investments, certain employee benefit plan costs, certain nonrecurring gains and losses, certain charges (such as the Greece receivables, business optimization and certain IPR&D charges), and the revenues and costs related to the manufacturing, distribution and other transition agreements with Fenwal.

 

Refer to the previous discussions for further information regarding net interest expense, the Greece receivables, business optimization and IPR&D charges, and Note 8 for further information regarding stock compensation expense.

 

Income Taxes

Effective Income Tax Rate

The effective income tax rate was 25% in 2010, 19% in 2009 and 18% in 2008. The company anticipates that the effective income tax rate, calculated in accordance with GAAP, will be approximately 20.5% to 21.5% in 2011, excluding any impact from additional audit developments or other special items.

 

The company’s effective tax rate differs from the U.S. federal statutory rate each year due to certain operations that are subject to tax incentives, state and local taxes and foreign taxes that are different than the U.S. federal statutory rate. In addition, as discussed further below, the company’s effective income tax rate can be impacted in each year by discrete factors or events. Refer to Note 10 for further information regarding the company’s income taxes.

 

2010

The increase in the effective tax rate in 2010 was principally due to a $588 million charge related to the recall of COLLEAGUE infusion pumps from the U.S. market for which there was no tax benefit recognized, a $39 million write-off of a deferred tax asset as a result of a change in the tax treatment of reimbursements under the Medicare Part D retiree prescription drug subsidy program under healthcare reform legislation enacted in the United States, a charge related to contingent tax matters, and $34 million of IPR&D charges for which the tax benefit was lower than the U.S. statutory rate. These items were partially offset by the tax benefits from the U.S. generic injectables business impairment charge, the business optimization charge and a charge related to litigation associated with the company’s 2008 recall of its heparin sodium injection products in the United States, in addition to a change in the earnings mix from higher tax to lower tax rate jurisdictions compared to the prior year period.

 

2009

The effective tax rate for 2009 was impacted by greater income in jurisdictions with higher tax rates, partially offset by $51 million of income tax benefit from the use of foreign tax losses.

 

2008

The effective tax rate for 2008 was impacted by $29 million of valuation allowance reductions on net operating loss carryforwards in foreign jurisdictions due to profitability improvements, $8 million of income tax benefit related to the extension of R&D tax credits in the United States and $14 million of additional U.S. income tax expense related to foreign earnings which were no longer considered indefinitely reinvested outside of the United States because the company planned to remit these earnings to the United States in the foreseeable future.

Uncertain Tax Positions

Baxter expects to reduce the amount of its liability for uncertain tax positions within the next 12 months by approximately $280 million due principally to the resolution of certain multi-jurisdictional transfer pricing issues and the expiration of certain statutes of limitation. While the final outcome of these matters is inherently uncertain, the company believes it has made adequate tax provisions for all years subject to examination.

 

Income and Earnings per Diluted Share Amounts

Net income attributable to Baxter was $1.4 billion in 2010, $2.2 billion in 2009 and $2.0 billion in 2008. The corresponding net earnings per diluted share were $2.39 in 2010, $3.59 in 2009 and $3.16 in 2008. The significant factors and events causing the net changes from 2009 to 2010 and from 2008 to 2009 are discussed above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flows from Operations

Cash flows from operations increased in both 2010 and 2009, totaling $3.0 billion in 2010, $2.9 billion in 2009 and $2.5 billion in 2008. The increases in cash flows in 2010 and 2009 were primarily due to higher earnings (before non-cash items) and the other factors discussed below.

 

Accounts Receivable

Cash flows relating to accounts receivable increased in 2010 and decreased in 2009. Days sales outstanding increased from 51.2 days at December 31, 2009 to 52.5 days at December 31, 2010, primarily due to longer collection periods in certain international markets and the geographic mix of sales. Days sales outstanding in the United States were less than 30 days. The decrease in cash flows in 2009 was primarily due to the geographic mix of sales, an increase in collection periods in certain international locations and a decrease in factoring of receivables, partially offset by improved collection periods in the United States.

 

Inventories

Cash flows from inventories improved in both 2010 and 2009. The following is a summary of inventories at December 31, 2010 and 2009, as well as inventory turns by segment for 2010, 2009 and 2008. Inventory turns for the year are calculated as the annualized fourth quarter cost of sales divided by the year-end inventory balance.

 

 

The higher inventory turns for the total company in 2010 were driven by a reduction of plasma-related inventories in the BioScience segment, as well as the favorable impact of the 2010 business optimization charge. Of the total charge, $132 million was recorded in cost of sales, which increased total company turns by 0.23. Refer to Note 5 for further information regarding this charge. The higher inventory turns for the total company in 2009 were principally due to increased sales in the Medication Delivery segment, partially offset by an increase of plasma-related inventories in the BioScience segment.

 

Other

Cash outflows related to liabilities, business optimization and restructuring payments and other increased in 2010 and decreased in 2009. Cash contributions to the company’s pension plans, which totaled $416 million, $170 million and $287 million in 2010, 2009 and 2008, respectively, were partially offset in each year by lower outflows relating to accounts payable and accrued liabilities.

Cash Flows from Investing Activities

Capital Expenditures

Capital expenditures totaled $963 million in 2010, $1.0 billion in 2009 and $954 million in 2008. The company’s investments in capital expenditures in 2010 were focused on projects that enhance the company’s cost structure and manufacturing capabilities, particularly as they relate to the company’s nutritional, anesthesia and PD products, as well as plasma and recombinant manufacturing platforms. A significant portion of the company’s investment in capital expenditures supports its strategy of geographic expansion with select investments in growing markets. In addition, the company continues to invest to support the company’s ongoing strategic focus on R&D with the expansion of research facilities, manufacturing sites and laboratories. Capital expenditures also included the company’s multi-year initiative to implement a global enterprise resource planning system that will consolidate and standardize business processes, data and systems.

 

The company makes investments in capital expenditures at a level sufficient to support the strategic and operating needs of the businesses, and continues to improve capital allocation discipline in making investments to enhance long-term growth. The company expects to invest approximately $1.0 billion in capital expenditures in 2011.

 

Acquisitions and Investments

Net cash outflows relating to acquisitions and investments were $319 million in 2010, $156 million in 2009 and $99 million in 2008.

 

The cash outflows in 2010 principally included a net cash outflow of $235 million related to the acquisition of ApaTech. Also included in net cash outflows in 2010 were payments of $30 million related to the licensing and acquisition of hemophilia-related intellectual property and other assets from Archemix, $28 million related to a manufacturing, supply and distribution agreement with Kamada for GLASSIA, and $18 million related to the company’s collaboration agreement for the development of a home HD machine with DEKA.

 

The cash outflows in 2009 principally related to a $100 million payment for the exclusive distribution of SIGMA’s infusion pumps in the United States and international markets, a 40 percent equity stake in SIGMA and an option to purchase the remaining portion of SIGMA. Additionally, in 2009 the company acquired Edwards CRRT for $56 million. Refer to Note 4 for further information regarding the acquisitions of and investments in ApaTech, Archemix, SIGMA and Edwards CRRT.

 

The cash outflows in 2008 principally related to an IV solutions business in China, the company’s in-licensing agreement to market and distribute Innocoll’s gentamicin surgical implant in the United States, the acquisition of certain technology applicable to the BioScience business, and payments related to the company’s agreements with Nycomed Pharma AS and Nektar Therapeutics.

 

Divestitures and Other

Net cash inflows relating to divestitures and other activities were $18 million in 2010, $24 million in 2009 and $60 million in 2008. Cash inflows in 2010 principally consisted of proceeds from the divestiture of certain Renal Therapy Services centers in Australia. Cash inflows in 2009 and 2008 principally consisted of cash collections related to the company’s securitization arrangements.

 

Cash Flows from Financing Activities

Debt Issuances, Net of Payments of Obligations

Debt issuances, net of payments of obligations, were net inflows totaling $91 million in 2010 and $473 million in 2009 and net outflows totaling $79 million in 2008.

 

In March 2010, the company issued $600 million of senior unsecured notes, with $300 million maturing in March 2013 and bearing a 1.8% coupon rate, and $300 million maturing in March 2020 and bearing a 4.25% coupon rate. In February 2009, the company issued $350 million of senior unsecured notes, which mature in March 2014 and bear a 4.0% coupon rate. In August 2009, the company issued $500 million of senior unsecured notes, which mature in August 2019 and bear a 4.5% coupon rate. In May 2008, the company issued $500 million of senior unsecured notes, maturing in June 2018 and bearing a 5.375% coupon rate. In

addition, during 2008, the company issued commercial paper, of which $200 million was outstanding as of December 31, 2008, with a weighted-average interest rate of 2.55%. The net proceeds from these issuances were used for general corporate purposes, including the refinancing of indebtedness, the repayment of $200 million of outstanding commercial paper in 2009 and the settlement of cross-currency swaps in 2008. In 2010, the company repaid its 4.75% $500 million notes and settled related cross-currency swaps, both upon their maturity in October 2010, resulting in a cash outflow of $545 million. In 2009, the company repaid approximately $160 million of outstanding borrowings related to the company’s Euro-denominated credit facility (further discussed below). The company repaid its 5.196% notes, which approximated $250 million, upon their maturity in February 2008.

 

Other Financing Activities

Cash dividend payments totaled $688 million in 2010, $632 million in 2009 and $546 million in 2008. In November 2008, the board of directors declared a quarterly dividend of $0.26 per share ($1.04 per share on an annualized basis), representing an increase of 20% over the previous quarterly rate. In November 2009, the board of directors declared a quarterly dividend of $0.29 per share ($1.16 per share on an annualized basis), representing an increase of 12% over the previous quarterly rate. In November 2010, the board of directors declared a quarterly dividend of $0.31 per share ($1.24 per share on an annualized basis), which was paid on January 5, 2011 to shareholders of record as of December 10, 2010. The dividend represented an increase of 7% over the previous quarterly rate of $0.29 per share.

 

Proceeds and realized excess tax benefits from stock issued under employee benefit plans totaled $381 million in both 2010 and 2009 and $680 million in 2008. In 2010, an increase in stock option exercises was offset by a decrease in realized excess tax benefits. The decrease in 2009 was due to a decrease in stock option exercises. Realized excess tax benefits, which were $41 million in 2010, $96 million in 2009 and $112 million in 2008, are presented in the consolidated statements of cash flows as an outflow in the operating section and an inflow in the financing section.

 

As authorized by the board of directors, the company repurchases its stock from time to time depending on the company’s cash flows, net debt level and market conditions. The company purchased 30 million shares for $1.5 billion in 2010, 23 million shares for $1.2 billion in 2009 and 32 million shares for $2.0 billion in 2008. In July 2009, the board of directors authorized the repurchase of up to $2.0 billion of the company’s common stock. At December 31, 2010, approximately $500 million remained available under the July 2009 authorization. In December 2010, the board of directors authorized the repurchase of up to an additional $2.5 billion of the company’s common stock. No shares had been repurchased under this authorization as of December 31, 2010.

 

Credit Facilities, Access to Capital, Credit Ratings and Net Investment Hedges

Credit Facilities

The company’s primary revolving credit facility has a maximum capacity of $1.5 billion and matures in December 2011. The company also maintains a Euro-denominated credit facility with a maximum capacity of approximately $400 million at December 31, 2010, which matures in January 2013. As of December 31, 2010 and 2009, there were no outstanding borrowings under either of the two outstanding facilities. The company’s facilities enable the company to borrow funds on an unsecured basis at variable interest rates (determined, in part, by the company’s credit ratings) and contain various covenants, including a maximum net-debt-to-capital ratio. At December 31, 2010, the company was in compliance with the financial covenants in these agreements. The non-performance of any financial institution supporting either of the credit facilities would reduce the maximum capacity of these facilities by each institution’s respective commitment. The company also maintains other credit arrangements, as described in Note 6.

 

Access to Capital

The company intends to fund short-term and long-term obligations as they mature through cash on hand, future cash flows from operations or by issuing additional debt or common stock. The company had $2.7 billion of cash and equivalents at December 31, 2010, with adequate cash available to meet operating requirements in each jurisdiction in which the company operates. The company invests its excess cash in

certificates of deposit and money market funds, and diversifies the concentration of cash among different financial institutions.

 

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

 

The company continues to do business with foreign governments in certain countries, including Greece, Spain, Portugal and Italy, that have experienced a deterioration in credit and economic conditions. While the economic downturn has not significantly impacted the company’s ability to collect receivables, global economic conditions and liquidity issues in certain countries have resulted, and may continue to result, in delays in the collection of receivables and credit losses. In 2010, the company recorded a charge of $28 million to write down its accounts receivable in Greece principally as a result of the Greek government’s plan to convert certain past due receivables into non-interest bearing bonds with maturities of one to three years. Refer to Note 1 for further information regarding this charge. Global economic conditions and customer-specific factors may require the company to re-evaluate the collectibility of its receivables and the company could potentially incur additional charges.

 

Credit Ratings

The company’s credit ratings at December 31, 2010 were as follows.

 

 

There were no changes in the company’s credit ratings in 2010. Standard & Poor’s downgraded the company’s outlook from Positive to Stable in 2010.

 

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

 

Net Investment Hedges

In 2008, the company terminated its remaining net investment hedge portfolio and no longer has any outstanding net investment hedges. Of the net settlement payments in 2008, $540 million of cash outflows were included as payments of obligations in the financing section and $12 million of cash inflows were included in the operating section of the consolidated statement of cash flows. The net after-tax losses related to net investment hedge instruments recorded in other comprehensive income were $33 million in 2008.

Contractual Obligations

As of December 31, 2010, the company had contractual obligations, excluding accounts payable, accrued liabilities (other than the current portion of unrecognized tax benefits) and contingent liabilities, including contingent milestone payments associated with joint development and commercialization arrangements, payable or maturing in the following periods.

 

 

 

Off-Balance Sheet Arrangements

Baxter periodically enters into off-balance sheet arrangements. Certain contingencies arise in the normal course of business, and are not recorded in the consolidated balance sheet in accordance with GAAP (such as contingent joint development and commercialization arrangement payments). Also, upon resolution of uncertainties, the company may incur charges in excess of presently established liabilities for certain matters (such as contractual indemnifications). For a discussion of the company’s significant off-balance sheet arrangements, refer to Note 6 to

the consolidated financial statements regarding joint development and commercialization arrangements and indemnifications, Note 7 regarding receivable securitizations and Note 11 regarding legal contingencies.

 

FINANCIAL INSTRUMENT MARKET RISK

 

The company operates on a global basis and is exposed to the risk that its earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange and interest rates. The company’s hedging policy attempts to manage these risks to an acceptable level based on the company’s judgment of the appropriate trade-off between risk, opportunity and costs. Refer to Note 7 for further information regarding the company’s financial instruments and hedging strategies.

 

Currency Risk

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

 

The company may use options, forwards and cross-currency swaps to hedge the foreign exchange risk to earnings relating to forecasted transactions denominated in foreign currencies and recognized assets and liabilities. The maximum term over which the company has cash flow hedge contracts in place related to forecasted transactions at December 31, 2010 is 18 months. The company also enters into derivative instruments to hedge certain intercompany and third-party receivables and payables and debt denominated in foreign currencies. The company historically hedged certain of its net investments in international affiliates, using a combination of debt denominated in foreign currencies and cross-currency swap agreements. As further discussed in Note 7, in 2008, the company terminated all of its remaining net investment hedges.

 

Currency restrictions enacted in Venezuela require Baxter to obtain approval from the Venezuelan government to exchange Venezuelan Bolivars for U.S. Dollars and require such exchange to be made at the official exchange rate established by the government. On January 8, 2010, the Venezuelan government devalued the official exchange rate of 2.15 relative to the U.S. Dollar. The official exchange rate for imported goods classified as essential, such as food and medicine, was changed to 2.6, while the rate for payments for non-essential goods was changed to 4.3. In 2010, the majority of the company’s products imported into Venezuela were classified as essential goods and qualified for the 2.6 rate. Effective January 1, 2011, the Venezuelan government devalued the official currency for imported goods classified as essential to 4.3. Since January 1, 2010, Venezuela has been designated as a highly inflationary economy under GAAP and as a result, the functional currency of the company’s subsidiary in Venezuela is the U.S. Dollar. The devaluation of the Venezuelan Bolivar and designation of Venezuela as highly inflationary did not have a material impact on the financial results of the company. As of December 31, 2010, the company’s subsidiary in Venezuela had net assets of $23 million denominated in the Venezuelan Bolivar. In 2010, net sales in Venezuela represented less than 1% of Baxter’s total net sales.

 

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

 

A sensitivity analysis of changes in the fair value of foreign exchange option and forward contracts outstanding at December 31, 2010, while not predictive in nature, indicated that if the U.S. Dollar uniformly fluctuated unfavorably by 10% against all currencies, on a net-of-tax basis, the net asset balance of $6 million with respect to those contracts would decrease by $41 million, resulting in a net liability position. A similar analysis performed with respect to option, forward and cross-currency swap contracts outstanding at December 31, 2009 indicated that, on a net-of-tax basis, the net liability balance of $69 million would increase by $69 million.

The sensitivity analysis model recalculates the fair value of the foreign exchange option and forward contracts outstanding at December 31, 2010 by replacing the actual exchange rates at December 31, 2010 with exchange rates that are 10% unfavorable to the actual exchange rates for each applicable currency. All other factors are held constant. These sensitivity analyses disregard the possibility that currency exchange rates can move in opposite directions and that gains from one currency may or may not be offset by losses from another currency. The analyses also disregard the offsetting change in value of the underlying hedged transactions and balances.

 

Interest Rate and Other Risks

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

 

As part of its risk management program, the company performs sensitivity analyses to assess potential gains and losses in earnings relating to hypothetical movements in interest rates. A 43 basis-point increase in interest rates (approximately 10% of the company’s weighted-average interest rate during 2010) affecting the company’s financial instruments, including debt obligations and related derivatives, would have an immaterial effect on the company’s 2010, 2009 and 2008 earnings and on the fair value of the company’s fixed-rate debt as of the end of each fiscal year.

 

As discussed in Note 7, the fair values of the company’s long-term litigation liabilities and related insurance receivables were computed by discounting the expected cash flows based on currently available information. A 10% movement in the assumed discount rate would have an immaterial effect on the fair values of those assets and liabilities.

 

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

 

CHANGES IN ACCOUNTING STANDARDS

 

Refer to Note 1 to the consolidated financial statements for recently adopted accounting pronouncements.

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of financial statements in accordance with GAAP requires the company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of the company’s significant accounting policies is included in Note 1. Certain of the company’s accounting policies are considered critical because these policies are the most important to the depiction of the company’s financial statements and require significant, difficult or complex judgments by the company, often requiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from the company’s estimates could have an unfavorable effect on the company’s results of operations and financial position. The company applies estimation methodologies consistently from year to year. Other than changes required due to the issuance of new accounting pronouncements, there have been no significant changes in the company’s application of its critical accounting policies during 2010. The company’s critical accounting policies have been reviewed with the Audit Committee of the Board of Directors. The following is a summary of accounting policies that the company considers critical to the consolidated financial statements.

Revenue Recognition and Related Provisions and Allowances

The company’s policy is to recognize revenues from product sales and services when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectibility is reasonably assured. The shipping terms for the majority of the company’s revenue arrangements are FOB destination. The recognition of revenue is delayed if there are significant post-delivery obligations, such as training, installation or other services.

 

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

 

Provisions for discounts, rebates to customers, chargebacks to wholesalers, and returns are provided for at the time the related sales are recorded, and are reflected as a reduction of sales. These estimates are reviewed periodically and, if necessary, revised, with any revisions recognized immediately as adjustments to sales.

 

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

 

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

 

Pension and Other Postemployment Benefit (OPEB) Plans

The company provides pension and other postemployment benefits to certain of its employees. These employee benefit expenses are reported in the same line items in the consolidated income statement as the applicable employee’s compensation expense. The valuation of the funded status and net periodic benefit cost for the plans are calculated using actuarial assumptions. These assumptions are reviewed annually, and revised if appropriate. The significant assumptions include the following:

 

 

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

The company’s key assumptions are listed in Note 9. The most critical assumptions relate to the plans covering U.S. and Puerto Rico employees, because these plans are the most significant to the company’s consolidated financial statements.

 

Discount Rate Assumption

For the U.S. and Puerto Rico plans, at the measurement date (December 31, 2010), the company used a discount rate of 5.45% and 5.40% to measure its benefit obligations for the pension plans and OPEB plan, respectively. This discount rate will be used in calculating the net periodic benefit cost for these plans for 2011. The company used a broad population of approximately 260 Aa-rated corporate bonds as of December 31, 2010 to determine the discount rate assumption. All bonds were denominated in U.S. Dollars, with a minimum amount outstanding of $50 million. This population of bonds was narrowed from a broader universe of over 500 Moody’s Aa rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top 10th percentile and bottom 40th percentile to adjust for any pricing anomalies and to represent the bonds Baxter would most likely select if it were to actually annuitize its pension and OPEB plan liabilities. This portfolio of bonds was used to generate a yield curve and associated spot rate curve, to discount the projected benefit payments for the U.S. and Puerto Rico plans. The discount rate is the single level rate that produces the same result as the spot rate curve.

 

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

 

To understand the impact of changes in discount rates on pension and OPEB plan cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point (i.e., one-half of one percent) increase (decrease) in the discount rate, global pre-tax pension and OPEB plan cost would decrease (increase) by approximately $37 million.

 

Return on Plan Assets Assumption

In measuring net periodic cost for 2010, the company used a long-term expected rate of return of 8.50% for the pension plans covering U.S. and Puerto Rico employees. For measuring the net periodic benefit cost for these plans for 2011, this assumption will decrease to 8.25%. This assumption is not applicable to the company’s OPEB plan because it is not funded.

 

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

 

To understand the impact of changes in the expected asset return assumption on net cost, the company performs a sensitivity analysis. Holding all other assumptions constant, for each 50 basis point increase (decrease) in the asset return assumption, global pre-tax pension plan cost would decrease (increase) by approximately $17 million.

 

Other Assumptions

The company used the Retirement Plan 2000 mortality table to calculate the pension and OPEB plan benefit obligations for its plans in the United States and Puerto Rico. For all other pension plans, the company utilized country and region-specific mortality tables to calculate the plans’ benefit obligations. The company periodically analyzes and updates its assumptions concerning demographic factors such as retirement, mortality and turnover, considering historical experience as well as anticipated future trends.

The assumptions relating to employee compensation increases and future healthcare costs are based on historical experience, market trends, and anticipated future company actions. Refer to Note 9 for information regarding the sensitivity of the OPEB plan obligation and the total of the service and interest cost components of OPEB plan cost to potential changes in future healthcare costs.

 

Legal Contingencies

The company is involved in product liability, patent, commercial, regulatory and other legal proceedings that arise in the normal course of business. Refer to Note 11 for further information. The company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. The company has established reserves for certain of its legal matters. The company is not able to estimate the amount or range of any loss for certain of the legal contingencies for which there is no reserve or additional loss for matters already reserved. The company also records any insurance recoveries that are probable of occurring. At December 31, 2010, total legal liabilities were $170 million and total insurance receivables were $87 million.

 

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

 

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

 

Inventories

The company values its inventories at the lower of cost, determined using the first-in, first-out method, or market value. Market value for raw materials is based on replacement costs and market value for work in process and finished goods is based on net realizable value. The company reviews inventories on hand at least quarterly and records provisions for estimated excess, slow-moving and obsolete inventory, as well as inventory with a carrying value in excess of net realizable value. The regular and systematic inventory valuation reviews include a current assessment of future product demand, anticipated release of new products into the market (either by the company or its competitors), historical experience and product expiration. Uncertain timing of product approvals, variability in product launch strategies, product recalls and variation in product utilization all impact the estimates related to inventory valuation. Additional inventory provisions may be required if future demand or market conditions are less favorable than the company has estimated. The company is not able to estimate the probability of actual results differing from expected results, but believes its estimates are appropriate.

 

Deferred Tax Asset Valuation Allowances and Reserves for Uncertain Tax Positions

The company maintains valuation allowances unless it is more likely than not that all or a portion of the deferred tax asset will be realized. Changes in valuation allowances are included in the company’s tax provision in the period of change. In determining whether a valuation allowance is warranted, the company evaluates factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. The

realizability assessments made at a given balance sheet date are subject to change in the future, particularly if earnings of a subsidiary are significantly higher or lower than expected, or if the company takes operational or tax planning actions that could impact the future taxable earnings of a subsidiary.

 

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

 

Fair Value Measurements of Financial Assets and Liabilities

For financial assets that are measured using quoted prices in active markets, the fair value is the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The majority of the derivatives entered into by the company are valued using internal valuation techniques as no quoted market prices exist for such instruments. The principal techniques used to value these instruments are discounted cash flow and Black-Scholes models. The key inputs, which are observable, depend on the type of derivative, and include contractual terms, counterparty credit risk, interest rate yield curves, foreign exchange rates and volatility. Refer to the Financial Instrument Market Risk section above for disclosures regarding sensitivity analyses performed by the company and Note 7 for further information regarding the company’s financial instruments.

 

In addition, the company’s pension plan assets and contingent payments related to acquisitions and investments are valued at fair value on a recurring basis. The valuation of pension assets, which are recorded net of the plan’s liabilities, depends on the type of security the plan holds. Principally, the securities are valued using quoted prices in active markets or pricing matrices or models that incorporate observable market data inputs. Refer to the Pension and OPEB Plans section above and Note 9 for further information on the company’s pension plans. Contingent payments are valued using a discounted cash flow technique that reflects management’s expectations about probability of payment. Refer to Note 4 for further information on the company’s contingent payments relating to acquisitions and investments.

 

Valuation of Intangible Assets, Including IPR&D

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

 

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

 

Beginning in 2009, the company adopted a new accounting standard for accounting for business combinations. Under this accounting standard, acquired IPR&D included in a business combination is capitalized as an indefinite-lived intangible asset and is no longer expensed at the time of the acquisition. Development costs incurred after the acquisition are expensed as incurred. Upon receipt of regulatory approval of the related technology or product, the indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the R&D project is abandoned, the indefinite-lived asset is charged to expense.

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

 

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

 

Impairment of Assets

Goodwill is subject to impairment reviews annually, and whenever indicators of impairment exist. Intangible assets other than goodwill and other long-lived assets (such as fixed assets) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Refer to Note 1 for further information. The company’s impairment reviews are based on an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings, and other assumptions and estimates. The estimates and assumptions used are consistent with the company’s business plans and a market participant’s views of the company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair values of the assets, and potentially result in different impacts to the company’s results of operations. Actual results may differ from the company’s estimates.

 

Stock-Based Compensation Plans

Stock-based compensation cost is estimated at the grant date based on the fair value of the award, and the cost is recognized as expense ratably over the substantive vesting period. Determining the appropriate fair value model to use requires judgment. Determining the assumptions that enter into the model is highly subjective and also requires judgment. The company’s stock compensation costs principally relate to awards of stock options, and the significant assumptions include long-term projections regarding stock price volatility, employee exercise, post-vesting termination and pre-vesting forfeiture behaviors, interest rates and dividend yields.

 

The company uses the Black-Scholes model for estimating the fair value of stock options. The company’s expected volatility assumption is based on an equal weighting of the historical volatility of Baxter’s stock and the implied volatility from traded options on Baxter’s stock. The expected life assumption is primarily based on historical employee exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield reflects historical experience as well as future expectations over the expected life of the option. The forfeiture rate used to calculate compensation expense is primarily based on historical pre-vesting employee forfeiture patterns. In finalizing its assumptions, the company also reviews comparable companies’ assumptions, as available in published surveys and in publicly available financial filings.

 

The pre-vesting forfeitures assumption is ultimately adjusted to the actual forfeiture rate. Therefore, changes in the forfeitures assumption would not impact the total amount of expense ultimately recognized over the vesting period. Estimated forfeitures are reassessed each period based on historical experience and current projections for the future.

 

The use of different assumptions would result in different amounts of stock compensation expense. The fair value of an option is particularly impacted by the expected volatility and expected life assumptions. To understand the impact of changes in these assumptions on the fair value of an option, the company performs sensitivity analyses. Holding all other variables constant, if the expected volatility assumption used in valuing the stock options granted in 2010 was increased by 100 basis points (i.e., one percent), the fair value of a stock option relating to one share of common stock would increase by approximately 4%, from $10.08 to $10.52. Holding all other variables constant (including the expected volatility assumption), if the expected life assumption used in valuing the stock options granted in 2010 was increased by one year, the fair value of a stock option relating to one share of common stock would increase by approximately 8%, from $10.08 to $10.90.

The company also grants performance share units (PSUs) as part of its stock compensation program. PSUs are earned by comparing the company’s growth in shareholder value relative to a performance peer group over a three-year period. Based on the company’s relative performance, the recipient of a PSU may earn a total award ranging from 0% to 200% of the initial grant. The fair value of a PSU is estimated by the company at the grant date using a Monte Carlo model. A Monte Carlo model uses stock price volatility and other variables to estimate the probability of satisfying the market conditions and the resulting fair value of the award. The three primary inputs for the Monte Carlo model are the risk-free rate, volatility of returns and correlation of returns. The determination of the risk-free rate is similar to that described above relating to the valuation of stock options. The expected volatility and correlation assumptions are based on historical information.

 

The company is not able to estimate the probability of actual results differing from expected results, but believes the company’s assumptions are appropriate, based upon the requirements of accounting standards for stock compensation and the company’s historical and expected future experience.

 

Hedging Activities

As further discussed in Note 7 and in the Financial Instrument Market Risk section above, the company uses derivative instruments to hedge certain risks. As Baxter operates on a global basis, there is a risk to earnings associated with foreign exchange relating to the company’s recognized assets and liabilities and forecasted transactions denominated in foreign currencies. Compliance with accounting standards for derivatives and hedging activities and the company’s hedging policies requires the company to make judgments regarding the probability of anticipated hedged transactions. In making these estimates and assessments of probability, the company analyzes historical trends and expected future cash flows and plans. The estimates and assumptions used are consistent with the company’s business plans. If the company were to make different assessments of probability or make the assessments during a different fiscal period, the company’s results of operations for a given period would be different.

 

CERTAIN REGULATORY MATTERS

 

In July 2005, the company stopped shipment of COLLEAGUE infusion pumps in the United States. Following a number of Class I recalls (recalls at the highest priority level for the FDA) relating to the performance of the pumps, as well as the seizure litigation described in Note 11, the company entered into a Consent Decree in June 2006. Additional Class I recalls related to remediation and repair and maintenance activities were addressed by the company in 2007 and 2009. Pursuant to the Consent Decree, in July 2010 the FDA issued a final order regarding the recall of the company’s COLLEAGUE infusion pumps currently in use in the United States. The company is executing the recall over the two years following the final order by offering its customers an option to replace their COLLEAGUE infusion pumps or receive monetary consideration. Under the replacement option, the company’s customers may receive SIGMA Spectrum infusion pumps in exchange for their COLLEAGUE infusion pumps. Alternatively, COLLEAGUE pump owners may receive the lesser of the pump’s depreciated value, which will be no less than $1,500 per single-channel pump and $3,000 per triple-channel pump, or the purchase price. The company will permit lessees to terminate their leases without penalty and will refund any prepaid, unused lease portion upon the return of the devices. As discussed in Note 5, following the FDA’s issuance of its initial order dated April 30, 2010, the company recorded a charge in the first quarter of 2010 related to the FDA’s order and other actions the company is undertaking outside the United States, in addition to a number of earlier charges in connection with its COLLEAGUE infusion pumps. As discussed in Note 11, the company received a subpoena from the Office of the United States Attorney for the Northern District of Illinois relating to the COLLEAGUE infusion pump in September 2009. It is possible that substantial additional cash and non-cash charges, including significant asset impairments related to the COLLEAGUE infusion pumps and related businesses, may be required in future periods based on new information, changes in estimates, the implementation of the recall in the United States, and other actions the company may be required to undertake in markets outside of the United States.

 

In June 2010, the company received a Warning Letter from the FDA in connection with an inspection of its Renal business’s McGaw Park, Illinois headquarters facility. The Warning Letter pertains to the processes by

which the company analyzes and addresses product complaints through corrective and preventative actions, and reports relevant information to the FDA. The company is working with the FDA to resolve these matters.

 

In January 2011, the company received a Warning Letter from the San Juan District Office of the FDA in connection with inspections of its Guayama and Jayuya, Puerto Rico facilities. The Warning Letter pertains to violations of Current Good Manufacturing Practices and the distribution of materials intended to assist customers with the use of certain nutrition products. Concerns about how the company investigates issues and reports relevant information to the FDA are also addressed. The company is working with the FDA to resolve these matters.

 

In January 2011, the European Medicines Agency (EMA) announced the review of Dianeal, Extraneal and Nutrineal peritoneal dialysis solutions manufactured in the company’s Castlebar, Ireland facility due to the potential presence of endotoxins in certain batches. The company is increasing supply of these products in its other manufacturing facilities as the EMA has allowed the company to temporarily import these products into the European Union. The company is working with the EMA to resolve these matters.

 

While the company continues to work to resolve the issues described above, there can be no assurance that additional costs or civil and criminal penalties will not be incurred, that additional regulatory actions with respect to the company will not occur, that the company will not face civil claims for damages from purchasers or users, that substantial additional charges or significant asset impairments may not be required, that sales of other products may not be adversely affected, or that additional regulation will not be introduced that may adversely affect the company’s operations and consolidated financial statements. See Item 1A of this Annual Report on Form 10-K for additional discussion of regulatory matters.

 

FORWARD-LOOKING INFORMATION

 

This annual report includes forward-looking statements, including statements with respect to accounting estimates and assumptions, litigation-related matters including outcomes, clinical trials, future regulatory filings and the company’s R&D pipeline, strategic plans including with respect to the global, multi-year business transformation initiative launched in 2011, credit exposure to foreign governments, potential developments with respect to credit ratings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, minimum funding requirements and rates of return, the company’s exposure to financial market volatility and foreign currency and interest rate risk, geographic expansion, business development activities, future capital and R&D expenditures, the impact of healthcare reform, the sufficiency of the company’s financial flexibility, the adequacy of credit facilities, tax provisions, properties and reserves, the effective tax rate in 2011, and all other statements that do not relate to historical facts. The statements are based on assumptions about many important factors, including assumptions concerning:

 

 

 

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

 

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

 

CONSOLIDATED BALANCE SHEETS

 

 

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

CONSOLIDATED STATEMENTS OF INCOME

 

 

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

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
AND COMPREHENSIVE INCOME