| DEBT, FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS | 8. DEBT, FINANCIAL INSTRUMENTS AND FAIR VALUE
MEASUREMENTS
Debt-for-equity exchanges
On January 27, 2016, Baxter exchanged Retained Shares for the
extinguishment of $1.45 billion aggregate principal amount
outstanding under its $1.8 billion U.S. dollar-denominated
revolving credit facility. This exchange extinguished the
indebtedness under the facility, which was terminated in connection
with such debt-for-equity exchange. There were no material
prepayment penalties or breakage costs associated with the
termination of the facility. Baxter recognized a net realized gain
of $1.25 billion related to the Retained Shares exchanged, which
was included in other income, net for the six months ended June 30,
2016.
On March 16, 2016, the company exchanged Retained Shares for the
extinguishment of approximately $2.2 billion in principal amount of
its 0.950% Notes due May 2016, 5.900% Notes due August 2016, 1.850%
Notes due January 2017, 5.375% Notes due May 2018, 1.850% Notes due
June 2018, 4.500% Notes due August 2019, and 4.250% Notes due
February 2020 purchased by certain third party purchasers in the
previously announced debt tender offers. As a result, the
company recognized a net loss on extinguishment of debt totaling
$101 million and a net realized gain of $2.0 billion on the
Retained Shares exchanged, which are included in other income, net
for the six months ended June 30, 2016.
Debt Maturities
In the second quarter of 2016, the company repaid the $190 million
outstanding balance of its 0.95% senior unsecured notes that
matured in June 2016.
Commercial paper
During the first six months of 2016, the company issued and
redeemed commercial paper, of which $781 million was outstanding as
of June 30, 2016 with a weighted-average interest rate of 0.76%.
There was a balance of $300 million outstanding at
December 31, 2015 with a weighted-average interest rate of
0.6%. This commercial paper is classified as short-term
debt.
Securitization arrangement
The following is a summary of the activity relating to the
company’s securitization arrangement in Japan.
Three months ended
Six months ended
(in millions)
2016
2015
2016
2015
Sold receivables at beginning of period $ 85 $ 96 $ 81 $104
Proceeds from sales of receivables 93 117 197 230
Cash collections (remitted to the owners of the receivables) (121 ) (105 ) (228 ) (225 )
Effect of currency exchange rate changes
5
(2 )
12
(3 )
Sold receivables at end of period $ 62 $ 106 $ 62 $106
The impacts on the condensed consolidated statements of income
relating to the sale of receivables were immaterial for each
period. Refer to the 2015 Annual Report for further information
regarding the company’s securitization arrangement.
Concentrations of credit risk
The company invests excess cash in certificates of deposit or money
market funds and diversifies the concentration of cash among
different financial institutions. With respect to financial
instruments, where appropriate, the company has diversified its
selection of counterparties, and has arranged collateralization and
master-netting agreements to minimize the risk of loss.
The company continues to do business with foreign governments in
certain countries, including Greece, Spain, Portugal and Italy,
that have experienced a deterioration in credit and economic
conditions. As of June 30, 2016, the company’s net accounts
receivable from the public sector in Greece, Spain, Portugal and
Italy totaled $183 million.
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. Governmental
actions and customer-specific factors may also require the company
to re-evaluate the collectability of its receivables and the
company could potentially incur additional credit losses. These
conditions may also impact the stability of the Euro.
Derivatives and hedging activities
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.
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, British Pound,
Chinese Yuan, Korean Won, Australian Dollar, Canadian Dollar,
Japanese Yen, Columbian Peso, Brazilian Real, Swedish Krona,
Mexican Peso, and New Zealand Dollar. The company manages its
foreign currency exposures on a consolidated basis, which allows
the company to net exposures and take advantage of any natural
offsets. In addition, the company uses derivative and nonderivative
instruments to further reduce the net exposure to foreign exchange.
Gains and losses on the hedging instruments offset losses and gains
on the hedged transactions and reduce the earnings and equity
volatility resulting from foreign exchange. Financial market and
currency volatility may limit the company’s ability to
cost-effectively hedge these exposures.
The company is also exposed to the risk that its earnings and cash
flows could be adversely impacted by fluctuations in interest
rates. The company’s policy is to manage interest costs using
a mix of fixed- and floating-rate debt that the company believes is
appropriate.
To manage this mix in a cost-efficient manner, the company
periodically enters into interest rate swaps in which the company
agrees to exchange, at specified intervals, the difference between
fixed and floating interest amounts calculated by reference to an
agreed-upon notional amount.
The company does not hold any instruments for trading purposes and
none of the company’s outstanding derivative instruments
contain credit-risk-related contingent features.
All derivative instruments are recognized as either assets or
liabilities at fair value in the condensed consolidated balance
sheets and are classified as short-term or long-term based on the
scheduled maturity of the instrument. Based upon the exposure being
hedged, the company designates its hedging instruments as cash flow
or fair value hedges.
Cash Flow Hedges
The company may use options, including collars and purchased
options, forwards and cross-currency swaps to hedge the foreign
exchange risk to earnings relating to forecasted transactions and
recognized assets and liabilities.
For each derivative instrument that is designated and effective as
a cash flow hedge, the gain or loss on the derivative is
accumulated in accumulated other comprehensive income (AOCI) and
then recognized in earnings consistent with the underlying hedged
item. Option premiums or net premiums paid are initially recorded
as assets and reclassified to other comprehensive income (OCI) over
the life of the option, and then recognized in earnings consistent
with the underlying hedged item. Cash flow hedges are classified in
net sales, cost of sales, and net interest expense, and primarily
relate to forecasted third-party sales denominated in foreign
currencies, forecasted intercompany sales denominated in foreign
currencies, and anticipated issuances of debt, respectively.
The notional amounts of foreign exchange contracts were $497
million and $378 million as of June 30, 2016 and December 31,
2015, respectively. There were no outstanding interest rate
contracts designated as cash flow hedges as of June 30, 2016 and
December 31, 2015. The maximum term over which the company has cash
flow hedge contracts in place related to forecasted transactions as
of June 30, 2016 is 18 months.
Fair Value Hedges
The company uses interest rate swaps to convert a portion of its
fixed-rate debt into variable-rate debt. These instruments hedge
the company’s earnings from changes in the fair value of debt
due to fluctuations in the designated benchmark interest rate. For
each derivative instrument that is designated and effective as a
fair value hedge, the gain or loss on the derivative is recognized
immediately to earnings, and offsets the loss or gain on the
underlying hedged item. Fair value hedges are classified in net
interest expense, as they hedge the interest rate risk associated
with certain of the company’s fixed-rate debt.
The total notional amount of interest rate contracts designated as
fair value hedges was $535 million and $1.3 billion as of June 30,
2016 and December 31, 2015, respectively. The decrease is due
to swaps terminated in conjunction with the previously mentioned
debt-for-equity exchanges.
Dedesignations
If it is determined that a derivative or nonderivative hedging
instrument is no longer highly effective as a hedge, the company
discontinues hedge accounting prospectively. If the company removes
the cash flow hedge designation because the hedged forecasted
transactions are no longer probable of occurring, any gains or
losses are immediately reclassified from AOCI to earnings. Gains or
losses relating to terminations of effective cash flow hedges in
which the forecasted transactions are still probable of occurring
are deferred and recognized consistent with the loss or income
recognition of the underlying hedged items.
There were no hedge dedesignations in the first six months of 2016
or 2015 resulting from changes in the company’s assessment of
the probability that the hedged forecasted transactions would
occur.
If the company terminates a fair value hedge, an amount equal to
the cumulative fair value adjustment to the hedged items at the
date of termination is amortized to earnings over the remaining
term of the hedged item. In March 2016, the company terminated a
total notional value of $765 million of interest rate contracts in
connection with the March debt tender offers, resulting in a $34
million reduction to the debt extinguishment loss. There were no
fair value hedges terminated during the first half of 2015.
Undesignated Derivative Instruments
The company uses forward contracts to hedge earnings from the
effects of foreign exchange relating to certain of the
company’s intercompany and third-party receivables and
payables denominated in a foreign currency. These derivative
instruments are generally not formally designated as hedges, and
the change in fair value, which substantially offsets the change in
book value of the hedged items, is recorded directly to other
expense (income), net. The terms of these instruments generally do
not exceed one month.
The total notional amount of undesignated derivative instruments
was $691 million as of June 30, 2016 and $580 million as of
December 31, 2015.
Gains and Losses on Derivative Instruments
The following tables summarize the income statement locations and
gains and losses on the company’s derivative instruments for
the three months ended June 30, 2016 and 2015.
Gain (loss) recognized in OCI
Location of gain (loss) in income statement
Gain (loss) reclassified from AOCI
(in millions)
2016
2015
2016
2015
Cash flow hedges
Foreign exchange contracts
(7 )
(19 )
Cost of sales
(2 )
15
Total $(7 ) $(19 ) $(2 ) $15
Gain (loss) recognized in income
(in millions)
Location of gain (loss) in income statement
2016
2015
Fair value hedges
Interest rate contracts
Net interest expense $ 4 $(72 )
Undesignated derivative instruments
Foreign exchange contracts
Other income, net
$(11 )
$(17 )
The following tables summarize the income statement locations and
gains and losses on the company’s derivative instruments for
the six months ended June 30, 2016 and 2015.
Gain (loss) recognized in OCI
Location of gain (loss) in income statement
Gain (loss) reclassified from AOCI
(in millions)
2016
2015
2016
2015
Cash flow hedges
Interest rate contracts
$ — $— Other income, net $ 4 $—
Foreign exchange contracts — (1 ) Net sales — —
Foreign exchange contracts
(11 )
45
Cost of sales
(1 )
40
Total $(11 ) $44 $ 3 $40
Gain (loss) recognized in income
(in millions)
Location of gain (loss) in income statement
2016
2015
Fair value hedges
Interest rate contracts
Net interest expense $ 26 $(25 )
Undesignated derivative instruments
Foreign exchange contracts
Other income, net
$ (5 )
$(25 )
For the company’s fair value hedges, equal and offsetting
losses of $4 million and $26 million were recognized in net
interest expense in the second quarter and first half of 2016,
respectively, and equal and offsetting gains of $72 million and $25
million were recognized in net interest expense in the second
quarter and first half of 2015, respectively, as adjustments to the
underlying hedged item, fixed-rate debt. Ineffectiveness
related to the company’s cash flow and fair value hedges for
the six months ended June 30, 2016 was not material.
As of June 30, 2016, $5 million of deferred, net after-tax losses
on derivative instruments included in AOCI are expected to be
recognized in earnings during the next 12 months, coinciding with
when the hedged items are expected to impact earnings.
Fair Values of Derivative Instruments
The following table summarizes the classification and fair values
of derivative instruments reported in the condensed consolidated
balance sheet as of June 30, 2016.
Derivatives in asset
positions
Derivatives in liability positions
(in millions)
Balance sheet location
Fair value
Balance sheet location
Fair value
Derivative instruments designated as hedges
Interest rate contracts
Other long-term assets $ 37 Other long-term liabilities
$ —
Foreign exchange contracts
Prepaid expenses and other 10
Accounts payable and accrued liabilities
2
Foreign exchange contracts
Other long-term assets
1
Other long-term liabilities
—
Total derivative instruments designated as hedges $ 48 $ 2
Undesignated derivative instruments
Foreign exchange contracts
Prepaid expenses and other
$ —
Accounts payable and accrued liabilities
$ 1
Total derivative instruments $ 48 $ 3
The following table summarizes the classification and fair values
of derivative instruments reported in the condensed
consolidated balance sheet as of December 31, 2015.
Derivatives in asset positions
Derivatives in liability
positions
(in millions)
Balance sheet location
Fair value
Balance sheet location
Fair value
Derivative instruments designated as hedges
Interest rate contracts Other long-term assets $ 46 Other long-term liabilities
$ —
Foreign exchange contracts
Prepaid expenses and other
9
Accounts payable and
1
Total derivative instruments designated as hedges $ 55 $ 1
Undesignated derivative instruments
Foreign exchange contracts
Prepaid expenses and other
$ 1
Accounts payable and
$ 1
Total derivative instruments $ 56 $ 2
While the company’s derivatives are all subject to
master-netting arrangements, the company presents its assets and
liabilities related to derivative instruments on a gross basis
within the condensed consolidated balance
sheets. Additionally, the company is not required to post
collateral for any of its outstanding derivatives.
The following table provides information on the company’s
derivative positions as if they were presented on a net basis,
allowing for the right of offset by counterparty.
June 30, 2016
December 31, 2015
(in millions)
Asset
Liability
Asset
Liability
Gross amounts recognized in the consolidated balance sheet $48 $ 3 $56 $ 2
Gross amount subject to offset in master-netting arrangements not
offset in the
(3 )
(3 )
(2 )
(2 )
Total $45 $— $54 $—
Fair value measurements
The following tables summarize the basis used to measure financial
assets and liabilities that are carried at fair value on a
recurring basis in the condensed consolidated balance sheets.
Basis of fair value
measurement
(in millions)
Balance as of June 30, 2016
Quoted prices in active markets for identical assets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges
$ 11 $—
$ 11 $—
Interest rate hedges 37 — 37 —
Available-for-sale securities
10
10
—
—
Total assets
$ 58 $10
$ 48 $—
Liabilities
Foreign currency hedges
$ 3 $—
$ 3 $—
Contingent payments related to acquisitions
21
—
—
21
Total liabilities
$ 24 $—
$ 3 $21
Basis of fair value
measurement
(in millions)
Balance as of December 31, 2015
Quoted prices in active markets for identical assets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Assets
Foreign currency hedges
$ 10 $—
$ 10 $—
Interest rate hedges 46 — 46 —
Available-for-sale securities
5,162
14
5,148
—
Total assets $5,218 $14 $5,204 $—
Liabilities
Foreign currency hedges
$ 2 $—
$ 2 $—
Contingent payments related to acquisitions
20
—
—
20
Total liabilities
$ 22 $—
$ 2 $20
As of June 30, 2016, cash and equivalents of $2.6 billion included
money market funds of approximately $676 million, and as of
December 31, 2015, cash and equivalents of $2.2 billion
included money market funds of approximately $500 million. Money
market funds would be considered Level 2 in the fair value
hierarchy.
For 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. As of June 30, 2016, the company had disposed of the
remainder of its Retained Shares of Baxalta. The investment in
the Retained Shares of $5.1 billion as of December 31, 2015 was
categorized as a Level 2 security as these securities were not
registered as of that date. The value of this investment was
based on Baxalta’s common stock price as of December 31,
2015, which represents an identical equity instrument registered
under the Securities Act of 1933, as amended. 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 are considered observable and vary depending on the type
of derivative, and include contractual terms, interest rate yield
curves, foreign exchange rates and volatility.
Contingent payments related to acquisitions consist of commercial
milestone payments and sales-based payments, and are valued using
discounted cash flow techniques. The fair value of commercial
milestone payments reflects management’s expectations of
probability of payment, and increases as the probability of payment
increases or expectation of timing of payments is accelerated. The
fair value of sales-based payments is based upon
probability-weighted future revenue estimates, and increases as
revenue estimates increase, probability weighting of higher revenue
scenarios increase or expectation of timing of payment is
accelerated. Changes in the fair value of contingent payments
related to Baxter’s acquisitions, which use significant
unobservable inputs (Level 3) in the fair value measurement, were
immaterial during the first half of 2016. The company made minor
sales-based payments in the first six months of 2016.
The following table provides information relating to the
company’s investments in available-for-sale equity
securities.
(in millions) Amortized cost
Unrealized gains
Unrealized losses Fair value
June 30, 2016 $ 12
$ — $ 2
$ 10
December 31, 2015
$732
$4,430
$—
$5,162
In the second quarter and first six months of 2016 the company
recorded $1.1 billion and net $4.4 billion, respectively, of
realized gains within other income, net related to exchanges of
available-for-sale equity securities, which represented gains from
the Retained Shares transactions. On May 6, 2016, Baxter made a
voluntary non-cash contribution of 17,145,570 Retained Shares to
the company’s U.S. pension fund. The company recorded $611
million of realized gains within other income, net related to the
contribution of Retained Shares. On May 26, 2016, Baxter completed
an exchange of 13,360,527 Retained Shares for 11,526,638
outstanding shares of Baxter common stock. The company recorded
$537 million of realized gains within other income, net related to
the exchange of the Retained Shares. The company held no
shares of Baxalta as of June 30, 2016. Refer to the
debt-for-equity exchange section above for discussion related to
the first quarter 2016 Retained Shares transactions. The
company did not have any sales of available-for-sale or equity
method investments in the first six months of 2015.
Book Values and Fair Values of Financial Instruments
In addition to the financial instruments that the company is
required to recognize at fair value in the condensed consolidated
balance sheets, the company has certain financial instruments that
are recognized at historical cost or some basis other than fair
value. For these financial instruments, the following table
provides the values recognized in the condensed consolidated
balance sheets and the approximate fair values as of June 30, 2016
and December 31, 2015.
Book values
Approximate fair values
(in millions)
2016
2015
2016
2015
Assets
Investments $ 29
$ 21 $ 29
$ 21
Liabilities
Short-term debt $ 791 $1,775 $ 791 $1,775
Current maturities of long-term debt and lease obligations 283 810 285 818
Long-term debt and lease obligations
2,094
3,922
2,308
4,077
The following tables summarize the basis used to measure the
approximate fair value of the financial instruments as of June 30,
2016 and December 31, 2015.
Basis of fair value
measurement
(in millions)
Balance as of June 30, 2016
Quoted prices in active markets for identical assets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Assets
Investments
$ 29
$—
$ 2
$27
Total assets
$ 29 $—
$ 2 $27
Liabilities
Short-term debt $ 791 $— $ 791 $—
Current maturities of long-term debt and lease obligations 285 — 285 —
Long-term debt and lease obligations
2,308
—
2,308
—
Total liabilities $3,384 $— $3,384 $—
Basis of fair value
measurement
(in millions)
Balance as of December 31, 2015
Quoted prices in active markets for identical assets (Level 1)
Significant other observable inputs (Level 2)
Significant unobservable inputs (Level 3)
Assets
Investments
$ 21
$—
$ 2
$19
Total assets
$ 21 $—
$ 2 $19
Liabilities
Short-term debt $1,775 $— $1,775 $—
Current maturities of long-term debt and lease obligations 818 — 818 —
Long-term debt and lease obligations
4,077
—
4,077
—
Total liabilities $6,670 $— $6,670 $—
Investments in 2016 and 2015 included certain cost method
investments and held-to-maturity debt securities.
The fair value of held-to-maturity debt securities is calculated
using a discounted cash flow model that incorporates observable
inputs, including interest rate yields, which represents a Level 2
basis of fair value measurement.
In determining the fair value of cost method investments, the
company takes into consideration recent transactions, as well as
the financial information of the investee, which represents a Level
3 basis of fair value measurement.
The estimated fair values of current and long-term debt were
computed by multiplying price by the notional amount of the
respective debt instrument. Price is calculated using the stated
terms of the respective debt instrument and yield curves
commensurate with the company’s credit risk. The carrying
values of the other financial instruments approximate their fair
values due to the short-term maturities of most of these assets and
liabilities. |
