BAXTER INTERNATIONAL 1

Baxter International

Name

Institution

Date
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Industry Overview: Pharmaceutical Industry

In the last few decades, the U.S. pharmaceutical industry has been experiencing rapid

growth. This has been the case since the passage of the Affordable Care Act, popularly known as

Obamacare. By 2015, Obamacare had rapidly expanded its coverage experiencing an addition of

16.9 million people who were under this coverage (Ellis, 2016). Many Americans have since

gained enough access to the medications they need to treat chronic and acute conditions. This

growth is attributed to the recent increase in overall health care spending in the U.S. The U.S.

citizens are the leading population in the world of prescription drug spending. This population

represents 30-40 percent of the total world prescription spending. This has made the United

States attract many of the global pharmaceutical companies. By 2007, it was reported that 40

percent of the worlds 6,500 drugs had their origin in the U.S. However, there has been reduction

in research efforts in the recent times. This may be attributed to the slowing rate of research

funding. Other factors that have led to this decline include inflationary losses, budget cuts, and

increases in development costs.

It is estimated that there was a reduction in the NIH budget for research between financial

year 2003 and financial year 2015. This accounted for a decrease of 22 percent. However, the

Congress increased this spending by a slight percentage of 5.9 percent. However, this was seen

by experts as a small increase due to the resources needed for research. This decline in funding

has slightly affected the U.S. pharmaceutical industry leading to declines in profitability.

The U.S. pharmaceutical industry has four out of the worlds top ten companies based in

the U.S. These companies are very active in research and development and production of drugs.

Pfizer is the market leader in the pharmaceutical industry followed by Merck, AstraZeneca,

Novartis, and Eli Lilly, in that order. The five companies are attributed for 30.4 percent of the

U.S. pharmaceutical industrys market share. Two companies in the pharmaceutical sector are
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going to be reviewed in terms of 2015 and 2016 financial ratios. These companies include Merck

and AstraZeneca, being some of the pharmaceutical companies with the best gross profit

margins. These companies have been so as to enable in reviewing the U.S. pharmaceutical

industry and for comparison with Baxter.

Merck and AstraZeneca Profit Margins

In 2015, Merck and AstraZeneca had gross profit margins of 62.2 percent and 81 percent,

respectively (Morning Star, 2016a; Morning Star, 2016b). In 2016, these profit margins rose to

65.1 percent and 82 percent, respectively. The profit margins for the two companies have been a

way better compared to the overall industry average. While AstraZeneca was way above the

industry average of 63.9 percent, Mercks gross profit margins were around the industry average.

In terms of SG&A margins, Merck had an SG&A of 26.11 in 2015 which then dropped to 24.52

in 2016 (Morning Star, 2016a). In 2015, AstraZeneca had an SG&A of 46.35 which then

dropped to 42.34 in 2016 (Morning Star, 2016b). Astra Zenecas SG&A for both financial years

were around the industry average of 41.5 percent. However, Mercks SG&A for both financial

years were way below the industry average of 41.5 percent. Both companies for the two financial

years, the EBIT margins were almost equal.

In 2015, Merck and AstraZeneca had EBIT margins of 13.67 percent and 12.42 percent,

respectively.In 2016, Merck and AstraZeneca had EBIT margins of 11.70 percent and 15.44

percent, respectively (Morning Star, 2016a; Morning Star, 2016b). Almost all the major

pharmaceutical companies in the U.S. hover around this number. In terms of net profit margin,

Merck and AstraZeneca had net profit margins of 11.25 percent and 11.43 percent in 2015. In

2016, Merck and AstraZeneca recorded net profit margins of 9.85 percent and 15.21 percent,

respectively. Both companies had net profit margins below the industry average.
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Baxters International Profit Ratio Analysis.

In the financial years 2015 and 2016, Baxter had gross profit margins of 41.6 percent and

40.4 percent, respectively. These profit margins are way far below the profit margins recorded by

major players Merck and AstraZeneca. However, these gross profit margin ratios for Baxter

were in consistent with its revenue growth over that period. In 2015, Baxter recorded the gross

profit of $9.968 million. The company recorded an increase in revenue in 2016 where it recorded

revenues amounting to $10,163 million. In terms of SG&A, Baxter recorded SG&As of 31.04

percent and 26.95 percent in financial years 2015 and 2016, respectively. This shows that

Baxters SG&A for both financial years were above those of Merck which were 26.11 in 2015

and 24.52 in 2016. This implies that Baxter is doing better in terms of SG&A compared to

Merck. However, Baxters SG&As were far below those of AstraZeneca which were 46.35 in

2015 and 42.34 in 2016. This implies that Baxter has to improve in terms of SG&A so as to

compete with AstraZeneca. Baxter recorded EBIT margins of 4.29 percent which later rapidly

rose to 48.75.

Despite not reaching the levels of Merck and AstraZeneca, it is clear, from its financial

statements that Baxter is one of the players in the pharmaceutical industry that has a promising

future in terms of profitability. Baxter generates great revenues, gross profits, and net income as

it is revealed by its income statements for the financial years 2015 and 2016.

Company Description: Baxter International

Baxter International prides as one of the Fortune 500 companies. Baxter has its

headquarters in Deerfield, Illinois. The primary products of Baxter International include products

for the treatment of chronic and acute disease, immune disorders, kidney disease, and

hemophilia. Baxter was founded in 1931 as a company for manufacturing and distribution of
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intravenous therapy solutions. Its first manufacturing was opened in 1933, in Glenview, Illinois.

Ralph Falk is the one who bought Baxters interest and immediately established an R&D

function in the company. From 1954 when it opened an office in Belgium, the company has

continued engaging in global expansion activities with it opening a major manufacturing plant in

Ashdod, Israel, in 1971. Currently, Baxter has manufacturing plants in more than 20 countries

around the world. In addition, Baxter sells its products in more than 100 countries around the

world. Its main customers include hospitals, individual patients, rehabilitation centers, nursing

homes, doctors offices, and kidney dialysis centers.

Impacts and Risks of International Trade

International trade brings certain impacts and risks to financial statements of many

companies (Sicilano&Zuvich, 2006). Global competition among pharmaceutical companies has

been significantly expanding. This makes companies become exposed to multiplicity of risks that

are related to international trade activities. International business is increasingly being

accompanied by heightened security concerns which have led to increased government scrutiny.

International trade risks are more complicated compared to other business risks. There are

various risk management approaches that businesses use depending on the nature of the product,

the countries involved, the financial impact of noncompliance, the size of the company, and the

companys overall export/import structure. There are various voluntary self-governance

programs that are used by companies. These programs are offered by the U.S. government

provided that these programs will not be audited (Sicilano&Zuvich, 2006).

The first factor that exposes Baxter to risks related to international trade is the

requirement by the U.S for the company (like other multinationals) to exercise reasonable care

when classifying and determining the value of its products and all the other forms of information
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needed by Customs to assess duties and collect statistics to enable it determine whether the

transactions meets all the legal requirements. If Baxter fails to exercise reasonable care, it could

encounter a delay in releasing of its products, and in other cases result in imposition of penalties

on these products. This may significantly affect the revenues of the company.

The other risks that Baxters financial statements are exposed to are interest rates and

other related risks (Sicilano&Zuvich, 2006). The financial statements that are adversely affected

by regular fluctuations in interest rates are earnings and cash flow statements. Baxter has in place

a policy of managing interest costs. Under this policy, the company has a combination of

floating-rate and fixed rate debt. The management believes that the two arevery appropriate for

the management of this type of risk. However, the company must make sure that it uses a cost

efficient manner to manage this mix. To achieve this, Baxter engages in a periodic interest rate

swaps. Under these swaps, Baxter exchanges, at specific intervals, the difference between

floating interest amounts and fixed interest amounts (Baxter, 2016). Other approaches that the

company uses are treasury rate locks and forward-starting rate swaps. These approaches enable

Baxter to hedge the risk to earnings arising from the fluctuations in interest rates.

Baxter has a risk management program in which it conducts sensitivity analyses to

determine the potential gains and losses in earnings related to regular fluctuations in interest

rates. For example, in 2006, there was a 26 basis-point increase in interest rates that significantly

affected Baxters financial instruments. The financial instruments that were affected include debt

obligations and related derivatives. This would lead to an immaterial impact on Baxters earnings

for that period and the fair value of fixed-rate debt as of the end of 2005 financial year and 2006

financial year. Baxter engaged in a particular approach to manage this risk. As indicated in its

Note 6, the fair values of its long-term litigation liabilities and insurance receivable related to
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these liabilities were computed by the company. Expected cash flows were discounted based on

the information available at the time. It was indicated that a 10 percent movement in the assumed

discount rate would not have any significant impact on the fair values of these assets and

liabilities. The management of Baxter has indicated that losses in fair values, earnings, and cash

flows are immaterial to companys financial position. This is in respect to Baxters investments

in affiliates.

Another factor that causes significant impacts and risks on Baxters financial statements

and its financial position are legal proceedings. Baxter and subsidiaries are regularly exposed to

a number of legal proceedings, claims, and lawsuits. These expose the company to many

complexities and uncertainties. However, the company has reserves as required under generally

accepted accounting principles (GAAP). It is highly likely for that resolution of the matters to

result in additional losses in addition to the already established reserve.

Financial Analyses for Business Management Planning and Decision Making

There are three important documents that provide a good understanding of company

performance, including thebalance sheet, income statement, and the statement of cash flows

(Weil, Scipper&Francis, 2013). Baxter uses the three documents in addition to financial ratios to

make necessary business decisions. Baxter has to use these pieces of information to determine

whether the company has an operating capability as well as financial flexibility. External users of

financial information use companys financial information to determine whether they are going

to enter into any dealings with the company, including making investment decisions. Since the

role of any company is to attract investors and customers, it has to ensure that it maintains these

pieces of financial information in good condition to ensure that it attracts these important

stakeholders. In addition to this, the company uses this financial information to gauge its
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performance as well as compare itself with the other players in the same industry. That is, gauge

whether it is above or below the industrys margin.

Financial ratios are the instruments that Baxter uses to benchmark its performance with

that of its previous financial periods as well as that of its competitors. The gross profit margin

and net profit margin are some of the two important ratios that Baxter uses to gauge its

performance against previous financial periods as well as those of its competitors, including the

two competitors (Merck and AstraZeneca) discussed in previous sections. For example, in the

financial years 2015 and 2016, Baxter had gross profit margins of 41.6 percent and 40.4 percent,

respectively (Morning Star, 2016c). These profit margins are way far below the profit margins

recorded by major players Merck and AstraZeneca. However, these gross profit margin ratios

for Baxter did not match revenue growth over that period. In 2015, Baxter recorded the gross

profit of $9.968 million. The company recorded an increase in revenue in 2016 where it recorded

revenues amounting to $10,163 million. In 2015, the costs of production may have been higher

thus consuming into the revenues. That is, despite the high percentage of gross profit margin in

2015, the revenue was a bit lower than the one recorded in 2016 ($10,163 million) (Morning

Star, 2016c). The lower amount of revenue in 2015 may have prompted Baxter to engage itself in

cost management decisions. After managing its costs, Baxter was able to realize a growth in

revenues in 2016. Therefore, gross profit margins and revenue growth helps Baxter to make

necessary business decisions, including cost management decisions, sales decisions, and risk

management decisions among others.

Baxter International also uses its balance sheet to guide it in its decision-making. The role

of the balance sheet in any company is to help both internal and external stakeholders evaluate

the ability of the company to achieve its primary goal which is to earn enough profits and remain
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solvent. The information provided by the balance sheet is not the same as the one provided by

the income statement. While the role of the income statement is to report on the actions of the

company over a period of time, the role of the balance sheet is to reveal the financial position of

the company on a specific date, particularly the end of a quarter, half, or year of a financial

period. This allows the company as well as its external stakeholders to evaluate the companys

assets, liabilities, and the companys equity as at that date. For example, Baxters total current

assets or the financial year ending December 2015 amounted to $11,796 million and $6,574

million in 2016 (Morning Star, 2016c). This implies that Baxter was holding a relatively higher

amount of assets as current assets in 2015 compared to 2016 where current assets amounted to

$6,574 million. The fixed assets remained almost the same for both financial periods ($9,179

million for 2015 and $8,972 million for 2016). Since 2012, Baxter recorded the least amount of

current assets and fixed assets in 2016 at $6,574 million and 8,972 million, respectively.

For the five-year period (2012-2016), Baxter has been experiencing a decline in assets

both current assets and fixed assets. Baxter Internationals current liabilities for 2015 and 2016

were $5,750 million and $2,744 million, respectively. Both the current assets and current

liabilities are very important for Baxter because, just like in any other organization, current assets

and current liabilities help the company to determine the working capital. The working capital is

used by the company to evaluate its liquidity. Liquidity shows how quickly a company can

convert its assets into cash in order to pay its bills. Secondly, the current assets and current

liabilities are used to determine the current ratio of the company. Current ratio helps a company

to compare itself with other different sized companies in the same industry. This enables the

company to benchmark itself against other companies in the industry and make necessary

decisions to ensure that it maintains pace or stays ahead of its competitors.

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Finally, these instruments are used to determine the quick ratio or acid-test which

represents a more convincing indicator of a companys short-term debt paying ability

(Saleem&Rehman, 2011). Both the current ratio and the acid test ratio help a company determine

its financial flexibility and whether it can be able to adapt to change. If the figures Baxter

International obtains for its current ratio and acid test ratio do not display this situation, the

management of the company has to make decisions that are focused on making these ratios

effective. For companies such as Baxter International, the debt ratio is very important in

assessing long-term financial flexibility (Marchika& Mura, 2010). The debt ratio is obtained as:

Debt Ratio =

If the debt ratio is high, it is an indication that the firm has a lower financial flexibility and if the

ratio is low, it is an indication that the firm has a higher financial flexibility. For Baxter, the debt

ratio is:
12,129
Baxters Debt Ratio for the 2015 Financial Year = 20975

= 0.578

7,256
Baxters Debt Ratio for the 2016 Financial Year = 15,546

= 0.467

Comparison of Debt Ratios with some major players in the industry

57,103
Mercks Debt Ratio for the 2015 Financial Year =
101,779

= 0.561

55,289
Mercks Debt Ratio for the 2015 Financial Year = 95,377

= 0.58
41634
AstraZenecas Debt Ratio for the 2015 Financial Year = 60124
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= 0.692
47672
AstraZenecas Debt Ratio for the 2015 Financial Year = 62526

= 0.762

From this analysis, it is clear that Baxter has a higher financial flexibility compared to the

two major players investigated in this paper (Merck and AstraZeneca). Also, comparing the two

financial periods, Baxter experienced a drop in its debt ratio being an indication that the

company is moving towards good financial health contrary to the other two players who have

experienced a rise in their debt ratios. There was a decline in Baxters debt ratios comparing the

two financial periods from 57.8 percent in 2015 to 46.7 percent in 2016. This is an indication that

the company was able to make effective decisions in 2015 which made it debt ratio drop.

Impact of Ethical, Regulatory, and Tax Consideration

Like any other business, Baxter International is exposed to challenges arising from the

need for regulatory compliance and safety of its products. These challenges have forced the

company, sometimes, to recalling the products that have already been sold to consumers. To

certain extents, Baxter has been exposed to lawsuits and fines. It is important for the company to

integrate compliance performance metrics and product safety metrics to the compensation plan

of the company. Baxter must also take a more proactive stance on the transparency of clinical

trials so as to promote safer and more effective drug development and consumption. This will

serve in ensuring the continuing confidence by the regulators and volunteer participants.
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References

Baxter International (2016). Retrieved from

https://www.sec.gov/Archives/edgar/data/10456/000119312516479471/d213870d10k.ht

Marchica, M. T., & Mura, R. (2010). Financial flexibility, investment ability, and firm value:

evidence from firms with spare debt capacity. Financial management, 39(4), 1339-1365.

Morning Star (2016a). Merck & Co. Inc. Retrieved from

http://financials.morningstar.com/balance-

sheet/bs.html?t=MRK&region=usa&culture=en-US

Morning Star (2016b). AstraZeneca PLC ADR. Retrieved from

http://financials.morningstar.com/balance-

sheet/bs.html?t=AZN&region=usa&culture=en-US

Morning Star (2016c). Baxter International Inc. Retrieved from

http://financials.morningstar.com/balance-

sheet/bs.html?t=BAX&region=usa&culture=en-US

Saleem, Q., &Rehman, R. U. (2011).Impacts of liquidity ratios on profitability. Interdisciplinary

Journal of Research in Business, 1(7), 95-98.

Sicilano, A. &Zuvich, D. (2006).The Risks of Being Global.Journal of Accountancy. Retrieved

from http://www.journalofaccountancy.com/issues/2006/dec/therisksofbeingglobal.html

Weil, R. L., Schipper, K., & Francis, J. (2013). Financial accounting: an introduction to

concepts, methods and uses. Cengage Learning.