BAXTER INTERNATIONAL INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Refer to our Annual Report on Form 10-K for the year ended December 31, 2019 (2019 Annual Report) for management’s discussion and analysis of our financial condition and results of operations. The following is management’s discussion and analysis of our financial condition and results of operations for the three and nine months ended September 30, 2020 and 2019. RESULTS OF OPERATIONS Net income attributable to Baxter stockholders for the three and nine months ended September 30, 2020 totaled $356 million, or $0.69 per diluted share, and $934 million, or $1.81 per diluted share, compared to $369 million, or $0.71 per diluted share, and $1.0 billion, or $1.97 per diluted share, for the three and nine months ended September 30, 2019. Net income for the three and nine months ended September 30, 2020 included special items which decreased net income by $75 million and $251 million, respectively, or $0.14 and $0.49 per diluted share, respectively, as further discussed below. Net income for the three and nine months ended September 30, 2019 included special items which decreased net income by $17 million and $192 million, respectively, or $0.03 and $0.37 per diluted share, respectively, as further discussed below. 29 Special Items The following table provides a summary of our special items and the related impact by line item on our results for the three and nine months ended September 30, 2020 and 2019. Three months ended September 30, Nine months ended September 30, (in millions) 2020 2019 2020 2019 Gross Margin Intangible asset amortization expense $ (57) $ (48) $ (165) $ (136) Intangible asset impairments 1 — — (17) (31) Business optimization items 2 (6) (10) (24) (39) Acquisition and integration expenses 3 — (8) (11) (25) European medical devices regulation 4 (8) (7) (22) (17) Investigation and related costs 5 — — (3) — Total Special Items $ (71) $ (73) $ (242) $ (248) Impact on Gross Margin Ratio (2.4 pts) (2.6 pts) (2.8 pts) (3.0 pts) Selling, General and Administrative (SG&A) Expenses Business optimization items 2 $ 25 $ 10 $ 53 $ 50 Acquisition and integration expenses 3 — 3 7 8 Investigation and related costs 5 2 — 18 — Total Special Items $ 27 $ 13 $ 78 $ 58 Impact on SG&A Ratio 0.9 pts 0.5 pts 0.9 pts 0.7 pts Research and Development (R&D) Expenses Business optimization items 2 $ 1 $ 8 $ — $ 42 Acquisition and integration expenses 3 — 2 22 8 Investigation and related costs 5 — — 1 — Total Special Items $ 1 $ 10 $ 23 $ 50 Impact on R&D Ratio 0.0 pts 0.4 pts 0.2 pts 0.6 pts Other Operating Expense (Income), net Business optimization items 2 $ — $ — $ (17) $ — Acquisition and integration expenses 3 1 — (2) (4) Insurance recoveries from a legacy product-related matter 6 — (4) — (37) Hurricane Maria insurance recoveries 7 — (40) — (40) Total Special Items $ 1 $ (44) $ (19) $ (81) Income Tax Expense Tax effects of special items and impact of U.S. tax reform ⁸ $ (25) $ (35) $ (73) $ (83) Total Special Items $ (25) $ (35) $ (73) $ (83) Impact on Effective Tax Rate (2.2 pts) (4.5 pts) (2.2 pts) (3.1 pts) Intangible asset amortization expense is identified as a special item to facilitate an evaluation of current and past operating performance and is consistent with how management and our Board of Directors assess performance. Additional special items are identified above because they are highly variable, difficult to predict and of a size that may substantially impact our reported results of operations for the period. Management believes that providing the separate impact of those items may provide a more complete understanding and facilitate a fuller analysis of our results of operations, particularly in evaluating performance from one period to another. 1 In 2020 and 2019, our results included charges of $17 million and $31 million for asset impairments related to developed-technology intangible assets. Refer to Note 4 in Item 1 of this Quarterly Report on Form 10-Q for further information regarding these asset impairments. 30 2 In 2020 and 2019, our results were impacted by costs associated with our execution of programs to optimize our organization and cost structure on a global basis. These actions included streamlining our international operations, rationalizing our manufacturing facilities, reducing our general and administrative infrastructure, re-aligning certain R&D activities and cancelling certain R&D programs. Our results in 2020 included business optimization charges of $32 million in the third quarter and $77 million in the first nine months. Our results in 2019 included business optimization charges of $28 million in the third quarter and $131 million in the first nine months. Additionally, we recognized a gain of $17 million in the first nine months of 2020 for property we sold in conjunction with our business optimization initiatives. Refer to Note 10 in Item 1 of this Quarterly Report on Form 10-Q for further information regarding these charges and related liabilities. 3 Our results in 2020 included $1 million in the third quarter and $38 million in the first nine months of acquisition and integration expenses. This included acquisition and integration expenses related to our acquisitions of Cheetah Medical Inc. (Cheetah) and Seprafilm and the purchase of in-process R&D assets in the first nine months. Additionally, the change in the estimated fair value of contingent consideration liabilities in 2020 was an expense in the third quarter and a benefit in the first nine months. Our results in 2019 included $13 million in the third quarter and $37 million in the first nine months of acquisition and integration expenses. This included acquisition and integration expenses related to our acquisitions of Claris and the Recothrom and Preveleak products in prior periods and the purchase of in-process R&D assets in the third quarter and first nine months, partially offset by the change in the estimated fair value of contingent consideration liabilities in the first nine months. Refer to Note 2 in Item 1 of this Quarterly Report on Form 10-Q for further information regarding business development activities. 4 Our results in 2020 included $8 million in the third quarter and $22 million in the first nine months of costs related to updating our quality systems and product labeling to comply with the new medical device reporting regulation and other requirements of the European Union’s regulations for medical devices that are scheduled to become effective in 2021. Our results in 2019 included $7 million in the third quarter and $17 million in the first nine months of costs related to these requirements. 5 Our results in 2020 included costs of $2 million in the third quarter and $22 million in the first nine months for investigation and related costs. This included $2 million in the third quarter and $14 million in the first nine months of costs related to our investigation of foreign exchange gains and losses associated with certain intra-company transactions and related legal matters. Additionally, we recorded incremental stock compensation expense of $8 million in the first nine months as we extended the term of certain stock options that were scheduled to expire in the first quarter of 2020. Refer to Notes 6 and 7 in Item 1 of this Quarterly Report on Form 10-Q for further information regarding the investigation and stock compensation expense. 6 Our results in 2019 included a benefit of $4 million in the third quarter and $37 million in the first nine months for our allocation of insurance proceeds received pursuant to a settlement and cost-sharing arrangement for a legacy product-related matter. Refer to Note 6 in Item 1 of this Quarterly Report on Form 10-Q for further information. 7 Our results in 2019 included benefits of $40 million related to insurance recoveries as a result of losses incurred due to Hurricane Maria. Refer to Note 6 in Item 1 of this Quarterly Report on Form 10-Q for further information. 8 Reflected in this item is the income tax impact of the special items identified in this table. Additionally, our results in 2019 included a benefit of $16 million related to an adjustment for U.S. tax reform. The tax effect of each special item is based on the jurisdiction in which the item was incurred and the tax laws in effect for each such jurisdiction. NET SALES Three months ended September 30, Percent change (in millions) 2020 2019 At actual currency rates At constant currency rates United States $ 1,244 $ 1,224 2 % 2 % International $ 1,728 1,627 6 % 5 % Total net sales $ 2,972 $ 2,851 4 % 4 % 31 Nine months ended September 30, Percent change (in millions) 2020 2019 At actual currency rates At constant currency rates United States $ 3,588 $ 3,537 1 % 1 % International $ 4,904 4,786 2 % 5 % Total net sales $ 8,492 $ 8,323 2 % 3 % Foreign currency had an insignificant impact on net sales during the third quarter of 2020 compared to the prior-year as the strengthening of the U.S. Dollar relative to the Brazilian Real, Mexican Peso and Colombian Peso was offset by the weakening of the U.S. Dollar relative to the Euro, Australian Dollar and British Pound. Foreign currency unfavorably impacted net sales by 1 percentage point during the first nine months of 2020 compared to the prior-year period principally due to the strengthening of the U.S. Dollar relative to the Mexican Peso, Australian Dollar, Brazilian Real, Chinese Renminbi and Colombian Peso. The comparisons presented at constant currency rates reflect local currency sales at the prior period’s foreign exchange rates. This measure provides information on the change in net sales assuming that foreign currency exchange rates had not changed between the prior and the current period. We believe that the non-GAAP measure of change in net sales at constant currency rates, when used in conjunction with the U.S. GAAP measure of change in net sales at actual currency rates, may provide a more complete understanding and facilitate a fuller analysis of our results of operations, particularly in evaluating performance from one period to another. Our global operations expose us to risks associated with public health crises and epidemics/pandemics, such as the novel strain of coronavirus (COVID-19). COVID-19 has had, and we expect will continue to have, an adverse impact on our operations, supply chains and distribution systems and has increased and will continue to increase our expenses, including as a result of impacts associated with preventive and precautionary measures that we, other businesses and governments are taking. These measures have led to unprecedented restrictions on, disruptions in, and other related impacts on businesses and personal activities. In addition to travel restrictions put in place in early 2020, governments have closed borders, imposed prolonged quarantines and may continue those measures or implement other restrictions and requirements in light of the continuing spread of the pandemic. We expect that these evolving restrictions and requirements, as well as the corresponding need to adapt to new methods of conducting business remotely, will continue to have an adverse effect on our business. For further discussion, refer to the Global Business Unit Net Sales Reporting section below, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019 and Part II, Item 1A. Risk Factors of this Quarterly Report on Form 10-Q. Global Business Unit Net Sales Reporting Our global business units (GBUs) include the following: • Renal Care includes sales of our peritoneal dialysis (PD), hemodialysis (HD) and additional dialysis therapies and services. • Medication Delivery includes sales of our intravenous (IV) therapies, infusion pumps, administration sets and drug reconstitution devices. • Pharmaceuticals includes sales of our premixed and oncology drug platforms, inhaled anesthesia and critical care products and pharmacy compounding services. • Clinical Nutrition includes sales of our parenteral nutrition (PN) therapies and related products. • Advanced Surgery includes sales of our biological products and medical devices used in surgical procedures for hemostasis, tissue sealing and adhesion prevention. • Acute Therapies includes sales of our continuous renal replacement therapies (CRRT) and other organ support therapies focused in the intensive care unit (ICU). • Other primarily includes sales of contract manufacturing services from our pharmaceutical partnering business. 32 The following is a summary of net sales by GBU. Three months ended September 30, Percent change (in millions) 2020 2019 At actual currency rates At constant currency rates Renal Care $ 955 $ 918 4 % 4 % Medication Delivery 680 701 (3) % (3) % Pharmaceuticals 540 527 2 % 1 % Clinical Nutrition 237 219 8 % 5 % Advanced Surgery 236 216 9 % 9 % Acute Therapies 177 130 36 % 35 % Other 147 140 5 % 4 % Total Baxter $ 2,972 $ 2,851 4 % 4 % Nine months ended September 30, Percent change (in millions) 2020 2019 At actual currency rates At constant currency rates Renal Care $ 2,744 $ 2,679 2 % 5 % Medication Delivery 1,982 2,024 (2) % (1) % Pharmaceuticals 1,552 1,575 (1) % (1) % Clinical Nutrition 676 639 6 % 7 % Advanced Surgery 628 646 (3) % (2) % Acute Therapies 519 391 33 % 35 % Other 391 369 6 % 7 % Total Baxter $ 8,492 $ 8,323 2 % 3 % Renal Care net sales increased 4% in the third quarter and 2% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter and first nine months was driven by global patient growth in PD. Changes in foreign exchange rates had an insignificant impact on Renal Care net sales in the third quarter and a negative impact of 3% in the first nine months of 2020, as compared to the prior-year periods. Medication Delivery net sales decreased 3% in the third quarter and 2% in the first nine months of 2020, as compared to the prior-year periods. The decrease in the third quarter and first nine months was primarily driven by lower demand for our infusion systems and related IV administration sets and solutions due to lower hospital admission rates and a reduction in elective surgeries resulting from the COVID-19 pandemic, including the impact from shelter in place initiatives as well as patient safety concerns related to potential COVID-19 infection risk. Changes in foreign exchange rates had an insignificant impact on Medication Delivery net sales in the third quarter and a negative impact of 1% in the first nine months of 2020, as compared to the prior-year periods. Pharmaceuticals net sales increased 2% in the third quarter and decreased 1% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter was driven by increased demand for our international pharmacy compounding services along with a significant nonrecurring purchase from the U.S. government and a 1% positive impact from foreign exchange rate changes, compared to the prior-year period. Those increases were partially offset by lower demand for inhaled anesthesia products as a result of lower hospital admission rates and reduced elective surgeries resulting from the COVID-19 pandemic. The decrease in the first nine months of 2020 was driven by lower demand for inhaled anesthesia products resulting from the COVID-19 pandemic and new competitive entrants for TransDerm Scop. Those impacts were partially offset by increased demand for our international pharmacy compounding services along with certain generic injectables and the nonrecurring purchase from the U.S. government. Clinical Nutrition net sales increased 8% in the third quarter and 6% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter and first nine months of 2020 was driven by increased demand for our PN therapies and related products, recent product launches and competitor shortages for amino acids. Additionally, foreign exchange rate changes had a positive impact on net sales of 3% in the third quarter and a negative impact of 1% for the first nine months of 2020, as compared to the prior-year periods. 33 Advanced Surgery net sales increased 9% in the third quarter and decreased 3% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter was due to the acquisition of Seprafilm, which contributed $30 million in net sales during the third quarter. The decrease in the first nine months of 2020 was driven by the impact of the COVID-19 pandemic as many elective surgeries were postponed and a 1% negative impact from foreign exchange rate changes, as compared to the prior-year period. Partially offsetting the decrease was the acquisition of Seprafilm, which contributed $66 million in net sales during the first nine months of 2020, and a benefit from increased demand for our hemostats and sealants early in the year due, in part, to competitive supply disruptions. Acute Therapies net sales increased 36% in the third quarter and 33% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter and first nine months was driven by increased global demand for our CRRT systems to treat acute kidney injuries. Additionally, foreign exchange rate changes had a positive impact on net sales of 1% in the third quarter and a negative impact of 2% for the first nine months of 2020, as compared to the prior-year periods. The COVID-19 pandemic drove the increases in demand for those products in the third quarter and first nine months of 2020. Other net sales increased 5% in the third quarter and 6% in the first nine months of 2020, as compared to the prior-year periods. The increase in the third quarter and first nine months of 2020 was driven by increased demand for our contract manufacturing services. Additionally, foreign exchange rate changes had a positive impact on net sales of 1% in the third quarter and a negative impact of 1% for the first nine months of 2020, as compared to the prior-year periods. Gross Margin and Expense Ratios Three months ended September 30, 2020 % of net sales 2019 % of net sales $ change % change Gross margin $ 1,195 40.2 % $ 1,230 43.1 % $ (35) (2.8) % SG&A $ 601 20.2 % $ 627 22.0 % $ (26) (4.1) % R&D $ 123 4.1 % $ 144 5.1 % $ (21) (14.6) % Nine months ended September 30, 2020 % of net sales 2019 % of net sales $ change % change Gross margin $ 3,396 40.0 % $ 3,463 41.6 % $ (67) (1.9) % SG&A $ 1,819 21.4 % $ 1,869 22.5 % $ (50) (2.7) % R&D $ 386 4.5 % $ 439 5.3 % $ (53) (12.1) % Gross Margin The gross margin ratio was 40.2% and 40.0% in the third quarter and first nine months of 2020, respectively. The special items identified above had an unfavorable impact of approximately 2.4 and 2.8 percentage points on the gross margin ratio in the third quarter and first nine months of 2020, respectively. The gross margin ratio was 43.1% and 41.6% in the third quarter and first nine months of 2019, respectively. The special items identified above had an unfavorable impact of approximately 2.6 and 3.0 percentage points on the gross margin ratio in the third quarter and first nine months of 2019, respectively. Refer to the Special Items caption above for additional detail. Excluding the impact of the special items, the gross margin ratio decreased in the third quarter and first nine months of 2020 compared to the prior year due to an unfavorable product mix, additional compensation costs, primarily for our manufacturing employees, reduced manufacturing efficiencies and incremental logistics costs, all in response to the COVID-19 pandemic. We expect the gross margin ratio for full year 2020 to be negatively impacted by those same factors. SG&A The SG&A expenses ratio was 20.2% and 21.4% in the third quarter and first nine months of 2020, respectively. The special items identified above had an unfavorable impact of approximately 0.9 percentage points on the SG&A expenses ratio in each of the third quarter and first nine months of 2020. The SG&A expenses ratio was 22.0% and 22.5% in the third quarter and first nine months of 2019, respectively. The special items identified above had an 34 unfavorable impact of approximately 0.5 and 0.7 percentage points on the SG&A expenses ratio in the third quarter and first nine months of 2019, respectively. Refer to the Special Items caption above for additional detail. Excluding the impact of the special items, the SG&A expenses ratio decreased in the third quarter and first nine months of 2020 primarily due to lower bonus accruals under our annual employee incentive compensation plans, actions we took to restructure our cost position and focus on expense management and reduced travel and related expenses due to the COVID-19 pandemic. R&D The R&D expenses ratio was 4.1% and 4.5% in the third quarter and first nine months of 2020, respectively. The special items identified above had no impact and an unfavorable impact of approximately 0.2 percentage points on the R&D expenses ratio in the third quarter and first nine months of 2020, respectively. The R&D expenses ratio was 5.1% and 5.3% in the third quarter and first nine months of 2019, respectively. The special items identified above had an unfavorable impact of approximately 0.4 and 0.6 percentage points on the R&D expenses ratio in the third quarter and first nine months of 2019, respectively. Refer to the Special Items caption above for additional detail. Excluding the impact of the special items, the R&D expenses ratio decreased in the third quarter and first nine months of 2020 as a result of the timing of project-related expenditures compared to the prior year and actions we took to restructure our cost position and focus on expense management. Due to a change in the timing and amount of projected cash flows associated with $140 million of acquired in-process R&D intangible assets from a historical acquisition, we updated the estimated fair values of these assets. While no impairment has been recorded because the estimated fair values of those assets exceeded their carrying values, the estimated fair values of these assets declined and are at risk of future impairment should the estimated timing or amount of projected cash flows further deteriorate. Business Optimization Items Beginning in the second half of 2015, we have undertaken actions to transform our cost structure and enhance operational efficiency. These efforts include restructuring the organization, optimizing our manufacturing footprint, R&D operations and supply chain network, employing disciplined cost management, and centralizing and streamlining certain support functions. Through September 30, 2020, we have incurred cumulative pre-tax costs of $1.1 billion related to these actions. The costs consisted primarily of employee termination costs, implementation costs, contract termination costs, asset impairments, and accelerated depreciation. We currently expect to incur additional pre-tax costs of approximately $15 million through the completion of the initiatives that are currently underway, primarily related to implementation costs. We continue to pursue cost savings initiatives and, to the extent further cost savings opportunities are identified, we may incur additional restructuring charges and costs to implement business optimization programs in future periods. The reductions in our cost base from these actions in the aggregate are expected to provide cumulative annual pre-tax savings of more than $1.2 billion once the remaining actions are complete. The savings from these actions will impact cost of sales, SG&A expenses, and R&D expenses. Approximately 95 percent of the expected annual pre-tax savings are expected to be realized by the end of 2020, with the remainder by the end of 2023. Other Operating Expense (Income), Net Other operating expense (income), net was an expense of $1 million and income of $19 million in the third quarter and first nine months of 2020, respectively. In the third quarter and first nine months of 2020, we recognized an expense of $1 million and a benefit of $2 million, respectively, as a result of the change in the estimated fair value of contingent consideration liabilities. Additionally, in the first nine months of 2020 we recognized a $17 million gain on the sale of property in conjunction with our business optimization initiatives. Other operating expense (income), net was income of $44 million and $81 million in the third quarter and first nine months of 2019, respectively. In the third quarter of 2019, we recognized a benefit of $40 million related to insurance recoveries as a result of losses incurred due to Hurricane Maria. In the three and nine months ended September 30, 2019, we recognized gains of $4 million and $37 million, respectively, when our share of the proceeds under a cost-sharing agreement became realizable following the resolution of a dispute with an insurer related to a legacy product-related matter. Additionally, in the first nine months 35 of 2019 we recognized a benefit of $4 million as a result of the change in the estimated fair value of contingent consideration liabilities. Interest Expense, Net Interest expense, net was $39 million and $96 million in the third quarter and first nine months of 2020, respectively, and $13 million and $51 million in the third quarter and first nine months of 2019, respectively. The increase in the third quarter and first nine months of 2020 was primarily driven by higher average debt outstanding as a result of the March 2020 issuance of $750 million of 3.75% senior notes due October 2025 and $500 million of 3.95% senior notes due April 2030. Additionally, interest expense, net increased in the first nine months of 2020 due to the May 2019 issuance of €750 million of 0.40% senior notes due May 2024 and €750 million of 1.3% senior notes due May 2029. We expect that interest expense, net will increase by more than $60 million in 2020 compared to 2019 primarily due to reduced interest income as a result of lower interest rates on cash balances and higher interest expense as a result of the $1.25 billion of senior notes issued in March 2020. Other (Income) Expense, Net Other (income) expense, net was an expense of $16 million and $32 million in the third quarter and first nine months of 2020, respectively, and an expense of $9 million and income of $8 million in the third quarter and first nine months of 2019, respectively. The increase in expense in the third quarter and first nine months of 2020 compared to the prior year was primarily due to lower pension benefits as a result of the annuitization of our U.S. pension plans in the fourth quarter of 2019. Additionally, we recognized an unrealized gain of $9 million on a marketable equity security in the third quarter of 2020. In September 2020, we offered certain former U.S. employees with a vested pension benefit a limited-time option to take a lump sum distribution in lieu of future monthly payments. Those accepting the option will be paid from the assets of the pension plan in December 2020. This action will accelerate the satisfaction of future pension obligations and could result in a non-cash pre-tax settlement loss in the fourth quarter of 2020, which will be determined based on the rate of acceptance. The settlement loss, if triggered, would be recognized as a non-operating benefit cost. Income Taxes Our effective income tax rate was 13.5% and 22.0% in the third quarter and 13.2% and 13.7% in the first nine months of 2020 and 2019, respectively. Our effective income tax rate can differ from the 21% U.S. federal statutory rate due to a number of factors, including foreign rate differences, tax incentives, increases or decreases in valuation allowances and liabilities for uncertain tax positions and excess tax benefits on stock compensation awards. For the three months ended September 30, 2020, the difference between our effective income tax rate and the U.S. federal statutory rate was primarily attributable to a favorable geographic earnings mix and changes related to our ability to realize foreign tax credits. For the nine months ended September 30, 2020, the difference between our effective income tax rate and the U.S. federal statutory rate was primarily attributable to a favorable geographic earnings mix and excess tax benefits on stock compensation awards. For the three months ended September 30, 2019, our effective income tax rate was substantially consistent with the 21% U.S. federal statutory rate as unfavorable return-to-provision adjustments in various jurisdictions were offset by excess tax benefits on stock compensation awards. For the nine months ended September 30, 2019, the difference between our effective tax rate and the U.S. federal statutory rate was primarily attributable to excess tax benefits on stock compensation awards and the recognition of tax benefits associated with a favorable tax ruling. Segment Results We use operating income on a segment basis to make resource allocation decisions and assess the ongoing performance of our segments. The following is a summary of financial information for our reportable segments: 36 Net sales Operating income (loss) Three months ended September 30, Nine months ended September 30, Three months ended September 30, Nine months ended September 30, (in millions) 2020 2019 2020 2019 2020 2019 2020 2019 Americas $ 1,549 $ 1,534 $ 4,455 $ 4,462 $ 577 $ 595 $ 1,610 $ 1,715 EMEA 777 730 2,262 2,179 160 162 480 465 APAC 646 587 1,775 1,682 161 138 432 394 Corporate and other — — — — (428) (392) (1,312) (1,338) Total $ 2,972 $ 2,851 $ 8,492 $ 8,323 $ 470 $ 503 $ 1,210 $ 1,236 Americas Segment net sales and operating income were $1.5 billion and $577 million, respectively, in the third quarter and $4.5 billion and $1.6 billion, respectively, in the first nine months of 2020. Segment net sales and operating income were $1.5 billion and $595 million, respectively, in the third quarter and $4.5 billion and $1.7 billion, respectively, in the first nine months of 2019. The decrease in operating profit in the third quarter was due to lower gross profit as a result of an unfavorable product mix and incremental logistics costs due to the impact of the COVID-19 pandemic. The decrease in operating profit in the first nine months of 2020 was primarily driven by decreased sales in multiple GBUs, particularly Medication Delivery, Pharmaceuticals and Advanced Surgery, and lower gross profit as a result of an unfavorable product mix and incremental logistics costs due primarily to the impact of the COVID-19 pandemic. The decreases were partially offset by favorable performance in Acute Therapies and Clinical Nutrition as well as the acquisition of Seprafilm. EMEA Segment net sales and operating income were $777 million and $160 million, respectively, in the third quarter and $2.3 billion and $480 million, respectively, in the first nine months of 2020. Segment net sales and operating income were $730 million and $162 million, respectively, in the third quarter and $2.2 billion and $465 million, respectively, in the first nine months of 2019. The change in foreign exchange rates had a positive impact on results in the third quarter of 2020 as compared to 2019. On a constant currency basis, operating profit increased in both the third quarter and first nine months of 2020 due to increased sales in Acute Therapies, Clinical Nutrition, Pharmaceuticals and Renal Care. For the first nine months of 2020, favorable results were partially offset by decreased sales in Advanced Surgery. APAC Segment net sales and operating income were $646 million and $161 million, respectively, in the third quarter and $1.8 billion and $432 million, respectively, in the first nine months of 2020. Segment net sales and operating income were $587 million and $138 million, respectively, in the third quarter and $1.7 billion and $394 million, respectively, in the first nine months of 2019. The increases operating profit in the third quarter and first nine months of 2020 were primarily driven by increased sales in multiple GBUs, particularly Renal Care, Acute Therapies and Pharmaceuticals. The acquisition of Seprafilm also positively contributed to results in 2020. Corporate and Other Certain items are maintained at Corporate and are not allocated to a segment. They primarily include certain foreign currency hedging activities, corporate headquarters costs, certain R&D costs, certain GBU support costs, stock compensation expense, certain employee benefit plan costs, and certain gains, losses, and other charges (such as business optimization, acquisition and integration costs, intangible asset amortization and asset impairments). The operating loss in the third quarter was higher than the prior-year period primarily due to higher intangible asset amortization expenses and business optimization charges in the current year and prior-year gains recognized for Hurricane Maria insurance recoveries. The operating loss in the first nine months of 2020 was lower than the prior-year period due to lower business optimization charges and lower intangible asset impairment charges in the current-year period, partially offset by insurance recoveries received in 2019 from a legacy product-related matter and Hurricane Maria, as well as higher investigation and related costs and intangible asset amortization in the current year. 37 LIQUIDITY AND CAPITAL RESOURCES The following table is a summary of the statement of cash flows for the nine-month periods ended September 30, 2020 and 2019. Nine months ended September 30, (in millions) 2020 2019 Cash flows from operations - continuing operations $ 1,158 $ 1,281 Cash flows from investing activities (915) (679) Cash flows from financing activities 798 614 Cash Flows from Operations — Continuing Operations In the first nine months of 2020, cash provided by operating activities was $1.2 billion, as compared to cash provided by operating activities of $1.3 billion in the first nine months of 2019, a decrease of $123 million. The decrease was primarily due to a more significant increase in inventory levels in the current year, the timing of customer payments and insurance recoveries received in 2019 from a legacy product-related matter and Hurricane Maria, partially offset by the timing of vendor payments and lower restructuring and employee incentive compensation payments in the current year. Additionally in the third quarter of 2020, we terminated an interest rate derivative contract which negatively impacted operating cash flows by $7 million for the nine months ended September 30, 2020. In October 2020, we terminated additional interest rate derivative contracts with a notional balance of $350 million and a liability fair value of $109 million as of September 30, 2020 for $100 million in cash payments, which will be reflected as operating cash outflows in the fourth quarter of 2020. While we did not experience significant collection issues related to our receivables during the first nine months of 2020, the timing of collection of our receivables may be adversely impacted by the COVID-19 pandemic during the remainder of 2020 and into 2021. Cash Flows from Investing Activities In the first nine months of 2020, cash used for investing activities included payments for acquisitions of $466 million, primarily related to Seprafilm and rights to multiple products we acquired, and capital expenditures of $472 million. In the first nine months of 2019, cash used for investing activities included capital expenditures of $505 million and payments for acquisitions of $186 million, primarily related to the U.S. rights to multiple products we acquired. Cash Flows from Financing Activities In the first nine months of 2020, cash generated from financing activities included $1.2 billion of net proceeds from the issuance of $750 million of senior notes due in 2025 and $500 million of senior notes due in 2030. We have used the net proceeds from the senior notes issuances for general corporate purposes, including to strengthen our balance sheet as a precautionary measure in light of the COVID-19 pandemic. Cash generated from financing activities in the nine months ended September 30, 2020 also included stock issued under employee benefit plans of $180 million and was partially offset by the repayment of borrowings under our Euro-denominated credit facility of €200 million ($225 million) and dividend payments of $348 million. In the first nine months of 2019, cash generated from financing activities included $1.7 billion of net proceeds from the issuance of €750 million of senior notes due in 2024 and €750 million of senior notes due in 2029 along with stock issued under employee benefit plans of $334 million, partially offset by payments for treasury stock repurchases of $1.0 billion and dividend payments of $310 million. As authorized by the Board of Directors, we repurchase our stock depending upon our cash flows, net debt levels and market conditions. In July 2012, the Board of Directors authorized the repurchase of up to $2.0 billion of our common stock. The Board of Directors increased this authority by an additional $1.5 billion in each of November 2016 and February 2018, by an additional $2.0 billion in November 2018 and by an additional $1.5 billion in October 2020. We did not repurchase any shares under this authority in the first nine months of 2020 and had $897 million remaining available under this authorization as of September 30, 2020. After giving effect to the October 2020 approval, we had $2.4 billion remaining under this authority as of October 29, 2020. We expect to recommence our share repurchase activity in the fourth quarter of 2020. 38 Credit Facilities and Access to Capital and Credit Ratings Credit Facilities As of September 30, 2020, our U.S. dollar-denominated revolving credit facility and Euro-denominated senior revolving credit facility had a maximum capacity of $2.0 billion and €200 million, respectively. There was no amount outstanding under our U.S. dollar-denominated and Euro-denominated credit facilities as of September 30, 2020. There was €200 million ($224 million) outstanding at a 0.91% interest rate under our Euro-denominated credit facility and no amount outstanding under our U.S. dollar-denominated credit facility as of December 31, 2019. As of September 30, 2020, we were 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. Access to Capital and Credit Ratings We intend 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. We had $4.4 billion of cash and cash equivalents as of September 30, 2020, with adequate cash available to meet operating requirements in each jurisdiction in which we operate. We invest our excess cash in money market and other funds and diversify the concentration of cash among different financial institutions. As of September 30, 2020, we had approximately $6.5 billion of long-term debt and finance lease obligations, including current maturities. Subject to market conditions, we regularly evaluate opportunities with respect to our capital structure. Our 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 our products or in the solvency of our customers or suppliers, deterioration in our key financial ratios or credit ratings or other significantly unfavorable changes in conditions. However, we believe we have sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support our growth objectives. Between March and July 2020, Standard & Poor’s, Fitch, and Moody’s reaffirmed our investment grade credit ratings that we disclosed in our 2019 Annual Report. LIBOR Reform In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the London Interbank Offered Rate (LIBOR) and other interbank offered rates, which have been widely used as reference rates for various securities and financial contracts, including loans, debt and derivatives. This announcement indicates that the continuation of LIBOR on the current basis is not guaranteed after 2021. Regulators in the U.S. and other jurisdictions have been working to replace these rates with alternative reference interest rates that are supported by transactions in liquid and observable markets, such as the Secured Overnight Financing Rate (SOFR). Currently, our credit facilities and certain of our derivative instruments reference LIBOR-based rates. The discontinuation of LIBOR will require these arrangements to be modified in order to replace LIBOR with an alternative reference interest rate, which could impact our cost of funds. Our credit facilities include a provision specifying that we and the lenders will negotiate in good faith for the determination of a successor LIBOR rate. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements in our 2019 Annual Report. Certain of our accounting policies are considered critical, as these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in our 2019 Annual Report. There have been no significant changes in the application of our critical accounting policies during the first nine months of 2020. 39 RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 1 in Item 1 of this Quarterly Report on Form 10-Q for information regarding recently adopted accounting pronouncements. There are no accounting standards issued but not yet effective that we believe will have a material impact on our condensed consolidated financial statements. LEGAL CONTINGENCIES Refer to Note 6 within Item 1 for a discussion of our legal contingencies. Upon resolution of any of these uncertainties, we may incur charges in excess of presently established liabilities. While our liability 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 our 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 our consolidated financial position. While we believe that we have valid defenses in these matters, litigation is inherently uncertain, excessive verdicts do occur, and we may in the future incur material judgments or enter into material settlements of claims. CERTAIN REGULATORY MATTERS The U.S. Food and Drug Administration (FDA) commenced an inspection of Claris’ facilities in Ahmedabad, India in July 2017, immediately prior to the closing of the Claris acquisition. FDA completed the inspection and subsequently issued a Warning Letter based on observations identified in the 2017 inspection (Claris Warning Letter). 1 While FDA has not yet re-inspected the facilities, we are continuing to implement corrective and preventive actions to address FDA’s prior observations and other items identified in connection with integrating Claris into our quality systems. While management cannot speculate on when the Claris Warning Letter will be lifted, management continues to pursue and implement other manufacturing locations, including contract manufacturing organizations, to support the production of new products for distribution in the U.S. in the meantime. As of December 31, 2019, we have secured alternative locations to produce a majority of the planned new products for distribution into the U.S. On May 6, 2019, we received a Show Cause Notice under the Drugs & Cosmetics Act, 1940 and Rules thereunder (Show Cause Notice) from the Commissioner of the Food & Drugs Control Administration in the Gujarat State in Gandhinagar, India (Commissioner). The Show Cause Notice was issued regarding an April 9, 2019 inspection of our Claris facilities in Ahmedabad, India by the Commissioner. The Show Cause Notice contained a number of observations of alleged Good Manufacturing Practice related issues across a variety of areas, some of which overlap with the areas covered in the Claris Warning Letter. We responded to the Show Cause Notice and a follow up inspection occurred in July 2019. This matter resulted in a two-day suspension order for certain manufacturing operations, which occurred on March 19 and 20, 2020. This matter is now closed. In June 2013, we received a Warning Letter from FDA regarding operations and processes at our North Cove, North Carolina and Jayuya, Puerto Rico facilities. We attended Regulatory Meetings with FDA regarding one or both of these facilities in October 2014, November 2015, July 2017, April 2018 and October 2018. The Warning Letter addresses observations related to Current Good Manufacturing Practice violations at the two facilities. The Warning Letter was closed out in September 2019. As previously disclosed, in the fourth quarter of 2012, we received two investigative demands from the United States Attorney for the Western District of North Carolina for information regarding our quality and manufacturing practices and procedures at our North Cove facility. In January 2017, the parties resolved the matter by entering into a deferred prosecution agreement and a civil settlement whereby we agreed to pay approximately $18 million and implement certain enhanced compliance measures. In July 2019, the deferred prosecution agreement expired and, based on our fulfillment of the terms of the agreement, the court dismissed the criminal information previously filed in the case with prejudice. 1 Available online at https://www.fda.gov/ICECI/EnforcementActions/WarningLetters/ucm613538.htm FORWARD-LOOKING INFORMATION This quarterly report on Form 10-Q includes forward-looking statements. Use of the words “may,” “will,” “would,” “could,” “should,” “believes,” “estimates,” “projects,” “potential,” “expects,” “plans,” “seeks,” “intends,” “evaluates,” “pursues,” “anticipates,” “continues,” “designs,” “impacts,” “affects,” “forecasts,” “target,” “outlook,” “initiative,” 40 “objective,” “designed,” “priorities,” “goal,” or the negative of those words or other similar expressions is intended to identify forward-looking statements that represent our current judgment about possible future events. These forward-looking statements may include statements with respect to accounting estimates and assumptions, impacts of the COVID-19 pandemic, litigation-related matters including outcomes, impacts of the internal investigation related to foreign exchange gains and losses and the material weakness identified as a result thereof, future regulatory filings and our R&D pipeline, strategic objectives, sales from new product offerings, credit exposure to foreign governments, potential developments with respect to credit ratings, investment of foreign earnings, estimates of liabilities including those related to uncertain tax positions, contingent payments, future pension plan contributions, costs, discount rates and rates of return, our exposure to financial market volatility and foreign currency and interest rate risks, potential tax liabilities associated with the separation of our biopharmaceuticals business from our medical products businesses, the impact of competition, future sales growth, business development activities (including the acquisitions of Cheetah and Seprafilm), business optimization initiatives, cost saving initiatives, future capital and R&D expenditures, future debt issuances, manufacturing expansion, the sufficiency of our facilities and financial flexibility, the adequacy of credit facilities, tax provisions and reserves, the effective tax rate and all other statements that do not relate to historical facts. These forward-looking statements are based on certain assumptions and analyses made in light of our experience and perception of historical trends, current conditions, and expected future developments as well as other factors that we believe are appropriate in the circumstances. While these statements represent our judgment on what the future may hold, and we believe these judgments are reasonable, these statements are not guarantees of any events or financial results. Whether actual future results and developments will conform to expectations and predictions is subject to a number of risks and uncertainties, including the following factors, many of which are beyond our control: • demand for and market acceptance risks for and competitive pressures related to new and existing products (including challenges with our ability to accurately predict these pressures and the resulting impact on customer inventory levels and the impact of reduced hospital admission rates and elective surgery volumes), and the impact of those products on quality and patient safety concerns; • product development risks, including satisfactory clinical performance, the ability to manufacture at appropriate scale, and the general unpredictability associated with the product development cycle; • our ability to finance and develop new products or enhancements on commercially acceptable terms or at all; • our ability to identify business development and growth opportunities and to successfully execute on business development strategies; • product quality or patient safety issues, leading to product recalls, withdrawals, launch delays, warning letters, import bans, sanctions, seizures, litigation, or declining sales; • the impact of global economic conditions (including potential trade wars) and continuing public health crises and epidemics, such as the novel strain of coronavirus (COVID-19), including related resurgences, on us and our customers and suppliers, including foreign governments in countries in which we operate; • the continuity, availability and pricing of acceptable raw materials and component supply, and the related continuity of our manufacturing and distribution; • inability to create additional production capacity in a timely manner or the occurrence of other manufacturing, sterilization or supply difficulties (including as a result of natural disaster, public health crises and epidemics/pandemics, regulatory actions or otherwise); • breaches or failures of our information technology systems or products, including by cyber-attack, data leakage, unauthorized access or theft (as a result of increased remote working arrangements or otherwise); 41 • future actions of (or failures to act or delays in acting by) FDA, the European Medicines Agency or any other regulatory body or government authority (including the SEC, DOJ or the Attorney General of any State) that could delay, limit or suspend product development, manufacturing or sale or result in seizures, recalls, injunctions, monetary sanctions or criminal or civil liabilities, including the continued delay in lifting the warning letter at our Ahmedabad facility or proceedings related to the misstatements in previously reported non-operating income related to foreign exchange gains and losses; • the impacts of the material weakness identified as a result of the internal investigation related to foreign exchange gains and losses and our remediation efforts, including the risk that we may experience additional material weaknesses; • developments that would require the correction of additional misstatements in our previously issued financial statements; • failures with respect to our quality, compliance or ethics programs; • future actions of third parties, including third-party payers, the impact of healthcare reform and its implementation, suspension, repeal, replacement, amendment, modification and other similar actions undertaken by the United States or foreign governments, including with respect to pricing, reimbursement, taxation and rebate policies; legislation, regulation and other governmental pressures in the United States or globally, including the cost of compliance and potential penalties for purported noncompliance thereof, all of which may affect pricing, reimbursement, taxation and rebate policies of government agencies and private payers or other elements of our business, including new or amended laws, rules and regulations (such as the California Consumer Privacy Act of 2018, the European Union’s General Data Protection Regulation and proposed regulatory changes of the U.S. Department of Health and Human Services in kidney health policy and reimbursement, which may substantially change the U.S. end stage renal disease market and demand for our peritoneal dialysis products, necessitating significant multi-year capital expenditures, which are difficult to estimate in advance); • the outcome of pending or future litigation, including the opioid litigation and litigation related to the investigation of foreign exchange gains and losses ; • failure to achieve our long-term financial improvement goals; • the impact of competitive products and pricing, including generic competition, drug reimportation and disruptive technologies; • global regulatory, trade and tax policies; • the ability to protect or enforce our owned or in-licensed patent or other proprietary rights (including trademarks, copyrights, trade secrets and know-how) or patents of third parties preventing or restricting our manufacture, sale or use of affected products or technology; • the impact of any goodwill or other intangible asset impairments on our operating results; • any failure by Baxalta or Shire to satisfy its obligations under the separation agreements, including the tax matters agreement, or that certain letter agreement entered into with Shire and Baxalta; • fluctuations in foreign exchange and interest rates; • any changes in law concerning the taxation of income (whether with respect to current or future tax reform), including income earned outside the United States and potential taxes associated with the Base Erosion and Anti-Abuse Tax; 42 • actions by tax authorities in connection with ongoing tax audits; • loss of key employees or inability to identify and recruit new employees; • other factors identified elsewhere in this report and other filings with the SEC, including those factors described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019, all of which are available on our website. Actual results may differ materially from those projected in the forward-looking statements. We do not undertake to update our forward-looking statements. 43