Shares of Baxter International (NYSE:BAX) fell 12.3% after the company released preliminary third-quarter results in which Baxter said it had started an internal investigation into foreign exchange gains and losses that the company had booked in the past.
The third-quarter numbers weren't too bad. Revenue was up 3% to $2.85 billion, just a hair under the consensus for Wall Street analysts' estimates of $2.86 billion. Improving operating margins helped adjusted operating income increase by 10% year over year to $555 million.
The foreign exchange issues are a bigger problem, mostly because it isn't clear how far the issue might extend.
As an international company, Baxter conducts intracompany transactions that require foreign exchange conversions, and the company used an exchange rate convention that was not in accordance with generally accepted accounting principles (GAAP). That boosted the "other (income) expense, net" line on the earnings report by $294 million over five and a half years.
The good news is that the extra boost is nonoperating income, so operating income -- how Baxter is performing -- should still be accurate. But Baxter is still investigating, and it might need to make other adjustments.
This accounting issue may turn out to be a minor issue for the company. Investors should have largely been valuing the company on revenue growth and operating margins that ultimately result in operating income. It's not very easy to predict the catchall "other (income) expense, net" line, so most investors largely ignore the variability from quarter to quarter.
Still, when investing in a large healthcare company like Baxter, investors are often looking for a lower-risk proposition than they'd get with a more volatile biotech. Accounting investigations, even if they're minor, introduce undue risk, so last month's decline is certainly understandable.