Abbott Laboratories: FY2017 Form 10-K Summary
Business context and reporting period
Abbott Laboratories filed its Form 10-K for the fiscal year ended December 31, 2017. Abbott develops, manufactures, and sells health care products through Established Pharmaceutical Products, Diagnostic Products, Nutritional Products, and Cardiovascular and Neuromodulation Products. Approximately 65% of 2017 net sales were generated outside the United States.
The filing is annual, although fourth-quarter results are separately disclosed. The 2017 results reflect the January 4 acquisition of St. Jude Medical, the October 3 acquisition of Alere, and the February 27 sale of Abbott Medical Optics.
Financial performance and key metrics
| Metric | 2017 | 2016 | Change or comment |
|---|---|---|---|
| Net sales | $27.390 billion | $20.853 billion | Increased 31.3%; acquisitions contributed 26.5 percentage points |
| Operating earnings | $1.726 billion | $3.185 billion | Declined primarily from acquisition-related amortization, inventory step-up, and integration costs |
| Gross margin | 47.7% | 54.1% | Declined 640 basis points |
| Earnings from continuing operations | $353 million | $1.063 billion | Diluted EPS was $0.20 versus $0.71 |
| Net earnings | $477 million | $1.400 billion | Diluted EPS was $0.27 versus $0.94 |
| Operating cash flow | $5.570 billion | $3.203 billion | Improved with working-capital management and acquired businesses |
| Capital expenditures | $1.135 billion | $1.121 billion | Primarily manufacturing, R&D, information technology, and instruments |
| Cash and cash equivalents | $9.407 billion | $18.620 billion | Declined mainly because cash funded the St. Jude acquisition |
| Long-term debt, including current portion | $27.718 billion | $20.684 billion | Increased following the acquisitions |
| Total assets | $76.250 billion | $52.666 billion | Increased substantially from acquisitions |
Fourth-quarter 2017 net sales were $7.589 billion, compared with $5.333 billion in the fourth quarter of 2016. Fourth-quarter earnings from continuing operations were a loss of $864 million, or diluted EPS of negative $0.50, compared with earnings of $765 million, or $0.51 per diluted share, in the prior-year quarter. The fourth-quarter loss primarily reflected the provisional $1.46 billion net tax expense from the Tax Cuts and Jobs Act.
Research and development expense was $2.235 billion, or approximately 8.2% of sales, compared with $1.422 billion in 2016. Intangible amortization was $1.975 billion, compared with $550 million, and included significant amortization from the St. Jude and Alere acquisitions.
Segment results and material changes
- Established Pharmaceuticals: Sales were $4.287 billion, up from $3.859 billion. Excluding foreign exchange, sales increased 9.5%, led by China and Latin America. Operating earnings increased to $848 million from $723 million.
- Nutritional Products: Sales were $6.925 billion, broadly unchanged from $6.899 billion. U.S. pediatric nutrition performed well, while international pediatric and U.S. adult nutrition faced market and competitive pressures. Operating earnings declined to $1.589 billion from $1.660 billion.
- Diagnostics: Sales were $5.616 billion, up from $4.813 billion. Excluding foreign exchange, sales increased 16.7%, including Alere and continued growth in core laboratory and point-of-care products. Operating earnings increased to $1.468 billion from $1.194 billion.
- Cardiovascular and Neuromodulation: Sales were $8.911 billion, compared with $2.896 billion, primarily due to St. Jude Medical. Operating earnings increased to $2.720 billion from $1.037 billion, while the operating margin declined to 30.5% from the 2015 level of 38.0% because of acquisition-related mix and coronary stent pricing pressure.
St. Jude Medical contributed approximately $23.6 billion of acquisition consideration, including $13.6 billion in cash and approximately $10 billion in Abbott shares. Alere was acquired for approximately $4.5 billion in cash, with approximately $3.0 billion of debt assumed and repaid. Together, the acquisitions contributed $6.5 billion of 2017 sales and approximately $1.3 billion of pretax loss, including approximately $1.5 billion of intangible amortization and $907 million of inventory step-up amortization.
Abbott sold Abbott Medical Optics for $4.325 billion and recognized a $1.163 billion pretax gain, or $728 million after tax. Abbott also sold its remaining Mylan shares for $2.704 billion and recorded a $45 million pretax gain.
Liquidity, debt, outlook, and risks
- Operating cash flow exceeded capital expenditures and cash dividends. Working capital was $11.2 billion at year-end, down from $20.1 billion, primarily because of the reduction in cash used for the St. Jude acquisition.
- Abbott had $27.9 billion of short- and long-term debt at year-end and $5.0 billion of revolving credit capacity expiring in 2019. Debt ratings were BBB from Standard & Poor’s and Baa3 from Moody’s at year-end; Moody’s raised the rating to Baa2 with a positive outlook in February 2018.
- Abbott repaid $3.95 billion of debt in January 2018, including the remaining Alere term loan and revolving borrowings, and authorized redemption of up to an additional $5 billion of long-term notes.
- Management’s 2018 priorities were integrating Alere, reducing debt, expanding cardiovascular and neuromodulation products, improving nutrition margins, expanding emerging-market pharmaceuticals, and developing differentiated diagnostics and diabetes technologies. The filing does not provide a consolidated 2018 revenue or earnings guidance figure.
- Research and development spending was expected to approximate 7.5% of 2018 sales.
- The company recorded a provisional $1.46 billion net tax expense related to the Tax Cuts and Jobs Act, including a $2.89 billion transition-tax charge partially offset by deferred-tax remeasurement benefits. The estimate remained subject to adjustment.
- Key risks include acquisition integration and leverage, pricing and reimbursement pressure, regulatory approvals and compliance, product liability and safety events, intellectual-property disputes, foreign exchange, international operations, manufacturing or supply interruptions, cybersecurity, and failure of research programs.
- Abbott received an FDA warning letter concerning a St. Jude manufacturing facility in Sylmar, California and was implementing corrective actions. Legal and environmental matters had an estimated possible loss range of $115 million to $160 million, with approximately $135 million accrued at year-end. Management did not expect these matters to have a material adverse effect.
Most important facts for an investor to verify
- Whether Alere and St. Jude integration produces the expected revenue synergies and cost savings without further significant restructuring or impairment charges.
- The pace of debt reduction, refinancing needs, interest expense, and the effect of leverage on credit ratings and liquidity.
- The final amount of the provisional Tax Cuts and Jobs Act charge and the timing of related transition-tax payments.
- Underlying organic growth and margins by segment, particularly diagnostics, cardiovascular devices, nutritionals, and emerging-market pharmaceuticals.
- Regulatory remediation at the Sylmar facility and any additional product quality, recall, litigation, or compliance developments.
- Future intangible amortization, which the filing estimates at approximately $2.4 billion in 2018 and $2.3 billion in 2019.
- The effect of foreign exchange, reimbursement pressure, sales rebates, and competitive pricing on reported revenue and profitability.
- Alere was excluded from management’s internal-control assessment and the auditor’s internal-control evaluation; investors should monitor the integration of Alere’s reporting controls.