Baxter International Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; interim financial statements are unaudited. Unless noted, amounts are in millions. Comparisons are with 2015. Baxalta’s results are presented as discontinued operations following its 2015 separation; Shire completed its merger with Baxalta on June 3, 2016.
Financial highlights
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $2,558 | $2,487 | $7,518 | $7,365 |
| Operating income | $186 | $92 | $442 | $271 |
| Income from continuing operations | $127 | $2 | $4,726 | $210 |
| Net income | $130 | $1 | $4,722 | $763 |
| Diluted continuing-operations EPS | $0.23 | $0.00 | $8.56 | $0.38 |
| Operating cash flow, continuing operations | Not provided by quarter | Not provided by quarter | $938 | $757 |
- Sales grew 3% in Q3 and 2% for the first nine months at actual exchange rates; at constant currency, growth was 4% and 5%, respectively. Foreign exchange reduced reported sales growth by about one and three percentage points.
- Q3 gross margin was 41.9%, up 0.3 percentage point; nine-month gross margin was 40.0%, down 1.7 points. Excluding disclosed special items, gross margin improved 1.1 points in Q3 and 0.2 points year to date.
- Q3 marketing and administrative expense was $726 (28.4% of sales), versus $794 (31.9%) a year earlier. R&D was $159, up 7%; excluding special items, R&D declined 8%.
- Segment sales and EBITDA increased year over year: Renal sales were $977 and EBITDA $214 in Q3; Hospital Products sales were $1,581 and EBITDA $588. Management attributed segment earnings growth largely to higher sales and cost savings.
- Nine-month capital expenditures were $519, versus $658 in 2015. Cash and equivalents were $2,597 at September 30. Debt and lease obligations totaled $2,840, including $6 current and $2,834 long-term; short-term debt was zero. Total current assets were $6,589 and current liabilities $2,606.
Material changes and unusual items
- Nine-month continuing income includes approximately $4.4 billion of net realized gains from transactions involving Baxter’s retained Baxalta shares. These included debt-for-equity exchanges, a contribution to Baxter’s U.S. pension plan, and an exchange for Baxter shares. Baxter held no Baxalta shares at September 30. The gains substantially inflate reported year-to-date earnings and are not indicative of recurring operating performance.
- Q3 continuing income included special items that reduced income by $184 million, or $0.33 per diluted share. For the first nine months, special items increased continuing income by $4 billion, or $7.17 per diluted share, principally because of the retained-share gains. The company also recorded nine-month debt-extinguishment losses of $153 million.
- Business optimization charges were $171 million in Q3 and $325 million year to date, including restructuring, implementation, accelerated depreciation and integration costs. Restructuring included workforce reductions and costs from discontinuing the VIVIA home hemodialysis program. Remaining restructuring reserves were $196 million, expected to be substantially used by the end of 2017.
- In August, Baxter issued $1.6 billion of senior notes at fixed coupons of 1.70% to 3.50%, with maturities from 2021 to 2046. In September, it redeemed approximately $1 billion of notes and recorded a Q3 debt-extinguishment loss of approximately $52 million.
Outlook, risks and contingencies
- Management forecast a full-year 2016 effective tax rate of approximately 20.5%, excluding audit developments and other discrete items. The filing gives no clear numerical revenue or earnings guidance.
- Management expects business optimization actions to provide future annual savings of $0.12 per diluted share when fully implemented by the end of 2017. Most remaining Baxalta-related operations and assets were expected to transfer in Q4 2016.
- Management cited continued PD and acute renal therapy growth, favorable U.S. IV solutions demand and pricing, and cost-reduction efforts. Risks to growth include foreign exchange, competition, lower U.S. cyclophosphamide sales and expected additional competitors, and European austerity measures affecting anesthesia demand.
- Cash flows may be affected by product demand, customer or supplier solvency, credit ratings, currency and interest-rate movements, and delayed public-sector collections. Receivables from public-sector customers in Greece, Spain, Portugal and Italy totaled $181 million.
- Legal reserves were $50 million, with related receivables of $10 million. The DaVita commercial dispute was awaiting a court decision after a Q3 bench trial. A November 2016 antitrust class action alleged that IV-solution manufacturers conspired to restrict output and affect pricing; Baxter also reported ongoing FDA warning-letter matters and a federal investigation concerning quality and manufacturing practices at its North Cove facility. Management said litigation outcomes were not expected to materially harm consolidated financial position, but noted that individual matters could significantly affect results or cash flows.
- The SIGMA SPECTRUM infusion-pump recall reserve was $4 million at quarter-end. The company also disclosed a sensitivity analysis indicating that a hypothetical 10% broad strengthening of the U.S. dollar would reduce the net-of-tax value of foreign-exchange instruments by $27 million; this analysis excludes offsetting changes in hedged items.
Most important facts for investors to verify
- Underlying operating performance excluding the $4.4 billion retained-share gain, debt-extinguishment losses and restructuring charges.
- Whether constant-currency sales growth, particularly in Renal and Fluid Systems, continues and whether weakness in injectable products persists.
- Delivery and timing of the projected $0.12-per-share savings and completion of remaining Baxalta transfers.
- Cash generation, capital spending, debt and interest costs following the 2016 debt exchanges, note issuance and redemptions.
- Developments in the IV-solutions antitrust complaint, DaVita dispute, FDA matters and North Cove investigation, including any financial exposure beyond recorded reserves.
- Actual full-year tax rate versus the stated 20.5% outlook and the effect of further audit or other discrete items.