Baxter International Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unless noted, amounts are in millions of dollars. The quarter’s results include Gambro, acquired in September 2013; comparable 2013 results do not.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $4,264 | $3,669 | $8,215 | $7,117 |
| Gross margin | $2,041; 47.9% | $1,939; 52.8% | $4,002; 48.7% | $3,695; 51.9% |
| Income before taxes | $661 | $743 | $1,370 | $1,436 |
| Net income | $520 | $590 | $1,076 | $1,142 |
| Diluted EPS | $0.95 | $1.07 | $1.96 | $2.07 |
| Operating cash flow | Not separately provided for the quarter | $1,158 | $1,149 |
- Sales rose 16% in Q2 and 15% in the first half at actual exchange rates; constant-currency growth was 16% and 16%. Gambro contributed $408 million of Q2 sales and $808 million for the half, accounting for about 11 percentage points of total sales growth in each period.
- BioScience sales increased 7% in Q2 and 6% in the first half; Medical Products sales increased 24% and 23%, respectively. The latter’s growth largely reflects Gambro; excluding Gambro, Renal sales declined 3% in Q2 at actual rates.
- Profitability weakened despite sales growth. Gross margin fell 4.9 percentage points in Q2 and 3.2 points in the first half. Management cited product-remediation charges, lower-margin Gambro operations and foreign currency, partly offset by product mix, pricing and lower pension expense.
- Reported earnings included special items reducing pre-tax income by $224 million in Q2 and $344 million in the first half, and net income by $172 million and $268 million, respectively. Items included the SIGMA pump remediation, Gambro integration, separation costs, collaboration milestones and other reserve adjustments.
- First-half R&D expense was $638 million, up 23%; marketing and administrative expense was $1,918 million, up 17%. Net interest expense was $85 million for the half, versus $42 million, largely reflecting debt issued in 2013.
Balance sheet, cash flow and liquidity
- At June 30, cash and equivalents were $1,866, down from $2,733 at year-end. Total assets were $25,629. Inventory increased to $3,836 from $3,499.
- Debt and lease obligations totaled $8,839, including $186 short-term debt, $1,125 current maturities and $7,528 long-term. This compares with $9,166 at December 31, 2013. Cash less reported debt and lease obligations was approximately negative $6,973.
- First-half operating cash flow was $1,158. Investing activities used $926, including $844 of capital expenditures and $176 for acquisitions and investments. Financing activities used $1,072; cash declined by $867 over the period.
- There were no borrowings under the revolving credit facilities at June 30; $150 million of commercial paper was outstanding. Baxter reported compliance with facility covenants. In July, it extended both revolving facilities to December 31, 2015.
- First-half capital expenditures rose from $639 million to $844 million, primarily supporting BioScience capacity expansion and manufacturing, geographic-growth and R&D investments. Dividends paid were $531 million; share repurchases were $450 million.
Material developments, outlook and risks
- Planned separation: Baxter announced plans to separate its biopharmaceuticals and medical products businesses through a tax-free distribution, targeted for completion by mid-2015, subject to market, regulatory, tax and board conditions. Q2 separation costs were $22 million. Subsequent to separation, the biopharmaceuticals business is expected to be reported as discontinued operations.
- Management outlook: The company anticipated a 2014 effective tax rate of approximately 21.5%, excluding audit developments and other special items. No consolidated revenue or earnings guidance is provided in the supplied filing text. Management described expected long-term hemophilia growth and identified a competitor’s extended-half-life therapy launch as a forthcoming competitive factor.
- Product and regulatory exposure: The FDA categorized the SIGMA Spectrum Infusion Pump corrective action as a Class I recall. Baxter recorded a $93 million charge; remediation was expected to continue through March 2016, and the company warned that substantial additional charges could arise. The filing also describes multiple FDA Warning Letters involving manufacturing, quality systems and devices.
- Other operating risks: Potential generic competition could affect U.S. cyclophosphamide pricing and demand; annual U.S. sales were approximately $400 million. Baxter also cited product quality, regulatory, clinical-development, pricing, foreign-exchange and integration risks.
- Credit and legal contingencies: S&P lowered Baxter’s senior and short-term debt ratings in the first half; all rating-agency outlooks were negative, attributed to the planned spin-off. Public-sector receivables in Greece, Spain, Portugal and Italy totaled $450 million. Legal reserves were $77 million; management cautioned that certain additional losses cannot be estimated and that outcomes could materially affect a particular period.
- Other unusual items: Baxter acquired Chatham Therapeutics and AesRx for gene-therapy and sickle-cell programs, respectively; contingent milestone liabilities were recorded. On July 29, Baxter agreed to sell assets and liabilities associated with two vaccines, with completion expected in the second half of 2014.
Important facts for investors to verify
- How much of reported sales growth and future performance is attributable to Gambro, and whether the acquired business’s margins improve.
- The total eventual cost, timing and operational consequences of the SIGMA Class I recall and other FDA quality matters.
- Whether the planned separation proceeds on schedule and on tax-free terms, and its effects on leverage, ratings and continuing-business results.
- Cash conversion and working-capital trends, especially rising inventories and the cash balance decline alongside substantial capital spending.
- Exposure to government receivable delays, litigation outcomes, contingent acquisition payments and generic or product competition.