Baxter International Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Financial statements are unaudited; PwC performed an interim review, not an audit. Unless noted, amounts are in U.S. dollars.
Business context
Baxter reported two segments: BioScience and Medical Products. On July 1, 2015, it completed the spin-off of Baxalta, distributing approximately 80.5% of Baxalta’s shares to Baxter shareholders and retaining approximately 19.5%, valued at about $4.3 billion at the distribution-date share price. The June 30 statements still include Baxalta; its results will be reported as discontinued operations beginning in Q3. Prior periods were recast for a segment realignment, and the Vaccines franchise is presented as discontinued operations.
Financial performance
| Metric | Q2 2015 | Q2 2014 | H1 2015 | H1 2014 |
|---|---|---|---|---|
| Net sales | $3.893bn | $4.154bn | $7.657bn | $8.002bn |
| Gross margin | $1.920bn | $1.969bn | $3.721bn | $3.860bn |
| Income from continuing operations | $336m | $468m | $756m | $975m |
| Continuing-operations diluted EPS | $0.61 | $0.85 | $1.38 | $1.78 |
| Net income | $332m | $520m | $762m | $1.076bn |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $792m | $1.158bn |
- Sales fell 6% in Q2 and 4% in H1 at actual exchange rates, but rose 3% in both periods at constant currency. Foreign exchange reduced reported sales growth by 9 percentage points in Q2 and 7 points in H1.
- Gross margin was 49.3% in Q2 versus 47.4%; H1 was 48.6% versus 48.2%. Marketing and administrative expense rose to 28.2% of sales in Q2 and 27.6% in H1, from 23.8% and 23.7%, respectively. R&D expense was $388m in Q2 and $688m in H1.
- BioScience sales were $1.429bn in Q2 (down 2% reported, up 7% constant currency) and $2.790bn in H1 (flat reported, up 8% constant currency). Medical Products sales were $2.464bn in Q2 (down 9% reported, flat constant currency) and $4.867bn in H1 (down 7% reported, up 1% constant currency).
- Q2/H1 continuing-operations income included special items that reduced income by $214m/$343m, or $0.39/$0.63 per diluted share. Separation-related costs were $131m/$248m; other items included collaboration milestone R&D charges and Gambro integration costs. The 2014 periods included $93m of infusion-pump remediation charges in Q2 and H1.
- Q2 other income, net of $67m included a $52m litigation-settlement benefit; H1 other income of $141m also reflected foreign-currency effects and investment-related income. These items contributed to period-to-period earnings variability.
Cash, liquidity and debt
- Cash and equivalents were $6.680bn at June 30, versus $2.925bn at December 31, 2014. Management said cash would have been approximately $1.8bn after giving effect to the Baxalta distribution and July debt tenders.
- H1 operating cash flow was $792m, down from $1.158bn. Investing cash outflow was $1.360bn, including $1.021bn of capital expenditures; financing cash inflow was $4.456bn, principally reflecting debt issuance.
- At June 30, reported short-term debt was $1.493bn, current maturities of long-term debt and leases $671m, and long-term debt and leases $12.054bn. These balances include debt raised by Baxalta before the spin-off and do not reflect subsequent transactions.
- Baxalta issued $5.0bn of senior notes in June; approximately $4.0bn of net proceeds were distributed to Baxter, and the notes became Baxalta’s obligation following the spin-off. Baxter borrowed $1.5bn under its revolving facility, outstanding at June 30.
- In July, Baxter bought about $2.7bn principal amount of its own notes for approximately $2.9bn, including premium and accrued interest. It expects to record an approximately $130m net loss on extinguishment in Q3. The filing’s pro forma post-spin, post-tender debt-and-lease obligations were $6.553bn, excluding transferred capital leases.
- H1 capital expenditures increased to $1.021bn from $844m, including investment in a plasma-treatment plant expected to begin commercial production in 2018. Inventory rose to $3.842bn from $3.559bn; inventory turns declined to 1.98 from 2.23.
Outlook, commentary and risks
- Management expected a full-year 2015 continuing-operations effective tax rate of approximately 21.5%, excluding audit developments and other special items. It warned that changes to assertions on foreign earnings could result in a significant Q3 tax charge.
- Management cited ongoing growth in immunoglobulin therapies and renal peritoneal dialysis, while warning that competition and timing of tenders affect product sales. Generic competition in the U.S. substantially reduced cyclophosphamide sales; management expected further competition to pressure its pricing and demand.
- The company estimated additional business-optimization savings of approximately $0.06 per diluted share through 2016 from prior initiatives, plus approximately $0.02 per diluted share from 2015 charges as programs are implemented.
- Risks include regulatory and product-quality matters, manufacturing and supply constraints, competition and pricing pressure, foreign-exchange and interest-rate volatility, customer collection delays, and litigation. Baxter had $327m of net public-sector receivables in Greece, Spain, Portugal and Italy, including $48m in Greece; management noted potential collection delays and credit losses.
- FDA Warning Letters remained outstanding concerning several manufacturing and quality-system matters. Baxter said it was working with FDA to resolve them. The company also reported ongoing investigations and litigation; it said certain outcomes could materially affect a period’s results or cash flows, although it did not expect the proceedings to materially adversely affect consolidated financial position.
- Credit ratings were S&P A- (negative outlook), Fitch BBB+ (stable) and Moody’s Baa2 (stable). Moody’s and Fitch had downgraded ratings in May, citing the expected effect of the Baxalta spin-off.
Important facts for investors to verify
- Post-spin operating results, segment mix and the retained Baxalta investment’s subsequent valuation and treatment.
- Cash, net debt, credit-facility usage and debt obligations after the distribution and July tender offers; June 30 reported balances include pre-spin financing activity.
- The amount and timing of any Q3 tax charge and the full-year tax rate relative to management’s stated estimate.
- Whether constant-currency sales growth is sustained, especially amid generic competition in cyclophosphamide and product-specific manufacturing or tender constraints.
- Progress on FDA Warning Letters, product quality and recall matters, and the potential financial effects of legal and regulatory contingencies.
- Conversion of operating cash flow, inventory levels and spending on capacity expansion into sales and returns.