Baxter International Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited interim financial statements; PwC performed a review, not an audit. Financial amounts below are in U.S. dollars, in millions unless stated otherwise.
Business context and results
Baxter sells healthcare products and therapies across Renal Care, Medication Delivery, Pharmaceuticals, Clinical Nutrition, Advanced Surgery and Acute Therapies. It reports geographically in Americas, EMEA and APAC. The company says COVID-19 affected demand, operations, supply chains and costs, with impacts varying by product.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $2,972 | $2,851 | $8,492 | $8,323 |
| Gross margin | $1,195 | $1,230 | $3,396 | $3,463 |
| Gross margin ratio | 40.2% | 43.1% | 40.0% | 41.6% |
| Operating income | $470 | $503 | $1,210 | $1,236 |
| Net income attributable to Baxter stockholders | $356 | $369 | $934 | $1,024 |
| Diluted EPS | $0.69 | $0.71 | $1.81 | $1.97 |
| Cash from operations | Not separately provided | Not separately provided | $1,156 | $1,275 |
Sales rose 4% in Q3 and 2% for the nine months year over year at actual exchange rates; nine-month growth was 3% at constant currency. Q3 net income attributable to Baxter stockholders declined about 4%, and nine-month income declined about 9%. Reported gross margin ratios fell 2.9 percentage points in Q3 and 1.6 points year to date.
Cash, debt and liquidity
- Cash and cash equivalents were $4,359 at September 30, 2020, versus $3,335 at December 31, 2019. Total current assets were $9,033 and current liabilities $3,422.
- Long-term debt and finance lease obligations were $5,760, with $727 in current maturities; management described total debt and finance lease obligations, including current maturities, as approximately $6.5 billion. No borrowings were outstanding under the U.S. dollar or euro revolving credit facilities at quarter-end.
- Nine-month operating cash flow was $1,156, down $119 year over year; continuing-operations operating cash flow was $1,158, down $123. Investing activities used $915, including $472 of capital expenditures and $466 for acquisitions and investments. Financing activities provided $798.
- Baxter issued $1.25 billion of senior notes in March 2020 and used proceeds for general corporate purposes, including strengthening its balance sheet amid the pandemic. It paid $348 in dividends during the first nine months and made no share repurchases in that period.
Material changes and operating drivers
- Acute Therapies sales grew 36% in Q3 and 33% year to date, driven by demand for continuous renal replacement therapy systems, including COVID-related demand. Renal Care rose 4% in Q3, supported by peritoneal dialysis patient growth.
- Medication Delivery fell 3% in Q3 as hospital admissions and elective procedures declined. Advanced Surgery rose 9% in Q3, including $30 of Seprafilm sales, but declined 3% year to date as elective procedures were deferred. Pharmaceuticals rose 2% in Q3, partly due to a nonrecurring U.S. government purchase, but declined 1% year to date.
- Management attributed lower gross margin, excluding special items, to product mix, added employee compensation, reduced manufacturing efficiency and incremental logistics costs related to COVID-19. Lower bonus accruals, cost actions and reduced travel helped reduce SG&A expense ratios.
- Interest expense, net increased to $39 in Q3 from $13 and to $96 year to date from $51, primarily due to higher debt and lower interest income.
Outlook, unusual items and risks
- Management provided no specific revenue or EPS guidance in this filing. It expected COVID-related mix, compensation, manufacturing-efficiency and logistics pressures to continue weighing on full-year 2020 gross margin. It expected 2020 net interest expense to increase by more than $60 versus 2019.
- The company expected more than $1.2 billion of cumulative annual pretax savings from business optimization actions when complete; about 95% was expected by the end of 2020 and the remainder by the end of 2023. It anticipated approximately $15 of additional pretax costs to complete initiatives underway.
- Special items reduced net income by $75 in Q3 and $251 for the nine months, or $0.14 and $0.49 per diluted share, respectively. Items included intangible amortization, restructuring and optimization costs, European medical-device regulation costs, acquisition costs and investigation-related costs. Prior-year periods included insurance recoveries, including $40 related to Hurricane Maria in Q3 2019.
- In September, Baxter offered certain former U.S. employees a pension lump-sum option. Depending on acceptance, it could record a noncash pretax settlement loss in Q4 2020; the amount was not yet determined.
- COVID-19 risks include unpredictable demand changes, delayed elective procedures, supply and distribution disruption, higher costs, customer payment or solvency issues, and cybersecurity exposure from remote work.
- Legal and regulatory contingencies include opioid litigation, two ethylene-oxide exposure lawsuits, shareholder litigation and an SEC inquiry related to the company’s foreign-exchange investigation. Legal and environmental reserves totaled $39 at quarter-end; Baxter said some potential losses cannot be estimated. Management did not expect the cited proceedings to materially harm consolidated financial position, while acknowledging uncertain outcomes.
- A material weakness in controls over accounting for foreign-exchange gains and losses led to prior-period restatements. Management had implemented remediation actions but had not yet determined that the weakness was remediated. Disclosure controls were reported ineffective as of September 30, 2020. The filing also discusses a continuing FDA Warning Letter for the Claris Ahmedabad facilities.
Important facts for investors to verify
- Whether COVID-related demand, elective-procedure levels, supply constraints and added operating costs change subsequent sales and gross margins.
- Whether operating cash flow improves as inventory builds and customer-payment timing normalize, and how acquisitions, capital spending, dividends and debt affect liquidity.
- Whether the foreign-exchange control weakness is formally remediated and whether the investigation or related litigation leads to additional disclosures, costs or restatements.
- Whether a Q4 pension settlement loss is triggered, and the eventual cash and earnings effects of terminated interest-rate hedges.
- Progress on Claris regulatory remediation, outstanding legal matters and the expected realization and cost of optimization savings.