Baxter International Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; compared with the corresponding 2017 periods. Baxter sells renal-care, medication-delivery, pharmaceutical, nutrition, surgical and acute-therapy products. Interim financial statements are unaudited; PwC performed a review, not an audit.
Key financial results
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $2.842bn | $2.605bn | $5.519bn | $5.080bn |
| Gross margin | $1.239bn; 43.6% | $1.132bn; 43.5% | $2.353bn; 42.6% | $2.176bn; 42.8% |
| Operating income | $384m | $347m | $816m | $700m |
| Continuing-operations income | $343m | $264m | $732m | $537m |
| Diluted continuing-operations EPS | $0.63 | $0.48 | $1.33 | $0.97 |
| Operating cash flow, continuing operations | Not separately stated | Not separately stated | $852m | $767m |
Sales increased 9% at reported currency and 5% at constant currency in both Q2 and the first half. Currency contributed approximately four percentage points to reported growth. Q2 operating income rose about 11%; first-half operating income rose about 17%. First-half gross margin declined 0.2 percentage points; management cited foreign exchange, higher supply-chain costs and Hurricane Maria-related lost sales, partly offset by operational expansion. Q2 gross margin increased 0.1 percentage points.
First-half investing cash flow was an outflow of $539m, including $311m of capital expenditures and $228m for acquisitions and investments. Financing cash flow was an outflow of $808m, including $781m of treasury-stock purchases and $173m of dividends. Cash declined $537m to $2.857bn from year-end 2017. At June 30, total debt and lease obligations were $3.498bn, including $3.495bn long-term; approximate net debt was $641m. Current assets were $6.890bn and current liabilities $2.629bn.
Material changes and operating performance
- All reported regions grew: Q2 sales were $1.525bn in Americas, $758m in EMEA and $559m in APAC. Segment operating income increased in each region year over year.
- Pharmaceuticals sales rose 19% in Q2, including Claris acquisition sales and strong BREVIBLOC demand while a competitor faced supply constraints. Baxter expects BREVIBLOC sales to be pressured in the second half as competitor supply improves and additional competition enters.
- Renal Care sales rose 9% in Q2, with constant-currency growth of 4%, driven by peritoneal dialysis and international hemodialysis. Medication Delivery was flat; U.S. large-volume parenteral growth was below expectations and small-volume parenteral supply remained affected by Hurricane Maria, though management expected supply to improve during the remainder of 2018.
- Advanced Surgery sales rose 15% in Q2, partly reflecting the RECOTHROM and PREVELEAK acquisition. Acute Therapies sales rose 15%, supported by demand for continuous renal replacement systems and first-quarter flu-season demand.
- Foreign-currency translation reduced first-half other comprehensive income: currency translation adjustments were a loss of $282m, and comprehensive income was $537m versus $917m in 2017, despite higher net income.
Outlook, commentary, risks and unusual items
- No company-wide earnings or revenue guidance is stated in the supplied filing text. Baxter expects approximately 10% of its $7.4bn remaining performance obligations for contracts of at least one year to be recognized in 2018, 20% in each of 2019–2021, and the balance thereafter.
- Business-optimization initiatives had incurred $661m in cumulative pretax costs through June 30. Baxter expected about $170m of additional pretax costs and $70m of capital expenditures through completion, and forecast approximately $1.2bn in annual pretax savings; about 80% of savings were expected by year-end 2018 and the remainder by year-end 2020.
- Notable first-half items included an $80m benefit from settling certain Claris-related claims; acquisitions and integration costs of $19m; business-optimization charges of $85m; and an estimated $10m charge for product litigation. Reported continuing-operations income included special items that reduced income by $78m in Q2 and $77m in the first half, according to management. Extending the ERP software useful life increased net income by $5m in Q2 and $9m in the first half.
- Regulatory risk: in July 2018, FDA issued a Warning Letter concerning observations from its 2017 inspection of Claris’s Ahmedabad facilities. Baxter was preparing a response and implementing corrective actions; related recalls were described as financially immaterial. FDA warning-letter matters also remain concerning North Cove and Jayuya facilities.
- Legal and credit exposures include a U.S. DOJ criminal investigation and New York Attorney General inquiry concerning IV solutions manufacturing, pricing and shortages; related antitrust litigation; and environmental remediation at seven Superfund sites and Irvine, California. Legal reserves were $34m; environmental reserves were approximately $20m. Management said legal outcomes were not expected to materially adversely affect consolidated financial position, while noting some losses could not be estimated.
- Other risks cited include product quality and patient safety, supply continuity and manufacturing capacity, competition and pricing, foreign exchange and interest rates, customer payment delays, regulatory actions, litigation and execution of cost-saving and acquisition plans. Public-sector receivables in Greece, Spain, Portugal and Italy totaled $133m.
- Liquidity: Baxter reported $2.9bn cash and access to revolving credit facilities of $1.5bn and approximately €200m; it was in compliance with facility covenants. The company repurchased 11.5m shares for $781m in the first half, with $1.8bn remaining under its authorization.
Important facts for investors to verify
- Whether constant-currency sales growth and operating-income improvement persist, particularly after acquisition contributions and temporary BREVIBLOC demand.
- Progress in restoring supply and sales patterns affected by Hurricane Maria, and any further supply-chain cost or inventory pressure.
- Execution, remaining costs and realized savings from the optimization program against management’s $1.2bn annual savings target.
- FDA remediation progress at Claris, North Cove and Jayuya, and any resulting restrictions, recalls or financial effects.
- Cash generation after substantial share repurchases, acquisitions, capital expenditures and dividends, alongside debt and working-capital trends.
- Potential effects of the DOJ inquiry, antitrust matters and other contingencies; the filing says certain possible losses cannot be estimated.