Baxter International Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data. Baxter completed the distribution of approximately 80.5% of Baxalta on July 1, 2015. Baxalta is reported as discontinued operations for all periods presented, so continuing-operations results principally reflect Baxter’s Renal and Hospital Products businesses.
Key financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales, continuing operations | $2,487 | $2,709 | $7,365 | $7,930 |
| Gross margin | $1,034; 41.6% | $1,193; 44.0% | $3,074; 41.7% | $3,374; 42.5% |
| Operating income | $92 | $217 | $271 | $465 |
| Income from continuing operations | $2; $0.00 diluted EPS | $175; $0.32 diluted EPS | $210; $0.38 diluted EPS | $330; $0.60 diluted EPS |
| Net income, including discontinued operations | $1 | $468 | $763 | $1,544 |
| Operating cash flow, continuing operations | Not stated for quarter | Not stated for quarter | $633 | $731 |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $658 | $624 |
- Actual net sales declined 8% in Q3 and 7% for the nine months. At constant currency, sales increased 2% and 1%, respectively; foreign exchange reduced sales growth by 10 and 8 percentage points.
- Q3 segment sales were $943 million for Renal and $1,544 million for Hospital Products. Segment EBITDA was $182 million and $515 million, respectively. Renal EBITDA increased 3% in Q3 but declined 12% year to date; Hospital Products EBITDA fell 13% in Q3 and 14% year to date.
- Q3 marketing and administrative expense was $794 million, or 31.9% of sales, versus $827 million, or 30.5%. Research and development expense was $148 million versus $149 million.
- Nine-month total operating cash flow, including discontinued operations, was $923 million versus $2.072 billion. Continuing-operations cash flow decreased to $633 million from $731 million.
- Cash and equivalents were $1.970 billion at September 30, down from $2.925 billion at year-end 2014. Total assets were $20.172 billion and total equity was $7.845 billion.
- Balance-sheet debt was approximately $6.729 billion: $1.962 billion short-term debt, $976 million current maturities, and $3.791 billion long-term debt. The company held a $4.156 billion investment in Baxalta shares, recorded at fair value.
Changes, unusual items, and management commentary
- Continuing-operations income was sharply lower, particularly in Q3. Management reported that special items reduced continuing-operations income by $223 million in Q3 and $309 million for the nine months. These included a $130 million loss on debt extinguishment, separation costs of $61 million and $89 million, and business optimization charges of $92 million and $102 million, respectively; reported special items also include offsets and tax effects.
- Reported net income comparisons are materially affected by the Baxalta separation: discontinued operations contributed $553 million for the first nine months of 2015 and $1.214 billion in the comparable 2014 period. Q3 2014 included $293 million from discontinued operations.
- Q3 sales at constant currency reflected growth in Renal and Hospital Products, but pressure from generic competition for cyclophosphamide was substantial. Management expected further competition to continue to weigh on the product’s pricing and demand. Lower high-margin cyclophosphamide sales and investments in manufacturing, quality systems, and processes pressured margins.
- Management cited growth in peritoneal dialysis, acute renal products, infusion systems, U.S. IV therapies, nutrition therapies, and anesthetics. It also cited lower chronic hemodialysis sales, emerging-market bad debt, and lost or reduced sales in some product lines.
- Business optimization programs were expected to generate approximately $0.15 per diluted share in savings as implemented through 2016, including about $0.10 per share from workforce-reduction actions. The company expects reserves for these programs to be substantially used by the end of 2016.
- Management expected a full-year 2015 continuing-operations effective tax rate of approximately 20%, excluding audit developments and other special items. The filing provides no clear full-year revenue or earnings-per-share guidance.
- Other comprehensive income included a $3.440 billion after-tax gain on available-for-sale securities for the first nine months, primarily reflecting the Baxalta share investment. This is not operating income or operating cash flow.
Liquidity, debt, and risks
- Baxter completed debt tender offers in July, purchasing approximately $2.7 billion principal amount of notes for about $2.9 billion, including premium and accrued interest. The company issued $6.868 billion of debt and paid $3.713 billion of obligations during the first nine months; these flows include financing associated with the separation. Baxalta’s $5.0 billion senior notes are Baxalta’s responsibility, not Baxter’s.
- A new $1.5 billion U.S. revolving facility and €200 million Euro facility mature in 2020. Baxter reported compliance with facility covenants at quarter-end. Credit ratings were S&P A- (negative outlook), Fitch BBB+ (stable), and Moody’s Baa2 (stable); S&P and Fitch had downgraded ratings in connection with the separation.
- The filing identifies foreign exchange exposure, possible delays or losses on public-sector receivables, competition and generic pricing, product quality and recalls, regulatory actions, manufacturing and supply risks, and litigation as risks. Receivables from public-sector customers in Greece, Spain, Portugal, and Italy totaled $251 million.
- Recorded legal reserves were $71 million, with related receivables of $37 million. The company said some potential losses could not be estimated; it did not expect the matters discussed to materially adversely affect consolidated financial position, while warning that individual-period results or cash flows could be affected.
- FDA matters included outstanding warning letters relating to quality systems and manufacturing sites; Baxter said the Aibonito warning letter was lifted in October 2015. The filing also describes the SIGMA SPECTRUM and COLLEAGUE infusion-pump remediation reserves.
- PwC performed an interim review, not an audit, and reported no material modifications needed to the interim financial statements. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Underlying sales and profitability trends after separating currency effects, discontinued Baxalta operations, and special items.
- The sustainability of growth and margins given cyclophosphamide generic competition, product mix, and continuing manufacturing and quality investments.
- Cash generation and debt-reduction plans, including the intended use of Baxter’s retained Baxalta investment and any related market-value or liquidity changes.
- Progress and costs of infusion-pump remediation, business optimization, and FDA compliance matters.
- Potential changes in legal, regulatory, customer-credit, and foreign-exchange exposures, including any effects on cash flow or guidance.