BAXTER INTERNATIONAL INC annual report, FY2015

Baxter International Inc. — 2015 Form 10-K

Reporting period: Fiscal year ended December 31, 2015. The filing is an annual report, not a standalone fourth-quarter filing; quarterly figures are noted where useful. Unless stated otherwise, financial results below are for continuing operations.

Business context

Baxter sells hospital and renal-care products, including IV solutions and infusion systems, nutrition and pharmacy products, anesthetics, biosurgery products, and dialysis therapies. Following the July 1, 2015 distribution of approximately 80.5% of Baxalta to shareholders, Baxter’s continuing business comprises the Hospital Products and Renal segments. Baxalta’s operations are reported as discontinued operations for all periods shown, which limits direct comparisons with Baxter’s pre-separation results.

Financial performance and liquidity

Metric	2015	2014
Net sales	$9.968 billion	$10.719 billion
Income from continuing operations	$393 million	$457 million
Diluted EPS from continuing operations	$0.72	$0.83
Operating income	$449 million	$656 million
Gross margin	41.6%	42.7%
Operating cash flow, continuing operations	$1.129 billion	$1.154 billion
Capital expenditures, continuing operations	$911 million	$925 million
Cash and equivalents at year end	$2.213 billion	$2.925 billion
Total assets at year end	$20.975 billion	$26.138 billion

Sales declined 7% at actual exchange rates, but rose 1% at constant currency; foreign exchange reduced reported growth by eight percentage points. U.S. sales were approximately flat at $4.001 billion; international sales fell 11% to $5.967 billion.
Renal sales fell 9% to $3.789 billion as reported, but increased 1% at constant currency. Hospital Products sales declined 6% to $6.179 billion as reported, and increased 1% at constant currency.
Segment EBITDA, a company-defined performance measure, was $2.564 billion versus $2.903 billion. Renal EBITDA was $566 million (down from $666 million); Hospital Products EBITDA was $1.998 billion (down from $2.237 billion).
Net income, including discontinued operations, was $968 million versus $2.497 billion. This comparison is substantially affected by Baxalta’s separation: discontinued-operations income was $575 million in 2015 versus $2.040 billion in 2014.
Fourth-quarter 2015 sales were $2.603 billion and continuing-operations income was $183 million, or $0.33 per diluted share. Fourth-quarter 2014 sales were $2.789 billion and continuing-operations income was $127 million, or $0.23 per diluted share.
Debt and capital lease obligations totaled $4.745 billion, including $810 million of current maturities; short-term debt was an additional $1.775 billion. The filing reported $1.45 billion drawn on a revolving facility and $300 million of commercial paper at year end.
Cash dividends paid totaled $910 million. Baxter made no share repurchases in 2015. R&D expense was $603 million, or 6.0% of sales.

Material changes and unusual items

The Baxalta separation materially changed the company’s scale, reporting segments, assets, liabilities, and year-over-year comparability. Baxter transferred $2.122 billion of cash with the separation and distributed net assets reported at $4.097 billion.
2015 continuing-operations income included special items that management said reduced income by a net $362 million, or $0.66 per diluted share. Notable items included $130 million of debt-extinguishment loss, $111 million of separation costs, $127 million of business-optimization charges, and $73 million of Gambro integration costs. Offsetting benefits included a $52 million litigation settlement and a $28 million net benefit from infusion-pump reserve adjustments.
Gross margin fell 1.1 percentage points. The filing cites lower cyclophosphamide sales, foreign exchange, and manufacturing and freight costs, partly offset by improved Renal product mix. 2015 sales and margins also reflected reduced U.S. cyclophosphamide competition benefits: annual sales were about $270 million, down from about $450 million in 2014.
Cash from continuing operations was $1.129 billion. Capital expenditures were $911 million; operating cash flow less capital expenditures was approximately $218 million, calculated from the reported figures.
In January 2016, Baxter exchanged about 37.6 million retained Baxalta shares for $1.45 billion of revolving-facility debt, extinguishing that borrowing. Baxter expected to recognize an approximately $1.2 billion gain in first-quarter 2016. After the exchange it held about 94.3 million Baxalta shares.

Outlook, management commentary, and risks

Management’s strategic priorities are portfolio optimization, cost-structure and operational improvements, and disciplined capital allocation. Baxter was evaluating long-term financial improvement goals and described an ambition for significant margin expansion, but the filing does not provide a clear quantified full-year 2016 revenue or earnings forecast.
The company planned to launch more than 50 products over five years. Management expected a 2016 continuing-operations effective tax rate of approximately 19.5%, excluding additional audit developments and special items.
Management expected 2016 pension expense to decline by approximately $100 million versus 2015, and planned an equity contribution of at least $600 million to its U.S. qualified pension plan, subject to regulatory approval. It also expected approximately $25 million of contributions to foreign pension plans.
Baxter expected U.S. cyclophosphamide sales of about $180 million in 2016 amid further competition, and warned that Protopam sales might not recur. These product-specific expectations are not a company-wide sales forecast.
Regulatory and product-quality matters remain important: FDA lifted the Aibonito warning letter in October 2015, but other warning-letter matters remained, including matters involving Round Lake and North Cove/Jayuya. The SIGMA Spectrum pump recall remediation was expected to finish by the end of 2016; the remaining reserve was $40 million.
Other significant risks include currency exposure (foreign exchange reduced 2015 sales growth by eight percentage points), pricing and reimbursement pressure, supply and manufacturing disruption, product liability and intellectual-property litigation, cybersecurity, tax audits, and separation-related obligations. Net public-sector receivables in Greece, Spain, Portugal, and Italy were $211 million at year end.
Baxter reported $29 million of recorded legal reserves, while stating that losses on some matters could not be estimated. It was cooperating with a U.S. Attorney investigation concerning North Cove quality and manufacturing practices; a commercial dispute with DaVita was scheduled for trial in August 2016.
Credit ratings at year end included S&P A- with a negative outlook, Fitch BBB+ with a stable outlook, and Moody’s Baa2 with a stable outlook. The company said it was in compliance with credit-facility covenants.

Important facts for investors to verify

How much of the 2015 sales and margin trend reflects foreign exchange, the Baxalta separation, and underlying continuing-business performance?
Whether Baxter achieves its post-separation margin and cost-savings goals, and whether restructuring or portfolio actions create additional charges.
Progress and costs to complete SIGMA Spectrum remediation and resolution of the remaining FDA warning-letter and investigation matters.
Actual 2016 cyclophosphamide sales, competitive pricing, and whether Protopam sales recur.
Use and market value of the remaining Baxalta stake, including planned debt exchanges and pension funding, and the tax treatment and indemnity protection for separation-related transactions.
Debt reduction, refinancing needs, cash generation after capital expenditures and dividends, and any effect of credit-rating changes.
Potential outcomes of litigation, tax audits, public-sector receivable collections, and other contingencies that may exceed recorded reserves.