Abbott Laboratories: 2016 Q2 Form 10-Q Summary
Business context and reporting period
Abbott Laboratories reported results for the three and six months ended June 30, 2016. The company develops, manufactures and sells health care products through Established Pharmaceutical Products, Nutritional Products, Diagnostic Products and Vascular Products, with additional non-reportable businesses. Approximately 70% of net sales were generated outside the United States.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $5.333 billion | $5.170 billion | $10.218 billion | $10.067 billion |
| Operating earnings | $816 million | $729 million | $1.340 billion | $1.339 billion |
| Earnings from continuing operations | $599 million | $786 million | $655 million | $1.315 billion |
| Net earnings | $615 million | $784 million | $931 million | $3.076 billion |
| Diluted EPS | $0.41 | $0.52 | $0.63 | $2.03 |
| Operating margin | 15.3% | 14.1% | 13.1% | 13.3% |
| Gross margin | 54.4% | 54.2% | 53.8% | 54.2% |
Reported second-quarter sales increased 3.2%; excluding foreign exchange, sales increased 6.4%. Six-month sales increased 1.5%, or 5.8% excluding foreign exchange. Q2 growth excluding currency was broad-based: Established Pharmaceuticals increased 9.5%, Nutritionals 4.3%, Diagnostics 6.0% and Vascular Products 8.9%.
- Six-month reportable-segment sales were $9.090 billion, up 1.6% reported and 6.2% excluding currency.
- Q2 international sales increased 7.5% excluding currency; U.S. sales increased 4.0%.
- Six-month operating cash flow was $816 million, compared with $943 million in the prior-year period.
- Capital expenditures were $490 million; investing cash flow was negative $1.244 billion.
- Financing cash flow was negative $1.611 billion, including $769 million of dividends and $520 million of share repurchases and other share purchases.
- Cash and cash equivalents declined to $2.578 billion from $5.001 billion at December 31, 2015. Short-term investments increased to $1.860 billion from $1.124 billion.
- Short-term borrowings were $2.892 billion, current long-term debt was $4 million and long-term debt was $6.016 billion, for total reported debt of approximately $8.912 billion.
- Abbott reported $5.0 billion of unused credit lines supporting commercial paper arrangements, expiring in 2019.
Material changes versus the prior comparable period
- Q2 operating earnings rose $87 million despite higher interest expense and the absence of significant prior-year gains.
- Continuing-operations earnings declined primarily because Q2 2015 included a $207 million pretax gain on the sale of Mylan shares and $79 million of income from a reduction in contingent consideration. Q2 2016 also had higher interest expense related to pending acquisition financing.
- Six-month continuing-operations earnings fell by $660 million. The comparison was affected by the $207 million Mylan gain in 2015, a $477 million Venezuela foreign-exchange loss in 2016, and tax benefits recognized in 2016.
- Six-month 2015 net earnings included a $1.736 billion after-tax gain from the sale of the developed-markets branded generics and animal-health businesses. Consequently, six-month 2016 net earnings and EPS are not directly comparable with 2015.
- The gross margin declined on a six-month basis because of unfavorable foreign exchange in Nutritionals, Diagnostics and Vascular Products, although Q2 gross margin improved modestly.
- Share count declined, with diluted weighted-average shares of 1.480 billion in Q2 2016 versus 1.504 billion in Q2 2015.
- The quarterly dividend increased 8% to $0.26 per share from $0.24.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear quantitative earnings or revenue guidance range. Management expects to fund dividends, capital expenditures and other investments through operating cash flow, cash on hand, short-term investments and borrowings, and expects to maintain an investment-grade credit rating despite anticipated acquisition-related borrowing.
- Abbott agreed to acquire Alere for an expected equity value of $5.8 billion and assume or refinance approximately $2.6 billion of net debt. The transaction remained subject to shareholder and regulatory approvals; an FTC request for additional information extended the HSR waiting period.
- Abbott agreed to acquire St. Jude Medical for an expected equity value of approximately $25 billion and assume or refinance approximately $5.7 billion of net debt. A $17.2 billion bridge facility was available as back-up financing. The FTC issued an additional-information request in July 2016.
- Alere subsequently disclosed expected revisions to prior financial statements and potential material weaknesses involving revenue recognition and income taxes, creating additional transaction and diligence risk.
- Abbott recorded a $477 million Venezuela foreign-currency loss in Q1 2016 after moving to the DICOM exchange rate. Management stated that additional losses were not expected to be material based on Venezuela representing approximately 0.1% of consolidated assets at June 30.
- Available-for-sale equity securities, principally Mylan shares, had a fair value of approximately $3.0 billion and unrealized gross losses of $589 million. A hypothetical 20% decline in their market prices would reduce fair value by approximately $600 million.
- Restructuring charges totaled approximately $25 million in the first six months of 2016. An additional $43 million impairment was recorded for an in-process research and development project.
- Legal and environmental proceedings had an estimated possible loss range of $35 million to $45 million, with approximately $40 million accrued. Management did not expect a material adverse effect, although outcomes remain uncertain.
- Tax matters produced approximately $145 million of continuing-operations tax benefits and $266 million of discontinued-operations tax benefits in the first six months. Abbott estimated that gross unrecognized tax benefits could decrease by $100 million to $200 million during the next twelve months.
- Foreign exchange, health-care regulation, pricing controls, competition, government reimbursement, acquisition approvals, integration financing and pending litigation were identified as key risks.
Important facts for investors to verify
- Reconcile reported earnings and EPS with continuing operations, discontinued operations, the 2015 Mylan/business-sale gains and the 2016 Venezuela loss.
- Assess liquidity and leverage after any financing used to close the Alere and St. Jude Medical acquisitions, including the effect on Abbott’s credit ratings.
- Monitor the status, regulatory approvals, financing and integration risks of the Alere and St. Jude Medical transactions.
- Evaluate exposure to Mylan share-price volatility and potential impairment of Abbott’s remaining equity investment.
- Track foreign-exchange effects, particularly in emerging markets and Venezuela, and distinguish reported from constant-currency growth.
- Review tax settlements, unrecognized tax benefits and the sustainability of the 2016 tax benefits.
- Confirm the impact of restructuring, intangible-asset amortization and contingent consideration on future operating results and cash flow.