Business Context and Reporting Period
Abbott Laboratories filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. Abbott develops, manufactures, and sells health care products through Established Pharmaceutical Products, Nutritional Products, Diagnostic Products, Vascular Products, Diabetes Care, and Medical Optics businesses.
In February 2015, Abbott completed the sale of its developed markets branded generics pharmaceutical business to Mylan in exchange for Mylan N.V. shares and sold its animal health business to Zoetis. Results of those businesses are presented as discontinued operations, and prior-period segment information was adjusted accordingly.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net sales | $5.150 billion, versus $5.079 billion | $15.217 billion, versus $14.891 billion |
| Operating earnings | $713 million, versus $728 million | $2.052 billion, versus $1.770 billion |
| Operating margin | 13.8%, versus 14.3% | 13.5%, versus 11.9% |
| Earnings from continuing operations | $596 million, versus $438 million | $1.911 billion, versus $1.087 billion |
| Net earnings | $580 million, versus $538 million | $3.656 billion, versus $1.380 billion |
| Diluted earnings per share | $0.38, versus $0.36 | $2.41, versus $0.90 |
| Cash flow from operations | Not separately provided | $2.138 billion, versus $2.437 billion |
Third-quarter sales increased 1.4% reported and 10.9% excluding foreign exchange. Nine-month sales increased 2.2% reported and 10.6% excluding foreign exchange. The stronger U.S. dollar reduced total sales by 9.5% in the quarter and 8.4% in the nine-month period.
- Established Pharmaceutical Products sales increased 24.6% in the quarter and 29.1% year to date, or 42.6% and 43.9%, respectively, excluding foreign exchange.
- Nutritional Products sales were essentially flat reported in the quarter and increased 0.5% year to date; international growth was offset by weaker U.S. adult nutrition sales.
- Diagnostic Products sales declined 2.1% in the quarter and 1.7% year to date on a reported basis, but increased 7.9% and 7.5%, respectively, excluding foreign exchange.
- Vascular Products sales declined 7.8% in the quarter and 6.3% year to date on a reported basis, reflecting foreign exchange and pricing pressure on drug-eluting stents.
Gross margin increased to 53.5% in the third quarter from 51.7% and to 54.0% for the first nine months from 51.2%, primarily due to margin improvement initiatives in Diagnostics, Nutrition, and Vascular. Research and development expense increased 23.7% in the quarter and 5.3% year to date. Selling, general and administrative expense increased 4.5% in the quarter and 5.5% year to date.
Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $3.132 billion at September 30, 2015, down from $4.063 billion at December 31, 2014.
- Operating cash flow was $2.138 billion. Investing cash flow used $1.160 billion, including $862 million of capital expenditures, $235 million for acquisitions, and $2.626 billion of net purchases of other investment securities, partly offset by $2.290 billion of proceeds from the sale of Mylan shares.
- Financing cash flow used $1.739 billion, including $2.019 billion of short-term debt repayments, $1.349 billion of share repurchases, and $1.083 billion of dividends, partly offset by $2.485 billion of long-term debt issuance.
- Short-term borrowings were $2.370 billion, current long-term debt was $32 million, and long-term debt was $5.953 billion at September 30, 2015.
- Abbott issued $2.5 billion of senior notes due in 2020, 2022, and 2025, with stated fixed rates of 2.00%, 2.55%, and 2.95%; interest-rate swaps effectively convert this debt to variable-rate obligations.
- Abbott reported $5.0 billion of unused credit lines supporting commercial paper arrangements. Long-term debt ratings were A+ from Standard & Poor’s and A2 from Moody’s.
- Working capital was $7.1 billion, compared with $4.7 billion at December 31, 2014. Short-term investments increased to $3.007 billion from $397 million.
- Abbott repurchased 26.9 million shares for approximately $1.25 billion during the first nine months and declared quarterly dividends of $0.24 per share, a 9% increase from $0.22 in the prior-year periods.
Material Changes and Unusual Items
- The sale of the developed markets branded generics and animal health businesses generated a $2.837 billion pretax gain, $1.085 billion of tax expense, and a $1.752 billion after-tax gain. This substantially increased reported nine-month net earnings and diluted EPS.
- Abbott sold 40.3 million Mylan N.V. shares for $2.29 billion of proceeds and recognized a $207 million pretax gain. Abbott retained 69.7 million shares, valued at approximately $2.808 billion at September 30, 2015, and reduced its Mylan ownership from approximately 22% to 14%.
- Comprehensive income was a loss of $1.627 billion in the quarter and income of $1.371 billion year to date, primarily because of foreign currency translation losses and unrealized losses on equity securities.
- Restructuring and cost-reduction actions generated approximately $118 million of employee-related charges in the first nine months, plus approximately $34 million of accelerated depreciation and other charges.
- Abbott acquired the remaining equity of Tendyne Holdings in August 2015 for approximately $225 million, plus potential milestone payments of up to $135 million. The preliminary purchase-price allocation included $240 million of in-process research and development and $155 million of goodwill.
Outlook, Risks, and Contingencies
Management expects to fund dividends, capital expenditures, and other investments through operating cash flow, cash, short-term investments, and borrowings. The filing does not provide a specific quantitative earnings or revenue forecast.
- Foreign exchange remains a significant risk, particularly for Abbott’s international operations and reported sales.
- Abbott had approximately $390 million of net monetary assets subject to revaluation in Venezuela and could not predict whether the bolivar would be devalued or whether the official exchange rate would remain available.
- Medical Optics goodwill of approximately $2 billion exceeded estimated carrying value by approximately 15%; lower growth, delayed regulatory approvals, adverse currency movements, or higher discount rates could result in impairment.
- Abbott held approximately $2.8 billion of available-for-sale equity securities, principally Mylan shares. A hypothetical 20% decline in their prices would reduce fair value by approximately $560 million.
- Legal and environmental proceedings had an estimated possible loss range of approximately $50 million to $65 million and an accrued balance of approximately $60 million. Management did not expect a material adverse effect, although outcomes remain uncertain.
- Tax authorities could reduce gross unrecognized tax benefits by approximately $525 million to $635 million within the next twelve months as matters are resolved.
- Abbott identified receivable exposure to governmental health systems in Italy, Spain, Portugal, and Greece; these receivables represented approximately 8% of total net trade receivables at September 30, 2015.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Separate recurring operating performance from the $1.752 billion after-tax gain on business dispositions and the $207 million Mylan-share-sale gain.
- Assess the sustainability of reported sales and margin growth excluding foreign exchange, acquisitions, discontinued operations, and restructuring effects.
- Monitor the value and concentration of Abbott’s remaining Mylan investment and related accumulated unrealized losses.
- Review debt maturity, variable-rate exposure created by interest-rate swaps, and the effect of higher leverage on future interest expense.
- Evaluate Medical Optics goodwill impairment sensitivity and the status of Tendyne and other regulatory-dependent acquisitions.
- Track Venezuelan currency exposure, governmental receivables, tax examinations, legal contingencies, and the potential resolution of unrecognized tax benefits.