BAXTER INTERNATIONAL INC quarterly report, Q2 FY2019

Baxter International Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data. Interim statements are unaudited and results are not necessarily indicative of the full year.

Financial performance

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Net sales	$2,840	$2,842	$5,472	$5,519
Gross margin	$1,159; 40.8%	$1,239; 43.6%	$2,239; 40.9%	$2,353; 42.6%
Operating income	$355	$384	$739	$816
Net income	$343	$343	$690	$732
Diluted EPS	$0.66	$0.63	$1.33	$1.33
Operating cash flow, continuing operations	Not separately presented quarterly	$617	$852

• Q2 reported sales were essentially flat year over year; constant-currency sales growth was 4%, offset by an approximately 4-percentage-point unfavorable foreign-exchange impact. First-half sales declined 1% reported and grew 3% at constant currency.
• Gross margin contracted 2.8 percentage points in Q2 and 1.7 points in the first half. Management cited unfavorable product mix, inventory write-downs, and added costs to address manufacturing issues at a U.S. dialyzer facility. Reported margins also included higher special-item charges.
• Q2 net income was unchanged, while diluted EPS increased partly alongside a lower weighted-average share count. First-half net income fell about 6% year over year.
• First-half operating cash flow from continuing operations decreased $235 million. The filing attributes the decline mainly to the prior-year Claris settlement and the timing of customer and vendor payments, partly offset by a 2019 insurance recovery. Capital expenditures were $352 million; operating cash flow less capital expenditures was approximately $265 million, calculated from reported figures.

Liquidity, debt, and capital allocation

• At June 30, cash and cash equivalents were $2.925 billion, versus $1.832 billion at year-end 2018. Current assets were $7.218 billion and current liabilities $2.597 billion.
• Long-term debt and finance lease obligations were $5.157 billion, compared with $3.473 billion at December 31, 2018. The increase largely reflects May euro-denominated note issuances: €750 million of 0.4% notes due 2024 and €750 million of 1.3% notes due 2029. The company designated the notes as net investment hedges of European operations.
• There were no amounts outstanding under revolving credit facilities, which had stated capacities of $1.5 billion and approximately €200 million. Baxter reported compliance with facility financial covenants and said it had adequate cash for operating requirements. Major rating agencies reaffirmed its investment-grade ratings during February–July 2019.
• First-half financing cash flow was $968 million, including $1.661 billion of debt issuance, partly offset by $720 million of share repurchases and $198 million of dividends. Baxter had $1.4 billion remaining under its repurchase authorization at June 30.

Changes, outlook, and management commentary

• Segment sales were mixed in Q2: Advanced Surgery rose 14% reported, benefiting in part from a competitor’s temporary supply disruption; Renal Care declined 2% reported but grew 3% at constant currency; Medication Delivery grew 1% reported; Pharmaceuticals was essentially flat; Clinical Nutrition declined 3%; and Other declined 12%. APAC sales increased while Americas and EMEA sales decreased.
• Management reported that first-half Renal Care constant-currency growth reflected global peritoneal dialysis patient growth, partly offset by lower U.S. in-center hemodialysis sales. Acute Therapies growth was supported by CRRT demand and the PrisMax launch in additional countries. Generic competition reduced U.S. cyclophosphamide and BREVIBLOC sales.
• The business-optimization program had incurred $899 million of cumulative pretax costs through June 30, with approximately $70 million of additional costs expected. Management expects about $1.2 billion in cumulative annual pretax savings once remaining actions are complete; approximately 90% of expected savings are anticipated by the end of 2019, with the remainder by the end of 2023. These are program estimates, not earnings guidance.
• The filing does not provide clear full-year revenue or EPS guidance. Baxter said it intended to fund obligations through cash, operating cash flows, or additional debt and believed it had financial flexibility to support growth.

Special items, risks, and contingencies

• 2019 results included a $31 million developed-technology intangible-asset impairment, attributed to reduced market expectations for the related product. First-half results also included a $33 million gain from an insurance settlement relating to a legacy product matter. In July, insurers approved a further $40 million of Hurricane Maria claims, expected to be recognized in Q3 2019.
• Business-optimization charges were $65 million in Q2 and $103 million in the first half. Q2 and first-half results also included costs related to acquisition integration and European medical-device regulatory compliance. Baxter’s first-half 2018 comparison included an $80 million Claris-related settlement benefit.
• Effective tax rates were 5.5% in Q2 and 8.5% in the first half, versus 15.1% and 13.1% in the comparable 2018 periods. Baxter attributed the lower 2019 rates primarily to a favorable resolution of an uncertain tax position and excess tax benefits on stock compensation; these factors may not recur.
• Regulatory matters include an FDA Warning Letter relating to the Claris Ahmedabad facility and a 2019 Indian regulator Show Cause Notice following an inspection. Baxter said it was cooperating and implementing corrective actions; related recalls to date were described as financially immaterial. The North Cove deferred prosecution agreement expired in July 2019, and the court dismissed the criminal information with prejudice after Baxter fulfilled the agreement’s terms.
• Legal reserves, including environmental matters, were $49 million at June 30; environmental reserves were $20 million. Baxter stated that certain additional losses cannot be estimated, and that litigation outcomes could significantly affect results or cash flow in a period, although the proceedings were not expected to materially adversely affect consolidated financial position. An IV-solutions antitrust case remained in litigation; the DOJ closed its investigation, while the New York Attorney General continued to seek information.
• Other risks identified include product quality and patient safety, manufacturing and supply continuity, regulatory actions, competition and pricing, foreign-exchange and interest-rate volatility, cybersecurity, and the ability to deliver expected cost savings. Baxter reported effective disclosure controls; its independent accountant performed a review of interim statements, not a full audit.

Key facts for investors to verify

• Whether margin recovery is achievable after dialyzer-facility costs, inventory write-downs, mix pressures, and elevated restructuring charges.
• Whether reported segment growth persists after accounting for currency movements, generic competition, and temporary competitor supply disruptions.
• Progress against the estimated $1.2 billion annual pretax savings target, remaining program costs, and the timing of savings realization.
• Debt and interest-cost trends following the 2019 euro note issuance, and the continuing scale of buybacks and dividends relative to operating cash generation.
• Developments at the Claris facility and with FDA and Indian regulators, as well as the status and potential exposure of unresolved legal matters.
• Recognition and cash receipt timing for the additional $40 million of Hurricane Maria insurance claims approved in July.