Baxter International Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Financial statements are unaudited. Amounts are in U.S. dollars; figures are in millions unless noted.
Business context and results
Baxter reports two segments: Renal and Hospital Products. The quarter showed modest sales growth and improved operating performance, while comparisons of net income with 2016 are heavily affected by large gains from Baxalta share transactions recorded in the prior year.
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $2,605 | $2,585 | $5,080 | $4,960 |
| Gross margin | $1,130 | $972 | $2,172 | $1,937 |
| Gross margin percentage | 43.4% | 37.6% | 42.8% | 39.1% |
| Operating income | $339 | $68 | $683 | $256 |
| Income from continuing operations | $264 | $1,212 | $537 | $4,599 |
| Net income | $265 | $1,212 | $537 | $4,592 |
| Diluted continuing-operations EPS | $0.48 | $2.19 | $0.97 | $8.33 |
Sales grew 1% reported in Q2 and 2% in the first half; at constant currency, growth was 2% and 4%, respectively. Foreign exchange reduced reported growth by about one percentage point in Q2 and two points in the first half. Hospital Products sales increased 1% in Q2 and 4% in the first half; Renal sales were approximately flat at actual currency rates. Segment EBITDA was $828 in Q2 (prior year $734) and $1,591 for the first half (prior year $1,365).
Management attributed improved gross margin to pricing, manufacturing performance and business transformation savings. Lower marketing and administrative expenses reflected cost reductions, partly offset by declining transition-services income from Baxalta. Q2 R&D expense was $156, down 20%; first-half R&D was $284, down 14%.
Cash flow, balance sheet and liquidity
- First-half cash from continuing operations was $767, compared with $401 in 2016. Total operating cash flow was $718, including a $49 outflow from discontinued operations.
- Continuing-operations investing cash flow was a $313 outflow, including $279 of capital expenditures. Financing cash flow was a $566 inflow.
- Cash and equivalents were $3,817 at June 30, 2017, versus $2,801 at December 31, 2016. Current assets were $7,704 and current liabilities $2,558.
- Long-term debt and lease obligations were $3,454, compared with $2,779 at year-end; including current maturities, total reported debt and lease obligations were $3,457. Baxter issued €600 million of 1.30% senior notes due 2025 in May.
- First-half dividends paid were $141. Baxter repurchased 1.8 million shares for $95 million and had approximately $1.6 billion remaining under its repurchase authorization.
Material changes, outlook and unusual items
- Prior-year earnings are not directly comparable: 2016 continuing income included net realized Baxalta-share gains of approximately $1.1 billion in Q2 and $4.4 billion in the first half, as well as a $101 million debt-extinguishment loss in the first half. Baxter said 2017 special items reduced continuing income by $84 million in Q2 and $129 million in the first half; 2016 special items increased it by about $1.0 billion and $4.1 billion, respectively.
- Venezuela: Baxter deconsolidated its Venezuelan operations on June 30, 2017, recording a $33 million pretax charge. The company said it would exclude the business from consolidated results beginning in Q3.
- Cost program: Cumulative pretax business-optimization costs reached $474 million through June 30. Baxter expects approximately $335 million of additional pretax costs and $90 million of capital expenditures through the end of 2018. The initiatives are expected to deliver about $950 million of annual pretax savings, with approximately 85% realized by the end of 2018 and the remainder by the end of 2020.
- Sales pressures: International market exits are expected to reduce full-year 2017 sales by about $50 million in each of Renal and Hospital Products versus 2016. Baxter expected further U.S. cyclophosphamide declines from generic competition.
- Acquisition after quarter-end: Baxter completed its approximately $625 million Claris Injectables acquisition on July 27, 2017; Claris is not included in these financial statements. An FDA inspection of Claris facilities concluded August 4 with a Form 483 containing observations; Baxter was preparing a response and corrective actions.
- Other risks and contingencies: Baxter disclosed a DOJ criminal investigation and related civil antitrust litigation concerning IV solutions and containers, as well as a New York Attorney General inquiry. It is cooperating. A separate DOJ civil investigative demand concerns certain product discount and promotion practices. Recorded legal reserves were $19 million; the company said some potential losses cannot be estimated. The DaVita commercial dispute was awaiting a court decision.
- Baxter reported that certain FDA warning letters were lifted in 2017, while warning-letter matters involving its North Cove and Jayuya facilities remained under regulatory engagement. Management cited product quality, regulatory, competition, supply, foreign-exchange and customer-credit risks. No company-wide revenue or earnings guidance is stated in the filing.
Important facts for investors to verify
- Separate underlying operating trends from 2016 Baxalta-related gains and from restructuring, amortization and other special items.
- Monitor whether the projected $950 million annual savings are achieved, alongside the remaining costs and capital spending.
- Assess the effect of market exits, generic cyclophosphamide competition, currency movements and segment-specific sales trends.
- Follow the Claris integration and FDA Form 483 response, and the status and potential financial impact of the disclosed investigations, litigation and facility regulatory matters.
- Track debt following the euro-note issuance, cash generation, working-capital needs and collection risk; public-sector receivables in Greece, Spain, Portugal and Italy totaled $148 million.