Baxter International Inc. — FY 2016 Form 10-K
Business context and reporting period. Fiscal year ended December 31, 2016; comparisons are primarily with FY 2015. Baxter now reports two continuing segments: Hospital Products and Renal. Its former biopharmaceuticals business, Baxalta, is presented as discontinued operations. Baxter disposed of its remaining Baxalta shares in 2016, and Shire acquired Baxalta in June 2016.
Financial performance
| Metric | FY 2016 | FY 2015 | Change / context |
|---|---|---|---|
| Net sales | $10.163 billion | $9.968 billion | Up 2% reported; up 4% at constant currency |
| Gross margin | $4.110 billion; 40.4% | $4.146 billion; 41.6% | Margin down 1.2 percentage points reported; excluding disclosed special items, up 0.6 points |
| Operating income | $724 million | $449 million | Operating margin approximately 7.1% versus 4.5% |
| Continuing-operations income | $4.966 billion; $9.01 diluted EPS | $393 million; $0.72 diluted EPS | FY 2016 includes $4.391 billion of net realized gains on Baxalta share transactions; special items increased continuing income by $3.9 billion after tax |
| Net income | $4.965 billion | $968 million | FY 2015 included $575 million from discontinued operations; FY 2016 discontinued-operations loss was $1 million |
| Operating cash flow, continuing operations | $1.624 billion | $1.253 billion | Increase of $371 million |
| Capital expenditures, continuing operations | $719 million | $911 million | Lower investment outlay year over year |
| Cash and equivalents | $2.801 billion | $2.213 billion | Up $588 million |
| Debt and capital lease obligations | $2.782 billion | $4.732 billion | Down $1.950 billion; no short-term debt at year-end |
- Sales by segment: Hospital Products revenue was $6.308 billion, up 2%; Renal revenue was $3.855 billion, up 2%. Segment EBITDA was $2.273 billion for Hospital Products (versus $1.998 billion) and $703 million for Renal (versus $566 million).
- Geography: U.S. sales were $4.259 billion, up 6%; international sales were $5.904 billion, down 1% reported but up 3% at constant currency. Approximately 60% of revenue was generated outside the U.S.
- Margins and spending: Marketing and administrative expenses were 27.0% of sales versus 31.0%. R&D expense rose 7% to $647 million, or 6.4% of sales.
- Liquidity and obligations: Baxter had $2.8 billion of cash and undrawn revolving facilities of $1.5 billion and €200 million, both maturing in 2020. It reported compliance with facility covenants. Pension plans were underfunded by $1.216 billion; other postemployment benefits were underfunded by $243 million.
Material changes and unusual items
- Baxter exchanged or contributed its retained Baxalta shares, recognizing $4.391 billion in net gains and extinguishing approximately $3.65 billion of debt; it also exchanged shares for 11.5 million Baxter shares and contributed shares to its U.S. pension plan.
- Business optimization charges totaled $409 million in 2016. Baxter reported cumulative costs of $407 million through year-end for its main restructuring program and expects approximately $390 million of additional pretax costs and $90 million of capital expenditures through 2018. Management estimates annual pretax savings of approximately $860 million, with about 85% expected by the end of 2018 and the balance by 2020.
- Other notable 2016 items included a $149 million debt-extinguishment loss, a $51 million impairment primarily involving developed technology, and a $706 million noncash contribution of Baxalta shares to the U.S. pension plan.
- Quarterly supplementary data show Q4 2016 sales of $2.645 billion and continuing-operations income of $240 million, or $0.44 diluted EPS. Q4 2015 figures were $2.603 billion, $183 million, and $0.33, respectively.
Outlook, management commentary, and risks
- Management expects 2017 sales in each of the Renal and Hospital Products segments to be reduced by approximately $50 million versus 2016 due to international strategic market exits. It also expects a significant decline in U.S. cyclophosphamide sales in 2017 because of additional competition.
- The company plans to launch more than 100 products by 2020. Management’s strategy emphasizes portfolio optimization, cost reduction and operational efficiency, and disciplined capital allocation.
- Management expected a 2017 GAAP effective tax rate of approximately 21.5%, excluding stock-compensation tax effects, audit developments, and other special items. The 2016 rate was unusually low at negative 0.2%, largely because Baxalta transaction gains were tax-free.
- Key risks include regulatory compliance and product quality, competitive and reimbursement-driven pricing pressure, supply interruptions, foreign-exchange movements, global operations and cybersecurity, litigation, and the possibility that restructuring savings or long-term financial goals are not achieved.
- FDA warning letters concerning the Round Lake and McGaw Park facilities were lifted in February 2017, after fiscal year-end. In January 2017, Baxter agreed to an approximately $18 million civil settlement and deferred prosecution agreement related to North Cove quality and manufacturing matters.
- Pending matters include litigation alleging an IV-solution manufacturers’ conspiracy to restrict output and affect pricing, a commercial dispute with DaVita awaiting a court decision, and a DOJ information demand concerning discount arrangements and promotion of TISSEEL and ARTISS. Baxter says certain legal outcomes cannot be estimated; recorded legal reserves were $53 million at year-end.
- The company’s 2016 net receivables from public-sector customers in Greece, Spain, Portugal, and Italy totaled $137 million; delays and credit losses remain possible. Baxalta separation-related tax and indemnity exposures also remain, including risk that indemnification from Baxalta or Shire may not fully cover liabilities.
Most important facts for investors to verify
- Separate recurring operating performance from the $4.391 billion Baxalta-related gain when assessing FY 2016 earnings and EPS.
- Track whether the forecast restructuring savings materialize, and compare them with remaining charges and implementation spending.
- Monitor 2017 segment sales impacts from international market exits and generic competition in cyclophosphamide.
- Review developments in the IV-solution antitrust litigation, North Cove settlement compliance, other regulatory matters, and Baxter’s legal reserves.
- Assess the adequacy of liquidity and debt maturities alongside pension funding needs, foreign-currency exposure, and the $137 million of public-sector receivables in the identified European countries.
- Confirm whether the expected 2017 tax rate and the continuing effects of Baxalta-related indemnities and separation arrangements remain consistent with management’s assumptions.