Baxter International Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Unaudited interim results; amounts are in U.S. dollars. Baxter sells healthcare products and therapies across the Americas, EMEA and Asia Pacific. The independent accountant conducted a review, not an audit, and reported no material modifications needed to the interim statements.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Net sales | $2.632 billion | $2.677 billion; down 2% reported, flat at constant currency |
| Gross margin | $1.080 billion; 41.0% | $1.114 billion; 41.6% |
| Operating income | $384 million | $432 million |
| Net income | $347 million | $389 million |
| Diluted EPS | $0.66 | $0.71 |
| Cash from continuing operations | $148 million | $447 million |
| Capital expenditures | $198 million | $155 million |
Management said currency movements reduced reported sales growth by four percentage points. Excluding the impact of U.S. cyclophosphamide, constant-currency sales growth was 2%. Gross margin excluding identified special items was flat year over year: favorable currency and manufacturing improvements were offset by unfavorable product mix.
Cash and cash equivalents were $1.908 billion at March 31, versus $1.832 billion at year-end 2018. Current assets were $6.087 billion and current liabilities $3.327 billion. Short-term debt was $796 million, including $695 million of commercial paper and $101 million of other short-term borrowings; long-term debt and finance lease obligations were $3.451 billion. No amounts were outstanding on the company’s revolving credit facilities, and Baxter reported compliance with their financial covenants. The company said it had adequate cash for operating requirements and reaffirmed access to capital, while noting that adverse business or credit conditions could affect financing access.
Operating cash flow from continuing operations fell $299 million year over year, primarily due to the prior-year Claris settlement and timing of vendor payments, partly offset by a 2019 insurance recovery. Investing activities used $306 million, including $198 million of capital expenditures and $109 million for acquisitions. Financing activities provided $238 million, including $795 million of net short-term borrowing; Baxter repurchased $597 million of stock and paid $101 million in dividends.
Changes versus the prior comparable period
- Reported net sales declined 2%; foreign exchange was a significant headwind. Medication Delivery sales were lower partly because customers had increased purchases of large-volume parenterals in early 2018 amid industry supply constraints.
- Renal Care, Pharmaceuticals and Advanced Surgery grew at constant currency; Clinical Nutrition and Medication Delivery declined. Advanced Surgery included $17 million of sales from RECOTHROM and PREVELEAK, acquired in 2018.
- Operating income and net income decreased. The prior-year period included an $80 million Claris-related settlement gain; Q1 2019 included a $33 million insurance-recovery gain connected with a legacy product matter.
- Reported cash from continuing operations was lower, while capital spending increased. Cash flows also reflect timing differences in vendor payments.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific full-year revenue or EPS guidance. Baxter expected approximately $35 million of additional pre-tax business-optimization costs. The program was expected to yield about $1.2 billion in cumulative annual pre-tax savings when complete, with approximately 90% realized by the end of 2019 and the remainder by the end of 2023.
- Special items: Management said special items reduced Q1 2019 net income by $52 million, or $0.10 per diluted share, versus a $1 million, or $0.01 per share, increase in Q1 2018. Q1 2019 included $38 million of business-optimization charges and $10 million of acquisition and integration expenses. It also included the $33 million insurance-recovery gain. Special items are management-defined measures; reported GAAP results are shown above.
- Regulatory and manufacturing risks: Baxter was addressing observations in an FDA Warning Letter concerning Claris facilities in Ahmedabad, India, and continuing corrective actions. On May 6, 2019, after quarter-end, it received an Indian state regulator’s Show Cause Notice following an April inspection. Baxter also disclosed an older FDA Warning Letter concerning its North Cove, North Carolina, and Jayuya, Puerto Rico, facilities. Product quality, regulatory action, supply continuity and recalls could affect operations and sales.
- Legal matters: Recorded reserves for legal matters, including environmental matters, were $39 million. The IV-solutions antitrust litigation remained pending; the DOJ closed its related criminal investigation in November 2018, while Baxter was cooperating with a New York Attorney General information request. The company said certain possible losses cannot be estimated and litigation could materially affect results or cash flows in a particular period, although it did not expect these proceedings to materially adversely affect its consolidated financial position.
- Other risks: The filing identifies competition and generic pricing, foreign exchange and interest-rate exposure, manufacturing and supply disruptions, product safety and quality, cybersecurity, regulatory changes, litigation and the ability to generate sufficient operating cash as risks. A 10% hypothetical weakening of the U.S. dollar would reduce the net value of outstanding foreign-exchange contracts by $21 million, excluding offsets from hedged items.
- Accounting and controls: Baxter adopted the new lease standard on January 1, 2019, recognizing $502 million of operating lease right-of-use assets and liabilities at adoption; March 31 balances were $517 million each. Management concluded disclosure controls were effective. ERP and finance-process transformation work was underway, with related control changes being implemented as needed.
Important facts for investors to verify
- Whether revenue trends improve, particularly in Medication Delivery and Clinical Nutrition, and how currency and generic competition affect sales.
- Whether operating cash flow recovers from the $148 million reported for Q1 and how working-capital timing, capital expenditures and short-term borrowing evolve.
- Progress and realized savings from the optimization program compared with the remaining expected costs and stated savings timetable.
- Resolution and operational impact of the Claris regulatory matters, including the post-quarter-end Show Cause Notice, and the status of the older FDA facility warning letter.
- Developments in the IV-solutions antitrust litigation and other contingencies, including whether potential losses beyond recorded reserves become estimable.
- Execution of the share-repurchase program: Baxter repurchased 8.1 million shares for $586 million in Q1 and reported $1.6 billion remaining under its authorization.