Baxter International Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited interim results. Unless otherwise noted, amounts are in U.S. dollars. Comparisons are with Q1 2016, whose earnings were substantially affected by Baxalta-related share transactions.
Financial performance
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $2.475 billion | $2.375 billion |
| Gross margin | $1.042 billion; 42.1% | $965 million; 40.6% |
| Operating income | $344 million | $188 million |
| Continuing-operations income | $273 million; $0.50 diluted EPS | $3.387 billion; $6.13 diluted EPS |
| Net income | $272 million; $0.49 diluted EPS | $3.380 billion; $6.12 diluted EPS |
| Operating cash flow, continuing operations | $206 million | $(174) million |
| Capital expenditures | $123 million | $184 million |
Gross margin increased 1.5 percentage points. Marketing and administrative expense was $570 million, or 23.0% of sales, versus $641 million, or 27.0%; research and development expense was $128 million versus $136 million. Net interest expense declined to $14 million from $28 million.
Cash and equivalents were $2.858 billion at quarter-end. Total debt and lease obligations were approximately $2.787 billion, including $3 million current and $2.784 billion long-term. No commercial paper was outstanding. Total liabilities were $6.984 billion and equity was $8.675 billion. Cash increased $57 million during the quarter.
Business and period comparisons
- Hospital Products sales rose 7% to $1.579 billion; Renal sales were essentially flat at $896 million. By geography, U.S. sales grew 11% and international sales declined 1% as reported. Foreign exchange reduced total sales growth by about one percentage point.
- Hospital Products growth was led by Fluid Systems (+12%) and Surgical Care (+10%). Renal growth in peritoneal dialysis and continuous renal replacement therapy was offset by lower international hemodialysis sales and pricing pressure.
- Segment EBITDA increased to $763 million from $631 million: Renal was $199 million versus $122 million, and Hospital Products was $564 million versus $509 million.
- Reported Q1 2016 continuing-operations income included approximately $3.2 billion of net realized gains on retained Baxalta shares, partly offset by a $101 million debt-extinguishment loss. Q1 2017 continuing income included special items that reduced it by $45 million, or $0.08 per diluted share. Therefore, reported net-income comparisons are not representative of underlying operating growth.
- Q1 2017 results also benefited by approximately $17 million from adoption of new share-based payment accounting guidance; the prior period was not restated.
Outlook, commentary, and risks
- Baxter expected its business-optimization program to require approximately $360 million of additional pretax costs and $90 million of capital expenditures through completion by the end of 2018. The program was expected to generate approximately $860 million in annual pretax savings, with about 85% realized by the end of 2018 and the remainder by the end of 2020.
- Strategic market exits were expected to reduce full-year sales by approximately $50 million in each of Renal and Hospital Products versus 2016. Management expected U.S. cyclophosphamide sales to continue declining in 2017 because of generic competition.
- Management cited cost savings, improved pricing and product mix as contributors to margin improvement. The filing does not provide a clear full-year revenue or earnings-per-share forecast.
- In April 2017, Baxter disclosed a U.S. Department of Justice Antitrust Division and grand-jury investigation concerning IV solutions and containers, including manufacturing, sales, pricing, shortages and competitor communications. Baxter said it was cooperating; related antitrust litigation and a New York Attorney General inquiry were also disclosed. Recorded reserves for all legal matters totaled $20 million, but the company said it could not estimate losses for certain contingencies.
- Other risks include product quality and regulatory actions, generic and pricing competition, foreign exchange, collection delays from certain governments, and litigation. Public-sector receivables in Greece, Spain, Portugal and Italy totaled $142 million. Two FDA Warning Letters were lifted in February 2017; other previously described regulatory matters remained under discussion with FDA.
- Business optimization charges were $29 million in Q1 2017 versus $15 million in Q1 2016. Baxter also recorded a $4 million other-than-temporary investment impairment in the quarter.
Important facts for investors to verify
- Assess sales and earnings trends excluding the unusually large Baxalta transaction gains in Q1 2016 and the specified special items in both periods.
- Track execution, remaining costs, capital spending and timing of the expected $860 million annual savings from business optimization.
- Monitor generic competition in cyclophosphamide, strategic market exits and whether temporary product supply factors affected Surgical Care growth.
- Follow developments and potential financial exposure from the DOJ investigation, antitrust claims and other legal or regulatory matters; some potential losses are not estimable.
- Reconcile the filing’s discussion of investment impairment: the note reports a $4 million other-than-temporary impairment, while MD&A refers to $7 million of investment impairment losses.
- Note that the independent accountant performed an interim review, not a full audit; the firm reported no material modifications were known to be necessary.