Business Context and Reporting Period
Abbott Laboratories filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2010. Abbott develops, manufactures and sells pharmaceutical, nutritional, diagnostic and vascular products worldwide. The filing was dated August 5, 2010, and reported 1.544 billion common shares outstanding at June 30, 2010.
Financial Performance and Position
| Metric | Three Months Ended June 30, 2010 | Three Months Ended June 30, 2009 | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 |
|---|---|---|---|---|
| Net sales | $8.826 billion | $7.495 billion | $16.524 billion | $14.213 billion |
| Operating earnings | $1.606 billion | $1.671 billion | $3.076 billion | $2.732 billion |
| Net earnings | $1.292 billion | $1.288 billion | $2.295 billion | $2.727 billion |
| Diluted EPS | $0.83 | $0.83 | $1.47 | $1.75 |
| Gross profit margin | 59.8% | 58.3% | 58.4% | 57.3% |
Reported second-quarter sales increased 17.8%, while six-month sales increased 16.3%. Operating margin was approximately 18.2% in the second quarter and 18.6% for the first six months, compared with approximately 22.3% and 19.2%, respectively, in the prior-year periods. Net margin was approximately 14.6% in the second quarter and 13.9% for the first six months.
Six-month segment sales were $9.018 billion for Pharmaceuticals, $2.734 billion for Nutritionals, $1.863 billion for Diagnostics and $1.581 billion for Vascular Products. Segment sales increased 18.9%, 10.9%, 9.9% and 21.4%, respectively, versus the first six months of 2009.
Six-month net cash from operating activities was $3.871 billion, compared with $2.413 billion in 2009. Investing cash flow used $7.355 billion, primarily reflecting $6.920 billion of business acquisitions and a $1.870 billion restricted-funds deposit. Financing cash flow used $307 million. Cash and cash equivalents declined to $4.322 billion from $8.809 billion at December 31, 2009.
At June 30, 2010, short-term borrowings were $3.651 billion, current long-term debt was $2.217 billion and long-term debt was $12.613 billion. Total reported debt was approximately $18.5 billion. Working capital was $5.2 billion, compared with $10.3 billion at year-end 2009. Abbott reported $6.3 billion of unused credit facilities and long-term debt ratings of AA from Standard & Poor’s and A1 from Moody’s.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven substantially by the February 2010 acquisition of Solvay Pharmaceuticals, favorable foreign exchange and unit growth. Solvay contributed approximately $880 million of second-quarter sales and $1.1 billion of six-month sales, but generated pretax losses of approximately $35 million and $70 million, respectively, including acquisition and integration costs.
- International sales increased 28.1% in the second quarter and 24.0% for the first six months; U.S. sales increased 6.4% and 7.3%, respectively. Excluding favorable currency effects, consolidated sales increased 15.1% in the quarter and 12.9% year to date.
- Gross margins improved, partly due to stronger vascular and diagnostic margins and favorable exchange rates. However, operating earnings declined in the second quarter despite higher sales, reflecting higher research and development, selling, general and administrative expenses, litigation provisions and acquisition-related costs.
- Research and development expense increased 28.0% in the quarter and 20.2% year to date. Selling, general and administrative expense increased 35.5% and 19.8%, respectively.
- Year-to-date net earnings and EPS declined primarily because the first six months of 2009 included a $797 million benefit from derecognition of a contingent liability related to the former TAP joint venture. The 2010 results also included a $75 million acquired in-process research and development charge and an approximately $86 million Venezuela currency devaluation charge.
- Abbott issued $3.0 billion of long-term debt in the second quarter, with maturities in 2015, 2020 and 2040 and interest rates of 2.7%, 4.125% and 5.3%. Proceeds were used to reduce short-term borrowings.
Outlook, Commentary, Risks and Unusual Items
- Management stated that operating cash flow is expected to continue exceeding capital expenditures and cash dividends. The planned acquisition of Piramal Healthcare’s Healthcare Solutions business was expected to close in the second half of 2010 and be funded with current cash.
- Abbott forecast full-year worldwide HUMIRA sales growth of approximately 20% in 2010.
- Abbott announced the planned Piramal acquisition for $2.12 billion in cash, plus potential payments of $400 million annually in 2011 through 2014. Additional contingent consideration may be payable under the Solvay transaction.
- Health care reform legislation increased Medicaid rebate rates, which Abbott expects to negatively affect Pharmaceutical Products gross margins. Additional Medicare Part D rebates and a branded-drug fee were expected in 2011; a medical-device excise tax was expected beginning in 2013. Abbott recorded an approximately $60 million first-quarter tax charge related to retiree health care deferred tax assets.
- In the HUMIRA patent litigation brought by New York University and Centocor, a judgment of approximately $1.67 billion plus $175 million of prejudgment interest remained subject to appeal. Abbott deposited $1.87 billion into escrow to secure the judgment and recorded no reserve, stating that it expected to prevail. The outcome could materially affect cash flows or results of operations.
- For other legal and environmental exposures, Abbott estimated possible losses of approximately $255 million to $300 million and recorded reserves of approximately $275 million. Some pricing, patent and other proceedings had uncertain potential losses.
- Restructuring charges were approximately $32 million in the first six months of 2010, and additional charges were expected through 2011. Estimated annual amortization expense for intangible assets was approximately $1.4 billion in 2010 and 2011.
- Management concluded that disclosure controls were effective and reported no material changes in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Reconcile reported sales and earnings growth with the Solvay acquisition, currency effects and acquisition-related costs; review the provided pro forma figures separately from reported results.
- Assess liquidity after the Solvay acquisition, the $1.87 billion escrow deposit, planned Piramal transaction and scheduled debt maturities.
- Monitor the HUMIRA patent appeal and the potential effect of the approximately $1.845 billion judgment and interest on cash flows.
- Evaluate future Medicaid rebates, Medicare Part D costs, the branded-drug fee and medical-device excise tax on margins and earnings.
- Review HUMIRA growth, generic competition affecting Depakote and other products, and the sustainability of international and vascular sales growth.
- Verify contingent consideration and milestone obligations associated with Solvay and the endometriosis development agreement, including potential payments of approximately $500 million under the latter.