Baxter International Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results; comparisons are generally with fiscal 2016. Amounts are in U.S. dollars.
Business context and reporting period
Baxter sells essential healthcare products, including dialysis therapies, IV solutions and infusion systems, injectable pharmaceuticals, nutrition products, and surgical sealants. It operated through Americas, EMEA, and APAC segments and generated approximately 60% of 2017 revenue outside the United States. The financial statements present Baxalta as discontinued operations. In July 2017, Baxter acquired Claris Injectables for approximately $629 million, net of cash acquired.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $10.561 billion | $10.163 billion |
| Gross margin | $4.462 billion; 42.2% of sales | $4.110 billion; 40.4% of sales |
| Operating income | $1.258 billion; 11.9% of sales | $724 million; 7.1% of sales |
| Income from continuing operations | $724 million; $1.30 diluted EPS | $4.966 billion; $9.01 diluted EPS |
| Net income | $717 million | $4.965 billion |
| Operating cash flow, continuing operations | $1.853 billion | $1.624 billion |
| Capital expenditures | $634 million | $719 million |
| Cash and equivalents, year-end | $3.394 billion | $2.801 billion |
| Debt and lease obligations, year-end | $3.512 billion | $2.782 billion |
Fourth-quarter 2017 net sales were $2.774 billion, versus $2.645 billion in fourth-quarter 2016. Continuing-operations income was a loss of $61 million, or a diluted loss of $0.11 per share, compared with income of $240 million in the prior-year quarter.
Year-end current assets were $7.263 billion and current liabilities were $2.821 billion. The company reported $3.4 billion of cash, unused revolving credit facilities with maximum capacities of $1.5 billion and approximately €200 million, and compliance with facility covenants. Operating cash flow was supported in part by improved receivables collection; days sales outstanding fell to 53.0 from 54.5.
Material changes versus the prior comparable period
- Sales grew 4% on both reported and constant-currency bases. U.S. sales rose 6% to $4.510 billion; international sales rose 2% to $6.051 billion. No net currency impact was reported on 2017 sales growth.
- All reported global business units grew in 2017. Pharmaceuticals sales rose 9%, including Claris revenue of $57 million; Medication Delivery rose 4%; Renal Care rose 2%.
- Gross margin improved 1.8 percentage points as reported. Excluding special items, it improved 0.9 points, reflecting pricing, manufacturing performance, and transformation savings, partly offset by currency.
- Income from continuing operations fell sharply from 2016, but the comparison is distorted: 2016 included $4.4 billion of gains from Baxalta retained-share transactions. In 2017, special items reduced continuing-operations income by a net $652 million, including a $322 million net charge related to U.S. tax reform.
- 2017 operating cash flow from continuing operations increased to $1.853 billion from $1.624 billion. Capital expenditures declined by $85 million.
- Debt increased by approximately $730 million, principally reflecting the 2017 €600 million senior-note issuance and financing activity. The notes carry a 1.30% coupon and mature in 2025.
Outlook, management commentary, risks, and unusual items
- Management expected a 2018 GAAP effective tax rate of approximately 19.5%; this estimate could change with tax guidance, audits, discrete items, and completion of its provisional Tax Act accounting.
- Business optimization actions were expected to incur approximately $240 million of additional pretax costs and $50 million of capital expenditures through completion. Baxter estimated approximately $975 million in future annual pretax savings from these actions, with about 90% expected by the end of 2018 and the remainder by the end of 2020. Management estimated approximately $730 million of savings in 2017.
- Baxter planned more than 200 product launches, geographic expansions, and line extensions by 2020. It also agreed in January 2018 to acquire RECOTHROM and PREVELEAK for approximately $153 million upfront, plus potential contingent payments, subject to closing conditions.
- Hurricane Maria disrupted Puerto Rico production. Baxter estimated a roughly $70 million adverse effect on fourth-quarter 2017 sales and expected a further approximately $25 million effect in first-quarter 2018. It recorded $32 million of 2017 pretax costs and had not recorded anticipated insurance recoveries because the amounts were not yet estimable.
- Generic competition reduced U.S. cyclophosphamide sales to $185 million in 2017 from $210 million in 2016; Baxter expected a further approximately $90 million decline in 2018 as additional competitors entered.
- Regulatory and product-quality matters include an FDA Form 483 following inspection of Claris facilities, with corrective actions underway; the North Cove and Jayuya FDA Warning Letter remained outstanding. Earlier Warning Letters for Round Lake and Irvine were lifted in 2017. The SIGMA SPECTRUM pump remediation generated a 2017 charge.
- The company disclosed a DOJ antitrust investigation and related class-action litigation concerning IV-solution manufacturing, pricing, and shortages; Baxter said it was cooperating. A separate North Cove matter was resolved in 2017 through a deferred prosecution agreement and civil settlement, including an approximately $18 million payment and enhanced compliance measures.
- Other risks include healthcare pricing and reimbursement pressure, supply and manufacturing interruptions, product quality and regulatory action, competition, foreign exchange, cyber and privacy threats, tax uncertainty, litigation, and potential liabilities related to the Baxalta separation. The 2017 Tax Act accounting was provisional.
Most important facts for investors to verify
- Reconcile the 2017 GAAP results and fourth-quarter loss to the disclosed special items, particularly the Tax Act charge, restructuring, Claris integration, Hurricane Maria, and product-related charges.
- Assess whether reported cost savings are recurring and whether remaining restructuring costs and the stated savings timetable are achievable.
- Track the recovery of Puerto Rico production, insurance claims, and the expected sales effects in 2018.
- Monitor generic competition and the outlook for cyclophosphamide, as well as the contribution and quality-system remediation of Claris.
- Review developments in the IV-solutions investigation and litigation, unresolved FDA matters, and other legal contingencies; recorded legal reserves were $41 million at year-end, while some potential losses could not be estimated.
- Check final tax accounting and the realized cash-tax consequences of the Tax Act, including the provisional transition-tax estimate and valuation allowances.
- Evaluate leverage, pension funding needs, and capital returns alongside the $3.4 billion cash balance, planned investments, dividends, and share repurchases.