Baxter International Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. Baxter’s results reflect continuing operations after the July 2015 separation of Baxalta; comparisons with 2015 are affected by Baxalta being reported as discontinued operations.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $2,585 | $2,475 | $4,960 | $4,878 |
| Gross margin | $972; 37.6% | $1,021; 41.3% | $1,937; 39.1% | $2,040; 41.8% |
| Operating income | $68 | $87 | $256 | $179 |
| Continuing-operations income | $1,212 | $74 | $4,599 | $208 |
| Diluted continuing-operations EPS | $2.19 | $0.13 | $8.33 | $0.38 |
- Sales grew 4% at actual exchange rates and 6% at constant currency in Q2; first-half growth was 2% and 5%, respectively. Currency reduced sales growth by 2 percentage points in Q2 and 3 points for the first half.
- Reported earnings were dominated by gains on Baxter’s former Baxalta shares: net realized gains were $1.1 billion in Q2 and $4.4 billion for the first half. Management said special items increased continuing income by about $1.0 billion and $4.1 billion, respectively. These reported earnings are not a straightforward indicator of operating performance.
- Business segments: Q2 Renal sales were $965 million, up 2% reported (4% constant currency); Hospital Products sales were $1.62 billion, up 6% reported (7% constant currency). Segment EBITDA was $158 million for Renal and $576 million for Hospital Products, versus $158 million and $460 million a year earlier.
- Q2 marketing and administrative expense was $709 million, down from $783 million; research and development was $195 million, up from $151 million. The reported gross-margin decline reflected special charges, including optimization charges and a $51 million intangible-asset impairment. Excluding special items, management said gross margin increased 0.8 percentage point in Q2 and declined 0.3 point for the first half.
Cash flow, balance sheet and capital
- First-half cash from operations was $442 million, including $434 million from continuing operations, versus $792 million total and $323 million from continuing operations in 2015. Continuing-operations investing cash outflow was $383 million, including $352 million of capital expenditures. Financing cash inflow was $328 million.
- Cash and equivalents were $2.63 billion at June 30, 2016, compared with $2.21 billion at year-end 2015. Current assets were $6.82 billion and current liabilities $3.72 billion; year-end comparisons are affected by the Baxalta investment and disposal-group reclassifications.
- Short-term debt, current maturities of long-term debt and lease obligations, and long-term debt and lease obligations totaled $3.17 billion, versus $6.51 billion at year-end. The reduction primarily followed debt-for-equity exchanges using retained Baxalta shares. Commercial paper outstanding was $781 million, at a weighted-average rate of 0.76%.
- Management reported compliance with revolving-credit-facility covenants and $2.6 billion of cash available to support operating needs. Credit ratings were S&P A−, Fitch BBB+, and Moody’s Baa2, all with stable outlooks; S&P revised its outlook from negative to stable during Q2.
- The quarterly dividend was reduced approximately 75% to $0.13 per share, announced in May. First-half cash dividends were $126 million versus $564 million in 2015.
Changes, outlook and notable items
- Renal growth was attributed to patient growth, new products, U.S. peritoneal-dialysis pricing, and acute kidney-injury therapies. Hospital Products growth was led by Fluid Systems, including U.S. IV-solution pricing and demand and SIGMA SPECTRUM pump sales.
- Management cited anticipated full-year 2016 effective tax rate of approximately 20.5%, excluding audit developments and other discrete items. This compares with reported first-half rates of −1.1% in 2016 and 18.8% in 2015; the 2016 rate benefited from tax-free share-transaction gains and tax settlements.
- Optimization initiatives generated estimated savings of $0.09 per diluted share through Q2 2016. Management expects further annual savings of about $0.08 per share from earlier programs and $0.09 per share from additional first-half 2016 initiatives, when fully implemented by the end of 2017.
- Baxter discontinued the VIVIA home hemodialysis development program; related restructuring costs were $58 million. First-half business optimization charges totaled $154 million, and $161 million of restructuring reserves remained at June 30, expected to be substantially used by year-end.
- Other risks and contingencies include the SIGMA SPECTRUM infusion-pump recall (remaining reserve $4 million), FDA warning letters and ongoing quality/manufacturing matters, a commercial dispute with DaVita scheduled for trial in the second half of 2016, and a U.S. government investigation concerning North Cove operations. Legal reserves were $40 million, net of related receivables of $10 million; Baxter said some potential losses cannot be estimated and that claims could materially affect results or cash flows in a period.
- Foreign-exchange exposure, customer and government receivable collection risks, competition, pricing and product-quality or regulatory actions are among the identified risks. Public-sector receivables in Greece, Spain, Portugal and Italy totaled $183 million. Baxter reported $25 million of Venezuelan net assets and a $9 million first-quarter devaluation charge.
Key facts for investors to verify
- Underlying sales, margins and earnings apart from the large Baxalta-share gains and other special items.
- Progress on optimization savings, including costs, implementation timing and the discontinued VIVIA program.
- Cash generation from continuing operations, debt maturities and liquidity following the debt-for-equity exchanges and dividend reduction.
- Whether the projected 20.5% tax rate remains appropriate after tax audits and other discrete items.
- Developments in FDA matters, the infusion-pump recall, the DaVita dispute and other contingencies for which the company cannot estimate potential losses.
The interim financial statements were reviewed by PwC, not audited; the firm reported that it was not aware of material modifications needed for GAAP conformity.