Baxter International Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. Comparisons are with Q1 2013 unless otherwise indicated.
Business context and reporting period
Baxter operated through its BioScience and Medical Products segments. Q1 2014 results include Gambro, acquired in September 2013; Q1 2013 results do not. On March 27, 2014, Baxter announced a planned tax-free spin-off of its biopharmaceuticals business, targeted for completion by mid-2015, subject to approvals and other conditions.
Financial results and key metrics
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Net sales | $3,951 | $3,448; up 15% reported, 16% at constant currency |
| Gross margin | $1,961; 49.6% of sales | $1,756; 50.9% |
| Income before tax | $709 | $693 |
| Net income | $556 | $552 |
| Diluted EPS | $1.01 | $1.00 |
| Operating cash flow | $559 | $386 |
| Capital expenditures | $421 | $292 |
| Cash and equivalents | $2,049 at March 31 | $2,733 at December 31, 2013 |
| Total debt and lease obligations | $8,694 at March 31 | $9,166 at December 31, 2013 |
| Current assets / current liabilities | $9,388 / $5,645 | $10,004 / $5,906 at December 31, 2013 |
Q1 net income included special items that reduced pre-tax income by $120 million and net income by $96 million, or $0.18 per diluted share; the comparable 2013 effects were $70 million pre-tax and $49 million net, or $0.09 per diluted share. The effective tax rate was 21.6%, versus 20.3%.
Segment sales were $1,608 million for BioScience, up 5% reported (6% constant currency), and $2,343 million for Medical Products, up 22% (24% constant currency). Gambro contributed $400 million of sales and 11 percentage points of total constant-currency sales growth. Segment pre-tax income was $597 million for BioScience (up 1%) and $293 million for Medical Products (down 9%).
Financing cash outflows were $852 million; investing cash outflows were $384 million. Baxter paid $266 million in dividends, repurchased $250 million of stock and repaid $510 million of debt and other obligations. No borrowings were outstanding under its primary or Euro-denominated revolving credit facilities at quarter-end.
Material changes versus the prior comparable period
- Sales growth was substantially acquisition-driven: excluding Gambro, company growth would have been materially lower. Medical Products growth reflected Gambro; excluding it, Renal sales were flat at actual currency rates and up 4% at constant currency.
- Gross margin declined 1.3 percentage points. Management attributed pressure in part to Gambro’s lower margins (2.5 percentage points of impact) and higher special items, partly offset by mix, pricing, lower pension expense and vaccine milestone timing.
- R&D expense increased 27% to $313 million, reflecting Gambro, pipeline investment and a $25 million Coherus collaboration milestone charge. Net interest expense rose to $43 million from $25 million, principally due to debt issued in 2013.
- Operating cash flow increased to $559 million. Inventory rose to $3,748 million from $3,499 million at year-end, while annualized inventory turns declined to 2.04 from 2.18 in Q1 2013.
- Other income included a $44 million gain on sale of equity-method investments, partly offset by a $17 million loss on the divestiture of the legacy CRRT business. Cash declined by $684 million during the quarter.
Outlook, commentary, risks and unusual items
- Management expected a full-year 2014 effective tax rate of approximately 21.5%, excluding audit developments and other special items. It estimated previously implemented optimization initiatives had generated annualized savings of about $0.18 per diluted share, with a further $0.23 expected when programs were fully implemented in 2015; Q1 initiatives were expected to add about $0.02 per diluted share in annualized savings.
- The proposed spin-off is not assured: it requires, among other things, board approval, tax-related opinions or rulings, regulatory conditions and an effective SEC registration statement. Baxter warned of execution costs, management distraction and possible delay, failure or less-than-expected benefits. Credit agencies’ outlooks were negative; S&P lowered senior and short-term debt ratings during the quarter.
- Product and regulatory exposures include FDA warning letters concerning Round Lake, North Cove, Jayuya, the SIGMA Spectrum infusion pump and a renal facility. Baxter said it was working with FDA to resolve these matters. Product quality, patient safety, recalls, regulatory actions and litigation could affect sales, operations or cash flows.
- Management cited potential generic competition to cyclophosphamide, which had annual sales of approximately $400 million, and anticipated possible launch of a competitor’s extended-half-life factor VIII therapy in 2014. Supplier shortages, product mix, foreign exchange and pricing/reimbursement changes were also risks.
- Public-sector receivables in Greece, Spain, Portugal and Italy totaled $418 million, down $143 million from year-end; management warned that economic and liquidity conditions could delay collections or cause credit losses. A 10% uniform weakening of the U.S. dollar in the company’s currency sensitivity analysis would reduce the net-of-tax net asset position on foreign-exchange contracts by $69 million.
- Legal reserves were $79 million, with related receivables of $6 million. Baxter reported a proposed settlement framework in a shareholder derivative action, subject to approvals, including $12 million for quality and regulatory compliance initiatives over three years. It also paid $64 million to settle direct-purchaser plasma-therapy claims; final court approval followed in April 2014. The filing states some legal losses cannot be estimated and could materially affect a period’s results or cash flows.
- After quarter-end, Baxter agreed to acquire Chatham Therapeutics’ gene-therapy programs, paying $70 million initially and potentially up to $560 million in development, regulatory and commercial milestones, plus sales-based payments. Coherus milestone payments could total up to a further $129 million, in addition to royalties.
Most important facts for investors to verify
- Whether the planned spin-off proceeds on the stated timeline and terms, and its separation costs, tax treatment and effects on credit ratings and capital allocation.
- How much reported growth and profitability are attributable to Gambro, and whether integration, synergies and margin improvement meet management’s expectations.
- Inventory levels and turns, capital spending, cash conversion and the company’s capacity to fund debt maturities, dividends and repurchases while maintaining liquidity.
- Developments in FDA warning-letter matters, product quality and safety, and the related effect on product sales, regulatory status and potential liabilities.
- Actual timing and amounts of Coherus and Chatham milestone obligations, and the commercial and regulatory prospects underlying those contingent payments.
- Resolution of pending litigation and the adequacy of recorded reserves; the filing says outcomes for certain matters cannot be estimated clearly.