Abbott Laboratories 2017 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Abbott Laboratories filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2017. Abbott sells branded generic pharmaceuticals, nutritional products, diagnostic systems and cardiovascular and neuromodulation products worldwide.
The results include St. Jude Medical from its January 4, 2017 acquisition. The acquisition materially changed Abbott’s scale, product mix, debt profile, intangible assets and share count.
Financial Performance and Key Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $6.637 billion, up 24.4% | $12.972 billion, up 27.0% |
| Operating earnings | $427 million | $225 million |
| Earnings from continuing operations | $270 million | $656 million |
| Net earnings | $283 million | $702 million |
| Diluted earnings per share | $0.16 | $0.40 |
| Operating margin | 6.4%, versus 15.3% in 2016 | 1.7%, versus 13.1% in 2016 |
| Gross margin | 46.3%, versus 54.4% in 2016 | 45.0%, versus 53.8% in 2016 |
| Cash flow from operating activities | Not separately provided | $1.925 billion, versus $816 million |
Sales growth was primarily acquisition-driven. Second-quarter sales increased 33.7% excluding foreign exchange in reportable segments, led by Cardiovascular and Neuromodulation Products, while underlying growth excluding St. Jude Medical, AMO, and foreign exchange was 2.7%. Six-month underlying growth on the same basis was 3.0%.
- Established Pharmaceutical Products: second-quarter sales increased 4.1%; six-month sales increased 5.5%.
- Nutritional Products: second-quarter sales declined 0.6%; six-month sales declined 1.1%, reflecting international pediatric nutrition weakness and U.S. adult nutrition competition.
- Diagnostic Products: second-quarter sales increased 3.8%; six-month sales increased 3.7%, or 5.1% excluding foreign exchange.
- Cardiovascular and Neuromodulation Products: second-quarter sales were $2.260 billion versus $782 million; six-month sales were $4.363 billion versus $1.467 billion, primarily because of St. Jude Medical.
Profitability declined because of approximately $914 million of intangible amortization and $822 million of inventory step-up amortization in the first six months related to St. Jude Medical. The acquired business contributed $2.9 billion of sales and an approximately $1.0 billion pretax loss during the first six months, excluding acquisition, integration and restructuring costs.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents declined to $9.675 billion from $18.620 billion at December 31, 2016.
- Six-month operating cash flow was $1.925 billion. Investing cash flow was negative $6.160 billion, including $13.027 billion for acquisitions, partially offset by $5.471 billion of business-disposition proceeds and $1.924 billion from sales of Mylan shares.
- Financing cash flow was negative $4.783 billion, including $2.507 billion of long-term debt repayments, $922 million of dividends and $1.429 billion of short-term debt repayments and other items.
- Short-term borrowings and current long-term debt totaled approximately $221 million, while long-term debt was $23.810 billion at June 30, 2017, for total reported debt of approximately $24.031 billion.
- Abbott reported $5.0 billion of unused credit lines expiring in 2019. Management stated that dividends, capital expenditures and other investments are expected to be funded through operating cash flow, cash, short-term investments and borrowings.
- Abbott’s long-term debt ratings were BBB from Standard & Poor’s and Baa3 from Moody’s. Management expected to maintain an investment-grade rating.
Material Changes Versus the Prior Comparable Period
- The St. Jude Medical acquisition added approximately $23.6 billion of purchase consideration, approximately $15.1 billion of goodwill, $15.0 billion of acquired intangible assets and approximately 254 million Abbott shares.
- Goodwill increased to $22.132 billion from $7.683 billion at year-end 2016, and net intangible assets increased to $18.653 billion from $4.539 billion.
- Interest expense increased by $100 million in the second quarter and $279 million in the first six months, primarily because of debt issued to finance St. Jude Medical.
- Six-month net earnings declined to $702 million from $931 million, while continuing-operations earnings were approximately flat at $656 million versus $655 million. The comparison was affected by acquisition-related amortization, inventory step-up amortization, restructuring costs, the 2017 AMO sale gain and significant tax items in both periods.
- Abbott completed the sale of Abbott Medical Optics to Johnson & Johnson in February 2017 for $4.325 billion in cash and recorded a $1.151 billion pretax gain, or $721 million after tax.
- Abbott sold 50 million Mylan N.V. shares for approximately $1.9 billion, reducing its ownership from approximately 14% to approximately 3.7%.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide a clear formal full-year revenue or earnings guidance figure. Management described continued growth opportunities from the St. Jude Medical combination and expected further expansion of Abbott’s diagnostics presence through the planned Alere acquisition.
- Abbott expected the Alere acquisition to close by the end of the third quarter of 2017, subject to regulatory and other customary conditions. The amended transaction value was approximately $5.3 billion, and Alere net debt of $2.3 billion was expected to be assumed, refinanced or repaid.
- On July 31, 2017, after quarter-end, Abbott entered into an agreement for up to $2.8 billion of unsecured term loans to help fund the Alere acquisition.
- Integration of St. Jude Medical generated approximately $161 million of restructuring charges in the first six months, including approximately $144 million related to integration.
- Abbott received an FDA warning letter in April 2017 concerning the Sylmar, California facility acquired with St. Jude Medical. The facility manufactures implantable cardiac devices; Abbott stated that corrective actions were in progress.
- International pediatric nutrition sales were pressured by challenging conditions in China. India’s new goods and services tax temporarily affected purchasing patterns, and Venezuela remained exposed to economic and currency risks, although management did not expect additional Venezuelan losses to be material.
- Recorded legal and environmental accruals were approximately $45 million, with estimated possible losses of approximately $40 million to $45 million. Management did not expect the ultimate resolution to have a material adverse effect.
- Tax authorities could reduce gross unrecognized tax benefits by approximately $200 million to $350 million within the next twelve months as matters are resolved.
- Available-for-sale equity securities were approximately $1.2 billion at June 30, 2017, principally Mylan shares. A hypothetical 20% decline in these securities would reduce fair value by approximately $240 million.
Important Facts for Investors to Verify
- Whether St. Jude Medical integration produces the anticipated synergies and whether acquisition-related amortization and inventory charges decline as expected.
- The final purchase-price allocation for St. Jude Medical, which remained preliminary and could materially change.
- The timing, regulatory approvals, financing and eventual accounting impact of the Alere acquisition.
- Progress on remediation of the FDA warning letter at the Sylmar facility and any effect on product manufacturing or sales.
- Debt reduction, interest expense, cash generation and preservation of Abbott’s investment-grade credit ratings.
- Trends in international pediatric nutrition, U.S. adult nutrition, coronary stents and underlying organic sales excluding acquisitions and foreign exchange.
- Potential changes in tax liabilities, legal and environmental exposures, restructuring costs and other acquisition-related contingencies.