Baxter International Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; 2019 comparative interim financial statements were restated. Amounts are U.S. dollars unless noted.
Business context and results
Baxter supplies medical products and therapies across renal care, medication delivery, pharmaceuticals, clinical nutrition, advanced surgery and acute therapies. COVID-19 materially disrupted hospital activity and demand patterns during the quarter.
| Metric | Q2 2020 | Q2 2019, restated | First half 2020 | First half 2019, restated |
|---|---|---|---|---|
| Net sales | $2.718 billion | $2.834 billion | $5.520 billion | $5.472 billion |
| Gross margin | $1.038 billion; 38.2% | $1.153 billion; 40.7% | $2.201 billion; 39.9% | $2.233 billion; 40.8% |
| Operating income | $331 million | $350 million | $740 million | $733 million |
| Net income attributable to Baxter | $246 million | $313 million | $578 million | $655 million |
| Diluted EPS | $0.48 | $0.60 | $1.12 | $1.26 |
| Operating cash flow | Not separately provided for quarter | Not separately provided for quarter | $646 million | $574 million |
Q2 sales fell 4% at actual exchange rates and 1% at constant currency; first-half sales grew 1% and 3%, respectively. Q2 weakness reflected reduced admissions and postponed elective procedures, particularly in Medication Delivery, Pharmaceuticals and Advanced Surgery. Acute Therapies sales rose 41% in Q2, supported by demand for CRRT systems; Renal Care and Clinical Nutrition also benefited from pandemic-related demand. First-half operating cash flow includes $648 million from continuing operations and $2 million used by discontinued operations.
Cash, debt and capital
- Cash and cash equivalents were $4.085 billion at June 30, 2020, up from $3.335 billion at year-end 2019; cash, cash equivalents and restricted cash totaled $4.094 billion.
- Total current and long-term debt and finance lease obligations were $6.373 billion, versus $5.350 billion at year-end 2019. Baxter issued $1.25 billion of senior notes in March and repaid €200 million ($225 million) of credit-facility borrowings. No credit-facility borrowings remained at quarter-end.
- First-half investing cash outflow was $758 million, including $453 million for acquisitions and investments and $316 million of capital expenditures. Financing cash inflow was $909 million; dividends paid were $223 million. No shares were repurchased in the first half.
- Current assets were $8.566 billion and current liabilities $2.880 billion. Management said cash was adequate for operating requirements and reported compliance with credit-facility covenants.
Material changes and unusual items
- Q2 net sales decreased 4% and net income attributable to Baxter decreased 21% year over year; first-half sales increased 1% while attributable net income decreased 12%.
- Special items reduced net income by $83 million ($0.16 per diluted share) in Q2 and $176 million ($0.34 per diluted share) in the first half of 2020. These included intangible amortization and impairment, optimization, acquisition/integration, European medical-device regulation and investigation-related costs.
- Baxter acquired Seprafilm product rights for approximately $342 million in February; the product contributed $23 million of Q2 sales and $36 million in the first half. Other product-rights acquisitions and development-related payments also contributed to investing outflows.
- Comparison periods for 2019 were restated for foreign-exchange accounting errors, among other corrections. The company said its prior convention for exchange-rate measurement was not consistent with U.S. GAAP and that certain intracompany transactions had been undertaken to generate foreign-exchange gains or avoid losses. The errors overstated 2019 other income and pretax income by $32 million and $36 million, respectively, for Q2 and the first half.
Outlook, risks and contingencies
- Management expected COVID-19-related product-mix shifts, manufacturing compensation and logistics costs to weigh on full-year 2020 gross margin. It expected 2020 net interest expense to increase by more than $60 million versus 2019, mainly due to the March debt issuance and lower interest income. No full-year revenue or EPS guidance is stated in the provided filing text.
- The company expected approximately $15 million of additional costs to complete current optimization initiatives. It projected approximately $1.2 billion of cumulative annual pretax savings once actions are complete, with about 95% expected by the end of 2020 and the remainder by the end of 2023.
- COVID-19 risks include unpredictable demand, delayed elective procedures, supply and distribution disruption, customer payment or solvency problems, added costs, and uncertainty over further outbreaks and recovery.
- Legal and regulatory exposures include securities litigation and SEC cooperation related to the foreign-exchange investigation, opioid-related claims and ethylene-oxide exposure lawsuits. Recorded legal and environmental reserves totaled $45 million; Baxter said some potential losses could not be estimated and that outcomes may affect results or cash flows in a period.
- A material weakness in internal control over financial reporting related to foreign-exchange accounting remained unremediated as of June 30, despite implementation of remediation measures. Management also concluded disclosure controls were not effective. The independent accountant’s interim review found no material modifications necessary, but was not an audit.
- Other risks include the FDA Warning Letter for Claris facilities in India, foreign-exchange and interest-rate exposure, and the transition from LIBOR after 2021.
Most important facts for investors to verify
- Review the restated 2019 comparisons and the scope of the foreign-exchange errors, including the status and operating effectiveness of control remediation.
- Track whether elective procedures and hospital demand recover, and whether COVID-related demand gains in acute therapies and renal care offset weakness in other product lines.
- Assess gross-margin performance, incremental pandemic costs, acquisition-related spending and progress toward stated cost savings.
- Monitor debt, interest expense, cash generation and customer collections; management cautioned that COVID-19 could affect receivable timing.
- Follow developments in securities, opioid and ethylene-oxide litigation and the Claris regulatory matter, including any effect beyond recorded reserves.