Baxter International Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Baxter supplies medical products and therapies across renal care, medication delivery, pharmaceuticals, clinical nutrition, advanced surgery and acute therapies. Unless noted, comparison figures for Q1 2019 are restated.
Financial performance and liquidity
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $2.802 billion | $2.638 billion |
| Gross margin | $1.163 billion; 41.5% of sales | $1.080 billion; 40.9% |
| Operating income | $409 million | $383 million |
| Income before taxes | $378 million | $386 million |
| Net income attributable to Baxter | $332 million | $342 million |
| Diluted EPS | $0.64 | $0.66 |
| Operating cash flow, continuing operations | $274 million | $134 million |
| Cash and cash equivalents, at March 31 | $4.110 billion | $1.902 billion |
Sales rose 6% at reported currency rates and 8% at constant currency; foreign exchange reduced reported growth by 2 percentage points. Gross margin improved 0.6 percentage points. SG&A was $628 million (22.4% of sales) versus $601 million (22.8%); R&D was $146 million (5.2%) versus $129 million (4.9%). The effective tax rate was 11.9%, compared with 11.4%.
Investing cash outflow was $604 million, including $443 million for acquisitions and investments and $172 million of capital expenditures. Financing cash inflow was $1.170 billion, including proceeds from $1.25 billion of senior notes. Cash increased $775 million during the quarter.
At March 31, total assets were $19.075 billion and total liabilities were $11.345 billion. Short-term debt, current maturities and long-term debt and finance lease obligations totaled approximately $6.532 billion, up from $5.350 billion at year-end 2019. Current assets were $8.333 billion and current liabilities $3.036 billion. Baxter reported $220 million outstanding under its euro credit facility, none under its $2.0 billion U.S. revolving facility, and compliance with credit-facility covenants.
Material changes and operating trends
- All geographic segments increased sales: Americas $1.499 billion, EMEA $754 million and APAC $549 million. Segment operating income was $544 million, $161 million and $128 million, respectively.
- By business unit, Acute Therapies grew 21% and Advanced Surgery 13% at reported currency rates; Medication Delivery grew 9%, Clinical Nutrition 7%, Other 7%, Pharmaceuticals 3% and Renal Care 2%.
- Net income attributable to Baxter declined about 3%, and diluted EPS fell from $0.66 to $0.64. Q1 2020 earnings included special items that reduced net income by $93 million, or $0.18 per diluted share, compared with a $52 million, or $0.09 per share, reduction in Q1 2019.
- Operating cash flow increased $140 million, primarily due to timing of vendor payments and lower employee compensation payments; the comparison was partly offset by insurance recoveries received in 2019.
- Other comprehensive loss was $467 million, mainly reflecting $359 million of currency translation losses and $130 million of hedge losses. Comprehensive loss attributable to Baxter stockholders was $135 million, versus comprehensive income of $244 million in the restated prior-year quarter.
Outlook, risks and unusual items
- COVID-19: Baxter reported uneven demand and operational risks. Demand increased for peritoneal dialysis, infusion products, generic injectables, parenteral nutrition and acute therapies; management expected several of these increases to continue in Q2. Deferred elective procedures significantly hurt Advanced Surgery late in Q1, and Baxter anticipated a substantial Q2 sales decline in that business. The company warned that supply-chain disruption could limit its ability to meet demand and that receivable collections could be delayed. The filing provides no quantified overall full-year sales or EPS guidance.
- Management expected full-year gross margin to face pressure from product mix, additional manufacturing-employee compensation and pandemic-related logistics costs. It expected 2020 net interest expense to increase by more than $60 million versus 2019, primarily because of lower interest income and the March debt issuance.
- Baxter reported approximately $1.0 billion of cumulative pre-tax business-optimization costs through March 31, and expected about $30 million more under the current program. The program is expected to deliver about $1.2 billion of cumulative annual pre-tax savings when complete; approximately 95% was expected by the end of 2020 and the remainder by the end of 2023.
- In February, Baxter acquired Seprafilm product rights for approximately $342 million in cash. The acquisition contributed $13 million of Q1 sales; related acquisition and integration costs included inventory fair-value step-ups. Baxter also paid $60 million for U.S. rights to another product and expensed $21 million for product distribution-license arrangements.
- The 2019 comparative statements were restated following correction of foreign-exchange accounting errors and other misstatements. Baxter said its historical exchange-rate convention was inconsistent with U.S. GAAP and that certain intra-company transactions had been undertaken to generate FX gains or avoid losses. The company stated the convention had been used for at least ten years.
- Management disclosed a material weakness in controls over foreign-exchange accounting and intra-company transaction approvals; disclosure controls were therefore not effective as of March 31. Remediation steps were underway but had not yet been deemed effective. PwC reviewed the interim statements and reported no material modifications were needed; this was a review, not an audit.
- Legal and regulatory exposures include securities litigation and an ongoing SEC staff inquiry associated with the FX investigation, opioid-related litigation, and new ethylene-oxide exposure suits. Recorded reserves for legal and environmental matters were $53 million. Management said outcomes were not expected to materially adversely affect consolidated financial position, while noting some losses could not be estimated and litigation remained uncertain. The IV-solutions antitrust class complaint was dismissed with prejudice in April 2020; the DOJ had closed its investigation in 2018.
Important facts for investors to verify
- Whether FX-control remediation is completed and tested effectively, and whether further financial-statement corrections or related regulatory developments arise.
- Actual COVID-19 effects on product demand, production and distribution, elective-surgery volumes, customer collections and full-year results.
- Debt-related interest costs, cash deployment and liquidity as acquisition spending and operating conditions evolve.
- Progress toward the stated business-optimization savings and remaining costs, and the realized performance of Seprafilm and other acquired product rights.
- Developments in litigation, regulatory matters and the Claris facility warning letter, together with any changes in reserves or potential losses.