Baxter International Inc. — Q3 2017 Form 10-Q
Business context and reporting period
Unaudited results for the three and nine months ended September 30, 2017, compared with the same periods in 2016. Baxter’s businesses are Renal and Hospital Products, supplying dialysis therapies, IV solutions, injectable drugs, infusion systems, and related products. Unless stated otherwise, amounts are in millions of dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $2,707 | $2,558 | $7,787 | $7,518 |
| Gross margin | $1,128 | $1,071 | $3,300 | $3,008 |
| Operating income | $292 | $186 | $975 | $442 |
| Continuing operations income | $248 | $127 | $785 | $4,726 |
| Diluted continuing-operations EPS | $0.45 | $0.23 | $1.42 | $8.56 |
| Operating cash flow, continuing operations | Not provided for quarter | Not provided for quarter | $1,343 | $938 |
Q3 sales rose 6% and nine-month sales rose 4%; management reported no consolidated sales impact from currency. Renal sales were $1,010 in Q3 and $2,874 for nine months, up 3% and 1%. Hospital Products sales were $1,697 and $4,913, up 7% and 5%. Segment EBITDA was $879 in Q3 versus $802, and $2,470 for nine months versus $2,167.
Gross margin was 41.7% in Q3 versus 41.9%, and 42.4% for nine months versus 40.0%. Management attributed underlying improvement to pricing, manufacturing performance, and cost initiatives, partly offset by special charges. Marketing and administrative expense was $685 in Q3 versus $726 and $1,890 for nine months versus $2,076; R&D expense was $151 versus $159 and $435 versus $490, respectively.
Nine-month 2016 continuing income and EPS are not directly comparable: they included approximately $4.4 billion of gains from Baxalta retained-share transactions. Baxter reported net income of $788 for nine months 2017 versus $4,722 in 2016, largely reflecting that prior-year gain. Q3 net income was $251 versus $130.
Cash, debt, and liquidity
At September 30, 2017, cash and equivalents were $3,517, compared with $2,801 at December 31, 2016. Long-term debt and lease obligations were $3,495, with $3 of current maturities; the comparable year-end amounts were $2,779 and $3. The company issued €600 million of 1.30% senior notes due 2025. Cash exceeded reported debt and lease obligations by approximately $19 at quarter-end, using the balance-sheet amounts.
Nine-month continuing operating cash flow was $1,343 versus $938. Continuing investing cash outflow was $1,088 versus $549, including $680 of acquisitions and investments, principally Claris. Financing cash inflow was $391 versus an outflow of $44. Capital expenditures were $410 versus $519. Baxter paid $228 in dividends and repurchased $275 of stock during the first nine months. It reported $1.4 billion remaining under its repurchase authorization and compliance with its credit-facility covenants.
Material changes, outlook, and unusual items
- Claris acquisition: Baxter acquired Claris Injectables on July 27 for approximately $629 net of cash acquired. Claris contributed $27 of sales in the period; acquisition and integration costs were $20 for nine months. Purchase accounting remained preliminary.
- Hurricane Maria: Baxter recorded $21 of Q3 charges for Puerto Rico asset damage, inventory impairment, and idle-facility costs. The company estimated a roughly $70 negative impact to Q4 2017 sales and did not expect a material sales impact in 2018 or thereafter. Insurance recoveries had not been recorded; the total loss and recovery were not yet estimable.
- Cost optimization: Cumulative pretax costs reached $526 through September 30. Baxter expected approximately $285 more in pretax costs and $90 in capital expenditures through completion by the end of 2018. It forecast approximately $950 in annual pretax savings, about 85% by the end of 2018 and the remainder by the end of 2020.
- Product and market pressures: SIGMA SPECTRUM pump remediation included a $22 Q3 charge in the financial-statement note. U.S. cyclophosphamide sales fell to $143 for nine months from $163, with further declines expected amid generic competition. International strategic market exits were expected to reduce 2017 sales by about $50 in each segment.
- Venezuela and prior-year comparability: Baxter deconsolidated its Venezuelan operations on June 30, 2017, recording a $33 pretax charge; results were excluded beginning in Q3. The 2016 comparison also included debt-extinguishment losses and the large Baxalta-related gain noted above.
- Tax and accounting: The 2017 effective tax rate on continuing operations was 14.5% in Q3 and 15.0% for nine months. Adoption of share-based payment accounting guidance increased 2017 net income and operating cash flow by approximately $18 and $48, respectively, for the nine-month period.
Management cited product demand and competition, quality and patient-safety matters, regulatory actions, manufacturing and supply disruptions, foreign exchange, customer credit and collections, litigation, and the execution of cost and acquisition plans as risks. The company reported $151 of public-sector receivables from Greece, Spain, Portugal, and Italy. A federal antitrust investigation and related civil actions concerning IV solutions and shortages were ongoing; Baxter said it was cooperating. Recorded legal reserves were $15, and management said certain potential losses could not be estimated. A Claris FDA inspection resulted in a Form 483; Baxter said it was implementing corrective actions. The filing provides no company-wide earnings guidance.
Investor verification points
- Assess underlying sales and margin trends after separating special charges, strategic product exits, Claris contribution, and the 2016 Baxalta transaction gains.
- Track Puerto Rico production recovery, the estimated Q4 sales effect, and subsequent insurance claims and recoveries.
- Test whether Claris’s preliminary purchase accounting, FDA corrective actions, and integration costs affect expected returns.
- Monitor progress, remaining cash costs, and realization timing for the optimization savings plan.
- Follow SIGMA pump remediation, IV-solutions antitrust proceedings and investigation, and the company’s other regulatory and legal exposures.
- Reconcile cash generation, acquisition spending, repurchases, and debt changes, including the foreign-currency effects on reported balances.
PricewaterhouseCoopers LLP reviewed the interim financial statements and reported that it was not aware of material modifications needed for GAAP conformity; this was an interim review, not an audit.