Baxter International Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Unaudited interim statements; reviewed by PwC, not audited. Results are primarily continuing operations after Baxter’s July 2015 spin-off of Baxalta; Baxalta’s remaining operations are reported as discontinued operations.
Financial performance
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales, continuing operations | $2.375 billion | $2.403 billion |
| Gross margin | $965 million; 40.6% | $1.019 billion; 42.4% |
| Operating income | $188 million | $92 million |
| Income from continuing operations | $3.387 billion | $134 million |
| Continuing diluted EPS | $6.13 | $0.24 |
| Operating cash flow, continuing operations | $(174) million | $(28) million |
| Capital expenditures | $184 million | $214 million |
- Reported continuing income was exceptionally elevated by approximately $3.2 billion of gains on exchanges of retained Baxalta shares for debt. The exchanges extinguished about $3.65 billion of debt; a $101 million debt-extinguishment loss partially offset the gains. Management said special items increased continuing income by $3.2 billion, or $5.77 per diluted share. These gains are not representative of recurring operating performance.
- Net sales declined 1% at actual exchange rates but increased 4% at constant currency; foreign exchange reduced reported sales growth by five percentage points. U.S. sales rose 5%, while international sales fell 5% as reported and rose 4% at constant currency.
- Gross margin fell 1.8 percentage points year over year, reflecting unfavorable foreign exchange, partly offset by improved Fluid Systems pricing and favorable Renal product mix. Marketing and administrative expense was $641 million, down from $784 million; the ratio declined to 27.0% from 32.6%. R&D expense was $136 million versus $143 million.
- Segment EBITDA increased to $631 million from $572 million: Renal $122 million versus $85 million; Hospital Products $509 million versus $487 million.
- Discontinued operations recorded a $7 million net loss, compared with $296 million income in Q1 2015. The prior-year period included $1.362 billion of Baxalta sales; Q1 2016 included $64 million from residual operations awaiting transfer.
Liquidity, debt and cash flow
- Cash and equivalents were $2.211 billion at March 31, 2016, essentially unchanged from year-end. Total assets were $17.350 billion, down from $20.962 billion, largely reflecting the reduced retained Baxalta investment.
- Reported debt and lease obligations totaled approximately $3.357 billion at quarter-end: $817 million short-term debt, $472 million current maturities, and $2.068 billion long-term debt and lease obligations. The comparable year-end total was approximately $6.507 billion. The debt-for-equity exchanges drove the reduction; commercial paper outstanding was $750 million at a weighted-average 0.75% rate.
- Cash flow from operations was negative $333 million including discontinued operations; continuing operations used $174 million. Financing activities provided $510 million, including $450 million net increase in debt with original maturities of three months or less. Cash declined by $2 million.
- Current assets were $8.017 billion and current liabilities $3.823 billion. The company reported compliance with credit-facility financial covenants and said it had adequate cash for operating needs. Credit ratings included S&P A- with a negative outlook, Fitch BBB+ stable, and Moody’s Baa2 stable.
Material changes and management outlook
- Renal sales grew 5% at constant currency, supported by peritoneal dialysis patient growth, U.S. pricing and continuous renal replacement therapy. Hospital Products sales grew 4% at constant currency, led by Fluid Systems (+11%); Surgical Care declined 2% and Other declined 14% at constant currency.
- Management attributed lower administrative costs to Baxalta transition-service billings, lower pension expense, foreign exchange, lower bad-debt expense, cost-reduction programs and reduced discretionary spending. Renal and Hospital Products EBITDA also benefited from cost savings, partly offset by currency and manufacturing/quality costs.
- Management expected a full-year 2016 continuing-operations effective tax rate of approximately 20.5%, excluding audit developments and other discrete items. The Q1 rate was negative 1.7%, aided by tax-free retained-share gains and tax-audit benefits.
- Management projected approximately $0.14 per diluted share of additional savings through 2017 from prior optimization initiatives, plus approximately $0.03 per diluted share through 2017 from new manufacturing-efficiency initiatives. No overall revenue or EPS guidance is stated in the provided filing text.
- Baxter expected to use all remaining retained Baxalta shares by the end of Q2 2016, including a planned pension contribution and a possible stock-for-stock exchange or other disposition. The remaining shares had a reported fair value of approximately $1.2 billion at March 31.
Risks, contingencies and unusual items
- FDA Warning Letters relate to quality systems and manufacturing at Round Lake, Irvine, North Cove, Jayuya and a former McGaw Park facility; Baxter reported ongoing work with FDA. The company also disclosed a U.S. Attorney investigation into quality and manufacturing practices at North Cove.
- The SIGMA SPECTRUM infusion-pump recall reserve was $14 million at March 31 after a $12 million estimate reduction and $14 million of reserve utilization during the quarter. Payments for pump recalls and business optimization initiatives totaled $34 million in Q1.
- DaVita filed a commercial dispute relating to peritoneal dialysis products; trial was scheduled for August 2016. Recorded legal reserves were $34 million, with $10 million of related receivables. Baxter said some potential losses cannot be estimated and litigation outcomes remain uncertain.
- Net receivables from public-sector customers in Greece, Spain, Portugal and Italy totaled $206 million; slower collections and credit losses remain possible. The Venezuela exchange-rate change resulted in an approximately $9 million Q1 charge, with potential for additional charges.
- Other disclosed risks include product quality and patient safety, regulatory action, competition and pricing, foreign-exchange volatility, supply/manufacturing constraints, tax and litigation outcomes, and the ability to realize benefits from the Baxalta separation.
Key investor verification points
- Separate recurring operating trends from the approximately $3.2 billion nonrecurring Baxalta-share exchange gain when assessing Q1 earnings and EPS.
- Check whether constant-currency growth, segment EBITDA gains and planned cost savings persist, particularly given the lower gross-margin percentage.
- Monitor operating cash conversion, receivables collections, inventory growth and the effects of debt repayments and remaining Baxalta-share dispositions on liquidity.
- Track the expected Baxalta share utilization and any related tax consequences, as well as the full-year tax-rate outlook.
- Review developments in FDA remediation, pump recalls, the North Cove investigation and the DaVita litigation; the filing does not quantify all potential exposure.