Baxter International Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; comparisons are with the same 2012 periods unless noted. Amounts are in U.S. dollars. Baxter operates BioScience and Medical Products businesses. Gambro’s results are included from its September 6, 2013 acquisition date.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $3.774 billion | $3.477 billion | $10.891 billion | $10.437 billion |
| Gross margin | $1.946 billion; 51.6% | $1.810 billion; 52.1% | $5.641 billion; 51.8% | $5.396 billion; 51.7% |
| Income before taxes | $682 million | $766 million | $2.118 billion | $2.315 billion |
| Net income | $544 million | $583 million | $1.686 billion | $1.832 billion |
| Diluted EPS | $0.99 | $1.06 | $3.06 | $3.29 |
| Cash from operations | Not separately provided for the quarter | Not separately provided for the quarter | $2.115 billion | $2.161 billion |
- Sales rose 9% in Q3 and 4% for the first nine months at actual currency rates; nine-month growth was 5% at constant currency. Gambro contributed $100 million of Q3 sales and increased reported growth by three percentage points for the quarter.
- Q3 gross margin declined 0.5 percentage points. Gambro reduced margin by approximately 0.8 points in Q3, including a $15 million charge from acquired inventory fair-value adjustments. Excluding Gambro, management said margins improved, helped by sales of higher-margin products.
- Q3 and nine-month net income declined approximately 7% and 8%, respectively. Higher marketing and administrative expense, debt-related interest expense, and other corporate items weighed on results.
- By segment, Q3 sales were $1.620 billion for BioScience, up 6%, and $2.154 billion for Medical Products, up 10%. Segment pretax income was $615 million and $343 million, respectively; Medical Products pretax income fell 12%, including acquisition/integration and collaboration costs.
Liquidity, debt and capital allocation
- At September 30, 2013, cash and equivalents were $2.376 billion, current assets $9.597 billion, and current liabilities $4.996 billion. Total debt and lease obligations were $9.066 billion, including $8.652 billion long term; debt increased from $5.930 billion at year-end 2012.
- Operating cash flow was $2.115 billion for the first nine months, versus $2.161 billion a year earlier. Investing cash outflow was $4.795 billion, including $3.772 billion for acquisitions and investments and $1.037 billion of capital spending. Financing cash inflow was $1.795 billion. Cash declined $894 million from year-end.
- June debt issuance totaled $3.5 billion across maturities from 2014 to 2043; approximately $3.0 billion of net proceeds funded Gambro. No borrowings were outstanding under the revolving credit facilities at quarter-end, and Baxter reported compliance with their financial covenants.
- Cash dividends paid were $757 million for the first nine months. Baxter repurchased 12.4 million shares for $863 million; $1.1 billion remained under its $2.0 billion authorization.
Material developments, outlook and risks
- Gambro acquisition: Baxter acquired the dialysis products company for $3.704 billion cash consideration. Preliminary purchase accounting included $1.650 billion of acquired intangible assets and $1.252 billion of goodwill; valuation remained incomplete and could change. Gambro contributed $100 million sales and a $17 million net loss from acquisition through quarter-end. Integration costs were reported at $33 million in Q3 and $73 million for the first nine months in marketing and administrative expense; segment discussion also reports Medical Products acquisition/integration-related costs of $58 million and $98 million, respectively.
- Other transactions: Baxter acquired OBI-1-related assets for an upfront $51 million, with contingent payments; the recorded fair value of contingent consideration was $269 million at acquisition. The company entered biosimilar and nutrition-product collaborations, including a $25 million Q3 R&D charge for the JW Holdings agreement.
- Guidance and savings: Management estimated a full-year 2013 effective tax rate of approximately 22%, excluding audit developments and other special items. Business optimization initiatives were expected to yield approximately $0.24 per diluted share in savings when fully implemented in 2015. The filing provides no broader earnings or revenue guidance.
- Regulatory and legal exposure: FDA Warning Letters concerned CGMP matters at North Cove and Jayuya facilities and the SIGMA Spectrum infusion pump’s 510(k) clearance status; Baxter said it was working with FDA. The filing reports $160 million in recorded legal reserves and $9 million in related receivables, while some potential losses could not be estimated. Other matters include heparin product-liability claims, shareholder litigation, plasma-therapy antitrust litigation, and government inquiries relating to possible Foreign Corrupt Practices Act issues and North Cove quality/manufacturing practices.
- Other risks: Baxter cited possible delayed collections or credit losses from public-sector customers in Greece, Spain, Portugal and Italy; related net receivables were $559 million. Risks also include product quality and patient safety, pricing and reimbursement pressures, foreign-exchange and interest-rate volatility, and the ability to integrate Gambro and realize expected benefits.
- Disclosure controls were assessed as effective at September 30, 2013. Gambro’s internal controls were excluded from Baxter’s 2013 internal-control assessment while integration work proceeded. PwC reviewed the interim statements; this was a review, not an audit.
Important facts for investors to verify
- Progress and final purchase-accounting adjustments for Gambro, including integration costs, acquired intangible amortization, and realized synergies.
- Whether sales growth and margins persist after separating Gambro’s contribution and the one-time acquired-inventory charge.
- Cash conversion, inventory levels and turns, and the effect of acquisition-related working capital on operating cash flow.
- Debt repayment capacity, interest expense, credit-rating outlook, and access to committed credit facilities.
- Developments in FDA warning-letter remediation, litigation and government inquiries, and any resulting charges or operating restrictions.
- Whether the approximately 22% tax-rate outlook and 2015 optimization savings remain achievable.