Baxter International Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods unless stated otherwise. Financial amounts are in millions of dollars except per-share data. The interim financial statements were reviewed by PwC, not audited.
Business context and performance
Baxter operates BioScience and Medical Products businesses. Q2 net sales were $3,572, up 1% at actual currency rates and 4% at constant currency rates. For the first half, sales were $6,960, up 2% reported and 4% at constant currency. Currency reduced sales growth by 3 percentage points in Q2 and 2 points in the first half, primarily because the U.S. dollar strengthened against the euro.
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Net sales | $3,572 | $3,536 | $6,960 | $6,820 |
| Gross margin | $1,872 | $1,835 | $3,586 | $3,510 |
| Gross margin percentage | 52.4% | 51.9% | 51.5% | 51.5% |
| R&D expense | $306 | $239 | $575 | $453 |
| Income before taxes | $817 | $803 | $1,549 | $1,534 |
| Net income attributable to Baxter | $661 | $615 | $1,249 | $1,185 |
| Diluted EPS | $1.19 | $1.07 | $2.24 | $2.05 |
Key financial position and cash flow
- Cash and liquidity: Cash and equivalents were $2,353 at June 30, down from $2,905 at December 31, 2011. Current assets were $8,048 and current liabilities $4,870. Baxter reported no borrowings under its revolving credit facilities and said it was in compliance with facility covenants.
- Debt: Short-term debt was $385; current maturities of long-term debt and lease obligations were $497; long-term debt and lease obligations were $4,432. Commercial paper outstanding was $375, with a 0.30% weighted-average interest rate. The company reported no change in credit ratings in the first half.
- Cash flows, first half: Operating cash flow was $1,356, versus $1,003 in 2011; investing cash outflow was $750, versus $504; financing cash outflow was $1,124, versus $1,186. Capital expenditures were $503, and acquisitions and investments used $321.
- Capital returns: Baxter repurchased 17.0 million shares for $960 in the first half and paid $374 in dividends. It declared a quarterly dividend of $0.45 in July, about 34% above the prior rate, and authorized a new share-repurchase program of up to $2.0 billion.
Material changes and management commentary
- BioScience sales increased 1% in Q2 and 2% in the first half as reported; constant-currency growth was 4% and 5%. Regenerative Medicine was a standout, with Q2 sales up 18% reported, helped by the Synovis acquisition and demand for surgical sealants. BioScience pretax income declined 9% in Q2 and 11% year to date, reflecting higher R&D and marketing spending and currency headwinds, partly offset by sales of higher-margin products.
- Medical Products sales rose 1% in Q2 and 2% in the first half as reported; constant-currency growth was 4% in both periods. IV Therapies and Global Injectables grew, while Infusion Systems sales fell 10% in Q2, partly reflecting lower access-set sales as the U.S. pump recall neared completion. Medical Products pretax income rose 6% in Q2 and 10% year to date.
- R&D expense rose 28% in Q2 and 27% in the first half. It included a $30 charge for the Chatham hemophilia B gene-therapy agreement in Q2 and a $33 charge for the Momenta biosimilar collaboration in Q1. Baxter also acquired Synovis for $304, net of acquired cash.
- The reported Q2 gross margin benefited by $23 from reserve adjustments, primarily the COLLEAGUE infusion pump reserve; excluding these adjustments, management said gross margin percentage declined. Marketing and administrative expense rose as a percentage of sales, reflecting pension expense, marketing spending, currency, acquisitions and Synovis and Baxa operations, partly offset by optimization savings.
- Other income was $62 in Q2 and $119 for the first half, including $38 and $53 gains, respectively, from reductions in contingent acquisition-payment liabilities. The Q2 COLLEAGUE reserve adjustment reduced cost of sales by $37. These items also contributed to lower effective tax rates.
Outlook, risks and contingencies
- Management anticipated a full-year 2012 effective tax rate of approximately 22%, excluding audit developments and other special items. The filing does not provide a clear full-year sales or earnings guidance figure.
- The COLLEAGUE pump recall was substantially completed in the United States in July 2012, after quarter-end; formal closure still required further dialogue and agreement with the FDA. Remaining pump reserves were $186 at June 30. Baxter said further costs, penalties, regulatory action, claims, impairments or effects on other product sales remained possible.
- Net public-sector receivables from Greece, Spain, Portugal and Italy totaled $395, including $62 from Greece. Management warned that economic and liquidity conditions could delay collections or cause additional credit losses. Collection of past-due balances in Spain contributed to a $197 second-quarter reduction in those receivables.
- Recorded legal reserves were $144, with related receivables of $38. The company said certain potential losses could not be estimated; it did not expect the matters discussed to materially adversely affect consolidated financial position, but acknowledged that a matter could significantly affect results or cash flows in a reporting period.
- Legal and regulatory matters include approximately 400 pending heparin-related lawsuits, shareholder and derivative litigation, and a DOJ/SEC inquiry concerning business activities in several countries. Baxter was cooperating with the inquiry. The SEC had also requested records relating to COLLEAGUE and SYNDEO accounting, reporting and disclosures. A separate government inquiry into U.S. contracting and pricing practices was closed in June 2012 with no further action.
- Other risks identified include product quality and patient safety, regulatory approvals and recalls, competition and pricing, foreign exchange and interest-rate movements, acquisition and R&D outcomes, and global economic conditions. Baxter plans to invest more than $1 billion over five years in a new Georgia plasma-treatment manufacturing facility, with construction expected to begin in 2012 and completion expected by 2018.
Most important facts for investors to verify
- Whether constant-currency sales growth and product-category demand persist, particularly given weakness in Infusion Systems and competitive pressures in anesthesia.
- Whether the U.S. COLLEAGUE recall is formally closed with the FDA, and whether the $186 reserve proves adequate for U.S. and international remediation.
- How much reported earnings and cash flow depend on nonrecurring reserve and contingent-liability gains, and the impact of elevated R&D spending.
- Whether cash generation can sustain the increased dividend, new buyback authorization, acquisition activity and planned capital investment while managing debt and lease obligations.
- Collections and credit-loss exposure on the $395 of public-sector receivables in Greece, Spain, Portugal and Italy, and developments in the pending legal and government inquiries.