Baxter International Inc. — 2010 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Financial amounts are in millions of U.S. dollars except per-share data. Interim statements are unaudited; the independent accountant’s review found no material modifications needed, but was not an audit.
Business context and financial performance
Baxter operates BioScience, Medication Delivery and Renal businesses. Third-quarter sales grew 3% year over year to $3,224, while nine-month sales grew 3% to $9,345.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $3,224 | $3,145 | $9,345 | $9,092 |
| Gross margin | $1,659 | $1,632 | $4,340 | $4,758 |
| Gross margin rate | 51.5% | 51.9% | 46.4% | 52.3% |
| Income before tax | $641 | $658 | $1,423 | $2,019 |
| Net income attributable to Baxter | $525 | $530 | $997 | $1,633 |
| Diluted EPS | $0.89 | $0.87 | $1.67 | $2.66 |
Q3 diluted EPS increased despite slightly lower attributable net income, alongside a lower diluted weighted-average share count (587 million versus 612 million). Nine-month results were substantially lower, principally reflecting the $588 COLLEAGUE pump recall charge. The charge reduced sales by $213 and cost of sales by $375; the filing says it reduced year-to-date gross margin by 5.2 percentage points.
Q3 segment sales were BioScience $1,387 (flat), Medication Delivery $1,230 (+5%) and Renal $594 (+3%). Nine-month segment sales were $4,107 (+1%), $3,438 (+3%) and $1,763 (+7%), respectively. Renal growth reflected increased peritoneal dialysis patients; Medication Delivery growth included IV therapies and injectables. BioScience was broadly flat, with growth in regenerative medicine offset by weakness in other product categories.
- Cash from operations was $2,068 for the first nine months, versus $1,923 a year earlier. Capital expenditures were $699; acquisitions and business investments used $274.
- Cash and equivalents were $2,788 at September 30, 2010, essentially unchanged from year-end 2009. Current assets were $8,140 and current liabilities $4,199.
- Short-term debt, current maturities and long-term debt totaled $4,883 at quarter-end, compared with $4,151 at December 31, 2009. Long-term debt rose to $4,360 from $3,440.
- The company issued $600 of senior notes in March 2010. It reported no borrowings under its $1.5 billion primary revolving facility or its euro-denominated facility and was in compliance with facility covenants.
- Dividends paid were $519 in the first nine months, and treasury-stock purchases were $1,273. Cash dividends declared per share rose to $0.29 in Q3 from $0.26.
Material changes, outlook and management commentary
- The $588 COLLEAGUE recall charge was recorded in Q1 following FDA action requiring recall of approximately 200,000 U.S. pumps. Baxter expects to execute the recall through July 2012; $526 remained in cash-cost reserves at September 30. The filing warns of possible substantial additional cash or non-cash charges, regulatory actions, penalties, claims and effects on other product sales.
- On October 29, 2010, after quarter-end, Baxter agreed to sell its U.S. generic injectables business to Hikma for approximately $112, subject to closing adjustments and customary conditions. A $112 impairment was recorded in Q3 based on the expected sale value. Closing was expected within the next few months.
- Other Q3 items included a $28 Greece receivables write-down in Q2, reflecting expected conversion of certain past-due receivables into non-interest-bearing bonds, and a $112 generic-injectables impairment. The nine-month effective tax rate was 29.7%, versus 18.8%; the COLLEAGUE charge received no net tax benefit and a $39 deferred tax asset was written off following healthcare reform changes.
- Management anticipated a full-year 2010 effective tax rate of approximately 20%, excluding audit developments and other special items. It expected full-year R&D expense to be lower than 2009. The filing provides no clear full-year sales or EPS guidance.
- Management cited cost inefficiencies in plasma-based therapies and vaccines, healthcare reform effects, and higher inventory reserves as pressures on margins. It also noted currency exposure and potential volatility in Antibody Therapy sales. U.S. healthcare reform and similar actions abroad adversely affected sales growth.
Risks, contingencies and other notable matters
- Legal matters include ongoing COLLEAGUE-related proceedings and investigations, plasma-therapy antitrust cases, approximately 750 heparin-related lawsuits, and other product, patent and reimbursement litigation. Baxter states that outcomes could materially affect results or cash flows in a period, although it does not expect the proceedings to materially adversely affect consolidated financial position.
- In a propofol-related case, a jury awarded plaintiffs $5 in compensatory damages and $500 in punitive damages, including $144 assessed against Baxter. Baxter and Teva planned to appeal; Baxter asserted an indemnity right against Teva. Further proceedings were pending.
- Baxter reported DOJ and SEC information requests concerning business activities in a number of countries and stated that it was cooperating. It also received U.S. Attorney requests regarding contracting, marketing, promotional and government-pricing practices.
- The FDA issued a Warning Letter concerning complaint handling and corrective/preventive action processes at the Renal business’s McGaw Park facility; Baxter said it was working with the FDA to resolve the issues.
- Standard & Poor’s changed Baxter’s outlook from Positive to Stable in Q2; the filing reported no credit-rating changes during the first nine months.
Most important facts for investors to verify
- Progress, actual costs and reserve adequacy for the COLLEAGUE recall, including any further FDA actions or claims.
- Completion, final consideration and any closing adjustments for the generic injectables divestiture.
- Cash conversion and debt trajectory, given increased debt, significant share repurchases and recall-related cash obligations.
- Resolution and potential financial exposure from the propofol verdict, heparin claims, investigations and other legal proceedings.
- Whether the anticipated 20% full-year tax rate and lower R&D spending remain achievable, and how sales, margins and healthcare reform effects develop.