Baxter International Inc. (BAX) Earnings Call Transcript & Summary

All right. Good morning, everyone, and thank you for attending us at the Annual Raymond James Institutional Investors Conference. I'm Larry Keusch, the hospital supply analyst. We're extremely excited to have with us for the next presentation, Baxter. Baxter continues to be a favorite name of ours. We really like the accelerating organic growth profile for the company over the next several years; the continued margin expansion; and obviously, the opportunity for capital deployment given the strength of the balance sheet. Execution has been pretty steady for this company over a number of years, and we don't see anything deviating for that going forward in the future. With us today is Jay Saccaro. Jay is Executive Vice President and Chief Financial Officer; and then Clare Trachtman, who is Vice President of Investor Relations. So we'll do some prepared comments and then have a little bit of time here for Q&A. And then management will be available downstairs in the Amarante 1 room. So to Jay -- with that Jay, I'll turn it over to you.

All right. Larry, as always, thanks for the invitation to Orlando here. Although I have to tell you, with Chicago being 58 degrees yesterday, it was not as easy to leave as it historically is this time of year. Thanks, everybody, for joining us this morning. We appreciate it. I'll make some comments today, I'll just walk you through the slides that we've prepared. We'll preserve some time at the end for questions. But before I do anything, I'll remind you all of our safe harbor statement, which is of course available on our website. So Baxter is a very special company. We have been around for 85 years. We have a global footprint, and it's a global manufacturing footprint and a global commercial footprint. We sell medically necessary, life-saving and sustaining products and we do so all over the world. With 60% of our sales outside of the United States, we sell in over 100 countries around the world. And that first point is really important because the mission of our company is to save and sustain the lives of the patients that we serve. But the benefit of that, in addition to being a very noble purpose, is that our products are quite resilient. People get sick, they need our products consistently. And so that specific facet of our business really does lend itself to resiliency, to stability as we think about the sales profile of our company. We have reach across all sites of care. So we are heavy in the home today, serving thousands of renal patients around the world. And we're, as I said earlier, virtually in every major hospital in the world, we had some level of relationship with. In 2019, we had a solid year. We -- from a sales growth standpoint, sales grew 5% on a constant currency basis. Now importantly, we view our end markets as growing in the 3% to 4% range. And so through innovation and through commercial excellence, we were able to outpace that a little bit in 2019. And if you look at it, you can see it was diversified performance that carried us through. Our Renal business, our largest business, $3.6 billion. We had a couple of headwinds that we had to fight through last year, and we expect this business on a long-term basis to be a little bit faster than this 3%. But because of a couple of headwinds, it took down our normal organic growth rate in our Renal business. Our Medication Delivery business, another very significant business for us, benefited to a large extent from a new pump that we had launched prior. And so we had a very strong performance in Medication Delivery with 7% growth, again, against a market that is growing far slower than that. Our Pharmaceuticals business, which is basically generic injectable drugs, we had a great performance there. 6% growth with some novel presentations of important generic drugs launched and really contributing to our financial results. And then you can see the other 3 businesses. Our Clinical Nutrition business, which is parenteral nutrition for patients. Again, solid growth, 3%. Our Advanced Surgery business, which benefited from a number of competitor outages, along with some smart business development that we pursued a couple of years ago, grew 12%. And then our Acute Therapies business, this is an interesting business in the sense that when the flu season is bad, this is a business that tends to do well. Because what we're doing with this business is providing continuous renal replacement therapy to our patients who have acute kidney injury, some form of kidney failure. In severe cases of flu, oftentimes, that's a business that will benefit. We expect this business on a sustained basis to grow high single digits, even threatening 10%. And so this is one we've been very excited about with the new product launch just recently. We have a series of goals as a company. Our goals are top-quartile performance in 4 specific areas. Patient safety and quality. Without that, our company is not sustainable. We have to be the best at providing safe, consistent therapies to our patients. Growth through innovation. Again, for a company of our nature, innovation is absolutely essential. And we really started investing in innovation several years ago. We've made tremendous progress on this. More to do. But this is one where, for us, our Vitality Index, which we measure as new products percent of total sales, is something that needs to get to double digits in the coming years and will really allow us to revitalize our portfolio. Best place to work. This is -- we want an engaged workforce. And furthermore, we want to be a responsible company along the way. And so this idea of best place to work is crucially important to us. And then finally, industry-leading performance, which is something that we define as -- we define in simple terms as measured total shareholder return over time, but that's another important area for us. Our strategy is simple: Strengthen portfolio and extend our impact through transformative innovation that spans prevention to recovery. And so if you read about some of our more recent business development activity, if you read about some of -- more of our recent R&D developments or other collaborations, what you can see is we are expanding beyond the core treatment that we have to something a little bit broader: Prevention to recovery. As I said earlier, without patient safety, frankly, we're going to have challenges. And so this idea of making the right investments in quality systems, improving key quality metrics and strengthening relationships with global regulators, those 3 form the basis of our approach to ensuring a world-class quality system. The output of that, you can see, is performance with respect to regulators. And I highlight one right here, which is over the last several years, we have closed 5 legacy FDA warning letters. So tremendous progress on the warning letter closure front. More to do. We have -- we still have a couple to work through. But again, great performance on this. And frankly, this is probably the #1 priority of our company, getting patient safety and quality at the right level and maintaining that over time. We are also focused, as I said earlier, on being the best place to work. And what that means is ensuring that we have an engaged employee workforce and also ensuring that we're a responsible member of our communities. So you can see down on the left-hand side, some of our areas of focus. Serving our communities worldwide. So we have deep engagement with each of our communities in terms of community service and the impact that Baxter can have through grants and other donations. Reducing our environmental footprint. Another crucial area for us. We have to be mindful of our -- of the impact and the footprint that we have, and we mitigate that wherever possible. Expanding access to care. So we are relentless on this. And frankly, this has been part of the company's mission for the last 85 years. And finally, focusing on inclusion and diversity. I think we, as a company, have made a lot of progress on this front at the Board level, at senior management, but throughout the entire organization. And this will be a continued area of focus. On the right-hand side, you can see some of the accolades that we've received, and I won't walk through these, but it's safe to say that this is acknowledgment of the hard work that we're doing to ensure that we have -- we are indeed the best place to work, be it for working mothers or other employees. Thinking about our business, there are 3 areas of focus from a strategic growth driver standpoint: Portfolio innovation; market development, which is about driving growth through evidence generation; and strategic partnerships, which is about business development. And when we think about this particular area, it's really about business development in the earliest stages and R&D collaborations that allow us to advance our mission. And thinking about it for a second, we had a great year in terms of each of these areas. And so one of the things we're incredibly excited about, starting in the upper left, portfolio innovation. One of the things that Baxter does well is we manufacture drugs or solutions in very high volumes, and we deliver them to our patients, okay? Now oftentimes though, we're able to put those in a proprietary container of some kind that allows us to differentiate our offering relative to the other offerings on the market. Myxredlin is a great example. Because today, in hospitals in the United States, if you want to give intravenous insulin to a patient that requires it, your choices are either to batch -- to compound a specific dose for the patient or to rely on a batch-compounded dose which is drawn down for that patient. And in some cases, nurses are doing this in the care setting in terms of compounding patient-specific doses, which is really not an ideal way to deliver this therapy. What Myxredlin does is it provides a room-temperature-stable dose that is available for the patient in a flexible, ready-to-use container. There is no thawing, there is no mixing, there is nothing other than administering the product to the patient. You can imagine, for hospitals, this reduces time, so it saves money in that sense, but it also eliminates risk. And so it's a great innovation. We're thrilled for that, and it's going to be an important product as we look here at 2020 performance. We have a number of these products which are premixed products which we've offered to the market. Last year, we -- was really the first full year of launch of dexmedetomidine, which is conscious sedation, tremendous performance over the course of the year. And a lot of it has to do with this differentiated presentation that we have. PrisMax is another one. PrisMax is a great product. Basically that acute business that I described to you earlier, which we've seen double-digit growth, high single-digit growth. And we expect that to continue because of the crucially, [ clinically ] necessary nature of the therapy, all of that was done on the back of a device that was more than 10 years old. And so now PrisMax is a radical step forward in terms of technology. And what we did was we worked very closely with clinicians to identify all the barriers and the challenges that they had with the therapy and we incorporated all of that into PrisMax. Our Spectrum IQ, which is our version 9 of the Spectrum pump, is the first one that we've launched with 2-way connectivity with the hospital. And so big improvement for us. It's a great pump. And we had a -- last year was the best pump year that we've ever had as a company. So it's an unbelievable performance on the back of our Spectrum IQ leading to that 7% Medicaid delivery growth. Now as we look forward, what's very exciting is we have a whole new suite of pumps that begins to launch the middle of this year. And so this will be a great catalyst for our business going forward. From a market development standpoint, a lot of this is about education. I will simply point to one, which is THERANOVA. So today, dialyzers oftentimes are viewed as commodity-like devices. A dialyzer which is critical to hemodialysis, it is really the raw ingredient that allows hemodialysis to take place. There's not a lot of differentiated outcomes coming from different dialyzers. Over the last several years, we've been hard at work, gathering data for THERANOVA. Our belief is that there is better clearance of large middle molecules, which more closely replicates the human kidney, which leads to lower levels of inflammation and lower other conditions. And so that's the work that we engaged in over the last several years to prove out. And now we are poised to gain approval in the U.S. and also poised to gain differentiated reimbursement. There is some work that needs to be done between now and September when the ESRD rules are finalized. But we are incredibly excited about the prospects of THERANOVA to, for the first time, provide really new innovation in renal in the last decade. And then looking at the right-hand side, I've highlighted a few of the earlier-stage strategic collaborations that we've had in place. What you can see is, look, a lot of activity, and then I'll share more about business development in a moment. As I said earlier, the pipeline is great. What I'm perhaps most excited about are these expanded pump offerings that we'll begin to launch. In 2020, we'll start with a large-volume and syringe pump, and then we'll add pumps after that. This will be the first time Baxter has a consolidated platform of pumps. Again, all on the same platform, all with the same user interface. I believe this will be a best-in-class offering with -- in a very large market in the United States and global. We've also been very focused on analytics and data with respect to our patients to drive outcomes. Our Sharesource technology is a technology used by renal patients today. And what it allows them to do is, when they're home, basically, it provides daily interaction with the clinic that they're working with. And so if a patient's therapy is interrupted, the clinic knows about it the following morning. So if the nocturnal therapy was interrupted or there was some challenge, the clinic knows about it. And so this is a very significant deal in the sense that it starts to allow us to drive enhanced outcomes for renal patients in the home through better oversight. And so what we've done is we launched Sharesource a number of years ago, but now we have started to add higher levels of data analytics to support patient outcomes. A couple of other ones. PIVA specialized monitoring. This is an interesting one because for Baxter, we have these sets which basically connect the patient to the pumping device and allows fluid to go -- or drug to go into the patient. But the interesting thing about this is, to date, those pump -- those sets are dumb devices. There's no information gathered from those sets. Well, what PIVA allows is for us to understand hydration levels, hemodynamic monitoring to take place through set in a very noninvasive manner. In fact, right now, the gold standard for hemodynamic monitoring involves very elaborate, very invasive procedures to take place. PIVA eliminates all of that. And then finally, I talked to you a little bit about Myxredlin, I talked about dexmedetomidine. There are a number of other differentiated molecules that we have in the work. All told, we expect to deliver $1.7 billion in new products by 2023. At the same time -- and so we're incredibly excited about the innovation story at the company. I will tell you, though, that at the same time, we are also incredibly disciplined about the resource utilization at the company. We are very focused on controlling costs. We are very focused on relentlessly driving operating margin, cash flow performance, up. And you can see, over the last several years, we have generated more than $1 billion in annual savings relative to 2015. So in a 5-year period of time, we have improved the margin of the company 1,000 basis points through these initiatives. Some of that has been reinvested. So the total margin improvement at the company, actually, is about 1,000 basis points. But what you can see here is this is a real commitment of our company. We're focused on zero-based budgeting, we're focused on being smart in terms of where we locate activity, and the effect has been profound and perhaps unprecedented. We will also be really thoughtful about capital deployment. Right now, I would say we have an under-levered balance sheet. And over time, we will fix that in the sense that we will add debt and sort of reconfigure our balance sheet to be a little more leveraged, but we'll do it through allocations to a number of different activities. It starts with reinvesting in the business. For us, to the extent that we can reinvest in activities that allow us to accelerate growth through our core business that was perhaps unplanned, that's ideal. One great example of that. In our prior long-range plan, we had no view that the advancing American Kidney Health Initiative would be potentially put in place. We had no view to that. And so what that represents is a big long-term opportunity. What that initiative comes down to is the Trump administration is very focused on driving kidney patient treatment to the home. As the leader in home dialysis, we are poised to support that in a very significant way, but it would also require incremental investment. It's a great investment because we understand this space as well as anybody, okay? And it's a lower risk than some of the more speculative business development somebody can do. So this is exactly the kind of investment that we like to see. We expect to continue this. Reinvesting in the business, that's the first item. Number two: Dividend. We've been raising the dividend over the last several years. Our target is a 35% of adjusted net income payout ratio. It will take some time to get there as our net income has grown quite substantially over time, but we will continue to focus on raising the dividend over time. From a share buyback standpoint, we opportunistically repurchase shares in a sense that if we believe they are discounted relative to our intrinsic value calculation, we will repurchase shares as we've done over the last several years. And then finally, we'll bolster with strategic M&A. It's a great -- when you do smart M&A, targeting ROIs that are meaningful and appropriate in the 3- to 5-year time frame, you can really drive a great outcome for your company. As we think about M&A, we're focused on a few core areas. One, we want category leadership in the sense that we like to have #1 or #2 position or a clear pathway to that. We want to capitalize on something -- there has to be some logic as to why Baxter should own a specific asset in the sense that, if we are simply a generic buyer of an asset, it becomes very challenging to make the economics of transactions work today. Third, attractive financial returns. What we really look at is the IRR over the life of a deal, and we want a double-digit IRR. But the reality is the life of the deal is a very long time frame. And so from our standpoint, we are also very focused on driving an ROI, as I said earlier, in years 3, 4, 5 because those are times when the deal will either work or not. And so driving the right economic return at that time frame is crucial. And then finally, right now we're A- with S&P; and Baa1, so BBB+, with Moody's. Preserving investment-grade credit rating is important. We want to have access to markets in good times and bad. We want to be able to finance our operations with limited risk. And so this idea of preserving investment-grade credit rating is quite important to us. Not to say we won't add significant debt, but we do have ample opportunity to do that and maintain that investment-grade credit rating. On the right-hand side, you can see 2 specific deals. And I'll just highlight 1 for you because it really is an illustration of the kind of deal that we like to do. Seprafilm is a product which is really an adhesion-prevention product. And so when you have Advanced Surgery sales force calling on surgeons in the U.S. or global as we do, oftentimes, what we sell today is adhesion and sealants, hemostats and sealants. That's what we do. What we do not sell is adhesion prevention. But on the minds of every surgeon who is working through a particular procedure is not only sealing but adhesion prevention because you don't want to have things adhering to one another that are not -- that's not in the best interest of the patient. And so oftentimes, what would happen is our sales force would be on a specific sales call and the topic of adhesion prevention would come up, we would not have an offering. What this does is this plugs this gap in our portfolio. And what it means is our sales force will not have to even make incremental sales calls. We will be leveraging the sales footprint that we have, we will be leveraging the sales calls that we make today and we'll be giving another thing to talk to surgeons about. You can imagine that the gross margin of this business, which is really quite good, will equal the operating margin in a few years' time because of the leverage that I've described. So what that also means is the ROI in this deal will be absolutely wonderful if it comes anywhere close to the pro forma that we expect. That's the kind of deal that we've done. This team, this BioSurgery team led by Wil Boren, they actually did one of these deals a couple of years ago when we acquired a couple of assets from Mallinckrodt: RECOTHROM and PREVELEAK. And what I can tell you is this strategy paid off in spades. In that case, we wanted to add a low-end product to the portfolio at a slightly lower price, and it worked out incredibly well. The team was able to do it with limited to no incremental SG&A investment. So that's a great example of the kind of deal that we like to do. We'll expect to do more of these as we go forward, being very mindful of the financial criteria that I outlined, because guess what? The financial story of Baxter is a very solid one as we look at what we expect to do in 2020. We shared preliminary financial guidance at the JPMorgan conference. And what we said was sales growth of 4% to 5% on a reported and constant currency basis; a GAAP operating margin of 17%, 18%; and adjusted operating margin of 19% to 20%. As a reminder, the adjusted operating margin in 2015 was 10%, so we've come a very long way on this critically important metric. To close out, our company remains incredibly focused on accelerating pace of innovation and the impact of innovation on our financials. That's about new product launches, market development, geographic expansion. We'll invest in quality in operations to support our expansion opportunities. We'll be really opportunistic and smart about strategic tuck-in acquisitions to unlock additional value. All the while, we will not lose focus of this idea of this ongoing cost transformation that we've undertaken. Because what we recognize is, look, innovation, coupled with smart resource utilization, can unlock tremendous value as we've seen. The final point is, in September, we plan to host an Investor Day in Deerfield, Illinois. Everybody in the room, you're all invited to join us, so please take advantage of that opportunity. At that session, we'll be focused on sharing innovation highlights, the pipeline, some of the more exciting aspects of what we're focused on going forward. So as I said, I appreciate everybody joining us early here in the morning in Orlando. Thank you for the interest in our company. And at this point, perhaps we have time for a couple of questions, Larry.

Yes, we do. Thanks for that, Jay. Maybe because it will come up throughout the day, so let's just spend a moment on coronavirus and the situation. I recognize it is dynamic, changing sort of every day. But maybe you can remind us how we should be thinking about it from a revenue exposure perspective and a supply chain perspective. You guys obviously have a sizable business in the Asia Pacific and China region specifically.

Yes. Look, China is a large business for us today. It's about 6% of sales. There are a number of businesses within China that are related to discretionary procedures and there are other businesses that are less so. So for example, our Renal business is the vast majority of our business in China today. And the Renal business in China, our patients need supply, so this becomes more of a integrity of the supply chain and how do you work to ensure that because those patients are on therapy today and we have to continue to support them. Where some of our other -- people will look to stay out of hospitals in places like China wherever possible. And so in fact we're seeing sort of solid performance from our Acute business, which is for patients with acute kidney injury. I described that earlier in my presentation. But in areas like basic IVs, we're actually seeing lower levels than perhaps you would have expected because people are staying out of hospitals. At the highest level, we are incredibly focused on the coronavirus situation. We have a task force that meets daily. But our #1 mission is the safe, continued supply of our patients and the safety of our employees. But as far as overall economic impact, it is really difficult to provide any kind of expected number for 2020 because we have no real view to how this is going to evolve. Will it subside in the spring, as some say? Will it continue to roll out across the world? We have a large business in Europe. Europe was fine until Italy, and so now that story is starting to change. I think what we can commit to is we're hard at work with those 2 elements that I described at the beginning of this presentation. And then as we host an investor call in the coming weeks, I think we'll have more to say about the anticipated outcome through the course of the year, although as I said, I have to recognize that the situation is highly volatile.

Right. And just to close up on that. How would you characterize your manufacturing facilities in terms of their operations within China are you seeing anything?

No. So far, so good. We've had some impacts, but nothing radical at this stage. What I will say is we're also really focused on, a number of our products have raw materials or components from Chinese suppliers or Asian suppliers, right? So ensuring the integrity of that supply chain is another aspect of the work that this task force is pursuing.

Okay. Very good. We should conclude there. And management will...