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

Well, good morning or good afternoon, depending on where you're hanging out here this week. My name is David Lewis, medical device analyst to Morgan Stanley. Welcome to the 2020 Health Care Conference for Morgan Stanley. I'm sure you've been watching for the last few days, and we're excited about our next couple of days and even more excited that we have with us here this morning the new Baxter International and 2 members of management from the company, Jay Saccaro, EVP, CFO; and Clare Trachtman, VP of IR. Before I begin, I just want to mention [indiscernible], if you want to see my research disclosures or need to, it's morganstanley.com/researchdisclosures, to see important facts about me. With that, Jay, do you want to give a preamble before we get going?

Sure, David. As always, thank you for the invitation to the conference. It's always great to see you. It's more fun to see you on stage in New York City, but we'll take this as a proxy for that. So we appreciate the invitation. I think over the years, we've spent a lot of time at this conference. And what I think is probably the nicest thing about the Baxter story is really the story continues unchanged despite all of the different elements we have in play. And when I say story unchanged, I'm talking about our commitment to innovation. I'm talking about our commitment to improving the economic efficiency of the company. These things that have become hallmarks, all the while, while we serve the patient communities, which we operate with and the communities we operate with, that story, that fundamental aspect of what we're trying to accomplish as an organization really hasn't changed over the last several years. And I think, generally speaking, despite a highly volatile environment, we've been really pleased with the progress that we've made on both of those fronts and supporting the communities and the patients, which has been absolutely critical in this environment. So once again, thank you, and let's get to it.

All right. Jay, it's a great preempt. I think we'll come back to a lot of those themes here throughout our conversation, at least I hope. Let's start with some of the basic and obvious stuff. And Baxter is a -- has been a more insulated business, was impacted less by COVID, it had some tailwinds. And obviously, therefore, will recover less quickly as some of our traditional medical device companies. And some of those questions that came up in the core, I want to come back to now, you have the traditional medical device recovery dynamics like some of your peers but you do have things like census and stocking. How are you feeling about hospital census, that was a key dynamic on the second quarter? And how do you believe the hospital census is sort of recovering here in the back half of the year? And then related to that, Jay, it was much more about census than most about stocking, but investors were sort of confused between those 2 dynamics. But just get us comfortable with where you sit with census now in the back half of the year? And how comfortable you are with stocking in the channel into the back half of the year?

Yes. The stocking really is a phenomenon we understand pretty well. What we saw was there was some -- in advance of the pandemic, you and I were buying Lysol napkins at home but of course, hospitals were very concerned with having adequate levels of supply. And so in Q1, we did see some stocking orders that took place that did impact Q2 sales. But ultimately, we have a good understanding. When we put together the guidance, we had a good understanding at that point of what the level of channel inventory was and how appropriate that was. And we felt comfortable about that. You hit the nail on the head. The reality of Q2 was all about patient census. We had a well-understood anticipation of surgical procedures, and that was down quite dramatically. But what -- the area that was a bit surprising was this area of actual admissions to hospitals. We had never seen a decline, the order of magnitude we experienced in the second quarter, a 20% decline. Now certainly, a portion of that was related to surgical procedures because oftentimes, if you have a surgical procedure, you are admitted to a hospital. So that's a segment. We understood that. But the residual impact, and really, there were a number of compounding elements to that. One, people were afraid to leave the home. And so as a result of that, those activities that oftentimes would lead people to get an injury perhaps requiring hospitalization, that was a factor. Staying away from hospitals was another factor. And then containment measures also, generally speaking, all of these things added up to this unprecedented decline, which, frankly, was more than we anticipated. What I will tell you is, from my perspective, and I think this is really important, and to your point earlier, it's a lot to do with the durability and the resiliency of the portfolio. We're down 20% admissions, 30-plus percent surgical procedures and our business was basically, not exactly, basically flat, okay? And so that speaks to this idea of selling medically necessary products that save and sustain lives. So we were really happy with that. Now I'm going to -- given that we're in a quiet period, and I know you're very sensitive to that, I'll stop sort of talking about how trends have emerged and so on. But what I will tell you is when we gave guidance in July, we had anticipated -- we had seen some improvement in both surgical procedures and admissions. And then as we look to the end of the year, we had line of sight to further improvements. But what I will tell you is all of these figures are very volatile by the day. And the notion of kind of forecasting out a normal 2021, that's really hard to do at this stage. I'm not saying that it won't happen. And I'm not saying that I have evidence to the contrary, but really looking at our crystal ball at this point and kind of forecasting out multiple months has proven very challenging given the dynamic environment and the changes that we're seeing day-by-day.

Okay. And then that leads me to my second question. And just, if you want to talk about things in the future, Jay, you're not going to offend me, for disclosure perspective. Just between you and I and a few friends. If we think about census, census is a hard thing to get your arms around. You about your 0% to 3% range for the year. Do you think that in an established [ widen of bans ] for -- to understand census, because it's harder to -- it's actually harder to model than an implantable device?

It really is. It's an important input, right? It really is a critically important input for us. So as we looked at the second half of the year, what we gave, a broader range than normal on our sales for the second half of the year. Because one of the things that I like about our business over the last 5 years, we have had very few issues in terms of forecasting sales performance. There was perhaps 1 or 2 dynamics. But generally speaking, the good news about our business is that it's highly predictable. And even amidst the pandemic, again, it's a highly predictable business. We were within a couple of points of the guidance that we shared. And so as we look to the second half of the year, we did give a wider range. And our hope was to accommodate any potential volatility in those -- really the 2 critical factors, surgical procedures, admissions, I would say there is a third, which is the hospital capital environment. That's always a wildcard that comes into play. And really, that's a -- that's both the first and second quarter impact of the pandemic. The first quarter, meaning it's actually harder to get into hospitals. Today it's actually sell and place equipment. And then second, as hospitals really get challenged in terms of the CapEx environment becomes a lot harder for them perhaps to justify certain things. So that's another factor, less relevant to us because we have a much smaller capital pool, but it is still an input to our sales forecast for the second half of the year. So as you look at all of those things, what we try to do is give us an appropriate ban. And so stay tuned, we'll report out shortly here in a couple -- in 6 weeks and then give guidance at that time for Q4 as well, some level of guidance, I expect.

Okay. And then, Jay, for the second quarter, if I back out the COVID dynamics, the underlying performance is sort of 4 to 5 points below than we saw in the prior 2 quarters. And admittedly, those were some pretty fancy quarters for Baxter. Should investors read into that second quarter underlying ex-COVID change as anything to be concerned about into the back half of the year and into '21?

Yes. I mean it's funny, you and I have had this discussion many times over the years. And my comment is always, look, don't overreact to the quarters. Look at it at 3-quarter trend, 4-quarter trend. And if you look at Q4 and Q1, those were high quarters. I don't -- and I have a great deal of confidence in our business, our ability of innovation to drive growth in excess of our market growth rates. But we're not at a 9% sustainable grower. And that's what we were putting on the Board, 9%, 8%, these kinds of numbers. And so some level of return to normalcy would be completely expected for us. But if you look at the trend over 3, 4 quarters, it starts to look a lot more like what you would expect from Baxter.

Okay. Jay, so think about '21, and let's focus on this year. I mean, at this conference, a lot of management [ are either ] talking more about '21. And if I kind of look at my model, I think I've got your '21 revenues, 8% above 2019, which I think is about your underlying performance as a business that's sort of [ that form per ad ], it doesn't seem crazy to me and your business, frankly, was less impacted than medical device companies. So I don't hate my number, but then again, it's my number, not yours. How are you feeling about 2021 as in relationship with 2019? If you can't give us kind of quantitative feedback, qualitative things we should be aware of as we think about '21? Acute care, obviously, is one thing that comes to mind.

Yes. It is a -- it's a -- we're always reluctant to give guidance this time of year. And I know you have a lot of companies willing and excited to do that. We're always reluctant to do that at this time of year. And given -- and under the circumstances in this particular year, holy cow, what a challenge to forecast out to 2021. What I will tell you is there are aspects that we feel great about. And a lot of them are within our control. I mean, the fact that we've been able to consistently advance the pipeline the way we have, really positions us for sustained long-term success. Some of the dynamics that we're seeing in the renal business in terms of the migration to the home, we're optimistic and hopeful about AAKHI, but regardless of that, you have patients who want to be in the home as much as possible, and that's a trend that's going to exist for years to come. And so you have this great dynamic supporting our PD business, which we're quite excited about. The launch of our NOVUM IQ is another area. That great progress there, a great catalyst for 2021. So we've got a lot of great catalysts. You're right, we will have some challenging comps, in particular, around the acute business, which really did benefit quite substantially from the coronavirus. But I think for me, the 2 biggest wildcards around 2021 are, how does this pandemic end? When is it truly back to normal? I mean that's something that we don't quite know what's going to happen. I've had a lot of people, and I appreciate that you have not asked this, but a lot of people say, hey, look, pandemic ends December 31 -- well, I certainly hope that the pandemic ends faster than anybody else. And maybe we're lucky, and we have great fortune and the pandemic ends, but it is a huge uncertainty as we look at 2021. And then the second big wildcard is David, we're sitting here. And the fact of the matter is there has been massive macroeconomic strain placed on hospitals, on governments around the world as a result of the pandemic. The unemployment rate in countries around the world, the challenges that this has face. So that whole macro phenomenon is one that, at this point, is really hard to say. I'm hopeful that we get a V-shaped recovery. I'm hopeful that we -- in January, when we give you guidance, we're able to say, hey, look, back to normal. We've been able to claw back the vast majority of our COVID-related expenses, we expect a normal year, and we don't see economic contagion as a result of the pandemic. But at this point in time, those are 2 very big uncertainties that I think a lot of companies appreciate and understand. And -- but I do think a lot of folks are just kind of looking at the base case only. And saying, hey, let's get back to normal here. So those -- a lot of puts and takes as we look at 2021. I really like what we're doing. I also really like how resilient our business is in light of that tumultuous environment, but it's hard to sit here and give you revenue and EPS targets for next year under the circumstances.

But as a fundamental basis, I mean, Jay, it's kind of mixed message a little bit to the investors cause you've been more durable. And you should be, frankly, less economically sensitive because you don't really have consumer-facing products. So you should be the best company, even in a bad neighborhood. So I just -- maybe a better way to ask the question would be about underlying fundamentals. Pre-COVID, this company was talking about 4% to 5% underlying growth, heading its way to 5%. As you think about the fundamental drivers of the business, is there anything to make you believe that sort of swayed you from the notion that 4% to 5% growth should not move higher here over the next 18 to 24 months?

So David, for a lot of different reasons, we've taken the long-term plan off the table and said, hey, look, stay tuned, we'll come back for more. Your point is a really important one. I actually think, amidst the environment that I described that might materialize, maybe it's 5%, 10% chance, maybe it's 10%, 20%, I think our company is extremely well situated to succeed and continue to thrive. And by the way, one of the things that was most noteworthy about second quarter was the solid cash flow performance amidst a really tumultuous environment, right? So we saw a top line decline, but we had a really good cash flow performance. So I do believe our company is quite insulated. But I'm just not prepared at this point in time because, could it be a couple of points impact from a recession, and what's the impact from COVID and this and that, and how do you decouple those from underlying business performance. Stop, it's too short. We don't give guidance in September for next year in a normal year. And so given the uncertainties that we're faced with today, we're not going to get into 2021 beyond what I said, which is, look, I feel good about the progress our company is making. Most notably, to be able to continue to advance the pipeline, the way we've had amidst a totally remote work environment or a 90% remote, I think that's pretty cool and something that I know Clare and I and the rest of the team are very proud of that progress.

Okay. Let's talk about something more structural. I think one thing that happened here pre-COVID was, through a combination of -- yes, it was COVID spending, but it started before that. It was pension. It was the accounting dynamics. I think there's been a concern that Baxter may have been over earning. And because of that, people were asking, what was margin expansion story, it may not be a margin expansion story anymore. And you were at least the overseer, if not the architect of massive margin expansion of the business from kind of 9% to 18%. So as I think about '21, I do some great basic math. We've got 2019, right, I backed out the COVID impact, which is kind of 1.25 to 1.5 points. I give you a very modicum of margin expansion of 50 bps. And I pretty easily get to the low end of your prior LRP, which is 20% for 2021. I mean is there other headwinds that I'm missing that would sort of feel, the COVID piece aside, let's just assume you don't like this -- COVID's not going to be there, but if your core business assuming that you get to 50 bps a year, and you quantified the COVID spending, so there's a reason why that 20% number in '21 [indiscernible]

Again, you answered a lot of math there, and I appreciate that. But let me -- my comments on margin will be limited to our company is really focused on continued margin expansion. The whole notion of 0 base. And what I mean by that really is challenging every dollar spent, making sure that we are being maximally efficient with the research as a company. That is center stage for our company. Furthermore, the interesting thing about COVID is we are getting some tangential benefits in terms of rethinking how we operate as an organization. And so we've talked a little bit about this. But really, I think the next leg of our cost transformation and our efficiency transformation journey, but then also our business model -- it's a digital one. And so that's been accelerated as a result of coronavirus. So as I think about where we go from here to the future, we are very focused on driving margin whenever possible. You can trust that. And you can trust that also as a result of COVID, there's some new tools in the toolbox. I will tell you, I'll give you one number for 2021, which is our travel spend, which I won't quantify for you, will be down relative to 2019, period. We will also relook at our global footprint in terms of how we think about real estate and the opportunities there. We'll look at the use of robotics, which has been enhanced and accelerated as part of COVID. So I'm really excited about the long-term opportunities from a margin standpoint as we embrace this next leg, which is this digital journey. You'll hear us talk more about that. The big -- a big wildcard for us among a number of others is this COVID spending, how quickly we can claw that back. For us, this is -- it's a $150 million in spending. The number one requirement of our company, keep employees safe; number two, save and sustain lives. So -- and that's why we are so quick to put this incremental spending in place. And that's why we'll be so cautious as we dial it back as the pandemic subsides, we'll be able to claw back the majority of that. The -- and then I'm always reluctant to comment on margin in normal years because, as you know, we go through a really deep in-depth budget process in September, October by line. So we have a long-range planning process, which we undertake, but then this robust bottoms-up, zero-based budget process, which I think is one of the best-in-class processes run by, I think, a former David Lewis protégé, David Roman runs that process for the company right now. So it's a great process. I don't want to front run that process and start making comments about puts and takes. But you can trust that we're really focused on driving margin improvement for the foreseeable future because it's a big driver of our valuation.

Okay. And in some of those savings on a post-COVID world, Jay, just real quickly, would you reinvest those savings or you drop those through the shareholders?

So I always -- for us, David, I -- if you say you're reinvesting savings, it's not clear to me that those are savings in the first place. What our company has been committed to, and I think we have proven, is when we say we expect margin improvement to come, it comes. We deliver it. We're focused on it. We reinvest certain things, but you also see continued improvement from us. So we wouldn't be talking about driving savings that we're just simply going to put the money somewhere else. There are important investments that we will make. Of course, we'll make those. We want to make sure we fund for success. And the interesting part of this -- the digital commentary that I made is the whole product portfolio and our investment in digitizing the products that we sell and really taking advantage of the information to drive better outcomes. That has a cost associated with it. So there are investments that we need to make, but I think you know we are really focused on driving margin improvement whenever possible. And you don't talk -- over the last 5 years, we've taken the margin from 9% of hundreds of basis points. But we've reinvested along the way. We have diverted along the way to fund critical initiatives. We just don't talk about that because we talk about -- when we talk about savings initiatives, we talk about driving margin improvement for the company.

So let's just move on from advances for a second here. THERANOVA, Jay, kind of a mixed decision from [indiscernible]. However, I thought you guys sounded more upbeat on the 2Q call relative to kind of a mixed decision. Help us understand what needs to be done to sort of drive that add-on payment here for next year? My concern would be the CMS had the data they need to make that decision [ and sell ]. We saw the recent publication. But if they already had the information they needed to make the decision, what's going to change their mind here come November as you think about '21?

So a couple of things. One is, I don't think it's unprecedented for CMS to make a ruling in one direction in the first instance and then have the company address specific items and then modify that ruling. So that's -- it is not unprecedented. And there are numerous case studies where that's happened. And so look, we're -- first of all, we got the approval. De novo approval, which is an important achievement for us. We are thrilled with that. And now regardless of CMS, we're going to be that product, which is really, we believe, a meaningful improvement over current technology, will be available for sale in the United States. So a great achievement. By the way, submitted, handled and now, that's ready to go. As far as CMS, we have a comprehensive submission that we believe has addressed their concerns. We've conducted meta analysis. So we believe that we have addressed what we can address. It's, of course, in their hands. We can't speak on behalf of that agency. But we're hopeful that we get a ruling in our direction in either way. We think this is a great product, which we'll continue to sell. But I'd love to hear some thoughts from Clare in terms of specific mechanics if she'd like to share that.