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

I think that the spending is largely in the gross margin area. So when we talk about the incremental manufacturing costs, principally, they hit gross margin. There's a little bit of expedited freight that we were seeing in the SG&A line. But by and large, the costs were in the gross margin line. Because if you think about it, SG&A and R&D in the third quarter were perhaps the lowest levels. And I don't know this with certainty, we could validate. But I think we're some of the lowest levels we've ever seen at 19% for SG&A and R&D threatening 4%. And those were really a function of us controlling spending, really focused on that, using different technologies like Zoom and things like that, instead of traveling. So those factors were all in play. I think that the one -- the challenge that we had was the revenue line, as you pointed out at the beginning of the year -- at the beginning of this call, has been largely intact. But it's just that it costs us more to get that product to customers as a result of the pandemic. And furthermore, and you didn't ask this, but we had to carry more inventory because we're nervous about that and want to make sure that we have adequate supply levels if this thing goes in the wrong direction. And so we do expect those costs to mitigate over the course of next year, certainly. And some of them have already started to -- we've already started to mitigate. Some of the freight costs that we were seeing in Q2, Q3 start to go away in Q4. Some of the personnel bonuses start to go away. So portions of these costs will go away in the first half of next year. There are some peculiarities with how costs roll out. So for example, some of our plants, because of demand in different -- asymmetry of demand -- or demand at different levels, some of our plants have been running at lower levels of utilization, the result of that, and that's because of the lower utilization and procedures, some of those costs will roll out next year that unabsorbed manufacturing costs rolls out in perhaps the first quarter. So you start -- you see some of that in the first quarter. But as we move through Q2, things start to improve, and we should see some positive impacts. Assuming everything goes according to our plan, we should see some positive impacts and by year-end, should have mitigated the vast majority of these costs. Again, that's all if things go according to plan. If coronavirus goes in a different way, if vaccines are unsuccessful, we have different questions. And I say that because a lot of our planning is done at a base case, but we also look at some of these other scenarios and what it could mean for us. And there are still some challenges that remain and a lot of hurdles for us to get through to get to that point. The only thing I will say is I expect that we will have, even post vaccines, some level of incremental PPE in our plants. And that's in the few tens of millions of dollars, say, $30 million, perhaps of sustained costs related to pandemic. If every employee in every manufacturing facility every day gets a mask, it just has a certain cost associated with it. So I think that portion of cost remains long term until such time as we feel very differently about the world. But the vast majority of costs should be mitigated. And I'm optimistic that towards the end of next year, we're in a much more normal spot.

Okay. That's helpful. And I guess if I could hear it again, what you're describing is most of that movement improvement is going to be in the COGS line in gross margin. I think you had mentioned some, I don't know, other efficiencies, reduction in sort of expediting shipping costs and things like on the last call that sort of suggested that there may be opportunities to drive efficiencies there. How meaningful is that?

I think there are. But realistically, I do think we're going to have -- look, I don't think the Q3 level of SG&A, for example, is sustainable. And as things normalize, I think we will ramp this spending a little bit, visiting doctors. For example, one of our products, Myxredlin, it's a new and innovative product. We're quite excited about it. But it's well short of expectations, in part because of limited access by reps to hospitals. So that's just one example of the activity we hope to resume swiftly. And in some cases, we've started resuming that. But that will have attendant with it, some incremental SG&A costs. So we'll have -- I think that the full year 2020 level of SG&A is probably a little bit lower than we might normally be. But having said that, there are things that will remain. And I said this recently, I said, "Look, our travel will be down 2019 to '21. There's no question." It's just that 2020 to '21, you'll probably see some uptick there.

Okay. So maybe if we could talk a little bit about what you're seeing geographically. You did mention this at the outset, various parts of the planet sort of in different stages of recovery and going forward or backwards. Maybe talk a little bit about areas of strength, areas of concerns in the next couple of quarters.

So we have been really pleased with how our business in Asia Pacific has gone. It's remarkable. The fact that they were out front with the first impacts and then, by and large, we've seen the right level of growth coming from this business over the course of the entire year. It's been a tremendous performance and a testament to the team that they've been able to continue to operate effectively amidst the pandemic. Now they did have the benefit of most of their markets are -- I don't want to say back to normal, but are much more normal than we're seeing in other places in the world. That's one benefit our Asia Pacific team had. And the second is we're heavily reliant on our renal business in Asia. And if you -- my comments earlier in the call, that's largely been unimpacted by coronavirus. So I think that Asia has been a real bright spot and we'll expect to continue to see growth there. Europe has done well. But this is one, where with the outbreaks and now if we were to think about where talks of shutdowns are taking place perhaps the most, Europe is where we're seeing that. And so as I look at 2021, I'm very cautious about what our assumptions are there until a wide availability of a vaccine. Because that's a market that could be heavily impacted. And then I think we've discussed the U.S. in a fair bit of detail. We're hopeful that we see continued improvements in the trends and optimistic that we will, but also respectful that we did not see the uptake that we were hoping for in Q3 in terms of admissions. And so we'll have to watch this closely. And by the way, even the simple approval of a vaccine may change people's mentality in terms of behavior and so on. So I think we'll have to watch. But Europe and the U.S. are 2. And when I say Europe, it's a lot of the developed regions. The big 5 in Europe, those are the ones that we have to watch carefully. And this short-term dynamic is something that we'll be very mindful of. Because lockdowns do and, to some extent, would negatively impact our business to the extent that they were prevalent and sustained. And it's something that we'll have to watch.

Sure. And I guess just on that, not to belabor a point that we all talk an awful lot about and think about and try to analyze the data around, but what you just mentioned, Europe and the U.S. are things we should look at and markets we should watch, Europe is rolling through some shutdowns. But then again, the other side of it, we all, I think for a good reason, are relatively comfortable with the idea that we aren't really going there in the U.S. for a variety of reasons. Why do you think -- or what's different? Or if someone listening to this from a distance, why would we think that way?

I think the lockdown as a tool is a very challenging one to implement in a country like the United States, given that in some -- and I'm not saying that in some states, they might or might not. But generally speaking, I think it's a difficult tool to implement in the U.S. for many different reasons. And to do it again, if you think about the economic consequence of a lockdown versus the clear benefit in terms of safety and so on, it's a hard tool. Because we did it, it had a dramatic impact on unemployment, on the short-term economics of the country in a huge way. We've responded, I think the appetite for that, based on what we've seen, is a little bit challenging. So I do think it's less likely in the U.S. But as we saw in the second quarter, we have a proxy for what that would do to our business were that to occur. And the reality is in the height of 20% decline in admissions and worse than that in procedures, our business declined 2%. And so we have a sense for what this kind of thing could do to our business. We'll watch. I'm not anticipating it wide scale. But like I say, we'll be prepared for it if it does occur.

Sure. No, I don't ask the question sort of wondering whether it will happen or questioning our view that it shouldn't happen, unlikely to happen in the U.S. But someone who doesn't spend all their time in health care would be listening to this saying, "Wait a second, what did they just say? And why is that even true?" But I tend to agree. And I think most companies that we talk to tend to agree. So maybe talk a little bit about some of the other growth opportunities that we'd get into next year. I know it's -- right now, we've been focused on stability and recovery and managing through this period. But what in -- other than the pump, which you talked about, and the opportunity to THERANOVA such that is in terms of specialty injectables or contribution for growth from other categories away from renal, away from some of the things you've already talked about, do you see opportunities for growth?

Yes. So the pump is a great one. Like we've discussed that though in detail. I think for me, one of the important drivers of sustained long-term growth is really what's going on with AAKHI. And more broadly speaking, an opportunity, I think, around the world, where I -- look, the coronavirus will end and life will get back to normal. But if you're thinking about something like receiving life-saving therapy and you have a choice of doing it in the home or in an alternate setting, I think mentally, people will want to do that in the home in a higher percentage than they historically would have. And so we've seen very good -- one of the areas we've been delighted with over the last 5 years is our PD business. It's been a solid and steady grower. Of course, there are puts and takes in any given year. But it's been a really nice growth opportunity for us. And so as I look to next year, I think PD will continue to grow. I think it's a multiyear, long-term opportunity. And then when you have things like AAKHI serving as an accelerant, lining up the incentives with behaviors that are just great from a patient standpoint and that grow the business, I think it really is -- it's going to be a nice sustained growth driver for us. We'll have some continued opportunities in pharma. There are a few launches in our pharma area. Although we have a lot -- numerous more in 2022, but we'll have a few launches in pharma. And frankly, I am -- I've talked a lot about this Myxredlin product that we've been quite excited about, is falling short of expectations, but it's largely an access issue. And so what I'd like to see is a really good year coming out of Myxredlin as a driver for our performance. That would be another one. Our BioSurgery business has been going quite -- despite the pandemic, our BioSurgery business has been hanging tough. And I think things like some of the assets that we've purchased, like Seprafilm, we'll expect to see some continued performance from there. It's nice that one of the theories of the case behind the Seprafilm acquisition was this was a great product, but it was underpromoted. And we had a sales force that really had a gap in their bag. And so now we put that in and we give it a great -- it's a great promotional opportunity for us in certain areas. And so I think this Seprafilm will be another nice one, and we'll look for continued acquisitions in the BioSurgery space. So a lot of nice momentum coming next year and we'll be -- I'll be excited to turn the calendar page to 2021 and just hopeful that we get this resolved as -- the pandemic resolved as swiftly as possible because that allows us to get back to the basic blocking and tackling and some of the things that you've come to see from us, the steady performance over time. We're excited to get back to that.

Great. So if we were to sketch out what another long-run plan they would look like, and I can realize that gets Clare just like a shutter, you can think about having to put that all together again. But some of those highlights might be some of the things you described, continued strong opportunity around the home hemo, home renal, PD opportunity, continued opportunity on pumps, continued opportunity for some pipeline increments in specialty injectables plus Myxredlin, which untapped potential just because it hasn't really had a chance to have a full lap around the track yet. So in terms of maybe margin opportunity is one of the things that we get questions about. Because that, post spin, has been a big part of what investors think about in terms of value drivers, taking your margins from x to y. You've made a ton of progress with zero-based budgeting and all the great things that you and Joe and team have done. What's -- what are some of the next frontiers for driving further margin improvement, again sort of putting this environment behind us for just a moment?

Sure. I think that there are 3 opportunities for continued margin expansion. And you have to understand that, for us, continued margin growth or operating income growth and excessive sales growth, that's an important focal point for us and will continue to be. The areas are new products will come in at higher margins and provide some mix shift. And we'll see some mix shift, generally speaking, when you see areas like acute, our Advanced Surgery business, some of these -- some of the pharma products growing in excess of some of the base areas. So long-term mix and new product mix, I think, is one catalyst. The second catalyst is we do have an opportunity in terms of cost of goods. It's an incredibly intense amount of money that we've spent in this area. And if you look at it, if you look at the performance since the spinoff, SG&A has come down, I think, from like 30% to 19% this quarter. I don't think 19% is sustainable, but the 30% to 19% is like a remarkable level of performance, even 30% to 22%, 800 basis points of SG&A. So we've seen that. But now we are tuning into the area of our manufacturing costs. What are our opportunities to really transform? And we brought in a new leader to our global supply chain manufacturing organization, who's leading that, Jim Borzi, who's got tremendous experience in this area and has started to work through some of the opportunities. And I would say that this is the second leg of the journey. The third leg relates to digital. Because frankly, having now spent the last several months really taking advantage of a few digital technologies, we've all concluded that digital represents a big-time opportunity in terms of back-office modernization, in terms of how we go to market across the board. And so this will impact all areas of the company. But I think this digital transformation will be another long-term uplift that we'll expect to see on the margin. So really, the mix, the manufacturing plus digital, I think that's the recipe for accelerating performance once everything gets stabilized.

Fair enough. And the last question here, I know we're coming right up on time. You reinstated the buyback. You had suspended it. I think everyone understood why you had suspended it at the time that you did. Can you just comment how we should think about that in the context of strategic investment, returning cash to shareholders, debt balance?

We've always pursued a mix of this. And we -- and we've always been active on the buyback front. I think the way we do it, we look at the trading price of the shares relative to what we think the intrinsic value is. And if we see an opportunity, we go in as much as we can. I think our record for a quarter was $1.5 billion in the fourth quarter of 2018. And it was just precipitated by our long-term view of value was intact and we saw the sales of shares trading low. So we really wanted to take an opportunity to get after that, and we were able to. So you can expect to see us buying shares for sure. And we don't like to talk about it like before doing it. We don't like to announce ASRs. We did announce a stock buyback authorization. But we don't -- we typically don't talk about it other than that. And then once we've done it, we'll talk about it in the earnings call in the quarter in which we've made those purchases. And so you can expect us to see us be active on the buyback front and hopefully active on the M&A front because we have a lot of nice targets out there. But it's just a matter of can you make -- I say hopefully because we will walk away from a lot of deals as we've done. And we have some reasonable ROI thresholds. They're not astronomical ROI thresholds. But we want to see some level of return. Especially in the more balance sheet we put to work, we want some level of return on that. So we're careful about that statistic as a governor for us and will continue to be. But I would say that I expect that we'll do some of both in the coming 12 months. I can say highly likely -- very, very highly likely we'll be repurchasing shares. That's something that -- but the M&A, it's like you have to make sure you get the right deal. Because unlike equity investors, we don't get to sell it if we don't like it. It's a very cumbersome process if we choose something incorrectly. But I'm optimistic and hopeful that we'll get some stuff done definitely on both fronts.

That's very helpful. Thanks. I think with that, we're out of time. And Jay and Clare, thanks again so much for joining us. It's been a great pleasure.

Yes. I really appreciate it, Matt. Thank you so much.

Goodbye.