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

Sure. And the one thing I will say is it's hard to differentiate the impact or dissect what the impact from COVID was on that LRP versus other factors. So I think things tend to get muddled because it's not so simple as calling out a specific impact for COVID. There are enormous second order effects from an event like that. But as we reflect back, I think we're definitely proud of much of the progress that has been made against that LRP over the last few years. And I would say that as we think about areas that have done better or worse, clearly, the renal business with the catalyst of the AAKHI initiative, that's one that's poised for a level of success that we probably didn't anticipate when we put forth the original LRP. And I think what we're seeing is we have the right technology, the right solution for providing a critical therapy to patients in the home. It's been well received. And when you add to that, the right incentive structure, plus a strong desire for patients to spend time in the home as opposed to out, you start to see this really play out in a positive way. So I think that would be one area that's gone quite well. The medication delivery business, we did have some challenges in 2018. And related to that, we made certain decisions in terms of signing long-term contracts with some small level of discounted pricing relative to our previous expectations. And clearly, that was a factor that we did not contemplate in the original LRP. We've had good progress on the pipeline. There have been a few things here and there that have taken longer than expected. While we're incredibly excited long-term about the impact of NOVUM IQ on our business, and what we'll be able to do with that platform, again, that has fallen short in terms of time frame, taking a little bit longer than we expected. We're still very optimistic about that, and it is a centerpiece to the long-term growth story. But getting pumps approved and getting it through correctly in the time of COVID, proved to be a challenge for us. Beyond that, advanced surgery, nutrition, acute, I would say it's really difficult to kind of say how would these businesses have gone without COVID. But what I can tell you is in the case of each of them, it's solid progress, and we're happy with how they've been moving along. In the case of Advanced Surgery, that was severely impacted by the decline in procedures. But some of the acquisitions that we've made in that area are really contributing to the returns of the company, and it's something that we'll continue to look for tuck-ins in this space. And then the pharma business, look, this is a solid one for us. But of course, with the warning letter in a MetaBot, getting that resolved has taken longer than we originally expected. And what I will tell you is, in the time of COVID, it's been hard to get that sort of moving as quickly as we would hope. And so that's been a bit of a bottleneck on growth for that business. We're hopeful and optimistic that we'll get this resolved, and we'll get back on to the long-term trajectory there, but that's a factor in play. Taking a step back, there are big things that we have to think about. When we -- in 2018, and we said, look, we expect a stable macro environment with no "shocks." Now I didn't have in mind a pandemic as a shock but how the pandemic ultimately impacts behavior, the ultimate hospital census? Was there some fluff in the system that goes away as a result of COVID? I don't know at this point. And so we're going to watch carefully. We're optimistic that we'll get back to historic levels, but that's one we're going to watch very carefully. And then as we look forward, there's been enormous bailouts by countries around the world in terms of providing citizens needed wages, needed relief, businesses the same and hospitals the same. How does that manifest itself? That's another question in terms of pricing dynamics and things of that nature. We'll have to watch that very carefully and try to develop an intelligent point of view by the time we sit down in September. In the meantime, I can say that those are a few of the uncertainties that we look at and digest.

Okay. That was helpful. Jay, on operating leverage so -- and margins going forward. You guys -- since 2015, you guys have seen tremendous margin expansion. And I guess I'm just curious, again, not asking you necessarily to put a number out there. But it feels like maybe some of the low-hanging fruit has been picked. And I'm just curious if you would agree with that. And sort of how we should think about the different drivers of positive leverage from here? How much is tied to execution on the pipeline versus some back-office stuff that you can still get done?

So definitely, in the first 1,000 basis points of margin expansion or whatever it was, there was a fair bit of low-hanging fruit. And -- but as we sit here today, there's still real opportunity. And the opportunity will manifest itself both on the gross margin line and against the normalized SG&A line. And I say normalized because we put a, I believe, in Q3, Q4, that we're talking about 19% SG&A at some point. And that's not a natural level for us. We were not traveling, not spending on promotional, not visiting hospitals. So there was a serious curtailment of activity that took place in all of 2020. So we did benefit from that. We'll spend some more, but there will be opportunities to reduce SG&A. We still have very paper-based functions in certain areas, including finance. And so how we think about getting creative about automation, how do we think about getting creative across the enterprise with the use of digital technology, I think that's a real opportunity for us that will positively assist the SG&A line. The bigger opportunity, though, is gross margin. Because if you think about the evolution of Baxter, I remember when we introduced our company to you in 2015, the margin was expected to be around 9%. And the reality was SG&A was 30%, R&D was kind of mid-single digits, gross margin was in the low 40s. Well, SG&A has totally transformed. But because of some incremental COVID cost, because of business mix impacted by COVID, because of non-optimized supply chain in 2020, the margin was similar to those levels, gross margin that is. And so looking forward, we see a real opportunity in gross margin to make that a catalyst for growth in a positive way. And there's going to be a few different things that help with that. One, new products, of course; two, mix. Because both of those elements come with higher margins than the corporate average. But then further optimization of our logistics. We still spend over $1 billion on logistics. And we brought in a new manufacturing and supply chain leader who comes to us with a wealth of experience and has started to put this plan into place. And there's meaningful opportunities in logistics and also optimization within the manufacturing facilities. That's clear to us today. And so I would say that while there is some SG&A opportunity, and we're probably more excited on balance by the gross margin opportunity presented at the company today. The one thing I will tell you, Danielle, is we took out the LRP off the table, and we suspended it. And it was the right thing to do for us, because we take very seriously any number that's out there. We want to have a clear line of sight to understanding exactly how we're going to achieve it. And while we may not always get there, we always have a specific plan to get there and more often than not, we do. But in light of the murky environment that we were operating in and have been operating in, we took it off the table. But we were reluctant to do so because I don't want anyone to lose sight of the fact that we are committed to the acceleration of revenue growth. We're incredibly focused on driving that. And furthermore, we are part and parcel to what the company is all about is improving the operating margin. It's something that we've done a great job at, but we recognize we have a lot more to do, and we're committed to the work necessary to execute on that. And so it was the right thing to do, like I said, but the company has been very focused on this idea that we can enhance the economic efficiency of our business. And further, we can accelerate growth over time through a rich product pipeline. And those are core concepts to how we think about things.

Can I ask a question? One of the key evolutions of Baxter since 2015 was on the R&D side of things and investing in R&D in a way that this portion of combined Baxter prior to 2015 just was not investing. And I'm just curious how COVID -- you guys had improved R&D productivity, I think, pretty meaningfully. Clare, we had hosted a call with your Head of R&D back in 2019, which was very helpful. And I'm just curious how COVID, if at all, has impacted that side of things from an R&D investment and productivity perspective?

So I would say that, by and large, it hasn't been a dramatic change, in the sense that we have been able to continue to do the work to advance the pipeline. There has been savings for sure as a result of COVID, but we're expecting some of that savings to normalize in the future. So you'll get some incremental spending. But I think we've been happy with the progress on the pipeline, notwithstanding the setback that I mentioned earlier. And could that be COVID related? It very well could have been. But we've been generally happy with the progress on the pipeline. And frankly, we're not interested in saving to risk milestones or anything like that. So this is about driving the right kind of productivity. And the changes that we've made over time have been good ones, like relocation of activity, consolidation of facilities, those things are all independent of COVID. And we'll look to continue to do things like that as appropriate, recognizing that the #1 job of our R&D team is not to save dollars, but rather create new dollars through an innovative and exciting pipeline.

Okay. Got it. All right. One thing, Jay, that I feel like you get this question all the time, I think it's your favorite, just kidding, and that's on M&A and capital deployment. Baxter has been active on smaller deals, licensing, in-licensing, things like that, but hasn't done much from a sort of -- I don't want to -- I don't know if I'd call it transformative, but bigger, larger scale perspective. How should we think about where you are today from an M&A strategy perspective?

So the M&A strategy is really unchanged relative to the last few years. And what we're focused on is we want solid assets, ideally market-leading, in growing markets that will improve the WAMGR of the company. We expect accretion, of course, that's a low bar. We want a reasonable ROI. We want a double-digit or near double IRR. And -- but there has to be some logic to Baxter ownership. And so what we found in today's environment with prices where they are, for so many assets, that -- because of that, you have to have an incredibly sound logic as to why you're the rightful owner of something. And if you are, then you can get a return on the investment that makes a lot of sense. And so the tuck-in deals that we've done, generally speaking, carry much higher ROIs than even the corporate average, which is pretty remarkable for a business development deal, but at the very least, you're looking at double-digit ROIs in the very near term because they were so linked into something that we do. When you buy an asset that's sold by an existing sales force, well, it's a no-brainer from a return standpoint. And so that's -- those are the kinds of deals that we've been able to do. The larger deals have been harder to get that model to work. And so for us, that's okay because, first of all, there's -- the existing business that we can reinvest in, and we'll look to continue to do that through capacity expansion and things like renal and so on. Second, there is shares that we can buy, and we're always happy to do that. We purchased 0.5 billion shares last quarter. We felt the shares were attractively priced, and we're going to get after that as we always do. We were hesitant to do that last year. That was exclusively because of the pandemic and maintaining adequate liquidity in the event of some sort of tail risk event. And then, of course, there's lots of M&A that we'll continue to look at and go after. And if we get things done, that's great. But at the end of the day, what I expect from an M&A deal is when we do it, you'll say, "Oh, I understand why Baxter did this." Because when somebody says that, what that means is we're able to drive the proprietary synergies that allow us to make that kind of a deal work. And so really, that's the capital allocation philosophy and the M&A philosophy. And I would add to that, of course, we've been steadily chugging away at the dividend, raising that over time, and that will be another vehicle that we'll continue to utilize to return capital to shareholders.

Okay. Yes, that makes sense. But I mean, I think nothing you're saying is new here, right? And a lot of large medtech companies are saying similar things, at least as it relates to valuations. But it feels like the valuations of a lot of the acquisition targets out there, they're just not going down. If anything, every year, they get higher and higher. And so I guess I'm just wondering how you, as a CFO, and looking for business development I mean, does the bar -- has the bar changed from an ROI perspective because who knows if when valuations are going to come down? I guess that's -- I'm just trying to reconcile that a little bit.

Yes. It's a good question. I think if you recall, since we're doing the history of the spin, the first time I talked about M&A criteria, I said a mid-teens ROI in less than 5 years or in the near term, okay? And I said that not as a function of the environment, but as a function of where we stood operationally. We didn't really, at that point, have the confidence to say, hey, we can go and buy something big, and there's no -- we don't need any margin of safety. And then as things evolved, we said, okay, oh, double digit. Now we said, a meaningful ROI. And that has nothing to do with assets are pricier, it has to do with our confidence in our ability to execute, drive and deliver on the pro formas that we put forth. So I would say that our criteria has changed over time. But in large part, because of our level of confidence, the capabilities that we've built from an integration standpoint, the understanding of our own business has improved quite dramatically. So for these reasons, I think we have a slightly different view, but we're still going to be really disciplined buyers, Danielle. That's part -- we'll walk away from way more deals than we'll actually transact on. And it will always come down to this ROI challenge that we, and all of you, of course, are faced with as you think about your investment portfolios.

Okay. That's fair. All right. I want to shift gears to renal, because we did get a question from the audience. And I think it's very relevant and a big growth driver going forward. So how do you see the shift in home dialysis playing out? And how are -- how do you see the opportunities for Baxter as the shift to in-home takes place?

Look, this is big. Worldwide, we're like 12%, 13% penetrated from a PD standpoint. And worldwide, any patient that is presented with the option of PD versus HD, they have a new consideration that they will be thinking about. Do I want to be in a setting with 10, 20, 50 other critically ill people? Or do I want to conduct my therapy in my own home? I think the safer-at-home approach is one that many patients will look to adopt and many nephrologists, frankly, will look to employ. And so this is one where I think that we have the right technology, we do, with the telemedicine aspect that we've added to all of our cyclers in major markets. So that's big. But then in addition to that, our ability to now capitalize on that environment, I think it's really exciting. Now when you add to that reimbursement changes, like we're seeing in the U.S. with the demonstration project, it can be a tremendous catalyst. Now is it going to happen overnight? Nothing in this business, in PD and HD and renal happens overnight. But will it generate a steady stream of growth for the foreseeable future? I believe that absolutely that will take place. Now the one thing I will say about renal, though that we have to watch in the short term, is the patient census may have been disproportionately impacted by COVID because of the critically ill nature of these patients. So that's one aspect that is a factor that we have to watch over the coming months and quarters. But long term, gosh, this is a really exciting area for us. And we were so thrilled with the AAKHI element, and I think that's going to be a source of growth for the long term. Could the PD penetration double in the U.S. over the demonstration period? It could. And so we'll watch it and see -- we'll watch carefully to see what happens.

Well, you front ran my question, Jay, because I was going to ask about the COVID impact on patients. So thank you for addressing that proactively, and it looks like we are at time. So Jay and Clare, thank you so much for joining us.

Danielle, very nice to see you. I hope to see you soon in person.

Yes, same. Thank you.