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

Hi, everybody, and thank you for coming back for the afternoon session in the virtual environment. For those who don't know me, I'm Joanne Wuensch, and I am the medical technology analyst here at Citi. But I'm thrilled to have the next presentation. We have with us both Jay Saccaro and Clare Trachtman from Baxter. So Jay and Clare, welcome virtually.

Yes. Joanne, thank you very much for inviting us to the conference. We really appreciate it and perhaps hope to see you soon in person.

In person, yes.

But I want to start off just sort of big picture, and I was really hoping that we don't have to talk about the pandemic this time next year, but we still have to talk about it now. What would you say you have sort of learned from it, we call it the silver linings, things that you go, oh, wow, I've changed the way we do business or we think about product launches that I'm going to keep doing because it makes sense?

We've learned a lot about the pandemic. And I think one of the things which is great about our business, the mission of our company to save and sustain lives, the durability of the portfolio, our portfolio of businesses, I mean, that's been something that's been on full display. And while it's not a new learning, I was just pleased to see the role that we played over the last couple of years in medically necessary, life-saving and sustaining role that we play, and I thought that was just awesome. So that's not necessarily a learning, but it's a confirmation. As far as learnings go, there are a few things. First of all, we've seen more of a shift to the home. I think some of the trends that we noticed long term is home and alt site would be of increasing importance over time. But the pandemic, to some extent, has served as an accelerant to that. And while in the short term, we've seen some challenges with respect to PD patients, longer term, I think the home as a setting where care is delivered is a macro trend that we'll see for a very long time. It's something that we'll be excited to support with our portfolio of businesses. The next learning, I would say, is this idea of digital. We were an in-person first, second and third environment as a company for years. We interacted with our customers in person. Everything was designed around that interaction. And while you can't replace that interaction, and I think long term it will be great when we are back in the office and things of that nature, this idea of using technology and digital connections as a means to enhance the way we interact, it's here to stay. We've adopted it completely as most others have, and I don't think that will change for a long time. Related to that, things like process automation and simplification were accelerated as a result of the pandemic because when you don't have the opportunity to sit down with people, you have to make sure your processes are even clearer than they would otherwise be. So that would be another area that I would say. And then look, we've seen an incredibly volatile supply chain environment. And so we are definitely upping our game in terms of how to respond to supply shocks, how to respond to highly volatile demand. This is still impacting our business in the Q4 and the Q1 guide. All of those were severely impacted by Omicron. But I think our ability to respond to this has enhanced and will continue to enhance as we move forward.

That leads me directly to my next question, which is your guidance. And as you reflect on how you put that guidance together, there was a very long list of headwinds, and I'm going to just going to read some of them off, not that you need a reminder: inflation, supply chain constraints, elevated back orders, employee absenteeism and staffing shortages. How did you think about each one of those? And is there a way to quantify the impact of each on the guide?

They all were significant challenges. I think the back order situation that we saw in the fourth quarter of last year was unparalleled. So we were short revenue as a result of staffing shortages, inability to procure raw materials or other critical components. We were short revenues. And we had more freight than perhaps we've ever had as a stand-alone company as a result of being hand-to-mouth from a supply chain standpoint. Those factors contribute to our Q1 guide, and then we start to see improvement. Really, what this comes down to is, I would say, the biggest impact in the fourth and first quarter related to Omicron and its attendant impact on staffing levels in our facilities. We have more absenteeism than ever with people either exposed to COVID or having COVID themselves directly. And the result of that was very challenging. And so again, the expedited freight was something that featured prominently in the fourth quarter. And then as we move to the first quarter, a lot of this was about back-order situations, continued high levels of freight and then some of the knock-on impact from material inflation that we saw last year that rolled into this year. So all of that was clearly challenging. How did we reflect at all? What we did was we really tried to assess the current state of each of these dynamics, what the improvement -- what we anticipate from an improvement standpoint and then, as always, be conservative wherever possible. We try to give conservative guidance. That's a philosophy of the company. We don't always get it right, but we really try to. And I think -- and I'm hopeful that we've reflected all of these things as we put forth the guidance that we shared. What I will say, though, is we have not baked in another round of significance of the pandemic. We haven't modeled that in terms of our thinking, and there might be some impacts from that. I certainly hope there aren't. And if there are, I certainly hope we can mitigate them, which we will try to do with the playbook that we've developed. And I would also say that we haven't factored in a large-scale conflict in Europe. I would say that we've reflected some of the aspects of that in our numbers but not a large-scale impact. But generally speaking, I would say, I think we've tried to reflect all of these things conservatively in the forecast that we put forth.

And one of the things which is consistent with all of the large cap companies that have been reporting is stronger second half, weaker first half as you think about the year, many have talked about sequential improvement each quarter. And how -- are those factors resonating for you? And is it just pandemic-driven? Or is it also some other factors that you want to sort of like underscore to say, okay, this is what formulated, not just the full year, but the progression throughout it?

Sure. Joanne, normally, our second half is better than the first half. We have a higher concentration of sales dollars in the second half, and that has an impact in terms of absorption of SG&A but also absorption of overhead in our manufacturing facilities. We also concentrate some of our spending in the first half of the year as we look to ramp up initiatives and sales meetings and so on. And so normally, there's this cadence that the year gets better. In last year's case, it was a very real phenomenon because it was enhanced by pandemic dynamics. In this year's case, the same is true. Essentially, what we're seeing in the first quarter is high levels of back orders, higher levels of freight, challenges with respect to raw material prices, which -- all of which improved in the second half of the year. And so what happens as we move to the second half is we have a sales dollar increase. We have a gross profit increase, in part, which is led by freight, in part, which is led by ramping up of VIPs. And then on the SG&A side, we have better leverage in the second half of the year. But then in addition to that, a lot of the synergies with respect to the Hillrom transaction are more loaded towards the back end of the year because it does take some time to get through all of that activity. So for all of those reasons, I would say this year, more than most, is a back half loaded or second -- second 3 quarters, 3 quarters loaded versus the first quarter. And so we expect those dynamics will change quite a bit.

Excellent. Well, I want to spend a little bit of time on Hillrom. But before we get there, many people in med tech, and it's not a Baxter thing, think about acquisitions, acquisitions, acquisitions. We don't think as much about divestitures. And yet on your most recent earnings call, that did come up a little bit more, I don't know if you want to say consciously or assertively. What has brought you to that stage? And how are you assessing the portfolio to decide what stays and what doesn't?

Sure. We have historically always looked at our portfolio category by category and business by business to assess how attractive this business is. And if you recall our Investor Day in 2018, and even before that, we talked about buckets of very attractive assets where we intend to grow, other assets that we intended to maintain and then other assets which were just sort of -- or core assets and then some assets that we were just going to maintain or try to manage differently. And so one of the things that came out of the Hillrom acquisition is there are some really exciting areas for us to invest in, areas where the weighted average mark growth is accretive to Baxter, areas where we had a real right to win in those places and the result was very attractive economics to Baxter. And so from a capital allocation standpoint, we are tilting money towards those areas. But related to that, as we looked at the Baxter portfolio and considered it, there were some areas that are less interesting to us. The market dynamics are a little more challenging. Our ability to win is less clear. And so those are some areas that we are looking at to figure out what the best pathway forward is. And we have done this historically. We've walked away from businesses and geographies. We've spun things out. We've sold things. So Baxter is no stranger to this. It's something that will -- and so as we look forward, this will be something that we talk more about starting in our Investor Day but then beyond. And I do think that there will be some opportunities to move away from businesses that are of a less clear strategic fit for us. By and large, I think the Hillrom portfolio that we've acquired is exactly what we want. So I think this is a little bit more centered on the Baxter side. Although there may be a small business here or there that we'll look at. But from a Baxter perspective, the opportunity to enhance value through managing the portfolio intelligently is something that we're excited to look at very carefully.

So let's switch a little bit up to Hillrom. You closed the transaction earlier than expected in December -- mid-December. In your early days, is there anything that has surprised you or anything where you go thinking that that's exactly how you wanted it?

One of the things that I knew, having worked at Hillrom, is it's got a great culture and a great set of people and a really, really interesting set of products. Now they've done a lot to evolve the product portfolio since I was there. But this idea of cultural alignment is something that I always felt would benefit the combination. And so when we did this deal and we got to know really the culture at Hillrom, it's actually really surprising how much of a nice fit this is for Baxter. And so it's a remarkable company. It's a remarkable set of products and opportunities but it's one that's going to fit well into Baxter. And that, Joanne, I can't emphasize how important that is to the success of an acquisition. So that's great. On the call, I said, look, from a synergy standpoint, on the cost side, we are tracking in line with our expectations, increasingly so -- with increasing confidence. I'm even more excited about that opportunity than I was looking at it from the outside. And a lot of that comes down to all the hard work that we're doing as a leadership team to identify, to ensure integrity of process, to move things forward. So that's been going -- the whole synergy story, that's been going great. On the revenue synergy side, we're extremely excited about a variety of different vehicles. So we've started to see that. So by and large, a lot of nice surprises as we've looked at the Hillrom transaction. Or at the very least, a lot of things that have confirmed our original hypothesis. Now of course, the one thing I would say is they are equally impacted by some of the supply chains challenges. While they had an excellent Q3, their Q4 was very challenged by supply chain issues, absenteeism in the plant. So it's another medtech company just like us. But -- and that's something that we'll have to work through, and we are as one combined enterprise. So that's the one thing that's been a bit of a challenge in the short term. But as we look at the long-term value creation opportunity from this transaction, I think all signs are pointing to a fulfillment of the original thesis of the deal.

Excellent. Moving to the NOVUM IQ pump -- we can even spend a couple of minutes on your entire pump portfolio. How do you think about the addition of that, why it's important? And if it is delayed or since it has been delayed, does that really matter on the ultimate revenue potential for it?

So the pump, we're so excited about the NOVUM pump. And indeed, it's taken a long time to get to market. We can talk extensively about that. But for us, we really want to ensure that when the FDA receives our application that this is something that can be approved in 30 days, I mean, that's all the work that we're doing is leading to that hopeful outcome. The reason the pump is exciting is it really leverages all of the best things that we have with our pump, including the master drug library, the medication safety provisions that we have with respect to it, a simple and easy user interface and then now adds to it a whole platform. And so we will launch a large volume pump followed by a syringe, followed by a PCA and all on the same platform working together in an integrated manner. I think this is a very big deal. And I don't think that the delay sort of sacrifices the long-term opportunity and the real revenue potential that we have. It impacted us in the short term, and I explain that and discussed that extensively through the various phone calls that we've had with investors. But the real long-term potential is intact and exciting because, in the past, if you want to use a Baxter pump, it meant, at a minimum, you would have 2 different platforms in your hospital. That's a lot of work in terms of administration and training that needs to take place. Now over time, you'll be able to consolidate on one platform with a trusted supplier. So we're quite excited about the long-term opportunity, and it's something that we're working very carefully at. Joe talked about the time line and what we're working through right now, but we're very optimistic and hopeful.

Excellent. It sounds like it's a matter of getting -- I don't want to put -- I want to use to phrase, ducks in a row, which it may not be the right phrase. But is it really just a matter of understanding what the FDA is looking for and delivering upon that?

I'm not sure if it's more ducks or geese. I'm not sure what fowl. But Clare, do you want to talk about the specific steps that we're undertaking and where we sit?

Yes. So I think there is -- Joe already talked about it, we're basically in the process of responding to additional information request from the FDA. So we wanted to be as thorough as possible. We've had our responses reviewed by some external folks and also we've brought in some internal folks who have previously worked at the FDA. So we've enhanced our disclosures around that area. We've taken our time to ensure the thoroughness and comprehensiveness in our submission and the responses to the FDA. We expect to submit here, I'd say, within the next 45 days, and then there's a 30-day approval after that. So our time line remains to launch in the first half with most of the sales coming really in the second half of the year.

Excellent. All right. I think we can move past pumps unless there's something else to be added there. Good. I do want to talk about advanced surgery and the exposure to elective procedures. And when you think about those returning, how do you think about that in terms of a bolus of procedures, a pent-up demand, a slow bleed? Like I've used -- I've heard so many different phrases as you think about the patient returning to the hospital for an elective procedure.

Clare, do you want to take that?

Yes. With respect to our kind of the guidance that we provided on the call, Joanne, and I actually think you were part of the ones to ask the question. For surgical procedures, we expect them to be down kind of low to mid-single digits here in the first quarter and improving sequentially over the course of the year. So still down in the second quarter and basically flat to down slightly in the third quarter and then up in the fourth quarter is kind of how we have that. Now what we capture this, just to be clear, and I have shared this with people, we are really talking about the acute setting. So the hospital inpatient but also hospital outpatient center or those outpatient clinics that are associated with an acute care hospital facility. So we aren't necessarily capturing all the ASCs out there with respect to that. So there could be some additional information or additional kind of bolus of surgeries that happen in those. So when we are referring to it, that's kind of the data that we're capturing it. But from what we see right now, we kind of are assuming that procedure is stable or pre-COVID level and then do increase to above pre-COVID levels in the fourth quarter, ending the year down around low single digits.

Excellent. In Renal Care, fourth quarter was a relatively strong quarter versus the rest of the year. And yet, it's -- the franchise has been hindered because of the macro -- well, not macro, but macro specific as it relates to the patient population. How do you think about that in a recovery mode? And then in terms of your franchise HD versus PD, how has this pandemic impacted where patients are being treated?

Sure. I think that there is a long-term answer to your question, and then there are some short-term dynamics to be cognizant of. As it relates to the long-term dynamic, the notion that folks that are critically ill will want to spend time in the safety of their home doing whatever medical treatments they need to do, that is a macro trend that will continue for years to come. And so there is a strong desire, and we see this, and we hear it and it tangibly makes sense to me. As it relates to the short-term dynamic, we've had a number of challenges with respect to PD. One is patient mortality. These are the most vulnerable patients. So to the extent that they are exposed to COVID, we've seen very high mortality rates in this area. The second thing is because patients have been not going to see doctors, there have been higher cases of urgent starts with respect to treatment. And oftentimes, when that happens, you see a tilt towards hemodialysis versus PD. Third, we've seen some staffing shortages, which has been another challenge with respect to patient starts. So all of these dynamics are ones that have impacted us in the short term. It's impacted growth rates and patient growth rates. While we had a good quarter, I would say, generally speaking, 2021 on both the PD and the HD side was negatively impacted by this phenomenon. Now the great news is, I believe this will change. And I believe that this will be a life-saving therapy for a large patient population. I mean, I think we're thrilled to play that role. But it's probably not going to shake out that way for another year. I think through 2022, we'll be challenged with some of this mortality issue along with some of the staffing shortage and starts issue before this starts to correct in earnest. So when we gave guidance, we've reflected a more tepid level of patient growth this year, and then we'll expect to see that start to accelerate. And remember, we do have favorable reimbursement dynamics in certain key markets like the U.S. I think that's a long-term positive but we just haven't seen those results yet in the short term.

Are there products in Renal that you have in development that might help in this transition to improved care over time?

I think for me, the single biggest is Sharesource and the analytics that we're putting around that. The -- because what's happened with Sharesource is, this really is a telemedicine platform, allowing patient and clinic to communicate back and forth in a safe manner. That data is shared with the clinics on a regular basis so that the patients can really feel safe in their homes as they conduct treatment, and the clinics can oversee in a way that they could not prior to Sharesource. So this product, I believe, is a gateway to continued expansion of renal and PD therapy. I think that's really the most important. We're doing things like various apps and other developments to simplify the administration of the product and keep the patient close and up to speed with information. So we have a number of bells and whistles. But I would say that the lion's share, which is, do you have a good cycler? The answer is we have a great cycler. Is it supported by a technology? The answer is we have a great technology in Sharesource. And then do you have a reliable supply of solutions and other disposals, which we -- disposables, which we do. You put those 3 things together and you really have a compelling vehicle to help support and treat end-stage renal disease. I don't know, Clare, if you would add anything to that.

The only thing I would add, Jay, is longer term, we are looking at continuing to enhance like our cycler. So we do have a number of programs going on to have a kind of more effective cycler that we could actually leverage on a global basis because most of the world right now, automated PD, so those patients using a cycler are in the developed markets. So we are looking at being able to broaden that with a new cycler in the coming years.

Excellent. If I -- I want to just go back for a second to a pump question, which I should have asked earlier. Given the urgent safety notification for Spectrum IQ, can you maybe gate or discuss what that impact may or may not be and whether or not you think it impacts the timing of the NOVUM IQ?

Sure. So I'll take that. From a financial impact, this does not require the return of the pumps nor does this prohibit any of the sales of the pump. So we are currently continuing to sell the pumps. And we will be -- this notification went out to customers towards the end of last year. This -- the notice last week was just the classification of it on Friday by the FDA. We are in the process of working through the next steps with our customers, and we'll be notifying them here in the coming weeks about what to expect from that in terms of the solutions for that. With respect to NOVUM, this does not have an impact on NOVUM. So this does not delay anything with NOVUM. Now of course, the FDA is -- will ask some questions around that, so will want some additional details within our submission around NOVUM with respect to that. But this does not impact our overall NOVUM time line.

Excellent. When we think about product launches, and we've already been talking about one, what others are you most excited about for 2022?

Sure. I'll answer and then I can turn it over to Clare as well. On the Baxter side, I think NOVUM is a landmark. When that launches, it will be a landmark achievement for the company. And I think it's a -- it really sets the stage for continuing this idea and continuing leadership in connected care and solving problems for hospitals in new and different ways. So we're so thrilled that, that one's in the works. And then I would add, simply put, I'm increasingly excited about Sharesource and analytics. And so as we continue forward, we will be supplementing Sharesource with different analytic modules that attempt to further address patient challenges and keep patients on therapy longer. And that's a big deal for us. If you can extend time on therapy a month, it radically increases our ability to serve patients and drive an impact. We'll have a couple of pharma molecules that launch in this upcoming year. And then there are a number of launches on the Hillrom side, particularly in front line care, that we're quite excited about. So I would say the interesting thing about Baxter is, generally speaking, -- and I learned this -- I've said this for probably 7 years, but I learned -- I never learned it more than the last 2 years, we are truly a diverse business with a lot of different product categories. We have no area -- no business in any country represents more than 5% of sales. And the result of that on the innovation side is we'll have a whole host of things to share with all of you when we sit down in May because the pipeline is rich. There's a tremendous amount in there. And we'll start to see that once the pump launches, pharma molecules start launching this year, a lot of exciting elements. Clare, would you add any one that you're particularly interested in?

No, I think, Jay, you covered a lot of those, and then we'll continue to augment that with some geographic expansion as well across the portfolio.

I mean one of the acquisitions which you made were the OUS commercialization rights for Caelyx and Doxil, which has been quite successful. How do you think about adding similar type of products to the pharma portfolio?

So we like deals in the pharma area. But I think you have to be very mindful of the different profile of those assets versus assets like Hillrom, the durability of it, the -- because pharma assets don't tend to last as long as certain others. And so you have to be really mindful of driving a very significant ROI in the short term from those deals. And if you can, they can be great deals. The Caelyx, Doxil deal is phenomenal, and we're thrilled with the performance there. But you have to be cautious. You have to make sure you understand market dynamics, ability to manufacture. And then when you do that, like I say, and you pay a fair price, you can drive a really nice return for the company. I would say, by and large, we will probably tilt our business development efforts a little bit towards connected care, digital, some of the aspects of Hillrom. Listen, Joanne, our strong view is that connectedness is the direction of health care over the next decade. We believe that. We also believe that Baxter is in a unique position with our current offering today and then especially when supplemented with the Hillrom product offering that we've acquired. If we can link those things together and then perhaps supplement with some tuck-in business development, it's -- I think we're going to be solving problems for hospitals today that are currently unsolved. So we're really excited about that, and I think we can find ways to do this in a very economically attractive manner. That's not to say we won't do pharma deals because we'll certainly look at them. And I expect to see some more pharma deals in the future. But I think over the next 5 years, more energy and effort will be tilted towards connected and digital technology from a business development standpoint. The last comment I would make on this is we are a little bit constrained on business development efforts for the next 2 years. On the one hand, operationally, we're integrating the largest asset that Baxter has ever acquired. But on the other hand, there are financial constraints. So we're very focused on getting to this 2.75x net leverage target. There is some room for business development, but not enormous in that environment.

Excellent. I think I would be remiss if I didn't ask a question about the P&L. So as we think about operating margin expansion potential, what are the levers that you have to make that happen?

Sure. So I think margin enhancement comes in the coming years from a few different areas. Clearly, there will be some positive benefit from synergies that we put forth. So that's one aspect. Second, the progress that we are making in terms of enhancing our manufacturing facilities is really astounding. And the interesting thing about it is we're doing reasonably well despite the worst inflationary environment we've seen since I've certainly been the CFO here, perhaps in my entire career. And so we're making progress despite that. So what I will expect to see is the inflation environment will abate at some point. And that's when you will really get to see the benefit of all of the great progress on the manufacturing transformation. So that's another one. And then on the SG&A side, there's still opportunity in terms of adoption of digital technology, adoption of automation, simplification of process, consolidation of our efforts in single locations. There's still opportunity on the SG&A side. So it's a multifactorial approach to margin improvement. And the last thing I would say is when you do things like launch a pump and you start selling sets next to that, that naturally enhances your margin. So as we do this portfolio exercise that I've just described, tilting our investments, forget about for a second, subtraction, but tilting our investments towards those areas that are higher margin will yield benefits over time. That's really the margin playbook in a nutshell. And I think all of these things will be on display when we speak with you all at our May Investor Day.

So before I let you go, when we're here talking a year from now, what do you think that as we look back, we're going to be saying, oh, remember that?

Well, I certainly hope, as you say, that we're doing so in person and not talking about the pandemic. I really hope that. I also will expect that we will have a different, much less severe inflationary environment. I think we will have a different and much less severe supply chain environment. So I think these are factors that we're all grappling with today. We'll be prepared if they'll continue all the way through to next year. Trust me on that. But I do think those things will ameliorate, allowing for us to kind of proceed in a bit cleaner of a manner. And then I'm also hoping that we'll have some really nice proof points on innovation. I hope that we'll talk about the pump installations. I expect that. I can't guarantee, but certainly expect that. I expect that we'll have some really exciting progress on combinations between Hillrom and Baxter products. So those would be a few things that I certainly hope I'm talking about.

Excellent. I think I'm going to leave it there.

Awesome. Joanne, so nice to see you. Thank you for the time and the interest in our company. We really appreciate it.

And I look forward to seeing you both soon in person.

Indeed.

Sounds good. Bye.

Okay.