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

Great. Thanks, everyone, for joining another session at the conference. I'm Drew Ranieri, one of the medical device analysts here. And it's my absolute pleasure to have Baxter International with us today, CFO, Jay Saccaro; and VP of Investor Relations, Clare Trachtman. Before we go into Q&A, just to highlight the disclosure, but for important disclosures, please see the Morgan Stanley research disclosure website. And if you have any questions, reach out to your Morgan Stanley sales rep.

So Jay, on to Q&A, and thank you again for being here. And kind of with the rumor that came out last night about potential asset sales, I know you won't necessarily comment on it specifically, but I mean, there has been a lot happening in the renal space from the corporate action side in 2022 on top of some government regulatory positive changes in targeting, moving care into the home. But maybe just help us kind of think about the rumor in terms of what it could mean for your LRP in terms of portfolio optimization. Just how should we generally kind of think about something like this?

Sure. First of all, Drew, thank you for the invitation to the conference. It's great to be here with you in person. And to the folks in the room, thank you all for joining us and spending time and for your interest in our company. As far as the rumor in the marketplace, we don't comment on M&A speculation, business development deals. We just have no comments on that. Generally speaking, what we have said is we are interested in portfolio management as a lever, both offensive, i.e., acquisition, and defensive sort of divestitures as part of our overall strategy to create value for our shareholders. And so that's definitely something that's sort of an area of focus for us. And what we do with business development is we are interested in entering spaces that have higher market growth than Baxter's, have higher economic profiles than Baxter's with a real ability for us to win in that space. So when we're buying things, that's what we're looking for. And then as we think about portfolio divestitures, it's really the opposite to the extent that the market growth is below Baxter's, more economics are less attractive. There's less clear ability for us to win. That's the criteria that we use. We've said that in the past. But beyond that, it's hard to comment on any specific rumors because we don't do that.

Not that you want to go into the detail there, but at least in terms of thinking about a $1 billion divestiture, is that kind of in the framework of some of the commentary that you've had of doing something larger but also doing several international business exits?

We've always said for us on the buy side and the sell side, size is really not the factor that's driving it. It's really those other criteria that I mentioned that are the overarching principle. So as far as commenting specifically on size of things that we would sell or buy, we don't really do that.

But any portfolio optimization? I mean, you would be maybe more confident in deleveraging, reaching your 2.75x target in 2024 and really accelerating your WAMGR and margin profile?

That's right. I mean, I think portfolio management could help accelerate our path to achieving 2.75x net debt. So it could help the balance sheet. That's certainly a consideration.

All right. Maybe kind of sticking or going to the macro for a moment. But yesterday, we had CPI data come out. And you're at a recent conference talking about macro headwinds. But just help us kind of think about this new incremental data point maybe in your guidance and kind of your commentary for next year about delivering a minimum of really 75 basis points of operating margin expansion.

Sure. And nobody knows more about inflation than I do, having last night tried to rent a hotel room in Midtown Manhattan, which is just outrageous. And so it's clear, we saw the print yesterday. What I would say is, I think there's some important elements to consider because as with all of these things, it's really the details that matter. And in the case of the inflation report from yesterday, really, it was the ex-oil inflation that most folks were talking about. But what's interesting for us is if you think about many of the indices that impact us, they are oil-related either directly or indirectly. So for example, we've seen improvements in diesel rates. We've seen some improvements in jet fuel rates. We've seen some improvements in the price of resin, the price of oil barrel. All of those things are very large elements of our cost structure. And so taking a step back, as we think about the inflationary environment, what I said this last week, it's basically slightly favorable to what we had previously expected. And that really hasn't changed since the last week. And as we look to -- those benefits don't really accrue to this year because of our long manufacturing cycles. And when we actually record the impact into our P&L, it's really more of a Q4, probably even more of a Q1 item. But we are seeing on balance a slightly positive environment, but this is a highly volatile area that we'll continue to watch. The one thing I would say also is the one thing that's probably a little bit worse than we expected from when we gave guidance was the European gas pricing. But I think on balance, the overall environment is net positive to us as it relates to these indices. And I'm hopeful that continues. That was the spirit that when we put forth guidance, we tried to pick the very extreme levels that we were currently at. And then our expectation is and all of the forecasters were saying there would be some improvement, and we'll be able to benefit from that.

So the 75 basis points include some improvement into next year and really the only -- well, maybe not the only risk, but at least one of the risks might be some of the European issues that could unfold.

The 75 basis points had largely static with slight improvements in some of the key indices that we purchase. And so I'm hopeful that this becomes an upside. And frankly, if things return to normalized levels, it certainly would be. But we're not banking on that. We put forth a plan that said, okay, even at elevated levels, can we deliver on the 75 basis points next year. And we were able to confirm, yes. That was very important for us.

Got it. Maybe just being an optimist for a moment, but you talked about really absorbing $1 billion in incremental costs since 2019. And I know that doesn't necessarily all come back at once, but how good could '23 be if you are seeing maybe better improvement than or higher improvement than what you're kind of currently factoring in? Is it 100 basis points maybe a ceiling there? Or could you potentially do better?

I think we have to see how the indices go. To your point, we have absorbed roughly $1 billion in incremental costs over the last couple of years. That's extraordinary for a company of our size to see that level of significant increase. And so there's a component of that, that is labor-related. Maybe it's around 1/3 of that is labor inflation-related. And I think that in the case of labor inflation, you're not going to see that resolved. You're not -- that's -- once you have higher levels, they remain that way. But on many of these other areas, we could see a restoration of or at least an approximation of some historic levels, which would be a real benefit to us.

Got it. Got it. Maybe sticking with macro for a bit. But I mean, in tech, there's kind of been an ongoing debate about utilization and admissions. But you probably don't want to give intra-quarter commentary on admissions, but maybe just how are you kind of seeing it maybe in the first half and your expectations into the back half of the year from an admissions or utilization standpoint?

Sure. As far as admissions, when we gave guidance, we basically had roughly kind of a month of data. And we anticipated the way we thought about the third quarter was down some, a little bit on the overall third quarter basis with the start of the first month sort of supporting that trend. So I think overall, from an admission standpoint, we haven't seen any wild departures from the expectations that we shared.

Okay. And you've made recent commentary on the overall capital environment, and we're hearing from more companies about elongated selling cycles. But I don't imagine much has changed in the past week. But just as you're having conversations with hospitals, they're dealing with inflation, dealing with staffing shortages, but are you incrementally more concerned? Or is the environment at least stable as you're thinking about it going into next year?

Certainly, this is an area that we watch very closely. As you know, it's a big driver for a lot of companies. When we gave guidance, we basically said because of hospital staffing shortages and inability to access hospitals in a timely manner, we were expecting some elongated sales cycles. And related to that, we wanted to just have some conservatism on hospital capital, generally speaking. So that's what we put forth. I would say we don't really have any new remarks relative to those expectations. But as we go into 2023, this becomes an important area that we'll assess in a lot of detail.

And maybe on the staffing-shortage side, I guess no one has a great crystal ball here. But as you're talking to customers, are they thinking this does improve into the back half, into 2023? Or is this going to be more of a lingering structural issue like a longer-term dynamic that really MedTech will have to deal with?

It's difficult to answer that question. I think you can -- you talk to customers, you can hear very different opinions on this depending on the type of hospital. Even similar hospitals have different views. So it's hard for me to point to a consensus from my chair in terms of how hospitals are thinking about the capital environment going into 2023. We'll continue to do work on this, though.

And maybe on capital. With the Hillrom business, there's been hospital beds. They have a connected care platform. With some of the access issues and installation issues, it's been causing kind of a backlog, back orders. But what's the expectation to kind of work through that? Is it really all more just supply chain, getting the semiconductors and then able to kind of recognize that revenue? But just curious kind of how you're seeing that pan out.

Yes. I would say that there is some on the hospital side in terms of the elongated sales cycle related to hospital staffing. But in fact, for us, the largest issue has been semiconductor access. I mean, this is both on the Baxter side and the Hillrom side. It's been a very tumultuous year in terms of having the ability to consistently access supply. And when we gave guidance, we said we're going to expect this to continue to be a little bit destabilized. And it's something that we battle every day. We have governmental support helping us try to encourage semiconductor manufacturers to favor the MedTech industry. So we're doing a lot of work on this. But this is another key variable that we look at, and it's going to be a key variable going into next year. We continue to assume some level of instability in the supply chain next year as the sooner that can get resolved, the better. Interestingly, in the second quarter of this year, we lost about $100 million in sales that we would have otherwise had. And the vast majority of that relates to access of components. And then on a full year basis, it's like $300 million, which for a company of our size is really significant. And so we're working hard to resolve this. Every day, it's a new battle, but this is one we think we'll continue to work through for the coming months and years.

And with the $300 million impact, that's been predominantly around just beds, frontline care. Can you give any more detail into it?

A combination of beds, frontline care and pumps. So we have been short of critical components for our SIGMA SPECTRUM version 9. It's a great pump. It's a workhorse pump. In the absence of NOVUM, that's a pump that really can sell in the marketplace, but we've been unable to sell that in large part because of lack of components.

Got it. Maybe just to move over to NOVUM for a moment, but you got the syringe pump approval, and the large volume pump is expected in 2023. Just I think that you've talked about that it is embedded in 2023 guidance. But I was listening to a competitor yesterday talk about just significant pent-up demand in this market, given some of the issues that have happened in infusion pumps over the last couple of years. But will you have adequate product to really go on the offensive next year? And kind of what are your expectations for market share kind of gains as you roll out NOVUM and really have kind of the latest, greatest new product on the market in infusion pumps?

Yes. We're extremely excited about the long-term opportunity with NOVUM to have multiple pumps on the same platform with a world-class master drug library with a simple and easy-to-use interface. We are so excited as a company to get going. We're not there yet. There's a critical milestone left in terms of the FDA approval. But what I would say is, first, on the syringe, great start. We got that approved. We'll be selling that in the marketplace here in the coming months. So very excited to have that offering, which is an entirely new market for our company. And when we have the large volume pump, it makes the large volume pump even more attractive, allowing hospitals to standardize on 1 pump platform. Now as it relates to NOVUM, it's an interesting question because we -- when we launched SIGMA SPECTRUM in, I believe 2015, we did see elevated sales levels for several quarters, maybe even more than 4 quarters. There had been a pent-up demand situation in that case, and bringing SPECTRUM to market yielded a wonderful result. As we think about NOVUM, we've included some sales in our 2023 expectations for that. Could they be more than that? Let's see. I think that this pump represents a great long-term opportunity for our company. So for me, I look at it and say, sure, there could be some short-term pent-up of demand that we're able to support. But really, for me, it's more importantly, this wonderful long-term value creator for our entire company. So we look forward to bringing that to market. In the short term, if there is an opportunity, we will work very hard to supply it. We do have some supply of NOVUM already. We've discussed this in the past. So we'll work very hard to ensure that we can address that.

With expectations for 2023, I think earlier this year, maybe the commentary was that NOVUM or maybe the broader infusion pump could add like $50 million or $100 million in sales. But how are you kind of thinking about -- I'm sorry if I'm misquoting that number, forgetting that off the top of my head. But how are you kind of thinking about the expectation in 2023?

Yes, we haven't really gotten specific in terms of NOVUM contribution. Clare, do you want to add to that?

What I would say in general is we would expect overall infusion pump sales next year of the LVP to be north of $100 million. So that when we remove the sales, we really removed the back half of the year sales opportunity.

Got it. And Jay, maybe going back to kind of your comments about the SPECTRUM launch, and there was elevated growth for a number of quarters. I mean, there's been maybe more pent-up demand from a pandemic standpoint over the past 2 years. And competitive dynamics kind of changed a bit. I mean, could you actually see maybe a stronger launch, maybe tempered by some of the supply constraints that are still happening?

Let's see. I think it will be interesting because clearly, there could be some pent-up demand, and we have to temper that with supply chain opportunities. I'm hopeful that we can address as much of that as possible. So to the extent that there is pent-up demand, we're able to support that in the marketplace.

Got it. You've kind of talked about pricing a little bit more recently. And kind of one thing, just going back to the Analyst Day, I think that there was a lot of focus on your portfolio innovation across Baxter, legacy Baxter and even on the Hillrom side. I mean, as you're kind of looking ahead and thinking about pricing action for next year geographically or segment levels, could you actually see better or more positive price maybe versus historic rates kind of given this innovation profile or innovation cadence?

There's a couple of elements in play here. The first is we have added $1 billion in incremental cost. I'll go back to that comment, not to repeat myself too many times here, but -- which creates extraordinary pressure on our company as we've discussed extensively. And so in that environment, we're working carefully with our customers to share a bit of that in the form of price, both in the U.S. and outside the U.S. And so that's an element that we will continue to work. And I expect that pricing next year will be a positive driver for the company, whereas historically, we've perhaps seen 50 to 100 basis points of price erosion across the entire portfolio. So I think we'll see a positive driver. And a lot of that reflects the incremental cost of simply operating a business of our nature. And then there will be some benefit from innovation. I think we've got a lot of exciting products in our pipeline, really neat stuff between Baxter and Hillrom along with some of the connected care opportunities that exist. So I think that's -- a lot of that is probably in years to come, but it will show up in price as well as volume over time.

And maybe on that pipeline, I mean, looking to next year, investors really want to see kind of a growth acceleration. And obviously, there's still the question about macro. But when you're looking at your segments for what you can control outside of the macro environment, can you maybe preview what you're more excited about? We talked about NOVUM, but is there anything else in a particular segment could drive above market growth for next year?

So I think that there are a lot of interesting areas as we look to next year. Clearly, Medication Delivery is at the very top of the list. But we've seen tremendous demand for our Front Line Care portfolio. And I actually arrived in Manhattan from Skaneateles, where we had a Board meeting the last couple of days. And during that time, we had the opportunity to share with our directors the rich pipeline of products that Welch Allyn -- the historic Welch Allyn business has on the marketplace today, along with a lot of really interesting ideas how our products can work together between Baxter, Hillrom and Welch Allyn. And I will tell you, we all left quite excited about the opportunities that exist. And in Front Line Care, to the extent that we're able to resolve some of these semiconductor issues, the demand is extremely robust for these products. And they provide -- serve a great purpose for physicians all over the world. So that's another area of real excitement from my perspective. I think one of the things that we've been fighting through is a really sad situation, which relates to the mortality related to end-stage renal disease patients. And that's basically -- we saw a lot of patients unfortunately die so sad. And then even patients that were pre-ESRD were expired due to COVID, which is, again, so unfortunate. And so that led to a restatement or a reset of the patient population for PD patients. I do expect that to subside at some point in the next 12 months, maybe a little bit more than that. But then all of a sudden, we'll get to see the natural growth in the PD business. What's really interesting about this is I do think there are long-term incentives that are now in place, and particularly in markets like the U.S. for home adoption. But in addition to that, I think there's a real desire of patients to conduct therapy in the home for a lot of good reasons, including safety, i.e., you can do it alone as opposed to amidst a large group of folks. So I'm optimistic about PD longer term, and I'm hopeful that we start to see some of that moving forward next year. There are going to be some challenges. The acute business has had a great year, but expecting growth off these elevated levels is a little bit more challenging. But that portfolio is just a wonderful one and a critical line of defense in ICUs. And same with -- vaccines has been a great source of revenue for us, but that will be an offset to some of the exciting things that will be growing next year.

Got it. And maybe with the Front Line Care business, as you are kind of thinking about getting semiconductors back working through the backlog or back orders. I mean, these are probably more of the higher-margin products within the Hillrom portfolio and really theoretically within the Baxter portfolio. Is that kind of the right way to think about that?

They are. They have a higher gross margin than the Baxter average than the Hillrom average. So they're really -- in general, I'm speaking generally. Really, it's a really nice product portfolio for us to the extent that we can tilt the growth curve in favor of that through resolution of the supply chain issues. It's a great win for the company. Like I said, we think the supply chain situation is going to linger. I'm hopeful that some of the reductions in demand for consumer-driven semiconductor products ultimately leads to some capacity opening up, and we start to see this moving in our direction in terms of supply availability, but we haven't seen that yet.

Got it. Just maybe still sticking with products for a moment, but there's, again, do you focus on the innovation profile of the company and moving that ahead within -- maybe within actually the PSS and GSS business, I mean, you've had kind of a -- Hillrom had a kind of a partnership with Intuitive Surgical. And there was kind of discussion about a new table launch, but any update on maybe that timing?

So again, we haven't said whether we are launching a new surgical table, and we expect that we said in kind of our near-term launches. So I would expect that within the next 12 to 24 months.

Okay. Jay, maybe back over to you, but kind of going back to like the first questions we were asking about portfolio optimization. I mean, you did Hillrom. It's a very transformative deal that can accelerate your WAMGR top line growth and margin profile. I mean, we've seen another -- a number of other MedTech companies kind of go through a buildup through transformational M&A and then kind of the simplification process. It sounds like you're going to do that with some business exits, but is there anything from an underlying basis to simplify like SKUs or efficiencies maybe more so than you kind of talked about at the Analyst Day?

No, I think it's a great question because portfolio rationalization is one way to simplify, but I think there's a lot more to it than that. And SKU rationalization is an area we constantly focus on. Reduction in SKUs leads to vast benefits that a company will experience. In addition to that, simplification of the manufacturing footprint. So there's opportunity for us. And one of the things that we do today is there are a number of instances where we manufacture in one geography and ship to another. Now in today's environment, that's created a lot of challenges with things like expedited freight due to port congestion, for example. And so longer term, there's an opportunity for us to think about how do we rationalize the manufacturing footprint, how do we do more make where you sell because that has great benefits for us in terms of the length of the supply chain and the inventory that you need to carry the cost because you're reducing cost by manufacturing closer. So that's a clear opportunity for us and one we'll continue to focus on. Jim talked a bit about that in his earnings -- in the Analyst Day, but you can expect to see more of that from us in the coming years.

And can you remind us that there's like specific geographies that you're thinking about doing more localized manufacturing?

We didn't say specifics. So stay tuned for that, but that will be an area of continued focus for us.

Okay. Got it. Maybe to take the opposite of portfolio pruning, but on the M&A side, you're working towards delevering right now. But maybe should we think of you kind of on the sidelines until you reach that goal? Or just talk about your broader M&A capabilities until deleveraging and then afterwards.

Sure. Our priority right now is getting to the 2.75x. For us, we appreciate having the BBB rating. The company has been around 90 years. We want to be around another 90 years. And I think the solid investment-grade credit rating has served us well during that time. So that's important to us. And to that end, getting to 2.75 is a real priority for us from a capital-deployment standpoint. Drew, as you know, we really like to buy shares when they're trading at a discount to the intrinsic value. We're not really buying shares right now because we want to make severe progress, significant progress towards this 2.75x. We also like doing strategic and thoughtful M&A. And I would say, by and large, we're going to hold off a bit on M&A until we get down this glide path, and we start to move very much in the right direction towards the 2.75x. Once we get there, you can expect Baxter to use the toolbox that we've deployed for the last many years, which is a mix of share buyback, some dividend increase along with strategic and targeted M&A.

Got it. And kind of to your earlier points, though, any asset sale would probably be used to accelerate your deleveraging plan versus like a repurchase at this stage?

I would say the first port of call would be paying down debt, which would allow us to, sooner than later, repurchase shares.

Got it. And we only have a minute left. We're almost out of time. But Jay, I wanted to turn it over to you if you had any closing comments.

I think, again, I want to thank you for the invitation to come speak at the conference and to all the folks that have joined us today. As we sit here, from my perspective, we're incredibly excited about the long-term opportunity that we've shared. We laid it out on the Investor Day. And as we've moved over the coming couple of months, what I would say is clearly, there's been a lot of short-term disruption. And we're very mindful of that situation. We understand it, and it's been a real challenge. But as I sit here today, I'm so excited about the pipeline, the product portfolio, the demand that we're seeing for the Hillrom assets and the Baxter products, Hillrom products and Baxter products that we sell. So we really are excited about the long-term projections that we've shared but also, and more importantly, the business plan that underlies it. I've come back from the last couple of days having spent time with our Welch Allyn team. And I can tell you that is a magnificent product portfolio that's going to be helping patients and providers for years to come. So with that, we'll conclude, and thank you again for the invitation.

Thanks, Jay. Thanks, Clare.

Thanks.