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

Good morning, everyone. I'm Robbie Marcus, the medtech analyst at JPMorgan. I'm happy to introduce our next company, Baxter. Joe Almeida, the CEO, is going to come up and do a presentation, then we'll do some question-and-answer afterwards. Joe?

Thank you, Robbie. Good morning, everyone. It's a pleasure to be here with you today, and I would like to just start by the safe harbor statement. Please take your time. And Baxter is a 100-year-old company that has a history of technology in health care, they have spanned in every continent over more than 120 countries. Baxter is transforming itself. Here today, I'm going to cover some aspects of this transformation. We are recognized as employers, it is not only for our social responsibility, but also for what we have done to improve lives and society. Baxter treats 350 million patients a year. Over 300,000 patients depend on us every single day in their homes for their peritoneal dialysis treatment. They rest in hospitals and clinics as well as new sites of care. We have been listed in the Dow Jones Sustainability Index, the Newsweek America's most responsible companies [indiscernible] 100 best corporate citizens. The company has paid significant attention to its social responsibility. We'll continue to put targets out there that will be challenged every single year to get to become an even more responsible company in every aspect, not only in the environment, but also its workforce and its ability to care for its customers and patients. We have a pretty compelling story for value creation. We're transforming the company in a third phase of transformation. We have 4 very specific areas of focus; innovation, market expansion, operational efficiency and capital allocation. Today, we're going to speak more about operational efficiency and capital allocation as we speak about the go forward for Baxter in terms of our announcement last Friday. So it is important that we never deviate everything we do in terms of strategy from the mission of save and sustain lives. It is a company that has 60,000 people committed to its future to the people that we treat, the 350 million people [indiscernible] our products every single year from a hospital bed to injection of IV solutions to injection of PD dialysis solutions in the home, so they can go to work every day. This is a very focused company with 4 strategic pillars. We'll be able to release more value in the long term for our shareholders. On January 6, we made a very significant announcement. For a while, we've been studying the portfolio of Baxter, the complexity, the locations around the globe, the customer, the endpoints, who buys, how we make it, how we distribute it. Does it make sense to be together and to reduce complexity. We announced a few things that we're going to cover today. The first was the creation of a new company, [indiscernible], which we plan to spin off in 12 to 18 months. It's going to be a leading health care company in the renal care space. We also said that we're going to create new business units by combining what we have today in more simplified vertically focused companies that will be able to operate within Baxter to promote our products and deliver on best return on invested capital. We also are pursuing strategic alternatives for our biopharma solution business, which is a business that provides services to the pharma industry and is a very good business of Baxter, and it's a business that is not quite in the core of what we do, but it's a great business that in the hands and the right companies are going to do even better than it does today. We have faced a significant amount of challenges in 2022. Some of them are not over yet. We had a highly diverse product portfolio that makes our global transportation and logistics and cost of goods highly complex. We move products from continent to continent. We have 65 manufacturing facilities, and that is what creates complexity and cost to Baxter. These portfolio moves will help us diversify in the right areas and allocate capital much more effectively between the 2 companies once they're separated. Also, this inefficiency in the complex aspect of our business requires that we optimize our manufacturing structure. We're going to reduce the footprint of Baxter. We're going to adhere by the simple rule of make where you sell, buy where you make. And this has not been Baxter's past because the company has an infrastructure created in the '60s and the '70s and early '80s. That was more driven for taxation optimization as well as labor savings, but those become highly complex and give us really a disadvantage in the world going forward. So we have a great deal of plans. We're going to shut down several plants. Also, we're going to highly automate few plants that require our labor force to be much more engaged. So I'm excited about the plan that we're going to be executing starting '23. When we think about our announcement, we are going to create 2 leading companies in health care, Baxter with essential products to health care with software that promotes a great deal of connectivity between hospital staff, nurses and the patient, the ability to connect them electronically through our devices, our software, our infusion systems that allow patients to be treated anywhere in the sites of care that we serve will create a company, which is the [indiscernible] Baxter of about $11 billion. On the other hand, we're going to have a very successful kidney company with about close to $5 billion in sales in 3 different areas of focus. So the way we will continue to create additional shareholder value is by delivering on a very well-designed strategy. The kidney company is going to have about 4 specific areas. And they are renal-focused in health care. They're going to have 3 different product lines, peritoneal dialysis, hemodialysis and acute kidney injury products, which are delivered in the ICU. Their focus on a strategy to unlock value is innovate to cost, create in a world where capitation is common, technology and processes that allow them to compete much more effectively and therefore, allocating their own capital to the products that make more sense to them. Baxter, on the other hand, is a medical technology leader in many areas of care. We're going to continue to double down on that through tuck-in acquisitions post the spin, creation of more software connected products and products are connected through software to deliver better health care, better efficiency in the hospitals as well as the hospital home, which is the extension of products that are sold in the hospitals today for Baxter. They need to be adapted for a more dynamic treatment of the patients. So we are working to finalize our simplified organization structure. We also have a restructuring program going in place to be able to size the SG&A for the companies appropriately as well as measures to continue to face off and offset as much as we can the cost increases that we had experienced in the last 18 months. Kidney Company has a very clear and well-defined objective. In peritoneal dialysis, there is increase of PD penetration. Pretty straightforward, we do it by delivering better technology that has cost in mind, meaning the products sold today, the new product has to have lower cost. So you can increase your margins not by reimbursement changes only, but also providing efficiency in our delivery model. Hemodialysis is the expansion of our HTX and turnover technology across the globe. And acute therapies is the adoption of that technology, which is in most places in the world quite underutilized, but the pandemic proved that this technology is quite essential for patients in tremendous distress in the ICU primarily with sepsis. The spin is expected to accelerate the value creation potential of the company in all areas of the operation, commercial, innovation and operations, all of them with specific transformational actions that will help us get there. The transaction that will be undertaken is complex in terms of time, 12 to 18 months, but it's something that Baxter has done in the best. If you go back many years, Baxter executed very successfully in transactions such as Allegiance back in the '90s, Caremark, Edwards Lifesciences and more recently, Baxalta, our former Bioscience business. And we did this very, very well, and we have the playbook. We know how to execute. So the transaction time is going to be 12 to 18 months. We also have the customer approvals of the regulatory agencies across the globe, and the leadership of the business, we're in process of recruiting internally and externally. So when we think about this, it's going to be a successful spin, is the one that is necessary to create a simpler company and separate 2 very distinctive businesses on the go-to-market front, manufacturing, disentanglement is in process. We have spent 4 to 5 months producing plans, which, by the way, is the first time I've seen in the separation, we do so much work to get to where we need to be. We -- with our automation, which became much more feasible after the pandemic and the labor rates went up so much, that becomes much more feasible for us to put automation in our plants. Doing that, we'll be able to separate the units in the next 3 to 4 years and would be probably 85% to 90% separator, which brings tremendous relief for the team, managing Kidney Co. as well as for the Baxter team that can focus on its own manufacturing operations. So this is, all in all, a positive strategy for Baxter, is the one that launches the new phase of transformation of Baxter associated with the ability to create a much more simple organization within the company with a lower cost. Remember, Baxter is one of the lowest SG&As in the industry, about 20% for a medtech company and a pharmaceutical generic company and allows us to go into areas of frontline care areas of connected care that will create much more momentum for the remaining co. So when we think about the actions that we have done to simplify our operating model is in the 3 areas of the business, in the commercial, innovation and operations. The ability to reinvest in those 2 groups into the 2 companies, rather, is essential to Baxter, invest commercially, invest in innovation and invest to reduce the cost that is today a 65 plant portfolio that needs to come down significantly and the ability to create the momentum in terms of automation and rationalization of our portfolio. So we're excited about this. So just to spend a little more time in how we're going to be optimizing our manufacturing is the footprint, as I said, as well as the enhancing of our operation systems. We are deploying software across the globe. Our procurement systems have been quite busy in the last 18 months with semiconductors. We have created offices that today, we have great understanding of our bill of materials where our electronics go. Electronic components is the life of 50% of our business. So we've got to be good at this. So there's significant changes in manufacturing. We have replaced almost everyone on top of our supply chain operations and have great confidence to have a strong and doable plan. When we think about the allocation of capital for Baxter once we start getting this done is through portfolio management. Debt repayment is very important. We're going to continue to pay our dividends, and we're going to reinitiate share repurchases once we get through this period that we are satisfied with the debt level of the company to a certain degree. I just want to underscore that portfolio management is just the beginning of the transformation. We are in 3-phase transformation. They start in 2016 to 2017, 2018 to about 2021 and '22 and the future is about managing the portfolio of Baxter, simplifying our operations and delivering better growth than WAMGR. To do this, we're going to continue to go after opportunities in portfolio management. These actions on our biopharma solutions is just the beginning. We're going to continue to look at opportunities to have the company more focused on its core business and be able to then deploy capital for tuck-in acquisitions that would create the momentum for the future. So the creation of this momentum of '23 and beyond is very important to Baxter. We have a proposed spin-off a Kidney Co. that will create a leading health care company in its space, focused very specifically $5 billion in sales. We are simplifying our operating model by restructuring the company as well as the way we have our labor force spread across the globe. We are rationalizing that. We're transforming and not only restructuring that. We also are working and will be working on the disentanglement of the Kidney Co. from Baxter, the RemainCo. Additional capital will allow us to focus investment in research and development. I want to stop a minute here. We're so much done in the last 18 months. In terms of cost containment, cost offset, the company has put a significant amount of pressure in its expanding controls to be able to offset partially, the great deal of input cost increases that we had. As a consequence of that, we feel there's investments that we have missed and should have made in areas like research and development and commercially. So the ability to actually reinvest in the business is critical for Baxter to be able to grow above WAMGR because that would be incremental investment in Front Line Care, which has business doing extremely well in our software and the creation of the new version of [indiscernible] more open software base, more easy to deploy in hospitals, the ability to create connectivity even further for our new pump that we hope to launch in 2023. And to create the artificial intelligence algorithms to help us in drug delivery safety, these kinds of investments are very, very important. So as we manage the short term of the company, we've got to think about the long term of Baxter. Baxter, as I said, a 100-year-old company. There has been part of health care, and it has innovated in health care for the last 100 years. It's important for us not to forget that. Despite the fact we're transforming the company in 3 different vectors, very specific portfolio, optimization of operations and rationalization and reduction of complexity. We've got, at the same time, not forget how much we have to put in our research groups. We have completely revamped our research and development groups in the last 5, 6 years with significant operations now in India and other parts of the world that allow the company to be more self-sufficient in the designing of products, which back in '16, we didn't design one medical device within Baxter, it was mostly designed by subcontract houses, which today are 100% in-sourced, and that has given us the advantage in R&D. We just need to double down on that. Allowing also to provide -- we will be providing additional commentary when we have our earnings call for Q4 in how the organization is going to be structured. And I think at this point, I'm going to adjourn and we're going to go for Q&A. And we'll be joined by Jay Saccaro and Clare Trachtman, our CFO and our Head of Investor Relations.

Great. Well, maybe I'll kick it off with the disclosure that due to JPMorgan's involvement in the Baxter SpinCo, I can't ask questions on SpinCo specifically. So feel free to answer however you want or feel free to ask questions on it. Maybe just to kick off, you've said on past calls that you've been in a portfolio review for several months now. Why 2022 and what brought it about and why now?

Okay. Great. I disconnected [indiscernible] here just in case. We -- when we started -- when I started at Baxter in '16, we had a phase to be able to improve cash flow, improve operating income. And we were able to deploy capital for very small tuck-in acquisitions and things that made sense for us. Once we evaluated the future Baxter and how we're going to transition the portfolio, we decided to go and acquire Hillrom, which has been added to Baxter's portfolio and has brought our connected care -- enhancer connector technology, created Front Line Care, which is a great business in cardiology, ophthalmology and monitoring. We also, at the same time, look at the rest of the portfolio and say what are the things that are core to Baxter versus the things that are here and we're -- have significant value but do not contribute to the future of our vision. And that was specifically -- now we have several analysis on that. So we came across the BPS business. But also, we looked at what is in Baxter that make us be a renal company and a hospital company and a hospital home company. And the relationship between the renal care business and Baxter is one-off simply manufacturing synergies, not one that creates commercial synergies, not even research synergies because they are different products altogether in the way they operate. So we decided to continue this analysis. We started in late '21 and accelerated in July '22. So why '22? I reverse the question, why not? Because at one point in time, the way to change a company weighted average market growth rate is to revamp its portfolio. We did it before in different companies, and I think as the path forward for Baxter. And it's time now to do it as we continue to work in making the company more efficient in the future.

If I look back, you did a bunch of additions to the portfolio last year with the addition of Hillrom. It's been just over a year now. I think you closed in December 2021. And so over your first year, how would you say it's gone? How has the business performed relative to expectations, both on the top and bottom line relative to your synergy targets?

The portfolio was the right choice for Baxter. We were able to bring the company and deliver the synergies that actually surpassed our expectations, we are on the 2x initial expectations. The supply chain crisis have created headwinds for that business in a couple of areas, supplies of electronic components, where Hillrom had less capability in supply chain and operations. Baxter came in, and we're starting to see the results of our better, more capable organization in that area. And we see in Front Line Care, for instance, as of lately starting to get products out in the field much faster. So we're starting to see some semiconductor and some stuff going on. So the supply chain caused a disruption in our sales growth, which were disappointing to us, but we just took on and put the right team in place to be able to cure that and is in process of being taking care. The second -- the third thing would be that there is -- there was in 2022 through the credit the interest rate and the issues with hospitals' profitability and hospitals' availability of nursing staff that we saw a reduction in capital orders going into the -- as we announced in the third quarter going to the fourth quarter. That we thought was a natural process that hospitals go through. We don't think that is a long-term effect, and we actually think that, that probably will last somehow into 2023, but not acutely in exiting 2023. We think the nursing crisis in terms of labor is one that eventually plays in the portfolio of Hillrom because for instance, software like [indiscernible], they offer better efficiency and productivity for hospitals, but also we need nurses available to be able to implement. So the turmoil in '22 certainly was a setback for that business, but we see that as a short term. Anything from my colleagues.

No, I think you got it, Joe.

Maybe touching on your call from Friday and the announcement. Maybe asking specifically on the RemainCo component. One of the comments I think that's caused a bit of confusion with investors was around the dissynergies that it might cause. And -- maybe you could just help clarify, I think, Jay, on the call, you made a comment around the upper end of normal. Is there any way to think about what normal is and how that might impact Baxter RemainCo?

Sure. There are -- and this is -- I'll make my comments relative to -- we've surveyed a whole host of spin-offs and then also our own experience with Baxalta where we spent a lot of time studying one-time costs and dissynergies. I would really characterize that as there are 2 pieces to this. One are one-time costs. And what we've seen in industry is roughly 3% to 4% of parent company sales in the form of one-time costs that are either capital or operating expense. We see this as towards the higher end of that, in large part because of the manufacturing entanglements that were going to be resolving as part of the spin. But it's important to note that much of this is CapEx and then much of this is one-time expense that may be adjusted out of our financial results as we've talked about non-GAAP measures given that they are more discrete and specific in nature. So that's the one-time cost piece. As far as the standup costs related to the new company, I think this is in the range right in the middle of the range of normal, which would be 1% to 2% is what we've seen in terms of standup costs for NewCo. So generally speaking, I would say that we're incredibly excited about this opportunity to drive shareholder value creation. And for me, as I went through the analysis, it was very heartening to see that the manufacturing disentanglement could be accomplished so efficiently. And once we had that in place, it was clear this will be a great long-term play for the company, for the 2 companies. But really, that's the detail on the 2 components. Would you add anything to that, Clare?

Perfect.

So just for everyone, just to be clear, it's not take RemainCo minus 4%. It's -- that's an amount, but we'll see some of that maybe in EPS. Some of that non-GAAP out, some of that on the balance sheet and cash flow.

That's exactly right. And that's consistent with how all companies treat spin-offs. I mean, so I think we're talking about standard practice here, and we don't see any major deviation from standard approach.

Great. I will open it up to the audience if there are any questions. No. All right. I'll keep going. You guys did not preannounce fourth quarter result here, but I want to see if there is any high-level thoughts you can give us qualitatively about how fourth quarter trended? How procedure volumes or hospital admissions are trending?

Let's divide in 2. Jay, do you want to talk about the first part of the question?

Sure. As it relates to fourth quarter performance, we're still finalizing our numbers for the fourth quarter. We're still in the close process as we speak. And so we're prepared to discuss that in a great degree of detail on February 9. Beyond that, it's a little bit difficult given the timing of this conference and the timing of the announcement that we made on Friday to get into financial performance in the fourth quarter. But as it relates to procedures, Joe?

Yes. We see procedures -- procedure volume is stabilizing, probably coming close to the levels in pre-COVID. And we want to stop talking about pre-COVID. We need to start thinking about versus prior year because we keep going to 2019, and we are in 2023, right? So my last comment about that would be now. The second is admissions in hospitals are slightly below pre-Covid levels. So we will be monitoring those. The acuity of disease primarily related to respiratory illnesses, either COVID or any pulmonary respiratory issues, including the flu, have lower acuity than before. So the utilization of health care is slightly lower than we saw in pre-COVID still.