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

And welcome to the 44th Annual Raymond James Institutional Investors Conference. My name is Jayson Bedford. I cover the Medical Device Sector here at Raymond James. It's really my pleasure to have with us the senior management team from Baxter. We're with the company's CFO, Jay Saccaro; and the company's VP, Investor Relations, Clare Trachtman. And I think we'll get going. And Jay can start off.

All right. Thank you very much. Thanks for the invitation here to Orlando. It's nice to see everybody. It's also great to see such a diverse investor base. So thank you all for your interest in our company. And it's my pleasure to share a few slides introducing our company to you for those that are new. I'll just pause briefly. We have our safe harbor statement here. This is also available on our website. Baxter is a company with a rich heritage. We've been around for about a century, saving and sustaining lives. And it's a -- the company that we have is a mission-driven organization and that mission to save and sustain lives is central to everything that we do. And we were also -- and I'm not -- I'll spend the majority of the presentation talking about products and financials and sales and so on. But I think it's important to also recognize that we serve an incredibly diverse stakeholder base. And for us, being responsible corporate citizens is also at the center of what we do. And so I'm very proud to share with you a number of the recognitions that we've received recently, including Dow Jones Sustainability Index, Seramount 100 Best Companies Corporate Equality Index, where we, for once again, have received a 100% score on the Human Rights Campaign Inclusion Index. So really proud of the progress that we're making as a company along a whole host of different dimensions. Last year, we outlined our strategy for investors. And as I said at the beginning, it starts with this mission to save and sustain lives but it encompasses a lot more than that. Our goal is quite simple: to transform health care with a patient-focused strategy and patient-focused initiatives to simplify workflow to make lives easier for our hospital customers and to enable cost-effective care. That's really -- everything that we're doing can be embodied in that particular statement. And we've identified 4 vectors upon which we're going to build this strategy. It begins with innovation. And I'll talk throughout the presentation today about a lot of the exciting innovation we have at our company. In addition, the idea of expanding the markets that we participate in is another core area of focus. Operational efficiency, we dealt with an unprecedented environment last year. The inflationary impacts that we've seen, the global supply chain fragility that we were exposed to were remarkable. But through it all, we were incredibly focused on enhancing operational efficiency through cost synergies, through digital transformation, through transformation of our integrated supply chain. We've made a lot of progress, but we have so much more to do. And then finally, capital allocation. Really being thoughtful about portfolio management, and I'll talk a bit more about this in a moment. And then also targeting deleveraging, which we will accelerate over the next couple of years, continuing to pay dividends and then over time, return to share buyback once we achieve the debt levels that we're targeting. Earlier this year, we announced a number of strategic initiatives. I'm convinced that these strategic initiatives will significantly enhance our prospects going forward. It starts with the proposed spin-off of renal care and Acute Therapies businesses. I'll talk more about this in the presentation, as I will, the simplified Baxter operating model. One of the -- as we looked at our business model and we looked at many of the challenges that we were faced with last year, we concluded that a regional business model with businesses that did not have full responsibility for the P&L for trade-off decisions and also for manufacturing was sub-optimal. So we decided to move forward with the simplified Baxter operating model, which I'll elaborate on in moments. And then finally, we announced the sale of our biopharma solutions business, a sale process or strategic alternatives. This is a great business that Baxter has. We are an incredibly valuable partner to the pharma partners and others that we support in this business. But as we look at our portfolio last year, as we study what we're trying to achieve, we concluded that this was an asset that while wonderful, was perhaps even better in the hands of others. And so we concluded that this process that we're undertaking right now, which is going very well, was the right thing to do with this particular asset. And what our view is, is each of these actions will contribute first to strategic clarity, simplifying our business structure, simplifying our operating model will go a long way to accelerating strategies. We'll also -- it will also allow us to accelerate investment in innovation. Importantly, and I think this was very much highlighted during some of the challenges we experienced last year, the world is incredibly volatile and having a supply chain that is effective and more important, agile is crucial to succeeding in today's environment. So that's one area where I think some of these changes will help. And finally, we'll ensure that capital is allocated directly against growth strategies that can win in the market. So first, as it relates to Kidney Co. and the remaining part of Baxter, we are very excited to spin off our renal business. And from our standpoint, we've had a lot of experiences with spin-offs, Edwards Life Sciences, Baxalta which has since been acquired by Shire then Takeda have been very successful spin-offs. And I think the ingredient in all of these was simple. We had very specific needs targeted by a business that was a little bit different than the rest of the company. And in the case of the renal business, we have -- it is so much about an intense close relationship with a very specific patient population targeting a very specific disease. And so in the case of renal co, we have this renal care plus acute therapies that will move to Kidney Co. and then remaining co will be about much of the hospital legacy of Baxter, along with some of the very exciting things [indiscernible] health care systems and technologies. And finally, we have our Pharmaceuticals business. Speaking for a second about our renal business or Kidney Co. I should say. It's -- that's a tremendously rich portfolio today. We are the leader in terms of providing peritoneal dialysis. And between PD and HD, we are one of the largest product suppliers to end-stage renal disease. Those businesses comprise $3.7 billion today, and they have a rich complement of products supporting that business. And then in our acute business, this was a remarkable business during the pandemic as it was a critical line of therapy for COVID patients that were in the intensive care unit. But beyond that, this is a life-saving and sustaining business, which we expect to grow for years to come. Now interestingly, the expected market growth rate for this is solid at 3% to 4%, but there are have been some factors that are negatively impacting this. So we do believe over time, the market growth rate will be air on this higher side of this 3% to 4%. And in the short term, it's been depressed. One of the factors that has contributed to this is the fact that unfortunately end-stage renal disease patients and pre-ESRD patients have been very vulnerable to COVID. And so we lost a lot of patients over the last several years. We are seeing -- but we expect to see this normalize in the coming months and quarters such that in 2024, '25 and beyond, will be at a much broader and normalized growth rate. And from an innovation standpoint, it's really an interesting story. We are essentially focused from a PD and HD standpoint on really 2 things. How can we enable better and extended outcomes through the use of technology? And then also how can we lower the cost of care. Those are really the dual mandates of the innovation pipeline in renal care. And if you think about it, the Sharesource platform, which we launched years ago and to those not familiar with it, it really is about this idea of using telehealth to connect patient and clinic in more advanced ways. But as we now progress, there is data and analytics that we can enhance with Sharesource. There are additional things that we can connect to Sharesource to measure the patient progress. All of these things yielding better outcomes. So excited about the innovations and Sharesource. And then as we look longer term, we're looking at a next-gen APD cycler that is lower cost because this comes down to, in many markets, a capitated reimbursement model. So to the extent that we can use innovation to lower cost, that's a great win for all parties. So a next-gen APD cycler and home PD solution generation. That's another area that we're focused on. Interestingly, we have an enormous logistics cost associated with this business. The reality is shipping patient's fluid to their homes is incredibly costly and burdensome. And so to the extent that there are elegant ways to solve that from an innovation standpoint, that's wonderful. And so we're hard at work in that. And then as we look at acute therapies, this is predominantly focused today on acute kidney injury. The vast majority of our sales are associated with that. But there are ways to potentially expand beyond that so you see some of the innovations here with respect to sepsis, there may be even further application of this particular and powerful technology in other areas in the future. And as we think about remaining Baxter, it too is an incredibly exciting story. We've grouped it into 3, and I've described this briefly. The heritage of Baxter, the Medical Products and Therapies business, nearly $5 billion. Our health care systems and technologies, which came to us through Hillrom is another area that we are really quite excited about. If I think about this particular business, really interesting end markets, a lot of innovation, in particular, coming from the Front Line Care business at Hillrom. So tremendous opportunity. And then finally, our Pharmaceuticals business, we are going to be launching more than 5 products this year in the U.S. So a lot of new launches to support growth in this area. As we think about the expected market growth, this is -- we expect roughly 3% compounded growth. And through innovation, our view is, over time, we can do better than that 3%. And the innovation that we're talking about starts soon. We will be -- we expect that this quarter, we'll be submitting our NOVUM pump platform application to FDA. And really, really interesting and new development. We've not included any impact from this important launch in our financials this year, but I can tell you, we are very optimistic about where we sit today and the opportunities provided by that pump over the long term. In medical products, you can see a number of the other areas like FLOSEAL where we'll have a next-gen offering there, HEMOPATCH. We'll also be launching an ambulatory pump over time to complete our suite of pumps that we'll have available. Health care systems and technologies, a number of exciting launches coming from Hillrom. I think with the semiconductor shortage in 2022, we had some challenges with respect to fulfilling the sales potential of the Hillrom business. But what I walk away from the year with is an incredible excitement about the portfolio of products that they have in the existing products, but also the pipeline in development. Notably, we expect to launch a next-gen upgrade to our ICU bed this year. That will be an important catalyst for 2024. And then our pharma business, as I mentioned earlier, we started to revitalize the pipeline. We have a new leader for this business, Alok Sonig, who's doing a wonderful job, and we'll be commercializing 5 products, as I mentioned earlier in 2023. Now looking at it from a manufacturing and supply chain standpoint, this is an area that we faced unprecedented challenges in 2022. It was remarkable. Not only did we see more inflation on our input costs than we could possibly imagine at the start of the year, but in addition to that, things like semiconductor shortages, things like the extended supply chain because of port closures and congestion, all of these things led to very real challenges that we had to confront. And so we've embarked on a number of improvements and some of these have been discussed in the past by our supply chain leader, Jim Borzi, things like manufacturing footprint network optimization. This represents a real opportunity for us to simplify the number of facilities that we have, the footprint, how things go. We've talked in the past about make where you buy, make where you sell. And we've done -- historically, we've had -- we've done an okay job at this. But the work that we're doing now really will enhance this idea of simplifying and shortening the global supply chain that we have. We are also looking at distribution networks as part of this. And then finally, we'll be disentangling the Kidney Co. operation from our business. I think that's one of the most important aspects that we're focused on of the separation is how can we elegantly and simply separate out the Medication Delivery and Renal businesses. And we've made enormous progress. And frankly, we would not be spinning it off had we not had developed a really sound plan for simplifying that network. And then we're also focused on enhancing our operations. It's interesting because we took out several hundred million dollars from our manufacturing network costs last year but it was clearly overshadowed by the dramatic impact of inflation. This year, we'll do the same. And so what you can expect in a stable inflation environment is these benefits to shine through in the P&L. What's happened is we've done our best to offset an extraordinary inflationary situation. The things that we're focused on, we have a real opportunity for automation in our facilities. Still today, many of our facilities are very manual in nature. And so by including robots, it really will simplify and expedite the flow of product through those facilities where we're also looking at how we can upstream and downstream integrate the various elements of the manufacturing process. One of the areas that I haven't really talked extensively about in this presentation is cash flow. We had a disappointing cash flow year for all of the reasons that I mentioned. We expect to more than double cash flow, free cash flow this year, which will be a dramatic improvement, and part of that relates to inventory optimization. We've come a long way in terms of enhancing our systems around inventory optimization. And I think the new business model that we've established, the vertical business model will also really help us think more intelligently and swiftly about how we optimize inventory. And then finally, continuing to enhance the analytics that we have in place. All of these things working together will radically improve the supply chain of Baxter and allow us to more effectively navigate a tumultuous global supply chain environment. So in short, we're really happy with where we sit today after what can only be described as a very challenging 2022. As we sit here in 2023, I believe the actions that we've outlined in this presentation and announced will really position our company for success. The proposed kidney spin-off, I think, benefits us by allowing both companies to focus on very specific and different things. The simplified operating model enables greater strategic clarity and faster decision-making. The manufacturing disentanglement will drive margin improvements. The additional capital will allow for focused investments in R&D and commercial development to accelerate value creation. And finally, we expect our new simplified GBU reporting model to be integrated beginning Q3 2023. And while this has implications for financial statements and reporting, I think far more important are the implications that it has to the effectiveness of the operating model of our company. So -- and where I began. We're -- we, as a company, we've been around 100 years. We're incredibly excited about the next 100 with the purpose of our company, simply put to save and sustain lives. I think the actions that we've discussed in this presentation today will really set us up for future and sustained success as we look to those next 100 years. At this point, I think we have a few minutes for some questions, so let's get into it.

We do. Jay, thank you and well done. I guess just to start, it's been a few months since you unveiled the strategy here. Curious as to the response from internal folks, from customers, from potential suitors in the case of BPS? Is it -- is the response what you thought it would be?

I would say, generally, yes. I think internally, there's a lot of excitement. Our company has had a lot of great success with spin-offs in the past. Our Baxalta business created opportunities for our bioscience team to really shine under their own spotlight. At the same time, it created a foundation for our Baxter business to really explore growth in new and different ways, which, to a large extent, we paid off on over the last several years. And I think interestingly, the renal -- many of the renal folks have been at the company for a long time. So as they look at it, there's a very real excitement around what does this mean for us? And can we proceed like some of Baxter's previous spin-off. So a lot of excitement on that front. From a customer standpoint, many of our hospital customers appreciate the simplicity because at the end of the day, having a more focused hospital business is something that they definitely appreciate. As we think about the BPS business, we announced that sale process. And what we knew about that business is it's a wonderful business. We have world-class facilities. We do -- that team does a great job but it's just so different than what we do on an ongoing basis that strategically, it didn't make sense to keep it, as I said earlier. But the result of this is we have a very rich process that's ongoing. I hope it results in sale. We'll see. But of course, we're open to all strategic alternatives and so far, so good. So that's generally speaking, what I would say.

Okay. And I guess one of my questions coming in was what if you don't get the price you want for BPS, but I think you mentioned in the prepared comments that the process was going well, which I assume is a good thing.

Yes, the process is going well. So I think I don't have a large concern about that at this point. But what I will tell you is we're very focused on economics. And so we understand what this business is worth to us. And so we would expect something well in excess of that as part of the sale process. And if that were not to materialize, then we look at things in a very different way. And so far, so good, not a real concern at this stage.

And what would you identify as the major risks in this strategy?

Overall? So I would always say that execution of a spin causes you to focus internal. Execution of a vertical model implementation too causes you to focus internally. And so what we have to make sure of -- and I'm actually very proud of the team in terms of our continued focus is that you continue to look outward because it is a dynamic and volatile environment, both from a supply chain inflation inputs but also from a competitive standpoint. And so as we think about this, I always worry about the risk of disruption. But I think we've got the right model in place and we have a lot of experience in this kind of stuff in the past, having done spin-offs, having done reorganizations in the past. I think we've got the right capability in place. We're staffing it in the right way, such that our critical teams, which need to sell and win in the marketplace every day, they're doing what they do.

Okay. Okay. Thinking about the combined business, pre-COVID, the op margin profile was in the 18%, 19% range. The guide this year is 15% to 16%. I think a lot of investors are asking, "Hey, is there structurally something different that would prevent you from getting back to 18% to 19%." So that's kind of the question, if you can comment on that.

Sure. I'll stop short of giving long-term guidance today, but like maybe some general comments. I believe that our business was incredibly impacted by some inflationary phenomena and a supply chain constraint on a lot of our business and I'm hopeful that some of those things alleviate going forward. We've started to see that. We commented on our earnings call that things were looking a little bit better. And so you see the second half margin of Baxter versus first half, we expect a very large improvement. Now as we move into '24, there are a number of other things that will accrue in our favor. First, we'll start to see, hopefully, the benefits of a couple of new products launching, namely our pump and Progressa [ Plus], a new bed for ICUs. In addition, as we move to '24, we will start to see the benefit of some of the cost actions that we take this year are not fully realized in 2023, but accrue more to 2024. In addition to that, we'll see some incremental Hillrom synergies and hopefully, commodities continue to cooperate. Semiconductors continue to cooperate. So some of that backlog that we've had and some of those incredible costs alleviate, all of which would lead to better performance in 2024. As we move to 2025, we'll look at various pricing levers and other levers that we have in place and so in combination, I do believe there is a very nice story on [ holdco ], the margin restoration plan, let's put it that way. And so that's something that we as a team are very much focused on.

And on the remaining Baxter business, is there a desire to accelerate some of the spending such that when it's a cleaner story, the top line growth is faster, meaning do you think there's going to be excess cost for the next couple of years in the base business to drive better top line?

We actually included some incremental R&D geared specifically towards Frontline Care and some of our other businesses in 2023 because it pays off. We had some very specific programs that pay off, and we expect will accelerate growth and so of course, it takes a little bit of time. But yes, to your point, making strategic investments now. Now I'm not talking hundreds of millions of dollars in excess. But in the case of this year, it's far less than that, but impactful. And so I think what we'll see is, I hope meaningful improvements in some of these indices, incremental cost, launches, leading to an enhanced margin story in 2024 but being mindful that there will be some reinvestment along the way in terms of R&D, but I think that the first factors will outweigh the second by far.

Okay. And just on the macro factors that hit you in '22, can you just level set us on what you're seeing today in terms of some abatement and some of those pressures?

Yes. I mean it's -- this is a movable piece, right? So I think what we said on the earnings call is, I think, generally correct, we've seen some improvement in commodities relative to our expectations. We're watching this very carefully, and it's a real wildcard, but things are going okay there. With respect to supply chain and semiconductor, we have started to see some alleviation here. Now I don't want to sit here and prematurely call victory. So we're going to be really cautious about this going forward. But so far, it's going okay. And I think that after 2022, which was clearly a challenge for us, it's nice to see some level of stability.

Okay. And lastly, I think we had one last ESG question from [indiscernible].

[indiscernible]

Yes. Actually, this is an exciting area. So we basically survey our supplier base. And we have a third party validate those results and compare to their benchmark. And for us, being a good corporate citizen is multifaceted and involves our suppliers. And so we actually have increased the number of suppliers that we've surveyed. We're now well over 1,000 up from, I think it was maybe perhaps 800. And the compliance with the surveys was over 80%, which too is really good. The fact that our suppliers understand that this is important to us and that they're willing to participate. And finally, as we look at these results, our suppliers benchmark above the -- our supplier base is above the benchmark overall in terms of the third party that we use. And the name of that third party is escaping me at this moment. But I think overall, it's a good story, and it's just one more illustration. I'm happy that we end with that question because for us, our company is about a lot of different things. But being a good corporate citizen is squarely in the middle of all of that. Holding our supplier base accountable to support us in this endeavor is something that is part of our mission. So anyways, I think we may be out of time.

That's it. We're bumped up again at time. Thank you, Jay. Thank you.