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

[Audio Gap] The medical device analyst at BofA. And we have Joel Grade, EVP and CFO; and Clare Trachtman, who everybody knows, too. I guess, Head of Investor Relations, right, official title?

Yes, sir.

I guess the -- just to start out, there was some news this morning about Saudi investing $5.8 billion in Michigan for a high-capacity IV fluid facility. And so just wanted to bring that up first and kind of get your take on that.

I'd say take #1 is good luck with economics on that, #1. I guess, #2, I'd look at -- this is something obviously going to take a number of years to build. A lot to learn there is, I guess, the way I'd say it. I mean, obviously, we've had [Technical Difficulty] I would say that are still trying to get figured out. So again, more to come, obviously, we'll have to understand more about what that looks like as it evolves. But at this point, that's really not else -- nothing else to say, I would say, other than again, that's a tough economic because I can tell you when you're -- at the price that you sell the IV bags at, that level of investment is hard to get your head around.

The only other thing I would mention, too, is, obviously, as you're aware, we did just resign our GPO contracts that are multiyear contracts in length. So they would -- obviously, there's limited ability for anyone to come in kind of within the next 3 to 5 years in 2/3 of the business. And our next one is up for renewal in -- obviously, negotiations in 2026 for implementation in 2027. Again, from the time it takes, just looking at previous investments, in capacity -- in IV capacity, it's at least a 3-year before they're even up and running and likely longer. It's probably even closer to a 5-year -- 3 to 5 years, where they're on. So, yes.

Super helpful. Maybe just to kind of start out. You kind of think about Baxter is a little bit of this transition period, just had basically the transformation, portfolio transformation, CEO change. Again, where do you see Baxter at kind of now? And kind of where is the kind of the benefits of the last transformation going to show up kind of going forward?

Yes. So I'd say in a number of different areas. I would start with what I always pegged as the real strategic reason for actually for selling kidney to begin with. And that really starts with our capital allocation. That business when it was within our company, #1, it was about half the return on invested capital that the entire company was. It was very capital-intensive, required a lot of cash that ultimately went to projects that didn't generate the returns that we would like them to have. And so the ability to prioritize and focus investments, for both companies, frankly but specifically now for Baxter, in terms of those areas that are actually going to drive higher growth, higher returns is certainly one of the really key elements of that. And you've heard us talking about that really has kind of come out of this. I'd say the second part is just what I'm going to refer to as general simplification of our company. I'm certainly not going to go all the way to us being simple. But the reality of it is, is that there was a lot of things that were very intertwined between the kidney business and particularly our solutions business. That kind of disentanglement allows for a lot cleaner view on our 3 vertical segments that have a very much clear kind of end-to-end. And so again, our ability to execute more efficiently. And I'll give you just an example of where that -- what does that look like. Our distribution network with kidney was -- there's -- a big part of that business that was actually home deliveries. So the last mile was very expensive. It was also very complicated and we had up to, let's call it, close to 50 distribution centers in the United States. The post-Baxter world in that is going to require substantially less distribution centers, allowing us to have, again, less roofs, therefore, less expense. Better management of our ability to move inventory around, et cetera, et cetera. So I'd say the simplification part is really the second one. And then I would just say, third, again, as we now head into a world where it actually allowed us to pay down a large part of the debt that remained on our balance sheet, by the end of this year, we're targeting 3x net debt-to-EBITDA leverage. That now allows us then to really refocus our kind of, I'll call it, capital allocation at a macro level that both focuses on our organic investments, again, in our R&D spend. But also the opportunity over time for fold-in, tuck-in M&A deals, the ability to restart a buyback program that both gives us a onetime opportunity to kind of re -- I guess, I'll say, recapture some of the dilution that occurred over the last few years where we haven't bought stock back but also have a regular program in place. And so that's really the third part that allows us to really reset that. So more innovative, faster growth, more nimble and ability to actually have a really effective capital strategy.

Sure. That's helpful. And where do things stand on the CEO search?

Continued good progress. I think our Board is running a very -- again, I'll say thoughtful diligent but also expedient process. It's -- I'd say it's progressing well. It is -- but we're going to ultimately -- I have a lot of high degree of confidence we're ultimately going to get the right person for the job.

What's the Board -- kind of characteristics the Board is looking for? How are they evaluating kind of internal versus external candidates, in terms of kind of big picture?

Yes. I think, look, if I had to summarize the characteristics they're looking for, it's somebody that can drive a culture of innovation, a culture of operational excellence into the organization. And so I think the -- ultimately, that's consistent with how we just think about the company going forward. And I would say it's a balanced perspective between considering candidates internally and from the outside.

Okay. I did want to kind of move towards the Q1 results that you just reported. There was 5% growth in the quarter. You called out 150 basis points of kind of onetime things. So 3.5% underlying. How did the quarter shape up versus expectations? How are you thinking about the pull forward from Q2? And maybe remind us exactly what that was and why it was pulled forward and confidence that it was really pull forward?

Yes. So a couple -- I'll start -- there's a couple of things. So #1, I think there's a number of things that went really well in the first quarter. I'm going to start with HST. I haven't had the opportunity to do that, that often, so I'm going to today. That business actually had a strong first quarter. Obviously, they had some favorable comparisons but they also had a couple of things going for it. #1, the CCS business actually had a 7% growth in the quarter. PSS U.S. had 14% growth. And so our capital orders, where we talked about a strong order book as we headed into the latter part of the -- at the end of last year and into this year, we saw the results of that and that continues to remain strong and I think in a really solid place. Balanced with that, our FLC grew 5%. So again, we had a nice balance between the 2. And I think you see some stabilization in the primary care markets. So those are all positives. The Novum pump continues -- the demand for Novum continues to remain strong. And MPT side, which also grew 6%, was, again, a continued source of strong growth there. What you're referring to as a pull forward was the -- some of the -- our distributors on the MPT side, actually, I would say, started to restock themselves. And so that was something that, that happened a little earlier than anticipated and so that was some of the impact that you're referring to in Q1. And those things all offset. I'd say some of the softness you saw with some of the conservation as well as a bit of softness in, particularly in compounding on the pharma side. That's a little bit of a summary. The one thing I would point out though is that even as you refer to the pull forward, again, primarily related to MPT distributor restocking. The first half of the year remains very consistent with how we had anticipated it playing out. And so while there is a bit of a pull forward there and we've had some questions at our Q2 guidance, I'm sure you'll get to -- that H1 is something that is very consistent with how we anticipated it playing out.

Do you have anything to add?

No, I think that's perfect. That was exactly right.

And yes, the follow up is, I think the Q2 guide has kind of surprised some people because you had 3.5% this quarter and guiding to 1% to 2% in Q2. What was the kind of the big reason for that 1% to 2% in Q2. And like how much of that is conservatism kind of bolt on and..

Yes. I mean I would say a couple of things there. I mean, #1, Q2 was always anticipated to be our lowest quarter and particularly as we anticipated some of the conservation from fluids actually kicking in there. And we -- so we've got that -- some of that built into this forecast. I would say we also, I think, took a, I would say, a degree of conservatism as it relates to HST. We continue to kind of feel good about that. But obviously, as we sort of built that into the continued full year guidance for them and as well as in the second quarter, we continue to be conservative as it relates to that. And then finally, the pull forward piece, again, that certainly did impact as we just talked about the second quarter relative to the first. But again, just to reiterate, H1 is consistent with how we anticipated [indiscernible].

Yes. I mean, I think from a comp perspective, too, what I'd -- kind of to your point, Q2 of last year was our highest growth for the year. So we knew like coming into that Q1, obviously, given HST was a little bit lower. So there's that comp issue as well. So I think going back to this first half is really -- as we looked at it, it basically was in line with where we were at. And I think that we knew there would have to be a distributor build because of what happened in the fourth quarter with Hurricane Helene and distributors, obviously. [Audio Gap] that did shift. But in general, one of the things we did was held that conservation in the second quarter, as we talked about on our earnings call, we do expect to remove the allocations this month. So that is our plan, is to remove the allocations, which we do think will likely lead to some accelerated purchases. We just did not build any of that in. We kind of just said let's hold to the conservation level we saw in the first quarter. Let's remain there -- we did, as you heard Heather say on the call, we expect it to wane over the course of the year. But actually, we're keeping that conservation -- level of conservation throughout the year, somewhat in line with what we saw during Hurricane Maria. So we're kind of taking, obviously, the lessons learned from Hurricane Maria and knowing that it does take some time for those, I'd say practices to return to their normal levels.

I just want to make sure it's clear to everybody, too, just maybe explain like the IV, there was a shortage with the hurricane back last year. And so hospitals have changed practices, using less IV solution. And now that IV is coming back. It's not like they're going to go back to old practices right away. And so I think that's with the conservation that you're talking about here.

Exactly. We had to incur -- so when the hurricane happened, obviously, Baxter is a key supplier for IV solutions in the United States and it's our largest facility. And so we actually had to encourage our hospital customers, some, kind of some efforts to conserve fluids. And one of the things -- one of the methods they can use is oral rehydration which, in essence, involves a -- taking Gatorade. And so that's something we'll look at as well because once we go off allocation, we can actually go to our customers and just educate them that at times, the cost of that Gatorade bottle is actually more expensive, actually, a lot more expensive than just the IV bag. But you're not necessarily seeing that. And because we were on allocation, we didn't want to go to the customers, encouraging that because we wanted to ensure that we had healthy supply to go back to them prior to obviously engaging with that. So once we go off this month, we will start those discussions with them on that. Now that we're back to -- and again, as we've talked about, our North Cove facility is back to pre-hurricane production. So we're back fully operational there and kind of obviously, we'll be in a position to remove those allocations here shortly.

And when you saw the last hurricane I think it was Helene, not Helene, like Maria, sorry. How long do they take customers to kind of get back to normal?

Great question. It was about a year. It was about a year that it took for customers to get back to that. So I think -- and I don't know if you recall but we -- actually, you'll -- if you go back and look at it, we had assumed that it would come back a little quicker but it did take some time to -- but then after about a year, we were back to just normal practices after that.

And then one question that comes up a lot is, how are you sure like the -- it's utilization and conservation and not share loss at this point?

Yes. So what I would say on that is, one, we do obviously track our end user data. So we get it. And so we either sell direct to a hospital or they will go through the distributors. And the distributors give us the tracing data. And one of the things, though, that did happen, obviously, after the hurricane was we actually tried to pull all the inventory back in so that we could better manage it from an allocation perspective. So we knew that distributors would need to rebuild those inventory levels. And so that's what we're seeing. It's just this natural rebuild but we do have the end user data. Now the one thing I do want to go back to is and this is where it can get a little confusing, so I'm going to try not to. But as we went through our GPO renegotiations that we just talked about earlier, we did assume that we would see some share shifts as a result of that, not -- nothing to do with the hurricane. But more just in general, obviously, given we were -- this is a long-term agreement, we were taking some price increases. Those, as we've talked about, were in line with what we were thinking. And actually, I think we ended up better than what we had thought we would be from a pricing perspective on that.

Okay. That's helpful. I guess there's some sense that you -- the restock that you saw in Q1 might actually continue, right? Like there's the ability for this to actually go better than expected in Q2 again.

Yes. Well, one of the things we did see was the hospitals -- so some hospitals operate more on a just a -- just-in-time type inventory. Some hospitals actually do keep a level of safety stock. Those hospitals, they're much better. So we have had outreach from hospitals looking at potentially keeping and holding more inventory. That's not built into our forecast right now but that's something we will look at as we go over the course of the year as well.

Yes. And I think that ties a little bit directly to the allocation piece that Clare talked about earlier. As we called out on our call that actually we're going to release our really full -- no more allocations essentially in the month of May. And so I think that we'll see a little bit how that's going to play out once our allocation [indiscernible].

That's a great point because they can order up to like basically 100% of their historical practices. So they don't have ability to actually build any inventory at this point. So they are limited and capped on what they can do.

So they'll get a letter and say, "Hey, you're able to order it.".

Exactly. Allocations have been removed and then they can say 120%. So their order can go through it like 120% or whatever they want to order at. Yes.

Okay. Helpful. Maybe switching gears to tariffs. You guys did a good job offsetting it. I think that was a surprise to some of us. So good job at that, the $60 million to $70 million in 2025. Now we've had some news on China, the rates going down. How do you think about the impact of the China trade negotiations over the last weekend?

Yes, I can start, and Clare can chime in there. I mean -- so one of the things we talked about was that our -- that China was actually about half of our exposure. And so initially, when we started talking about tariffs before all this went in, we said it was a fairly minor part of our ecosystem and the tariff obviously escalated to -- were escalated to and then all of a sudden became basically half our issue. And so certainly, it's one of those things. Again, it's 90 days, so we'll see kind of how this thing plays out. But it does have a really, I'd say, a relatively disproportionate impact in a positive way in the event that, that does shift permanently. We'll see how it goes. But that's certainly -- like it's about half our issue at this point.

Okay. So like if you do the math, let's -- if $35 million is China and adjust for the rates, it's probably a $15-plus million benefit, just that alone this year. How do you think about the ability to let some of that flow through versus reinvest in some of the offsets that you had?

Yes. I mean, if you recall in the last -- certainly for our last call, we moved the range. We got a 16.5% OI, we moved that down to 16% again. So there's certainly maybe some element of moving within that range as a result of that. But at the same time, I think also part of the work that we were doing to offset potential tariffs was really tied to also the work that we're doing on cost savings related to the stranded costs that we had that obviously were left for the Kidney Care. So I think I'd say it's some combination of that, would be the way I would like to think about that. And I think that there's still work we need to do to eliminate cost. But unrelated to the tariff that obviously factors into that as well. But there's probably some of both.

Okay. And how are you thinking about the pharma tariff -- tariffs at this point?

So again, I'll start here. I would say, #1, again, still a lot to be determined. But I would say I feel -- we feel pretty good about how we're set up for those for a couple of different reasons. One, the majority -- again, a large part, I'll say, of our -- what this constitutes pharma in our world is actually manufactured in the United States or in Puerto Rico. And generally speaking, kind of manufactured where it's sold. Again, there is some element of it that obviously is not. And I think the -- what we're doing kind of in the spirit of what can we do about it? The same way that we've thought about some of the other opportunities for the -- what we need to do for tariff impacts, thinking about what opportunities we may have from a pricing standpoint, pretty targeted but a pricing standpoint in that way. Thinking about supply chain opportunities, where direct shipments versus shipping freight lanes that may go through a country that has tariffs, figuring out how to be able to move if there are opportunities to move production or move product into our country or into maybe from -- again, from Costa Rica to a Puerto Rico, for example. So those are the kind of proactive things. Obviously, in addition, we're certainly working with our industry association on that. But again, generally speaking, I think we're decently positioned for it. But to be clear, we have not factored in tariff impact from pharma into any of the conversations we've had. Is there anything you'd add?

I'd add -- 2 things I wanted to add. One, to circle back to, I was thinking about the savings that we would have this year. Partly -- I do want to make it clear, though, because you referenced, Joel referenced this earlier about innovation, like of things that we're, like innovation is very critical for us. We recognize that is the lifeblood to drive accelerated growth. So we have not lowered our R&D investments at all. If anything, we actually increased them this year. So that was not one of the offsets we looked at. We actually still held the guidance range with actually meaningfully increasing our R&D relative to what we had originally expected there. So -- and then on the pharma tariffs, I mean, I think you pretty much -- we feel pretty well positioned with that. . The reality is that with the timing of it, the impact in 2025 would likely be pretty immaterial just from a perspective of when they actually would get implemented to when inventory would roll and things like that. So we wouldn't expect a significant impact in 2025 but it is something we'll have to continue to look for, for 2026. But given -- just so everyone understands, I think we hear pharmaceuticals. Our pharmaceuticals are typically, obviously, generic pharmaceuticals. And so it is slightly different. Most of those -- our specialty injectables business is manufactured a lot we do a lot of that in Round Lake, Illinois. So we do have a good facility there for a lot of our antibiotics and anti-infectives within Round Lake, Illinois. I mean, we will have to look at things with respect to it but we feel pretty well positioned with that.

Actually, I just add 1 thing. You've, Clare, you've often made an interesting point on also the fact that we -- the majority of our business in that area is premix. And many of those products are actually premixed, if you will, for lack of a better word, in this country. We don't do nearly as much of vials, actually come from outside the U.S. So I guess that's just one other aspect of our business that why we say, hey, we're fairly well positioned for that. That's just one of the parts that I would add.

On margins, this year, you raised the guidance to 16.5% this year. How should we think about the cadence on the Q2, like front half, second half in margins? Anything to kind of call out for us to be aware of puts and takes? I know there's a lot of moving parts with TSAs and MSAs and tariffs. And [indiscernible] Street models kind of get in the right place from a cadence perspective this year.

Yes. I'll start and again, Clare can certainly chime in. A couple of things just to remember. And again, I know this isn't your question, I'm going to say something here and I'll get back to your point. I mean, obviously, remember the one thing in Q4, we do have the easier comparison, if you will, of what happened in North Cove. And so there's a lot of just kind of general impact out of that, that happens in Q4. From a margin standpoint, though, I think there's a couple of things. I mean, one, we called out the fact that our MSAs were coming a little bit lower than we'd anticipated, which, obviously, the MSAs themselves have a dilutive effect on gross margin. And so there's a little less effect of that. But on the flip side of it, our TSAs are actually coming in somewhat higher than we had anticipated. And that -- the way that manifests itself in our P&L is that we do obviously get the TSA income or revenue but it doesn't sit -- some of the expenses sit in a number of different lines of our company. Some of those sit in our SG&A, some actually sit in our COGS. And so because of the fact that we are providing more services, we get more TSA income but it doesn't always directly offset. And so some of what you're seeing from a gross margin impact is actually somewhat impacted by this phenomenon as it relates to the TSA income. So a couple of just key points there. And I mean, I think, generally speaking, we do anticipate our margins to continue to pick up over the course of the year, that the second part or the second -- remaining part of the year is higher than it was in Q1. Other things you might have...

Yes. I mean, I think -- from a gross margin perspective, what I would say is, I would expect the first half and second half to be fairly similar to each other because the impact of the tariffs and obviously, something we'll look at. But that impact of the tariffs will be primarily felt in the second half of the year. So it would lower that. Now we would expect, though, our OpEx to come down. So we have nice leverage in the back half, which will drive a lot of that operating margin expansion. So every quarter, we should see that sequential step up in operating margin going forward.

And some of that is leverage on growth, I'm sorry to interrupt -- some of that's leverage on growth and some of it also, some of the programs, the cost reduction programs that we've had in place related to the stranded costs we talked about, we anticipate that obviously kicking in over the course of the year.

So Q2 margins above Q1, Q3 above Q2.

You got it. [indiscernible] Yes, within the year, the highest. Yes.

It seems to be kind of a positive sign for the go-forward margin expansion of this company kind of longer term. How you're still thinking about the opportunity to keep on the margin progress here? I don't know how much of that's driven by stranded costs versus other cost savings initiatives, kind of as you move forward kind of post 2025?

Yes. It's really all those things. I mean I think about, #1, just to say it clearly, we do have a continued opportunity to expand our margins. And as we think about the growth of this company, it's both growing -- accelerating our growth on top but also doing so in a way that continues to expand margins. So I would think about that in a number of different categories. I would think about it, #1, you just kind of said it that we anticipate continued leverage as our cost structure continues to, again, set based on the stranded cost work we're doing, both the cost take out itself but also the leverage on the what I'll call the fixed portion of our cost, continues to get better, which will drive operating margin. We continue to focus on mix. It's one of the things we talk about a lot in our company is our mix of products, our mix of business, our mix of categories as HST continues to evolve, as advanced surgery, as our injectables, these different areas of our business that are actually positive from a mix perspective. You'll also recall, we've exited IV solutions in China, for example. Those are examples of things where we are thoughtfully and strategically exiting lower-margin businesses that will ultimately, again, drive positive. Our ISC, we continue to have opportunities within our supply chain related to margin improvement programs. Things where we ultimately continue to implement these programs that impact our overall margins. And then as you said, the stranded cost work, again, we -- our TSA income, obviously, will remain for a while. But then as we go along, we're also continuing to do work, that work is already in flight on some of the cost reduction measures that ultimately reset our cost structure. And again, Clare made a really important point and I just want to reinforce it. It is not -- these programs I'm talking about are not in any way incongruent with our desire to actually to drive R&D costs and drive innovation. We will remain -- we will continue to invest. We will continue to drive innovation. And based on the work that we need to do to eliminate stranded costs, we'll continue to do that as well.

Still a path back to kind of the 19-plus percent operating margins for this business?

Yes. The way I've always try to frame this question up, I've been asked in any number of ways on this is that is there -- is there something structural about our company that would not allow us to get back to that place and my -- over time. And my answer is, there's not. There's not something that would prevent us from doing that. And so.

What if we move back into an inflationary environment at a point where you have secondary inflation, like how is Baxter better positioned at this point to mitigate inflation versus kind of where it was before?

Yes. I think one of the biggest things is, as part of the renegotiation of the GPO agreements, unlike where we were back in 2022, where we really didn't have a lot of ability to move, we do have actually clauses and indices in the contracts that actually allow us to take, again, if certain costs go up higher, we have the ability to pass some of those costs along, as well as just, I'll call it, broader range of opportunities within general cost increases on a year-over-year basis to take price.

The only thing -- I mean, the business is significantly streamlined as well post Vantive. Vantive had a heavy logistical and so that added a lot of costs during that time period as well. So not having that infrastructure definitely positions us well.

Yes, it's actually interesting sort of from a fuel perspective, [indiscernible] fuel costs would go up that part of the business had a much bigger impact.

I remember doing that math.

Yes. Me too.

Every day. Yes, And before we end here, any -- I just wanted to ask on the 4% to 5% revenue growth, kind of the building blocks there. Like some people are sometimes kind of surprised, well, Baxter is a 4% to 5% growth company and you've been putting it up. So I want to just get the kind of the durability of the top line here in your mind and we'll end.

Well, I think it starts with our -- this -- what you've heard from us about new product development. I think one of the things that you're going to hear more and more from us is a consistent opportunity to grow and develop new products. And I think focus -- again, focusing on these categories and in these markets that are actually growing at a faster rate. And then I would just tell you, on top of that is, again, as we talked about the capital allocation earlier over time. And this is really -- the 4% to 5% is really the base. But being able to actually work in hold-in, tuck-in acquisitions as part of our growth strategy in those areas where we think it's better again to build versus buy in a space like that. Not large transformational deals, hold-in, tuck-in opportunities that really supplement that. So I think there's, again, I feel very confident about our path.

Awesome. Great. Thanks a lot. I think we're out of time.

All right. Thank you.

[indiscernible]. Thank you.