Baxter International Inc. ($BAX)

Good morning, everyone. Very pleased to welcome the management team from Baxter, Andrew Hider, President and Chief Executive Officer; and Kevin Moran, Head of Investor Relations. Kevin, I know you wanted to make some obligatory comments. So I'll turn it to you, and then we'll jump in.

Thank you and I appreciate you having us here today. Just a reminder, we will be making forward-looking statements that are subject to risks and uncertainties. For more information, please check out our website or our SEC filings. Thank you. Back to you, David.

Well, hopefully, that means we will get something good out of you because this is webcast, and you are offering the forward-looking statement disclosure. So I guess you can say whatever you want and change your mind tomorrow.

I can...

Well, maybe we could just jump in. And Andrew, you've been in the CEO seat coming up on 9 months, I think. Maybe just give us some of your reflections in the role, what have you been excited about? What's been disappointing to you as you thought about your expectations coming into the role? And where do you go from here?

Yes. So good morning, everyone. Look, first off, that's a 3-part question. So I'll try to get all 3 parts correct. But if you do a step back I took this job with the excitement around the potential with Baxter. And I'll tell you that, that was vetted and I've known this business for decades. And I was able to do a bit of diligence before even entertaining the offer around where Baxter sits with health care providers. I will just say it's a strong brand position and it's a strong trust position with our customers. And so when I came on it was around how do we get Baxter back on track for execution. I'd like to say, say-do ratio. I'm a pretty simple guy. When it comes to execution, it's, do you say what you're going to do and do you deliver what you say. And the other piece is we've had a real focus around how to enable that execution with also the rich history that comes with Baxter. And I'd like to say we're almost 100 years old. Yet we've got the refreshed view of how we think about the future. And with 100 years comes a lot of complexity in how to minimize that. The last piece of this equation around what I was faced with is our view or where we sit with capital allocation and leverage. And so I'm going to fast forward to -- we launched our 3-point plan around stabilizing the business, around delevering the balance sheet and around driving continuous improvement. And to know me, you know that I'm not a light believer in this. I'm a huge believer, I've been part of GE for 6 years, Danaher for 10, ran a private company, then I took over ATS Corp. for almost 9 years. it works. If you can focus on it, so if you can identify the key metrics, and you can enable the key metrics, you can improve the key metrics. And so we started our journey. And the proof points along the way, we launched Baxter GPS within, I would say, within 6 weeks of me being on board, that's growth and performance system. We've gone to a decentralized model. So as a CEO, I don't like secret decoder ring. I want to know if we're winning and losing in 3 seconds, and we have 8 value creators, not 7, not 10, 8, revenue, margin, free cash flow, ROIC, top 4 financial, 2 are wrapped around customer, on-time delivery and quality. Because when I talk to our customers, and I do frequently as a CEO, they tell me if you deliver me my product on time, higher level of quality, I want to buy more of it and people, hire from within to our internal fill rate and turnover, track, retain, development. And so we've gone decentralized. We've launched our Baxter GPS. We very quickly took the dividend away. And the reason we did was we had stated in 2025 would be under 3x, quickly realized that, that's not going to be the case, and we took the critical decision around how do we make sure that, that is a top priority because Capital allocation is aligned with long-term shareholder value creation. And so we will take action to drive impact. And we now have aligned the business around continuous improvement. So fast forward now where do we sit today? And I'm almost 10 months on the job. I visited, I don't know, probably 60-plus percent of our locations. I visited many of our customers. And what I can tell you, it's starting to take shape. In Q1, we did over 200 continuous improvement events, over 200. And I'll tell you proof point is when I go on site, and I see the leaders driving the behavior around red or green, not pink, purple or yellow, red or green. So we know where we're winning and we know where we need to focus and then driving Kaizen to get back on track, really that constant drive to always get better. And I'm seeing more and more proof points. We've stated the target this year around our leverage and being approximately 3x by the year-end because that enables us to then utilize other avenues for capital allocation. And if you join my leadership team, you get 2 books. One is The Outsiders. The reason why you get that book is I want you to know how we think about capital allocation and how we think about operating the business. The other one is Extreme Ownership, no excuses leadership. So now the path forward, what you're going to see is our drive to always get better. And it stems with the path to a high say-do ratio and getting our leveraging endpoint where we can invest at a higher level internally and start the discussion externally. But it's rooted through execution. And so we're making progress. I would say I was pleased with Q1, not happy. But we're making progress in the direction. And it's about that constant drive to always get better. And I'm just going to say one other item before I turn it over, and I know I'm a little bit long-winded, but it's for a reason. I was recently at 1 of our facilities. Where I was walking around with a senior supervisor and the gentleman was about at his retirement, and he was walking through with me and he's thanking me for bringing GPS. And if you don't know this, continuous improvement is everyone, not Andrew Hider, it's everyone within the organization. But the reason why he was thanking me, he said, Andrew, I have been telling my supervisor for the last 10 years. If we just focus on this improvement, we can make a much greater impact on the output. And he said, "I'm about to retire, and I finally had a shot to drive that continuous improvement to make the impact and to see the outcome. " They said, you gave us an environment where if we fail, we just went back to what we did before, but we could improve that, and we did. And now we can turn it over for the next person to have a better experience on their operation. And it's that mindset that drive on the culture aspect that is going to propel us forward. And so continuous improvement never stops, and we're just started in that journey.

So you gave me a long answer, and I asked a long question, but the -- maybe dive into some of the details here. Sort of about stabilizing the business. You're talking about flat growth or approximately flat growth this year. What has stabilized the business mean? And can you -- when do you get the company growing again?

Yes. So we recommitted for the year. And what we've said is the markets that we're in today are low single digits, and we would expect to start to see that. We're lapping a lot of areas this year. And we would start to see that as we go into next year. It's very early. So the path to '27, and I'm not going to give any more -- I'm not going to give any guidance on '27, is through '26 as we go in the latter half of the year, it's about executing and getting us ready to perform in '27.

And have some of the kind of end market headwinds that negatively impacted performance last year, where are we in the IV utilization cycle? Maybe we'll start with that one and then go to a couple of the others.

Yes. So this is one, and I would say this is a bit of a -- we had to drill and dive deep into the IV conservation discussion. And to give the short answer to a longer question, we originally thought because we've had experience with challenges like this in the past, that IV is going to just come back. And what I can tell you is through 3 avenues, our internal assessment an external source, so an external group and my own diligence with customers, this is the new norm. And we'll see that kind of flush out this year, so it will be more stable. And as we go into future years, we would expect this to be normal course operation, which is low single-digit growth. But we had to do a lot of assessment around this, and then we've rightsized the business because once we then identify that this is the new norm, we took the action on the organization to rightsize it for where it sits. And we've done all that work, and so we should start to see that get back in line. .

Okay. And so sort of at the new normal, meaning hospital behavior has changed. It's changed for good, but that change is now it's in the rearview mirror fully? Or you still need to go through this year to you think, to bottom out trend?

Well, obviously, we're going to lap some areas. So Q1 is a bit of a lap time. And I would say, latter half of the year is when we should start to see that come back. We took the action. So our inventory roll will start to take shape latter half of the year as well. And so again, as we exit the year, it should be on a more normal course as we look at that business specifically.

And then maybe sort of the other business that does stick out is the injectables and anesthesia franchise. What what's happening there put simplistically? And what's the path to turning it around? .

So a couple of items on that. First, when we looked at our Pharma business, it also has some of the same dynamics as the ITT business. So the fluid conservation also happened in that area. And so not only did we have to take the same actions around view of the business, we then looked at it and said, there's a lot of synergies with those 2 businesses, and we have combined them. So we've now put that -- because it's the same buying behavior, same logo, same area. So we've combined those businesses to drive a greater impact. And so we've now restructured around how we're going to execute for the commercial portion of the business. That said, there's also a couple of internal dynamics. One, and I talked about this on the call, we had an operational site that was challenged. And it's been a challenge for a while, ups and downs on performance. Well, we put a team in to drive impact. And I'll say early signs, and I was there 2 weeks ago, we've seen nice turnaround. Now 1 quarter, 1 month isn't a long-term view, but it's moving in the right direction. And not only that, they're seeing the strongest performance in a while. And so now it's about how they sustain that impact and continue to drive Kaizen after Kaizen. So we're pleased with the progress on our internal. We have had a challenge on an external and it's a contract manufacturer. We're working, we're on site I've held calls with them. And we are working on not only the direct course on this, but then what do we want to think about this long term to make sure it's not a challenge for the future. And I can't get into too much detail beyond that, but it is something that's an absolute key focus for us.

And on the injectable portfolio specifically, that's a interesting business. It's pretty good margin, very good margin. But it's also kind of a hamster wheel from a product launch perspective is that you have to have continuous product launches to stave off natural price decline in a generic market. And when you look at your primary competitor, Kabi, I feel like every day I'm reading about it like an FDA approval. So how do you get the engine going? I know a Ahmedabad isn't probably the answer given some of the quality issues there. Like how do you get that engine going.

A couple of things. First, it's now approval, so Ahmedabad, is a new option for us as we expand, which we're very pleased with that. It took us took us a long time to get there. And now we're pleased that we can put new product into that facility. The other piece is, it's around how we view our investment to launch. And just to give you some insight around how we think about innovation, enabling our future. If you look at the 5 points of capital allocation, internal investment generally is one of the higher returns for shareholders over a long period of time. So we have not shortened that area. We've kept our investment high there even while we're going through these other areas to drive our leverage down. This portion of our business with every other area they're doing quarterly business reviews with me to make sure they drive and launch new solutions. And I would say we lost our track a little bit. The team is very focused on how they're launching new products in this space and what that means. And so what I can tell you is laser-focused on execution and how we drive higher R&D and lower sustaining on our launch cadence.

And how about the anesthesia side of the business? I know that that's a franchise that faces some of its competition, some of it is the shift in modality of anesthesia. Where are we in that kind of transition in that franchise? And can that business get back to growth?

Yes. So inhaled anesthesia is a challenging market and challenging space. And we look at our -- look, we laid the business out in 3 categories. There's the invest and growth which we expect high return from that invest and grow, there's sustained and I would say, like our ITT business is in this sustained area around how do we sustain that share position? How do we drive free cash flow in that area? How do we have strong ROIC on our investment and then there's a bit around the fix. And I would say our inhaled anesthesia, we're in that fixed category. It's a challenged market, challenged space. We're doing the necessary areas of focus, but it does take time as far as how do we look at that longer term. And I would say for right now, it's in the fixed category, and it's focused on how to out execute and outperform in the space, but we've got some work to do.

And then maybe I'll close on compounding before going to the HST business. Compounding has been sort of a consistent standout performer for you. We can talk about the P&L implications later. But what's driving the sustained growth in compounding? How much of that is volume versus price? And how do you think about where are you in capacity? And put another way, how do you keep growing this business?

Yes. So rough area, and I'm going to do rougher. So this market grows mid-single-digit-ish. And obviously, with our performance, we've been outpacing that, largely driven by Australia, New Zealand, U.K. And we have a unique position in this space. And I would say our team has been laser-focused on how do we bring the value for our customers, make it easy to do business with our business and we've been able to realize that within the growth and within the space. And so a lot of it's around execution, and we've seen that. Now this business growth has been good. Free cash flow is good in this area. ROIC is generally good. Margin is the discussion and making sure that we're constantly looking at how do we drive this as profitable growth. And I'd say that's where you're going to see us focusing on more and more over time because the market is there. It's our ability and customers are leaning into Baxter providing a solution that helps them in their ability to provide care, but we need to also make sure it's margin. We're looking at the margin as we're looking at growth in the market in the space.

And is the margin of that business has been going up or down?

So I would say it's getting better, but it's not at the pace that we would expect.

Is it profitable?

Oh, yes.

If I said high single-digit operating margin, would I be wrong?

I would say it's profitable, and that's a great way to put it, and it's a higher growth area of our business.

All right. All right. I'll reach back into my memory bank. Maybe just going on HST. Obviously, business has seen a lot of volatility, but it's also kind of an interesting one because you've got a lot of other things masked in there like you have the Bardy franchise, for example, which is a high-growth area. You have some other pieces of the puzzle that are smaller in revenue, but much higher in growth. Like how do you think about sustaining? We all think about beds, right, fine. That's a big business. How do you think about just like the growth algorithm in that business and then being able to put enough dollars into the higher-growth areas to such that they can move the needle.

I love that you're calling out some of the areas, of course, that we do internally as well. And I would say similar to how we think about the broader Baxter, we put those businesses in the same view. There's going to be invest and grow, sustain and fix. And we actually announced this on the call last quarter is within our Front Line Care business, we did some SKU rationalization. And there were some SKUs that guess what, we weren't making money on. We had launched new product solutions that you should shift to, yet we were still offering the product. And so we're going through the cleanup phase on that. We're not in the business to lose money, and therefore, we want to make sure if we have option B as a better option for the patient, for the customer, and we should be shifting there, we're going to help our customers shift there. The second piece of that is also shifting to investment around the growth and enablement of growth. And you talked about Bardy, I have been on site. It's a great product set. It's cardiac monitoring. We're excited about this product. There's optionality for how we're thinking about new product launches in this area. We have a strong product set with strong data for the customers, for the patients. We're excited about that space. And there's many more in that camp. Oh, by the way, also in our bed business and not to drive into this one as well, but we've just launched our new stretcher platform. And we did that in a very fast pace with Dynamo with a significant customer engagement. And I'll tell you, when you speak to customers around it, the demand has been very high. Because they had engagement in the design process to enable and meet what their needs are. And so look, there's excitement. And then the last one, I'll just walk through and I would say we've got pieces of the puzzle and we're laying this out is the connected care piece. And simple numbers, right, the average hospital, 300 beds, every patient has many, many areas for data collection. We have a strong position and it's -- if you take the 6,000 [Technical Difficulty] in U.S., there's a significant opportunity for helping with workflow as customers are looking to maximize their patient care and minimize any challenge with the ability to support that. We're still working on connecting those dots and really enabling the data to impact to how we're going to monetize and how we're going to make sure our customers feel the impact as well as we see the revenue stream. And there is a strong potential around that.

So as I kind of put the top line outlook together, I want to talk a little bit about the P&L and capital allocation further. It sounds like saying end markets grow, call it low single digits, maybe that's 2% to 3% or something like that. This year is kind of a year of stabilization for the company, growth would be below that 2% to 3% level as you kind of work through some of the dynamics that I think have been very well telegraphed, but you see a path back to market growth next year. Okay.

That's fair enough.

All right. Very helpful. Maybe we turn over to the P&L. One of the conversations I have with investors a lot, and it's sort of -- it's hard to reconcile sometimes if you even just look at like the gross margin. Gross margin is below where company total was before the separation with Vantive and we've all seen the Vantive P&L. So we know where that sat relative to total Baxter. So can you just help us think about where we are specifically on the gross margin? And where that -- can you get back to, call it, I don't know, 40% by the end of the year?

Maybe I'll take that one. I certainly acknowledge some of the headwinds we've had at the gross margin line. And I think the Vantive divestiture and the TSA arrangements have added a lot of noise to that with the activity in COGS and getting TSA income below gross margin. We're lapping some of that. And obviously, TSA are going to roll off going forward. And so hopefully, we'll have a much cleaner view of what's going on. We've been pretty transparent about some of the headwinds that we face. In Q1, we talked about the prior year comparison, the reclass from SG&A to COGS. We've talked about tariffs now for a couple of quarters, and we'll begin to lap that as we go into the second half of the year. . And then finally, we've talked about higher manufacturing costs and including absorption. And again, we're going to cycle through a lot of that in the first half of the year. We gave an operating margin bridge this last quarter from first half to second half. Many of those drivers are relevant at the gross margin line. So if you just take big round numbers, we've reported 11% in Q1. We said similar earnings in Q2, so call it, 11% first half midpoint of our full year guidance, that's over 500 basis points of expansion first half to second half. About half of that is attributable to volume and getting the appropriate level of leverage with that. Said a different way, we are not expecting a Herculean ramp in volume think consistent historical levels of volume. Second, cycling through that higher cost inventory. Andrew talked about the cost actions we took to rightsize our support footprint. We expect to have that behind us as we go into the second half of the year. And then finally, not gross margin, but the third piece to the operating model walk is realizing the benefits from those cost structure actions that we took earlier in the year. So I haven't provided explicit gross margin guidance for the year, but if you take our operating margin guidance and kind of work your way up, the back half is definitely in the ZIP code of the number you referenced.

Okay. And maybe just one of the -- I had a conversation with someone yesterday kind of walking through the accounting around manufacturing variances. It's sort of like you had to pay the bill twice in the first half of the year. So you have -- remind me i think it's $75 million of capitalized variances that hit the P&L in the first half of the year?

The difference between first half, second half.

Yes, the different.

Yes. So we had about $20 million in Q1. You would expect the difference in Q2. So call it north of $50 million. And then...

And then you have flat operating margin despite higher volume Q1 to Q2.

Correct. We didn't -- we said similar earnings in Q2. So if you assume incremental volumes on similar earnings, that would actually be slightly dilutive, but I would consider it similar to be appropriate.

So as we look at the back half of the year, is that a good picture of, I don't know, kind of like a normalized P&L jumping off point, meaning there's -- you have the higher manufacturing costs are in the base, the variance have been having cap -- have been recognized. Is that a good starting point like what the business looks like.

Without providing guidance for '27, I would say there's a significantly better view of underlying earnings power, and we have cycled through many of the headwinds that have plagued us in '26.

Yes, I won't be doing my job if I don't keep pushing. But you talked about the $0.14 of headwind on TSA next year. Can you grow earnings. Can you overcome that?

Yes. So we've said what we said the path to '27 is through '26. And I want to be very clear. We're not going to share it anymore. I mean we're confident. We reiterated '26 on the first call the year. Our path to getting there is through driving execution. And we got to earn that right. We've got to deliver for our shareholders and we get to show what the business can do. And so by doing that, puts us in a much better position as we go into future years. And I would say, we're laser-focused on that. The team is committed, and we're driving the right level of engagement and discussions in the organization. And oh, by the way, we've also said we want to get to approximately 3x, which puts us in a unique position as we are to talk about capital allocation into next year. And that's going to give us the ability to look at different levers for the future. But the path to '27 is through '26 and its execution.

And just to build on that, with respect to TSAs. So we've sized what we expect TSA income to be in 2026, $130 million to $140 million. I would say, think about that in 2 buckets. There's a piece of that, that as soon as the activity stops, we can very quickly stop incurring the cost. So think about direct freight on product or a direct head count that supports it. So that can come out very quickly. The other portion relates to kind of more shared costs to think IT. That takes a little bit more time to pull out. But I would just leave you with we have known about TSAs expiring now, it will be over 2 years when we get there. And so this is not a surprise. We have taken actions. We've talked about the actions we took earlier in January to right size our cost support footprint and other actions. Part of this is chipping away at what we know is coming in '27.

Okay. Very helpful. Maybe I want to come on the capital allocation side. But before we touched on that, one of the things you talked about was the cost actions that the company has taken. The company has taken a lot of cost actions over many years and multiple kind of changes in reporting structure, vertical matrix, decentralized. How do you keep people engaged and make sure you have the right people to invest for growth and execute. You talked about the path to '27 is through '26. I mean how do you ensure -- for lack of a better word, keep things together, and drive that performance?

Yes. So culture is squishy. But you kind of know it when you see it. And I would say I travel a lot around seeing firsthand, how our leaders show up. And you get a sense of that, and I'm just going to point out last week, I was in Monterrey, I highlighted them because of they did a Kaizen event. It was an incredible Kaizen event. I actually -- with Baxter, I'm doing our GPS wins and it talks about different Kaizen events and the impact. And I use that as an example because here is a facility that the turnover was very high in the past. And when I say very high, it was like 30-plus percent they're going down to 10-ish percent in turnover. That is a massive improvement. It starts with leadership engagement. It starts with a high say-do ratio and driving from the front. They're not all green. And if they were all green, that would be a problem for somebody setting the bar high enough and I expect my leaders to stretch their business. And so they were 70% green, they were 30% red. And it's okay to be red, but it's not okay to be red and not do something about it. And so here I am on site, and this team, they're red at 30% of their metrics. And oh, by the way, you know my critical 8. But the power is, not only have they're red, they're driving countermeasures. They're looking short term, they're looking long term. They're doing Kaizen event as they have their Kaizen event. They get back on track for their stretch targets. That is a team now when I leave I know they're moving in the right direction. The engagement is higher, the turnover is lower, and they're driving the right behaviors around their businesses. And so when I think about the future of Baxter, and by the way, we're going to be a decentralized business. I view that as the winning strategy around how we execute because then GPS is part of who we are and how we operate. And the next question everyone is going to ask me is, "Oh, Andrew, is it done? Is that turnover? " No. Everyone says they want to do continuous improvement until they have to do continuous improvement. And so for a person like me, there are leaders that they step up every year, and they say, I want to set the bar even higher. And then those leaders that don't. But we know where we're going to gravitate to and is that constant drive to always get better. And so I'm going to look at our leadership team over time to always get better and set that tone at every site, every location, every business unit to outpace, outdrive and out impact. That's the future of where we're going at Baxter.

Excellent. And that's a good kind of segue to kind of the final thing I want to ask. You made a couple of references to capital allocation in 2027. I know some of that's mathematical around where your leverage ratio is. But what are you signaling, How do you want people to interpret those comments? You've referenced the dividend? What's next?

So a couple of items. Free cash flow is critical to this. Q1 -- And by the way, we all know free cash inventory management, all that. We're getting better. I would say we're not perfect yet. We need to constantly get better and drive this as an enabler. It's 1 of our 8 value creators. It's a focus. We look at every business, every site, every organization around this. Number two, once you get under 3, then we look at what's the value creation long term for shareholders. So there's 5 points. We all know them but let me just walk through them. There's internal investment. There's debt repayment, there's dividend, there's share buybacks and then there's M&A, 5. We now have had to limit many of those because we had to get under 3x. And if you know this, you know when I came on, we thought we'd do it in '25. We had to push that to '26 and that's why we took the critical action around the dividend. Once we open that up, then we're going to look at what is that value creation, long-term value creation for shareholders. And that's when we start to really deploy it both internally and externally. And I would say we're starting to cultivate potential M&A. No, I'm not saying that's a conclusion. I'm just saying to be in the space, you want to cultivate and you want to start to build out your capability to understand because when you join the future of Baxter, it's like you're joining a train going to Chicago. And this is the last stop. But when you're on this, GPS is the North Star, and we're going to drive the critical elements of how we execute the business to outperform in the markets. And so we're starting to set that tone but it's early. And what excites me about that is once you get that internally, you're investing in areas that you can drive, and it's more R&D versus sustainment. And by the way, we're doing quarterly business reviews around that. Every R&D leader has to go through that on how we think about that. And then future for tuck-ins, how we think about that strategic area of technology and capability with the Baxter brand and the Baxter penetration. So it brings value for our customers drives impact for their market and allows us to drive continuous improvement on the new potential.

I got one more in here in the 15 seconds we have. Would you be buying back stock now if you could? And where do share buybacks rank in that priority scheme?

We're at time, what I can tell you is we don't look at -- I don't think it's an or discussion, I think it's an and. You can do Internal investment, you can do M&A and you can do buybacks, and we're going to look at those as where we trade to make sure that we're constantly looking at the greatest value over time. Because one can be short term and one can be long term. And I don't think it's an or discussion. Thank you so much. I appreciate the time. It's great seeing everyone.

Thank you, everybody. Thank you, Andrew. Thank you, Kevin.