Baxter International Inc (BAX) — Q4 2019 Earnings Call Transcript

Thanks, Katherine. Good morning, and welcome to our fourth quarter 2019 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer. On the call this morning, we will be discussing Baxter's fourth quarter and full-year 2019 financial results as well as growth comparisons to restated historical financial results as disclosed in today’s comprehensive 10-K filing. We will also provide our financial outlook for the first quarter of 2020. A supplemental presentation to complement this morning's discussion can be accessed on our website. This presentation, including related non-GAAP reconciliations, can be accessed on Baxter's external website in the Investors section under Events & News. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development, and regulatory matters, contain forward-looking statements that involve risks and uncertainties and, of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable US GAAP financial measures is included in our earnings release and available on our website. On the call this morning, we will be discussing operational sales growth, which for a historical period adjusts for the impact of foreign exchange and generic competition for cyclophosphamide in the U.S. Operational sales growth guidance for 2020 adjusts for the impact of foreign exchange and the acquisition of Seprafilm, which closed on February 14 of this year. Now, I'd like to turn the call over to Joe.

Good morning and thank you for joining us. Before Jay and I review the financials for the fourth quarter and full-year 2019, I want to update you on our internal investigation regarding non-operating income related to foreign exchange gains and losses. As you know, the company and the Board have taken this matter very seriously. We have moved to address it quickly and comprehensively with the help of independent experienced advisors and forensic accountants. We also communicated proactively to the SEC and have maintained open dialogue with the commission throughout.

Thanks, Joe, and good morning, everyone. As Joe mentioned, our fourth quarter results demonstrate robust operational performance with solid growth across all six global business units and three geographic segments. Throughout the year, we delivered on our goal of growth through innovation and drove further benefits from our ongoing transformation initiatives. Moving into 2020 and beyond, we will continue to execute on our commercial strategies, while also investing in several initiatives to support accelerated growth opportunities.

Good morning, guys. Thanks for taking the questions. First one is on your manufacturing site. You talked about in the script that you guys don't believe in the issues with the supplies. Can you sort of go into more detail around where the majority of your raw materials are coming from? What percent of those are sourced from China? And sort of why is that not a risk in terms of being able to offset from the other suppliers? I have a follow-up after that.

Yes. So just to refresh, I think this is a little hard for you to hear, Pito. So I think what you’re talking about is the overall manufacturing where we're at, where our raw materials are coming from, how confident we are in the supply chain. Is that kind of summarizing what you were asking?

Yes. Yes. And I apologize, on the cell phone, obviously.

Okay. Pito, good morning. Our raw materials come from a variety of places around the globe. Let me address your question regarding COVID-19 and our supply chain. Our electronics come primarily from parts of Europe and China. We're working diligently to get components out of China. We have good safety stocks and feel comfortable that towards late spring we will have enough stock for most of our products to be sold across the globe. I'm not that concerned. If things become really difficult in China, as they were in January or February, then the conversation would be different. But today, the shipping lanes are clearing up, and we're getting products into our factories, so I don't feel that we're under tremendous pressure now. Regarding IV bags, the products made in the U.S. are exclusively manufactured in the U.S., meaning the raw materials come from our plant in Arkansas. The bags are made in the Carolinas, and we can also produce bags down in Cuernavaca, Mexico. This backup plant has been set up since Hurricane Maria, and we are currently receiving products from there. Our supply chain consists of approximately 20 to 25 components and raw materials that we're monitoring closely. We have 24-hour coverage around the globe, and our procurement departments are set up in many parts of the world. So at this moment, we feel confident about our inventory levels and our ability to supply the demand.

Great. Then the follow-up question is going to be a non-COVID-19 question. Can you walk us through the manufacturing capabilities of THERANOVA at this point? How fast can that be expanded? Whether it's new lines of manufacturing sites? And how much would each of those cost, and how many units would those create? Thanks so much.

So, Pito, we have the ability to produce THERANOVA. We can currently manufacture mid-single digits in the millions. We are starting in October to convert production lines from our current REVACLEAR to THERANOVA, enabling the lines to produce either one of them. By the completion of the conversion, we expect to supply approximately 28 to 30 million units. This is, as we know today. We can always make investment plans for more capacity. We manufacture our own equipment, our spindles, and spinning equipment, and we bundle the fibers into very proprietary but high-quality products that we currently design and are not produced outside of the U.S. today. So that's our capacity. Furthermore, we are prepared, once the two-year demonstration period for the add-on payment passes, we can accelerate investment and produce more than 30 million units if necessary.

Great. Thanks so much.

Thank you.

Hi. Thanks for taking the question. I imagine everyone is very curious about what life will be like under COVID-19. You pulled the guidance, but we are almost completely through the first quarter here. So I was wondering if you could comment on trends you're seeing in the first quarter in terms of different positives and negatives in the business and any actions you're seeing from the hospitals in Europe and U.S. as they prepare for what's to come.

Robbie, let me address part of your question, and Jay is here as well to provide input. We are noticing buying patterns that are typically seen in these situations. We can compare this to severe flu seasons, like we remember from 2003. The buying patterns have shifted from uncertainty to widespread stockpiling. Baxter is actively involved in treating patients with acute respiratory and generalized infections, providing essential therapies, fluids, antibiotics, and equipment. Currently, the buying patterns are aligning more closely with the COVID-19 outbreak that we observed around the middle of the first quarter when China was more focused. We noticed an increase in purchasing for peritoneal dialysis products in China. We anticipate that the U.S. will also see higher orders from state governments and hospitals for stockpiling products. We're beginning to notice an uptick in order volumes. We are confident in our ability to supply the necessary products globally and activate our backup plans that have been in place since Hurricane Maria. The guidance for the quarter is challenging, as it was issued shortly before we concluded the quarter. The buying patterns we’re observing demonstrate the resilience of our business, as we provide products utilized in various environments, including home care, acute care, and long-term care, for both elective and emergency procedures. Jay, do you have any further insights?

Joe, I think that's a great commentary. You described the resiliency and durability of our portfolio. We have several product lines that benefit in this kind of scenario, such as acute IV and some of the antibiotics as Joe mentioned. We will watch our anesthesia and advanced surgery businesses closely, as they relate directly to procedures taking place in hospitals. Overall, this is a very durable portfolio that we have.

Great. And maybe just one follow-up. People are starting to worry about the impact on capital equipment sales. With you set to launch a new pump system that could experience high demand, do you expect any impact on that or your PD cyclers over the next few weeks and months? Thanks.

Very different dynamics, Robbie. First and foremost, hospitals today in the U.S. are prioritizing the treatment of potential patients. I don't believe we have dramatically altered their capital buying patterns mid-term, but in the short-term, there may be some shifts in priorities. We may still sell the pumps and provide products to customers impacted by the Class 1 recall of our competitor. However, the sequence may change as hospital priorities evolve. Remember, while we are sending service personnel to hospitals, we are unlikely to send numerous individuals to install pumps into hospitals right now. This may shift timelines slightly, but I don't expect capital buying patterns to change significantly in the mid to long-term. In terms of PD, it's a different conversation. PD allows for safer treatment environments, giving patients the chance to avoid crowded clinics filled with other very ill patients. The pandemic reinforces the government’s prerogative for home treatment. This situation adds a compelling case for the peritoneal dialysis modality.

Thanks a lot.

Thanks, Robbie.

Great. Thank you and good morning. I hope everybody is well. Two quick questions. From your commentary, it sounds like you have some products with increased demand, similar to what you see in a heavy flu season, while others have seen decreased demand. Can you tell me if this overall feels like a net neutral to your business as far as you can tell right now?

It's tough to say, Bob. That's the reason why we are not providing long-term guidance for 2020 because we need more clarity. The buying patterns are indeed strange. We're receiving orders for our CRT equipment that exceed anything we've seen before. We also have a healthy advanced surgery business. Nonetheless, the changes in hospital procedures may impact some of our business, especially anesthesia. Conversely, we have significant business in the ICU. It's challenging to determine definitively if the overall impact is neutral or not. We hope by late April, when we announce our first-quarter results, we can provide guidance for the rest of the year, or at least a clearer understanding of the current situation.

Okay. And then one quick follow-up. I'm curious about what you're seeing in China regarding the advanced surgery business. Are you noticing any return to stabilization in procedures in China at this point?

That's a very small business for us. On an annual basis, it's in the single-digit millions, making it difficult to comment on procedure volumes in China given its size. Our largest business in China is our renal business, which is different and doesn't represent what's happening in hospitals.

Okay. I was just trying to gauge trends in hospitals in China as they hopefully recover from the situation. Thank you.

Yes.

Good morning. Thanks for taking the questions. I have a couple for Jay. We didn't see segment guidance for the first quarter. I wonder if you could clarify if COVID has had a limited impact, as it seems more neutral thus far for Q1. Can you bridge us from the first quarter guidance of 5% to 6%? Clearly, the fourth quarter was very strong, and Q1 is anniversarying an easier comp. What should we consider as headwinds and tailwinds to think about the fundamental momentum deceleration in the first quarter? What businesses are stronger, which ones are weaker, or what dynamics change from fourth to first? This would be super helpful.

Sure. Overall, looking at the fourth quarter, as we've said in the past and David, you and I have discussed, we were very pleased with the performance across the portfolio. We observed strength in every geographic region and across the business portfolio, particularly in medication delivery. That fourth quarter was notable for a couple of one-time components. We saw some distributor buying related to our flu business and benefited from our advanced surgery business as we had roughly $50 million advantage when competitors were off the market. We also experienced some accounting adjustment true-ups at the end of the year, rounding up to about $10 million. Therefore, we don't see markedly different trends from Q4 to Q1. We anticipate a slight decrease in medication delivery due to its strength in Q4, but still expect a solid first quarter in that area. So no significant differences. The Q1 guide aligns well with what we've communicated previously. There were specific items that amplified the great performance in Q4, which won't be repeated in Q1 but are primarily responsible for that variance.

Okay. And then Jay, just a related question, both for the first quarter and for the year. EPS guidance for Q1 appears flat. Can you provide insight into the headwinds and tailwinds for Q1 '19 to Q1 '20, given the guidance is relatively flattish? Additionally, for 2020, will there be any revenue impact, positive or negative? Help us understand if there is a potential negative impact and how we should think about the spending activities happening within Baxter now to support customers. Thanks so much.

Sure. As it relates to Q1 year-over-year, you're right. In Q1 of 2019, we had roughly $0.75 in earnings per share, and our current guidance is $0.72 to $0.74. The primary driver is not related to operational performance; the leading factor is the difference in tax rate. Last year included a sizable FAS 123R benefit in the first quarter. Additionally, we recorded certain other income during this period, which is detailed in our restated financial tables. If we adjust for those items, we see about a $0.06 impact. Sales growth and a slight improvement in operating margin will contribute positively, yet these financial items offset performance. For the balance of the year, our top priority remains to fulfill our mission, saving and sustaining lives. This entails ensuring reliable product delivery to our customers. Some situations may require additional supply chain costs to maintain this continuity. We expect to invest in crucial raw materials from affected regions and so will incur extra expenditures to support our supply chain. While we'll work hard on enhancing cash flow, we must also be ready to carry increased inventory in the upcoming months for our critical products. This takes precedence over merely focusing on unnecessary cash flow performance this quarter. As the pandemic plays out, we will prioritize our customers while ensuring employee safety. These are some foundational comments.

Great. Thanks so much.

Hi. Thanks for taking the question. I wanted to clarify two points about your inventory and supply management currently. Are you starting to increase your inventory levels? It didn't appear so from your commentary. Regarding stockpiling, are you beginning to ration any product, or how are you managing your inventory to ensure adequate supply as the situation progresses?

I'll address the inventory question, and Joe can tackle the aspects regarding customer stockpiles. We are aiming to build inventory levels for critical products whenever feasible. In some instances, it's not possible because we are operating at full capacity. However, we're creatively considering where to locate inventory globally and maximizing our operating facilities to support that. We must be prepared for disruptions. This is our philosophy, and you'll see this reflected in our Q1 cash flow discussions. We are certainly willing to build extra inventory for the foreseeable future until the situation stabilizes. Joe, do you want to discuss customer stockpiling?

Absolutely. Matt, we limit excessive customer stockpiling because we want to prevent hospital systems in the U.S. from hoarding antibiotics and other supplies. We have a control tower approach to monitoring consumption, allowing us to ensure timely supply to everyone. We prevent customers from purchasing surplus inventory that they cannot store, as these items take up significant space. Our strategy is to manage our inventory responsibly and handle our stockpiling internally. Bob Reed, who oversees our operations and supply chain, is being conscientious about our product allocation. We are initiating backup production lines; for instance, we started a production line in Mexico specifically for producing millions of bags for the U.S. We ensure that we have adequate supplies while also avoiding over-allocation. Our focus is on making sure that all critical customers receive what they need without excessive hoarding. We are also cautious about CRT machine orders. We see countries placing large orders for hundreds of these machines, but this raises the question of the necessity for such numbers when they have fewer hospital beds. We are increasing production of CRT machines and ensuring suppliers can meet lead times.

Thanks, guys. Maybe I could just ask one follow-up. I appreciate all the comments on your mission, which is crucial right now. The European situation appears fluid. You commented a bit on China, and it's notable that things have returned to normal there, which is encouraging. I'm wondering if you could provide some insights into your operations in Italy or other European nations where infections are rising and what those trends might mean for the U.S.?

First, we can't take China's situation for granted as their relative isolation has played a role there. I recently read a paper from the Imperial College in London on how the communicable nature of the disease can spread again. We are cautious about developments. Regarding our plant operations in Italy, we have provided employees with special letters for when they travel to work, as our manufacturing occurs in Lombardy. We have three plants operating there for producing fluids and other equipment, ensuring our staffing remains intact. To date, we have experienced minimal disruption, and the border crossings for our supplies are functioning well. So far, we are managing through the challenges posed by the pandemic. In addition to Italy, we have operations in Spain, primarily serving the local and southern European markets, and we also manufacture in England. All these plants are operating fairly normally, which may not seem normal considering the global situation, but our team's commitment is notable as they continue to report for duty every day.

Thanks a lot.

You're welcome.

Katherine, we have time for one more question.

Good morning, guys. Thanks so much for taking the question. I hope everyone's staying healthy during these crazy times. Just a quick question related to the non-COVID-19 aspect of your business. On medication delivery, you showed very strong operational sales growth in Q4. Obviously, that won't likely continue. Can you help us understand how sustainable any momentum in the medication delivery space might be in 2020 and beyond, and the different drivers contributing to this strong growth we saw in the latter half of the year?

Danielle, here’s some additional context about our business. We have transformed the sales and marketing organization in the U.S. and successfully sold more pumps. This progression didn't happen overnight; we achieved the success of Q4 through months of preparation involving account management and successful bids. So I would say that the pumps performed admirably in the fourth quarter due to prior planning. We're following a similar strategy into 2020 as we believe we have an established pump platform. Also, once the FDA approves our current new pump platform, we anticipate being able to perform as well or better with a more comprehensive product range. We experienced good fluid sales in Q4, with some anticipation related to flu season. Overall, I believe this business displays considerable resilience and should continue benefiting from a new platform and solid pump performance moving forward. However, will it be easy? No, but we have secured long-term contracts and a reliable pump platform, which should lead us to continued performance.

Yes, and Danielle, just to add to that, we appreciated the unique set of circumstances that allowed us to guide to 6% growth in 2019, which has made 7% growth significant. We were thrilled to exceed that number due to strong teamwork. However, we must acknowledge that 2019 was an anomaly. We anticipate a decrease in growth rates to more closely align with long-term expectations for this business. Nevertheless, we remain enthusiastic about our trajectory.

Okay. I have one more quick follow-up regarding the generic injectables business. How dependent is the growth of that segment on upcoming new product launches? Given that there are concerns about potential slowdowns at the FDA, do you feel the current portfolio can sustain growth there, or is there a significant dependency on future launches?

Regarding the FDA, we expect potential delays in the approval process due to the current remote work environment. Surprisingly, we received the approval for our PrisMax2 ahead of schedule, with some hardware modifications and enhancements like true view analytics integrated into the software. So, we were happy to see that progress. We recently filed for another molecule sooner than anticipated with the FDA. While we can't control the FDA's timeline, we should prepare for delays. We will keep you informed as we gain better insights. Overall, we have experienced timely approvals in the past, but the status of the approvals may vary based on how the current environment unfolds. Thank you so much.

Thanks, Danielle.

Thanks. Good morning, everyone. Jay, you talked in your prepared comments regarding the cash situation of the company, the drawdown on the European revolver, and comments around the U.S. revolver. Could you elaborate on how you're approaching capital allocation priorities considering the current stock performance and asset valuations? Any insights on that would be appreciated.

Yes. Thanks, Larry. We must be prepared for unforeseen situations, specifically the coronavirus. Accordingly, we've been very strategic about ensuring sufficient capital availability. The cash position is critical right now, and we actively manage our balance sheet. In Q1, we borrowed around $200 million on our European revolver, which we sometimes utilize. Currently, we have approximately $3 billion in cash and just successfully refinanced a U.S. revolver with a $200 million same-day withdrawal feature and additional modern provisions. Our aim has been to ensure continuity in our operations. As the coronavirus impacts the economy, our focus revolves around maintaining liquidity. That said, we also observe many potential opportunities for acquisition as asset prices decline. We executed a recent transaction with Seprafilm and are now considering the implications of potential valuation adjustments. We wouldn't discount the attractiveness of our stock pricing in the current market.

Yes. First, we must ensure that we have liquidity, and we have an abundance of it. We are prepared for whatever comes our way. Furthermore, we previously hesitated on talking about major or mid-sized acquisitions due to inflated prices. It seems time may be on our side now, and having sufficient capital on hand could provide opportunities in the M&A landscape.

Okay.

Katherine, we have time for one more question.

Hey, thanks, guys. Quick question regarding guidance, Jay. You mentioned margins for Q1, and I think I heard you say a slight expansion. Maybe, can you clarify if there are incremental investments happening for Q1 that may affect free cash conversions? Given the restated figures are in the 80s, is that the new normal? Should we expect that cash conversion to step back to 90s? Thanks, guys.

So, Vijay, there are indeed some factors impacting investments in the first quarter, relating to supply chain costs and other operational activities. However, this is a fluid situation that we monitor. Despite being rigorous about our spending, supporting consistent product delivery to our patients is paramount. We strive to enhance cash flow performance; the figure you mentioned is not a new normal. We've engaged a new chief procurement officer, focusing on our vendor base while restructuring payment terms and optimizing our supply chain forecasting, which will yield positive results. Nevertheless, our primary focus now is ensuring sufficient product supply to our customers. As the pandemic situation unfolds, our spending flexibility will guide our actions. Expect updates when we report Q1 results. Thank you for your question, Vijay.

Thank you.

Thank you all, and please stay safe and protect your health. We wish you all well. Thank you.