I think the other part of it that was really interesting to me is just the opportunities that we have here at Baxter. I think, you know, I came from an industry that had large complexity that had a 4% operating margin on a good day. And you either operated or executed, or you didn't make it in that industry. And I think one of the things that I see as some of the opportunities at Baxter is to continue driving some real operational excellence, continue driving really rigorously around things like cash flows, working capital management, some of the things that are just, again, kind of some of the blocking and tackling that I think we can do a continuously better job of. And then you translate that into investments for growth. I think there's, again, there's the opportunity at this company to continue to accelerate growth through innovation.
So I think when you kind of couple all that together, the ability, and the ability to make an impact, those are some of the things that were really, really interesting to me. And then that's all played out just the way I guess I expected it to since I've been here.
Okay. And maybe we could talk about strategy here, and then we'll go into some of the business and financial performance in a second. But Baxter's been through a number of evolutions in its strategy over the past 10 or 15 years. We had both acquisitions and spinoffs and sort of reconstructing the portfolio. From where we sit today, how would you kind of characterize Baxter's key strategic priorities over, call it, the next 3-5 years?
Yeah. I mean, I think what I'd start with a little bit is what are we today? And then, you know, I think Baxter is a company, you know, clearly that has an incredibly important place in the industry. There's really, I'll call it medically very necessary products in this space. It's a very global, very diversified product portfolio. We're going to have a presence in over 100 countries. We serve 350 million patients in any given year. And so there's a tremendous amount of real breadth and depth to the business that Baxter has. You know, I think it also, you know, with the acquisition of Hillrom, I would say what was, you think of as a legacy Baxter, really transitioned into a space where we now have more access into the digital space, into the connected care space.
And then obviously the other part of it that's really been strategic for the company is some of the really key transitions and transformational work that's happened. You know, I think about the sale of BPS. I think about the verticalization of the business, which, by the way, is something else I really loved about the company when I got here. I think this idea that people have an ending, and we have leaders that have an end-to-end view of the businesses. So that's been an important strategic initiative. And then obviously the kidney transformation, the kidney separation. And so I'd say today we're heading down, again, a really strong path of being able to essentially, again, transform and reset the business a bit. And then I think we'll have the opportunity to really head into a future that has a lot of innovation associated with it.
And so now, as I think about where are we moving forward, I think, you know, certainly more to come as a part of some type of a capital markets day or something we'll go to the market with. But I think, you know, as the medical industry continues to evolve and change, this idea of servicing, providing, servicing the needs of our customers and the patients in a really ever-changing, evolving space. They have lack of staffing. There's all kinds of different issues that they have that is something that I think we feel a strong ability to be a part of. The ability to innovate. Again, you think about some of the products, obviously starting with Novum, but also products across our other businesses in the pharmaceutical space, also in HST.
And so I think the future is one of that is going to involve a set of, again, innovations from Baxter. And then also, then driving, and then execution is going to be an important part of this. I think we think about driving shareholder value. It's accelerating our growth. It's expanding margins. It's 80% free cash flow conversion. It's the things that actually going to allow us to then make those types of investments both organically, inorganically, and then through R&D. So I think that's just maybe at a summary level what I would say is where we are today, where we're headed in the future.
Let's talk about kidney care for a second. Can you maybe help us think through just the decision tree and key considerations around spin versus sale? Because as I look at them, they appear to be sort of diametrically opposed outcomes from a strategic and financial outcome for the companies. Maybe just talk through like what are the things that are going to go into your decision-making process and how should we kind of think about those considerations?
Yeah. So I'd say a couple of things. Number one, strategically, the separation itself is certainly an important aspect of this. We can go into that a little more later if you'd like in terms of just the, but the idea that actually allows for capital allocation in both businesses for Baxter, for strategic focus, for simplicity, et cetera, et cetera. So I think there's a, for the separation itself, that rationale I think is fairly consistent. The difference I would say between the two, I mean, number one, obviously there's a valuation aspect of this in terms of what that might look like in public markets, what it might look like in a sale transaction. Obviously from a sales transaction standpoint, you know, again, let's assume valuations are at relatively equal values. You do get more cash upfront.
There's an ability to deliver more quickly, to put ourselves in a position from a balance sheet standpoint where we're able to move to a capital allocation of further investment as opposed to more debt pay down focused. There's also sort of valuation certainty, I'd say, around a sale that is different than maybe in the public market. So I guess those are some of the things we're certainly contemplating. The thing I would just emphasize is the most, I guess the most key point really is that we're going to do what's best for our shareholders. And so whatever that decision is, whatever it comes to, you can be sure that's where, and all else that's where we're going to end up.
And in terms of that assessment, is that in a lot of ways just a time value of money question? Because I appreciate the common valuations being equal. It's hard to imagine a scenario where if you're going to get the cash upfront, that would be the same absolute dollar value as what you might be able to achieve in a spin, but, you know, bird in the hand is worth two in the bush type thing. Like is it a time value of money or NPV question? Like how do you define the creation of shareholder value metric?
I think it is that, but then again, I also go back to the point on uncertainty of valuation. Because again, I think the, you know, obviously in a spin scenario, we would have a retained stake. We wouldn't necessarily look at that in and of itself as a delivering event. I think what we've said is, you know, that would, we'd look at putting debt on that new company and in somewhat of the same range that we would have today. In other words, we're not loading up that company with debt. And so I think the deleveraging would happen over time in a spin scenario and again, and with some less certainty of valuation. And so I think those are some of the things that are really just the ways to think about this.
I appreciate kind of wanting to put good parameters around the timing. But as you think about the opportunities in the kidney business, it looks like there's a lot of margin expansion potential here. I appreciate Q1 might have been overstated because of the Opelika dynamic, but at the same time as you exit some of these lower margin or potentially negative margin businesses in HD, acute, and USPD and other higher margin businesses become a bigger percentage of total, like the value you could potentially accrue from a sale could be higher if you saw that margin expansion. So maybe like why put the, this has got to be done by the end of the year timeline out there, sort of drawing that proverbial line in the sand? What does that accomplish?
Yeah. I mean, I think first of all, again, we've committed to doing that. And I think from a timing standpoint, obviously it's important for our balance sheet, number one, from the ultimately deleveraging standpoint and again, our ability to move forward. But I think just as again, a reminder, and again, I said this a second ago, but just elaborate on it a bit. The strategic rationale, though, number one, the kidney business, and yes, Q1 was a bit of an anomaly, I'll call it from a margin perspective. But even within our portfolio, that business is certainly, again, the lowest margin business. It's the opportunity, when I think again about capital allocation for ourselves, it's capital intensive. When I think about higher versus lower ROIC projects, the prioritization of that.
And again, I think the simplicity, again, allowing for strategic focus and clarity, allowing for simplicity in the business. Again, there's, you know, in a post-spin world, most of our manufacturing businesses are very cleanly lined up with our business segments. And I think that there's an element to that that actually allows for, there's a lot of benefits out of that for us. And so I think, you know, just I would look at it as much in the context of where it sits in our portfolio, what it allows us to do within the portfolio versus outside of it. And then of course for kidney, that allows them to focus their investments as well in a way that can help drive their outcomes.
Okay. One more on Kidney Care then we'll move on to the balance sheet and back to the business. But how should we think about the underlying profitability of that business? I appreciate what you give from a disclosure perspective today, but you also have the spin-related costs that are GAAP, that are just a non-GAAP, and I think we all understand why. But those separation-related costs, would those on a standalone basis actually be in the P&L? So we take the $200 million or so, whatever the number was last year, I think that's right. And that gets added back to OpEx for Kidney Care on a standalone basis?
Yeah. I guess the way I'm thinking about it, and Clare you can chime in here. I think the business itself within Baxter. I know that's not what you're specifically asking, but I'll get to this. Within Baxter, you know, this number is. It's more of the high single, kind of low double-digit number. I think there's then on a standalone basis. There's going to be public company costs in the spin. There's going to be obviously other costs that today are absorbed as part of Baxter that would not be there. And so I guess, you know, I think that's just the way I would think about this thing because there are going to be standalone costs that would be deducted, if you will, from.
And the only clarification I would make of the $200 million, some of that would be one-time costs. That would not be the recurring costs that would be included as a standalone entity. So it's a little bit, there are some recurring costs in there right now, but not all of that $200 million is it.
Care to offer a percentage of the?
What we had said previously is that typically what we have seen with precedents is that standalone costs are about 1%-2% of sales for spinoffs. Everything we've seen so far, Kidney Care, Vantive would be in that range of that.
Very helpful. A little out of order here, but you brought up the balance sheets. I want to touch on that because I think you paid the debt in May that was due, the EUR 800-some-odd euro bonds with the remaining proceeds from the BPS sale. You do have debt due in November. I think you also have debt due January of next year. So as you think about, I think it's like $1.8 billion of debt coming due that sits around a 1.5% interest rate. How should we think about managing that?
Yeah. I mean, so first of all, again, I'm going to put a little through the decision on the structure of the separation. And so again, that's going to impact the answer to this question. So it won't be as maybe definitive as you'd like it to be. But I guess what I would say to this is certainly the proceeds from the separation would be something that would be used to pay down debt. And I think, you know, I think about it as we've got, as you said, a tranche due in November of this year. We also have a term loan in 2026. That's one of our actually the higher end of the coupon debts that I think would be something we would also look to focus on as some of those proceeds are used.
I would just say the separation proceeds are certainly going to be a key part of what we're going to use. Obviously remaining cash that we have from the BPS sale.
Is there a good number we should think about as cash you would keep on the balance sheet to fund working capital that is in CapEx? Then we'll be, yeah, maybe you can answer that first.
Yeah. Again, I think somewhere in the $1 billion range is probably maybe a little higher, but I think that's a reasonable view.
I'm more aligned with you. I think our treasurer would say higher, but I think around $1.5 billion, we're good.
You got to push her. So maybe we could talk. So if you think about the proceeds from a spin or sale, that's one avenue to pay it down. Just from where we sit today though, if we assume you had to refinance that, that would create a pretty significant interest headwind for 2025. If we said you're paying off 1.5% debt with, I don't know, 5%-5.5%, whatever rates are now, that would create some sort of incremental net interest expense headwind for next year.
Yeah. Again, I would go back to my previous answer. We're still evaluating, again, depending on how the structure of this happens, we may or may not end up in that place. And I think there's certainly, but either way, we're evaluating what the different options are in terms of navigating that. So I guess just not ready to actually give specific clarity on that at this point.
Okay. Maybe we could toggle onto the business. You know, Q1 had a number of puts and takes in it. But as you look then you look to Q2, you're guiding to a modest deceleration in sales from the 3% in Q1 to 2%-3% in Q2. Maybe help us think through the thought process there. If it seemed like HST should be improving markedly on a sequential basis, what are some of the puts and takes in the trajectory of guidance here Q1 to Q2?
Yeah. I'll start and certainly getting Clare to chime in if she likes. I mean, I think generally speaking, I'd say the overall business itself is pretty consistent between the two with a couple of things I would call out. As you said, we are anticipating some incremental improvement from HST, certainly from Q1. We've talked about somewhat negative, but yet again, improved incrementally from the first quarter. We also, you know, when I think about the kidney business, we had a very strong in the acute business in the first quarter. That's something I think we're anticipating some softening of as we head into the second quarter. As well as the in-center HD, I think is also something that we're anticipating having lessening in Q2 versus Q1.
I think finally the compounding in pharma, we had a very strong first quarter from a compounding standpoint that we're anticipating some softness in or lessening, I'll say, of that in the second quarter. Those are I think the really primary puts and takes from her.
Yeah. The one piece I would add to there if we think about just the margin, because I take your point, is we are going to increase, incur some increased costs as we separate out kidney care from Baxter from a manufacturing standpoint. So kidney care will be shifting to its own location. And so as a result, we're going to incur some increased costs, logistics-related as we do that. And that's really one of the primary drivers kind of of margin because we do expect gross margins to actually decline slightly in Q2 versus Q1.
I'm going to push back on that for a second, but if I start just sticking on the top lines, those are some of the other things. How does Novum and some of the injectable pharmaceutical launches factor into the top line outlook? You know, Novum, you don't really have anything Q1.
Yeah. If you're talking about second quarter, they don't as much. As we head into the second half of the year, that's part of where you've seen us actually increase our guidance for MPT, seen us increase our guidance for pharma. And I think that's where that plays in.
So on the margin piece, I appreciate the 42, I think it was 42.4, 42.5 in Q1 had some elevated factors related to overabsorption in the HD plant. But you also had this big headwind in the HST business. And I think if you look at the, I assume most of the 5-point margin decline year-over-year that was registered in operating margins in that business came in the gross profit line for that segment. So.
There's a lot of leverage there. So yeah, so no, it wasn't all just in gross margin.
But you did have some improvement there in gross profit where you have probably injectables continuing to grow, shifting the mix toward injectables from compounding, exiting the lower margin businesses within Kidney Care, HST improving, and despite the cost headwinds and the normalization of margins in Opelika. So all that together still gets you to down sequentially.
Sequentially.
Okay. And then maybe we could talk about, hold on, I'm going to step back. Stay on revenue for a second. I think you also said bridging from Q2 to the rest of the year, I think you mentioned on the call you expect the business ex-kidney to be in the 4%-5% range by the fourth quarter. That was 2% in Q1. Talk to us about how we get from 2% to 4%-5% exiting the year.
Yeah, I can start with that. I mean, so back to my comment a couple of minutes ago, keep in mind, number one, we raised guidance for both our MPT segment as well as pharma. So that's actually part of it. And then again, when you think about MPT, again, you know the introduction of Novum, that is actually going to have starting to have a strong impact. We've talked about an incremental $25 million in the second half of the year for MPT. And to your point, some of the injectable product launches in pharma. I think the other part of it though is HST. And certainly as we continue to think about how, again, over the course of the year that continues to evolve, they have a typically stronger second half than they do first half. And we're anticipating that as well.
I think one of the things that gives us confidence about that is certainly in the CCS business. We referenced the fact that we had late incoming orders, if you will, in Q1. That was a bit of a timing element for what happened in the first quarter. The ability for us to continue to build, again, the order book's been strong. We anticipate those orders continue to ship over the second quarter, but also as we head into the second half of the year. So I think in general between that and if you think about from a Front Line Care standpoint, last year we'd had a significant backlog that we had kind of pushed through in the, I'll say the first half of 2023. Again, that comparison changes as well as we head into the second half of the year.
On the CCS business specifically, appreciate the timing of orders and then the corresponding impact on installation and revenue recognition. Is there anything holding you back from executing conversion of order to revenue either from a supply chain perspective or you talked about operational factors on the Q1 calls or any reason why those orders would not translate into revenue at the normal pace you would see?
No, there's not. That's something that I think we, one of the things I asked early on in my time here back to kind of what have I learned in the first few months is this question between actually an order coming in and a shipment, there's what I'll call extremely high batting average on that. Timing has fluctuated some, obviously, and certainly did in this case. But there's certainly nothing that we anticipate that would prevent us from actually shipping.
On the operational issues that you discussed on the Q1 call, where were you in terms of resolving those as of May and any other updates you can provide?
Yeah. And maybe just a bit of specifics on that. I mean, the Q1 call had more of a general statement. I think the main operational issue that happened in our CCS business in particular was really around, we actually, as part of our work in our integrated supply chain, we're actually consolidating manufacturing facilities. In the case of CCS, there was a manufacturing facility in Massachusetts. There's one in Mexico. We worked to consolidate those two facilities and frankly didn't execute it as well as we would like to have done. That drove both some timing of shipments, also increased distribution costs. And so there was actually a margin impact on that as well. And so I would say we're the majority of the way through resolving that. Certainly by, I'd say, the end of the second quarter, early third quarter, we'll be through that completely.
And so that's not a structural thing. It's an issue that we, I think, are well in control of. And then the other operational thing I'll just say in Front Line Care as part of what we also saw in the first quarter, I guess I'll call it, we called out some quality issues in Western Europe. That also has been as well on its way to being resolved. And so I'm confident those are not going to be issues that are going to hold us back.
One of the things that I didn't appreciate about Front Line Care was the mix between hospital and physician offices. Can you just remind us what is the mix of business there and what are the trends in each of those subsegments?
Yeah. So we've talked about the primary care market, which is probably about a third of the overall Front Line Care business. And that's where we have seen some softness within the overall market. So we've discussed that. The other part of the business for Front Line Care that's in the acute setting, we haven't seen that type of impact with it. That business has been doing well. We also have the cardiology and respiratory health businesses as well that have also been performing well. So within the primary care market, this is a market that we saw softness in the second half of last year, really in the fourth quarter. We saw a seasonally slow start to new construction starts given the high interest rate environment that has carried through.
We anticipated it to carry through to 2024, but it has been exacerbated a bit by some of the cyber attacks that we've seen on both Henry Schein and Change . So that has led to some softness as well. We expect that to slowly resolve. In general, we expect the primary care market to decline this year and rebound as we go into 2025.
Probably two other factors in that I think that have been a part of that as well is the Change Healthcare that's come up as well as there was in 2023, there was still at least about the first half of the year, some pandemic-related reimbursements that had happened that fell off. I think that's had also some impact. To Clare's point, we do anticipate slow recovery in that, but over time it will recover.
Okay. It's a good segue to the P&L. I think you've talked about at least 50 basis points of operating margin expansion this year. It would seem like, I appreciate some of the cost dynamics, but as HST improves, you exit the certain businesses on the kidney side, it would seem like you could do much better than that.
Well, I'll start. And I think one thing to remember last year, we had a 300 basis point delta between our operating margin in the first half and the second half of the year. That was a lot related to some of the, again, some of the inflationary costs that we were up against in the previous year. So I think it's as much that as anything where we certainly anticipated some of a larger amount of expansion in the first half of the year than in the second half. And I think that's anything you'd add to that?
Yeah. I mean, I think that your question is probably more going forward.
This year.
This year.
This year. I mean, 50 basis points given the expected improvement in HST in the back half of the year. I appreciate, Kidney might come down from what you saw in Q1, but it would seem.
But the rest of the business.
But the rest of the business should be moving higher. So it seemed like there's opportunity to be more in the 15-ish% operating margin range, 15+ versus what I know at least 50 basis points is a lot of room above at least 50. But if you take the 14.3 last year, it would seem like a number into the 15s is reasonable for this year.
I mean, I think right now we have said 50 basis points is kind of the floor and that's the minimum. We would expect hopefully to do more than that.
How should we think about just conceptually longer-term margins? So one of the things that's always challenging is that Baxter has been going from 9% to 19% to 14% post the separation with Baxalta. At 19%, you had a, you still had BPS in there. So it's not a good representation of it. And maybe BPS, it was sort of in the high 17s without BPS or something like that. Is that a good benchmark to think about where margins can go over time? How should we think about normalized margins?
Yeah, I think that is a reasonable starting point. And I think that's something certainly we'll come out with a longer-range plan at some point more definitively. But I do think, again, that's a reasonable starting point. And we'd certainly want to accelerate from there. And I think that's reasonable.
As you look at the profile of the P&L now, it would seem like most margin expansion needs to come through the gross margin, which as we know takes time, is harder to move. At the same time, many of the input cost pressures that you faced throughout COVID, maybe they're not going down, but at least the pace of growth is moderating. As your business, as your kind of your volume grows into your new cost base, how should we think about the progression of gross margin going forward?
Yeah, I think so, a couple of primary areas of focus to think about on that. Number one is in our ISC space. I think we've had a continued stream of margin improvement programs that both offset increases that are happening, but also continue to expand our margins. We have a robust pipeline of margin improvement programs. We've talked about $300 million-$400 million a year in improvement in the ISC. And that's certainly a big part of it. We've also done a lot of work and are continuing to do a lot of work on automation. I think one of the things that certainly has come up and isn't going back down is the cost of labor and our ability to actually make the types of automation improvements that we've done. Our plant in North Carolina, for example, is our largest solutions plant.
Done a lot of really good things in that area. That's something we continue to work to scale across our supply chain. ISC certainly is a big part of that. Pricing is another. I think there's another part of this that is an area that's going to also continue to drive gross margin. We talked about this year where we've had 50-100 basis points improvement in pricing. A lot of that this year is coming from outside of the U.S. The team has done a lot of good work in that space. Then as we think about going forward, one of the things we've talked about is the renegotiation or the negotiation of our GPO contracts. Those have been two of the three large GPOs. One of them is not due till 2026 or 2027. That's why it's not three of three.
But two of the three, those have been successfully renegotiated. We're now negotiating the IDNs under that. But from a pricing perspective, we were able to, again, to successfully take price there as well as some, I'd say, additional flexibility in the event that for whatever the reason we had supply chain or other impacts on the business. And so I think as we think about the 50-100 basis points of pricing this year, again, mostly outside of the US, 2025 impacts from some of that and other work we're doing, I'd say think about that in the same way as we head into next year. So those are really the two main impacts from a gross margin, but it's both.
Okay. Then on the OpEx side, like, optically you look at SG&A and R&D, and it's hard because when you compare to "med tech peers," it's not an apples-to-apples comparison because if you look at your revenue portfolio, you have a lot of businesses in there that are the fluid solutions business that doesn't require the same level of R&D as some of the compounding as some of the other portfolios. So how should we think about the trajectory? You get 4.5% of R&D; it's probably more like 7%-8% on the segment for the R&D of both sales, so to speak, excluding sustaining. So how should we think about the trajectory of R&D and SG&A going forward?
Yeah, from an R&D perspective, I would think about it as a, I'll say modest incremental gains year over year. Now, again, I don't know that we're going to go.
In dollars though, or is it percentage of sales?
Percentage of sales.
Okay.
So I'd say that's going to, again, I'll say modestly increase. But I think what we're going to do though there is from a focused and prioritization standpoint, I think that's where we really have some continued opportunities to advance that work. And so I think that certainly, again, innovation is driven by R&D and that's going to be a continued focus for us. From an SG&A standpoint, I've said a couple of times, we're not going to SG&A ourselves to profitability, if you will. But we do continue to see opportunities in the SG&A space. And in particular around, I just recently hired a global services leader. Baxter today has a large, but very fragmented shared services environment. There's areas between that and that's really a focus of ours that I think is an opportunity to go from an operating model standpoint for efficiency.
The other part of it, of course, is as we do separate kidney, the work around what you'd call stranded costs or some of the just essentially almost ensuring our cost structure was lined up properly. I have a transformation office that's also reporting into me directly, as is the shared services work. Excuse me, that is really a key workstream of ours to ensure that we continue to drive real leverage in our business in SG&A. I think we'll continue to align it more with industry peers.
Maybe just sort of close on sort of a cash flow question. You've talked about, you referenced an 80%+ free cash flow conversion number. Appreciating it's going to be below that now because of the spin costs and other dynamics. But what's the path back there and how should we characterize timelines?
Yeah. I think it starts with really a focus and a real rigor around driving working capital. I think from an inventory standpoint, during COVID and some of the supply chain disruptions, the company had appropriately actually increased its inventories in order to ensure with some of the service disruptions. I think we have continued opportunities to focus on that area and then obviously in receivables collections as well. And this ties right into the business services and some of that. But that type of rigor around working capital, which again is something I had a ton of experience in from the company I came from is a real key part of that.
I'll put you on the spot here. Maybe to fast forward, as we think about, I'm not going to put a timeline on it, but as we think about Baxter going forward, I appreciate kidney is a variable, but is it fair to think about the company as the goal to get to mid-single-digit top-line growth, mid-high-teens operating margins and 80% free cash flow conversion? Is that a fair rough set of objectives?
I think that's a fair set of objectives, yes.
Okay. Excellent. Well, thank you for making the extra effort to be here. We really appreciate it. There's a ton of interest in Baxter. So I think you'll see that in your one-on-one schedule. Very much appreciate your making the time and being here. And Clare, thank you for making the trip as well.
Thank you.
Thanks, everyone. Appreciate it.