Baxter International Inc.

Thank you for standing by. Good morning. Welcome to Baxter's International Third Quarter 2021 Earnings Conference Call. Your lines will remain in a listen-only mode until the question and answer segment of today's call. At this time, if you would like to ask a question, you will need to press star, then the number one on your touchtone phone. If anyone should require assistance during the conference, please press star then zero on your touchtone phone. As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Claire Trackland, Vice President, Investor Relations at Baxter International. Ms. Trackman, you may begin.

Good morning and welcome to our third quarter 2021 earnings conference call. Joining me today are Joel Maida, 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 third quarter 2021 financial results and fourth quarter and full year 2021 financial outlook. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the fourth quarter and full year 2021, the pending acquisition of Hillerom, 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 detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand factors ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website. Now I'd like to turn the call over to Joe. Joe?

Thank you, Claire. Good morning, everyone, and thank you for joining the call. As usual, I will begin with an overview of Baxter's third quarter performance. Jay will take a closer look at the financials and outlook for the rest of the year. Then we'll close with your questions. Clearly, the most notable highlight from the quarter is last month's announcement of our agreement to acquire HillROM, subject to the approval of HillROM shareholders and other customary closing conditions. I recently made site visits to select HillROM locations as part of our integration planning process, and I was joined by other members of our senior leadership team, meeting face-to-face with HillROM's dedicated employees entering the facilities only underscored our confidence and enthusiasm for the proposed acquisition of Hiram. Upon closing of the transaction, we plan to bring a broader array of products and services to patients and clinicians across the care continuum and around the world. We are focused on identifying opportunities to further accelerate innovation to address the rapidly evolving needs of our customers. The teams are working diligently on plans to bring together these two complementary portfolios to deliver enhanced value for our stakeholders. We look forward to updating you on these acceleration opportunities following the close of the deal. Earlier this month, the Hartz IV Rodino, or HSR, waiting period in the U.S. expired with no of a second request by the FTC. While the FTC reserves its right to take further action, this is a key milestone to clear the way for a successful closing. We are in the process of securing all remaining global regulatory approvals required for closing, and the Hill-Rom shareholder meeting to vote on the transaction is currently scheduled for December 2nd. In addition, our integration planning management office is up and running with teams from both organizations preparing for a swift, effective combination once the deal closes. We will expect to close by early 2022. Moving on to the third quarter financial performance, I'm pleased to report solid ongoing momentum as we make our way toward the close of the fiscal year. Baxter delivered third quarter sales growth of 9% on a reported basis, 7% at a constant currency, and 6% operationally. Like last quarter, growth was impacted by the continuing, if somewhat erratic, pace of COVID-19 pandemic recovery. While the pandemic still represented a headwind to top-line sales in the quarter, the magnitude of this headwind has continued to decline, reflecting the improved rate of hospital admissions in the U.S., as well as ongoing pandemic recovery in international markets. This resulted in a favorable comparison to the same period last year. On the bottom line, third quarter adjusted earnings per share were $1.02, up 23%, and exceeded our third quarter guidance. Positive mix and disciplined expense management drove the favorability. As you saw in our earnings release, all of our geographic segments and product categories contributed to the positive performance in the quarter. The pace of pandemic recovery continues to vary by both therapeutic and geographic market. Our broad global footprint and diverse portfolio of essential products combine to help mitigate the variability and shore up the strength of our overall enterprise. We also benefit from our resilience and agility, which have been greatly enhanced through our ongoing transformation. Looking at performance by business, growth was led by biopharma solutions, which advanced 45% at constant currency rates. Performance was driven by revenues related to our manufacturing of multiple COVID-19 vaccines. Medication delivery grew at 11% constant currency, reflecting the improved rate of U.S. hospital admissions a new infusion pump contract with a large health system in the U.S. and increased demand for Baxter's small volume parenterals. With respect to our Novum IQ 510 case submission, we are continuing to work with the FDA to address their questions on our submission. While we hope to receive clearance by the end of this year, it is possible it may shift into early 2022. In pharmaceuticals, 7% constant currency growth reflects the benefit of our acquisition of specified rights outside the U.S. to Calix and Doxil. Adjusting results for the acquisition, operational growth rose 1%. Year-over-year growth in the quarter reflects lower U.S. sales in part due to a large pandemic-related government order received in Q3 2020 and softness in inhaled anesthesia. This challenging comparison was offset by strong growth internationally, driven by our pharmacy compounding business. Our third quarter launch of premixed norepinephrine was met with strong demand, part of an increasing trend as hospital pharmacies embrace premixed formulated drugs and other products that improve efficiency, particularly in the wake of the pandemic. This is a key strength of our pharma portfolio and we plan to continue launching more molecules with differentiated presentations or complex formulations in the months to come. During the quarter, advanced surgery performance in the U.S. was affected by lower surgical volumes, which remain depressed versus pre-pandemic rates. Procedure volumes were unfavorable to our prior expectations as hospitals delayed elective procedures in light of the Delta variant. This was more than offset by growth in the international markets, which could slowly recover from the effects of the pandemic. Growth in clinical nutrition reflected the benefit of our new product launches, particularly in international markets. Acute therapies continues to perform very well. A year-over-year decline in U.S. sales reflects a difficult comparison in the face of last year's surge in demand for continuous renal replacement, or CRRT, products. Again, this was offset by international growth. As an outcome of the pandemic, we now have many more CRRT devices in the field, as well as heightened engagement and utilization on the part of clinicians, creating a platform for sustained momentum. Growth in renal care was driven by our home-based peritoneal dialysis, or PD, products globally. As I have mentioned on past calls, demand does continue to be dampened amid the the pandemic due to higher mortality rates for patients with kidney disease and a slowdown in new patient diagnosis. We expect the ESRD market to gradually recover to pre-COVID growth rates over the next one to two years. Our Renal Care Teams Global Safer at Home campaign is dedicated to helping clinicians, patients, and other stakeholders learn more about the benefits of home-based PV care, especially in the context of today's pandemic conditions. From an ESG perspective, I'm pleased to highlight a new partnership between UNICEF USA and the Baxter International Foundation to improve access to safe water in La Guajira, Colombia, one of the country's most water-challenged regions. A $1.5 million foundation grant is helping fund the multifaceted three-year program. This quarter, we're also honored to be included on Forbes' latest list of the world's best employers and America's best employers for women. In addition, we're recognized as a leading organization on Surmount's Inclusion Index. Looking forward, we continue to navigate with some uncertainty on the horizon. The overall trajectory of pandemic recovery appears more clear, but the new geographic contours remain inconsistent. New variants may take an unknown toll on our business and our employees, and we will continue to contend with the effects of macroeconomic issues. Related to this last point, we are not immune to inflationary pressures and the rising cost of raw materials, commodities, components, fuel, and ongoing supply chain disruptions. While we are actively working to address these rapidly rising costs, we recognize these factors may continue to impact our operations into 2022. Amid these challenges, we are on pace for a strong close to the year. This translates into momentum as we get set to execute on the vast potential of our proposed Hill Realm acquisition and launch the next phase of our transformation journey, fueled by the commitment of our outstanding global team. Now I will pass it to Jay for a closer look at our financial results and outlook.

Thanks, Joe, and good morning, everyone. As Joe mentioned, we're pleased with our strong third quarter performance. Third quarter 2021 global sales of $3.2 billion advanced 9% on a reported basis, 7% on a constant currency basis, and 6% operationally. Sales growth this quarter reflects the benefit from revenues associated with the manufacturing of COVID vaccines, strength in medication delivery, and OUS sales of Calix and Doxil. which totaled approximately $32 million in the quarter. On the bottom line, adjusted earnings increased 23% to $1.02 per share, exceeding our guidance range, driven by a favorable product mix, primarily from better than expected sales of acute therapies and biopharma solutions, as well as disciplined operational execution. Now, I'll walk through performance by our regional segments and key product categories. Starting with our regional segments, sales in the Americas increased 7% on both a constant currency and operational basis. Sales in Europe, Middle East, and Africa grew 7% on a constant currency basis and 3% operationally. And sales in our Asia Pacific region advanced 8% on both a constant currency and operational basis. Moving on to performance by key product category, note that for this year, constant currency is equal to operational sales growth for all global businesses, except for pharmaceuticals business, for which we will provide both constant currency and operational growth, adjusting for the acquisition of rights in select territories outside the U.S. for Calix and Doxil. Global sales for renal care were 981,001% on a constant currency basis, Performance in the quarter was driven by global growth in our PD business, where we experienced year-over-year improvement in global patient volumes despite the negative impact on volumes resulting from the pandemic, including increased mortality rates in ESRD patients, delays in new patient diagnoses, and market-wide staffing shortages. PD growth was partially offset by declining international sales in our in-center HD business and renal care clinics. We continue to monitor the impact of excess mortality among ESRD patients and delays in new patient diagnoses resulting from the pandemic and expect the market to return to pre-COVID growth rates over the next 12 to 24 months. Delivery of $747 million increased 11% on a constant currency basis. Strong global growth in this business reflects continued recovery in the pace of hospital admissions as well as increased demand for large-volume infusion pumps, IV solutions, and small-volume parenterals. During the quarter, we estimate that U.S. hospital admissions were down approximately 4% compared to pre-COVID levels, a significant improvement from the same quarter last year, which saw U.S. admissions down approximately 5% versus pre-COVID levels. In addition, during the quarter, we executed and began delivering infusion pumps under a contract with a large health system in the U.S., which resulted in our highest number of quarterly pump placements in over five years. Pharmaceutical sales of $589 million advanced 7% on a constant currency basis and 1% operationally. Performance in the quarter was driven by demand for our international pharmacy compounding business and the contribution from OUS sales of Calix Doxil. Growth in the quarter also benefited from increased sales of Dexmed and our portfolio of premixes as hospitals continue combating the COVID-19 pandemic and look toward premix formulations and workflow efficiencies. This growth was partially offset by declines in our US business related to lower surgical procedures and a government order of approximately $20 million in Q3 2020. Moving to clinical nutrition, total sales were $244 million, increasing 3% on a constant currency basis. Performance in the quarter was driven by the benefit of new product launches within our broad multi-chamber product offering. Sales in advanced surgery were $249 million, increasing 5% on a constant currency basis, Within the quarter, we saw strong growth from our international business and estimate surgical procedures improved both sequentially and on a year-over-year basis in many international markets. This growth was partially offset by performance in the U.S. with surgical procedures estimated at 95% of pre-COVID levels, a sequential and year-over-year decline in surgical procedure volumes due to the impact of the Delta variant and staff shortages. This was below our previous... procedures returning to pre-COVID levels during the third quarter. Sales in our acute therapies business were $185 million, advancing 3% on a constant currency basis, and were favorable to our expectations. Performance in the quarter continued to benefit from elevated demand for CRRT, particularly given the rise in COVID cases associated with the Delta variant. Biopharma solution sales in the quarter were $206 million, representing growth of 45% on a constant currency basis, reflecting incremental sales related to the manufacturing of COVID vaccines, which totaled more than $50 million in the quarter. Moving through the rest of the P&L, our adjusted gross margin of 44% increased by 140 basis points over the prior year, reflecting a favorable product mix and operational improvements in manufacturing. Adjusted SG&A of $640 million increased 11% as compared to the prior year period and was favorable to expectations driven by disciplined expense management, which more than offset increased supply chain and logistics expenses recognized in the quarter. Adjusted R&D spending in the quarter of $129 million increased 6% versus the prior year period. Both adjusted SG&A and R&D spending reflect a somewhat more normalized level of spend. Certain expense categories were depressed last year as a result of the pandemic, particularly those related to employee bonus accruals. This improvement in gross margin coupled with the continued OPEX management resulted in an adjusted operating margin in the quarter of 20.2%. an increase of 100 basis points versus the prior year. Adjusted net interest expense totaled $32 million in the quarter and other non-operating expense was $12 million in the quarter. The adjusted tax rate in the quarter was 14.8 percent, a decrease over the prior year driven primarily by a favorable change in earnings mix. And as previously mentioned, adjusted earnings of $1.02 per diluted share exceeded our guidance of 93 to 95 cents per diluted share. With respect to cash flow, year to date, we've generated $1.5 billion in operating cash flow. Free cash flow totaled over $1 billion and represented growth of nearly 50% as compared to the prior year period. I would like to take a moment to reiterate our excitement around our recent announcement to acquire Hillrom. We believe the strategic rationale and underlying financials of the combination are compelling and provide us with a meaningful opportunity for value creation. Our integration teams are hard at work, and we look forward to finalizing this combination by early 2022. In the meantime, we continue to follow a strategic approach to capital allocation that is founded on accelerating growth, driving innovation, and returning value to our shareholders. Let me conclude my comments by discussing our outlook for full year 2021. For full year 2021, we expect global sales growth of 7% to 8% on a reported basis, 5% to 6% on a constant currency basis, and 4% to 5% on an operational basis. This assumes a benefit of approximately 100 basis points to both reported and constant currency revenue growth for the acquisition of Calix Doxil, and over 200 basis points of positive top line impact from foreign exchange on reported growth. Our expectation remains that on a full year basis, hospital admission rates in the U.S. will remain below pre-COVID levels, exiting the year down low single digits. Although surgical procedure data in the U.S. declined sequentially Q2 to Q3, our current expectation is that U.S. surgical procedures will improve sequentially and return to pre-COVID levels in the fourth quarter. We are continuing to monitor this assumption in light of potential impacts from COVID outbreaks and hospital staffing shortages. Moving down to P&L, we now expect adjusted operating margin to expand more than 60 basis points. For the year, we now expect an adjusted tax rate of 16.5% to 17%. and a full year diluted average share count of approximately 510 million shares. Based on these factors, we now expect 2021 adjusted earnings, excluding special items, of $3.58 to $3.62 per diluted share. For the fourth quarter of 2021, we expect global sales growth of 3% to 4% on a reported basis, 4% to 5% on a constant currency basis, and 3% to 4% on an operational basis. And we expect adjusted earnings excluding special items of $1 to $1.04 per diluted share. With that, we can now open the call up to Q&A.

Thank you. We will now begin the question and answer session. If you have a question, please press star and the number one on your touchtone phone. If you wish to remove yourself from the queue, press the pound key. If you are using a speakerphone, please lift the handset to ask your question. So that we may be respectful of everyone's time, please limit your comments to one question with one follow-up question if necessary. We appreciate everyone's patience and would like to provide as many of you as possible the opportunity to ask a question. We will pause for just a moment while the list is being compiled. I would like to remind participants that this call is being recorded and a digital replay will be available on the Baxter International website for 60 days at www.baxter.com. Your first question comes from Robbie Marcus of J.P. Morgan. Your question, please.

Congrats on a good quarter. Thanks for taking the question. Thanks, Robbie. Maybe to start, Jay, you talked about volumes recovering to pre-COVID levels in fourth quarter. I think it'd be good just to run through how you're coming up with that assumption. Is that what you're seeing today? Is that what you expect given trends that you're seeing in the U.S.? Is it different? U.S. to Europe and just sort of how you're coming up with that.

Sure. For procedures and volumes, the comments really relate to the United States because outside the U.S., we are seeing more variability. But from a U.S. standpoint, you know, our expectation is that by year end, We'll be down low single digits. And the quarter will be down low single digits from a division standpoint. Again, a third quarter, we were down 4%. And we're seeing that in the marketplace today. So far, you know, things are tracking broadly in line with our expectations. For procedures, we were a little bit disappointed with procedures in the third quarter. It came in below our expectations, down 5%. But we are seeing some recovery, and we expect that to continue so that the year-end assumption, the Q4 assumption, Now, I will tell you, there are risks that we're monitoring with respect to this. Certainly there's the COVID factor, but another one that's acute and we have to be mindful of is nursing and staffing shortages. hospitals. We were just having conversations with our U.S. sales force, and frankly, this is a factor that's coming into play. I don't necessarily think at this point it's a meaningful factor relative to the expectations that we've shared, but as far as risks go, moving into November and December, we will continue to monitor that.

Great. And maybe to tie in that point, you know, you had really good expense management down the P&L both on the SG&A and R&D a little lighter on gross margin than what the street was thinking. So as you think about expenses, both in fourth quarter and from a high level going forward, where do you think you are in terms of percentage of normal spend? Meaning how much is held back here because of the lower revenues due to COVID or the environment you're spending in and And where do you think gross margin could go from here, given that there are some higher cost inputs? Thanks.

Sure. A number of components to that question. First, I'll address the SG&A piece. SG&A in the second half of the year will be sub-20%. And certainly as we look at that number, I would expect to see some elevation of that as we move into next year. We're going to resume more normal activities. We've still been very limited on a travel basis. We've still been very limited on a promotional basis in light of the COVID environment that we're faced with. And so we'll expect to resume normal activities as we move into next year. and there will be some uptick in SG&A percent of sales is our current expectation. So I think that's one thing to consider. As we look at the gross margin, this is a more interesting one for me. From our standpoint, gross margin came in, broadly speaking, in line with our expectations in the quarter. In Q4, we don't have tremendous surprises. But embedded in that, we are seeing some material and wage inflation We're also seeing some planning and fulfillment costs in excess of our expectations. So those factors have been dragged, frankly, on our gross margin in Q3 and Q4. And as we look to next year, one of the big uncertainties that we're facing are these categories of versus temporal, how much destruction continues to exist in the supply chain. These are key factors that we're currently evaluating as we look at the plan. And it's a very dynamic environment. If you think about this year, you know, we've had things like the Suez Canal, the Houston freeze disrupting logistics and also the resin market. But more recently, Hurricane Ida has put a fragile resin market under real pressure. evolves over the coming months is going to be a critically important input as we look at our 2022 operating plan.

Great. Thanks for all the color.

Thanks, Robbie.

Bob Hopkins of Bank of America Securities is online with a question. Please state your question, please.

Oh, thank you. Can you hear me okay? And good morning. Morning, Bob. Morning. So, um, yeah, I think, uh, just pick up a little bit on that last thread there, Jay, um, your comments on watching inflation and supply chain. Um, I completely understand and appreciate that, but it was only in September that you guys provided some preliminary thoughts on operating margin target targets for the company. And I was just wondering, did those targets that you provided for standalone Baxter, um, Do those still hold? Do you think those might be at risk based on what you're seeing, you know, kind of more recently on the inflation and supply chain front? At this point, there's no change to the information that we shared in early September related to our projections. So we don't have any expectation of change. But what I will say is Hurricane Ida in September did change the dynamic in short term in the inflation trend. related to certain critical raw materials that we're watching. But to be clear, Bob, we're not changing our projections at this point, and we're going to continue to work and evaluate over the coming months. Okay. Thank you for that. And then just one other quick follow-up on that is – You guys were nice earlier in the year and on the second quarter call to kind of specifically quantify headwinds related to inflation, supply chain, and you threw a couple of other things in there. I apologize if I missed that, but I'm just wondering if you can give us kind of an updated thought on what that headwind will be for the year. I think originally you called it out as maybe $70 million, then it bumped it up to $130. I apologize if I missed that, but where does that stand today? Sure. As we look at Q3 and Q4, supply chain and logistics expenses has been the key driver that's deteriorated relative to those expectations. And I would estimate that we're off those projections by five or six cents. related to planning and fulfillment costs, use of expedited freight, use of premium freight, related to really trying to get our product to the right spot where it's needed and when. It's been incredibly challenging for us to address the needs in this volatile supply chain environment. So that's really the key factor that's playing into our numbers today. As we think about inflation, some of the recent moves actually don't roll out until next year because, as you know, we purchase a product, we manufacture the product, it sits in inventory and then sold. And once sold, that's when we reflect the impact in our financials. So the impact in Q3 and Q4 on inflation is more limited, but that's the piece that we're watching as we move to next year.

Thank you for the caller. Sure.

Larry Beagleson of Wells Fargo is online with a question. Please state your question.

Good morning. Thanks for taking the question. One on the revenue outlook, one on the margins. You know, you're guiding this year, I think, to 4% to 5% underlying growth, and that's the same as the, you know, LRP you provided us, you know, in September.

How are you feeling about, you know, achieving that in 2022? And if you're not willing to kind of bless that now, you know, what are some of the puts and takes we should think about? For example, you know, will BPS and acute therapies be a headwind next year? I have one follow-up.

Sure, I will stop short of doing a detailed review on 2022, but, you know, the compounded growth of 4% to 5% for the next several years is something that we feel comfortable with. As we look at 2022, there are a couple of factors, and I highlighted some of these on the September call, and really it relates to the Delta variant and the continued COVID situation that could be disruptive. Right now, our sense and view is that the COVID variants are progressing in a positive manner, meaning I think that our assumptions underlying our long-term guidance are intact and not disruptive, or not disruptive, I should say. And then from a vaccine standpoint, certainly we're expecting some reduction in vaccine sales. We had very large sales this year. That will abate to some extent. but still be a large component of the overall sales mix of the company. That's helpful. And, Joe, you guys have seen, you know, kind of what the street, you know, has been writing on Hill ROM.

I'm curious, you know, now that you've learned more, kind of what do you see as some of the misunderstandings or things that are underappreciated right now by investors on the Hill ROM acquisition? Thanks for taking the questions.

Larry, I...

Just want to make sure that we clarify that at this moment, which is between starting and closing, we're in planning phase and meeting with our future colleagues here on a planning purpose only. We are absolutely not involved in their day-to-day activities, so we want to make sure that they are running the company at the best of their ability, and we are not involved in that at all. But I can tell you, based on the meetings that we had, the visits that we had, that we feel that the street has missed what they have done in the last two, three years in terms of connecting their products and going into some very specific markets, primarily the frontline care. and also the evolution of what used to be just a hospital bed or a capital purchase by the hospital for being a part of an ecosystem that goes from patient safety to patient diagnostic and communication between the patient and the clinician. So there's a lot going on there. I was pleasantly surprised going to the sites, what we're able to see. Thank you, Joe.

Vijay Kumar of Evercore ISI is online with a question. Please state your question.

Good morning, Joe, and congrats on a nice steady quarter. Joe, I think you guys called out the May delivery strength in the quarter, highest quarterly pump placements. Was this a timing element, or perhaps are we seeing some share shifts in the market? Commentary on the market would be helpful.

Vijay, good morning.

We are seeing shift in share where some of those pumps were competitive pumps. And we don't want to get into share percentage. I think we had those conversations a few years ago. We always get into what is the share, our perception versus other people. So I just want to say to you that it's sufficiently that a lot of those bumps were competitive accounts.

That is Chris here. Thank you.

It related to, so Vijay, I'm sure you saw the prepared remarks. This related to a contract that we signed and delivered those pumps during the quarter with a large health system here in the U.S.

Understood, sir. Thank you. And Jay, one for you. Could you just remind us on... You know, the Q4 operational growth guidance of 3% to 4%, you know, we just did 6% in 3Q. You know, what changes Q and Q, you know, the U.S. admissions, it seems like that's improving Q and Q. Thank you.

Sure. From Q3 to Q4, one of the big drivers relative to our prior expectations is the removal of Novum IQ from the fourth quarter sale. So we had roughly $30 million expected in the fourth quarter. And we've taken those sales out. We're confident in this product launch and very excited about it. It will be coming to market hopefully soon. But as far as prudence, it made sense to take out that. So that's really the largest change relative to our expectations from the third to the fourth quarter. We'll see some improvement globally in renal on the back of the HD business. Our acute business will decline in the fourth quarter is our expectation. Medication delivery will also lower from the 11% that we saw globally in the third quarter to a mid-single-digit number in the fourth quarter. So those are a few of the factors that come into play, but I think the biggest change from our own internal expectations relates to the pump. Thank you, guys.

Travis Steed of Barclays is online with a question. Please state your question.

Hey, thanks for taking the question. Just a follow-up to Larry's question earlier. As you've had time to spend more time on the Hillworm acquisition, just curious if you have any updated thoughts on where things stand on revenue synergies and cost synergies. Anything that you've learned on that front that you can articulate would be helpful?

We are where we said we're going to be on the cost synergies. We are putting together an organization structure. We're making sure we understand more in depth the products. And when we come out with our investor day later in 2022, we'll give you that perspective. It's a little too early for us to jump into that. We have an idea what we think we can do. But it's not the right time, and we want to make sure that this transaction closes. And when it closes, we have no full ability to go in and understand the R&D capabilities and what investments we need to do to bring it together with a new product offering if that is the case.

All right, great. That's helpful. And then given all the time you spend with hospitals and touching hospitals around the world every day, and Jay, given all the modeling and forecasting you guys do, just curious to think about over the next 12 months, how much better do you think hospitals are prepared for another COVID rebound And, you know, we're hearing from some management teams, you know, that they have cautious optimism at least that COVID could be less impactful next year. I know it's a little bit of uncertainty, but we're curious to kind of see what your outlook is on the next 12 months from a hospital capacity perspective.

I'll take this on. We believe, and we're not the forecasters of COVID-19 response by hospitals, but I believe that what you still have is the factor that many people in the United States are not vaccinated. and that has proven to be the Achilles heel of the recovery in 2021, was the lack of vaccination that caused the issue. Second, hospitals have responded very differently upon the regions of the country that got hit the hardest. So it's tough to sit here and predict. I'm sure everybody learned a lesson, but until you get to a point that this moves from a pandemic infection to an endemic infection is going to be tough to predict. I believe what we are seeing, what needs to be considered, and I'm sure you've heard this from other companies, is the labor shortage in hospitals, the issues with nursing availability, the travel nurses are very expensive, so inflation in hospital costs as well as the availability of nurses to be able to perform procedures. Some hospitals are doing just day procedures, no overnight. Some hospitals are cutting the day short because of lack of support. So this is not... is not across the board everywhere. It is very regional, sometimes very local, depends upon the hospital. So I want to make sure that we're not the COVID predictors. I'm sure the country has learned a very tough lesson. Hospitals and everybody's much better prepared today. But a lot of the issues that you saw during summer and beginning of the fall were related to unvaccinated people, and that is a different subject. I don't want to get into it right now.

Yeah, of course. Thanks for the thoughts, Joe, and congrats on the good quarter. Thank you.

Danielle of LVB has a question. Please state your question, please.

Good morning. Thank you all so much for the question. Just a quick question on med delivery. You guys are already gaining share. You have Novum coming. How do you get a midterm outlook for that business? You know, thinking about how a sustainable above-market growth is there over the midterm given the current share dynamics and the upcoming new product launch. And then I have one follow-up.

I would say that...

When we look at competitive accounts and contracts coming up, more so age of the fleet in the United States, it looks positive to us with a good, very solid product right now, but a launch coming up. we are not predicting gains and things above normal but i'd say that we'll be competing more effectively in the in the replacement market for competitive uh accounts because we will have a syringe pump which is something we don't have today so we'll have a more complete portfolio a brand new product um But nevertheless, we are competing very effectively today with our current product. So it is a positive outlook for this market for us.

Got it. Thank you for that. And then, Jay, one quick question for you. Just thinking about the exit rate for margins heading into next year, can you help frame that for us? Thanks so much.

Sure. Thanks, Danielle. We'll end the year, the second half margin should be over 20%, which is really a nice achievement in the context of the environment in which we're operating. So as we move to next year, really there are a few factors in play. Every year the second half margin is ahead of the first half margin, in part because of larger sales contribution in the second half versus the first half. And in addition, we have a lot of spending that's concentrated in the first half of the year relative to promotional activity. And so those things sort of lower the first half margin relative to the second half. But there's a couple of other things that will happen next year that we'll be mindful of. First, and I referenced this earlier, there will be a normalization of operating expenses as we resume activity, promotional activity and travel. And that's our current expectation. But then the final piece, and this is the piece, as I referenced earlier, we'll have a lot of work to do on, is the inflationary impact that I referenced and Joe referenced in his preparer remarks. The impact of material inflation and wage inflation has increased throughout the year. We had the hurricane Ida disruption. So the full magnitude of this is something we're currently quantifying and carefully watching, and the sustained nature of it. We've seen resident prices abate a little bit, but how that emerges, that's an important cost category for us. All of those things will impact 2022, and so we'll watch those things very carefully.

Thank you, guys.

Matt Taylor of UBS is online with a question. Please state your question.

Hi, guys. Thanks for taking the question. I wanted to just follow up on some of those thoughts on how cost development could play out in 2022. Previously, you had talked about some of the COVID-related manufacturing costs winding down in the second half of this year. Could you give us an update on how much of those are lingering or expected to linger and when they could abate? And what are you watching to predict how some of your input costs like materials inflation shipping and labor um could could last you know through either the first half or second half of 2022 how are you going to what to predict that when you're in some

Sure. It's a good question, Matt. We have seen improvement in terms of COVID-related expenses this year, but I will tell you that we still have some significant lingering costs, even in Q3. But part of the improvement from first half to second half relates to a reduction in COVID-related costs. Now, the key question for us is, We're watching very carefully. the evolution of the pandemic. And that will be an important input as we model out COVID-related costs for next year. What we've always said is we expect roughly $30 million of sustained costs. And I believe in the past, we've talked about up to $150 million of total COVID-related costs impacting our numbers. So we expect some sustained level of cost. And frankly, we could have some costs remain in the first half of next year, depending on how things emerge. The critical variable for us, and we've seen very volatile movements in this, are some of the raw material costs related to resin and packaging and also accessibility of components. And so we spend a lot of time analyzing the indices, but I think the quality of the forecast of these indices only goes out so far. And what we've seen thus far is, you know, you can probably have reliable data for a few months, but beyond that, you have to take a position in terms of improving or disimproving And so this is going to be an important part of the guidance that we put forth. Frankly, we'll study this for the next couple of months heading into January when we ultimately give guidance because it is such a volatile input and it's such an important input for us because a lot of our costs are related to resin, the cost of freight, the price of fuel. All of these things are key drivers for us.

And could I just ask one follow-up, Jay? Thanks for that. That was a good caller. But just wanted to know if you had any ability to pass some of those costs through to customers through price raises. I know in the past you've talked about some of your contracts being longer term and having like CPI employers in Med-Del, for example. Could you give us any sense for that at a company level or any specific examples?

Matt, we don't comment at all on our price strategy. We do have, just to confirm, we have adjustments built into contracts, but our price strategy is not public. Thank you. Thanks, Joe. Thanks, Matt.

Amran Zafar of Deutsche Bank is online with a question. Please state your question.

Hi, good morning. Thanks for taking my question. I wanted to get a little bit more color around the renal business. First, in the U.S., regarding the sequentially slower growth, could you talk a little bit more about relative impact of the various moving parts, you know, new patient growth, excess mortality from COVID? I think you mentioned staffing shortages being a factor.

And then my second question is on the OUS renal business. Can you talk about...

new pd patient trends in some of the key geographies and then i guess question 2b is is the weakness in in center hd is that from ice pressure or from share loss in dialyzers thank you very much uh sure so overall the renal business in in the third quarter grew approximately one percent

And we're expecting to see that improve to the fourth quarter, a couple hundred basis points. So we are seeing, we expect to see a recovery in the renal business. And if we look at it, our PD business was sort of mid-single-digit growth, and we did see declines in HD. In the fourth quarter, we'll expect to see mid-single-digit growth again in PD, and it will also be matched by an improvement in center HD. The improvement in IncentRHD relates to the timing of tenders that we see in our ischemia region. But I think your question is a good one related to the trajectory in this business. Obviously, we're incredibly excited about the renal business, in particular as it relates to AAKHI, the Advancing American Kidney Health Initiative, which we believe will provide a great incentive for movement to the home in the coming years. So long-term, very excited about this, and this is an important component of the long-range plan that we've shared. But we are seeing in the short-term some real disruptions in the marketplace. And what I would say is there's really three factors. Excess mortality, that's, you know, these are very vulnerable patients. And very unfortunately, we saw a lot of patients die related as a result of the COVID pandemic. And then the second thing relates to slower patient starts, and this is really a global phenomenon. People have been reluctant to go to doctors and hospitals, and these catheter insertions in some cases have been deprioritized or other procedures are favored relative to that in today's environment. But then the final factor is one that impacts a number of our businesses, and I referenced this earlier related to advanced surgery, but I think there is a significant nursing shortage that our country and internationally will need to be addressed. Nurses are in short supply, and that's another factor that's impacting treatment. So frankly, we've seen a challenging patient environment in the U.S. We did gain patients globally, but the vast majority of those came from China. Outside China, we were essentially flat Q2 to Q3. So these are all factors that ultimately we believe will correct in the coming months and years, as we referenced earlier. But in the short term, this market's going to continue to be a challenging one.

I would add that AAHI in the U.S. is a particularly point of interest because that effort will yield a good future for penetration in the U.S. and adoption of the peritoneal dialysis modality in the U.S. It is depressed because COVID, but as Jay mentioned, we had growth in that business on a global basis. much greater than HD. And HD is the mobility in the U.S. that not in-home HD, but HD in-clinics is the one that drove a lot of that reduction. So what I think the outlook for the business is positive. It is going to be a 12 to 24-month CLIMB BECAUSE THE DEATH THEY WERE EXPERIENCED DURING COVID, BECAUSE THESE PATIENTS ARE EXTREMISTIC PATIENTS OF CHRONIC DISEASE, AND THEY WERE AFFECTED BY THE VIRUS, THE DEATH RATE WAS HIGHER AMONGST THAT POPULATION. BUT WE FEEL VERY POSITIVE ON AAPHI GOING FORWARD AS WE CLIMB OUT OF THIS. WE BELIEVE THAT THAT'S SOMETHING THAT IS HERE TO STAY. IT'S JUST THAT COVID CAUSED US TO HAVE A DETOUR ON THE TRAJECTORY.

Great. Thank you so much.

Thank you.

Joshua Jennings of Cohen is online with a question. Please state your question.

Hi. Good morning. Thanks for taking the questions. I wanted to just ask a quick one, a high-level one on the Baxter-Hillrond combination. I think MedTech acquisitions that have been challenged, typically there's disruptions that occur, there's Salesforce attrition, overlapping products, there are a host of reasons. But Can you help us understand from a high level why you think the Baxter-Hillrond combination can minimize business disruptions? And my follow-up question is just on the staffing shortage headwinds that you guys are calling out and just with your broad reach. What are hospitals capable of doing to rectify these shortages, if anything? What are they doing currently? And then just And with your commentary, I think you're still optimistic that procedure volumes can get back to 2019 levels or improve from 2019 levels in 4Q. So just was curious about that dynamic just in terms of your commentary on staffing shortages and just your expectation for that recovery in 4Q. Thanks for taking the questions.

Josh, on the HUROM, you know, when you acquire a company, you're acquiring – the best assets of the company is the people and the culture of the company, followed by the product and markets, right? So you're buying that because of that. So when we look at the synergies that we can achieve with the acquisition of Huron, none of the sales and marketing and research and development are part of the synergies. But we want to make sure that we continue to thrive and grow and hopefully accelerate growth in the future. But it's not going to be a disruption to how they go to market and how they're doing their business. Now, we have synergies. Of course we do. And those are duplication of functions, different ways of doing things. And we have several shared service centers across the globe. We are a larger company with different resources. Of course, we do have the ability to take costs out and make that, hence, synergies. But at the moment, now sitting here today, we don't have any plans in the short term at all to make any change that would disrupt their go-to-market and serve their patients. Because the focus is patients. That's what we do. On your other question about staff shortage, this is a comment not related to Baxter only. Baxter is a healthcare company with injectable pharmaceuticals and medical devices and peritoneal dialysis home products. where nursing shortages affect the overall market. Hospitals are dealing with this very effectively in most cases, and their ability to deal with it depends upon their size and depends upon the original location. So I can't speak on behalf of our customers, but I can tell you that what we see is tremendous adaptability on their side. It does have an overall impact for the business, but not one that we can pinpoint. It's just a headwind that the industry is seeing. We're just repeating here to make sure you understand that we're not exempt of this headwind, but it's not a headwind that we can mitigate on behalf of hospitals, but we can actually, with a very diverse portfolio, as we've proven in the past, be a more resilient company.

There are no further questions at this time. Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for participating.