Baxter International Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 9, 2023

There are 10 speakers on the call.

Operator

Morning, ladies and gentlemen, and welcome to Baxter International's 4th Quarter 2022 Earnings Conference Call. Your lines will remain in a listen only mode until As a reminder, this call is being recorded by Baxter after and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time. The end of the call.

Operator

I would now like to turn the call over to Ms. Claire Trachtman, Vice President, Investor Relations at Baxter International. Ms. Trachtman, you may begin.

Speaker 1

The end of Q4

Speaker 2

2022 earnings conference call. The call. Jo Almeida, Baxter's Chairman and Chief Executive Officer and Jay Sekaro, Baxter's Chief Financial Officer. The call. On the call this morning, we will be discussing Factor's 4th quarter and full year 2022 financial results, the call comes from the line of John Kerry.

Speaker 2

With that, let me start our prepared remarks by reminding everyone that this presentation,

Operator

the call

Speaker 2

comes from the line of John Franzrebren, including comments regarding our financial outlook for the Q1 and full year 2023, new product development, the potential impact of recently announced strategic actions, proposed pricing actions, business development and regulatory matters contain forward looking statements that involve risks and uncertainties. The call. And of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings the call for more details concerning factors that could cause actual results to differ materially. In addition, on today's call, the non GAAP financial measures will be used to help investors understand Baxter's ongoing business performance.

Speaker 2

A reconciliation of the non GAAP the 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. The end of the call this morning, we will be discussing operational sales growth, which for the Q4 and full year 2022 the quarter. Adjust for the impact of foreign exchange and the acquisition of Hill Rom. Now I'd like to turn the call over to Joe. Joe?

Speaker 1

The call.

Speaker 3

Thank you, Claire, and good morning, everyone. We appreciate you taking the time to join us. I will begin with a brief overview of Baxter's the performance for the quarter year and then provide some additional information on the strategic road map we announced on January 6. These actions further outlined in this morning's press release will help Baxter to emerge as a more agile innovative market the sponsor enterprise with expanded opportunities to create long term shareholder value. Jay will follow with a deeper dive on our 2022 results and outlook for 2023, and we will close with Q and A.

Speaker 3

Starting with our financial results, sales the Q4 2022 were $3,900,000,000 growing 11% on a reported basis, 17% at constant currency the quarter and 2% on an operational basis. 4th quarter adjusted earnings per share were $0.88 came in below our expectations, the quarter. For the full year, sales of $15,100,000,000 the 18% on a reported basis, 23% at constant currency and 2% on an operational basis. The Adjusted earnings per share for the year were $3.50 Jay will provide more granularity on the numbers, but some themes are clear. The Demand across our portfolio remains solid and sales rose across the majority of our legacy Baxter and Huron businesses, offsetting modest the or expected declines in others driven by factors such as generic competition or challenging year over year comparisons.

Speaker 3

As we've discussed previously, this top line growth was offset by a wave of macroeconomic and supply chain factors that has continued the

Speaker 1

end of the call to put pressure on the cost of

Speaker 3

doing business. And as I have stressed many times, we will never pursue reduced costs in ways the expected and demand of ourselves. And our ability to advance our mission is grounded 1st and foremost in our capacity the next quarter. We are committed to delivering steady solid performance as a sustainable corporate enterprise. This is precisely why earlier this year, we announced the call is being recorded.

Speaker 3

As I shared in January, we spent the latter part of 2022 the Undertaking a comprehensive review of our operations, focused keenly on opportunities to improve our commercial responsiveness, the reinvigorate our innovation engine and streamline our operations. This work led to last month's the announcement of our intention to spin off a new kidney care company, explore options for our biopharma solutions contract manufacturing business the and implement a new operating model for our remaining Baxter businesses. These are 3 distinct initiatives with a single agenda, the Increased stakeholder impact with improved long term shareholder value. Cutting across these actions are common goals, the Enhance and refine strategic clarity, increase accountability and line of sight, enhance agility and bring our global businesses even closer to the patients, the clinicians and customers they serve. Today, I will share the next level of detail on the Baxter business model we expect the end of the quarter.

Speaker 3

This work entails a fundamental reconfiguration of how we operate and deliver products to the customers the end markets we serve. This new operating model is focused on 4 vertically integrated global business units or GBUs the Grouped along general therapeutic areas encompassing multiple sites of care. These GBUs, Which will become Baxter's core operating and reporting segments when implemented include the Medical products and therapies comprising our current medication delivery, advanced surgery and clinical nutrition portfolios, Healthcare Systems and Technologies, comprising our legacy Huron Businesses, including Patient Support Systems, the Global Surgical Solutions and Front Line Care. Pharmaceuticals, which will include our current pharma portfolio the as well as our biopharma solutions business until its potential separation. And finally, Kidney Care comprising our current the Renal Care and Acute Therapies businesses.

Speaker 3

To reiterate, our intention subject to satisfaction of customary conditions the is to spin KineCare into an independent publicly traded company in the next 12 to 18 months. The Until then, this GBU will benefit from the strategic work we are doing right now, helping to hone a well focused and streamlined the entity in preparation for its anticipated launch as a standalone company. In this way, we can think of Baxter as having 4 GBU the structure or perhaps a 3 plus 1 GBU structure once the model is in place later this year. Each new GBU will have its own precedent. Reporting directly to me, each will have full global P and L accountability.

Speaker 3

We'll begin to realign our current 3 region global commercial structure. So the global commercial teams will report directly into each the GBU, the dedicated R and D manufacturing and supply chain and functional support teams will also be embedded the by GBU to optimize visibility and oversight. This new structure is designed to generate more direct, clear accountability across each business the and promote more agile decision making across sales, marketing, manufacturing, distribution and innovation. The So what you see upon completion of this process is that each of the GPUs will have more autonomy and agility than the current businesses do today. The GPUs will be able to respond to market dynamics faster and more effectively, accelerate commercial investments, design and produce products the and prioritize R and D spending, all to help meet critical market needs and accelerate business performance.

Speaker 3

From a manufacturing perspective, Baxter will become more nimble with manufacturing sites mapped directly to each GPU leading to an optimized manufacturing footprint in a more resilient supply chain. Preparation for the new operating model is the Already surfacing opportunities for streamlining and efficiency that are intended to further bolster the bottom line performance. The redesign being contemplated coupled with additional actions the company has undertaken to enhance performance the are expected to deliver more than $300,000,000 in total savings during 2023 and a workforce reduction of less than 5%. We plan to begin implementing our new operating model early in the second quarter. Looking the Ahead to 2023, more broadly, we expect to continue navigating a challenging operational environment.

Speaker 3

The Hand in hand with our transformation efforts, we have been taking a hard look at our forecasting models and processes As we reflect on our performance last year and the lessons learned in an era of unprecedented macroeconomic challenges, We have taken a stance of incorporating more potential downside risks into our financial outlook for 2023. The Jay will provide additional details on our outlook and various assumptions included. Before I pass it out to Jay, I want to close by the My confidence and optimism for the future and our commitment to continue to maintain the important work we do every day. Baxter holds a fundamental place in global healthcare with a durable portfolio of essential products, market leading positions the and passionate employees who bring our mission to life. We're setting out on a well considered plan to redefine our operations and potential the in pursuit of incremental long term value for the stakeholders and shareholders that rely on us.

Speaker 3

2023 the Now becomes a pivotal year. We are on our way to creating 2 leading healthcare companies with robust portfolios and strong market momentum. We look forward to sharing our progress and performance in the quarters to come. With that, I'll pass it over to Jay. The end of the call.

Speaker 4

Thanks, Joe, and good morning, everyone. Despite in line sales results, our 4th quarter earnings performance came in below our expectations. The This variance was primarily driven by foreign exchange losses and product mix in the quarter. As Joe mentioned, we're not satisfied with our results and as such the We're taking a number of actions to improve our performance. Some of these initiatives are already underway and will be further enhanced with the cost reduction program the We are in the process of finalizing in parallel with our operating model redesign.

Speaker 4

These actions are necessary and are expected to accelerate future performance. Collectively, these actions are expected to deliver more than $300,000,000 in savings in 2023. Turning to our financial performance. Q4 2022 global sales of $3,900,000,000 the quarter. Advanced 11% on a reported basis, 17% on a constant currency basis and 2% operationally.

Speaker 4

The sales performance in the quarter continues to underscore the strength of our broad portfolio of core therapy and connected care offerings the across the care continuum. As we've discussed previously, supply for select products remains constrained the And we estimate that these constraints impacted our revenues by approximately $50,000,000 in the quarter the quarter or approximately 140 basis points. These supply constraints are a mixture of electromechanical components the and shortages from other third party suppliers. On the bottom line, adjusted earnings decreased 15% to $0.88 per share the outside our guidance range of $0.92 to $0.99 per share. As mentioned earlier, this was due to unfavorable product mix and an the approximate $0.04 headwind from foreign exchange losses on balance sheet positions, primarily due to the devaluation of the Russian ruble the quarter.

Speaker 4

Now, I'll walk through performance by our regional segments and key product categories. Note that constant currency growth is equal to operational sales growth for all global businesses and Baxter's the 3 legacy geographic regions. Starting with sales by operating segment, sales in the Americas were flat to the prior year on a constant currency basis. The Sales in Europe, Middle East and Africa grew 5% on a constant currency basis and sales in our APAC region increased the 2% constant currency. Quarterly sales in the region reflected strength in geographic segment sales offset by relatively the flat growth in China due to the impact from various government based procurement initiatives being implemented in that market.

Speaker 4

The Moving on to performance by key product category, global sales for renal were $981,000,000 the Increasing 3% on a constant currency basis. Performance in the quarter was driven by solid growth in our PD business, the where we observed an increase in PD patients globally, particularly in the U. S, which saw a sequential improvement in growth of 100 basis points the end of the year with patient growth of approximately 4%. Mid single digit PD growth in the quarter the benefited from incremental revenues of nearly $20,000,000 resulting from a customer that was looking to build out a new business the and did not meet its contractual minimum purchase requirements. This arrangement has been terminated and the related revenues will not recur in future periods.

Speaker 4

The performance in the quarter was partially offset by lower in center HD sales due to HD monitor and associated consumable component supply the Challenges. Sales in medication delivery of $745,000,000 declined 2% on a constant currency basis. The performance in the quarter was affected by a difficult comparison to the prior year, which benefited from higher levels of infusion pump placements. The Demand remains strong for Baxter's smart infusion pumps and as we have discussed is currently outpacing our ability to supply Given continued challenges sourcing components, our IV therapy portfolio grew low single digits globally, Driven by strong demand internationally. During the quarter, we did not see pronounced impact from flu related cases, which although reported case numbers were high did not translate into increased hospital admissions.

Speaker 4

The Pharmaceutical sales of $552,000,000 declined 1% on a constant currency basis. The performance in the quarter reflected the continued impact of generic competition in the U. S, which was partially offset by increased demand for our drug compounding portfolio the Internationally. Moving to Clinical Nutrition, total sales were $243,000,000 increasing 6% on a constant currency basis. The performance in the quarter was driven by demand for our broad multi chamber bags and vitamin product portfolio.

Speaker 4

The Sales in Advanced Surgery were $260,000,000 advancing 8% on a constant currency basis. The Growth in the quarter reflects an improvement of elective procedures globally. Surgical volume recovery was strong across all regions. The Sales in our Acute Therapies business were $182,000,000 declining 3% on a constant currency basis the And reflecting a tough comparison to the prior year where we had experienced elevated demand for CRO T given the rise in COVID cases. The Biopharma Solutions sales in the quarter were $153,000,000 increasing 12% on a constant currency basis.

Speaker 4

The Demand for non COVID services more than offset the decline in COVID vaccine related revenue compared to the same period last year. The COVID vaccine sales for the quarter totaled $22,000,000 Legacy Hillron contributed $734,000,000 in sales in the quarter compared to $212,000,000 in the prior year period after the acquisition closed on December 13, 2021. The PILROM sales included $360,000,000 of sales in Patient Support Systems, dollars 293,000,000 of sales in Front Line Care the $81,000,000 of sales in Global Surgical Solutions. Legacy Hill Rom sales grew mid single digits on a pro form a and FX neutral basis the as compared to Q4 2021. This growth reflects demand for the physical assessment and cardiology portfolios within the frontline care business.

Speaker 4

The quarter. Within the quarter, we were able to secure some additional electromechanical components on the spot market, which enabled us to address the portion of the backlog associated with the Frontline Care business. Sales in Patient Support Systems declined low single digits in the quarter, primarily driven by lower rental revenues in the quarter as the prior year period benefited from more than $10,000,000 in sales due to COVID related rentals. Moving through the rest of the P and L, adjusted gross margin of 41.6% the decreased 2 70 basis points versus the prior year, reflecting increased cost of goods sold, primarily driven by the factors we've discussed the as a percentage of sales, an increase of 30 basis points versus the prior year, driven by the addition of Hill Rom as well as higher freight expenses. The Adjusted R and D spending in the quarter of $157,000,000 represented 4% of sales, the quarter.

Speaker 4

An increase of 10 basis points versus prior year. Both SG and A and adjusted R and D reflected a benefit from lower bonus accruals the under our annual employee incentive compensation plans, which are directly tied to Baxter's performance. These factors resulted in an adjusted operating margin in the quarter of 17.1%, a decrease of 3 10 basis points the quarter. Adjusted net interest expense totaled $117,000,000 in the quarter, the an increase of $73,000,000 versus the prior year driven by higher outstanding debt balances related to the acquisition of Hill Rom the quarter and the impact of interest rates on the variable rate debt. Adjusted other non operating expense totaled $12,000,000 in the quarter, the a decrease of $9,000,000 versus the prior year driven primarily by amortization of pension benefits.

Speaker 4

As I mentioned earlier, the non operating expenses were unfavorable to our expectations, primarily due to foreign exchange losses. The adjusted tax rate in the quarter was 16.1% as compared to 18.6% in the prior year period. The year over year decrease was primarily driven by statute expirations the uncertain tax positions partially offset by an increase due to a change in geographic earnings mix the Following the Hill Rom acquisition. And as previously mentioned, adjusted earnings of $0.88 per share declined 15% versus the prior year period. The earnings in the quarter reflected the increase of cost of raw materials freight and labor as well as the impact of rising interest rates and foreign exchange headwinds.

Speaker 4

Turning to full year 2022, sales of $15,100,000,000 increased by 18% on a reported basis, the 23% on a constant currency basis and 2% operationally. Legacy Hill Rom's Front Line Care, Patient Support Systems the and Global Surgical Solutions Businesses contributed $2,900,000,000 to full year sales on a reported basis. On a pro form a basis the After adjusting for foreign exchange, full year legacy Hill Rom sales were flat as compared to the prior year period, primarily reflecting the impact of supply constraints for electromechanical components. On the bottom line, Baxter's the adjusted earnings decreased 3% to $3.50 per diluted share, reflecting the impact we just highlighted. The call.

Speaker 4

On a full year basis, we generated operating cash flow from continuing operations of $1,200,000,000 and free cash flow of $532,000,000 the Throughout 2022, we remain focused on debt repayment following our Hill Rom acquisition with $900,000,000 paid towards deleveraging. The We also returned approximately $600,000,000 to shareholders through dividends and share repurchases. As we execute on our strategic actions outlined in the beginning of 2023, we are 1st and foremost committed to meaningfully improving our cash flow generation. Our priorities for cash deployment are focused on accelerating debt repayment, maintaining our dividend and resuming share repurchases over time. We are also actively pursuing strategic alternatives for our Biopharma Solutions business, while continuing to assess the additional inorganic growth vectors for products, therapies and Connected Care platforms for our new streamlined operations.

Speaker 4

The As we progress towards the proposed spin off of Kidney Care Company, we'll look to utilize proceeds from these actions to accelerate Baxter's debt repayment schedule. We remain committed to an investment grade credit rating profile, including taking actions towards achieving our previously stated commitment to achieve 2.75 times net leverage. Although current business conditions might challenge our ability to satisfy that commitment the end of 2024, we do expect to make significant progress towards achieving the target during 2023 2024. The Additionally, given the proposed spin off and potential sales of BPS, we expect to provide additional information Regarding our forward looking outlook for both Baxter RemainCo and KidneyCo at a Capital Markets Day prior to completion of the proposed spin off. The Let me conclude my comments by discussing our outlook for the Q1 and full year 2023 including some key assumptions underpinning our guidance.

Speaker 4

On the top line, 2023 is expected to benefit from underlying volume growth, the pricing actions taken last year as well as new product launches the Some of these new planned product introductions include more than 5 injectable drug launches, the next gen ICU bed, Exactimate's pro nutrition compounder, continued rollout of Novum IQ LVP and Syringe Pump in Canada and launch of the Novum IQ Syringe Pump in the U. S. At this time, our 2023 guidance does not contemplate any U. S. Revenues for the Novum IQ large volume infusion pump.

Speaker 4

We anticipate submission of our final responses to FDA within the quarter. We continue to be very excited about the prospect of this launch the benefits it offers our customers. Our objective remains to launch this pump in 2023. Throughout 2022, demand for our products and therapies remained solid, but supply chain challenges impacted our ability to fully supply this demand. We experienced record levels of back orders and backlog, particularly for the legacy Hill Rom business.

Speaker 4

The And while we observed positive developments in supply availability in the Q4 of 2022, we currently anticipate the component availability will remain challenging and will continue to hamper top line sales in 2023. We are working relentlessly to secure components and address order backlog and our expectation is that supply for electromechanical components the will improve in the second half of the year. As Joe outlined, we're implementing a series of changes across our organization that ours is designed to meaningfully simplify the operating model and manufacturing footprint, drive strategic the model and manufacturing footprint drive strategic clarity, improve operational efficiencies and accelerate future growth. The In addition to consolidating our operations into 4 vertically integrated global business units, we're also evaluating additional strategic actions, the including potential product line and country exits to better position the company for more profitable growth over the mid to long term. These exits are expected to reduce sales by more than $100,000,000 as compared to full year 2022.

Speaker 4

The end of the quarter. Lastly, as it relates to the top line 2022 results included approximately $140,000,000 of sales they're not expected to repeat in 2023 as well as the benefit of approximately $50,000,000 due to lower customer rebate costs. This includes lower COVID vaccine revenue of approximately $100,000,000 and 2 contractual payments, Which benefited Renal Care sales by approximately $40,000,000 in the second half of twenty twenty two. Moving on to dynamics impacting the rest of the P and L. The First, I want to point out a couple of factors that are impacting our 2023 performance as compared to 2022, such as higher annual incentive compensation payments for employees, increased interest expense and a higher tax rate assumption.

Speaker 4

The In addition, while we see some improvement in the external macro environment with select indices coming down from the peaks seen last year, expected to be a headwind compared to 2022. This is due to the rollout in the first half of twenty twenty three of manufacturing related costs the Capitalizing to inventory in the second half of twenty twenty two as well as the challenging comparison to the first half of twenty twenty two. The prior to the start of significant increases in inflation, we expect the impact from these inflationary pressures to begin to ease in the second half of the year. The Also, as mentioned earlier, in response to the significant macro challenges the company has experienced over the last 2 years, We will be implementing a cost reduction program in parallel with our operating model redesign that is expected to be finalized later this quarter. This initiative and additional actions the company has undertaken to enhance performance are expected to deliver more than 300,000,000 the in total savings during 2023.

Speaker 4

These savings are expected to increase over the course of the year with a majority of the savings being realized in the second half of the year. The lower cost of goods coupled with the increased savings are expected to drive meaningful margin expansion and earnings growth In the second half of the year as compared to the first half, we also expect the impact from foreign exchange to lessen in the second half of the year. The end of the call. Finally, as Joe mentioned, with respect to our outlook for 2023, we bias our guidance towards capturing additional potential downside risks. We recognize that our performance last year disappointed investors and us alike.

Speaker 4

While we are confident the actions we are undertaking will set us on course for the improved performance longer term. We have recognized that 2023 will be a transition year on our path to achieving this objective. Incorporating all of these factors, I'll now walk through our guidance and expectations. For full year 2023, we expect global sales growth of 1% to 2% on a reported basis and flat to 1% growth on a constant currency basis. We expect full year adjusted operating margin to be between 15% 16%.

Speaker 4

Interest expense is expected to total approximately 530,000,000 which reflects past and potential future rate increases and adjusted tax rate of approximately 22% and a diluted average share the Based on these dynamics, we expect 2023 adjusted earnings excluding special items the of $2.75 to $2.95 per diluted share. Specific to the Q1 of 2023, We expect global sales to decline by approximately 3% on a reported basis and approximately 1% on a constant currency basis. The We expect adjusted earnings excluding special items of $0.46 to $0.50 per diluted share. With that, we can now open the call up for Q and A.

Operator

Thank you. We will now begin the question and answer session. The start one again. 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 the one question with one follow-up question if necessary.

Operator

We appreciate everyone's patience and would like to provide as many of you as possible the opportunity to ask a question. We'll pause for 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. And we'll go to our first question from Pito Chickering at Deutsche Bank.

Speaker 5

The Hey, good morning. Thanks for taking my questions. I guess, the first one is going to be on the operating margin compression. I guess, details on what the the quarter. What is between SG and A, cost of sales and R and D?

Speaker 5

And can you point to the biggest pressure points in the gross margins? Is it diesel, resin, microchips, labor? I think investors understand the macro pressures we're facing you guys. It's been challenging to understand how these macro pressures flow through the P and L. So any color there would be great.

Speaker 4

The Sure. And is your question in reference to 2023 or Q4 2022 or what period are you referring to?

Speaker 5

Oh, apologies. This is all for 2023, 15% to 16% operating margin that you guys referenced.

Speaker 4

Sure, sure. The So overall, we are seeing increased pressure on operating margin in the Q1 and throughout the 2023. And a lot of that relates to supply chain costs that we've incurred in the second half of the year the start to roll out into 2023. And as we think about the timing of those pressures, really it's most the prominent in the Q1 of the year. So we'll have a trough margin in the Q1 of the year and then it starts to accelerate from there moving forward.

Speaker 4

The As we think about where the impacts are,

Speaker 1

it is as

Speaker 4

I say largely related to gross margin although Because of freight costs, we do see some incremental SG and A costs that show up throughout the year. And like I say, it starts to much more normalize By the Q4 of next year.

Speaker 5

Okay. And then when you have your talks to your customers about increased pricing, I guess, any color on how those are going? And what is your overall pricing view in 2023 versus 2022? And then if you break out the gross margins from pharma specifically, do they have any outsized movement in your pricing for 2023? The

Speaker 3

Peter, I will take the price question overall and Jay can give a little bit more detail. We the are able to put price through where we can and we see price being neutral to a slight positive in 2023 the For the company, obviously, we have long term contracts. As these contracts become available for negotiation, we will have the viewpoint in how we're going to put in escalation for inflationary pressures the way we just saw them in 2021 2022. So in terms of the how that more specific about your question, Jay can come from that.

Speaker 4

Sure. Overall, the Pricing is a net positive as we look at the year. So there is some benefit that we've reflected based on all the work that we've conducted over the last year along with the Some existing contractual arrangements. There is some negative pricing pressure in pharma that offsets a higher number excluding the impact of the pharma business.

Speaker 1

The Great. Thanks so much.

Operator

We'll take our next question from Robbie Marcus at JPMorgan.

Speaker 1

The end.

Speaker 6

Great. Good morning and thanks for taking the questions. Jay, maybe to I think it'd be helpful for everyone to try and get a sense of what's conservatism in the guide with some of the new philosophy you talked about, what's and what's actually being contemplated. There's $300,000,000 in cost savings, but the margin is down as you just talked about. So really just help us understand What are some of the negative assumptions in there that you're putting in to help add more cushion on the bottom after the 2022 the cadence.

Speaker 4

Sure. Listen, as I mentioned in my prepared remarks, Robbie, we were disappointed with performance the in 2022, clearly. And frankly, as we reflect back, it was a highly volatile and dramatic environment that we were faced with and that we were operating through over the course of the year. As we put together guidance for this year, I would say a couple of things. We've taken levels In terms of indices as they currently sit today, we've reflected continued supply constraints And things like electromechanical components.

Speaker 4

And then in addition to that, we've added margin of safety In terms of contingency to offset, which is why you see a much wider range than we've had previously. I would add to that, we've also done things like taken out the LVP pump. We're really optimistic about the large volume pump the getting approved this year. We're working very closely with FDA towards achieving that goal. But from a guidance standpoint, We've removed $100,000,000 related to sales for that product.

Speaker 4

And so I'm hopeful the that these assumptions prove conservative and that by the end of the year, we're looking at a very different world in terms of indices, the electromechanical component availability and it really sets the stage up for a nice second half and a nice 2024, We'll continue to watch these very carefully. Part of the issue as we look at the 2022 to 2023 the The rollout of the very significant manufacturing costs that we've incurred this year. And so we have a big headwind that we're faced there. The Offsetting that is $300,000,000 worth of savings. Now that's not all incremental based on the new model.

Speaker 4

What I would tell you is approximately $200,000,000 of that or so relates to previously discussed or identified initiatives, including the Hill Rom synergies. There's roughly $100,000,000 related to the new program that we put in place that will be reflected in our numbers. So really that's the overall story. The We've tried to take all of the learnings as we look at volatility and those items and reflect it as we put it together. The

Speaker 6

Great. And Jay, how should we think about cash flow going through the year here and how it will the play out in 2023 relative to 2022. Will these cost savings actually cost Money in 'twenty three to achieve or do you think you could see cash flow improve despite the lower margins? Thanks.

Speaker 4

The Sure. Robbie, we have an intense focus on cash flow. And I will tell you that the financial performance in 2022 was challenging. And certainly the free cash flow performance reflected those challenges. As we move to next year, my expectation is that free cash flow will more than double relative to the 2022 level.

Speaker 4

And a lot of that has to do with the quarter. Improvements in working capital balances. If you look at the working capital balances as I currently said, today's inventory on hand the has expanded over the course of the year in large part due to missing components and having our plans run sub optimally, the longer lead times for products leading to disruptions of our supply chain, longer shipping lanes, all of those those things have led to a higher days inventory on hand. Additionally, from a receivable standpoint, because of the cadence of sales, we actually had very strong sales in December, leading to a higher receivables balance than we would normally have relative to prior years. And finally, due to timing of some vendor payments, our payables balance came in low.

Speaker 4

So our clear expectation is each of these categories will improve and by along with careful CapEx management, our expectation is more than doubling free cash flow. The Because like I said, at the end of the day, that's an important valuation metric for us. In addition to that, it's an important incentive compensation metric for us.

Speaker 1

The end.

Speaker 7

Appreciate it. Thanks a lot.

Operator

We'll go next to Vijay Kumar at Evercore ISI.

Speaker 8

The Hey, guys. Thanks for taking my question. My first one, Joe and Jay, for you guys on revenues. If I go back to the 3rd quarter commentary of 4% organic growth assumptions for fiscal 2023, The updated guidance here is reflecting a 3 50 basis points change. The Now I understand product exits and pumps are incremental, right?

Speaker 8

That's maybe 100, 150 basis points impact. The Can you help us bridge what changed from that 4 to the 50 basis points, because I feel like vaccine headwinds, These were known as of the Q3 call last year. Are you contemplating some incremental supply chain headwind here on revenues or what changed from that, the 4%?

Speaker 4

The Sure. Vijay, let me walk through that specifically. To your point, we have a reduction from the 4%, which we talked about on the earnings call to flat to 1%. And there's really a few primary drivers of that. And interestingly, a lot of those impacts will be confined to 2023, which I think is really good news as we look at setting the stage for 2024.

Speaker 4

It begins with the large volume pump. And this in my view, this is really about conservatism on the sales guide. We've taken out $100,000,000 relative to our prior expectations, roughly 70 basis points of growth relative to that 4%. The The second item relates to the weighted average market growth. If you reflect back on our January 6 the call.

Speaker 4

We talked about a slight lowering of the wamaker of our markets on a compounded basis. But interestingly, a lot of that impact is most prominent and in fact, in some cases confined the to 2023. What I mean by that is, are the renal mortality issue that we face with that we've been faced with the really collides into 2023. In addition to that, the acute growth challenge really is a 2023 impact. The And then some of the capital assumptions that we've made, which again is another area we hope to prove conservative is really focused on 2023.

Speaker 4

So as we approached year end and refreshed our view of patient census of expectations into 2023, We did lower the WAMAGR for 2023 by approximately 100 basis points, which is included In the commentary that we made on January 6. In addition to that, we're looking very carefully at the profitability by product line. At the end of the day, we're ensuring that every dollar in every market is a profitable one and a cash flowing one for Baxter. So we have made the decision to exit approximately $100,000,000 or 70 basis points worth of sales. And then we did have roughly $50,000,000 shift from 2023 to 2022.

Speaker 4

And I did make some commentary on this And so listen, we obviously don't like to lower expectations on the sales line. But what I take part in is the fact that the Many of these impacts are not sustainable impacts, but are rather discrete to 2023. The And we'll expect to see acceleration from there. In the case of the pumps, let's watch carefully how that evolves over the course of the year.

Speaker 8

The Understood. That's helpful, Jay. And then one on margins here. I think your prior commentary was 75 basis points of margin expansion And the current guidance is a decline of 150 basis points at the midpoint. So that's a 2 25 basis points change.

Speaker 8

Maybe can you bridge us through what's changed versus your prior expectations, where the impact is coming from? And Is this current guidance including any dis synergies from spin or is that an incremental headwind as we think about fiscal 2024? The

Speaker 4

Sure. So overall, with respect to operating margins, we do now anticipate a reduction as you pointed out. And I would say that there are a few drivers of that. First, the lower sales outlook, the end of the quarter. When you think about things like absorption, some of the higher margin areas, the lower sales outlook the does have an impact of $0.40 to $0.50 in earnings with an attendant operating margin impact.

Speaker 4

Secondly, I point to supply chain headwinds that impact the first half of the year most prominently. And these are incremental to what we previously said. As we went through the Q4, we were still purchasing electronic components the at much higher levels than we anticipated. The spot market was very challenging. So things like that led to incremental costs the that roll out into the first half of the year.

Speaker 4

And then we do have some benefits related to the incremental savings program And FX is a modest headwind overall. As we look at operating margin, it's basically flat, maybe a little bit of a Maybe it's basically flat as we look at the bottom line. And so those are the factors that impact the operating margin. The But Vijay, I do want to make a really important point as we think about the cadence of the story that occurs over the course of the year. The first half of the year will be a challenging operating margin story as I've discussed.

Speaker 4

But as we start to benefit the from indices that currently sit at today's levels in the product that we sell in the second half of the year as we start to benefit the from more electronic component availability and we only reflected modest very cautious improvements in this area in the second half the And as we add incremental sales to the second half as we always do, the second half margin starts to look a lot nicer the And a lot more consistent with the trajectory that we expect to see. As far as the synergies and incremental costs and so on, From a cash flow standpoint, we've included roughly $100,000,000 in our cash flow statement. There is maybe $0.03 or so of non adjusted impact in the P and L for things that are sub optimized as it relates to the the So a modest impact in that regard. We've reflected that. It's a bigger impact from a free cash flow standpoint.

Speaker 4

I've discussed this with a number of you already. The So I think we've got that correctly modeled. And like I said, I think the operating margin story really does start to look a lot better as we approach Q3.

Speaker 8

The Understood. Thanks guys.

Operator

We'll go next to Matt the mic I apologize, Matthew Mishan with KeyBanc.

Speaker 7

Thank you for taking the question. How are you guys looking at R and D into the end of 2020 3. Do you have the flexibility to kind of speed up some projects, especially in a transition year like this that they set you up for better growth in 2024 2025?

Speaker 4

We have earmarked some R and D dollars, in particular for some of the Hill Rom portfolio And some of the connected areas there in frontline care in particular. I will say that as we look at the next question comes from the line of the Hill Rom acquisition. It's a really tremendous one long term and we're talking the Once we've resolved the supply constraints, last year growth was essentially flat. We're seeing we're expecting mid single digit growth in the Hill Rom portfolio this year in the face of continued supply constraints. And part of that comes from new products.

Speaker 4

We'll launch a new ICU bed as I referenced in my prepared remarks. But to your point, Matt, There are some really interesting opportunities that will protect investment for as we go forward. And I think that should start to accrue to the benefit Frankly, both companies in 2024 and beyond. Yes.

Speaker 3

I just want to compliment that we are planning for double digit the R and D increase in 2023 versus 2022, and we're going to do no, probably this cadence year over year, we found some debt. The Q1 portfolio, primarily Parts in Connected Care, will receive the a significant portion of our increase in research and development. This is one of the things that we discussed in the thesis the The separation of the kidney code was the ability to allocate capital to the right places. So if you look forward to batch, there will be the Significant investment in connected devices as well as smart devices. So you look at continuation once We get through the large volume parental pump approval is the next generation of integration of the pump and safety software.

Speaker 3

And you'll see us in Q3 launching the Progressive Plus. So really making solid our position in the So there's quite a bit of change in how we've seen the R and D, we think innovation is a path forward for Baxter and the way to do it is actually to do what we're doing in 2023 and allocating dollars On a double digit growth to that line.

Speaker 7

Okay. And then if I heard you right, I think you said a 22% tax rate for 2023. What's changing there? And then is that the go forward tax rate for the core backs for moving forward?

Speaker 4

The Sure. We could have some one time and planning benefits accrued to 2022. And then as we look at the 2023, we included things like sort of modified assumptions related to FAS 123R benefits among other things. So it's hard to say what the go forward is beyond 2023. I think we've got it correctly pegged.

Speaker 4

The Well, the tax team is hard at work. I mean, I know many of them listening to this call, looking at planning ideas for 2022. The But as we look beyond that, so much of this will depend on the setup of the 2 new companies that it's very challenging for me to comment specifically the in this forum around the tax rates for the 2 companies, but 22% is a good number for this year.

Speaker 1

The Thank you.

Operator

We'll take our next question from Matt Miksic at Barclays. The

Speaker 1

end. Hi, thanks so much for fitting me in. So I wanted to just follow-up on where things stand with the integration and sort of synergies for Hillam. Maybe, Jay, if you could talk a little bit about the next question comes from the line of John. How some of the inflationary pressures, energy costs, etcetera, have weighed on that business and whether this sort of the change in componentry and supply chain is something that you expect to kind of be able to sustain here in the first half or is that still sort of the Copy and then I had one follow-up.

Speaker 4

Sure. So from an integration standpoint, I would say overall the integration the Going very well. We had the disruption last year and that disruption has continued all the way through the Gene, today in terms of electromechanical component availability, the ability to procure at reasonable prices, All of those things has been very disruptive to the initial stages of the Hill Rom acquisition. But having said that, the We're very pleased with where we currently sit and the path forward. I commented moments ago, flat growth last year, the Largely driven by supply constraints, ex supply constraints, we would have seen nice mid single digit growth.

Speaker 4

We start to see some of that normalize, but we do see residual the impacts from supply chain into 2023. But despite that, we're talking about mid single digit growth this year. The From a cost synergy standpoint, we're ahead of our expectations. And in the numbers that we've reported, there's a clear benefit the I'm included for Hill Rom integration. And then as we look forward, I think we have a lot of optimism about the portfolio, the interaction with Baxter products And where we can take this going forward.

Speaker 4

And maybe I'll turn it over to Joe to talk a little bit about some of

Speaker 3

the things that we've seen there. Yes. We have the pre rich pipeline of products starting with progressive lung. As I said, it's going to really put Baxter the continued production of very solid leadership position in the pet market. Our Centrala pet has done the Great job and it's a product that continues to sell well.

Speaker 3

When you look at Frontline Care, that business could have grown double digits easily in 2022 as well as in 2023. We're planning for Hill Rom as a whole to grow around 4%, the North of that if the components become more available. We're starting to see the thawing of that market, primarily frontline care starting to see more components coming. We just look at that in the month of January, which we're able to see some of that coming through. And also the innovation pipeline coming out of those the Two businesses look really good and the connected devices, what we call care communications, we see good backlog coming into nurse call systems As well installation of both, we see in the first half of the year a little bit depression in that as the nursing the Shortages continue to apply pressure in hospitals and also the macroeconomic indexes make the hospitals be more cautious, but we see that improving in the second half.

Speaker 3

So you look at the market for capital improving the second half, you look at the product launches that we have coming up. And the pipeline of innovation coming out of Huron is very exciting. Further to that, we're putting more money the into research and development in 2023 disproportionate into Huron to accelerate the growth of that business.

Speaker 1

The Super helpful. And if I could, just maybe at a high level, Joe, you touched on some of these things the just now, but I think most folks are looking at the guide as more conservative than folks were expecting. And the I think you get that and I think so because we'll be able to just sketch out the script for today, the They might have recommended something like that given the struggles that the company and the sector really has had in energy and technology and everything last year. The So maybe with that in mind, if this is kind of sort of rebasing and taking all these things into account, what are some of the things that you think could kind of potentially present some bright spots and the Inflationary pressures that you're seeing, what are some of the things that you say could possibly go well or better this year?

Speaker 3

The Listen, when I look at 2023, coming from 2022, we saw the Incredible pressure in our manufacturing base. If you think about us, we're disproportionately Affected by the significant increase in energy cost, transportation, remember, Baxter's transportation the As a percentage of sales, it's the high single digits. And if you go into some of our markets, it's even higher than that for some of the renal products. So the What I think is remarkable is how we're able to get very quickly once we start seeing those things coming up so fast. We went on the other hand, we have created significant programs to offset, but offset is not what transforms.

Speaker 3

What transforms Baxter the is the amount of automation that we are putting into our manufacturing operations, the amount of plants we're going to be able to consolidate because of that. And this is all will take place in 12 to 24 months. We're also looking at disproportional allocation of capital into the businesses they are connected and have the possibility for growth. The market is very anxiously waiting for our pump. We feel optimistic where we are with the pump today.

Speaker 3

We don't speak on behalf of the FDA, neither we're making a prediction about that, but we're Saying that we're enthusiastic because we know the product is doing very well in Canada. We just closed another few 1,000 pumps deal in one of the provinces. So we are excited about the portfolio. So when I looked all in all, 2023 is the year that the They have 2 different stories. The first half is a story of paying for some of the incremental cost and significant cost that we had in 'twenty two coming through the inventory, selling of the inventory that was produced with that incremental cost.

Speaker 3

I see the second half of the year becoming the more focus on what Baxter used to be, which is time to see leverage of the bottom line in bringing back the things the They used to be part of BAPSA, but this crisis brought to surface a lot of weaknesses in some of our supply chain operations. And while we took the opportunity the was to regroup and understand how to modify this permanently and take away some of this variability from our future. I'm going to get out the of being in the resin based business, no, but we're going to make sure that our plants are in the right place, our plants are automated And we have the ability to get really efficiency out of our system. So the cost reductions that we're putting for instance until Into 2023 are over $300,000,000 So that efficiency will pan out in 'twenty four with another $300,000,000 in the 24 come into our supply chain. So all those things that we're doing is a transition year for Bassons, one that we reset, We regroup, look at our portfolio, restructure our capital structure with the selling of BPS, Getting debt to help us take the debt down, but also feel future inorganic tuck in opportunities.

Speaker 3

So this is the year that Baxter will execute in its final stage of the transition that started 7 years ago.

Speaker 1

The Super helpful. Thank you.

Operator

We'll take our final question from Lawrence Bagelson at Wells Fargo.

Speaker 9

The Good morning. Thanks for taking the question. Jay, maybe it would be helpful to give us an update on the stand up the cost and the stranded cost is the right assumption about 1% of the respective company the sales and the one time disentanglement cost of 3% to 4% of total company sales. What's the timing on that? And will some of that impact non GAAP earnings?

Speaker 9

And any Jay, I mean, you know it's early, but people are looking at 24 for valuation. Any framework on Could margins get back to 2022 levels?

Speaker 1

Thanks.

Speaker 4

Sure. No commentary yet on 2024. We are Incredibly focused on delivering 2023 period. And we do believe That there are some discrete headwinds that we're facing in 2023 that abate in 2024 or go completely away. So as Joe commented just moments ago, we're really excited about where this thing goes into the future As evidenced by what happens in the second half of the year as we look at the operating margin of the company.

Speaker 4

So I We're very optimistic, but at this point, I have to stand down in terms of giving multiyear guidance. As it relates the Stand up costs and the synergy or one time costs. Stand up costs for NewCo, we said around 1% to 2%. No real adjustments at this point. From a one time cost, we've commented previously on the higher end of the 3% to 4% precedents that we've seen.

Speaker 4

But you're seeing some of that in the numbers that we shared today. Specifically, we have roughly $100,000,000 in cash related cost that impact cash flow, but much of that is either CapEx or non GAAP, so to speak. The And so in our non GAAP results, we have roughly $0.03 of impact costs related to this program in the numbers that we shared today. So that's really how we're looking at it in 2023. The cash is a very real cost.

Speaker 4

And to my comments earlier in relation to Robbie Marcus' question, the For us, cash flow is a crucial and important area of focus for us in 2023. So those are very real costs. But as it relates to what's impacting the P and L, It's a couple, dollars 2, dollars 3.

Speaker 9

Hey, Jay, that's helpful. Just let me ask one quick one here. The backlog and backorders, Can you quantify those and do you expect to get those back over time? We have seen some companies report Q4 results where we've Some benefit from those coming through. Thanks for taking the questions guys.

Speaker 4

Sure. I won't get into too much specifics on this. We do have Some benefit from improvement in backlog where we have clear line of sight. And so We have reflected a little bit of that in our numbers. But what I will tell you is in the plan that we've reflected here today, there continues to be supply constraints on what we could otherwise sell.

Speaker 4

And so once we have line of sight to freeing up the full year of electronic components among other key inputs will hopefully modify that assumption the to the better, but at this point in time, there is still some backlog that exists over the course of the year. And we did comment in the prepared remarks on continued impacts in the Q4. The Yes, I just I

Speaker 3

would add that I would add the backlog. We're starting to see some movement, positive movement in the Semiconductors, primarily frontline care, we're starting to see that. And that is very encouraging to us. But I think the It is early to take a victory lap here. I think our supply chain folks have done a lot of work.

Speaker 3

However, we're starting to See this progress coming through, hopefully continues on and we can actually in the next quarter speak more about the positive

Operator

the call. Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for participating.

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Earnings Conference Call
Baxter International Q4 2022
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