Baxter International Inc.

Good morning, ladies and gentlemen, and welcome to Baxter International's fourth quarter 2022 earnings conference call. Your lines will remain in a listen-only mode until the question and answer segment of today's call. At that time, if you have a question, you will need to press star 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 Trachtman, Vice President, Investor Relations at Baxter International. Ms. Trachtman, you may begin.

Good morning, and welcome to our fourth quarter 2022 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer, and and Jay Saccaro, Vector's Chief Financial Officer. On the call this morning, we will be discussing Vector's fourth quarter and full year 2022 financial results, along with our financial outlook for 2023. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the first quarter 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. And of course, our actual results could differ materially from our current expectations. Please refer to today's press release in 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 Baxter's 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. On the call this morning, we will be discussing operational sales growth, which for the fourth quarter and full year 2022 adjusts for the impact of foreign exchange in the acquisition of Hill Round. Now I'd like to turn the call over to Joe. Joe?

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 performance for the quarter and year, and then provide some additional information on the strategic roadmap 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-responsive 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'll close with Q&A. Starting with our financial results, sales for the fourth quarter 2022 were $3.9 billion, growing 11% on a reported basis, 17% a constant currency, and 2% on an operational basis. Fourth quarter adjusted earnings per share were $0.88, came in below our expectations, primarily driven by foreign exchange losses and product mix in the quarter. For the four-year sales of $15.1 billion, advanced 18% on a reported basis, 23% at a constant currency, and 2% on an operational basis. Adjusted earnings per share for the year were $3.50. Jay will provide more granularity on the numbers, but some themes are clear. Demand across our portfolio remains solid, and sales rose across the majority of our legacy Baxter and Huron businesses. Offsetting modest or expected declines in others driven by factors such as generic competition or challenging year-over-year comparisons. As we've discussed previously, this top line growth was offset by a wave of macroeconomic and supply chain factors that has continued to put pressure on the cost of doing business. And as I have stressed many times, we will never pursue reduced costs in ways that could compromise our fundamental mission to save and sustain lives. But even factoring in these headwinds, we did not perform at the level we expected and demand of ourselves. And our ability to advance our mission is grounded first and foremost in our capacity to deliver steady, solid performance as a sustainable economy. corporate enterprise. This is precisely why earlier this year we announced plans to accelerate our transformation journey. The actions we announced on January 6 and are expanding on today are as necessary as they are timely. As I shared in January, we spent the latter part of 2022 undertaking a comprehensive review of our operations, focused keenly on opportunities to improve our commercial responsiveness. reinvigorate our innovation engine, and streamline our operations. This work led to last month's announcement of our intention to spin off a new kidney care company, explore options for our biopharma solutions, contract manufacturing business, and implement a new operating model for our remaining bachelor businesses. These are three distinct initiatives with a single agenda, increased stakeholder engagement, impact with improved long-term shareholder value. Cutting across these actions are common goals. Enhance and refine strategic clarity, increase accountability and line of sight, enhance agility, and bring our global businesses even closer to the patients, clinicians, and customers they serve. Today, I will share the next level of detail on the Backstreet business model we expect to begin implementing next quarter. This work entails a fundamental reconfiguration of how we operate and deliver products to the customers and markets we serve. This new operating model is focused on four vertically integrated global business units or GBUs 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 medical products and therapies comprising our current medication delivery, advanced surgery, and clinical nutrition portfolios. Healthcare systems and technologies comprising our legacy heroine businesses, including patient support systems, global surgical solutions, and frontline care. pharmaceuticals, which will include our current pharma portfolio, as well as our biopharma solutions business until its potential separation. And finally, kidney care comprising our current renal care and acute therapies businesses. To reiterate, our intention subject to satisfaction of customary conditions is to spin kidney care into an independent, publicly traded company in the next 12 to 18 months Until then, this GBO will benefit from the strategic work we are doing right now, helping to hone a well-focused and streamlined entity in preparation for its anticipated launch as a standalone company. In this way, we can think of Baxter as having four GBO structure, or perhaps a three plus one GBO structure once the model is in place later this year. Each new GBU will have its own president reporting directly to me. Each will have full global P&L accountability. We'll begin to realign our current three-region global commercial structure, so the global commercial teams will report directly into each GBU. The dedicated R&D manufacturing and supply chain and functional support teams will also be embedded by GBU to optimize visibility and oversight. This new structure is designed to generate more direct, clear accountability across each business and promote more agile decision-making across sales, marketing, manufacturing, distribution, and innovation. So what you see upon completion of this process is that each of the GBUs will have more autonomy and agility than the current businesses do today. GBUs will be able to respond to market dynamics faster and more effectively, accelerate commercial investments, design and produce products, and prioritize R&D spending, all to help meet critical market needs and accelerate business performance. From a manufacturing perspective, Baxo 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 already surfacing opportunities for streamlining and efficiency that are intended to further bolster bottom-line performance. The redesign being contemplated coupled with additional actions the company has undertaken to enhance performance are expected to deliver more than $300 million 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 ahead to 2023, more broadly, we expect to continue navigating a challenging operational environment. 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. Jay will provide additional details on our outlook and various assumptions included. Before I pass it out to Jay, I want to close by reinforcing my confidence and optimism for the future and our commitment to continue doing 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, and passionate employees who bring our mission to life. We're setting out on a well-considered plan to redefine our operations and potential in pursuit of incremental long-term value for the stakeholders and shareholders that rely on us. 2023 now becomes a pivotal year. We are on our way to creating two 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.

Thanks, Joe, and good morning, everyone. Despite inline sales results, our fourth quarter earnings performance came in below our expectations. 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, 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 that we are in the process of finalizing in parallel with our operating model redesign. These actions are necessary and are expected to accelerate future performance. Collectively, these actions are expected to deliver more than $300 million in savings in 2023. Turning to our financial performance, fourth quarter 2022 global sales, $3.9 billion, advanced 11% on a reported basis, 17% on a constant currency basis, and 2% operationally. Sales performance in the quarter continues to underscore the strength of our broad portfolio of core therapy. and connected care offerings across the care continuum. As we've discussed previously, supply for select products remains constrained, and we estimate that these constraints impacted our revenues by approximately $50 million in the quarter, or approximately 140 basis points. These supply constraints are a mixture of electromechanical components and shortages from other third-party suppliers. On the bottom line, adjusted earnings decreased 15% to $0.88 per share outside our guidance range of $0.92 to $0.99 per share. As mentioned earlier, this was due to unfavorable product mix and an approximate $0.04 headwind from foreign exchange losses on balance sheet positions, primarily due to the devaluation of the Russian ruble during the quarter. 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 three legacy geographic regions. Starting with sales by operating segment, sales in the Americas were flat for the prior year on a constant currency basis. Sales in Europe, Middle East, and Africa grew 5% on a constant currency basis. and sales in our APAC region increased 2% constant currency. Quarterly sales in the region reflected strength in geographic segment sales offset by relatively flat growth in China due to the impact from various government-based procurement initiatives being implemented in that market. Moving on to performance by key product category, global sales for renal were $981 million increasing 3% on a constant currency basis. Performance in the quarter was driven by solid growth in our PD business, where we observed an increase in PD patients globally, particularly in the US, which saw a sequential improvement in growth of 100 basis points and end of the year with patient growth of approximately 4%. Mid-single-digit PD growth in the quarter benefited from incremental revenues of nearly $20 million, resulting from a customer that was looking to build out a new business and did not meet its contractual minimum purchase requirements. This arrangement has been terminated, and the related revenues will not recur in future periods. Performance in the corridor was partially offset by lower in-center HD sales due to HD monitor and associated consumable component supply challenges. Sales and medication delivery of $745 million declined 2% on a constant currency basis. Performance in the quarter was affected by a difficult comparison to the prior year, which benefited from higher levels of infusion pump placements. Demand remains strong for Baxter smart infusion pumps, and as we have discussed, it's currently outpacing our ability to supply, giving 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. Pharmaceutical sales of $552 million declined 1% on a constant currency basis. Performance in the quarter reflected the continued impact of generic competition in the US, which was partially offset by increased demand for our drug compounding portfolio internationally. Moving to clinical nutrition, total sales were $243 million, increasing 6% on a constant currency basis. Performance in the quarter was driven by demand for our broad multi-chamber bag and vitamin product portfolio. Sales in advanced surgery were $260 million, advancing 8% on a constant currency basis. Growth in the quarter reflects an improvement of elective procedures globally. Surgical volume recovery was strong across all regions. Sales in our acute therapies business were $182 million, declining 3% on a constant currency basis and reflecting a tough comparison to the prior year. where we had experienced elevated demand for CRRT given the rise in COVID cases. Biopharma solution sales in the quarter were $153 million, increasing 12% on a constant currency basis. Demand for non-COVID services more than offset the decline in COVID vaccine-related revenue compared to the same period last year. COVID vaccine sales for the quarter totaled $22 million. Legacy Hill ROM contributed $734 million in sales in the quarter compared to $212 million in the prior year period after the acquisition closed on December 13, 2021. Hill ROM sales included $360 million of sales in patient support systems, $293 million of sales in frontline care, and $81 million of sales in global surgical solutions. Legacy Hill ROM sales grew mid-single digits on a pro-forma and FX-neutral basis, as compared to Q4 2021. This growth reflects demand for the physical assessment and cardiology portfolios within the frontline care business. Within the quarter, we were able to secure some additional electromechanical components on the spot market, which enabled us to address a portion of the backlog associated with the frontline care business. Sales and patient support systems declined low single digits in the quarter, primarily driven by lower rental revenues in quarter as the prior year period benefited from more than 10 million in sales due to COVID-related rentals. Moving through the rest of the P&L, adjusted gross margin of 41.6%, decreased 270 basis points versus the prior year, reflecting increased cost of goods sold, primarily driven by the factors we've discussed around inflation, freight, and supply chain constraints. Adjusted SG&A of $797 million represented 20.5 as a percentage of sales, an increase of 30 basis points versus the prior year, driven by the addition of HILROM as well as higher freight expenses. Adjusted R&D spending in the quarter of $157 million represented 4% of sales, an increase of 10 basis points versus prior year. Both SG&A and adjusted R&D reflected a benefit from lower bonus accruals 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 310 basis points versus the prior year. Adjusted net interest expense totaled $117 million in the quarter, an increase of $73 million versus the prior year driven by higher outstanding debt balances related to the acquisition of HILROM and the impact of interest rates on the variable rate debt. Adjusted other non-operating expense totaled $12 million and a quarter, a decrease of $9 million versus the prior year driven primarily by amortization of pension benefits. As I mentioned earlier, 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 explorations on certain tax positions, partially offset by an increase due to a change in geographic earnings mix following the Hill-Rom acquisition. And as previously mentioned, adjusted earnings of $0.88 per share declined 15% versus the prior year period. 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. Turning to full year 2022, sales of $15.1 billion increased by 18% on a reported basis, 23% on a constant currency basis, and 2% operationally. Legacy Hill ROM's frontline care patient support systems and global surgical solutions businesses contributed $2.9 billion to full-year sales on a reported basis. On a pro-form basis and 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 adjusted earnings decreased 3% to $3.50 per diluted share, reflecting the impact we just highlighted. On a full year basis, we generated operating cash flow from continuing operations of $1.2 billion and free cash flow of $532 million. Throughout 2022, we remain focused on debt repayment following our Hill ROM acquisition with $900 million paid towards deleveraging. We also returned approximately $600 million to shareholders through dividends and share repurchases. As we execute on our strategic actions outlined in the beginning of 2023, we are first 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 BioPharm Solutions business while continuing to assess additional inorganic growth factors for products, therapies, and connected care platforms for our new streamlined operations. As we progress toward the proposed spinoff 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 by the end of 2024, we do expect to make significant progress towards achieving the target during 2023 and 2024. Additionally, given the proposed spinoff and potential sale of BPS, We expect to provide additional information regarding our forward-looking outlook for both Baxter Remain Co. and Kidney Co. at a capital markets day prior to completion of the proposed spinoff. Let me conclude my comments by discussing our outlook for the first quarter and full year 2023, including some key assumptions underpinning our guidance. 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 across our GBUs. Some of these new planned product introductions include more than five injectable drug launches, a next-gen ICU bed, Xactimix Pro Nutrition Compounder, continued rollout of our Nohum IQ LVP and syringe pump in Canada, and launch of the Nohum IQ syringe pump in the U.S. At this time, our 2023 guidance does not contemplate any U.S. revenues for the Nohum IQ large volume infusion pump. We anticipate submission of our final responses to FDA within the quarter. We continue to be very excited about the prospect of this launch and the benefits it offers our customers. Our objective remains to launch this pump in 2023. Throughout 2022, demand for our products and therapies remain solid. but supply chain challenges impacted our ability to fully supply this demand. We experienced record levels of backorders and backlog, particularly for the legacy Hill Run business. And while we observed positive developments in supply availability in the fourth quarter of 2022, we currently anticipate 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 will improve in the second half of the year. As Joe outlined, we're implementing a series of changes across our organization that are designed to meaningfully simplify the operating model and manufacturing footprint, drive strategic clarity, improve operational efficiencies, and accelerate future growth. In addition to consolidating our operations into four vertically integrated global business units, we're also evaluating additional strategic actions, 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 million as compared to full year 22. Lastly, as it relates to the top line 2022 results, included approximately 140 million of sales that are not expected to repeat in 2023, as well as the benefit of approximately $50 million due to lower customer rebate costs. This includes lower COVID vaccine revenue of approximately $100 million and two contractual payments, which benefited renal care sales by approximately $40 million in the second half of 2022. Moving on to dynamics impacting the rest of the P&L, 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. In addition, while we see some improvement in the external macro environment with select indices coming down from the peaks seen last year, our cost base is still elevated relative to historic norms. As such, cost of goods sold is expected to be a headwind compared to 2022. This is due to the rollout in the first half of 2023 of manufacturing-related costs capitalized into inventory in the second half of 2022, as well as the challenging comparison to the first half of 2022, prior to the start of significant increases in inflation. We expect an impact from these inflationary pressures to begin to ease in the second half of the year. Also, as mentioned earlier, in response to the significant macro challenges the company has experienced over the last two 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 million in total savings during 2023. 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. Finally, as Joe mentioned, with respect to our outlook for 2023, we biased our guidance towards capturing additional potential downside risks. We recognize that our performance last year disappointed investors and us alike. While we are confident the actions we are undertaking will set us on course for improved performance longer term, we recognize 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% and 16%. Interest expense is expected to total approximately $530 million, which reflects past and potential future rate increases, an adjusted tax rate of approximately 22%, and a diluted average share count of 508 million shares. Based on these dynamics, We expect 2023 adjusted earnings excluding special items of $2.75 to $2.95 per diluted share. Specific to the first quarter of 2023, we expect global sales to decline by approximately 3% on a reported basis and approximately 1% on a constant currency basis. And we expect adjusted earnings excluding special items of 46 to 50 cents per diluted share. With that, we can now open the call up for Q&A.

Thank you. We will now begin the question and answer session. If you have a question, please press the star 1 key on your touchtone phone. If you wish to remove yourself from the queue, press the star 1 again. If you are using a speakerphone, please lift a 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'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.

Hey, good morning. Thanks for taking my question. I guess the first one is going to be on the operating margin compression. I guess details on what the split is between SG&A, cost of sales on R&D. And can you point to the biggest pressure points on 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&L. So any color there would be great.

Sure. Pito, is your question in reference to 23 or Q4 22 or what period are you referring to?

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

So overall, we are seeing increased pressure on operating margin in the first quarter and throughout 2023. And a lot of that relates to supply. half of the year that start to roll out into 2023. And as we think about the timing of those pressures, really it's most prominent in the first quarter of the year. So we'll have a trough margin in the first quarter of the year, and then it starts to accelerate from there moving forward. As we think about where the impacts are, you know, it is, as I say, largely related to gross margin, although because of freight costs, we do see some incremental SG&A costs that show up throughout the year. And like I say, it starts to much more normalize by the fourth quarter of next year.

Okay, and then when you have your talks to your customers about increased pricing, I And what is your overall pricing view in 2023 versus 2022? And then if you break out gross margins from pharma specifically, do they have any outsized movement in your pricing for 2023?

Pedro, I will take the price question overall, or Jay can give a little bit more detail. We are able to put price through where we can, and we see price being neutral to a slight positive in 2023. for the company. Obviously, we have long-term contracts. As these contracts become available for negotiation, we'll have a different viewpoint in how we're going to put in escalation for inflationary pressures the way we just saw them in 21 and 22. So in terms of how that more specific about your question, Jake can complement. Sure.

Overall, 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 some existing contractual arrangements. There is some negative pricing pressure in pharma that offsets a higher number, excluding the impact of the pharma business.

Great. Thanks so much.

We'll take our next question from Robbie Marcus at J.P. Morgan.

Great. Good morning, and thanks for taking the questions. Jay, maybe to start, 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, and what's actually being contemplated. There's $300 million in cost savings, but 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 cadence? Sure.

Listen, as I mentioned in my prepared remarks, Robbie, we were disappointed with performance 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 in things like electromechanical components. 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 getting approved this year. We're working very closely with FDA towards achieving that goal. But from a guidance standpoint, we've removed $100 million related to sales for that product. And so I'm hopeful 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, electromechanical, component availability, and it really sets the stage up for a nice second half and a nice 2024. But we'll continue to watch these very carefully. Part of the issue as we look at the 2022 to 2023 is 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. Offsetting that is $300 million worth of savings. Now, that's not all incremental based on the new model. What I would tell you is approximately 200 of that or so relates to previously discussed or identified initiatives, including the Hill-Rob Synergies. There's roughly $100 million related to the new program that we put in place that will be reflected in our numbers. So really, that's the overall story. You know, 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.

Great. And, Jay, how should we think about cash flow going through the year here and how it will play out in 23 relative to 22? Will these cost savings actually cost money in 23 to achieve, or do you think you could see – cash flow improve despite the lower margins? Thanks.

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 And a lot of that has to do with improvements in working capital balances. If you look at the working capital balances, as I currently said, the day's inventory on hand has expanded over the course of the year, in large part due to missing components and having our plans run suboptimally, longer lead times for products leading to disruptions of our supply chain, longer shipping lanes. All of 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. So our clear expectation is each of these categories will improve And along with careful capex management, our expectation is more than doubling free cash flow. 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.

Appreciate it. Thanks a lot.

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

Hey, guys. Thanks for taking my question. My first one, Joe and Jay, for you guys on revenues, if I go back to the third quarter commentary of 4% organic growth assumptions for fiscal 23, the updated guidance here is reflecting a 350 basis points change. Now I understand product exits and pumps are incremental, right? That's maybe 100, 150 basis points impact. But can you help us bridge that? What changed from the four to the 50 basis points? Because I feel like vaccine headwinds, these were known as of the third quarter call last year. Are you contemplating some incremental supply chain headwind here on revenues? What changed from the 4%? Sure.

Vijay, let me walk through that specifically. To your point, we have a reduction from 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. 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 million relative to our prior expectations. of growth relative to that 4%. The second item relates to the weighted average market growth. If you reflect back on our January 6 call, we talked about a slight lowering of the whamager of our markets on a compounded basis. But interestingly, a lot of that impact is most prominent, and in fact, in some cases, confined to 2023. What I mean by that is the renal mortality issue that we've been faced with really collides into 2023. In addition to that, the acute growth challenge really is a 2023 impact. 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. And so as we approach year end, and refreshed our view of patient census of expectations into 2023. We did lower the WAMGR for 2023 by approximately 100 basis points, which is included in the commentary that we made on January 6th. In addition to that, we're looking very carefully at 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. And so we have made the decision to exit approximately 100 million or 70 basis points worth of sales. And then we did have roughly $50 million shift from 2023 to 2022. And I did make some commentary on this in the calls. And so, listen, we obviously don't like to lower expectations on the sales line. But what I take heart in is the fact that many of these impacts are not sustainable impacts, but are rather discreet to 2023. And we'll expect to see acceleration from there. In the case of the pumps, you know, let's watch carefully how that evolves over the course of the year.

Understood. That's helpful, Jeff. And then one on margins here. I think the 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 225 basis points change. Maybe can you bridge us to what's changed versus your prior expectations, where the impact is coming from? And, you know, is this current guidance including any disenergies from spin, or is that an incremental headwind as we think about fiscal 24?

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. You know, when you think about things like absorption, some of the higher margin areas, the lower sales outlook does have an impact of 40 to 50 cents in earnings with an attendant operating margin impact. 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 fourth quarter, we were still purchasing electronic components at much higher levels than we anticipated. The spot market was very challenging. So things like that led to incremental costs that roll out into the first half of the year. 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. 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. First half of the year will be a challenging operating margin story, as I've discussed. But as we start to benefit 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 from more electronic component availability. And we only reflected modest, very cautious improvements in this area in the second half. And as we add incremental sales to the second half, as we always do, the second half margin starts to look a lot nicer 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 million in our cash flow statement. There is maybe $0.03 or so of non-adjusted impact in the P&L for things that are sub-optimized as it relates to the spend. So a modest impact in that regard. We've reflected that. It's a bigger impact from a free cash flow standpoint. I've discussed this with a number of you already. And so I think we've got that correctly modeled. And like I say, I think the operating margin story really does start to look a lot better as we approach Q3.

Understood. Thanks, guys.

We'll go next to Matthew Michon with KeyBank.

Thank you for taking the question. How are you guys looking at R&D into 2023? Do you have the flexibility to kind of speed up some projects? especially in a transition year like this, that sets you up for better growth in 2024 and 2025?

We have earmarked some R&D dollars, in particular for some of the Hill Run portfolio and some of the connected areas there and frontline care in particular. I will say that, you know, as we look at the opportunities presented by the Hill-Rom acquisition, it's a really tremendous one long-term. And we're talking, you know, once we've resolved the supply constraints, last year growth was essentially flat. We're seeing, we're expecting mid-single growth, 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. 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 we'll protect investment for as we go forward. And I think that should start to accrue to the benefit of, frankly, both companies in 2024 and beyond.

Yeah, I just want to compliment that we're planning for double digits here. r d increase in 2023 versus 2022 and we're going to do it now probably this cadence year over year we found some uh um that the hill rom portfolio primarily parks in connect in connected care um will will receive a significant portion of our increase in research and development this is one of the things that we discuss in the thesis of the separation, the kidney code, was the ability to allocate capital to the right places. So if you look forward to Baxter, it will be 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. And you'll see us in Q3. launching the Progressive Plus, so really making solid our position in terms of market leader in embeds. So there's quite a bit of change in how we've seen R&D. We think innovation is the best forward for Baxter, and the way to do it is actually to do what we're doing in 23 and allocating dollars on a double-digit growth to that line.

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 Moonsword?

Sure. We did have some one-time and planning benefits accrued to 2022. And then as we looked at 2023, you know, we included things like sort of modified assumptions related to FAS 123R benefits, among other things. And so it's hard to say what the go-forward is beyond 2023. I think we've got it correctly pegged. The tax team is hard at work, and I know many of them to this call, looking at planning ideas for 2022. But as we look beyond that, so much of this will depend on the setup of the two new companies that it's very challenging for me to comment specifically in this forum around the tax rates for the two companies. But 22% is a good number for this year.

Thank you.

We'll take our next question from Mike Sick at Barclays.

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 Hill Law. Maybe, Jay, if you could talk a little bit about how some of the inflationary pressures, energy costs, et cetera, have weighed on that business and whether this sort of change in componentry and supply chain is something that you expect to kind of able to sustain here in the first half, or is that still sort of choppy and then I had one follow-up? Sure.

So from an integration standpoint, I would say overall the integration is going very well. We had the disruption last year, and that disruption has continued all the way through today in terms of electromechanic 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, we're very pleased with where we currently sit and the path forward. I commented moments ago, flat growth last year, largely driven by supply constraints. At supply constraints, we would have seen nice mid-single-digit growth. We start to see some of that normalized, but we do see residual impacts from supply chain into 2023. But despite that, we're talking about mid-single-digit growth this year. From a cost synergy standpoint, you know, we're ahead of our expectations. And, you know, in the numbers that we've reported, there's a clear benefit 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. And maybe I'll turn it over to Joe to talk a little bit about some of the things that we've seen there.

Yeah, we have a pretty rich pipeline of products, starting with Progressive Floods. As I said, it's going to really put Baxter, continue to put Baxter in a very solid leadership position in the pet market. Our Centrella pet has done a great job and it's a product that continues to sell well. When you look at frontline care, that that business could have grown double digits easily in 2022, as well as in 2023. We're planning for Hill Rum as a whole to grow around 4%, could be north of that if the components become more available. We're starting to see the thawing of the market, primarily frontline care, starting to see more components coming. We just looked at that in the month of January, we were able to see some of that coming through. And also the innovation pipeline coming out of those two businesses look really good and they're connected. devices, what we call care communications. We see good backlog coming into nurse call systems as well as installation of VOTE. We see in the first half of the year a little bit of depression in that as the nursing shortages continue to apply pressure in hospitals. And also the macroeconomic indexes make hospitals be more cautious, but we see that improving in the second half. So you look at the market for capital, improving the second half, and look at the product launches that we have coming up. And the pipeline of innovation coming out of Hiram is very exciting. Further to that, we're putting more money into research and development in 2023, disproportionately into Hiram to accelerate the growth of that business.

It's super helpful. And if I could just maybe at a high level, Joe, you touched on some of the things just now, but I think most folks are looking at the guide and, you know, more conservative than folks were expecting. And I think you get that. And I think folks will be able to to sketch out the script for today, 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. 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 upside as as we kind of get into from here get into kind of a turning point and the business turning point some of the inflationary pressures that we're seeing you know what where you know what are some of the things that you say you know could could possibly go well or better this year listen um when i look at 2023 coming from 2022 we saw an 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 as a percentage of sales is a high single digits. And you go into some of our markets, it's even higher than that for some of the renal products. So 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 had created significant programs to offset, but offset is not what transforms. What transforms Baxter 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 also... looking at this proportional allocation of capital into businesses that 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. We don't speak on behalf of the FDA. Neither are we making a prediction about that, but we're saying that we're enthusiastic because we know the product's doing very well in Canada. We just closed another few thousand pumps deal in one of the provinces. So we are excited about the portfolio. So when I look, all in all, 23 is the year that has two different stories. The first half is the story of paying for some of the incremental costs and significant costs that we had in 22 coming through the the inventory, selling of the inventory that was produced with that incremental cost. I see the second half of the year becoming more focused on what Baxter used to be, which is starting to see leverage of the bottom line in bringing back the things that used to be part of Baxter. But this crisis brought to surface a lot of weaknesses in some of our supply chain operations. And while we took the opportunity 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 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, into 2023 are over $300 million. That efficiency will pan out in 24 with another $300 million in 24 coming to our supply chain. So all those things that we're doing is a transition year for vaccines. One that we reset, we regroup, look at our portfolio, restructure our capital structure with the selling of BPS, getting that to help us take the debt down, but also feel future inorganic tuck-in opportunities. So this is the year that Baxter will execute in its final stage of the transition that it started seven years ago.

Super helpful. Thank you.

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

Good morning. Thanks for taking the question. Jay, maybe it would be helpful to give us an update on the stand-up cost and the stranded cost. Is the right assumption about 1%? of the respective company 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? And any, you know, Jay, I mean, you know it's early, but people are looking at 24 for valuation. Any framework? Can margins get back to 2022 levels? Thanks.

Sure. No commentary yet on 2024 costs. 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, you know, what happens in the second half of the year as we look at the operating margin of the company. So I, you know, we're very optimistic, but at this point I have to stand down in terms of giving multi-year guidance. As it relates to stand-up costs and to synergy or one-time costs, Stand-up costs for NUCO, we've set 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% precedence that we've seen. But you're seeing some of that in the numbers that we share today. Specifically, we have roughly $100 million in cash-related costs that impact cash flow. But much of that is either CapEx or cash. non-GAAP, so to speak. And so in our non-GAAP results, we have roughly three cents 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. And to my comments earlier in relation to Robbie Marcus's question, for us, cash flow is a crucial and important So those are very real costs. But as it relates to what's impacting the P&L, it's a couple, two, three cents.

AJ, that's helpful. Just let me ask one quick one here. The backlog and back orders, 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 seen some benefit from those coming through. Thanks for taking the questions, guys.

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. And so once we have line of sight to freeing up of electronic components among other key inputs, will hopefully modify that assumption 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 fourth quarter.

Yeah, I would add the backlog. We're starting to see some movement, positive movement in semiconductors, primarily frontline care. We're starting to see that. and that is very encouraging to us, but I think it is early to take a victory lap here. I think our supply chain folks have done a lot of work. 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 tailwind of Deccan Plus. Thank you.

Thank you.

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