Good morning ladies and gentlemen and welcome to Baxter International's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] 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. Clare 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 Almedia, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer. On the call this morning, we will be discussing Baxter's fourth quarter and full year 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 and our SEC filings for more detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand 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, adjust for the impact of foreign exchange and the acquisition of Hillrom. Now, I'd like to turn the call over to Joe. Joe? José Almeida: Thank you, Clare 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 road map we announced on January 6. These actions, further outlined in this morning's press release, will help…

Thanks, Joe and good morning, everyone. Despite in line 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 of $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,…

[Operator Instructions] And we'll go to our first question from Pito Chickering at Deutsche Bank.

So I guess the first one is going to be on the operating margin expression. I guess, details on what the split is between SG&A, cost of sales and R&D. 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 for facing you guys, it's been challenging to understand how these macro pressures flow through the P&L? Any color there would be great.

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

Apologies; this is all for 2023. A 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 in 2023. And a lot of that relates to supply chain costs that we've incurred in the second half of the year that start to roll out into 2023. And as we think about the timing of those pressures, really is 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, 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 would 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 gross margins from pharma specifically, do they have any outsized movement in your surprising for '23. José Almeida: Peter, I'll take the price question overall and 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 slight positive in 2023 and for the company. Obviously, we have long-term contracts. As these contracts become available for negotiation will 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 the -- how that more specific about your question, Jay can comment.

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.

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

Great. 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 the new philosophy you talked about. What's -- 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 taking 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 million of that or so relates to previously discussed or identified initiatives, including the Hillrom 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. We've tried to take all of the learnings as we look at volatility and those items and reflected 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?

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. 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 sit, the days inventory on hand has expanded over the course of the year, in large part due to missing components and having our plans run sub-optimally, 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 by -- 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.

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

My first one, Joe and Jay, for you guys on revenues. If I go back to the third quarter commentary of that 4% [ph] organic growth assumptions for fiscal '23. The updated guidance here is reflecting a 350 basis point change. And I understand product exits in pumps or incremental rate, that's maybe 100, 150 basis points impact. 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 third quarter call last year. Are you contemplating some incremental supply chain headwind here on revenues? Or 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, roughly 70 basis points 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 WAMGR 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 face with -- that we've been faced with really collide 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 6. 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 to 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 call. 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 many of these impacts are not sustainable impacts but are rather discrete to 2023. And then 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.

Understood. That's helpful, Jay. And then one on margins here. I think your prior commentary was 75 basis points on 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? Is this current guidance including any dis-synergies from spin? Or is that an incremental headwind as they think throughout 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. When you think about things like absorption, some of the higher-margin areas, the lower sales outlook does have an impact of $0.40 to $0.50 in earnings with an attending operating margin impact. Secondly, I'd 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 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 suboptimized as it relates to the spin. 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. 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.

We'll go next to Mike -- I apologize. Matthew Mishan with KeyBanc.

How are you guys looking at R&D into 2023? Do you have the flexibility to kind of speed up some projects, especially in the transition 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 Hillrom portfolio and some of the connected areas there in Front Line Care, in particular. I will say that as we look at the opportunities presented by the Hillrom acquisition, it's a really tremendous one long term. And we're talking -- 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 Hillrom 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 will 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. José Almeida: Yes. I just want to complement that we're planning for double-digit R&D increase in 2023 versus 2022. And we're going to do -- no, probably this cadence year-over-year. We found some debt in the Hillrom portfolio, primarily parts in Connected Care will receive a significant portion of our increase in research and development. This is one of the things that we discussed in the thesis of the separation but KidneyCo was the ability to allocate capital to the right places. So if you look forward to Baxter will be significant investment in connected devices as well as smart devices. So, you look at continuation once we get through the large volume rental pump approval is the next generation of integration of the pump and safety software. And you'll see us in Q3 launching the progressive FLOSEAL, really making solid our position in terms of market leader in beds. So there's quite a bit of change in how we've seen R&D. We think innovations a path forward to 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 Baxter moving forward?

Sure. We did have some onetime and planning benefits accrued to 2022. And then as we look at 2023, we included things like sort of modified assumptions related to FAS 123R benefits, among other things. And so it's hard to say what to go-forward is beyond 2023. I think we've got it correctly pegged. We'll -- the tax team is hard at work and I know many of them, coming 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 2 new companies that it's very challenging for me to comment specifically in this forum around the tax rates for the 2 companies but 22% is a good number for this year.

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

I wanted to just follow up on where things stand with the integration and sort of synergies for Hillrom. 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 be able to sustain here in the first half? Or is that still sort of choppy? And then I have one follow-up.

Sure. So from an integration standpoint, I would say, overall, the integration is going very well. We had a 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 Hillrom 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. Ex-supply constraints, we would have seen nice mid-single-digit growth. We start to see some of that normalize 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, we're ahead of our expectations. And in the numbers that we've reported, there's a clear benefit included for Hillrom 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. José Almeida: Yes. We have a pretty rich pipeline of products, starting with progressive FLOSEAL. As I said, it's going to really put Baxter -- continued probation of a very solid leadership position in the PET market. our Centrella bed has done a great job and is a product that continues to sell well. When we look at our Front Line Care, that business could have grown double digits easily in 2022 as well as in 2023. We're planning for Hillrom as a whole to grow around 4%. It could be north of that if few components become more available. We're starting to see that showing up the market, primarily from like [indiscernible] to see more components coming. We just look at them in the month of January. We're able to see some of that coming through. And also the innovation pipeline coming out of those 2 businesses look really good. And the Connected Devices, what we call care communications. We see good backlog coming into Nurse Call System as well as installation of Voalte. We see in the first half of the year a little bit depression in that as the nursing shortages continue to apply pressure the 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. We look at the product launches that we have coming up. And the pipeline of innovation coming out of Hillrom is very exciting. Further to that, we're putting more money into research and development in 2023 disproportionately into Hillrom to accelerate the growth of that business.

That'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 more conservative than folks were expecting. And I think you get that and I think we'll be able 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, 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 and upside as we kind of get into -- from the year, getting to kind of a turning point in the business, turning point in some of the inflationary pressures that you're seeing? What are some of the things that you say could possibly go well or better this year? José Almeida: Listen, 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 the high single digits. And 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 have created significant programs to offset -- the offset is not what transformed, what transforms Baxter is the amount of automation that we are putting into our manufacturing…

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

Jay, maybe it would be helpful to give us an update on the standup cost and the stranded cost. Is the right assumption about 1% of the respective company sales and the onetime 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 -- 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?

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. So we're very optimistic. But at this point, I have to stand down in terms of giving multiyear guidance. As it relates to standup costs and dis-synergy or onetime costs, stand-up costs for NewCo, we've said around 1% to 2%. No real adjustment at this point. From a onetime 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 shared today. Specifically, we have roughly $100 million in cash-related costs that impact cash flow but much of that is either CapEx or non-GAAP, so to speak. 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. And the cash is a very real cost. And to my comments earlier, in relation to Robbie Marcus question, 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&L, it's a couple $0.02, $0.03.

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 seen some benefit from those coming through.

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, we'll 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. José Almeida: Yes, just I would add that the backlog. We're starting to see some movement -- positive movement in semiconductors, primarily Front Line 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 that, that can plus. Thank you.

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