Baxter International Inc. (NYSE:BAX) Q4 2022 Earnings Call Transcript February 9, 2023
Operator: Good morning ladies and gentlemen and welcome to Baxter International’s Fourth Quarter 2022 Earnings Conference Call. 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.
Clare Trachtman: 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 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 will 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% at 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 full year sales of $15.1 billion advanced 18% on a reported basis, 23% at 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 Hillrom 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 weighing 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 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 Baxter businesses. These are 3 distinct initiatives with a single agenda, increase stakeholder impact with improved long-term shareholder value. Cutting across these actions are common goals, enhancing refining strategic clarity, increased 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 Baxter 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 4 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. Hillrom businesses, including Patient Support Systems, Global Surgical Solutions and Front Line 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 used to spin Kidney Care into an independent publicly traded company in the next 12 to 18 months.
Until then, this GBU 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 stand-alone company. In this way, we can think of Baxter as having 4 GBU 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 President, reporting directly to me. Each will have full global P&L accountability. We will begin to realign our current 3 region global commercial structures. 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 restructure 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, 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, Baxter will become more nimble with manufacturing sites mapped directly to each GBU 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 expect 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 effort. 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 the stance of incorporating more financial 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 in our commitment to continue to maintain the important work we do every day. Baxter holds a fundamental place in global health care, with a durable portfolio of essential products, market-leading position 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 — to leading health care 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.
James Saccaro: 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, in Baxter’s 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. 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 U.S. which saw a sequential improvement in growth of 100 basis points and ended 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 quarter was partially offset by lower in-center HD sales due to HD monitor and associated consumable component supply challenges.
Photo by Christopher Boswell on Unsplash
Sales in 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’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. Pharmaceutical sales of $552 million declined 1% on a constant currency basis.
Performance in the quarter reflects the continued impact of generic competition in the U.S. 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 bags and vitamins product portfolio. Sales in Advanced Surgery were $260 million, advancing 8% on a constant currency basis. Growth in the quarter reflects an improvement of electric 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 Solutions 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 Hillrom 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. Hillrom sales included $360 million of sales in Patient Support Systems, $293 million of sales in Front Line Care and $81 million of sales in Global Surgical Solutions. Legacy Hillrom 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 Front Line 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 Front Line 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 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 Hillrom 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 Hillrom and the impact of interest rates on the variable rate debt. Adjusted other nonoperating expense totaled $12 million in the quarter, a decrease of $9 million versus the prior year, driven primarily by amortization of pension benefits.
As I mentioned earlier, nonoperating expenses were unfavorable to our expectations primarily due to foreign exchange losses. The adjusted tax rate in the quarter was 16.1% compared to 18.6% in the prior year period. The year-over-year decrease was primarily driven by statute expirations on certain tax positions, partially offset by an increase due to a change in geographic earnings mix following the Hillrom 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 Hillrom’s Front Line Care, Patient Support Systems and Global Surgical Solutions businesses contributed $2.9 billion to full year sales on a reported basis. On a pro forma basis and after adjusting for foreign exchange, full year legacy Hillrom 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 impacts 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 Hillrom acquisition with 900 million paid boards 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 BioPharma 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 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 2.75x 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 spin-off and potential sale 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. 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 5 injectable drug launches, a next-gen ICU bed, ExactaMix Pro, Nutrition Compounder, continued rollout of our 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. 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 remained 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 Hillrom business. And while we observed positive development and 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 4 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 2 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 a challenging comparison to the first half of 2022 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. 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 million in total savings during 2023. These savings are expected to increase over the course of the year, with the 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 force for 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% and 16%.
Interest expense is expected to total approximately $540 million which reflects pass and potential future rate increases and 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 $0.46 to $0.50 per diluted share. With that, we can now open the call up for Q&A.
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