Good morning, ladies and gentlemen, and welcome to Baxter International's Second Quarter 2022 Earnings Conference Call. Your line will remain in a listen-only mode until the question-and-answer segment of today's 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 your conference.

Good morning, and welcome to our second quarter 2022 earnings conference call. Joining me today are Joe Almeida, 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 second quarter 2022 financial results and our full-year financial outlook for 2022. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the third quarter and full-year 2022 and our 2022 to 2025 long range plans, the recent acquisition of Hillrom, new product development, the potential impact of proposed pricing actions, business development and regulatory matters contains 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 adjusts 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 your joining today's call. I will begin with an overview of the macroeconomic factors that have and will continue to impact our performance in 2022. I will then provide some commentary on the second quarter. Jay will take a closer look at our financials and outlook, after which we will open up…

Thanks, Joe. And good morning, everyone. As Joe mentioned, we're continuing to navigate a dynamic and ever-changing macro environment. This near-term volatility has created certain challenges for our business, and led us to lowering our full-year outlook. But we're committed to working through these headwinds and delivering on our long-term commitments off this new base. Most importantly, demand for our Baxter products remain strong and our integrated supply chain and commercial teams are working tirelessly to get products in the hands of our customers and patients to fulfill our mission. Turning to our financial performance. Second quarter 2022 global sales of $3.7 billion advanced 21% on a reported basis, 26% constant currency, and 3% operationally. As the US dollar strengthened over the quarter, foreign exchange negatively impacted reported sales by approximately 500 basis points. And as Joe mentioned, sales within the quarter were constrained due to lack of both raw materials and component availability, particularly as it relates to electromechanical components. Second quarter sales were also impacted by a lack of hospital access, which is needed to install select products, particularly in our patient support systems product category. We estimate these constraints negatively impacted sales by over 300 basis points in the quarter. Compared to the prior-year period, operational sales grew 3%, reflecting a gradual recovery in hospital admission rates and elective surgeries, strength in our medication delivery and nutrition businesses and solid growth in PD. On the bottom line, adjusted earnings increased 9% to $0.87 per share, falling within our guidance range of $0.86 to $0.89 cents per share. 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 operational segment,…

[Operator Instructions]. Our first question comes from Robbie Marcus.

Jay and Joe, there's a lot of moving pieces. And we just had the Analyst Day in May. So I was hoping maybe you can bucket for us the biggest changes from when you first gave guidance in January, EPS is now about a 15% lower. How should we think about the biggest impacts? How many are transitory? And how much of that is, would you say, more semi-permanent or permanent?

I'll start by answering this question in relation to the guidance that we shared in April. And then I'll add some additional commentary as it relates to what changed since May. Because I think that's perhaps the easiest way to do it. Q2 from an earnings standpoint largely came in line with our expectations. And the complexion of that was a bit different. But, really, the big driver of this relates to the second half of the year, where we're reducing the outlook by over $0.45. And I think there are a few different component pieces to this. First of all, from a commercial sales standpoint, we have had serious constraints related to electromechanical components, along with other raw materials. The result of that is our Hillrom business is off over $100 million in sales, in large part because of these constraints. We're also seeing some pharma pricing that's been challenging on the Baxter side. So, in combination, the commercial sales has impacted us roughly $0.15, maybe a little bit more than that, with the lion's share of that impact related to product shortage and component shortages. Now, on the offset side to that, we are offsetting that with lower spending, lower bonus accruals, and so the work that we're doing in terms of P&L preservation is offsetting that miss and it's also offsetting a $0.05 FX headwind in the second half of the year. The major impact comes down to headwinds that we're experiencing in our integrated supply chain. We have a roughly $0.45 impact in the second half of the year, and it's across a number of factors. Higher fuel rates and freight, roughly $0.15 of impact. Some of this has to do with the decoupling that was described between diesel prices and the price of oil that…

And maybe just as a follow up, Jay, at the Analyst Day that you talked about in the new LRP that you think – floor of 75 basis points and margin expansion, I guess would be the floor over the LRP. Do you think that still holds, given the new environment? Or there may be some changes to that comment?

We do. Robbie, we went through an analytic exercise based on the evolution of the environment over the last four to six weeks. We went through an analytic exercise and we looked at, first of all, the overall quantum of improvement over the LRP, that 350 to 400, the expected sales compounded growth rate of 4% to 5%, along with the free cash flow conversion. We looked at all of that. In addition, we looked at 2023 and the statements that we made. We validated all of those statements, that those are intact, relative to where things currently sit. So, based on the challenging environment that we've experienced, I was pleased that we're able to confirm that at this point. Listen, if European gas gets shut off in the winter, if that situation exacerbates and takes a further toll, a further step down on the supply chain, who knows what will happen? But as we sit here today, based on what we know and the current rates and the current expectations around chips and so on, we feel good about the long range plan commitment, albeit starting off the lower base.

Vijay Kumar of Evercore is on the line with a question.

Jay, just off of those last comments you just made on affirmation of LRP plan, I think the LRP had 350 to 400 basis points of margin expansion. I guess my question is expansion over what baseline? Are we looking at 2022 as the baseline? I think the updated guide implies 17.5% op margins. If you could just clarify that thing, that'll be helpful.

The updated LRP is off the lower base. So, it was a relative improvement from 2022. Vijay, the factors that I listed, the $0.45, I suspect that a number of them will be transitory, okay? But as we've thought about the modeling, we really don't have enormous easing of some of these constraints that we've seen. So, let's see how that evolves over time. But for now, what we're able to do is confirm the growth against this lower level.

One for Joe. Joe, these electronic components shortages, et cetera, some of your peers are seeing some alleviation. And I guess, from a Street perspective, the fear is, is this what we're seeing in Hillrom? Is this a CapEx slowdown, right? Based on your comments, it feels like this is not a demand issue and there is a potential for a catch up based on your comments on backlog and order book. Maybe talk about why this is not a demand issue, why you're confident about the outlook for Hillrom and the business? José Almeida: Vijay, when we look at Baxter, let me take this in two portions. We have experienced significant shortages of semiconductors. And the semiconductors – and sometimes, we all read in the news, the semiconductor business may alleviate as consumer goods will decline due to recession, potential recession, inflation and so forth. We as a company and many, many people in the medical devices use chips that are not the same chips used in consumer goods, and that varies by nanometers. You probably know this as well. We use thicker chips, chips that have embedded software. Our suppliers – we have a half a dozen suppliers. And one of these suppliers has been a real problem. And coincidentally, this supplier is one that supplies most of our frontline care products. This is not an issue in our [indiscernible] but more so into our frontline care. And also affects our ability to make Sigma Spectrum pump, as Jay mentioned. So, we need to separate that. So when it comes to capital, we have not seen a widespread change in demand. What we saw in the second quarter are fewer accounts that moved the implementation and the justification was more on staff shortages and the ability to really…

Pito Chickering of Deutsche Bank is on the line with a question.

The first one is on the CapEx side. You talked about seeing some delays from customers who are pushing out orders on CapEx spending. Is this a [indiscernible] Hillrom, I guess any color you can give us on what parts of your book business you're seeing those delays of CapEx.

A lot of this comes down to staffing availability. I think that's been the primary driver that we've seen in terms of – we've seen a bit of an expansion in terms of installations on our care solution. So hospital beds, care communication, some of those items, it's taking longer – the installation process has been taken longer as a result of some of the staffing shortages that we've outlined in the prepared remarks. And then, Joe, again – we don't see at this stage a substantive change to the appetite for capital at hospitals. But we're watching this very carefully. And we're watching to ensure that the delays that we're seeing are related to staffing versus budget constraints or something like that. We've tried to take a cautious forecast through the balance of the year, which protects us in the event that there's some further shortage impacts. But that's what we said. Now as far as pumps, we're not selling an enormous number of pumps, in large part because of the constraints on electromechanical components. So, that's a huge challenge that we're faced with until we resolve that at some point here in the future. José Almeida: As a matter of fact, we have significant demand for pumps. We just cannot take the orders and we cannot make the products because we don't have the semiconductors going in. But I want to also to underscore what Jay said. When it comes to capital, capital is not the same for every hospital system. The hospital systems, they are large, they have the capacity to move forward. So we are observing very rapidly what is happening. So, is this postponement of capital issue or supply or staffing issues. Right now, the information that we have is a staffing issue, and those are the smaller accounts that we saw in the second quarter. We have large installations coming in third and fourth quarter, will be a telling point how those go through in the third and fourth quarter.

My second question is on the margins. Looking at the implied margin growth from 3Q to 4Q, can you walk us through how you get that margin improvement sequentially? Is this from getting the chips back online and getting leverage from that? Or is it from [indiscernible] margins 3Q from diesel fuel costs. Any color there would be great.

Looking at that, I think there's a few things in play. First of all, the fourth quarter of the year is typically our highest margin quarter as a result of incremental sales. And so, if we look at the cadence between the third and fourth quarter of the year, we add well over $100 million in sales. And given that, there is a fairly substantial fixed cost base at a company like ours. Those sales tend to flow through at a much higher margin than the corporate average. So, if you look at the last few years, the fourth quarter is normally higher. Now, that's not always the case. But generally speaking, it's normally higher than the third quarter as a result of these incremental sales. The second thing is, listen, we take the preservation of the P&L very seriously. And so, while we weren't able to offset the extreme challenges that we've seen, we have offset a portion of those through some cost actions that we're taking. And many of those cost actions, the benefit of those accrues more to the fourth quarter than the third quarter. So, I think, perhaps, those are the two primary drivers that lead to the fourth quarter accelerated versus the third. And then, the final thing I would say is, we are ramping on the Hillrom synergy side throughout the year. That's been an area that's been going quite well. But each quarter that rolls on, we're adding synergies. So, that's another factor that comes to bear on the fourth quarter in excess of the third on our way to achieving the long term goal that we outlined at the Investor Day.

Travis Steed of BofA Securities is on the line with a question.

Jay, obviously, a lot of macro pressures right now, but maybe talk a little bit about some of the offsets, things that are in your control. You mentioned pricing a little more visibly, as other companies have as well, just maybe talk a little bit about how much of this inflationary pressures can you actually offset with price? And how long does it take to roll through the P&L, given contracts? José Almeida: Historically, we have realized price increases in the US as part of our standard contracting process. This is normal practice increases. We have taken pricing actions to date, and they are reflected in our 2022. They can offset 100% of our incremental cost. So, therefore, we additionally, right now, are preparing the implementation of a second wave of actions in response to the significant price increases that we have received from our suppliers and our cost increase, Jay outlined in the beginning of the call, in terms of the labor cost and other internal costs, fuel costs, and energy costs and everything. So, we're putting an additional cost increase. At the moment, we're planning to start rolling out the second wave to customers on a global basis, by the way, not only US, in most of our businesses in the coming weeks. The actions that we're intending right now are to help offset a portion of the significant cost increase that we have, a portion, and doesn't cover everything. But we are determined to go through a second wave of price increases, price actions, I would say – better defined as price actions – throughout the company because of the incremental unprecedented cost increase that we are receiving right now.

Jay, in an earlier question, I think to Robbie, you're still committed to the 75 basis point floor per year. Just curious, when you think about on earnings, does that still translate into low-double digits or is 2023 probably more likely to be more of a transition year with less than double-digit earnings growth for that one year? Any comments on there? And also, where divestitures might fit in the LRP? If you've got to wait on somebody as more macro pressures ease before you'd move into divestitures or you could do that more near term?

As it relates to the cadence of earnings, we're committed to the floor of 75 basis points of margin improvement in any given year. And also, as you point out, we're looking at double-digit earnings growth compounded over the period of the plan. 2023, there's two factors in play. Right now, the operating margin expansion, barring meaningful improvements in some of these exogenous factors, will be towards the lower end versus the average rate that we expect to see over the term of the plan, but above the 75 basis points. The second thing that impacts 2023 in the short term is, given some of the rate hikes that we're seeing from the Fed, you do have that interest expense impacting the 2023 numbers, as we rapidly look to deleverage over the next few years. So that's another factor that comes to bear. So I would say that the 2023 earnings will be a bit below the compounded growth for the overall plan period.

And then divestitures? José Almeida: Listen, when we think about our portfolio management, it's something very actively in our minds. Some are easily executed than others. We have a couple of areas we're working very diligently. One of them is a much faster process, the other one is a little longer. And we're looking at feasibility of the second one, which is a little longer at the moment. It's all about making sure that Baxter is set up for the future. This portfolio actions that we're going to take and are currently examining are long-lasting initiatives to make sure that Baxter is aligned in allocating capital to the businesses that will be connected to our strategy and our vision in terms of the digital work that we're doing in healthcare, with our ability to deploy our technology across the globe. And right now, Baxter has some businesses that fall – not fall outside our main area of vision. So we're looking at those. I don't have any news about the nature of these businesses. We're probably going to have one action later this year. The second one, we're still analyzing, because of the complexity.

Joanne Wuensch of Citi is on the line with a question.

Two parts. One, can you quantify the backlog that you're building associated with all these factors? And then second piece of it is, headwinds that are going to roll into 2023 on the revenue side. And thank you for color on the EPS and operating margin side of it. José Almeida: Let me talk about the backlog and Jay will supplement my answer and go to the second part of the question, Joanne. Our backlog has been growing primarily in frontline care. So let me define what we think – how we define backlog because we have two things going on. One is backlog and one is back order. Our back border is all time high. And what is back order? It is when we take an order and we cannot fulfill 100% of that order. The order is still pending in the system. As soon as we get inventory in the warehouse, it gets shipped to that customer. So, that is all time high at the moment at most probably sevenfold what normally we would see. Backlog is something new actually because if we don't have to assemble pumps, those pumps don't get into a backlog system. Baxter never used that system, but backlog comes with Hillrom and it's very appropriate for them to look at their business such as this, which is future orders put in the system for delivery in the future. We've been accumulating significant backlog in our frontline care. Right now, we have significant demand, primarily now with the graduation of med school students and students going back. It's one point that we do with that part of the business, [indiscernible] business. There are other parts of our business, monitors as well, that we feel if we had those chips would have significant revenue increase in the future. So, we're planning, as we receive those chips, the situation eventually normalizes, the backlog will come back to normal levels. I would say that our backlog today are multiple times what was used to be called normal for Hillrom. And we have also a healthy backlog in our bed system, the traditional Hillrom. So I want to make sure that you all know that backlog is something new for us. We're going to be talking every call about that and we're telling you right now that backlog is multiple times what is considered normal for Hillrom and Baxter.

Looking to 2023, as we think about 2023 sales, there's a couple of factors, headwinds and tailwinds, that are in play here. One headwind for next year is COVID vaccines. We expect that to be a reduction to next year. So that's one factor, and that really hasn't changed since our Investor Day. In addition to that, we don't expect that the chip shortage will be fully alleviated. So we think that will continue to depress the demand to some extent, as we move through next year. Now, I'm hopeful that this will provide an upside for us. But at this point, I don't necessarily see that alleviating. And then finally, we do hope to have a large volume pump available for the marketplace in 2023. We're extremely excited about all of the work that's going into that, and what that means for the future of our company. So we're hopeful that we will have that to bring to bear in 2023, which would be an upside. As it relates to margin going into 2023, I guess the big thing I would say is, we are assuming many of the factors that we're experiencing today remain at essentially current levels. And so, we are not anticipating a major alleviation in these product categories. So, that's going to be a continued factor. I'm hopeful that this resolves over time as well, but we've trying to be very, not pessimistic per se, but ultra-realistic as we're looking at the situation. And then, in addition to that, we'll have the continued benefit of Hillrom synergies rolling through to next year's results as a tailwind. So, that's a little bit of color as we're seeing things shakeout to 2023, but we continue to watch this very carefully. José Almeida: I would just add that we're also excited about the syringe pump that may come faster in terms of approval. They are the large volume parenteral pump, which is the LVP. So, the update is that we are under active review with the FDA on Novum IQ syringe infusion pump. And the large volume infusion pump, it is pending, our response to the FDA additional information request, which we are expecting to respond within this calendar year. And hopefully, both pumps will satisfy the FDA's questions, and hopefully, we can get them approved. But we're excited about the launch of both.

And one comment I would add is that we don't anticipate having the same chip issue with Novum that we are currently experiencing with Spectrum. So we do have some Novum pumps in inventory. José Almeida: Yeah, we have about probably close to 20,000 Novum pumps, large volume pumps in inventory. Yet more will be made preparing for the hopeful launch this year and full next year sales. So, we're working very close to our suppliers, but this is very different. This is a next generation chip, a new generation chip versus what is in Sigma Spectrum.

Larry Biegelsen of Wells Fargo is on the line with a question.

Jay, two to free you. First, simple, on interest expense, based on the $400 million this year, this run rate right now about $440 million, is that how we should think about it for 2023. Or maybe just some color on what you're assuming for rate increases and debt paydown. And then I just have one follow up.

I'll take that one. We do expect interest rates to come down a little bit next year because as we continue to pay off some of our debt balances. So interest rate will come down. It'll be elevated next year, but it won't be at the same level in 2023 as it was this year, given some of our debt paydowns.

So, the math I did there, Clare, is probably not the right way to think about it?

You should not take into account any of the term loans that we will pay down.

There should be some paid down. Larry, wildcard, what does the Fed do with rate increases, but as we currently see it.

Jay, everyone's asked on this call about the macro headwinds. What happens if diesel prices come down? What happens if some of these headwinds ease? Do we get some of this back? What's the right way to think about it, if, actually, some of these prices come down.

Larry, the answer is yes. We get benefits. So, we have been severely impacted by a lot of factors. So, the worldwide stress on the supply chain, the inability of our suppliers to supply and that shows up all over the operations of our company. If we do get alleviation of diesel rates, if we get alleviation of the global supply chain crunch, which would allow us to use less expedited freight, if we're able to see some improvement in material inflation, and finally, and perhaps most importantly, if we can run our plants consistently with the products and the inputs that they need, then, yes, the situation will be significantly better than it is today. Now, the way we've modelled this, as we look to the second half of the year, we are assuming some level of shutdown. We're assuming elevated rates, continued use of expedited freight. So we've got all that embedded. And that's embedded in much of our thinking for 2023. We should get this back at some point. And so, I'm optimistic that this will turn. I just don't know when, and we're not prepared to call that at this stage. José Almeida: I'd just underscore the fact that we will have benefits. So, if diesel cuts – goes down 20%, 25%, this directly impacts our ability to ship products, so ship for less money, affects our renal business profitability, as well as surcharges that we're currently getting from our suppliers on every invoice that we pay for shipment of products. So, that is a potential tailwind if the situation turns. We're watching that very closely. But Jay said, we want to make sure that you have a picture of the future as we see today, as we also understand the trends on the market.

And to add to that, Larry, if we have normalized back order/backlog levels, that's another tailwind. And we're not there yet. We're not anticipating that we get there in the near term. But to the extent that we secure the critical components that we have, then we'll be able to see some sales uplift as well.

Joshua Jennings of Cowen is on the line with a question.

Just wanted to ask, it's only been a couple of months since the Investor Day, but just on the Hillrom sales synergy side of the forecast in the LRP, I know there's a lot of muddling with the supply constraints and then the current environment, but just any data points you can share just in the 2Q in terms of how your outlook of Hillrom synergies are advancing or is evolving? And then second, Jay, and I think you called here the guidance updates conservatively realistic. And that makes sense. Assuming that the environment stays consistent, have you baked into the guidance update? Where do you see areas of conservatism in this update? I think investors probably concerned about the potential for another revision. Clearly, if the environment gets worse, it will impact the entire group of large cap medtech players. But it seems like the capital spending slowdown that you're assuming by hospitals in the back half, particularly on the PSS and GSS businesses, there's some conservatism there. But are there any other areas of conservatism you've called out in this guidance revision?

I think, by the way, we will conclude with this question. So, appreciate everybody joining us today. Here's the interesting thing. While the short term has been extremely volatile, as we look at the acquisition of Hillrom, we are very excited about the long-term prospects. So much of the issue that we're seeing relates to shortfalls and components at this point. But as we laid out the strategy for this business over the long term, from a revenue standpoint, from an integration standpoint, all of those elements are in place and continue to excel. Our synergies are doing better than expected. We reflected that in the financials that we've shared with you for this year. Longer term, tremendous opportunity in terms of product combinations. We are really excited about the innovation potential. So, what I would say is a lot has changed since May. And nobody appreciates that more than me. But what has not changed is our real excitement about the acquisition and where we can take it over the long term. So, we didn't really have revenue synergies meaningfully in the second quarter, but didn't expect that. But as we move forward, the plan in terms of the revenue synergies that we outlined is very much intact. Now, as we think about conservatism and things of that nature, I guess what I would say is we've taken a perspective on the worldwide situation that we're currently facing, and reflected that in the forecast that we share. And so, where I think there might be some opportunity is, to Larry's question, if diesel improves, if all of the work that we're doing to secure electronic components is successful, those kinds of things are the things that would drive us above this forecast. I think it's an accurate portrayal of kind of where we sit. I'm just hopeful that this situation that we're in, well, I know that, over time, it will resolve. I just can't answer at this point how quickly that will occur.

So with that, I think we appreciate everybody joining us today and we will conclude the call and are obviously available as always for follow-ups. Thank you all very much for joining.

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