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.

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 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, adjusts for the impact of foreign exchange and the acquisition of Hillrom. Now, I'd like to turn the call over to Joe. Joe?

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 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 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, coming 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 a weighing of macroeconomic and supply chain factors that have 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 three 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 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 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 standalone company. In this way, we can think of Baxter as having four GBU structures, or perhaps a three plus one 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 three-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 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 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 to Jay, I want to close by reinforcing my confidence and optimism for the future and our commitment to continue to maintain the important work we do every day. Baxter holds a fundamental place in global health care, with a durable portfolio of essential products, a 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 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.

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 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 of 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 three 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 of 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. 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 in 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 in 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 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 the 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 non-operating 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, non-operating 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 the 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 the 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 remained focused on debt repayment following our Hillrom 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 at 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 the 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 the 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 five 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 the 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. While we observed positive development 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 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 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 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 course 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 past 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.

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 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. Are you asking about 2023, the fourth quarter of 2022, or what specific period are you referring to?

Apologies; this is all for 2023. A 15% to 16% operating margin that you guys referenced.

Sure. Overall, we are seeing increased pressure on operating margin in the first quarter and throughout in 2023. 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 it 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 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 pricing for '23?

Pito, 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 for the company. Obviously, we have long-term contracts. As these contracts become available for negotiation, we 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 that, I'll have Jay 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, to start, it would be beneficial for everyone to understand the level of conservatism in the guidance along with the new philosophy you mentioned. What is actually being considered? There is $300 million in cost savings, but margins are down as you just explained. Please help us understand the negative assumptions you’ve included to create some buffer on the bottom after the 2022 outcome.

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 a 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 the 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 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. We are highly focused on cash flow, and the financial performance in 2022 was tough. This was evident in our free cash flow performance. Looking ahead to next year, I expect free cash flow to more than double compared to 2022. This is largely due to improvements in working capital balances. Currently, the days inventory on hand has increased throughout the year, primarily because of missing components and sub-optimal production plans, along with longer lead times and shipping delays that disrupted our supply chain. These factors have contributed to higher inventory levels. On the receivables side, we experienced very strong sales in December, leading to a higher balance than we typically see in previous years. Additionally, some timing issues with vendor payments resulted in a lower payables balance. We expect improvements in all these areas. Together with careful management of capital expenditures, we anticipate our free cash flow will more than double, as it's a critical metric for valuation and incentive compensation 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% 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 a 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, let me walk through that specifically. We have reduced our growth expectation from 4% to a range of flat to 1%. The primary reasons for this change will mostly impact 2023, which is good news as it sets us up for 2024. The first factor is the large volume pump, where we have taken out $100 million from our previous expectations, resulting in roughly a 70 basis point reduction. The second factor involves the weighted average market growth, which we slightly lowered on a compounded basis. A significant portion of this impact is also confined to 2023, particularly the issues related to renal mortality and the acute growth challenges. We’ve also made conservative assumptions regarding capital for 2023. As we approach the end of the year and revise our patient census expectations, we reduced the WAMGR for 2023 by about 100 basis points, as noted in our January 6 commentary. We are carefully analyzing profitability across our product lines to ensure that every dollar spent in every market generates profit and cash flow for Baxter. This led us to make the tough decision to exit around $100 million of sales. Additionally, we shifted about $50 million in revenue from 2023 to 2022. While we don’t like lowering our sales expectations, it's important to note that many of these impacts are likely to be one-time occurrences specific to 2023, and we anticipate growth beyond this year. In regards to the pumps, we will monitor how this situation evolves throughout 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. Overall, we now expect a decrease in operating margins. There are a few factors contributing to this. First, the lower sales outlook has an impact of $0.40 to $0.50 in earnings, which also affects the operating margin due to absorption and higher-margin areas. Secondly, we are facing supply chain challenges in the first half of the year, which are additional to what we mentioned previously. In the fourth quarter, we were still buying electronic components at much higher levels than we had expected, and the spot market conditions were tough. These factors have generated extra costs that will carry over into the first half of the year. We do have some benefits from our savings program, but foreign exchange remains a slight headwind overall. When we evaluate the operating margin, it appears mostly flat, with perhaps a slight variation. These are the factors influencing the operating margin. It's important to note, as we look at the progression over the year, that the first half will pose challenges for operating margins. However, as we see improvements in the indices related to the products we sell in the second half, gain better availability of electronic components, and account for the usual incremental sales we experience then, the margins for the second half should become more favorable and align better with our expected trajectory. Regarding synergies, incremental costs, and cash flow, we have factored in about $100 million into our cash flow statement. The impact on the P&L from things that fall short of optimization related to the spin is roughly $0.03. This has a more pronounced effect on free cash flow, which I have discussed with many of you already. Overall, I believe the operating margin outlook will improve significantly as we move towards Q3.

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

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

We have allocated some research and development funds specifically for the Hillrom portfolio and related areas in Front Line Care. Looking at the opportunities from the Hillrom acquisition, I believe it's a significant long-term advantage. After addressing the supply constraints, last year's growth was nearly flat. However, we anticipate mid-single-digit growth in the Hillrom portfolio this year despite ongoing supply challenges. This growth will be driven in part by new products, including a new ICU bed that I mentioned earlier. Additionally, there are promising opportunities that will support our investments moving forward. I expect these benefits to positively impact both companies in 2024 and beyond.

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 probably this cadence year-over-year. We found some depth in the Hillrom portfolio, primarily parts in Connected Care which 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, there 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 cementing 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 innovation is 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 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. 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, 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 two new companies, which makes it 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.

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, etc. 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. 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 have 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 the 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.

Yes. We have a pretty rich pipeline of products, starting with progressive FLOSEAL. As I said, it's going to really position Baxter with 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 in the market, primarily from semiconductors, 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 two businesses looks 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 of depression in that as the nursing shortages continue to apply pressure in 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 in 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 very useful. Joe, you mentioned some points earlier, but it seems that many people are viewing the guidance as more conservative than anticipated. I believe you understand this, and I think we can outline our discussion for today. They may have suggested this approach, considering the challenges faced by the company and the sector in energy and technology last year. With that perspective, if we view this as a recalibration that considers all these factors, what are some potential bright spots and areas for improvement as we move forward this year? What aspects do you think could perform well or improve?

In 2023, compared to 2022, we experienced significant challenges in our manufacturing operations, particularly due to rising energy and transportation costs. Transportation is a considerable expense for us, especially in specific markets related to our renal products. It’s impressive how quickly we’ve adapted to these rising costs. We have developed substantial programs to counteract these challenges, but the real transformation for Baxter stems from the automation we are implementing in our manufacturing processes. We will be able to consolidate several plants because of this, with changes expected to occur within the next 12 to 24 months. We're also strategically directing more capital toward growing businesses. The market is eager for our pump, and we feel positive about its current status, especially since the products are performing well in Canada, where we recently secured a deal for several thousand pumps. Overall, 2023 will present two narratives. In the first half, we'll focus on absorbing the heightened costs from 2022 through the sale of inventory produced at those elevated costs. In the latter half, we intend to shift towards the core strengths of Baxter, aiming for better bottom-line performance as we reignite our traditional operations. This crisis has highlighted several weaknesses in our supply chain, and we took this as an opportunity to reassess and modernize our operations to minimize future variability. We will remain in the resin-based business but will ensure our plants are well-positioned, automated, and highly efficient. Our cost-saving measures for 2023 are projected to exceed $300 million, with an additional $300 million expected in 2024 as we enhance our supply chain efficiency. This year is pivotal for Baxter as we reset and reevaluate our portfolio, refine our capital structure through the sale of PPS to reduce debt, and explore future growth opportunities. It marks a crucial stage in the seven-year transition we have been undertaking.

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

Jay, could you provide us with an update on the standup and stranded costs? Is it correct to assume those are around 1% of company sales and a one-time disentanglement cost of 3% to 4% of total sales? What is the timeline for that, and will it have an effect on non-GAAP earnings? Also, while it's still early, people are considering 2024 for valuation. Can you provide any insight on whether margins could return to 2022 levels?

Sure. No commentary yet on 2024. We are incredibly focused on delivering 2023, period. 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% precedent 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. In our non-GAAP results, we have roughly $0.03 of impact costs related to this program in the numbers that we shared today. So that's really how we're looking at it in 2023. The cash is a very real cost. 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. We have reflected a little bit of that in our numbers. 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. Once we have line of sight to freeing up electromechanical components among other key inputs, we'll hopefully modify that assumption to the better. 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.

I want to emphasize that we are beginning to see some positive movement in our backlog, particularly in semiconductors and Front Line Care. This is quite encouraging, but it is too soon to claim complete success. Our supply chain team has made significant efforts, and we are starting to see the results. We hope this progress continues so that by next quarter we can discuss the positive momentum it may bring.

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