Q3 2022 Baxter International Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to Baxter International's third quarter 2022 earnings conference call.
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I would now like to turn the call over.
To Miss Claire Trackman, Vice President Investor Relations at Baxter International MS. Trackman you may begin.
Good morning, and welcome to our third quarter 2022 earnings Conference call. Joining me today are Joe Almeida, Baxter's, Chairman and Chief Executive Officer, and Jason <unk>, Baxter's Chief Financial Officer.
With that let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook for the fourth quarter and full year 2022, or 2022 to 2025 long range plan the acquisition of Torah New product development.
Potential impact of proposed pricing Ashton business development.
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 Hill ROM now I'd like to turn the call over to Joe Joe.
Thank you Claire and good morning, everyone. We appreciate your joining today's call I will start with a look at our third quarter performance, including some perspective on the macro environmental factors impacting our near term trajectory.
Jay will provide a deeper dive on our financials and outlook after which we will open up the lines for your questions Q.
Q3, 2022 represents the third full quarter since the close of our Hill ROM acquisition total company sales of $3 8 billion grew 17% on a reported basis and 23% at constant currency rates legacy Hill ROM contributed $735 million.
Sales in the third quarter.
Excluding the impact of Hill ROM and foreign exchange third quarter sales rose slightly on an operational basis on the <unk>.
Both topline and bottom line performance in the quarter reflect the continued impact of macroeconomic headwinds, including significant inflationary pressures as well as ongoing global supply chain constraints consistent with what many others are ya com shrink globally with further regard to the map.
Economic environment I want to note the impairment charge in our third quarter for Nash is related to the Hill ROM acquisition, Joe will provide additional details but in short this charge relates to Mandy off the shifting market dynamics, including rising interest rates.
And lower valuation multiples that they have reduced equity values broadly along with the increased supply chain related costs that we've previously discussed with that said and with 10 months of progress in perspective, I want to underline are continuing.
Confidence in the potential up the Hill ROM acquisition.
This is already play out as an opportunity to expand the reach of both legacy portfolios geographically and across the continuum of care. It is also accelerating our connected care journey, expanding our digital footprint and helping to unlock the next wave.
Buffy innovation across our R&D pipeline integration of our legacy organizations advancing swiftly and as previously shared we are achieving even greater value capture through cost synergies than initially anticipated. Additionally, overall demand across the Baxter and legacy Huron portfolios remains solid.
We continue to experience meaningful back quarters in backlogs due to reduced access to a variety of raw materials and the electromechanical components as I have shared previously this has resulted not only in higher cost spot purchases, but also expedited freight costs as we work.
Steadfastly to get our life sustaining products to the patients and clinicians who depend on us.
While we see signals that some of these macro factors may begin to ease next year. Our current expectation is that select supply constrains will persist into 2023, particularly as it relates to semiconductors, where we continue to see high levels of volatility in <unk>.
Why.
During the quarter, we experienced several deep commits from various suppliers meaningfully impacting our overall demand planning process.
We have also seen supply constraints from other raw materials, which has further impacted performance in total we estimate that the semiconductor and raw material constraints, we've experienced negatively impacted Baxter topline performance in the quarter by more than $100 million or a proxy.
And at least 400 basis points.
And on a year to date basis, we estimate this figure to be approaching $300 million.
We continue to take decisive action to help mitigate this constraints and position the company for improved future performance. Some of the actions. We've already undertaken include extending the horizon of our demand forecasts out to 24 months for supply constrained categories.
To allow our suppliers to allocate capacity and inventory to Baxter over a long horizon validating alternate supply options to provide flexibility in sourcing establishing direct buying relationships with critical secondary component suppliers in enhancing our manufacturing processes too.
Further optimize mature usage and reduce waste and meeting with the management teams of our key suppliers and select government officials to reinforce the criticality of Baxter's products.
We are confident that these actions will further enhance our ability to help mitigate supply chain impacts from <unk> near and mid term performance at the same time, we remain focused on improving the operational efficiency across the organization. We've already implemented several initiatives there I expect to drive improved future perform.
<unk>, including ensuring that we have the optimal organization structure and business processes in place. In addition, we are pursuing some near term actions to help offset the increased expenses. We're experiencing these actions, including recent restructuring initiatives broad hiring.
Freeze reduced discretionary spending and accelerating our <unk> integration efforts.
Additionally, we do expect to realize savings this year through lower annual employee incentive bonuses, which are directly tied to business performance.
We deeply value these relationships and appreciate the challenges of our customers themselves are facing upon successful execution and implementation of these agreements. We anticipate the related revenues will be reflected in our results. Each year. We believe these actions will help underscore our unwavering commitment to our patients and cut.
Collectively these initiatives are fueled by the sustained emphasis on operational efficiency and cost base optimization that has powered our transformation to date and so we will continue to be stress, we would never pursue any action that compromise our fundamental mission to statements.
We are also actively advancing our strategic review of the portfolio to ensure the optimal structure to execute on our vision of transforming healthcare to improve patient outcomes and enhanced workflow efficiency and enable cost effective care. We anticipate that we will be in a position to provide more details on.
These ongoing activities early next year I want to reiterate that our strategic core and prospects remain firm as is our commitment to driving long term value for our shareholders and other stakeholders, we serve baxter's strength is.
Founded on our diverse durable portfolio of a special healthcare products, which will continue to be enhanced by our focus on driving innovation in connected care and core therapies <unk> industry leadership and increased scale combined with our rapidly advancing digital capabilities create a spectrum of.
Prospects to help advance our APAC in line with our lifesaving mission and in turn to share our success with our shareholders and the other stakeholder communities.
Finally, I want to recognize and thank our employees for their remarkable effort always and especially as we navigate the current macro environment.
Global team consistently embraces our lifesaving mission above all rising to meet each new challenge with dedication passion and a key focus on serving the many stakeholders who depend on US now Jay will provide more details on our third quarter performance and outlook for the remainder update here.
Thanks, Joe and good morning, everyone as Joe mentioned, our results for the quarter came in largely as expected with some impact of sales due to sell select supply chain related constraints as.
Turning to our financial performance third quarter 2022, global sales of $3 8 billion advanced 17% on a reported basis, 23% on a constant currency basis and rose slightly on an operational basis on the bottom line adjusted earnings decreased 20% to eight.
<unk> per share falling within our guidance range of <unk> 79 to 83 per share earnings in the quarter reflect the increased cost of raw materials freight and labor as well as the impact of rising interest rates foreign exchange headwinds and a higher tax rate.
Before I review, our financial performance for the quarter I wanted to spend a moment discussing the non cash impairment charge that we recorded related to the Hill ROM acquisition.
When we purchased Hill ROM, we valued the business based on anticipated cash flows baxter's prevailing cost of capital and market EBITDA multiples at the time of the transaction.
As Joe mentioned the primary reason for the write down was due to changes in external factors that have occurred since the acquisition date, specifically the significant increase in interest rates, we have seen and the reduction in market base EBITDA multiples.
As we evaluated these environmental factors and coupled them with the supply chain impacts, we've incurred which we carryforward in our projections, we deemed it appropriate to reduce the carrying value of goodwill and certain other intangible assets associated with Hill ROM.
I want to reinforce Joe's earlier comments that we continue to see tremendous potential for our combined portfolios. We have accelerated our cost synergy targets, which continues to track ahead of our expectations and our commercial leaders are driving actions to unlock the growth of the combined.
Now I'll walk through performance by our regional segments in key product categories, no that constant currency growth is equal to operational sales growth for all global businesses and Baxter's three legacy geographic regions.
Starting with sales by operating segment sales in the Americas were flat to the prior year on a constant currency basis.
Quarterly sales in that region reflected a slowdown in growth in China due to the country's zero carbon policy, which we estimate impacted sales by approximately $10 million in the quarter as well as the anticipated impact from various value based procurement initiatives being implemented in the region.
Performance in the quarter was partially offset by lower in center HD sales, partially due to HD monitor supply challenges due to component availability.
Coupled with a large hospital system order in Q3, 2021, which created this difficult comparator to the prior year.
Pharmaceutical sales were $525 million declined 3% on a constant currency basis performance in the quarter reflects declines in our global generic injectables portfolio. Due to continued increased competitive activity, which were partially offset by increased sales of inhaled anesthesia.
Moving to clinical nutrition total sales were $231 million, increasing 4% on a constant currency basis performance in the quarter was driven by demand for our broad multi chamber product offering partially offset by supply related challenges for our vitamins.
Sales in advanced surgery were $247 million advancing 6% on a constant currency basis.
Surgical volume recovery was strong in Europe , while procedures in the U S and APAC region came in slightly below our expectations within the U S. We observed a slow start to July with an uptick in August and September .
Sales in our acute therapies business were $158 million declining 9% on a constant currency basis, and reflecting a tough comparison to the prior year, where we had experienced elevated demand for CRT given the rise in Covid cases, biopharma solution sales in the quarter were 172.
$2 million declining 10% on a constant currency basis.
$1 million of sales in frontline here at $76 million of sales and global surgical solutions Hill ROM declined mid single digits on a constant currency basis as compared to Q3 2021, when the company was a standalone entity.
Performance in the quarter reflects a difficult comparison to the prior year period as well as the impact of the semiconductor supply constraints we've discussed.
We continued to experience record levels of backlog for the legacy Hill ROM business. Our order book remains strong and to date, we have not seen any significant cancellations from customers as mentioned last quarter, we remain somewhat cautious on capital spending as hospitals continue to assess.
Their budgets in light of the current market environment move.
Moving through the rest of the P&L, our adjusted gross margin of 42, 9% decreased by 110 basis points over the prior year reflect the increased cost of goods sold primarily driven by the factors, we've discussed around inflation freight and supply chain constraints adjust.
Adjusted SG&A of $821 million represented 21, eight as a percentage of sales an increase of 200 basis points versus prior year driven by the addition of Hill ROM as well as higher freight expenses as mentioned earlier, we continued to tightly manage our G&A base.
Adjusted R&D spend in the quarter of $148 million represented three nine as a percentage of sales a decrease of 10 basis points versus prior year, both adjusted SG&A and adjusted R&D reflect a benefit from lower bonus accruals under our annual employee incentive compensation plans, which is directly tied to <unk>.
<unk> performance. These factors resulted in an adjusted operating margin in the quarter of 17, 2% a decrease of 300 basis points versus the prior year adjusted net interest expense totaled $104 million in the quarter, an increase of $72 million versus the prior year driven by higher <unk>.
Standing debt balances related to the acquisition of Hill ROM.
Adjusted other non operating income totaled $2 million in the quarter compared to a $12 million loss in the prior year period, driven by primarily by amortization of pension benefits.
The adjusted tax rate in the quarter was 23, 8% as compared to 14, 8% in the prior year period. The year over year increase was primarily due to the mix of earnings in the quarter, which has changed following the Hill ROM acquisition. In addition.
During the third quarter of 2021, the company recognized the benefit in its effective tax rate from a discrete item due to a reserve release, resulting from a favorable tax ruling and.
And as previously mentioned adjusted earnings of <unk> 80 to purge diluted share declined 20% versus the prior period.
Let me conclude my comments by discussing our outlook for the fourth quarter and full year 2022, including some key assumptions underpinning our updated guidance.
We have adjusted our full year earnings per share outlook, primarily to account for a strengthening U S dollar and the resulting foreign exchange headwind increased interest expense assumptions, given rising interest rates and a higher expected full year tax rate due to earnings mix as discussed we anticipate electro mechanical component avail.
Ability will remain challenged in the fourth quarter and into 2023, which will continue to hamper sales growth for select businesses, including medication delivery frontline care and patient support systems.
For the fourth quarter of 2022, we expect global sales growth of mid to high single digits on a reported basis mid teens on a constant currency basis and approximately flat on an operational basis and we expect adjusted earnings excluding special items of 92 to <unk> 99 per diluted share.
For full year 2022, we now expect global sales growth of 17% to 18% on a reported basis approximately 23% on a constant currency basis and low single digits operationally.
Moving down the P&L, we expect full year adjusted operating margin to be between 17% and 17, 5%, reflecting the impact of all of the various dynamics. We've discussed today for the year. We now expect interest expense to total approximately $400 million given rate increases and adjusted tax rate of approximately 20%.
On a diluted share count of 508 million shares based on these factors. We now expect 2022 adjusted earnings excluding special items of $3 53 to $3 60.
Per diluted share.
With that we can now open up the call for Q&A.
Thank you we will now begin the question and answer session. If you have a question. Please press Star then one on your telephone keypad, if you wish to remove yourself from the queue Press Star then one again.
You are using a speaker phone please lift the handset to ask your question.
So that we may be respectful of everyone's time. Please limit your comments to one question with one follow up question if necessary we.
We appreciate everyone's patience and would like to provide as many of you as possible the opportunity to ask a question.
We will pause for a moment, while the list is being compiled I would like to remind participants that this call is being recorded and a digital replay will be available on the Baxter International website for 60 days at Www Dot Baxter Dot com.
Our first question comes from the line of Travis Steed of.
Bank of America Securities. Your question. Please.
Hi, good morning, everybody. Thanks for taking the question I guess, Jay just to start out bridging the gap on the changes by 2022 guidance, but would be helpful. But more importantly, we'll love to see if you would provide some initial thoughts on 2023, if you would commit to some level of earnings growth. After 360 for next year and thoughts.
The five basis points of margin expansion as before.
Overall Q3 came in largely in line with our expectations.
Pleased to put 82.
In the books and really the commercial operations were off a couple of cents in large part related to shortfalls in sales driven by supply constraints in certain areas.
The tax rate and FX came in a little bit worse than our expectations, but offsetting this and I think this is important to note was better than anticipated performance in our supply chain. As you know this has been an area of extreme volatility for us as we've navigated the complicated macro environment. So it was really nice to see.
With respect to EPS, we now expect roughly a 5% headwind from foreign exchange tax and interest relative to our previously issued guidance.
On a year over year basis, these items impact us roughly 15.
And so we expect a continued supply constrained environment on the sales line. This is an area that we're navigating very carefully but overall the real driver in the fourth quarter relates to this headwind from these non operational items. So now as we transition to next year what previous.
As shared with you all is.
Template, which says 4% to 5% compounded sales growth minimum 75 basis points of operating margin expansion in a given year.
As we thought about 2023, the sales growth will come in on the lower end of the range closer to 4% in large part because of lower levels of Covid vaccines emanating from our bps business.
As it relates to margin through continued focused on cost through execution of our hill ROM synergies, along with a real and significant impact of value improvement programs in our plants.
We can confirm at this point the 75 basis points of margin expansion now of course, we're going through our plan as we speak and I will tell you that the world has been extremely volatile, but it was it's very nice to be able to share that with you at this point in time and a lot of this comes down to stability coming out of our supply chain.
<unk> now the one thing I will say as part of the reason, we're not seeing accelerating sales growth is as we look at 2023. There are continued headwinds from a supply constraint standpoint, so we're going to expect to see component challenges through parts of 2023 and <unk>.
Other areas and so that's from a supply and semiconductors will continue to be challenging as we move as we move through next year. So that's going to be something that we have to live with for a while we're hoping that rehabilitates over the course of next year and certainly provides a tailwind as we move to 2024 now moving to some other items.
As we look at foreign exchange that is going to be fairly neutral to operating margin, but it will be a roughly 15% headwind year over year and a lot of that will be concentrated in the first half of the year, because we've seen rates really deteriorate in Q3, and Q4 and then from an interest expense standpoint.
We're looking at approximately a <unk> <unk> headwind. So this is a this before that in the interest rate will start to become a tailwind later on in this long range plan and so I think I think for us as we sit here today.
We feel really good about the prospects going into 2023, and so we've been dealing with a lot of volatility and I think.
Really putting controls in place to navigate some of that I mean, I think the our ability to confirm the 2023 is an important step as we move forward Joe I don't know if you'd want to add anything to that you've.
Cover at all.
Yes. Thanks, a quick follow up just to make sure I think putting that all together it still sounds like earnings can be up next year versus 2022 and on the 75 basis points, what does that assume on the 1 billion in place and does it assume that stable and does it assume no novum Iq.
Yeah.
So as it relates to EPS I think there is a little bit of EPS growth as we look at it based on.
Some of the non operational items impacting us, but we do expect some level.
As we look at it and then.
I'm sorry, I missed the second part of your question I Couldnt quite hear that.
Basis points, what's assumed in add on inflation and over my queue.
Yeah, Okay, so from an inflationary standpoint.
I think I think we're looking at kind of consistent levels to today. So we're not anticipating significant price up in any commodities, we're anticipating some slight improvement in certain areas, but also some negatives related to utilities for example in Europe , Joe do you want to address <unk> question.
So we.
We always preface any conversation on products, which are not approved.
Do not.
Speak on behalf of the FDA.
We believe that we have successfully resolved the issue was the primary subject with the Fda's last additional information request, we referenced as you show in the Q2 call.
We'll submit data that we believe demonstrates successful resolution of the issue as part of our response since that time, we have identified additional software changes were planning to implement proactively in consultation with the FDA. We're in process of updating our response.
Because of that we're doing everything we can to submit our responses as quickly as possible, while we hope that to be in a position to submit those responses by late Q4, you may spillover.
Into.
Couple of weeks of January maybe.
Half January so we're doing the best we can to pull this together we are very comprehensive in how we answered the FDA work very collaboratively with them and we want to make sure that the product has all the formation before we sent to them. So there is no further request for information Thats our objective.
Really helpful color. Thanks, a lot for taking the question.
Thank you.
Robbie Marcus of Jpmorgan is on the line with a question.
Please state your question.
Great. Thanks.
I could start off.
On <unk>.
Capital allocation, how youre thinking about the business mix, we saw some reports in the news about potential.
Sales or divestitures of some of the assets within renal that were low to no growth in low to negative margin, maybe just give us a sense of how youre thinking about your portfolio here in the environment to get deals done, whether it's additive or subtraction.
Robert Good morning.
We are actively looking for first of all I am not going to comment on the rumors from the market, but im going to tell you what we're doing.
Looking at portfolio by the company.
We will be ready to speak about that.
By early January .
Not at the moment, but I can tell you is some.
Bits of information what is going on we are looking at every opportunity of the company to focus on the vision that we had set forth during our <unk>.
Investor Day back in May which is connected care areas that will drive higher gross margin areas of higher topline growth software and the ability to be.
Head of connecting the dots for clinicians and institutions. So when we look at that we're looking at our portfolio. Some products will make sense for us to retain some products will not.
So we are looking to optimize our portfolio. We are about three quarters off of the way there in terms of understanding and we'll make a decision with our board of directors and then come forward with what we think is going to be.
The new portfolio of Baxter going forward as I said earlier January so.
I wanted to just also underscore that any portfolio movement.
Which implies sale of assets or any kind of transaction.
<unk> always takes into account number one creation of shareholder value.
He has never secondary <unk>.
We never secondary is always spread there and that is creation of improved return on invested capital with.
Accretion of value through <unk>.
Discount cash flows so.
We're going through this process has been very very dense and we hope to have.
As I've said early June .
Okay.
Great maybe just as a follow up Jay you talked about something like $100 million in.
I guess theoretical loss sales in the quarter from supply chain issues, but also about how the supply chain was a positive in the quarter and helped our margins.
Should we think about those two reconciling next year and in that 4% growth in the 75 bps of margin how should we think about what's being resolved in the backlog and how much improvement we will be seeing in the supply chain. Thanks a lot.
Ravi I'll, let Jay.
Really comment on the numbers I would tell you about a couple of aspects.
Sets of circumstances, as we said labor inflation and material inflation have been significant to Baxter and theyre doing a great drop navigating through that our procurement group is doing a erratic drop getting the products to us what is happening is there is a significant amount of <unk>.
Backlog in that quarter for the company on products, depending on semiconductors, and there is no one company or two several of its a plethora of companies that produce products for us and we source semiconductors from them. What a couple of things that we are doing that I feel.
More confident that throughout 2023, the situation will be will.
We will be better is that we are <unk>.
Developing long term relationships directly with the manufacturers of the chips instead of going to distributors or going directly to board assemblers. The second thing yes.
The amount of Decommit.
Companies are coming forward during the quarter mix, sometimes very difficult for us to predict what we can assemble and ship at the end of the quarter.
It's getting better into 2023 as our supply chain now has a full view of commitments into 2023, what we need to make our our our growth.
<unk> business. They have been very affected by these are frontline care, which is our business under our acquisition Hill ROM our PSS of patients patient support systems, the ability to make more pumps, we have very good.
Demand for our current <unk>.
Our Sigma spectrum pump, we can make more because we're missing two or three key components that are in short.
In shortage in the marketplace due to high demand from other sources and knowing the automotives and other areas. So what I can tell you is we are doing everything we can in the supply the supply constraint is really what has impacted <unk> performance in the top line.
Now.
As we think about as we think about the margin improvement really that's emanating from a significant improvement in value improvement programs things like automation initiatives that we have going on in the plan and that really helps support the 75 basis points improvement that we've discussed will see lower than expected freight.
Folio of products the innovation, the complementarity with the Bachelor portfolio.
Credibly excited.
And the environment for their orders has been fairly strong throughout the year, it's been fairly consistent but we have had severe supply constraints and so without supply constraints Hill ROM would have been probably flat in the third quarter and on a year to date basis would be growing close to mid single digits, which I will.
Characterized as kind of where we would've hoped it would've been but with the supply constraints that had been extremely challenging in particular in the case of frontline care. It's.
It's been hard to get to the sales level that we hoped for.
So Joe maybe you want to add to that yes.
We have done.
The company is.
Gary.
Arrow integration dropped here, our synergies are coming higher much higher than we had estimated in the first first year of the integration our supply chain people have to come in into Hill ROM into our water work to reestablish lines of supply.
And each of the business when the semiconductor prices hit Baxter was better prepared to handle without the huge loss and what we did is we've put our best.
The products out of the door. We also have extremely competent management. He had in both business. We have we are resolved we saw.
Ed.
Our front line care, we have Andy Andy Frye, the head of GSS PSS. So we're very confidence into business. We purchased the business has the ability to perform we will fix the supply chain issues as we're currently doing and we'll be able to get.
Uh huh.
<unk>.
Back to Hugh.
We.
Made assumptions too.
As you heard from Jay our growth would have been ex supply chain. What we had expected to be so I think Baxter brought to a fuel from a combination of great portfolio <unk>.
<unk> brings with great management and discipline. The Baxter has to replace the team there was Eric and with stable probably to do in the long term better drop discomfort in nation.
Gotcha.
Maybe I'll change the topic, a little bit for my follow up.
You talked about passing along the cost pressures and Youre in the process are you are well along signing new price agreements can you help us.
Through.
Are you is this a 100% of your business how do we think about the impact and just even touchy feely, Jay how do we sort of factor that into our thinking as we look ahead to 'twenty three that you could have another 50 basis points of price on half the portfolio any extra debt.
There color perspective would be great. Thank you so much.
Rick.
We will do it.
Great question. So we are going to split Jay and me here, but let me, let me start by saying that.
We do not comment in pricing.
General course of business, but as Baxter has has taken so much.
To input costs that went up significantly in the last two years we are.
Very focus in recouping a portion of that.
Possible. So we already had as I've mentioned.
Price actions throughout the year, but I would say that beyond what I have said I'm not going to comment on any specifics about pricing discussions our agreements with our customers, but I can say to you.
In my opening remarks.
I said, we strongly prefer we strongly prefer to build on our long term relationships with our customers to reach agreements on how best to share and the increased cost of delivering products to them, which causes a significant amount of more money because the cost of while the cost of logistics cost of raw materials cost delivery and everything that goes in.
We have made significant process I am sorry.
Rather say, we have made significant progress towards that end, but to the extent that we do not reach agreement with any customer.
We will of course continue to evaluate the options in front of us.
To recover the increased cost of our delivering on our mission to serve patients. It's very important to us because Baxter. If you ask any any of our 65000 employees is all about the mission of the company is an incredible company I came here seven years ago almost to the date.
I continue to be impressed by the dedication of our employees, but we took a significant amount of cost increase in the last two years, our input cost in the supply chain has done a great job trying to defray that and offset but is.
As you can see by our margins is not possible, we would like that to be a partnership with our suppliers to continue to understand that for us to deliver what we're delivering to them and the innovation of the products, we need that that partnership to continue to one so.
And I'll end, there and pass on to Jay sure, Rick I don't want to get into too much detail on specifics around price and what pieces of the portfolio and so on but it's safe to say price. We expect price will be a positive contributor to our numbers next year in 2023.
The other thing I would say is we it is something that we look at in every single market in every product line why because in every one of our areas. We have been challenged with very high levels of inflation very high levels of incremental cost so from.
Our perspective, we really have to challenge every sale to make sure that we're garnering enough profit from it.
Offsetting some of the significant cost that we've had.
Thank you very much.
Thanks.
Peter Chickering Deutsche Bank is on the line with a question. Please state your question.
Hey, good morning, guys. Thanks for taking my questions. Like you mentioned that you haven't seen any cancellations due to hospital capex pressures in that backlog.
It remains full here, how do you look at new orders.
The supply issues, so keeping that backlog high and are you seeing any impact to new sales versus historical levels as hospitals struggle with lower margins and lower cash flows.
We have seen sporadic cancellations of orders in institutions that are too small.
Have labor issues and implementing.
Capex projects that sometimes are large but for the most part we haven't seen that.
If we could make.
Three times four times more infusion pumps, we would have sold I believe those pumps. If we hadn't made twice as many dollars monitors we would have sold the monitor so it becomes a little different when it comes to beds beds are larger implementation and software software like nurse call.
But these software like <unk>.
Becomes more elaborate those are the ones that sometimes we see postponement not because the price, but more because of the labor now because of the cost.
Should say, but more because of delayed more so at the moment in time I don't believe we're seeing.
A retraction in the capital market.
We're seeing a high cost of labor for hospitals, and a shortage of labor that makes difficult for them to undertake large programs sometimes.
Okay Fair enough and then a follow up on the supply chain can you break the honeymoon impact to revenues in <unk> on semiconductor is versus the other raw materials out of curiosity what are the other raw material shortages.
Semiconductor side, the macro data shows that the pressure peak sort of end of <unk> is an improving sort of during <unk> security you see any semiconductor shortage improvement from.
From July into versus October .
Yes.
Sure.
So a couple of things I would say related to this question first the vast majority of the sales impact relates to semiconductors.
I would say that over 90% of the challenges that we face relate to semiconductors. There are other select areas, where we have seen.
Meaningful impact for example, in our nutrition business.
Certain ingredients and vitamins that were unable to secure due to supplier challenges.
It had an impact as well, but the majority relates to semiconductors now as it relates to your semiconductor question.
Type of semiconductor used in medical devices is a little bit different than standard semiconductors that are used in the most the highest tech products available today and so while there has certainly been a curtailment of demand for some of these consumer products the size of the semiconductor that we use.
Use does not benefit from this curtailment of demand and normalization of supply and I would even say first or some semiconductor manufacturers. They are seeing inventory levels built of the supercenter semiconductor and so we just have not yet seen this normalized in our case, we are all hands on deck working to secure the components.
That we need.
And we will continue to do that but this is something that as I have said, we don't we don't have a pathway for this getting resolved in the immediate term Joe I don't know if you'd like to add anything to that.
More so.
What we are doing is because we are seeing this this decision with this.
The semiconductor manufacturers not all chips are created the same so you hear Intel.
Sales are down quite a bit the PC is a good news for four of our ships is not we don't use the same chips at all we actually use very little very few chips from adult for instance, we use our chips are Iot internet of things. They are sicker. They are much thicker and the chips are using better software so that.
Demand by the way some of these chips are about 12% of the semiconductor output industry output. So because of that we worked very closely held directly with companies were very being very successful with fuel companies. So working very well with us, but what we also doing started redesign program for our <unk>.
We have identified critical components, we have.
We started a process in our renal business to redesign 30 of our boards with one of our suppliers and we have frontline care a program starting right now to replace six keep semiconductors. There may be constraints in the next 18 months with redesign onboard so redesign of orders is not as simple as that.
<unk> zinc is not a plug and play because the form fit and function of the semiconductor exchange you have to redesign. The board you have sometimes to re validated clinically we validate the board so seeing just that.
Redesigning boards dependency is not is all hands on deck is finally, finding new ways to deal with our current suppliers is buying directly from them.
By through brokers throughout the world inventory there is available as well as redesigning the boards. So we can have.
Alternatives that can be put in in the future so serious.
Became a much more.
Sharp company when it comes to semiconductors imports and this process is despite effect is very painful we have to acquire significant expertise in this area. It is it is it is going to pay dividends in the future.
Great and Joe just sort of quick follow up on the first question just to make sure I have this right youre, saying that new orders for capital equipment. In last 90 days in 2022 is in line or better than it was at this time in 2021 for new orders six months.
No I'm, saying that in 2021.
This time of the year last year in 2021, we were not.
We didnt not only <unk>, but the orders were extremely high primarily the rentals were extremely high because the profit okay. What im saying to you is we have not seen our book of business be affected by capital constraint now and going forward, what we see.
Delays in some accounts due to labor shortages and and primary large installations, but we have continued dialogue with everyone about our orders.
Effect on planning to see in the first quarter next year, a large installation that we're going to probably be doing any hospitals in the U S. So I don't see we don't see today, a significant change in the order the order pattern in capital that's what I meant I'm not comparing to 2021, which.
Significant high rental revenue into a few wrong because the COVID-19 effect, primarily as you know coming out of the summer's go into Omicron in October November of last year.
Thanks, So much guys, yes. Thank you.
Joanne wins of BD is on the line with a question. Please state your question.
Thank you for taking my question.
Briefly.
It sounds like you have significant back orders and backlogs.
What is happening to those orders are they being fulfilled by somebody else or they just piling up so that at some stage in the future they get Matt and I'll talk to my second question at the same time.
Sounds like you're also working to get better expense synergies that is how long is there a way to quantify what you think there's maybe now versus what you thought they would be before and thank you.
Sure. So from a backlog standpoint overall, we are seeing those orders for the most part stay in place we're not we're not seeing others take share as a result of these constrained supply environment that we have in place.
And frankly, a number of manufacturers have similar challenges now the question is how long will those orders remain in some cases, if there. If there is short term needs. Then those are those are things that perhaps.
Be impacted but.
But as we think about longer term for the most part.
Think that these sales will represent some level of opportunity.
In the future.
As it relates to Hill ROM, we feel very good about.
Where things are trending with the exception of the constraints that we have in place and so we high.
Highlighted increased incremental cost capture at the May Investor day, and we are still trending along those lines very much in line with that with increasing confidence I mean, I think it's important because we have some big step ups as we move to 2023 and 2024 in terms of incremental cost synergies.
What's great at this point as we sit here today, we feel we feel we have clear line of sight and continue to make progress towards those numbers. So I think.
As far as that goes it's a very good story.
Thanks.
Thank you Joanna we have time for one more question.
Yeah.
We have Joshua Jennings of Cowen on the line with a question. Please state your question.
Hi, good morning, Thanks, a lot.
Joe maybe wanted to ask just about connected care initiatives.
Anything you can share on progress close to the hill.
Home acquisition on developing.
At least connected care technologies.
We're programs and how should we be thinking about.
And tracking the progress.
Maybe just a second question for Jay just thinking about that.
The target of getting down to two five times net leverage in 2024, just help us think through some of the puts and takes.
And your confidence level in terms of that you are on pace to hit that target. Thanks for taking the questions.
Josh Good morning. So we are seeing several programs, where we are working across divisions in the connected care. We established a new group that is actually under Andy Frye one of our executives who is also the head of GSS and PSS patient support system.
And.
We are seeing several programs from basic creating.
Unified portals to excess EMR systems and hospitals to features that can be enabled by commonality and connecting the devices. So there's a lot going on I think.
We should give an update to investors probably in.
In the first quarter of 2023 about where we are with this connected care programs and.
So we have a brand new group that is now across Baxter that he is looking at this and creating opportunities. So we're making good progress.
In this area of pass on to Jay for answering the other question sure as you know, we're really focused on maintaining solid investment grade credit ratings.
We define that as triple B. So the rating that we currently have is one that we're targeting maintaining and in order to do that we want to make very good progress towards the 275 net debt to EBITDA, which is which is our objective.
Say that from a cash flow standpoint. This year has fallen short of our expectations and I would say that of course, we've had some challenges on the income statement, but as we look at inventory, we had a fairly substantial inventory build over the course of the year, which is interesting because what's happening is you have a pump which is lacking one <unk>.
For components.
And so youre unable to sell that pump until you get that critical component. For example, we also saw extended shipping lead times over the course of the year and increases in the cost of our inventory due to our suppliers and so for all those reasons. We have had a very challenging year from an inventory standpoint, I would note that in the.
In the first and the third quarter, we did see a decline in inventory and we are expecting a fairly substantial improvement in free cash flow in the fourth quarter.
It's typically the case.
But here's the interesting thing while net income growth next year is low free cash flow growth, we expect to be substantial and so we're still finalizing our plans, but youre going to start to see a very significant acceleration of free cash flow growth as the inventory situation normalizes over.
The next one to two years and that will really support some of the work that we're doing to get to 275 times net debt to EBITDA, which again is a clear focus for our entire management team.
Thanks, a lot.
Thank you very much.
Ladies and gentlemen that is all the time, we have today for questions. This concludes today's conference call with Baxter International Thank you for participating.
Please wait the conference will begin shortly.
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