Baxter International Inc (BAX) — Q4 2016 Earnings Call Transcript

Thanks, Candice. Good morning, and welcome to our fourth quarter 2016 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 2016 financial results along with our outlook for 2017 before taking your questions. Please note that we have also posted a supplemental presentation that complements this morning’s discussion. This presentation can be accessed on Baxter’s external website in the investors section under events and presentations. In addition, I would like to remind everyone to please limit yourself to one question during the Q&A session, so we can accommodate others in the queue. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product developments, and regulatory matters, contains forward-looking statements that involve risks and uncertainties, and of course, our actual results could differ materially from our current expectations. Please refer to today’s press release and our SEC filings for more details 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. Now, I’d like to turn the call over to Joe.

Good morning, everyone, and thanks for joining us. I will start today with some comments on our fourth quarter performance and will also share some perspective on the year, on how we’re building our momentum in 2017 and beyond. Jay will then take a closer look at our financials and outlook for 2017, and I will close with the Q&A. As you saw in this morning’s press release, Baxter finished the year with another strong quarter. We delivered fourth quarter sales growth of 2% in both constant currency and reported basis. Adjusting for generic competition for cyclophosphamide in the U.S., sales increased 3% in the quarter. Key drivers included strong performance in U.S. Fluid Systems and anesthesia along with continued momentum in peritoneal dialysis and acute renal care. Globally, price contributed approximately 1 percentage point to growth in the quarter. On the bottom line, adjusted earnings were $0.57 per diluted share, an increase of more than 30% versus the prior year. Growth in the quarter reflects solid sales, improved gross margin, and the benefit of our ongoing business transformational efforts. Now, I will discuss performance by business and franchise on a constant currency basis to provide a clear look at underlying operational performance. In the quarter, Hospital Products sales totaled to $1.6 billion globally, increasing 1%. Adjusted for cyclophosphamide, sales improved 2% globally, in line with our expectations. Taking a closer look at fourth quarter performance by franchise, our sales in Fluid Systems were $614 million, up 8%; performance was driven by favorable pricing and volume for IV solutions in the U.S. along with incremental placements of the SIGMA SPECTRUM infusion system and the related pull-through of access sets. Fluid Systems sales growth in the quarter was negatively impacted by 1 percentage point from strategic exits of IV solutions in selected markets outside the U.S. Integrated Pharmacy Solutions or IPS, fourth quarter sales were $563 million, a 4% decline; adjusting for cyclophosphamide, sales decreased 2%. The performance in the quarter was impacted by lower sales in nutrition globally, given an increased competitive environment, lower pharmacy compounding sales, and higher sales deductions. Surgical Care sales of $349 million were 1% in the quarter, mid single-digit growth in our anesthesia business, offset by lower sales in biosurgery. While we are disappointed with biosurgery performance, we continue to view this business as a core growth platform and have significantly reallocated investments to biosurgery to improve performance. In addition, we’re pleased to welcome Wil Boren to the new role of President, Biosurgery. Wil is a 20-year healthcare veteran with extensive global leadership and surgical care experience. We’ll benefit from his experience and expertise as we expand our presence in this high-potential market. Finally, in Hospital Products, fourth quarter sales of $104 million in other declined 6% year-over-year, reflecting lower manufacturing services revenues from Shire. Adjusting for this impact, sales growth in the quarter was comparable to the prior year. Moving on to the Renal business, global Renal sales for Q4 were $1 billion, reflecting 5% growth. We continue to see strong momentum in peritoneal dialysis with growth of 7% globally, driven by patient growth of 6% along with favorable pricing and product mix in the U.S. where we now have nearly 1,500 patients on AMIA. Fourth quarter Renal results also benefited from our high single-digit growth in acute renal care. Our PRISMAFLEX system continues to lead a rapidly growing market for continuous renal replacement therapy or CRRT. In-center hemodialysis performance declined slightly in the quarter while we are pleased to see growth stabilizing following a number of actions we have taken to enhance performance. Growth improved 2 percentage points sequentially and importantly, profitability continues to improve in this business. In the fourth quarter, we launched our novel and proprietary HDx therapy enabled by our THERANOVA dialyzer, which has the potential to raise the standard of treatment and improve outcomes for end-stage renal disease patients. With that, let’s shift focus to the full year. This call marks my first anniversary as Baxter’s CEO. I found that at a company with a solid foundation and good people, the goal quite simply has been to convert this potential to consistent top quartile performance, to do it fast and do it well. Our full year results demonstrate our progress towards this objective of mid single-digit sales growth, adjusted income of $1.96 per diluted share, and free cash flow greater than $900 million. Our business transformation has focused on three clearly defined strategic levers: portfolio and innovation management, operational excellence, and capital allocation. We rolled out this strategy at our 2016 Investor Conference along with our Baxter 2020 financial targets. And it has been about execution discipline. This passionate portfolio management has meant taking a hard look at where we drive the greatest value expectations and the business across our vast portfolio and global footprint, and then invest accordingly to strengthen top line growth and return on invested capital. We have made some very candid assessments that have been crucial to optimize our portfolio, go-to-market strategy, and commercial mindset. Some of these decisions will impact our top line growth in 2017, but position Baxter for accelerated growth as we redirect resources to higher growth, higher margin opportunities. Just like our portfolio, our research and development pipeline must drive clear value for patients and the business. In 2016, we accelerated R&D productivity and shifted differential investment to our core growth areas and some compelling strategic bets. These actions will create a foundation for ongoing growth. We have also made excellent progress establishing a more efficient organizational structure and disciplined cost management strategies. And while these actions have meaningfully contributed to margin expansion in 2016, we’ll continue to identify new initiatives through our business transformation office to drive operational efficiency across our organization. Executing our capital allocation strategy through appropriate investment in our business and return value to shareholders is pivotal to deliver sustained top quartile performance. In 2016, we successfully completed the disposition of the Baxalta retained stake and have opportunistically restructured debt. Rewarding shareholders is essential to this equation, which we emphasized through a 13% dividend increase and opportunistic share repurchases of approximately $300 million. Finally, we initiated the acquisition of Claris Injectables, providing a key platform for future growth. So, in summary, it has been a year of rapid and meaningfully strategic execution across the board in advancing both the top line and bottom line. Am I satisfied? No, but we are off to a solid start, and there is more to come. And with that, I will turn it over to Jay.

Thanks, Joe, and good morning, everyone. As Joe mentioned, we’re pleased with our fourth quarter results demonstrating continued progress towards achieving our long-term financial goals. Sales in the quarter increased 2% on both the reported basis and constant currency basis, in line with our expectations. Walking through the rest of the P&L, adjusted gross margin of 44.5% represents an improvement of nearly 200 basis points over the prior year, driven by improved pricing in select areas of the portfolio and favorable manufacturing performance in the quarter. Adjusted SG&A totaled $619 million, decreasing 8% on a reported basis. The primary driver of the improvement was our ongoing focus on controlling expenses and the benefit from lower pension expenses. TSA income totaled approximately $23 million in the quarter compared to approximately $30 million in the fourth quarter of 2015. As mentioned last quarter, TSA income from Shire will continue to decline as the need for these services ramps down, which is expected to be by mid-2017. Adjusted R&D spending in the quarter of $152 million decreased 4% versus the prior year. Adjusted operating margin in the quarter was 15.4%, an improvement of 470 basis points versus the prior year. Operating margin compared favorably to our expectations driven by improved gross margin and disciplined expense management. Interest expense was $13 million in the fourth quarter. Adjusted other income totaled $19 million in the quarter, primarily resulting from gains on the sale of select investments and the foreign exchange benefit on balance sheet position. The adjusted tax rate was 24.5% for the quarter. This rate was higher than expected and reflected the finalization of the effective tax rate for the full year, which reflects incremental profitability generated in higher tax jurisdictions in 2016 as compared to 2015. As is previously mentioned, adjusted earnings of $0.57 per diluted share exceeded our guidance of $0.49 to $0.52 per share. Relative to the midpoint of our range, this favorability was driven by approximately $0.06 of operational strength and a $0.02 benefit from other income. This was partially offset by approximately $0.02 due to a higher tax rate. During the fourth quarter, we opportunistically repurchased approximately $250 million or approximately 5 million shares during the quarter. These repurchases were partially offset by option-related dilution. Before I turn to our outlook for 2017, I wanted to spend some time discussing our cash flow performance. In 2016, we generated free cash flow of $905 million, an improvement of more than $550 million versus 2015 and ahead of our most recent guidance of $650 million for 2016. This improvement was driven by strong operational performance, disciplined management of capital expenditures, which declined by nearly $200 million, along with the implementation of new programs focused on improving the Company’s working capital. These new initiatives around days payable and days receivable contributed to the strong cash generation in the fourth quarter. We also took the opportunity in the quarter to repatriate approximately $1 billion in overseas cash to the U.S. We were able to bring this cash back to the U.S. in a tax-efficient manner via the partial repayment of an intercompany loan, as well as the repatriation of previously taxed earnings in certain foreign jurisdictions. Let me conclude my comments this morning by providing an update on our outlook for 2017. Starting with sales, on a constant currency basis, we expect 2017 full year sales for Baxter to increase approximately 2%, and after adjusting for the U.S. cyclo impact and the select strategic product exits we’ve discussed, we expect underlying operational growth of approximately 4%. This growth is in line with our long-term projections and does not reflect any benefit from the proposed Claris acquisition. With respect to Claris, we expect the acquisition to close in the second half of 2017, and we’ll provide updated expectations following the completion of the acquisition. On a reported basis, including the impact of foreign exchange, we expect full year 2017 sales to be comparable to the prior year. We expect growth in the Hospital Products business of 1% to 2%, or approximately 3% to 4% excluding cyclo and strategic exits. Within the Hospital Products franchise, we expect sales growth of 2% to 3% for Fluid Systems; adjusting for strategic exits, we expect growth of 4% to 5%. For the Integrated Pharmacy Solutions franchise, we expect sales to decline low single digits. We expect full year sales for cyclo of $150 million as compared to $210 million in 2016. Our assumption is that additional competitors enter the market during the second quarter and third quarters of 2017; after adjusting for cyclo, sales are expected to increase by 3% in IPS. Within the Surgical Care franchise, we anticipate sales to grow approximately 2% to 3%, with both the anesthesia and biosurgery businesses expected to grow in that range. Finally, for the Hospital Products business, we now expect BPS and other to increase low to mid single digits. For the Renal business, we expect full year sales to increase by 3% to 4%, driven by continued growth across the segment; adjusting for select strategic exits, sales are expected to increase between 4% to 5%. Moving down to the P&L, we expect an operating margin of 15%, approximately 150 basis points improvement versus 2016. This is ahead of our long-term outlook we provided in May 2016, and reflects the benefits of all the actions we’ve taken to optimize our cost structure. We expect to provide an update to our long-term guidance on our second quarter conference call. We expect interest expense to total approximately $60 million and other income of approximately $20 million for the year. For the year, we expect an average adjusted tax rate of approximately 20.5%; this reflects a benefit of $20 million or approximately $0.03 related to the adoption of the new stock compensation guidance. For full year 2017, we anticipate an average share count of approximately 550 million shares. Based on these factors, we expect 2017 adjusted earnings, excluding special items, of $2.10 to $2.18 per diluted share. Finally, for the year, we expect to generate operating cash flow of approximately $1.75 billion and free cash flow of approximately $1 billion. Specific to the first quarter of 2017, we expect sales growth to increase approximately 2% to 3% on a reported basis and 3% to 4% on a constant currency basis. Adjusting for the impact of cyclo and selective strategic product exits, we expect underlying constant currency sales growth of 5% to 6%. And we expect adjusted earnings excluding special items of $0.50 to $0.52 per diluted share. With that, we can now open the call for Q&A.

First off, congratulations on another fine quarter. Let me ask you a couple of questions on the guidance, if I can, Jay. So, your margins over the last two quarters have obviously been exceptional; you’ve made a ton of progress; your EBITDA margin was 15.4% this quarter, 16% last quarter; your 2017 guidance is for 15%. So, tell me why is 15% the right number for 2017, given the second half of 2016 performance?

Yes, great. First of all, normal seasonality; we typically do better from a margin standpoint in the second half of the year versus the first half of the year. So, there are a number of factors that drive that in terms of seasonality of sales and normal hospital buying patterns. But, we do see some normal historic uptick in the second half of the year margin relative to the first half, and that was certainly the case in 2015. Interestingly, maybe I’ll make a few comments in terms of overall guidance as we think about 2017 operating margin. Really, there are a number of factors at play; one of them is we do have a cyclo headwind moving into next year, right. So, that’s about an 80 basis points impact on operating margin, or call it $0.13 of headwinds; from a foreign exchange standpoint, we have another roughly 30 basis points of headwind; and from a TSA standpoint, we have about 50 basis points of headwind. So, when you sum these up, we’re talking about headwinds of roughly 150 basis points or actually as we calculate it other way, maybe $0.35 of headwinds. Now, converting that to performance, we expect to see adjusting for that roughly 300 basis points of margin improvement, gross of those headwinds that takes us from on a full year basis what was 13.6% to roughly 15% for 2017. So, there are a couple of factors that match the quantum of the overall margin improvement. If you think about it from an overall EPS standpoint, like I said, we have about $0.35 of headwinds; we’re doing a lot of work on the SG&A line, and we’re going to see normal operational growth and portfolio optimization that contribute to allow us to offset that but it is a fairly substantial increase.

Okay. And Jay, just two follow-ups. So, if I look back at the Analyst meeting in June, your 2018 margin guidance was 14% and 15%. Your cash flow guidance was for $1.8 billion operating cash flow, $1 billion of free cash flow. You’re going to hit those targets and not exceed them in 2017. So, the question is, are the 2018 targets that you laid out last June now basically no longer effective or operational? And then, second question is, are you assuming any share buybacks in your guidance for 2017? Thanks.

Yes. So, as we think about the projections that we shared in May, I mean I will tell you on the operating margin side and certainly on the free cash flow side, we’re extremely pleased with the performance so much so that we’ve pulled forward 2018 basically one year to 2017 from a margin standpoint and from a free cash flow standpoint. So, we have to update those numbers. My full expectation is we will be able to overachieve those numbers clearly based on the 2017 performance. But from an overall process standpoint, we feel through a bottoms-up long range financial planning process, our teams have initiated that work; it’s work that we’ll conduct over the next several months or review the output with our Board of Directors. And then, I certainly look forward to sharing it with our investors at the July earnings call, in part because I do believe there will be upside to the numbers that we’ve shared. As it relates to share buyback, we are assuming share buyback to offset dilution. So, there are a few hundred million dollars of buyback embedded in our guidance. As we’ve said, our standard approach; we don’t commit the specific amount; a lot of it depends on the evaluation of the share price relative to the intrinsic value of our Company. In the fourth quarter, we saw a great opportunity because from an intrinsic value standpoint, the share traded at a higher discount than normal, so we repurchased $250 million in shares. We’ll look to do that again to the extent to the opportunity presents itself in 2017. But, from a planning standpoint, we basically have share buyback offsetting dilution.

Good morning. Thanks for taking the question. So, just a follow-up on the margin piece; you outlined a number of the headwinds. I’d love to understand the components of margin expansion. If you could just kind of walk us through portfolio management, new products, cost savings, things like that so that we can understand the bridge that allows you to make such a nice jump over some of these hurdles in 2017.

Yes, great question. I did focus on headwinds in the first answer. As I said, we have about $0.35 worth of headwinds or 150 basis points. But, the work that we’re doing in a number of areas has paid remarkable dividends in 2016, and we expect a very big impact in 2017. The area that I’ll point out from an SG&A standpoint, we expect about 120 basis points, 130 basis points of net improvement or roughly $0.18 related to the cost savings initiatives that we’ve put in place. Now, we’ve talked a lot about this concept of zero-based budgeting and how from an organizational standpoint and from a spending standpoint we’ve been incredibly disciplined looking at every dollar consumed by our Company. That featured prominently in our results in 2016. But, it allows us to do in 2017 is improve our SG&A once again by 120 basis points, 130 basis points and $0.18, and that’s net of inflationary increases that we normally see from a payroll standpoint. So that one factor is having a very big impact and frankly it offsets a number of the headwinds that we’re facing. But then, the next piece relates to normal operational growth. If you think about the normal operational growth that we talk about, roughly 4 plus percent, that will contribute because we’ve walked away from sales that are at a zero margin really. That drops too at a higher level than the standard corporate average. And when we start to see growth in those core growth areas, which attach to them have a higher margin than the corporate average, it has the great impact on the operating margin. So, with the operational growth of our business, it’s roughly 170 basis points of positive impact, we’ll see roughly north of $0.30 of benefit from the operational growth of Baxter. So, taking a step back, we have a number of headwinds that we’re fighting through but we have two very important tailwinds. One is this SG&A focus that we have as an entire organization; and two is the drive to accelerate the growth of the business and the natural improvement that drives toward the bottom line.

Great and then just one follow-up, I’d love to hear kind of your updated thoughts on the Claris acquisition and the injectables space in general. Can you talk about how that’s core to your strategy and does Claris get you where you need to be in injectables or are there other assets that you could add there or other whitespace that is kind of higher priority?

Matt, the strategy we outlined is very clear. We are going to be into the injectables. It’s difficult to make a market. Claris is a step in the right direction. Between Claris and Baxter portfolio, in the next three to five years, we’ll be launching 100 different new molecules for us into the market. We also have plans to sign several different collaborations and partnership agreements; coming up probably in the next 30 days, we’re going to have one or two. And we are planning to have 100 more molecules on top of that. So, expect more to come. We also have segregated our organization within Baxter to make sure that we have the right people in place to create a competitive advantage that this market requires which is cost, quality, and speed.

Hey guys, congratulations on another impressive performance here. Maybe, I’ll start with one high level question on the revenue guidance. Jay, I mean, if you look at the 2% constant revenue growth, I think there has been some question about what is the true underlying growth for Baxter ex-pricing? Can you just comment on the volume versus price dynamic for that 2%?

Yes. I mean, the 2% is principally volume-related; there is a small impact of price included in that. But, by and large, it’s a volume related number. We’ve historically talked about this notion of organic or long-term sustainable growth of 4% with our expectations that we look to accelerate beyond that over time. So, as we sit here today, the 4%, when you adjust for cyclo and the strategic exit, we're kind of broadly consistent with that.

Great, and maybe one for Joe. Joe, when you think about the top line cash generation, it really is a remarkable rate. You guys, I think in the last year set out the target of $500 million, almost double the free cash. One, why is that $1 billion free cash I think for 2017 a right number; were there any timing-related impacts in the fourth quarter period which sort of affects the comp? And two, what’s the use of cash? If I do the math, 5 million shares repurchased for 250; that gets an average share price of 47.50. Your stocks right now are at close to those levels. So, how should we think about M&A versus share repo? Thank you.

Sure. I will discuss cash flow performance in 2016 and our outlook for 2017, after which Joe will address how we plan to use our cash and our strategy regarding mergers and acquisitions versus share buybacks. In 2016, we had several positive outcomes, but one of the standout achievements was our free cash flow performance, which exceeded the guidance we provided in the third quarter. However, forecasting cash flow can be challenging for a couple of reasons. Primarily, a significant portion of cash flow is generated toward the end of the year. Additionally, we currently have large working capital balances, and since historical free cash flow has been relatively low, small improvements in working capital can significantly impact free cash flow, which we witnessed this year. We were very pleased with our progress. In terms of working capital, we focused on three key areas: days payable, days sales outstanding, and days inventory on hand, and our team at Baxter surpassed our expectations in all these areas. For days sales outstanding, we reduced it by two days year-over-year, with several countries achieving their lowest DSOs in a decade, especially Spain where we now have a DSO of 100 days, a level I haven’t seen since 2007. Our goal was to ensure the Baxter team didn’t hinder collections, and teams in Mexico, Italy, and Spain excelled in this respect. Regarding days payable, we improved by one day from last year, a program I mentioned earlier that we just started this year but already shows promise. Regarding inventory, we reduced it by over $100 million, with days inventory on hand down by 10 days, thanks to the excellent work of our supply chain team. Overall, we made significant strides in all three aspects of working capital. Our capital expenditures came in slightly lower, but our guidance for next year suggests a modest increase in CapEx. Some spending was shifted from December to January along with some product placements, which will not materially impact revenue growth but did affect the timing. Thus, the benefits from CapEx were seen earlier in the year but will continue into 2017. Looking ahead to 2017, we anticipate a 10% growth in cash flow along with continued improvements in working capital metrics. We also expect about $150 million in restructuring payments that will occur throughout 2017, presenting some challenges. Nonetheless, we are confident in achieving our $1 billion cash flow target and are committed to working diligently to reach that goal.

I think the great use of cash is to provide opportunities for the Company to deliver on a top quartile total shareholder return. So, for us, it’s not a matter of one versus the other; it’s we can do them all. We can allocate CapEx with the dividends, our long-term objective is 35%; we’re going to continue to pursue that. We will buy shares back opportunistically because we’re not going to hold cash in our balance sheet. But more importantly, with this cash flow performance associated with a clean balance sheet and a very, very low net debt over EBITDA, we can now contemplate inorganic opportunities that we probably were a little shy in looking into in the past. So, as I said in the previous meeting this year, 15% to 20% of our market cap is reasonable to think about acquisitions and at that level. We have several opportunities that we’re evaluating. And the transformation of our portfolio in a higher weighted average growth market rates business is our objective.

Good morning, guys. I’ve got two franchise level questions; first, on the IV business. Can you comment on where Baxter is with the upgrade cycle for SIGMA SPECTRUM? And I know there has been some competitive disruption there. So, I am wondering if there is more share to be had in the actual pump market. And then secondly, it sounded like you have a little pricing leverage within that business; wondering if you could just talk about some of the pricing dynamics within the injectables. And then, I’ll go ahead and ask my second one, just on biosurgery, Joe. I think you’ve got a new leader there. You are guiding for that business to improve. I am just wondering if it is execution, is there a product pipeline to call out, are you looking at deals there, if you could give us some details on how that business should start to turn around? Thanks.

We have several improvements to our pump portfolio coming for the U.S. Recently, we signed a development partnership deal with a reputable company outside the U.S. that will enhance our international portfolio. Baxter still holds a significant number of channels outside the U.S. under the Colleague pump. As we phase out the Colleague pump, we will introduce a new platform to replace it. This partnership is expected to expand into new areas with different pump applications. I feel very confident about two main efforts: the internal launch, which includes connectivity improvements and programmability of our pumps, and the international effort with another platform. Our 2016 SIGMA SPECTRUM pump is leading the market, and we have a solid strategy for approaching this market. Regarding pricing dynamics, we generally don't discuss that, but I can say our pricing has contributed modestly to our growth. We previously mentioned a 1% impact. We have long-term contracts with U.S. hospitals that are solid and being executed. Our main focus now is ensuring plenty of supply, and we are investing $100 million in our North Carolina operations to maintain quality products for the market, while also expanding our North American network to include increased capacity for Canada and Mexico. In biosurgery, we haven't performed at our best, but with Wil Boren now on board, I believe he will quickly turn this business around. We are currently exploring a promising licensing agreement. We are rebranding this unit within our company to advanced surgery, which will open up opportunities for new areas and acquisitions. This will encompass not just adjunct therapy but also specialized surgical areas, which is an exciting development. Our priority is execution with the new president in place. We have restructured this business globally, creating a truly vertical organization within Baxter, separate from the traditional international operations, and we are also amplifying license deals and doubling our research and development efforts. We have strong faith in Wil, and I am confident he will successfully revitalize this business.

Good morning. Just a couple of financial questions for Jay and then one strategic one for Joe. So, Jay, just real quickly, a couple of things. IPS performance was a little lower in the fourth quarter and that sort of relative to our model looks a little lower in 2017 as well. So, on an underlying basis, is there something in IPS that happened in the fourth quarter that kind of bleeds into 2017? And then operationally, for the guidance for the year, just the pacing of the quarters; first quarter starts out very strong and then obviously that slows a little bit across the next two quarters. Is there anything going on there other than just comparables? Obviously your second quarter and third quarter were the toughest comps of the year. And then a quick follow-up for Joe.

Okay. Let me hit the second one first. We do see some of the strongest growth in our Fluid Systems occurring in the first half of the year. As you recall, we signed a number of agreements and the last of which was really signed I believe in the second quarter of last year. So, we start to annualize those benefits in the second half, thus there is slight deceleration in sales growth from really the first quarter and maybe second quarter to the rest of the year. So that’s really the seasonality factor. As we think about IPS, I would point out that in the U.S. in the hospital business, we don’t really do a lot of discussion around selling days, but we did have a couple of days less from a selling days standpoint, which is call it a 3% or 4% impact. And in particular in businesses like IPS, it can have a material impact on the growth rate. So, I would point to that. I think there is not really other trends going on in that particular business. We continue to be very excited about it. IPS, as you know, includes nutrition, GPI or injectables business, which so far the injectables we’re very optimistic about that space.

Okay. Joe, reflecting on the analyst day and the strategic priorities, you mentioned that 40% of the Company’s dialysis business has a strong product suite and good guidance for 2017. You highlighted the significance of generic injectables for Brook's team, and that has materialized. Now that Wil has joined and renamed that group, do you see the greatest opportunities for transforming the Company's growth rate in the advanced surgery or biosurgery area? This seems to be a strategic opportunity that could be addressed following the analyst day. Thank you.

David, that points to a great area of opportunity, I think, inorganic. And now with our balance sheet and our performance in cash flow, I feel more confident in how we go about these businesses because it gives us more flexibility. I think when you start going away from classifying your business as products or narrow areas, it opens strategic opportunities, the adjacencies. So, in the surgery business, I think that is the case. I would like to underscore that renal, despite the fact that we are market leaders in peritoneal dialysis and we’ve been gaining market share in the U.S. and other markets in acute renal care, which is our CRRT versus our competition because our technology is far superior. I would say that there is still opportunity in peritoneal dialysis for growth in emerging markets with technology that currently does not exist there. So, I feel that we’re always going to have that nice business, 5% to 6% growth in renal; this keeps churning and churning and delivering on cash. And Giuseppe Accogli has done a great job with his team, turning the in-center hemodialysis business around and with the adoption of AMIA with the stellar medicine platform, I feel really confident about that business. So, as we see the opportunities in adjacencies, I still think our base renal business continues to churn and a great deal of cash and helping the Company finance expansion in that area and other areas.

So, Joe, emerging markets are about 25% of Baxter sales. Can you talk about what you’re seeing for Baxter in emerging markets; what was growth in Q4; what’s your expectation for 2017? And, I have one follow-up.

Our emerging markets saw a 3% growth in the fourth quarter, but I want to clarify that all of our exits are occurring in that market. We’re scaling back operations in India, Turkey, and Venezuela, which are struggling. In Greater China, we have increased to 6% with plans to reach high single-digit growth. Our peritoneal dialysis business is recovering in China, which is crucial for us. We are also witnessing a recovery in Latin America. Much of the underlying growth will mainly come from biosurgery and peritoneal dialysis, which we intend to concentrate on. We have exited and will continue to exit many parts of the IP business in markets where we are not generating profits and are incurring losses. I feel optimistic about our investment plan for China, which aims to bring that business close to $1 billion within a few years. We are very positive about Latin America and our increased investment there. For the near to mid-term growth rates, we expect low to high single digits for that region, particularly after we navigate the effects of exiting the business in India, Turkey, and Venezuela over the past 12 months.

Thank you. That’s very helpful. And then just back to Claris, I know there was a question asked on that earlier. But, can you tell us what the sales were for 2016 and the growth? And I’m asking because the IMS data implies for at least the U.S. that growth was north of 50% through the first three quarters of 2016. And just I wanted to confirm that if it closes later this year to about $0.01 to $0.02 benefit in 2017. Thanks for taking the questions.

We are looking to close Claris as quickly as possible, likely by the second half of the year, around July or August, which will give us more clarity. We're anticipating a benefit of a couple of cents per share for this year, and the Company has over $100 million in sales. You can calculate the potential impact from that. I believe we will provide clear guidance on how this will affect 2018, allowing you to factor it into your long-range planning. Additionally, we will update you on the acceleration programs we're implementing for more products in this market.

Just a quick question first for you, Jay, on the guidance. I know we talked about this a little bit already in terms of how Q1 starts and then the rest of the year. But, what I’m curious about, if you could just talk about what drives the improving underlying growth in Q1 versus Q4. Because I think in Q4 you said you’re going to 3% and then you’re expecting 5% to 6% underlying in Q1. Is that just comps or what drives such an acceleration from Q4 to Q1?

Yes. It’s interesting. There is definitely a comp in play. As we look back to last year, we had a strong Q4, and then Q1 was not quite as relatively strong as Q4. But then, and I don’t want to get into this whole billing day thing, but it is a factor that comes into play, in particular in the hospital business globally. We lost a couple of billing days, which was several points of growth; and I believe in Q1, we actually gained one billing day. So that swing factor actually modulates the growth rate to some extent. Those are really factors that are in play.

Okay. So, it’s less fundamental issues, more sort of calendar issues, it sounds like, and just in terms of Q4 to Q1.

Exactly.

And then, Joe for you, again for everybody, congrats on a great 2016. You’ve talked a lot about M&A already on this call. But, I was wondering if you could just, in broad terms, set expectations for us for M&A in 2017. How likely are deals, how confident are you that there are attractive assets out there that could be priced at levels that you find interesting in 2017?

Bob, it is quite a task to answer your question because it’s opportunistic and our efforts are relentless. So, eventually we’re going to get to the right target; we’re working very hard. As you know, we’ve rebuilt our M&A team completely from scratch. We have very good people on board. But we are financially disciplined. So, our ability to strategically identify targets is there, but things have to work. And some assets are expensive, and we want to make sure that we can extract value because our first priority is to really return the top quartile total shareholder returns. So, we’ll do that. We have plenty of targets, a good team in place, good direction where to go. We need to find the opportunity where this target becomes available or is interested, and the price is something that will be attractive for the Company. We are always speaking about three to five years Company average ROIC return; we’re talking about internal rate of return greater, by far exceeding cost of capital all debt and equity included. So, we will continue down this path. But we are excited about the position that we have in our balance sheet. But that does not create a bias for us to act without thinking about the financial returns.

I wanted to address the questions about Claris and other initiatives aimed at enhancing performance across the portfolio. We believe the Claris deal aligns well with the injectable strategy presented last year. One point that has been raised several times during the call is your effective handling of product line rationalization, especially by region. You've highlighted some adjustments made in the latter half of the year. Jay, could you share more details about how significant that has been in contributing to the 300 basis-point operational improvement you mentioned, excluding headwinds? I also have a follow-up question.

Yes. I mean, it’s interesting because for us over the last year and a half, and we’ve really intensified the focus over the last six months, we’ve been focused on rationalizing the portfolio and challenging every single sale. And I think we’ve done a nice job looking at the fully loaded and variable profitability of every product line in every country in which we operate. And as part of that, we identify a set of sales which didn’t quite make sense for us on a going forward basis. And so, we walked away; the impact next year is around $100 million in sales. That was really a zero margin contribution. And so, the simple fact of walking away from those sales is roughly 10 to 20 points of margin improvement due to those strategic exits. Now, it’s important to note, as we sit here today, I think we have cleansed the portfolio to the extent it needs to be cleansed at this stage. Of course things change. So, it could be a foreign currency evolution; it could be pricing pressure in a particular emerging market which would cost us to relook at this. But again, as we sit here today, I think we feel very confident that all the sales that we have contribute positively to the economics of Baxter. But now, it’s about from a portfolio management standpoint, not so much walking away but shifting our R&D investments and our SG&A investments towards those areas that we think are promotionally sensitive where Baxter has a proprietary right to win where we have higher margins, and that will be the next leg of the journey as we think about margin improvement related to portfolio management.

That's great. For a follow-up, I’d like to revisit the topic of pricing that has come up in previous questions. Given the sensitivity and emphasis on drug pricing, which is outside your main business areas, it would be beneficial to clarify your situation. We understand that most of your growth is largely driven by volume. However, we often analyze performance in terms of price adjusted for mix or price and mix as factors affecting growth rates. Are you currently experiencing a decline in pricing with some positive mix, or is it the opposite? How should we approach this?

Yes. I think, what I would say is as we look at 2017, to be clear we have roughly 30 basis points of pricing in our numbers. So, it’s not a substantial number from an overall pricing standpoint. And really that’s not new price increases that we’re anticipating, so much as it is previously agreed to agreements that we have in place with our major customers with normal price increases attached to them. So, really that’s the environment that we’re operating in. As we’ve said, when we look at our long-range plan, we see a fairly mutual price environment; there is some benefits and some areas where we’re seeing pressure. We’ve commented historically about price pressure in the area of dialyzers, but we’ve also commented about things like the launch of AMIA, and what that does as a new therapy and ability to charge a higher price because of the great value that we’re providing with that product. So, it’s a difficult question to answer, but what I can say is we’re not really counting on much price. We think the environment is fairly neutral and it’s a little bit different in some of the other dynamics that are in play with other areas in healthcare.

First, Jay, did you give us targets for gross margin and R&D ratio for 2017?

We did not share those targets. I think from a gross standpoint, we’re looking at roughly 50 basis points of expansion next year; mind you some of the foreign exchange impact and some of the cyclo impact in particular impact that line which is why we’re not seeing more expansion. And from an R&D standpoint, we’re looking at mid-single-digit increase. And it’s interesting because our R&D team has done a very nice job looking at infrastructure cost and controlling costs, and diverting spending to new product development. And so, while we’re only increasing mid single-digit, the actual amount spent on projects is going up fairly substantially. So, we’re very pleased with that. And then from an SG&A standpoint, we expect again, there will be a decline in SG&A down low to mid-single digits, and that’s in large part driven by the zero-base budgeting techniques that we’re applying across the portfolio.

Okay. And then let me just follow up on that SG&A comment just because one of the questions I often get from investors is, how sustainable or how much runway is left in terms of bringing down SG&A. In other words, has all the low-hanging fruit been removed? So, maybe some thoughts, either for you Joe or Jay in terms of the sustainability of the SG&A decline over time. Thanks.

Glenn, we are in the middle of doing it. We still have few programs that are in process of being contemplated. And what I’m finding here at Baxter that I did not find before in my previous experience is that the business transformation office has changed the way we look at things and how we spend money and the effectiveness of our spending patterns. So, we are now a Company that is for the vast majority a six-layer Company with very few exceptions. We are a Company that understands category management. But every meeting that we go, we go to a two-hour business transformation meeting every month, we just identify significant amount of savings in the future of programs that are not contemplated. So, this is a journey; this is not a project. So, do we have more? Yes. Is it more elasticity? Yes. Do we want to see the SG&A lower? Yes. What is the right SG&A for this Company? Well, we’re going to talk more about what we think the margins are going to be in 2020, later this year. So then, you can estimate what the SG&A is going to be as a target. But, we’re not satisfied; we’re happy with the progress and the people at Baxter have done a great job embracing this very difficult way of managing business in terms of expense.

Thank you very much for taking the question, very nice quarter. Joe, you’ve been there for about a year now. What would you say were your key highlights and takeaways? And a year from now when we’re all together, what do you really want to make sure that we’ve seen happen this year?

Joanne, I was surprised by a culture that was ready to be changed. People here were looking for a change. And so, some of the things that we were doing in terms of portfolio management, reallocation of R&D resources, completely revamping of our marketing organizations, how we are organized, our BDNL, our M&A groups. This has been a significant change in how people used to do business. And folks here have adopted and really didn’t use to be in getting on with the program. So, I will highlight that of everything we’re doing, we couldn’t have done it without the great employees of Baxter. On looking forward, if I am sitting a year from today, what I’d like to see, I’d like to see this biosurgery business start to transform itself and look for some opportunities outside. I’d like to see us with probably another 100 to 200 molecules in our pipeline above what we have today. I’d like to see us with a well-defined pump technology, which is not only U.S. but is a global one that has the ability to meet industry levels of pump platforms that we need to have. So, I have significant expectations. And lastly, we need to make sure that we don’t lose the sense of urgency and speed by which we transform the Company.

As my follow-up, there has been a lot of questions already on M&A; we throw around a lot of different names amongst yourselves. But what is your current thinking about adding another leg to the stool or is it really just adding in things to your current structure? Thank you.

We will continue to look at adjacencies. You’ve got to be able to walk before we go into the triathlon here. So, a white space and a brand new leg to the stool becomes a high order for a company that has not done many M&As and in the areas that they did were always on adjacencies. So, we’re going to look into adjacencies we have not looked in the past. However, to have a complete new leg of the stool, I think is a little premature for us to speak about.

So, Joe, for the year on a constant currency basis, it looks like you did 6% growth in the U.S. and about 3% overseas. So, I wanted to just pick your brain a little bit on how you think about accelerating the overseas growth, because I think it’s probably a bit below what you’re anticipating in your long-range plan, and just want to see if you could expand upon that a little bit?

Larry, couple of things; the overseas will be impacted by two or three factors. Let me start by saying that once we anniversary the exits of $137 million in sales that we are exiting in Turkey, India, and Venezuela for the most part, you gain a good 1.4%, 1.5% or 150 basis points of incremental growth right on that. The second thing is, we must improve performance in Europe. We’re making some changes in Europe to make sure that we get the right people in place, so we can get performance. It has been a while, and despite the fact Europe is a slow-growth market and it’s a difficult market for the most part, the developed part of the Europe, not the emerging part of the Europe, which would be the Eastern Europe, Middle East, and Africa which in 2017 we expect good growth from. And I want to make sure that we have the right structure in Europe. We’re making changes to that effect and also getting the biosurgery out of Baxter’s structure on a fully vertical organization and couple of licensing deals, and I think we can accelerate that. So, our objective for outside the U.S. is to make sure that we return to a 4.5% to 5% growth rate in the midterm.

Okay, perfect. And then, the other question is just thinking about your pump business specifically. How are you thinking in sort of 2017 outlook relative to the potential for a pause in spending at the hospital level, given some of the uncertainties around ACA?

It’s currently very uncertain regarding the review and replacement policies, as well as what will be implemented to ensure coverage for those potentially without it. Hospitals tend to hesitate on significant capital expenditures and expansion investments. However, the capital products we have are minor investments that hospitals require, such as pumps, rather than large diagnostic equipment. If there is any effect from these uncertainties, we’re likely experiencing the tail end of it and expect minimal impact into 2017. We have seen remarkable success with our SIGMA SPECTRUM pump in the U.S. over the past two years, and we expect this trend to continue in 2017, particularly due to the number of accounts we've gained from competitors. This is distinct from the fact that hospitals' capital spending policies are influenced by the political landscape and directives being issued. It’s important to separate these factors. I believe that Baxter will perform well in 2017, focusing on maintaining and selectively expanding our presence in U.S. hospitals with more beds, benefiting from the considerable market share we've achieved in recent years. Our focus now is on maintaining slight growth and ensuring proper utilization of the pumps.

Thanks so much for taking the question and congrats on a great quarter. Jay, I was hoping you could give some color on some of the various topline headwinds as we head into 2017, all the headwinds and tailwinds as well. Just thinking about your underlying growth projection or guidance for 4% is below the 5% you delivered in 2016; just looking to get some color on the puts and takes there. Thanks so much.

In 2016, we experienced a strong performance in our Fluid Systems segment that exceeded our long-term expectations, partly due to the initial phases of the CIGMA SPECTRUM re-launch and our efforts in increasing volumes and contracting within the Fluid Systems business. The primary factor for the anticipated deceleration, excluding one-time impacts, is the expected slowdown in this business. As we look to 2017, a few key points are worth noting. We have a cyclo impact around $100 million and a strategic exits impact also around $100 million, while the rest of our portfolio is mostly aligned with our long-term expectations. There are no major shifts, but the stabilization of the Fluid Systems business, which is expected to grow a bit faster in the first half of the year, is the main reason for the change in growth rate.

Perfect, that makes total sense. Thanks for that. And then, any major tenders, I guess specifically in the renal business that we should be cognizant of over the next 12 months that are coming up?

We have nothing major at this stage from a significant tender standpoint to point out. We do have a lot of our business that goes through tenders outside the U.S., some of them are large tenders; some of them are small tenders. But as we sit here, nothing major to point out to you that would be an area of concern for us.

I just want to augment Jay’s comments quickly: we’re seeing a 5% to 6% increase in patients in PD which is a great indicator for us into 2017.