Baxter International Inc (BAX) — Q4 2017 Earnings Call Transcript

Thanks, Canda. Good morning, and welcome to our fourth quarter 2017 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 2017 financial results, along with our financial outlook for 2018. As a reminder, we have posted a supplemental presentation to complement this morning's discussion. This presentation, along with the related non-GAAP reconciliations can be accessed on Baxter's external website in the Investors section under Events and Presentations. As previously mentioned, we've reorganized our commercial structure to boost performance, optimize cost, increase speed in the decision-making process, and drive improved accountability across Baxter. To that end, we will be modifying how we report our quarterly financial sales in segment analysis. This new structure will reflect the current makeup of our commercial operations, and while we recognize these changes will impact their model, we believe this presentation will provide you with more granularity regarding our topline performance by global business units. To aid you in this transition, this morning we posted reclassified sales schedules for the global businesses for the last three years inclusive of 2017. These schedules can be found in the Investor Section of baxter.com. The regional segment structure will be included in our 10-K filings with the SEC. With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development, and regulatory matters, contains forward-looking statements that involve risks and uncertainties and, of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website. Now, I'd like to turn the call over to Joe.

Good morning, and thanks for joining us today. I will start with a brief look at our fourth quarter performance, then I will share some thoughts on 2017 as a whole and how we are well positioned to sustain this momentum into 2018 and beyond. Jay will then take us closer look at our 2017 financials and outlook for 2018. We'll close with Q&A. Baxter finished the year with another solid quarter delivering fourth quarter sales growth of 5% on a reported basis, 3% on a constant currency basis, and 2% operationally. Operational sales adjust with an impact of foreign exchange, generic competition for U.S. cyclophosphamide, the Claris acquisition, and the previously communicated select strategic product exits the company has undertaken. On the bottom line, adjusted earnings per share was $0.64, up 1% year-over-year driven by strong operational performance, the ongoing impact of our business transformation efforts, and a lower tax rate. This performance more than offset the impact in the quarter from Hurricane Maria which reduced our results by approximately $70 million on top line and approximately $0.06 on the bottom line. For the full year 2017, Baxter achieved top line growth of 4% on a reported constant currency basis and 5% operationally. Adjusted income from continuing operations up $2.48 per diluted share, an increase of 27% and free cash flow of more than $1.2 billion. Before we discuss some key highlights for 2017, I wanted to take a moment to update you on our operations in Puerto Rico. We've been intently focused on addressing the supply situation in U.S. and the aftermath of the hurricane and the challenging impact it has had on our customers. Our primary goal, as always, is to ensure we can address the needs of patients and healthcare providers, and we have mobilized quickly. All of our Puerto Rico facilities are now connected to the electrical grid and we've been ramping up production to pre-hurricane levels. Our expectation is that we will be able to return to more normal supply levels over the coming weeks, and as such, we expect the residual sales impact of approximately $25 million in the first quarter of 2018. In a related matter, as you are likely aware, an aggressive flu season in U.S. coupled with industry-wide supply changes has heightened demand for Baxter's large volume IV solutions which we produce outside of Puerto Rico. As I mentioned in our last earnings call, we have received further FDA approval to import large volume IV solutions from our plant in Cuernavaca, Mexico to help address increased demands from our customers and potentially serve new customers in the future. Now turning to some 2017 highlights. The Claris acquisition represents an important example of our commitment to enhancing our portfolio and pipeline in our core growth businesses like generic injectable pharmaceuticals. We are rapidly integrating the Claris team, bringing these operations fully online with Baxter's quality systems, and looking forward to continued momentum and commercial growth over the long-term. Earlier this year, we announced an agreement to acquire two hemostat and sealant products from Mallinckrodt, RECOTHROM and PREVELEAK; both compelling additions to our advanced surgical portfolio. From an R&D perspective, we enter into promising partnerships designed to augment our portfolio and potentially lead to transformative patient care technologies. Our organic R&D pipeline is also advancing several high potential developments. In the U.S. market, we received FDA guidance clarifying the regulatory pathway for new home-based peritoneal dialysis solution generation system that may allow even more patients to experience the benefits of home therapy. We have initiated U.S. clinical trials of HDx therapy enabled by TheraNova; a Baxter technology now available in many global markets that is designed to closely mimic the natural clearance of certain molecules during dialysis. Outside the U.S., we began a limited launch of PrisMAX, our latest technology advanced for acute care therapies in Europe. We anticipate a full European launch later this year; also in acute therapies we launched a labeled expansion for oXIRIS, blood purification set in selected markets outside the U.S. This marks the first three-in-one set for use in continuous renal replacement therapies and sepsis management protocols. We continue to advance customer-focused enhancements with high-value technologies across our core portfolio, including our AK 98 hemodialysis system, our FLOSEAL and TISSEEL Hemostatic agents, and the SIGMA SPECTRUM infusion system. In 2017 also marked a million PD treatments used in our proprietary Share Source telemedicine technology. Share Source is foundational rather to the success of our newest automated PD cyclers, AMIA in the U.S. and HomeChoice CLARIA in international markets. Last week, we announced FDA approval of Bivalirudin used with Baxter's proprietary frozen GALAXY container technology, making it the first and only presentation of this generic cardiovascular inject with a convenient source and premixed solution. These internal and external investments designed to accelerate future growth are balanced along with our commitment to return significant value to our shareholders. Through this end, in 2017, we increased our annual dividend rate by 23% but also repurchased more than $560 million worth of shares. Overall, we are energized by what we accomplished for our stakeholders in 2017, and it has all been made possible by our 47,000 employees globally who are absolutely committed to our mission and the success of our transformation. As we look to our expectations for 2018, increased operational efficiency remains essential and we will continue to identify opportunities to improve operating leverage, at the same time we intensely focus on accelerating top line performance. We know by enhancing our product mix we can drive sustainable gross margin improvement for the company. As schedules continue to ramp up, our emphasis on new product innovation and business development support this objective. We look forward to updating you on these strategic initiatives, particularly many of our existing and exciting pipeline programs at our upcoming investor conference on May 21 in New York City. In summary, while we have a lot of work ahead, as we continue to position for the future, I'm confident that we are up for the task. Now I'll pass it to Jay for a deeper dive on the fourth quarter performance and outlook for 2018.

Thanks, Joe, and good morning, everyone. As Joe mentioned, we're pleased with our fourth quarter results, which represented a strong finish to a great year. I'll start by discussing our fourth quarter and full year 2017 results before providing our financial outlook for 2018. Beginning with the fourth quarter, sales increased 5% on a reported basis, 3% on a constant-currency basis, and 2% on an operational basis. Key growth drivers for the quarter included continued momentum across our U.S. fluid systems and renal businesses, as well as strength internationally in nutrition and increased demand for our cytotoxic contract manufacturing services. As previously mentioned, disruptions to our Puerto Rico manufacturing facilities negatively impacted fourth quarter sales by approximately $70 million. On the bottom line, adjusted earnings increased 12% to $0.64 per diluted share. This exceeded our previous guidance of $0.56 to $0.59 per share, driven by operational performance, disciplined management of expenses, and a modest benefit from foreign exchange gains on balance sheet positions. Now, I'll walk you through performance by business. I'll speak to growth figures on an operational basis to provide a clearer understanding of underlying performance. As a reminder, operational growth excludes the impact of foreign exchange, U.S. cyclophosphamide, Claris, and select strategic product exits. Global sales for Hospital Products were $1.7 billion, advancing 1% operationally. Breaking this out by business, sales in Fluid Systems were $632 million, up 2% operationally. Performance was driven by strength for large volume IV solutions and IV access sets in the U.S. Growth in the quarter was offset by lower sales internationally and impact from Hurricane Maria. Integrated Pharmacy Solutions, or IPS, sales were $602 million, flat to the prior year on an operational basis. Sales growth in the quarter was negatively impacted by $56 million from Hurricane Maria which offset increased sales of our premixed injectable drugs in the U.S. and from nutritional therapies internationally, as well as strengthening our hospital pharmacy compounding business. Sales of U.S. Cyclo were $43 million in the quarter and Claris contributed $30 million globally. Moving to Surgical Care, which includes anesthesia and advanced surgery; total sales were $363 million, increasing 3% operationally. Growth in the quarter benefited from increased sales in inhaled anesthetics internationally, and U.S. sales of BREVIBLOC. Also contributing to performance was growth in advanced surgery of 3%. Sequentially, advanced surgery grew 5% as we are beginning to recognize many of the actions we have implemented to improve performance in this business. Fourth quarter surgical care was impacted by lower sales of Transderm Scope as a result of increased competition. Finally, in Hospital Products, sales in our other category were $108 million, increasing 1% driven by favorable demand for the company's cytotoxic manufacturing services. Turning to our Renal business; sales were approximately $1.1 billion, up 4% operationally. Sales in the quarter benefited from solid performance across all lines of the business. Chronic renal therapies, inclusive of PD, in-center HD, and renal therapy services rose 3% globally and our Acute Renal therapies business delivered high-single digit growth globally, driven by balanced growth in the U.S. and internationally. Walking through the rest of the P&L, our adjusted gross margin of 44.3% declined 20 basis points over the prior year; operational expansion due to positive mix, select pricing, and business transformation initiatives was more than offset by the impact of lost sales due to Hurricane Maria and a negative impact from foreign exchange. Adjusted SG&A totaled $628 million, increasing 2% on a reported basis but declining 1% on a constant currency basis. The positive contribution from our relentless focus on effectively managing our expense base was offset by lower transition service agreement income from Shire and more than a two-percentage point contribution from foreign exchange. Adjusted R&D spending in the quarter of $182 million increased 20% versus the prior year, reflecting our stated intention to accelerate investments in our core growth businesses. Growth in the quarter also reflects the timing of some milestone payments to partners. Foreign exchange contributed five percentage points to growth in the quarter. Adjusted operating margin in the quarter was 15.1%, a decline of 30 basis points versus the prior year. Strong operational performance in the quarter was more than offset by the loss of transition service income, foreign exchange, and the impact of Hurricane Maria. Net interest expense was $14 million in the quarter. Adjusted other income totaled $24 million in the quarter, primarily reflecting a benefit from foreign exchange gains on balance sheet positions. The adjusted tax rate was 17.7% for the quarter, which reflects approximately $8 million of benefit from the new stock compensation guidance. And as previously mentioned, adjusted earnings of $0.64 per diluted share exceeded our guidance of $0.56 to $0.59 per share, driven by operational strength, expense savings, and the gain on foreign exchange balance sheet positions. During the fourth quarter, we repurchased approximately $290 million, or approximately 4.5 million shares. These repurchases were somewhat offset by option-related dilution. Now turning to the full year 2017. Sales increased 4% on a reported basis, 4% at constant currency, and 5% on an operational basis. On the bottom line, adjusted earnings increased 27% to $2.48 per diluted share driven by operational strength, the ongoing benefit from our business transformation efforts, and a favorable tax rate. Moving quickly through the rest of the P&L; our adjusted gross margin of 44.8% increased by 90 basis points over the prior year reflecting favorable product mix, improved pricing in select areas of the portfolio, and manufacturing efficiencies. Adjusted SG&A totaled approximately $2.4 billion, decreasing by 4%, and adjusted R&D spending totaled $617 million, an increase of 9% versus the prior year. Adjusted operating margin for the year was 16%, a 240 basis point increase versus the prior year and at the high end of our expectations. Net interest expense was $55 million, and adjusted other income totaled $47 million. The full year adjusted tax rate was 18% which included the benefit of approximately $56 million related to new stock compensation guidance. Finally, adjusted earnings of $2.48 per diluted share exceeded our guidance of $2.40 to $2.43. Before turning to our 2018 outlook, I will provide some commentary regarding our cash flow performance. On a full year basis, we have generated free cash flow of more than $1.2 billion, an improvement of more than $300 million versus the prior year. Growth was driven by underlying operational performance and lower CapEx along with the continued focus on improving the company's working capital performance. Let me conclude my comments this morning by providing our guidance for the first quarter and full year 2018. As previously mentioned, we have updated our external sales reporting structure, and I will provide guidance consistent with this new format. Globally, we expect 2018 full year sales to increase between 6% to 7% on a reported basis and approximately 4% on both a constant currency basis and an operational basis. I would like to point out some key assumptions reflected in our full year sales outlook which include approximately 250 basis points of favorable foreign exchange contribution. Approximately $25 million of negative sales impact from Hurricane Maria in the first quarter. Approximately $145 million from Claris sales compared to $57 million in 2017. Full year U.S. cyclophosphamide sales of approximately $95 million versus $185 million in 2017. We have for the most part anniversary select strategic product exits we have undertaken and leveled; while we will continue to optimize the portfolio, we will no longer be adjusting sales for these exits. Finally, this guidance does not include any contribution from the two hemostat and sealant products from Mallinckrodt. We continue to expect this transaction to close in the first half of the year. In terms of our new external reporting structure, we will no longer be classifying sales by the two segments of hospital products and renal. Sales will now be broken down into six global businesses and the segment analysis we provide will be reported by our three regions; Americas, EMEA, and Asia Pacific. As Clare mentioned, we have posted schedules on our website reclassifying sales into the new global business unit structure. Sales guidance has been provided in the new structure on a constant currency basis, starting with Renal Care which includes our peritoneal dialysis, in-center hemodialysis, and renal therapy services; we expect growth of 3% to 4%. Our next global business, medication delivery which includes infusion systems, large and small volume IV solutions, and our reconstitution product such as Mini-Bag Plus, we expect to see this area grow 6% to 7%. The pharmaceutical business which includes our broad generic injectibles portfolio, anesthesia and critical care products, and our hospital pharmacy compounding services conducted outside the U.S.; performance in this business is expected to be flat to 2017 given some sales we recognized in 2017 that are not expected to repeat in 2018 along with increased competition for select products. Moving to our next global business, nutrition, which was previously part of integrated pharmacy solutions; we expect sales growth of 4% to 5%. For our advanced surgery business, we expect sales to increase 3% to 4%. For the acute therapies business, we anticipate growth of 8% to 9%, similar to 2017 levels. Finally, in the other business, which primarily includes our contract manufacturing services, we expect low single-digit decline as 2017 sales benefited from a customer stockpile order and we're projecting lower manufacturing revenues from Shire. Moving down to the P&L; we anticipate adjusted operating margin expansion of 80 to 100 basis points. We expect net interest expense to total between $65 million to $70 million and adjusted other income between $50 million and $60 million for 2018. For the year, we expect an average adjusted tax rate of approximately 19.5%, which reflects approximately one percentage point benefit from the new U.S. tax reform legislation and a lower benefit from stock compensation. For full year 2018, we anticipate diluted average share account of approximately 550 million shares; this reflects the benefit of certain ongoing share repurchases. Based on these factors, we expect 2018 adjusted earnings excluding special items of $2.72 to $2.80 per diluted share. Finally, for the year, we expect to generate operating cash flow of approximately $2.1 billion. We expect CapEx of approximately $700 million and as a result, we anticipate free cash flow of approximately $1.4 billion. Specific to the first quarter of 2018, we expect sales growth of 5% to 6% on a reported basis and 1% to 2% on a constant currency basis; operationally, sales in the first quarter are expected to be flat to up 1%. And we expect adjusted earnings excluding special items of $0.60 to $0.62 per diluted share. With that, we can now open up the call to Q&A.

Let me start with this fourth quarter. If I back out the Puerto Rico impact from the quarter, you're at $0.70, you're at $2.80 run rate. How do I think about that as I go into your 2018 guidance because obviously your earnings power is a lot higher than just the headline numbers suggest here.

Mike, your calculations are not completely wrong, but there are some important factors to consider. The reduction in the second phosphamide is significant, nearly $100 million year-over-year. We're anticipating new competitors entering the market; we can't predict the future, but based on our best information, we expect one or two new competitors in 2018. This is a key reason contributing to the notable decrease in EPS on a run rate basis. We're addressing this decrease through various means, not just with Claris. Additionally, as you pointed out, Hurricane Maria will provide a positive boost in 2018 compared to 2017, but the primary change is the $100 million reduction in cyclophosphamide.

You bought back more stock this quarter than you had been buying back, and I was wondering if you could just talk a little bit about that and then in the broader context of capital allocation going forward. Obviously, there has been a lot of discussion last several quarters about M&A and the opportunity for you guys to do some bolt-on transactions using Claris. Last year you had the Mallinckrodt deal that's pending, but you have a balance sheet that enables us to do both, bolt-on M&A and buybacks. It looks like you've stepped up your activity this quarter, how should we think about it for '18? And are you assuming incremental buybacks in your guidance? Thanks.

Overall, if you look at 2017, we've purchased the company for approximately $600 million, we also repurchased approximately $600 million worth of shares, and so if you put that in the context of free cash flow of $1.2 billion, we essentially deployed all of it. Now our objective is not relative to a free cash flow number but I can tell you that we intend to be active, both on the business development front and on the buyback front. I talked to you in the past about how we think about buybacks; we have an internal model which calculates the value of the shares, and as we look at the share price we look at opportunities to purchase shares relative to that looking for a discount. I mean, typically, the share is traded at a discount so we are active buyers in the marketplace. We expect to continue to do this through 2018 and we also expect to continue to do a number of bolt-on transactions, and of course, Joe will speak to this in a moment; for us we have to be very disciplined about business development and so it's not just about doing deals, it's about doing very positive deals for our company. Similar to this Mallinckrodt deal. As far as the guidance, we have embedded some incremental guidance, we've been repurchasing shares in the quarter, this current quarter we expect about $500 million worth of buyback currently planned, although I expect this is not the final number; it will be different than that and it will be based on the mechanics that I described earlier. Joe, do you want to talk about business development?

Sure. Referring back to our approach to capital allocation, we plan to analyze our businesses based on their adjacencies and aim for more incremental deals at a quicker pace as we enhance our M&A team. This team is now fully established, and we have a clear strategic direction. While larger acquisitions are still a possibility, they are challenging to pursue and harder to achieve satisfactory returns on at this time. However, we remain open to various opportunities. Our focus on M&A and strategy will persist, and we will continue executing our plans, which include buying back shares, maintaining and increasing dividends annually as we have in the past, and engaging in smaller, complementary deals at a high volume and speed.

I don't want to go through all the different businesses and the guidance for 2018 is relative to our expectations; but I don't want too many surprises. I thought that you're probably being a bit conservative and advanced surgery given the product flow there in the R&D; then put it in the work side, I'd love to hear your thoughts on that. And as well, maybe the same comment on the renal side where there is a lot going on in really all three or four different parts of that business. Thanks.

Thank you, Mike. I believe we have a good understanding of our business and this marks the start of the year. We generally manage to follow through on our forecasts. Therefore, when we provide a target for this suite, we have confidence in our ability to reach it. Naturally, the year can bring unexpected challenges, such as Hurricane Maria. However, the company is well-equipped to deliver strong results going forward. I anticipate solid growth across most of our operations, along with ongoing geographic expansion and product launches. Our capacity to surpass expectations is closely tied to the successful execution of new products in the latter half of the year, including the new pump version for SIGMA SPECTRUM and the launch of our automated peritoneal dialysis device in Japan. If we can successfully implement these initiatives and everything aligns, we will update our outlook for the year. For now, this is our perspective, taking into account several variables, including cyclophosphamide.

I want to start by discussing IV solutions. You mentioned that you expect supply in the U.S. to return to a more normal state in the coming weeks. What will enable that? Is it a mix of increased imports and continued production ramp-up in Puerto Rico? Additionally, could you break that down by large volume IVs and Mini-Bags?

We can break the discussion into two parts. The first part involves the small volume parenteral products, which we refer to as Mini-Bags and Mini-Bag Plus, as well as pre-filled bags containing nutrition and amino acids. In terms of small parenteral bags, we are currently producing at a good pace at our facilities in Puerto Rico and have supplemented that output with production from our facility in Ireland. We believe that by the end of the first quarter, our inventory levels will be back to normal. At present, we have allocated 100% of average purchasing volume from six months ago, allowing customers to purchase Mini-Bags and Mini-Bags Plus without restriction. We expect to fully normalize production even earlier than the end of the first quarter. Additionally, we have contingency plans to increase Mini-Bag Plus capacity by late 2018 and mid-2019, as we can sell everything we produce, which is advantageous for both the market and Baxter’s profitability. The second part of our discussion concerns large volume parenterals. The challenges there stem from increased demand and some manufacturers unable to meet production needs, rather than the hurricane. We secured permanent importation licenses and product registration for Mexico and are transitioning some volume to the U.S., moving away from certain business in Mexico that local competitors can take over. Recently, we also received importation permits for Brazil, allowing us to bring products into the U.S. By the end of the next six months, we will establish a network of global factories that can efficiently deliver products to the U.S., ensuring we can fulfill future contracts with existing and new customers.

And then one other one, maybe a little bit longer in nature; I think Joe that you've been focused on Japan as an opportunity, it sounds like you guys are fairly under-indexed there relative to other large multinational U.S. companies. So just briefly, how do we think about the opportunity there in Japan and what are you doing?

In Japan, our primary opportunity lies in the significantly under-penetrated peritoneal dialysis market. The reimbursement rates for PD in Japan are quite favorable, allowing us to generate substantial profits in this area, although the volume is relatively small compared to other regions. By introducing the new Kaguia cycler in Japan, we aim to address specific market demands, such as the automatic connectivity of the tubing, which enhances user experience. Japan has unique requirements for adopting technologies, and since our separation from Baxalta, we haven’t performed exceptionally well there, as Baxalta was a major part of the business. Our strategy now will focus on enhancing peritoneal dialysis offerings, launching advanced surgical products, and improving our pharmaceutical capabilities in Japan. This is a long-term strategy, but it is a priority for us, especially as we enhance our talent and resources in the region.

Could you clarify the Q1 revenue guidance? Some questions I have are whether the capacity returning from Puerto Rico affected this guidance and if there were any specific adjustments made to the modeling of certain line items.

I want to highlight a couple of points regarding Q1 sales growth, which, as you mentioned, Vijay, is below the rate we anticipate for the rest of the year. We're experiencing solid operational performance, but Puerto Rico is impacting us by one point of growth. Additionally, last year we saw a spike in sales from a product called Transderm Scope, which is creating about a 1% headwind year-over-year. These two factors are contributing to our growth being slightly lower than expected. As we move into the latter part of the year, we will start to see positive effects from some new product launches. Joe mentioned Kaguia, and we are also very excited about the upcoming version 9 spectrum pump, which we expect to launch toward the end of the first half of the year. This will help to improve and accelerate our growth. Thus, these specific items and new product benefits really summarize our Q1 performance in context of your sales guidance.

I have a couple of quick follow-ups regarding guidance. Firstly, the historical numbers you provided are very helpful, particularly relating to medication delivery and the capacity coming back from Mexico. In terms of year-over-year comparisons, we see the capacity remaining flat or possibly increasing slightly. Therefore, it’s reasonable to conclude that this guidance does not account for any additional shares. I also have a follow-up question regarding free cash flow. Thank you.

As we look at 2018 performance for medication delivery, we are going to benefit certainly from the reallocation of sales back to the U.S. from IVs, from some of the markets that Joe mentioned early on. So that's certainly a tailwind for us. What I will tell you is over the last several years, we benefited from a number of items including the relaunch of the Version 8 pump which featured prominently in our numbers for a number of quarters. We also benefited from negotiation of selected contracts that we have in place with GPOs. So we’ve always anticipated and we've modeled long-term that there would be a deceleration in growth, particularly in the U.S. over time but this guidance is largely consistent with our expectations and does reflect some benefit of the reallocation of products.

The free cash guidance indicates double-digit growth for 2017, and looking at their 2020 targets of $2 billion shows how free cash flow is expected to accelerate back to the high-teens. Was there any timing impact in 2018 regarding the free cash number?

What I will tell us is, relative to the guidance that we shared in July, our confidence in our long-term ability to generate cash flow has increased in the sense that we had a great 2017 performance ahead of our expectations, so solid performance on free cash flow. Not really timing items specifically; I think we were pleased to exceed $1.2 billion. $1.4 billion will reflect continued performance with respect to working capital management which we are driving relentlessly along with continued operating income growth. So stay tuned, we'll watch this one closely; it's always very difficult at the start of the year to predict cash flow; it's a highly volatile number. It's, frankly, the most challenging one for us to predict on a full-year basis. So stay tuned; we'll watch this one carefully as we go on but I will tell you, the performance of our team on the supply chain side on accounts payable, receivable side; very good performance and we're tracking where we want to be on the free cash flow side.

The first question I wanted to ask was about the injectables outlook in Claris. You provided a number for Claris, and I was hoping you could share more details on what you're expecting from your internal program and any updates on Claris 43 and the progress on the remediation.

We are continuing to pursue internal development. We are launching a coronary drug, just got approved. We have other drugs planned to be launched here, either frozen or not frozen made by Galaxy. We continue to launch products outside Claris and outside the U.S. for Claris, and the 43 is quite simply, we have done to date everything that we said we were going to do, we're still not finished; we have couple of more things to do but we're still in the timeline in some of the things we're doing ahead of our timeline. We are optimistic that what we're doing is going to resolve the issues outlined in 43, but we are not the agencies, so we cannot speak on behalf of the agency. We do everything we can to satisfy what we said to the agents we're going to do, and we feel comfortable that we're doing; now rest is with the FDA to make that determination, but we work very hard and we have integrated significant quality systems into the best of quality systems, and if you went to the site today, you would see a significant amount of physical improvement in things that we've done to correct issues that we personally as a company have found and stuff that the FDA has found on top of our findings.

I would like to hear your thoughts on some of the positive developments from a product perspective in 2018. Specifically, could you highlight any products that you believe have been overlooked by investors but have the potential to make a significant impact?

I will concentrate on three or four key areas. Firstly, our capability to supply the market with LVPs and SVPs contributes to the volumes the market requires and may provide an advantage in competing accounts. While we are uncertain if this will be realized in those competitive accounts, we are confident that we now have robust factories solely dedicated to the U.S. market. Baxter is the leading manufacturer of solutions globally, and not utilizing this capability previously was a missed opportunity. Currently, we are fully committed to leveraging this capability and flexibility worldwide, which is encouraging. Additionally, the new version of our pump, SIGMA SPECTRUM, launching in the second half of the year brings exciting new features that are essential for the market, and people are eager for its release. Our successful launch of this product could be beneficial for us. Another positive development is the introduction of the Kaguia in Japan. Lastly, in terms of geographic expansion, we are working diligently to obtain product approvals; recently, we received approval for a monitor in China ahead of schedule. Our team is committed to developing new products to support our mid-term objective of achieving a 5% topline growth for the company.

At a high level, looking beyond 2018, what do you see as the key pipeline initiatives that will drive accelerating growth beyond the 4% operationally projected for 2018? Also, how do you plan to leverage the P&L to achieve positive results in the coming years, considering it seems many easy opportunities may have already been utilized?

I'll start by talking about the operating margin leverage that we have, and then Joe, perhaps you can talk about some of the exciting pipeline products that start to accelerate growth as we move past 2018. And by the way, it's a bit premature to talk about '19 and '20 as we sit here on February 1, so that's a risk of doing that. I think we are very pleased with the transformation efforts on the cost side. Danielle, your question is a good one because to a large extent we have taken a lot of low hanging fruit and reflected that in our numbers over the last couple of years in terms of implementing zero-based budgeting, certain other tactics that we've employed. As we look at 2019-2020 and beyond, there are certain more complicated or bit more challenging programs that we have on the back office with respect to G&A, and perhaps it’s better to say longer lead time items. As we look to transform our back office to streamline shared service centers, we've made tremendous progress; our functions have done really amazing work, but our expectation long term is that those would not have an impact in 2016 or 2017 but would start to play out as we're seeing in 2018 and then 2019 and 2020. So that's one area I would say, and then the other thing that's going to be very interesting as we move to 2019 and 2020 is, our manufacturing team has done a great job in terms of controlling cost. Now, obviously, that team has been very focused on responding to things like natural disasters and tight supply situations; so they've been very focused on that but at the same time, they've been very focused on optimizing our manufacturing network and optimizing operations within our manufacturing network. So moving to 2019 and 2020, we continue to expect very solid performance coming out of that team, along with a restored supply situation. Now, with respect to acceleration of growth on the top line and products that are going to drive that, Joe, maybe you could take that one.

Our mid-term goal for revenue growth is 5%. We are working diligently to achieve this, particularly through better product launches than we have planned, and there is potential for that. First, we need to optimize our supply chain to ensure we are in the right locations in the U.S. The second focus is launching our product in Japan, called Kaguia. The third is expanding geographically to ensure success. The fourth is the SIGMA SPECTRUM pump. For 2018, we expect global growth in medication delivery to be between 6% and 7%, which is a solid increase. As we look beyond that to 2019 and further, TheraNova is set to significantly impact in-center hemodialysis; having the product fully approved in the U.S., completing clinical trials, and fostering adoption there are crucial for our growth. We plan to launch PrisMAX, our new acute renal care monitor in the U.S., which will further enhance our growth in that market; we are already leaders in acute renal care with the CRRT modality. The market is over $1 billion, and CRRT has captured only about 50% of that market, presenting a strong conversion opportunity. We also aim to explore additional modalities in acute renal care. Furthermore, the acquisitions we are making will have a positive organic impact once they have fully integrated; we are not acquiring businesses that show no growth. For example, Claris is expected to grow by 12% to 14% in 2018. We see opportunities ahead, and we are laying the groundwork to reach our 5% goal while operating with a significantly lower cost base, which is highly advantageous.

Just thinking about the pacing of 2018 numbers, I think so description of first quarter topline; just in the bottom line Jay, I think our math has 50 bips of margin maybe for the first quarter? Can you just talk a little bit about the factors impacting the bottom line for the first quarter? And then, as you think about the third quarter, that's either tough comp this year, should we also expect growth to be a little low in the third, kind of similar to the first?

In the first quarter, we are experiencing the lowest sales growth of the year, and several factors are affecting the bottom line. One major factor is Puerto Rico, which we anticipate will have a marginal impact of a couple of cents, approximately 40 basis points on the operating margin. Additionally, the TDS sales item does not significantly affect the bottom line, but when adjusting for that and considering a challenging TSA comparison that impacts about 50 basis points in the first quarter, we can see why margin growth is lower in this quarter than in others. However, we expect an acceleration as we progress through the year. These two items account for about one point of the growth. Looking ahead, we are optimistic about solid performance for the remainder of the year, despite a challenging sales comparison in the third quarter. Important to note, we will begin to see the effects of new product launches, specifically version 9 of the SPECTRUM pump, which will appear in our Q3 results. Overall, while Q1 is starting off slowly due to factors like Puerto Rico and TDS, we believe the trajectory for the rest of the year remains consistent with our overall expectations. In Q3, we will also face a $20 million compounding settlement from our 2017 results, which we will address, but beyond that, we anticipate steady progress.

And Joe, just two strategic questions for you. I guess the first is, one that is breaking out of this global business structure, it occurs to me that some of the businesses you're breaking out actually have dramatically faster end-market growth rates. I mean as you think about this new structure, are you starting to be of the view that the weighted average market growth rate for this business is frankly closer to 5% relative to 4%?

I think our weighted average market growth rate for the overall business is 3%, but the ability to perform at 5% has to do with new product launches and the ability to focus. Hence the organizational restructuring, we were not focused and now deploying capital some time ago to the right business, despite the fact our intention was that but the organization structure was not prepared. What it has allowed us to do is two-fold; get people paid on global growth for certain franchises, and second, allow us to really put people in those businesses with more specialization given the example of pharmaceuticals. For instance, we have a big mountain to climb with a $100 million headwind on cyclophosphamide. Now having the execution of Claris and our own organic molecules is key; to do that you got to have people who understand the generic pharmaceutical business; this is not a hospital product. This is not the same people who will do design infusion lines and infusion pumps; it's completely different. So we have brought and are bringing people who have the ability to bring this business to the next level. So this reflects more of how we want to build people, how we want people to focus and also to get to our 5% objective on the top line.

I wanted to start with the operating margin guidance and the goal for 2020; I think of 20% Jay. So this year I think you're guiding to 80 basis points to 100 basis points of operating margin improvement, I guess that implies that you need about 150 basis points per year in '19 and '20 to reach the 20%. So why only 80 basis points to 100 basis points this year, and that acceleration? I think earlier in prior calls, I think there was an impression that you could do a little better than 20%; do you still feel that you can exceed that number? And I have one follow-up.

I'll discuss 2018. Looking ahead to 2020, we remain very confident in our ability to continue driving the business forward. I want to briefly mention our May Investor Day, where we will update our long-term financial projections for 2020 and beyond, and the entire team is really enthusiastic about it. Regarding our 2018 guidance, I want to highlight three items worth noting. On one hand, we're anticipating an improvement of 80 to 100 basis points, but there are three headwinds to consider. First, cyclophosphamide is expected to have about a 70 basis point negative impact this year, which we will closely monitor, but it's a significant drag on 2018. Looking at margin performance over the next three years, we believe the largest single impact will occur this year. The second item is the loss of TSA income, which is approximately a 40 basis point negative impact specific to 2018 and will not affect future years. Lastly, we have adopted new pension accounting guidance, which has moved several items below the line while certain items remain above the line. This change, which will be detailed in our 10-K, results in about a 40 basis point drag on our 2018 results. We will provide footnotes and extensive details in our 10-K, and there will also be additional information regarding the impact in 2017. In summary, of our expected 80 to 100 basis points improvement, 40 basis points of that headwind comes from the new pension accounting. Overall, we face about 150 basis points of challenges this year as we work towards achieving the anticipated margin improvement. We do not expect similar challenges in the coming years, and we feel very confident about our performance in 2019 and 2020.

Lastly for me, Joe, any update on emerging market performance?

Yes, we had a strong performance in emerging markets with about 6.7%, nearly 7% for the year. In China, we exceeded 6%, which is excellent for us. It's important to note that sectors like medical devices do not pertain to Baxter; we've been involved in these markets for quite some time. China represents a good growth opportunity for us with a solid GDP growth, allowing us to geographically expand our product lines, especially in Brazil, Mexico, and Colombia, along with Southeast Asia. While we provide commentary on emerging markets during calls for analysts, internally we focus on three regions: Americas, Europe, and Asia, without specifically monitoring emerging markets anymore. We concentrate on China, which continues to perform well and is a significant and profitable market for us. Emerging markets represent about 22% of our overall sales, which is notably larger compared to many of our peers, which is why we don't focus on them specifically.

Joe, big picture medtech. You guys are probably closest to the ground at what's happening in the hospital as it relates to volume, price, and flu. Can you just give us some of the brief overview of what you're really seeing out there?

We are expecting low single-digit growth in hospital procedures and admissions in general, based on our analysis across our businesses. Additionally, there is a renewed interest in capital investment from hospitals, as one large hospital group has announced plans to revitalize investments, which is promising for the market. Overall consumer consumption remains stable, which is a positive indicator. The healthcare market in the U.S. is responding well to recent tax legislation. The flu season is gaining significant momentum and is already at a high level, which positively affects some of our businesses and products used in critical care situations, such as in ICU patients with severe distress and multi-organ failure; a strong flu season typically boosts our business.

A follow-up and more specific question; every year I feel like we start-off with a relatively high cyclo competition headwind and then window it down throughout the year. Why is $100 million the right number for 2018? Thank you.

We extensively model the impact of market entrants, whether it's one, two, three, or four. This is because we sometimes enter as the second or third player, giving us insight into the market dynamics. Based on the applications for cyclophosphamide, we've determined that is the expected impact. If competitors can bring their products to market but lack the regulatory capability, there’s clearly potential for Baxter. We'll provide updates to our quarterly forecasts and guidance if no new entrants emerge, and we will adjust our estimates accordingly. We’re very open about cyclophosphamide, and its success positively affects the company, as it generates more revenue. Manufacturing this drug is complex, and Baxter has a cutting-edge facility that serves both our needs and those of various pharmaceutical companies due to these challenges. The desire to produce cyclophosphamide does not necessarily correlate with the ability to do so. Recently, a potential manufacturer received two warnings at their facility in India, likely hindering their production capabilities. However, we have identified other potential manufacturers, and should they enter the market, we have estimated a precise $100 million impact.