Baxter International Inc (BAX) — Q4 2018 Earnings Call Transcript

Thanks, Candace. Good morning, and welcome to our fourth quarter 2018 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 2018 financial results along with our financial outlook for 2019. A supplemental presentation to complement this morning's discussion can be accessed on our Web site. This presentation, along with related non-GAAP reconciliations, can also be accessed at Baxter's external Web site in the Investors section under Events & News. 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 contain forward-looking statements that involve risks and uncertainties. And, of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause 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 Web site. On the call this morning, we will be discussing operational sales growth which for historical periods adjusts for the impact of foreign exchange, generic competition for U.S cyclophosphamide, our acquisition of two surgical products from Mallinckrodt in the first quarter of 2018, and for a full-year 2018 approximately 7 months of sales from the acquisition of Claris in July 2017. 2018 operational sales growth guidance adjusts for the impact of foreign exchange and generic competition for U.S cyclophosphamide. Now I'd like to turn the call over to Joe.

Good morning and thank you for joining us. We are pleased to share our fourth quarter results with you today and to discuss our expectations for 2019. I will begin with a quick review of our fourth quarter performance before sharing my reflections on the year as a whole. Jay will then provide more detail on the financials, including our 2019 outlook. We will wrap up with Q&A. Baxter closed the year with a solid fourth quarter, delivering sales growth of 2% on a reported basis and 5% on both a constant currency and operational basis. A strategic execution with strong operational performance and disciplined financial management resulted in adjusted EPS of $0.78, up 22% year-over-year. Drivers of growth in the quarter included the company's Renal Care, Pharmaceuticals, Advanced Surgery, and Acute Therapies businesses; increased demand for Baxter's contract manufacturing services also contributed to performance in the quarter. This strength helped offset performance in our Medication Delivery and Nutrition businesses, which was in line with the guidance we shared on our third quarter call. Growth in Renal Care continues to benefit from increased demand for our peritoneal dialysis products globally. In the U.S., we experienced the highest growth for PD patients of the year with patient volumes increasing high-single digits in the fourth quarter. And in Japan, the successful rollout of Kaguya is also contributing to performance with patient growth advancing mid-single digits in the quarter. In Pharmaceuticals, growth in the quarter was driven by strength across the portfolio globally, increased sales of premixed injectables, anesthesia, and critical care products as well as a strong performance in our pharmacy compounding business, all contributed to growth. This helped to offset expected lower U.S sales of BREVIBLOC and cyclophosphamide in the quarter. Advanced Surgery achieved growth of 17% on a constant currency basis in the quarter, including a contribution of approximately $20 million from sales of RECOTHROM which benefit from competitive supply constraints during the quarter. Performance in acute therapies continued to be driven by improving utilization for CRRT globally as well as increased demand for our multi-organ support products. Finally, performance in our U.S Medication Delivery and Nutrition businesses has stabilized, and we are in the process of executing on efforts to return demand for impacted products to pre-hurricane levels. In addition, we are seeing closer alignment between end-user unit demand and financial unit purchases for large volume IV solutions. As we discussed last quarter, going forward we continue to expect these businesses to grow in line with their respective market growth rates as well as benefit from new product launches. In addition, last quarter I mentioned that we were taking decisive action to renew strategic momentum in our U.S hospital businesses. To this end, I’m pleased to announce that Heather Knight will join us as the new General Manager for our U.S hospital business effective February 11. I worked with Heather previously, so I know firsthand that she will bring outstanding leadership skills and superior insights on the medical device market. Our fourth quarter performance illustrates important progress in our long-term strategic journey, Baxter's emphasis on increasing innovation, unwavering financial discipline, and driving operational efficiency, all contributed to our ongoing growth. For the full-year 2018, Baxter achieved sales growth of 5% on a reported basis, 4% on a constant currency basis, and 3% on an operational basis. Our overall strength was also reflected geographically, where we achieved mid-single digit constant currency sales growth across all three of our geographic reporting segments: Americas, APAC, and EMEA. Of note, Q4 represented the highest quarterly operational growth of the year for both our APAC and EMEA regions. Our momentum carried over to the bottom line. Our adjusted EPS was $3.05, up 23% year-over-year. And Baxter generated free cash flow of over $1.4 billion in 2018, up 16% versus 2017. Creating value for stockholders is essential to our business model. In 2018, we increased our quarterly dividend by 19% and returned over $2.4 billion to investors through our share repurchase program. In addition, the research and development and commercial milestones we achieved in 2018 and the early weeks of 2019 demonstrate a promising future of organic growth through innovation. Earlier this month, we announced that we had enrolled the first patient in our U.S clinical trial for our in-home, on-demand PD solution generation system. Now, a few weeks later, patient treatments are underway. We believe this technology has great potential to improve the patient experience and simplify therapy management. In 2018, we announced a collaboration with the Mayo Clinic to establish a Renal Care Center of Excellence, serving patients across a continuum of care to drive improved outcomes. This will be an opportunity to put our combined expertise to work in new ways. It also represents a meaningful pathway for pursuing other creative collaborations with the potential to advance patient care and drive business performance. 2018 also featured a range of pivotal, differentiated new product launches from across all six of our businesses. Our leading-edge PrisMax, CRRT in organ support technology is now helping treat acute care patients in multiple European markets. As I mentioned earlier, the Kaguya APD cycler with embedded share source technology is quickly being embraced in Japan and is a compelling in-home therapy option. Our spectrum IQ smart pump platform is now being adopted in the U.S and Canada. And the Evo IQ pump platform is being launched in other global markets. Additional launches across the U.S and around the world include IV pharmaceuticals, surgical hemostats, sealants, and nutritionals. As 2019 unfolds, we are moving ahead at full speed. We are continuing to address unmet patient and customer needs, building out our pipeline and working with regulatory agencies to successfully launch our products across the globe. We continue to thoroughly assess opportunities to further our impact to patients and healthcare providers through strategic partnerships and business development. And we remain intently focused on expanding efficiencies across the organization. This all supports our objective to accelerate performance and deliver top quartile results for all stakeholders. Now I will pass it to Jay, who will walk you through the financials in more detail.

Thanks, Joe and good morning, everyone. As Joe mentioned, our fourth quarter results demonstrate a strong finish to 2018. Throughout the year we delivered consistent bottom line strength through improved operational performance coupled with the ongoing benefit of our business transformation initiatives. Moving into 2019 and beyond, we continue to be well-positioned to achieve our long-term financial goals. I will start by discussing our fourth quarter and full-year 2018 results, before providing our financial outlook for 2019. Beginning with the fourth quarter, global sales of $2.8 billion increased 2% on a reported basis and 5% on both a constant currency and operational basis. This was favorable to our expectations driven by performance in our Renal Care, Pharmaceuticals, and Advanced Surgery businesses. On the bottom line, adjusted earnings increased 22% to $0.78 per diluted share. This also exceeded our previous guidance of $0.71 to $0.73 per share, driven primarily by sales performance, disciplined financial management and a modest benefit from increased share repurchase activity, which Joe referenced earlier. Now I'll walk you through performance by our geographic segments in global business units. Note, for this quarter constant currency sales growth is equal to operational sales growth for all businesses with the exceptions of our Pharmaceuticals and Advanced Surgery businesses and for the Americas region, for which we will provide operational growth in addition to constant currency growth. Starting first with sales growth for our three geographic segments. Sales in the Americas advanced 4% on a constant currency basis and 3% operationally. Sales in both our EMEA and APAC regions advanced 6% on a constant currency basis. Moving on to performance by global business units. Global sales for Renal Care were $953 million, advancing 5% on a constant currency basis. As Joe mentioned, performance in the quarter was driven by high single-digit growth for PD therapies globally. Partially offsetting this growth was lower U.S sales of in-center HD, primarily related to lower sales of low margin distributed bloodlines. Sales in medication delivery of $660 million were flat on a constant currency basis in line with the expectations we communicated last quarter. During the quarter, we continued to work with distributors as they reduce their inventory levels. We believe that destocking is largely complete and distributor purchases will now more closely align with end-user demand. With respect to small volume parenterals, we're on track with our efforts to return demand to pre-hurricane levels, as we continue to reinforce to our customers the safety and efficiency of our SVPs for drug reconstitution. Finally, pump sales came in slightly below expectations. As discussed last quarter, we are seeing a longer sales cycle for Spectrum IQ, given the two-way hospital connectivity with the hospital EMR, as well as customers somewhat delaying purchases of new pumps. Despite these dynamics, we gained just under a point of market share in 2018 and expect to gain a similar amount in 2019. Pharmaceutical sales were $540 million, increasing 9% constant currency and 11% operationally. Growth in the quarter benefited from strength in our anesthesia and critical care products, driven by increased sales of Transderm Scop and Sevoflurane. Strong sales of Baxter's injectable premixed drugs also contributed to growth in the quarter benefiting from recent product launches. Finally, increased demand for Baxter's pharmacy compounding services also contributed to performance. This growth was partially offset by lower sales of BREVIBLOC and cyclo during the quarter. U.S cyclo and BREVIBLOC sales were $39 million and $14 million, respectively, in the quarter. Moving to Nutrition, total sales were $215 million, down 5% on a constant currency basis. We continue to focus on driving growth recovery through market education and reinforcement of supply availability. During the quarter, we saw a slight pickup in the market and our efforts to regain demand loss as a result of the hurricane are on track. Sales in Advanced Surgery were $214 million, increasing 17% constant currency and 5% operationally. Sales of RECOTHROM and PREVELEAK contributed approximately $21 million in the quarter. As Joe mentioned, RECOTHROM fourth quarter sales benefited from a competitor supply constraint. These issues have since been resolved. Sales in our Acute Therapies business were $137 million, representing growth of 12% on a constant currency basis. Strong performance in the business continues to be driven by increased global demand for Baxter's continuous renal replacement therapies. Finally, sales in our Other category, which primarily includes our contracting manufacturing services were $122 million, an increase of 14% on a constant currency basis. Performance in the quarter was driven by increased demand for our contract manufacturing services. Moving through the rest of the P&L, our adjusted gross margin of 44.3% decreased 10 basis points over the prior year as the benefit of operational improvements were offset by a certain one-time manufacturing cost in the quarter. Adjusted SG&A totaled $597 million, decreasing 4% on a reported basis and 2% on a constant currency basis, driven by our business transformation initiatives targeted with improving operational efficiency, which helped to offset a loss of approximately $9 million in transition service income received from Shire in 2017. Adjusted R&D spending in the quarter of $165 million, decreased 9% on a reported basis and 7% on a constant currency basis versus the prior year as we anniversaried certain milestone and third-party payments made in the fourth quarter of 2017. Strategic investment in our innovation pipeline continues to be a priority. Adjusted operating margin in the quarter were 17.5%, an increase of 210 basis points versus the prior year. Growth was largely driven by operational expansion and continued focus on transforming how we more effectively manage our business. Net interest expense was $11 million in the fourth quarter and adjusted other income totaled $34 million in the quarter, primarily reflecting a benefit from changes in our U.S pension plan and foreign exchange gains on balance sheet positions. The adjusted tax rate was 18.9% for the quarter and as previously mentioned adjusted earnings of $0.78 per diluted share exceeded our guidance of $0.71 to $0.73 per share. Within the fourth quarter we repurchased approximately $1.4 billion or 20.9 million shares of Baxter stock, reflecting our stated intention to strategically repurchase shares trading at a discount to our intrinsic value calculation. Turning to full-year 2018, sales of $11.1 billion increased by 5% on a reported basis, 4% at constant currency and 3% on an operational basis. On the bottom line, adjusted earnings increased 23% to $3.05 per diluted share. On a full-year basis, we generated free cash flow of more than $1.4 billion, marking an improvement of approximately $200 million or 16% versus the prior year. This is slightly below our guidance of approximately $1.5 billion, primarily due to a higher year ending inventory balance than we expected. Let me conclude my comments this morning by providing our guidance for the first quarter and full-year 2019. For full-year 2019, we expect flat to 1% reported sales growth globally, 2% to 3% constant currency, and 3% to 4% operational. I would like to point out some key assumptions reflected in our full-year sales outlook, which included approximately 200 basis points of foreign exchange impact, and full-year's U.S cyclophosphamide sales of approximately $95 million versus $166 million in 2018. Operational sales growth adjusted for the impact of foreign exchange and generic competition for U.S cyclophosphamide in 2019. Operational growth includes the impact and were approximately $75 million related to lower U.S sales of BREVIBLOC as well as approximately $55 million of lower U.S in-center HD sales. Collectively, these two factors negatively impact 2019 growth by approximately 130 basis points. Moving to guidance by business, on a constant currency basis, except for otherwise noted, in Renal Care we expect growth of 2% to 3% reflecting continued momentum in PD partially offset by lower sales of U.S in-center HD, aligned with our stated strategy of enhancing performance by exiting lower margin product lines. In Medication Delivery, we expect sales to increase approximately 6%. We expect our Pharmaceuticals business to decline 3% to 4% on a constant currency basis. Adjusting for U.S cyclo, operational growth is expected to be flat to 2018, reflecting the lower BREVIBLOC sales I just mentioned. Moving to Clinical Nutrition, we expect sales growth of approximately 3% as we work to return customers in the U.S back to pre-hurricane prescribing patterns. For our Advanced Surgery business, we expect sales to increase 3% to 4% on a constant currency basis. For the Acute Therapies business, we expect growth of approximately 7% to 8%. Finally, in our Other business, we expect sales to decline low single digits as we don't currently anticipate the outperformance in 2018 to repeat in 2019. Moving down to the P&L, we anticipate adjusted operating margin expansion of 60 to 100 basis points. We expect net interest expense of approximately $60 million to $65 million and adjusted other income of approximately $80 million to $85 million for 2019. For the year, we expect an average adjusted tax rate of approximately 18% and a full-year diluted average share count between the range of 515 million to 520 million shares. Based on these factors, we expect 2019 adjusted earnings excluding special items of $3.22 to $3.30 per diluted share. And finally for the year, we expect to generate operating cash flow of approximately $2.3 billion and free cash flow of approximately $1.6 billion. Specific to the first quarter of 2019, we expect sales to decline approximately 3% on a reported basis, growth of approximately 1% on a constant currency basis, and growth of 1% to 2% on an operational basis. We expect adjusted earnings excluding special items of $0.66 to $0.68 per diluted share. With that, we can now open-up the call for Q&A.

Good morning, David.

Hello. This is Jon Demchick standing in for David. Thank you for taking the questions. I would like to discuss the IV solutions segment of the medication delivery business and inquire about your projections for the first couple of quarters this year, as well as how you perceive the alignment of supply with the financial results you're anticipating. How much visibility do you think there is now compared to what you experienced in 2018?

Good morning, John. We never met, but welcome to our call. I’m going to take the first part of the question and then I will pass on to Jay, who will get into more of the financial impact. Listen, we found now that we're largely the inventory in the chain is largely balanced, meaning that while we see financial results or dollars coming in and the inventory levels at distributors, so sales out to hospitals and inventory is balanced. We saw that throughout Q4, we think that we have a stable market right now, and which made us conclude that we have not lost market share. Our market share is stable and some of the OEM contracts that we had spoken about are coming back a little faster, and we have some opportunities. So what you see in the progression of the quarters is that we have a very tough comp in the first quarter because quite a few remember last year there was a significant amount of buy-in, a tough flu season was the reaction to the hurricane in late 2017. So this is a tough quarter for us to compare, but if you look across the other quarters and for the year, Medication Delivery will be a 6% business, which tells you that this is a well-established business, a stable business. And we have plans to continue to convert that. We have the launch of our new pump coming in. The new pump will drive more stats, will drive more volume and the ability to capture those will be great. The other thing that makes this quite stable is we are two out of three GPOs signed. In one of them, we are 100% re-signed with the IDNs and we feel very comfortable about our position in the marketplace. Now let me pass on to Jay, who will talk a little bit more of the financial impact.

Yes, considering the IV therapy business, we experienced a significant buy-in during the first quarter of last year, which resulted in approximately a $15 million positive sales impact for that quarter. It's important to note that we are seeing low-single digit demand from end users, marking a departure we have discussed previously. As we plan for our U.S. business in IV therapy, we anticipate a decline in the first quarter this year to double digits. However, moving into the second quarter, we expect a more typical performance, and in the latter half of the year, we will benefit from easier comparisons largely due to some inventory exiting the channel. So, that outlines the expected progression for the year.

Okay. And actually guys this is David. I’m stepping in for John. Sorry about that. So two questions for me, Joe, kind of more strategically. And the first one, obviously, is two focus items for investors. The first is fluids, and I think you’ve addressed that for '19 and the first quarter. The second, obviously, is balance sheet deployment, Joe. How urgent are you feeling about deployment in 2019 to sort of get back to 5%. On one hand, I think about the headwinds in your business BREVI and HD, you can almost get back to 5%, just adjusting for those headwinds versus your '19 guidance. But how important is M&A to you this year to deliver your LRP targets in '20? And then for Jay, just thinking about margins, obviously, you’ve talked about a margin opportunity of 300 basis points over the next two years guiding to about 50 this year. How good do you feel about the ability to still deliver those margin targets into 2020, just relative to the '19 guide? Thank you.

Good morning, David. That was very well orchestrated. We have three questions from your call; you mentioned only two, but those are good questions, so we will address them properly. Regarding M&A, we are actively seeking opportunities. I want you to consider not just the size but also adjacent possibilities that make sense for Baxter. Let's not confuse our aggressive search for targets with our disciplined approach to understanding the financials and returns on acquisitions, which remain unchanged. We are looking for molecules in the market to enhance our Pharmaceuticals. We are focused on Critical Care and other areas adjacent to our business. Size is not the priority; rather, it's about enhancing our portfolio. M&A will play a significant role in our Long-Range Plan. I am confident in our ability to deliver on this plan. We have not yet conducted M&A because we expect to introduce $1.7 billion in new products in 2023, which is still part of our strategy. If you review our new product development sales contribution in the second half of 2018, it was impressive. We have many exciting new products on the way, and we are optimistic about that. However, it's important to remember that we are focusing on adjacencies and M&A without fixating on size. Some opportunities may vary in size, but we are putting in considerable effort. I want our investors to recognize that delivering solid returns to our shareholders is extremely important to us, so we will not pursue deals that could negatively affect our shareholder returns. I will now pass it to Jay regarding the balance sheet.

In terms of margin and actual sales growth, I believe it's important to note that our operational sales growth this year is 3% to 4%. This figure excludes the impact of cyclo but includes two significant factors. One is BREVIBLOC, which we have discussed extensively, with an impact of approximately $75 million. The other factor is our strategy to exit lower margin businesses, particularly in our in-center HD business, which has around a $60 million impact. Therefore, the 3% to 4% sales growth reflects about 130 basis points of suppression compared to the normalized growth rate we expect going forward. Regarding margin expansion, this has been a major focus for us in recent years, and we anticipate further margin growth this year. However, we are facing considerable headwinds that will affect our margin expansion. Cyclophosphamide accounts for about a 1% margin impact, BREVIBLOC contributes roughly 50 basis points, and cyclo is also roughly 50 basis points, with foreign exchange at about 30 basis points. Collectively, these factors add up to about 130 basis points of headwinds that we are navigating in pursuit of margin expansion. Despite these challenges, we have a history of achieving margin growth and remain committed to delivering that even amidst headwinds, although they do hinder our typical rate of growth.

Great. Thanks so much.

David, any handle off for further questions or should we move on? Right.

No, I will stop there. Thanks, guys.

Thanks. Thank you, David.

Great and congrats on the good quarter. Jay, maybe I can follow-up on that. The guidance came in, I think, pretty good on the top line, especially considering all the headwinds that weren't factored into street models. But first quarter came in a little bit lighter. So maybe you can walk us through the puts and takes of the cadence through 2019 and maybe some of the product launches or different factors that give you confidence in that second half acceleration.

Yes, Robbie, you're correct. We expect a significant acceleration in the latter half of the year. There are several specific factors affecting our first quarter growth. We projected operational sales growth of 1% to 2%. A major contributor to this is BREVIBLOC, which should generate around $35 million in sales and approximately 1.3 percentage points of growth in the first quarter. Additionally, we observed a notable increase in buying patterns in the IV business, contributing about $15 million or roughly 50 basis points of growth. In-center HD also affected Q1 sales growth, with around $15 million in impact. Overall, while we anticipate first quarter growth of 1% to 2%, we are facing nearly 2.5 points of sales growth headwinds, particularly notable in the first quarter. As for the EPS discussion, BREVIBLOC impacts by about $0.05, cyclo by $0.01, and foreign exchange (FX) by $0.03, with FX being more influential in the first half than in the second half. These factors significantly impact our first quarter EPS. However, we expect various benefits to develop in the second half of the year, including easier comparisons in the U.S. Medication Delivery business and the positive effects of new products and their acceleration. Joe mentioned our exciting progress, and while we’re pleased with the overall advancements, these products won't show immediate results, leading to a larger impact in the second half of the year and an even greater effect in 2020.

Thanks. That’s really helpful. One other thing I wanted to dive into is, it looks like the pharma business did very well in the quarter, even when backing out the generic headwinds. I think it's a part of the business a lot of people don't understand the underlying drivers. Can you give us a little bit more insight into what’s driving the outperformance there and how to think about the key growth drivers in '19? Thanks.

Robbie, the performance is being driven by several factors. Let me start highlighting the success of the molecules that we’ve been launching internally from Baxter, and those are special molecules, not the molecules themselves, but the delivery of the API. And the second is our premix. So premix is the substitute for when we have shortages. We made great efforts to substitute some of our MINI-BAG Plus product lines in the marketplace by premixes and the premixes are more effective and even safer way of delivering the medication and that is doing extremely well. The growth is fantastic. We are moving up 30% plus of growth in premixes. So I know that we both had Medication Delivery and the recap of and recovery of our MINI-BAG plus and MINI-BAGS business. But some of that we actually prefer the conversion into premixes which has been extremely success, but the margins are higher by 20%, 30% and we think that that is the way to go. So our Pharmaceutical business is doing extremely well. We have more molecules coming up in '19 and '20. And we feel that that business is finally taking off, ex this cyclo and BREVIBLOC, which eventually will be something of the past and we can move onto the new Pharmaceutical business which is leadership in generic injectables with novel ways of delivering the medication. Thank you. Thanks, Robbie.

Great. Thank you and good morning. Just two questions for me. One is a clarification and I'm sorry if I missed this. But are you guys today explicitly reiterating your 2020 operating margin EPS and rev growth targets that you set last year?

Yes, Bob, yes we are. There is no changes to those guidance numbers.

Okay. And then the other thing I wanted to ask about was just Medication Delivery. We have talked about it a little bit here, but obviously that was a division that caused you trouble for two quarters of 2018. And now your guidance for this year is for 6% growth. I realize some of that is easy comps, but it just seems like a little higher guidance than I anticipated given what happened in 2018. And also given your comments about the tough competitive landscape on the pump side. So maybe you could walk through a little bit what gives you confidence in that 6% from a new product prospective, because even comp adjusted you’re projecting accelerated growth here in 2019.

We are definitely seeing some advantages from the recapture and acceleration campaigns related to MINI-BAG and MINI-BAG Plus, along with some stability in the LVPs. Due to the rebates offered across several product lines, we are experiencing growth rates in certain categories that exceed the market average. As mentioned earlier, we were pleased with the progress made in these areas during the fourth quarter of 2018, indicating that the recapture campaign is yielding positive results. This growth should continue, aside from the challenges faced in the first quarter. Additionally, we are beginning to see improved performance from version 9 of our spectrum pump, which is expected to gain momentum in the latter half of the year. The pump has been well received by clinicians across the U.S., which is encouraging, although the sales cycle has taken longer than we anticipated. Consequently, we expect to see the benefits manifest in 2019. We are confident in our pipeline, which supports this outlook. All these factors combined give us a strong belief in the expected acceleration, and we have easier comparisons to make in the second half of the year, which should contribute to our performance.

Okay. Thank you.

I would also like to mention that we expect to see some acceleration outside the U.S. as we anniversary some of the comparisons. As you recall, we shifted some of that volume to the U.S., and now we have successfully managed to bring some of that volume back to those Latin American markets.

Thanks very much.

Hi. Thanks for taking the question. So the first one I wanted to ask about was the Renal business, that was a little bit of a tick up here and you highlighted now you got all your cyclers is around the world and more people are using them. Can you talk about assumptions for 2019 in terms of any pickup that you could see in PD because of the cyclers? And then, I would love to get a little bit more color on how you're feeling about on-demand PD looking into 2020 and what kind of impact that can have?

Our guidance for Renal Care in 2019 is 2% to 3%. I want to explain why we set this range and how it relates to the growth in PD patients. We have intentionally moved away from unprofitable business in certain areas, particularly bloodlines, which had a large volume but no profitability. As a result, our HD business is experiencing an artificial decline due to this decision, as we were actually losing money in that segment. Moving on to the PD business, we anticipate patient growth of around 5% to 6%. This sector remains very healthy, with the best markets being North America, Japan, and China. We successfully launched CLARIA with SHARESOURCE and have reintroduced it to parts of Europe after overcoming privacy challenges related to software regulations and home monitoring. Now, several countries in Europe are utilizing this updated cycler, which is similar to the previous HomeChoice in the U.S. Our operations are improving, particularly in Japan, where our Kaguya business is thriving with over 1,000 patients already on therapy. We expect to accelerate growth in 2019 and 2020, targeting 5% to 6% patient growth. Overall, the U.S. market is performing well, and our partnership with DaVita is strong, making for a great collaboration.

Great. Thank you. And any additional color you can talk about in terms of the pipeline with on-demand PD?

We have a few patients ready to start the therapy, and one has already begun and is doing well so far. While it’s too early to make definitive statements, this aligns with our traditional approach at Baxter. We tend to follow through on our commitments, and we've initiated the therapy as promised. We will work diligently on this complex therapy, which involves producing the drug in patients’ homes, but it is progressing well. I believe we will see several advancements with this technology in the future, much like the evolution of electric cars over the past several years. We will continue to enhance this technology and remain leaders in home therapy for peritoneal dialysis.

Great. Thank you. And can I just ask one follow-up on the pharma business? You mentioned some of the dynamics before, but I was hoping you could be more specific about kind of the both number of molecules you're launching in '19 versus '20, really thinking about the Claris dynamic there. I mean, should we see some acceleration in terms of the molecules in the growth in '20?

Let me break this down. We have Claris molecules, which are part of our plan for Claris. As you know, we received a warning letter for the facility, and we are committed to fulfilling our promises to the FDA. We will be inspected a couple of times before we can receive clearance or VAI for that location. Our current focus for Claris is to clear the warning letter at that facility, and we are following through on all the commitments made to the agency. We also have a contingency plan for that plant, as we want a Plan B. This Plan B involves having contract manufacturers or backups for most of our products sold in the U.S. to ensure operations continue without disruption due to the Claris warning letter. Regarding other molecules, we launched some significant products at the end of 2019 and in 2020, which feature a novel delivery system known as a premix, something unique in the market. While I won’t disclose the names of these molecules, I can say we have some promising developments. One molecule launched last year has performed exceptionally well, with sales estimates up 40% compared to the previous year, and we expect this trend to continue. Our strategy for Pharmaceuticals is strong, transitioning from past key products like cyclophosphamide and BREVIBLOC to an expanded portfolio, with plans to introduce nearly 70 new molecules and over double that in delivery methods. We are on track to achieve this across multiple regions, as promised last year. We aim to launch an important molecule by the end of 2019, and we will make a formal announcement when it happens.

Hey guys, thanks for taking my question. So couple of, I guess, guidance, housekeeping questions here. Is the guidance assuming any contribution or I guess I should say contribution, the resolution of FDA a warning letter of Claris? And I'm curious, Jay, you mentioned the LATAM business coming back for IV fluids, that happens to be a tender business. I'm just curious have you signed any tenders? Do you have any visibility?

So from an FDA standpoint, there is no resolution assumed in our 2019 numbers for resolution of the Claris warning letter. Obviously, that becomes an important component of our 2020 numbers. So to the extent that we get that resolved along the time frame we expect, then the long range plan that we have are intact with no change. We are looking for mitigation tactics in the event that, that does not occur. But as we look at 2020, that will be an important component for us to get resolved. As it relates to Latin America, yes, certainly there is a different dynamic in terms of tendering in Latin America versus certain other markets. And so, we have moved some volumes back to Latin America. We have clear line of sight to sales performance and where that's going to go. In some cases tenders have been won, but as opposed to going through that in a lot of detail, what I will tell you is we have a high level or solid level of confidence in our ability to deliver some of the IV sales in the Latin America business.

That's helpful, Jay. Just one follow-up on the interest expense guidance. It looks like interest expense is going up. I'm curious about the implication for cash balance or capital deployment since this is increasing.

Yes, we have a higher interest expense year-over-year, which has a slight impact. There are two main factors at play. One is the rising interest-rate environment. More importantly, we have repurchased a significant number of shares. As we have mentioned before, when we identify opportunities to buy shares in the market below their intrinsic value, we take advantage of them. In the fourth quarter, we noticed a substantial movement in the stock price, but our long-term valuation of the shares remains strong. We seized the chance to repurchase a significant amount of shares, positively affecting our share count for the full year. However, this comes with increased interest expenses. Looking at Baxter's overall position, our net debt is still significantly below one turn of net debt to EBITDA. While our long-term target is a 2X net debt to EBITDA, our main focus is to maintain a solid investment-grade credit rating. I believe we have more flexibility regarding capital deployment than that. Therefore, the share repurchase we executed in the fourth quarter does not significantly affect our business development or capital deployment strategy moving forward, though the increase in interest expense is a valid concern.

I want to emphasize what Jay just mentioned. We have committed not to let cash remain idle on the balance sheet. Therefore, we plan to return that cash to shareholders in the most effective way possible. Ideally, we would prefer to acquire more companies and invest in mergers and acquisitions, but if we can't find suitable targets that provide the right return, we will return funds to shareholders through share repurchases and dividends. It's important to understand that these three options are not mutually exclusive; they can be executed simultaneously. However, we will prioritize one over the other as necessary. I want to reiterate that our cash will not sit unused on the balance sheet.

Thank you. Good morning everyone. Joe, I obviously caught the comments related to share being stable in IV solutions. I think one concern that investors have is that as we go through contracting process and contract renewals, given some of the pricing around the spot market et cetera, that pricing overall could start to come down. So I was hoping you could perhaps provide a little bit of color and I guess in that maybe some thoughts around just given the tremendous job that you guys have done with creating redundancies for supply, how that also resonates and factors into some of those discussions.

We were not the beneficiaries of the spot market sales because, prior to our supply chain flexibility in the Americas, we were at a disadvantage. Now, our supply chain capabilities are unmatched, allowing us to guarantee product delivery to our customers with penalties if we fail to do so. However, without that flexibility, our competitors often sold to our customers at higher spot market prices. As a result, we did not gain significant advantages from those sales. The pricing in our markets is based on contractual agreements, and we maintain stable contracts and market share. Pricing is influenced by competitiveness, which we address by ensuring we remain competitive in the marketplace. Unlike many competitors, we have manufacturing volume and a robust redundancy plan. We are authorized to sell products in the U.S. from our plants in the Carolinas, Ireland, Mexico, and Brazil. This allows us to quickly build inventory contingencies across the Americas, which is a crucial advantage. Regarding pricing, we don't control it aside from negotiations with our customers. We did not take advantage of spot market fluctuations. Therefore, if there is a concern about declining prices in our contracts for 2019, that is unlikely as we did not inflate prices for spot sales.

Okay, perfect. I just need a clarification and then a follow-up. The clarification is that I know you worked hard with the FDA to get clearance for many facilities to bring supply into the U.S. I want to confirm that those are permanent approvals. For the second question, Joe, I wanted to discuss M&A from a different angle. Amy Wendels has joined the Board of Directors. She is someone you have worked with for a long time and has been very impactful at Covidien regarding the M&A strategy. I wanted to hear your thoughts on the implications of her joining the Board.

Going back to the first part of your question, regarding what is permanent, Mexico is permanent. Brazil is currently temporary but is expected to become permanent after a second inspection from the FDA that we anticipate shortly. Ireland is also permanent, and we will eventually add Canada as soon as we arrange FDA inspections. Mexico represents a significant amount of volume that we can direct into the U.S. and other regions in Latin America as needed, providing us with a lot of flexibility. To illustrate, Mexico accounts for about 85% of our supply chain flexibility, with the remaining 15% coming from Ireland. Once Brazil secures permanent importation status, which we expect in 2019, we’ll gain even more flexibility.

Great. And then Amy?

I'm really pleased to announce that Amy is joining the Board. I worked with Amy for over 20 years at Covidien, including at Tyco Healthcare and Kendall Company, so we go way back to 1995. She will play a crucial role on the Board, particularly in M&A. Amy is a healthcare strategist, excelling in that field, and we're excited to have her contribute to our strategy and ensure our team is performing at its best. This is excellent news for Dennis.

Hey, good morning, everyone. Thanks so much for taking the question and congrats on a strong quarter. To exit the year, Jay, I know how much you love to talk about cash flow and not to nitpick on the quarter, but cash flow did come in a little bit under the updated guidepost Q3 for the year. Wondering if you could talk a little bit about that and what the drivers for the cash flow guidance for 2019 are? Thanks so much.

Certainly, Danielle. Thanks for the question. I always focus on cash flow as it’s critical for us. Looking back at the fourth quarter of 2018, it was quite a strong quarter with operating cash flow growth of nearly 50% and free cash flow growth essentially doubling, increasing from $270 million to over $500 million. However, cash flow can be quite back-end loaded. About 40% of the annual cash flow comes in the fourth quarter, primarily in December. This makes forecasting monthly performance challenging. Although we reported slightly below our expectations, a few factors contributed to this. The sales mix leaned more towards drugs than devices, and some devices we planned to place in Q4 were pushed to Q1, but this won't affect long-term revenues, and customer demand remains solid. Additionally, some of our sales overperformance occurred in December, which can benefit inventory cash flow while delaying receivable collections. Consequently, even with a 30-day DSO, sales made in December won’t reflect until January. Taking all these factors into account, cash flow was a bit below expectations. However, achieving a 16% to 17% growth in free cash flow, aligned with earnings growth, is a decent performance. As we look ahead, we have a clear path forward. I hope we’ve made improvements to better manage December's cash flow, although we describe our cash flow guidance as approximate because of its volatility. Our conversion ratios continue to show good performance, and improving our process remains a focus for the entire organization. Today, Joe and I will meet with our supply chain team to discuss enhancements to our S&OP process, which is critical to our operations. Overall, it was a solid year for cash flow.

Hey, everybody. Thanks for squeezing me in.

Hi, Matt.

Hey, how are you? Congratulations on a really strong end of the year. I have a couple of clarifications regarding guidance and one about capital deployment. For Jay, I'd like to clarify Q1. The information on the 230 basis points of nonrecurring growth items within the 1% to 2% growth guidance was very helpful. If I'm interpreting this correctly, that would suggest underlying growth closer to 3.5% to 4.5% for the first quarter excluding those items. I'm curious if that's accurate, and if so, could you provide more details on the impact on the bottom line? I estimate it to be about $0.05 to $0.07, but any further quantification or insight would be appreciated. Additionally, I have one question about capital deployment.

Certainly. So in the first quarter, you're right, Matt, BREVIBLOC is $35 million. It's like 1.3%. The IV buy-in is another two factors, adding about 1%. So it is a fairly substantial impact. I will stop short of adding those to the reported operational growth number to come up with this fictitious adjusted number. I don't want to do that, but you can certainly do that to get a more accurate long-term representation of what the growth rate will be. We try to be judicious at using adjusted financial measures here. But then from an EPS headwind standpoint, it's actually more than that, because BREVIBLOC is a $0.05 headwind. Cyclo is a $0.01 headwind. Now that's not included in the operational sales growth number, but it is, of course, included in the EPS number. So that's a $0.01 headwind. And then foreign exchange is also a $0.03 headwind. Now we’ve a number of good guys, things like share count and so on. But like I say, those are $0.09 of specific headwinds to the first quarter that, by and large, are the most pronounced in the first quarter of the year. So you point to we do have a bit of a decline in EPS in the first quarter before we see the acceleration. But really, those are the key factors that impact that. I would say that the IV buy-in is also probably about $0.01 of impact to earnings with the in-center HD is less than that because it is a low margin business. So that’s really the overview.

Okay. That's very helpful. Regarding the follow-up, I understand your organic growth guidance is set at 3% to 4%. However, if we analyze the 130 basis points similarly, one could argue that the underlying growth of your businesses is already aligning with the 4% to 5% long-term growth CAGR you've mentioned since 2020, based on our assessment. Additionally, I'd like to confirm and clarify your thoughts on the urgency for a deal. There seems to be a perception that a deal is perhaps more urgent in order to achieve this 4% to 5% growth, or whether potential enhancements to the portfolio and strategic investments would support those long-term objectives. Could you provide any clarifying thoughts on this as we conclude the call?

I apologize for the mix-up earlier. First and foremost, it's crucial for us at Baxter to avoid hastily entering into a deal just for short-term benefits, as those decisions are often poor and poorly thought out. We've been actively looking for deals for some time, which is why we have a robust M&A team in place. However, this doesn’t indicate that we are in a desperate situation; we are not. In fact, we’ve rejected several deals over the last three quarters because the financials did not align with our expectations. We continue to thoroughly evaluate every opportunity and work closely with our Board to formulate a strategic approach for potential acquisitions. Each deal must be strategic, beneficial, and provide financial returns while enhancing Baxter’s long-term interests. If we don’t find the right opportunity, we will utilize our funds elsewhere to improve the company’s bottom line, as we did at the end of 2018. There is no urgency to close a deal. I want our investors to understand that while a deal could enhance our performance in 2019 or 2020, it is not a necessity, and we will not make uninformed decisions just to meet a financial target. Thank you.

Thank you.