Baxter International Inc (BAX) — Q2 2019 Earnings Call Transcript

Thanks, Candace. Good morning, and welcome to our second quarter 2019 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 second quarter 2019 financial results and our updated financial outlook for full-year 2019. A supplemental presentation to complement this morning's discussion can be accessed on our website. This presentation, along with related non-GAAP reconciliations, can also be accessed on Baxter's external website 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 is available on our website. On the call this morning, we will be discussing operational sales growth, which adjusts for the impact of foreign exchange and generic competition for cyclophosphamide in the U.S. Now, I'd like to turn the call over to Joe.

Good morning and thank you for joining us. We’re pleased to share our second quarter results with you today and to discuss our updated expectations for 2019. I will begin with a quick review of our performance in the quarter and Jay will then provide more detail on the financials. Baxter maintained a strong trajectory in the second quarter of 2019, delivering sales growth of 4% on both a constant currency and operational basis. On the bottom line, adjusted earnings per share were $0.89, exceeding our expectations and up 16% year-over-year. Growth in the quarter was driven by top-line sales performance, operational efficiency initiatives, a lower tax rate, and a reduced share count. All six of our global business units contributed positively to constant currency sales growth, powered in part by our revitalized innovation efforts. On a constant currency basis, global growth in the Renal Care business continues to be driven by increasing patient volumes for our peritoneal dialysis products. As expected, results in the quarter were negatively impacted due to the strategic exit from the U.S. in-center hemodialysis Bloodline business. Performance was also impacted by a recall and certain manufacturing challenges at one of our facilities that produces Revaclear dialyzers used for hemodialysis. This is creating a temporary supply constraint as we have been selectively slowing down production lines at this facility to address this situation. However, Revaclear production is now ramping up and we expect to return to healthy inventory levels over the next few months. We do expect to incur incremental costs in the second half of the year as we work to enhance our production capabilities at this facility. I also wanted to take a moment to discuss the recent Advancing American Kidney Health Initiative announced by the White House earlier this month. As proposed, it would have a transformative impact on the treatment of end-stage renal disease or ESRD in the U.S. This is part of an emerging trend taking shape worldwide, as payers, clinicians, and patients increasingly embrace home PD as a frontline ESRD treatment option based on key economic, therapeutic, and lifestyle benefits. Baxter is the pioneer and global market leader in home PD and we fully support this initiative to broaden the adoption of home dialysis across the United States. As noted in our release this morning, we anticipate capital investments of $500 million to significantly increase our production capacity and meet new patient needs in line with proposed CMS models. These investments will be scaled to align with the patient and market dynamics across the innovation curve. Increased demand would, in turn, help accelerate Renal Care growth and contribute positively to Baxter’s previously communicated financial estimates. We are working to model the anticipated impacts and expect to be in a better position to provide additional information about what this initiative means for Baxter once the rule is potentially finalized later this year. Moving along, our medication delivery business returned to solid constant currency growth globally. We’re now emerging from a challenging performance comparison to a spike in demand for large volume IV solutions in the first half of 2018. Growth this quarter benefited from the continued uptake of our new infusion pumps, Spectrum IQ in the U.S. and Evo IQ in selected international markets, and related disposables. Increased sales for Mini-Bag Plus in the U.S. and Large Volume IV Solutions internationally also contributed to the growth in the quarter. Mid-single-digit constant currency growth in our pharmaceuticals business was driven by increased demand for Baxter’s hospital pharmacy compounding services, along with the contribution from recent launches of injectable pharmaceuticals such as dexmed and the Baxter MetaBot business. This trend helped offset the expected impact of generic competition in the U.S. for Brevibloc and cyclophosphamide, and we expect to benefit from new product launches, including the recent approval of Myxredlin, the first and only ready-to-use insulin for IV infusion in a hospital or acute care setting. Baxter's Clinical Nutrition business delivered low-single-digit sales growth globally on a constant currency basis. We’re continuing to rebuild momentum here, supported in part by the launch of new products, including OLIMEL N11, a higher protein formulation, and FINOMEL, our novel fish oil-based triple-chamber container. We’re also positioning for a U.S. launch of Clinolipid, Baxter's proprietary olive oil-based lipid emulsion, later this year. Advanced surgery delivered high-teens growth at constant currency rates. Performance in the quarter benefited from competitive supply constraints, which resulted in incremental demand for both FLOSEAL and RECOTHROM. Finally, acute therapy has posted high-single-digit constant currency growth, fueled in part by the ongoing rollout of our PrisMax next-generation technology for CRRT and Therapeutic Plasma Exchange. PrisMax can be found in intensive care units in more than 20 countries across Europe and Asia-Pacific. There are plans to bring additional markets on board through 2020. As all these highlights reflect, we’re continuing to see Baxter's renewed emphasis on innovation gaining traction and delivering results across our businesses. There is great promise and potential ahead, fueled by our research and development pipeline, strong balance sheet, and emerging opportunities. Most importantly, our employees, who are inspired and empowered by our mission to save and sustain lives. Our transformation is on track and we remain absolutely focused on delivering sustainable top quartile performance in service of patients, shareholders, and the rest of our broad stakeholder base. Now, I'll pass it on to Jay for a closer look at our financials and outlook.

Thanks, Joe, and good morning everyone. As Joe mentioned, our second quarter results reflect solid constant currency growth across each of our six business units and further reinforce confidence in our full-year outlook. I’ll start by discussing our second quarter results before providing our updated financial outlook for 2019. Beginning with the second quarter, global sales of $2.8 billion were flat on a reported basis and increased 4% on both a constant currency and operational basis, reflecting strength across our portfolio. On the bottom line, adjusted earnings increased 16% to $0.89 per diluted share. This exceeded our guidance of $0.80 to $0.82 per diluted share, driven by top-line performance, ongoing operational efficiencies, and a lower tax rate. Now, I’ll walk you through performance by our geographic segments in global businesses. Note that for this quarter, constant currency sales growth is equal to operational sales growth for all businesses and region segments, except for our pharmaceuticals business and 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 grew 1% on a constant currency basis and 2% operationally. Sales in EMEA grew 6% on a constant currency basis, and sales in our Asia-Pacific region advanced 9% on a constant currency basis. Moving to performance by global businesses. Global sales for Renal Care were $910 million, advancing 3% on a constant currency basis. Performance in the quarter was driven by high-single-digit growth in PD therapies globally, partially offsetting this growth was the lower sales of select in-center HD products, including the Bloodline business exited earlier this year, which negatively impacted sales in the quarter by approximately $14 million. Renal Care sales growth in the quarter was also impacted by the recall and temporary supply constraints associated with the Revaclear dialyzer. The impact was less than $10 million in the quarter. Sales in medication delivery of $689 million grew 4% on a constant currency basis, representing a return to solid and balanced growth in both the U.S. and internationally. Performance in the quarter benefited from strength in infusion systems following the launch of Spectrum IQ and Evo IQ. International growth of large volume IV Solutions, particularly in Latin America, and the continued momentum from Mini-Bag Plus contributed to the growth in the quarter. Pharmaceutical sales were $539 million, increasing 4% constant currency and 7% operationally. Strong international sales contributed to performance in the quarter, driven by the increased demand for our hospital pharmacy compounding services, generic injectables, including Baxter's MetaBot, and anesthesia products. This growth was partially offset by declines in our U.S. business, which reflected approximately $40 million of lower U.S. sales of Brevibloc and cyclophosphamide, as compared to the prior year period. Sales in the U.S. were also impacted by lower sales of anesthesia and critical care products in the quarter. Moving to nutrition, total sales were $215 million, up 2% on a constant currency basis and reflecting sequential improvement in both the U.S. and internationally. We expect sales to continue to ramp throughout 2019 as we work to rebuild our U.S. business and capitalize on new product launches. Sales of $232 million in advanced surgery increased 17% on a constant currency basis. Strong global growth benefited from our ability to address competitive supply constraints in the hemostat market in the U.S. These supply dynamics contributed approximately 12 percentage points to growth in the quarter. Sales in our acute therapies business were $133 million, representing growth of 8% on a constant currency basis. Growth in this business is now normalized, after a difficult year-over-year comparison in the first quarter, and we continue to see growth globally driven by new product launches and demand for Baxter's CRRT therapies. Finally, sales in our other category, which primarily includes our contract manufacturing services, were $122 million, a decrease of 9% on a constant currency basis, reflecting a challenging comparison to the prior year period. Moving through the rest of the P&L, our adjusted gross margin of 44.5% represents a 100-basis point decline compared to the prior year period as benefits from our manufacturing improvements and portfolio initiatives were more than offset by lower U.S. sales of Brevibloc and cyclophosphamide and a less favorable product mix. In addition, gross margin was negatively impacted by incremental expenses related to enhancing manufacturing capabilities at our dialyzer facility. Adjusted SG&A totaled $610 million, decreasing 5% on a reported basis and 1% on a constant currency basis, reflecting the positive contributions from our targeted initiatives to improve operational efficiency. We continue to strategically invest in sales and marketing initiatives, while maintaining our focus on driving increased effectiveness in general and administrative expenses. Adjusted R&D spending in the quarter of $141 million decreased 14% on a reported basis and 10% on a constant currency basis versus the prior year period. We continue to see benefit from our efforts to enhance our processes and optimize our R&D organization, while prioritizing strategic investment in our innovation pipeline. Adjusted operating margin in the quarter was 18%, an increase of 90 basis points versus the prior year. Net interest expense totaled $20 million in the second quarter, an increase of $9 million compared to the prior year, driven by lower interest income and increased interest expense resulting from higher average commercial paper borrowings during the quarter, and the issuance of our new $1.5 billion of Euro-denominated debt. This debt was issued at an average coupon of 75 basis points and an average duration of 7.5 years. Further income totaled $28 million in the quarter, driven by pension benefits and foreign exchange gains on balance sheet positions. The adjusted tax rate was 10.8% for the quarter, favorable to our expectations, primarily driven by a benefit resulting from a favorable tax ruling along with stock compensation deductions. And as previously mentioned, adjusted earnings of $0.89 per diluted share exceeded our guidance of $0.80 to $0.82 per share. Within the second quarter, we repurchased approximately $123 million or 2 million shares of Baxter stock, which was partially offset by option-related dilution within the quarter. With respect to cash flow, in the first half of 2019, free cash flow of $265 million was in line with our expectations. In the second quarter, we drove sequential improvement in days inventory on hand and we continue to expect the cash conversion ramp in the second half of the year. Let me conclude my comments this morning by providing our guidance for the full-year 2019 and the third quarter. For the full-year 2019, we now expect reported growth of 1% to 2% globally and approximately 4% sales growth on both a constant currency and operational basis. Moving to full-year guidance by business, on a constant currency basis except where otherwise noted. In Renal Care, we now expect growth of approximately 2%. Strong growth for our PD therapies globally is expected to be partially offset by lower sales in in-center HD, due to strategic exits in our U.S. Bloodline business, which negatively impacted Renal Care sales in 2019 by approximately $55 million. In addition, the impact of supply disruption from the Revaclear dialyzer is expected to negatively impact full-year sales by approximately $20 million. We expect to return to normal inventory levels by the end of the year. In Medication Delivery, we continue to expect sales to increase approximately 6% with sequential improvement in the second half of the year. For our pharmaceuticals business, we now expect an increase of low single digits on a constant currency basis. U.S. cyclo sales are now expected to total approximately $125 million versus our previous assumption of $105 million; adjusting for U.S. cyclo, operational growth is now expected to increase mid-single digits. As a reminder, Brevibloc sales are included in operational growth and are expected to decline approximately $75 million in 2019. Moving to Clinical Nutrition, we continue to expect sales growth of approximately 3%. For our advanced surgery business, we now expect sales to increase high-single digits, given the strong performance year-to-date. Our guidance assumes that competitive supply constraints begin to ease in the third quarter. For the Acute Therapies business, we continue to expect growth of approximately 7% to 8%. Finally, in our other business, we continue to expect sales to decline low-to-mid single digits. Moving down to the P&L, we continue to anticipate adjusted operating margin expansion of 80 basis points to 100 basis points, with additional savings in operational expenses being offset by the gross margin impact of mitigation efforts to return our dialyzer manufacturing plant to full capacity by year-end. The full-year estimate of these incremental expenses is expected to total approximately $50 million. We continue to expect net interest expense of approximately $65 million to $70 million, and we now expect adjusted other income of approximately $90 million for 2019. For the year, we now expect an average adjusted tax rate of approximately 16%, reflecting the favorability from Q2. We continue to anticipate a full-year diluted average share count of approximately 520 million shares. Based on these factors, we now expect 2019 adjusted earnings, excluding special items, of $3.34 to $3.40 per diluted share. Finally, for the year, we continue to expect to generate operating cash flow of $2.3 billion and free cash flow of $1.6 billion. Specific to the third quarter of 2019, we expect sales growth of 3% to 4% on a reported basis, and approximately 5% on both a constant and operational basis. We expect adjusted earnings, excluding special items, of $0.82 to $0.84 per diluted share. With that, we can now open the call to Q&A.

Good morning. Joe, I thought your comments on ESRD were pretty clear. So, maybe I’ll focus on medication delivery and a quick one for Jay. Joe, in Med Delivery, obviously, you beat our number; there was a significant momentum improvement, you are maintaining guidance. Can you just talk about how you’re feeling about market stability, new customer, new account penetration, and in fact, the pump business as we head into the second half of the year and then a quick one for Jay?

Good morning, David. The business, as we had predicted, had a really tough comparison in the first quarter, but we had confidence in our ability to secure current customers that have been with us for many years. So, we have re-signed all GPO agreements and for the most part, we have signed a great deal of IDM agreements as well. The market is stable. We found opportunities to gain new customers, not only in the acute care market but also in the OEM or contract manufacturing business, which is important to us, and helps us in our facilities but also improves the visibility of Baxter's product line across all sets of care. When it comes to pumps, we have a very healthy pipeline. There are always pluses and minuses, but I would say at the moment the pluses are winning handily. The opportunities that we have are significant. I would tell you that the new management group that we have put in the U.S. has done an extraordinary job in understanding the pipeline and the creation of value. Our Spectrum version 9 is a wonderful pump; it’s a really good device with the number one best-in-class drug library. That has been very important to us in terms of showcasing this product for our customers. So, the business, as we predicted, is healthy. We’re going to continue to make progress and this continues to be our source of investment for continued success. Our new pump platform is coming along extremely well and we’re very comfortable with the launch timeline for it.

Okay, very clear. And then Jay, just thinking about a couple of items in the guidance in the back half of the year, I mean, FLOSEAL was a benefit to this particular quarter, and I’m curious what your assumptions are for the back half of the year for FLOSEAL? And then with Myxredlin, maybe just talk briefly about the size of the opportunity there for the company. I think we’ve talked about this product launch for a while. How big is that opportunity and what are the assumptions for the back half? Thanks so much.

Sure. With respect to our biosurgery business, yes, we did comment on some upside that we experienced in the second quarter. We don’t like to forecast competitor outages, so we don’t maintain long-term assumptions on that. However, if we have very clear visibility to a short-term situation emerging, we will reflect that in our guidance. So, as we think about advanced surgery, there’s roughly two months of upside that we’re counting on in our numbers as we sit here today. We expect that to continue for a couple of months. If it continues further than that, of course, we will be available to supply our customers, but we’re not counting on anything more than that. We’ve talked previously about how exciting the insulin-Myxredlin launch is. It’s a new presentation of our workforce product for hospitals; we're absolutely thrilled about it. The size of the market is significant; it’s over a $100 million market in hospitals in the U.S. So, this represents a very viable long-term opportunity for us. As it relates to this year’s guidance, we have single-digit millions built into our guidance at this point; in large part, we want to be cautious about launch timing and having adequate supply available when we actually go to market. So, no meaningful impact this year, but stay tuned as we give guidance for 2020. This will have a more meaningful impact in those numbers.

Thanks so much, nice quarter.

Thank you.

Great, and again, congrats on a nice quarter here. Jay, two questions for you. First, maybe we could start on the P&L performance. It’s really impressive how you were able to offset some of the lower gross margin product strength in the quarter with lower R&D and SG&A, but with R&D taking such a hit and SG&A coming down so rapidly, maybe you could just give us some insight into where that’s coming from; is it more just a general efficiency in overhead, or are you holding back on some projects for the future?

Sure. Just with respect to gross margins, to your comment, gross margin did come in a little bit below our expectations. Really, there were just a few drivers of that. Some of it related to business mix as you pointed out. We had very strong performance in our drug compounding business, but that carries a much lower margin in the corporate average. Now interestingly enough about this business, it is a very high return on invested capital business for us, but the gross margin is lower. So, the fact we overachieved that business cost us about 30 basis points to our gross margin, and then addressing some of the dialyzer manufacturing issues, that’s roughly a 20-basis point impact in the quarter. So, those were two of the more prominent items impacting gross margin for us. Of course, there were always other bits and pieces, but we were able to offset that with continued focus on spending. So, on the SG&A side, we are very focused on improving the efficiency of our back-office operations along with judiciously spending every single dollar. So, we’ve talked in the past about the zero-based spending approach that we have here, being disciplined around all spending categories along with really thinking creatively about how we organize the back office. That continues to pay dividends today, paying dividends in the quarter; you saw a decline of SG&A of 1%, and again this is on the back of three or four years of continued improvements in this particular area. So, a great performance on the SG&A line. R&D is a little bit different; some of this relates to timing, some of it relates to the fact that we’ve been able to get after some of the infrastructure cost in R&D faster than accelerations in certain areas and new product spending. We will see some R&D tick up in the second half of the year. What I will tell you is our overarching principle on R&D is we want to invest to grow, and we are funding programs for success. We are not holding back on any dollars. I think the press release and Joe’s comments about this spirit of innovation at the company is evident of that philosophy in action. Having said that, we did see savings in this particular area, so stay tuned to the back half. Joe, you want to add to that?

Yes, sure. Robbie, the whole thing about R&D was for us to create efficiency in the R&D line and the spending has not been very different than if you go back to 2016; it’s just a mix—where we are spending and how we are spending the money? So, we abandoned large programs that had absolutely no return on investment and we invest in significant opportunities in areas of medication delivery, acute Renal Care with our point of care in PD, as well as have some very quick turnaround new products in advanced surgery, some in the nutrition area. So, if you think about it, we also have significant arbitrage in labor because we created centers of excellence across the globe; we now have a very large center in Bangalore, India that we never had. So, it is well-managed group. Our heads of R&D, led by our GPO leaders and Sumant Ramachandra, who has overarching responsibility for the function, have been very successful in reallocating cost. I want to just tell investors that we’re very focused on innovation and that fluctuation in spending is nothing other than being efficient and the timing of the investments has nothing to do with us tightening the belt in R&D programs.

Very clear, and if I could sneak one more in. Just on capital deployment, not surprised that we haven’t seen any M&A here with MedTech valuations where they are, but how are you balancing your capital allocation plans here with Baxter's share price at highs and MedTech valuations where they are? Thanks.

Robbie, it has been a very, very busy first half analyzing opportunities. The way we have allocated capital inorganically is not very different than how we allocate organically. We do have focus in the area of monitoring in the areas of acute Renal Care and critical care. We are also very focused on looking at individual molecules. So, what I’m going to say to our investors is to think about Baxter adding value through small tuck-ins as we look for the right opportunity and valuation for a larger deal. It is very, very rich; right now the market is frothy and we are not going to compromise on the returns of this acquisition. Every acquisition has its inherent risks, especially the larger they get, and we all understand that, we all take risks, but there is a point where the cost of investing in that asset and the price valuations are so out of whack that you cannot make internal rate of return of low single digits; it doesn’t work. And then if anything goes wrong, for example, if the FDA informs us that a product we have holds a compound that doesn’t work, then your whole evaluation of that target is under scrutiny. You’ve got to be very careful with this and understand your target. I think Baxter is surprising to our investors; how much opportunity there is and there will be in our base businesses, as well as how we have the opportunity to innovate and continue to maintain our number one position in most of our businesses. Watch us in the pump business, as we are coming out with a great platform of pumps and monitoring devices. So the thought is to add to those inorganically as tuck-ins; let’s not think all the time about huge capital investments allocated into overly expensive assets. And I tell you something else: we will continue to acquire our shares prudently while we see prices where they are, because we are not going to sit on cash—cash is not going to burn a hole in our pocket.

Thank you.

Thank you and good morning.

Good morning.

I wanted to start with a big picture question. Joe, obviously you put up a very solid Q2, and it sounds like the pipeline is making good progress. During the quarter, you also got some nice new structural tailwinds in some of your business. As you think about all these factors and put them together, do they suggest some upward pressure on your long-range plan from a revenue growth perspective, or are they just nice offsets to other headwinds? Just trying to get a sense for the cumulative effect of all these things that are going on right now.

Well, if you think about our long-range plan, when you give a five-year plan, you are going to have both positive and negative factors that can affect how you plan to make things happen. You have the best intentions and the best plans, but not everything works the same way on either the positive or negative side. For instance, we didn’t plan to have our insulin product premixed approved as early as we did; we actually planned to have that approval towards the end of the year. That’s a plus for us, but other things worked the other way, as well. However, when I look at the major forces that we have going on right now, there’s tremendous momentum in our peritoneal dialysis business. We are experiencing a healthy growth in terms of patient numbers. We do not even have the executive order from the White House implemented yet, which will be transformative for the renal business. It’s clear that we’ve experienced high-single-digit growth in patients in PD. So, that has a significant effect that has the potential to offset many negatives that could show up in the future. At this moment, I think that between everything happening in the market and the things that are occurring at Baxter, we can comfortably say that we told you last year, and we reconfirm that today.

Okay, that sounds fair. But for my second question, I’ll just ask a follow-up to that. I understand your philosophy, but it does seem like, since you gave that guidance, most of the incremental news flow you’ve been receiving has been positive. I want to ensure I’m not missing anything. When we think long-term, are there other negatives that have popped up that would make you hesitant on this issue, relative to some of these incrementally positive pieces of news you’ve gotten over the course of the last couple of months?

Remember the last time we gave guidance, the dynamic in the Medication Delivery business shifted quite a bit, and we’ve been able to reconfirm our long-term expectations despite that shift as a result of strength in many different areas in our portfolio and general buoyancy of the new product pipeline, along with successful product progress in areas like PD and successful adoption there. So, I think it’s too early to start changing our long-range plan at this point. We will consider doing that at some point in the future, but on balance, we are very pleased with the quarter. We were pleased with the signs of operational strength, along with some of the longer-term positive pieces of news that we’ve been able to either de-risk or add to the story.

Great. Thanks very much.

Good morning everybody and very nice quarter. I want to spend a couple of minutes on the renal business, and this is sort of a two-part question. The first part is, you’ve been facing a headwind as you’ve exited the in-center HD business. At what stage does that annualize, and we don’t see that anymore? And then the second part is, regarding your $500 million investment, can you just elaborate on that a little? What do you think the benefit will be? And then I would assume there is some level of pressure on gross margins; how should we think about that over time? Thank you.

Sure. I’ll make the comments on the bloodlines and then Joe, maybe you can share the excitement around the investment. With respect to the bloodlines, that’s just one component of the HD business in the U.S. We do have other products that we sell in the U.S., but that particular one was a product that we distributed and it was a very low margin business. It was a $55 million impact roughly for this year, and by the end of this year, it will cease to be a headwind. As we relate to the investment, Joe, would you like to add comments about that?

We have outlined our project as thoroughly as possible according to our understanding of the executive order. This is not yet a final rule, and the comment period will conclude in about 50 days, after which the HHS will have time to finalize the rule. Based on our interpretation of the executive order, we are pursuing a three-phase investment. The first phase involves supplying the market with the growth studies we initially projected, aimed at the top 50% of the overall served market. From this segment, there will be a period for clinics to adjust their practices between hemodialysis and home therapy. We are prepared to manage this change through supply chain adjustments we implemented successfully a year and a half ago by relocating and registering products across the Americas. The second phase involves a modest investment within the $500 million framework to increase our capacity, culminating in future facility investments. The timeline for this investment may overlap or be staggered, but its benefits will materialize over the next several years. This is a seven-year program, and we believe it is our obligation to our customers and patients to seize this opportunity. We are committed to ensuring a smooth ramp-up, as outlined in the executive order.

Thank you.

Thank you, Joanne.

Congrats on the nice piece here, Joe and Jay. Jay, maybe on the 3Q EPS, if I just look at the OpEx rate, the last two years, EPS has grown sequentially; revenues are accelerating in the back half. I’m not sure why EPS would be down because it looks like the dialyzer impact on gross margins was felt in 2Q. Maybe you can just walk through that EPS math and maybe settle some timing elements on expenses here, which would be impacting 3Q?

Sure. As we look at the Q2 to Q3 story, there are a couple of factors to keep in mind. One is the dialyzers impacted us about $0.01 in Q2, but as we move to Q3, that will ramp up a little bit to somewhere between $0.02 and $0.03 of impact. The second prominent driver relates to the tax rate. We’ll see a significant uptick in tax from Q2 to Q3, that’s somewhere around $0.08 or $0.09. So, it really does match some of the strong operational performance. I have to say hats off to the tax team for great work optimizing the tax rate and allowing us to capitalize on opportunities that emerge, and really think about how we organize our operations effectively in a tax-efficient manner. We saw a benefit in Q1 and Q2, but we don’t expect to see that in Q3 and Q4 to the same extent. The tax rate in the third and fourth quarter kicks up to roughly 19% from the 12% we’ve had year-to-date. So, those are the primary drivers. We’ll see continued operational strength that helps support and offset those items, but that really is the big drivers as we move from Q2 to Q3.

That’s really helpful, Jay. And one quick – on Pharma, I mean, Brevibloc was about a 700 basis point to 800 basis points impact to revenues first half, and despite that you guys did phenomenal in Pharma rates. As those headwinds go away in the back half, I'm just curious why, you know, perhaps Pharma couldn’t come in better?

As we look at the pharmaceuticals business to your point, we’ve had a very solid performance in the first half of the year, and a lot of that was driven by great performance in our compounding business outside the U.S. We do expect that, and our business grew in the first half of the year by 20%, very significant. As we move to Q3 and Q4, we do not expect to see that level of accelerated performance in the back half, so that really is the primary driver that takes the former growth rate down. But I will tell you, we’re very pleased with the performance in this area. It's been a great source of overachievement for us, and steady growth, and you know, with things like Myxredlin on the horizon, which will benefit future years, along with some of the premixed injectables and Claris portfolio, that has been selling well here in the U.S. Overall, this has been a very solid performer for us.

Thank you, guys.

Thanks, Vijay.

Good morning. Thanks for taking the question. Just one on infusion systems, and one on Asia-Pacific. Joe, one of your competitors has had some issues with their pump and infusion sets. Do you see an opportunity for Baxter to take some share here? And with a new pump platform coming out in 2020, are customers extending the selling cycle to wait for the new platform? And I have one follow-up.

Larry, the opportunities we’re having are mostly related to the strength of our version 9 of our pump. Its operability and our drug library have made it appealing to our customers who have been with us for a long time. Given this, we've renewed many agreements; innovation and evolution of the product has driven this success. There is always opportunity when there’s a problem with a competitor in the market. If that problem is perceived to be more permanent than temporary, so we need to consider that. As we look at our Advanced Surgery business, that specialization is likely a temporary gain until the competitor comes back on the market, and because our product is so good, FLOSEAL is regarded as the best product on the market. There is opportunity to retake market share. The same applies for the infusion pumps. You know it really depends upon how permanent or temporary the issue is that competitors may be experiencing. But I think the success that we’ve been having is a result of a very good sales effort from our new team, which is completely focused on the pipeline. Second is our ability to demonstrate the technical superiority of our drug library compared to our competitors. To your point on the new platform, no, customers who need the product now are willing to take the product now. I just want to let you know that LVP, which is a large volume parenterals pump, which is what we have to-date, remember we don't have any other pump at the moment. The guts of the new pump are different; they are more modern and will be a horizontal pump. But the workflow, the drug library, and all the features are the same, meaning you have a new product with phenomenal operability and a great pumping mechanism. Our current version 9 has a great pump mechanism and operability is the same, so the customers have a lot to gain when Baxter launches the other pumps, which are part of the same family with the same operations. So, it will be a new platform on the market that has this capability and I think that customers can see that going forward. If they need the pump, there’s nothing they lose with this current version versus the new platform for the large volume parenterals, but we will bring into the market not only syringe—patient-controlled PCA, as well as ambulatory pumps. So, I hope this satisfies your question and reassures our investors that there is no business being postponed due to lack of availability today.

Very helpful, Joe. And just lastly, Asia-Pacific has been very strong. What’s driving that and how sustainable is that? Thanks for taking the questions.

Great. We’re really pleased with the performance in the Asia-Pacific region, with 9% growth coming primarily from strength across the board. We’ve gotten used to solid performance from China in the quarter, around 7% plus growth from that particular business. Perhaps more surprising, based on historical commentary from Baxter, is the tremendous performance in Japan, with high single-digit growth coming from our Japanese business as well. It’s a combination of factors at play, looking at the other areas, we’re experiencing solid performance in Southeast Asia, and we’ve had great business in Australia and New Zealand for medication delivery. We’ve been there for many years, and they’ve experienced double-digit growth mainly benefiting from compounding. Overall, this is a combination of commercial execution along with new product launches that has really contributed to this performance. On a full-year basis, we expect this to come down a little bit from a growth rate standpoint, but not materially. So, overall, you know, great performance from the team in Asia.

Thank you very much.

Hi, and thanks so much for the question, and congrats on a good quarter. I was wondering if you could just provide us with an update on the Pharmaceutical business and some of the legacy Claris manufacturing, FDA warning letters, how you’re feeling about that, and how there may be opportunities to deal with that? Thanks.

Hi, good morning. Our Pharmaceutical business strategy is starting to take shape. It took a little bit of time. We have built a second-to-none formulation team between India and Northern Illinois that is very talented, particularly with our partnership to launch the insulin product—the Med—which is just the beginning of our extensive pipeline. Regarding Claris, or what we call Baxter MetaBot, we are doing everything we have spoken about to the FDA. It’s now up to the FDA to lift or inspect us again and provide us with their feedback. Nevertheless, we are de-risking any Claris opportunity for the future by having ultimate suppliers for almost everything we manufacture there. Additionally, for the future molecules, we are reducing risk by going to CMOs instead and maintaining Claris as a backup. There is one molecule that I cannot name at the moment, but we are developing it in Baxter MetaBot while also initiating pilot operations in our Illinois facilities to have a possible backup. This is more of a long-term strategy. We’re doing everything we told the FDA to remediate the one letter issued to us the day we purchased the company. We’re also ensuring that all of our future revenue streams have a backup plan in place. The performance of our business is showing strong double-digit growth. This business is resilient, doing well—not only in the U.S. but in Europe, where it is also performing well. This summarizes the state of our Pharmaceutical business.

And just as a follow-up, do you still anticipate that you may be able to move beyond the warning letter issues next year? I think that's what you’ve said before, and do some of the actions that you’re taking imply that there could be P&L impact as well? Could that put a little bit more pressure on the margin side for 2020? Thanks.

We have done a couple of things. We accelerated the development and placed the molecules from the future that we think in any case we will be able to offset any negatives that will come out of a potential—and I cannot specify what is likely or unlikely because I’m not the FDA. Our plans are for 2021. If we get the clearance and can commercialize products that are new on file from the plant, it will be great. We’ll follow our plan. If that is postponed for any reason, we do have backup plans to maintain the trajectory of that business.

Candace, we have time for one more question.

Hi, good morning, and thank you for taking the question. I wanted to follow up on a couple of things in the renal business. First, Joe or Jay, you’re talking about the investments that you’re planning, according to the model that could come out. I was wondering if you could share with us some insight into those plans in terms of the scale that you are currently planning for, meaning if you do invest that $500 million. Could you help us understand what number of additional patients or dollars that would allow you to address? And just create a clearer roadmap?

Matt, consider this: if you read the executive order, it contains significant interpretations embedded within that, and that's why they have the comment period and why the rule is not established yet. Right now, we have 12% penetration in PD in the United States. This is our home market, and there are three components to it. Two of them are interconnected: the transplantation process and the number of kidneys available to be transplanted, along with incentives from healthcare insurance for donors and policies designed to promote movement from clinic hemodialysis to home therapy in two different modalities. Baxter is the leader, holding close to 70% of global market share in PD and similar numbers in the U.S. If it’s only 12% in the U.S., and there’s a 50% population target for demonstration, it's not unreasonable to expect that within the demonstration period, we could double the incident patients, not the prevalent ones. This is how we’ve conducted our analysis, but our plans remain flexible. We can flex up or down our investment as needed, given it’s staged. There’s Phase 1, which occurs with no investment; Phase 2, involving some investment; and Phase 3, which pertains to the construction of a new plant. All of these will likely launch concurrently, given their different lead times for execution. We see it as our moral responsibility as a company to ensure we are ready and supportive of this opportunity. We will make every effort to avoid problems during the ramp-up outlined in the executive order.

Thank you. If I could just sneak in one follow-up, you mentioned that a lot of data was presented on Theranova, and I was wondering if you have any updated thoughts about giving some differential reimbursement for that product?

We are currently awaiting a decision from HHS—not just from them, but through the scoring process that happens at the budget office. We are just as informed as you. We remain excited about the possibilities and have several avenues to get Theranova into the U.S. Most importantly, we have agreed with the FDA on the novel process; this challenge we faced at our U.S. plant will be resolved in a timely manner and ramping the plant up too quickly led to issues since the dialysis volume exceeded expectations at that point.

Thank you very much.

Thanks, Matt.

Thanks, Matt.