百特醫療 (BAX) 2016 Q2 法說會逐字稿

Welcome to Baxter International's second-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Ms. Clare Trachtman, Vice President Investor Relations at Baxter International. Ms. Trachtman, you may begin.

Thanks, Candace. Good morning. Welcome to our second-quarter 2016 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Chief Financial Officer.

On the call this morning, we will be discussing Baxter's second-quarter financial results and updated outlook for 2016, before taking your questions. I would just like to remind you, during the Q&A session, if you could please limit yourself to one question, so we can accommodate others in the queue.

With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, and regulatory matters, contains forward-looking statements that involve risks and uncertainties. Of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning the factors that could cause actual results to differ materially.

In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website.

Now, I'd like to turn the call over to Joe.

Good morning, everyone. Thanks, Clare.

This is our first earnings announcement since our May investor conference. The strategies we outlined at the time are clearly gaining traction. We're making steady progress in our efforts to enhance our financial performance through our disciplined focus on portfolio and innovation management, operational excellence, and capital allocation.

As you've seen in our press release, Baxter delivered strong top-line and bottom-line results in the second quarter, exceeding expectations. I will share a few comments on our progress, and then turn it over to Jay, who will provide more details on the quarter and our updated financial outlook. After that, we will open the call for Q&A.

So let's get started. Baxter's worldwide sales grew 6% on a constant-currency basis and 4% on a reported basis. Sales growth was driven by strong performance in the US Fluid Systems, US peritoneal dialysis, and global acute care Renal therapies. On the bottom line, Baxter delivered adjusted earnings of $0.46 per diluted share, reflecting the benefit of better-than-expected sales growth, favorable product mix, and the positive impact of our continuing business transformation efforts.

Now, I'll briefly walk you through the performance of our businesses and franchises, where we speak to sales growth on a constant-currency basis, excluding foreign exchange to provide a clearer picture of underlying operational performance. Global sales for Hospital Products totaled $1.6 billion, increasing 7%; excluding US cyclophosphamide sales, Hospital Products sales increased 13% in the US and 9% globally.

Now to break out Hospital Products at the franchise level. Sales in Fluid Systems were $586 million, up 15%. Growth continues to reflect the strong launch of the SIGMA SPECTRUM infusion system in the US, where we continue to gain market share, plus favorable demand and pricing in the US for IV solutions.

Moving to Integrated Pharmacy Solutions, or IPS, sales were $563 million, increasing 4%. Growth, excluding cyclophosphamide, was up 8%, both in the US and globally, driven by solid performance across nutritional products, pharmacy injectables, and hospital pharmacy compounding services. With surgical care, which includes our anesthesia and biosurgery products, sales totaled $347 million, up 5% year over year.

We continue to view biosurgery as an attractive opportunity for growth through both innovation and geographic expansion. In the quarter, biosurgery sales increased mid-single digits globally. Sales continue to be impacted by lower sales of selected non-core biosurgery products, ACTIFUSE and PERI-STRIPS, which depressed growth in the quarter by approximately 2 percentage points.

As we discussed at our May investor conference, we continue to focus on strengthening this portfolio through the introduction of new products and delivery devices, expanded indications, and continued geographic expansion. During the quarter, we expanded the launch of HEMOPATCH, our advanced surgical patch, to Brazil, Mexico, and New Zealand. HEMOPATCH provides surgeons in these markets a new, ready-to-use option that has broad indications as an advanced surgical patch.

Our line of inhaled anesthetics continue to lead the market globally, with second-quarter sales up 7%, globally driven by double-digit growth internationally, where we continue to leverage our array of high-quality, well-trusted anesthetics as a platform for continued geographic expansion. During the quarter, revenues in the biopharma services partnering business totaled $124 million, a decline of 5%, as expected. As previously mentioned, growth in the business has been impacted by a customer that elected to take manufacturing in-house.

Next, turning to our Renal business, global Renal sales were $965 million, up 4%. Performance was driven by double-digit growth in our US peritoneal dialysis business work, where our highly innovative AMIA APD cycler, featuring SHARESOURCE two-way online connectivity, continues to build momentum in the marketplace. There are already more than 500 patients on AMIA in the US today, which have provided well over 30,000 treatments, taking advantage of our cloud-based platform for remote patient therapy management. In addition, during the second quarter, AMIA with SHARESOURCE was also approved in Canada, representing a new frontier for growth.

Renal growth in the quarter also benefited from a strong growth in acute business driven by increased market adoption for continuous renal replacement therapy, or CRRT, as a treatment for acute kidney injuries. Performance in the quarter also benefited from the strong flu season and competitive supply issues. We're very excited about the opportunities for this business, which remains one of our fastest-growing areas, and an active area of focus moving forward.

Our leading PRISMAFLEX platform was recently approved in China. We've initiated launch of our PRISMALUNG, low-flow carbon dioxide removal device in France, Germany, and Sweden. Growth in the in-center HD business declined in the quarter, as we continued to take a targeted approach to how we manage this business, including being selective about what market and tenders we need to participate in to support our objective of improving profitability in this business.

Before concluding, I will share a quick leadership update. Over the past few weeks, several outstanding executives have joined Baxter's senior leadership team. These include: Giuseppe Accogli, the new appointed President of our Renal business; Stacey Eisen, our new Vice President of Corporate Communications; Scott Pleau, our new Vice President of Operations; and finally, Andy Kidd, our Vice President of Strategy and Business Development. Andy will lead Baxter's effort to accelerate activities in the area of strategy and business development to augment our growth aspirations.

The entire team, those you met in May and our most recent additions, share my passion for Baxter's mission and the sense of urgency to drive transformation to pursue a top quartile performance. I have the utmost confidence in them as individuals and as a highly unified team to deliver on the potential that lies ahead for the Company and all of our stakeholders.

With that, I will pass it to Jay for more details on the financials and updated outlook for 2016. Then we will have time at the end for questions. Jay?

Thanks, Joe. Good morning, everyone. As Joe mentioned, we are pleased with our second-quarter results. It's another important building block as we look to achieve our long-term financial goals.

Operationally, sales increased 6% in the quarter. On a reported basis, sales grew 4%. Growth came in 2 points above our expectations, driven primarily by favorability in Fluid Systems, acute renal, and anesthesia. Walking through the rest of the P&L, adjusted gross margin of 43.8% also compared favorably to our expectations, and was driven by a positive sales mix and improved pricing in select areas of the portfolio.

Adjusted SG&A totaled $663 million, and decreased 11% on a reported basis. This represents a 440-basis-point year-over-year improvement. The primary driver of the improvement was our ongoing focus on controlling expenses and the rebasing of our cost structure.

SG&A also benefited from lower pension expenses and TSA income from Baxalta/Shire. TSA income totaled approximately $30 million in the quarter compared to $20 million in the second quarter of 2015. TSA income from Shire will continue to decline, as the need for these services ramps down. We expect TSA income in the second half of 2016 to be approximately $50 million compared to $65 million in the second half of 2015.

Adjusted R&D spending in the quarter of $150 million increased 1% versus the prior year. As we had previously announced, we discontinued our investment in the VIVIA home hemodialysis program in the second quarter, but plan to reinvest that spending into new programs in PD, biosurgery, and other initiatives to fuel future growth.

Adjusted operating margin in the quarter was 12.3% and compared favorably to our expectations, driven by increased sales, positive product mix, and continued discipline around expense management. This represents a 530-basis-point improvement over the second quarter of 2015.

Interest expense was $11 million in the second quarter, reflecting the benefit of lower debt balances resulting from the utilization of the Baxalta retained stake to retire approximately $3.7 billion of gross debt. Interest expense in the quarter was also impacted by a one-time reclassification of capitalized interest from other to interest. During the second quarter, Baxter completed its disposition of the retained Baxalta equity through a contribution to its US qualified pension plan of approximately $700 million, and an equity-for-equity exchange, which reduced Baxter's outstanding share count by approximately 11 million.

Adjusted other income totaled $13 million in the quarter, and included a foreign exchange gain on balance sheet positions of approximately $3 million and dividend income of approximately $7 million associated with our former Baxalta equity stake. The adjusted tax rate was 20% for the quarter.

As previously mentioned, adjusted earnings of $0.46 per diluted share exceeded our guidance of $0.38 to $0.40 per share. Relative to the mid-point of our range, this favorability was driven by approximately $0.06 of operational strength and a $0.02 benefit from interest and other income. This was partially offset by approximately $0.01, due to slightly lower-than-expected cyclophosphamide sales in the quarter.

Let me conclude my comments this morning by providing an update on our outlook for 2016. Starting with sales, on a constant-currency basis, we now expect 2016 full-year sales for Baxter to increase between 3% and 4%. After adjusting for the US cyclophosphamide impact, we expect underlying operational growth of 4% to 5%. On a reported basis, including the impact of foreign exchange, we expect sales to increase 1% to 2%.

We expect growth in the Hospital Products business of 3% to 4%, or 5% to 6% excluding US cyclophosphamide. Within the Hospital Products franchise, we now expect sales growth of low-double digits for Fluid Systems, driven by continued strength in the US business.

For the Integrated Pharmacy Solutions franchise, we expect sales to decline low-single digits, including the impact of US cyclophosphamide. We've adjusted our full-year sales forecast for cyclophosphamide, and now expect full-year sales of $190 million, with the assumption that additional competitors enter the market during the fourth quarter of 2016. After adjusting for cyclophosphamide, sales are expected to increase 2% to 3% in IPS.

Within the surgical care franchise, we anticipate sales to grow 1% to 2%. Finally, for the Hospital Products business, we now expect BPS and other to decline low-single digits, reflecting a change in our manufacturing service agreement with Shire. Selected products we had previously been manufacturing on their behalf will now be transitioned to self-manufacture by Shire. For the Renal business, we now expect full-year sales to increase 3% to 4%, driven by continued growth in our PD and acute businesses, offset by lower sales in our in-center HD business.

Moving down the P&L, we now expect an operating margin of approximately 12%, a 100-basis-point improvement versus our original guidance, reflecting increased sales and ongoing disciplined management of expenses. We expect interest expense to total approximately $80 million. For 2016, we expect other income of approximately $40 million.

For the year, we now expect an average adjusted tax rate of approximately 20.5% to 21%. We expect the tax rate in the second half of the year to increase, as the first half benefited from certain discrete items.

For the full year, we anticipate an average share count in the range of 545 million to 550 million shares. Based on these factors, we now expect 2016 adjusted earnings, excluding special items, of $1.69 to $1.74 per diluted share, as compared to our previous guidance of $1.59 to $1.67 per diluted share. Finally, for the year, we expect operating cash flow to exceed $1.4 billion and CapEx of approximately $900 million, resulting in more than $500 million in free cash flow.

Specific to the third quarter of 2016, we expect sales growth, excluding the impact of foreign currency, to increase 3% to 4%. At current foreign exchange rates, we expect reported sales to improve 2% to 3%. We expect adjusted earnings, excluding special items, of $0.43 to $0.45 per diluted share.

With that, we can now open up the call for Q&A.

(Operator Instructions)

I would like to remind participants that this call is being recorded and a digital replay will be available on the Baxter International website for 60 days at www.Baxter.com.

Bob Hopkins, Bank of America.

Congratulations on a really strong second quarter. I will limit myself to two questions. The first one for Joe, I was wondering since it's such a topic of consideration for investors, I was wondering if you could just give us an update on the outlook for the balance sheet and M&A? What's the environment look like right now? Obviously, you have been disciplined to date, but just curious if you could give us an updated outlook for the balance sheet and M&A across the businesses. Thank you.

Bob, good morning. We don't comment specifically on targets as we want to make sure that we get there first and don't get to pay too much for them. But we are very disciplined in that area. We've been looking at a significant amount of opportunities. I just reviewed yesterday, we have probably more than 15 different opportunities in our pipeline. But I have to say that we also walked away from four deals in the last 90 days. They were too expensive. We have got to make sure that we have the discipline to execute. We could execute those deals internally. We have absolutely the right teams to get them done. But the price was too high and somebody else was willing to pay more money for that asset.

If we don't see a way there, we're not going to be competing (inaudible) scratches off deals (inaudible). I tell you, our focus is acute. We have -- having Andy Kidd as part of my operating team. Also, you raised the profile of the M&A jobs in our Company. We're working very hard to find those, as we continue to progress in creating operational opportunities for the Company as well as organic opportunities. Our balance sheet is pristine at this moment in time. So one thing about M&A, it doesn't preclude us of buying shares back. Shares back doesn't preclude us from doing M&A. I think we need to have a balanced approach. We can do probably both of them if we do it correctly.

Great. Thank you for that, Joe. Then, Jay, one question for you. I was just wondering if you could give us a sense of the really strong top line growth that you are generating? Can you give us a sense as to how much of that roughly is coming from price? Of the 6%, 7%, is that 1 or 2 points from price this particular quarter? Then maybe a quick comment also on just how we should be thinking about the sustainability of fluid systems growth, especially in the US? Thank you.

Generally, you're right, it was a great quarter from a sales perspective. You look at businesses like the US fluid systems, as you pointed out, and we saw a north of 30% growth in the US. Just thinking about that business for a second, there's really two primary components to it. One is the infusion systems business. That's really driven by sales of the Spectrum Pump along with sales of the attendant sets. So once you install a pump, you have the sets that ride along with that. Our sets' growth in the quarter was north of 20%. Then in the infusion systems, overall growth was north of 30%.

Then on the other side, we have the IV therapy business in this particular area. That also grew north of 30%. In the case of IV therapy, it was a balanced mix of price and volume that drove the growth. The other area where we saw some pricing in the portfolio is in the area of US PD, where we did see some opportunities to capture value. But beyond that, it is a fairly stable pricing environment. I wouldn't say that there are massive or very significant changes to price beyond those two areas that I've referenced.

But is that 1% to 2% of the total 7%, roughly the right way to think about it this quarter?

We don't really specify -- we don't really do price volume on the entire portfolio for a number of different reasons. But I think that the two areas where price was most pronounced would be in the PD arena and then also in the US infusion systems business, in the fluid systems business. The only thing I would add is, we do see some pockets of price pressure in the portfolio. So in some instances, there are offsets to price increases that we see. In certain markets, for example, where we see dialyzer pricing or other particular product areas, there are certain areas where we do see price pressures. So it is a balance. It's hard to answer the question across the board.

Great. Thank you.

Vijay Kumar, Evercore.

Congratulations on a really strong quarter. So maybe, one high-level question on the guidance. When you look at the back half, right, just given the one half performance, it seems to be a tad light in the back half, especially when you look at cyclo, the presumption is now, cyclo to impact in 4Q versus I think what we originally thought as a 3Q impact. So can you maybe just walk through some of what changes one half versus back half as we think about top line?

Yes, sure. I think from the first half to the second have there are a number of drivers of change. One is we do have cyclo impact, in particular, in the fourth quarter, we'll expect to see around $40 million of year-over-year decline related to cyclo on the sales line. As it relates to other areas in terms of sales growth, we are taking a very disciplined approach across the portfolio. So as we look at areas that don't earn the right economic return for us, we will very much walk away from particular tenders or businesses.

So in the fourth quarter of this year, there's probably another $30 million to $40 million of low-margin sales that we choose to forgo. Then finally -- the other comment I would make on the third quarter relates to PROTOPAM last year, we did have a PROTOPAM order in the third quarter of last year that makes a tough comparable. That was about $20 million. So if you adjust for those items, I think the sales makes -- is more explainable.

Overall, as we think about the guidance on EPS in the second half, if you were to go back to last quarter's earnings call, the implied second-half guidance was $0.85 to $0.91 in earnings per share in the second half. As we think about today, our current view is $0.87 to $0.92. So essentially, we've raised the midpoint of the second-half guidance by about $0.015. What you have to realize is there are a couple of drags on the second-half number, the tax rate is slightly higher than our expectations, in part because of profitability coming in higher tax jurisdictions.

So that's about 1 point. The share count's a little bit higher -- I should say, $0.01. Then the share count is a little bit higher as well in the second half of the year. So that's about $0.01. We do see a benefit of cyclo of about $0.01 but the ongoing organic base performance that we anticipate improving in the second half is about $0.03 relative to the last time we shared guidance. So overall, I think it's a story of continued momentum but there are some factors that do slow second half relative to first half.

That was helpful, Jay. Just maybe a follow-up on gross margins. I know you've mentioned sales mix and pricing. Just as we sort of look at on a medium-term basis, right, if we look at new whitespace in general, a lot of your peers talk about anywhere from 50 to 200 bips of pricing headwinds. How should we think about pricing at the corporate level for Baxter on a medium-term basis? Should we think about it at net neutral? Then in the Q of gross margin, obviously, the other part was mixed, right, so as we roll profit to margin, how sustainable is some of those underlying strong gross margins trends we're seeing? Thank you.

Sure. From an overall gross margin standpoint, clearly, we were pleased with the result in the quarter. As we think about what drove margin in the second quarter and what drives it through the balance of the year, gross margin, that is, there is the price -- net price positive impact that we've seen in the quarter. So that is one element. Now, importantly, we've signed many of our agreements. We've concluded many of the agreements in a variety of our business. So as we move to next year, we don't expect to see the same level of price or economic value captured that we've experienced. But there are still some opportunities for pricing. The other element in the second quarter that was, from my standpoint, very exciting was the area of mix.

So I commented earlier on 20% growth in sets. Sets carry a higher margin than the corporate average. We talked about the acute business, which was just a star performer in the quarter, That to carries a higher margin than the corporate average. We also saw good growth coming out of anesthesia and nutrition. This idea of accelerating the growth of our higher-margin products, that is something that we expect to continue for the balance of this long-range planning period. That will be one of the contributor's that takes us to our aspiration of a 17% to 18% operating margin by 2020.

The last comment I would make is generally speaking, we saw very solid volumes in the first and second quarters. This accelerated sales growth does have a positive absorption impact on the entire manufacturing and distribution network, which allows us to benefit from higher margins by absorbing more costs. So it really was a confluence of events. We do expect to see continued margin improvements moving forward.

Mike Weinstein, JPMorgan.

Congratulations as well on a very nice quarter. So, there's a couple of items, I just want to follow-up on. One, it looks like the cash flow guidance for the year has been relatively unchanged start of the year, despite obviously very significant provisions to the EPS expectations. Jay, can you just spend a minute on that. Then secondary, I just wanted to follow-up on the price discussion thus far. Thanks.

Great. Yes, from a cash flow standpoint, you'll see in the 10-Q when we report it, we're finalizing cash flow for the quarter with PWC working very closely. But we're pleased with the second-quarter performance. What I would say, as we look for the full-year cash flow forecast is, the probability of achieving our forecast has increased based on the two quarters that we have under our belts. I'm very pleased with the performance.

At the investor day, we talked about a number of important initiatives that we are embarking on. We just started a days payable project. One of the comments I made at the investor day is, the ratio between days payable and days receivable, days held outstanding, doesn't quite work for us. It's a real opportunity. I will tell, you the early signs, that some of these projects are going very well.

But the reason that we haven't changed guidance on cash flow is, a lot of our cash flow is back-end loaded due to normal seasonality patterns. Until I get a little bit better line of sight to how Q3 emerges and expectations on Q4, it is a bit premature to raise the cash flow guidance but I will tell you that the probability of achievement has increased. The other thing I will say is, we have been really focused on CapEx. So this is an area where we believe that there's opportunity for us.

The 9% of sales is something that we're striving very aggressively to improve, we have long-term plans to do so. But that's another area that as we move toward the end of the year that may be another area that we update. So on balance, I feel quite good about how the cash flow story is shaping of our Company and frankly, from a free cash flow standpoint. This is a real opportunity for us not only this year but moving forward.

Then on the pricing discussion, if I look across the portfolio, I was hoping you could maybe just provide some more insight into the contribution from price and different businesses? Obviously, it's most pronounced in fluid systems, but the ability to take price in PD is something that relatively new for the Company. The growth of the anesthesia business this quarter was particularly strong, are you getting price there? If you could just help identify maybe the level of price you're getting in some of these businesses within hospital products? Where you are able to take price today that maybe you weren't 12 months ago? Thanks.

Mike, we have contracts that are signed very recently in the last 12 months, they're 3 to 5 years that have price clauses built into them. Okay. We look at it for trajectory of growth like fluid systems going forward. We're going to continue to see growth in that business, perhaps the rate is not the same as we took a significant amount of market share lately, but that is built into the contracts. So I feel comfortable about that. The point that you underscored about AMIA, our PD business for many years, has not experienced new technology. We have this breakthrough technology with AMIA that really had stunned the market.

We have a significant amount of providers coming to us -- the price of the product is coherent with the technology and the benefits, thanks to our patients. So we've seen some really good momentum. We see a lot of interest, not only from the providers, but from the payers side in this program, because it's selling medicine and the innovative aspect of AMIA. So we have slowed down the price erosion in dialyzers, so all in all, the Company is looking at price neutral to slightly positive going forward versus any negative price pressure or erosion. So, just again, price neutral to positive going forward.

Joe, that comment is about your dialyzer business? Or is that a broader color?

No, this is about the whole Company. The whole Company -- I see the Company when you look at all the price point analysis of what is built into contracts, the pressure in dialyzers, the AMIA launch and some of the new product launches we have, I would say, Baxter will have price neutral to positive going forward at least for the next foreseeable future.

Joe, that's a comment beyond 2016, right? Because in 2016, price contribution's more meaningful. --

Yes, this is beyond 2016. As I said, some of these contracts are long into the future, So this goes into 2017 as well.

Perfect. Thank you, Joe.

You're welcome.

Thanks, Mike.

Brooks West, Piper Jaffray.

I had a question on the growth trends in the US versus international. It seems like you have pretty meaningful out-performance in the US this quarter. I'm just wondering, are you seeing something in the O-US markets that's changing? Is this just a one-quarter phenomenon? I was wondering if you spend a little time on that? Then secondly, just curious what you're seeing in the O-US markets, which hit emerging market performance in Europe, et cetera. Thanks.

Sure. Overall, the US did benefit from two very significant product launches, more so on the spectrum side than the AMIA side. But in the US, we are seeing the continued adoption of our spectrum version 8 pump, which is really a great innovation but also very exciting for -- from an overall financial standpoint. Then the US PD business also benefits from AMIA and also some of the execution that we're seeing overall in the US PD business.

Then finally, the acute businesses has seen outstanding growth in the US, in part benefiting from a flu season that extended and was a bit more acute than we previously expected. So there were a number of factors that set the conditions up for success in the US that allowed us to over-achieve our expectations and deliver the 10% growth. Outside the US, we reported 3% growth internationally. What I would say is, emerging markets roughly mid single-digits growth.

We did have lower growth in China in the quarter. So low single-digits in large part, you'll recall, we exited certain tenders for PD, where the margins weren't attractive to us. So there was that overhang on our overall business in emerging markets and in China. We do expect to sunset that after this quarter. So, we'll see an acceleration, we expect to see, in emerging markets in the Q3, Q4 timeframe. So those would be a few of the overall comments I would make on that.

That's helpful. Then on the bio-surgery business, if I could, it looked like a nice step up in performance there. I'm wondering, is that just getting the portfolio straightened out? Is it underlying volumes? Any detail there would be helpful. Thanks.

A couple of things. One was focus, make sure that we are on global basis focusing on that business. We have great portfolio and I think other things were taken precedence. Second thing was we launched HEMOPATCH as well. In our efforts there, it's time to ramp up. I have to tell you, we're in the process of a very -- the final stages of hiring a President, a global President for bio-surgery, which creates a vertical for this business on the global basis.

It creates a very different focus in our Company for bio-surgery, which is a very different product than the rest of our portfolio and requires a significant amount of detailing into accounts. So that associated with us doubling the amount of R&D going into bio-surgery is, and also two or three potential smaller cases is that can go into this business, it will revitalize our bio-surgery business and put us on track to over perform.

Great. Thanks, guys.

David Lewis, Morgan Stanley.

Two quick questions for Joe or Jay. The first one's on US fluid systems, so I'm looking at that said performance here in the quarter. It looks like about half the organic growth of the business is coming from just the US fluid systems business, about 3.5%. So Jay, can you sort of walk us through anything you can tell us on mix of capital and consumables? How that contracting sort of falls forward into 2017? What you think the structural growth rate for this business is on a longer-term basis? Then I had a quick follow-up on guidance.

Yes. I mean, look, overall, fluid systems business, we anticipate over the next five years to be a 3% to 4% grower, although, I look at this particular quarter and it's a very solid data point in terms of growth and adoption that we were pleased with. Thinking about the performance of the business, it's important to decompose it into a couple of different segments, right? One is the IV business. We are working very hard to bring additional volumes to the market. We're very focused on delivering. So as we think about the sustainability of this particular aspect, this should be a steady grower for the next several years. In part because of the contracts that we've discussed but also in part because of continued volume that we look to bring to the US.

In the other roughly half of the business, the infusion systems area, there's two component pieces to this. The larger one today, relates to pump sales. So we've had great success with pump business. We continue to perform in line with the expectations or better than with the expectations that we've shared with investors over the last year on pump placements. But then the other benefit is as we place pumps, going with those pumps is a non-capital sale. That's the set piece, right?

So our sets were up, as I said earlier north of 20% in the quarter, just a very solid element. This becomes more of an annuity or an ongoing stream of business that's related to pumps. So I would say that's a more sustainable business than the capital sales, which are a little bit lumpier in nature if you will. Overall, though, we feel confident that the business will grow, I believe north of 10% on full-year basis globally, Then moving forward for the next five years, this 3 to 4 kind of mid single-digits type growth is what we can expect to see from fluid systems.

Jay, very, very helpful. Then second, just to reconcile the fourth quarter number, My way of thinking about it is, maybe you plant a 2%, 2.5 % constant currency for the fourth quarter and then we sort of add back 1.5 point from cyclo and 1.5 from the discontinued operations you talked about. That kind of gets you back to 5%, 5.5%, which is sort of consistent with the first half? Is that sort of a decent way of thinking about the fourth quarter?

That's exactly how we look at there. So we had about 1.5 points for cyclo. I wouldn't characterize it as discontinued operations. But for us, we're going to be very disciplined about sales. We will forgo sales in certain incidents that don't make sense. That's about a 1.5 point of half of impact, in that case though, that's a very low margin impact. As you know, the cyclo on the other hand is a higher margin impact.

Great. Thank you very much. Great quarter.

Thank you.

Matt Miksic, UBS.

So one follow-up for you, Jay, on gross margin. So, very strong in the quarter at least relative to our estimate. I'd love to get some additional, anything you can quantify around some of the puts and takes there by sort of business line or product line. I mean, based on David's question, it looks like even through those sets, for example, they started to pick up growth. You're not quite growing as fast as capital in infusion systems. So is that reflecting some of the strength here? Or cyclo some of the strength? Just maybe take through the business lines, then maybe you can talk a little bit about that. Then I have a follow-up for Joe.

Sure. Just from a gross margin for the quarter, actually cyclo was below our expectations by a little bit. There were a variety of reasons, but it was not meaningful. But when you talk about missing cyclo sales relative to expectations by $5 million, $7 million. That has an impact on both gross margin and EPS. So the margin that we saw was even in excess from a pure operational standpoint, but, look, there are two primary factors, right? One is price. So we did see some price benefit in the quarter. But another and again, this is the more sort of exciting area as I look at the business is the area of mix.

So when you have: our sets business; our acute business, which is $400 million business; our anesthesia business, which is I believe north of $700 million; our nutrition business, which is also a very healthy sized business for us. When you have roughly 20% of your portfolio growing at a faster rate than the corporate average and when that has a much higher average margin than the corporate average, it really is a benefit that you see on the gross margin line. In our case, that's something that we experienced in the second quarter.

Now turning to the rest of the year, we do expect to see some of that continued benefit from the accelerated growth of those higher-margin businesses. But then there's also a secondary impact, which I referenced earlier, which is as you -- as your plans fill up with incremental volume, there is additional absorption that is occurred, the manufacturing network becomes more utilized. So you do see unintended absorption benefit on the cost profile, which also impacts margin. So, second quarter, great, you see price and mix [plane] coming to bear, moving forward, we'll have price, mix and volume. That's why we've been able to increase the guidance in the second half of the year.

Great. Thanks. The follow-up for Joe. You'd mentioned when we were out to see you, these initiatives sort of reinvigorating the entrepreneurial spirits of some of the teams across Baxter, as one of the things you've been focusing on. I'd love to get your perspective, if you could spend a few minutes just on the progress there. Specifically on, what we'll see from that? The types of benefits you hope and expect to see in terms of growth and margins? When maybe we start to see some of that blow through?

We have a pretty structured program. We have somebody in charge of that who reports directly to Paul Vibert, our President of International. A couple notable, as we just launched a pain pump in Italy, in Europe, that was a local initiative. The elastomeric business is active outside the US. We didn't have the right product for parts of Europe, we just launched that. So it could pick up good margin and sales for the group. We also have a plan to bring China to $1 billion by 2021, which is now much shorter than that in our LRP, so that brings growth up to close to 10%.

So we're very excited about that. That was all done local, China for China, a significant amount of change in directions and mix of products with parts of the business refocusing attrition for China, which is a great opportunity and introducing bio-surgery in China, which we don't have today. So these are just two examples. I can give you a great example in Brazil and Colombia, we'll be launching our ringer product with big sales in three years of $15 million, a highly profitable.

So we have significant amount of programs going on in the Company to sustain organic growth, driven by a more disciplined and cadence of launching products and have products available for the rest of the world. We didn't do particularly a good job in launching products on a global basis. We have reinvigorated that. We have so many good products and good invention and innovation in house. So those are really exciting and creating momentum in the Company.

Thanks.

Glenn Novarro, RBC Capital Markets.

It's more of a back row question. Your fluid systems, your hospital products business all grew very strongly in the US and very specific to the Company in your execution. But I was wondering if in the second quarter you saw any favorable macro trends? In other words, did you see any pick-up in hospital admissions or surgical volumes? I wonder if you can speak to and address the health of the US market in general, Joe? Thank you.

We see a slight uptick in the procedure volume, probably 3% and 4% growth in the US. This is a good thing for us, with the fluid systems being driven primarily by debt. Also a good flu season helped, was important this year for use of fluids and pumps. We see the environment in the US is stable. Not with a trajectory of growth that we probably saw before, but with growth, as we see unemployment still subdued and below, sub 5%. So it's a good trend for the country and continuing.

Just on an unrelated -- I just wanted to get back to Bob's question on M&A. I believe on -- it was handled at the analyst day or one of the previous calls, you talked about integrated pharmacy solutions. That's a business on the M&A front. I believe you used the words, you wanted to double down. You also just mentioned on this call that there were four deals that you just passed up on in the last 90 days. So were some of these deals in integrated pharmacy solutions? Why has the dynamic become so competitive of late? Thank you.

You're welcome, ahead of answering my question. I would say to you that there are very few areas of growth if you think about healthcare and about the targets. The multiples in EBITDA are skyrocketing in some areas, go figure out why. I just saw a couple of deals. One that just got concluded in the US, on the front end, generics company. The multiples are extremely high for -- in capability more than anything else because the Company did not make any products. So we have those capabilities in-house. We look at some of these deals and we don't see the price, the coherence between price and value.

I think, when we don't see the coherence and it does not meet our expectations, we have very established guidelines with our Board, they reflect our best interest of our shareholders. I would say will not step into those deals. We walked away from another deal that had a significant difference between us and a foreign party who was trying to buy the company. There's not a deal that is important enough that will make us spend our shareholders money in vain. So we're going to continue to pursue the couple deals on the table right now that we think are actionable. We're pursuing them, but we're going to always keep our eyes on value.

Okay. Thanks, Joe.

Thank you.

Danielle Antalffy, Leerink.

Congrats on an excellent quarter. Jay, I was wondering if you could talk about Brexit and the impact both on sales overall but specifically, as it relates to FX, your exposure to the UK?

Great. Thanks for the question. Overall from volume standpoint, we don't expect an impact from some of the macro challenges we're seeing in Europe. Most of our product lines are more steady stream from a unit standpoint. So we don't really anticipate an impact in that sense. From a foreign exchange standpoint, really, we have a number of hedges and opportunities that we have. So as it relates to the UK, we have roughly 5% of our sales in the UK. We do have a manufacturing plant in the UK that provides a natural hedge against fluctuations in that currency.

Then in the euro zone area, we have a number of plants. So as the euro moves, we do have natural offsets to sales -- the currency fluctuations in that market as well. But the other thing that we do is, we use synthetic hedges or derivatives, principally, options to hedge foreign currency exposure. We have a well-disciplined approach where we hedge out up to five or six quarters; we hedge roughly 20% per quarter. We use options, which really caps the downside associated with those instruments.

Now for us, as we evaluated the Brexit situation leading up to that particular event, we actually did a couple things, we increased our exposure or increased our derivative positions on the pound and increased our derivative positions on the euro as well, as an insurance policy to ensure that there would be no adverse impact this year or next year. So the result of that is, despite the movement in the pound and the euro, we really offset some of the translational impact of the P&L with gains associated with those derivatives that we put into place.

We are very pleased with the situation that we're currently in. The other item that we did is, as the yen strengthened, we did take the opportunity to increase some of our exposure, again, using options, so that the downside is limited to the yen. So we had some of our incremental yen positions at basically JPY100 to $1, again, a trade that we were pleased with and situated us well for both this year and next year from a foreign exchange risk standpoint.

Okay. That's really helpful. If I could follow-up, one more macro question following up on Glenn's question about US volumes. Ex-US, there's a little bit more uncertainty, turmoil if you want to call it that, in emerging markets and both -- also in Europe, just wondering what you're seeing from a volume trend -- procedure volume trend, ex-US? Whether that's offsetting some of the strength we're seeing here in the US? Thanks so much.

There is a very high diversity of scenarios. So you have China with -- it's a pretty stable market regarding our products, the products we serve the Chinese market in terms of pricing. But you always have the trend of risk of price controls and things like that. But we see of China with a pretty stable outlook, as well some parts of Latin America, even Brazil, depending on -- independently of the currency situation. You still have Brazil with good prospects for growth, Columbia, Mexico. I would say when we move away from emerging markets, developed markets such as Australia with very strong growth, good performance.

We see markets there for areas like hospital admissions. But we see that via our compounding business there that is doing very well, no issues. I would say Europe is always a point of attention, with very slow growth in most of the five large countries in Europe, with some exceptions in parts of probably, England and Spain, we see little bit of growth there. But it's a market that we are being very careful in how we compete. We are very disciplined in pricing, but we see that market a bit more tenuous than the rest of the developed markets.

Very helpful. Thank you.

You're welcome.

Larry Keusch, Raymond James.

Joe, I wanted to come back to emerging markets. I think if I have got the math right, you have probably some somewhere in the 4%-ish range growth in the first half of the year. I think on the first-quarter call, you were talking about more like 9% to 10% growth for 2016, after you do some adjusting for a renal situation in China. So, I wanted to see if the thoughts around that kind of high single-digit growth, 9%, 10% are still in place? If so, what gets you from that kind of 4%-ish range to 9%, 10% for the year.

The 9%, 10% for the year is towards the back-end of the year. Then we also have China being the biggest drivers. So think about the size of China for our business is over $600 million in sales. That drives a lot of the numbers when you look at emerging markets and primarily Asia. China, there was -- we walked away from an unprofitable bid last year for PD patients. Because we lost those patients, the impact was felt this year in the first and second-quarter anniversary -- just anniversaried. So we're going to see a recovery in China by the third and fourth quarter, which subsequently will create the momentum for the growth rate that we have outlined.

Yes. Overall, Larry, what I would say is that we expect emerging market growth for the full-year, in line with the guidance that we provided at our May investor conference of around 5% to 6%. So that's kind of the outlook for the full year. As Jay referenced earlier, there are certain markets and products that we're going to be exiting or not participating in those tenders. A lot of those are in emerging markets. That impact will be in the fourth quarter. So that will depress growth in the fourth quarter in emerging markets. But overall, will grow in line with that guidance that we outlined in May.

Okay. Terrific. That's very clear. Then lastly, just on CRRT, obviously the growth has been very impressive. I was wondering if you can deconstruct that a little bit as to what's really driving that? Is that market share gain? Is it increasing use of the therapy? How do we think about the runway for that growth? How sustainable is it?

It is all the above. So the way to deconstruct and see the underlying growth for acute renal care, which uses CRRT technology to be at 10%, 11% growth business. We have benefited from a couple things. One is we've been gaining market share from other [modalities] on top of the growth of the usage of that technology. We can see that by the sales of equipment, by sales of capital. So when we have the sales of capital being increased, we know that the pull-through will happen, but we need to be at the hospitals to make sure that technology is used instead of flat or something else. So it's a very good underlying market growth.

Second is there was a supply issue in the marketplace, primarily, in the US. Baxter is always there for our customers. We were able to supply product for our patients. By doing it so we were able to help our hospitals as well as create some momentum and potential conversion opportunities of those accounts, because not all of them probably will go back to the original manufacture, who was in that quarter and short in the market. So we will be able to pick that up in the near future. So it is a great business for us; hence, our ability to continue to tag other technologies like PRISMALUNG and the other things that we spoke of in May at our investor day, because it's a real door opener into the ICU for us.

The only other thing I would add too, is the first half of the year really benefited from a strong flu season that we don't expect that to repeat in the second half of the year. So that's why the growth in the acute will kind of come down to the levels that Joe referenced earlier in terms of the underlying market growth rate.

Okay. Terrific. Thank you.

Joanne Wuensch, BMO.

Terrific quarter and good morning. When I take a look at your third-quarter guidance and full-year guidance and we back into the fourth quarter, it looks like you're looking at about 2%, ex-FX. Some of that, I suspect is cyclo, some of that is probably flu because it's not going to be there, but how would we sort of peel away that somewhat lower organic revenue growth rate versus what you just delivered in the second quarter?

Sure. There's two factors. One is cyclo, which is about 1.5 points. This year, the biggest year-over-year impact will be in the fourth quarter, as we assume the entrance of a couple of new competitors to that business. So it's about $40 million or 1.5 points. The other item is, it's more of a sales than profit impact, but we regularly look at our portfolio and we'll walk away from certain sales that are below a margin threshold. In the case of Q4, as we planned and expected, there are certain things that we are walking away from that will impact the fourth quarter by about 1.5 percentage points as well. So in combination, those two items yield roughly 3 points of growth to the fourth quarter.

That makes sense. Thank you. Then as my follow-up question, the US fluid system's number is so wonderfully strong. How do we get that going outside the United States? Not that I'm asking for more, but just asking. Thank you.

Well, we have a very nice base of pharmacy installed outside the US still, with significant amount of channels. We, through partnerships right now in a strong group, work with our partner who will be able to launch products in the future, not too far. They will start replacing our fleet outside the west and continue to growth with more variety and different types of pumps. But we need to sustain that business.

I think that was key. As we look back and thought about the priorities -- you asked us to a big priority (inaudible) some pumps. But as we have seen this traction going and we have new versions coming up from product development, it's for us now to focus outside the US with our global product line. I think we have that strategy and the products line now to do so, so we'll be coming out soon with new products that will create momentum outside the US and protect our base.

Joanne, the only other comment to add is, in the second quarter, growth was adversely impacted because we had a shipment to a particular country, Canada, last year of pumps, so it was more of a -- it was a [bullish] order that we had that impacted growth several percentage points in the fluid systems business. So that negative 1%, we actually saw a mid single-digit growth in IV therapy, which was a solid performer in the quarter, but we did have the overhang of that one order.

Thank you so much.

Matt Keeler, Credit Suisse.

Just a couple of quick ones. First the -- now that the retained stake utilization has been completed, where there any changes versus your prior thinking to the P&L guidance?

Our P&L guidance, any changes to our P&L guidance?

No, broadly in line. Look, we were very pleased with the execution of the retained stake. Frankly, the tax treasury and legal team here Baxter worked very hard in the face of the Shire transaction to execute on those transactions in a timely manner, exactly as we expected it. So from our standpoint, a broad brush, we had anticipated about $0.15 of impact this year. We'll experience $0.15 of impact this year. We're very thankful and appreciative of all the hard work that allowed us to get to that stage.

Just to wrap it up, the reallocation has spend from VIVIA to PD and bio-surgery. Any more color you can give us on where that spending will go? Is there any impact there to the -- either revenue or expense guidance for the year?

A couple of examples, we have several but we will give three to you. One is we're going to be launching a variant of our offsets outside the US that we need, so someone is going there. Then we're doubling the R&D dollars going into bio-surgery, just launched several different programs in bio-surgery. Lastly, our point of care is now being fully funded as we are planning to come into the US in about three years with a new point of care to provide patients with on-demand manufacture of peritoneal dialysis, a solution in the home.

So a quick use of that money. That's one of the reason that didn't -- would not flow through the bottom line, we have just better use of the money. Very consistent with our capital allocation policy, as well as we see great opportunity across the board in many organic opportunities. One last to mention is IPS, actually we accelerated all the molecules that were out, slated for 2019, 2020, 2021 to come earlier. That program costs money. We're funding that as well with some of the [PTM] money. So a great organic opportunity in the Company, could not pass the opportunity of putting money in the right places.

Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call with Baxter International. Thank you for your participation. Have a great day.