百特醫療 (BAX) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Baxter International's Second Quarter 2017 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.

Thank you, Candace. Good morning, and welcome to our second quarter 2017 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer.

On the call this morning, we will be discussing Baxter's second quarter 2017 financial results, along with our updated outlook for 2017.

In addition, as previously mentioned, we will be providing an updated financial outlook for 2020 as compared to the expectations we laid out at our investor conference in May of 2016.

As a reminder, we have posted a supplemental presentation to complement this morning's discussion. This presentation, along with the related non-GAAP reconciliations, can be accessed on Baxter's external website in the Investors section under Events & Presentations.

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

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

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

Good morning, everyone, and thanks for joining us today. I will get started with a brief look at our second quarter results, then I will share some highlights reflecting the progress and potential of our ongoing business transformation, and conclude with an update to our 2020 guidance. After that, I will turn the call over to Jay, who will walk through our second quarter results and financial outlook in more detail. We'll close with Q&A.

Baxter delivered another solid quarter, achieving top line sales growth of 1% on a reported basis and 2% on a constant currency basis. Operationally, Baxter's sales increased 3%, which excludes the impact of foreign exchange, net of competition for U.S. cyclophosphamide and the previously communicated strategic exits the company's undertaken.

Key top line drivers include a strong U.S. performance, include systems nutrition and anesthesia as well as steady global growth in PD and acute renal therapies.

On the bottom line, adjusted earnings were $0.63 per diluted share, increasing 37% over the prior-year period.

This reflects solid top line growth, improved gross margins and the steady impact of our ongoing business transformation efforts.

A little over a year ago, we outlined our road map for achieving sustained top quartile performance. As far as this transformation, we created a foundation that is redefining how we do business and deliver value for our patients, employees and shareholders.

To date, we have made great progress, rather, in executing this transformation and are focused on positioning the company for continued success. I will share a few recent highlights that support this objective.

We expect to close our proposed acquisition of Claris Injectables imminently. This acquisition broadens our presence and prospects in generic injectable pharmaceuticals, and provides expanded capabilities in one of our core growth areas.

Claris brings us a product portfolio of more than 50 products on the market and a robust pipeline of more than 100 new products in development. We will continue to augment this business with strategic partnerships like the agreement we signed in the quarter with Dorizoe Lifesciences to accelerate the development of more than 20 generic injectables.

During the quarter, we also announced research and clinical development collaborations with leading institutions, Mayo Clinic and Ramot at Tel Aviv University and Tel Aviv Sourasky Medical Center, to transform patient care with new technologies and products across an array of therapeutic areas, including renal care and surgical care, respectively.

We also received FDA guidance in the quarter, clarifying the regulatory pathway for a new home-based PD solutions generation system. This technology has the potential to remove some existing barriers to home-based dialysis, enabling more patients to experience the lifestyle benefits of home therapy.

We will continue expanding our research and development pipeline with significant investment targeted to new product development and additional collaborations to accelerate growth through 2020 and beyond.

And while the pipeline continues to expand, we are also maintaining a steady tempo of new product launches, new indications and geographic expansions across our global portfolio.

Our progress and pace have also been reinforced by continued evolution in our operating structure and leadership.

Over the last few months, we've further built our -- built out, rather, our leadership team with some major names in new positions and some talented new players joining the company. With Paul Vibert's recent retirement, we are in process of simplifying our geographic structure into 3 regions: The Americas, including North and South America; EMEA, or Europe, Middle East and Africa; and Asia Pacific.

Brik Eyre is now serving as President of our Americas region.

Onboarding this week is Andy Frye, our new President of Asia Pacific. He joins us from DKSH Healthcare, one of the largest service providers in Asia, where he served as the Global Head of Healthcare.

Cristiano Franzi has been named our new President of EMEA effective September 1.

Most recently, Cristiano served as President, Minimally Invasive Therapies Group EMEA for Medtronic. Giuseppe Accogli now has an expanded role as President, Global Businesses, responsible for driving global growth through strategy, product development and marketing for the business franchises within Hospital Products and Renal.

And Sumant Ramachandra joined us in June as our new Chief Science and Technology officer. Sumant was most recently Senior Vice President and Head of R&D for Pfizer Essential Health.

This leadership team is aligned, energized and ready to lead the charge forward.

In light of our progress, trajectory and potential, we're now prepared to update our 2020 guidance. We are projecting sales to grow approximately 4% on a compounded annual basis from 2016 to 2020. We expect a 2020 adjusted operating margin of approximately 20% and adjusted earnings of $3.25 to $3.40 per diluted share. Finally, we expect to generate free cash flow of approximately $2 billion.

We're pleased with these increases, and we'll continue to evaluate opportunities to accelerate this performance, both organically and inorganically. We continue to see business development playing a crucial role in building out our portfolio and pipeline, focused on key growth categories and adjacencies. This will be enabled by our healthy cash flow, allowing us to deploy capital to create value on both the top and bottom line. In parallel, we will remain relentless in our efforts to increase efficiency, process improvements, smart expanding and the engagement of all Baxter employees have been fundamental to our transformation to date and will continue to fuel a reinvestment and margin expansion in future quarters.

In sum, we have arrived at the next phase of our transformation journey and, just like before, persistent, disciplined execution points the way forward. We have a sound strategy and our leadership team is fully engaged to help us realize our goals.

Most importantly, we have exceptional talent across the entire company that embraces our mission to save and sustain patients' lives and advance our aspirations to deliver top quartile performance for all of our stakeholders.

Together, we are ready to set our sights higher.

With that, I'll pass it to Jay for a closer look at our financials.

Thanks, Joe, and good morning, everyone.

As Joe mentioned, we're pleased with our second quarter results, reinforcing our confidence that we are on the right path to achieve our goal of sustaining top quartile performance.

Sales in the quarter increased 1% on a reported basis, 2% constant currency and 3% operationally in line with our expectations. The results were really driven by strength across many of our U.S. businesses and improving operational growth internationally.

On the bottom line, adjusted earnings were $0.63 per diluted share. This exceeded our guidance of $0.55 to $0.57 per share and reflects solid execution on the top line, the ongoing impacts from our business transformation efforts and a modest benefit from other income and a lower tax rate.

Now I'll walk you through performance by business. I will be speaking to growth figures on an operational basis to provide a clearer understanding of underlying performance. As a reminder, our operational basis presentation excludes the impact of foreign exchange, U.S. cyclophosphamide and select strategic product exits.

Global sales for Hospital Products were $1.6 billion, advancing 4% operationally.

Breaking this out by business, sales in Fluid Systems were $607 million, up 6% operationally. Performance was primarily driven by strong sales of IV solutions in the U.S.

Moving to Integrated Pharmacy Solutions, or IPS, global sales were $568 million, increasing 4% operationally. Contributing to performance in the quarter was increased demand for the company's nutritional therapies in the U.S., driven by a temporary market disruption for select nutritional products.

Sales for premixed injectable drugs also increased in the quarter, driven by recent launches and incremental pull-through of other premixed injectable products in our portfolio.

Moving to Surgical Care, which includes anesthesia and BioSurgery, total sales were $352 million, increasing 3% operationally. Performance in the quarter was fueled by strong U.S. growth for anesthesia and critical care products, driven by increased sales of BREVIBLOC, a fast-acting IV beta-blocker, and Transderm SCOP. We did experience a slight benefit in the quarter as the alternate supplier for Transderm SCOP returned to the market a bit later than expected.

Globally, BioSurgery sales slightly declined during the quarter. Mid-single-digit growth of [pore] hemostats and sealants was more than offset by the impact from lower sales of non-core products such as Peri-Strips and Actifuse.

Finally, in Hospital Products, sales in our other category were $110 million, declining 10%.

Growth in the quarter was impacted by lower demand for our contract manufacturing services in our Bloomington, Indiana facility and lower manufacturing service revenues from Shire.

Turning to our Renal business. Sales were $968 million, up 3% operationally. Sales in the quarter benefited from solid sales of peritoneal dialysis and acute renal care products.

The in-center hemodialysis business advanced low single digits globally, driven by strong sales in the U.S., partially offset by lower sales internationally.

The acute business delivered mid-single-digit growth globally in the quarter, driven by increased sales internationally. Growth in the U.S. slowed in the quarter given the difficult year-over-year comparison, as sales in Q2 2016 benefited from a temporary market disruption for continuous renal replacement solutions. We expect growth in this business to return to double digits in the back half of the year.

Walking through the rest of the P&L. Adjusted gross margin of 45.2% represents an improvement of 140 basis points over the prior year, driven by improved pricing in select areas of the portfolio, favorable manufacturing performance and a benefit from our business transformation efforts aimed at simplifying the portfolio to drive efficiency and reduce costs.

Adjusted SG&A totaled $603 million, decreasing 9% on a reported basis. The primary driver of the improvement was our ongoing focus on effectively managing our expense base to eliminate costs and reduce inefficiencies.

Transition service agreement total income totaled approximately $16 million in the quarter, a reduction of approximately $10 million compared to the second quarter of 2016. We expect transition service income to total approximately $20 million in the second half of 2017.

Adjusted R&D spending in the quarter of $155 million increased 3% versus the prior year. This reflects our stated intention to increase investments in R&D to drive innovation and augment top line growth.

Adjusted operating margin in the quarter was 16.1%, an improvement of 380 basis points versus the prior year. Operating margin compared favorably to our expectations, driven by improved gross margin and disciplined expense management.

Net interest expense was $13 million in the quarter, as was adjusted other income, which totaled $13 million in the quarter. This reflected a benefit from foreign exchange gains on balance sheet positions.

The adjusted tax rate was 16.9% for the quarter, which reflects a benefit from the new stock compensation guidance, along with select discrete items.

And as previously mentioned, adjusted earnings of $0.63 per diluted share exceeded our guidance of $0.55 to $0.57 per share, driven by operational strength, other income benefit and a lower tax expense.

During the second quarter, we repurchased approximately $45 million or approximately 750,000 in shares. These targeted repurchases were more than offset by option-related dilution.

Before turning to our updated outlook, I will provide some commentary regarding our cash flow performance. On a year-to-date basis, we've generated free cash flow of $488 million, an improvement of more than $400 million versus the prior year, driven by strong operational performance and lower capital expenditures, along with continued focus on improving the company's working capital performance.

Of particular note, we ended the quarter with DSO of 53 days and days payable of 52 days.

Let me conclude my comments this morning by providing an update on our outlook for 2017 and 2020. Starting with 2017, we expect full year sales to increase approximately 3% on a reported basis and approximately 4% on a constant currency basis. And after adjusting for the U.S. cyclophosphamide impact, select strategic product exits and removing the benefit from the proposed Claris acquisition, we expect underlying operational growth of approximately 5%. All 3 of these sales ranges represent an increase from our prior guidance.

This growth reflects approximately $55 million in incremental sales from the Claris acquisition, which as Joe said, we expect to close imminently.

We now expect growth in the Hospital Products business of 4% to 5% on a constant-currency basis and 5% to 6% operationally.

Within Hospital Products, we now expect Fluid Systems constant currency sales growth of 5% to 6% and 7% to 8% on an operational basis.

For the Integrated Pharmacy Solutions business, we expect constant currency sales growth of 4% to 5%. We expect full year sales for cyclophosphamide of approximately $160 million as compared to our previous guidance of $135 million. Our updated assumption is that additional competitors will enter the market during the fourth quarter of 2017.

And as I just mentioned, we anticipate that Claris will add approximately $55 million of revenues to IPS.

Operationally, IPS sales are expected to increase 4% to 5%.

Within Surgical Care, we now anticipate sales to grow approximately 4% on a constant-currency basis and 4% to 5% operationally.

And finally, for the Hospital Products business, we now expect bps and other to increase low single digits.

For the Renal business, we expect full year constant currency sales to increase approximately 3% and growth of approximately 4% operationally.

Moving down the P&L. We now expect an adjusted operating margin of approximately 15.5% to 16%.

We expect net interest expense to total approximately $60 million and other income of approximately $20 million for 2017.

For the year, we now expect an average adjusted tax rate of approximately 19.5%. For full year 2017, we anticipate a diluted average share count of approximately 555 million shares.

Based on these factors, we now expect 2017 adjusted earnings, excluding special items, of $2.34 to $2.40 per diluted share.

Finally, for the year, we are increasing our outlook and now expect to generate operating cash flow of approximately $1.8 billion and free cash flow of approximately $1.1 billion.

Specific to the third quarter of 2017, we expect sales growth to increase approximately 4% on a reported basis and increase approximately 5% on a constant-currency basis.

Operationally, sales in the third quarter are expected to increase approximately 6%.

Claris is expected to contribute approximately $20 million in sales to the third quarter.

And we expect adjusted earnings, excluding special items, of $0.58 to $0.60 per diluted share.

Before opening up the call to Q&A, I'd like to expand a bit on our updated longer-term financial outlook. Since we provided our updated projections last May, we've been very focused on opportunities for improvement. Our solid operational performance to date has positioned us well for continued success.

As Joe stated, we expect sales growth of 4% compounded annually. While our sales outlook has not changed, I do want to point out a couple of factors. Top line performance in 2016 came in better than we had projected in May of 2016, and the guidance provided last year did not incorporate the select strategic exits we undertook this year. These 2 factors offset the expected benefit from the Claris acquisition.

In addition, as we approach 2020, we expect sales growth to be north of 4% on an annual basis, as we benefit from the actions we've taken to optimize the portfolio and drive increased productivity from our pipeline investments.

The adjusted operating margin of 20% compares favorably to previous guidance of 17% to 18% and reflects continued momentum from our business transformation efforts as well as improved manufacturing performance.

In 2020, we expect adjusted EPS of $3.25 to $3.40 per share, representing a mid-teens increase from the prior guidance of $2.75 to $3.00 per share. Our EPS outlook does not assume any meaningful share repurchases. We've only modeled repurchases to offset dilution, holding our share count flat to 2017 levels.

In addition, we've not included any additional meaningful business development initiatives beyond the Claris acquisition in these projections.

For me, one of the most important numbers Joe mentioned earlier is our increased cash flow outlook. We expect to generate more than $2.6 billion in operating cash flow by 2020. We will further reduce CapEx spending, which is expected to be less than 6% of sales by 2020, resulting in free cash flow improving approximately $250 million to approximately $2 billion in 2020.

And to rephrase my earlier comment, this is an unlevered view of our business. It does not reflect any meaningful deployment of the balance sheet other than the repurchase of shares to offset dilution.

Similar to our previous guidance, this plan was built from the bottoms up. We're pleased with this update. But as always, we'll look for ways to enhance this performance. And 2020, by no means, represents the peak, but rather just another step in our journey.

We expect to host an Investor Day during the second quarter of 2018, where we will provide a review of our business strategies, product pipeline, innovation, along with a more extended financial outlook.

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

(Operator Instructions) I would like to remind everyone that the call is being recorded, and the digital replay will be available on the Baxter International's website for 60 days at www.baxter.com. And our first question comes from Vijay Kumar of Evercore ISI.

So maybe up, one on the LRP. And I'm curious, the revenue outlook of 4%, that wasn't changed. I mean, just given the underlying momentum we're seeing in the business, I'm curious why that was maintained. And does the LRP contemplate any increase in gross margins?

Sure, Vijay. Thanks for the question.

So just commenting on your second question first with respect to gross margin performance over the LRP. In the last -- in last year's iteration of our financial projections, we shared an operating margin of roughly 17% to 18%. We've increased that to 20% in our current look at 2020. But to decompose the 17% to 18%, we were really in the range of 44% to 45% on a gross margin standpoint. R&D was roughly 5%, and then SG&A was 22%. As we move to this year's LRP, there are a number of areas of improvement. One of the biggest relates to gross margin, where we now expect roughly a 46% gross margin in 2020.

There are a number of contributing factors to this. I said in the past, I've been very pleased with the manufacturing performance under the leadership of Scott Pleau. That team has been incredibly focused on driving cost savings and improvements in the manufacturing network. So we expect to see some of that. But on the gross margin line, we'll also benefit from mix as we move forward, as we did exit some lower-margin sales; and then furthermore, as we look at the inclusion of Claris in our projections.

To complete the picture, R&D is basically unchanged versus the prior iteration, and SG&A improves another 100 basis points, again driven by continued and relentless focus on cost. So that's really the picture from a margin standpoint.

As it relates to sales projections, yes, I think it's safe to say we've been very pleased with the sales performance of our business, right? And as we look at the LRP, really the biggest changes for us are a couple of fold. One, we've included Claris. So the IPS business now will grow faster than we previously expected, but then we did exit certain strategic lower-margin sales areas. And so we do have an impact on Fluid Systems and on the Renal business. Those business growths are down a little bit from the prior version of the LRP.

So as we sit here today, obviously we're looking to accelerate wherever possible. And in fact, Joe's comments and my comments around innovation, as we look over long term, we're looking to accelerate the pace of innovation and pull forward where possible. But as we sit here today, we feel comfortable with the 4%.

Absolutely. And then, just one follow-up, guys, on just maybe the guidance for the current fiscal. You look at the one half versus second half mix, the last couple of years, it's somewhere in 40%, 45% in one half versus 55% to 60% in second half. I know you have a number of items hitting you in the back half, including the PSA transition. The guidance basically implies the mix is more 50-50 this year. Can you just walk us through that, Jay?

Certainly. We would normally expect to see an uptick in the second-half EPS just based on natural business trends, and that's something that we've seen over the last several years.

There are several factors that we have to be mindful of. First of all, transition service income. We expect Shire to wind down their need for our services. And right now, that's a $0.03 headwind, first half to second half.

Secondly, we did -- from a cyclo performance standpoint, we have roughly $0.04 of deterioration -- $0.03 to $0.04 of deterioration, first half to second half. Third, we are going to be accelerating some R&D investments. I think these are very strategic and important. And as we get to your first question in relation to how do we accelerate sales growth, it's very much about pulling forward timelines as much as possible, something our team is really focused on. R&D ticks up roughly $0.03 in the second half of the year.

And then finally, the way the tax rate works with the benefits related to FAS 123R, typically, those benefits are concentrated in the first half of the year. And so we do see the tax rate ticking up $0.03 to $0.04. And finally, we have other income and interest, which is $0.01 -- or there's a $0.01 impact in the second half of the year. So as we look at the first half to the second half, there are roughly $0.14 to $0.15 of headwinds, as we analyze it, that we fight through to give the guidance that we've shared with you today.

And our next question comes from Mike Weinstein of JPMorgan.

Maybe I can sneak in 2 questions here. So one, can you talk about the Claris accretion to your 2020 guidance with what the expected EPS contribution would be? And then second, I just want to make sure I'm reading the capital allocation slide correctly on the dividend. So is the assumption that the dividend payout ratio is still 35% or something below that?

Yes. From a Claris standpoint, we expect roughly $0.05 of accretion in 2020, a little bit north of that. And then from a dividend payout ratio, our expectation is to maintain, over the long term, this targeted payout ratio of 35% of adjusted net income. As you know...

And then, Joe, we just want to get your kind of latest thoughts on business development. On the last quarter call, we talked about the potential for larger acquisitions. And then it felt, I think, to The Street as if the likelihood of larger transactions may be diminished over the course of the quarter. So can you just give us your latest read on kind of what's out there? And what's the likelihood of different sizes occurring?

Sure, Mike. Just augmenting Jay's previous answer on Claris, we're giving this guidance on Claris for 2020. As Claris is to-date, Claris for Baxter is the foundation of getting us to a significant number of molecules in other areas. So when we speak about Claris itself, as Claris as it is today, is it transitions over there, there's a significant amount of investment that we're going to be making in new molecules, that will be adding to the pharmaceutical business of Baxter, which we plan to be much bigger than just Claris.

On the business development, we have a significant capacity in our balance sheet, organic and inorganic, meaning we are generating a significant amount of cash. I think Jay has spoken about our conversion ratio as really good. It's one of the best I've seen. The team has done a great job. So our natural generation of cash, plus what we can borrow, put us in a very good position. So what is the difference between where I am right now and a big acquisition and several tuck-ins that we'll get to the value that we had spoken last quarter, but in a different way?

Clearly, there is scarcity of large targets, as we all know, so -- and also, when you look into the financials and how that works with the company, you have an inherited risk pertinence to these kinds of transactions. They're much greater than several smaller transactions. So as we look at how to pursue our inorganic pathway here, first of all, put a strong team in place. And I just brought my old team back, almost the whole team back from my old job into Baxter. And that team will be now responsible for M&A.

The second thing is that, for me, it doesn't matter. If you do a large deal, it's going to take us a while to digest, and will probably take us a while to continue down the path of further acquisitions versus these smaller deals. So as we evaluate both, we have -- we're open for both. It's not that one is losing to the other, it's what are the opportunities that we'll return to our shareholders what we want the shareholders to have.

Remember, we want internal rate of returns that are significant above our weighted average cost of capital, in the double digits. We want ROIC 3 to 5 years to have now close to the company average. So we have put some limits in how we're going to use our shareholders' money. The other alternative that we have, we have said that money is not going to burn a hole in our pocket. So if we do have excess cash, we will buy shares back at our discretion, when we think it's the most effective way of doing so.

We're opening both channels. And we can do both at the same time, because of the amount of cash that we have. So as we pursue diligently and with significant amount of grit, our M&A path, we also will be returning money to the shareholders in terms of shares buyback. So I want to leave those channels open. And size of acquisition is less important than the strategic fit of those companies within our portfolio.

And our next question comes from Matthew Taylor of Barclays.

So I wanted to follow up on some of the thoughts on the Claris accretion, and maybe just spin this into a discussion around how you think the mix could improve with your injectable initiatives in general. Could you give us some thoughts on the different partnerships that you have, Claris and in your internal programs? And what you think the margin structure of that business could look like over the course of the LRP? Because as you know, not all injectable businesses are created equal.

Yes. We feel that we have 3 pathways here. We had our internal programs, which I thought were good, but not at all sufficient. Those were good molecules. Our internal program, when we first arrived at Baxter, were related to things that are difficult to create a solution to stabilize. We're looking at our GALAXY technology in Round Lake, Illinois to make them, and our pace was one of not great speed, okay? So that program could only -- would not get us where we want.

Claris adds a piece of the puzzle, which is the ability to do the filling operations and packaging, also the procurement of APIs -- the manufacturing of APIs in a very cost-effective way with good quality product.

We are expanding now with the ScinoPharm and as well as the result of partnerships to be able to get more volume of molecules. But this is not volume of $1 million molecules. We're looking at molecules that are more relevant to the portfolio, therefore creating good accretion to the gross margin.

If you think about this business, this is a business with a low SG&A. So it's all about gross margin here. And gross margins is providing the market with effective supply chain that creates a cost advantage for us in the market and for the customer. So with 45%, and Jay said 46% by 2020, we feel this business has a bigger capacity to deliver on the gross margin, but more so, Matt, is down the P&L with very low SG&A, okay?

So we are actively, actively pursuing more partnerships and with all kinds of different companies either for distribution of the drug, for augmentation of portfolio, for the design of this generics, which is the case of hard-to-make oncolytics with ScinoPharm, or just capacity to develop the API and the formulation with Dorizoe. So it's all in a -- when you put together, it is a business -- it's a core growth business for us, which is the definition is, has better gross margin, better growth rates, change to vector of growth and also impacts our operating income and our EPS.

Some helpful perspective. And I just wanted to follow up on the Fluid Systems business. That continues to perform very well. I know you've been saying it kind of gets the trophy every quarter for best performing business. And I just wanted to understand some of the dynamics there between, I guess, the competitive environment and share gains, how you're doing on pricing and some of the pull-through. Maybe you could touch on those things to understand how much longer you can continue to grow above-market like this.

Well, if you think about the fluids business in general, we came back to the market with an effective pump strategy. We have probably 22%, 22.5%, 23% market share in pumps, and where we are today, and I'm talking about the U.S. per se. So let's focus on the U.S., as the Fluids business outside the U.S. has completely different characteristics and profit profile.

So the pumps in the U.S. is the SIGMA SPECTRUM. We have a nice momentum on product development. We're going to be launching the new revised version of SIGMA with our programmable functions and other features next year. And then we have a pathway all the way to a new platform not too far in the future. That is the foundation of creating momentum in terms of our fluids business.

The fluids themselves is all about capacity and quality. And right now, I feel confident that we're working very hard in both fronts. So we have product availability as much as we can. We're augmenting capacity. We're validating new lines in our North America planned footprint. So the ability to provide product to the market at a higher rate is one that will determine in the future our ability to continue to grow.

Remember, those products are not sold in the spot market. Those are created through contracts, and those are long-term contracts. So as long as Baxter has the capability to continue to provide those long-term contracts, where price escalation's built in. Second, we have invested in the right capacity, meaning when I say right capacity, it's capacity in the right places, and we are. And we maintain the quality required by the FDA. We will be -- continue to deliver on this business.

Clearly, there is a point where there is a reduction in growth just by the sheer volume of products that we make. We're #1 in the market in terms of solutions. So we expect this business to taper off a little bit in growth, but our expectation is, as we continue to augment capacity, we continue to gain market share. And I think this is something that our team here in North America is doing a significant amount of work and will continue on to be able to provide products to our customers.

And our next question comes from Larry Biegelsen of Wells Fargo.

Let me start with the 2020 margin -- operating margin target. Could you talk about how you thought about that target in 2020? Is there some conservatism baked in? Is there room for further expansion beyond the 20% in 2020 -- beyond 2020, I'm talking about? And how should we think about the path to 20%? Should we think about it linear between 2017 and 2020? And I did have one follow-up.

Okay. Larry, thanks for the question.

Overall, from a margin standpoint, the first comment I would make is, we do not believe that 20% is the peak. In fact, as we share our guidance in May of next year, we'll extend beyond 2020. And you heard Joe make some earlier comments about businesses like our injectables business. There's incredible excitement around that, in part because of the higher margin those businesses carry than the Baxter corporate average. So as we move from 2020 to beyond, we start to get lift from mix and innovation, really, really accelerating and helping the margin improvement.

In terms of how we develop the target, is it conservative or not, it's the same methodology that we've used over the last 3 years for developing our long-range financial planning commitments. Specifically, we have programs earmarked from a bottoms-up standpoint that sum totaled to 20%. In the past, I've talked with investors about outside-in and comparing to competitors and using that as a basis. But for us, we've never done that. We've always done bottoms-up initiative-by-initiative. And so we know exactly how we are going to get from where we are today, 15.5% to 16%, to the 2020 target of 20%. And in fact, as we leave this call, Joe and I will be going to a zero-based budgeting meeting, where we'll be reviewing many of the savings initiatives that support this 2020 objective.

As far as the linearity of this, I don't want to get into guidance discussions for 2018 at this point. What I will tell you is, it is not like there's 300 basis points of an improvement in a particular year. It is fairly balanced. But again, I'll stop short of giving annual targets for margin improvement.

That was, I guess, on the guidance. My follow-up question was just on the 4% CAGR. What's the -- on this revenue. What's the definition of that? It includes Claris, but it doesn't include other business development. And I did hear you say, Jay, that you expect -- or it may have been Joe, accelerating above 4% as you come to 2020. My question was going to be around how to think about 2018. Anything different from 2017? Should we be thinking about it in a similar way? Not sure if you're willing to kind of give us some of the puts and takes at this point.

Larry, the way we think about the top line is the following.

Our weighted average market growth rate, our WAMGR, is about 3%, okay? So we have a 4% plan, which is significant amount of new product launches, geographic expansion, things you put an end to grow above market, primarily in our growth categories, okay, as we outlined in our presentations in the past, we call core growth.

When you look at how to get to 5% is basically execution excellence on those initiatives and derisking those initiatives. So the more we derisk our initiatives, the more we fill our bullpen of new opportunities. We can possibly get to 5%. It's a stretch. It's not easy, and I'm not saying we're going to get there, but we have a lot of Baxter people probably listening to this call. We are getting ready to get there, because we're executing. We're doing everything we can.

We brought good people from the outside, with excellent people from inside. We're mixing our teams with very good execution people. So we have a possibility to get there. But right now, we feel that with what we have on the table, 4% is adequate for our shareholders to model our growth going forward, but we are working hard to get to 5%.

And our next question comes from David Lewis of Morgan Stanley.

Just two questions, one short and one longer term. Jay, maybe you for the short-term question. If I think about the second quarter and back half of the year from an organic growth perspective, so momentum slowed a little bit in the second quarter, but your guidance implies a fairly material acceleration in organic growth into the third quarter. And then you have the easy comp in the fourth quarter. So I think about the 5% guidance at the top end, it looks like if you can do the third quarter, frankly, you would more than do that in the fourth quarter. So can you just help us understand the acceleration into the third quarter, and how you think the third quarter will play out in terms of your back half of the year growth guidance?

Sure. One important point relates to Claris. And so as we think about the growth rate for the third quarter, there is some benefit from Claris, roughly $15 million, in the third quarter -- or actually, is it $15 million or $20 million...

$20 million...

$20 million, sorry. $20 million in the third quarter. So that's one item.

As far as other areas, there is some acceleration outside the U.S. And part of the business outside the U.S. relates to tenders. And so as we look at some of our regions, our CEMEA region, our Asia Pacific region, we do see a sequential growth from Q2 to Q3 based on the timing of tenders, which is a little bit different than we've seen in prior quarters and years. So really, that is one of the factors that drives this acceleration into the third quarter. And then, of course, we had a solid Q4 last year. So that factors into our math.

Okay, that's helpful. But can you sustain those levels, sorry, Jay, into the fourth quarter? Because then the comp gets a little easier. But is this -- it just feels like whatever you deliver in the third quarter should be able to do consistent growth in the fourth quarter, just based on the easier comparable.

Well, again, we also have cyclo, which tails off a little bit in the fourth quarter. So that's a factor as we look at pure constant currency growth. So that's another element to consider.

I think that as we look at the second-half growth, we feel confident in our ability to achieve it. There are some nuances between Q3 and Q4 related to timing of tenders, performance in Q4, cyclo. But on balance, I think it's consistent with what we've expected. And like I said, we feel confident in our ability to deliver it.

Okay. And then 2 long-term questions. First, Jay, I'll start with you and then finish with Joe. So Jay, I don't know if we didn't get an EBITDA margin guidance update on this call. I think you initially had said 24% to 25%. Obviously, the EBIT margins are fantastic. So if you think about EBITDA in 2020, just given the tremendous improvements you've had on CapEx and the impacts on depreciation, how do we think about EBITDA guidance in 2020?

And then for Joe, I think all these questions about organic growth from the call are trying to get to sort of one question, which is, if you can do 6% operationally in the third quarter, are you really saying you're going to see some deceleration in the business intermediate-term before you get acceleration into '19 and '20? Or are we just making more of this than we should be, and these numbers may be a little conservative?

So let me start with my -- with your question, and Jay will talk to you about EBITDA.

A lot of the growth on a quarter-to-quarter basis is about comps from the previous quarter. We need to look at sequential and we also need to look at sustainability. So we feel comfortable with the long term being 4% because we look at how our programs are being factored into the growth, and also the tenders that we have. Remember, we have a steady business in terms of the products that we sell. And if we are out of a tender, we're out of a tender. This is the issue that we had in Europe in the last 18 months is that we are out of some tenders because we didn't want to bid. When we get back in, it guarantees the business for the longer term.

So I feel comfortable that we are -- that the 6% is to be delivered in the quarter. But going forward, we want to make sure that we are at about a 4% level. This is because we are looking at more sequential growth and sustainable growth. We will have quarters that have higher growth and lower growth, like we just had this quarter, because of discontinuation of business. But in the meantime, we want to have that 4% there and target 5%.

The delivery of our second half, we would not be giving guidance today and affirming the numbers if we couldn't do it. I'm confident about our ability to deliver on that as we speak today. However, that should not be something that the analysts should be thinking about for us going forward, okay? Because it is quarter-by-quarter, we look at more the long term.

So the 4%, David, may have had an acceleration towards the end of the period that we provide you guidance with the 2020. We'll have an acceleration, so we can make that number happen based on the numbers for '18 and based on the discontinued products that we have.

I just want to also tell that -- say that this number, organically, is completely unlevered. But we continue to pursue tuck-in acquisitions that will help us on an inorganic side for the next 12 months, but also that will bring pipeline into the company and will help us with the organic going forward. So it is a combination. But right today, we're sticking to the 4%.

David, the EBITDA margin in 2020 is approximately 26%.

And our next question comes from Isaac Ro of Goldman Sachs.

First question on the long-term guidance. I was just trying to go through some of the moving parts that were yet uncovered, and one was on share count. I just want to confirm that you're assuming that you believe perhaps enough share repurchase to offset option solution, but not assuming that there'll be a meaningful net reduction in share count through 2020. Is that sort of the right way to think about it?

That's exactly right. In our model, and we have held share count flat to 2017 levels. And underlying that is an assumption about a certain amount of buyback. But the result of that, given the very strong cash flow generation of the company, is a serious positive net debt or net asset position as we look at cash relative to gross debt.

Right, great. That's what I was getting at. And then a follow-up on just a couple of the product specifics. BioSurgery, you guys mentioned a slight decline there, but I think you've also talked a little bit about how your pretty strong pipeline is in 2018. So I'm just trying to handicap how we should take about the recovery to growth. Is it going to be sort of a sharper inflection towards this time next year? Or could we see an improvement sooner than that?

So we have a significant amount of activity going on at the end of this year and into '18 for BioSurgery. What is affecting us today is the performance of the Synovus acquisition products that were made by the company a few years ago. Those are products that are legacy. They have very little improvement to those products to be made. And what we are focusing on, our hemostat sealants base business of Baxter, which just in one category, just the FLOSEAL alone is growing 7%, okay? So that is good growth there.

So for us to return to a market growth rate, this is what we expect to do in 2018, okay? And then we will look forward to some augmentation inorganically speaking into that business, that will help us deliver more pipeline and some adjacencies into the surgery business.

I'm quite confident in the delivery of these new products. They're not home runs. They're singles and doubles. But just reignite the innovation that the company has not delivered in the past years and just the new management into that business is really -- is stealing the innovation part quite a bit. That's why we're having so many things happening next year. We have launched of new forms of FLOSEAL, new applicators, new geographic expansions. So we'll get back into this game in a good way and beginning to see that transformations '18 in terms of getting to market growth.

And our next question comes from Bob Hopkins of Bank of America.

So just 2 quick things, because a lot of questions have been asked. Joe, I was wondering if you could talk a little bit more about some of the leadership changes that you're referring to on this call just in terms of kind of when they happen and maybe a little bit more on the folks that you're bringing into the company. And then I have one quick one for Jay to follow up.

Yes. Bob, we had an organization that was -- had the international businesses all concentrated under one person. When this person retired, it was an opportunity for us to really take a look and say, "I don't like to concentrate 60% of our business with very different profiles under just one person."

So bringing Americas under Brik, a very experienced leader within Baxter; and Cristiano Franzi, who worked with me before; and Andy Frye, who comes from a large distributor in Asia, and before that Abbott, will give us a great execution lever to focus on those regions instead of just have one person looking at everything but the U.S. It's just a philosophy and a proven theory that I have that when you divide the world in the right regions, you have people focused on those regions, not only the top line, but also the EPS per region.

The other -- Sumant is a great technology and research and development leader, comes here to the company with significant experience, as we have ambitions to continue to grow our pharmaceutical business. Sumant brings a wealth of knowledge and experience into this area. And I think The Street's familiar with him, and he worked for Hospira before and then Pfizer. We're really excited about that.

And Giuseppe moving up to have a global role in terms of managing our product franchise in terms of innovation as well as upstream marketing, and working closely with our M&A group to make sure that we have the right inorganic opportunities in place makes this team pretty strong. On top of it, we brought Dennis Crowley, who used to work for me before in M&A. Dennis really brings a strong background in acquisitions with him. There are a couple more team members that came to Baxter. So we're [augment] to what we need. You never say you're finished. There's no finishing line when you manage a company, but we think today that we confidently have a strong team amongst our peers.

Great, that's helpful. And then just to finish, Jay, previously, in your LRP, you gave specifics on 2018 and 2020 for top line growth. And we've talked a lot about top line growth here, but I'm just curious if maybe you could talk a little bit more about the cadence of operational revenue growth over the course of the LRP. And you've mentioned growing above 4% in 2020. Is there a more specific target for 2020 that you'd be willing to disclose here? And I guess, just a question on cadence.

Yes. Again, for us, the relevant number is the 4% over the period. As we approach the back part of this long-range plan horizon, you start to see the impact of innovation. And annual rates ticking the 20% rate is a little bit above the 4%. And then as we look at 2018, there are a few different factors in play that impact that. You have the full -- a annualization or some part of your benefit from Claris, but you also have an assumption around cyclo competition that we will be taking. And then also the impact of innovation in 2018 is not as great as it is in the latter part of this plan period. So a number of different factors; we'll stop short, again, today of giving annual revenue guidance because, again, there's a lot of puts and takes as we approach 2018.

And our next question comes from Joanne Wuensch of BMO Capital Markets.

Briefly, could you please give us an idea of how the cyclophosphamide competition you expect will be annualizing over the next couple of years? You briefly mentioned the impact in '18, but you have a better line of sight on the competition than we do.

By 2020, we have a fairly small cyclo business. So we expect this winding down very significantly from the current level to a 2020 number. And that occurs -- starts to occur at the end of 2018 -- or 2017 as a result of incremental competition onboarding. But I will tell you, this is one that we have frankly been surprised by over the last several years. The level -- the number of competitive entrants has been fewer than we originally modeled in 2015 than we modeled again in 2016. So it's best for us to keep watching this one.

We'll provide an update on cyclo guidance on our January earnings call certainly and, again, as we approach the balance of this year and next quarter's call. But it's hard to say what's ultimately going to happen. What I can tell you is we have a fair amount of competition that's assumed by 2020 with a fairly de minimis business left in cyclo at that point.

That's helpful. And as my follow-up question, there's no doubt you have a lot of cash that you can deploy, and yet I feel like investors are waiting for you to do so. What does it take internally for you to pull that trigger? What kind of conversation does it -- has to happen?

We have a lot of conversations. What it takes is to have the right strategic target.

You've got to make sure that you are returning money to the shareholders. You can't just make an acquisition and think that internal rate of return of 7% is good enough. Maybe it's good enough for a few investors, for the majority of investors that is below our long-term WACC, and that is not something that I responsibly will do.

We'll select the right targets, we are doing that as we speak, a significant amount of work. But I said to you, we're going to deliver value no matter what, either through acquisitions and as well through share buybacks. So I feel comfortable, both ends of the scale. We didn't discard large acquisitions at all, we are just going now after everything that we can look at that makes sense for Baxter, okay?

With a better team in place, we're looking at a much more agile process to get to our targets and as well as the amount of balance sheet capital that we have today, the ability to raise capital in our organic way to get there. We will return money to the shareholders. So it's a win-win because we have 2 good avenues, and we can do both at the same time.

And our final question comes from the line of Danielle Antalffy of Leerink Partners.

Jay, I was hoping you could give a little bit more color on what's driving the average -- the increase in EPS guidance. How much of that is coming from FX in the back half of the year versus Claris, versus better operational performance. And then I had one follow-up.

Sure. The prior guidance, the midpoint of the range was roughly $2.24. And as we think about the current midpoint, it moves to $2.37. There's a few drivers. The overperformance that we experienced in Q2 contributes roughly $0.07. The tax rate -- improvements in tax is roughly $0.03. Cyclophosphamide is a couple of pennies of impact. FX is $0.01, and Claris is $0.01. So if you add those up, it's roughly $0.14 versus the midpoint of the last guidance range. About half of that speaks to the Q2 performance, with the residual relating to other aspects of the business.

Okay, that's helpful. And then my follow-up is on long-term perspectives. Some of the higher profile pipeline products, specifically the on-demand PD product, just wondering how you see products like that coming into play and driving that 4% CAGR through 2020. I mean, how do we think about the on-demand PD product for your Renal business? Is that something that takes penetration, in your view, from 12% to 14% in the U.S. today to some number significantly higher? Is it more a pricing play? How do we think about that impacting the Renal business and how much that contributes to your long-term guidance?

You're welcome.

Our on-demand product is on track. We are -- we see this as excess to PD. We have modeled the penetration and how you're going to behave in the marketplace. I think it's a little too early for us to give you that information as we're starting our clinical trials, I know, next year. And we'll be having this product on the market probably by 2020, once the clinical trial is finished.

The plans that I've seen, I've seen a rapid succession of improvements to the product, which makes me very happy in terms of R&D agility and continue to improve the product as it launches. Our philosophy today versus the old one is, we launch products faster with possibility of improvement as we go along to provide more value to the customer instead of getting and waiting for the optimal product with the most features to come out, because what we find is highly featured products are not the way forward for an efficient health care system.

So we want to make sure that we have in the product what is needed, and not what all the features that we could engineer and put into the product. So we are confident that this product is going to do a few things for us. One is increase the penetration of PD for the ease-of-use. Not everybody would like to receive a palliative product every month.

The second thing is a product that eventually can customize a solution concentration. This is not how we're coming out known to the market with, but it's eventually you can get there.

Thirdly is also cost savings for the company in terms of the logistics costs of moving fluid around. So -- but we're factoring that alongside our AMIA introduction, which happened last year. So what happens is a sequential of innovation for PD. And our end objective is to make sure that as many patients that can receive PD are receiving PD in their homes. That's our main objective, because we know the therapy is equally efficient as HD, but also provide a better life experience for the patient, who then can work during the day and do -- be productive during the day.

So we are a little too early to give you the numbers. When we are ready, when we're close to the end of the clinical trial, we'll have more numbers in terms of penetration and how we're going to do this introduction. But we're very confident in talking to the FDA. The FDA is working with us, very interested, as a matter of fact, how they can help move this technology forward. Thank you.

Thank you. And that concludes our question-and-answer session for today. Ladies and gentlemen, this does conclude today's conference with Baxter International. Thank you for participating, and have a great day.