百特醫療 (BAX) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Baxter International's Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded by Baxter and is copyrighted materials. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objection, 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 and welcome to our fourth quarter 2017 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer.

On the call this morning, we will be discussing Baxter's fourth quarter 2017 financial results, along with our financial outlook for 2018. As a reminder, we have posted a supplemental presentation to complement this morning's discussion. This presentation, along with the related non-GAAP reconciliations, can be accessed on Baxter's external website in the Investors section under Events & Presentations.

As previously mentioned, we've reorganized our commercial structure to boost performance, optimize costs, increase speed in the decision-making process and drive improved accountability across Baxter. To that end, we will be modifying how we report our quarterly financial sales and segment analysis. This new structure will reflect the current makeup of our commercial operation. And while we recognize these changes will impact your models, we believe this presentation will provide you with more granularity regarding our top line performance by global business units and regions.

To aid you in this transition, this morning, we posted reclassified sales schedules for the global businesses for the last 3 years, inclusive of 2017. These schedules can be found in the Investors section of baxter.com. The regional segment structure will be included in our 10-K filing with the SEC.

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

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

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

Good morning and thanks for joining us today. I will start with a brief look at our fourth quarter performance, then I will share some thoughts on 2017 as a whole and how we are well positioned to sustain this momentum into 2018 and beyond. Jay will then take a closer look at our 2017 financials and outlook for 2018. We'll close with Q&A.

Baxter finished the year with another solid quarter, delivering fourth quarter sales growth of 5% on a reported basis, 3% on a constant currency basis and 2% operationally. Operational sales are adjusted for the impact of foreign exchange, generic competition for U.S. cyclophosphamide, the Claris acquisition and the previously communicated selected strategic product exits the company has undertaken.

On the bottom line, adjusted earnings per share were $0.64, up 12% year-over-year, driven by strong operational performance, the ongoing impact of our business transformation efforts and a lower tax rate. This performance more than offset the impact in the quarter from Hurricane Maria, which reduced our results by approximately $70 million on the top line and approximately $0.06 on the bottom line.

For full year 2017, Baxter achieved top line growth of 4% on a reported and constant currency basis and 5% operationally. Adjusted income from continuing operations of $2.48 per diluted share, an increase of 27% and free cash flow of more than $1.2 billion.

Before we discuss some key highlights for 2017, I wanted to take a moment to update you on our operations in Puerto Rico. We've been intently focused on addressing the supply situation in U.S. in the aftermath of the hurricane and the challenging impact it has had on our customers. Our primary goal, as always, is to ensure we can address the needs of patients and healthcare providers, and we have mobilized accordingly.

All of our Puerto Rico facilities are now connected to the electrical grid, and we've been ramping up production to pre-hurricane levels. Our expectation is that we'll be able to return to more normal supply levels over the coming weeks. And as such, we expect the residual sales impact of approximately $25 million in the first quarter of 2018.

In a related matter, as you are likely aware, an aggressive flu season in U.S. coupled with industry-wide supply challenges has heightened demand for Baxter's large volume IV solutions, which we produce outside of Puerto Rico. As I mentioned on our last earnings call, we have received permanent FDA approval to import large volume IV solutions from our plant in Cuernavaca, Mexico, to help address increased demands from our customers and potentially serve new customers in the future.

Now turning to some 2017 highlights. The Claris acquisition represents an important example of our commitment to enhancing our portfolio and pipeline in our core growth businesses like generic injectable pharmaceuticals. We are rapidly integrating the Claris team, bringing this operations fully online with Baxter's quality systems and looking forward to continued momentum and commercial growth over the long term.

And earlier this year, we announced an agreement to acquire 2 hemostat and sealant products from Mallinckrodt, RECOTHROM and PREVELEAK, both compelling proposed additions to our advanced surgical portfolio.

From an R&D perspective, we entered into some promising partnerships designed to augment our portfolio and potentially lead to transformative patient care technologies. Our organic R&D pipeline is also advancing with several high potential developments. In the U.S. market, we received FDA guidance clarifying the regulatory pathway for new home-based peritoneal dialysis or PD solution generation system that may allow even more patients to experience the benefits of home therapy. And we have initiated U.S. clinical trials of HDx therapy enabled by THERANOVA, a Baxter technology now available in many global markets that is designed to closely mimic the natural kidney through a clearance of certain molecules during dialysis.

Outside the U.S., we begin to limit launch of PrisMAX, our latest technology advanced for acute care therapies in Europe. We anticipate full European launch later this year. Also in acute therapies, we launched a label expansion for oXIRIS blood purification set in select markets outside the U.S. This marks the first 3-in-1 set for use in continuous renal replacement therapies or CRRT in sepsis management protocols.

We continue to advance customer focus enhancements for high-value technologies across our core portfolio, including our AK 98 hemodialysis system, our FLOSEAL and TISSEEL hemostatic agents and the SIGMA SPECTRUM infusion system. In 2017, also marked the 1 million PD treatment using our proprietary SHARESOURCE telemedicine technology. SHARESOURCE is foundational rather to the success of our newest automated PD cyclers, AMIA in the U.S. and HOMECHOICE CLARIA in international markets.

Last week, we announced FDA approval of Bivalirudin, using Baxter's proprietary frozen GALAXY container technology, making it the first and only presentation of this generic cardiovascular injectable in a convenient frozen premixed solution.

This internal and external investments designed to accelerate future growth are balanced, along with our commitment to return significant value to our shareholders. To this end, during 2017, we increased our annual dividend rate by 23%, while also repurchasing more than $560 million worth of shares.

Overall, we are energized by what we accomplished for our stakeholders in 2017. And it has all been made possible by our 47,000 employees globally, who are absolutely committed to our mission and the success of our transformation.

As we look to our expectations for 2018, increased operational efficiency remains essential, and we will continue to identify opportunities to improve operating leverage. At the same time, we are intensely focused on accelerating top line performance. We know by enhancing our product mix, we can drive sustainable gross margin improvement for the company. As such, we will continue to ramp up our emphasis on new product innovation and business developments for this objective. We look forward to updating you on these strategic initiatives, particularly many of our existing and exciting pipeline programs at our upcoming investor conference on May 21 in New York City.

In summary, while we have a lot of hard work ahead, as we continue to position for the future, I'm confident that we are up to the task.

Now I'll pass it to Jay for a deeper dive on fourth quarter performance and outlook for 2018.

Thanks, Joe, and good morning, everyone. As Joe mentioned, we're pleased with our fourth quarter results, which represented a strong finish to a great year. I'll start by discussing our fourth quarter and full year 2017 results before providing our financial outlook for 2018.

Beginning with the fourth quarter. Sales increased 5% on a reported basis, 3% at constant currency and 2% on an operational basis. Key growth drivers for the quarter included continued momentum across our U.S. Fluid Systems and Renal businesses as well as strength internationally in Nutrition and increased demand for our cytotoxic contract manufacturing services. As previously mentioned, disruptions to our Puerto Rico manufacturing facilities negatively impacted fourth quarter sales by approximately $70 million.

On the bottom line, adjusted earnings increased 12% to $0.64 per diluted share. This exceeded our previous guidance of $0.56 to $0.59 per share driven by operational performance, disciplined management of expenses and a modest benefit from foreign exchange gains on balance sheet positions.

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

Global sales for Hospital Products were $1.7 billion, advancing 1% operationally. Breaking this out by business, sales in Fluid Systems were $632 million, up 2% operationally. Performance was driven by strength for large volume IV solutions and IV access sets in the U.S. Growth in the quarter was offset by lower sales internationally and the impact from Hurricane Maria.

Integrated Pharmacy Solutions or IPS. Sales were $602 million, flat to prior year on an operational basis. Sales growth in the quarter was negatively impacted by $56 million from Hurricane Maria, which offset increased sales of our premixed injectable drug in the U.S. and parenteral nutrition therapies internationally as well as strength in our hospital pharmacy compounding business. Sales of U.S. cyclo were $43 million in the quarter and Claris contributed $30 million globally.

Moving to surgical care, which includes anesthesia and advanced surgery. Total sales were $363 million, increasing 3% operationally. Growth in the quarter benefited from increased sales in inhaled anesthetics internationally and U.S. sales of BREVIBLOC. Also contributing to performance was growth in advanced surgery of 3%. Sequentially, advanced surgery grew 5% as we are beginning to recognize many of the actions we have implemented to improve performance in this business.

Fourth quarter surgical care growth was impacted by lower sales of Transderm Scop as a result of increased competition.

Finally, in Hospital Products, sales in our other category were $108 million, increasing 1%, driven by favorable demand for the company's cytotoxic manufacturing services.

Turning to our Renal business. Sales were approximately $1.1 billion, up 4% operationally. Sales in the quarter benefited from solid performance across all lines of the business. Chronic renal therapies, inclusive of PD, in center HD and renal therapy services, rose 3% globally. And our acute renal therapies business delivered high single-digit growth globally, driven by balanced growth in the U.S. and internationally.

Walking through the rest of the P&L. Our adjusted gross margin of 44.3% declined 20 basis points over the prior year. Operational expansion due to positive mix, select pricing and business transformation initiatives was more than offset by the impact from lost sales due to Hurricane Maria and a negative impact from foreign exchange.

Adjusted SG&A totaled $628 million, increasing 2% on a reported basis, but declining 1% on a constant currency basis. The positive contribution from our relentless focus on effectively managing our expense base was offset by lower transition service agreement income from Shire and more than a 2-percentage-point contribution from foreign exchange.

Adjusted R&D spending in the quarter of $182 million increased 20% versus prior year, reflecting our stated intention to accelerate investments in our core growth businesses. Growth in the quarter also reflect the timing of some milestone payments to partners. Foreign exchange contributed 5 percentage points to growth in the quarter.

Adjusted operating margin in the quarter was 15.1%, a decline of 30 basis points versus the prior year. Strong operational performance in the quarter was more than offset by the loss of transition service income, foreign exchange and the impact of Hurricane Maria.

Net interest expense was $14 million in the quarter. Adjusted other income totaled $24 million in the quarter primarily reflecting a benefit from foreign exchange gains on balance sheet positions. The adjusted tax rate was 17.7% for the quarter, which reflects approximately $8 million of benefit from the new stock compensation guidance. And as previously mentioned, adjusted earnings of $0.64 per diluted share exceeded our guidance of $0.56 to $0.59 per share, driven by operational strength, expense savings and a gain on foreign exchange balance sheet positions.

During the fourth quarter, we repurchased approximately $290 million or approximately 4.5 million shares. These repurchases were somewhat offset by option-related dilution.

Now turning to full year 2017. Sales increased 4% on a reported basis, 4% at constant currency and 5% on an operational basis. On the bottom line, adjusted earnings increased 27% to $2.48 per diluted share, driven by operational strength, the ongoing benefit from our business transformation efforts and a favorable tax rate.

Moving quickly through the rest of the P&L. Our adjusted gross margin of 44.8% increased by 90 basis points over the prior year, reflecting favorable product mix, improved pricing in select areas of the portfolio and manufacturing efficiencies. Adjusted SG&A totaled approximately $2.4 billion, decreasing by 4%. And adjusted R&D spending totaled $617 million, an increase of 9% versus the prior year. Adjusted operating margin for the year was 16%, a 240-basis-point increase versus the prior year and at the high end of our expectations.

Net interest expense was $55 million and adjusted other income totaled $47 million. The full year adjusted tax rate was 18%, which included the benefit of approximately $56 million related to new stock compensation guidance. And finally, adjusted earnings of $2.48 per diluted share exceeded our guidance of $2.40 to $2.43.

Before turning to our 2018 outlook, I will provide some commentary regarding our cash flow performance. On a full year basis, we've generated free cash flow of more than $1.2 billion, an improvement of more than $300 million versus the prior year. Growth was driven by underlying operational performance and lower CapEx, along with a continued focus on improving the company's working capital performance.

Let me conclude my comments this morning by providing our guidance for the first quarter and full year 2018. As previously mentioned, we have updated our external sales reporting structure, and I will provide guidance consistent with this new format.

Globally, we expect 2018 full year sales to increase between 6% to 7% on a reported basis, with approximately 4% on both a constant currency basis and an operational basis. I would like to point out some key assumptions reflected in our full year sales outlook, which include: approximately 250 basis points of favorable foreign exchange contribution; approximately $25 million of negative sales impact from Hurricane Maria in the first quarter; approximately $145 million in Claris sales as compared to $57 million in 2017; full year U.S. cyclophosphamide sales of approximately $95 million versus $185 million in 2017.

We have, for the most part, anniversaried the select strategic product exits we have undertaken. And while we will continue to optimize the portfolio, we will no longer be adjusting sales for these exits.

And finally, this guidance does not include any contribution from the 2 hemostat and sealant products from Mallinckrodt. We continue to expect this transaction to close in the first half of the year.

In terms of our new external reporting structure, we will no longer be classifying sales by the 2 segments of Hospital Products and Renal. Sales will now be broken down into 6 global businesses. And the segments analysis we provide will be reported by our 3 regions: Americas; EMEA, Europe, Middle East and Africa; and Asia Pacific. As Clare mentioned, we have posted schedules on our website reclassifying sales into the new global business unit structure.

Sales guidance is being provided in the new structure on a constant currency basis. Starting with renal care, which includes our peritoneal dialysis, in-center hemodialysis and renal therapy services, we expect growth of 3% to 4%.

Our next global business, medication delivery, which includes infusion systems, large and small volume IV solutions and our reconstitution products such as Mini-Bag Plus, we expect sales in this area to grow 6% to 7%.

The Pharmaceutical business, which includes our broad generic injectables portfolio, anesthesia and critical care products and our hospital pharmacy compounding services conducted outside the U.S. Performance in this business is expected to be flat to 2017, given some sales we recognized in 2017 that are not expected to repeat in 2018, along with increased competition for select products.

Moving to our next global business, Nutrition, which was previously part of Integrated Pharmacy Solutions, we expect sales growth of 4% to 5%. For our advanced surgery business, we expect sales to increase 3% to 4%. For the acute therapies business, we anticipate growth of 8% to 9%, similar to 2017 levels.

Finally, in the other business, which primarily includes our contract manufacturing services, we expect low single-digit declines as 2017 sales benefited from a customer stockpile order, and we're projecting, also, lower manufacturing revenues from Shire.

Moving down the P&L. We anticipate adjusted operating margin expansion of 80 to 100 basis points. We expect net interest expense to total between $65 million to $70 million and adjusted other income between $50 million and $60 million for 2018.

For the year, we expect an average adjusted tax rate of approximately 19.5%. The tax rate reflects approximately a 1-percentage-point benefit from the new U.S. tax reform legislation and a lower benefit from stock compensation.

For full year 2018, we anticipate a diluted average share count of approximately 550 million shares. This reflects the benefit of certain ongoing share repurchases. Based on these factors, we expect 2018 adjusted earnings, excluding special items, of $2.72 to $2.80 per diluted share.

Finally, for the year, we expect to generate operating cash flow of approximately $2.1 billion. We expect CapEx of approximately $700 million. And as a result, we anticipate free cash flow of approximately $1.4 billion.

Specific to the first quarter of 2018, we expect sales growth of 5% to 6% on a reported basis and 1% to 2% on a constant currency basis. Operationally, sales in the first quarter are expected to be flat to up 1%. And we expect adjusted earnings, excluding special items, of $0.60 to $0.62 per diluted share.

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

(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. And our first question comes from Mike Weinstein of JPMorgan.

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

Mike, we -- your method is not totally incorrect, but there's a caveat to it. The cyclophosphamide is a huge reduction, close to $100 million reduction year-over-year. We expect the new entrants -- as we don't have a crystal ball, but we have our best intelligence, so we are estimating that we're going to have 1 or 2 entrants in 2018. And that is one of the reasons by which we have a significant reduction in the EPS on a run-rate basis. We're compensating that with other things such as Claris and also we had a onetime reduction in the -- like you noted, Hurricane Maria provides a positive momentum in 2018 versus '17. But the biggest difference is the $100 million in cyclophosphamide.

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

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

Sure. So going back to the theme of capital allocation, I think Jay described pretty accurately our ability to do all of those things together. Our intention is to look at our businesses on an adjacency basis and do those incremental deals at a higher volume and velocity, meaning more of them and a little faster as we continue to refine our M&A group. Our M&A group is now complete. We have our strategy group in place. We have a pretty well-defined boundaries where we want to go. And I never take no, never considered that large acquisitions are completely off the table. They are just difficult to come by, and they are much more difficult today to get decent returns on those. But we -- as we look opportunistic in many different things, our focus on M&A and the strategy are the adjacencies. We're going to continue to do that. But we can do the 3 things that we plan -- we have planned all along. We continue to buy shares, we're going to continue to pay the dividends and increase dividends every year like we have done in the past and do these smaller deals or deals which are complementary in higher volume and velocity.

Joe, last question, I'll drop here. I don't want to get through all the different businesses and the guidance for 2018 is relative to our expectations. But there weren't too many surprises. I thought that you're probably being a bit conservative in advanced surgery given the product flow there and the R&D you've been putting to work so I'd love to hear your thoughts on that. And as well, maybe the same comment on the renal side, where there's a lot going on in really all 3 or 4 different parts of that business.

Thank you, Mike. I have to think that we are good forecasters of our business. And this is the beginning of the year. We always have the ability to -- for the most part, to do what we say we're going to do. So when we give a number to the Street, it's something we have confidence that we can achieve. Clearly, the year always holds surprises. We had a huge one with hurricane season. But the company had enough in the bank to be able to provide for the results that we did. I would say that we have good growth in most of our businesses, and we are -- continue to do geographic expansion product launches. So the ability to kind of exceed what we have is our ability directly related to execution on the new products in second half of the year when we come in with a new pump version for SIGMA SPECTRUM or launch of our new peritoneal dialysis automated device in Japan and geographic expansion. So if we can execute on those things, everything goes right, we'll let you guys know, and we will change our outlook for the year. But at the moment, that's what we see with a significant amount of puts and takes including cyclophosphamide.

And our next question comes from Larry Keusch of Raymond James.

Just wanted to quickly start off on IV solutions. I know that you made the comments that you expect to be back in -- I think, more normalized supply in the U.S. over the coming weeks. What gets you there? Is it a combination of the ability to import and Puerto Rico continuing to ramp up? And then if you could sort of segment that between large-volume IVs and Mini-Bags?

Larry, good morning. We're going to split the conversation into 2 pieces. The piece that got affected by the hurricane is a Small Volume Parenteral that we call the SVP. Those are we call Mini-Bags, Mini-Bag Plus. And prefilled bags in small amounts for nutrition amino acids, dual chamber bags and other things like that. So we have 2 different distinctive situations. Let me talk about the small parenteral bags. We are producing at a pretty good clip at our plants in Puerto Rico. We supplemented that production with volume that is coming from Ireland, our Castlebar facility, and we'll continue to make progress. And we think by the end of the first quarter, the production -- rather not production, but inventory levels will be at a place that we can put this behind us. As we speak today, the allocation that we put out is 100%. So people can buy Mini-Bags and Mini-Bags Plus today, we just changed that, at a 100% of the average purchasing volume of 6 months ago, okay? And we will get this completely normalized by the end of the first quarter, probably earlier than that, okay? So we also had contingency plans, which will put towards the end of '18, mid '19, more capacity for Mini-Bag Plus for 2 reasons. One is we have the ability to sell as much as we make, is better for the market and more profitable for Baxter. So we're shifting the mix to benefit all the stakeholders, including ourselves in terms of profitability. The second part of the conversation is the large volume parenteral. That has nothing to do with the hurricane, that has to do with increased demand and inability of some of the manufacturers in the marketplace to make the product. We obtained permanent importation licenses and product registration from Mexico. We walk away from some of the business that we had in Mexico, which can be taken over by a local competitor and is moving their volume permanently to the U.S. The second thing is, yesterday, we just got approval from importation permits for Brazil. So now the product is going to be coming into the U.S. So by the end of this next 6 months, we will have a network of global factories that cost-effectively can bring products into the U.S. in any situation even to guarantee future contracts with our current customers and potential new customers.

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

Japan, the first opportunity for us is to capitalize in a tremendously underpenetrated peritoneal dialysis business. Japan has a very, very, very rich reimbursement for PD, and we make significant amount of profit from that modality. But the volume compared to the rest of the world is quite small. So by launching the new Kaguya cycler in Japan, we'll be able to satisfy some of the market needs, for instance, it's more the connectivity of the tubing in this machine is done automatically hands-free. So there's some peculiarities that Japan requires to adopt technologies different. We, as a company, have done not a great job in Japan once we separate from Baxalta because Baxalta was a bulk of the business in Japan. And our business now will focus on augmentation of the PD, launching new advanced surgery products in Japan as well as augmenting the pharmaceutical capabilities in Japan. So this is a more of a long-term road map, but I tell you, that is one that has our focus. Andy Frye now is the President for Asia. Japan falls under him, and we have significant plans for talent improvement to be able to get those things there.

And our next question comes from Vijay Kumar of Evercore ISI.

So maybe, Jay, on the Q1 guidance -- on the revenue guidance. So some of the questions I'm getting is, if sequentially, you had capacity coming back from Puerto Rico, right? Was this guide a little bit tad below? Or what was the Street mismodeling on some of the line items?

Yes, just a couple of things to point out in relation to Q1 sales growth, which, to your point, Vijay, is below the run rate we expect for the balance of the year. Solid operational performance, but Puerto Rico does impact us by 1 point of growth. And then the other comment I would make is, last year, we had a bolus of sales related to a product called Transderm Scop. And year-over-year, that's about a 1% headwind. So those 2 items collectively dragged down the growth a little bit below what we expect moving forward. The other thing that happens as we approach the latter part of the year is we start to benefit from some of the new product launches. Joe mentioned Kaguya. We are also extremely excited about the Version 9 Spectrum pump, which we anticipate launching towards the first -- end of the first half of the year. So that starts to benefit and accelerate some growth. So 2 very specific items and then certain benefit from new products is really the story on Q1 relative to rest of the year sales guidance.

That's helpful. Jay, just a couple of quick guidance follow-ups. One on the segment details. This is extremely helpful, the historical numbers you gave out. But on medication delivery, right, so if capacity is coming back from Mexico repurposing capacity, right? So if I'm looking at that year-on-year, it looks like flattish to maybe up slightly. So one, are we fair to assume this guidance of 6% to 7% from med delivery does not assume incremental share gains? And I have one follow up on the free cash.

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

Just one on free cash, Jay, and apologies for the extra question. The free cash guidance so that's a -- call it, double-digit growth for '17. But if we're looking at the 2020 targets of $2 billion, so that assumes free cash accelerates back to high teens. Was there any timing impact for '18 when you look at the free cash number?

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

And our next question comes from Matt Taylor of Barclays.

The first question I wanted to ask was just around the injectables outlook and Claris. I guess, you gave us a number for Claris. I was hoping maybe you could supplement that with some color on what you're expecting from your internal program? And maybe any update on the Claris 483 unit and how you're doing with remediation there?

We are -- continue to pursue the internal development. We are launching a coronary drug, just got approved. We have other drugs planned to be launched here, either frozen or non-frozen, they're made by GALAXY. We continue to launch products outside Claris -- outside the U.S. for Claris. And the 483 is quite simply, we have done to date everything that we said we were going to do. We're still not finished. We have a couple more things to do, but we're still in the timeline and some of the things we're doing we're ahead of time of our time line. We are optimistic of what we're doing is going to resolve the issue outlined in the 483, but we are not the agency, so we cannot speak on behalf of the agency. We do everything we can to satisfy what we said to the agency we are going to do, and we feel comfortable that we are doing that. Now versus with the FDA to make that determination, but we are working very hard and we have integrated significant amount of quality systems into the Baxter quality systems. And if you went to the facility today, you would see a very significant amount of physical improvement in things that we've done to correct issues that we personally, as a company, have found and some that the FDA has found on top of our findings.

And I want to give you a chance to -- without biasing you, maybe talk about some of the tailwinds from a product standpoint in 2018 and specifically, would like to hear from you products that you think could make a difference that you believe are underappreciated by investors?

I'll focus on 3 or 4 areas. First of all, I think our ability to provide the market with LVPs and SVPs add the volumes that the market not only needs, but potentially has competitive -- going to competitive accounts is a potential upside. We don't know if that's going to materialize the competitive accounts, but we know that we now have solid factories being completely focused in the U.S. market. Baxter is the largest manufacturer of solutions in the world and having not used that capability in the past was a mistake. Now we are fully engaged in using this capability and flexibility across the globe. So that is a positive. I think the new pump -- the new version of our pump, SIGMA SPECTRUM, coming out now second half of the year is a good thing. The pump has really new features and new things that we think are needed in the marketplace and people waiting for it. So our ability to launch that well offers the possibility to be a positive for us. The third one is the launch of the Kaguya in Japan. I think that is a positive. And geographic expansion, lastly is, we're starting to get products approved. We just got one approved in China the other day. Actually, early this week. We just got a monitor, AK 98, approved in China for sale, way ahead of time. So our people are starting to work very diligently on new products to be able to get those things to augment our objective in the midterm, which is to get the company to a 5% top line growth.

And our next question comes from Danielle Antalffy of Leerink Partners.

Just to follow up, if I could, Jay. And I know you guys will provide more detail on this at the upcoming Analyst Day, so not trying to front run too much. But just at a high level, if you think about beyond 2018, and what in the pipeline -- and, Joe, maybe this is a question for you as well, what do you see is the key pipeline initiatives that are going to drive accelerating growth beyond the 4% operationally you're projecting in 2018? Number one. And then Jay, for you, number two, the incremental leverage you can pull on the P&L to drive positive leverage in the out years considering feels like a lot of low-hanging fruit might have already been picked here?

Yes, Danielle, I'll start by talking about the operating margin levers that we have and then, Joe, perhaps you can talk about some of the exciting pipeline products that start to accelerate growth as we move past 2018. And by the way, it's a bit premature to talk about '19 and '20 as we sit here on February 1 so at the risk of doing that. I think we are very pleased with the transformation efforts on the cost side. Danielle, your question is a good one because, to a large extent, we have taken a lot of low-hanging fruit and reflected that in our numbers over the last couple of years in terms of implementing zero-based budgeting, and certain other tactics that we've employed. As we look to 2019, '20 and beyond, there are certain more complicated or a bit more challenging programs that we have on the back office with respect to G&A. And perhaps it's better to say longer lead time items as we look to transform our back office to streamline shared service centers. We've made tremendous progress, our functions have done really amazing work. But our expectation all along is that those would not have an impact in 2016 or '17, but would start to play out as we are seeing in 2018 and then '19 and '20. So that's one area I would say. And then the other thing that's going to be very interesting as we move to 2019 and '20 is our manufacturing team has done a great job in terms of controlling costs. Now, obviously, that team has been very focused on responding to things like natural disasters and tight supply situation. So they've been very focused on that. But at the same time, they've been very focused on optimizing our manufacturing network and optimizing operations within our manufacturing network. And so moving to 2019 and '20, we continue to expect very solid performance coming out of that team, along with a restored supply situation. Now with respect to acceleration of growth on the top line and products that are going to drive that, Joe, maybe you could take that one.

Sure. Our midterm goal for the top line is 5%, okay? We're working very hard to get there. And to get there is the ability to launch those new products a little better than we have planned. And there is opportunities for that. So the first one, as I said, is optimization of the supply chain and having the right product in the right place in the U.S. I feel confident on that. The second is to launch the product in Japan, the Kaguya, the cycler in Japan. The third is geographic expansion, get this thing right. Fourth, the pump, the SIGMA SPECTRUM is half a deal. Remember, our medication delivery guidance for global growth is between 6% and 7% for 2018, which is pretty good growth, okay? Then let's look at a little bit more on the midterm. Let's talk about '19 and beyond. THERANOVA. THERANOVA is a game-changer in in-center HD. So having that thing, having the product completely approved in the U.S., have the clinical trials in and have the ability to drive adoption in the U.S. is key for us to continue to grow. Launching PrisMAX, which is our new acute renal care CRRT monitor in the U.S. will drive continuously more growth in the U.S. We are already market leaders in acute renal care with the CRRT modality. This is over $1 billion in market. We only have this modality, which is CRRT, Continuous Renal Replacement Therapy, has only 50% or less of the overall market. So the conversion is great. Also getting in other modalities in the acute renal care is a desire of ours. And please don't forget that some of these acquisitions that we're making will have organic impact in the company once they anniversary, meaning they have their own growth. We're not buying businesses that have 0% growth. So we're buying business, they have the ability like Claris, because 12%, 14% growth happen in 2018. So there is opportunity going forward. We're seeding the way to be able to get to 5%. And like Jay said, with a significant smaller cost base for the company to operate brings a very desirable formula to the table.

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

Just a couple of questions, Jay, and maybe one for Joe. Jay, just thinking about the pacing of 2018 numbers, thanks for the description of first quarter top line. Just on the bottom line, Jay, I think our math has 50 bps of margin maybe for the first quarter. Can you just talk about the factors impacting the bottom line for the first quarter? And then as you think about the third quarter, that's the other tough comp this year, should we also expect growth to be a little low in the third kind of similar to the first?

Yes. I think that in the first quarter, to your point, we're seeing the lowest level of sales growth of the year. And then also as we look at the bottom line, there are a number of factors in play that impact bottom line growth. The first one being Puerto Rico, that's a couple of cents of margin impact that we expect to see, and that's probably the most prominent. On the operating margin line, the Puerto Rico impact is roughly 40 basis points. Some of the others -- the TDS sales item, that does not really have a bottom line impact. So I would say that if you adjust for that, along with a tough TSA comp, which represents about a 50-basis-point impact in the first quarter, remember, we -- that ceases to be an issue for us in the second half of the year. Those 2 items really explain why the margin would be the lowest growth rate in the first quarter relative to the other quarters in the year, and we start to see acceleration there. So really, those are the 2 items explaining about roughly 1 point of the growth. As we look to the balance of the year, we do expect to see solid performance throughout. And so 2018, the third quarter does represent the tough sales comp. But importantly, we'll start to benefit from some of the new product launches, so the Version 9 of the Spectrum pump just starts to feature in our Q3 results. So I think that on balance, we feel quite good about the quarterly forecast. Q1, a little bit of a slower start, but again, that is entirely explained by things like Puerto Rico and TDS. And then as we move through the rest of the year, the story becomes consistent with the full year picture. The one item I would say in Q3, we do have a $20 million compounding settlement in our 2017 results, so we'll probably talk about that. But beyond that, I think it's fairly steady progress.

Jay, very clear. And Joe, just kind of 2 strategic questions for you. I guess, the first is, (inaudible) is this breaking out of these global business structures, it occurs to me that some of the businesses you're breaking out actually have dramatically faster end market growth rates. I mean, as you think about this new structure, are you starting to be of the view that the weighted average market growth rate for this business is frankly, closer to 5% relative to 4%?

I think, David, our weighted average market growth rate for the overall business is 3%, okay? But the ability to perform at 5% has to do with new product launches and the ability to focus, so hence, the organizational restructuring. We were not focused and not deploying capital some time ago to the right business despite the fact our intention was that. But the organization structure was not repaired. What is allowed us to do is twofold: get people paid on global growth for certain franchise; second, allow us to really put people in those business with more specialization, given Exemplar Pharmaceuticals, for instance. We have a big mount to climb with $100 million in headwind on cyclophosphamide. Now having execution on Claris and our own organic molecules is key. To do that, you've got to have people who understand the generic pharmaceutical businesses. This is not a hospital product. This is not the same people who will do design infusion lines and infusion pumps, it's completely different. So we brought and are bringing people who have the ability to bring this business to the next level. So this reflects more how we want to pay people, how we want people to focus and also to get to our 5% objective on the top line.

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

So I wanted to start with the operating margin guidance and the goal for 2020. I think of 28%, Jay. So this year, I think, you're guiding to 80 to 100 basis points of operating margin improvement. I guess, that implies that you'd need about 150 per year in '19 and '20 to reach the 28%. So why only 80 to 100 this year in that acceleration? I think earlier, in prior calls, I think there was an impression that you could do a little better than 28%. Do you still feel that you can exceed that number? And I had one follow up.

Yes, great. I'll talk about 2018. As far as 2020, we remain very confident in our ability to drive the business going forward. So I would insert a brief commercial for our May Investor Day, we look forward to updating our long-term financial projections for both 2020 and beyond, which the whole team is really excited about that. As it relates to 2018 guidance, there's actually 3 items that I think are worthwhile pointing out that provide some color because on the one hand, you could say, hey, it's 80 to 100 basis points, and that's what we expect, but there's 3 headwinds to point out. First, cyclophosphamide is approximately 70 basis points of impact in this year. So that's an assumption that we've made. We'll see. We'll monitor this very closely, but that's a very big drag on 2018 and frankly, as we look at margin performance over the next 3 years, we're modeling the largest single impact occurring in 2018. The second item is we have approximately 40 basis points of impact from TSA income loss. So again, that's an item that is explicit to 2018 that does not impact future years. The final thing I would comment on is we have adopted the new guidance for pension accounting. And what that means is a number of items have moved below the line, and there's certain items maintained above the line, and this will be spelled out in detail in our 10-K. But at the highest level, reflecting this guidance, it's about a 40-basis-point drag on our results in 2018. We'll footnote this and describe in a lot of detail like I say in our 10-K. There will also be some additional information available related to 2017 impact. But simply put, in our 80 to 100 basis points, there's 40 basis points of headwinds related to the new pension accounting. So as we think about what those drivers add up to, that's about 150 basis points of drag that we worked through this year on our way to achieving the 80 to 100 basis points of margin improvement. We don't expect similar magnitude, and so it becomes, we can be -- we can sit here confidently and say we feel very solid about 2019 and '20 performance.

That's very helpful. Just lastly for me. Joe, any update on emerging market performance?

Yes. We had pretty good performance in emerging markets. We got about 6.7%, close to 7% in emerging markets for the year. We also had China over 6%, which is great for us. I just want to underscore that emerging markets like medical devices qualify does not apply to Baxter. We've been in those markets for a long time. So China, for us, is a good growth market, has good GDP growth, and that represents an opportunity for us to geographically expand new product lines there as well as Brazil and Mexico, Colombia, I see those as probably the most prominent and then Southeast Asia. So we do emerging markets commentary on calls for actually you folks, the analysts. Internally, we have 3 different regions in the world; Americas, Europe and Asia, and we don't specifically monitor emerging markets anymore. We monitor specifically China, which we think is -- continued to perform well and is a very profitable large market for us. And if you qualify emerging markets like you speak, it's about 22% of our overall sales. So it's very much larger than for many of our peers. So that's why we don't focus on that. Thank you.

And our final question comes from the line of Joanne Wuensch of BMO Capital Markets.

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

We are projecting low single digits for hospital procedures and admissions in general. That's what we see in our -- when we connect the dots of our businesses. We also see a renewed interest in the capital investment from hospitals, at least one of the large hospital not-for-profit groups announced that they will revitalize plans for investment, and that is good for the market. And we see also, in general, consumption at a stable to slightly positive level. So it is, altogether, a unique situation for the country, for the U.S., specifically where we see the healthcare markets reacting well to new tax legislation and so forth. The flu season is clearly picking up a significant amount of steam. It's already high for all accounts. And there's some -- there's always a slight positive impact because a couple of our businesses and products are used for situations where the patient is in ICU with a distress and multiorgan failure. So there is a big cap for our business when there is a good flu season. Flu season is all-time high.

Okay. And then a follow-up, a more specific question. Every year, I feel like we start off with a relatively high cyclo competition headwind and then winnow it down throughout the year. Why is the $100 million the right number for 2018?

Because we do model quite extensively and very precisely the impact of 1 entrant, 2 entrants, 3 entrants, 4 entrants. We do this because as a matter of fact, we are, sometimes on the other hand, we're coming in as the second or the third entrant, so we know what the number is. So we have modeled, based on the number of applications out there for cyclophosphamide that, that is the impact. Now if people can't pull through, they don't have the regulatory capability, clearly, there's an upside for Baxter, and you guys we'll let you know as we give updates to our quarterly forecast and update guidance if we see that there's no entrant, we'll update and increase that if that's the case. As I always say, we're very transparent about cyclophosphamide, and it's always a positive for the company because more cash in our pocket. And it's a drug that is proven to many, not that easy to make. Cytotoxic drugs are very difficult to make, and Baxter has a state-of-the-art facility that is not only used by us, but used by many different pharmaceutical companies because of the difficulty of doing it. So the desire to do it is not -- that doesn't relate to the ability to do it and recently one potential manufacturer got 2 warning letters in their facility in India so they'll probably put a stop on their ability to produce. But there are others out there than we have modeled. So if they come to the market, we estimate it very precisely $100 million of impact.

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