Baxter International Inc. (BAX) Q2 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and welcome to Baxter International's Second Quarter 2019 Earnings Conference Call. Your lines will remain in a listen-only mode until the question-and-answer segment of today's call. [Operator Instructions] As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time.I would now like to turn the call over to Ms. Clare Trachtman, Vice President, Investor Relations at Baxter International. Ms. Trachtman, you may begin.

Thanks, Candace. Good morning, and welcome to our second quarter 2019 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer.On the call this morning, we will be discussing Baxter's second quarter 2019 financial results and our updated financial outlook for full-year 2019. A supplemental presentation to complement this morning's discussion can be accessed on our website. This presentation, along with related non-GAAP reconciliations, can also be accessed on Baxter's external website in the Investors section under Events & News.With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development, and regulatory matters contain forward-looking statements that involve risks and uncertainties and, of course, our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause results to differ materially.In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and is available on our website. On the call this morning, we will be discussing operational sales growth, which adjust for the impact of foreign exchange and generic competition for cyclophosphamide in the U.S.Now, I'd like to turn the call over to Joe.

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

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

Thank you. [Operator Instructions] And our first question comes from David Lewis from Morgan Stanley. Your line is now open.

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

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

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

Sure. With respect to our biosurgery business, yes, we did comment on some upside that we experienced in the second quarter. We don’t like to forecast competitor outages, so we don’t maintain long-term assumptions on that. However, if we have very clear visibility to a short-term situation emerging, we will reflect that in our guidance. So, as we think about advanced surgery, there is roughly two months of upside that we’re counting on in our numbers as we sit here today. So, we’ll expect that to continue for a couple of months. If it continues further than that, of course, we will be available to supply our customers, but we’re not counting on anything more than that.We’ve talked previously about how exciting the insulin-Myxredlin launch is. It’s a new presentation of our workforce product for hospitals absolutely thrilled, the size of the market is significant, it’s over a $100 million market, I mean hospitals in the U.S. So, this represents a very viable long-term opportunity for us. As it relates to this year’s guidance, we have single digit millions built-in basically nothing built into our guidance at this point. In large part, we want to be cautious in terms of launch timing, preparing, and having adequate supply available when we actually go to market. So, no meaningful impact this year, but stay tuned as we give guidance for 2020. This will have a more meaningful impact in those numbers.

Thanks so much, nice quarter.

Thank you.

Thank you. And our next question comes for Robbie Marcus from JPMorgan. Your line is now open.

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

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

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

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

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

Thank you.

Thank you. And our next question comes from Bob Hopkins from Bank of America. Your line is now open.

Thank you and good morning.

Good morning.

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

Well, if you think about our long-range plan, when you give a five-year plan, you always going to have put and takes and how you are going to make things happen, okay. You have the best intentions in the world, you have the best plans in the world, not everything works same way on the positive side or negative side. For instance, we didn’t plan to have our insulin product premixed approved as early as we did, we planned actually to have that approval towards the end of the year. That’s a plus for us, but other things worked the other way as well. So, when I look at the major forces that we have going on right now, you have a tremendous momentum in our peritoneal dialysis business. So, you know, just in terms of patient growth, we are experiencing a healthy growth in terms of patient.We don’t even have the executive order from the White House coming in and becoming a rule and there will be a transformation for the renal business, but just that, we experienced high-single-digit growth in patients in PD. So, that has an effect to our plan to offset many, many negatives that can appear in the future. So, I figured this moment that between everything that is happening in the market and the things that happened in Baxter that we can sit here and say well, we told you last year, we reconfirmed today, okay.

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

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

Great. Thanks very much.

Thank you. And our next question comes from Joanne Wuensch from BMO Capital Market. Your line is now open.

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

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

Sure. We have to the best of our ability scoped our project. Based on the interpretation of the executive order that we have, okay. And that is not final rule yet, and the comments will be complete in about 50 days, and after that the HHS has time to put the rule in place. So, based on what we know and interpreted from the executive order, we have a three-phase investment here. We have an investment where we can supply the market with the growth studies projected in the beginning, because this is the progress, remember this addresses the best market about 50% of the overall served market and then from that 50% there is a ramp, there is a period where clinics are given an opportunity to change their patterns between clinic, hemodialysis, and home therapy.So, based on that we can accommodate with some supply chain that we did extremely well about a year-and-a-half ago by relocating and reregistering products from all over the Americas so we can do that. Then there is a second phase where we do a small investment, more modest than – part of the 500, they give us incremental capacity all the way [indiscernible] starting to invest into a new plant. The investment will be, depends upon the time, sometimes concurrently done, but the effect of the throughput will be felt later – in later years. Remember, this is a seven-year program. So, we feel, as company, our responsibility, moral responsibility to our customers and more so to the patients is to be there for this opportunity. So, we’re going to make everything possible to not be a problem during the ramp up that is so aggressively laid out in the executive order.

Thank you.

Thanks, Joanne.

Thank you. And our next question comes from Vijay Kumar from Evercore ISI. Your line is now open.

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

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

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

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

Thank you, guys.

Thanks, Vijay.

And our next question comes from Lawrence Biegelsen of Wells Fargo. Your line is now open.

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

Larry, the opportunities that we’re having are mostly, mostly related to the strength of our version 9 of our pump. Its operability, it’s our drug library, so we have customers who have been our customers for a long time and start with them to renew their like – innovation and evolution of the product and they just buy it. There's always opportunity when there is a problem with a competitor in the market. If that problem is perceived to be more permanent than temporary, so we need to think about, as we look at our Advanced Surgery business, that is going to be a – probably a temporary gain until the competitor comes back on the market, and because our product is so good, the FLOSEAL is the best product on the market.There is opportunity to retake ups, right? So, the same applies for the infusion pumps. You know it depends upon how permanent, how temporary the issue is that competitors are having. But I think the success that we’ve been having is, first of all, a very good sales effort, new team completely focused on pipeline, second is the ability to demonstrate the technical superiority of our drug library, compared to the competitors. To your point on the new platform, no, there are customers who need the product now, they will take the product now.I just want to let you know that LVP, which is a large volume parenterals pump, which is what we have to-date, remember we don't have any other pump, that’s what we have today, the guts of the new pump, all are different, are more modern and will be a horizontal pump. But, but work flow, the drug library, all the features are the same, meaning you have a new product with phenomenal operability, but also has a great pumping mechanism in the new pump platform. We have a great pump mechanism today, Version 9, and the operability is the sane, so the customers have a lot to gain Baxter launches the other pumps, which are part of the same family, with the same interoperability.So, it will be a new platform on the market that has that capability and I think that customers can see that going forward. If they need the pump now, there’s nothing that they are losing on this current version versus the new platform for the large volume parenterals, but what we will bring into the market is not only syringe – patient, patient-controlled [indiscernible] PCA as well as in 12 months from the launch of their first one is ambulatory. So, I hope this answers the answer to your question and put our investor at easy that there is no business being postponed because we don't have the NTP today.

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

Great. We’re really pleased with the performance in the Asia-Pacific region, 9% growth coming – it was really strength across the board. You know we’ve grown a custom to solid performance coming from China in the quarter, you know, 7% plus growth from that particular business. But what perhaps has been more surprising based on historical commentary from Baxter is the fact that we had a tremendous performance in Japan, high single-digit growth coming from our Japanese business, and it’s really a combination of factors in play.Looking at the other areas, you know, solid performance in Southeast Asia, we’ve had a great business in Australia and New Zealand for the med. We’ve been there for many, many years, double-digit growth there, a lot of that benefiting from compounding. But what I will tell you is this is a combination of commercial execution along with the benefits of new product launches. We’ve talked quite a bit about the impact of Kaguya. We are seeing continued momentum in patient gains in Japan and this is, you know that’s a great driver for us. But I think across the region, there is examples of innovation, but like I said, commercial excellence that have really contributed to this performance. On a full-year basis, we’ll expect this to come down a little bit from a growth rate standpoint, but not materially. So, overall, you know, great performance from the team in Asia.

Thank you very much.

Thank you. And our next question comes from Kristen Stewart from Barclays. Your line is now open.

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

Hi, good morning. Our Pharmaceutical business is – our strategy is starting to take shape. It took a little bit. We have built a second-to-none formulation team between India and Northern Illinois, very talented vis-a-vis now our partnership to launch the insulin product, that's Med, and this is just the beginning of our very long pipeline. When it comes to Claris, or what we call [Baxter Metabot] we are doing everything that we have spoken to the FDA and have told the FDA we’re going to do. It’s up to the FDA to lift or to inspect us again, and provide us with their feedback, okay. But nevertheless, we are de-risking any Claris opportunity for future by having ultimate supplies for almost everything that we make there. And also, for the future molecules, we are de-risking that by going to CMOs instead and having Claris possibly as a backup in the future.There is one molecule that I won’t read – speak about, the name of the molecule, but that molecule we're developing in [Metabot], but also, we’re going to have a pilot operation in our Illinois facilities, so we can have possibly a backup. This is more of a longer term. So, we’re doing not only everything that we told the FDA we’re going to do remediate the one letter that was given to us the day that we bought the company, but also, we are doing everything we can to de-risk any future revenue stream. Now, the performance of the business is doing very well, its double-digit growth. That business is resilient, is doing well and is not only U.S., but is also in Europe, that is doing well. So, this is the state of our Pharmaceutical business.

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

We have done a couple of things. We accelerated the development and placed the molecules from the future that we think in any case we’ll be able to offset any negatives that will come out of a potential and I cannot actually rate likely or unlikely because I’m not the FDA. So right now, our plans are for 2021. If it happens, if we get the clearance and can commercialize products that are new on [file] from the plant, it will be great. We’ll follow our plan. If that has any postponement for whatever reason, we have backup plans that will probably not alter the trajectory of that business.

Thank you very much.

So, there is upside is that happens, if we are successful in 2021.

Candace, we have time for one more question.

Thank you. And our final question comes from the line of Matt Taylor from UBS. Your line is now open.

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

Matt, you think about this. If you read the executive order, is the significant amount of interpretations and things that buried in and that's why they have the comment and that’s why the rule is not there yet. But think about this today, we are 12% penetrated in PD in the United States. Remember this is our home, there’s three pillars to it. Two of them are interconnected, which is a transplantation process and number of available kidneys to be transplanted with a lot of incentives not only – in terms of healthcare insurance for donors and things like that all way to moving from the clinic to the home, two different modalities from human dialysis and PD. Baxter is a leader with close to 70% of the market share in PD on a global basis in U.S. around the same number, okay.So, if its 12% in the U.S. and there's a 50% population that is being targeted for demonstrating, if you look at the targets of the government, it’s not inconceivable to think about double patients just in the period of demonstration within the seven years of the demonstration period. So, it tells you that you would double the incident patients, not the prevalent, but the incident patients going forward. That’s how we have done some of our analysis, but our plans are flexible, so we can flex up the investment if we need to or flex down the investment because it’s progressive.There is Phase 1 with no investment, Phase 2 with some investment, Phase 3, which is to build a new plant, all of them will launch very similarly in time because they have different lead times for execution. But those are designed to support the program as it was designed, but as I said to you, if this rule comes out in November, we will have the ability to adjust our plans, but right now, we want to ensure that the government knows, our investor knows, our patients and customer know that we are committed to the program and we’ll do everything possible to help patients get the therapy that they deserve and for us as a company to grow in this sector, which is so important and has been so underestimated and underpenetrated for so many years, not only in the US, but across the globe.

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

Well, we are here waiting for decision from – actually not from HHS, but probably from between the HHS and the scoring process that happens at the budget office. So, we know as much as you do, but we are excited about the possibility and we have several different avenues to get Theranova in the U.S. Most importantly, we have agreed with the FDA on the novel process and this challenge that we have at our plant in the US will be timely resolved, and the plant – one of the issues that we had with the plant, we tried to ramp up the plat too fast because our dialysis volume went up between two different forecast, and when we tried to do the ramp up, we encountered some issues because the plant was underutilized at that moment. But with this, no, not all bad, few things good come out of it, and one of them is that we’re going to be fully staffed and equipped on our order lines plant in Opelika to be able to have the ability to produce Theranova when it’s needed.

Thank you very much.

Thanks, Matt.

Thanks, Matt.

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