Good morning, ladies and gentlemen, and welcome to Baxter International's Third Quarter 2015 Earnings Conference Call. [Operation 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, Stephanie. Good morning and welcome to our Third Quarter 2015 Earnings Conference Call. Joining me today are Bob Parkinson, CEO and Chairman of Baxter International. Jay Saccaro, Chief Financial Officer; and Scott Bohaboy, Corporate Vice President, Investor Relations, and Treasurer.

On the call this morning we will be discussing Baxter's Third Quarter Financial results and outlook for the remainder of 2015 before taking your questions.

Before we review our financial performance in the quarter, I'd like to mention that this morning we issued an 8-K detailing the 2014 and 2015 quarterly income statements for Baxter on a stand-alone non-GAAP basis.

Today's review of the results for the third quarter of 2015 and outlook for the remainder of the year will reflect comparisons to the 2014 ongoing baseline detailed in the 8-K filing.

With that let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product developments, and regulatory matters, contains forward-looking statements that involve risks and uncertainties.

And of course our actual results could differ materially from our current expectations. Please refer to today's press release and our SEC filings for more details concerning factors that could cause actual results to differ materially.

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

Now I'd like to turn the call over to Bob Parkinson.

Bob?.

Thank you, Clare. Good morning and thanks to all of you joining us. We're very pleased to report strong performance for the third quarter, our first as a stand-alone leading medical products company.

These results clearly demonstrate the momentum our organization has established following the spin-off of Baxalta, momentum upon which we will build to further accelerate profitable growth in the quarters and the years ahead.

As you saw in our press release this morning for the third quarter, Baxter delivered adjusted earnings of $0.41 per diluted share, significantly exceeding our guidance of $0.29 to $0.31 per diluted share. On a constant currency basis worldwide sales increased 2% and also exceeded our guidance.

After adjusting for foreign exchange and the impact of increased U.S. competition for cyclophosphamide, sales advanced 3%. Results in the quarter benefited from a favorable product mix, lower operating expenses, and other income resulting from foreign exchange related gains.

As you know at our – excuse me – at our May Investor Conference we outlined a number of initiatives focused on expanding margins and accelerating profitable growth. These measures are gaining traction, as evidenced by our strong third quarter performance.

While these are still early days, the initial results reinforce our confidence that we're clearly on the right path to achieve our financial objectives, which will create value for our shareholders, patients, employees, and other stakeholders.

And as we've repeatedly stated our aspiration remains to exceed the profitability targets that we had laid out at that Investor Conference.

As you'll recall we're executing a three-pronged strategy to accelerate profitable growth, focused on rebasing our cost structure, optimizing our existing products and services through rigorous portfolio management, and finally, expanding our offering of high valued differentiated products through execution of our robust new product pipeline.

I want to share a few highlights from the quarter in each of these areas to demonstrate the substantive progress that we're making on this journey. So let me start with cost structure.

Back in May we acknowledged the compelling need to rebase our structural cost to better align our expense base with the resource requirements of our new stand-alone enterprise. During the quarter we took an important step in this regard, initiating a global workforce reduction program, representing approximately 5% of all non-manufacturing payroll.

This action is expected to generate approximately $130 million in annual savings once complete and is one of the first that we've taken to address our cost structure. As we move forward, we'll continue to evaluate our support levels to ensure that they're appropriate.

In addition post separation we've implemented an array of expense controls targeting discretionary spending categories that will reduce our ongoing spend moving forward. Collectively, these actions will ensure that we enter 2016 with a leaner cost base that supports our new business profile and financial goals.

And I can assure you that our aggressive focus in this area will continue in the months to come, as we pursue additional opportunities to increase efficiency and reduce structural cost. The second area that we emphasized in May was successfully managing and optimizing our existing product portfolio to improve operating performance.

And as we've previously mentioned, we're taking a very disciplined approach with respect to our top line growth opportunities to ensure that they're aligned with our margin improvement objectives and deliver appropriate returns.

This year there have been certain international tenders that we have opted not to pursue, because they would not deliver benefits aligned with our profit improvement goals. More broadly we're applying this same discipline to each the product areas and geographies we serve.

And we'll evaluate our presence in select markets to ensure it's aligned with our targeted return profile. And going forward you can expect regular updates on the progress being made in this important area. We know emerging market performance has been the key topic of discussion for investors.

These geographies play an important role in our growth strategy. And while we're certainly not immune to the macro challenges in play, we're confident that the medically essential nature of our products, combined with the breadth of our portfolio, will continue to position Baxter well over the long-term, despite some near-term volatility.

During the quarter the company's emerging market sales rose mid-single digits on a constant currency basis, largely aligned with the long-term guidance that we provided in May. And finally, I want to highlight some key developments in our new product pipeline. Innovation has and will always remain a cornerstone of our success.

And we're committed to a future of ongoing advances in areas of clear medical need. Looking out over the months and years ahead, we'll launch a number of highly advanced new products, make significant life-cycle improvements to existing offerings, and expand penetration of our current products into new geographies.

Some of our recent achievements include FDA clearance for AMIA, our new automated peritoneal dialysis system with SHARESOURCE, our two-way web-based remote connectivity platform for home parents. AMIA is the only system approved in the U.S.

that incorporates innovative patient centric features, such as voice guidance, a touch screen control panel, and SHARESOURCE. SHARESOURCE provides physicians with the ability to remotely access their home patient's historical treatment data and deliver individual treatment settings.

We're initiating the launch of AMIA with SHARESOURCE and anticipate having units in the market before year end. Also the recently CE-marked HOMECHOICE CLARIA APD system is successfully launching in markets across Europe.

CLARIA builds on the strength of our market leading HOMECHOICE cycler, now incorporating advanced technology and the benefits of the SHARESOURCE web-based remote connectivity, among other patient- and other provider-centric enhancements.

Moving to our Hospital Products business, we continue to successfully expand the launch of our next generation SIGMA SPECTRUM infusion pump across the U.S., Canada, and Puerto Rico. Demand for the newly enhanced SPECTRUM technology remains strong and is trending better than our prelaunch expectations.

Also in the third quarter Hospital Products announced FDA approval of Cefazolin 2-gram injection in our proprietary GALAXY Container. Cefazolin has been on the FDA's drug shortage list and in a variety of presentations due to high demand. This is the first of nine molecules that Baxter is developing and expects to launch over the next several years.

And we recently submitted the second molecule for a review with the FDA and expect to launch this molecule in early 2016. As these highlights demonstrate we're making meaningful advances across our overall margin improvement framework, and this is only the start.

So with that let me now turn over to Jay for a closer look at the third quarter performance and also outlook for the remainder of the year. And then prior to taking your questions I'd like to take a moment to make some closing comments. So, Jay, please..

Thanks, Bob, and good morning everyone. As Bob mentioned, adjusted earnings in the second quarter of $0.41 per diluted share exceeded our previously issued guidance range of $0.29 to $0.31 per share.

Performance in the quarter benefited from the disciplined management of discretionary expenses, a favorable product mix, which included better than expected cyclophosphamide sales, and other income from foreign exchange related gains.

On a GAAP basis, income from continuing operations of $2 million included net after tax special items totaling $223 million or $0.41 per diluted share, primarily for costs associated with the company's spinoff of Baxalta, business optimization initiatives, debt extinguishment, and intangible asset amortization.

Before I walk you through the P&L I wanted to take a moment to make some comments regarding our historical financial statements, which we detailed this morning in our 8-K filing. First, I want to start by acknowledging your patience with respect to these statements.

Given the highly integrated nature of the BioScience and Medical Products businesses pre-spin, the preparation of the historical filings required significant time. Second, I wanted to highlight that these statements have inherent complexities associated with them when comparing current results with those of prior periods.

More specifically, for the most part prior periods do not reflect income we received from Baxalta related to transition service agreements and deferred country closings.

In addition given the highly integrated nature of our businesses, we were not able to clearly isolate select expense categories between Baxalta and Baxter in the discontinued operations presentation.

And lastly, the historical P&Ls included payroll expenses for certain positions initially determined as backfills for employees that transitioned to Baxalta. Upon further evaluation post-spin, some of these roles have since been eliminated and will not be replaced.

Investors should consider all of these factors when comparing Baxter's current results to historical periods. Now let me briefly walk you through the P&L by line item before turning to the financial outlook for the fourth quarter of 2015. Starting with sales, worldwide revenues of approximately $2.5 billion declined 8% on a reported basis.

On a constant currency basis, sales increased 2%, which compares favorably to our guidance for the quarter of comparable sales to the prior year. Excluding the impact of both currency and increased competition for cyclophosphamide, Baxter's sales grew 3% globally. Sales in the U.S.

declined 1% on a reported basis, and after adjusting for cyclophosphamide, U.S. sales advanced 3%. International sales on a constant currency basis increased 3% and declined 12% on a reported basis.

In terms of individual business performance, within Hospital Products, global sales of approximately $1.5 billion declined 7% and on a constant currency basis sales rose 2%. Adjusting for the impact of U.S. cyclophosphamide and foreign exchange, Hospital Products sales increased 4%.

Within the Fluid Systems franchise, sales of $526 million declined 3% and on a constant currency basis sales advanced 5%. Performance in the quarter was driven by double-digit growth in the infusion systems business, supported by the successful launch of our next generation SIGMA SPECTRUM pump as well as a favorable customer mix for U.S. IV solutions.

Sales in the Integrated Pharmacy Solutions, or IPS franchise, totaled $590 million and declined 8%. On a constant currency basis, sales grew 1%.

Excluding the cyclophosphamide impact, sales in the category increased 9%, driven by strength across the franchise, which includes our nutritional products, pharmacy injectables, and hospital pharmacy compounding services. IPS and performance in the quarter also benefited from a U.S. government order for the pharmacy injectable PROTOPAM.

During the third quarter, U.S. cyclophosphamide sales totaled $80 million as compared to our previous expectation of approximately $50 million. To date there remains one competitor in the U.S. market, but we continue to expect additional competition to enter, although the timing of these entrants remains uncertain.

Revenues in Surgical Care, which includes our anesthesia and biosurgery products, were $322 million in the quarter and declined 5%.

On a constant currency basis, sales grew 2%, driven by strong performance globally in the anesthesia business and growth of core surgical sealants and hemostasis products, including our market leading FLOSEAL Hemostatic Matrix.

This performance was offset by lower sales of select non-core biosurgery products, including PERI-STRIPS, where prior year's sales benefited from a competitor being out of the market, who has since returned.

Finally, sales in the biopharma solutions and other category, which is our pharma partnering business, totaled $106 million, and as expected declined 19% on a reported basis or 12% on a constant currency basis.

As we have previously discussed, this decline is driven by a large customer choosing to self-manufacture products that were previously contract manufactured by Baxter. I'd also note that this category now reflects sales for products Baxter is manufacturing on behalf of Baxalta, which totaled approximately $14 million in the quarter.

Turning to the Renal business. global Renal sales totaled $943 million, reflecting a decline of 11% on a reported basis. Excluding the impact of foreign currency, sales grew 1%. Performance in the quarter was driven by mid-single digit growth in our peritoneal dialysis business and high-single digit growth in the acute business.

This growth was offset by lower sales in our chronic hemodialysis business, resulting from our previously discussed decisions to forgo certain lower margin sales opportunities, the implementation of select austerity measures in Western Europe, and a particularly competitive environment for dialyzers. Turning to the rest of the P&L.

Gross margin in the quarter was 43.8% and compared favorably to our expectations, driven primarily by positive product mix in the quarter. SG&A totaled $670 million and decreased 15% on a reported basis.

On a constant currency basis, SG&A declined 6%, reflecting the benefit of the initial actions we have taken to re-base our cost structure and reduce discretionary expenses, along with transition service income we received from Baxalta in the quarter.

Further actions to optimize our support structure needs are somewhat constrained in the short term by the transition service agreements we have in place with Baxalta. These agreements extend over the next 18 to 24 months.

And as we pursue additional opportunities to streamline our ongoing functional support requirements, we must be mindful of the services we're providing to Baxalta. R&D spending in the quarter of $140 million decreased 5% versus the prior year.

On a constant currency basis R&D expenditures increased 2%, as we have balanced increased investments to support our new product pipeline with efforts to optimize our overall R&D spend.

Operating margin in the quarter was 11.2%, which compared favorably to our guidance of 9% for the second half of 2015, driven by the positive gross margin and operating expense savings I just referenced.

As Bob mentioned this quarter we implemented a global workforce reduction program, which will generate approximately $130 million in annual savings when fully implemented. This program is a component of our comprehensive strategy to improve profitability and significantly expand operating margins by 2020.

As we move forward we'll continue to streamline our operations and control spending in support of this objective. All of our cost structure initiatives remain on track. And we are confident in our ability to achieve the 2020 operating margin target. Interest expense was $34 million in the third quarter, compared to $31 million last year.

During the quarter we successfully executed a tender for $2.7 billion of outstanding bonds. The benefit of this reduced debt level was more than offset by lower levels of capitalized interest in the quarter.

At quarter end our current gross outstanding debt balance was approximately $6.7 billion and consisted of approximately $4.8 billion of bonds and other term debt, approximately $1.5 billion of outstanding balances on our revolving bank line, and approximately $400 million of commercial paper.

As previously communicated we'll look to further delever our balance sheet in the months ahead as part of our strategy to optimize the retained equity stake. In addition to these activities we expect our retained stake utilization plans to include equity for equity exchanges as well as a contribution to our U.S.

qualified pension plan, subject to regulatory approval. Cash on hand at the end of the quarter totaled approximately $2 billion.

Other income totaled $39 million and included a planned gain related to the sale of select equity investments of approximately $20 million and an unplanned foreign exchange gain from hedges on balance sheet positions of approximately $20 million. The tax rate was 20.8% for the quarter.

And as previously mentioned adjusted earnings of $0.41 per diluted share exceeded our guidance range of $0.29 to $0.31. Let me conclude my comments this morning by providing an update on our full year sales guidance and outlook for the fourth quarter. Starting with sales on a constant currency basis.

We now expect sales for the full year 2015 to increase approximately 1%. And after adjusting both periods for the cyclophosphamide impact, we continue to expect underlying growth of approximately 3%. This is driven by growth in the Hospital Products business of approximately 1%, or 4% excluding cyclophosphamide.

Specific to the franchises within Hospital Products we now expect sales growth of 4% to 5% for Fluid Systems, reflecting the strong performance from infusion systems and U.S. IV solutions. For the Integrated Pharmacy Solutions franchise we now expect sales to decline low single digits. As you know this category includes cyclophosphamide.

For the full year 2015 we now estimate U.S. cyclophosphamide sales to total more than $250 million, reflecting the $30 million third quarter benefit and an additional benefit of approximately $25 million in the fourth quarter, relative to previous guidance.

Growth for the category after adjusting for cyclophosphamide is expected to increase mid-single digit. With the Surgical Care franchise we anticipate sales to grow approximately 3%. This growth is somewhat slower than our original expectations and reflects lower sales of non-core biosurgery products.

And finally, for the Hospital Products business we now expect the other category, which includes our biopharma solutions franchise, to decline mid-single digits. As I mentioned earlier this category now includes sales related to contract manufacturing agreements we have in place with Baxalta.

For the Renal business we now expect full-year sales to increase approximately 1%, as we remain focused on maximizing the profitability of this business and maintaining a disciplined approach with respect to international tenders.

In addition as a reminder, the Renal business is more exposed to the current volatility in emerging markets than other areas of our portfolio.

While over the long term we feel very confident that we're well positioned to capitalize on the growth opportunities within these geographies, near-term performance will be impacted by softness in these markets. Moving to the fourth quarter of 2015. We expect sales growth excluding the impact of foreign currency to decline approximately 1%.

And after adjusting for U.S. cyclophosphamide to increase 1% to 2%. At current foreign exchange rates we expect reported sales to decline approximately 9%. For the fourth quarter we expect an operating margin between 9.5% and 10%, which again compares favorably to our previously issued second half guidance of 9%.

The sequential decline from the third quarter reflects incremental operational improvements and additional savings from our cost reduction initiatives being more than offset from the impact of lower sales of higher margin products like cyclophosphamide and PROTOPAM, as well as the negative impact from foreign exchange.

We expect interest expense to total approximately $35 million and other to be an expense item of approximately $5 million in the quarter. We continue to expect a tax rate of approximately 20% and an average share count of 550 million shares.

As stated in our press release we expect adjusted earnings excluding special items of $0.30 to $0.32 per diluted share. Relative to our previous guidance earnings in the quarter reflect the benefit of incremental sales for cyclophosphamide, offset by a negative impact from foreign exchange.

Before we open up the call for Q&A I'd like to turn the call back over to Bob for some closing comments.

Bob?.

Thanks, Jay. So before we do open up for Q&A I'd like to spend just a minute addressing Baxter's path forward. Certainly, our biggest milestone in 2015 was the successful completion of the BioScience spinoff, resulting in the establishment of two leading global healthcare companies.

The spinoff positioned both Baxter and Baxalta with improved focus and an ability to innovate and operate more effectively, which will create enhanced value for all of our stakeholders.

I would tell you I couldn't be more pleased with the progress the Baxter organization has made following the spinoff, and my confidence in our future has never been stronger.

Our third quarter results I think demonstrate the commitment of all of our employees around the world and the clear alignment that exists throughout the organization on achieving our strategic, operational, and financial objectives.

Given this momentum which has been established I'd like to touch on the search process for a new Baxter Chief Executive. As I mentioned last quarter this is a front burner topic for the board. I would tell you we're making very good progress in the search for my successor.

As I think you can understand due to the confidential nature of the search we can't comment now on timing or other specifics this morning. Turning to capital allocation and in particular our use of the retained Baxalta equity stake, where our primary objective remains maximizing the after-tax value of the stake.

Consistent with our previous statements we intend to use the stake in a highly tax efficient manner to optimize our capital structure, which will provide additional flexibility to support organic growth initiatives and pursue external business development opportunities. Regarding M&A.

While we did not include any benefit in the financial projections that we provided in May, going forward we expect M&A to be a key component of our strategy to accelerate profitable growth.

Over the next 12 months as we enhance our balance sheet and progress on our post-spin margin improvement initiatives, we will have significant flexibility to evaluate opportunities that are more transformative in both scope and scale, but still align with our business model and leverage our broad channel strength and geographic presence.

In closing our aspiration remains to be a truly great company in service of our mission to save and sustain lives. And I'm confident that we're on our way to achieving this goal. So with that I think we can now open up the call to questions, Clare.

Okay?.

Stephanie, would you open?.

Thank you. We will now begin the question-and-answer session. I would like to remind participants that this call is being recorded and additional replay will be available on the Baxter International website for 30 days at www.baxter.com. And our first question comes from David Roman with Goldman Sachs. Your line is open..

Thank you. Good morning, everybody. I wanted to ask one strategic question and one financial question. And maybe, Bob, I'll pick up on where you ended the call with respect to M&A. I think at the time of the Analyst Meeting back in May, the communication was that unlikely to see M&A for at least 12-plus months.

And now it sounds like M&A is becoming a more important part of the potential forward path. And understandably it might not happen immediately.

But can you maybe just sort of talk us through the evolution of the thought process around M&A? And give us some flavor for why M&A has become a – potentially moved up the priority scheme? And then what type of deals you might be considering?.

Well I think a lot of this, David, is about timing. At the May conference I commented on two constraints in the short term, certainly within let's say the first 12 months. One was some financial constraints certainly as we navigated our way through the retained stake and so on. But the second one being organizational.

Completing the innovation of Gambro, our ability to continue to support the Baxalta spinoff, which requires a significant organizational commitment on Baxter's behalf going forward. Relative to the organizational constraint, frankly things have moved ahead even better than we had anticipated I think on all fronts.

So I think our organizational capacity to contemplate being more proactive, perhaps maybe even a little sooner on M&A, is better today than what maybe we had anticipated in May. And it's not going to be long before we've worked through this retained stake and so on.

And as I commented in my prepared comments we're going to have significant flexibility. So we've advanced our thinking on things that we might want to do on the M&A front. I'm not going to be real specific in terms of size. But possibly we could be thinking bigger than maybe what we've characterized in the past.

What we do know is we have such a strong presence in the acute care hospital channel, wherever you go in the world. The Baxter brand is well recognized. It's respected. And so the opportunity to do some things that fill out that channel more effectively, we're very interested in. So beyond that I'm not going to be any more specific than that.

But hopefully that gives you maybe a little bit more color as to how I think things evolved since we got together last May..

No, that's definitely helpful. Thank you for – and then just....

Sure..

On the financial side obviously the second half of 2015 is coming in better than you had communicated, some of which is tied to a slower run down in cyclophosphamide than might have been previously expected.

But how should we think about what we're seeing in the back half of 2015 as it relates to the initial targets you provided for 2016 back in May? How much of what we're seeing is sustainable versus more one time in nature?.

Jay, you want to handle that?.

Sure. Just making a comment in terms of third quarter performance. We over-achieved the midpoint of our guidance by $0.11. And there was really three primary drivers which contributed to that. One was cyclophosphamide. A second item related to some other income driven by foreign exchange and the timing of investment gains.

And then the third piece relates to savings related to the cancellation of (30:51) spending controls that we put in place as well. So those really are the three primary drivers of the over-achievement in Q3.

As we move forward, what I would say, is the one that was most important to us was the operational performance related to the spending controls that we put in place. And we're not updating 2016 guidance at this stage.

But what I will tell you is we're very confident in our ability to execute, particularly on the cost side and also on the margin side as we move forward. We'll update guidance in January.

But at this stage, I think this first quarter was a very important building block for us to put in place that gives us a high level of confidence as we move forward through the rest of the plan..

Okay. Got it. Thank you very much..

Thanks, David..

Our next question comes from Matt Taylor with Barclays. Your line is open..

Hi. Thanks for taking the question. So you had good performance. You outlined the three factors. I guess could you expound a little bit on the third one that you talked about in terms of the savings cancellation? And I was just wondering if you could help us put that into context with your prior guidance.

How much of the upside was driven by that? And then how much does that change your margin expectations maybe relative to the LRP? What wasn't in the guidance before?.

discretionary spending controls that we put in place and then also the cancellation of open roles.

And so as we had a high level of confidence that we were going to successfully execute the spin, and we started to see the performance work out well very early in the July timeframe, we were very proactive in terms of pulling forward some of the spending initiatives that we had earmarked for later in the year.

So some of the benefit that we saw in Q3 is not something that we would quote-unquote tack on to future periods, but rather something that benefits Q3 specifically. And because we were confident in our ability to execute, we were able to put those pieces in place earlier than we previously expected.

So as far as the impact on the long-range plan, I wouldn't say that this is quote-unquote incremental at this stage, but rather it just gives us confidence that we're going to be able to execute as we move forward..

Okay. That's helpful. And then I guess another piece that you've talked a little bit about that wasn't in the plan numbers is an opportunity on price, maybe in the PD business or in the IV solutions business.

Could you talk a little bit about the opportunities in each of those two businesses, and I guess why you feel like pricing may be a lever that you can pull over the next 12 months?.

Now I don't, Matt, I don't think there's anything new there from what we've messaged previously on that. And so for a number of reasons, including competitive reasons, I don't think I'd want to expand on that any further this morning..

Okay. All right. Thanks a lot for the comments..

Thanks, Matt..

Our next question comes from Bob Hopkins with Bank of America Merrill Lynch. Your line is open..

Hi. Thanks.

Can you hear me okay?.

Sure, Bob, go ahead..

Great. So I wanted to follow up with a couple questions on the operating margins. So I'll just rattle off a few things here.

So in the quarter, how much of the roughly 200 basis points of operating margin beat was due to the $30 million in better cyclo sales? And in terms of the fourth quarter guidance, which looks like it's down by about 150 basis points, could you just break that out a little bit more? Because it seems like cyclo is only coming down by $5 million.

So just want to understand the kind of Q3 to Q4 dynamic there a little bit in a little bit more detail..

Sure. Just one clarifying comment before I address the rest of the question. Cyclo is actually down from Q3 to Q4 sequentially $30 million, so in Q3 we achieved roughly $80 million. We expect to achieve roughly $50 million in Q4..

Got it..

As it relates to the operating margin of 11% in the quarter, there were really two drivers of that. One relates to the cyclo over-performance, and that was about 1 point. And the second relates to the timing of the spending savings that we were able to initiate. And that was another roughly 1 point of margin.

So if you adjust for those two items, those were the two drivers of the over-performance. Now turning sequentially from Q3 to Q4. We're guiding to 9.5% to 10%. And so relative to the 11.2% that we experienced in Q3, there are a number of drivers. First, we have about 1 point of cyclo deterioration from Q3 to Q4.

Second, we have about 1 point of foreign exchange deterioration from Q3 to Q4. The other comment is in Q3 we had a large order of PROTOPAM. And while that's not necessarily a one-timer, it is a periodic order that we receive, and we don't forecast one for Q4.

And that's roughly 0.7 points of margin that we're going to lose from Q3 to Q4 that we expected and planned for.

But as we think about our performance moving forward, there are two drivers that we're going to continue to experience benefits from, general operational improvements of about 80 basis points and operational OpEx savings will also continue to accelerate as well. So as we think about it, that's what drives the 11.2% to roughly 9.5% to 10%..

Great, Jay. That's very clear. Thank you. And then one big picture question regarding the request last night from a couple senators for the FTC to investigate saline business broadly among the big three competitors there. I'm sure there's probably not much you can say about that. But I just wanted to make sure I had a good understanding.

In the current LRP, this business is a decent chunk of the overall whole. What kind of – I mean I assume you've been assuming pretty decent price increases in that business in your LRP.

Could you just confirm what kind of price increases you've got assumed in the LRP for saline going forward?.

Yeah. Overall in the long-range plan we had fairly modest price increases across the portfolio. In some product categories we had low increases. In other product categories we actually had price declines.

Bob, you want to add anything?.

So thanks for asking the question, Bob. And again I'm somewhat limited in terms of what we can say. But maybe some thoughts I would share. I think everybody appreciates the fact that IV solutions are probably one of the best medical values in healthcare today.

We've used the analogy of the cost of an IV as less than a cup of coffee or a bottle of water that you'd buy at 7-Eleven. Right? I will tell you all we've made extraordinary efforts to maximize the availability of product to address the shortage, including significant investments to identify and secure additional sources of supply.

By the way this includes working with the FDA to get one of our foreign plants in Spain approved to import product from Spain to help mitigate the shortage situation. We continue to work with them on other international sourcing locations as well. The average price for IVs has increased at a fairly modest level over the past.

Okay? And Jay commented on our views going forward. So I would just conclude by saying look, we're confident in our practices. I would characterize them as reasonable, appropriate. But again just to reiterate, we're taking every step we possibly can to make product available to address the shortage. So beyond that I won't expand any further, Bob.

But thanks for asking the question..

Great. Thanks for taking the questions..

Sure..

Our next question comes from David Lewis with Morgan Stanley. Your line is open..

Good morning..

Hi, David..

Bob, just to start with you really quickly here. Emerging market commentary kind of across the coverage universe this quarter has varied amongst companies. I think you commented that your EM business was generally in line with what you talked about back in May.

Can you sort of talk about how you saw the business in May? What you're seeing here in the third and early fourth quarter? And how you describe your EM business here from a growth perspective? Is it stable? Is it slowing? Is it accelerating?.

Yeah. So thanks for asking the question, David. Yeah, I characterized it as generally in line. Frankly, it's a tad softer than what we had messaged in May, although it's hanging in there pretty well and probably stronger than a lot of other companies.

And I think that speaks to, as I mentioned in my prepared comments, the "essential nature" of our products and so on. But look, the reality is – and we all know what's going on – emerging markets are a real challenge right now. And I'm not going to project a significant turnaround in the near term.

But I do think the guidance that we provided over our LRP in terms of revenue growth will be achieved over the 5-year period of time.

I would tell you the one business that has been particularly hit by that has been kind of the traditional in-center hemodialysis business, which we saw a disproportionate impact of the softening of the emerging markets.

But just so you don't misinterpret my comments, emerging markets – continued investments in emerging markets given the nature of our products will continue to be an important aspect of our growth prospects over the LRP..

Okay. And maybe just, maybe two quick ones. Bob, just one more strategic view..

Yeah..

You mentioned the word transformative in your M&A commentary. Is transformative M&A possible during the CEO transition? And then second one just for Jay. In Fluids Systems there's a lot of strength there.

Jay, was that systems or disposables mix? What was the bigger driver? And specifically can you flush out what was it about the disposable mix that drove the acceleration? Thank you..

So I would say in the first part, transformative is a relative term. But obviously we're open-minded to things that are material. I will tell you that I've had dialogue with our Board on some things that we might want to consider doing, relative to the timing of this as it relates to succession.

I guess we need to define the succession timing first and then go from there. But the succession has not gotten in the way of us having strategic dialogue with our Board in this regard. And I'm confident that based on the timing of the succession that that dialogue will continue, David.

Okay? Jay, you want to do the second one?.

Yeah, sure. And as it relates to the infusion system strength, really the key driver of that was the sale of the SIGMA SPECTRUM Pump in the U.S. We did see mid to high single-digit sales growth of access. But from an overall driver standpoint we're pleased with the progress that we're making on the infusion pump launch. That's going very well.

And that was the key driver in the quarter that led to the double-digit growth..

Great. Thank you..

Our next question comes from Mike Weinstein with JPMorgan. Your line is open..

Thank you. I just want to go back to maybe the first couple questions on the call. So just to flesh out the quarter.

So, Jay, if you broke it down, the different upside drivers in the quarter between cyclo delay, the gains, FX, and other that were in the other income line PROTOPAM shipment this quarter, and then maybe the continuing ops, how would you break that down?.

Sure. The PROTOPAM piece was actually included in our original guidance. So that was not an upside to the guidance. But that was about $0.025 roughly of EPS that we had expected. The important thing about PROTOPAM is like I said in my comments earlier, it is not a one-time order. These are periodic orders that we receive.

We just don't receive them every quarter. So it was an expected driver of performance in the quarter. Relative to our $0.30 midpoint, as you said there were three upsides. One relates to cyclophosphamide. We had about roughly $30 million of unplanned upside in that category. One relates to other income.

We had forecasted certain other income for the second half of the year, but we did over-achieve that, largely driven by balance sheet positions that we had in place in overseas entities driving foreign exchange gains. And that was about $0.03 of over-achievement.

And then finally, the OpEx savings that I described earlier was about $25 million, between $0.03 and $0.04 of impact in the quarter. And as I said that was a very important component for us to put in place early on this margin improvement journey..

Okay.

So the – you would characterize it as $0.03 to $0.04 is what you would view as being ongoing?.

Yes. Exactly. Those – that would be more ongoing..

Okay. Perfect. And then just to make sure we're thinking about the Baxalta stake correctly.

Jay, is your priority still, besides the pension, the revolver that comes due in December?.

Yeah, maybe just taking a step back. Thanks for the question, Mike. I'll make some further comments on the retained stake, so everyone is on the same page. The strategy with the retained stake remains the same. Our objective is to maximize the after tax value.

We have a private letter ruling from the IRS, which supports essentially three mechanisms for us to utilize that stake over the next 18 months in order for us to achieve that tax free status that I described. One is an equity for equity exchange. One is an equity for debt exchange. And one is a contribution to our pension plan.

As it relates to progress that we're making in the quarter, we are continuing our discussions on the pension with Department of Labor. And we're very confident that we'll receive the appropriate approvals that will allow us to make a pension contribution. And we were pleased with the progress in the quarter.

As it relates to equity for debt, you're right. We did file – Baxalta on our behalf filed an S-1 in the quarter, which we have earmarked for a piece of debt that expires in December.

The reason I like that debt is because it's a very low-cost way for us to use the retained stake in the sense that there are no premium or breakage fees associated with retiring that piece of debt. So it really does help achieve our objective.

To the extent that the market conditions are right, and we feel like we have a transaction window that's appropriate for us to take advantage of, we do expect to target that piece of debt with a portion of the Baxalta equity stake.

More broadly we will think about equity for debt and looking at the overall bond complex in the form of a secondary offering with a modified debt tender later on. So overall that all continues as we expect moving forward.

And we do – we'll evaluate conditions as we move forward to see if there is an opportunity for us to target that piece of debt prior to December..

That's very helpful. Thanks, Jay. Thanks, Bob..

Thanks, Mike..

Our next question comes from Matt Miksic with UBS. Your line is open..

Thanks. Thanks for taking the question. So one follow-up for Bob on your questions about M&A and strategic investment. Not to beat a dead horse, but I did just want to touch on one aspect of your meeting in May. It was talking about accelerating profitable growth.

And so if we think of assets or transformative or mid-sized acquisitions or – and so on, should we be thinking about something that is a synergy play on your platform and with cost synergies involved? Or should we be thinking of something that is in fact going to help sort of drive growth your – as well?.

Yeah. Matt, I'm not sure I can expand a lot beyond what I said in answer to one of the earlier questions on this, but maybe to reiterate a point. The priority would be things that as I said before flesh out our acute care hospital channel. So that's another way of saying commercial synergy, where one plus one is greater than two.

Clearly structural cost would be part of it as well. And targets that we would look at would be meaningfully accretive. But it would be both a commercial synergy play leveraged in the acute care channel, and depending upon on what the target may be, a structural cost as well..

And one if I could follow-up on a question earlier on pumps..

Sure..

If you could talk a little bit about the success that you've had there? That process is of course winning contracts, placing channels, and enjoying and driving the pull through of utilization.

Could you talk a little bit about maybe where you are this year? If there is a point where you've sort of either hit changing comps or change in mix? Or just some color on the process of that roll-out? And then I have one more follow-up for Jay..

Yeah. So the momentum on the SIGMA launch as I commented is building. We're very pleased with the market response to date. Just to ground everyone you'll recall in our Investor Conference and the LRP projections, we assumed that we would regain approximately 5 of 10 share points in the U.S.

launch lost over the last number of years, because of the colleague challenges and so on. All I would say, Matt, on that is given the early impact of the relaunch, we are highly confident that we will be able to regain at least those 5 share points in the LRP.

And I think our longer term aspiration of recovering all of that share loss, if not more, is certainly very, very viable. Admittedly there's a little bit of pent-up demand. And so we want continue to gauge that and monitor the sustainability of that.

But again all I can just really say qualitatively or subjectively is we're very, very pleased with the market response to SPECTRUM. The product is performing very well. And really beyond that I'm not going to expand. Hopefully that helps..

Sure. Well congrats on the progress so far..

Yeah, thanks..

And then, Jay, a comment. You mentioned a couple times the gains, FX gains, as being one of the positives. I was wondering if you could highlight – those sounded like balance sheet or asset-related gains below the operating line.

Could you talk a little bit about the impact of the sort of FX gains that dropped through the P&L in terms of the offset, either natural hedges or otherwise? If you have a net feel for what the impact of FX was to the P&L?.

Sure. So to your point the gains that I was pointing to are really other income related gains related to balance sheet positions held in overseas entities that are mark-to-market as part of our standard process on a monthly and quarterly basis.

As it relates to overall impact of FX, I did mention that sequentially from Q3 to Q4, excluding the area of sundry, we are seeing some deterioration in foreign exchange. So sequentially from Q3 to Q4 we have about $0.04 of impact that we expect to see.

And that's about $0.01 to $0.02 worse than our expectations, driven by its deterioration in a number of currencies. We've seen a lot of volatility in emerging markets in particular. From a hedging standpoint overall, for the developed market currencies we do have an approach where we look to hedge a portion of our exposure with the use of options.

And then for those currencies that we don't, there are a lot of emerging market currencies today that we don't actually hedge in, because it's not economic to do so. In the case of those markets there are some natural hedges that we have in place.

As you know we have manufacturing facilities in 40 countries around the world, or 40 manufacturing facilities in 25 countries around the world. And so as a result of that we do have some natural expense offsets to the sales that we have in place.

And that we don't have that many products that are truly global in nature, creating additional foreign exchange exposure. So we will continue to be exposed to foreign exchange. It's an area we watch very closely. We do see this $0.01 to $0.02 impact. But there are active hedging programs that we have in place.

And there are some balance sheet programs we have in place. And then there are also the natural hedges that I just mentioned..

Great. Thanks so much..

Thanks, Matt..

Our next question comes from Larry Keusch with Raymond James. Your line is open..

Okay. Thanks. Good morning, everyone..

Morning, Larry..

Bob, I was wondering if you might take a stab at just giving us some thoughts around the environment in the U.S. and Europe.

I know you already talked through emerging markets, but how about in some of the other geographies?.

Yeah. I mean ironically probably the U.S. market is as stable or strong as any geography in the world right now. You saw that with our performance in the first half of the year in the U.S., where we're seeing some recovery. We're seeing some expanded expenditure on capital goods, which helps our pump business.

And we would project that that's going to continue. Europe clearly continues, developed Europe continues to be a challenge. We don't see any significant improvement there. I don't see any significant deterioration as well going forward. And then emerging markets I think both Jay and I have commented on this morning.

It's really kind of an unknown in the near term. Although clearly long term all of these countries are increasing the amount of spend to healthcare. And that particularly plays to our strength in terms of the essential nature of our product. So beyond that I realize that's all very qualitative.

I don't know if there's anything, Larry, specifically within that you'd like me to comment on..

No. That's helpful. I just had two other questions for you. You did mention in the prepared comments about some competition in dialyzers. Again I recognize that's not necessarily new.

But if you could sort of speak to that and weave in there sort of where we are on the dialyzer capacity expansion? And then the other quick question for you was if I sort of just do the very high level math on the operating margin for the second half, it implies somewhere around 10.5% or so. You guys had been sort of focused on 11% for 2016.

So how should we think about that 100 basis point improvement in 2016 from the initially targeted 9% in the second half of this year?.

Okay. Let me comment on the dialyzer competition maybe a little bit more broadly on the Renal performance. And then, Jay, if you would pick up on the second part of the question. So first of all just kind of stepping back, we continue to believe the ESRD patient growth globally is growing around 5%.

Our performance to date is impacted really by a number of factors. First of all as I commented in the prepared comments, we've decided to forgo some lower margin tenders, which has impacted us in the short term.

We continue to manage through conversion of distributors that Gambro had to going direct, which is the right thing to do strategically and long term, but in the short term can be somewhat disruptive. And then of course I think a more competitive environment in the in-center chronic business than what we had anticipated.

Although in fairness I would say in our modeling, we've always assumed some modest price erosion over the long-range plan for dialyzers. In terms of expanded capacity, that won't come on until late 2016 in our investment in Opelika, Alabama.

We also as I think you know are expanding capacity in the production of PD solutions in China and Southeast Asia and so on. So the combination of the capacity expansion as well as an array of new product launches. AMIA, I talked about the approval in the U.S., which is very exciting.

I mean that really builds on the HOMECHOICE, which is a $1.5 billion system globally today, so that's big. PrisMAX, the CLARIA launch in Europe, and then of course VIVIA for home HD. So whether it's capacity expansion or new product flow, that's what's going to accelerate the Renal growth going forward.

I'm confident that as we move into 2016 we're going to ramp up the year-to-year growth in the Renal business. But the reality is that the chronic in-center business, particularly in dialyzers, continues to be very competitive.

We anticipated that, that perhaps to a greater degree than we had anticipated, but we're looking forward to the capacity expansion. So that's about as much color as I can provide there.

Jay, you want to handle the other?.

Sure. On the operating margin, we did guide to 9% for the second half, and we're pleased that the second half is running better than that. As it relates to 2016, we actually guided to a 10% margin for 2016 and 11% in 2017, essentially 100 basis points of margin improvement per year.

It's important to note that in 2016 we also expected about 100 basis points of deterioration due to cyclo. So in fact the organic or the true growth in margin in 2016 was really 200 basis points. But like I said, our guidance for 2016 was 10%. Based on our performance in the second half thus far, we're pleased.

And we have confidence in our ability to achieve the projections that we've shared. At this stage we're not making any changes to guidance moving forward. There's a lot of moving pieces, things like foreign exchange, pension, operational improvements, et cetera.

And we're actually going through a budgeting process as we speak to firm up our 2016 expectations. You can expect to hear an update from us on our January earnings call..

Okay. Great. Thank you..

Thanks, Larry..

In the interest of time we'll take two more questions. Our next question comes from Rick Wise with Stifel. Your line is open..

Good morning. Hi, Bob. Just I wanted to follow up on the question on operating margins if I could. And maybe push you a little further. I mean just when companies I've noticed over the years start down this path of focusing more intently on cost reduction and efficiency, sometimes they can even surprise themselves. Maybe a couple things.

The – for example the global work force reduction, how quickly will that $130 million savings hit the P&L? And maybe, Jay, talk to us about the possibility of other discretionary spending cuts? I mean just remind us what some of the opportunities are.

Is it in supply chain? Is it back office? Is it IT? Just help us understand the larger directional picture if you would..

So let me maybe comment, Rick – this is Bob – on kind of to set this up a little bit with some statistics. And then Jay can pick up the second part of your question. First of all in terms of timing the actions that we discussed this morning are going to largely be completed by the end of this year. So this is pretty immediate.

As you gathered from our prepared comments this is the first part of what will be other actions that we will take over time. One thing we have to continue to be sensitive to, as Jay commented earlier, is the organizational support requirements for the Baxalta spinoff and so on. So we want to be cognizant of that as well.

But we do think there are meaningful actions going forward. And of course what we didn't comment on was the completion of the Gambro integration, which continues on track as well.

So in aggregate fairly meaningful undertakings, the impact of which will be near term the – maybe to give you some specifics on the reduction, which we characterize as about 5% of non-manufacturing jobs. This translates into about 1,400 jobs globally, about 70%.

Our existing head count, about a third of which are cancellation of open positions, roughly two-thirds of the reductions are outside the United States. And really spread around the world fairly evenly. So hopefully that's helpful.

Jay, you want to pick up on the second part of the question?.

Yeah. And just to elaborate a little bit further. I mean overall we commented at our Investor Conference outlining 430 basis points of very specific cost improvements, 90 of which comes from Gambro, 80 of which comes from manufacturing, 50 of which comes from the pension, and 210 basis points related to G&A.

And so by no means were we surprised by the size, scope, or scale of the restructuring that we announced. And so far everything is moving forward very much in line with our expectations from a cost standpoint. One of the areas to your point that we're very focused on relates to discretionary spending.

And we believe there is some opportunity to look hard at certain categories. We're using some zero-based techniques and looking at very detailed spend levels in areas like travel, consulting, and some other discretionary spending, like marketing and professional services. And so as we go through our budget that's a clear area of focus for us.

We think we have the opportunity pegged appropriately in terms of the impact on our long-range plan financials. But I can assure you with respect to all of these actions and the overall plan, the three components of the plan that Bob described earlier, we are looking to do better than we've outlined. And we're attempting to do that at each step.

And so cost is squarely in that focus. But I wouldn't say we've been surprised by our performance at this stage..

Great. I'll leave it at that. Thanks for the color. Appreciate it..

Thanks, Rick..

Our last – our final question comes from Joanne Wuensch with BMO Capital Markets. Your line is open..

Oh thank you very much for including me, and very nice quarter.

In Renal did I understand that you're largely done with the Gambro integration?.

No. We still have work to do. I think we're approaching the conclusion of it.

Jay, you want to comment?.

Yeah, sure..

Specifically on the dollars..

Well by the end of this year we expect to have achieved approximately $200 million in savings. And then in 2016 and 2017 we expect $100 million in incremental savings. Really the drivers of the remaining piece relates to certain manufacturing, a consolidation of activity, certain warehousing, and distribution consolidations.

And then finally, there are some IT savings. As we roll out Baxter platforms across the Gambro network, there will be some G&A savings. And we still have a few IT implementations to go. Those are the primary drivers of the remaining $100 million in savings..

That's very helpful.

As a follow up as we think about 2016, can you remind us where FX may or may not impact different items on the income statement, other than obviously revenue? But how is it going to roll through, so that we don't get to 2016 guidance and suddenly have either other income or margins significantly different than expectations?.

Yeah. As we look at FX in 2016, what we had assumed in May was essentially a constant FX environment in the sense that we assumed flat currencies over the long-range plan period. To the extent that there are departures from that, we'll first look to hedge using various techniques that we've discussed.

There will be the benefit of natural hedges in place. But as we saw in Q4 based on the change in foreign exchange from Q3 – from June to today, let's just put it that way, we did see a negative impact of around $0.01 to $0.02 in the fourth quarter.

So this will be one of the important assumptions that we update as part of our January guidance, along with many other items that we look forward to discussing with investors..

Terrific. Thank you so much..

Thanks, Joanne..

Thank you, ladies and gentlemen. This concludes today's conference call with Baxter International. Thank you for participating. You may all disconnect..