Good morning, ladies and gentlemen, and welcome to Baxter International's Third Quarter 2017 Earnings Conference Call. Your lines will remain in a listen-only mode, until the question-and-answer segment of today's call. 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, Canda. Good morning, and welcome to our third quarter 2017 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer, and Jay Saccaro, Baxter's Chief Financial Officer.

On the call this morning, we will be discussing Baxter's third quarter 2017 financial results, along with our updated outlook for 2017. As a reminder, we have posted a supplemental presentation to compliment this morning's discussion.

This presentation, along with related non-GAAP reconciliations can be accessed on Baxter's external website in the Investors section under Events and Presentations.

With that, let me start our prepared remarks by reminding everyone that this presentation, including comments regarding our financial outlook, new product development, business development, and regulatory matters 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 detail concerning factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used to help investors understand Baxter's ongoing business performance.

A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website. Now, I'd like to turn the call over to Joe.

Joe?.

Thank you, Clare, and, good morning, and thanks for joining us today. I will get started with an overview of our third quarter results, then I will share some key highlights for the quarter that reflect Baxter's accelerating momentum around innovation and drive towards sustainable top-quartile performance.

I will also briefly address our response to the natural disasters that have recently devastated parts of the Americas and Caribbean, and the related projected impact on our operations in the fourth quarter. Finally, I will pass it over to Jay who'll walk through our third quarter results and financial outlook in more detail. We'll close with Q&A.

As you saw in our press release, Baxter delivered solid third quarter results on both the top and bottom lines. You'll recall that we closed our acquisition of Claris Injectables on July 27, our third quarter performance includes $27 million in sales from Claris. Sales growth in the quarter was 6% on a reported constant currency and operational basis.

Operational sales are adjusted for the impact of foreign exchange, generic competition for U.S. cyclophosphamide, the Claris acquisition, and the previously communicated selected strategic product exits the company is undertaking.

In the third quarter, we realized our strongest growth of the year, driven by continued strength in the U.S., particularly in Fluid Systems, pharmaceuticals, including Claris, and renal therapies. Internationally, we saw improved performance across both the Hospital Products and Renal businesses.

On the bottom line, adjusted earnings were $0.64 per diluted share, increasing 14% over the prior-year period. This reflected solid top-line growth and improved gross margins driven by favorable mix in the quarter, as well as positive contributions from our ongoing business transformation efforts.

Our company-wide results for the quarter reflect our focus on disciplined execution to drive an improved operational performance. We will continue to implement actions to support our business transformation, while also investing in the businesses, both organically and inorganically to drive innovation and growth.

The Claris acquisition represents an example of this commitment. This acquisition allows us to build a broader presence in the generic injectable pharmaceuticals market. The early market response has been positive, with customers welcoming this addition to the expanding Baxter portfolio.

We will continue to build on our momentum and commercial synergies as we launch additional molecules going forward. The molecules being advanced in the generic injectables pipeline represent a combination of internal development and external strategic partnerships.

Our top priority during these early months of integration is to bring Claris fully online with Baxter's systems and processes. We have focus on bringing Claris up to Baxter's global quality standards and have taken actions to support this critical objective.

We have made progress since the acquisition closed and we'll maintain this emphasis in the months ahead. M&A deals like Claris will continue to play an important role in building out our portfolio and pipeline across our key growth categories and adjacencies.

Our third quarter highlights also demonstrated transformative and accelerating tempo of innovation of the company. During the quarter, we upgraded the SIGMA Spectrum Infusion System with the launch of DeviceVue Advanced Asset Tracking System.

Baxter is the first and the only smart infusion pump manufacturer to offer a tagless, end-to-end acid tracking application designed in consultation with our customers to drive operational efficiencies and help maximize the clinical value of their pump investments. In our chronic Renal business, we have now enrolled the first patient in our U.S.

clinical trial for HDx therapy enabled by TheraNova. This is a crucial step in bringing the benefits of TheraNova to patients in the U.S. market. TheraNova technology is designed to closely mimic the natural kidney through clearance of certain molecules during dialysis.

It is already available in several markets worldwide, including Colombia, where we have just launched a second trial of the technology. In acute therapies, we have just launched the first 3-in-1 set for use in continuous renal replacement therapy, CRRT and sepsis management protocols.

This is a label expansion for our oXiris blood purification set and adds to Baxter's multi-organ therapy offering, utilizing the Prismaflex system. The oXiris label expansion takes effect in more than 30 countries in Europe, as well as geographies in the Middle East and Africa.

These highlights represent the small fraction of our activity and ongoing investment focus on supporting new products, the indications and new research. These investments are critical for fueling our continued growth hand-in-hand with improved efficiencies, (7:27) and disciplined execution.

Before turning it over to Jay, let me take a moment to address the natural disasters that have overwhelmed parts of the Americas the Caribbean in recent weeks.

We mobilized quickly in the aftermath of each of these catastrophes through a combination of product donations, financial assistance, on-the-ground support, and employees going above and beyond to help maintain patient access to our life-sustaining products and therapies. This work continues.

In an update to the press release issued October 12, the FDA has granted two new approvals for regulatory discretion to temporarily import certain drugs from our facility in Canada and Mexico. We now have four sites approved to help address demand in the U.S. market.

As it relates to product supply from Puerto Rico, we have targeted recovery strategies in place and are continuing to do everything we can to help mitigate patient and provider disruptions.

As mentioned in the press release, even with the contribution of special import approvals from other sites and expected increased production in Puerto Rico in the weeks ahead, we will not be able to fully bridge the gap in demand in the fourth quarter.

Accordingly, we currently project that aftermath of Hurricane Maria will negatively impact fourth quarter revenue by approximately $70 million. However, we expect the related effect on adjusted earnings will be offset through positive performance in other areas of the business.

In terms of projected recovery dates, a limited number of products won't return to healthy inventory levels until the first quarter of 2018; however, we currently expect that a number of product families will return to normal supply by the end of this year. We fully understand and regret the hurricane-related inventory impact affecting our customers.

Restoring reliable product supply remains our collective priority. Disruptions like this, in whatever form they may take, are an inevitable part of doing business. What matters is our ability to prepare, move fast, and then react swiftly while maintaining our commitments to our stakeholders.

Everyday we're focused on achieving our mission for patients, strengthening our fundamentals as a company, and driving greater value for investors, employees, and the communities where we make a difference. Tenacious execution is the path forward and there's no letting up the pace.

With that, I will pass it to Jay, for a deeper dive on the third quarter performance..

Thanks, Joe, and good morning, everyone. As Joe mentioned, we're pleased with our third quarter results, which represented our highest quarterly growth rate for the year. Sales in the quarter increased 6% on a reported constant-currency and an operational basis.

Top line growth exceeded our expectations on both the constant-currency and reported basis, driven by better-than-expected contributions from Claris and cyclophosphamide, as well as a favorable foreign exchange benefit from a weaker U.S. dollar. On the bottom line, adjusted earnings were $0.64 per diluted share.

This exceeded our guidance of $0.58 to $0.60 per share, and reflects solid top-line performance and improved gross margin, driven by favorable product mix, as well as the ongoing impact from our business transformation efforts. A modest benefit from other income and a lower tax rate also contributed to the results in the quarter.

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

I will point out that top line performance in the quarter was not materially impacted by any of the natural disasters experienced during the third quarter. Global sales for Hospital Products were $1.7 billion, advancing 6% operationally. Breaking this out by business, sales in Fluid Systems were $610 million, up 7% operationally.

Performance was primarily driven by robust sales of IV solutions in the U.S. Moving to Integrated Pharmacy Solutions, or IPS, global sales were $627 million, increasing 8% operationally.

Contributing to performance in the quarter were increased sales for premixed injectable drugs and a one-time benefit from an early contract settlement with one of our hospital pharmacy customers outside the U.S. Sales of U.S. Cyclo were $47 million in the quarter and, as mentioned previously, Claris contributed $27 million globally.

Moving to Surgical Care, which includes anesthesia and BioSurgery; total sales were $338 million, increasing 6% operationally, contributing to performance in the quarter with low double-digit growth for anesthesia and critical care products, driven by positive demand for inhaled anesthetics internationally, as well as increased U.S.

sales of BREVIBLOC, a fast-acting IV beta blocker. As a reminder, in the third quarter of 2016, international anesthesia sales were negatively impacted by an austerity adjustment. Globally, BioSurgery sales increased low-single digits in the quarter.

We expect growth in this business to continue to improve as a result of our efforts to enhance commercial effectiveness and reinvigorate the portfolio with a number of new product launches expected next year. Finally, in Hospital Products, sales in our other category were $122 million, declining 2%.

Turning to our Renal business, sales were $1 billion, up 6% operationally. Sales in the quarter benefited from solid performance across all lines of the business. Both our peritoneal and in-center hemodialysis businesses advanced mid-single digits globally.

Notably, the in-center HD business reported positive international sales growth for the first time this year, reflecting our efforts to stabilize and improve performance in this business. The Acute Renal business delivered high-single digit growth globally in the quarter, driven by mid-teens growth in the U.S.

and mid-single digit growth internationally.

Walking through the rest of the P&L, our adjusted gross margin of 45.2% represents an improvement of 30 basis points over the prior year and was driven by improved pricing in select areas of the portfolio and the benefit from our business transformation efforts aimed at simplifying the portfolio to drive efficiency and reduce costs.

This improvement was modestly offset by a negative impact from foreign exchange. Adjusted SG&A totaled $633 million, increasing 4%. The positive contribution from our relentless focus on effectively managing our expense base was offset by lower transition service agreement income from Shire in the quarter.

In addition, we continue to make select investments in sales and marketing in key areas of the portfolio to support our growth initiatives. Adjusted R&D spending in the quarter of $150 million increased 16% versus the prior year, reflecting our stated intention to accelerate investments in our core growth businesses.

Adjusted operating margin in the quarter was 16.3%, an improvement of 30 basis points versus the prior year, and favorable to our expectations, driven primarily by improved gross margin. Net interest expense was $14 million in the third quarter.

Adjusted other income totaled $12 million in the quarter, reflecting a benefit from foreign exchange gains on balance sheet positions. The adjusted tax rate was 18.9% for the quarter, which reflects a benefit from the new stock compensation guidance.

And as previously mentioned, adjusted earnings of $0.64 per diluted share exceeded our guidance of $0.58 to $0.60 per share, driven by operational sense, other income benefit and a lower tax expense. During the third quarter, we repurchased approximately $180 million, or approximately 3 million shares.

These targeted repurchases were more than offset by option-related dilution. Before turning to our updated outlook, I will provide some commentary regarding our cash flow performance.

On a year-to-date basis, we have generated free cash flow of $933 million, an improvement of more than $500 million versus the prior year, and already exceeding the 2016 full-year total of $905 million.

Growth has been driven by strong operational performance and lower capital expenditures, along with continued focus on improving the company's working capital performance. Let me conclude my comments this morning by providing an update on our outlook for the remainder of 2017.

We expect 2017 full-year sales to increase approximately 4% on a reported basis, and approximately 4% on a constant currency basis. And after adjusting for U.S. cyclophosphamide impact, select strategic product exits, and removing the benefit from Claris, we expect underlying operational growth of 4% to 5%.

I would like to point out some key assumptions reflected in our full-year sales outlook. These include approximately $70 million of negative sales impact from Hurricane Maria, approximately $57 million in Claris sales, and full-year cyclophosphamide sales of approximately $190 million.

Looking at the sales outlook in more detail, we now expect growth in Hospital Products business of approximately 4% on a constant currency, and 4% to 5% on an operational basis. This outlook reflects the full impact of Hurricane Maria, with approximately 80% of the lost sales realized in the IPS franchise.

The remainder of the impact is reflected in the full Fluid Systems franchise. Within Hospital Products franchises we now expect Fluid Systems constant currency sales growth of 5% to 6%, and approximately 7% on an operational basis. For the Integrated Pharmacy Solutions or IPS franchise, we expect constant currency sales growth of 3% to 4%.

Operationally, IPS sales are expected to increase approximately 2%. As I just mentioned, IPS includes a negative impact from Hurricane Maria of approximately $55 million. Within Surgical Care, we continue to expect sales growth of approximately 4% on a constant currency basis and 4% to 5% operationally.

And finally, for the Hospital Products business, we expect BPS and other to increase in low-single digits. For the Renal business, we continue to expect full-year constant currency sales to increase approximately 3% growth, and growth of approximately 4% operationally.

Moving down the P&L, we expect an adjusted operating margin of approximately 15.5% to 16%. We expect net interest expense to total between $55 million and $60 million, and adjusted other income of approximately $35 million for 2017. For the year, we now expect an average adjusted tax rate of approximately 18%.

For full-year 2017, we anticipated diluted average share count of approximately 555 million shares. Based on these factors, we now expect 2017 adjusted earnings, excluding special items, of $2.40 to $2.43 per diluted share.

Finally, for the year, we are once again increasing our outlook and now expect to generate operating cash flow of approximately $1.85 billion, and free cash flow of approximately $1.2 billion.

Specific to the fourth quarter of 2017, we expect sales growth of approximately 4% to 5% on a reported basis, and approximately 2% on a constant currency basis. Operationally, sales in the fourth quarter are expected to increase 1% to 2%.

I did want to note that operational sales growth includes approximately three points of negative impact due to Hurricane Maria. And we expect adjusted earnings, excluding special items, of $0.56 to $0.59 per diluted share.

This includes a $0.06 negative earnings impact from Hurricane Maria, which is mitigated by an increase in our sales projections for U.S. cyclophosphamide and a lower-than-expected tax rate for the fourth quarter. With that, we can now open up the call for Q&A..

Thank you. We will now begin the question-and-answer session. And our first question comes from Matt Taylor of Barclays. Your line is now open..

Hey, good morning, and thanks for taking the question. I guess, the first thing I wanted to clarify is, it seems like when you're talking about your recovery efforts in Puerto Rico that there should be very little spillover into the first quarter.

Is that right in terms of what you're currently projecting? And what's the risk that some of these efforts take a little bit longer to kind of shore up your supply?.

Matt, good morning. We have three factories in Puerto Rico. And I think our lowest percentage of operating capacity right now is at probably around 70% to 80%, okay? So, we will have very little impact in the first quarter.

We're going to have on-hand inventory of those products towards the end of January, meaning on-hand, I mean product in the inventory that can be shipped. So nothing that we know today would prevent us from having inventory position be well-positioned by the end of January.

That doesn't mean that you're not selling the product, meaning that we have a pretty good inventory levels at that moment in time. So, I will say the impact in the first quarter is small. But I want to make sure that people understand that the infrastructure in Puerto Rico is devastated.

So we are operating under emergency situation with generators, and we have water in our plants and everything else. So the plants are fully operational, but we need to make sure the federal government continues to provide the support for the recovery of the island.

We have one of the plants already going on to the grid, hopefully by the end of this week. So, as we continue to see progress, our confidence becomes even stronger. But based on what we know today, very little impact in the first quarter..

Okay, Joe, thanks for that. And then, I wanted to ask one on the Renal business. If I look at the guidance for the year, it looks like you're projecting a little bit of a pick-up in the fourth quarter, and this is the first quarter the HD business has grown in a while.

Can you talk about what you're expecting going forward, and if we could see more of a pick-up, I guess, in the HD business, with you participating in tenders, or what's going on there?.

Yeah, we are expecting low single digits in the HD business.

But one thing that we have done is, we anniversary some issues that we had in dialyzers on a global basis, primarily outside the U.S., where we encountered significant competition and price erosion that has been anniversaried, but also, we're the second largest manufacturer of dialyzers in the world, so we have the ability to compete very effectively outside the U.S., and I think this is one of the changes in mindset from the old Baxter to the new Baxter.

You operate where you can and make sure that manufacturing is a strategic weapon for the company. So, when we look at the market, we can provide the market with the great products outside the U.S., in a very cost-effective manner and also profitably. So, we want to make sure that we participate.

You know previously here in the company we probably did not have that window into the opportunity. So what you're seeing right now is the pick-up of our dialyzer business outside the U.S. markets and the stabilization of our monitor sales, as well. So, we feel cautiously optimistic and happy with the turnaround in the HD business..

Okay. Great, Joe. Thanks for the color..

You're welcome..

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

Hi. Thanks very much. First, just a clarifying question.

I'm sorry if I missed this, but, Jay, in terms of the EPS impact of currency in 2017, can you tell us what the impact is in 2017, and your thoughts on how currency is shaping up as we look forward?.

Yeah, I mean, as we think about the second half of the year relative to forecast, while we have seen a fairly meaningful sales improvement relative to foreign exchange, the actual drop-through has been fairly low. So, maybe a penny or two on the bottom-line. And I bet – I would characterize that as a result of a couple of things.

One is, given that a lot of this strength comes from Euro strength, we have a very large European cost base in place. So, we don't see a great benefit from the translation back of dollars of increasing Euro performance. Now, we are working on our European cost base, and that will improve over time, but, the benefit of a stronger Euro is a bit muted.

The other factor that comes into play when we think about foreign exchange is we have had – we have put on hedge positions over the last six quarters, hedging out Euro and other currencies, and so, we have a little bit of an offset.

As the Euro strengthens, our translation improves, but that's offset a little bit by lower gains in terms of foreign exchange on the hedge positions that we have. So, in combination, I would say that while we did see a sales impact, we didn't see an intended drop-through to the bottom line, for the most part.

And looking out to 2018, clearly there is some currency strength that we're evaluating that could have an impact, but there are a lot of different factors in play as we look to 2018..

Great. That was very thorough. Thanks, Jay.

And then, Joe, just I was wondering if we can get an update on your latest thoughts on capital allocation? And specifically, how you're thinking about the growing free cash flow and cash that you have? If deals do not materialize, are larger buybacks what we can expect as the most likely use of cash? Or are there circumstances where you'd let cash build? Thank you..

Bob, we always prefer to invest the money back into the company. In this case, the cash flow of the company into acquisitions. When it is not possible, we're going to buy shares back, okay? But I want to make sure there is not an exclusivity to my statement, meaning that those are not mutually exclusive.

We will do both of them because I think our cash position and our ambitions in terms of targets, we can do both, buy shares and continue to pursue M&As. I would say that large acquisitions are very difficult to combine, and the return-on-invested capital that they bring along is marginal. So, we are focusing on molecule purchasing.

We have a lot of those in process right now, tuck-ins, product lines from companies are divesting, things such as this to augment our growth in the long-term, and augment our four pillars of growth in our business, which is the pharmaceutical business, the critical care, the surgical, as well as parts of our renal area, primarily areas that will be beneficial to us outside the U.S.

in terms of buying clinics and things like that. So, if we find acquisitions in these areas where we're going to execute and we have a brand-new M&A team and we see some really good momentum there. But, it is not exclusively one or the other.

Be sure that we will continue to apply our cash flow, our growing cash flow to share buyback and to deliver value to our shareholders. I would say maximized value for our shareholders..

Great. Very clear. Congrats on a great quarter. Thanks..

Thank you..

Thanks, Bob..

Thank you. And our next question comes from Mike Weinstein of JPMorgan. Your line is now open..

Good morning. I want to try and run through a couple of items. So, first, in the quarter, what was your ability to capitalize on B.

Braun's manufacturing challenges in the Solutions business? And then, could you just spend another minute on the IPS out-performance this quarter going into, obviously a more challenging fourth quarter because of the hurricane? Thanks..

Mike, I would say that one thing that we have changed at Baxter is our view of supply chain. And this has changed significantly in the last six months. And the reason is that we not only now are preparing to come into the U.S. with significant volume in LVPs to help assure our current customers that they will have LVPs.

So, we do have that capability coming from other plants in the Americas, and that has already advanced to a point that we're going to start seeing that volume coming into secure volume and help guarantee volume for our current customers in the first quarter of 2018.

But, also, volume that will serve to consistently meet the necessities of customers that are not ours in a situation like B. Braun. So, we are selling every LVP that we have today. I know the situation in the U.S.

is not desirable from the point of view of the providers with the current – the competitor that you just mentioned having quality issues or supply issues. I don't know which one is what, but I know that we are doing everything we can.

But in the future, to be able to capitalize on this, we are bringing significant volume into the U.S., now that it has been redirected permanently, permanently from other parts of the world to the U.S. in a very cost-effective manner and also it is approved by the agency.

In terms of the fourth quarter, I think Jay was clear about the upside that we have in cyclophosphamide, as we don't see a third competitor or fourth competitor coming to that market, so, we'll be able to offset the Hurricane Maria impact. But once you clear that impact, we also are making provisions so we can have enough SVPs.

So, let me clarify what SVP is. It's small volume parenterals, and that's the product made in Puerto Rico. Puerto Rico does not make one-liter bags, does not make 500-mL neither 250-mL bags. Okay? So, separate both of them. I think there's some misinformation going around, spread by other competitors about what makes what and who makes what.

So, we want to make sure that people know. We also are augmenting volume and production of SVPs coming out of Puerto Rico to be able to satisfy not only current customers, future customers. So, we see the Solutions business in the U.S. as a good business; therefore, we made some permanent decisions in allocation of capacity back into the U.S.

to augment current contracts and future contracts..

Okay. And just to clarify, there was a piece in the IPS Business internationally this quarter that you said was one-time.

Could you just maybe explain what that was, and how much it was? And then, Jay, just a tax rate question, you're guiding to a lower tax rate, initially it was after the fourth quarter at 18%, can you just speak to the sustainability of that in 2018? Thanks..

So, Mike, what happened was, that was a one-time contract – contractual payment due to us outside the U.S. in a compounding pharmacy area, and there was $20 million this quarter.

Okay?.

Got it..

That's what we highlighted, we're not going to repeat, but was a contractual paid to us. And I'll pass it on to Jay to answer the second part of your question..

Yeah, certainly. The tax rate has trended favorably relative to our expectations. In the third quarter relative to out-performance, tax rate contributed about a penny. And then, again, in the fourth quarter, we're seeing some positive performance from tax rate.

The biggest driver of this relates to FAS 123-R, which is the new stock compensation guidance. At this point, it's difficult to forecast the long-term impact of that, because to a large extent, it's dictated by auctions exercise and the nature of those auctions, in terms of their value relative to what's anticipated by the Black-Scholes model.

So, it's hard to say what the tax rate impact will be in 2018 based on these items, but we're certainly pleased with the performance that we've seen in 2017 related to this item..

Understood. Thank you..

Thank you. And our next question comes from David Lewis of Morgan Stanley. Your line is now open..

Good morning. Joe, I wanted to follow-up on one of Mike's questions on Fluid Systems. Our sense at our conference was increased enthusiasm for the ability to add capacity in the back half of this year to provide more capacity to customers next year. And you mentioned this could be a tailwind through the first quarter.

Could this actually turn out to be relative to some of the destruction when your competitors, a tailwind longer, or have a longer duration into 2018 than just the first quarter?.

David, I think we don't know the extent of other people's problems, and unlike other competitors, we will not speculate what their problems are. But, what we can say is what we are preparing to do. We are preparing to bring to the U.S. a strong volume of LVPs in the first quarter.

It's starting in the first quarter, coming from one of our factories in the Americas that is approved to ship into the U.S. already. And that will not only help secure volume for our current customers, but also open our ability to compete for secured volume for other customers, which currently are not our customers.

So, I'm not saying that we're going to be able to do it. I'm saying that we have the opportunity in front of us. And knowing our Baxter U.S. team, led by Scott Luce, I would say that I have full confidence that team can deliver on the opportunities..

Okay. Maybe just two quick follow-ups. So, Joe, obviously last quarter you provided an LRP, and a general association of growth for sort of 4 percentage growth for the LRP.

Can you just give us a sense kind of roughly, Is that a good proxy for how we should think about 2018 growth rates? And then for Jay, just on Claris, I mean you're pretty confident at our conference around this. But the warning letter sort of came out here intra-quarter, more details of that letter.

Are you comfortable with sort of where you are from a mediation perspective on Claris? And do you forecast any additional costs that we may not know about heading into 2018? Thanks so much..

David, what we said in July about the LRP has not changed. But we would like not today to provide guidance into 2018. So, we will be tuning first week of February, we'll tell you all about 2018.

But today, I think we should focus on the third quarter of this year, which we finished, and the quarter coming up, which we're currently on the fourth quarter of 2017. Let me comment on the first part of the question of Claris, and I think Jay can talk about the cost, if there's something to add.

We have already responded and are on schedule to deliver on every promise we made to the agency to address their concerns on every observation. So, to summarize, we are on the good path of addressing, from our perspective, the issues that have been raised by the agency. Okay? We knew some of those issues ahead of time.

And we already had plans, before we closed this deal, that we're going to put Baxter quality systems in place. We had no doubt about that. We are doing everything we can accelerating the pace to put those in place.

We feel that the value of the acquisition is still very much on target, and the value proposition has not changed, which is quality, low cost, and availability of product. And I think the amount of the resources that we have deployed to Claris to resolve these issues and improve their quality systems has been second to none.

Baxter does a great job in mobilizing and addressing a crisis, and they did a pretty good job. So now we feel very comfortable that everything that we're doing, we're seeing the effect and we've seen the effect in a positive manner. Remember I speak from our behalf, not on behalf for the agency.

Second thing, the amount of money that is going to be used to remediate the quality issues that we have, that we already had most of this cost predicted, we don't think at this point in time, I'll pass on to Jay, there will be something of large extent. Because, first, we know some of them are not expensive to fix.

It's just procedural things that we have to do, but I will pass it on to Jay if he has anything else to add..

Really not much. I mean, we have no material changes to our financial cost projections for the business. I think Joe summed up the situation very well..

Thank you very much..

Thank you. And our next question comes from Isaac Ro of Goldman Sachs. Your line is now open..

Good morning, guys. Thank you. I wanted to ask a couple of questions about the growth strategy. First, just kind of looking internally; not a lot of attention on the call today regarding Claris, in terms of the pipeline. Can you maybe just give us an update on kind of where you stand, bringing some new products to market.

As I recall, it was more of a 2019-2020 story, but just looking for an update on how we should think about the contribution to organic growth?.

Innovation is picking-up momentum at the company. I would say that bringing Sumant on board was a big victory for us, and he's starting to make a big difference in how we see innovation. I would say it is playing 19-20 is more of a play there. But we're making everything we can today. Actually, just look at our R&D spending.

It was a little up on a sequential basis, and the reason for that is, we're going after some more clinical trials, something the company has shied away in the past of doing. So we're going more after clinical trials, like TheraNova. We have clinical trials in a couple of different places. We are spending more money in our infusion systems.

As you know, we have a new version to be submitted to the agency and then to be released hopefully next year, of our spectrum, SIGMA Spectrum. We have new platforms coming up in 2020. We have our new CRRT machine coming to the U.S. in 2019. We have new filtration systems going in for different types of toxins. Going to be launched in 2019 and 2020.

So we have the momentum going. I think the biggest challenge that we have is to make sure that we balance the spending in R&D with the spending in the infrastructure of R&D.

So, as we continue to modernize and bring the right people to the company to help cement this innovation, we don't get ahead of ourselves in creating more R&D centers, which we're not going to do. As a matter of fact, we're going to reduce the amount of spending in infrastructure and increase the spending in product development.

So, we just want to keep transparency and give you, on a quarterly basis, an update of some of our advancements in innovation, which is the next thing for Baxter to be successful, is to combine the significant transformation of the business costs with the innovation, to deliver the best benefit for our shareholders..

Great, thanks. And maybe just a follow-up on the inorganic side for growth. You mentioned earlier that large transactions are difficult and, of course, the overall environment for asset prices continues to go up.

So, I'm curious if you could talk a little bit about the extent to which your strategy for M&A is evolving, and in particular, sort of the opportunities that you see maybe outside the U.S. that are perhaps less obvious to those of us in the U.S. market? Thank you..

M&A follows a strategy. We don't have an M&A strategy per se. We have a strategy for every business of the company. And M&A is following that. In the past, we had those two not very well coupled and now we do. Our strategy for the company is expansion inorganically, not only in the U.S., but across all regions.

In Europe, as well as Asia with focus in China. And we have the people being put in place to be able to scout those opportunities. We have an M&A team that is focused in bringing more deals. I'm seeing more deals now in the pipeline than I have seen before, but not deals that are – more relevant deals.

Deals that have higher probability to be executed in a very large and very fast, by the way, process going on in our pharmaceutical groups, our pharmaceutical group led by Bob, Robert Felicelli. Now, it's time to accelerate and we have identified a significant amount of opportunities in their group for growth. So, inorganically, by the way.

And so, now I feel a bit more comfortable that we have the right structure and the right strategy for the company to execute on inorganic opportunities..

Got it. Thank you..

Thank you..

Thanks, Isaac..

And our next question comes from Matt Miksic of UBS. Your line is now open..

Hi, good morning. Thanks for taking my questions and congrats on a terrific quarter. So, I wanted, Joe, maybe just first to follow-up on that last comment. You've made a few comments on strategic investment perhaps preferring kind of tuck-in smaller molecules, as you've talked about.

And I'd love to understand, you know, there's clearly opportunities in your – across your operating structure to sort of drive leverage, Claris and molecules is one, and your specialty injectable platform. Surgical call-points is another.

And on the Hospital side, on the Surgery side for product lines or things like that, I'd just love to get a sense of which elements of Baxter's infrastructure, operations, call points, sales force, I don't know, distribution, adjacencies, do you see as opportunities to leverage? Because I assume if you're looking at product lines, that's one of the key elements of the opportunities.

And I have one follow-up..

Our call points go from Hospital to Home. In the Hospital side, we have, in the U.S. and large geographies around the globe, a very good, I would say, probably one of the best key account management groups in the industry.

So, our ability to put things in contract, private label products, primarily drugs for GPOs, becomes a real strength when you're looking at these small molecules and how you bring them online. So, look at Claris. With Claris benefited from Scott Luce's opportunities in the U.S. Scott runs our business in the U.S.

sales for the Hospital business and immediately got some accretion going on with the Claris molecules in the U.S. So, that is a sweet spot for us. We will shy away, at least in the beginning, to go into spaces that you have to create a brand new sales force with no synergies because the value of those acquisitions are quite dilutive to begin with.

Then you look at the Home. We have a sales force to call on home in our Renal business, our PD business, with significant penetration in the U.S. So, the ability to put more on their bag is important to us, and is also an opportunity.

So, the call points in Surgery, for instance, we have – we are in the ORs, but we need to find the sweet spot in the ORs with our sales reps can be relevant. So, we're not going to look into generic instrumentation and laparoscopy stuff because those things the market is saturated with that.

There are companies that own that space and we have no value there. But we add value to niche operations, niche spaces of therapies or procedures that we can probably have our sales force scanned it back.

So, we will see some movement in terms of inorganic opportunities in the future that capitalize on our sales force and the hospital surgery-wise, where we put more products in their bags and they will probably do a great job on that..

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

Good morning, guys. Thanks for taking the question. So, Joe, emerging markets account for about 20% of your sales, but they don't get a lot of attention on these calls, and the growth has been sluggish, I think, in the first half of the year in emerging markets for your business.

What was growth like this quarter in emerging markets? And what's the outlook there? And I had a follow-up. Thank you..

Larry, just want to clarify. What is called emerging markets is 23% for Baxter. So, you can see Baxter different than other companies, that are called peers, have a pretty high penetration in those markets.

Most of the products we sell in emerging markets are not devices, per se, they are renal and they are fluids, okay? So, when we look at market growth rates, and you said sluggish in the first half, we were just growing in market rates for the markets we compete.

We had a pretty strong third quarter with, for instance, China at 7%, okay? That was a pretty good market growth for us. We do have depressed numbers in emerging markets because it's the place we exited the most of our IP business.

So, places like Turkey, like a reduction in volumes in the Middle East, Venezuela, parts of Latin America, as well as parts of Greece, that we took volume down. India, we got out of 100% of Fluids business in India. That's where you see a depressed number. When you remove those, you still are pretty good, strong underlying.

So, having a 7% growth in China, it is a great growth for us, because in China we are in peritoneal dialysis, nutrition, and IV fluids and anesthesia gases, okay? So, these are the businesses we have there. We do a great job.

We have market share leadership in almost everything we participate in China and China is completely – is going through a complete transformation where we're going to bring more value-added fluids to the market instead of just your regular dextrose and saline.

So, I feel really strong about China in our LRP crossing the billion-dollar mark, which I think is a challenge, but is going to be a doable – doable challenge to the Chinese team..

Joe, just to clarify. So, when the business exits, and this year we should see an improvement in your emerging market growth rate, it sounds like. And then just one for Jay. You know, year-to-date growth is about 5%. You did 6% in Q3 operational growth, it looks like adjusting for the $70 million from Puerto Rico.

It's about 4% in Q4, and that's off of a little bit of an easier comp year-over-year, I believe. So, maybe if you could help us just kind of bridge Q3 to Q4, what do you expect to decelerate a little bit, that would be helpful? Thank you..

Certainly. The primary driver, as you noted, of the sales deceleration in the fourth quarter relates to the $70 million impact from Hurricane Maria.

But beyond that, as we think about comparison Q3 to Q4, as Joe mentioned in his answer to a question, we did have about $20 million related to a contract buyout, which we don't anticipate repeating in the fourth quarter. That was more of a one-time item, per se, or a specific to the third quarter, I should say, item.

And so, if you adjust for that the growth rate essentially comes down a point. We had anticipated that. It was no surprise, but it was part of the forecast that we put together. So, what I would say, generally, is we – when we guided in July of this year, we said overall the business is a 4% grower from 2017 to 2020.

In many cases, there are quarterly fluctuations. The first quarter was above that rate, the second quarter was below, the third quarter was above, and the fourth quarter we expect to be in line, but for the Hurricane Maria impact. So, I think largely we're growing a little bit faster than our end markets.

And then what we do is we go through a bottoms-up forecast process and isolate things like austerity measure impacts and one-time buyouts, and so on, and put together the forecast. So, really, that's the essential commentary, I think, thinking about the fourth quarter, but no material change in trends, per se.

Continue to grow in line with our long-term expectations..

Thanks for taking the questions..

Certainly..

Thank you. And our next question comes from Danielle Antalffy of Leerink. Your line is now open..

Thanks so much. Good morning, everyone. Thanks for taking the question. Joe, I just wanted to ask about the impact of the Renal business from the Fresenius-NxStage deal.

How do you think that changes the competitive dynamics, and does that change Baxter's overall view of home hemodialysis?.

I think the market dynamics will not change in the long term.

Okay? I believe that the leadership positions that we have today become the same going forward three, four years out when you think about innovations that we are bringing to the marketplace in PD with point of care, and also the CRRT business with us launching our new Prismax platform in the U.S., as well as extracorporeal stuff that we're going to be launching in the U.S.

So, I would say that, I can't comment on why people do things. They are not related to Baxter. So I'm not making a judgment on why one company bought another one.

I just don't see the reason why that would affect our market in the short and long term, primarily because, to date, we have market share leadership in CRRT, and we're not letting up on innovation. And in PD, the same thing.

So, we want to make sure that our investors understand that we have a very strong pipeline going forward, and the acquisition or the merger of these two companies are quite immaterial to us at the moment, the way we see it..

Okay, thanks for that. And just sticking to renal, I was hoping you could talk about how to think about the drivers of the Renal business in 2018. Not asking for guidance, but you're continuing to roll out AMIA. You will anniversary some of these less favorable tender exits.

So, just wondering, do you view 2018 as a growth acceleration year, or do we really have to wait for the on demand PD system in 2019 before we see the Renal business pick up? Thanks so much..

I just want to start with the end. I will not – I want our investors to understand that the POC, point of care is not a driver of our business, neither is something that will transform the business and change the growth rate of the business in any way, shape, or form. Remember, we are the market share leaders in PD around the globe.

And so, for that purpose, the growth rates of the market are primarily dictated by the growth of the disease and our growth. So, I would say that you will continue to see a growth in patients. The patient growth has been healthy for us, and we think we'll continue to become healthier as we move forward.

And the HD negative tenders that we either did not participate or had a significant price impact, we will anniversary. So, the Renal business is in good shape, and we will save some of the news for 2018 for February when we give guidance..

Okay, that's fair. Thanks so much..

Thank you. And our final question comes from the line of Larry Keusch of Raymond James. Your line is now open..

Thanks, guys. Thanks for squeezing me in. Joe, so, maybe this is getting a little bit in the weeds. But I'm very curious about this Sepsis opportunity that you sort of started to talk about and some of the clinical trialing going on.

Could you just shed a little bit of light on sort of the way to think about either the opportunity or the timeline here? And then I had one quick one for Jay..

Larry, what we find is, extracorporeal technology has evolved, and our know-how in membranes and filtration systems help us get there faster. So, if you combine the fact that a patient who is in continues renal replacement therapy in an ICU, will have the probability of developing multi-organ failure.

Starting with the kidneys and you go to lung, liver. We are developing filtration systems or membranes specifically for that. So the Sepsis one is, there are some toxins that our oXiris product will filter. And is successful in Japan, which is making this changes and creating the momentum across the globe, all the way coming to the U.S.

We have a lung product that we currently distribute today, which is very effective. We also have MARS. Which is used – I was at Emory University the other day, and extensively used there for treatment of liver toxins. And is used in conjunction with our current CRRT product, which is in the market, Prismaflex, today. So, we really like that space.

We have a new general manager for this business on a global basis. As a matter of fact, I'm going to see some revised plans this week in terms of how to expand this technology a little faster and a little deeper into markets.

But we're excited about those extracorporeal technologies using the current technology that we have for CRRT, but also banking on Prismax, which is the new platform coming out today – coming out in the U.S., probably sometime in 2019..

Okay, perfect. And then, Jay, just quickly. Obviously, working capital improvements have been a big opportunity for you guys.

So just, again, remind us where you've been making the improvements in working capital, and just any thoughts on opportunities as you look forward?.

Sure. Really, working capital and I would say, generally speaking, cash flow performance has been a core area of focus of the entire organization. And I think we're really pleased with the progress. On the working capital front, frankly, it's been all three areas that have been squarely in our focus. Inventory management, days payable, and DSO.

And in the third quarter, we had good performance across all three. I think the quarter ends with days payable of 49, days sales outstanding of approximately 55 days, and inventory on hand in the 90's.

Now, certainly, we want to make sure we have adequate inventory on hand and, I think with the hurricanes and so on, that number may be a little bit low relative to standard levels. So, we'll look to rebuild the days inventory on hand. But overall, very pleased with the progress.

We have initiatives across each of those three areas, along with a clear focus on CapEx with a zero-based budgeting process for CapEx. And it's just nice to see them all paying dividends..

Okay. Very good. Thank you..

Thank you..

Thank you. And there are no further questions at this time. Ladies and gentlemen, this does conclude today's conference call with Baxter International. Thank you for participating and everyone have a great day..