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Edited Transcript of BAX earnings conference call or presentation 25-Apr-19 12:30pm GMT

Q1 2019 Baxter International Inc Earnings Call

Deerfield Apr 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Baxter International Inc earnings conference call or presentation Thursday, April 25, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Clare Trachtman

Baxter International Inc. - VP of IR

* James K. Saccaro

Baxter International Inc. - Executive VP & CFO

* José E. Almeida

Baxter International Inc. - Chairman, President & CEO

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Conference Call Participants

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* Danielle Joy Antalffy

SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst

* David Ryan Lewis

Morgan Stanley, Research Division - MD

* Matthew Charles Taylor

UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices

* Matthew Stephan Miksic

Crédit Suisse AG, Research Division - Senior Research Analyst

* Robert Adam Hopkins

BofA Merrill Lynch, Research Division - MD of Equity Research

* Robert Justin Marcus

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Baxter International's First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded by Baxter and is copyrighted material. It cannot be recorded or rebroadcast without Baxter's permission. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Ms. Clare Trachtman, Vice President, Investor Relations at Baxter International. Ms. Trachtman, you may begin.

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Clare Trachtman, Baxter International Inc. - VP of IR [2]

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Thanks, Candace. Good morning, and welcome to our first quarter 2019 earnings conference call. Joining me today are Joe Almeida, Baxter's Chairman and Chief Executive Officer; and Jay Saccaro, Baxter's Chief Financial Officer.

On the call this morning, we will be discussing Baxter's first quarter 2019 financial results and our updated financial outlook for full year 2019.

A supplemental presentation to complement this morning's discussion can be accessed on our website.

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

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

And of course, our actual results could differ materially from our current expectations.

Please refer to today's press release and our SEC filings for more details concerning factors that could cause 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 is available on our website.

On the call this morning, we will be discussing operational sales growth, which adjusts for the impact of foreign exchange and generic competition for cyclophosphamide in the U.S.

With that, I'd now like to turn the call over to Joe. Joe?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [3]

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Good morning, and thank you for joining us. We're pleased to share our first quarter results with you today and to discuss our updated expectations for 2019. I will begin with a quick review of our performance in the quarter, and Jay will then provide more detail on the financials. We will wrap up with Q&A.

Baxter opened 2019 with a solid first quarter, delivering sales growth of 2% from both a constant currency and operational basis, representing the high end of our projections. Reported sales declined 2% with foreign exchange negatively impacting sales by approximately 400 basis points in the quarter.

On the bottom line, adjusted earnings per share were $0.76 and advancing 9% year-over-year. Growth was driven by top line sales performance, operational efficiency initiatives, a lower tax rate and a reduced share count. The breadth and essential nature of our portfolio reinforced Baxter's underlying stability even in a dynamic health care landscape.

First quarter results benefited from positive performance across our Renal Care, Pharmaceuticals, Advanced Surgery and Acute Therapies' businesses, supplemented by increased demand for Baxter's cytotoxic contract manufacturing services. This strength helped offset the sales declines in our Medication Delivery and Nutrition businesses in the quarter as expected.

Renal Care continued to perform well and maintained underlying momentum globally. Negative growth in the U.S. as expected was due to our strategic exit of the in-center hemodialysis bloodline business. Demand for our peritoneal dialysis therapies remains strong with patient volumes increasing high single digits in the U.S. and mid-single digits globally. The continuing rollout of our new PD cyclers, AMIA in North America, KAGUYA in Japan and CLARIA in Europe is helping to fuel this growth.

Pharmaceuticals delivered a strong mid-single-digit growth globally on a constant currency basis despite facing unfavorable comparisons from increased U.S. generic competition for cyclophosphamide and BREVIBLOC. The strength in the Pharmaceuticals business reflects the positive contribution of the Claris Injectables portfolio and our steady launch of new molecules, including the recent launches of 2 premixes in the U.S., dexmed and epti. Increased demand for Baxter's Hospital pharmacy compounding services as well as growth in our anesthesia business also contributed to growth in the quarter.

Double-digit constant currency growth in Advanced Surgery was driven by the U.S., which benefited from last year's acquisition of RECOTHROM and PREVELEAK. We're continuing to enhance our hemostatic product line in response to customer needs, most recently with the FDA approval of a next-generation faster prep configuration for FLOSEAL. This makes it even easier and quicker to employ our leading hemostatic in the operating room.

And our Acute Therapies business delivered solid mid-single-digit constant currency growth globally. Recall last year, this business benefited from an intense flu season, creating a difficult year-over-year comparison. We continue to see strong trajectory here with the launch of our next-generation PrisMAX technology, gaining traction in the ICUs in Europe and is off Q1 Asia Pacific as well.

This quarter, Baxter and NantHealth also announced that a digital health solution is now available to connect Prismaflex with the hospital EMR system. This represents a key enhancement in our digital care portfolio.

In addition, a new collaboration with bioMérieux is focused on identifying biomarkers to diagnose acute kidney injury earlier, reflecting our strategy to broaden our impact across the continuum of care. The growth in this business was partially offset by the anticipated declines in our Medication Delivery and Nutrition businesses. This past quarter, Medication Delivery faced a challenging comparison to our first quarter 2018.

You will recall the demand for U.S. large-volume IV solutions spiked in the first half of last year. This was due to hospitals and distributors stocking up in response to industry-wide supply challenges following Hurricane Maria as well as the intense flu season. Performance in this business is expected to improve sequentially over the course of 2019 driven in part by our ongoing recapture efforts for small volume parenterals and the continued uptake of our new pump platforms Spectrum IQ in North America and Evo IQ in selected international markets.

And as I have mentioned previously, we are re-basing our Nutrition business in the U.S. The upcoming launch of Clinolipid marks our first U.S. launch in our Nutrition business in over a decade. It will be an important milestone in our efforts to reactivate growth.

Our employee base remains highly engaged and focused on delivering innovation that improves patient outcomes, enhances safety, facilitates the shift of care to the home setting and increases the ready access to generics, including drugs in short supply. This will allow us to address many of the pressing issues facing hospitals today as they look for opportunities to further reduce the potential for medication error and decrease costs.

In summary, we're encouraged by the underlying strength of the quarter. Our results are built on a combination of enhanced operational efficiency and a revitalized innovation pipeline as we are well positioned for growth acceleration.

Before I pass it over to Jay, I want to provide a quick update on our quality efforts. As you know, we have been operating since 2013 with an FDA warning letter in place for our North Carolina and Jayuya, Puerto Rico manufacturing plants. This week, we received notice that the FDA has now classified our Jayuya site as voluntary action indicated or VAI. We're pleased with this development, which we believe reflects our steadfast commitment to quality in Baxter and acknowledges progress in our efforts to help ensure reliable product supply for our customers.

Now I will pass it to Jay to provide more details on our financial performance and outlook.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [4]

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Thanks, Joe, and good morning, everyone. As Joe mentioned, our first quarter results, which exceeded our expectations, position us well for accelerating growth throughout the year. I'll start by discussing our first quarter results before providing our updated financial outlook for 2019.

Beginning with the first quarter, global sales of $2.6 billion decreased 2% on a reported basis but increased 2% on both a constant currency and operational basis, reflecting global strength across several of our businesses. On the bottom line, adjusted earnings increased 9% to $0.76 per diluted share. This exceeded our guidance of $0.66 to $0.68 per share driven by solid operational performance, phasing of certain R&D investments and a lower tax rate.

Now I'll walk you through performance by our geographic segments and global businesses. Note for this quarter, constant currency growth is equal to operational sales growth for all businesses and segments except for our Pharmaceuticals business in the Americas region, for which we will provide operational growth in addition to constant currency growth.

Starting first with sales growth for our 3 geographic segments. Sales in the Americas declined 1% on a constant currency basis and were flat operationally. Sales in Europe, Middle East and Africa grew 4% on a constant currency basis, and sales in our Asia Pacific region advanced 7% on a constant currency basis.

Moving on to performance by global businesses. Global sales for Renal Care were $851 million, advancing 3% on a constant currency basis. Performance in the quarter was driven by continued momentum for PD therapies partially offset by lower sales in the U.S. for select in-center HD products, including the recently exited bloodline business. Adjusting for this impact, underlying growth in the Renal Care business was approximately 6% in the U.S. and 5% globally.

Sales in Medication Delivery of $634 million declined 4% on a constant currency basis, in line with our expectations. We are on track with our recapture efforts related to small-volume parenterals as our teams continue to reinforce to our customers the safety and efficiency of our SVPs for drug reconstitution.

Finally, we are pleased with the market response to both our Spectrum IQ and Evo IQ infusion pumps. As Joe mentioned, we expect growth to accelerate in this business over the course of the year as we anniversary the 1H 2018 stocking impact, execute on SVP recapture efforts, capitalize on new pump launches and improve product availability internationally.

Pharmaceutical sales were $509 million, increasing 6% constant currency and 9% operationally. Contributing to performance in the quarter was strength in our international hospital pharmacy compounding business, increasing demand for anesthesia and critical care products and robust sales of generic injectable drugs, which benefited from the new product launches Joe discussed earlier. Pharmaceutical growth in the quarter was partially offset by approximately $40 million of lower U.S. sales of BREVIBLOC and cyclo as compared to the prior year period.

Moving to Nutrition. Total sales were $205 million, down 5% on a constant currency basis. We continue to focus on returning to positive growth in the U.S. and are gaining traction with our recapture efforts. International sales also declined in the quarter primarily driven by the phasing of some orders in Asia Pacific and CEMEA, which shifted from Q1 to later in the year. We remain focused on enhancing performance for our global Nutrition business through improved execution and innovation, including the introduction of new products for both U.S. and international markets. We expect sequential improvement in growth rates for our Nutrition business throughout 2019.

Sales of $198 million in Advanced Surgery increased 12% on a constant currency basis. Growth in the quarter was driven by increased sales of hemostats and sealants, including a contribution from RECOTHROM and PREVELEAK of approximately $17 million in the quarter. The acquisition of these assets from Mallinckrodt has allowed us to broaden our portfolio of hemostats and sealants, so we can offer surgeons more choices.

Sales in our Acute Therapies business were $128 million, representing growth of 4% on a constant currency basis. As Joe mentioned, this business faced a challenging year-over-year comparison as Q1 2018 benefited by approximately $11 million due to flu-related sales in the quarter. Adjusting for this impact, growth in our acute business remains strong driven by new product launches, continued focus on geographic expansion and our clinical education efforts, demonstrating the benefits of CRRT for the treatment of hemodynamically unstable AKI patients.

Finally, sales in our other category, which primarily includes our contract manufacturing services, were $107 million, an increase of 8% on a constant currency basis. Performance in the quarter was primarily driven by increased demand for our cytotoxic contract manufacturing services and reflects an easier comparison to the prior year period.

Moving through the rest of the P&L. Our adjusted gross margin of 43.7% declined slightly as compared to the prior year period as the benefits from manufacturing improvements and portfolio optimization initiatives were more than offset by lower U.S. sales of cyclo and BREVIBLOC and a less favorable product mix. Adjusted SG&A totaled $587 million, flat to prior year on a reported basis and increasing 4% on a constant currency basis. The positive contribution from our targeted initiatives to improve operational efficiency were partially offset by the loss of approximately $7 million in transition service income received from Shire in 2018. In addition, as we continue to ramp up our efforts on accelerating innovation, we are making select investments in sales and marketing to help ensure successful commercial execution of new product launches.

Adjusted R&D spending in the quarter of $114 million decreased 17% on a reported basis and 13% on a constant currency basis versus the prior year period. R&D expenses in the quarter were impacted by the timing of certain project-related spend, which is expected to pick up beginning in the second quarter.

We continue to prioritize strategic investments in our innovation pipeline and the phasing of this trend does not materially impact any of our time lines related to new product launches.

Adjusted operating margin in the quarter was 17.1%, an increase of 40 basis points versus the prior year. Net interest expense totaled $18 million in the first quarter, an increase of $6 million compared to the prior year driven by a lower interest income and an increase in commercial paper balances in the quarter.

Adjusted other income totaled $25 million in the quarter driven by pension benefits and a gain on an equity investment as well as foreign exchange gains on balance sheet positions. The adjusted tax rate was 12.7% for the quarter, favorable to our expectations primarily driven by a benefit of $34 million related to stock compensation deductions as compared to $13 million in deductions the previous year.

And as previously mentioned, adjusted earnings of $0.76 per diluted share exceeded our guidance of $0.66 to $0.68 per share. Within the first quarter, we repurchased approximately $600 million or 8 million shares of Baxter stock, which was partially offset by option-related dilution in the quarter.

Before turning to the 2019 outlook, I will provide some commentary regarding cash flow performance. In the first quarter, free cash flow of negative $50 million was in line of with our expectations due largely to normal seasonality of the business. We do expect improvement throughout the year, particularly with respect to days inventory on hand.

Let me conclude my comments this morning by providing our guidance for the full year 2019 and the second quarter. For the full year 2019, we continue to expect flat to 1% reported sales growth globally, 2% to 3% constant currency growth and 3% to 4% operational growth.

Moving to full year guidance by business on a constant currency basis except where otherwise noted. In Renal Care, we continue to expect growth of 2% to 3% with ongoing momentum in PD being partially offset by lower sales in U.S. in-center HD. As a reminder, the strategic exits made in this business are expected to negatively impact Renal Care sales in 2019 by approximately $55 million.

In Medication Delivery, we continue to expect sales to increase approximately 6% with sequential improvement due to the drivers referenced earlier.

For our Pharmaceuticals business, we now expect a decline of low single digits on a constant currency basis. U.S. cyclo sales are now expected to total approximately $105 million versus our previous assumption of $95 million. Adjusting for U.S. cyclo, operational growth is expected to increase low single digits. As a reminder, BREVIBLOC sales are included in operational growth and are expected to decline approximately $75 million in 2019.

Moving to Clinical Nutrition, we continue to expect sales growth of approximately 3%. For our Advanced Surgery business, we continue to expect sales to increase 3% to 4% on a constant currency basis.

For the Acute Therapies business, we continue to expect growth of approximately 7% to 8%. Finally, in our other business, we now expect sales to decline low to mid-single digits.

Moving down to P&L. We now anticipate adjusted operating margin expansion of 80 to 100 basis points. We now expect net interest expense of approximately $65 million to $70 million and adjusted other income of approximately $85 million for 2019.

For the year, we now expect an adjusted tax rate of approximately 17%, reflecting the favorability from Q1. We now anticipate a slightly higher full year diluted average share count of approximately 520 million shares driven by increased option exercises in the first quarter. Based on these factors, we now expect 2019 adjusted earnings, excluding special items, of $3.27 to $3.35 per diluted share. This reflects the benefit of our first quarter overachievement as well as the anticipated shift in R&D investments to future quarters.

Finally, for the year, we continue to expect to generate operating cash flow of $2.3 billion and free cash flow of $1.6 billion. Specific to the second quarter of 2019, we expect sales to decline approximately 2% on a reported basis, growth of approximately 2% on a constant currency basis and growth of 2% to 3% on an operational basis. And we expect adjusted earnings, excluding special items, of $0.80 to $0.82 per diluted share.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) I would like to remind participants that this call is being recorded, and a digital replay will be available on the Baxter International website for 60 days at www.baxter.com. And our first question comes from Robbie Marcus of JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [2]

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There's obviously a lot of investor focus on Medication Delivery and Nutrition. But we're also seeing some really good results out of pharma. So maybe you could just spend a minute and discuss some of the puts and takes in the quarter in Medication Delivery and what you're seeing, but also some of the offsets and the benefits you're seeing in pharma. And then any commentary you can give us on expected cadence for the balance of the year given the focus there.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [3]

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Robbie, I will start, and then I'll pass on to Jay. Well put, investors tend to focus on things that they feel most comfortable which not necessarily is how management feels. So probably this answers about 50 questions that I'm going to get on the same thing that you just asked. So I feel comfortable with our ramp up in Medication Delivery. Why is that? First of all, the first quarter last year, we had close to $50 million in excess purchases in LVPs and SVPs that were not necessarily needed but were purchased because the hurricane effect, the flu that was very hard and people stocking up all those products. Consequently, the other quarters that we had were -- it started with quarter 2 and then culminating with 3 and 4, were really, really destocking, severe destocking. So when I compare Q1 this year with Q1 last year, what I get is a negative growth, rightfully so. Now why do I believe that we can get to the guidance in Medication Delivery? Right now, I have no indication otherwise. First of all, we have a good pipeline of pump either conversions or replacements in the horizon. So we feel good about that. Second, we are, as you know, have signed all the GPO contracts with extension of supply of our LVPs and SVPs. We're now signing IDNs with some of the GPOs with almost 100% of IDNs we signed and with opportunity to continue to gain potential market share because the investment that Baxter made in its supply chain culminating with investment in quality that resulted with the FDA issuing voluntary action indicated from the inspection that they had in December, not necessarily I'm affirming that the FDA will lift or not the warning letter that we have in those 2 facilities but indicates that our efforts have resulted in progress against observations of the past. So when we show this to our customers and potential customers, we have now redundancy in our supply chain, and people should feel comfortable about that, okay? So the SVPs and the LVPs, which are part of Medication Delivery, including the pumps, we have a plan to get there. And right now, I have nothing otherwise telling me that the plan is in jeopardy. Okay. When I shift to Nutrition, Nutrition is a longer recapture of the market. It's a product that has different indications for use. The discretion of the nutritionist and the physician changed once we could not supply them with amino acids after the hurricane. Practice have changed. We see us continue to make progress. It's not a '19 story. It's a '20 story, but I feel comfortable that we have enough gas in the tank with the launch of the Clinolipid this year that we can augment this growth.

Let me shift now to the Pharmaceutical business. When I first came to Baxter, I thought Baxter had a hidden gem in its ability to mix APIs in solution, make them stable either at room temperature or frozen and continue to advance in this niche space that has been very good to Baxter. Our Pharmaceutical team has executed extremely well, not only on new molecules that we're launching but also in molecules that we purchased through Claris. So we will continue to double that in Pharmaceuticals. We don't tell everything to everyone that we're doing, but we have a significant amount of development, a very healthy pipeline in Pharmaceutical, and that was by design put in play to create diversification for Baxter's base business, and what it's doing today is exactly that. I feel very comfortable about Acute Therapies. I think we are -- huge pluses from last year. I see that business growing. We have an opportunity with this business to get close to double digits even in face of a tough comp from last year's first quarter flu season. We launched PrisMAX. We just got file with the FDA, and the FDA started its period of review of our PrisMAX in U.S. It's doing well outside the U.S. Prismaflex, which is the generation before that, just got augmented with 2-way communication to the EMR. I found also Advanced Surgery to be doing a pretty good job in getting market share. We are there. There is a shortage in the market due to a competitor having a recall. We have capacity. Our FLOSEAL is still the best product out there for severe bleeding. So we're still doing well. We took the business from Mallinckrodt, RECOTHROM and PREVELEAK and did extremely well last year with it. So I find the execution of the company going well.

So going back to Medication Delivery, what I have in front of me is no indication that we're not going to do what we said we are going to do. So perhaps this can alleviate the same question in 5 different versions that may come after you. And one last comment is on Renal Care. Our patient growth has been good. It has been slightly over 5%. U.S. is doing extremely well with 8.5% growth in peritoneal dialysis patient growth. So we feel good about that. We got out on purpose of bloodlines. We made no money on that business. That business was $40 million, $50 million that was making no profit. As a matter of fact, we're losing money. So we made the right decision there. So all in all, I think the company is focused on execution, and we are absolutely with a brand-new team in the U.S. led by [Josette Macauley] and by Heather Knight, both of them with great track records, we continue to strive to meet our commitments.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [4]

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That's great color, Joe. Maybe Jay, just one quick question. We saw R&D tick down a little bit and SG&A tick up a little bit in the quarter, but you felt confident enough to raise the bottom end of the operating margin guidance for the year. Maybe just give us a little color in what was postponed in R&D and what the investments are in SG&A.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [5]

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Sure. So as I referenced during the call, one of the things we are incredibly excited about is the new product pipeline that we have. We're launching probably more products this year than we have in many years. But attendant with that, we want to make sure that we have the right commercial teams and commercial investments on the ground to support successful launches. So this was a rare quarter. On the face of it, SG&A grew 0%. But on a constant currency basis, we did see a few points of growth adjusting for TSAs, maybe it's 3% growth. And really what it comes down to is some of those select marketing investments. I'll stop short of delineating actually where those investments took place. But from an investment standpoint again, we just want to make sure that the markets are ready to successfully launch. Now from an R&D standpoint, it's always difficult to get the exact timing of specific milestone payments outlined in a quarterly plan. And so one of the things we found as we looked at results for this year is certain of our payments were shifting from Q1 to future quarters. And so we expect an acceleration as we move through Q2 to Q4 in terms of some of these payments. And frankly, we have reflected in our guidance roughly a $0.03 shift of R&D spending from Q1 to later quarters. It's not specific to one program. And I think from my standpoint, most importantly, it does not impact the launch timings of any of the products that we put forth. So there's no change to time lines. We can talk more about it but we are as bullish as we've ever been about the pipeline, but we did see some phasing. And we did not want to reduce R&D spending on a full year basis. We're going to see that spending come through in future quarters. The only other comment I would make is one of the things we've been really focused on is improving the efficiency of our R&D spending. So there have been a number of global initiatives in terms of consolidation and simplification, and you are seeing some of that yield dividends in the overall performance of the spend category.

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Operator [6]

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

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [7]

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Just to follow up on that last train of thought on the pipeline, Jay or Joe. Could you just talk a little bit about key pipeline time lines or launch dates for the rest of this year? Just kind of refocus us on what you think are the most important things as we look forward over the next 6 to 12 months on the pipeline perspective? And how that drives your confidence, not only in the outlook for this year but in the outlook for acceleration for next year as you'd expressed in the LRP.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [8]

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Bob, let's start with Pharmaceutical as we have a couple of molecules that we're launching. We are expecting a good-sized molecule for sometime early next year. So we're talking about 6 to 12 months from today. We also have the version 9 of our pump we launched last year, but we have a new pump platform coming up next year. And we're going to have 2 pumps coming out right out of the gate, which is a large volume pump and syringe pump, all integrated 2-way integration with EMR, all the stuff that you should have plus the best drug library in the market. We will have later that year, which is next year, we'll have the PCA pump, which is the third leg of the stool. And then in another 6 months after that, we'll have the ambulatory pump. So we have a 4-pump platform. We also continue to experience a significant uptake in demand for our KAGUYA cycler in Japan. That is going -- it's doing well. We just crossed 1,000-patient mark. And we've seen this business for the first time since I got here with growth in Japan. We also have PrisMAX, which I just spoke about. PrisMAX for the U.S. is a big deal. We hope to get approval probably within 6 months to 8 months, depends upon the FDA review time frame. And so we have over 20 products actually coming up for launch in the next 12 months. So some are small, some are more relevant, some are more long term, some more durable like the pumps and PrisMAX. We continue to look at a lot of different molecules, and so we feel comfortable that Baxter's shifting a bit now from its operations excellence and efficiency as all of you know, we've been doing for the last 3.5 years to start to see the fruits of the innovation coming through.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [9]

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And then just one quick follow-up for Jay. Jay, can you just comment on the puts and takes impacting the gross margin this quarter? It was a little weaker than we anticipated, and then your expectations for how gross margin flows over the course of the rest of the year.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [10]

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Yes. So from a gross margin standpoint, that was principally in line with my expectations, in large part because of the significant headwinds we experienced in some high-margin products in the first quarter. And so if you look at the first half of the year, we have a big drag related to BREVIBLOC. It's basically $30 million plus in Q1. It's another $30 million in Q2, and that comes through at a much higher margin than the corporate average. Furthermore, we have a little bit of an FX headwind in the quarter. We also have a cyclo headwind year-over-year again in the first quarter. And so those were particularly pronounced year-over-year headwinds that impacted the first quarter. As we move to the balance of the year, we'll see the normal cadence of improving gross margins throughout the year. So typically, Q4 is our strongest gross margin quarter. Q1 is typically our lightest. So we'll see that uptake as we normally do. But then we'll also have the benefit of an accelerated sales growth in the second half of the year, which will lend itself to a higher gross margin, both from a mix standpoint but also from a utilization in our manufacturing facility standpoint. If you look at the first half of the year, our overall guidance operationally is in the 2% to 3% range. As we move to the back half of the year based on easier comps but other accelerations as well, you start to see a much faster sales growth and an uptick in overall sales. So I think those are a few of the drivers that impacts gross margin. But like I said, this is largely in line with my expectations.

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Operator [11]

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

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David Ryan Lewis, Morgan Stanley, Research Division - MD [12]

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Just 2 quick questions for me. The first is just want to focus on cash flow and capital deployment. Maybe Jay, the question for you would be cash flow got up to a slower start here in the first quarter. So what's the pacing? What drove that in the first quarter? What's the pacing for the balance of the year? And then related to that, Joe, I just wonder if you could take a second and talk about cap deployment. Obviously, you're still continuing to purchase huge dramatic amounts of stock, I think $600 million this quarter. What are you thinking in terms of the pace of capital deployment relative to buyback versus M&A the balance of the year, and I had one quick follow-up.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [13]

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Sure. As it relates to cash flow, the cash flow came in, in line with our expectations. Q1 is typically the lowest quarter of the year for a number of different reasons, one of which is incentive payout from the prior year occurs once a year in the first quarter. We also had a large vendor payment that we had anticipated in the first quarter of this year that impacted the number. So, by and large, it came in very close to our expectations. So what that implies, David, to your point is a significant ramp as we approach the back portion of the year, and we'll start to see improvements in Q2. Now looking at the balance sheet -- and so what will happen, what will drive this improvement is operating margin and earnings growth, of course. But then you transition to look at working capital. And on the working capital side, 2 categories we don't expect to change too much: our days payable for the first quarter will be in the mid-50s, our days receivable will be in the low to mid-50s. So those 2 categories are exactly where we want them to be, and we'll continue to manage those aggressively. Where we expect to see a significant improvement in working capital relates to inventory. This is an area that has disappointed us over the last year. The inventory buildup as a result of different sales mix than we anticipated has been a real problem and something that we focused on correcting. But it's not something that corrects overnight. And in the first quarter of the year, the days inventory on hand will end at roughly 107 days. By year-end, we'll expect to see roughly a 10-day improvement in that particular area. And frankly, that will be the drive the lion's share of performance in our cash flow, free cash flow for the year. We've got a new leader in supply chain, Philippe Reale comes to us, and we're excited to have him on Board. He's been on Board for several months, and he has a number of new operating mechanisms. Joe and I are personally involved as well along with our Head of Operations. So we feel quite good about this, and we also knew that this number would be high in Q1. But I definitely am very focused on watching this improve through the balance of the year. Joe, do you want to take the question on capital deployment?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [14]

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Yes, just going back into inventory. A bit of the inventory was planned because we had nothing in terms of large volume parenterals in the inventory. Now we carry inventory at the levels that are appropriate to service our customers of today and future customers. So going back to capital deployment, David, we continue to look extensively at all kinds of different opportunities. We like some of the stuff that we're seeing. We're looking at molecules. We buy molecules, we buy small stuff all the way to large stuff we're looking at. Buying shares back until very recently was a good deal because we thought the multiple was depressed, and our treasury group did a great job. We continue to evaluate the deployment of capital in face of opportunities that we have in front of us. So we may or may not continue with the program at the pace that we had in the first quarter. It will depend a lot upon what opportunities we have in M&A. As I said before, there's always a good balance between strategy and buying shares back. We couldn't pass the opportunity in the last 6 months to buy the shares because we thought the price was adequate. And lo and behold, I think we made a very good decision in buying that. And if we speak to our investors, folks who are long holders of Baxter, they probably appreciated the fact that we had an opportunity, took that opportunity. Nothing would payback as best as that did for us and for our investors. But with that said, we need to continue to look at expanding Baxter's technology and opportunities. There's not a week that goes by that I don't see 1 or 2 opportunities. And as I say to folks, when it's the right one, you'll be the first one to know.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [15]

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Okay. And with my follow-up, I take a step back here. If I think about the debate into this year, it really was focused on the ability to drive earnings and your ability to deliver Med Delivery. I think in the first quarter, you jumped over the hardest margin quarter of the year, raising operating guidance and now we see raise earnings, so I think that's sort of asked and answered. Just to come back to Medication Delivery, Joe, I think you did a nice job sort of outlining how from a share capture perspective customer recapture, you're doing as well as you expected. The key question I think it's just from Medication Delivery underlying fundamentals, the demand equation in the channel and where you see inventories in the channel, how comfortable are you that those signals and what you're seeing in the channel are stable at a pace that you can build on and sort of benefit from this recapture you are discussing?

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [16]

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So David, I can see where our investors feel uneasy looking at a performance of the last year, a couple of quarters, coming into the first quarter and said, "How can you get there?" and it's one of the things is our credibility, right? So what we're saying to you is that we can do that because we can see through it, and we have the numbers, we have the reviews, but let me give a little bit more color. The market is quite stable, meaning there are not shortages out there. There's not a company that is out of the market. There's nothing like that. So what is important to our customers? That you have continuity of supply, that you have inventory, that you have the ability to supply a large swath of products under the Medication Delivery and be safe at the end of the day. So what Baxter brings to the table are a few things. We are a very stable supply chain right now. We modified significantly the last 3 years. We invested over $120 million in our factories to improve our quality, to improve output. We completely revamped our management at our factories. So we do have the capacity today from Canada, United States, Brazil, Spain and Ireland. We have a network that is flexible enough that can provide products. We launched a new product that has been very instrumental in recapturing the small-volume parenterals, the Mini-Bag Plus, which is the single pack. We also took advantage of one of the competitors that filled in during the shortage of small-volume parenterals is on a recall, and the product is not available on the market, which brings our product to life as a safe product, Mini-Bag Plus. So we've been seeing, signing 2-, 3-, 4-year agreements with hospital systems right now. So we feel that our pipeline is strong enough of deals that we think we can deliver on our promise. Things can change 6 months down the road. I don't think, as I see it today, that they will. But things can. What we're doing is making sure that we are signing every single account, and we're showing to customers who are not ours today how Baxter can serve them with value as well as supply and breadth of products. Remember, we are a company that goes from the pharmacy all the way to the ICU. So we have a breadth of products that can be offered that way. On top of it, we also have one of the best pumps, if not the best drug library in the market, which is in our SIGMA SPECTRUM version 9. So all of this together with the new team that we have with experienced people, it's not a new team, but it's experienced people, I'm very confident that we can get to the end of the year and deliver to our investors what we said we're going to deliver. If we have any changes to that, we will let you guys know.

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Operator [17]

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

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [18]

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Just wanted to ask a question about how to think about the different business segments and their growth profiles specifically in Q2. Last quarter, you guys did a great job, I thought, of calling out some of the quarter-specific headwinds. Can you help us think about how to think about that for Q2? And I guess specifically as it relates to some of the more controversial businesses like Medication Delivery. And then I have one follow-up.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [19]

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Sure. Q1 was interesting, right? Because we had a number of headwinds that were specific to the quarter, and some of those go away, some of those persist in Q2. And so I referenced earlier BREVIBLOC. That was like $33 million in the first quarter. It will be around $30 million in the second quarter. So that is a real headwind to operational pharmaceutical sales growth that we're mindful of. And we have tremendous work coming from this group in terms of all the activity and the new launches but that's going to be a specific headwind for the second quarter. We've talked in the past about the bloodlines headwind, which is on a full year basis around $50 million. We'll see continued decline related to this particular item impacting our renal growth in the second quarter. But there are a couple of headwinds that subside. One is you will see a normalization of the acute growth because the flu headwind of roughly $10 million moves away in the second quarter. So we'll see a solid performance, improved performance out of that group in the second quarter. And then the IV buy-in that we have described in the past, which impacted the first quarter of this year, again subsides. Now interestingly enough, that headwind becomes an actual tailwind in Q3 and Q4 because our Q3 and Q4 were depressed by this amount as Joe referenced earlier. Q2 is fairly neutral. So as we think about the growth profile in Q2, you'll see renal growth kind of consistent with overall annual growth. We expect to see acute growth closer to the annual rate. That should be in line with that. Medication Delivery will increase in the second quarter but not to the extent that we'll see in the back 2 quarters of the year as we look at all of the efforts that Joe described, many of those benefits accrue to the second half of the year. Pharmaceuticals will have a lower rate for the BREVIBLOC reason that I mentioned, and then we should -- we expect to see some Nutrition growth in the quarter as well. Advanced Surgery again should have a solid quarter largely in line with full year expectations, maybe a little bit better. So that really kind of walks you down the overall components of the growth in the second quarter. Like I said, the biggest change in overall growth rate occurs in the second half. So we go from this operational growth of 2% to 3% accelerating to 4% to 5%-ish in the second half of the year.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [20]

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Okay. That's super helpful, and maybe we can talk about I thought there were 2 really bright spots in the quarter, Pharmaceuticals and the Advanced Surgery business. And I know you called out contract manufacturing. But also curious how much contribution was from new products for pharma and Advanced Surgery because to me, it feels like maybe the pipeline story's really starting to take hold. Any color you could give there would be great.

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James K. Saccaro, Baxter International Inc. - Executive VP & CFO [21]

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We don't really break out new product contribution by quarter, by business. But what I can tell you is in the case of the Pharmaceutical business, we were definitely excited with the launch of dexmedetomidine. That has been well received in the market. It's a novel presentation, and that should be a continued solid growth engine for us for the balance of the year. As we think about BioSurgery, we did have the benefit in our operational growth numbers of the Mallinckrodt assets. Roughly $15 million of RECOTHROM and PREVELEAK featured in our numbers in the quarter. And so that annualizes as a comp moving into the second quarter. So the growth rate will return to a lower rate. But we did see a very solid benefit in the first quarter in particular, in the U.S. As we look forward, BioSurgery has been an area that has been performing well. The team is executing with the core hemostats and sealants, and we're seeing good momentum there. So we'll expect continued positive progress in those areas. And as we think about business development, I do think the assets that we acquired from Mallinckrodt really are a great example of the kind of business development that we can be incredibly successful with. It leverages the same sales call point, same sales team. And we're seeing that really resonate well as we look to commercialize that product.

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Operator [22]

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And our next question comes from Matt Taylor of UBS.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [23]

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So the first question I wanted to ask was just on renal market dynamic. So I was wondering if you had seen any shift. It seems like the PD volume are relatively healthy, and I was wondering if you could parse out how much of that you think is coming from cyclers or being helped by the cyclers or if you're seeing any market shift to push patients toward PD.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [24]

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Matt, I think what we see is the number of patients are related to penetrate -- a couple of things. One is the penetration of the therapy, our renewed partnership with DaVita and lastly is also maybe related to length of stay in terms of durability of the revenue, right, on therapy. So I would say to the number of patients, I attribute it mainly by the excellent relationship that we have with DaVita where we seek the best therapies for the patients. And the organizations are aligned, and Baxter is making investments in its plants to provide more capacity for growth. In PD right now, as we speak, we're investing dozens of millions of dollars in our facilities to be able to support DaVita. We had this agreement with them. So I find this to be the result of that execution.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [25]

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Okay. And then I just want to get the 50th question here on delivery. I just wanted to understand the dynamic a little bit better. You called out $50 million of excess purchasing that you had in Q1 '18 and from the outside in it's hard for us to think about the pace of destocking. Could you offer any specific on the next couple of quarters to help us model how the comps are going to play into your recapture in that sector?

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Clare Trachtman, Baxter International Inc. - VP of IR [26]

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So Matt, it's $15 million, 1-5 was the stocking impact for U.S. LVPs in the first quarter of last year. We did see some elevated purchases in the first couple of months of the second quarter. And then in June of last year is when we started to see the destocking that occurred throughout the rest of the year. So that's really how it relates to the progression of the destocking impacts for the U.S. LVPs. And again, as Joe was saying, with respect to small-volume parenterals, we are on track with that. Those will continue to ramp throughout the year as well. So our recapture efforts are going there. We're doing really well with our Mini-Bag Plus, particularly the single packs. So we'll continue to drive those efforts, really focused on education about the safety and efficiency of using Mini-Bag Plus to reconstitute drug. So our sales reps are armed with that and are out there working with clinicians on that. I think Joe talked about pump. So continue to see both Spectrum IQ and Evo IQ as well ramp throughout the rest of the year. And in addition, our reallocation of volume to international markets will continue to pick up over the course of the year as well. So I think those are the dynamics. Again, it's more the growth will be more back-end weighted as we face those easier comps with respect to destocking in the U.S. LVP market.

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Operator [27]

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And our final question comes from the line of Matt Miksic with Credit Suisse.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [28]

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I'll spare you the umpteenth Med Delivery question and just ask if you could maybe elaborate on a couple of the other businesses. The first on the PD side. If you could talk, maybe just remind us, what some of the drivers are of that growth, if there's any macro or economic or reimbursement dynamics that are driving that strength in PD. And then I have one follow-up on pharma.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [29]

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Matt, the government announcement that they would initiate a move to take patients from clinics to home is too new to have caused any significant impact on our numbers. Our numbers, as I said, are driven primarily in the U.S. by a strong relationship with DaVita. That continues to get stronger. Our availability of product, which is most importantly we are making investments in our plants to supply the market with product. So we will have availability of products for the longer term. We are investing in technology, point of care, for instance, our first patient just came off successfully from the 3-month clinical trial period. We continue to enroll more patients on that technology. So all in all, the U.S. has done well because our renewed effort in partnership. When I look in Asia Pacific, the growth in patients for the year was 6.5%. Don't forget the Asia Pac, primarily China, we are 70-plus percent market share holder in China. And in China, we have twice as many patients in PD that we have in the U.S. And then the areas that we need to continue to improve is Europe has always been behind in PD penetration compared to the U.S. and parts of Asia. So all in all, 5.1% growth in patients for PD is a pretty healthy number. And consequently, now our outlook for the year is a little more than that. So we continue to see a very strong outlook in the U.S., Asia Pacific as well as Canada.

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Matthew Stephan Miksic, Crédit Suisse AG, Research Division - Senior Research Analyst [30]

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That's great. I appreciate that. And then just on pharma, again impressive growth. Can you talk a little bit about -- maybe remind us or update us as to the kinds of additional assets, businesses, size of these molecules, strategy there and how it compares to sort of the traditional specialty injectable businesses as folks may know it? Just some perspective would be helpful.

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José E. Almeida, Baxter International Inc. - Chairman, President & CEO [31]

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Yes. So if you compare like BREVIBLOC and cyclophosphamide, we will not see drugs like that in our portfolio, not to that extent anymore because those were drugs that were semi-specialty drugs. They had patents, and they had things that we had, and it was a different Baxter at that time. Our intent in Pharmaceuticals is to launch 3 to 4 molecules a year, which are injectable, mostly, mostly premixes, which is Baxter's strength. It's premix. It's our GALAXY technology that comes to light. We will launch some APIs primarily once we get the warning letter resolved out of Ahmedabad. There will be some APIs launched out of that facility. But if you look at our objective is to launch in 5 areas of care: Oncology, Anesthesia, Antibiotics, Specialty Antibiotics and a conglomerate of small parts of therapy as well as the premixes. So we're going to take those areas of therapy and launch specialty products, 3 to 4 molecules a year. Some are going to be $70 million, $80 million. Some are going to be $3 million, $4 million. It's going to be a mix of them. Our objective by 2023 is to more than double the number of molecules that we currently have, and we are ahead of plan to get there.

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Operator [32]

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